Peter Alexis Gourevitch. International Organization. Volume 50, Issue 2, Spring 1996.
Most theorists of international affairs would argue that international cooperation is a good thing. Private-regarding behavior creates efficiency, but some public goods are needed for optimal results, be they in producing peace or prosperity. It is in the logic of markets and of decentralized systems such as international relations to undersupply those public goods.
Arms races, beggar-thy-neighbor economic policies, environmental degradation—these are but some examples of actions that take place in the absence of mechanisms to enforce cooperative agreements. Regimes that can punish defectors are able to do better: a good security regime avoids arms races; a good trade regime avoids tariffs; a good monetary regime avoids aggressive devaluations and instability; a good regulatory regime prevents particularistic mercantilism. All these arrangements require international cooperation.
How do we get international cooperation? In two ways: first, through a convergence of policy objectives—agreement on the substance of what is sought in trade, security, or other issues; second, by credible commitment to institutions that manage policy disputes. Put in the negative, nations conflict when they cannot agree on policy or when they are unable to sustain commitment to agreements that they may make. For nations to cooperate on a trade or monetary regime, they must agree to the regime (convergence of policy preference) and they must agree that they will not cheat and will adhere to the regime and to a process of resolving disputes that may occur (credibility of commitment).
When will that happen? When politics (the making of foreign policy) within each country leads to convergence of preferences and to commitment to a regime. In that sense, international cooperation turns on domestic politics. For nations to sustain a regime, the political processes in each participating country must lead to those behaviors that sustain the regime, overtly or implicitly. Cooperation requires some paying of cost: in trade, giving up jobs in weak sectors to gain jobs in strong ones or raising interest rates to defend price stability at the expense of employment.
If we turn to domestic politics to explain international cooperation, we must look at the theories that explain policy output in domestic policy. There are many, of course, as this is a rich field. For this discussion, it is useful to group these many into two: “preference-driven” models and “institution-driven” models. Each comes in an “aggressive” and a “moderate” version.
Preference-driven models explain public policy as the output of what actors in the society want. Why they want these things may turn on ideology, economic situation, organizational self-interest, or a number of other factors that, brutally, can be simplified into preferences. Decision makers must please those whose compliance is required to keep them in office and to make things work. People have various levers with which to make their views known and effective: functional powers, like going on strike or sending money out of the country; political ones, like the ballot box; or other modes of power through “selectorates.”
Institutional models explain public policy as the output of process defined by institutions. Preferences are insufficient as an explanatory mode because we know quite well that the way in which preferences are aggregated influences the results: different institutions yield different results out of the same set of preferences. The institutionalist premise is to suppose that the preference structures of all advanced industrial societies are more or less similar. They all have farmers, workers, advanced high-technology sectors and declining industries, civil servants, teachers, small proprietors, unions, the liberal professions, and so on. Variance in policy output therefore expresses variance in institutions.
In aggressive versions of each approach, the one swallows the other. For the institutionalists, preferences are nullified as an explanatory variable by holding them constant. For the preference theorists, institutions are nullified as an explanatory variable by arguing that institutions themselves express preferences. Political systems have the institutions that people want to produce the policy outcomes they want. The small democracies of Europe changed voting systems to proportional representation in order to produce the economic and social policies of stability needed to be effective in world trade. The U.S. President acquired power over trade because Congress delegated it to him, and Congress can always take it back.
In the moderate versions of these two schools, the two variables interact. Preferences shape institutions and institutions shape preferences. Moderates relax the strong assumptions of their aggressive brethren to explore the interaction of preferences with institutions to produce results.
Vigorous debates between these approaches have shaped debates over current public policy events: the European Monetary Union, the new World Trade Organization and the North American Free Trade Agreement (NAFTA), trade disputes between Japan and the United States, post-cold war arrangements, and the like. These arguments also influence our understanding of earlier events and, of course, by doing so come back to have meaning for current disputes whose outcomes are less clear. In this discussion I will examine two fine books on the interwar years that directly address the linkage between domestic politics (preferences and institutions) and international cooperation or its lack. The sharpness of these books’ argumentation will assist us in returning to the same policy disputes in the current period.
Independent variables and the interwar years
The period between the two world wars remains of compelling interest, as it continues to shape theories of reality to academics and nonacademics alike, thus influencing decision making. In a televised debate preceding U.S. ratification of NAFTA during the fall of 1993, Vice President Al Gore gave Ross Perot a portrait of Senator Smoot and Representative Hawley upon whom Gore heaped opprobrium for causing the Great Depression of the 1930s with their famous tariff. Thrilled as we were to have a Vice President who actually had heard of these gentlemen we so frequently cite, we may not wholly agree with Gore’s causal argument in singling them out quite so harshly. We do nonetheless share his battle for historical meaning, as the interwar years continue to shape our images of the future.
One of the two most important lessons drawn from that period was that international economic stability requires international cooperation (the other was that appeasement does not pay). Countries pursued their own goals in those years. International institutions were weak, and there was no hegemon or great power willing to pay the costs of leadership. A classic collective action situation produced the expected results: beggar-thy-neighbor policies that could yield benefits for a single country if no others did likewise but would hurt all countries if copied: tariffs, devaluations, reparations, and other barriers amplified a business cycle downturn into the worst depression of the modern era.
Barry Eichengreen and Beth Simmons provide two superb accounts of these events. Cooperation turned out to be a problem: countries were committed to sustaining a bad policy regime—the gold standard, which transmitted policy mistakes in one country to others. Only when governments in each country broke the “golden fetters” could they get the policy space to focus on fighting the depression.
Eichengreen and Simmons both explore carefully the political economy of the commitments to gold and the politics of breaking those commitments. Eichengreen’s account stresses the economic effects of the golden fetters, while Simmons’s focuses more on the politics of breaking with orthodoxy. Whereas Eichengreen probes political explanations of economic choices, Simmons looks at the impact of economics on politics. Both authors examine and reject general systemic explanations, be they at the level of global international systems or of the nation as a unitary whole. Aggregate properties of countries or systems of countries do not suffice. The two authors consider and reject explanations that rely exclusively on such variables as business cycles, composition of the economy, and size of the economy.
