Phelps on what might be wrong with Economics

This is an interesting article by Edmund S. Phelps (Nobel prize winner in Economic Sciences, 2006) that takes up an important topic:

Enjoy the semester break!


Natural Resources


The question of whether natural resource endowment is a good or bad thing, in regards to its contribution to both economic and political development in individual nation-states, is a rather complex one. Natural resources, “stocks of material that exists in the natural environment that are both scarce and economically useful in production or consumption, either in their raw state or after a minimal amount of processing” (WTO, 2009), without a doubt, play a dominant role in the economy of many nation-states. But in Rents to Riches, Barma explained that, too often the extractive industries of mostly resource-dependent developing countries have been plagued with what he termed a “resource curse” (p.1). This he attributed to the fact that, most of these countries “pursue short-sighted, suboptimal policies for extracting resources and capturing rent” through the unfair allocation of the resultant dividends to the ruling elites rather than for the public good. In this paper, we will be focusing on economic, as well as political, explanations for the advent of the resource curse and suggest some policy recommendations in an attempt to proffer solutions to some of the issues raised.

Economic Explanations

In this section, we will be exploring the economical perspective in relation to the political economy of natural resources. At first glance, natural resources can be deemed to be advantageous for the development of a particular national economy. This vıew was supported by most development economists, in the early 1950’s. They claimed that less developed countries, which mostly suffer from capital shortfalls, with an abundance of natural resources can export primary products to overcome their capital shortfalls to boost their economy (Ross, Michael L., World Politics, p.301). Not only in the case of less developed countries can it be beneficial, but in that of developed countries as well. An example can be seen in the case of Norway, the second largest exporter of natural gas and fifth largest exporter of oil, and considered as one of the richest world economies. (Paltseva and Jesper, 2011, p.2). ´ On the other hand, the abundance of natural resource might create unexpected hardship on national economies. We can take the Democratic Republic of Congo as a counter example. Congo is the world largest producer of cobalt (49% of the world production in 2009), of industrial diamonds (30%) and is also a large producer of gemstone diamonds (6%). It has around 2/3 of the world’s deposit of coltan and significant amount of copper and tin deposit. However, it has the world’s worst growth rate and the 8 th lowest GDP per capita over last 40 years (Paltseva and Jesper, 2011, p.1). Moreover, when we consider the fast growing economies in East Asia such as Hong Kong, South Korea and Singapore, they all have less natural wealth in comparison with the less developed countries with natural wealth such as in Africa and other Latin American countries. All these examples and contradictions put the arguments which support natural resources-led development in a questionable condition.

While most economists argue that natural resources is a windfall for indıvıdual economies, other economists like Prebish and Singer and most structuralists, challenge this assertion. There are, in general, four main economical explanations why the natural resources might actually harm the national economies rather than helping for their development. First of all, countries who only rely on export of primary commodities can suffer from a decline in the terms of trade. In fact, recent studies revealed that aggregate terms of trade for primary commodities have been on a steady decline since the early 20th century (Ross, Michael L., 1999, p.301-303). The second skeptical economic outlook on natural resource-led development is the instability of the international commodity markets. International commodity markets are usually influenced by unexpected sharp price fluctuations. Countries that only depend on primary product exports can be harmed by this price fluctuations since international markets can affect national economies through foreign exchange and government revenues from this exports (p.304).

A third explanation is the poor economic linkage between the commodity exports and other sectors of the domestic economy. When this linkage is poor, earnings from natural resource industry may encounter difficulties in stimulating other sectors of the economy. This hardship occurs when resource extraction in the domestic economy is mostly owned by foreign multinational companies and particularly, when these foreign multinational companies are allowed to repatriate their profits abroad instead of investing this profits to the host country (p.305). The fourth economical explanation for the so-called “resource curse” is a boom in natural resource exports that may create economic stagnation. This phenomenon is termed “Dutch Disease”. Dutch Disease occurs through two different channels at the same time. First, when there is a boom in resource export, this creates an appreciation in real exchange rates. At the same, it creates a boom in the resource sector to draw capital and labor away from the manufacturing and agricultural sectors of the domestic economy which in turn increases the production costs at the end. This two combined effects lead to a decline in the exports of the manufacturing and agricultural sector and can lead to an increase in the costs of the goods and services in the nontradable sector, which cannot be imported (p.306-307).

Another additional observation on the undesirable effects of natural resources on the domestic economy is the link between the rents from the natural resources and corruption. This link is related to the competition level of the resource sector in the economy. One economical explanation is that, less competition means higher rents for companies and creates a tendency for bureaucrats, who have the control rights over them e.g. tax inspectors and regulators, to behave malfeasantly. Therefore, natural rents and rents induced by the lack of product market competition may foster corruption. (Ades and Di Tella, 1999, p.982-983). However, empirical studies on the relationship between natural resources and corruption are relatively few. The case of Nigeria in the 1970’s is a good example in portraying this relationship. After the oil shock of the 70’s, observers noted that Nigeria’s oil income created extraordinary opportunities for corruption to fester due to the increase in rents of the natural resources (p.982).

