Michael Bordo and Harold James have a paper where they explain the challenges of globalization, especially that arising from cross-border capital flows, facing countries in terms of four distinct policy constraints or trilemmas. They write,
The analysis of a policy trilemma was developed first as a diagnosis of exchange rate problems (the incompatibility of free capital flows with monetary policy autonomy and a fixed exchange rate regime); but the approach can be extended. The second trilemma we describe is the incompatibility between financial stability, capital mobility and fixed exchange rates. The third example extends the analysis to politics, and looks at the strains in reconciling democratic politics with monetary autonomy and capital movements. Finally we examine the security aspect and look at the interactions of democracy with capital flows and international order. The trilemmas in short depict the way that domestic monetary, financial, economic and political systems are interconnected with the international. They can be described as the impossible policy choices at the heart of globalization. Frequently, the trilemmas conjure up countervailing anti-globalization tendencies and trends.
Countries trade-off among these choices as they pursue their macroeconomic policies. Consider the case of India. It has adopted a regime of floating exchange rates, partial capital controls, and monetary policy autonomy, as its strategy to achieve financial market stability. As regards the political dimension, it is currently grappling with the tension between democratic politics and monetary autonomy of the central bank. The recent Union Budget even usurped some of the Central Bank's powers in managing cross-border capital flows.
The last trilemma is the newest and assumes great significance in view of the challenges thrown up by the Global Financial Crisis. It is amply clear that global financial market stability requires close co-ordination among atleast all the major economies. The quantitative easing policies pursued in US, Europe, and Japan, motivated by domestic economic considerations, have generated large-scale negative externalities, especially by way of enhanced cross-border capital flows volatility, with considerable destabilizing effects. Developing countries, which faced the brunt of these effects, have expressed their concern at the absence of international co-ordination in the management of effects of such domestic policies. However, the achievement of such co-ordination to mitigate the externalities arising from cross-border flows would require trade-offs between democratic politics, both within countries and among nation states.
This squares up with another framing of this conundrum outlined a few years back by Dani Rodrik. He argued that full democracy, national sovereignty and global economic integration may be incompatible. The major fault lines on this include the adverse impact of international trade on certain sections of the population. Faced with the pressure from their constituents, democratic governments have generally preferred to hold back on full economic integration.