Chapter 1: International Political Economy PDF

# Chapter 1 ## International Political Economy How does the global economy affect your life - and yours? One of the most obvious ways in which the global economy matters is through the impact it has on the items we consume. Because of international trade, grocery stores can keep a wide variety of...

# Chapter 1 ## International Political Economy How does the global economy affect your life - and yours? One of the most obvious ways in which the global economy matters is through the impact it has on the items we consume. Because of international trade, grocery stores can keep a wide variety of fresh fruits and vegetables in stock throughout the year. When we shop for clothing, we find that global production and increased trade in the apparel industry have helped to reduce the prices that American shoppers pay for clothing and footwear. The same is true in the technology industries. Your smartphone, as well as the notebook computer that you are using to write this book, are "American" products, but they carry lower prices precisely because their production processes have been organized globally - designed in America, manufactured and assembled largely outside of the United States. And when it comes time for you to purchase a new car, the fact that your country participates in the global economy ensures that you have a wide range of brands to choose from - European, Japanese, South Korean, American, and probably soon Chinese. The global economy thus makes the consumers in us better off by reducing the prices of the goods and services we buy and expanding the range of choices we have. Living in a global economy also means that global economic forces play a much larger role in determining many of your career opportunities today than they did a few decades ago. Twenty-five years ago, manufacturing industries made high-paying jobs available that provided Americans a middle-class lifestyle. In many southern states, for instance, textile and apparel mills provided jobs for two if not three generations of workers. In the Great Lakes region, steel mills and the huge automobile factories built by Ford, GM, and Chrysler did the same. Today, many of these opportunities have disappeared and much of this loss has occurred as a consequence of international trade. At the same time, the opportunity to find work in a service industry and in high technology has increased dramatically. Medical care, computer design, Internet-based businesses, biotechnology, finance, and high-technology manufacturing industries all have emerged as large growing employers of the American work force since 1980. Thus, the opportunities available today are far different today than they were a quarter-century ago. The global economy has played a central role in bringing about these changes. ## International Political Economy International political economy (IPE) studies how politics shape developments in the global economy and how the global economy shapes politics. It focuses most heavily on the enduring political battle between the winners and losers from global economic exchange. Although all societies benefit from participation in the global economy, these gains are not distributed evenly among individuals. Global economic exchange raises the income of some people and lowers the income of others. The distributive consequences of global economic exchange generate political competition in national and international arenas. The winners seek deeper links with the global economy in order to extend and consolidate their gains, whereas the losers try to erect barriers between the global and national economies in order to minimize or even reverse their losses. IPE studies how the enduring political battle between the winners and losers from global economic exchange shapes the evolution of the global economy. This chapter introduces IPE as a field of study. It begins by providing a broad overview of the substantive issues that IPE examines and the kinds of questions scholars ask when studying these issues. The chapter then briefly surveys a few of the theoretical frameworks that scholars have developed in order to answer the questions they pose. The chapter concludes by looking at the emergence of a global economy in the late nineteenth century in order to provide a broader context for our subsequent focus on the contemporary global economy. ## What is International Political Economy? IPE studies the political battle between the winners and losers of global economic exchange. Consider, for example, the decision by the Trump administration to raise tariffs on softwood lumber imported from Canada in April 2017. The decision to raise tariffs was prompted by lobbying by American lumber mills and timberland owners. The U.S. Lumber Coalition pressed for higher tariffs on Canadian lumber because they were losing trade. Imported Canadian lumber was capturing a large share of the American market, resulting in mill closings and layoffs, and higher tariffs would protect American lumber from competition, thereby reducing the number of American mills in distress. The higher tariff on Canadian lumber had negative consequences for other groups in society, however. The tariff hurt American industries that use lumber to produce goods, such as home builders, because these firms had to pay more for wood. Higher lumber prices would cause home prices to rise, higher prices would cause demand for new homes to fall, and as many as 8,200 jobs would disappear. The tariff hurt Canadian lumber producers, who could sell less lumber in their largest market. Groups that suffered from the lumber tariff turned to the political system to try to reverse the decision. In the United States, The National Association of Home Builders pressured the Trump administration and Congress to reduce and even remove the tariff. The Canadian government