Political Explanations

In the field of Political Science research, and in regards to the widely observable prevalence of a resource curse amongst primary commodity exporting nations, Michael Ross postulated that, there currently exist only “weak non-cumulative findings”. He further went on to argue that, “this dearth in hypothesis testing,” in this regard, according to Ross, “has hindered the contribution of political science to the study of resource curse” and “[m]ore subtly, has enabled political scientist to produce theories that are unworkably vague” (p.321). Ross earlier identified three categories of these theories in trying to explain a possible Political basis for the reoccurring phenomenon that is the resource curse in his article, The Political Economy of the Resource Curse. First, was a cognitive explanation that entailed the contention “that resource booms produce a type of shortsightedness among policy maker; societal explanations, which argue that resource exports tend to empower sectors, classes or interest groups that favor growth-impending policies; and state centered explanations […] which contend that resource booms tend to weaken state institutions” (p.298).

Thad Dunning expounded on the political angle of understanding the behavior involving governments of resource-rich nations by focusing on what he termed: “the political foundation of resource dependence” brought about by resource wealth in his conditional theory of the resource curse. Making use of examples from three case studies that included: Mobutu’s Zaire, Suharto’s Indonesia, and post-independence Botswana, in a description of the three equilibrium path model of a resource rich political economy, Dunning came to the conclusion that there exist variations in outcomes among resource-rich countries that can be linked to the existence of political and economic incentives for elites to diversify as well as the factors that influence these incentives. He further outlined how the world market structure for the resource, the degree of societal opposition to elites, and the prior development of the non-resource private sector can influence elites’ incentive for diversification and thus shape outcomes along the dimensions of political stability and economic performance (p.451).

In the case of Botswana, a stable market in the diamond industry was an incentive not to diversify, while the degree of opposition was the incentive not to in the case of Mobutu. For Suharto, development in the non-resource sector led to incentivized diversification with the main aim of each of these cases being the attainment of political stability. But what Dunning failed to take into account was other factors like violent suppression of the opposition by each of these despotic regimes and that such stability may also prove to be unsustainable in the long-term as Mobutu was subsequently forced out of power in 1997 as Zaire (now the Congo) was plunged into a long drawn-out and bloody civil war while Suharto was disgraced out of office in 1998. This further reinforces the argument of Ross regarding the prevalent “weak non-cumulative findings” in the political science field.


In Barma’s Rent to Riches he further expounds on what he termed the resource paradox in which resource-rich countries tend to grow more slowly than other poor countries—even after such variables as initial per capita income and trade policies are taken into account. He provided several pathways for intervention that could be implemented by resource-rich governments that could to enhance the developmental orientation of the natural resource management (NRM). He outlined three main incentives-compatible interventions. They include, policies aimed at extending time horizon and thereby improving inter-temporal credibility e.g. emphasis on a process that grants resource concessions, leading to a minimization of investors uncertainty and the enhancement predictability; policies that mobilizes stakeholders to cooperate on such NRM, which expands political inclusiveness e.g. through the use of model contract and fiscal regime; and policies that enclave institutions and capacities in NRM in order to foster some form of functionality in a context of perverse political economy dynamics (p.221).

Also, in accordance with the “good-fit” approach for the extractive sector, proposed by Barma, individual policies have to be implemented that functions properly in each section of extraction, taxation or investment. This differentiation helps to ameliorate the adverse effect of weak inter-temporal credibility and low political inclusiveness. Further prescriptive suggestions for promoting better NRM, particularly in cases of nation-states with weak institutions may include the promotion of transparency as a precondition to addressing the apparent poor management of natural resources (Ascher, 1999). In this regard, the Extractive Industries Transparency Initiative (EITI) provides an institutionalized mechanism for reconciling and validating information concerning the payments made by firms operating in the extractive industry, and the payments governments report as received. The EITI is built on a multi-stakeholder platform that brings together governments, extractive companies and civil society, which requires among other things some common norms and standards, and ensures there’s more accountability amongst resource extraction companies. There still exist more room for improvement both in the field of research and establishment institutional mechanisms that can alleviate the prevalence of the so-called “resource curse.”

Ades, Alberto and Di Tella Rafael (1999). The American Economic Review, Vol. 89, No. 4, p 982-993 Barma, Naazneen, et al. (2011). Rents to Riches?: The Political Economy of Natural Resource-Led Development. World Bank Publications
Dunning, Thad. (2005). Resource Dependence, Economic Performance and Political Stability. Journal of Conflict Resolution 49 (4) p.451-482
Michael L. Ross (1999). The Political Economy of the Resource Curse. World Politics, 51, pp. 297-322
Paltseva, Elena, and Roine, Jesper, (2011). Resource Curse: What Do We Know About It? Web: (Access: 29.06.2015)
Paltseva, Elena (2013). Empirical Evidence on Natural Resources and Corruption. Web: (Access: 29.06.2015)

Who gives foreign aid to whom and why?

While many would certainly agree that we have – at least in theory – the capacity to eliminate hunger from the face of the earth, it remains, until today, a crucial question what role development aid from government(s) to government can or should play in this endeavor. This essay seeks to shed light on exactly this question. The answer to it seems mainly dependent on two aspects: First, what motivates official development aid (ODA)? Second, what does ODA effectuate? After examining these two questions for bilateral ODA and ending up with sobering results we will ask, whether multilateral aid via international institutions can cure some of the deficits of bilateral aid.

What motivates ODA?

In contrast to what pure economic rationality and also altruism would suggest, donors do not determine whom to give aid to by investigating mainly the economic openness and democracy or the level of poverty of the different recipients. It is rather political and strategic incentives that determine the decision of aid distribution. A developing country gets only 17% more bilateral aid if it is relatively open in economic terms ceteris paribus. Relatively here refers to being one standard deviation above the mean. Countries being relatively democratic, ergo one standard deviation above the mean in policy terms, can expect 36% more ODA. Having a relatively long colonial past brings in 72% more aid – this variable is measured with the number of years in the 20th century a country was colonized. It is important to note here, that those 72% are essentially paid by the former colonial power. Another determinant, which qualifies a country as aid recipient, is being an “UN-Friend”. UN Friend means voting with the donor most of the time in the UN General Assembly. This correlation exists especially in the case of Japan, who increases its aid by 177% for such countries.

