Introduction to International Political Economy

1. Introduction to International Political Economy International Political Economy Prof. Tyson Roberts

2. Lecture Goals • What is IPE? • Why is IPE important? • Applying the IPE framework to the EU

3. Review of concepts • Utility • Expected utility • Time discounting/present value • Pareto efficiency/optimality • Externalities • Transaction costs • Institutions • Market as freedom vs. market as prison

4. “Institutions are the rules of the game in society or, more formally, are the humanly devised constraints that shape human interaction.” (North, 1990) • In other words, institutions (formal & informal) are like common habits shared in a society that shape how people respond to situations because of expected payoffs

5. Takeaways from Rodrik Chapter 1 • Markets & states are substitutes: alternative institutions for allocation & re-allocation of resources • Markets & states are complements: • States (and interstate arrangements) enable markets to function, and • Markets efficiently facilitate economic exchange for states

6. What is IPE?

7. What is IPE? • Oatley: IPE “studies life in the global economy. It focuses most heavily on the enduring political battle between winners and losers from global economic exchange” (p. 1)

8. What is IPE? • Oatley: IPE “studies life in the global economy. It focuses most heavily on the enduring political battle between winners and losers from global economic exchange” (p. 1) • Grieco & Ikenberry: “a field whose central concern involves the reciprocal relationships between state interests and power on the one hand, and world market structures and economic dynamics on the other” (p. 3)

9. Y = α + βX + ε • Economic winners Market exchange • Market exchange Politics

10. Why is IPE important? Source: PWT

11. Why is IPE important? Source: WDI

12. Why is IPE important? Source: WDI

13. Why is IPE important?

14. Why is IPE important? Source: S&P 500 (Orange) and EuroStoxx 500 (Blue) from Economist, Feb. 6, 2011

15. Why is IPE important?

16. Why is IPE important? Source: Reinhart and Rogoff 2008

17. Why is IPE important? Source: MPI Data Hub and Angus Maddison

18. Why is IPE important?

19. Some immigrants are fleeing civil wars or political persecution, but they also seek economic opportunities where they can be more productive

20. The Value of Models Source: Tetlock 2008: Expert Political Judgment

21. Traditional Schools of IPE • Mercantilist • Liberal • Marxist

22. Traditional Schools of IPE • Mercantilist: Actor is the state, interest is accumulating wealth, policy preferences include export promotion & import protection • Liberal: Actor is the individual, interest is individual welfare maximization, policy preference includes free trade • Marxist: Actor is the class (capitalist vs. workers), interest for capitalist is to profit maximize, policy preferences include property rights & union busting

23. Modern Approach to (International) Political Economy is Generalizable • “Actors”

24. Who are some actors we might consider in IPE? (Write down 10)

25. Actors • States • Corporations • Individuals • Organizations of states, corporations, or individuals

26. State Actors • Actors within states • Governments (executive & cabinet) • Legislatures • Bureaucracies • States as national economies • Large vs small • Rich vs poor • Lenders vs borrowers • Manufacturing-based vs. farming-based • Organizations of states • UN, WTO, IMF, EU, ASEAN, etc.

27. Corporation Actors • Actors within corporations • Shareholders • Management • Employees • Corporation sectors • Manufacturers • Financial services • Non-financial services • Organizations of corporations • Chambers of Commerce, industry groups, etc.

28. Individual Actors • Consumers • Workers/Employees • Borrowers • Investors and lenders • Tax-payers • Government service recipients • Voters • Politicians • Landlords • Renters • Organizations of individuals: unions, associations, parties, etc.

