political economy chapter five pearson publishing 2011

Political EconomyChapter Five

Pearson Publishing 2011

Political Economy

• The good society depends upon institutional arrangements that enhance people’s capabilities.• Soviet Union – too much state intervention.• Post-Communist Russia – too little state intervention.

• So how much state activity is enough to produce the good society?• Applies most often with regard to the economy.• Milton Friedman: two ways to coordinate the economic activity

of millions – central planning by the government or the voluntary cooperation of individuals via the marketplace.

• So what balance between states and markets most enhances people’s capability and contributes to the good society?


Political Economy

• Political economist Charles Lindblom – markets have always been with us, but market systems have not.

• Today, almost all countries use market systems to organize and coordinate production.• Market system: refers to an economy in which production

for profit is intended for and coordinated through private exchanges between buyers and sellers.

• Shift in Europe difficult from subsistence production to market.

• Trade throughout the world has increased. Many countries invest directly in countries other than their own.


Institutions and Power

• The market system has become more extensive & more intensive.

• States determine how extensive markets are.• They can discourage foreign trade by placing

taxes on imports or encourage it by keeping the playing field even between domestic and international goods.

• Strict border control on currency or free flow.• Treaties or international organizations that

encourage exchange.• Encourage or discourage foreign investment.• All of these rules can also either promote or

inhibit the extensive growth of markets.

• States determine how intensive markets are.• Restrict what can be sold.• Role of competing pressures between those who

benefit from intensive and extensive markets and those who do not.


In Brief: Market SystemsIn Brief: Market Systems

• Commodity production in which goods are produced for sale.

• Productive assets are privately owned and employed to earn profits for their owners.

• Prices are not administered but set through supply and demand.


States & Markets

• In market systems, production is coordinated through the mutual interactions of those who are buying and selling according to Lindblom.• Supply and demand.

• People respond to shifts in the markets, but no one controls it.

• But markets require states to function and CANNOT exist without them.• For example market systems need states to create a common

currency to facilitate trade and exchange; to enforce contracts; and to supply public goods, such as transportation networks and police protection, that markets cannot furnish themselves.


States & Markets

• Imagine playing Monopoly with no rules.

• Institutions matter: France versus Britain in the 18th century in the area of commerce.

• The balance between political and market forces within a country, its political economy, is critical in determining whether it will meet the minimal conditions of a good society.


Advantages & Disadvantages of Market Systems

Advantages• Extraordinarily dynamic,

promoting development of new products and more efficient methods of production and technology.

• Enormously productive.• Enhances the prospects of

democracy and political rights.

• Extraordinarily dynamic, promoting development of new products and more efficient methods of production and technology.

• Enormously productive.• Enhances the prospects of

democracy and political rights.

Disadvantages• Highly volatile – boom and

bust.• Housing market plunge• Recession

• Tend to generate extraordinary inequality

• Create harmful spillover effects (externalities)• Global warming• pollution

• Highly volatile – boom and bust.• Housing market plunge• Recession

• Tend to generate extraordinary inequality

• Create harmful spillover effects (externalities)• Global warming• pollution


In Brief: Advantages & Disadvantages of Market SystemsIn Brief: Advantages & Disadvantages of Market Systems

• Advantages• Promotes efficiency and

productivity• Promotes innovation• More conducive to

democracy than command economies

• Disadvantages• Promotes inequality• Subject to volatile and

destructive swings between recession and prosperity

• Social costs of production are ignored


The Shifting Balance Between States and Markets

• States do more to assist market systems than simply reassure participants that others will play fair.• Steer economies to certain goals- counteracting the three

drawbacks discussed earlier.• Welfare system to counteract inequality.

• Create regulations to minimize harmful spillover effects.

• Use budgetary powers and control over the money supply to steady the swings in the business cycle.

• But the degree to which states should intervene is often the focus of debate and conflict.


The Shifting Balance Between States and Markets

• States intervention became the new gospel across the globe, however, the tide shifted in the 1970s.• Recessions of the 1970s – new leaders such as President Ronald

Reagan (U.S.) and Prime Minister Margaret Thatcher (GB) argued that state intervention was the cause of this economic downturn.

• Political failures; need for market restoration.• Welfare state had undermined the work ethic.• Regulations had constrained entrepreneurial energies.• Taxes had diverted too much income.• Public enterprises were inefficient.

• Management of the economy changed to reflect this new consensus.

• Global recession of 2007 cast doubt on the model.


The Good Society In Depth: India – From States to Markets

• India became independent in 1947.

• Leaders embarked on policy of state intervention in the economy.• socialist inclinations and

ambitions to create a strong state with which citizens could identify.

