The Capitalist Peace: What Happened to the Golden Arches Theory?

Many are familiar with the Democratic Peace Theory, the idea that two democracies have never waged war against one another. The point is widely recognized as one of the major benefits of democracy, and the hand-in-hand development of more democracies and fewer/less-devastating wars than virtually any other period of human history, is a tempting and enticing explanation.

Now, it is not overly difficult to come up with counter-examples to the Democratic Peace Theory, and indeed there’s an entire Wikipedia page dedicated to it. Here are some notable and obvious counters:

  • Yugoslavian wars of the 1990s
  • First Kashmir War between India and Pakistan War (1947-49)
  • Various wars between Israel and its neighbors (1967, 1973, 2006 etc)
  • The Football war (1969)
  • Paquisha and Cenepa wars (1981, 1995)

Some people even include the First World War and various 18th and 19th century armed conflicts between major powers (American War of Independence comes to mind), but the question of when a country becomes a democracy naturally arises.

There’s another, equally enticing explanation, the main rationale underlying European Integration: The Capitalist Peace, or in a more entertaining and relatable version: The Golden Arches Theory – as advanced by New York Times columnist Thomas Friedman in the mid-1990s:

No two countries that both have a McDonald’s have ever fought a war against one another.

Countries, frankly, “have too much to lose to ever go to war with one another.” As a proposition it seems reasonable, an extension of the phrase apocryphally attributed to Bastiat: “When goods don’t cross borders, soldiers will”. And not because your Big Mac meal comes with a side of peace-and-love or enhanced conflict-resolution skills, but because the introduction of McDonald’s stores represents close economic interdependence and global supply chains. After all, if your suppliers, your customers or your collegues consists of people on the other side of a potential military conflict, a war seems even less useful. Besides – paraphrasing Terry Anderson and Peter Hill in their superb The Not So Wild Wild Westtrading is cheaper than raiding. Even as adamant a critic as George Monbiot admits that a fair number of McDonald’s outlets “symbolised the transition” from poor and potentially trouble-making countries, to richer and peace-loving ones.

Not unlike poor Thomas Malthus, whose convicing theory had been correct up until that  point, reality rapidly decided to invalidate Friedman’s tongue-in-cheek explanation. Not long after it was published, the McDonald’s-ised nations of Pakistan and India decided to up their antics in the Kargil war, quickly undermining its near-flawless explanatory power of Friedman’s. Not one to leave all the fun to others, Russia engaged in no more than two wars in the 2000s to undermine the Golden Arches theory: the 2008 war with Georgia, and more recently the Crimean crisis. Adherring to their namesake creation, McDonald’s pull-out from Crimea was just a tad too late to vindicate Friedman.

The Capitalist Peace, the academic extension of the general truism that trading is cheaper than raiding, came undone pretty quickly thanks in part to our Russian friends. The updated version, the Dell Theory of Conflict Prevention, may unfortunately fall into the same trap as the Democratic Peace Theory: invoking ambiguous definitions that may ultimately collapse to mere than tautologies.

Brexit Breakdown

Ir has been obvious for at least a month now that soft Brexit has won out in the UK, though the Prime Minister Theresa May would never admit such a thing directly. Government discussion of access to the EU internal market at its existing level, or very close, and keeping the border open between the Republic of Ireland and Northern Ireland (a fundamental of the peace settlement in the north) would at the very least require continuing regulatory alignment in goods (that is, following the rules made by the European Union).

It seems very likely that negotiations of the terms of exit with the EU itself would make even this partial alignment with the internal market inadequate in order to get the desired level of access. At the very least EU negotiators would demand some inclusion of services (financial services are the big issue here) and something at least resembling free movement of labour.

That inclusion would be full UK access to the internal market after exiting and would require at least a Swiss style relationship with the EU, in which there is full market access in exchange for accepting EU rules and something close to free movement of labour. Such a relationship would mean accepting judgments of the European Court of Justice even if they are not incorporated into UK law. The UK might not follow Switzerland into EFTA (European Free Trade Association, see paragraph below).

It has even been suggested that the UK might find it necessary to adopt a ‘Norway’ solution, in which the UK is directly a member of the European Economic Area. Norway has free movement but opts out of common agricultural and fisheries agreements. It is not part of the EU customs agreement. Like Iceland, Lichtenstein, and Switzerland, it is a member of the European Free Trade Area, which essentially harmonises regulations between these countries and the EU; that is, EU regulations are enforced by EFTA institutions.

