Until recent centuries, trade was mostly local and there was no monetary system. The barter trade system where people exchanged one good with another was the dominant exchange of trade. When barter became inadequate for long distance trade, gold and sliver became the mode of payment. And when metals became difficult to sustain the global trade, the currency notes were introduced and global monetary system emerged. Roman Empire was probably the first to create a monetary system throughout its empire.
The countries involved in global trade had different understandings of how their national economies should be governed. Should it adhere to free market policies? Or, should it adopt protectionist measures for national wealth? Or, a complete overhaul of global economy where working class would own the means of production? These are the primary questions when we study International Political Economy. And primarily there are three theoretical lenses to see the political economy: Mercantilism, Liberalism and Marxism. But before we turn our head into theories, it's necessary to understand the historical process through which these theories emerged.
Trade in Medieval Europe
In the Medieval Europe, a number of city-states emerged and commerce flourished all over the continent. Particularly, Italian city of Florence and in Belgium self-governing cities emerged. The growing trade required money and thus, banks emerged. In 13th century, Florence became Europe's banking center. For instance, Florence bankers Bardi and Peruzzi families opened banking facilities all around the Europe and became rich. The most important banking family of Florence was however, Medici Family. Machiavelli's The Prince was dedicated to the prince of this family only. The Medici family's main client was Pope. They collected 10% of earnings across Europe on behalf of Pope.
However, political lending often caused bankruptcy to many banking families. Peruzzi went bankrupt for loan given to England's king Edward III as 100 Years War between 1337 to 1453 exhausted the king's resources and they were unable to pay the debt.
Soon the European countries such as Spain and Portugal discovered New Lands in America and new economic links emerged. As territorial states became more powerful in 17th century, they assumed the role of money provider and trade regulator. These states developed first international monetary system which as Gold Standard where gold=money. And the mercantilist system emerged in Europe.
The mercantilists dominated the economic thinking in 16-18th centuries where the mantra was export more, import less. Some from of mercantilist policies still exist in the form of tariffs, quota and duties.
Liberalism rose in 18th century in the form of free market capitalism, spread by the US and Britain.
Marxism came in 19th century as an alternative to capitalism. However, with the end of Cold War in 1990, economic liberalism or neoliberalism became the dominant vocabulary of global economy.
1. Mercantilism
Mercantilists slogan was "export more, import less." During the 16th and 17th centuries, states were the main players of global economies and they encouraged exports over imports to finance their huge armies. Similar to realists, mercantilists argued that economic policies should advance state power.
They believed accumulation of metals (gold and silver) was more important than trade as it increased the national wealth. So national economies that time were measured on how much gold one country had not how much trade they had. Spain's conquest of Latin American countries: Panama, West Indies, Venezuela and Peru, provided abundance of gold mines and Spaniards became extensively rich. Spain also put restriction on the colonial trades. colonies couldn't trade with other countries. Mercantilism thrived in Europe from the exploitation of colonies. Soon other European countries joined the loot of colonies in Africa, Asia and elsewhere.
Mercantilists as with realists argue that economic policy of a state shouldn't be judged on absolute wealth but 'relative wealth'. If a country has more wealth than others, than it is relatively rich than others. They argue that even infant industries should be protected through tariffs and trade restrictions, although it meant higher prices for consumers. Even America's first secretary of Treasury, Alexander Hamilton, supported the mercantilist policy.
What are the mercantilist tools?
1. Tariff: Put tariff on imports to protect the national industries and to finance the defense expenditure.
2. Government Monopolies: European monarchs often interfered in their economies and decided the economic policies. They nationalized the industries and even the colonial businesses were carried out on the name of royal families.
3. Imperial Expansion: European countries colonized Africa, America and Asia to get the raw materials and market for their products.
4. Population Growth: Mercantilist supported population growth to get laborers and armies for conquest. The European monarchs rewarded the large families.
5. Monopoly over Colonial Trade: As almost 95% global trade was conducted through sea route, it became the major source of income for European countries. For instance, England's 1651 Navigation Act required goods imported from British colonies to use only English vessels with English crews. Later, the Act was amended that required colonial exports to first reach English ports before re-exporting elsewhere.
How England then became champion of free trade?
