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.”
 Zooming out:
The political trilemma of the world economy
Deep economic
integration

Golden Global
Straitjacket Federalism

Nation state Democratic politics

Bretton Woods compromise

Pick two, any two

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
as percent of base income in
in 2001 dollars (billions) 2015
High High
Developing countries liberalize Developing income World Developing 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
 Where globalization’s constraints bite:
poor countries

 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:
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 backlash
3. 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