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
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 Wheat (tons) Iron (tons)
Britain 100 250
USA 200 150
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 Hegemonic Stability Theory, as argued by Krasner, maintains that the hegemony of a leading power is necessary for the
creation and continuance of free trade. This is based on a few reasons. Firstly, a hegemon enjoys comparative advantage
and would benefit from free trade. A hegemon would set trade rules that benefits its interests, and could use its power
to force other countries to open up. A hegemon also solves the prisoner’s dilemma (fear of defection/protectionism by
other states) by institutionalizing freer trade. In addition, hegemony suggest stability and security, which are beneficial
for free trade. In State Power and the Structure of International Trade, Krasner applies his model to six periods and finds
that it explains four out of the six. He then offers an amended version of the theory, suggesting that institutions are
sticky; once policies are adopted, they are pursued until a new crisis demonstrates unfeasibility. Examples of hegemonic
stability in action are Pax Britannica and Pax Americana.
The Bretton Woods system was created in 1944 through agreement by 44 nations. It created three new institutions, the
International Monetary Fund (IMF), the International Bank for Reconstruction and Development (later, the World Bank)
and the General Agreement on Tariffs and Trade (GATT, which later became the World Trade Organization).. Bretton
Woods was meant to support international trade by providing low tariffs, a stable exchange rate and growing markets
through investment and development aid. The IMF would be a lender of last resort and the IRBD would rebuld Europe.
The US played a key role, guaranteeing a new ‘gold standard’ ($35) with its currency serving as an anchor for the entire
monetary system. This became an expensive role over time because as the US printed money to cover its debt, it ran out
of gold to back its currency. In 1971, Nixon pulled the US out and the monetary leg of Bretton Woods collapsed. Since
then, we’ve had a floating exchange rate system. However, Bretton Woods seems to have worked, as trade and world
exports have increased consistently since it was created. This is important to IR because it is an example of the
significance of institutions, greatly supporting the liberal paradigm.
In “How Far Will International Economic Integration
Go?” Dani Rodrik introduces the concept of an
international political trilemma. It is the idea that in
the long run, a choice must be made between
international economic integration, the continuation
of the nation-state system, and mass politics. The
trilemma represents a trade-off in which only two of
the three objectives can be attained. For instance,
building deep economic integration and retaining the
nation-state system would require that states
become less responsive to their populations, who
may be put at a disadvantage by open trading policies that bring down the prices of labour and exports. In his article,
Rodrik argues that the only feasible outcome is global federalism because people are very unlikely to give up hard-
fought political rights or the goods an integrated world market can deliver.
Factor Price Equalization Theorem
This is a theory by Samuelson which argues that free trade will eliminate price differences for commodities across
countries. Subsequently, the prices of the factors of production related to those commodities (capital and labour) will
also equalize. When market forces are allowed to work and compete freely, they will push toward equilibrium. For
example, labour is cheaper in Mexico so after NAFTA, factories might be built there (ignoring politics). Demand (and
wages) for Mexican workers would go up while demand for, and wages of, Canadian workers would go down. Eventually
the wages would equalize. While there is a trend toward this at the moment, whether it works depends on the data
Modernization Theory Modernization theory predicted post-colonial growth and development, claiming that former colonies would follow the
same modernization process as Europe and North America. This involved industrialization, urbanization, the rise of
middle classes, democracy and adoption of modernity, and finally, growth. The theory held that new countries would
follow an accelerated version of the European model because of new technology and knowledge. It also held that free
trade and minimal government intervention was necessary to this. In practice, this strategy led to economic stagnation,
a series of coups, instability and economic decline. Attempts to salvage the theory often blame local conditions within
LDCs such as economic policies, institutions, wars or the natural environment.
Import Substitution Industrialization (ISI)
Import Substitution Industrialization (ISI) is an economic policy that attempts to enable a developing country to
substitute products which it imports, mostly finished goods, with locally-produced substitutes. This is a mercantilist
approach that seeks improved terms of trade with little regard for comparative advantage. India, for example, used this
approach until the late 1980s. The problem with this policy is that it often leads to inefficiencies, requires a lot of
government regulation and makes it nearly impossible for people inside the country to import goods that can’t be
bought locally. Despite these issues, there are countries that continue to stick with ISI, including many less-developed
African nations. The economic wisdom of this is questionable but politics within states (ex. organized urban workers who
benefit from regulation) might explain use of this policy.
