200 words DQ

CHAPTER 8

Realist and Liberal Perspectives on Globalization Trade, Investment, and Finance Lines of people wait to get inside the Apple store on Fifth Avenue in New York City to purchase the new iPhone6. Do the economic policies that make their purchases possible make the countries of the world increasingly interdependent—and more vulnerable? Timothy A. Clary/AFP/Getty Images How does globalization actually work? What policies and institutions govern it? Too many scholars and commentators write about globalization without saying anything about how the actual economic mechanisms of globalization work. In this chapter, we consider the domestic economic, trade, investment, and financial policies that make the international economy work or not work. Domestic policies provide the ballast for the world economy. Most of the economic activity in which a country engages still takes place inside that country. Foreign trade (exports and imports) constitutes only about one quarter of total national production in the United States and about one-third in Japan; in the case of the EU as a whole, foreign trade dependence is smaller, around one-sixth. Even in the poorest countries receiving the most foreign aid, domestic saving accounts for more than 90 percent of all savings. So domestic economic policies are crucial for all countries and constitute, so to speak, the ground floor or foundation of that country’s participation in the world economy. If the domestic economy is poorly managed, global markets are unlikely to compensate. The domestic policies of the larger countries are especially important because they have the largest impact on global markets. International trade, investment, and finance build on domestic policies and constitute the principal upper floors of the world economy. To switch metaphors, trade and investment are the meat and potatoes of the global market. When they function properly (and domestic policies support them), the world economy flourishes. Economists refer to trade and investment markets as the real economy. International finance provides the money to pay for trade and investment and to encourage and allocate savings. It is the wine or beverage of the world economy. It supplies the liquidity that enables the world economy to digest the meat and potatoes and to invest in the next meal of meat and potatoes. Economists refer to saving and lending markets as the financial economy. When trade and investment markets go bad, financial markets lose their anchor and slosh around with plenty of speculation and much instability. They act like diners who have had too much wine and too little meat and potatoes. Perhaps that’s what happened to the world economy in 2008–2009. International bankers and investors sold and swapped mountains of mortgage and credit card debt and related derivatives that were less and less tied to the real economy of property and productive investment. On the other hand, if the world economy does not have enough liquidity or wine, markets stagnate or choke on meat and potatoes. That’s probably what happened in the 1970s when government financing became insufficient to cover oil debts and private capital markets were not yet liberalized. Global lending was relatively scarce, and factories and farms could not get enough capital to break bottlenecks and move new products to market. For the world economy to work properly, the real and financial economies have to work in sync. Meat, potatoes, and wine—trade, investment, and finance—are all necessary for a good meal or healthy world economy. In this chapter, we focus largely on realist and liberal aspects of the global economy. Realist perspectives view the world economy primarily in terms of relative gains and security. Global markets are unlikely to emerge, they argue, unless countries feel safe. Nations do not trade eagerly with adversaries. Thus, from a realist perspective, as the causal arrow suggests, security relations create the context for economic relations and determine whether free trade or mercantilist policies prevail. From the historical record, realists observe that extensive global markets in which governments reduce barriers to economic exchanges do not emerge usually except under the aegis of a hegemonic power. The hegemonic power dominates security relations, has little to fear from rivals, and therefore supports and gains most from extensive economic relations. That’s why globalization accelerated under British and American hegemony and may be sustained, according to realist perspectives, only if the United States or another hegemon exercises dominance in world affairs. Otherwise, under conditions of equilibrium, states worry more about their security and limit their economic ties primarily to allies. Even then allies may be temporary. Thus, during periods of multipolar security relations, such as in the seventeenth century before British hegemony and in the 1930s between the British and American hegemonies, global markets slowed or contracted. They became mercantilist, not laissez-faire, with governments seeking to intervene more in economic exchanges rather than to reduce government barriers to trade. Liberal perspectives, by contrast, focus on absolute or collective gains. They stress the joint benefits that can be obtained through comparative advantage in trade, investment, and finance and expect, as the causal arrow shows, that over time growing wealth tempers security competition and creates a world of satisfied powers with compatible norms. Such satisfied powers, despite the existence of equilibrium in power relations with one another, seek to preserve economic interdependence and avoid the disruptions of security conflicts and war. Unlike realist perspectives, where security leads economic ties, liberal perspectives see economic interdependence eventually determining and lessening security competition. International institutions such as the Bretton Woods institutions set up after World War II diminish the significance of national institutions and establish more global standards of security. Once again the direction of the causal arrows is key to distinguishing between realist and liberal perspectives. Snapshot of Globalization Let’s begin by looking at globalization and how it affects you directly through the various domestic and international economic policies that make up the world economy. Let’s assume you buy a new smartphone. What are the policies that affect your purchase? Domestic economic policies: Maybe you purchased the smartphone because you got a new job, received a tax cut, or were able to borrow money cheaply. Government policies lie behind each of these options. Most jobs are created by the private sector, but government regulations affect those jobs indirectly, and government spending or tax cuts may stimulate the creation of new jobs directly. Interest rates may be low because the Federal Reserve System is also trying to stimulate the economy. Government spending and tax policy we call fiscal policy; Federal Reserve policy we call monetary policy. Taken together, fiscal and monetary policies constitute macroeconomic policy—that is, broad policy that affects the domestic economy as a whole. Government regulations constitute microeconomic policy—specific policy that affects only targeted sectors or industries, such as antitrust policy that ensure competition among the telecom companies handling your smartphone calls. Trade policies: The smartphone you bought was probably imported from overseas. It may have been assembled in China with components made in Taiwan and Singapore. Production on such a global basis cannot be profitable unless government policies reduce barriers to trade. Lower barriers mean that when items move across national boundaries they are not subjected to excessive tariffs or limited by quotas and other regulations called nontariff barriers. If the United States imports more goods and services from China and other countries than it exports to them, it runs a trade deficit. And if net government transfers (for example, foreign aid) and net interest and dividend earnings on foreign investment (earnings from previous U.S. investments abroad minus earnings of previous foreign investments in the United States) are added, it runs a current account deficit in its balance of payments (more on these accounts later). Investment and savings policies: If a country spends more than it earns in the international economy—that is, runs a current account deficit because it imports more than it exports—it has to borrow from abroad to pay for those extra imports. Where does that money come from? Workers and companies in Taiwan, Singapore, and China save more than do workers in the United States. They do not spend all their wages and profits from producing your smartphone. Because their governments provide fewer retirement and health care benefits, workers have to save more for their own future. Chinese workers, for example, put almost half their earnings in the bank. Developing countries use some of those savings for domestic investments. But if savings are larger than domestic investments, those savings go abroad. The outflow—or inflow for the other country—of those savings equals what we call the capital account of a country’s balance of payments. This account includes portfolio investment, the transfer of money to buy stocks and bonds, and foreign direct investment (FDI), the transfer of new capital in that year to build factories or purchase real estate abroad. Since the 1980s, barriers to capital flows have been reduced, just like those for trade flows. Companies can now move whole factories to other countries without heavy fees or restrictions and, as our example suggests, invest easily in other countries’ stock and bond markets. This liberalization of capital markets is the distinctive feature of globalization 3.0 (see the introduction to Part III). Financial and exchange rate policies: The capital account and current account taken together constitute the balance of payments. The balance of payments records all economic transactions with other countries, and these international transactions involve the use of foreign currencies. Net supply and demand for a country’s currency yields its exchange rate, that is, the value of the country’s currency in terms of a foreign currency. In fall 2015, for example, one U.S. dollar equaled roughly one hundred and twenty Japanese yen. Exchange rates have a powerful impact on the prices of imports and exports. A higher exchange rate makes exports more expensive, and a lower exchange rate makes imports more expensive. Thus, exchange rate movements are controversial among countries. In a system of floating exchange rates, the current and capital accounts more or less offset one another because exchange rates go up or down to clear accounts. In a system of fixed or managed exchange rates, however, a country may lose or accumulate foreign currencies, called foreign exchange reserves, as the country buys or sells its currency to maintain a fixed or targeted rate for its currency. If countries hold large foreign exchange reserves, they may target a lower value for their exchange rate, which helps them sell more exports than they would if market forces prevailed. China has been accused of doing this in recent years. Meanwhile, countries with surplus foreign exchange reserves invest in sovereign debt funds that buy assets abroad. China today owns more than $1.2 trillion in U.S. Treasury bonds. If, on the other hand, a country runs consistent current account deficits and its foreign exchange reserves are low or exhausted, it has to borrow an equivalent amount from abroad, which shows up on its capital account. If foreign lenders doubt that the country will be able to pay back such loans, foreign lending dries up and the country’s currency plummets, because without loans the currency has to go down to make exports cheaper and imports more expensive. This is the stuff of which foreign debt and currency crises are made, such as the eurozone crisis in Greece in 2015 and similar crises in Ireland, Spain, and Portugal. Theoretically, the United States could face such a crisis as well, and indeed it did in 2008–2009. It has run current account deficits for most of the past forty years, and there is always the possibility that foreign countries might start selling the dollars they have accumulated. But because many international trade (such as oil) and financial transactions are paid for in dollars and markets for dollars are large and liquid, countries are willing to hold large reserves of dollars. As long as they are willing to do so, the United States can cover its debt by simply printing more dollars—that is, until dollars become worth less due to inflation in the United States or foreign governments begin to sell dollars for political reasons, as France did during the Cold War and China may do in the future. The crisis in 2008–2009 was not a run on the U.S. dollar as much as it was a drying up of liquidity in the global, private-sector banking system, which came into existence only in the 1970s and 1980s. Concerned about bad loans, private banks everywhere—in Europe, Asia, and the United States—suddenly began to lend less. With all banks drawing back, private-sector lending froze up. Governments had to step in big time. All these policies interact with one another. For example, when the United States uses monetary policies to lower interest rates, as it has done since the financial crisis of 2008–2009, dollar assets such as bonds yield lower returns and investors are encouraged to buy bonds or other assets in foreign currencies, such as the yen, to earn higher interest rates abroad. The demand for foreign currency drives up the exchange rates of those countries and makes their exports more expensive. Countries such as Brazil and South Korea complained bitterly during the financial crisis that easy U.S. monetary policy had a detrimental effect on their economic growth. Similarly, domestic policies affect exports. When European countries faced debt crises and tightened fiscal policies, the United States complained because it wanted Europe to spend more and increase demand for U.S. exports and stimulate U.S. recovery. Countries are increasingly interdependent. If they want to retain the economic benefits of international markets, they have to give up a certain amount of control over their domestic policies. As the first causal arrow in the margin illustrates, liberal perspectives generally assume that they will do so to preserve mutual benefits and override security concerns. Realist perspectives are not so sure. They worry, as the second causal arrow shows, that security concerns place limits on interdependence to preserve national autonomy. For example, what if China decides for political reasons not to lend its savings to the United States anymore? When it stops, U.S. interest rates will rise, U.S. housing and growth will slow, and companies may cut back production and employment. American housing and jobs did decline in 2008–2009, and so did Chinese lending. Of course, Chinese exports to the United States also slowed. Both sides paid a price, and that’s why liberal perspectives assume they will continue to cooperate. Nevertheless, others believe it makes no sense and may even be immoral to take savings out of poor countries like China and give it to rich countries like the United States. From this moral or identity perspective, as the third arrow indicates (addressed more fully in Chapter 9), the world is supposed to help poor countries grow rich, not help rich countries indulge their insatiable consumer appetites. It’s not surprising therefore that globalization, just like the balance of power, looks different from the standpoints of different perspectives. OK, that’s a first cut at the way globalization works. Take a deep breath now, while we look more slowly and systematically at each of these mechanisms. current account: the net border flows of goods and services, along with government transfers and net income on capital investment. capital account: the net flows of capital, both portfolio and foreign direct investment, into and out of a country. portfolio investment: transfers of money to buy stocks, bonds, and so on. foreign direct investment (FDI): capital flows to a foreign country involving the acquisition or construction of manufacturing plants and other facilities. balance of payments: a country’s current and capital account balances plus reserves and statistical errors. exchange rate: the value of a country’s currency in terms of a foreign currency. fixed or managed exchange rates: exchange rates that are fixed by governments to gold, another currency, or a basket of currencies. Domestic Economic Policies There are basically two types of domestic economic policies: macroeconomic policies, which include fiscal and monetary policies, and microeconomic policies, which include regulatory policies of all sorts. Figure 8-1 Globalization: Go with the Flow Macroeconomic Policies Fiscal policy, as we have noted, is the national budget. If it is balanced, the budget’s influence on the economy is neutral. If the budget is in deficit, however, the government is spending more in the economy than it is taking out of the economy in taxes or revenues. In that case, fiscal policy is stimulating the economy, creating more net demand. Keynesian policies call for such a stimulus whenever the economy has unused resources, that is, when unemployment and unused industrial capacity are high. In the financial crisis of 2008–2009, all governments, including the United States, adopted stimulus packages to revive economic growth. As the economy then revives, according to Keynesian logic, production and employment increase, people and businesses earn and spend more, tax revenues go up, and the budget comes back into balance. If the budget is in surplus, the government is taking more resources from the economy by taxing than it is providing by spending. Thus, the government is contracting or slowing down the growth of the economy. Governments are seldom eager to do that, so Keynesian logic usually works in only one direction, to stimulate an economy and eventually contribute to overheating and inflation when industrial production cannot keep up with consumer demand. Monetary policy seeks to control the money supply. In open-market operations, central banks buy and sell short-term government securities, thereby pushing up or lowering the prices of these securities. If the price of the security goes up (down), the interest rate goes down (up). Changes in short-term interest rates then indirectly affect long-term interest rates. When short-term interest rates fall close to zero and can’t be reduced any lower, central banks may buy long-term securities to lower long-term interest rates directly; this action is called quantitative easing. The U.S. central bank has taken this step several times in recent years: during the financial crisis of 2008–2009 and again in fall 2010 and fall 2012. The Japanese and European central banks have done so as well. Now, consider how fiscal and monetary policy interact with one another and with the world economy. If fiscal policy is stimulative—that is, in deficit—the government is borrowing from domestic savings. Domestic savings consist of what the government saves (public savings, which are negative if the government runs a deficit) and what private households and industries save after they finish spending and investing (private savings). If the government absorbs total private savings to finance its fiscal deficits, additional savings have to come from abroad. That creates an inflow or surplus on the capital account. Now, as we know, if the capital account is in surplus, the current account has to be in deficit. In this way, a budget deficit may lead to a current account deficit, and economists frequently speak, especially in the case of the United States, about the “twin deficits,” namely, a budget deficit linked with a current account deficit. Notice, however, that a budget deficit does not have to cause a current account deficit. If private savings are huge, the government can run a deficit and not have to borrow from abroad. The country can still run a current account surplus. That’s exactly what Japan has done in recent decades; the government ran chronic budget deficits, but Japan continued to show a current account surplus. The Japanese people and companies save an enormous amount compared to their counterparts in the United States, and the Japanese government was able to finance its budget deficits entirely from domestic savings. Now, what if, in addition to a budget deficit, the government is running a tight monetary policy? It is trying to fight inflation and absorb excess local currency, or liquidity, by selling bonds and raising interest rates. Higher interest rates attract foreign capital or savings. The bigger the budget deficit (loose fiscal policy encouraging imports) and the higher the interest rate (tight monetary policy encouraging foreign deposits), the larger the capital inflow. This inflow creates a capital account surplus and, as its flip side, a current account deficit. All this assumes no change in private savings. But what if the budget deficit stimulates more consumption and business spending? After all, that’s what it is designed to do. Private savings then also go down. Eventually the inflow of foreign savings has to increase to cover not only public but also private spending and investment. This describes the flow of foreign savings to the United States in the early 1980s, caused by U.S. fiscal deficits and tight money policy. No wonder, at the time, European leaders like German chancellor Helmut Schmidt complained about “the highest interest rates since Jesus Christ.” He meant the enormous squeeze that U.S. policies of big budget deficits and tight money were putting on capital resources (savings) and, hence, interest rates in Europe. Often governments combine a loose monetary policy with budget deficits. They are trying to revive an economy and avoid deflation, a downward spiral of prices. Stimulating both fiscal and monetary policies creates two bangs for every buck—higher spending and more money. This combination of domestic macroeconomic policies, however, generates large debts, both at the treasury department and at the central bank. After the 2008–2009 financial crisis, the U.S. government added $1 trillion to the federal deficit with its stimulus program, and the Federal Reserve added another $3 trillion to its balance sheet through quantitative easing, by printing money to buy long-term securities from banks and other financial institutions. The danger is that such a stimulus may not work if there are other bottlenecks in the economy, such as excessive regulations and price controls (the case in the United States in the 1970s) or bad existing loans inhibiting banks from making new loans (the case in the United States in 2009–2012). Despite unprecedented stimulus, the United States experienced the slowest recovery in history after 2009. And if the stimulus does work, it may create another danger, namely inflation, if the government and the Fed do not withdraw the excess money from the economy in a timely way. Demand will rise faster than supply, prices will go up, exports will become less competitive (because they are now more expensive), imports will become more attractive (because they are now relatively cheaper than domestic goods), and the country will incur a growing current account deficit. If interest rates are low and inflation is rampant, a country may find it difficult to attract foreign savings. Indeed, capital may go in the opposite direction. Anticipating that the growing current account deficit may lead to a depreciation of the currency to correct the deficit (by increasing exports and decreasing imports), local investors may try to get their money out of the country. This scenario all too often afflicts poor developing countries that have lost control of their domestic policies and offer few good opportunities to attract foreign investment. But it also affected the United States in the 1970s and could do so again in the aftermath of recent stimulus policies if investors flee a weakening dollar. Realist perspectives expect countries to pursue different macroeconomic policies and rely on market forces and fluctuating exchange rates to coordinate or narrow differences in fiscal and monetary policies. They resist coordinating policies internationally. This approach, depicted in the causal arrow in the margin, was used by the United States in the early 1980s to drive inflation down by driving U.S. interest rates and the dollar up, thereby leading other countries to raise their interest rates as well (and reduce inflation) or see their currencies decline as savings moved abroad to capture higher interest rates. Liberal perspectives, which emphasize repetitive interactions, urge the direct coordination of macroeconomic policies through international summits. As the arrow in the margin shows, collective decisions at summits reduce national autonomy and create similar approaches. In the preparations for the Tokyo Summit in 1986, the United States and other major industrial countries agreed to reduce interest rates together to bring the dollar down. If the United States had reduced interest rates unilaterally, the dollar might have gone down too rapidly (because money would have flowed into other currencies offering higher interest rates), and if Europe or Japan had reduced interest rates without the United States, the dollar might have gone up and not down. Identity perspectives urge the adoption of similar macroeconomic policies by all countries. For example, free market policies championed by Ronald Reagan and Margaret Thatcher created more competitive markets and increased national wealth (depicted by the next causal arrow). At the Williamsburg Summit in 1983, the G-7 countries agreed to pursue similar policies of sound money, disciplined spending, low inflation, and deregulation. This consensus, which spread throughout the 1980s and became known in the 1990s as the Washington Consensus, advocated low inflation and market reforms in developing as well as developed countries. Eventually, strong opposition emerged to these free-market ideas, and in the recent financial crisis, the world buzzed about the need for a new policy direction, the Beijing Consensus, reflecting more statist or government-mandated economic policy ideas. Federal Reserve Chair Janet Yellen testifies before the House of Representatives Financial Services Committee in Washington DC in July, 2014. At the time, the U.S. economic recovery was still incomplete, though improving. Reuters/Kevin Lamarque Microeconomic Policies Fiscal and monetary policies influence supply and demand, and supply and demand in turn influence prices. So a big factor for any country is how well supply and demand structures respond to macroeconomic policy. That depends on domestic labor and capital markets and whether individual workers and firms are sensitive to price changes and market forces. A government’s microeconomic policies have a lot to do with the flexibility of domestic capital and labor markets. Are those markets free to adjust to changes, or are there significant bottlenecks in various sectors that resist change? Microeconomic policies come in many forms. The principal ones are regulations, subsidies, price controls, competition or antitrust policies, and labor union laws. These policies may apply to specific sectors of the economy, such as agriculture or telecommunications; specific industries, such as steel or semiconductors; or specific firms, such as General Motors, which the U.S. government took over temporarily during the financial crisis of 2009. As a rule, such policies do not apply to the economy as a whole, and that is why we call them micro instead of macro. Regulations establish health, safety, environmental, labor, and other standards for domestic products and services. They apply to traded products through various qualitative restrictions, such as the requirement that imported windshields for automobiles meet domestic crash standards. Obviously, a point of conflict arises when domestic and trade regulations differ. A big task of international trade negotiations is to narrow these differences. In the Single Market Act of 1987, the European Community rationalized domestic regulations among its member countries to create a single integrated market with compatible regulations, not just a customs union with zero internal tariffs. Although regulations serve good purposes, they also involve costs and, if excessive, reduce market flexibility and efficiency. Subsidies come in the form of grants and loans at below-market interest rates. Boeing, the U.S. aerospace company, has long complained that the European Union subsidizes Airbus, the European aerospace company that competes with Boeing. The EU, on the other hand, argues that the U.S. government does the same thing for Boeing by procuring large defense systems from the company. Such purchases create a large guaranteed market for Boeing, enabling it to reduce costs for commercial aircraft. Japan and the Asian tigers subsidized domestic industries to jump-start their development and then subsidized the exports those industries produced. Price controls are used to keep prices down, and price supports are used to keep them up. The United States introduced price controls in 1973 to contain inflation, but at the same time it stimulated the economy with loose fiscal and monetary policies, which drove prices up. The government was heating up the economy—in effect, creating steam—while freezing relative prices that might have redirected resources toward scarce supplies—allowing no place for the steam to go. Eventually, the kettle exploded. Conflicting policies produced goods that were not scarce and put unbearable pressure on the prices of goods that were scarce. Both stagnation and inflation resulted. The EU’s Common Agricultural Policy is a prominent example of the use of price supports. CAP sets domestic prices for agricultural products above market levels. It then imposes import quotas to keep cheaper foreign products out and provides export subsidies to encourage the sale of more expensive domestic surpluses abroad. Notice that all these microeconomic policies, like the macroeconomic ones, affect trade and hence globalization. Competition policies deal with monopolies. Sometimes they legalize monopolies. For example, in former communist countries, practically all industries were state monopolies. Today, in China, many still are. Until the 1980s, the telecommunications sectors in many Western countries were monopolies, such as AT&T in the United States. Today, utility sectors in most countries remain monopolies, although that’s beginning to change.3 For years, however, and particularly since the end of communism, governments have deregulated or privatized many monopolies. Antitrust policies in the United States broke up the Rockefeller Standard Oil empire in 1911 and AT&T in 1984. Eastern European countries sold numerous state monopolies in the 1990s. The EU investigated the U.S. firms Microsoft and Intel on charges of monopoly practices in the computer operating system and computer chip industries. Labor union laws set minimum wages and working conditions for factory and other workers. Labor unions in advanced countries complain bitterly that these laws are so lax in developing countries such as China, where unions are forbidden, that these countries have unfair trade advantages. Immigrants from Mexico and other developing countries undermine labor laws more directly, taking jobs below minimum wage and working illegally in advanced countries. Unions, on the other hand, restrict layoffs and push expensive compensation packages that reduce competitiveness and cause companies to invest abroad or in equipment to eliminate rather than create jobs at home. European countries have much stronger unions than does the United States. In past decades, they also have had much higher unemployment than the United States—roughly twice as high. European companies are reluctant to hire new workers because they can never get rid of them. On the other hand, many workers in the United States lose their jobs, and those who find new ones may work for lower wages or fewer benefits than they received previously. Trade Trade policy affects the prices of goods and services when they cross borders, either by taxing or subsidizing the prices or by restricting the quantity or quality of the goods and services. Taxes on goods and services crossing national borders are called tariffs. The price of an import may be increased by a certain percentage, customs fees and duties collected, and export taxes (for example, the United States taxed soybean exports in the 1970s to protect short supplies at home) or subsidies imposed (for example, to boost exports of aircraft, large industrial machinery, or food products). Trade policy also involves nontariff barriers (NTBs) such as quotas and qualitative regulations. Quotas are quantitative limits on imports and exports regardless of price. An embargo reduces imports or exports to zero; for example, the Arab members of the Organization of the Petroleum Exporting Countries (OPEC) embargoed oil in 1973. Qualitative regulations involve restrictions on traded products to protect safety, health, labor standards, and the environment. Imported toys have to meet certain safety standards, agricultural products certain health requirements, imported clothing basic labor standards (for example, no slave labor), and car mufflers approved environmental standards. Trade policies also include domestic laws that allow companies to appeal for relief from import surges, dumping practices (a foreign producer’s sale of a product abroad at a price below domestic production costs), subsidies, and other unfair trade policies pursued by foreign producers. Sometimes governments use domestic trade laws to protect products through the back door. For example, other countries often accuse the United States, whose tariffs are low, of using antidumping laws to restrict imports. Seventeen seventy-six was an eventful year. For Americans, it was the year Thomas Jefferson wrote the Declaration of Independence—the inspiring manifesto of political freedom stating that all people are created equal. In the same year in London, Adam Smith published another manifesto, this one dealing with economic freedom. In his book An Inquiry into the Nature and Causes of the Wealth of Nations, Smith traces the wealth of nations to the principle of specialization—the more specialized nations are, the wealthier they are. “The division of labour,” he writes, “occasions, in every art [activity], a proportionable increase of the productive powers of labour. The separation of different trades and employments from one another... is generally carried furthest in those countries which enjoy the highest degree of industry and improvement.”4 Specialization and the Division of Labor Smith gives the example of the manufacture of pins. One person draws the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head, and so on. Altogether, making a pin in Smith’s day involved eighteen distinct operations. As workers specialized, they became more proficient, saved time, and discovered easier and readier means to accomplish their individual tasks. Workers can also specialize to make different products rather than components. Smith spoke about the butcher, the baker, and the brewer, each of whom could specialize and become more proficient in making a particular product. Then they all could exchange their products and have more of everything than they would if they had produced each product for themselves. Notice that, to specialize, workers must be free to exchange the products of their labor with one another. If the butcher’s meat is taxed or embargoed, he cannot purchase the baker’s bread. Thus, specialization brings with it the idea of unimpeded exchange or integration of economic activities. Factories integrate such specialized exchanges vertically, while markets integrate them horizontally. Obviously, factories and markets may work under different rules. Communist economies organize factories and markets based on direct political control and government plans. Bureaucracies set multiyear production and consumption quotas and dictate direct exchanges of resources and final products. Capitalist economies organize production based on opportunity costs and market competition. Numerous independent managers calculate the opportunity costs, or the costs of alternative uses of resources based on competitive prices, and decide to buy or sell products based on the most efficient use of those resources. If markets are truly competitive, meaning no one producer or consumer is large enough to influence price, benefits increase for all by what Smith calls the “invisible hand.” Producers and consumers act independently against competitive forces that are beyond their control, and the net result is an increase in the wealth and well-being of all participants. Does Smith then believe that there is no role for domestic or international government—that is, for the visible hand? No, he devotes one of the five parts of his treatise to the role of government. He sees defense and education as government tasks. He even anticipates the drudgery of factory work, or what he calls the “mental mutilation” induced by specialization—boredom from repetitive activities in a production process—and calls on the government to encourage public diversions (such as recreation and parks).5 But the government must leave the butcher, baker, and brewer free to exchange their products on a wider competitive basis so that they are not dealing just with friends, which restricts the size of markets, or being told what to charge, which distorts the efficiency of markets. Specialized businesses need access to a relatively free marketplace in which prices are determined by impersonal competition rather than by friends or government connections and, hence, possibly corruption. tariffs: taxes on goods and services crossing borders. nontariff barriers (NTBs): policy instruments other than price, such as quotas and qualitative restrictions, designed to limit or regulate imports and exports. opportunity costs: the costs of alternative uses of resources based on competitive prices. Comparative Advantage Comparative advantage in international trade derives from the same principles of specialization and division of labor. Countries have different talents, resources, institutions, and people. They are better at doing some economic activities than other economic activities. Even if they are more advanced and better at doing everything—mining, manufacturing, and farming—they are still comparatively better at doing one of these activities and letting others do the rest. Think of Tiger Woods, the professional golfer. He plays golf a lot better than he sews shirts or produces food. It pays for him to focus on golf, even if he is just as good at sewing and farming as someone else. His comparative advantage derives from his relative talents, not from his absolute talents. The same is true for countries. If they can specialize in what they do relatively best, they can be more productive. Thus, poor countries do not have to produce something more efficiently than rich countries; they just have to produce one thing more efficiently than some other thing that they produce themselves. In 1817, David Ricardo, another English economist, demonstrated Smith’s principle of specialization for international trade. He took two countries, Portugal and England, and considered