The fact that bilateral aid is mainly incentivized of political interests and strategic concerns becomes most obvious when considering the amount of aid allocated to Egypt and Israel. For Egypt we note an increase of 481% above average, for Israel the amount is estimated to be even higher. (Dollar, Alesina 1998: 8f.) Those numbers clearly imply some political and strategic incentives in the donors’ decisions. Among others these policies serve the securitization of trade routes and the overall stability in the Middle East.
It is, however, also the case, that democratizers get a substantial increase in aid, viz. 50% and trade liberalizers get an increase of 25%. (Dollar, Alesina 1998: 23).

Besides the foreign policy objectives examined above, also domestic policies play an important role in determining aid flows. Studies show that the probability of American legislators voting for foreign aid in the Congress is affected by two factors. First, economic characteristics of a legislator’s district which reflect the interests of the constituency in aid. (Milner, Tingley 2010: 203) Since redistributive effects of foreign aid advantage individuals owning a higher level of capital, legislators of districts with a majority of capital owners are more likely to vote in favor of aid. (Milner, Tingley 2010: 210) Second, legislators from districts with a majority of individuals who have a right-wing ideology will be more likely to oppose foreign aid in order to satisfy the ideological beliefs of their constituency and thereby increasing their chances of being re-elected. (Milner, Tingley 2010: 210).

Thus, the pattern of aid flows is in fact mostly dictated by political as well as strategic considerations, where both foreign and domestic policy objectives are taken into account. They have, however, little to do with rewarding good policies and helping more efficient and less corrupt regimes in developing their countries. (Dollar, Alesina 1998: 1)

What does ODA effectuate?

One must not believe in the necessity of true altruism in order to find these facts problematic. Burnside and Dollar (1997: 3) apply a neoclassical growth model to argue “that foreign aid has a positive effect on growth in a good policy environment”. In reality however, “the donor interest variables seem to overwhelm the effort to reward good policy (..).” In other words: If foreign aid was strictly distributed according to economic efficiency a dramatically different allocation from the observed one would result. Consequently, Easterly is wrong, when he argues that this scientific result has heavily influenced the foreign aid policies of donors (Easterly 2003: 23), for if it had, how come there is still such a large part of foreign aid that is not distributed according to economic efficiency?

What Easterly manages to show, however, is that measuring the economic effectiveness of foreign aid is highly dependent on the operationalization of variables such as ‘aid’, ‘good policy’ and ‘growth’. For instance, if one includes concessional loans into the definition of ‘aid’ and not only grants, all of a sudden the statistical significance between good policies, foreign aid and economic growth is no longer observable. As a consequence, the assumption that foreign aid leads to economic growth if only the right fiscal, monetary and trade policies are applied is too simple, for cultural, institutional and historical particularities are lost out of sight under neoclassical growth models. In Easterly’s words: “The idea of aggregating all this diversity into a ‘developing world’ that will ‘take off’ with foreign aid is a heroic simplification.”

Having outlined the difficulty of measuring and predicting the economic consequences of foreign aid, how about its political consequences? Or to quote Kono and Montinola: “Does Foreign Aid Support Autocrats, Democrats, or Both?” Their answer slightly relativizes the often repeated concern about foreign aid propping up autocratic governments. While “over the long run sustained aid flows promote autocratic survival because autocrats can stockpile this aid for use in times of crisis” they also find that “each disbursement of aid, however, has a larger impact on democratic survival because democrats have fewer alternative resources to fall back on.” (Kono, Montinola 2008: 716). In addition, support of autocratic governments is not undesirable per se, because it might prevent citizens of autocratically governed countries from starving to death, for instance. In these rare cases, the unwanted side effect of supporting autocrats might be the lesser evil.

Multilateral Aid

Our findings appear to confirm the assumption that the act of allocating bilateral aid is by no means incentivized by moral commitments or altruistic motives. In fact, self-interests, policy objectives and strategic concerns determine “Who gives aid to Whom and Why?” like Alesina and Dollar put it (1998). It goes without saying, that as soon as the donor country gives top priority to its national interests, the recipient’s needs and well-being become secondary. Under these circumstances bilateral aid allocations are charged with disregarding its actual purpose, which is to bring about development and to fight poverty. It is for this reason that multilateral aid is now brought into focus.

Multilateral aid disbursements are pooled by and channeled through international aid agencies. The multilateral institution is in funds of expertise and experience besides having the capacities to promote development projects on a larger and more professional scale. It acts as an intermediary between the donor and the recipient and in so doing neutralizes the self-interest of the former and pays respect to the needs of the latter. In consequence, one should rightly assume that multilateral aid arrangements are less corrupted by political manipulation than bilateral aid allocations. In fact, however, there are cases which controvert this assumption. For better or worse member states of multilateral aid agencies find ways and means to exert influence on seemingly objective decisions for aid allocation.

