Trade Politics, a Politics of Illusion

By Sheldon Birkett

On December 18, 2017, Canadian and British governments materialized in front of a U.S. trade tribunal arguing against Trump’s aggressive countervailing duties on Bombardier’s C-series jet. [i] The Canadian Ambassador to the United States, David MacNaughton, said the imposition of up to a 300 percent countervailing duty is illegitimate speculation premised on pure conjecture. [ii] This is one of the latest developments in the pro-protectionist populist backlash against the historic trend of global economic liberalization (circa. 1945).

The politics of trade protectionism must not be viewed in isolation from globalization, rather, protectionism is part of globalization. Irrespective of the variants of populism, which now pierces through the frontiers of domestic politics into global politics, globalization has perpetuated horizontal and vertical socio-economic global inequalities. Globalization in its entirety is a multifaceted and illusive concept, which is ambiguous when examining it as a singular comprehensive topic. Instead it is more practical to study the elements of globalization (i.e. economic liberalization, supranationalism, populism, integrated national policies etc.) in isolation then bring such topics together under a multifactor framework of analysis. This frame of analysis is similar in going from a partial to general equilibrium analysis in economics, but rather from a multidisciplinary approach. However, a complete comprehensive assessment of globalization could not be adequately portrayed in this article for sake of brevity, for that reason I will only examine the effects of trade liberalization on the politics of trade.

Like any good trade model measuring the welfare effects of trade on the factors of production (capital, labour, land) it is necessary to start with the stolper-samuelson theorem as the theoretical backbone for the welfare analysis of trade liberalization. The stolper-samuelson theorem states that the relatively abundant factor used relatively intensively in production benefits from trade liberalization, while the relatively scarce factor used relatively non-intensively in production does not benefit from trade liberalization. [iii] In other words, an increase in the relative price of labour-intensive goods will increase the wage rate and reduce the (capital) rental rate relative to both commodity prices (i.e. labour and capital-intensive goods). The stolper-samuelson theorem works because according to the ricardian trade model the price of the good that has a comparative advantage increases, while the price of the good that does not have the comparative advantage decreases, when free trade occurs between two countries.

The simple insight that the stolper-samuelson model provides, when it comes to the welfare effects of trade, goes a long way in explaining both the recent rise in resentment and prejudice against global trade liberalization. However, the stolper-samuelson theorem in reality does not act in isolation from other macroeconomic phenomena, such as global finance. Therefore, why does trade face the brunt of accusations in the backlash against globalization? To answer this question it is necessary to steer away from the topic of economics and focus on the ethics behind why individuals – in the west – can justify financial risk adverse behaviour, which has resulted in one of the largest moral hazards in history (i.e. 2008 financial crisis), while not justify the minor economic consequences of free trade. The divergence between justifying financial risk adverse behaviour versus not justifying the negative consequences of free trade is certainly an arbitrary assessment. Professor Dani Rodrik at Harvard University’s John F. Kennedy School of Government found that individuals resisted free trade when it resulted in job losses as a result of unfair trade practices, as “It’s one thing to lose your job to someone who competes under the same rules as you do. It’s a different thing when you lose your job to someone who takes advantage of lax labor, environmental, tax, or safety standards in other countries.” [iv] Free trade under the same regulatory rules underpins the “fair trade” argument, however it is equally important to recognize that when barriers (i.e. countervailing duties, quotas, production subsidies) arise due to “unfair trade practices” they are often met with political buyins that distort the gains from trade. [v]

The politics of free trade shows that people suffer from a sense of “adiaphorization” of perception, when there is a disconnect between a person’s behaviour and the outcome (or effect) of their action. Adiaphorization is also referred to as the “disappearance of [individual] responsibility as a result of the division of labour.” [vi] This is most commonly illustrated in collective action failure problems. For example, the divergence between an individual’s action and the accumulated effects of his or her action(s) adding to the negative consequences of climate change (e.g. pollution). As such, people’s perception of free trade is heavily disconnected from the real economic implications of trade liberalization policies. In the 1990’s U.S. advocates for the North American Free Trade Agreement (NAFTA) professed the extraordinary benefits NAFTA will have for North American productivity, competitiveness, and economic growth. However, a 2003 study illustrated that NAFTA would at most contribute to 0.5 percent of GDP growth in the United States once the agreement became fully integrated. [vii] Similarly, for Canada and Mexico the NAFTA narrative is mixed.

Despite the modest economic gains attributed to NAFTA, the public perception of free trade has hit a wall. No, this is not Trump’s physical wall with Mexico, but it is an inherently ideological, populist, idiosyncratic anti-trade barrier that has been steamrolled by demagoguery political ideals.

The recent anti-NAFTA political reaction in the United States and other western liberal democracies represents a divergence between people’s perception of FTAs, filtered through ideological lenses, and the real aggregate implications FTAs have on the overall economy. In essence, this has been the crux of trade politics as a politics of illusion. Despite the divergence between perception and effects of FTAs this does not entail that citizens’ reactions against FTAs, such as NAFTA, are inherently justified. Similar to individuals support for or against FTAs justified as being fair or unfair agreements, it is possible to justify people’s perception of FTAs (for or against free trade) depending on the political alignment of the population. This is to say even if free trade has no negative welfare impact on a person’s wellbeing, perhaps can even be beneficial, individuals will still choose to support or not support FTAs based on their own political/ideological alignment. For example, anti-free trade support based on political alignment has recently been seen across most western liberal democracies with the rise in right-wing (and left-wing) political parties. Surprisingly, the most developed countries have not been immune to trade politics as a politics of illusion.

