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POLICY MAKING IN A GLOBALISING WORLD
Richard E. Baldwin
Graduate Institute of International Studies, Geneva
1998 Ola Virin Lecture
Delivered at the Federation of Swedish Industry, Stockholm, 1998.
1. Introduction & Main Themes
Globalisation is competition
Globalisation is a tough word to define. Here’s my entry. Globalisation is
competition. When the brunt of increased international competition fell mainly on
businesses, we called it “liberalisation.” Now that governments are also starting to
feel the cold wind of competition, we have the G-word and hundreds of books to
explain its implications.
Just as there is not all that much new to be said about competition, I don’t think
there is not all that much new to be said about globalisation. Of course, it would be
too embarrassing to end right here so I will have something to say, but I like to admit
up front that I do not have any massively clever insight into the issue. What I will do
is lay out how I organise my thinking about the globalisation and its implications for
economic policy making. I will stress three broad themes.
More Demands and Fewer Tools
The first point is that due to globalisation, national governments are being asked to
do more and to do it with fewer tools.
Everywhere you turn, people and markets are demanding more from governments.
I will go into this in more detail later on, but let me just mention one example. The
GATT process allowed national governments to eliminate most tariffs on OECD
imports. But instead of thanking them and getting on with it, exporters now push
their government to extend the GATT’s successor (the World Trade Organisation,
WTO) into unknown territory: intellectual property rights, government procurement,
competition policy, etc.
While globalisation means that governments are being asked to do more, it also
means that they have fewer tools than before. The heightened mobility of goods,
services and capital—above all capital—implies that the old familiar tax-and-regulate
solutions are increasingly unattractive or even unavailable.
The implication is that governments and international institutions are just going to
have to work harder. In all aspects of policy making, globalisation means that
governments will have to become faster and smarter, just as competition has meant
that private businesses have had to become faster and smarter.
Swifter and Hasher Punishment for Mistakes
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While I will not have the time to go into details, I think it is worth pointing out that
the extra competition means that governments, like private businesses, have much
less room for error. Quite simply, the punishment for bad policy is swifter and hasher
than ever before. On the macroeconomic level a single word suffices to make my
point. That word is “Asia”. Given that this talk is in Sweden, single word suffices to
illustrate the point on the microeconomic level. That word is “Ericsson”.
Globaphobia
The second broad theme has no analogy in the private sector.
Governments around the world are facing new sense of unease among voters.
While it is hard to know exactly why, there is undeniably a greater perception by
voters that globalisation, or at least international factors, are responsible for social
problems. In some nations the focal point is low wages, in others it is unemployment
or crime. The French Maastricht referendum debate, the Swedish debate over
European Union (EU) membership, and the US debate over fast-track renewal are but
a few examples I could cite.
I think it is clear that whether these concerns are justified, national governments
should be responding forcefully to this fear—what Bob Lawrence calls globaphobia.1
The point is that even if the perceptions behind globaphobia are misguided,
perceptions matter in politics. Moreover, simple ignoring these fears may lead to
very unfavourable outcomes such as the rise of the far right in Europe, and renewed
isolationism in the United States.
Lessons from Europe
My third theme is “Look first to what Europe has done”.
European governments have dealt with tight integration of markets for goods,
labour and capital for longer than most. It is not surprising, therefore, that we can
learn much from how European nations have reacted over the past 50 years. This
point is perhaps less relevant to a Swedish audience, since Europeans naturally look
to the European experience for lessons. Nevertheless, the vast majority of the
literature on the G-word is generated by analysts on the Western side of the Atlantic.
For example, when I punched in “globalisation” into the search engine of
www.amazon.com, I found two titles. When I punched in “globalization” (the US
spelling), I found 282 titles. In much of this literature authors act as if the close
integration of goods and factor markets were something the United States discovered
in the 1990s.
Outline of Talk
I will divide my comments into two parts. The first will deal with macroeconomic
policy making, the second with microeconomic policy making.
1
See Burtless, Lawrence and Litan (1998).
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2. Globalisation: The Macro-Side
Perhaps the most stunning aspect of globalisation has been the spectacular growth
and integration of world financial markets. This change has been so massive that it
has quite distinctly changed the environment facing macroeconomic policy makers, a
point that will not be lost on Swedish observers who followed events in 1992. For
this reason, the first part of my talk focuses on capital markets and financial
integration.
The “Symptoms”: Capital Market Integration
Growth in the international financial markets has been so rapid that it is best
viewed as a qualitative rather than a quantitative change. There are many ways of
documenting this growth. I mention just a few. On an average day, turnover in the
foreign exchange market has grown from $190 billion to $1,190 billion in just ten
years. To get some perspective, note that the current daily turnover exceeds the stock
of official reserves of all IMF members put together (Eichengreen 1994). Private
lending flows to developing nations have ebbed and flowed during the past three
decades, but since 1990 they have increased sixfold, according to IMF (1996a).
Also significant is the fact that individual and institutional investors are
increasingly holding foreign securities. Eichengreen (1994) points out that between
1980 and 1991, US pension funds increased the share of foreign securities in their
portfolios from 1% to over 5%, and in other OECD nations the trend is similar. Since
these are stocks of assets (not just annual flows), they represent an enormous amount
of money that cares a lot about exchange rates. And this stock will assuredly continue
to rise.
Another important feature of globalising capital markets is financial innovation.
International capital markets have developed a broad range of very sophisticated
instruments for diversifying risk, hedging risk and for isolating individual sources of
risk. Whatever else these so-called derivatives have done, they have certainly made it
easier for financial market players to disguise their intentions and actions.
Perhaps the most spectacular ‘symptom’ is the spat of currency crisis observed in
recent years.2 The list of these crises will be familiar. Most recently, Thailand,
Korea, Indonesia, Malaysia and the Philippines experienced massive involuntary
exchange rate devaluations in 1997. In Thailand, Korea and Indonesia devaluation
was accompanied by widespread crises in the financial sector. Rapid and massive
private capital flows were central to these crises. Radelet and Sachs (1998) point out:
“The single most dramatic element—perhaps the defining element—of the crisis has
been the rapid reversal of private capital flows into Asia.” In the five Asian nations
net private capital inflows flip-flopped from plus $93 billion to minus $12 billion
between 1996 and 1997, with about 80% of this coming from reduced lending by
2
There is nothing new about currency crisis. In his classic treatises “Manias, Panics
and Crashes” Charlie Kindleberger calls them “hardy perennial” and documents many
of the crises that occurred in the first wave of globalisation (1870-1914).
Nevertheless, the last 5 or 10 years have seen a number of extremely dramatic crises
that seem to be ‘contagious’.
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foreign commercial banks. The rapid reversal of the capital flow, equivalent to about
10% of the five nations’ collective GDP, provoked powerful macroeconomic
contractions, sharp exchange rate and stock market drops, and triggered banking crisis
at least in Indonesia, Thailand and Korea. In 1994 Mexico was shaken by a similar
outflow although the fundamental source of the Mexican crisis was more traditional
(macroeconomic mismanagement).
