Background notes on globalization September 2007

1. Background notes on globalization September 2007 Narrow definition of globalization: Economic integration, through increased flows of goods, services, investment and labor, information, and ideas. Broader definition includes cultural, political, military integration.

2. Basic disagreement about role of markets • Debate over merits of globalization have “taken the place” of previous debates over merits of capitalism and imperialism. • Pro- and anti- have different views of roles of markets and governments. • Globalization associated with increased role of markets, changing role (“internationalization”) of governments. • Real policy choice is not either/or, but about the rules under which the market operates

3. Brief overview of policy, last 60 years • The “orthodox view” changes over time • Post WW II orthodox view favored reform of capitalism, heightened government intervention • Creation of IMF, World Bank, attempt to create International Trade Organization • Post Soviet (early 1990s) orthodoxy saw markets as pre-eminent.

4. Changing perception of international institutions • Role of IMF to avoid financial crises by making short term loans to countries with severe short term balance of payments deficits. • Today IMF critics see its role as enforcer of “neo-liberal” policies. • IMF does not want to subsidize policies that contribute to a country’s financial crisis.

5. The ITO—GATT—WTO • ITO Charter agreed at UN in 1948 • Objective to promote free trade • US critics call it “Economic Munich” (explain “Munich”), claim excessive reliance on government interventions. US refuses to ratify 1950. • GATT adopted 1948 by 28 of 50 countries negotiating ITO. Seen as forum to enable trade negotiations. • Several rounds of GATT.

6. The World Trade Organization (WTO) • Uruguay round leads to WTO. • Critics object that WTO is a wealthy nations’ club that promotes special interests, e.g. agriculture, pharmaceuticals (via special agreements on ag and intellectual property/patents). • Current “Doha round”, billed as the “development round” appears to have collapsed, largely over disagreements about rich countries’ ag policies, and developing countries’ liberalization requirements.

7. Trade and development strategies • A simple model divides economic activity in “export” and “import” sectors. • Basic economic fact: When factors of production enter one sector, they leave some other sector. A subsidy on one sector is an implicit tax on other sectors. (Illustrate using production possibility frontier) • Import substitution policies: promote growth by subsidizing/protecting industries that compete with imports. (Latin America) • Export promotion polices: promote growth by subsidizing/protecting export sectors. (Southeast Asia)

8. Effect of policies, debate over their merits • Import substitution policies decrease trade, export promotion policies increase trade. • Both involve government intervention in market. • Rationale for govt. intervention: (a) correct market failures. Example: (i) infant industry argument (ii) promote foreign direct investment (FDI); (b) change distribution. • Skepticism of govt. intervention: informational and institutional problems.

9. Basic arguments for free trade • Trade intervention “distorts market signals” leads to inefficient allocation of resources. • Trade intervention protects domestic monopolies, increases their market power. • Trade restrictions limit range of products available to consumers (in addition to price effect). • Trade and investment restrictions impede adoption of new technology. • For all these reasons trade restrictions reduce economic growth, and welfare.

10. Graphical illustration of trade restrictions • Use supply and demand and “surplus” to show efficiency and distributional effects of trade restriction (import tariff or export tax) for “small country. • Assumptions of model: No “market failures”: there is perfect competition and there are no externalities. • (Market failures makes the study of economics interesting. Market failures are central to this class.) • In order to understand the effect of market failures, it helps to understand how markets work in the absence of those failures.

11. Lessons from partial equilibrium model • (i) There are gains to trade for both importers and exporters. • (ii) Policy changes, e.g. a move from autarky to free trade, or a change in tariff level, have distributional effects. Some people win and others lose. • (iii) Trade restrictions lower aggregate welfare: the gain to the winner is less than the loss to the loser. • (iv) The welfare loss is proportional to the square of the trade restriction (e.g. the tariff). Therefore, if the trade restriction is small a further reduction in the restriction (a movement toward free trade) has a very small welfare effect. • v) The distributional effect of a trade restriction is large relative to the welfare effect. The amount by which a winner gains or a loser loses is large relative to the net losses.

