Roy Den Hollander

1. CONCEPTUAL FOUNDATIONS FINAL
1. Finance and Trade: Since the end of World War II, the dramatic increase in trade and flows of
capital among nations has greatly stimulated economic growth. Led by the United States, the
capitalist states established institutions and rules that created a Liberal International Economic
Order based on the unfettered flow of investment and trade. Liberalism heralded that commerce
was replacing power politics as the foundation for national security while burgeoning economic
interdependence fostered cooperation benefiting all states. Realism stated that the exercise of
political power by states controlled the distribution of material wealth, and that states engaged in
unilateral actions to increase their economic welfare at the cost of others out of fear of losing
economic rank and advantage. Neither theory alone can explain the economic order that evolved
since World War II, but together, and with other models such as domestic influences and the
hybrid Realist-Liberal Hegemonic doctrine, the evolution of international finance, trade and
relevant non-state actors, can be accounted for.
Hegemony theory contends that a dominant state stabilizes the international economic
order. The hegemon sets the rules, creates regimes, compels cooperation, preserves order and
permits relative gains by other states in order to preserve stability. However, the hegemon also
assures that the system benefits its economic and political interests through coercion, if necessary.
(Gilpin) With the decline of a hegemon, political and economic conflict may break out among
ascending powers desirous to rule the economic order. On the other hand, imbedded Liberalism
may result where the regimes established by the hegemon take its place, at least in part, and the
habit of cooperation and transparency established during the hegemon's rule mitigates reversion to
short-term, self-interested pursuits of autarchy. (Mastanduno)

2. The United States assumed the hegemonic position following World War II because it
produced nearly 50% of the world's gross product, possessed more gold reserves than all states
combined (Cohen) and was militarily preeminent. By the 1970's, however, America's control over
markets, finance capital and raw materials had declined, which resulted in a degree of finance and
trade instability but not, as Realism feared, closure of the economic order leading to political
conflicts. (Uriu) The different national interests of America's economic rivals, however, have led
to economic tensions. (Cohen) Japan and Germany have engaged in Neomercantilist policies
while the U.S. has become increasingly intolerant of the relative economic gains of its trading
partners. Especially now with the end of the Cold War, America no longer feels compelled to
economically sacrifice to gain political support for its power rivalry with the Soviet Union. The
decline of America's economic power has not caused significant disruptions in the world's finance
and trade order perhaps due to the regimes established during America's preeminence and the
growth of international non-state actors such as multinational corporations, transnational banks,
International Monetary Fund (IMF), World Bank and regional development banks. (Gilpin)
International Finance System: A key cause for the 1930's depression, and perhaps World
War II, was the failure of industrialized states to cooperate in maintaining currency exchange
stability. States tried to increase economic growth through exports by depreciating their
currencies. Depreciated currency made a state's exports cheaper overseas and foreign imports at
home relatively expensive. Until the Depression, states had cooperated in stabilizing exchange
rates by pegging their currencies to gold. Responding to domestic pressures and beggar-thy-neighbor
policies, one state after another rejected the gold standard and depreciated its currency
in order to increase exports and growth at the expense of their trading partners. The failure of
cooperation and pursuit of parochial self-interests plunged the international order into an
economic depression.

3. In 1944, the Western Allies agreed to institutionalize cooperation by limiting exchange
rate fluctuations to narrow ranges and financing the recovery of Europe. From a Liberal
perspective, the Western Allies had learned to avoid the harm that comes from the pursuit of
relative gains in a distrustful, anarchic system. With the Bretton Woods' regime, the Western
Allies acted rationally in pursuit of maximizing economic utility for all through joint cooperation
made possible by similar finance and trade interests, compatible democratic political structures, a
norm of cooperation during the war and, not in the least, a hegemon..
From the Realist perspective, the resurrection of Europe would provide a political and
economic rival to the United States, which may explain why America failed to act immediately to
help finance Europe's recovery. The IBRD and the IMF proved inadequate and America failed to
act until it became apparent that its growing political rivalry with the Soviet Union would be
initially waged over Europe. Perceiving that a political benefit could be gained with a viable
Europe, the U.S. supplemented the IBRD with the Marshall Plan. The U.S. also increased its
trade deficits in order to provide international liquidity in dollars. The trade deficit increased
competition for some domestic manufacturers, but the security rationale of deterring Soviet
expansion along with establishing a market for the investment of surplus capital apparently
justified the cost. Under Bretton Woods and the Marshall Plan, dollars flowed to Europe and
Japan enabling them to purchase capital goods from the U.S., which benefited certain segments of
the American economy (Spero). The acceptance of the dollar as the international currency of
payment facilitated America's Realist security policy to contain the Soviet Union by printing
dollars for military aid and overseas bases. In addition, American businesses readily expanded
into multinational corporations by using dollars to invest abroad. The combination of a powerful
hegemon, pursuit of political self-interests, domestic influence of finance capital and an
international regime of cooperation stabilized the financial order, provided funds for the recovery

