International Political Economy, Institutions and Trade

International Political Economy, institutions and trade

-Overview (from Nau (2007))

Realism: HST, Gowa (1994)
Liberalism: Smith (1776), Coase, North (1990), Milgrom, North, and Weingast (1990)
Identity: Weber, Smith, Ricardo, Marx
Economic ideas
Keynesian (1930s): Polanyi (1944), Ruggie (1982)
Hayekian (1944)

-Hegemonic Stability Theory

Overview: Gallagher and Robinson (1953), Olson (1965), Kindleberger (1973), Gilpin (1975), Krasner (1976), Keohane (1980)
Critiques, general: Conybeare (1984), Snidal (1985), Baumgartner and Burns (1975), Gilpin (1982), James and Lake (1989), Gowa (1989), Cohen (1990)
Critiques, with declining US hegemony, regimes still matter (hegemon not necessary or sufficient for cooperation/states pursue power and wealth): Gilpin (1983), Keohane (1984), Rosecrance (1986), Gilpin (1987), Conybeare (1987), Lake (1988), Milner (1988), Young (1986)

-Regime Theory (not just hegemonic coercion matters, but bargaining matters)

Overview: Keohane and Nye (1977), Keohane (1982), Ruggie (1982), Haggard and Simons (1987), Milner (1992), Grieco (1988), Haas (1989)
How to cooperate? Regimes and issue linkage: Axelrod and Keohane (1985), Haas (1980), Oye (1979)
Beyond transaction costs, regimes have additional purposes, states bargain and create linkages: Aggarwal (1993), Aggarwal (1998)

Critiques: Strange (1982), Kratochwil and Ruggie (1986), Abbott and Snidal (1998)

-Explicitly adding international organizations (IOs) to regime theory

Adding in a constructivist view: Barnett and Finnemore (1999)
Differential effects on third world: dependency theorists + world systems(see CPE, developing outline), Krasner (1981)
Critique: Gallarotti (1991)

-Looking specifically at institutions in trade – regimes (see IPE, CPE, globalization outline) and national institutions/politics

Theories: Frieden (1991), Alt et al. (1996)
Overview: Odell (1990), interdependence
Market conditions: Milner (1988)
Leaders’ values/beliefs: Goldstein (1988)
National institutions: Destler (1986)
Global political-economic structures
Protectionism: Aggarwal, et al. (1987), Aggarwal (1985)

-Historical overview in context of theories: Nau (2007)