responded to pressure from its producers by imposing a tariff on American gypsum (drywall) exported into Canada and is currently considering retaliatory tariffs on American coal and a variety of products made in Oregon (the home to an American Senator who has been a strident advocate of the U.S. tariff on Canadian lumber). As this dispute escalates, it could wind up eventually as an investigation within the World Trade Organization (WTO) the international organization with responsibility for trade disputes or become a central component of a renegotiated North American Free Trade Agreement (NAFTA). The story of the U.S. tariff on Canadian lumber thus nicely illustrates the central focus of international political economy as a field of study: how the political battle between the winners and losers of global economic exchange shapes the economic policies that governments adopt. The softwood lumber tariff dispute also highlights the many distinct elements that IPE must incorporate to make sense of the global economy. To fully understand the dispute, we need to know something about the economic interests of the businesses and workers who produce and consume lumber. Understanding these interests requires us to know economic theory. Moreover, we need to know something about how political processes in the United States transform these economic interests into trade policy. This requires knowledge of the American political system and the American trade policy process. In addition, we need to know something about how a policy decision made by the United States affects businesses and workers based in other countries (more economic theory for this), and we need to know how the governments in those countries are likely to respond to these consequences (which requires knowledge about the political systems in the various countries). Finally, we need to know something about the role that international economic organizations like the WTO and NAFTA play in regulating the foreign economic policies that governments adopt. Thus, understanding developments in the global economy requires us to draw on economic theory, explore domestic politics, examine the dynamics of political interactions between governments, and familiarize ourselves with international economic organizations. Even though such an undertaking may seem daunting, this book introduces you to each of these elements and teaches you how to use them to deepen your understanding of the global economy. One way scholars simplify the study of the global economy is to divide the substantive aspects of global economic activity into distinct issue areas. Typically, the global economy is broken into four such issue areas: the international trade system, the international monetary system, multinational corporations (or MNCs), and economic development. Rather than studying the global economy as a whole, scholars will focus on one issue area in relative isolation from the others. Of course, it is somewhat misleading to study each issue area independently. MNCs, for example, are important actors in the international trade system. The international monetary system exists solely to enable people living in different countries to engage in economic transactions with each other. It has no purpose, therefore, outside consideration of international trade and investment. Moreover, problems arising in the international monetary system are intrinsically connected to developments in international trade and investment. Trade, MNCs, and the international monetary system in turn all play important roles in economic development. Thus, each issue area is deeply connected to the others. In spite of these deep connections, the central characteristics of each area are sufficiently distinctive that one can study each in relative isolation from the others, as long as one remains sensitive to the connections among them when necessary. We will adopt the same approach here. The international trade system is centered upon the WTO, to which some 164 countries belong and through which they have created a nondiscriminatory international trade system. In the international trade system, each country gains access to all other WTO members' markets on equal terms. In addition, the WTO and its predecessor, the General Agreements on Tariffs and Trade (GATT), have enabled governments to progressively eliminate tariffs and other barriers to the cross-border flow of goods and services. As these barriers have been dismantled, world trade has grown steadily. Today, goods and services worth about $7.6 trillion flow across national borders each year. During the last 10 years, however, regional trading arrangements have arisen to pose a potential challenge to the WTO-centered trade system. These regional trade arrangements, such as the NAFTA, are trading blocs composed of a small number of countries who offer each other preferential access to their markets. Scholars who study the international trade system investigate how the political battle between the winners and losers of global economic exchange shapes the creation, operation, and consequences of the WTO-centered system and the emerging regional trading frameworks. The international monetary system enables people living in different countries to conduct economic transactions with each other. People living in the United States who want to buy goods produced in Japan must be able to price these Japanese goods in dollars. In addition, Americans earn dollars, but Japanese spend yen, so somehow dollars must be converted into yen for such purchases to occur. The international monetary system facilitates international exchange by performing these functions. When it performs these functions well, international economic exchange flourishes. When it doesn't, the global economy can slow or even collapse. Scholars who study the international monetary system focus on how political