Saving Globalization from its Cheerleaders

National Trust Forum on Democracy, Globalization and Societal Welfare

October 2007

Dani Rodrik

Three apparently different problems created by globalization

Chinese exports of toys containing lead paint

The spread of the sub-prime mortgage lending crisis from the U.S. to the rest of the world

The use of child labor in internationally-traded products

…which are less different than it seems

In all three cases, a country is exporting a good, service, or asset that is problematic for the importing country Chinese exports of lead-tainted goods U.S. exports of mis-priced mortgage-based

assets Developing country exports of child-labor

services International rules (and our prevailing

conception of globalization) do not provide clear-cut solutions

Consider the similarities In all of the cases, selling goods that are “sub-standard” is

cheaper and provides a competitive advantage. In all of the cases, we deal with exporting countries

that have, on paper, strong domestic regulations and standards Chinese lead standards are more stringent than those in

the U.S. In the labor standards arena, most countries have

ratified more ILO conventions than the U.S. has. Credit rating agencies in the U.S. are presumably the

best in the world. Enforcement of these domestic regulations and standards

turns out to be weak and problematic.

Consider the similarities The relevant attribute of the exported good is not directly

observable to the consumers in the importing country A consumer cannot tell whether the toy contains lead

paint or has been manufactured using child labor under exploitative conditions; nor can a lender really tell the risk characteristics of the bundled assets it holds.

Consumers in the importing countries have preferences over this "hidden" attribute. We are less likely to buy the good, ceteris paribus, if it

contains lead paint or has been made by children, or is likely to cause financial havoc.

Consumers' preferences are heterogeneous. That is, each one of us is likely to have a different evaluation of the tradeoff between the "hidden" attribute and other aspects of the good, such as its price. (Put differently, the price discount at which we are likely to prefer buying the leaded or child-manufactured good differs across consumers.)

Possible solutions (0)

Do nothing This is the current approach Deal with problems on a case-by-case

basis At the cost of

inefficient outcomes erosion of public support for and

legitimacy of globalization

Possible solutions (1)

Market-based approach: labeling Currently preferred approach for “fair” labor

standards: “fair trade” In principle, that is what credit-rating agencies

did The information conveyed was not nearly as

meaningful as it appeared Possibly similar problems with fair trade?

Plus, we routinely and instinctively reject it in other areas

e.g., food and child safety

Possible solutions (2)

International rules Requires harmonization of policies and

practices Combined with international “policing” and

monitoring Hard to imagine that it is practical

Norms and values are divergent Few countries are likely to accept the

constraints on national sovereignty that this would require

Example of US versus Europe following sub-prime mortgage crisis

Possible solutions (3)

New “traffic rules” to manage the interface between national regulatory settings and social orders

Creation of policy space E.g. expanded role for domestic “safeguards” That would allow restrictions on trade in good, service, or

asset when multilaterally accepted procedural requirements are met

Problem: international rules currently overlook the need for such “policy space,” and often prohibit the exercise of safeguards

Example of Japanese imports of spinach from China Chinese export licensing is WTO-legal; Japanese import-licensing may not

have been It is WTO-illegal to restrict imports because of labor standards

that violate importing country norms Re-create something akin to the “Bretton Woods

compromise,” or “embedded liberalism.”

Deep economic integration

Democratic politicsNation state

 Zooming out:The political trilemma of the world economy

Golden Straitjacket

Pick two, any two

Global Federalism

Bretton Woods compromise

The new conventional wisdom

Globalization does contribute to rising inequality, stagnant median wages, and rising sense of insecurity in rich countries (e.g., Blinder, Krugman, Summers)

cf. “trade and wages” debate 20 years ago Trade and financial openness are unlikely to lead to

economic growth on their own, in the absence of a wide range of complementary institutional reforms (e.g., World Bank, Rogoff)

cf. trade and growth literature 10-15 years ago Therefore, globalization requires stronger safety nets in

the North and stronger institutions in the South.

