Introduction to International Political Economy International Political Economy Prof. Tyson Roberts.

Introduction to International Political Economy

International Political EconomyProf. Tyson Roberts

Lecture Goals

• What is IPE? • Why is IPE important?• Applying the IPE framework to the EU

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Review of concepts

• Utility• Expected utility• Time discounting/present value• Pareto efficiency/optimality• Externalities• Transaction costs• Institutions• Market as freedom vs. market as prison

• “Institutions are the rules of the game in society or, more formally, are the humanly devised constraints that shape human interaction.” (North, 1990)

• In other words, institutions (formal & informal) are like common habits shared in a society that shape how people respond to situations because of expected payoffs

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Takeaways from Rodrik Chapter 1

• Markets & states are substitutes: alternative institutions for allocation & re-allocation of resources

• Markets & states are complements:– States (and interstate arrangements) enable

markets to function, and– Markets efficiently facilitate economic exchange

for states

What is IPE?

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What is IPE?

• Oatley: IPE “studies life in the global economy. It focuses most heavily on the enduring political battle between winners and losers from global economic exchange” (p. 1)

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What is IPE?

• Oatley: IPE “studies life in the global economy. It focuses most heavily on the enduring political battle between winners and losers from global economic exchange” (p. 1)

• Grieco & Ikenberry: “a field whose central concern involves the reciprocal relationships between state interests and power on the one hand, and world market structures and economic dynamics on the other” (p. 3)

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• Y = α + βX + ε• Economic winners Market exchange• Market exchange Politics

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Why is IPE important?

Source: PWT

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Source: WDI

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Source: WDI

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19701971

19721973

19741975

19761977

19781979

19801981

19821983

19841985

19861987

19881989

19901991

19921993

19941995

19961997

19981999

20002001

20022003

20042005

20062007

20082009

2010

-1

0

1

2

3

4

5

6

FDI, % of GDP

Developing economies Transition economies Developed economies

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Source: S&P 500 (Orange) and EuroStoxx 500 (Blue) from Economist, Feb. 6, 2011

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Source: Reinhart and Rogoff 2008

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1820 1829 1838 1847 1856 1865 1874 1883 1892 1901 1910 1919 1928 1937 1946 1955 1964 1973 1982 1991 2000 20090

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20

30

40

50

60

New Immigrants Per 1000 Residents

CanadaAustralia USA

New

Imm

igra

nts p

er 1

000

resid

ents

Source: MPI Data Hub and Angus Maddison

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The Value of Models

Source: Tetlock 2008: Expert Political Judgment

Traditional Schools of IPE

• Mercantilist

• Liberal

• Marxist

Traditional Schools of IPE

• Mercantilist: Actor is the state, interest is accumulating wealth, policy preferences include export promotion & import protection

• Liberal: Actor is the individual, interest is individual welfare maximization, policy preference includes free trade

• Marxist: Actor is the class (capitalist vs. workers), interest for capitalist is to profit maximize, policy preferences include property rights & union busting

Modern Approach to (International) Political Economy is Generalizable

• “Actors”

Who are some actors we might consider in IPE?

(Write down 10)

Actors

• States• Corporations• Individuals• Organizations of states, corporations, or

individuals

State Actors

• Actors within states– Governments (executive & cabinet)– Legislatures– Bureaucracies

• States as national economies– Large vs small– Rich vs poor– Lenders vs borrowers– Manufacturing-based vs. farming-based

• Organizations of states– UN, WTO, IMF, EU, ASEAN, etc.

Corporation Actors

• Actors within corporations– Shareholders– Management– Employees

• Corporation sectors– Manufacturers– Financial services– Non-financial services

• Organizations of corporations– Chambers of Commerce, industry groups, etc.

Individual Actors

• Consumers• Workers/Employees• Borrowers • Investors and lenders• Tax-payers• Government service recipients• Voters• Politicians• Landlords• Renters• Organizations of individuals: unions, associations, parties, etc.