their relative talents in producing two goods: cloth and wine. As Table 8-1 shows, Portugal can produce both products more efficiently than England. It can produce a bolt of cloth in 90 days of labor, while England requires 100. And it can produce a barrel of wine in 80 days, while England requires 120. Portugal has an absolute advantage in both products, meaning it can produce both products more efficiently than England. The benefits of comparative advantage are easier to show when each country is better at producing one product, but Ricardo wanted to take the hard case, when one country is better at producing both products. At first glance, then, why should Portugal or any country specialize and trade if it can produce both products more efficiently? But look again at Table 8-1. In Portugal, one bolt of cloth should exchange for 9/8 barrels of wine. Why? Because it takes exactly the same number of days of labor—or input—to make these two quantities. In England, one bolt of cloth will exchange for 5/6 barrels of wine. Thus, one bolt of cloth buys more wine in Portugal (9/8 barrels) than it does in England (5/6 barrels). Conversely, one barrel of wine buys more cloth in England (1 and 1/5 bolts) than it does in Portugal (8/9 bolts). So if Portugal and England could trade cloth (where 1C stands for one bolt of cloth) for wine (where 1W stands for one barrel of wine) at any ratio between 1C = 9/8W and 1C = 5/6W, both countries would gain. To see this, look again at Table 8-1. With 1,000 days of labor invested, half in each product, Portugal and England together produce 10 5/9 bolts of cloth and 10 5/12 barrels of wine. With 1,000 days of labor invested in only the product each produces more efficiently, England produces 10 bolts of cloth and Portugal 12 1/2 barrels of wine. They have not used more resources, yet they have produced almost the same amount of cloth (10 compared to 10 5/9 bolts) and 20 percent more wine (12 1/2 compared to 10 5/12 barrels). The reason is comparative advantage—Portugal is comparatively more efficient at making wine, even though it is better than England at making both products, and England is comparatively better at making cloth, even though it is less efficient than Portugal at making both products. Source: Data on “days of labor required to produce” are from James C. Ingram and Robert M. Dunn Jr., International Economics, 3rd ed. (New York: John Wiley, 1993), 29. This is a simplified example. More is involved in making wine and cloth than labor, and exchange rates may distort costs and push the exchange ratios outside the range where trade is beneficial (in the example, between 1C = 9/8W and 1C = 5/6W). But the result holds even if we include other costs: land, capital, and knowhow. Whatever it takes to make a bolt of cloth, we compare that to the costs of making wine. What are the opportunity costs we forgo if we make cloth instead of wine, or vice versa? The more alternative uses of resources that are involved, meaning the more products and countries involved, the bigger the gains. Comparative advantage offers all countries the opportunity to create more wealth without using additional resources, including the poorest countries. Trade, in short, is a powerful multiplier of wealth for all countries, just like technology. (Critical theory perspectives see comparative advantage as coerced and exploitative, not free and mutually beneficial; see Chapter 10.) comparative advantage: a relationship in which two countries can produce more goods from the same resources if each specializes in the goods it produces most efficiently at home and the two trade these goods internationally. Exceptions to Unrestricted Trade If unrestricted trade is so wonderful, we might ask, why then is it so disputed? Well, there are obvious limitations to liberalizing barriers to trade. One involves products critical to a nation’s defense. A nation may wish to have national security export controls to limit trade in military and dual-use (having both commercial and military applications) products and technology. Adam Smith recognized this limitation, and all nations and economists since have drawn the line at liberalizing barriers if national security interests might be compromised. They impose limits not only on critical military weapons materials, parts, and designs but also on imports of vital products crucial to the overall economy, such as energy, food, and potentially scarce resources, such as copper or bauxite. The difficulty with national security exceptions to free trade is where to draw the line. In some sense, every product may be essential for national security. As a rule, exceptions apply more to new products and technologies than to widely used ones and more to WMDs than to conventional weapons. Still, the United States frets about dependence on foreign oil, and Japan worries about excessive dependence on food imports. Diversifying suppliers of crucial imports and stockpiling reserves, such as oil, are alternative ways to minimize the national security risks of trade dependence. A second exception to unrestricted trade is protection for infant industries. How do countries develop new industries to compete in international markets if from the get-go those industries are wide open to imports from more advanced industries in foreign countries? Thus, infant industries, it is argued, warrant initial trade protection until they develop the scale and experience to compete effectively with imports. This was the rationale for the import substitution policies of developing countries right after World War II. These policies sought to substitute domestic industries for imports—hence the term import substitution—to protect them from imports until they could compete at world standards. As we discuss in Chapter 9, Latin American countries pursued such policies, as did late-developing industrialized nations in the nineteenth century like the United States, Germany, and Japan. Infant industry protection seems logical enough. The problem, of course, is to know when the “infant” has grown up. Too often, protected industries get used to protection and never grow up. They compete only against local counterparts, which are also infants, while industries in other countries that compete in foreign markets face stiffer competition and develop new and better products. Larger countries, such as Brazil, Argentina, and Mexico, are more tempted by import substitution strategies than are small ones, such as the Netherlands and Singapore, because large countries have big internal markets for local industries to supply. But even large countries run into limitations and eventually shift to more open trade policies. The United States did so in the early twentieth century, Germany and Japan came around after World War II, and the large Latin American countries followed suit in the 1990s. infant industries: developing industries that require protection to get started. import substitution policies: policies developed in Latin America that substitute domestic industries for imports. Strategic Trade Theory A more serious challenge to the theory of comparative advantage developed in the 1980s and 1990s. Until World War II, most international trade involved the exchange of complementary products, such as food products for manufactured goods. Trade was mostly interindustry trade, in which complementary products were exchanged by different industries and often by countries at different stages of development. In colonial regimes, for example, imperial powers exported manufactured goods and imported agricultural products and commodities. Even as late as the early 1950s, two-thirds of all trade took place between advanced and developing countries. In this case, comparative advantage seemed to explain trade patterns quite well. Colonial territories were mostly southern countries with climates and populations suitable for agriculture and mining. Advanced countries were northern countries with less arable land and more industry and technology. Each country traded products that it produced relatively more efficiently than other countries. After 1950, however, trading patterns began to shift. By 1990, three-quarters of all trade was among advanced countries and only one-quarter between advanced and developing countries. And the trade among advanced countries was in competitive, not complementary, products. Advanced countries shipped automobiles, aircraft, cameras, machine tools, and semiconductor chips to one another, not agricultural or raw material products. And they often shipped products to one another within a single industry; for example, some exported the semiconductor chips for computers while others shipped central processing units. Trade was mostly intraindustry trade, in which components from the same product or industry were traded. What explained this type of trade? Did countries have different capabilities (that is, talents) within industries (for example, within the cloth industry) as well as between them (cloth and wine)? Yes, in one sense, specialization had advanced now to differentiating tasks within industries as well as between industries. If Japan could specialize in semiconductor chips and produce them in sufficient volume to cover the U.S. and European as well as the Japanese markets, it could exploit economies of scale, whereby the larger the amount of anything produced, the lower the average cost of production. The United States might do the same in customized chips or sophisticated central processing units. OK, but what explains the fact that Japan specialized in computer chips and the United States in central processing units? Or that the United States dominated the international aircraft market? How did comparative advantage work in these cases of economies of scale? It might be argued that the United States simply had more sophisticated workers in the computer central processing and aircraft industries. But did it have more sophisticated workers because it already had a dominant share in computer and aircraft sales around the world, or did the existence of more sophisticated workers create the dominant market share? Which came first, the sophisticated workers or the dominant market share? And, as discussed earlier in the case of Boeing and Airbus, did governments help their industries gain dominant market share? Seeking to explain this conundrum, economists developed a new trade theory called strategic trade, starting from the premise that in markets for some products the economies of scale are so large that only one firm or country can make a profit in that product in world markets. If another firm enters the market, profits drop below costs and neither firm can gain. In such markets, the firm exploits what economists call monopoly rents. Lacking competition, it sets prices higher than they would otherwise be. Thus, the firm that gets to the market first wins, whether its product is more efficient or not. Think of the keyboard for the typewriter and now the computer. The placement of the keys on the typewriter is neither logical nor efficient. But the so-called QWERTY keyboard became the standard. It got to the market first and everyone learned to type using it. Another example may be Microsoft, which dominated the market in operating software systems for computers with Windows, which, some believe, was actually inferior to others, such as Apple’s Macintosh. But Microsoft got to the market first and captured monopoly rents. Now it is hard for other companies to challenge Microsoft. In 2009, the EU moved to break up Microsoft’s monopoly by demanding that it separate parts of the Windows operating system before it can compete in European markets. Here is a classic example of path dependence, a result that no one consciously intends. Because it costs a lot of money to get into monopoly markets, what economists call “high barriers to entry,” governments may be the only actors with sufficient resources and authority to help companies compete. So this theory of trade assumed that comparative advantage did not just exist naturally to be exploited; it had to be created. And only governments had the deep pockets to create it. Thus rather than reducing government intervention to encourage comparative advantage, governments intervened in the case of strategic trade to create what became known as competitive advantage. Competitive advantage calls for governments to protect and subsidize key industries and technologies, whereas comparative advantage calls for governments to lower protection and subsidies for trade. Japan was thought to have a special advantage in strategic trade because it had a highly trained bureaucracy and a relatively weak parliament. Government could pick industries and technologies for the long term and not be besieged by special interests promoting this or that industry important to some legislator’s constituency. Japan, it was said, had patient capital—that is, money invested by the government or government-directed banks over the long term to develop dominant industries for the future. By contrast, the United States was short-term oriented, with a Congress dominated by special interests and industries expected to earn profits on a quarterly basis. What about this new trade theory? Does it invalidate comparative advantage and call for governments to intervene in trade markets rather than withdraw from them by lowering barriers to trade? Realist perspectives tend to favor strategic trade because they focus on relative gains and view markets as zero-sum. As the first causal arrow in the margin suggests, monopoly in markets, like hegemony in international politics, creates strategic opportunities to increase national autonomy. Identity perspectives, as the second causal arrow illustrates, see strategic trade as suggesting how different economic cultures—a more consensus-oriented Japanese culture versus a more individualistic American culture—distort and limit comparative advantage. Liberal perspectives tend to be skeptical of strategic trade because it limits common gains. As the third causal arrow shows, they believe comparative advantage may still apply in determining which industries will be strategic in the future. Indeed, liberal economists who came up with the idea of strategic trade warned that it had some limitations. Although theoretically valid, it is very difficult to implement in practice.6 The reasons? First, very few industries actually have the features that permit one company or country to dominate that industry. And second, if there are such industries, it is very difficult to know in advance which ones are critical for the future. Bureaucrats may be good, but if they were that good they would have a better track record. Japan’s Ministry of International Trade and Industry (MITI), now the Ministry of Economics, Trade and Industry (METI), made many choices about industry development in Japan that proved to be wrong, especially as Japan caught up with Europe and the United States.7 And now that Japan is no longer catching up in world markets, its economy has slowed dramatically, and its strategic trade model seems to offer no special advantages. Identifying future technologies and industries and targeting them using government programs are easier to do when countries are catching up. Japan was catching up in the 1960s and 1970s, as China is doing today. While catching up, a government can look at competitive world markets and see where its industries are behind. It can then subsidize and protect those industries until they achieve global competitiveness. In this situation, strategic trade theory is a form of the infant industry argument applied to catching up with world standards in high technology. But guessing which completely new industries will dominate world markets in the future is another matter. Nanotechnology, which exploits the property of materials at very small dimensions, is a new technology for the future. But its uses are vast and still in many cases unknown. As liberal perspectives see it, sorting out what aspects to focus on and particularly what aspects to develop first is difficult and best left perhaps to a competitive process of trial and error in the marketplace among multiple participants. Government policies for research and development (R&D) and procurement still play a role, but this role is more one of supporting broad infrastructure for an economy (for example, funding multiple research projects and educating qualified engineers), similar to developing an efficient transportation and communications system, than one of picking specific winners in the technology and industry sweepstakes of the future. Workers unload imported unprocessed sugar at the Dhampur Sugar Mill in Asmoli, India, in August 2009. Sugar jumped to a twenty-eight-year high in New York as low monsoon rainfall in India threatened to limit cane yields and excess precipitation delayed harvesting in Brazil, prolonging a global production deficit. India is the world’s biggest consumer of sugar. Keith Bedford/Bloomberg via Getty Images economies of scale: cost advantages whereby the larger the amount of a good that is produced, the lower the average cost of production. competitive advantage: a trade advantage created by government intervention to exploit monopoly rents in strategic industries. Trade and Jobs Does trade create jobs or destroy them? This is the biggest controversy related to trade. As we will see, it does both. It destroys relatively less skilled or low-wage jobs and creates relatively more skilled or high-wage jobs. In this sense, trade acts as a jobs escalator, moving people up to higher levels of skills and wages, assuming they can acquire the required training and education. On balance, trade creates better jobs but not necessarily more jobs. Companies that engage in international trade pay workers 15 to 20 percent more than industries that engage only in domestic markets.8 From a realist perspective, which emphasizes exports, taking in more imports than exports may be seen as substituting foreign jobs for domestic jobs. As the causal arrow shows, lost jobs warrant import restrictions that enhance national autonomy. This is what led Latin American countries to embrace import substitution policies. They sought to substitute domestic jobs for the foreign jobs producing imports. Realists tend to see trade as a zero-sum game. But this reasoning, according to the liberal perspective, looks too narrowly at trade. It ignores broader interconnections (interdependence). Much more is going on in domestic policies and overall relations between importing and exporting countries than in trade. Remember from our earlier discussion that importing more than exporting also means that foreign countries are lending money to the importing country. The liberal perspective focuses on how this money is spent. As shown in the next marginal feature, the causal arrow runs from capital flows to domestic investments to greater national autonomy. Now, if that money goes into luxury consumption or corruption, it is wasted. But if it goes into productive uses, it helps the importing country develop and grow. Poorer countries are expected to import more than they export; they need machinery and capital equipment to build new factories. Richer countries such as the United States are expected to export more than they import; they then lend money to developing countries. But the United States imports more than it exports and thus borrows from developing countries like China. Is such lending perverse? Not necessarily. It depends on what the United States does with the borrowed money. If it invests the foreign money to develop new service and high-tech industries, where it has a comparative advantage, it creates new and better jobs. Labor in the United States moves out of low wage jobs so that labor in developing countries can move into these jobs. Whether the United States or any other net-importing country actually uses capital inflows for such purposes is a function of its domestic policies, not its trade policies. Identity perspectives emphasize the ideas governing domestic policy more than net exports (the realist perspective) or the specialization and comparative advantage derived from trade and capital flows (the liberal perspective). For example, as the causal arrow shows, a developing country may pursue domestic policies that encourage elites to import luxury goods, not machinery. Domestic policies support an elite culture, not economic efficiency. Or, as another example, the United States might be pursuing inflationary domestic policies, as it did in the 1970s. Higher prices encourage imports for consumption, not investment, because consumers buy now before prices go up while industries wait to invest until prices stabilize. Economic policies serve a consumer, not investor, culture. If domestic policies encourage savings and investment rather than luxury or inflation-driven consumption, a trade deficit does not cost jobs but, instead, creates the right kind of jobs. Developing countries need to import more than they export because they are developing. But they also need to import the right products that will enable them to grow in the future and later pay back the money they borrowed for excess imports. What about trade with low-wage countries? If such trade doesn’t cost jobs, doesn’t it lower wages and reduce standards of living in advanced countries if they try to compete with low-wage countries? An economic theory known as the Hecksher-Ohlin theory suggests it might. Over time, trade will equalize prices for products from different countries. That’s the effect of creating a single world market with converging prices. But economists Eli Hecksher and Bertil Ohlin argued that it will also equalize prices eventually for labor and other inputs or factors of production. As prices for final products become more competitive through trade, so will prices for factors of production such as labor. Thus, some critics of free trade worry that, with unlimited supplies of labor in developing countries, trade will eventually drive wages in advanced countries down to levels prevailing in developing countries. After all, in the late 1990s, the average worker in manufacturing in China cost only $730 per year, while in Germany the average worker cost $35,000 per year and in the United States $29,000 per year.9 The critics are right that wages for low-skilled jobs will move down in advanced countries, at least relative to higher-skilled wages in advanced countries. But they are wrong that wages in developing countries will never move up relative to wages in advanced countries. Wages in developing countries are lower because productivity is lower. Productivity is measured by how much output is produced by a given input. A worker in a developing country takes longer to do a job than a worker in an advanced country because of less equipment, fewer skills, and poorer health. So the worker in China who makes $730 a year produces annually only $2,900 worth of value-added (that is, output minus inputs), while the German worker who is paid $35,000 a year produces $80,000 worth of value-added and the American worker paid $29,000 produces $81,000 of value-added.10 For trade to drive wages down, productivity would have to go down. Yet, as we learn in this chapter, trade increases efficiency and hence productivity in both advanced and developing countries. Thus, if trade equalizes wages, it does so at higher, not lower, levels in both countries. The data in Figure 8-2 suggest that as imports from developing countries increase, wages in developing countries move up toward levels in advanced countries. In 1960, developing countries that traded with the United States paid their manufacturing workers only 10 percent of the wages paid to American workers. By 1992, that figure had jumped to 30 percent.11 Wages for workers in industrial countries that traded with the United States rose even faster, exceeding U.S. wages in 1992. Productivity and, hence, wages in manufacturing go up, not down, as developing and industrial countries trade more with one another. As the accompanying graph (Figure 8-3) shows, manufacturing wages today in China are going up, not down, causing Chinese officials to worry about developing higher value-added export industries. Thus, trade shifts jobs from lower productivity and wage levels to higher ones. This movement is, after all, the story of industrialization and development. Map 8-1 shows this story as told by employment or jobs data. In the nineteenth century, before the industrial revolution took off in the United States, 80 percent of the American people earned their living on the land. Today, less than 1 percent are engaged in agriculture; jobs moved into the manufacturing sector. By 1950, more than 40 percent of American workers were employed in manufacturing. Then, the next phase of the industrial revolution began. Jobs moved into the service sectors. Today, less than 10 percent of American workers are employed in manufacturing, while more than two-thirds are employed in service sectors. Jobs moved into retail, transportation, banking, data processing, software, finance, marketing, and other information-related activities. In recent decades, for example, United Parcel Service (UPS), a major U.S.-based delivery service, added on average several hundred thousand jobs per year to its workforce. We read about the loss of steel and automobile jobs but seldom about the creation of new jobs in service industries, such as UPS. This is another reason we need to know more about international events than just what newspapers tell us. Figure 8-2 Wages of U.S. Trading Partners as a Share of U.S. Wages, Manufacturing Source: Gary Burtless, Robert Z. Lawrence, Robert E. Litan, and Robert J. Shapiro, Globaphobia: Confronting Fears about Open Trade (Washington, DC: Brookings Institution, 1998), 69. Used with permission. Figure 8-3 Manufacturing Wages in China on the Rise Source: Mark Wiersum, “China’s Manufacturing Wages Rise to $7,000 per year: Baidu benefits,” Market Realist.com, http://marketrealist.com/2014/04/chinas-manufacturing-wages-rise-7000-per-year-baidu-benefits/ MAP 8-1 Labor Patterns Worldwide Source: Central Intelligence Agency, “The World Factbook,” https://www.cia.gov/library/publications/the-world-factbook Note: Data for percentage of labor force by occupation come from different years, but most are from within the past ten years. For labor force data, agriculture, fishing, forestry, and mining are considered agriculture. Government, public works, construction, trade, tourism, commerce, utilities, and the like are considered services. Any processing of raw materials beyond agriculture, mining, fishing (e.g., food processing, oil refining, or canning tuna) is considered manufacturing. In cases where employment in manufacturing is less than 15 percent, that country is classified according to which other sector claims the greatest share. That causes some countries to be classified as service economies when they are still developing manufacturing industries but the manufacturing share is still below 15 percent. Most services in some developing countries, such as Mongolia, may also be government related, not the information age services that high tech countries develop. Data are not available for some countries; those countries are not shaded. Think about this statistic. In 2005, when the U.S. economy was growing, just over twenty-nine million people lost jobs and thirty-one million found jobs.12 The net number of 2 million represented the increase in employment. Jobs are being destroyed, rotated, and created every day, what economists call churning. Why don’t we read about that? What perspective or special interest is driving the news coverage? Jobs changing on a massive scale is the mark of a growing and robust economy. The former communist countries tried to save jobs by not participating in free international trade—and they did save jobs. They saved the same old jobs in the same old industries that became obsolete and uncompetitive and eventually went bankrupt. Then everyone lost and had to change jobs, all at once. By contrast, throughout the cycles of job loss and creation over the past century, per capita incomes in the United States and other capitalist countries rose. And during the periods of greatest prosperity in this century—before World War I and after World War II—world trade markets were open and expanding. In the interwar period, when trade was restricted, the United States suffered a severe depression. Certainly no one would argue that free trade hinders growth. U.S. citizens are far better off today than they were a century ago. Developing countries also gain from trade if they pursue sound domestic policies and world markets remain open to their products. In fact, in recent decades, as globalization exploded, developing countries such as China, India, Brazil, and Mexico grew twice as fast as advanced countries. Opponents of free trade say, yes, but trade involves job losses by the least-skilled workers in a society, those least capable of finding new jobs. These workers become marginalized and inequality increases. And the critics are right. As we have learned, trade shifts jobs from activities in which countries are less efficient into those in which they are more efficient. That means the less efficient or least-skilled workers are displaced. (By reporting only jobs lost, the media clearly act as advocates for these workers.) This happens in both developing and advanced countries. Think of the enormous displacement going on today in the Chinese countryside. Millions of Chinese laborers are no longer needed on the farm, where machinery and better farming know-how are increasing production with less labor. They migrate to the cities, a strange and disorienting environment for people used to a traditional rural culture. Today, 53 percent of China’s people live in cities, compared to 18 percent in 1978. On average, at least thirteen million make the shift every year. They are the least educated and the most vulnerable Chinese citizens. Similarly, high school–educated steel and automobile workers in the United States, whose families have worked in these industries and lived in the same communities for generations, suddenly lose their jobs and have to move to new and unfamiliar areas. These are serious issues, and past remedies have been inadequate. Many countries offer trade adjustment assistance in the form of cash benefits or programs to retrain workers displaced by trade. But these programs often discourage workers from searching for new jobs by paying them what they earned before and do little to help workers overcome the psychological effects of losing a job and moving a family. Newer plans call for wage insurance that would encourage displaced workers to take new jobs at whatever level of pay. The insurance would then make up the difference between the old and new wages. But is a remedy pegged specifically to jobs lost through trade the answer, or should the problem, like an excess of imports over exports, be viewed in a broader perspective? Data show that job loss for workers without high school diplomas is just as great in industries that are not affected by trade as in those that are.13 Something larger is going on. From a liberal perspective, the fundamental cause of change in jobs is not trade but technological development. Farmers in China and steelworkers in the United States lose jobs primarily because new machinery does their old jobs more efficiently, not because trade takes place. Technological development is a function of education and domestic economic policies. So doing a better job generally of educating and retraining workers and of pursuing domestic policies to sustain healthy growth may be more important than specific trade assistance programs. Domestic policies, in short, play a bigger role than trade policies. Notice the primary level of analysis here. As the causal arrow in the margin shows, domestic policies are more important than international trade to increase incomes. In Chapter 10, we discuss trade from the critical theory perspective, which emphasizes systemic over domestic levels of analysis and is much more critical of trade. One thing is certain. Stopping trade ends the possibility of using resources more efficiently and, thus, stops or reduces growth. On the other hand, neglecting displaced workers creates powerful forces to stop trade. So dealing with the transition of the least-skilled workers displaced by technology and trade in both developing and advanced countries is part of the global effort to continue open trade and spread the benefits of growth. Finally, what about unfair trade? A catchall complaint is that countries at different stages of development cannot trade with one another because their standards are too different. Identity perspectives are particularly concerned about this aspect of trade. It is not just that wages are lower in developing countries but also that labor, environmental, health, and other regulatory standards that reflect different domestic values are lower. Think about the controversy that arose in the United States in 2007 concerning the import of toys from China. Some four million toys from China sold as Aqua Dots were recalled because children swallowed beads in the toys containing a dangerous chemical.14 If industries can export products that are unsafe, that are produced with child labor or with few concerns for pollution and the health or safety of their own workers, and that are subject to lower taxes or higher subsidies, their exports are not fairly priced and therefore undercut the higher labor, environmental, and other standards in the importing countries. Numerous trade rules exist in domestic legislation and international agreements to safeguard against these abuses. But differences will always exist unless countries become identical to one another. In that case, however, there would be no basis for comparative advantage and mutually beneficial trade. From a liberal perspective, managing regulatory differences by rules that meet minimal levels of fairness and raise standards as countries develop is probably the best way to proceed. As we see next, that’s increasingly the job of the World Trade Organization. The Jin Mao Tower (center left) and the Oriental Pearl Tower (background center right) stand among other commercial buildings, seen from the Shanghai World Financial Center, in Shanghai, China. Urbanization has swelled in China as government efforts to revive demand have driven a rebound in industrial output, retail sales, and the housing market. Tomohiro Ohsumi/Bloomberg via Getty Images productivity: output per unit of input. trade adjustment assistance: cash benefits or retraining programs for workers displaced by trade. unfair trade: trade that violates an international trade agreement or is considered unjustified, unreasonable, and discriminatory. Global Trade Negotiations In the nineteenth century, Great Britain applied free-trade policies unilaterally. It simply removed tariffs on corn (grain) imports and reduced barriers on other imports as well. Why didn’t farmers resist? They lost jobs as agricultural products from abroad flooded British home markets. Moreover, because Britain was liberalizing trade unilaterally, export interests did not immediately gain. So why did Britain do it? The realist answer from the domestic level of analysis is that farmers were simply too weak politically to stop the free-trade movement. Technology had shifted the advantage to manufacturing activities. Exporters had gained the upper hand earlier by shipping manufacturing goods to colonial territories. Now, once other industrializing countries such as France and the Netherlands followed Britain’s lead to liberalize unilaterally, manufacturing exporters gained access to industrial markets as well. In the 1930s, when the United States took the lead in trade negotiations, it did not liberalize imports unilaterally but reduced barriers through bilateral negotiations. It negotiated so-called reciprocal trade agreements; each country lowered tariffs and opened markets. Now, although importers lost, exporters in the same country gained. As long as export interests dominated, free-trade agreements went forward. Consumers gained because of lower prices, and workers gained new jobs in the export sector but lost others in the import sector. So the politics of trade liberalization depended on whether export interests outweighed import-competing interests. Consumers are usually not a significant factor in trade politics because they are affected only indirectly—through incremental price increases on imported products—and do not organize nationally to protect their wallets as labor unions do to protect their jobs. Protectionism dominated through World War II. In 1947, more than two hundred bilateral quota agreements limiting imports by specific amounts carved up markets in Europe. The liberalization process to reduce these barriers was slow. Gains from bilateral trade agreements between just two countries were not enough to generate much enthusiasm. Moreover, the United States applied the most-favored-nation (MFN) principle to these agreements. The MFN principle gives all countries, including those that do not participate in the bilateral negotiations, the same benefits as the countries participating. Some way had to be found to get more countries involved directly in negotiations if trade liberalization was to become more significant. This was the rationale for the initiation of multilateral trade rounds, in which multiple countries negotiated simultaneously. The GATT, which dealt only with manufactured goods, organized the first such round in 1947, which lowered tariffs by an average of 20 percent. Even among twenty-three countries, however, these negotiations went slowly. As more countries joined the GATT, the process became more difficult still. The next four rounds accomplished less, although free trade moved forward in the OEEC (the Marshall Plan) and the European Common Market. By the sixth round in the 1960s, known as the Kennedy Round, a broader approach was undertaken, called across-the-board trade negotiations. Countries agreed to lower tariffs by a certain average across all manufactured products rather than product by product. The Kennedy Round reduced tariffs on average by about 35 percent. This was the first round in which the EC countries negotiated as a group. They had consolidated their common market in 1962 and now had a common external tariff toward outside countries. Few developing countries participated in the GATT rounds, and few of the products, such as agriculture and commodities, for which the GATT was not responsible, were included. Nevertheless, some developing countries in Asia that emphasized exports, such as South Korea, exploited the MFN principle to get a foothold in advanced-country markets. The participation of developing countries increased in the next two rounds. The Tokyo Round in the 1970s moved trade liberalization forward even as developing countries challenged the GATT and other Bretton Woods institutions. UNCTAD, the developing countries’ preferred trade organization, demanded tariff preferences for developing countries. Known as the Generalized System of Preferences (GSP), these preferences violated MFN rules by granting exports from developing countries duty-free access, while similar exports from advanced countries faced tariffs. Developing countries were also not required to reciprocate. Notice the realist premise of GSP (as compared to the liberal premise of MFN), skewing relative gains toward developing countries. GSP, however, was severely limited by restrictions. Many exports did not qualify, such as textiles, steel, and footwear. These products were