Chapter 8

The realist and liberal perspectives view the world economy in different ways: realist perspectives view economic activity in terms of relative gains and emphasize that global markets require security to function, while liberal perspectives focus on absolute or collective gains and argue that economic interactions and interdependence – often managed by economic institutions – lessen conflict and war.

The world economy is built on domestic economic policies. The first type of domestic policy is macroeconomic policy, which targets the domestic economy as a whole by influencing supply and demand, which in turn influence prices. Fiscal policy deals with the national budget and its effect on the economy rests on whether the budget is balanced or running at a surplus or deficit. Monetary policy deals with the money supply and rests on whether central banks buy or sell government securities, which affects short- and long-term interest rates. The second type of domestic policy is microeconomic policy, which targets specific industries, sectors, or firms in the economy. It includes regulations, subsidies, price controls, competition or antitrust policies, and labor union laws.

States’ policies also deal with international trade, investment, and finance. Trade policy affects the price of goods and services as they cross state borders, either by affecting the price of those goods and services through tariffs or subsidies, or by restricting the quality or quantity of those goods and services through non-tariff barriers like quotas and qualitative regulations. Trade rests on the principles of a specialization and comparative advantage and works best with as few barriers as possible; however, exceptions to free trade have been made in the cases of national security, infant industries, strategic trade, and the protection of jobs. Investment policies deal with foreign direct investment in resource-based, manufacturing, and service industries, and they involve the operation on multinational corporations. Financial policies deal with exchange rates, as well as currency markets and debt markets – the latter of which was critical in sparking the 2008-2009 financial crisis.

A state’s balance of payments records the state’s economic activity and illustrates its place in the world economy. The balance of payments is composed of a state’s capital account (the net flows of investment into and out of the state) and current account (the net flows of goods and services into and put of a state, plus government transfers and net income on capital investment), plus its reserves and statistical errors (which, when accounted for, make the balance of payments balance).

Learning Objectives

After reading this chapter students should be able to understand:

• The basic principles of economics – that is, what factors, when changed in some way, lead to what outcomes.
• What policies states can use as tools for manipulating economic factors.
• How the realist and liberal perspectives view the operation of economic activity, what outcomes they see as desirable, and what factors they argue should be manipulated to lead to those outcomes.