Political Foundations of the
World Economy
International Political Economy
Prof. Tyson Roberts
1
Lecture Goals
• States & Markets in International Context
• Bilateral and Multilateral Global Institutions
• Brief History of the World, IPE style
2
If Robinson lives alone, he does
everything himself
3
If a second person arrives, one can specialize in
coconuts and the other can specialize in fish,
and they can benefit from trade
4
If each actor is “fully informed,” trade
results in a Pareto Improvement
Friday
Don’t trade
Trade
Don’t trade
0, 0
0, 0
Trade
0, 0
1, 1
Robinson
5
However, each actor may have an
incentive to cheat
Friday
Cheat
Stay true
Cheat
-1, -1
2, -2
Stay true
-2, 2
1, 1
Robinson
6
Cheat, Cheat is the Nash Equilibrium
Stay true, Stay true would be Pareto Improvement
Friday
Cheat
Stay true
Cheat
-1, -1
2, -2
Stay true
-2, 2
1, 1
Robinson
7
Institutions to prevent cheating
1. Long-term relationships based on reciprocity
and trust
8
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
Cheat
-1, -1
2, -2
Stay true first trade;
Cease trading if
cheated
-2, 2
1+1+1+…, 1+1+1+…
Robinson
9
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
10
As the distance and complexity of trade
increases, potential for trade benefits increase…
11
As the distance and complexity of trade
increases, potential for trade benefits increase,
but cheating is more difficult to monitor
12
The challenge of long-distance trade
• Strong incentive to cheat, makes trade costly
Trader 2
Cheat
Stay true
Cheat
-1, -1
2, -2
Stay true
-2, 2
1, 1
Trader 1
13
Institutions to prevent cheating
1. Long-term relationships based on reciprocity
and trust
– Works best in smaller groups (repeated
interactions, reputation)
14
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
15
Cooperation solution in state of anarchy
The repeated interaction cooperation solution
depends on valuing the future
http://www.youtube.com/watch?v=BPS9YKGaK
QE
16
The Wire’s Baltimore: When Avon
Barksdale is in charge
Barksdale
Prop Joe
Fight for territory
Don’t fight
2,2
4,1
1,4
3,3
Fight for territory
Don’t fight
What is the expected outcome? (i.e., Nash Equilibrium)
Is it Pareto Efficient?
The Wire: When Avon Barksdale is
in charge
Barksdale
Prop Joe
Fight for territory
Don’t fight
2,2
4,1
1,4
3,3
Fight for territory
Don’t fight
The Wire: When Stringer Bell is in
charge
Stringer Bell
Prop Joe
Fight for territory
Share territory in
exchange for good
product; attack if
crossed
2,2
4,1
1,4
3 + 2 = 5,5
Fight for territory
Share good product in
exchange for territory;
withhold if crossed
What is the expected outcome? (i.e., Nash Equilibrium)
Is it Pareto Efficient?
The Wire: When Stringer Bell is in
charge
Stringer Bell
Prop Joe
Fight for territory
Share territory in
exchange for good
product; attack if
crossed
2,2
4,1
1,4
5,5
Fight for territory
Share good product in
exchange for territory;
withhold if crossed
Two (Pure strategy) Nash Equilibria:
(1) PJ - Fight; SB - Fight
(2) PJ - Share; SB - Share
Repeated interactions can but do not necessarily
lead to cooperation
Another mechanism is third party enforcement
21
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
22
State of nature
Civil society
Enforced by State
Forbear
Steal
Forbear
Steal
Forbear
(3,3)
(1,4)
Forbear
Steal
(4,1)
(2,2)
Steal
(3-t,3-t)
(1-t,4-p-t)
(4-p-t,1-t) (2-p-t,2-p-t)
Indicates the NE in each game.
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
Steal
(4,1)
(2,2)
Steal
(3-t,3-t)
(1-t,4-p-t)
(4-p-t,1-t) (2-p-t,2-p-t)
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?
State of nature
Civil society
Enforced by State
Forbear
Steal
Forbear
Steal
Forbear
(3,3)
(1,4)
Forbear
Steal
(4,1)
(2,2)
Steal
(3-t,3-t)
(1-t,4-p-t)
2½,2½
½,1½
(4-p-t,1-t) (2-p-t,2-p-t)
1½,½
-1/2 , -1/2
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
State of nature
Civil society
Enforced by State
Forbear
Steal
Forbear
Steal
Forbear
(3,3)
(1,4)
Forbear
Steal
(4,1)
(2,2)
Steal
(3-t,3-t)
(1-t,4-p-t)
(4-p-t,1-t) (2-p-t,2-p-t)
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?
