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International Integration and the Interdependence of Economic Variables

Published online by Cambridge University Press:  22 May 2009

Robert D. Tollison  and
Thomas D. Willett
Robert D. Tollison
Affiliation:
The authors are assistant and associate professors of economics and public affairs, respectively, atCornell University.
Thomas D. Willett
Affiliation:
The authors are assistant and associate professors of economics and public affairs, respectively, atCornell University.
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Type
Note on Theory and Method
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International Organization , Volume 27 , Issue 2 , Spring 1973 , pp. 255 - 271
Copyright
Copyright © The IO Foundation 1973

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References

1 An exception is Nye's use of shared services as a measurement of regional economic integration. See Nye, J. S., Peace in Parts (Boston: Little Brown, Inc., 1971).Google Scholar

2 In terms of Nye and Keohane's recent discussion of the major effects of transnational interactions, the first rationale relates to their first two categories, attitude change and international pluralism, while the second rationale is important in terms of their third category, the increase in constraints on states through dependence and interdependence. See Nye, Joseph S. and Keohane, Robert O., “Transnational Relations and World Politics: An Introduction,” International Organization, Summer 1971.Google Scholar

This view of economic and policy interdependence has been stressed, for instance, by Cooper, R. N. in The Economics of Interdependence (New York: McGraw–Hill, 1968).Google Scholar See also the review article by Morse, Edward L., “Politics of Interdependence,” International Organization, Spring 1969.Google Scholar

3 Alker, Hayward and Puchala, Donald, “Trends in Economic Partnership: The North Atlantic Arena, 1928–1963,” in J. David, Singer (ed.), Quantitative International Politics (New York: Free Press, 1968), p. 288.Google Scholar

4 See Hughes, Barry B., “Transaction Analysis: The Impact of Operationalism,” International Organization, Winter 1971, pp. 132–139,Google ScholarCaparoso, James A., “Theory and Method in the Study of International Integration,” International Organization, Spring 1971, pp. 228–253,Google Scholar and references cited in these works.

5 ibid.

6 Russett, Bruce M., “’Regional’ Trading Patterns, 1938–1963,” International Studies Quarterly, 12 1968 (Vol. 12, No. 4), p. 362,CrossRefGoogle Scholar and “Transactions, Community, and International Political Integration,” Journal of Common Market Studies, 03 1971 (Vol. 9, No. 3), pp. 224–245.Google Scholar Also see Caparaso, op. cit., p. 240.

7 Bruce M. Russett, “Delineating International Regions,” in J. David Singer (ed.), op. cit., p. 339.

8 Another use of economic variables to indicate degrees of social integration or regional homogeniety among countries would be to look at the degree of similarity of demand patterns. High levels of economic contact between countries would tend to reduce disparities in patterns of relative prices, and demonstration effects would tend to influence the pattern of consumer preferences as contact between different economies increases. On both counts, increasing economic integration would tend to increase similarity of the patterns of consumer expenditures between trading partners. Thus, in attempting to delineate regional groupings, such as has been undertaken by Russett, op. cit., data on patterns of consumption expenditures could be a useful input. On the relationships between trade and demand patterns see, for instance, Findlay, Ronald, Trade and Specialization (Baltimore: Penguin, 1970), ch. 4.Google Scholar

9 See, for instance, Richard N. Cooper, op. cit., and “Economic Interdependence and Foreign Policy in the Seventies,” World Politics, January 1972. The qualification with respect to international transactions as the mechanism for generating interdependence is necessary because it is possible that in some cases economic developments in one country may effect those in another directly via the interdependence of expectations without transactions being induced. An example would be that the outcome of wage negotiations by a major union in the United States may influence the wage demands of unions in Canada as well as other unions in the United States. Likewise, a portion of the international interdependence of interest rates and forward exchange rates may be brought about directly by ex–pectational effects instead of through international capital movements. On the role of expectations in this context and references to the literature see Thomas D. Willett, “Discussion: Eurodollars, Speculation and Forward Exchanges,” delivered at the 1970 ABA–University Professors of Monetary Economics Conference at Lake Arrowhead, forthcoming in the Journal of Money, Credit and Banking.

