POL208Y1 Study Guide - Final Guide: Bretton Woods System, Economic Integration, Voluntary Export Restraints
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POL208: Midterm Review – IDs
Introduction to Political Economy
Guns vs. Butter
The concept of guns vs. butter is a common metaphor for the national production
possibility frontier. As societies, we can choose between two types of goods: guns
(defense) and butter (civilian). For any amount of butter produced, we sacrifice a
certain amount of guns, and vice versa. In IR we assume that both are necessary, so the
real choice for societies is what the balance will be between the two. The metaphor
becomes very important in wartime, because that is when the trade-off becomes most
noticeable. For example, in WWII Britain, families’ water and food were rationed so that
resources could be directed toward the war. Guns vs. butter is also useful in differentiating
between economic liberalism, economic nationalism and Marxism. For liberals, there is always a trade-off. Butter should
be chosen over guns because cooperation between countries is boosted by increased trade and undermined by
increased defense. For nationalists, there is no dilemma between guns and butter. As sources of power, both trade and
defense should be employed strategically to ensure a nation’s relative advantage. For Marxists, guns serve the needs of
butter: the military-industrial complex (the guns) represents the interests of the capitalists, who have all the butter.
An opportunity cost is the amount of some other good that is lost in order to obtain a unit of a given good.
Transaction costs are the costs of trade (including transportation but also risk, etc.).
The relative price of a good is its price in terms of other goods (barter price).
Economic warfare is an intense, coercive disturbance of the economy of an adversary aimed at diminishing its power. It
can be waged separately from military warfare (sanctions) or in conjunction with an ongoing war (strategic bombing,
siege, blockade, etc.). Examples include submarine warfare during the world wars, the oil embargo on Japan during
WWII, and current U.S. sanctions against Iran. International law acknowledges and distinguishes between different types
of economic warfare. It separates between goods that are part of the war effort and those which are for civilian use,
insisting that it is not legitimate to target the latter type of goods. This brings up the problem of dual use: for instance,
the Lusitania carried both arms and civilian passengers. More recently, we’ve seen the development of smart sanctions;
these are meant to be more targeted and specific, but have a mixed record.
Economic liberalism is paradigm of IPE, often associated with Adam Smith, which argues that economics and politics
should exist in separate spheres. While emphasis varies; both sides of the political spectrum in most Western countries
(social democrats and libertarians) can be considered economically liberal (Gilpin). Liberalism involves the belief that
free markets and minimal government intervention will result in market forces reaching efficient equilibrium and
stability. The actors it focuses on are individuals and firms; states simply reflect what resides within their borders. It
characterizes individuals and firms as rational profit maximizers and claims that actors are motivated by absolute gains
as opposed to relative gains. Because of this, cooperation is sustainable. Trade increases interdependence and therefore
results in peace (liberal peace theory). In terms of the guns vs. butter metaphor, liberals believe there is always a trade-
off between civilian and defense goods and that the former are more important and conducive to peace. The theories in
competition with liberalism are economic nationalism and Marxism.
Economic nationalism is a paradigm of IPE which argues that economic activities should be subordinate to the goal of
state building and the interests of the state. Governments can and should intervene in their economies and industries.
Most economic nationalists believe that wealth is an absolutely essential means to power and that power is an essential
means to wealth. There is no trade-off between guns and butter (civilian and defense goods). Wealth and power are the
ultimate ends of national policy. Although these ends are not always complementary in the short run, they are in the
long-run. The foremost objective of nationalists is industrialization, which is the basis of military power and national
security. Nationalism arises in part from the tendency of markets to concentrate wealth and to establish dependency or
power relations between strong and weak economies. Trade can be detrimental because greater interdependence can
mean greater vulnerability and potential conflict. Nationalists encourage strategic trade, which is trade limited to non-
threatening partners and partners who will gain less from the relationship than the state at hand. The main actors for
economic nationalists are states and there is a focus on relative gains. This perspective is basically the economic side of
Marxism is a theory of IPE first formulated by Karl Marx and later added to by Vladimir Lenin. According to Marxism, the
world economy is dominated by capitalists who seek to maximize profit. This leads to overproduction which causes
instability and crisis. Capitalism creates a concentration of wealth (and power) in the hands of a smaller and smaller
capitalist elite leading to the growing impoverishment of the rest. Hence, the capitalist system is unsustainable and
irrational; capitalism sows the seeds of its own destruction and replacement by a socialist system. When Karl Marx’s
projections didn’t come true, Lenin added to the theory, arguing that imperialism and trade helped capitalism delay its
inevitable demise. Whereas Marx predicted a rising of the proletariat (working class) against the bourgeoisie
(capitalists), Lenin adjusted the theory to focus on exploitation of periphery states by core states (similar to Wallerstein).
The main actors in this theory are social classes (Marx) and capitalist mercantilist states (Lenin).
Adam Smith’s Theory of Trade
Adam Smith’s theory of trade focuses on the principle of absolute advantage. This refers to the ability of a country to
produce more of a good than its competitors for the same amount of labour. It is based on a scenario in which there are
two countries, each of which can only produce two products.