29. Actors, Interests, & Policy Preferences • Actor: Borrowers • Governments, economies, firms, or individuals • Interest: Want easy & cheap access to credit • Policy Preference: Low interest rates, loose conditions, no penalties

30. Actors, Interests, & Policy Preferences • Actor: Lenders • Governments, economies, firms, or individuals • Interest: Want high returns & low risk • Policy Preference: High interest rates, strict conditions, tough penalties

31. Preference intensity • Individuals have many attributes • For example, I am … • A borrower • A lender • An investor • A consumer • An employee • An employer • A tax payer • A government services recipient

32. Preference intensity Which of my attributes will determine my (most intense) policy preferences?

33. Policy preference intensity An actor’s (most intense) policy preferences are determined by • Susceptibility of attributes/assets to policy • Concentration & functional specificity of attributes/assets • Ideology

34. Groups, institutions, & outcomes • Some actors will act as groups • Similar interests • Few collective action problems • Group size, enforcement mechanisms, etc. • Institutions (as cause) • help determine which actors will group together, and • which groups will achieve preferred policy • Institutions (as effect) • Groups dissatisfied with policy outcome will attempt to change political institutions

35. Continental Break-up podcast • Who are the primary actors? • What are their interests? • What are their policy preferences? • How do they group together? • What are the institutions that dictate outcomes?

36. EU Example, Part I • Lender countries prefer strict rules (Germany wanted United States of Europe), low inflation rates • Borrower countries prefer loose rules, domestic sovereignty, care less about inflation • EU institution: Treaty among sovereign nations • Formal: consensus, each state has equal votes (Germany wants peace & customers, willing to accept smaller countries as equal partners) • Policy outcome: Maastricht Treaty: Moderately strict rules with no teeth

37. Examples of Consensus Institutions • Voluntary and informed decisions => Pareto improvements • Market exchange. Actors: transacting parties • Treaty. Actors: sovereign nations • Policy change. Actors: institutional veto players

38. Introduction of Euro reduced borrowing costs for many “less developed” European economies

40. When investors realized/were told indebted countries could default (Maastricht Treaty doesn’t include bailouts), interest rates rose => vicious cycle, crisis

41. EU Example, Part II • Crisis => • Large negative effect on borrowers (& lenders, less so) • Pressure to change policy: • Lender countries want more teeth • Institution • Formal: consensus • Informal: negotiating power of lenders was increased • New policy proposal: • More information & more teeth

42. Market as freedom:Trade enables Pareto improvements In good market conditions, win/win transactions are readily available

43. Market as Prison:In crisis, PIMCO’s pursuit of profits undermines Greek democratic autonomy P: Exit G: Default Withdraw funds P Austerity P: Higher return G: Avoid default Lend G P: Exit G: Default Withdraw funds High spending budget P Lend P: Low Return G: Continue spending

44. Solving sequential games in game theory • Players make choices sequentially • Payoffs are result of choices made by each player • To solve, look at last move first and work backwards • Subgame perfect equilibrium: Actions each player would choose at each decision node

45. PIMCO can choose to withdraw funds (Exit) or continue lending (Loyalty) after seeing Greece’s policy decision P: Exit G: Default Withdraw funds P Austerity P: Higher return G: Avoid default Lend G P: Exit G: Default Withdraw funds High spending budget P Lend P: Low Return G: Continue spending

46. Numerical values for payoffs Greece Pimco Best outcome: High returns = +1 2nd best: Exit (and invest elsewhere) = 0 3rd best: Low returns = -1 • Best outcome: Continue high spending (and avoid default) = +1 • 2nd best: Avoid default (but austerity) = -1 • 3rd best: Default = -3

47. PIMCO’s Loyalty payoff is better than the Exit payoff if Greece chooses Austerity P: 0 G: -3 Withdraw funds P Austerity P: 1 G: -1 Lend G P: 0 G: -3 Withdraw funds High spending budget P Lend P: -1 G: 1

48. PIMCO’s Exit payoff is better than the Loyalty payoff if Greece chooses to Continue spending P: 0 G: -3 Withdraw funds P Austerity P: 1 G: -1 Lend G P: 0 G: -3 Withdraw funds High spending budget P Lend P: -1 G: 1

49. Step 1: Last player chooses best payoff from each node P: 0 G: -3 Withdraw funds P Austerity P: 1 G: -1 Lend G P: 0 G: -2 Withdraw funds High spending budget P Lend P: -1 G: 1

50. Step 2: Replace decision nodes with payoffs from players best choice P: 0 G: -3 Withdraw funds P: 1 G: -1 P Austerity P: 1 G: -1 Lend G P: 0 G: -2 P: 0 G: -2 Withdraw funds High spending budget P Lend P: -1 G: 1