In considering trade politics not just as the politics of utility maximization, but as a politics of illusion filtered through ideology, much of the economic models used to understand the welfare effects of trade liberalization have become obsolete. Much to the same degree how protectionism must be viewed as part of the tension of the globalization process, and not as globalization’s antithesis, a multidisciplinary approach is inherent in the study of globalization. In terms of trade politics, a multifactor approach spanning across both political science, economics, literary and cultural studies is essential. In this regard, trade politics as a politics of illusion is an exemplar of such an approach.

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i. Adrian Morrow & Nicolas Van Praet, “Boeing, Bombardier battle up in final U.S. hearing,” The Globe and Mail, December 18, 2017,
ii. Ibid.
iii. W. Stolper & P. Samuelson, “Protection and Real Wages,” The Review of Economic Studies, 9, no. 1, (1941): 58-73,
iv. Dani Rodrik, “Populism and the Economics of Globalization,” John F. Kennedy School of Government Harvard University, August 2017, page. 15,
v. Ibid, 16.
vi. Harald Welzer, “Climate Wars: Why People Will Be Killed in the 21st Century,” Polity Press, page. 16.
vii. M. Angeles Villarreal & Ian F. Fergusson, “The North American Free Trade Agreement (NAFTA),” Congressional Research Service, page. 16,


Faculty of Public Affairs Research Month 2018: The Political-Economy of Trade Policy: North American Free Trade Agreement (NAFTA)


The United States’ decision to renegotiate the North American Free Trade Agreement (NAFTA) represents a shift in the global governance of trade policy from mere tariff reduction towards “comprehensive,” or “ambitious,” free trade agreements (FTAs). This paper asks: What are the domestic and international factors that have resulted in the United States’ decision to renegotiate NAFTA? This paper argues that the U.S. decision to renegotiate NAFTA cannot be explained by a single mono-causal factor. Instead, a combination of domestic and international factors were key in the U.S. decision to renegotiate NAFTA. International factors include regime change, centralization of state power in international agreements, and a country’s relative terms of trade as a measure of a state’s competitive economic dominance. Domestic factors include a state’s internal institutional structure, income distribution, political cleavages, and voter perception. This paper identifies the potential factors that persuades a state to renegotiate FTAs.

Please see PDF of Poster and literature review in the link below 

The Political-Economy of Trade Policy: North American Free Trade Agreement (NAFTA) Poster

The Political-Economy of Trade Policy: North American Free Trade Agreement (NAFTA) Literature Review

Strategic Trade Policy, What’s Next?


By Sheldon Birkett



As Canadian official tread lightly in latest round of NAFTA negotiations the United States is strategically “gaming” the odds in their favour. Developed from game theory, which each “state-actor” (or player) makes their optimal decision contingent other players actions, strategic trade policy applies trade barriers (technical and non-technical barriers) to optimize a state’s domestic and international political position. More classically described as “win-sets,” developed by political scientist Robert Putnam, determines the degree of policy options available within international negotiations given the domestic political constraints present.[i] A state, with a more complacent domestic population, entails that international negotiators would be able to consider more varied policy options when active in trade negotiations. Having more varied policy options occurs because political figures, under conditions of a complacent population, have less political capital to lose if negotiations turn sour. Meaning a larger variance in public opinion emerges because of a multiplicity of complacent attitudes. Therefore, the larger variance of public opinion, or lack thereof, would not hold political representatives to account if they get a maleficent deal. This is simply because domestic public opinion is not polarized to the extent that political representatives must appeal to certain sectors of the population to remain in power. On the other hand, a narrow “win-set” would mean that political representatives would have a scarcity of policy options to choose from in international negotiations.[ii] This is simply due to the fact that a less complacent, more polarized, domestic population would place strict (more directed) demands on political representatives to appeal to their agenda. Therefore, underlying a trade negotiator’s role is the hawk of public opinion constraining the optimum trade policy option.

One might say, how is the notion of a “win-set” considered in reality when many factors are at play in modern trade negotiations. For example, if international negotiators more closely considered the elasticity of political demands of their constituents they would be better able to fine-tune the key points in negotiations. However, the example described above is an ideal “textbook” case when it comes to the breath of multinational trade negotiations at play. If you wanted a deeper understanding of why trade negotiations succeed, or fail in dismay, one needs to consider economic interdependence between countries. In other words, by calculating the marginal rate of substitution between two goods it is possible to estimate the likelihood of the good being imported (through trade) given its domestic cost in autarky. Needless to say, by calculating the first derivative at a given quantity for a particular good it is possible to estimate the value of a good relative to another good (assuming that changes in the market for the factors of production and socio-cultural preferences are accounted for). This same idea can be applied to a “good” such as a political demand making it possible to calculate the marginal rate of substitution between policy options, although a government’s policy is an intangible good. Therefore, by aggregating all possible policy options’ elasticities it would be possible to calculate the optimum trade policy option. As an idea it sounds good on paper, but we do not have the computational power necessary to calculate such an aggregate result. Even if we did have such a computer, the optimum policy at that given point does not take into consideration political-economic changes in the environment. The result calculated would not be dynamic over time. As shown in statistics, the more variables you consider in a model calculating an “optimum trade policy” the more factors you have to consider as the inaccuracy of the model grows exponentially. Therefore, the notion of a “win-set” proves useful in simplifying the factors to consider in free trade negotiations albeit it is an abstraction from reality. Thus, by examining dynamic cases it is possible to further understand the relative weights on the factors considered by lead negotiators.


