'Do uncoordinated national policies seriously limit our ability to manage our own economies, and would international economic policy coordination lead to better results?', asked economist Andrew Hughes Hallett at a CEPR lunchtime meeting on 22 January. He presented new research results which suggest that all participants would gain from policy coordination. In particular, there would be clear gains for Europe. The payoff would come from choosing coordinated policies to exploit the structural differences between national economies and from coordinating the timing of impacts - mainly with respect to changes in monetary policy. More research was needed, however, to provide policy- makers with better estimates of the likely gains from coordination.

Andrew Hughes Hallett is Professor of Economics at the University of Newcastle and a Research Fellow in the Centre's International Macroeconomics programme. He has written widely on economic policy, strategic behaviour, risk and commodity market management. His talk was based on research reported in CEPR Discussion Paper No. 77 and summarised in the last issue of the Bulletin. Hughes Hallett spoke at a lunchtime meeting organised by the Centre, one of a regular series of meetings at which Research Fellows discuss policy-relevant research. They may also advance specific views on policy at these meetings, but such views are their own and not those of CEPR, which takes no institutional policy positions.

Recession, two oil-price shocks, an international debt crisis, and increasing 'North-South' inequalities have made national policy-makers acutely aware of the interdependence created by trade and capital movements. Their understanding that this has curtailed the scope for independent policy choice is reflected in the annual summit meetings devoted to economic cooperation. Hughes Hallett found it extraordinary that there were virtually no estimates of the costs of uncoordinated policies, nor of the potential gains from international coordination.

The average OECD country, Hughes Hallett noted, exports about 30% of its GNP. Disturbances in one economy can therefore have powerful spillover effects on others. Competitive devaluations are a standard example of the dangers posed by spillovers resulting from uncoordinated policies. Similarly, fiscal contractions abroad may frustrate domestic reflation plans, while increased foreign budget deficits can crowd out domestic investment. The realisation that policy choices abroad often interfere with domestic economic plans has led to calls for greater policy coordination.

But despite the recognition of such spillover effects, Western governments have been unable to agree upon and implement a set of coordinated policies. One reason for this, Hughes Hallett suggested, was that the political will to achieve such agreement will not exist unless policy-makers appreciate the likely advantages and how they could be achieved.

In the absence of coordination, governments must pursue independent national policies. Many commentators have argued that this will lead to isolationist or even protectionist strategies which will reverse the post-war trend towards world economic integration. For example, the 'export' of growth and jobs has left the United States with a productivity problem; but if the United States introduces measures to stimulate productivity and eliminate its trade imbalance, the world economy will lose its capacity to expand. Similarly, Japan must control its trade surplus and stimulate a stagnant domestic economy; Europe must generate employment without recourse to increased budget deficits or protectionism. These problems all suggest obvious 'national' solutions, each of which will fail if other countries also adopt such 'national' solutions.

In his research Hughes Hallett had explored the payoffs from concerted policy action by the United States and the EEC over the period 1974-78. His policy simulations were based on an empirical multi-country model typical of those employed by policy-makers. The results clearly illustrated the undesirability of uncoordinated policies. They also provided empirical evidence that cooperation not only restores the effectiveness of domestic policy (which interdependence otherwise tends to reduce) but also makes intervention less costly by accelerating the economy's response to policies.

Hughes Hallett had simulated three policy regimes. 'Isolationist' policies were formulated by pretending that the rest of the world economy did not exist; the effects of domestic policies on other economies were simply ignored. 'Non-cooperative' policies were formed taking account of the response of other economies, but without any agreements among policy-makers. 'Cooperative' policies involved bargaining between policy-makers. Hughes Hallett outlined the estimated payoffs to policy coordination which could have been presented to the participants at the 1978 Bonn Economic Summit [see table below]. He found that adoption of non-cooperative instead of isolationist policies produced benefits equivalent to large increases in the growth rate of GNP for both the United States and the EEC, and that the gains in moving from non-cooperative to cooperative policies, while smaller, were still important. By adopting 'non-cooperative' instead of isolationist policies over the period 1974-78, the United States would have experienced a welfare gain equivalent to an annual growth of 5.3% in its GNP. By adopting 'cooperative' instead of 'isolationist' policies the benefit would have been the equivalent of an annual GNP increase of 5.8%. He also noted that, although these particular results were specific to the period 1974-78, his conclusions regarding the effects of policy coordination were generally applicable.

Hughes Hallett argued that his analysis yielded an important general insight into policy coordination: that the gains result largely from the asymmetries between the economic structures of cooperating nations. Since the countries concerned have different economic structures, the multiplier effects of policies differ. It therefore pays each country to concentrate its efforts on those policy instruments with the largest multiplier effects; Hughes Hallett found that this means monetary policy for the United States and fiscal policy for the EEC. Coordination is beneficial because it allows governments to specialise in those policies where they have a 'comparative advantage'. In addition, a dynamic framework of internationally concerted action allows governments to time their policy changes for maximum effect, which is particularly important in setting monetary policies.

Paradoxically, therefore, asymmetries may actually increase the effective autonomy of national policy-makers in a cooperative policy agreement and also make it easier to absorb shocks and policy changes originating abroad. That could partly compensate for the evident failure of flexible exchange rates to insulate economies from external shocks during the last decade.

TABLE
Hughes Hallett's Three Policy Regimes
Increase in annual growth rate of GNP 1974-78

US EEC

From isolationism 5.3 2.6
to non-cooperation

From non-cooperation 0.5 1.3
to cooperation

From isolationism 5.8 3.9
to cooperation

Note: The movement from isolationism to non-cooperation, for example, allowed policy-makers to achieve more satisfactory values for a variety of target variables such as inflation, unemployment and growth. This table measures these gains as if they had been taken entirely through faster GNP growth, whereas in fact the benefits would be taken through lower inflation and unemployment as well.