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McGill University
Political Science
POLI 243
Mark Brawley

POLI 243 FINAL EXAM REVIEW GERMANY – role in European Monetary Union - Werner Report (1969) o First consideration of a European monetary union  There was already a European interest in lowering economic barriers, free movement of peoples, etc. (Treaty of Rome) o Said that a unified European currency would probably be effective, however it wasn’t really a pressing issue at the time  Meant as a long term possibility for the future o Issued during the Bretton Woods regime – thus countries weren’t too worried about fluctuating exchange rates  However… with the collapse of Bretton Woods in the early 1970s, Europe now has to deal with fluctuating exchange rates - The collapse of Bretton Woods results in “the Snake” o An attempt to tie European currencies together in order to regain the stability of the Bretton Woods system, with the gains of a common European market o The Snake eventually loses members and becomes a deutschemark zone… reasons:  There was a desire for domestic monetary policy autonomy (Mundell-Fleming)  Italy and France had relatively high inflation rates; they did not want to conform to Germany’s policies of maintaining extremely low inflation o Italy and France end up leaving; what’s left is Germany and a few neighbouring countries with similar economies  Germany wasn’t too worried about a fluctuating exchange rate because it was focused on high quality exports (e.g. BMW) that aren’t very affected by price - The European Monetary System (1979) is created in response to challenges of currency speculation (which makes retaining a fixed exchange rate costly) o Maintains a fixed exchange rate, but makes speculation much harder with the introduction of a basket currency – the ecu  Basket currency in the sense that individuals do not hold or exchange it – it is used only as a representation of the value of all member currencies together  National currencies were fixed to the ecu which made speculation much more difficult  Larger economies (i.e. Germany) had the most sway over the total value and also benefited the most from it o Side deals were required to get these smaller economies to join the EMS, mostly paid for by Germany o Eventually the EMS becomes just as rigid as the Bretton Woods system in order to maintain the most stability  This allows for easy speculation again – member states start to push for domestic monetary convergence o Domestic autonomy was still causing problems  No unity among currencies meant that the underlying problems of Bretton Woods kept coming back - Result: the Delors Committee (1989) recommends monetary union o The plan was to solve problems with fluctuating exchange rates among European countries by getting rid of individual exchange rates all together (w/ a single unified currency) o A new common currency managed by a European Central Bank would have significant benefits:  End the problem of speculators (one of the main challenges of the EMS)  Eliminate exchange rate risk among members (a common currency eliminates all uncertainty)  Stimulate trade and investment within Europe  Reduces transaction costs that come from exchanging currencies every time you cross the border o Potential downsides:  By this point many firms had learned to deal with fluctuating currencies by holding large amounts of different currencies  It was other Europeans making the money from exchanging currencies, not foreigners o Germany’s concerns on monetary union:  Ensuring low inflation  Confidence over liquidity to maintain the value of the euro  Bundesbank vs. the European Central Bank - Benefits outweigh the downsides, and the Maastricht Treaty (1991) begins the implementation of monetary union + the euro Issues for Germany concerning monetary union (detailed) - Costs of adjustment… two main concerns: o Germans wanted any new institutions (i.e. the ECB) to be explicitly committed to maintaining low inflation o Wanted the differing interests of the member states to converge around German interests and current domestic policies  Ex: Italy was used to high inflation – but because Germany was the leader of EMU Italy would be forced to commit to low inflation before it could join the euro - Germany wanted states to prove they could comply with the rules of the game first, before joining the institutions of EMU o Wanted to make sure states could achieve low inflation before joining o Reduces the burden on Germany to bail out/bear the costs of adjustment for new members trying to join - Germany’s preferences: o Require unanimity – especially on the admission of new members o Institutions to discipline – punishment for members that didn’t comply o Yet willing to make side payments – emphasizes German leadership Explaining Germany’s role - Systemic factors: o The problem: Deutschmark potentially rivaled the dollar  Post-Bretton Woods people begin to lose confidence in the $  The Deutschmark was a viable alternative because of its strong economy and commitment to low inflation o As the international community began to switch to the DM, this meant that Germany would be more affected by international crises  Closer European monetary integration would