In their paper “Delegation to International Organizations: Agency Theory and World Bank Environmental Reform” Nielson and Tierney set a positive example on how members states succeed in influencing institutional decisions. Reportedly, the World Bank invested in development projects, which were accused of causing fatal environmental damages. Despite all the severe criticism raised, World Bank officials did not change their course of action. Up to the moment in which the United States of America as the largest shareholder “grew serious about environmental reform at the Bank” and threatened to cease payments the World Bank encouraged reforms. (Nielson, Tierney 2015:258)

On the other hand, Dreher, Sturm and Vreeland quote rather negative examples. Their paper “Global Horse Trading: IMF loans for votes in the United Nations Security Council” investigates whether it is true that non-permanent members of the Security Council trade their vote for IMF grants. They compile a set of occurrences of the following pattern: for instance Yemen as an aid recipient country failed to vote in favor for the United States of America and was subsequently confronted with the suspension of its IMF arrangements. Vice versa, there are reported cases in which “the United States apparently used its influence at the IMF to change the voting at the Security Council”.(Dreher et al. 2008:724) For instance Romania which was granted considerable IMF loans, backed all the US-supported resolutions during its UNSC tenure. These findings demonstrate that even multilateral aid arrangements are not protected against national influence and control.

It confirms that the allocation of aid – bilateral or multilateral – is by no means to be confused with an altruistic expression of moral commitment but in fact subject to substantial strategic interests. In evaluating its impacts one has to bear in mind that foreign aid is not given on the basis of where it is needed the most, but where it best serves the donors’ interests.

In consequence, to expect ODA to eliminate world poverty would be naive in the light of the motives we have summarized above.

Alesina, Alberto/ Dollar, David (1998): Who Gives Foreign Aid to Whom and Why? NBER Working Paper No. 6612.
Burnside, Craig/ Dollar, David (1997): Aid, Policies and Growth. Policy Research Department, World Bank.
Dreher, Axel/ Sturm, Jan-Egbert/ Vreeland, James Raymond (2009): Global horse trading: IMF loans for votes in the United Nations Security Council. European Economic Review 53 (2009), 742-757.
Easterly, William (2003): Can Foreign Aid Buy Growth? The Journal of Economic Perspectives, Vol. 17, No. 3, (2003), 23-48.
Kono, Daniel Yuichi/ Montinola, Gabriella R. (2009): Does Foreign Aid Support Autocrats, Democrats, or Both? The Journal of Politics, Vol. 71, No. 2, (2009) 704-718.
Milner, Helen V./ Tingley, Dustin H. (2010): The Political Economy of U.S. Foreign Aid: American Legislators and the Domestic Politics of Aid. Economics & Politics, Vol. 22, No. 2, (2010), 200-232.
Nielson, Daniel L./ Tierney, Michael J. (2003): Delegation to International Organizations: Agency Theory and World Bank Environmental Reform. International Organization, Vol. 57, No. 2 (2003), 241-276.

The Political Economy of the WTO. Non-Preferential and Preferential Trade Agreements: Friends, Foes or Strangers?

World trade, quo vadis? The current global state of affairs

After more than 12 years of deadlock, going through 9 rounds of negotiations at the ministerial level, the Doha Development Round (DDR) of the WTO, initiated in 2001, finally approved the ‘Bali Package’ [1] by the end of 2013. This agreement, however, is merely a first offshoot and only a small part compared to the DDR’s original objectives[2]. One cannot stop wondering: how much more time will it take to reach agreements, approved by all 161 WTO members (MS), in other more controversial areas, such as those concerning agricultural products. As a bloc of developing countries (DCs) has been formed in the WTO, they are now more pressure-resistant to the demands of developed countries, which dominated the international trade agenda in the later half of the 20th century. Simultaneously, Preferential Trade Agreements (PTAs) are proliferating. According to the WTO statistics, as of April 2015, 262 Regional Trade Agreements (RTAs)[3] are currently in force. And not only in terms of number, the scope of PTAs is expanding as well. ‘Mega-PTAs’[4] like the Trans-Pacific Partnership (TPP)[5], the Transatlantic Trade and Investment Partnership (TTIP)[6], and ‘Mercoeuro’[7] are under progress. This essay will examine to what extent PTAs pose challenges to the WTO.[8] Will they, for instance, so marginalize the WTO that the latter becomes obsolete? Will it be more likely for them to integrate into the WTO? Or, if so possible at all, should PTAs be regarded as distinct phenomena with no relation to the WTO?

The WTO legal framework, exceptions and original purposes of PTAs

WTO agreements are basically Non-Preferential Trade Agreements (NPTAs), built upon two principles: reciprocity and non-discrimination. In other words, every WTO member has the right of the Most Favored Nation (MFN)[9] treatment. PTAs, on the other hand, are by definition discriminative in nature (it is true that the distinction between the two is more a matter of degree than of kind[10], but for simplicity’s sake, we leave the distinction aside at the moment).

However, PTAs are not something new, alien or totally external to the WTO legal framework. The MFN allows for two exceptions of the basic principles: (1) if formulating a PTA is to the benefit of developing countries or (2) if the envisioned PTA maximizes the total welfare of the whole world. More specifically, exceptions allowed for are based on Article 24 of the General Agreement on Tariffs and Trade (GATT) of 1947 as well as Article 5 of the General Agreement on Trade in Services (GATS) of 1994, according to which any MS can participate in a PTA, if the PTA removes barriers to ‘substantially all the trade’ among MS, and does not ‘on the whole increase of protectionism against non-MS’. In addition, the ‘Enabling Clause’[11], incorporated into GATT in 1979, strengthens the possibility of DCs to form PTAs with one another. These exceptions, although written for greater flexibility to the functioning of the WTO, are clearly contrasting the fundamental multilateral trade principles of reciprocity and MFN.

