The inescapable trilemma of the world economy

Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches.  I have an "impossibility theorem" for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.

Here is what the theorem looks like in a picture:

To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs.

So what do we do?

One option is to go for global federalism, where we align the scope of (democratic) politics with the scope of global markets. Realistically, though, this is something that cannot be done at a global scale. It is pretty difficult to achieve even among a relatively like-minded and similar countries, as the experience of the EU demonstrates.

Another option is maintain the nation state, but to make it responsive only to the needs of the international economy. This would be a state that would pursue global economic integration at the expense of other domestic objectives. The nineteenth century gold standard provides a historical example of this kind of a state. The collapse of the Argentine convertibility experiment of the 1990s provides a contemporary illustration of its inherent incompatibility with democracy.

Finally, we can downgrade our ambitions with respect to how much international economic integration we can (or should) achieve. So we go for a limited version of globalization, which is what the post-war Bretton Woods regime was about (with its capital controls and limited trade liberalization). It has unfortunately become a victim of its own success. We have forgotten the compromise embedded in that system, and which was the source of its success.

So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man's land.   

Comments

[inthemachine]

One might argue that nation-state democracy is still the best way of determining whether people want more globalization, and if so, at what pace.

[Matt Eckel]

It strikes me that perhaps the most positive potential effect of globalization - eventually, over decades if not centuries - is the erosion of national sovereignty in favor of a more universalist global order. By eroding sovereignty, the more pernicious elements of international competition - war in particular - can be mitigated. I agree with your "trilemma," but see it as a potential long-term positive.

[Gabriel M.]

Matt, yes, that's one aspect, but what about fiscal competition? Would we like one world, with one 75% income tax rate, let's say?

[wjd123]

"Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches. I have an "impossibility theorem" for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full."--Dani Rodrick

Keep democracy, give up some national sovereignty to international governments that represent the values of the countries involved. See that that rights are expanded. (For example EU laws protect women in the work force against discrimination more fully than any to its member countries. If I'm a Spaniard living and working in England my EU membership allows me to vote in local elections there.) Give up some global economic integration where integration weakens rules and regulations governing business, the economic morality of countries. (It's more likely that democratic countries will enact international regulations for the benefit of all stakeholders in global commerce. It's also more likely that democratic and developed countries will have the resources and institutions to enforce the rules and regulations that they enact for themselves.)

Integrate in a way that enhances democracy and civil rights. What may be lost to economic growth can be offset by gains in protection under the law along with social stability. By using the lure of greater trade along with the right carrots and sticks real progress can be made in expanding civil rights globally.

Expanding democracy and international government are the best ways to see that global economic integration works for all of our interests instead of just corporate interests.

It's unrealistic to think that diverse systems can be intergrated under one international government. The best hope for making progress with the weakening of national soverinity is to replace its protections with better protections. The EU is a working model of just such an international government.

[hariknaidu]

Laissez faire capitalism is another name for what Clinton/Rubin imposed on the gobal market-just before the Asian crisis. It was followed by Russian meltdown...
Capitalism per se is not bad when it's embedded in national-state sovereign structure. Outsiders are then able to enter the market based on rules.
What we've now, after years of Gatt negotiations on tariffs and trade, is a frenzied run on weak merkets - for quick buck!
I accept, some of us didn't see globalization or financial markets run amock by foreign capital for quick profits (eg. Asean markets).
The concept of national sovereignty is fundamental to law and order in any system. US is trying to dismantle that global order for its (own) capital. This is not going to work, as far as I can see now.
International system we tried to built under Gatt rounds are now wasted by WTO - it won't work under so-called laissez faire economics which OECD is trying to enforce.
World political economy is such that laissez faire capitalism will not be able to superimpose itself as a new pradigm. Instead of liberalizing tariffs and trade we've created a monster called WTO!
I spend 30years promoting globalization, under Gatt, and now I'm sorry we made such a mess.
The trilemma makes is abundant ie. economics is fundamentally a political-economic decision-making
process.

[Michael Sullivan]

I think this is a key observation, modulo some constraints.