State of nature
Civil society
Enforced by State
Forbear
Steal
Forbear
Steal
Forbear
(3,3)
(1,4)
Forbear
Steal
(4,1)
(2,2)
Steal
(3-t,3-t)
(1-t,4-p-t)
1, 1
-1, 0
(4-p-t,1-t) (2-p-t,2-p-t)
0, -1
-2, -2
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
State of nature
Civil society
Enforced by State
Forbear
Steal
Forbear
Steal
Forbear
(3,3)
(1,4)
Forbear
Steal
(4,1)
(2,2)
Steal
(3-t,3-t)
(1-t,4-p-t)
(4-p-t,1-t) (2-p-t,2-p-t)
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.
A third mechanism to facilitate trade is ideology
(focal point)
29
Institutions to prevent cheating
1. Long-term relationships based on reciprocity
and trust
– Works best in smaller groups (repeated
interactions, reputation)
2. Belief systems
3. Third party enforcement
30
History of the World, IPE-style: Unilateral
Institutions & Mercantilist Beliefs
• ~1600-~1850: Mercantilism
– Trade facilitated by empires & chartered trading
companies within empires
31
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
32
Large, leading economies gain most from free
trade
33
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
34
• 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
35
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?
36
Payoffs with absolute gain
Challenger
Hegemon
Reduce tariffs
High tariffs
8, 6
4, 4
6, 2
2, 1
Reduce tariffs
High tariffs
What is expected outcome? (i.e., Nash Equilibrium)
37
Payoffs with absolute payoffs
Challenger
Hegemon
Reduce tariffs
High tariffs
8, 6
4, 4
6, 2
2, 1
Reduce tariffs
High tariffs
What is expected outcome? (i.e., Nash Equilibrium)
38
Now transform the outcomes in each cell from
absolute payoffs to relative payoffs
For example, my relative payoff is my
payoff/your payoff.
39
Payoffs with relative payoffs
Challenger
Reduce tariffs
Hegemon
High tariffs
Reduce tariffs
Heg.
8/6 =
4/3
Chall.
6/8 =
3/4
Heg.
4/4 =
1
Chall.
4/4 =
1
High tariffs
Heg.
6/2 =
3
Chall.
2/6 =
1/3
Heg.
2/1 =
2
Chall.
1/2 =
½
What is expected outcome? (i.e., Nash Equilibrium)
40
Payoffs with relative payoffs
Challenger
Hegemon
Reduce tariffs
High tariffs
4/3 , 3/4
1, 1
3, 1/3
2, 1/2
Reduce tariffs
High tariffs
What is expected outcome? (i.e., Nash Equilibrium)
41
• 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
42
• International regimes can affect
– Capabilities of states
– Interests of states
43
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?
44
Large, leading economies gain most (in absolute
terms) from free trade
45
Hegemon gains most from free trade regime & can afford to maintain
Challenger also benefits, but is less able to afford maintenance
Challenger
Hegemon
Spend to maintain
regime
Spend to maintain
regime
Don’t spend
8, 3
5, 4
6, 1
2, 2
Don’t spend
46
Challenger can therefore free-ride on hegemon’s efforts
Challenger
Hegemon
Spend to maintain
regime
Spend to maintain
regime
Don’t spend
8, 3
5, 4
6, 1
2, 2
Don’t spend
47
World GDP per capita
1st Era of Globalization
Source: Angus Maddison
48
Without a hegemon, no country can capture benefits of
free trade regime enough to make maintenance of free
trade regime worthwhile => lack of cooperation
49
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
50
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
51
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 lawbased bargaining
• LDC’s outside option: Trade with Soviet Bloc
• Result: Exceptions for LDCs
Uruguay Round (1986-94) closed with powerbased 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?
GATT/WTO Benefits – Worldwide
(2nd Age of Globalization)
BW
Post-BW
Source: PWT for countries w/1950 data only; not sure about Maddison
60
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
• 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
64
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
65
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?
66
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
67
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
68