Before delving into specific cases of trade negotiations it is pivotal to situate the global trajectory of international economic integration. I believe the best way to conceptualize the trajectory of international trade since WWII is to situate it within Dani Rodrik’s augmented political trilemma.[iii] Note that I am not saying Rodrik’s framework is an exact science, but far from it, I am just using the augmented political trilemma to illustrate how international trade policy has developed. Similar to the macroeconomic “impossible trinity principle”[iv] the augmented political trilemma states that a country can only maintain two of the three characteristics between strong international economic integration, a sovereign nation-state, and mass politics.[v]

In the augmented political trilemma, a country has three broad economic policies to choose from. Firstly, the golden straight-jacket maintains a country’s national sovereignty while pursuing international economic integration. Under the golden straight-jacket a government will practice small government economic policies, which advocate flexible labour legislation, privatization, and deregulation of capital markets. For example, most developing countries fall into the golden straight-jacket trap because of their need to compete for foreign investment from larger “more robust” economies.[vi] In contrast to the golden straight-jacket is global federalism (or supranationalism). Global federalism combines integrated international economies and mass politics at the expense of national sovereignty. Unlike the golden straight-jacket, which sacrifices mass politics, global federalism embraces mass politics (e.g. European Union).[vii] Lastly, the Bretton Woods compromise combines national sovereignty and mass politics as its broad economic policy.[viii] The Bretton Woods compromise is reminiscent of the post-WWII international economic order when national economies were skeptical of complete economic integration and ad-valorem tariffs were permissible under GATT rules.

According to Rodrik, global federalism is the inevitable end-goal in the long-run (over 100 years). However, given the short-term climate of rising protectionism Rodrik predicts the golden straight-jacket to be the predominate broad international economic policy of the early twenty-first century.[ix] Therefore, if Rodrik’s predictions are true about the future of international economic integration it would imply that the short-term future of international trade would follow a more protectionist (or cautionary) approach then at the start of the 2000’s. As a result, the urgency to understand strategic trade policy in an age of protectionism is more relevant now then ever before.


The struggles of renegotiating the North American Free Trade Agreement (NAFTA) shows that the golden straight-jacket policy is the predominate trade strategy in the twenty-first century. The United States demands to reject the current dispute-settlement (Chapter 19) procedure, in favour of domestic dispute resolution, and its insistence to increase patent protections on Canadian pharmaceuticals challenges Canada’s “fireproof house” mentality. Considering NAFTA has been under an intense thirteen-month renegotiation period, with minimal success on the most pressing issues (i.e. dispute settlement, supply management etc.), it is fair to say that a complete United States-Mexico-Canada deal seems unlikely by then end of 2018. It is much more probable that the United States-Mexico deal will come into affect by early 2019, given that the outgoing Mexican administration under President Nieto (and the Trump administration) would like to sign a deal as a political statement. Meanwhile, the Canadian negotiators, under Foreign Affairs Minister Chrystia Freeland, have little leverage over the United States Trade Representative Robert Lightizer when it comes to the final negotiation issues. Under pressure from the American administration Mexico would likely sign a deal without Canada, given that the September 30th deadline is fast approaching.[x] However, with the United States and Canada in a political gridlock it is unlikely a tri-national deal would be agreed upon anytime soon. The reason for the United States reluctance to agree upon a deal is because the policy trade-off is simply too high. In other words, the marginal rate of substitution of American demands is simply too high of a cost when contrasted against Canadian preferences.

Even in a world burgeoning with political juxtapositions between nationalism and globalism the economic calculus does not lie. No matter how extravagant the Trump administration, or any other political party, would like to bring back the day when “America was great” it simply isn’t going to happen. Even if Trump would willingly accept the fact that the manufacturing jobs of the 1960’s will not come back, but still aim for a national policy targeting full-employment, free-market economists would surely object to such a policy at the expense of inflation. One only has to look at the 1973 OPEC crisis which was followed by a period of severe stagflation (inflation and lower output) to understand the costs of inflation.[xi] In a world where neoclassical economics has prevailed, and free-market ideology has been widely accepted amongst the world’s top economists, it is likely that protectionism will not last long. The question is not if protectionism will prevail, but when will protectionism fail?

Lastly, trade is not a matter of political concessions for exchange of market access, rather, free trade is a matter of national welfare. Revisiting the fundamentals of the Ricardian model of international trade any student of economics will be familiar with the phrase that “free trade is beneficial if the gains from the winners exceed the loss of the losers and the losers are compensated for their losses”.[xii] Applying this redistributive principle to the NAFTA negotiations it is apparent that strategic trade policy is politically motivated, while the fundamentals of international trade are motivated by economics. I’d like to think that the economic calculus will always prevail against politically motivated policies, but only time will tell under auspicious protectionism.


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[i] Robert Putnam, “Diplomacy and Domestic Politics: The Logic of Two-Level Games,” International Organization, 42, (1988): 427–460.

[ii] Ibid.

[iii] Dani Rodrik, “How Far Will International Economic Integration Go?” Journal of Economic Perspectives, 14, no. 1, (2000): 177-186,

[iv] Macroeconomic phenomenon that an open-economy can only maintain two of the three macroeconomic characteristics between an independent monetary policy, fixed exchange rates, and an open capital account.