spread the reliance on the DM (and thus the consequences of a crisis) across more economies o The opportunity: German could lead Europe  Concerns of a newly unified and powerful Germany gaining European leadership post-WWI and WWII  Europe needed the strong German economy however and allowed German leadership - Domestic factors: o Reduction of transaction costs  Germany’s main trading partners were other Western European states  A unified currency would eliminate exchange costs and make a NAFTA-like free trade situation possible o Exchange rate preferences: clearly for hard money  Wasn’t much business opposition to monetary union – a fluctuating exchange rate in the transition period wouldn’t really harm them because of their reliance on high quality exports o Maintain momentum of European political union  Not just about a common market, not just about free trade… political union was something bigger  Question of a “democratic deficit” – the ECB would have control over all members’ macroeconomic policy, yet would not be democratically accountable o Bureaucratic politics:  Bundesbank was reluctant to give up powers (especially since they felt responsible for Germany’s economic success so far)  Bureaucratic battle between the Bundesbank and the Foreign Ministry (which was responsible for international negotiations)  The Bundesbank successfully set the terms and conditions for negotiations o Constructivism  The idea of monetary union had gained traction and was a major force in convincing European states to adopt a common currency JAPAN – international monetary cooperation - Historical build-up to the 1980s: conflict between the U.S. and Japan o Historically, the yen had always been undervalued  The Marshall Plan encouraged certain developing countries to undervalue their exchange rates in order to boost exports  The U.S. did this because it wanted to see these countries (including Japan) succeed to gain them as long-term allies  Japan got preferential access to the U.S. market to further boost economic modernization o As Japan’s economy became more technologically advanced, it moved from exporting only textiles to machinery, automobiles, and electronics (i.e. similar to American exports) - With the Nixon Shocks and oil crises of the 1970s, the U.S. began to deal with high inflation… leads to a shift in monetary policy in the late ‘70s o The Federal Reserve comes up with a plan to fight inflation  Finding a new balance between confidence & liquidity  Tightening the money supply (high interest rates)  Slows the economy down by convincing people to reduce borrowing  Reagan: loose fiscal policy  Stimulate the economy through large gov’t spending (financed by taking on foreign debt) o Result: a sharp rise in the value of the dollar, making American exports less competitive  Japan was able to steal significant American market share because…  Undervalued yen made exports attractive  Japanese products were beginning to catch up on quality, as well as being cheaper (e.g. Caterpillar)  Oil crisis raised demand for smaller fuel efficient cars  Japanese firms were putting American workers out of jobs because of this (especially in the auto sector)  At the same time Japan wasn’t buying many American goods either o All of this leads to demands within the U.S. for some sort of action to be taken (mid-1980s)  Gov’t chooses a change in monetary policy, not trade policy  U.S. was engaged in GATT and the Uruguay Rounds and did not want to be seen as contradicting their push for liberalization by putting tariffs on Japan - Thus by the mid 1980s, the U.S. began “taking the dollar down” to a “soft landing” o Inflation had been greatly reduced – however once the economy starts to grow again the problem of inflation comes back o The Fed wanted to slowly reduce interest rates, while still maintaining the value of the dollar (maintain confidence)  Result: the Fed would slowly ease down the value of the dollar a small amount, while at the same time lowering interest rates to stimulate the economy again o Was this a ploy, or a genuine bureaucratic struggle? (Federal Reserve vs. Treasury)  The Treasury was connected to the president and wanted him to remain popular – this involved stimulating the economy  The Fed was against this because a drastic stimulation of the economy would bring back inflation o Result: coordinated exchange interventions, under floating exchange rates  This required talking and compromising w/ other countries  Japan however did not want the U.S. economy to recover or the value of the dollar to decrease, as it would take away the trade advantage the Japanese had previously been enjoying  They needed to coordinate policy, however there was no institutional setting to do so (i.e. no more Bretton Woods = no more rules) - Results in the Accords o Plaza Accord (1985)  Finance ministers from the G5 meet together  Coordination of domestic policies needed as well  The U.S. was asked to reduce its budget deficit by lowering spending, while the other G5 countries would increase spending  Goal: bring the exchange rates of the dollar, yen, and deutschemark back into more reasonable patterns  Resulted in a period of closer coordination among the major powers  Result: achieved certain