View
3
Download
0
Category
Preview:
Citation preview
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Collateralization of Assets, Over-Extension of Credit, and Free Trade: An Empirical Analysis in Search of Justice and an Expanding Middle Class
John Charalambakis; David Coulliette, Ken RietzAsbury College
Introduction
In Plato’s Republic we find Socrates asking the fundamental question that has been with
us for centuries, “What is justice?” It seems that for Plato, as well as for Aristotle who
followed him, justice is the essential virtue of a society. Socrates taught his disciples that
justice is giving and getting one’s due. Plato describes that justice must be counted as
desirable for its own sake (Plato, trans. Grube, 1982.) Justice, in other words, is harmony
in the soul and harmony in the state. Furthermore, Plato tells us that responsibility should
be delegated in accordance to one’s ability and place.
We believe that the latter could become the foundation for viewing international trade as
an instrument of justice, because what is produced, where it is produced, and by whom is
produced, depends upon the ability to produce in an efficient manner. In such a case,
everyone can gain from the transaction, a concept that was taken to the next step by
Aristotle.
In this framework of thought, justice is viewed as fairness, power is restrained, the
disadvantaged are empowered, and the interests of the society as a whole are being
advanced. If that is the case then, sectors in the economy would work together in
harmony (nowadays that would apply to the production and financial sectors), while
convergence would be observed across nations.
This paper discusses first international trade as a venue and instrument of justice from a
theoretical perspective, then adds a theological dimension to the theoretical framework
where justice issues are viewed from a wholistic perspective and where international
trade is viewed as the main venue of capital formation, which in association with social,
physical, and financial infrastructures creates and sustains a middle class, without which
democracy cannot function (Zakaria, 2003). Finally, the paper tests the above hypothesis
by employing a vast number of factors and data from forty-four countries (categorized as
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
1
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
frontier, emerging, and developed) and by using the support vector machine (SVM)
algorithm.
The empirical results verify the hypothesis that trade is a source of creating a middle
class, and thus serves as a venue of distributive and commutative justice. The paper
concludes with a thesis (which still needs to be tested) that when the financial interests of
collateralization and securitazation, are separated from production interests at a global
level, then Pandora’s box is being opened, financial crises take place, and the reverse
route starts i.e. the destruction of the middle class and injustice prevails.
From Plato to Rawls and Nozick
In the Republic, Socrates refuses and rejects the argument of Thrasymachus who argued
that justice always serves the interests of the rulers of the society, the interests of the
stronger in our midst. Moreover, Socrates rejects Glaucon’s argument which suggested a
more modest approach, that justice is ultimately a matter of self interest and that people
observe justice to avoid punishment. Both of these negative views about justice were
rejected by Socrates who insisted that justice is the ultimate responsibility of the person,
and should be delegated according to ability and place. Justice cannot be viewed as
punishment, retribution or revenge. In ancient times, in Platonic terms, justice is a matter
of social harmony and in Christian ethics, it is a matter of mercy. In economic terms we
can talk about just wages, just distribution of rewards and of income. Issues of justice
come at the forefront when there are exchanges. In his famous 1971 book, The Theory of
Justice, John Rawls takes the liberal approach to find the proper balance between liberty
and equality, with a particular concern for the least advantaged. A few years later his
colleague, Robert Nozick takes a more libertarian approach to justice defending a strong
notion of entitlement where everyone gets what he or she is entitled to, based on
endowments, without any reference to needs or inequalities.
We have the impression that any reference to justice by neglecting the concept of
community (ecclesia in theological terms) would have horrified Plato, Socrates, Aristotle
and their followers. Cicero long argued that the leading virtue in a society is justice and
that the definitive ingredient of justice is merit. Therefore, meritocracy in society is a
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
2
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
necessary condition for justice to be administered. Meritocracy at the same time requires
the observance of the rule of law, because the rule of law distributes rights and a just law
advances fairness. (In the theoretical framework below, this will be titled the legal
infrastructure.)
If production responsibilities are designated according to merit and ability (Plato and
Cicero) then, the responsibility of justice is to enable the individuals across nations to
produce according to their natural and enhanced capabilities and endowments. If we take
the concept of justice a step further, we would probably understand that justice is
inseparable from righteousness (in the form of dikaiosyni as proclaimed in the New
Testament), at least in the Platonic and Aristotelian paradigms. In that sense, Plato’s
central claim of righteousness is “performing the functions for which one’s nature is best
fitted.” It is also interesting to note that both Plato and Aristotle defend non-egalitarian
views of justice.
In The Ethics, Aristotle gives us a complex concept of justice. He divides justice in two
broad categories as the lawful (he does not necessarily mean obedience to the laws of any
particular state) and the concept of fair and equal. It is the latter that is advanced in
Aristotelian ethics (Aristotle, transl. Irwin, 1985.) The literal meaning of the word justice
in Aristotelian ethics is the meaning of righteousness, which is the form of justice that
represents complete virtue of the soul which cannot be understood unless it is
comprehended within the framework of community, i.e., in relationships. There is no
doubt then, that this Aristotelian understanding of justice fits well into the ecclesiastical
paradigm of koinonia. Aristotle divides this kind of justice into distributive and
rectificatory. For Aristotle, the student of Plato, justice should be viewed as fairness.
Distributive justice for Aristotle is primarily concerned with what people deserve. We
also need to keep in mind that Aristotle is particularly concerned with the justice of
transactions. When Aristotle talks about justice in transactions, he refers to commutative
justice in voluntary exchanges such as buying, selling and lending, or involuntary matters
where we have victims of insults, thefts or assassinations. When Aristotle talks about
equality and justice he refers to proportional, or what he calls geometrical proportion in
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
3
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
distributive justice. Through the centuries since then, we understand that in Aristotelian
ethics we need to treat equals equally, while unequals deserve unequal treatment in
proportion to their merit, in proportion to their abilities, and in proportion to their
enhanced capabilities.