[v]  Dani Rodrik, “How Far Will International Economic Integration Go?” Journal of Economic Perspectives, 14, no. 1, (2000): 177-186,

[vi] Ibid.

[vii] Ibid.

[viii] Ibid.

[ix] Ibid.

[x] Alan Rappeport, “Trump Trade Negotiator Warns That Canada Is Running Out of Time,” The New York Times, September 25, 2018,

[xi] Michael Corbett, “Oil Shock of 1973-74,” Federal Reserve Bank of Boston, November 22, 2013,

[xii] Paul Krugman, Maurice Obstfeld, and Marc Melitz, “International Economics: Theory and Policy Tenth Edition,” Pearson.

Divergence of the European Monetary Union’s Monetary Policy from Member-States’ Fiscal Policies as a Structural Deficiency in the Eurozone Crisis

By Sheldon Birkett

The European Monetary Union’s (EMU) reforms, following the 2009 Eurozone crisis, proved to have mixed results on the future stability of European economic integration. For example, the stabilization of the European economies through macroeconomic fiscal consolidation policies, and the subsequent polarization of political parties across EU member-states, has proven that the EMU’s response to the crisis has been inadequate. This paper will show that the Eurozone crisis was perpetuated by the structural deficiencies present within the EMU since its establishment by the Treaty of the European Union (TEU). The principal structural deficiency within the EMU was the divergence of perspectives between EU supranational institutions and member-states involvement in monetary and fiscal policy. It is argued that the EMU mistakenly made the assumption that a singular monetary policy would inevitably lead to systematic fiscal policy coordination between member-states through “spillover” effects. On the other hand, member-states assumed that the EMU would inevitably bail them out in times of economic difficulties. The inevitability of the EMU as a “lender-of-last-resort” is due to the intergovernmental dependence of each member-state on one another under a singular monetary policy. This paper will firstly introduce the structure and organization of the EMU followed by an analysis of the main structural deficiencies within the EMU, which perpetuated the Eurozone crisis. Next, the paper will highlight three EMU reforms, and the implications of those reforms within the EU, in response to the Eurozone crisis. Lastly, there will be a short discussion of the EMU’s trade-off between supranational and intergovernmental policy coordination when it comes to ensuring the EMU’s democratic governance.
The European Monetary Union (EMU) is responsible for establishing sustainable economic development balanced on growth and price stability (Art. 3, TEU). The European Monetary Union (EMU) consists of the “Eurosystem” and the European System of Central Banks (ESCB). The Eurosystem is comprised of the European Central Bank (ECB) and the member-states’ National Central Banks (NCBs). The Eurosystem member-states also hold the euro as their official currency making them part of the Eurozone (ECB, 2011, 13). The European System of Central Banks (ESCB) is comprised of the ECB and NCBs of all member-states not in the Eurozone, in which they do not participate in European monetary policy (ECB, 2011, 13). Other than balanced economic growth and price stability, at the heart of the “institutional set-up” of the EMU, is the idea that it is possible to have “one monetary policy and many fiscal policies” by having a strong coordination amongst fiscal policies to achieve a sort of “fiscal federalism.” Fiscal federalism refers to how fiscal responsibilities of taxation and expenditure are divided up between different levels of government (Baldwin & Wyplosz, 2015, 427). In the case of the European Union, fiscal federalism is referring to how fiscal competencies should be allocated between national governments and supranational (EU) institutions. Along with establishing monetary policy, and (indirectly) coordinating sound fiscal policy, the EMU is responsible for a flexible exchange rate regime, converging long-term interest rates, maintaining independence from political influence, and European Supervisory Authorities (ESAs) in areas of banking, insurance, and securities to secure adequate intervention when economic difficulties arise (ECB, 2011, 18).
In accordance to Article 130 in the Treaty on the Functioning of the European Union (TFEU) the central bank shall remain politically independent from “Union institutions, bodies, offices or agencies and the governments of the Member States… and not to seek to influence the members of the decision-making bodies of the European Central Bank or of the national central banks” (Art. 130, TFEU). The strong principle of monetary independence, where there was a lack of coordination with member-states’ fiscal policies, resulted in macroeconomic divergence between the EU’s monetary and fiscal policies. Macroeconomic divergence in the EMU was a prominent contributing factor to the Eurozone crisis. However, it was not only the deficiencies within the EMU structure that lead to the Eurozone crisis, but the fact that such challenges are inevitable in being part of the European integration process. As Mario Draghi, the President of the ECB, stated in 2014 this was the “Achilles Heel” of European integration (Jones, Keleman, Meunier, 2016, 1011).


