Review and Global Public Goods

1. Review and Global Public Goods International Political Economy Prof. Tyson Roberts

2. Market as freedom:Trade enables Pareto improvements “The possibility of coordination through voluntary co-operation rests on the elementary -- yet frequently denied -- proposition that both parties to an economic transaction benefit from it, provided the transaction is bi-laterally voluntary and informed.” (M. Friedman 1962)

3. Market as freedom:Trade enables Pareto improvements Which outcome is Pareto Efficient? Answer: Offer, Offer (at least one is better off, none are worse off)

4. Public Goods (and Externalities generally) lead to a Coordination Problem

5. Public Good • Nonrival – Use by one person does not prevent use by others • Nonexcludable – once provided, everyone has access

6. Externalities/Spillovers Externality: a cost (negative externality) or benefit (positive externality) that is not transmitted through pricesand is incurred by a party who was not involved as either a buyer, seller, or producer of the goods or services causing the cost or benefit.

7. A farmer considers whether to drill a deeper well into the aquifer in order to grow more pistachios during the droughtShould he? What is the “rational” thing to do?

8. High demand + Low Supply => High PricesRational decision is to drill more during drought! Price S D 5 3 1 Quantity 1 3 2

9. Thousands of farmers tap into the same aquiferIf everyone drills “rationally” the aquifer may eventually dry up:Tragedy of the Commons

10. Market as prison:Trade ONLY allows Pareto improvements “policy is imprisoned not in the sense that it cannot break out of its confinement but in the sense that to release it we must pay ransom” (Lindblom)

11. What are three possible outcomes from drought and farmers digging wells?(According to podcast) • Mad Max (no restraint) • Government Regulation (imposed restraint) • Cooperation (negotiated restraint)

12. But if EVERY farmer chooses to drill => Tragedy of the Commons

13. 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

14. Public Goods can be Local • Aquifer • Local law and order • Education system • Solid waste management • Public road and rail system

15. Public Goods can be National • Political system • National security • Macroeconomic policy – fiscal, monetary, exchange rates • Regulated financial system • Regulation of food safety, water quality, etc. • Interstate road and rail

16. Public Goods can be Global • International security • Protection from asteroids • Stable, secure, and efficient international trade system • Stable, secure, and efficient international financial system • Stable, secure, and efficient international migration system • Prevention of climate change

17. Solutions to cooperation problem • Repeated transaction • Works most easily within small groups • Institutions that enable sharing of information and facilitate “tit-for-tat” strategies can enable cooperation among large groups • Belief system/ideology (focal point) • Also works best in tight-knit communities • Third-party enforcement • E.g., by a imperial power or a hegemonic state

18. Political Economy • Actors and their interests • Grouping of actors with similar interests • Depends in part on coordination costs • Institutions determine outcomes • Losers may strive to change the institutions

19. Greek governments respond to protests with frequent parliamentary electionsYear: Plurality winner (vote share) • 2007: New Democracy (42%) • 2008: Recession begins • 2009: PASOK (43%) • May 2010 & March 2012: 1st and 2nd bailout/austerity agreements • 2012 (May): New Democracy (19%) • No government formed • 2012 (June): New Democracy (30%) • 2014: New Democracy (26%) • 2015 (January): SYRIZA (27%) • August 2015: 3rd bailout/austerity agreement • 2015 (September): SYRIZA (36%)

20. SYRIZA supporters say “This is a really good night, Ms. Merkel” This was in January 2015. Since then, SYRIZA agreed to new bailout/austerity package

21. Deep global governance is not feasible under current conditions; voters unwilling to give up democratic politics at national level Democratic politics Global governance Bretton Woods compromise Hyperglobalization Nation state “Golden Straitjacket”

22. Alternatives for global governance • Global standards • Difficult to pass and enforce • Not always helpful • Basel 1 encouraged short-term borrowing => Asian crisis • Basel 2 relied on credit ranking agencies and banks’ own models to calculate risk => Global crisis • Basel 3 increases liquidity requirements to (hopefully) prevent credit freeze & bank runs • Market-based standards • Information often difficult or compromised (e.g., credit rating agencies)

23. Versions of Capitalist Systems (Rodrik) • Capitalism 1.0: Gold Standard • World Wars & Interwar period • Capitalism 2.0: Bretton Woods • Post-Bretton Woods • E.g., Rodrik’s Capitalism 3.0

