Chapter 10Political EconomyChapter Objectives1. Describe the r.docx

Chapter 10
Political EconomyChapter Objectives
1. Describe the relationship between governments and the
economy.
2. Describe different types of economic systems, including
capitalism, socialism, and command economies.
3. Examine measures of economic performance.
4. Identify the fields of comparative and international political
economy, including their major areas of research.
The presidential election of 1992 was an interesting one. Not
only did the incumbent president, George H. W. Bush, have a
stunningly high approval rating coming out of the Gulf War but
the election also featured a third-party candidate, Ross Perot,
who received the highest percentage of votes ever in American
history for a third party. The Democratic challenger, Bill
Clinton, was also an anomaly. A Democrat from the solid
Republican South, he had also been accused of sexual
harassment. Despite what would seem an easy reelection for
then president Bush, James Carville, one of Clinton’s campaign
advisers, summed up Clinton’s message for the voters quite
succinctly: “It’s the economy, stupid.” With America in a
recession and Bush having gone back on his pledge of “no new
taxes,” Clinton’s economic message resonated with the
American people, and Clinton handily won the Electoral
College that November. Political science research has
consistently shown that economic concerns are a primary issue
for voters—especially voters who ask themselves “Am I better
off now than I was four years ago?” when deciding how to cast
their vote for president. Thus, politicians are rightly concerned
with a country’s economy and challenged about how to respond
to economic pressures.
This chapter explores the very crucial relationship between
government and economy, the study of which is termed political
economy. Although certainly not an absolute rule, a government

cannot long be successful if its citizens suffer economic
hardships and poor quality of life. Although there have been
exceptions to this like North Korea, those states usually succeed
because of their authoritarian nature. We will start first with a
discussion of the connection between politics and economy and
then move to discuss different types of economic
systems, including capitalism and socialism. Although we
discuss these ideal-type models, the reality is that there is no
country in the world that is completely capitalist or completely
socialist; rather, types of economies fall on a wide spectrum,
having to do with how much each government is involved in
economic activity. Following this, we will discuss the ways in
which the government can be involved in the economy,
primarily through the tools of fiscal and monetary policies and
the types of factors that influence economic performance.
Finally, the chapter discusses two subfields in this area of
study: comparative political economy and international political
economy.What Does Politics Have to Do with the Economy?
Politicians care very much about how the economy is
performing. One theory of how people vote is based on their
experiences with the economy in previous years; if individual
voters feel like they have benefited economically, they tend to
vote for the person or party already in power. On the other
hand, if they are feeling the economic pinch or have been hurt
by the economy, people tend to vote for the person or party not
already in power. In this sense, politicians must be concerned
about the economy because it directly affects their chances for
reelection.
Politicians are also concerned about the economy for other
reasons. When the economy is humming along, governments
tend to take in an increased amount in taxes. Depending on the
spending priorities of the government in power, this can be a
powerful incentive to shape economic dynamics. When
economies are shrinking, on the other hand, governments almost
always have to become involved to soften the blow for its
citizens. An economist named Keynes recognized this in the

twentieth century, putting forth a model of a government-
economy relationship we now call Keynesian economics. In this
model, during economic downturns, governments should spend
money, thereby pushing funds into the economy, which can
lessen the impact of recessions or depressions. According to
Keynes, it would be acceptable for governments to deficit
spend, or spend more than they are taking in in taxes, in order
to spend more. As economic conditions improved and tax
receipts increased, a government could cut its spending and pay
off the debt that it had accumulated in the meantime.
Politics and government can influence the behavior and
performance of the economy in various other ways. The types
of tariffs, taxes on imported goods, implemented can encourage
domestic economic growth by making foreign goods more
expensive to buy. The type and amount of regulations that a
government enacts and enforces can make it harder or more
expensive for businesses to operate. For example, regulations
restricting the amount of pollutants released into the air by
factories, while good for the general health and the
environment, often require those businesses to make expensive
modifications to plants to reduce their emissions.Know a
Political Scientist John Maynard Keynes
John Maynard Keynes was an influential economist who
significantly affected the way in which politicians and
economists think about the involvement of government in the
economy. Born in England in 1883, he received a BA and MA
from Cambridge in the early twentieth century. He began a
career as a British civil servant by first working in India and
later serving as an economic advisor to Prime Minister David
Lloyd George at the Versailles Peace Conference after World
War I. Deeply influenced by his experience there, Keynes
criticized the economic burdens placed on Germany after the
war. High British unemployment and the ensuing Great
Depression caused Keynes to rethink his position supporting
free market systems with relatively little government
involvement. He published The General Theory of Employment,

Interest, and Money in 1936 in which he argued that
governments should deficit spend in order to promote full
employment as a solution to economic depressions. Although
not a political scientist by training, Keynesian economics, as
these ideas would come to be called, has influenced generations
of politicians, economists, and policy analysts. Keynes died in
1946 but was named to Time magazine’s TIME 100 Persons of
the Century in 1999.
Overall, however, societies cannot long survive, or survive
easily, without economic success or opportunity. Take for
example, the Middle East. Over the past several decades, there
has been a lack of economic opportunity and growth in many
countries despite the oil resources that they have. The benefits
of such resources are often misdirected in these countries to
ruling families or through corruption (we call this the resource
curse) rather than distributed to all the people. As a result, the
growing youth population of many of these countries have little
opportunity either educationally or workwise. This has made
that population vulnerable to the preaching of fringe and
extremist religious groups, which have destabilized several
Middle Eastern countries and whose effects have been felt
across the West. Thus, governments and politicians must be
concerned with and think about the state of their own economy
as well as the now-globalized economy to ensure the happiness
of their people and the success of their government.
Types of Economic Systems
An economic market or system is a framework of how firms
produce goods and consumers buy and use those goods. In other
words, an economy is a system of exchange. Wherever goods
are exchanged between people, some sort of economy arises.
However, these systems of exchange can be heavily influenced
and even regulated by states and their governments.
Governments can effectively institute the economic system they
believe will be most effective through economic policy.
This section identifies several economic systems, including
capitalism and command economies.

