Political Foundations of the World Economy

1. Political Foundations of the World Economy International Political Economy Prof. Tyson Roberts

2. Lecture Goals • States & Markets in International Context • Bilateral and Multilateral Global Institutions • Brief History of the World, IPE style

3. If Robinson lives alone, he does everything himself

4. If a second person arrives, one can specialize in coconuts and the other can specialize in fish, and they can benefit from trade

5. If each actor is “fully informed,” trade results in a Pareto Improvement

6. However, each actor may have an incentive to cheat

7. Cheat, Cheat is the Nash EquilibriumStay true, Stay true would be Pareto Improvement

8. Institutions to prevent cheating • Long-term relationships based on reciprocity and trust

9. The prospect of repeated interactions converts cooperation into a Nash Equilibrium(But Cheat, Cheat also remains a Nash Equilibrium)

10. If the coconut seller gets a bad fish, he knows who sold it to him. He can refuse to trade again until he is compensated

11. As the distance and complexity of trade increases, potential for trade benefits increase…

12. As the distance and complexity of trade increases, potential for trade benefits increase, but cheating is more difficult to monitor

13. Law and Order & Property Rights (protection from cheating, theft, etc.) are examples of a public good • Public goods are non-rival and non-excludable • Public goods generally cannot be provided profitably by markets • Public goods are there often provided by governments

14. The challenge of long-distance trade • Strong incentive to cheat, makes trade costly

15. Institutions to prevent cheating • Long-term relationships based on reciprocity and trust • Works best in smaller groups (repeated interactions, reputation)

16. Solutions to cooperation problem • Repeated transaction • Works within tight-knit communities (Jews, Lebanese, Hausa, etc.), but not among the world at large • Belief system/ideology (focal point) • Also works best in tight-knit communities • Third-party enforcement • E.g., by a imperial power or a hegemonic state

17. Example of 3rd party enforcement:State Building, Wars, and Markets • Kings need resources to fight wars • Taxing money is less costly than extracting tribute • Money is mobile • Solution: Property rights enforced by King

18. Indicates the NE in each game. p is penalty for stealing. Assume p>1 Is enforcement by the State Freedom or a Prison?

19. Indicates the NE in each game. p is penalty for stealing. Assume p>1 Is enforcement by the State Freedom or a Prison? If p =2 & t= ½ , is society better off with or without the state?

20. Is enforcement by the State Freedom or a Prison? If p =2 & t= 1/2, is society better off with or without the state? WITH. STATE => FREEDOM

21. Indicates the NE in each game. p is penalty for stealing. Assume p>1 Is enforcement by the State Freedom or a Prison? If p =2 & t= 2, is society better off with or without the state?

22. Is enforcement by the State Freedom or a Prison? If p =2 & t= 2, is society better off with or without the state? WITHOUT. STATE => PRISON

23. Indicates the NE in each game. p is penalty for stealing. Assume p>1 Is enforcement by the State Freedom or a Prison? If the state does not charge too much tax (3-t > 2, or 1 > t), life will be better in civil society.

24. Institutions to prevent cheating • Long-term relationships based on reciprocity and trust • Works best in smaller groups (repeated interactions, reputation) • Belief systems • Third party enforcement

25. Ideology can facilitate trade by making cooperation the “focal point”

26. History of the World, IPE-style: Unilateral Institutions & Mercantilist Beliefs • ~1600-~1850: Mercantilism • Trade facilitated by empires & chartered trading companies within empires

27. History of the World, IPE-style: Unilateral Institutions & Liberal Beliefs • ~1850-1913: 1st Age of Globalization • Common belief system among key economic decision-makers: market liberalism (Smith, Ricardo) & rules of Gold Standard • Enforcement by imperial governments, esp. Britain

28. Large, leading economies gain most from free trade

29. State Power and the Promotion of National Interests through Economic Integration • Powerful states with leading economies have strong interest in promoting an open world economy • UK in 19th Century • US in 20th Century • Economic integration creates markets & reduces cost of maintaining world order

30. Neoliberal institutionalism (Keohane, etc.) • Institutions are solutions to interstate problems such as cheating • Institutions are agreements or contracts between actors that reduce uncertainty, lower transaction costs, and solve collective action problems

31. International regimes can affect • Capabilities of states • Interests of states

32. International regimes can affect capabilities of states • Dependency theory (e.g., Marxist): regimes reinforce dominance of rich, powerful states • Hegemonic stability theory: international regimes enrich hegemon (but over time may dissipate hegemon’s resources) Why?

