Market Integration

Globalization is a term that means different things to politicians, business people, and social scientists. To
economist it means the integration of markets. Economists have long thought this a good thing.

In the 18th century Adam Smith attacked the old mercantilist ideas of protectionism, which aimed to
restrict the inflow of foreign goods. He argued that international trade would expand the size of markets
and allow countries to become more efficient by specializing in certain products. Often, market
integration is seen as inevitable because it rides on the back of a wave of new technology such as smarter
phones, faster planes, and an expanding internet. But Globalization is also affected by choices made by
nations sometimes conscious, sometimes accidental. Although technological change tends to bring
nations together, policy choices can push them apart.

Modern globalization is not unprecedented. Globalization has waxed and waned over time as nations
have made different policy choices. Sometimes these choices have added to the effect of technological
progress on the integration of markets and sometimes, they have hindered it.

Market integration is the fusing of many markets into one. In one market a commodity has a single price
such as the price of carrots would be the same in east Paris and west Paris if these areas were part of the
same market. If the price of carrots in west Paris was higher, sellers of carrots would move from the east
to the west and prices would equalize. The price of carrots in Paris and in Lisbon might be different,
though, and high transport costs and other kinds of expenses might mean that it would be uneconomical
for Portuguese sellers to move their stocks to France if prices were higher there. In distinct markets the
price of the same good can be different for long periods of time.

Global market integration means that price differences between countries are eliminated as all markets
become one. One way to the progress of globalization is to look at trends how prices converge or become
similar across countries. When the costs of trading across borders fall, there is more potential for firms to
take advantage of price differences, for Portuguese carrot sellers to enter the French market, for example.
Trading costs fall when new forms of transport are invented, or when existing ones become faster and
cheaper. Also, some costs are man-made. For instance, states erect barriers to trade, such as tariffs and
quotas on imports. When these are reduced, the cost international trading falls.

The rise of global trade

Long-distance trade has existed for centuries, at least since the trade missions of the Phoenicians in the
first millennium BCE. Such trade was driven by growing populations and incomes, which created a demand
for new products. But the underlying barriers to trade that divided up markets, such as transport costs,
did not change that much.
Globalization only really took off in the 1820s, when price differences started to close up. This was caused
by a transport revolution such as the advent of steamships and railroads, the invention of refrigeration,
and the opening of the Suez Canal, which slashed the journey time between Europe and Asia. By the eve
of World. War I the global economy was highly integrated, even by late 20th century standards with
unprecedented flows of capital, goods, and labor across borders.

From the 19th century onward, technological change helped to integrate markets. It is this that makes
globalization seems irreversible once technology such as steam powered transport is invented it is not
then uninvented but tends to become economically viable in more countries. Much of this development
is outside the direct control of governments. However, at a stroke, governments can put up tariffs and
other types of barriers to trade that choke off imports and stymie trade.

The most dramatic policy related reversal of globalization in modern times occurred during the Great
Depression of the 1930’s. As countries headed into recession, governments imposed tariffs. These were
intended to switch the demand of their consumers toward domestically produced goods. In 1930, the US
enacted the Smoot-Hawley tariff, which raised tariffs on imported goods to record levels. These tariffs
reduced demand for foreign goods. Foreign countries retaliated by imposing their own tariffs. The result
was a collapse in world trade that worsened the effects of the Depression. It took decades rebuild the
world economy.

Integration

By the end of the 20th century globalization across most markets had returned to the levels seen just
before World War I. Today, markets are more integrated than ever as transportation costs have continued
to fall and most tariffs have been scrapped altogether.
One vision of the future of globalization involves the elimination of other kinds barriers to trade caused
by institutional differences between countries. Markets are embedded in institutions such as property
rights, legal systems, and regulatory regimes. Differences in institutions between countries create trading
costs in the same way that tariffs or distance do. For example, there may be different laws in Kenya, China
about what happens when a buyer fails to pay. This might make it hard for a Chinese exporter to recover
what it is owed in the event of a dispute, which could make the firm reluctant to enter the Kenyan market.
Despite the removal of tariffs the world is far from being a single market. Borders still matter because of
these kinds of institutional incompatibilities. Complete integration requires the ironing out of legal and
regulatory differences to create a single institutional space.