I'm pretty sure that there are programs that can be worse or better for all three things, or at least for some function of all three that one chooses to maximize.

personally, I will shed no tears for national sovereignty if the resulting global federation is not merely democratic but also liberal (in the classical sense).

If not, I might long for the days when choice between nation states was meaningful if terribly costly.

[shawn]

this theorem is destined for the textbooks. i wouldn't be so quick to discount what you term "global federalism" - the EU isn't such a good example, as nation-states are still very much in the way. i'm glad to have benefited from reading your post!

[Keypoints]

Globalization may or may not mean "global equity" for all people (young and old) -- whether it's a limited one or not is not that "relevant", provided that each and every consumer is given a minimum living allowance and shelter -- thus, with any "execss money" left consumers can choose to buy domestic or imports (regardless of price).

In the end, to accumulate more "paper money" may not be the goal to "hoard resources" but to propell to put that in good use to advance societies.

[paine]

i think dani
your vision --a realistic one --- is not of an "international" globalization but
a largely
North based
"trans national" globalization

hence the trilemma

the ever redrafted blue prints
for this "working" globalizing paradigm
is a TNC "vision"

globalizing
a paradiso for
giant corporate
national boundary busting

looking at the
won loss records over 60 years
can one say no its not ??

bretton woods
was the sytem still wearing training wheels as we decolonized

but now we got a free booters gold rush ---last
corporation "IN"is a rotten egg --- a south world profit raid is fast trying to turn itself into a second " period of occupation"
not by 19th century imperial states
per say
but by their sundry hegemonic corporate
epigone

beneath the wilsonian
helium balloons
t'is indeed
a smaller earth once more

but right now
the set up has its
various
signifigant limitations

not all borders fall
to the mere TNC touch
quite as easily as they "ought to "
and that's where
uncle sam and his posse come in
so under the banner of freedom and progress
the real global system
ends up in the clinches
operating on principles
closer to
the 9th century vikings
then europe's figmentary
21st century Erasmians

this fact might
be a curb
to south world
sanguinity eh ??

as in
" them guys is after one worlditude... my frickin' left foot ...more like ...dedicated to the proposition
that globality
of the TNCs
by the TNCs
and for the TNCs
shall not perish from this earth "

-------------------
ps
come to think of it

200 odd of your
" national straight jackets"
prolly sounds to these guys
like a nice next stage
refinement

so we may see em
get all three balls to drop

bretton woods first
federal democracy second
and finally
straight jackets for everyone

hey the present policy
struggle epitomized

those favoring
more northern life jackets
vs those favoring
more southern straight jackets

or are they both playing for the same franchise ???

[mik]

Who died and made Rodrik and other libertoads new Founding Fathers?

I seem to remember a little document called Constitution, it talks about pursuit of happiness and Human Rights for Americans and democracy in USA. I don't remember it postulated pursuit of Globaloonie, Free Trade, Supernation Federation run by Jeffry Sachses of this world.

You can piss on my leg and tell me it is raining. It does not make it so.

[stagel]

That's Mundell trilemma in an another way. But what you fail to do is give some sense to "global federalism" as a way to implement democratic politics. There is no such thing as a real democratic global federalism. Up to now, all the forms of global federalism (such as the UE) are rather undemocratic institutions. Modern representative democraties are the historical product of the transformation of Nation State governance for a reason. They are at ease with the Nation States, as they need institutions that make the political participation of people as citizens possible. I don't see any such institution in global governance.

[Eric H]

"Laissez faire capitalism is another name for what Clinton/Rubin imposed on the gobal market"

If, by "Laissez faire capitalism" you mean "free markets", I will point out that they cannot be imposed by anyone *by definition*. Perhaps what you mean is "state capitalism was imposed by Clinton/Rubin ..." I can agree with that. But then you go on to alternately endorse and then condemn state-capitalism. Perhaps the nature of your confusion lies in the fact that "free market" and "capitalism" aren't the same thing.