12. Why do countries pursue “harmful” policies? • Benefits of trade restriction are concentrated, costs are dispersed. • Problems of collective action make it easier to lobby for, rather than against trade intervention. • Difficult for governments to resist political pressure. • Therefore, “external rules” (e.g. GATT) that limit freedom of government action can increase welfare

13. Why does a country want its partners to liberalize? • Even if all partners are small (so each country has negligible effect on market) their cumulative effect can be large. • If you export food (for example) you want partners to eliminate policies that reduce the world price of food (e.g. their production subsidies and import restrictions). Existence of world markets means that policies in country A can affect country B, even if the two countries do not trade. • How should a country that imports food feel about policies that reduce the price of food? What is the implication of the answer to this question for current calls by developing countries for developed countries to reduce their ag subsidies?

14. Early US experience with protectionism • US trade embargo 1807-1809 reduced US GDP by 8%, during a period when trade/GDP ratio was 13% (i.e. small). • Early 1800’s US imposed the “tariff of abominations”. Reduced trade and promoted development of “infants”, many of which subsequently succumbed to international cooperation

15. Evidence linking trade to growth • Important difference between statistical analysis and selection of facts (e.g. correlations) to support a view. • But correlations are still interesting. Developing countries growth rates higher in 60s and 70s than in period of rapid globalization, the 80s and 90s. • Different views on strength of statistical evidence that trade promotes growth. Trade does not retard growth. • China very important in statistical analyses. • Statistical analysis (80’s – 90’s) found evidence that trade promotes growth – but there were contrarians. Also much of the earlier statistical evidence is currently disputed because of problems with measurement, endogeneity, and possible spurious correlation.

16. Trade is not sufficient for growth • Example of Haiti • Increased recognition of importance of institutions. • Trade is a convenient “policy lever”. It is hard to change institutions. • Economists broadly agree that “free trade” is better than restricted trade. • There are exceptions (market failures) – a major emphasis in this class

17. “Washington Consensus” • Usually a term of abuse. • Favors privatization of public services, reducing or eliminating barriers to trade in commodities and barriers to movements of capital, and floating rather than fixed exchange rates • International labor mobility not a key part. • The “end of history” beginning early 90s. (End of the dialectal process that Hegel and Marx claimed history followed.)

18. Erosion of “Consensus” • Asian financial crises late 90’s. • Implosion of Argentine economy early 2000’s. • Low growth in developing countries. • Rise in anti-globalization movement. • Emerging political and military crises (the “war on terror”). • The end of the “end of history” beginning late 90s, early 2000s

19. Criticisms of international institutions • Lack of “democratic accountability”. (Do tribunal rulings “reduce democracy” – what about domestic court rulings? Is fast-track authority undemocratic? ) • Lack of access. (“Friends of the court” briefs in NAFTA cases provide some access.) • Lack of transparency. (Some NAFTA disputes are not required to be public knowledge.) • Reform or dismantle international institutions?

20. Battle-lines between “pro and anti-globalizers” are sometimes unclear • There are pro-market “anti-globalizers” (e.g. environmental groups favoring the use of markets). Skepticism about planned economy. • Some mainstream economists are critical of features of globalization (e.g. free mobility of international capital, free currency convertibility; specific trade rules such as TRIPs (trade-related intellectual property)

21. What is the source of difference between pro- and anti-globalizers? • Different objectives (e.g. industry and labor groups interested in profits and jobs, environmental groups interested in environmental protection. Remember the “time dimension”). • Different emphasis on the different environmental services (e.g. provisioning Vs cultural). • “Economy vs. environment” is not a good way for environmentalists to frame the debate.

22. Differing emphases on inequality • Should we care about relative as well as absolute levels of consumption? What are the individual and social implications of inequality? Does globalization increase inequality? • (Recent research shows that happiness depends on income relative to society, not just on absolute level of a person’s income. Kingdom of Bhutan’s “gross national happiness”). • The stock economist’s response: use trade to increase size of pie, and other policies to address inequality (an example of “Principle of Targeting”).

