Chapter 4: Political Economy

What is Political Economy?

• Political economy: the study of the interaction between states and markets
• Examines the balance of freedom and equality, and which one is more prioritized in a state’s economic policy-making.

The Components of Political Economy

Markets and Property

• Markets: interactions between the force of supply and demand that allocate resources
  • Composed of sellers and buyers
• Markets are…
  • The medium through which buyers and sellers exchange goods.
  • Sellers seek to create products that will be in demand.
  • Buyers seek to buy the best or most goods at the lowest price.
  • Markets emerge spontaneously and are not easily controlled by the state.
• Property: goods or services that are owned by an individual or group
  • Can be owned privately or publically
  • Can be tangible or intangible

Public Goods

• Public goods: goods provided or secured by the state that are available for society and indivisible
• Examples:
  • Roads
  • Primary education
  • Healthcare*

Know the Difference: Private versus Public Goods

• Private Goods
  • Possible to exclude others from consuming
  • Consumption reduces availability
  • Markets are efficient at providing private goods
• Public Goods
• Impossible to exclude others from consuming
• Consumption does not reduce availability
• Markets are bad at providing public goods

Oil as a Public Good

• Oil and gas can provide wealth or lead to a “resource curse”
  • Can lead to authoritarianism, such as in Russia and Iran
  • Can be a source of corruption, such as Brazil’s Petrobras scandal
  • Can lead to a vulnerable economy if it is too reliant on the resource, such as in Russia, Nigeria, and Mexico
• Private ownership and production can also lead to issues
  • Weak states struggle to capture profits from industry, especially when controlled by foreign companies, such as in Nigeria
  • Can lead to environmental change

Social Expenditures: Who Benefits?

• Social expenditures: the state’s provision of public benefits, such as education, healthcare, and transportation.
  • Commonly called welfare or the welfare state.
  • Prioritizes equality value
  • Main beneficiaries: middle class
• Advantages:
  • Provide “economic building blocks”
  • Insurance against economic downturns
• Disadvantages:
  • May discourage people from seeking work
  • Costly for governments to maintain

Taxation

• Used to pay for social expenditures
• Tax revenue comes from a variety of sources
  • Income taxes
  • Corporate and payroll taxes
  • Value-added (or sales) taxes
  • Property taxes

Taxation: Costs and Benefits

• Advantages
  • More government revenue
  • May decrease harmful behavior
• Disadvantages
  • May penalize work and investment
  • May distort markets and decrease competitiveness

Money, Inflation, and Economic Growth

• Money is a medium of exchange
  • A store of value
  • A unit of account
• The value of money is determined by states.
  • Money is printed and produced by states.
  • Money is a social institution.

Role of a Central Bank

• Central bank: an institution that controls how much money is flowing through the economy as well as how much it costs to borrow money in that economy.
• Central banks and interest rates
  • Higher rates: Less loans + more savings = less money flowing
  • Lower rates: More loans + more spending = more money flowing
• A Central Bank…
  • Controls the amount of money in the economy.
  • Controls the cost of borrowing money.
  • Lowers interest rates to stimulate the economy.
  • Raises interest rates to check inflation.

Too Much Money Flowing: Inflation

• Inflation: increase in the general price level of goods and services in the economy when demand outstrips supply.
  • Problem: too much money
  • Money is less valuable; the same goods cost more
  • Poverty increases
• At the extreme: hyperinflation
  • Inflation greater than 50% a month for more than two months in a row.

Too Little Money Flowing: Deflation

• Deflation: too many goods are chasing too little money
  • Also known as the “liquidity trap”
  • Problem: not enough money
  • Prices lower, as do profits and spending
  • Businesses close and unemployment rises

Regulations

• Regulations: rules or orders that set the boundaries of a given procedure
• Some regulations limit commerce
• Other regulations govern the organization and operation of firms

Regulating Markets

• Regulations limiting commerce
  • Public health and safety rules
  • Food safety, consumer protections
  • Bans on some commerce
  • Drugs
• Regulations governing firms
  • Employee protections
  • Worker safety
  • Allowing or banning monopolies: a market controlled by a single producer
  • Telecommunications

Trade

• The mechanisms states use to regulate trade:
  • Tariff: tax on an imported good (not applied to an otherwise similar domestic good)
  • Quota: a limit on the number of certain goods that can enter the country
  • Nontariff regulatory barriers: health, packaging, or other restrictions that make it more difficult for foreign goods to sell in local markets

Comparative Advantage

• Comparative advantage: the ability to produce a particular good or service relatively more efficiently than other countries
• Comparative advantage shaped by:
  • Relative resource endowments
  • Climate
  • Production technologies
  • Human capital and innovation
  • Labor costs
  • Government policies

Regulate Trade or Promote Free Trade?

