Global politics from the view of the political-economy trilemma

Joshua Aizenman, Hiro Ito 07 August 2020

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Changing paradigm in global politics

In recent years, political landscape has been changing drastically in many countries. In the US, Donald Trump’s administration has pushed the ‘America-first’ agenda and prioritised the nation’s interest above all else since coming to power in 2017. Regardless of existing trade or other agreements, the administration has threatened to increase tariffs for trading partners or walk away from negotiations in case the conclusions are not favorable to the country. The administration’s anti-globalisation or isolationist stance has been observed in the ongoing COVID-19 pandemic as is evident from the country’s departure from the World’s Health Organization (WHO).

The UK has also prioritised its national interest and sovereignty by withdrawing from the EU. In many other countries, populist governments have arisen, both on the left and the right, touting similar slogans and advocating for de-globalisation to recover the economic and social benefits which they claim foreigners and immigrants have free ridden so far.

These new political forces are different from those of the recent past.

For example, after WWII, Europe pursued regional political and economic integration through democratic process, although it required each country to sacrifice its own national interest. Given this history, the rise of countries prioritising self-interest and advocating anti-globalisation means a paradigm shift in the postwar order and a challenge against long-lived European unification efforts.

Even in originally rather democratic countries, such rifts between political authorities and the people have led the former to suppress the latter through undemocratic or authoritarian measures. The example includes Hong Kong, Venezuela, and Turkey.

Rodrik’s political-economy trilemma

The current changes in political order can be comprehensively viewed through the lens of Dani Rodrik (2000)’s political-economy trilemma.

The word ‘trilemma’ may remind international economists of the open economy trilemma.

The open economy trilemma, which has become a central theorem in international finance ever since its introduction by Mundell (1960) and Fleming (1961), states that a country may simultaneously choose any two, but not all, of the three goals of monetary policy independence, exchange rate stability, and financial market openness to the full extent (Fig 1–a).1

Figure 1 Open economy trilemma and the political-economy trilemma

a) Open economy trilemma

b) Political-economy trilemma

Dani Rodrik applied this theory to political economy, asserting that among national sovereignty, democracy, and globalisation, only two of these policy goals or forms of governance can be simultaneously achieved to the full extent, but not all three.

For example, the member states of the EU each have democratic institutions of governance and are open to the globalised markets. However, each state cannot pursue its own national interest or assert its sovereignty (more fully than other member states do). In other words, the EU is a good example of a region marching toward global federalism (Fig. 1–b, bottom right corner of triangle).

Reclaiming its sovereignty in order to pursue its own national interest is exactly what the UK has been trying to accomplish by withdrawing from the EU. According to Rodrik’s political-economy trilemma, the UK could have gone further toward fuller sovereignty either by restricting democratic policymaking or by limiting openness to the global economy (i.e. going from the bottom right corner of the triangle in Fig. 1–b toward the side of ‘national sovereignty’). Considering that Boris Johnson’s administration is acting in strict accord with democratic process, sacrificing globalisation would be the only way the UK could withdraw from the EU. Greater pursuit of a nation’s national interest requires curtailing its access to international markets.

Other countries try to reap the benefit of globalisation while still fully embracing their own sovereign statehood. These countries align themselves with international rules and standards when making their own, but they do not necessarily follow a fully democratic process for policymaking. Their domestic standards and rules are not based on democratically determined policies, but rather on those of multinational corporations and international organisations, or on treaties and agreements concluded by administrative bodies (i.e. bureaucrats who were not necessarily democratically elected). Thomas Friedman (1999) calls this “the Golden Straitjacket” (Fig. 1–b; top of the triangle), which he describes as a state of affairs where “[a country’s] economy grows and its [democratic] politics shrinks.”

A country wearing the Golden Straitjacket can free itself by either pursuing a higher level of democracy or becoming less globalised.

It is also possible for a fully democratic nation to strengthen its national statehood and prioritise its national interest. However, such a country cannot reap the benefits of globalisation (Fig. 1–b; bottom left corner of the triangle). The Bretton Woods system, which existed from 1944 to 1971, allowed its member states to impose capital controls and barriers to international trade. From the perspective of the political-economy trilemma, this is a policy mix of full democracy and national sovereignty.

As these examples show, policy makers can simultaneously choose any two of the three policy goals of national sovereignty, democracy, and globalisation, but cannot achieve all three to the full extent.

Empirical validity of the political-economy trilemma

Now, a natural question arises: Can the theorem of the political-economy trilemma be empirically proven with actual data?