battles between the winners and losers of global economic exchange shape the creation, operation, and consequences of this system. Multinational corporations occupy a prominent and often controversial role in the global economy. A multinational corporation is a firm that controls production facilities in at least two countries. The largest of these firms are familiar names such as Ford Motor Company, General Electric, and General Motors. The United Nations estimates that there are more than 82,000 MNCs operating in the contemporary global economy. These firms collectively control about 810,000 production plants and employ about 77 million people across the globe. Together, they account for about one-quarter of the world's economic production and about one-third of the world's trade. MNCs shape politics because they extend managerial control across national borders. Corporate managers based in the United States, for example, make decisions that affect economic conditions in Mexico and other Latin American countries, in Western Europe, and in Asia. Scholars who study MNCs focus on a variety of economic issues, such as why these large firms exist and what economic impact they have on the countries that host their operations. Scholars also study how the political battle between the winners and losers of MNC activity shapes government efforts to attract and regulate MNC activities. Finally, a large body of literature studies economic development. Throughout the postwar period, developing-country governments have adopted explicit development strategies that they believed would raise incomes by promoting industrialization. The success of these strategies has varied. Some countries, such as the Newly Industrializing Countries (NICs) of East Asia (Taiwan, South Korea, Singapore, and Hong Kong) have been so successful in promoting industrialization and raising per capita incomes that they no longer can be considered developing countries. Other countries, particularly in sub-Saharan Africa and in parts of Latin America, have been less successful. Governments in these countries adopted different development strategies than the NICs throughout much of the postwar period and realized much smaller increases in per capita incomes. Students of the politics of economic development focus on the specific strategies that developing countries' governments adopt and attempt to explain why different governments adopt different strategies. In addition, these students are concerned about which development strategies have been relatively more successful than others (and why), and about whether participation in the international economy facilitates or frustrates development. In trying to make sense of these aspects of development, IPE scholars emphasize how the political battle generated by the distributive consequences of the global economy shapes the development strategies that governments adopt. Those who study the global economy through the lens of IPE are typically interested in doing more than simply describing government policies and contemporary developments in these four issue areas. Most scholars aspire to make more general statements about how politics shape the policies that governments adopt in each of these issue areas. Moreover, most scholars want to draw more general conclusions about the consequences of these policies. As a result, two abstract and considerably broader questions typically shape IPE scholarship. First, how exactly does politics shape the decisions that societies make about how to use the resources that are available to them? Second, what are the consequences of these decisions? Because these two overarching questions are central to what we cover in this book, it is worth taking a closer look at each of them now. How does politics shape societal decisions about how to allocate available resources? For example, how does a society decide whether to use available labor and capital to produce semiconductors or clothing? Although this question might appear quite remote from the issue areas just discussed, the connections are actually quite close. The foreign economic policies that a government adopts-its trade policies, its exchange rate policies, and its policies toward MNCs-affect how that society's resources are used. A decision to raise tariffs, for example, will encourage business owners to invest and workers to seek employment in the industry that is protected by the tariff. A decision to lower tariffs will encourage business owners and workers currently employed in the newly liberalized industry to seek employment in other industries. Decisions about tariffs, therefore, affect how society's resources are used. Foreign economic policies are, in turn, a product of politics, the process through which societies make collective decisions. Thus, the study of IPE is in many respects the study of how the political battle between the winners and losers of global economic exchange shapes the decisions that societies make about how to allocate the resources they have available to them. These decisions are complicated by two considerations. On the one hand, all resources are finite. As a result, choices about how to allocate resources will always be made against a backdrop of scarcity. Any choice in favor of one use, therefore, necessarily implies a choice to forgo another possible use. On the other hand, in every society, groups will disagree about how available resources should be used. Some groups will want to use the available resources to produce cars and semiconductors, for example, whereas others will prefer to use these resources to produce clothing and agricultural products. Societies, consequently, will always confront competing demands for finite resources. One of the important goals of IPE as a field of study is to investigate how such competing demands are aggregated, reconciled, and transformed