10 The Challenge of Corporate Globalization
Globalization has been a central development of the past twenty-five years. Not only did it play a critical role in creating the conditions that led to the financial crisis; it is now a key factor driving the prospect of a long stagnation. Reforming globalization and reining in the existing model is therefore vital.
The Special Significance of Globalization
Chapter 4 showed how the flawed U.S. model of global economic engagement contributed to undermining the economy. This model can be termed corporate globalization as it was designed and sponsored by corporate interests.
Globalization represents one side of the neoliberal policy box discussed in Chapters 4 and 9. However, it has claims to be primus inter pares – the most important of the four sides. This special standing is because globalization negatively implicates all dimensions of the economy and economic policy.
There are two critical features to globalization. First, it has undermined the internal demand-generating process by fostering wage stagnation via international labor competition, expanding the leakage of spending via imports, and offshoring jobs and investment. Second, it provided a new architecture binding economies together.
One part of the new architecture involved reconfiguring global production by transferring manufacturing from the United States and (to a lesser degree) Europe to emerging market (EM) economies. This new global division of labor was then supported by having U.S. consumers serve as the global economy’s buyer of first and last resort, which explains the U.S. trade deficit and the global imbalances problem.
The other part of the new architecture was financial and involved recycling of foreign country trade surpluses back to the United States, which had two effects. First, it abetted financial excess in the United States as foreign investors channeled funds into mortgage-backed securities. Second, the recycling process tied other economies to the U.S. property bubble so that when it burst, there was a massive spillover that damaged financial systems elsewhere, particularly in Europe.
The economic policy challenge of escaping the Great Recession and restoring shared prosperity is illustrated in Figure 10.1. Policy makers face a threefold challenge. First, policy must rebuild financial stability in light of the financial excess and fragility revealed by the financial crisis. Second, it must stimulate and revive demand so that the private sector increases output and employment. Third, it must rebuild the income-generating process so that the economy permanently generates a stable level of demand consistent with full employment and shared prosperity.
Figure 10.1. The Great Recession policy challenge.
Globalization adversely implicates all three policy challenges. With regard to financial reform, attempts to regulate banks and financial markets risk triggering jurisdictional shopping whereby financial capital leaves countries that impose tough regulations and migrates to countries with lax regulation.
With regard to stimulating demand, globalization weakens policy because of increased trade openness. Thus, stimulus may leak out of the economy via spending on imports rather than domestically produced goods so that it creates jobs offshore rather than at home. Additionally, financial markets tend to dislike budget deficits, and they may try to punish governments that pursue stimulus policies. The classic example of this is France in 1983, where President Mitterandwas forced to abandon his Keynesian policy aimed at restoring full employment under pressure from international markets.
Finally, globalization hampers rebuilding the demand-generating process. Chapter 9 framed the rebuilding challenge in terms of repacking the neoliberal policy box. In the pre-globalization era (1945–80), countries would have had more policy space to pursue a national strategy to repack the box. However, in the era of corporate globalization, “go it alone” national strategies are far more difficult because globalization imposes powerful constraints that restrict policy. Developing countries, including large EM economies like Brazil, have long complained about this aspect of globalization. Today, the United States is feeling some of the same policy space limits, albeit still on a much smaller scale.1 For instance, attempts to change labor market institutions so as to raise wages and improve income distribution may be met by offshoring production and investment to countries with worker- unfriendly laws and institutions.
Figure 10.2 provides a heuristic map (think of it like a subway map) of the global economy, which consists of four parts. The global economic core consists of North America, Europe, and the export-oriented emerging economies. The resource-based economies and less-developed countries are placed outside of the core. That is because the less-developed economies are substantially disengaged from the core, whereas the resource-based economies conform to traditional periphery status in terms of center-periphery economic relations.2
Figure 10.2. A map of the global economy.
The map helps understand how globalization complicates the policy problem. First, the countries and regions of the global economy are linked together by an international economic system, represented by the solid triangle in Figure 10.2. That system concerns arrangements governing trade, international financial markets, and global policy coordination. The system is part of the problem and has contributed to the undermining of the demand-generating process, within both the U.S. economy and the rest of the global economy. Additionally, the system undermines policy effectiveness and limits space for “go it alone” national policy. That is why reform of globalization is so important.
Second, because countries are linked to each other, successful policy requires policy coordination. If country policies are working against each other, their effects will be correspondingly diminished.
Worse yet, countries may have an incentive to free-ride and take no action, hoping to be pulled along by the coattails of others while avoiding bearing any costs of action. Viewed from a global perspective, there is a need for policy coordination, yet viewed from the individual-country perspective, there can be incentives to evade and shirk such cooperation.