Actors, Interests, & Policy Preferences

• Actor: Borrowers– Governments, economies, firms, or individuals

• Interest: Want easy & cheap access to credit• Policy Preference: Low interest rates, loose

conditions, no penalties

Actors, Interests, & Policy Preferences

• Actor: Lenders– Governments, economies, firms, or individuals

• Interest: Want high returns & low risk• Policy Preference: High interest rates, strict

conditions, tough penalties

Preference intensity

• Individuals have many attributes• For example, I am …– A borrower – A lender – An investor – A consumer– An employee – An employer– A tax payer– A government services recipient

Preference intensity

Which of my attributes will determine my (most intense) policy preferences?

Policy preference intensity

An actor’s (most intense) policy preferences are determined by

1. Susceptibility of attributes/assets to policy2. Concentration & functional specificity of

attributes/assets3. Ideology

Groups, institutions, & outcomes

• Some actors will act as groups– Similar interests– Few collective action problems

• Group size, enforcement mechanisms, etc.

• Institutions (as cause)– help determine which actors will group together, and– which groups will achieve preferred policy

• Institutions (as effect)– Groups dissatisfied with policy outcome will attempt to

change political institutions

Continental Break-up podcast

• Who are the primary actors?• What are their interests?• What are their policy preferences?• How do they group together?• What are the institutions that dictate

outcomes?

EU Example, Part I

• Lender countries prefer strict rules (Germany wanted United States of Europe), low inflation rates

• Borrower countries prefer loose rules, domestic sovereignty, care less about inflation

• EU institution: Treaty among sovereign nations– Formal: consensus, each state has equal votes (Germany wants peace

& customers, willing to accept smaller countries as equal partners)

• Policy outcome: Maastricht Treaty: Moderately strict rules with no teeth

Examples of Consensus Institutions

• Voluntary and informed decisions => Pareto improvements

• Market exchange. Actors: transacting parties• Treaty. Actors: sovereign nations• Policy change. Actors: institutional veto

players

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Introduction of Euro reduced borrowing costs for many “less developed” European economies

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When investors realized/were told indebted countries could default (Maastricht Treaty doesn’t include

bailouts), interest rates rose => vicious cycle, crisis

EU Example, Part II

• Crisis =>– Large negative effect on borrowers (& lenders, less so)

• Pressure to change policy:– Lender countries want more teeth

• Institution – Formal: consensus – Informal: negotiating power of lenders was increased

• New policy proposal: – More information & more teeth

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Market as freedom:Trade enables Pareto improvements

PIMCO

Offer loans Sit on cash

Greece Borrow & invest/ spend

4, 4 2, 2

Live on modest means

2, 2 2, 2

In good market conditions, win/win transactions are readily available

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Market as Prison:In crisis, PIMCO’s pursuit of profits undermines

Greek democratic autonomy

Austerity

High spending budget

Withdraw funds

Lend

G

P

P: ExitG: Default

P: Low ReturnG: Continue spending

Withdraw funds

Lend

P

P: ExitG: Default

P: Higher returnG: Avoid default

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Solving sequential games in game theory

• Players make choices sequentially• Payoffs are result of choices made by each

player• To solve, look at last move first and work

backwards• Subgame perfect equilibrium: Actions each

player would choose at each decision node

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PIMCO can choose to withdraw funds (Exit) or continue lending (Loyalty) after seeing Greece’s

policy decision

Austerity


Withdraw funds

Lend

G

P

P: ExitG: Default

P: Low ReturnG: Continue spending

Withdraw funds

Lend

P

P: ExitG: Default

P: Higher returnG: Avoid default

Numerical values for payoffs

Greece• Best outcome: Continue

high spending (and avoid default) = +1

• 2nd best: Avoid default (but austerity) = -1

• 3rd best: Default = -3

Pimco• Best outcome: High returns

= +1• 2nd best: Exit (and invest

elsewhere) = 0• 3rd best: Low returns = -1

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PIMCO’s Loyalty payoff is better than the Exit payoff if Greece chooses Austerity

Austerity

Withdraw funds

Lend

G

P

P: 0G: -3

P: -1G: 1

Withdraw funds

Lend

P

P: 0G: -3

P: 1G: -1


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PIMCO’s Exit payoff is better than the Loyalty payoff if Greece chooses to Continue spending

Austerity

Withdraw funds

Lend

G

P

P: 0G: -3

P: -1G: 1

Withdraw funds

Lend

P

P: 0G: -3

P: 1G: -1


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Step 1: Last player chooses best payoff from each node