into foreign economic policies. The second abstract question asks: What are the consequences of the choices that societies make about resource allocation? These decisions have two very different consequences. Decisions about resource allocation have welfare consequences-that is, they determine the level of societal well-being. Some choices will maximize social welfare—that is, they will make society as a whole as well-off as possible, given existing resources. Other choices will cause social welfare to fall below its potential, in which case different choices about how to use resources would make society better off. Decisions about resource allocation also have distributional consequences-that is, they influence how income is distributed between groups within countries and between nations in the international system. Welfare and distributional consequences are both evident in the American lumber tariff. Because the tariff makes it more profitable to produce lumber in the United States than it would be otherwise, some investment capital and workers, who might otherwise be employed in highly efficient American industries such as information technology or biotechnology, will be used in the less efficient American softwood lumber industry. The tariff thus causes the United States to use too many of its resources in economic activities that it does less well and too few resources in activities that it does better. As a consequence, the United States is poorer with a high tariff on lumber than it would be without it. The lumber tariff also redistributes income. Because the tariff raises the price of lumber in the United States, it redistributes income from the consumers of lumber, such as American homebuilders that use lumber in buildings and American consumers who purchase these homes, to the American lumber mills. In addition, because the tariff makes it more difficult for Canadian mills to sell in the American market, it redistributes income from Canadian producers to American producers. The tariff on Canadian lumber, like many economic policies, affects both the level and the distribution of income within a society. These two abstract questions give rise to two very different research traditions within IPE. One tradition focuses on explanation, and the second focuses on evaluation. Explanatory studies, which relate most closely to our first abstract question, are oriented toward explaining the foreign economic policy choices that governments make. Such studies most often attempt to answer "why" questions. For example, why does one government choose to lower tariffs and open its economy to trade, whereas another government continues to protect the domestic market from imports? Why did governments create the WTO? Why do some governments maintain fixed exchange rates whereas others allow their currencies to float? Why do some governments allow MNCs to operate in their economies with few restrictions, whereas other governments attempt to regulate MNC activity? Each of these questions asks us to explain a specific economic policy choice made by a government or to explain a pattern of choices within a group of governments. In answering such questions, we are most concerned with explaining the policy choices that governments make and pay less attention to the welfare consequences of these policy choices. Evaluative studies, which are related most closely to our second abstract question, are oriented toward assessing policy outcomes, making judgments about them, and proposing alternatives when the judgment made about a particular policy is a negative one. A welfare evaluation is interested primarily in whether a particular policy choice raises or lowers social welfare. For example, does a decision to liberalize trade raise or lower national economic welfare? Does a decision to turn to the International Monetary Fund (IMF) and accept a package of economic reforms promote or retard economic growth? More broadly, do current policies encourage society to use available resources in ways that maximize economic welfare, or would alternative policies that encouraged a different allocation result in higher economic welfare? Because such evaluations are concerned with the economic welfare consequences of policy outcomes, they are typically based on economic criteria and rely heavily upon economic theories. Scholars also sometimes evaluate outcomes in terms that extend beyond narrow considerations of economic welfare. In some instances, scholars evaluate outcomes in terms of their distributional consequences. For example, many nongovernmental organizations are highly critical of international trade because they believe that workers lose and business gains from trade liberalization. Implicit in this criticism is an evaluation of how global trade distributes income across groups within countries. Evaluations may also extend the frame of reference within which outcomes are evaluated beyond purely economic efficiency. For example, even those who agree that international trade raises world economic welfare might remain critical of globalization because they believe that it degrades the environment, disrupts traditional methods of production, or has other negative social consequences that outweigh the economic gains. Explanation and evaluation both play an important role in international political economy. This book, however, focuses primarily upon explanation and, secondarily, upon evaluating the welfare consequences of government policies. ## Studying International Political Economy Scholars working within the field of IPE have developed a large number of theories to answer the two questions posed earlier. Three traditional schools of political economy-the mercantilist school, the liberal school, and the Marxist school-have shaped the development of these theories over the last 100 years. Each of these three traditional