Third, the global economy consists of different regions with different conditions. There are many similarities across regions, but there are also differences. Regions vary in their stage of development, have different internal economics problems, and some are running trade surpluses whereas others are running deficits. That means there is no one-size-fits-all policy. Countries and regions need to take different actions, but those different actions must fit into a coordinated framework. In particular, all countries should work to increase demand because the global economy is short of demand, and all should also aim to build a stable sustainable demand-generating process within countries and in the global economy.
Fourth, reform of corporate globalization is critical. However, because globalization concerns the international system, reform requires international agreement, which makes the political process of reform even more difficult.
Fifth, one-third of humanity lives in resource-exporting countries and less-developed countries that are outside of the global core. Those countries have qualitatively different development problems that are not directly addressed in this book. However, it is ethically clear that their development needs to be a priority. Those needs should be promoted in ways that add to global demand (i.e., they should benefit by receiving resources) and support the underlying global demand-generating process in financially and environmentally sustainable fashion.
In sum, the global economic architecture is of profound importance. It shapes the dynamic of the global economy by shaping the way that countries and regions interact, and by determining what countries can do on their own and what they are willing to do together. The current architecture is flawed, which means there is a need to change the rules governing international trade, capital flows, and exchange rates. However, changing the architecture will require changing the architects, illustrating once again the importance of ideas and politics.
The Economics of Globalization
Globalization refers to the process of international integration of national goods, financial, and labor markets. It is a process that is being driven by technology, businesses’ quest for profits, and policy.
Globalization changes the structure of economies and creates three forms of economic leaks. The first is macroeconomic leakiness, whereby there is a tendency for demand to leak out of the national economy owing to an increased propensity to import goods. The second is microeconomic leakiness, whereby there is a tendency for jobs to leak out of an economy if wages and other employment costs are not sufficiently low, labor markets are not sufficiently flexible, or taxes are relatively unfavorable compared to conditions elsewhere. The third is financial leakiness, whereby finance is free to flow across borders.3
All three types of leakiness matter and they promote and amplify each other. Thus, increased trade increases macroeconomic leakiness, whereas increased financial leakiness promotes trade and foreign direct investment, which increases microeconomic leakiness.
All three types of leakiness also make national economic policy more difficult. Increased macroeconomic leakiness means more spending leaks out of the economy. That makes it harder to use traditional Keynesian stimulus measures to increase domestic demand as stimulus leaks out. Increased financial leakiness makes it hard to adopt policies that regulate finance as financiers will sell domestic financial assets, driving up interest rates. Increased microeconomic leakiness makes it harder to promote decent working conditions, promote a fair distribution of income, and protect the environment, because corporations will offshore jobs and investment.
The critical new feature of globalization is international mobility of the means of production (capital and technology). Trade has existed throughout human history and has yielded enormous economic benefits, as well as occasionally imposing costs on specific regions and industries. The game changer in globalization is the ability to move and coordinate production between countries at low cost. This has fundamentally changed the character of global competition, undermined the demand-generating process, and undermined governments’ ability to conduct national economic policy.
Free trade created a “global marketplace.” Globalization has created a “global production zone.” The new reality was captured in the late 1990s by Jack Welch, then CEO of General Electric, who talked of ideally having “every plant you own on a barge.” The economic logic was that factories should float between countries to take advantage of lowest costs, be they a result of undervalued exchange rates, low taxes, subsidies, or a surfeit of cheap labor.
Globalization has made Welch’s barge a reality, giving rise to “barge economics” that has replaced the old economics of trade based on the theory of comparative advantage. In the old era of classical trade, countries competed regarding the most efficient production of goods. That competition lowered prices and also caused some dislocation as some industries closed. In the new era of globalization, the competition is for jobs. Before, companies wooed customers with cheaper goods: now, workers and governments kowtow to companies to retain jobs and attract investment.
From a Structural Keynesian perspective, the shift from free trade to globalization has numerous adverse consequences. First, it undermines the income- and demand-generating process by undermining worker bargaining power. The result is continuous downward pressure on wages and an increase in the profit share as workers settle for less to hold on to jobs. Globalization also pressures institutional arrangements (such as employment protections, minimum wages, and rights to unionize) supporting the income-generating process, again in the name of staying attractive to business. Furthermore, the income- generating process is also weakened at the after-tax level as governments are pressured to shift the tax burden from profits to wage income to increase their relative attractiveness to business.
Second, globalization undermines the effectiveness of standard Keynesian demand-management policy by increasing macroeconomic leakiness. Increased reliance on imports means fiscal and monetary stimulus tends to leak out of the economy as spending on imports rather than spending on domestically produced goods and services. Reduced policy effectiveness in turn discourages government from adopting such policies.
Not only is the effectiveness of Keynesian policy undermined; governments are also discouraged from pursuing either demand-management policies or structural policies that strengthen the demand-generating process. One reason is the free-rider problem. For instance, fiscal stimulus is costly as it increases the national debt. Governments may therefore prefer other countries stimulate demand so that they can piggyback for free on the induced economic expansion.
