Economic Policy and Theory

David Shreve

Merging in numerous ways, economic theory has often been linked to U.S. foreign policy. When the United States began its life as a fledgling exporter of raw materials vitally dependent upon connections to Liverpool merchants, crude economic theories accompanied virtually all deliberations and pronouncements on foreign affairs. As the nation grew in size, population, and wealth, this connection became less apparent and, indeed, far less critical or commonplace. By most estimates, foreign trade rarely exceeded 5 percent of the American gross national product. Moreover, after significant growth and increasing specialization in export markets in the late nineteenth century, levels of international market integration that prevailed in 1914 were equaled again only in the 1990s, albeit with far less market segmentation than in the earlier period. The information gaps of that earlier period have almost completely disappeared.

Only when it emerged as a world power following the two world wars did the United States again endeavor to combine the latest in economic theory with virtually all of its foreign policy concerns. The rise of professional economics had much to do with this resurgence; so did the demands for the cooperation and rebuilding made virtually indispensable by both economic depression and destructive and widespread conflict. Institutionalization of professional economic advice, most of which followed the Great Depression and World War II in the twentieth century, brought economic theory into the limelight, where it joined readily and quite seamlessly with heightened international concerns for peace and prosperity. Here it began by acknowledging as well the growing awareness that domestic prosperity was at least partly hinged to global prosperity.

The adaptable theories of giants such as the British economists Adam Smith and David Ricardo notwithstanding, economic theory previously had been applied only loosely to U.S. foreign policy concerns or, as it was in the early Republic, only in forms of a largely prescientific character, too amorphous and philosophical to construct a lasting bond or significant transgenerational analysis. Here it had often reflected little more than a concern for how one might either tease out the factors behind international commercial advantage or better discern both commercial limits and commercial potential in world markets. Falling loosely under the rubric of "mercantilism," such concerns seldom reflected anything approaching a scientific method or cognizance of recent or past advances in economic theory, and they seldom attracted those social scientists interested in testing the theoretical challenges of pioneers such as Smith and Ricardo. Smith's suggestion that political economists must find a theory that comports with maximum wages and modest profits, for example, along with Ricardo's critique of landlord-based economic exploitation, remained obscured by conventional analyses designed mostly to promote commercial interests.

Despite this tendency toward limited, mostly superficial economic analysis of international affairs, discussions of monetary policy in the early Republic often veered into the analysis of international factors and approached levels of sophistication unmatched by many twentieth-century analysts. In some ways, for example, late nineteenth-century U.S reliance on a gold standard with fixed exchange rates represented a departure from an earlier, more flexible bimetallic monetary policy—to which the nation would ultimately return. The alteration, in 1834, of Alexander Hamilton's 15:1 silver-to-gold valuation of the dollar—to a 16:1 ratio—largely kept silver dollars out of circulation, limited the worldwide potential of later Nevada silver discoveries, and signaled the advent of a more restrictive, even emasculating, U.S. monetary policy. Ceding control of domestic monetary policy to the vagaries of international gold flows, and the overall level of international commerce to the total gold supply, policymakers had essentially ignored existing economic theory, however immature, in favor of economic policy handcuffs.

But talk of trade clearly occupied the minds of far more policymakers and economic theorists than did international currency analysis. Smith's theories, principally those found in his ground-breaking synthesis published in 1776, An Inquiry into the Nature and Causes of the Wealth of Nations, focused attention squarely on international trade, proffering an analysis designed to integrate trade policy and consumer welfare. Smithian analysis of how to pay for war (taxation versus borrowing)—designed to make its costs more obvious and disabling—also filtered into a great number of American foreign policy debates and was digested and considered fully by both late eighteenth-and early nineteenth-century American leaders. David Ricardo's early nineteenth-century postulates regarding comparative advantage—the notion that two nations may gain through trade even if one can produce everything more efficiently than the other—had percolated, as well, into policy circles in both Great Britain and the United States. Few of these theories, however, found anything but temporary or comparatively insecure footholds in the policy arena until the mid-twentieth century.

From the American economists who toiled for the Strategic Bombing Survey during World War II to those serving today as consultants on currency stabilization, economic theory has now permeated virtually every conceivable foreign policy analysis and situation. It no longer remains confined principally to questions of international commercial advantage or even international trade. At the same time, its chief occupation has most often been limited to three major areas: trade policy, international monetary policy, and policies for international growth and development (for developed, developing, and undeveloped nations). Since the breakdown of the Bretton Woods system for international currency stabilization in the early 1970s, monetary policy has become much more newsworthy; much more often the subject of policy discussions, high and low; and has increasingly become the preoccupation of many skilled economists and specialized policy advisers. Likewise, growth and development policy also increased in significance in the late twentieth century, albeit mostly as a result of both increasing numbers of American, European, and East Asian multinational corporations and increasing emphasis on development that emerged along with post–World War I and post–World War II rebuilding efforts. As the welfare of these companies came to depend increasingly on rising prosperity abroad, and as altruism merged increasingly with self-interest in prominent rebuilding or relief efforts, more people naturally came to ask how such prosperity should be created or sustained.

Analysis of trade policy, however, continues to engage economic theorists more than any other large foreign policy concern. Indeed, a great number of international monetary policy analyses are, in effect, designed to explain how international money affects international trade.

See also Foreign Aid ; International Monetary Fund and World Bank ; Tariff Policy .