Invested interests: The politics of national economic policies in a world of global finance

International Organization

Volumn 45, Issue 4, 1991, Pages 425-451

  Frieden, Jeffry A ^a  

^a NONE

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EID: 84976017401     PISSN: 00208183     EISSN: 15315088     Source Type: Journal    
DOI: 10.1017/S0020818300033178     Document Type: Article

References (72)

1. For prominent examples from each of these issue-areas, see Helen V. Milner, Resisting Protectionism: Global Industries and the Politics of International Trade (Princeton, N.J.: Princeton University Press, 1988);
2. Peter Evans, Dependent Development: The Alliance of Multinational, State, and Local Capital in Brazil (Princeton, N.J.: Princeton University Press, 1979);
3. David G. Becker et al., Postimperialism: International Capitalism and Development in the Late Twentieth Century (Boulder, Colo.: Lynne Rienner, 1987);
4. Robert Kaufman and Barbara Stallings, eds., Debt and Development in Latin America (Boulder, Colo.: Westview Press, 1989);
5. Benjamin J. Cohen, In Whose Interest? International Banking and American Foreign Policy (New Haven, Conn.: Yale University Press, 1987);
6. Charles Lipson, Standing Guard: Protecting Foreign Capital in the Nineteenth and Twentieth Centuries (Berkeley: University of California Press, 1985). The bodies of literature, of course, are far too large to cite or discuss here.
7. The two quintessential works on this subject are Peter Gourevitch's Politics in Hard Times: Comparative Responses to International Economic Crises (Ithaca, N.Y.: Cornell University Press, 1986)
8. Ronald Rogowski's Commerce and Coalitions: How Trade Affects Domestic Political Alignments (Princeton, N.J.: Princeton University Press, 1989).
9. Jeffrey Sachs and Charles Wyplosz, “The Economic Consequences of President Mitterand,” Economic Policy 2 (April 1986), pp. 262–322.
10. See John Freeman, “Banking on Democracy? International Finance and the Possibilities for Popular Sovereignty,” mimeograph, University of Minnesota, 1990. From a politically different quarter, former Citibank chief executive officer Walter Wriston has said similar things about the impact of financial internationalization—but approvingly: “It's a new world and the concept of sovereignty is going to change…. The idea of fifteenth-century international law is gone. It hasn’t laid down yet, but it's dead. It's like the three-mile limit in a world of Inter-Continental Ballistic Missiles.” Wriston is cited in my Banking on the World: The Politics of American International Finance (New York: Harper & Row, 1987), p. 115.
11. See also Walter Wriston, Risk and Other Four-Letter Words (New York: Harper & Row, 1986).
12. Bank for International Settlements (BIS), Sixtieth Annual Report (BIS: Basle, 1990), pp. 63, 82, and 125.
13. See Morris Goldstein, Donald Mathieson, and Timothy Lane, “Determinants and Systemic Consequences of International Capital Flows,” in Determinants and Systemic Consequences of International Capital Flows (Washington, D.C.: International Monetary Fund, 1991), p. 5. This assumes a low level of international bond lending in 1973, which is almost certainly the case. Exact figures are not available.
14. See BIS, Sixtieth Annual Report, pp. 208-9. See also pp. 146-52, which offer data regarding some short-term instruments and indicate that open positions in interest rate futures and options totaled about $1.6 trillion at the end of 1989.
15. The early classic work was M. Feldstein and C. Horioka's “Domestic Savings and International Capital Flows,” Economic Journal 90 (June 1980), pp. 314-29.
16. For more on the issue and debates over it, see Ralph Bryant, International Financial Intermediation (Washington, D.C.: Brookings Institution, 1987), pp. 82-86.
17. For a recent test, see Tamim Bayoumi, “Saving-Investment Correlations: Immobile Capital, Government Policy, or Endogenous Behavior?” IMF Staff Papers 37 (June 1990), pp. 360-87.
18. The most careful assessment of the Feldstein-Horioka findings, updated through the late 1980s, emphasizes the great increase in capital mobility and the continued importance of currency premiums. See Jeffrey A. Frankel, “Quantifying International Capital Mobility in the 1980s,” in Douglas Bernheim and John Shoven, eds., National Saving and Economic Performance (Chicago: University of Chicago Press, 1991), pp. 227-60.
