MNC

(Two types of integration)

• actor making investment/production decisions according to market logic
•  Horizontal integration: same products produced in many locations
•  Vertical: production process spread across borders; different stages in supply chain in different countries, but within single firm

FDI

(and different than other investment flows because..)

flow of direct investment as firm invests in plant/factory in other country

• Different because it is less colatile since it is investing in something physical

• econ activity out of market under single corporate structure
• Locational advantage: natural resources, large national market access, production efficiency (labor-intensive manufacturing stage in one place and high-skill capital-intensive in another)
• Avoids market imperfections by internalizing inputs and supply chain 

• gain savings from abroad to finance development, tech/managerial expertise, access to global markets (Malaysia Motorola)

• ·      lost control over resource allocation (AIC corporation decides how resources distributed in your country and corp. is accountable to shareholders); profits often repatriated back home (no reinvestment in host); can overcharge foreign affiliates for inputs; can drive local firms out of business; not necessarily share technology

MNC versus host countries

game?

over what?

• Limit FDI in strategic/sensitive sectors
• Nationalization/expropriation: “nuclear option” --> lost incentive to invest
• Limits repatriation (must invest some profits into host economy)
• Performance requir.: MNCs must buy local inputs; do R&D in host; no borrowing from local capital markets (just steals capital away)
• Export-processing zones: FDI welcome; duty-free inputs but products must be exported to prevent selling in country (local industries don’t have to compete)

What does outcome of MNC/Host country battle of sexes depend on?

in what cases does each side win?

• Power resources, bargaining power, BATNA
• Host country win: when natural resources/large market can't be easily found elsewhere
• MNC win: when capital/technology can't be easily gotten elsewhere --> host country loses and even may have to compete to attract FDI by giving tax breaks for low-skilled manufacturing

Flaw in battle of sexes game of MNC/Host country

Oatley: what kind of issue has FDI become?  ___ is being pitted against ____ to define international investment rules?

• Assumption that MNCs and host countries are only players and that there are no overarching international rules on investment
• Oatley notes that treatment of FDI has become an inter-state issue --> capital-exporting countries pitted against capital-importing countries to define international investment rules

customary law rule

relates to what discussion within international investment law?

Other examples?

• no expropriation w/out compensation
• host countries can’t nationalize foreign investments w/out ‘fair and adequate’ compensation--> but very vague term
• Relates to struggle to define rules
• ITO 1947 weak protections in effort to establish more rules (US objects wanting term that countries couldn't regulate MNCs)
• G77 nonbinding challenge; weak TRIMS WTO agreement

BITS 

when started? when took off? some include?

how are they different from customary law rules?

who are the winners?

• Bilateral investment treaties: began in 50s, took off since 90s, some like NAFTA include investment provisions
• Different: much more protective of investment: MFN, guarantees to FDI, investors can transfer profits, can't be forced to buy local (performance requ.), ISDS
• Battle of Sexes winners clearly MNCs and capital-exporting countries
• whereas customary law only says expropriation requires host countries to give investors ' fair compensation'

Why do LDCs sign treaties that hurt them?

Traditional answer?

___'s answer?

• Traditional: host's time inconsistent preferences - promises MNC a lot at first to initially attract investment, but later tempted to renege (e.g. expropriate), BUT this tendency scares off investors so signing BIT seen as signal of credible commitment in market; reassured investors
• Simmons: host countries more likely to sign BIT in desperate times - when capital scarce, competition is high, host country in recession

Investor-State Dispute Settlement (ISDS) 

Problem?

Example?

• private actors (investors) right to sue states for violation of rights (‘revolutionary’ according to Simmons)
• Asymmetrical right to sue since host state can't sue investor
• Investors can challenge expropriation / any action that reduces profits 
• Controversial argument that ISDS takes away from democratic countries: Argentina recession gov tried to cap rates that foreign corp. could charge people: company sued adn won but gov was trying to protect people from poverty

BITs bad for LDC host countries

•  Signing a BIT--> much more likely that host state will be sued
• Backlash against ISDS:countries increasingly lose ISDS and appeals rarely get overturned + appeals increasingly from democratic states seeking “policy space” to legislate for public good (even if investor profits are reduced) --> Argentina
• Also unclear if host countries who sign BITs get more investment

Exchange rate systems: definitions

1. exchange rate
2. foreign exchange markets
3. exchange-rate system

1. price of one currency in terms of another
2. markets in which world’s currencies are traded; banks/investment/hedge funds/etc. have immensely grown recently; much speculative

3.  

   set of rules governing how much national currencies can appreciate/depreciate in forex market; continuum from rigid to flexible

    

Fixed exchange rate systems

what might states do to influence/defend fixed rate?