being increasingly restricted by quotas, and GSP exports lost duty-free access if they exceeded a de minimis level, which was usually set fairly low. Nevertheless, the Tokyo Round recognized the need to bring developing countries increasingly into the world trading system. Overall, the Tokyo Round lowered tariffs on average by another 30 to 35 percent. Tariffs were now so low that other restrictions or NTBs, such as domestic regulations, were becoming more important and attention was shifting to product sectors that the GATT was never intended to address, such as services, agriculture, and investment. The Uruguay Round was the first round to bear the name of a developing country and the first to involve significant participation by developing countries. Initially, developing countries blocked the round. They broke up a GATT ministerial meeting in Geneva in 1982 because they feared that a new focus on services and investment would divert attention from their concern with manufactured goods, especially the quota restrictions on textiles and other low-technology exports.15 Domestic reforms in the 1980s changed their minds. Countries such as Mexico and India shifted toward more market-oriented policies and followed Asian countries to focus more on exports. The Uruguay Round was finally launched in 1986 and ended successfully in 1994. The Uruguay Round lowered tariffs further, but its big accomplishment was to extend the principle of free trade beyond manufactured goods to services, investment, agriculture, and intellectual property. Liberal perspectives would see this development as another example of path dependence, unintended consequences from the earlier liberalization of manufacturing trade. The new General Agreement on Trade in Services (GATS) was signed and steps were taken to convert agricultural barriers to tariffs for future liberalization and to create common rules for investment and intellectual property. The widened agenda for liberalization was incorporated into the WTO, which subsumed the GATT along with GATS and other agreements. The WTO ended quantitative restrictions on textiles and other products. And developing countries looked ahead to the next round, which would deal for the first time with the liberalization of agricultural products, an area of potentially enormous benefit for large and small developing countries alike. The latest round of multilateral trade negotiations commenced in Doha, Qatar, in November 2001. As in the case of the Uruguay Round, the first attempt to launch the Doha Round failed. In 1999, hundreds of NGOs turned out in Seattle to protest the spread of free trade. Nevertheless, known as the Developing Country Round, Doha puts key objectives of developing countries at the top of the agenda, such as reducing agricultural subsidies in the European Union and United States, liberalizing patents for high-priced medical drugs for AIDS and other diseases in the third world, and strengthening trade capacity-building infrastructure and procedures in the most vulnerable developing countries. At the same time, the Doha Round also calls for further measures that benefit advanced countries, such as lower barriers on industrial, service, and investment flows. most-favored-nation (MFN) principle: a principle under which nations that negotiate tariff reduction offer the same low tariff to all nations that they offer to the most favored nation, meaning the nation that pays the lowest tariffs. multilateral trade rounds: trade negotiations in which multiple countries participate and reduce trade barriers simultaneously. Doha Round: the ninth and most current round of trade talks, which offers significant potential benefits to developing countries in agriculture, medicines, and infrastructure. Regional Trade Multilateral trade rounds are complex and difficult to manage. Free trade on an MFN basis is a collective good. All countries can enjoy it even if they don’t contribute to it. In these circumstances, many countries become free riders; they wait to see what other countries will contribute, thereby hoping to get the benefits without contributing much themselves. The WTO currently has 161 members. Recall that the GATT and WTO operate on a one-country, one-vote basis, unlike the IMF and World Bank, which have weighted voting (see Chapter 6). Decisions in trade areas require consensus, a time-consuming process. The Uruguay Round took eight years to complete. In 2015, the Doha Round was in its fourteenth year and still not concluded. Countries become impatient and seek alternative trading arrangements at the bilateral or regional level, even though such trade is theoretically less beneficial than global trade. Article 24 of the GATT makes an exception to the MFN principle for discriminatory regional trade blocs that agree to reduce their internal tariffs to zero. A common market does this and then establishes a common external tariff, while a free-trade area also eliminates internal tariffs but allows members to retain different external tariffs. This was the basis for the creation in the 1950s of the European Common Market and the European Free Trade Area (EFTA). The countries that founded EFTA eventually joined the European Union, Britain being the most important one in 1973. Many developing countries also tried regional trade arrangements, but none of these arrangements came close to the achievements of the European Union. Examples included the Central American Common Market (El Salvador, Nicaragua, Costa Rica, Guatemala, and Honduras), the Andean Common Market (Peru, Bolivia, Ecuador, Colombia, and Venezuela), the East African Common Market (Kenya, Tanzania, and Uganda), and the Latin American Free Trade Association (LAFTA). Through the Tokyo Round, however, the emphasis remained on global trade liberalization. Then, in the early 1980s, the United States, frustrated by its failure to launch a new global round in 1982, turned more to bilateral and regional arrangements. It signed bilateral trade agreements with Israel and Canada, and then it negotiated NAFTA, bringing Mexico into the U.S.–Canadian bilateral agreement. President Clinton extended this idea to a free-trade area for all of Latin America, the Free Trade Area of the Americas (FTAA). But major countries such as Brazil and Argentina objected, and FTAA stalled. Brazil and Argentina had formed their own regional trade organization, known as Mercosur, fearing dominance by a North American trade bloc. The United States negotiated a smaller regional pact with five Central American countries plus the Dominican Republic, known as the Central American Free Trade Agreement, and concluded further bilateral agreements with, among others, Chile, Morocco, Australia, Colombia, Panama, Peru, and South Korea. Regional agreements proliferated elsewhere. ASEAN initiated regional trade arrangements in Asia. Then, in the late 1980s, Australia and, subsequently, the United States launched APEC. Bringing together the countries of the Pacific Rim, APEC is a consultative mechanism rather than a free-trade area. Nevertheless, it reflects the enormous growth of trade in the Asian region, especially since China became a member of the WTO in 1999. China, South Korea, and Japan also pursue the “ASEAN plus three” forum, which excludes the United States. And “ASEAN plus six” adds Australia, New Zealand, and India and negotiates a Regional Comprehensive Economic Partnership (RCEP), which also excludes the United States. To counter these exclusive initiatives, the United States launched the Trans-Pacific Partnership (TPP), which brings together the United States, Japan, and ten other Asian and Latin American countries. Meanwhile, bilateral free-trade agreements proliferate. Japan and China have such agreements with countries in Southeast Asia; the United States with South Korea, Panama, Chile and others; and the EU with Mediterranean countries and the so-called Lomé countries in Africa. Trade representatives from the US and Japan meet in February, 2015 to discuss the Trans-Pacific Partnership trade agreement. Kimmasa Mayama/AFP/Getty Images Figure 8-4 Key Issues in Trade: The Realist and Liberal Perspectives and Levels of Analysis From 1948 to 1994, the GATT reported 123 regional trade agreements. Since 1995, the WTO has reported more than 612, of which 406 are in force. Most of these agreements are small and insignificant. But, as regional and bilateral trade arrangements proliferate, a big debate arises about whether these arrangements are “stepping-stones” or “stumbling blocks” to global free trade. Regional arrangements inherently give preference to members over nonmembers. The increasing number of regional blocs therefore increases discrimination and reduces the benefits compared to MFN trade. On the other hand, bilateral and regional ties spark emulation. Brazil lowers tariffs with its neighbor Argentina to better compete with the United States, which lowers tariffs with its neighbor Mexico. Countries compete to lower tariffs, albeit within competitive regional blocs. As long as bilateral and regional agreements move in a liberalizing direction, they may develop momentum that might recharge negotiations at the global level, unlike the protectionist pacts of the 1930s, when countries competed to raise tariffs. But current bilateral and regional free-trade arrangements add to the complexity of international trade, what trade specialists call a “spaghetti bowl” of deals that distort investment by creating incentives to get behind the external tariff walls of regional common markets.16 And as countries narrow their focus to regions, they may become more alienated from one another politically. Global free trade still offers greater benefits, and the completion of the Doha Round remains the test of whether regional pacts have stimulated global liberalization or substituted for it. Figure 8-4 summarizes the realist and liberal aspects of trade issues from the different levels of analysis. Investment As noted earlier, foreign direct investment involves the transfer of physical assets or facilities to a foreign country (factories, warehouses, real estate purchases, back-office activities such as accounting, etc.). It may be accomplished through mergers and acquisitions across borders, in which a foreign firm takes over an existing local firm, or through so-called greenfield investments, in which a foreign firm builds a new facility on an open “green field.” FDI is usually long term and brings into play what is now a major nonstate international actor—the multinational corporation, such as IBM or Royal Dutch Shell. Realist perspectives regard international investment from the standpoint of gaining access to resources and markets and protecting defense industries from foreign takeover. As the causal arrow in the margin suggests, protection of defense industries discourages foreign investments and strengthens national autonomy. In 2005, the United States blocked a bid by the Chinese oil company CNOOC to take over the American oil company Unocal. In 2009, Australia nixed a bid by the Chinese metals company Chinalco to buy the Australian mining firm Rio Tinto. Countries resist foreign investment in security areas and use their economic clout to gain access to critical supplies, such as energy, or to put pressure on other countries’ domestic and foreign policies. In recent years, China has used foreign aid aggressively to secure resources around the world, while Russia has used gas supplies to extend its influence in former Soviet countries. In 2010, in a spat over control of uninhabited islands in the East China Sea, China cut off supplies of rare earth minerals, used in products from cell phones to precision-guided munitions, first to Japan and later to the United States and Europe. Liberal perspectives acknowledge the security and economic dependence created by foreign investments but prefer broader measures to diversify investments and strengthen international rules to protect national interests. They support the inclusion of resource and service industries in the WTO to settle investment conflicts, much the way the WTO does in trade. And they hope investment links, like trade ties, will become so intense that states will no longer contemplate the use of military threats or force to affect investments. As the causal arrow shows, international rules reduce security competition from foreign investments and thereby increase shared interests. Identity perspectives that emphasize cultural equality may see problems with unlimited investment flows. As the causal arrow suggests, they worry that powerful capitalist corporations and banks use liberalized capital markets to dominate and exploit developing-country resources. Some approaches may advocate strict limits on private international capital flows and urge more foreign aid and public or government sources of international financing. Critical theory perspectives see FDI as one of the multiple tentacles by which core countries maintain their stranglehold on peripheral developing countries (more in Chapter 10). Resource-Based Foreign Investments Until 1960, most FDI went into resource-based industries (mining and agriculture) and infrastructure (roads, railroads, public utilities, etc.). In the last quarter of the nineteenth century, British firms invested heavily in mines, public utilities, and railroads in North and South America, India, Australia, and South Africa. American firms followed with major investments in plantation crops in Latin America: tobacco, cotton, sugar, coffee, bananas, and fruit of all sorts. During and after World War II, American firms accelerated overseas investment in critical raw materials such as copper, tin, bauxite, and oil often with the encouragement of and subsidies from the U.S. government. Resource-based foreign industries were often oligopolies, or concentrations of a few firms that were integrated both vertically (that is, they did their own shipping and marketing, as well as production) and horizontally (that is, they produced raw materials, as well as agriculture and processed goods). Oligopolies were highly profitable. At one point before World War I, returns on FDI supplied about 10 percent of Britain’s national income.17 This early FDI took place within colonial empires or along North–South lines and left a legacy of exploitation and ill will that persists today (more on this in Chapter 10). For the countries that have them, abundant resources often prove to be a mixed blessing. In fact, economists call this phenomenon the resource curse. Where resources are abundant, corruption is easy, and local elites fight one another to grab resources. Diamonds in Angola and oil in Nigeria led to civil wars. Moreover, resource-based extraction often does little to develop the interior of a country and sometimes ravages the landscape and environment. The delta region in Nigeria experienced repeated oil spills. Moreover, resource demand is cyclical and declines over time, compared to manufacturing. This causes wide price fluctuations and drives up the value of the local currency, which then costs more than it should and discourages foreign investment and exports in nonresource areas. In Saudi Arabia, for example, oil still makes up 45 percent of GDP, 90 percent of export earnings, and 80 percent of government revenues. After more than fifty years of development, the country’s non-energy-related manufacturing sector remains minuscule. Resource-based MNCs have considerable leverage when they first begin operations in a country. Local governments need the MNCs’ resources and expertise. After a while, however, foreign companies become more subject to local government influence as it becomes easier for governments to impose taxes and other regulations. Firms with a lot of capital already invested cannot pick up and leave a country as easily as they entered it. In addition, host countries gradually learn the technology and business of the MNCs and may nationalize foreign firms, as OPEC did in the case of the big “Seven Sisters” oil companies. In recent years, nationalist governments in Venezuela and Bolivia imposed new taxes and nationalized some parts of foreign companies that were developing oil and natural gas in those countries. The rapid development of China and India has added enormous new pressure on natural resource markets in the Middle East, Africa, and Latin America. With a fifth of the world’s population, China now consumes half of the world’s cement, a third of its steel, and more than a quarter of its aluminum. And Chinese firms are scouring the world from Canada to Indonesia to Kazakhstan to secure additional resources. In late 2007, the government of the Democratic Republic of the Congo announced that Chinese state-owned firms would invest $12 billion to build or refurbish railroads, roads, and mines in that country in return for the right to mine copper ore of equivalent value. The size of the deal is the equivalent of DR Congo’s entire foreign debt, three times its annual budget, and ten times the amount of foreign aid the country receives. China is also guzzling oil and investing in the oil-rich states of the Persian Gulf to secure oil imports. In 2014, it imported an average of 6.2 million barrels of oil per day, a figure that is expected to rise steadily over the next twenty years. China’s growing influence promises to make MNC expansion into resource development increasingly important in world politics, reviving the role that resource development played in the colonial era of Western expansion. Representatives from South Africa’s Eastern Cape stand with officials of First Automobile Works (FAW), a Chinese company, during a ceremony marking the start of construction at a state-of-the-art truck and passenger car plant in the Coega industrial development zone in Port Elizabeth, South Africa. FAW is set to invest 600 million rand toward the plant. Foto24/Gallo Images/Getty Images resource curse: a phenomenon in which an abundance of natural resources inhibits development in other sectors. Manufacturing Foreign Investments By the mid-1950s, however, resource-based investments were less significant than booming manufacturing investments. Some manufacturing companies became multinational before World War II. The Singer Sewing Company set up operations in Europe in the late nineteenth century, and Ford and General Motors established factories in Europe during the interwar period. FDI in manufacturing, however, did not expand in a big way until the late 1950s and 1960s. The Bretton Woods economic system established after World War II did not liberalize foreign investment and other capital flows across national borders, so investing abroad had to come primarily from the Eurodollar market or dollars accumulated in foreign banks. By the late 1960s, American MNCs were a strong presence in western Europe, concentrated in growth sectors and under the control of a relatively few American companies. U.S. firms, for example, accounted for 25 to 30 percent of the automobile market, 60 to 70 percent of the aircraft and tractor markets, 65 percent of the computer market (industrial computers; there were no personal computers as yet), 30 percent of the telephone market, and 25 to 30 percent of the petroleum products market. Three companies—Esso (now ExxonMobil), General Motors, and Ford—accounted for 40 percent of all U.S. investments in France, Germany, and Britain, and just twenty-three firms controlled two-thirds of all U.S. investments in western Europe. These investments sparked European complaints that U.S. companies, concentrated in high-tech sectors, impeded European technological development. This so-called technology gap controversy generated new interest in the causes of FDI.18 Did investment flows increase efficiency as trade flows did? If so, should FDI, and perhaps capital flows more generally, be liberalized as the GATT was liberalizing trade flows? Theoretically, investments should flow to countries that provide the highest rates of return. And returns should be higher where capital is scarcest and in greatest demand. That suggests that investments should flow primarily from advanced countries to developing countries. In past years, that has not been the case. As Figure 8-5 shows, with improvements in the investment climate in many developing countries, more than half of FDI inflows in 2013 went to developing, not advanced, countries. Of a total of $1.45 trillion in global direct investment, $778 billion, or 54 percent, went to developing countries; $566 billion, or 38 percent, went to developed ones; and $108 billion, or 7 percent, went to the Commonwealth of Independent States (CIS).19 Still, developed countries host most existing foreign investment. At the end of 2013, the stock of FDI in developed countries was twice that in developing countries. The U.S. corporate investment position in Europe was nearly four times larger than its investment position in all of Asia. Why is this so? Figure 8-5 Foreign Direct Investment Inflows: Global and by Group of Economies, 1984–2013 Sources: Data are from UNCTADStat, http://unctad.org/en/Pages/DIAE/World%20Investment%20Report/Annex-Tables.aspx One explanation was developed by economist Raymond Vernon.20 Known as the product life cycle, it argues that high-tech product development goes through various stages. In the first stage, when the product is first created, the company operates close to home, where R&D facilities are located and new products can be tested and adapted to consumer needs. American firms had an advantage at this stage because U.S. research and consumer markets were highly advanced. Thus, U.S. firms produced at home and exported to other advanced markets where there was a demand for sophisticated products. In the second stage, as the technology matures and other costs—labor and shipping—become more important, it is advantageous to shift production to European markets. Once the European Common Market existed, tariffs were lower inside Europe, and by producing the product inside the Common Market, a company avoided paying the external tariff and was more competitive vis-à-vis local rivals. Finally, in the third stage, when production has become fully routine, production shifts to developing countries, which have the lowest labor costs. Developing countries then export the product back to the United States and Europe. Thus, the expansion of U.S. investments to Europe in the 1960s reflected the second stage of the product life cycle, when FDI displaces exports in advanced markets, and the expansion of MNCs to Asia in the 1970s and 1980s reflected the third stage, when FDI moves to developing countries, which export back to more advanced countries. According to the product life cycle theory, FDI seemed to follow demand (consumers) more than supply (labor), and thus most of it went to advanced countries where demand was high and changing. A second explanation is that, initially, few developing countries welcomed FDI in manufacturing. As noted in previous chapters and again in Chapter 9, Latin American countries were intent on developing their own industries through import substitution policies, and many newly independent developing countries feared neocolonial influences from the MNCs. They advocated technology transfer without the accompanying capital and management, but that approach was neither accepted by MNCs nor terribly effective for mastering new technologies. Some Asian developing countries bucked the trend. Starting in the 1950s, the four tigers—Taiwan, Hong Kong, South Korea, and Singapore—focused on exports and welcomed FDI. As the product life cycle theory predicted, investments began to flow to these countries in labor-intensive and standardized technology products. In the 1970s, a second wave of MNCs expanded to Asia, this time including European as well as American companies. The success of the Asian tigers encouraged emulation, and other Asian nations opened up to FDI: the Philippines, Thailand, Indonesia, Malaysia, and later China and India. Some Latin American and African countries, such as Mexico and Tanzania, did so as well. The GATT did not deal with investments, so the expansion of MNCs was negotiated on a country-by-country and, often, contract-by-contract basis. Bilateral investment treaties proliferated, much the way bilateral trade agreements did in the 1940s. These treaties were often discriminatory and involved numerous restrictions that affected trade. Developing countries set up free-trade export-processing zones in which they gave foreign companies profitable concessions, such as low or no taxes, lenient labor laws, and duty-free imports, as long as these companies produced for export. Foreign investors found such zones attractive for importing components and assembling final products for export. However, export zones produced limited local benefits. Often the value-added to production (the difference between the value of the inputs and the value of outputs from these zones) was relatively small, and while foreign firms employed local workers, they created enclave communities rather than linking up with internal markets and developing local resources. In some ways, manufacturing export zones resembled the natural resource enclaves of earlier resource-based multinational investments. Proliferating export zones and the oil crisis accelerated interest in liberalizing capital markets. In the 1970s, the United States began to negotiate bilateral investment treaties that contained clauses requiring national treatment. National treatment meant that rather than offering special treatment for FDI in selective export zones host countries treated foreign investors the same as local or national investors in the rest of the economy. This reduced the discrimination inherent in export zones. The GATT began to discuss and negotiate rules to govern investment and technology restrictions that distorted trade, so-called trade-related investment measures (TRIMs) and trade-related intellectual property measures (TRIPs). The GATT also discussed a Multilateral Agreement on Investment (MAI), and the WTO acquired jurisdiction over investment as well as trade issues when it superseded the GATT in 1994. As technological development quickened and FDI became freer, the product life cycle collapsed. That is, countries had very little time to recoup their R&D costs between the development of a product and the shifting of its production overseas. Investments spread simultaneously to many markets at once. It was essential for companies to be invested in all these markets from the outset and to develop comparative advantage in high technology by encouraging networks of universities, entrepreneurs, and financiers to create new products. Strategic trade theory suggested that comparative advantage was no longer based on fixed factors, such as lower labor costs, but depended increasingly on getting to markets first and dominating those markets as quickly as possible. Once a company had a large market share, it could reap monopoly profits or rents and recoup development costs. The next, or fourth, wave of MNC expansion reflected this emphasis on investing in the most advanced markets simultaneously. First Japan in the 1980s and then European countries in the 1990s invested massively in the U.S. market. Some developing countries—Brazil, Mexico, and South Africa—also developed their own MNCs. In 2008, 28 percent of 82,000 transnational corporations came from developing countries. Some countries are friendlier to FDI than others. China welcomed FDI primarily for export, while FDI in Japan remains a small share of the value of total sales or employment compared to the United States or Europe. Overall, FDI spread, and world markets became intensely competitive. Companies were now truly global, often decentralizing to run operations from regional headquarters abroad rather than from the home countries. Service-Sector Foreign Investments A further step in this evolution became visible in the early 2000s. Companies expanded abroad not just to manufacture products but also to provide services. Historically, services such as entertainment were more homebound enterprises catering to local cultures, languages, and tastes. But advances in transportation and communications now shrank the service world. Financial companies—banks, insurance companies, and mutual, pension, and hedge funds—set up operations overseas. Retail (for example, Wal-Mart and McDonald’s), telecommunications (AOL and Google), and entertainment companies (Disney and Bertelsmann) did so as well. The latest expansion of multinational service industries comes in areas of data processing, back-office accounting services, software development, and call centers. This phenomenon is known as foreign outsourcing. Whereas in earlier expansions MNCs continued to do payroll, data services, and R&D activities at the home headquarters, they now exploited the Internet to outsource these tasks to foreign firms. Payroll and other forms of accounting and data processing could be sent to firms in India or China for completion and shipped back via the Internet to the home company within a day or two. Even research tasks could be outsourced. An R&D firm in Dalian, China, might be asked to develop a new software program for a cell phone chip. The task could be done entirely online, without the need to transfer physical facilities. Textile workers, steelworkers, and their unions have long decried foreign or offshore investment in manufacturing. As they see it, each investment offshore subtracts from U.S. jobs onshore. More recently, highly skilled labor has raised similar concerns about outsourcing. Silicon Valley software operations are being outsourced to Egypt, India, and Ireland, where engineers work for much less pay. FDI, like trade, involves job displacement, and job displacement is disruptive. But the issue is also what the alternative might be. If foreign outsourcing is banned, companies will become less competitive or have to invest in more advanced technology at home. The latter, too, results in job losses, because machines replace labor. More textile jobs have been lost in the United States because of the modernization of local plants than because of trade or offshore investments. Perhaps the next service to be outsourced will be education. Training by corporations as well as instruction by universities may be done online from offshore locations. Professors may lose their jobs or at least have to compete with instructors abroad who specialize and teach online courses in specific topics. Then we’ll get a chance to see how much professors—especially economics professors—really favor free trade. The problem with restricting foreign investments is the same as that with restricting foreign trade. Restrictions by one country can be matched by restrictions by another country. If the United States blocks U.S. firms from investing in Japan, Japan will retaliate by blocking Japanese investments in the United States. Today, Japanese companies operate in forty-nine U.S. states and employ approximately 700,000 Americans. What happens to these jobs if the United States tries to save other jobs by preventing U.S. firms from investing abroad? Won’t Japanese unions insist that those jobs created in the United States be brought back home to Japan? Everyone loses. Remember, trade does not necessarily increase jobs; it just promotes better jobs. The same is true of foreign investment. In 2007, U.S. MNCs and foreign MNCs based in the United States created jobs that paid on average 20 percent more than all other jobs in the U.S. economy. These same firms undertook $665.5 billion in capital investment, which constituted 40.6 percent of all private-sector nonresidential investment. They exported $731 billion in goods, 62.7 percent of all U.S. goods exported. And these firms also conducted $240.2 billion in R&D, a remarkable 89.2 percent of all U.S. private-sector R&D.21 Offshore firms are the most advanced in any economy. Cut them off and world growth will shrink. Multinational Corporations Yes, but aren’t these MNCs too big, and don’t they, like their resource predecessors, abuse local economies and cultures, especially in less advanced countries? In 2013, world sales (domestic and exports) of foreign affiliates totaled $35 trillion, up from $2.7 trillion in 1982. Their world exports in 2013, by comparison, equaled only $7.7 trillion, up from $2.2 trillion in 1982. The gross domestic product of foreign affiliates—the sales of foreign affiliates minus the cost of production, or the value-added—totaled $7.5 trillion in 2013, compared to the world GDP of $75.0 trillion.22 Thus, in 2013, foreign affiliates, some 770,000 worldwide, accounted for about 10 percent of world production, while their total sales were almost four times as large as their world exports. Moreover, MNCs themselves accounted for over 33 percent of world exports. And they employed some 71 million workers, or about 4 percent of the world’s workforce. FDI has integrated the world economy far more than trade. Because FDI takes place primarily among advanced countries, this integration is more extensive among advanced countries than between them and developing countries. Nevertheless, MNCs headquartered in developing countries now account for about one-quarter of all MNCs. If we use total sales as a measure, in 2000, MNCs made up fifty-one of the world’s one hundred largest economies. But this measure compares the total sales of MNCs with the GDP of countries, and recall that GDP is measured by total sales (output) minus total costs (inputs), or value-added. When corporations are measured by value-added, only twenty-nine companies appear among the top one hundred economies, and only two of these—ExxonMobil at forty-five and General Motors at forty-seven—rank in the top fifty.23 Still, that is a large number. Few developing countries appear in the top one hundred economies. So twenty-nine MNCs are much larger than the economies of many developing countries, certainly of the poorest countries. Doesn’t this give them enormous clout? Yes and no. Yes, they control large amounts of capital and labor, and, as realist perspectives point out, that gives them real power. But no, they also must compete, and recipient countries can play them off against one another, certainly more so than they could fifty years ago, when MNCs were fewer in number and highly concentrated in specific sectors such as resources. MNCs usually pay higher wages than local firms but not as high as they pay in their home countries. Yet international human rights groups find numerous instances of labor abuses, especially among sweatshops in export-processing zones. That wages and conditions can be improved is beyond doubt, but applicable standards need to be proportionate. Workers in developing countries are less productive than their counterparts are in advanced countries. If they were paid the same wages as workers in developed countries, no firm would invest in or trade with developing countries. The relevant standard is what they were paid before they went to work for foreign firms. In almost all cases, workers—especially women and children—do better where MNCs are present. Most women are unemployed before the MNCs arrive; children work because parents often require it, and they would be working anyway if they stayed on the farm. Children also worked during the early stages of development in advanced countries; at that time, abuses occurred and had to be corrected. The same holds true today in developing countries. For a dissenting view on the impact of MNCs, see the critical theory perspective developed in Chapter 10. Immigration Policies The movement of people across national boundaries is a relatively new feature of globalization. Immigration, of course, has always existed, but people flows accelerated after the end of the Cold War and the adoption by developing countries, such as Mexico, of more open and market-oriented economic policies. Most countries limit immigration. The United States is one of the most open. The European Union concluded the Schengen Agreement, which opened borders within the EU but maintained restrictions toward immigrants from outside the EU, especially from Muslim countries. Other countries, such as Japan, control immigration to fill specific and usually less desirable jobs in the economy. Germany admits guest workers, principally from Turkey and the Balkan states that made up former Yugoslavia, but its laws make it difficult for such workers to become German citizens. Some immigrants also represent security threats, which have escalated in the era of terrorism. When people are free to move, wages are the principal economic factor driving them. Wages in the United States are some five times higher on average than wages in Mexico.24 This disparity drives labor north, so much so that it comes in illegally as well as legally. Although the United States has admitted some twenty-three million immigrants since 1965, mostly from Latin America, another eleven million—three to four million from Mexico alone—have slipped in illegally. How to treat these immigrants is a perennial and heated issue in U.S. politics. Immigrants are a growing issue in Europe. Roughly 1 million refugees from Syria and the Middle East are pouring into the EU countries each year, putting the Schengen agreement to a severe test. Illegal immigration is also a problem in many other countries. Immigrants make up 15 percent of the population in more than fifty countries worldwide, suggesting that flows of people are becoming as common as flows of goods and capital. Skilled immigrants have become more important as globalization has affected the information industries. Software engineers from India populate Silicon Valley and other high-tech centers in the United States. Skilled laborers in the United States worry about the outsourcing of other service jobs to India and Egypt. With the Internet, people don’t have to move. The jobs are brought to them. People located in India, not the United States, often do data processing and handle customer service calls for companies located in the United States. Realist perspectives tend to see population as an important ingredient of national power and are reluctant to liberalize immigration flows unless doing so offers relative national advantage. Liberal perspectives emphasize the opportunities to match labor skills and economic needs across national boundaries and increase common material benefits. Identity perspectives tend to view immigration flows in the context of preserving cultural homogeneity or encouraging cultural diversity. They might also emphasize basic human rights and treat immigration issues largely as refugee problems. We take up refugee and population questions again in Chapter 9. Figure 8-6 summarizes investment aspects of the global economy from the different levels of analysis. Migrant farmworkers from Mexico harvest organic spinach at the Grant Family Farms in Wellington, Colorado. The farm, the largest organic vegetable farm outside California, hires some 250 immigrant workers during the peak harvest season. Owner Andy Grant lamented that the issue of illegal immigration has become politicized nationally. “They feed America,” he said of immigrant workers. “They should not be victimized.” John Moore/Getty Images Figure 8-6 Key Issues in Investment: The Realist and Liberal Perspectives and Levels of Analysis Finance Since the liberalization of financial markets in the early 1980s, finance (portfolio investments), including currency transactions, has become by far the biggest component of global markets, dwarfing trade and FDI. In 2007, global financial stock, which includes bank deposits, government and private debt securities, and equities, reached a grand total of $194 trillion, up from $12 