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Sept 30, 2000

GLOBALIZATION: NOT A CHOICE. Rudi Dornbusch Massachusetts Institute of Technology Monsieur Jove Bove, a French farmer (apparently both parents are apparently U. of Berkeley graduates) made headlines when he hitched his tractor to the bright red roof of a McDonald establishment and drove off, roof included. He has since become an icon of the anti-globalization movement in France, a hero standing up against the one-haircut-fits-all view of globalization, against “malbouffe”, against Americanization plain and simple. Condemned to 3 month of jail, he is on appeal and to judge from his sense for drama, he is sure to be heard of soon. Globalization is controversial far more than the protesters at Prague, Washington and Seattle would lead us to believe. Change is controversial, radical change is threatening. *** Around the world, companies and politicians, students and workers have to grapple with globalization. In one way or another, they are in the midst of a current that carries them toward a far more open, fast-changing economy where information and communication flows rapidly, where asset markets play a central role trading countries like companies. The impossible is happening at the drop of a hat: stock exchanges merge as traditional institutions like the London Stock Exchange receive hostile takeover bids from a start-up high tech firm in Sweden. Japanese corporate boards hold their meetings in English, with foreign members, to force fast cultural change. Demonstrators organize on the Web just as the Chinese government uses the web to move its citizens faster into the midst of the world economy. A German government hopes to control the fact and details of takeover until it throws in the towel, recognizing that market forces are more powerful and are delivering more prosperity than a status quo government can do. A simple every day fact should remind us how far we have gone in redefining where we are: What is your address? How may people will answer with their email address, how many business will put www.etc rather than a street and number and a town? No, we don’t lose local identity; in fact, we all gain by being also part of a wider community. Well into the 20th century, Spanish railroads had a different track width from that of France; the world stopped at the border. Of course, that world exists no longer. Gradually, over the past 50 years the world has opened up again and now, because of technology and aggressive capitalism, all and any border – drawn by governments or just tradition and the mind—is being broken down. The world is being rewired, a change that is both immensely positive and, no doubt, threatening to many. The wave will carry away a lot that is obsolete and stands in the way of freedom and prosperity. It will clear up the morass of sleaze and privilege that closed and stale political systems accumulate. (As the

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Chinese proverb in opposition to transparency goes, “clear water, no fish”) But, will it also carry away a lot that defines the community, dignity and culture? Globalization is on and spreading like a wild fire; probably we cannot even control where it goes and how fast. And, indeed, we probably should not even try. Why not just let capitalism find its way? And just as certainly, many will rise to say, “stop the beast before it destroys everything we value, from culture to the environment, from community to even human dignity.” While pockets of resistance from Seattle to Washington and Prague demonstrate against uncontrolled change, the fact is that nobody can stop the wave and few even entertain the illusion that they should even try. “Globalization” is surely the battle cry around the world; it is the battle cry on both fronts. For corporations it is a necessity if they want to be competitive in world markets. For organized labor it is seen as a threat against the status quo, for the men in the street it involves both threat of competition and opportunity of choice. Politicians see it as a nightmare because they cannot say no, but for the most part – and surely in countries that have not suffered a crisis-- they are reluctant to embrace it. Wherever the issue arises, globalization is controversial, very controversial indeed. The reason is that it threatens the status quo, it means change. And whenever change does happen, there are winners and losers. The winners can be excited with the prospects of the upside; the losers can be scared with the downside. To get a great controversy going, all that is needed is blowing the script out of proportion: the winners are large and greedy corporation, the losers are poor and vulnerable workers. Globalization has so different connotations for different people and it is so open to misrepresentation by the winners. The issue arises all over the place: in Europe it was a debate about social dumping as low wage Spain and Portugal joined the European Union; it is an emerging huge issue as the European Union expands to the low wage, low social protection East. In North America globalization became a big deal in the context of NAFTA – the “giant sucking sound” of Ross Perot with the fear of US jobs being sucked off to Mexico. And then again, with the Uruguay round and with WTO for China, the debate each time is large and greedy corporations versus poor, unprotected workers. The issue each time is to dress up the protest agenda with seemingly human sensible conditions (protection of the environment, minimum wages in poor countries, no prison labor, human rights, child labor protection) all of which are excuses, and bad excuses at that, to clamp down on free trade. The controversy over globalization is not an accident. It is certainly true that, just as technological progress, globalization moves the chairs. It cuts into the status quo, threatens established privileges and gives fresh opportunities to firms and to consumers. That is the case with explicit agreements that open up or reinforce cross border competition in goods and services; it is also the implication of the revolution in communications that spreads information worldwide far more rapidly than the speed of light. More than anything, globalization involves fast and deep change, and change is what galvanizes people into action, more so when it is fear of change. Moreover, many

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groups use globalization as an umbrella for organizing dissidents on environmental issues, on civil rights issues, on trade and labor issues, on issues of gay rights, on just about anything including the sheer fun of joining a protest. US labor in particular has pursued the strategy of joining the anti-globalization issue as seen in the website www.gatt.com that unites the growing worldwide opposition to globalization, to the widening of the flow of goods and services, to information and communications spreading worldwide at an accelerating pace.

WORLD TRADE AND GDP (Index 1950=100, constant prices, Source: Madison and IMF)

0

200

400

600

800

1000

1200

1400

1600

1800

2000

1870 1900 1913 1929 1950 1960 1970 1980 1990 2000

Note: The dark bar shows the real volume of world exports while light bar represents world real GDP. Data through 1990 come from Madison and are updated using IMF estimates. The demonstrations in Seattle, Washington and Prague have given the spectacle some appeal and color. The press cannot help picking up the issue and the more that happens, the more globalization can be assured to have a stage as an immensely controversial issue. The big player in the game, unknown to most, but formidably influential in mobilizing protests and making governments back down, against their better judgment, is organized labor. 1 The talent of organizers, getting into the spotlight, aggregating protesters of the most unrelated issues is sure to keep globalization in the limelight, misrepresent the issues, and build growing support of the anti-globalization camp. Fortunately for the cause, spectacular US economic growth and full employment have kept the issue contained—where are the unemployed, who does not have a job? And even in Europe where performance falls short of spectacular, the absence of recession has kept 1 See the interview “Lori’s War” with US labor mobilizer Lori Wallach in the spring issue of Foreign Policy who has been at the center of organized opposition responses to any US trade initiative.

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some room for politicians not to turn outright against globalization. But make no mistake; politicians will turn on a dime if we have an economic calamity. Globalization then will become really a dirty word. In the meantime, globalization takes its course, even if the latest round of the WTO failed, even if China is not quite in the WTO yet. Globalization is growing by the day as corporations restructure to operate at the world level, as individuals empowered by new information technology expand their interests. Globalization expands as a very large segment of every economy and community looks across the border to the wide world in defining their identity, their opportunities, and their activities. That is as much true for teachers and students as it is for protesters, for charities, governments, and corporations. That was the world of 1900, that is the world in the making today and surely there tomorrow. In the broad sweep of more than a century, the world economy has become increasingly open. Using data of Angus Madison and the IMF, we can paint that picture easily by comparing the evolution of GDP in the world and of world exports, both measured in real terms. The accompanying figure shows how dramatically openness has risen over a century.2 These data relate only to trade in merchandise trade and hence underestimate the very important emerging trade in services of the past 2 or 3 decades. There is the extra important fact of increasing capital flows, disrupted in the interwar period, but surely as great a driver of integration today as they were in the late 19th century. In fact, in the past 50 years we have seen a far faster pace of growth of GDP and especially trade than in the preceding 80 years.