4. of Europe and Japan and dramatically increased interdependence among capitalist states.
Beginning in the late 1950's and continuing through the 1960's, America's pursuit of its
international political and multinational corporations' economic interests resulted in large balance
of payments deficits. Dollars flows increased dramatically for Vietnam, other military policies and
private investment. The transfers of large amounts of capital increased the free worlds' monetary
interdependence through the Eurodollar market and internationalization of banking and
production. As U.S. deficits grew, domestic groups such as labor, agriculture and some
manufacturers called for protectionist measures to lessen foreign import competition and stimulate
exports by depreciating the dollar. Since many of America's allies in its struggle against
Communism held large reserves of dollars, any depreciation would further strain political relations
already stretched thin by Vietnam. At the same time, MNC's overseas wanted open markets in
the U.S. so they could repatriate their overseas profits and stable exchange rates to preserve the
value of their investment capital.
The U.S. role as manager of the financial system was undermined by the emergence of
economic and political rivals it helped to develop through trade deficits, regimes to provide
contra-cyclical long-term lending and maintain currency stability and provisions of foreign aid.
(Cohen) Such efforts were undertaken to contain America's political rival, the Soviet Union,
benefit powerful sectors of its economy and foster democratic values threatened by
totalitarianism. In addition, domestic export interests and the negative implications for free
market capitalism were U.S. gold reserves to become depleted caused America to reject the gold
standard in 1971. The stability of the financial order now depends on negotiations among the
leading economic states and the activities of the participants in the currency and non-money asset
markets. A combination of state cooperation and hegemonic pursuit of self-interest has resulted
in a complex interdependent system of states, institutions, transnational banks, speculators and

5. MNC's impacting the world's financial stability.
International Trade: The World Trade Organization (WTO) created by GATT is the key
non-state actor trying to prevent trade protectionism from encumbering the liberal trade regime
that arose following World War II. Consistent with the Liberal theory of trade, the WTO's
purpose is to prevent states from discriminating against the exports of other states. The Liberal
theory stresses comparative advantage for explaining how states behave with respect to trade.
Under comparative advantage, each states specializes in the goods or services that it can produce
with the greatest efficiency. The state then trades its goods and services for those efficiently
produced by other states. The least amount of resources, therefore, have been used to maximize
production, and each state benefits from the lower cost of foreign goods providing there are no
politically imposed trade barriers.
The post World War II history of world trade does not always show states acting
cooperatively to maximize their economic utility via the unfettered trade of comparatively
advantaged products. Some states engage in Neomercantilism to benefit their domestic economy
at the expense of their trading partners while others intentionally create a comparative advantage
in strategic industries for security reasons, technological spin-offs, the surplus from high-value
sectors and profits from economies of scale and monopoly rents. (Gould) Neomercantilism
involves a number of tactics by which a country increases its exports and/or reduces imports to
cause a trade surplus, which benefits the domestic economy by promoting local employment and
production.
The Liberal theory cannot explain why states use their political power to intervene in
domestic economic affairs since Liberalism argues that the forces of the free market will leave the
state better off than protectionism. Japan, however, by subsidizing strategic industries and
limiting the leakage of national income by restricting imports has benefited from a multibillion