• ·      govs established fixed price of currency in terms of some standard and defend rate in forex markets
•  states might influence/defend by: imposing capital controls to restrict supply, using monetary policy to raise interests rates (to have better rates and people would want to invest here)

Floating Exchange-Rate systems

where does it lie on the "continuum" of exchange rate systems?

• no limits on movement of ER; no gov effort to defend particular rate (determined by supply/demand in forex markets); let market determine 
• opposite extreme of fixed ER systems

Fixed but adjustable exchange rate system

where on continuum?

• govs set fixed exchange rate, but allow possibility of occasional adjustments (devaluation/revaluation) under specific conditions 
• intermediate system closer to fixed ER side

Managed float

where on continuum?

• govs intervene either individually/collectively to influence their currency’s value against other currencies in forex markets; but no specific fixed/target rate and generally no binding rules on when states intervene 
• intermediate system closer to floating ER side

All exchange rate systems reflect crucial trade-off between __ and ___

___ systems provide ___ at expense of ____

___ systems provide ___ at expense of _____

consideer ___ to understand why

• Exchange rate stability and national macroeconomic policy autonomy
• Fixed-rate systems: ER stability at expense of macroecon. policy autonomy
• Floating rate systems: macroeconomic policy autonomy at expense of ER stability
• Balance of payments accounting

Current account

four categories 

records of all current nonfinancial transactions between US residents and rest of world

1. Trade account: import/export of goods (manufactured + agriculture)
2. Services account: import/export of financial/transport./construct. services 
3. Income account: payments in/out from loans, investment, licensing fees, interests payments, profits
4. Unilateral transfers: foreign aid, remittances, etc.
   

Current account (4 types)

versus

capital account 

BoP

• Current: records of all current (nonfinancial) transactions between US residents and rest of the world (trade, services, income, unilateral)
• Capital: financial flows between US and rest of world; purchase of foreign assets (negative debit); sale of US assets to foreigners / capital inflow (positive credit)

   

• BoP: current account = capital account

BoP surplus

BoP deficit

mechanisms for BoP adjustment?

• BoP Surplus: current account surplus > capital account deficit
• BoP deficit: current account deficit > capital account surplus
• Restrict international economic policy (e.g. raise tariffs, quotas, impose capital controls)

•  

   Change domestic economic policy (fiscal, monetary policy)

  Intervene in international currency markets

   

Adjustment mechanisms for fixed exchange rate system

what might countries with BoP deficits do?

Burden is on ___ to act

need for ___ adjustment

• need for domestic adjustment: burden on state to fix problem: BoP imbalances put pressure on fixed rate so state must act to defend exchange rate in markets
• Countries w/ BoP deficits: can mean using up forex reserves and/or raising domestic interest rates to attract foreign capital, increase demand for domestic currency
• tradeoff (less macro policy autonom)--> impacts domestic econ.

adjustment mechanism for floating exchange rate system

what might countries with BoP deficits do?

how is it restored?

need for ___ adjustment

what does the tradeoff mean?

• BoP imbalances affects supply of / demand for currencies and thus exchange rates --> need for exchange rate adjustment
• Countries w/ BoP deficit: decline in demand for its currency: depreciates 
• New exchange rate improves terms of trade (Deficit country's exports cheaper, imports more expensive) and hence the current account deficit, restoring balance
• state retains autonomy to use macro policy to regulate domestic economy, but at cost of exchange rate fluctuations/volatility

·      Distributive issues (winners and losers): who pays costs of adjustment?