Central to both authors’ accounts of the working of the international economy are the nationally specific processes of policy production where political institutions, politicians, leaders, and interest groups interact. Governments are pressed to take actions that please their constituencies but that also must please markets. These goals may diverge, and as they do, tension builds. At some point something may snap—markets may punish the governments enough to force policy change (cut deficits, devalue the currency), or politics may support the government to overcome market resistance to exchange rate changes, deficit spending, and tariffs.
The German hyperinflation of 1922 was caused by specific decisions not to raise taxes or balance spending in response to the French demand for reparations payments through occupation of the Ruhr. The U.S. stock market contraction of 1929 was caused by specific decisions of the Federal Reserve Board to contain the stock market boom through tighter credit, despite the effect this would have on European exchange rates and foreign economies already in a state of business cycle contraction. The ripple effects of these moves were caused by central bank and national government commitments to maintaining exchange rate parities to the gold standard: governments chose deflationary contraction rather than devaluation and deficit spending. The contraction continued until governments gave up that commitment. New policies of devaluation and deficit spending led to better results.
The overarching logic of both books links economic outcomes and international cooperation to domestic government policies. What requires explanation, therefore, is the choice of policy. What caused the commitment to certain orthodox policies concerning gold, deflation, and budget deficits? What caused governments to abandon those commitments? For both authors, these questions are best answered by disaggregating the various countries into component constituencies struggling over costs, benefits, and power.
The bonds that tie—the effects of the commitment to gold
The gold standard, as Eichengreen explains, required that governments place external balance ahead of the domestic economy. If sale of their currencies put pressure on parities fixed to gold, governments were expected to take corrective measures: raising interest rates, cutting budget expenditures, or increasing taxes. One or more of these moves would reduce the incentives to sell the currency, thus restoring balance. It would also have a deflationary effect on the economy: higher costs to capital, less demand stimulus from the budget, and less purchasing power to the consumer. The gold standard obligated governments to accept these deflationary costs.
For the system to work, therefore, governments needed to accept the commitment to take those measures and the “market”—the holders of currencies—needed to find that commitment credible. Prior to World War I, conservative politics and institutions provided that credibility. In most countries suffrage was restricted, labor unions weak, left-wing parties suppressed, and farmers poorly organized. Institutions put central banks beyond the reach of populist pressures. Ideologies limited the responsibilities and role of governments in economics. They were not expected to provide full employment, nor was it understood how they might do so if asked. Economic thinking supported the management of a gold system as the best path to prosperity.
With this sort of political, institutional, and ideological protection, bankers had the latitude within their countries to put the gold standard ahead of other concerns. Because each important economy was so committed, cooperation among bankers could and did occur. When one currency came under attack, bankers would organize loans to slay the speculators. They were all the more willing to take this step of cooperation because they found credible the commitment by the threatened country to carry out the monetary and fiscal policies needed to restore parity.
Tariffs were the one major deviation from gold standard thinking. In some countries they were useful as a source of revenue when other forms of taxation remained primitive. In others, intense global competition after 1870 put irresistible political pressures on governments, including pressure from producers well represented in political systems.
Then came 1914 and the catastrophe of war. After the guns stopped, it became clearer how dependent the gold standard system in its heyday had been on political institutions and on relatively benign international conditions. Extensive political change brought about by the war pressed sharply against the insulation of the system from politics. Universal suffrage (in some cases, however, for men only), legalized trade unions, mass political parties, organized farmers, mass communications, and democratized political processes all subjected governments to a wider range of influences than before the war. The deference of internal to external balance could now be challenged.
To political pressure was added the stress of difficult conditions. International payments confronted quadruple pressures resulting from reparations in Germany, wartime debts, drastic global shifts in production, and sharp political changes (the collapse of Austria-Hungary, the Ottoman Empire, and Imperial Russia). To this were added the structural effects of new technologies (cars, electrical appliances) and new productive processes (standardized parts, the assembly line).
The gold standard now faced a double squeeze. Within each country, policies needed to defend currency values that now faced political challenge. Between countries, bankers had less confidence in the commitments of their counterparts and had vastly more difficult cooperation problems to handle. Almost all governments tried to restore the old system, rejecting the implications of the vastly changed circumstances. In less than two decades, the postwar system disintegrated.
Eichengreen takes us through the steps of the collapse. The first ten years after 1918 saw costly efforts to fix parities. In Germany, weak governments could not handle the pressures of reparations, debt, and reconstruction. The government found it politically easier to let inflation grow out of control than to undertake the tough measures needed to stop it—draconian taxes and repressed living standards. The situation finally was stabilized with American loans. In Britain, the effort to restore the pound to its higher prewar parity required deflationary moves that provoked the general strike of 1926. In France, center-left governments tried to prevent deflationary measures, without success. The franc plummeted until President Poincare assembled a political coalition that accepted the costs of stabilization. Toward the end of the decade, many countries had returned to gold and the system appeared to have been rebuilt, albeit on new parity levels.
But the weakness of this structure was revealed when it was stressed. In 1927-28, signs of a business cycle contraction began to appear in Central Europe, Latin America, and the Orient. Alarmed by the rapid surge of the New York Stock Exchange, the U.S. Federal Reserve Board began to raise interest rates. This put further pressure on European countries that already had their own currency problems. The Reserve Board seemed unresponsive to those concerns. Eichengreen notes that the creation of the Federal Reserve system in 1914 had the positive effect of strengthening the institutional basis of U.S. monetary policy, but this did not in the short term increase U.S. commitments to the international system. The old system had relied on New York bankers who were more internationalist in experience and perspective than the nationally based group in which the new system placed power. As Eichengreen puts it, “A Federal Reserve System which, harking back to the problems of seasonal stringency and slack that dominated U.S. monetary affairs prior to World War I, used nominal interest rates to guide the formulation of monetary policy might fail to offset cyclical fluctuations that demanded a very different response. Unfortunately, the Great Depression would be required to drive home this point.”
The gold standard system intensified the interconnections at work: business contractions reduced the revenues for paying international obligations—especially those due to the United States—thus putting pressure on currencies and forcing deflationary policies, which then made it harder to raise revenues, and so on. With the United States already the world’s greatest creditor, fighting the stock market problem with a blunt instrument like interest rates made matters worse. The stock market collapse in the autumn of 1929 was a symptom of those problems, not its cause.
