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TWN Info Service on Finance Issues (Aug07/05)

20 August 2007


SAVING GLOBALIZATION FROM ITS CHEERLEADERS

Globalization in some appropriate form is a major engine of economic growth, but the current gung-ho process of globalization has produced paradoxes in both rich and poor countries, and is creating a backlash, and needs a rethink of rules and policies to save globalization from its cheerleaders, according to Dani Rodrik, Professor of international political economy at Harvard’s JFK School of Government.

In a research paper titled “How to Save Globalization from its Cheerleaders”, and published on his website, Prof. Rodrik argues that in the current realities of the world, pursuit of perfect globalization – more openness – endangers the present imperfect, but still remarkable globalization, by intensifying conflicts that the system inevitably generates. The paper cites and analyses several studies to show that in terms of realities of the world polity today, there is a mutual incompatibility of deep integration, national sovereignty and democracy.

The following is a review of Prof. Rodrik’s paper by Chakravarthi Raghavan, Editor Emeritus of the SUNS. It was published in the SUNS #6316, Friday 17 August 2007.

With best wishes
Martin Khor


Saving Globalization from Its Cheerleaders

By Chakravarthi Raghavan*

Globalization in some appropriate form is a major engine of economic growth, but the current gung-ho process of globalization has produced paradoxes in both rich and poor countries, and is creating a backlash, and needs a rethink of rules and policies to save globalization from its cheerleaders, according to Dani Rodrik, Professor of international political economy at Harvard’s JFK School of Government.

In a research paper titled “How to Save Globalization from its Cheerleaders”, and published on his website, Prof. Rodrik argues that in the current realities of the world, pursuit of perfect globalization – more openness – endangers the present imperfect, but still remarkable globalization, by intensifying conflicts that the system inevitably generates.

The paper cites and analyses several studies to show that in terms of realities of the world polity today, there is a mutual incompatibility of deep integration, national sovereignty and democracy.

The world economy, Prof. Rodrik notes, has witnessed more rapid economic growth since 1950, than at any other period before excepting perhaps the classical gold standard era (1870-1913), and this is entirely because the world economy became a much more enabling environment for growth after 1950. Also, the world economy received a more significant boost during 1950-73 than either the post-1990 period of “gung-ho globalization” or the transition period between 1973-90.

And the countries that did best under each one of these periods – Japan, South Korea and China – were hardly poster children for open markets and laissez-faire economics. These countries combined orthodoxy mostly on macroeconomic policy fronts with a good bit of heterodoxy on other fronts – especially in microeconomic policies. Each of these countries played by very different rules than those enunciated by the guardians of orthodox globalization – multilateral institutions such as the World Bank, IMF, and Western-based academics.

Prof. Rodrik’s paper is premised on the view that globalization, in some appropriate form, is a major engine of economic growth. However, several of its paradoxical features, affecting both rich and poor countries, require that its rules need to be rethought.

Globalizations’ chief beneficiaries are not necessarily those with the most open economic policies. Globalization has come with frequent financial crises and considerable amounts of instability. Both are costly and in principle avoidable. Even more, globalization remains unpopular among large segments of the people it is supposed to benefit, especially in rich countries.

In this situation, there is now an emerging new conventional wisdom and new orthodoxy that to reap the benefits of trade and financial globalization, better domestic institutions are needed - improved safety nets in rich countries and improved governance in poor countries.

This improved strategy of “more of the same but better” is on the presumption that insufficiently open markets continue to be an important constraint on the world economy. Hence, the concerns of the proponents of this new orthodoxy centre on institutional reforms needed in countries and internationally to ensure that further market openings are politically acceptable and sustainable.

Challenging this presumption, Prof. Rodrik argues for an alternative approach – that of enhancing policy space rather than market access. It is lack of policy space, and not lack of market access, that is proving a real binding constraint on a prosperous global economy, he insists in his paper.