• Internationally: asymmetric pressures to adjust fall on countries with BoP deficits 
• Domestically: depends on exchange rate system to know where burdens of adjustment are improsed

•  

Political economy of gold standard

model

fixed relationship between __ and ____

Winners and losers?

commitment to standard viewed in market as __

• Countries fix currency to gold; central banks hold gold as international reserves
• Domestic currency convertability into gold at fixed price
• Fixed relationship between money supply and gold reserves
• Signal of credibility b/c govs prepared to use monetary/fiscal policy to defend rate
• Winners (those in global financial transactions like traders/financiers) + losers (Workers and domestically-oriented producers who'd prefer macro policy autonomy over stability)

• Intellectual climate (ideas): govs attached priority to currency + ER stability over other things (like domestic econ management) –  liberal orthodoxy
• Political setting (interests/institutions): govs are particularly attentive to interests of financiers/traders; shielded from demands of labor (limited right to vote, infant trade unions, labor/socialist parties in formative years)

• International-political: UK decline; unwilling to bear convertability burden (HST)
• Domestic-political: less gov insulation from domestic demands (workers): suffrage, rise of trade unionism + socialist/labor parties, demand for domes. pol. auton.
• International-economic: markets question gov commitments to currency defense; speculative attacks anticipate devaluation--> BoP crises (UK suspends1931; US in 33) 
• Ideational: Keynesian ideas (using gov fiscal/monetary policy to manage domestic demand); push for break w/ orthodoxy / gov in econ management (employment)

Society-centered approach

core assumption

importance of ___ to understand ____

• assumptions:monetary and ER choices have distributive consequences for domestic actors who mobilize to influence gov policy w/in institutions; interests and institutions with additional causal role for economic ideas
• domestic politics to understand state monetary preferences 

Factor analysis (based on ___)

preferences of each (2) in stability/autonomy tradeoff

• Capitalist class prefers ER stability over autonomy (intl transactions; gold standard->low inflation protects wealth)
• Working class care less about stability; prefer gov autonomy to pursue full employment, higher wages (even at risk of inflation/ER volatility)

Interwar break with orthodoxy tipped balance in favor of _____ over ____

2 key changes in interwar era

• in favor of autonomy over stability
• Interests (rising working class/unions) + institutions (universal suffrage) promoted rise of Euro/US left parties (prefer autonomy for employment; FDR left Gold '33)
• Economic ideas: Keynes (markets not self-regulating; prob. of long term unemploy): long-run solution: manage aggre. demand (fiscal policy: gov spend for demand) (monetary: money supply)

Keynesian ideology runs directly against ____

Keynesians don't want to sacrifice ____ in order to ___

Helps explain ___ and ____

• against liberal orthodoxy, including exchange rate
• fiscal/monetary policy tools to defend exchange rate
• Abandonment of gold standard (33) + shaping of Bretton Woods system (44)

3 models of Society-centered approach

Shared assumption

how they differ

• Electoral, partisan, sectoral
• Shared: monetary policy reflects political conflict among groups w/ preferences over montetary policy w/ distributive implications
• Different in specification of groups and their preferences

Electoral Model

key actors, example, weakness

• Voters w/ econ prefs + office-seeking politicians
• Politicians incentive to use fisc/mon policy to stimulate economy before elections
• Ex: after expansionary policy created BoP crisis, Nixon chose autonomy over defending gold ER 71
• Weakness: no specific predictions beyond general tendency for govs to abandon fixed rates pre-election

Partisan model

based on ___ which is tradeoff between __ and ___

what do actors (2) prefer?

• Phillips curve: gov use loose mon pol to reduce unemployment (risk inflation) OR tight to reduce inflation (risk unemployment)
• Right parties (business, financial, middle class) seek low inflation + tight monetary policy, fixed ER
• Left parties (working class) care less about inflation / ER, more about employment, more likelty to prefer expansionary policy; monetary policy autonomy + floating exchange rates
  

• Sectoral model
• ___ key groups/sectors according to ___
• sectors have different monetary policy interests along 2 dimensions
• weaknesses

• Frieden: 4: stability v. autonomy + strong v. weak ER currency
• Export-oriented: fixed ER (high stable), weak currency
• Import-competing: floating ER (low stable), weak currency
• Nontradable goods: floating ER (low stable), strong currency
• Financial services: cross-cutting/agnostic esp. on currency dim.
• May overstate EO attachment to stable rate + nontradable pref for strong currency; doesn't say which interests win gov support 

all explain interests, not outcomes

all leave out noneconomic interests

all assume that societal interests determine policy

no independent role for govs acting autonomously (insulated from societal pressures)

• From Keynesian to Monetarism
• Time inconsistency problem
• Delegation to independent central banks

From Keynesian to Monetarism

___ criticizes ___ + ___; says there's no ____

rational expectations

result (historical ex.)

