IR/AFP Models, Theories, and Other Course Concepts:

What They Are and How to Use Them

Professor Dan Lindley

448 Decio, 631-3226, dlindley@nd.edu

November 10, 2003, Rev. 4.1

You are a Doctor of Politics: The Meaning and Use of Theory

            This handout outlines many of the basic models and concepts central to courses in foreign policy, international security, and international political economy. Students should understand the models and be able to apply them to both current events and historical cases. If you give enough thought to these concepts, you will begin to see how threads of the different models relate to each other. Another symptom of thinking about this handout is giving me suggestions about how to improve it.

            What does a medical doctor know? Nothing any one of us would not know if we spent enough time on it. But when a doctor applies a stethoscope to your body, the doctor has a checklist in his/her mind and can quickly ask and answer the questions: what sounds normal and what does not? Likewise, if you learn these course concepts and theories, you can diagnose foreign policy and international relations with greater sophistication, speed, and reliability.

            From the purposes of this course, you are now a doctor of international politics. Course concepts give you an idea of what to look for and think about when you must make judgements or arguments about international politics. Is the security dilemma at work? Should we deter or appease? Should we be tough or despiral? What must we know in order to answer these questions?

            International relations theories and concepts help us answer these questions. Indeed, they even help us ask the right questions in the first place. If some event seems puzzling or can not be readily explained, theory can point us in the right direction. Note, for example, how Jervis' psychological theories or how Allison's organizational model help us explain otherwise odd and irrational behavior by and within states.

            No theory is right all of the time. Sometimes deterrence works and sometimes appeasement works. Reality in international relations is not black and white, not all zeroes and ones. As international relations doctors, we deal with shades of grey, continuums, percentages. But as international relations doctors, we deal with not just one patient dying, but states going to war. People killing each other. So, while we deal with shades of grey, we must still try our best to figure out how the world works.

            Should the U.S. be tough with Iraq's President Saddam Hussein, or should we ease the embargo? If two states are buildings nuclear weapons because they fear each other, is there anything we can do to lessen the danger of nuclear war? What do you need to know to answer these questions? Welcome to international relations theories and concepts.

CAVEAT EMPTOR: This is not a comprehensive list of theories and concepts. Listings accrete here when I have time and inspiration. Those who wish to excel will use this handout to supplement, not substitute for, the readings.

Grand Strategy

            What is foreign policy but a strategy for pursuing one's interests? Professor Barry Posen described grand strategy as follows:

            "A grand strategy is a political-military, means-ends chain, a state's theory about how it can best "cause" security for itself....A grand strategy must identify likely threats to the state's security and it must devise political, economic, military, and other remedies for those threats....Priorities must be established...resources are scarce."

National Interest and Vital Interest

            National interests are the goals states pursue when conducting foreign policy. There can be many interests, but most boil down to security, wealth, and health. Interests may conflict. A state trying to strengthen its alliances may not pursue a trade dispute with its allies quite as vigorously. Many factors may shape a nation's interests: the president's vision, congressional laws or politics, bureaucratic politics, foreign lobbying, domestic politics, and so forth.

            For the purposes of this course and for clarity in your own thoughts, it is important to distinguish vital national interests from other interests. Vital interests are those you (or the state) would be willing to fight for. This means that a vital interest is one you are willing to kill for and one in which you are willing to have U.S. soldiers die for.

Anarchy

            This term is used to distinguish international politics from domestic politics. Anarchy is the absence of hierarchy. In domestic politics, there is a central government, laws, and police to enforce the law and keep order. These elements are lacking in international politics. Anarchy increases the degree to which states must fear each other (see security dilemma below). Anarchy means that there is no central authority to enforce agreements made between states.

            There are several things to note about this term. First, do not confuse the use of it in this course with its connotation of riots and mayhem (although that is what war is to some degree). It simply means absence of hierarchy. Second, this is a broad-brushed and general distinction. The degree to which it is difficult to enforce or gain compliance with agreements may depend on whether or not there is a hegemon (a state with preponderant power) who can coerce compliance. While a hegemon can create a rough hierarchy in some instances, a hegemon is still not a legally-empowered sheriff. Compliance may also depend on whether the agreement is about a vital national security interest or about a lesser economic issue. It may depend on whether or not a state values its reputation in living up to agreements.

            To understand the effects of anarchy, think about how you would feel and how would you behave walking around the old West in a town without a sheriff and compare that to walking around the MIT campus. How much would the warranty on your car be worth if there was no small claims court, no Federal Trade Commission, etc?