In our recent work (Aizenman and Ito 2020), we construct a set of the indexes, each of which measures the extent of attainment of the three political-economic factors: globalisation, national sovereignty, and democracy. The indexes are available for 139 countries between 1975 and 2016. Using these indexes, we test whether the weighted average of the three indexes is constant. If the indexes are to be found linearly correlated, it would mean that the three variables operate within a trilemma relationship, i.e. the trilemma is empirically valid.

The regression analysis shows that for industrialised countries, there is a linear negative association between globalisation and national sovereignty, while the democratisation index is statistically constant during the sample period. That means, for the industrial countries during 1975-2016, the political economy trilemma was mostly a dilemma between globalisation and national sovereignty. For developing countries, a weighted average of the three indexes adds up statistically to a constant with positive and significant weights, indicating they are in a trilemma relationship, as Rodrik claims.

Closely examining the development of the three indexes over the sample period reveals that for industrialised countries, while the level of democracy is stable and high, there is a combination of rising levels of globalisation and declining extent of national sovereignty from the 1980s through the 2000s, mainly reflecting the experience of European industrialised countries. Developing countries, in contrast, experienced convergence of declining sovereignty and rising globalisation and democratisation around the same period. Emerging market economies experienced rising globalisation and democratisation earlier than non-emerging market economies with all the three variables converging around the middle.

Figure 2 Development of political economy trilemma indexes – income groups

The possible impacts of the three policy goals on political and economic stability

Lastly, what kinds of impact could these three policy goals (national sovereignty, democracy, and globalisation) have on actual politics and economics? We perform regression analysis to examine how the three trilemma variables can affect political stability and economic stability.

Our results indicate that (a) more democratic industrialised countries tend to experience more political instability; and (b) developing countries tend to be able to stabilise their politics if they are more democratic. The lower the level of national sovereignty an industrialised country embraces, the more stable its political situation tends to be. Globalisation brings about both political and economic stability for both groups of countries.

Developed countries, particularly the US and the UK, are now asserting their national sovereignty, touting policies that prioritise their national interests and an anti-globalisation stance. If the regression analysis is correct, such policies could increase political instability and the probability of financial crisis. Furthermore, if a developing country takes an anti-democratic or an anti-globalisation stance, it could face more political or economic instability.

Let us see what will happen.

Editor's note: The main research on which this column is based (Aizenman and Ito 2020)  first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan

References

Aizenman, J and H Ito (2020), “The Political-Economy Trilemma”, Open Economies Review.

Aizenman, J, M D Chinn and H Ito (2013), “The ‘Impossible Trinity’ Hypothesis in an Era of Global Imbalances: Measurement and Testing”, Review of International Economics 21(3): 447–458.

Aizenman, J, M D Chinn and H Ito (2010), “The Emerging Global Financial Architecture: Tracing and Evaluating New Patterns of the Trilemma Configuration”, Journal of International Money and Finance 29 (2010): 615–641.

Mundell, R A (1963), “Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates”, Canadian Journal of Economic and Political Science 29 (4): 475–85.

Fleming, J M (1962), “Domestic financial policies under fixed and floating exchange rates.” IMF Staff Papers 9(3):369–379.

Friedman TL (1999), The Lexus and the olive tree: understanding globalization, Farrar, Straus and Giroux, New York

Obstfeld, M (2015), "Trilemmas and Tradeoffs: Living with Financial Globalization", Central Banking, Analysis, and Economic Policies Book Series. In: Claudio Raddatz & Diego Saravia & Jaume Ventura (ed.), Global Liquidity, Spillovers to Emerging Markets and Policy Responses, edition 1, volume 20, chapter 2, pages 013-078 Central Bank of Chile.

Obstfeld, M, J C Shambaugh and A M Taylor (2005), “The Trilemma in History: Tradeoffs among Exchange Rates, Monetary Policies, and Capital Mobility”, Review of Economics and Statistics 87 (August): 423–438.

Rodrik, D (2000), “How Far Will International Economic Integration Go?”, Journal of Economic Perspective 14(1 (Winter 2000)):177–186.

Shambaugh, J C (2004), “The Effects of Fixed Exchange Rates on Monetary Policy”, Quarterly Journal of Economics 119 (1): 301-52.

Endnotes

1 See more on the open economy trilemma in Aizenman et al. (2010, 2013), Obstfeld (2015), Obstfeld et al. (2005), and Shambaugh (2004).

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Topics:  Macroeconomic policy Politics and economics

Tags:  sovereignty, democracy, globalisation, index, Trilemma, Political Economy

Dockson Chair in Economics and International Relations, USC, and Research Associate, NBER

Professor of Economics, Portland State University

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