The good and bad kind of external discipline

In its Fact Sheet on CAFTA, the US Trade Representative assures domestic sugar interests that the market access the Agreement offers is no bigger than "about one day’s U.S. production, or approximately one teaspoon of sugar per week per adult American" and boasts that "CAFTA would not come close to returning U.S. [sugar] imports to [mid-1990s] levels." This is emblematic of the meager pickings that is on offer from CAFTA to the participating countries.  

When you bring this up in discussions with economics officials of developing nations, you often get the following response: "You don't understand, this is not about market access. It is about having an external anchor for our policies. It is about importing discipline from abroad and making our own liberalization more credible and less reversible."

Governments often use international institutions and agreements to tie their hands on economic policies. By signing on, say, to a bilateral trade agreement or to an IMF program, a government voluntarily gives up some of its policy space and commits to live by rules on which it has little influence.

How do we think about this?

To many political groups at home, this represents an abdication of sovereignty, is undemocratic, and should be avoided. Many economists (and political scientists), on the other hand, say that this is nothing other than a form of "delegation" by which a political authority gives up some autonomy in return for a greater good. Typically, the objective is to pre-commit against an undesirable political outcome in the future. In the domestic setting, such delegation is common: parliaments delegate authority to the executive, independent commissions, or judicial authorities all the time.  In the U.S., for example, Congress delegates trade negotiation authority to the President (committing itself to a straight up or down vote) in order to rule out Congressional horse-trading and micro-management. Delegation to an external authority, the economists' argument goes, is no different, and should be viewed as an equally democratic prerogative.

What is not sufficiently appreciated in the discussion is that external discipline can be sought in two different kinds of settings--one of which is much more defensible on the traditional delegation grounds than the other. 

Consider first the case where the government faces a "time-inconsistency" problem. It would like to commit to free trade or to fiscal balance, but realizes that over time it will give in to pressure and deviate from what is its optimal policy ex ante. So it chooses to tie its hands through external discipline. This way, when protectionists and big spenders show up at its door, the government says: "sorry, the WTO or the IMF will not let me do it." Everyone is better off, save for the lobbyists and special interests. This is the good kind of delegation and external discipline.

Now consider the second kind. Here, the government fears not its future self, but its future opponents: the opposition party (or parties). The latter may have different views on economic policy, and if victorious in the next election, may well choose to shift course. Now when the incumbent government enters an international agreement, it does so to tie the hands of its opponents. From an ex-ante welfare standpoint, this strategy has much less to recommend itself. The future government may have better or worse ideas about government policy, and it is not clear that restricting its policy space is a win-win outcome. (This by the way is why I think it was a good idea to hold a referendum on CAFTA in Costa Rica.)    

So next time you hear the external-anchor argument, ask yourself whether the government in question wants to "import" external discipline for the first reason or the second.       

Comments

[Nathan Lambert]

Hi Professor Rodrik,

Always enjoy the blog, I find the economic commentary invaluable and enjoy the digressions (if I can call them that) on Turkey, Radiohead, etc.

However, as someone who works in party politics (albeit at a junior level), I think there is probably a great deal of overlap between your two cases, probably so much so that the distinction is not particularly useful.

From a policy-maker's point of view, the fear that a government will 'give in to pressure' is usually a fear that others within their party, who have different views or serve different interests, will get an opportunity to reverse their decision. That is not really that different to the fear that the opposition will reverse it -- in fact, if the policy-maker in question is a moderate, they may fear radical elements in their party more than the opposition.

Of course in theory the opposition would reverse a decision only because they had a clear democratic mandate to do so. But in reality representative democracy is rarely that clear cut -- particularly in areas like trade where vocal minorities are often set against a disinterested majority.

If I could suggest an alternative response, it would be: 'Are the government importing external discipline because they believe it to be in the best interests of the nation (which happens, sometimes) or are they importing it because they derive personal or party-political advantage?'.

For instance, in 2004 the conservative Australian government signed a free trade agreement with the US that included binding clauses on pharmaceutical subsidies, tariffs, and others issues that it knew would be difficult for its centre-left opposition to accept. There is a strong argument that it did so in order to 'wedge' its opposition in an election year -- that is, to force the opposition to choose between supporting the agreement, which would have angered its left-wing supporters, or opposing it, which would have damaged its economic credentials.

These sorts of ploys are of course a day-to-day occurrence in politics, but there is a greater cause for concern when they lead to international agreements that are difficult for future governments to over-turn. I think that's why there is an argument for making international agreements subject to some sort of at least vaguely bipartisan process.

Nathan.

[Sriram]

Well, Latin America seems to have not many options then to do "Free Trade" with US. They are too much dependent on US when it comes to framing economic policies. Also some of these countries are split down the middle when it comes to supporting or opposing the US(Mexico, Costa Rica etc.. are a few examples).

Whom do they turn towards if they do not want "Free Trade" with US ? Currently they have to two options:

1. Integrating among themselves(Latin American alliance in Economic policy), which is slowly happening(Mercasur and other regional groups are being formed). These coailitions are politically and strategically important for Latin America.