Realism – attributes Europe’s ascendance primarily to demography, geography, and the decentralized distribution of power; see trade and economic activities flourishing only under favorable security conditions like alliances and hegemony or imperialism; free trade, exploiting comparative advantage, enhances economic efficiency, and economic efficiency frees up resources for military purposes; world economic expansion should be least robust in a multipolar world where countries cannot be sure of stable alliances, more robust in a bipolar world because alliances are more predictable, and most robust in a unipolar or imperial world because there is no significant challenge to the military power of the dominant power
Gowa (1994): free trade more likely within than across political-military alliances; alliances have had a much stronger effect on trade in a bipolar than in a multipolar world
Age of mercantilism and colonial expansion: central objective of state policy was to increase the state’s wealth relative to that of other states in a zero-sum struggle for material advantage (Jean Baptiste Colbert); alliances were temporary and formed to fight adversaries, not to develop wealth with allies; each state sought to export more than it imported (because this would translate into military power); western and eastern Europe developed symbiotic relationship in agriculture, colonial areas became places of slavery to increase labor force—trade fueled European industrial expansion; religions followed colonialists
Wallerstein (1974): overseas expansion cannot be explained by the “crusading spirit” or the need to evangelize; religious enthusiasm was rationalization – belief systems are not primary factors in explaining the genesis and long-term persistence of large-scale social action; material factors trump religious or ideological ones; European expansion exploited other regions of the world from the very outset and must be understood in the context of the world-system of core (western Europe), periphery (Asia, Africa, and Latin America), and semi-periphery (eastern Europe)
Pax Britannica (industrial revolution – WWI):industrial revolution around 1750, by 1850, England was dominant country; it was free to pursue efficiency and expand global, not just national, wealth because its interests were global while those of other countries were only local or regional (it faced no significant military challenger and therefore did not fear that economic gains by others might be used to harm England)
Kindleberger (1973), Keohane (1980): hegemonic stability theory states that a hegemonic power is necessary to support a highly integrated world economy
As long as power is evenly distributed among several great powers, no single power can influence the system as a whole – so, no single power takes the lead to organize the world economy
At the extreme, where there are many powers that are equally competitive, the world economy approaches the model of a perfect market (because no single actor exerts significant influence on other actors, each acts to maximize its own national self-interests); in a perfect market, we would see higher gains for all since competition maximizes efficiency – this assumes that some hegemon – such as a domestic government – has already organized the market to provide for safety
But, the international market has no such hegemon normally
Hegemonic power overcomes obstacles like the fear that economic gains by another state may harm a state militarily (hegemony is a prerequisite to providing collective goods – these are indivisible goods that cannot be provided selectively to some and not to others and their consumption by one nation does not diminish the benefits available to other nations)
The hegemon provides security for global markets (example: Britain dominated the seas by 1850 and ensured safety of traders and their investments)
The hegemon provides a large market for the exports of other countries (example: Britain opened its markets in the latter half of the 19th century by repealing the Corn Laws protecting agriculture and reducing other tariffs – this was unilateral trade liberalization – Britain didn’t ask other countries to reciprocate)
Hegemon supplies a dominant currency in which international transactions can be conducted (example: Britain in 19th century adopted the gold standard – gold fixed in price with respect to local currencies)
Hegemon supplies loans to world economy, which provides a large and deep capital market in which other countries can conduct sophisticated investment and hedging activities (example: London became world economy’s financial center in 19th century)
First era of globalization was under Pax Britannica – from 1870-1913, British FDI increased 250 percent and by WWI nearly half of British assets other than land were invested overseas, almost 90 percent in primary product areas like agriculture
World economy achieved levels of interdependence prior to WWI that would not be seen again until the 1970s
But, most exports and investments involved inter-industry trade (after WWII, this switched to intra-industry trade)
Interwar period: Britain declined after WWI, US grew, but withdrew to political isolationism  world economy lost its hegemon, so the world economy shrank and fragmented
Kindleberger (1973): “part of the reason for the length, and most of the explanation for the depth of the world recession was the inability of the British to continue their role as underwriter to the system and the reluctance of the US to take it on”
Reparations – though countries had already gone off the gold standard, reconstruction efforts pressured prices even more; Versailles Treaty imposed severe reparations on Germany to rebuild war-torn Europe  severe inflation
Demise of the gold standard – no stable common monetary unit  currencies fluctuated; by 1926, US held 45 percent of world’s gold supply, so leading economy was now US, but in isolation; when raised interest rates in 1928 due to domestic concerns, international lending and payments system crashed (hegemon was no longer willing to finance the system)  every country for itself