Intellectual move toward monetarism, which says... (ex?)

• Friedmen anti Keynes mon pol + Phillips curve: no longterm inflation-unemploy. tradeoff; in long run, inflationary mon pol does not produce more employment
• If worker think inflation will b high: demand higher wages: wage-price spiral: inflation effect=more inflation(not full emplo)
• Stagflation 1970s: high unemploy w/ inflation (all evil, no ben.)
• Ex. Fed early 80s raise int rates; inflation under control

Time inconsistency problem

problem?

what needs to be made?

2 historical mechanisms?

• Monetarist policy problem: govs tempted to loosen mon pol pre election (electoral model)
• Short term incentive-->subopt. long run policy(boom/bust cycle)
• How to make credible commitment to keep tight mon pol over time / to resist voter pressure for stimulus
• Mechanisms: fixed ER (external constraint) + independent central bank (internal constraint)

Delegations to independent central banks

fully independent CB: how? prototype? factor?

Historically?

• strong mandate insulated from gov pressure can maintain price stability (low inflat) + ignore voter press. to print$$ (German prototype); institut. design
• Indep. rare; most accountable to gov as Keynesian instrument (Bank of England); subject to political press, boom/bust cycle

Delegation to independent central bank

US Fed Reserve, European central bank, diffusion to rest of world - Oatley (bottom line)

• Pres nom, Senate confirm, then indepen. but subj to new Cong leg.; dual mandate: theor. priority price stability, debate in prac
• Euro CB: "most indepen" single price-stab mandate; CBers 8 yr; all Eurozone CBs ind; mandate only changed by unanim. agree 
• Strong correl. w/ low inflation (but also w/ lower econ growth/higher unemploy
• Bottom line: monetary policymaking w/ CBers as key players

Bretton Woods system defined by ____ rates

trying to combine stability and autonomy; target exchange rates adjustable by agreement; key role of dollar, convertible to gold; widespread use as reserve currency

Capital controls

Keynes view

•  Keynes view:  liberalized capital would prompt speculative runs on currency, hence controls allowed
•  Keynes belief in mixed/managed economy; free, unfettered flow of capital would overwhelm system; govs should limit/regulate capital movement

Rainy day fund of BW system = ____

What kind of game does this cause?

• Stabilization fund: States w/ temporary BoP deficits could borrow, get through crises without devaluing
• for govs to borrow from when fell into short term deficit
• PD game of devaluing currency and borrowing from fund; everyone wants to do both so have to ensure member states don’t just do whatever; need for IMF

IMF 

___ and ___ prone to misues (___ game)

IMF polices both by ____ and ____

IMF exec board is ___, what kind of voting? who dominates?

• devaluation + use of stabilization fund prone to misuse (PD game)
• IMF to police both: collective agreement for devaluation; conditionality for stab loans
• Intergovernmental exec board
• Weighted voting (US most share, EU collectively most)
• Bureacracy based in DC; US dominates

Why was BW a short lived regime?

System started in ___ when ____

By _, system under pressue due to __ + US decision to __

cause of system going arry?

result?

• Starts 1959 when Euro/Japan achieve convertability
• By late 60s, dollar overhang (US in tradeoff decides mon pol autonomy over defending ER role of dollar; Nixon off gold in 71)
• 1945 US abundance of gold; late 60s US BoP deficits by putting $ in world post WW2 (East Asia)
• Currency float after 73; managed float in 80s

Managed float in 80s

downfall of BW system collapse? Leads AICs to try __?

2 examples

Oatley's take on successful example?

• post 1973 AICs let currencies float; increased volatility of ER is costly, esp for exporters; AICs experiment w/ ER cooperation
• Managed float story G% 80s: pressure from dollar strength rise (US exporters losing); Plaza meeting 85 to manage decline dollar value; cooperate to limite ER volatility; agree on coordinated market intervention; success (Louvre agreement)
• Oatley: may be last hurrah for managed float: capital movement hugely inceased; today not enough $ to move ER enough

• From managed float to fixed rates
• 73 volatility; EU incenive for fisc/mon pol to restore ER stability within Europe; 79 decide on fixed-but-adjustable ER system w/ Euro Monetary System

European Monetary system; exchange rate mechanism (?)