A second reason is the prisoner’s dilemma, whereby globalization establishes a pattern of incentives that encourages noncooperative behavior. Every country believes it can do better going it alone, which results in all doing worse than if they cooperated. The prisoner’s dilemma is illustrated in Figure 10.3, which shows the hypothetical payoffs to a policy game. There are two countries, A and B. Each country has two policy options: cooperate or cheat. The payoff to a country is highest (= 10) if it cheats and the other country cooperates, and lowest (= −10) if it cooperates and the other country cheats. For the system as a whole, the payoff is lowest if both countries cheat (−5, −5) and highest if both cooperate (5, 5).
Figure 10.3. The prisoner’s dilemma and international economic cooperation.
The problem is each country has an incentive to cheat to try and get the highest payoff (10), but when both cheat, they actually get the lowest payoff (−5). What is needed is cooperative behavior, but the incentives are not there. The only way to get the cooperative outcome is some form of international coordination, perhaps backed up by sanctions disciplining countries that renege. That is why the design of the correct international architecture is so important.
Worse than that, corporate globalization aggravates these problems by design. A fundamental goal of neoliberalism is to weaken government restraints over markets and expand the power of capital. Putting governments in competition with one another accomplishes that. Corporate globalization does exactly that by increasing economic leakiness, which puts governments in competition, and that worsens the global economy’s generic prisoner’s dilemma problem.
One example concerns labor market protection, the minimum wage, and rights to join unions. Each country may feel it can do better by having weak labor market protections, thereby making itself more attractive to business. However, if all pursue that strategy, none is relatively more attractive to business. Instead, the net result is to weaken the global demand-generating process by lowering wages and the wage share, making all worse off.
A second example concerns fiscal stimulus, and it is exemplified by the situation in European economies like Portugal, Italy, Ireland, Greece, and Spain – the so-called PIIGS economies. Financial markets dislike budget deficits. Financial capital therefore tends to migrate to countries with lower deficits, increasing interest rates in large-deficit countries and lowering rates in small-deficit countries. Given this, governments have an incentive to pursue fiscal austerity to make themselves relatively more attractive to financial markets. However, none gain when all do this, and the only effect is to impose fiscal austerity that reduces demand and worsens recession.
A third example concerns exchange rates. Globalization and increased economic leakiness gives countries an incentive to depreciate their exchange rate to increase their competitiveness and also to make themselves more attractive to foreign investment. However, when all do this, exchange rates are unchanged, and the only effect is to create financial turmoil that may undermine business planning and investment.
In sum, corporate globalization is extremely problematic. The neoliberal policy box shows how corporate globalization contributes to undermining the demand-generating process. When the box is simultaneously implemented in other countries in the context of a neoliberal international architecture, its impact is multiplicative across countries. Thus, it undermines the effectiveness of structural Keynesian policies within each country, and it also undermines the willingness of governments to pursue such policies. The net result is a profound deflationary bias in the global economy.
Mending Globalization
Escaping the Great Recession and the pull of the Great Stagnation requires stimulating demand and rebuilding the income- and demand-generating process. Corporate globalization discourages both, which is why it must be radically reformed. The existing system imposes a global deflationary bias. The goal of reform should be to replace that bias with an expansionary bias.
Core Labor Standards
A first critical reform is implementation and enforcement of global core labor standards (CLS). Such standards are needed to build a sustainable demand-generating process and to address the ethical wrongs of globalization. CLS can improve income equality and create conditions in which wages rise with productivity. That will help remedy the current problem of global demand shortage and contribute to creating a new global demand-generating process consistent with full employment. It will also promote shared prosperity by having workers share in rising productivity.
CLS refer to five core articles of the International Labor Organization (ILO) concerning freedom of association and protection of the right to organize, the right to organize and bargain collectively, the prohibition of all forms of forced or compulsory labor, the abolition of exploitative child labor, and the elimination of discrimination in respect of employment and occupation. These standards are very much in the spirit of “rights” and are intended to hold independently of a country’s stage of development. This links CLS with the discourse of human rights.
Two of the standards are affirmative in character, giving workers the right to organize and bargain collectively, while three of the standards are prohibitive in character, banning forced labor, exploitative child labor, and discrimination. The standards are all “qualitative” in nature, not “quantitative.” That means they do not involve labor market interventions contingent on an economy’s stage of development. Contrary to the claims of opponents, CLS do not impose on developing countries quantitative regulation befitting mature economies. No one is asking developing countries to adopt the U.S. minimum wage.
Lastly, the freedom of association and right-to-organize standard is particularly important. This standard covers labor unions, but it also covers civil society and religious organizations. As such, it promotes democracy and civil liberty, which constitute essential goals of development along with higher living standards.