Following orthodox prescriptions, countries slashed spending, raised taxes, and increased interest rates. These actions intensified economic distress and provoked a sharp political response. Under the new post-World War I political conditions, governments were pressured to undertake other measures and did so. The test of commitment to maintaining currency parities was often the slashing of unemployment benefits. The British Labour government split over this move. Benefits were cut, but the pound nevertheless proved insupportable. Britain went off gold and, for the first time in almost a century, raised tariffs. At varying rates of speed and timing, other countries did the same. Gold standard norms were rejected: taxes were lowered, deficits run up, interest rates held down, and trade restricted. In some cases, governments experimented with deficit spending.
The rejection of the gold standard liberated governments to fight the depression. External balance by old rules was subordinated to achieving better internal performance. Freed from defending impossible parities, deflation could be ended. In some cases, a rather stable rate of exchange to gold was found, so that the traditional policy mix operated at a new level. In other cases, the policy mix was more varied.
To Eichengreen, an important consequence of the new policy approach lay in decoupling the shocks among countries. Proof came with the American slump of 1937. As in 1929, tightening by American policymakers led to a stock market crash (19 October 1937) and a severe slump. Unlike 1929, other countries were no longer obligated to deflate their own economies in response to U.S. pressure. The golden fetters were, at last, broken. It also helped, Eichengreen notes, that decision makers had learned from previous experience and moved quickly to reftate the economy and that military spending already was stimulating economies quite strongly. But his important conclusion is that the major effect came from the policy freedom of the new policy approach.
Eichengreen’s account is magisterial. It already has become the classic account of the period, the touchstone of all economic historical references to it. It may not so easily replace Charles Kindleberger’s classic work on university reading lists, however, because Golden Fetters is longer, dense with data, deeply rooted in economic theory, and wide-ranging in its comparative and historical framework. It is well worth the effort.
Eichengreen’s book is strongly political in its account. Throughout the analysis, the role of politics rings loud and clear: in creating the gold standard, in making it work, in its stresses, and in its collapse. Simmons notes the tendency among many economists to minimize politics in their accounts of events. Eichengreen is not one of those. How can we understand the politics of the commitment to and the rejection of that system and the adoption of alternative policy mixes?
Untying the knot—the politics of breaking commitments
Simmons and Eichengreen share an understanding of the political issues in explaining foreign economic policy. In order for countries to comply with the gold standard, they must have had enough domestic political support to pay the costs. For countries to leave the standard, they must have had enough political support to break their commitments. Conformity to the exigencies of gold prior to World War I relied on the insulation of bankers from populist pressures desirous of putting full employment and domestic profits ahead of international commitments to an external balancing of gold parities. When the institutions protecting bankers were changed, these commitments were weakened. Under stress, gold standard adherents lost power.
In his treatment of politics, Eichengreen notes the importance of the political changes that took place after World War I: the rise of labor, extension of suffrage, and democratization of constitutional procedures. He puts particular weight on electoral laws, noting the contributions of many political scientists. Proportional representation systems gave voice to a wider range of interests than did the winner-take-all single member plurality systems. This increased the leverage of those who protested the costs of deflation. In countries with dramatically difficult problems (such as France, Germany, Italy, and Poland), proportional representation made decision making unworkable and exacerbated crisis. Scandinavian countries were less stressed by objective pressure and could therefore use proportional representation systems without disaster. As described by Eichengreen, when the stakes are high “proportional representation will be associated with governmental instability and policy deadlock … [when the stakes are low, proportional representation] … will be associated with stable coalitions and compromise.” For Eichengreen, the development of proportional representation systems is in some ways a shorthand for expanded democracy. He combines institutions (proportional representation) with intensity of conflict to produce general statements about results.
In her discussion, Simmons looks more precisely at just what combination of factors in a democracy sustained a commitment to gold, which factors undermined the commitment, and which factors led to specifically different new policy mixes. Simmons casts the gold standard policy as a set of norms: norm 1 is that external balance prevails over internal goals; norm 2, that liberal trade policies are preferred over external controls; and norm 3, that exchange rate crises would be handled by supplementary financing. The three are related. Complying with norm 1 is costly to the domestic economy. Governments would therefore be tempted to defect through tariffs or devaluation. To avoid that, surplus countries (countries with current account surpluses) offered norm 3, financing supplemental loans if countries would adhere to norms 1 and 2.
We know analytically what it took to sustain a given country’s adherence to the gold standard. What were the indicators to actors of the period that a particular government would actually do so? This is Simmons’s central concern and major contribution—a very careful operationalization and testing of the indicators of credibility to markets, which are also indicators of the probabilities of moving to alternative policies. Gold parities could be sustained only if the holders of currencies believed the policy actions necessary to sustain them would be taken. Would governments deflate the economy to protect parity at the cost of unemployment and business failures? This mattered not only to speculators but also to those foreign bankers who had to find the resources needed to stop speculation. The less credible the commitment, the harder to stop a run.
Simmons defines five indicators of credible commitment to the gold standard or lack thereof:
(1) Regime type—authoritarian government or rule by decree signaled a country’s greater willingness to undertake unpopular economic measures. Democracy signaled that the gold regime was no longer inviolable.
(2) Political orientation of the party in power—left-wing parties experienced pressures from their constituencies that ran counter to balanced budgets and high interest rates, thus signaling a weaker commitment to gold.
(3) Labor unrest—influential unions and major strikes threatened economic disruption, undermining adjustment and the likelihood that governments could sustain the tough measures required by adherence to the gold standard.
(4) Government instability—adjustment to currency pressures is costly in the short term but beneficial in the long term. To reap those benefits, governments must last. Unstable governments based on a precarious consensus are unlikely to take serious measures to deflate the economy. Thus, government instability undermined the credibility of gold-standard adherence.
(5) Central bank independence—independent banks were seen as more likely than politically controlled ones to carry out deflation.
After carefully operationalizing these political variables, Simmons constructs a set of policy behaviors and economic outcomes against which to test them: devaluation and currency fluctuations; tariff adoption; and deficits in capital and current accounts. Against these dependent variables Simmons also tests a purely economic model with no politics.