23. Kanbur’s paper: different views about economic development • Paper was written after two years of consultation on poverty reduction standards, with academic, policy making, and advocacy groups. • “When an institution (WB) whose self-stated mission is to eradicate poverty can only hold is Annual Meetings under siege from those who believe its mission is to further the cause of the rich and the powerful, there is clearly a gap to be bridged. ”

24. Question in Kanbur’s paper • "How can people who agree on ends (poverty reduction) disagree so vehemently on means?“ • Seeks to explain different views as a result of difference in perspective, rather than difference in motive or intelligence.

25. Areas of agreement • (i) Health and education outcomes are as important as income in assessing poverty. (This area of agreement is relatively recent. Today's debate involves importance of participation and empowerment.) • (ii) Importance of public intervention to promote international public goods, such as environmental protection, financial stability. • (iii) Pragmatism regarding role of markets. Agreement about importance of institutions in regulating markets.

26. Simplified description of debate • Group A is "Finance Ministry", including economic journalists and many academic economists. • Group B is "Civil Society", including NGOs, aid and development workers, non-economist academics. Former favors rapid globalization, latter opposes it. • “...the lack of mutual comprehension is leading to polarization, with Goup A often retreating into the formal technical bunker...and Group B dismissing Group A's analysis as either out of touch with reality or ...actively manipulated to get certain answers.”

27. Kanbur’s explanation for division between “A” and “B” • Different assessments of benefits of rapid globalization are due to different perspectives on Aggregation, Time horizon, and Market Power. • Goup A concerned with higher level of aggregation (and thus less concerned with distribution); more concerned with medium, rather than short and long run; tends to view world through lens of perfectly competitive model. • Group B places more emphasis on outcomes for poor; both short run and long run perspective; has in mind model of market power.

28. Example of poverty assessment in Ghana based on income-expenditure data. • Early 90s estimate showed that the fraction of people living below a poverty level had declined by 3 or 4 percentage points. Few people in Ghana believed this result. Their reasons for skepticism: • (i) the data does not capture the value of public services, which might have deteriorated. • (ii) Regional variation. Rural poverty decreased and urban poverty increased. National poverty had decreased, but some major groups have been made worse off. • (iii) Goup A focuses on incidence of poverty, group B thinks of absolute numbers. (The International Development Target is to cut in half the incidence of poverty.) In Ghana the population was increasing more rapidly than the incidence of poverty was falling, so absolute number of poor increased.

29. Difference in time horizon. • Group A has a 5-10 year time horizon. • Group B is concerned about short-run vulnerability. Group A recognizes importance of safety nets, but sees these more as and add-on. (Safety nets were "banished" in the 80s after their misuse and inefficiencies during the 60s and 70s.) • Group B sees safety nets as essential to policies such as trade openness; Group A would recommend trade openness even in the absence of these safety nets. • Environmental groups have time horizon of 50 - 100 years. Current levels of consumption not sustainable, especially if the poor have consumption levels similar to the rich. Increased consumption by poor requires redistribution. • Group A are "techno-optimists“. They also doubt that massive redistribution from rich to poor is feasible in the middle term.

30. Disagreements about market power: example 1 • Standard theory (with competitive markets): Liberalizing trade benefits the “relatively abundant” factor, harms relatively scarce factor. (Later in course I will explain the theory behind this conclusion.) Example: • US and Mexico, two factors: “skilled and unskilled” labor. Unskilled labor relatively abundant in Mexico. • Relaxing trade restrictions benefits unskilled labor in Mexico, harms unskilled labor in US. • Welfare effects ambiguous with imperfectly competitive markets, or other market failures.

31. Disagreements about market power: example 2 • Group B thinks that free mobility of investment capital harms workers in both source and host countries. • This view is “incoherent” if markets are competitive. (Workers in one of the countries must benefit.) • If wage outcomes determined by bargaining rather than market, capital mobility increases capital’s bargaining power.

32. Summary • Group A sometimes claims B is anti-growth. B favors (sustainable) growth but disagrees with policy prescription. • Group A has tried to remain “on message” because “an inch of nuance leads to a mile of protection”. • Group A wants to avoid “mission creep”.

