Nations, Conglomerates, and Empires: The Tradeoff between Income and Sovereignty
52 Pages Posted: 20 Apr 2016
Date Written: October 1996
Why, after the breakup of such multinational states as the Soviet Union, Czechoslovakia, and Yugoslavia - whose republics justified their decision by claiming that they wanted to regain their sovereignty - did the new states express strong desire to join the European Union, thus dissipating the very sovereignty they had sought?
One of the apparent inconsistencies in the breakup of such multinational states as the Soviet Union, Czechoslovakia, and Yugoslavia is that while the republics justified their decision by claiming that they wanted to increase (regain) their sovereignty, the new states' strong desire to join the European Union shows their intention to dissipate the very same newly acquired sovereignty. How can the two desires be reconciled? Why would someone go through the ordeal of secession in order to quickly get rid of the very sovereignty that justified the secession? Or was sovereignty not the real (or sole) goal behind the secessionist drive?Milanovic explains that full sovereignty (like the individual's full freedom) is neither reachable for most countries nor desirable - because greater sovereignty is often traded for reduced income. Economic sovereignty is normally limited in key areas: Exchange rate policy (by rules stemming from IMF membership, for example, or participation in regional currency systems), trade policy (by GATT rules, for example), labor and banking regulations, accounting practices, and so on.
There is a tradeoff curve between sovereignty and income. Countries do not choose maximum sovereignty, but an optimal one. They choose a combination of income and sovereignty that allows them to maximize welfare. But that combination is not the same for all countries.
Larger countries (measured by their GDP) have the luxury of choosing more sovereignty per unit of income, simply because for them domestic markets are more important than for small countries.
Countries with abundant natural resources or very skilled labor (that is, with high per capita human and natural wealth) tend to be more integrated internationally. For them, economic sovereignty is less important because they need to export their resources and the returns to their labor increase with international integration.
More democratic countries also tend to be better integrated because in democracies the power of the political elite - who may often prefer not to be bound by international rules - is lessened. Testing these hypotheses on the 199394 data for 165 countries, Milanovic finds a statistically strong impact of per capita wealth and democracy on international integration. The effect of country size is weaker.
Milanovic discusses why different countries may wish to form conglomerates, defined as looser or tighter unions that imply shared sovereignty and redistribution from richer to poorer members. He finds that the willingness to join conglomerates (free trade associations) is greater for countries that are relatively poor (compared with the average income of the target conglomerate), and for democracies. The country size effect is U-shaped: The willingness to join conglomerates is high for small countries (whose sovereignty might actually increase in a conglomerate because of the conglomerate's sovereignty-sharing features) and for very large countries that may expect to play the role of core states. The key gain from independence for the relatively rich republics that were former members of the Communist conglomerates was not economic sovereignty in itself but the ability to switch from a poor to a rich conglomerate.
This paper - a product of the Poverty and Human Resources Division, Policy Research Department - is part of a larger effort in the department to study transition economies.
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