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News Bulletin
"Remarks on the Relation between Domestic Economic Policy and International Co-operation"

by Andreas Freytag
Institute for Economic Policy, Cologne

Volume 3, Issue 2
Friday, June 18, 1999, 3:00 p.m.

There is much hope that international economic policy co-operation might solve a number of policy problems. International agreements are supposed to enhance economic welfare. This hope is justified, provided international co-operation is not too ambitious or overdone.

Economic analysis has made clear that one cannot expect too much in the way of policy outcomes. For instance, agreements on exchange rates or employment cannot work and have, in reality, always failed. The reason is that agreements at this level always touch domestic economic policy issues. Also, countries have to do their homework; if they don't, international agreement does not help. However, there is a way to make international economic policy co-operation work well. Due to the nature of the political process, it can help governments to resist vested interests that force them to deviate from a sound economic policy. Well organized interest groups in democratic societies regularly succeed in gaining rents via protection or subsidies. These rents are at the expense of other groups less well organized.

It has to be acknowledged that governments normally do not intend to favor someone at the expense of others. However, even a government with the best of intentions might be forced to do so. Rather, the political power to influence the government and its decision is simply distributed uneven within society. Economically unjustified rents are the endogenous outcome of the political process. Once governments have recognized this, they have a chance to improve on their policymaking by implementing different, and economically sound, economic policy. The best forum to do so is in international agreements. Such an agreement can make the commitment credible as the government then can resist pressures laid upon it internally by quoting the agreement. The function of international economic policy co-operation is that of a scapegoat. Put differently; it overcomes powerful domestic interest by being completed on the international stage.

The most prominent example for this positive relationship between domestic and internationally co-ordinated policy is the multilateral trade liberalization process through the GATT and its successor, the WTO. Although unilateral free trade is economically rational, it is only very seldom implemented. Import competing interests are easier to organize than export interests. This could eventually stop liberalization efforts completely. After WWII, liberalization has been fostered through multilateral agreement within the GATT. Three principles have proved to be helpful: reciprocity, most favorite nation and national treatment. Apart from the fact that governments have opened their markets to foreign competition, they have improved the economic situation of their citizens. Thus, the GATT was a treaty that prevented governments to favor certain groups at and thereby hurting others. There can be no doubt that the GATT has been a great success.

Therefore, the first and foremost function of international economic policy co-operation is to protect citizens from bad economic policies pursued by their governments. This function cannot be underestimated and should be further exploited not only in commercial policy but also in macro-economic policy!