Averting a New Depression and protecting the welfare state: The New Post- WW II World Economic Order Embedded liberalism, International Institutions and Hegemonic Power If goods dont cross borders, soldiers will Todays agenda: Markets are global, politics are local. Can the two be reconciled? Review: the welfare state, tendency toward economic nationalism, embedded liberalism, the collective action problem, and the need for a leader to make liberalism work The United States as a candidate for hegemonic leadership Able but unwilling to lead in the 1930s International Institutions as an alternative to hegemony? IMF World Bank GATT (WTO) Institutions not enough: the requirement for a hegemonic leader Why the U.S. decided to take the lead The consequences of leadership and institutions for the world economy Keynes repair of classical liberalism Theory of macroeconomics grew out of the Great Depression Classical liberal models built on assumptions of individual behavior (rationality) This might work for individuals but not for whole economies Economic stability is not assured through market forces Political stability requires state intervention to achieve economic stability First Modification:The welfare state and aggregate demand Social insurance: permits those not working to create demand in the economy Governments provide bank guarantees to encourage savings and investment The government itself creates demand Government intervenes in the trough of the business cycle to take over financial institutions and even industry The New Deal in the United States: Domestic Embedded Liberalism + regulation WPA Social Security Minimum Wage Banking regulations FDIC, Glass-Steegal Act SEC WPA employed Artists! But Free Trade tends to undermine these new roles for the state Free trade and comparative advantage demand that inefficient industries should fail and employment should be left to the market Employment will fluctuate with supply and demand for labor For Liberals, too much state intervention to create demand does not allow the free market to work properly: tax and spend reduce money available for investmentgovernments should reduce taxes to create aggregate demand Leading to the demise of democracy Democracy becomes less appealing than dictatorship when democracy fails to deliver the economic goods, people begin to doubt its value. The Great Depression showed that the classical liberal response was too risky for governments Not only was democracy endangered and destroyed, but all states closed their economies Dominant belief after WW II: Dictatorship + Protectionism leads to war beliefs about the economic causes of war. and Free Trade leads to Peace To preserve the welfare state and preserve peace, the international liberal economy would need to be discarded or repaired Discarding Liberalism was not an option What kind of repair was needed: embedded Liberalism But how to achieve it? Hegemonic leadership International institutions What kind of repair was needed: Embedded Liberalism Transplant from the simplest notions of democracy : no long-term winners and losers Limited liberalism: open trade but allowing for government intervention to stimulate the economy and to maintain the welfare state And how to get it: Hegemonic Power to the Rescue overcome collective action problems to help states keep markets open AND protect citizens Credit ease balance of payments deficits Liquidity: counter-cyclical lending prop up the welfare state discount lending in crisis maintain welfare state Before the Depression, the US had the capability but not the willingness to provide these resources to the international economy Why? Many believed the collapse of liberalism, depression and war were caused by the absence of a hegemon Was there an alternative? Keynes believed that international institutions could take on this task in the absence of supranational institutions of governance, the international economy had an even more pronounced bias toward deflation and instability than national governments International institutions were needed to protect the welfare state The architects of global governance: Keynes and White The Institutional Mission: Embed Liberalism! Resolving the dilemma between internal and external stability. Intergovernmental collaboration to facilitate balance-of-payments equilibrium Multilateralism in trade and finance based on domestic intervention to achieve full employment The world could have its cake and eat it too! 1944 UN Monetary and Financial Conference. Bretton Woods, New Hampshire, "if goods can't cross borders, soldiers will." Conference agenda: The problem of exchange rates imports +exports trade deficit need to pay up deplete reserves confidence in currency value currency value unstable trade (bad for trading system) or.. What you need for free trade: Fixed Exchange Rates Currency convertibility But No more Gold Standard!!! There would be Fluctuating exchange rates in the absence of the gold standard Roadblock to Free Trade At Bretton Woods, the IMF was created International Governance of Public Finance A new Gold Standard? Not exactly. It was called the gold exchange standard The IMF was a watchdog: to ensure the members did not change their exchange rates If they got into trouble, the IMF would loan them money to replenish reserves to pay for imports Fixed exchange rates with IMF as lender of last resort, and provider of liquidity imports +exports trade deficit need to pay up borrow from IMF currency stability trade stability How does it work? The Quota System How a quota is determined What you give What you get voting rights in relation to your quota borrowing rights in relation to your quota World Bank The GATT: (WTO) Main Principles of the GATT/WTO: All promise not to defect from cooperation Multilateralism Reciprocity Exceptions Development The WTO as a solution to the problem of cooperation for Free trade Cooperate (free trade)Defect (protectionism) cooperate 5, 5 carrots: GATT and IMF assurances that if I keep my market open even with BOP deficits I will receive help for my problems and assurance that others will not cheat. 3,3 sticks DSM raises the costs of defection Defect (protectionism) 3,3 You keep your market open but if I close mine, You report me to the WTO for non-compliance and we use the DSM. If I lose, I must pay you compensation 1,1 We both close our markets; you close yours, I retaliate, you retaliate, and so on..no more free trade. No access to MFN, reciprocity, etc. Problem with these governing institutions: The war had weakened the economies of the industrial powers The Devastation of War in Europe Destruction in Europe And the institutions were too weak to solve collective action problems Inadequate IMF resources Inadequate World Bank resources GATT was only a set of rules