33. Aissbett’s paper Early Bhagwati (who’s he?) view: “No one can escape the antiglobalists today.....This motley crew comes almost entirely from the rich countries and is overwhelmingly white, largely middle class, occasionally misinformed, often wittingly dishonest, and so diverse in its professed concerns that it makes the output from a monkey's romp on a keyboard look more coherent.” He has become more moderate.

34. Why do many people think that globalization has worsened poverty and inequality? Her answers: • Theory and empirical evidence is ambiguous. • People’s interpretation is influenced by their values and beliefs (their “priors”)

35. Measuring (economic) globalizaton • Two broad approaches to measuring the extent to which a country is integrated with the global economy. • The first approach measures the level of restrictions placed on the movement of goods, services and factors into and out of the country. (Absence of trade restrictions, liberalized capital markets, and free movement of labor are indicatiors of an integrated economy. • The second measure of a country's integration is the relative size of the flows of goods, services, factors, and profits into and out of the country.

36. Difference in measures • These two measures are often used interchangeably, but they are not identical concepts, and are not even highly correlated empirically. • Example of export subsidies: Large export subsidies “count against” globalization by first measure, but for globalization by second measure. (Recall my discussion of Production Possibility Frontier, and the observation that a tax on one sector is an implicit subsidy on the other sector.)

37. Ways of measuring relation between globalization and poverty & inequality • Cross-country regression analyses test for correlations among trade, growth, income, poverty and inequality measured at the national level; • Partial equilibrium/ cost of living analyses are typically based on household expenditure data and emphasize commodity markets and their role in determining poverty impacts; • General equilibrium studies are based on disaggregated economy-wide Social Accounting Matrices, and account for commodity, terms of trade and factor market effects; • Micro-macro syntheses that involve general equilibrium analysis coupled with some form of post-simulation analysis based on household survey data.

38. Consensus findings 1. Trade is correlated with, and often a source, of growth. 2. Growth is on average good for the poor. 3. U.S. and E.U. should liberalize their trade, particularly in agriculture and textiles. 4. FDI is correlated with, and often a source of, growth. 5. Liberalization of markets for short term capital can be detrimental and should be approached with caution. 6. Governments should provide safety nets to compensate the poor who lose as a result of liberalization. 7. TRIPs should be modified to limit negative impacts on provision of drugs to the poor. 8. Access to education, health, and credit are important factors in ensuring the poor benefit from globalization. These factors also increase the growth potential from openness. 9. Poverty should be measured using education and health as well as income. 10. Excessive corporate power (market and political) is a problem. 11. Capture of market or political power by elites has negative implications for growth and welfare. 12. Political reform is needed in many developing countries.

39. Difficulty of determining relation between globalization and poverty & inequality • Same kind of problem facing literature on growth effects: no unambiguous theoretical outcome, so empirical tests are needed. • The observable outcomes, growth, inequality, and poverty, depend on many past and present variables, and causation runs in both directions. • It is difficult to prove what is a cause, what is an effect, and what is merely a spurious correlation. (Does a country grow because it liberalizes, or does it liberalize because it grows, or does it grow for some reason independent of liberalization, e.g. an improvement in terms of trade?

40. Does growth reduce poverty? • Paraphrase Ravallion: According to some observers …growth is sufficient. Period. The basis of this claim is the evidence that poverty reduction has generally come with economic growth. But that misses the point. Those who are saying that growth is not enough are not typically saying that growth does not reduce absolute income poverty....They are saying that combining growth-promoting economic reforms with the right [other] policies ....will achieve more rapid poverty reduction than would be possible otherwise. • Deaton: “.. there is no credibility to the claim that globalization has been good for the poor based on a calculation that applies badly measured distributional shares to (upwardly biased) measures of growth from the national accounts. … we must genuinely measure the living standards of the poor, not simply assume them. We cannot prove that growth trickles down by assuming that growth trickles down, nor argue that globalization has reduced poverty without measuring the living standards of the poor.”