33. Large, leading economies gain most (in absolute terms) from free tradebut also bear the costs of maintaining the global regime (e.g., British navy)Smaller economies can “free ride”

34. World GDP per capita1st Era of Globalization Source: Angus Maddison

35. Without a hegemon, no country can capture benefits of free trade regime enough to make maintenance of free trade regime worthwhile => lack of cooperation

36. History of the World, IPE-style: Breakdown of free trade regime • World Wars: 1914-1945 (Breakdown, Trade barriers go back up) • 1914-1918: WW1 • 1919-1939: Interwar period & WW2 • 1939-1945: WW2

37. History of the World, IPE-style: Return of free trade; new hegemon supports multilateral institutions (negotiated agreements) instead of imperial approach • 1945-present: 2nd Age of Globalization • Enforcement by US & Bretton Woods Institutions • 1945-1972: Bretton Woods System • 1944, 1947: IMF & GATT established • Belief system: Keynes, etc. • 1972-2009: Transition & Washington Consensus • 1995: WTO established • Belief system: Chicago School

38. World GDP per capita2nd Era of Globalization WTO GATT Source: Maddison

39. International Decision-Making Rules • Anarchic • Unilateral or negotiated decisions based on self interest and power. • Lack of cooperation => War • Hegemonic Institution(s) • Hegemon’s law backed by power (empire, gunboats) • Multilateral Institution (official) • Majoritarian • Weighted voting • Consensus • Multilateral institution (unofficial) • Invisible weighting/ informal agenda setting

40. Scope of GATT • Trade in most manufactured goods liberalized quickly • Exceptions: Clothes, textiles, some cars, etc. • Services & agriculture initially left alone • Focus on tariffs and trade quota • Developing countries given waivers or extra time to comply • GATT had weak enforcement teeth

41. GATT decision making rules • Officially: majoritarian • Unofficially: Informal consensus • Launching rounds: law-based bargaining • Closing rounds: increased power-based bargaining

42. Sources of bargaining power • Patience • Willingness to live with status quo • Outside option • Related to market size (US can produce for self) & international relations • Agenda setting • Access to “Green Room” • Ability to act collectively • OECD, G-20

43. Bargaining in the Shadow of Law or Power(Steinberg 2002) The Tokyo Round (1973-79) closed with law-based bargaining • LDC’s outside option: Trade with Soviet Bloc • Result: Exceptions for LDCs Uruguay Round (1986-94) closed with power-based bargaining • No outside option for LDCs • Result – uniform rules in WTO

44. Scope of WTO • Liberalization of all goods (including textiles & agriculture) and services • Rules extended to subsidies, intellectual property, investment, regulations & standards • All members (including developing countries) bound to comply • Enforcement teeth: appellate court to decide disputes– authorizes dispute winner to retaliate

45. Cotton Wars • Does the cotton dispute indicate law-based or power-based decision making? • Does the cotton dispute indicate that international regimes change outcomes? • How do sub-national interest group politics play a role in determining the outcome?

46. International regimes can affect • Capabilities of states • Hegemon gains in absolute terms, but challengers able to catch up • Interests of states • Winners from trade gain political influence & press for more free trade (Corn Laws, etc.) • As interdependence decreases probability of conflict, governments focus more on absolute gain & less on relative gain

47. Challenges in studying regime effects on cooperation • Difficult to ascertain whether cooperation is due to institutions or to complementary interests & underlying distributions of power • A solution: if actors obey rules that are “inconvenient”, then institutions matter

48. The EU • What are the benefits to strong states (e.g., Germany)? • What are the benefits to weak states (e.g., Greece)? • What are the costs? • What choices by Germany and Greece demonstrate that institutions affect the decisions of sovereign states?

49. Takeaways • International trade, lending, and investment is costly and risky in state of anarchy • Enforcement institutions facilitate trade and lending/investment • Enforcement institutions can be unilateral (predominant pre-WWI) or multilateral (predominant post-WW2). • Institutions that constrain have costs and benefits for all, including the great powers

50. Takeaways • Even if everyone wins in absolute terms, there are relative winners and losers, within and across countries • Hegemonic stability theory: the hegemon is a relative winner at first, but becomes a relative loser as the challenger benefits from freeriding