The Trilemma of International Finance

In IS210, we will be reading about domestic political economy next week. Understanding the role of state and market, politics and economics, we can learn about what causes some countries’s economies to grow quite rapidly and other countries’ economies to grow more slowly. We’ll look at the role of domestic institutions and policy choices as key root causes in economic development. [How does this contrast with Inglehart’s arguments, or Weber’s idea of the ‘Protestant work ethic?’] Increasingly, though, our ever more globalized and interdependent world economy provides domestic economies with opportunities and threats that didn’t exist to nearly this extent even 50 years ago. We’ll look at economist N. Gregory Mankiw’s New York Times editorial piece on the “trilemma of international finance.”

Have a look at this Frontline excerpt on the Asian financial crisis of 1997 and the role that fixed exchange rates played:

What causes civil conflict?

In a series of recent articles, civil conflict researchers Esteban, Mayoral, and Ray (see this paper for an example) have tried to answer that question. Is it economic inequality, or cultural differences? Or maybe there is a political cause at its root. I encourage you to read the paper and to have a look at the video below. Here are a couple of images from the linked paper, which you’ll see remind you of concepts that we’ve covered in IS210 this semester. The first image is only part of the “Model of Civil Conflict.” Take a look at the paper if you want to see the “punchline.”

Screen shot 2014-02-07 at 1.54.26 AM

Here is the relationship between fractionalization and polarization. What does each of these measures of diversity measure?

Screen shot 2014-02-07 at 1.56.50 AM

And here’s a nice youtube video wherein the authors explain their theory.

Deal or no deal and rational choice theory

As my students are aware, I have been under the weather since the beginning of January and am finally feeling somewhat like a human being again. During my down time, I took some rest and had time to do some non-school-related activities, one of which was trying out the Deal or No Deal app on my smartphone. You do remember the TV show hosted by Howie Mandel, right?

Deal or No Deal and Rational Choice Theory

Deal or No Deal and Rational Choice Theory

Anyway, the basic idea of the show is this:

  • There are 26 suitcases on state, each with a card containing a dollar amount between $1 and $1 Million.
  • The game begins when the contestant chooses one of the 26 suitcases as “their” suitcase. If the contestant keeps the suitcase until the end of play, they win the dollar amount written on the card inside the suitcase.
  • The contestant must begin opening a certain amount of suitcases during each round of play–5 the first round, 4 the next, etc.
  • After each round, the game pauses and the contestant receives an offer from the mysterious banker via telephone with Howie as the intermediary.
  • The contestant is then asked whether there is a “deal, or no deal.” The contestant may accept the banker’s offer or continue. [There is where the drama gets ramped up to 11!]
  • If you have watched the show, you’ll notice that the banker’s offer depends upon which dollar amounts have been revealed. If the contestant reveals many high-value suitcases, it becomes like likely (probable) that the suitcase s/he chose at the beginning is a high-value suitcase.

The smartphone version is slightly different from the TV show in that the suitcases do not have dollar amounts attached but point multiples (that is, you win 1X, 2X, 3x, etc. 1000X the pot).

Take a look at the images above screenshot (is that the past participle?) from my smartphone. What do you notice about the banker’s offer? What’s of importance here is the red boxes in each picture. These are two separate games, btw.

These are two separate games. In the top game, there are only two suitcases left–one of them is the 20X and the 200X, Therefore, I have either the 20X or the 200X. That’s quite a big difference in winnings–ten times. So, what would you do? What would a rational choice theorist say you should do? Are the bankers offers rational in each case? Why or why not?

My Intro to IR Class is full of Realists

Last Tuesday in POLI 1140, the students completed an class oil-market exercise in which pairs of students engaged in a strategic situation that required them to sell oil at specific prices. Many students were able to understand relatively quickly that the “Oil Game” was an example of the classic prisoner’s dilemma (PD). As Mingst and Arreguin-Toft note on page 78, the crucial point about the prisoner’s dilemma:

Neither prisoner knows how the other will respond; the cost of not confessing if the other confesses is extraordinarily high. So both will confess, leading to a less-than-optimal outcome for both.

From a theoretical perspective (and empirical tests have generally confirmed this) there will likely be very little cooperation in one-shot prisoner’s dilemma-type situations. Over repeated interaction, however, learning can contribute to higher levels of cooperation. With respect to IR theories, specifically, it is argued that realists are more likely to defect in PD situations as they are concerned with relative gains. Liberals, on the other hand, who value absolute gains more highly, are more likely to cooperate and create socially more optimal outcomes. What were the results in our class?

The graph above plots the level of cooperation across all six years (stages) of the exercise. There were seven groups and what the probabilities demonstrate is that in each year there was only one group for which the interaction was cooperative. In year 2, there was not a single instance of cooperation. Moreover, it was the same group that cooperated. Therefore, one of the groups cooperated 5 out of 6 years, while none of the other six groups cooperated a single time over the course of the sex years!! What a bunch of realists!!

If you were involved in this exercise, please let me know your reactions to what happened.