Export-Led Industrialization (ELI)
Export-Led Industrialization (ELI) is an economic policy that aims to speed up the industrialization of a developing
country through the export of goods in which it enjoys a comparative advantage. Export-led growth implies opening
domestic markets to foreign competition in exchange for market access in other countries. It is a neo-liberal policy that
can still involve a certain level of protectionism for infant industries. ELI has seemed to work better than ISI; countries
that have used ELI include the Asian Tigers who have developed relatively quickly compared to many African countries
that have maintained ISI policies.
The J-Curve of Economic Reform
The J-Curve of Economic Reform refers to the
idea that economic reforms (such as moving
from ISI to ELI) are politically challenging,
especially when political institutions are weak
and their legitimacy low. This is because in the
short-term, the reforms can often leave people
worse off, creating instability and public
backlash. It takes time for positive results to
start appearing and before then, citizens may
push their government to backtrack. The J-
Curve has been cited as the reason many countries stick with ISI (Import Substitution Industrialization) despite poor
results. For example, at the request of the World Bank, Mozambique liberalized its cashew sector in the early 1990s.
While this seemed to be a rational economic decision, there were no apparent short-term gains but there was major
political instability (demonstrations by workers). Though liberalization might have been in Mozambique’s interests in the
long term, the short-term costs resulted in political pressure on the government to back-pedal.
The Poverty Trap
The poverty trap, discussed by Sachs in The Strategic Significance of Global Inequality, is the concept of poverty as a
reinforcing cycle. It is a condition in which a poor country is simply too poor to achieve sustained economic growth.
Economic growth requires health, education and infrastructure which are usually absent in underdeveloped countries.
Sachs characterizes most of Africa as being stuck in this trap. This theory is significant to IR and IPE because it suggests
that modernization means first giving these countries the basic essentials to build upon. Dependency Theory
Dependency theory suggests that the world economy is built in a way that prevents the south from developing because
the rules of the game actively perpetuate a state of dependency. A closely associated theory is Immanuel Wallerstein’s
World Systems Theory. The south (periphery) provides the raw materials that the north (core) needs and the north sells
finished goods to southern markets. Any attempt to break free will lead to sanctions, military interventions or coups.
The north is said to collude with the capitalist elites in the south, resulting in the institutionalization of dependency in
the domestic political and social systems of the southern countries. The solution is to break the rules, which is very risky
and difficult. This theory is significant because it offers an important counter-narrative to modernization theory, arguing
that periphery states cannot just modernize in the way core states have because core states have an interest in keeping
the periphery the way it is.
This thesis adds to dependency theory in arguing that the terms of trade between the north and the south deteriorate
over time. Because of this, ISI (Import Substitution Industrialization) is necessary. To allow for development, the south
needs to stop buying from the north and the north needs to give the south access to its markets. Development will not
occur without direct intervention in the market; there is a need to maintain stable and high prices for some raw
materials. The thesis encourages cartels, which collude to create monopolies so that the north is pressured to agree to
these prices. The thesis was brought into question during the Debt Crisis, when Prebisch admitted that ISI was a failure.
Institutions are the rules of the game. They are the norms that regulate behaviour and are meant to generate repetitive
and predictable behaviour. They define the social constraints and opportunities that actors face. Examples include
sovereignty, reciprocity, and the balance of power. International institutions can include multi-national organs like the
UN as well as international organizations and regimes. Benefits of institutions include increased cooperation, decreased
transaction costs and stability. Costs include decreased sovereignty, new dimensions of conflict and vulnerability to
exploitation. Institutions are important because how they are understood in a system of anarchy depends greatly on
one’s IR worldview. There are two perspectives: institutions as puppets that simply reflect existing power structures
amongst states, or institutions as independent actors that, once created, acquire a life of their own. Those who support
the former opinion might say the UN is simply a tool of larger powers like the USA and Britain while those who support
the latter would argue that the UN restricts the actions of these large states as well.
The Stag Hunt
In game theory, the stag hunt is a Cooperate (Hunt Stag) Defect (Hunt