Chapter 5 CPO2002 Lecture

Political Economy
Chapter Five

Pearson Publishing 2011

• The good society depends upon institutional arrangements that
enhance people’s capabilities.
• Soviet Union – too much state intervention.
• Post-Communist Russia – too little state intervention.

• So how much state activity is enough to produce the good
society?
• Applies most often with regard to the economy.
• Milton Friedman: two ways to coordinate the economic activity
of millions – central planning by the government or the voluntary
cooperation of individuals via the marketplace.

• So what balance between states and markets most enhances
people’s capability and contributes to the good society?

Political Economy

• Political economist Charles Lindblom – markets have
always been with us, but market systems have not.
• Today, almost all countries use market systems to
organize and coordinate production.
• Market system: refers to an economy in which production
for profit is intended for and coordinated through private
exchanges between buyers and sellers.
• Shift in Europe difficult from subsistence production to
market.

• Trade throughout the world has increased. Many
countries invest directly in countries other than their own.

Political Economy

• The market
system has
become more
extensive &
more
intensive.

• States determine how extensive markets
are.
• They can discourage foreign trade by placing
taxes on imports or encourage it by keeping the
playing field even between domestic and
international goods.
• Strict border control on currency or free flow.
• Treaties or international organizations that
encourage exchange.
• Encourage or discourage foreign investment.
• All of these rules can also either promote or
inhibit the extensive growth of markets.

• States determine how intensive markets
are.
• Restrict what can be sold.
• Role of competing pressures between those who
benefit from intensive and extensive markets and
those who do not.

Institutions and Power

• Commodity production in which goods are produced for
sale.
• Productive assets are privately owned and employed to
earn profits for their owners.
• Prices are not administered but set through supply and
demand.

In Brief: Market Systems

• In market systems, production is coordinated through the
mutual interactions of those who are buying and selling
according to Lindblom.
• Supply and demand.
• People respond to shifts in the markets, but no one controls
it.
• But markets require states to function and CANNOT exist
without them.
• For example market systems need states to create a common
currency to facilitate trade and exchange; to enforce contracts;
and to supply public goods, such as transportation networks
and police protection, that markets cannot furnish themselves.

States & Markets

• Imagine playing Monopoly with no rules.
• Institutions matter: France versus Britain in the
18th century in the area of commerce.
• The balance between political and market forces
within a country, its political economy, is critical
in determining whether it will meet the minimal
conditions of a good society.

States & Markets

Advantages

Disadvantages

• Extraordinarily dynamic,
promoting development of
new products and more
efficient methods of
production and technology.
• Enormously productive.
• Enhances the prospects of
democracy and political
rights.

• Highly volatile – boom and
bust.
• Housing market plunge
• Recession

• Tend to generate
extraordinary inequality
• Create harmful spillover
effects (externalities)
• Global warming
• pollution

Advantages & Disadvantages of
Market Systems

• Advantages
• Promotes efficiency and
productivity
• Promotes innovation
• More conducive to
democracy than
command economies

• Disadvantages
• Promotes inequality
• Subject to volatile and
destructive swings
between recession and
prosperity
• Social costs of
production are ignored

In Brief: Advantages & Disadvantages
of Market Systems

• States do more to assist market systems than simply
reassure participants that others will play fair.
• Steer economies to certain goals- counteracting the three
drawbacks discussed earlier.
• Welfare system to counteract inequality.
• Create regulations to minimize harmful spillover effects.
• Use budgetary powers and control over the money supply to
steady the swings in the business cycle.

• But the degree to which states should intervene is often
the focus of debate and conflict.

The Shifting Balance Between
States and Markets

• States intervention became the new gospel across the globe,
however, the tide shifted in the 1970s.
• Recessions of the 1970s – new leaders such as President Ronald
Reagan (U.S.) and Prime Minister Margaret Thatcher (GB)
argued that state intervention was the cause of this economic
downturn.
• Political failures; need for market restoration.
•
•
•
•

Welfare state had undermined the work ethic.
Regulations had constrained entrepreneurial energies.
Taxes had diverted too much income.
Public enterprises were inefficient.

• Management of the economy changed to reflect this new
consensus.
• Global recession of 2007 cast doubt on the model.

The Shifting Balance Between
States and Markets

• India became independent
in 1947.
• Leaders embarked on
policy of state intervention
in the economy.
• socialist inclinations and
ambitions to create a
strong state with which
citizens could identify.
• Abandoned statist
economic policies in
1980s.
• Privatization
• Deregulation

• Consequence of shift from state to
market:
• Foreign trade and direct investment
grew dramatically, as did GDP.
• Income has risen for all groups,
including the poor.
• Middle class has grown dramatically.
• However, they have failed to have
much of an impact on rural residents.

