The Politics of International Economic Relations : Session 5 21 November 2006

1. The Politics of International Economic Relations: Session 521 November 2006

2. Overview • Domestic sources of foreign economic policies (Michael Hiscox) • Policy Preferences (Interests) • Institutions • Extensions (Ideas, Information, Issue-Linkage, multi-level games)

3. Preferences • „When it comes to taking positions on how to regulate ties with the global economy, individuals and groups are fundamentally concerned with how different policy choices affect their incomes“ • Political Debates on Trade Openness • Mutual gains, yet trade creates winners and losers • Insights from Economic Trade Theory • Heckscher-Ohlin model • Stolper-Samuelson model

4. Eli Heckscher and Bertil Ohlin (H-O Model) - 1930 Assumptions: • Constant economies of scale • Production technology free available • Endowments of different factors of production (land, labor and capital) • Factor proportion as comparative advantage Predictions: • A country exports products where factors are abundant, e.g. capital-rich countries will export capital-intensive products • Trade benefits sectors which are export-oriented and weakens import-competing sectors • Exports of agricultural products (Aus, Can), exports of textiles and footwear (India, China), exports of automobiles and pharmaceuticals (US, EU, Japan)

5. Wolfgang Stolper and Paul Samuelson - 1941 • Likely effects of trade on real incomes of different sets of individuals within an economy • Trade benefits owners of production factors with which the economy is well endowed, trade hurts owners of scarce factors • Explains why trade is such a divisive political issue • Simple, elegant predictions for lobbying

6. Ricardo-Viner • Empirical observation (e.g. workers and owners in the same industry lobbying jointly) • Specificity of production factors (Stolper-Samuelson theorem assumes factors of production to be highly mobile between different industries) • Specific factor approach dominant to derive trade policy preferences

7. The repeal of the Corn Laws • Stolper-Samuelson Theorem • Protectionist laws on imports of various grains • Defended by landowning elite (land) • Pressure from manufactures (e.g. textile), want to lower tariffs (Richard Cobden) „You must untax people‘s bread“ • Urban middle and working classes (labor) • External shock (potato crop failure in 1945)

8. Issue Areas • Trade • Immigration • Foreign Investment • Exchange Rates

9. Immigration • Historically more controversial than trade or investment • Economically non-sense (yet what matters is who gains and who looses) • E.g. China comparative advantage in labor-intensive exports but also naturally suppliers of emigrants • Effects of immigration in the local economy (depending on their skills) • Low-skill immigration will hurt local low-skilled workers, but will raise earnings for local owners of land, capital and skills… • In a factor-proportion analysis • Yet, non-economic preferences strong!

10. Foreign Investment • Financial transactions between citizens of different nations that transfer ownership rights over assets: buying companies (to use as a subsidiary), buying shares of foreign companies, or bank lends money to foreign firms • Dramatic increase in volumes (role of portfolio investments: short term flows of capital, e.g. purchase of company shares, government bonds, etc). • Influence on national monetary and exchange-rate policies • Long-term FDI (purchase of foreign assets) political controversial (economic leverage) • Controls in short- and long-term FDI common • The economic case for free flow of investments • Also substitute for exports in capital-intensive goods and services

11. Foreign Investment • Distinction between short-term and long-term FDI • In the latter case, H-O prediction weak (most FDI between industrial economies, intra-firm trade) – new trade theories • The role of high-tariffs – tariff-jumping (Japanese car companies in Europe and US) • Factor-proportion approach: • Inflow of foreign capital: increase local supply of capital • Lower returns for local owners of capital, raise earning for owners of land and labor)

12. Foreign Investment • Yet, when capital is “specific”, not only capital owners but also local land owners and labor might object • Pressure for domestic-content laws (rules of origin), see role of United Auto Workers Union (also suspicious of labor rights in new firms…) • FDI in developing countries (sketchy view…) • Preferences on controlling capital export (e.g. workers and land owners)

13. Exchange Rates • Prior to WW1: gold standard (and other bullion) • Between WW2 and 1973: currencies fixed to the US$ (and fixed 35$ per ounce) • After that most currencies fluctuate freely, exception EU (stabilize exchange rates at the regional level) • Developing nations: many governments fix to US$ and other currencies (e.g. currency boards) • Between pure float and fixed exchange rate

14. Exchange Rates • No consensus among economists • Fixed exchange rates: Ceding control of monetary policy, control of fluctuation for economic activity (stability) • Example: • country‘s balance of payments (value of transactions with the rest of the world) influence supply of money • deficit means excess demand for foreign currencies • in order to maintain the exchange rate the government will be a net buyer of its own currency • sell off its reserves of foreign currency (or gold) • total supply of the nation‘s money in circulation decreases... • also limited tools when „importing recession“

15. Exchange Rates • Thus, fixed exchange rate regimes mean limited control over monetary policy • Monetary policy allows to influence supply of money, cost of credit, inflation and unemployment • During recessions expanding money and lowering costs of credit • This leads to an increase in economic activity and promotes job creation (inverse in boom cycle) • Choice between stability and policy control

16. Exchange Rates • OECD world more in favor for keeping monetary policy, developing countries more in favor for fixed exchange rates • Stolper-Samuelson • Exchange-rate volatility is a barrier to international trade and investment • Owner of locally abundant factors are more likely to prefer a fixed exchange rates – owners of locally scarce factors prefer floating rate • Empirical Record is mixed

17. Institutions • Interest are channeled through institutions, interest aggregation (collective action) • Elections and representation • Extending voter power to the middle and working classes • Electoral systems • proportional vs. majoritarian • size of electoral districts • Referenda • local vs. national interests, see US Senate and US House

18. Institutions • Legislatures and policy-making rules • Political parties • Number of parties in a government • Institutional setting (Executive and Parliament) • US Experience • US Trade Policy (Smoot-Hawley Tariff Act of 1930 (log rolling: vote trading between protectionist interests). The Senate made 1253 amendments to the original bill • Cordell Hull: 1934 Reciprocal Trade Agreements Act (granting authority to the president for 3 years to negotiate alterations up to 50% of existing import duties) • 1974 fast-track procedures • Today Trade Promotion Authority

19. EU trade policy Decision-making process Council &Member States Commission European Parliament Initiation Art. 133 Com Commission COREPER 1 1b EP GAERC 2 3 Negotiation Art. 133 Com Commission 4 3a 5 EP Commission GAERC 6 7 9 8a/8b Ratification GAERC EP 8c MS t Adapted from Elsig 2002

20. Institutions • Bureaucratic Agencies (Agent-Principal theories on delegation) • Delegation • Control • Advisory Committees

21. Extensions • Information (full and complete information?, believes in cause-and-effect relationship) • Keynes (1936): „The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else“ • To what degree are ideas independent from interests? (Hiscox)

22. Extensions • Combination of Economic Policies • Other foreign policy interests: • Security Interests • Geopolitical interests • Development and Aid policies (e.g. Strong NGOs!) • Exporting models

23. Extensions • Multi-level games • International bargaining and domestic politics • Robert Putnam‘s Two Level Game (Plaza Accord) • National Preferences define win-sets (acceptable outcomes) • Bargaining process (the role of negotiators, negotiations at two tables)

24. Missing Extensions • Statism • The role of ideas (as Constructivists would see it) • The role of non-economic policy interests • The way institutions constrain interest competition (e.g. multi-level EU system)