schools offers distinctive answers to the two questions, and these differences have structured much of the scholarly and public debate about IPE. Although the three traditional schools remain influential, more and more often, students of IPE are developing theories to answer our two questions from outside the explicit confines of these traditional schools. One prominent approach, and the approach that is developed throughout this book, suggests that the foreign economic policies that governments adopt emerge from the interaction between societal actors' interests and political institutions. We begin our examination of how people study IPE with a broad overview of these alternative approaches. We look first at the three traditional schools, highlighting the answers they provide to our two questions and pointing to some of the weaknesses of these schools that have led students to move away from them. We then examine the logic of an approach based on interests and institutions in order to provide the background necessary for the more detailed theories that we develop throughout the book. ## Traditional Schools of International Political Economy Historically, theories of IPE have been developed in three broad schools of thought: mercantilism (or nationalism), liberalism, and Marxism. **Mercantilism** is rooted in seventeenth- and eighteenth-century theories about the relationship between economic activity and state power. The mercantilist literature is large and varied, yet mercantilists generally do adhere to three central propositions (see, e.g., Viner 1960; Heckscher 1935). First, the classical mercantilists argued that national power and wealth are tightly connected. National power in the international state system is derived in large part from wealth. Wealth, in turn, is required to accumulate power. Second, the classical mercantilists argued that trade provided one way for countries to acquire wealth from abroad. Wealth could be acquired through trade, however, only if the country ran a positive balance of trade, that is, if the country sold more goods to foreigners than it purchased from foreigners. Third, the classical mercantilists argued that some types of economic activity are more valuable than others. In particular, mercantilists argued that manufacturing activities should be promoted, whereas agriculture and other non-manufacturing activities should be discouraged. “Modern” mercantilism applies these three propositions to contemporary international economic policy: 1. Economic strength is a critical component of national power. 2. Trade is to be valued for exports, but governments should discourage imports whenever possible. 3. Some forms of economic activity are more valuable than others. 4. Manufacturing is preferred to the production of agricultural and other primary commodities, and high-technology manufacturing industries such as computers and telecommunications are preferable to mature manufacturing industries such as steel or textiles and apparel. The emphasis on wealth as a critical component of national power, the insistence on maintaining a positive balance of trade, and the conviction that some types of economic activity are more valuable than others leads mercantilists to argue that the state should play a large role in determining how society’s resources are allocated. Economic activity is too important to allow decisions about resource allocation to be made through an uncoordinated process such as the market. Uncoordinated decisions can result in an “inappropriate” economic structure. Industries and technologies that may be desirable from the perspective of national power might be neglected, whereas industries that do little to strengthen the nation in the international state system may flourish. In addition, the country could develop an unfavorable balance of trade and become dependent on foreign countries for critical technologies. The only way to ensure that society’s resources are used appropriately is to have the state play a large role in the economy. Economic policy can be used to channel resources to those economic activities that promote and protect the national interest and away from those that fail to do so. **Liberalism**, the second traditional school, emerged in Britain during the eighteenth century to challenge the dominance of mercantilism in government circles. Adam Smith and other liberal writers, such as David Ricardo (who first stated the modern concept of comparative advantage), were scholars who were attempting to alter government economic policy. The theory they developed to do so, liberalism, challenged all three central propositions of mercantilism. First, liberalism attempted to draw a strong line between politics and economics. In doing so, liberalism argued that the purpose of economic activity was to enrich individuals, not to enhance the state's power. Second, liberalism argued that countries do not enrich themselves by running trade surpluses. Instead, countries gain from trade regardless of whether the balance of trade is positive or negative. Finally, countries are not necessarily made wealthier by producing manufactured goods rather than primary commodities. Instead, liberalism argued, countries are made wealthier by making products that they can produce at a relatively low cost at home and trading them for goods that can be produced at home only at a relatively high cost. Thus, according to liberalism, governments should make little effort to influence the country's trade balance or to shape the types of goods the country produces. Government efforts to allocate resources will only reduce national welfare. In addition to arguing against substantial state intervention as advocated by the mercantilists, liberalism argued in favor of a market-based system of resource allocation. Giving priority to the welfare of individuals, liberalism argues that