The relationship between the WTO and PTAs[12]

This said, depending on the context, the relationship between the WTO and PTAs can be classified into three categories: friends, foes, and strangers.

How would they be friends?

By friends, we mean the WTO and PTAs are in a mutually beneficial relationship. As the ‘single undertaking’ approach of the DDR – that ‘nothing is agreed until everything is agreed’ – is deemed to be time-consuming, and the fact that the nature as well as the scope of trade and the (gobal) socio-economic environment has changed significantly, it seems to be a pragmatic approach to prioritize PTAs, which are in comparison easier to be agreed upon, i.a. because of the smaller number of MS. Successful PTAs might then provide momentum to bring the DDR into a fruitful conclusion. The North American Free Trade Agreement (NAFTA), signed in 1992, is arguably such an example. Former US trade representative Carla Hills actually claimed that it saved the Uruguay Round (1986-1994), leading to the creation of the WTO soon afterwards. Mutual recognition first achieved among the PTA members thereby attributed to a positive conclusion of the Uruguay Round. From this perspective, the debate on WTO vs. PTAs is simply misguided and inappropriate for the goal of a multilateral trade framework which is influenced and essentially brought about by PTAs. Ultimately, one might rather speak about multilateralization of plurilateral agreements.

In fact, PTAs are considered as ‘second best’ when compared with multilateral free trade. Assuming that both share the same purposes, which are to reduce trade barriers for trade liberalization, it should only be reminded that “plurilateral agreements and the multilateral trading system (MTS) can effectively work in mutually supportive ways, but the first could be inefficient – or even detrimental in some cases – without the latter.” (Meléndez-Ortiz, 2012).

How would they be foes?

How then can PTAs as potential building blocks to the WTO turn to become its own stumbling blocks, i.e. from friends to foes?
Firstly, PTAs are by definition internally liberalized, but externally protectionist in nature. MS might experience trade creation whereas non-MS might suffer from trade diversion. Current mega-PTAs as TTIP & Co. could eventually undermine the MTS by rewriting international trade rules in the future, making the exceptional to become norms.

Secondly, it is argued that (hegemonic) PTAs would put DCs into a disadvantaged position[13], for these PTAs often include “trade-unrelated agendas”[14], i.a. stricter labor and environmental standards. Developed countries could then use these as a form of “export protectionism” (Bhagwati, 2008), enforcing DCs to follow the same standards, which results in a loss of their competitiveness because of higher cost of production. One of the consequences would be a widening wealth gap between DCs and developed countries by institutionalizing, i.e. legitimatizing the trade advantage of the latter. This contradicts especially the DDR’s multilateral objectives to “make positive efforts designed to ensure that [DCs], and especially the least developed among them, secure a share in the growth of world trade commensurate with the needs of their economic development.”[15]

Thirdly, as both, WTO and PTAs, hold own dispute settlement mechanisms, issues of “forum shopping” and overlapping jurisdictions, like multiple ruling on a same dispute between the same members, might arise. As a consequence, “a web of bilateral dispute resolution fora” prevails and increases the risk of conflicting rulings to reduce predictability, not only for governments but also for producers and traders. Jain (2007) regards this dichotomy as a new dimension in addition to the traditional regionalism vs. multilateralism debate yet to be solved.

How would they be strangers?

Thinking about the relationship between the MTS and PTAs as inherently strange we assume both being substantially different with respect to their nature and purposes. Even though implemented in the legal framework with the intention to provide greater flexibility to the functioning of the WTO, PTAs do not lead to free trade. Krishna (2012) indirectly delivers evidence to this view by showing that intra-PTA trade shares are relatively small for most PTAs. Therefore, PTAs are not to be judged on the alleged global fragmentation of trade and might take a neutral position. Even though this might not to be wished for, mega-PTAs indicate a change in the purpose of such agreements. Bhagwati (1997) emphasizes the importance of trade-unrelated agendas, which cast doubt on the real aims of PTAs: “[It] is deceptive, when all it means is that new members may apply and be accepted if approved by national legislatures, with all the ‚nontrade’ conditions that are now attached to such membership”. In line with Krishna (2012) and Bhagwati (2008), Hosuk Lee (2014) offers a clear-cut summary on the strangeness of WTO and PTAs: “It’s simply not true assuming the things that can be done in bilaterals can also be done in Geneva”. Whether these arguments might be sufficiently plausible to contemplate about the inherent strangeness of WTO and PTAs, is subject to the reader’s beliefs.

Final Considerations

The purpose of each PTA varies from each other – some might be formed mainly because of geo-political strategic reasons like the US-Jordan free trade agreement, while others like TTIP concerns above all trade – so the impact of PTAs on the WTO has to be contextualized in each case; they can be friends, foes, or strangers, dependent on the nature of the particular PTA concerned. From an empirical perspective, Freund and Ornelas (2010) find out that trade creation tends to be the norm in RTAs, and conclude that RTAs in general have so far been more of a blessing than a burden for the multilateral trading system. Of course, this friendly relationship can be broken one day due to new rules laid out in those mega-PTAs, but it needs to be confirmed by further empirical studies in the future.

[1] Officially named as ‚The Bali Ministerial Declaration’. For more information see:

[2] DDR’s 3 objectives are as follows: 1. Market access for agricultural products (including tariffs and subsidies), for industrial goods (‚non-agricultural market access’), and for services, 2. Rules, e.g. on trade facilitation and anti-dumping, 3. Development. Retrieved from Bendini, Roberto:
The European Union and the World Trade Organization. Factsheet on the European Union. 2015. P. 2.