He notes that of the four countries - China, India, Vietnam and Uganda – identified as “star globalizers” by the World  Bank in its 2001 publication, “Globalization, Growth and Poverty: Building an Inclusive World Economy”, three – China, India and Vietnam - remain the exemplars of globalization’s benefits.

However, the three could hardly be described as free trade types. By any standard measure, they were the most heavily protected in the early 1990s, and whatever trade liberalisation took place thereafter, it happened with a significant delay after the onset of economic growth. The three increased their volumes of trade and inward foreign investment through heterodox strategies, and showed that the countries that benefited most from globalization were those that did not play by the rules.

By contrast, Latin America, which tried harder than any other part of the world to live by the orthodox rules, and despite the boost provided by the natural bounce-back from the debt crisis of the 1980s, experienced on the whole a dismal performance since the early 1990s. It is not just that Latin America did worse than Asia, but its performance was also worse than its pre-1980’s performance.

As for international finance, financial globalization - supposed to enable developing countries to augment their savings, raise their investment levels, and grow more rapidly - has in fact done little of any of it.

The absence of evidence on direct benefits of financial globalization, Prof. Rodrik notes, is such that proponents and researchers are turning to indirect benefits (to promote financial liberalization).  And financial globalization has not enhanced risk sharing and consumption smoothing for developing nations. If anything, the evidence points in the reverse direction.

Moreover, one noticeable consequence of financial globalization has been a series of costly financial crashes - in Mexico, Thailand, Indonesia, South Korea, Russia, Argentina, Turkey, and many other countries. This has forced developing nations to accumulate huge amounts of foreign reserves in order to purchase self-insurance against the fickleness of financial-market sentiment.

In recent years, the world economy has avoided similar financial crises, indicating that developing nations have become more resilient to financial turbulence.

But this is due in no small part to the mountains of liquidity that developing nations now sit on. It is also due to the fact that many emerging markets are now running trade surpluses –  i.e., lending money to the rest of the world. In other words, in order to protect themselves from the whiplash of financial crises, developing countries have been forced not only to shun its benefits, but to make transfers to rich countries on top!

A third paradox of globalization is that it remains restricted in precisely those areas where further relaxation of barriers would yield the greatest economic benefits. Barriers on labour mobility in particular are inordinately higher than they are anywhere else. Even minor reductions in labour-market barriers would generate gains that are vastly larger than those from the conventional areas under negotiation in the WTO and elsewhere.

Some estimates suggest that even a temporary South-to-North labour mobility scheme that would expand the industrialized countries’ labour force by about 3% would result in benefit to nationals of poor countries of $262.5 billion per annum.

By contrast, current estimates of the gains to developing countries from the completion of the Doha Round do not exceed $30 billion.

And while many tears have been shed about the recent demise of the Doha Round, multilateral negotiations on reducing barriers to labour mobility are not even on the agenda, the paper notes. A recent proposal in the United States Senate to institute a temporary guest worker program was eventually killed, alongside the proposed immigration reform.

Globalization has produced not only paradoxical outcomes for developing countries, but remains quite unpopular in most advanced countries. So much so that even such boosters of globalization like Paul Krugman, Larry Summers and Alan Binder are acknowledging that globalization is contributing to inequality and insecurity.

In response, a new conventional wisdom is emerging that globalization needs a range of institutional complements in both rich and poor countries, with a multi-pronged effort to deepen globalization - the Doha development agenda with focus on agricultural liberalization.

However, the Doha process seems dead on its tracks due to a combination of unwillingness of the rich countries to offer substantial cuts in agricultural supports and market access and the reticence of developing nations to offer low enough bindings on their own tariffs.

Other elements in the new conventional wisdom calls for promotion of “cautious” capital account opening in developing countries, the governance agenda of the multilateral institutions, focusing on anti-corruption at the World Bank and financial regulation and supervision at the IMF, and ongoing discussions in the US and other advanced countries on a menu of proposals to take the “pain” out of globalization - through increased progressivity in taxation, enhanced adjustment assistance, portability of health insurance, and wage insurance to cover part of the income losses due to dislocation.