Current strategy of globalization

Continue to lower economic barriers at the border Doha Round Cautious capital-account opening

While strengthening institutions In the rich countries

Social safety nets In the poor countries

Enhanced “governance,” deregulation of product and labor markets, improved financial market regulation and supervision

Maintained hypothesis: the greatest bang for the buck lies in pushing for increased openness and market access

But is this view correct? What if the binding constraint on maintaining a healthy global

economy lies elsewhere?

Do existing barriers to international economic integration constrain growth? (A)A parable of two countries

Country A … has preferential, free access to the US market for its exports… can send several millions of its citizens to the US as workers… receives huge volumes of direct investment… is totally plugged in to US production chains… for which the US Treasury stands ready to as lender of last

resort… has effective security guarantee from the US military

Does globalization get better than this? Whereas B is a country for which

… the US maintains a trade embargo, and does not have diplomatic relations

… which receives neither aid nor any other kind of assistance… and which is kept outside international organizations like the

WTO… which is prevented from borrowing from the IMF and WB.

Which country did better?

A digression: Explaining the puzzle

Without institutional harmonization, economic integration is condemned to remain shallow

Despite disappearance of formal border barriers, border effects remain strong

Trade: the role of regulatory & jurisdictional discontinuities (borders are estimated to raise costs by around 40%)

Capital flows: problems of sovereign risk, moral hazard, and absence of ILLR

EU versus NAFTA models One is hard because it entails legal, institutional, political integration

Acquis communautaire (>90,000 pages) European Court of Justice Significant inter-regional transfers Labor mobility Growing pains of a quasi-federal political system

The other is comparatively easy But only the first model can generate convergence in living standards

EU model not in the cards for the vast majority of developing countries

Second-best world requires second-best policies The challenge of generating domestic capabilities in a world with

national borders

Do existing barriers to international economic integration constrain growth? (B)The role of international trade

Impacts on real income from full liberalization of global merchandise trade, 2015

in 2001 dollars (billions) as percent of base income in

2015

Developing countries liberalize Developing High

income World Developing High

income World Agriculture and food 26 14 40 0.34% 0.04% 0.10% Textile and clothing 9 14 24 0.12% 0.04% 0.06% Other merchandise 6 52 58 0.08% 0.16% 0.15% All sectors 45 79 124 0.58% 0.25% 0.31% High-income countries liberalize Agriculture and food 26 98 124 0.34% 0.31% 0.31% Textile and clothing 15 1 16 0.19% 0.00% 0.04% Other merchandise 4 5 9 0.05% 0.02% 0.02% All sectors 44 106 150 0.57% 0.33% 0.38% All countries liberalize Agriculture and food 55 118 173 0.71% 0.37% 0.44% Textile and clothing 22 16 39 0.29% 0.05% 0.10% Other merchandise 10 57 67 0.13% 0.18% 0.17% All sectors 87 192 278 1.13% 0.60% 0.70%

Source: Anderson, Martin, and van der Mensbrugghe (2006)

Do existing barriers to international economic integration constrain growth? (C)The role of international capital flows

Source: Prasad, Rajan, and Subramanian (2006)

Countries with less access to foreign savings have grown more, not less!

Some intermediate conclusions

The gains from further liberalization of goods and capital markets are small

As long as the world remains politically fragmented and transaction costs emanating from jurisdictional discontinuities block “deep” economic integration

But the losses from a real retreat from today’s globalization would be huge

Therefore, we should place a high premium on policies that make such a retreat less likely

even if they run contrary (in the short run at least) to the market-opening agenda

The requisite policies will typically expand policy space to allow:

rich nations to provide social insurance, address concerns about labor, environmental, health, and safety consequences of trade, and shorten the “chain of delegation”

poor nations to position themselves better for globalization through economic restructuring

Where globalization’s constraints bite:rich country examples

Labor standards Domestic labor laws protect workers from displacement through the

hiring of child labor; should trade be allowed to contravene this norm?