24. Financial liberalization post-Bretton Woods associated with both bank failures and income inequality

25. Top earners (1%) income share increased in the US, UK & decreased in many Continental European countries Source: Data from Atkinson, Piketty, and Saez 2011

26. Time for a new version of capitalism? • Capitalism 3.0 (Rodrik’s proposal) • Empower democratic regulation by nation-states • Allow nation-states to protect own social arrangements, regulations, and institutions • Multilateral regimes enforce procedures (e.g., democratic opt-outs), not policies (e.g., free trade) Replace one-size-fits-all policies with country-specific policies

27. Economic effects of globalization • Increased economic activity => economic growth in China, etc. => more cars, factories => more pollution • Increased economic activity => higher income levels in China, etc. => cleaner technologies => less pollution

28. Greenhouse gas emissions, such as CO2, generally increase with economic activity Annual world GDP growth (green) and annual change of CO2 emissions (black) Source: University of Michigan

29. 2014 was the first time since in 40 years of CO2 data collection that CO2 emissions were flat while the economy grew

30. Political effects of globalization • Multilateral Environmental Agreements (MEAs) to achieve goals such as ozone layer protection • WTO rules constrain national governments from enforcing rules regarding process and production methods (PPMs) to protect the environment

31. Increased global CO2 emissions are associated with increased temperatures, …

32. Negative externalities of pollution cross international borders • Acid rain in Japan & South Korea from China’s coal-fired power plants • On some days, 25% of particulates in the Los Angeles atmosphere originated in China • China is largest polluter of the Pacific Ocean • By 2007, China surpassed the US as the world’s largest contributor of CO2

33. Long-term externalities

34. Drastically reduced world emissions can reduce future level of water by up to 0.8 meters (red vs. blue)

35. Potential responses to predicted global warming crisis • International agreement to reduce greenhouse gas emissions • Adaptation to higher temperatures, more severe weather, rising water levels, etc.

36. Challenges to adaptation solution • An estimated 1/3 of cost of global warming can be offset through investment in adaptation • Other 2/3 of costs => higher prices, lower growth, more misery (death, illness, etc.) • Rich countries better able to adapt through investment in new projects, insurance against disasters, healthcare to treat diseases, etc. • Tropical countries (often poor) at more risk than moderate climate countries (often rich)

37. Challenge to international agreement solution:Reduced emissions are a global public good

38. China and the US (the 2 largest emitters of CO2) both want strong economic growth, and both continue to increase emissions

39. Given what the other does, each has an incentive to focus on growth (in the short run)

40. Challenges to international agreement solution • Prisoner’s dilemma • Best choice is to focus on growth. No external enforcer. • Time inconsistency problem • Current generations bear costs, future generations benefit • Targets are goals – not enforceable (no enforcer) • Reducing global warming is a public good • Poor countries can’t afford the investment, don’t have state capacity to enforce targets – need aid from rich • Poor countries: rich countries created problem • Rich countries: poor countries source of rising carbon levels

41. “We need to convince China to adopt the cooperative equilibrium in which everyone taxes carbon. “Starting with a small tax that increases over time, together with the threat that we will revert to the non-cooperative equilibrium without a tax if China does not participate too, may be an effective strategy for inducing cooperation.” - Mankiw

42. Progress?November 12, 2014:China & US reach agreement • The United States intends to achieve an economy-wide target of reducing its emissions by 26%-28% below its 2005 level in 2025. • China intends to achieve the peaking of CO2 emissions around 2030 and to make best efforts to peak early and intends to increase the share of non-fossil fuels in primary energy consumption to around 20% by 2030.

43. Paris Talks • Previous attempt in Copenhagen attempted strict goals and policies • Paris – each country commits to make best effort to own targets and approach • More modest goals, but • More likely to achieve acceptance Replace one-size-fits-all policies with country-specific policies

44. Conclusions • The global distribution of resources and benefits is the result of both market exchange and political institutions • The dynamics of market exchange enables increases in efficiency and the possibilities of material well-being • The efficient functioning of market exchanges depends upon political institutions to solve market imperfections

45. Conclusions • When there are market failures such as coordination problems or externalities (positive or negative), market exchange does not always achieve optimal outcomes • The benefits of market exchange are not equally distributed, and often result from exogenous causes (rich parents, home country with good institutions, lucky timing) rather than merit • Political institutions can help address these issues

46. Conclusions • In order to make decisions that achieve your desired goals, whether in the context of market exchange or politics, it is important to understand how the world works • Hopefully what you have learned in this class will help you do that