A central research question in international and comparative political economy concerns the influence of international financial markets on government policy outcomes. To what extent does international capital mobility limit government policy choices? Does capital market openness render impossible the public provision of education and health care, income redistribution, and active labor market policies—all hallmarks of the contemporary welfare state? I argue that the influence of international financial markets on the governments of advanced industrial democracies is somewhat strong, but also somewhat narrow. Capital market openness allows participants in financial markets to react dramatically to changes in government policy outcomes. Market participants, however, consider only a small set of government policies when deciding how to allocate their assets. Therefore, governments face pressures to adopt market-pleasing policies in aggregate policy areas but retain ‘‘room to move’’ in many other policy areas. Despite financial internationalization, we will observe a significant amount of crossnational policy divergence among advanced industrial democracies. I position my analysis within current international and comparative political economy debates and develop expectations regarding the influence of financial market pressures on government policies. I then assess these expectations by employing interviews with financial market participants. I further evaluate my hypotheses using a statistical analysis of the determinants of interest rates on government bonds. I briefly discuss governments’ responses to financial market influences and conclude by offering suggestions for future research.
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