Capitalism
As a theory, or an ideal type, economies can exist outside of a
political system in what is often termed a free market: If there
is consumer demand for a good or service, some firm will
provide it with the costs of products or services determined by
the amount of supply in the market and the amount of demand.
When there is an excess of supply with little demand for a
product, prices would go down while when supply is limited and
demand is high, prices would rise. As coined by eighteenth
century economist Adam Smith, the “invisible hand” would
regulate the market without the need for government
intervention. These basic ideas form the basis of the economic
system known as capitalism. Jaeggi identifies five
distinguishing characteristics of capitalism:
1. “Private ownership of the means of production and a
separation between producers and the means of production;
2. “The existence of a free labor market;
3. “The accumulation of capital, and as a consequence;
4. “An orientation toward the exploitation of capital, thus
toward gain instead of need, toward the cultivation of capital
instead of the consumption of it or subsistence on it;
5. “Under capitalism the market typically functions as a
coordinating mechanism for the allocation, as well as the
distribution, of goods, such that capitalism and the market
economy are closely bound—though not identical—to one
another.”1
However, even at the time in which Adam Smith was writing,
there was widespread government involvement in the economy.
For example, in medieval feudal systems, states were built
around the distribution of labor by the peasants, to local
landowning elites, to lords, and finally to the ruling monarchy.
While loyalty and military service flowed upward, so did taxes.
These taxes allowed the aristocracy and the monarchy to operate
as rulers. Indeed, Adam Smith recognized that the object of the
study of political economy is to provide people and the state

with “plentiful revenue.”2 This revenue also allows states to
overcome the deficiencies of the free market—namely the
possibility of market failures. Market failures occur when an
economic market or system fails to produce or distribute needed
or wanted goods and services. Market failures tend to happen
most often when the provision of public goods, or
nonexcludable goods, are at play (recall the tragedy of the
commons from Chapter 1).
Although the virtues and values of a free market system are
often extolled, capitalism certainly has its critics. Jaeggi
identifies three major critiques: functional, moral and ethical.3
The functional critique argues that capitalism itself, as a
system, is intrinsically flawed and cannot function as a social or
economic system. When left unchecked, free market policies
allow for the existence of monopolies, or sole providers, of a
good or service that can drive up prices. Firms can also work
together to control the supply of a product and therefore its
prices. This sort of collusion among private firms can create
profits for owners and producers but leave those at the other end
of the spectrum in dire straits. This sort of economic inequality
can in turn lead to social inequality or even the inability of poor
people to advance in a society. In concentrating economic
power in the hands of the few, a large class of people are left
almost permanently “pauperized” with that population getting
ever larger leading to an eventual breakdown in society.
Another critique noted by Jaeggi is an ethical one—that the type
of life created by a capitalist system is in and of itself bad; “it
is impoverished, meaningless, or empty, and it destroys the
essential components of a fulfilled, happy, but above all,
‘veritably free’ human life.”4 Although this also sounds related
to the Marxist critique, Jaeggi notes that Marx was but one of
many people who took up this theme in the early 1800s. While
Marx’s solution was the abandonment of the capitalist project
altogether, others saw danger in such a proposition. If all
private property were abolished and people received only
according to their need, what incentive would individuals have

to excel, innovate, and create? In a capitalist system, the profit
motive encourages people to not just to do enough to survive
but do enough to thrive.
The Communist Critique
The moral critique of capitalism is that it is unjust and exploits
workers:
Capitalism exploits human beings by ‘depriving’ them of the
fruits of their own labor in an unfair and unjust way; in other
words, people are ‘enslaved’ by a system that in many ways
defrauds them of that to which they are entitled and coerces
them into social relations that are immoral and degrading.5
The moral critique is very similar to that made by Marx. Recall
from Chapter 3 that Marx saw in capitalism not just a system
that benefited private owners rather than producers but the
seeds of its own eventual destruction. Marx posited that once
capitalism created so much inequality, the working class, or the
proletariat, will come to realize the extent to which they have
been taken advantage of by the producing class, the bourgeoisie,
and initiate a revolution. Realizing the capitalism and private
ownership caused the severe inequality between classes, a
dictatorship of the proletariat would take control, begin to
abolish private ownership, and eventually transition into a
system of communism. Marx’s ideal form of communism
envisioned no private property, no money or wealth, and a
system of common ownership. In such a system, each individual
would receive what they needed and no more.
In their ideal forms, neither capitalism nor Marxist communism
will likely work. While communism as an ideal type has never
been attempted on a large scale
Other Economic Systems
Command economies represent those systems in which the state
controls all aspects of an economy from prices to what goods
will be produced in what numbers. Command economies have

existed and persisted in those countries that have attempted to
establish communist states: the former Soviet Union and today’s
North Korea. China is an interesting mix; in the middle part of
the twentieth century, they instituted a command economy but
have since introduced elements of capitalism and private
ownership. Despite these modest free market reforms, the
Chinese government remains heavily involved in their own
economy from owning hundreds of thousands of corporations
and businesses to artificially setting prices low or subsidizing
goods to prop up their export market. Proponents of command
economies see this method as a way to ensure development and
industrialization and to avoid the excesses of capitalism and the
free market. However, there are also significant problems with a
command economy, including the opportunity for corruption in
the higher ranks of government and perhaps even the inability
of the government to make sound economic decisions that
reflect the needs and desires of the citizenry.
Socialism represents a middle ground between social
democracy, discussed in the next paragraph, which retains a
capitalist-style market, and a command economy. Socialism
shares many of the same ideological concerns as does
communism, but as Shively notes, the split between the two
stems largely from the beginnings of the Russian Revolution
itself. “Marx and Engels had never fully settled whether they
thought the working class should take control of the state
peacefully through electoral victory or violently through
revolution.”6 Thus, the revolutionary elements, including
Lenin’s Bolsheviks, established communist parties while the
other branch of socialism continued to call themselves socialist
or even democratic socialists.7 Socialists today advocate for a
larger government role in the economy to include government or
public ownership of key parts of the market. Added to this is a
significant welfare infrastructure to provide services to citizens,
including a basic wage, education, health care, and housing.
Finally, social democracy tries to “balance capitalist markets
and private property with a greater degree of state intervention