trillion in 1980 and $53 trillion in 1993. During this period, global capital markets grew faster than world GDP, topping out in 2007 at almost four times the global GDP. That trend was broken by the global financial crisis of 2008–2009. The global capital stock fell in 2008 by $16 trillion to $178 trillion. Another $12 trillion was lost in the first half of 2009. Global households save about $1.6 trillion per year, so the decline equaled about eighteen years of global household savings. Capital flows (annual) as opposed to stock (cumulative) cratered from $10.5 trillion in 2007 to $1.9 trillion in 2008.25 What happened to cause this crisis? To understand that, we need to know more about how global finance functions. Global finance involves exchange rates, currency markets, balance-of-payments accounting, debt financing, and financial crises, such as the Asian financial crises in the 1990s, the banking crash of 2008–2009, and the ongoing European Union debt crisis. Exchange Rates The exchange rate is the price of one country’s currency in relation to another country’s currency. Change it, and you have changed the relative prices of everything that moves across the borders between these two countries. Let’s say we import a Chinese shirt today that costs 12 renminbi and we pay $2 for it because the exchange rate (in 2015) is roughly $1 to 6 renminbi. Tomorrow the value of the renminbi goes up (fewer renminbi buy the same amount of dollars); the exchange rate changes to $1 to 4 renminbi. The shirt still costs 12 renminbi, but we now pay $3 instead of $2 to import it. Notice how powerfully the exchange rate affects trade. A country can in effect subsidize all its exports by maintaining an undervalued exchange rate. That’s why exchange rates are so controversial and why the U.S. Congress in recent years threatened China with tariffs if it did not raise its exchange rate so U.S. consumers would pay more for Chinese imports and hence buy fewer of them. U.S. consumers might then buy more domestic goods and create more domestic jobs, or so it is thought. Consequently, exchange rates are often the first thing that governments have to coordinate when they want to create a stable world economy. If they don’t, they get the beggar-thy-neighbor policies that destroyed world markets in the 1930s, when every country tried to cheapen its export prices by devaluing its currency and no country succeeded because imports became more expensive and export demand dried up. What should the exchange rate be? Sometimes governments fix exchange rates, called a fixed exchange rate system, as under the Bretton Woods system right after World War II. But how do governments know what the correct price should be? It’s a tough call. Because many factors affect prices, such as unemployment and trade policy, it matters what the general conditions in a country are when the exchange rate is fixed. For example, employment was low and trade restricted in 1945 when exchange rates were set at Bretton Woods. As restrictions and other conditions changed, more than twenty countries, including Great Britain, had to alter their exchange rates in 1949. Economists talk about equilibrium exchange rates or purchasing power parity—that is, what a general basket of goods in one country costs compared to the same basket in another country. This measure eliminates the influence of different inflation rates on exchange rates. Often purchasing power parity rates are used to compare total output in one country to that in another. But using any particular measure to set exchange rates is not very reliable. So maybe the best policy is to let the marketplace decide the exchange rate, just watch to see how much of the currency for a particular country is supplied and how much is demanded by all the exporters and importers in the world economy. To some extent, that’s the system that exists now. Except for some developing countries such as China, which peg their rates either to the dollar or to a basket of currencies, exchange rates float. That means, of course, they may be volatile because markets are sometimes volatile, especially if short-term capital flows are not restricted. And if rates are volatile, trade and investment become unpredictable, and then the world economy shrinks. So most governments today watch their exchange rates carefully, and sometimes they intervene to keep them from falling or going up too much. In the midst of the world financial crisis in 2010, Japan, China, Brazil, and South Korea all intervened to influence the value of their currencies. The governments feared that a higher currency value would make their exports more expensive just at a time when these countries were trying to increase domestic production and jobs to recover from the economic recession. To prevent such undesired exchange rate movements, governments intervene to keep their exchange rates within certain ranges or to have them go up or down gradually. Economists call this system a managed float or dirty float because governments often intervene secretly. Currency Markets How do governments affect exchange rates? Central banks buy or sell their own countries’ currency in large enough quantities to affect its price. That’s called exchange market intervention. But global currency markets today are so deep that even government purchases or sales amount to only a small proportion of the market and therefore may not have much effect. Transactions of roughly $5 trillion take place every day in currency markets. Over a year, that adds up to more than $1 quadrillion. Compare that with annual global output of around $70 trillion,26 and you can see that the world economy is getting pretty heady, with a lot of wine flowing across national boundaries compared to a significantly smaller amount of meat and potatoes. Thus, timing becomes very important. Central banks act secretly and try to catch the markets off guard. On other occasions, central banks may coordinate their interventions. If they all buy or sell a currency at the same time, chances are they will have a bigger impact. Even better is when central banks coordinate their short-term interest rates to support currency changes. If the United States is trying to weaken the dollar, it lowers its interest rates while European countries do not lower their rates as much or keep them the same. Now currency traders demand more European currencies with higher interest rates and fewer dollars with lower interest rates. This is what the G-7 countries did in 1985 when they acted to bring the high dollar down. Now you know why investors and financial markets pay so much attention to G-7 and G-20 meetings and to what central bankers say. Often central bank officials try to affect markets just by what they say, knowing that the best way to affect the market, given the small part that governments affect directly, is to get private actors to move in a certain direction. For example, in the 1990s, a strong dollar was important to ease the Asian financial crisis. Why? Because a strong dollar encouraged U.S. imports and helped Asian economies export more and recover sooner. Thus, the U.S. secretary of the Treasury, Robert Rubin, repeated over and over again during this period that a high dollar was in U.S. interests. Intervening to alter exchange rates can change other policies, such as monetary policy. Let’s say the New York Fed, one of the regional banks of the Federal Reserve System, acting under instructions from the U.S. Treasury Department—which has exchange rate authority in the U.S. government—sells dollars to keep the price from going too high. It acquires foreign currencies and puts them into its foreign exchange reserves. Now there are more dollars in circulation. In effect, the intervention has expanded the money supply. If the Fed does not want to expand monetary policy, it has to reabsorb those dollars. It does so by selling U.S. Treasury securities and sponging up excess dollars. That’s called sterilization. Now the dollar supply is back to where it was before. But if that’s the case, the price of the dollar cannot be affected much, right? Well, maybe it can be affected in the short term until the market figures out what the Fed is doing. But, generally, economists believe it is not possible to change exchange rates significantly through intervention unless monetary authorities are willing to let the money supply expand or contract—in other words, unless they do not sterilize the intervention. In past years when the Bank of Japan intervened to prevent a rise in the yen, it did not sterilize its intervention, thereby pursuing an extremely loose monetary policy involving interest rates only fractionally above zero. Liberal perspectives, which emphasize reciprocal interactions, tend to favor G-7 and G-20 coordination to maintain exchange rates within relatively narrow ranges, believing that exchange rate volatility encourages protectionism and capital flight. As the first causal arrow shows, joint policy making pushes national policies in similar directions to maintain equilibrium. Realist perspectives tolerate greater exchange rate competition, believing that it is hard enough to get agreement on policy choices domestically, let alone among numerous countries internationally. And without underlying agreement on policies, coordination is, at best, a short-term fix and, at worst, a long-run inflationary threat, because when politicians meet in public gatherings they like to cut interest rates, not raise them. Thus, as the second causal arrow illustrates, exchange rate competition pressures countries to change domestic policies and encourages best practices. Finally, identity perspectives are eclectic, favoring stable exchange rates if they serve the right goals and flexible rates if they don’t. For example, labor groups tend to favor flexible rates because they oppose the budget austerity that is sometimes required to maintain fixed rates, whereas investor and management groups tend to favor fixed rates, which create a more stable environment for savings and investments. As the third arrow shows, countries pursue different policies to maximize relative gains. Balance of Payments Border flows of goods and services plus government transfers and net income on capital investments constitute a country’s current account. Government transfers involve foreign aid and military expenditures. Net income on capital investments includes the interest and dividends earned by one country on its foreign investments in all other countries minus the interest and dividends earned by all other countries on foreign investments in the first country. Notice that trade of goods and services is only one part of the current account. Merchandise trade is an even smaller part because it excludes trade in services, which in the information age is becoming larger. Thus, trade deficits and current account deficits are not the same thing. For twenty-five years after World War II, the United States ran trade surpluses that were large enough to offset its foreign aid and military expenditures. But after 1970, the trade surplus declined and then disappeared altogether. America’s current account went into deficit and has stayed there ever since, except for seven years. The United States has been borrowing from other countries for a long time, although only more recently from poor countries such as China. This borrowing (and lending for China) comes through the capital account and includes portfolio investments (stocks, bonds, and cash) and FDI (plants and other facilities). Taken together, the current and capital accounts make up the country’s balance-of-payments account. People flows do not appear in the balance of payments, although any money that immigrants remit to their home countries does appear in the current account. Table 8-2 shows a typical balance of payments for the United States from calendar year 2008. One way to think about the balance of payments is as your country’s checkbook at a bank known as the World Economy. If you spend more than you earn, you have a deficit in your checkbook, a current account deficit, and have to borrow an equivalent amount, a capital account surplus or inflow, from the World Economy bank. If you spend less than you earn, you have a surplus in your checkbook, a current account surplus; if you don’t draw it out, you in effect lend that amount, a capital account deficit or outflow, back to the World Economy bank, which pays you interest on your checking or savings account. Notice that any checkbook surplus is offset by a loan to the bank and any checkbook deficit by borrowing from the bank. Similarly, any current account surplus is offset by loans to other countries, or a capital account deficit. And any current account deficit is offset by borrowing from other countries, or a capital account surplus. The current and capital accounts are mirror images of one another with opposite signs (if one is negative, the other is positive). As Table 8-2 shows, after increases or decreases in foreign exchange reserves held by central banks and statistical discrepancies, the balance of payments equals zero. Like your checkbook, it’s just an accounting device. Nevertheless, realist perspectives often see a checkbook or current account surplus as desirable. In the mercantilist era, such a surplus meant that a country accumulated gold, and that was a good thing because gold could be used to buy the instruments of national military and economic power. In today’s global economy, it means that a country accumulates foreign exchange reserves and lends to other countries. As the causal arrow illustrates, countries use surpluses to bind other countries to them and maximize their national prestige. Is that good or bad? Realist outlooks say it’s good because it’s better to be a lender than a borrower. And they have a point. During financial crises in the late 1990s, Asian countries resented the policies that the IMF and United States imposed on their economies as conditions for new loans. Subsequently, they formed their own lenders’ club, the Chiang Mai Initiative, to make loans to one another in future crises and avoid IMF conditionality. Similarly, in 2015, Greece resented conditions tied to loans made by the IMF and European Union to help that country survive a financial crisis. But how big an advantage is it to be a lender? What if the borrower can’t pay the loan back? You know the old saw: If I owe the bank $100, I’m in trouble; if I owe the bank $100 million, the bank is in trouble. Neither the IMF nor the United States could afford to let the Asian countries go bankrupt. Nor could the EU simply cut Greece loose without jeopardizing the financial well-being of other countries such as Spain and Portugal. So there is risk in international lending, just as in any other type of lending. As the causal arrow in the margin suggests, liberal perspectives tend to emphasize mutual dependency between lender and borrower and see current account surpluses and deficits as normal and inevitable given the high levels of trade and capital interdependence. Chronic balance-of-payments and debt imbalances, however, are a problem because they threaten the sustainability of trade and capital flows. Debt Markets The expansion of financial markets was inevitable once trade and FDI were liberalized. Current account deficits and surpluses grew and had to be financed by lending from surplus countries to deficit ones. As liberal perspectives see it, it was a classic case of spillover or path dependence. If corporations operated worldwide, so must banks, insurance companies, investment houses, pension funds, mutual and hedge funds, and stock, bond, and currency exchanges. After all, companies have to borrow, invest, and work in multiple currencies. They have to insure trade and financial transactions, hedge against currency and interest rate risks, and diversify their assets across country markets. Global banks and financial institutions mobilize world savings and make them available for investment opportunities worldwide. As we learned earlier, countries that save more than they invest accumulate current account surpluses and then make loans to other countries by running capital account deficits. Countries that invest more than they save do the reverse. Overall, this financial intermediation function is good for everyone. If global financial institutions did not exist, countries that saved more than they invested would have to bury the extra savings in the ground. No country could invest more than it saved. Local resources and opportunities would be wasted. But open financial markets also bring global problems. Whereas capital flows in the earlier Bretton Woods system came largely from governments and intergovernmental institutions, such as the IMF and World Bank, private sources (commercial banks, investment houses, and pension, mutual, and hedge funds) now provide the bulk of capital flows in world markets. These flows are not only large; they are also volatile. In 2008, as we have noted, annual global capital flows dropped by more than $8 trillion, or 80 percent. These are huge sums and shifts. Short-term capital flows are particularly volatile. Some economists advocate restricting short-term flows. For these economists, as the first causal arrow suggests, the problem is speculation and systemic. Others believe the problem lies in weak banking systems in developing countries, as the second causal arrow depicts. For them, the solution is domestic reforms to make local banks more competitive. Can you see the tension here between the domestic and systemic levels of analysis? Do you start at the domestic end of the problem or the international one? And if you do both, which takes the lead? Now derivatives markets come into the picture. A derivatives market involves the exchange of financial claims against future earnings by households, corporations, and financial institutions. An example of a derivative is a stock option. The option derives from the stock, hence the term derivative. You buy an option, however, not the stock. The option is a right to purchase or sell a stock at a given strike price within a given time period. You may be hedging against the rise or fall of a stock that you own, or you may just be speculating against price changes. Derivatives can be created for any asset: commodities, loans (including mortgages), insurance policies, and so on. Parties in global financial markets often swap or package financial assets to spread risks. They also sell insurance to cover risks on regular assets as well as derivatives assets. Creating derivatives doesn’t create new wealth, as in the case of new loans, equity investments, or FDI, but it does serve the useful business purposes of hedging against changes in future earnings, prices, or interest rates. If you are in business and need raw materials in the future (say, oil), you may wish to purchase future contracts, an option or derivative to buy those commodities at a given price in the future. You are anticipating that prices may go up, and you want to lock in a price now. Someone on the other end of the contract sells you that option because he or she may hold the commodities and anticipate that the price will go down. Market participants take opposite sides of a trade and make these sorts of guesses about future prices all the time. It’s a part of normal business activity. In September 2008, the stock market ticker in New York’s Times Square flashes that the Dow has plunged 778 points after the U.S. Congress failed to pass a proposed bailout bill. Andrew Savulich/NY Daily News Archive via Getty Images The derivatives market grew phenomenally and then collapsed spectacularly in the financial crisis. In 2006, the notional value of the derivatives market was $477 trillion. That was more than thirty times the size of U.S. GDP, which was around $15 trillion, and roughly three times the size of all global financial assets of $167 trillion in 2006. This market was not only huge, but, because it was new, it was also largely unregulated by international and, in many cases, national authorities. Let’s take a closer look at how these elements of global finance came together in the 1990s and 2000s to create the financial bubble that burst in 2008.27 derivatives markets: the market that exchanges instruments derived from existing loans and financial assets, hedging them against future changes in prices, earnings, or interest. Global Financial Crisis In 1998, bankers at J. P. Morgan (which became JPMorgan Chase in 2000 when it merged with Chase Manhattan Bank) packaged the first collateralized debt obligations (CDOs), or what were then called Bistro deals. They pooled into a single security or CDO some three hundred loans on the books of J. P. Morgan worth about $9.7 billion. They intended to sell these loans as securities based on the income stream or interest payments of the loans. Normally, when a bank sells securities, it has to keep a certain amount of capital in reserve in case the loans go sour. In this case, J. P. Morgan calculated that it needed to hold only $700 million in reserve against the nearly $10 billion worth of securities it wanted to sell. Some bank regulators signed off on that, but others urged J. P. Morgan to reserve or insure against the missing $9 billion as well. Enter American International Group (AIG), the London firm that became notorious during the financial meltdown. AIG was a regular client of J. P. Morgan and had a division that specialized in derivatives. AIG decided that it would sell J. P. Morgan insurance on the extra $9 billion of the CDO package. Because it operated out of London and was an insurance company, AIG did not face the same requirements to hold reserves as banks did. Thus, it sold the insurance, known as credit default swaps (CDSs), for a tiny but steady stream of income, assuming that the deal was essentially risk-free and that AIG would never have to pay out the $9 billion. In time, these CDSs became very valuable. Remember, they were insurance policies that paid off if the loans went sour. For the moment, however, the loans seemed good and the insurance seemed to be as worthless as insurance against the end of the world. International rating agencies, such as Moody’s, which grade loan instruments on the basis of riskiness, essentially agreed that such deals were low risk and gave the securities package a triple-A rating, the highest possible. The die was cast for rolling out literally trillions of dollars worth of these types of security packages over the next decade. J. P. Morgan was followed by every other big bank and investment house around the world—in Europe and Asia as well as the United States. All kinds of loans, including housing, credit card, and car loans, began to be packaged and sold as CDOs, covered in many cases by insurance policies or CDSs. It was not only private banks that joined the party. Two of the biggest mortgage lenders were government agencies, Fannie Mae and Freddie Mac, created by Congress to encourage home ownership. They borrowed money in private markets on the basis of tax-supported government guarantees to finance home loans for middle-class families. They packaged and sold mortgage loans to the tune of $5 trillion. Because home ownership is considered a good thing, Fannie Mae and Freddie Mac pushed loans that many people could not afford, called subprime loans. As long as housing prices went up, everything was fine. Owners could always sell the house for a profit or borrow more against the increased value or equity of the house to keep up their payments. In all these cases, the assumption was that if one loan went bad, others would remain good. In fact, securities were broken down into tranches, with the riskier tranches bearing higher interest rates, precisely to insulate less risky loans from more risky ones. The chance that defaults in any given pool of loans might be interconnected in such a way that one bad loan might trigger another one, a problem known as correlation, was considered minuscule. But you guessed it—that’s exactly what happened. Once housing prices began to decline, the riskier tranches went bad first. But then investors began to fear that the less risky tranches were also worth less. Rating agencies downgraded the less risky securities. Not knowing exactly who held the loans, how many of the loans were bad, and what the real prices of these assets were, the markets panicked and began to pull back from making any loans at all. Eventually debt markets froze up completely. Interest rates spiked even for overnight loans, which are the lubricant of daily banking. Government central banks in the United States, Britain, and other countries had to step in. They bought debt to make cash available to the banks to keep them afloat. Not only the commercial banks were involved. For the first time, the Federal Reserve Bank intervened to keep an investment house from going under. Bear Stearns, a Wall Street investment company, was taken over by JPMorgan Chase, with substantial financial assistance from the Federal Reserve Bank. But the Fed was unlikely and unable to save every financial institution. When a second investment house, Lehman Brothers, went under in September 2008, the Fed did not step in, and the global contraction of credit cascaded. Make no mistake—some people made money. Investors who bought the CDSs or insurance policies on the securitized loans saw the value of their insurance policies rise dramatically or received payment in full for the loans that went bad, which they had insured against. That’s the nature of markets. For every trade that turns out bad, there is another one that turns out good. The question is whether governments should step in to make the bad loans good again. If they don’t, will markets implode, as they did in the 1930s? Are financial institutions, especially big private banks and investment houses, too big to fail? So far, governments have not decided that they are. Altogether, by buying debt assets from private institutions, the Federal Reserve Bank added more than $2 trillion to its balance sheet, tripling the amount it carried before. In addition, Congress authorized a $700 billion bailout package for the banks, the Troubled Asset Relief Program, known as TARP. This money was initially intended to buy bad debt from the banks, the so-called toxic assets of CDOs and CDSs that were now worth much less. If these assets were valued at market prices, the capital assets of banks would be drastically reduced, compelling them to do still less lending. But because it was too difficult to figure out how much the toxic assets were worth (there were no buyers), the TARP money was used instead to recapitalize the banks—that is, to buy their stock to replenish their capital reserves. Much of the bad debt still remains on the balance sheets of banks, not only in the United States but abroad as well, and may be a factor reducing the capacity of banks to lend for a long time to come. But private bank stocks have recovered, and by selling the stock it acquired, the U.S. government recovered most of the money it provided in the bailout.28 Here is a classic case of how global markets sometimes outpace the capacity of both national and global governments to manage them. At about the same time in 1998 that J. P. Morgan was packaging its first CDO, Fed and U.S. Treasury regulators met to consider a proposal by the Commodity Futures Trading Commission (CFTC) to regulate the derivatives market. Robert Rubin, then U.S. Treasury secretary, Alan Greenspan, chairman of the Federal Reserve System, and Lawrence Summers, who succeeded Rubin as Treasury secretary, agreed that the markets understood more about risk than any federal regulator did and refused to intervene. Over the next decade, Treasury and White House officials of both parties reaffirmed this decision even as the derivatives market exploded. According to one observer, “Stopping this [CFTC proposal] let the momentum build and led to subprime as well as soaring commodity prices today because unregulated derivatives trading soared after that.”29 So who regulates the derivatives markets? Even inside countries, the regulators are not clearly designated. In the United States, regulations are dispersed among a whole series of alphabet-soup agencies, including the Fed, the U.S. Treasury, CFTC, and the Securities and Exchange Commission (SEC). In the midst of the subprime crisis, the U.S. Treasury Department unveiled a comprehensive proposal to revise and restructure banking and financial regulations, and the IMF reviewed a report by the Financial Stability Forum, a commission of banks and regulators from the major industrial countries, which recommended the strengthened surveillance of international banking and derivatives markets. Since the liberalization of financial markets began in the 1970s, central banks meeting at the Bank for International Settlements (BIS) in Basel, Switzerland, have regulated global capital markets through what are called the Basel Accords (also known as the Basle Accords, using the British spelling). In 1988, central banks issued Basel I, a set of minimal guidelines for banks prescribing how much capital they must hold to back up loans and what qualifies as capital (for example, equity such as stocks or corporate bonds and other debt instruments). The ratio of loans to capital reserves is called the leverage ratio and has been generally set in the case of domestic banks at about 8 to 1. Basel II was adopted in 2004 to tighten and link required reserves to the riskiness of the loans being made. But banks became adept at defining the riskiness of both loans and assets to foster expanded lending, and neither Basel I nor Basel II prevented leverage ratios from rising during the recent financial crisis, at some financial institutions to 100 to 1 and more. After the financial crisis, Basel III was concluded in 2010. It sets strict requirements on what qualifies as capital but phases the requirements in over a decade. Regulators fear that being too strict in the middle of the global recovery from the financial crash might squeeze lending even more and delay new investment and growth. Meanwhile, global debt especially by governments continues to increase. More regulation seems to be in the cards, but bear in mind that if regulations become too tight, banks and other financial institutions will reduce lending. If they reduce lending, they take in fewer deposits. In short, they mobilize fewer savings. And if private and public institutions cannot put their savings in the bank, they have to bury them in the sand. So banking is not a rogue activity, although some banks may engage in rogue activities. Banking is an essential function that lubricates expanding international trade and investment markets and makes sure that the meat and potatoes of the world economy—namely, trade and investment—stay on the table, not just for the next meal but for future ones as well. Eurozone Crisis Financial markets bring to the fore the sensitive interrelationships between domestic policies and international trade and investment. When the financial crisis hit in 2008–2009, companies and consumers got fewer loans and drastically curtailed production and spending. Not far behind came drastic cutbacks in jobs and freezes on new hires. Growth and employment contracted more sharply but not more deeply than in previous recessions, in part because they had started at higher levels after three decades of solid global growth. (With respect to unemployment and inflation, the 2008–2009 recession was not as bad as the 1981–1982 recession.) As already noted, governments reacted to this downturn with massive stimulus programs. But now questions arose about how governments and central banks should manage all this debt and easy money as economies recovered. The European countries faced a particularly tricky situation. As we discussed in Chapter 6, some nineteen of the twenty-eight EU member states, called the eurozone countries, had unified their currencies in a common currency known as the euro. They established the European Central Bank, like the U.S. Federal Reserve Bank, to set interest rates and manage this new currency. Eurozone states no longer exercised their own independent monetary and exchange rate policies. But what happens now when some members—like Ireland, Greece, Portugal, and Spain—get into balance-of-payments and debt problems? A traditional way for countries to cope with this situation is to lower interest rates and the value of their currency. That increases the price of imports and decreases the price of exports, reducing imports, increasing exports, and cutting the current account deficit. Governments are very reluctant to cut spending programs and deficits because that slows growth and causes domestic political protests. In the eurozone, however, they no longer control their own monetary policy. They have to persuade the European Central Bank to offer generous terms to finance and reschedule their debt to avoid cutbacks in government spending. If the central bank is too generous, however, investors lose confidence in the currency and capital flees the eurozone, creating a wider financial crisis. Who provides the financing for this eurozone rescue? Unless the EU turns to outside lenders such as China or the IMF, the surplus countries in the eurozone have to come up with the financing. In the EU that’s principally Germany. So Germany is now calling the shots about how generous or strict the EU will be with Greece and other eurozone countries in default on their debts. That doesn’t sit well with citizens in Greece or Portugal. The eurozone countries do not have a common fiscal policy, so there is no safety net such as a government normally provides when a section of a country experiences high unemployment. In effect, by keeping money tight with no offsetting spending, Germany and the European Central Bank force the indebted countries to cut their own spending. This spending, while reckless in some ways, also involves pensions and other income programs that affect millions of workers. Germany now emerges as an imperialist power forcing the indebted countries into austerity programs. In spring 2015, the EU led by Germany engaged in tough debt negotiations with Greece. In these situations, there are only so many actions that countries can take. These actions reflect the use of the policies discussed at the beginning of this chapter by which countries manage their relationships with the world economy: exchange rate, macroeconomic (fiscal and monetary), microeconomic, trade, and financial policies. One action is that countries can let their currency float, risking higher prices for their exports and the loss of jobs. The eurozone countries, which have given up independent monetary policy, cannot do that. A second option is they can intervene in the exchange markets to keep their currency down, as China does, or up, as the EU sometimes does. If they try to keep their currency down by selling it, they accumulate further foreign exchange reserves. At the end of 2013, China held some $3.9 trillion in reserves, giving it a massive treasure chest to invest around the world ($1 trillion or more in U.S. Treasury bonds). A third action is they can alter their macroeconomic policies. Unwilling to cut budget deficits, the United States, Japan, and the European Union have dramatically loosened monetary policy in recent years. A fourth action is they can undertake domestic structural reforms (change their microeconomic policies) to boost spending (e.g., road building) in surplus countries (China, Germany, Japan, and some OPEC countries) and savings (e.g., cut social security) in deficit countries (United States, Britain, France, Canada, and Australia). After 1991, Sweden cut public spending from 67 to 49 percent of GDP. A fifth action is they can impose restrictions on trade, as the U.S. Congress threatened to do in recent years. And a sixth action is they can impose capital controls to stem the inflow or outflow of money, as Brazil and Thailand did in 2010. The interrelationships of all the instruments of international economic policy are summarized in Figure 8-7. Who bears responsibility for coordinating these instruments at the international level? This is the governance question. Do you start with domestic or international actions? For years, the United States pressed China to revalue its currency unilaterally—that is, to produce more for domestic consumption rather than export. Then, in late 2010, it proposed a multilateral or systemic-level approach that called for a limit on current account surpluses or deficits for all countries of 4 percent of GDP. And who leads? Domestically, as the first causal arrow suggests, central banks control the punch bowl and rein in the party when financial liquidity, the wine-inducedmerrymaking, becomes excessive. But central banks are secretive and usually independent of elected authorities. Congress and other political authorities often resent the power of the central banks. Think of all the unhappiness in the United States over the recent bank bailouts, even though the government has gotten back most of this money. No one is terribly eager to give this kind of power to central bankers in the global economy. By default, therefore, from realist perspectives, power flows to the dominant country, as the second causal arrow depicts. In the early 1980s, the United States acted single-handedly as the world’s central bank to end the inflationary party of the 1970s. Today, in the eurozone, Germany acts as the EU’s central bank; and the Fed may be acting once again as the world’s central bank, this time to ease the supply of money, inflate the world economy, and avoid what some Fed economists fear could be a deflationary spiral. Figure 8-7 Instruments of International Economic Policy Figure 8-8 summarizes financial aspects of the world economy from the different levels of analysis. Figure 8-8 Key Issues in Finance: The Realist and Liberal Perspectives and Levels of Analysis Summary Trade, investment, and finance create the opportunity for specialization and comparative advantage in the global economy. All other things being equal, comparative advantage results in the more efficient use of resources; with the same input, countries can produce more output. In the real world, however, all other things are seldom equal. Thus, trade and investment advantage some workers, industrial sectors, and countries while disadvantaging others. The least-skilled workers, sectors, and economies lose benefits; the most-skilled gain them. To preserve the benefits of trade, investment, and financial markets, therefore, countries have to find ways, both domestically and internationally, to smooth the transition from less skilled to more skilled workers. Better education, wage insurance, and the accountability of MNCs, banks, and local governments are necessary; or the backlash from the less skilled workers and countries may shut down trade, investment, and banking activities. If nothing is done, nations may be bypassed or may collapse, as happened in communist countries with outdated workers and industries. Realist perspectives raise important questions about who gains and who loses, relatively, from international trade and investment. Liberal perspectives raise equally important questions about equity, accountability and institutional arrangements to achieve better outcomes at the domestic and international levels. And identity perspectives focus on the changes in policy ideas and traditional cultures that are inevitable when growth occurs. Change is a constant that alters identities. That fact becomes even more evident as we turn in the next chapter to a discussion of the development process in Asia, Latin America, Africa, and the Middle East.