The Industrial Revolution in the 17th century gave way for free trade. The revolution changed the British society from agrarian to industrial society. These industrial workers resided in urban centers and these workers needed cheap foods. England faced famines and droughts in 19th century which skyrocketed the bread prices and it became difficult to provide food at affordable prices for workers. Britain first abolished the Corn Law which restricted import of grains from other countries. By abolishing Corn Law, England imported food grains from other countries which helped in reducing the prices. And by 1860, Britain became the advocate of free trade.
Neomercantilism
Today, a modern form mercantilism exists in the form neomercantilism. The Make in India or Make in USA are the slogans and narrative of national leaders in order to reduce the trade deficit. Leaders often use the economic nationalism to influence the citizens to buy home country products. For example, recently economic nationalism was ignited through media which demanded boycott of Chinese products in India. Even the more advanced economies like the US banned the Chinese TikTok app citing data theft. Some countries adopt non-tariff measures such as subsidies and tax benefits to local industries to make the foreign products expensive for consumers.
Impact of Mercantilism/Neomercantilism
- Inefficient industries may benefit from neomercantilism policies but competitive industries wouldn't benefit from it.
- Products may become costlier for consumers.
- Interest in innovation can take sideline.
- The global trade agreements would also suffer. For example, the US president Donald Trump withdrew from Trans-Pacific Partnership.
- If more and more countries adopt these policies, trade war can ensue as the case with US-China Trade war.
2. Economic Liberalism
In contrast to mercantilism, the underlying theme of economic liberalism is that economic policies should improve citizen's standard of living, not increase state power. The economic liberalism was championed by Adam Smith and later, David Ricardo.
Adam Smith: The Wealth of Nations
Actually, the term mercantilist was first given by Adam Smith in his book The Wealth of Nations. He championed the idea of market economy.
He argued that manufacturers were more important than accumulation of metals for states. Countries could achieve economies of scale by specializing in good that they could produce more efficiently. Smith believed in market which provided general welfare. Competition among entrepreneurs provide a wide range of products at lower prices for consumers. And most importantly, market works under an 'invisible hand' which transforms individual greed into social prosperity. Government should be limited to provide nation defense and public goods such as rail, road, schools, etc.
David Ricardo: On the Principles of Political Economy and Taxation
Ricardo added that free trade was beneficial because in specializing, countries achieved a "comparative advantage".
Suppose a country could produce everything at inexpensive prices. But the country could still benefit more by specializing in whatever it could produce more efficiently. It's specialization depends upon cost of factors of production which are land, labor, capital, technology and energy. The specialization provides an avenue to minimize the "opportunity cost".
For example, suppose you are a successful freelance web developer and blogger who caters to clients . You are good in coding as well as writing. But the coding pays you much higher than writing but the latter takes most of your time. In order to increase your income, you want to focus more on coding rather than time consuming freelance writing work. You hire a content writer to do the blogging work and you focusing more on coding projects. In this way, you have minimized the opportunity cost and increased your income.
Thus, comparative advantage doesn't mean doing everything better than anyone else. It simply means weighing the opportunity cost.
Economic Liberalism in 21st Century
The world has changed from Smithian world. Today, there are transnational corporations (TNCs) and MNCs who do the bulk of global trade. Their enormous capital often distort the market competition and make the trade favorable to these MNCs and TNCs. For example, Google has become a monopoly in internet search and there is almost non-existent competition. They dictate the terms and conditions for businesses and they have unapparelled power to influence not only businesses but public perception too.
Neoliberal Economists
Neoliberals too favor free market and minimal government intervention in economic affairs, but they see a greater role of international economic institutions such as IMF or World Bank than classical economic liberals.
They argue that free movement of capital and labor produces more good than harm, although inefficient economies and industries may suffer. They believe economic efficiency is more important than economic equality.
Problems with Neoliberal Policies
- Unfettered competition may trigger speculation that drives up the prices of assets above their value, and when such bubbles burst, they cause economic distress. For example, the US Subprime Lending Crisis 2008.
- Unregulated capitalism creates economic inequality. The rich becomes richer and poor becomes poorer. For example, the richest 1% own 44% of the global wealth, according to Credit Suisse Wealth Index.