in the economy… in an effort to ameliorate the economic
inequalities that the free market tends to create.”8 Social
democratic systems are in wide use across Europe, where a
greater degree of cooperation between the state and business is
found. In fact, Germany practices something
called corporatism, which is a formal system of cooperation
between business and government. Social democratic systems
supplement a capitalist-style market with a broader
redistribution of wealth; taxes are higher, especially for the
wealthy, but are used to more widely provide social services.
The idea behind such a system is to allow for the working of a
free market but to balance out the excesses and inequality of the
free market with a social safety net provided by the
government.CASE STUDY Germany
Although not directly written into Germany’s constitution,
businesses in Germany work closely with the federal
government in determining economic policy. Though very
broad, the term corporatism refers to formal and informal
mechanisms through which businesses and business groups work
and coordinate economic policy with a government. In
Germany’s case, corporatist practice stems back to the 1960s
and 1970s when the new Federal Republic (the democratic
portion of Germany that was formed post–World War II) was
experiencing its first recession. The governing coalition of the
Christian Democrats and Social Democrats initiated a series of
“concerted action” meetings that “brought business,
government, and labor together… to reach national agreements
about wage and price increases, broad macroeconomic and
social policy issues,” and a law on balanced growth.9 Although
business involvement in government policy occurs far more
informally now, Germany’s main banks have helped in
coordinating economic policy.
What about the role of labor in these arrangements? In some
ways, labor has a far more significant, formal role in business
policies. Codetermination “gives unions half the seats on the
boards of directors of all companies with more than two

thousand employees.”10 Representation in the boardroom,
however, does not automatically mean a seat at the table. Kuo
argues that the development of corporatist arrangements in
Germany has also been due to concerted repression of labor
organizations by businesses.11 Further, as Hauss and Haussman
note, other groups involved in economics issues such as
women’s rights, immigrant workers, and the poor are often left
out entirely.12 Finally, an argument can also be made that such
coordination is an undemocratic feature of Germany’s
government. Although government is involved in the decision-
making process, businesses, after all, are self-interested actors
that do not take all sentiments into account.
The Great Recession, which the United States and the world
experienced beginning in 2008, also hit Germany hard with the
German government forced into bailing out one of Germany’s
smaller banks. Not only did this hurt the corporatist
arrangement directly but it also exposed a certain element of
corruption that had emerged as a result of these practices.13
While corporatist practices may be on the wane in Germany,
they are still used widely in Scandinavian countries even
despite changing economic conditions.Critical Thinking
Questions
1. Why might cooperation between business and labor be
helpful in economic terms?
2. Who do you believe would have more advantages in
negotiating in a corporatist system, business, labor, or
government?
3. Given this arrangement in Germany, where would the German
economy fall on the continuum seen in Figure 10.1?Government
Involvement and Economic Performance
Some of the means through which governments can influence
the economy were mentioned at the beginning of this chapter:
taxes, spending, tariffs, regulations. Broadly, however, there are
two main types of government policy that affect the economy:
fiscal policy and monetary policy. The directions in which
states decide to go with both fiscal and monetary policy can

significantly affect the performance of an economy.
Fiscal Policy
Fiscal policy includes the mix of taxing and spending that a
state chooses to undertake. Taxes, although often seen and
portrayed as an all-around negative, can be used to both
encourage and discourage economic behavior. To understand
this, we can consider some different categories of taxes. The
types of taxes you are probably most familiar with include the
income tax and sales tax. In the United States, the federal
income tax is a progressive tax, meaning that the more money
you make, the more money you are supposed to pay. Sales taxes
are used by states and localities to generate revenue for their
actions and are often placed on goods and services. While a
sales tax on a haircut probably isn’t going to discourage you
from getting that haircut, there are other types of taxes that are
imposed for the specific reason of discouraging people from
using them. Sin taxes are taxes placed on “sinful” behavior like
alcohol, tobacco and cigarettes, marijuana, or even gambling.
When used as such, the higher tax is meant to discourage people
from partaking in the activity.
Taxes levied on businesses have a direct effect on an economy.
Particularly in a globalized world, businesses will seek out
locations in which they have to pay the least amount of taxes.
Governments would like to, then, create a mix of taxes that is
not just low but attractive to businesses and corporations to
bring them to their state or locality. For instance, if state A
offers a business tax of 20 percent and state B offers a tax of 35
percent, all else being equal, businesses are likely to choose
state A. With more businesses in state A come more jobs; more
economic investment; and, ideally, more taxes. This concept is
often called trickle-down economics, referring to the idea that
although businesses and richer people will benefit from lower
taxes, the economic benefit may trickle down to other people in
the community and the economy as a whole. Critics of the idea,
however, claim that businesses and those with higher incomes