Opponents of labor standards assert they are a form of “hidden protection” for developed-country workers and claim standards would retard growth and development. However, there are strong theoretical and empirical grounds for believing labor standards would raise global growth, and that developing countries stand to gain the most.
One source of economic benefit is static efficiency gains, whereby CLS correct distortions in labor markets, resulting in better resource allocations that raise output and economic well-being. Raising wages via labor standards can increase productivity because higher wages elicit greater worker effort and reduce malnutrition. Giving workers the right to join unions can neutralize excessive bargaining power of employers, thereby increasing both employment and wages. Eliminating discrimination can raise employment, output, and wages by ensuring efficient matching of jobs and skills. Lastly, eliminating inappropriate child labor can contribute to higher wages for adult workers, which can promote economic development by contributing to better child nutrition and helping human capital formation by supporting lengthened years of schooling. Far from reducing employment in developing countries, these static efficiency effects will raise employment and higher wages will increase employment by increasing consumption spending and countering demand shortage.
Dynamic economic efficiency gains refer to gains that come from changing the path and pattern of economic development. With regard to such gains, CLS can encourage firms to pursue business plans focused on increasing productivity rather than plans that aim to increase profits by squeezing workers and redistributing existing productivity.
At the global level, CLS can help block the problem of race-to-the-bottom competition between countries, which results from situations of prisoner’s dilemma. Market incentives often lead agents to pursue actions that seemingly benefit individuals but actually turn out to be harmful when all choose such actions. A classic example is bribery that appears to benefit the individual but ends up harming all when all choose to bribe. The same holds for labor exploitation, which promotes “low road” competition between countries marked by a degraded environment, lack of public goods, and lack of investment in skills.
The hallmark of globalization is increased mobility of production and capital between countries. This has allowed business to pit countries in adverse competition that erodes environmental and workplace regulations and undercuts wages of all workers – both in the North and South. Multinational corporations may actually exploit South-South divisions even more than they exploit North-South divisions, pitting developing countries in destructive competition to secure foreign investment. CLS can help rein in this adverse competition by establishing standards applying in all countries.
Another feature of corporate globalization has been the adoption of export-led growth strategies. Countries that were early to adopt this strategy have benefitted, but with so many countries adopting this strategy, its underlying destructive prisoner’s dilemma character is being revealed. Export-led growth is deflationary, promotes financial instability, and is unsustainable.
One flaw with export-led growth is that it encourages countries to engage in race-to-the-bottom competition as each tries to gain competitive advantage over its rival. A second flaw is that it creates global excess capacity and problems of export displacement, whereby one country’s export sales displace another’s. Both of these flaws create deflationary pressures. A third flaw is that it promotes financial instability by encouraging countries to seek competitive advantage through undervalued exchange rates – a strategy that China has been particularly adept at exploiting. However, since everyone cannot have an undervalued exchange rate (some must be overvalued), one country’s gain comes at the expense of others. Moreover, in the case of China, its gain has come at the expense of both developing and developed countries. Thus, China has sucked industries out of the United States and has also sucked foreign direct investment away from other developing economies.
In sum, global application of the strategy of export-led growth increases global supply while simultaneously undermining the global demand-generating process. Production is shipped from poorer Southern countries to richer Northern countries, but at the same time the incomes and buying power of Northern consumers is undermined. That makes export-led growth globally unsustainable.
Instead, countries need to shift to a new strategy that relies more on domestic demand-led growth, which would allow the benefits of development to be consumed at home. CLS are critical to a new domestic demand-led growth strategy as they can help tie wages to productivity growth, thereby building the necessary domestic demand-generating process.4
A final benefit of CLS concerns politics and governance.5 There is now growing awareness that transparency, accountability, and democratic political competition enhance growth and development. They do so by limiting corruption and cronyism, promoting institutions and policy processes responsive to economic conditions, and promoting fairer income distribution. By protecting freedom of association and the right to organize, CLS contribute positively to both the overall development of civil society and the specific development of labor markets and worker-based organizations.
A Global Minimum-Wage System
A second critical reform is the establishment of a global minimum-wage system. This does not mean imposing U.S. or European minimum wages in developing countries. It does mean establishing a global set of rules for setting country’s minimum wages.
The minimum wage is a vital policy tool that provides a floor to wages and reduces downward pressure on wages. The barrier created by the floor also creates a rebound ripple effect that raises wages in the bottom two deciles of the wage spectrum.6 Furthermore, it compresses wages at the bottom of the wage spectrum, thereby helping reduce inequality. Lastly, an appropriately designed minimum wage helps connect wages and productivity growth, which is critical for building a sustainable demand-generating process.7
Traditionally, minimum-wage systems have operated by setting a fixed wage that is periodically adjusted to take account of inflation and other changing circumstances. Such an approach is fundamentally flawed and inappropriate for the global economy. It is flawed because the minimum wage is always playing catch-up, and it is inappropriate because the system is difficult to generalize across countries.
