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

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Political Foundations of the World Economy

International Political EconomyProf. Tyson Roberts

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Lecture Goals

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

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If Robinson lives alone, he does everything himself

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If a second person arrives, one can specialize in coconuts and the other can specialize in fish,

and they can benefit from trade

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

Friday

Don’t trade Trade

RobinsonDon’t trade 0, 0 0, 0

Trade 0, 0 1, 1

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However, each actor may have an incentive to cheat

Friday

Cheat Stay true

RobinsonCheat -1, -1 2, -2

Stay true -2, 2 1, 1

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

Friday

Cheat Stay true



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Institutions to prevent cheating

1. Long-term relationships based on reciprocity and trust

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The prospect of repeated interactions converts cooperation into a Nash Equilibrium

(But Cheat, Cheat also remains a Nash Equilibrium)

Friday

Cheat

Stay true first trade;Cease trading if cheated


Stay true first trade;Cease trading if cheated

-2, 2 1+1+1+…, 1+1+1+…

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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

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

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

but cheating is more difficult to monitor

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The challenge of long-distance trade

• Strong incentive to cheat, makes trade costly

Trader 2

Cheat Stay true

Trader 1Cheat -1, -1 2, -2


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1. Long-term relationships based on reciprocity and trust– Works best in smaller groups (repeated

interactions, reputation)

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Solutions to cooperation problem

1. Repeated transaction– Works within tight-knit communities (Jews,

Lebanese, Hausa, etc.), but not among the world at large

2. Belief system/ideology (focal point)– Also works best in tight-knit communities

3. Third-party enforcement– E.g., by a imperial power or a hegemonic state

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Cooperation solution in state of anarchy

The repeated interaction cooperation solution depends on valuing the future

http://www.youtube.com/watch?v=BPS9YKGaKQE



The Wire’s Baltimore: When Avon Barksdale is in charge

Barksdale

Fight for territory Don’t fight

Prop Joe Fight for territory2,2 4,1

Don’t fight1,4 3,3

What is the expected outcome? (i.e., Nash Equilibrium)

Is it Pareto Efficient?

The Wire: When Avon Barksdale is in charge

Barksdale

Fight for territory Don’t fight

Prop Joe Fight for territory2,2 4,1

Don’t fight1,4 3,3

The Wire: When Stringer Bell is in charge

Stringer Bell

Fight for territory Share territory in exchange for good product; attack if

crossedProp Joe Fight for territory

2,2 4,1

Share good product in exchange for territory; withhold if crossed

1,4 3 + 2 = 5,5

What is the expected outcome? (i.e., Nash Equilibrium)

Is it Pareto Efficient?

The Wire: When Stringer Bell is in charge

Stringer Bell

Fight for territory Share territory in exchange for good product; attack if

crossedProp Joe Fight for territory

2,2 4,1

Share good product in exchange for territory; withhold if crossed

1,4 5,5

Two (Pure strategy) Nash Equilibria: (1) PJ - Fight; SB - Fight(2) PJ - Share; SB - Share

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Repeated interactions can but do not necessarily lead to cooperation

Another mechanism is third party enforcement

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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

p is penalty for stealing. Assume p>1

Is enforcement by the State Freedom or a Prison?

State of nature Civil society Enforced by State

Forbear Steal Forbear Steal

Forbear (3,3) (1,4) Forbear (3-t,3-t) (1-t,4-p-t)

Steal (4,1) (2,2) Steal (4-p-t,1-t) (2-p-t,2-p-t)

Indicates the NE in each game.



If p =2 & t= ½ , is society better off with or without the state?







If p =2 & t= 1/2, is society better off with or without the state?

WITH. STATE => FREEDOM



Forbear (3,3) (1,4) Forbear (3-t,3-t)2 ½ , 2 ½

(1-t,4-p-t)½ , 1 ½

Steal (4,1) (2,2) Steal (4-p-t,1-t)1 ½ , ½

(2-p-t,2-p-t)-1/2 , -1/2



If p =2 & t= 2, is society better off with or without the state?







If p =2 & t= 2, is society better off with or without the state?

WITHOUT. STATE => PRISON



Forbear (3,3) (1,4) Forbear (3-t,3-t)1, 1

(1-t,4-p-t)-1, 0

Steal (4,1) (2,2) Steal (4-p-t,1-t)0, -1

(2-p-t,2-p-t)-2, -2



If the state does not charge too much tax (3-t > 2, or 1 > t), life will be better in civil society.