Finally, we have the 1992-93 exchange rate crises in Europe. Since the
lessons from the 1992-93 crises are better understood and provide an example near to
home, Box 1 (which is based on Krugman 1997) goes over the example of the 1992
attack on the British pound. This illustrates many of the causes and consequences of
the new international financial environment facing policy makers.
Box 1: The ’92 Attack on Sterling
The 1992 attack on the British pound illustrates many key features of how
financial market integration has changed the circumstances in which policy
makers operate.
The UK pegged its currency in the European Monetary System’s (EMS)
exchange rate mechanism (ERM) in 1990, the same month that Germany
unified. Having promised that unification would not lead to higher taxes, the
Kohl government financed much of the unification-related expenditures (higher
welfare payments, subsidies, etc.) by deficit spending. This unintended fiscal
stimulus created upward pressure on prices that the Bundesbank countered by
tightening monetary policy. The UK (and the rest of Europe) had to raise
interest rates in order to defend its exchange rate against the DM. Britain
therefore got the Bundesbank’s tight-money policy without the offsetting fiscal
stimulus. A recession and rising unemployment resulted.
This created a policy dilemma. The UK could stick with its new currency
peg, or it could relax monetary policy to alleviate unemployment. Clearly, then,
there were two political equilibria possible as far as UK monetary policy was
concerned. The first—a hard-nosed monetary policy that allowed the UK stick
to its peg—would be costly in terms of joblessness. Of course, the UK
government would not be willing to pay any price (in terms of joblessness) for
defending a peg. If the costs crossed some ill-defined line, the UK would
abandon its peg. But having dropped the peg, the hard-nosed monetary policy
would be replaced by a lax, pro-growth monetary policy and the pound would
drop.
This sets the stage for a so-called one-way bet. If the market made it
sufficiently costly for the Brits to defend their peg, the pound would drop and
those taking positions against the pound would make a killing. If the pound
stayed on its peg, speculators would lose little. All this is a classic situation, but
the 1992 crises had one special feature.
George Soros guessed early on that market would push the British
government over the pain threshold and he set about discreetly establishing a
short position in pounds. Specifically, he set up a number of short-term credit
lines (totalling approximately $15 billion) that allowed him to borrow pounds
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and sell them for deutschmarks (DM). If the pound collapsed he could sell the
DM, repay the sterling loans and make a tidy profit ($1 billion or so, as history
would have it). In fact, these sales helped to precipitate the collapse by raising
the cost of defending the peg. It remains unclear, however, how important a
role his actions actually played; it is arguable that the fundamental reasons for
the crisis would have set it off even without any action on Soros’s part.
Krugman guesses that he might have advanced the date of the crisis by only a
few weeks or months.
The UK sterling crisis of 1992 demonstrated the near-irrelevance of
foreign exchange reserves in a world of high capital mobility. The British
central bank had substantial reserves, and was also entitled to borrow from
Germany (under ERM rules). Thus it was able to engage in direct foreign
exchange intervention on a very large scale—Britain appears to have bought
some $50 billion worth of sterling over the course of a few days. On the final
day, it spent about $20 billion (half of its reserves). Such intervention tends to
raise domestic interest rates (since the Bank is taking currency out of
circulation), but the Bank of England mostly offset the intervention, so interest
rates rose very little.3 Since this had virtually no impact on the pressure on the
pound, it became clear that the defence of sterling would require unacceptably
high interest rates. In short, the market had pushed the UK government over
that ill-defined pain threshold and the fixed parity was abandoned.
Interestingly, this crisis seems to have been virtually unanticipated by the
financial markets. Rose and Svensson (1994) show that interest differentials
against the pound (a sure sign that the market smells a devaluation in the offing)
did not begin to widen until August 1992—just one month before the finale.
Finally, a remarkable fact about the ERM crises is that the countries that
‘failed’ (i.e., were driven off their pegs) did better by almost any measure in the
following period than those that succeeded in defending their currencies. The
UK, in particular, experienced a rapid drop in its unemployment rate without
any corresponding rise in inflation.
The Causes: Technology and Deregulation
The facts I have just listed are pretty well known. Before looking at their
implications, however, I think it essential to study their causes.
Technology, deregulation and the rapid rise of trade and investment are the root
causes of these symptoms. Advances in information technology and lower
communication costs have encouraged globalisation of financial markets in two
distinct ways. First, technology makes it easier to manage a global portfolio and to
search for arbitrage opportunities. Second, technology, together with increased trade
3
This so-called sterilisation offsets the monetary base reduction via ‘open market’
operations. In essence, the Central bank sells its German government bonds to buy
sterling in the foreign exchange market. But then it buys sterling denominated assets
in the domestic market in order to put the pounds back into circulation. A sterilised
foreign exchange market intervention, therefore, is basically a shift in the currency
composition of Central Bank assets. Little wonder then that sterilised interventions
rarely work.
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and investment flows, has rendered capital controls obsolete, or at least more costly
and less effective. Eichengreen (1994) provides a nice example:
discouraging purchases of foreign currency by requiring banks to place
non-interest-bearing deposits with their central banks was easier to do when
all foreign exchange transactions passed through banks, when its was not
possible to use derivative instruments to disguise open positions, and when
banks did not possess offshore subsidiaries with which to book those
transactions. (p.63)
Similarly, the growing inter-linking of markets by two-way foreign direct
investment, international trade in goods and services, and international co-operation
among domestic and foreign firms makes it easier for firms to skirt exchange
restrictions by manipulating transfer prices. Box 2 provides a line-sketch of how this
can work, but the basic intuition is simple. Firms with close international connections
have always been able to blur the distinction between trade transactions and capital
account transactions, eroding the ability of national policy makers to control capital
inflows and outflows. While this has always been the case, the increased magnitude
of trade and investment integration magnifies the problem. Indeed by some measures
intra-firm trade accounts for between a third and a half of OECD imports.
Box 2: Blurring Current and Capital Account Transactions
Consider a company that imports supplies and exports goods. In a
situation of an impending devaluation, the company faces an incentive to
advance payments for its imported supplies and delay payments for exported
goods (the jargon for this is ‘leading’ and ‘lagging’ payments). That is, it will
wish to pre-pay its suppliers (while the local currency is still at its high value)
and will ask its customers to delay payments for its product (in hope of cashing
in the dollars for a larger amount of local currency after the devaluation). If
many firms do this, even for a short period, the inflow of foreign exchange
(from exports) to the Central Bank can dry up over night and the demand for
dollars to pay for imports can surge. Governments can and do attempt to limit
such behaviour but, given the complexity of modern business, these efforts tend
to be costly and ineffective.
Multinationals and domestic firms with very close ties with foreign firms
can accomplish similar ends by under-invoicing their exports (with
compensating payments made to foreign banks) and over-invoicing purchases
of supplies and/or payments for headquarter services.
Deregulation of financial markets is a trend observed in most countries around the
world. The driving forces behind this deregulation are manifold. As mentioned
above, technology has rendered capital controls less effective and this has made
governments less reluctant to abandon them. Direct pressure for deregulation has
come from three sources. First, in some countries, domestic industry encouraged
financial liberalisation as a means of obtaining cheaper credit and financial services.
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Second, a major item on the US trade agenda has been to win its big banks better
access to foreign markets, so prompting from the US has encouraged liberalisation.
