POLS1005 WK 7 Politics of Trade and Finance

Today’s puzzle:
 If states benefit from economic co-operation and free trade is expected to maximise
states’ welfare...
o Why do states have trade barriers
o Why is economic co-operation often hard to achieve?
 Collective action problem
Today
 Understanding the post WWII international economic order
o International trade: key theoretical approaches
o International trade: key concepts
o International trade: key institutions (IMF, WB, WTO)
 Motivating example: shifting into a new international economic order?
o China’s Asian Infrastructure Bank and the One Belt Road Initiative

Understanding the post WWII international economic order

Key theoretical approaches

International Trade: Why do we care about economics and trade?

 Because it is political
o About power, security, distribution and therefore also about peace and
conflict
o Key arena for conflict to be escalated or mitigated
Theoretical approaches to political economy

Mercantilism Liberalism Marxism

(protectionist)
Nature of economic Conflictual Harmonious Conflictual
relations
Actors Nation states Individuals and firms Economic classes
Goal of economic Maximisation of Maximisation of Maximisation of
activity national interests global welfare class interests
(positive sum view)
Relationship Politics determines Economics should Economics does
between economics economics determine politics determine politics
and politics
Theory of change Shift in the Dynamic equilibrium Tendency toward
distribution of disequilibrium
power

Mercantilism
 States are the main actors in the international political economy
 Economic relations are inherently conflictual (zero sum game)
 Politics drives economics
 Trade’s goal is to maximise state power
Liberalism
  A focus on individualism households and businesses
 The nature of economic relations is harmonious and interests are reconcilable
(positive sum game)
 Economics drives politics
 Trade’s goal is to maximise global welfare
Marxism
 Focus on socio-economic class and social forces (Bourgeoisie owns the means of
production, proletariat are exploited as labourers)
 Economic relations is inherently conflictual (zero sum game)
 Economics drives politics
 Trade’s goal is to maximise class interests
(Socialism: public and not private ownership of property, natural resources and the
means of production as the basis for a state’s economy)

Key concepts
Free Trade
 Definition: the free movement of goods between countries as much as possible
unimpeded by government-imposed barriers to import and export of goods (also
called laissez-faire)
Adam Smith on comparative advantage
 “if a foreign country can supply us with a commodity cheaper than we ourselves can
make it, better buy it of them with some part of the produce of our own industry,
employed in a way in which we have some advantage.”
o Specialisation and the division of labour
o Leads to efficiency (production of the best quality product for the lowest
price)
Generates comparative advantage determined by:
o A country’s inherent endowments
o The endowments of that country’s trade partners
Absolute vs. comparative advantage
 AA- one country is more efficient than another at producing one product
 CA- even if a country is not the most efficient at a given product when compared to
other countries, it should specialise in what it does best
o Producing other products less efficiently wastes resources
Factors of production
 Land: farming or natural resources
 Labor: skilled or unskilled
 Capital: human or financial
Hecksher-Ohlin theorem
 A country is best off specialising in producing goods that it is comparatively best at
producing and exchanging these goods for those it is comparatively less adept at
producing.
o Focus on relative productivity rather than absolute productivity
 Abundant FOP are those inputs that a country possesses in greater proportion than
the world average
  Scarce FOP are those possessed in smaller proportion than the world average
o E.g. AUS today is relatively abundant in economic and human capital,
intermediate in land and relatively scarce in unskilled labor
o AUS than exports capital and human capital intensive goods and imports
goods that are relatively intensive in unskilled labor
Stolper-Samuelson theorem
 Abundant FOP (and producers who use them) gain from freer trade
 Scarce FOP ( and producers who use them intensively) lose from freer trade
 As export production expands, demand for the abundant FOP rises relative to
demand for the scarce FOP
 Free trade will lead to a contraction of the scarce-factor-intensive industry
International trade interactions: a collective action problem
 Everyone wants to have consumers to sell to
 No one wants others to have access to their own consumers
 Mutual liberalisation resembles a prisoner’s dilemma
 And a collective action problem
Domestic tensions are inevitable
 All states must balance:
o The desire to have to material benefits of an open economic system
o The pressure to promote or defend state or sector interests
 There is a clear collective action problem in managing this tension
o Ideally, governments would compensate trade’s losers with part of the
winner’s trade gains
Protectionism
 Definition: a policy of protecting domestic industries against foreign policy
competition by means of tariffs, subsidies, import quotas or other restrictions or
handicaps placed on the imports of foreign competitors
Trade restrictions
 Tariffs: taxes on the import or export of a good
 Quotas: limits on the volume of values of goods that can be traded
 Nontariff barriers: barriers that are not taxes
o Legislated preferences
o Health and safety standards that target foreign products
o Antidumping penalties
 Subsidies: government payments to business producing goods and services to export
 Prohibitions: some exports are prohibited. Often these are sensitive military
technologies
Tensions between producer and consumer interests
 Producers have concentrated interests in protecting their businesses and receive
significant benefits from protection (e.g. profits, jobs)
o Expected to be in favour of some protectionist policies
 Consumers have diffuse interests (e.g. lower prices) in free trade
o Generally in favour of free trade
Trade barriers redistribute income
 With less competition, domestic producers can charge more for their goods and
services
  Due to collective action problems, producers often enjoy greater political influence
than consumers
 For domestic producers seeking trade protection, the benefits are concentrated and
high
 This helps them overcome collective action problems to mobilise for economic gain
 Protectionism is costly for consumers, who have to pay higher prices
Does free trade promote prosperity and opportunity? (Costs and benefits)
 YES
o The market is the only reliable means of generating wealth
o Everyone wins (absolute gains). The rich get richer but the poor get less poor
o Economic freedoms promote other freedoms
 NO
o Deepens poverty and inequality (relative gains)
o Hollows out politics and democracy
o Corruption of consumerist materialism: cultural and social distinctiveness is
lost