Environmental, health and safety standards If European citizenry want to apply a higher precautionary standard

than other countries, should trade rules prevent them?

Regulatory “takings” Should foreign firms in the U.S. receive greater protection from policy

changes than domestic firms (as NAFTA and BITs may require)?

Currency “manipulation” Does it make sense that WTO rules permit countervailing for export

duties, but not for undervalued currencies?

Where globalization’s constraints bite:rich country examples

Redistributive provision of social insurance If taxation of capital and skilled professionals has historically helped

fund social insurance programs, should their mobility be allowed to undercut this “social compact”?

Trade versus technological change Domestically, R&D and technological progress are highly regulated (cf.

stem cell research); should trade, which is analogous to technological change, be left unregulated as a rule?

These are all difficult questions, without clear-cut answers. They will likely increase in salience with services off-shoring. The appropriate locus for their discussion and resolution is most likely at the national level, given the wide variety of standards and norms that prevail.

Where globalization’s constraints bite:rich country examples

Is there evidence that more than narrow self-interest is at work in rich countries? Greater concern about foreign labor practices

in skill-rich congressional districts (Krueger 1996)

Anti-trade attitudes determined only in part by labor-market impacts; values and norms seem to matter too (Mayda and Rodrik 2005)

Women and individuals with high levels of “neighborhood attachment” are more protectionist

Positive willingness to pay by rich-country consumers for improved labor standards in poor nations (Hiscox and Smyth, 2006)

Where globalization’s constraints bite:poor countries

Evidence and theory suggest that growth strategies require policy space From the Washington Consensus to a diagnostic

approach Different fixes for different countries

“Binding constraints” differ Different constraints throw different diagnostic signals For example, investment constrained economies

respond differently to capital inflows than saving constrained economies

Task: match policy priorities with diagnostics Desirable policy reforms can be heterodox

Dual-track pricing, TVEs, SEZs in China provided effective price incentives, security of “property rights, and outward orientation, but not in the standard way

Successful heterodoxy is a reflection of the need to overcome second-best complications

Trade regime Agreements on subsidies, TRIMs, TRIPs, and other

negotiations on services narrowing room for “industrial policies”

International capital markets Financial codes and standards no roles for

development banking and credit market interventions Monetary rules

CB independence and “free floating” no role for exchange rate as developmental policy instrument

Where globalization’s constraints bite:poor countries

Where globalization’s constraints bite:lessons of history

Three interpretations of collapse of earlier wave of globalization, 1815-1913 (James 2001):

1. Inherent instabilities in global finance 2. Social and political backlash3. Overloading of institutions that manage

globalization

What is common in each of these explanations is the imbalance between the global nature of markets and the national nature of institutions of governance.

Where globalization’s constraints bite:lessons of history

“The ensuing backlash [against globalization] had some predictable properties. Supporters of the classical order had argued that giving priority to international economic ties required downplaying such concerns as social reform, nation building, and national assertion. In the new environment, some of those newly empowered responded that if the choice was between social reform and international economic integration, they would choose social reform – thus leading to the Communists’ option of radical autarky. If the choice was between national assertion and global economic integration, another set of mass movements chose nation-building – thus leading to fascist autarky in Europe and economic nationalism in the developing world.”

Jeffry Frieden (2006)

Can policy space be enhanced without endangering globalization?An illustration

Generalizing the WTO safeguards/escape-clause approach:

Allows countries to re-impose tariffs under certain circumstances Principle behind safeguards: negotiated opt-outs, with procedural

constraints, better than disorganized opt-outs Restricted at present to very limited circumstances

An import surge, causally linked to “injury” to domestic industry; must be applied on MFN basis; must be temporary; requires compensation

Can be broadened to wider set of circumstances in which the legitimacy of trade is at issue

Subject to institutional and procedural prerequisites Which, in particular, provide standing to beneficiaries of trade

A “development box” for developing countries Variable geometry instead of single undertaking

Exchange of policy space instead of market access Risk of slippery slope

Limited if experience with AD is a guide