social welfare will be highest when people are free to make their own decisions about how to use the resources they possess. Thus, rather than accepting the mercantilist argument that the state should guide the allocation of resources, liberals argue that resources should be allocated through voluntary market-based transactions between individuals. Such an exchange is mutually beneficial as long as it is voluntary, both parties to any transaction will benefit. Moreover, in a perfectly functioning market, individuals will continue to buy and sell resources until the resulting allocation offers no further opportunities for mutually beneficial exchange. The state plays an important, though limited, role in this process. The state must establish clear rights concerning ownership of property and resources. The judicial system must enforce these rights and the contracts that transfer ownership from one individual to another. Most liberals also recognize that governments can, and should, resolve market failures, which are instances in which voluntary market-based transactions between individuals fail to allocate resources to socially desirable activities. **Marxism**, the third traditional school, originated in the work of Karl Marx as a critique of capitalism. It is impossible to characterize briefly the huge literature that has expanded on or been influenced by Marx’s ideas. According to Marx, capitalism is characterized by two central conditions: the private ownership of the means of production (or capital) and wage labor. Marx argued that the value of manufactured goods was determined by the amount of labor used to produce them. However, capitalists did not pay labor the full amount of the value they imparted to the goods they produced. Instead, the capitalists who owned the factories paid workers only a subsistence wage and retained the rest as profits with which to finance additional investment. Marx predicted that the dynamics of capitalism would lead eventually to a revolution that would do away with private property and with the capitalist system that private property supported. Three dynamics would interact to drive this revolution. First, Marx argued that there is a natural tendency toward the concentration of capital. Economic competition would force capitalists to increase their efficiency and increase their capital stock. As a consequence, capital would become increasingly concentrated in the hands of a small, wealthy elite. Second, Marx argued that capitalism is associated with a falling rate of profit. Investment leads to a growing abundance of productive capital, which in turn reduces the return to capital. As profits shrink, capitalists are forced to further reduce wages, worsening the plight of the already impoverished masses. Finally, capitalism is plagued by an imbalance between the ability to produce goods and the ability to purchase goods. Large capital investments continually augment the economy’s ability to produce goods, whereas falling wages continually reduce the ability of consumers to purchase the goods being produced. As the three dynamics interact over time, society becomes increasingly characterized by growing inequality between a small wealthy capitalist elite and a growing number of impoverished workers. These social conditions eventually cause workers (the proletariat, in Marxist terminology) to rise up, overthrow the capitalist system, and replace it with socialism. In contrast to liberalism’s emphasis on the market as the principal mechanism of resource allocation, Marxists argue that capitalists make decisions about how society’s resources are used. Moreover, because capitalist systems promote the concentration of capital, investment decisions are not typically driven by market-based competition, at least not in the classical liberal sense of this term. Instead, decisions about what to produce are made by the few firms that control the necessary investment capital. The state plays no autonomous role in the capitalist system. Instead, Marxists argue that the state operates as an agent of the capitalist class. The state enacts policies that reinforce capitalism and therefore the capitalists’ control of resource allocation. Thus, in contrast to the mercantilists who focus on the state and the liberals who focus on the market, Marxists focus on large corporations as the key actor determining how resources are used. In the international economy, the concentration of capital and capitalists’ control of the state are transformed into the systematic exploitation of the developing world by the large capitalist nations. In some instances, this exploitation takes the form of explicit colonial structures, as it did prior to World War II. In other instances, especially since World War II, exploitation is achieved through less intrusive structures of dominance and control. In all instances, however, exploitation is carried out by large firms based in the capitalist countries that operate, in part, in the developing world. This systematic exploitation of the poor by the rich implies that the global economy does not provide benefits to all countries; all gains accrue to the capitalist countries at the top of the international hierarchy. The three traditional schools of political economy thus offer three distinctive answers to our question of how politics shapes the allocation of society’s resources. Mercantilists argue that the state guides resource allocation in line with objectives shaped by the quest for national power. Liberals argue that politics ought to play little role in the process, extolling instead the role of market-based transactions among autonomous individuals. Marxists argue that the most important decisions are made by large capitalist enterprises supported by a political system controlled by the capitalist class. Each traditional school also offers a distinctive framework