At the heart of the deficiencies of the EMU (which perpetuated the Eurozone crisis) was consistent conflation between an intergovernmentalist fiscal policy and a supranationalist monetary policy, whereas EU bureaucrats were promoting a supranational “fiscal federalism” even though fiscal policy was primarily intergovernmental in nature. Instead, the ECB assumed that neo-functionalist integration in the EU’s monetary policy would create a “spillover” effect into a seamless coordinated “intergovernmental” fiscal policy between member-states, however, this did not come to fruition (Jones, Kelemen, Meunier, 2016, 1016). On the other hand, member-states assumed that the ECB would inevitably have to offer a bailout package if a member-state did not maintain sound fiscal policy. Although the promise of a bailout package was not the case in the TFEU, the implicit assumption of bailout remained true as the failure of one member-state would mean the failure of the EMU. Therefore, the ECB would be “forced” to bailout the member-states to serve their own interest of achieving macroeconomic stability. At the creation of the EMU in 1999 these two perspectives of implicit coordination of fiscal policy, as a form of “fiscal federalism,” and the assumption by member-states that the ECB would inevitably bail them out in times of extreme economic difficulty created a lack of coordination between fiscal and monetary policy which exacerbated the Eurozone debt crisis.
In economics, coordination of fiscal and monetary policy is critical in an optimum currency area because monetary policy affects the ability for governments to finance budget deficits while fiscal policy coordinates taxation and expenditure (Laurens & Piedra, 1998, 3). Therefore, if a state decides to have a large fiscal deficit but does not adjust the interest rate this can result in asymmetric currency shocks. Due to asymmetric currency shocks the state would have to devalue its currency or become fiscally insolvent (Laurens & Piedra, 1998, 5). Since all “Eurosystem” member-states share the euro it would be difficult to devalue the euro currency accordingly. Similarly, the EU as an optimum currency area (OCA) is subject to asymmetric shocks because the Mundell-Fleming model predicts that when capital markets are open EU member-states must choose between exchange rate stability or domestic policy autonomy (Copelovitch, Frieden, Walter, 2016, 824). The “Mundell-Fleming trilemma,” or the “impossible trinity principle,” implied that member-states of the European Union had to reluctantly give up domestic monetary policy autonomy to achieve exchange rate stability (Copelovitch, Frieden, Walter, 2016, 824).
Member-states of the Eurozone that gave up their monetary autonomy reflected the EU historic trend of moving from an intergovernmentalist to a supranationalist approach of EU policy-making (Tommel, 2018, 90). However, policy-makers during the formation of the EMU did take the difficulties of monetary and fiscal policy coordination into consideration; although, individual member-states were too reluctant to give up fiscal policy competencies to a supranational institution (i.e. ECB). For example, at the time of formation, the EMU knew of the risks associated with discoordinated monetary and fiscal policy, but they did not establish an effective method for regulating fiscal policy because the costs of giving up fiscal policy were too high for member-states wishing to maintain national sovereignty (Copelovitch, Frieden, Walter, 2016, 825). As a result of the endogenous constraints from the member-states’ reluctance to give up fiscal competencies, in favour of an intergovernmentalist approach to European integration, a revision of the EMU was inevitable since its establishment in 1999. As on the eve of the launch of the euro currency European Commission President, Romano Prodi, stated that “I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But someday there will be a crisis and new instruments will be created.” (Jones, Kelemen, Meunier, 2016, 1018).
The Eurozone crisis had to be dealt with separately from the United States’ subprime mortgage crisis, even though the catalyst for the Eurozone crisis was the collapse of Lehman Brothers in 2008. The United States’ subprime mortgage crisis and the Eurozone crisis must be dealt with separately because there were structural problems within the EMU that perpetuated moral hazards in fiscally adverse EU states, such as the PIIGS countries (i.e. Portugal, Ireland, Italy, Greece, and Spain) (Shure & Verdun, 2018, 137). The principal structural deficiencies in the EMU that perpetuated the Eurozone crisis were: 1) a lack of a “mutual-recognition” approach that facilitated macroeconomic divergence; 2) a lack of fiscal policy coordination between member-states, and with the ECB’s monetary policy; 3) weak financial regulation, most notably the Stability and Growth Pact (SGP); and, 4) the lack of credibility behind the no bail-out commitment (Art. 125, TFEU) meant that sovereign default risk was not taken into consideration when financial market risk increased in 2008 (Bernoth & Erdogan, 2012, 651). These four factors contributed to a divergence of expectations between EU institutions and member-states. The core structural deficiency being the ECB’s assumption of “spillover convergence” of fiscal policies and the member-states assumption that the ECB would have to bail out insolvent member-states. Next, I will provide an assessment of how the four deficiencies developed within the EMU. This will be followed by an assessment of the key reforms and their implications since the start of the Eurozone crisis.
There was a lack of “mutual recognition” of the structural trade relationships between northern and southern European countries leading up to the Eurozone crisis. For example, between 1998 and 2007 German inflation averaged 1.5 percent per year while in Spain inflation averaged 3.5 percent per year (EuroStat, 2018). As a result of the differences in inflation, labour costs increased by 30.4 percent in Spain while in Germany labour costs fell by 3.9 percent between 1998 and 2007 (Copelovitch, Frieden, Walter, 2016, 818). Irrespective of the differences in inflation rates between Spain and Germany the EMU followed the optimum currency area (OCA) theory. Following OCA theory, the ECB targeted the interest rate between EU member-states inflation differentials to best serve all EMU member-states at around 3 percent inflation (Copelovitch, Frieden, Walter, 2016, 818). However, this implied negative real interest rates for southern European member-states, after factoring in high inflation, and slightly positive interest rates for low-inflation northern member-states. As a result, negative real interest rates in high-inflation member-states induced large amounts of private borrowing (Johnston, Hacke, Pant, 2014, 1772). With the exception of Greece, a “wage price-level effect” induced domestic inflation that eroded export competitiveness, which led to a surge in the current account deficit (i.e. net import surplus) (Johnston, Hacke, Pant, 2014, 1794). Therefore, Portugal, Italy, Ireland, and Spain’s involvement in the optimum currency area (Eurozone) resulted in an overvaluation of the euro relative to the domestic strength of their economies. The overvaluation of the euro induced heavy private sector borrowing in high-inflation member-states (e.g. Spain) and heavy private sector lending in low-inflation member-states (e.g. Germany). This meant that capital was following north to south in the EMU because of interest rate arbitrage in the financial/private sector. Interest rate arbitrage in the financial sector implied that the sovereign debt crisis was not the result of reckless fiscal spending but was the result of private sector mismanagement, which turned into a sovereign debt crisis once the financial institutions were “bailed-out” (Johnston, Hacke, Pant, 2014, 1794). Failure of the EMU to adequately consider the effects of asymmetric supply shocks in an optimum currency union, which would increase the inflation rate under a targeted exchange rate, has been a core structural deficiency within the EMU (Roisland & Torvik, 2003, 113).
There was also a lack of effective fiscal policy coordination due to structural deficiencies within the EMU’s Stability and Growth Pact (SGP). The Stability and Growth Pact (SGP) was established in 1999 to “speed up and to clarify the excessive deficit procedure set out (Art. 126, TFEU) in order to deter excessive general government deficits” (Council Regulation, 1997, No. 1467/97). The main role of the Stability and Growth Pact (SGP) was to ensure responsible fiscal policy coordination amongst EU member-states. However, a 2010 European Commission paper from the Directorate General of Economic and Financial Affairs found out that there were two “critical elements” overlooked in the SGP.
Firstly, it was found that rules and procedures for national fiscal policy making were “entrusted” to the member-states to decide on what was in common EU interests, which was an inevitable result of a “lowest common denominator solution” (Copelovitch, Frieden, Walter, 2016, 831). The key failure of this mechanism was that there was no institutional framework to enforce the SGP mechanism other than “peer pressure” from the no bailout clause in the ECB and “moral persuasion” from other EU member-states (Jonung, Noord, Larch, 2010, 5).
Secondly, the original SGP did not implement a proper escape clause because they did not factor in that even the most complicated SGP system would be unable to account for all potential financial situations or “contingencies” in the EU (Jonung, Noord, Larch, 2010, 5). A lack of foresight by SGP policy-makers and the fact that fiscal deficits did not show up on the public deficit figures, because they were private deficits, increased the financial risk of the EMU leading up the Eurozone crisis (Copelovitch, Frieden, Walter, 2016, 820).
Lastly, there was a lack of commitment behind the no bailout clause (Art. 125 TFEU) because EU member-states’ self-interest appealed to intergovernmentalist thinking in which integration efforts only “intermittently spilled over into related sectors and policies.” (Moravcsik, 1993, 476). For example, Article 105 (6) within the TEU (Maastricht Treaty) contained a provision that allowed member-states to “confer on the ECB a leading role in financial supervision” (Jones, Kelemen, Meunier, 2016, 1019). However, the Council of the European Union rejected the idea of a regulatory authority as “a step too far towards regulatory integration” (Jones, Kelemen, Meunier, 2016, 1019). Similarly, in response to the no bailout clause ECB President Mario Draghi stated he promised to do “whatever it takes” to protect the euro in 2014. The Outright Monetary Transactions (OMT) was his solution to the constitutional limitation of the ECB to act as a “lender-of-last-resort” when faced with the no bailout clause in Article 125 of the TFEU. The Outright Monetary Transactions (OMT) was a secondary bond market outside of the ECB placed under sovereign bond prices. The OMT made “unlimited purchases of obligations” with short-term maturities with governments that participated in fiscal consolidation (Jones, Kelemen, Meunier, 2016, 1025). Although the OMT saved the euro it implied strict “fiscal consolidation” policies that had stringent conditionalities similar to the IMF’s structural adjustment programs.
In Greece, the OMT conditionalities under the European Stability Mechanism (ESM) implemented “austerity programs” which had strong contractionary effects on the Greek economy from 2010 to 2014. For example, the Greek GDP (Purchasing Power Parity 2009 adjusted) declined by 22 percent in less four years, unemployment rate increased from 7 percent in 2008 to more than 28 percent in 2014, final consumption expenditure decreased by 30 billion euros, and monthly minimum wages saw a real decline of 23.2 percent before income tax and social security contributions between 2008 and 2014 (Panagiotis, 2017, 43). As a result of “austerity reforms” the Greek economy’s debt-to-GDP ratio still remains high at 179 percent in 2016 (Shure & Verdun, 2018, 141). The Greek’s debt-to-GDP ratio is quite high considering Canada’s debt-to-GDP ratio was only 92.3 percent in 2016 (Trading Economics, 2018). Despite the stabilization of the major European economies after 2014 the implications of “austerity” policies have created an environment for political polarization, with the rise of political parties such as SYRIZA in Greece, PODEMOS in Spain, and the Five Star Movement in Italy (Mavrozacharakis, Kotroyannos, and Stylianos, 2017, 39). In Greece SYRIZA led by Alexis Tsipras came to power in 2015 after George Papandreou of PASKO implemented austerity policies to manage the economic crisis (Mavrozacharakis, Kotroyannos, and Stylianos, 2017, 41). However, SYRIZA both wanted to leave the EU and stay within the Eurozone. Since Greece could not have it both ways the Tsipras government was forced to implemented further austerity policies in return for the chance to stay in power (Mavrozacharakis, Kotroyannos, Tzagkarakis, 2017, 40). SYRIZA presents an interesting case where decades of “spillover” integration of the Greek economy with the European Union limited Greece’s sovereign ability to engage in intergovernmental bargaining with the EMU. The EMU’s supranationalist authority over the Greek economy stands in direct contrast to the predominantly intergovernmental SGP program, where a lack of an effective enforcement mechanism gave rise to discoordinated fiscal policies. However, the success of Mario Draghi’s OMT policy is debatable, as on the one hand it protected the euro and possibly the EU from disintegration; but, on the other hand it established strict austerity policies which has presented a challenge towards the democratic-sovereignty of EMU member-states.


