International Political Economy

International Political Economy – Final Exam Notes
The Rise of International Political Economy
Classical Political Economy
Origins of Political Economy
Population and economic growth in the 19th century after a period of stagnation from 1500-1800
Moral philosophy in the 18th century began to focus on the economy when previously religiously based
Example: Adam Smith applied philosophical explanations to how the economy works
The rise of “economic philosophy”
Smith, Ricardo, Malthus, Mill and Marx
The philosophical process became less focused on the divine and more on human order
The value of a product was dependent on the cost of that product
The Marginal Revolution and the Birth of Economies
Studies of Marginal Utility and that humans are inherently utility maximizers
As the governments increased their wealth in the 19th century (post Industrial Revolution), the advent of national accounting occurred to control taxation and therefore further increase wealth
In the 20th Century, economic models distanced themselves from their moral philosophy roots of the 19th century and became increasingly quantitative
Focused on the efficiency of the market
The switch from “classical” to “neoclassical” economics
The Rebirth of Political Economy
Economics had replaced the term ‘political economy’ during the marginal revolution
During the independence of many states during the 1950s and 1960s, Economics did not explain the emergence of newly developed economies
The Free Market only applied to industrialized markets
When industries were “too efficient,” needed government intervention and a return to politics
Income distribution, infrastructure, etc.
The Development of International Political Economy
The 1970’s and the Post-War Period
The development of “soft-powers”
Militaries without monetary/economic power
The growth of International Relations and its relationship to economics, not just political empires
Began on the left with Marxism and Feminism, but skewed to the right to Conservatism
Economics focuses on becoming more efficient, politics focuses on becoming more powerful
Money
The Role of Central Banks
An institution that manages a state’s currency, money supply and interest rates
Example: United States Federal Reserve, European Central Bank (ECB)
Manages a state’s money supply through managing interest rates or implementing monetary policies
Manages interest rates through buying and selling government bonds
Acts as a lender of last resort for financial crisis and bank insolvency (inability of debtor to pay debt)

States require a deposit in order to take out a loan
Example: Canada’s deposit is 3% of the amount of the loan
Definition: “Run on the Bank”
Rapid cash withdrawal by customers of a financial institution after customers worry the bank might become insolvent
Demand cash or transfer funds to government bonds or other secure institutions
Central Bank will attempt to prevent bank runs
Central banks set the reserve requirement
Shadow Banking System
Institutions and markets that carry out traditional banking functions outside of traditional purview
Example: Investment Banks, Mortgage Companies
Carrying out traditional banking, just not in a bank
Doesn’t report to central bank

Money Supply and Liquidity
Definition: “Liquidity”
Availability/ability to buy and sell a commodity without strongly affecting the price
Excess Liquidity: too much money (inflation)
Too little Liquidity: Constrained buying and selling (recession, possible deflation)
Illiquid market: price increases with more consumers (increase in demand)
The central bank controls the money supply of a state
Typically includes currency in circulation and demand deposits
Inflation
The declining value of money/an increase in the general price level of goods and services
Discourages depositing money in the bank
Demand pull: excess demand leads to inflation
Supply push: Supply of Money > Demand for Money (inflation increases)
Disinflation
Slowing rate of inflation
Deflation
Falling prices/a decrease in the general price level
Slows the rate of the economy

The Price of Money
Money is a medium of exchange, a unit of account and a store of value
Its key is the faith of individuals that it can be used in financial transactions without losing its value
It is regulated by the government, but created by private agents
Interest Rates
As inflation increases, interest rates increase
Higher interest rates make it more expensive to borrow money, thus encouraging saving so inflation rates decrease as less money is supplied
Interest rates go up to deter spending, paradox of thrift
People are saving too much, causing demand to go down during time of economic recession
Even though people are saving more, it hurts the economy
Everyone tries to save more
Aggregate demand: total demand (Keynes)
Foreign Exchange
Currencies
Refers to money in any form when actually in circulation as a medium of exchange
Most typically bank notes
A country that uses another country’s currency is a colony
A state that transacts its own business with its own currencies, but accepts other currencies, is working within an economic space essentially controlled by another player (impact on sovereignty)
Definition “Legal Tender”
The currency that a country says a court settlement can be settled with
Definition “Key Currency”
The currency that nonresident private and public actors most often hold, used globally for cross-border transactions and for purchase in the form of bonds
Currently, the U.S. Dollar, prior to the Great Depression, the British Pound