things, but not entirely successful o Louvre Accord (1987)  G5 + Canada  Coordinating the drop in value of the U.S. dollar with the rise in value of the Japanese yen  Result: Japan agrees to a rise in the yen’s value, plus promises to increase domestic spending - Explaining Japan’s cooperation: o System-level:  Japan’s post-war economic strategy  Industrializing by focusing on exports, encouraged by the US  GATT member – thus had low tariffs with other markets (especially the US)  De-valued currency (again encouraged by the US) made their exports more competitive  By the 1980s, the trade balance with the US was causing friction – pressure within the US to take action  Economic problems in the US – looking to Japan as a scapegoat o “Losing American manufacturing jobs to Japan”  Potential yen-dollar rivalry if the yen rose too high  Japan didn’t want this (like West Germany) o Would make their exports less competitive o Japan didn’t want to be an international financier o Domestic-level:  Decades of export-oriented growth meant that the exporting sectors in Japan were the biggest and most powerful (strong opposition against a rise in value of the yen)  Employed the most people, bought inputs from other Japanese firms, fuelled Japanese economic growth  They didn’t want the value of the yen to rise because it would reduce their competitiveness  Rural farmers wanted protectionism = more opposition to deals with the U.S. (rural areas historically over- represented in parliament)  Japanese exporters and rural farmers were vulnerable to US trade sanctions  U.S. Congress says any country consistently running a trade surplus with the U.S. must be doing something unfair and would be subject to sanctions/retribution  Japanese gov’t thus preferred action on monetary policy over trade sanctions  Trade sanctions would hurt either their export-firms or rural areas  Changes in monetary policy would instead affect all industries in a lesser amount (spread of consequences) o Bureaucratic politics or individual level?  Bank of Japan’s preferences vs. Ministry of Finance’s  Bank of Japan is not independent – it is directly subservient to the Ministry of Finance  The Minister of Finance is in cabinet and is concerned with getting reelected, thus he is worried about gov’t budget and keeping the population happy  Finance Minister: Kiichi Miyazawa  Brought a willingness to cooperate with the US  Fluent in English allowed him to negotiate better and more directly with US politicians  Knowledgeable about finance – it was his field, not just some cabinet position he was dumped into - Consequences of Japanese cooperation: o Trade disputes controlled – i.e. no trade sanctions imposed  This is what the US really wanted because it was in the process of pushing for liberalization everywhere with GATT and the WTO o Value of the yen was overshot, it increased beyond what was planned  Good for the US: gave the dollar its soft landing (no sharp inflation)  Harder on Japan however… still dealing with a slow economy o Japan eventually becomes an international financier anyways  Buys up tons of real estate in the US and other countries o Japanese products forced to evolve  Auto-manufacturers start producing trucks and SUVs to get around their voluntary export-restraints with the US on small cars o Japan’s financial problems last from then until the present today… no growth at all for the past 20 years MALAYSIA – capital controls during the East Asian financial crisis - The Washington Consensus: ideological contests end with the Cold War, American Capitalism and liberal trade has won over communism o Neo-liberal models of trade dominate o IMF and World Bank encourage free trade & open capital markets - Open Capital Markets: advantages and disadvantages o Capital inflows increase – volume of international investment grows  Lack of capital is often one of the main obstacles for developing countries – capital is needed for industrialization  Instead of raising capital through ISI (which has negative consequences later), open capital markets are an alternative o …But this comes with increased vulnerability  Capital investments go in, however investors are looking mainly to make a (short-term) profit  Capital can leave as quickly as it comes  Many investors in the 90s are looking for short-term investments/profits made off exchange rate fluctuations  International loans require that you pay it back later, with interest o Exchange rate instability during these years… investors trying to make a quick profit off this causes problems  Domestic actors try to make long-term investments on short- term loans  Ex: some firm invests $100M in Malaysia with the intention of taking it back in 3 months  However the bank lends it to someone trying to build a factory (long-term investment)  When the lender wants their money back, neither the bank nor the factory-builder have it  This is what happened in the East Asian crisis - East Asian Financial Crisis hits (1997-1998) o “Contagion” – somehow all the East Asian economies were connected so they all felt the consequences of the crisis (investor panic) - Malaysia responds with capital controls (the only country to do so; completely opposite of the IMF and World Bank’s