While these efforts may be useful in themselves, Prof. Rodrik challenges the view that such global reforms can help increased openness and market access, and thus maintain a healthy global economy.

Under certain conditions, economic integration can be a powerful force for economic convergence, and it can promote rapid economic growth in poorer regions, he concedes, citing the example of the US and the benefits of its nationally established and integrated set of product, capital, and labour markets. However, the US showed that achieving integration of this kind is not just a matter of eliminating barriers to inter-state commerce (which are prohibited in the constitution itself), but required many more things. A national market required a national polity. Only then the transaction costs associated with jurisdictional and legal discontinuities across state lines eroded sufficiently to permit economic convergence.

The European Union was currently presenting significant growing pains associated with efforts to create seamless integration. The EU is engaged in a process of legal, institutional, political integration that is somewhat similar to the process that took the United States some two centuries. Even with all the progress being made, this, convergence within the EU is far from complete, and remains a stop-and-go process.

In the absence of the legal and political integration of the type that the US has already achieved and the EU is attempting to construct, transaction costs condemn the global economy to a patchwork of national economies. This is the model of “shallow integration” in contrast to the US/EU models of “deep integration”. And in a world of shallow integration, the prospects for convergence are doomed to remain incomplete.

Capital flows are hindered by sovereign risk and the absence of international financial regulation and bankruptcy procedures. Financial panics and crashes are rendered more likely by the absence of a true international lender-of-last resort. Labour can flow in very small quantities, and often only illegally. And differences in national regulatory, legal, and currency regimes impose severe transaction costs on international trade. Net capital flows end up being too small, and often go in the “wrong” direction - that is, from poor to rich nations. Trade flows similarly remain too small, compared to intra-national trade, and national borders exert significant depressing effect on trade even in the absence of import duties or other government-imposed barriers.

For developing countries, all these paradoxes of globalization imply that the vast majority of them do not face the realistic option of full economic integration with their rich trade partners: legal and political integration a la EU or US model is not on offer, and even if it were, national sovereignty is perceived to be too valuable for many to give up.

Developing countries need to recognize therefore that they are living in a second-best world, in which international economic integration remains incomplete due to the transaction costs. And living in a second-best world requires second-best strategies.

If markets cannot solve their problems of labour-surplus and capital shortage (because the former is not free to leave and the latter comes only in small quantities), the developing countries need round-about policies. They may need to postpone import liberalization in order to protect employment for a while, they may need to subsidize tradables to achieve more rapid structural change. In fact, they may need a whole range of industrial policies in order to build technological and productive capacity at home.

This is why some countries that sharply lowered their barriers to trade and capital flows are still waiting for the rewards, while others who have been much more cautious have done so much better.

Prof. Rodrik’s paper points to Mexico as the most notable development failure of the last fifteen years. It has free and preferential access to the US market for its exports, can send several millions of its citizens across the border as workers, receives huge volumes of direct investment and is totally plugged into US production chains, and for which the US Treasury has acted as a lender of last resort. It is hard to imagine a case where globalization gets any better. Yet even though trade and investment flows have expanded rapidly, the results have been underwhelming, to say the least - in economic growth, employment, poverty reduction, and real wage growth. NAFTA, it turns out, is another instance of shallow integration.

Prof. Rodrik argues that given successive rounds of multilateral trade liberalization and the extensive unilateral liberalization that developing countries have already undertaken, the shallow integration model has already run into strong diminishing returns. This is one reason why Doha has stalled. There are simply not enough gains to get people excited.

Citing various studies and data, Prof. Rodrik argues that the realistic gains from further trade liberalization through shallow integration in the world economy are small.

As for financial liberalization, a recent study by Easwar Prasad, Raghuram Rajan and Arvind Subramanyam shows that countries that rely more on external capital markets grow less rapidly. According to the abstract of the study, non-industrial countries that have relied on foreign finance have not grown faster in the long run. Prof. Rodrik notes from this study that for a variety of reasons, countries do not do that well when they attract capital from abroad. There is hence a need for “second best thinking” over benefits of further financial liberalization too.

