Benjamin Cohen on the problems of International Monetary Cooperation

This page is an attempt to summarize Benjamin Cohen's essay entitled "The Triad and the Unholy Trinity: Problems of International Monetary Cooperation."

Cohen starts with a very simple fact: "international monetary cooperation {...} is a good thing but difficult to sustain." For him, the reason for this difficulty lies in the incompatibility of the three key desiderata of government, namely the exchange-rate stability, the capital mobility and the national policy autonomy. Clearly, he asserts that this "Unholy Trinity" is responsible for states's inconstancy of behavior as to monetary cooperation.

1. The Case for Policy Cooperation:

After briefly presenting his thesis, he first defines cooperation as "a mutual adjustment of national-policy behaviour in a particular issue-area, achieved through an implicit or explicit process of inter-state bargaining."Synonyms include such words as "coordination", "joint" and "collective decision-making." He then goes on and underlines the undeniable evidence that there is "an intensified interdependence across much of the world economy" which then leads to "spillover effects", or foreign repercussions. Those externalities show a lessened insulation that can keep a given state from achieving its macroeconomics objectives. The existence of those spillover effects means that each government has partial control over the actions of others.

The study of cooperation is thus a very important aspect of IPE scholarship nowadays. Cohen further writes that policy coordination may be used to pursue at least two sets of goals, both derived from structural and policy interdependence.

a) policy-optimising, where cooperation is a means to achieve individual policy.

b) regime-preserving or public-goods, where states cooperate to pursue broader collective goals.

But he then lists five major issues related to policy coordination (=cooperation) that have been raised by many analysts:

1) Magnitude of gains --> small externalities for foreign states means small benefits from cooperation.

2) Magnitude of costs --> marginal cost of efforts and time needed to organize policy cooperation exceeds the marginal benefit of coordination itself. Although Cohen acknowledges that creating an explicit framework (=set of rules) for cooperation could minimize this cost, according to him, the loss of states's autonomy that would result from the adoption of this framework would lessen states's incentives to embrace it.

3) Time-inconsistency --> risk of unilateral defection since enforcement mechanisms are too weak to prevent a state from violating agreements. He also notes that, according to many specialists, the risk of defection isn't paramount because of the importance of additional factors such as reputation, credibility, and historical and institutional context.

4) Distortion of incentives --> international cooperation could be counterproductive if the wrong policies are implemented (i.e. policies more politically convenient than economically sound).

5) Model Uncertainty --> policy-makers are dense and don't understand how their economies operate and interact. There is therefore a real chance that politicians will make the wrong decisions.

Yet, most analysts, Cohen included, still view policy coordination as an inherently good thing because none of the above-mentioned problems seem overly dangerous to the welfare of states.

2. The Ebb and Flow of Policy Commitments:

Although cheating is not unexpected from an isolated state, Cohen stresses the importance of the collective (=most states) commitment, which must be enduring if one wants to make sense of it. However, he observes that "the history of international monetary cooperation is one long lesson in the fickleness of policy fashion." He uses as example the G-7 summits that are for him nothing but a façade to hide a tendency to shirk quite widespread among states.

Yet, despite this negative account, Ben Cohen admits that, far from being without redeeming social value, the effort put towards the multilateral surveillance process "has on balance been beneficial, both in terms of what has in fact been accomplished and in terms of what has been avoided. In brief, cooperation policies have had two main benefits:

1) Policy-makers have become more aware of the foreign externalities engendered by their domestic actions.

2) The structures meant to serve policy cooperation, although virtually useless at times, were ready to be used in times of crisis (e.g. the rising wave of U.S. protectionism in 1985 and the stock market crash of 1987).

Then again, Cohen's acknowledgment that what has been done was probably worth it (since the benefits seem to be greater than the costs) is immediately undermined by his lamenting the inefficiency (understand the non-optimization) of policy cooperation. Indeed, he states that the gains could have been larger without states's inconstancy of behavior. Every new state defection makes the building of new joint initiatives harder. Multilateral surveillance is a good thing but its stop-go pattern increases its cost and, in the long run, it might even be detrimental to cooperation, and therefore to the welfare of states.