Broadly speaking, Simmons’s findings confirm the power of political variables in explaining outcomes. Markets had confidence in the deflationary policy capacities of governments when their coalitions were stable, when central banks were independent, when the left was not a coalition member, and when institutionalized limits on direct democracy were in force. Attacks on gold standard parities were more likely when these conditions did not hold.
By isolating each variable with its own indicators, Simmons is able to probe the explanatory power of each. The most powerful explanation for capital account and current account movements is political stability—the expected longevity of governments: unstable governments with short time horizons won little confidence from markets. The second most powerful variable was the independence of central banks, followed by labor unrest. The role of the left was partially predictive—better for the current account than for the capital account, and regime type did least well. The political variables fared better than a purely economic explanation by itself.
Simmons then focuses on devaluation. What conditions made governments more or less likely to keep currency parity? “Economies headed by unstable governments, with significant left-wing participation in government and with politically controlled central banks, chose more often to devalue rather than to make fundamental adjustments that would halt current account deficits and encourage capital inflows.” Left-wing governments were more sensitive to the effects of the depression and depreciated their currencies more extensively than the right when they did so. Cabinet instability had a strong relation to depreciation, while the labor unrest variable did not.
With great effect Simmons uses a cumulative methodology to develop her findings. Moving from one test to another, she argues that support in one test reinforces confidence in the previous one and, if the different tests continue to point in the same direction, for the results as a whole. For example, having probed her political tests in dealing with fluctuations in capital and current accounts and in devaluations, she turns to a specific case: that of France. Her goal is to reinforce through the details of a case the specific timing and sequences that illustrate the way in which actors operated. Simmons works carefully through the French policy moves. Despite the inflationary effects of postwar reconstruction, some stabilization was reached. Then the Ruhr occupation failed, governments became more unstable, the left entered the coalitions, a scandal erupted surrounding the operation of the Bank of France, revealing it to have been more responsive to pressure from the Finance Ministry than had been thought—and the franc collapsed. Finally, under Poincare a new consensus emerged to back a hard line, a stable coalition was constructed to support it, and the franc stabilized. The political variables operated on the French currency exactly as the correlations of the many countries did, lending credibility to the whole.
Simmons then turns to other policy instruments, tariffs and deficits, applying the same methods of testing policy choice against the political variables she devised for testing the credibility of commitment to gold. On tariffs, she distinguishes between levels and changes in levels. Tariff levels correlate with a country’s size and degree of trade dependence: small countries highly dependent on trade were less likely to have high tariffs than large countries with lesser trade involvement, a confirmation of Peter Katzenstein’s discussion. Tariff increases rose with economic downturns. In contemporary trade disputes, labor movements in industrial democracies tend toward protectionism. In the interwar years, labor tended toward free trade, as “greater left-wing representation contributed to tariff decreases,” and protection was the choice of the center-right.
Finally, Simmons examines her argument through the prism of three detailed cases of response to deficits: Belgium, Britain, and France. The sequence of events in each country reinforces her general findings. In each country, orthodoxy prevailed as the initial response to pressure on the currency. In each country, the costs of deflation were found eventually to be intolerable, and political pressure finally was able to force a break. The precise pattern of timing and subsequent policy moves differed among countries. In Britain, the break came early, in 1931. The Conservatives led the abandonment of free trade but, once the pound was devalued, pursued strict policies of high taxes and low deficits to defend the new levels. Belgium was too small to try tariffs and tried instead to internalize the adjustment by deflating prices. As the costs of deflation rose and its economic results were seen to be meager, a political shift brought the socialists into a coalition that devalued the currency but kept trade open. Political stability allowed fairly rapid stabilization of the Belgian franc. In France, a similar sequence of deflation, political shift, and devaluation did not lead to political stability nor to stabilization of the French franc. Thus, left-wing governments, labor unrest, and cabinet instability are associated with deterioration of the current account, capital flight, and low credibility for pursuing deflationary policies. The larger the national economy and the lower the dependence on trade, the more likely a country is to turn to protectionism.
Simmons’s conclusions can be concisely put: instability in government, restive labor movements, cabinet inclusion of left parties, and non-independent central banks all undermined the credibility to markets of a government’s ability to control domestic prices and demand, resulting in capital flight, current account deterioration, and the unwillingness of surplus countries to provide stabilization loans. Just how governments responded to those problems depended upon the same variables. The willingness to internalize the costs of adjustment, which is Simmons’s operationalization of the concept of cooperation, was greater among countries that were “politically stable and, with less certainty, were not plagued by widespread strikes or, one suspects, other forms of social unrest.” “Countries experiencing internal conflicts had clear incentives to export [depreciate the currency or raise tariffs] their problems rather than to solve them.”
Simmons’s findings support those political scientists who find distinctly different patterns in left- versus right-wing governments. They stand in opposition to those who abstract from politics to find general characteristics of a country (for example, size) independent of its internal politics and in opposition to strategic theories (for example, tit for tat) that abstract from who is in power. The devaluations that occurred in Britain in 1931, the United States in 1933, and France in 1936 occurred when left-wing parties acquired enough political force to say that the costs of deflation were intolerable. Conservative governments were more likely to defend the currency at the expense of growth and employment, and they were more likely as well to use tariffs, sometimes to defend the currency. As Simmons concludes,
What is remarkable is that these domestic political explanations have an important impact on the balance of payments and the choice of adjustment strategies even when economic conditions and structural constraints are controlled…. Stable governments and politically insulated monetary authorities were associated with strong currencies even when such structural conditions as net investment position, wealth per capita, size, and trade dependence (none of which could be shown to be convincingly related to currency depreciation) were taken into account. It is true that changes in tariff policies were influenced by a country’s size and degree of trade dependence, but significant changes in policy were associated with the degree of political influence of the Left. Finally, an important negative finding was the lack of evidence of tit-for-tat behavior between a country and its major trading partner in the implementation of tariffs.
Simmons’s book is the best political account of economic policy adjustments in the 1930s that we have. It carefully operationalizes the independent variables of politics and the dependent variables of economic policy and behaviors. It states hypotheses and devises empirical tests of them. It provides an account of the mechanisms that link aggregate national variables (such as factor endowments) to specific conflicts over policy, and it provides considerable leverage in explaining variations of policy behavior and timing. It provides a model for work on other countries and other periods dealing with the important issue of credible commitment.
