Nations, Conglomerates, and Empires: The Trade-off Between Income and Sovereignty

The paper proposes a framework within which to study countries’ decision to enter into international binding agreements that limit their economic decision-making power. Increased income, achievable through greater international integration, comes at the cost of reduced national policy-makers’ sovereignty. The policy makers have fewer economic variables they control as many of them are determined globally. Each country chooses an equilibrium sovereignty-income ratio. More democratic countries and those with larger endowments (human and physical capital and natural resources) will choose less sovereignty per unit of income: the first because population tends to value income relative to sovereignty more than autocrats, and the second because endowments cannot be fully used in isolation. Countries with larger domestic markets will select more sovereignty per unit of income simply because they are less dependent on international integration. Using the sample of 165 countries for years 1993-94, we find empirical support for the above relationships. This framework is then used to study the process of tighter integration among groups of countries: formation of conglomerates which are, for simplicity, assumed to consist of a large core country, a small rich, and a small poor nation. The conglomerates imply some sovereignty and income sharing as well as all-around income gain due to free trade and/or circulation of factors of production. Countries poor relative to the rest of the conglomerate, and small, will gain the most from joining. Small rich countries will balance income losses from redistribution against sovereignty gains (because their sovereignty as fully independent countries would be even smaller). The position of the core member is more ambiguous: it may gain or lose both in terms of income and sovereignty. Its decision to stay in the conglomerate or leave will determine the fate of the conglomerate. Using the same sample, we find support for these hypotheses as well, except that being poor or rich relative to the rest of the conglomerate does not seem to matter for the decision to join. This may be due to the fact that none of the conglomerates (free trade areas) included except the European Union does have redistribution.