will not reinvest the money they save via tax cuts and will
instead keep the economic benefits for themselves. Economic
research on whether tax cuts to businesses and others with a
higher income is mixed; on the whole, however, it has not been
supportive of the idea that tax cuts to the rich will filter down
to others.
Tax expenditures, or tax breaks, are another way in which the
government can influence economic behavior. Tax expenditures
include money that is foregone by the government because
people are allowed to claim a reduction in their overall tax bill.
In the United States, one major example is the home mortgage
interest deduction. Homeowners are allowed to deduct the
interest they pay on their home mortgage from the income taxes
that they owe each year; while the government loses out on that
money, they encourage people to buy homes, which can provide
other benefits to the economy. Tax expenditures can be used to
stimulate investment in certain areas of the economy by
encouraging individuals and businesses to partake in certain
activities so that they can deduct from their overall taxes.
Governments can also use tax penalties to encourage particular
behaviors. In the United States, one recent prominent example
is a tax that is enforced on people who do not have health
insurance in a given year. The 2010 Patient Protection and
Affordable Care Act imposed a requirement on individuals to
have health insurance. One of the rationales behind requiring
people to do so is because of the basic concept of insurance
itself. People buy insurance in general in case certain scenarios
happen like car accidents, home damage, or problems with one’s
health. If those bad things do not happen, the money paid into
the insurance pool is lost, but if you run into one of those
problems, the insurance policy will pay for damages or costs.
Insurance companies, therefore, will often charge those at
higher risk more money and those at lower risk less money. In
the case of health insurance, health insurance for everyone will
be more expensive if only those who are at high risk of having
medical problems join the insurance pool; if, on the other hand,

all people are required to have insurance regardless of their
health situation, the costs for everyone will go down. While
there were a number of other reasons for enacting the
Affordable Care Act, this was the general philosophy behind the
individual mandate. In order to enforce this requirement, the
law requires people to pay a tax penalty if they do not have
insurance.
Many people complain about taxes in general; they don’t like
paying them, they think they can do better if they keep the
money themselves, or they don’t like what the government is
doing with the money that it takes in. Others believe that the
imposition of taxes or the usage of tax expenditures on certain
activities is in essence the government choosing who wins and
who loses in economy activity. Governments take in nearly all
of their revenue via taxes with that revenue used on things many
people cannot imagine going without using, including basic
infrastructure like roads, bridges, and ports; schools; military
and police protection; and other public goods from which no
one can be excluded.
Monetary Policy
Where fiscal policy determines a country’s taxing and spending
policies, monetary policy determines how much money is
actually available in a country. Restricting or enlarging the
money supply in an economy is done to control and affect
economic performance in terms of inflation, interest rates, and
unemployment. Inflation refers to a situation in which prices in
general go up, making currency worth less than it was
previously. It can happen for a number of reasons, but in
general, it happens “when consumers and governments have a
large amount of money to spend, relative to the supply of things
they want to buy.”14 Situations such as government deficit
spending, a shortage in significant goods, monopolies, and trade
restrictions can all cause inflation to increase. Although some
inflation in an economy is good, too much can cause severe

economic downturns and depressions. Thus, central banks, or
government organizations, which are in charge of setting and
determining monetary policy, endeavor to keep inflation low.
Monetary policy can involve several different tools. One way is
through the buying and selling of short-term government bonds.
When a government or central bank intervenes
to buy government bonds, they are putting money into the
economy; when they sell bonds, they are taking money out of
the economy. A second way is central banks can set benchmark
interest rates that can raise or lower the cost of borrowing
funds. When interest rates are low, borrowing money is cheaper
and can encourage more spending in the economy; when interest
rates are high, it can discourage borrowing and economic
activity. One way to think about this is in terms of one of the
most expensive purchases people tend to make: a house. When
interest rates are low, you will spend less money to get a
mortgage loan for the house, thereby encouraging people to go
out and buy houses. But when it costs more to get a mortgage,
when interest rates are higher, people are less inclined to go out
and make large purchases. Interest rates, then, have the ability
to encourage or discourage economic activity to help keep
inflation in check.
Another issue that is involved in monetary policy is
unemployment. Unemployment is not just a difficult policy
problem to tackle but it can be difficult to define. As of January
2019, the unemployment rate in the United States is 4 percent;
however, this unemployment rate includes only those who are
actively looking for jobs and do not have one. People not
included in this figure are those who have dropped out of the
job market for reasons including inability to find a job within a
specific time frame. It also does not include people not actively
looking for a job. Therefore, the percentage of people in the
United States without a job is usually some percentage points
higher than the official unemployment rate. A second related
issue is underemployment, or those who would like to be
employed full-time but are working only part-time. This has

been a growing problem for the United States in the wake of the
2008 Great Recession. Finally, some unemployment is to be
expected in any economy; therefore, an unemployment rate
below 5 to 5.2 percent is considered full employment by the US
Federal Reserve.
Governments must be concerned with the unemployment rate for
a number of reasons. One reason is that when there are high
numbers of unemployed, more government assistance, even if
temporary, will be required. This will increase the need for
governments to spend money on social welfare programs.
Secondly, high unemployment is simply inefficient in an
economy; “the economy would benefit if everyone who wanted
to work productively could do so.”15 A final reason is more
political: if people are unemployed and therefore unsatisfied
with the current economic situation, they are likely to take out
their frustration on those in political office, perhaps voting
them out. Research demonstrates that economic performance is
a significant predictor of incumbent success; when the economy
does well, incumbent parties tend to be reelected, whereas when
the economy is on a downswing, incumbent politicians and
parties are punished.
Where interest rates and the availability of money in an
economy can directly affect inflation, unemployment is a more
difficult problem to tackle. When interest rates go up and
economic activity declines, unemployment is likely to go up as
well. Central banks could decrease interest rates to assist in
countering unemployment, but then the risk is that the pace of
inflation will increase. Other government policies can be used
to combat unemployment as well including the provision of
government jobs. When government spending increases, the
number of government jobs usually increases as well. Other
policies can encourage job creation—such as lower taxes or the
use of tax breaks specifically designed to reward employers for
creating more jobs.
In all of these scenarios, central banks play key roles in making
decisions. Because of the political implications that these