19. For rough evidence on intranational and international stock price differentials, see Barry Eichengreen, “Is Europe an Optimum Currency Area?” mimeograph, University of California at Berkeley, 1990, pp. 6-9. The differentials may have to do with nontransferable advantages accruing to national owners, such as greater access to information or to monitoring and enforcement mechanisms.
20. The modern theory of foreign direct investment is based on the proposition that multinational firms exist precisely because they facilitate (but do not make costless) the international transmission of such specific assets. The classic statement by Caves is still probably the most appropriate here. See Richard E. Caves, “International Corporations: The Industrial Economics of Foreign Investment,” Economica 38 (February 1971), pp. 1-27.
21. This is a conclusion made by Frankel in “Quantifying International Capital Mobility in the 1980s.” One indication of the high degree to which markets for financial assets are integrated is the virtual disappearance of significant spreads between domestic and offshore interest rates in most currency instruments of members of the Organization for Economic Cooperation and Development (OECD). Regarding this subject, see Goldstein, Mathieson, and Lane, “Determinants and Systemic Consequences of International Capital Flows,” pp. 7-11.
22. Although I am unaware of any studies of this phenomenon, arguments to this effect are frequently heard among American competitors of the Japanese transplants, often in the context of complaints over the Japanese firms’ access to low-cost Japanese funds. There are reasons to doubt the accuracy of the argument, however. First, most foreign direct investment is funded in the host country. Second, if Japanese firms have privileged access to Japanese finance, then financial markets are not fully integrated. The result might be due to preferential ties among Japanese financial and nonfinancial firms, which would constitute a “natural” barrier to financial capital mobility. Further study in this regard is required. A related issue is the effect of foreign-owned branch plants on political lineups in the host country. For anecdotal evidence that Japanese investment in the United States has created or reinforced domestic interest groups that favor freer trade, see “Influx of Foreign Capital Mutes Debate on Trade,” The New York Times, 8 February 1987, p. 113.
23. See the following works of Robert A. Mundell: “The Appropriate Use of Monetary and Fiscal Policy Under Fixed Exchange Rates,” IMF Staff Papers 9 (March 1962), pp. 70-77;
24. “Capital Mobility and Stabilization Policy Under Fixed and Flexible Exchange Rates,” Canadian Journal of Economics and Political Science 29 (November 1963), pp, 475-85;
25. “A Reply: Capital Mobility and Size,” Canadian Journal of Economics and Political Science 30 (August 1964), pp. 421-31.
26. The basic model can be found in any good textbook discussion of open-economy macroeconomics; a useful survey is W. M. Corden's Inflation, Exchange Rates, and the World Economy, 3d ed. (Chicago: University of Chicago Press, 1986).
27. For a good survey and evaluation, see Michael M. Hutchison and Charles A. Pigott, “Real and Financial Linkages in the Macroeconomic Response to Budget Deficits: An Empirical Investigation,” in Sven Arndt and J. David Richardson, eds., Real-Financial Linkages Among Open Economies (Cambridge, Mass.: MIT Press, 1987), pp. 139-66.
28. For an illuminating discussion of cross-border effects, see Michael Mussa, “Macroeconomic Interdependence and the Exchange Rate Regime,” in Rudiger Dornbusch and Jacob Frenkel, eds., International Economic Policy: Theory and Evidence (Baltimore, Md.: Johns Hopkins University Press, 1979), pp. 160-204.
29. American tax reform in 1986, for example, was followed by widespread OECD movement toward the new American corporate tax rates. By 1989, direct corporate tax rates in the principal EC member countries were all in the 35 to 42 percent range. See Price Waterhouse, Tax: Strategic Corporate Tax Planning (London: Mercury Books, 1989).
30. Across industries, there is evidence that such footloose sectors as finance face lower effective tax rates. In the United States in 1983, for example, while twenty-four nonfinancial industries paid an average effective federal income tax rate of 17.5 percent, the three financial sectors (insurance, investment, and financial services companies) paid an average of 8.5 percent. See “New Threat to Smokestack America,” The New York Times, 26 May 1985, p. 3:1.