It is clear that most Conservative MPs and businesses (though more large business than small business) regard something like the arrangements above, soft Brexit, as preferable to hard Brexit (trade agreement with the EU as a completely external country, possibility of no deal). These MPs and business people, along with most Treasury economists and economists in general, believe that keeping complete access to EU markets is more valuable than vague claims of a trade boom through deals with non-EU states across the world.

Hard Brexiteers believe that economic growth of other parts of the world requires breaking free of EU shackles on global free trade. The soft Brexit, as well as Remain, argument is that membership of the EU does not prevent trade with the rest of the world and that some EU countries are already doing that very well compared with the UK. On this argument, geographical proximity will always make EU trade disproportionately important so that limiting access to EU markets in the hope that non-EU countries will want free trade agreements is unnecessary and probably very damaging.

May’s drift towards soft Brexit after presenting herself as the guardian of hard Brexit has the support of most of the Cabinet, and Conservative MPs, but has been disappointing hard Brexiteers for some time. An agreement of the full cabinet at the Prime Minister’s country residence for soft Brexit has led to the resignation of the two most hard Brexit-oriented ministers.

It seems unlikely this this will deter May from a soft Brexit policy, which everyone agrees can only become more soft in negotiations with the EU to achieve an agreed exit. It also seems unlikely that most Conservative MPs will resist this policy. The biggest problem for May could be that the opposition parties want to vote against the government in call circumstances, so could vote with hard Brexit Conservative MPs to bring down any Brexit agreement.

At this point Brexit might completely break down, with the UK becoming a full member of EFTA, so in practice a member of the EU which exchanges some opt-outs for absence from the decision making processes and institutions. It might even lead to a suspension of Brexit, or a second referendum in which the electorate chooses between the exit package and staying in the EU.

At present, the most likely options in descending order are: 1. soft Brexit, outside formal association with the EU, but like that in practice, 2. formal association with the EU, maybe meaning membership of EFTA, 3. the complete breakdown of Brexit. This could change and so far change has been to move further and further away from hard Brexit.

Personally I support continuing membership of the EU. It is inevitable that large parts of the UK economy will ‘align’ with EU regulations, so it is best to be part of the institutions and processes which decide on these regulations. That is the most pragmatic version of my argument.

I am also a strong European integrationist, even a federalist romantic. The qualification of this idealism is that integration should not go further than public opinion or institutional capacity can accept at any one moment and that economic realities should guide the relationship with Europe for and against the kind of integration I favour at heart.

My own ideal is a kind of revival of the medieval dreams of ‘universal’ (i.e. European) Empire. The poet Dante was a great exponent of such a vision in his classic of political thought On Monarchy, which does not exclude city republics, even favours them under a high European sovereign. We can join it with Marsiglio of Padua’s slightly later call for an empire with elections to have something like democratic federation for Europe.

Leaving my European romanticism aside for the moment, the current realities are that the UK’s exit from the EU has become more and more complicated by the disadvantages of disentangling complex and far reaching institutional and economic links, particularly when most people involved want to keep an open border with the Republic of Ireland and keep 100% of the current level of access to the internal market.

Minorities and Economic Growth: Evidence from Jewish Communities in Premodern Europe

Urban theorist Richard Florida is celebrated for arguing that cities today succeed by attracting members of the “creative class.”  In a similar spirit I have a recent paper with Noel D. Johnson where we investigated whether or not cities in medieval and early modern Europe grew faster if they possessed a Jewish community.

Scholars have long noted the role of minority groups in economic development. This is particularly true for the the premodern period. The great scholar of long-run historical development in Europe, Fernand Braudel, observed that “successful merchants who controlled trade circuits and networks often belonged to foreign minorities.” These minorities could be other nationalities or religious minorities, for example, “the Jews, the Armenians, the Banyans, the Parsees, the Raskolniki (Old Believers) in Russia or the Christian Copts in Muslim Egypt” (Braudel, 1979, 1982, 165).

Hornung (2014) studies the impact of the Huguenot migration to Prussia. Since the nineteenth century, scholars like Friedrich List linked the presence of Huguenots with the transmission of human capital, skills, and innovation. Hornung (2014) is able to test this hypothesis using Prussian immigration lists from 1700 that document the location of Huguenot settlements and firm-level data on input and output for all 750 textile manufactories in Prussia in the year 1802. Approximately 16,000 to 20,000 Huguenots fled France to Prussia at the end of the seventeenth century.  Hornung finds that the presence of Huguenots significantly increased firm productivity. Specifically, a 1 percentage point increase in the share of Huguenots was associated with 1.5 percentage points higher productivity in 1802.