• Question:
• How can market reforms have such
unequal effects, leaving out the bulk
of the population in the countryside
engaged in agriculture, yet maintain
popular support in a democracy such
as India?

The Good Society In Depth: India
– From States to Markets

• Globalization refers to the
increasing flow of money, people,
skills, ideas, and goods across
borders, or in other terms, the
extensive development of markets.
• Global production chains:
•

Many countries involved in the
production of a single product such
as a Barbie doll, or an iPod.

• Today we have a tremendous
increase in volume of international
exchange.

• Part of this is the result of
technology.
•

• Part of it comes from the
“Washington Consensus” on
market based growth and
neoliberalism – idea is to balance
budgets by cutting spending,
open markets, sell off
nationalized industries to private
investors.
•
•
•

Globalization

More intercontinental flights

Had support of large multinational
corporations, and international
agencies.
World Bank & the IMF
Critics: hurt the poor, increased
unemployment, drove out small
business, weakened democracy

Detractors of
globalization
argue that it
creates a
“race to the
bottom”.

•

Each country competes to have the lowest
wages, lowest taxes, and fewest regulations
in order to attract foreign investors.
Record of countries that followed the
Washington consensus strategy has been
uneven.

•
•
•

•

Chile succeeded whereas most other Latin
American countries did not.
World Bank concedes that the one-size-fitsall prescription of balanced budgets, open
markets, and privatization did not work.

Globalization has varied outcomes because
it is refracted through different institutions
and governing coalitions as well.

Globalization

Problem

Methods & Hypotheses

• Mosley & Uno ask whether
globalization contributes to
or compromises workers’
rights in developing
countries?
• Is it a race to the bottom or
does it offer a climb to the
top?

• They hypothesize that the
impact of globalization on
workers depends on the way
countries participate in
global production networks.
• Workers will benefit when
countries attract foreign
direct investment but they
will suffer when countries
engage in more trade.

Comparative Political Analysis:
Does Globalization Help or Hurt Workers in the Developing World?

Operationalizing Concepts

Results

1.

• Statistical analysis confirmed their
hypothesis: The higher the level of
FDI as a percentage of GDP, the
greater the respect for labor rights.
• Conversely, trade openness was shown
to be detrimental to workers.
• So it appears that globalization’s effect
on workers’ rights depends on the
specific ways in which countries are
integrated into the global economy.

2.

3.

Workers rights, the dependent
variable, captured by counting the
number of labor rights violations
that countries committed from 1985
to 2002 as recorded by the U.S. State
Department, the International Labor
Organization, and the International
Confederation of Free Trade Union.
Foreign direct investment is
operationalized by looking at
annual changes in FDI and the
overall level of FDI as a percent of
GDP.
Operationalize trade by looking at
the ratio of imports and exports to
GDP

Comparative Political Analysis:
Does Globalization Help or Hurt Workers in the Developing World?

• States try to influence economic conditions through fiscal
policy.
• This involves juggling their budgets, their overall levels of
revenues and expenditures.
• Often set by the executive branch:
• Can run a budget deficit, which puts money into circulation
that increases demand for goods, which, in turn, encourages
businesses to invest and put people to work.
• Can run a surplus, taking in more money than they spend. This
withdraws money from circulation, which depresses spending
and discourages investment, thereby reducing inflationary
pressures in the economy.

Forms of State Intervention: Fiscal Policy

• States differ greatly in the proportion of their economy
devoted to taxes and state expenditures.
• U.S. – citizens complain about high taxes and too much
government spending but actually have a lighter tax burden
than citizens in other rich democracies, and the American
government is relatively lean. (See Table 5.1)
• Only Australia, Ireland, Japan, and Switzerland recorded
lower state spending as a percentage of their economies
than the U.S.
• At the opposite end is Sweden, where state revenues and
spending amount to more than half of GDP.

Forms of State Intervention: Fiscal Policy

• Another means by which
states influence economic
conditions: monetary
policy
• Manipulation of interest
rates/regulating how much
it costs to borrow money.
• High interest rates tend to
discourage borrowing and
spending; used to counteract
tendencies toward inflation.
• Low interest rates encourage
borrowing and spending by
making loans cheap.

• Interest rates are largely
determined by central
banks.
• Central banks issue
currency and manage its
value in foreign
exchange.
• May be insulated from
politics and states have
little control over them.
• Ex.: Federal Reserve in U.S.;
European Central Bank even
more insulated.