Year, definition, evolves into __, in shadow of ___ policies, external constraint lowers ___, but burden of adjustment on ___

essentially creates __; national gov role by doing?

• fixed-but-adjustable system w/in narrow + wide bands; ERM
• Evolves into anti-inflationary mechanism; emulate Germ Bundesbank's strict monet policies; External constraint lowers inflation; adjustment on weak-currency countries
• Imaginary currency: fixed real currencies w/in imaginary limits; national gov supposed to defend ER before fluctuates beyond (by buying more currency, driving up interest rates)

EMS is open to ___, just as ___ was

This vulnerability especially after ___

Frieden conclusion?

• Speculative attacks like BW system, esp. after liberalization of capital movements 1990 (92 forces UK pound out of ERM; bands widen)
• Frieden: fixed-but-adjustable ER systems no longer stable; must choose fixed or floating

Road to Maastricht (year?)

After EMS (frieden prob?), countries decide on __ and ___

initiative from? which suggests?

Report (year?) suggests __ style ECB and ___

3 stages

who opts out?

• Maastricht signed 1992
• EMS failed fixed-but-adjust: decide fixed rates + single currency
• French Delors 89: Bundesbank (germ)style ECB + conv. criteria
• stage 1: liberalization of capital movements
• Stage 2: creation of EMI (Euro Monet Instit.) to monitor econ performance for convergence
• Irrevocable locking of currency in new Euro by 1999 for qualified

1. Inflation must converge 
2. Interest rates must converge 
3. Stabilization of exchange rates, EMS membership within narrow bands for 2 years to show they could do it
4. Important fiscal policy one: National budget deficits of participants cannot exceed 3% of GDP, public-sector debt cannot exceed 60% of GDP (at least show progress)

ECSB

what does it do?

• European System of Central Bank
• All central national banks independen
• Makes monetary policy for Eurozone ms; national CBs remain; regulate national banking

Euro currency entered in circulation in ___

Introduced __ where?

External value of Euro ___ a lot since 1999

Internally, ECB focuses on ___ to ___, but ___

• 2002 introduced ER stability within Eurozone
• External value fluctuates
• Internal focus on inflation target, not external value, to establish market credibility as inflation fighter, but lowers interest rates during Euro recession

Stability and Growth Pact

Adopted in __ in response to ____

Its significance in Greece crisis?

• 1997 from German pressure: feared that member govs would meet converg. criteria to appl then relax financial rigor "limbo"
• All Eurozone members must keep respecting criteria; if exceeds for over 3 consec yrs, Council can impose fines (many pay lip service but flout ceiling starting 05)
• Clear rule of no EU bailouts if member states run into BoP difficulties --> Greece!

Design of the Euro and the ECB as game of ___

between?

who wins and why?

• Battle of Sexes between Germany (North) and South
• Germany wants independent CB w/ price stability mandate, strict rules on fiscal policy
• South wants less independent CB w/ dual mandate; flexible fiscal policy
• North had better BATNA: EMU takes place on German terms

 statutory objectives for monetary policy

two broad macroeconomic goals: “maximum employment and stable prices.”

In tradeoff Eurozone countries chose __ over ___

advantages and disadvantages

In context of overall trend of tradeoff?

• Stability over autonomy: advs of stable ER to facilitate interEuro trade; spurs FDI, lowers borrowing costs
• Disadvs: lost macroecon pol auton; can't use fisc/mon policy to manage domestic economy, nor devalue currency to boost exports to grow out of recession; can't run deficits to stimulate econ; can't lower interest rates since ECb controls
• Exception: trend to floating rates since80s; states dislike sacrifice domestic macro pol

Globalization distinguished not by __, but by ___ and ___

Keynes take?

Oatley: ___ is good/bad because?