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A third mechanism to facilitate trade is ideology (focal point)

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1. Long-term relationships based on reciprocity and trust– Works best in smaller groups (repeated

interactions, reputation)

2. Belief systems3. Third party enforcement

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History of the World, IPE-style: Unilateral Institutions & Mercantilist Beliefs

• ~1600-~1850: Mercantilism– Trade facilitated by empires & chartered trading

companies within empires

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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

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Large, leading economies gain most from free trade

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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

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• Neorealism (Waltz)– ‘in a condition of anarchy, relative gain is more

important than absolute gain’– emphasizes the weakness of international

institutions and the fragility of cooperation

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What is the difference between relative gain and absolute gain?

Should states focus on relative or absolute gain?

Why are actors focused on relative gain less likely to cooperate?

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Payoffs with absolute gain

Challenger

Reduce tariffs High tariffs

Hegemon Reduce tariffs8, 6 4, 4

High tariffs6, 2 2, 1

What is expected outcome? (i.e., Nash Equilibrium)

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Payoffs with absolute payoffs

Challenger


Hegemon Reduce tariffs8, 6 4, 4

High tariffs6, 2 2, 1


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Now transform the outcomes in each cell from absolute payoffs to relative payoffs

For example, my relative payoff is my payoff/your payoff.

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Payoffs with relative payoffs

Challenger


Hegemon Reduce tariffs Heg.8/6 =4/3

Chall.6/8 =3/4

Heg.4/4 =

1

Chall.4/4 =

1High tariffs Heg.

6/2 =3

Chall.2/6 =1/3

Heg. 2/1 =

2

Chall.1/2 =

½


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Payoffs with relative payoffs

Challenger


Hegemon Reduce tariffs4/3 , 3/4 1, 1

High tariffs3, 1/3 2, 1/2


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• 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

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• International regimes can affect– Capabilities of states– Interests of states

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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?

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Large, leading economies gain most (in absolute terms) from free trade

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Hegemon gains most from free trade regime & can afford to maintainChallenger also benefits, but is less able to afford maintenance

Challenger

Spend to maintain regime

Don’t spend

Hegemon Spend to maintain regime 8, 3 5, 4

Don’t spend6, 1 2, 2

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Challenger can therefore free-ride on hegemon’s efforts

Challenger

Spend to maintain regime

Don’t spend

Hegemon Spend to maintain regime 8, 3 5, 4

Don’t spend6, 1 2, 2

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World GDP per capita1st Era of Globalization

Source: Angus Maddison

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Without a hegemon, no country can capture benefits of free trade regime enough to make maintenance of free

trade regime worthwhile => lack of cooperation

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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

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History of the World, IPE-style: Return of free trade; new hegemon supports multilateral institutions

• 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

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

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

GATT decision making rules

• Officially: majoritarian• Unofficially: Informal consensus– Launching rounds: law-based bargaining– Closing rounds: increased power-based bargaining

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

Organized Hypocrisy

Consensus in the GATT/WTO• Naked power available as

alternative• Consensus rules provide

legitimacy and information gathering to powerful nations – stable, low cost method to achieve goals

• Some votes bought with pay-offs• Weaker nations unlikely to

protest openly if hypocrisy not too blatant

Multiparty elections in authoritarian regimes

• Naked power available as alternative

• Multiparty elections provide legitimacy & information gathering to ruling elites – stable, low cost method to achieve goals

• Some votes bought with pay-offs• Opposition unlikely to protest

openly if hypocrisy not too blatant

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 LDCsUruguay Round (1986-94) closed with power-based bargaining• No outside option for LDCs• Result – uniform rules in WTO

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

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?

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GATT/WTO Benefits – Worldwide(2nd Age of Globalization)

Source: PWT for countries w/1950 data only; not sure about Maddison

BW Post-BW

GATT/WTO Benefits - Distribution

• International: – According to some studies, developed countries

benefited more from WTO (Uruguay Round) than developing countries

– According to some studies, some developing countries are net losers from WTO (diminished development policy space)

– Other developing countries are winners, e.g. China and India

GATT/WTO Benefits - Distribution

• Intranational:– Trade integration has contributed to income

inequality in the US (but technological change likely played a larger role)

– Inequality has also increased in China and India– Low-skilled workers in labor-intensive

manufacturing sectors were first losers in US; higher skilled workers in services may follow

Takeaways

• All countries can benefit from free trade• Within countries, there are winners and losers• Domestically, potential losers from free trade (e.g.,

producers) can solve collective action problem, which enables successful lobbying

• Institutions such as WTO facilitate cooperation for mutual benefit (at the country level)

• WTO increases role of law, but power still plays a role (e.g., availability of outside options)– Some countries may be net losers from WTO

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• 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

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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

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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?

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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

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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

Documents

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