to evaluate the consequences of resource allocation. Mercantilists focus on the consequences of resource allocation for national power. The central question a mercantilist will ask is: “Is there some alternative allocation of resources that would enhance the nation’s power in the international system?” Liberals rely heavily upon economic theory to focus principally upon the welfare consequences of resource allocation. The central question a liberal will ask is: “Is there some alternative allocation of resources that would enable the society to improve its standard of living?” Marxists rely heavily upon theories of class conflict to focus on the distributional consequences of resource allocation. The central question a Marxist will ask is: “Is there an alternative political and economic system that will promote a more equitable distribution of income?” Thus, liberalism emphasizes the welfare consequences of resource allocation, whereas mercantilism and Marxism each emphasize a different aspect of the distributional consequences of these decisions. These very different allocation mechanisms and unique evaluative frameworks generate three very different images of the central dynamic of IPE (see Table 1.1). Mercantilists argue that the IPE is characterized by distributional conflict when governments compete to attract and maintain desired industries. Liberals argue that international economic interactions are essentially harmonious. Because all countries benefit from international trade, power has little impact on national welfare, and international economic conflicts are rare. The central problem, from a liberal perspective, is creating the international institutional framework that will enable governments to enter into agreements through which they can create an international system of free trade. Marxists argue that the IPE is characterized by the distributional conflict between labor and capital within countries and by the distributional conflict between the advanced industrialized countries and developing countries within the international arena. | **Table 1.1** | **Mercantilism** | **Liberalism** | **Marxism** | | :------------------ | :---------------- | :--------------- | :------------------------------------------- | | **Most Important Actor** | The State | Individuals | Classes, particularly the capitalist class | | **Role of the State** | Intervene in the economy to allocate resources | Establish and enforce property rights to facilitate market-based exchange | The capitalist instrument of the capitalist class uses state power to sustain capitalism | | **Image of the International Economic System** | Conflictual: Countries compete for desirable industries and engage in trade conflicts as a result of competition | Harmonious: The international economy offers benefits to all countries. The challenge is to create a political framework that enables countries to realize these benefits | Exploitative: Capitalists exploit labor within countries; rich countries exploit poor countries in the international economy | | **Proper Objective of Economic Policy** | Enhance power of the nation-state in international state system | Enhance aggregate social welfare | Promote an equitable distribution of wealth and income | These three traditional schools have structured studies of and debate about the international political economy for a very long time. And although the presence of all three will be felt in many ways throughout the pages of this book, we will spend little more time examining them directly. In their place, we will emphasize an analytical framework developed during the last 15 years or so, which focuses on how the interaction between societal interests and political institutions determines the foreign economic policies that governments adopt. ## Interests and Institutions in International Political Economy To explain the policy choices made by governments, this book concentrates on the interaction between societal interests and political institutions. Such an approach suggests that to understand the foreign economic policy choices that governments make, we need to understand two aspects of politics. First, we need to understand where the interests, or economic policy preferences, of groups in society come from. Second, we need to examine how political institutions aggregate, reconcile, and ultimately transform competing interests into foreign economic policies and a particular international economic system. **Interests** are the goals or policy objectives that the central actors in the political system and in the economy—individuals, firms, labor unions, other interest groups, and governments—want to use foreign economic policy to achieve. In focusing on interests, we will assume that individuals and the interest groups that represent them prefer foreign economic policies that raise their incomes to policies that reduce their incomes. Thus, whenever a group confronts a choice between one policy that raises its income and another that lowers its income, it will always prefer the policy that raises its income. We focus on two mechanisms to explain the formation of these policy interests. First, people have **material interests** that arise from their position in the global economy. The essence of this approach can be summarized in a simple statement: tell me what you do for work, and I’ll tell you what your foreign economic policy preferences are. Consider once again the American softwood lumber tariff. Whether a particular individual supports or opposes this tariff depends on where he or she works. If you work in an American lumber mill or timberland, you favor the tariff because it reduces the likelihood that you will lose your job. If you own an American lumber mill of timberland, you also will favor the tariff, because it helps ensure a market and a relatively high price for the wood you produce. If