Threats

            Threats are a combination of capability and intention. Walt distinguishes three related things that add up to useable capability: aggregate power, geography, and offensive power. Aggregate power such as population or wealth is not too threatening unless it is turned into military power. Geography can aggravate or lessen the threat posed by others. Are potential adversaries near or far? Are there mountains or plains between you and your adversaries? See Jervis for more on factors that make the world offense or defense dominant. Offensive power consists of military forces that can be used to attack or assist in attacks. Are any military forces truly defensive?

            Intentions are the plans to use capabilities. Intentions can be hard to discern. Information on others' intentions may simply be lacking. Communications may be unclear and contradictory messages may be sent (perhaps by the various departments and agencies in the foreign government). Both sides may be afflicted by Jervisian misperceptions.

            Credible threats are those that combine real useable capability as well as good reasons to believe the intentions behind the use of that capability. Intentions can be hard to judge, but there are still times and situations in which one can make reasonable assessments about intentions. For example, if Israel threatens to take decisive action about something, that threat is solidly credible. It is a highly capable and powerful state, it has a long history of using military force, and it strongly believes in maintaining its credibility.

Balancing and Bandwagoning

            Balancing is when states ally to defeat or deter a common threat. Bandwagoning is when states ally with a bigger power or threat. Determining which model is prevalent in general or in a particular situation is critical. Should a state be tough and loud, hoping to deter and attract bandwagoners? Or will this simply create more enemies? What did Walt say about US policy during the Cold War? And how would his arguments apply to the US today?

            Walt invented Balance of Threat (BOT) theory, and distinguished it from traditional Balance of Power (BOP) theory. In BOP, states balance against the strongest state. In BOT, states balance against the greatest threats. As mentioned above, threat is determined by aggregate power, geographic proximity, offensive military power, and aggressive intention. This boils down to useable capability plus intention.

            Walt thinks that BOT is better at explaining why alliances form (and fall apart, according to 'absence of threat' theory) than three competing explanations: ideology (birds of a feather flock together), foreign penetration (lobbying, ethnic groups, etc.), and foreign aid (buying friends, making them dependent). Note that the foreign aid arguments are similar to arguments about sanctions: they work better on less significant issues and when the target state is very reliant on the product offered/denied.

            It is worth remembering that once a state decides a threat exists, it can do more than just balance or bandwagon. It can try to negotiate, it can try to lay low (or 'hide'), it can try to mediate, and so forth. States can also 'balance internally' by building up their forces against a threat (as opposed to finding allies). Of course, building up and finding allies are not mutually exclusive.

Deterrence

            Deterrence aims to prevent an adversary from taking a hostile action by making it think that it is not worth its while to take that action. Typically, this is done by creating sufficient fear in the mind of the adversary that the costs of the action outweigh its benefits.

            Deterrence requires capability and the resolve to use that capability. Together, capability and resolve (should) present a credible threat to the adversary. Deterrence also requires that enough is known about the adversary so that effective threats can be selected and it requires that the adversary be rational and in control of its own forces. These threats must then be communicated to the adversary (or they are worthless). There are many ways to communicate... How do states send signals? How do you know when a state is serious about its signal and when it is just blustering?

            The opposite of deterrence is appeasement. Rather than preventing the adversary from achieving its goal, appeasement gives the adversary some or all of its goal (or some other bribe) in the hope that the appetite of the adversary will be sated and peace achieved. See also spiraling and de-spiraling below. To correctly choose between deterrence or appeasement, one must assess how hungry (or non-status quo) the adversary is. This assessment is crucial. Think of the consequences of making a mistake...

            A twist on deterrence is called compellence (Schelling) and, instead of trying to prevent an action, it tries to compel an action. It has the same mechanisms and requirements as deterrence. For example, Iraq was not sufficiently deterred from conquering Kuwait. Desert Shield failed to compel Iraq to leave. Desert Storm compelled Iraq to leave.

            To return to the crucial issue of assessing one's adversary, think about what it takes to figure out how hungry that adversary is. Is the country really hungry? Is it suffering from famine? Does it need your farmland? Or is there a domestic political problem that may lead it to want a confrontation to divert attention from these problems? Or does the leader need to be tough to win over some faction within its government? To what extent does will a leader need to take into account other factions or the people if the government is a democracy or a dictatorship? What if the leader is trying to impress allies? Are your own biases influencing your assessment of the adversary? And what about your adversary's biases? Are you stronger than the adversary? If you are weak, can you get allies, can you mobilize your economy and army, or should you just go along with the adversary?