• distinguished not by trade, but growing capital flows + shrinking capital controls
• Keynes: believed in capital controls and didn’t believe in too much capital flows; we’ve moved away from Keynes here
• Oatley: intl financial intergration GOOD since  free movement of capital across borders brings savers and borrowers together to engage in financai ltransactions with each other

   

Explosion of capital movement since ___ with rise of ___ from both __ and ___ borrowing

Capital market liberalization follows that growth in ____, a dual result of ___ and ___

Result of exponential increase in capital movements

• Capital movement explosion since 70s with rise of bank landing and portfolio investment from both private (industry) and gov (bond) borrowing
• Liberalization follows growth in 80s as result of technology (comptuing, telecoms) and policy (Reagan/Thatcher/EU internal market)

Pros: access to less expensive credit, promotes econ growth/development

Cons: capital market liberalization allows rapid inflows/outflows in response to volatile investor confidence; capital market investments prone to error; can lead to crisis

Open-Economy Trilemma

Gold standard example

Bretton woods example

Since BW we've lived in wolrd of ___ and __ with loss of ___ (exception?)

• Tradeoff betw. ER stability + macroecon pol auton extended to capital mobility (only 2 at once)
• Gold standard early 20th fixed ER + capital mobility but no macroecon pol auton (1930s working class resulting pressure on gov; 1933 FDR took off
• BW: govs wanted both fixed ER + macro policy auton but capital mobility ends up killing BW since it opens door to speculative attacks + dollar overhang
• World of capital mobility and monetary autonomy but lost fixed ER (exception within Eurozone)

• 1980s-90s: G7 managed float and EMS attempt to combine autonomy w/ ER stability, but both falter w/ arrival of capital market liberalization / specualtive attacks
• Developing economies struggle w/ trilemma
• By 2006 half of emerging economies moved to floating, but little sign there's movement away from fixed ER toward floating

Financial crisis; theme and variation (Oatley)

theme (3 parts)

• Theme: boom+bust cycle: overborrowing (LDC access intl capital borrow on short-term contracts), crisis (LDC govs/banks external shocks hard to pay debt; threat of loan default; lenders lost confidence; hot$ flees, spec attacks on fixed ER), adjustment (lost private lending; turn to IMF but conditions)
• Variations: nature of lending (banking v portfolio), borrowers (States v banks), shocks (intl/domestic, polticial/economic)

• 70s/80s huge increase in int commercial bank lending to LDCs
• To finance industr. develop; from priv bankes thru gov bonds
• Overbor: debt service capac: whats owed 2 creditors>export rev
• External shocks: late70s early 80s risen interest rates; can't pay loans; AIC recession->less market for exports; oil prices rise
• 1982 Mexico defaults n loans followed by others; asked to be forgiven

LA Debt Crisis: response

what game is it and why?

result of who wins?

• Commercial banks+IMF restructure loans (extend not forgive) in return for macroecon tighterning in fiscal (balance budget) + monetary (stop printing money causing inflation) policy; structural adjustment (trade lib, FDI, privatization, dereg)
• Battle of Sexes: no one wants LA to go bust but whose terms
• LA terms: forgive debt, but foreign creditors have BATNA
• Adjustment costs on debtor nations; 80s lost decade

4 tigers = ___

new model of ___ growth, end of ___, encourage ___

all adopt ____

• HK, Singapore, SK, Taiwan
• Export-oriented, end of capital controls, encourage FDI
• All adopt fixed rates pegged to dollar; ER stability to export market and import low inflation

• Hot$ (bonds/equities) flows into countries (high payoffs but more risks); lent to private banks (poorly regulated), which borrow short-term internationally (constant need for new loans) + end long-term domestically
• Thailand (domest. banking crisis from failing real estate prices); shock contagion, investor panic; speculat. attacks on currency; govs must devalue/float currencies; destroy foreign reserves

Response to Asian crisis

Lessons learned?

• IMF w/ conditions (Wash consensus): macroecon stabil, financial sector reform, close insolvent banks, recapitalize weak ones, restructure financial; Structur reform: trade lib, FDI, privat SOEs
• Need better banking system (regs), probs w/ hard peg to dollar, need capital controls for selectively letting in FDI (patient investment>hot$), China esp. wants huge forex reserves, tries to incentivize domest. savings for more domestic capital 

Did IMF "save the world"?

political responses

policy responses

keynesian thoughts? which author aligns?

• or jsut save Western investors at expense of LDCs?
• political responses: IMF riots Indonesia; regime change Thailand
• Policy: states seek insulation against future crisis: better banking regs, abandon fixed rates, more capital controls, large forex reserves and capital account surpluses
• Stiglitz (Keynesian): crisis shouldn't be time of austerity