Table 1 Growth of World GDP and World Trade (Percent per year) 1870-1950 1950-2000

World GDP World Trade

2.0 2.4

4.0 6.2

Source: Madison and IMF O’Rourke and Williamson (1999) have documented the importance of trade for growth of the world economy. They give primary importance to reduced transport costs as the driver of trade opportunities. Interpreting transport costs broadly to include the widening impact of falling costs in communications and information technology, transport costs surely continue to be the driver today of an accelerating tendency toward globalization.

2 See A. Madison (1995) updated using IMF World Economic Outlook data.

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Background: The Come and Go of the State A century ago, in the economic area, the State practically did not exist. There was total freedom of trade in goods and services; the world was on gold as a common currency (with a bit of silver in odd places). The welfare state was unheard of and government production of goods and services, outside defense, just did not exist. Even public utilities were predominantly private or, at best, municipal. The 20th century brought all that. However, just as a new century is opening up, the Economic State—or statism for short, one of the truly bad ideas-- is progressively being dismantled everywhere. A world without boundaries, competition in private markets, and a sharp retreat of the welfare state all promise to create a fresh base of prosperity and flexibility to handle the overriding challenges posed by the dramatic arrival of new technologies and billions of people joining the world market place. There are some doubts, but the presumption now is that, barring a catastrophe like the 1930s, the State is an idea of the past. Developments in the few last decades the 20th century take us back where we were a century ago: enormous confidence in technology, an ever expanding world of opportunity and challenge and a liberal economic system. During the 20th century we first departed from that blissful world; statism and protection became the rule and the welfare state made its appearance. Now the world economy is on a bold new course that turns back to where we came from—economic liberalism and individualism, competition and opportunity. In the late 19th century, and at the turn of the century, the world economy was in a phase of prosperity built on free trade, the free flow of capital to the periphery, the flow of people toward opportunity and freedom. And these developments were underpinned by the stability of money based on the gold standard. Colonialism took economic advancement to the periphery and getting rich was glorious. One country after another joined the system, from Argentina to Japan, from Germany to the US. Internationalism was the rule; the World Fairs of Chicago in 1889 and Paris in 1893 and 1900 were just one way of showing excitement in a world without borders either in space or technological promise. Internationalism was also obvious in the international conferences to standardize just about anything, from weights and measures to the mail. And, of course, achieving a common monetary standard was very much part of the agenda. Peace among the major players and a deep belief in the explosion of technological opportunities created a confidence in ever expanding opportunities. It is clear that today we are back to just such a world; we think it is new, but in fact it just takes us back to where we were a century ago. It is instructive to ask how the sense of an extraordinary future for a wide open world economy was lost and how it was recovered. It will help ask the key question: can this bright new world last?

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The Imprint of the Interwar Years

Two developments were central to the disintegration of the liberal (in the European sense) world: the rise of the nation state and the rise of governments as economic actors both in their welfare state role and as operators of public sector enterprises. The reversal of these tendencies, at least in the economic sphere, is largely responsible for the current prosperity. The loss of the liberal world was, of course, the result of the Great Wars and of the Great Depression. Whether these were made inevitable by the forces of history or just the result of plain stupidity of decadent emperors, militarists and misguided economic policy makers remains unresolved. The fact is that the World War I introduced the deep disillusion about internationalism: the terror of mechanized warfare, the dramatic challenge to established and outdated authority, and weak, new and unprepared democracy. Along with income taxes and large public debts, the 1920s brought protection, hyperinflation, and competitive devaluation. The Great Crash and the Great Depression moved governments to the center of economic life. Exchange rate control became routine; quotas on trade outdid tariffs. Government projects to create jobs, regulation of economic life, state operation of key industries — all these became routine as did the belief that the competitive capitalist economy is at the least unstable and in need of pervasive support and control. Many though went further to say that the public sector simply had to be at the center of economic life and was essential to stabilizing the private economy and limit economic power in the hands of the wealthy. Not every country went to these extremes. But it is clear that in Europe, outside Germany, that model was dominant. Erhard, Germany's architect of economic reform in the late 1940s, may have taken Germany back to the market, but the “market” was all tangled up in restrictions to a point that even after liberalization it could barely move. Only the US mostly escaped; in the 1930s it went in the direction of statism but that went away quite fast. Japan even in the late 19th century never quite made it to the open economy: the Meiji restoration was a dramatic start in terms of modernization, but imperial-militaristic government was a counterweight to an open competitive economy. In the inter-war period Japan, of course, in a difficult world trade environment found its way to a pervasive role of the state that lasted well into the 1980s. The world’s economic periphery had opened up in the 19th century but closed dawn in the 1930s: Latin America went to import substitution and capital controls, pervasive nationalization of business, to public sector investments in strategic sectors, and to fascist labor market institutions imported from Europe. And what was true of Latin America was also true of Eastern Europe. In fact, that region went straight from statism to communism. Asia in the meantime was caught up in postcolonial and revolutionary wars that kept economic issues on the sidelines for a long time to come. Return to Free Trade

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In the mid-1930s, the world economy and the liberal economy had been destroyed as thoroughly as we can imagine. It had barely any defender and certainly no place on earth that practiced it. Keynesian economics, with government activism as the stabilizer was the rule. There was, too, a substantial expansion of state economic activity together with a deep contraction of trade; all this even before the next war got underway. Emerging from the second war, two currents are apparent. The first was to reverse gradually the dismantling the dramatic contraction of trade. That was a long task and it is even incomplete today. The other was the building of the welfare state, which is just now, over the past decade coming into question and under attack. The reopening of trade started quite early on two fronts. Already in 1934 the US started reversing its extreme protectionism with the Reciprocal Trade Agreements Act which has been the basis for multilateral trade liberalization ever since. Then, as soon as the war was over, the US pushed aggressively for multilateralism and opening up in the European economies. The US accepted discrimination against itself if only Europe started trading within. The Marshall Plan provided quite explicit carrots and it has worked: the European Union as we see it now is the outcome of those early seeds put in place by the US architects of the postwar international system. Why were policy makers so eager to rebuild world trade? The reasons are two. First, the collapse of trade in the inter-war period had been nothing but spectacular. Between 1929 and the bottom year in the early 1930s, the volume of US exports declined by exactly half and so did the volume of Germany and of almost everybody else. Beggar-thy-neighbor policies, and discriminatory arrangements such as imperial preferences of Britain, had disintegrated any sense of the gains from trade and the notion that trade can only function if it is a two-way street. As the earlier Figure of world trade and GDP and Table 1 showed, the reduction of obstacles to trade along with peace and improved conditions of transport and communications has produced a spectacular expansion of trade. In fact, the expansion has proceeded at a far more significant pace than that of the 19th century. In just 35 years, German trade has increased tenfold and that of Japan almost twenty times. The liberalization of merchandise trade is a well-recognized fact and, with the rare exception of protectionists is recognized around the world as a great boon. All countries have participated in it, on a regional and on a world basis. Japan was one of the late comers but, in the past decade, has gone very far in accomplishing an effective liberalization of trade in goods. Of course, even though trade obstacles were gradually removed, plenty needs to be done since continuing protection is indeed in place and is costly. Studies focusing on the cost of protection around 1990 report high costs to consumers expended for “saving” a very minute portion of jobs. Note, more importantly, that the cost per job “saved” far exceeds the earnings of workers in the protected sectors. In other words, a sheer waste is taking place.