As a result of the Eurozone crisis there have been a number of EU programs established to manage the economic fall-out and potential recurrence of the Eurozone crisis. These policy programs can be characterized under fiscal policy reform, financial sector reform, and crisis resolution reform (Buti & Carnot, 2012, 906). In response to the lack of coordinated “macro-prudential” approach in the management of fiscal and monetary policy, it was critical that the Stability and Growth Pact (SGP) be revised to implement more stringent enforcement mechanisms. The European Commission revised the SGP into the 2011 “Six Pack” reforms that established quantitative fiscal rules for member-states to meet including an “operationalization of debt criterion” (Buti & Carnot, 2012, 907). The operationalization of debt criterion stated where public debt exceeded 60 percent of GDP member-states would have to reduce the excess debt by 5 percent per year over an average of three years (Buti & Carnot, 2012, 907). Otherwise, member-states would have to implement an excessive deficit procedure (EDP). The EDP is an action by the European Commission that would follow a set of financial procedures resulting in the imposition of strong financial sanctions against a EU member-state (EuroStat, 2016). Thus, the “Six Pack” reforms would enforce responsible fiscal policies amongst Eurozone member-states by increasing the severity of repercussions against states facing a sovereign debt crisis.
In the financial sector, the Basel III agreement increased capital requirements for credit institutions and investment firms. Increasing the capital reserve requirement for national and commercial banks reduced the risk of financial insolvency, which also improved transparency, accountability, and regulation of the banking system. These EU regulations and directives were based of the Basel Committee on Banking Supervision (BCBS) regulation (Regulation EU, No. 575/2013). Alongside the Basel reforms, the EU reformed the European financial supervision framework into the European Systemic Risk Board (ESRB) that monitored excessive risk-taking and deficit leveraging (Buti & Carnot, 2012, 908). However, the reforms in the financial sector have proved difficult to enforce because of the close relationship between governments and national banks (Buti & Carnot, 2012, 909).
Lastly, the EMU’s crisis resolution reform established the European Financial Stability Facility (EFSF), later superseded by the European Stability Mechanism (ESM), which restructured monetary policy in Greece, Portugal, Ireland, Spain, and Cyprus through intervention in secondary bond markets (Buti & Carnot, 2012, 909). As proposed by the ECB President, Mario Draghi, the EFSF did stabilize the insolvent EU member-states. However, the imposition of harsh fiscal consolidation “austerity” policies on insolvent member-states contracted recipient countries’ economies (Mavrozacharakis, Kotroyannos, and Stylianos, 2017, 39). In fact, it has been found that merely belong to the EMU would “increase the vulnerability of sovereign issuers relative to non-Eurozone countries” as private financial markets can “force” default on a state despite sound fiscal policies (Buti & Carnot, 2012, 909). Although the ESM system provided an effective curtailment of the Eurozone crisis the contractionary effects on recipient economies, and the political fallout (e.g. Greece), has hindered ESM policies as a politically attractive stabilization mechanism.