• Abandoned statist economic policies in 1980s.• Privatization• Deregulation

• Consequence of shift from state to market:• Foreign trade and direct investment

grew dramatically, as did GDP.• Income has risen for all groups,

including the poor.• Middle class has grown dramatically.• However, they have failed to have

much of an impact on rural residents.• Question:• How can market reforms have such

unequal effects, leaving out the bulk of the population in the countryside engaged in agriculture, yet maintain popular support in a democracy such as India?


Globalization

• Globalization refers to the increasing flow of money, people, skills, ideas, and goods across borders, or in other terms, the extensive development of markets.

• Global production chains:• Many countries involved in the

production of a single product such as a Barbie doll, or an iPod.

• Today we have a tremendous increase in volume of international exchange.

• Globalization refers to the increasing flow of money, people, skills, ideas, and goods across borders, or in other terms, the extensive development of markets.

• Global production chains:• Many countries involved in the

production of a single product such as a Barbie doll, or an iPod.

• Today we have a tremendous increase in volume of international exchange.

• Part of this is the result of technology.• More intercontinental flights

• Part of it comes from the “Washington Consensus” on market based growth and neoliberalism – idea is to balance budgets by cutting spending, open markets, sell off nationalized industries to private investors.• Had support of large multinational

corporations, and international agencies.

• World Bank & the IMF• Critics: hurt the poor, increased

unemployment, drove out small business, weakened democracy

• Part of this is the result of technology.• More intercontinental flights

• Part of it comes from the “Washington Consensus” on market based growth and neoliberalism – idea is to balance budgets by cutting spending, open markets, sell off nationalized industries to private investors.• Had support of large multinational

corporations, and international agencies.

• World Bank & the IMF• Critics: hurt the poor, increased

unemployment, drove out small business, weakened democracy


Globalization

• Each country competes to have the lowest wages, lowest taxes, and fewest regulations in order to attract foreign investors.

• Record of countries that followed the Washington consensus strategy has been uneven.• Chile succeeded whereas most other Latin

American countries did not.• World Bank concedes that the one-size-fits-

all prescription of balanced budgets, open markets, and privatization did not work.

• Globalization has varied outcomes because it is refracted through different institutions and governing coalitions as well.

Detractors of globalization argue that it creates a “race to the bottom”.


Comparative Political Analysis: Does Globalization Help or Hurt Workers in the Developing World?


Problem• Mosley & Uno ask whether

globalization contributes to or compromises workers’ rights in developing countries?

• Is it a race to the bottom or does it offer a climb to the top?

Methods & Hypotheses

• They hypothesize that the impact of globalization on workers depends on the way countries participate in global production networks.

• Workers will benefit when countries attract foreign direct investment but they will suffer when countries engage in more trade.




Operationalizing Concepts

1. Workers rights, the dependent variable, captured by counting the number of labor rights violations that countries committed from 1985 to 2002 as recorded by the U.S. State Department, the International Labor Organization, and the International Confederation of Free Trade Union.

2. Foreign direct investment is operationalized by looking at annual changes in FDI and the overall level of FDI as a percent of GDP.

3. Operationalize trade by looking at the ratio of imports and exports to GDP

Results• Statistical analysis confirmed their

hypothesis: The higher the level of FDI as a percentage of GDP, the greater the respect for labor rights.

• Conversely, trade openness was shown to be detrimental to workers.

• So it appears that globalization’s effect on workers’ rights depends on the specific ways in which countries are integrated into the global economy.


Forms of State Intervention: Fiscal Policy

• States try to influence economic conditions through fiscal policy.• This involves juggling their budgets, their overall levels of

revenues and expenditures.

• Often set by the executive branch:• Can run a budget deficit, which puts money into circulation

that increases demand for goods, which, in turn, encourages businesses to invest and put people to work.

• Can run a surplus, taking in more money than they spend. This withdraws money from circulation, which depresses spending and discourages investment, thereby reducing inflationary pressures in the economy.


Forms of State Intervention: Fiscal Policy

• States differ greatly in the proportion of their economy devoted to taxes and state expenditures.• U.S. – citizens complain about high taxes and too much

government spending but actually have a lighter tax burden than citizens in other rich democracies, and the American government is relatively lean. (See Table 5.1)

• Only Australia, Ireland, Japan, and Switzerland recorded lower state spending as a percentage of their economies than the U.S.

• At the opposite end is Sweden, where state revenues and spending amount to more than half of GDP.


Forms of State Intervention: Monetary Policy

• Another means by which states influence economic conditions: monetary policy• Manipulation of interest

rates/regulating how much it costs to borrow money.• High interest rates tend to

discourage borrowing and spending; used to counteract tendencies toward inflation.

• Low interest rates encourage borrowing and spending by making loans cheap.