            These are all good questions, and I am sure you can think of more. This course should help ask and answer these questions more quickly.

Security Dilemma

            The dilemma is that what country A does to improve its security usually diminishes the security of country B. This is because as country A buys weapons, the relative strength of country B is decreased. The security dilemma underlies the spiral model of arms races in which each country builds up its arms responding to or fearing the adversary's buildup (see also deterrence). Concessions or build-downs may be able to start the process of de-spiraling, but, like appeasement, the outcome depends on how 'hungry' the adversary is.

            A key element of the security dilemma is that there can be unforeseen or unintended consequences of policies that side A may think are completely benign. Side A may not think that side B should or would interpret its buildup as hostile. This effect is exacerbated by several Jervisian misperceptions.

            The type of weapon being built may affect the severity of the security dilemma. A truly defensive weapon would be less threatening to another's security and thus would lessen the effects of the security dilemma. On the other hand, a weapon that could only be used for offensive purposes would aggravate the security dilemma. But this is more complicated than it may appear. Is any weapon truly defensive or solely offensive? When is a shield a defensive weapon and when is it simply a safer place from which to stab forward? What are examples?

            Here is an exercise I often run through to show how the above concepts work. Think of a typical street in the old U.S. West, one near the OK corral...there is no sheriff ...

- imagine two people walking on that street. What do they think of each other? Why?

- imagine that one goes into a store and comes out with a gun. Now what do they think?

- imagine that they both have a gun. Now what?

- what if one begins training to draw quickly and fire accurately?

- what if one is extremely intoxicated? And bellicose?

- what if one builds a wall? What if the other builds a wall? What is the situation in the time between the building of the first and second wall?

- what if one has a machine-gun with a dead man's switch that will spray the street with a deadly hail if the person holding it dies? What if both have this weapon? Then what if one builds a wall in this situation?

- now go back over each stage of this exercise and imagine one person asking the other to give him some money. How would the person being asked react at each stage? Would the person try appease or try to deter? And what should the 'askee' know about the 'asker' in order to properly answer that fundamental question?

            If you spent some time thinking about it, this exercise evoked the security dilemma, the spiral model/arms races, the role of (deducing) intention, deterrence, appeasement, the difficulty of discerning defense from offense, mutually assured destruction, and the difficulties of crisis (in)stability.

            A final note, if state A is a known aggressor buys weapons to attack state B, and this intention is clear, then this is not really a security dilemma for state B. However, it is a big security problem for state B. The security dilemma usually implies an unintended security spiral, or a spiral aggravated by uncertainty or misperceptions. If war is certain, it is not a dilemma!

Jervis' 14 Hypotheses on Misperception

            In very short form, the 14 hypotheses are as follows:

1. New information is fit into pre-existing theories and images, especially if the new data is ambiguous and the theory/image is strong. Note: this is not always a bad thing. You should not always be changing your mind every time someone whispers something new in your ear.

2. Actors fit new information into their views more than they alter their theories.

3. Actors are more apt to change images if new information comes in as a big block, rather than bit by bit.

4. The more new information does not fit into existing concepts, the harder it will be to correct misperception (I am not sure my interpretation of Jervis is correct. See Jervis p. 470). The sources of existing concepts are: 1. One's own political system and domestic political structure; 2. personal previous experiences; 3. international history/analogy.

5. Misperception is increased if the information sender and receiver are from different backgrounds. The two parties' "evoked sets" (existing concepts; see #4) are different.

6. If a state spends time on planning and carefully crafting a message, it thinks the message will be clear.

7. Actors do not understand how others may misperceive their actions. Actions may be mis-executed.

8. States tend to see others as more hostile than they are.

9. States tend to see others as more centralized and coordinated than they are.

10. States overweight information coming from another state's foreign office. (really, this is 9a)

11. If another's behavior seems caused by one's own actions, then it must be so; if their behavior is contrary to one's own actions and pressures, then the state must be acting according to domestic politics (as opposed to its own self-interest).

12. States think others will accurately perceive its motivations. States find it hard to believe that others see it as a menace.

13. States do not understand why other's do not weight issues the same way they do. State A does not understand why state B does not think a certain issue is vital.