6. dollar trade surplus with the world. (Lake) Neomercantilism, however, does account for import
restrictions. States view economic power as measured in comparison to other states as an end in
itself or, under Realism, as a means to military strength and autonomy. Under the rationale of
national security, the U.S. imposed import quotas on oil. But Neomercantilism also includes an
important domestic component. The U.S. textile industry has in the past pressured the
Government into agreements with Asian states to limit exports. (Odell) Local environmental and
safety standards also act as barriers to imports that fail to measure up to the requirements.
Likewise, developing states may try to stimulate growth in strategic industries by protecting them
from foreign imports. Liberalism argues that such industries may never become competitive at
world standards but simply consume ever-increasing amounts of resources through their
inefficient operations. By failing to pursue its comparative advantages, the economy becomes
poorer rather than richer. Studies have shown that the pursuit of strategic trade has failed to
provide significant gains (Odell), but states still try to create comparative advantages to achieve
gains relative to other states, despite the fact that free trade will yield greater economic benefits
for all. In effect, the state has defined self-sufficiency and export market share in some products
as important for security reasons. (Mastanduno).
The liberal trading regime following World War II resulted not only from the free market
force of comparative advantage but the hegemonic role played by the U.S. By the 1970's, the
U.S. role was declining, but major industrialized nations found themselves locked in a web of
trade interdependence, each applying variations of free trade and Neomercantilism precepts to
their activities. Interdependence, the norm of at least partial cooperation, the threat of a collapse
in world trade and the promise of additional growth spurred many states to finalize the GATT
regime in 1994. This key non-state actor continues the reduction in trade barriers consistent with
the Liberal comparative advantage view.

7. Liberal and Neomercantile concerns in one sense made the GATT inevitable. As national
corporations expanded overseas, commerce grew beyond the territorial boundaries of
governmental control. Neomercantilism's efforts to promote local industries at the expense of
foreign ended up, to an extent, harming local industries that had expanded overseas and were
trying to sell foreign produced products at home. Many powerful local corporations had evolved
into MNC's and used their influence with governments to promote open trading borders through
GATT.
While the passage of GATT appears to confirm the ascendancy of the Liberal theory,
Neomercantilism may soon be used by regional trading blocks. North and South America, the
European Union and a trading block in Asia may impair the benefits of comparative advantage by
promoting trade barriers among each other but free trade within each group. The states in each
region appear to be acting out of the Realists' concern over national power and status while
engaging in Liberal cooperation to offset any relative losses by being left out of a trading block.
This new economic structure will create constraints and opportunities that shape trade strategies
(Lake), which may lead to a regional trading block "dilemma."
On the whole, the rapid growth of international economic transactions since World War II
has increased interdependence and in turn cooperation among states in contrast to Realism tenets
of national autonomy and zero-sum competition with other states. The pursuit, however, of self-interest,
relative gains and security through economic power still explains many of the activities of
states. In the economic arena, influential non-state actors have arisen, such as GATT, WTO,
International Monetary Fund, transnational corporations and banks, currency speculators and
regional trading blocks. Contrary to Realist views, the nation state is not the sole moving force in
the international economy although perhaps still the most powerful. Furthermore, states must
take into account domestic interest groups in developing their international economic policy.

8. Two-level games require policy makers to consider powerful interest groups that may or may not
benefit from Liberal or Neomercantile economic foreign policy. Domestic interest groups (a
subset of Liberalism) can ironically cause a state to act in a Realist fashion by pursuing self-serving
policies that augment its power by benefiting strategic industries at the expense of trading
partners. On the other hand, with the end of the Cold War and the development of a belief in the
importance of economic power, Realism's emphasis on military power as the primary end of states
has declined in significance but still remains material.
Realism, Liberalism, Hegemonic power and Neomercantilism all have their usefulness and
drawbacks in explaining finance and trade since World War II. Each by itself proves inadequate
as a sole unifying vehicle. (Odell).
3. Share Our Wealth (Development): The persistent disparity in wealth between the North and
the South led many Third World policy makers in the 1960's to adopt the Dependency theory as
an explanation for their states' impoverishment. Dependency postulates that the North exploits
the South through the Liberal International Economic Order (LIEO) established by the
industrialized states. The South serves as a source of raw materials or cheap manufactured goods
and a place for the investment of surplus capital. Integration into the LIEO of free trade and
capital mobility creates a permanent state of dependency and worsening terms of trade for the
South rather than progression along the Liberal unilinear path to inevitable economic
modernization. (Gilpin)
Believing that the structure of the LIEO was the cause of underdevelopment, the South
tried to establish a New International Economic Order (NIEO) to change the regimes influencing
the flow of goods, services, capital and technology. Stirred by the initial success of OPEC and a
belief in the power of commodity cartels, the NIEO regime expanded and escalated their demands
on the North to share the wealth. The South tried to increase control over their natural resources,