A different concept of interdependence proposed by Waltz is discussed in note 10.

10 This concept of interdependence corresponds to the concept of the degree of “openness” of an economy with respect to income changes discussed in the economics literature on balance of payments adjustment. While openness is a multidimensional concept, which may relate to different types of economic activities such as labor and capital mobility and the liquidity value of money as well as trade, we shall illustrate the concept in the text with respect to trade interdependence only.

We should note that the GNP model is frequently a proxy for one of the major aspects of openness, the ratio of traded to non–traded goods. This aspect of openness is quite important for questions concerning the liquidity value of domestic currencies and the efficacy of exchange rate adjustments, questions which are not unrelated to the general question of integration. See, for instance, McKinnon, Ronald I., “Optimum Currency Areas,” American Economic Review, 09 1963,Google Scholar and “Optimum World Monetary Arrangements and the Dual Currency System,” Banca Nazionale del Lavoro Quarterly Review, December 1963. Discussion of these relationships lies beyond the scope of this note, however.

For discussions of the multidimensional nature of the concept of economic openness and how the meaning of the term must be interpreted in the context that it is used, see Wallich, Henry, “Money and Growth,” Journal of Money, Credit and Banking, 1969, pp. 281–302,Google ScholarWhitman, Marina von N., “Economic Openness and International Financial Flows,” Journal of Money, Credit and Banking, 1969, pp. 727–749,Google Scholar and Willett, T. D. and Tower, E., “Currency Areas and Exchange–Rate Flexibility,” Weltwirtschaftliches Archiv, Helf 1, 1970, p. 53, n. 1.Google Scholar

11 The basic idea is that holding constant the elasticities of the underlying demand and supply curves, an increase in the ratio of internationally to domestically traded goods will decrease the elasticity of excess demand and supply for the good, the elasticities from which export and import demand and supply elasticities are derived. For further discussion see R. I. McKinnon, “Optimum World Monetary Arrangements and the Dual Currency System,” op. cit., Orcutt, G. H., “Exchange Rate Adjustment and the Relative Size of the Depreciating Bloc,” Review of Economics and Statistics, 02 1955,Google Scholar and Tower, E. and Willett, T., The Theory of Optimum Currency Areas, Princeton Studies in International Finance, (forthcoming).Google Scholar

12 Recent elasticity studies for trade and capital movements include Houthakker, H. S. and Magee, Stephen P., “Income and Price Elasticities in World Trade,” Review of Economics and Statistics, 05 1969Google Scholar, and Branson, William and Hill, Raymond D. Jr, “Capital Movements Among Major OECD Countries,” Journal of Finance, 05 1971.Google Scholar See also the surveys by Learner, Edward and Stern, Robert in Quantitative International Economics (Boston: Allyn and Bacon, 1970),Google Scholar and Officer, L. H. and Willett, T. D., “The Covered Arbitrage Schedule: A Critical Survey of Recent Developments,” Journal of Money, Credit and Banking, 05 1970,Google Scholar and references cited in these works.

13 Waltz, Kenneth N., “The Myth of National Interdependence,” in Kindleberger, Charles P. (ed.), The International Corporation (Cambridge: MIT Press, 1970), pp. 205–223.Google Scholar For a critical review of a number of additional aspects of Waltz's paper, see Morse, Edward L., “Transnational Economic Processes,” International Organization, Summer 1971 (Vol. 25, No. 3), pp. 373–397.CrossRefGoogle Scholar