2. They need to engage in Trade with emerging economies such as China and India in particular. This is also happening gradually. Already we see that China is becoming a major trading partner with Latin American countries. They are also increasing Trade with India(Wipro and TCS have already opened their shops in Mexico:http://www.networkworld.com/news/2007/091107-wipro-expands-into.html)

So, for now they need to engage in trade with US. But they must understand that putting all the eggs in one basket is risky and so they should expand trade with other emerging economies. For now US has the upper hand with respect to Latin America. But in due course as Latin America engages more and more with other countries, their reliance on US will diminish, which would also deter US from "arm twisting" them.

[hari]

Dani-

Why can't US open up its trade flow from CAFTA states on a unilateral basis?

[robertdfeinman]

Either motivation shows an unwillingness for the ruling regime to trust the future of the country to democratic institutions.

Either they are arrogant in the belief that they know best, or they are implicitly acknowledging that the democratic processes don't exist or are not really effective. Nominal democracies can have elections which are meaningless for one reason or another.

There is only one fair approach to governance and that is a true democracy. If the people in their ignorance or short-sightedness choose to drive their country over a cliff at least they were responsible for their own fate.

Philosopher-Kings don't have a terribly good track record and tend to become autocrats and install themselves for life much too often.

[corvad]

what is true democracy? we certainly don't have it in the US. not sure it exists anywhere, which is why I like to think that democracy should always be considered a work in process -- and that its primary purpose should be opening up spaces of information sharing and consensus building. Democracy is a problem that can't be solved: the refusal of its solution should be the basis for its strength as a mode of governance.

[Per Kurowski]

At the end of the day everything can be reversed suffices one chávez and, in the best of cases, one second referendum.

Everyone gives in and delegates. The US accepted to give in to the Basel Committee frame of mind on bank regulations and accepted their risk-adverseness as expressed by the minimum capital requirements methodology and even though they should know what happens when a country decides to rest and become risk adverse.

We, every day, give in and accept when bombarded by so much information to use the centrifuge and classify it in either on of mostly-in-agreement-and-therefore-must-be-true or the mostly-in-disagreement-and therefore-must-be-wrong categories… and which when we use really low common denominators results in crazy propositions such as “chávez is great… he must be since is against Bush.”

[Mansour]

The argument suggests that the same policy is good if the government is at the beginning of its term and there is a high probability it will remain in power (thus binding itself controls pressure groups), but bad near the end of its term if there is a low probability it will remain in power (it would restrict opponents). Therefore external discipline is always good in an undemocratic context where political opposition is too weak to contest the government. But what if the IFI-prescribed policies are not good in the first place? Allowing national governments to learn from their own mistakes by fostering a wider policy space seems to me more convincing.

[wjd123]

"Consider first the case where the government faces a "time-inconsistency" problem. It would like to commit to free trade or to fiscal balance, but realizes that over time it will give in to pressure and deviate from what is its optimal policy ex ante. So it chooses to tie its hands through external discipline. This way, when protectionists and big spenders show up at its door, the government says: "sorry, the WTO or the IMF will not let me do it." Everyone is better off, save for the lobbyists and special interests. This is the good kind of delegation and external discipline.

"Now consider the second kind. Here, the government fears not its future self, but its future opponents: the opposition party (or parties). The latter may have different views on economic policy, and if victorious in the next election, may well choose to shift course. Now when the incumbent government enters an international agreement, it does so to tie the hands of its opponents. From an ex-ante welfare standpoint, this strategy has much less to recommend itself. The future government may have better or worse ideas about government policy, and it is not clear that restricting its policy space is a win-win outcome. (This by the way is why I think it was a good idea to hold a referendum on CAFTA in Costa Rica.)" --Dani Rodrik

I read the above yesterday morning and got the feeling that something was amiss. I wasn't convinced that motivation made the difference between good and bad external discipline. In fact I wasn't sure that there was a good to be had from the external discipline Congress imposes on itself. I'm a fiscal conservative. I support Pay/Go rules yet I worry that it will be the weakest in society that are hurt the most by this kind of discipline. In fact, I resent that Congress has to impose this external discipline on itself. It's more a discipline to hide behind than one that builds good habits.

Yet, that wasn't it. That wasn't why I didn't like the distinction Dani was making. I tried again by looking at different types of economic discipline. Maybe I would find a clue there.

There is the necessary discipline of the market place--the invisible hand--and there is the self imposed discipline of the political economy--the rules and regulations governing how business is done. Fast track or pay/go would be a subset of this second type of discipline, a discipline that the government imposes on itself. And, according to Dani, depending on our representatives' motivation this subset can be beneficial, done for the good of the country, or obstructionist, done for ideological reasons. But what criterion can we use to tell the difference in motivation? Only the Shadow knows.

That wasn't much of a conclusion and it wasn't very helpful. What was I trying to get at, what was amiss. I shut down my computer and went to the market with my wife.