Third, external pressure has also come from the IMF since capital market
liberalisation is high on its list of policy recommendations/demands.
Finally, large capital inflows are extremely helpful to domestic policy makers.
They are, in essence, a source of credit that relaxes most of the macroeconomic
constraints faced by governments. For example, when a country grows rapidly it
tends to run a current account deficit and this may put undesirable pressure on the
exchange rate. By financing the current account deficit, large foreign capital inflows
allow the government to maintain the exchange rate and rapid growth. Importantly,
this credit has very small short-term political costs, and any downside is unlikely to
appear for a number of years. Consequently politicians are often more than happy to
liberalise capital controls since doing so helps attract foreign capital thus making their
lives easier.
To summarise, governments around the world face increasing political pressure
(internal and/or external) to remove capital controls just at the time when technology
has rendered capital controls less effective. As a result, capital controls are falling
rapidly around the world and this has fostered integration and growth in the world
capital markets.
What We Learn from the Causes
Financial Market Integration is Here to Stay.
It is easy to imagine that George Soros and his kindΧthe modern day >gnomes of
Zurich=Χare behind the radical globalisation of international financial markets and
the attendant ‘hot money’ flows. This is an illusion. Portfolio investors, commercial
banks and multinationals, in pursuit of perfectly legitimate trade and investment
activities, find themselves exposed to exchange rate changes. As a matter of good
business practice they will seek to avoid capital losses from currency devaluations. In
times of crisis these good business practices will be labelled speculation and hotmoney flows. The truth of it, however, is that these actors would be irresponsible if
they did not attempt to avoid capital losses. Of course, hedge funds and real-life
gnomes do participate in currency attacks but banning all the Soros-es would not stop
the crises.
The implication of this is that unless something reverses the positive aspects of
integration—more trade, investment and international diversification—the big turn
over in foreign exchange markets and short-term capital flows are here to stay.
ΨAnd Is Difficult to control
The second implication of the causes is that capital mobility will be extremely
difficult to control. To look at this a bit more closely, recall how Soros ‘earned’ his
$1 billion in 1992 (see box 1). When investors or businessmen believe that a
currency will be devalued, they first sell the currency (if they have any) or buy a
hedge against the devaluation (using a forward contract, for example to lock in an
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exchange rate). If they are feeling a little more aggressive, they also borrow the
currency with the intention of reversing the process after the devaluation. Capital
controls attempt to restrict or forbid the ability of investors, businessmen and
speculators to borrow the currency, orΧmore frequentlyΧto sell the currency against
dollars.
When it comes to the major currencies, this is a futile exercise since virtually
unlimited amounts can be borrowed and sold in offshore markets. Indeed, due to
financial innovation, you can sell a currency in the future without owning any today.
Finally, as mentioned before, trading companiesΧespecially multinationals and
other firms that have close relationships with firms located abroadΧcan get around
currency controls in several ways (see Box 2).
We see therefore that the existence of the global financial network and a
widespread inter-penetrating network of trade and investment relationships has
created an ‘irreversibility’; nations can no really longer control the purchase and sale
of their currencies. This is especially true for large and medium size currencies for
which sophisticated offshore markets already exist. Small nations, for now, have a
greater ability to tax and/or regulate short-term capital flows. However, given the
pace of financial innovation, new instruments for speculation on (or more kindly,
hedging against) changes in an adjustable peg can appear virtually overnight.
Global financial market integration is here to stay.
Implication #1: A World Central Bank?
If you have been reading the Financial Times, Economist magazine or have been
surfing the financial crises web sites, you’ll know that many analysts are now calling
for massive reforms of the international financial systems. It is easy to understand the
logic behind these calls.
A Bank, as we all know, is a house of cards. It is in the business of investing
moneyΧthat depositors think can be withdrawn on short noticeΧin projects that
cannot be liquidated on short notice. If the depositors all decide that they want their
money back now, the bank will collapse unless the Central Bank steps in.
Increasingly, banks are doing their borrow-short-lend-long business internationally
and this creates risks.
First, just as a bank can go broke if everyone wants his or her money back, so too
can a countryΧas Indonesia has found out rather dramatically in the past few months.
Second, since banks increasingly lend to, or through, banks located in other nations, a
bank failure in one nation may threaten banks in other nations.
Of course there is absolutely nothing new about this. National debt crisis and
international bank failures were common in the 19th century. More recently bank
stability was a real concern in the Latin American debt crises of the 1980s since US
and European money-centre banks were heavily exposed. Now since these risks are
not new, calls for reforms are not new either. At least since the emergence of large
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offshore-markets in the 1970s, governments around the world have recognised these
risks and have undertaken a number of important reforms.
The Current ’System’ Works Well for Rich Nations
In particular, the BIS supports the so-called Basle Process in which nations coordinate their bank supervision. This system, together with idiosyncratic
interventions by individual nations (e.g. US action in the 1994 Mexican crisis) has
worked pretty well in past crisesΧat least as far as the world‘s rich nations are
concerned. The point is that European, Japanese and North American central banks
are strong enough to act as lenders of last resort to their own big banks. Since these
big banks are the de facto backbone of the international financial system, it seems
exaggerated to say that panics threaten the international financial system.
Poor Countries Cannot Act Unilaterally
Of course, the Asian crises show clearly that the system is not perfect. In
particular, individual nations and banks can be harmed by unregulated reactions of
international financial markets. Yet in the medium term, and maybe in the long term,
the major beneficiaries from massive reform of the international monetary and
financial system would be the weaker emerging economies and big international
banks and investors. I have just argued that the current system is basically good
enough for the rich countries and, as far as I can see, rich-nation voters and taxpayers
are not in the mood for extra helping of international largesse. Taking all this as true,
the implication is that the political drive for important reforms will have to come from
emerging economies themselves.
While many of these nations have dynamic economies, the simple truth is that they
are still not yet economically large enough to push through such initiatives.
Moreover, I suspect that many developing nations have a rather too idealistic view of
how a global lender of last resort would operate. For example, even if there had been
one in place late last year, I am not sure that is would have bailed Indonesia. After
all, a good bank regulator must let some borrowers go belly up Αpour encourager les
autres≅, as the French say.
In short, prospects for new global financial institutions seem meagre. Many
observers come to the same conclusion by pointing to the many incentive problems
(to say nothing of legal and political problems) involved in some of the more
ambitious proposals one hearsΧfor example, the setting up a global lender of last
resort. While I agree with these commentaries, I think they miss the basic point. The
current system works reasonably well for the world=s rich nations. And although it
has proved pretty harsh on various emerging economies, these nations just do not
have the political economy horsepower needed to set up new global institutions.
More Data, More Bank Regulation and Capital Controls
What should and will be done, I think, is a bit of tidying up around the edges. A
little more data collecting, most analysts seem to think, would be a good place to start.
Data on the aggregate debt positions by firms, governments and central banks in
emerging economies as well as on the net exposure by global banks would be useful.
Moreover, there are plenty of incentives for private credit rating agencies to do some
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of this. Yet governments might usefully contribute since governments= ability to
compel disclosure would be a great facilitator. It seems to me that individual
developing economies have sufficient incentive to pursue this course, although some
harmonisation on accounting and reporting standards would be helpful. Here the IMF
and BIS could play a role.