Austerity

Withdraw funds

Lend

G

P

P: 0G: -2

P: -1G: 1

Withdraw funds

Lend

P

P: 0G: -3

P: 1G: -1


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Step 2: Replace decision nodes with payoffs from players best choice

Austerity

Withdraw funds

Lend

G

P

P: 0G: -2

P: -1G: 1

Withdraw funds

Lend

P

P: 0G: -3

P: 1G: -1

P: 1G: -1

P: 0G: -2


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Step 3: Previous player chooses best payoff from each node (in this case the only node)

Austerity

Withdraw funds

Lend

G

P

P: 0G: -2

P: -1G: 1

Withdraw funds

Lend

P

P: 0G: -3

P: 1G: -1

Subgame Perfect Equilibrium:• G: Austerity, P: Lend if Austerity,

Withdraw if Spend

P: 1G: -1

P: 0G: -2


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Subgame Perfect Equilibrium:G: Austerity,

P: Lend if Austerity, Withdraw if Spend

Austerity

Withdraw funds

Lend

G

P

P: 0G: -2

P: -1G: 1

Withdraw funds

Lend

P

P: 0G: -3

P: 1G: -1

P: 1G: -1

P: 0G: -2


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Because PIMCO has a viable exit option, Greece is under pressure to accept conditions

Austerity

Withdraw funds

Lend

G

P

P: 0G: -2

P: -1G: 1

Withdraw funds

Lend

P

P: 0G: -3

P: 1G: -1

P: 1G: -1

P: 0G: -2

Investors’ economic freedom imprisons democratic government


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Other sources of funds, such as domestic taxpayers, may not have an attractive exit option

(e.g., jail if don’t pay taxes)

Austerity, low taxes

High spending, high taxes

Stop paying taxes

Pay taxes

G

C

C: -2G: -2

C: -1G: 1

SOLVE!

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Stop paying taxes

Pay taxes

C

C: -2G: -3

C: 1G: -1

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Other sources of funds, such as domestic tax payers, may not have an attractive exit option (e.g., jail if don’t pay taxes)

Government can then use spending to buy political support

Austerity, low taxes

ContinueSpending, high taxes

Stop paying taxes

Pay taxes

G

C

C: -2G: -2

C: -1G: 1

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Stop paying taxes

Pay taxes

C

C: -2G: -3

C: 1G: -1

Subgame Perfect Equilibrium:• G: Spend, C: Pay if Austerity, Pay if

Spend

Lack of economic freedom undermines political freedom

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A generalized view of IPE actors

• Businesses & investors can influence government (as can any other group)

• Governments can command and induce businesses (as they can any other group)

• Capitalism can therefore protect or undermine democracy, depending in part on the distribution of economic resources and the institutional environment

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When actors have more influence

• Government relies heavily on actor’s loyalty • Actor has viable exit options– Investors: global capital markets enable exit by

withdrawing funds– Citizens: competitive democracy enables “exit”

from loyalty to government if citizens can act collectively

The latest: Anti-austerity SYRIZA party poised to win Greek election on Jan. 25

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Some takeaways

• Markets & states are substitutes: alternative institutions for allocation & re-allocation of resources

• Markets & states are complements:– States (and interstate institutions) enable markets to

function, and– Markets efficiently facilitate economic exchange for states

• If current institutions deliver outcomes unsatisfactory to actors, actors can sometimes change institutions

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Some more takeaways

• Actors with Exit options have more Voice if they also have valuable resources

• Actors without Exit options (or w/o valuable resources) may be resigned to Loyalty

• Democracy reduces transaction costs => Voice• If Exit options for private resource-holders are

lacking, this may undermine democracy• If a minority has most resources + Exit options,

this may also undermine democracy

More takeaways

• IPE affects economics and politics for everyone in an increasingly globalized world

• The IPE method – Actors’ interests => policy preferences, which

interacts w/ institutions to determine group formation.

– Groups then interact w/ institutions => policy outcomes and/or new institutions

• The modern IPE method can capture the 3 traditional IPE schools and beyond

Final takeaways

• In Europe, everyone’s interests favored the Euro, until the crisis. – Rational? – Imperfect information? – Time horizons?

Introduction to International Political Economy International Political Economy Prof. Tyson Roberts.

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Transcript of Introduction to International Political Economy International Political Economy Prof. Tyson Roberts.