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Capital mobility, trade, and the domestic politics of economic policy

Published online by Cambridge University Press:  22 May 2009

Geoffrey Garrett
Geoffrey Garrett
Affiliation:
Associate Professor, Department of Management, The Wharton School, University of Pennsylvania, Philadelphia.
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Abstract

The conventional wisdom about the domestic political effects of economic internationalization in recent decades is overdrawn and too simple. Increasing exposure to trade and capital mobility has not led all countries to pursue the same types of economic policies. The political power of the left and the strength of organized labor still have a marked bearing on macroeconomic policy. Rather than being constrained by internationalization, the relationship between left-labor power and fiscal expansions has increased with greater trade and capital mobility. However, the political left and organized labor have had to pay a price for these expansions. With greater exposure to world market forces, left-labor power has been increasingly associated with lower levels of corporate taxation and with higher interest rates. Nonetheless, common assertions about the demise of partisan politics must be reconsidered.

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Articles
Information
International Organization , Volume 49 , Issue 4 , Autumn 1995 , pp. 657 - 687
Copyright
Copyright © The IO Foundation 1995

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References

1. See Andrews, David M., “Capital Mobility and State Autonomy,” International Studies Quarterly 38 (06 1994), pp. 193–218CrossRefGoogle Scholar; Goodman, John B. and Pauly, Louis R., “The Obsolescence of Capital Controls?” World Politics 46 (10 1993), pp. 50–82CrossRefGoogle Scholar; Kurzer, Paulette, “Unemployment in Open Economies: The Impact of Trade, Finance, and European Integration,” Comparative Political Studies 24 (04 1991), pp. 3–30CrossRefGoogle Scholar; Notermans, Ton, “The Abdication of National Policy Autonomy,” Politics and Society 21 (06 1993), pp. 133–67CrossRefGoogle Scholar; and Scharpf, Fritz, Crisis and Choice in European Social Democracy (Ithaca, N.Y.: Cornell University Press, 1991)Google Scholar.

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6. The capital taxation variable combines taxes on corporate income with employers' social security contributions, which operate as a de facto tax on corporate income. I thank Deborah Mitchell for suggesting this operationalization.

7. However, trade has always been much higher in countries where the left and organized labor are powerful. Thus, the decision to cut capital taxes to promote competitiveness in international markets was made long ago in these countries, not in the 1980s.

8. For a discussion of alternative measures of financial integration, see Frankel, Jeffrey, On Exchange Rates (Cambridge, Mass.: MIT Press, 1993)Google Scholar.

9. The reported figures are parameter estimates for the impact of private domestic savings on private domestic investment for annual cross-national (fifteen country) regression equations for each year from 1967 to 1990. The seminal article on this approach is Feldstein, Martin and Horioka, Charles, “Domestic Savings and International Capital Flows,” Economic Journal 90 (06 1980), pp. 314–29CrossRefGoogle Scholar. The measure used in that article is taken from the modification of the Feldstein Horioka approach suggested in Bayoumi, Tamin, “Savings-Investment Correlations,” IMF Staff Papers 37 (06 1990), pp. 360–87CrossRefGoogle Scholar.

10. The data are from International Monetary Fund, (IMF), Exchange Arrangements and Exchange Restrictions (Washington, D.C.: IMF, various years)Google Scholar. The categories are restrictions on the capital account, bilateral payments with IMF members, bilateral payments with nonmembers, and foreign deposits. Recent articles that have used these data include Alesina, Alberto, Grilli, Vittorio, and Milesi-Ferretti, Gian Maria, “The Political Economy of Capital Controls,” Center for Economic Policy Research (CEPR) discussion paper no. 793, CEPR, London, 1994Google Scholar; and Eichengreen, Barry, Rose, Andrew, and Wyplosz, Charles, “Speculative Attacks on Pegged Exchange Rates,” manuscript, Department of Economics, University of California, Berkeley, 1994Google Scholar.

11. For a recent presentation of this argument with respect to trade, see Frieden, Jeffry and Rogowski, Ronald, “The Impact of the International Economy on National Policies: An Analytic Overview,” in Keohane, Robert and Milner, Helen, eds., Internationalization and Domestic Politics (New York: Cambridge University Press, forthcoming)Google Scholar. On capital mobility, see Andrews, “Capital Mobility and State Autonomy”; Bryant, Ralph, International Financial Integration (Washington, D.C.: Brookings Institution, 1987)Google Scholar; and Goodman and Pauly, “The Obsolescence of Capital Controls.”

12. See Kitschelt, Herbert, The Transformation of European Social Democracy (New York: Cambridge University Press, 1994)CrossRefGoogle Scholar; and Piven, Frances Fox, ed., Labor Parties in Postindustrial Societies (New York: Oxford University Press, 1991)Google Scholar.

13. See Kurzer, “Unemployment in Open Economies”; Lee and McKenzie, “The International Political Economy of Declining Tax Rates”; Notermans, “The Abdication of National Policy Autonomy”; and Scharpf, Crisis and Choice in European Social Democracy.

