Saving Globalization from its Cheerleaders

1. Saving Globalization from its Cheerleaders National Trust Forum on Democracy, Globalization and Societal Welfare October 2007 Dani Rodrik

2. 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

3. …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

4. 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.

5. 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.)

6. 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

7. 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

8. 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

9. 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.”

10. Zooming out: The political trilemma of the world economy Deep economic integration Golden Straitjacket Global Federalism Democratic politics Nation state Bretton Woods compromise Pick two, any two

11. 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.

12. 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?

13. 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?

14. 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

15. Do existing barriers to international economic integration constrain growth? (B)The role of international trade Source: Anderson, Martin, and van der Mensbrugghe (2006)

16. 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!

17. 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

18. 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?

19. 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.

20. 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)

21. 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

22. 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

23. Where globalization’s constraints bite:lessons of history Three interpretations of collapse of earlier wave of globalization, 1815-1913 (James 2001): • Inherent instabilities in global finance • Social and political backlash • 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.

24. 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)

25. 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