• Interest rates are largely determined by central banks.

• Central banks issue currency and manage its value in foreign exchange.• May be insulated from

politics and states have little control over them.• Ex.: Federal Reserve in U.S.;

European Central Bank even more insulated.

• Other countries have a great deal of influence.• China’s People’s Bank


Forms of State Intervention: Regulatory Policy

• States manipulate budgets and central banks manage interest rates, but states can also issue regulations that set explicit rules of behavior that firms must follow.

• Some states are very regulatory.• The number of procedures and days it takes to start a new

business is a standard measure used to compare the thickness of the regulatory environment from country to country. • GERMANY: 45 days and 9 separate interactions to obtain

licenses and permits to start a business.

• BRAZIL: 152 days and 17 steps.

• US: 5 days and 5 steps.• U.S. economy is actually one of the least regulated in the world.


Forms of State Intervention: Nationalization

• States try to influence economic activity by nationalizing industries in which states own and control public enterprises.

• Nationalized industries permit the state to control strategic assets through which it can influence the economy.• Examples: oil industries in Mexico, Venezuela, & Saudi Arabia

• Can also help inject social criteria into the economy• China: inefficient industries are often subsidized because they provide

jobs and services to millions who would be poor and jobless without them.

• States differ in the degree to which they nationalize industry.• Socialist countries (Cuba, North Korea) own & control all means of

production. Few in number now.

• More countries have privatized once state-owned industries.


Forms of State Intervention: Nationalization

• Where markets play a greater role we expect to find that:1. States do not redirect as much of

the country’s income through taxes and expenditures.

2. States do not exert much influence upon central banks that set interest rates.

3. State regulations are not as copious or intrusive upon managers.

4. Public enterprises contribute little to GDP.

• The opposite is the case where states play a powerful role in determining who gets what.

• Continuum of most market- oriented to the most state-directed.

States have many tools to utilize in order to influence the economy beyond fiscal policy, monetary policy, regulation and nationalization.

Mix varies from country to country.

States have many tools to utilize in order to influence the economy beyond fiscal policy, monetary policy, regulation and nationalization.

Mix varies from country to country.


Table 5.1Pearson Publishing 2011

Markets and the Good SocietyPearson Publishing 2011

o Do countries in which market systems prevail do a better job of enhancing people’s capability than countries with heavy state intervention?

o Physical well-being?o Figure 5.2: countries that received top scores from the

Fraser Institute were also the countries in which infant mortality rates are low.

o Market systems do a better job at meeting the physical needs of citizens than more state-directed economies.

Figure 5.1Pearson Publishing 2011

Markets and the Good Society

o Informed Decision-makingo According to Figure 5.3, the average literacy rate for

countries in the top quintile (top fifth) of market-based societies was 96.1 percent; in the fourth quintile it was 92.2, the third was 89.6 and so on.

o The average literacy rates for countries in the bottom quintile, which included countries with the most state-directed economies was 62.3%.



o Safetyo Warfare poses the greatest threat to citizens’ safety and wars

are far more likely to occur within states than between them.o Type of political economy a country has is virtually

irrelevant in determining its risk of war.o Safety can also be assessed via homicide rates

o Figure 5.4: the average homicide rate does rise as we move from the highest to the lowest quintile of market economies.

o Correlation, but not a strong relationship. Very different murder rates among countries, even among those with the same economic systems.



o Democracyo Fraser Institute rankings (market friendly states) find robust

democracies in the top quartile and repressive dictatorships at the bottom.

o Some striking anomalies: Hong Kong, Singapore, Israel, Egypt

o Market friendly states do not guarantee liberal democracy, but there are no liberal democracies without them.

o Organizing economies along market lines does improve people’s capabilities, but not consistently so.


Conclusion

• Markets are not a panacea.

• They must be supplemented in order to increase people’s capabilities.

• Important: develop a balance between states and markets that promotes the best qualities of markets, such as innovation and productivity, while avoiding their worst effects – instability and inequality.


Critical Thinking Questions

• Why do countries differ in their balance between states and markets? What factors determine why some countries depend more on markets while others depend more on states?

• What sort of activities should be left to the marketplace and what should be insulated from it? What criteria should determine where it is appropriate and where it is inappropriate for markets to operate?


Critical Thinking Questions

• Why have some developing countries benefited from globalization while others have been victimized by it?

• Many central banks that set monetary policy and influence interest rates are independent of government and, in effect, unaccountable to the people their policies affect. Should central banks be more democratically accountable?

• The authors noted that although there are no democracies that are not also capitalist, many capitalist economies operate within authoritarian political systems. Why is it the case that democracy seems to require capitalism but capitalism does not seem to require democracy?


political economy chapter five pearson publishing 2011

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