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Table 2 The Annual Cost of Protection

US Japan Korea EU

Consumer Cost Bill. $US % of GDP Jobs “Saved” (% of Employment) Cost per Job Saved ($US)

$70 1.2 0.2 $170,000

74-110 2.6-3.8 0.3 600,000

12-13 3.6-4.3 0.9-2.0 33,000- 67,000

67-100 1.1-1.6 1.1 70,000

Source OECD

Skeptics keep arguing that competition and technology wreak havoc for the established harmony in society, that it created inequality and does away with the middle class. True, new economy is tough for those who sit on their backside and live at the expense of stockholders or taxpayers. True it gives a chance to people on the sidelines. Interestingly, in the US it has meant full employment and, most recently, a sharp improvement in the economic status of the poorest. Yes, people will have to change jobs, yes they have to hustle, but who wants to go back to the 80s? Not the parents who see great mobility and opportunities for their kids; not the children who have the time of their life. Three cheers for creative destruction. In the meantime, productivity growth is formidable and high rates of investment push out bottlenecks and implement the new economy. Of course, there is more to be done to get to a fully open trading world: China needs to be integrated fully, a process that is under way with WTO membership, and India as well. Services are just at the beginning stage of a real opening. Less mundane but of critical interest to some countries is the issue of liberalizing trade in agriculture, a sore point for 50 years with little progress to date.3 However, there is every reason to believe that these extra areas will be covered in the coming decade. The emergence of regional trade agreements, far from breaking up globalism, are in fact a driving force for pushing liberalization ahead on a smaller scale and then widening it around the world. If APEC holds out for freer trade to emerge only in 2006, do not believe it. It is sure to come much 3 See J. Schott (2000) “Toward WTO 2000 “ Federal Reserve Bank of St Louis, Review July August. for an assessment of the remaining agenda and the politics to get there.

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earlier just as the integration of Eastern Europe into the European Union is happening surprisingly fast.

Challenge to Big Government The reconstruction of a liberal trading order is not the big surprise of the day. The surprise is rather the sharp challenge to statism that has come in the past decade. Thatcher and Reagan were the first to promote the issue and start doing something about it; now it is a common theme around the world. Big inefficient government had become a dominant characteristic of all advanced economies and even more so in the developing world; it had been the other side of protectionism, opposition to capitalism, individualism. Those who thought of it as an accomplishment called it the welfare state, those who recognized the impediment to competition and innovation and the waste of resources called it pervasive and stifling government.

Government outlays—consumption and investment and the very large transfer payments reflecting all social programs from health to unemployment as well as increasing debt service, are much of the story of big government.

Table 3 Government Outlays (% of GDP) 1960 1980 1990 2000 US Europe Japan

24.8 27.4 13.0

31.4 44.7 32.3

33.6 46.7 31.3

29.5 46.0 38.4

Even more striking is what happened to public sector employment: The share of the labor force working for the government, outside the US and Japan, has increased vastly. This was most dramatically the case in Scandinavia, the paradise of the welfare state where in the end (before the crisis of the past few years) fully a third of the labor force was working for the government! In Germany the share of government employment rose from 8 percent in 1960 to 15 percent in the 1990s; in France government employment in the 1990s reached 24 percent and in Sweden even 32 percent!

There are a number of reasons government is now under attack and markets are returning to competition and private initiative. First and foremost, big government has become unaffordable. Inefficient state enterprises have become a liability for the productive sector: too little innovation, too high costs, too high taxes to pay for the unproductive use of resources. When firms have to compete they need a streamlined economic environment, at least as good as their best competitors around in the world. The overriding reason for smaller government, however, is surely financial: in the past 30 years every government in the world borrowed to spread in the broadest fashion the gains from economic growth; subsidies were pervasive; unemployment was seen as a plight to

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be relieved by generous and unconditional compensation. There was always money for everything. Pensions are unfunded everywhere and hence, in addition to the run up of explicit public debt, there is the implicit pension debt which is all the more dramatic in that demographic trends bring the issue closer. In a country like Sweden all net new jobs until recently were in the government sector. Now the debts are large and the future debts in the form of unfunded pension liabilities are huge. The conclusion, popular or not, is that government must shrink. The State is also under attack in the labor market. In Europe especially, labor markets have traditionally been highly fossilized. Under the pressure of unions, flexibility and competition have been suspended in favor of a high cost and highly restrictive employment system. Of course, that means high unemployment but what is the problem if the government can pay for it? The government can no longer defend the existing restrictions and so even labor markets are coming into the range of radical reform. The new idea is that the welfare state and restricted labor markets were a very bad idea. The welfare state is being disbanded and labor markets are being freed. That will be the work of a decade, but at least it has started. Can it work? The US example, and that of smaller Northern European economies, the only fully ~ employed economies in the world today, clearly demonstrates that it can be done—there are enough jobs for everybody. Of course, often it takes a crisis to get the mind set right. The ways in which the welfare state is being undone are many. In the US, recent welfare reform was a dramatic step. Nobody knows how the experiment will fully work – so far, in the midst of a boom very well--, but the fact is that time on welfare is now limited and then, who knows how, people who have not worked for years will suddenly have to do so. They need to be integrated into a normal social life (i.e. a working life) from which the welfare state in its perversion had given them unlimited leave. In Europe, unemployment has been one of the better jobs for many years. Replacement of earnings via unemployment compensation reaches (after adjustment for taxes) up to 70 percent. Even after 60 months of unemployment, a couple with 2 children can get more than 60 percent earnings replacement. Throw in a bit of the informal labor market and you make a good living. By comparison, in the US long term unemployment does not pay. For those who are insured, the replacement rate falls to 17 percent! In Germany and France the attack on the welfare state is particularly hard: the German government is weak and therefore mostly talk, the French socialists have taken a step back by promising to create more government jobs. It will not last, in just a few years these key welfare state countries will be on the same track. The reason is that the public debts and deficits just cannot afford to pay the bill for a large number of people to stay away from work while others refuse to pay the taxes that are required to finance the existing scheme. Piling up more debt is impossible and hence the need for change. Big government is also under attack in the area of public sector enterprises. The reason is simple: services are bad and costs are huge. As an approximation that is the right picture. Privatization is the effective response. It is now underway from telecommunications to the railroads, from electricity to airlines. The old idea that the government must control the “commanding heights of capitalism” just looks silly: international competition and

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the absence of significant barriers to entry do far more for the viability of a firm than government running it. Even though privatization is being practiced from Moscow and Kiev to Havana and from Tokyo to London, there are places where it remains controversial. Even a socialist government, understanding full well that privatization means increased productivity imposed by the new owners or, in other words, dramatic cuts in jobs, resists. However, it can not really hold out long. The swing of the pendulum is against big government. Everybody understands that there are productivity gains of 30 percent or more to be harvested. They are politically controversial, but so is more debt and so are higher taxes. That is why public enterprise is on the chopping block, even if the unions call a general strike. New Economy Drivers “New economy” continues to reign supreme as a win-win paradigm. It is fashionable in macroeconomics mostly from the US experience -- no inflation to speak of, stocks at all time highs and beyond, four years of 4 percent plus growth, full employment, budget surpluses and a benign Federal Reserve. But even outside the US, new economy is seen as the solution to otherwise insurmountable problems of growth, employment and public finance. New economy is not a fad of the moment but rather a deep transformation of economic life, a force for productivity and a force for globalization. It will shape our economies and our lives for the next decades. New Economy involves three interacting drivers: • technology, • competition, • a new economic culture for government, households and business. Investment complements these drivers. Let us review these briefly. Technology is the most obvious part of the story: a revolution in telecommunications that is far more pervasive and more importantly spreading more rapidly than the telegraph or the telephone did in their time. The internet is a central piece of this dramatic change and it is already transforming how businesses are run at a world scale. There is also the information revolution with a formidable ability to create software programs that restructure dramatically tasks from accounting to ticketing, from finance to shopping to leisure. All this is far from done: in fact, just the past few years have shown the dramatic step from possibility to reality for a widening range of applications. The explosion of computing capacity introduces opportunities that simply were out of reach even of anyone’s imagination. The vast increase in computing power allows investigation in areas where before no progress could possibly be made, the human genome program being just one case in point. The second driver is competition: we have not had as much and as pervasive competition since early in the century or perhaps ever. Moreover, sharply higher competition is even