Jewish Communities and City Growth

In our paper we take a broad sweep of European history from 1400 to 1850.  We have a total of 1,792 cities in our panel data from the Bairoch (1988) dataset and 1,069 Jewish communities that appear in the Encyclopedia Judaica. The figure below shows both the cities in the Bairoch dataset and the Jewish communities mentioned in the Encyclopedia Judaica.

 

bairochandjewishcitiesgreyscale

To understand the relationship between the presence of a Jewish community and subsequent city growth we conduct a difference-in-differences style regression analysis.

The fact that we have data on city populations every century means we can hold constant the identity of a city using city fixed effects and see whether or not it grew faster in the centuries when it had a Jewish community in comparison to those centuries when it did not. We can also control for the possibility that overall city growth was faster in some centuries in comparison to others using century fixed effects.

We are also able to hold constant other factors that could plausibly have affected city growth. We control for local geography including cereal suitability, proximity to rivers, and proximity to coast, as these factors likely affected city growth in different ways over time. We also control for local infrastructure including presence of university and distance to a medieval trade route.

Our  analysis suggests that, indeed, cities with Jewish communities grew faster on average between 1400 and 1850. The effect we find suggests that cities with Jewish communities grew about one third faster than those that did not have Jewish communities. This analysis remains a correlation, however. We do not know if the presence of a Jewish community brought with it economic benefits or if Jews merely choose to settle in faster growing cities.

Instrumenting the Presence of a Jewish Community

We model the network of Jewish communities as one way to see whether the effect of Jews on city growth was indeed casual. By examining how Jewish communities expanded we hope to isolate a source of exogenous variation in the presence of a Jewish community.

We assume that a Jewish community is more likely to be established close to another Jewish community because of trade networks, financial relationships, or cultural linkages. We then calculate the closest travel path between Jewish communities using our information about the location of roads and river networks and estimates of premodern transport costs. The important assumption we make is that if cities with Jewish communities share certain “unobservable” characteristics that might make them more likely to grow rapidly, these characteristics become less correlated with distance.

We then divide Europe into 5km x 5km grids and assign the lowest travel cost to each grid. We apply Djikstra’s algorithm to determine the lowest cost of travel between all 3,211,264 city pairs (van Etten, 2012). This allows us to create a measure of ‘Jewish network access’ for each city.

Jewish network access itself is, of course, correlated with the unobservable characteristics of the city for which it is calculated. To overcome this we adopt two strategies to create valid instruments out of the network access measures. First, we calculate Jewish network access for cities that are only more than a certain distance away from each other. Second, we use information on expulsions to weight our measure of Jewish network access. The intuition behind this is that Jewish expulsions consist of an exogenous “push” factor leading to Jews settling in new cities close to the existing network of Jewish communities. Using these two strategies we obtain similar (though larger in magnitude) effects from the presence of a Jewish community on city growth. This provides further suggestive evidence that the correlation we found in our baseline analysis was indeed causal.

The Relationship Between Urban Growth and the Presence of a Jewish Community Over time

Across specifications, we find that cities with Jewish communities experienced no growth advantage in the 15th and 16th centuries. After 1600, however, they began to grow significantly faster.

motivationlpoly

The relationship we observe in the Figure does not appear to be inline with a pure human capital story. Jews had higher human capital than Christians throughout the medieval and early modern period. But the growth advantage of cities that had Jewish communities only became evident after 1600. This raises the possibility that something else changed around  17th century that made the human capital and skills of Jews more complementary to economic growth.

Two Mechanisms: Jewish Emancipation and Market Access

The two factors that stand out in explaining the emergence of a growth advantage for cities with Jewish communities after 1600 but not before are: (1) Jewish Emancipation after 1750; and (2) a complementarity between the presence of a Jewish community and market access.

The process of Jewish emancipation began in continental Europe after 1780. It was a major institutional break that signified a major change in the economic, social, and political status of the Jews in Europe. In work with Jean-Paul Carvalho, I’ve shown that Jewish emancipation lead to a religious schism and the emergence of both Reform and Ultra-Orthodox Judaism.