More and better domestic bank regulation in developing nations is also a sure bet,
perhaps aided by technical assistance from the international agencies, or increasing
reliance on private accountancies. Again, this should not be too difficult since the
emerging economies (who are the ones that must adopt the changes) seem to have a
lot of incentive to reinforce their financial supervision.
A fresh round of capital controls also seems inevitable, although I doubt these will
be very helpful given the ingenuity of today=s financial markets. Indeed, if more
capital controls give governments the impression that they can ignore the markets,
then a new set of controls may do more harm than good. That is, if controls on shortterm capital allow governments to delay necessary adjustments, they may help turn
problems into crises. After all, the more successful nations are in segmenting
financial markets, the more profitable it will be to bring down the barriers.
Implication #2: The Adjustable Peg is Dead
Perhaps the most startling implication of the globalisation of capital markets is the
polarisation of exchange rate regimes. In short, the massiveness and speed with
which an adjustable exchange rate peg can be challenged has, or at least may soon,
completely eliminate the middle ground between floating exchanges rates and
monetary unions. Barry Eichengreen pushed this point in his 1994 book and after the
Asia crisis I think he would feel even more comfortable with his conclusion that the
adjustable peg is dead.
A Holier >Holy Trinity=
Permit me to lay out Eichengreen=s logic. The ’holy trinity’ of monetary policy
consists of fixed exchange rates, perfect capital mobility and independent monetary
policy. Governments would love to have all three, but, being holy, the trinity is
unobtainable for mere mortals.
If a country has an immutably fixed exchange rate, then roughly speaking domestic
nominal interest rates must equal foreign interest rates. If they did not, large amounts
of capital would flow into or out of the country thereby forcing an exchange rate
change. This rules out monetary independence. Likewise, if monetary policy is
independent, then the exchange rate will have to move around to equalise dollar rates
of return. Of course, if capital flows are not perfectly free and costlessΧand they are
not in realityΧthe country can get a bit of daylight between domestic and foreign
interest rates (as thus gain some monetary autonomy)–at least for short periods. The
sustainable length of the deviation depends upon some combination of the
restrictiveness of capital controls and the size the country=s foreign exchange
reserves and credit lines.
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As discussed above, the effectiveness of capital restrictions have diminished, many
capital restrictions have been removed, and the potential volume of foreign exchange
flows have come to eclipse all conceivable levels of official intervention. As a
consequence, the holy trinity has become even holier, that is to say even more
unobtainable. Defending an unsustainable exchange rate peg has become
inconceivably expensive; sometimes not even a 500% interest rate is enough!
Self-fulfilling Currency Crises
The second factor contributing to the death of the adjustable peg is the appearance
of so-called self-fulfilling speculative attacks.
Consider Estonia=s currency board, which is really just an adjustable peg that is
very hard (politically) to adjust. The Estonian kroon is pegged 8 to 1 to the DM.
According to the Estonian government this will not change, and indeed they defeated
a pretty important speculative attack late last year. Right now, Estonia=s inflation
rate is 6 or 7 times Germany=s. It is running monthly trade deficit of 1.5 billion
kroons with an annual GDP of about 63 billion kroons, and its short-term interest rate
is almost double Germany=s (the long-term rate is even higher).
Now ask yourself, if the Estonian government had no credibility invested in the 8to-1 exchange rate, is this the exact peg they would choose? If the answer is “no”,
you have just predicted a self-fulfilling attack on the kroon.
Here are the elements. First, speculators will suspect that if Estonia were pushed
off its peg, then Estonia would adopt a lower peg, or perhaps switch to a managed
float. In either case the kroon would drop, making boatloads of money for
speculators. Second, speculators also suspect that Estonia would abandon its
currency board if Estonian interest rates rose to outrageous levels. Taken together,
this means that speculators can almost surely make boatloads of money if they are
willing to pour in enough money into an effort to force the Estonians off their peg. In
a world where over a trillion dollars changes hands on average day, how difficult
would it be to suck out the entire money supply of a economy whose GDP is only 8
billion DM?
The morale of this reasoning is that nations will be forced to choose a managed
float with all its attendant instability, or to join a monetary union. The middle ground
is rapidly vanishing.
By the way, this means that Sweden will almost surely join EMU in the coming
years.
A Fortiori in Europe
In Europe, where economies are tightly bound by trade and investment flows, the
tendency towards monetary union is even stronger. Exchange rate fluctuations cause
temporary but important shifts in industrial competitiveness, as the pound and lira
depreciations of the early 1990s showed. If such events occurred frequently enough,
some EU member states would consider undoing parts of, or even all of, the Single
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Market. For example, French industrialists called for protection against exports from
Italy and the UK after the 1992 depreciations.
European Lessons for the World
Take Eichengreen=s logic as correct, if you will, and assume that the adjustable
peg is dead. The first place it died is Europe, so this must be the place to look for
lessons.
Deep International Co-operation is Difficult
The first lesson is that monetary union is damned difficult. Europe had more than
40 years of wildly successful integration (by contemporary standards) under its belt
before the Maastricht Treaty was mooted.4 European are also quite similar in terms
of income level and economic philosophy (again, by world standards). Despite this
the Economic and Monetary Union (EMU) has proved one of the divisive and
politically difficult phases of European integration. Quite simply, printing money is a
key function of a national government and nations are not happy about foregoing such
a large chunk of national sovereignty.
What was hard for European nations to agree will probably be impossible for other
groups of nations. Of course, nations can unilaterally abandon monetary authority by
adopting the currency of another country. Panama, for instance, used to use the US
dollar as its legal tender. The fact that the US used this against the Noriega regime
will probably put off others from pursuing the unilateral approach.
The Stabilisation Deficit
Monetary union creates a stabilisation/adjustment deficit. This is well understood
and has led many to criticise the EU’s Stability Pact and to call for more labour
market flexibility. I agree with these points and I have little to add. However,
whether or not the Stability Pact is effective, I suspect that fiscal policy at the national
level is increasingly the wrong tool for the adjustment/stabilisation challenges facing
Euroland in the coming decades.
My reasoning has two branches. First, as EU nations become increasingly
integrated, spending patterns become increasingly similar. This is important since the
effectiveness of national aggregated demand management in stimulating national
output depends critically on the extent to which domestic residents spend their money
on local output. In a perfectly integrated world, take an extreme, a big fiscal deficit
produces a big trade deficit and little stimulus of local output. This is why very few
local governments never undertake demand stimulation via a tax cut for example. If
they want to spur local employment and output they pay directly for it by, for
example, building a road or improving a park.
Second, European integration has not produced a homogenous integration of
economies. Certain sectors, such as manufactures and financial services, have
become quite tightly linked, while others (medical, retail and government services, for
4
And Maastricht was not the first post-war attempt. Two oil shocks and global
stagflation destroyed the so-called Werner plan of the early 1970s.