14. See Frieden, Jeffry, “Invested Interests: The Politics of National Economic Policies in a World of Global Finance,” International Organization 45 (Autumn 1991), pp. 425–51CrossRefGoogle Scholar; and Frieden and Rogowski, “The Impact of the International Economy on National Policies.”

15. Alvarez, Garrett, and Lange, “The Political Economy of Macroeconomic Performance.”

16. The partisan centers of gravity scores reflect the share of cabinet portfolios and legislative seats (in the primary chamber) held by different parties in each year, based on the classification provided by Castles, Francis and Mair, Peter, “Left-Right Political Scales: Some Expert Judgments,” European Journal of Political Research 12 (03 1984), pp. 73–88CrossRefGoogle Scholar. The data on legislative seats are from Mackie, Thomas and Rose, Richard, International Almanac of Electoral History, 3d ed. (New York: Free Press, 1991)CrossRefGoogle Scholar. The data on cabinet portfolios are from Keesing's Contemporary Archives.

17. The data on union density are from Visser, Jelle, “Trends in Trade Union Membership,” OECD Employment Outlook, 07 1991Google Scholar. Some argue that the portion of wage contracts covered by collective bargaining agreements is a better measure than union density. See Traxler, Franz, “Collective Bargaining: Levels and Coverage,” OECD Employment Outlook, 07 1994Google Scholar. However, so-called coverage data are available only for the 1980s.

18. Torben Iverson, “Power, Flexibility, and the Breakdown of Centralized Wage Bargaining,” Comparative Political Studies (forthcoming).

19. The public sector union data are from Visser, “Trends in Trade Union Membership.”

20. See Garrett, Geoffrey and Way, Christopher, “The Sectoral Composition of Trade Unions, Corporatism and Economic Performance,” in Eichengreen, Barry and Frieden, Jeffry, eds., The Political Economy of European Integration (New York: Springer-Verlag, forthcoming)Google Scholar.

21. Golden, Miriam, “The Dynamics of Trade Unionism and National Economic Performance,” American Political Science Review 87 (06 1993), pp. 439–54CrossRefGoogle Scholar.

22. Golden and Wallerstein, “Trade Union Organization and Industrial Relations in the Postwar Era in Sixteen Nations.”

23. Nonetheless, the position of all owners of capital is clearly more privileged in a world of few controls on cross-border capital flows than Lindblora envisioned in his closed economy framework. See Lindblom, Charles, Politics and Markets (New York: Basic Books, 1977)Google Scholar.

24. See, for example, McKinnon, Ronald I., “Monetary and Exchange Rate Policies for International Financial Stability,” Journal ofEconomic Perspectives 2 (Winter 1988), pp. 83–103CrossRefGoogle Scholar.

25. In a recent article, it has been argued that this will hold only where investors expect taxes to rise. See Michael Wallerstein and Adam Przeworski, “Capital Taxation with Open Borders,” Review of International Political Economy (forthcoming).

26. See Aschauer, Public Investment and Private Sector Growth; Barro, “Government Spending in a Simple Model of Endogenous Growth”; Lucas, “On the Mechanics of Economic Development”; and Romer, “Endogenous Technological Change.”

27. This is not to say that new growth theory pertains to all types of government spending. For example, it would be hard to argue that family allowances or industrial subsidies constitute productivity-enhancing collective goods. For a recent effort to delineate the effects of internationalization on different types of government spending, see Cusack, Thomas R. and Garrett, Geoffrey, “International Economic Change and the Politics of Government Spending, 1962–1988,” manuscript, Stanford University, 1994Google Scholar.

28. Katzenstein, Small States in World Markets.

29. See Kurzer, “Unemployment in Open Economies”; Notermans, “The Abdication of National Policy Autonomy”; and Scharpf, Crisis and Choice in European Social Democracy.

30. The full Kmenta model was not used because that procedure exerts a downward bias on standard errors when applied to panel data sets with relatively short time series (as is the case here). See Nathaniel Beck and Jonathan Katz, “The Analysis of Cross-National Panel and Related Models,” American Political Science Review (forthcoming).

31. Alvarez, Garrett, and Lange, “The Political Economy of Macroeconomic Performance.”

32. For a more detailed description of these data, see the Appendix.

33. These coefficients are not reported to simplify the presentation, but they may be obtained from the author.

34. Trade constituted a lower portion of GDP in many other cases, but in all of these there were simultaneously very few controls on capital flows (as in the United States), and the combined internationalization scores (based on the sum of standardized scores for trade and capital mobility) were higher than for Finland in 1976.

35. Cameron, “The Expansion of the Public Economy.”

36. Indeed, Krugman argues that the effects of trade competitiveness on the U.S. economy are still trivial. Krugman, Paul, “Competitiveness: A Dangerous Obsession,” Foreign Affairs 73 (03/04 1994), pp. 28–44CrossRefGoogle Scholar.

37. Goodman and Pauly, “The Obsolescence of Capital Controls.”