Trilemma of International Finance
What is the trilemma? The New York Times had a great article by Gregory Mankiw on the trilemma almost two months ago. The trilemma is that economic policy makers would like to achieve the following three goals, but economic logic only allows regulators to choose two of the three:
- International capital mobility;
- Ability to use monetary policy to stabilize the economy; and
- Maintain currency stability.
Although some argue that the trilemma can be challenged, research tends to show that it does indeed exist.
The US has chosen the first two 1) by allowing Americans to easily invest abroad and by allowing foreigners to easily invest in America, and 2) by using the Federal Reserve to set monetary policy. 3) But at the price of a volatile dollar value which is set by international markets.
Europe has chosen the first and third 1) by allowing Europeans to easily invest abroad and by allowing foreigners to easily invest in Europe, and 3) by maintaining currency stability, at least across the euro zone. 2) But at the cost of nations giving up the ability to use monetary policy to the European Central Bank.
China has chosen the second and third 2) by setting monetary policy, and 3) by maintaining tight control over the exchange rate of the yuan. 1) But at the cost of restricting outbound and inbound international capital mobility to control how much money comes into and goes out of the country.
Russia's policy is closest to the US in practice. 1) There are some restrictions on international capital mobility, but a) they are not as strict as China's, and b) the geographic realities of China and Russia make them more difficult to enforce in Russia's case. 2) and 3) The goal of the Central Bank of Russia is to maintain currency stability, but it has proven ineffective at maintaining currency stability, and is instead focusing on using monetary policy to stabilize the economy (see the link to the "goal of the Central . . .").
When economic policy makers choose to restrict international capital mobility, I think that it necessitates a government with stronger or more authoritarian control over its citizens. And I think a democratically elected government would have a much harder time maintaining legitimacy with such tight controls on capital mobility. That isn't to say that China's economic policy isn't working brilliantly, just that democracy suggests greater freedom, and capital mobility restrictions are a more tangible restriction on freedom than currency pegging and a central bank's tinkering with monetary policy.
We all know the traditional narrative about government institutions in the West v. those in the East, right?
The historical tradition in the West follows an embrace of an idealized Athens and Rome. Athens became super-rich as the de facto head of the Delian League, and being rich is totally awesome because you have all this cash to make art and pay for plays. People even forget that everybody got pissed at you for being super-rich, and you got your ass handed to you by Spartans in the Peloponnesian War, and twice more by barbarians: one Macedonian, and the other Roman. Rome was super-powerful, and being powerful is awesome because it allows you to dominate others. To be super-rich and super-powerful, the Western tradition dictates that you should be like Rome and/or Athens, and to be like Rome/Athens, we look to their writers. Democracy, or at least a republic, where citizens exercise votes to choose their leaders is considered ideal because Plato wrote about Socrates arguing about topics such as courage, liberty and freedom. But Plato actually believed in philosopher-kings, and when western philosophers started reading all of the awesome Aristotle during the Renaissance that Islamic and Jewish scholars had preserved, they started to totally dig this idea of a real republic which resulted in liberty and freedom, not that fake one that Plato writes about. Then a bunch of well-educated people bought a bunch of printing-presses and had some revolutions. Some were cool, some were creepy, and tradition is preserved.
In the East, Qin Shi Huang unified China through a highly bureaucratic state in which the nobility was replaced by a relatively meritocratic hierarchy of officials who administered the state which begat a major ass-kicking of the other kingdoms during the Warring States period. After Liu Bang successfully exploited Qin and Chu weaknesses, the Han dynasty emulated Qin's bureaucracy. Fast-forward through a couple thousand years of monarchical bureaucracies to the People's Republic China, and what China now has is a single-party, nominal republic with a highly bureaucratic state. Tradition is preserved, but the monarchy has, if you'll allow me some wiggle room, been replaced by the Party.
But what of Russia, that great nation that straddles East and West? As anyone who has ever read Tolstoy's War and Peace can tell you, a) it's long, and b) 19th century Russians really dug French culture. We see Russia's fascination with and eagerness to engage with Europe over the arc of it's history, particularly manifested in 1) the declaration of Moscow as the New Rome under Ivan the Great following the Ottoman conquest of Byzantium in 1453, 2) the military, political and economic reforms of Ivan the Terrible, and 3) a turbulent affair with a pair of Germans. Russia aspired to be a part of the West, and democratic institutions are more in line with the historical traditions of the West, which Russia has engaged with for far longer than the east, than a single-party bureaucracy.
Circumstances at the Inception of the Adoption Market Economies
This, I think, is the big one. Fortunately, I think I can describe it less verbosely than the other two.
The collapse of the Soviet Union began with turmoil in the Warsaw Pact allies. The communist countries of Eastern Europe were economically inefficient as a direct result of the command economy. The governments had lost legitimacy because of the form of government. After the Sinatra Doctrine, the Eastern European countries turned to new forms of government that were modeled on representative democracies. When economic inefficiencies finally brought down the Soviet Union in 1991, it was also because the form of government was blamed for the economic inefficiencies. With the form of a highly centralized and all-powerful federal government rendered illegitimate, a new form of government was needed, and because of tradition and the First World's success with representative democracies, the Second World decided to take the democratic route. Of course, this probably could not have been accomplished without the strong personalities of Gorbachev and Yeltsin.
The adoption of a market economy in China began in 1978 when Deng Xiaoping became head of the CPC and guided the Party toward political and economic pragmatism. But it was never the Party or the autocratic government that had lost legitimacy; it was people in the government that had lost legitimacy. Mao Zedong's policy of perpetual revolution had caused the country to economically stagnate, and atrocities were committed under the Gang of Four, but people still believed in Communism, and Deng Xiaoping brought China a socialism with Chinese characteristics: "Poverty is not socialism. To be rich is glorious."
China had not been a world superpower on the order of the Soviet Union post-WWII and prior to the adoption of market reforms. There was not glorious scientific, athletic, and artistic achievement in China in the post-WWII to Deng period. Communism was not associated with poverty, poverty simply existed, and Deng started to bring China wealth under the auspices of Communism. The CPC has not been without its hiccups since 1978, but it has been remarkably successful at maintaining control and legitimacy.