[3] RTAs are one of the different specific types of PTAs.

[4] Also referred to as ‚mega-bilaterals’, ‚mega-regional PTAs’ or ‚trans-regional PTAs’.

[5] Plurilateral agreement between the US and 11 states. The plurilateral method is defined as between more than two states but not a great many, which would be considered as multilateral.

[6] Bilateral agreement between the US and the EU.

[7] Bilateral agreement between the EU and Mercosur.

[8] Due to the quantity of possible arguments and positions adopted in academic and political debates on this topic, this essay will only address a selection of what we consider the most relevant arguments.

[9] MFN is mentioned under Article 1 of GATT: Any WTO member has to give the same
best treatment to all other WTO members, so that they all remain most favored.

[10] WTO. World Trade Report 2011, p.49.

[11] The ‚Enabling Clause’ permits discrimination between categories of trading partners as ‚developed’, ‚developing’ and ‚least developed country’.

[12] The title ‘Friends, Foes or Strangers?’ is retrieved from Bhagwati, J., & Panagariya, A. (1999). Preferential Trading Areas and Multilateralism: Strangers, Friends, or Foes?

[13] Hegemonic PTAs refer to PTAs with the US and/or the EU as MS. Another argument on (non-)hegemonic PTAs claims that hegemonic PTAs in itself have massive consequences for the whole world whereas non-hegemonic PTAs have comparatively more consequences for the respective regions. See: Bhagwati (1996), p.31.

[14] Also referred to as ‘advanced trade issues’.

[15] WTO. Trade topics. Doha agenda. Online available at dda_e.htm.

[16] Defined as a litigant’s attempt “to have his action tried in a particular court or jurisdiction where he feels he will receive the most favorable judgment or verdict.” Retrieved from Jain (2007), p. 1.

Bendini, R. (2015) The European Union and the World Trade Organization. Factsheet on the European Union. P. 2.
Bhagwati, J., & Panagariya, A. (1999). Preferential Trading Areas and Multilateralism: Strangers, Friends or Foes? P. 33-100.
Bhagwati, J. (2008). Termites in the Trading System: How Preferential Agreements Undermine Free Trade. P. 78.
Bhagwati, J. & Krishna, P. & Panagariya, A. (2014). The World Trade System: Trends and Challenges. Columbia University, Johns Hopkins University.
Gordon, F (1997). Book review on ‘The Economics of Preferential Trade Agreements’ by Bhagwati, J. and Panagariya, A. (1997). Asia-Pacific Review. Volume 4, Number 2. 1997. P. 169.
Jain, G. (2007). The Luxury of Forum Shopping in International Trade Disputes: Problems and Solutions. Briefing Paper (8). CUTS Centre for International Trade, Economics & Environment, Jaipur, India. P. 1. Online available at:
Krishna, P. (2012). Preferential Trade Agreements and the World Trade Aystem: A Multilateralist View. No. w17840. National Bureau of Economic Research. P. 1.
Meléndez-Ortiz, R. (2012). The Future of the WTO. Confronting the Challenges. International Centre for Trade and Sustainable Development (ICTSD). P. 10. Online available at
Freund, C. & Ornelas, E. (2010). Regional Trade Agreements: Blessing or Burden? CEP. Online:
Hosuk Lee at the Asan Plenum 2014 on „WTO vs Mega FTAs“, The Asan Institute for Policy Studies. Online available at

What role do multilateral international organizations play in global governance?

Traditional conceptions of global governance associate it with the actions of nation states. But the development of technology and the further deepening of the global market economy posed new challenges the solution to which goes beyond the expertise of state representatives. The outcome has been a relegation of responsibility to non-state actors or multilateral institutions with the tools and personnel capable of meeting the challenges of an increasingly complex global political economy. Multilateral international organizations can be separated into two categories: intergovernmental and nongovernmental organizations. Notwithstanding the role of state actors in shaping the global political economy, this essay, however, will focus on the latter kind; specifically paying attention to how civil and private organizations that operate beyond national boundaries are influencing global governance processes. In the following, the essay will take a brief look at the role of NGOs and élite clubs such as the World Economic Forum (WEF) in the governance of our world.

Contribution to the global governance

NGOs differ from each other in many ways they have varying degrees of scope and influence, are composed of different types of members, have their own structures and hierarchies, own goals, motivations, interests, tools, ideologies and sets of challenges. These differences make it difficult to carve out a single definition for NGOs. But for the purpose of this essay we shall focus on two specific kinds: Social NGOs and Club NGOs. The two types of NGOs differ primarily in their focus. Thus, social NGOs are „outward looking“ in the exact sense that they are primarily focused on advancing interests beyond their immediate ones; they provide a public good. Club NGOs on the other hand are more „inward looking“ such that advancing the interests of their own members, or shaping society according to their own values, is their underlying goal.

Social NGOs in particular, occupy a unique space between government and civil society. The motivation of individuals to „ coalesce with likeminded others “ (Teegen et al. 2004, p. 465) in order to achieve goals that just one or few individuals cannot achieve on their own often emerged from vacuums and gaps created by the nation states. This is usually due to the fact that governments fail to meet certain needs of their citizens. Hence, one important role that the NGOs play is increasing awareness as well as mitigating social, political, or environmental problems on national, regional, and international levels.
Using various tools and methods such as lobbying, networking, and campaigning NGOs are able to establish certain spheres of action and influence, making it harder for governments to ignore the pressing demands of the civil society. Furthermore, because of the knowledge and practical skills possessed by NGOs in their various fields of work, they have become the „go to source“ of expertise by state actors in critical moments such as relief coordination on a national, regional and global scale. Thus, accomplishments such as contributing to the establishment of the International Criminal Court, as well as shaping the UN’ s human rights policy, has pushed NGOs from the backstage to the main stage of international politics. Thus, the close ties established with intergovernmental organizations like the UN and the World Bank express the importance as consultants that NGOs have gained over decades.