31. Rogowski, Commerce and Coalitions.
32. The classic statement is Stephen Magee's “Three Simple Tests of the Stolper-Samuelson Theorem,” in Peter Oppenheimer, ed., Issues in International Economics (London: Oriel, 1980), pp. 138-53.
33. In Commerce and Coalitions, pp. 16-20, Rogowski addresses these objections and more; needless to say, I am unconvinced by his treatment. Benjamin J. Cohen has pointed out to me that this simple transfer of the Heckscher-Ohlin approach from trade to capital movements ignores the inherent differences between the two realms and especially the importance of expectations in determining asset prices (and therefore capital movements). This may be another reason to avoid a straightforward application of the approach to capital movements.
34. The seminal modern statement is Ronald W. Jones's “A Three-Factor Model in Theory, Trade, and History,” in Jagdish Bhagwati et al., eds., Trade, Balance of Payments, and Growth (Amsterdam: North-Holland, 1971), pp. 3-21.
35. Two other important articles, which essentially argue for combining specific factors in the short run with the Heckscher-Ohlin approach in the long run, are Wolfgang Mayer's “Short-Run and Long-Run Equilibrium for a Small Open Economy,” Journal of Political Economy 82 (September 1974), pp. 955-68
36. Michael Mussa's “Tariffs and the Distribution of Income: The Importance of Factor Specificity, Substitutability, and Intensity in the Short and Long Run,” Journal of Political Economy 82 (November 1974), pp. 1191-1204.
37. Based on these two articles, the approach is sometimes known as the Mayer-Mussa framework. For a useful summary and geometric representation of the short-term and long-term adjustment processes, along with a critique of the Heckscher-Ohlin assumption of intersectoral capital mobility, see J. Peter Neary, “Short-Run Capital Specificity and the Pure Theory of International Trade,” The Economic Journal 88 (September 1978), pp. 488-510.
38. I refer here to those Marxist (and non-Marxist) views that assume labor-capital contradictions to be the principal axis of political conflict. Many other Marxists focus on intraclass differences or blocs; for a good example of relevance to the issue at hand, see Stephen R. Gill and David Law, “Global Hegemony and the Structural Power of Capital,” International Studies Quarterly 33 (December 1989), pp. 475-99.
39. The point is not that portfolio diversification is the same as asset mobility but, rather, that the policy implications are parallel. A more sophisticated but somewhat more controversial version of this argument might focus on multinational corporations as combinations of intangible assets within a vertically integrated firm; the relevant literature is surveyed by Martin Perry in “Vertical Integration: Determinants and Effects,” in R. Schmalensee and R. D. Willig, eds., Handbook of Industrial Organization, vol. 1 (Amsterdam: North-Holland, 1989), pp. 183-255.
40. Inasmuch as such assets can more easily be moved within multinational corporations, this does in fact make the assets of these corporations more geographically mobile than those of other firms in similar industries. See, for example, Daniel M. Shapiro, “Entry, Exit, and the Theory of the Multinational Corporation,” in Charles P. Kindleberger and David B. Audretsch, eds., The Multinational Corporation in the 1980s (Cambridge, Mass.: MIT Press, 1983), pp. 103-22.
41. For an application of similar ideas to the cases of U.S. and French trade policies in the 1920s and the 1970s, see Milner, Resisting Protectionism.
42. It is worth emphasizing again that these conclusions abstract from many specifics that may indeed override them. For example, in the early 1980s, financial asset-holders in many Latin American countries benefited strongly from capital mobility. In the context of political instability and strong and unsustainable currency appreciations, they were able to get their money out of Latin America and to overseas bank accounts. On the process, see Donald Lessard and John Williamson, eds., Capital Flight and Third World Debt (Washington, D.C.: Institute for International Economics, 1987). Clearly, other characteristics of these political economies outweighed the tendencies discussed here.
43. For a more detailed argument to this effect, see Jeffry A. Frieden, “Third World Indebted Industrialization: State Capitalism and International Finance in Mexico, Brazil, Algeria, and South Korea,” International Organization 35 (Summer 1981), pp. 407-31. The degree to which workers and others benefited from the capital inflow would depend, in this framework, on how specific their assets were.