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becoming the rule in countries that hate it like the devil—Germany, France, Japan and more. The agents of competition are of course world trade, made more effective by technology, domestic deregulation or dismantling of the welfare state, stockholders that for the first time insist on getting their pound of flesh. Risk capital is available to anyone, not just the establishment, and there is no limit. Suddenly everybody has choice, learns fast about best opportunities and best practice. It is a short step from there to the breakdown of protected markets. It’s a rat race, but everybody, at least as a buyer, is king. The third driver is a new economic culture. Central banks and treasuries have learnt that stable prices and sound budgets bring an extraordinarily important contribution to prosperity. At least as important, individuals and businesses have gotten the two key messages of a world where everything is possible: “ Don’t take NO for an answer!” And “Don’t wait for the government, if you have a problem solve it.” These new attitudes fundamentally change the way the world works: middle management is being liquidated as is the case in every revolution, protagonists of the status quo are kicked out. Risk-taking is valued rather than shunned. Young people want to be in startups, not in investment banks. The man who said it was impossible is interrupted by someone who just did it. These new economy drivers create a formidable force for change, something Schumpeter (the beginning of the century failed Austrian finance minister at 21, bankrupt banker shortly after, and formidable Harvard economist after that) called creative destruction. He envisaged the result of a major market opening by trade or changed rules of the game, or of an important innovation. The result would be that the existing economic situation—prices, players, rules of the game—would change throughout the economy. In the process a dramatic reshuffling would greatly raise productivity as the established and tired organization of the economy breaks up. Surely there is no better example of Schumpeter’s creative destruction than what has happened in the US over the past decade. Surely too, that cannot stay a US story; indeed, it is the very proposition of creative destruction (reinforced by economic openness and technology) that it now will sweep the whole world.

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U S PRO D UC TIV ITY GR OW TH(% Per Year. Source C EA)

0

0.5

1

1.5

2

2.5

3

3.5

1899-48 1948-73 1973-90 1990-99 1995-99 1999-2010

After a strong performance in the postwar period, US productivity growth was lost in the early 1970s. And the same happened everywhere. New economy forces are now the driver for a far stronger showing and the only question is how long it will last. The most plausible guess is that it will take a decade to put in place and adapt to all the innovations in technology, competition and organization/culture. And even as that happens, the rest of the world will increasingly undergo much the same experience. Skeptics keep arguing that competition and technology wreak havoc for the established harmony in society, that it creates inequality and does away with the middle class. True, new economy is tough for those who sit on their backside and live at the expense of stockholders or taxpayers. Interestingly, in the US it has meant full employment and, most recently, a sharp improvement in the economic status of the poorest. Yes, people will have to change jobs, yes they have to hustle, but who wants to go back to the 80s? Not the parents who see great mobility and opportunities for their kids; not the children who have the time of their life. Three cheers for creative destruction. In the meantime, productivity growth is formidable and high rates of investment push out bottlenecks and implement the new economy. All this used to be called neo-liberalism and free market economics-- for many those were derogatory terms. Now it is “New Economy”, everybody’s game. It plainly has come of age. Of course, even with new economy the world is still round. It does not offer a quick way to riches, it does not double the growth rate, it does not happen to you by just breathing the air. New economy is hard work and risky investment, it can’t do outright miracles but its accomplishments to date and its potential are entirely real.

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Around the world, the incidence of new economy varies widely. India, in the midst of third-worldness, is emerging as a key software producer; China is dashing to the internet as an integration mechanism and is taking formidable pain in its effort to gain WTO accession. Finland is a high tech center of the world; Germany is lagging because change is trouble; Japan’s slumping economy may be rescued by formidable technology potential. Latin America lags far behind; using the competitiveness indicators published by the Davos World Economic Forum as some proxy for new economy status, Latin American economies are way down between #50 and 100 in the world. In the US, by contrast, there will be an extra 5 years or more of expansion by pushing out those bottlenecks that typically translate expansion into inflation. All that means fresh energy for a world economy that does not have anymore central banks or treasuries to create false prosperity. The US example is sure to make new economy an ongoing theme that few countries can afford to opt out. In the meantime, and most important, perhaps we have even done away with the business cycle or at least made it much less dominant. What Lies Ahead? It would be a mistake to believe that 20 years from now the world is radically different from what it is now. A brief thought experiment, going back to the early 1980s, will remind anyone that yes there has been important change but so much is the same mostly because our own nature and priorities evolve only very gradually. True, governance may have improved, competition has risen, opportunities from technology and the world economy are more significant and there is more to come. How then will ongoing globalization impact a range of issues such as money and finance, trade in goods and services, information and communications and technology more broadly. What will happen to governments in the process and to politics? Money and Finance At the turn of the past century, the gold standard had been established as the international monetary rule. Britain had been there for much of the century, the US joined after the civil war, Germany after unification in 1871 and soon much of the world from Australia to Argentina, from Russia to Portugal was on Gold. And so was Japan, adding in the wave of Meiji restoration a gold standard to the many other reforms. Internationalism was the rule and the gold standard was one of its dimensions along with international lending and open trade. Paper money and flexible rates were not unheard of, but they only occurred in the midst of financial distress as had occurred in Russia or in Austria and in Latin America. But experiences with paper money and flexile rates had only reinforced the case for gold and financial discipline. Gold lasted to the first war and it had a brief come back in the 1920s. After wartime suspension of international currency standards and flows, gradually the world returned to hard money and gold. Britain did so, boldly at the prewar parity. Germany came back to gold after the devastating hyperinflation and the US had never left. But the return did not last. One after the other, led by Britain, (Churchill when told that Britain went off gold apparently said, "nobody ever told me you could do that.") they went off gold to escape