Likely to keep its Key Currency status as decentralization and fragmentation in the Eurozone, as well as Britain not converting to the Euro leaves the Eurozone at a relative disadvantage to more unified US financial structures
The Euro’s inability to recover after the 2008 financial crisis depicts its instability as an alternative
Exchange Rates
The value of a currency on external markets
Appreciation/Depreciation
A market driven increase or decrease in a currency’s price
Revaluation/Devaluation
When a state raises/lowers its currency’s official price
Revaluation can reduce the cost of imports and reduce inflation and devaluation can increase exports (China)
Done through the buying and selling of their own currency
Definition: “Exchange Value”
What a currency can buy of/with other currencies
The ‘Classical Gold Standard” 1870s to 1914
A regime based on fixed exchange rates where specific currencies had fixed their exchange rates in relation to gold and countries held their official international reserves in gold
Stabilized currency values and facilitated trade
Regime was backed by British Hegemony
Provided public goods, loans and an open market for exports
Based on the orthodox liberal objective of maintaining monetary openness and stability by maintaining stable exchange rates
The ‘Interwar Period’ 1918 to 1944
Floating exchange rates post-war caused volatile currency values
The Gold Exchange Standard Regime was implemented where central banks held their reserves in major currencies and gold
Each central bank fixed the exchange rate of its currency to a key currency (The British Pound) with a fixed gold price
Permitted more flexibility for increases as the international reserves are not limited to the supply of gold
However, caused persistent balance of payments deficits or surpluses
Reserve Currencies
Used for trade between countries as most currencies can only be used in their issuing country
Banks conduct deals by depleting their Canadian reserves to purchase US Dollars to increase their US Credit in an US institution
With excess reserves, US institutions will sell their excess to the Bank of Canada (our central bank)
Bank of Canada can in turn sell their excess US Dollars to the Federal Reserve
The US Treasury Department prints money in US Dollars and has the ability to pay for the foreign spending by printing money (financing their deficit)
Definition: “Top Currency”
Favoured for international monetary transactions because other countries have confidence in the economic position of the issuing state
Currently: US Dollar
US Military power and size contributes to the confidence in the dollar (soft power)
Sovereign Bonds and Bond Markets
Definition: “Bond”
A fixed income security and an instrument of indebtedness of the bond issuer to their subsequent holders
The Bank of Canada can buy bonds to decrease the interest rate (decreasing the money supply) or sell bonds to increase the interest rate (increasing the money supply)
The yield on a bond has an inverse relationship to its price
As the price of a bond increases, the yield will decrease
Example: Price raises from $100 to $101, yield decreases to 1% or below (previously a yield of 2% when bond was priced at $100)
National Accounts
Current Account
All transactions related to a state’s current expenditure and national income
Merchandise trade (trade in tangible goods)
Services trade (trade in intangible items, such as insurance)
Investment income and payments (interest and dividend payments on investments by citizens of a country to foreigners)
Remittances and official transactions (income from migrant workers or foreign companies sent out of a country)
Capital Account
Includes all movements of financial capital into and out of a state
Capital exports are debit items because they involve the purchase of financial assets from foreigners
Capital imports are credit items
Includes savings and loans
Includes Foreign Direct Investment (FDI)
A capital investment or a subsidiary of an MNC which the investor has some operating control
Includes Portfolio Investment
The purchase of stocks and bonds that does not involve operating control
Balance of Payments
Countries seek to offset a current account deficit with foreign investment or an inflow of funds into the capital account
If the current account deficit > capital account surplus, the central bank sells bonds or uses their cash reserves
Can also sell a bond at a very high interest rate to encourage the buying and selling of bonds
The total of a country’s current account, capital account, statistical discrepancy and change in reserves always equals zero
A minus figure indicates an increase in reserves and a plus figure indicates a decrease in reserves
A balance of payments surplus can appreciate the currency making exports more expensive
Excess official reserves can increase inflation and hence rising domestic prices
Seek to inflate the economy, expand the money supply and increase the budget deficit
China buys US debt to pay for exports
A balance of payments deficit indicates that a state’s reserves have been depleted
To adjust the deficit:
Contractionary monetary policy (Central bank increases interest rates to make borrowing more costly, decreases the money supply for loans and sells bonds to withdraw money from the economy)
Deflationary fiscal policy (Lowering government expenditure and raising taxes to withdraw purchasing power from the economy)
Commercial policy (Increasing exports or decreasing imports through tariffs, quotas, export subsidies, etc.)