14. Facts may be consistent with many theories and states do not understand that.

            I think there is a lot of overlap between these models and I boil them down into three main hypotheses. First is the Newtonian Psychology hypothesis in which once a state adopts images, models, and analogies about how the world works and who its friends and enemies are, then it is very hard to change this image. An image 'at rest' remains at rest unless a very strong and persuasive alternative image knocks it away. A derivative of the Newtonian Model is that it is hard to understand another's images, and it is hard for them to understand your images. The Newtonian model largely subsumes hypotheses 1-7. Second is the pre-Copernican Psychology hypothesis in which one (incorrectly) sees oneself as the center of a hostile, well-organized universe. This subsumes hypotheses 8-10. Third, is the Bowling Shoe hypothesis in which it is hard to wear another's shoes, and vice-versa. Based on the saying that you can not understand someone if you do not walk in their shoes, this model subsumes hypotheses 11-14. It overlaps with the derivative of the Newtonian model, especially hypotheses 5-7.

            Note that Jervis cautions against applying psychological models and theories to whole states, and then does it anyway. My view: the hypotheses seem to offer insight into state behavior some of the time,

 in some situations. That is all you can ask in this business, so why not apply the hypotheses?

            Note how these theories may work with or exacerbate other problems. For example, seeing states as more hostile than they are aggravates the security dilemma and spirals. Seeing other states as centralized makes it harder grasp that a state's actions may in fact be explained by Allison's organizational model.

            How can one safeguard against or fix these problems? You must know about these problems. And you must know yourself.

Allison's Three Models:

Rational Actor, Organizational, and Bureaucratic

            What is a state? This question is more complicated and important than it may appear. If a state is simply a rational, self-interested actor, we could take the OK corral example above and prescribe deterrence or appeasement simply by determining which state was more powerful. The most powerful state should always win in a rational world. But the more you think about it, the more that simple prescription is hard to justify. We do not know how much the asker wanted the money or how easily the askee could afford to give it up. We do not even know why the asker wanted the money. What if we prescribed appeasement but the asker really wanted the whole wallet and the house keys to boot? Or what if we prescribed deterrence, but then the asker could not afford food, got desperate, and attacked?

            In international politics, people often assume that states are rational and narrowly self-interested. But that is not always the case. As mentioned above, the type of government (democracy, dictatorship, etc.), organizations, bureaucracies, domestic politics, foreign lobbying, resource dependence, ideology, individual and group neuroses and cognitive processes, and other influences all may affect: 1. what a state thinks is important, 2. what it will do about achieving its goals, and 3. how it will carry out the actions taken to further its goals. These three points are also known as agenda setting, decision making, and implementation.

            When making foreign policy decisions about such things as deterrence or appeasement, it turns out that there may be a lot you have to know about your adversary to figure out how hungry it is. Is the adversary's president really in charge of policy or is it responding to bureaucratic or domestic politics? Allison's models highlight on two things that affect what might otherwise be rational, self-interested policies: organizational processes and bureaucratic politics. Of course, to see how things influence the rational 'baseline,' Allison first needed to define the rational actor model. In his classic and easy to read book, Essence of Decision, Allison shows how each of the three models sheds light on what happened in the Cuban Missile Crisis. Each model supplies a different lens with which to view the crisis and each model helps reveal new and important facts and interpretations.

1. Rational Actor Model

Actor: unitary nation-as-a-whole actor

Goal(s) and Motivations(s): Maximize overall strategic national interest

Actions determined by: Choices made from wide variety of options

Other influences on actions: Choices reflect a stable, prioritized value system. All information relative to choices is known to actor. Actor is assumed to be rational.

Prediction using this model: Requires knowing the actor's values and capabilities. However, values are often assumed to be known since actor is motivated by strategic national interest.

2. Organizational Model

Actor: An organization (one of many within government)

Goal(s) and Motivations(s): Organizational health (often measured in terms of size and wealth). Reduce uncertainty.

Actions determined by: Standard operating procedures (SOPs), routines, and other actions motivated by promotion or protection of the organization and reduction of uncertainty.

Other influences on actions: Information and action distorted by parochial priorities and perceptions. Scope of information and action reduced by factored problems and fractionated power. Organizations have limited flexibility and are often slow to learn and change.

Prediction using this model: Requires knowing the organization's SOPs. Knowing what they did yesterday (t-1), allows to predict what they will do today.

3. Bureaucratic or Governmental Politics Model

Actor: Actors defined by their power position within government. (I think actors can be organizations as well as individuals)

Goal(s) and Motivations(s): Maximizing power and influence as well as strategic national interest. Values and goals may conflict.

Actions determined by: Results of bargaining between actors. Bargaining is affected by power of each actor, position within hierarchy, action channels, available information.