Some economists argue that this process is underway and inevitable, end that global markets drive the
harmonization of institutions across countries. Consider a multinational firm choosing a country in which
to locate its factory. In order to attract the firm’s investment, a government might cut business tax rates
and loosen regulatory requirements. Other competing countries follow suit. The resulting lower tax
revenues make countries less able to finance welfare states and educational programs. All policy decisions
become oriented toward maximizing
integration with global markets. No goods or services would be provided that are incompatible
with this.
Globalization v. democracy

The Turkish economist Dani Rodrik has criticized this vision of deep integration, arguing that it is
undesirable and far from inevitable, and that in reality considerable institutional diversity persists
between countries. Rodrik’s starting point is that choices about the direction of globalization are subject
political “trilemma.” People want market integration because of the prosperity that it can bring. People
want democracy, and they want independent, sovereign nation states. Rodrik argues that the three of
these are incompatible. Only two are possible at any one time. How the trilemma is resolved implies
different forms of globalization.

The trilemma comes from the fact that the deep, or more complete, integration of markets requires the
removal of institutional variations between countries. But electorates in different countries want different
types of institutions. Compared to US voters, those in European countries tend to favor large welfare
states. So a single global institutional framework in which nation-states still existed would mean ignoring
the preferences of electorates in some countries. This would conflict with democracy and governments
would be placed in what US journalist Thomas Friedman has called a golden straitjacket. On the other
hand a global institutional framework which democracy reigned would require global federalism or a
single worldwide electorate and the dissolution of nation states.

Today, we are far from either the golden straitjacket or global federalism. Nation states are strong, and
persistent institutional diversity across countries suggests that the varied preferences of different
populations are still important. Since World War II Rodrik’s trilemma has been resolved by sacrificing deep
integration. Markets have been brought together as much as possible given nations’ varied institutions.
Rodrik calls this the Bretton Woods compromise, referring to the global institutions that were established
after the war, the General Agreement on Tariffs and Trade (GATT), the World Bank, and the International
Monetary Fund (IMF).
These organizations aimed at preventing a repeat of the catastrophic backlash seen in the 1930’s through
a form of managed integration, in which nation states were free to pursue their own domestic policies
and develop along varied institutional paths.

The liberalization era since the 1980’s saw an undermining of the Bretton Woods compromise, with the
policy agenda being increasingly driven by the aim of deep integration. Rodrik argues t institutional
diversity should be preserved over deep integration. European electorates desire for welfare states and
public health systems is not just about economics, but also their view of justice. Institutional diversity
reflects these different values. More practically, there is more than one institutional route to a healthy
economy. The requirements for growth in today’s developing countries may be different from those for
developed nations. Imposing a global institutional blueprint runs the risk of placing countries in a
straitjacket that suffocates their own economic development. Globalization may have limits, and it may
be that the complete fusion of economies is neither feasible nor ultimately desirable.

Liberalizing the money markets

The liberalization of capital markets, where funds for investment can be borrowed, has been an important
contributor to the pace of globalization. Since the 1970’s there has been a trend towards a freer flow of
capital across borders. Current economic theory suggests that this should aid development. Developing
countries have limited domestic savings with which to invest in growth, and liberalization allows them to
tap into a global pool funds. A global capital market also allows investors greater scope to manage and
spread their risks.

However, some say that a freer flow of capital has raised the risk of financial instability. The East Asian
crisis of the late 1990’s came in the wake of this kind of liberalization. Without a strong financial system
and a robust regulatory environment capital market globalization can sow the seeds of instability in
economies rather than growth.