Finance the deficit
Borrowing from external sources or decreasing foreign exchange reserves
National Debt
Debt owed by the national government (doesn’t include provincial or private debt)
Measured by the ratio of debt-to-GDP
All governments borrow due to cyclical changes in the economy
Example: Canada’s tax revenue is collected at April/May
Example: Canada’s is 36% for their ratio and over $655 billion
Developing countries have better debt-to-GDP ratios which is more appealing for investors

The Birth of a Global Economy
Imperialism and Colonialism
Imperialism
The current global economy is as a result of European imperialism
Definition:
An unequal human and territorial relationship, typically in the form of an empire, based on ideas of superiority and practices of dominance
Example: In 1800, the average European per capita income was 3x larger than that of a country they were going to colonize
By 2000, the average per capita income of someone in a western country is 60x more than someone in a lesser developed country
Colonization
Almost every third world country started as a colony of one of the former imperial powers of Europe or Asia (Britain, France, Belgium, Germany, Spain, Portugal and the Ottoman Empire)
Characteristics of a Third World Country:
Not Communist (Second World) or Capitalist (First World)
Shorter life expectancies, high rates of infant mortality and lower level of education attainment
Average incomes increase after colonialization
The terms of trade tend to favour the colonizing country
Many nationalists argue that by using colonies as sources for raw primary goods and markets for finished manufactured goods, while establishing intra-imperial trade blocs impoverished the third world for first world enrichment
The initial construction of empires facilitates the surplus of transfers
Decolonization
A number of colonies obtained their independence after WW2
Example: Britain gave the Indian subcontinent Independence in 1947
The 1960s saw the independence of African and Caribbean states
Many countries went “backward”
Inequality in income distribution continued after independence between 1950 and 2000
Since 1999, Western states have seen an increase in the transfer of capital, but a slowdown in economic average growth rates
Example: Western States: 1% per annum
Example: Developing countries (with variation) grow around 4% per annum
Neo-Imperialism
Neo-Imperial economic model:
Exporting primary goods for the importing of finished, manufactured goods
During the 1930s Depression era, the fall in First World demand for Third World primary products caused global prices for Latin American exports to fall
Revenue from primary products decline and restricted opportunities for importing manufactured goods
Latin America responded by creating large scale firms and encourage private firms to produce substitutes for goods previously imported
The Global Economy created large returns and developing countries used export revenues to build up their manufacturing sector (as a modern economy)
Imposed an idea of a Western culture to the idea of Independence from the West
Developmental Models
Import Substitution Model (Latin American Model)
Underlying principle is to reduce imports by way of tariffs
Can also use nontariff barriers, such as quotas, content regulations and quality controls
The restrictions raise the price of imported goods to local consumers, by adding a surcharge to the world price (tariffs) or reducing the supply and causing buyers to bid up the price (nontariff barriers)
As the domestic market is relatively small, producers produce at lower volumes and are not able to take advantage of economies of scale
The principle that as volume of output increase, unit product costs decrease
They are not cost minimizing and therefore not efficient
Their prices are higher than those on the world market
The Developmental State Model (Asian Model)
Pioneered by Japan
Followed a Western style model of development, but in a “Japanese” way
The state makes development its top priority, by encouraging people to give up the benefits of growth to maximize investment The state redistributes land if necessary to expand the national market
The state guides the market extensively, exercising strict control over investment
Invests heavily in human-capital formation
Protect local industry
Japan produced to export (manufactured products, such as cars and electronics) and imported primary goods
The State in Modernity/The State in the Economy
