Chapter Iii Market Realism: Currency Pricing and the Gains from Trade between Countries at Different Levels of Political Development

Chapter 1 introduced the foundations for the neoliberal interpretation of international institutions’ advocacy of liberalized trade. A critical assumption behind the neoliberal perspective is that free markets are in the collective interest – that is, that liberalized trade maximizes the gains to world as a whole, without regard to how those gains might be distributed. The economic theory underpinning this belief was reviewed in Chapter 2, “Economics and Interest,” where I also noted that the principal challenges to laissez-faire economics have concerned distributional issues, not market liberals’ claim that perfectly free markets lead to the optimal use of resources. In this chapter, I present a model that calls this latter belief into question. While the classic arguments upon which free market liberalism is founded involve barter models of trade, I introduce differentially risky currencies, and derive two important results. First, consumers in countries with the riskier currency pay higher prices in perfectly free markets than those with less risky currencies, shrinking their share of world output. Second, currency traders’ aversion to risky currencies introduces an endogenous distortion into perfectly free markets that leaves the equilibrium suboptimal from the perspective of the collective interest. The chapter begins with a review of the