The State S Role Inmacroeconomic Demandmanagement
They also have considerable institutional capacity to deliver economy-wide wage restraint. However, the real benefits to labor of delivering this restraint are uncertain, unless credible assurances can be obtained that public policy will encourage the productive reinvestment of profits in the domestic economy, and will safeguard the welfare of workers (Przeworski and Wallerstein 1982; Lange 1984). This uncertainty implies that governments can potentially play an important role in influencing wage behavior. Common knowledge about parties’ ideological and electoral commitments, renders left governments more credible as guarantors of the protection of labor interests. Thus, the argument goes, in a centralized environment, left governments are more capable than governments of the right of encouraging wage restraint and achieving superior growth and inflation performance. Under a right-wing government, uncertainty about the distribution of the economic benefits of wage restraint will reduce the incentive for powerful centralized unions to act cooperatively. In contrast, in a more decentralized environment, common knowledge about the ideological and electoral commitments of left governments renders them more likely to be taken advantage of by opportunistic fragmented unions, so that their economic performance will tend to be worse than that of governments of the right.
Thus the appropriate role for the government, and the economic effectiveness of governments of different partisan hues, is expected to vary depending on the institutional context. Lange and Garrett’s “institutional partisan” model is quite successful in explaining variations in cross-national growth performance in response to the oil shocks of the 1970s. In recent years, however, in response to the increased trend towards the delegation of monetary policy to independent central banks, a new set of arguments has been developed which model inflation and unemployment rates as emerging from the interaction between independent monetary authorities and the parties to the wage negotiation process (unions and employers’ organizations) (Hall and Franzese 1998; Iversen 1999). Again these models are designed to show how the impact of policy intervention can vary depending on the institutional context, but in this instance the government’s role is more restricted.While it bears responsibility for the selection of the monetary regime, it may have limited powers to alter it once it is in place. If its selection involves the delegation of monetary authority to an independent central bank, for example, this implies that in future iterations of the game, the principal political actors engaged in the macroeconomic management of the business cycle will be central bankers, and the representatives of unions and employers’ organizations. Their behavior, in turn, is dictated by the system of incentives emerging from the institutional environments in which they operate. In these arguments, macroeconomic outcomes are principally determined by the interaction between the socioeconomic institutions of the state, and the impact of their structures on the behavior of economic actors, rather than by the direct actions of democratic governments. Additional constraints on the ability of governments effectively to pursue macroeconomic demand management policies are identified in the growing literature on the domestic economic impact of trade and capital market liberalization.
On the monetary policy side, for example, it is argued that the ability of large financial institutions to transfer funds rapidly across borders creates a strong impetus for crossnational convergence in policy outcomes (see, for example, Kurzer 1993; Moses 1994; Keohane and Milner 1996; Simmons 1998). Where exchange rates are fixed, crossnational convergence in interest rates will be induced by the free movement of capital in search of the highest returns (Mundell 1961). Where exchange rates are allowed to float, states retain some capacity to engineer monetary expansions via currency depreciations, but such expansions are rendered less effective by associated increases in the cost of imports, and increase the prospect of economically damaging speculative currency attacks (McKinnon 1988). Similarly, on the fiscal side, increased trade and capital market openness creates a number of problems with the pursuit of countercyclical deficit-financed expansions. First, trade openness reduces the effectiveness of such policies, since the multiplier effect associated with domestic expansions is diminished where large components of domestic demand are international. Second, capital market openness increases their cost, since higher levels of debt lead to higher expected rates of inflation and are thus likely to be associated with capital flight unless nominal interest rates are allowed to rise. These arguments have given rise to an extensive empirical literature which attempts to estimate the extent of these constraints in practice, and in particular, their impact on patterns of monetary and fiscal policy-making across parties.
The findings of this literature, while mixed, tend to support the hypothesis that the capacities of governments in this area have been reduced by economic openness.While the evidence does not indicate that the constraints on the ability of governments to pursue independent monetary and fiscal policies are overwhelming, it does appear as though the size of partisan effects in these areas has declined in recent decades, and is associated in particular with the increased liberalization of capital markets and the introduction of fixed exchange rate regimes (Oatley 1999; Boix 2000). These findings provide some support for the hypothesis that the feasibility of Keynesian demand management policies favored traditionally by left-wing governments has been compromised by the globalization process..