In the period before Jewish emancipation, legal barriers limited the ability of Jews to put their labor to its highest value use. Jewish businesses were prevented from hiring non-Jewish workers. Jews could not attend universities. Moreover, Jews and Christians were culturally isolated. This changed with emancipation, and we expect to see it reflected in the contribution of Jewish communities to city growth in the post-1750 period.

The second factor we study is the complementarity between the presence of a Jewish community and the development of markets. The historical literature points to the importance of Jewish trading and financial networks. But, while economic historians have conducted numerous studies of market integration during the early modern period, with a few exceptions these have focused on the grain trade with little systematic study of other markets due to data limitations. Jewish merchants in medieval and early modern Europe, however, did not play a prominent role in the grain trade but, rather, were involved in the transport of diamonds, sugar, silks, tobacco, and other luxury products in addition to playing a large role in banking and finance. Therefore, rather than looking at grain markets, we explore a more general measure of market integration based on market access.

Market access depends on the population size of nearby cities weighted by the cost associated with the least cost travel path. We show that market access was increasing for all cities after 1700. We find evidence that cities with Jewish communities were better able to take advantage of this increase in market access. As we detail in the paper, our findings are consistent with the argument made by numerous historians that Jewish trading and finance networks help to knit together the European economy, particularly in the period 1650 to 1800 (Israel, 1985).

 

Our analysis provides support for the accounts of historians who have emphasized the important role played by Jewish traders in 17th and 18th century Europe (such as Fortune, 1984; Israel, 1985; Trivellato, 2009). Furthermore, our story is in line with institutional arguments such as those developed by Douglass North, John Wallis and Barry Weingast, and Daron Acemoglu and James Robinson.  In the Middle Ages, the presence of Jewish communities was part of an institutional arrangement that extracted rents from society and distributed them among members of the ruling elite. The eradication of these rent-seeking arrangements and the liberalization of Jewish economic activity, first in the Netherlands and England and then in the rest of Europe following Jewish Emancipation, was of critical importance as it is in those cities that possessed emancipated Jewish communities that we observe the strongest relationship between the presence of Jews and economic growth.

NGDP, NGO and total expenditures

I did not think that my post on NGO versus NGDP would gather attention, but it did (so, I am happy). Nick Rowe of Carleton University and the (always relevant) blog Worthwhile Canadian Initiative responded to my post with the following post (I was very happy to see a comment by Matt Rognlie in there).

Like Mr. Rowe, I prefer to speak about trade cycles as well. I do not know how the shift from “transactions” to “output” occurred, but I do know that as semantic as some may see it, it is crucial. While a transaction is about selling a unit of output, the way we measure output does not mean that we focus on all transactions.  I became aware of this when reading Leland Yeager (just after reading about the adventures on Lucas’ Islands). However, Nick (if I may use first names) expresses this a thousand times better than I did in my initial post. When there is a shift of the demand for money, this will affect all transactions, not only those on final goods. Thus, my first point: gross domestic product is not necessarily the best for monetary transaction.

In fact, as an economist who decided to spend his life doing economic history, I do not like gross domestic product for measuring living standards as well (I’ll do a post on this when I get my ideas on secular stagnation better organized). Its just the “least terrible tool”. However, is it the “least terrible” for monetary policy guidance?

My answer is “no” and thus my proposition to shift to gross output or a measure of “total spending”. Now, for the purposes of discussion, let’s see what the “ideal” statistic for “total spending” would be. To illustrate this, let’s take the case of a change in the supply of money (I would prefer using a case with the demand for money, but for blogging purposes, its easier to go with supply)

Now unless there is a helicopter drop*, changes in the money supply generate changes in relative prices and thus the pattern (and level) of production changes too. Where this occurs depends on the entry point of the increased stock of money. The entry point could be in sectors producing intermediary goods or it could closer to the final point of sale. The closer it is to the point of sale, the better NGDP becomes as a measure of total spending. The further it is, the more NGDP wavers in its efficiency at any given time. This is because, in the long-run, NGDP should follow the same trend at any measure of total spending but it would not do so in the very short-run. If monetary policy (or sometimes regulatory changes affecting bank behavior “cough Dodd-Frank cough”) causes an increase in the production of intermediary goods, the movements the perfect measure of total spending would be temporarily divorced from the movements of NGDP. As a result, we need something that captures all transaction. And in a way, we do have such a statistic: input-output tables. Developed by the vastly underrated (and still misunderstood in my opinion) Wassily Leontief, input-output tables are the basis of any measurement of national income you will see out there. Basically, they are matrixes of all “trades” (inputs and outputs) between industries. What this means is that input-output tables are tables of all transactions. That would be the ideal measure of total spending.  Sadly, these tables are not produced regularly (in Canada, I believe there are produced every five years). Their utility would be amazing: not only would we capture all spending (which is the goal of a NGDP target), but we could capture the transmission mechanism of monetary policy and see how certain monetary decisions could be affecting relative prices.** If input-output tables could be produced on a quarterly-basis, it would be the amazing (but mind-bogglingly complex for statistical agencies).