Beggar-thy-neighbor policies – countries engaged in unrestrained, competitive policies to reduce imports, increase exports, and devalue currencies  shrinking world markets in the 1930s  bilateral and regional markets that were discriminatory – countries often sought to balance trade through quotas
Pax Americana (post-WWII – early 1970s):US clearly dominant and led the effort to provide for postwar security
Bretton Woods – wanted to open trade markets, but fixed exchange rates in terms of the dollar rather than gold (dollar standard) and countries could change their exchange rates under specified circumstances (“fundamental disequilibrium” – less rigid than gold standard); established mechanism for multilateral trade liberalization – nations would negotiate reciprocal tariff reductions and apply the same low tariff to all nations that they offered to the “most-favored nation” (to avoid discrimination); provided external financing to give countries more time to adjust to trade imbalances (IMF); allowed countries to control capital flows
Second era of globalization – “Golden Age”; trade follows the power; the ebb and flow of international markets are largely determined by the ebb and flow of the distribution of power; global markets flourish under a dominant power and decline under competition among many powers
Liberalism – traces Western success to technology, specialization, and institutional innovations, such as the modern factory, markets, and domestic and international bureaucracy; technology taken as exogenous; specialization, the division of labor in which two parties specialize to make common or different products, offered unique advantages because it meant that workers became more efficient; this perspective emphasizes relationships and repetitive interactions; recognition of comparative advantage at international level (trade)
North (1990)
Increasing specialization and trade raised the transaction costs of exchanges (meaning the additional expenses incurred to find appropriate buyers and sellers and establish appropriate prices); international institutions help to lower the costs of long-distance trade
Milgrom, North, and Weingast (1990)
How to promote trust necessary for efficient exchange when people have incentives to cheat?
By establishing a continuing relationship – a bond in which a trader would be unwilling to cheat unless the gain from dishonest behavior was large.
Reputation system – informal way to bond good behavior, but not adequate on its own
Transferable reputations (because two traders can’t meet face to face often enough, have to hear the reputation from others) are only an adequate bond for honest behavior if members of the trading community can be kept informed about each other’s past behavior
Early Middle Ages (“Champagne Fairs”) – without state enforcement of contracts, merchants created their own private code of laws, “the law merchant,” with disputes adjudicated by a judge who might be a local official or private merchant
Judges were not substitutes for reputation, but made the system more effective as a means of promoting honest trade
Formal system allowed them to transmit just enough information to the right people at the right times to enable the reputation mechanism to function for enforcement
How? The judge bundles the services which are valuable to the trader with services that are valuable to the community
Reputation system and institutions are complementary parts of a total system (neither sufficient on its own)
Industrial Revolution –expansion of world economy dates from onset of the industrial revolution (1750s England), which created new rules and institutions for both domestic and international societies; created modern manufacturing economy  crucial role of technological change
Efficiency of specialized trade – the key to this revolution was the harnessing of mechanical power to the production of goods
Laissez-faire trade rules (free trade) –starting in the 1820s, England began to lower tariffs on imports; new rules based on comparative advantage; a country reduced tariffs and specialized in products that it produced most efficiently, while importing products that other countries produced more efficiently  non-zero sum, laissez-faire policy
Gold standard – pressures moved various countries to gold standard – England in 18th century, Germany in 1871, then France, then US in 1879
So, sequential and path-dependent interactions, not British power or ideas, explain economic change
Path dependence: countries started on a certain path and accumulated advantages or disadvantages along that path
Pre-WWI rules/institutions were weak and crises occurred, but as a start, the new market rules generated more prosperity than before
Confirmed Smith (1776): “invisible hand” – if each nation acted on its own best interests, the common good would be served; generally beneficial outcomes could be obtained from decentralized initiatives rather than centralized institutions
Increasing/innovative role of international institutions – breakdown from pre-WWI global economy  need for stronger international institutions; Bretton Woods thus created:
General Agreement on Tariffs and Trade (GATT) – focused on liberalizing trade in industrial or manufactured products only; agreement, not organization; concluded in 1947, supervised multilateral trade negotiations to reduce tariffs and other trade barriers on manufactured goods; through eight major rounds of trade negotiations starting in 1948, GATT cut tariffs and quotas dramatically in a non-discriminatory, or “most-favored-nation,” basis; became World Trade Organization in 1994 after the eighth (Uruguay) round
International Monetary Fund (IMF) – supervised the system’s fixed exchange rate system and provided external loans to countries undergoing balance of payment adjustment; by 1959, currencies became fully convertible
International Bank for Reconstruction and Development (IBRD)
World Bank – set up to provide additional long-term financing
Marshall Plan – supplied bulk of postwar financing
Note: these institutions were not universal – excluding most developing countries(colonies), Soviet Union, and communist satellites