Given the complexity of the EMU structure, and Eurozone crisis, establishing viable policy solutions to aid the structural deficiencies present has proven difficult. However, the approach taken to aid the Eurozone debt crisis has presented new challenges that question the democratic nature of the EMU. Questions revolving around the democratic legitimacy of the EMU’s policies can be attributed to the macroeconomic divergence of monetary and fiscal policies in the EMU. Furthermore, the discoordination of monetary and fiscal policies can be attributed to the divergence of perspectives between member-states that assumed the ECB would act as a “lender-of-last-resort,” and the ECB’s assumption under a centralized monetary policy fiscal policy coordination would be inevitable.
Dani Rodrik’s trilemma between deep economic integration, national sovereignty, and mass politics implies that only two out of the three components can be maintained at a single point in time. For example, due to the separation between monetary and fiscal policy in the currency union mass politics was sacrificed to maintain national sovereignty of the member-states and EMU price stability (Snell, 2016, 178). The transfer of mass politics to EU institutions, at the expense of national sovereignty, can prove to be a viable solution in establishing a democratic and stable EMU. However, the complete transfer of democratic politics to EU institutions is unlikely given the reluctance of member-states to give up fiscal policy autonomy (Snell, 2016, 179). Rodrik’s trilemma shows that the EMU’s response to the Eurozone financial (and sovereign debt) crisis has proven to be an ad-hoc arrangement with mixed implications for EMU member-states. Overall, divergence of expectations between supranationalist institutions (e.g. EMU) and intergovernmentalist member-states has proven to be a fundamental deficiency within the EMU’s architecture regardless of the EMU’s reforms.

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Buti, Marco and Nicolas Carnot. 2012. “The EMU Debt Crisis: Early Lessons and Reforms.” JCMS: Journal of Common Market Studies 50, no. 6: 899-911.

Copelovitch, Mark, Jeffry Frieden, and Stefanie Walter. 2016. “The Political Economy of the Euro Crisis.” Comparative Political Studies 49, no. 7: 811-840.

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EuroStat (2018). “Real Effective Exchange Rate – 37 Trading Partners”. 2010. Accessed: March 1, 2018.