Key institutions (IMF, WB, WTO)

Bretton Woods Conference
 July 1944: representatives from 44 nations setting the stage for the current
international economic order
Bretton Woods conference key purpose
 Set up a new system of international finance consisting of rules, regulations and
procedures to ensure global economic stability
 Established the IMF and the WB
International finance
 Monetary interactions between countries: bilateral and multilateral
 Benefit: cross-border investment can improve welfare in both countries
 Risk: financial ties can make societies mutually vulnerable, as seen in the 2008
financial crisis and the Greek debt crisis of 2015
International finance- actors
 States
 Multinational corporations (MNCs)
 International organisations (e.g. IMF)
Cross-border investment types
 Portfolio: investor has no roles in management
o Bonds
 Net value is specified at time of sale
 Issued by governments or firms
 Loans
 Terms (e.g. interest rate) but not value-set at the time of sale
 Issued to and from individuals, firms, banks, governments or
international organisations such as the WB
o Stocks
 Value and dividend vary without guarantee
  Firms sell shares to individual and institutional investors
 Direct investment: the investor maintains control of facilities (and risk)
o MNCs engage in FDI
o Conflicts between firm and host country can arise over distribution of profits
and control of resources
IMF
 Key purpose
o Further international financial stability by providing short-term loans to
countries (at low interest) that are having balance of payment problems
(struggling to pay back foreign debts)
 Established at Bretton Woods in 1944
 Current membership: 189 states
 Based in Washington DC, USA
 IMF loans
o Provided with low interest rates
o However, conditions are attached: borrower must show signs of reform.
These reforms often include austerity measures (e.g. policies aiming to
reduce govt. budget deficit by cutting spending, raising taxes)
 Conditions criticised
o Lender of last resort- typically to assist countries in financial crisis
 Has the IMF achieved the objective of preventing financial crises?
o The financial standards and information that the IMF provides seem to have
a limited impact on preventing crises
o Recent crises include: Mexico (1982, 1988, 1994) east Asia (1997) Brazil
(1998) Russia (1998) Argentina (2001) and 2008 GFC, Eurozone crisis (2015-)
WB
 Key purpose
o Finance infrastructure and other projects in developing countries with
longer-term loans to finance specific infrastructure and development
projects
 Est. Bretton Woods in 1944
 Current membership: 189 states
 Based in Washington DC, USA
Enforcement mechanism for both IMF and WB
 No actual enforcement mechanisms
 However, both can refuse to grant future loans
 There are also big reputational costs that impact the attractiveness of a country to
investors if a country does not repay loans
Example of an international institution to regulate trade and facilitate co-operation
 GATT/WTO
 WTO replaced GATT in 1995
WTO
 Key purpose
o Forum for govts. to negotiate trade agreements and settle trade disputes,
operating under a system of trade rules (helps states with information
problems, commitments, enforcement issues)
  Est. 1995
 Current membership: 164 member states and 23 observer govts.
 Headquarters: Geneva, Switzerland
Overcoming barriers to cooperation
 Barriers can be overcome when:
o Smaller number of states involved (bilateral trade agreements)
o Increase information about other’s interests and strategies is available
o Iterated interaction- over time
o Issue linkage- concessions can be linked to other areas (log-rolling)
o Institutions can help to promote trade liberalisation and provide and
enforcement mechanism

