Federal Budget Review

Week 6 Discussion: US Budget

 Required Resources

• Textbook: Chapter 10
• Lesson
• Minimum of 1 scholarly source (in addition to the textbook)

Writing Requirements

• Minimum of 1 posts (1 initial & 1 follow-up)
• Minimum of 2 sources cited (assigned readings/online lessons and an outside scholarly source)
• APA format for in-text citations and list of references

Initial Post Instructions
You are an advisor to the President tasked with cutting at least $300 billion from the budget. The president wants your recommendations to cut lines, not large categories. Submit your recommendations and your reasoning for such recommendations using these guidelines:

- Use evidence (cite sources) to support your recommendations from assigned readings or online lessons, and at least one outside scholarly source.

- Use the format provided below to present your numbers and totals followed by an explanation below the chart.

- Please note that these are not true US budget numbers, but are reasonable hypothetical numbers to help us consider the budget processes complexities.

CHAPTER 10
POLITICAL ECONOMY

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 ScientistJohn 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 (remember from Chapter 8 that Soviet- and Chinese-style communism are modifications of Marx and Engel’s original theories), capitalist systems have been attempted and have always had some sort of government involvement in order to compel the paying of taxes, provide for public goods, and avoid market failures. The obvious question, then, is this: How much government involvement is needed? To consider this, we can think of a continuum of the sort pictured in Figure 10.1. The continuum represents the extent to which the government is involved in the economic life of a country from total to none at all. Capitalism would be placed on the left side of the spectrum, representing little government involvement. Communism, you will notice, is not on the continuum at all; in its ideal form, there is no government whatsoever and therefore no exchange of goods for a government to be involved in. What is on the right-hand side of the line are types of economies that do have significant government involvement: social democracy, socialism, and a command economy.

Figure 10.1 Continuum of Government Economic Involvement

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 STUDYGermany

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.

Career Guidance

As the career of John Maynard Keynes demonstrates, economists can have a great impact on politics as well. For those interested in economics, this career field has a number of exciting opportunities—particularly in the business world where economic analysis, forecasting, and planning are vital. For political science students interested in economics and finance, consider a minor in economics or business and look into opportunities on campus to enhance your education, such as investing clubs.

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.

Table 10.1 Inequality across the World

Source: CIA World Factbook.

One way we can measure economic inequality is through the Gini index. The index is a statistical measure of dispersion of income across a country. Depending on how the index is calculated, it can be measured either on a scale of 0 to 1 or 0 to 100; the basic logic, however, is 0 represents perfect equality and 1 or 100 represents perfect inequality, where one person would have all the wealth. Figure 10.2 displays how the Gini index varies across the world with high levels of inequality in South America and Africa. Although the United States compares favorably to the developed world, economic inequality has been on the rise. The Gini index for the United States in 1979 was 34.6 while, more recently, it has risen to 45.

Figure 10.2 Gini Index Globally

Source: Data from World Bank.

Income inequality can often be dealt with through a set of government policies collectively known as redistribution. Redistribution policies provide special subsidies and assistance for the poor—usually using tax revenues drawn from the more wealthy. While redistribution policies can provide a valuable and helpful social safety net for those left out of the economy for whatever reason, critics often argue against them for reasons similar to the arguments against progressive taxes: people should work for what they receive and be able to reap the benefits of working hard, and you may discourage people from working and bettering themselves if they know they will receive government assistance in any case. The question of what redistributive policies, then, to employ, is clearly a very political one with everything from the state of the economy to a country’s culture and beliefs about responsibility for the less fortunate playing a role.

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 institutio