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Jones, Erik, R. Daniel Kelemen, and Sophie Meunier. 2016. “Failing Forward? the Euro Crisis and the Incomplete Nature of European Integration.” Comparative Political Studies 49, no. 7: 1010-1034.

Johnston, Alison, Bob Hancké, and Suman Pant. 2014. “Comparative Institutional Advantage in the European Sovereign Debt Crisis.” Comparative Political Studies 47, no. 13: 1771-1800.

Jonung, Lars, Paul Van den Noord, Martin Larch, and European Commission. 2010. “The Stability and Growth Pact: Lessons from the Greater Recession”. Directorate-General for Economic and Financial Affairs.Vol. 429. Brussels: European Commission.

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Moravcsik, A. 1993. “Preferences and Power in the European-Community – a Liberal Intergovernmentalist Approach.” Journal of Common Market Studies 31, no. 4: 473-524.

Mavrozacharakis, Emmanouil, Dimitrios Kotroyannos, and Stylianos I. Tzagkarakis. 2017. “3 Mediterranean Left-Wing Populism: The Case of SYRIZA.” European Quarterly of Political Attitudes and Mentalities 6, no. 2: 39.

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Ontario Increase in Minimum Wage: A Phillips Curve Analysis

By Sheldon Birkett

Preached by business associates, CEO’s, and the wealthy elite, is often stated that an increase in the minimum wage increases long term unemployment, costing the working class. Ontario’s initiative to increase the minimum wage to $15 per hour is a sign that the realities of precarious working conditions, and the adverse effects of globalization are finally starting to be understood by policymakers.

The neoclassical rational expectations model of contemporary economics is still widely believed in as a macroeconomic “law” when it comes to the minimum wage. When people talk about minimum wage increases, individuals fail to consider the fundamental negative relationship between inflation and unemployment: the Phillips Curve. Popularized by Paul Samuelson and Robert Solow as a menu of policy options, the Phillips curve is highly regard as a foundational principal of macroeconomics. Economists such as Edmund Phelps and Milton Friedman, took the idea of the Phillips curve, and used the Phillips curve to further promote the centralized importance of monetary policy and the rational expectations model of macroeconomics. Many say that the direct correlations between inflation and unemployment are not as coherent as one may expect them to be, often characterized as an argument against Freidman’s rational expectations model. Despite the naysayers of the rational expectations model, it can very well be considered that a rational expectations theory can be utilized to justify increases in the minimum wage; implying, a minimum wage increase would hold unemployment constant to the long-run trend with a low sacrifice adjustment ratio.

Phillips Curve image

The explicit reasoning of applying a rational expectations model to justify increases in the minimum wage, is due to the neutrality of the unemployment rate around the “natural rate of unemployment.” The “natural rate of unemployment,” is more accurately defined as the “nonaccelerating inflation rate of unemployment,” (NAIRU).[1] The NAIRU is often assumed to be “fixed” or constant in nature, though such an assumption about the macro-economy can be misleading. The NAIRU is determined by real factors affecting the supply and demand for labour, such as demographics, technology, unionization, labour regulation etc. Any variation experienced in the real factors will affect variation in the NAIRU, though the exact deviation of NAIRU variation from the mean NAIRU, is often unknown. The World Economic Forum reported that the difference between British inflation rates and Ireland inflation rates was only 0.05 percent, though the standard deviation between the measures was excess of 2.5 percentage points, which implied (with a 95 percent confidence interval) inflation between Ireland and Britain was 10 percentage points wide.[2] Given the ambiguity in variation of the NAIRU measure, it is difficult to determine the long-term “real” affect an increase in the minimum wage would have on unemployment.

It is true the initial impact of a spike in minimum wage, such as to $15, will increase unemployment; though, it is often overlooked that an increase in the minimum wage will also enhance labour productivity. The mixed results of an immediate minimum wage increase often leads policy officials to reconsider minimum wage increases. If the minimum wage increase is projected on a long-run trend, it is possible to see that an increase in minimum wage will effectively increase inflation, though, the negative externalities inflicted on employment will not persists. At first, the wage increase will increase aggregate demand, increase workers bargaining power, and eventually increase consumer prices, raising the consumer price index (CPI) and inflation. As projected time and time again, there will initially be a decrease in unemployment, advent of experiencing greater aggregate demand. This trend of lower unemployment will eventually return to the natural rate of unemployment (NAIRU) once consumer expectations are adjusted. The time horizon it takes for peoples expectations, to adjust back to the long run trend is debatable. It is certain that an increase in the minimum wage will not increase unemployment in the long run, but in affect, result in lower unemployment rate in the short run. The relational concept of inflation and unemployment rates to increases in the minimum wage is widely misunderstood and overlooked. The importance of the Phillips Curve relationship should not be underestimate in macroeconomics, when considering increases to the minimum wage.

Given the findings about the Phillips Curve, it is apparent that many of the criticisms against a minimum wage increase are inherently embedded in class politics. From a business perspective, it is self-evident that an increase the minimum wage would be cutting away at marginal profits. Individual businesses fail to analyze the return of benefits from a minimum wage increase on the collective economy, and is a classic fallacy of viewing the economy as non-cyclical in nature. Respective on minimum wage increases, it is apparent that precarious labour conditions cannot persists in a globalized economy.

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[1] Kevin Hoover, “Phillips Curve,” The Concise Encyclopedia of Economics, 2008,

[2] Stefan Gerlach, “Why the Phillips curve still works for Ireland,” World Economic Forum, July, 22, 2015,