decisions are likely to have, an important decision for states is
how independent a central bank should be. Central banks that
are more independent, or have more autonomy, can insulate
economic decisions from very real day-to-day political
considerations. However, one question that ultimately arises
from an independent central bank is how accountable they are in
general and especially to political leaders and the public. While
the ideal would be to have an independent central bank that
makes decisions based on economic situations and applicable
theory and experience, there is very real fear that central banks
will begin to operate without any sort of accountability. In a
democratic society, especially, this accountability to elected
officials and ultimately to the public is an important
consideration to keep in mind.
Take the US Federal Reserve as an example. The Fed, as it is
also known, consists of twelve regional Federal Reserve Banks,
each overseen by a governor. Collectively, the governors make
up the Federal Reserve Board, which is headed by the chair of
the Federal Reserve. The Fed chair is a position appointed by
the president and confirmed by the Senate with a five-year
renewable term. The five-year term makes it so that Fed chairs
go beyond a single four-year term of the president and therefore
insulates them to some degree from presidential politics. The
Fed is subject to oversight from Congress and gives annual
testimony and reports to Congress on American economic
performance. Central banks in other countries can have more or
less oversight and relationship to state governments.
Gross Domestic Product
Economies are generally talked about in terms of size, growth,
and stability; unemployment and inflation, discussed
previously, are simply two elements of an overall assessment of
a state’s economy. But how do we know when an economy is
growing? Or when it is contracting? The most commonly used
measure is a country’s economic strength is the gross domestic
product (GDP). GDP represents the sum total of all economic

activity in a state; the higher the GDP, the more economic
activity there is. However, GDP on its own can be somewhat
misleading; China’s GDP in 2017 was $12.01 trillion, while the
US GDP was $19.49 trillion. The GDP in the United States is
clearly higher, but think about the number of people involved in
economic activity in China versus the United States. That the
United States is doing that much better with far fewer people is
a more impressive feat. Therefore, in order to account for the
differing sizes of states in terms of populations, GDP is often
calculated in a per capita manner. To get to this calculation, a
country’s GDP is divided by its population, making China’s
GDP per capita $16,700 and $59,800 for the United States.16
True free market, capitalist economies have natural cycles that
are referred to as boom and bust. Over time, economies grow as
unemployment is low, and central banks keep inflation low.
With money plentiful and as interest rates grow, money to
invest is widely available. Sometimes, however, people do not
invest the money well, and “bubbles” begin to form. Bubbles
represent increased investment in certain segments of the
economy and perhaps not the best ones. For example, in the late
1990s, people overinvested in dot-coms: new Internet
companies that then could not produce any economic benefits or
profits. At a certain point, the bubble bursts and people begin to
pull back from investment. As money comes out of the market,
economic activity shrinks and inflation rises—and so does
unemployment. The bust cycle can turn into an economic
recession if there are three consecutive quarters of negative
economic growth and a depression if the GDP growth rate
becomes at least a negative 10 percent over a sustained period
of time. As the economy shrinks, panic and fear among
consumers and investors can inspire further withdrawals from
the market and banks, leading to an even more dangerous and
damaging depression. All of these factors were apparent in the
lead-up to the Great Depression. While recognizing that boom
and bust cycles are natural characteristics of free market
economies, monetary and fiscal policy is used to smooth out the

highs and the lows.
Inequality
Unfortunately, the benefits of a growing economy do not always
accrue equally. As was noted previously regarding critiques of
capitalism, the rich do tend to reap the most economic rewards
in a free market system. Thus, another way of measuring
economic success in an economy is examining how it affects
everyone—particularly in terms of economic inequality. High
economic inequality can have significant effects not just on the
economy but on people themselves: states with a high degree of
economic inequality “have greater infant mortality, higher rates
of obesity, and lower life expectancy.”17 Higher economic
inequality also means that governments will be expected to step
in more and perhaps spend more to assist those with a lower
socioeconomic status.
Economic inequality can be measured in a number of ways,
including percentage of people in a country below the poverty
line or the difference in percentage of income earned by the top
10 percent of wage earners and the bottom 10 percent of wage
earners. Measuring inequality via percentage under the poverty
line is difficult as the poverty line, or the income level that is
considered adequate, differs by country. Table 10.1 displays
some of these inequality measures for a selection of countries in
different regions around the world.
International Political Economy
As stated at the beginning of this chapter, the study of political
economy examines the relationship between politics and the
economy. The broader study of this can also be broken down
into two further subfields: international political economy and
comparative political economy. While related, the two are used
to examine two distinct questions. International political
economy examines the “two-way relationship between
international politics and international economics.”18 While we
have thus far discussed economies at the state level, the global
economy is also a relevant and important area of study, which is

what international political economy studies.
Dickins notes that the origins of international political economy
as a field came from “the failure of International Relations
scholars to engage with the international economy. International
political economy emerged as the international economy
developed apace in the 1960s.”19 Recall from Chapter 8 that
globalization represents the increased and increasing economic
ties between countries across the world. It is nearly impossible
today to totally isolate a country’s economy from that of the
rest of the world; in fact, it is almost necessary to produce the
goods that millions of people use around the world. For
example, the widely popular Apple iPhone utilizes precious
metals, including gold; silver; palladium; platinum; aluminum;
copper; and rare earth metals like lanthanum, terbium, and
gadolinium.20 While most of these can be found in the United
States, the rarer earth metals are not. Therefore, in order to
create one of the products Americans use the most, trade—in
some form or another—is required.
Comparative Advantage
The theory of comparative advantage supports the idea that
trade can be mutually beneficial to both partners that engage in
it. If it is cheaper to produce product A in country X and
cheaper to produce product B in country Y, both countries are
better off trading with one another even if country X could
produce both products A and B. Comparative advantage works
well in the scope of free market policies as well; if there is
limited to no government involvement in the economy or in the
setting up of trade barriers, then trade across countries can
occur unimpeded, and the overall economy will benefit.
However, in the domestic sphere, increased international trade
of this sort can have serious impacts. For example, if China can
produce steel in a greater amount and more cheaply than in the
United States, there is no economic incentive to actually make
steel in the United States. This would cause steel mills to go out
of business and steel workers to lose their job. In some cases,