9. improve the terms of trade, create a code of conduct for MNC's, increase the availability of
Northern technology at reduced costs, acquire greater access and preferential treatment for their
exports to the North and gain control of the IMF, World Bank, UN and other international
institutions. (Gilpin) The commodity cartels, however, failed to remain united because some
states pursued relative gains by cheating. In addition, the North chose to reduce its
interdependence with the South by decreasing its consumption of imported raw materials.
While the failure of cooperation, in part, doomed the NIEO, the pursuit of Dependency's
import substitution retarded development.(Macomber) Many Latin American states isolated
themselves from the LIEO in order to stimulate manufacturing of substitutes for imported
products in an effort to generate local surplus capital for domestic investment. High tariffs and
appreciated currencies not only reduced imports but the incentive for local companies to produce
efficiently. Restraints on exports decreased capital inflows, which required many Latin American
states to obtain loans in order to raise the initial funds for investment in manufacturing.
(Macomber) Dependency's import-substitution industrialization also failed because government's
used strategic industries for patronage purposes (Macomber), the sharp rise in oil prices diverted
foreign reserves from the export of raw materials to energy, the rise in interest rates in the North
to curb inflation increased the South's debt burden and, finally, a worldwide recession reduced
commodity prices.
Other Third World states, however, participated in and took advantage of the LIEO by
following a combination of Liberal and Neomercantile tenets. Taiwan, South Korea, Hong Kong
and Singapore emphasized export-led industrialization. The Newly Industrialized Countries
(NIC) used the Neomercantile precepts of developing comparative advantage in certain strategic
industries through government subsidies and temporary protection from import competition until
the industries were able to enter the world market. The NIC's engaged in reciprocity whereby

10. subsidies were provided to certain businesses as long as they met specific performance standards.
(Amsden) The NIC's concurrently followed the Liberal concept of opening up their economies to
foreign direct investment. Unlike many Latin American states, the NIC's rejected the Dependency
viewpoint that MNC, retard development by exporting host country profits home, stifle the
growth of local technology, and threaten the state's autonomy. (Gilpin) Rather the NIC's chose
the Liberal view that MNC's pay more taxes, transfer technology, pay high wages to local
employees, provide management training, improve local productivity, contribute to export
earnings and integrate national economies into an expanding and beneficial interdependence.
(Gilpin)
Realism explains the NIC's development success as a result of the West's efforts to contain
communism in Asia. The West provided the NIC's extensive foreign aid, encouraged the
establishment of SEATO and ran up trade deficits to assist the growth of their economies.
Domestic Asian factors, however, also played an important role: the NIC's lacked abundant
natural resources, so were compelled to pursue wealth through manufacturing, they possessed a
growing pool of technically educated workers that made efficient production possible (Wade);
and they had a high savings rate that provide the funds for indigenous investment. (Gilpin)
The success of the NIC's export-led development has caused many other states to switch
from emphasizing import-substitution to exports. GATT has significantly reduced the trade
barriers previously erected in the North against the South's products. The cooperation of states in
their pursuit to maximize their economic utility opened up the global marketplace, but has also
created a highly competitive playing field. GATT has restructured the economic order consistent
with free trade theory, but that structure may continue to impede the South's development if it
fails to generate local surplus capital by successfully competing in the world's markets.
Before and after GATT, the South has suffered from unfavorable terms of trade with the

11. North because, as Dependency postulates, the LIEO has institutionalized colonial independence.
The prices for the South's exports are volatile in the short run but stagnant or fall over the long
term. The prices for the North's imports, however, continually increase. Since the North
possesses much of the world's realized wealth, it can determine the prices for products.
Dependency argues the South will remain dependent on Northern manufactured goods because
the North's reluctance to establish research and development programs in the South prevents host
states from competing for the monopoly rents provided by advanced technology. (Evans) The
Liberal theory counters that the quality of the Third World manufactured goods have increased
and in some cases competed successfully in the global marketplace. Further, the increase in trade
caused by GATT will offset part of the decline in the terms of trade.
Explaining efforts to foster a more equitable division of the wealth among nations in the
context of economic and security regimes, along with state and non-state actors, requires using
the theories of Liberalism, domestic influences (a subset of Liberalism), Dependency, Realism (to
which Dependency is closely related) and Neomercantilism. The usefulness of each theory
depends on the behavior desired to be analyzed. Once again, no one theory applies to all
situations, rather the entire bag of analytical tools helps illuminate international activities, which
may eventual lead to a comprehensive and integrated view of development.
4. Preventing Nuclear Proliferation: Realism contends that the state exists in an anarchical
environment where it can rely only on self-help to assure its survival. The states primary task,
therefore, is to acquire political and military power in order to further its national interests with
respect to other states. Relative strength matters, and cooperation among states is bound to fail
because defection works at gaining an advantage. Because state survival depends on military
power, cheating on a security cooperation regime in the defense area may leave an abiding state's
autonomy and very existence at stake. As a result, few security regimes have developed in the