CHAPTER 9

Identity Perspectives on Globalization Development and Environment

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A group of children from the town of Kabo in northern Central African Republic (CAR) line up to be vaccinated against measles during an outbreak of the disease. CAR is one of the world’s poorest and most neglected countries, with an average life expectancy of thirty-nine years. Central African Republic’s challenges are particularly severe, but the obstacles it faces are not unique among developing countries: domestic and regional conflict resulting in massive internal displacement, poor or nonexistent infrastructure, lack of access to health care, few reliable political or social institutions, and more.

Spencer Platt/Getty Images

Development is about wealth, but even more so it is about wealth for whom and at what cost to the environment. In this chapter, we focus on the identity aspects of development and the environment. There are four aspects to development: Where do countries start in the process? What are the human measures of development and change regarding jobs and social interactions? What are the consequences for the environment? And, finally, what are the values that development serves, and what constitutes social justice in the age of globalization?

Map 9-1 shows the distribution of national income measured by gross domestic product per person in purchasing power parity (PPP), which takes account of the fact that goods are cheaper in poorer countries and a dollar buys more there than elsewhere. North America, western Europe, Israel, Qatar, Kuwait, Oman, Japan, Taiwan, South Korea, Hong Kong, Singapore, Australia, and New Zealand are the principal areas of the world where the average annual income exceeds $25,000 per person. By contrast, in most countries in Africa incomes average less than $5,000 per person. A few countries in eastern Europe, Latin America, the Middle East, and Asia, such as Poland, Russia, Mexico, Brazil, Chile, Saudi Arabia, and Malaysia, have incomes over $10,000 per capita, but the majority of countries in these areas have incomes that fall below $10,000.

But while wealth remains unevenly distributed today, that’s not the whole picture. Over the past forty years, development has brought about greater income equality in many parts of the world. Since 2000, we have seen significant growth in the middle class across regions that once showed major disparities between the rich and poor, notably in Latin America and parts of Asia. Still, much of Africa suffers the highest levels of inequality. Map 9-2 tracks these changes between 2000 and 2013, expressing the GDP per capita for each country as a ratio to world GDP.

Development takes place through work and social change. The type and location of jobs migrate from less to more sophisticated levels. Look back at Map 8-1, which shows the employment side of development. Influenced by technological change, development involves the movement over generations of the bulk of jobs from agriculture to manufacturing and eventually to high-skilled service activities. The least developed countries still have most of their populations employed in agriculture (or in low-skilled service jobs in tourism or government). More developed and industrializing countries have a substantial proportion of their workforces employed in manufacturing. Some, such as France and Germany, are downsizing jobs in manufacturing and moving them into services; others, such as China, are increasing jobs in manufacturing and moving them out of agriculture. The most advanced countries, such as the United States, have completed the transition from manufacturing to services. They have entered the information age. Their workforces are employed predominantly in high-skilled service activities, such as finance, telecommunications, software, and consulting. This employment transition does not mean that the most advanced countries have lost their manufacturing or agricultural sectors. The United States remains a leader in both sectors, and manufacturing output in the United States today equals the same share of GDP that it did fifty years ago—between 20 and 25 percent. It’s just that U.S. companies produce manufactured and agricultural goods with far less labor than they used to. The United States needs less than 1 percent of its workforce in agriculture and less than 10 percent in manufacturing to produce these products.

Development also has major implications for the environment. The world’s environment or ecosystem is complex. Development’s impacts start with population growth, because crowding limits the amount of land available for the cultivation of crops, exhausts resources such as energy and water, and threatens the diversity of animal and plant life. Population growth is compounded by industrial and agricultural growth that pollutes the atmosphere and waterways, damages the ozone layer, and arguably warms the Earth. The ecosystem is the medium that transmits deadly diseases and pandemics and causes natural disasters such as hurricanes and earthquakes. These natural disasters, in turn, contribute to massive refugee movements that catalyze trafficking in drugs and human beings. (See Map 9-6 later in the chapter for a snapshot of climate vulnerability.)

MAP 9-1 Global Development: Country GDP (PPP) per CapitaFigure 74

Source: World Bank, “GDP per capita, PPP (current international dollars).” http://data.worldbank.org/indicator/NY.GDP.PCAP.PP.CD/countries?display=defaultk.

MAP 9-2 Income Distribution: Persistent Inequalities and New OpportunitiesFigure 75

Source: UN Department of Economic and Social Affairs, “National Accounts Main Aggregates Database,” http://unstats.un.org/unsd/snaama/selbasicFast.asp.

Note: The numbers in the legend measure each country’s GDP expressed as a multiple of the average world GDP. Countries with scores of 1 to 2 or more have GDPs above the average world GDP for the years shown. Countries with scores of less than 1 are below the world average. Notice the changes in Latin America and Asia in particular as many of those countries have moved from lower to higher GDPs and into the middle class. No data are available for French Guiana and Western Sahara.

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Ecuadoran women from the Amazon region march through the streets of Quito, the capital city, to protest the federal government’s recent decision to exploit the oil reserves of the Yasuni National Park, a move that will affect the lands of many indigenous communities.

Edu Leon/LatinContent/Getty Images

Most of all, development is about values and identity. Who or what is it that develops? Is it an ethnic or tribal group, a religious sect, a social class, a nation, a civilization, or a world? What kind of people are we? How are we alike and how do we differ? Today’s developing countries have different roots, come from different cultures and religions, and face different circumstances from those of advanced countries when the latter were developing. Emerging from colonization by the Western world, developing nations seek independent futures and fear neocolonialism, or dependence on global markets that embody historical oppression. Moreover, while they recognize that their development has costs for the environment, they resent the idea that they must share equally with advanced countries the burdens of climate change. They expect advanced countries to bear the costs of developing renewable energy sources and either subsidize such sources in the developing world or do the lion’s share of reducing carbon emissions in the advanced world. Many in both the developed and the developing worlds believe the world needs a new self-image, one that emphasizes a common destiny rather than separate national interests. They argue that the world has many players but only one stage, and that stage is planet Earth. The environment—the Earth’s surface, the materials below it, and the atmosphere and space above it—is the world’s common home. It is the classic example of a collective good. It will be preserved for all peoples, or it will be preserved for none.

Issues of identity and justice therefore lie at the root of the development process. Most analysts agree that wealth disparities cannot be ignored, especially in an age of globalization. But is the goal perfect equality and social solidarity? Or is the goal maximum freedom, a solid floor for everyone, and then space for individuals, communities, and nations to pursue excellence and differentiate themselves through competition? In some countries, such as Russia, people assume that if their neighbors get ahead they must be corrupt. Hence, fewer incentives exist for individuals to take the initiative and seek to excel. In other countries, such as Haiti, elites do take the initiative and get ahead, but then they forget about their neighbors. What is the right mix of incentives to help oneself and to help others? Without individual initiative, development does not occur, as many communist countries learned. And without social solidarity, communities divide and development becomes oppression, as many failed states have experienced.

Identity perspectives highlight the separate and common values of a globalizing world. Advanced countries, which are mostly Western, hold the advantage and both help and hinder the development of poorer countries, which are mostly non-Western. Western countries tend to see their civilizations as superior and urge developing nations to adopt Western policies and standards. The Western identity embraces free markets, dating back to the Reformation, which blessed worldly efforts as a way to please God. Other identities see free markets as degrading and blasphemous in the eyes of their religion. Evidence suggests that global markets do indeed offer appealing prospects for acquiring material wealth. Since World War II, countries in Asia, which exploited global markets early, fared best, while those in Latin America, which pursued more protectionist policies, floundered. Some countries in the Middle East and North Africa got rich on oil, and some Latin American countries benefitted from a commodity boom. But many remained poor in terms of industrialization, suffering from what we identified in Chapter 8 as the resource curse. Conditions in sub-Saharan Africa stagnated, although prospects in resource-rich African countries improved in recent years as China, India, and other rapidly developing countries scrambled for African resources to fuel globalization.

So growth has accelerated and spread over the past fifty years, a remarkable, if uneven, achievement. Yet growth also raises poignant identity issues, especially for countries with non-Western religions and cultures. What or whose values drive growth, and are these values shared or separate? One big shared value of all cultures and peoples of the Earth is the environment. The shared identity of planet Earth implies the need to adopt more common approaches to problems of globalization and social justice. From an identity perspective, as the causal arrow suggests, values shape institutional and material outcomes more than the reverse.

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In this chapter, we examine and compare the development experiences of developing countries in four regions: Asia, Latin America, the Middle East and North Africa (MENA), and sub-Saharan Africa (SSA). In each region, we look at four aspects of development: domestic and regional stability, macro- and microeconomic policies, trade strategies, and the role of domestic and regional culture and values. At the end, we summarize and compare the regions’ development experiences using this framework. Then we address the major issues of the environment and development. As always, we consider all perspectives but highlight identity aspects in contrast to the realist and liberal aspects of development emphasized in the previous chapter.

development: the process of material, institutional, and human progress in a particular country or region.

climate change: The warming and cooling of the earth’s temperature in cycles over centuries.

Asia

Asia has been the most successful developing region since World War II, far more successful than Latin America, which is the next-best-performing area. Even after Asia experienced severe financial crises in 1997–1998 and again in 2008–2009, the region grew by an average of 8 to 9 percent per year through 2014, more than doubling its wealth and lifting millions of people out of poverty.1

The World Bank explored the reasons for this so-called East Asian Miracle. Until 1990, most of the gains occurred in just eight economies: Japan; the “Four Tigers”—Hong Kong, the Republic of Korea [South Korea], Singapore, and Taiwan, China; and the three newly industrializing economies (NIEs) of Southeast Asia, Indonesia, Malaysia, and Thailand.2 (See Map 9-3 for Asia’s regions.) These eight countries grew twice as fast as the rest of Asia, three times as fast as Latin America and South Asia, and five times as fast as sub-Saharan Africa. After 1990, China joined the growth parade, followed by India. From 1990 to 2010, China and India, where 40 percent of the world’s population resides, grew by 10 and 8 percent per year, respectively. No country in the world grew as fast as China, and no country with the same poverty rates and population, except China, grew as fast as India. As a result, 400 million people in China and some 200 million in India have been lifted out of poverty into the middle class. Asia shows that both high growth and greater equity are possible in global markets. Since the financial crisis, Asian growth has slowed—from around 8–9 to 6–7 percent per year, but it still remains above the rate of growth in most other countries, including the advanced ones.3

Why did East Asia grow three times faster than Latin America? And why are China and India growing faster even today? Asia and Latin America make a good contrast because Asian countries pursued export-oriented development strategies that exploited economic competition in open international markets, while Latin American countries, for the most part, adopted import substitution strategies that counted on protected domestic markets for development. Both regions learned something from their different experiences. By the turn of the millennium, Latin American countries moved toward more export-oriented strategies, while some Asian countries questioned the value of completely open markets, especially for short-term capital flows.

Economic Miracle

The original tigers of East Asia—Hong Kong, Singapore, Taiwan, and South Korea—pioneered export-led development and achieved a development status that, for all practical purposes, put them in the same class as developed countries. With annual per capita income around $30,000, South Korea, for example, is now a member of the OECD, the economic organization of industrial countries. The tigers were followed by a second wave of newly industrializing countries (NICs) in Southeast Asia: Malaysia, Philippines, Thailand, and Indonesia. These countries boast per capita incomes roughly halfway between developing and industrialized countries. The most recent wave of Asian export tigers includes China and India, countries that alone account for 36 percent of the world’s population and 80 percent of the world’s poor people. On a nominal basis (meaning not adjusted for inflation), China now has a per capita income of approximately $7,593 and India of $1,630.4

MAP 9-3 Asia’s RegionsFigure 76

Note: North or East (sometimes called Northeast) Asia includes China, Hong Kong (now part of China), Taiwan (claimed by China), the two Koreas, and Mongolia; it also includes Japan, which is, however, an industrialized country. Southeast Asia includes the ten nations that make up ASEAN. South Asia includes India, Pakistan, Bangladesh, Afghanistan, and the small island or mountain states of Sri Lanka, Bhutan, and Nepal. Central Asia consists of the former republics of the Soviet Union: Kazakhstan, Kyrgyzstan, Turkmenistan, Tajikistan, and Uzbekistan.

What is more, these countries not only grew, but they also witnessed a dramatic reduction in inequality. In the 1970s and 1980s, Indonesia, Malaysia, Singapore, and Thailand reduced the proportion of people living below the poverty line by 25 to 40 percentage points. As noted earlier in this chapter, China and India achieved similar reductions in the 1990s and 2000s. Each of the four tigers and three of the four NICs (Malaysia is the exception) had a relative inequality ratio (that is, the ratio of the income share of the top 10 percent, or decile, of the population to that of the bottom decile) of less than 10, well below that of almost all other developing countries. In short, development in Asia did not increase domestic inequality. One reason may be that Asian countries, such as South Korea, invested in rural areas and general education rather than in urban development and elite universities, as did many Latin American countries.

East Asian Miracle: a period of unprecedented economic growth and development in East Asia between 1965 and 2010.

Stable Governments/Unstable Region

Domestic political stability helps development, and Asia had domestic political stability in spades. After World War II, authoritarian or stable one-party governments (as in China) held power for long periods throughout the region. However, international unrest was a major negative factor in Asia. Two major wars took place there—Korea (1950–1954) and Vietnam (1961–1975). And China continues to reunify its territory—at least as China defines it—peacefully in the case of Hong Kong and Macao but increasingly with threats and a buildup of military force in the case of Taiwan. North Korea pursues nuclear weapons and could start another war of major proportions in the region.

So it is hard to argue that overall stability, taking into account the international as well as the domestic environment, is the secret to Asian development success. What is more, democracy has spread in Asia, particularly since the mid-1980s. And democracy, while it aids development in some ways, often brings with it greater political disputes, scandals, and uncertainties that also impede economic policy.

Military governments in South Korea repressed labor groups for three decades, including engaging in violent crackdowns that remain issues in South Korean politics today. In 1987, the military finally turned the government over to civilian leaders, but the conservative political party that initially controlled the government was still supported by the military. It was not until ten years later that the liberal opposition party not beholden to the military won office. In 2007–2008, the government (both presidency and legislature) switched back again to the conservative parties, reflecting a peaceful rotation of parties in power that even Japan did not achieve in the first forty-five years of its postwar existence. Today, South Korea has a robust multiparty system and wrestles with the legacy of past authoritarian governments (complete with trials of former presidents and military leaders) as well as the delicate problem of living side by side with North Korea and its threat of another devastating war.

Taiwan, too, is now a democracy that rotates power peacefully between opposition parties, complicating the issue of reunification with mainland China, which remains an authoritarian communist country. A civilian government supported by the military took power in 1987. Then in 2000, a liberal opposition party not identified with the military won the presidential elections and, in 2001, a plurality in the legislature as well. In 2007–2008, power rotated back to the conservative parties. Taiwan’s parties differ on relations with mainland China. The conservative Kuomintang, or Nationalist Party, accepts the notion of “one China” and supports eventual unification with China. The liberal Democratic Progressive Party leans more toward national self-determination and independence for Taiwan. Because Taiwan’s economic life is closely tied up with trade and investment on the mainland, these political differences add uncertainty to economic policies.

Democracy also made inroads in Southeast Asia. In 1986, the Philippines ousted dictator Ferdinand Marcos. Thailand held competitive elections in 1988. And Indonesia held its first parliamentary elections in thirty years in 1999 and its first direct elections for the presidency in 2004. All these democracies are weak. The Philippines remains vulnerable to military coups (six attempts from 1986 to 1992 alone, and the most recent one in early 2006). Thailand, too, suffered military coups, most recently in May 2014. Indonesia lost one province in 1999 when East Timor separated from it violently, and it faces secessionist struggles in other provinces such as Aceh, the scene of the tsunami disaster in 2004.

What is more, unlike the situation in most of Europe, Asian democracies still live with totalitarian neighbors. Three of the four remaining communist governments in the world—China, Vietnam, and Laos—are in Asia (Cuba is the fourth). Brutal military governments rule in North Korea, Bhutan, and Myanmar (formerly Burma), although since 2011 some relaxation of military restrictions has occurred in Myanmar, where a courageous woman, Aung San Suu Kyi, leads the democratic opposition. Even successful small states, such as Singapore (which separated from Malaysia in the 1960s) and Malaysia, have repressive governments. Beijing has been slowly squeezing democracy in Hong Kong since the former British territory reverted to China in 1997.

A bright spot for democracy in Asia is India. The largest but also the poorest democracy in the world has recently opened up to trade and foreign investment. Its growth prospects now rival China’s. But India, too, has hostile and unstable neighbors. India and Pakistan possess nuclear weapons and face off against one another over the disputed province of Kashmir. India and China have border disputes. Pakistan has an unstable government and fights against Taliban terrorists in Afghanistan and within its own borders. Afghanistan fights for its modest democratic life surrounded by right-wing theocrats in Iran and military generals in Pakistan. Bangladesh and Sri Lanka struggle against separatist movements. Maoist guerrillas toppled the Nepalese monarchy in 2008.

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Myanmar’s prodemocracy leader Aung San Suu Kyi arrives at her National League for Democracy headquarters on November 14, 2010, in Yangon, Myanmar. Suu Kyi had been held under house arrest for the majority of the past fifteen years but was released by the country’s military leaders. In historic elections held in November 2015, Suu Kyi and her NLD party appear to have won control of Myanmar’s parliament. If power is transferred peacefully, the NLD would elect the country’s first president and Myanmar’s fifty year long military regime would end.

CKN/Getty Images

What about Asia’s colonial legacy? Western European countries colonized much of Asia in the eighteenth and nineteenth centuries, and in the twentieth century the United States, China, and Japan followed suit. Only Thailand, like Saudi Arabia in the Middle East, escaped colonialism. Colonial rule was harsh and left lasting grievances. China resents Western and American hegemony. South Korea and China harbor bitter memories of Japanese occupation. French colonialism in Indochina spawned the Vietnam War and left lingering communist governments in Laos and Vietnam. Nevertheless, colonialism did not cripple development in Asia to the extent that it may have in Latin America, Africa, and the Middle East. Why? Some might say, from a realist perspective, that it is because Asia geopolitically was farther away from the Western powers than Latin America, the Middle East, or Africa and benefited from Cold War conflicts that poured American aid money into South Korea and Taiwan. Others might say, from a liberal perspective, that it’s because the region was more central to commerce and shipping than landlocked countries in other regions (countries close to the Suez and Panama Canals being exceptions). Still others might argue, from an identity perspective, that it’s because Asia had a more unified and resilient regional culture based in Confucianism, or what people today call “Asian values.” The causal arrow in the margin illustrates this argument.

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Sound Economic Policies

In its study of the Asian economic miracle, the World Bank praised the sound domestic economic policies of the eight high-performing Asian economies (HPAEs):

Macroeconomic management was unusually good and macroeconomic performance unusually stable, providing the essential framework for private investment. Policies to increase the integrity of the banking system, and to make it more accessible to nontraditional savers, raised the level of financial savings. Education policies that focused on primary and secondary schools generated rapid increase in labor force skills. Agricultural policies stressed productivity and did not tax the rural economy excessively. All the HPAEs kept price distortions within reasonable bounds and were open to foreign ideas and technology.5

As a result of sound domestic policies, inflation was only one-tenth as great in the HPAEs as it was in other developing countries and only one-twentieth the levels in Latin America. Because inflation rates remained under control, interest rates were more stable and real interest rates, which subtract out inflation, stayed positive, encouraging long-term savings and investments. Asian countries had savings and investment rates twice as high as those of other developing countries—40 percent compared to 20 percent. Money stayed at home rather than fleeing into foreign currencies, as happened so often in Latin American countries. One reason inflation stayed low is that governments restrained fiscal policy and kept fiscal deficits in line. The average annual budget deficits in South Korea as a share of GDP ran one-fifth the levels of many Latin American countries.6

Microeconomic policies focus on land reform, primary education, small enterprises, and housing and health services.7 Indonesia and Thailand traditionally had widespread landownership, but South Korea and Taiwan, as well as Japan, did not and instituted land reform after World War II. Taiwan seized land from landlords and compensated them with shares in state enterprises. In South Korea, U.S. occupation forces redistributed land confiscated from Japanese landowners, and then the South Korean legislature, after lengthy debate, seized the properties of Korean landlords, paid them nominal compensation, and parceled out the properties to 900,000 tenants. Hong Kong and Singapore had no agricultural sector. Land reform in the Philippines and elsewhere lagged behind, and so did economic development.

Land reform created a sense of participation on the part of rural areas and formed the basis for successful education programs. Asian governments poured money into public education. Compared to other developing countries, Asian governments concentrated on primary and secondary education. South Korea, for example, put 85 percent of its investment into basic education and only 10 percent into higher education and universities. Venezuela, by contrast, put 45 percent into higher education. Education in Asia served the masses, not just the elites. South Korea and Taiwan developed educated labor forces, which then took jobs in the urban and industrial sectors. Educated workforces, in turn, developed demand for higher education, which was supplied in good part by private universities and capital.

Asian governments absorbed educated labor forces by supporting small and medium-size enterprises. In all economies, these firms account for most of the employment. As government policies stimulated the broad economy, specific programs provided preferential credits and specific support services for smaller companies.

Why didn’t Korean and Taiwanese peasants coming to the big cities to find jobs wind up, like Latin American peasants, living in slums on the outskirts of affluent neighborhoods? A big reason is the investment that Asian governments made in housing and health services. Hong Kong and Singapore, besieged by migrants from China and Malaysia, built massive public housing projects. By 1987, more than 40 percent of the population in Hong Kong and 80 percent in Singapore lived in public housing. Most of the inhabitants owned their own units. South Korea and Indonesia had similar public-supported housing programs.

For decades, Asian workers were not free. Governments suppressed radical activity in the labor sector. But the political discontent was managed and did not result in coups or revolutions, as often was the case in Latin America, because the governments provided generous education, housing, and other benefits, such as land reform, that sustained a sense of participation in national prosperity.

land reform: domestic policies to redistribute land for the purposes of equity and development.

Export-Led Development

Throughout the region, therefore, governments played a crucial role in Asian development. The issue was not the government’s role per se, but what kind of role the government played. Did government provide incentives to support market-oriented and competitive development, or did it give special privileges to cronies and corrupt industrial and technological elites, and suppress market competition? The debate intensified between those who urged reliance on market or comparative advantage and those who emphasized government intervention to create market or competitive advantage. This was the same debate, now in the development arena, that divided advocates of comparative advantage and advocates of strategic trade in the trade arena (discussed in Chapter 8).

One point is certain: Asian high performers geared their development toward foreign markets. They relied primarily on export-led development to exploit foreign markets, not on import substitution policies to protect domestic markets. Governments intervened domestically to create internationally competitive industries; they did not intervene internationally to coddle inefficient domestic industries. They created export zones for selected industries, usually industries at the lower end of the technological spectrum, where the countries possessed a labor cost advantage. For example, the Asian tigers first exported toys and handicrafts and later textiles, shoes, radios, and black-and-white television sets. Eventually, they graduated to the heavy manufacturing industries, including steel, chemicals, and shipbuilding, and thereafter to more sophisticated components and consumer products such as semiconductor chips, automobiles, computers, and electronic games.

The key point, then, is that Asian governments took their development signals from international markets and intervened in domestic markets to achieve international competitiveness. This strategy required a disciplined bureaucracy. Here Asia had another advantage over Latin America. By tradition, the best and the brightest in Asia went into government service, and government bureaucrats were motivated more by technical expertise than by political or personal gain. Governments were not immune to corruption, as scandals in Japan, South Korea, and Taiwan repeatedly demonstrated. And bureaucrats were often closely connected to business interests, leaving government posts at some point to take up second careers in the corporate sector. But the process was motivated by a sense of national pride and duty, not the rent-seeking and resource-stripping policies that afflicted many elitist Latin American governments.

Later studies showed that Asian development was not necessarily a result of greater efficiency or productivity—that is, getting higher output out of the same level of capital and labor inputs. It was mostly a consequence of investing more capital and labor to achieve higher output.8 Asian countries did a better job than other developing countries of mobilizing domestic savings (capital) and a well-educated, healthy workforce (labor). A part of the secret at least was the sound underlying domestic policies that created stable prices and exchange rates to guide and sustain resource mobilization. At some point, however, growth by accumulation involving the addition of more and more labor and capital resources to achieve higher output reaches its limits. Further growth requires higher productivity, or getting more outputs with the same inputs, and that requires innovation and industrial restructuring toward higher-technology or value-added industries.

Limits to Export-Led Growth

By the late 1990s, Asian export-led development reached its limits in three areas. The first was the rapid expansion of international markets. More and more countries were pursuing export-led growth. Recall that the end of the Cold War brought the former communist countries into world markets. Trade markets were becoming increasingly crowded. Countries had to run faster to stay in place. Before Japan had mastered the shipbuilding industry, South Korea was building ships and taking away market share. And before South Korea had mastered shipbuilding, China was building ships. As suppliers multiplied and each sought to protect its own home market, consumers relatively dwindled. In a small way, export-led development, after many countries adopted it, replicated the market squeeze that occurred in the 1930s when everyone wanted to export and no one wanted to import—export markets became saturated. By the mid-1990s, Asia was awash in excess production capacity for electronic products, steel, automobiles, and shipbuilding.