14 Waltz, op. cit., p. 210.

15 When looking at dependence with respect to a particular exporting country (B), then the export supply functions would be included with domestic ones in deriving the demand function for imports from country B. Using standard economic techniques, the welfare loss from a given reduction in trade can be approximated by an area under the import demand curve (typically called the “welfare triangle") over the range of reduction in imports. We should warn, however, against a possible misunderstanding. Where we are considering the placement of a tax or tariff on a particular good, welfare losses decrease with increasing inelasticity of the demand function. Inelasticity implies a small percentage change in quantity demanded with respect to a small percentage change in price, and hence the distorting effect (i.e., the reduction of quantity demanded) will be less for a given change in price, the less is the elasticity of demand. How–ever, where the independent change is in the quantity supplied, rather than price, just the reverse relationship holds. For any given externally imposed cutback in the quantity of imports, the welfare measured by the area under the demand curve which will be lost will be greater the more inelastic (i.e., more steeply sloped) is the demand curve. For a recent discussion of the use of the area under demand curves to measure economic welfare, see Harberger, Arnold C., “Three Basic Postulates for Applied Welfare Economics: An Interpretative Essay,” Journal of Economic Literature, 09 1971, pp. 785–797.Google Scholar

16 With respect to Nye and Koehane's list (op. cit.), of the effects of transnational interactions, Waltz's concept would come under category four, the ability of certain governments to influence others.

17 Morse, Edward L., “The Transformation of Foreign Policies: Modernization, Interdependence, and Externalization,” World Politics, 04 1970, p. 371.Google Scholar

18 An interesting case which falls between the extremes of pure high and low politics involves the possibility of countries closing or reducing the access to their domestic markets, i.e., refusing to buy rather than to sell. Examples are the recent temporary import surcharge following President Nixon's August 15 message announcing his new economic policy and the famous chicken war between the United States and Europe during the 1960s. While probably concerned more with the welfare of domestic producers than with national security, bargaining over import barriers is certainly influenced by countries’ mutual dependence and ability to withstand a potential trade war.

19 Morse, E. L., “The Politics of Interdependence,” op. cit., p. 318.

20 Of course, it is possible that concern over both could increase if the overall weight given to economic issues increased sufficiently relative to other types of problems. (It should be emphasized that we are talking about high–level policymaking at this point.) Likewise the election of a president more interested in foreign than domestic policy would at least partially offset the tendency posited by Waltz.

21 See, for instance, Haberler, Gottfried and Willett, Thomas D., U.S. Balance of Payments Policies and International Monetary Reform (Washington: American Enterprise Institute, 1968);Google ScholarOfficer, Lawrence H. and Willett, T. D. (eds.), The International Monetary System (Englewood Cliffs: Prentice Hall, 1969), and references cited in these works.Google Scholar

22 See also the discussion by Cooper, op. cit., p. 152, and Morse, “Transnational Economic Processes” op. cit., p. 395.

28 See Okun, Arthur, Political Economy of Prosperity, (Washington: Brookings, 1969).Google Scholar

24 The tendency of the present international monetary system to breed crisis is also discussed by Morse, “Transnational Economic Processes,” op. cit., as an indicator of policy interdependence. For discussions of interdependence and the crisis problem under the Bretton Woods systems, see Officer, L. H. and Willett, T. D., “Reserve–Asset Preferences and the Confidence Problem in the Crisis Zone,” Quarterly Journal of Economics, 11 1969,Google Scholar and “The Interaction of Adjustment and Gold–Conversion Policies in a Reserve–Currency System,” Western Economic Journal, March 1970.

25 The other most widely used definition of an integrated area, the absence of discriminatory institutional arrangements such as tariffs or quotas, is not a functional definition. For critical discussion of the various major definitions of economic integration, see Nye, op. cit., ch. 2, Cooper, op. cit., ch. 1.

26 For instance, Nye, op. cit., p. 28, seems to imply that this model requires full equality in prices to be operational.

27 As a coamplement, to this, definition., one May also want to look at the similarity of movements of quantites such as the money supply and the level of GNP.