Instead, countries should set a minimum wage that is a fixed percent (say 50 percent) of their median wage – which is the wage at which half of workers are paid more and half are paid less. This design has several advantages. First, the minimum wage will automatically rise with the median wage, creating a true floor that moves with the economy. If the median wage rises with productivity growth, the minimum wage will also rise with productivity growth.
Second, because the minimum wage is set by reference to the local median wage, it is set by reference to local economic conditions and reflects what a country can bear. Moreover, because all countries are bound by the same rule, all are treated equally.
Third, if countries want a higher minimum wage, they are free to set one. The global minimum-wage system would only set a floor: it would not set a ceiling.
Fourth, countries would also be free to set regional minimum wages within each country. Thus, a country like Germany that has higher unemployment in the former East Germany and lower unemployment in the former West Germany could set two minimum wages: one for former East Germany, and one for former West Germany. The only requirement would be that the regional minimum wage be greater than or equal to 50 percent of the regional median wage. Such a system of regional minimum wages would introduce additional flexibility that recognizes that wages and living costs vary within countries as well as across countries. This enables the minimum-wage system to avoid the danger of overpricing labor while still retaining the demand-side benefits a minimum wage confers by improving income distribution and helping tie wages to productivity growth.
Finally, a global minimum-wage system would confer significant political benefits by cementing understanding of the need for global labor market rules and showing they are feasible. Just as globalization demands global trade rules for goods and services and global financial rules for financial markets, so too labor markets need global rules.
Managed Exchange Rates
A third critical reform concerns the global system of exchange rates. Exchange rates matter more than ever because of globalization. However, the current system of exchange rates is dysfunctional. It contributed to the emergence of massive global financial imbalances that are a critical part of the crisis, and the system now contributes to political tensions between countries, as none wants to bear costs of correcting these imbalances.
With regard to the U.S. economy, the overvalued dollar contributed to the trade deficit and offshoring of jobs and investment, all of which were important factors in undermining the income- and demand-generating process. The overvalued dollar has also weakened the effects of stimulus by increasing imports rather than domestic production, thereby hindering recovery from taking hold. With regard to other economies, undervalued exchange rates have been an important factor driving export-led growth based on attracting foreign direct investment.
The existing system is justified by appeal to orthodox arguments that flexible exchange rates generate stable sustainable outcomes. In fact, they are neither stable nor sustainable. The 1990s witnessed a series of exchange rate crises, as speculative capital flows whipsawed exchange rates, first appreciating them and then crashing them. This was exemplified by the East Asian financial crash of 1997. That turbulent experience prompted many governments to intervene, creating the current problem of undervalued exchange rates.
The situation is exemplified by China’s currency market interventions aimed at keeping the Chinese yuan undervalued. China’s actions in turn force other East Asian countries to intervene to keep their exchange rates undervalued so as not to lose competitiveness versus China. The result has been a generalized overvalued dollar that has contributed to the massive U.S. trade deficit, devastation of the U.S. industrial base, and undermining of the income- and demand- generating process.
The problem of misaligned exchange rates is persistent and long-standing. The current problem is dollar overvaluation. In the 1990s, the problem of overvalued exchange rates afflicted Latin America and, to a lesser degree, East Asia. This problem of rolling exchange rate misalignments is bad for the global economy and often results in costly crises. Even when there is no ultimate crisis, such misalignments cause inefficiency by misallocating production across countries and distorting trade. Rather than competing on the basis of productivity, too often countries compete through undervalued currencies that confer an exchange rate subsidy.
For much of the past fifteen years, the costs to the U.S economy were obscured by the debt-financed boom, while other countries were happy to go along because U.S. trade deficits created matching trade surpluses that spurred export-led growth. Now, the system has imploded and the costs have become evident.
The current global exchange rate system is a suboptimal arrangement. There are many theoretical reasons for believing that foreign exchange markets are prone to mispricing, and there is also strong empirical evidence that exchange rates persistently depart from their theoretically warranted levels. The existing system also permits strategic manipulation so that some countries (particularly in East Asia) actively intervene to undervalue their currencies. That has made for a lopsided world in which half reject intervention and half are neomercantilist – a configuration that has created economic and political tensions.
It is possible to do better than the current system. The immediate need is for a coordinated global realignment of exchange rates that begins to smoothly unwind existing imbalances. The 1985 Plaza currency accord provides a model of how this can be done. China’s participation is critical as it has the largest trade surplus with both the United States and Europe. Moreover, other East Asian countries with trade surpluses will resist revaluing unless China revalues for fear they will become uncompetitive. Finally, this realignment must be credible, and markets must believe it will hold. Absent that, business will not make the changes to production and investment patterns needed to restore equilibrium.