Other influences on actions: Information and action may be distorted by parochial priorities and perceptions, in this case phrased as "where you stand depends on where you sit." Since this model includes individuals, it includes constraints on decision making such as time pressures, misperceptions, and personality.

Prediction using this model: Requires knowing the relative power of each actor as well as each actor's value system. Organization model often helps explain an actor's values.

            This may seem pretty dry, but think back to the question about what you need to know to assess your adversary. Each model tells you something about what you need to know about each states. The reason this is important brings us back to the question: What policy is most likely to work? If you could assume that all states were rational, then you would not have to know about the state's history, its bureaucracy, which faction was more influential, whether it was dictatorship, or even how its history was taught. Governments are not always rational. Allison teaches us that you often have to know about the government's structure and how it works to explain its goals and actions (see the prediction section under each model).

Professor Meyer's Framework for Decision-making

            Professor Meyer teaches in American National Security Policy that there are four stages in decision-making:

1. Agenda Setting: An issue gets put on the agenda when it reaches sufficient prominence to necessitate decision(s) and action(s). Key questions are why issue gained prominence, and who put it there.

2. Option Formulation: defines possible responses to issue. Key questions are what are the constraints on options, and what are the various actors' stakes in the options.

3. Decision: Speaks for itself. Key questions are how is the decision made, and what are the constraints and stakes involved in the decision.

4. Implementation: Speaks for itself. Key questions are who implements that decision, and whether the implementation reflects the intent of the decision.

            Professor Meyer's framework helps one recognize that the decision-making process is indeed a process and is not a monolithic or discrete event. It is also a useful tool for systematically applying Allison's models. As we discussed in class, some models are more aptly applied to some parts of decision-making than others. However, a complete analysis of a decision will involve the following matrix.

Integrating Meyer's Framework with Allison's Models:

(++) denotes a particularly good fit; relatively strong explanatory power

Ostrom's Three Concepts

Tragedy of the Commons, Prisoner's Dilemma, and Collective Action

            The Tragedy of the Commons is that people, businesses, states, etc. tend to consume and consume, without regard for others, either in terms of using up what they are consuming or in terms of producing pollution. The benefits of consumption are immediate to the person, but the costs are delayed or not obvious. For example, a fisherman might fish and fish and be delighted with the catch, but not really notice until too late that his own actions were contributing to overall depletion of the fishing stocks. This applies to (over) fishing, pollution, famine, and other issues where resources are finite. The 'tragedy' could be ameliorated by rationing or other regulations.

            The Prisoner's Dilemma (PD) is a concept often used by political scientists. The technical aspects may appear daunting (see my PD handout – and your class notes – for more on this, but the heart of the matter is this: Imagine a world where it is hard to enforce an agreement (does anarchy ring a bell?). If two sides could agree, they would both do pretty well (if they could amicably divide up and ration a fishing area, for example). However, in this imagined world, they really do not trust each other. And if one side can get away with cheating, then it can catch a bundle of fish while leaving the other with little. But getting away with cheating is just as hard cooperating. It is obvious if you are using too many boats. So what happens? If cooperation is hard and cheating seems likely, then everyone tries to fish as much and as quickly as possible. The end result is that there are no fish left and everyone loses in the long run.

            So, in PD, there are three possible worlds: 1. Everyone cooperates. 2. One side cheats and gets away with it. 3. Both cheat and both lose. As 1 and 2 are unlikely, then 3 is what tends to happen. This is in a sense a formalized version of the Tragedy of the Commons and helps explain how individual rationality leads to collective bads. The PD could be ameliorated if you could reduce anarchy and make cooperation/enforcement more likely... This is where strategies like increasing communication, transparency, and the shadow of the future come in.

            Collective Action problems explain why groups can have difficulty acting in their own self-interest. Groups offer a "public good" to their members. For example, alliances offer security. If all members get this good, then it is hard to make every and all members contribute equally to this good. Denmark will be protected by NATO (especially by the US, and then by Germany and Britain) whether or not it spends less than its fair share on defense. Denmark can "free ride" on others and is unlikely to be excluded. Free-riders contribute less than their fair share, while enjoying all of the benefits.

            The larger the group, the more likely it is to suffer from free-rider problems. Each individual contribution will count for less and policing each contribution is harder. Solving free-rider problems can involve making the group smaller, coercion of free-riders by others, and credible threats to exclude free-riders from the public good.