- The global integrated financial system creates havoc worldwide when one country's economy flounders, as it happened during the US Financial Crisis 2008. The US crisis became a global crisis.
- National governments often find it difficult to raise the workers' wages as can be seen with Indian government which has so far not able to fix a minimum wage policy. If Indian government increases the labor prices, the companies will soon move their operations to those countries where labor cost is less.
Angered by the injustices of industrial revolution, Karl Marx and Engels offered a revolutionary alternative to capitalism.
3. Marxism
According to Marx, history has evolved owing to changing 'modes of production' that allowed some economic classes to dominate and exploit others. His theory premises on two opposing forces, which is called Dietetical Materialism. He argued that economic conditions determine politics, not the other way around.
Each historical period saw a revolution which overthrew a dominant class. Capitalist class removed feudal lords and they would soon be overthrown by working class, as he predicted.
How the revolution would occur?
Capitalists own the means of production and workers own their labor. Capitalist's main motive is profit, and profit would increase if they could reduce the costs of factors of production. And they could achieve it by keeping the wages as low as possible.
As capitalists' greed would grow, the anger among working class would rise, and ultimately the 'proletariat' would rise up to destroy the capitalists.
What would happen after the revolution?
After the revolution, socialism would emerge as the way of organizing national economies and later, global economy. In socialism, workers would be paid according to his contribution rather than according to capitalist law of supply and demand.
From each according to his need, to each according to his work.
After socialism, the world would enter the stage of Communism, a classless society that distributed the wealth as:
Each according to his ability, each according to his needs.
Although, the Marxist theories have declined in political economy after the collapse of USSR in 1990. A number of Marxist variants emerged in many developing countries. The most important are World System Theory and Dependency Theory
World System Theory: Immanuel Wallerstein
Influenced by Marx's theory, Wallerstein developed World System theory to explain the global gap between rich and poor. According to him, the modern capitalist world system emerged from a fedual world in 16th century in Europe. These European countries spread the capitalism and free market concepts all over the world.
He identified three main global division of world system: core, semi-periphery and periphery. The core countries are the developed countries in North America and Western Europe. And the periphery are countries who rely on exporting raw materials. These peripheries have unequal trade relations with the core. Semi-peripheries are countries or associations such as ASEAN whose economies intersect at both core and periphery.
Dependency Theory
Like Wallerstein, Dependency Theory emerged in Latin America which argued that world trading system benefited only advanced capitalists' economies. Often the Terms of Trade favored these countries over the least developing countries (LDCs).
Terms of Trade = Export Prices / Import Prices
LDC economies depend upon export of raw materials and agricultural commodities. And they import finished products from developed countries.
As the commodity prices rise slowly but manufactured product prices rise sharply, the terms of trade would deteriorate for LDCs unless their exports rise faster than the imports. The global trade is done mostly by corporate subsidiaries thus commodity prices are not exposed to market. These giant corporations often secure the deal with long term agreements, thus even though commodity prices might have rose but they would pay what was agreed in the agreement. They also have sophisticated accounting devices which enable them to avoid paying taxes. They often artificially overprice the products in high-tax countries and underprice where taxes are low.
Many LDCs depend upon export of single commodity or raw materials. If the international prices of commodities decline, they often resort to international creditors which increases the national debt for LDCs.
It creates a vicious cycle of rich getting richer and poor becoming poorer.
How to incorporate favorable Terms of Trade for LDCs?
- Reduce imports
- Become self-reliant
- State control over the economy
Failure of Dependency Policies
Initially, Latin American countries enjoyed some success by adopting Dependency theory recommendations in 1980s.
But developing own industries and investing in agriculture required capital, but capital was available through only foreign loans. A country couldn't print as much as currency as they want as it would cause hyperinflation. So LDCs borrowed heavily for development from international creditors such as US, European Union, World Bank and IMF. But when the commodity prices fell, their ability to pay the debt was reduced. The Latin American debt reached to a new height and quadrupled between 1975 and 1982.
The failure of Marxian economic analysis, renewed the interest in free market, and countries started to compete for Foreign Direct Investments (FDI). But FDIs reached only to those countries which de-regularized their economies, reducing the state capabilities to continue welfare measures.
Currently, despite the rise of economic nationalism, free market model is the most dominates system of International Political Economy..
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