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deflation and opted for flexible rates and beggar-thy-neighbor competitive depreciation. The US was one of the last to leave gold, in the midst of the depression but it did too. Gold was gone and never came back. True, there was a shadow role for gold in the fixed exchange rate period of Bretton Woods but the gold was safely stored in Fort Knox and when the US trading partners wanted gold rather than promises, even the last vestige of gold went overboard in 1971. A last tango came under President Reagan and his gold commission, a commission of enquiry on the convenience of returning a monetary function for gold. No was the answer and gold plummeted in free markets. Gold was gone, fixed rates had been discredited in the 1960s, flexible rates were the de factor answer. Nobody quite likes the system except, as the saying goes, by comparison with any alternative. Yet the debate is on as to where the system should be taken from here. Consider first reform proposals and then, judging that they are unlikely to lead to much, let us ask where history is taking us de facto. Reform proposals of the international monetary system come in two ways. One is associated above all with the name of Paul Volcker, the former head of the Fed and a towering figure in world finance by any definition. This strand of opinion looks for a return to fixed exchange rates, plain and simple fixed rates. Yes, they understand it amounts to internationalism, to subordinating domestic policies to the maintenance of fixed rates, to sacrifices and developing procedures across borders to make it work. But everything said, they believe it must be done, it can be done. Even though some of the promoters of the scheme do not lack in stature and in influence, they are a lonely bunch. No US administration is going that way, nor is Europe or Britain. And, one suspects, Japan is too overburdened with stabilization to add a fixed exchange rate to its burdens. Rigidly fixed rates among major currencies, then, won't have a comeback. The second alternative, seemingly more pragmatic, is an arrangement of target zones. Here currencies would have limited flexibility around agreed "equilibrium exchange rates" but at some range, say +/- 15 percent, there would be hard line of defense implemented by supportive monetary and fiscal policy. This idea won't die simply because whenever rates go far, far away from equilibrium it seem so plausible. But it is far easier to agree on a spontaneous intervention whenever the extreme happens then to negotiate an agreement that puts the equilibrium rate and the procedures rigidly on paper. A formal system of target zones, as proposed by the influential Bergsten Institute, has little support in official circles. That leaves us with what is happening de facto. Here two tendencies are clearly underway and will mark the next few decades: the formation of three or four currency blocks with rigid rates within and flexible rates between them. The processes is vigorously underway in Europe: the formation of the European Monetary Union (EMU) -- unthinkable 20 years ago but a fact already and complete with the introduction of common Euro bills and coins in January 2002-- is the kernel of the European money to come. Don't believe currency speculator George Soros who predicts its collapse. The system is alive and well; it is a cornerstone of Europe's competition with US supremacy even if just now a record low Euro is a bit of an embarrassment. The circle is widening

16

from the current union of only 11 countries. Britain surely, 1000 years of history as an island notwithstanding—cannot stay out. Britain is not a star performer in world competition and as that becomes more apparent, the support of membership will be all the more urgently necessary. And all of Eastern Europe will join over the years to come. In fact, a Poland or Hungary and all the others are already busily at work getting ready to enter the customs union and the common monetary zone. How far will it spread? Surely Turkey will join, will Russia? The second zone is more pragmatically in formation and is built around the dollar. In a world of intense financial integration, national central banks in small countries become an oddity; at best they add to noise in financial markets, at worst they create formidable crises as we see in Latin America or in Asia recently. Once central banks are independent, which is now the gospel around the world, it is a short step to recognize that closing them altogether is a bonus. Interest rates would fall to near NY levels; capital would flow more freely. The pressure is already on in Latin America. Argentina is there, fully linked to the dollar and possibly going further and ditching the peso. Mexico is surely next and with it will come the host of little countries. Brazil will be the last, but one more crisis and it is there and it does not take even that; just like Italy, it will recognize that in a high-debt economy not having a central bank is a bonus. A dollar zone is a certainty in the next decade simply because devaluation strategies have become futile and what else would you use an independent central bank ? National monies were an upshot of the disorganization of the world economy in the 20th century; as the world integrates they become increasingly obsolete, as are all forms of contrived cross border segmentation. The most exciting and controversial development is surely the Asian Monetary Area (AMA). On the surface this is implausible and unpopular: Japan is the natural leader but there is too much history to make that easy. China is too big and in time will want its place; many of the other countries such as Korea would like to stay on the fence playing a strategy that benefits with links to both Japan and the United States. But the Asian crisis has brought home a dramatic lesson learned much earlier already in Germany: unless there is significant cooperation, crises will come back, and now that the fragility of Asia has been found out, they will came back more often and more vigorously. Japan responds now by negotiating integration agreements: free trade proposals are afloat, currency swap arrangements among Asia central banks are being put in place. And, most recently, the pressure is on for a Japan-Korean monetary arrangement. And who is to say that in time China, once it liberalizes its international payments, will not find important support and stability in such an arrangement. It won't happen overnight but remember how recently the European overtures started and how by now it has happened and is a matter of history. Asia will inevitably go to a common monetary arrangemnent; Korea has no alternative and that will be the beginning. There is this important question left in Asia, what will China do? The most likely answer is surely to expect a Southeast Asian adherence to a China-centered monetary arrangement. Once Taiwan and Singapore are in, who doubts that everything from

17

Vietnam to Indonesia will follow. A Japanese-Korean arrangement is just a few years off, a Chinese monetary zone remains a conjecture, depending as it does on China's progress, its geographic coherence and its off-shore projection Just in the next two or three decades there will be a profound transformation of world money and it is underway. But there is, of course, the other important unknown. One occurs with Internet and information technology underway,-- who needs money or just exactly what might it be? Surely that development is intolerant of a multitude of funny monies and supports our conclusion of a mega-consolidation. The interesting question is whether there is a possibility of major private money that suddenly appears as a competitor and private money might immediately head for world scale. Indeed, it is a natural adjunct to the internet that seamlessly links people anywhere in the world. Don't rule it out. Governance and Finance In finance, too, major change lies ahead. An immediate byproduct of globalization is for citizens to recognize that they may be poorly governed—sleazy and corrupt government trapped in mediocre mindsets that are destructive to both freedom and economic progress or, indeed, mere stability. The movement toward a more deep-seated democracy with full and thorough accountability does not come easily and it does not come fast. Democracy and accountability today do have a voice. Mexico’s PRI no longer can steal an election, a Fujimori must back down, a Chavez is ostracized, corruption scandals see the light and must meet consequences as Brazil’s President is finding out the hard way. Governments cannot anymore overlook major corruption scandals simply because inside and outside publicity is too quick and insistent. The public more and more asks for rules of the game and rebels against autocratic and inefficient bureaucracies. The lack of honest administration of the law, not just in respect to civil liberties and human rights but increasingly also in the economic area is a fact. Of course, all this is more tendency than an accomplished fact. But the pressure for change is there and changes are, indeed, happening The trend toward improved governance has, of course, immediate implications for finance. Today capital markets – flows notwithstanding—are extraordinarily segmented. If the London and Frankfurt stock exchange have trouble integrating, how much bigger must be the complications for emerging economies? Among developing countries the segmentation issue has 3 principal reasons: first, very poor corporate and debtor governance. Second, dubious property rights and support of law for creditors, third difficult to predict government policies. These facts translate into thin, speculative markets with high costs of transactions and significant premia reflection credit risk and currency risk. The irony, of course, is that developing countries can least afford the high credit premia and, as a result, one would expect governments to focus altogether is the root causes. That is underway – a currency board for example does miracles—but the agenda is far from complete. Indeed, surprise such as the absence of the rule of law in the Asian crisis.

18

Still abounds. Indeed, the incidence of capital controls indicate shows much of the agenda remains to be accomplished.4 Emerging markets remain risky however we choose to measure the proposition. Credit ratings are far from triple-A and in many instances securities are not even investment grade. Closely connected, credit spreads reflect the poor rating of securities, which in turn is a reflection of less than full willingness and ability to pay. Yet another measure of riskiness is the correlation between an index of emerging market dollar debt (EMBI) and securities in the US market, a measure proposed by the IMF. The point of the correlations in Table 4 is to show that emerging market securities show fluctuations in parallel with US risky assets; they have no significant correlations with US interest rates. Emerging market debt is more nearly like stock than a bond since the downside is wide open. The downside is open, of course, because risky scenarios for the world economy get amplified in the returns on the periphery. The periphery has debt and deficits, it needs money. When risk assessments rise at the center, asset prices plunge on the periphery.