Together, the two books show the rewards of disciplinary interaction. Typically, the comparative advantage of economists in political economy lies in modeling the impact of different variables on economic outcomes in which the behavior of policymakers is simply one of a number of variables. Without careful work of this kind, we could not debate policy options and politics. Rarely, though, do economists examine the politics that lead to the choice of policies. That is the comparative advantage of political scientists. Economists specify the dependent variable (economic policy) that then requires explanation. What causes the politics that produced the policy?
These books reflect to some degree that division of labor. Eichengreen focuses on the policy moves and their consequences, Simmons on the politics behind the moves. But Eichengreen’s account is suffused with politics. He does not for a moment believe that economics follows some inner logic in which policy behaviors have no effects or in which the policy behaviors are somehow disconnected from politics. Simmons’s account is suffused with economic analysis. She is careful to provide economists’ accounts of the causal effects of policies, so that she knows which are the actions that require explanation and so that she can examine the motives of political actors. Each book comes out of its discipline. Neither author would have written the other’s book, but each book reflects an admirable interdisciplinary cross-fertilization of ideas, explanations, method, and research.
Starting over: commitment after the war
These two books will be savored by specialists of the interwar period as among the best works in the field. However, they deserve a wider audience because their discussions bear significantly on a number of important arguments in comparative political economy and international relations. They are of particular relevance to discussions of international cooperation and stability in a multipolar world and to the explication of comparative policymaking in response to international pressures.
Multipolar systems pose acute problems for international cooperation. Robert Axelrod, Robert Keohane, and others have demonstrated that cooperation can occur among egotists without hegemonic leadership. But the conditions for egotistical cooperation are quite demanding. Our complex, heterogeneous world does not meet those conditions very well. Cooperation in our day will require deliberate self-conscious efforts to construct ties that bind. Be it egotistical or led, cooperation will in either case require domestic concordances. “Cooperators” in each country will have to find common ground with their allies in other countries, constructing a regime that is able to provide enough benefits for the winners to overcome the losers in each country seeking to overthrow the regime.
For the interwar period, Eichengreen and Simmons show the way in which cooperation at the international level required two kinds of support, each operating through different mechanisms of power: confidence in world markets, operating through the functional leverage of private actors in shaping economic conditions; and political support at home in each country, operating through political processes. At times, markets refused to support policy. At other times, populations refused to pay the costs of compliance. Similar mechanisms are in operation half a century later. Both the content of policy debates—the relative importance of monetary stability and full employment—and the analytics of explaining the outcomes—institutions, interest groups, ideology, etc.—remain quite similar. Some elements of the situation are different.
Old wine in new bottles
The cooperation problems examined by Simmons and Eichengreen ring with loud familiarity in the world economy of today. Devaluations, fiscal deficits, divergent interest rates, trade barriers, and fluctuating employment rates continue to mark the contours of political economy in contemporary Europe. A major difference from the interwar years is the far more ambitious effort at coordination currently underway. Most striking is the European Community (EC), its successor, the European Union (EU), and the various agreements undertaken to intensify economic integration of the Continent.
Policymakers after the war judged harshly the beggar-thy-neighbor anarchy of their predecessors. They sought new institutions to prevent this from recurring. Today, the European countries seek a far greater degree of coordination than was ever attempted in the interwar years. They long ago surpassed the customs union approach of the European Coal and Steel Community and the early days of the Common Market. Now, through the EU, they extend cooperation to include the coordination, often by “mutual recognition,” of the microinstitutions of finance, corporate governance, rules, and regulations concerning health, safety, labeling, and many other aspects of economic life. With less success they have tried to institutionalize monetary union.
How far can this process go? Can institutions contain anarchy? The analytic tangle unraveled by Simmons and Eichengreen for the interwar years recurs in the present. The components of analysis are the same: the interaction of interests, preferences, and institutional rules. But the content has changed: political balances within the countries have shifted considerably, and many institutional rules are new.
The institutions of the EU define interests and expectations, and thus preferences and calculations about outcomes. At the same time, the institutions themselves rest on political commitment made through politics. They are delegations of authority resting on political engagements, delegations that can be withdrawn if they do not conform to desired policy outputs.
The new institutions help structure a complex game of strategic interaction among actors in the market, policymakers, interest groups, and voter groups operating through politics. Governments make policy commitments to cooperate. They define a regime, be it in monetary policy, trade, or fiscal policy. Markets evaluate the political action required to honor the commitments. Politicians judge the domestic political costs of honoring the commitments, and voters and interest groups judge the effects of those policies on their welfare. Institutions alter these strategic judgments, but one of the variables at play is the durability of the institutions themselves. Since the rules are expressions of delegation, the rules can themselves be challenged. They can become one of the objects of struggle. Thus, actors have to include in their judgment of results the durability of the institutional arrangements for managing disputes about the substance of policy.
Can institutions hold countries to the commitments they have made? The EU comprises a bold effort to institutionalize these commitments, to make them so deeply vested that no country will wish to break them. The logic of institutional arguments is that these new institutions change the calculus or preferences of actors within them, generating commitment to the institutions themselves. Has that happened in Europe?
The answer is mixed. The EU continues to be the creation of states. It has authority over countries to the extent that the countries accept that authority; it is the agent of the countries that make it up. Should France, Germany, or Italy refuse to obey an EU decision, Brussels cannot march on Paris or Bonn or Rome and obligate the country to comply. Compliance, adherence, and cooperation all turn on the political calculation of member countries that it is best to comply. The EU lacks the authority over subunits that most European governments have over their lower political forms.
The EU’s ability to obtain compliance rests on the way its existence influences the political game within the states that make it up. Here there is certainly an impact. The EU embraces a very wide range of issues within a single institutional structure. In so doing, it increases the opportunities for both deal making and deal honoring. Keohane notes that “Clustering of issues under a regime facilitates the side-payments among these issues: more potential quids are available for the quo. Without international regimes linking clusters of issues to one another, side-payments would be difficult to arrange in world politics.” Institutions make deals more likely. The deals in turn, as Lisa Martin notes, strengthen the institutions. Members can obtain a deal by trading something of lower importance to them for something worth more. They do pay a price, giving something up to get something they value. They are deterred from defecting by their desire to maintain what they have obtained. Thus the more trades of this kind, the more members are committed to the regime or institution, in this case the EU, and the less likely will be defections. Issue linkage strengthens commitment. Where issue linkages weaken, the chances of a deal erode. Martin connects the concept of issue linkage to a careful analysis of the institutional machinery for ratification within each country to provide an explanation of the European Monetary Union dislocation of the past several years—an explanation that links domestic politics to domestic institutions (national rules for ratification) and to international institutions (EU rules for legislation and rule making).