While there is plenty of research and information to be found on NGOs, information about elite clubs and their role in global governance is rather limited. Unlike their „outward looking“ counterparts, Élite clubs are more exclusive. This separation from the rest of society is an attractive feature of the club to the global elites. It provides security – or at least the sense of it and confers a sense of prestige on those with membership. One of the biggest international élite clubs, the WEF, has gained a certain image and reputation over the years of its existence; attracting some and repelling others. Officially as a nonprofit foundation, the WEF is „ committed to improving the state of the world through public-private cooperation “ (WEF 2015). Yet the annual meeting in Davos, Switzerland, is of a very exclusive nature: only paying members over 1000 big international enterprises of different sectors and specifically invited guest gain full access to the conference and thus, to the network of high-ranking business leaders, politicians, scholars, and well-disposed journalists.

The annual conference is also used as a neutral ground for meetings between conflicting parties, such as Yasser Arafat and Shimon Peres or Greece and Turkey, which resulted in the no-war agreement called „ The Davos Declaration“ in 1988. Research reports, such as the Global Competitiveness Report, are intended to help countries to recognize opportunities for improvement in areas such as trade, tourism, gender studies etc. Various initiatives, dealing with issues of environment, health, education, corruption etc., are dedicated to bringing public and private actors together in order to tackle these problems. Here lies the special feature of the WEF: it obtains its legitimacy in the expertise and influence of its members (largely public officials and high ranking business leaders with important knowledge and ideas). Thus, by „clubbing“ and utilizing those expertise and ideas, elite clubs like the WEF is able to claim a stronghold hold over solutions to global financial and economic problems that prove too complex for state actors to tackle.

Challenges & responses

Some of the challenges facing NGOs and elite clubs alike are the lack of legitimacy, credibility, and transparency. In the case of Social NGOs, dependence on state and private enterprises for funds often compromises their credibility in the eyes of the general public. If their work is to help civil society fight against some of the problems created by governments and corporations, financial dependency on those entities could weaken their effectiveness. Other criticisms include the lack of transparency, mismanagement and cultural insensitivity on the part of „Western“ NGOs in their involvements with the global South.

In the case of elite clubs, it is apparent that the „ public“ doesn’t have access to this gathering, apart from reading newspaper articles and watching webcasts of official panels that take place during the conference. The informal networking is taking place behind closed doors, showing that the powerful few are excluding the majority of people. This has raised a number of criticism against it as more of a social network forum than a credible assembly of elites concern with the welfare of the rest of the world. Some of the criticism against elite clubs such as the G30 and the WEF comes in the aftermath of the Global Financial Crisis of 2008. For many, the lack of regulation on Over the Counter-Derivatives which contributed to the crisis was the result of the policy recommendations of the G30. This has helped to shape an image of multilateral elite clubs as corporate friendly and less concerned about global welfare.

But their lack of credibility does not undermine the reality of their influence on global governance through the provision of policy recommendations and a forum where global governors exchange ideas with business leaders who have a stake in the global political process. As long as the knowledge needed to safely guard the global economy lies outside the hands of state actors, their dependency on those who claim to possess such knowledge and ideas, that is the elites, will be the source of the power and gateway to global governance for elite clubs.

Graz 2003, „ How Powerful are Transnational Elite Clubs? The Social Myth of the World Economic Forum “ . Rast, Deborah 2008,, 13.06.2015
Teegen/Doh/Vachani 2004, „ The importance of nongovernmental organizations (NGOs) in global governance and value creation: an international business research agenda “ . University of Dublin 2015, , 13.06.2015.
WEF 2015, , 13.06.2015.

What Are the Costs of Bank Equity?

After the lead up to the financial crisis of 2008, the Basel Committee on Banking Supervision developed Basel III, a new set of regulatory measures. One of the crucial changes involved the increase in banks’ required equity(1), e.g., gradual increases in the Minimum Common Equity Capital Ratio from 3.5% to 4.5% of the total of risk-weighted assets with an additional Capital Conservation Buffer(2) of 2.5 % (Basel Committee, 2011, 77, annex 4) by 2019, as a response to the recently observed systemic risk of spill-over effects from one financial institution to another in a situation of financial distress, which led to national and global recessions or even depressions (Admati 2013, 6). Bank equity can thus be understood as a bank’s financial “buffer” to insulate itself from financial shocks.

Basel III has faced considerable opposition, particularly from the financial sector, (see for example BAFT-IFSA, 2010; ASF in Elliott, 2010, 11, IIF; 2010, 6), which claimed that higher bank equity requirements would threaten banks’ socially valuable functions of providing credit and creating liquid deposits (Admati et al. 2013, 60). Yet some economists state that the measures taken are still insufficient. Admati et al. even declare equity capital ratios of 20% or even 30% as not “unthinkable” (ibid., 55), and take up several variants of their opponents’ central argument of bank equity’s social costs and prove their invalidity, due to “fallacies, irrelevant facts, and myths.”