12. defense area except for the Nuclear Nonproliferation Treaty (NPT).
Realism postulates that nuclear proliferation will increase security for all by maintaining
the balance of power equilibrium. (Solingen) Yet adherence to NPT has been extensive and,
therefore, unexplained by Realism, although the failure of some states to join the regime and the
cheating by signatories is explainable under Realist principles. Israel, India and Pakistan are all
considered defacto nuclear states, but none have signed the NPT.
Since its inception, Israel has been surrounded by belligerent states and only relatively
recently have the prospects for political stability appeared viable. However, a couple of
intractable opponents, Iraq and Iran, lie within short range and both states may currently be on the
road to developing nuclear weapons. Israel's relatively small size in area and population leave it
especially vulnerable to the coordinate attack by conventional forces or swift obliteration by a few
nuclear weapons. (Solingen) To assure its physical survival, Israel has developed a second strike
nuclear capability that deters both a successful conventional forces attack and any attempt at a
first strike annihilation. For Israel to halt its nuclear arms program would require Iraq and Iran to
do the same. The difficulty, even under the NPT, is verification. Iraq came within a couple of
years of developing an atomic weapon even while being inspected by the International Atomic
Energy Agency. Iran may be doing the same. Both are Realist worst-case scenarios that Israel
would be irrational not to assume. An alternative would be for a power such as America to agree
to defend Israel if it faced military defeat. But would potential attackers view such a threat as
credible especially if they were allied with a rival nuclear power like China. It is unlikely that the
U.S. would abide by a bilateral security alliance with Israel, if it meant the nuclear destruction of
some of its citizens. In a world with no supranational government to punish defectors from
cooperation agreements, Israel has chosen the Realist course of self-help and mutually assured
destruction to deter attack.

13. India and Pakistan also have a history of conflict but it appears unlikely that one country
could or wishes to annihilate the other due to the size of their territories and populations. Yet
both have nuclear weapons in order to prevent the other from using the nuclear threat to extract
concessions on territory or in other areas. Under Realism, a state's national interest includes not
just survival but autarky. India and Pakistan are pursuing a balance of power in the military field,
but may join the NPT when there exists sufficient transparency to guarantee that the other state is
not defecting. From the Liberal view, each country also has domestic political coalitions that have
played key roles in shaping the Kashmir crisis. (Solingen)
North Korea has apparently defected from the NPT. Such defection may have resulted
from domestic rather than Realist international forces. With the fall of Communism, North
Korea's inward-looking, nationalist coalition lost the economic order that bolstered its failing
economy. As its growth stagnates, local political pressure increases on its leader and the potential
for divisions within the ruling elite rise. To distract from its domestic economic crises, North
Korea may have pursued nuclear power for its prestige and patriotic accouterments.
Despite the defections and refusal by some states to join NPT, the Liberal cooperative
regime has significantly reduced the spread of nuclear weapons. Most of the states that
developed nuclear weapons since NPT's inception, did so before the norm against proliferation
became firmly established. Probably the reason for NPT's success is the incredible destructiveness
of nuclear weapons. States fight wars because the gain will exceed the cost. (Mansfield) With
nuclear weapons, the likelihood is that the cost of war will be suicide. (Jervis) Domestic
grassroots organizations have also played a significant role in pressuring governments to join the
NPT, since it is primarily civilian populations that nuclear weapons target.
Liberalism explains that on the security issue of nuclear proliferation states have agreed to
cooperate in solving a global problem in large part out of their absolute self-interest. Since

14. Chernobyl and Three Mile Island, states realize the injurious impact that even a small nuclear war
between distant countries could have by spreading radioactivity throughout the world. Given
domestic concerns, relative dosages of radioactive poisoning does not appear acceptable. NPT
provides a degree of transparency that prevents most states from making the worse case
assumption about another states actions, thereby, avoiding a spiraling nuclear arms race. Through
the IAEA, NPT lengthens the shadow of the future by exposing and potentially bringing sanctions
against violators. A state is unlikely to defect without paying a price, such as Iraq. Finally, an
international norm against proliferation has developed.
In conclusion, neither Realism nor Liberalism theories can explain all the different
behaviors of states with respect to nuclear proliferation, but each does expand various aspects.

15. CONCEPTUAL FOUNDATIONS
FINAL
ROY DEN HOLLANDER
May 8, 1995