AUTONOMY AND THE CHOICE OF POLICY IN ASYMMETRICALLY DEPENDENT ECONOMIES

Abstract

OFFICIAL concern at the multiplying problems faced by policy makers is clearly recognisable in Prime Minister Muldoon's remark: 1983 was the year that interdependence leapt out of the textbooks and landed on ministers' desks everywhere .' Persistent recessions since 1974, two oil price shocks and an international debt crisis, have made policy makers all too aware of the links between their economies, and that mutual dependence through trade and capital movements also makes their policy choices interdependent. The problem is serious enough; the average OECD country now exports about 30% of its GNP, so that the spillover effects of policy changes from one country to another can be very powerful. Even the US is 20% dependent on foreign activity. How should policy be designed in these circumstances, and could the international coordination of policy lead to better results? The fact that foreign reactions often interfere with domestic policies has persuaded many politicians to call for coordinated economic policies. Competitive devaluations used to be the standard example, but nowadays few countries can divorce their monetary policies from foreign monetary conditions. Thus not all countries can reduce inflation simultaneously by tight money, high interest rates, or currency appreciation. But if all countries do tighten their policies simultaneously, the losses of output and employment are likely to be larger than any of them planned because of the adverse spillovers between economies. Similarly budget reductions abroad may frustrate domestic reflation plans, while foreign budget deficits can crowd out domestic investment. Given the degree of their interdependence, the European economies have an obvious incentive to export their inflation and unemployment-yet if they all do that, no country will benefit. Similarly, if they all expand together the inflation gains may well be larger, and the employment gains smaller, than expected because of the spillovers. The problem here is clear enough; uncoordinated policies may actually limit our ability to control individual economies. It therefore seems odd that, after a decade of annual economic summit meetings, there is so little evidence on how interdependence should affect policy design. Similarly, although economic theory has shown that coordinated policies can bring gains, there is no evidence on either whether these gains will be significant over a period of time, nor on how they would be distributed between 1 Sir Robert Muldoon at an OECD meeting.