China actually subsidizes the cost of certain products, thereby
making them cheaper and therefore more competitive on a
global market. Further, imagine a scenario where relations
between China and the United States deteriorate to such a
degree that China refuses to let the United States buy any of
their steel. The US economy would be significantly hurt, not to
mention the potential national security implications of not being
able to build any military infrastructure that uses steel.
Free and Fair Trade
It is for these reasons that economic protectionists support
limits on free trade through the imposition of trade barriers such
as import taxes and tariffs. Tariffs are a type of tax that are
imposed on certain goods coming from other countries that
essentially raise the prices of those goods. This can make it
more cost effective for the good to be produced domestically,
thereby protecting the domestic economy and domestic jobs.
However, the levying of tariffs and other import taxes can lead
to retribution by the countries the tariffs are aimed at with those
countries often imposing their own set of taxes on imports from
a country. When taken to extremes, the result is a trade war that
progressively increases trade barriers, eventually harming the
economies of both countries involved. It is for these reasons
that the concept of “fair trade” is often invoked. Where free
trade is the lowering of trade barriers and little government
involvement in trade and the economy, fair trade is an approach
that “advocates retaliation against states that are perceived as
‘cheating’ on free trade by using various barriers to trade to
stimulate their economies.”21
The politics involved in these sorts of international trade
disputes are quite easily seen in the politics of the North
American Free Trade Agreement (NAFTA). NAFTA originated
in the early 1990s as a trade agreement among Mexico, the
United States, and Canada that would limit trade barriers among
the three countries and create a free trade zone across North
America. While Republicans, who have traditionally supported

free trade and limited government involvement in the economy,
were supportive of the plan, Democrats, who feared for the jobs
that might be lost, were not. The situation changed as Bill
Clinton became president in 1993 and broke with Democratic
orthodoxy and supported the joining of NAFTA. In the short
term, some jobs were indeed lost. Many manufacturing
companies left the United States and relocated to Mexico where
labor was cheaper; with labor at a lower cost, the goods
produced would cost less. Since there were no tariffs on goods
coming from Mexico into the United States, goods could be
produced more cheaply in Mexico and sold at a lower price in
the United States. The overall effect on the US economy was
positive even though some manufacturing and other sectors lost
jobs and capacity.
Debates over the value of NAFTA and other free trade
agreements continue. In the 2010s, the United States engaged in
negotiations with several other Pacific countries to create the
Trans-Pacific Partnership (TPP), a free trade agreement that
would lower trade barriers among the countries that signed on
to the deal. Like Democrat Bill Clinton, then president Barack
Obama also supported the TPP; however, it became an issue in
the 2016 presidential election when then candidate Donald
Trump came out against TPP and even against NAFTA. Then
candidate and now president Donald Trump’s arguments
stemmed very much from these criticisms of fair trade: that free
trade agreements of this sort took jobs away from American
industry and that other countries were “cheating” the system
and creating conditions that favored their own goods and
products at the expense of the United States. When he became
president, Trump pulled the United States out of the TPP and
renegotiated NAFTA with Mexico and Canada. The president
has repeatedly used arguments including unfair trade and trade
imbalances to bolster protectionist policies such as the
imposition of tariffs on steel and aluminum imports in March
2018.

Exchange Rates
One additional element that can affect the international
economy is that of exchange rates. Exchange rates represent the
price of one currency in terms of another. In other words, how
much, in US dollars, does one euro cost? Exchange rates
typically float and change based on currency markets; when the
US dollar is expensive to buy, the currency can be said to be
strong, and when it is inexpensive, it is weak. Exchange rates
can affect international trade because how strong or weak a
currency is can affect how expensive products are to buy from a
given country. While the United States and many Western
countries allow their currency and exchange rates to be
governed by the market, some states, such as China, subsidize
and control their currency so that they can keep it artificially
low. This makes products cheaper to buy and can increase their
exports relative to their imports. This can become a diplomatic
sticking point between countries and can contribute to the idea
that countries are not trading fairly.Comparative Political
Economy
Comparative political economy utilizes many of the methods of
comparative methods to examine the connection between a
country’s policies and its economy. “Contributions to this field
of inquiry have emphasized institutional differences between
countries and the way that such differences have refracted
political and economic responses to common economic shocks
or opportunities.”22 For example, Pontusson, Rueda, and Way
examine the effects of differing institutions on wage
distribution, finding that “unionization, centralization of wage
bargaining and public sector employment primarily affect the
distribution of wages by boosting the relative position of
unskilled workers.”23 They add that the effect of partisanship
in a government is contingent on how centralized wage
bargaining is. Iversen and Soskice examine the role of unions
and political coalitions in determining why some states have
high exchange rates along with a large number of exports.24
Finally, Urbatsch suggests that the distribution of occupations