The second area limiting export-led performance was that, as Japan and other Asian high performers caught up with world standards, they had to rely more on innovation to develop future markets. Asian bureaucracies may have been better at imitating existing industries, but they were not necessarily better at inventing and creating future ones. As one critic noted in the case of Japan, “Funding concentrated on a ‘catch-up’ targeting of known technologies was much easier than having to push out along an unknown technological frontier.” Once a country caught up, “it was no longer clear where and how to spend the money since future technologies by definition did not exist.”9

Much of Asian development also depended on a single market, the United States. In 1999, the United States still absorbed 24 percent of Hong Kong’s exports, 31 percent of Japan’s, 30 percent of the Philippines’s, 21 percent of South Korea’s, 25 percent of Taiwan’s, and 22 percent of Thailand’s.10 In 2012, the United States absorbed 19 percent of China’s total exports, double that of any other country.11 As the dollar soared in the 1990s, so did the currencies of a number of Asian countries that tied their currencies to the dollar, such as South Korea and Hong Kong. So currency appreciation also hurt export performance. Finally, protectionism in the United States was growing. As country after country, including now the titan of China, grew by exporting to the U.S. market, Congress called for protection against imports. In a real sense, as the above numbers show, the open U.S. market gets a good deal of the credit for the success of Asian development strategies, and now for development strategies in Mexico and elsewhere. But, like export markets overall, the U.S. market reached a saturation point, at least in the political sense of being willing to absorb more and more foreign imports.

The third limit on the Asian export-led model was in the financial area. Finance or banking was the sector in Asian countries that was least efficient. Governments dominated credit markets through postal savings systems and then disbursed loans to support government industrial and technological development. There was little competition from private sources. Japan and South Korea restricted foreign investment; and private equity markets, where companies raise money directly by selling stocks and bonds, were relatively small in most Asian countries. As a result, the allocation of loans became routine and hard to change. Banks invested in the same companies, and companies invested in the same industries, developing cozy relationships, in what subsequently became known as crony capitalism. As a result, industries built up excess capacity. They added new steel or automobile plants when none was needed or more roads and bridges when existing ones were not being used. Many of these loans later went sour.

China pursues policies similar to those of the earlier Asian fast growers. It bases its growth on exports, it channels loans to industry largely through state banks, and it maintains an undervalued exchange rate to gain a foreign market advantage. But there is one major exception. Unlike Japan and South Korea, which initially discouraged FDI, China welcomes it. In 2006, FDI inflows into China totaled $69 billion.12 In 2014, it exceeded $347 billion.13 The accumulated stock of FDI in China amounts to more than $1.3 trillion. In addition, China saves an enormous percentage of its GNP, around 50 percent.14 So China is not dependent on foreign capital, although it does need the foreign expertise that comes with FDI. Indeed, it exports capital, using its surpluses on current account to buy U.S. Treasury bonds and finance the twin deficits of the United States, as discussed in Chapter 8.

The problem in China is massive inefficiency. The country is accumulating bad loans at an astonishing rate. It uses four to five times more energy to produce a unit of output than the industrialized countries. Although it has privatized many sectors, it maintains large numbers of inefficient state enterprises to preserve the jobs they provide. And it wrestles with the rural and urban disruption that moves thirteen million people per year from farms to cities, looking for work. At the moment, investment in transportation, energy, and business infrastructure takes precedence over investment in housing and health care. In the future, China may have to spend more on housing and health services, thereby co-opting the working classes the way Hong Kong, Singapore, and Taiwan did.

India is moving in the same direction, but it is probably twenty years behind China. China has reduced average tariffs more than India, and India is much less open to foreign investment, with a total FDI stock of $261 billion, compared to China’s $1.3 trillion. Enforcing a contract in India takes 1,420 days, compared to 453 in China, while shutting down a bankrupt business takes 4.3 years, compared to 1.7 years in China.15 Illiteracy is higher in India than China. In 1999–2000, only 47 percent of children passed through five years of primary school in India, while 98 percent did in China. In India, 68 percent of the people still live in the countryside; in China, 47 percent. Industrial activities employ 20 percent of the labor force in India, but just over 30 percent and rising in China.

Microfinancing, or the provision of small loans to individual entrepreneurs, especially women, originated in South Asia. Muhammad Yunus, a Bangladeshi who won the Noble Peace Prize in 2006, started the Grameen Bank in 1976 with $27. Today it serves more than 6.7 million borrowers, and microfinancing worldwide topped $8.1 billion in 2012. As microlending has grown, however, so have microlenders’ problems with defaults and corruption. Like all development initiatives, microfinancing is only one of many instruments to combat poverty.16

crony capitalism: noncompetitive lending and investment relationships between government financial institutions and private industry.

microfinancing: the provision of small loans to individuals, especially women, in developing countries.

Asian Values

Successful Asian societies are more ethnically homogeneous than Latin American or African countries. China is mostly Han, with a small but restive Muslim population in the western part of the country. Japan, except for minuscule Korean and indigenous minorities, is, as Edwin Reischauer, Harvard professor and onetime U.S. ambassador to Japan, observed, “the most thoroughly unified and culturally homogeneous large bloc of people in the world, with the possible exception of the Northern Chinese.”17 Both North and South Korea are ethnically unified, although the peninsula was divided historically into three separate regional kingdoms. South and Southeast Asian countries are more diverse. Overseas Chinese constitute a majority in Singapore and significant minorities in Malaysia, Indonesia, and other countries. The overseas Chinese often dominate commercial life and create resentment among indigenous populations, for example, among the Malays and Indonesians. Four major religions divide the region: Islam in Pakistan, Bangladesh, and Indonesia; Hinduism in India; Buddhism in China, Tibet, and Japan; and Shintoism in Japan.

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A man makes chapatis as an Air India passenger jet flies over the Jari Mari slum before landing at nearby Mumbai Airport in Mumbai, India. The redevelopment of the Jari Mari slum, along with that of the nearby Dharavi slum, has stalled since the global economic financial crisis.

Daniel Berehulak/Getty Images

Asia’s success sparked a debate about Asian values. Was it widespread Confucian values that contributed to domestic stability and motivated bureaucratic and commercial success? Confucianism gives priority to family and society over the individual. Nowhere in Asia is individualism celebrated as it is in the United States; instead, authority patterns infuse all levels of society—in the family, business, and the state. This authority is patrimonial, personalized, and less institutional or accountable than authority in the West. It creates extended family ties that infiltrate formal institutions and are difficult for outsiders, especially foreigners, to access. Quanxi, the Chinese word for close personal relationships, ties markets together rather than legal contracts. Japanese business practices too are notoriously exclusive and discriminatory. While much of this is changing, Asian societies are still comparatively more cohesive than societies in other regions of the world. As Mahathir Mohamad, the former president of Malaysia, put it bluntly, “The group and the country are more important than the individual.”18

Asian values may also help explain the less formal and less institutionalized nature of economic integration in Asia and the continued political divisions that make Asian international affairs more unstable. There is no common market in Asia as there is in Europe. APEC is a forum rather than a legal institution like the European Union. China, to be sure, is more open to FDI than are Japan and South Korea. Nevertheless, much of this integration is a function of the relocation of investments from Southeast Asia and Hong Kong to mainland China, where products are assembled from imported components and shipped to the United States and other world markets. (Remember the story in Chapter 8 about the purchase of your smartphone.) Asian integration is still more vertical and outward-oriented than European integration, which is more horizontal—competitive—and inward-oriented. The European Union, for example, exports only 15 to 20 percent of its trade outside Europe, whereas Asian countries, as we have noted, depend more heavily on U.S. markets.

Figure 9-1 Key Factors in Asian Development: The Identity Perspective and Levels of AnalysisFigure 77

Paradoxically, Asian values may also explain the greater rivalry that permeates the Asian region. Because Asian societies are ethnically insulated from one another, especially in East Asia, they have been less willing to forgive and forget wartime or historical wrongs. Bitter memories linger between Japan and China and between Japan and South Korea, breaking out periodically in ugly violence, such as anti-Japan demonstrations in China in fall 2012. Cultural homogeneity strengthens development within a country, but it impedes integration among countries or gives this integration a less institutional and stable character. Reconciliation in Asia lags well behind that in Europe, where a common European culture of multilateral institutions and law is slowly supplementing national cultures. China’s looming dominance may also deter integration in Asia; in contrast, relatively equal partners developed the EU.

Figure 9-1 summarizes the key features of Asian development, which we now contrast with Latin American development.

Asian values: the Confucian ideas emphasizing authority over individualism that motivated economic success in Asia.

Latin America

Latin America’s development experience contrasts sharply with that of Asia. Except for Chile, Latin American countries deliberately opted out of the GATT free-market trading system after World War II and based their development strategies on import substitution rather than on export-led growth. This model facilitated some initial industrial development in Brazil, Argentina, Mexico, and other countries, but it actually made Latin America more, rather than less, vulnerable to international markets. Industries served domestic markets only and did not stay competitive in the absence of foreign competition. They developed little export capacity to finance vital imports. When the oil crisis hit in the 1970s, Latin American countries had to borrow heavily to finance higher-priced oil imports, and when interest rates went up in the 1980s, they could no longer service their loans. Latin America experienced a lost decade while East Asia experienced an economic miracle.

Lost Decade

From 1950 to 1973, Latin American countries grew on average by 2.5 percent per year in real GDP per capita. This performance was slightly below the average for all developing countries (2.7 percent per year) but less than half the growth rate in South Korea and Taiwan and one-third the growth rate later in China and Thailand. Brazil and Mexico did best, growing at about 3.8 percent and 3.1 percent per year, respectively. These were the years of domestic-oriented import substitution policies in Latin America, and the performance was not that bad. So it is incorrect to say that protectionist policies never pay. Notice, however, that these policies paid off mostly in big countries, such as Brazil and Mexico, which had large domestic markets to support import substitution industries.

MAP 9-4 Latin America’s RegionsFigure 78

Note: As this map shows, Latin America encompasses one country in North America (Mexico), seven in Central America, and twelve in South America. Strictly speaking, not all are “Latin” (or Spanish and Portuguese)—some are English, Dutch, and French—and eight small Caribbean countries also belong to the developing countries of the Western Hemisphere.

The issue is, at what price do such policies pay? The next decade and a half, from 1973 to 1987, suggested the price was pretty high. Known as the lost decade, this period saw average real per capita growth in Latin America plummet to 0.8 percent per year. It held up best in Brazil at 2.2 percent, dropped dramatically in Mexico to 0.9 percent, and was negative for the entire period in Argentina at –0.8 percent. What happened? Well, Latin America went through a very difficult transition period occasioned in part by oil crises, which ran up the region’s external debt. The debt of six major countries—Argentina, Brazil, Chile, Colombia, Mexico, and Peru—increased from $35 billion to $248 billion in less than a decade. But import substitution policies also played a role. They fueled inflation and did nothing to reduce inequality. Inflation rates soared to an average of more than 100 percent per year, compared to 20 percent in the earlier decades, ten to thirty times higher than inflation rates in Asia and the industrialized countries. In addition, the disparity of incomes between the top 10 percent of income earners and the bottom 20 percent was twice as high in Latin America as in Asia and the industrialized countries.19 Chile was the only country to weather the oil crises and continue to grow, and it was also the only country that followed export-led rather than import substitution policies.

Starting in the late 1980s, almost all Latin American countries undertook market-oriented policy reforms. Following the Washington Consensus, which emphasized free-market economics, they stopped accommodating inflation, liberalized domestic markets, and opened trade and investment ties with foreign firms. As the World Bank reports, “Policies were better in nearly every country in Latin America in 1999 than they were in Chile in 1985.”20 And remember, Chile had the most liberal policies in 1985. At first, the expected economic growth did not follow. Although growth in the region accelerated in the early 1990s—reaching 7 percent in 1992—it tailed off badly after 1995, when Mexico underwent a financial crisis, and slumped to zero in 1998, where it stayed through 2002.21 After 2002, however, Mexico and the rest of Latin America rebounded smartly. From 2003 to 2008, the region grew by more than 5 percent per year, the best record since the early 1970s. Even after the financial crisis of 2008–2009, Latin America grew again in 2010 by more than 5 percent, but the crisis took a longer-term toll, and the growth rate slowed down to 1.3 percent in 2014.22

Was this belated performance the result of free-market policies finally paying off, or was it a consequence of soaring oil, agricultural, and commodity prices, which benefited Latin American energy producers such as Mexico and Venezuela and beef producers such as Argentina? Some analysts see changes in Latin America largely as a product of U.S. neocolonialism and intervention (realist). Others see them as the consequences of insufficient market interdependence and weak national and regional institutions (liberal). And still others see them as the outcomes of conflicting ideologies and class and ethnic warfare (identity). The causal arrows in the margin depict these alternative explanations.

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The World Bank suggests that four “syndromes”—that’s diplomatese for “causes”—account for Latin America’s failure to match the better performance of Asian developing countries: (1) governments that are dominated by elites, are unstable, do not protect property rights, and engage in corruption; (2) macroeconomic policies that cause inflation, fiscal deficits, volatile exchange rates, and high debt; (3) external policies that restrict trade and investment; and (4) financial systems that are dominated by state-owned banks and legal institutions that do not enforce contracts. The World Bank also adds a fudge factor—bad luck. This covers geography (landlocked countries), disease susceptibility, and the “curse” of resources (remember from Chapter 8 the problems of resource-based industries?).23

Whatever the syndromes or causes, here are the results. In 1800, Argentina had a per capita income equal to that of the United States; today, its per capita income is less than one-third that of the United States. Similarly, in 1800, Brazil, Mexico, Chile, and Peru had per capita incomes at 40 to 50 percent of the U.S. level. By the early twenty-first century, Chile remained at about 40 percent, and all the others had dropped to 25 percent. Let’s look more closely at the four syndromes associated with this dramatic divergence in living standards between the United States and Latin America. They correspond to the four dimensions of the comparative regional framework we use in this chapter—geopolitics, internal policies, external policies, and cultural values.

lost decade: a period of economic stagnation in Latin America brought on by domestic policies, the oil crises, and high debt, lasting from the early 1970s to the late 1980s.

Early Decolonization/Unstable Governments

Colonized by European powers after 1500, Latin America had already secured its independence in the early nineteenth century. After that, South American countries, such as Brazil and Argentina, remained largely free of outside interference—with a few exceptions, such as British intervention in the Falkland Islands in 1833. But Mexico, the Caribbean, and Central American countries endured American expansion and periodic intervention for the next one hundred years. Mexico lost roughly half its territory to American conquest, and American troops occupied Cuba, Nicaragua, Honduras, the Dominican Republic, and other neighbors for extended periods of time. In most cases, the pretexts for intervention were instability and the threat of interference by outside powers, principally the former European colonial powers. In 1823, the Monroe Doctrine (named for James Monroe, who was U.S. president at the time) declared the Western Hemisphere to be America’s sphere of influence, and U.S. forces intervened in Colombia in the early twentieth century to create the state of Panama and build the Panama Canal. Thus, while Latin American countries, unlike other developing countries, escaped early from direct colonialism, they labored under the continuing presence and sometimes direct intervention of the “colossus to the north.” Puerto Rico and the Virgin Islands, of course, became and remain American territories.

Military rule and political instability characterized Latin American politics throughout much of the nineteenth and twentieth centuries. Interruptions of constitutional power were common. In the seventy-five years after 1900, only Colombia and Costa Rica had fewer than ten years of nondemocratic rule. All the other countries clocked at least two decades of dictatorial rule. Some, such as Argentina, Brazil, Ecuador, Bolivia, Mexico, the Dominican Republic, and all the Central American countries except Honduras, clocked four decades or more. A few, such as Haiti, never experienced a peaceful transfer of power from one party to another. The only exceptions to this experience of authoritarian rule are the small English-speaking islands of the Caribbean.24

Today, most Latin American countries, with some exceptions (Cuba and Venezuela, for example), are democracies. But they are weak democracies. Although elections take place, the continuous, stable transfer of power between opposing political parties is less common. Instead, Latin America has experienced waves of democratization and then reversals. After World War II, democracy spread to all Latin American countries except five: Paraguay, El Salvador, Honduras, Nicaragua, and the Dominican Republic. By 1954, however, this wave had been reversed, and only four countries remained democratic: Uruguay, Costa Rica, Chile, and Brazil.25 Then, in 1964, Brazil succumbed to a military coup; Chile did likewise in 1973. Critics blamed U.S. policies for this rollback. Fearing communist governments in the region, U.S. intelligence agencies assisted coups in Guatemala (1954) and Chile (1973) and fought Castro’s takeover in Cuba (1959).

Another wave of democratization began in 1978. Some thirty elections occurred over the next sixteen years in fifteen countries that had previously been under authoritarian rule. Half of these elections represented second, third, or fourth elections, and four-fifths of them involved peaceful transitions to opposing parties.26 Latin America seemed to be on the way to a more stable pattern of pluralist politics. Mexico’s democratic turn in 1997 provided further encouragement. Opposition parties took control of the National Assembly for the first time, and a center-right party, the National Action Party (Partido Acción Nacional, or PAN), won the presidency in 2000, taking that office from the Institutional Revolutionary Party (Partido Revolucionario Institucional, or PRI), which had ruled Mexico for seventy years. The PAN retained the presidency in elections in 2007, but the office was returned to the PRI in 2012 with the election of Enrique Peña Nieto. Rotating opposing parties peacefully in power was becoming more common.

Nevertheless, Latin America also endured some democratic reversals. A dictator, Alberto Fujimori, ruled Peru for a decade before he was driven into exile in Japan. Venezuela succumbed in 1999 to the populist military dictator Hugo Chávez, whose successor (after Chávez’s death in 2013), Nicolás Maduro, continues repressive policies. Colombia and Ecuador fought debilitating civil wars against drug lords and guerrillas. Bolivia experienced riots, threats of secession by individual provinces, and unstable governments. Argentina flirted with a populist and potentially extraconstitutional regime. And Cuba, even after Fidel Castro stepped down in 2008 in favor of his brother Raúl, remained an outpost of authoritarian and quixotic rule in the region. As the causal arrow in the margin suggests, a so-called pink tide, a turn to the left, seemed to engulf parts of Latin America.

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Political instability is undoubtedly a major cause of the disappointing economic performance in Latin America. It is also a reason that governments in this region tend to centralize and control economic policies and institutions. When politics and markets are unstable, economic resources do not grow, and the political game becomes zero-sum. Governments pursue dirigiste or state-directed policies to keep economic resources under tight political control and thereby marginalize the opposition. The only way the opposition can gain economic advantage is by seizing political power; there is no independent marketplace of any significance. As the marginal arrow shows, realist considerations (struggle for wealth) trump institutional (dirigiste) and ideological (democratic) factors.

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President Nicolás Maduro greets a crowd of people on election day, April 14, 2013, in Caracas, Venezuela.

Amanda Perobelli/Brazil Photo Press/LatinContent/Getty Images

Import Substitution Policies

Latin American countries were the “poster children” for import substitution policies. These policies called for developing local industries to substitute for imports. Even before World War II, elites in Brazil, Mexico, and other Latin American countries found such centralized economic policies congenial for political control. Import substitution policies meant protected and, hence, highly profitable domestic markets. The governments doled out licenses to political supporters, who then ran companies either as state-owned enterprises or as private companies with generous state subsidies.

State policies encouraged a massive and rapid reallocation of capital from agriculture and rural areas to industry and urban areas. State marketing boards bought and sold major food products. They set food prices very low to feed the urban population, in effect extracting savings from the rural sector by not paying market prices for agricultural output. Economists call this policy financial repression, forcing savings from rural areas at below-market rates of return. State entities also controlled and developed natural resources, such as oil, selling these products at subsidized prices at home and profiting from their export abroad. Pemex, the state-owned oil company in Mexico, dominated all aspects of energy supply, including electricity. State-run or state-dependent companies controlled most industries. During World War II, Brazil created state companies in steel, iron ore, airplane engines, tractors, trucks, automobiles, soda ash, caustic soda, and electricity. Other licenses went to private companies. These companies then lobbied to limit competition. They were what economists call rent-seekers, hoping to exploit monopoly rents from markets that had limited or no competition. If the markets were large enough to support significant volumes of output, as they were in Brazil and other big Latin American countries, companies could make high profits. They achieved low costs from economies of scale while setting high prices in the absence of competition. Best of all, they faced no foreign competition and could get cherished import licenses, if needed, to purchase foreign equipment or technology that was not available locally.

Governments controlled the commanding heights of the economy. To finance industrial development, they extracted savings by tapping natural resources and holding wages down. Financial repression worked as long as labor and natural resources remained plentiful and local industries expanded. From 1940 to 1982, the large Latin American countries grew at rates of 6 to 8 percent per year. But the government budgets were always under strain; the tax base of the economy was small, and industry absorbed more taxes in the form of government subsidies than it paid. Savings and natural resources eventually became more difficult to extract. Meanwhile, expenditures soared, mostly to accommodate privileged elites and to build infrastructure—universities, hospitals, and electrical power—that catered to urban needs. Budget deficits became chronic, and monetary policies expanded to accommodate government deficits. Central banks, controlled by finance ministries, printed money to pay the bills. Too much money chased too few goods, and inflation soared and encouraged debtors, who repaid loans in currency that was worth less. By 1986, the per capita debt in Latin America was three times as high as that in Asia.27 Inflation also encouraged capital flight; money moved out of the local currency and country. If you’re holding a local currency that is declining in value daily due to inflation, it makes sense to convert it into a foreign currency that is appreciating.

External shocks ended the party. The oil crises of the 1970s hit oil importers such as Brazil hard, although they benefited oil producers such as Mexico and Colombia and were fairly neutral for self-sufficient oil producers such as Argentina, Chile, and Peru. The real crunch came from higher interest rates in the 1980s. The one thing someone in debt does not want is higher interest rates. When Great Britain and the United States decided to attack the inflation of the 1970s by raising interest rates, Latin America’s debt mountain cracked and then collapsed. With massive debt burdens, high interest rates raised debt-servicing costs dramatically. Because most of the debt was in dollars, Latin America had to export more. But import substitution policies had done little to develop exports. Latin American exports in 1986 were only 13 percent of GDP, compared to 22 percent in 1929.28 Exports had gone backward. Thus, Latin American countries first paid only the interest on their loans and rolled over the principal. Then they could not pay the interest either, and they defaulted altogether. Mexico was the first to do so in 1982, and others followed. Latin American countries spent the next decade rescheduling debt and trying to reverse domestic policies that had reached a dead end.

financial repression: a policy in which states extract savings from one sector, such as agriculture or labor, to benefit another sector, such as industry.

rent-seekers: firms that lobby to limit competition, extracting monopoly rents by producing at low costs while selling at high prices.

capital flight: the movement of money out of the local currency and country because of inflation and economic or political instability.

Opening Markets

Chile was the first Latin American country to try export-led development policies. Under a repressive but stable military government, which the United States helped bring into power, Chile moved in the late 1970s toward more competitive market-oriented policies. It attacked inflation by disciplining the growth of the money supply, reduced fiscal deficits, converted a portion of foreign debt into equity (an early form of privatization), deregulated the domestic economy, and opened markets to foreign trade and investment. Such sweeping changes had their costs, but Chile weathered the lost decade better than other Latin American countries and became the model in the 1990s when other Latin American countries adopted more market-oriented policies.

Mexico made the decisive breakthrough. In the late 1980s, it abandoned 150 years of economic autarky, or a closed domestic economic system; shut down the notorious citadel of Mexican economic nationalism, the Ministry of Commerce and Industry; and joined the GATT and the world trading system. It reduced tariffs and integrated markets with its developed neighbors in NAFTA. Over the next decade, Mexico abolished seven hundred of its twelve hundred state enterprises, introduced more realistic market prices for previously subsidized commodities, made large cuts in bloated public-sector bureaucracies, and established an independent central bank and more competitive private banks. Mexico also became a major oil exporter, although the government retained state control of the energy sector.

The returns were not immediate or spectacular. The Mexican economy overheated, and Mexico suffered another financial crisis in 1994. It devalued the peso, reallocating resources from domestic use to exports. The devaluations squeezed domestic demand and hurt small consumers and entrepreneurs. Nevertheless, with the help of NAFTA, Mexico bounced back quickly. It paid off its emergency loans sooner than required. On balance, as the World Bank concludes, NAFTA “had positive effects on trade, foreign direct investment, technology transfer, and growth, and is also associated with productivity improvements in manufacturing.”29 Mexico grew sixfold from 1990 to 2014, more than doubled its ratio of trade to GDP, and absorbed more FDI than any other Latin American country. Except for the financial crisis in 2009, when GDP dropped by 6.5 percent, Mexico continued to grow at around 3.5 percent per year, almost doubling its GDP in purchasing power terms from 1993 to 2012.30

Other Latin American countries followed suit. Argentina, Colombia, Costa Rica, El Salvador, Guatemala, and Nicaragua lowered tariffs by 10 to 20 percent, and exports and imports soared 1.5 to 2 times as a ratio of GDP. Brazil and Argentina formed a free-trade community of their own in 1991, known as Mercosur, which Paraguay and Uruguay also joined, and Chile and others became associate members. Again, the transition was not smooth. Argentina’s experience suggests the risks of opening markets when domestic institutions are weak. The central government lost control of fiscal policy, and Argentina’s provinces went on a spending spree, issuing dollar-denominated bonds to finance debt. External obligations mounted until the currency collapsed in 2002. Argentina defaulted on its debt, and it signed new agreements with the IMF to reform its fiscal policy. Eventually, it reached an agreement with most of its private foreign bank creditors to forgive three-quarters of its debt. But, as with personal credit records, a history of default bedevils Argentina’s future access to credit.

The business climate in many of these countries improved, not just for foreign investment but, more important, for domestic investment as well. But microeconomic policies still impede local as well as foreign investment. Most Latin American countries fall in the bottom 50 percent of all countries regarding ease of doing business.31 Chile ranks highest at 39 (Singapore ranks number one), and only four other countries—Peru, Mexico, Colombia and Panama—rank in the top 50 percent. Ease of business includes starting a business, getting credit, getting electricity, paying taxes, and trading across borders, among other things. As a result, entrepreneurs operate outside the law. The informal sector in many Latin American countries, in which businesses operate without legal documents and pay no taxes, is huge. In Mexico, it accounts for about 30 percent of GDP and in Peru more than 50 percent.32 In urban areas alone throughout Latin America and the Caribbean, 56 percent of all jobs are in the informal sector.33 Think how much faster these countries might grow if this money tied up in the informal sector was injected into the broader domestic economy.

Mexico privatized commercial banks in 1991, after nationalizing them in 1982. While privatization was considered a technical success, subsequent bank lending to politically powerful groups contributed to the financial crisis in 1994. After the crisis, Mexico permitted foreign banks and investment firms to enter and increase competition. But banking and financial markets in other countries remain underdeveloped, largely because of a lack of competition and foreign expertise. Most loans still go to those with close connections to the lenders rather than to the most profitable ventures. Equity and bond markets, where firms can raise money independent of government influence, are weak.34 Nevertheless, in the 1990s, many governments established independent central banks. By the early 2000s, Brazil, Chile, Colombia, Peru, and Mexico had taken away the printing presses that finance ministries used to finance debt and fuel hyperinflation.

From liberal perspectives, market-oriented reforms clearly moved Latin American countries in the right direction. Exports not only grew but also diversified away from commodities, for which prices were declining, and toward manufactured goods, for which prices were rising. For Latin America and the Caribbean as a whole, the share of manufactured exports to total exports tripled from 15.4 percent in 1970 to 46.6 percent in 2000.35 From realist and identity perspectives, however, trade and other reforms did not measurably reduce inequality, although they did not increase it either. Unlike China and India, Latin America did not see a large reduction in the number of people living below the poverty line.

informal sector: business activities that take place outside the legal system of a country because of excessive regulations.

Social Inequality

Inequality in the mainly middle-income Latin American region is among the highest in the world. According to one report, “8 of the 10 countries in the world with the highest indices of income inequality were in Latin America.”36 An enormous proportion of income is controlled by a small fraction of the population: 32 percent of income accrues to 10 percent of the population, while the poorest 40 percent receive only 15 percent. Poverty reduction has improved somewhat in recent years but twenty-eight million people in the region—almost 5 percent of the population—remain mired in extreme poverty.37 Why is inequality in Latin America so resistant to change?

