Embedded Liberalism in the International Economy

Review: domestic embedded liberalism: three lessons of the Great Depression

• Economic stability is not assured through market forces

• And market forces that lead to economic downturns create political instability

• Political stability requires state intervention to achieve economic stability

• Welfare state and deficit spending to keep workers happy to they don’t turn to communism and fascism

Review: Embedding liberalism: market regulation and the welfare state

• Welfare State– Social insurance– bank guarantees– Govt. created demand– Minimum Wage

• Market regulation – Banking regulations– FDIC, Glass-Steegal Act– SEC

But Free Trade tends to undermine these new roles for the state

Welfare State Full

Employment

• Inefficient industries must fail!

• Employment must fluctuate with supply and demand for labor

• But welfare state won’t let that happen

• A big impasse….leading to

If they left their economies open, what would happen to the welfare state?

• Open international economy requires trade to balance so that states pay for what they buy from others and get paid for what they sell. So……

• ↑imports +↓exports trade deficit need to pay up no credit? deflate their economies—i.e. raise interest rates inefficient economies fail + ↓ access to credit bankrupcies, +unemployment↓ in income so that imports would slow down trade payments would balance

And If they maintain the welfare state, what happens to Free Trade?

• A welfare state, is one in which government provides safety nets, like unemployment benefits, health care for citizens

• And spending on those safety nets and human investments takes more than a fifth of GDP.

• Creates Big government• Crowding out private investment and competition• Stagnant economy• Balance of payment deficits

the tendency toward economic nationalism

WelfareState FULL

Employment

States can borrow to balance payments and keep economies open…

• But In the “trough,” credit dries up• Deflation not possible w/ welfare state + Keynesian

deficit spending to ↑ domestic demand• So instead…….• ↑imports +↓exports trade deficit need to pay

up no credit? deplete reserves ↓ confidence of others in currency value ↓ currency value↑ exports competitive devaluations - all want to export and noone wants to import all erect tariffs global economy closes

Tendency toward economic nationalism Summary

• Market imperatives– The business cycle– Free Trade creates losers and requires “adjustment”

– Losers are free to fail

• Political Imperatives• Nations and states need political and social stability—losers are must have

a safety net because they are citizens of the “nation”• Safety nets + Keynesian policies mean states must run deficits to ↑

demand and keep people working, otherwise protests weaken governments

• The political need for stability and the requirements of the market are contradictory under the above conditions

• Governments must intervene in markets • to protect the “nation” • To prevent instability from toppling the govt.

Tendency toward economic nationalism: explaining protectionism as a PD Game…why to

states close their economies?Cooperate (free trade) Defect (protectionism)

coop

erat

e

5, 5Comparative advantageGrowth for all, I keep my market open even with BOP deficits because I know things will get better

0,3I keep my market open but you close yours; I lose so eventually I will retaliate

Def

ect

(pro

tect

ioni

sm) 3,0

You keep your market open, I close mine, I win, you lose and eventually you retaliate

1,1 We both close our markets; you close yours, I retaliate, you retaliate, and so on…..no more free trade

Contradictions between needs of the domestic political economy and the need for cooperation in the International economy

So that tendency is powerful

• But after WW II, there was an effort to restore open and free trade……

• beliefs about the economic causes of war.

Backlash against democracy

Belief in Economic

Nationalism

Protectionism

International Economic

fragmentation

Trade Wars War

Totalitarianism Militarism

Expansion

Dominant belief after WW II: Dictatorship + Protectionism leads to war

If the tendency toward econ. Nat. was so powerful, why was there an effort to restore liberalism in the international economy?

And belief that Free Trade leads to Peace

Free Trade Comparative Advantage

Global Interdepe

ndenceGlobal

Prosperity

Raises price of

aggression

Peace

Prosperous Economies; no need

to fight

Big contradiction between liberal international economy, state power, and stable political systems

• Markets are global, politics are local. Can the two be reconciled?

• And Stable Politics require– Full employment– Safety nets– Protection of – Govt. intervention in the economy

• States in the international system require:– Sovereignty– Sovereignty requires national wealth translated into power– And the power to produce wealth (List)

• But liberal international economy requires– Open markets aggregate growth– Need to allow inefficient business to fail– Need for “adjustment” meaning fluctuations in employment– Need for states to remain small: spending on social services, defense, etc. takes productive

resources out of the economy and out of the hands of private actors

Can the contradiction be resolved to overcome economic nationalism?

• Can states open their markets AND preserve the welfare state? What keeps their markets open in the “trough” of the business cycle?

• Open markets need currency stability + promise not to raise tariffs (defect from free trade cooperation)

• This will stimulate free trade and maintain stability of the domestic political economy

• So….Stable politics AND free trade require:– Credits for payment deficits– Markets for exports in downturns– lender of last resort when exports can’t pay for imports

To preserve the welfare state, peace, and democracy the international liberal economy would need to be

discarded or repaired

• Discarding Liberalism was not an option• What kind of repair was needed: International

embedded Liberalism—embed Liberalism in the global economy – 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

– This will…. Reduce the need for economic nationalism

But getting embedded liberalism is a collective action problem

Cooperate (free trade) requires Leadership

Defect (protectionism)

coop

erat

e

5, 5Comparative advantageGrowth for all, I keep my market open even with BOP deficits because I can get loans until things will get better

0,3I keep my market open but you close yours; I lose so eventually I will retaliate

Def

ect

(pro

tect

ioni

sm) 3,0

You keep your market open, I close mine, I win, you lose and eventually you retaliate

1,1 We both close our markets; you close yours, I retaliate, you retaliate, and so on…..no more free trade

Collective Action requires help for the weak to cooperate

How can that happen?