and jobs affects public opinion on trade policy, which can
ultimately affect a state’s trading policies themselves.25
The focus on the role of states is important. Schmidt identifies
four ways in which the structure of a state can impact an
economy. First, the state determines what kind of economy a
state is going to have, whether it is more liberal and free market
in its posture or whether there will be more government
involvement. Second, states can affect the “substantive content
of policies,” not just determining the type of economy but
specific fiscal and monetary policies that will affect the
economy directly.26 Third, “as a polity, the state constitutes the
political institutions that frame the interactions between
political and economic actors.”27 In other words, the state
forms the context in which political and economic actors
interact. And finally, institutional change and the mechanisms
through which that occurs can have direct impacts on the
economy.
Women and the Economy
Women also play a key role in studies of political economy and
economic development. Women comprise more than half of the
people globally who live in impoverished situations.28 And
although studies have shown that globalization generally
enhances the status of women, “feminist scholars argue that the
international political economy has particular effects on women,
because women often are assigned specific (disadvantageous)
economic roles around the world.”29 These roles are either left
behind or forgotten about as economic development continues.
In some countries, women are left out of economic improvement
altogether. For example, even though free market theorists
argue that a continuously growing economy will benefit all,
many women who are homemakers, stay-at-home caretakers (for
children or other dependent individuals), or who pursue other
“domestic” labors are left out of the wage market altogether. In
some economies, women may be disadvantaged from the start:
they may be denied educational opportunities that would allow

them to advance economically, or they are not allowed to enter
the market at all. These conditions combine to keep women
systematically disenfranchised from the market, dependent (on
men, governments, or families), or severely impoverished.
Inequality and poverty often hit women and children the
hardest.30 Inequality can even strike in highly developed
economies, including the United States. Depending on
profession, women on average in the United States earn 78 to 82
percent of what men earn. Around the world, however, that
percentage is much larger, with the World Economic Forum
finding that globally women earn only 68 percent of what men
earn.
Despite these disadvantages, women can be very important in
stimulating economic development. To demonstrate this on a
small scale, we can look at the effect of microlending
programs. Microlending is a term referring to programs that
provide small loans to people in impoverished situations—in
many cases, women—that allow them to buy livestock such as
goats or chickens or that allow them to start a small business. If
a woman buys a goat, they not only have a source of milk and
cheese with which to feed their family but can sell the excess
milk and cheese in the local area and therefore establish an
income stream, which can be used to assist with the educational
goals of their children or improve the living situations of their
families. As women are able to economically develop, this has
strong benefits for the family and in particular children in a
family.31 Because of the success of microlending programs in
stimulating economic development, Muhammad Yunus, who
pioneered the theories and practices of microlending, won the
Nobel Peace Prize in 2006.
Because of the benefits that can accrue in economic
development through women, many development agencies
purposefully focus on women in development efforts. Beath,
Christia, and Enikolopov report on a field experiment in
Afghanistan where, in some villages, women were required to
participate in economic development programs.32 Although

they found that such programs did not necessarily transform
entrenched views on the status of women, the programs did
enhance female economic mobility and income generation.
Studying small communities in Ghana, Opare finds that the lack
of political opportunity for women in community affairs
severely restricts their ability to develop socioeconomically.33
Nongovernmental organizations have also been key in
promoting women’s economic development, with Chowdhury
showing the importance of nongovernmental organizations in
very rural and remote areas of Bangladesh and their ability to
promote the economic outcomes of women.34
Democracy and the Economy
The relationship between economic and political opportunity
highlighted by studies of women’s opportunity discussed
previously are a key element in discussions of the relationship
between free market, liberal economic policies and democracy.
Some scholars propose that democracy can hamper economic
development because of the need to appease multiple audiences.
If the goal of legislators is to be reelected, then they must listen
to and satisfy the concerns of interest groups and voters; if
those groups and individuals agitate for more resources at the
cost of spending on other activities to promote economic
development or to the point where taxes must be raised, then
economic growth may stall out. In more authoritarian-type
governments, like China, leaders do not have to listen to public
opinion when making significant policy decisions, freeing them
from reelection concerns and allowing them to make decisions
that can foster economic growth.
However, there are just as good theoretical reasons to believe
that democracy can encourage economic growth. One,
authoritarian leaders are not guaranteed to be public minded—in
other words, the decisions they make do not automatically have
to benefit the citizenry. In fact, one of the biggest problems of
authoritarian regimes, often, is the amount of corruption, which
wastes economic potential. Additionally, the threat of being

thrown out of office is nonexistent, meaning that authoritarian
leaders do not have to worry about public opinion at all, so if
they make bad economic decisions, there is no way to either
take the leader out of office or make them conform to public
desires through the voting mechanism. Two, democracies can
promote economic development through their protections for
private property and property rights, which can affect the
incentives workers have to take part in the economy. If
individuals know that the fruits of their labor, their property,
will be protected and will be theirs, there is more incentive for
them to work harder, whereas in authoritarian style states, there
is no guarantee that what workers earn will be theirs to keep.
There is one further argument about the relationship between
democracy and economic development, and that is that
economic development can cause a growth in democracy. The
arguments for this proceed along many of the same lines as
those noted previously. When an economy is growing,
developing, and producing, workers will want to keep the
benefits they receive and thus their own property. This can
encourage more authoritarian states to begin to institute
protections for private property and the legislative and judicial
systems needed to enforce them. Further, as a state establishes
more global economic ties, its people are exposed to new ideas
and attitudes, perhaps stoking their desire for a more democratic
type government. As the people begin to advance economically
and reap the benefits that that entails, including education, they
will be in a better place to demand democratic reforms. This
hypothesis has been put to the test in states like China, where
theorists hoped to see democratic reforms as the country
increased its global ties and economic development (discussed
further in the next section). Despite solid economic growth,
China has continued to lag behind in terms of democracy.
Chapter Summary
· There is a complicated relationship between politics and the
economy with politics influencing economic growth and trends