13
example) are still quite autarkic. This featureΧlong known in Sweden as the K and S
sectorsΧhas important implications for demand management. A good example can be
found in the UK economy. Its manufacturing sector is having a hard time due to the
recent pound=s strength but the service economy is moving along at a healthy clip
(perhaps too healthy). In such a situation, aggregate demand management seems
rather too blunt a tool.
If we combine these facts with the fact that Euroland governments will be looking
for more stabilisation/adjustment tools after January 1 1999, it seems clear that
governments will inevitably turn to other stabilisation tools.
Micro Stabilisation
>Micro stabilisation’, a phrase I would like to suggest to you, is what Europe
needs and what Euroland nations will increasingly turn to. Throughout the post-war
period, governments have dealt directly with sector-specific and region-specific
employment and output deficiencies. The tools they have used include regional
spending programmes, nationalisation of ailing industries, preferential government
procurement, tax breaks and other subsidies, re-training programmes, protection and
re-regulation.
Now many of these policies are riddled with problems, but what I want to suggest
to you is that governments will face increasing pressure to try such policies. We
should, therefore, devote some thought to sorting them out into the good, the bad and
the ugly. In particular, I would say that we may come to view so-called activity
labour policies more as stabilisation than structural policies.
Conclusions
The >Outs= will Join
If most of what I have been saying is correct, Sweden and the other >outs= will
probably join EMU, at least eventually. Of course, for Great Britain this sort of
reluctant regionalism would be standard operating practice. When the EEC was first
discussed, the UK snubbed the effort and went off and created the European Free
Trade Association (EFTA) instead. Yet just three years after the launch of the
Common Market, Britain put in its first membership application. This time, Britain
might not wait so long. When the UK goes in, I would guess that Sweden will too.
Exchange Rate Crises East of the Oder
The eastern enlargement will also pose many problems from an exchange rate
point of view. These economies are very different to those of West Europe. In
particular they are growing much faster, undergoing massive sectoral resource shifts,
and struggling with root-and-branch structural transformations. According to
textbook macroeconomics, these types of countries will need exchange rate
flexibility. Nevertheless, they probably also need the nominal exchange rate as an
anchor for monetary policy. To me, this tension implies that we will see a few more
currency crises in Europe in coming years. Most of them will be east of the Oder.
14
An interesting question is how the Central and Eastern Europeans will react to
such crisis: like the Brits who opted for more flexibility, or the French who opted for
less.
15
3.
Globalisation: Micro-Side
The macroeconomics of globalisation are continuously in the headlines. There is,
however, another less sexy side to globalisation—microeconomic globalisation. By
this, I mean tighter integration of markets for goods, services and direct investment.
It is to this type of globalisation that I turn to now.
The “Symptoms”: Flows and Policies
Let me divide the main symptoms of microeconomic globalisation into two
categories: flows and policies. The facts on flows are well known.
The Increase in Flows
Trade in goods and services has expanded faster than output since WWII, bringing
OECD nations (except Japan) to their highest levels of openness ever recorded
(although these levels are not much higher than those recorded in 1913). Trade in
services is much harder to measure, but this too has expanded more rapidly than
output. Especially in a few fields, like financial services, economies are much more
closely integrated. Two aspects of this growth are worth highlighting.
While trade as a whole has expanded rapidly, the growth in trade has had a
regional dimension. For all regions except Africa, the former communist nations, and
the Middle East, intra-regional trade has expanded more rapidly than total trade.
Indeed, at this point about half of world trade takes place within Europe or within
North America. Neither the expansion of trade nor its regionalisation are new trends,
as Table 1 shows. In fact they are less pronounced in recent years than they were in
the two decades following WWII.
Table 1: Intra-Regional Trade as Share of Total Trade (%), 1928-1996
Western
Europe
1928 1938 1948 1958 1963 1968 1973 1979 1983 1993 1996
51 49 42 53 61 63 68 66 65 70 68
Central & East
19 13
Europe
and exUSSR
North America
25 22
Latin America
11 18
Asia
46 66
Africa
10
9
Middle East
5
4
World
39 37
Source: WTO(1995, 1997).
46
61
71
64
59
54
57
20
32
27
20
39
8
20
33
32
17
41
8
12
41
31
16
47
8
9
44
37
18
37
9
8
47
35
28
42
8
6
49
30
20
41
6
6
46
32
18
43
4
8
44
33
19
50
8
9
50
36
19
52
9
7
52
16
Imports from the newly industrialising countries (NICs) is still a small share of
OECD GDP, about 2% for the US and about 1.5% for the OECD nations as a whole.
This, however, is up sharply from the ¼% it was in 1970. OECD exports to these
nations have risen by approximately the same amount, but the rapid growth in imports
from NICs has been concentrated in manufactured goods, especially labour-intensive
manufactured goods. For instance, as share of total manufactured imports, the NICs
account for 22% for US manufactured imports, up from about 10% in 1970. (The
corresponding figures for the OECD as a whole are 13% and 6% respectively.)
Another new trend is the rapid expansion of foreign direct investment (FDI). As
Figure 3-1 shows, FDI flows rocketed in the mid 1980s even when compared with
overall investment. A good deal of this is associated with newly traded services,
especially financial services. Fully 60% of the EU’s inward FDI went to the services
sectors (European Commission 1996), with most of the rest going to manufactures.
Much of this service-related FDI is best thought of as facilitating trade in services
since many types of services require a local presence. Banks are a classic example.
The part of FDI that goes to the manufacturing sector, especially FDI that flows to
low-wage nations, is part of another important aspect of globalisation—the fracturing
of manufacturing processes. “The Global Factory”, the apt title of a 1985 book by
Kenneth Flamm and Joseph Grunwald, describes the process. In Europe, this process
is sometimes called delocalisation.
The Internationalisation of Policy
The last important symptom concerns the internationalisation of policy. During
the last 10 to 20 years, a whole host of new microeconomic policies—which were
formerly viewed as matters of purely national concern—have appeared on the trade
policy agenda. Issues ranging from restrictions on dolphin-tuna kill-ratios to
restrictions on foreigners buying coastal property are now routinely discussed in
international forums. Perhaps the most important of these are: investment
restrictions, competition policy, intellectual property rights, rights-of-establishment,
and all manners of industrial, health, safety and environment standards (so-called
technical barriers to trade).
The Causes: Technology and Liberalisation
Popular writers often cite improved communication and transportation technology
as the prime cause of the rapid growth in world trade. While technology surely
accounts for part of the trade growth, it cannot have been essential. After all, 80 years
ago the technology of railroads, steamships and the telegraphs was good enough to
permit trade-to-GDP and FDI-to-GDP ratios that the most OECD nations have only
recently attained. This is even more striking since much of the trade in the late 19th
century depended more heavily on transportation than today’s trade. The point is that
much of 19th century trade involved intercontinental exchanges of primary goods for
manufactured goods, rather than the two-way trade in manufactures that dominates
world trade today. Thus even if there had been no improvement in transportation, the
17
removal of formal trade barriers alone would have allowed most of the massive
growth in trade that we have observed.
The Liberalisation Juggernaut
The most important cause of microeconomic globalisation is, in my view, the
massive liberalisation of international trade that occurred over the past half century.
