Chapter 4 (CPO2001)

Political Economy: How politics and economics are related and how each affects the balance between equality and freedom. Questions: What role do states play in managing the economy? Ideal relationship between the state and the economy?

• Some believe the economy is the way to achieve freedom, while others see it as a way to achieve equality.

Components of Political Economy:

• Markets: interaction between forces of supply and demand. Creates value for goods and services. Decentralized.

  • Emerge spontaneously, hard to control by the state

  • Require the state to enforce contracts, sanction activity, regulate supply and demand.

• Property: Ownership of goods and services. Property rights are enforced by the state– what can I do with my property?

  • Intellectual property: ownership to a specific type of knowledge or content

• Public goods: used by society, not privately owned. Because some goods do not function well in the marketplace (want to avoid privatization because they may lower its quality/incentivize it). Examples: roads, national defense.

  • Nonexcludable and nonrival

• Social expenditures: often defined as “welfare.” State provision of public benefits, not used by everyone. Redistributive power placed in the hands of the state, often controversial– who pays? Examples: education, healthcare, transportation.

• Taxation: Used to pay for public goods and social expenditures. Taxation varies in who is taxed/how much is taxed.

Money, Inflation, Hyperinflation & Deflation:

• Money is a medium of exchange, a form of IOU.

  • Example: Greek debt crisis– money is only valued because everyone believes (mutual assurance). In Greece, one individual spread the idea that Greek bonds weren’t worth anything, and the illusion was shattered, causing people to realize it may not be worth anything.

• Legitimacy is backed by the state.

  • Central banks control its supply, typically through interest rates.

    • Lowers interest rates to stimulate the economy

    • Raises interest rates to check inflation

  • Actions closely tied to inflation and unemployment.

    • Quantitative assurance: Printing more money to manage state debt.

• Two extremes:

  • 1) Hyperinflation: Inflation of more than 50% a month for two months in a row.

    • Government prints money to pay basic expenditures.

    • Causes a collapse in public trust and subsequently state legitimacy

    • Leads to currency collapse

  • 2) Deflation: Too many goods chasing too few dollars.

    • People spend less

    • Depresses wages

• Regulations

  • Why regulate trade:

    • To generate state revenue

    • Too foster local industry

    • To protect local jobs

    • To keep wealth in the country

  • Why not:

    • To promote competition

    • To keep the costs of the goods low

    • To stimulate domestic innovation in areas of comparative advantage

Political–Economic Systems: Actual relationships between political and economic institutions in a particular country, and the outcomes these systems create.

Liberalism (Adam Smith– The Wealth of Nations (1776))

• Related to the ideology of the same name. 

  • High priority on individual political & economic freedom, less on equality.

  • Argues that a weak state and strong capital markets foster democracy. 

  • US and other former British colonies.

  • Best state is a weak one. 

• Components:

  • Limited regulations

  • Fewer public goods

  • Lower taxes

  • Free trade

  • Laissez-faire

• Greater tolerance for inequality and poverty.

Social Democracy (Eduard Bernstein– Evolutionary Socialism (1899))

• Balance between individual freedom & collective equality

  • Accepts private property & markets, but seeks to regulate.

  • Many European countries fall into this category.

• More public goods than in liberalism– less tolerance for inequality, poverty

  • Trade and competition under state management

  • Outright ownership of some industries by state is seen as acceptable or necessary.

• Neo–corporatism: state, labor, and business set policy in concert, not through conflict (such as strikes).

  • Most common in Europe: high autonomy and high capacity.

Communism (Karl Marx– Das Kapital (1867))

• Emphasis on collective equality over individual freedom

  • Property, markets viewed as instruments of exploitation

  • USSR & Eastern Europe until 1989-1991, Cuba, North Korea

  • No private property– nationalized

  • Private transactions are illegal

  • No ‘free’ markets– controlled by state

  • No unemployment (full employment policies)

  • Trade restricted (minimized, isolated)

  • Creates a gap between those who control the economy and those who merely labor in it.

• Wide range of public goods/social expenditures

• Extremely high autonomy, but often lacks capacity

Mercantilism (Friedrich List– The National System of Political Economy (1841))

• Predates modern ideologies– associate with earlier empires

  • Modern mercantilism associated with fascism

  • Can be found today in non-democratic and democratic settings

• State views market as a tool of international power

  • Japan, South Korea, India & other developing countries

  • Private property along with national ownership

  • Active industrial policy– state directs production, para-statals

  • Small welfare state

  • Tariffs and other trade boundaries

  • Low interest rates

• Neither individual freedom or collective equality emphasized– rather, state power relative to other states.

• More authoritarian than democratic.

• Ownership of specific industries called parastatals

Measures of Political Economic Systems:

• Gross Domestic Product (GDP):

  • Defined as the total production in a country irrespective of who owns it.

  • GDP is limited in that it does not take into account costs of living in different countries.

    • Not the same as personal income– includes things like government expenditures

    • Does not assign a value to leisure or innovation

  • Using GDP per-capita can compare easier across systems.

• Purchasing Power Parity (PPP):

  • PPP looks at GDP in terms of buying power.

  • In countries where costs are low, GDP is increased when adjusted for PPP.

  • In countries where costs are high, GDP is lowered when adjusted for PPP.

• Gini Index:

  • Measures relative wealth and inequality within the state (perfect equality = 0, perfect inequality = 100)

  • What percent of the population owns what percent of the country’s wealth?

  • Higher inequality in liberal countries than social democratic ones

  • Higher inequality in poorer than richer countries

• Human Development Index (HDI):

  • Emphasis on poverty/development over inequality

  • Not focused on wealth, but rather outcome of that wealth (quality of life, literacy and education, life expectancy and health)

  • Strong correlation between GDP and HDI

• Happiness:

  • The pursuit of happiness is the main motivation for human behavior

  • Relative versus absolute happiness

  • Easterlin Paradox: when standards of living rise past a certain level, happiness stagnates

    • Relative income is a stronger predictor of happiness

Future implications

• Wealthier countries are generally happier than poorer ones

• The future of liberalism:

  • Developed from mercantilism to liberalism to communism to social democracy

  • Now, communism has effectively vanished, and liberalism and social democracy have appeared as the only viable forms

  • Economic liberalization: cutting taxes, reduction of regulation, privatization of state-owned businesses, and expansion of property rights. Emerged in the late 70s– seen as neoliberalism and more anti-statist view than classical liberalism

    • US– highest instance of economic liberalization

    • Growth of inequality between middle and upper classes, while inequality decreased between middle and lower classes.