Table 4 Correlation of EMBI With US Securities: 1994-2000 T-Bills 10 Year Bonds High Yield Index Nasdaq Dow Jones S&P

-0.02 -0.07 0.36 0.30 0.39 0.37

Source: IMF

The implication, of course, is that economies on the periphery, both governments and corporations, have to learn how to reduce perceived risks. Immediate steps are abolition of discretion at the central bank, value at risk assessments of the national balance sheet, sharply reduced vulnerability to debt crises, sharply improved performance in the fiscal area. That, and in addition of course, reliable regulation, supervision and auditing and reporting standards. In the past these issues have been neglected as if money was available without regard to credit risks. Today money does ask questions and when it does the penalty of risk premia quickly emerges. High debt countries, and indeed any borrowing country, simply cannot afford to run a slob house; globalization makes that much more costly.

4 See LaPorta, R. et al “Law and Finance” Journal of Political Economy, 1998, pp.307-343

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Failure to adapt to the higher standards imposed by globalization means credit rationing and a high cost of capital. That, in turn, means low investment and falling behind. That in turn means no growth in real wages, which opens up a vicious circle of bad governance and decapitalisation. The past 2 decades in Latin America were an unfortunate monument to just this process. World Trade in Goods and Services It is hard to believe that trade expansion, under the force of globalization, can proceed much faster than it has, on average in the past 50 years. Yet that is certain to occur. There are three immediate reasons for confidence in much deeper trade penetration – trade growing faster than GDP—than we have seen in the past. First and foremost, many countries remain very closed. Indeed some are more closed today than they were early in the century. Argentina is, of course, a case in point. In 1913, the share of exports plus imports in GDP was fully 42 percent; by 1970 it was down to only 10 percent. Since then there has been a recovery but to nowhere near even half the early in the century levels. Yes, this relative closedness provides the economy with a major problem—it is not easy to shift resources from domestic demand to world markets and hence protracted stagnation in the aftermath of shocks is a real risk. The second reason for rapid trade growth is the widening of the range of services in world trade. With telecommunications and information technology reaching across borders, there is an entirely new specialization of labor becoming possible. This is already apparent in engineering and construction design where the services are located worldwide and operated in teams and very disjoint locations, tied together by modern communications. The potential for a vast new range of services to go that way is basically unlimited; just because someone chooses to sit in New York or in Buenos Aires surely does not mean for a minute that there services cannot be delivered in Europe or Japan. For countries rich in human capital this possibility offers a dramatic new opportunity to escape from the limits imposed by the size of the domestic market. The third reason for dramatic trade growth is the adoption of new economy strategies of deregulation, restructuring, reform of organization adopted by governments and businesses worldwide. They naturally help escape from a segmentation imposed by old technologies, transport costs, obsolete integrated production modes or plain economic nationalism. True, going across borders is no panacea or quick fix, delivering an instant and pervasive improvement of costs and performance. But it is still true that it is vastly underutilized and that, accordingly, a normalization is due and that means expanding worldwide horizons of most businesses everywhere. If in the past a port symbolized internationalization, today it is the portal. Transparency, Technology, Information and the State The role of the state and the interactions of the public with the state are radically changing. Around the world government is forced to retrench and abandon tasks better performed by the private sector. One immediate reason is that governments in most parts

20

of the world do not have the resources to keep up investments in modern infrastructure. In part their reason for conducting economic activity is being undermined by more competitive private provision as in telecommunications or the postal system. But there is also a much more broad recasting of government that emerged from the stark outburst in publicity: transparency-- national and cross border-- has exploded, modern communications technologies put every official within a few yards of CNN. Internet sites allow organizing of interest groups and their international linking. Democracy, of course, strongly enhances these tendencies and joins them increasingly, and importantly, with accountability. The past decade has seen a total first: governments get together to denounce corruption in badly governed countries. The public, looking across border, asks for first-world standards of governance. Governments are increasingly restrained by international standards of conduct and best practice. From security laws and supervision of finance, to the quest for strong credit ratings to the drive for attracting direct investment—wherever one looks, governments have to resign themselves to give up idiosyncrasy, sleaze, and discretion. That is even true of the government of Japan or Korea, of France or of Mexico. China is self-imposing limits with the entry into the WTO. In the area of competition policy we have moved far beyond the nation state as the European Union and the US pursue parallel evaluation of anti-trust cases. Of course, we are far from having completed the adherence to and compliance with best practice, but the drive has never been more formidable and the eagerness to accept and as a result enhance access to opportunities, including finance, has never been as formidable. At the same time, the voices opposing globalization have never been as vocal and as organized. Globalization and its Critics The Asian crisis has proven to be one of the watersheds in the discussion on globalization. In Asia’s rendition, big speculators overthrew hard-working stable, prospering countries. The crisis was different from those in Latin America, at least in Asia’s eyes, because here there were economies that had done everything right in the sense of achieving dramatic progress in growth, education, technology and sometimes even democracy. Latin America by contrast, in the eyes of Asia, had always been a failed experiment. If Asia was brought down by these new forces, the forces had to be evil and in need of control. That view is common from Tokyo to Bangkok. It is articulated most strongly in Malaysia as, for example, in Mahatir Mohamad’s (1999) claim for a “New Deal in Asia” – controlling outside influences so as not to interfere with the domestic agenda. In an altogether different area, the great floods in China are blamed on globalization. The pursuit of growth at any price, without regard to the environment, is held responsible for this disaster and for those coming from environmental degradation by profit-greedy uncontrolled corporations. Governments, it is argued, lose their focus and yield to the pressures for growth – or just to the pressure and bribe of global business-- at the expense of a much more farsighted strategy of sustainability.

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In advanced countries, globalization means a reallocation of labor and capital along fresh lines of comparative advantage. Unskilled and low wage labor is made redundant by even cheaper and often more skilled labor on the periphery. And that is not only true for low wage labor; rapidly it spreads up the value ladder to get to the traditional good jobs that define industry and indeed society. When Detroit is no longer safe, what is? If the middle class comes under pressure and breaks up, where will the process stop? Yes, globalization is an expedition into the unknown and the voices of protesters as important to listen to as the exhortations of professional globalizers. For the economist there is no doubt that globalization is a winning strategy for the world, but we also understand that there are losers in the process, and risks, and these must have an answer, too. Th risks, particular in finance, cannot b belittled. We are using high octane financial technology, that is stuff from which accidental worldwide blasts can result. Dislocation and Inequality Is there a downside to globalization? There are questions about the viability of the attack on the state. Is this just the swing of the pendulum and soon we are back to where we were, perhaps with a bit of dampening and some lessons learned? There is no chance whatsoever that we go back to public sector enterprises. The private market demonstrates by the day that it can finance any scale of operation, that it can design and innovate in a way government is most unlikely to do. Malaysia may get points for spearheading an industrial upgrading and former Vice President Al Gore for talking up the Internet, but big government in production is gone. The return of the nation state, likewise, is not likely. The nation stare is no longer the right economic frame of reference. Effective firms play worldwide in their sourcing, production and sales. They are more interested in market access and deregulation than defending territory against challengers. The area where the changes have most political fall-out is the abolition of the welfare state. This is being fought street by street, so to speak. One can take encouragement from Clinton's abolishing long term welfare or Tony Blair’s message to European socialists—change or count your days. However, one cannot fail to recognize that competition, privatization and globalization have a dramatic incidence on the earnings of relatively unskilled people. In the US, the shift has already happened and one is almost getting to a reversal; in Europe and Japan it is still being fought.