The long-run effect of this issue linkage is what Ernst Haas called “spillover.” Policies influence the structure of society: the uncompetitive are wiped out, the strong expand. Gradually interests are altered and reshaped, and with them preferences. Groups develop a stake in the policies of the EU and thus in its institutions. The institutions themselves spawn their own constituencies, who each have a stake in the perpetuation and growth of the system. As these supporters increase in number, they are able to resist any actions by their national governments to damage it by reneging on commitments.
This line of reasoning shows the power of the institution to produce a kind of politics that would not occur without it. At the same time, it remains important to trace back the politics to see the role of preferences within countries and of market forces across them in influencing policy outcomes. The politics of the European Monetary System (EMS) provide a particularly appropriate example, for itself and for its echoes of the interwar years. The EMS is to be a single currency for the EU. To work, all national currencies would have to be pegged within a specified band to the common unit, the “euro.”
This is a very demanding commitment upon each government. It obligates national economic policies in money supply, interest rates, and fiscal stimulus to keep national currencies at the fixed relationship. Thus it resembles strongly the kind of commitment made in prewar days to the gold standard. If the currency were to weaken, governments would have to institute deflationary measures, such as higher interest rates or lower fiscal stimulus. If the currency were to become too strong, governments would have to lower interest rates or increase spending.
Most currency crises focus on the former situation, weak currencies falling below the band. Governments are blamed for failing to hold the course and having to leave the “snake” at the bottom. Recent years also have seen a striking example of the other case, that of a strong-currency country refusing to reduce pressures on the snake from the top, namely, German insistence on holding the mark firm in the midst of national debates on whether to ratify the Maastricht Treaty. The collapse of the Soviet bloc had put unexpected pressures on the mark. Chancellor Kohl insisted on parity between East and West German marks as an engagement of full national unification. This greatly overvalued the purchasing power of the East Germans, which, along with massive spending, created inflationary pressures. Germany had a choice: defend the national currency or encourage a single currency by easing off. It chose the national route.
The institutions of the EU cannot compel compliance if governments refuse. British politics have led that government to resist joining the EMS. As a result, Britain has been allowed to define its own terms of relationship. This is dangerous for the strength of the community, for it leads to the kind of unbundling of issues that weakens the force of commitments.
To understand Germany’s desire to sustain the mark, Britain’s refusal to surrender sovereignty of the pound, and the reluctance of other governments to pursue deflationary policies in order to keep their currencies within the snake, it is necessary to examine the politics within each country. In each case, strong preferences within the countries push governments in one policy direction or another, which in turn affects their ability to keep international obligations—exactly as in the days of the gold standard.
British policy toward the EU turns on preferences in political parties. In both the Conservative and Labour parties can be found a reluctance to give up sovereignty combined with calculations about policy objectives in the economic and social spheres. The Tory “dry” side dislikes regulatory and social Europe. It sees the power balances in Brussels as more favorable to social legislation, worker rights, and environmental and employment restrictions than what they would like to see in Britain. To resist the EU means for the drys to uphold for Britain the cluster of market-oriented policies associated with former Prime Minister Thatcher. Conversely, Labour has shifted its attitude toward Brussels in response to the dynamics of British and community politics. Before Thatcher, when the Conservatives led Britain’s conversion toward the Common Market, Labour resisted out of concern that joining would erode labor gains in British policy. As Thatcher gained ascendancy in Britain, Brussels at the same time became more sympathetic to “social Europe,” and Labour switched sides. A Labour majority supports a particular kind of Europe, while a Labour minority remains suspicious. The key point is that domestic electoral, interest group, and party politics shape British positions toward cooperation in the EU. These calculations have motivated British resistance to key steps in the integration process, most recently monetary union.
Germany had been expected to lead the efforts on monetary union, so its recent behavior compels explanation as well. The Bundesbank and the German government chose to assert the value of fighting inflation against all other goals. Why? The memory of the hyperinflation of 1922 is not an adequate answer, though perhaps it is the one most commonly given. Certainly it was a traumatic experience, but why does that particular interpretation of the meaning of that event dominate politics more than seventy years later when many other traumatic events are forgotten or subject to varying interpretations? Institutionalization of the Bundesbank is a more compelling argument. The Bundesbank has the political autonomy to pursue this policy, and central bankers the world around generally favor strongly anti-inflationary positions.
Yet the autonomy of the Bundesbank is not self-evident either. It is delegated by German politics. If political forces do not like the politics pursued, they can rescind that delegation. The politics surrounding the central bank’s powers are linked to other institutions and political arrangements. After the war, German politics structured a complex historical compromise among social, economic, and political actors. German labor relations, welfare, education, worker training, and management systems such as mitbestimmung link wage increases to productivity gains and provide stable employment for the great majority and substantial assistance to the unemployed. Systems of corporate governance link main banks to groups of companies, constrain competition, and prevent open struggles for control. The microinstitutions of German capitalism are part of an institutionalized social compromise of which central bank autonomy and tight money are but one part. The willingness of populist forces in Germany to accept tight money, when their counterparts in other countries do not, cannot be extricated from this politically shaped network of macro- and micropolitics, industrial structure, and social institutions. In comparative terms, it is wage bargaining systems that, as Peter Hall shows, shape inflation rates—not bank institutions.
French monetary policy represents an interesting case to juxtapose against those of Britain and Germany, for France has moved from the politics of soft money to hard. In the early 1980s, Francois Mitterrand, responding to the demands of major components of the coalition that elected him the first Socialist President of France, tried to steer French economic policy to the left. Extensive nationalization of industry was carried out along with a strong stimulative fiscal policy, going against the direction of most other industrial countries. Rather quickly market forces judged this behavior quite negatively. Mitterrand was faced with a choice very much like that of the British Labour government in 1929: conform to the judgment of private investors in the finance markets of the world and give up these policies, or see money pour out of France, depressing the economy.