In the evening I turned on the Republican debate over the economy and trade. It was the same mantra I've been hearing for the past 20 years: cut taxes, cut spending, cut regulations, shrink government, grow the economy and the huge deficits modern Republicans always seem to run every time they get in power will pay for themselves. Republicans don't like paying for anything, they would rather have their magic mantra do it for them. It never works, but, no matter, they keep repeating it all the same, so great is their aversion to paying for anything the normal way: by raising taxes.

Sometime during the debate I put my finger on what was bothering me. Now if I can only remember it after waking from the stupor their mantra put me in.

This morning I can't remember what was said that triggered my eureka moment. And there is no way I will subject myself to that debate again.

Nevertheless, even though I can't remember the moment, I do remember the general tenure of my criticism. It goes back to a question Emile Durkheim asked about the economic sphere at the turn of the twentieth century during the Industrial Revolution. He thought that the economic sphere was claiming a special privilege for itself. It didn't want to be disciplined by the moral sphere. After all, economists argued, the economic sphere already had the discipline of the invisible hand and to subject it to the moral intervention of society would just mess up its internal workings.

Durkheim wasn't convinces. And whether he was right or wrong, his view prevailed as laws and regulations were passed to mitigate the evils of the Industrial Revolution on society.

So when Dani implies that the discipline of fast track is the kind that is beneficial to the social welfare as long as it is done with the social welfare in mind, I wonder if he hasn't forgotten the lessons of history. Lessons that blue collar workers remember and hold on to tenaciously. Weaken our ability to intervene morally into the economic sphere and we will go backwards in history. And this, in turn, is where trade agreement such as NAFTA and CAFTA are taking us. Fast track rules facilitate the acceleration.

In a free trade environment, economic morality hinders a nations ability to compete. This in turn leads to a changing political economy more in tuned with the discipline of Adam Smith's invisible hand than with Emile Durkheim's moral intervention.

Trade agreements such as CAFTA have social consequences. Without making social concerns part of these trade agreements, as the EU does, the easier it is to destroy the internal discipline of a countries economic morality, the rules and regulations governing its political economy.

For those countries that have very little economic morality, agreements such as CAFTA are a lost opportunity to use free trade agreements to foster it. Why is that important? Because failing to do so will leave the weakest in society vulnerable to losing out on the economic gains of free trade.

We need free trade agreements that protect social values and allows them expression. Therefore I don't believe that when it come to free trade agreements such as CAFTA there can be an external discipline that government imposes on itself that leads to the social welfare. It also seems to me that if we are going to base policies on ex-ante outcomes we ought to remember the lessons of history.

[parashar]

It is logically taxing to find a government that enters into an agreement to tie the hands of a future government.

The reasons being
1) By this logic, the current party is not expecting to be in power in the future. If they were, then they would also bind their own hands.

2) Agreements are perfectly culpable/apportionable. Hence any government can raise its hands and blame the previous government for a bad agreement.

3) Agreements are never perfect straight jackets. Given 1 and 2, a new government can simply not comply with an agreement and pay penalties that arise, blaming the same on the earlier government.

[Todd Tucker]

Re: "In the U.S., for example, Congress delegates trade negotiation authority to the President (committing itself to a straight up or down vote) in order to rule out Congressional horse-trading and micro-management."

Before Fast Track was first passed in 1973-1975, the U.S. Congress successfully wrote trade policy for two centuries, sometimes to reduce barriers to trade, and sometimes to increase them.

Since that time, the executive branch has used multiple grants of Fast Track to ram through trade policy that would have never made it through the normal congressional process. Some of this policy increased barriers to trade (patent protection), and some of it decreased barriers to trade (manufactures). What (primarily) was different was the expansive deregulatory implications of NAFTA, WTO, etc.

One thing Fast Track has NOT done, however, is "rule out Congressional horse-trading." Trade votes face as much "horse-trading" as ever (see link below). Arguably today's horse-trading is more about pork and political cover than about making trade policy more palatable to the median voter. It seems more accurate to say that Fast Track has made members of Congress much less informed about the trade policy they are voting on, which is why you are more likely to hear Friedman-ite platitudes than serious debate.

Link - http://www.citizen.org/publications/release.cfm?ID=7391&secID=2057&catID=126

[Ali Sohail (Pakistan)]

There is only one fair approach to governance and that is a true democracy. If the people in their ignorance or short-sightedness choose to drive their country over a cliff at least they were responsible for their own fate>>

In countries with heightning spatial variations such comments are nothing more than mere cliches!
just to remind you, most developing countries have low literacy rates hence however the majority may have good understanding of what is good for one's self, they rarely possess the technical, analytical and rigorous training to revitalise, broaden and shape a suggestive framework for an all out economy wide understanding and betterment and if they do then there is no need to for the educated,classified and acclaimed field of economics, political or government sciences or any other related scientist.

In addition, there is normally a conflict between policies in between different sectors of the economy hence a clash between the different selfs,(which is further reinforcing force in a capitalistic world) plus rarely do policies bring maximum sustainable fruit in the short run hence will auomatically conflict the rational response of the commom man for immediate support as he may not be equiped to think on the chronigical long term implications i.e a giveup of today for tomorrow which is many ways is central to the study of economics and specifically for growth and development.

Cheers

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