Social Implications of a Global Economy

Colorado College's 125th Anniversary Symposium
Cultures in the 21st Century: Conflicts and Convergences

Delivered at Colorado College on February 6, 1999 at 9:30 AM
in a discussion forum with the same title.

by

Dani Rodrik

Thank you very much. It’s a real pleasure to be here, and I thank you and the College for your invitation to participate in this important occasion. And also I’m humbled to be in such illustrious company these days. I am also humbled because I am a professional economist, and, as many of you know, economics is a dismal science, and most of what I’m going to tell is not going to exactly cheer you up. So let me start with a story, instead. An economist is traveling on a train with a physician and an architect, and they get to talking about which of their professions is the most honorable one, and they decide whichever is the oldest must be the most honorable. So the physician says, "Well, before there was any of us, before there was humanity, Adam and Eve started us off, and, as you remember, God fashioned Eve out of Adam’s rib, and that was an act of surgery so surely medicine is the oldest profession of all." The architect said, "Well, hold on. Before there was Adam and Eve, the universe had to be created, and God created the universe out of chaos, and that was architecture. Surely architecture is the oldest profession." The economist turned to them and said, "Where do you think chaos came from?"

I tell this story for two reasons: one, because it is funny, even to an economist, and, second, because in many ways the international economic system that we are in today approximates chaos of some sort. It is a system in disarray, and, as the title of this session puts it, it is entirely appropriate to ask what are the social implications of the international global economy that we have created. And many of you might be tempted to say, well, sure, if you let economists design the global economic system, sure enough you are going to get chaos. I’m going to try to put a slightly different twist on this and argue that what has brought chaos, what has brought disorder in the current financial crisis that the international economy is experiencing, is a perversion of the ideas that, in fact, most professional economists hold dear. So it is a caricature of ideas that professional economists believe in that has brought us to this particular impasse.

Let me expand on that. First, let’s understand that there is not a single model of what a global economy should look like. I think that the trouble we have currently is that we have pushed a particular idea of a global economy, and this model, this idea, has essentially made a fetish out of international trade and investment and has treated international trade and investment as the end goal to which everything else must adjust. And I think this gets our priorities badly wrong. I would say that this is a relatively recent vision, one that actually emerged beginning in the early 1980s.

I can think of at least two sources for that vision. One was the Reagan and Thatcher revolutions that sort of brought us what is now currently called market fundamentalism. But, for most of the developing world, probably much more important was the debt crisis of 1982, which engulfed a large number of countries in the developing world into a deep economic crisis—Latin America had its lost decade of the 1980s. That led to an overhaul and complete reconsideration of many of the policies that these countries had embarked on. This essentially led to a very deep-seated reaction to the interventionist policies of the past, a much greater degree of openness, and a view that, essentially, international economic integration was going to be the salvation for these countries.

I think this vision of the global economy, which puts international trade and investment up there as first priority, has led to a number of myths. Let me state just some of them. One myth is that free trade is the surest way to national prosperity. Another one is that foreign investment, direct foreign investment in particular, is a key to national economic development. A third myth is that free capital flows allocate resources around the globe. And a fourth myth is that international financial markets exert useful discipline on national monetary and fiscal policies. Now, I selected my words carefully as I was stating these propositions. In the form I have just stated them, they are all false statements. I think most professional economists would agree that, in the form I have just stated them, they are actually false. But these kinds of ideas have been hijacked by a range of interests and people, whether it’s in the media, whether it’s by policy advocates, by policy advisors, by a number of governments, and certainly a lot of corporate interests. They have become part and parcel of conventional wisdom of what is good economic policy and what drives economic prosperity around the world.

The consequence of all this has been that trade and foreign investment began to trump essentially everything else, and there are many, many examples of that. Since the 1980s, trade negotiations began to reach beyond explicit trade restrictions at the border to remake national institutions, whether in the area of regulatory institutions, labor market institutions, or environmental protections. So it became entirely legitimate for the United States to tell Japan what its labor practices or its retail laws should look like. It became okay for the WTO to tell the United States what its environmental protection regime should look like or how we should adjust to the needs of international trade. Elsewhere, governments all over the world began to fall over each other subsidizing and attracting foreign investment, believing that foreign investment was going to be tremendously important to their economy—even though, when one looks at the evidence, one finds that there is actually nothing that suggests that a dollar of foreign investment is more useful to an economy than a dollar of domestic investment.