Therefore, according to Vlastos (Vlastos, 1962) – a leading scholar for Plato and
Aristotle – a distribution to be just is almost always an unequal one. Vlastos writes, “the
meritarian view of justice paid reluctant homage to the equalitarian one by using the
vocabulary of equality to assert the justice of inequality.”
We believe that central to Aristotle’s overall argument is the concept of justice as a state
of attitudes, habits, customs and cultivated policies that advance and enhance the
capabilities of persons, groups and nations. The enhancement of that capability leads to
the development of character and to the development of a nation. When individuals are
deprived from their potential, their nations cannot prosper. This kind of justice according
to Aristotle is complete virtue, not complete virtue unconditionally, but complete virtue
in relation to another (koinonia). Aristotle writes, “Moreover justice is complete virtue to
the highest degree because it is the complete exercise of complete virtue and it is the
complete exercise because the person who has justice is able to exercise virtue in relation
to another not only in what concerns himself for many are able to exercise virtue in their
own concerns but unable in what relates to another… and for the same reason justice is
the only virtue that seems to be another person’s good because it is related to another for
it does what benefits another, either the ruler or the fellow member of the community…
and the best person is not the one who exercises virtue only toward himself but the one
who also exercises it in relation to another since this is a difficult task… for virtue is the
same as justice, but what it is to be virtue is not the same as what it is to be justice.”
A few sections later, Aristotle would argue, “what is just then is what is proportionate
and what is unjust is what is counter proportionate, hence in an unjust action one term
becomes more and the other less and this is indeed how it turns out in practice since the
one doing injustice has more of the good and the victim less.” This proportionality in
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
4
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
distributive justice is in accordance with merit, ability, and - in economic terms -
efficiency. Therefore, in Aristotelian ethics justice in order to be just has to have unequal
proportions.
It should not be a surprise that Christian teachings from the first few centuries
(Chrysostom, Basil, Gregory of Nyssa among others) as well as from the Middle Ages to
the Wesleyan renewal movements emphasized the uplifting of the poor as a natural
outcome of Christian conversion. The lack of social uplifting and social holiness portrays
betrayal of the Christian–kingdom principles. St. Thomas Aquinas synthesized the
Christianity of the Church with Aristotelian ethics and came up with some articles
relating to justice that can be summarized as follows (Solomon and Murphy, 1990):
First, justice is a habit whereby a man renders to each one his due by a constant and
perpetual will. Second, justice is always towards another, and third, justice is a virtue
and actually it’s the chief of all the moral virtues.
Aquinas concludes his thesis on justice by echoing St. Augustine and Cicero by
suggesting that charity, generosity and liberality is an essential part of justice, especially
to the ones who are the least among us.
Other Philosophical and Historical Dimensions
Now, if we go further back and examine the ancient Chinese and far Eastern
philosophies, we will discover that there are two concepts that summarize the moral
elements of the mind and of the soul. Those two elements are the concept of li and ren.
The idea of li, is what is known in Confucian thought as the rules of conduct. The second
concept is the idea of ren or what we would call today agape, the benevolent love toward
others exhibited by rulers as well as the average person. In the far eastern thought when
the soul loses its sense of justice it loses its moral compass and as Confucius said it’s like
a mountain that has lost its trees (Mencius, 1970.)
In the midst of the seventeenth century Thomas Hobbes in his classic work (Hobbes,
1926), The Leviathan, describes the state of nature and a state of affairs as one
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
5
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
underlined by fear and insecurity. It’s a state of affairs where there is no right or wrong,
no right to property, no mine or thine, no law and justice or injustice, only force and
fraud. It is in this state of affairs and in this climate of uncertainty where all members in
the society feel the need for a mutual social compass, a social contract that becomes a
matter of rational necessity. The need for this kind of social compass forms the basis of
Hobbes’ argument that people have a basic ability to do damage to one another and in the
absence of any sense of duty towards one another, in the absence of any power over the
people, people become competitive, insecure, and mutually defensive. From a trade
perspective Hobbes views international exchanges as a zero sum game where life on
earth and exchanges are nothing but unhappy transactions of a life where there is no
justice. Obviously Hobbes portrays a horrifying picture of relationships.
On the other hand, John Locke’s thesis gives us a more optimistic picture of how a social
contract implements the natural law more fully and formally (Locke, 1983.) The primary
purpose, according to John Locke, of this kind of social contract is to unify individuals
into mutual transactions for the benefit of the community and it is a looser association
and affiliation of individuals - who have freely chosen this kind of arrangement - than
Hobbes would have allowed.
Following John Locke in the midst of the eighteenth century, Jean-Jacuqes Rousseau
contemplates a society where individuals, in contrast to the vision Hobbes has, will
wander the face of the earth picking up food, sleeping comfortably and getting what they
need from the naturally abundance around them. So they are happy creatures who are not
compelled to enter into a social contract because of their meager provisions. However,
Rousseau believes that the foundational institution that perpetuates inequalities is the
invention is private property, and that all inequalities have resulted from that. For him
our competitiveness and unhappiness arises from the institution of private property and
from the struggle between those in power and those without power. However, Rousseau
wants to look to the future and to the foundations of better society and therefore he offers
his own version of the social contract not as an instrument and a vehicle for controlling
each other or protecting ourselves or our property, but as a way of giving the law to
ourselves, and therefore elevating people to become citizens in a community of mutual
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
6
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
respect and mutual advancement. From a libertarian standpoint Friedrich Hayek (Hayek,
1976) and Robert Nozick (Nozick, 1974) would have emphasized the idea of
commutative justice whose purpose would be to enforce contracts, to advance the liberty
of persons, the protection of property, and the advancement of individualism in a society
that doesn’t have a common scale of values because there is no wide agreement on
values, therefore in such a society justice in those terms does not reward merit in some
moral sense.
However, we believe that we need to move beyond commutative justice and even beyond
distributive justice as envisioned by John Rawls in his veil of ignorance (Rawls, 1971.) If
justice relates to relationships with others, and if a person does not live only by bread,
then justice as fairness, where equals and treated equally and unequals are treated
unequally, should become a venue and an instrument to advance society to a better place
and could also become an instrument of empowerment for the person himself.
Free Trade vs. the Philistines at the Gate
The pursuit of aesthetic, cultural and intellectual goals is part of the process of
rediscovering the image of God in our lives. However, it presupposes that people are fed,
clothed and have achieved the necessities of life. If we echo Mathew Arnold’s call to be
careful of the Philistines in our society - whose goal is to convert means to ends and
social beings into material amoral existences – then, we have to identify the venues and
the instruments where people are freed from the fear of lacking the necessities of life
(Honan, 1983.)
The pursuit of higher ideals as well as intellectual achievements could only take place
when the fear of starvation and the fear of lacking the necessities of life disappear. For
the latter to take place - which might be equivalent to the disappearance of the
philistinism mentality - in our culture, we have to reach a point of creating a middle class
that is sustainable. Justice in such a society, where middle class can be created and be
sustained, is not achieved overnight, but over time, and its achievement is determined by
institutional arrangements.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
7
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
This is exactly where free trade fits. Even if it is not the purpose of the paper to
exemplify the advantages of free trade it would be proper to review that according to both
theoretical and empirical evidence, free trade could become an instrument of
convergence, of uplifting the poor from their misery, of restraining monopoly and
oligopolistic powers, of advancing opportunities to the least in the society, of offering
new horizons for the disadvantaged, and certainly of bringing better understanding and
dialogue among rivals. However, any instrument that is not being taken care of, loses its
appeal, especially when it neglects those who are left behind. Free trade has the potential
of becoming an instrument of justice, and therefore of social equality where equals are
treated equally. However like any double-faced sword, when it neglects the
disadvantaged and allows inequalities to get out of hand (especially when the latter are
coupled with over-extension of credit via over-collateralization means), then social and
political instabilities feed the capital formation process, and ultimately lead to economic
stagnation.
Speaking of the intellectual and moral consequences and benefits of international trade,
we would do great injustice if we fail to look at the writings of Charles Montesquieu
(Montesquieu, 1989), especially book twenty of his The Spirit of Laws where he clearly
declares that, “commerce is a cure for the most destructive prejudices.” Later in the same
book Montesquieu will declare “peace is the natural effect of trade. Two nations who
traffic with each other become reciprocally dependent for, if one has an interest in
buying, the other has an interest in selling and thus their union is founded on their mutual
necessities.” Furthermore, Montesquieu will declare and articulate that trade among
nations produces a sense of justice among them, as the latter has been understood by
Aristotle. We believe that when people exchange goods or services they start
understanding each other better, there is a dialogue that is being established, and
therefore uncivilized notions are being eliminated through communication. Moreover,
they discover that there are mutual benefits and advancements of efficiencies in their
economies and organizations, and through this mutual advancement peaceful resolutions
could heal particular disputes, while creating an environment of better understanding
among peoples and nations.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
8
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
It was easily understood even before the time of Adam Smith - and according to
Montesquieu’s arguments - that international exchanges will bring specialization and that
specialization will lead, as Montesquieu explains, from small to grand enterprises which
implies greater productivity and efficiency, and an ability to produce at a lower cost. The
latter will lead to lower prices, especially for the poor who previously could not get
particular goods or services. The standards of living then increase because of greater
efficiencies, lower costs, and the ability that is given to poor persons to not only purchase
goods but also to be actively involved in the production of goods.
From that perspective international exchanges and international trade becomes and
instrument of enhancing the capabilities of persons and especially of the least
advantaged. Montesquieu continues and shows through historical examples, how harbor
cities and nearby communities to the port thrived by immigrants who came to those cities
to find jobs. The poor found good fortune where international exchanges were taking
place, whether it was at Tyre, Venice or the cities of Holland. The ability of the port
cities to attract immigrants signifies the concept of mobility, because we all know that
without mobility there cannot be social progress.
However, if we read carefully Montesquieu’s arguments we will clearly see the
underpinning theory which advocates that capital formation is the essence of establishing
the framework of prosperity for the average person. Capital formation then, could
become the alpha and omega of having a peaceful society that cares for the least
advantaged, for the sustainment of a middle class, and for higher values and ideals.
Montesquieu writes, “when the Dutch were almost the only nation that carried on the
trade from the South to the North of Europe, the French wines which they imported to the
North were in some measure only a capital or stock for conducting their commerce in that
part of the world.” Capital formation and the ability to generate stock of capital is the
essence of economic activity and commerce in a society that generates jobs, incomes and
the ability to consume the necessities of life. Montesquieu will continue by saying that
even a losing trade will be beneficial for the society due to the kind of jobs that will be
created and the social environment that will be advanced. He writes, “Further it may
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
9
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
happen so that, not only a commerce which brings in something is useful, but even a
losing trade shall be beneficial.”
The Theoretical Framework
We are very fortunate to have the latest work published by William Bernstein entitled, A
Splendid Exchange, How trade shaped the world, (Bernstein, 2008), who in a fascinating
and elaborate way reminds us that from Mesopotamia in 3000 B.C. to the globalization
debates in the Seattle battles, trade is the foundation of capital foundation. Bernstein in
his study reminds us how the early traders floated ivory, copper and barley through the
Tigris and Euphrates and he reminds us how the Greeks fought wars in order to advance
the concept of trade. He also tells us the story of the Chinese and how they carried silk
from China to Rome, and how the Portuguese traded spices in the sixteenth century.
When he reviews for his readers how the British came to Jamaica and how American
trade policies in the late nineteenth and early part of the twentieth century became the key
elements of economic growth, then we could concur with him and Montesquieu that trade
is the foundational cornerstone of capital formation.
To that of course, we should add that it was the ability that the U.S. extended to
Europeans to reconstruct themselves and buy American products, that helped not only the
American producers but also the local communities in Europe for their reconstruction
efforts, for employment, for income, for capital formation, and for growth. So unless
there is international trade, unless there is the liberty to move things, to buy imported
goods, to move capital, to move technology, to move people across nations and
communities, unless there is freedom to move financial capital across oceans, there could
not be a case of capital formation. The latter is the seed that is necessary for any kind of
infrastructure to be produced whether that infrastructure is in the social sector (hospitals
or schools), in a physical form (highways, roads, bridges and water systems), or in the
financial field (banks, exchanges, brokerages). The buildup of these kind of
infrastructures will create jobs and by creating jobs there will be savings and that savings
will become the seed for loans and for credit extension which is necessary for business
formation. Now, all the above could be represented in the following diagram.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
10
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
The spirit of the Philistines could only be defeated in a society which is able to explore,
which is open to new ideas, open to other cultures, which is open to other forms of capital
formation, which in turn lead to a better and more prosperous society. In such a society
free trade is advanced for the sake of justice. Therefore, free trade is not an end in itself,
it is a means to a higher end and that higher end is to treat equals equally.
The defeat of the Philistinian spirit is part of the process of growth, and it is a stimulated
intellectual process which presupposes the understanding that the benefits which come
from international trade may not be possible to be quantified in terms of econometric
models and in terms of successes, but it certainly brings stability in a society, peace
among nations, and certainly justice in commercial transactions, because as Montesquieu
would remind us competition is the instrument by which a just value is achieved when
exchanges take place. Furthermore, he explains that nations will eventually be enslaved
into poverty and misery unless they undertake international transactions and exchanges. I
believe the following table, taken from Bernstein’s book would demonstrate that exact
point.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
11
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Per Capita GDP in Nations Open and Closed to World Trade
Always Open 2006 Always Closed 2006Nation Per Capita GDP Nation Per Capita GDP
Barbados $17,610 Algeria $7,189Cyprus $21,177 Angola $2,813Hong Kong $33,479 Bangladesh $2,011Mauritius $12,895 Burkina Faso $1,285Singapore $28,368 Burundi $700Thailand $8,368 Central African Rep. $1,128Yemen $751 Chad $1,519
China $2,001Congo $1,369Cote d’Ivoire $1,600Dominican Republic $7,627Egypt $4,317Ethiopia $823Gabon $7,055Haiti $1,791Iran $7,980Iraq $2,900Madagascar $900Malawi $596Mauritania $2,535Mozambique $1,379Myanmar $1,693Niger $872Nigeria $1,188Pakistan $2,653Papua New Guinea $2,418Rwanda $1,380Senegal $1,759Sierra Leone $903Somalia $600Syria $3,847Tanzania $723Togo $1,675Zaire $774Zimbabwe $2,607
When we contemplate on this last thought, two hundred and fifty years after those words
were drafted, we will wonder what has been happening to the distribution of income
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
12
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
across nations, what has been happening to inequality and poverty or the concept of
convergence among nations.
Just a couple of years ago, Xavier Sala-i-Martin (Sala-i-Martin, 2006) published a well-
documented survey of the world distribution of income, and he concluded that we have
been experiencing falling poverty and convergence around the globe, primarily in
continents and nations that were characterized prior to the 1970s by extreme poverty and
divergence. His chief examples are the nations of China and India along with the whole
region of Southeast Asia. It would have been great if the survey had discussed the role
that free trade has played in uplifting those countries and those continents out of poverty.
However, before we explore in greater detail Sala-i-Martin’s arguments regarding the
reduction of poverty and convergence of global income, as well as discuss this paper’s
findings regarding the role that international trade plays in the formulation of capital, the
forming of infrastructures, and the establishment of the middle class, we would like us to
review briefly what the classic arguments of John Stuart Mill (Mill, 1910) were in the
midst of the nineteenth century when he was writing on international trade.
We would like to emphasize that in his writings, while he articulates well the advantages
of free trade in terms of lower prices, higher incomes, great efficiencies, reduction of
costs, allocation of resources, inviting new investments and in terms of higher
productivity, he makes a very good point when he says that international trade and
foreign transactions become the cornerstone of surplus capital that can be used to produce
other things. Therefore, it is the savings in capital which advances efficiency, prohibits
misallocation of resources, and assists nations in the production of goods or in the
consumption of imports, all of which lead to higher standards of living, higher levels of
disposable income, and thus greater propensity for capital accumulation. However, all
these benefits from free trade are not as important according to John Stuart Mill as the
intellectual and moral advantages that free trade carries with it. Mill writes:
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
13
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Empirical studies throughout the world have documented that free trade of goods, capital,
and technology not only reduce prices and enhance incomes, but also act as the conduit
for transferring the technologies that enhance productivity, increase competition and
therefore, stimulate industries to become more efficient. Moreover, the push for
efficiency forces unproductive businesses to reform or go out of business. Competition
stimulates efficiency, and over the years study-after-study has documented this
phenomenon. Therefore, when we look at studies by Keller (Keller, Wolfgang, and
Yerple, 2003), Hay (Hay 2001), Edwards (Edwards, 1998), Crafts, (Crafts, 2000),
Harrison and Hanson (Harrison and Hanson, 1999), and Sachs and Warner (Sachs and
Warner, 1995), we can see that overall economic growth as well as productivity growth
can double and sometimes triple when industries become less sheltered from foreign
competition. Mexico is a classic case because it can be demonstrated that after its trade
liberalization in 1985 its productivity increased dramatically. The same happened in
India as well as in South Korea. These productivity gains, which we clearly understand
to be economic gains, take place due to the new allocation of resources within industries
as well as across industries. Empirical studies have also shown that trade liberalization
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
14
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
over the past few decades in Spain, Chile and New Zealand have contributed to rapid
growth in productivity as well as greater growth in their economy. While there might be
a dispute as to whether trade is directly responsible for greater growth - studies actually
diverge in their conclusions, see Franklen and Romer, 1999 or Rodriguez and Rodrik,
2001 - we do have however, a consensus which says that trade may not be directly
correlated with growth, however it stimulates growth indirectly through investments, i.e.
we have sufficient evidence of indirect relationship where growth increases in countries
via the mechanism of international investments, which in our paradigm is the cornerstone
of capital formation.
Therefore, the idea that the free movement of capital goods or of intermediate goods, is
the cornerstone that promotes investments which in turn supports growth could be
supported by empirical evidence and could be clearly seen in the three graphs that follow,
and which have been adapted from Douglas Irwin’s book, Free Trade Under Fire, (Irwin,
2002.) In the next three graphs we can clearly see starting with the case of South Korea
that the trade reforms that were initiated in 1964-65 have contributed to significant
increases in GDP per capita. In the second graph we can see a similar trend in a totally
different continent. Chile adopted trade reforms, both qualitative and quantitative
restrictions were lifted in 1974-75, and again we see a significant and dramatic increase
in the GDP per capita after trade liberalization took place. Again, I would like to
emphasize that this became the cornerstone of capital formation. A more recent case
which is related to the famous BRICs (Brazil, Russia, India, and China) has to do with
the trade reforms that took place in India in 1991. Tariffs were reduced from an average
of 85% to an average of 25%, and the complex system of import controls was eliminated,
the Rupee was devalued and was also made convertible. It is interesting to observe the
significant increase in GDP per capita that India has experienced to the point that several
analyst has said that India lost several decades after its independence in 1947 because the
trade restriction suppressed economic liberty for almost 40 years and destroyed growth
for at least two generations. The truth of the matter is that India since 1991 has been
formulating social capital, physical capital and infrastructure, and the proofs of financial
infrastructure become more evident year-after-year, as millions of Indians have start
taking part in the formation of a middle class.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
15
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
16
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Source: Irwin, 2002, pp. 42-44.
Now, if we return for a moment to our previous intellectual benefits, the non-economic
benefits from trade, we can still remember the perpetual peace advocated by Immanuel
Kant who suggested that a durable peace could be built upon a tripod of representative
democracy, international organizations and economic interdependence. Of course, we
cannot neglect the expanding political science literature which illustrates that indeed
economic interdependence among nations reduces the risk of conflict, mitigates the risk
of war and finds that there is a positive link between trade and peace. Even if we are
tempted to question the plausibility of the relationship, we should not neglect the fact that
study-after-study points to the apparent link between political reforms as an outcome of
liberalization. So while trade may fail to generate movement towards democracy, there is
ample evidence to point that domestic institutions perform better, and are less corrupt
when there is open trade and competition and when nations are open to each other in an
accountable manner (Irwin, 2002).
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
17
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Is it Convergence or Divergence?
Of course, there is plenty of literature that reviews the distributional effects of
globalization. We could point out reviews by Harrison and Gordon (1999), Adrian Wood
(1999), Goldberg and Pavcnik (2007.) The latter, points out to the fact that countries that
have experienced great forms of globalization either through more imports and exports or
through the magnitude of capital flows, (FDIs, foreign exchange fluctuations, etc.) have
experienced higher levels of inequality. Particularly on pp.48-49 of that review, the
authors point out that countries from different continents have experienced either
significant or slight increases in inequality, with the latter being measured either as skill
premium between skilled and unskilled workers, or by the Gini coefficient, and
sometimes by consumption or income patterns.
We need to point out that, as we mentioned earlier, the Xavier Sala-i-Martin (2006)
article is very emphatic in demonstrating that worldwide poverty has been reduced and
convergence has been achieved through globalization. Sala-i-Martin points out that
China has a lot to do with this kind of convergence, and he shows that if we use the $2
per day income line, then we could clearly see that poverty estimates have experienced a
significant decrease in China between 1980 and the beginning of the twenty-first century,
from about 48% to less than 15%. For China, Sala-i-Martin reports that more than 250
million people escaped poverty because of globalization. He further reports the same
thing for countries such as Indonesia and Thailand with the only exception is Southeast
Asia being Papua New Guinea. Overall, and excluding China, more than 200 million
people escaped poverty because of globalization in the last quarter of a century. He does
point out that the big Asian success is dramatically different from the African experience.
In Africa, the total number of those living in poverty has jumped by more than 200
million persons. In all African countries poverty and inequality has increased, with the
exception of Botswana and maybe some small countries like Mauritius. Sala-i-Martin
composes what he calls the WDI (World Distribution of Income) and presents an
impressive time-series table of the WDI from the 1970s to the beginning of this century.
In that table, we could clearly see that all measures of inequality have been declining,
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
18
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
whether we measure inequality using the Gini coefficient or the variance in the logs of
income. Moreover, he shows that that ratio of income of the top twenty percentile to the
bottom twenty percentile, as well as the ratio of income of the top ten percentile to the
bottom ten percentile has been experiencing significant decreases by as much as 30%.
Therefore, the graph below summarizes the WDI from the 70s to the beginning of the
twenty-first century.
Source: Xavier Sala-I- Martin, 2006
The argument of the paper is that the significant reduction in inequality which has been
empirically demonstrated by Sala-i-Martin is the effect and the outcome of capital
formation using the means of international trade. Now, this is a strong argument that
needs further investigation and a lot more work, however from a theoretical standpoint as
well as from a historical standpoint we can say that nations, empires and economic
powers have built themselves up through savings and capital formation using the means
of international trade. As Bernstein clearly explains in his book, A Splendid Exchange,
whether we talk about the Sumerians, Chinese, Portuguese, Spanish, British or the
Americans, they all have built their capital by opening or financing (in the case of the
U.S.) international exchanges. So, in our theoretical framework there is always a need
for a rule of law and the right to property, what we call the legal infrastructure.
However, this must always be accompanied by capital formation.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
19
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
If historical experience is teaching us anything, it is that capital formation is best done
through international trade, trade liberalization and international exchanges. Eventually,
trade liberalization becomes the venue or vessel of empowering people to experience
upward economic mobility. It is like having many people at a port on the coast and some
of them board a vessel, the vessel empowers them to get better acquainted with
technologies, to have better access to capital and other resources, exposes them to ideas,
to better education, because it takes them away from the port, to new places. The
distance between those who are left behind at the port and those who are now sailing
away from the port may be rising initially, but the ones who are on the vessel are the ones
who are experiencing the phenomenon of being part of the middle class. In another
analogy, we can think of a moving escalator, the international trade becomes the escalator
of moving people up, being part of better educational opportunities (social infrastructure),
better health care provisions (again, social infrastructure), being able to move around and
experience upward mobility, get better jobs, save and invest i.e. take advantage of
physical and financial infrastructures. The country as a whole in that case, is able to
export and import, to experience growth through investments and FDIs, capital
importation, better technologies and production techniques.
The country through export-led growth experiences physical and social infrastructure
investments, which eventually empowers the people and the middle class to enjoy
savings. Those savings will become the seed for a financial infrastructure, both local and
foreign-owned. The emergence of the this kind of infrastructure will finance the
formation of new vessels, which in turn will bring the people from the port/coast to the
ocean, thus sustaining the creation of the middle class.
So while we may be taking a leap forward without enough evidence at this point, I think
it would be normal to expect that globalization, as it is evolving may be showing some
measures of higher inequality. However, if properly realized that is simply a means to
create and sustain a middle class via capital formation, then over time liberalization and
higher international trade will lead to the creation of the middle class, leading eventually
to lower rates of inequality and poverty.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
20
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
If convergence is indeed achieved, then justice has been implemented, because justice
relates to others and becomes reality when equals are treated equally.
The Empirical Results: Methodology, Selection of Variables, and of Countries
We need to emphasize in the beginning of this section that the results and analysis here is
preliminary and research is already underway for better understanding of the ideas that
have been developed in this paper. Since part of the research is to determine which
factors in the four infrastructure areas would contribute to the emergence of a middle
class (once capital formation has taken place via the means of international trade), the
first (and admittedly most subjective) step was to develop an initial list of factors that
describe the infrastructure for each country.
Data were collected from different sources, such as the World Bank, the IMF, different
branches of the UN (UNDP, and UNCTAD), and the World Factbook for the 2005 year.
Note that the first step of the algorithm scaled the data by dividing by the maximum
absolute value that occurred for each data variable, to prevent the larger-scale factors
(such as exports) from overwhelming the smaller-scale factors (such as student-teacher
ratio) in the model. This allowed us to readily compare the effectiveness of the
coefficients that we obtained.
Since part of the purpose was to establish a proof of concept for using the Support Vector
Machine (SVM) and a broad scope of infrastructures, originally it was decided that
limiting the number of countries would achieve the purpose. We selected small lists of
countries under each of the three categories frontier, emerging, and developed. Frontier
countries are ones that most economists would agree have very few people in the middle
class, but have the potential, such as sufficient resources, to develop one. Emerging
countries have a middle class that is growing. Developed countries have a mature and
stable middle class. An initial run used a very small sample of countries in each category.
It was exceedingly successful, prompting an expansion of the lists. This paper details the
results of the newer results.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
21
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Discussion of Algorithm
The mathematical technique used to determine the significance of the factors was the
Support Vector Machine (SVM). This is a classification method from learning theory
that uses a set of input training data {(x1, y1), (x2, y2), . . ., (xk, yk)} where the xi represents
vectors of dimension n and the y values are assigned a value of +1 or -1, depending on
whether the point is inside a set or not. For the purposes of this study, the x vectors hold
the list of factors that describe the state of a given country that may be characterized as
having a middle class (y = +1) or not (y = -1).
In common with most learning algorithm, the SVM algorithm operates in two phases. In
the training phase, the SVM model with a linear kernel takes the training data and
produces a bias value b and a vector c (dimension n) of coefficients. The testing phase of
SVM is then run on all the data, using just the n-dimensional vectors even if the y-value
is known. The algorithm will calculate the dot product of the coefficient vector with the
data vector and then subtract off the bias value. If the resulting number is positive, the
algorithm predicts a y-value of +1; if it is negative, the algorithm predicts a y-value of -1.
Running the algorithm on the training data verifies that the training phase worked well.
This particular implementation of the SVM algorithm uses what is termed a linear kernel.
It was chosen because of the limited number of countries in the data set, and because the
linear kernel tends to be the worst performer. If this kernel works, then increased data and
a non-linear kernel should work much better. A non-linear kernel has an additional step
when the data is transformed non-linearly before the coefficients are determined.
A non-linear kernel will be important as this study proceeds. An example will illustrate
the reason. One factor that is critical to the development of the middle class is the
extension of credit. People in the lower classes do not have the capital with which to start
a business and thereby move to a higher class. The marvelous success of microloans
illustrates this point. Therefore, in a linear model, the amount of credit extended would
certainly have a positive coefficient. That would imply that as more credit is extended,
even greater benefits accrue. But at some point, credit may become overextended, and
become detrimental to the middle class (see concluding note.) This is arguably a
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
22
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
significant factor in what caused the collapse of the middle classes of Argentina and
Mexico in the recent past. That means that the extension of credit must, at that point,
have a negative coefficient. Only a non-linear approach to modeling the middle class can
accommodate both aspects of the extension of credit. Similar comments could be made
about other data, such as inflation (CPI), which has a rather small range of values
considered healthy, while values much outside that range are considered detrimental to a
country’s economy.
Analysis of Data: Initial Run
First, we ran SVM on a collection of 44 countries using 45 factors for each country. The
training set was the collection of 17 frontier countries and 10 developed countries. The
testing phase consisted of finding the predictions for those as well as the 17 emerging
countries. (The same process was used during the reduced factor run of SVM.) The
results are summarized in Table 1 on the next page, giving the SVM output value, but not
the prediction, which is easy to determine from the sign of the output.
The first 17 rows of the table list the frontier countries, the next 17 rows list the emerging
countries, and the last 10 rows list the developed countries. There are also two columns.
The first numeric column gives the SVM output using all 45 factors for training and
testing. The other numeric column will be explained below.
The results show very clearly that the SVM algorithm (even with the linear kernel) works
very well. The frontier countries, except for Thailand, all fall into the SVM output range
of -1.0 to -1.6; the emerging countries mostly fall in the range from -0.8 to 0.0; the
developed countries, except for South Korea, fall in the range 0.6 to 1.5. These results,
especially for the frontier and developed countries, form a primary validation of the SVM
algorithm; it does seem to be doing what we want it to do. The separation between the
ranges for the different categories of countries also seems remarkably large, providing
further evidence that the algorithm is working.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
23
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Country 45 Factors 10 factorsAlbania -0.9999 -1.0479Angola -1.5701 -1.3473Bolivia -1.0987 -1.2265Ethiopia -1.6106 -1.4777Georgia -1.2053 -1.1505Ghana -1.4369 -1.2124Guatemala -1.1876 -1.0855Indonesia -1.2804 -1.2320Kazakhstan -1.0000 -0.8798Kenya -1.4301 -1.3824Lebanon -1.0003 -1.0088Morocco -1.1062 -1.0533Nigeria -1.4359 -1.3758Peru -1.0963 -1.0486Philippines -1.1356 -1.1535Thailand -0.9608 -0.8136Venezuela -1.0001 -1.0002Argentina -0.6834 -0.7224Botswana -0.4742 -0.5624Brazil -0.7782 -0.9008Chile -0.4801 -0.3891China -0.1282 -0.6589Czech Republic 0.4781 0.0827Egypt -1.1327 -1.1795India -1.1646 -1.1560Iran -1.1666 -1.0534Malaysia -0.2523 -0.4184Mexico -0.8208 -0.7842Poland -0.4681 -0.4366Romania -0.8441 -0.7429Russia 0.0256 -0.6292South Africa -0.5709 -0.5240Turkey 0.5125 0.8718Ukraine -0.5202 -0.7147Australia 0.9445 1.0000Canada 1.0754 1.0976France 1.2936 1.0998Germany 1.4943 1.5142Japan 1.5026 1.0235Republic of Korea 0.1209 -0.0290Singapore 0.9340 0.9998Sweden 1.0516 1.2535United Kingdom 0.6674 1.0005USA 1.4181 1.5219
Table 1
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
24
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Reduction of Factors
It could easily be argued that with 45 factors and 44 countries, it is easy to expect results
of this caliber. So, we attempted to reduce the number of factors used, still regarding the
conceptual framework.
The factors used in the remainder of this discussion are as follows:
For physical infrastructure:
Paved roads in kilometers per capita
Number of cell phones per capita
For social infrastructure:
Amount spent on healthcare per capita
Literacy Rate
For financial infrastructure:
Private sector credit as a percent of GDP
GDP (PPP) per capita
For legal infrastructure:
Corruption index (Transparency International)
For international trade (in dollars):
Exports
Imports per capita
Foreign reserves per capita
Table 1 above lists the output of the SVM algorithm using only these ten factors, in the
second numeric column. Table 2 below lists these ten factors, and the coefficients that the
SVM algorithm generates for each. (It should also be noted that results equivalently good
can be obtained with only six factors, showing that SVM is more than adequate for
separating the categories of countries.)
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
25
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Factor Coefficient
Paved roads in km per capita 0.2416
Number of cell phones per capita 0.3675
Amount spent on healthcare per capita 0.7636
Literacy rate 0.05407
Private sector credit as a percent of GDP 0.1571
GDP (PPP) per capita 0.9074
Corruption index 0.8518
Exports (billions USD) 0.4490
Imports per capita 0.3133
Foreign reserves per capita 0.2819
Table 2
The following comments are in order: First, all developed countries, with the exception
of South Korea, show up with SVM output values in the appropriate range. This
exception appears puzzling at first glance, but an examination of the data shows that it is
almost entirely due to a value of the corruption index that is considerably lower than for
other developed countries.
Second, this time only the Czech Republic shows with a positive prediction, although
Turkey is very nearly positive. This complies with the liberalization and openness that
both countries have exhibited over the last two decades, both most likely the result of the
incentive provided by the future possibility of membership in the European Union. We
could then, make the claim that international openness and exchanges serve the purpose
of forming capital and thus, advancing the formation of the needed infrastructures which
in turn will lead to the creation of the middle class.
Third, the relatively weak positions of Egypt, India, and Iran need to be reviewed in a
time series before any conclusion is reached.. However, it is also worth mentioning that
just by trade alone China performs better in the SVM, a fact which by itself could help us
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
26
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
understand a little better the value of international trade in forming the necessary
cornerstones that a middle class needs.
Conclusion: A Word of Caution and Direction for Future Research
The empirical part of this paper should be viewed as a proof-of-concept attempt for using
a multi-factor and linear approach to quantifying the extent to which international trade
forms the basis of capital formation, which in turn advances the formation of
infrastructures that create a middle class. These results seem to indicate that using
international trade and the infrastructures as have been described above along with the
SVM algorithm, is a feasible methodology, and is worth continuing in broadly the same
direction.
However, at this point I would like very briefly to introduce the idea of what happens
when things go to the extreme, especially when the financial sector’s interests diverge
from the trade sector’s interests i.e. from the production or real economy’s interests.
When efforts are being made to sustain prosperity and the middle class with paper means
rather than real assets and real production, then we will see a divergence of the
production and real sectors interests from the financial sector’s interests. The latter will
tend to produce paper assets which will be over-collateralized, over-securitized, for the
purpose of generating significant short-term profits. The table below shows the explosion
of derivatives and other related instruments (CDOs, CLOs, etc.) in the last few years. It
demonstrates the extent of irrational collateralization of “assets”, where the financial
sector keeps pushing for more and more securitization of paper assets, which will be
sliced into pieces and sold to individual and institutional investors.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
27
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Source: Bank of International Settlements, 2008
Of course, it seems that we are just start learning the lesson that these paper-assets are
nothing more than paper, i.e. there is nothing behind them. This is the phenomenon of
extreme and irrational securitization and collateralization that is taking place in the U.S.
and the EU, and which has been destroying the financial sector, because it can only create
bubbles and bubbles usually burst. The bursting of the bubbles will create in turn
instability not only in the economic sector but also in the political and social sectors, and
therefore the whole economy’s cohesiveness may become unstable and questionable,
which eventually may lead to significant destructions. As direction for future research, it
would be interesting to identify the possibility for economies to establish a rule by which
they collateralize and securitize assets in a way that will not destabilize the economies.
The proposal for future research would be to form an index of internationalization of the
economy - whether this is imports and exports as a fraction of GDP, foreign reserves,
FDIs, currency swings, technology transfers, etc – and use this index as the
compass/anchor of collateralization and securitization, so that the interest of the real
economy (production) are not disassociated from the interests of financial capital, and
thus do not jeopardize the sustainment of the middle class via misallocation of resources.
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
28
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
References
Aristotle, 1985, Nicomachean Ethics. T. Irwin, trans., Hackett, IN
Bernstein William, 2008, A Splendid Exchange, Atlantic Monthly Press, NY
Chen, P.-H. & Lin, C.-J. & Scholkopf, B. A Tutorial on ν-Support Vector Machines, [available at http://www.csie.ntu.edu.tw/~cjlin/papers/nusvmtutorial.pdf]
Crafts Nicholas, 2000, Globalization and Growth in the Twentieth Century, IMF Working Paper, march
Donaldson, James; Roberts, Alexander, ed., 1994, Ante-Nicene Fathers, The Teachings of the Twelve Apostles, Hendrickson Publishers, Vol. 7
Dunning, H. Ray, 1998, Reflecting the Divine Image: Christian Ethics in Wesleyan Perspective, Intervarsity Press
Edwrads Sebastian, 1998, Openess, Productivity and Growth: What Do we Really Know? The Economic Journal, Vol. 108, pp. 383-398
Goldberg P., and Pavcnik N., 2007, Distributional Effects of Globalization in Developing Countries, Journal of Economic Literature, Vol. XLV, No. 1
Hayek Friedrich, 1976, The Mirage of Social Justice, Vol. 2 of Law, legislation, and Liberty, Routledge and Kegan-Paul, London, UK
Harrison Ann and Hanson Gordon, 1999, Who Gains from Trade Reform? Some Remaining Puzzles, Journal of Development Economics, Vol. 59, No. 1
Hay Donald, 2001, The Post-1990 Brazilian Trade Liberalisation and the Performance of Large manufacturing Firms, Economic Journal, Vol. 111, pp. 620-641
Hobbes Thomas, 1926, Leviathan, Hafner, NY
Honan Park, 1983, Matthew Arnold: A Life, Harvard University Press, MA
Irwin, Douglas, 2002, Free Trade Under Fire, Princeton University press, NJ
Keller, Wolfgang, and Yeaple, 2003, Multinational Enterprises, International Trade, and Productivity Growth, NBER Working Papers, No. 9504
Lock John, 1983, The Second Treatise on Government, Hackett, IN
Mencius, The Mind of Mencius, D.C. Lau, trans., Penguin, NY
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
29
2009 Oxford Business & Economics Conference Program ISBN : 978-0-9742114-1-1
Mill, John Stuart, 1910, The Letters of John Stuart Mill, ed. Hugh Elliot, Longmans Green, NY
Montesquieu, 1989, The Spirit of the Laws, trans., Cohler, Miller and Stone, Cambridge University Press, NY
Nozick Robert, 1974, Anarchy State and Utopia, Basic Books, NY
Plato, 1982, The Republic, G.M.A.Grube, trans., Hackett, IN
Rawls John, 1971, A Theory of Justice, Harvard University Press, MA
Sachs Jeffrey and Warner Andrew, 1995, Economic Reform and the Process of Global Integration, Brookings Papers on Economic Activity, Vol. 25, No. 1
Sala-I-Martin, Xavier, 2006, The World Distribution of Income, The Quarterly Journal of Economics, Vol. CXXI, No. 2
Solomon Robert and Mark Murphy, 1990, What is Justice? Oxford University Press, NY
Vlastos Gregory, 1962, Justice and Equality, in R. Brandt, ed., Social Justice, Prentice Hall, NJ
Wood Adrian, 1999, Openness and wage Inequality in Developing Countries, in market Integration, Regionalism and the Global Economy, ed., R. Baldwin et al., Cambridge University press, NY
Zakaria Fareed, 2003, The Future of Freedom, Norton, NY
June 24-26, 2009St. Hugh’s College, Oxford University, Oxford, UK
30
Recommended