Per worker production
In this scenario, the UK gives up 1.5 tons of iron per ton of wheat while the US only gives up .75 tons of iron. So to get 4
tons of wheat in the UK, you’d have an opportunity cost of 10 tons of iron. The UK could instead produce 10 tons of iron
and then trade it to the USA in exchange for 13.33 tons of wheat. The rational choice here is to trade. If the UK
specializes in iron and the USA specializes in iron, both countries will gain more of both. This is why Adam Smith came to
the conclusion that specialization benefits the entire world. This has important consequences for IR because it is one of
the main arguments of economic liberalism. The only problem is that it is possible for a country to have no absolute
advantage in anything, in which case no trade would occur. This is where Ricardo’s principle of comparative advantage
David Ricardo’s Theory of Trade
David Ricardo explained his theory of trade in On the Principles of Political Economy and Taxation (1817). It offers an
important correction to Adam Smith’s theory of trade and the concept of absolute advantage. It rests on the idea of
“gains from trade.” States differ in their ability to produce certain goods. There is no need for an absolute advantage in
productivity because as long as the two states differ in relative productivity of at least two goods within their
economies, it makes sense for them to specialize and trade. While global welfare is maximized if everyone chooses free
trade, some countries “win” relatively more than others. From a liberal IPE viewpoint, however, absolute gains are more
important than relative gains. In addition, within a country, free trade benefits some and hurts others, creating winners
and losers domestically. Trade therefore involves the political question of “who gets what, when, and how?” Countries
have relative advantages in terms of the factors of production: capital, land and labour. For example, China has an
advantage when it comes to labour-intensive goods.
A country has a comparative advantage in producing goods that make relatively intensive use of the country’s relatively
abundant factor of production. For example, the US has an advantage in capital-intensive goods.
According to this theory, owners of relatively abundant factors of production benefit from free trade while owners of
relatively scarce factors of production benefit from protectionism (domestically). For instance, free trade raises wages in
labour-abundant countries and lowers them in labour-scarce countries. The scarce factor is made worse off under free
trade. This has the implication that owners of scarce factors are likely to seek barriers to free trade. Labour in Canada,
for example, might have a reason to be against NAFTA. Trade generates coalitions of winners versus coalitions of losers
who respectively lobby for free trade and protection. This creates a clash between aggregate benefits from free trade
and private/individual benefits/losses (sectoral politics).
Terms of Trade
The terms of trade refers to the ratio of the price of an export commodity to the price of an import commodity. An
example would be raw materials vs. processed goods. An improvement in a nation’s terms of trade is beneficial for that
country because it has to give up less exports for the goods it imports.
Protectionism (Tariffs, Subsidies, VERs, NTBs, Dumping, Manipulation of Exchange Rates)
Protectionism refers to economic policy that restricts international trade. This can be done through tariffs (taxes on
imported goods), subsidies (sums of money given by governments to industries to reduce prices), dumping (selling
products abroad at artificially low prices to drive industries of other countries out of business), VER’s (voluntary export
restraints), NTB’s (non-tariff barriers such as advertising campaigns promoting local products), and manipulation of
exchange rates (lower exchange rates mean cheaper exports). The logic behind protectionism includes tariffs as a source
of income, fear of interdependence creating vulnerability and instability, and the problem of relative gains. Also
important is domestic politics. Pro-protectionism coalitions tend to be made up of the wealthy, who have a lot of
influence. In addition, the “losers” from free trade, such as those whose wages are decreasing, are likely to be well-
organized and highly motivated. In terms of the larger IPE theories, liberals see protectionism as detrimental to
everyone while nationalists see it as necessary in ensuring a country’s relative power.
The Corn Laws
The Corn Laws set duties on grain imports into Britain to protect British agriculture from outside competition. They were
essentially a form of protectionism. Their repeal is the first modern example in which the hegemonic country in a system
adopts free trade policies on its most important exports. This was a unilateral act, so the UK was opening itself up to
potential exploitation. Britain’s climate was inhospitable to growing grain, and the tariffs from the Corn Laws were
making a lot of money for the government so the repeal is not easily explained. Explanations include the influence of the
anti-Corn Law League, the potato famine, and ideology (emergence of Liberal Party in (UK). Among several competing
explanations for the rise of free trade at this time is Krasner’s version of Hegemonic Stability Theory.
Hegemonic Stability Theory
The concept of guns vs. butter is a common metaphor for the national production possibility frontier. As societies, we can choose between two types of goods: guns (defense) and butter (civilian). For any amount of butter produced, we sacrifice a certain amount of guns, and vice versa. In ir we assume that both are necessary, so the real choice for societies is what the balance will be between the two. The metaphor becomes very important in wartime, because that is when the trade-off becomes most noticeable. For example, in wwii britain, families" water and food were rationed so that resources could be directed toward the war. Guns vs. butter is also useful in differentiating between economic liberalism, economic nationalism and marxism. Butter should be chosen over guns because cooperation between countries is boosted by increased trade and undermined by increased defense. For nationalists, there is no dilemma between guns and butter.