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C E O /W O R K E R P A Y R A T IOS o u r c e : F T

0

5

1 0

1 5

2 0

2 5

3 0

3 5

4 0

U S U K F ra n c e Ita ly G e rm a n y J a p a n S p a in S w e d e n C a n a d a A u s tra lia

Europe and Japan will have to allow a wider dispersion of wages and with that the expansion of low wage employment. That is already the case in all these countries that most low paid workers are in the service sector—67 percent of all low paid workers in France versus 74 percent in the US. Thus, what is to come is not really new but there will be more of it. The discrepancies of course get far wider when it comes to workers and bosses. The possible rise of inequality will be the decisive new development. On one side there are the mega-billionaires who develop technologies that dramatically enhance human productivity, for work and play. And on the other hand there are the former middle class voters who are left out. So far very little of a backlash has come. However, most assuredly, in this new century, democracy combined with inequality and economic insecurity almost surely offering a prescription for sparks flying and for globalization to be blamed. If, by contrast, globalization comes with high growth, the frictions might not be too tough. Interestingly, in the US that has been the case, at least so far. The shift to full employment and high growth has left opening of the economy and the retreat of government mostly uncontroversial. Even though inequality increased, poverty fell and median real income increased substantially. It is worth looking at the record for a moment since it shows a best-case scenario. The new economy and globalization story involves radical restructuring and reform driven by new technologies as well as increased competition. Sharply higher productivity growth as much as the pressure for cost cutting creates an environment that tests a society's cohesion. Doubtlessly these pressures must be highest in the US, the place where new economy has been driven with more exhilaration and zest than anywhere else. At the same time, the US at least in comparison with Europe, is the country where the

23

social net hangs low and has lots of holes. No question then that the US is the place to look for the footprints of what new economy might do to the social map. The old story was one of the hamburger flipping society and the homeless, the new one might be that of mega-billionaires and the displaced worker. And if that is mostly the story, no question that governments in economies that are lagging in their new economy efforts might have second thoughts. So what is the record? Data just released make four points: First, the US poverty rate is at the lowest point in 20 years. Yes, still more than 30 million in poverty but a few million less than the year before. Second, real median family income is at the highest level in the more than 30 years for which the data exist. Third, the unemployment rate is at the lowest level in 30 years. Finally, there is one more statistic, this one distinctly unfavorable: Over the past few years, the income share of the bottom 20 percent of households is at its lowest in more than 30 years while that of the top 5 and 20 percent is at the highest.

US MEDIAN HOUSEHOLD INCOME (1999 Dollars)

32000

33000

34000

35000

36000

37000

38000

39000

40000

41000

42000

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

Those who look for a positive picture will find it in median income, reduced incidence of poverty and record low unemployment. But those who look for the bleak side will find it

24

in continuing mass poverty--12 percent of the population-- or in the deterioration of income distribution. No, the US has not abolished poverty in the midst of plenty, the progress is more limited at the bottom to just absolutely and relatively fewer people in destitution (i.e. less than $17,000 for a family of 4). The data do, however, contradict the view that the rich are getting richer and the poor are getting poorer. True, the rich are getting richer --a lot richer--, but the low-income groups are getting a little bit ahead, too. Of course, their advance is very disappointing compared to the economy at large and even less in comparison with the top 20 or even 40 percent. The top 5 percent starts at an income of $142,000 while the bottom 20% peaks at 17,000, a ratio of 8.3. The comparable ratio has steadily increased over the past 30 years from the much lower number of 6.3. Yes, the rich are getting richer, absolutely and relatively.

Table 5 US Income Distribution

1970 1980 1990 1999

Bottom 20% Top 20%

4.1 43.3

4.3 43.7

3.9 46.6

3.6 49.4

The verdict then is less poverty, higher median incomes, and more inequality. That, indeed, is the mixed blessing of New Economy. The good news is surely that everybody is getting ahead. Even skeptics must accept that that is unambiguously positive. It is interesting to ask what exactly is at work. Surely, increased competition, restructuring, new technologies involve a vast possibility of displacing workers. How then is it that even they get ahead? The answer lies probably in this fact: increased competition and important productivity growth have reduced the inflationary pressures that in the past came with economic expansion. As a result, economic expansion could continue much longer -- the longest expansion on record-- and, in that way ultimately gets everybody a job. The battle won’t be as easy in less flexible and less successful economies. The debate about inequality and lack of progress is not only an issue in the US but, if anything, is more vociferous on the periphery. The suggestion is that , worldwide, the gap between rich and poor is widening. True, but the more relevant question for people concerned with the poor should be this: is poverty rising or falling and how does this question relate to policies. Unless we move in the direction of asking what can be done to relieve poverty we are just wasting our time just belaboring the fact that there are poor, more poor, that the absolute distance between rich and poor growing. Specifically, is there evidence that globalization strategies have advanced growth and that growth helps

25

the poor? The answer is definitely yes and the conclusion must be that we should pursue these policies more vigorously and more pervasively. A study of the World Bank concludes that contrasting reform and non-reform countries; the reformers have higher growth. At the same time there is broad evidence for emerging economies that growth reduces poverty. Moreover, growth spreads its benefits not only in a reduction in poverty but far more broadly, including via education and reduced civil conflict.

Table 5 Growth Performance (Percent per year)

1984-90 1990s

16 Reform Countries 44 Nonreformers

2.8 -0.5

3.5 0.1

Source World Bank (2000a) Table 2.2

The evidence on poverty reduction is actually quite stark. Across the developing world the share of relative poverty -- the population living on less than a third of average national consumption-- has declined from 36.3 to 42.1 percent. Yes, a third of the world lives in poverty but over the past decade there has been visible progress in reducing that share. Reformist policies do help.

Table 6 Share of Population Living on Less Than One-Third of National Consumption 1987 1998

Total East Asia Europe & C.Asia Latin America M.East & N.Africa S.Asia Sub-Saharan Africa

36.3 33.0 7.5 50.2 18.9 45.2 51.5

32.1 19.6 25.6 51.4 10.8 40.2 50.5

That does not, however, answer the question of the rich getting richer and the poor getting poorer. As the World Bank points out, income in the richest 20 countries today is 37 times that in the poorest countries, up from only 9 times in 1960! Yes, the rich are getting richer and the poor are getting poorer. Never mind, if countries like China and India where most of the world lives can steadily move ahead, using reformist strategies

26

and integration in the world economy, that makes these policies the single most important weapon we have to address the shared concern for raising levels of consumption. Equality is a luxury that we probably cannot afford and which, assuredly should be second to poverty reduction. The Environment Among the most vocal opponents of globalization are environmentalists. Their concern is that growth per se is destructive to the environment via deforestation and carbon dioxide emission. Pollution is foremost in their mind but also large corporations exploiting natural resources without much concern for environmental issues. The immediate answer is that, of course, they are right to voice concern.5 It is also likely to be true that the right answer is not an end to growth, an end to large cross border operations of corporations, but rather a focus of what regulation and taxation is appropriate. To the extent that part of the environmentalist groups are absolutist, their contribution is counterproductive and does not deserve attention. But the center is surely right in asking about environmentalist risks and appropriate regulation. It is critical to recognize two points. First, as countries grow in per capita income, beyond a hump, there is increasing concern for the environment, tougher standards and better performance. The issue therefore is to create internationally agreed standards and subsidies to achieve better performance at large. It is, of course, essential that a country like the US be at the center of compliance rather than a wary bystander. It is equally essential that countries like India and China, Brazil and Indonesia be made central players in these efforts. The truth is that we have been far better at liberalizing financial services than at dealing with a minimal international environment program. In the meantime, it is also the case that environmentalist concerns have become part of the corporate governance agenda. To that extent, environmental concerns at the center are translating, via stakeholders, into better environmental performance at home and around the globe. Curiously, this sort of turns the greed argument on its head. But much more than that, done intelligently, is necessary. Angst, Power and Control People of late middle age and above, around the world, perceive that globalization carries the risk of undermining the stability of their lives; they easily believe that volatility, falsely perceived to be higher than ever, puts them at grave risk. They feel they have lost control and they perceive the same is true of their governments. They want assurance that security is regained, someone has to do something. The is the potential of a Japanese crash, of a US crash, of mega bets by people confidently betting on the wrong model, LTCM-style. And if any of this happens, we can be sure the fall-out is worldwide and we must fear that the first instinct is to play the defensive and destructive strategies of the Great Depression. And because that is the instinct, the risk of self-fulfilling expectations is all the more serious. 5 For evidence on the link between growth and environmental degradation see World Bank (2000) The Quality of Growth and the references given there.