There is a large rise of the manufacturing sector in the developing world
Export higher priced manufactured/finished products
The period after decolonization saw the reinforcement of global trade dominated by western countries
Due to import substitution, all countries are fighting for the same primary goods as there are less of them on the market (causes decreases in prices)
The Development of the Modern Global System
Bretton Woods System
Established a gold exchange standard where the value of each country’s currency was pegged to gold or the U.S. Dollar (the key currency)
Based on the assumption that fixed/pegged exchange rates provided monetary stability for international trade, but provided some flexibility so that country’s could focus on inflation or unemployment
Embedded liberal compromise:
All countries other than the US could devalue their currencies under IMF regulation to correct chronic balance of payments issues
Countries could impose national controls over capital flows to limit instability
Capital account liberalization in the 80s/90s opposed that
Governments could exchange US Dollars for Gold
1 ounce = $35 US
Every government began to use the USD for international trade
Allows each country to be sufficiently liquidated (keeping the ability to trade)
The International Monetary Fund (IMF)
Could provide short term loans to countries with balance of payments problems so they could maintain exchange rate stability
Member states had to peg their currencies to Gold or the US Dollar
Member states also contributed to a pool of funds (currencies) to be available for IMF loans
Each member is given a quota based on its relative economic position and that quota determines their voting power and the amount it can borrow from the IMF
Borrowers must agree to certain monetary policies in exchange for loans
Contractionary monetary and fiscal policies
Countries with the largest subscriptions and most votes are the G5:
US, Japan, Germany, France and Britain (as of March 2010 account for 38.2% of the votes)
Monitors the system of pegged or fixed exchange rates to avoid the competitive devaluation of currencies that led to trade wars during the Inter-War period
Members now rely on a managed floating system, where central banks intervene to deal with disruptive conditions, such as excessive fluctuations in exchange rates
General Agreement on Tariffs and Trade (GATT)
Reduce tariffs overtime, but didn’t address non-tariff trade barriers
If you are importing more than you are exporting, a system must be set that changes the way costs are shifted onto those you export goods to
Avoid protectionist strategies
Governments are not allowed to use tariffs to correct balance of payments deficits
Superseded by the World Trade Organization in 1995
The End of the Bretton Woods Monetary System
US Foreign Investment and loans had been a main source of the balance of payments deficits
In 1971 the US had its first balance of trade deficit since 1893 so President Nixon suspended the official convertibility of dollars into gold and imposed a 10% tariff on all durable imports
Caused extreme currency volatility
Crisis in the 1970s
Israel invaded by Syria and Egypt
US couldn’t lose Israel so they backed them financially, but OPEC cut oil exports to the USA and the Netherlands
Results: Oil prices quadrupled (major inflationary shock and set countries into recession)
Keynesian policy was used and flooded the economy with money, but the oil prices rose again in 1979 when Iran reduced the oil supply
Monetary policy used instead to combat inflation
The International Bank for Reconstruction and Development (World Bank)
Provided long term loans for post-war reconstructions of Europe and economic developments in LDCs
Initially did not have a large reconstruction role as the US was fighting Communism
US financed the reconstructions of Europe via the Marshall Plan
Economic recovery was viewed as a pre-requisite for a strong anti-Soviet alliance
Affects the terms on which LDCs gain access to development finance and international capital markets
To be a Bank member, countries must also join the IMF
Members pay 10% of their membership to the International Bank for Reconstruction and Development
The Changing Roles of the IMF and World Bank
Groups that have posed the biggest challenge to North DC dominance:
1960 formation of the Organization of Petroleum Exporting Countries (OPEC)
Can manipulate oil prices
Newly Industrializing Economies (NIEs)