Ethnic (cultural) diversity and public spending

We talked a little bit in class today about the link between ethnic (cultural) diversity and public spending. The empirical record seems to find that the more ethnic diversity in a polity, the less public spending–health, education, etc.–there is. A recent article in the American Political Science Review (Habyarimana et al. 2007) addresses the theoretical mechanisms that may underlie this empirical association:

A large and growing literature links high levels of ethnic diversity to low levels of public goods provision. Yet although the empirical connection between ethnic heterogeneity and the underprovision of public goods is widely accepted, there is little consensus on the specific mechanisms through which this relationship operates. We identify three families of mechanisms that link diversity to public goods provision—what we term “preferences,” “technology,” and “strategy selection” mechanisms—and run a series of experimental games that permit us to compare the explanatory power of distinct mechanisms within each of these three families. Results from games conducted with a random sample of 300 subjects from a slum neighborhood of Kampala, Uganda, suggest that successful public goods provision in homogenous ethnic communities can be attributed to a strategy selection mechanism: in similar settings, co-ethnics play cooperative equilibria, whereas non-co-ethnics do not. In addition, we find evidence for a technology mechanism: co-ethnics are more closely linked on social networks and thus plausibly better able to support cooperation through the threat of social sanction. We find no evidence for prominent preference mechanisms that emphasize the commonality of tastes within ethnic groups or a greater degree of altruism toward co-ethnics, and only weak evidence for technology mechanisms that focus on the impact of shared ethnicity on the productivity of teams. (my emphasis)

Thus, what the experimenters found was that (at least in their experiment) co-ethnics were more likely to co-operate in a strategic setting than non-co-ethnics. An additional important factor is the ability of the threat of social sanction to be stronger within a homogenous social group, presumably due to more closely linked social networks. (“I’ll tell your mother on you!” as a threat has more of a potential enforcement effect if you think the person making the threat may actually know your mother. And the likelihood of that person knowing your mother increases, other things being equal, if s/he shares the same ethnicity as your mother.

Social Network Media and Revolution

In the wake of the revolutionary changes that have (hopefully) taken place in Tunisia and Egypt, much has been made about the role of social media–particularly Facebook–in facilitating the participatory aspect of the revolutionary end-game. (A Google search of `Facebook AND Egypt revolution’ turns up over 22 million hits.) The Globe and Mail’s  Chrystia Freeland is the latest journalist to address the phenomenon, quoting economists Daron Acemoglu and Matthew Jackson.

Freeland notes that social network media have helped resolve what social scientists refer to as the collective action problem.

“It is a question of co-ordinating people’s beliefs,” said Daron Acemoglu, a professor of economics at the Massachusetts Institute of Technology, who, with Matthew Jackson of Stanford University in California, is working on a paper about the effect of social networks on collective action problems.

Protesting against an authoritarian regime is a prime example of this issue, Mr. Acemoglu said, because opponents of a dictator need to know that their views are widely shared and that a sufficient number of their fellow citizens are willing to join them to make opposition worthwhile.

“I need to know if other people agree with me and are willing to act,” he said. “What really stops people who are oppressed by a regime from protesting is the fear that they will be part of an unsuccessful protest. When you are living in these regimes, you have to be extremely afraid of what happens if you participate and the regime doesn’t change.”

That makes publicly protesting an oppressive regime a classic collective action problem: If everyone who wants regime change takes to the streets, the group will achieve its shared goal. But if too few protest, they will fail and be punished. Even if an overwhelming majority wants change, it is smart for individuals to speak out only if enough compatriots do, too.

To Freeland’s characterisation of the collective action problem I would add that the reason it is “smart for individuals to speak out only if enough compatriots do, too” is because each individual reasons in the following manner:

  • I am only one person; my individual marginal contribution to the probability of having a successful revolution is infinitesimally small.
  • Thus, my taking part or not will not be determinative. That is, the revolution will succeed or fail regardless with or without my participation.
  • Given the above, and given potential costs of participating, it is rational for me to not participate.

Social media, however, can help to change the calculus of participation by assuring the would-be participant that millions of others will also participate, thereby decreasing the potential costs of participation to any one individual. I do have an issue, however, with Freeland’s use of the Groupon analogy, which is based on the difference between the types of private goods Groupon specialises in and the truly public good that is a revolution.

A Wave of Protests across North Africa and the Middle East

Following closely in the aftermath of the dramatic changes that have taken place in Tunisia recently, the political unrest seems to have swept its way across northern Africa, with the situation in Egypt now drawing most of the attention. Alan Cowell of the New York Times writes:

After days of protests that have toppled one president and shaken many others, governments across the Middle East braced on Friday for http://www.guardian.co.uk/global/blog/http://www.guardian.co.uk/global/blog/2011/jan/25/middleeast-tunisia://www.guardian.co.uk/global/blog/2011/jan/25/middleeast-tunisia/jan/25/middleeast-tunisia outbursts of rage and discontent directed at entrenched regimes confronting an exceptional clamor for democracy.

The immediate epicenter of the protests was Egypt, where Internet and cellphone connections were closed or restricted in Cairo, Alexandria and other places. Riot police took to the streets of Cairo before the Friday noon prayers that in http://www.guardian.co.uk/global/blog/2011/jan/25/middleeast-tunisia parts of the Islamic world have been a prelude to unrest as worshippers pour onto the streets.

The protests have underscored the blistering pace of events that have transformed the visage of the Arab world, particularly among regimes that have traditionally enjoyed the support of successive administrations in Washington.

Note the words that I have changed to red in the quote above. Is this author using these words as synonyms? If so, is he using them as precisely as he could be? Is he using them incorrectly?

For more information, here’s a useful set of reports, with myriad links to video and audio, from the UK Guardian’s Jack Shenker reporting in Cairo. In addition, the CBC website has an interesting flash-type graphic showing how the geographical extent of the spread of the protests.