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Citizens want to know who is in charge? The answer is nobody; the US can’t lead Japan, Europe cannot lead the US. The US urges Europe to move to prosperity policies but has no resonance; the US urges Japan to move to financial stability but gets no hearing and surely no success. Europe is critical of the huge US trade deficits and lack of saving, not recognizing that if the US started saving the dollar would come down and Europe would lose jobs on a large scale. The Japanese dream of not buying US T-bills, not realizing that the Yen would go through the roof and the Nikkei through the floor. And in the closets of financial firms worldwide there are surely skeletons and bets that, were they known and transparent, would horrify. Plenty of risk and possibly a very limited ability to limit the fallout even if w have been lucky in the past five years. An important question in the context of globalization then is this: who is in charge, who looks after the risks in a world where segmentation-- a formidable barrier to spillovers -- has been dismantled? The question is critical because, as the Asian crisis has demonstrated, the financial world is enormously connected in two ways: first, a crisis anywhere is a crisis everywhere. Second, because of leverage, crises have become more like nuclear explosions rather than the old-style localized hick-ups. The crisis provoked by the failure of Long Term Capital Management (LTCM) in 1998 gave a taste of that. For a moment, there was a genuine and justified fear that world finance would get unhinged with grave consequences for stability and growth everywhere.6 The response from the US and much of Europe is simple: there is a public policy issue and regulatory agencies have to set tight standards of risk management. Supervisory agencies have to practice uncompromising control; stockholders' capital must be at risk to focus attention on risk management and thus exert discipline. 7 But in other parts of the world the answer is quite different. In Asia the crisis was interpreted as a process of contagion driven by hedge fund speculators. The answer, not surprisingly, was to call for a tight control of speculation. And, failing the collaboration of Western governments, the attention is shifting toward Asian cooperation to avoid the weakness experienced in the process of the one-country at a time battle in the last crisis. The ideas include, of course, an Asian IMF which provides pre-arranged emergency assistance, capital controls and, interestingly, zero focus on better-managed financial systems. This response to globalization failures points to a radically different viewsof the world. In the West better regulation and a lender of last resort is the answer, and has been for the past two centuries. In the East, joining hands to stare down speculators is emerging as the answer. These are radically different answers and their coexistence poses a dramatic risk for the stability of international finance. This case points out that in a vital area of risk management no confidence can be placed in the notion "we are in charge, we know what 6 Se Lowenstein (2000) When Genius Failed. NY : Crown Books. 7 Rumor has it that a bank CEO once asked former Fed Chairman Volcker whether in case of trouble he could expect to be bailed out. The answer was, "I will discuss that with your successor."

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we are doing, don't worry". It is fair to say that in the past 5 years the dominance of the US and the good luck of effective management at the Fed, the Treasury and the IMF avoided a calamity. If the problems arise in a major economy like Japan, not at all implausible, the world fallout could be dramatic. Moving back to closed domestic finance is definitely undesirable, but moving forward or just staying where we are urgently requires a better risk management infrastructure. Concluding Remark Golbalization has been underway, with setbacks, for all of 150 years. It has gone into fast speed in the past 50 years and even more so in the past decade. Nobody has a better idea and the market drives the process. Governments that do not have the resources to "make" growth look to policy reform and opening for delivering what the welfare state cannot or can no longer. Globalization is not an option, it happens whether you like it or not. Governments do have the option to make the best of it. Making the best of it means two things: one is to integrate as fully and as completely as possible, eliminating all that multitude of frictions that make integration less perfect and less successful. At the same time government must assure with stable macroeconomic policies a growth pattern so that those left out or cast out by globalization have the assurance of a rapid and full integration in the process. At the world level, there is a critical task to deal with the aggregate fall-out. That means risk control. Two areas of primary importance are finance and the environment; the former has instant formidable explosion risks from a neglected financial infra structure. The latter will not explode but runs the risk of an irreversible degradation. These are by no means reasons to stand in the way of globalization but they do need full attention. REFERENCES Anti-globalization website www.gatt.org Bairoch, P. (1993) Economics and World History Chicago: University of Chicago Press Bhagwati, J. (2000) "Globalization in Your Face." Foreign Affairs Vol. 79, No. 4 Craft, N. (2000) “Globalization and growth in the 20th Century” at www.imf.org Djankov,S., R.de La Porta, F. Lopez de Silanes, A.Shleifer (2000) “The Regulation of Entry” unpublished manuscript, Harvard University. Frankel, A. (2000) Globalization of the Economy." NBER Working Paper No 7858. Friedman, T. (2000) The Lexus and the Olive Tree NY: Anchor Books

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Haberler, G. (1988) International Trade & Economic Development. San Francisco: International Center For Economic Growth. Laporta, R. et al. (1998) “Law and Finance” Journal of Political Economy, pp. 307-343 League of Nations (1945) Industrialization and Foreign Trade (Reprinted NY: Garland, 1983) Lechner, F. and J. Boli (2000) The Globalization Reader. Malden, Mass. Blackwell. Luttwak, E. (1999) Turbo Capitalism. NY: Harper Maddison, A. (1991) Dynamic Forces of Capitalist Development NY: Oxford University Press ----------------- (1995) Monitoring the World Economy, 1820-1992. Paris: OECD Micklethwait, J. and A. Wooldridge (2000) A Future Perfect NY Crown Books Mohamad, M. (1999) A New Deal for Asia. Jubang Jaya (Malaysia): Pelanduk Publications. Murray, A. (2000) The Wealth of Choices. NY: Crown Business Mussa, M. (2000) “Factors Driving Global Integration" http://www.imf.org/external/np/speeches/2000/082500.htm OCED (1998) Open Markets Matter. Paris:OECD O'Rourke, K. and J. Williamson (1999) Globalization and History Cambridge, Ma.: MIT Press Pritchett, L. “Divergence, big Time.” Economic Perspectives, Summer 1997. Reynolds, L. (1985) Economic Growth in the Third World. New Haven: Yale university Press. Rodrik, D. (1997) Has Globalization Gone Too Far? Washington DC: Institute for International Economics. Schott, J. 2000) “ Toward WTO 2000 “ Federal Reserve Bank of St Louis Review, July/August. Schumpeter, J. (1934) The Theory of Economic Development. New Brunswick, NJ Transactions Books Reprint, 1983.

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Van Wyncoop, E. (2000) "Borders and Trade." Unpublished manuscript, Federal Reserve Bank of New York. Foreign Policy (2000) “Lori’s War” (interview with Lori Wallach), Spring issue. Woodruff,W.1967) The Impact of Western Man NY: St. Martin's Press World Bank (2000a) World Development Report 2000/2001. www.worldbank.org World Bank (2000b) The Quality of Growth. Washington, DC: the World Bank World Trade Organization website http://wto.org