Mitterrand switched sides rather quickly. He abandoned the plans for nationalization and cut back on demand stimulus, shifting his policies, his coalition, and his party toward the center. At first, Mitterrand gained strength from these moves and won reelection. Over time, the French left weakened considerably, thereby cutting the ground from the populist forces that had historically opposed strong monetary policies. While Mitterrand continued as President until 1995, the Socialists lost control of the legislature much earlier. France developed the politics to sustain the strong franc.
France “bandwagoned” with the German mark. The effect has been low inflation but also high unemployment. France, like most of Europe, has had stubbornly high unemployment levels, which have remained despite strong money policies. The institutionalized rigidity of European labor markets contributes to this. It is much harder to discharge workers in the EU than it is in the United States, so the United States is able to create more jobs but at lower pay and with poorer benefits. Fewer people work in Europe, but those who do have better benefits. One effect of unemployment has been the growth of xenophobic political movements like Le Pen.
Cooperation among EU members depends significantly on the internal politics within member countries on economic policy. The capacity to cooperate turns critically on the degree of convergence on substantive issues. In the 1930s, cooperation required agreement on the deflationary values of the gold standard. When domestic political forces proved unwilling to pay the costs, the agreement collapsed. In its place after the war, a system was institutionalized with very strong commitments to employment, sustained by corporatist arrangements and the welfare state. This arrangement created an inflationary pressure in the system, with stickiness on the down side.
In response, over time an anti-inflationary coalition has grown in strength in several countries, led by Germany. That coalition has defined the basis of cooperation on the monetary union to be strongly anti-inflationary. A single currency requires a high degree of alignment of monetary and fiscal policy among countries. The major countries must agree to internalize domestically the obligations that such a system requires.
Cooperation on this point has sputtered as domestic politics process the costs. Some countries refuse to pay. Germany refuses to yield on its definition of tight money, while other countries refuse to align their weaker economies to that standard. In each country, the capacity to define monetary standards is linked to the institutional and political arrangements on other issues such as health, unemployment insurance, education, incomes, policy, and taxation. The authority given to the monetary institution, the central bank, is connected to the institutional arrangements to manage these other policy arenas.
On monetary policy, the EU has not found the convergence among the countries required to sustain a common policy. In other issue-areas, it has managed to do so. Thus the EU survives and prepares to handle the money issue sometime in the future.
Cooperation without an institution
The EU provides a context for analyzing the issues of cooperation in a case where a variety of processes has advanced integration of interests, ideas, and institutions quite substantially. Japan-U.S. relations provide an important case where these factors are substantially weaker. In the European case, the institutionalization of an open trade regime led to a convergence on monetary policy. Japan and the United States have not been able to work out an agreement on the substance of trade relations concerning a variety of dimensions (macroeconomic coordination, regulatory reform, nontariff barriers, grievance mechanisms). In the absence of other policy accommodation, monetary fluctuation has been the major instrument of adjustment.
During the dozen years of the increasing U.S. trade deficit with Japan, numerous negotiations and discussions have taken place, frequently ending in declarations of agreements. Markets have doubted the meaning of those words and the credibility of the arrangements. Over the years, the dollar fell from a value of about 360 yen to under 100 yen. From 1993 to 1995 alone, the dollar lost approximately 30 percent of its value against the yen, and the Japanese global trade surplus grew to record levels.
The problems of credibility in accommodation between the two countries lie in the obstacles to convergence on the substance of policy. In both countries, the politics of blame are easier than the politics of adjustment. Decision makers in each country prefer to fix responsibility for tensions on the other rather than to convince domestic constituencies to pay the costs of adjustment. To lower the trade deficit, the United States could reduce consumption and increase savings (by instituting such measures as higher taxes, less government spending, tax incentives to save rather than consume, and restrictive monetary policy). Japan could relax its various trade restrictions (cartelization of retail distribution, extensive regulatory barriers, and ownership and investment rules), lower interest rates, increase spending, and cut taxes. Each of these actions provokes opposition from the domestic beneficiaries of the status quo. As a result, governments on each side make partial concessions—some loosening of regulations on the Japanese side, a modest deficit reduction move on the U.S. side—but resist substantial changes. Markets cut through the rhetoric surrounding these negotiations to say little has happened and to drive up the yen.
How can agreements between Japan and the United States be made more credible? The areas of conflict between and within the two countries themselves are instructive. Institutional changes mark one such area. The United States and other foreign observers seek greater transparency in Japan’s regulatory practices; administrative guidance (bureaucratic coordination without publicly stated explicit rules) makes it difficult for outsiders to know whether agreements are being followed. Reformers inside Japan have sought to change the electoral law. The multimember nontransferable voting system is thought to encourage corruption, inhibit broad policy debates, and favor specialized interest groups that oppose free trade. This law has recently been changed toward single-member districts, but as of this writing, an election under the new system has yet to occur. The new law, it is argued, would change the internal distribution of power, thereby altering the relationship of constituencies to the electoral process. Institutionalist observers of Japan differ sharply in their views of the relationship between these two areas: theorists of ministerial autonomy stress the capacity of bureaucracy to dominate decision making, including the organization of political activity. Theorists of party politics see ministerial autonomy as delegated by electors and parties, so that changing the party system by altering the electoral law shifts the signals sent to the bureaucracy.
On the U.S. side, institutional issues involve the relationship of Congress to trade negotiations and to the administrative structures of trade regulation. Because of the fragmentary quality of the U.S. political process, protectionist pressure groups have their strongest voice in Congress. In recognition of this, free-trade supporters seek to persuade Congress to adopt a self-denying ordinance: fast-track authority that allows the President to present for approval trade treaties without further amendment in the congressional process. Presidential authority is not the cause of free trade; but it expresses a substantive commitment to adopt it. As support for free trade has weakened in the 1990s, Congress has failed to renew fast-track authority. Other institutional issues in U.S. trade relations involve regulatory and administrative systems. The fragmentation of authority in Washington among agencies and the fragmentation that comes with federalism in general cause negotiation problems and undermine credibility.