44. For an elaboration of this argument, see Frieden, Banking on the World, especially pp. 196-246.
45. See David Dollar and Jeffry Frieden, “The Political Economy of Financial Deregulation in the United States and Japan,” in Giacomo Luciani, ed., Structural Change in the American Financial System (Rome: Fondazione Olivetti, 1990), pp. 72-102. Again, this generalization ignores specific national policy episodes, such as that involving American capital imports in the 1980s. In my own defense, however, I can note that those involved in political debates over the regulation of international financial flows to and from the United States do appear to have longer-term considerations in mind.
46. For details on the 1983 IMF quota increase debate, see Frieden, Banking on the World, pp. 179-90.
47. See Benjamin J. Cohen, “European Financial Integration and National Banking Interests,” in Pier Carlo Padoan and Paolo Guerrieri, eds., The Political Economy of European Integration (London: Harvester Wheatsheaf, 1989), pp. 145-70.
48. For an interesting perspective on the implications of financial deregulation, see the following works of Vittorio Grilli: “Financial Markets and 1992,” Brookings Papers on Economic Activity, no. 2, 1989, pp. 301-24;
49. “Europe 1992: Issues and Prospects for the Financial Markets,” Economic Policy 9 (October 1989), pp. 388-421.
50. Regarding the important issue of the U.S. response to European and Japanese policies, see Thomas Bayard and Kimberly Ann Elliot, “Reciprocity in Financial Services: The Schumer Amendment and the Second Banking Directive,” mimeograph, 1990.
51. Two excellent studies are Louis W. Pauly's Opening Financial Markets: Banking Politics on the Pacific Rim (Ithaca, N.Y.: Cornell University Press, 1988)
52. Frances McCall Rosenbluth's Financial Politics in Contemporary Japan (Ithaca, N.Y.: Cornell University Press, 1989).
53. In Japan, as in some European nations, members of the banking community were reluctant to see international competition threaten their domestic cartel, but the rapid globalization of financial markets appears to have led them to regard deregulation as the better of two evils. For a more detailed elaboration of this argument, see Dollar and Frieden, “The Political Economy of Financial Deregulation in the United States and Japan.”
54. For an argument that is complementary in many ways to the one presented here, see John Goodman and Louis Pauly, “The New Politics of International Capital Mobility,” mimeograph, Harvard University Business School and University of Toronto, 1990.
55. Possibilities such as these tend to imply imperfect competition—increasing returns and learning-by-doing—in the financial sector, which is almost certainly the case. For a representative theoretical approach along these lines, see Stephen D. Williamson, “Increasing Returns to Scale in Financial Intermediation and the Non-Neutrality of Government Policy,” Review of Economic Studies 53 (October 1986), 863-75.
56. Some complications may result from this melding of the Mundell-Fleming and specific-factors models. The Mundell-Fleming model generally assumes some unutilized resources and some wage stickiness, while the specific-factors model does not. The contradiction may be relevant for the analysis of effects on national welfare, but it does not appear to matter much for the short-and medium-term distributional effects, which are the focus here. For a discussion, see Corden, Inflation, Exchange Rates, and the World Economy, pp. 22-34.
57. One important consideration to keep in mind is the extent to which the relative price effect (say of an appreciation on raising demand for nontradable goods) may be counteracted by the macroeconomic effect (say of reduced aggregate demand more generally); this is, so to speak, the contest between the income and substitution effects or between expenditure reduction and expenditure switching. For a useful survey and application to the LDCs, see Sebastian Edwards, Real Exchange Rates, Devaluation and Adjustment (Cambridge, Mass.: MIT Press, 1989).
58. For more technical essays, see John Bilson and Richard Marston, eds., Exchange Rate Theory and Practice (Chicago: University of Chicago Press, 1984). Another point to keep in mind is that the nontradable goods and services sector includes those who operate behind prohibitive barriers to trade (especially quotas).
59. Of course, from the standpoint of an overseas investor, the desire for a strong home currency to allow greater purchases of overseas assets is balanced by the desire to maximize home currency earnings from these assets, which demands a weak home currency. The best possible scenario, as usual, is to buy cheap and sell dear—that is, to buy foreign currency when the home currency is strong and sell it when the home currency is weak. There are a number of defensible theoretical reasons why international investors might favor strong home currencies; it is probably enough to note here that empirically they tend to do so. On the relationship between foreign direct investment and the exchange rate, see Steven W. Kohlhagen, “Exchange Rate Changes, Profitability, and Direct Foreign Investment,” Southern Economic Journal 44 (July 1977), pp. 43-52.