Average tariffs in the rich nations have fallen from over 40% to under 4%. Indeed
after the Uruguay Round cuts have been fully implemented, more than 40% of OECD
imports will be duty-free, according to WTO (1995). It is worth reflecting upon how
unusual this outcome is. After the war, the great-and-the-good set up the IMF to
stabilise world exchanges rates, the World Bank to alleviate world poverty and the
ITO/GATT to liberalise world trade. Despite its inauspicious start (the US Congress
refused to sanction the International Trade Organisation—ITO—so the treaty had to
proceed without a solid institutional basis), the GATT is the only one that fulfilled its
original mission.
GATT-Think
The spectacular liberalisation of trade resulted, I think, from the clever
arrangement of the GATT. In fact that the GATT is a masterpiece of institutional
design. Let me explain myself. Exports are good and imports are bad, according to
what Paul Krugman calls ‘GATT-think’. The economics of this mercantilist thinking
have been thoroughly rejected by economists, and most policy makers denounce it in
public speeches. Nevertheless, mercantilism is still the paramount force behind trade
liberalisation. Politically powerful export industries in search of new markets compel
their governments to negotiate trade deals. For the export industries, access to foreign
markets is the prize. For the government, the political support of exporters is the
reward. The cost, as far as politicians are concerned, consists of having to allow
foreigners access to the domestic market, which tends to anger domestic importcompeting industries. Domestic consumers, who benefit directly from liberalisation,
carry little political weight since they are almost never organised. This is why, from a
political point of view, exports are good and imports are bad.
The MTN Process
Given this GATT-think, arranging international negotiations as massive Rounds
based on an exchange of market access is a stroke of genius. Insisting that market
access be exchanged reciprocally arrays the political power of exporters against the
political power of protectionists. The dynamics of this are fascinating, resulting in
what I have elsewhere called a political economy juggernaut, Baldwin (1994). Here
is the reasoning. A round of GATT talks produces some market opening that is
phased in over a number of years. As liberalisation takes hold, export industries grow
in size and import-competing industries shrink. Since size and political power are at
least roughly correlated (leave aside farming), the next time nations sit down to talk,
the anti-trade forces are weaker and the pro-trade forces are stronger. More
liberalisation results and the juggernaut rolls forward. Slowly but surely, the
juggernaut grinds down all the barriers in its path.5
5
The MTN process excluded a couple of sectors in OECD nations, notably
agriculture, textiles and clothing. These, not coincidentally, are the sectors in which
18
Dominoes and Regionalism
Similar logic – the domino theory—accounts for rampant regionalism (Baldwin
1997). In short, the formation of a regional bloc harms the exporters in non-member
nations. These export interests push their governments to negotiate membership. As
membership expands, the cost of non-membership rises and even more nations switch
to a pro-membership stance. If the trading bloc is truly open, the process stops only if
some outsiders have very high, intrinsic resistance to membership. Here the cases of
Switzerland and Norway come to mind. If the block is not entirely open, the process
may stop when incumbents refuse to admit an outsider whose membership would be
very costly (economically or politically). Here the cases of Turkey and Slovakia
come to mind. If the bloc is entirely closed, membership requests will pile up, and
the outsiders may turn elsewhere. Here the case of NAFTA comes to mind.
Broad Implications
Having reviewed the forces that are driving globalisation on the micro-side, we can
now turn to extrapolating the process in order to make guesses about its future course.
There are three points on which I think we can be reasonable certain.
Trade Liberalisation Will Continue…but it is Reversible
Powerful political economy forces in every major industrialised nation are pushing
for continued multilateral liberalisation and each subsequent liberalisation weakens
the opposition. It seems clear, therefore, that these forces will continue to push for
ever higher levels of openness. This is true in the multilateral setting but it is
especially true for Europe where monetary union will increase pressures for deeper
integration.
The political-economy domino process that has been driving the recent wave of
regionalism is almost certain to continue. This is especially true in Latin America
where the underlying forces for inclusion are as strong as ever. The one big question
mark, however, is Asia. To date, very little preferential liberalisation has occurred in
Asia, so the domino process has not really begun. The turmoil in Asia might seem to
postpone such liberalisation, but, at least in the past, turmoil has often kick started
liberalisation. If dominos do start to fall in Asia, I would guess that rapid Asian
integration will result.
Predicting the future is a dangerous business so allow me one caveat. In the postwar period, political attitudes towards international market opening initiatives have
been shaped almost entirely by pro- and anti-trade business and labour groups. In the
late 1990s, however, a few new players seem to be making their debut. During the
US debate over NAFTA and the European debate over Maastricht, opposition came
from a much broader base than usual. If this integration-phobia continues, and it
OECD import barriers are still significant. Import barriers for manufactures are still
high in developing nations since the principle of special and differential treatment
excluded them from the exchanges of market access. Their exporters won better
foreign market access without having to face down protectionists in their own nation.
19
might very well, then it is entirely possible that the liberalisation juggernaut may find
itself stuck in the sand of broad-based, but ill-focused opposition to future marketopenings.
In particular, two new constituencies that have come into play are activities
promoting labour standards and extra-territorial environmental protection (more on
this below).
While liberalisation is most likely to continue, trade liberalisation is unlike
financial integration in one important way. In the case of capital mobility borders are
not really very important anymore. In the case of trade, however, goods must still
cross national borders. Nations still control these. Thus it is conceivable (although
improbable) that the trend towards ever more open markets could be reversed (as it
was in the inter-war period) since there is no technological mechanism preventing a
rapid return to protection. Indeed once the juggernaut starts rolling in the opposite
direction, it is the pro-trade forces that get progressively weaker and the anti-trade
forces that get progressively stronger.
Trade Talks Will Get Harder
Since the tariffs have been substantially eliminated on the world’s high-volume
trade flows further liberalisation must go beyond tariff and quota liberalisation.6 As a
result, trade talks will get harder since removing non-tariff, non-quota barriers is
intrinsically more difficult. To justify this, consider the following.
Find the Barriers.
A couple of years ago, the UK’s Foreign and Commonwealth Office asked Joe
Francois and I to try to quantify the effects of a trans-Atlantic free trade initiative.
Our first task was to identify the barriers that would be removed by such a move. The
strange thing was that we found it very difficult to identify specific barriers to US-EU
trade. Tariffs on the high volume trade items – industrial goods – were very low or
entirely absent. There is still lots of protection on agriculture, steel and a few other
items but these account for very little trade. So we had to look deeper.
We found a good deal of implicit protection in the form of pro-national
government procurement practices, but again this covered only a modest fraction of
trade (governments spend most of their money on government salaries, not on goods).
Yet despite this apparent lack of barriers, most businessmen still viewed the trade as
far from free. The solution to this paradox is technical barriers to trade: a massive
lattice of small and seemingly innocuous regulations, standards and procedures—
some practised by governments and some by private industry. While each measure
seems trivial (at least to non-specialists), the confluence of thousands of such
measures serves to substantially restrict international trade in goods and services.
6
Of course tariffs and quotas are still significant for a number of trade flows. For
example OECD imports of textiles, clothing and food and developing nation’s
imports of manufactures, but such trade flows are only a relatively modest fraction of
world trade.