• Arguments over the Regulation of Trade
  • Why Regulate Trade?
  • To generate state revenue
  • To foster local industry
  • To protect local jobs
  • To keep wealth in the country
  • Why Not?
  • To promote competition
  • To keep the costs of goods low
  • To stimulate domestic innovation in areas of comparative advantage

Political-Economic Systems

• Political-economic system: the relationship between political and economic institutions in a particular country, as well as the policies and outcomes they create.
• Four basic classifications:
  • Liberalism
  • Social democracy
  • Communism
  • Mercantilism

Liberalism

• Goal: maximize economic freedom to promote growth
  • Laissez-faire: the principle that the economy should be “allowed to do” what it wishes
  • Capitalism: a system of production based on private property and free markets.
• State policies minimize direct intervention; seek to support free markets.
  • Protect private property.
  • Enforce contracts.
  • Break up monopolies.
• Examples: United Kingdom, United States, Singapore, United Arab Emirates

Liberalism in Practice: Chile (post-1980s)

• Liberalization began under the dictatorship of General Augusto Pinochet
  • Has continued since its democratic transition
  • Emphasized promoting greater economic freedoms
  • A few major liberal elements;
  • Private pensions (instead of state-run)
  • Most healthcare through private insurers

Social Democracy

• Goal: balance freedom and equality
• State policies play an active role in shaping markets.
  • Strong protections for private property
  • Free trade, but state-supported industries
  • Significant redistribution of wealth
  • High taxes
  • Public investments in education, transport, and so on
  • Safety net to help the poor
  • Examples: Germany, Norway, Sweden

Social Democracies and Economic Equality

• How Do Social Democracies Seek to Achieve Greater Equality?
  • Through taxes, which make high levels of social expenditure possible while redistributing wealth from rich to poor
  • Through trade, which is promoted but balanced with preserving domestic industry and jobs
  • Through government regulation and even ownership of important sectors of the economy

Social Democracy in Practice: Sweden

• Extensive welfare state to promote economic equality
  • Well-funded public health, education, retirement
  • High tax rates
  • Trade unions help shape business policy
  • Swedish Trade Union Confederation
  • Government-owned and -affiliated industries
  • Systembolaget
  • Liberal business rules to promote economic freedom
  • Free trade: EU membership
  • Business-friendly regulations

Communism

• Goal: eliminate individual economic freedom to achieve equality
• Active state intervention in the economy
  • Little or no private property
  • All property is viewed as public good
  • Massive redistribution of wealth
  • Nationalized industry under heavy bureaucratic control
  • Prices and wages set by the state
  • Indiviudals limited in choice of jobs
  • Trade heavily regulated

Communism in Practice: A Dead System

• Today, a very rare system
  • USSR collapsed
  • Economic reforms in China and Cuba
• North Korea: the last holdout?
  • Heavy central planning
  • Little international trade
  • Markets severely restricted
  • However, increasing signs of some liberal reforms

Mercantilism

• Mercantilism: a political-economic system in which national economic power is paramount and the domestic economy is viewed as an instrument that exists primarily to serve the needs of the state
• Goal: maximize state wealth as a means to increase state power
  • Economic freedom and equality are low priorities.
• State as a primary economic actor prioritizing certain goals
  • Strategic industries are fully nationalized or parastatals.
  • Parastatals: industry partially owned by the government
  • Other sectors see less government support or intervention.
• Examples: Japan, South Korea, post-Mao China

How Do Mercantilist States Seek to Achieve Economic Power?

• By directing the economy toward certain industries and away from others through the use of subsidies and taxation
  • Through partial or full state ownership of industries that are considered critical (parastatals)
  • With the strong use of tariffs, nontariff barriers, and other regulations
  • By limiting social expenditures and thereby keeping taxation to a minimum
  • With low-interest rates set by the central bank to encourage borrowing and investment

Mercantilism in Practice: East Asia

• Japan, 1950s-1980s
  • Savings and capital directed to national firms
  • State support for exporters
  • Barriers against imports
• South Korea, 1960s-present
  • Government invested in chaebol conglomerates
  • Favorable foreign loans
  • “Special favors” in government policy

Final Comparisons: Contributors to Theories

Contributors to the Theories of Political Economy

Final Comparisons: The State-Economy Connection

Political-Economic Systems

Political-Economic Systems and the State: Comparing Outcomes

Measuring Wealth

• Gross domestic product (GDP): total value of goods and services produced in a country in a year
• Problems with comparability
• Common “fixes” to GDP:
  • Purchasing power parity (PPP): a statistical tool that attempts to estimate the buying power of income in each country by comparing similar costs, such as food and housing expenses, by using prices in the United States as a benchmark
  • GDP per capita: divide GDP by the country’s population