            In sum, Ostrom's concepts explain various difficulties that arise from the absence of strong, coercive enforcement in international relations (and elsewhere). Note that rest of her book goes on to talk about how institutions can be created to help remedy, or at least reduce, the significance of these problems.

Dan Lindley

Fundamentals of International Trade and Finance

v. .06 early edition; November 25, 2000

Fundamentals of Trade

Supply and Demand determine price. As supply goes up, price goes down. As demand goes up, price goes up (if supply remains constant).

Increased prices imply higher profits. Higher profits generally motivate other competitors to provide the same good. Supply goes up, prices go down. If prices go down enough, competitors will go out of business, and supply will go down. Prices will begin to rise. In the end, there tends to be enough supply, and enough suppliers, to meet demand at prices that guarantee some but not overly high profits. This magical equilibrium is Adam Smith’s Invisible Hand (invisible hands are one reason economists are famous for and can get away with saying "on the one hand...).

This equilibrium is the cornerstone of faith in liberal economics. Liberal in economics means belief in free trade and unregulated markets.

Natural equilibrium of markets depends on two core assumptions. The first is that there are multiple suppliers. Lack of multiple suppliers erodes competition, raises prices, reduces efficiency, and is called oligopoly or monopoly. The second is that consumers have good information and can make informed decisions about products. Competition wouldn’t work if you didn’t know the same thing was available for cheaper around the corner.

Why is trade beneficial?

            David Ricardo's Comparative Advantage: Comparative advantage works when goods are produced by the parties that will trade with different rates of productivity. This means that one party has a comparative advantage in producing one good, while another party can better produce another good. Here is an example:

1.         I make 2 bottles of wine or 1 cork per unit of labor

2.         You make 2 corks or 1 bottle of wine per unit of labor

3.         Thus we can make 2 corked bottles each for 3 units of labor each.

4.         BUT, if you make 6 corks and I make 6 bottles for 3 units of labor respectively, and IF we trade, then we can each end up with 3 corked bottles for the same labor. No trade: 2 bottles each. Trade: 3 bottles each.

5.         Trade essentially expands our production-possibility frontier

6.         Note that when trade is possible, it is never worth my time to make corks, and not worth your time to make wine. We Specialize. We become interdependent.

Here is a neat comparative advantage trick: it can be worth my while to trade, even if I make both things better, if the price is right:

1.         I make 2 bottles of wine or 3 corks per unit of labor, but wine sells for 2 dollars and corks for .50. Per unit of labor I can make 4 dollars or 1.5 depending on what I produce.

2.         You make 2 corks per unit of labor and no wine. You can earn 1.00 per unit of labor. (ie you're the poor inefficient country, I'm the rich productive one - sorry)

3.         A corked bottle of wine sells for 2.50. With five units of labor and without trade, I can make 6 bottles worth 15.00 (3 lab units to make 6 bottles; 2 units for 6 corks). You can make 10 corks worth 5.00.

4.         If I make only wine, and no corks, I can make 10 wines worth 20.00 for the same five units of labor. But I have no corks. Invent trade. Let me exchange 2 bottles for 8 corks (with equal values of 4.00). I now have 8 corked bottles worth 20.00 (instead of 15.00), for the same 5 units of labor. Meanwhile, you now have 2 corked bottles of wine (worth 5.00). I make $5, you at least have useable bottled wine... You could probably raise the price of corks and we'd still profit.

This sounds weird, but it helps explain a number of things: why economically advanced countries may no longer want to produce lower value items (textiles), why rich countries get richer (sometimes), and why attorneys might hire a secretary even if they can type faster than the secretary (they can earn more lawyerizing). Most importantly, this is the fundamental argument for free trade.

Market Imperfections

            In addition to insufficient competition and incomplete or imperfect information, other market imperfections include: taxes, tariffs, regulations, quotas, sanctions, and so forth. These are "imperfections" because they affect the price of goods. "Imperfections" like taxes or environmental regulations may provide public goods. The cost of these goods are higher prices and perhaps reduced competitiveness.

Fundamentals of Finance

            Finance is about the price of money. Money does have a price. The price for money varies, in part because the supply and demand for money also vary. The price of money is expressed in interest and currency exchange rates. Other facets of finance are the sources of investment capital (such as international banks, the IMF, the World Bank, aid, stock markets, and private investors) and the flow of capital (international currency traders, exports, imports, and investment flows).

Below are some basic elements of finance: balance of trade, balance of payments accounts, and currency exchange rates.