Identity – attributes the rapid development of Europe relative to the rest of the world largely to Renaissance, Reformation, and Enlightenment ideas that inspired the Protestant ethic of scientific, technological, and commercial achievement; emphasizes the role of ideas, norms, values, and identities inspurring material/institutional change
Protestant ethic – Weber: Reformation created the Protestant ethic, the idea of a specific calling of the individual by God to a life-task, a definite field in which one was divinely inspired to work; idea of worthiness preceded and now made possible specialization (opposite of what liberalism argues); ethical justification of the modern specialized division of labor; so, ideas influenced institutions such as specialization in the economic sphere, which significantly altered the existing distribution of power (and ultimately weakened the Catholic Church); religion inspired commerce and conquest
Economic liberalism –Smith (1776) and Ricardo (1815): relationships facilitate specialization but they do not necessarily direct it toward the production of wealth; relative equality of the parties in a relationship (Locke); marketplace of free and competitive exchange – ensured through competition and relative equality of participants that the value of goods and services would be on the basis of economic price and not on inheritance or where one came from (like liberals emphasize with path dependence); assuming protection of property rights and existence of competition, the two ideas of equal status and free exchange put a high value on efficiency and hence specialization
Ideas drove development, not institutions or power
Economic nationalism/Marxist socialism – approach of assisting national industries to catch up with and compete with more advanced foreign industries; Marx: markets distribute wealth unevenly, concentrating economic and social power in the hands of bankers and corporations and exploiting the labor of workers and farmers, so Marxist socialism called for strong labor unions to match big corporations and state regulations and ownership to control substantial sectors of the economy
So, the clash of economic ideas and ideologies explains the course of world economic events better than weak institutions or the absence of a strong power
Keynesian/Hayekian economics (Chicago School)
Keynes: 1930s, called for more activist government intervention to stimulate domestic growth, protect imports, and adjust exchange rates more frequently; adjust external trade and exchange rate policies to meet domestic goals of full employment rather than to adjust domestic demand to maintain free trade and fixed exchange rates
Polanyi (1944)
Idea that self-regulating markets never work; their consequences are so great that government intervention becomes necessary and the pace of change is of central importance in determining consequences; “myth of the free market” – in their transformations, governments of today’s industrialized countries took an active role in protecting their industries through tariffs and in promoting new technologies
Stresses the interrelatedness of the doctrines of free labor markets, free trade, and the self-regulating monetary mechanism of the gold standard
Supported more government intervention and called for “the Great Transformation” from market rationality to social regulation and planning, moving beyond the laissez-faire policies of the gold standard
Problem is that rapid transformation destroys old coping mechanisms, old safety nets, while it creates a new set of demands, before new coping mechanisms are developed (example: in industrial age, a farmer might lose his crop, but never lacks employment; in modern industrial age, individuals can do little about unemployment – they can’t simply offer to work for a lower wage)
Bretton Woods as “embedded liberalism”(Ruggie 1982)– governments accepted the discipline of free trade in the international economy, but ”embedded” this liberalism in the domestic economy by commitments to intervene to achieve full employment, control prices, and prevent disruptive capital flows
Emphasized aspects of Bretton Woods that sided with Keynesian policies – countries facing balance of payments deficits could alter their exchange rates, control capital flows, GATT provided rules for safeguards and exceptions, IMF/World Bank were first international institutions ever to make loans for balance of payments and reconstruction purposes (though didn’t go as far as Keynes wanted)
Chicago School: allowed for fiscal and monetary policies to manage domestic demand, but sharply limited government spending and taxation and reduced tariffs to encourage a more robust private economy and competitive international marketplace
Hayek (1944): supported greater market competition to preserve basic economic and political freedoms and warned that the move toward social regulation and planning was “the Road to Serfdom”
Bretton Woods as “neo-classical liberalism” – system of international free trade and fixed exchange rates which effectively limited the ability of governments to intervene in the domestic economy
Emphasized aspects of Bretton Woods that sided with US policies
Sided with moderate (not aggressive) Keynesian approach – accepted some government intervention in the domestic economy to achieve high, but not necessarily full, employment
Commitments to fix exchange rates, open markets, and limit financing for trade deficits meant that domestic policies would have to adjust (conservative policies)
Collapse of Bretton Woods in 1970
Embedded liberalism advocates – this was a consequence of contradictions in the system (like insufficient gold and financing) that could be corrected by extending the social safety net to international markets
Chicago School/neo-classical liberalism advocates – this was a consequence of changing ideas, like the US abandoning moderate Keynesian policies of fiscal/monetary discipline in mid-1960s and inflating US economy, thereby causing other countries to be less willing to hold dollars

-Overview of standard schools of thought on institutional development: