Downloaded by [University of Defence] at 20:07 09 May 2016 …opac.lib.idu.ac.id/unhan-ebook/assets/uploads/files/9c0a... · 2016. 6. 5. · 12 Regionalization and Globalization in

The Asymmetries of Globalization

The discourse on globalization has become polarized Proponents consider glob-alization as the silver bullet for targeting growth in the world economy and forpoor countries specifically while opponents see it as the poisoned arrow ofexploitation and impoverishment of the Third World

The Asymmetries of Globalization deals with the ldquowhatrdquo and ldquohowrdquo but pri-marily with ldquowhyrdquo globalization has most often negative outcomes for develop-ing countries It breaks new ground in approaching globalization not only astrade in commodities but also as trade in positional goods (ldquodecommodifiedtraderdquo)

The two novel and munificent forms of post-Ricardian decommodified tradetrade in services and trade in hard currency in the form of currency substitutionare sculpted in the introductory chapter as the foundation of the systematicasymmetries of globalization Decommodified trade involves exports ofdeveloped countries that cater mostly to the elites of the developing world Thedeveloping countries in turn procure the foreign exchange to pay for theseimports by exporting commodities that trade on comparative advantage at theleast cost of production The analytical approach of introducing ldquopositionalgoodsrdquo in the form of decommodified trade in the discourse on globalization isoriginal It is also timely in a situation where the tail of trade in ldquoservicesrdquo hasgrown enough to wag the traditional trade-in-commodities dog of globalization

The balance of the chapters in this volume constitute a tapestry of casestudies that elaborate and empirically investigate the causes of systematic asym-metries of globalization The bookrsquos appeal transcends economics to make italso highly useful to students across the disciplines of sociology and politicalscience especially in the fields of international political economy and the poli-tics of international trade It will certainly enlighten all those working in thegeneral areas of globalization poverty and economic development

Pan A Yotopoulos is Distinguished Professor University of Florence Italy andProfessor Emeritus Stanford University USA Donato Romano is ProfessorUniversity of Florence Italy

Routledge studies in development economics

1 Economic Development in theMiddle EastRodney Wilson

2 Monetary and Financial Policies inDeveloping CountriesGrowth and stabilizationAkhtar Hossain and Anis Chowdhury

3 New Directions in DevelopmentEconomicsGrowth environmental concerns andgovernment in the 1990sEdited by Mats Lundahl and Benno J Ndulu

4 Financial Liberalization andInvestmentKanhaya L Gupta and Robert Lensink

5 Liberalization in the DevelopingWorldInstitutional and economic changes inLatin America Africa and AsiaEdited by Alex E Fernaacutendez Jilbertoand Andreacute Mommen

6 Financial Development andEconomic GrowthTheory and experiences fromdeveloping countriesEdited by Niels Hermes andRobert Lensink

7 The South African EconomyMacroeconomic prospects for themedium termFinn Tarp and Peter Brixen

8 Public Sector Pay and AdjustmentLessons from five countriesEdited by Christopher Colclough

9 Europe and Economic Reform inAfricaStructural adjustment and economicdiplomacyObed O Mailafia

10 Post-apartheid Southern AfricaEconomic challenges and policies forthe futureEdited by Lennart Petersson

11 Financial Integration andDevelopmentLiberalization and reform in sub-Saharan AfricaErnest Aryeetey andMachiko Nissanke

12 Regionalization and Globalizationin the Modern World EconomyPerspectives on the Third World andtransitional economiesEdited by Alex E Fernaacutendez Jilbertoand Andreacute Mommen

13 The African EconomyPolicy institutions and the futureSteve Kayizzi-Mugerwa

14 Recovery from Armed Conflict inDeveloping CountriesEdited by Geoff Harris

15 Small Enterprises and EconomicDevelopmentThe dynamics of micro and smallenterprisesCarl Liedholm and Donald C Mead

16 The World BankNew agendas in a changing worldMichelle Miller-Adams

17 Development Policy in the Twenty-First CenturyBeyond the post-WashingtonconsensusEdited by Ben Fine Costas Lapavitsasand Jonathan Pincus

18 State-Owned Enterprises in theMiddle East and North AfricaPrivatization performance and reformEdited by Merih Celasun

19 Finance and Competitiveness inDeveloping CountriesEdited by Joseacute Mariacutea Fanelli andRohinton Medhora

20 Contemporary Issues inDevelopment EconomicsEdited by BN Ghosh

21 Mexico Beyond NAFTAEdited by Martiacuten Puchet Anyul andLionello F Punzo

22 Economies in TransitionA guide to China Cuba MongoliaNorth Korea and Vietnam at the turnof the twenty-first centuryIan Jeffries

23 Population Economic Growth andAgriculture in Less DevelopedCountriesNadia Cuffaro

24 From Crisis to Growth in AfricaEdited by Mats Lundal

25 The Macroeconomics of MonetaryUnionAn analysis of the CFA franc zoneDavid Fielding

26 Endogenous DevelopmentNetworking innovation institutionsand citiesAntonio Vasquez-Barquero

27 Labour Relations in DevelopmentEdited by Alex E Fernaacutendez Jilbertoand Marieke Riethof

28 Globalization Marginalization andDevelopmentEdited by S Mansoob Murshed

29 Programme Aid and DevelopmentBeyond conditionalityHoward White and Geske Dijkstra

30 Competitiveness Strategy inDeveloping CountriesA manual for policy analysisEdited by Ganeshan Wignaraja

31 The African Manufacturing FirmAn analysis based on firm surveys insub-Saharan AfricaDipak Mazumdar and Ata Mazaheri

32 Trade Policy Growth and Povertyin Asian Developing CountriesEdited by Kishor Sharma

33 International CompetitivenessInvestment and FinanceA case study of IndiaEdited by A Ganesh KumarKunal Sen and Rajendra R Vaidya

34 The Pattern of Aid GivingThe impact of good governance ondevelopment assistanceEric Neumayer

35 New International PovertyReduction StrategiesEdited by Jean-Pierre ClingMireille Razafindrakoto andFranccedilois Roubaud

36 Targeting DevelopmentCritical perspectives on theMillennium Development GoalsEdited by Richard Black andHoward White

37 Essays on Balance of PaymentsConstrained GrowthTheory and evidenceEdited by JSL McCombie and AP Thirlwall

38 The Private Sector AfterCommunismNew entrepreneurial firms in transitioneconomiesJan Winiecki Vladimir Benacek andMihaly Laki

39 Information Technology andDevelopmentA new paradigm for delivering theinternet to rural areas in developingcountriesJeffrey James

40 The Economics of PalestineEconomic policy and institutionalreform for a viable Palestine stateEdited by David Cobham andNursquoman Kanafani

41 Development DilemmasThe methods and political ethics ofgrowth policyMelvin Ayogu and Don Ross

42 Rural Livelihoods and PovertyReduction PoliciesEdited by Frank Ellis and H Ade Freeman

43 Beyond Market-DrivenDevelopmentDrawing on the experience of Asiaand Latin AmericaEdited by Makoto Noguchi andCostas Lapavitsas

44 The Political Economy of ReformFailureEdited by Mats Lundahl andMichael L Wyzan

45 Overcoming Inequality in LatinAmericaIssues and challenges for the twenty-first centuryEdited by Ricardo Gottschalk andPatricia Justino

46 Trade Growth and Inequality inthe Era of GlobalizationEdited by Kishor Sharma andOliver Morrissey

47 MicrofinancePerils and prospectsEdited by Jude L Fernando

48 The IMF World Bank and PolicyReformEdited by Alberto Paloni andMaurizio Zanardi

49 Managing DevelopmentGlobalization economic restructuringand social policyEdited by Junji Nakagawa

50 Who Gains from Free TradeExport-led growth inequality andpoverty in Latin AmericaEdited by Rob Vos Enrique GanuzaSamuel Morley andSherman Robinson

51 Evolution of Markets andInstitutionsA Study of an emerging economyMurali Patibandla

52 The New FaminesWhy famines exist in an era ofglobalizationEdited by Stephen Devereux

53 Development Ethics at WorkExplorations ndash 1960ndash2002Denis Goulet

54 Law Reform in Developing andTransitional StatesEdited by Tim Lindsey

55 The Asymmetries of GlobalizationEdited by Pan A Yotopoulos andDonato Romano

The Asymmetries ofGlobalization

Edited by Pan A Yotopoulosand Donato Romano

First published 2007by Routledge2 Park Square Milton Park Abingdon Oxon OX14 4RN

Simultaneously published in the USA and Canadaby Routledge270 Madison Ave New York NY 10016

Routledge is an imprint of the Taylor amp Francis Group an informa business

copy 2007 Selection and editorial matter Pan A Yotopoulos and DonatoRomano individual chapters the contributors

All rights reserved No part of this book may be reprinted or reproduced orutilized in any form or by any electronic mechanical or other means nowknown or hereafter invented including photocopying and recording or inany information storage or retrieval system without permission in writingfrom the publishers

British Library Cataloguing in Publication DataA catalogue record for this book is available from the British Library

Library of Congress Cataloging in Publication DataA catalog record for this book has been requested

ISBN10 0-415-42048-2 (hbk)ISBN10 0-203-96229-X (ebk)

ISBN13 978-0-415-42048-8 (hbk)ISBN13 978-0-203-96229-9 (ebk)

This edition published in the Taylor amp Francis e-Library 2007

ldquoTo purchase your own copy of this or any of Taylor amp Francis or Routledgersquoscollection of thousands of eBooks please go to wwweBookstoretandfcoukrdquo

ISBN 0-203-96229-X Master e-book ISBN

Contents

List of figures ixList of tables xList of contributors xiiAcknowledgments xiv

Editorsrsquo introduction 1P A N A Y O T O P O U L O S A N D D O N A T O R O M A N O

PART I

Decommodification from trade in commodities to trade in services 5

1 Asymmetric globalization impact on the Third World 7P A N A Y O T O P O U L O S

2 Positional goods and asymmetric development 28U G O P A G A N O

3 Growth and poverty reduction under globalization thesystematic impact of currency substitution and exchangerate misalignment 48Y A S U Y U K I S A W A D A A N D P A N A Y O T O P O U L O S

4 With whom to trade An examination of the effects ofintra-national and between-country income inequality on bilateral trade 67R A N I A S M I N I E S Y A N D J E F F R E Y B N U G E N T

PART II

Institutional asymmetries 87

5 Communities and markets for rural development underglobalization a perspective from villages in Asia 89Y U J I R O H A Y A M I

6 Export outsourcing cost disadvantage and reputation advantage 108B I H J A N E L I U A L A N Y U N L U A N D A N - C H I T U N G

7 Transition economies and globalization food systemasymmetries on the path to free markets 126K O L L E E N J R A S K A N D N O R M A N R A S K

PART III

Agricultural poverty and decommodification 145

8 Genetically modified seeds and decommodificationan analysis based on the Chinese cotton case 147M I C H E L A C F O K W E I L I L I A N G D O N A T O R O M A N O

A N D P A N A Y O T O P O U L O S

9 Globalization and small-scale farmers customizing ldquofair-trade coffeerdquo 164M A R I J K E D rsquo H A E S E J A N V A N N O P P E N A N D

G U I D O V A N H U Y L E N B R O E C K

PART IV

Conclusions 179

10 What have we learned about globalization 181D O N A T O R O M A N O

Subject index 199Author index 205

viii Contents

Figures

11 International trade in commercial services value and share in totalexports 1980ndash2002 11

51 Channels of local rice marketing in Laguna Philippines 9452 Operations of an inter-village collector for vegetable marketing

in an upland West Java Indonesia 996a1 A places orders directly with C 1196a2 A places orders indirectly with C 12071 Food consumption measured in cereal equivalents cereals

fruits vegetables and livestock components 13172 Per capita consumption adjustments pre- and during transition

for selected countries and regional groups 1975ndash2001 13573 Per capita consumption adjustments pre- and during transition

in former Soviet republics 1992ndash2001 13674 Positions in food consumptionndashincome relationship relative

to market trend 2001 13791 The supply chain of coffee 16792 Evolution of coffee retail price 1975ndash2004 16893 Product flow reports and controls in the fair-trade coffee

supply chain 172

Tables

21 Consumption according to the nature of goods 3122 First order legal relations 3723 Second order legal relations 3824 Legal equilibrium 3825 Legal disequilibrium 3931 Required annual income growth rate (1990ndash2015) for exit

from poverty by 2015 of an average poor person in 1990(country per capita income in 1990 US$2000) 52

32 Required annual income growth rate (1990ndash2015) for exitfrom poverty by 2015 of an average poor person in 1990 (country per capita income in 1990 US$2000) 53

33 Growth and poverty reduction 1990ndash2015 5434 Growth and exchange rate misalignments 5841 Determinants of bilateral trade for the pooled data set including

observations with zero trade 7442 Determinants of bilateral trade among EU and non-EU countries

based on data that includes observations with zero trade 76ndash743 Determinants of bilateral trade excluding observations with

zeros or missing data 78ndash944 Means of variables by group of trading partners 814a1 List of countriesterritories included in the analysis 82ndash34a2 Descriptive statistics on variables used in the analysis from

maximum sample size 8351 Credit costs for vegetable producers under alternative credit

arrangements in the Majalengka District West Java Indonesia 1990 102

61 Types of outsourcing 11062 Export outsourcing of Taiwanese firms 11463 Reasons for export outsourcing multiple choices by outsourcing

firms 11564 Location of export outsourcing for Taiwanese firms 11665 Wages in Asian cities 2002 1176a1 A classification of industries by export performance 121

71 Sample cereal equivalent coefficients for crop and livestock products 132

72 Incomendashconsumption relationship estimates for marketeconomies 1990ndash2001 133

73 Potential increases in consumption per capita for selectedtransition economies 138

74 Percentage changes in livestock product output since transition(1992ndash2001 for Baltic countries 1989ndash2001 for other transitioncountries) 139

81 Cotton production in Hebei Province 15282 Comparison of profitability of cotton wheat and maize

cultivation 15383 Distribution of farmers adopting GM cotton according to their

seed acquisition mode and the number of adopted GM cotton varieties 154

84 Market share and cost of GM cotton seeds in Hebei Province 15485 Factors affecting GM cotton diffusion in selected LDCs 15791 Number of fair-trade cooperatives by regions (total) and

partner countries (indicative) 17192 Trade volume of fair-trade coffee 1995ndash2004 17293 Major consumers of fair-trade coffee 1995ndash2004 173

List of tables xi

Contributors

Marijke DrsquoHaese is Assistant Professor at Wageningen University theNetherlands

Michel AC Fok is head of research team at Centre de Coopeacuteration Interna-tionale en Recherche Agronomique pour le Deacuteveloppement (CIRAD) andresearch member of UMR Marcheacutes Organisations Institutions et StrateacutegiesdrsquoActeurs (MOISA) Montpellier France

Yujiro Hayami is Chairman at the Graduate Faculty of the Foundation forAdvanced Studies on International Development (FASID) and Visiting Pro-fessor at the National Graduate Institute of Policy Studies (GRIPS) TokyoJapan

Guido Van Huylenbroeck is Professor at Ghent University Belgium

Weili Liang is Professor at the Hebei Agricultural University BaodingPeoplersquos Republic of China

Bih Jane Liu is Professor at the National Taiwan University Taipei Taiwan

Alan Yun Lu is Professor at the National Taiwan University Taipei Taiwan

Rania S Miniesy is Lecturer at the British University in Egypt Cairo Egypt

Jeffrey B Nugent is Professor at the University of Southern California LosAngeles USA

Ugo Pagano is Professor at the University of Siena Italy and at the CentralEuropean University Budapest Hungary

Kolleen J Rask is Associate Professor at the College of the Holy CrossWorcester USA

Norman Rask is Professor Emeritus at the Ohio State University ColumbusUSA

Donato Romano is Professor at the University of Florence Italy

Yasuyuki Sawada is Associate Professor at the University of Tokyo Japan

An-Chi Tung is Associate Research Fellow at the Academia Sinica TaipeiTaiwan

Jan Vannoppen is head of the advocacy department at Vredeseilanden LeuvenBelgium

Pan A Yotopoulos is Distinguished Professor at the University of FlorenceItaly and Professor Emeritus at Stanford University USA

Contributors xiii

Acknowledgments

Chapter 1 Asymmetric globalization impact on the ThirdWorld

bull Pages 7ndash8 quotation reprinted from p 3 of Richard Baldwin and PhilippeMartin (1999) ldquoTwo Waves of Globalization Superficial Similarities andFundamental Differencesrdquo In Horst Siebert ed Globalization and LabourTuumlbingen JCB Mohr for Kiel Institute of World Economics pp 3ndash59with permission by the Kiel Institute of World Economics

Chapter 5 Communities and markets for rural developmentunder globalization a perspective from villages in Asia

bull Figure 51 reprinted from Agricultural Economics Volume 20 YujiroHayami Masao Kikuchi and Esther B Marciano ldquoMiddlemen and Peasantsin Rice Marketing in the Philippinesrdquo pp 79ndash93 copyright 1999 with per-mission from Elsevier

bull Table 51 Yujiro Hayami and Toshihiko Kawagoe The Agrarian Originsof Commerce and Industry A Study of Peasant Marketing in Indonesia1993 Macmillan reproduced with permission of Palgrave Macmillan

Chapter 8 Genetically modified seeds and decommodificationan analysis based on the Chinese cotton case

bull Page 147 quotation reprinted from p 191 of Michael Pollan (2001) TheBotany of Desire A Plantrsquos-Eye View of the World New York RandomHouse with permission by Michel Pollan

bull Table 81 reprinted from Table 1 on p 48 of Michel AC Fok Weili LiangGuiyan Wang and Yuhong Wu (2004) ldquoI risultati positivi della diffusionedel cotone Bt in Cina limiti al trasferimento dellrsquoesperienza cinese in altripaesi in via di sviluppordquo Nuovo Diritto Agrario 32004 45ndash67 with per-mission by Nuovo Diritto Agrario

bull Table 82 reprinted from Table 8 on p 52 of Michel AC Fok Weili LiangGuiyan Wang and Yuhong Wu (2004) ldquoI risultati positivi della diffusione

del cotone Bt in Cina limiti al trasferimento dellrsquoesperienza cinese in altripaesi in via di sviluppordquo Nuovo Diritto Agrario 32004 45ndash67 with per-mission by Nuovo Diritto Agrario

bull Table 83 reprinted from Table 14 on p 58 of Michel AC Fok WeiliLiang Guiyan Wang and Yuhong Wu (2004) ldquoI risultati positivi delladiffusione del cotone Bt in Cina limiti al trasferimento dellrsquoesperienzacinese in altri paesi in via di sviluppordquo Nuovo Diritto Agrario 3200445ndash67 with permission by Nuovo Diritto Agrario

bull Table 84 reprinted from Table 8 on p 21 of Michel AC Fok Weili LiangGuiyan Wang and Yuhong Wu (2005) ldquoDiffusion du coton geacuteneacutetiquementmodifieacute en Chine leccedilons sur les facteurs et limites drsquoun succegravesrdquo EconomieRurale 285 5ndash32 with permission by the Socieacuteteacute Franccedilaise drsquoEconomieRurale (SFER)

bull Table 85 reprinted from Table 15 on p 63 of Michel AC Fok WeiliLiang Guiyan Wang and Yuhong Wu (2004) ldquoI risultati positivi della dif-fusione del cotone Bt in Cina limiti al trasferimento dellrsquoesperienza cinesein altri paesi in via di sviluppordquo Nuovo Diritto Agrario 32004 45ndash67with permission by Nuovo Diritto Agrario

Chapter 9 Globalization and small-scale farmerscustomizing ldquofair-trade coffeerdquo

bull Figure 91 reprinted from World Development Volume 30 Stefano PonteldquoThe lsquoLatte Revolutionrsquo Regulation Markets and Consumption in theGlobal Coffee Chainrdquo pp 1099ndash1122 copyright 2002 with permission byElsevier

bull Figure 93 reprinted from the Figure on product and control flow of MaxHavelaar (2002) ldquoMax Havelaar Het keurmerk voor eerlijke handelCriteria certificering en controlerdquo September 2002 with permission byMax Havelaar Belgium Online available wwwmaxhavelaarbe (accessed31 March 2004)

Acknowledgments xv

Editorsrsquo introduction

Pan A Yotopoulos and Donato Romano

It is beyond contention that globalization in the form of trade openness is animportant driver for economic growth Economic growth in turn is a pre-condition for development especially in less developed countries The seem-ingly inexorable increase in poverty among plenty is also beyond dispute Thesolution predicated by the supporters of the strategy of trade openness resonateshighly in this volume that is dedicated to the challenges of globalization for theThird World

At the same time it is widely recognized that globalization is not the silverbullet to achieving development Even enthusiastic proponents of globalizationacknowledge that there is a wide array of institutional macroeconomic andmicroeconomic conditions to be met along with a set of social policies to beinstituted if globalization is to bear fruit and especially so in developing coun-tries This type of elegiac ode to globalization usually comes from the side ofeconomics The kindred disciplines of sociology political science and economicgeography to mention a few appear much more vocal and certainly trendy instressing the polar view that globalization is a poisonous arrow There is in factsome consensus that certain operating aspects of globalization are punitivefor developing countries while the same are remunerative for the richer coun-tries that participate in trade and openness Both these types of critique of glob-alization the benign and the vitriolic rest on observing certain aspects ofglobalization and associating trade and openness with some negative outcomesin the developing and most recently also in the developed world The charac-teristic of these critiques is that they observe the world and they describe theldquowhatrdquo and ldquohowrdquo of the positive or negative aspects of globalization in aspecific environment

The Asymmetries of Globalization is certainly a critique of globalizationrsquosimpact on the Third World Not unlike some other studies of globalization it isalso pragmatic based on observing globalization in action However in contrastto the critiques mentioned above the chapters in this volume describe not onlythe ldquowhatrdquo and ldquohowrdquo but primarily the ldquowhyrdquo globalization has most oftennegative outcomes for developing countries The volume highlights the system-atic asymmetries of globalization that weigh down on the growth and develop-ment of the less developed countries One set of systematic asymmetries has its

origin in inherent characteristics of poverty The outcomes of globalization arenegative in poor countries because of the lack of modern infrastructure whetherit is physical in the form of transportation networks and market networks educa-tional infrastructure as in good public schools or social infrastructure as in thenon-existence of safety nets These infrastructural investments serve as lubri-cants to growth and as adjustment mechanisms in the case of abrupt transforma-tional change in their absence free trade may not be automatically also mutualadvantage trade

Any form of trade that systematically bestows disproportional benefits on thericher nations can be viewed as presumptively unfair trade The origin of suchunfair trade can be the nature of a trade agreement the regulatory framework inwhich free trade is contracted or some inherent characteristics in the nature ofcertain forms of trade While the Ricardian comparative advantage trade in com-modities delivers fair trade outcomes the ldquodecommodified traderdquo (includingtrade in services which exists at the other end of trade in commodities in thecontinuum of globalized trade) incorporates also economic rents To the extentthat these accrue disproportionately to developed countries they can be thesource of presumptively unfair trade The analytical component for approachingthis post-Ricardian form of trade is the role that reputation plays in a ldquoflattenedrdquoglobalized world Within the ambit of ldquopositional competitionrdquo reputation is anatural accoutrement of wealth and power and as such it is incorporated indecommodified trade which represents the bulk of exports from the developedcountries to the rest of the world The returns to reputation in turn are capturedin the form of economic rents which also accrue to those who have wealth andpower This is a novel asymmetry of globalization that operates to deliverdisproportional benefits of trade to the rich countries

The two kinds of post-Ricardian trade launched in the introductory chaptertrade in services including decommodified trade and trade in currency in theform of currency substitution enter as imports to developing countries and catermostly to the needs of the elites and the wealthy It is the well-off in the ThirdWorld who can afford to buy the brand names of the developed world ndash from theiPods to the burgers of the Arches of McDonaldrsquos ndash and who have the liquidassets to protect by denominating them into dollars whether the dollars are keptunder the mattress or they are whisked to the safe-harbor of a bank deposit in thedeveloped world It is the rich in the Third World who have most to gain fromreputation-intensive decommodified trade they gain primarily the freedom toengage in First World consumption But the poor are consumers too Wouldthey not also benefit from the bargain prices at which commodities are purveyedby globalization That would have also been correct for the poor whether theyare in developed or in developing countries if it were not for the fact that thepoor unlike the rich cannot afford to be consumers of the cornucopia of goodsthat globalization purveys without first being producers When the poor of thepoor countries have too little as opposed to the rich who have too muchthe benefits of globalization are lost for the former while they are lavished on thelatter Similarly the poor in some developed countries cannot afford to take

2 PA Yotopoulos and D Romano

advantage of the consumer benefits of globalization because globalization hasoutsourced their jobs to yet poorer people elsewhere in the world In eithercase presumptive logic suggests that the divide between the poor and the richwithin a country developed or developing must have been increasing underglobalization

Globalization and free trade certainly generate the gains that classical polit-ical economy identified The current globalization on the other hand bestows itsbenefits asymmetrically and largely to the rich countries as this volumeattempts to demonstrate Within a country whether rich or poor the presump-tion is that the rich classes gain disproportionately as compared to the poor

The main body of the volume the nine chapters that follow the introductorychapter weave a case-study tapestry around the theme ldquoAsymmetric Globaliza-tion Impact on the Third Worldrdquo that the opening chapter outlined On thequestion raised about the fairness of the distribution of the gains from globaliza-tion the focus is mainly at the country level while the socioeconomic classdistinction is brought in only tangentially in some instances

The germ of the idea that grew into this volume was conceived at theFlorence Symposium on ldquoGlobalization Asymmetric Processes and Differenti-ated Outcomesrdquo of September 2004 that was sponsored by the University ofFlorence and the European Association of Agricultural Economists This bookstarted as a conference volume which is the academic equivalent of a businessconglomerate ndash ldquoa little of this and a little of thatrdquo After various iterations overthe period of two years the editors discovered ndash and the authors acceptedinitially grudgingly ndash that economic development is not like the Russian dollswhere the same basic mold is repeated in successively smaller sizes Thus thisvolume acquired a central theme and the various chapters developed synergiesaround that theme ndash which is missing from many conglomerate businessenterprises

Editorsrsquo introduction 3

Part I

DecommodificationFrom trade in commodities to tradein services

1 Asymmetric globalizationImpact on the Third World1

Pan A Yotopoulos

Introduction

There has been abundant coverage of globalization and its implications both inprofessional and in popular media spanning the entire range from extolling itsbenefits to damning it for all kinds of ills There seems to be a widespread viewthat globalization is a new phenomenon but there is substantially less agreementon what globalization means A broad definition of globalization that covers alot of the disputed ground highlights the increased connectivity and interdepen-dence of the worldrsquos markets businesses and even cultures The outcomes ofglobalization have been pronounced on balance positive although this balanceis strongly disputed by the detractors of globalization

The operational formulation of the institutional setting of globalization restson the universal adoption of a common set of ldquorules of the gamerdquo2 for economicinteractions in the form of ldquofree-markets free-trade laissez-fairerdquo (FM-FT-LF)which is also known as the ldquoWashington Consensusrdquo The same freedom ofcomportment is in principle extended to other aspects of life be they educa-tional cultural social or political covering tastes mores and forms of gover-nance (participatory) The global connectivity of the phenomenon ofglobalization is enabled by the technological advances of the twentieth centuryand the ease of transportation communication and transmission of information

While the catchwords of globalization and Washington Consensus are cer-tainly new the phenomenon is not The first wave of globalization transpiredroughly from 1870 to 1914 while the current one started in the 1980s and isgoing strong today Baldwin and Martin (1999) who have studied the twowaves of globalization find superficial similarities between the two but alsosome important differences

The chief similarities lie in aggregate tradendashto GDP and capital flowsndashtoGDP ratios These stand today approximately at the level they attained atthe end of the 19th century Moreover both globalization waves weredriven by radical reductions in technical and policy barriers to internationaltransactions [ ] which were reconstructed by protectionist barriers inbetween the two world wars Taking a very high level of abstraction [ ]

we believe that one fundamental difference lies in the impact that thesereductions had on trade in goods versus trade in ideas While both wavessaw reduction in both costs the uniqueness of the recent globalization isheavily shaped by the dramatic reduction in communication costs what issometimes referred to as ldquothe death of distancerdquo A second fundamental dif-ference lies in the initial conditions At the beginning of the first wave theworld was fairly homogeneous homogeneously poor and agrarian that isAt the beginning of the second wave the world was sharply dividedbetween rich industrial nations and poor primary producers

(Baldwin and Martin 1999 3)

In their analysis of production structures and of income levels in the two global-ization waves the authors find that the initial conditions at the beginning ofthe current globalization (twentieth century globalization) included a verylarge northndashsouth income differential that has by now developed into the de-industrialization of the north while the industrialization of (part of) the south isstill in progress The first globalization wave (nineteenth century globalization)on the contrary industrialized the north and de-industrialized the south prima-rily India and China thus producing enormous income differences amongnations that were not that far apart in the middle of the nineteenth century

This volume and more specifically the present chapter that sets its themetakes a different tack It does not challenge the benefits of globalization Thoseare significant for the north and in some cases also for the south The focus is onthe costs of globalization that happen to be considerable What is even moreimportant the positive and negative outcomes of globalization are not distrib-uted randomly The asymmetries of globalization are systematic and workagainst the developing countries (less developed countries or LDCs)

This chapter formalizes the challenge of globalization as a development strat-egy for the LDCs From this standpoint the antecedent characteristic differencesbetween the two waves of globalization lie in the two novel features of the twen-tieth century globalization trade in services and free movements of financialcapital that were absent in the nineteenth century globalization The task thatlies ahead therefore is to build an analytical model of the asymmetric outcomesthat are the signature of the twentieth century globalization by tracing theircausal origin in the growing importance of trade in services (in the third sectionof this chapter) and also in the free market in foreign exchange (in the fourthsection) which coupled with free flows of financial (portfolio) capital sendstorrid amounts of hot money sloshing around the world The concluding sectionextends the conceptual model beyond the between-countries asymmetries tocover also the increasing chasm between the rich and the poor within a countrywhether developed or developing

Asymmetries based on institutional infrastructure

In the current environment of globalization free markets are championed fordispensing optimal outcomes in the form of bountiful benefits to consumers as

8 PA Yotopoulos

well as to the efficient producers ndash without regard to the endowments the socialclass or the states of the world a trading individualcountry finds itself inCompetition is the automatic homeostatic mechanism that favors the least-costproducer (in the process of the Schumpeterian ldquocreative capitalist destructionrdquo)and delivers the benefits of Ricardian comparative advantage trade to con-sumers (And parenthetically it is occasionally mentioned that even if the bene-fits from trade are not mutual for producers and consumers the gains of thewinners are big enough to compensate the losers)

On the other hand if the free market and free trade or globalization for shortdelivered the majority of benefits systematically say to the developed countriesand the poor ones were for the most part the losers then FM-FT-LF does notmete out mutual advantages in this specific configuration and the questionbecomes ldquowhyrdquo

Adam Smith the first and arguably the most enthusiastic advocate of freemarkets made it abundantly clear that markets need all the help they can getin order to perform as intended He properly emphasized the important role ofthe state in providing defense for its citizens with an army security with apolice force justice with a court system plus whatever we would currentlycall ldquogood governancerdquo He especially noted the need that the state providesthe ldquoinstitutions for facilitating the commerce of societyrdquo like roads bridgesand ports He implicitly signaled a sequence of institutional requisites thatlengthens as the market expands its reach as the complexity of transactionsincreases and as the requirements of international commerce become moreexigent Today the most basic Smithian infrastructure would probably includeamong others a high-speed venue of telecommunications infrastructuretelematics technology plus the requisite transport infrastructure for the move-ment of people merchandise documents and ideas All this modern infrastruc-ture is necessary for providing the appropriate setting for contingent marketsto develop in order to span time space and uncertainty thus paving the way toan Arrow-Debreu world

The Arrow-Debreu world is the world of benign competition ndash a competitionwithout tears3 It bestows mutual benefits to (efficient) producers and to con-sumers As long as markets exist and are ensconced in the basic (enhanced)Smithian infrastructure FM-FT-LF can deliver the optimal outcomes that theFundamental Theorems of Welfare Economics (FTWE) extol in most casesThe ldquonewrdquo development economics however identifies an important area of themarket economy where the homeostatic mechanisms of FM-FT-LF and of theFTWE do not operate There is need for intervention where there is marketfailure and especially in the case of incomplete markets that are characterizedby asymmetric information and adverse selection of risk4 Intervention in turnrequires an even heavier dose of good governance in terms of the reservoirs ofcompetence and integrity that are needed in the public sector This representsanother tall order of institution building

An important and certainly not new message of this chapter is that global-ization is institution laden and its success is predicated on the presence of some

Asymmetric globalization causes effects 9

key institutional parameters above and beyond the basic ones identified byAdam Smith Institution building however becomes an expensive propositionthat comes easier in the richer countries while most poor countries can ill affordit One would expect therefore that globalization in the form of FM-FT-LFdelivers benefits that flow mainly to the well-endowed countries those withwealth and a reliable nexus of political social and economic institutions ndash andby extension to the elites of the rest of the world On the other hand the costs ofthe failure of globalization afflict the masses of the population of the poorercountries that become the victims of rent-seeking activities culminating in klep-tocratic regimes in general anomy and in the eventual derailment of economicdevelopment (Stiglitz 2003) To say the least free trade and free marketsalthough they may often serve as drivers to growth they are certainly not thesilver bullet and the ldquoup-by-the-bootstrapsrdquo cure-all for LDCs that the messen-gers of the Washington Consensus have marketed to the Third World Here liesone type of systematic asymmetries of globalization

Trade in commodities and trade in servicesanother asymmetry

In the nineteenth century globalization international trade consisted exclusivelyof transactions in commodities ndash agricultural primary commodities semi-finished intermediate products and manufactures Trade in commodities can bereadily accommodated within the standard neoclassical theory and can be fittedinto either version the static or the dynamic of the FTWE In other words freetrade in commodities is the classical case of mutual advantage trade it matchesthe supply of the least-cost producers with the demand of consumers who areable and willing to pay the marginal cost of production

The paragraph above is a distilled summary of the stylized Ricardo (1817)and Mill (1844) version of comparative advantage trade In simple words com-parative advantage trade is the case of the best lawyer in town who also happensto be the best typist in town Notwithstanding she still hires a typist who ismediocre but he has a comparative advantage a low opportunity cost of histime and thus low wages as compared to the absolute advantage that his bossenjoys in lawyering

Comparative advantage trade in commodities is still an important part inthe twentieth century globalization ndash after all it is the ldquosecret weapon ofmass destructionrdquo that China possesses What is new in the contemporaryscene is trade in services that first featured as a significant component of inter-national trade in the 1980s and has by now become the tail that wags theinternational trade dog ndash at least as it relates to the asymmetries of mutualadvantage trade The share of services in international trade ndash from transporta-tion and communications to insurance and financial services to royaltieslicense fees and copyrights ndash quadrupled in value in 16 years (1986ndash2002)accounting in 2002 for 20 percent of total World Trade Organization (WTO)international trade (Figure 11)

10 PA Yotopoulos

Why is trade in services different from trade in commodities

The economics literature highlights the germane characteristics of trade in servicesbased on the distinction from trade in goods Goods are appropriable and there-fore transferable between economic units they can be stored transported andaccumulated Services on the other hand are intangible instantaneous (in thatthey perish in the very instant of production) and therefore involve the interactionof the consumer with the provider ndash which can take any form in a continuum fromface-to-face to armrsquos length interaction (Fuchs 1968 Hill 1997)

Building on those characteristics the terminology of the WTO distinguishesfour classifications (ldquomodesrdquo) of international trade in services based on thetype of interaction between the consumer and the provider (Bhagwati et al2004) In the case of providing medical care to foreign patients or education toforeign students as well as in the case of international tourism the consumermoves to the location of the provider (Mode 2 services) Mode 4 services coverthe cases where doctors or teachers move to the location of the recipient as wellas the case of guest workers (gastarbeiter in Europe or Mexican migrant labor inthe USA) Mode 3 services require the move of the provider to another countryin proximity to the consumer and that involves some direct foreign investmentwhich often is miniscule so that the main element consists of the ldquoright to estab-lishrdquo or to trade the brand name Examples vary from shelving the Kelloggrsquosbox of cereals in the local supermarket to establishing banking or insuranceagencies and exporting McDonaldrsquos franchises to another country Finally inMode 1 services the supplier and the buyer remain in their home bases and theirat-armrsquos-length interaction is made possible by snail mail or more prominently

01980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

Commercial services

Share of commercial services in total exports

Figure 11 International trade in commercial services value and share in total exports1980ndash2002 (based on WTO 2004)

by the revolution in the information and telecommunications technology thatallows for the instantaneous transfer of voluminous sets of data across the globeThis Mode 1 type of services is at the core of the controversy over outsourcingand constitutes another quaint wrinkle in the asymmetry of globalization men-tioned earlier

In making analytically operational the typology of trade in goods and serviceswe return to the characteristics of non-storability non-fungibility and theinstantaneous perishability of services at the moment of production as opposedto the appropriability substitutability and transferability in the case of purecommodities

Since services are produced at the point of consumption a service transac-tion involves the obligation by a party to deliver according to certain speci-fications This means that services are ordinarily more ldquocustomizedrdquo thangoods [ ] And since normally it is impossible to establish with certaintythe intentions [ and ability] of a party to deliver it also means that ser-vices ordinarily involve some amount of trust (or reputation) Trust goesbeyond a simple personal contact between the provider and the consumer Itcan be viewed as the qualitative factor-augmenting face-to-face interactionthat is needed for the production of services Trust becomes an importantelement of cost in transactions involving uncertainty

(Yotopoulos 1996 105)

Trade in services is distinguished from trade in commodities by two character-istics that are interactive customization and trust Customization implies thatsomething is distinct for which the consumer is willing to pay a premium Trustmeans that the producer of services will deliver according to specifications andtherefore can claim a premium Both are components of the more generalldquoatmosphericrdquo condition of reputation that yields the economic rents Lest itbecomes ephemeral in international trade the customization component is oftensheltered by patents copyrights and intellectual property rights that generallyenjoy legal protection and more recently have been endowed with WTO globalrecognition Similarly the trust is grounded on licensing for providing a serviceon the certification of a certain process of production (eg organic agriculture)and on registration of brand names or of a recognized denomination of origin(eg Champagne) Customization and trust are registered in the market place interms of reputation which makes the specific market less contestable Reputa-tion is thus rewarded with economic rents that accrue to the producers

The market of services is different from the market of commodities that oper-ates on the basis of the least cost of production But since customization andtrust in one word reputation create profits there is no reason that they berestricted to apply to services only Trade in commodities also can be foundedon reputation to a certain extent by ldquomoving up the value-added chainrdquo in orderto deliver economic rents5 In effect customization starts where pure commoditytrade ends which probably ended with the trade in agricultural commodities in

12 PA Yotopoulos

raw materials and in semi-finished products of the nineteenth century globaliza-tion And customization finishes with trade in pure services say the personalvalet ndash human as opposed to the PDA the personal digital assistant In betweenthose two extremes of pure commodities and pure services lies a huge band ofldquodecommodifiedrdquo trade that involves a lesser or greater degree of customizationand trust Examples of such decommodified trade are Lipton tea Kona coffeethe Hilton Hotels or the business class airfare6 It must be noted that this entiresector of ldquodecommodifiedrdquo trade is missing from the WTO data of trade in ser-vices in Figure 11 In other words the 20 percent share of ldquocommercialservicesrdquo in total exports in Figure 11 suffers a statistical undercounting if oneconsiders also the missing component of decommodified trade

Decommodification and positional goods

The kindred sociological literature deals with reputation as well as with powerand prestige under the categorization of positional goods and finds that theyconstitute ldquosocial limits to growthrdquo (Hirsch 1976 Frank and Cook 1976 Frank1985 Pagano 1999) As Pagano (Chapter 2) observes the characteristic of posi-tional goods is that a positive amount of the good (reputation) must be jointlyconsumed with a negative quantity of it because

It is impossible for somebody to consume prestige or ldquosocial superiorityrdquo ifothers do not consume some social ldquoinferiorityrdquo [ ] Positive and negativeamounts of the positional good must be jointly consumed No (European)soccer team in a tournament can consume three points of advantage ifanother team is not consuming three points of disadvantage

The implication is that positional goods are ranked in an ordinal (reputational)ladder from first or best to last or worst7 This makes it possible for the teamranked third to improve its position either by winning or by a higher-rankedteam losing to anybody else in the rank ordering

Applying the typology of positional goods to decommodified trade we have adistinctly different category from the price-competition based trade Within thecontinuum of customization a good is traded at a price that reflects its cost ofproduction a cardinal number but includes also a component for the ldquoreputa-tion payoffrdquo that consists of the monopoly returns and the economic rents thataccrued in the process of creating reputation Decommodified trade thereforeand especially trade in services that incorporates to a considerable degree a ldquorep-utation payoffrdquo becomes trade in positional goods In this formulation reputationis a general term for the quality of the decommodified good and as such it entersthe rank ordering that determines choice In the final analysis reputation is amatrix of various components that establish the ranking of a good in the posi-tional scale When a Fortune 500 multinational corporation sets shop in a devel-oping country it attracts its clientele not because it has a comparative advantagebut primarily because of its reputation (which may or may not have been earned)

of having been successful being more reliable being better capitalized havingbetter corporate governance in other words for having a better ldquobrand namerdquo8

Whatever the core component of trust is in this case it is certainly enhanced byadvertising it is supplemented by a conforming culture and all contribute tomaking a successful ldquobrandingrdquo (ldquoswashingrdquo) Developed countries are bettersituated to engage in decommodified trade in general and to provide services inspecific and thus to capture the economic rents that accrue to reputation Thereason is that reputation in the international arena is most often an attribute ofwealth and power and is nourished by visibility all three characteristics arefound more readily in the developed countries It is easier for the developedcountries to market the reputation that already exists than it is for poor countriesthat have first to create it from scratch

Another factor that favors developed countries in producing decommodifiedexports and especially in exporting services is the pre-existing domesticdemand that is the result of their higher income levels Miniesy and Nugent(Chapter 4) dealing with the effects of income inequality on trade incorporatethe Linder (1961) hypothesis that the export of manufactures (and services) ispredicated on the pre-existing local demand for their production in moredeveloped countries The advertising that created demand for more ldquosophistic-atedrdquo goods in Linderrsquos terms whether it addresses the middle-income classesand the elites in the developed countries or in LDCs has the same effect of pro-moting these exports from the developed countries9 The reputation embeddedin successful branding travels fast among socioeconomic classes in a globalizedworld The middle-class mothers that appreciate the ldquoconveniencerdquo of buyingthe box of Cornflakes in the supermarket of Caracas as an example have beenexposed to the same media advertising by Kellogg that convinced the mother inNew York that Cornflakes are better for her baby The proliferation of McDon-aldrsquos and of the United Colors of Benetton does not constitute the triumph ofcomparative advantage trade It is instead the triumph of the globalization ofpop culture In the extreme case the universal bulldozer of popular culturemagnifies the reputation advantages of an international franchise and bestowson it ample reputation payoffs while driving out of the market its local counter-parts which controlling for the quality of the good lack the reputationaladvantage that accrues from trading in a global market The globalizationasymmetry in the case of services arises from the fact that the reputationcomponent in that trade favors in general the developed countries at theexpense of the poor

The extreme case of the asymmetry in trade arises when network effects arebundled in the provision of a service resulting in a winner-takes-all situationThis happens in a wide range of services from telephony to information techno-logy to banking and insurance A typical example is the case of MicrosoftWindows where reputation enhanced by network effects created a winner-takes-all environment Controlling for the similarities and differences in therespective operating systems it was the popularity contest that led to the demiseof Apple in the 1980s since the users of the Mac operating system could not

14 PA Yotopoulos

communicate with their (more numerous) Windows-using correspondentsNetwork effects create systematic winners in the developed countries to thedetriment of a swath of service sectors in the developing world It is not so muchthe cost advantage or the quality of service as it is the network effect that hasBank Megara Indonesia and Star Insurance Malaysia on the ropes when theBank of America and Lloyds Insurance move in under the services liberalizationprotocol of the WTO10 It is all the more surprising that this huge systematicasymmetry in outcomes was signed away in 1996 in Singapore by the develop-ing countries without any reciprocal concessions from the developed world Agenerous gift indeed it was given the vertiginous increase in recent years oftrade in services (Figure 11)

Outsourcing and other trade in commodified services

Trade competition in services is a competition in which developing countries arebound to be the losers overall as long as developed countries have the advant-age that earns a reputation payoff in international trade This is not to deny thatsome developing countries are important exporters of tourism and others exportservice-provider workers More often than not however the mass tourism indeveloping countries becomes commodified ie it is reduced to backpacktourism that not unlike commodities trades on the lowest common denominatorof price competition The munificent sector of luxury tourism is by and largecontrolled by multinational hotel chains which based on the ldquoright to establishrdquoexport well-paying brand-name services to the main tourist destinations aroundthe globe often with only a nominal contribution in direct foreign investment(Mode 3 services) Similarly the Mode 4 exports of LDCs the temporary move-ment of people to supply services that has become a major source of earningforeign exchange for many countries is largely based on arbitrage in theminimum wage between developed countries and LDCs11 Finally there aresome indications that the international tourism type of Mode 2 services can beextended to cover elective surgery procedures which are imports of developedcountries from certain LDCs that are gradually achieving credibility for com-pliance with international medical standards (such as India or Thailand) Despitethe initial success of this type of service export it still remains to be seenwhether such provision of medical services will not elide to the luxury-tourismprototype to be captured by multinational health-care conglomerates

One type of export of services that does not fit the mold I have been casting isthe much celebrated (or notorious) outsourcing of services relating to informa-tion technology and back-office support that has been directed from thedeveloped countries to India and China in recent years This Mode 1 type ofservice certainly represents profitable trade for the developing country and assuch is an asymmetry which as noted by Samuelson (2004) works against thedeveloped world Two idiosyncrasies of this type of service outsourcing shouldbe noted however unless one rushes to the conclusion that the case vindicatesthe obligatory economistsrsquo complacencies about the overall benign effects of

globalization for the developing world First the outsourced services have oftenbeen parsed to the extent that they are devoid of any element of trust or reputa-tion which is what claims the economic rents in the trade of services Theexport of services in the case of outsourcing constitutes to a large extent com-modified trade that is transacted in arbitraging the wage differential for technicalsupport workers between say Silicon Valley in California and Bangalore inIndia12

The other notable point is that the current wave of US outsourcing is notrepresentative of the garden-variety service exports that could be easily access-ible to developing countries The public infrastructure that has made such exportspecialization possible usually comes at great cost to the countries involved Itrequires excellent education in technical and language skills (including fluencyin the English language) infrastructure in the form of technology and biotech-nology parks high speed fiber optics communication networks that make theinstantaneous transmission of data possible and especially an army of welltrained engineers13 The happy accident for the developing countries that becamethe beneficiaries of the US services outsourcing was their timing The burstingof the Silicon Valley technology bubble in 2001 and the ensuing Americanrecession drastically decreased the cost of technological outfitting for newentrants in this market Such propitious happenstances notwithstanding we canconclude that on balance developing countries are bound to remain netimporters of services in world trade Moreover the more unequal the distribu-tion of income is within a country the greater the imbalance in trade that theservice component is likely to represent14

There exist also two different scenarios with respect to outsourcing thatfeature a rainbow at the end of the day for the developing country In the clas-sical paradigm of free trade globalization where a developed and a lessdeveloped country (country 1 and 2) trade in two goods (good 1 and 2) with theformer ldquodeveloped countryrdquo having an absolute advantage in the production ofgood 1 (legal services) and the latter (developing country) only a relativeadvantage in the production of good 2 (back-office work for legal services) freetrade benefits both countries In the previous example of outsourcing from theUS to India an increase in the productivity of the outsourcee (the secretary ofthe lawyer acquires the skills that raise him from mediocre to good) will stillhurt Indiarsquos terms of trade As Lewis (1978 18) had observed India wouldbenefit by improving its share in the mutual benefits of trade only if it increasedproductivity in the third common good that the two countries share (productionof food in his case) that is a proxy for the standard of living in a country In ourearlier example of the lawyersecretary this would correspond to a broad-basedincrease in wages in the outsourcee country India There is some evidence thatthis process has started already in India a country that has the advantage ofestablished and globalization-fit infrastructure in the form of enough bandwidthto reach also big villages As a result the former outsourcee (Satyam ComputerServices of Bangalore) has started outsourcing some of its work that was previ-ously done at headquarters to educated and eager villagers in the countryside

16 PA Yotopoulos

who used to migrate to the cities in search of wages (Friedman 2006) This isequivalent to increasing productivity in Lewisrsquo home-good in the form ofincreasing wages on a broader level

While the logic of comparative advantage trade in the example of the lawyerand her secretary is unassailable for a single country in its application to Indiawith the back-office work Samuelson (2004) casts not unlike Lewis aboveserious doubts on the simplified version of professional wisdom regarding themutual benefits of fair free trade He finds that outsourcing work from the US toIndia to be done at Indian wages while definitely benefits the outsourcee it canpermanently hurt the outsourcing country by reducing its share in the combinedgains of trade that are possible for the two countries It is this form of dynamicfree trade that has been overlooked in the classical argument in favor of freetrade This case of ldquoimmiserizing growthrdquo constitutes another asymmetry ofglobalization which however in this instance hurts the developed country andbenefits the poor Although bad for the US it is part of the rainbow of globaliza-tion for the developing countries

Samuelson (2004 143) considers this challenge that arises for free trade andhe rejects the protectionist solution ldquoIn 1900 free traders proclaimed lsquoTariffsare the Mother of trustsrsquo In the millennium a more pregnant truth may belsquoTariffs are the breeder of economic arteriosclerosisrsquordquo Protectionism howeveris a multi-headed Lernaean Hydra arising in a different form each time itbecomes decapitated In the millennial environment the novel form of protec-tionism consists in setting the industry standards at the nationalregional leveland in legitimizing these standards internationally eg in the Service Liberaliza-tion Protocols at the WTO level As mentioned earlier (cf end note 10) thedeveloped countries within the framework of WTO exercise their control at thatlevel by promoting a stream of IPR (intellectual property rights) regulations thatconsistently enhance the reputation content (and monopoly returns) of interna-tionally traded services The overall asymmetry of globalization arises becausethe developed countriesrsquo absolute advantage in providing these services is pos-sibly stronger than their erstwhile absolute technological advantage that was lostto outsourcing to the Indias and Chinas of this world15

The conclusion is that globalization of services (in the broader sense ofdecommodified trade) benefits the developed countries and the elites of theLDCs but it is not the silver bullet for promoting development and decreas-ing poverty in the rest of the world The question then arises does it matter ifthe wealthy in the Third World spend their money in buying First Worldbrand names to the detriment of the domestic production of (internationally)ldquonon-tradedrdquo commodities The cost of shrinking the indigenous servicesector is not insignificant especially when network effects are involved andcreate a winner-takes-all situation for the multinational service exporter Tothis cost one should add the damage to poor countriesrsquo trade balances thedeficits of which must be covered by international borrowing normally ofdollars that slosh from country to country taking advantage of the interest ratedifferential that depreciating currencies provide relative to the reservehard

currency The scourge of systematically depreciating ldquosoftrdquo currencies istreated presently

The commodification of soft currencies and currencysubstitution

The significant damage that asymmetric reputation in the provision of servicesdoes to trade and the balance of payments of the Third World is still a minorevil compared to the financial wreckage that asymmetric reputation in curren-cies has meted to poor (and to some rich) countries in the last three decades Atthe domestic level a countryrsquos currency is used as a medium of exchange ndash inparallel with any consensual fiat money like ldquotrading stampsrdquo or ldquofrequent fliermilesrdquo that also can do service for transaction purposes In settling internationaltransactions however the reserve currency and a handful of other (hard) curren-cies are exclusively used as foreign exchange When currency is held as anasset the number of eligible currencies decreases further On their capitalaccount central banks hold the reserve currency in their reserves and indi-viduals also hold the reserve currency and hard-currency denominated assetsThis pecking order of currencies held as assets is an affirmation that not all cur-rencies were created equal As opposed to the use of currency for transactionpurposes the currency held as asset trades as a positional good based on reputa-tion In the ordinal reputational ranking of currencies for asset-holding purposesfrom ldquobestrdquo to ldquoworstrdquo the reserve currency ranks at the top of the reputationalladder The dollar therefore substitutes in agentsrsquo portfolios for a wide swath ofless-preferred currencies because of its reputation The reserve currencyrsquos repu-tation in turn in a process of cumulative causation earns the munificentseigniorage returns Moreover in continuing the same cumulative process thereserve currencyrsquos reputation as the ldquobestrdquo currency is reinforced by the networkeffects that it generates by doing better service as a medium of exchange and asa store of value because it has a large transactional domain ie it has greater liq-uidity than other currencies The currency (dollar) that is used by 500 millionpeople in the USA and elsewhere is 50 times more liquid than a currency thatis money for ten million people (Mundell 2000)16 In the case of positionalgoods and in the currency competition business the network effects are evenmore important than they are in the case of cell phones or international banksthat were mentioned earlier

Currency substitution as a case of market incompleteness

The asymmetries in the reputation of currencies induce asymmetric demand forholding currencies as assets Citizens of developing countries for exampleinclude in their portfolio the reservehard currency for asset-holding purposesThe motivation is buying insurance against a devaluation which is more likely tohappen for their countriesrsquo soft currencies than for the substitute reservecurrency Citizens of hard-currency countries on the other hand have not a

18 PA Yotopoulos

matching interest in holding soft currencies those of developing countries Con-trolling for the current account this currency substitution of the reserve currencyfor the soft in the capital account of the central bank will lead to the devaluationof the soft currency Thus currency substitution ldquocommodifiesrdquo the soft currency(the ldquopesordquo) and makes its devaluation a self-fulfilling prophecy17 This is on thedemand side On the supply side the current (neo-liberal) system of inter-national finance extends FM-FT-LF also to foreign exchange rates and to finan-cial capital flows Thus while monetary interventions intended to prevent thistype of currency substitution-induced devaluation are proscribed on the otherhand the freedom of speculative capital to empower this self-serving game andto participate in its spoils is countenanced

The type of devaluation that occurs as a result of currency substitution is dif-ferent from the benign devaluation featured in economics textbooks thatimproves the macro-fundamentals of an economy In the conventional case ofcurrency devaluation as a result of current account imbalances its impact in thereal world will restore equilibrium in the economy by increasing exports thatnow earn more in local currency and decreasing imports that correspondinglycost more Post-devaluation the prices of tradables (in domestic currency) haveincreased relative to non-tradables which contributes to restore the equilibriumin the allocation of resources It is a process of good competition that remediesthe macro-fundamentals of the economy along with the original current accountimbalances

The case of the currency substitution-induced devaluation on the other handcan be viewed as the result of bad competition and of a race for the bottom byextending the standard Stiglitz and Weiss (1981) model of incomplete marketsto cover also the market defect of asymmetric reputation ndash as opposed to asym-metric information that is familiar in the literature Controlling for the state ofthe current account and the reserves of the central banks it is the developing(soft-currency) countries that bear an additional risk of devaluation of their cur-rencies by the positional-good nature of reputational asymmetry Replicating theimplications of the standard incomplete markets model the asymmetricreputation-induced devaluation of the peso is the result of the wrong incentivesthat are motivated from gaming the devaluation and when the inevitable devalu-ation happens it rewards those who caused the crisis by fleeing away from thelocal currency in favor of hoarding dollars When coupled with free flows ofcapital the spoils of devaluation go also to international speculators who movefinancial capital (hot money) across borders for the purpose of placing a (lever-aged) one-way ldquocannot-loserdquo bet against in this example the Mexican centralbank (Yotopoulos 1996 Yotopoulos and Sawada 1999) This type of ldquobadrdquocompetition in the limiting case can lead to serial devaluations thus provokingfinancial crises18

As in the standard case of incomplete credit markets the remedy for themarket incompleteness of foreign exchange lies in rationing ie making foreignexchange available at the prevailing free market rate for transaction purposesonly while holdings of foreign monetary assets by individuals are prohibited or

otherwise penalized (for example delegated to the black market)19 While in thestandard case of incomplete credit markets the damage is limited to the ldquoracefor the bottomrdquo ie the default of the creditor the case of incomplete foreignexchange markets has broad repercussions economy-wide The decrease in thereserves of the central bank registers in the capital account as an imbalance butonly because the dollars have ended up under the mattress or in a Mexicanrsquos USbank account on the other side of the Rio Grande Currency substitution is oftenthe preamble to capital flight that hemorrhages private savings and represents adysfunctional integration into the world economy (Collier forthcoming)

Currency substitution the transmission of a monetary phenomenonto the real world of resource misallocation and poverty

The devaluation that normally follows an epidemic of currency substitution notonly is gratuitous as a remedy of the macro-fundamentals but it also results infurther distorting the allocation of resources in the economy by misaligning theexchange rate and inducing a misallocation in favor of the tradable sector20

Whether the extant allocation of resources is optimal or not the rational-expectations signal the producer of non-tradables receives from the devaluationof the peso is that his resources that so far produced say the equivalent of onedollarrsquos worth of tradables will yield less than one dollar in the future Rationalexpectations would have the peso devalue further in the future and in anticipa-tion the economy becomes more ldquodollarizedrdquo by shifting more resources to theproduction of tradables (which trade in dollars) whether the ex ante allocation ofresources was the correct one or not Currency substitution is the perfect recipefor misallocating resources21

Why is this case of currency substitution-induced financial crisis so pivotalfor the asymmetries of globalization It epitomizes the importance of the grada-tions that are introduced to classical commodity trade and to the Ricardo-Millversion of comparative advantage by the experience gained in the current roundof globalization The result of reputational asymmetry-induced currency substi-tution for asset-holding purposes can afflict any and all currencies since they areby definition ldquoworserdquo than the ldquobestrdquo reserve currency Notwithstanding theexperience of England Spain and Italy in the serial devaluations episode of1992 currency substitution-induced devaluations commonly impact ldquosoftrdquowhich is developing-country currencies The risk of endemic devaluations bearsa number of adverse effects for developing countries that become part of thesystematic asymmetries of globalization (and of free flows of financial capital)

The assets of the central bank in a devaluing country are in foreign exchangewhile its liabilities are in the local currency Devaluation results in changing therelative prices of the bankrsquos assets and liabilities and thus in higher interest ratesthat have a contractionary effect on the economy on the one side while on theother side attract free-floating portfolio capital that is expensive to service inforeign exchange Hot money far from promoting domestic investment consti-tutes instead the fuel that given a spark leads to the conflagration of a (highly-

20 PA Yotopoulos

leveraged) currency substitution and on to the next devaluation of the domesticcurrency This serial relationship between currency substitution and devaluationcan only find temporary relief in developing countries shoring up their reservesby borrowing dollars at exorbitant rates of interest (Stiglitz 2003)

Again at the economy-wide level as devaluation makes exports cheaper andimports costlier the terms-of-trade and the balance-of-payments effects tend towork against the developing countries given the usual assumptions about priceand income elasticities of their exports vis-agrave-vis their imports This tends toweaken further the fundamentals of the economy and thus increases the risk ofan ensuing devaluation

The reallocation of resources has also socioeconomic class-specific implica-tions When resources are being increasingly allocated in favor of sectoraloutputs denominated in dollars (exports including tourism etc) as opposed tosectors that produce the indigenous non-tradable goods that are transacted in thelocal currency the cost of production of non-tradables escalates (assuming asignificant import component)22 The result is that the cost of living of the lowereconomic classes increases By the same process of shifting the allocation ofresources from non-tradables to tradables often in an irreversible mannerpoorer people in developing countries tend to suffer twofold losses one as longas their preferences are tilted towards cheaper non-tradable goods they sufferutility losses two to the extent this conversion hurts the environmental resourcebase of the developing countries and their poor citizens they suffer a further lossof utility23

The ancillary effect of currency substitution-induced devaluations is that theycan easily evolve into full-scale financial crises The adverse effects of crises onthe real economy of developing countries are well documented and do not needto be rehashed here

Conclusion globalization and the divide of inequalitybetween and within countries

The transparent theme of The Asymmetries of Globalization is that free marketsand free trade work as long as they are supported by an intricate and extensiveinstitutional structure And since institutions do not come springing from thetrees the outcomes of globalization are more likely to be asymmetric favoringthe countries that are wealthy and institution rich at the expense of those thatare poor This argument is not to deny the universality of the benefits of freetrade It simply signals that comparative advantage trade becomes unattainablefor countries that do not have the requisite institutional infrastructure in place

The more subtle and novel theme of this volume revolves around the idea thatthe systematic outcomes of globalization depend on the degree of commodifica-tion of the trade in question Trade in the classical commodities agriculturalprimary goods and manufactures can be reduced to Ricardian comparativeadvantage trade that delivers its benefits to consumers and to the least-cost pro-ducers without any viable asymmetries in the outcomes between rich and poor

countries Given the (enhanced) Smithian institutional infrastructure free tradeand comparative advantage can act as a homeostatic mechanism that lifts thepoorer countries up by their bootstraps This is consonant with the WashingtonConsensus

In the current era of globalization trade in services that only recently enteredworld trade and the WTO writ has become the most rapidly growing componentof international trade Trade in services differs from the traditional commoditytrade by its characteristic of instantaneous perishability and the requirement fora degree of person-to-person interaction both being consumed jointly with trustand reputation in the provision of services Patents and intellectual propertyrights have entered the scene and so has advertising in the attempt to establishbrand names all in an effort to create and cement trust thus reinforcing the freetrade inhibiting characteristics of the non-contestable markets in which servicesare transacted Trust becomes the foundation of trade in services and it isrewarded with monopoly returns and ancillary economic rents that accrue toldquoreputationrdquo International exchange that incorporates a component of reputationdoes not deal in comparative advantage anymore because reputation is a posi-tional good and it is subject to ordinal measurement only based on the rankingof a service from best to worst What is necessary in the trade of servicesbecomes applicable also in the trade of the erstwhile (pure) commodities that arebecoming increasingly decommodified by the incorporation of components ofeconomic rents In fact the ldquotrade in ideasrdquo that solidifies trust whetherreflected in intellectual property rights and their monopoly returns or in advert-ising and brand names that yield economic rents has expanded the role of repu-tation to apply in a continuum of decommodification between the two extremesof the traditional ldquopurerdquo commodities and ldquopurerdquo services The novel contribu-tion of this volume is to signal the growing importance that the reputationcomponent implies for the expanded domain of world trade Far from deliveringmutual benefits trade in positional goods rewards the rank ordering which getsreshuffled when the runner-up wins in the competition with the leader or theleader loses to anybody else in the order The message for trade in services isthat winning the reputation game in competition with the developed countriesis not as automatic for the developing world as it is having a comparativeadvantage in the trade of commodities The reason is that reputation is anattribute of wealth and power which the developed countries can take to thebank as opposed to the developing countries that have to build reputation fromscratch

Another unorthodox insight gleaned from the previous two sections of thischapter relates to the need for intervention in the trade of the reserve currencyfor asset holding purposes Given the asymmetric reputation of any of theworldrsquos currencies relative to the reserve currency the outcome of a free marketin currencies is a race for the bottom in an exact parallel to the incompletenessof the credit market The difference is that the origin of incompleteness in asym-metric information has become instead asymmetric reputation in the case ofcurrency substitution Even worse the race for the bottom in this latter case does

22 PA Yotopoulos

not end with the default of the creditors as in the case of asymmetric informa-tion In the worst case it can end in serial devaluations that wreak havoc onLDCs

While this chapter focused mainly on the increasing divide that separates richand poor countries in the era of globalization on occasion the impact of freetrade on poverty within the LDCs was also examined and yielded systematicasymmetries that increase the divide between rich and poor people Yet both thepoor and the rich within a country are consumers of the goods purveyed by glob-alization at bargain prices To that extent poor and rich alike must be benefitingfrom globalization Why should the divide between socioeconomic classesincrease

The analytical mechanism that turns the poor into losers whether indeveloped countries or in LDCs is simple the poor have too little while therich have too much The argument refers not to equality or to the sense ofjustice but to an economic asymmetry between the consumption and the pro-duction processes The difference between the poor and the rich lies in the factthat the poor were previously the producers of those one-euro Chinese blouseswhen they were produced locally at the textile factories of Prato in Italy or ofThessaloniki in Greece Those jobs in the local industry were paying decentwages and they were feeding the workersrsquo dreams of stepping on the escalatorthat would propel them from poverty to the middle classes With globalizationthese jobs have disappeared and the unemployed have lost their wage checksBy not being producers any more they can no longer afford the consumersrsquo cor-nucopia and the one-euro blouses that globalization offers24

The rich on the other hand have no problem of losing their jobs to importsnor do they face an income constraint since they have wealth They profit fromthe cheap commodities of globalization trade but mainly they profit from thefreedom to import the decommodified standards of living of their rich brethrenin the First World Their graduation from consumers in the Third World wherethey live to consumers of the First World in terms of what imports they canafford to buy has become the problem of the central bank that finds its inter-national reserves depleted by the economic imbalance of producing like a poorcountry and consuming like the rich

Although this chapter has focused on the risk that globalization becomes theepitaph of growth in the Third World the increasing divide between the rich andthe poor within the developed countries may prove even more ominous for thefuture of globalization Unless the gains from free trade are shared more equallybetween rich and poor countries and among the rich and the poor within themthe future of this second globalization may be short lived

1 I am grateful for comments to Samar Datta Jeff Nugent Kolleen Rask DonatoRomano Yasuyuki Sawada and TN Srinivasan

2 Kreps (1994) defines ldquoinstitutionsrdquo as the set of the rules of the game

3 For more exacting conditions of the Arrow-Debreu world and its application in thisessay see Pagano (Chapter 2)

4 The need for intervention in cases of market failure is not new dating at least as farback as the early years of the modern economics of development when governmentplanning of the economy was still respectable and Rosenstein-Rodan was formulatinghis theory of the big-push (Rosenstein-Rodan 1961 57ndash81 Yotopoulos and Nugent1976 Chs 20 and 21) The ldquonewrdquo element in development economics is the extensionof the need for intervention in cases of market incompleteness that comes in an erawhen the alternative of government planning has been finally buried and free marketsare enthusiastically promoted as the only way to run an economy

5 In contemporary business parlance the euphemism for the process of creating andcapturing economic rents is ldquomoving up the value-added chainrdquo

6 For an example of such decommodification in developing country agriculture cfDrsquoHaese et al (Chapter 9)

7 In extending this literature and viewing customization as a process of creating ldquoposi-tional goodsrdquo I postulate that the rank ordering of customized goods in general and ofservices in particular is based on more elements than the tangible ldquoquality character-isticsrdquo of the good that are identifiable ex ante

8 These components that establish reputation may be attributed to better institutions andmore resources that are at the disposal of developed countries and may resultarguably to producing better services defined in terms of average higher qualityandor lower quality variation

9 Bergstrand (1991) endogenizes the effect of advertising in a model that assignsincome elasticity of demand for services greater than one and for commodities lesserthan one This makes developing countries better able to produce services See alsoRomano (Chapter 10)

10 Restrictions of trade in the form of regional (or national) standards are effective incontaining these network effects For example the need to customize IT products forEuropean standards in business systems fuelled the success of the Irish softwareindustry in the 1990s Similarly the difference in standards for the US cellular phoneindustry as compared to those adopted in Europe and in most Asian countries has pro-tected the respective regional interests

11 In case the temporary stay is converted to permanent residence the foreign exchangegains of LDCs become more significant but at the expense of a costly brain drain forthe country of origin

12 Cf Liu et al (Chapter 6) for examples of commodification of these types ofservices

13 One of course could define such investments as part of the (extended) Smithianinfrastructure that is requisite for comparative advantage trade It would still strike meas an attempt of excessive word-smith-ing in the altar of mainstream conventionalwisdom

14 Cf Miniesy and Nugent and Sawada and Yotopoulos (Chapters 4 and 3 respec-tively)

15 Pagano (2006 and Chapter 2) refers to ldquolegal disequilibriardquo in the case of ldquopan-posi-tionalrdquo goods when the legal framework of ldquorightsrdquo does not also assign clearldquoresponsibilitiesrdquo for their enforcement Such is the case of WTO ldquolegislationrdquo onintellectual property rights with the residual responsibility for enforcing the lawfalling on hapless governments in the Third World that may or may not have theresources or the will to do that In such cases the economic system works sub-optimally See also Romano (Chapter 10)

16 Pagano (Chapter 2 fourth section) generalizes the model of positional competition interms of the cumulative causation between reputation and liquidity

17 This is precisely the reason why restrictions in the capital account that limit or totallyprohibit holdings of foreign monetary assets have had a long history in international

24 PA Yotopoulos

finance They were abolished in the United Kingdom only in 1979 ndash just in time onemight observe for the pound to be hit by a historical currency substitution crisis in1992 In China on the other hand the currency until early 2006 had been convertibleon the current account only ndash and not on the capital account

18 For the modeling and testing of this case cf Sawada and Yotopoulos (2005)19 It is noted that this has been a long-venerated practice in development planning in

most countries prior to the 1980s and in China until more recently On the otherhand gold held for asset-holding purposes has served India well for more than acentury For reasons of illiquidity and of storage cost gold becomes an expensive wayof buying insurance against future devaluations and thus its use for that purpose ismore limited than of the foreign exchange alternative But what is even more import-ant an increase in imports of gold is treated like any other item in the current accountwith its demand and supply adjusting subject to the exchange rate An increase in thedemand for dollar assets on the other hand triggers the devaluation of the pesowhich changes the prices of all items in the balance of payments plus the relativeprices of tradables and non-tradables in the economy This is a huge change in thereal world that follows the mere repositioning of liquid assets (by the wealthy)

20 Yotopoulos and Sawada (2006) provide an empirical test of the proposition that thedamage from the misalignment of the exchange rate originates in the free market forforeign exchange to be used as an asset

21 For the modeling and quantification of these allocative inefficiencies see Yotopoulos(1996 51 and Ch 7) and Sawada and Yotopoulos (2005)

22 Moreover since luxury tourism is normally transacted in dollars in poor countries therevaluation of the dollar would have offset the result of the devaluation of cheaptourism becoming cheaper and more attractive for the backpack crowd In additionwhere luxury tourism is controlled by foreign multinationals its profits enhance theGDP but are not part of the national product having fled the country

23 Contrary to normal regulatory treatment that applies to developed countries develop-ing countries cannot claim benefits for the environmental goods they produce nor canthey demand compensation for the environmental damage they inflict on themselvesthrough their export activities

24 Memories in economics are short sometimes The Japanese ldquodollar-blouserdquo trade warwith the United States in the late 1950s ended with an American tariff against Japan-ese imports This in turn propelled the Ministry of Industry and Trade to launch anew strategy of ldquoarticulated developmentrdquo that propelled Japanese industrializationuntil 1992 (Yotopoulos 1996 193 and Ch 9) It seems that China might havedigested this strategy while the West is again toying with ldquotariffing-awayrdquo theChinese ldquothreatrdquo

References

Baldwin Richard and Philippe Martin (1999) ldquoTwo Waves of Globalization SuperficialSimilarities and Fundamental Differencesrdquo In Horst Siebert ed Globalization andLabour Tuumlbingen JCB Mohr for Kiel Institute of World Economics pp 3ndash59

Bhagwati Jagdish Arvind Panagariya and TN Srinivasan (2004) ldquoThe Muddles overOutsourcingrdquo Journal of Economic Perspectives 18 (4) 93ndash114

Bergstrand Jeffrey H (1991) ldquoStructural Determinants of Real Exchange Rates andNational Prices Levels Some Empirical Evidencerdquo American Economic Review 81(1) 325ndash34

Collier Paul (forthcoming) ldquoAfrica and Globalizationrdquo In Ernesto Zedillo ed TheFuture of Globalization Explorations in Light of Recent Turbulence London Rout-ledge

Frank Robert H (1985) Choosing the Right Pond New York Oxford University PressFrank Robert H and Philip J Cook (1976) The Winner-Take-All Society Why the Few

at the Top Get So Much More Than the Rest of Us New York PenguinFriedman Thomas (2006) ldquoOp-Edrdquo New York Times 19 May Online available at

nytimescom (accessed 19 May 2006)Fuchs Victor R (1968) The Service Economy New York National Bureau of Economic

Research and Columbia University PressHill T Peter (1997) ldquoOn Goods and Servicesrdquo Review of Income and Wealth 23

(December) 315ndash38Hirsch Fred (1976) Social Limits to Growth Cambridge MA Harvard University PressKreps David (1994) ldquoCorporate Culture and Economic Theoryrdquo In James Alt and

Kenneth Shepsle eds Perspectives on Positive Political Economy Cambridge Cam-bridge University Press pp 90ndash143

Lewis W Arthur (1978) The Evolution of the International Economic Order PrincetonNJ Princeton University Press

Linder Steffan (1961) An Essay on Trade and Transformation Stockholm Almqvistand Wicksell

Mill John S (1844) Essays on Some Unsettled Questions of Political Economy LondonParker

Mundell Robert A (2000) ldquoThe Euro and the Stability of the International MonetarySystemrdquo In Robert A Mundell and Armand Cleese eds The Euro as a Stabilizer inthe International Economic System Boston Kluwer Academic pp 57ndash84

Pagano Ugo (1999) ldquoIs Power an Economic Good Notes on Social Scarcity and theEconomics of Positional Goodsrdquo In Samuel Bowles Maurizio Franzini and UgoPagano eds The Politics and Economics of Power London Routledge pp 63ndash84

Pagano Ugo (2006) ldquoLegal Positions and Institutional Complementaritiesrdquo In FabrizioCafaggi Antonio Nicita and Ugo Pagano eds Legal Orderings and Economic Institu-tions London Routledge pp 54ndash83

Ricardo David (1817) On the Principle of Political Economy and Taxation LondonJohn Murray

Rosenstein-Rodan Paul N (1961) ldquoNotes on the Theory of the lsquoBig Pushrsquordquo In HowardS Ellis and Henry C Wallich eds Economic Development for Latin America NewYork St Martinrsquos Press

Samuelson Paul A (2004) ldquoWhere Ricardo and Mill Rebut and Confirm Arguments ofMainstream Economists Supporting Globalizationrdquo Journal of Economic Perspectives18 (3) 135ndash45

Sawada Yasuyuki and Pan A Yotopoulos (2005) ldquoCorner Solutions Crises and CapitalControls Theory and Empirical Analysis on the Optimal Exchange Rate Regime inEmerging Economiesrdquo Stanford Institute for Economic Policy Research Paperno 04ndash037 (September 2005) Online available at sieprstanfordeduPaperspdf04ndash37html (accessed 13 September 2005)

Stiglitz Joseph E (2003) The Roaring Nineties A New History of the Worldrsquos MostProsperous Decade New York WW Norton

Stiglitz Joseph E and Andrew Weiss (1981) ldquoCredit Rationing in Markets with Imper-fect Informationrdquo American Economic Review 71 (June) 393ndash410

WTO (2004) ldquoInternational Trade Statistics Statistical Databaserdquo Online available atwwwwtoorgenglishres_estatis_estatis_ehtm (accessed 29 December 2004)

Yotopoulos Pan A (1996) Exchange Rate Parity for Trade and Development TheoryTests and Case Studies Cambridge and New York Cambridge University Press

26 PA Yotopoulos

Yotopoulos Pan A and Jeffrey B Nugent (1976) Economics of Development EmpiricalInvestigations New York Harper and Row

Yotopoulos Pan A and Yasuyuki Sawada (1999) ldquoFree Currency Markets FinancialCrises and the Growth Debacle Is There a Causal Relationshiprdquo Seoul Journal ofEconomics 12 (Winter) 419ndash56 (Available also online at sieprstanfordedupaperspdf99ndash04html)

Yotopoulos Pan A and Yasuyuki Sawada (2006) ldquoExchange Rate Misalignment ANew Test of Long-Run PPP Based on Cross-Country Datardquo Applied FinancialEconomics 16 (1) 127ndash34

2 Positional goods and asymmetricdevelopment1

Ugo Pagano

Introduction

Standard international trade theory considers the case in which countries special-ize in the production of private goods In an open economy countries specializein the production of the private goods in which they have a comparative advant-age In this way all countries gain from trade and improve their welfare andtheir level of development This theory has even more optimistic implicationswhen public goods are included in the picture Most catch-up theories of devel-opment were based on the idea that the wealthier and more advanced countrieswere likely to specialize in knowledge-intensive processes and therefore makesubstantial investments in public goods that could also be used by poorer coun-tries International trade would have either implied symmetric benefits or evenrepaired pre-existing asymmetries between developed and developing countries

In this chapter I will argue that this picture changes substantially when weintroduce positional goods into the analysis Positional goods can be viewed as acase polar to that of public goods If ldquoFirst Worldrdquo countries specialize in goodssharing a positional nature this optimistic view of global development changesand international trade may lead to forms of increasing asymmetric develop-ment In the following section I consider the characteristics of positional goodsIn the next section I give a very short account of the role that positional goodslike status and power can play as a possible cause of asymmetric developmentIn the fourth section I argue that also money (the most typical example of apositional good) can be an important cause of asymmetric development In thefifth section I build on the Hohfeld-Commons analysis of legal relations andargue that legal disequilibrium can be the cause of the asymmetric effects thatcompetition systematically generates in various countries notably the developedas opposed to less developed In the final section I consider the role of theglobal legal positions defined by intellectual property and I maintain that theyhave an important role in causing diverging paths of international specializationI argue that the recent process of globalization can be seen as a shift from aninternational order in which the public goods supplied by developed countrieshad an important developmental role to play to a new global order that ismainly driven by the developed countriesrsquo specialization in positional goods

The nature of positional goods and welfare theory

Positional vs private and public goods

In his famous book Hirsh (1976) argued that positional goods pose social limitsto growth Hirsh argued that while some goods could be produced withoutlimitations other goods which he labeled positional goods were only availablein limited supply Economic development implied an increasing price of posi-tional goods and was inevitably constrained by the scarcity of these goods

Under the umbrella of positional goods Hirsh included two types of goodsThe supply of the first set of goods was limited by their natural scarcity By con-trast the second set included goods like power and status whose supply waslimited by their social scarcity In both cases the possibility of acquiring thesegoods was related to the relative standings of the individuals and a process ofdevelopment could not improve everybodyrsquos chances of getting them Theimportance of relative positions induced Hirsh to use the term positional goodsfor both types of goods However the two types of goods have differentcharacteristics and in my view only the second category deserves the label ofpositional goods

Goods such as natural resorts that cannot be reproduced are positional onlyin the weak sense that the relative positions of the individuals matter to acquirethem Natural scarcity implies that a form of social scarcity related to the rela-tive standings of the different individuals does indirectly matter Howeverthese goods could be consumed independently of the behavior of other indi-viduals and indeed more easily without their interference Moreover an egalit-arian consumption of these goods is not impossible and it is indeed a likelyoutcome when there are no relevant differences in the social standing the rela-tive wealth and the preferences of the different individuals

The positional nature of the second category of goods is much stronger in theact of consumption individuals must necessarily divide themselves into two dif-ferent groups of ldquopositiverdquo and ldquonegativerdquo consumers Consider the case ofstatus and power Any positive amount of power and prestige must be jointlyconsumed with negative quantities of it It is impossible for some individuals toexercise power if other individuals do not undergo the exercise of this power orin other words it is impossible for somebody to dominate if somebody is notdominated positive power must be jointly consumed with negative power2 In asimilar way it is impossible for somebody to consume prestige or ldquosocial supe-riorityrdquo if others do not consume some social ldquoinferiorityrdquo Again positive andnegative amounts of the good must be jointly consumed No (European) soccerteam in a tournament can consume three points of advantage if another team isnot consuming three points of disadvantage Unlike the features of uniquenatural resorts the positional characteristics of these goods are intrinsic to theirnature In this case it is impossible to consume positive amounts independentlyof the behavior of some other individuals who must undergo a negative con-sumption of the same goods Moreover the egalitarian consumption of these

Positional goods in asymmetric development 29

goods is seriously limited by their intrinsic positional nature If everybody canbe somebody nobody can be somebody it is impossible for all the members ofa group of individuals to be equally powerful and prestigious without spoilingthe very meaning of these goods that do necessarily imply divisive consump-tions with two opposite signs

Therefore we define as positional goods only the second category of goodswhich are somehow related to the legacy of Veblen (1899) We will observethat unlike the first category (which does not differ from the standard scarceeconomic goods) the second category of goods requires an extension of thestandard economic classification into private and public goods

Private goods are characterized by the fact that other individuals consume azero amount of what a certain individual consumes The other individuals areexcluded from the consumption of these goods The exclusion from positiveamounts of consumption is impossible in the case of public goods and indeedin the case of a pure public good all the agents will consume the same positiveamount

In the case of positional goods like status and power when some individualsconsume these goods other individuals must be included in consumption ofrelated negative quantities A pure positional good can be defined as a good suchthat an agent consumes the same but negative amount of what another agentconsumes In this respect pure positional goods define a case that is polar to thecase of pure public goods3

Consider the case of Robinson Crusoersquos island At the beginning beforeFridayrsquos arrival Robinson will not observe any relevant difference among thegoods that he consumes He cannot perceive the distinction between private andpublic goods The impossibility of exclusion that distinguishes public goodsfrom private goods cannot be perceived in a situation where there are not otherindividuals and positional goods cannot be consumed at all if nobody else isincluded in their negative consumption When Friday arrives the distinctionbetween public and private goods becomes evident and according to thecommon prejudices of his time the white civilized Robinson can start toconsume positive amounts of positional goods such as status and power

Referring to the simple case of the two individual RobinsonndashFriday economythe relation between the signs of these goods can be summarized as in Table 21

It is not surprising that the problems of positional goods are opposite to theproblems of public goods In the case of public goods we have the standardunder-investment problem in their supply (and in their abatement when they arepublic bads) It may turn out to be impossible to exclude the individuals fromexternalities having the ldquosame signrdquo of the good By contrast in the case of posi-tional goods we have a problem of over-investment All the agents may try toconsume positive amounts of these goods and include other individuals in thecorresponding negative consumption For this reason ldquopositional competitionrdquois much harder and sometimes more violent than competition for ldquoprivaterdquogoods It is also wasteful because individual efforts do often offset each other Insome cases they may end up with the same outcome that they would have

30 U Pagano

achieved if they had not dedicated any effort to the improvement of their relativepositions

Positional goods and welfare

The standard maximum welfare conditions can be generalized to include thecase of positional goods Let us assume that we have two goods one good ywhich is lsquoa priorirsquo defined as a private good and another good x that has manylsquoa posteriorirsquo definitions according to the values taken by the fraction tih of x thatindividual i consumes when individual h consumes a quantity xh

We can therefore distinguish among the following three ldquopurerdquo cases

1 tih is equal to 0 this is the standard case of private goods where no indi-vidual i consumes fractions of the goods that are also consumed by otherindividuals h

2 tih is positive this is the case of (semi)public goods where individuals iconsume positive fractions of the good consumed by each individual hWhen for all the individuals i and h tih is equal to 1 x is a pure public goodWhen tih is equal to 1 for some individuals and 0 for other individuals wehave the standard case of local public goods

3 tih is negative in this case x is a (semi)positional good Other individuals iconsume negative fractions when h consumes a positive amount xh When tih

is equal to 1 for all the individuals i different from h we have a case sym-metric to the pure public good case and we can label x a pure ldquopan-positionalgoodrdquo An advantage in a soccer team ranking is an obvious example of apure pan-positional good Also positional goods can have the characteristicsof ldquolocalrdquo positional goods A particular case of such positional goods are thebi-positional goods where when h consumes x only one individual con-sumes a fraction equal to 1 of the positional good while all the other indi-viduals consume 0 quantities of the good A masterndashservant relation can beconsidered as an example of these types of bi-positional goods

While pure cases may be interesting semi-public and semi-positional goods arelikely to be more common cases Moreover one cannot exclude cases of goods

Table 21 Consumption according to the nature of goods

Robinson Friday

Public good Private good 0Private good 0 Positional good Positional good Public bad

that are public goods for a group of individuals and are at the same time posi-tional goods for another group of individuals National security is one of thesegoods It is considered to be the classic textbook case of a pure public good inthe sense that when an individual h of a nation consumes additional units ofnational security the other individual i consumes the same amount (tih 1) ofthe good In this sense the undersupply of national defense would be theoutcome of a stateless nation and national defense is the classic public goodrequiring state intervention However the consumption of national security bythe individuals of some nation can involve a corresponding consumption ofnational insecurity by the individuals of another rival nation (tih 1 for theseindividuals) and be an example of a pure positional good For this reasoninvestments in national security are also said to be characterized by oversupplyand can easily degenerate in wasteful arms races

We can generalize the standard model of welfare economics to deal with allthese cases by assuming that each individual i will consume a quantity yi of theprivate good and quantities tihxh of good x Let us denote by microi the weight givento the utility function of individual i in the social welfare function and by T(xy)the social transformation function between the two goods

The maximization problem for society taken as a whole is

max WiUi(yiti1x1 ti2x2 hellip tiixi tihxh hellip tinxn)hhUh(yhth1x1 th2x2 hellip thixi thhxh hellip thnxn)

h1hellipn h i

subject to T(xy)0We yield the following condition4

tiiMRS i(xiyi)hthi MRSh(thi xiyh)MRT(xy) (1)

The condition in equation (1) expresses the most general case and it is also com-patible with cases such as national security in which thi is positive for someindividuals and negative for other individuals

In the case of private goods (tih is equal to 0 and tii is equal to 1) condition (1)becomes

MRSi(xiyi)MRT(xy) (2)

In the case of pure public goods (tih and tii are both equal to 1) condition (1)becomes

MRSi(xiyi)hMRSh(xiyh)MRT(xy) (3)

In the case of bi-positional goods (tih is equal to 1 for hj and otherwise equalto 0 tii is equal to 1) condition (1) becomes

32 U Pagano

MRSi(xiyi)MRS j(xiyh)MRT(xy) (4)

Finally in the case of pan-positional good (tih is equal to 1 for all individualsh tii is equal to 1) condition (1) becomes

In the case of private goods the fact that an individual consumes units of thegood has no effect on the level of goods consumed by the other individuals whocan be excluded from the consumption of the good By contrast in the case ofpure public goods non-rivalry in consumption and the impossibility of exclusionimplies that the marginal rates of substitution of other individuals have to beadded to that of the individual consuming the good Finally in the case of posi-tional goods the necessity of including the negative consumption by other indi-viduals implies that their marginal rates of substitution have to be subtractedfrom the marginal rate of substitution of the individual consuming the (corre-sponding positive amount of the) good

A comparison of this extended set of maximum welfare conditions with thoseof standard competitive markets shows that while public goods are going to beunder-supplied positional goods are going to be over-supplied (Pagano 1999)In the first case there are missing markets to bargain with the individuals whocannot be excluded from a joint consumption of positive amounts of the goodBy contrast in the second case there are missing markets to bargain with all theindividuals who must be included in the corresponding negative consumption

The role of status and power in economic development

For too long status and power have been totally overlooked in economic reason-ing They are very important for the issues concerning economic developmentOne can even argue that the stagnant nature of agrarian societies and thedynamism of capitalist societies are related to this characterization of positionalgoods The agrarian societies turn out to have different relations between theseldquosociological dimensionsrdquo (resulting from an enlargement of the space of ldquoeco-nomic goodsrdquo to values where thi assumes negative values) and the investmentsin both human and non-human capital

In agrarian societies coercive power and status determine the access towealth and to education The positions of individuals in society in terms ofpower and status are relatively fixed and are usually given by birth They deter-mine the access of individuals to education and to wealth The opposite directionof causality (from education and wealth to power and status) is much weakerand it is often explicitly repressed

In capitalist societies causation flows often in the opposite direction Thepositions of the individuals are not given in terms of power and status whileaccess to education to occupations and to wealth accumulation is not explicitlyforbidden to any individual While status and power can sometimes favor the

access to some occupations and to the accumulation of wealth this relation israther weak and is not typical of a capitalist society The opposite is true Theaccumulation of wealth and of human capital becomes now the key that unlocksfor individuals power and status

We could simplify the argument by saying that while in an agrarian society agiven distribution of status and power determines the distribution of wealth andthe access to education in a modern capitalist society the acquisition of wealthand education determines the distribution of status and power In other wordsunder the two social arrangements causation between power and status on theone hand and physical and human capital on the other flows in two oppositedirections5

In an agrarian society the distribution of power and status is fixed by birthand determines the access to wealth and education For this reason there is littleincentive to innovate and to accumulate wealth and the society is often stuck instagnant conditions Here social scarcity constrains natural scarcity in a strongway because the fixed allocation of power and status positions destroys theincentives that can generate a process of economic development The accumula-tion of human and physical capital is constrained by not allowing changes in thedistribution of power and status Thus in welfare terms we are likely to have anldquounder-accumulationrdquo of wealth

In a capitalist society the distribution of power and status is not fixed by birthin the sense that there is no given percentage of blue blood that guarantees agiven position in society and a given access to the wealth produced by societyThe opposite is rather true Access to wealth via productive and innovativeactivities gives access to temporary positions of power and status Howeverunlike wealth power and status are zero-sum goods and the increase in thepositive consumption of positional goods by some individuals brings about anincrease of negative consumption by some other individuals Here socialscarcity far from limiting the incentive to produce and innovate brings about adrive to accumulate physical and human capital that is often unrelated to the aimof increasing present or future consumption of material wealth While the desireof the rich may well be limited by the human capacity to enjoy wealth socialscarcity may well bring about an unlimited drive to accumulate When wealth isonly aimed at the acquisition of positional goods more wealth means a tempo-rary advantage for somebody and a corresponding disadvantage for others thatcan be cancelled only by accumulating an even greater amount of wealth Theresult is an ldquoover-accumulationrdquo of physical capital that is in sharp contrast withthe ldquounder-accumulationrdquo that characterizes agrarian societies A similar argu-ment holds for the accumulation of human capital While the necessity ofkeeping the fixed ranks of agrarian societies limits the access of education totheir own elites in capitalist societies the access to education is not only open toeverybody but it is one of the means by which one can gain access to sociallyscarce positions As it was observed by Hirsch (1976) an over-accumulation ofeducation may take place because only the relative level of education matters forthe access to a given social position Thus whereas agrarian societies are

34 U Pagano

characterized by the under-accumulation of human and physical capital moderncapitalist societies often tend to over-accumulate both forms of capital

While this way of reasoning may be too schematic to provide a satisfactoryaccount of asymmetric patterns of economic development it shows that the rela-tions between positional goods and other economic variables can easily pusheconomic systems towards different directions More insights in these effectscan be gained by considering money probably the purest case of positionalgood

The positional nature of money and of other reputationalgoods

In real-life market economies the goods that have a reputation for higher mar-ketability command a higher value In a world characterized by positive transac-tion costs commodities have different degrees of liquidity and individuals areready to pay more for those commodities that have money-like attributes Com-modities are ranked according to their reputation for liquidity and governmentscan guarantee this differential reputation also for commodities that have other-wise no use value6

In a globalized world where commodities move across national bordersdifferential reputation for liquidity has dramatic self-reinforcing effects If theliquidity reputation of a commodity is high it is used as intermediary in agreater number of transactions and in this way it further increases its liquidityreputation Currency represents the prototypical case of this liquidity that isbased on differential reputation and is rewarded with more extensive use Whileall currencies do service as media of exchange in their home transactions only ahandful of currencies the reserve and some hard currencies are most widelyused for international transactions The winners in this fierce competition of dif-ferential reputational advantage enjoy the fruits of the cumulative causationbetween reputation and diffusion for a rather long time7 The extreme case ofthis positional competition among currencies occurs when currency is used as anasset as opposed to its transactional service alone In a globalized environmentwhere (financial) capital sloshes across national borders and where exchangerates are free the currency at the top of the positional ladder is bound to bechosen broadly around the world for asset holding purposes by the elites and thewealthy who wish to buy insurance against devaluation of their liquid assetsheld in the local currency And since exchange rates are flexible superimposingthe asset demand for the reserve currency on top of the transactions demand forservicing the current account is bound to strain the reserves of the local centralbank and lead to devaluation of the local currency This process of substitutingthe foreign reserve (hard) currency for the domestic in holding liquid assets con-stitutes in turn a self-fulfilling prophecy Whether the dollars that were pur-chased to buy insurance against devaluation are kept under the mattress or theybecame part of the capital flight that seeks refuge in a more reputationallyadvantaged environment the ensuing devaluation has rewarded the perpetrators

of the devaluation Yotopoulos in this volume signals this type of incompletemarket because of asymmetric (currency) reputation as a deleterious case ofldquobadrdquo competition for providing the wrong incentives of undermining the localcurrency Currency substitution for the soft currency brings about its devaluationand the expectation of future devaluations fuels even further currency substitu-tion in a cumulative circular causation process

In the case of currencies positional competition is highly wasteful The cur-rencies that challenge the winner have to follow rather restrictive policies thatcompensate the greater liquidity of the dominant currencies with the hardness oftheir own currency Even this costly strategy is not available to the weaker cur-rencies They suffer indirectly from the positional struggle happening at the topand are trapped in a vicious circle of currency substitution and devaluationWhile the country of the winning currency is able to obtain for free (against thepaper employed in the production of their currency) real goods and servicespoor countries have to supply these goods without getting much in exchange asa result of their devalued currencies

While currencies are perhaps the most extreme case of a reputational goodthe decentralization to developing countries of the production of famousWestern trademarks can be partially seen in a similar way8 Also in this case areputational positional good (the trademark) is exchanged for standard economicgoods

In general the traditional international trade model must be modified to con-sider the fact that many goods of the First World far from competing in tradi-tional competitive markets trade instead in non-contestable (restricted) marketsThey acquire characteristics of monopolistic uniqueness They become decom-modified in the sense that an exclusive right of production is assigned to certainproducers while othersrsquo economic liberties are severely limited by traditionaleconomic means such as monopoly power and investments in reputationMarkets also become restricted and non-contestable by the fact that only someagents in the world hold the legal rights to produce certain goods In this situ-ation international trade takes place among countries holding very asymmetriclegal positions Some countries specialize in decommodified goods protected byinternational legal trademarks while other countries specialize in the standardcommodities for which there is a very strong competition in world markets

The international protection of the trademarks is one aspect of the globaldimensions of intellectual property rights that give rise to these asymmetriesWe are going to consider other dimensions of asymmetries in the followingsections

Legal relations and positional competition

Building on the work of Hohfeld (1919) Commons (1924) proposed a table thathighlights the positional nature of legal relations (Table 22)9

In this simple two-individual world the set of actions for which x has rightsdo not only define the duties of y They define also the remaining actions for

36 U Pagano

which y has the liberty to act (ie the set of actions for which x has no right tointerfere and is exposed to the liberties of y) In other words in this simpleframework the legal relations entail that the boundary between the rights andthe exposures of x should coincide with the boundary between the duties and theliberties of y and vice versa

For instance ships that are in danger enjoy some legal right to be helped byother ships This right is necessarily correlated with the duty of other ships notto leave when another ship is in danger This duty does also necessarily entailthat other ships do not have the liberty to leave and that the ship which is indanger is not exposed to the liberty of other ships of refusing help

In these legal relations there is a social scarcity that is typical of positionalgoods The rights of some agents can only be enlarged by restricting the libertiesof other agents and lsquovice versarsquo the liberties of other agents can only be enlargedby exposing other individuals to these liberties that is by limiting their rights tointerfere with their actions even when they dislike them

The positional nature of legal relations implies that rights and liberties can beoversupplied This is likely to happen if politicians and other agents do not takeinto account the correlated duties and exposure to liberties that must be jointlyconsumed with them Individuals often have conflicting interests about rightsand liberties A disequilibrium may easily arise because the individuals mayhold different expectations about their reciprocal legal positions This disequilib-rium is an ex ante phenomenon regarding contrasting a priori claims of the indi-viduals Ex post the legal relations that we have considered become identitiesone ship x will consume its right to be helped only if the other ship y has ful-filled its duties and x has not been exposed to yrsquos liberty to leave x in troubleHowever ex ante the agents may have different beliefs about their respectiverights and liberties It may well happen that x believes that he has the right to behelped while y believes that she has the liberty to leave

Wasteful positional competition may well occur when the individuals try toenlarge their own sphere of rights and liberties This conflict is an inevitableaspect of most societies and in many cases it has even favored the advance-ment of civilization However legal institutions have also greatly favoredhuman development by helping to find shared solutions to these contradictionsand by aligning many ex ante expectations about the future interactions of theindividuals According to Hart (1961) law making is a system of second orderlegal relations (Table 23) that involves the power to change and possibly toalign the relations that we have just considered in Table 22 As Commons(1924) himself Hayek (1973) and Fuller (1969) also stressed this change doesnot involve only the public ordering but also the private sphere Even in the

Table 22 First order legal relations

Right of x Duty of y

Exposure of x Liberty of y

private sphere the employers exercise some power and align the expectations ofthe rights and the duties that the employees have within their firms (Coase1937)

Moreover the second order legal relations entail a symmetric ex post correla-tion between the positions of two (or more) agents In this case if the ex anteexpectations of the agents are ex post satisfied the boundary between the powersand the disabilities of x should coincide with the boundary between the liabilitiesand the immunities of y (and vice versa)

For instance if public officials have the power to stop me smoking thisimplies that I am liable to their orders and I have no immunity against themwhich implies that the officials have no disability to give me that order Secondorder relations can be used to align first order legal positions If y has no libertyto smoke this implies that x is not exposed to his liberty Her right to have y notsmoking can be aligned to the corresponding duty of y by resorting to the powerof public officials to enforce xrsquos rights This power implies that y is liable to theauthority of the public officials and has no immunity against their actions Whenpublic officials succeed in the alignment of xrsquos and yrsquos legal positions we havethe following Table 24 that describes a situation of ldquolegal equilibriumrdquo

In a legal equilibrium the broken line separating the rights and the exposuresof x coincides with the power and the disabilities that are granted to public offi-cials (po) to enforce her rights It also coincides with the broken line separatingthe duties and the liberties of y which in turn coincides with the broken line thatdefines the boundary between the liabilities and the immunities that y hastowards public officials

However the broken lines of Table 24 do not need to be necessarily alignedIn reality a situation of ldquolegal disequilibriumrdquo such as that considered in Table25 may well arise (Pagano 2006) In Table 25 the broken line defining theboundary between the rights and exposures of x does not coincide with thatdefining the boundary between the duties and the liberties of y In this case thepowers of and the liabilities towards public officials fail to correlate the legal

38 U Pagano

Table 24 Legal equilibrium

Power of x harr Right of x harr Duty of y harr Liability of yvia po via po

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

Disability of x harr Exposure of x harr Liberty of y harr Immunity of yvia po via po

Table 23 Second order legal relations

Power of x Liability of y

Disability of x Immunity of y

entitlements of the two agents Ex ante also the expectations between powersand liabilities can well be divergent and all legal relations can be in disequilib-rium By contrast a well working legal system equilibrating the powers and lia-bilities that agents acquire through public officials tends also to equilibrate theirrights and duties or in other words tends to achieve the legal equilibrium con-sidered in Table 24

Because of the positional nature of legal relations legal disequilibrium tendsto be an important real-life phenomenon From Hobbes onwards political theoryhas stressed the waste that is due to positional competition when individuals tryto enlarge their rights and powers and limit other individualsrsquo liberties andimmunities and vice versa Unlike standard economic competition positionalcompetition has no self-equilibrating mechanism and complicated legal institu-tions are required to limit the tendency of each individual to expand its rightsand powers at the expense of the liberties and the rights of the others

While the Hobbesian tradition has emphasized the vices of unfettered posi-tional competition the Smithian tradition has emphasized the virtues ofcompetition for the supply of private goods If legal relations are properlydefined positional competition can be replaced by competition to supply usefulprivate goods If individuals care about their absolute (not relative) wealth andtheir legal positions cannot be altered then they can only increase their ownwelfare by producing goods that are useful for others In the same vein the neo-classical Pareto optimality claims of competition can be interpreted as statingthe virtues that can be achieved by market equilibria for private goods if the dis-equilibrium generated by positional competition can be eliminated by the legalsystem However the standard requirement that private property rights are welldefined implies itself a complicated set of legal equilibria The property right is acomplex bundle of claim-rights liberties powers and immunities10 The exist-ence of this bundle of rights involves the establishment of a complicated legalequilibrium The right of exclusive use of assets by some individuals has to becorrelated to the duties of others not to consume these resources and the libertythat the owners have to choose among different uses of the resources is to becorrelated to the exposure of others to this liberty Moreover the power that theprivate owner has to transfer her title has to be aligned to the liability thatthe other agents have towards these transfers of property and the immunity ofthe owner against having his title altered or transferred by the act of another is to

Table 25 Legal disequilibrium

Power of x Right of x Duty of y Liability of yvia po via po

- - - - - - - - - - - - - - - - - - - - - -Disability of x - - - - - - - - - - - Liberty of y - - - - - - - - - - -

via poExposure of x Immunity of y

via po

be aligned to the disability of others to perform these acts The economistsrsquo termldquowell-defined property rightsrdquo conceals a complicated setting of institutions thatare able to equilibrate conflicting legal positions and to overcome wastefulpositional competition11

As Romano (Chapter 10) has pointed out the fact that legal positions have noself-equilibrating tendency implies that countries may widely diverge accordingto the nature of their institutions When in some developing countries the equili-brating institutions are lacking economic competition can easily degenerate intowasteful positional competition Competition can have asymmetric effects ondevelopment in different frameworks

Global legal positions and intellectual property rights

Legal positions can involve rights duties and liberties that relate to interactionswith our neighbors They may regard private property rights on well-definedphysical objects In this case the enforcement can be done ldquolocallyrdquo by verify-ing that others do not interfere with the rights defined over that particular objectThe nature of the property of a computer a car or a house is such that legal rela-tions can be defined at local level As long as an individual does not interferewith the local space occupied by the objects owned by other people the respectof the property rights of others does not limit her liberties On the other hand aslong as the objects are not visibly taken away or changed by others an owner cansafely assume that his ownership rights are respected The related legal positionshave a local domain geographically limited by the position in space that at acertain moment in time is occupied by the material object over which the rightsare defined The material character of the good and its defined location imply apossible overcrowding by potential consumers and are a source of rivalry in con-sumption When an individual uses the good others cannot consume it at thesame level and in many cases they are likely to consume zero fractions of thegood This circumstance brings such goods very close to the case of the pureprivate goods considered in the second section of this chapter In this case aslong as individual i keeps under control the good x in a given physical locationhe can be sure that the other individuals are not consuming it and are not violat-ing its (irsquos) private property Both the definition and enforcement of privateproperty are specified at local level and they are unlikely to have any relevantimplications for the other countries

Legal positions can also have a global nature They may involve restrictionsfor many individuals at various country locations and potentially for all the indi-viduals in the world Intellectual property rights (IPR) such as they are currentlydefined by the Trade Related Aspects of Intellectual Property Rights (TRIPS)agreements and enforced by the WTO have this nature Their ownership bysome individuals involves restrictions for all other individuals To use the termi-nology introduced in the second section of this chapter the global application ofIPR has created pan-positional goods in the sense that the exclusive rights of anindividual or a firm involve for all the individuals duties that are independent of

40 U Pagano

their physical location in the world The ownership of a house a car or a fieldinvolves some duties for the surrounding individuals who should not interferewith the property rights of the owner and are only for this reason limited in theexercise of their liberty By contrast the ownership of a piece of intellectualproperty implies that all the individuals in the world have a duty not to interferewith that legal position They have to comply with the rights that it creates bylimiting their actions in their daily life in multiple ways irrespective of thecountry in which they operate If some individuals happen to produce (or in a rel-evant case they have already produced) the same knowledge on which the right isgranted their liberty to use the results of their efforts is limited by the monopolyon knowledge that has been already granted to the right holder12 The rightndashdutyrelation acquires a pan-positional character and the right to exclusive use involvesthe limitation of liberty of many individuals in many countries

The strengthening and the extension of IPR have been compared to the enclo-sure of lands that preceded the industrial revolution13 Also in this casecommons were turned into exclusive private property There is however a fun-damental difference In the case of land the object of privatization was a localcommon that involved the legal positions of few individuals By contrast theprivatization of intellectual property changes the legal positions of many indi-viduals and has major implications for the international standings of the variouscountries

Here we have a public-positional-good paradox Because of its non-rivalnature unlike land knowledge can be used by many individuals withoutdecreasing its value However the public-good nature of knowledge makes itsprivatization much more limiting for the liberty of other individuals Privatiza-tion turns the ownership of a piece of public knowledge into a pan-positionalright that involves duties for all the other individuals and has little to do with thetraditional rights of exclusive consumption of the owners of material objectsThe non-rival symmetric nature of the consumption of knowledge becomesparadoxically the cause of a sharp asymmetric division The domain of therights of some individuals is greatly extended while the range of the liberties ofother individuals is dramatically restricted To use Jeffersonrsquos vivid imageknowledge is like the flame of a candle that can light many other candleswithout decreasing its own flame14 The exclusive ownership of the flame canonly mean that others are deprived of the liberty to light their own flames Therival nature of land implies that its private ownership restricts the liberty of non-owners only in the few cases in which it interferes with the (necessarily local)private uses of a piece of land The private appropriation of knowledge cannotimply that the liberty of the non-owners should be only limited when it inter-feres with the consumption of the owners because of the public nature of know-ledge this never happens The nature of ownership is here necessarily muchmore restrictive it means that non-owners have no liberty to ldquolight their taperrdquoand use their own flame without the permission of the owner This is morerestrictive than simply non-decreasing the ldquoflamerdquo of the owner as the analogywith land would imply

The limitation of the costless liberty to use knowledge is inefficient It is awell-known piece of economic theory that the non-rival nature of a good shouldnot be the cause of an excessive restriction of liberty but rather a reason to grantto all the individuals the liberty to light their own flames There is however alsoa well-known argument that can support this restriction if the person that hasborne the cost of lighting the first candle is not compensated for this effortperhaps the overall flame of knowledge would be weaker An appropriate incen-tive for the inventor requires that she becomes the owner of the knowledge thatshe has discovered and that the liberty of access of others is restricted Howeverthis restriction is always costly after the first discovery many other candlescould have been lighted in some cases also independently without decreasingthe flame of the first candle

The cost of depriving other candles of the flame increases when the know-ledge is ldquobasicrdquo in the sense that it comes upstream in the production of otherknowledge or it is ldquocomplementaryrdquo to other pieces of knowledge For thisreason it is undesirable to impose private property restrictions to fartherupstream or basic knowledge Since early times public institutions like universi-ties have provided alternative systems of compensating the producers of open-access science Publications based on peer reviews and careers and prizes thatare based on these publications are the most typical types of incentives offeredby universities to promote effort and universal disclosure of knowledge Unsur-prisingly a great deal of the funding of these institutions has traditionally comefrom public sources

Where should one draw the line between more upstream knowledge producedand freely transmitted by universities and the more downstream knowledge thatcan be privately owned by its discoverers There is no precise answer to thisquestion but wherever the line lies it will change when we move from a closedeconomy ruled by one single state to an open economy with many independentstates

A world government (or in similar way a state isolated from the worldeconomy) could try to draw the line between the production of ldquoopen accessknowledgerdquo (funded by tax revenue) and the production of ldquoclosed access know-ledgerdquo (that is left to the profit motive of private firms) in such a way as to maxi-mize the benefits accruing to its citizens

However the real economy is different No national state can be isolatedfrom the world economy and no world government exists In this frameworkeach national state will realize that its citizens get only a fraction of the benefitsof the investments in public knowledge while some of them (and all throughnational taxation) can gain the full benefit of the investments in privately-ownedknowledge because the benefits from the latter are not shared with the citizens ofthe other countries Thus in an integrated world economy characterized byinternationally enforced IPR national states have an incentive to increase thenumber of ldquoclosed access sciencerdquo research projects over which private propertyrights are defined and to move upstream the line that separates them from theldquoopen access sciencerdquo research projects Institutions producing and diffusing

42 U Pagano

public knowledge are increasingly seen as a ldquowaste of moneyrdquo and there is awidespread tendency to decrease their funding For the same reason the sameinstitutions (universities in the first place) are also under severe pressure tobetray their nature of institutions mainly dedicated to the production and dif-fusion of public open-access knowledge and are pushed towards the productionof private intellectual property

Basic knowledge should be a global common However the presence ofTRIPS and the absence of global cooperation have created an environment withglobal intellectual private property rights and with local national funding forpublic research As a result we face an inefficient over-development of privateknowledge and a corresponding under-development of public knowledge whichnecessarily leads to an asymmetric development of the poor as compared to therich areas of the world The increasing privatization of knowledge which isdone by the most advanced countries turns public goods shared by allhumankind into private goods characterized by a pan-positional legal right thatlimits the liberties of all other individuals in the world In this way equal andunrestricted global liberties to enjoy the benefits of public goods are replacedby global duties constraining the development of local systems of knowledgeand creating sharp asymmetries in the paths of development of the differentcountries

As the New Property Rights approach has shown (Hart 1995) private prop-erty of the means of production has important incentive effects A frictionlessmarket for the means of production should imply that this property goes to themost capable individuals However the market is far from being frictionless andindividuals are usually wealth constrained For this reason causation may wellwork in a self-reinforcing manner also in the opposite direction the owners ofthe means of production have a greater incentive to develop their capabilitiesand for this reason tend to become the best owners This incentive effect ofownership is much stronger for intellectual property because the right to excludeinvolves a restriction of the liberty of all the other individuals to replicate similarmeans of production (Pagano and Rossi 2004)

In the case of a machine an individual who has learnt to work and possiblyto innovate with skills that are partially specific to the machine is only partiallydamaged if he is deprived of its use He keeps the liberty to work with othermachines or to build identical machines The damage is more relevant in thecase of an individual who has acquired skills that are specific to a piece of intel-lectual property and he is denied the access to this piece The nature of intellec-tual property implies that he does not keep the liberty to work with or toldquorediscoverrdquo a similar piece of knowledge The legal position concerning anIPR is a global one and involves a pan-positional right to limit the access of allindividuals to the use of all the similar pieces of knowledge including those thatare independently developed Turning a public good like knowledge into aprivate good transforms a universal unlimited liberty into an asymmetric legalposition limiting non-ownersrsquo freedom well beyond the restrictions that stemfrom the property rights defined on traditional rival goods

In the current era of globalization and within the framework of internationaleconomic policy private intellectual property rights have had a major role increating the systematic conditions for asymmetric global development thatfavors the developed countries at the expense of the poor Advanced countriesmonopolize the frontier of knowledge Far from sustaining the effort for the pro-vision of a public good that allows the catch-up of other countries they enjoy aself-reinforcing process of development The monopolistic ownership of intel-lectual property encourages the investment in the skills necessary to improvethese pieces of knowledge and the skills that are developed make it even moreconvenient to acquire and produce private knowledge By contrast other coun-tries may be trapped in an asymmetric vicious circle of (under-)developmentwhere the lack of intellectual property discourages the acquisition of skills andthe lack of skills discourages the acquisition of intellectual property

While the countries at the frontier of knowledge advocate free trade policiesthey themselves are specializing in goods whose ownership almost by definitioninvolves an internationally enforced barrier to the entry for other firms Coun-tries specializing in IPR enjoy a legal protection barrier that works well beyondnational boundaries and extends to include the whole world15 For this reasonthey can easily advocate the simultaneous enforcement of open markets and IPRwhich is the implicit constitution of WTO This means free trade for the com-modities exported by developing countries and closed markets protected byIPR at world level for the ldquodecommodifiedrdquo goods produced by the ldquoFirstWorldrdquo countries (Yotopoulos Chapter 1) The global legal positions associatedto private intellectual property create and reinforce the conditions for an increas-ing asymmetry in the process of development

Conclusion

The optimistic view of the process of economic development is usuallygrounded on economic reasoning focusing on the distinction between public andprivate goods Global public goods like knowledge imply opportunities forsymmetric development and for a distribution of costs favoring the lessdeveloped countries Moreover since Ricardo economic theories have emphas-ized the mutual advantages of trade involving private goods

Taking exception to the optimistic outcomes of conventional theories of tradeand development by referring to the standard economic space of public andprivate goods is familiar in the literature In this chapter I have extended theanalysis of the approach to free trade as a trigger of growth and development byincluding positional goods that constitute a large and rapidly increasing share oftrade under globalization Free trade in conventional commodities as practicedin the nineteenth century version of globalization is very different from thecurrent profile of trade that involves a significant and fast increasing componentof decommodified goods and services that in many cases enjoy the protection ofinternational property rights

In the distinction between these two patterns of trade we identify a tendency

44 U Pagano

of free trade to induce further development of modern capitalist societies whileit perpetuates underdevelopment in the rest of the world The existence of repu-tational goods can explain these types of unequal exchanges and in particularthose occurring between countries that have hard currencies with high inter-national reputation and the rest of the countries that have soft currencies that areused mostly for within-the-country transactions Moreover positional competi-tion due to incompletely structured legal relations can be one of the causes ofthe asymmetric effects that competition can have within different countries

Finally the global privatization of knowledge involves a dramatic shift awayfrom public goods that allows an equal liberty of use in all countries to a systemof pan-positional rights that restricts the liberty of use all over the world andcreates a strong asymmetry between countries specializing in decommodified(often IPR-protected) production and the developing world that relies largely onthe trade of standardized commodities

1 I am very grateful to Sam Bowles Pan Yotopoulos Donato Romano and Matteo Riz-zolli for their very useful comments

2 On different concepts of power see Bowles et al (1999) Bowles and Gintis (1999)and Pagano (1999)

3 This definition is given in Pagano (1999) A different definition based on rank isgiven by Frank (1985) Frankrsquos definition is focused on the definition of status and isnot also related to the definition of the exercise of power

4 For a more detailed analysis see Pagano (1999)5 This section draws on Gellner contributions (1983 1998 1999) For an account of

Gellnerrsquos work see Pagano (2003)6 The importance of the relative status that commodities have in terms of liquidity dis-

appears in abstract theoretical constructions such as the Arrow-Debreu model whereall goods are equally liquid and can be used as means of exchange The absence of aspecific good with the role of money does not imply that the Arrow-Debreu model isa barter economy In barter economies no commodity is liquid and exchange requiresa double coincidence of wants By contrast the Arrow-Debreu model applies in aldquosuper-monetary economyrdquo where all goods are perfectly liquid and have got thestatus of money In order to get closer to reality the real issue is not the ldquointroductionof moneyrdquo into general equilibrium but it is rather the elimination of the too manymoney-like commodities existing in this theoretical construction

7 This point as well as much of this section draws from the work of Yotopoulos(1996) Yotopoulos (Chapter 1) and Sawada and Yotopoulos (Chapter 3)

8 Also on this point see Yotopoulos (Chapter 1)9 For a modern analytical defense of Hohfeld see Kramer (2001)

10 For instance a landowner typically enjoys the claim-right that others do not trespasshis land boundaries the liberty to walk on his land the powers to transfer title toothers and the act of immunity against having his title altered or transferred by theact of another (Simmonds 1986)

11 Nicita et al (2006a) show how while there has been much literature on incompletecontracts many rich consequences stem from incomplete property

12 An account of cases in which traditional knowledge is stolen by multinationals isgiven by Shiva (2001)

13 For instance see Shiva (2001 44ndash8)

14 ldquoHe who receives an idea from me receives instruction himself without lesseningmine as he who lights his taper at mine receives light without darkening merdquoThomas Jefferson letter to Isaac McPherson ldquoNo Patents on Ideasrdquo 13 August 1813Sometimes paraphrased as ldquoKnowledge is like a candle Even as it lights a newcandle the strength of the original flame is not diminishedrdquo

15 On the relation between IPR and anti-trust law in an incomplete property rightsframework see Nicita et al (2006b)

References

Bowles Samuel and Herbert Gintis (1999) ldquoPower in Competitive Exchangerdquo InSamuel Bowles Maurizio Franzini and Ugo Pagano eds The Politics and the Eco-nomics of Power London Routledge pp 13ndash31

Bowles Samuel Maurizio Franzini and Ugo Pagano (1999) ldquoIntroduction Trespassingthe Boundaries of Politics and Economicsrdquo In Samuel Bowles Maurizio Franzini andUgo Pagano eds The Politics and the Economics of Power London Routledgepp 1ndash11

Coase Ronald H (1937) ldquoThe Nature of the Firmrdquo Economica 4 (16) 386ndash405Commons John R (1924) Legal Foundations of Capitalism Clifton Augustus M

Kelley PublishersFrank Robert H (1985) ldquoThe Demand for Unobservable and Other Non-positional

Goodsrdquo American Economic Review 75 (1) 101ndash16Fuller Lon L (1969) The Morality of Law New Haven and London Yale University

PressGellner Ernest (1983) Nations and Nationalism Oxford BlackwellGellner Ernest (1998) Nationalism London PhoenixGellner Ernest (1999) ldquoThe Coming of Nationalism and Its Interpretation The Myths of

Nation and Classrdquo In Samuel Bowles Maurizio Franzini and Ugo Pagano eds ThePolitics and the Economics of Power London Routledge pp 179ndash224

Hart Herbert LA (1961) The Concept of Law Oxford ClarendonHart Oliver D (1995) Firms Contracts and Financial Structure Oxford ClarendonHayek Friedrich (1973) Law Legislation and Liberty Chicago University of Chicago

PressHirsch Fred (1976) Social Limits to Growth Cambridge MA Harvard University PressHohfeld Wesley N (1919) Fundamental Legal Conceptions New Haven and London

Yale University PressKramer Matthew H (2001) ldquoGetting Rights Rightrdquo In Matthew H Kramer ed Rights

Wrongs and Responsibilities Basingstoke and New York Palgrave pp 28ndash95Nicita Antonio Matteo Rizzolli and Maria Alessandra Rossi (2006a) ldquoTowards a

Theory of Incomplete Property Rightsrdquo University of Siena MimeoNicita Antonio Matteo Rizzolli and Maria Alessandra Rossi (2006b) ldquoIP Law and

Antitrust Law Complementarity When Property Rights Are Incompleterdquo University ofSiena Italy Mimeo

Pagano Ugo (1999) ldquoIs Power an Economic Good Notes on Social Scarcity and theEconomics of Positional Goodsrdquo In Samuel Bowles Maurizio Franzini and UgoPagano eds The Politics and the Economics of Power London Routledge pp 63ndash84

Pagano Ugo (2003) ldquoNationalism Development and Integration The Political Economyof Ernest Gellnerrdquo Cambridge Journal of Economics 27 (5) 623ndash46

Pagano Ugo (2006) ldquoLegal Positions and Institutional Complementaritiesrdquo In Fabrizio

46 U Pagano

Cafaggi Antonio Nicita and Ugo Pagano eds Legal Orderings and Economic Institu-tions London and New York Routledge pp 54ndash83

Pagano Ugo and Maria Alessandra Rossi (2004) ldquoIncomplete Contracts IntellectualProperty and Institutional Complementaritiesrdquo European Journal of Law and Eco-nomics 18 (1) 55ndash76

Shiva Vandana (2001) Protect or Plunder Understanding Intellectual Property RightsLondon and New York Zed Books

Simmonds Nigel E (1986) Central Issues in Jurisprudence Justice Law and RightsLondon Sweet amp Maxwell

Veblen Thorstein (1899 1953) The Theory of the Leisure Class New York VikingPress

3 Growth and poverty reductionunder globalizationThe systematic impact of currencysubstitution and exchange ratemisalignment1

Yasuyuki Sawada and Pan A Yotopoulos

Introduction

The Millennium Declaration of the United Nations signed by 189 countriesincluding 147 heads of state on 8 September 2000 led to the MillenniumDevelopment Goals (MDGs) The MDGs formalize the international commun-ityrsquos unprecedented agreement on the development goals by 2015 with explicitnumerical targets for reducing poverty in the world The first goal of MDGs is toeradicate extreme poverty and hunger with the interim explicit target ofdecreasing by 2015 the extent of poverty by one half defined as halving the pro-portion of people whose income is less than one dollar a day as compared to thesame proportion in 1990 With the 1990 baseline for the head count ratio being2794 percent of the total the targeted ratio of a-dollar-a-day for MDGs corres-ponds to 1397 percent of the worldrsquos population (cf World Bank 2004)

The focus of this chapter is on the feasibility of achieving this target and onthe appropriate policy instruments for doing so While direct poverty reductionprograms may be effective their costs could become prohibitive if they weretargeted at the communities that are the poorest and therefore the less easilyaccessible (Besley and Burgess 2003) In skirting this dilemma a good part ofthe literature advocates a higher rate of economic growth as an alternative and amore effective approach toward a comprehensive poverty reduction programThe empirical literature that supports this view rests on a strong and statisticallysignificant relationship between macroeconomic growth and poverty reduction(Ravallion 2001 Dollar and Kraay 2002 Besley and Burgess 2003)

Globalization defined as the cross-national integration and interdependenceof the worldrsquos markets of goods labor and finance as well as businesses andcultures is generally considered an important driving force for enhancing eco-nomic growth (World Bank 2002) This causality by implication makes eco-nomic growth an effective instrument for reducing poverty in developingcountries (Dollar and Kraay 2002)

The existing literature identifies different channels that lead from globaliza-tion to economic growth First there is a direct positive relationship between thetrade openness of a country and its economic growth (Harrison 1996 Dollar

and Kraay 2004) Second foreign direct investment (FDI) has been found to bean important venue for transferring technology therefore FDI can contributerelatively more to growth than domestic investment This positive nexusbetween FDI and growth works especially well when the host economy isendowed with sufficient absorptive capacity for assimilating advanced technolo-gies (Borenzstein et al 1998) Finally not only direct investments across coun-tries but also indirect capital flows might affect growth positively

These virtuous synergies between globalization and growth are subject to thecaveats of misalignment of exchange rates Harrison (1996) and World Bank(1991) found that a black market premium in foreign exchange rates is nega-tively associated with growth This observation leads to the implication thatchronic misalignment in the exchange rate has been a major source of slowgrowth in Africa and Latin America through deterring smooth flows of capitalwhile prudent macroeconomic trade and exchange rate policies have fosteredgrowth in Asia (Dollar 1992 Edwards 1988 Ghura and Grennes 1993Rodrik 1994)

This chapter evaluates the role of economic growth under globalization inachieving the first target of the MDGs ie of decreasing by one-half the head-count of poverty in the world The second section of the chapter approacheseconomic growth as the one important instrument that can serve in achievingthe above target We extend the concept of ldquoexit timerdquo of Kanbur (1987) andMorduch (1998) to reach a quantitative assessment of the success or failure ofthe MDGs by comparing the requisite rate of growth for the target group to exitpoverty with the historical growth trajectory (of the years 1960ndash90) for eachcountry in question The inevitable result is that more robust growth is neces-sary for the success of the MDGs as compared to the historical record ofgrowth

The finding in the second section of the chapter that ldquogrowth as usualrdquo couldnot deliver the MDGs is challenging In the least it makes a compelling case forthe re-examination of the mechanics of growth The novelty in the third sectionof the chapter is that it addresses the mechanics of growth by extending the trun-cated treatment of the subject in the literature of exchange rate misalignmentThis is done by accounting for systematic deviations of nominal exchange ratesfrom their purchasing power parity levels and considering the possibility thatsuch deviations could cause systematic distortions in resource allocation leadingto growth debacles2 Moreover these same deviations could provoke severeinstabilities of the international macroeconomic system and especially so in theenvironment of ongoing globalization Despite the compelling reasons that mili-tate for chronic exchange rate misalignments having strongly negative effects ona countryrsquos rate of growth there is relatively little empirical evidence on thesubject with the only possible exception being the systematic cross-countryanalysis conducted by Yotopoulos (1996) In an attempt to fill in this gap in theliterature we employ the Yotopoulos and Sawada (2006) empirical formulationof chronic misalignment in nominal exchange rates in order to reassess indi-rectly the prospects of the target countries for achieving the requisite rates of

Exchange rate misalignment and growth 49

economic growth for meeting the first MDGs target given the extant realities oftheir exchange rate regimes

In an effort to identify more closely the specific source of exchange rate mis-alignment we formulate in the fourth section of the chapter the currency substi-tution hypothesis that is consistent with the severe exchange rate misalignmentand with the faltering of growth that we observe in many developing countriesduring the current era of globalization

The final section provides the conclusion on the MDGs and assesses thepolicy approaches that could increase growth by alleviating the severe negativeimpact that exchange rate misalignment was found to have on achieving therates of growth requisite to reach these targets

The role of economic growth in reducing poverty

In investigating the role of macroeconomic growth in reducing poverty thewell-known article by Dollar and Kraay (2002) showed that economic growth isa necessary condition to achieve poverty reduction Besley and Burgess (2003)and Ravallion (2001) estimated the poverty reduction elasticity with respect toincome by using cross-country data and a micro data set respectively Bothstudies found that the elasticity is significantly negative although the actual esti-mates diverged from 073 for Besley and Burgess (2003) to 250 for Raval-lion (2001)

Seeing that these approaches will not provide us with practically relevantparameter estimates for each of the target countries we employ alternatively theconcept of ldquoexit timerdquo of Kanbur (1987) and Morduch (1998) Using thisapproach we can estimate the growth rate that is required for each country toachieve the first target of MDGs and we compare the result with the countryrsquoshistorical trajectory of growth By doing so we will be able to analyze howcountry-specific economic growth can deliver as the prime actor in effectivelyachieving poverty reduction

The exit time t is given by the time a person i with income yi below povertyline z will exit the poverty situation (Morduch 1998)

yi) (1)

where g is the growth rate of income of this person Kanbur (1987) introducedthe exit time of the ldquoaverage poorrdquo (superscript a) with mean income of thepoor P

Let P() be the poverty measure as per Foster et al (1984) where P(0) and P(1)are the poverty headcount ratio and the poverty gap measure respectively

50 Y Sawada and PA Yotopoulos

Ravallion et al (1991) showed that P(1)[1(Pz)]P(0) Then equation (2)can be rewritten as

tia (3)

Similarly with the median income of the poor m Morduch (1998) showed thatthe time to halve the number of the poor can be computed by

By using equation (3) we can compute the required income growth rate for theaverage poor in 1990 to exit poverty by year 2015

ga exp 1 (5)

Tables 31 and 32 show the required economic growth rates as computed fromequation (5) using the Global Poverty Monitoring database of the World BankNote that the required growth rate for the median poor in 1990 to exit poverty by2015 based on equation (4) can be interpreted as the required growth rate for thefirst target of MDGs Yet using the fact that Pm in the lower tail of a uni-modal income distribution function it is straightforward to show that thisrequired growth rate based on the concept of the average exit time can be inter-preted as the upper bound of the required growth rate to achieve the first targetof MDGs (Sawada 2004)

Our results in Table 31 suggest that about one-half of the countries whoseper capita income is above US$2000 can achieve the first target of MDGs bymaintaining their historical levels of economic growth rate (1960ndash90) Thesame successful-by-one-half record is maintained in Table 32 for the countriesthat had per capita income in year 1990 between US$1000 and US$2000 Inthe same table the second and poorest cohort of countries with per capitaincome below US$1000 is a complete failure no country in this group will beable to reach the first target of MDGs by replicating its past growth recordThese findings highlight the importance of accelerating economic growthparticularly for the poorest economies as a necessary condition of effectivepoverty reduction

Table 33 again utilizes the exit time concept to compute the required growthrate by region using the Global Poverty Monitoring data set (World Bank2004) The results are comparable with the figures computed by Besley andBurgess (2003) also shown in Table 33

In general the exit time-based estimates give lower required annual percapita growth rates than the BesleyndashBurgess estimates except for the EasternEurope and Central Asia regions Moreover according to the same table growth

ln(P(0)) ln(P(0)P(1))

ln[P(0)] ln[P(0)P(1)]

ln(1ga)

Table 31 Required annual income growth rate (1990ndash2015) for exit from poverty by2015 of an average poor person in 1990 (country per capita income in 1990 US$2000)

Per capita (A) Average

Country income inannual per (B) Required If (B) (A) = 1

1990capita growth growth rate otherwise= 0 rate 1960ndash90

Algeria 260488 0012 0016 1Belarus 436779 0022 0005 0Botswana 473968 0071 0019 0Brazil 535313 0027 0014 0Chile 481004 0017 0009 0Colombia 471473 0021 0012 0Costa Rica 530226 0014 0020 1Dominican Republic 324768 0022 0009 0Egypt Arab Rep 241604 0032 0006 0El Salvador 296962 0002 0029 1Estonia 821316 0010 0014 1Guatemala 284720 0012 0029 1Honduras 206222 0009 0025 1Jamaica 329435 0008 0011 1Jordan 321861 0097 0010 0Kazakhstan 470079 0012 0002 1Kyrgyz Republic 201047 0033 0026 0Lithuania 913465 0051 0009 0Mexico 619749 0021 0017 0Moldova 308915 0014 0008 1Morocco 278090 0020 0008 0Namibia 429265 0014 0021 1Panama 370873 0018 0025 1Paraguay 387128 0023 0010 0Peru 320310 0001 0012 1Philippines 321093 0014 0010 0Poland 608360 ndash 0017 0Romania 541285 0017 0022 1Russian Federation 859373 0036 0012 0South Africa 826622 0012 0007 0Thailand 369777 0047 0010 0Trinidad and Tobago 581069 0025 0013 0Tunisia 375541 0029 0012 0Turkey 433263 0021 0011 0Turkmenistan 537000 0002 0013 1Ukraine 704631 0004 0014 1Uruguay 955752 0007 0023 1Uzbekistan ndash 0015 0006 0Venezuela RB 481202 0003 0010 1Zimbabwe 224926 0013 0015 1

performance that tracks a countryrsquos past trajectory will reach unambiguously thefirst MDGs target only in the group of Asia-Pacific and conceivably also in theMiddle East and North Africa group Therefore Table 33 also reinforces ourconclusion of the need for more robust economic growth as compared to thetargeted countriesrsquo growth records (1960ndash90) and especially so for the poorestcountries in the sample

Table 32 Required annual income growth rate (1990ndash2015) for exit from poverty by2015 of an average poor person in 1990 (country per capita income in1990$2000)

Country income in annual per (B) Required If (B) gt (A) = 1

1990capita growth growth rate otherwise = 0rate 1960ndash90

US$1000 Per capita income in 1990 US$2000

Bolivia 174000 0000 0009 1Central African Republic 103158 0007 0037 1China 133166 0037 0014 0Cote drsquoIvoire 149713 0009 0008 0Ecuador 144587 0021 0019 0Gambia 150209 0008 0023 1Ghana 133606 0008 0010 1India 139711 0018 0014 0Indonesia 187525 0037 0008 0Lesotho 105513 0031 0024 0Mauritania 116882 0013 0023 1Mongolia 160672 0023 0010 0Nicaragua 172124 0011 0022 1Pakistan 138035 0029 0013 0Senegal 115482 0005 0023 1Sri Lanka 195603 0024 0007 0

Per capita income in 1990 US$1000

Bangladesh 097012 0008 0011 1Burkina Faso 063116 0009 0022 1Ethiopia 047969 0016 0012 1Kenya 094059 0018 0019 1Madagascar 078378 0011 0021 1Mali 056113 0001 0020 1Nepal 084696 0007 0012 1Niger 073283 0018 0028 1Sierra Leone 083544 0008 0051 1Tanzania 043687 0014 0028 1Uganda 075047 0007 0018 1Zambia 080557 0010 0031 1

0ndash20

adarsquo

rsquos r

960ndash

Chronic exchange rate misalignments and economic growth

The previous section lays heavy responsibility for achieving the first target ofMDGs on the acceleration of growth in developing countries A timely accelera-tion of growth becomes especially critical for the countries at the low end of thedistribution those with GDP per capita less than US$1000 What are thechances that adequate growth records can be achieved to reach the MDGsGiven the strong results in the literature linking development failures toexchange rate misalignment such as Dollar (1992) Edwards (1988) Ghura andGrennes (1993) Rodrik (1994) and Yotopoulos (1996) this section delves intothe subtleties of the relationship between exchange rate misalignment andgrowth The innovation in this chapter is the adoption of a new conceptualframework for measuring exchange rate misalignment and identifying its originWhy is this necessary

Misalignment is normally defined as the systematic deviation of the nominalexchange rate (NER) from purchasing power parity (PPP) or in a looserformulation its deviation from the real exchange rate (RER) The relationshipbetween the nominal and the real exchange rate has always been a challenge toeconomists The attempt to untie this Gordian Knot dates to the writings ofCassel (1921) and Keynes (1923) who were interpreting the experience of thefirst globalization (roughly between 1870 and 1914) Only in the recent years ofthe second globalization have economists adopted an over-simplified conven-tional framework and have considered the Knot non-existent (Yotopoulos 1996Ch 5)

The standard short cut on which the measurement of exchange rate misalign-ment is based involves the comparison of a countryrsquos i real price level (RPL) attime t with that of the numeraire country US in some form of the equation (6)

RPL(it)e(

t) (6)

where e and P represent a countryrsquos nominal exchange rate and overall pricelevel respectively3 For a number of reasons this formulation is unsatisfactorythe most important being that in cross-country comparisons where exchangerates are involved any aggregate index that intends to capture relative pricelevels while totally disregarding the distinction between tradables and non-tradables is misleading and deficient As an example a change in the exchangerate whether appreciation or devaluation will have more (or less) profoundeffects in the economy and in the allocative function of prices depending on thestructure of the economy the level of income the size of the tradable and thenon-tradable sector and so on Even worse since a ldquosuccessful devaluationrdquoimplies an increase in the price of tradables and a corresponding decrease in therelative price of non-tradables (in units of the home currency) in the best of allworlds not much would be registered in equation (6) that reflects a change in theprice index or the PPP

ldquoCountry specificityrdquo that is totally absent from the above equation can beintroduced by decomposing the price index into its two components PT and PNdenoting prices of tradables and non-tradables respectively (Yotopoulos 1996Ch 6) As an alternative and for economy of data and computation nominalexchange rate misalignment can be captured readily with the following decom-position (Yotopoulos and Sawada 2006)

t)u(t)(i)w(it) (7)

In equation (7) PT is the price of tradables and the price ratio PT (it)PT (USt)represents the purchasing power parity in prices of tradables Note that the mis-alignment of NER from PPP has been decomposed into a common aggregatetime-specific component u(t) a country-specific time-invariant fixed component(ie country fixed effects) (i) and another time-variant random componentw(it) The time-specific term u(t) can be interpreted broadly as representing thetime trend of exchange rate parity fluctuations of the US dollar4 The variable(i) represents the degree of the country-specific chronic misalignment of thenominal exchange rate NER which can be attributed to systematic factors suchas country-specific structural characteristics of an economy chronic marketimperfections transaction costs andor government (dis)intervention in theforeign exchange market in country i In other words (i) is a long-term (iechronic) deviation of NER from PPP

The variable (i) is intended to capture the effect of any systematic character-istics of (developing) countries that bear on exchange rate misalignment and arenot specifically accounted for in equation (6) The Ricardo principle also knownas the Samuelson-Balassa equation states that the relative prices of tradables tonon-tradables decrease in the process of development (Ricardo 1817 Balassa1964 Samuelson 1964) This systematic relationship whether it originates inproductivity differentials (as per Ricardo) or in factor proportions (as perSamuelson or Balassa) constitutes a structural characteristic of an open economyin the process of development The systematic component of the relationship isalmost axiomatic Whether as a result of labor being cheap in low-income coun-tries (the productivity approach) or labor being plentiful in relation to capital(the factor proportions approach) the prices of non-tradables relative to trad-ables tend to be cheap in developing countries and increase as developmentoccurs By the same process not only the internal terms of trade (the realexchange rate) improve but the law of one price dictates that the prices of trad-ables tend to converge across countries The result of these two effects should bethat misalignments defined as deviations of the real exchange rate (formed inthe price domain of tradables and non-tradables) from the nominal exchange rate(formed in the domain of tradables alone) are likely to be smaller in thedeveloped countries and greater in the developing ones

The discussion of the Ricardo principle above has an important corollary forthe measurement of exchange rate misalignments Controlling for the nominal

exchange rate the extent of exchange rate misalignment in a specific case isdetermined by the structural characteristics of a country at a certain stage ofdevelopment As a result misalignment cannot be properly assessed unless therelative prices of both the tradables and the non-tradables are accounted for inthe method of measurement Looking at it in another way this means that theimpact of a change in the nominal exchange rate on the relative prices of trad-ables and non-tradables is muffled in developed countries where these prices aremore closely aligned in developing countries on the other hand the attendantreallocation of resources as a result of the same change in the exchange rate canbe sizeable ndash and what is worse it can become a potent factor driving the sys-tematic misallocation of resources

We implement the Yotopoulos and Sawada (2006) procedure in specifyingequation (7) for measuring the chronic NER deviation (i) We use the familiarcross-country data set of Heston et al (2002) for 153 countries covering a spanof 20 years from 1980 to 2000 We then estimate a standard cross-countygrowth regression by adding the measure of chronic NER deviation as anadditional variable

In the estimated growth regression in Table 34 the dependent variable is theaverage annual growth rate of real GDP per capita between 1980 and 2000 Thevariable that measures the chronic exchange rate misalignment comes fromthe implementation of equation (7) as above We use the dummy variable fortrade openness developed by Sachs and Warner (1995) and we create an open-nessexchange-rate-misalignment interaction variable We hypothesize that thenegative impact of exchange rate misalignment on growth is more severe whena country is more open on the external account and thus becomes susceptible tochanges in the global economy Accordingly the key variable we are interestedin is the interaction term of the chronic exchange rate misalignment and open-ness The rest of the independent variables in the table are traditional in growthregressions The data of real GDP per capita are extracted from Heston et al(2002) Following Burnside and Dollar (2000) we consider the policy qualityindex as formed by a linear combination of the budget surplus the inflation rateand the trade openness We add the government share of per capita GDP asanother variable The dummy variables for African Latin American and high-performing East Asian Countries are included in order to mitigate an omittedvariable bias from unobserved heterogeneity

Table 34 presents the estimated results using OLS with Whitersquos heteroskedas-ticity-consistent standard errors The estimates confirm the results already famil-iar in the literature The per capita income and the exchange rate misalignmentmeasure have a negative (but non-significant) impact on growth the coefficientfor the policy quality index is positive and significant the country dummies forregional groupings have all (highly) significant coefficients negative for Africaand South America and positive for the high-performing East Asian countriesThese results are canonical and unassailable the coefficients have the expectedsigns and are consistent with previously estimated cross-country growth regres-sions such as the studies listed in Durlauf and Quah (1999)

The one novel and surprising result is the misalignmentndashopenness interactionvariable that has consistently negative and highly significant coefficients Theinevitable implication is that the more open the economy the more pernicious isthe effect of the chronic exchange rate misalignment and the more punishing is itsimpact on growth In other words the closed economy can achieve more growththe degree of exchange rate misalignment notwithstanding The theoretical conun-drum is how to explain this negative interaction of openness and misalignment

The Sachs-Warner dummy variable for openness rests largely on absence ofgovernment control on major tradable goods and absence of high (greater than 40percent on the average) tariffs on machinery and materials The remaining compo-nent of the openness dummy variable is a black market premium of foreignexchange that is less than 20 percent while any higher premium makes the

Table 34 Growth and exchange rate misalignments

(1) (2) (3) (4)

Per capita real GDP 0450 0420 0249 0294 (in US$1000000) (152) (130) (078) (092)

Measure of chronic 0001 00019 0002 0002 exchange rate (065) (071) (079) (083)misalignments

Measure of chronic 0015 0013 0013 exchange rate (512) (438) (429)

misalignments 13openness

Policy index (in 1000) 0028 0026 (191) (163)

Government share of 00001 per capita real GDP (054)

Africa 0030 0031 0026 0025 (565) (553) (438) (429)

Latin America 0017 0019 0016 0016 (361) (389) (316) (313)

East Asia 0017 0018 0019 0019 (361) (306) (259) (252)

Constant 0027 0026 0025 0027 (586) (485) (447) (411)

No observations 86 73 63 63

R-squared 0415 0531 0513 0517

NotesThe dependent variable is annual growth rate (years 1980ndash2000) of real per capita GDP We presentt-statistics in parentheses where Whitersquos heteroskedasticity-consistent standard errors are employedSignificant at the 10-percent level Significant at the 5 percent level Significant at the 1 percentlevel

economy closed in the Sachs-Warner definition A low black market premiumindicates a high degree of globalization and therefore good integration with theglobal economy The misalignment of the NER on the other hand can also be theoutcome of a systematic devaluation due to the softness of the currency Althoughthe two may be causally related they are not so in our model since they are notboth endogenously determined So the puzzle remains how could a low degree ofopenness interact with misalignment to deliver a positive impact on growth

Could currency substitution account for the punishing effectsof misalignment in an open developing economy

The discussion in the previous section was hypothesis driven With the introduc-tion of the distinction between tradables and non-tradables in equation (7) wecontrol for the impact of openness (ldquoglobalizationrdquo) in increasing trade in goodsand services of a developing country with its trading partners At the currentstate of the empirical evidence there is a dearth of hard data on currency substi-tution to make its research hypothesis driven5 We therefore engage in hypothe-sis-generating research in the balance of this chapter to discuss the likely impactof currency substitution on exchange rate misalignment to the extent that mis-alignment can also be exogenous in the sense that it does not originate in theusual shift in demand and supply of foreign exchange for transactions purposesthat are registered in the current account

In the current environment of globalization the concepts of free markets andfree trade are extended to apply also to free markets for foreign exchange and tofree financial capital flows (portfolio capital) thus allowing for foreign curren-cies to be bought and held as assets not only by central banks but also and to alarge extent by individuals and especially so in developing countries Unlessthis currency substitution is otherwise sterilized it results in higher exchangerates than would have been obtained from the current account transactionsHowever sterilization through increasing foreign demand for the domestic cur-rency of developing countries is not forthcoming since not all currencies werecreated equal While any currency or other fiat money can be used as a consen-sual medium of exchange the currency held as an asset trades as a positionalgood based on reputation6 In the ordinal reputational ranking of currencies fromthe ldquobestrdquo to the ldquoworstrdquo that becomes applicable when currencies are held asassets the reserve currency ranks at the top The dollar therefore systematicallysubstitutes in agentsrsquo portfolios for a wide swath of less-preferred currencies Infree currency markets this asymmetric reputation of currencies induces asym-metric demand for holding currencies as assets Therefore while residents ofdeveloping countries include in their portfolios the reservehard currency forasset-holding purposes residents of hard-currency countries have not a matchinginterest in holding soft currencies those of developing countries In the openeconomy model of the modern era of globalization the devaluation of thenominal exchange rate in developing countries is more often than not the resultof currency substitution as opposed to the transactions demand for foreign

exchange for servicing the current account (Yotopoulos 1996 50ndash1 andChapter 1)

Ordinarily devaluations are considered benevolent and especially so fordeveloping countries since they strengthen the current account and serve to cureallocative inefficiencies The question arises why is the exogenous devaluationof a soft currency as a result of currency substitution different and has insteaddeleterious effects for developing countries leading to a gross misallocationof resources Yotopoulos (1996) formulates the answer in terms of a time-inconsistency proposition that can trigger currency substitution and parlay it to asizeable resource misallocation

Consider an equilibrium situation in which a bundle of resources producestradables T or nontradables N measured such that one unit of each isworth $1 Entrepreneurs should be indifferent between producing one unitof T or one of N But since the soft currency is more likely to be devalued itbecomes risky for the entrepreneur to produce (or hold) one unit of N thatcould not be converted for later spending into $1 Expressed in another wayentrepreneurs are attracted to producing T because that is the only way theycan acquire $1 they wish to hold for asset purposes With the relative pro-ductivities of the bundle of resources (measured at ldquonormalrdquo prices) remain-ing unchanged N becomes undervalued and (the allocation of) resourcesbecomes biased towards T This is manifest in a relative price of N that istoo low compared with productivities (in other words) too high an RER

This dilemma does not exist for the D(eveloped) C(country) producer Inhard currency $1 of T will always be worth $1 of N as opposed to the softcurrency where the expectation of devaluation becomes a self-fulfillingprophecy Controlling for the other determinants of devaluation in develop-ing countries the process alone of converting soft currency into hard forasset-holding purposes tends to make the market-clearing NER too highThis is manifest in the relative price of tradables that is too high comparedwith productivities ndash again too high an RER

By allowing for the possibility that currency substitution is exogenous asdefined above we proceed to investigate its possible outcomes on LDCs interms of exchange rate misalignment

In a globalized world the free market in currency exchanges offers theopportunity of conversion of domestic into foreign currency In the case ofdeveloped countries the ldquoreputationrdquo of their reservehard currency makes thisconversion of their local currency immaterial and unnecessary the hardness oftheir currencies allows the producer of non-tradables to exchange his proceedsof domestic currency into tradables or for that matter into hard assets (ldquodollarsrdquo)for future use with a credible commitment for the stability of relative prices(in terms of the domestic currency) In developing countries on the other handthe experience with soft currencies is that they do not simply fluctuate they

depreciate systematically In an attempt to foreclose future devaluation of theirsoft-currency assets agents substitute the hardreserve currency for thedomestic thus tending to make the devaluation of the soft currency a self-fulfilling prophecy The current globalization environment with free inter-national movements of financial capital becomes the ideal breeding ground forsystematic currency-substitution-induced devaluations and for fostering financialcrises in soft-currency (ie developing) countries (Yotopoulos 1996)7

This formulation of the hypothesis of currency substitution can be viewed asan extension of the canonical case of market incompleteness for asymmetricinformation (Stiglitz and Weiss 1981) but for the fact that in the case of foreignexchange it is asymmetric reputation in the positional scale of currencies thatanoints only a small and select group of them for also doing service as assetsThe canonical policy that becomes applicable in cases of market incompletenessis regulation most often in the form of rationing We venture some thoughts onthis issue in the concluding section

Revisiting the cross-country results reported in Table 34 to account for cur-rency substitution we distinguish two components of the negative and highlysignificant coefficient of the exchange rate misalignment variable regressed onthe openness of the economy The formulation of equation (7) takes care of thecomponent of misalignment that emanates from the Ricardo principle (Yotopou-los and Sawada 2006) It reduces to a characteristic of the economic structure ofdeveloping countries and it is reflected in a relatively high value for the RERControlling for that the interaction of the misalignment variable with opennesscaptures the effect of any other likely source of deviation that is not captured inthe equation in this case the degree of opennesscloseness in the economy in theform of a smalllarge black market premium of the foreign exchange rate Thenegative and significant coefficient of the interaction variable in the growthregression is precisely what the currency substitution hypothesis would predicthigh openness of the economy with low transaction costs for currency substitu-tion represents an opportunity for investors (speculators) to profit by buying acheap insurance policy against the devaluation of the domestic currency This inturn becomes an enabling factor for devaluation and when devaluation comes itrewards the flight away from the domestic currency In this environment of ldquobadcompetitionrdquo with adverse incentives currency substitution often leads to furtherdevaluations and at times to endemic crises in a process of cumulative causation(Yotopoulos 1996 Yotopoulos and Sawada 1999 Sawada and Yotopoulos2005) Currency substitution thus becomes a potent factor in increasing the mis-alignment of the exchange rate for developing countries ndash the deviation betweenthe NER and its PPP value the RER

Whether the target countries of the MDGs were in the cross-country samplefor the growth equation or not (some of course were) transference of the find-ings of Table 34 to the poorest countries in the MDGs makes the emphaticlesson from the findings of section three of this chapter ever more ominous TheRicardo principle was applied earlier as an axiomatic mechanism that accountsfor systematic deviations of the NER from its PPP value with the deviations

varying inversely with the level of income in a developing economy The poorerthe economy the greater is the misalignment of its exchange rate and the loweris its feasible rate of growth A parallel relationship holds between currencysubstitution-induced devaluation of the nominal exchange rate and poverty In aglobalization environment the allure of and the opportunities for currency substi-tution (by the elites who have the liquid assets to insure against devaluation) areso much greater the poorer the country is This taste for currency substitution isintermediated by higher exchange rate misalignment leading to a lower growthpotential

If the negative coefficient of the relationship between openness and growthreceives the attention it deserves the best place for the poorest countries to startin enhancing their growth potential is by imposing a modicum of controls on thefree convertibility of their currency A mild form of such restrictions that hasbeen time tested in various countries makes foreign exchange available at thefree market rate for transactions in the current account while holding of foreignmonetary assets by individuals is prohibited or otherwise penalized8 Thiswould also have ancillary implications in limiting the free flows of portfoliocapital into developing countries

Conclusions

There is broad agreement in the literature that the objective of the MillenniumDevelopment Goals of graduating by year 2015 one-half of the worldrsquos denizenswho live in abject poverty can best be served by economic growth Our tests inthe first part of the chapter indicate that the set goal can only be met by one-halfof the target population (or one-quarter of the poor) unless there is a vigorousacceleration of the historical rate of growth in a large number of countries espe-cially in those among the poorest in the list Thus our search is refocused in thesecond part of the chapter on the lessons from growth analysis with cross-country data in an attempt to identify any neglected factors that might bepromising for contributing to higher growth rates

Exchange rate misalignment has featured in the literature as an importantfactor with negative implications on growth although its correct measurementhas been elusive Taking a short cut to the more appropriate specification ofexchange rate misalignment as the deviation of the nominal exchange rate fromits PPP levels we conduct an endogenous growth analysis that leads to asurprising result the significantly negative impact of exchange rate misalign-ment on growth originates in the openness of the economy We interpreted thisfinding as pointing to an incomplete market in foreign exchange in the develop-ing countries of the sample The market incompleteness arises because of theasymmetric reputation of currencies when they serve for asset-holding purposesand it induces developing country citizens to engage in currency substitution forthe purpose of holding hard-currency-denominated assets

The results of this study may grate on conventional wisdom The challenge tothe unconventional results may arise either with the definition and measurement

of the variable of exchange rate misalignment or in doubts about the replicabilityof the results in another sample The former issue has been adequately addressedin section three On the latter issue the evidence presented ten years ago withone set of data (Yotopoulos 1996) is in effect replicated in the current analysiswith more recent data the differences in the empirical formulation of thehypothesis notwithstanding In the original study Yotopoulos makes three pointsanalytically first productivity differences between developed and developingcountries are smaller for non-traded goods than for traded goods (the Ricardoprinciple) second free market forces (in the form of currency substitution)produce nominal exchange rates in developing countries that undervalue thedomestic currency thus leading to high RER (real exchange rates ie PT PNTfor prices of tradables and non-tradables respectively) and third the combina-tion of the axiomatic productivity differentials with the nominal exchange rateundervaluation leads to a severe misallocation of resources that takes a toll oneconomic growth in developing countries These propositions were subjected toanalysis in a growth model (that included a country-specific RER variable) in acombination of cross-sectional and longitudinal data (years 1970 1975 1980and 1985) for 62 developed and developing countries The data that entered theRER consisted of prices and expenditures for all tradable and non-tradablegoods and services derived from the International Comparisons Project (Kraviset al 1982 and earlier years) and they were combined with statistics on direc-tion of trade in order to determine the country-specific extent of tradability ofeach good As such the econometric tests engaged the RER as a measure of theexchange rate misalignment variable based on primary data

In the present study the proper definition of exchange rate misalignmentremains the same as in Yotopoulos (1996) but the model formulation its empir-ical implementation and the data are different and so is the measurement of themisalignment variable Equation 7 in section three of the current study employsa proxy of the misalignment variable that relies on secondary data The resultshowever of the two approaches are identical on the negative impact of misalign-ment on growth despite the different formulation of the variable in the twocases The coincidence of the two independent studies strengthens our conclu-sion that interventions in the capital account which are designed to curb thedesire of developing-country citizens to hold hard-currency-denominated assetsby prohibiting or limiting such holdings are likely to provide a boost to growthThe simple extension of the standard theory of incomplete markets to apply alsoto asymmetric reputation of currencies used for asset-holding purposes leadsdirectly to the policy recommendation of a dual exchange rate system for LDCsa free market for foreign exchange in the current account while currency substi-tution in the form of purchasing and holding foreign currency assets is prohib-ited or else it is discouraged with a black market exchange rate premium

We recognize that for mainstream economists who view exchange rate con-trols as one of the policies that lead to economic stagnation this conclusion ishard to swallow We take no exception to the position that the main advantageof a flexible exchange rate regime is that it allows for monetary independence

(McKinnon 1982 Darrat et al 1996) But this is no longer true in the presenceof currency substitution that makes devaluation as an instrument of adjustmentlose its bite Moreover restrictions in purchasing and holding hard-currencyassets have had a long and effective service record as instruments of monetarypolicy They were rightly abolished in some countries because they were nolonger needed in the rest they were also rightly abolished because they wereonerous But if one takes the findings of this study seriously such controls havebecome once again necessary for a specific set of developing countries

As a final caveat it should be mentioned that ldquogood governancerdquo which iscaptured by the ldquopolicy indexrdquo in Table 34 is a necessary factor for benigninterventions to work well The importance of the appropriate institutional infra-structure including good governance for restoring symmetry in the outcomes ofglobalization has already been emphasized fittingly in other chapters in thisvolume

1 We would like to thank Nick Hope Odin Knudsen Jeffrey Nugent and DonatoRomano for useful comments on an earlier version of this chapter

2 As for instance exemplified in Yotopoulos and Sawada (1999)3 Note that this relative price level is the inverse of a simple version of the real exchange

rate4 Note however that country-specific effects for the numeraire country the USA are not

captured5 Cf Sawada and Yotopoulos (2005) for an attempt at a hypothesis-driven research on

the subject6 The parallel literature on ldquopositional goodsrdquo identifies the social ldquopecking orderrdquo as ldquoa

shared system of social statusrdquo where for example it becomes possible for an indi-vidual (a good) to have a positive amount of prestige (reputation) such as a feeling ofsuperiority or a ldquotrendyrdquo appeal only because the other individuals (goods) have asymmetrical feeling of inferiority ie have less or negative reputation (Hirsch 1976Frank and Cook 1976 Pagano 1999) In extending this literature and viewing foreignexchange as a ldquopositional goodrdquo we postulate that in a free currency market the simplefact that reservehard currencies exist implies that there are soft currencies which areshunned for some (asset-holding) purposes Cf also Pagano (Chapter 2) and Yotopou-los (Chapter 1)

7 Yotopoulos (1996 141ndash5) proceeds to test for the hypothesis of the transmission ofthe effects of exchange rate misalignment from the monetary to the real sector of theeconomy

8 Such a policy was in effect in the UK until 1979 Until early 2006 the Chinese yuanwas convertible on the current account only partial and controlled convertibility on thecapital account came later

References

Balassa Bela (1964) ldquoPurchasing Power Parity Doctrine A Reappraisalrdquo Journal ofPolitical Economy 72 (6) 584ndash96

Besley Timothy and Robin Burgess (2003) ldquoHalving Global Povertyrdquo Journal of Eco-nomic Perspectives 17 (3) 3ndash22

Borenzstein Eduardo Josegrave de Gregorio and Jong-Wha Lee (1998) ldquoHow Does Foreign

Direct Investment Affect Economic Growthrdquo Journal of International Economics 45(1) 115ndash35

Burnside Craig and David Dollar (2000) ldquoAid Policies and Growthrdquo American Eco-nomic Review 90 (4) 847ndash68

Cassel Gustav (1921) The Worldrsquos Monetary Problems New York EP Dutton andCo

Darrat Ali F Ahmed Al-Mutawa and Omar M Benkato (1996) ldquoOn Currency Substitu-tion and Money Demand Instabilityrdquo International Review of Economics and Finance5 (3) 321ndash34

Dollar David (1992) ldquoOutward-oriented Developing Economies Really Do Grow MoreRapidly Evidence from 95 LDCs 1976ndash1985rdquo Economic Development and CulturalChange 40 (3) 523ndash44

Dollar David and Aart Kraay (2002) ldquoGrowth is Good for the Poorrdquo Journal of Eco-nomic Growth 7 (3) 195ndash225

Dollar David and Aart Kraay (2004) ldquoTrade Growth and Povertyrdquo Economic Journal114 (493) F22ndashF49

Durlauf Steven N and Danny T Quah (1999) ldquoThe New Empirics of EconomicGrowthrdquo In John B Taylor and Michael Woodford eds Handbook of Macro-economics Amsterdam North-Holland pp 235ndash308

Edwards Sebastian (1988) Exchange Rate Misalignment in Developing Countries Balti-more MD Johns Hopkins University Press

Foster James Joel Greer and Erik Thorbecke (1984) ldquoA Class of Decomposable PovertyMeasuresrdquo Econometrica 52 (3) 761ndash6

Frank Robert H and Philip J Cook (1976) The Winner-Take-All Society Why the Fewat the Top Get So Much More Than the Rest of Us New York Penguin

Ghura Dhaneshwar and Thomas J Grennes (1993) ldquoThe Real Exchange Rate andMacroeconomic Performance in Sub-Saharan Africardquo Journal of Development Eco-nomics 42 (1) 155ndash74

Harrison Ann (1996) ldquoOpenness and Growth A Time-series Cross-country Analysisfor Developing Countriesrdquo Journal of Development Economics 48 (2) 419ndash47

Heston Alan Robert Summers and Bettina Aten (2002) ldquoPenn World Table Version61rdquo Philadelphia Center for International Comparisons at the University of Pennsyl-vania (CICUP)

Hirsch Fred (1976) Social Limits to Growth Cambridge MA Harvard University PressKanbur Ravi (1987) ldquoMeasurement and Alleviation of Povertyrdquo IMF Staff Papers 34

(1) 60ndash85Keynes John M (1923) A Tract for Monetary Reform New York MacmillanKravis Irving B Alan Heston and Robert Summers (1982) World Product and Income

International Comparisons of Real Gross Product Baltimore MD Johns HopkinsUniversity Press

McKinnon Ronald (1982) ldquoThe Order of Economic Liberalization Lessons from Chileand Argentinardquo Carnegie Rochester Conference Series in Public Policy 17 24ndash45

Morduch Jonathan (1998) ldquoPoverty Economic Growth and Average Exit Timerdquo Eco-nomics Letters 59 (3) 385ndash90

Ravallion Martin (2001) ldquoGrowth Inequality and Poverty Looking Beyond AveragesrdquoWorld Development 29 (11) 1815ndash2001

Ravallion Martin Gaurav Datt and Dominique van de Walle (1991) ldquoQuantifyingAbsolute Poverty in the Developing Worldrdquo Review of Income and Wealth 37 (4)345ndash61

Rodrik Dani (1994) ldquoKing Kong Meets Godzilla The World Bank and the East AsianMiraclerdquo In Robert Wade ed Miracle or Design Lessons from the East AsianExperience Washington DC Overseas Development Council pp 13ndash53

Sachs Jeffrey and Andrew Warner (1995) ldquoEconomic Reform and the Process of GlobalIntegrationrdquo Brookings Papers on Economic Activity 1 1ndash118

Samuelson Paul A (1964) ldquoTheoretical Notes on Trade Problemsrdquo Review of Eco-nomics and Statistics 46 (May) 145ndash54

Sawada Yasuyuki (2004) ldquoMDGs and the Exit Timerdquo Faculty of Economics Universityof Tokyo Mimeo

Sawada Yasuyuki and Pan A Yotopoulos (2005) ldquoCorner Solutions Crises and CapitalControls Theory and Empirical Analysis on the Optimal Exchange Rate Regime inEmerging Economiesrdquo Stanford Institute for Economic Policy Research Paper no04ndash037 (September 2005) Online available at sieprstanfordeduPaperspdf04ndash37html (accessed 13 September 2005)

Stiglitz Joseph E and Andrew Weiss (1981) ldquoCredit Rationing in Markets with Imper-fect Informationrdquo American Economic Review 71 (3) 393ndash419

World Bank (1991) World Development Report Washington DC World BankWorld Bank (2002) Globalization Growth and Poverty Building an Inclusive World

Economy New York Oxford University PressWorld Bank (2004) ldquoGlobal Poverty Monitoringrdquo Washington DC World Bank

Online available at wwwworldbankorgresearchpovmonitorindexhtm (accessed 5July 2004)

Yotopoulos Pan A and Yasuyuki Sawada (2006) ldquoExchange Rate Misalignment ANew Test of Long-run PPP Based on Cross-country Datardquo Applied Financial Eco-nomics 16 (1) 127ndash34

4 With whom to tradeAn examination of the effects of intra-national and between-country incomeinequality on bilateral trade1

Rania S Miniesy and Jeffrey B Nugent

Introduction

In this increasingly globalized world income inequalities ndash both between andwithin countries ndash deserve center stage in any analysis of the asymmetries ofglobalization While recent academic research has investigated many effects ofincome inequality it has not looked at those on trade At the same time whilemuch attention has been devoted to the conditions under which trade can giverise to polarization and inequality the reversed relationship from inequality totrade has been largely neglected

This chapter tries to fill this gap by taking up the theme suggested byYotopoulos (Chapter 1) and Romano (Chapter 10) that the effects of trade arelikely to be most asymmetric when the commodities and services to be tradedare subject to reputational differentials That is with reputational effects and anuneven infrastructural and institutional playing field between them the tradepartner with the better reputation is likely to gain more from trade than the otherpartner Moreover these asymmetries are likely to be systematic rather thanrandom Indeed these authors have argued that the benefits will be more mutu-ally beneficial the more level the playing field between any pair of countries themore similar the income levels infrastructure and other institutions and whenboth partners enjoy good governance But when free trade is practiced betweencountries that have very unequal incomes infrastructure and governancestructures the results will tend to give rise to asymmetries

Since most trade is voluntary at least in the normal sense of the word ceterisparibus our point of departure is to suggest that this implies also that therewould be less trade among countries with different endowments of these typesthan among countries with more similar endowments Specifically this chapterhypothesizes that controlling for the various factors that have been shown toexplain bilateral trade patterns over time and space in standard gravity modelsinequality in income both between and within countries tends to reduce trade asdoes poor governance in any one partner It then goes on to an empirical test ofthe hypotheses based on an application of an extended version of the standardgravity model of bilateral trade to data on trade matrices and also numerousdeterminants of trade at the aggregate level for the years 1985 1990 1995 1997

and 2000 The results are used to answer the following question ldquoIf you want totrade in such a way as to avoid being on the short end of asymmetries in trade andto trade more thereby supporting economic development with whom shouldyou traderdquo

The chapter is organized as follows the first section derives the basichypotheses from the trade theories of Steffan Linder (1961) the second sectiondescribes the gravity model that is used for this purpose section three identifiesthe data used section four presents the empirical results and the fifth sectionconcludes with some tentative answers to the question of ldquowith whom to traderdquo

Review of the literature on income inequality and trade

In contrast to traditional comparative advantage theory which is primarily drivenby supply-side considerations much of modern trade theory is demand deter-mined Since reputational considerations on the demand side of items tradedinternationally have (and are likely to continue to) become more important overtime as has been argued quite persuasively in Yotopoulos (Chapter 1) reputa-tional effects on the demand-side considerations are bound to become even moreimportant in the future

But what does this imply as far as inequality within and between countries isconcerned There were hints of a negative effect of income inequality onimports and exports in the second of Keynesrsquo ldquopsychological lawsrdquo (Keynes1936) Since both the average and marginal propensities to consume and importcould be expected to fall with the level of income one could expect that a mean-preserving redistribution of income away from equality could reduce aggregateconsumption and thus imports in an open economy context Such expectationshave frequently been confirmed in empirical studies2

Another theoretical insight into inequality effects comes from theoriesemphasizing imperfections and incompleteness of markets for consumerdurables and capital goods In the absence of complete markets for creditgreater income inequality for any given average level of income would implythat more consumers would be credit constrained and hence unable to importbulky goods like capital goods and consumer durables For the poor in poorcountries these credit constraints may be such as to limit spending and importseven of basic consumer non-durables Once again this would suggest that coun-tries with weaker and less developed or even just different institutions wouldtrade less

The single most explicit analysis of income inequality effects on trade ndash andagain by way of demand ndash is that of Linder (1961) Linder argued that acountryrsquos exports of manufactures a type of export that has been occupying anever-increasing share of world exports are likely to be quite dependent on thatcountryrsquos own demand for such products Actual production and export arehypothesized to follow from prior demand Linder explained this by saying thatthere would be no production or export of a product unless an entrepreneurwould first have seen an investment opportunity An investment opportunity

68 RS Miniesy and JB Nugent

would be identified only when the entrepreneur realizes that production wouldsatisfy some discernible economic ldquoneedrdquo Such a need would be most dis-cernible when it appears in the domestic economy and when the production ofthe good is based on an invention Linder concedes that by contrast thoseldquoneedingrdquo the countryrsquos primary exports (especially oil minerals and tropicalagricultural products) are likely to be foreign explaining why entrepreneurs inthese kinds of production and export are likely to be foreign

The neoclassical factor proportions theory therefore may be fairly satisfac-tory for explaining primary exports but not manufactures (and similarly not forservice) exports Linder derived two important hypotheses First manufacturestrade is likely to be most intensive between countries that are at similar levels ofper capita income Second even for countries at the same levels of per capitaincome the demand patterns will be most concentrated on overlapping com-modities thereby making for sizeable reciprocal demands for manufacturesimports the lower is income inequality within each country Hence incomeinequality both across countries and within countries is likely to reduce trade

Linderrsquos theory has also been extended by various authors viewing everycommodity produced as going through a product life cycle As such like othermore recent theories it puts more emphasis on dynamic factors and changesover time Much of this work eg Helpman (1981) Helpman and Krugman(1985) and Grossman and Helpman (1991) has formalized the demand-sideeffects and focused on new products As such these authors model consumersrsquoutility as being more affected by the variety of goods they consume than by thequantities of a given number of goods In treating the extra complications ofproduct differentiation new products and imperfect competition however mostof the models ndash both static and dynamic ndash have assumed a representative con-sumer in each country and thus have abstracted from inequality considerationsThe exceptional studies that have in fact allowed for multiple consumers haveusually made the assumption that the income elasticities of demand are unitaryonce again eliminating the possibility of distributional effects arising fromchanges in inequality Hence income inequality effects on trade have been lostsight of in recent years

A stunning exception is the theoretical paper by Mitra and Trindade (2003)showing that for countries with similar aggregate resource endowments thetrade pattern can be determined strictly by demand patterns including the con-centration of demand on certain commodities that would be expected of coun-tries with low income inequality They also show that when intra-nationalincome inequality is combined with endowment differences across countries thewell-known tendency for trade between countries to be only a fraction of thatoccurring within countries (otherwise known as ldquothe missing trade problemrdquo)can be explained If the two countries or regional aggregates of countries arelarge like ldquoeastrdquo and ldquowestrdquo or ldquonorthrdquo and ldquosouthrdquo these factors may alsodetermine both relative factor prices and the international terms of trade3 Alsounder certain conditions a policy to redistribute income within one of theregions will also affect the distribution of income in the other region

Income inequality and international trade 69

The effects of cross-country differences in income have been picked up andanalyzed by Markusen (1986) and Thursby and Thursby (1987) Consistent withLinder they find that countries with similar levels of per capita income andtastes tend to trade more With respect to intra-national income distributionHunter and Markusen (1988) and Hunter (1991) have shown aggregate demandfunctions to be non-homothetic and that the non-homotheticity of these demandfunctions has the effect of reducing trade volumes by as much as 25 percentWhile non-homotheticity in demand functions is a necessary condition forincome distributional effects on international trade these studies did not explic-itly examine the effects on trade of either intra-national income inequality or itsinteraction with international income inequality

Gravity model and its specification and estimation

To examine the effect of both intra-national and between-country incomeinequality on bilateral trade flows we make use of what has become the work-horse of empirical studies of international trade namely the gravity model Thegravity model is especially attractive in this context because of its demonstratedapplicability to many different kinds of countries and regions its robustnessover time and to various different specifications4 According to this model tradeflows between any pair of countries should be affected by their mass (theproduct of their respective GDPs) as well as by the distance between them5 Thelatter is because transport and transaction costs can be assumed to rise with dis-tance Since factors such as exchange rate variability common languagecommon colonial or other historical experience common currency free tradeagreements and sharing a common border can affect these transaction or trans-portation costs all such variables can be included in the gravity model6

The model is specified as follows

Ln (Bilatijt) 0 1 Ln GDPijt 2 Ln GDPPCijt 3 Ln Distij 4 Ln Areasij 5 LLij 6 Borderij 7 Langij 8 Regionalijt 9 Nationij 10 Colonizerij 11 Colonialij 12 ERVijt 13 CUijt 1 Gov_dsijt 2 CPYijt 3 CPEijt 4 Gini2ijt 5 M2GDPijt 6 DiffGDPPCijt 7 OneFTAijt 8 Year Dummy Variables ijt

where subscripts i and j denote the countries trading with each other and tdenotes time The variables are grouped in two sets one with coefficients andthe other with coefficients The -coefficient group relates to the standardgravity model where geographical and historical locations play a major role The-coefficient group intends to capture institutional factors and more specifi-cally the income distribution and inequality characteristics of the trading part-ners that may affect the direction and the volume of trade

The variables of the -coefficient group are defined as follows Bilatijt is thenominal value of bilateral trade between i and j at time t GDP and GDPPC arethe nominal value of gross domestic product (GDP) and GDP per capita

respectively Distij is the great circle distance between i and j in miles Areas isthe sum of the areas of i and j in square kilometers (hence a proxy for distancewithin the country to the border) LLij is a dummy variable which is 0 if nocountries are landlocked 1 if one partner is landlocked and 2 if both are land-locked Borderij is a binary variable which is 1 if i and j share a border and 0otherwise Langij is a binary variable which is 1 if i and j share an official lan-guage and 0 otherwise Regionalijt is a binary variable which is 1 if i and jbelong to a regional trading agreement in year t Nationij is a binary variablewhich is 1 if i and j are part of the same nation Colonizerij is a binary variablewhich is 1 if i and j shared the same colonizer in or after 1945 Colonialij is abinary variable which is 1 if i colonized j or vice versa ERVijt is the volatility ofthe bilateral nominal exchange rate between i and j in period t CUijt is a binaryvariable which is 1 if i and j use the same currency at time t

The variables in the -coefficient group are defined as follows Gov_dsijt is thesum of the governance indices of i and j at t CPYijt is a dummy variable which is0 if neither partner was centrally planned at year t 1 if only one country was and2 if both countries were centrally planned in year t CPEij is a dummy variablewhich is 0 if no country was ever centrally planned 1 if only one country wasever centrally planned and 2 if both countries were ever centrally plannedGini2ijt is the sum of the Gini coefficients of the two countries M2GDP ijt is theproduct of the two countriesrsquo M2 ndash GDP ratios (where the money supply andGDP are proxies for financial deepening) DiffGDPPCijt is the difference in percapita income between i and j OneFTA is a dummy variable measure of tradediversion defined as 1 if only one of the countries is in a regional trading arrange-ment (and 0 otherwise) the Year Dummy Variables are for 1990 1995 1997 and2000 (1985 being the omitted variable) and ijt is the error term

As indicated by the form of the equation the model is log-linear in some butnot all of the continuous variables Some explanatory variables are categoricalones with only two or three scores A distinct novelty among the -coefficientvariables is the inclusion of the difference in per capita income (DiffGDPPC) tocapture the inter-country income inequality of Gini2 to capture the effect ofintra-national income inequality and of Gov_ds to capture institutional factorsFurthermore we will also add an interaction term (GiniDiffGDPPC) betweenthe two types of inequality intra-national inequality (Gini2) and inter-countryinequality (DiffGDPPC) The inclusion of this interaction term represents whatwe believe to be an important extension of the Linder model Although he didnot explicitly make this argument by his logic one should expect such an influ-ence to be positive This is because the greater the difference in the per capitaincomes of two trading partners and the lower are their domestic incomeinequality indexes the less overlap there would be in the demand patternsbetween the two countries But as intra-national inequality increases the degreeof overlap could be expected to increase thereby stimulating reciprocal demandand trade between the two partners

As a result there are three inequality effects on bilateral trade to be tested (1)that of cross-country income inequality (DiffGDPPC) (2) that of internal

income inequality (Gini2) and (3) that of the interaction between the two typesof inequality (GiniDiffGDPPC)

The data

The trade data for well over 100 countries for all years except 2000 were takenfrom Feenstra (2000)7 Missing data in this source in these years as well as 2000trade data were taken from the International Monetary Fundrsquos Direction of TradeStatistics (DOTS) CD-Rom (IMF 2003) For simplicity as well as because theIMFrsquos DOTS CD-Rom has only aggregate data we confine our attention toexplaining variations in aggregate values of bilateral trade across pairs of tradingpartners and over time Data on GDP GDPPC and M2GDP were taken from theWorld Bankrsquos 2003 World Development Indicatorsrsquo CD-Rom (World Bank2003) Some missing values for GDP and population were taken from UN(2003) Data on Areas LL Border Lang Nation Colonizer Dist and Colonialare taken from the US Central Intelligence Agencyrsquos website (CIA 2004) and ina few cases from Rose (2000) The variables Regional and OneFTA were con-structed on the basis of information about the commonly recognized trade agree-ments obtained from the World Trade Organizationrsquos website (WTO 2004)

Exchange rate volatility between countries i and j at time t (ERV) was calcu-lated in the way suggested by Rose (2000) as the standard deviation of the first-difference of the monthly natural logarithm of the bilateral nominal exchangerate (using the IMFrsquos International Financial Statistics (IFS) Line ae) in the fiveyears preceding the date of the bilateral trade observations For the CU variableinformation on the use of a common currency by the two trading partners istaken from Rose (2000) and corrections thereof in Glick and Rose (2002) CPYand CPE were constructed on the basis of knowledge about the use of centralplanning in the past In some cases that would involve membership in Councilfor Mutual Economic Assistance

For Gini2 a combination of two sources was used (1) Deininger and Squire(1997) and (2) WIDER (2000) The higher the value of Gini2 the greater isincome inequality

The governance indicator Gov_ds is a broad measure capturing (1) theprocess by which governments are selected monitored and replaced (2) thecapacity of the government to effectively formulate and implement soundpolicies and (3) the respect of citizens and the state of the institutions thatgovern economic and social interactions These three dimensions of governanceare operationalized on the basis of six different sub-indicators as suggested andconstructed by Kaufmann et al (2002)8 based on subjective indicators takenfrom the International Country Risk Guide9 The six different indicators werecombined into a single index via a principal components analysis Since thevarious indicators make use of somewhat different scales they were also stand-ardized into a similar scale Furthermore since all the resulting country-specificindexes were highly correlated with GDPPC a separate auxiliary regression ofthe standardized weighted governance variable of the individual countries was

run on GDPPC and then the deviation between the predicted governance and theactual governance variables was used to come up with an index for eachcountry Putting these together for trading partners the governance variable (adeviated standardized weighted sum) was finally reached10

Empirical results

The trade matrices have one potentially important pitfall there are numerousmissing values As noted above we have tried to fill in these missing observa-tions by making use of data from additional sources Nevertheless that by nomeans solves the problem since even after this there remain many cases for whichit is difficult to know whether the values are actually zero or missing Most ana-lysts have simply assumed that these cases represent missing values and henceestimate the gravity equations from the non-missing values by ordinary leastsquares (OLS) Alternatively one can assume that these values are zeros andestimate the equations by OLS or more appropriately by TOBIT recognizing thatthe observations are bounded from below (negative values are ldquocensoredrdquo) Else-where we have found the results to be quite sensitive to the choice of assumptionsand hence in this chapter we estimate the gravity models both ways

In Table 41 we present the results for the pooled data on bilateral trade forall countries and years (15756 observations) under the assumption that themissing observations are zeros For this reason we provide both OLS andTOBIT estimates Moreover we do so for two different specifications of themodel one without and one with the extra interaction term involving the twotypes of inequality that as noted above we feel is needed to complete the Lindermodel

Note that in both specifications of the model and by both estimation proce-dures many of the parameters of the standard gravity model in Table 41 havethe expected signs and are statistically significant In particular those for GDPLang Colonizer Regional and currency union (CU) are all positive and highlysignificant11 and those for Distance Areas LL and ERV are all negative andsignificant Of the non-standard variables that we have added to the gravitymodel OneFTA and CPY have significant negative effects on bilateral tradedemonstrating the presence of a trade diversion effect of regional tradingarrangements and the negative effect of central planning on bilateral trade Asexpected the effect of Gov_ds is positive and significant Slight surprises are thefact that the coefficients for per capita income (GDPPC) are not significant andthat colonial relationship has a negative effect

Of special relevance of course are the results for Gini2 DiffGDPPC and theinteraction term (GiniDiffGDPPC) that combines the two types of inequalityWhile from the results of the first specification without the interaction term eachof the inequality terms has negative coefficients the effects are rather small andin the case of the between-country inequality (DiffGDPPC) not statisticallysignificant Yet when the interaction term is included as in the second andfourth columns of the table the negative values of the coefficients of these

Table 41 Determinants of bilateral trade for the pooled data set including observationswith zero trade

Variables OLS TOBIT

Gini2 002 015 002 018

(001) (002) (001) (002)GinidiffGDPPC 002 002

(000) (000)DiffGDPPC 004 149 002 179

(005) (021) (006) (026)GDP 245 245 272 271

(004) (004) (005) (005)GDPPC 007 010 005 008

(005) (005) (006) (006)Distance 259 -265 282 289

(009) (009) (011) (011)Areas 090 091 106 107

(006) (006) (007) (007)LL 086 078 101 092

(012) (012) (013) (013)ERV 346 358 411 425

(084) (084) (084) (087)Border 027 014 013 002

(032) (033) (048) (048)Lang 218 219 248 249

(017) (017) (022) (022)Colonial 258 275 325 346

(118) (118) (169) (169)Colonizer 197 197 228 228

(024) (024) (027) (027)Regional 066 059 043 035

(036) (036) (067) (066)OneFTA 072 068 088 084

(012) (012) (015) (015)CU 500 520 560 584

(054) (060) (094) (094)M2GDP 000003 000003 000007 000007

(000003) (000003) (000004) (000004)Gov_ds 045 043 052 050

(004) (004) (005) (005)CPY 268 276 313 323

(085) (086) (078) (078)CPE 012 009 016 012

(014) (014) (016) (016)Constant 7014 5866 7850 6445

(163) (242) (187) (277)

No observations 15756 15756 2197a 13559b

R2 047 055Pseudo R2 008 008Log likelihood 50784 50761

NotesSignificant at p001 Significant at p005 Significant at p010a Left-censored cf p 73b Uncensored cf p 73

separate types of inequality become much larger and more significant Ashypothesized the coefficient of the interaction term is positive These resultsrather dramatically demonstrate the importance of our extension of the Lindermodel and also the significance of the two types of inequality in affecting thelevel of bilateral trade Separate analyses by year though not reported here alsoshowed the values of all parameters except the constant terms to be quite stableover time thereby justifying the inclusion of year dummies in the specificationused throughout this chapter

The European Unionrsquos (EU) ldquocohesionrdquo policies represent a much moreserious attempt to level the playing field for trade among its members throughredistributive transfers to its poorer members and in homogenizing governanceand other institutions Therefore in Table 42 we present the corresponding OLSand TOBIT estimates for the preferred specification (inclusive of the interactionterm) for the European Union (689 observations) and for all other countriesseparately

If these homogenizing actions of the EU have had any influence one mightexpect the estimated coefficients from the EU sample to differ from thoseobtained from the non-EU sample To that end notice that bilateral trade amongEU countries is much less negatively affected by the transaction cost variablesDistance Areas and LL and also by ERV OneFTA and DiffGDPPC and muchless positively affected by mass (represented by GDP) than bilateral tradeamong all non-EU countries We interpret these results as indicating that theEU has done much to succeed in reducing the effects of these naturally asym-metric differences among countries of different size levels of development andgovernance institutions

Table 43 presents the corresponding OLS estimates for the preferred specifi-cation of the extended gravity model of bilateral trade for all countries and thenthe EU and all non-EU countries separately for the more conventional case inwhich the missingzero observations are treated as missing In this case the fullsample consists of 13559 observations the non-EU sample 12870 observationsand the EU sample the same as it was before (689 observations) Notice that forboth the full sample and the non-EU sample the R2 value is quite a bit higher thanit was when the missingzero observations were treated as zeros as in Tables 41and 42 There are also numerous examples of considerable differences in thecoefficients estimated according to the two different assumptions about themissingzero observations For example the coefficients of GDP ColonizerLang and CU are all smaller (though still positive) in Table 43 compared withTable 41 while the negative coefficients for Distance Areas LL and ERV are allsmaller in absolute terms On the other hand the positive influence of Regional isnow larger and much more significant Yet once again with the inequality inter-action term included the results for all three inequality measures are qualitativelysimilar to those in Tables 41 and 42 In other words both intra-country inequal-ity (Gini2) and inter-country inequality (DiffGDPPC) have negative and signific-ant effects on bilateral trade whereas GiniDiffGDPPC has a positive andsignificant influence Once again all three hypotheses are supported

Table 42 Determinants of bilateral trade among EU and non-EU countries based on datathat includes observations with zero tradea

VariablesEU Non-EU

OLS TOBIT TOBIT OLS TOBIT TOBIT

Gini2 019 001 019 014 002 017

(005) (001) (005) (002) (001) (002)Gini_diffGDPPC 002 002 002 002

(000) (001) (000) (000)DiffGDPPC 134 027 133 143 012 173

(037) (006) (042) (022) (006) (028)GDP 091 091 091 248 276 276

(005) (004) (004) (004) (005) (005)GDPPC 021 023 021 015 011 014

(005) (005) (005) (005) (007) (007)Distance 079 081 080 272 294 299

(008) (008) (008) (009) (011) (011)Areas 013 014 013 092 108 109

(005) (005) (005) (006) (007) (007)LL 036 034 035 078 101 092

(013) (012) (012) (013) (014) (014)ERV 010 012 010 383 444 457

(072) (068) (068) (086) (090) (090)Border 101 095 100 002 010 022

(042) (048) (048) (034) (049) (049)Lang (dropped) (dropped) (dropped) 220 250 251

(018) (023) (023)Colonial (dropped) (dropped) (dropped) 294 355 372

(115) (173) (173)Colonizer (dropped) (dropped) (dropped) 204 238 238

(024) (028) (027)Regional (dropped) (dropped) (dropped) 057 038 031

(038) (069) (069)OneFTA 039 041 039 077 098 095

(011) (011) (011) (013) (015) (015)EU 035 025 035

(013) (058) (057)CU (dropped) (dropped) (dropped) 509 553 574

(060) (096) (096)M2GDP 000017 000016 000016 000002 000007 000007

(000003) (000004) (000004) (000003) (000004) (000004)Gov_ds 005 006 005 044 053 051

(003) (003) (003) (004) (005) (005)CPY 059 034 058 272 311 321

(066) (058) (058) (088) (081) (081)CPE 048 040 048 009 016 013

(014) (015) (015) (015) (016) (016)Dum_1985 (dropped) 112 (dropped) (dropped) 092 092

(020) (027) (027)Dum_1990 098 022 097 032 059 061

(017) (017) (016) (026) (026) (026)Dum_1995 131 013 131 037 055 055

(019) (016) (016) (023) (022) (022)

continued

Table 42 Continued

VariablesEU Non-EU

Dum_1997 141 021 141 085 (dropped) (dropped)(017) (015) (016) (023)

Dum_2000 121 (dropped) 121 108 024 026(018) (020) (024) (021) (021)

Constant 1109 2784 1119 5966 7961 6692

(406) (177) (434) (244) (195) (287)

No observations 689 689 689 15067 15067 15067688 1b 12870b 2197c

R2 08032 04699RMSE 11211 73520Pseudo R2 03436 03483 00823 00826

NotesSignificant at p001 Significant at p005 Significant at p010a Variables deliberately omitted are indicated as blank cells Variables that resulted as linear combi-

nation of other variables have been droppedb Uncensored cf p 73c Left-censored cf p 73

Conclusions

While some earlier empirical studies have examined the effects of cross-countryincome inequality (ie differences in per capita income between trading partnersor DiffGDPPC) on bilateral trade to the best of our knowledge no such studyhas focused on the effects of intra-national income inequality (Gini2) or its inter-actions with DiffGDPPC on such trade Yet the results presented here based onpooled data in Tables 41ndash43 show that overall the effects of both inter-country inequality and within-country inequality are both negative and highlysignificant But this is primarily the case only after one includes also the inter-action term between the two types of inequality (GiniDiffGDPPC) Theseresults are quite robust to differences in treatment of the missingzero observa-tions and to the choice of estimation technique

The inspiration for both such effects was the famous essay of Linder (1961)He argued that both such effects on bilateral trade should be negative at least inthe case of trade in manufactures He recognized however that primary tradewould be likely to have rather different determinants indeed along the lines ofcomparative advantage based on relative factor endowments Hence the factthat in our study the negative and significant effects of both intra-national andbetween-country income inequality hold even for total bilateral trade in com-modities is quite important

In view of the strength of these findings one can only wonder why the effectsof inequality on trade have been so much neglected One possible clue can beobtained by comparing the results of the first two columns in Table 41 In

Table 43 Determinants of bilateral trade excluding observations with zeros or missing dataa

Variables All countries EU Non-EU

Gini2 000072 004 001 019 000084 004

(000159) (001) (001) (005) (000164) (001)Ginidiff GDPPC 000495 002 000449

(000073) (000) (000075)DiffGDPPC 001 041 027 134 000 038

(001) (006) (007) (037) (001) (006)GDP 110 110 091 091 111 111

(001) (001) (005) (005) (001) (001)GDPPC 005 006 023 021 006 006

(001) (001) (005) (005) (001) (001)Distance 135 137 081 079 140 141

(003) (003) (008) (008) (003) (003)Areas 015 015 013 013 016 016

(002) (002) (005) (005) (002) (002)LL 026 024 034 036 026 024

(003) (003) (013) (013) (004) (004)ERV 032 029 012 010 027 024

(023) (023) (072) (072) (024) (024)Border 082 079 095 101 076 074

(011) (011) (045) (042) (011) (011)Lang 062 063 060 061

(005) (005) (005) (005)Colonial 065 059 056 052

(034) (032) (035) (033)Colonizer 058 059 058 058

(007) (007) (007) (007)Regional 136 134 134 133

(013) (013) (013) (013)OneFTA 001 002 040 039 003 003

(003) (003) (012) (011) (004) (004)EU 025 035

(013) (013)CU 161 167 (dropped) (dropped) 160 166

(024) (024) (024) (024)M2GDP 000015 000015 000016 000017 000014 000014

000001 000001 000003 000003 000001 000001Gov_ds 013 012 006 005 013 013

(001) (001) (003) (003) (001) (001)CPY 026 028 034 059 024 026

(019) (019) (064) (066) (020) (020)CPE 006 007 040 048 009 010

(004) (004) (014) (014) (004) (004)Dum_1985 (dropped) (dropped) 111 (dropped) (dropped) (dropped)

(018)Dum_1990 037 036 022 098 035 034

(007) (007) (015) (017) (007) (007)Dum_1995 058 058 013 131 056 056

(006) (006) (014) (019) (007) (007)Dum_1997 076 076 021 141 075 075

(006) (006) (012) (017) (007) (007)continued

particular the results given in the first column of Table 41 show that when thetwo inequality measures (Gini2 and DiffGDPPC) are included by themselves theinter-country inequality term has a negative but not significant effect on bilateraltrade Only when the third inequality measure namely GiniDiffGDPPC isincluded in the specification do the other effects become strongly negative Sincethe interaction term was ignored by Linder and hence by all empirical researcherstrying to test Linderrsquos hypotheses one can begin to see why the Linder hypothe-ses have found only scant support in the literature

Should these results hold up to further replication and testing with new datasome interesting implications including some for policy may follow First sincethe characteristics of the countries one trades with can have especially importanteffects on the quantity of trade in the increasingly important reputational goodsthe choice of trade partners may have considerable long-term impacts on the totalvolume of realizable trade Therefore if trade is actually good for growth anddevelopment for all trading partners as suggested by Frankel and Romer (1999)and many (but by no means all) scholars working on ldquoopenness and growthrdquo orldquoexports and growthrdquo then policy efforts to reduce inequality both betweennations and within nations could have an additional justification

Second the positive effect on bilateral trade of the interaction of the twotypes of inequality (GiniDiffGDPPC) suggests that intra-national inequalityhurts trade most among countries at similar levels of income per capita Hencein the context of economic integration it might suggest that countries should tryto integrate with countries at similar levels of development and with low levelsof income inequality Since the governance index has also been shown to havehighly significant positive effects on bilateral trade the results also suggest thatcountries would do well to choose trading partners with good governance insti-tutions Put differently the results would suggest that efforts to reduce trade andtransaction cost barriers would be most effective among trading partners withsimilar levels of average income low inequality and good governance

Moreover given a regional trade arrangement the results would imply thattrade can be promoted by measures designed to mitigate inequalities both within

Table 43 Continued

Dum_2000 051 052 (dropped) 121 052 052

(006) (006) (018) (007) (007)Constant 2482 2145 2777 1109 2465 2163

(045) (069) (199) (406) (046) (070)

No observations 13559 13559 689 689 12870 12870R2 072 072 080 080 071 071RMSE 189 189 113 112 192 191

nation of other variables have been dropped

and between countries At a global level the model would suggest that efforts toincrease trade through tariff and other liberalization measures would be moresuccessful when preceded or at least accompanied by measures designed toreduce these same inequalities It would also suggest that efforts to improvegovernance among countries one trades with would also be trade promotingFurther evidence in support of these last implications can also be seen by com-paring the means of the different inequality and governance measures for eachof the different sample years in Table 44 Note for example the fact that thevalues of Gini2 and DiffGDPPC are both lower for the EU trading partners thanfor those of the NAFTA CACM CARICOM ASEAN or Non-FTA samples12

Even the average difference in Gini coefficients (Gini2diff) between tradingpartners is smaller than those of all other regions except CARICOM Althoughthe governance index among each pair of EU members fell with expansion ofthe EU in the 1990s the index has increased since 1995 and remains higher in2000 than those of trading partners in all but one other region

The fact that our results hold for aggregate commodity trade that includesagricultural and other primary commodities for which Linder conceded that hismodel would not apply implies that the results should hold a fortiori for manu-factured goods However in view of the increasingly close linkage betweenagriculture and food processing supermarket distribution and patenting of agri-cultural varieties it is not inconceivable that the same considerations may nowbe applying even to agriculture This would be interesting to test using more dis-aggregated data

Also some of the same brand name product differentiation and networkinfluences lying behind the Linder-oriented trade in manufactures might wellapply to trade in services However to the extent that industry concentrationwould appear to be greater in many services it is less obvious that the samecoincidence of greater income equality and greater trade would also prevail inservices Since trade in services is now accounting for over half of total tradeflows this issue deserves careful investigation

Table 44 Means of variables by group of trading partnersa

EU NAFTA Non-FTAb CARICOMb CACM ASEANb All Otherb

No observations 36 0 9728 36 0 10 0 36 0 1060GDPPC 16452 6992 6226 2231 6027 6687Gov_ds 526 057 330 310 040 108Gini2 6480 18030 8590 10200 8010 8530Gini2diff 454 1153 442 688 868 777DiffGDPPC () 1580 6360 5770 2345 7886 5713

No observations 91 0 3 0 12507 36 0 10 0 45 0 1220GDPPC 45961 33724 12129 7310 3099 10837 12182Gov_ds 014 055 001 042 033 077 023Gini2 6370 8230 8090 8190 10340 7910 8350Gini2diff 570 1520 1170 370 610 780 730DiffGDPPC () 1853 4858 7134 5682 4563 7377 5576

No observations 91 0 3 0 12365 36 0 10 0 28 0 1050GDPPC 42409 42432 11653 10162 3733 7920 12560Gov_ds 168 0 0 080 093 228 106 113Gini2 6523 8677 8145 8110 10546 7944 8444Gini2diff 540 1420 1100 450 710 830 760DiffGDPPC () 1476 4531 7052 5321 4602 8221 5079

Notesa NAFTA North America Free Trade Area CACM Central American Common Market

CARICOM Caribbean Community and Common Market ASEAN Association of SoutheastAsian Nations

b Some variables have fewer observations than the number indicated for the year shown

Appendix

Table 4a1 List of countriesterritories included in the analysis

1 Afghanistan2 Albania3 Algeria4 Angola5 Argentina6 Armenia7 Australia8 Austria9 Azerbaijan

10 Bahamas11 Bahrain12 Bangladesh13 Barbados14 Belarus15 Belgium-Luxembourg16 Belize17 Benin18 Bermuda19 Bhutan20 Bolivia21 Bosnia and

Herzegovina22 British Indian Ocean

Territories23 Brazil24 Brunei25 Bulgaria26 Burkina Faso27 Burundi28 Cambodia29 Cameroon30 Canada31 Cayman Islands32 Central African Rep33 Chad34 Chile35 China36 Colombia37 Comoros38 Congo39 Congo Dem Rep of

(Zaire)40 Costa Rica41 Cote DrsquoIvoire42 Croatia43 Cuba

44 Cyprus45 Czech Rep46 Fm Czechoslovakia47 Denmark 48 Djibouti49 Dominican Rep50 Ecuador51 Egypt52 El Salvador53 Eq Guinea54 Estonia55 Ethiopia56 Falkland Islands57 Fiji58 Finland59 Fm German Dem

Rep (East)60 Fm USSR61 Fm Yugoslavia

(includes CroatiaSlovenia)

62 France63 French Guiana64 Gabon65 Gambia66 Georgia67 Germany68 Ghana69 Gibraltar70 Greece71 Greenland72 Guadeloupe (includes

Martinique)73 Guatemala74 Guinea75 Guinea-Bissau

(includes Cape Verde)76 Guyana77 Haiti78 Honduras79 Hong Kong80 Hungary81 Iceland82 India83 Indonesia (including

Macao)

84 Iran85 Iraq86 Ireland87 Israel88 Italy89 Jamaica90 Japan91 Jordan92 Kazakhstan93 Kenya94 Kiribati (includes

Tonga)95 Korea Dem P Rep

(North)96 Korea Rep (South)97 Kuwait98 Kyrgyz Rep99 Laos P Dem Rep

100 Latvia101 Lebanon102 Liberia103 Libyan Arab Jamahiriya104 Lithuania105 Macedonia106 Madagascar107 Malawi108 Malaysia109 Maldives110 Mali111 Malta112 Mauritania113 Mauritius114 Mexico115 Moldova116 Mongolia117 Morocco118 Mozambique119 Myanmar (Burma)120 Nepal121 Neth Antilles122 Netherlands123 New Caledonia

(includes FrenchPolynesia andVanuatu)

124 New Zealand

125 Nicaragua126 Niger127 Nigeria128 Norway129 Oman130 Pakistan131 Panama132 Papua New Guinea133 Paraguay134 Peru135 Philippines136 Poland137 Portugal138 Qatar139 Reunion140 Romania141 Russia142 Rwanda143 Saudi Arabia144 Senegal145 Serbia and Montenegro146 Seychelles

147 Sierra Leone148 Singapore149 Slovak Rep150 Slovenia151 Solomon Islands152 Somalia153 South Africa154 Spain155 Sri Lanka156 St Kitts Nevis

(includes DominicaSt Lucia St Vincentand GrenadinesGrenada)

157 St Pierre Miqu158 St Helena159 Sudan160 Surinam161 Sweden162 Switzerland163 Syrian Arab Rep164 Taiwan

165 Tajikistan166 Tanzania167 Thailand168 Togo169 Trinidad-Tobago170 Tunisia171 Turkey172 Turkmenistan173 Turks Caicos Isl174 Uganda175 Ukraine176 United Kingdom177 United Arab Em178 Uruguay179 USA180 Uzbekistan181 Venezuela182 Vietnam183 Western Sahara184 Yemen185 Zambia186 Zimbabwe

Table 4a2 Descriptive statistics on variables used in the analysis from maximumsample size

Variable No observations Mean Standard Deviation

Totaltrade2 7614 000540 001304Gini2 3363 008085 001390GinidiffGDPPC 3158 063330 016229DiffGDPPC 5815 000786 000180GDP 5815 004648 000314GDPPC 5815 001499 000221Distance 7591 000827 000074Areas 7614 001313 000163LL 7614 000034 000053Border 7614 000001 000013Lang 7614 000012 000032Regional 7614 000001 000011Colonizer 7614 000007 000027Colonial 7614 000000 000007ERV 5719 000008 000011CU 7614 000000 000009Gov_ds 3540 000001 000233CPY 7614 000004 000020CPE 7614 000040 000056M2GDP 4260 165395 196563OneFTA 7614 000038 000048

1 The authors express their appreciation to Fahyre Loiola de Alencar for her researchassistance in finding relevant papers and preparing tables and to an anonymousreferee Yujiro Hayami Odin Knudsen Donato Romano and especially Pan Yotopou-los for their useful comments on an earlier draft of the chapter

2 See especially Deaton and Muellbauer (1980) for a detailed analytical surveyHowever systematic error in stated income measurement across income groups isanother possible explanation In particular people with low incomes are often self-employed and likely either to deliberately or to inadvertently understate their incomein surveys

3 See also Matsuyama (2000) Matsuyama however did not introduce income distribu-tion into the analysis

4 Use of the gravity model has become even more popular after Anderson (1979)Bergstrand (1989) and others provided a theoretical underpinning for it

5 Leamer and Levinsohn (1995) attribute to the gravity model ldquosome of the clearest andmost robust empirical findings in economicsrdquo

6 Prices and tariffs are not used as explanatory variables because of the very limitedavailability and low quality of data on them

7 The countries are listed in Table 4a1 in the Appendix8 These are of ldquoVoice and Accountabilityrdquo ldquoPolitical Stabilityrdquo ldquoGovernment Effec-

tivenessrdquo ldquoRegulatory Qualityrdquo ldquoRule of Lawrdquo and ldquoControl of Corruptionrdquo Data onthese governance components were taken from the International Country Risk Guide(ICRG) produced by the Political Risk Services (PRS) group where the componentsof the political risk index were used which report subjective assessments of thefactors influencing the business environment in the countries studied Several of thesecomponents were in turn based on additional sub-indicators Specifically ldquoVoiceand Accountabilityrdquo was based on two sub-components from ICRG data Military inPolitics and Democratic Accountability ldquoPolitical Stabilityrdquo was based on one sub-component Internal Conflict ldquoGovernment Effectivenessrdquo on both GovernmentStability and Bureaucratic Quality ldquoRegulatory Qualityrdquo on Investment ProfileldquoRule of Lawrdquo on Law and Order and ldquoControl of Corruptionrdquo on Corruption TheICRG data has two very desirable features (1) its large sample of developed anddeveloping countries (130) and (2) its length of coverage over time (1982ndashcurrent)The ICRG data depends on polls of experts The central advantage of polls of expertsis that they are explicitly designed for cross-country comparability and great effort isput into the benchmarking process to ensure this

9 While the aforementioned aspects of governance are admittedly subjective there areseveral reasons for believing their use to be beneficial First objective data eg on cor-ruption are almost by definition very difficult to obtain Second while a country mayenjoy a set of sound institutions according to some objective standards the confidenceof residents of this country in these institutions is required if those residents are toparticipate in and contribute to good governance Thus perceptions of the quality ofgovernance may be as important as objective differences in institutions across countries(Kaufmann et al 1999a) Third subjective perceptions might have greater explanatorypower for future economic outcomes than past objective data For example Kaufmannet al (1999b) in the context of the East Asian financial crisis found that investor per-ceptions of future financial instability had significant explanatory power for futureactual volatility Fourth the data are not intended to constitute absolute measures butonly ldquoindicesrdquo As such their aim is primarily to sort countries into broad groupingsaccording to levels of governance and to indicate changes over time

10 Descriptive statistics on all the variables are given in Table 4a211 The dummy variable for a regional trading arrangement between the two trading part-

ners (Regional) however though positive is not statistically significant

12 For more detailed analyses and comparisons of the effects of different regionaltrading agreements see Miniesy et al (2004)

References

Anderson James E (1979) ldquoA Theoretical Foundation for the Gravity Equationrdquo Amer-ican Economic Review 69 (1) 106ndash16

Bergstrand Jeffrey H (1989) ldquoThe Generalized Gravity Equation MonopolisticCompetition and the Factor Proportions Theory in International Traderdquo Review of Eco-nomics and Statistics 71 (2) 143ndash53

CIA (2004) ldquoThe World Factbookrdquo Langley VA US Central Intelligence AgencyOnline available wwwodcigovciapublicationsfactbookindexhtml (accessed 3 June2004)

Deaton Angus and John Muellbauer (1980) Economics and Consumer Behavior Cam-bridge Cambridge University Press

Deininger Klaus and Lynn Squire (1997) ldquoMeasuring Income Inequality A New DataBaserdquo Washington DC World Bank

Feenstra Robert C (2000) World Trade Flows 1980ndash1997 Davis CA Center for Inter-national Data Institute of Governmental Affairs

Frankel Jeffrey A and David Romer (1999) ldquoDoes Trade Cause Growthrdquo AmericanEconomic Review 89 (3) 379ndash96

Glick Reuven and Andrew K Rose (2002) ldquoDoes a Currency Union Affect Trade TheTime Series Evidencerdquo European Economic Review 46 (4) 1125ndash51

Grossman Gene M and Elhanan Helpman (1991) Innovation and Growth in the GlobalEconomy Cambridge The MIT Press

Helpman Elhanan (1981) ldquoInternational Trade in the Presence of Product Differenti-ation Economies of Scale and Monopolistic Competitionrdquo Journal of InternationalEconomics 11 (August) 305ndash40

Helpman Elhanan and Paul R Krugman (1985) Market Structure and Foreign TradeIncreasing Returns Imperfect Competition and the International Economy Cam-bridge The MIT Press

Hunter Linda C (1991) ldquoThe Contribution of Nonhomothetic Preferences to TraderdquoJournal of International Economics 30 (2) 345ndash58

Hunter Linda C and James R Markusen (1988) ldquoPer-Capita Income as a Determinantof Traderdquo In Robert C Feenstra ed Empirical Methods for International TradeCambridge The MIT Press pp 89ndash109

IMF (2003) Directon of Trade Statistics (DOTS) 2003 CD-Rom Washington DCInternational Monetary Fund

Kaufmann Daniel Aart Kraay and Pablo Zoido-Lobatoacuten (1999a) ldquoAggregating GovernanceIndicatorsrdquo Policy Research Working Papers no 2195 Washington DC World Bank

Kaufmann Daniel Gil Mehrez and Sergio Schmukler (1999b) ldquoWas the East Asia CrisisPredictablerdquo Washington DC World Bank

Kaufmann Daniel Aart Kraay and Pablo Zoido-Lobatoacuten (2002) ldquoGovernance MattersIIrdquo Policy Research Working Papers no 2772 Washington DC World Bank

Keynes John M (1936) The General Theory of Employment Interest and Money NewYork Harcourt Brace and World

Leamer Edward E and James Levinsohn (1995) ldquoInternational Trade Theory TheEvidencerdquo In Gene M Grossman and Kenneth Rogoff eds Handbook of Inter-national Economics vol III Amsterdam Elsevier-North Holland

Markusen James R (1986) ldquoExplaining the Volume of Trade An Eclectic ApproachrdquoAmerican Economic Review 76 (5) 1002ndash11

Matsuyama Kiminori (2000) ldquoA Ricardian Model with a Continuum of Goods underNonhomothetic Preferences Demand Complementarities Income Distribution andNorth-South Traderdquo Journal of Political Economy 108 (6) 1093ndash120

Miniesy Rania S Jeffrey B Nugent and Tarik M Yousef (2004) ldquoIntra-regional TradeIntegration in the Middle East Past Performance and Future Potentialrdquo In HassanHakimian and Jeffrey B Nugent eds Trade Policy and Economic Integration in theMiddle East and North Africa Economic Boundaries in Flux London RoutledgeCurzon pp 41ndash65

Mitra Devashish and Vitor Trindade (2003) ldquoInequality and Traderdquo NBER WorkingPaper no 10087 Cambridge MA National Bureau of Economic Research

Rose Andrew K (2000) ldquoOne Money One Market Estimating the Effect of CommonCurrencies on Traderdquo Economic Policy 15 (April) 7ndash46

Thursby Jerry G and Marie C Thursby (1987) ldquoBilateral Trade Flows the LinderHypothesis and Exchange Riskrdquo Review of Economics and Statistics 69 (3) 488ndash95

UN (2003) ldquoNational Accounts Statistics Main Aggregates and Detailed Tables(1985ndash2000)rdquo New York United Nations Online available unstatsunorgunsdnationalaccountnasphtm (accessed 5 June 2004)

WIDER (2000) ldquoWorld Income Inequality Database (2000)rdquo Helsinki United NationsUniversityWorld Institute for Development Economic Research Online availablewwwwiderunueduwiidwiidhtm (accessed 5 June 2004)

World Bank (2003) World Development Indicators 2003 CD-Rom Washington DCWorld Bank

WTO (2004) ldquoRegional Trade Agreements Notified to the GATTWTO and in ForcerdquoGeneva World Trade Organization Online available wwwwtoorgenglishtratop_eregion_eeif_exls (accessed 5 June 2004)

Part II

Institutional asymmetries

5 Communities and markets forrural development underglobalizationA perspective from villages in Asia1

Yujiro Hayami

Introduction

The current surge of globalization is creating the opportunity to increase incomefor the rural poor by conveying demands from advanced economies for suchhigh-valued products as flowers fruits and vegetables to the hinterlands thathave hitherto been bypassed in development currents However rural producersin low-income economies will not be able to capture this opportunity unless ade-quate channels exist for connecting them with distant urban markets andorcenters for exports It is well known that rural markets in low-income economiesare underdeveloped being characterized by high transaction costs owing toimperfect information and high risk as well as absence of effective mechanismsto protect property rights and to enforce contracts Under these constraints it hasoften been feared that small producers and petty traders in rural hinterlands tendto be exploited by foreign or urban traders who have monopoly access to globalinformation ndash the so-called ldquoasymmetric information problemrdquo

The major thrust of this chapter is to show that the trust and cooperationmechanisms existing in rural communities in developing economies could forma basis for the efficient functioning of markets that channel global demands toproducers in the hinterlands The conceptual framework shall be based on recenttheoretical developments in institutional economics and shall be further sup-ported by concrete examples from case studies on the marketing of peasantsrsquoproduce in Asia

Community trust a conceptual framework

In this use of the word a ldquocommunityrdquo is a group of people tied by mutual trustbased on intense personal interactions Theoretically communities range fromthe family to the national community and further to the global communityHowever the communities discussed in this chapter are those in between thisrange characterized by personal relationships closer than the armrsquos length rela-tion In developing economies they are typically identified as tribes and villagestied by blood and locational affinities

The community in this definition can be considered one major component of

the economic system As aptly pointed out by Adam Smith advancement in theproductive power of human society is brought about by progress in the divisionof labor As people specialize in various activities a system is required to co-ordinate them The ldquoeconomic systemrdquo in its present definition is a combinationof the economic organizations that coordinate various economic activities so asto achieve a socially optimum division of labor The market is the organizationthat coordinates profit-seeking individuals through competition under the signalof parametric price changes The state is the organization that forces people toadjust their resource allocations by the command of government On the otherhand the community is the organization that guides community members to vol-untary cooperation based upon close personal ties and mutual trust In otherwords the market operates by means of competition based on egoism the stateoperates by means of command based on legitimate coercive power and thecommunity utilizes cooperation based on consent to coordinate the division oflabor among people towards a socially desirable direction (Hayami and Godo2005)

The comparative advantage of the community lies in the supply of ldquolocalpublic goodsrdquo whose benefit is limited to a particular group as compared withthe marketrsquos advantage in the supply of private goods and the governmentrsquosadvantage in the supply of global or pure public goods (Pagano Chapter 2) Thelocal public goods that the community normally supplies may be classified intothree categories The first is the provision of social safety nets for rescuing dis-advantaged members from eventual subsistence crises This role of the commun-ity has long been emphasized since Thomas Morersquos Utopia (Hayami 1989) Thesecond is the conservation of common-pool or common-property resources suchas forests grazing lands irrigation systems and village roads This role hasincreasingly been advocated recently (Feeny et al 1990 Ostrom 1990 Balandand Platteau 1996) In contrast the third possible role of community to facilitatemarket transactions by aiding to enforce trade contracts has received relativelylittle attention (Aoki and Hayami 2001)

The communityrsquos contribution to market development is based on the samecharacteristic as is its contributions to the provision of social safety nets and tothe conservation of common-pool resources the power of the community rela-tionship to prevent free riders from trying to profit by violating contracts For thecommunity-based safety nets to be effective all the members must contributedue insurance premiums according to the principle of reciprocity dictated bycustoms and norms The same applies to community membersrsquo contributions tothe conservation of common-pool resources However it is very tempting forany member to be a free rider for example by utilizing a village road built byothersrsquo collective work without his participation in the project Therefore if oneis allowed to be a free rider all others tend to follow with the result of no newlocal public goods being supplied

The community has the power to suppress onersquos incentive to be a free riderby means of cooperative spirit nurtured through intensive social interactionsamong its members and their fear of being ostracized The cost of being sub-

90 Y Hayami

jected to social opprobrium and ostracism as the result of acting as a free ridercan be very high especially in a small closed community such as a tribe or avillage in low-income economies where exit options are severely limited If thiscost plus the psychological cost of violating social norms and established moralcodes is higher than the expected gain from exercising opportunism thecommunity has elided the free rider problem

The same mechanism can apply to the enforcement of trade contracts Thefree rider problem in market transactions often takes the form of the so-calledagency problem arising from information asymmetry For example a farmergrows tomatoes under a contract with the trader who promised to purchase hisentire crop at a certain price Should this farmer be suddenly confronted with thebuyerrsquos demand to accept a lower price for his tomatoes after the harvest thefarmer will hesitate to enter the same contract again however profitable thatmight be for both parties when it is faithfully enforced Likewise the trader willhesitate to advance credit to the farmer before harvest if he foresees the risk ofthe farmerrsquos failure to deliver the tomatoes at the agreed upon quantity andquality It may appear that these market failures stemming from agentsrsquo oppor-tunism against principals can be corrected by contract enforcement through legalprocedures However the costs involved in formal court proceedings are largeoften exceeding the expected gains from dispute settlement on the small trans-actions that are typical in low-income economies Moreover where judges andpolice are not necessarily the faithful agents of citizensrsquo rights it can happenthat the market failures stemming from information asymmetry not only fail tobe corrected but may even be enlarged by government failures

Under such conditions trade tends to be limited between buyers and sellerswho are embraced by common community relations Farmers prefer to sell theircrops to traders who come from their same village or to those who have relativesand close friends in that village so that the parties are bound by the respect andreputation they have cultivated in their community which will be jeopardized incase either one defaults on his obligations The same stands for the traders sothat both parties expect that the community mechanism of cooperation andostracism will effectively force their trade partners to honor their contracts Thetrade circle based on community relationships may originally be small as it isconstrained by blood and locational ties in traditional rural communities such asfarming villages It can be gradually expanded to form a wider trade networkbeyond the traditional community by relying on the initial introduction by othermembers of the village community who have had transactions with a broadernetwork of traders operating at the town level or the level above it the city levelInitially the farmer will approach the outside trader gingerly and the latter mayneed a guarantee from a trader who has closer ties in the village community forsigning the contract for growing the crop With repetitive transactions howevertrust develops and the ldquooutsiderdquo trader can come to enjoy the same trust that acommunity trader would enjoy

Indeed long-term regular transactions have long been recognized byanthropologists as being effective in forging mutual trust and cooperation that

Community and markets under globalization 91

prevents opportunism from being exercised between transacting parties beyondthe confines of a narrow community like a rural village This process has beencalled ldquoclientelizationrdquo by Geertz (1978) In his example a jeweler in townbazaar may be strongly tempted to cheat a first-time new customer in his shopby selling low-quality jewels at high prices However for a regular customer hewould be inclined to feel guilty and not willing to lose a long-lasting businessopportunity for a one-shot moral hazard This anthropological explanation ismatched by the theory of repeated games or the Folk theorem (Kreps andWilson 1982 Fudenberg and Maskin 1986 Abreu 1988) Mutual trust createdby long-term continuous transactions can further be reinforced by interlinkedtransactions (Bardhan 1980 Bell 1988 Hayami and Otsuka 1993) Forexample a trader not only purchases a commodity from a particular producerregularly year after year but also supplies him with materials and creditsMutual trust enhanced by intensified interactions as well as by fear of losing amultifaceted cooperation relationship is a strong force in curbing moral hazardfor both parties The psychological basis of mutual trust could further bestrengthened by incorporating personal elements in business transactions suchas exchanges of gifts and attendance at weddings and funerals

The strength of such a community relationship in support of market transac-tions has been demonstrated by the success in trade and finance of Jewishtraders in medieval Europe and of Chinese traders in modern Southeast Asia tomention only few examples These ethnic groups were able to establish domin-ant positions in commercial and financial activities as they were successful inreducing transaction costs across distant trading posts among the traders andbankers bound by the same ethnic community ties (Landa 1981 Greif 19891993 Hayami and Kawagoe 1993) This model of cooperation is repeatedacross other ethnic communities throughout

The role of trust in peasant marketing

The trade channels through which rural producers in developing countries areintegrated with markets are various and differ across different agrarian struc-tures Here the emphasis will be on small family farms (ldquopeasantsrdquo) familiarfrom our field observations in Southeast Asia as well as from documentaryknowledge of Japanese history

One common channel is direct sales from producers to consumers Womenfrom farm households selling their products in open bazaars or peddling themaround house by house in the town are a familiar sight in any developingcountry They may be selling vegetables harvested from their backyards pota-toes from their fields or snacks they themselves processed from beans At firstsight the scene of intensive bargaining in bazaars may give the impression ofthe familiar spot cash transactions among the casual sellers and buyers thatpopulate the world of neoclassical economics Yet a closer look will reveal thecase of mostly regular clientele that is well-known to the merchant Whether it isthe bazaar or the street stall the sellerrsquos territory is well determined and this is

92 Y Hayami

confirmed by the fact that the peddler often sells to the regular customers oncredit Typically a new peddler is given a small territory from an establishedpeddler from the same village that he gradually expands by cementing andenriching the clientele circle that he was handed A peddling woman said to theauthor ldquoIf I am honest with a customer she will introduce her friends to me butif I would cheat her I will not only lose her alone but lose other customers whoare friends to herrdquo The power of mutual trust forged through long-term regular(ie repetitive) trading to reduce transaction costs is evident even in such rudi-mentary trade cases It is also evident that long-term transactions contribute toexpand community relationships beyond the confines of a traditional communitysuch as a village

The direct sales of producers to consumers within a narrow location asexplained above are largely limited to (a) sideline enterprises for farm house-holds producing small amounts of marketable surplus which family memberscan handle and (b) perishable commodities for which quick delivery from pro-duction to consumption is necessary

Marketing channels for major crops such as rice which can find outlets inwider markets are much more complicated The analysis here will attempt toillustrate their characteristics based on the case study for the Laguna province inthe Philippines (Hayami et al 1999 Hayami and Kikuchi 2000) The market-ing flow of rice in the study area is as shown in Figure 51 Paddy retained forfarmersrsquo home consumption is milled at a piece rate in small village mills(kiskisan) The surplus that is destined for the market is milled at large commer-cial mills (cono) located in towns or which have easy access along highways Arelatively small portion of paddy that was consigned to the mills is purchaseddirectly from farmers The majority is assembled by middlemen called ldquocollec-torsrdquo who are typically residing in villages and are known to the farmers It iscommon that a collector employs several commissioned agents in his operationwho can better cement his relationship with the farmers The independent traderbuys stores and sells paddy at his own risk Considerable skill is necessary forthem to judge the qualities of paddy Since sale prices to mills vary for differentvarieties and moisture contents miscalculation on the quality of paddy in offer-ing prices to farmers may entail major losses Further the trader must carry themarket-price risk which becomes large when he engages in stock-holding opera-tions He also needs substantial capital investment in owning a truck for haulingthe paddy In contrast the commission agent is largely free from the traderrsquosrisks as he is paid a percentage of the paddies he procured irrespective of priceHis capital requirement is low because he uses his principalrsquos truck to haulpaddy from farmersrsquo houses Therefore villagers who wish to enter the collec-tion business usually start as commission agents and work toward becomingindependent traders

The hierarchy of traders from commission agents to independent traders andfurther up to rice millers is a common form of the marketing system of peasantagriculture It is founded on the fact that small farmers have small surpluses tosell which increases the transaction cost per unit of product collected by the

middleman An independent trader who has the sunk costs of his equipment(truck) and his trade skill that he needs to amortize would rather hire the pooramong the peasants who have low opportunity cost to have them contact theirneighbor farmers so that he could produce a contract of a full truckload that thetrader needs This condition applies more strongly to rice millers in their deal-ings with collectors For the sake of increasing the rate of utilization of theirlarge fixed capital consisting of milling and drying facilities together with a fleetof trucks they must endeavor to maximize the procurement of paddy fromvarious farms with different harvesting seasons This condition determines theinevitability of the millersrsquo reliance on the services of collectors Leaving thetask of paddy collection to independent self-employed agents is much more effi-cient than the vertical integration of the process of collection and of milling Theformal employment of workers by the mill for paddy collection entails highlabor management costs since the task is characterized by high seasonality and alarge number of small-lot transactions over a wide space

Given the critical importance of maintaining an assured supply of paddy ricemillers employ various methods to develop a long-term trade relationship withcollectors Credit tying is one method used for this purpose Millers oftenadvance to collectors short-term credits from a few daysrsquo to a few weeksrsquo

94 Y Hayami

Figure 51 Channels of local rice marketing in Laguna Philippines (source Hayamiet al 1999)

Commercial rice mill(cono)

Distributor

Retailer

Consumer

Independantcollector

Agentcollector

FarmerVillage mill(kiskisan)

duration with the agreement that paddy procured by the debtors shall be deliv-ered to the lenders who will deduct the corresponding portion of debt repay-ment from the loan This method is also occasionally practiced by independenttraders in lending to commission agents as well as to farmers It should be notedthat the incidence of credit advancement from collectors to farmers is smallerthan that from farmers to collectors typically collectors pay the price of paddyto farmers after they haul and sell the paddy to rice mills and subsequently theypay off their loans The trust between farmers and collectors in the same villagethat underlies the practice of paddy sales on credit is an important factor indecreasing the cost of working capital for the collectors

Rice millers usually act as wholesalers in the distribution of milled rice tolocal retailers although some also ship a part of their produce to metropolitanmarkets via specialized wholesale agents It is therefore of vital importance forthe rice-milling business to secure a stable flow of business from retailersholding stores in town To this end millers become inventive in developing andcementing the trust with retailers One such approach is through advancinginterest-free loans to regular customer retailers in the form of sales on creditThis credit operation is said to be risky because a mutual trust relationship withtown retailers is more difficult to establish than with farmers and village-basedcollectors A manager of a cooperative owning a rice mill remarked that thecoop milling was often interrupted by shortage of demand from retailers Thisremark reflects the lack of an incentive mechanism to motivate such risky creditoperations since coop managers are not claimants for residual profits unlike theprivate mill operators Coop managers tend to allocate greater efforts in obtain-ing subsidies from governmental and non-governmental aid agencies thantoward winning competition in the market

In contrast to the motivation of employees of a business enterprise privatetraders are more focused on surviving market competition through the effectiveuse of a community relationship Indeed competition is stiff especially amongcollectors because the low capital requirements for this business open the entryvirtually to any villager Rice mills compete in procuring paddy so as to maxi-mize the utilization of their capital They have to contest business over a widearea because they have to procure paddy from different locations with differentharvesting seasons in order to even out the paddy supply over time This con-dition precludes the possibility of any large mill exercising local monopsonypower Intense competition also applies to the wholesaling of rice to retailers aswell as to retailing to consumers

The participants in this competitive market endeavor of crafting stable long-term trade relationships with their partners are driven by the motive of reducingrisk and of saving in the transaction costs that arise from the possibility of moralhazard under information asymmetry Farmers middlemen and consumers con-tinue to maintain long-term trade relationships as long as it is beneficial to thembut they are quick to switch trade partners if the current relationship is found tobe unsatisfactory As such long-term trade relationships supported by traditionalcommunity norms in rural villages promote rather than constrain market

competition for crops produced by small producers in small lots for which thetime of harvest and delivery is difficult to predict and quality standardization isdifficult to establish Data of marketing margins and of costs collected from ourfield survey did not show evidence of existence of monopolymonopsony profitin any segment of rice marketing in the study site

According to our extensive observations in Asia the structure of rice market-ing outlined in the case of the Philippines is common not only for rice but alsofor traditional peasant crops in general The exception is in cases where govern-ment market interventions create major distortions by rendering the large institu-tional rents to a certain favored group that is appointed to transact the marketingMoreover this system has not significantly changed for many years In theLaguna study site for example major changes have occurred since the SecondWorld War The means of transportation have changed from carabao and pony-drawn wagons to trucks paralleled with improvements in infrastructure such ashighways and telephone systems The dramatic innovations of the ldquogreenrevolutionrdquo that diffused modern varieties since the late 1960s contributed tomore than doubling the average rice yield per hectare Large-scale modern millshave increased their market shares relative to the traditional kiskisan mills Yetaccording to the recollections of veteran farmers collectors and millers the mar-keting structure has remained essentially unchanged Thus the system observedin loco and outlined above can be considered a ldquoprototyperdquo of peasant market-ing

Is there a role for community trust under globalizationFrom peasant marketing to modern ldquojust-in-timeagriculturerdquo

Although the system of peasant marketing outlined in the previous section maybe largely efficient in marketing traditional peasant crops for local demand it isdoubtful that it can also serve as an appropriate channel to connect small familyfarms with wide national and international markets that deal in new commodi-ties These new agricultural commodities that are in great demand in worldmarkets such as vegetables or fruits and flowers are perishable which meansthat timely delivery from producers to consumers or to processing plants is criti-cally important For this purpose farm-level production from planting to har-vesting must be much more closely coordinated with the schedules of marketingand processing than is the case of the prototype peasant marketing system inwhich production plans including the choice of crops and varieties as well asthe planting and harvesting periods are left to the decentralized decisions ofindividual farm producers

A traditional approach to achieving sufficient coordination between farmproduction and marketingprocessing for delivery of tropical agriculturalproducts to international markets is the vertical integration in the form of planta-tions (Hayami 1994 2002) A typical example is the case of black tea Themanufacturing of black tea at a standardized quality for export requires a

96 Y Hayami

modern fermentation plant in which fresh leaves must be fed within a few hoursafter plucking The need for close coordination between farm production andlarge-scale processing underlies the traditional use of the plantation system forblack tea manufacture Unfermented green tea in contrast remains predomi-nantly the product of family farms in China and Japan Another example isbananas for export In this case harvested fruits must be packed sent to thewharf and loaded on a refrigerated boat within a day A boatful of bananas thatcan meet the quality standards of foreign buyers must be collected within a fewdays Therefore the whole production process from planting to harvesting mustbe precisely controlled so as to meet the shipment schedule Thus the plantationsystem has a decisive advantage for bananas for export but not for bananas fordomestic consumption which in turn are usually produced in family farms

A large plantation system based on hired wage laborers under centralizedmanagement was a necessary and efficient organization for opening new landsfor export crop production because of its ability to build necessary infrastruc-ture such as road and harbor The family farms on the other hand have noincentive to invest in infrastructure because their operational sizes are too smallto internalize gains from infrastructural investment However after the land-opening stage was over and the infrastructure was built the plantation systembecame increasingly more inefficient relative to the peasant system because ofhigh costs to supervise hired wage laborers as compared to the peasant farm thatrelies on family labor that requires no supervision Because of the high costs ofmonitoring hired labor in spatially dispersed and ecologically diverse farmoperations plantations usually practice monoculture Complicated intercroppingand the cropndashlivestock combination are more difficult to manage by thecommand system implying that both labor input and income per hectare arelower in plantations Moreover continuous cultivation of a single crop over awide space increases the incidence of damage from pests and the counteractingapplication of chemicals tends to pollute the environment

The approach that has been recently advocated as a substitute for the planta-tion system is the ldquocontract farmingrdquo system in which an agribusiness enterpriseor a cooperative that manages the processing and marketing contracts with smallgrowers for the assured supply of farm-produced raw materials The contractmay include stipulations not only on the time and quantity of material supply butalso on prices credit and technical extension services In this way the advantageof agribusiness in large-scale marketingprocessing and the advantage of thepeasant system in farm-level production can be combined (Hayami 2002)

Contract farming has recorded several significant successes notably inpineapples for processing by multinational agribusiness in Thailand on the basisof which Thailand rose to become the worldrsquos top exporter of pineapple prod-ucts surpassing the Philippines that remains based on the plantation systemHowever many failure cases have also been reported The failure usually stemsfrom the difficulty of agribusiness or coop management to enforce contractswith a large number of smallholders concerning the quantity quality and timingof their product delivery to processing plants andor marketing centers In this

regard one wonders if the skills of enforcing contracts by effective use ofcommunity trust in peasant marketing could be extended to develop ldquomodernrdquocontract farming In what follows I will try to illustrate this possibility with thecase of commercial vegetable marketing in an upland village in Java Indonesia(Hayami and Kawagoe 1993 Ch 4)

The study village is located in a hilly plateau near the border between Westand Central Java about 300 kilometers east of Jakarta Typical of uplandvillages the village was characterized by meager endowments of land resourcesand hence low incomes as compared with lowland villages that were endowedwith irrigated rice lands Average farm size was only 04 hectares a half ofwhich was under tenancy Farmers traditionally eked out bare subsistence bymixed cropping of upland crops such as corn and soybean and upland rice withvery low shares of marketable surplus

In about five years in the mid 1980s this village economy underwent a majorchange with successful introduction of commercial vegetable production mainlygeared for metropolitan markets With this innovation average farm income perhectare increased as much as eight times surpassing the income level of irri-gated rice farming in lowland areas The cool high altitude environment in thisvillage and its surroundings is suitable for vegetable production Rapidlyincreasing urban demands for fresh vegetables corresponding to the success oflabor-intensive industrialization in Indonesia that was based on liberalization intrade and foreign direct investment in the 1980s had spilled over to benefit thishinterland However the opportunity for marginal farmers in this area wouldhave not been captured unless a new marketing system had been developed todeliver a large bulk of perishable product to the Jakarta metropolis some 300kilometers away It is remarkable to find that this marketing system was organ-ized not by ethnic Chinese traders who held a dominant share in inter-regionaltrade in Indonesia but by indigenous entrepreneurs based in rural communities

The vital consideration in marketing vegetables is how to minimize the timerequired for delivering them from producers to consumers The traditionalapproach relied on the farm women bringing their harvests to sell at morningbazaars in nearby towns In the village study some vegetables went through thischannel but more than 70 percent was shipped to distant markets in Jakarta andother major cites For an entrepreneur to organize this long-distance shipment itis critically important to assemble a full truckload of vegetables since a half loadwould effectively double the cost of transportation But unlike the case of stor-able commodities for fresh vegetables the shipper cannot wait for long until thefull truckload is assembled For this reason vegetable marketing must be verytightly coordinated with production and harvest In their ability to establishcoordination with farm producers the indigenous entrepreneurs living in vil-lages had a decisive advantage over ethnic Chinese traders who were based incities and towns

Organizers of the long-distance shipment of vegetables are called ldquointer-village collectorsrdquo who assemble vegetables through smaller collectors calledldquovillage collectorsrdquo For developing a concrete image an inter-village collector

98 Y Hayami

who operated in the study village will be portrayed He owned about fivehectares of farmland (quite large in the context of Java) of which a part wascultivated under his direct administration and the rest was leased out He con-tracted with some 20 village collectors for assembling vegetables for shipmentmainly to Jakarta markets

His daily operations are as illustrated in Figure 52 In the early morningfarmers harvest vegetables and deliver them to village collectorsrsquo houses whichserve as and are also commonly called ldquodepotrdquo Then the inter-village collectorsends chartered trucks each with one of his agents to go around depots to loadthe assembled vegetables As soon as the truck becomes fully loaded it immedi-ately proceeds to Jakarta In about five hours the truck reaches either one of thetwo major wholesale markets in Jakarta The cargo is delivered to a consigneewho sells vegetables by the sack to resalers in open space or else in a roofedfloor that is leased from the market office Although formal auction is not prac-ticed the operation constitutes ldquode facto auctioningrdquo as many resalers gathertogether to buy in competition one with another The resalers bring back their

AM Farmer harvests

and brings vegetables

to village collector (depot )

Send truck with agent to load vegetables at depots

and proceed to Jakarta

Consignee Resaler

Payment to agent

Jakartawholesalemarket

returns

with agent

Payment to village collector farmer

Arrangement of truck for tomorrow

Figure 52 Operations of an inter-village collector for vegetable marketing in anupland West Java Indonesia

purchase to their stalls within the market and sort out vegetables by grade forsale to retailers such as grocery shopkeepers and peddlers with carts As soon asthe inter-village collectorrsquos agent receives the sales proceeds from the consigneethe truck returns to the village After receiving the money from the agent theinter-village collector goes round his village collectors to pay for the vegetablescollected by them in the morning that he sold in Jakarta deducting first his owncommission from the sales proceeds At the same time he tries to obtain thevillage collectorsrsquo estimates of the amounts of vegetables to be assembled nextmorning using this information to charter the trucks from various sources forthe next dayrsquos operation

This is a very tightly scheduled operation designed for quick delivery of per-ishable commodities to metropolitan consumers with minimum loss in theirvalue For this marketing system to be viable the inter-village collector must beable to secure (a) reliable supply from vegetable growers via village collectorsand (b) conscientious services of consignees in metropolitan wholesale marketsTaking the latter point first unlike the case of wholesale markets in developedeconomies the consignee in the Jakarta markets is not a formal agent officiallylicensed to conduct auctions based on some formal rules With no official recordkept of the transactions between consignees and resalers the inter-village collec-tors cannot check the veracity of the sales reports handed to their agents fromconsignees It is also difficult for their agents to monitor a consigneersquos dealingswith the many resalers that take place in an apparently unorganized chaoticmanner In fact agents and drivers usually go to lunch while this de facto auc-tioning is taking place

Under such conditions a consigneersquos conscientious services can only besecured by mutual trust established through long-term regular transactions It iseasy for a consignee to cheat an inter-village collector on the sales of hiscargoes However if he under-reports prices too much and too often thechances improve that his opportunism will be detected as the inter-village col-lector may compare his trade outcomes with those of other inter-village collec-tors in the same community dealing with different consignees This will possiblyresult in impairing the trust and confidence in this consignee that could lead toloosing his trade which is suicide for the consignee living on commission on defacto auction sales In this way the community mechanism of social opprobriumand ostracism restrains marketing agents outside the village community such asthe consignees in the Jakarta markets from venturing in moral hazard

For sustaining this mechanism to function an inter-village collector mustsend his truckload regularly to consignees each in a different wholesale marketFurthermore the inter-village collector must plan for delivering a number oftruckloads and to different destinations in order to reduce his risk As iscommon with perishable commodities the price of vegetables fluctuates widelyin various wholesale markets based on the deviations of a dayrsquos truck deliveriesfrom the normal amount of cargoes usually received In the specific case of thisstudy the inter-village collector usually sent his cargoes to four wholesalemarkets two in Jakarta and two in other major cities Correspondingly his task

100 Y Hayami

to secure the reliable supply of vegetables from farmers becomes more difficultbecause the needed supply not only is large in volume but must also be regularand predictable for the sake of accurately scheduling truck transportation

A device for securing the reliable supply is to tie both village collectors andfarmers by credit The inter-village collector advances credit to farmers throughvillage collectors for the purpose of assuring delivery of their collected vegeta-bles The same mechanism of tying through credit is also in operation occasion-ally between large wholesalers in towns and small collectors in villages withrespect to storable commodities such as corn and soybeans However tradecredits involved in these crops are short term ranging from a few days to a fewweeks and they seldom flow to farmers In contrast it is unique for vegetablemarketing that this credit tying mechanism is practiced for longer-term produc-tion loans to farmers that extend to two or three months and involving two prin-cipal agents the inter-village collector who advances credit to the villagecollector and the latter who typically delivers the credit to the vegetable growersin kind in the form of fertilizer and chemicals with the agreement that theirtotal harvests shall be delivered to him Farmersrsquo credit repayments are deductedfrom the sales proceeds of vegetables over the harvest season At the end thevillage collector delivers to the inter-village collectors on their agreement thatall the vegetables assembled shall be marketed by the latter With the successfulconclusion of the season the renewal of the contract becomes automatic for thenext season

In this contract interest is not charged explicitly for lending to farmers nor isit reckoned implicitly by paying lower prices to credit-receiving farmers than tonon-credit receivers Nevertheless collectors are able to recover their creditcosts by taking advantage of the differential in prices paid by collectors andthose paid by farmers for various farm inputs For example inter-village collec-tors bought the urea at the wholesale price of Rp185 per kilogram from fertilizerdealers in town In turn they had the village collectors charge the farmersRp200 on their credit repayments which is less than the farmers would have topay if they bought their urea at the village grocery stores in small lots As illus-trated in Table 51 the average cost of current inputs advanced as credit in kindwould have totaled to Rp70500 per farm according to the 1990 case survey iffarmers themselves were to buy in cash whereas the same inputs could havebeen purchased by collectors at the cost of Rp65550 In the credit-tying opera-tion collectors charged the farmers a total of Rp70750 for these inputs If creditis paid back in two months collectors earned in effect an interest rate of 39percent per month Credit cost for inter-village collectors who generally ownsizeable land assets should have been close to 15 percent per month which wasthe official rate of collateral loans from the government Bank (Bank RakyatIndonesia) Thus collectors could capture a large margin in this financial inter-mediation which is considered a return to their higher credit-monitoring capa-bility with respect to farmer debtors as compared to the Bankrsquos monitoringcapability

This lucrative credit operation for collectors is also advantageous for farmers

The input cost in farmersrsquo own cash purchase (Rp70500) compared with theirpayment to collectorsrsquo credit in kind (Rp70750) implies an effective interestrate as low as 02 percent per month This rate was much lower than the interestrates farmers would have paid if they were to purchase the inputs on credit fromfertilizer dealers (19 percent) or if their purchases were based on non-collateralloans from the government bank (38 percent) which accounts also for the hightransaction costs of the bank for dealing with small credit sizes (Hayami andKawagoe 1993 Appendix B) Thus this credit-tying contract represents aPareto improvement benefiting both collectors and farmers

The credit-tying contract stipulates that a farmer sells his produce exclusivelyto a village collector at prices offered by the latter during the season under con-tract2 This does not establish monopsonistic power for the collector since thefarmer can always shift to another collector in the next season if he considersthat he received a bad deal in relation to the market prices The same relationholds between an inter-village collector and the village collectors In fact aninter-village collector who once operated in the study site was cut off fromfarmers and village collectors resulting in the closure of his business as hedeveloped the reputation of paying ldquounfairrdquo prices

With the reliable supply of vegetables based on the mutually beneficial con-tract inter-village collectors are able to organize efficiently the long-distancemarketing of perishable commodities involving high risk and high transactioncosts Enforcement of this contract has to rely solely on community relationshipsbetween farmers and collectors living in the same village community It is diffi-

102 Y Hayami

Table 51 Credit costs for vegetable producers under alternative credit arrangements inthe Majalengka district West Java Indonesia 1990

Input costEffective interest rate for

per farma

(Rp)Farmer Collector

(percent per month)

Cash purchaseFarmer (in small lot) 70500Collector (in large lot) 65550

Credit purchaseCollectorrsquos trade credit 70750 02 39Fertilizer dealersrsquo sale on credit 73250 19Bank loan 75950 38b 15c

Source Hayami and Kawagoe (1993 Table 46 p 129)

Notesa Cost for 150 kg of urea 50 kg of triple superphosphate 100 kg of ammonium sulphate and one

liter of Azodrin per 125 bata (018 ha)b Official interest rate plus transaction costsc Official interest rate for collateral loan

cult to enforce such contracts on traders outside the community especiallyethnic Chinese traders based in town In Indonesian villages in particularChinese traders are discriminated against and cannot carry incentives from thefarmers that would induce them to honor their contracts They can hardly rely onthe mechanism of social opprobrium and ostracism for protecting their interestsfrom moral hazard exercised by people living in rural villages Also they cannotexpect fair play from governmental agencies including the police and the courtfor dispute settlement There is no wonder therefore no ethnic Chinese traderwas found operating in vegetable shipments in the study site Similarly but cer-tainly not for the same reasons no village cooperative operated in this field3

In retrospecting on this case study and viewing it in its stepwise sequentialdevelopment one may recognize that vegetable marketing in a marginal uplandarea in Indonesia has the same organizational structure as the institution of con-tract farming The ultimate aim is to coordinate efficiently the farm-level pro-duction of smallholders with long-distance shipment that is subject to economiesof scale for the timely and suitable delivery of highly perishable commodities tothe market The lubricant of this fragile coordination is the reservoir of trust andreputation that binds together the members of a village community and deliversefficient enforcement of a long-term interlinked contract

It came as a real surprise to find great similarities between this vegetable-marketing system in Indonesia and the modern subcontracting system used byautomobile assemblers in Japan (Hayami and Kawagoe 1993) Typically aJapanese automobile assembler develops long-term multi-linked contracts witha relatively small number of part suppliers involving technical guidance andcredit guarantees in a ldquovirtualrdquo community relationship The mutual trustdeveloped between the parties enables the assembler to rely on the supply of theparts in the right quantity and quality and at the right time so that the assemblerdoes not need to hold any significant inventory of parts (Asanuma 1985 Wada1998 Fujimoto 1999) This system known as Toyotarsquos ldquojust-in-timerdquo system(kanban) has the same contract structure as the system of vegetable marketingin Java In both the Indonesian and the Japanese case the success of the systemlay in the arrival of the commodity specified in the contract in the market (inIndonesia) or in the factory for processing (in Japan)4 This resemblance may notbe merely coincidental In fact the Toyota automobile company started as arural-based industry when it was first founded in 1932 as a department of a loommanufacturer From the beginning it purposively tried to develop a communityrelationship with parts suppliers according to the model of rural entrepreneurswho were then organizing peasant marketing and putting out contracts widelyover Japan (Wada 1998)

It cannot be over-emphasized that the Indonesian marketing system which isequally intricate as Toyotarsquos just-in-time system was appropriately designedand operated by indigenous entrepreneurs rooted in rural villages If the poten-tial of rural entrepreneurs in low-income economies as demonstrated by theIndonesian study can be adequately tapped it will become an important basisfor the development of modern contract farming which can serve as an efficient

mechanism to channel rising global demands for new high-valued commoditiesto subsistence farmers in the marginal areas of developing economies Withldquojust-in-timerdquo agriculture the contract farming system could be extended beyondthe plantation crops and geographically into the village communities

Concluding remarks

Rural markets in low-income economies are simply underdeveloped They oftenlack the legal infrastructure for dispute adjudication and the police infrastructurefor a mechanism of third-party contract enforcement They are subject to marketfailures they are imperfect as opposed to perfectly competitive and they arealso incomplete because of information asymmetries as a result of which theyare subject to moral hazard and adverse selection of risk Yet they work

This chapter analyzed the case of vegetable marketing in Indonesia in whichrural entrepreneurs have built a sophisticated ldquojust-in-timerdquo system for deliver-ing to distant markets perishable commodities utilizing the rural communitiesrsquomechanisms for building personal trust The trust that grows as a result of per-sonal interaction in tightly linked communities can be used to decrease transac-tion costs and effectively contest markets that were previously not accessible tothe producers in these communities

An important corollary from this application of trust is that it works bestwhen governments keep off and let the markets be contestable It is criticallyimportant in supporting rural entrepreneurs for governments to refrain from dis-torting incentives of market agents If markets are competitive profit-seekingprivate entrepreneurs in rural areas will try to make the best use of communityrelationships for reducing transaction costs in order to win in competition Theresulting efficiency improvements in marketing will benefit both consumers andproducers including poor peasants and cottage manufactures under competitivemarket environments On the other hand if the government or other agencies inan attempt to favor the communityrsquos efforts of repositioning their resourcesdeliver special privileges say to agricultural cooperatives and village associ-ations by granting them monopoly rights or exclusive access to subsidizedcredits and inputs they risk initiating a monopolistic process of cultivating eco-nomic rents The presence of monopoly will induce the elites to allocate theirresources to rent-seeking activities as opposed to activities that reduce costs andimprove services in their business that are needed for winning competition in themarket

In organizing contract farming for example it is not appropriate to grant anexclusive franchise over a territory to either an agribusiness enterprise or a coop-erative in order to force farmers operating in the territory to deliver their prod-ucts to the center for processing or marketing that is controlled by a particularprincipal In contrast if alternatives exist in processing or marketing farmerswould have an exit option to move to other principals after completing thecontract for the present period Otherwise contract farming will be an oppressorin support of monopsony to exploit smallholders irrespective of whether it is

104 Y Hayami

organized by a profit-seeking private business or by a non-profit organizationlike a cooperative

In concluding it should be pointed out that community-based trust asaddressed in this chapter bears in part some symmetry to the function that repu-tation serves at the global level as discussed in the introductory section of thisvolume (Yotopoulos Chapter 1 Pagano Chapter 2) Reputation is applied inParts III and IV of this volume at the global level and in uncontestable marketsie on all goods that transcend the definition of commodities which trade on thebasis of the minimum cost of production (Fok et al Chapter 8 DrsquoHaese et alChapter 9 and Romano Chapter 10) The ldquodecommodificationrdquo applies togoods and services that involve economic rents and thus trade as ldquopositionalgoodsrdquo in uncontested markets These markets are uncontested since economicrents are the result of some type of restricted competition whether it derivesfrom government edict from a special characteristic of talent or skill or as aresult of advertising and name recognition Reputation is a generic term for non-contestable market interactions that capture the economic rents embodied inldquopositional goodsrdquo

On the other hand the community-based trust is efffective in reducing transac-tion costs as illustrated in this chapter This can be instrumental in the develop-ment of the community network towards more ldquomodernrdquo exchange relationships(Liu et al Chapter 6) which can eventually make possible the involvement ofthe poor and marginal communities of the Third World in global markets

1 I would like to thank Pan Yotopoulos for his heavy-handed editing although I willnot absolve him from the collateral responsibility where he might have misunderstoodme

2 Usually the prices offered are determined from the sales proceeds at the metropolitanmarkets minus a certain percentage in commissions to the village and the inter-villagecollectors

3 In fact a village cooperative once tried it but gave it up The reason may be the samethat underlies the high interest rates that banks charge to farmers The type of closemonitoring of credit contracts that appears to be necessary from the discussion above iscostly and difficult for an impersonal enterprise to deliver

4 The general and generic shortage of space in Japan is equivalent to the perishabilitycondition of the vegetables in Indonesia that makes the ldquojust-in-timerdquo system crucialfor the fulfillment of the contract

References

Abreu Dilip (1988) ldquoOn the Theory of Infinite Repeated Games with DiscountingrdquoEconometrica 56 (March) 383ndash96

Aoki Masahiko and Yujiro Hayami eds (2001) Communities and Markets in EconomicDevelopment Oxford Oxford University Press

Asanuma Banri (1985) ldquoOrganization of Parts Purchases in Japanese Automobile Indus-tryrdquo Japanese Economic Studies 13 (Summer) 32ndash53

Baland Jean-Marie and Jean-Philippe Platteau (1996) Halting Degradation ofNatural Resources Is there a Role for Rural Communities Oxford Oxford UniversityPress

Bardhan Pranab K (1980) ldquoInterlocking Factor Market and Agrarian Development AReview of Issuesrdquo Oxford Economic Papers 32 (March) 82ndash98

Bell Clive (1988) ldquoCredit Markets and Interlinked Transactionsrdquo In Hollis Chenery andT N Srinivasan eds Handbook of Development Economics Vol 1 AmsterdamNorth-Holland pp 763ndash830

Feeny David Fikret Berkes Bonnie J McCay and James M Acheson (1990)ldquoThe Tragedy of the Commons Twenty-two Years Laterrdquo Human Ecology 18 (1)1ndash19

Fudenberg Drew and Eric Maskin (1986) ldquoThe Folk Theorem in Repeated Games withDiscounting or with Incomplete Informationrdquo Econometrica 54 (May) 533ndash4

Fujimoto Takahiro (1999) The Evolution of a Manufacturing System at Toyota NewYork Oxford University Press

Geertz Clifford (1978) ldquoThe Bazaar Economy Information and Search in Peasant Mar-ketingrdquo American Economic Review 68 (May) 28ndash32

Greif Avner (1989) ldquoReputation and Coalitions in Medieval Trade Evidence on theMaghribi Tradersrdquo Journal of Economic History 49 (December) 857ndash82

Greif Avner (1993) ldquoContract Enforceability and Economic Institutions in EarlyTrade The Maghribi Tradersrsquo Coalitionrdquo American Economic Review 83 (June)525ndash48

Hayami Yujiro (1989) ldquoCommunity Market and Staterdquo In Allen Maunder and AlbertoValdes eds Agriculture and Government in the Interdependent World AldershotGower pp 3ndash14

Hayami Yujiro (1994) ldquoPeasant and Plantation in Asiardquo In Gerald M Meier ed FromClassical Economics to Development Economics New York St Martinrsquos Press pp121ndash34

Hayami Yujiro (2002) ldquoFamily Farms and Plantations in Tropical Developmentrdquo AsianDevelopment Review 19 (2) 67ndash89

Hayami Yujiro and Yoshihisa Godo (2005) Development Economics From the Povertyto the Wealth of Nations 3rd edn Oxford Oxford University Press

Hayami Yujiro and Toshihiko Kawagoe (1993) The Agrarian Origins of Commerce andIndustry A Study of Peasant Marketing in Indonesia London Macmillan New YorkSt Martinrsquos Press

Hayami Yujiro and Masao Kikuchi (2000) A Rice Village Saga Three Decades ofGreen Revolution in the Philippines London Macmillan New York Barnes amp NobleLos Bantildeos Philippines International Rice Research Institute

Hayami Yujiro and Keijiro Otsuka (1993) The Economics of Contract Choice AnAgrarian Perspective Oxford Oxford University Press

Hayami Yujiro Masao Kikuchi and Esther B Marciano (1999) ldquoMiddlemen and Peasantsin Rice Marketing in the Philippinesrdquo Agricultural Economics 20 (March) 79ndash93

Kreps David M and Robert Wilson (1982) ldquoReputation and Imperfect InformationrdquoJournal of Economic Theory 27 (August) 253ndash79

Landa Janet T (1981) ldquoA Theory of the Ethnically Homogeneous Middleman GroupAn Institutional Alternative to Contract Lawrdquo Journal of Legal Studies 20 (June)349ndash62

Ostrom Elinor (1990) Governing the Commons New York Cambridge UniversityPress

106 Y Hayami

Wada Kazuo (1998) ldquoThe Formation of Toyotarsquos Relationship with Suppliers AModern Application of the Community Mechanismrdquo In Yujiro Hayami ed Towardthe Rural-Based Development of Commerce and Industry Selected Experiences fromEast Asia Washington DC The World Bank Economic Development Institute pp69ndash86

6 Export outsourcingCost disadvantage and reputationadvantage1

Bih Jane Liu Alan Yun Lu and An-Chi Tung

Introduction

The recent bout of globalization has brought about fundamental changes in thenature of international trade One of the most prominent changes is the integra-tion of world markets Although neither the extent nor the impact of the global-ization is symmetric across countries the integration of world markets proceedsin all parts of the world through the ldquofree-markets free-trade laissez-fairerdquomechanism in general and under the WTO framework in particular(Yotopoulos Chapter 1)

It is not surprising that globalization transcends the trade sector and manifestsitself also on the production side (Feenstra 1998) More precisely productionprocesses that had previously been integrated and performed within a firm havegradually been split up and assigned to different production units (Jones andKierzkowski 1989) In many cases the reassignment of production processeshas spread to suppliers beyond national borders due to cost concerns Further-more recent advances in telecommunications the globalization of finance andreductions in trade barriers have made offshore sourcing more appealing As aresult foreign outsourcing has been so widespread in the last two decades that ithas become ldquoa symbol of globalizationrdquo (Jones et al 2005 315)

Among all types of foreign outsourcing an important new mode export out-sourcing has been rapidly expanding in recent years Export outsourcing is thepractice by which firms that receive export orders subcontract part or the entireorder to firms in lower-wage countries while playing the dual role of a middle-man and a manufacturer Aside from their apparent similarities export outsourc-ing distinctly differs from three other types of outsourcing namely (a) theldquooutput outsourcingrdquo by large firms like Wal-Mart and Nike usually known asinternational subcontracting (Sharpston 1976) (b) the deepening of verticalspecialization in manufacturing trade (Hummels et al 2001) and (c) the out-sourcing of service jobs (Garner 2004) A major feature of export outsourcing isthat it involves three parties rather than two a point that will be elaborated later

Export outsourcing deserves careful attention for several reasons First it hasbeen prevalent among the newly-industrializing economies especially those inEast Asia since the 1990s (Gereffi 1999) In Taiwan for example almost

one-third of all the export orders received in 2004 (in terms of value) were filledand delivered from abroad increasing from almost none at all in the early 1990sSecond and more important as export sourcing is based on asymmetricinformation among the three parties involved it is a frequently-used means bywhich the export-outsourcing firms capitalize on the ldquoreputationrdquo advantagewhen faced with a cost disadvantage2

This chapter focuses on export outsourcing which is an important but under-studied area in the literature The next section introduces the new mode offoreign outsourcing and examines the basis of such a practice Two issues areexplored namely why the final buyer would prefer to have the intermediaryfirms involved and why these latter firms would agree to take on the middle-manrsquos role The third section proceeds to look into the pattern of export out-sourcing practiced by Taiwanese firms while paying special attention to howthe buyersrsquo requests exert their influence and why most firms choose to go toChina The case of Taiwanese firms is interesting not only because their roleshave switched in the practice of outsourcing over the years but also becausetheir sourcing activities have contributed considerably to the recent rise ofChina as the worldrsquos major exporter of textiles electronics and many otherproducts In concluding the chapter the final section discusses the futureprospects for export outsourcing in Taiwan as well as its relevance for othereconomies

Export outsourcing concept and basis

Characteristics of export outsourcing

Foreign outsourcing as mentioned above has long been used to implementinternational division of labor based on comparative advantage but has latelybecome more diversified and more extensively used There are four main typesof outsourcing It is important to highlight the differences between export out-sourcing and the other three types namely traditional outsourcing (or outputoutsourcing) input outsourcing and service offshoring In export outsourcingthe outsourcee who receives the order and subcontracts to a third party plays adistinct role in a game of information asymmetry Table 61 illustrates thesituation

The traditional type of outsourcing output outsourcing usually involves anoutsourcer in the north and an outsourcee in the south (Sharpston 1976) Fromthe mid 1960s on many branded firms (eg Nike) and large retailers (eg Wal-Mart) in industrial economies have contracted production to suppliers in lower-wage countries A certain portion of the subcontracted final products may beaimed at the export market but the lionrsquos share usually goes to the homemarket3 Over time the destination of sourcing has shifted from the middle-income countries whose wages have risen to countries with lower wages butthe age-honored operation has continued to be managed and controlled by theoutsourcers

Export outsourcing and reputation 109

Input outsourcing also involves two parties In a typical case of input out-sourcing an outsourcer subcontracts an intermediate input to an outsourceeimports the intermediate input and manufactures the final output at home(Hummels et al 2001)4 This practice has undergone quantum growth in recentdecades with the increase in vertical specialization Earlier studies have foundthat the percentage share of imported intermediates in domestic production hasrisen over time in both high- and middle-income countries (Campa and Gold-berg 1997)

Service offshoring is concerned with the outsourcing of services instead ofcommodities In services ranging from front-office to back-office functionsdeveloping countries around the world particularly in Asia have become largesuppliers for developed countries More often than not the kinds of services thatare moved offshore are those at the low end being labor-intensive information-based codifiable and of high transparency (Garner 2004) These services areldquocommodifiedrdquo and contain little rent for the outsourcees to capture (YotopoulosChapter 1)

Export outsourcing distinguishes itself from these three types of out-sourcing in that there are three parties involved Besides the two parties in thefirst-tier contract the outsourcee plays the role of a middleman and sub-contracts to a third party in the second tier5 Furthermore the intermediationin the two-tier contract functions in a different way from the usual middle-manship In the traditional type of intermediation such as the outsourcingof production to Taiwan engaged in by Japanese trading companies three orfour decades ago production experience on the part of the intermediary wasnot required In the current type of export outsourcing the second partyexercises the primary role of monitoring product quality and delivery(Gereffi 1999) and sometimes also provides product design (Hsing 1999)and managerial functions (Cheng 2001) All of these functions are basedmainly on competence in production In sum the intermediary firms not onlyextend the globalized supply chain by introducing new outsourcees to thegame but also create a new niche by crossing between commodity trade andservice trade thus ldquodecommodifyingrdquo the goods in which they trade(Yotopoulos Chapter 1)6

110 BJ Liu et al

Table 61 Types of outsourcing

Types First party Second party Third party

Output outsourcing outsourcer orders outsourcee producesa ndashInput outsourcing outsourcer orders outsourcee producesb ndashService offshoring outsourcer orders outsourcee providesc ndashExport outsourcing outsourcer orders outsourcee intermediates outsourcee produces

Notesa Final outputb Intermediate inputc Services

Basis of export outsourcing

Export outsourcing is a new option for exporting firms to respond to the chang-ing configuration of comparative advantage which has been commonlyobserved in East Asia It is worth noting that during the 1960s and 1970s thesefirms were the major receivers of original equipment manufacturing orders forlabor-intensive products from the industrial countries As wage levels in thesecountries went up the production sites gradually shifted away In view of thesechanges a firm can respond in one or several non-mutually exclusive ways suchas by engaging in technological upgrading outward investment or export out-sourcing7 each of which involves different degrees of resource commitment andflexibility8 One particular strategy that these firms adopted was to develop theintermediation function

Why is there room for intermediation in export outsourcing The key to thislies in the information asymmetry between buyers and producers (Wan andWeisman 1999)9 The middleman has to know what the buyer wants what thelow-end producer is capable of and how to coordinate the two parties Moreoverthe middleman has to establish a level of trust with both the buyer and the low-end producer to smooth the coordination process (Cheng 2001)

The assets these East Asian firms possess when engaging in this practiceinclude the following three a long-term partnership with industrial-countrybuyers a reputation as a reliable supplier of stable quality and timely deliveryand an ethnic or cultural linkage with certain low-wage countries (such as Chinaand Southeast Asia)10 As long-term business relationships are formed foreignclients tend to prefer not to incur the transaction costs associated with changingpartners With superior production competence the intermediary firm is assuredthat it has an edge over the low-end suppliers so as not to be replaced rightaway Finally with the proximity in culture or language with low-end producersthe first two advantages can be brought into full play11 By serving as middle-men the high-wage East Asian firms are able to earn the economic rent embod-ied in these implicit assets which in turn mitigates or even offsets the loss ofbusiness due to high wage levels

Yet the reputation advantage may gradually fade away which means thatwith time the market of the outsourcee becomes more contestable (HayamiChapter 5) Through the intermediation the outsourcer becomes more familiarwith production conditions and the final outsourcee improves in terms of manu-facturing competence The possibility of ldquodisintermediationrdquo increases with thenarrowing of the information gap between these two parties (Fingleton 1997)There are plenty of examples of suppliers appealing directly to buyers and mid-dlemen being replaced in the long run (eg Chen and Ku 2000 327) Assumingadequate rationality firms that practice export outsourcing capitalize on thereputation payoff with calculated risk

Analyzing export outsourcing

To understand when and how export outsourcing works in practice two inter-connected questions need to be answered First why would the clients whodesire to outsource go through the middleman firm instead of approaching thefinal producer themselves Second why would the middleman firm choose totake on this role12

Concerning the first question the client whose interest is to have the orderfilled at minimal expected cost has three choices besides producing in-house athigh cost Assume there are three parties A a client in the north (say in theUSA) C a producer in the south (say in China) and B a (Taiwanese) firm thathas served as Arsquos final outsourcee for many years Now with a rise in Brsquos wagerate A can either continue to contract with B but to pay v0 a price higher thanthe original one or hunt for other possibilities A new option is to contractdirectly with the low-wage C Yet as A is unfamiliar with the production con-ditions C may act opportunistically and over-charge A at v1 rather than the trueaverage cost v2 For simplicity we assume v0 gt v1 gt v2

Still another option for A is to contract C through B who has a reputation forbeing well-informed of the production conditions With the knowledge of Bsystematic falsehood by C is prevented13 Therefore when B is involved A onlyhas to pay C at v2 but has to pay B an intermediation fee v3 If the net saving inproduction cost exceeds the intermediation fee that is if v1 v2 gtv3 A wouldprefer to have B intermediated14 It is worth mentioning that if B and C areclosely connected culturally or in some other ways the saving in production costcan be much larger than in a case where B and C are alien to each other

The second question concerns the willingness of B to take on the middle-manrsquos role To intermediate B has to make some effort in monitoring and tutor-ing at the (opportunity) cost of v4 Assuming v3 gtv4 the net receipt fromintermediation is v3 v4 However by bringing A and C closer together B runs arisk of being bypassed in the future The risk v5 means a loss of future profitfrom a shorter remaining life If the net receipt exceeds the potential loss that isif v3 gtv4 v5 it is in the interest of B to engage in export outsourcing

In sum for A to subcontract C through B two conditions have to be met Amust be willing to go through B and B must have a matching interest such thatv1 v2 gtv3 gtv4 v5 If the intermediation fee v3 is too high relative to thesaving in production cost v1 v2 A will bypass B and contract directly with CIf the disintermediation risk or the opportunity cost is too high relative to theintermediation fee B will not choose to serve as the middleman according to theself-selection principle Only when the intermediation fee is in the right rangewill export outsourcing become the equilibrium outcome

This simplified analysis highlights the conditions for a three-party game totake place In reality firm B does not usually make a yesno decision rather itdecides on what percentage which segment and when to outsource based on itsown characteristics and external opportunities Some of these complications willbe discussed below while others will be left for future study

112 BJ Liu et al

Export outsourcing the Taiwan case

Data and measurement

The case of Taiwan is interesting and important as an example of export out-sourcing in two ways First the economy has gradually evolved from an out-sourcee in the south into an intermediary between the long-term clients in thenorth and the new suppliers in the south Whatrsquos more the Export OrdersSurvey 2001 conducted by the Ministry of Economic Affairs in Taiwan offers avaluable opportunity for us to understand better the pattern of export outsourc-ing as firm-level data are usually hard to obtain The survey includes a total of1712 respondents who accounted for 68 percent of Taiwanrsquos total export ordersin 2001 and encompass all manufacturing industries and the entire spectrum offirm sizes

Unlike the outsourcing ratios defined for input outsourcing15 the extent ofexport outsourcing has not yet been formally measured in the literature Twosets of export outsourcing indices are constructed here The first group of indicesmeasures the frequency of firms that outsource The second group calculates thepercentage of the value of outsourced orders in either all exporting firms or alloutsourcing firms16

Basic statistics

As summarized in the last row of Table 62 the frequency of all 1712 firmsengaged in outsourcing activities (OR1 hereafter) amounted to 3616 percent or619 firms The ratio of the value of the outsourced export orders (OR2) was2388 percent of all export orders and the ratio of outsourced orders for out-sourcing firms (OR3) was higher at 4541 percent17 These figures demonstratethat export outsourcing is a common practice among Taiwanese exporting firms

The 1712 firms are further categorized on the basis of industry or firmcharacteristics The first row shows a comparison of firms with and withoutoutward FDI Export outsourcing turns out to be positively related to foreigninvestment18 Firms with outward FDI had a higher outsourcing ratio than firmswithout both in terms of the frequency ratio OR1 (5327 percent vs 2186percent) and the value index OR2 (2930 percent vs 1549 percent) though therewas not much difference in the ratio of outsourced orders among outsourcingfirms OR3 (4637 percent vs 4281 percent) The rationale underlying the strongassociation between export outsourcing and FDI activities is that FDI firms havethe flexibility in choosing between multiple production sites and can minimizethe uncertainty in dealing with unrelated foreign suppliers (Hanson et al2003)19 Another reason is that firms without FDI may possess inadequate know-ledge to perceive outsourcing opportunities and to deal with the outsourceersquosopportunism (Helleiner 1981)

Second although pure traders outsource abroad more in terms of frequencyand percentage of value than manufacturing firms export outsourcing is already

widely used among manufacturers In 2001 3377 percent of the manufacturersoutsourced abroad The ratio is smaller than in the case of the pure trading firms(4906 percent) but the difference in the OR3 ratio is rather insignificant ndash 4474percent for manufacturers and 4960 percent for traders These results are not atall surprising as manufacturers in general need to worry more about the loss ofbusiness secrets to the outsourcees than do traders in other words the latter mayface a smaller v5 than the former

Third firm sizes do not matter much In particular small firms do not shyaway from export outsourcing The frequency ratio OR1 for small firms (3876percent) turned out to be slightly higher than for medium-sized (3464 percent)and large firms (3392 percent) while large firms tended to outsource a smallerportion of their export orders than the small- or medium-sized firms A likelyreason is that the services of the middleman here do not include the full range ofldquoheadquarter servicesrdquo as mentioned in Antraacutes and Helpman (2004) and aretherefore less sensitive to economies of scale

Finally firms in industries with either high or low growth rates engage morereadily in export outsourcing than firms with growth rates at the medium levelIn Table 62 firms are classified according to the long-run export performanceof the industry they belong to20 Firms with either the best (ldquoexport-thrivingindustryrdquo) or worst (ldquoexport-declining industryrdquo) export performances havehigher values of OR1 OR2 and OR3 than the rest of the firms One reason is thatfirms in both the thriving and the declining groups may have a smaller v5 as it is

114 BJ Liu et al

Table 62 Export outsourcing of Taiwanese firms

Types of firms No of firms OR1 ()a OR2 ()b OR3 ()c

Firms with FDI 779 5327 2930 4637Firms without FDI 933 2186 1549 4281

Manufacturers 1445 3377 2278 4474Traders 267 4906 3276 4960

Firms of small sized 663 3876 3209 5367Firms of medium sized 384 3464 2650 6008Firms of large sized 628 3392 2159 4135

Export-thriving industriese 976 4057 2688 4760Export-sluggish industriese 547 2962 1085 2787Export-declining industriese 189 3228 2918 6398

All firms 1712 3616 2388 4541

Source authorsrsquo calculations based on the Taiwanese Export Orders Survey 2001

Notesa OR1 percentage of firms engaging in outsourcing activity in all 1712 firmsb OR2 percentage of the value of outsourced orders in total export orders for all 1712 firmsc OR3 percentage of the value of outsourced orders for the 619 outsourcing firmsd Small firms are those with employment of less than 100 persons medium firms are those with

employment between 100 and 200 persons and large firms those with above 200 peoplee Firms are grouped according to the long-term export growth rate of their respective industries

(cf Table 6a1 for details)

hard to leak the business know-how out when the technology gap is large andthere is not much to leak out when the industry is at the sunset stage21 In sumthese observations are consistent with the economic intuition offered in thesecond section of this chapter (p 112)

Buyerrsquos request

We now look into the 619 firms that are engaged in export outsourcing Aspecial feature of this practice is the function of the buyerrsquos request Table 63lists the motivating factors specified by the firms in multiple choices such asthe presence of outward investment the need for flexibility the ease of secur-ing input quota or tariff considerations and so on22 The factor most frequentlyidentified is cost reduction which was chosen by 7609 percent of the 619firms23 In fact cost saving has been the major concern for all other types ofoutsourcing as well (Bryce and Useem 1998 Gereffi and Sturgeon 2004Garner 2004)

What is unique about export outsourcing is that many firms reported that theyconducted export outsourcing at the request of foreign clients The presence ofbuyerrsquos request confirms that there is a potential conflict of interest between A andB as shown in the second section of this chapter (p 112) Over half (5525percent) of the 619 firms specified that they were pushed by the requests of foreignbuyers The actual importance of this factor could be even higher because therequest is not needed if the intermediation is already in position and a tacit pres-sure can be exercised in place of an explicit request (Jan 1989 Fuller 2005)24

Table 63 Reasons for export outsourcing multiple choices by outsourcing firms

Number Reasons for outsourcing ()a

of out-Types of firms

sourcing Cost Buyerrsquos Need for Securing Tariffs

firms reduction requestFDI

flexibility inputsand

quotas

Firms with FDI 415 7735 5325 6193 3855 1783 1036

Firms without FDI 204 7355 5931 ndash 3382 1961 686

Export-thriving 396 7172 5707 4823 3813 1944 758industries

Export-sluggish 162 8580 4938 4506 3519 1543 1296industries

Export-declining 61 7869 5902 4590 3443 1967 984industries

Total 619 7609 5525 4717 3700 1842 921

Notea The row totals of the percentages do not necessarily add up to 100 due to multiple choices

Going to China

Another striking feature of the export outsourcing among Taiwanese firms isthat the bulk (7440 percent) of the outsourced orders went to China (Table 64)Why do firms go to China Cost saving unquestionably lies at the core Theaverage wage rate of workers in Taipei is five or ten times higher than that paidin China (Table 65) However Chinese wages are not the lowest in Asia andthe relocation of export orders to China must have been triggered by otherfactors as well Here cultural affinity matters The intermediation by Taiwanesefirms in China has been more effective than in other countries such as Mexicoin textiles as well as electronics (eg Ancelovici and McCaffrey 2005) Further-more Taiwanese firms have also faced fewer barriers than firms of othercountries such as Korea in intermediating in China in footwear and other indus-tries (Levy 1991 Lin 2001)

Given the cost and cultural concerns why do some firms choose to go to non-China regions An important consideration is the location of overseas invest-ment25 For firms that have already invested abroad export outsourcing followsFDI in most cases Firms with past investment in Southeast Asia for examplesent only 3128 percent of their outsourced orders to China which was lowerthan the percentage sent to their own overseas affiliates (6594 percent)However for FDI firms whose investment was driven by non-cost concerns (eginvesting in the USA as a sales office) and for firms that have not yet engagedin foreign investment China is again the dominant choice of location forsending the outsourcing orders (with 8016 percent and 6993 percent of out-sourced orders respectively)

116 BJ Liu et al

Table 64 Location of export outsourcing for Taiwanese firms

Number of Location composition ()a

outsourcingTypes of firms

firmsChina

Southeast OtherAsia countries

Firms with FDI (mainly in) 415 7244 1325 1432China 338 7718 809 1474Southeast Asia 40 3128 6594 278Other countries 37 6993 953 2054

Firms without FDI 204 8016 745 1239

Export-thriving industries 396 7446 1084 1470Export-sluggish industries 162 6199 2436 1364Export-declining industries 61 9358 617 025

Total 619 7440 1177 1383

Notea Percentage of total outsourcing value

Concluding remarks

Export outsourcing a practice combining middlemanship and manufacturinghas been expanding rapidly in recent decades As a newly-opened option forexporting firms to respond to the globalization under severe cost competitionthe practice raises a series of questions How does it differ from other types ofoutsourcing or intermediation Why is there room for export outsourcing Whenwill an exporting firm choose to engage in export outsourcing Will this practicebe viable in the long run Is it a useful model for firms in other countries tofollow

This chapter has answered the first couple of questions using Taiwanesefirms as an example The major findings are summarized as follows Firstexport outsourcing distinguishes itself from similar practices in that it extendsbeyond a two-party game into a three-party one Second the middleman firmcan capitalize on a reputation payoff which is derived from its past productionexperiences as well as the information asymmetry between the three partiesThird there may be conflicts of interest among the three parties and intermedi-ation takes place under certain conditions Fourth export outsourcing thesedays is increasingly practiced by Taiwanese firms and China is the mostpopular destination this being due not only to cost concerns but also to culturallinkages

These findings provide some hints in regard to the last two questions whichare relevant to Taiwan as well as to firms in other countries in the south Histor-ically Japan outsourced export orders to Taiwan in the 1960s and 1970s at atime when Japanese producers started to suffer from rising wages EventuallyTaiwan has evolved to play a role similar to that which Japan had played by

Table 65 Wages in Asian cities 2002 (US$)

City Monthly wage for workersa

Taipei Taiwan 10285Shenzhen China 2210Kuala Lumpur Malaysia 2080Shanghai China 2070Bangkok Thailand 1630Shenyang China 1550Manila Philippines 1500New Delhi India 1380Chongqing China 1325Ho-Chi Minh City Vietnam 1175Jakarta Indonesia 1080Dalian China 1075

Source authorsrsquo calculations based on JETRO (2003)

Notea Average monthly wage of workers employed in Japanese companies investing in Asia

outsourcing export orders to China and other countries though with certain dif-ferences mentioned earlier During this evolutionary process Japan has beendisintermediated by Taiwan in quite a few instances especially in industrieswith low levels of sophistication such as footwear (Levy 1991) In the mean-time Japan has upgraded and has stayed in the high-income club

Will Taiwan follow in Japanrsquos footsteps to become fully developed Anumber of Taiwanese firms have managed to climb up the quality ladder ie totrade in decommodified exports with examples ranging from footwear to elec-tronics However the lack of brand reputation and core technology seems toplace Taiwanese firms in a weaker position in the global supply chain today thanthe Japanese firms when they served as the intermediary decades ago What thefuture holds for Taiwan is thus not certain

Then what are the implications for the rest of the south It is true that Tai-wanese or more broadly East Asian firms have a number of unique assets asexplained in the second section of this chapter It is also true that the particularconditions in each economy give rise to different sets of possible responses tothe changes in the asymmetric trading world Taiwan itself is now in a halfwayhouse being in neither the best nor the worst of the worlds To other economiesin similar positions globalization may bring about either the best of times or theworst of times should things go really wrong26 More research in this area iswarranted

Appendix

An analysis of the three-party game

A simple game theory analysis is offered here to answer the two questions con-cerned with the three-party game (1) If outsourcing is desirable for the out-sourcer why does it need the Taiwanese firm to get involved instead ofapproaching the actual producer by itself (2) If the involvement of the Tai-wanese firm is useful then why would the firm sometimes choose not to take onthe role

Question 1

To answer the first question as to why the client needs the middleman firm con-sider a situation with three parties A a client in the north (say in the USA) B a(Taiwanese) firm that has served as the outsourcee to A for many years and C aproducer in the south (say in China) There is also Nature which randomlyselects the state of the production conditions to be either g (good) or b (bad)which is identically and independently distributed for each task in each period

A has diversified needs Both B and C are specialized operators where B isone of a number of competing firms with a well-known reputation for beingfamiliar with production conditions for clients like A who is unfamiliar with theproduction conditions

118 BJ Liu et al

The interest of A is to have the order filled at a minimal expected cost The inter-est of B is to maximize its expected present value of profit The interest of C is tomaximize its own expected reward by choosing the needed effort level which iseither ldquohighrdquo for the good state or ldquolowrdquo for the bad state and reports what thatstate is (γ for good and β for bad) how much effort is accordingly needed and thenpresents the bill for the task The charge will of course be higher if a bad state isreported The bill will be either accepted (symbol a) or rejected (symbol r) by A

A is accustomed to outsourcing to B before the wage rate rises in B After thewage rise A can either continue to contract with B by paying v0 on averagewhich is assumed to be lower than Arsquos own in-house production cost or torespond in one of the following ways

Case 1 A contracts directly with C (Figure 6a1)

Since A is unfamiliar with the production conditions C can act opportunisti-cally Whether the true state of nature is good (g) or bad (b) the reported state(by C) is always bad (β) leading to two possible nodes one reached by (g β)and another by (b β) Faced with an information set that consists of both nodeswhich represents Arsquos inability to tell what is true from what is false A musteither reject all which is self-defeating or accept all and acquiesce with the sys-tematical fraud of C The heavy lines in the game tree show the equilibriumoutcome This means an inflated bill at cost v1 for A rather than the true cost v2on the average and v1 v2 For simplicity assume v0 v1 v2

Nature

Figure 6a1 A places orders directly with C

Case 2 A places orders indirectly with C through B at a market-determined fee v3 (Figure 6a2)

The responsibility for monitoring the behavior of C now shifts to B Since Bhas the experience of being a specialized operator B knows well the probab-ility that the state of Nature is good Any attempt by C to falsely report thestate as bad (β) while the true state is good (g) will be rejected by B As such arejection will inadvertently affect Crsquos record or reputation in the specializedprofession it will be an unacceptable outcome for C So systematic falsehoodis prevented

If the cost saving v1 v2 on average for A from working through B is higherthan the fee paid to B v3 A will prefer having B involved If v1 v2 v3 insteadA will place its order directly with C

Question 2

The second question concerns why the middleman firm sometimes chooses notto get involved For B to engage in the service of providing export sourcing itmust expend some effort at an opportunity cost v4 which may be less than v3that is v4 v3

In addition B runs a higher risk of being bypassed by A if it plays the middle-manrsquos role and brings A and C together The capital loss arising from the

120 BJ Liu et al

Nature

Figure 6a2 A places orders indirectly with C

additional risk is denoted by v5 which is proportional to the present value of thebusiness based on a certain hazard rate By staying out of the three-party gamethe profit of B is v4 by staying in its net profit is v3 v5 Therefore B will takeon the middlemanrsquos role if v4 v3 v5 otherwise it will prefer to engage inother activities

Remarks

1 The above discussion indicates that for A to contract C through B two con-ditions have to be satisfied A must be willing to go through B and B musthave a matching interest

v1 v2 gtv3 gtv4 v5

If v3 is too high A will bypass B and contract directly with C If v3 is toolow or v4 v5 is too high it is in the interest of A to invite B in but thelatter may not want to play the middlemanrsquos role Unless A is willing toraise v3 adequately high B would not ldquodrink poison to quench the thirstrdquo asthe Chinese proverb goes

2 There is another case where the cost disadvantage to B is not very serious ascompared with the inflated charge by C such that v1 v0 v2 Then whenv0 v2 v3 it is in the interest of A to have B involved as a middleman onrequest but not as a producer especially if B has a higher payoff throughproduction than through intermediation

Growth of export outsourcing by industry classification

Table 6a1 A classification of industries by export performance

Average annualIndustry types export growth rate Industries covered

1990ndash2000

Export-thriving industries ge7 Electronics information and (world average) communications chemicals basic

metals precision instrumentselectrical equipment plastics andrubber

Export-sluggish industries lt7 but ge0 Machinery transportationequipment textiles furniture andmiscellaneous manufacturing

Export-declining industries lt0 Footwear plywood householdappliances processed food toysgames and sports animal andplant products leather andceramic products

1 The authors would like to thank Pan Yotopoulos for very helpful comments Bih JaneLiu also acknowledges the financial support of the National Science Council(NSC91ndash2415ndashH-002ndash021ndashSSS)

2 By reputation here we mean being known to possess competence or informationregarding production (as analyzed in the first part of the appendix to this chapter)Note that the term reputation is used as in Yotopoulos (Chapter 1) and not in theway it is used in game theory for instance as in the chain-store paradox (Selten1978)

3 American retailers for example K-mart and Wal-Mart outsource for the mainpurpose of domestic sales Nike derived 63 percent of its total revenue in footwearsales from the US market in 1988 (Donaghu and Barff 1990) The ratio fell to 48percent in 2004 but was still high (calculated from Nikebiz 2005)

4 Various other terms such as ldquoslicing the value chainrdquo (Krugman 1994) have beenused in the literature to address similar but differentiated aspects of vertical special-ization (Feenstra 1998)

5 By contrast the ldquotriangle manufacturingrdquo practice as described in Gereffi and Pan(1994 138) is in essence a two-party game as the buying offices of American retail-ers in Taiwan that handle both onshore and offshore production are not independentdecision makers

6 Even after disintermediation which will be discussed later in the text this catalyticrole remains important

7 For example export outsourcing now may serve as the ldquocash cowrdquo to finance upgrad-ing later

8 Upgrading requires heavy technological and capital investments Owning a foreignsubsidiary necessitates the commitment of capital as well as managerial input andtechnological know-how In comparison export outsourcing requires less resourceinputs but carries more uncertainty

9 Spulber (1999) offers a general and comprehensive discussion on the role of themiddleman

10 The East Asian trader-manufacturer firms differ from the independent traders of ricein the Philippines (Hayami Chapter 5) who also have these three assets More specif-ically the long-term partnership with buyers in the industrial country and specificallythe reputation that has accrued as a result has ldquodecommodifiedrdquo their export productsenabling them to capture also economic rents therefrom Expressed in more generalterms the East Asian firms have by now improved their production capabilities andare better in adapting in a dynamic world with frequently changing comparativeadvantage

11 Taiwan (or Hong Kong) and China in particular share the same language and thesame race of people

12 A more detailed game-theoretic analysis of these two issues is presented in the appen-dix to this chapter

13 Although not considered here it is possible that the yield rate of C improves throughthe tutoring of B

14 Cf the appendix to this chapter for another case when the cost disadvantage of B isnot very serious as compared with the inflated charge by C

15 Campa and Goldberg (1997) for example calculated the ratio of imported intermedi-ate to total intermediate input purchases in four advanced countries Hummels et al(1998 2001) computed the imported input content in exports in ten OECD countriesand four newly industrialized countries

16 Note that based on the rules of origin the value of export orders produced and trans-ported abroad is recorded under the outsourceersquos country

17 It is understandable that the OR3 is not 100 percent in the case where firms continue

122 BJ Liu et al

to manufacture high-end products by themselves to earn v0 while engaging in exportoutsourcing to earn v3 on low-end products

18 International outsourcing is seen as a substitute for FDI in the literature (eg Gross-man and Helpman 2003) for only imports from non-affiliates are included as inputoutsourcing

19 For example when an independent outsourcee fails to meet the quality or punctualityrequirement the owned subsidiary can meet it

20 Industries are categorized according to their average annual export growth rate in1990ndash2000 The export-thriving industries include those industries with a growth rategreater than or equal to the world average of 7 percent Those with a rate between 0percent and 7 percent are referred to as export-sluggish industries and those with anegative growth rate are referred to as export-declining industries Table 6a1 in theappendix gives more details

21 Other factors such as the magnitude of the saving in production cost v1 ndash v2 mayalso be at work

22 For example the Multi-fibre Arrangement (MFA 1974ndash94) and the Agreement onTextiles and Clothing (ATC 1995ndash2004) had governed world trade in textiles andclothing for many years

23 Note that the reduction in ldquocostrdquo asked in the survey refers to the costs to B and isdifferent from the cost saving of v1 v2 from Arsquos point of view

24 Moreover if firm B refuses to take the order there would be no observation even iffirm A had made the request

25 There may be a time effect Those who went offshore in the 1980s had a foothold inSoutheast Asia or other locations and those who made later the FDI decision havetended to go to China

26 The case of Lesotho illustrates how things could go wrong when globalization andthe abrupt end of the MFA wiped out a major source of foreign exchange (sourcesNew York Times Asia edn 18 April 2005 32 New York Times 31 May 2005 1)

References

Ancelovici Marcos and Sara J McCaffrey (2005) ldquoFrom NAFTA to Chinardquo InSuzanne Berger and Richard K Lester eds Global Taiwan Building CompetitiveStrengths in A New International Economy Armonk NY ME Sharpe pp 166ndash93

Antraacutes Pol and Elhanan Helpman (2004) ldquoGlobal Sourcingrdquo Journal of PoliticalEconomy 112 (3) 552ndash80

Bryce David J and Michael Useem (1998) ldquoThe Impact of Corporate Outsourcing onCompany Valuerdquo European Management Journal 16 (6) 634ndash43

Campa Joseacute and Linda S Goldberg (1997) ldquoThe Evolving External Orientation of Man-ufacturing A Profile of Four Countriesrdquo Federal Reserve Bank of New York EconomicPolicy Review 3 (2) 53ndash81

Chen Tain-Jy and Ying-Hua Ku (2000) ldquoForeign Direct Investment and IndustrialRestructuring The Case of Taiwanrsquos Textile Industryrdquo In Takatoshi Ito and Ann OKrueger eds The Role of Foreign Direct Investment in East Asian Economic Develop-ment Chicago and London National Bureau of Economic Research pp 319ndash48

Cheng Leonard K (2001) ldquoLi amp Fung Ltd An Agent of Global Productionrdquo InLeonard K Cheng and Henryk Kierzkowski eds Global Production and Trade inEast Asia Boston Kluwer Academic Publishers pp 317ndash23

Donaghu Michael T and Richard Barff (1990) ldquoNike Just Did It International Subcon-tracting and Flexibility in Athletic Footwear Productionrdquo Regional Studies 24 (6)537ndash52

Feenstra Robert C (1998) ldquoIntegration of Trade and Disintegration of Production in theGlobal Economyrdquo Journal of Economic Perspectives 12 (4) 31ndash50

Fingleton John (1997) ldquoCompetition between Intermediated and Direct Trade and theTiming of Intermediationrdquo Oxford Economic Papers 49 (4) 543ndash56

Fuller Douglas (2005) ldquoMoving Along the Electronics Value Chainrdquo In Suzanne Bergerand Richard K Lester eds Global Taiwan Building Competitive Strengths in A NewInternational Economy Armonk NY ME Sharpe pp 137ndash65

Garner Alan C (2004) ldquoOffshoring in the Service Sector Economic Impact and PolicyIssuesrdquo Federal Reserve Bank of Kansas City Economic Review 89 (3) 5ndash37

Gereffi Gary (1999) ldquoInternational Trade and Industrial Upgrading in the Apparel Com-modity Chainrdquo Journal of International Economics 48 (1) 37ndash70

Gereffi Gary and Mei-Lin Pan (1994) ldquoThe Globalization of Taiwanrsquos Garment Indus-tryrdquo In Edna Bonacich Lucie Cheng Norma Chinchilla Nora Hamilton and PaulOng eds The Apparel Industry in the Pacific Rim Philadelphia Temple UniversityPress pp 126ndash46

Gereffi Gary and Timothy J Sturgeon (2004) ldquoGlobalization Employment and Eco-nomic Developmentrdquo Sloan Workshop Series in Industry Studies Rockport MA14ndash16 June

Grossman Gene M and Elhanan Helpman (2003) ldquoOutsourcing versus FDI in IndustryEquilibriumrdquo Journal of the European Economic Association 1 (2ndash3) 317ndash27

Hanson Gordon H Raymond J Mataloni and Matthew J Slaughter (2003) ldquoVerticalProduction Networks in Multinational Firmsrdquo NBER Working Paper no 9723 Cam-bridge MA National Bureau of Economic Research

Helleiner Gerald K (1981) Intra-Firm Trade and the Developing Countries LondonMacmillan

Hsing You-Tien (1999) ldquoTrading Companies in Taiwanrsquos Fashion Shoe NetworkrdquoJournal of International Economics 48 (1) 101ndash20

Hummels David Dana Rapoport and Kei-Mu Yi (1998) ldquoVertical Specialization and theChanging Nature of World Traderdquo Federal Reserve Bank of New York EconomicPolicy Review 4 (2) 79ndash99

Hummels David Jun Ishii and Kei-Mu Yi (2001) ldquoThe Nature and Growth of VerticalSpecialization in World Traderdquo Journal of International Economics 54 (1) 75ndash96

Jan Wei-Shiung (1989) ldquoDiscoloring of Taiwanrsquos lsquoFootwear Denrsquordquo Commonwealth102 134ndash9 (in Chinese)

JETRO (2003) ldquoThe 13th Survey of Investment-related Cost Comparison in Major Citiesand Regions in Asiardquo Tokyo Overseas Research Department Japan External TradeOrganization

Jones Ronald W and Henryk Kierzkowski (1989) ldquoThe Role of Services in Productionand International Trade A Theoretical Frameworkrdquo In Ronald W Jones and Ann OKrueger eds The Political Economy of International Trade Cambridge MA BasilBlackwell pp 31ndash48

Jones Ronald W Henryk Kierzkowski and Lurong Chen (2005) ldquoWhat Does EvidenceTell Us about Fragmentation and Outsourcingrdquo International Review of Economicsand Finance 14 (3) 305ndash16

Krugman Paul (1994) ldquoDoes Third World Growth Hurt First World ProsperityrdquoHarvard Business Review 73 (4) 113ndash21

Levy Brian (1991) ldquoTransactions Costs the Size of Firms and Industrial Policy ndashLessons from A Comparative Case Study of the Footwear Industry in Korea andTaiwanrdquo Journal of Development Economics 32 (1ndash2) 151ndash78

124 BJ Liu et al

Lin Wei-Jen (2001) ldquoPao Cheng Footwear USA as the Mentorrdquo Commonwealth 23784ndash91 (in Chinese)

Nikebiz (2005) ldquoCompany Overview The Facts Nike Incrdquo Online availablewwwnikecomnikebiznikebizjhtmlpage3ampitemfacts (accessed 28 March2005)

Selten Reinhard (1978) ldquoThe Chain-Store Paradoxrdquo Theory and Decision 9 (2)127ndash59

Sharpston Michael (1976) ldquoInternational Subcontractingrdquo World Development 4 (4)333ndash7

Spulber Daniel F (1999) Market Microstructure Intermediaries and the Theory of theFirm Cambridge and New York Cambridge University Press

Wan Henry Y Jr and Jason Weisman (1999) ldquoHong Kong The Fragile Economy ofMiddlemenrdquo Review of International Economics 7 (3) 410ndash30

7 Transition economies andglobalizationFood system asymmetries on the pathto free markets1

Kolleen J Rask and Norman Rask

Introduction

Asymmetries in agricultural institutions

The emotional and often violent demonstrations accompanying global tradetalks underscore the enormity of the transformations occasioned by increasingintegration of global markets especially for developing economies While thesecountries try to mitigate the redistribution effects of trade-related changes(thereby often limiting trade itself) transition economies are faced with a con-trasting fundamental challenge recreating their economies to conform to globalmarket structures as a precondition for enhanced trade

Common to all markets whether classified as ldquofree marketsrdquo or ldquocommandsystemsrdquo is some level of governmental and institutional presence Indeed clas-sical economists were concerned not just with markets but with how marketswork within the broader context of society stressing that for proper functioningmarkets require some limited governmental (as well as moral) foundations(Yotopoulos Chapter 1) These foundations include legal institutions and trade-enhancing infrastructure among others In the United States and in WesternEurope the post-war development of agricultural markets was supported by sub-stantial public investment in areas such as research and development of inputs andproducts transportation rising standards for sanitation quality and safety Low-income countries could not provide this level of support resulting in the notedasymmetry of agricultural conditions In particular the relative paucity of institu-tional and infrastructural support in low-income countries places them at a severedisadvantage as they try to participate in world markets In recent years this asym-metry has been further exacerbated by the globalization of supporting serviceindustries and by the accelerating shift in agriculture from classical cost-basedcompetition in homogeneous products (in which low-wage countries would have acomparative advantage) to reputation-based sales of high value-added productsunder conditions of imperfect competition in which institutional and infrastructuresupport plays a bigger role (Yotopoulos Chapter 1 Romano Chapter 10)

During the same time a third group the centrally planned economies withintermediate incomes focused their government efforts in a different direction ndash

controlling and subsidizing quantity flows and generating artificially low foodprices thereby significantly enhancing domestic consumption relative to marketeconomies at similar income levels These differential policies created a furtherasymmetry in agricultural institutions and with market economies dominatingworld trade the institutions developed in these market countries would becomethe dominant global institutions Therefore with the onset of transition formercommand economies have also entered global markets at a marked disadvan-tage The rules of production and international exchange written by the marketeconomies do not value the institutions of central planning so the transitioneconomies must alter their institutions accordingly before they can compete suc-cessfully in this environment

These transformations are particularly acute for the agricultural and foodsystems in transition economies Following World War II the Soviet blocestablished a food supply and consumption system completely isolated fromoutside markets The limited trade consisted primarily of food from CentralEuropean countries and Baltic republics exchanged for energy from theUSSR Food prices were administratively set at low levels and agriculturalproduction was specified and subsidized creating a largely self-sufficientsystem However low food prices led to rich country diets with significantover-consumption of livestock products relative to market economies withsimilar income levels In the early years substantial agricultural resourcesand subsidies allowed production to keep pace with consumption The infa-mous ldquoRussian Wheat Dealrdquo in the early 1970s further exacerbated the distor-tions as the USSR entered world grain markets in a large way to purchaselivestock feed necessary to support even higher levels of livestock productconsumption

With the onset of transition in the early 1990s this ldquohouse of cardsrdquo cametumbling down as restructuring in countries of the former Soviet bloc broughtfood prices higher and closer to free market levels while per capita incomesdeclined As a result consumption of livestock products dropped precipitouslyRemarkably production of livestock products declined in line with consump-tion partly from the restructuring of agricultural production systems but perhapsas importantly from an inability to meet international market standards for dis-position of surplus production (infrastructure asymmetry) In the former USSRboth per capita consumption and production of livestock products fell below1960 levels and remain at low levels even today

Some recovery of consumption and production is evident in the western rimof transition countries where international standards are being imposed by acces-sion rules to the European Union However the fact that the base productionlevel for EU agricultural programs is set at the current low level of production(low relative to pre-transition levels) could lead to further consumptionndashproduction distortions as incomes and consumption continue to grow in theseagricultural countries

Food asymmetries in transition economies 127

The incomendashfood consumption asymmetry in transition economies

In this study we focus specifically on the paths followed by consumption asym-metries However as we have noted a decline in production has accompaniedthe decline in consumption up to this point and we raise concerns about meetingfood needs as production and consumption are likely to recover at different ratesas these economies grow in the future

It has been shown previously (Rask and Rask 2004) that there exists aremarkably stable market relationship between per capita income and resource-based food consumption measured in terms of cereal equivalents Distortions inthe centrally planned years created an asymmetry in this relationship betweenmarket and non-market economies reflecting non-market diets unusually rich inlivestock products for the given income levels accompanied by production sub-sidies and other distortions to enable those diets Lacking free market pricesfree trade and the free expression of comparative advantage effective participa-tion in economic globalization was precluded for these countries As distortionsare lifted and market institutions arise the incomendashconsumption relationship fortransition economies shifts dramatically and begins to approach the level ofmarket economies at which point greater participation in global marketsbecomes possible

The transition experience of the last decade or so is characterized by widelydivergent degrees of success in eliminating the food sector asymmetry Manytransition economies historically enjoyed a strong agricultural sector butendured significant distortions during the centrally planned years In particularlow- and medium-income populations in these pre-transition economies wereeating high-income diets abundant in livestock products The higher prices forlivestock products and lower incomes characteristic of the early transition yearssharply reduced demand for livestock products bringing consumption patternscloser to those of poorer market economies Within this general trend thosecountries that have experienced income growth during the transition period havereduced this incomendashconsumption asymmetry more quickly while others stillhave quite a distance to travel Once the asymmetry is removed and incomeimproves we expect significant reverse diet changes as livestock product con-sumption rises creating pressure on domestic agricultural resources and perhapsa need for greater imports of livestock products for some countries

It is significant that livestock production levels have generally fallen com-mensurately with consumption reductions reflecting lower demand internalstructural and policy changes and an inability to access international marketswith surplus livestock products Thus at later stages of transition and lowerlevels of per capita food consumption most countries are still only marginallymeeting food requirements Our analysis indicates that food consumption is nowlikely to begin increasing significantly as these countries enter a period of eco-nomic growth Increases in production however are hampered by a variety ofproblems including slow development of the non-agricultural rural economyslow transformation of the institutional systems of agricultural production (eg

128 KJ Rask and N Rask

consulting training research state administration) and the need to restructurethe food industry to accommodate higher quality demands (Csaki 2000)

This emerging scenario of increased livestock product consumption alsoposes particular resource use problems for the western rim of transition coun-tries currently entering or about to enter the European Union (EU) since pro-duction expansion is discouraged through quotas (milk sugar) and supplymanagement instruments such as base areas reference yields and productionpremiums (EU 2003) which are set at current historically low productionlevels Other authors have similarly sounded a cautionary note in this respectChevassus-Lozza and Unguru (2002) predict a substantial increase in agricul-tural imports especially for Poland and Hungary while the older EU membersparticularly Germany gain export markets Weber (2001) expects older EUmembers to export poultry and eggs to acceding members More fundamentallyErjavec et al (2003) and Ferto and Hubbard (2003) express concerns that thedevelopment of agriculture in acceding countries will be hurt by the distortionsembedded in EU agricultural policy The potential need for imports thereforecomes from the fact that while consumption is poised to rise structural adjust-ments in production agriculture as noted above may be more difficult toachieve and for some countries efficient production will be discouraged by rulesof accession to the European Union

To measure diverse food diets with a common denominator we use aresource-based per capita cereal equivalent (CE) measure (rather than nutritioncalories or expenditures) that approximates the resource difference in dietsexperienced at different levels of income Progress in the transition to non-distortionary market institutions is indicated by proximity to the market-basedrelationship between real income and CE consumption Individual transitioncountry as well as group experience is compared to the world market trendhighlighting contrasts projections for future changes in food consumption andimplications of EU membership

The incomendashfood consumption relationship during economic developmentand the cereal equivalent factor measure are discussed in the next section Themodel and data are presented in the third section with individual countryexperience detailed in section four The fifth section extends the analysis to live-stock production changes associated with transition including policy implica-tions with a summary presented in the final section

Incomendashfood consumption relationship using cerealequivalent factor values2

The incomendashfood consumption relationship in market-baseddevelopment

In the early stages of development food consumption responds dramatically toincome changes due both to the high proportion of income devoted to food con-sumption and the high marginal propensity to consume food (Rask 1991 Kydd

et al 1997) These changes are due primarily to the substitution of higher orderfoods (eg livestock products) for cereals and tubers Growing populations alsogenerate growing demand for food

At higher levels of income population growth typically slows while the per-centage of income spent on food consumption plummets reducing the impact ofincome growth on food demand As absolute food consumption levels off athigh incomes changes in demand center around ldquoconvenience and qualityfactorsrdquo such as packaging advance preparation and away from home consump-tion (Rask 1991) Therefore while expenditures on food continue to rise thedemand on raw food production resources eventually stabilizes In order toportray changes in basic food resource consumption we use the CE measurewhich accounts for both quantity and quality diet adjustments but excludes con-venience factors

Development of the cereal equivalent (CE) measure

The CE measure captures the changing resource requirements consistent withchanging diets across countries and level of development especially in regard toconsumption of livestock products Weight calorie and monetary measures donot reflect resource use since an ounce or a calorie of meat requires many moreresources to produce than does an ounce or a calorie of cereals and the use ofmonetary values is hindered by exchange rate issues lack of relevant price datain many countries and the inclusion of service and convenience cost factors notrelated to basic resource use

Early work on direct and indirect consumption

Yotopoulos (1985) showed that demand for food cereals as a function of incomeis comprised of a direct demand and an indirect demand Direct consumption ofcereals initially rises with income (under low elasticity) but then decreases athigher income levels Indirect demand for cereals (animal protein) however isvery elastic to income changes Using recent data Figure 71 illustrates thispoint showing dramatic increases in the portion of food consumption devoted tolivestock products as per capita income (real US$) grows Note that cereal con-sumption declines marginally at higher incomes while fruit and vegetable con-sumption rises slightly3 The inefficient conversion of cereals (feed) into animalprotein therefore has serious consequences for total resource availability con-tributing to the paradox of worsening famines as global incomes rise For ouranalysis we have extended the concept of cereals to cereal equivalents toinclude all forms of food4

Cereal equivalent factor values

Recognizing that cereals are consumed directly and indirectly we use CEs todefine diets across all stages of development expressed in tons of cereal

equivalents per capita per year CE values for crop products consumed in vege-table form (cereals root crops fruits vegetables) are calculated based on theircaloric content relative to the caloric content of an equal weight of cereals5 Thespecific CE coefficients for crops will vary slightly by country A sample of cropcoefficients for world averages for 2001 developed from FAO food balancesheet data is presented in Table 71

CE factor values for animal products are calculated using the CEs of feedsconsumed by the animal relative to production of specific consumable livestockproducts Grains and cereals are assigned a CE factor value equal to ldquo1rdquo Pro-duction livestock and livestock products are then converted to CE factor valuesbased on the feed embedded in their production This live weight measureincludes all forms of feed such as grains protein supplements forages (includ-ing pasture) and other feeds and includes feed consumption by breeding herdsThe live weight calculation is then adjusted for dressing weight percentage togive a final CE value for consumable product The principal consumable live-stock product CE coefficients are shown in Table 71 and their derivation isexplained further below

The livestock product CE coefficients were developed from USDA data onUS feed consumption feed conversion ratios and livestock production for theten year period 1964ndash73 (USDA 1975) chosen for data availability US feedconversion ratios from this period are probably equal to or somewhat more effi-cient than in many transition countries today but less than in many developedeconomies The USDA data for all feeds is given in corn equivalents Thecaloric content for current (2001) FAO data for the US for the cereal category isexactly equal to the caloric content for corn on a per unit weight basis

Total food consumptionmarket economies

1990ndash2001

0 5000 10000 15000 20000 25000 30000

Consumption oflivestock products

Fruits and vegetables

Cereals

Real GNI (PPP) per capita ndash US$

Figure 71 Food consumption measured in cereal equivalents cereals fruits vegetablesand livestock components

Thus we feel it is appropriate to use feed corn equivalents for determining CEcoefficients for livestock products For the world average corn has a slightlylower caloric content than the cereal category As with livestock production inmuch of the world non-concentrate feeds are a substantial part of the US live-stock feed supply with forages making up over three-quarters of all beef cattlefeed and over 90 percent for non-feeder beef cattle

The incomendashfood consumption relationship using cerealequivalents

The model and data

We begin with the straightforward model developed in Rask and Rask (2004)Food consumption rises as income increases but at a decreasing rate

Cce g(GNIPC) g0 g0 (1)

where Cce is per capita consumption measured in CE factor values and GNIPC isreal per capita gross national income The independent variable proxies the levelof economic development which directly affects consumption in terms of CEsRecall that this measure of food consumption focuses on resource use elimin-ating packaging and convenience aspects which dominate food expenditures athigher incomes

Updating previous work (Rask and Rask 2004) we used data from a broadrange of market economies to estimate the incomendashconsumption relationship inequation (1) in which annual per capita CEs of food consumption developedfrom FAO (2004a 2004b) data were regressed against annual real GNI percapita in PPP purchasing power parity (World Bank 2002) using the followingfunctional form

Cce A1 A2ekGNIPC (2)

Table 71 Sample cereal equivalent coefficients for crop and livestock products

Crop products Livestock products

Cereals 100 Beef 198Fruits 015 Pork 85Pulses 109 Chicken 47Starchy roots 026 Milk 12Sugar sweeteners 111Tree nuts 079Vegetable oils 278Vegetables 008

Source authorsrsquo calculations based on FAO (2004a) and Rask (1991)

The criteria for selecting data points for this group of market economies are thefollowing The time period covers the initial transition decade and more recentdata 1990ndash2001 Transition economies are excluded from the comparisongroup as are countries with low or negative income growth defined as less than10 percent aggregate growth in real gross national income per capita for years1990ndash20016 Only countries within a broad range of 07 to 13 agricultural self-sufficiency ratios are included in the comparison group as countries with veryhigh or low self-sufficiency ratios have a significantly different food resourcebase and pricing structure such as Japan and Australia All transition economiescurrently fall within this range Countries at all income levels are included forthe purpose of describing a market-based development pattern throughout thedevelopment process Finally small countries of less than one million popu-lation are excluded as outliers The resulting market economy group represents56 countries with 672 observations for the 1990ndash2001 period Regression resultsare detailed in Table 72 with the market-based relationship shown in Figure 71above

The market incomendashfood consumption relationship

In the process of market development per capita consumption measured in tonsof CEs per capita per year rises rapidly with income growth at low levels ofincome but the growth rate slows at higher income levels and begins to stabi-lize above US$25000 GNI (PPP) per capita Over this income range annualconsumption per capita increases about fivefold from less than 04 to over 20tons of cereal equivalents per capita per year Clearly people do not eat fivetimes as much food rather the diet change incorporating more livestock prod-ucts reflects more cereal or grain equivalents consumed As is shown in Figure71 cereal consumption decreases marginally with development fruit and vege-table consumption increases marginally and almost all of the fivefold increasein consumption is accounted for by livestock products Recall that consumers incentrally planned economies consumed a far higher proportion of livestockproducts and therefore cereal equivalents than the market-based curve wouldpredict for their income levels The transition process is therefore seen in part asa movement from this distorted position toward the market relationship definedhere

Table 72 Incomendashconsumption relationship estimates for market economies 1990ndash2001

Estimate Asymptotic standard error

A1 2374 00749A2 2036 00649k 589sdot105 4471sdot106

R2 = 090 n = 672

Reducing the consumption asymmetry during transition

Throughout the pre-transition era consumers in centrally planned economiesconsumed as much food in terms of cereal equivalents as consumers in marketeconomies with income levels more than 75 percent higher (Rask and Rask2004) As transition to market began these countries experienced severedeclines in consumption which leveled off for some countries but continue forothers We begin by dividing the transition countries into three country groupsto highlight three very different paths of incomendashconsumption adjustmentThese groups are the former USSR the Central European countries (Czechoslo-vakia Hungary Poland) and the Balkan countries (Albania Bulgaria Romania)The paths followed by the Central European countries highlight the importanceof income growth in removing the asymmetry with less consumption loss Notethat China is not included in FAO data for transition economies and is not con-sidered in our analysis here due to its very different transition process andtiming We have however shown its incomendashconsumption path in Figure 72 asa contrast to that of other transition countries and indicated its current positionrelative to the market trend in Figure 74 Given the statistical dominance of theRussian Federation and the Ukraine in the former USSR we then disaggregatethe USSR in Figure 73 to display the diversity of experience in this region Thecurrent position of all countries is shown in Figure 74 with anticipated changesin consumption for selected countries and country groups presented in Table 73

Each group shown in Figure 72 follows a significantly different path ofadjustment From 1975 to 1989 both China and the USSR enjoyed increasingreal income as well as increasing per capita food consumption with the USSRshowing a greater asymmetry in its relationship compared to the market trendAfter 1989 the USSR (and eventually the 15 countries comprising the formerUSSR) took a sharp turn in the reverse direction losing both in income and con-sumption on a per capita basis There is some income recovery beginning in1999 while consumption remains at a level 40 percent below its 1989 peakChina in contrast began its transition much earlier and had less distortion tobegin with resulting in a continuous positive trend for both income and con-sumption not exhibited by any other transition economy In 2001 China wasexperiencing consumption levels somewhat above that of market economies atsimilar income levels reflecting increasing asymmetry Surprisingly after start-ing from very different initial conditions the USSR and China are converging interms of their incomendashfood consumption relationship

The Balkan countries (Figure 72) experienced rising income prior to 1989while consumption remained roughly steady and slightly above the market trendto that point After 1989 income fell sharply turning around only recently Foodconsumption per capita initially rose then declined to below its pre-transitionlevel There is as yet no clear trend toward removing the asymmetry in thesecountries The Central European countries showed much greater distortion infood consumption relative to market trends initially but consumption droppedoff sharply after 1989 Their rapid return to growing incomes has enabled these

countries to approach the market relationship with less consumption adjustmentcompared to the former USSR With little or no income growth their pathwould have continued to descend vertically whereas consumption has in factsteadied at around the 14 level Per capita consumption in these countries as agroup now approaches the market trend indicating the successful elimination ofthat asymmetry

0 2000 4000 6000 8000 10000 12000 14000 16000

Balkan countries1980ndash2001

Market economies 1990ndash2001

1984ndash88Central Europe composite

1984ndash2001

2001 1980ndash89

China1975ndash2001

1975ndash89

1989ndash2001

Real GNI (PPP) per capita ndash US$Central Europe (Czechoslovakia Poland Hungary) and Balkans (Albania Bulgaria Romania)

Figure 72 Per capita consumption adjustments pre- and during transition for selectedcountries and regional groups 1975ndash2001

On an individual country basis it is clear that the income changes associatedwith transition are critical determinants of the degree to which the consumptionasymmetry is eliminated CE consumption levels in most countries (exceptRomania or some former Soviet republics) prior to transition had nearly reachedthe level of high-income market economies but at substantially lower incomesCzechoslovakia had in fact surpassed the average Western Europe consumption

Ukraine

Russian Federation

Market economies 1990ndash2001Moldova

Baltics

Belarus

Central Asia

Caucasus

0 2000 4000 6000 8000 10000 12000 14000 16000

Figure 73 Per capita consumption adjustments pre- and during transition in formerSoviet republics 1992ndash2001

level in 1989 With the onset of transition consumption dropped dramaticallybut the individual approaches to the market economy curve following this earlydrop have differed due in large part to the income changes accompanying theireconomic restructuring processes (The poorer countries of the Caucasus andCentral Asia have experienced less dramatic incomendashconsumption adjustmentsbut consumption continues to remain above market economy levels) For thosecountries with fairly constant incomes the path descends vertically (eg Latviashown as part of the Baltic countries in Figure 73) until consumption eventuallystabilizes near the market trend For countries with income growth the pathangles to the right toward the market curve necessitating less adjustment in con-sumption (eg Poland and Hungary composite in Figure 72 and to a lesserextent Belarus Lithuania and Estonia) In the case of the Russian FederationUkraine and Moldova (Figure 73) income fell so dramatically that even greaterconsumption adjustment was required Thus income changes are criticaldeterminants of both the speed and level of consumption adjustment and theattainment of incomendashconsumption equilibrium in a market context

Each transition country included in this study is identified in Figure 74 interms of its current incomendashfood consumption relationship relative to the markettrend Two implications immediately appear First while a few countries havereached (Hungary Estonia) and even crossed (the Czech Republic SlovakiaLatvia) the market trend line in recent years most are still consuming dietshigher in CEs than market economies at similar income levels Further adjust-ments are required to eliminate this asymmetry Second transition countries areclustered in the low to middle income range resulting in the projection that oncethe market relationship is achieved income growth will result in significant

Belarus

PolandLithuania

BulgariaKazakhstan

KyrgyzstanAlbania

Russian Fed

Romania

Estonia

ChinaUzbekistan

Moldova

Georgia

Czech RepublicHungary

Slovakia

LatviaUkraine

Turkmenistan

AzerbaijanArmenia

Tajikistan

020 5000 10000 15000 20000 25000 30000

Figure 74 Positions in food consumptionndashincome relationship relative to market trend2001

increases in per capita food consumption (especially livestock products)measured in CEs for all transition countries Based on current per capita con-sumption levels compared to a high-income consumption level of two tons ofCEs per capita per year future consumption increases could range from 33percent (Belarus) to over 400 percent (Tajikistan) with a possible doubling ofconsumption for a number of countries (Table 73) The issue now becomes canproduction rebound to match these projected consumption increases and inaddition contribute product to world markets or will transition countries becomenet importers of food

The food production conundrum signs of an emergingproblem

Since the pre-transition consumption asymmetry reflected expanded consump-tion of livestock products the subsequent decline in food consumption duringthe transition period has been largely a reversal of that trend resulting in lowerlivestock product consumption Livestock production has followed suit as evi-denced by relatively stable agricultural self-sufficiency ratios (Rask and Rask2004) The reasons for these production losses go beyond the reduced demandfrom consumption adjustment to include restructuring problems in agricultureand the inability of transition countries to market surpluses to the internationaleconomy largely stemming from the quality and institutional asymmetriesreferred to earlier For transition economies these asymmetries are in additionto the institutional asymmetries associated with levels of development and notedby other authors (Yotopoulos Chapter 1 Romano Chapter 10) The net result isa significant underutilization of agricultural resources when compared to theproduction levels experienced prior to transition Now with consumption of

Table 73 Potential increases in consumption per capita for selected transition economies(cereal equivalents)

Percent increase Percent increase Country or Current to reach high to reach estimated

regional group consumption income consumption maximum consumption level = 20 level = 237

Belarus 150 33 58Central Europe 136 47 74Baltic countries 124 61 91Russian Federation 122 64 94Balkan countries 117 71 103Former USSR 110 82 115Ukraine 101 98 135Central Asia 095 111 150China 095 111 150Caucasus 071 182 234Tajikistan 038 426 524

livestock products poised to rise in a number of these countries can productionrebound in a commensurate way

While production issues are not a central focus of our analysis research find-ings from other studies and production limitations embedded in the rules ofaccession to the EU raise concerns that rapid expansion of agricultural produc-tion particularly for livestock products is unlikely These concerns are notedbelow First we quantify the level of reduction in livestock output during tran-sition to provide dimension to the current reduced resource use in the livestockproduction sector

Reduction in livestock output

The degree of loss in livestock-based food production during transition is hereassessed by means of the CE measure to capture underlying resource needsRecall that a given reduction in beef production idles more resources than doesan equal reduction in poultry production (Table 71) Comparing total livestockoutput production levels at the onset of transition (1989 for non-Baltic countries1992 for Baltic due to data availability) with levels in 2001 yields the percent-age reductions presented in Table 74 The eight individual countries shown inTable 74 have joined or will soon enter the European Union Data for all trans-ition countries and the former USSR as well as selected individual products areshown for comparison purposes

Table 74 Percentage changes in livestock product output since transition (1992ndash2001 forBaltic countries 1989ndash2001 for other transition countries)

Country or All Bovine MilkPigmeat

PoultryEggs

regional group livestock meat products meat

(percent change 1989ndash2001)a

All transition 43 53 41 42 32 30Former USSR 47 55 45 58 59 35Poland 18 50 32 0 105 1Czechoslovakia 43 64 45 39 33 17Hungary 26 51 32 45 8 28Bulgaria 34 42 32 40 43 41Romania 20 34 8 42 16 16

Estonia 53 69 42 33 11 39Latvia 66 84 52 69 58 24Lithuania 38 72 36 41 2 16

Source authorsrsquo calculations based on FAO (2004b)

Notea Percentage changes based on cereal equivalent values estimated

The reduction in production of livestock products is common to all transitioncountries and is most apparent in the former USSR especially the Baltic coun-tries For transition countries as a group livestock production declined 43percent between 1989 and 2001 while the former USSR suffered a 47 percentloss Production of bovine meat and dairy the most resource-intensive productsexperienced the greatest decline for most countries Poultry production the mostefficient in resource use declined the least and actually increased in PolandCzechoslovakia and Hungary This substitution of more resource-efficient live-stock products (lower price) is consistent with what we would expect in amarket economy especially during a time of declining income

For Poland constant pigmeat production and increased poultry productionlargely offset significant declines in beef and dairy resulting in a modest 18percent reduction in total livestock production At the other extreme the Balticcountries have experienced very deep cuts in livestock production as they havesuffered reductions in both internal and external (within the greater USSR)markets that once existed for their former high levels of production It is proba-ble that if comparable data back to 1989 were available the declines in produc-tion noted for the Baltic countries in Table 74 would be even larger In factlivestock production in the combined countries of the former USSR of whichthe Baltics are a part had already dropped 21 percent by 1992

Can production rebound

Several studies indicate continuing production concerns for transition countriesCsaki (2000) predicts that animal husbandry will continue to stagnate in CEECswhile declining in CIS countries7 He also concludes that the need to restructurethe food industry to accommodate rising quality demands will restrict thegrowth of output for a long time (This view is in broad agreement with ourearlier assertions concerning asymmetries in agricultural institutions) Whilepredicting that the region will be able to export pork and poultry he expects theregion to be a net importer of beef and a net importer of food in general

Moreover this current situation of historically low production levels formsthe basis for the supply management instruments negotiated for those countriesentering the European Union (CEC 2002 EBRD 2002) In general suchsupply management policies aimed at restricting agricultural production posefewer problems for the established EU members since almost all EU countrieshave reached stable food consumption levels However these same policiesintroduce potential supply difficulties for new members whose CE consumptionis expected to grow from 30 percent to near 100 percent with these difficultiesfurther compounded by the low newly established basis levels Weber (2001)predicts that acceding countries will import poultry and eggs from older EUnations Balcombe et al (1999) see Bulgaria as a net importer of food from theEU Erjavec et al (2003) and Ferto and Hubbard (2003) express broader con-cerns about EU agricultural policies hindering healthy market development ofthe agricultural sector

Unfortunately this asymmetry in the current level of livestock production rel-ative to available productive resources (as demonstrated by pre-transition pro-duction levels) must still overcome many structural and institutional problemsFurthermore for some countries this asymmetry forms the basis for productionlimitations based on quotas and other supply management measures uponentrance to the European Union Production resource asymmetries appear set toexpand as consumption asymmetries decline

Summary and conclusions

The process of globalization poses unique challenges for transition economiesstruggling to overcome consumption asymmetries created by distortions in thecentrally planned era The largest asymmetries were experienced by those coun-tries with relatively high per capita incomes prior to transition such as theCentral European nations of Poland Hungary and the former Czechoslovakia aswell as the Baltic countries and Belarus These populations as a group enjoyeddiets rich in livestock products similar to those of market economies with muchhigher income levels and in the case of Czechoslovakia per capita food con-sumption (measured in CEs per capita) exceeded the Western European averagein 1989

Alleviating the consumption asymmetry has entailed early reductions in live-stock food consumption and income for all transition economies The adjust-ment paths for these countries after the initial drop have been highly dependenton their ability to stabilize or increase income levels Those countries experienc-ing income growth during transition (Central European countries Belarus theBaltic countries) have been able to reduce or eliminate the asymmetry withmuch less reduction in per capita food consumption Those countries with con-tinued falling incomes (Ukraine Russian Federation) have suffered larger con-sumption losses

As transition economies eliminate the distortions and begin to develop alongmarket lines per capita CE food consumption is projected to increase accordingto the identified market trend Based on the current income range for these coun-tries we therefore expect per capita CE consumption to rise between 30 percentand 100 percent for most individual countries before stabilizing

An emerging problem concerns the ability of these once major agriculturalproducing countries to match the dynamic consumption changes with a reboundin production principally in livestock products Food production in the centrallyplanned economies mirrored the high consumption levels prior to transitionhighlighting the enormous agricultural potential in these countries The sharpdrop in production coinciding with the loss of consumption points both to thesevere disruptions in production caused by transition and to the inability of thesecountries to market the surplus globally as consumption plummeted As otherauthors have noted the necessary structural and institutional adjustments withinthe agricultural sector as well as in the surrounding rural economy will requireconsiderable time to complete

Moreover the current low level of food production is particularly troublingfor those countries entering or about to enter the European Union (the Balticcountries Central European countries Romania and Bulgaria) The terms ofaccession are based on the current low levels of agricultural output makingmore difficult the process of recovering their traditionally high production levelsfor meeting increasing consumer demand and possible exports in the future EUagricultural policies designed for stable consumption populations do not trans-late well for populations whose consumption is poised to rise On the otherhand to the extent that production is allowed to recover the discipline forced onthese acceding countries in terms of transforming their agricultural institutionsto conform to world standards may provide some benefits in terms of participat-ing in global markets outside the EU

The projected significant increases on the consumption side combined withcontinued difficulties on the production side set the stage for a growing produc-tion asymmetry just as the consumption asymmetry inherited from the commandeconomy years is being resolved for many transition countries To the asymmet-rical impact of globalization on rich and poor countries must be added the spe-cific problems faced by intermediate income formerly command economieswhich must now overcome their unique initial conditions While entering worldmarkets can help spur certain positive changes the particular legacy of agricul-tural policy in the pre-transition years has created its own impediments to realiz-ing gains from trade Thus after more than ten years of transition thesecountries face continuing challenges in adjusting their institutions to integratetheir economies into world markets in order to benefit from globalization

1 The authors would like to thank the editors for their vision and support and also theanonymous reviewers for their valuable comments on an earlier draft of this chapterAny errors that remain are of course our own

2 This section draws heavily on Rask and Rask (2004)3 The data and regression analysis are discussed in the third section of this chapter4 Extensions of this work into the concept of CE factor values can be found in Gilland

(1979) Sanderson and Mehra (1988) Rask (1991) Rask and Rask (2004)5 CE coefficient refers to number of tons of cereals that is equivalent to one ton of crop

or livestock product See below for further explanation6 Countries with low or negative growth do not have enough variation in income to

provide sufficient additional information for statistical analysis7 CEECs are Central and Eastern European countries and CIS refers to the Common-

wealth of Independent States

References

Balcombe Kelvin Sophia Davidova and Jamie A Morrison (1999) ldquoConsumer Behav-iour in a Country in Transition with a Strongly Contracting Economy The Case ofFood Consumption in Bulgariardquo Journal of Agricultural Economics 50 (1) 36ndash47

CEC (2002) ldquoEnlargement and Agriculture Successfully Integrating the New MemberStates into CAP ndash Issue Paperrdquo Brussels Commission of the European Communities

Chevassus-Lozza Emmanuelle and Manuela Unguru (2002) ldquoAgri-food Exports to theCEECs Winners and Losers from EU Enlargementrdquo Euro Choices 1 (3) 18ndash23

Csaki Csaba (2000) ldquoAgricultural Reforms in Central and Eastern Europe and theFormer Soviet Union Status and Perspectivesrdquo Agricultural Economics 22 (1)37ndash54

EBRD (2002) ldquoTransition Report 2002 Agriculture and Rural Transitionrdquo LondonEuropean Bank for Reconstruction and Development

Erjavec Emil Miroslav Rednak Tina Volk and Jernej Turk (2003) ldquoThe Transition fromlsquoSocialistrsquo Agriculture to the Common Agricultural Policy The Case of SloveniardquoPost-Communist Economies 15 (4) 557ndash69

EU (2003) ldquoThe Treaty of Accession 2003 of the Czech Republic Estonia CyprusLatvia Lithuania Hungary Malta Poland and Slovenia to the European UnionrdquoBrussels European Union

FAO (2004a) Food Balance Sheet Data Rome Food and Agriculture OrganizationFAO (2004b) Livestock Production Data Rome Food and Agriculture OrganizationFerto Imre and Lionel J Hubbard (2003) ldquoRevealed Comparative Advantage and Com-

petitiveness in Hungarian Agri-Food Sectorsrdquo World Economy 26 (2) 247ndash59Gilland Bernard (1979) The Next Seventy Years Population Food and Resource Kent

UK Abacus PressKydd Jonathan Allan Buckwell and Jamie A Morrison (1997) ldquoThe Role of the Agri-

cultural Sector in the Transition to a Market Economy in Central and Eastern EuropeAn Analytical Frameworkrdquo In Jonathan Kydd Sophia Davidova Miranda Mackayand Thea Mech eds The Role of Agriculture in the Transition Process towards aMarket Economy New York United Nations

Rask Norman (1991) ldquoDynamics of Self-Sufficiency and Income Growthrdquo In Fred JRuppel and Earl D Kellogg eds National and Regional Self-sufficiency GoalsImplications for International Agriculture Boulder CO and London Lynne RiennerPublishers

Rask Kolleen J and Norman Rask (2004) ldquoReaching Turning Points in EconomicTransition Adjustments to Distortions in Resource-based Consumption of FoodrdquoComparative Economic Studies 20 (4) 542ndash69

Sanderson Fred H and Rekha Mehra (1988) ldquoBrighter Prospects for AgriculturalTraderdquo In M Ann Tutwiler ed US Agriculture in a Global Setting Washington DCNational Center for Food and Agricultural Policy Resources for the Future

USDA (1975) ldquoLivestock-Feed Relationships National and Staterdquo Washington DCUnited States Department of Agriculture Economic Research Service

Weber Gerald (2001) ldquoThe CAPrsquos Impact on Agriculture and Food Demand in CentralEuropean Countries after EU Accession Who Will Lose and Who Will Gainrdquo InGeorge H Peters and Prabhu L Pingali eds Tomorrowrsquos Agriculture IncentivesInstitutions Infrastructure and Innovations Burlington VT Ashgate pp 498ndash505

World Bank (2002) World Development Indicators 2002 Washington DC World BankYotopoulos Pan A (1985) ldquoMiddle-income Classes and Food Crises The lsquoNewrsquo

FoodndashFeed Competitionrdquo Economic Development and Cultural Change 33 (3)463ndash83

Part III

Agricultural poverty anddecommodification

8 Genetically modified seeds anddecommodificationAn analysis based on the Chinesecotton case1

Michel AC Fok Weili Liang Donato Romanoand Pan A Yotopoulos

Introduction

Decommodification of international trade is becoming a pervasive phenomenoneven in a sector like agriculture where products are primarily traded as com-modities Of course this is not an entirely novel breakthrough since inter-national trade in high-value differentiated agricultural products such as winescheeses etc has been taking place for centuries What is new is the accelerationof this trade and the expansion of its domain under the current wave of global-ization as a result of a complex set of technological and institutional changesthat occurred in the last two decades (Yotopoulos Chapter 1)

One of the driving forces of this process of decommodification is agriculturalbiotechnology Indeed the application of new scientific methods ndash more preciseand more effective than the traditional ones ndash makes possible a degree ofproduct ldquocustomizationrdquo that was simply unimaginable a few decades ago Butthose changes would not have made much difference if they had not beenfavored by policy interventions that reshaped the institutional set-up at thenational as well as at the international level The worldwide strengthening of theprotection of intellectual property rights (IPR) provided robust incentives forunprecedented private investments in biotechnology This is good news becauseit has brought more private resources into the agricultural research industry Yetit is also a fundamental cause of systematic asymmetries in globalization(Pagano Chapter 2) In fact as artfully written by Michael Pollan in presentingthe story of a recent agricultural biotechnology innovation

In the case of the NewLeaf [potato] a gene borrowed from one strain of acommon bacterium found in the soil ndash Bacillus thuringiensis or Bt for shortndash gives the potato plantrsquos cells the information that they need to manufac-ture a toxin lethal to the Colorado potato beetle This gene is now Mon-santorsquos intellectual property With genetic engineering agriculture hasentered the information age and Monsantorsquos aim it would appear is tobecome its Microsoft supplying the proprietary ldquooperating systemsrdquo ndash themetaphor is theirs ndash to run this new generation of plants

(Pollan 2001 191)

As Pollan adds the Peruvian Incas whose ancestors domesticated the Solanumtuberosum 7000 years ago can never claim property rights over the domesti-cated potato genes since intellectual property can be recognized only to indi-viduals and corporations ndash not to tribes Furthermore the economic rentsaccruing to the IPR holder seem systematically to favor the developed countries(DCs) vis-agrave-vis the less developed countries (LDCs) because the former have astronger institutional setting and a better resource endowment to producedecommodified goods market them and enforce compliance of the customerswith the IPR regulations

This chapter provides an assessment of the application of genetic engineeringto agriculture and its marketing to LDCs in the specific case of a success storynamely the creation of a genetically modified (GM) seed Bt-cotton (GM cottonfrom here on) and its adoption in China Although a thorough and exhaustiveassessment of the adoption of GM seeds in LDCs is still far to come there isquite a widespread disbelief regarding the suitability of GM seeds for LDCsjustified with the claim that GM seeds do not match poor farmersrsquo real needsand even if suitable they cannot be accessed because they are too expensive(Myers 1999 Mazoyer 2000) On the contrary the Chinese case seems to con-tradict the expected adverse impacts on LDCs of decommodification of agricul-tural inputs2 about one-half of the total Chinese cotton acreage is currently inGM cotton and this has led to a decrease in insecticide use a reduction in therelated costs an increase in cotton yields and a higher profitability due tosignificant labor savings (Pray et al 2001 Huang et al 2002 Huang et al2003a Huang et al 2003b) But on balance we argue that welcome as it is thecounter-example of the Chinese cotton case is unique and as such it representsan exception which confirms the general rule

This chapter is organized as follows The next section is devoted to the analy-sis of the changes of the rules of the game that accompanied the emergence ofthe GM seed industry and summarizes the debate about the pros and the cons ofGM seed adoption in LDCs The third section analyzes the Chinese GM cottoncase using original data from a survey carried out in 2002ndash3 in Hebei Provincethat show the positive impact of GM seed adoption by farmers In the fourthsection the institutional and economic conditions that made possible this successare assessed contrasting them with the conditions existing in most LDCs Thefifth section analyzes the likely future evolution of GM seed diffusion and the interventions required to ensure a reasonably high likelihood of success Thefinal section summarizes the main findings of this study

The gene revolution ldquopan-positionalrdquo IPR protectionand product decommodification

The advances in biotechnology especially genetic engineering and thecontemporary change of IPR regulation at the national as well as the inter-national level marked a profound change in agricultural research and develop-ment (RampD) activities that can qualify as a true revolution the so-called ldquogenerdquo

148 MAC Fok et al

revolution We argue that the shift towards stronger plant IPR protection and thecontemporary presence of product ldquodecommodificationrdquo dramatically changedthe rules of the game of competition in the agricultural sector and ultimatelydetermines asymmetric outcomes between DCs and LDCs

Strengthening of IPR protection

Prior to 1980 patenting was applied only to inanimate things like machines andequipment The situation changed with the advent of modern biotechnology Theapplication of genetic engineering to living things represents indeed the funda-mental justification for claiming intellectual property protection throughldquoexpanded patentsrdquo on the grounds that an ldquoinventiverdquo step is involved in creat-ing the GM good in a process that is not dissimilar to that of standard patentsHowever the IPR protection granted with expanded patents ie the ones thatapply to genetically engineered plants and animals is much stronger than thatgranted in traditional patents as in the fields of mechanics electricity or chem-istry for instance

In the case of expanded patents the traditional removal-from-secrecy clausethat was intended to make public the knowledge associated to the invention nolonger applies so that a researcher or inventor is not free to use it in making afollow-on invention The IPR owner of expanded patents has the right toexclude their use in breeding programs because the parental components can beidentified in the biological progeny which can be regarded as an IPR-protectedcomponent of the invention This ldquohigh-potentialrdquo nature of expanded patents isfurther compounded by the fact that the knowledge of useful genes (genomics)and of engineering transgenic plants is ldquobasicrdquo in the sense that it is located atthe upstream extreme of the RampD process and can be used in a variety of down-stream innovations It is this prospect of capturing the huge economic rentsaccruing to the GM innovator that makes entering the agricultural biotech indus-try so appealing to private firms

Beginning with the Bayh-Dole Act of 1980 the institutional arrangements forpatenting university research discoveries and protecting plant varieties were sub-stantially strengthened in the United States Other developed countries followedthe US example in strengthening domestic intellectual property rights in thisarea Eventually also the European Union which includes some of the mostguarded countries on this issue adopted the Directive 9844EC on the legal pro-tection of biotechnological inventions that explicitly allows patenting of alltypes of life forms except for the clearly stated exceptions such as the humanbody

At supranational level there were several legal and regulatory breakthroughsin this field In 1991 the Convention for the Protection of New Varieties ofPlants was amended strengthening plant breedersrsquo rights making them morepatent-like and weakening the ldquofarmer privilegerdquo which allowed farmers toreplant saved seeds without reference to the breeder (see the next part of thissection) More important in 1994 an agreement was reached at WTO level in

GM seeds and decommodification 149

Marrakesh giving the WTO powerful dispute-settlement jurisdiction This wasfollowed by enacting in 1995 the Trade Related Aspects of Intellectual PropertyRights (TRIPS) agreement which extended US-like patentability of living formsto the global level

As emphasized by Pagano (Chapter 2) all those regulatory shifts changed therelative position of different individuals in the sense of who will enjoy the rightand who will bear the symmetrical obligation More specifically the worldwideextension of IPR protection warranted under the TRIPS agreement is a proto-typical example of what Pagano calls a ldquopan-positional goodrdquo that is the casewhere the exclusive right of an individual or a firm implicitly assigns obligationsto all other individuals in the world Paradoxically it is the non-rival nature ofknowledge that determines such a strong asymmetric outcome once knowledgeis privatized and its protection is extended to the whole world as within theTRIPS framework

This has major implications for the international standings of the differentcountries In such a context it is easy to anticipate asymmetric outcomes deriv-ing from the different endowment of resources skills and infrastructuresbetween DCs and LDCs In fact for many developed countries the compliancewith international regulations often means no more than the application ofalready implemented domestic regulations This is not the case with developinglet alone poor countries for which the cost of compliance with international reg-ulations like IPR protection and biosafety risk assessment (food safety andenvironmental protection) is much higher On top of the cost of enforcement ofthe domestically sanctioned standards the additional obligation to enforce alsothe internationally sanctioned standards entails an extra cost This is not a trivialcost for many LDCs especially if we take into account their meager budgets andif we consider their real opportunity cost in terms of foregone developmentalternatives (Romano Chapter 10) This is also a vivid example of what Paganocalls a ldquolegal disequilibriumrdquo because the international regulations egthe TRIPS agreement while clearly making the ldquorightrdquo of inventors ldquopan-positionalrdquo in protecting their IPR in all WTO member countries do not explic-itly assign the corresponding ldquoobligationrdquo of enforcement nor do they providefor the cost of such enforcement Implicitly the obligation of that protection isleft to the member-country governments which may find the cost prohibitiveand may not be able to deliver

GM seeds decommodification and the ingredients of customization

The rules that form the marketing framework of introducing the Bt-gene intocotton varieties to create the GM cotton were initially drawn up by Monsantofor the USA in the mid 1990s and were subsequently extended to apply to allcountries3 The commercialization of the GM seeds is illustrative of theapproach of customizing a ldquonewrdquo good the GM cotton in this case with theobjective of embodying in it economic rents that the ldquoproducerrdquo can claimFrom the point of view of the economic characteristics the price of the seed

150 MAC Fok et al

remains the same as the price of conventional seeds but this price is no longerthe only cost users have to incur Indeed the economic rents accruing to thebiotechnology manufacturer are created and captured in a triple customizationintervention First a surcharge is applied on the price of the conventional seedsin the form of (an annual) ldquotechnology feerdquo for the production of the geneti-cally modified seed for GM cotton4 Second the buyer of the GM cotton seedsassumes a formal contractual commitment not to hold back seeds from oneseason to another (in any vegetative form) Third the buyer is also contractu-ally obligated to implement techniques that prevent the development of resis-tance to the traits incorporated in the GM cotton in this case of the resistanceto Bt-toxins5

The purpose of all three customization features embedded in the GM cottonis to create and protect economic rents fully exploiting the market power guar-anteed by the extension and deepening of IPR6 The more conventional means ofextorting economic rents are also widely employed The levels of technologyfees seem in fact quite arbitrary Fees for GM cotton for example were first setat US$90ha before being reduced to around US$60ha with some variationbetween countries or even between provinces within the same country(Mexico) In South Africa the technology fees applied differ according to agri-cultural irrigation features fees are higher for farmers who produce cotton underirrigation and have higher expected yields7 Clearly the biotechnology service isnot being provided at the marginal cost of production but on what the marketwould bear (Romano Chapter 10)

More important seem to be the other two institutional innovations devised toextract rents In fact the technology fee is a familiar feature of intellectual prop-erty rights in various information-technology applications The fact that it isannualized through the total prohibition of holding back seeds is a rather blatantand unusual innovation8 Software companies for example attempt to achievethe same result through creating ldquoupgradesrdquo of their products but the choice iswith the customer whether to buy the upgrade or to continue using the olderversion of the program The obligation of the customer to protect the GM cottonfrom new strains of pests that are resistant to Bt-toxins is an even more creativemethod of extracting economic rents It is akin to obliging the passengers of acruise ship to buy insurance remunerating the ship owners in case the vesselproved not sea-worthy in the event of a storm or even worse to contribute toprevent the rising storm

The essence of decommodification is to remove a commodity from thedomain of cost-of-production competition and to launch it into the domain ofpositional goods where the ordinal ranking of decommodified goods applies (asopposed to the cardinal measurement of the cost of production) based on ldquorepu-tationrdquo which is a general term for the ability to extract economic rents(Yotopoulos Chapter 1) The discussion above on the decommodification in theseed industry makes clear why the diffusion of GM crops in LDCs is questionedand challenged by international environmental groups and by NGOs althoughseldom explicitly from the perspective of the decommodification process there

is a risk of exploitation of farmers through the strong market power that hasbeen vested to GM seed companies (McDonald 2003 Pschorn-Strauss 2004)9

However decommodification of GM cotton seems to have its limits InChina for instance the farmers seem to be those who benefit the most from theadoption of GM cotton10 The success of the Chinese experience seems to under-mine the argument that LDCs usually lie on the short end of trade asymmetrieswhen decommodification is involved In order to assess this apparent contra-diction we have first to analyze whether the Chinese case is a success story ornot and if so what are the conditions that made such success possible andfinally whether those conditions can be replicated in other LDC contexts

A success story of GM seed adoption cotton in HebeiProvince

At first glance the experience with the Chinese adoption of GM cotton lookslike a counter-example of the decommodification process which is taking placein the GM seed industry and trade Indeed the economic impact of the adoptionof GM cotton is beneficial to farmers and no monopolistic exploitation is appar-ent as reported by the results from a survey conducted in 2002ndash3 in HebeiProvince11 Historically this province has contributed significantly to Chinesecotton production but the development of strong resistance in the cotton boll-worm (Helicoverpa armigera Huumlbner) in the early 1990s stalled the cotton culti-vation The long legacy of cotton in the province was threatened and thechallenge was to find an effective technical solution Therefore Hebei Provincewas the first province where the dissemination of the GM cotton varieties beganin 1998 and soon thereafter the entire cotton area of the province was convertedto GM cotton which eventually led to a remarkable rebirth of cotton productionin this region (Table 81)

Growing GM cotton is very profitable for the farmers by far exceeding theprofits from the main alternative available to the farmers in the province the cul-tivation of wheat and maize that are grown in sequence (Table 82)

152 MAC Fok et al

Table 81 Cotton Production in Hebei Province (103 tons of lint)

Year 1986 1987 1988 1989 1990 1991 1992 1993 1994

Hebei province 511 626 577 536 571 634 306 192 390China 3541 4245 4149 3788 4507 5673 4510 3739 4342HebeiChina () 144 148 139 142 127 112 68 51 90

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source Fok et al (2004b Table 1 p 48)

At the international level also and in comparison with other LDCs Chinesefarmers dominate in terms of profitability The financial profitability of growingGM cotton depends on the level of yields achieved and on the favorableoutputndashinput price ratios In fact the price of cotton is quite high due to thecontinuing protection of the domestic market from imports and despite Chinarsquosentry into the WTO The cotton lint farm gate prices found in the survey wereUS$057lb and US$089lb in 2002 and 2003 respectively whereas the worldmarket parity prices (cif Northern Europe) were US$041lb and US$063lb

On the input side the average cost of production inputs (fertilizers pesti-cides seeds plastic film growth regulators irrigation water) is only 15ndash20percent of the output value while for instance in West African cotton countriesit is roughly twice as much (Beacuteroud 2001 Fok et al 2004a)12 More specifi-cally the cost to Hebei farmers for accessing GM cotton seeds is far less than inother countries This is the outcome of an effective competition between severalGM seed suppliers foreign as well as domestic with the result that the farmerscan choose from a large portfolio of distinct GM cotton varieties13 The access toGM cotton seeds by Hebei farmers seems quite easy as shown by the fact thatmany of them grow more than one variety and by the mode of GM seed acquisi-tion more than half of farmers use either partly or totally the seeds they heldback from the previous season at virtually zero cost (Table 83)

Even when farmers access the GM cotton seeds through market purchasesthe cost they have to pay is lower than in other countries In fact no supplier hasbeen able to maintain a monopolistic position in the province In particulardespite the fact that Monsanto had a virtual monopoly in marketing GM cottonseeds when the government first gave permission for GM cotton cultivation itsmarket share has been gradually decreasing as a result of the competition froman increasing number of domestic GM varieties which are commercialized at alower price (Table 84)

Although the profitability of cotton seems to rest on the technological fea-tures of GM cotton (eg higher yields fewer pesticide sprays etc) it should bestressed that institutional factors played a crucial role in encouraging the adop-tion of GM cotton and in gaining from it higher profits with little risk IndeedChina succeeded in designing and enforcing quite particular rules of GM seedcommercialization that can hardly be found in other countries

Table 82 Comparison of profitability of cotton wheat and maize cultivation (US$ha)

Gross revenue Income net of input costs

2002 2003 2002 2003

Cotton 1716 2377 1425 2064Wheat 781 819 461 554Maize 814 880 578 707

China launched a very ambitious biotechnology research program from themid 1980s This enabled Chinese scientists to identify many genes to build newspecific gene constructions of their own and to master an original method forgene transfer through the pollen tube14 With this head start in the field ofresearch and development of GM varieties Chinese institutions had been net-working successfully The Chinese government endorsed a joint venturebetween Monsanto and the local Hebei Seed Company At the same time aldquoprivaterdquo Chinese biotech firm that held the rights of Chinese Bt-genes the Bio-century Transgene Company Limited (BTCC) started a collaboration with theChinese Academy of Agricultural Sciences and its local branches to developGM cotton seed varieties adapted to the different ecological conditions of ChinaIn parallel the government-sponsored field experiments to determine the

154 MAC Fok et al

Table 83 Distribution of farmers adopting GM cotton according to their seed acquisi-tion mode and the number of adopted GM cotton varieties (percent)

Farmers adoptinga All farmers Seed acquisition mode adopting

One variety Two varieties Three varieties GM seedsb

By exchange 1 0 0 1Partly bought 26 29 75 30Totally bought 53 33 0 44Totally held back 20 38 25 25Total 100 100 100 100

Source adapted from Fok et al (2004b Table 14 p 58)

Notesa The percentages reported in these three columns are the shares to totals after partitioning the

farmer sample according to the number of GM cotton varieties they adoptedb The percentages reported in this column are the shares to the whole sample of farmers adopting

GM cotton varieties

Table 84 Market share and cost of GM cotton seeds in Hebei Province

Origin of Type of 2002 2003

varieties varietiesa Seed cost users surface

Seed cost users surface

(US$kg) (US$kg)

China Population 33 29 39b 45 43 49b

Hybrids 48 4 54 6

USA Population 50 67 61 61 51 51

Source adapted from Fok et al (2005 Table 8 p 21)

Notea Populations are varieties composed of plants which are not completely identical from the genetic

point of view but whose genetic composition is stable vice versa hybrids are made from thecrossing of two parents which are pure lines that is varieties composed of plants which are com-pletely identical from the genetic point of view

b Sum for China of population and hybrids

suitability of GM cotton cultivation in the region led to approval of GM cottonAs a result when Monsanto started marketing its own GM cotton varieties in1998 China had already put in place the local institutions that would eventuallycontain the voracious appetite of the multinational

The success of the Chinese plan was immediate as shown by the willingnessof Monsanto to adjust its standard ldquorentalrdquo seed contract giving favourabletreatment for China As a result the GM cotton varieties were supplied rightfrom the beginning under the same conditions that usually prevail for conven-tional seeds Farmers were not required to sign a contract that prevented the pos-sibility of holding back seeds or commited them to special cultivationtechniques (eg refuge plots to prevent the emergence of resistance by the tar-geted pest to the Bt-toxin)15 The prices farmers paid were all inclusive with nodistinction or mention of any technology fee16 Finally as the local GM cottonvarieties were being released into the market the farmers had more seedchoices By the time of the survey farmers could choose from 20 local GMcotton varieties that compete with the two varieties of Monsanto Moreover theample varietal offerings of local GM cotton not only are better matched to theecological adoption conditions than the alternative two varieties but they arealso cheaper than the foreign GM cotton seeds (Table 84) All these conditionscontribute to make cotton production very attractive and profitable and reducethe financial risk in adopting GM cotton

Replicability is the Chinese success with commodifiedGM seeds a unique case

As mentioned already in the previous section the Chinese case cannot beregarded as a general counter-example of the decommodification processbecause China basically is not representative of LDCs Referring to the eco-nomic results of GM cotton adoption it should be noted that China ranks as oneof the top three countries in terms of yield among the countries with substantialcotton production in the world This means that an attractive price impactsgreatly on farmersrsquo revenues Moreover such a high level of yield is theoutcome of a high degree of intensification in using production inputs (fertiliz-ers pesticides etc) The direct implication is that the additional cost derivingfrom using GM seeds appears to be relatively more acceptable compared tocountries where agricultural intensification is low17

In terms of technological abilities China was able to decrease further the costof adopting GM cotton As mentioned earlier the country has its own endoge-nous and flexible GM technology that is adaptable to producing many GMcotton varieties characterized by a great genetic diversity and being adaptable tovarious micro-environmental conditions This home-grown technology can bemanaged independently of the strategy of any multinational firm

In terms of the rules under which the GM cotton is being diffused thegovernment played a crucial role that is multifaceted The Chinese success wasnot due so much to Adam Smithrsquos invisible hand on market operation as it was

to the strong arm of the governmentrsquos intervention It was the suasive power ofthe state that changed the extortionary terms of the standard contract of themultinational This power became even more persuasive as a result of Chinarsquosgeneral policy for managing foreign investment through joint ventures in thiscase that by Monsanto and the Hebei Seed Company that was mentioned earlierIn summary there was a comprehensive package of technical and institutionalfactors that worked synergistically in recommodifying the GM cotton seeds forsale to the farmers at minimum production cost thus thwarting the decommodi-fication regime of globalized IPRs and of multinational corporations

Can this pattern be replicated in the developing countries Considering dif-ferent categories of countries according to their ability to carry out biotechRampD India and Brazil can be ranked at the same stage of technological sophisti-cation as China and as a result they may achieve substantial GM seed diffusionsoon On the other hand most developing countries lack the technological andinstitutional infrastructure that makes the diffusion of GM agriculture possibleFor the purpose of making an assessment of the replicability of the Chineseexperience we examine the case of India and Brazil along with the Sub-Saharan African (SSA) countries that have featured on the international radarscreen as promising for the adoption of GM varietal agriculture

The objective of Table 85 is to compare the three cases in terms of variousfactors that can be considered as proxies for the requisite infrastructural endow-ments both technological and institutional that would be favorable to GM agri-culture more specifically GM cotton Of the 13 indicators appearing in thetable India and Brazil have a modest command in the first eight factors thatrelate to agricultural and technological preconditions They have solid ldquoNordquos onthe last five institutional factors weighing the balance between free markets andregulation These indicators are eclipsed in India and Brazil by the tendency toconsider the free market approach to globalization as an ldquoup-by-the-bootstrapsrdquouniversal prescription for development This may or may not be the case But itis certainly different from the Chinese approach to GM agriculture As for theSSA countries the favorable factors are the existence of a pool of cotton vari-eties and the number of research institutions plus an ambivalent approach tostate involvement in reaching the pro-farmer GM goals The conclusion is thatthe Chinese pragmatic approach that yielded the pro-farmer outcomes of GMcotton introduction is not easy to replicate in the three cases examined in thetable In other words there is no guarantee whatsoever that other LDCs couldeasily copy Chinarsquos achievements

There are however some promising signs that the competition in the biotechsector is being further opened up Multinationals are no longer the uniqueproviders of commercial biotech outputs Due to the high price of GM cottonseeds in India (as a consequence of the Monsanto monopolistic position in pro-viding the Bt-genes) some Indian companies are establishing partnership withthe Chinese biotech firm BTTC to contest the Monsanto supremacy (Jishnu2006) This is made possible because the Chinese biotech firm gained a reputa-tion by successfully challenging the US multinational at home And it also

156 MAC Fok et al

shows that in positional competition the reputation ranking of the contestants isfluid and changes with each outcome of gain or loss This means that oncedefeated in China the biotech multinationals do not look convincingly invincibleanymore

Counter-balancing the decommodification process in the agriculture biotech industry

The view expressed above might be too pessimistic The future may be betterthan expected if some institutional reforms aimed at making agricultural biotechRampD work for the poor were implemented and if some promising emergingtrends materialized Addressing the current issues of IPR protection meansessentially focusing on (i) the asymmetric and costly burden that LDCs bear ofenforcing the IPR protection on account of owners in DCs who are the holdersof these ldquopan-positionalrdquo rights and (ii) the lack of incentives for private com-panies to invest in LDC-oriented agricultural biotechnology research The diffi-culty lies in balancing patent protection to induce private sector investment inresearch with offering access to cheap GM products for the poor of this world

Some ideas that have been recently proposed to solve similar problems in thepharmaceutical sector can provide inspiration for the reform in the agriculturalbiotech sector as well (Lanjouw 2002) For instance considering that the world-wide markets for GM products of interest for LDCs are very different from the

Table 85 Factors affecting GM cotton diffusion in selected LDCs

Factors India Brazil SSAa

High pest resistance to insecticide Yes No NoHigh yield No Yesb NoHigh intensification in input use No Yesb NoAvailability of own Bt-gene technology No No NoGood command of biotechnology Yes Yes NoAvailability of a gene portfolio from national Yes No No

researchExistence of a great pool of cotton varieties Yes Yes YesExistence of many research institutions Yes Yes YesWillingness for the state to get involved No No YesSufficient bargaining power No No NoForeign direct investment policy favoring No No No

domestic firmsCapacity to adjust diffusion rules to the interest No No No

of the smallholdersCapacity to ensure favorable price for cotton No No No

produced by smallholders

Notesa Sub-Saharan Africab Valid for commercial farms not necessarily for smallholders

markets for the same products in DCs the IPR protection system would beimproved by being tailored to the differences in these markets In the case ofldquoglobalrdquo crops those that can be raised both in LDCs and DCs the domain ofapplication of IPR can be restricted by making them weaker in LDCs18 Thepatentee would be required to choose enforcement of his IPR protection either inrich or in poor countries but not in both19 For GM crops that are LDC-specific(mainly subsistence crops) the problem is that there is no market because theprospective adopters cannot afford them In such a case IPR protection alone isineffective in stimulating the biotech company to invest in such crops There-fore other mechanisms should be devised like investing public grants or privatebenevolent donations to research on LDC-specific GM crops20 Alternativelyinvestments should be channeled to make biotechnology RampD available as afree-share (public) good as it has been recently made by the CAMBIA consor-tium or the BIOS initiative under an ldquoopen-sourcerdquo license scheme (Nature2004 The Economist 2005)21

IPR compliance might become less constraining in the near future even ifIPR rules remain unchanged because many patents covering biotechnologyoutputs are about to expire with the outputs falling into the public domain(Kowalski et al 2002) If this materializes it may be possible to establish aclearing-house of those most suitable for LDCsrsquo biotechnology techniques andoutputs making them thus more accessible for public research (Graff and Zil-berman 2001)

Another potentially positive factor is that some countries like China and Indiaown genes of agronomic interest through their public research institutionsPrivate and multinational companies are no longer having the monopoly ongenes of agronomic interest This new context might offer some room tonegotiate more affordable conditions of technology transfer to LDCs providedthat international organizations are invested with some leading role in thesenegotiations

Finally the effective adoption of GM seeds depends also on the economicconditions of crop intensification In most developing countries the cost of cropintensification has increased as a consequence of the implementation of struc-tural adjustment interventions that canceled all extraneous support for input useHopefully this situation may positively unwind as acknowledged in the WTODoha Round where in earlier discussions the principle of supporting poorfarmers to get into crop intensification has been rehabilitated (Fok 2002)

Conclusions

There are various controversies raging about agricultural biotechnology ingeneral and genetic modification in specific that this chapter has totally over-looked Instead building on the theme of this volume The Asymmetries of Glob-alization it focuses on a specific characteristic of agricultural biotechnology thaton an a priori basis is expected to tip the balance of the benefits of biotechnolog-ical agriculture in favor of the developed countries while rendering trivial

158 MAC Fok et al

residual profits to the farmers in the LDCs The spring that releases this asym-metry is decommodification more specifically the decommodification of theseeds that farmers used to carry forward from one season to the other in order toplant the next yearrsquos crop

The profits from decommodification are generally slanted in favor of theDCs where the new technologies originate and where the reputation that createsand captures the economic rents resides being normally an attribute of wealthand power In the case of agriculture this asymmetry is especially pronouncedsince the IPRs the producers of biotechnology have been granted claim globalapplicability These rights not only create an obligation for all countries toprotect them for the benefit of their right holders in this case multinational cor-porations but the beneficiaries themselves have creatively exploited the protec-tive fence of international legislation built around their product to construct amost generous rent-generating ldquooperating system that runs the biotechnologicalagriculturerdquo This ldquohigh-tech envyrdquo does not constitute an idle boast It hasmaterialized in ldquorentingrdquo for one yearrsquos use the GM seeds that the farmers pur-chased with the obligation to ldquore-rentrdquo them for the next year After a multina-tional has squeezed dry all possible economic rents out of agriculturalbiotechnology one would have expected that there is precious little left in termsof profits for the farmer in an LDC

The case of GM cotton in China is unique in that it has turned the tables onthe patent holders thus making GM cotton cultivation one of the most profitablecrops growing in China and among the top profit earners of cotton cultivation inthe world The bottom line of this success rests with the ability of the localbiotechnology industry to compete on equal grounds with imported GM cottonseeds For this to happen a certain institutional flexibility is required along withthe determination of the government The resultant success consisted of re-commodifying the GM cotton seeds so that the economic rents of the newtechnology are captured in loco and go to the farmers as opposed to corporateprofits that flee abroad

The analysis of the replicability of the Chinese experience in other LDCscomes to the conclusion that China should be considered as the exception thatconfirms the general rule of biotechnological agriculture having little to offer inalleviating rural poverty in LDCs At present the adoption of GM seeds in devel-oping countries is not gaining much traction nor is it likely soon to becomesufficiently rewarding for the local farmers This pessimistic outlook could bemoderated if the bar of the IPR barrier protecting the use of GM seeds couldbe lowered But this outcome would not materialize automatically Initiativesare needed to reform the current institutionalization of the WTOndashTRIPS agree-ment This is a necessary condition Beyond that LDCs need to create anenvironment that is conducive to implementing crop intensification since this isthe essence of GM agriculture In the meanwhile a more definitive prospect isthat various GM genes and some biotechnology methods will be maturingbeyond their statutory patent protection and will be falling in the public domainAt that stage public research initiatives at the international level could play an

active intermediation role in identifying such opportunities and help the LDCstake advantage of these ldquosecond hand technologiesrdquo to create a remunerativebiotechnological agriculture

1 The authors acknowledge the contribution of Guiyan Wang and Yuhong Wu in theconduct of the survey in Hebei Province

2 Another apparently success story of GM cotton adoption is South Africa where ahigher profitability is reported by smallholder growers in the Makhatini FlatsKwazulu Natal Province ( Ismaeumll et al 2002 Gouse et al 2002 Thirtle and JenkinsBeyers 2003) However the dramatic reduction in cotton production in the MakhatiniFlats during the 2002ndash3 crop season due both to institutional and climatic reasons aswell as the rising cost of GM seeds due to an increasing market concentration in theseed industry show that the alleged success of the South African case must be morebalanced (Fok et al 2004a)

3 Monsanto (and its seed subsidiary Delta and Pineland Co hereafter just Monsanto)were the first to market GM cotton and they have enjoyed so far nearly a monopolypower in this area

4 The effective price the farmer pays for the GM seeds is higher than the price of con-ventional seeds by the amount of the ldquotechnology feerdquo The latter represents the eco-nomic rents accruing through decommodification to the producer and claimed on thegrounds that the GM seed is a totally new product which required a substantial invest-ment and which must be used according to particular specifications This procedure ofdistinguishing between seed price and technology fee is legally devolved into thepartnership between the biotech firm (Monsanto) which owns the IPR on the Bt-geneand its subsidiary seed company (Delta and Pineland) that produces (with the Bt-gene) and markets the GM cotton seeds

5 This contractual clause in the case of GM cotton is honored by forcing the farmers toset up in adjacent fields ldquorefuge plotsrdquo to be sown with conventional varieties that arenot to be controlled chemically The purpose of this intervention is to prevent theemergence of new strains of pests resistant to the Bt-toxin that might be metabolizedwithin GM cotton

6 Another feature signaling the market power enjoyed by the agro-biotech companies isthe promotion of a very limited number of GM cotton varieties a feature which ismore or less hidden through the use of distinct varietal trade names in the USA andAustralia the same GM cotton variety is commercialized with two different varietalnames (Bollgard and Ingard) in South Africa only two varieties (NuCotton andNuOpal) were successively launched and in China and also Mexico the same two USGM cotton varieties (named 33B and 99B) are commercialized The strategy of dis-seminating a very limited number of varieties makes sense for Monsanto that prob-ably holds the patents only on 33B and 99B varieties but it is quite suboptimal andcertainly unusual from an agronomic standpoint Objectively one can hardly expectthat the same varieties could be adapted to growing conditions which vary greatlyfrom one country to another if not from one region to another within the samecountry

7 For example in the Makhatini Flats where rain-fed production still dominates small-holders paid fees of about US$50ha during the 2002ndash3 crop season

8 In contrast in the case of conventional seeds the notion of ldquofarmersrsquo seedsrdquo isretained so as to enable their producers to reuse them to their convenience althoughthey can no longer pass them to other farmers either donating or selling them InEurope the transmission to third parties of farmersrsquo seeds has been seriously curtailedby Directive 9895CE after the appearance of GM seeds

160 MAC Fok et al

9 On the distribution of costs and benefits of adopting GM seeds over the traditionalseeds some studies for DCs show that biotech companies actually capture a big shareof the additional gains generated (cf Falck-Zepeda et al 1999 McBride and Books2000) For instance in the USA the trend of the share of Monsanto in the gains gener-ated by using GM cotton in 1996 1997 and 1999 were 26 percent 44 percent and 47percent respectively while the farmer shares decreased accordingly In South Africathe share of the GM cotton gains accruing to smallholders is more favorable (Gouseet al 2004)

10 In 1999 it was estimated that the Chinese farmersrsquo share in the gains from adoptingGM cotton varied between 825 and 870 percent depending on the use of either aChinese or an American GM cotton variety respectively (Pray et al 2001)

11 The Hebei Province is situated in northern China along the Yellow River The surveycovered 218 farms across seven counties in the five most important cotton producingdistricts of the province (Cangzhou Handan Hengshui Shijiazhuang and Xingtai)The average family size in the survey was four people cultivating about 07 ha 40percent of which was devoted to growing cotton These figures are consistent withearlier studies (Pray et al 2001 Huang et al 2003b)

12 Chinese farmers benefit from easy access to production inputs One-half of surveyedfarmers could access their farm inputs from quite a few input providers located withinone kilometer from their farms Therefore the problem of monopoly in supply ofinputs does not exist Farms in general have a certain degree of motorization whilemechanization is very common All farmers are equipped with tractors and chemicalsprayers and they can also easily call for other mechanized field operations on aservice basis

13 In fact at least 22 distinct cotton GM varieties are grown in the survey area Only twoof these varieties are supplied by a foreign company (Monsanto) while there are tenvarieties provided by research institutes operating at the national level five at theprovincial level and five at the district level

14 A Chinese research company the Biocentury Transgene Co Ltd (BTCC) is theowner of a new Bt-gene construction technology based upon sequences controllingCry 1B and Cry 1C toxins those are the genes used in all Chinese GM cotton vari-eties China also launched more or less at the same time as Monsanto a new varietywith dual-gene resistance to bollworms (SGK 321) by combining a Bt-gene and aprotein inhibition gene The combination of two distinct pest control mechanismscould potentially be more sustainable than just combining two Bt-genes as Monsantodid

15 It is worth noting that this contractual clause can be hardly justified on pure technicalgrounds in many LDCs In fact while the obligation to keep refuge plots can be justi-fied in countries where farmers grow the crop extensively as in the US its applica-tion becomes disputable in the Chinese environment featuring a multi-croppingpattern based on smallholder farms that already serve as refuges for cotton pests (Wuet al 2004)

16 It is noteworthy that BTCC initially tried to act as any private biotech company byclaiming a high technology fee This was considered excessive by the Chinese breed-ers and the central government intervened to support the breedersrsquo position by forcinga revision of the commercialization conditions

17 For example the adoption of GM seeds in Mali with the same degree of intensifica-tion of other inputs as in China would have doubled the total input costs the farmersare facing (Fok et al 2004a)

18 This is based on the premise that the profit derived from having a patent-based mon-opoly in poor countries makes a very limited contribution to the worldwide profitsrealized by the biotech company (cf Taylor and Cayford 2003)

19 There are several advantages in a proposal like this but the most relevant for our caseis that the mechanism relies on the quality and reliability of the DCsrsquo institutions and

will not impose any extra-burden on LDCsrsquo institutions Moreover it does not contra-vene existing treaties

20 This mechanism mimics in the agricultural sector what for instance the Melinda andBill Gates foundation is doing in the drug sector to induce research on combatingmalaria and AIDS in LDCs

21 CAMBIA is the Australian Center for the Application of Molecular Biology to Inter-national Agriculture based in Canberra BIOS is the Biological Information for OpenSociety initiative that attempts to extend the achievements originating with CAMBIABoth try to foster collaborative open-source development of sets of key enabling tech-nologies that intend to develop licensing strategies inspired by the open-source move-ment in software

References

Beacuteroud Franccedilois (2001) ldquoSans dopage le coton africain reste en courserdquo Marcheacutes Trop-icaux 27 July 2001 1538ndash41

Falck-Zepeda Joseacute B Greg Traxler and Robert G Nelson (1999) ldquoRent Creationand Distribution from the First Three Years of Planting Bt-Cottonrdquo ISAAA Briefsno 13 Ithaca NY International Service for the Acquisition of Agri-biotechApplications

Fok Michel AC (2002) ldquoInteacutegration de lrsquoagriculture dans les neacutegociations interna-tionales de lrsquoOMC comment saisir les opportuniteacutes offertes pour les filiegraveres coton-niegraveresrdquo Online available wwwcmaocorg (accessed 2 August 2002)

Fok Michel AC Hamady Djouara and Carlos Tomas (2004a) ldquoProgress and Chal-lenges in Making Productivity Gains Cotton Production by Smallholders in Sub-Saharan Africardquo In Anna Swanepoel ed Proceedings of the 3rd World CottonResearch Conference Cape Town South Africa 9ndash12 March 2003 Pretoria Agricul-tural Research Council Institute for Industrial Crops pp 1515ndash30

Fok Michel AC Weili Liang Guiyan Wang and Yuhong Wu (2004b) ldquoI risultati posi-tivi della diffusione del cotone Bt in Cina limiti al trasferimento dellrsquoesperienza cinesein altri paesi in via di sviluppordquo Nuovo Diritto Agrario 32004 45ndash67

Fok Michel AC Weili Liang Guiyan Wang and Yuhong Wu (2005) ldquoDiffusion ducoton geacuteneacutetiquement modifieacute en Chine leccedilons sur les facteurs et limites drsquoun succegravesrdquoEconomie Rurale 285 5ndash32

Gouse Marnus Johann Kirsten and Lindie Jenkins Beyers (2002) ldquoBt-Cotton in SouthAfrica Adoption and the Impact on Farm Incomes Amongst Small-Scale and Large-Scale Farmersrdquo Working Paper no 2002ndash15 Department of Agricultural EconomicsExtension and Rural Development University of Pretoria Pretoria

Gouse Marnus Carl E Pray and David E Schimmelpfennig (2004) ldquoThe Distribution ofBenefits from Bt-Cotton Adoption in South Africardquo AgBioForum 7 (4) 187ndash94

Graff Gregory and David Zilberman (2001) ldquoAn Intellectual Property Clearinghouse forAgricultural Biotechnologyrdquo Nature Biotechnology 19 1179ndash80

Huang Jikun Ruifa Hu Scott Rozelle Fangbin Qiao and Carl E Pray (2002) ldquoTrans-genic Varieties and Productivity of Smallholder Cotton Farmers in Chinardquo AustralianJournal of Agricultural and Resource Economics 46 (3) 367ndash87

Huang Jikun Ruifa Hu Hans van Meijl and Franck van Tongeren (2003a) ldquoEconomicImpacts of Genetically Modified Crops in Chinardquo Proceedings of the XXV Conferenceof International Association of Agricultural Economists Durban South Africa 16ndash22August 2003 IAAE pp 1075ndash83

Huang Jikun Ruifa Hu Carl E Pray Fangbin Qiao and Scott Rozelle (2003b)

162 MAC Fok et al

ldquoBiotechnology as an Alternative to Chemical Pesticides A Case Study of Bt-Cottonin Chinardquo Agricultural Economics 29 (1) 55ndash67

Ismaeumll Yousouf Lindie Jenkins Beyers Colin Thirtle and Jennifer Piesse (2002) ldquoEffi-ciency Effects of Bt-Cotton Smallholder Adoption and Economic Impacts of Bt-Cotton in Makhathini Flats KwaZulu Natal South Africardquo In Evenson Robert EVittorio Santaniello and David Zilberman eds Economic and Social Issues in Agricul-tural Biotechnology Wallingford UK and New York CABI Publishing pp 325ndash49

Jishnu Latha (2006) ldquoBt-cotton The Chinese Are Here Almostrdquo Online availablewwwbusinessworldindiacomsep0803indepth_btchineseasp (accessed 24 February2006)

Kowalski Stanley P Reynaldo V Ebora David R Kryder and Robert H Potter (2002)ldquoTransgenic Crops Biotechnology and Ownership Rights What Scientists Need toKnowrdquo Plant Journal 31 (4) 407ndash21

Lanjouw Jean O (2002) ldquoA Patent Proposal for Global Diseasesrdquo In Boris Pleskovicand Nicholas Stern eds Annual World Bank Conference on Development Economics20012002 Washington DC World Bank pp 189ndash219

McBride William D and Nora Books (2000) ldquoSurvey Evidence on Producer Use andCosts of Genetically Modified Seedrdquo Agribusiness 16 (1) 6ndash20

McDonald Nick (2003) ldquoGenetically Modified Organisms ndash The Last Thing the Devel-oping World Needsrdquo Online available globalvisionorglibrary6561 (accessed 16November 2003)

Mazoyer Marcel (2000) ldquoLa moitieacute de la paysannerie mondiale nrsquoest pas solvable pourles grands laboratoiresrdquo Le Monde eacutedition eacutelectronique Paris 16102000 Onlineavailable wwwlemondefr (accessed 16 October 2000)

Myers Dorothy (1999) ldquoGM Cotton Fails to Impressrdquo Pesticides News (The PesticideTrust) 44 (June) 6

Nature (2004) ldquoOpen-Source Biologyrdquo Nature 431 (30 September) 491Pollan Michael (2001) The Botany of Desire A Plantrsquos-Eye View of the World New

York Random HousePray Carl E Danmeng Ma Jikun Huang and Fangbin Qiao (2001) ldquoImpact of Bt-

Cotton in Chinardquo World Development 29 (5) 813ndash25Pschorn-Strauss Elfrieda (2004) ldquoBt-Cotton and Small-scale Farmers in Makhatini A

Story of Debt Dependency and Dicey Economicsrdquo Online available wwwgrainorgresearchbtcottoncfmid100 (accessed 23 September 2004)

Taylor Michael R and Jerry Cayford (2003) ldquoAmerican Patent Policy Biotechnologyand African Agriculture The Case for Policy Changerdquo RFF Report November 2003Washington DC Resource for the Future

The Economist (2005) ldquoThe Triumph of the Commons Can Open Source RevolutioniseBiotechrdquo 12 February pp 61ndash2

Thirtle Colin and Lindie Jenkins Beyers (2003) ldquoCan GM-technologies Help AfricanSmallholders The Impact of Bt-Cotton in the Makhatini Flats of Kwazulu-NatalrdquoWorld Development 31 (4) 717ndash32

Wu Kongming Hongqiang Feng and Yuyuan Guo (2004) ldquoEvaluation of Maize as aRefuge for Management of Resistance to Bt-Cotton by Helicoverpa armigera (Huumlbner)in the Yellow River Cotton-farming Region of Chinardquo Crop Protection 23 (6)523ndash30

9 Globalization and small-scalefarmersCustomizing ldquofair-trade coffeerdquo1

Marijke DrsquoHaese Jan Vannoppen and Guido Van Huylenbroeck

Introduction

Globalization either directly or indirectly has brought about profound changesin the previously existing institutional order Specifically in the agriculturalsector structural adjustment reforms called for the disappearance of governmen-tal regulatory institutions (eg marketing boards) and lowering if not totallyremoving of various trade protection barriers in many developing countriesHowever the long overdue changes in the previously extant institutional orderthat globalization entails surely cannot be reduced to no institutions at all Infact the changes in the institutional environment have had dramatic impacts onthe production and market environment of many producers in less developedcountries (LDCs) especially for small non-organized farmers because of forexample the resulting more risky environment

At the same time a new international institutional order is being created byorganizations and world agencies like the WTO For example the institutional-ization of a worldwide intellectual property rights (IPR) protection under the so-called Trade Related Aspects of Intellectual Property Rights (TRIPS) agreementdramatically changed the room for maneuver of economic agents under global-ization As emphasized by Yotopoulos (Chapter 1) these changes entailsystematically asymmetric outcomes that usually work against the LDCsbecause the preconditions of success (ie the existence of physical infrastruc-tures and appropriate economic institutions) are more likely to exist and areeasier to satisfy among the rich countries than among the poor countries

This is especially true under globalization where the trade compositionchanges towards ldquodecommodified traderdquo that is trade of products that havemoved up the value-added scale by incorporating a greater degree of customiza-tion or a significant reputation component in the spirit of this volume In such asituation international trade is not anymore the Ricardian least-cost trade basedon comparative advantage and becomes instead trade in ldquopositional goodsrdquo thatis based on the reputation of the product The TRIPS framework reinforces thistrend imposing what Pagano (Chapter 2) calls a ldquopan-positionalrdquo legal orderwhich grants an exclusive ldquorightrdquo to the IPR holder while involving ldquoobliga-tionsrdquo (duties) for all other individuals Therefore in order to prevent outcomes

that may be systematically distorted against the poor (countries andor people)globalization needs to be enhanced by incorporating also pro-poor institutionsThis chapter provides an application of such an institutional enhancement in thecase of ldquofair-trade coffeerdquo

Until 1989 the international coffee market was regulated by the InternationalCoffee Agreement which warranted a stable economic environment Agree-ments were made on predetermining the overall coffee supply levels throughexport quotas for producing countries and enforcing a price band to keep theprice of coffee relatively stable In 1989 the regulations on supply and pricestability were dismantled (Oxfam 2002) The orthodox mechanism of copingwith increased price risk ie futures markets is non-existent and is alsounaffordable to producers in most LDCs ldquoFair-trade coffeerdquo represents analternative institutional arrangement that guarantees fairly stable prices to theproducers by filling in for the erstwhile marketing boards that operated inthe rural setting of LDCs and have by now fallen victims of globalization Fair-trade coffee organizes the environment-friendly production of coffee and helpsin strengthening the bargaining power of small producers vis-agrave-vis the inter-mediaries

Furthermore the branding of fair-trade coffee is an institutional innovationthat mimics the formal protection of intellectual property rights that is availablefor (mostly developed country) services and manufactures in order to ensuresome economic rents also to small farmers in the form of higher prices at thefarm gate More specifically fair trade is an example of how the same strategyadopted by developed countriesrsquo producersprocessors (ie the sequence ofproduct differentiation institutional certification and advertising) can be used byLDC producers to increase the reputation content of the good they produceFair-trade labeling is viewed as a form of ldquodecommodificationrdquo (YotopoulosChapter 1) that differentiates the decommodified (ie customized and morereputed) good from its standard counterparts on ldquoethical groundsrdquo The goodnews is that under globalization it is much easier to find a market for suchhighly-reputed goods because there will be consumers with preference for thisldquo(ethically) customizedrdquo coffee that can be reached at relatively affordable costsOn the other side it should be stressed that this outcome cannot be taken forgranted since investments are needed to produce high quality coffee for market-ing plus an institutional arrangement which safeguards the identity of the differ-entiated product

This chapter is organized as follows The next section provides an overviewof the problems faced by small-scale coffee producers in view of the novel glob-alized economic and institutional environment in which they operate The thirdsection discusses the effects of fair-trade labeling in mitigating market failuresand shows the features of the decommodification process in the specific case offair-trade coffee The fourth section analyzes the institutional changes requiredfor the marketing of fair-trade coffee and assesses the pros and cons of theprocess of coffee decommodification through fair-trade labeling The finalsection summarizes the main findings of the study

Customizing ldquofair-trade coffeerdquo 165

Small-scale coffee producers under globalization

Smallholder coffee producers have been experiencing very harsh times sincethe early 1990s Decreasing prices and reduced market opportunities haveseverely affected producersrsquo livelihoods (Ponte 2002 Taylor 2005) This ismainly due to the changes induced by globalization such as the dismantling ofpre-existing market institutions (eg the International Coffee Agreement) andthe entry of new suppliers in the world market that compounded the alreadyexisting weaknesses of the coffee supply chain The final outcome was thatcoffee production became less profitable which in turn increased the vulnera-bility of coffee producers especially those who are small scale and are notorganized

The coffee supply chain is structured in an articulated and complex cobwebof relationships that links production and consumption where informationasymmetries and market power are pervasive problems (Figure 91) Forinstance on the consumption side the information on the origin of the beans andon the cultivation methods is merely anecdotal while on the production side theinformation on prices and market opportunities is hardly accessible to thefarmers especially to the small-scale producers2 In the pre-globalization yearsmany operators (including marketing boards domestic traders exporters inter-national traders brokers retailers and restaurateurs) used to transact along thesupply chain Under globalization the market liberalization induced a reorgani-zation of the worldwide coffee supply chain which implied the disappearance ofthe marketing channel that used to pass through coffee marketing boards (cf thedotted-arrow links in Figure 91) and nowadays the supply chain is dominatedby five multinationals that control almost 70 percent of the product trans-formation and marketing (Ponte 2002)

Overall the international coffee trade is characterized by the increase inmarket power at the marketing and processing stages that along with excesssupply contributed to a dramatic decrease of the green coffee price at farmgate Although since 1989 the world consumption of coffee has been growingat an average rate of about 15 percent per annum the price at farm gatehas been decreasing in real terms and in 2003 it barely reached a quarter ofwhat it had been in 19603 At the same time the prices at consumption levelhave been increasing or not decreasing in real terms (Figure 92)

In more recent years the situation has become even more critical for produc-ers because of the structural oversupply of coffee at world level In fact worldcoffee production increased from 59 million metric tons in 1989 to 78 millionmetric tons in 2004 (FAO 2005) We can identify three main factors that con-tributed to the oversupply and therefore to the constant decline of prices forgreen beans on the world market First coffee production techniques drasticallyimproved in Brazil as consequence of the cultivation of less frost-prone areasand of a more extensive use of irrigation and mechanical harvesting4 Secondthe entry of Vietnam into the world coffee market in the last decade caused adramatic increase in supply of low cost coffee5 Third the increasing production

166 M DrsquoHaese et al

and use of robusta variety coffee contributed further to softening the coffeemarket On the production side robusta is much more resistant to adverseenvironmental conditions than arabica6 On the consumption side innovationsintroduced at the processing stage reduced the acid taste of robusta thus makingit usable in blends especially in popular flavored coffees sold in price-sensitivecountries

Consumer

RetailerSupermarket

RestaurantCafeacute

RoasterInstant coffeemanufacturer

Internationaltrader

Consumingcountries

Broker

Marketingboard

Exporter

Producingcountries

Curing planthuller

Domestic tradercooperative

Farmer groupAgent

EstateSmallholder

dry cherry orparchment

green coffee

roastedinstant coffee

Figure 91 The supply chain of coffee (source Ponte 2002)

The decreasing prices at the farm gate were not the only problem for small-holder coffee producers The broad implementation of structural adjustmentreforms in the 1990s implied that many countries liberalized fully or partiallythe coffee market Under the pre-existing International Coffee Agreements(ICA) framework producer countries agreed to control supply through exportquotas and buffer stocks that helped to keep prices high especially between1962 and 1989 (ICO 2006) In 1989 the ICA was abolished leaving the farmersto deal directly with the strong commercial intermediaries and with the vagariesand uncertainties of the global market Talbot (1997) shows that under liberal-ization the producersrsquo share of the final retail price dropped from almost 20percent in 1989ndash90 to 13 percent in 1994ndash5 while the share retained in consum-ing countries increased to 78 percent

Farmers were also left to the unpredictability of the world market Ponte(2002) reported that price volatility increased dramatically in the 1990s themonthly nominal price variability in 1990ndash7 expressed as coefficient of vari-ation amounted to 37 percent that is twice as large that of the previous decadeand it has further increased to 43 percent by 1998ndash2000 But farmers have onlylimited mechanisms of coping with increased risk Coffee is a perennial crophence production is not adaptable to price shocks in the short run Diversificationto other crops andor income-generating activities is too expensive and risky initself The standard institution for hedging against price risks ie future marketsis not available for the smallholder producers Moreover the reduction in subsi-dies for coffee production and agricultural services such as credit for input pro-curement left the producers and especially the small-scale and non-organizedfarmers especially vulnerable to the vagaries of a receding coffee market7

FranceGermanyNetherlandsSwitzerlandUSAUK

Figure 92 Evolution of coffee retail price 1975ndash2004 (authorsrsquo calculations on ICO2006 data)

In response to the problems of smallholder farmers a new internationalcoffee agreement was signed in 2001 Its aim was to promote coffee consump-tion to provide a forum for the private sector and to promote farmer training andinformation programs in member countries (ICO 2006) However the lack ofeconomic coordination and the opportunism of producers and intermediaries inthe marketing chain undermined its effectiveness There have been numerouscases reported of traders taking advantage of the lack of price information tocheat farmers and of farmers who breached their contracts with traders whenthey could obtain a higher price elsewhere (Vannoppen 2003)

In conclusion the old institutional order disappeared with globalization andhas not been adequately replaced Fair-trade labeling can be viewed as an alter-native institutional arrangement that provides the farmers with an opportunity toorganize production as well as to strengthen their bargaining power vis-agrave-vis theintermediaries

Fair-trade coffee a case of product decommodification

The origin of fair-trade can be traced back as far as the early 1950s when it waspromoted to support farmers in war-hit regions Trade of fairly priced productsfrom developing countries increased since the 1968 UNCTAD conference thatlaunched the so-called ldquoTrade not Aidrdquo initiative This was an incentive forNGOs like SOS Wereldhandel in the Netherlands and Oxfam in UK to developa fair-trade campaign (Solagral 2002) The first fair-trade label for coffee waslaunched in 1988 and fair-trade coffee is currently available in some 20 coun-tries worldwide (Rice and McLean 1999)

Fair-trade initiatives intend to provide farmers with a more favorable positionin the market and to solve the problem of information asymmetries between pro-ducers and consumers (Renard 1999) A firm can choose to disclose informationon a given product through labels that provide missing information on the pro-duction process andor through product attributes like minimum requirements forsocial economic and environmental development (Bougherara and Grolleau2002) This information is disclosed and advertised because consumers arewilling to pay a premium for these extra attributes (Golan et al 2000)

Voluntary labels ie the ones developed by an individual or a group of firmscan be viewed as a marketing tool and in this case it is imperative that the bene-fits from increased sales of a labeled product outweigh its costs On the otherhand mandatory labels ie those issued by the government pursue instead asocial goal and can be seen as providing a public good (eg information on foodsafety) Yet both voluntary and mandatory labels try to target the consumersrsquobehavior by attracting attention to certain product attributes that usually areeither ldquoexperiencerdquo or ldquocredencerdquo attributes8 A third-party assessment is com-monly required in order to add credibility and ensure a trustful relationshipbetween consumers and producers

Therefore the fair-trade label signals the commitment of fair-trade organi-zations that the premium paid by consumers represents a fair value of additional

attributes of coffee and also contributes to a more remunerative price for thefarmer (Browne et al 2000 Leclair 2002)9 The direct welfare effect of fair-trade on individual farmers is difficult to assess because of the very differentoperational environments where fair-trade initiatives are implemented (eg thecooperative costs and the distribution of the social premium indeed differs foreach cooperative) but it has been reported by many studies as significantlypositive10

Fair-trade labeling is a genuine example of ldquodecommodificationrdquo (Yotopou-los Chapter 1) fair-trade coffee is differentiated from the bulk of coffee andthe fair-trade label signals to the consumers the higher ethical reputation of theformer vis-agrave-vis the latter This process of product differentiation requiredsome institutional innovations in order to succeed The most important institu-tional development was the establishment in 1997 of the Fair-trade LabellingOrganizations International (FLO) an umbrella organization for 17 nationalinitiatives that has built up partnerships with 197 coffee producer partnersin Africa Asia and Latin America (Table 91) 33 export partners 105importers manufacturers roasters and distributors and 402 license holderswho market the coffee Simultaneously a single fair-trade label was created andan agreement was made on fair-trade standards11 The FLO and national initi-atives certify the compliance to the standards throughout the supply chain(Figure 93)

Until now farmers have not been charged any certification fee Howeverthe investment required to comply with the knowledge and the quality stand-ards of the fair-trade organizations is substantial Small-scale producers inparticular have to struggle with developing the required technical knowledgeas well as building up the organizational structures and trust relationships inthe chain The process is long and requires intensive training and follow-upactivities Farmersrsquo organizations may provide support to their members bycovering inspection fees after the first harvest pre-financing investments andat times providing a subsidy in lieu of wage even in the period before the firstharvest

FLO and national initiatives are financed through the contribution of thelicensees The control procedures are issued by the FLO and include quarterlyadministrative controls reports to auditors and visits of local consultants trainedby the FLO The controls are performed throughout the supply chain in collabo-ration between the national initiatives and the FLO (Max Havelaar 2002)Recently however FLO has drafted a Producer Fee System that anticipates theintroduction of a producer certification fee to all producers applying for a fair-trade FLO certification (FLO 2005)12

Although the consumption of fair-trade coffee is increasing it remains aniche-market segment that reaches only 003 percent of the overall worldcoffee trade amounting to slightly more than 24000 metric tons in 2004 (FLO2004) Yet its sales are steadily increasing (Table 92) at an average annualgrowth of 93 percent over the past ten years This is remarkable because theincrease of fair-trade coffee took place in an environment where traditional

Table 91 Number of fair-trade cooperatives by regions (total) and partner countries(indicative)

RegionsCountries Number

RegionsCentral America 93Caribbean 9South America 63Africa 27Asia 5

CountriesBolivia 17Brazil 5Cameroon 1Colombia 19Congo 2Costa Rica 1Dominican Republic 2East Timor 1Ecuador 2El Salvador 3Ethiopia 3Guatemala 16Haiti 7Honduras 19Indonesia 1Mexico 40Nicaragua 14Papua New Guinea 2Peru 17Rwanda 2Tanzania 6Thailand 1Uganda 13Venezuela 3

Source FLO (2004)

and larger brands are struggling to keep their market shares Major markets forfair-trade coffee include France Germany the Netherlands UK and the USA(Table 93)

Giovannucci and Koekoek (2003) estimate that consumers in 11 major Euro-pean coffee markets consumed more than 154 million kilograms of certifiedfair-trade and 112 million kilograms of certified organic coffees in 200113 Outof these 53 million kilograms were double certified as both fair-trade andorganic Sustainable coffees (grouping fair-trade organic and eco-friendlycoffees) represent on average less than 2 percent of the consumption indeveloped markets even though with large variations across these marketsranging from 03 percent to 34 percent

Institutional innovation through fair-trade labeling

Customizing coffee through fair-trade labeling is an institutional innovation thatmakes possible a fairer distribution of value added along the supply chain andthe empowerment of the weakest agents (ie small-scale producers) vis-agrave-vis thestrongest ones (ie commercial intermediaries) However this institutionalinnovation brings about far reaching consequences that go well beyond the dis-tribution to poor producers of a share of the price premium paid by consumers inpurchasing fair-trade coffee It guarantees in fact a stable access to globalmarkets the access to otherwise inaccessable production assets and the develop-ment of safety nets to increase risk-coping capacity In short it creates therequired preconditions in terms of institutional infrastructure and capacity build-ing that may help poor farmers to fend off the adverse effects of globalization(Romano Chapter 10)

The access to fair-trade marketing channels is more than just the physicalpossibility of selling the product It is also about finding traders and creating atrust relationship while negotiating prices The business of poor farmers is

Table 92 Trade volume of fair-trade coffee 1995ndash2004 (metric tons)

Year Sales volume Annual change ()

1995 99711996 10883 911997 11370 451998 11663 261999 11819 132000 12818 852001 14387 1222002 15780 972003 19872 2592004 24223 219

Source Max Havelaar the Netherlands for data prior to 1998 otherwise FLO (2005)

ProducerProducergroup or

organization

TraderImporter

Licenseholders

Processing

Nationalinitiative eg

Max HavelaarBelgium

Consumer

Flow of products

Reporting

Control audit

Registered partner

Figure 93 Product flow reports and controls in the fair-trade coffee supply chain(source Max Havelaar 2002)

indeed too small and often too remote to make possible the development of acomplete set of markets that can span space time and uncertainty This is themain reason why farmers generally sell on a spot market whereas private traderscan hedge on private commodity markets thus reducing price risks significantly(Tollens 2003)

Therefore fair-trade initiatives can be seen as triggers for farmers to self-organize in new networks that increase their bargaining power in price and con-tract negotiations enhance their access to credit and their creditworthiness andcreate more room for the exploitation of economies of scale in using indivisiblephysical infrastructures (Dankers and Liu 2003) The institutional innovationscan operate at different levels in the coffee supply chain both horizontally asfarmers associate collectively to market coffee and vertically as the farmersrsquoassociation engages in new trade arrangements with private traders An exampleis the creation of small-scale coffee producer cooperatives14 In this case theadvantage derives from the possibility of collective grading and sorting of coffeebeans thus providing the trader with properly packaged cherries of differentqualities In this sense the fair-trade new institutional arrangement guaranteeinga higher price provides also incentives to farmers to improve quality Moreovertransaction costs will be lower because of the economies of scale in the use ofindivisible inputs like managerial abilities (eg information gathering contractnegotiation) and physical infrastructure (eg storage facilities transport equip-ment) Furthermore it also increases the credibility of suppliers because socialcontrol among the group members could increase the reliability of compliance tothe codes of practices In short collective action and better access to informationhelp lower the transaction costs and stimulate farmers to invest time knowledgeand assets in the production

New institutional arrangements (eg contracts and management tools) need tobe developed not only between the farmers but also vertically along the supplychain up to the consumers In this case the trader who is part of the fair-tradeinitiative is contractually obliged to pay the farmers a ldquofairrdquo price The fair-tradeexperiment can even go further and provide a market access to those farmerswho want to add extra attributes to their product for example the production oforganic coffee the identification of special characteristics of the production area

Table 93 Major consumers of fair-trade coffee 1995ndash2004 (metric tons)

Countries 1995a 2004b 1995ndash2004 change ()

USA Not yet started 6577 NAThe Netherlands 3100 2982 238United Kingdom 427 3339 6819Germany 3984 2981 252France Not yet started 2784 NASwitzerland 1389 1462 253Belgium 472 1865 833

Sources a Max Havelaar the Netherlands b FLO (2005)

or traditional processing techniques (Dankers and Liu 2003) Considering thecredence nature of fair-trade labeling attributes those institutional arrangementsneed to be based on a trust relationship Trust can arise either from interpersonalcontacts or from general knowledge about the population (Fafchamps 2004)Strong networks and dense social ties reinforce the interpersonal contacts andthereby personalize trust while trading experience creates generalized trustbetween the trader and the farmer cooperative (Lazzarini et al 2001 HayamiChapter 5) This trust is reinforced by the operation of a third-party organizationFLO that adequately monitors and controls the compliance with the codes ofproduction along the whole supply chain

In conclusion the fair-trade initiatives create value in two ways namelythrough capacity building and collective action in the cooperatives (Dankers andLiu 2003) and by increasing the market efficiency along the supply chain15 Theinstitutional arrangements provided under fair-trade initiatives are thereforeclose to what Kydd (2002a 2002b) describes as an ideal institutional arrange-ment for smallholder farmers that should be deliberative working horizontallyinside a sector and vertically along the supply chain and need to be based on aconsensus of what may constitute a just and fair outcome

Conclusion

The impact of globalization on the operational environment of many small-scalefarmers has been dramatic The old institutional order disappeared and there is aclear need for a new institutional order that can help small-scale farmers to dealwith the adverse effects of globalization Fair-trade coffee represents a casestudy that shows how this can be done

Fair-trade labeling involves the use of rather common marketing tools such asproduct differentiation certification and advertising for the purpose of breedingreputation and thereby value to a traditional product such as coffee The labelitself helps to overcome pervasive information asymmetries between the produc-ers and the consumers

Large coffee roasting companies are reluctant to develop or join a fair-tradelabel as they consider it not to be a solution to the crisis in the coffee marketThey argue that providing an incentive for farmers to continue producing coffeecan restrain them from thinking about available economic alternatives andtherefore prolonging their economic dependence On the other hand it can beargued that fair-trade coffee can help to offset the negative effects of the crisis ofthe coffee market on small-scale producers that derive from the oversupply oflow quality coffee cherries Therefore fair-trading initiatives especially thosefocusing on quality and on the marketing of high reputation coffee should beable to mitigate the effects of the crisis

Whether fair-trade labeling can make a difference on world production andprovide an incentive towards the production of more quality and less quantity isstill under debate However considering the structural change in internationaltrade from a commodity-based trade to a reputation-based trade this can be

viewed as an example of the strategy LDC farmers can adopt to exploit theopportunities offered by globalization ldquoDecommodifyingrdquo coffee through fair-trade labeling can in principle help small-scale coffee producers to enter theglobalized markets and to increase their own revenues However this outcomecannot be taken for granted since non-trivial investments are needed to promotethe required institutional innovations

1 The authors gratefully acknowledge the comments of the editors of this volume andof anonymous reviewers of earlier drafts We also thank Max Havelaar Belgium MaxHavelaar the Netherlands and the Fair-trade Labelling Organizations International fortheir help The usual disclaimer applies

2 The lack of information for small-scale producers is compounded by the structuralrigidity in coffee bean supply due to the fact that it takes three years before new treesstart to produce fruit and to the requirement of picking coffee cherries yearly formaintaining healthy trees regardless of the market price

3 Lewin et al (2004) report that since 1970 prices have declined on average 3 percentand 5 percent per year for arabica coffees and robusta coffees respectively Occa-sional price rebounds have been reported in 1995 and 1997 (Chalmin 2003) and 2005(Muradian and Pelupessy 2005)

4 Moreover the Brazilian government improved the operational environment of Brazil-ian producers by providing price forecasting and risk management services and favor-ing the enhancement of productivity coordination and market responsivenessthroughout the supply chain (Technoserve 2003)

5 Coffee production in Vietnam increased from virtually nil in early 1980s to 41000metric tons around the end of 1980s to more than 830000 metric tons in 2003ndash4(FAO 2005) The average growth rate of Vietnamese production in the 1990s was anastonishing 252 percent per annum and Vietnam became the second largest producerin the world at the end of the decade with a share of 99 percent in world production(Ponte 2002) The share of Brazil Vietnam and Colombia in global production hasincreased from about 30 percent in 1970 to 52 percent in 2004 (Lewin et al 2004)

6 Most commercial green coffee is either the Coffea arabica or Coffea canephoraspecies which are referred to commercially as arabica and robusta respectivelyArabica beans are generally considered of higher quality and fetch slightly higherprices than robusta beans Historically arabica coffee was cultivated in LatinAmerica Ethiopia and Kenya while Brazil Vietnam and Uganda were the major pro-ducers of robusta coffee (Bacon 2005)

7 Subsidized production inputs such as fertilizers pesticides and credit for input pur-chase were provided through state or parastatal organizations Yet both the credit ser-vices and subsidies were removed with the economic structural adjustment in manycountries (Hillocks 2001)

8 Product attributes can be classified into three groups ldquosearchrdquo attributes provideinformation on the product quality that can be perceived before purchase throughproduct inspection ldquoexperiencerdquo attributes can be assessed after purchase throughproduct consumption while ldquocredencerdquo attributes cannot be accurately assessedeven after consumption (Darby and Karny 1973) The latter are better known by theproducers than by the consumers as is the case for environmental or ethicalattributes

9 Certified producer organizations are paid a price that covers the production costsldquoBuyers shall pay producer organizations at least the fair-trade minimum price asset by FLO (Fair-trade Labeling Organizations International)rdquo (FLO 2004) The

fair-trade minimum prices vary according to the type and origin of the coffee In addi-tion to the fair-trade minimum price the buyers pay a fair-trade premium as set byFLO at US$005lb For certified organic coffee an additional premium of US$015lbof green coffee is charged on top of the fair-trade minimum price or market-referenceprice respectively The market price referred to above is based on the New York ldquoCrdquocontract for arabica and on the London ldquoLCErdquo contract for robusta and it becomesrelevant any time the fair-trade minimum price enhanced by the relevant premiumsis lower than the market price (FLO 2002)

10 Taylor et al (2005) report that in the case of Majomut cooperative (ChiapasMexico) by entering the fair-trade scheme the cooperative members increased theirearnings from US$550 of the conventional trade to US$1700 Furthermore indirecteffects of fair-trade initiatives should not be underestimated Building on theexperience of seven case studies in Latin America Taylor et al (2005) conclude thatfair label initiatives are conducive to a greater economic and social stability by (i)improving the organizational capacity of the farmersrsquo association (ii) developing thefarmersrsquo ability to handle administration (iii) enhancing farmersrsquo capacity tonegotiate (iv) developing greater social and trade networks and (v) improving theaccess to credit Moreover diverse community projects are financed through thesocial premiums

11 Generic fair-trade standards are issued for small farmersrsquo organizations and for hiredlabor on plantations with the aim to ensure that (i) fair-trade benefits reach the smallfarmers andor workers (ii) the small farmersrsquo organizations andor the workers havepotential for development and (iii) fair-trade instruments can take effect and lead to adevelopment which cannot be achieved otherwise (cf FLO 2001a 2001b 2002)

12 FLO certification fees include an application fee and initial certification fee as well asyearly renewal certification fees and follow-up inspection fees The amount of such afee depends among others on the nature of the organization number of products tobe certified number of members products and processing installations (FLO 2005)

13 The relevant countries are Belgium Denmark Germany Italy Finland France theNetherlands Norway Sweden Switzerland and the United Kingdom

14 The focus of such cooperatives is on post-harvest activities not on production itselfthis avoids the adverse incentive problems usually reported in the case of productioncooperatives (Hayami Chapter 5)

15 It should be recalled however that critics against fair trade (cf among othersZehner 2002) have stressed that (i) fair trade is a poor vehicle to transfer wealthfrom consumers to producers and (ii) eliminating middlemen is unlikely to resolveproblems in the traditional supply chain

References

Bacon Christopher (2005) ldquoConfronting the Coffee Crisis Can Fair Trade Organic andSpecialty Coffees Reduce Small-scale Farmer Vulnerability in Northern NicaraguardquoWorld Development 33 (3) 497ndash511

Bougherara Douadia and Gilles Grolleau (2002) ldquoCan Ecolabelling Mitigate MarketFailure An Analysis Applied to Agro-Food Productsrdquo In Willie Lockeretz ed Eco-labels and the Greening of the Food Market Proceedings of a Conference BostonMA Tufts University pp 111ndash20

Browne Angela W Phil JC Harris Anna H Hofny-Collins Nick Pasiecznik and RRWallace (2000) ldquoOrganic Production and Ethical Trade Definition Practice andLinksrdquo Food Policy 25 (1) 69ndash89

Chalmin Philippe (2003) Le marches mondiaux Cyclope 2003 Paris EconomicaDankers Cora and Pascal Liu (2003) ldquoEnvironmental and Social Standards Certification

and Labelling for Cash Cropsrdquo Report prepared for the Commodity and Trade Divi-sion of the Food and Agriculture Organization of the United Nations Rome FAO

Darby Michael R and Edi Karny (1973) ldquoFree Competition and the Optimal Amount ofFraudrdquo Journal of Law and Economics 16 (1) 67ndash88

Fafchamps Marcel (2004) Market Institutions in Sub-Saharan Africa Theory and Evid-ence Cambridge MA The MIT Press

FAO (2005) ldquoStatistical Databaserdquo Online available wwwfaoorg (accessed 15 Decem-ber 2005)

FLO (2001a) ldquoGeneric Fair-trade Standards for Hired Labourrdquo Version November 2001Online available wwwfairtradenetpdfhlenglishGeneric20Fairtrade20Standard20Hired20Labour20Dec20200520ENpdf (accessed 23 February 2004)

FLO (2001b) ldquoGeneric Fair-trade Standards for Small Farmersrsquo Organisationsrdquo VersionNovember 2001 Online available wwwfairtradenetpdfspenglishGeneric20Fair-trade20Standard20SF20Dec20200520ENpdf (accessed 23 February 2004)

FLO (2002) ldquoFair-trade Standards for Coffeerdquo Version April 2002 Online availablewwwfairtradenetsitesstandardsstandardshtml (accessed 15 February 2004)

FLO (2004) ldquoFLO Coffee Salesrdquo Online available wwwfairtradenetsitesproductscoffeesaleshtml (accessed 10 December 2004)

FLO (2005) ldquoDraft FLO-Cert Producer Certification Feesrdquo Online available wwwfair-tradenetsitescertificationfee_2006html (accessed 27 December 2005)

Giovannucci Daniele and Freek Jan Koekoek (2003) The State of Sustainable Coffee AStudy of Twelve Major Markets An IISDndashUNCTADndashICO Book Cali Feriva

Golan Elise Fred Kuchler and Lorraine Mitchell (2000) ldquoEconomics of FoodLabellingrdquo Agricultural Economic Report no 793 Economic Research Services USDepartment of Agriculture Washington DC

Hillocks Rory (2001) ldquoCoffee Is It Still a Viable Cash Crop for Smallholders inAfricardquo Outlook on Agriculture 30 (3) 205ndash12

ICO (2006) ldquoInternational Coffee Organizationrdquo Online available wwwicoorg(accessed 4 April 2006)

Kydd Jonathan (2002a) ldquoAgriculture and Rural Livelihoods Is Globalisation Openingor Blocking Paths Out of Rural Povertyrdquo Agricultural Research and ExtensionNetwork Agren Network Paper no 121 London Overseas Development Institute

Kydd Jonathan (2002b) ldquoTrade Liberalisation Institutions and Agriculturerdquo Centre forDevelopment and Poverty Imperial College at Wye Wye

Lazzarini Sergio C Fabio R Chaddad and Michael L Cook (2001) ldquoIntegrating SupplyChain and Network Analysis The Study of Netchainsrdquo Chain and Network Science 1(1) 7ndash22

Leclair Mark S (2002) ldquoFighting the Tide Alternative Trade Organizations in the Eraof Global Free Traderdquo World Development 30 (6) 949ndash58

Lewin Bryan Daniele Giovannucci and Panos Varangis (2004) ldquoCoffee Markets NewParadigms in Global Supply and Demandrdquo Agricultural and Rural Development Dis-cussion Paper no 3 Washington DC World Bank

Max Havelaar (2002) ldquoMax Havelaar Het keurmerk voor eerlijke handel Criteria certi-ficering en controlerdquo September 2002 Online available wwwmaxhavelaarbe(accessed 31 March 2004)

Muradian Roldan and Wim Pelupessy (2005) ldquoGoverning the Coffee Chain The Role ofVoluntary Regulatory Systemsrdquo World Development 33 (12) 2029ndash44

Oxfam (2002) ldquoMugged Poverty In Your Coffee Cuprdquo Oxfam International Onlineavailable wwwmaketradefaircom (accessed 13 December 2005)

Ponte Stefano (2002) ldquoThe lsquoLatte Revolutionrsquo Regulation Markets and Consumptionin the Global Coffee Chainrdquo World Development 30 (7) 1099ndash122

Renard Marie-Christine (1999) ldquoThe Interstices of Globalization The Example of FairCoffeerdquo Sociologia Ruralis 39 (4) 484ndash500

Rice Paul D and Jennifer McLean (1999) ldquoSustainable Coffee at the Crossroadsrdquo AReport for the Consumerrsquos Choice Council Washington DC Online availablewwwconsumercouncilorg (accessed 28 February 2004)

Solagral (2002) ldquoEtat des lieux et changement drsquoeacutechelle du commerce eacutequitable Solidar-iteacute agricole et alimentairerdquo Online available wwwsolagralorg (accessed 13 March2004)

Talbot John M (1997) ldquoWhere Does Your Coffee Dollar Go The Division of Incomeand Surplus Along the Coffee Commodity Chainrdquo Studies in Comparative Inter-national Development 32 (1) 56ndash91

Taylor Peter L (2005) ldquoIn the Market But Not of It Fair Trade Coffee and Forest Stew-ardship Council Certification as Market-based Social Changerdquo World Development 33(1) 129ndash47

Taylor Peter L Douglas L Murray and Laura T Raynolds (2005) ldquoKeeping Trade FairGovernance Challenges in the Fair Trade Coffee Initiativerdquo Sustainable Development13 (3) 199ndash208

Technoserve (2003) ldquoBusiness Solutions to the Coffee Crisisrdquo 2 December 2003Online available wwwtechnoserveorg (accessed 2 February 2004)

Tollens Eric (2003) ldquoFair Trade An Illusionrdquo Working paper 200384 Department ofAgricultural and Environmental Economics KU Leuven Leuven

Vannoppen Jan (2003) ldquoA Coordinated Market Economy to Benefit the Poorrdquo Tijd-schrift Economie en Management 48 (4) 641ndash52

Zehner David C (2002) ldquoAn Economic Assessment of lsquoFair Tradersquo in Coffeerdquo ChazenWeb Journal of International Business (autumn) Online available wwwgsbcolum-biaeduchazenjournal (accessed 31 March 2004)

Part IV

Conclusions

10 What have we learned aboutglobalization1

Donato Romano

Introduction

No recent economic phenomenon has received more attention than globalizationin scholarly circles as well as in the policy arena and even among laypeopleAnd no other phenomenon has so polarized the discussion around two contrast-ing views which ultimately reflect alternative assessments of the benefits andcosts of globalization The critics have argued that globalization has exploitedpeople in developing countries caused massive disruptions to their lives andproduced few benefits in return Its supporters point to the significant reductionsin poverty achieved by countries which have embraced integration with theworld economy with China and India being the current poster-countries of suchsuccess

Irrespective of which side of globalization people stand on both critics andsupporters would agree that the pace of globalization is uneven across the worldand that its outcomes are differentiated Where people disagree is on the expla-nation of the differentiated impacts of globalization and indeed there is scantliterature that attempts to provide a causal and systematic framework for theuneven outcomes of globalization This is the general objective of this volumewhich through theoretical and empirical contributions goes even farther arguingthat the effects of globalization are not only differentiated but also fundament-ally asymmetric and generally detrimental to poor countries unless specific pro-poor policy reforms are implemented The purpose of this concluding chapter isto add emphasis to the analytical component of the chapters collected in thisvolume and to organize them around the various sources of the asymmetries ofglobalization that have been identified

In pursuing this objective the chapter is organized as follows The nextsection focuses on the systematic asymmetries that weigh against the developingcountries by having their origin in inherent characteristics of poverty such aslack of basic infrastructure The novel contribution of this volume comes in thethird section which focuses on the asymmetries that arise when internationalexchange transcends the traditional trade in commodities and extends to trade inservices which includes trade in ldquopurerdquo services but also a broad range of more-or-less ldquodecommodifiedrdquo goods This is the signature trade of the modern era of

globalization and constitutes the second cause of systematic asymmetries ofglobalization It incorporates ldquoreputational payoffsrdquo that accrue in the form ofeconomic rents which the developed countries are best positioned in capturingIn the same section a third source of asymmetry is presented that is trade in cur-rency that is used as an asset primarily the reserve currency This third source ofsystematic asymmetries is also rooted in reputational asymmetries and material-izes in munificent payoffs in the form of economic rents to the reservehard cur-rency countries and to the rich in the developed and the developing world Thefourth section argues that a unifying feature of international trade under thecurrent wave of globalization is that services decommodified goods and curren-cies are all ldquopositional goodsrdquo and briefly discusses the consequences of this interms of development perspectives for poor countries In this case the speciali-zation of the First World in reputational and intellectual goods which are oftenprotected by ldquopan-positionalrdquo global rights can be a cause of asymmetricdevelopment This is associated with serious disadvantages for the countriesproducing standard commodities and implies de facto trade restrictions andunequal exchanges that favor the richest countries

The fifth section highlights some policy implications that arise from the endo-geneity of the asymmetries of globalization The final section draws the conclu-sion that structural differences among developing countries matter but onlysome of them are the inevitable offspring of poverty As a result poverty allevi-ation alone is not sufficient for restarting growth in poor countries Some struc-tural characteristics of the international trade system that yield presumptivelyunfair outcomes also need to be addressed

Asymmetric infrastructural endowments

Globalization is predicated on the extension and deepening of the market as aresult of the reduction of the transaction costs of trading internationally Themost striking feature of modern globalization is the increase in trade2 and infinancial integration3 as a percent of GDP across the world an observation thatstands true both over time and across countries Not unlike the experience of thenineteenth century globalization the trade outcome can be attributed largely tothe innovations in transport and communication technologies and it wasenhanced and complemented with the extension of international finance in thepost-WTO years due to the parallel liberalization of trade and capital flows(Baier and Bergstrand 2001 WTO 2003 2004)

One would have expected that an increase in international competition wouldnormally benefit the less developed countries (LDCs) by strengthening theircomparative advantage in operating with low wage costs vis-agrave-vis the developedcountries (DCs) This expectation does not seem to be warranted by aggregatedata on LDC shares of trade in world totals4 Although the aggregate data arerough-strewn and hide dramatic differences among LDCs they serve to high-light that trade in general and international trade specifically is founded oninfrastructural and institutional prerequisites that may be wanting in LDCs to

182 D Romano

various degrees The benefits of trade can be reaped only if the necessary physi-cal infrastructures (eg road storage facilities and distribution networks) as wellas ldquoimmaterialrdquo infrastructures (eg telecommunication networks good educa-tional systems) are already in place To the extent that LDCs are infrastructure-poor they are also handicapped in taking full advantage of the tradeopportunities that might arise

Strictly related to infrastructures is another prerequisite the existence ofappropriate legal and economic institutions It is a trite proposition that a statewhere there is no security ensured by a police force where the legal system isweak and where the courts are not impartial is unlikely to see economic activi-ties flourishing This precondition for growth was first emphasized by AdamSmith and played a crucial role in Myrdalrsquos ldquosoft staterdquo (Myrdal 1968) It hasbeen tested more recently by statistical analyses that proved the importance ofsecurity stability and accountability as factors conducive for growth5 and it hasbecome by now a staple in all good-governance packages that are targeted toLDCs (World Bank 2004) While the existence of the requisite economic andlegal institutions is taken for granted in DCs it is the lack of the same that is thenorm in many LDCs The main reason that most political economic and legalinstitutions do not exist is that poor countries cannot afford their cost And evenwhere they exist they often end up being captured by special interests and by thelocal elites that may pay lip service to growth but they scarcely contribute topromoting development

The core argument regarding institutions is that they do not come for freeand consequently a necessary condition for having them in place is theiraffordability This condition is not successfully met in many LDCs Forinstance recent data show that globalization has caused a sustained increase incommodity price uncertainty (Dehn 2000) This calls for interventions to copewith price volatility Derivative markets represent one of the more effective andnon-distorting instruments for intervention in such cases (World Bank 1999UNCTAD 2002) While such markets routinely exist in the DCs they havefirst to be set up and regulated in LDCs which becomes an expensive exercisethat poor counties usually cannot afford In the same vein the spanning ofspace is not possible unless a road network and storage facilities are already inplace while spanning space and uncertainty requires a stock exchange plus anetwork of contingent markets Lacking these there is not an Arrow-Debreuworld and the failure of the dynamic version of the fundamental theoremsof welfare economics means that free markets and free trade do not elicitPareto-optimal outcomes In other words the mutual benefits of free trade areno longer automatic and regulation becomes necessary because of marketincompleteness

Related to the existence (or the lack) of institutions is the access to socialcapital In fact many routine market exchanges involve matters of trust becauseof the pervasiveness of information asymmetries Social capital is an importantingredient in generating the trust that is necessary for transactions Trust is chan-neled either formally through an extant institutional infrastructure as is the case

What have we learned about globalization 183

in mature market economies or by means of informal institutions as is commonin many LDCs The positive role played by social capital as contract enforcerhas been emphasized by many authors in this volume For instance Hayami(Chapter 5) stresses how trust implicit in long-term repetitive transactions as isthe case in communities like tribes and villages6 can play a crucial role in theenforcement of trade contracts and how this can be conducive to the transitionfrom a traditional informal economy to a modern market economy that could besubsequently integrated into the globalized world

Serious problems arise when the existing social capital gets squanderedwithout leaving a working substitute in its stead7 The economic history ofEastern Europe over the last two decades provides a vivid example of institu-tional derangement that resulted from the disruption of the old economic orderas a result of the abrupt introduction of unbridled market forces without thebuffer of time or resources for building a new formal institutional setting whichcould guarantee a certain level of social capital that would provide the benefit ofcontinuity The Russian story is paradigmatic of the perils of institutional derail-ment that abrupt change entails Its ldquobig-bangrdquo transition to capitalism broke thesocial contract which bound citizens together with their government and createdan anomous and kleptocratic environment that was inimical to investmentslowed down the process of restructuring and ultimately undermined macro-economic stabilization (Stiglitz 2000)

A unique example of the backlash created by the combination of big-bangcapitalism and the sudden undermining of the social contract is provided byRask and Rask (Chapter 7) in connection to the transition of the centrallyplanned economies into the market-oriented regimes of the current globaliza-tion era The three groups of countries that the authors distinguish ndash the formerUSSR the Central European countries and the Balkan countries ndash benefitedbefore the collapse of the Soviet bloc by enjoying better nutritional conditionsespecially in terms of high indirect consumption of cereals (in the form ofmeat) as compared to market economies in the West with comparable percapita income This benefit was the outcome of two factors most of theplanned economies had fertile and productive agricultural lands the output ofwhich was shielded from international trade and was reserved for ldquodomesticrdquoconsumption within the former Soviet bloc and second and most importantgood nutrition was considered an entitlement in the social contract of the Sovietera

With the collapse of the Soviet empire and the abrupt advent of the shock-treatment transition to the free market system the insularity of the agriculturalsector was removed the pre-existing structure of agriculture collapsed and sodid the per capita incomes of the countries in transition The dissonance betweenthe Soviet era institutions and the free market institutions that were suddenlyintroduced when the former collapsed is responsible for the current ldquodislocationrdquobetween income and cereal consumption Even worse graduating to the incomelevels that could support the current level of consumption is bound to be alengthy and difficult process

184 D Romano

Asymmetries arising from reputation differentials

Change in the composition of international trade trade in servicesand in decommodified goods

The institutional and infrastructural poverty of developing countries becomeseven more binding for growth and development if we look beyond the tradeaggregates and focus on the composition of trade with respect to goods and ser-vices In the 20 years since the mid 1980s the share of exports of commercialservices to total world exports rose drastically8 What are the implications of thischange in the composition of trade that may relate to the theme of this volume

In the classical model of international trade the DCs have an absolute advan-tage in producing the high-productivity good (services) while the LDCs have arelative advantage in the production of the low-productivity good (commod-ities) All the same the trade is of mutual advantage and services and commod-ities are supposed to trade at their marginal cost of production Yotopoulos(Chapter 1) introduces a slight modification in this model by recognizing as acomponent of the price of services the economic rents that originate in monopo-listic elements (certification copyrights etc) or in ldquobrandrdquo name recognition inone word the economic rents that accrue to reputation In this formulation ser-vices do not trade anymore at their marginal cost of production but on the basisof ldquowhat the market will bearrdquo nor is trade mutual advantage trade but it isbiased to favor the producer of services

In this specification DCs are better positioned to hold an absolute advantagein the production of services as long as services are goods that trade on a reputa-tional basis DCs as a result are better qualified as exporters of ldquodecommod-ifiedrdquo trade and in capturing the economic rents that the production of servicesentails But there exists an additional advantage that drives the DCs to specializein the production of services and it comes from the demand side Specializationin production is predicated on the existence of a corresponding demand for theoutput whether this is domestic or foreign demand Linder (1961) is credited forhaving rounded the classical supply-side oriented theory of comparative advant-age by elaborating on the impact of an increase in incomes that induces the crea-tion of ldquomore sophisticatedrdquo commodities to fill what otherwise would havebeen merely a ldquobasic needsrdquo consumer basket The DCs have by definition ahead start in the production of services since they have a captive domesticdemand from their middle income classes that have an income elasticity ofdemand for services greater than one

Bergstrand (1991) tested for the Linder effect of a shift in tastes in an inter-national cross-section of countries with the conventional PPP data The findingssuggest that the ldquocreationrdquo of demand for more ldquosophisticatedrdquo decommodifiedtrade in the above formulation of Yotopoulos is no longer the exogenous resultof advertising It becomes the result of increasing real incomes whether thisincrease is spread across socioeconomic classes (in the DCs) or it reflects theballooning incomes of the middle class and the elites (in the LDCs) This

formulation of the increasingly important trade in services is a novel contribu-tion of The Asymmetries of Globalization and it has grave political-economyimplications

Miniesy and Nugent (Chapter 4) address precisely this wrinkle in a Linder-type hypothesis by pursuing the asymmetries when the commodities and ser-vices to be traded are subject to reputational effects and the trading partners havean unequal infrastructural and institutional playing field between them Thehypothesis they formulate and test for in an otherwise standard gravity-typemodel of international trade attempts to answer the following question ldquoIf youwant to trade in such a way as to avoid being on the short end of asymmetries intrade and to trade more thereby supporting economic development with whomshould you traderdquo The answer is that countries tend to share more equally thebenefits of trade when they trade broadly with their (income) counterparts ndash andmore selectively with their income peers

The crucial role played by reputation in determining asymmetric outcomes ininternational trade has been emphasized also in other contributions that addempirical content to the present volume by discussing the cases of the adoptionof genetically modified seeds in China the production and trade of ldquofair-traderdquocoffee in Latin America and the double outsourcing in Taiwan

The first two case studies (Fok et al Chapter 8 DrsquoHaese et al Chapter 9)build on the same hypotheses namely there are fundamentally two non-mutuallyexclusive mechanisms that allow firms to capture the rents generated from repu-tational advantages by moving along the continuum from pure commodities topure services first by building an institutional ldquofencerdquo around their product thatguarantees differentiation whether it is branding certification protected denomi-nation of origin and so on second by using advertising and marketing to createand secure consumer loyalty

Fok et al (Chapter 8) discuss the operation of these two mechanisms in thecase of the agricultural biotech sector that in recent years went through a dra-matic change in the locus of agricultural research that shifted from public insti-tutions where it was located during the period of the ldquogreen revolutionrdquo toprivate multinationals as is the case with the biotechnology advances of theldquogene revolutionrdquo The driving forces of this change are both technical innova-tions (eg genetic engineering) and institutional innovations (strengthening ofintellectual property rights) which create a completely new environment wherethe prospect of extracting substantial economic rents becomes highly attractiveto private investors

The application of biotechnology makes possible a degree of product cus-tomization that enables the ldquodecommodificationrdquo of otherwise standard agricul-tural commodities the planting seeds for next yearrsquos crops In fact theapplication of recombinant-DNA techniques constitutes the fundamental justifi-cation for claiming that the creation of transgenic varieties involves a genuineinventive step and therefore the ldquonewrdquo good the genetically modified (GM)seed is eligible for intellectual property right (IPR) protection throughldquoexpanded patentsrdquo9 The immediate consequence from the economic point of

186 D Romano

view is that the producer of this new good can claim the economic rents thatcome along with the production and commercialization of the GM seeds underthe new proprietary regime The authors show that only under the very peculiarChinese conditions the adverse impacts of decommodification of GM seeds canbe balanced through a process of ldquore-commodificationrdquo which can be hardlyreplicated outside China

DrsquoHaese et al (Chapter 9) present another case study of decommodificationwhich this time applies for the benefit of poor countries and people It is anexample of how the same strategy adopted by DC producersprocessors (ie thesequence product differentiation ndash institutional certification ndash advertisement) canbe used by LDC producers to increase the reputation content of their outputs bytransforming them from mere commodities into ldquodecommodifiedrdquo (ie cus-tomized and more reputed) goods More specifically they report how the ldquofair-traderdquo labeling for coffee in Latin America made possible the customization of abulk commodity coffee so as to match the preferences of ldquoethicalrdquo consumersin DCs The branding of fair-trade coffee is an institutional innovation whichmimics the IPR protection available for services and manufactures thus makingpossible the transfer to small farmers of a share of the accruing economic rentsin the form of higher prices

Globalization makes easier the process of decommodification because thereduction of transportation and information costs makes more affordable thepurchase of such highly-reputed goods by consumers with preference for thisethically customized coffee Fair-trade coffee was thus able to penetrate themarkets of developed countries and increase by 140 percent its sales in the lastdecade despite the price differential that it bore relative to the standard coffeeOn the other hand it should be stressed that this outcome cannot be taken forgranted because moving up the reputational ladder requires some sensible insti-tutional changes which safeguard the identity of the differentiated product andconsiderable investments to produce high-quality coffee for marketing Still thisis a story that inspires and can conceivably be transplanted elsewhere

Traditional trade in goods can also include a component of decommodifiedtrade when it becomes subject to the ldquodouble outsourcingrdquo that Liu et al(Chapter 6) present During the industrialization period of Taiwanrsquos develop-ment from the early 1960s to the early 1990s the country developed a thrivingexport trade especially in domestic appliances and manufactures The tightresource endowment of the island as opposed to the cheap sources of supplythat were available in other Asian countries made the continuation of this typeof Taiwanese export trade doubtful in more recent years The solution was foundin a new type of export outsourcing that is based on the interplay between pro-duction costs and reputation differentials It involves a Taiwanese outsourcee(sub)contracting out some of its export orders to manufacturers in lower-wagecountries thus playing the dual role of a middleman and a manufacturer andcapturing their respective economic rents

As the title of the Liu et al chapter indicates this double outsourcing is theresult of exploiting the Taiwanese reputational advantage in the export trade

The fundamental reason that leads to this intermediation opportunity lies in theinformation asymmetry between the buyer (a DC firm) and the producer (a can-didate LDC firm) Necessary conditions for the intermediation are that the mid-dleman knows what the buyer wants what the producer is capable of and howto coordinate the two parties The long-term partnership experienced in the pastby the Taiwanese export outsourcing firms with industrial country buyers even-tually developed into a trusted relationship so that the latter would prefer not tochange partners even though their orders would have cost less should they havebeen placed directly with the supplier in the low-wage country Here the costadvantage of the low-wage country is more than offset by the reputation advant-age of the Taiwanese firms as credible suppliers of stable quality with timelydelivery ndash a reputation that is costly to establish for an upstart poor-countrysupplier

Asymmetric reputation in currencies

The reputational ladder of decommodified trade underlies the treatment byYotopoulos (1996 and Chapter 1) of currency as the prototypical case of posi-tional good When currency is held as an asset instead of being used for transac-tion purposes alone reputation becomes a discriminant factor for rankingcurrencies in a continuum that goes from the reserve currency at the top to thehard the soft and the worthless currency In a free currency market with freeflows of financial capital the reputation differential that favors accumulation offinancial assets in the reservehard currency translates operationally into aprocess of currency substitution of the more reputed (ie reservehard) currencyfor the less reputed (ie soft) currency

This type of currency substitution is analyzed as a parallel metathesis of thestandard theory of incomplete markets but on grounds of asymmetric reputationIt otherwise parallels the incomplete market of credit In the case of credit ahigher interest rate will induce adverse selection of risk Similarly in the case offoreign exchange the local currency is the certain loser when the devaluation isnot in response to the current account fundamentals of the economy but to thereputation contest with the reserve currency for preserving the value of liquidassets Thus the currency substitution-induced devaluation constitutes a confirma-tion of the ability of the reserve currency to protect the liquid assets invested in itand the next devaluation becomes a self-fulfilling prophecy This is a paradigmaticcase of ldquobadrdquo competition and a ldquorace for the bottomrdquo (Yotopoulos Chapter 1)

Positional goods as determinants of the globalizationasymmetries

The discussion in the previous sections highlighted some stylized facts aboutglobalization that feature in this volume The purpose of this section is to weavethese facts into a tapestry using the thread of a (relatively) novel economicconcept that of positional goods

188 D Romano

Standard economics acknowledges the existence of two types of goodsprivate and public According to Samuelsonrsquos classical analysis pure privategoods are characterized by rivalry in consumption and by excludability whilethe opposite holds true for pure public goods (Samuelson 1954) The opera-tional consequences of these features are that for private goods the consumptionchoices of each individual are independent of the choices of others while forpublic goods (and ldquobadsrdquo) the individual consumption choices must move in thesame direction More recently a third category of goods has been proposed thatof ldquopositionalrdquo goods (Hirsch 1976 Frank 1985) One can think of positionalgoods in terms of a reputation ladder with the ranking ranging from the best tothe worst In this context a pure positional good is a good such that given theconsumption choice of one agent another agent must consume a correspondingnegative amount of what the first chooses to consume (Pagano Chapter 2) Forone individual to be more reputable another one has to be less reputable In thepositional ladder the measurement is ordinal which implies that for examplethe second-ranked positional good can advance to first rank by the first-rankedgood losing (in reputation) to anyone in the ladder or by the second-rankedwinning in competition with the first-ranked Positional goods are the classiccase of the ldquotennis ladderrdquo

The link between positional goods and globalization asymmetries is a novelcontribution of this volume It is based on the reputation differentials that existamong ldquodecommodifiedrdquo goods and also services and among various curren-cies (Yotopoulos Chapter 1) The implication of the increasing decommodifi-cation of trade is that international competition is also shifting from acomparative advantage-based trade that rewards the least-cost producer to areputation-based trade that conveys economic rents for reputational advantageIn this latter case the customization of reputation in the transaction of servicesand of decommodified goods turns this dominant component of internationaltransactions into trade in positional goods Moreover due to the advantage inreputation that the DCs enjoy decommodified trade between rich and poorcountries is likely to become one-way trade from the DCs to LDCs10 Further-more the economic rents that accrue to reputation can be compounded by theexistence of network effects thus distorting even further the mutuality of ben-efits between developed and developing-country trade partners (YotopoulosChapter 1)

The various gradations of trade under globalization that have been treated inthe previous sections fit in well with the embellishment that Pagano (2006)makes on the asymmetric outcomes of standard competition the one that fea-tures trade in pure commodities vis-agrave-vis positional competition the one thatfeatures trade in services and in decommodified goods Trade in commodities isan example of mutually beneficial exchange between the trading partners Thepicture is completely different when we consider trade in services and in decom-modified goods in a context where the intellectual property right (IPR) protec-tion is extended worldwide as is the case under the WTOndashTrade Related Aspectsof Intellectual Property Rights (TRIPS) agreement This qualifies the current

international order of IPR protection as a ldquopan-positionalrdquo legal right (PaganoChapter 2) that benefits the right holder while imposing the costs of the obliga-tion of protecting the economic rents attached to the decommodified good on alleconomic agents through third-party governments whether these costs areaffordable for them or not The pan-positional nature of worldwide IPR protec-tion extends the reputational ladder beyond the limits of the community andbeyond the borders of the nation state to cover the world developed and devel-oping countries alike This is a heavy burden especially so for LDCs that haveneither the legal infrastructure nor the policing capability to deliver11 Theldquolegal disequilibriumrdquo of pan-positional goods in assigning explicit rights butonly implicit obligations to third parties is the source of additional inefficienciesin an economic system (Pagano Chapter 2)

As shown by Fok et al (Chapter 8) in their discussion of the GM seeds casethe joint result of the decommodification of GM products and their mandatedexpansionist international IPR protection implies a change in the mutuality of thebenefits of international trade The economic rents accruing from the decommod-ification of GM seeds are more easily captured by global multinationals fromDCs than by the farmers in LDCs In fact the international enforcement of IPRas well as the dissemination of global advertising is generally uni-directionalfrom the DCs to LDCs for reasons relating to the stronger institutional settingand to the richer resource endowment of the former as compared to the latter

Balancing the asymmetric effects of this positional competition is very hard Inthe case of the Chinese GM cotton seeds this was achieved through a process ofldquorecommodificationrdquo of the GM seeds Unfortunately this success case rests onvery unique conditions that cannot be easily replicated in other LDCs In fact theChinese scientists had already developed their own technology for incorporatingnew genetic traits into cotton and subsequently Chinese GM cotton varieties wereavailable to farmers along with the GM cotton varieties that Monsanto was export-ing Moreover the Chinese government was able to negotiate with the biotechcompanies and succeeded in having the Chinese farmers absolved from the obliga-tion of signing the standard contract that included payment of annual ldquotechnologyfeesrdquo and the prohibition of ldquoholding backrdquo of seeds between seasons for replant-ing As a result it was the competition between the local GM cotton varieties withthe imported GM varieties that worked to the benefit of the Chinese farmers Ingeneral positional competition has adverse impacts on LDCs

Both Yotopoulos (Chapter 1) and Pagano (Chapter 2) emphasize that posi-tional competition has more asymmetric and damaging effects in the case of cur-rency which is indeed the prototypical case of positional good (cf alsoYotopoulos 1996) As emphasized in the previous section the differential repu-tation of currencies as store of value determines a ranking from the reserve tothe worthless currencies and eventually in a context of liberalized financialmarkets their very positional nature triggers a process of currency substitutionwhich is generally detrimental for LDCs

Sawada and Yotopoulos (Chapter 3) test precisely for this proposition in thesample of the poor countries that have been targeted in the Millennium Develop-

190 D Romano

ment Goals (MDGs) initiative The objective of MDGs is to help the targetcountries in order to lift out of abject poverty one-half of their ldquopoorrdquo popula-tions by year 2015 The question asked is how many of these countries couldreach their MDGs target by following their ldquohistorical record of growthrdquo (thatincludes at least ten years of the globalization era) The answer is that at leastone-half of all the targeted countries and the totality of countries in the poorestgroup will not reach the set target of graduating from poverty if they were tocontinue on the trajectory of their growth experience

In the same chapter the authors provide an indirect test of some causalfactors that relate to globalization and may explain the poor growth record ofmany LDCs especially the poorest of them Their target is the equilibriumexchange rate (ldquoa non-misalignedrdquo exchange rate) and it is confirmed that it isimportant for achieving economic growth But totally unexpectedly for theorthodox view the results indicate in general that the more open the economyis the greater is the misalignment of the exchange rate towards excessive devalu-ation of the domestic currency This result is interpreted as an indirect confirma-tion that currency substitution in the capital account as opposed to deficits in thecurrent account is the likely cause of this undervaluation-tripped exchange ratemisalignment that works to the detriment of economic growth This findinghighlights the importance of the proper combination of trade and exchange ratepolicies in fostering growth in developing countries in the current environmentof globalization

This evidence along with the experience from the Asian crises of 1997 sug-gests that currency substitution is an economic infectious disease that hasreached epidemic proportions in a globalization environment where the principleof ldquofree-market free-trade laissez-fairerdquo has been extended to cover freeexchange rates and free movements of portfolio (ldquospeculativerdquo) capital(Yotopoulos and Sawada 1999 Yotopoulos Chapter 1 Sawada and Yotopou-los Chapter 3)12

Having acknowledged the existence of positional differences in trade rela-tionships between LDCs and DCs we can ask ourselves why should those differ-ences matter The obvious answer that has been already anecdoticallyanticipated above is that positional competition is much harder than competitionfor pure private goods (Pagano Chapter 2) In standard competition if peoplework harder they may consume more private and public goods thus improvingtheir own welfare position But the same is not true for positional goods where ifall worked harder none could consume more of the positional goods In otherwords climbing up the reputational ladder of decommodified goods or curren-cies is much harder as compared to operating in (and profiting from) tradecompetition for pure commodities

Policy implications

The central theme that links together the chapters in this volume is thatthe current wave of globalization as it impacts different countries yields

differentiated outcomes that are systematically referenced to the level of devel-opment of a given country These outcomes depend on the asymmetric endow-ments of DCs and LDCs in terms of physical and social infrastructures as wellas in human and social capital The interaction of such differential endowmentswith the ongoing change in the rules of the game of international trade ndash that isfrom comparative advantage-based trade to reputation-based trade ndash reinforcesthe asymmetric impacts of the current wave of globalization

The dominant hue in the tapestry of the differentiated outcomes of globaliza-tion that was woven in the previous sections is gray It adumbrates the Pangloss-ian outcomes for growth in poor countries that the selling of globalization in thelast two decades has energetically postulated Moreover the findings in thisvolume strengthen the motivation for further searches for modifying the stand-ard recipe of ldquofree-market free-trade and laissez-fairerdquo that has been cooking upnow for more than two decades It is indeed well known that the lack of anappropriate physical infrastructure in most LDCs is one of the basic determi-nants of coordination failures and is bound to lead to missing markets By thesame token the lack of some economic institutions like derivative marketsimplies market incompleteness because it prevents the spanning of time spaceand uncertainty On the other side reputation differentials represent formidablebarriers to entry in both the domestic and the international markets and becomea determinant of increasing returns to scale and of network effects All those fea-tures represent exceptions to the fundamental theorems of welfare economics ndasheither in their static or dynamic version ndash and are legitimate causes that maylock the LDCs in a low equilibrium trap

The acknowledgement of the existence of systematic asymmetries betweenDCs and LDCs in globalization trade calls for a different approach that goesbeyond simple and uniform recipes and requires differentiated and cautiousinterventions Intervention in turn opens Pandorarsquos box of good governance ndashwhich is another commodity that is expensive and in short supply in poor coun-tries13 Therefore improving governance both at the international and at thenational level is crucial for designing a successful development strategy Thepolicy interventions that are designed for such a pro-development strategy needto take into account the institutional differences between DCs and LDCs andespecially the positional nature of trade in services in decommodified goods andin currencies A few examples can help to clarify this statement

The prevailing view of WTO and other multilateral lending institutionsarticulated since the early 1980s has been that integration of the LDCs into theglobal economy is an essential determinant of their economic growth and it isgood for the poor (Dollar and Kraay 2001) However opening up the economyis hardly ever a key factor at the outset of the development process (Rodrik2001) A critical assessment of the modern economic growth experience showsthat market incentives macroeconomic stability and sound institutions areinstrumental for economic development but these requirements can be gener-ated in a number of different ways14 A gradual and sequenced approach isneeded in opening-up to imports and to foreign investment and this should be

192 D Romano

part of a broader strategy based on the combination of the opportunities offeredby world markets In the meantime resources need be shifted into building insti-tutions and providing incentives for investment and for domestic entrepreneur-ship This is a tall order but historically development never came on the cheapFor instance Miniesy and Nugent (Chapter 4) refer to the European type ofglobalization that was based on quite a long and expensive period of pre-accession to the European Union that was aimed at leveling the playing fieldThe success in integrating the latecomers came at great expense of the initialpartners Their empirical tests also emphasize that a selective integration in theworld markets so that the competition can take place among countries thatbelong to the same level on the development ranking has a tremendous impactin determining the long-term effect on trade15

As long as the various currencies by definition stand on different steps of thereputational ladder the control of the flows of financial capital becomes animportant precondition for preventing currency substitution Whether hot moneyis or is not controlled the remedy for the market ailment of currency substitutionis foreign exchange controls This means maintaining exchange rates at mildlyrepressed levels through rationing out of the market the component of thedemand for foreign exchange that emanates from people hoarding foreign cur-rency (or spiriting it out of the country) as a hedge against the potential devalu-ation of the local currency The financial crises experienced in the last 20 yearsare consistent with the hypothesis that views free currency markets and freemovement of portfolio capital as enabling currency substitution which isparticularly harmful for LDCs (Yotopoulos Chapter 1 Sawada and Yotopoulos2005)

Last but not least in a world where a multilateral system of internationaltrade deregulation is becoming more important by the day there is a need torebalance the institutional asymmetry that works against poor countries start-ing with the ruling institution of international trade ndash the WTO It is importantto recognize that accepting all the WTO clauses is not cheap for developingcountries For most DCs whose systems are compatible with international con-ventions admission to the WTO implies no more than an obligation to applytheir domestic regulations fairly at the border Vice versa an LDC that cur-rently applies its own standards has the additional and far larger obligation toapply the internationally sanctioned standards in its domestic economy Thistrade-related reform comes with the opportunity costs of crowding out alternati-ves that may be more development friendly16 Acknowledging this at WTOlevel means condoning institutional diversity rather than seeking to eliminateit and tolerating a nuanced freedom of trade for LDCs and temporary suspen-sion of their existing WTO obligations when their development priorities are inthe balance (Rodrik 1997) In the example of the European Union the WTOmay also find room for membership with subsidiarity rights especially for theLDCs

Conclusion

The theme of this volume is that globalization is a process characterized by fun-damental asymmetries that eventually result in differentiated economic out-comes There is no simple explanation for this However a common feature thatemerged from the analyses carried out in this volume is that trade in positionalgoods ndash that is goods to whom a different reputational rank ordering can beattached notably trade in services in decommodified goods and in currencies ndashis becoming increasingly more important under globalization Reputation is thekey competitive factor in the current wave of globalization and narrowly framesthe room of maneuver of economic agents whether those are individuals firmsor countries Unfortunately for LDCs the relative position of a given country onthe reputational ladder as well as the likely economic impacts induced by repu-tation asymmetries seem to be systematically related to the level of thecountryrsquos development

Here the emphasis is on the adverb in the sense that the asymmetries of glob-alization are likely to work systematically against the poorer countries In factthe preconditions for the success of globalization are more likely to exist and areeasier to satisfy among the rich whether countries or (social and economic)strata within a country than they are among the poor The same can be said con-sidering the different endowments between DCs and LDCs in terms of human(ie competence skills) as well as social (ie trust) capital that is required inorder to produce high-reputation goods In other words the poorer the countrythe less likely it becomes that it can afford the entry costs necessary to claimbenefits from globalization Moreover globalization also affects adversely somemacro-fundamentals of LDC economies and the basic reason for this has to besought in reputation effects operating both in the real and in the monetaryeconomy In summary it seems there is a new poverty trap in the modern glob-alization that compounds the traditional negative effects of the lack of physicalcapital and infrastructure as noted first by Nurkse (1953) with the lack ofappropriate institutions of human and social capital of governance skills andwith the adverse change of some macroeconomic fundamentals

The contributions collected in this volume have emphasized various conduitmechanisms that can lead to asymmetric outcomes under globalization Notwith-standing the attempt made in this volume to find out the common ldquowhysrdquo toexplain the ldquowhatsrdquo and ldquohowsrdquo of globalization sheds light on a unifying sourceof asymmetric outcomes It is the combination of some structural changes inworld trade and the simultaneous enforcement of a new international institu-tional order that is transforming global competition into a ldquopositionalrdquo competi-tion In fact trade in services and in decommodified goods is gainingmomentum in global transactions while the movement of financial capital espe-cially hot money has literally exploded in the last two decades The commonfeature that trade in services and decommodified goods share with trade in hardcurrencies for asset-holding purposes is that both relate to positional globalcompetition

194 D Romano

The structural change in trade is compounded with a legal architecture ofworld trade that reinforces the positional nature of global competition Thepredicament of free capital movements in an environment characterized by thepositional nature of currencies is bound to cause systematic devaluations ofLDCsrsquo softer currencies For the same reasons the simultaneous enforcement ofopen markets and the worldwide protection of intellectual property rights ndash as isthe case under the WTOndashTRIPS framework ndash translates into institutionalizing ofpositional competition in open (but protected) markets for decommodified tradewhile leaving the (standard) commodities trading in open and free (contestable)markets that are found preponderantly in LDCs (Yotopoulos Chapter 1) Theseglobal legal positions create and reinforce the conditions for an increasing asym-metry in the process of development (Pagano Chapter 2)

Is therefore globalization bound to be detrimental for LDCs Not necessarilyGlobalization proved to be very successful for some LDCs particularly in EastAsia (eg China India South Korea) What makes the difference between thesesuccess stories and the numerous dismal LDC failures is that the former playedthe globalization game being willing and able to define it in their own termsthey were invariably more elastic in interpreting and applying the standardldquofree-market free-trade laissez fairerdquo recipe predicated by international organi-zations in the last two decades

The fundamental lesson learned from these experiences is that differencesmatter and consequently better-articulated policy responses are required Theldquoone-size-fits-allrdquo approach pursued by the Washington Consensus failedbecause its recipe is a standard package of reforms while policies need becountry specific and need be flexible enough so that their mix can evolve alongwith the evolution of the economic system at hand The assessment carried outin The Asymmetries of Globalization concurs and calls for a profound rethinkingof the development practice

1 I am grateful to Samar Datta Jeff Nugent and especially to Pan A Yotopoulos forhelpful comments on earlier versions of this chapter Of course any remaining errorsare my own

2 The change of the share of trade in GDP between 1981ndash5 and 1997ndash2001 was 39percent for developed countries and 154 percent for developing countries (IMF2002) The estimate is based on measuring trade flows and it is consistent with morerobust price-dispersion measures of trade integration (cf among others Parsley andWei 2001 Hufbauer et al 2002)

3 The change in the ratio of external finance (that is the sum of external assets and liab-ilities of FDI and portfolio investments) to GDP between 1981ndash5 and 1997ndash2001 was773 percent for developed countries and 199 percent for developing countries (IMF2002)

4 In fact in the period 1981ndash5 to 1999ndash2003 the share of LDC exports in world totalsrose only from 356 percent to 370 percent (40 percent) and their share of exportsin world commercial services exports increased even less from 272 percent to 278percent (21 percent) (WTO 2004)

5 This hypothesis has been tested in different contexts for example with reference to

trade liberalization (Dollar and Kraay 2001) and aid (cf among others Burnside andDollar 2000 Easterly et al 2004)

6 This is well known in the anthropological literature (cf Geertz 1978 on ldquoclienteliza-tionrdquo) as well as in game theory (the Folk theorem) both emphasizing the role ofreputational mechanisms

7 The same dislocation occurs when a new institutional order is superimposed onto theold one as was the case with private property rights which substituted for commonproperty rights in Sub-Saharan Africa under colonization causing an ldquoinstitutionaldissonancerdquo between what was felt and accepted by the society and what was writtenin the law

8 In percentage terms the share of services in total world trade rose from 16 percent to20 percent while in absolute terms the increase was more than fourfold since the early1980s (WTO 2004) Moreover this is most likely an underestimate since WTO takesan extremely limited view of ldquoservicesrdquo totally disregarding the intermediate degreesof ldquodecommodificationrdquo that intervene between pure goods and pure services(Yotopoulos Chapter 1)

9 The three basic requirements for obtaining patent protection are novelty usefulnessand invention While the first two requirements apply both to the breedersrsquo rights (iethe IPR that can be claimed using traditional breeding techniques already in forcebefore the gene revolution) and to expanded patents (ie the IPR that can be claimedin the case of GM innovations) the third feature invention is non-existent or veryweak in the breedersrsquo rights but very strong in the expanded patents

10 The success of globalized logos in a developing or a transition country ndash eg McDon-aldrsquos in Moscow ndash is largely due to this reputation effect as opposed to the superior-ity of McDonaldrsquos in terms of comparative advantages The difficulty ofreputation-based competition is stressed also by the reported example of the Tai-wanese outsourcing firms which are able to capitalize on the economic rent embodiedin their implicit reputational assets (Liu et al Chapter 6)

11 For an assessment of those costs in the case of IPR protection under the TRIPSframework see Louwaars et al (2005) for the costs of compliance to the BiosafetyProtocol under the Convention on Biological Diversity see Cohen (2005)

12 For modeling and directly testing the case of currency substitution see Sawada andYotopoulos (2005)

13 Good governance requires the governmentrsquos competence and integrity and representsa necessary precondition of successful economic development Competence is neces-sary to guarantee that the policy maker knows in which cases he should intervene ndashie only in cases of market failures or market incompleteness ndash and how to intervenein other words what to do and when and where to do it On the other hand integrityis necessary also because in a less than perfect world the economic rents of interven-tions are pervasive and can be misapplied to private gain (Yotopoulos 1996 150ndash2290ndash2)

14 This is valid for many countries that developed under different growth strategiesranging from import-substitution industrialization (eg Brazil Ecuador IranMorocco Cote drsquoIvoire and Kenya before 1973) to outward orientation (eg Taiwanand South Korea among others) and the so-called ldquodual-trackrdquo approach (egChina) For a detailed account of these historical records cf Yotopoulos (1996) andRodrik (1999)

15 Some proposals aimed at favoring more southndashsouth trade rather northndashsouth tradeseem to acknowledge this need

16 It has been estimated that the implementation of just three WTO agreements(customs valuation sanitary and phytosanitary standards and intellectual propertyrights) costs a typical LDC an amount which in many cases is in the same order ofmagnitude with a yearrsquos development budget (Finger and Schuler 1999 Lengyel2004)

196 D Romano

References

Baier Scott L and Jeffrey H Bergstrand (2001) ldquoThe Growth of World Trade TariffsTransport Costs and Income Similarityrdquo Journal of International Economics 53 (Feb-ruary) 1ndash27

Bergstrand Jeffrey H (1991) ldquoStructural Determinants of Real Exchange Rates and NationalPrice Levels Some Empirical Evidencerdquo American Economic Review 81 (1) 325ndash34

Cohen Joel I (2005) ldquoPoorer Nations Turn to Publicly Developed GM Cropsrdquo NatureBiotechnology 23 (1) 27ndash33

Dehn Jan (2000) ldquoCommodity Price Uncertainty in Developing Countriesrdquo WorkingPaper no 2426 Rural Development Development Research Group Washington DCWorld Bank (August)

Dollar David and Aart Kraay (2001) ldquoGrowth Is Good for the Poorrdquo World BankDevelopment Research Group Washington DC World Bank

Easterly William Ross Levine and David Roodman (2004) ldquoAid Policies and GrowthCommentrdquo American Economic Review 94 (3) 774ndash80

Finger J Michael and Philip Schuler (1999) ldquoImplementation of Uruguay Round Com-mitments The Development Challengerdquo Policy Research Working Paper Series no2215 Washington DC World Bank (October)

Frank Robert H (1985) ldquoThe Demand for Unobservable and Other Non-PositionalGoodsrdquo American Economic Review 75 (1) 101ndash16

Geertz Clifford (1978) ldquoThe Bazaar Economy Information and Search in Peasant Mar-ketingrdquo American Economic Review 68 (2) 28ndash32

Hirsch Fred (1976) Social Limits to Growth Cambridge MA Harvard University PressHufbauer Gary C Erika Wada and Tony Warren (2002) ldquoThe Benefits of Price Conver-

gence Speculative Calculationsrdquo Policy Analyses in International Economics no 65Washington DC Institute for International Economics

IMF (2002) World Economic Outlook September 2002 Washington DC InternationalMonetary Fund

Lengyel Miguel (2004) ldquoThe Implementation of WTO Agreements The Case ofArgentinardquo Latin America Trade Network working paper Online available atwwwlatnorgar (accessed 17 January 2006)

Louwaars Niels P Robert Tripp Derek Eaton Victoria Henson-Apollonio Ruifa HuMaria Mendoza Fred Muhhuku Suresh Pal and Joseph Wekundah (2005) ldquoImpacts ofStrengthened Intellectual Property Rights Regimes on the Plant Breeding Industry inDeveloping Countries A Synthesis of Five Case Studiesrdquo Wageningen Center forGenetic Resources Wageningen UR (February) Online available at wwwcgnwurnl(accessed 31 March 2006)

Myrdal Gunnar (1968) Asian Drama An Inquiry into the Poverty of Nations and theChallenge of World Poverty New York The Twentieth Century Fund

Nurkse Ragnar (1953) Problems of Capital Formation in Underdeveloped CountriesOxford Clarendon

Parsley David C and Shang-Jin Wei (2001) ldquoLimiting Currency Volatility to StimulateGoods Market Integration A Price-Based Approachrdquo NBER Working Paper no 8468Cambridge MA National Bureau of Economic Research

Rodrik Dani (1997) Has Globalization Gone Too Far Washington DC Institute forInternational Economics

Rodrik Dani (1999) The New Global Economy and the Developing Countries MakingOpenness Work Washington DC Overseas Development Council

Rodrik Dani (2001) ldquoThe Global Governance of Trade as if Development Really Mat-teredrdquo paper prepared for United Nations Development Programme New YorkOnline available at wwwservicesforallorg (accessed 12 August 2005)

Samuelson Paul A (1954) ldquoThe Pure Theory of Public Expenditurerdquo Review of Eco-nomics and Statistics 36 (4) 387ndash9

Sawada Yasuyuki and Pan A Yotopoulos (2005) ldquoCorner Solutions Crises and CapitalControls Theory and Empirical Analysis on the Optimal Exchange Rate Regime inEmerging Economiesrdquo Stanford Institute for Economic Policy Research Paper no04ndash037 (September 2005) Online available at sieprstanfordedupaperspdf04-37html (accessed 13 September 2005)

Stiglitz Joseph E (2000) ldquoWhither Reform Ten Years of the Transitionrdquo In Joseph EStiglitz and Boris Pleskovic eds Annual World Bank Conference on DevelopmentEconomics 2000 Washington DC World Bank pp 27ndash56

UNCTAD (2002) ldquoFarmers and Farmersrsquo Associations in Developing Countries andTheir Use of Modern Financial Instrumentsrdquo Study prepared by the UNCTAD Secre-tariat UNCTADITCDCOM35 Geneva UNCTAD

World Bank (1999) Dealing with Commodity Price Volatility in Developing CountriesA Proposal for a Market-Based Approach Washington DC World Bank

World Bank (2004) World Development Report 2005 A Better Investment Climate forEveryone New York Oxford University Press

WTO (2003) World Trade Report 2003 Geneva World Trade OrganizationWTO (2004) World Trade Report 2004 Geneva World Trade OrganizationYotopoulos Pan A (1996) Exchange Rate Parity for Trade and Development Theory

Tests and Case Studies Cambridge and New York Cambridge University PressYotopoulos Pan A and Yasuyuki Sawada (1999) ldquoFree Currency Markets Financial

Crises and the Growth Debacle Is There a Causal Relationshiprdquo Seoul Journal ofEconomics 12 (Winter) 419ndash56 (Available also online sieprstanfordedupaperspdf99ndash04html)

198 D Romano

Subject index

absorptive capacity 49accountability 84n8adverse selection see asymmetric

information adverse selectionadvertising 14 22 24n9 105 165 174

185 186 190Arrow-Debreu world see globalization and

requisite institutions Arrow-Debreuworld

ASEAN (Association of Southeast AsianNations) 80 81

asymmetric information 9 19 22ndash3 6189ndash91 109 111 117 118ndash22 188adverse selection 9 104 188 credencegoods and experience goods vs searchgoods 169 174 175n8 moral hazard92 95 100 103 104

asymmetric trade see international tradereputation-based trade

asymmetries of globalization definition 148 causalities of 1 consumptionasymmetries 23 30ndash3 41 128ndash33 184currency substitution as source of 1ndash28 18ndash21 35ndash6 59ndash61 62 188decommodification as source of 1ndash2 810ndash15 infrastructure and institutions assource of 1 8ndash10 15ndash16 67 70 182ndash4positional goods and asymmetries of 213ndash15 44ndash5 61 62 63ndash4 productionasymmetries 138ndash41 systematicasymmetries against LDCs 1ndash2 15 148159 192ndash3

Balkan countries 134ndash8 135 137 138139 see also transition economies

biotechnology 147ndash52 157ndash8 186 190gene revolution vs green revolution186 institutional innovations 148ndash52technical innovations 147ndash8

black market premium 49 58 61brain drain 24n11branding see economic rent branding

reputation brandingBrazil 155ndash7 157 166 175n4 175n5

196n14buffer stocks 168

CACM (Central American CommonMarket) 80 81

capital controls 24n17 25n18 25n19 4964n8 182

capital movements 8 19ndash20 35 4959ndash62 182 191 193 195 see alsofinancial crises

CARICOM (Caribbean Community) 8081

CEEC (Central and Eastern EuropeanCountries) 134ndash8 135 136 137 138139 see also transition economies

cereal equivalent 129ndash32 131 132certification 12 165 170 176n12 185

187China 25n24 116ndash17 118 122n11

123n25 135 137 138 152ndash7 152 153154

clientelization 92 196n6coffee consumption 166ndash7 170ndash1 173

175n8 fair-trade 165 169ndash74 171 172173 187 ICA 166 168 169 price166ndash7 168 168 169ndash70 175n3 175n9production 166ndash7 168 169 172 174175n5 175n9 supply chain 166ndash7 167172ndash4

collective action 90 173ndash4commodities commodification

decommodification 2 13ndash15 19 24n736 45 102ndash5 147 157ndash8 164ndash5 169ndash70185ndash8 trade in commodities vs trade in