Balance of trade is the balance between exports and imports of goods and services. If you export the same value of each, there is a perfect trade balance. If you import more than you export, there is a trade deficit because you are exporting more dollars than you are importing. Where do those dollars come from? How can you get them back?

Balance of payments accounts is balance of the total amount of dollars flowing into and out of the country. This adds to the exchange of good sand services to include: investment flows, purchases of government bonds by foreign investors (and vice versa), and tourist dollars (see table 9.2 from Goldstein, 5^th ed. p. 409 which adds these finance aspects to the basic trade balance). This is part of the answer to the questions in the last paragraph. The other great equalizer, and hidden hand, in the finance department is currency exchange rates.

Currency Exchange Rates

            Currency exchange rates are currency prices. Like stocks, the price is determined by Supply and Demand, plus Psychology. Currency exchange rates are the great equalizer in international trade and finance.

            To illustrate, the dollar goes (sometimes, depending) higher when:

            a.         Monetary policy tightens (US interest rates rise), increasing demand for dollars due to better rate of return here (and perhaps increasing demand for dollars because there are less of them, but perhaps decreasing demand if economy slows);

            b.         Fiscal policy tightens (less deficit spending, for example). Like monetary policy, this has a combination of effects whose ultimate effect are currency rates is uncertain: it makes the country seem more stable and creditworthy (dollar up), but interest rates may decline (dollar down), and the economy may go up (dollar up) or down (dollar down).

                        i.         Note: Budget deficits pump dollars out, decreasing demand for dollars. But, the need to finance deficit with government bonds can keep interest rates up in order to attract foreign investment.

                        ii.        Note: as a general rule, the stock market goes up when interest rates go down. Declines in interest rates alone would make the dollar go down, but demand for dollars may go up as foreigners invest in the rising US stock market and need dollars to do so.

            c.         Economy is strong. Demand up because the U.S. needs more dollars to fuel purchases of imports;

            d.         Economy is strong and the rest of world is weak or at war. Add previous factor, plus some psychology: Demand up because the U.S. is a more safe and stable place (dollars are kind of like gold);

            e.         Purchasing power viz. other currencies is out of whack (ie dollar is low). Things are cheap here, so demand for dollars goes up as others import more of our goods and our exports rise.

            f.         Investors buy dollars as part of speculation/currency trading for profit. Investors switch pounds into dollars anticipating a fall in the pound (then buying pounds when it drops, then waiting for dollar to drop...Or buy dollars anticipating its rise).

                        i.         Note: investors often have a herd mentality: if some start to sell (stocks, currency, etc), others may sell too, to avoid holding cheapened goods. At other time, some will buy as part of a bargain hunt. Almost all great crashes were caused or exacerbted by herd/panic mentality.

            Currency exchange rates have serious consequences. For example, when dollar goes higher:

            a.         prices of imports decline (inflation may fall, but that's good if you are about to buy something imported);

            b.         prices of exports rise (export dependent jobs may be lost);

            c.         Note the cycle: as imports rise (due to stronger dollar) we have to buy more foreign currency, eventually raising the price of that currency relative to the dollar, so the dollar falls, imports fall, exports rise, the demand for dollars begins to rise again... This is why currency exchange rates are the great equalizer in international trade and finance.

            d.         Finally, when the dollar is high: Hit the road! It is a great time to be a tourist abroad!

                                    Most statements can be inverted to explain their inverse. Aha!

All of this shows that, in IPE, the headbone really is connected to the toe bone. And if the brain and heart in between were not so mushy, some economist could have made a model and become a super-trillionaire....but no one has....

Uses of Models and Concepts - Who Cares?

            Models and course concepts are just formal, explicit formulations of intuitive concepts. Who does not understand something about deterrence and appeasement after a run-in with a sandlot bully? The trick is to make all the components of deterrence part of your conscious, analytical thought process.

            Viewed this way, models allow for a more conscious, explicit, thorough, speedy, and analytical understanding of everyday events. Models can also help the policy analyst (you) make predictions and recommendations. What do you need to know before making the fundamental choice between deterrence and appeasement? Which of Allison's models help understand how hungry an adversary is or help explain its past actions? How might a policy of deterrence lead to an arms race?

            Models and Theories help you answer, and ask, these questions.

            As the Allison reading demonstrates, a better understanding of the models would have helped diffuse tensions during the Cuban Missile Crisis (you figure out why). You can not ask academic models and concepts' to be more relevant than that.