The centrality of institutional issues in defining the probable course of policy in each country is challenged by interest group-theorists and political sociologists. Electoral law reform in Japan will not change policy very much if major groups in society oppose the substance of such change. Policy change often occurs without institutional change when economic and social constituencies push for it. Congressional fast-track delegation cannot occur unless constituencies want it.
Following this line of reasoning, the major obstacle to Japanese-U.S. cooperation lies in the sharp divergence of interests among significant actors in the two societies: in Japan, major actors comprise agriculture, construction, automobiles, retail distribution, electronics, and a variety of other producers—all whom prefer the anticompetitive cartel to freer trade. In the United States, the major actors comprise all those industries impacted by Japanese competition and excluded from Japanese markets. In Europe, the specialization and interpenetration of interests that have facilitated societal policy convergence have taken several decades to develop. In this sense, nonconvergence of economic profiles (patterns of investment, foreign ownership, specialization across borders within product families) provides the foundation for continued conflict. Japan’s resistance to direct foreign investment—the low amounts make it the greatest outlier among the advanced industrial countries—reduces the convergence of interests of foreign companies with Japanese ones; at the same time, this resistance inhibits the influence of foreign economic influences within the Japanese economy (there is no foreign dealer network in Japan, for example, to complain about import barriers).
Foreign pressure appears in both countries through two mechanisms. First, it can work through the political process by finding allies within the country that support policy change. Leonard Schoppa finds that adjustment to U.S. pressure that resulted in the Structural Impediments Initiative (negotiations over nontariff barriers) occurred when there was internal Japanese support for change (as with the retail and distribution system) but failed to occur when there was united Japanese opposition to change (as with the keiretsu system). Second, foreign pressure can work through the market by changing cost relationships, which either produce the desired adjustments directly or generate political pressure for policy change.
While the Japanese-U.S. relationship lacks any formal institution comparable to the Common Market, it arose from and has rested on cross-issue exchange, or “linkage,” between economic policy and security. As the cold war developed, the United States sought to boost the Japanese economy, stabilize Japanese domestic politics, and provide a base for American troops in Asia. To do so, it encouraged Japanese economic growth, accepting economic restrictions that excluded American investments; took in Japanese imports; and accepted a passive involvement of Japan in its own security arrangements. Japan received in exchange access to U.S. markets and a security umbrella, allowing it to keep military costs low and avoid the acute fragmentation of domestic politics that more active engagement in world affairs would have involved.
In the new conditions of the post-cold war world, this bargain is under growing stress. Japan, fully recovered, is an economic competitor to the United States, whose closed markets cause conflict. The security motives for the United States are weakening, and the internal Japanese inhibitions on foreign policy engagement are eroding. No international institution manages these bilateral tensions. Only the convergence of self-interest can sustain cooperation between the two largest economic powers in the world.
Other mechanisms besides formal institutions promote coordination: direct foreign investment, strategic alliances among companies, ethnic and family ties, and cultural linkages, to name a few. The networks developed by overseas Chinese in East Asia and the very extensive investment by Japan in Southeast Asia comprise one example. Private networks provide coordination mechanisms in the market. They can also be destabilizing through speculative attacks on currencies. Though they cannot directly provide policy coordination, which only governments can do, they can influence governments—indeed they are the interests who help define the costs and benefits of policy coordination and cooperation.
Conclusion
Eichengreen and Simmons place economic policy squarely in the realm of politics and political choices. International cooperation on policy survives so long as the political forces committed to its continuation within each country are able to prevail. The gold standard and trading system prior to World War I turned on a particular political balance within the countries as well as between them. World War I changed the internal balance as well as the geographical distribution of economic activity. Democratization gave voice to other groups and preferences; it increased the power of the ballot box and the power of the market through strikes and capital flows. When crises came, inflicting great costs on various constituencies within each country, these new patterns of power were able to force change against classic deflationary policies. For antideflationists this was good, as it liberated productive forces from the straitjacket of gold. For monetarists the new system set loose the forces of inflation that have plagued modern economies ever since.
The old struggles continue to the present day—how to obtain cooperation in monetary, fiscal, and trade policy. Modern conditions are significantly different in two major respects. First, the internal political situation among important countries is dramatically altered. Germany is the most conspicuous example, where entire social and economic groups no longer exist (the Junker landed aristocracy, for example) and political life has shut out Communist and fascist organizations. Second, the countries of Europe have placed themselves in a dense network of institutions, altering the conditions of politics between and within them.
Can these new conditions sustain cooperation in Europe of a kind that was missing between the wars? The optimism that came with the end of the cold war faded quickly with the Gulf War, the Bosnian crisis, and the stresses of economic adjustment in the former Soviet Union and Soviet bloc countries. And yet, despite the verbal sparring and the proliferation of nontariff barriers, the trading system has not unraveled. Indeed world trade continues to grow. For the optimists this is proof that cooperation among egotists is possible. The pessimists say it is too soon to tell. The sputtering steps of European integration cut in both directions. There was consensus to move forward with deepening of integration through regulatory coordination—far greater integration than any customs union had undertaken in the past, through expansion of the number of members and through an effort to create a single currency. Conversely, the failure of the currency effort revealed the importance of national domestic political considerations in limiting the direction and pace of change. Certainly, one can see dissatisfaction in each society with current features of the trade regime, which have resulted in unemployment, declining purchasing power, pressure from migrants and foreign labor, political entrepreneurs seeking to mobilize discontent, and fiscal crises on state expenditures.
The credibility of international arrangements continues to rest on the convergence of domestic interests and politics. Strengthening cooperation will require action on several fronts, all of them difficult. It can only result from harmonizing political processes so that allies can evaluate more clearly the authority of those who make commitments; from convergence of economic interests so that allies can evaluate the policy positions of important groups; from harmonization of regulatory rules and procedures so that there is both substantive convergence in policy among countries and greater transparency to allow the evaluation of policy behavior; and from the development of dispute resolution mechanisms so that countries can be confident about enforcement.
By examining the domestic microfoundations of international cooperation and breakdown in an earlier period, Eichengreen and Simmons have given us not only the pleasure of outstanding research on the past but also extremely useful tools with which to explore how credible such commitments might be.