Beyond such realignment, there is a need for systemic reform to avoid recurring misalignments. The solution is a target zone system of managed exchange rates for major currencies. Such systems rely on a number of parameters that would need to be negotiated by participants. These choices include the target exchange rate, the size of the band in which exchange rates can fluctuate, and the rate of crawl, which determines the periodicity and size of adjustments of the target exchange rate.
The rules for intervening to protect the target exchange rate must also be agreed on. Historically, the onus of defense has fallen on the country whose exchange rate is weakening, which requires it to sell foreign exchange reserves. That is a fundamentally flawed arrangement, because countries have limited foreign currency reserves, and the market knows it. Consequently, speculators have an incentive to try and “break the bank” by shorting the weak currency (i.e., forcing the central bank to buy its own currency and sell its reserves until they are used up, at which point it must capitulate) and they have a good shot at success given the scale of low-cost leverage financial markets can muster.
Instead, the onus of intervention must be placed on the strong-currency country. Its central bank has unlimited amounts of its own currency for sale so it can never be beaten by the market. Consequently, if this intervention rule is credibly adopted, speculators will back off, making the target exchange rate viable.
Intervening in this way will also give an expansionary tilt to the global economy. When weak countries defend exchange rates, they often use high interest rates to make their currency attractive, which imparts a deflationary global bias. If strong-surplus countries do the intervening, they may lower their interest rates and impart an expansionary bias.
In sum, a sensible managed exchange rate system can increase the benefits from trade, diminish exchange-rate-induced distortions, and reduce country conflict over trade deficits. The means are at hand, but the political domination of neoliberal ideology has blocked change.
In the United States, discussion of exchange rate policy is still blocked by simplistic free-market nostrums. It is also blocked by mistaken fears that a managed system would surrender sovereignty and control. Yet, that is implicitly what has been happening. By absenting itself from the market, the United States has de facto allowed other countries to set the exchange rate, and that means the United States has been letting itself be strategically outgamed.
Other countries have had no incentive to change because they have benefited from the overvalued dollar. The net result is that the global economy is locked in a suboptimal system that promises stagnation and conflict. Escaping that system requires political leadership, as the system of exchange rates is a system that is agreed between nations.
Legitimize Capital Controls
Undervalued and misaligned exchange rates are one major problem afflicting global economy. A second problem is unrestricted international flows of capital, which was the dominant problem of the 1990s. Capital inflows followed by outflows created rolling boom-bust cycles. Massive inflows distorted asset prices, promoted credit booms, encouraged foreign borrowing, and appreciated exchange rates. This was the pattern behind the string of financial crises that included Mexico in 1994, East Asia in 1997, Russia in 1998, Brazil in 1999, and Argentina in 2000–02.
The 1990s problem of unstable capital flows prompted governments to switch to manipulating exchange rates. Thus, the unstable international hot money flows of 1990s sowed the seed of the current problem of undervalued and manipulated exchange rates. That speaks to the need for capital controls that give policy makers the power to limit inflows and outflows.
One control is to tax currency transactions – the Tobin tax.8 A second control is to require part of capital inflows be deposited interest free with central banks for a period of time before being released. This penalizes inflows, and the penalty can be adjusted according to economic conditions. Thus, the proportion deposited and the holding period can both be adjusted at the discretion of the central bank, depending on whether it wants to discourage or encourage inflows.9
Once again, the problem is that neoliberal ideology discourages such policies. In the 1990s, the IMF explicitly fought to prohibit such controls by making prohibition of capital controls part of its articles of association. That would have obliged IMF member countries to repudiate capital controls. U.S. economic policy still requires that trade agreements outlaw such controls.10 Although the current crisis has spawned some musings at the IMF about changing policy attitudes to capital controls, there is no evidence of deep-seated acceptance of such controls, and economic orthodoxy is still robustly against them.11
Rewrite Trade Rules
Another area of reform is trade rules, which need to be significantly rewritten. Market access must be contingent on adherence to core labor standards, a global minimum-wage system, and participation in a system of managed exchange rates.
Another important change is the treatment of value added tax (VAT). VAT is a form of sales tax, and under existing WTO trade rules, it is refunded on exports. That gives countries using VAT systems an unjustifiable international competitive advantage over those (like the United States) that raise tax revenues differently. Moreover, it encourages countries to adopt VAT systems, which are regressive. That is because they tax consumption, and poorer households spend proportionately more on consumption and therefore pay a higher effective tax rate.