Measuring Inequality and Poverty

• Why equality matters:
  • Highly unequal societies tend to grow more slowly and become politically unstable.
  • Poverty wastes human potential.
  • Inequality can indicate deeper problems.
• Gini index: a mathematical formula that measures the amount of economic inequality in a society
  • Income distribution overpopulation
  • Range of 0 to 100
  • Higher Gini scores = more unequal societies

In Focus: Measuring Wealth

Human Development Index (HDI)

• Human Development Index (HDI): a statistical tool that attempts to evaluate the overall wealth, health, and knowledge of a country’s people
  • Created by the United Nations Development Programme
  • Measures “quality of life” by combining:
  • Expected years of education
  • Life expectancy
  • Income per capita

Comparing Human Development

• Very high: Germany, Canada, United States, Sweden, United Kingdom, Japan, South Korea, France, Russia
• High: Mexico, Brazil, China, South Africa
• Low: Nigeria

Comparing Happiness?

• Happiness as a measure of economic fulfillment?
• Wealthier, more equal countries tend to be happier
  • But not always

The Rise and Fall of Liberalism?

The Rise of Liberalism

• Economic liberalization: policy changes consistent with liberalism that aim to limit the power of the state and increase the power of the market and private property in an economy
• Liberalism rises: 1980s-1990s
  • Communism fails
  • Countries increasingly adopt liberal policies, including:
  • Cutting taxes
  • Reducing regulation
  • Privatizing state-owned businesses and public goods
  • Expanding property rights

Levels of Economic Liberalization

• Some caveats:
  • “Mixed” economies are the norm
  • Liberalism peaks in 2005

Liberalism in Decline?

• Who wins (and loses) in a globalized economy?
  • Winners: emerging economies and global elite
  • Losers: middle-class in high-income countries
• “Left behind” voting for nationalists and populists
  • These politicians are dismantling economic liberalism.

In Sum: A New Economic Era?

• Basics of economics include markets and properties.
• States use a number of policies to shape economies. States can regulate money by using central banks, set regulations on commerce and trade, and/or redistribute wealth through taxation and social expenditures.
• When it comes to political-economic systems, states vary between liberalism, social democracy, communism, and mercantilism. Each has a preferred balance between the values of freedom and equality.
• There are many ways to measure wealth and prosperity. Some better capture the value of freedom, others the value of equality.
• Liberalism has dominated global economics over the last few decades, but significant criticisms have emerged in recent years.

Key Terms

1. Capitalism - a system of production based on private property and free markets
2. Central bank - the state institution that controls how much money is flowing through the economy, as well as how much it costs to borrow money in that economy
3. Comparative advantage - the ability of one country to produce a particular good or service more efficiently relative to other countries’ efficiency in producing the same good or service
4. Deflation - a period of falling prices and values for goods, services, investments, and wages
5. Economic liberalization - changes consistent with liberalism that aim to limit the power of the state and increase the power of the market and private property in an economy
6. Gini index - a statistical formula that measures the amount of inequality in a society; its scale ranges from 0 to 100, where 0 corresponds to perfect equality and 100 to perfect inequality
7. Gross Domestic Product (GDP) - the total market value of all goods and services produced by a country over a period of one year
8. Human Development Index (HDI) - a statistical tool that attempts to evaluate the overall wealth, health, and knowledge of a country’s people
9. Hyperinflation - inflation of more than 50% a month for more than two months in a row
   10. Inflation - an outstripping of supply by demand, resulting in an increase in the general price level of goods and services and the resulting loss of value in a country’s currency
   11. Laissez-faire - the principle that the economy should be “allowed to do” what it wishes; a liberal system of minimal state interference in the economy
   12. Market - the interaction between the forces of supply and demand that allocates resources
   13. Mercantilism - a political-economic system in which national economic power is paramount and the domestic economy is viewed as an instrument that exists primarily to serve the needs of the state
   14. Monopoly - a single producer that is able to dominate the market for a good or service without effective competition
   15. Nontariff regulatory barriers - policies and regulations used to limit imports through methods other than taxation
   16. Parastatal - industry partially owned by the state
   17. Political-economic system - the relationship between political and economic institutions in a particular country and the policies and outcomes they create
   18. Political economy - the study of the interaction between states and markets
   19. Property - goods or services that are owned by an individual or a group, privately or publicly
   20. Public goods - goods, provided or secured by the state, available to society, and which no private person or organization can own
   21. Purchase Power Parity (PPP) - a statistical tool that attempts to estimate the buying power of income across different countries by using prices in the United States as a benchmark
   22. Quota - a nontariff barrier that limits the quantity of a good that may be imported into a country
   23. Regulation - a rule or an order that sets the boundaries of a given procedure
   24. Social expenditures - state provisions of public benefits, such as education, healthcare, and transportation
   25. Tariff - a tax on imported goods