recommendations) o By closing capital controls, investors weren’t able to take their money out… long-term consequences: investors will be afraid of Malaysia in the future o Goals of closing capital controls:  Stabilize the ringgit (Malaysian currency)  Allows imports/exports to carry on and drive the economy as before  End speculation against the currency  End capital flight – prevent investments for leaving for 1 year o By closing capital controls and fixing the exchange rate, Malaysia regained control over its domestic monetary policy (Mundell- Fleming)  This allowed the gov’t to lower interest rates and increase spending to stimulate the economy - Explaining the decision: o Systemic constraints don’t help much  The IMF, World Bank, U.S. gov’t, etc. all told Malaysia not to put capital controls in place… yet Malaysia does anyways o Domestic-level arguments:  Dealing with the Mundell-Fleming constraints  Gov’ts must choose 2/3: stable exchange rates, open capital markets, domestic monetary policy autonomy  Malaysia chooses stable exchange rate & domestic autonomy, in return for closed capital markets  Political competitions within the UNMO (United Malays Organization – governing political party)  The UNMO pushes for native Malays (Bumiputera) having more power in politics and the economy  Blocs within the party lead by prime minister Dr. Mahathir Mohamad and deputy prime minister Anwar Ibrahim o Mahathir pushes for closed capital controls, while Anwar wants to listen to the IMF  Bumiputera vs. ethnic Chinese  UNMO sponsors Malays businesses which are hurt when investments try to leave the country… this hurts the UNMO as well because of their close ties o Individual-level arguments:  Mahathir’s statements on the source of the crisis  Says the IMF and World Bank are trying to recolonize Asia, just as bad as the original Europeans  Says that international lenders are run by Jews that don’t like Muslims  Mahathir’s dislike of the IFI’s  Timing suggests his real motive: internal politics  He was determined to get rid of his deputy prime minister because of his opposition  Institutes capital controls in September 1998, after most investments had already been taken out  Arrests Anwar the day after controls are implemented on made-up charges PRACTICE ID’S “Soft Landing” - With the Nixon Shocks and oil crises of the 1970s, the U.S. was experiencing high inflation and a sharp rise in the value of the dollar o This made American exports less competitive at a time when they were already losing significant market share to Japanese exporters  American jobs were being lost to Japanese firms who, because of their undervalued currency, were exporting cheaper goods of similar quality - U.S. government decides to take action: they want to coordinate a decrease in value of the dollar with a rise in value of the yen o This had to be done gradually and with much coordination between Japan and the U.S. (a soft landing); if this was done too fast both economies would suffer and the U.S. would see a return of inflation - There was strong opposition to this monetary policy coordination from Japanese export firms who would lose competitiveness from the deal o However with the expertise of finance minister Miyazawa, the U.S., Japan, and other G5/G7 countries were able to coordinate a change in monetary policy through the Plaza and Louvre Accords - Result: the U.S. got its soft landing, however the rise in value of the yen was overshot and the Japanese economy has had slow growth ever since European Central Bank - The ECB is an institution that was created from European monetary union, with the purpose of managing a central currency (the euro) and coordinating member states’ macroeconomic policies - The creation of the ECB brought two major issues to the idea of monetary union: o Challenges from within Germany – the Bundesbank felt responsible for Germany’s economic growth and did not really want to give up powers to a central European bank  Germany also wanted to make sure that the ECB would be explicitly committed to maintaining low inflation and steady growth o Question of a “democratic deficit” from the ECB  Executives within it would be in charge of managing every member state’s macroeconomic policy… however they wouldn’t be democratically accountable to any one state  This is still a problem with the ECB today Mahathir Mohamad - Prime Minister of Malaysia during the East Asian financial crisis, he is one of the biggest reasons why Malaysia rejected the advice of the IMF and World Bank during the financial crisis and implemented capital controls instead o One of the best examples of the individual level of analysis and how much impact a single person can have on the international stage - He was leader of the United Malays Organization (UNMO party) during the crisis, and was a strong supporter of native Malays entrepreneurs and businesses (Bumiputera) o This caused a political divide within the UNMO between himself and his deputy prime minister, Anwar Ibrahim o Mahathir supported the Bumiputera and ignored the advice of the IFI’s, while Anwar was more open to implementing policies recommended by the IMF and World Bank o Mahathir event
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