This favorable trade treatment of VAT is the result of a historical policy blunder. In the late 1940s, when the global economy was being reconstituted after World War II, VAT schemes were almost nonexistent. At that time, the United States was the undisputed global economic superpower, keen to promote global economic recovery, and trade was a relatively small part of economic activity. The United States therefore mistakenly agreed to refundability of VAT payments under the General Agreement on Tariffs and Trade (GATT). That rule was then grandfathered into the World Trade Organization (WTO), which was established in the 1990s and replaced the GATT.
The rule should have been abolished when the WTO was created, but U.S. corporations and neoliberal policy makers were keen to push corporate globalization. The Clinton administration therefore let it pass rather than trigger a trade confrontation that could have derailed the corporate globalization process.
The current treatment of VAT is wrong on two counts. First, it discriminates in favor of countries using VAT systems, giving them a competitive advantage. Second, it encourages countries to shift to VAT systems even though they are regressive in that they disproportionately tax lower-income households. The solution is to abolish VAT refunds on exports. The global trade system should not discriminate in favor of one tax regime over another. That is a matter of domestic political choice.
Two other areas needing a fundamental rewrite are trade rules governing intellectual property rights concerning patents and copyrights, and rules that give international investors the right to sue governments under binding international arbitration. Neither is of macroeconomic significance but both reveal starkly the audacious nature of the corporate globalization project.
That project aimed to impose, in the name of free trade, a set of global rules that operated for the benefit of large corporations. The project was audacious in its arrogance of imposing a one-size-fits-all approach and in choosing a size that benefited corporations. Even ardent neoliberal free-trader Jagdish Bhagwati (2002) of Columbia University has been critical of these rules.
With regard to intellectual property rights, the essence of the new rules is that countries have to effectively adopt U.S. laws regarding copyright and patents to participate fully in the global trading system. This constitutes a form of corporate economic imperialism that breaks with the past. Historically, trade rules were exclusively concerned with governing international competition, and copyright and patent law were therefore excluded as matters of domestic commerce.
Corporate globalization aims to take away the power of countries to chart their own economic course, hence the imposition of global patent and copyright rules. The same holds for new trade rules giving foreign investors the right to sue countries under binding international arbitration. This grants foreign investors rights that domestic citizens do not have and undermines national sovereignty. Such developments are fundamentally undemocratic and should be rolled back.
Lessons from History
The global economy is beset by recession and contradiction. Escape from recession is blocked by shortage of demand. The contradiction is that neoliberal corporate globalization promotes a pattern of development that increases global supply while simultaneously undermining global demand. This problem was hidden for twenty years by asset price inflation and borrowing that filled the demand gap, but the economic crisis has exposed it. The implication is that the global economy needs a new model of development that attends to domestic demand, and U.S. economic history offers powerful salient lessons.
Globalization represents the international integration of goods, labor, and financial markets. In the late nineteenth and early twentieth centuries, the U.S. economy underwent a similar process of integration. The U.S. economy was continental in scope, and the creation of a successful national economy required new laws and institutions governing labor markets, financial markets, and business. This is the history of the antitrust movement of the Progressive era and the history of the New Deal that created Social Security, the Securities and Exchange Commission, and labor laws protecting workers.
These institutional innovations solved the structural problems that caused the Great Depression and they generated America’s famed blue-collar middle class. Today, the challenge is global institutional innovation that will create shared global prosperity. Meeting that challenge means profoundly reforming corporate globalization.
The Problem of Lock-in
Reason and evidence point to the need to reform corporate globalization, but that is easier said than done because of the problem of “lock-in.” Lock-in is a concept developed by economic historians to describe how economies get stuck using inefficient technologies. It also applies to institutions because economies and societies can get locked into suboptimal institutional arrangements. This has relevance for globalization where the arrangements governing the global economy are suboptimal, which poses problems of how to change them. The economics of lock-in helps understand the problem and suggests how to solve it.
Lock-in arises because a technology adopted first may gain a competitive advantage that encourages others to adopt it, even though other technologies are superior and would be chosen if all were at the same starting point. An example of lock-in is a narrow-gauge railroad that is less efficient than broad gauge on which railcars are more stable and can carry greater loads. However, once a stretch of narrow gauge has been laid, there is an incentive for additions to be narrow gauge to fit the existing track. Moreover, the incentive increases as the size of the rail network grows.
Lock-in has enormous relevance for globalization, which has seen the creation of new institutions and patterns of economic activity. Trade agreements and financial market opening have created new rules, fostering new patterns of global production and setting the basis for future trade and investment negotiations.
Globalization lock-in matters because today’s global economy has been designed with little attention to income distribution and labor, social, and environmental issues. This is because the system was largely stitched together in the last quarter of the twentieth century, a period of neoliberal laissez-faire intellectual dominance. This design was locked in through a steady flow of corporate-sponsored trade agreements, both multilateral and bilateral.