Hong Kong, Singapore, South Korea, Brazil, Mexico
BRIC Economies
Brazil, Russia, India, China
The Organization for Economic Cooperation and Development (OECD)
Has 33 DC members and is committed to liberalizing international transactions
The Evolution of Trade
The Logic of Comparative Advantage
Strategic trade theory focuses on a state’s creation of comparative advantage through industrial targeting
Ricardo’s comparative advantage:
Refers to the ability of a party to produce a particular good or service at a lower opportunity cost
Even if a country has an absolute advantage in all goods, countries will still gain by trading with each other because of the efficiencies of comparative advantage
The Terms of Trade Debate
Intra-Industry trade is where differentiated products are traded within the same industry group
Liberals theorize that intra-industry trade provides benefits, such as economies of scale, varied consumer tastes and the production of manufactured goods
The higher wages in DCs create a larger domestic market for goods, encourage mechanized production and elevate the prices of DC goods
LDCs end up paying more for their imports
The Effects of Trade Liberalization
GATT promoted trade liberalization mainly by lowering tariffs
Between the 1980s to 1995, LDCs were more willing to accept the GATT’s liberal economic principles
The Business Cycle
For Keynesian economists, stimulating demand when it is too low and reducing demand when it is too high stimulates steady growth
Stimulate demand through tax credits, increases in minimum wage and increases in public sector jobs
For Neo-Liberal economists (a combination of neoclassical economics and neo-liberal political theory), regulate the monetary state
If there is excess demand, decrease the money supply or increase it to stimulate demand
At a peak (boom) in the business cycle, it indicates that there is too high of an inflation rate
A trough (slump) indicates too low of an inflation rate
Demand re-enters the economy at the trough and then starts the expansion (recovery) phase
Speculative Bubbles and Crashes
Property bubbles have three distinct phases:
Phase 1: Financial liberalization or the conscious decision by the central bank to increase lending
This expansion in credit is accompanied by rising prices in real estate and stocks
Phase 2: The bubble bursts and asset prices collapse
Phase 3: Firms and other agents default after buying assets at the inflated prices
Crises are usually accompanied by governments either lowering their interest rates to ease the banking crisis or raise them to defend the currency
Finally, a significant decline in output occurs and the recession lasts on average for approximately a year and a half
Examples:
1997 Asian Financial Crisis, 1998 Rouble Crisis, 2000 Dot Com Crisis, 2008 Global Financial Crisis
2008:
Supply of houses increased above the demand, until house values declined by 35-40%
Everyone sold their houses to protect their losses, causing excess supply
Theories of Economic Management: Keynesianism and Structuralism
The Keynesian Model
The Depression led John Maynard Keynes to believe that high unemployment could persist indefinitely without government intervention
Advocated the use of expansionary fiscal policy to deal with recessions
Would not increased inflation because increased investment would occur alongside increased demand
Governments were to save during good times, but spend during bad
Governments were to borrow when necessary
Loans were to be repaid from the earnings generated by a newly robust economy
Shovel ready jobs

Structuralism
Concentrated state action
States had to stimulate industrialization and third world countries had to reduce their dependence on trade with the first world and trade amongst themselves
Raul Prebisch and Hans Singer hypothesis regarding the declining terms of trade for developing countries played a key role
Third world countries had to export one of their primary commodities to maintain their levels of imports of finished goods from the first world
Differences in income elasticities contributed to higher demand for finished goods as income rises, but demand for primary goods did not rise as much with rises in income
The importance of political and institutional factors in the analysis of economic problems
Need to raise the level of domestic saving in order to raise the rate of investment
The Crisis of Keynesianism and the 1980s Debt Crisis
Theories of Economic Management: Neoliberalism
What is Neoliberalism?