References to tables and figures are presented in italics

commodities continueddecommodified goods 10ndash13 185ndash8196n8 see also decommodificationinternational trade

common pool resources 90community 89ndash92 95ndash7 103comparative advantage see international

trade comparative advantage tradecompetition good competition vs bad

competition 19 36 61 189 positionalcompetition 2 13ndash14 24n16 31 36ndash4045 157 189ndash91 194ndash5

composition of trade see internationaltrade change in the composition oftrade

contestable markets see marketcontestable markets vs non-contestablemarkets

contingent markets see market contingentmarkets globalization and requisiteinstitutions Arrow-Debreu world

contract enforcement 91 97 102ndash3 110173 184

contract farming 97ndash8 103ndash4cooperation 90ndash2cooperatives 95 97 103ndash5 105n3 170

174 176n10 176n14corruption 84n8 84n9credit 19ndash20 22 68 91 93ndash5 101ndash2 102

105n3 168 173 188cultural linkages 70 71 111 112 116

117 112n11cumulative causation process 18 24n16

35 36 61 see also poverty povertytrap

currency as a medium of exchange 18 35as a store of value 18 36 64 currencysubstitution 35ndash6 49 59ndash62 64 188 ingeneral equilibrium 45n6 reservehardcurrency 18 35ndash6 59ndash63 64n6 182188 194

customization 12ndash13 24n7 147 150ndash2164 172 186ndash7 189 see alsodecommodification

customs 90

decommodification economic rents 211ndash15 17 22ndash3 24n5 105 122n10148 150ndash2 159 160n4 165 185ndash91intellectual property rights 12 17 2240ndash4 148 157ndash8 160n4 164ndash5 186ndash7recommodification 156 159 reputation2 11ndash15 18ndash21 35ndash6 5ndash62 64n6 105109ndash12 122n10 118ndash22 150ndash2 157ndash8

165 170 185ndash91 see also asymmetriesof globalization decommodification assource of

decommodified trade see internationaltrade reputation-based trade

devaluation allocative inefficiencies of25n21 benevolent 19 impact ontourism of 25n22 non benevolent19ndash21 25n19 25n22 35ndash6 55 59ndash62188 192 195 self-fulfilling prophecy19 35 60 188

dollarization 20double outsourcing see outsourcing export

outsourcing

economic growth endogenous growth 6269 exchange rate misalignment andeconomic growth 55 57ndash8 income-food consumption relationship 129ndash33inequality and economic growth 3 1421ndash3 market liberalization andeconomic growth 48 59ndash62 182 192

economic rent branding 2 11ndash15 1722ndash3 24n5 165 186 187 intellectualproperty right protection 12 17 2240ndash4 148 157ndash8 160n4 164ndash5 186ndash7labeling 165 169ndash70 172 174ndash5175n9 176n10 187 non-contestablemarkets 22 36 105 153 156reputation and economic rents 2 11ndash1517 22ndash3 24n5 105 118ndash22 122n10148 150ndash1 172ndash4 185ndash91

economies of scale 103 114 173 192endogenous growth see economic growth

endogenous growthEU (European Union) 75 76ndash81 76

77 78 79 80 127 129 138ndash42 149193

exchange rate controls 64 64n8 exchangerate regimes 63 191 nominal exchangerate 49 55 62 72 nominal exchangerate misalignment 25n20 36 49 5455ndash9 61ndash2 64n7 real exchange rate 5556 61 62 64n3

exit time from poverty see poverty exit time

fair-trade 165 169ndash74 171 172 173 187see also international trade reputation-based trade

FDI (foreign direct investment) 11 15 49113 114 114 115 115 116 116123n18 123n25 156 192ndash3 195n3

financial crises 19 21 61 84n9 193 seealso devaluation non benevolent

200 Subject index

financial depth 70ndash81FLO (Fair-Trade Labelling Organizations

International) 170ndash1 172 174 175n9176n11 176n12

FM-FT-LF (free market ndash free trade ndashlaissez faire) 19 67 108 191 195 seealso Washington consensus

Folk theorem 92 196n6free markets see market free marketsfree trade 2 7 9ndash10 16 17 21ndash2 44 59

108 128 183 191 195fundamental theorems of welfare

economics 9 183 192future markets see market contingent

markets

gene revolution 148ndash52 186 196n9 seealso biotechnology gene revolution vsgreen revolution

globalization definition 1 7 48 19thcentury vs 20th century globalization7ndash8 10 change in the composition oftrade 10ndash17 11 185ndash8 196n8 financialintegration 8 59 182 195n3globalization and economic growth 120 48ndash49 globalization andoutsourcing 15ndash17 108ndash12 187ndash8 seealso asymmetries of globalization

globalization and requisite institutions 121 24n9 24n13 Adam Smith classicalinfrastructure 2 9 10 22 Arrow-Debreu world 9 45n6 182 completemarkets 9ndash10 18ndash19 enhancedSmithian infrastructure 9 goodgovernance 9 64

globalization and poverty 1 20 increasingdivide between rich and poor 2 3 23losers of globalization 2 23 withincountry impact of globalization on thepoor 2ndash3 20 23

GM (genetically modified) seeds 148 152155ndash7 159 160n4

good governance 9 64 67 79 84n9 192196n13 effects on trade 70ndash81measurement of 72ndash3 quality of 84n884n9 see also globalization andrequisite institutions

gravity models 67 70ndash3 84n4 84n5green revolution 96 186 see also

biotechnology gene revolution vsgreen revolution

hard currency see currency reservehardcurrency

human capital 33ndash4 192 194

ICA (International Coffee Agreement) seecoffee ICA

immiserizing growth seeunderdevelopment immiserizing growth

incomendashfood consumption relationship seeeconomic growth incomendashfoodconsumption relationship

incomplete markets see marketincomplete markets market contingentmarkets

India 8 15 16 17 25n19 155ndash7 157158

Indonesia 98ndash103 99 102 105n4inequality between-countries 21ndash3

68ndash72 effects on trade 68ndash70 73ndash81inequality and economic growth 3 1421ndash3 measurement 71ndash2 withincountry inequality 21ndash3 68ndash72

infrastructure see asymmetries ofglobalization infrastructure andinstitutions as source of

institutions central-planning institutionsvs market institutions 70ndash2 184institutions and legal equilibrium 37ndash8190 see also market asymmetries ofglobalization infrastructure andinstitutions as source of

integration EU as an example of 7576ndash81 76 77 78 79 80 193 financialintegration 7ndash8 59 182 195n3 marketintegration 7ndash8 79 126ndash7 182 192ndash3195n2 trade agreements 70ndash81

interlinked transactions 92 103intermediation see outsourcing

intermediationinternational trade change in the

composition of trade 10ndash17 11 185ndash8 196n8 comparative advantagetrade 2 8 10ndash13 15ndash16 20 24n1356 110 118 182 185 189 192reputation-based trade 2 10ndash13 67ndash881 110 165 185 189 192 196n10trade agreements 40 70ndash2 79 8185n12 193 196n16 trade andinequality 68ndash70 73ndash81 trade incurrency and currency substitution 218ndash21 35ndash6 59ndash61 62 188 tradeopenness 1 48 52 58ndash9 61ndash2 79192ndash3 trade wars 25n24 unfair trade2 44

IPR (intellectual property rights) costs of compliance 196n11 196n16

Subject index 201

IPR continuedeconomic rents 12 17 22 81 148150ndash2 157ndash8 160n4 164ndash5 186ndash7IPR strengthening 40ndash4 147 149ndash50186 TRIPS 40 43 150 159 164 189195

Japan 25n24 110 117 118just-in-time system 103ndash4 105n4

knowledge 41 42 45n12

labeling see reputation labelinglegal disequilibrium legal equilibrium vs

legal disequilibrium 38ndash9 39 150 190pan-positional rights 24n15 31 33 4041 149ndash50 157 164 190 positionalcompetition and legal disequilibrium39ndash40 see also intellectual propertyrights TRIPS

legal equilibrium see legal disequilibriumlegal equilibrium vs legaldisequilibrium

legal relations 36ndash40liberalization 17 81 98 166 182 195n5

see also economic growth marketliberalization and economic growth

Linder hypothesis 24n9 68ndash71 73 77 81185ndash6

market integration see integration marketintegration

market power see economic rent marketnon-contestable markets

market contestable markets vs non-contestable markets 12 22 36 104195 contingent markets 16 183 freemarkets 7 9ndash10 21 59 127 156 183191 195 incomplete markets 18 24n445n11 61 62 68 183 188 193196n13

marketing boards 165 166MDG (Millennium Development Goals)

48ndash9middleman see outsourcing

intermediationmonitoring 110 112 120 see also

asymmetric information moral hazardmonopoly see economic rent non-

contestable markets moral hazard see asymmetric information

moral hazardmultinationals 14 109ndash10 155ndash6 158

160n3 160n4 160n6 160n9 190

mutual advantage trade see internationaltrade comparative advantage trade

NAFTA (North American Free TradeArea) 80 81

natural scarcity see positional goodsnatural scarcity vs social scarcity

network effects 14 18 24n10 81 189192

ldquoNewrdquo development economics 24n4non-contestable markets see market

contestable markets vs non-contestablemarkets

non-tradables 55 56 57 79 60 see alsoRicardo principle

norms 90ndash1 95

offshoring see outsourcing serviceoutsourcing

open-source license 158 162n21opportunism 91 92 100 112 113 120

169opportunity cost 94 112 120 150 193ostracism 91 100 103outsourcing cost differential vs reputation

differential 109 111ndash12 118ndash22187ndash8 disintermediation 111 112 116117 export outsourcing 109ndash12118ndash22 187ndash8 input outsourcing 109110 113 122n4 122n15 123n18intermediation 108 110 111 112 114117 118 120 121 122n9 outputoutsourcing 109ndash10 service outsourcing108 109 110 see also globalizationglobalization and outsourcing

pan-positional goods see positional goods pan-positional goods intellectual property rights pan-positional rights

patents expanded 149 157 186 196n9standard 12 22 46n14 149ndash50 157ndash8161n18 see also intellectual propertyrights

peasant economy 89ndash92 93ndash6Philippines 93ndash7 94plantation 97portfolio capital 8 18ndash19 59 62 191

193 see also capital movementspositional goods 13 24n7 24n15 24n16

31 59 64n6 natural scarcity vs socialscarcity 29 34 37 pan-positional goods24n15 31 33 40 41 149ndash50 157 164182 190 positional competition 2

202 Subject index

13ndash14 24n16 31 36ndash40 45 157189ndash91 194ndash5 positional goods vsprivate goods and public goods 29ndash3131 189 positional goods in agrarianand capitalist societies 33ndash5 public-positional good paradox 41 reputationand positional goods 2 35 36 64n6183ndash91 status and power as positionalgoods 33ndash5 45n2 45n3 64n6 welfaremaximization conditions 31ndash3 see alsoasymmetries of globalization positionalgoods and asymmetries of

poverty exit time 50ndash1 52 MDG 48ndash9poverty and exchange rate misalignment62 poverty reduction through growth49ndash50 52ndash3 poverty trap 18 24n1635 36 61 194 see also asymmetries ofglobalization systematic asymmetriesagainst LDCs

poverty trap see poverty poverty trappower see positional goods status and

power as positional goodsprivate goods 29ndash31 31 39 90 189product differentiation 69 81 165 170

174 186ndash7 see also decommodificationproduct life cycle 69property rights 39ndash40 see also intellectual

property rightsprotectionism see international trade trade

openness economic growth marketliberalization and economic growth

psychological laws (of Keynes) 68public goods 29ndash31 31 39 41ndash4 90 189purchasing power parity 55 56 62 132

rationing 19 61 193 see also creditreciprocity 90regional blocks see integration trade

agreementsrent-seeking activities 10 104repeated games 92 184 196n6reputation 14 18 60 as a source of

positional competition 2 35 36 64n6183ndash91 asymmetric reputation andmarket incompleteness 18 24n4 61 6268 188 branding 2 11ndash15 17 22ndash324n5 165 186 187 decommodification2 11ndash15 18ndash21 35ndash6 5ndash62 64n6 105109ndash12 122n10 118ndash22 150ndash2 157ndash8165 170 185ndash91 economic rent 211ndash15 17 22ndash3 24n5 105 118ndash22122n10 148 150ndash1 172ndash4 185ndash91labeling 165 169ndash70 172 174ndash5176n10 187 reputation differentials vs

cost differentials 109 111ndash12 118ndash22187ndash8 reputational ladder 18 59 64n6trust 12 22 89ndash96 100 103 104ndash5111 170 172ndash4 184 194

reputation-based trade see internationaltrade reputation-based trade

reserve currency see currency currency asa store of value

resource allocation 20 49 60Ricardian trade see international trade

comparative advantage tradeRicardo principle 51 61rule of law 84n8Russia 134ndash8 135 136 137 138 139

184 see also transition economies

safety nets 90 172seignorage 18self-fulfilling prophecy see devaluation

self-fulfilling prophecyservices services and commodity

customization 2 10ndash14 165 170 185trade in services vs trade incommodities 10ndash17 11 185ndash8 196n8

social capital 183ndash4 192 194 social limits to growth 13 29 see also

positional goods natural scarcity vssocial scarcity

social opprobrium 91 100 103social scarcity see positional goods

natural scarcity vs social scarcitysoft state 183spanning see globalization and requisite

institutions Arrow-Debreu worldmarket contingent markets

state 90 154ndash6status see positional goods status and

power as positional goodsSub-Saharan Africa 54 155ndash7 157 196n7

Taiwan 113ndash18 114 115 116 122n5122n11

technology fee 151 155 160n4 160n7161n16 190 see alsodecommodification economic rents

terms of trade 16 21 56 69Thailand 15 97three-party game see outsourcing export

outsourcingtradables 55 56 57 79 60 see also

Ricardo principletrade agreements see international trade

trade agreementstrade diversion 73

Subject index 203

trade openness see international tradetrade openness economic growthmarket liberalization and economicgrowth

transaction costs 61 70 75 79 93 104111 173

transition economies 126ndash9 134ndash41 184tribe 91TRIPS (Trade Related Aspects of

Intellectual Property Rights) seeIntellectual property rights TRIPS

trust see reputation trust

underdevelopment immiserizing growth17 power and status as causes of 33ndash5

unequal exchange 45 182 see alsointernational trade unfair trade

USSR 127 134ndash8 135 136 137 138139 140 see also transition economies

vertical integration 94 96vertical specialization see outsourcing

input outsourcingvillage 91ndash2

Washington consensus 7 10 22 195WTO (World Trade Organization) 11 17

24n15 44 149ndash50 158 164 182 193196n8

204 Subject index

Author index

Abreu Dilip 92 105Acheson James M 106Al-Mutawa Ahmed 65Ancelovici Marcos 116 123Anderson James E 84n4 85Antraacutes Pol 114 123Aoki Masahiko 90 105Asanuma Banri 103 106Aten Bettina 65

Bacon Christopher 175n6 176Baier Scott L 182 197Baland Jean-Marie 90 106Balassa Bela 56 64Balcombe Kelvin 140 142Baldwin Richard 7 8 25Bardhan Pranab K 92 106Barff Richard 122n3 123Bell Clive 92 106Benkato Omar M 65Bergstrand Jeffrey H 24n9 25 84n4 85

182 185 197Berkes Fikret 106Beacuteroud Franccedilois 153 162Besley Timothy 48 50 51 54 64Bhagwati Jagdish N 11 25Books Nora 161n9 163Borenzstein Eduardo 49 64Bougherara Douadia 169 176Bowles Samuel 45n2 46Browne Angela W 170 176Bryce David J 115 123Buckwell Allan 143Burgess Robin 48 50 51 54 64Burnside Craig 57 65 196n5 197

Campa Joseacute 110 122n15 123Cassel Gustav 55 65Cayford Jerry 161n18 163

CEC 140 142Chaddad Fabio R 177Chalmin Philippe 166 175n3 176Chen Lurong 124Chen Tain-Jy 111 123Cheng Leonard K 110 111 123Chevassus-Lozza Emmanuelle 129 143CIA 72 85Coase Ronald H 38 46Cohen Joel I 196n11 197Collier Paul 20 25Commons John R 28 36 37 46Cook Michael L 177Cook Philip J 13 26 64n6 65Csaki Csaba 129 140 143

DrsquoHaese Marijke 24n6 105 186 187Dankers Cora 173 174 176Darby Michael R 175n8 177Darrat Ali F 64 65Datt Gaurav 66Davidova Sophia 142de Gregorio Josegrave 64Deaton Angus 84n2 85Dehn Jan 183 197Deininger Klaus 72 85Djouara Hamady 162Dollar David 48 49 50 55 57 65 192

196n5 197Donaghu Michael T 122n3 123Durlauf Steven N 57 65

Easterly William 196n5 197Eaton Derek 197Ebora Reynaldo V 163EBRD 140 143Edwards Sebastian 49 55 65Erjavec Emil 129 140 143EU 129 143

Fafchamps Marcel 174 177Falck-Zepeda Joseacute B 161n9 162FAO 132 132 139 143 166 175n5 177Feenstra Robert C 72 85 108 122n4

124Feeny David 90 106Feng Hongqiang 163Ferto Imre 129 140 143Finger J Michael 196n16 197Fingleton John 111 124FLO 170 171 172 173 175n9 176n11

176n12 177Fok Michel AC 105 152 153 153

154 157 158 160n2 161n17 162 186 190

Foster James 50 65Frank Robert H 13 26 45n3 46 64n6

65 189 197Frankel Jeffrey A 79 85Franzini Maurizio 46Friedman Thomas 17 26Fuchs Victor R 11 26Fudenberg Drew 92 106Fujimoto Takahiro 103 106Fuller Douglas 115 124Fuller Lon L 37 46

Garner Alan C 108 110 115 124Geertz Clifford 92 106 196n6 197Gellner Ernest 45n5 46Gereffi Gary 108 110 115 122n5 124Ghura Dhaneshwar 49 55 65Gilland Bernard 142n4 143Gintis Herbert 45n2 46Giovannucci Daniele 171 177Glick Reuven 72 85Godo Yoshihisa 90 106Golan Elise 169 177Goldberg Linda S 110 122n15 123Gouse Marnus 160n2 161n9 162Graff Gregory 158 162Greer Joel 65Greif Avner 92 106Grennes Thomas J 49 55 65Grolleau Gilles 169 176Grossman Gene M 69 85 123n18 124Guo Yuyuan 163

Hanson Gordon H 113 124Harris Phil JC 176Harrison Ann 48 49 65Hart Herbert LA 37 46Hart Oliver D 43 46Hayami Yujiro 90 92 93 94 96 97 98

102 102 103 105 106 111 122n10174 176n14 184

Hayek Friedrich 37 46Helleiner Gerald K 113 124Helpman Elhanan 69 85 114 123n18

123 124Henson-Apollonio Victoria 197Heston Alan 57 65Hill T Peter 11 26Hillocks Rory 175n7 177Hirsch Fred 13 26 34 46 64n6 65 189

197Hofny-Collins Anna H 176Hohfeld Wesley N 28 36 46Hsing You-Tien 110 124Hu Ruifa 162 197Huang Jikun 148 161n11 162 163Hubbard LJ 129 140 143Hufbauer Gary C 195n2 197Hummels David 108 110 122n15 124Hunter Linda C 70 85

ICO 168 168 169 177IMF 72 85 195n2 195n3 197Ishii Jun 124Ismaeumll Yousouf 160n2 163

Jan Wei-Shiung 115 124Jenkins Beyers Lindie 160n2 162 163JETRO 117 124Jishnu Latha 156 163Jones Ronald W 108 124

Kanbur Ravi 49 50 65Karny Edi 175n8 177Kaufmann Daniel 72 84n9 85Kawagoe Toshihiko 92 98 102 102 103

106Keynes John M 55 65 68 85Kierzkowski Henryk 108 123 124Kikuchi Masao 93 106Kirsten Johann 162Koekoek Freek Jan 171 177Kowalski Stanley P 158 163Kraay Aart 48 49 50 65 85 192 196n5

197Kramer Matthew H 45n9 46Kravis Irving B 63 65Kreps David M 23n2 26 92 106Krugman Paul R 69 85 122n4 124Kryder David R 163Ku Ying-Hua 111 123Kuchler Fred 177Kydd Jonathan 129 143 174 177

206 Author index

Landa Janet T 92 106Lanjouw Jean O 157 163Lazzarini Sergio C 174 177Leamer Edward E 84n5 85Leclair Mark S 170 177Lee Jong-Wha 64Lengyel Miguel 196n16 197Levine Ross 197Levinsohn James 84n5 85Levy Brian 116 118 124Lewin Bryan 175n3 175n5 177Lewis W Arthur 16 26Liang Weili 162Lin Wei-Jen 116 125Linder Steffan 14 26 68 77 86 185 197Liu Bih Jane 24n12 105 187 196n10Liu Pascal 173 174 176Louwaars Niels P 196n11 197

Ma Danmeng 163McBride William D 161n9 163McCaffrey Sara J 116 123McCay Bonnie J 106McDonald Nick 152 163McKinnon Ronald 64 65McLean Jennifer 169 178Marciano Esther B 106Markusen James R 70 85 86Martin Philippe 7 8 25Maskin Eric 92 106Mataloni Raymond J 124Matsuyama Kiminori 84n3 86Max Havelaar 170 172 173 177Mazoyer Marcel 148 163Mehra Rekha 142n4 143Mehrez Gil 85Mendoza Maria 197Mill John S 10 26Miniesy Rania 14 24n14 85n12 86 186

193Mitchell Lorraine 177Mitra Devashish 69 86Morduch Jonathan 49 50 51 65Morrison Jamie A 142 143Muellbauer John 84n2 85Muhhuku Fred 197Mundell Robert A 18 26Muradian Roldan 175n3 177Murray Douglas L 178Myers Dorothy 148 163Myrdal Gunnar 183 197

Nature 158 163Nelson Robert G 162

Nicita Antonio 45n11 46n15 46Nikebiz 122n3 125Nugent Jeffrey B 14 24n4 24n14 27

86 186 193Nurkse Ragnar 194 197

Ostrom Elinor 90 107Otsuka Keijiro 92 106Oxfam 165 177

Pagano Ugo 13 24n3 24n15 24n16 2633 38 43 45n2 45n3 45n4 45n5 4647 64n6 65 90 105 147 150 164189 190 191 195 197

Pal Suresh 197Pan Mei-Lin 122n5 124Panagariya Arvind 25Parsley David C 195n2 198Pasiecznik Nick 176Pelupessy Wim 175n3 177Piesse Jennifer 163Platteau Jean-Philippe 90 106Pollan Michael 147 163Ponte Stefano 166 167 168 175n5 178Potter Robert H 163Pray Carl E 301 148 161n10 161n11

162 163Pschorn-Strauss Elfrieda 152 163

Qiao Fangbin 162 163Quah Danny T 57 65

Rapoport Dana 124Rask Kolleen J 128 132 134 138

142n2 142n4 143 184Rask Norman 128 129 130 132 132

134 138 142n2 142n4 143 184Ravallion Martin 48 50 51 65 66Raynolds Laura T 178Rednak Miroslav 143Renard Marie-Christine 169 178Ricardo David 10 26 56 66Rice Paul D 169 178Rizzolli Matteo 46Rodrik Dani 49 55 66 192 193 196n14

198Romano Donato 24n9 24n15 40 67 105

126 138 150 151 172Romer David 79 85Roodman David 197Rose Andrew K 72 85 86Rosenstein-Rodan Paul N 24n4 26Rossi Maria Alessandra 43 46 47Rozelle Scott 162

Author index 207

Sachs Jeffrey 57 66Samuelson Paul A 15 17 26 56 66

189 198Sanderson Fred H 142n4 143Sawada Yasuyuki 19 24n14 25n18

25n20 25n21 26 27 45n7 49 51 5456 57 61 64n2 64n5 66 190 191193 196n12 198

Schimmelpfennig David E 162Schmukler Sergio 85Schuler Philip 196n16 197Selten Reinhard 122n2 125Sharpston Michael 108 109 125Shiva Vandana 45n12 46n13 47Simmonds Nigel E 45n10 47Slaughter Matthew J 124Solagral 169 178Spulber Daniel F 122n9 125Squire Lynn 72 85Srinivasan TN 25Stiglitz Joseph E 10 19 21 26 61 66

184 198Sturgeon Timothy J 115 124Summers Robert 65Talbot John M 168 178Taylor Michael R 161n18 163Taylor Peter L 166 176n10 178Technoserve 175n4 178The Economist 158 163Thirtle Colin 160n2 163Thorbecke Erik 65Thursby Jerry G 70 86Thursby Marie C 70 86Tollens Eric 173 178Tomas Carlos 162Traxler Greg 162Trindade Vitor 69 86Tripp Robert 197Turk Jernej 143

UN 72 86UNCTAD 183 198Unguru Manuela 129 143USDA 131 143Useem Michael 115 123

van de Walle Dominique 66van Meijl Hans 162van Tongeren Franck 162Vannoppen Jan 169 178Varangis Panos 177Veblen Thorstein 30 47Volk Tina 143

Wada Erika 197Wada Kazuo 103 107Wallace RR 176Wan Henry Y Jr 111 125Wang Guiyan 162Warner Andrew 57 66Warren Tony 197Weber Gerald 129 140 143Wei Shang-Jin 195n2 198Weisman Jason 111 125Weiss Andrew 19 26 61 66Wekundah Joseph 197WIDER 72 86Wilson Robert 92 106World Bank 48 49 51 66 72 86 132

143 183 198WTO 11 26 72 86 182 195n4 196n8

198Wu Kongming 161n15 163Wu Yuhong 162

Yi Kei-Mu 124Yotopoulos Pan A 12 19 24n4 24n14

25n18 25n20 25n21 25n24 26 27 3644 45n7 45n8 47 49 55 56 57 6061 63 64n2 64n5 64n6 64n7 66 6768 105 108 110 122n2 126 130 138143 147 151 164 165 170 185 188189 190 191 193 195 196n8 196n12196n13 196n14 198

Yousef Tarik M 86

Zehner David C 176n15 178Zilberman David 158 162Zoido-Lobatoacuten Pablo 85

208 Author index

Book Cover

Copyright

Contents

Figures

Tables

Contributors

Acknowledgments

Part I Decommodification From trade in commodities to trade in services

1 Asymmetric globalization Impact on the Third World

2 Positional goods and asymmetric development

3 Growth and poverty reduction under globalization The systematic impact of currency substitution and exchange rate misalignment

4 With whom to trade An examination of the effects of intra-national and between-country income inequality on bilateral trade

Part II Institutional asymmetries

5 Communities and markets for rural development under globalization A perspective from villages in Asia

6 Export outsourcing Cost disadvantage and reputation advantage

7 Transition economies and globalization Food system asymmetries on the path to free markets

Part III Agricultural poverty and decommodification

8 Genetically modified seeds and decommodification An analysis based on the Chinese cotton case

9 Globalization and small-scale farmers Customizing ldquofair-trade coffeerdquo

Part IV Conclusions

10 What have we learned about globalization

Subject index

Author index

The Asymmetries of Globalization

The discourse on globalization has become polarized Proponents consider glob-alization as the silver bullet for targeting growth in the world economy and forpoor countries specifically while opponents see it as the poisoned arrow ofexploitation and impoverishment of the Third World

The Asymmetries of Globalization deals with the ldquowhatrdquo and ldquohowrdquo but pri-marily with ldquowhyrdquo globalization has most often negative outcomes for develop-ing countries It breaks new ground in approaching globalization not only astrade in commodities but also as trade in positional goods (ldquodecommodifiedtraderdquo)

The two novel and munificent forms of post-Ricardian decommodified tradetrade in services and trade in hard currency in the form of currency substitutionare sculpted in the introductory chapter as the foundation of the systematicasymmetries of globalization Decommodified trade involves exports ofdeveloped countries that cater mostly to the elites of the developing world Thedeveloping countries in turn procure the foreign exchange to pay for theseimports by exporting commodities that trade on comparative advantage at theleast cost of production The analytical approach of introducing ldquopositionalgoodsrdquo in the form of decommodified trade in the discourse on globalization isoriginal It is also timely in a situation where the tail of trade in ldquoservicesrdquo hasgrown enough to wag the traditional trade-in-commodities dog of globalization

The balance of the chapters in this volume constitute a tapestry of casestudies that elaborate and empirically investigate the causes of systematic asym-metries of globalization The bookrsquos appeal transcends economics to make italso highly useful to students across the disciplines of sociology and politicalscience especially in the fields of international political economy and the poli-tics of international trade It will certainly enlighten all those working in thegeneral areas of globalization poverty and economic development

Pan A Yotopoulos is Distinguished Professor University of Florence Italy andProfessor Emeritus Stanford University USA Donato Romano is ProfessorUniversity of Florence Italy

ISBN13 978-0-415-42048-8 (hbk)ISBN13 978-0-203-96229-9 (ebk)

Contents

PART I

PART II

PART III

PART IV

Conclusions 179

viii Contents

Figures

supply chain 172

Tables

List of tables xi

Contributors

Contributors xiii

Acknowledgments

Acknowledgments xv

Part I

Pan A Yotopoulos

Introduction

8 PA Yotopoulos

10 PA Yotopoulos

01980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

Commercial services

12 PA Yotopoulos

14 PA Yotopoulos

16 PA Yotopoulos

18 PA Yotopoulos

20 PA Yotopoulos

22 PA Yotopoulos

24 PA Yotopoulos

References

26 PA Yotopoulos

Ugo Pagano

Introduction

30 U Pagano

Robinson Friday

h1hellipn h i

32 U Pagano

34 U Pagano

36 U Pagano

38 U Pagano

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

via po

40 U Pagano

42 U Pagano

Conclusion

44 U Pagano

References

46 U Pagano

Introduction

yi) (1)

tia (3)

ga exp 1 (5)

ln(P(0)) ln(P(0)P(1))

ln[P(0)] ln[P(0)P(1)]

ln(1ga)

0ndash20

adarsquo

rsquos r

960ndash

RPL(it)e(

t) (6)

t)u(t)(i)w(it) (7)

(1) (2) (3) (4)

Policy index (in 1000) 0028 0026 (191) (163)

Africa 0030 0031 0026 0025 (565) (553) (438) (429)

Latin America 0017 0019 0016 0016 (361) (389) (316) (313)

East Asia 0017 0018 0019 0019 (361) (306) (259) (252)

Constant 0027 0026 0025 0027 (586) (485) (447) (411)

R-squared 0415 0531 0513 0517

Conclusions

References

Introduction

The data

Empirical results

Variables OLS TOBIT

Gini2 002 015 002 018

(001) (002) (001) (002)GinidiffGDPPC 002 002

(000) (000)DiffGDPPC 004 149 002 179

(005) (021) (006) (026)GDP 245 245 272 271

(004) (004) (005) (005)GDPPC 007 010 005 008

(005) (005) (006) (006)Distance 259 -265 282 289

(009) (009) (011) (011)Areas 090 091 106 107

(006) (006) (007) (007)LL 086 078 101 092

(012) (012) (013) (013)ERV 346 358 411 425

(084) (084) (084) (087)Border 027 014 013 002

(032) (033) (048) (048)Lang 218 219 248 249

(017) (017) (022) (022)Colonial 258 275 325 346

(118) (118) (169) (169)Colonizer 197 197 228 228

(024) (024) (027) (027)Regional 066 059 043 035

(036) (036) (067) (066)OneFTA 072 068 088 084

(012) (012) (015) (015)CU 500 520 560 584

(054) (060) (094) (094)M2GDP 000003 000003 000007 000007

(000003) (000003) (000004) (000004)Gov_ds 045 043 052 050

(004) (004) (005) (005)CPY 268 276 313 323

(085) (086) (078) (078)CPE 012 009 016 012

(014) (014) (016) (016)Constant 7014 5866 7850 6445

(163) (242) (187) (277)

VariablesEU Non-EU

Gini2 019 001 019 014 002 017

(005) (001) (005) (002) (001) (002)Gini_diffGDPPC 002 002 002 002

(000) (001) (000) (000)DiffGDPPC 134 027 133 143 012 173

(037) (006) (042) (022) (006) (028)GDP 091 091 091 248 276 276

(005) (004) (004) (004) (005) (005)GDPPC 021 023 021 015 011 014

(005) (005) (005) (005) (007) (007)Distance 079 081 080 272 294 299

(008) (008) (008) (009) (011) (011)Areas 013 014 013 092 108 109

(005) (005) (005) (006) (007) (007)LL 036 034 035 078 101 092

(013) (012) (012) (013) (014) (014)ERV 010 012 010 383 444 457

(072) (068) (068) (086) (090) (090)Border 101 095 100 002 010 022

(038) (069) (069)OneFTA 039 041 039 077 098 095

(011) (011) (011) (013) (015) (015)EU 035 025 035

(060) (096) (096)M2GDP 000017 000016 000016 000002 000007 000007

(000003) (000004) (000004) (000003) (000004) (000004)Gov_ds 005 006 005 044 053 051

(003) (003) (003) (004) (005) (005)CPY 059 034 058 272 311 321

(066) (058) (058) (088) (081) (081)CPE 048 040 048 009 016 013

(020) (027) (027)Dum_1990 098 022 097 032 059 061

(017) (017) (016) (026) (026) (026)Dum_1995 131 013 131 037 055 055

(019) (016) (016) (023) (022) (022)

continued

Table 42 Continued

VariablesEU Non-EU

Dum_2000 121 (dropped) 121 108 024 026(018) (020) (024) (021) (021)

Constant 1109 2784 1119 5966 7961 6692

(406) (177) (434) (244) (195) (287)

R2 08032 04699RMSE 11211 73520Pseudo R2 03436 03483 00823 00826

Conclusions

Gini2 000072 004 001 019 000084 004

(000159) (001) (001) (005) (000164) (001)Ginidiff GDPPC 000495 002 000449

(000073) (000) (000075)DiffGDPPC 001 041 027 134 000 038

(001) (006) (007) (037) (001) (006)GDP 110 110 091 091 111 111

(001) (001) (005) (005) (001) (001)GDPPC 005 006 023 021 006 006

(001) (001) (005) (005) (001) (001)Distance 135 137 081 079 140 141

(003) (003) (008) (008) (003) (003)Areas 015 015 013 013 016 016

(002) (002) (005) (005) (002) (002)LL 026 024 034 036 026 024

(003) (003) (013) (013) (004) (004)ERV 032 029 012 010 027 024

(023) (023) (072) (072) (024) (024)Border 082 079 095 101 076 074

(011) (011) (045) (042) (011) (011)Lang 062 063 060 061

(005) (005) (005) (005)Colonial 065 059 056 052

(034) (032) (035) (033)Colonizer 058 059 058 058

(007) (007) (007) (007)Regional 136 134 134 133

(013) (013) (013) (013)OneFTA 001 002 040 039 003 003

(003) (003) (012) (011) (004) (004)EU 025 035

(024) (024) (024) (024)M2GDP 000015 000015 000016 000017 000014 000014

000001 000001 000003 000003 000001 000001Gov_ds 013 012 006 005 013 013

(001) (001) (003) (003) (001) (001)CPY 026 028 034 059 024 026

(019) (019) (064) (066) (020) (020)CPE 006 007 040 048 009 010

(018)Dum_1990 037 036 022 098 035 034

(007) (007) (015) (017) (007) (007)Dum_1995 058 058 013 131 056 056

(006) (006) (014) (019) (007) (007)Dum_1997 076 076 021 141 075 075

(006) (006) (012) (017) (007) (007)continued

Table 43 Continued

Dum_2000 051 052 (dropped) 121 052 052

(006) (006) (018) (007) (007)Constant 2482 2145 2777 1109 2465 2163

(045) (069) (199) (406) (046) (070)

Appendix

Macao)

124 New Zealand

References

Part II

Yujiro Hayami

Introduction

90 Y Hayami

92 Y Hayami

94 Y Hayami

Distributor

Retailer

Consumer

Agentcollector

96 Y Hayami

98 Y Hayami

AM Farmer harvests

Consignee Resaler

Payment to agent

returns

with agent

100 Y Hayami

102 Y Hayami

per farma

(percent per month)

Concluding remarks

104 Y Hayami

References

106 Y Hayami

Introduction

110 BJ Liu et al

112 BJ Liu et al

Basic statistics

114 BJ Liu et al

All firms 1712 3616 2388 4541

Buyerrsquos request

quotas

Firms with FDI 415 7735 5325 6193 3855 1783 1036

Total 619 7609 5525 4717 3700 1842 921

Going to China

116 BJ Liu et al

firmsChina

Total 619 7440 1177 1383

Concluding remarks

Appendix

Question 1

118 BJ Liu et al

Nature

Question 2

120 BJ Liu et al

Nature

Remarks

v1 v2 gtv3 gtv4 v5

1990ndash2000

122 BJ Liu et al

References

124 BJ Liu et al

Introduction

1990ndash2001

0 5000 10000 15000 20000 25000 30000

Cereals

The model and data

A1 2374 00749A2 2036 00649k 589sdot105 4471sdot106

R2 = 090 n = 672

0 2000 4000 6000 8000 10000 12000 14000 16000

1984ndash2001

2001 1980ndash89

China1975ndash2001

1975ndash89

1989ndash2001

Ukraine

Russian Federation

Baltics

Belarus

Central Asia

Caucasus

0 2000 4000 6000 8000 10000 12000 14000 16000

Belarus

PolandLithuania

BulgariaKazakhstan

KyrgyzstanAlbania

Russian Fed

Romania

Estonia

ChinaUzbekistan

Moldova

Georgia

Slovakia

LatviaUkraine

Turkmenistan

AzerbaijanArmenia

Tajikistan

020 5000 10000 15000 20000 25000 30000

PoultryEggs

References

Part III

Introduction

(Pollan 2001 191)

148 MAC Fok et al

150 MAC Fok et al

152 MAC Fok et al

Year 1986 1987 1988 1989 1990 1991 1992 1993 1994

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003

2002 2003 2002 2003

154 MAC Fok et al

GM cotton varieties

(US$kg) (US$kg)

Hybrids 48 4 54 6

156 MAC Fok et al

Conclusions

158 MAC Fok et al

160 MAC Fok et al

References

162 MAC Fok et al

Introduction

Consumer

RetailerSupermarket

RestaurantCafeacute

Internationaltrader

Consumingcountries

Broker

Marketingboard

Exporter

Producingcountries

Curing planthuller

Farmer groupAgent

EstateSmallholder

green coffee

Source FLO (2004)

1995 99711996 10883 911997 11370 451998 11663 261999 11819 132000 12818 852001 14387 1222002 15780 972003 19872 2592004 24223 219

organization

TraderImporter

Licenseholders

Processing

Max HavelaarBelgium

Consumer

Flow of products

Reporting

Control audit

Registered partner

Conclusion

References

Part IV

Conclusions

Donato Romano

Introduction

182 D Romano

184 D Romano

186 D Romano

188 D Romano

190 D Romano

Policy implications

192 D Romano

Conclusion

194 D Romano

196 D Romano

References

198 D Romano

Subject index

187China 25n24 116ndash17 118 122n11

123n25 135 137 138 152ndash7 152 153154

customs 90

outsourcing

77 78 79 80 127 129 138ndash42 149193

200 Subject index

markets

India 8 15 16 17 25n19 155ndash7 157158

Subject index 201

160n3 160n4 160n6 160n9 190

norms 90ndash1 95

202 Subject index

Taiwan 113ndash18 114 115 116 122n5122n11

Subject index 203

24n15 44 149ndash50 158 164 182 193196n8

204 Subject index

Author index

176n12 177Fok Michel AC 105 152 153 153

154 157 158 160n2 161n17 162 186 190

102 102 103 105 106 111 122n10174 176n14 184

206 Author index

86 186 193Nurkse Ragnar 194 197

142n2 142n4 143 184Rask Norman 128 129 130 132 132

198Romano Donato 24n9 24n15 40 67 105

Author index 207

25n20 25n21 26 27 45n7 49 51 5456 57 61 64n2 64n5 66 190 191193 196n12 198

143 183 198WTO 11 26 72 86 182 195n4 196n8

Yousef Tarik M 86

208 Author index

Book Cover

Copyright

Contents

Figures

Tables

Contributors

Acknowledgments












Part IV Conclusions


Subject index

Author index

ISBN13 978-0-415-42048-8 (hbk)ISBN13 978-0-203-96229-9 (ebk)

Contents

PART I

PART II

PART III

PART IV

Conclusions 179

viii Contents

Figures

supply chain 172

Tables

List of tables xi

Contributors

Contributors xiii

Acknowledgments

Acknowledgments xv

Part I

Pan A Yotopoulos

Introduction

8 PA Yotopoulos

10 PA Yotopoulos

01980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

Commercial services

12 PA Yotopoulos

14 PA Yotopoulos

16 PA Yotopoulos

18 PA Yotopoulos

20 PA Yotopoulos

22 PA Yotopoulos

24 PA Yotopoulos

References

26 PA Yotopoulos

Ugo Pagano

Introduction

30 U Pagano

Robinson Friday

h1hellipn h i

32 U Pagano

34 U Pagano

36 U Pagano

38 U Pagano

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

via po

40 U Pagano

42 U Pagano

Conclusion

44 U Pagano

References

46 U Pagano

Introduction

yi) (1)

tia (3)

ga exp 1 (5)

ln(P(0)) ln(P(0)P(1))

ln[P(0)] ln[P(0)P(1)]

ln(1ga)

0ndash20

adarsquo

rsquos r

960ndash

RPL(it)e(

t) (6)

t)u(t)(i)w(it) (7)

(1) (2) (3) (4)

Policy index (in 1000) 0028 0026 (191) (163)

Africa 0030 0031 0026 0025 (565) (553) (438) (429)

Latin America 0017 0019 0016 0016 (361) (389) (316) (313)

East Asia 0017 0018 0019 0019 (361) (306) (259) (252)

Constant 0027 0026 0025 0027 (586) (485) (447) (411)

R-squared 0415 0531 0513 0517

Conclusions

References

Introduction

The data

Empirical results

Variables OLS TOBIT

Gini2 002 015 002 018

(001) (002) (001) (002)GinidiffGDPPC 002 002

(000) (000)DiffGDPPC 004 149 002 179

(005) (021) (006) (026)GDP 245 245 272 271

(004) (004) (005) (005)GDPPC 007 010 005 008

(005) (005) (006) (006)Distance 259 -265 282 289

(009) (009) (011) (011)Areas 090 091 106 107

(006) (006) (007) (007)LL 086 078 101 092

(012) (012) (013) (013)ERV 346 358 411 425

(084) (084) (084) (087)Border 027 014 013 002

(032) (033) (048) (048)Lang 218 219 248 249

(017) (017) (022) (022)Colonial 258 275 325 346

(118) (118) (169) (169)Colonizer 197 197 228 228

(024) (024) (027) (027)Regional 066 059 043 035

(036) (036) (067) (066)OneFTA 072 068 088 084

(012) (012) (015) (015)CU 500 520 560 584

(054) (060) (094) (094)M2GDP 000003 000003 000007 000007

(000003) (000003) (000004) (000004)Gov_ds 045 043 052 050

(004) (004) (005) (005)CPY 268 276 313 323

(085) (086) (078) (078)CPE 012 009 016 012

(014) (014) (016) (016)Constant 7014 5866 7850 6445

(163) (242) (187) (277)

VariablesEU Non-EU

Gini2 019 001 019 014 002 017

(005) (001) (005) (002) (001) (002)Gini_diffGDPPC 002 002 002 002

(000) (001) (000) (000)DiffGDPPC 134 027 133 143 012 173

(037) (006) (042) (022) (006) (028)GDP 091 091 091 248 276 276

(005) (004) (004) (004) (005) (005)GDPPC 021 023 021 015 011 014

(005) (005) (005) (005) (007) (007)Distance 079 081 080 272 294 299

(008) (008) (008) (009) (011) (011)Areas 013 014 013 092 108 109

(005) (005) (005) (006) (007) (007)LL 036 034 035 078 101 092

(013) (012) (012) (013) (014) (014)ERV 010 012 010 383 444 457

(072) (068) (068) (086) (090) (090)Border 101 095 100 002 010 022

(038) (069) (069)OneFTA 039 041 039 077 098 095

(011) (011) (011) (013) (015) (015)EU 035 025 035

(060) (096) (096)M2GDP 000017 000016 000016 000002 000007 000007

(000003) (000004) (000004) (000003) (000004) (000004)Gov_ds 005 006 005 044 053 051

(003) (003) (003) (004) (005) (005)CPY 059 034 058 272 311 321

(066) (058) (058) (088) (081) (081)CPE 048 040 048 009 016 013

(020) (027) (027)Dum_1990 098 022 097 032 059 061

(017) (017) (016) (026) (026) (026)Dum_1995 131 013 131 037 055 055

(019) (016) (016) (023) (022) (022)

continued

Table 42 Continued

VariablesEU Non-EU

Dum_2000 121 (dropped) 121 108 024 026(018) (020) (024) (021) (021)

Constant 1109 2784 1119 5966 7961 6692

(406) (177) (434) (244) (195) (287)

R2 08032 04699RMSE 11211 73520Pseudo R2 03436 03483 00823 00826

Conclusions

Gini2 000072 004 001 019 000084 004

(000159) (001) (001) (005) (000164) (001)Ginidiff GDPPC 000495 002 000449

(000073) (000) (000075)DiffGDPPC 001 041 027 134 000 038

(001) (006) (007) (037) (001) (006)GDP 110 110 091 091 111 111

(001) (001) (005) (005) (001) (001)GDPPC 005 006 023 021 006 006

(001) (001) (005) (005) (001) (001)Distance 135 137 081 079 140 141

(003) (003) (008) (008) (003) (003)Areas 015 015 013 013 016 016

(002) (002) (005) (005) (002) (002)LL 026 024 034 036 026 024

(003) (003) (013) (013) (004) (004)ERV 032 029 012 010 027 024

(023) (023) (072) (072) (024) (024)Border 082 079 095 101 076 074

(011) (011) (045) (042) (011) (011)Lang 062 063 060 061

(005) (005) (005) (005)Colonial 065 059 056 052

(034) (032) (035) (033)Colonizer 058 059 058 058

(007) (007) (007) (007)Regional 136 134 134 133

(013) (013) (013) (013)OneFTA 001 002 040 039 003 003

(003) (003) (012) (011) (004) (004)EU 025 035

(024) (024) (024) (024)M2GDP 000015 000015 000016 000017 000014 000014

000001 000001 000003 000003 000001 000001Gov_ds 013 012 006 005 013 013

(001) (001) (003) (003) (001) (001)CPY 026 028 034 059 024 026

(019) (019) (064) (066) (020) (020)CPE 006 007 040 048 009 010

(018)Dum_1990 037 036 022 098 035 034

(007) (007) (015) (017) (007) (007)Dum_1995 058 058 013 131 056 056

(006) (006) (014) (019) (007) (007)Dum_1997 076 076 021 141 075 075

(006) (006) (012) (017) (007) (007)continued

Table 43 Continued

Dum_2000 051 052 (dropped) 121 052 052

(006) (006) (018) (007) (007)Constant 2482 2145 2777 1109 2465 2163

(045) (069) (199) (406) (046) (070)

Appendix

Macao)

124 New Zealand

References

Part II

Yujiro Hayami

Introduction

90 Y Hayami

92 Y Hayami

94 Y Hayami

Distributor

Retailer

Consumer

Agentcollector

96 Y Hayami

98 Y Hayami

AM Farmer harvests

Consignee Resaler

Payment to agent

returns

with agent

100 Y Hayami

102 Y Hayami

per farma

(percent per month)

Concluding remarks

104 Y Hayami

References

106 Y Hayami

Introduction

110 BJ Liu et al

112 BJ Liu et al

Basic statistics

114 BJ Liu et al

All firms 1712 3616 2388 4541

Buyerrsquos request

quotas

Firms with FDI 415 7735 5325 6193 3855 1783 1036

Total 619 7609 5525 4717 3700 1842 921

Going to China

116 BJ Liu et al

firmsChina

Total 619 7440 1177 1383

Concluding remarks

Appendix

Question 1

118 BJ Liu et al

Nature

Question 2

120 BJ Liu et al

Nature

Remarks

v1 v2 gtv3 gtv4 v5

1990ndash2000

122 BJ Liu et al

References

124 BJ Liu et al

Introduction

1990ndash2001

0 5000 10000 15000 20000 25000 30000

Cereals

The model and data

A1 2374 00749A2 2036 00649k 589sdot105 4471sdot106

R2 = 090 n = 672

0 2000 4000 6000 8000 10000 12000 14000 16000

1984ndash2001

2001 1980ndash89

China1975ndash2001

1975ndash89

1989ndash2001

Ukraine

Russian Federation

Baltics

Belarus

Central Asia

Caucasus

0 2000 4000 6000 8000 10000 12000 14000 16000

Belarus

PolandLithuania

BulgariaKazakhstan

KyrgyzstanAlbania

Russian Fed

Romania

Estonia

ChinaUzbekistan

Moldova

Georgia

Slovakia

LatviaUkraine

Turkmenistan

AzerbaijanArmenia

Tajikistan

020 5000 10000 15000 20000 25000 30000

PoultryEggs

References

Part III

Introduction

(Pollan 2001 191)

148 MAC Fok et al

150 MAC Fok et al

152 MAC Fok et al

Year 1986 1987 1988 1989 1990 1991 1992 1993 1994

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003

2002 2003 2002 2003

154 MAC Fok et al

GM cotton varieties

(US$kg) (US$kg)

Hybrids 48 4 54 6

156 MAC Fok et al

Conclusions

158 MAC Fok et al

160 MAC Fok et al

References

162 MAC Fok et al

Introduction

Consumer

RetailerSupermarket

RestaurantCafeacute

Internationaltrader

Consumingcountries

Broker

Marketingboard

Exporter

Producingcountries

Curing planthuller

Farmer groupAgent

EstateSmallholder

green coffee

Source FLO (2004)

1995 99711996 10883 911997 11370 451998 11663 261999 11819 132000 12818 852001 14387 1222002 15780 972003 19872 2592004 24223 219

organization

TraderImporter

Licenseholders

Processing

Max HavelaarBelgium

Consumer

Flow of products

Reporting

Control audit

Registered partner

Conclusion

References

Part IV

Conclusions

Donato Romano

Introduction

182 D Romano

184 D Romano

186 D Romano

188 D Romano

190 D Romano

Policy implications

192 D Romano

Conclusion

194 D Romano

196 D Romano

References

198 D Romano

Subject index

187China 25n24 116ndash17 118 122n11

123n25 135 137 138 152ndash7 152 153154

customs 90

outsourcing

77 78 79 80 127 129 138ndash42 149193

200 Subject index

markets

India 8 15 16 17 25n19 155ndash7 157158

Subject index 201

160n3 160n4 160n6 160n9 190

norms 90ndash1 95

202 Subject index

Taiwan 113ndash18 114 115 116 122n5122n11

Subject index 203

24n15 44 149ndash50 158 164 182 193196n8

204 Subject index

Author index

176n12 177Fok Michel AC 105 152 153 153

154 157 158 160n2 161n17 162 186 190

102 102 103 105 106 111 122n10174 176n14 184

206 Author index

86 186 193Nurkse Ragnar 194 197

142n2 142n4 143 184Rask Norman 128 129 130 132 132

198Romano Donato 24n9 24n15 40 67 105

Author index 207

25n20 25n21 26 27 45n7 49 51 5456 57 61 64n2 64n5 66 190 191193 196n12 198

143 183 198WTO 11 26 72 86 182 195n4 196n8

Yousef Tarik M 86

208 Author index

Book Cover

Copyright

Contents

Figures

Tables

Contributors

Acknowledgments












Part IV Conclusions


Subject index

Author index

ISBN13 978-0-415-42048-8 (hbk)ISBN13 978-0-203-96229-9 (ebk)

Contents

PART I

PART II

PART III

PART IV

Conclusions 179

viii Contents

Figures

supply chain 172

Tables

List of tables xi

Contributors

Contributors xiii

Acknowledgments

Acknowledgments xv

Part I

Pan A Yotopoulos

Introduction

8 PA Yotopoulos

10 PA Yotopoulos

01980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

Commercial services

12 PA Yotopoulos

14 PA Yotopoulos

16 PA Yotopoulos

18 PA Yotopoulos

20 PA Yotopoulos

22 PA Yotopoulos

24 PA Yotopoulos

References

26 PA Yotopoulos

Ugo Pagano

Introduction

30 U Pagano

Robinson Friday

h1hellipn h i

32 U Pagano

34 U Pagano

36 U Pagano

38 U Pagano

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

via po

40 U Pagano

42 U Pagano

Conclusion

44 U Pagano

References

46 U Pagano

Introduction

yi) (1)

tia (3)

ga exp 1 (5)

ln(P(0)) ln(P(0)P(1))

ln[P(0)] ln[P(0)P(1)]

ln(1ga)

0ndash20

adarsquo

rsquos r

960ndash

RPL(it)e(

t) (6)

t)u(t)(i)w(it) (7)

(1) (2) (3) (4)

Policy index (in 1000) 0028 0026 (191) (163)

Africa 0030 0031 0026 0025 (565) (553) (438) (429)

Latin America 0017 0019 0016 0016 (361) (389) (316) (313)

East Asia 0017 0018 0019 0019 (361) (306) (259) (252)

Constant 0027 0026 0025 0027 (586) (485) (447) (411)

R-squared 0415 0531 0513 0517

Conclusions

References

Introduction

The data

Empirical results

Variables OLS TOBIT

Gini2 002 015 002 018

(001) (002) (001) (002)GinidiffGDPPC 002 002

(000) (000)DiffGDPPC 004 149 002 179

(005) (021) (006) (026)GDP 245 245 272 271

(004) (004) (005) (005)GDPPC 007 010 005 008

(005) (005) (006) (006)Distance 259 -265 282 289

(009) (009) (011) (011)Areas 090 091 106 107

(006) (006) (007) (007)LL 086 078 101 092

(012) (012) (013) (013)ERV 346 358 411 425

(084) (084) (084) (087)Border 027 014 013 002

(032) (033) (048) (048)Lang 218 219 248 249

(017) (017) (022) (022)Colonial 258 275 325 346

(118) (118) (169) (169)Colonizer 197 197 228 228

(024) (024) (027) (027)Regional 066 059 043 035

(036) (036) (067) (066)OneFTA 072 068 088 084

(012) (012) (015) (015)CU 500 520 560 584

(054) (060) (094) (094)M2GDP 000003 000003 000007 000007

(000003) (000003) (000004) (000004)Gov_ds 045 043 052 050

(004) (004) (005) (005)CPY 268 276 313 323

(085) (086) (078) (078)CPE 012 009 016 012

(014) (014) (016) (016)Constant 7014 5866 7850 6445

(163) (242) (187) (277)

VariablesEU Non-EU

Gini2 019 001 019 014 002 017

(005) (001) (005) (002) (001) (002)Gini_diffGDPPC 002 002 002 002

(000) (001) (000) (000)DiffGDPPC 134 027 133 143 012 173

(037) (006) (042) (022) (006) (028)GDP 091 091 091 248 276 276

(005) (004) (004) (004) (005) (005)GDPPC 021 023 021 015 011 014

(005) (005) (005) (005) (007) (007)Distance 079 081 080 272 294 299

(008) (008) (008) (009) (011) (011)Areas 013 014 013 092 108 109

(005) (005) (005) (006) (007) (007)LL 036 034 035 078 101 092

(013) (012) (012) (013) (014) (014)ERV 010 012 010 383 444 457

(072) (068) (068) (086) (090) (090)Border 101 095 100 002 010 022

(038) (069) (069)OneFTA 039 041 039 077 098 095

(011) (011) (011) (013) (015) (015)EU 035 025 035

(060) (096) (096)M2GDP 000017 000016 000016 000002 000007 000007

(000003) (000004) (000004) (000003) (000004) (000004)Gov_ds 005 006 005 044 053 051

(003) (003) (003) (004) (005) (005)CPY 059 034 058 272 311 321

(066) (058) (058) (088) (081) (081)CPE 048 040 048 009 016 013

(020) (027) (027)Dum_1990 098 022 097 032 059 061

(017) (017) (016) (026) (026) (026)Dum_1995 131 013 131 037 055 055

(019) (016) (016) (023) (022) (022)

continued

Table 42 Continued

VariablesEU Non-EU

Dum_2000 121 (dropped) 121 108 024 026(018) (020) (024) (021) (021)

Constant 1109 2784 1119 5966 7961 6692

(406) (177) (434) (244) (195) (287)

R2 08032 04699RMSE 11211 73520Pseudo R2 03436 03483 00823 00826

Conclusions

Gini2 000072 004 001 019 000084 004

(000159) (001) (001) (005) (000164) (001)Ginidiff GDPPC 000495 002 000449

(000073) (000) (000075)DiffGDPPC 001 041 027 134 000 038

(001) (006) (007) (037) (001) (006)GDP 110 110 091 091 111 111

(001) (001) (005) (005) (001) (001)GDPPC 005 006 023 021 006 006

(001) (001) (005) (005) (001) (001)Distance 135 137 081 079 140 141

(003) (003) (008) (008) (003) (003)Areas 015 015 013 013 016 016

(002) (002) (005) (005) (002) (002)LL 026 024 034 036 026 024

(003) (003) (013) (013) (004) (004)ERV 032 029 012 010 027 024

(023) (023) (072) (072) (024) (024)Border 082 079 095 101 076 074

(011) (011) (045) (042) (011) (011)Lang 062 063 060 061

(005) (005) (005) (005)Colonial 065 059 056 052

(034) (032) (035) (033)Colonizer 058 059 058 058

(007) (007) (007) (007)Regional 136 134 134 133

(013) (013) (013) (013)OneFTA 001 002 040 039 003 003

(003) (003) (012) (011) (004) (004)EU 025 035

(024) (024) (024) (024)M2GDP 000015 000015 000016 000017 000014 000014

000001 000001 000003 000003 000001 000001Gov_ds 013 012 006 005 013 013

(001) (001) (003) (003) (001) (001)CPY 026 028 034 059 024 026

(019) (019) (064) (066) (020) (020)CPE 006 007 040 048 009 010

(018)Dum_1990 037 036 022 098 035 034

(007) (007) (015) (017) (007) (007)Dum_1995 058 058 013 131 056 056

(006) (006) (014) (019) (007) (007)Dum_1997 076 076 021 141 075 075

(006) (006) (012) (017) (007) (007)continued

Table 43 Continued

Dum_2000 051 052 (dropped) 121 052 052

(006) (006) (018) (007) (007)Constant 2482 2145 2777 1109 2465 2163

(045) (069) (199) (406) (046) (070)

Appendix

Macao)

124 New Zealand

References

Part II

Yujiro Hayami

Introduction

90 Y Hayami

92 Y Hayami

94 Y Hayami

Distributor

Retailer

Consumer

Agentcollector

96 Y Hayami

98 Y Hayami

AM Farmer harvests

Consignee Resaler

Payment to agent

returns

with agent

100 Y Hayami

102 Y Hayami

per farma

(percent per month)

Concluding remarks

104 Y Hayami

References

106 Y Hayami

Introduction

110 BJ Liu et al

112 BJ Liu et al

Basic statistics

114 BJ Liu et al

All firms 1712 3616 2388 4541

Buyerrsquos request

quotas

Firms with FDI 415 7735 5325 6193 3855 1783 1036

Total 619 7609 5525 4717 3700 1842 921

Going to China

116 BJ Liu et al

firmsChina

Total 619 7440 1177 1383

Concluding remarks

Appendix

Question 1

118 BJ Liu et al

Nature

Question 2

120 BJ Liu et al

Nature

Remarks

v1 v2 gtv3 gtv4 v5

1990ndash2000

122 BJ Liu et al

References

124 BJ Liu et al

Introduction

1990ndash2001

0 5000 10000 15000 20000 25000 30000

Cereals

The model and data

A1 2374 00749A2 2036 00649k 589sdot105 4471sdot106

R2 = 090 n = 672

0 2000 4000 6000 8000 10000 12000 14000 16000

1984ndash2001

2001 1980ndash89

China1975ndash2001

1975ndash89

1989ndash2001

Ukraine

Russian Federation

Baltics

Belarus

Central Asia

Caucasus

0 2000 4000 6000 8000 10000 12000 14000 16000

Belarus

PolandLithuania

BulgariaKazakhstan

KyrgyzstanAlbania

Russian Fed

Romania

Estonia

ChinaUzbekistan

Moldova

Georgia

Slovakia

LatviaUkraine

Turkmenistan

AzerbaijanArmenia

Tajikistan

020 5000 10000 15000 20000 25000 30000

PoultryEggs

References

Part III

Introduction

(Pollan 2001 191)

148 MAC Fok et al

150 MAC Fok et al

152 MAC Fok et al

Year 1986 1987 1988 1989 1990 1991 1992 1993 1994

Year 1995 1996 1997 1998 1999 2000 2001 2002 2003

2002 2003 2002 2003

154 MAC Fok et al

GM cotton varieties

(US$kg) (US$kg)

Hybrids 48 4 54 6

156 MAC Fok et al

Conclusions

158 MAC Fok et al

160 MAC Fok et al

References

162 MAC Fok et al

Introduction

Consumer

RetailerSupermarket

RestaurantCafeacute

Internationaltrader

Consumingcountries

Broker

Marketingboard

Exporter

Producingcountries

Curing planthuller

Farmer groupAgent

EstateSmallholder

green coffee

Source FLO (2004)

1995 99711996 10883 911997 11370 451998 11663 261999 11819 132000 12818 852001 14387 1222002 15780 972003 19872 2592004 24223 219

organization

TraderImporter

Licenseholders

Processing

Max HavelaarBelgium

Consumer

Flow of products

Reporting

Control audit

Registered partner

Conclusion

References

Part IV

Conclusions

Donato Romano

Introduction

182 D Romano

184 D Romano

186 D Romano

188 D Romano

190 D Romano

Policy implications

192 D Romano

Conclusion

194 D Romano

196 D Romano

References

198 D Romano

Subject index

187China 25n24 116ndash17 118 122n11

123n25 135 137 138 152ndash7 152 153154

customs 90

outsourcing

77 78 79 80 127 129 138ndash42 149193

200 Subject index

markets

India 8 15 16 17 25n19 155ndash7 157158

Subject index 201

160n3 160n4 160n6 160n9 190

norms 90ndash1 95

202 Subject index

Taiwan 113ndash18 114 115 116 122n5122n11

Subject index 203

24n15 44 149ndash50 158 164 182 193196n8

204 Subject index

Author index

176n12 177Fok Michel AC 105 152 153 153

154 157 158 160n2 161n17 162 186 190

102 102 103 105 106 111 122n10174 176n14 184

206 Author index

86 186 193Nurkse Ragnar 194 197

142n2 142n4 143 184Rask Norman 128 129 130 132 132

198Romano Donato 24n9 24n15 40 67 105

Author index 207

25n20 25n21 26 27 45n7 49 51 5456 57 61 64n2 64n5 66 190 191193 196n12 198

143 183 198WTO 11 26 72 86 182 195n4 196n8

Yousef Tarik M 86

208 Author index

Book Cover

Copyright

Contents

Figures

Tables

Contributors

Acknowledgments












Part IV Conclusions


Subject index

Author index

Documents

Downloaded by [University of Defence] at 20:07 09 May 2016 …opac.lib.idu.ac.id/unhan-ebook/assets/uploads/files/9c0a... · 2016. 6. 5. · 12 Regionalization and Globalization in