60. Practically the only systematic empirical study on these issues in recent years is I. M. Destler and C. Randall Henning's Dollar Politics: Exchange Rate Policymaking in the United States (Washington, D.C.: Institute for International Economics, 1989), which appears to bear out some of these observations. The issue is somewhat clouded by the difficulty, which Destler and Henning recognize, of separating debates over the level of the exchange rate from debates over its volatility; in the early 1980s in the United States, the former tended to dominate the latter. The authors note that international financial institutions benefit from exchange market volatility, which can make their trading desks extremely profitable. However, they should—and many do—weigh this benefit against the cost of international business foregone because of uncertainty about currency values. At least some portion of the international business of American money-center banks is due to the widespread belief in the reliability of the dollar and the American macroeconomic environment more generally.
61. The literature on the EMS is now enormous, and almost all of it is purely economic in content. For an excellent survey along these lines, see Francesco Giavazzi and Alberto Giovannini, Limiting Exchange Rate Flexibility: The European Monetary System (Cambridge, Mass.: MIT Press, 1989).
62. For a good study that discusses many of the domestic and international political aspects of the EMS, see Peter Ludlow, The Making of the European Monetary System (London: Butterworth, 1982); unfortunately, events have moved far beyond what Ludlow described in 1982.
63. I avoid three issues that are more closely associated with a single currency per se: the potential welfare costs of reduced seignorage opportunities, the welfare gains associated with reduced transactions costs, and the potentially differential impact of these reduced transactions costs on various economic agents. I focus entirely on the more immediate issue of the differential effects of fixed but adjustable exchange rates within the EMS. For a discussion of some of these other issues, see Barry Eichengreen, “One Money for Europe?” Economic Policy 5 (April 1990), pp. 118-87.
64. See S. G. Warburg Securities, Into the ERM: The Outlook for the UK Economy and Equity Market, London, August 1990. A summary table is on p. 31, but more useful sectoral summaries are on pp. 32-52. The projections are complicated a bit (for our purposes) by the study's conflation of greater exchange rate stability with a firmer pound sterling, both of which it expects to ensue but which may operate in slightly different directions distributionally, as I discuss below. The study also notes that while 45 percent of profits from firms in the Financial Times stock exchange index are from overseas activities (exports and profits of foreign affiliates), only 13 percent come from the EC and 17 percent from North America. This may help explain some of the British reluctance to tie sterling to the ERM, especially at a time when the European currencies were appreciating strongly against the dollar.
65. In Dollar Politics, pp. 17-80, Destler and Henning provide an excellent interpretive survey of the course of dollar politics and policies over the 1980s.
66. For descriptions of the interplay of the various interest groups, see Destler and Henning, Dollar Politics; Frankel, “The Making of Exchange Rate Policy in the 1980s”;
67. C. Randall Henning, “International Monetary Policymaking Within the Countries of the Group of Five,” mimeograph, 1990.
68. One influential and controversial proposal was offered by John Williamson and Marcus Miller in Targets and Indicators: A Blueprint for the International Coordination of Economic Policy (Washington, D.C.: Institute for International Economics, 1987).
69. For some representative surveys of this rapidly growing literature, see Martin Feldstein, ed., International Policy Coordination (Chicago: University of Chicago Press, 1988);
70. Jeffrey Frankel, Obstacles to International Macroeconomic Policy Coordination, Princeton Studies in International Finance no. 64 (Princeton, N.J.: Department of Economics, International Finance Section, 1988).
71. For a demonstration of this point, see Jeffrey Frankel and Katharine Rockett, “International Macroeconomic Policy Coordination When Policy-Makers Do Not Agree on the True Model,” American Economic Review 78 (June 1988), pp. 318-40. The argument is controversial; among other things, it assumes that policymakers try to maximize national welfare, ignores the potential costs of not cooperating (or not appearing to cooperate), and makes it difficult to explain circumstances in which coordination has apparently been achieved.
72. See, for example, Alberto Giovannini, “National Tax Systems Versus the European Capital Market,” Economic Policy 9 (October 1989), pp. 346-86.