41. Measuring poverty (headcount) • Measures very sensitive to poverty line ($1 or $2 per day). • The number of people living below $1.08 per day fell from 1981 to 2001, by just under 400 million (approximately a halving in the incidence of poverty as a fraction of world population). • The number of people living between the $1.08 and $2.15 lines increased by 680 million. The estimated number living under the $2.15 poverty line increased by 285 million between 1981 and 2001.

42. Overestimating income of the poor • Explain PPP; use the “McDonalds index” example. If a “McDonalds” meal costs $2 in the US and 20 pesos in Mexico, the PPP exchange rate (using this basket of goods) is $1 = 10 pesos. • If a person in Mexico earns 20,000 pesos/year, their PPP income is $2,000. (PPP exchange rate can be quite different from official exchange rates.) • The consumption basket used to estimate purchasing power parities (PPP) (arguably) does not reflect the consumption patterns of the poor. The baskets of goods and services used in all the World Bank's PPP calculations are based on a representative national consumption bundle, not the bundle of goods typically consumed by the poor. • Because basic needs are relatively more expensive in poor countries, the use of such 'broad gauge' PPP measures overestimates the purchasing power of the incomes of the poor in developing countries.

43. Example to show how PPP might overstate income of poor • Suppose that the “McDonald bundle” consists of one order of fries and one hamburger. Cost of each item is $1 in US. Costs of fries is 12 pesos and cost of hamburger is 8 pesos in, so the cost of the bundle is 20 pesos. Therefore 10 pesos = $1 using PPP exchange rate. • Suppose a poor person earns 2000 pesos/month, so his PPP income is $200/month using this basket. But suppose the poor person consumes only fries (e.g. because fries provide more calories/peso). For this person, the correct PPP exchange rate is $1 = 12 pesos (a lower exchange rate for the peso). His “true” PPP income equals 2000/12 = only $166. • The “official” PPP measure overstates his income by 20%.

44. Consistency over time • PPP baskets change over time. A difference in level of poverty may largely reflect differences in the way that PPP is calculated.

45. Measuring inequaltiy • Should we consider every citizen as a member of a single global income distribution (“world inequality”)? Or should we recognize the existence of national borders and talk about ‘within country’ and ‘between country’ components of inequality?

46. Some areas of agreement • Two thirds or more of inequality in the world is due to between-country inequality, and that this share has changed little since 1980. • Since 1980 within-country inequality has increased in more countries than it has decreased. • Between-country inequality has increased if all countries are given equal weight. Between-country inequality has decreased if countries are weighted by population. • The driving force underlying any inequality calculations has been the fact that major economies especially at the very poor end (China and India), but also at the very rich end (US and UK), experienced a combination of growth and increased within-country inequality.

47. World inequality • World inequality is essentially the sum of between-country and within-country inequality. The fact that India and China both grew and experienced increased internal inequality causes estimates of changes in ‘world inequality’, to consistently lie between the estimates of changes in between country inequality calculated using alternatively unit weights or population weights for each country. • Measures depend on whether incomes are compared on exchange rate or purchasing power parity (PPP) terms, with PPP the more widely accepted basis. Use of PPP leads to the conclusion that inequality has fallen. Questions remain regarding the correct PPP conversion.

48. Gini coefficient measures inequality (see Wikipedia) • Gini coefficient is a measure of inequality of income distribution or inequality of wealth distribution. It is defined as a ratio with values between 0 and 1: the numerator is the area between the Lorenz curve of the distribution and the uniform distribution line; the denominator is the area under the uniform distribution line. Thus, a low Gini coefficient indicates more equal income or wealth distribution, while a high Gini coefficient indicates more unequal distribution. 0 corresponds to perfect equality (e.g. everyone has the same income) and 1 corresponds to perfect inequality (e.g. one person has all the income, while everyone else has zero income).

49. Picture of calculation of Gini

50. A numerical example of Gini Coefficient • This example uses total wealth and total population of illustrate Gini. There are 4 people and total wealth =$4. Points in column A correspond to points on curved line (previous slide) and points in column B correspond to points on straight line. Column C shows the difference, corresponding to difference in the two curves. Add elements in column C to obtain 1.75. Divide by total wealth = 4 to obtain 1.75/4 = 0.4375 = Gini Coefficient for this distribution of wealth.