In sum, the likely gains from further liberalization in goods and capital markets are small, as long as the world remains politically fragmented and transaction costs emanating from jurisdictional discontinuities prevent “deep” economic integration.

Strong diminishing returns may have set in on the prevailing liberalization agenda, but the losses from a real retreat from today’s globalization would be catastrophic. A collapse towards protectionism and bilateralism a la 1930s can never be ruled out - it has happened before - and would be bad news for poor and rich nations alike. Therefore, a high premium ought to be put on policies that make such a retreat less likely - even if they run contrary (in the short run at least) to a market-opening agenda.

Unless deeper integration is accepted as a feasible option, the challenge becomes not “how do we liberalize further,” but “how do we create the policy space for nations to handle the problems that openness creates.”

Such a policy space would allow rich nations to address issues of social insurance and concerns about the labour, environmental, and health consequences of trade; and poor nations to position themselves better for globalization through economic restructuring and diversification.

In the rich countries, the policy space and its dilemmas relate to labour standards, environmental health and safety standards, regulatory “takings” and redistributive provisions of social insurance, currency policies and “unfair trade” and trade vs technological challenge.

These are difficult questions without clear-cut answers, but can’t be dismissed, as they are now, by economists as instances of self-interested pleadings by those adversely affected.

Globalization is a hot button issue in the advanced countries not just because it hits some people in their pocket book; it is controversial because it raises difficult questions about whether its outcomes are “right” or “fair.” That is why addressing the globalization backlash purely through compensation and income transfers is likely to fall short. Globalization also needs new rules that are more consistent with prevailing conceptions of procedural fairness.

As for developing countries, and globalization’s constraints on them, successful development strategies often require second-best and therefore unorthodox policies. Current thinking has moved considerably away from a standardized Washington Consensus-style approach to a diagnostic strategy which focuses on each country’s own binding constraints. Differences in the nature of these constraints shape the appropriate economic strategies.

Key areas, in terms of policy space, for developing countries are the WTO agreements on subsidies, TRIMs and TRIPS.

The conventional view is that there is a slippery slope whereby even the slightest relaxation of international disciplines spawns further demands for protection – to the point that the system of free trade and finance eventually unravels. This view sometimes finds expression in the “bicycle theory” of international trade, which states that maintaining an open economic regime requires constant efforts to liberalize. In this line of reasoning, policy space is a recipe for mischief.

National polities cannot be trusted to work out reasonable internal compromises among competing domestic political forces with varying views on globalization. They need to have a straitjacket imposed from the outside.

Yet, there is little evidence that favours the slippery slope hypothesis in our contemporary political economy. The political balance in most countries, including developing countries, has tilted sharply in recent decades towards groups that favour links with the global economy.

A “policy space” approach would include negotiated opt-outs, with internationally agreed procedural constraints, which are better than disorganized, unilateral opt-outs. It is better for the rules to recognize that sometimes countries need their own manoeuvring room than to leave such a possibility outside the scope of the rules.

In this view, Prof. Rodrik makes several suggestions, including “a broadening of the safeguards agreement” with institutional and procedural prerequisites to minimize risk of protectionist capture, and similarly, a “development box” for developing countries to pursue developmental policies that may conflict with existing rules, for example, subsidies.

Several of his proposals, on the face of it are controversial and trade theologians would reject them out of hand. But the paper makes a powerful case for detailed consideration of these concepts, and perhaps many modifications.

In effect, Prof. Rodrik argues, rich and poor nations would then be in the game of exchanging policy space instead of market access. Negotiators would be tasked not with maximizing the flow of trade and investment, but with designing rules that managed the interface among different regulatory environments.

* The full text of Prof. Rdorik’s paper can be accessed in PDF format at

his website: http://ksghome.harvard.edu/~drodrik/Saving%20globalization.pdf



* Editor Emeritus of the SUNS.

 


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