China’s Asian Infrastructure Investment Bank and the One Belt Road Initiative
Asian Infrastructure Investment Bank (AIIB)
 Key purpose
o Multilateral development bank
o Aims to support infrastructure development primarily in the Asia-Pacific
region
 Grown from 57 founding member-states in 2016 to 84 member-states as of April
2018-04-17
One Belt One Road initiative (OBOR)
 What is the OBOR?
o An initiative from China’s president Xi Jingpin to improve China’s land and sea
connectivity with the rest of the world
o First mentioned in speeches by Xi in 2013
o Opens new trade routes that span from China across central Asia to EUR, to
the Mid-East, SE Asia and sea routes connecting CHN ports to EUR and the
South Pacific
o Investment in road and sea infrastructure such as highways, bridges and
waterways
o Joint-goal of developing under-developed regions in CHN, and contributing to
development across the SE and Central Asian region
 International support for OBOR
o EIB, Britain etc
 Global interconnection, increased cooperation and mutual benefit? Or a bid for
hegemony?

Today’s puzzle: why is international economic cooperation challenging?

 What have we learnt?
o Because econ. Cooperation is inseparable from political concerns
o Int. trade presents a collection action problem and can be likened to a
prisoner’s dilemma
 However
o Institutions can greatly increase the chances for cooperation
Wk 7 Tutorials
 International political economy
o Definition
 Global economic interactions
 Alliances, treaties and agreements
 Key actors involved: states and sovereign governments, international
institutions, MNCs, individuals/investors, labour unions, criminal
organisations (terrorists and cartels, crime syndicates)
 Different types of interactions
o Trade
o Investment
o Trade agreements
o Research and development
o Transport
o Trade barriers/protectionist policies
o Dumping etc.
 Different institutions
o DFAT, Austrade, DoD, Chamber of Commerce, ABC (AUS Business Council)
 Why states interact
 Constraints in interactions
o Geography etc.
 AUS trade agreements
o 10 FTAs- China, JPN, SK, NZ, SING, THD, US, CHILE, ASEAN and Malaysia
 Benefit the involved nations because of stronger trade and
commercial ties, open opportunities for exporters and investors to
expand into key markets, benefit consumers, more G+S for cheaper
o TPP concluded negotiations in Oct 2015
 TA between AUYS, Brunei, CND, Chile, JPN, etc. signed on Feb 2016
 Cuts over 18,000 tariffs, includes environmental protections, combats
illegal fishing, promotes sustainable fisheries combats wildlife
trafficking etc.
 Also, prohibits forced labour and child labour
o APEC- regional economic forum established in 1989 to leverage growing
interdependence
 21 members
 Benefits the 21 member states, ensures that G+S, investment and
people move more easily across borders, faster customs procedures
at borders, more favourable business climates and consistent
regulations and standards between members
o Benefits: involved member states, interest groups such as environmental
groups and farmers, R+D groups, businesses
 Why do countries trade
o Comparative advantage
o Military trade connection
o Scarcity/resources
o Historical trade relations
o Culture
o Geographical proximity
o Convenience