28 For an excellent study of the lag structure of international capital movements, see Branson, William H., Financial Capital Flows in the U.S. Balance of Payments (Amsterdam: North Holland, 1968).Google Scholar

29 For discussions of the importance of the pattern of disturbances on the desirability of a country's undertaking monetary integration, see Willett and Tower, op. cit., Tower and Willett, op. cit., and Willett, T. D. and Tower, E., “The Welfare Economics of International Adjustment,” Journal of Finance, 05 1971.Google Scholar

30 Of course, such harmonization may not be without considerable costs. For discussion of this question see the works cited in the preceding footnote.

31 Empirical studies of the interdependence of trade flows and money and capital markets include Karz, Rolf Pie and Stekler, Lois E., “Induced Changes in Trade and Payments,” Review of Economics and Statistics, 11 1967;Google ScholarArmington, Paul S., “The Geographic Pattern of Trade and the Effects of Price Changes,” International Monetary Fund Staff Papers, 07 1969, pp. 179–201;Google ScholarAdams, F. Gerald and Junz, Helen B., “The Effect of the Business Cycle on Trade Flows of Industrial Countries,” Journal of Finance, 05 1971, pp. 251–268;Google ScholarMorgen–stern, Oskar, International Financial Transactions and Business Cycles (Princeton: Princeton University Press, 1959);Google ScholarTriffin, Robert and Grubel, Herbert G., “The Adjustment Mechanism to Differential Rates of Monetary Expansion Among the Countries of the European Economic Community,” Review of Economics and Statistics, 11 1962Google Scholar (and comment by D. V. T. Bear, February 1966); Whitman, Marina von N., “Economic Openness and International Financial Capital Flows,” Journal of Money Credit and Banking, 1969;Google ScholarRich, George, “A Theoretical and Empirical Analysis of the Euro–dollar Market,” Journal of Money, Credit and Banking (forthcoming);Google ScholarGrubel, Herbert G., “The Interdependence of International Equity Markets,” Journal of Finance, 03 1971,Google ScholarHendershott, Patric H., “The Structure of International Interest Rates,” Journal of Finance, 09 1967, pp. 455–467;Google ScholarBlack, Stanley W., “An Econometric Study of Euro–Dollar Borrowing by New York Banks and the Rate of Interest on Euro–Dollars,” Journal of Finance, 03 1971;Google Scholar and Mendelson, Morris, “The Eurobond and Capital Market Integration,” Journal of Finance, 03 1972, pp. 110–126.Google Scholar

32 Hawkins, Robert G., “Intra–EEC Capital Movements and Domestic Fmancial Markets,” National Bureau of Economic Research Conference Volume on the International Mobility and Movement of Capital, (forthcoming).Google Scholar

33 ibid., p. 34.

34 Pendergrass, Robert, “Measurement of Economic Integration in the European Economic Community,” unpublished MBA Honors Thesis, Graduate School of Business and Public Administration, Cornell University, 1971.Google Scholar

35 See, for instance, Nye, op. cit., p. 31.

36 For a recent review of this debate and references to the literature by Deutsch, Kuznets and others, see Morse, “Transnational Economic Processes,” op. cit., Section III.

37 See Oskar Morgenstern, op. cit. Also of interest are the discussions by Cooper, op. cit., pp. 150–153, and Leland B. Yenger, International Monetary Relations (New York: Harper and Row, 1966), ch. 14.Google Scholar Of course, besides looking just at indices of interdependence and integration, much fruitful historical work can be undertaken in attempting to ascertain the causation of observed associations. For instance, on the debate over whether the observed interaction between the balance of payments of the United States and United Kingdom during the previous century was caused primarily by events originating in one country or the other, see Jeffrey G. Williamson, American Growth and the Balance of Payments: 1820–1913 (Chapel Hill: University of North Carolina Press, 1964).Google Scholar