The closest thing, at present, to this ideal measure is gross output. It is the only quarterly statistic of gross output (one way to calculate total spending) that exists out there. The closest things are annual datasets. Yet, even gross output is incomplete as a measure of total spending. It does not include wholesale distributors (well, only a part of their activities through value-added). This post from the Cobden Centre in England details an example of this. Mark Skousen in the Journal of Private Enterprise published a piece detailing other statistics that could serve as proxies for “total spending”. One of those is Gross Domestic Expenditures and it is the closest thing to the ideal we would get. Basically, he adds wholesale and retail sales together.  He also looks at business receipts from the IRS to see if it conforms (the intuition being that all sales should imitate receipts claimed by businesses). His measure of domestic expenditure is somewhat incomplete for my eyes and further research would be needed. But there is something to be said for Skousen’s point: total nominal spending did drop massively during the recession (see the fall of wholesale, gross output and retail) while NGDP barely moved while, before the recession, total nominal spending did increase much faster than NGDP.

NGONGDP1

In all cases, I think that it is fair to divide my claim into three parts: a) business cycles are about the deviation from trends in total volume of trades/transactions, thus the core variable of interest is nominal expenditures b) NGDP is not a measure of total nominal spending whose targeting the market monetarist crowd aims to follow; c) since we care about total nominal spending, what we should have is an IO table … every month and d) the imperfect statistics for total spending show that the case made that central banks fueled spending above trend and then failed to compensate in 2008-2009 seems plausible.

Overall, I think that the case for A, B and C are strong, but D is weak…

* I dislike the helicopter drop analogy. Money is never introduced in an equal fashion leading to a uniform price increase. It is always introduced through a certain number of entry points which distort relative prices and then the pattern of trade (which is why there is a positive short-term relation between real output and money supply). The helicopter drop analogy is only useful for explaining the nominal/real dichotomy for introductory macro classes.
** Funny observation here: if I am correct, this means that Hayek’s comments about the structure of production would have been answered by using Leontief’s input-output table. Indeed, the Austrians and Neoclassicals of the RBC school after them have long held that monetary policy’s real effects are seen through changes in the structure of production (in the Austrian jargon) or by inciting more long-term projects to be undertaken creating the “time to build” problem (in the RBC jargon). Regardless of which one you end up believing (I confess to a mixed bag of RBC/Austrian views with a slight penchant to walk towards Rochester), both can be answered by using input-output tables. The irony is that Hayek actually debated “planning” in the 1970s and castigated Leontief for his planning views. Although I am partial (totally) to Hayek’s view on planning, it is funny that the best tool (in my opinion) in support of Hayek is produced by an intellectual adversary

Slowly debunking the trade leads to peace fallacy

In 2010 I wrote that economic issues are just another factor in decisions on war or peace. There is nothing to suggest that free trade leads to peace per se (The Liberal Divide over Trade, Peace, and War, International Relations, vol 24, number 2, June 2010).

This is not a particular popular viewpoint, certainly not among classical liberals and libertarians, for reasons written about before at this blog.

So it is nice to read in Dale C. Copeland’s new book Economic Interdependence and War (Princeton University Press 2015), that indeed it all depends upon the situation. Economic factors can just as easily be cause for war, as a cause for refraining from violence. Copeland does not write from the liberal tradition, but if he had, he could have used Adam Smith, David Hume or Friedrich Hayek in support for his argument.

Anyway, the good thing is that the free-trade -leads-to-peace thesis is slowly but surely being debunked. It makes for a better and more mature discussion about international relations, inside and outside liberalism.

Around the Web

  1. When governments go after witches
  2. Borders, Ethnicity and Trade [pdf]
  3. A Lonely Passion. Libertarians in China
  4. Halloween in Germany: read this with globalization and its critics in mind
  5. Should Japan take the lead in mediating US-Iranian talks? Props to Obama, by the way
  6. Another excellent Free Speech blurb from Ken White
  7. Culture in a Cage