All over the world, governments, particularly in the developing world, were told to remove restrictions not only on foreign trade, which for many of them would actually do good, but also to go beyond that and to remove restrictions on all kinds of capital flows, including short-term flows. So, for example, for South Korea or Mexico, countries that were joining the OECD, removing these kinds of controls became part of the conditionality they had to fulfill. And now, we’ve understood how dangerous, in fact, is a regime of free movement of short-term capital flows—and how that is a recipe for disaster. The international financial crisis, since the devaluation of the Thai currency in July of 1997, is a very good reminder that one has to be particularly careful in the area of short-term capital flows and make sure there is a very sound regulatory regime with restrictions on flows.

Now, what is wrong with this is, I think, that the vision has ignored something that we actually know very well in the national setting—that markets, in order to work properly, need to be embedded in a set of social and political institutions. And such social and political institutions essentially serve at least three kinds of purposes in order to make markets work well. They regulate markets, they stabilize markets, and they legitimate markets. So in the area of regulating markets—again this is something that we were all familiar with in the national setting—we understand that you need an antitrust authority in order for national domestic markets to work efficiently and to allocate resources efficiently and to have a certain degree of fairness and legitimacy. So today we have, of course, this big case of Microsoft. It is not a coincidence, I think, that the United States, which has the freest domestic market of all countries in the world, also has the most vigilant antitrust authority at the same time because of the understanding that, in order for a market to work well, it has to have a high degree of regulation not just in the antitrust area but of information disclosure and other areas. We have many kinds of necessary regulatory bodies in all the advanced industrial countries.

Secondly, the markets need institutions to stabilize them. … We have now come to understand (ever since Keynes) that markets are given to their own boom and bust cycles; there’s no guarantee that markets will generate full employment or full capacity utilization. So you need national authorities, monetary and fiscal authorities, to provide that stabilizing role—central banks (here in this country the Fed) play a tremendously important role in stabilizing domestic demand, stabilizing the operation of national markets.

And third, I think, social and political institutions are very important in that they legitimate markets in the sense of providing safety nets, providing social insurance. The form that the safety nets and social insurance take differs in a lot of different countries. Europe has the welfare state that provides these safety nets. In Japan, the safety nets have traditionally been provided through other kinds of institutions. Japan does not have a welfare state but has a fairly rigid, non-trade sector and also typically had the practice of lifetime employment. All institutions that attempt to soften the edge of risks and uncertainties that unfettered markets create therefore legitimate, in the eyes of the public, the working of a market system. So the point is that markets are never on their own. They always have this institutional infrastructure that allows them to operate efficiently and with a certain degree of legitimacy.

The problem is that, when you think about the global economy, none of these institutions exists at the international level. In fact, it is very difficult to envisage how they could, short of anything that would look like global federalism. Any of these institutions—the regulatory institutions, the stabilizing institutions, the legitimating institutions—the moment you start thinking of what it would take to create them at the international level, you understand, in fact, how that is going to be impossible. People talk a lot about a global lender of last resort or a global central bank, an international financial architecture. But, when you scrutinize it, you see that it is going to be very difficult in fact to construct these things, precisely because of problems having to do with national sovereignty, first and foremost, and, secondly and very importantly, because different societies have created different mixes of institutions, and there is no reason to believe that there is going to be just one model that is going to fit them all.

So, even if countries were in principle willing to give up national autonomy to a well-functioning set of international, supranational institutions, there would still be the question of which model of corporate governance, which model of regulation, which model of the welfare state, which model of social insurance you would take and endow these supranational institutions with. And this is, I think, where the notion of cultural—I would prefer to call it national—pluralism really comes in, in that we have no reason to believe that any one of these systems is essentially better than any other and no reason to suspect that different groupings or different nations, in fact, don’t have legitimately different ways of thinking how they want to have these kinds of institutions. And, therefore, there is a big stumbling block in how you create these international institutions. So, I think, at the most fundamental level, the current crisis of the global economy is the result of having let markets expand beyond the reach of these three types of institutions, and, simply put, markets have expanded beyond the institutional infrastructure needed to support them.