20
There is a very nice analogy for what is going on here. Think of your domestic
market as a castle surrounded by a moat. In the early post-war years tariffs and
quotas, which were still quite high from the 1930s, constituted the key barriers to
trade. In those days, when exporters wanted better access to foreign markets, they
asked their government to negotiate for lower tariffs. There were, of course, many
other barriers to international trade and investment but tariffs—like the water in a
moat surrounding a castle—the importance of these non-tariff barriers was submerged
by the main obstacle.
Five decades of GATT talks have drained the moat, exposing all the other
obstacles. What sort of barriers are we talking about? Idiosyncratic standards are
perhaps the most important type and these include health, safety, environmental and
industrial. A good name for these is technical barriers to trade (TBTs). Fiscal
barriers also posed important hurdles, especially to international investment. The list
is quite long—and given the ingenuity of protectionists it is growing—but also worth
mention are entry restrictions (e.g. via certification), state-owned monopolies, biased
government procurement and state-aids.
What Trade Talks Will be About
Now a days, when exporters want better foreign market access it is not enough to
ask their government to negotiate down foreign tariffs. For instance if US exporters
and multinationals want substantially better access to the EU market, the US will have
to get the EU to lower its all these other deeper-than-border-measures (sometimes
called non-tariff barriers).
By their very nature, these barriers are more difficult to liberalise. For instance
when cutting tariffs in GATT rounds, nations are supposed to make substantially
equivalent ‘concessions’ (the GATT-think name for import liberalisation). Figuring
the equivalence for tariffs is not very hard, but how should trade negotiators measure
‘concessions’ on preferential treatment in government purchases? The anti-foreign
preference is the outcome of the process by which governments chose contractors.
Yet this process is massively detailed and can be quite different for different types of
purchases (e.g. postal trucks versus military hardware). Moreover, some nations have
very different traditions as to how legalistic the procedure is, so simply inspecting a
nation’s laws and regulations may not accurately gauge the level of protection. All
this makes it difficult for negotiators to define the barriers, to negotiate reductions in
the barriers, and to be sure that other practices or regulations have not offset the
negotiated liberalisation.
This one example shows why the Uruguay Round was so much more difficult than
the Tokyo Round and why the next round (the Millennium Round?) will be harder
still.
I have focused on procurement as an example, but a similar conclusion could be
drawn with respect to standards and regulations, competition policy, rights-ofestablishment, investment restrictions, subtle fiscal barriers, etc.
21
A Two-Tier Global Trading System
The final broad implication I would like to stress is the impact of all this on the
world trading system. Since the liberalisation of complex trade barriers are hard to
define, measure, negotiate and—above all—hard to verify, deeper than tariff
liberalisation is likely to be limited to the world’s advanced industrialised nations.
The point is that deep integration necessarily involves a pooling of sovereignty on
issues such as standards and regulations. This sort of pooling requires an inordinate
amount of trust among the poolers. Finally, only the advanced industrial nations have
sufficient information infrastructure, transparency of government and reliability of
regulatory authorities to create the necessary trust.
This leads to two predictions. First, pluri-lateral, extra-GATT/WTO are likely to
proliferate. Discussions of a trans-Atlantic mutual recognition agreement is a good
example. Second, since there are really very few nations at the level of development
of Europe, North America and Japan, it seems that a two-tier world trading system
could emerge. Europe again provides an example. Single Market access to the EU is
limited to West European nations for now. Turkey and Tunisia, for example, get
duty-free access, but not single-market access.
Second, to the extent that this violates the spirit of the most favoured nation
principle, I suspect that it will generate friction in the multilateral trading system.
Many of these frictions will be between the newly industrialising nations and the rich
northern nations. In short, North-South trade tensions are likely to be an important
feature in the coming decades.
I will turn now to a separate development that stems from microeconomic
globalisation, that of labour and environmental standards.
Protectionism and Labour Standards: Old Wine, New Bottles
In the early 1990s interest grew in linking trade policies to non-trade objectives—
labour and environmental standards in particular. Environmental and labour standards
are emotional and highly charged issues that have faced policy makers with relatively
new challenges. Moreover, in my opinion, this is one of the most dangerous trends to
appear in the trade policy arena since the US’s aggressive unilateralism in the 1980s.
It is, therefore, worth our while to spend some time on the topic.
In interests of time, I will focus on the labour standards issue since this (along with
environmental concerns) has made it onto the Clinton administration’s trade agenda.
Globaphobia and Social Safeguards
Proponents of tying trade to labour standards speak of two types of standards:
wages and basic worker rights. The call for higher wages in poor nations as a way of
‘levelling the playing field’ is just plain nonsense that reflects a profound ignorance
of basic economics. I will ignore these. Calls for carrots-and-sticks (mostly sticks) to
induce nations to enforce basic rights for their workers cannot be dismissed so lightly.
Rodrik’s Social Safeguards
22
Rodrik (1996), for instance, proposes that nations adopt a new system—with new
legislation and new institutions—for imposing duties on individual products whose
production “violates a widely held moral code” (p. 63). Rodrik’s proposal is so
egregious and politically naïve that it has been and probably will continue to be
ignored by the serious policy makers. However, it is a good example of just how
dangerous the trend could become, so allow me to explain it briefly.
Rodrik would allow any domestic private group to bring a ‘social-safeguard’ case
before a domestic investigating body. The body would determine 1) whether the
labour-standard concern has “widespread” public support, and 2) whether the import
restrictions “fulfill an objective consistent with the standard in question” (p.64). To
this end, the body would hear testimony from various domestic groups that might
support or oppose the tariffs. If the tariff was imposed, compensation (along the lines
of GATT Article 19) would be offered to the offending nation, if that nation is
“broadly democratic”. Of course, Rodrik would require an amendment to the GATT
in order to make all this legal.
Moral Underpinnings
What are the moral underpinnings of this proposal? Rodrik argues that people and
nations should be able to refuse to buy goods produced in conditions that they find
morally outrageous.
Two Views
When faced with calls for tying trade and labour standards, economists must
answer two questions. First, do such trade-and-standards proposals constitute good
policy? Second, why are such proposals taken seriously now? A great deal has been
written on the first question, but I think the key to the first question lies in the answer
to the second. Here economists are of two minds. Allow me to characterise the views
as the charitable and the cynical.
CNN and the Race to the Bottom
The charitable view attempts to take these concerns at face value. This, however,
raises the question of why such concerns have come to the forefront recently. The
charitable view posits a fairly sophisticated two-prong explanation consisting of new
pop-culture and old public finance theory.
The CNN-isation of the world, this view asserts, has made workers and voters
more aware of conditions in the rest of the world. Voters in rich nations therefore
care more about the plight of people in poor nations. Moreover, when a worker in
South Carolina is told that she lost her job to competition from garment factories in
China, she has a good idea that labour conditions in China are appalling compared to
those in South Carolina.
The second prong starts from the observation that firms are more internationally
mobile than ever. In principle, this footloose-ness of firms creates the possibility of
harmful policy competition among states – what economists call a ‘race to the
bottom’. That is, nations reduce their taxes or loosen regulatory burdens in an attempt
to keep or attract footloose firms.