On the banks’ side, higher levels of equity are often said to diminish their societally significant lending function, increasing their funding costs and decreasing the return on equity. Admati et al. argue that all these fears are unfounded: the lending function does not have to be affected because a bank’s balance sheet can be changed in different ways to correspond to increased capital requirements; reducing loans is merely one way to do so. Another could be to lower liabilities while increasing capital and leave the amount of loans unchanged. Furthermore, the banks’ funding costs are hardly affected because equity only bears higher costs in situations of risk; after deleveraging, risk would be reduced. This is also reflected in the return on equity: higher levels of equity indeed require a higher return on equity than the required return on debt––this mirrors the higher risks of equity which enjoys no legal protection like debt in cases of bankruptcy and is assessed higher taxes. Such tax policy serves to make debt a far more appealing means of funding than equity, distorting the benefits equity inherently offers. In addition, it has to be said that funding costs or lower return on equity are private costs.

Resistance to higher levels of equity comes mainly from the shareholders who are afraid of losing the value of their existing claims. This again depends on how a bank would react to the higher capital requirements: if it creates new assets, the existing liabilities would not necessarily be diminished by higher equity. But truly, the return on the shareholders’ claim would go down if the borrowed money were used for less risky investments. Only in this scenario would higher equity lead to lower returns on debt.
Contributing to the possible withering of the banks’ lending function is the fact that Basel III does not adequately address risk-weighing of complex financial instruments, which were a substantial contributor to the latest financial crisis. As ‘low-risk’ assets can still be held with little required capital, this incentivizes banks to avoid risky, yet productive endeavors, like multitudes of small business loans, in favor of highly rated, allegedly secure debt, such as sovereign bonds (The Economist, Sep. 13, 2010). This essentially leads to a cycle where those who orchestrated bailouts have created incentives for banks to write nations a blank cheque allowing for further unhampered borrowing, instead of incentivizing more socially productive lending. This, however, would require a paradigmatic conception of the common good (Zamagni 2009, 329), a distinctly different normative goal for a financial sector otherwise governed by Benthamite utilitarianism.

The financial crisis was exacerbated by a crisis of generalized trust, as even banks came to prefer state bonds over inter-bank lending (ibid., 333). More bank equity would mean more public and private faith in banks and financial institutions and would reduce the taxpayer burden implicitly behind government guarantees. Bank equity is not idle, un-investable money which would prevent banks from fulfilling their lending function, but serves the system’s overall stability and people’s trust in it; the trade-off rather seems to lie between profits and stability. Following Zamagni, “[i]n order to increase ever more the capital gains, it is necessary to raise the levels of risk” (ibid., 330). This will likely never cease to be true, and increasing bank equity requirements is a simple, though difficult to implement hedge against ludicrous leverage––at least until the next round of miraculously risk-nullifying financial instruments and creative leveraging tools are born. Capital requirements and regulation is a delicate dance between allowing the banking sector room to maneuver and enshrining its stability. While it is unlikely that regulators will ever become nimble enough to effectively regulate a highly dynamic financial system, higher capital requirements seem like an attractive means of providing a greater degree of stability. However, this still neglects the appeals for a regulatory race to the bottom encouraged under the current paradigm, ignoring the nationally focused social costs of a highly competitive international banking industry as was seen in Iceland, Ireland and Cyprus.

Admati et al. provide convincing proof that arguments put forward by opponents of higher capital requirements lack validity in their central premises. The question remains what is left of the considered objections other than a mere resentment against more external regulation. In sticking to the functioning of a leverage-based financial economy, there is an odd discrepancy between the workings of the financial sector and the rest of the economy. In the words of David Miles, member of the Monetary Policy Committee of the Bank of England: “It is as if banks cannot play by the same rules as other enterprises in a capitalist economy – after all, capitalists are supposed to use capital” (Miles, 2013).

(1) Following Douglas Elliott, former investment banker and fellow at the American think tank Brookings, Washington, D.C., we define bank equity as a specific form of shareholder equity which consists of common shares to investors and bank profits accumulated over time. See Elliott, 2013.
(2) Common Equity Tier 1, in essence, only allows for common shares, stock surplus resulting from these shares, and retained earnings to be taken into consideration, as formulated in the definition above (see Basel Committee, 2011, p. 13). In non-stress periods, banks are required to hold additional Common Equity Tier 1 called “Capital Conservation Buffer” (see Basel Committee, 2011, pp. 54-55).

Admati, Anat R./Peter M. DeMarzo/Martin F. Hellwig/Paul Pfleiderer: Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Socially Expensive (2013). (9 June, 2015).
BAFT-IFSA: Joint Industry Communication on Proposed Increased Cost of Trade Finance (2010). (9 June, 2015).
Basel Committee on Banking Supervision: Basel III: A global regulatory framework for more resilient banks and banking systems (2011). (9 June, 2015).
The Economist: Basel III: Third Time’s the Charm. (13 September, 2010).
Elliott, Douglas J.: Basel III, the Banks, and the Economy (2010). (9 June, 2015).
Elliott, Douglas: Higher Bank Capital Requirement Would Come at a Price (2013). (9 June, 2015).
IIF: Interim Report on the Cumulative Impact on the Global Economy of Proposed Changes in the Banking Regulatory Framework (2010). (9 June, 2015).
Miles, David: Bank capital requirements: Are they costly? (2013). (9 June, 2015).
Zamgani, Stefano: The Lesson and Warning of a Crisis Foretold – A Political Economy Approach (16 July 2009).