Is it, as the first causal arrow suggests, the culture and the long history of oppression of native populations by European (Spanish and Portuguese) elites, as identity perspectives might argue?

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Is it, as the second arrow implies, the unholy alliance between U.S. intervention and local elites that maintains political stability, exploits Latin American resources, restricts Latin American exports such as textiles and agricultural products, and floods Latin American markets with U.S. manufactured exports, as realist perspectives contend?

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Is it, as the third arrows illustrates, the failure of social and economic reforms that fuels populist and revolutionary resentment and creates the damaging cycle of political revolution and instability that defeats sustained economic growth, as liberal perspectives might see it?

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From a critical theory perspective, it is probably all these things and more (see Chapter 10). But, in comparison to Asian countries, three factors stand out: the absence of large-scale land reform, the relative lack of primary education, and a culture of paternalism and clientelism. Let’s look at these factors in sequence.

In Latin America, some 5 to 10 percent of the population, depending on the country, owns 70 to 90 percent of the land. Yet 20 percent of the population still earns its living in the countryside. There have been periodic attempts at land reform. Mexico redistributed some land to peasants under the ejido system, but the plots were owned collectively, not individually, and depended on government development banks for financing. The U.S. aid program in the 1960s known as the Alliance for Progress pushed land reform, and nearly one million peasant families acquired plots. But another ten to fourteen million families did not and continued to work the land as tenant farmers.38 In Colombia, which until recently was torn by the narcotics trade and crime, large landowners ruled whole tracts of the countryside as feudal fiefdoms and even employed paramilitary forces to protect their territories. In Ecuador, 45 percent of the people live on the land, while 86 percent of the land is owned by the wealthiest 20 percent of the population.39 Nothing contributes more to the inequality of income in Latin America than the absence of land reform. The richest 10 percent of the people control almost twice as much wealth in Latin America as in the United States, 47 percent compared to 28 percent.

Investment to sustain basic human needs—such as education and health care—has improved steadily in Latin America, but primary and elementary school education still lags behind other regions. Much of the problem lies in the fact that so many people still live in the countryside or in urban slums on the edges of gargantuan cities such as São Paulo in Brazil. In Haiti, for example, 43 percent of the population lives outside the urban areas. The earthquake that struck Haiti in 2010 not only killed 300,000 people and displaced another million but also revealed the primitive rural life of many Haitians under normal circumstances. Haitians in rural areas lack access to basic sanitation, housing, and health care. In rural ghettos, families need children to scratch a living from the land. When these children lack employment, they are drafted into drug gangs and criminal activities such as those that plague Mexico and Central America and that contribute to the general political discontent and violence throughout Latin America. Discrimination also plays a role. Large portions of the populations of Latin American countries are black or of mixed race (in Brazil, 51 percent; in Colombia, 84 percent). These groups do not receive the same opportunities for education and employment as those of European ancestry. The problems are interconnected. The education problem is part of the land reform problem, which in turn is part of the problem of industrial development, which, if it could happen, might spur education and employment of the rural masses.

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Protesters demonstrate in Mexico City against the kidnapping of 43 students in September 2014 in the southwestern Mexican state of Guerrero. The protester’s sign reads, “Deceitful government that kills students/We are missing 43/It was the state.

Manuel Velasquez/LatinContent/Getty Images

Figure 9-2 Key Factors in Latin American Development: The Identity Perspective and Levels of AnalysisFigure 79

Industrial development in Latin America is held back by a paternalistic and clientelist culture in which family and fraternal ties suffocate initiative and entrepreneurship. Individual initiative is not lacking; that’s evident in the robust informal sectors in most Latin American countries, which by one estimate account for anywhere from 15 percent to 70 percent of economic activity in these countries.40 But economic and political institutions do not welcome individual initiative and entrepreneurship. A tradition of paternalism prevails, grounded in part in the Catholic Church, which dominates the region. At one point, the church owned 60 percent of the land in Latin America. The heavy weight of the church on society led some Catholic priests and laity to rebel and fight the state openly. They preached a hard-left type of liberation theology and allied with Marxist guerrillas to fuel many of the rebellions in Latin American countries during the Cold War. When institutions stifle the masses long enough, revolutions follow. Democracy is caught in the middle, a desirable but dangerous alternative, as President Kennedy said, if it entails the prospect of fascist populism or paternalistic communism, as we see today in Venezuela and Cuba.

Figure 9-2 identifies some of the key factors in Latin American development from an identity perspective at the different levels of analysis.

ejido system: Mexican land reform project that redistributed some land to peasants.

basic human needs: necessities such as clothing, shelter, food, education, and health care.

paternalism: a system in which institutions such as the church or state provide for the needs of individuals or groups while stifling individual initiative and entrepreneurship.

Sub-Saharan Africa

Sub-Saharan Africa (SSA) is part of the larger region of Africa and the Middle East. This region possesses abundant resources, and indeed the Middle East has developed oil resources to become the world’s dominant supplier of energy. Those resources, of course, were first developed under colonial rule. Western intervention is a fact of life in these two regions, more so than in parts of Asia—such as Japan—or most of South America. Africa and the Middle East are also the poorest regions of the world, with the largest youth populations and the most deeply embedded discrimination against women. In some Muslim countries, women are largely banned from public places, let alone public life, although change is coming. Liberia elected the first woman ever to serve as an African head of state, Ellen Johnson Sirleaf; women hold one-third of the cabinet posts and 65 percent of parliament positions in Rwanda; and several Arab countries, such as Morocco, Egypt, and Jordan, now mandate a number of seats for women in national parliaments. Parts of the Middle East are oil rich but industrially poor. Heavy dependence on oil discourages the development of manufacturing and services, and economic fortunes rise and fall with world oil demand. Meanwhile, the fortunes of Africa, which still has little trade or foreign investment, are largely divorced from the world economy. Not surprisingly, these two parts of the developing world face massive obstacles to achieving sustained industrial growth and human development.

Although we speak informally of Africa and the Middle East, what we actually have are two regions divided by the Sahara, a vast desert that stretches across the upper third of the African continent. As Map 9-5 shows, sub-Saharan Africa encompasses the forty-eight states that are located south of the Sahara, and the region referred to here as the Middle East and North Africa, or MENA, is made up of the band of African countries along the Mediterranean and Red Seas, the countries of the Arabian Peninsula and Persian Gulf, the countries of the Levant (Israel, Lebanon, Syria, and Jordan), and Turkey. SSA is non-Arab and draws deeply from earlier African civilizations with largely indigenous and, after colonization, Christian religions. MENA is Arab—Israel, Iran, and Turkey are the main exceptions—and draws deeply from the cultural and spiritual legacies of ancient Egypt and the Golden Age of Islam. We deal with SSA in this section and MENA in the following one.

(Nau 407-437)

Nau, Henry R. Perspectives on International Relations: Power, Institutions, and Ideas, 5th Edition. CQ Press, 20160105. VitalBook file.

The citation provided is a guideline. Please check each citation for accuracy before use.

CHAPTER 10

10 Critical Theory Perspectives on Globalization Inequality, Imperialism, and Injustice

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In June 2013, thousands of protesters march in Frankfurt, Germany’s financial district in a “Blockupy” demonstration against capitalism, European Central Bank debt policy, and the exploitation of textile workers in third-world countries, among other issues.

Sean Gallup/Getty Images

In the previous two chapters, our discussion of globalization focused primarily on the contemporary era—globalization 3.0. Let’s begin this chapter on critical theory perspectives on globalization by rewinding to globalization 1.0, starting with the observation that, while recorded world history is about five thousand years old, the world economy is only about five hundred years old. This allows us to circle back to a key question that this fact raises: What happened around 1500 that suddenly drove the world together and produced modern-day globalization? Why did much of the West in particular see a surge in trade and development?

The mainstream perspectives on international relations have some answers. The identity perspective attributes the rapid development of Europe relative to the rest of the world largely to Renaissance, Reformation, and Enlightenment ideas that inspired the Protestant ethic of scientific, technological, and commercial achievement. As Max Weber, the well-known German sociologist, points out, prior to the Reformation the activities of invention and making money were not looked on as worthy callings in Europe or anywhere else in the world.1 Protestantism made them acceptable. Not surprisingly, from this perspective, Protestant—not Catholic, Muslim, or Confucian—countries led the process of modernization. Britain launched the industrial revolution, and the United States, its offspring, later pioneered the information revolution.

The realist perspective attributes Europe’s ascendance primarily to demography, geography, and the decentralized distribution of power. Europe’s population dipped in the tenth and eleventh centuries as a result of the Viking and other invasions and dipped again in the fourteenth century as a result of the Black Plague. But thereafter Europe’s population grew vigorously. It fanned out to find more space to grow grain and raise animals. China’s agriculture, by contrast, was based on rice and required less space. Thus, China had less motive to expand. According to Pulitzer Prize–winning author Jared Diamond, Europe had a number of environmental advantages over other continents: larger choice of wild plants and animals available for domestication, which enhanced food production and released people to pursue the kinds of specialty crafts that help develop technology; denser population more conducive to the development of resistance to virulent germs; and orientation of its continental axes predominantly from east to west rather than north to south, which accelerated the spread of food production and other technologies.2 Another favorable factor, emphasized by Paul Kennedy, was the decentralized competition for “ships and firepower.”3 When Columbus sought resources to sail around the world, he was turned down by one monarch after the other. After many years, the Spanish monarchs, Ferdinand and Isabella, finally supported him. By contrast, when a Chinese explorer, Wang Chin, applied in 1479 to explore the Indochinese kingdom of Annam (now Vietnam), he was turned down by the Chinese emperor and had no other monarch to go to. Separate powers—the pope and the Holy Roman Emperor initially, and later multiple states—always struggled to control Europe. Rivalry among the many European monarchs and states spurred progress and enabled Europe to colonize and exploit more centralized, less dynamic empires in other parts of the world.4

The liberal perspective traces Western success to technology, specialization, and institutional innovations, such as the modern factory, markets, and domestic and international bureaucracy. Technology was an exogenous factor that multiplied the output of human and animal labor. Its impact, although initially disruptive, was generally progressive over the longer run. Specialization, or the division of labor in which parties specialize to make common or different products, offered unique advantages. From a liberal perspective, which emphasizes relationships and repetitive interactions, such specialization meant that workers became more efficient. By dividing tasks so that each person concentrated on only one component of a product, they produced more together than any individual could produce by trying to make all the components. It also meant that workers could exchange products on a relatively open basis. Specialization became the basis for the emergence of more sophisticated systems of exchange or markets. By contrast, realist perspectives see specialization more in terms of hierarchy and control of exchanges through domestic bureaucracies (e.g., factories) and the international structure of power, while identity perspectives emphasize the ideologies, such as capitalism and Marxism, that motivate specialization.

Trade institutionalized the practice of specialization at the international level and created the attendant need to lower transaction costs. According to economic historian Douglass North, increasing specialization and trade initially raised the transaction costs of exchanges. When trade takes place over longer distances, people do not know one another, as they do in villages. They have to spend more money to find out who owns a particular piece of property, what a fair price for that item might be, and how they might ensure its delivery. From the fifteenth century on, state and international institutions emerged in part to handle these tasks and lower the transaction costs of long-distance trade. As a result, Europe developed “more complex forms of organization” than the traditional exchanges in the Middle East (the souk or bazaar) and Asia (the caravan trade).5

When and what kind of state institutions took shape also mattered. A country started on a certain path and accumulated advantages or disadvantages along that path, what liberal perspectives call path dependence. England, for example, got an early start toward decentralized institutions when English lords forced King John to sign the Magna Carta in 1215. It passed these institutions on to the United States. By contrast, Spain, when it united, adopted Castile’s centralized bureaucratic system rather than Aragon’s decentralized merchant system, and France compounded already centralized Capetian institutions with policies of economic nationalism advocated by Jean-Baptiste Colbert in the seventeenth century. Out of their decentralized institutions, England and the United States went on to create innovative societies that started the industrial and information revolutions. A more centralized France developed later and never quite as efficiently, while Spain and its colonies in Latin America developed even more centralized, paternalistic institutions, such as a large, landowning church, which were less friendly to change and innovation.

What’s wrong with these mainstream answers to the question of why the West developed faster than the rest? Remember that the purpose of mainstream perspectives is to understand objectively—that is, independent of the observer or scholar—how the world works by designing propositions or hypotheses (perspectives) about what causes events and then testing these hypotheses against the facts. If the propositions are not falsified, mainstream perspectives try to take this knowledge from the past and apply it to improve or predict the future.

Now comes the rub. Think for a minute about what mainstream conclusions are doing when they are applied to future world development. They establish the West, which has been dominant since 1500, and its experiences as the standard for thinking about and shaping the future of other societies. First, according to identity perspectives, if other countries want to become modern, they have to adopt the Western ideas of the Renaissance, Reformation, and Enlightenment. Second, according to realist perspectives, they may not be able to develop independently because geography and demography appear to favor the Western countries. To the extent that they can develop at all, they may have to do so under the hegemonic rule and stability offered by Western powers. Third, according to liberal perspectives, developing countries have to implement the Western rules and institutions of specialization, comparative advantage, multinational corporations, open markets, and pluralist political systems. In short, the mainstream perspectives suggest that development is a universalistic process that follows a single course initially set by Western ideas, power, and institutions.

Critical theory roundly rejects this conclusion. It contends that Western development is not a product of internal Western ideas, institutions, and competition that can serve as models for future development. Rather, it is a consequence of the systematic exploitation of other countries. This exploitation involves military imperialism and colonialism, which began around 1500 and continue to the present day. It involves, further, the cultural marginalization of foreign societies, creating two categories of countries: countries that are Western and advanced, and all the other countries, which are non-Western and undeveloped, primitive, savage—indeed, uncivilized. In addition, it imposes the economic institutions of capitalism, in particular the unique oppressive mechanism of the factory and now MNCs, which extract profits from local labor to finance the cosmopolitan consumerism of elite classes. Most of all, Western development was achieved on the backs of women and minorities, who were literally slaves in the colonial era and remain practically so today—oppressed and disenfranchised in the sweatshops and squalid slums spawned in developing countries by globalization. (Each of the concepts italicized above is defined further in the discussion that follows.)

Figure 10-1 Critical Theory Perspective on Globalization: Globalization as Consequence, Not CauseFigure 86

What is more, this exploitation was not carried out piecemeal by individual countries such as Spain and England acting independently or through isolated forces such as Western ideas, institutions, and military forces causing specific outcomes. It was carried out through systemic and historical processes deeply rooted in the structures of particular eras. What made the globalization of the world economy so encompassing and relentless was the fact that it stemmed not just from material circumstances but from cultural, social, institutional, and even spiritual conditions of capitalism. Karl Marx marveled at the power of the bourgeoisie movement that ignited globalization. As John Micklethwait and Adrian Wooldridge observe,

In less than a hundred years, Marx argued, the bourgeoisie had “accomplished wonders far surpassing Egyptian pyramids, Roman aqueducts and Gothic cathedrals”; had conducted “expeditions that put in the shade all former exoduses of nations and crusades”; and had “created more massive and more colossal productive forces” than all the preceding generations put together.6

Thus, as critical theory perspectives see it, globalization is driven by a totalistic (not sequential) logic that cannot be steered or stopped. But it can be understood within a historical period, and the consciousness of the people can be raised to oppose it. As Robert Cox, a respected critical theorist, writes, “Positivism [that is, Western rationalist or mainstream perspectives] can be useful but only within ‘defined historical limits.’”7 Critical studies help unpack specific historical periods and reveal the contradictions and conflicts driving events at a deeper level. These contradictions and conflicts locate marginalized voices and, most of all, demonstrate that another future is possible. Critical theory does not see the future constructed from a set of propositions tested against the past and applied to the future. Rather, it sees a future without the past or other than the past. That future is one in which marginal and minority voices are emancipated, global inequities are lessened, and inclusive institutions prevail. Such a future must be imagined, and therein lies the normative, even utopian, element of critical theories.

Colonialism and Imperialism

From a critical theory perspective, it is hardly a coincidence that Western development began at the same time as Western colonialism. European voyages to discover and colonize other parts of the world began in the fifteenth century. Portugal led the way, capturing Cueta (today a part of Spain) on the northern coast of Africa across from Gibraltar in 1415. By the end of that century, Portuguese explorers had worked their way down the western coast of Africa and initiated voyages around the Cape of Good Hope to the Far East, reaching India and China in the early decades of the sixteenth century. Along the way, they established bases in the Persian Gulf and Malacca, on the west coast of the Malay Peninsula.

Meanwhile, Spain carved out an empire in another direction. Columbus’s voyage in 1492 opened up the Americas, initially the various islands of the Caribbean and then the vast interiors of Central and South America. It was not that Western technology and ideas were that superior to those of the countries colonized. Chinese navigating techniques were as advanced as Portuguese techniques; Chinese ships had already reached the eastern shores of Africa in the early 1400s.8 And Western ideas that brought slavery and the righteous wrath of Christianity to colonial shores were hardly the liberating forces of the Renaissance or Reformation. Rather, from a critical theory perspective, it was historical happenstance and the unusual cunning of Western adventurers that made the difference. When Spain joined Portugal to contest foreign lands, the two monarchies literally divided the world into two parts rather than fight one another over its boundless resources. At the Treaty of Tordesillas in 1494, they drew a straight line south of the tip of Greenland (370 leagues west of the Cape Verde Islands) across the middle of the Atlantic Ocean, hiving off the easternmost section of South America. Portugal took the territories east of this line, essentially today’s Brazil, Africa, and Macau. Spain took everything west of the line, essentially the rest of the Americas and the Philippines. The audacity of partitioning the then-known universe illustrated the Western mind-set of imperialism that carved up the world to dominate other societies, militarily, economically, and politically.

When the English and Dutch, under the impetus of the Reformation, revolted against Spain and the Hapsburg Empire in the sixteenth and seventeenth centuries, these two sea powers challenged and eventually supplanted Spain and Portugal. France, too, although more of a land power, joined the colonization effort. The later colonial powers transformed the character of colonization. Whereas Spain and Portugal conquered in the name of their monarchs, England and Holland did so in the name of commercial companies, the East India companies, that presaged the age of MNCs. In all cases, however, the motives and methods of conquest were the same. Early colonizers bought cotton cloth in India, exchanged it for slaves in Africa, shipped slaves to Central and South America to mine gold and silver, and used gold and silver to purchase spices and silks in the Far East. The imperialists ransacked the gold and silver in colonial territories and enslaved the human population to work the mines and later the plantations—sugar, cotton, tobacco, and rubber—that did the plundering. Altogether, some ten million slaves were transported from Africa to the New World. Untold millions more died en route or in the local wars among rival tribes in Africa that supplied the slaves.

Map 10-1 Colonialism in the Modern World, circa 1900Figure 87

Note: This map shows the global extent of Western colonialism, which originally included Latin America, although Latin America was largely independent by 1900.

Eventually, as Map 10-1 shows, the West colonized the entire world. The devastation done to the cultures and institutions of local societies was severe and long lasting. At the core, according to critical theory perspectives, was the phenomenon of exploitation. Growth was not a process of mutual benefit and gain, a non-zero-sum game; rather, it was a zero-sum game, a process by which a dominant country or class systematically extracted profits from a subordinate country or class and drew that country/class into a tight system of global interconnections from which it was impossible to escape. These connections made it possible for the dominant country/class to strip the subordinate of its just returns and transfer these returns systematically to the dominant center. With the coming of the industrial revolution, the phenomenon of exploitation took on even more sinister dimensions. It led subsequently to the developments of dependency and world systems dynamics that continue to characterize the world economy to the present day.

colonialism: conquest and exploitation by the European states of poorer peoples and lands in Latin America, Africa, and Asia.

imperialism: the forceful extension of a nation’s authority to other peoples by military, economic, and political domination.

exploitation: the extraction of profits from the resources and labor of others in an unjust way.

Dependency

From a critical theory perspective, colonialism was not just an historical phenomenon. It cut deeply into the fabric of local societies and established patterns of dependency and integration that permanently yoked those societies to the objectives and needs of the advanced world. The inequity and indeed brutality of these patterns were best expressed by one of the leading colonizers of Africa, the Englishman Cecil Rhodes, who founded the colony of Rhodesia (now Zimbabwe) and endowed one of today’s top prizes for academic achievement, the Rhodes Scholarship (notice how colonialism continues to influence and distort contemporary life):

We must find new lands from which we can easily obtain raw materials and at the same time exploit the cheap slave labor that is available from the natives of the colonies. The colonies would also provide the dumping ground for surplus goods produced in our factories.9

Here, as critical theorists see it, are the trading and political patterns that characterize globalization today, a set of dynamics they refer to as dependency theory. Comparative advantage is not some God-given distribution of resources that confers advantages on each country that it can then exploit in free and uncoerced trading relationships. Rather, it is a pattern of historically determined and dominant relationships shaped by colonial governments and raw power.

Colonial powers not only stripped the colonies of precious metals and other material resources; they also converted and reorganized resources to produce cash crops that paid off handsomely year after year. Agriculture became another large “gold mine” that colonial powers exploited. In Gambia, colonizers replaced rice farming for local consumption with peanut plantations for European consumption. All over Africa, the local foodstuffs that had been grown were replaced: in Ghana and other parts of the Gold Coast of West Africa by cocoa, in Liberia by rubber plantations, in Uganda by cotton, in Dahomey and Nigeria by palm oil, and in Tanganyika (now Tanzania) by sisal. The same patterns prevailed in Asia. Under French rule, rice became the dominant export crop in Indochina, rubber in Malaysia, and coffee in Indonesia. And the great fruit companies, like United Fruit Company, along with other agricultural and mining conglomerates, replicated these patterns in Central and South America. Plantations became the first multinational “factories” in colonial countries, diverting production from local to foreign demand; usurping the best infrastructure, such as land and water, for commercial purposes; and forcing the peasantry onto marginal soil or into work at slave wages in the new enterprises servicing metropole markets.

One consequence of this coerced allocation of comparative advantage was that developing countries lost the capacity to feed themselves. As Frances Moore Lappé and Joseph Collins note, “Colonialism destroyed the cultural patterns of production and exchange by which traditional sectors in ‘underdeveloped’ countries previously had met the needs of their people.”10 To this day, global trade incentives favor Western agriculture, which dumps surpluses generated by domestic protectionist programs onto global markets and undercuts prices for agricultural products produced in developing countries. Another consequence of coercive comparative advantage is that most local enterprise and production activity is forced into the informal sector—that is, the part of the economy in developing countries that is not globalized and exists without the protection of law, subsidies, and other privileges that flow to the formal sector. Local production in both agriculture and industry is marginalized and can never get hooked up in a beneficial way with the globalized economy, which dashes further and further ahead.

So indelible and enduring were these patterns of plundering that critical theorists developed a more elaborate dependency theory, drawn from the experience of Latin America. Latin America actually had the earliest and least recent encounters with colonialism. By the mid-nineteenth century, most of Central and South America was independent. The Bolivarian revolutions of the early part of that century severed colonial ties with Europe and brought independence to Latin America a century or more before it arrived in Asia or Africa. Yet Latin America’s experience is relevant, critical theorists believe, because it reveals the long-lasting effects of colonialism. Despite the hundred years or more since colonialism, Latin America still shows the deep-seated scars of dependency.

According to dependency theory, the advanced country, or metropole, relates to the developing colonial country or satellite in the same way that a city relates to the countryside. The metropole, like the city, organizes the satellite, or countryside, to serve its social and political purposes. The metropole becomes an all-encompassing center of economic, social, and political life and in the process also becomes an all-encompassing center of exploitation. The exploitation derives from five factors.

First, the metropole is independent, but the satellite or dependent country never becomes independent. It is permanently subordinated. The proof of this point for dependency theorists is the experience of the great metropolitan areas of Latin America such as São Paulo and Buenos Aires. These metropolitan areas enjoyed nominal independence in the nineteenth and twentieth centuries. They grew significantly during this period but still at the end of the twentieth century remained largely dependent on the outside metropolis—first the European powers and then the United States.

Second, Latin America’s experience suggests that the satellite grows fastest when it is isolated from the metropole. The greatest industrial development in Argentina, Brazil, Mexico, and other countries such as Chile occurred precisely during those periods when Europe and the United States, the metropoles, were weak and hence less dominant in the international economy. These periods included the European wars of the early seventeenth century, the Napoleonic Wars, World Wars I and II, and the Great Depression of the 1930s. In each of these periods, large Latin American countries enjoyed significant economic growth.

Third, this autonomous development of satellite regions is choked off the minute the metropole recovers and reasserts its oppressive role in the world economy. For example, British-led economic liberalism in the eighteenth and nineteenth centuries undercut incipient manufacturing development in Latin America. Foreign investment destroyed local competition, the export economy absorbed the best lands and other resources, and systematic inequality increased both between rural and urban areas and between metropole and satellite countries.

Image 202

In 1915, bananas are loaded for export onto a train on the Northern Railway in Costa Rica. The railway was owned by the United Fruit Company and was part of its extensive infrastructure.

Paul Popper/Popperfoto/Getty Images

Fourth, the plantation or hacienda (latifundium) is a direct result of metropole-satellite relationships. It is not a reflection of the natural stage of agricultural development that subsequently leads to industrial development, as in the evolution of feudalism to capitalism in Europe. Rather, it exists and survives solely at the will of the metropole. Plantations produced products for the metropole country, which in turn supplied food to the satellite country. The development of agriculture did not produce food for industrial and urban development in the satellite country.

Fifth and finally, the proof of this dependence lies in the fact that, as industrialization proceeds, the demand for agricultural and raw material products relatively declines. The terms of trade—what is paid in exports for imports—turns against the satellite countries. Because the metropole spends more on industrial goods and less on foodstuffs and raw materials, the satellite economy produces products of declining relative value and slowly dries up. This pessimistic view of the capability of world markets to provide the demand that could spark development in the satellite regions led Latin American countries after World War II to reject export-led growth strategies and turn to strategies based on developing local industries to substitute for industrial imports. In effect, this strategy was an attempt to break completely with the world economy in which the ancient patterns of colonial exploitation were so irreversibly embedded.

dependency theory: theory developed by critical theorists that explains lack of development in terms of colonialism and oppression.

metropole: the metropolitan (political, commercial, and military) center of imperial power.

systematic inequality: deep-seated disparity in the distribution of wealth and/or power generated by colonialism and dependency.

terms of trade: relative price of exports and imports.

World Systems

Other work by critical theorists formalized dependency theory into a world systems model. Building on Marxism, world systems analysts emphasized the totality of social and economic phenomena in the world economy. Consistent with critical theory perspectives, they rejected the idea of sequential or rationalist causation. As Georg Lukács, a Marxist, once wrote, “It is not the primacy of economic motives in historical explanation that constitutes the difference between Marxism and bourgeois thought, but the point of view of totality.”11

The world economy—globalization—must be seen as a whole. It is a system or total structure whose unifying metric is the division of labor. Firms and workers existed long before the world economy expanded in 1500. But they did not exist in a total system of multiple states and a global market. The capitalist world system dates from that moment when multiple states and a global market came together for the purpose of accumulating capital. The system, as Marx made clear, is driven by the desire for more profit and capital. This desire persists today, as illustrated by the television commercial featuring a stockbroker who says he never thinks about how well he has done on the last trade, only about how he can do better on the next trade. The accumulation of profits and capital, raw greed, is the raison d’être of the system.

Ideally, any individual or country in the global marketplace would prefer to have a monopoly, because a monopoly generates the greatest differential between the sales price and the cost of production. However, the presence of multiple actors/states makes the establishment of perfect monopolies difficult. Still, larger or leading actors/states can create quasi-monopolies using patents and other market restrictions. Quasi-monopolies last long enough to accumulate considerable profit, but they are eventually challenged by other actors/countries and become less profitable. Once patents expire and innovations arrive in the trailing states, the profits are far less. (There are some similarities here with the product life cycle discussed earlier in this book, but, according to mainstream perspectives, developing countries eventually catch up, as Japan did after World War II and the East Asian tigers, such as South Korea, did thereafter.)

Image 203

A Bangladeshi boy works in a recycling facility in Dhaka, Bangladesh. Plastics recycling workers in Bangladesh, one of the world’s poorest countries, labor in primitive working conditions and are paid $2 per day. The waste plastics are cut in smaller pieces and then melted in a furnace to make various products.