Often credited to the economists Frederich Hayek and Milton Friedman
Friedman: By reducing the money supply during times of high inflation and increasing it during times of recession, governments could regulate aggregate demand and maintain economic growth
When interest rates are high, people prefer to invest rather than buy on credit as loans are expensive, so economic activity slows down and inflation decreases
When interest rates are low during recessions, people withdraw money from savings and buy on credit so activity increases
Government should only be concerned with stabilizing monetary growth
Push for free trade, deregulation, privatization, and an overall reduction of government in the economy
The Neoclassical Model
Credited to Margaret Thatcher and Ronald Reagan
Argue against government regulation and taxation whose goal is to redistribute wealth
Free market economies enable individuals to pursue their set interest that will ultimately benefit society
The determination of prices, outputs and income distribution through supply and demand
Mediated through income-constrained utility-maximizing individuals and cost-constrained profit-maximizing firms
Structural Adjustment
The neoclassical recipe for development
Seeks to make the state and the market more efficient in such a way to accelerate growth and eliminate waste/inefficiencies
Structural Adjustment Programs (SAPs)
Included fiscal austerity (government reductions in spending) and disinflationary policies, privatization of state owned enterprises, trade liberalization, currency devaluation and the general deregulation of the economy
Maximizing the free flow of goods and services, maximizing efficiency in the market, privatization raises money for cash-starved governments and reducing spending reduces interest rates so people buy on credit
The 2008 Crash and the Crisis of Neoliberalism
Deregulation seen as a primary cause of the 2008 Financial Crisis
The neoliberalism response to a crisis is to “do nothing” as what does not fail is the most efficient as the model dictates
The 2008 Crisis:
September 2008, Lehman Brothers Investment Bank declared bankruptcy
Doubled the US debt and caused 30 million people to be unemployed
The 1980s Reagan Administration deregulated the Investment Banking Sector of Savings and Loans in 1982 and allowed them to make risky investments
The Clinton Administration allowed banks to acquire monopoly power after risky mergers
Example: Citi Bank and Travellers merged
Crashed in 2001 after internet stocks failed (banks were promoting internet businesses they knew would fail)
The market for Derivatives (technology created during the boom of the economy) became a deregulated $50 trillion US Dollar market
Deregulation allowed Investment Banks to loan out subprime expensive loans with higher interest rates (through the repackaging of loans and mortgages) that people couldn’t afford to pay back
Schools of IPE – Liberalism and Realism
Realism
Favours political security to economic issues
A security dilemma results because even though a state arms itself only for defensive purposes, this may raise fears and contribute to an arms race
Concerned with relative gains and its position alongside other states
Preserve national sovereignty
Realists see the IMF, World Bank and WTO as arenas for acting out power relationships where the most powerful shape the rules to fit their national interests
Realists viewed the Industrial Revolution as essential for a state’s military power, security and economic self-sufficiency
Free trade would be valuable in the long term for states that achieved industrial supremacy
Realist IPE revived after the decline of the Cold War and the subsequent disarray of the global economy
As well as the OPEC price increases and decline of US Hegemony
Hegemonic Stability
Hegemonic stability theory asserts that the international economic system is more likely to be open and stable when a dominant or hegemonic state is willing and able to provide leadership
Major state’s view the hegemon’s policies as relatively beneficial
Britain was a major hegemon during the 19th Century and the US after WW2
Realists view hegemony as an extremely unequal distribution of power in which a single powerful state controls or dominates the lesser states in the international system
Pursuing its own interests rather than the general good
Liberals criticize that while a hegemon can create open regimes, they might not be necessary to maintain them
Status of US Hegemony
Military supremacy has enabled the US to maintain its presence around the world
However, results of the Iraq war show the overestimated nature of the US’s ability to replace coercive regimes with Western style governments
A low savings rate, poor educational system, stagnant productivity and declining work habits contribute to the US’ Hegemonic decline
Liberalism
Orthodox liberals promote negative freedom, or freedom from
Minimum interference from the state for the market to function
Interventionist liberals believe that negative freedom isn’t sufficient because the market doesn’t always provide widespread benefits
Some government involvement to promote equality and justice in a free market economy
Institutional liberals view some outside involvement as necessary to supplement the market
Favour strong international institutions, such as the WTO, IMF and the World Bank
In IPE, liberals give priority to the individual consumer or firm
The international economic system functions best if it ultimately depends on the price mechanisms and the market
Aggregate measures of economic performance (GDP, GNP, etc.) are more important than relative gains