                                             GAME THEORY and Prisoner's Dilemma

Professor Dan Lindley

448 Decio, 631-3226, dlindley@nd.edu, Spring 2000 office hours: Tuesday 1-3pm and by appt.

November 10, 2003, Rev. 1.4

            Prisoner's Dilemma is the most commonly used form of game theory in security studies. Game theory (PD) is an analytical tool and abstraction that can be used to increase understanding of both the arms race and the geo-politics of the cold war.

            In PD, two thieves are caught by the police but, due to lack of evidence, neither can be convicted without the implicating confession of the other. The prosecutor separates the prisoners so that they ca not communicate and tells each: if both of you remain silent, you will be prosecuted on a minor charge and get 1 year in prison. If you both confess, you each get 5 years. If one confesses and the other does not, the confessor gets a very light sentence (.25) while the other gets 10 years. The choices and the resultant outcomes (payoffs) can be depicted in a two by two matrix:

Prisoner # 1

Silent Confess

    Silent

#2

   Confess

(Example of how to read the 2x2 matrix: in the lower left box, prisoner #2 receives almost no time in prison while prisoner #1 gets 10 years.)

            Unable to communicate and knowing each other to be as trustworthy as thieves tend to be, they each confess and both end up in the lower right box.

            How does this relate to national security? In place of the prisoners, the interactions of two adversaries can be substituted in the matrix, illustrating several characteristics of arms races and geo-politics.

            Arms races and geo-politics are often viewed as zero-sum games. Zero-sum means that when one side gains (an amount of something), the other loses (an equal amount). Thus, zero-sum games result in relative gains or losses. The word 'relative' indicates that each player's position is measured 'relative' to the other. Zero-sum games usually imply that players are fighting over a fixed and finite amount of something: area on a chessboard, amounts of wealth, allies, etc.

            If both players are able to make simultaneous gains, then it is a positive-sum game. Competition is often viewed as a zero-sum game, while cooperation is usually undertaken to achieve positive-sum results. When players are concerned over relative position (my position as measured by your position), this can aggravate tensions more than when they are concerned over 'absolute' position (my position, regardless of your position). Think about it.

            When the world was divided into opposing U.S. and Soviet 'camps' during the cold war, a shift of camp by a minor country was a relative shift in the superpower balance: one camp gained and the other lost. This would have also been true in the arms race if one side had gained a decisive lead in some form of decisive weaponry.

            However, this rarely happened. Instead, the arms race caused greater and greater insecurity for both sides (you may disagree here - would not larger arsenals also make deterrence more robust? What about crisis stability?). As arsenals grew, the amount of damage war could cause increased and large sums of money and talent continued to be spent. The superpowers went down this road together and their levels of security dropped in a negative-sum game.

This graph shows the difference between zero and positive/negative sum games. When relative position shifts, as in a zero-sum game, it is reflected along a single line. This is seen at points x, y, z along line A below. Along line A, the aggregate total of whatever one is measuring along the axes (area, wealth, etc) remains the same no matter where one is located. However, the share allocated to #1 and #2 shifts. When absolute position shifts, as in a positive/negative sum game, that is reflected in moving from line A to line B or C. The aggregate total shifts but the share does not.

            It is worth noting that absolute and relative shifts can occur simultaneously or in sequence. For example, the security dilemma (as discussed in class) is typically a two-part sequence. Player 1 tries to achieve the upper right box (new weapon). Player 2 counters this (builds same weapon) and in doing so, both move into the lower right box.

            The outcomes for each side depend on actions by the other. The two payoffs for each player are interdependent. Whether or not Player 1 gets to achieve or remain in the upper right box depends on what the other does. This seems to be an obvious point, but this interdependence is at the heart of the security dilemma. The security dilemma has been ignored by nations time and again throughout history.

**************** ADDITIONAL COMMENTS ********************

            The outcomes in PD can vary due to a wide variety of factors; the preferences (the codes in each box) are not fixed. What are the players' (subjective) preferences? How well do the players know each other? Has their past behavior created any predictable patterns? Can the players communicate? Even if the player's have no means of communication, what happens if they play over and over again? Can a history of repeated play serve as a form of communication? How can the players alter the payoff matrix and try to obtain various outcomes? How can an outside force alter the payoff matrix? To what extent does this whole framework depend on rationality? How do the boxes change if seen through each of Allison's models? What would you put in the boxes to represent the nuclear arms competition between India and Pakistan, in the Korean peninsula...?

Free Thought Zone:

                                                                          Player ?

No X Yes X

        No X

  Player ?

        Yes X