• Liberal Hegemony and/or

• Global governance of the international economy through international institutions

Either could theoretically 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

Kindelberger says that Hegemonic Power is required for cooperation to create a system of embedded

liberalism• Hegemonic states have the resources to

– Open markets even with a trade deficit– Extend credits to countries with payments deficits– Provide countercyclical lending and be a lender of last

resort in the “trough”

• That softens the contradictions…….• Many argue that a central source of the Great

Depression in the 1930s was a lack of British leadership and the unwillingness of the U.S. to provide leadership in the world economy.

Hegemonic Leadership

• What does “leadership” mean

• It means assisting others in a liberal world economy

• Britain did this until it began to decline

Hypothetical Recovery with Hegemonic leadership

Hegemonic help Required to build upnerve

But People lost their nerve and called on Govt. to interveneProtectionism

Open marketsCreditsCountercyclical loans

Britain as Hegemonic Leader

It takes power and willingness to be a hegemon

• Britain had both.. the capability to – Extend credits for payment deficits

– Offer a market for others’ goods

– Be a lender of last resort

• But then Britain began to decline

• And the US had the capability but not the willingness

Without a clear leader western governments created Institutions to “embed liberalism”: Bretton Woods

Conference

• “If Goods can’t cross borders, soldiers will”

• Resolving the “dilemma between internal and external stability.”

• Intergovernmental collaboration to facilitate balance-of-payments equilibrium

• Multilateralism based on domestic intervention

The architects of global governance in the services of embedded liberalism: Keynes and

White

Their Agenda: Create Free Trade Again

They had to think of a way to embed Liberalism!

• Resolving the “dilemma between internal and external stability.”

• Intergovernmental collaboration to facilitate balance-of-payments equilibrium so states would not have to deflate their economies and could pursue domestic intervention to achieve full employment AND

• Multilateralism in trade and finance• The world could have its cake and eat it too!

How to do it?

• Currencies had to be stable but No more Gold Standard!!!– It demanded deflation which would harm welfare

state

• But There would be Fluctuating exchange rates in the absence of the gold standard……

• So…..

Create conditions for stable currencies w/o the Gold Standard

• Keynes and White had to come up with a way to get stable currency

• Stable currency depended on– Fixed Exchange Rates

– Currency convertibility

So they came up with a bright idea!

Keynes and White created the IMF at Bretton Woods

• 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

Another problem: War devastation

• WWII had left Europe in an incomparable state of destruction.

• Estimates of total dead range from 50 million to over 70 million.[36] The sources cited on this page document an estimated death toll in World War II of roughly 72 million, making it the deadliest ever. Civilians killed totaled around 47 million, including 20 million from war-related disease and famine

So the World Bank was created to help with post-war reconstruction

Next Problem: How to get Free Trade Make everyone promise to keep economies open, no matter what:

(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)

coop

erat

e

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 sticksDSM raises the costs of defection

Def

ect

(pro

tect

ioni

sm)

3,3You 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

1,1We 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

Hiroshima Tokyo

Destruction in Europe

• Air bombing had reduced whole cities, especially in Germany, to piles of debris. The Allies' strategic bombing had blighted the productive industry and the transport facilities of the Continent. Goods, even if produced, could not be moved; millions of refugees from bombed-out cities or from hostile political regiems sought desperately for an asylum. The war had ruined one of the world's chief industrial areas and brought its economic system to collapse.

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---promises no good without resources to back them up

So the United States rose to the occasion.……..

How did the U.S. exercise hegemonic leadership of an open world economy?• the United States assumed primary

responsibility for the management of the world monetary system partially under the disguise of the IMF.

• The dollar became the basis of the international monetary system.

• The US took in the world’s distressed goods and began to build a trade deficit itself

Liquidity and Credit

Taking in the world’s (well…Europe and Japan’s) distressed goods

What were the results?

• The Welfare State was protected

• Decline in Trade Barriers Economic GrowthPer Capita Income

1950 1973

Western Europe $4,594 $11,534

U.S. and Canada $5,257 $9.288

Japan $1.926 $11,439

Embedded Liberalism was successful!

• GATT negotiations reduced tariffs• Since 1948, world trade has consistently

grown faster than world output. I• one quarter of world production is now

traded.• Meaning that one quarter of world production

is subject to the WTO rules of international trade.

•

Rescuing Europe

What kind of help did the U.S. provide to Europe?

• Aid for the development of European export industries

• Encouraged European cooperation in the European Community

• Why?

• Military security

• Financial backing

• Took in Europe’s distressed goods

The Marshall Plan

Marshall plan in action

The End