• Other countries have a great
deal of influence.
• China’s People’s Bank

Forms of State Intervention: Monetary Policy

• States manipulate budgets and central banks manage
interest rates, but states can also issue regulations that set
explicit rules of behavior that firms must follow.
• Some states are very regulatory.
• The number of procedures and days it takes to start a new
business is a standard measure used to compare the
thickness of the regulatory environment from country to
country.
• GERMANY: 45 days and 9 separate interactions to obtain
licenses and permits to start a business.
• BRAZIL: 152 days and 17 steps.
• US: 5 days and 5 steps.
• U.S. economy is actually one of the least regulated in the world.

Forms of State Intervention: Regulatory Policy

• States try to influence economic activity by nationalizing industries
in which states own and control public enterprises.
• Nationalized industries permit the state to control strategic assets
through which it can influence the economy.
• Examples: oil industries in Mexico, Venezuela, & Saudi Arabia

• Can also help inject social criteria into the economy
• China: inefficient industries are often subsidized because they provide
jobs and services to millions who would be poor and jobless without
them.

• States differ in the degree to which they nationalize industry.
• Socialist countries (Cuba, North Korea) own & control all means of
production. Few in number now.
• More countries have privatized once state-owned industries.

Forms of State Intervention: Nationalization

States have many tools
to utilize in order to
influence the economy
beyond fiscal policy,
monetary policy,
regulation and
nationalization.
Mix varies from
country to country.

• Where markets play a greater role
we expect to find that:
1.
2.
3.
4.

States do not redirect as much of
the country’s income through taxes
and expenditures.
States do not exert much influence
upon central banks that set interest
rates.
State regulations are not as copious
or intrusive upon managers.
Public enterprises contribute little
to GDP.

• The opposite is the case where states
play a powerful role in determining
who gets what.
• Continuum of most market- oriented
to the most state-directed.

Forms of State Intervention: Nationalization

Table 5.1

o Do countries in which market systems prevail do a better
job of enhancing people’s capability than countries with
heavy state intervention?
o Physical well-being?
o Figure 5.2: countries that received top scores from the
Fraser Institute were also the countries in which infant
mortality rates are low.
o Market systems do a better job at meeting the physical
needs of citizens than more state-directed economies.

Markets and the Good Society

Figure 5.1

o Informed Decision-making
o According to Figure 5.3, the average literacy rate for
countries in the top quintile (top fifth) of market-based
societies was 96.1 percent; in the fourth quintile it was 92.2,
the third was 89.6 and so on.
o The average literacy rates for countries in the bottom
quintile, which included countries with the most statedirected economies was 62.3%.


Figure 5.2

o Safety
o Warfare poses the greatest threat to citizens’ safety and
wars are far more likely to occur within states than between
them.
o Type of political economy a country has is virtually
irrelevant in determining its risk of war.
o Safety can also be assessed via homicide rates
o Figure 5.4: the average homicide rate does rise as we move
from the highest to the lowest quintile of market economies.
o Correlation, but not a strong relationship. Very different
murder rates among countries, even among those with the same
economic systems.


Figure 5.3

o Democracy
o Fraser Institute rankings (market friendly states) find robust
democracies in the top quartile and repressive dictatorships
at the bottom.
o Some striking anomalies: Hong Kong, Singapore, Israel,
Egypt
o Market friendly states do not guarantee liberal democracy,
but there are no liberal democracies without them.

o Organizing economies along market lines does improve
people’s capabilities, but not consistently so.


Figure 5.4

• Markets are not a panacea.
• They must be supplemented in order to increase people’s
capabilities.
• Important: develop a balance between states and markets
that promotes the best qualities of markets, such as
innovation and productivity, while avoiding their worst
effects – instability and inequality.

Conclusion

• Why do countries differ in their balance between states
and markets? What factors determine why some countries
depend more on markets while others depend more on
states?
• What sort of activities should be left to the marketplace
and what should be insulated from it? What criteria
should determine where it is appropriate and where it is
inappropriate for markets to operate?

Critical Thinking Questions

• Why have some developing countries benefited from globalization
while others have been victimized by it?
• Many central banks that set monetary policy and influence interest
rates are independent of government and, in effect, unaccountable to
the people their policies affect. Should central banks be more
democratically accountable?
• The authors noted that although there are no democracies that are not
also capitalist, many capitalist economies operate within
authoritarian political systems. Why is it the case that democracy
seems to require capitalism but capitalism does not seem to require
democracy?

Critical Thinking Questions

Chapter 5 CPO2002 Lecture

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