and the economy influencing political developments.
· States can choose which economic system to utilize through
the types of policies and regulations that they enact. These can
include free market systems like capitalism, social democracy,
socialism, and command economies.
· Governments can utilize fiscal policy (taxing and spending)
and monetary policy (affecting the supply of money in an
economic system) to influence an economy. Economies can be
measured in terms of growth of GDP or even assessed in terms
of how much inequality is produced.
· International political economy examines the interaction of
international politics on the global economy while comparative
political economy focuses on how states can and do affect
economics.
KEY TERMS
· capitalism: An economic system in which there is a free
market wherein supply and demand regulates the availability
and price of goods and labor
· command economies: Systems in which the state controls all
aspects of an economy
· comparative advantage: Theory that proposes the idea that
trade can be beneficial to all states involved
· comparative political economy: A field of study using the
methods of comparative politics to examine the relationship
between politics and economics across a range of states
· corporatism: A formal system of cooperation between business
and government
· economy: A system of exchange of goods
· exchange rates: The price of one currency in terms of another
· fiscal policy: The mix of taxing and spending policies that a
state enacts
· gross domestic product (GDP): The sum of all economic
activity in a state
· inflation: The general increase in prices, causing money to be
worth less than it previously was
· international political economy: Field of study examining

international politics and its relationship with the international
economy
· market failures: Occurs when an economic system fails to
produce or distribute needed goods and services
· monetary policy: Determines how much money is available in
an economic system
· political economy: A field of study examining the connections
between economies and politics
· progressive tax: The more you make, the more you pay
· resource curse: Countries that have vast mineral resources and
often misdirect the benefits toward ruling families and
corruption
· sin taxes: Taxes placed on goods and services to discourage
people from buying them
· social democracy: Economic system that utilizes government
intervention to balance out the excesses of a free market system
· socialism: Economic system that envisions a greater role for
the state in controlling the negative aspects of capitalism and
providing significant welfare benefits
· tariffs: Taxes on imported goods
· tax expenditures: Taxes foregone by a government because
people are allowed to claim a reduction in their overall tax bill
Discussion Questions
1. Through what methods and policies can politics affect
economies?
2. Compare and contrast capitalism, social democracy, and
command economy.
3. What is the best method for measuring economic inequality
in a country?
4. What is the difference between fiscal and monetary policy?
5. How much accountability should central banks have to their
governments?
For Further Reading
Jaeggi, Rahel. “What (if Anything) Is Wrong with Capitalism?
Dysfunctionality, Exploitation, and Alienation: Three
Approaches to the Critique of Capitalism.” The Southern

Journal of Philosophy 54, Spindel Supplement (2016): 44–65.
Schmidt, Vivien A. “Putting the Political Back into Political
Economy by Bringing the State Back in Yet Again.” World
Politics 61, no. 3 (2009): 516–546.
World Bank: https://www.worldbank.org
Notes
1. Rahel Jaeggi, “What (if Anything) Is Wrong with Capitalism?
Dysfunctionality, Exploitation, and Alienation: Three
Approaches to the Critique of Capitalism,” The Southern
Journal of Philosophy 54, Spindel Supplement (2016): 46.
2. Gustav Cohn, Joseph Adna Hill, and Edmund J. James,
“Supplement: A History of Political Economy,” The Annals of
the American Academy of Political and Social Sciences 4,
supplement 6 (1894): 11.
3. Jaeggi, “What (if Anything) Is Wrong with Capitalism?”
4. Ibid., 60.
5. Ibid., 53.
6. W. Phillips Shively, Power and Choice: An Introduction to
Political Science, 14th ed. (New York: McGraw-Hill, 2013),
37–38.
7. Ibid.
8. David J. Samuels, Comparative Politics (Boston: Pearson,
2013), 299–300.
9. Charles Hauss and Melissa Haussman, Comparative Politics:
Domestic Responses to Global Challenges, 8th ed. (Boston:
Wadsworth, 2013), 165.
10. Ibid.
11. Alexander G. Kuo, “Explaining Historical Employer
Coordination: Evidence from Germany,” Comparative
Politics 48, no. 1 (2015): 87–106.
12. Hauss and Haussman, Comparative Politics
13. Wolfgang Munchau, “Two Nails in the Coffin of German
Corporatism,” Financial Times, Feb. 17,
2008, https://www.ft.com/content/cafc5320-dd77-11dc-ad7e-
0000779fd2ac.
14. Shively, Power and Choice, 105.

15. Ibid., 106
16. CIA World Factbook, “China,” March 1,
2019, https://www.cia.gov/library/publications/the-world-
factbook/geos/ch.html; CIA World Factbook, “United States of
America,” March 1,
2019, https://www.cia.gov/library/publications/the-world-
factbook/geos/us.html.
17. Ibid., 109.
18. Paul D’Anieri, International Politics: Power and Purpose in
Global Affairs (Belmont, CA: Wadsworth, 2010), 245.
19. Amanda Dickins, “The Evolution of International Political
Economy,” International Affairs 82, no. 3 (2006): 479.
20. Bianca Nogrady, “Your Old Phone Is Full of Untapped
Precious Metals,” BBC, Oct. 18,
2016, www.bbc.com/future/story/20161017-your-old-phone-is-
full-of-precious-metals.
21. D’Anieri, International Politics, 251.
22. Lucio Baccaro and Jonas Pontusson, “Rethinking
Comparative Political Economy: The Growth Model
Perspective,” Politics and Society 44, no. 2 (2016): 176.
23. Jonas Pontusson, David Rueda, and Christopher R. Way,
“Comparative Political Economy of Wage Distribution: The
Role of Partisanship and Labour Market Institutions,” British
Journal of Political Science 32 (2002): 281.
24. Torben Iversen and David Soskice, “Real Exchange Rates
and Competitiveness: The Political Economy of Skill
Formation, Wage Compression, and Electoral
Systems,” American Political Science Review 104, no. 3 (2010):
601–623.
25. R. Urbatsch, “Industries, Occupations, and Trade Policy
Preferences,” Political Behavior 35, no. 3 (2013): 605–620.
26. Vivien A. Schmidt, “Putting the Political Back into Political
Economy by Bringing the State Back in Yet Again,” World
Politics 61, no. 3 (2009): 517.
27. Ibid.

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