Is there an alternative vision? In fact, we do have one successful model, and that is the Bretton Woods system under which the world economy did exceedingly well until the late 1970s. Let me review this model because, I think, most of us have forgotten how far our thinking has actually diverged from the conception of the world economic system that was outlined in 1944 by Harry Dexter White and John Maynard Keynes as they built the Bretton Woods system. Now, White and Keynes, the architects of this system, did not contemplate a regime whose main purpose was to maximize the international flow of goods and capital. Their most important objective was that of international economic stability. They sought a system that would prevent nations from exporting their economic difficulties to their trade partners—therefore, a system that would avoid the problems of the inter-war-period: destabilizing capital flows, excessively volatile currencies, and an eventual descent into bilateralism and protectionism in the 1930s. So they devised a large number of safeguards, and, in particular, they allowed countries the freedom to regulate capital flows.

In the area of trade, the GATT system as it started out and evolved through at least the late 1970s, was concerned almost exclusively with policies at the national border, [and] so it didn’t reach beyond the national border to try to remake national institutions in order to make them consistent with free trade. And in a successive round of negotiations, trade negotiators brought down especially quantitative restrictions on imports and tariffs. But, while the rules frowned on quantitative restrictions, they didn’t on tariffs so you were allowed to have tariffs. Furthermore, there were large sectors that were left out of international discipline altogether—agriculture and textiles being the two key ones. There was a safeguard clause in the GATT that permitted countries to raise tariffs temporarily when an increase in imports threatened to injure a domestic industry. So there were explicit rules for opt-outs or escape from the international discipline if the domestic economy came under pressure.

The developing countries were effectively left outside the rules altogether. I think what these international rules led to was that they left enough space for national development efforts to proceed along successful but divergent paths. So when you look at all the successful cases in this period, you see that they essentially took somewhat different forms. In Western Europe, countries chose to integrate within themselves and to erect an extensive network of welfare states. The share of government spending in national output essentially doubled over a period of thirty years in Western Europe. Japan caught up with the West and exceeded many Western countries with a very distinctive brand of capitalism which combined a dynamic export sector with an efficient and protected set of activities in services and agriculture. China began to grow by leaps and bounds once it recognized the importance of private initiative, even though it flaunted every other rule in the guidebook in terms of what makes for successful economic growth. Much of the rest of East Asia generated miraculous rates of economic growth, relying on industrial and trade policies that, if followed today, would be illegal under the rules of the WTO. Until the late 1970s, at least, there were scores of countries in Latin America, the Middle East, and even some in Africa, which generated economic growth rates that would have been unthinkable in an earlier era. And they did so with their import substitution policies that insulated them to a large extent from the world economy.

Now, can we go back to the old system? I don’t think we’re going to go back to that old system. Nostalgia does us no good although we should understand that this was, in fact, a golden period, and, for a vast majority of countries, it worked very well. Clearly, much has changed in the world in the area of communications and transportation. We have essentially been undergoing a series of revolutions that in and of themselves make the world economy more integrated, independent of what governments choose to do. Many of the economic changes that have taken place, in the area of financial markets in particular, are essentially irreversible. So the genie is out of the bottle, and it is impossible to put it back in. So the Bretton Woods system cannot be reenacted, but the general lesson it holds for us, I think, remains valid and still applicable. Let us not be too ambitious in economic integration, in particular in going beyond national barriers to trade and trying to remold domestic institutions in some economist’s idea of what the ideal institutions are. Let us realize that all successful countries have evolved their somewhat different national economic models and that convergence among these national models is neither desirable nor in any case imminent. Let us realize that the international economy is a means to an end, not and end in itself, and that a more productive vision of it is one that allows different brands of national capitalism to co-exist side by side.

Economics in the final analysis is all about tradeoffs, and this is where we face the tradeoffs. There is a famous story that I am sure many of you have heard about President Eisenhower, who kept getting advice from his economic advisors that sort of went, "On the one hand this, on the other hand that." Finally, Eisenhower erupted, saying, "Please bring me a one-armed economist!" The tradeoffs that we face here are between two conflicting values—that of national autonomy and the value of keeping national/social arrangements, and that of a competing value of partaking in all of the good things that openness and an integrated economy can bring. We have to find a happy medium between those two. I think the last thing the world needs today are one-armed economists.

© 1999 by Dani Rodrik