Ranak Martin/Anadolu Agency/Getty Images

Thus, the world systems dynamic creates a division of labor between leading sectors that generate high profits and lagging products that generate little or no profits. Large and leading countries constitute the core states of the world economy; they produce most of the leading products, which enjoy an initial monopoly. Smaller and less developed countries constitute the peripheral states, which produce most of the low-profit or lagging products after the monopoly qualities of these products have been substantially diminished. Some countries fall in between. They are semiperipheral states, which produce a nearly even mix of monopoly and competitive products.

The global economy is thus stratified and fixed. Core states have a permanent advantage in producing monopoly products and use their clout in global markets to protect patents and other privileges that produce disproportionate profit. Peripheral states are at a permanent disadvantage because the dynamic of global markets makes available to them only those products for which competition has lowered the available profit. Semiperipheral countries have the greatest difficulty. They struggle to keep from falling back into the peripheral zone while using government intervention (protection, subsidies, etc.) to attempt to advance into the core group. Unless they are of substantial size, like India, Brazil, or China, they have little chance of succeeding.

According to world systems theorists, therefore, a global division of labor is inevitable and largely static. There will always be the need for a division of labor. And while some countries may rise in the hierarchy of core and peripheral states, others will fall. The advantages lie with already developed countries. Thus, as critical theory perspectives see it, global divisions and inequalities persist. Whereas earlier the industrial countries produced textiles, the developing countries now do so. The same is true of steel, automobiles, consumer electronics, and so on. Yet industrial countries retain their lead by producing an endless stream of new products fueled by the profits of earlier products and the protection of patents and other market restrictions. Meanwhile, peripheral states industrialize and some even make it into the semiperipheral class of states, but they can never leap forward far enough financially and technologically to reverse the capitalist world order. Indeed, in return for exports of competitive (low- or no-profit) products to core countries, peripheral countries must continue to accept the exports of core countries in monopoly products. At the heart of Doha Round trade negotiations today, for example, is a trade-off between, on one hand, advanced (core) countries seeking to reduce barriers to trade in developing countries for their highly profitable products in the high-technology, pharmaceutical, and service industries and, on the other hand, developing (peripheral) countries receiving in return reduced barriers in advanced countries for their lower-profit agriculture and low-technology products.

world systems: theories (updating Marxism) that explain how colonialism reinforced capitalism and enabled capitalism to survive by exploiting the peripheral countries of the world.

division of labor: the division of world markets into core, peripheral, and semiperipheral areas.

core states: large and leading countries that produce most of the innovative products, which enjoy an initial monopoly.

peripheral states: smaller and less developed countries that produce most of the competitive or lagging products after the monopoly qualities of these products have been substantially diminished.

semiperipheral states: states that produce a nearly even mix of monopoly and competitive products.

Multinational Corporations and Exploitation of Labor

A large reason for the frozen economic hierarchy of global markets is the MNCs. Like the trading and plantation corporations during the colonial era, the MNCs internalize the division of labor and structure global markets to perpetuate the advantages of the core states. Because of global dependence, states are no longer effective agents that control the MNCs. The states lose a measure of autonomy and cannot reverse the dynamics of capitalist world systems. MNCs hold “sovereignty at bay” and make it more difficult for states to accomplish their domestic and foreign policy objectives.12

Although protected by the law, MNCs, critical theorists argue, operate outside the law. They circumvent laws in advanced countries by relocating factories to developing countries. And they circumvent the laws in developing countries by exploiting the desperate conditions of the local poor. If MNCs don’t violate the laws directly, they frequently do business with local enterprises and entrepreneurs who are little more than common criminals. The most egregious offenses involve child labor and discrimination against women.

An oft-cited example is a brave young Pakistani boy named Iqbal Masih. Iqbal was indentured to work in a locally run carpet factory at age four for a payment, essentially a loan, of $16 to his parents. Shackled to a loom for twelve hours a day, seven days a week, Iqbal earned so little that at the end of six years his parents owed $400 rather than the $16 for his original servitude. At age ten, Iqbal, learning that bonded labor was no longer permitted, stole away one day to attend a rally sponsored by an NGO known as the Bonded Labour Liberation Front. He returned to the factory to free his fellow laborers, infuriating the factory owner, and then became a spokesman on behalf of more than 100 million children under the age of fifteen who worked in peripheral countries in 1994 essentially as slaves. Three years later, he was killed, many suspect by henchmen of the Pakistani carpet industry.13

Image 204

Iqbal Masih, the twelve-year-old boy who won international acclaim for highlighting the horrors of child labor in Pakistan, was shot dead in 1995, allegedly because of his campaign against child labor.

AP/Gunnar Ask

Through Iqbal’s efforts and NGOs such as the college student organization United Students Against Sweatshops, corporate codes have improved labor conditions in a range of low-tech developing-country industries such as textiles, apparel, footwear, forest products, coffee, and toys. RugMark, a consortium of carpet manufacturers and exporters in India, Nepal, and Pakistan, inspects factories and certifies with the RugMark label rugs that are made without child labor. Reebok, Nike, and other apparel firms have developed similar codes. However, abuses continue and, from some critical theory perspectives, abound. From this perspective, exploitation lies at the heart of the global development process; when confronted in one area, such as slavery, it pops up again in another area, such as child labor.

From the point of view of mainstream perspectives, abuses by MNCs can be corrected and even abolished. From a critical theory perspective, however, MNCs are not the primary cause. There is no single cause; the global system itself is at fault. Competitive processes compel all states to remain open, including core states. Consider the following. If countries want to survive in a highly competitive global economy, they can’t tax their MNCs more than other countries do, impose pension and welfare costs that disproportionately burden their industries, or pile up regulations that prevent their firms from adapting to rapid changes in technology and other market conditions. If they do, the MNCs will cut back operations at home and relocate them abroad, where costs and regulations are less onerous. The system, in short, gives MNCs carte blanche.

Countries also lose control of fiscal and monetary policies. They may expand government spending to create jobs and exploit resources, but if they import a large percentage of their consumption, as many developing countries do, much of this added domestic spending goes into imports. It leaks out, in effect, to foreign firms and does not increase domestic jobs. So domestic spending has to be increased even more to create jobs. Thus, profligate spending and fiscal deficits in developing countries are not the consequences primarily of bad governance, corruption, or incompetent leaders in those countries; rather, they are the consequences of world system constraints. Local government officials have to pump more and more fiscal gas into the domestic economic car because the gas line of the car is leaking fuel out to foreigners on its way to the engine. Or consider monetary policy. As we have noted in earlier chapters, governments raise interest rates to slow money growth. But raising interest rates more than other countries only attracts capital from abroad, requiring local central banks to raise interest rates still more by selling bonds (reducing bond prices and raising interest rates) to absorb the excess money coming in from abroad.

Mainstream perspectives focus on only specific aspects of this phenomenon of globalization. Liberal perspectives, for example, which emphasize interactions rather than power or ideology, conclude that, because of spillover, governments have no choice but to integrate monetary policies and coordinate fiscal policies, as EU members, for example, are doing today. Their only other alternative is to leave their countries at the mercy of the biggest central banks and government spenders in the global economy—today these are in the United States and the EU. The effect of expanding the reach of globalization to more and more sectors, however, is ultimately beneficial. The scope of governance expands, and global society as a whole becomes more like domestic societies.

But from the critical theory perspective, the situation is actually much worse and cannot be easily corrected by any one measure. There is no way to escape the dependence and relentless division of labor that lies behind these global inequities. The effects of globalization are total. They go well beyond economic policies and weaken the psychological and political will of peripheral countries. Countries lose control of their national media and entertainment industries and, indeed, of their local languages and cultures. Small countries, in particular, are defenseless. McDonald’s golden arches descend on these countries, and Hollywood movies and music dominate their airwaves. Slowly, local-language broadcasts and artistic opportunities dwindle. Ancient languages disappear. Cultural diversity is the victim, and the whole world is the loser.

Except perhaps for the big countries. The United States, Japan, and the MNCs of the advanced world may be the winners. As Thomas Friedman explains, the Lexus (representing the culture of modernity) drives out the olive tree (representing the culture of tradition). “Olive trees,” Friedman writes, “represent everything that roots us, anchors us, identifies us and locates us in this world—whether it be belonging to a family, a community, a tribe, a nation, a religion or, most of all, a place called home.”14 The Lexus, built for export with ultramodern robots, on the other hand,

represents all the burgeoning global markets, financial institutions and computer technologies with which we pursue higher living standards today. The biggest threat today to your olive tree is likely to come from the Lexus, from all the anonymous, transnational, homogenizing, standardizing market forces and technologies that make up today’s globalizing economic system.

Friedman, however, is a mainstream analyst, seeing the world, as we have noted previously, largely from a liberal perspective. Unlike some critical theory perspectives, he can imagine that globalization has a liberating side:

There are some things about this system that can make the Lexus so overpowering it can overrun and overwhelm every olive tree in sight. . . . But there are other things . . . that empower even the smallest, weakest political community to actually use the new technologies and markets to preserve their olive trees, their culture and identity.

Witness the upsurge of ethnicity, nationalism, religion, local pride, and interest in personal roots that belie the notion that globalization homogenizes culture. Maybe, as Friedman concludes, the Lexus and the olive tree need one another.

That’s the mainstream view of globalization, that it benefits, not destroys, national sovereignty and culture. Countries choose to join the global economy, and globalization gives them more options. No country has developed in isolation. The communist countries were the last to try, and they did not preserve their sovereignty and cultures but eventually lost them. Modernization has been going on for a long time, yet people have retained their identities, their homes, and their communities. Technology benefits local languages and arts by making people aware of diversity and, through the Internet and other information technologies, better able to defend their cultural heritage.

Some critiques of conventional ways of thinking about social movements in the contemporary world have emerged. Sociologist Kevin McDonald argues that Western thinking leads us to analyze social movements, such as protest groups or religious sects, through the lens of antagonistic relationships, dialectical processes, and individuals versus the collectivity. McDonald bypasses even constructivism in favor of a more radical alternative that liberates oppressed groups in the future but does not threaten other groups. The alternative he proposes is resonance, where groups that are different resonate or feed off one another rather than conflict with one another. He writes that

[a]n older international context, where social life largely took place within the borders of nation-states, and where states were the main actors on the international stage, is increasingly giving way to a context involving new global actors, from NGOs, organized crime, or terror networks, and with it, to a whole series of debates attempting to interpret the nature of this emerging global world. . . .

We need to grapple with forms of sociality transforming the relationship between individual and collective; with grammars of movement that are better understood in terms of cultural pragmatics . . . and personal experience . . . than organization building and collective identity; with new forms of complexity and fluidity.

He goes on to advocate “a radical paradigm shift” that emphasizes “embodiment and the senses.” Instead of action among separate or disembodied groups, in which one group encounters or confronts another, he wants to talk about actions that resonate among groups and reinforce them such as we experience when we encounter “dance, music, drumming, bicycle riding, experiences of vulnerability.” These experiences, he writes, “allow us to break out of often repeated debates framed in terms of individual versus the community.” He then studies protest and religious groups (NGOs), such as the Falun Gong movement in China, that are searching for more fluid and resonating ways to deal with global differences that do not automatically separate people into disembodied and, hence, antagonistic groups.15

bonded labor: a form of unfree or indentured labor, typically a means of paying off loans with direct labor instead of currency or goods.

Marginalized Minorities: Global Injustice

From a critical theory perspective, nothing is more evident from the assault of globalization than the marginalization of indigenous peoples and women. Colonialism, imperialism, and then open world markets ran roughshod over native peoples and forced women into what are in effect ghettos. Think of the plight of the Native Americans, who fell like weeds beneath the scythes of white men expanding across the American continent. Land, the most cherished possession of indigenous peoples, was systematically appropriated or, more accurately, stolen from them. Indigenous tribes were stripped of their livelihood and, even worse, of their culture, identity, and dignity. They were dismissed as primitive, uncivilized, and uneducable. The indigenous peoples of Latin America and Asia suffered no less. And the legacy of such material and moral looting goes on to the present day.

Let’s listen to Subcomandante Marcos, a leader of the indigenous people of the southeast Mexican state of Chiapas, as he talks about his eviscerated homeland:

Chiapas loses blood through many veins: . . . petroleum, electricity, cattle, money, coffee, banana, honey, corn, cacao, tobacco, sugar, soy, melon, sorghum, mamey, mango, tamarind, avocado, and Chiapaneco blood all flow as a result of the thousand teeth sunk into the throat of the Mexican southeast. These raw materials, thousands of millions of tons of them, flow to Mexican ports, railroads, air and truck transportation centers. From there they are sent to different parts of the world—the United States, Canada, Holland, Germany, Italy, Japan—. . . to feed imperialism. . . .

In 1989 these businesses took 1.2 trillion pesos from Chiapas and only left behind 616 million pesos worth of credit and public works. More than 600 million pesos went to the belly of the beast.

In Chiapas . . . Pemex [the Mexican state oil company] has eighty-six teeth sunk into the townships of Estacion Juarez, Reforma, Ostuacian, Pichucalo, and Ocosingo. Every day they suck out 92,000 barrels of petroleum and 517 billion cubic feet of gas. . . .

Chiapas also bleeds coffee. Thirty-five percent of the coffee produced in Mexico comes from this area, . . . 53 percent is exported abroad, . . . more than 100,000 tons of coffee are taken from the state to fatten the beast’s bank accounts: in 1988 a kilo of pergamino coffee was sold abroad for 58,000 pesos. The Chiapeneco producers were paid 2,500 pesos or less.

Three million head of cattle wait for middlemen . . . to take them away to fill refrigerators in Arriasga, Villahermosa, and Mexico City. The cattle are sold for 400 pesos per kilo by the poor farmers and resold by middlemen and businessmen for up to ten times the price they paid for them.

The tribute that capitalism demands from Chiapas has no historical parallel. Fifty-five percent of national hydroelectric energy comes from this state, along with 20 percent of Mexico’s total electricity. However, only a third of the homes in Chiapas have electricity. . . .

The plunder of wood continues in Chiapas’ forests. Between 1981 and 1989, 2,444,777 cubic meters of precious woods, conifers, and tropical trees were taken . . . to Mexico City, Puebla, Veracruz, and Quintana Roo. . . .

The honey that is produced in 78,000 beehives in Chiapas goes entirely to the United States and European markets.

Of the corn produced in Chiapas, more than half goes to the domestic market. . . . Sorghum grown in Chiapas goes to Tobasco. Ninety percent of the tamarind goes to Mexico City and other states. Two-thirds of the avocados and all the mameys are sold out of state. Sixty-nine percent of the cacao goes to the national market, and 31 percent is exported to the United States, Holland, Japan, and Italy. The majority of the bananas produced are exported.16

The indictment is total. And Chiapas is but one example. In the Philippines, indigenous peoples totaling 16 to 18 percent of the population, mostly Muslims, face expulsion from their native lands to accommodate power generating facilities from hydroelectric dams to wind and solar plants. The proposed energy supply is to encourage foreign investment, not local entrepreneurs. In Peru, Colombia, and elsewhere in Latin America, landless peasants join guerrilla movements to reclaim land and natural resources. In Cuba and Venezuela, Fidel Castro and Hugo Chávez and their successors have championed a new revolutionary-style politics to empower the poor and indigenous peoples. In southern Africa, the Sari, an indigenous people, were evicted from land that became the Central Kalahari Game Reserve, one of the largest such reserves in the world.

Altogether, the United Nations estimates that some 370 million indigenous people live in more than seventy countries around the world. Through efforts by NGOs, the Africa Commission on Human Rights, and the first United Nations International Decade of the World’s Indigenous People (1995–2004), the United Nations adopted in September 2007 the landmark Declaration on the Rights of Indigenous Peoples, emphasizing their rights to culture, identity, language, employment, health, education, and other benefits and outlawing discrimination against them. Canada, Australia, New Zealand, and the United States voted against the declaration, arguing that the language was unclear and the negotiating process had not been transparent.

Women are the other main victims of marginalization. Globalization has marginalized women in four principal ways: through low wages to fuel export zones; through neglect of the informal economy, where most women work; through increased unpaid labor by women in the household sector; and through damage to the environment where most women live.

Women constitute most of the workforce of the globally oriented trade activities imposed on developing countries by colonialism. Export sectors have to maintain low wages to service metropole markets, and women are the cheapest source of labor and fill most of the jobs in export-processing zones throughout the developing world. Women constitute up to 90 percent of the workforce in such export zones. They assemble garments, electronics, and other items that require tedious and repetitive manual skills. Women, it is argued, have the natural dexterity and nimble fingers needed to carry out repetitive tasks at very high rates of speed. In export zones, women work fifty to eighty hours a week and earn less than $1 per hour, generally 30 to 40 percent less than men are paid for comparable work. They enjoy few basic job or social protections and are sometimes subjected to physical and sexual abuses. The practices used in recruiting and housing the women needed to work in these industries have led in some cases to kidnapping and prostitution rings. Women have been lured to fill jobs and then forced into prostitution either directly or indirectly to pay off loans. A sex trade has developed in emerging countries, often associated with other low-wage service industries such as tourism and hotels.17

The systematic marginalization of women in developing countries was dramatized in 2012 by the shooting of a fifteen-year-old Pakistani girl, Malala Yousafzai, for seeking an education. While riding the bus home from school, she was shot in the head at point-blank range. In this case, Muslim extremists are the culprits. They consider it an affront to their religion to educate girls and regard Malala as a pawn of Western imperialists who seek to destroy their culture. Miraculously, Malala recovered and initiated a global campaign to promote education for women. She wrote a book, spoke at the United Nations, and became a symbol of the battle against discrimination of women throughout the world.18

Discrimination, on a smaller and less exploitative scale, also affects women in industrialized countries. In these countries, the employment of women is concentrated in the garment and low-wage sectors, and these sectors are usually the first affected by job losses when consumers buy the still-cheaper garment and toy imports produced by women in developing countries. When jobs are lost in advanced countries, women, families, and sometimes whole regions are devastated.

Exploited and then just as quickly neglected by the global economy, women work mostly in the informal sector of developing countries. They do jobs that mimic housework, such as cleaning, sewing, and cooking, and are paid far less than even the low wages they would get in the formal sector. For this reason, some mainstream perspectives argue that the formal, or export-centered, global economy is still a step up for women. But critical theory perspectives emphasize the few opportunities that women have to move up within, or to break out of, the export-oriented global economy. Women in developing countries and among the poor in advanced countries are either exploited by the global (modern) economy or left to work in a ghettoized informal economy where there is little support in the form of credits (loans), child care, educational incentives, or health care. As in the case of developing countries more broadly, the patterns of global dependency and world systems involve a dynamic that does not lift individuals, especially women and minorities, from the bottom to the top but rather exploits them for the benefit of those who are already at the top.

Globalization further de-emphasizes the valuable work that women do in the home, even in the most advanced economies. By stressing modernization and the transformation of traditional tasks and communities, globalization values home care even less than traditional societies do. Bearing children and caring for them, maintaining a household that often takes care of elderly members, and sustaining village and community relations are all tasks that are invaluable, indeed priceless, for any society. Yet they are unacknowledged and unpaid in a modern globalized world. The United Nations recently estimated that the unpaid work that women in Mexico did in the home in a year amounted to about $200 billion—a full 23 percent of Mexico’s GDP.19 Even that estimate seems low, because the value of raising healthy, educated children cannot really be measured.

Finally, globalization has devastating impacts on the environments in which most women live. As Manisha Desai points out,

Whether it is the destruction of the rainforest in Latin America, the felling of trees in the Himalayan Mountains in India, desertification in Africa, or toxic dumping in the United States, the environmental desecration caused by global economic policies has led to increasing material and cultural hardships for women.20

Women, who have the primary responsibility for home care, have to work harder to fetch wood, find drinking water, feed cattle, and care for children afflicted by poisons and deprivation. And they do so while seldom owning the land. Overall, only a small percentage of the world’s landowners are women, although the percentage is higher in individual countries. They work the land with less and less help because globalization not only strips the environment of natural resources but also strips the village of their husbands and children. These vital human resources are drawn increasingly from the countryside into the urbanized and globalized economy. This movement of human beings from rural to urban areas (at least thirteen million each year in China alone) creates transient and often impoverished communities where criminal organizations lure young men and women into the sex industry and drug trafficking.

Image 205

Migrant Bangladeshi women and children haul stones in a quarry in the northeastern Indian state of Assam, earning less than $1 per person per day.

AP Photo/ Shib Shankar Chatterjee

marginalization: the social process of making unimportant or powerless certain groups within a society, especially indigenous peoples and women.

Persisting Global Inequality

Despite all the development of the past five hundred years, why do all these shocking inequalities still exist? Mainstream perspectives answer this question in separate parts.

From a realist perspective, for example, the key question is who gains most? Does globalization spread economic benefits or concentrate them? Does the hegemon stay on top, or do other countries—China, India, and oil-producing states—gain more and counterbalance the hegemon? Or, at the individual and domestic levels of analysis, do individuals and minorities eventually work their way up the income ladder? Or are workers and minority groups stuck at the lower end and capitalist managers and financiers ensconced at the upper end?

As we’ve noted, realist perspectives don’t always agree with one another. The power transition school believes hegemons endure because movement toward balance is dangerous and brings war. They agree, in effect, with critical theory perspectives that some kind of hierarchy is necessary to promote development. But power transition realists do not necessarily believe that this hierarchy is rigid or static. The same hegemons, classes, or individuals may not endure. Different countries and classes may rise and fall. Nevertheless, realist accounts do believe that global development is greatest when hegemons rule because hegemonic stability favors growth, as recounted in Chapter 8. So inequalities are inevitable from this power transition perspective, even though the winners and losers in the inequality sweepstakes change.

The balance-of-power realist school sees it differently. It expects other states or classes and individuals to rise eventually and counterbalance the hegemon. It sees inequalities as dangerous and destabilizing. Thus, at the individual, domestic, and systemic levels of analysis, power balancing realists accept, if they don’t seek, relative balance or equality as the norm. They see markets and politics as competitive exercises and trust that increasing equality will stabilize and maximize benefits in the same way that perfectly competitive markets maximize growth. They assume, however, that a balancing of military capabilities preserves stability and peace. If not, power balancing realists favor a world that discriminates between friendly and enemy states. Development is pursued to reduce inequalities among friends, but in relations with adversaries development is a zero-sum game and not recommended.

Liberal perspectives don’t have a single answer either. Let’s listen first to economists who fear that globalization increases inequalities. According to Joseph Stiglitz, a Nobel Prize–winning economist,

[a] growing divide between the haves and the have-nots has left increasing numbers in the Third World in dire poverty, living on less than a dollar a day. Despite repeated promises of poverty reduction made over the last decade of the twentieth century, the actual number of people living in poverty has actually increased by almost 100 million. This occurred at the same time that total world income increased by an average of 2.5 percent annually.

In Africa, the high aspirations following colonial independence have been largely unfulfilled. Instead, the continent plunges deeper into misery, as incomes fall and standards of living decline. The hard-won improvements in life expectancy gained in the past few decades have begun to reverse. While the scourge of AIDS is at the center of this decline, poverty is also a killer. Even countries that have abandoned African socialism, managed to install honest governments, balanced their budgets, and kept inflation down find that they simply cannot attract private investors. Without this investment, they cannot have sustainable growth.21

On similar grounds, economist Dani Rodrik agrees and notes that globalization is leading to a new “digital divide, . . . a deep fault line between groups who have the skills and mobility to flourish in global markets” and groups that don’t, “such as workers, pensioners, and environmentalists.”22 The information age, in short, has opened up further inequalities, a digital divide between advanced and developing countries with respect to access to computers, cell phones, and other telecommunication devices.

But now let’s listen to an economist who sees globalization as reducing inequalities. According to Martin Wolf, a distinguished economist and journalist at the Financial Times in London,

[b]etween 1980 and 2000, India’s real GDP per head more than doubled. . . .

China . . . achieved a rise in real income per head of well over 400 per cent between 1980 and 2000. China and India, it should be remembered, contain almost two-fifths of the world’s population. . . .

Never before have so many people—or so large a proportion of the world’s population—enjoyed such large rises in their standards of living. Meanwhile, GDP per head in high-income countries (with 15 per cent of the world’s population) rose by 2.1 per cent a year between 1975 and 2001 and by only 1.7 per cent between 1990 and 2001. . . . [T]he incomes of poor developing countries, with more than half the world’s population, grew substantially faster than those of the world’s richest countries. . . .

What . . . has this progress to do with international economic integration? . . . the World Bank divided seventy-three developing countries . . . into two groups, the third [or twenty-four countries, including China, India, Brazil, Bangladesh, Mexico, the Philippines, and Thailand, which alone make up 92 percent of the population of the twenty-four countries] that had increased ratios of trade to GDP, since 1980, by the largest amount and the rest. . . .

The average incomes per head of these twenty-four globalizing countries rose by 67 per cent . . . between 1980 and 1997. . . . [T]he other forty-nine countries managed a rise of only 10 per cent . . . over this period. . . .

[T]he notion that international economic integration necessarily makes the rich richer and the poor poorer is nonsense.23

Are these economists talking about the same planet? Some see more people living in poverty than ever before; others see more people climbing out of poverty than ever before. Can both views be right? Well, yes, they can. It depends on which statistics economists use and what they emphasize. The absolute number of people living on less than $1 per day did go up between 1990 and 1998. But, as a ratio of total population over a longer period of time, this number has gone down from 50 percent in 1950 to 32 percent in 1980 to 24 percent in 1992.24 By more recent estimates, the ratio dropped to 18 percent in 2004 and 14 percent in 2014.25 Thus, Wolf looks at ratios, a longer time period, and the populated countries of India and China. Stiglitz and Rodrik focus on absolute numbers, the most recent period, and the poorest countries of Africa. Reality is different depending on the perspective you bring to bear on it.

Measuring inequality is also very tricky. Are we talking about inequality between countries or within them? For example, between 1820 and 1980, global inequality increased among countries but inequality actually went down within countries.26 So, from 1960 to 1997, the ratio of incomes of the 20 percent of the world’s population living in the richest countries to that of the 20 percent living in the poorest countries went up from 30:1 in 1960 to 74:1 in 1997, while it increased from 7:1 to only 11:1 in the previous era of globalization before World War I (1870–1913).27 During the same period, however, a burgeoning middle class reduced income differences within countries, ending the appeal of class warfare ideologies such as Marxism and communism. Are we talking about ratios or absolute numbers? From 1980 to 2000, Chinese average real income per head rose by 440 percent; U.S. income per head rose by 60 percent. But the absolute per capita income gap between China and the United States increased from $20,600 to $30,200 per head. China grew faster than the United States but from a much smaller base. It would have had to grow thirty, not seven, times faster to reduce the absolute gap.28 Closing relative gaps thus takes time and accelerates only toward the later phases of catch-up. Moreover, are we talking about just incomes or the quality of life, which includes life expectancy, education, and health care? Life expectancy and other measures of the quality of life in most developing countries grew steadily from 1950 to 2000, even as incomes grew less in some countries or stagnated in others.

What governs these interpretations and methodological preferences among economists who generally favor a liberal perspective? Perhaps their views are determined not just by wealth and markets (relational or liberal aspects of reality) but also by substantive or ideational issues such as what they consider to be the rate of sustainable development, the preferred quality of life, or the best mechanism for political life—redistributive versus decentralized political practices. In short, identity factors may trump liberal or realist factors. Is it ideologically acceptable that some people remain poor and perhaps even get poorer, at least relatively, as long as more (other) people leave poverty and get richer? Is it acceptable that some people become many times richer than others as long as still others also get richer? For example, is it immoral for Bill Gates to make billions while average middle-class incomes have gone up much less? After all, Gates did create a whole new industry and millions of jobs. Would anyone take such big risks if he or she could not reap big rewards? Should limits be applied to multiples of wealth until every individual, group, or state in the world has reached a certain minimal level of development? If so, what is that minimal level for all participants, what is the multiple limit of wealth that must be enforced until everyone reaches the minimal level, and how do we know what degree of redistribution of resources is still consistent with overall growth and does not result only in the redistribution of the wealth that already exists? These are not easy questions to answer—or they are questions that can be answered only from different ideational, material, institutional, or critical perspectives.

(Nau 475-498)

Nau, Henry R. Perspectives on International Relations: Power, Institutions, and Ideas, 5th Edition. CQ Press, 20160105. VitalBook file.

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