Dani, I'm with Matt, but not for the same reason: I think the long term erosion in sovereignty in favor of regionalism and/or localism is to be preferred. I hope a time will come when we look back at the rise of the nation-state and wonder why we ever wanted to aggregate that much power in so few hands.

mlk -- I've read the entire constitution and cannot remember where the phrases "Human Rights for Americans and democracy in USA" appear. In fact, I recall that it described a loose federation of sovereign states that in no way limited their numbers to 13, 50, or 100. Why do you think the world should be arbitrarily frozen now instead of at the time of ratification? And why should the blessings of liberty be secured only to people who happen to currently be citizens of this country now? And what makes you think that free trade makes us worse off?

[mik]

"I recall that it described a loose federation of sovereign states that in no way limited their numbers to 13, 50, or 100."

When Swiss will ask to join USA and will be admitted, there will be no problem to integrate Swiss Confederation into free trade within USA.

Till then they are a foreign country and will be treated as Reps of USA citizens will decide.

Perhaps in year 2990 China and India will ask to be admitted.

"why should the blessings of liberty be secured only to people who happen to currently be citizens of this country now?"

You can have all the liberty you want. It does not include you coming into my house without invitation. Your liberty does not obligate me to "free" trade with you or even trade at all.
It is up to us, US citizens, owners of this country, to decide what, if anything, we want to do with you.

Note that UN, EU, International Court, Red Cross, etc have no say in the matter.

Sachs and Rodrik have only 2 votes out of 150 Million.

"what makes you think that free trade makes us worse off?"

Who is us in this statement? If us is USA, there is no question that current "free" trade setup is hurting American middle class. Observe stagnation of middle class wages for the last 30 years.

If us is World citizens, free trade benefits people in low cost producer countries.
I'm not against them prospering, but not at my expense. So far it is at my expense. It is not going to continue.
No matter how much tenured professors will tell me how stupid me does not understand that I'm so much better off.

Peeing on my leg does not rain make.

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Lawmakers Sell Out Americans!

When I ran against Congressman Tom Price I pointed out how Price was selling out American jobs and wages in exchange for campaign donations by co-sponsoring a bill (H.R. 3938) to increase the annual cap on all employment-based visas (not just technically-oriented H1Bs) by over 115% (from 120,000 to 260,000).

Please watch this training video by a law firm that teaches companies how to disqualify American workers and instead hire low-wage immigrants.

http://controlcongress.com/uncategorized/lawmakers-sell-out-americans

LD-According to the According to the Bureau of Labor Statistics, between 2000 and 2005, the United States’ employment for computer workers grew by about 332,000.

During the same time period, the United States imported about 330,000 H1-B workers for computer occupations.

The situation for engineers was even worse, with 95,000 H1-B visas issued in the same period for engineering, yet according to the Department of Labor, engineering jobs shrank by almost 124,000 jobs.

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[gani]

mik:"If us is World citizens, free trade benefits people in low cost producer countries.
I'm not against them prospering, but not at my expense. So far it is at my expense. It is not going to continue.
No matter how much tenured professors will tell me how stupid me does not understand that I'm so much better off."

many people in switzerland currently use the same kind of arguments for a pretty important national decission (for which we can vote)

so I really get angry when I see people being against an open economy and labor market, because they fear loosing out in it, but ALSO vote AGAINST stronger social security or some kind of guaranteed basic income from which they would profit.

[gani]

mik:"If us is World citizens, free trade benefits people in low cost producer countries.
I'm not against them prospering, but not at my expense. So far it is at my expense. It is not going to continue.
No matter how much tenured professors will tell me how stupid me does not understand that I'm so much better off."

many people in switzerland currently use the same kind of arguments for a pretty important national decission (for which we can vote)

so I really get angry when I see people being against an open economy and labor market, because they fear loosing out in it, but ALSO voting AGAINST stronger social security or some kind of guaranteed basic income from which they would profit.

make the economic pie as big as possible and then redistribute so that evrybody has got atleast a certain share in it!

[gani]

sorry for doublepost... but after the first post typepad said i d need java script activated for it to verify me not being a bot...

statement thats in the first but not the second post:

make the economic pie as big as possible and then redistribute (some of it) so that evrybody has got atleast a certain share in it!

[Anton]

The EU experience is a perfect illustration of the trilemma. It is all about sacrificing some national souveregnity in order to achieve closer integration.

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