you are an American homebuilder or you are looking to buy a new home, however, you will oppose the tariff. Higher prices mean that it costs more to produce homes. As homes become more expensive, fewer are sold and, consequently, fewer are produced. The tariff thus increases the chances that construction workers will be laid off and it causes real estate developers to earn smaller profits. These are compelling reasons for builders and their employees to oppose the higher tariff on Canadian lumber. In short, one’s position in the economy powerfully shapes one’s preferences regarding foreign economic policy. As we shall see, economic theory enables us to make some powerful statements about the foreign economic policy preferences of different groups in the economy. Second, interests are often based on ideas. **Ideas** are mental models that provide a coherent set of beliefs about cause-and-effect relationships. In the context of economic policy, these mental models typically focus on the relationship between government policies and economic outcomes. Not surprisingly, therefore, economic theory is a very important source of ideas that influence how actors perceive and formulate their interests. By providing clear statements about cause-and-effect economic relationships, economic theories can create an interest in a particular economic policy. The theory of comparative advantage, for example, claims that reducing tariffs raises aggregate social welfare. A government that believes this theory might be inclined to lower tariffs to realize these welfare gains. Alternatively, a government might adopt high tariffs because a different economic theory (the infant industry argument, for example) suggests that under the right conditions, tariffs can raise national income. What matters, therefore, is not whether a particular idea is true or not, but whether people in power, or people with influence over people with power, believe the idea to be true. Thus, ideas about how the economy operates can be a source of the preferences that groups have for particular economic policies. Understanding where interests come from will enable us to specify with some precision the competing demands that politicians confront when making foreign economic policy decisions. It does not tell us anything about how these competing interests are transformed into foreign economic policies. To understand how interests are transformed into policies, we need to examine political institutions. **Political institutions** establish the rules governing the political process. By establishing rules, they enable groups within countries, and groups of countries in the international state system, to reach and enforce collective decisions. Political institutions determine which groups are empowered to make choices and establish the rules these “choosers” will use when doing so. In domestic political systems, for example, democratic institutions promote mass participation in collective choices, whereas authoritarian systems restrict participation to a narrow set of individuals. In international economic affairs, governments from the advanced industrialized countries often make decisions with little participation by developing countries. Political institutions also provide the rules that these groups use to make decisions. In democratic systems, the usual choice rule is majority rule, and policies are supposed to reflect the preferences of a majority of voters or legislators. In international economic organizations, the choice rule is often relative bargaining power, and decisions typically reflect the preferences of the more powerful nations. Political institutions thus allow groups to make collective decisions and, in doing so, determine who gets to make these decisions and how they are to be made. Political institutions also help enforce these collective decisions. In many instances, individuals, groups, and governments have little incentive to comply with the decisions that are produced by the political process. This is particularly the case for those groups whose preferences diverge from those embodied in the collective choice. And even in cases where a group or a country as a whole does benefit from a particular decision, it may believe it could do even better if it cheated a little bit. If such instances of noncompliance are widespread, then the political process is substantially weakened. This problem is particularly acute in the international state system. In domestic political systems, the police and the judicial system are charged with enforcing individual compliance with collective decisions. The international system has neither a police force nor a judicial system through which to enforce compliance, however. Consequently, it can be very tempting for governments to attempt to “cheat” on the international economic agreements they conclude with other governments. International institutions like the WTO and the IMF can help governments enforce the international agreements that they conclude. A focus on interests and institutions will allow us to develop a set of reasonably comprehensive answers to our first question: How does politics shape societal decisions about how to allocate resources? The explanations we construct almost always will begin by investigating the source of competing societal demands for income and then explore how political institutions aggregate, reconcile, and ultimately transform these competing demands into foreign economic policies and a particular international economic system. This approach may not always provide a full explanation of the interactions we observe in the international political economy, but it does provide a solid point of departure. ## The Global Economy in Historical Context Although we will focus on how the interaction between interests and institutions shapes government behavior in the post-World