3. The Influence of the Unholy Trinity:

Cohen now tries to understand the reason for the episodic nature of the international monetary cooperation. He suggests that the dilemma that states face when having to choose between cooperation and defection is systemic, which means that it results from the interaction of several sovereign national governments. He notes that the three key desiderata of governments (exchange-rate stability, private capital mobility and monetary-policy autonomy) are incompatible, hence the principle of "Unholy Trinity", which is explained in the following paragraph:

The problem of the Unholy Trinity, simply stated, is that an environment of formally or informally pegged rates and effective integration of financial markets, any attempt to pursue independent monetary objectives is almost certain, sooner or later, to result in significant balance-of-payments disequilibrium, and hence provoke potentially destabilising flows of speculative capital. To preserve exchange-rate stability, governments will then be compelled to limit either the movement of capital (via restrictions of taxes) or their own policy autonomy (via some form of multilateral surveillance or joint decision-making). If they are unwilling or unable to sacrifice either one, then the objective of exchange-rate stability itself may eventually have to be compromised. Over time, except by chance, the three goals cannot be attained simultaneously.

The problem, he says, comes from another simple fact: although policy-makers value free integrated markets, they value exchange-rate stability and policy autonomy even more. However, the control of capital mobility is virtually impossible, and states have therefore to choose between sacrificing their exchange-rate stability or their policy autonomy. According to Cohen, keeping both is absolutely impossible. This choice can be visualized on a continuum:

   1) Absolute Monetary Independence  <-------------------------------------------------------------------------------------------------> 2) Full Monetary Integration                                                                                                                                                                                                                                                                                                                                        

1) individual governments sacrifice any hope of a long term exchange-rate stability for the presumed benefit of policy autonomy in addition to an improvement in effectiveness of monetary policy as an instrument to attain national macroeconomic objectives.

2) individual governments sacrifice their autonomy completely for the presumed benefits of a permanent stabilization of their exchange-rates in addition to an improvement in the usefulness of money in each of its three functions: a) medium of exchange (less currency conversions so reduction of transaction costs); b) store of value (less exchange risks because smaller number of currencies); c) unit of account (information saving since less price quotations).

Cohen then defines his hypothesis: "My hypothesis is that for each participating country both cost and benefit vary systematically with the degree of policy cooperation, and that it is through the interaction of these costs and benefits that we get the episodic quality of the cooperation process we observe in practice."

In sum, the fickleness of states's behavior as to cooperation policies is due to a fluctuation in the costs and benefits of those policies. When the benefits exceed the costs, all is good, but when the situation is reversed, states will tend to shirk.

4. Can Cooperation Be "Locked In"?

Is there any solution to that problem? For Cohen, it is not a matter of education since, according to his theory, states know very well what their best interest is (on the short term at least). Instead, the real question seems to be: can collective commitment be "locked in" once it has been made? Or, in other words, can anything prevent a state from retreating?

Given that Cohen is looking for a way to enforce policy-cooperation commitments, all the solutions examined imply a certain degree of loss of autonomy. Visually, it means that they can be found somewhere on the right side of the continuum.

--> He first studies the adoption of a common currency, but cites a few examples to show that this solution is not infallible.

--> He then considers the voluntary submission of governments's authority to an external authority over their individual policy behavior. This overarching authority can refer to three distinct principles: 1) supra-nationality (states have agreed to abide by the decision of that authority); 2) hegemony (states have no choice but to accept the binding rule of a single dominant state); 3) automaticity (states are reasonable units and they accept the binding norms and rules of a self-disciplining regime). Although the European Community demonstrates that it is a possible solution, Cohen does not nurture much hope and asserts that the EC is a very unique case.

--> Finally, he suggests that states should define more precisely and more publicly their policy guidelines and commitments. According to that reasoning, policy-makers would be less likely to defect if they had to face public pressure. Furthermore, Cohen proposes the creation of an independent secretariat to record and archive every decision in order to provide states with reliable information about one another. Cohen ends his essay by writing that this solution could be doable if governments "feel they share a common destiny across the full spectrum of economic and political issues."