23
In such cases, old-fashioned local public finance theory suggests that agreeing a set
of international minimum standards or tax rates may improve the welfare of all
nations. Offsetting this, however, is the healthy aspect of jurisdictional competition.
That is, competition often induces corporations to do a better job with fewer resources
and the same surely applies to governments. Governments around the world still tend
to over-tax and over-regulate most industries, so a little more pressure from firms is
likely to improve the situation in most cases.
The import of these two prongs of logic is that globalisation may create a
legitimate need for governments to harmonise labour standards, or at least insist that
nations respect a minimum level of workers’ rights.
Passion and Sincerity versus Politics and Sophistry
I do not share this view, being a cynic at heart. Let me start by saying, however,
that I too believe that people should refuse to buy goods that are made under morally
intolerable circumstances, or whose purchase supports morally abhorrent regimes.
After all, if you found out that your dentist abused under-aged boys while on holiday
in Thailand, wouldn’t you consider switching dentist? Moreover, the basic principle
is already an accepted facet of the international trading system. GATT’s Article 20,
for instance, allows nations to put up trade barriers against goods produced by prison
labour, and it also justified trade sanctions against South Africa and Libya.
Let me also say that I do not doubt that many of those who espouse workers’ rights
are undoubtedly sincere in their passionate calls for trade sanctions. But when this
passion meets politics, the sincerity is transformed into sophistry. Quite simply, calls
for trade sanction aimed at forcing a harmonisation of labour and environmental
standards have received global attention for only one reason. They are old
protectionist ‘wine’ in a shining new bottle. Let me explain.
Moral Outrages Galore
First let us acknowledge that the world is rife with morally outrageous acts
supported by national governments either directly or indirectly. Female circumcision
in Africa, child prostitution in East Asia, slavery in the Middle East, sexual slavery in
Europe, and torture in jails around the world are a few outrages that come to mind.
One might also add the death penalty in the United States, and abject poverty of more
than half the world’s population. All of these phenomena are denounced loudly by
various groups of activists.
Ask yourself, why is it that of all the moral profanities in this world, only concerns
over labour and environmental have found a place on national agendas? Does the
Clinton Administration want to put labour and green provisos in the GATT because
lax environmental regulation and a lack of basic workers’ rights are really the most
nasty aspects of human behaviour? Of course not.
Strange Bedfellows: Passion and Politics
The answer is that politics makes strange bedfellows. Groups of well-intentioned
political activists have caught the ears of policy makers because the basic result of
heeding such calls – the institution of new mechanisms for protecting rich nation’s
markets from the exports of rapidly developing nations – fits in with the agenda of old
24
fashioned protectionists, some of which are in the Democratic Party’s core
constituency.
The politics of labour and environmental standards do matter since they give us
clue as the sorts of political pressures that will be in play when it comes time to
decide on raising trade barriers.
Two examples
When originally proposed in the 1930 Trade Act, US antidumping laws were
motivated by a desire to restrain predatory practices by large foreign corporations.
Hard to argue with this. But soon enough all mentions of predatory pricing were
dropped and the result is a fairly important system of imposing GATT-sanctioned,
old-fashioned protection.
The 1984 Trade Act stipulates that GSP tariff-cuts be granted only to nations that
enforce basic worker rights. The US executive branch – mainly the State
Department—is in charge of certifying these rights. In 1991, when I was working for
the Bush Administration, the case of Syria came under review. Although Syria was
pretty clearly a violator of basic worker rights, the US needed Syria in the alliance
against Saddam Hussain. Guess what? Politics trumped moral outrage and Syria got
GSP preferences. The morale is simple. When evaluating policy, a careful analyst
must consider the political forces governing implementation, not just motives for
passing the legislation.
Product-Specific or Embargoes
Another clue as to intent comes from the form of protection proposed. If we really
wanted to punish nations who fail to adopt basic worker rights, then surely it is the
regime we should target—not particular products. Although I do not support such a
call, it seems to me that the proper punishment would take the form of an across the
border ban on trade, both imports and exports. This is what nations did with South
Africa. But the proposals on labour standards call for product-specific protection.
Let us be more specific. In practice this would surely mean higher tariffs on
clothing and textiles, especially those made in China. In virtually every case I have
seen discussed, the effect of “doing something” about labour and environmental
standards would result in protection against the imports of emerging economies. A
goal that old-fashioned protectionists have pursued for at least three decades.
A Skeptic’s View
Would it be cynical of me to suggest a causal link between the phase-out of the
Multi-Fibre Agreement and the sudden increase in labour’s concern for workers’
rights?
The Way Forward
Policy Over-rides, Carrots and Sticks
To conclude, governments should not, and probably cannot, ignore the concerns of
those promoting labour and environmental standards. There are what Joen Whalley
25
calls ‘policy overrides’. Opposing apartheid, for example, was an overriding goal that
justified extreme measures including trade and investment sanctions.
The danger in the trade-and-labour-standards trend lies in the fact that this new
protectionist bandwagon is being pulled by two kinds of horses: old-fashioned
protectionists, and moralist whose arguments appeal to well-intentioned voters.
The key to good policy in this situation will be to separate the moralist from the
protectionists. Rich nation governments should actively address workers’ rights by
means other than protection. A good start would be voluntary labelling. National
governments or private groups could encourage or maybe even require firms to label
more clearly where their goods were made and provide more information on the
labour and environmental standards in these nations.
If nations feel the need to do more, then let them use carrots rather than sticks. For
instance, they can promise extra dollops of foreign aid or technical assistance to
nations that respect workers’ rights. This way, we can be surer that the resulting
actions reflect moral passion, not mangy politics.
4. WTO, IMF and World Bank are Needed More than Ever
A constant theme in my talk is that tighter integration of markets requires more
from governments, not less. This also applies to the multilateral governance bodies,
especially the WTO.
There is a close analogy with post-Cold War role for UN. When international
relations were dominated by Cold-War politics, nations had little need for the UN as a
problem solver. Exaggerating to make a point, we can say that on any given issue,
the United States and the Soviet Union took up positions and other nations in the
world generally had the choice of choosing sides and being ignored, or staying neutral
and being ignored. With the end of this dominate conflict, international relations
became to be dominated by many small conflicts, each of which was massively
complex. Bosnia, Somalia, Burundi and Cambodia are but a few examples. This
shift made the UN a much more useful institution.
Likewise, when tariffs and quotas dominated the trade agenda, the world was a
simpler place and nations had little need for strong international organisation to deal
with many, small complex problems. Now that trade policy disputes concern minute
details (e.g. whether shrimp nets need metal filters or not), the WTO has become a
much more useful institution.
I would point out three areas in which the WTO will become more important:
negotiations, rules and dispute settlement. Almost paradoxically, as the obvious
barriers to trade were eliminated, it turns out the nations have more to negotiate, not
less. Moreover, as we have seen in the EU, as the number of members grows and
simple trade barriers (tariffs and quantitative restrictions) fade, it becomes more
important to agree and respect a set of underlying rules. Finally, as the nature of
remaining barriers gets more complex, the need for a trans-national dispute settlement
process becomes even greater.
26
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27
Figure 3-1. Growth of domestic and foreign direct investment,
1980-1996
(Index, 1980=100)
Source: UN.