The economics of lock-in helps understand what is going on and it also suggests an escape from the problem. Recalling the example of narrow-gauge railroads, the market can produce a gradual escape by cherry-picking the most profitable parts of the existing network, causing it to gradually implode. Thus, a parallel wide-gauge track may be built on the most profitable segments of the existing narrow-gauge network, draining the latter’s profitability while promoting the gradual buildup of a wide-gauge network.
This provides a metaphor for globalization. The modern global economy has been built on a narrow-gauge rail, and countries now need to find a way to build a broad-gauge replacement. That points to several policy measures. First, countries should stop building more narrow-gauge track, which means no more trade agreements without high-quality labor and environmental standard; commitment to a global minimum-wage system; exchange rate provisions guarding against currency manipulation and unfair competition based on undervalued exchange rates; acceptance of capital controls; and changed intellectual property and investor rights.
Second, developed democratic economies should start cherry- picking the existing “narrow-gauge” trade system and promote “broad-gauge” trade agreements. For instance, the United States and Europe could negotiate a Trans-Atlantic Free Trade Agreement (TAFTA) that includes proper labor and environmental standards, commitment to a common minimum-wage system, and a managed exchange rate agreement. Similar agreements could be negotiated with Canada, Japan, and South Korea. All of these countries would have little difficulty complying with standards, and together they comprise approximately 75 percent of the global economy. Such a trading bloc would quickly become a “broad-gauge” magnet for other countries.
Third, multilateral institutions, such as the IMF and World Bank, must be thoroughly house-cleaned. These institutions must be made to promote labor and environmental standards, legitimacy of capital controls, and legitimacy of managed exchange rates. Under pressure of events, there has been some movement in this direction, but that movement is half-hearted and easily reversible given the deep neoliberal convictions of the staff appointed over the past thirty years. A thorough remake will require not just policy change, but also personnel change. Absent that, policy change will not stick.
The bottom line is it is still possible to escape corporate globalization lock-in. The key is creating a new dynamic in which forces of competition promote progressive upward harmonization in place of the existing dynamic that promotes a race to the bottom.
Conclusion: Mend it or End it
The phenomenon of lock-in means there will be costs to escaping the current mode of corporate globalization. If all goes well and a cooperative spirit prevails, those costs can be small. However, that is unlikely. Corporations that have benefitted from corporate globalization will fight tooth and nail against change. Likewise, countries that are exploiting the system will also fight to keep it. This explains the political alliance between autocratic China and large U.S. multinationals like Caterpillar and Boeing.
The tragedy of the current era is that the acceleration of global economic integration triggered by changing technologies occurred at a time of dominance by neoliberal economics. That resulted in the creation of a form of globalization that blocks shared prosperity.
It could have been done differently by expanding a social democratic globalization built on the post–World War II model of social and economic inclusion. In that alternative world, NAFTA would have stood for North Atlantic Free Trade Agreement. However, the opportunity was missed.
At this stage, there are two possible responses to corporate globalization: mend it or end it. Mend it means putting in place the policy recommendations discussed previously, which will shift globalization onto a path that promotes shared prosperity rather than a race to the bottom. This corresponds to a structural Keynesian model of globalization that bolsters the global demand-generating process by shifting countries away from export-led growth and attending to the deficiencies of global governance and repeated instances of prisoner’s dilemma.
End it means rolling back many of the agreements put in place over the past two decades and restarting the process. Under this latter scenario, the global economy will revert to a regionalist system organized around economic blocs that share common goals and a common state of development, with tariffs and capital controls between blocs. Thereafter, the gradual process of integrating blocs can begin again, this time getting it right.
There will be significant costs to an “end it” strategy. Many corporations will face significant losses as they have invested in global production networks, or even abandoned production and transformed themselves into marketing agencies (like Nike or Gap) that source globally from low-cost, exploited workers. This will produce temporary price increases, but it will also produce large numbers of jobs as production is brought back.
Most importantly, the costs are worth it if the system defies reform. Staying the current course entails a future of wage stagnation, massive inequality, and continuous economic insecurity. It is better to pay the up-front costs of change, even if large, to rescue a prosperous future, rather than bear the costs of a flawed globalization that permanently renders shared prosperity a thing of the past.
1 For a discussion of the policy space issue, see Grabel, I. [Reference Grabel2000], “The Political Economy of ‘Policy Credibility’: The New-Classical Macroeconomics and the Remaking of Emerging Economies,” Cambridge Journal of Economics, 24, 1–19; Bradford, C.I., Jr. [Reference Bradford2005], “Prioritizing Economic Growth: Enhancing Macroeconomic Policy Choice,” G-24 Discussion paper No. 37, April.
2 Mexico as well as Japan, China, and other East Asian economies can be considered export-oriented economies. Brazil, Russia, Australia, and Latin American economies are part of the resource-based bloc. India is a little difficult to peg. Despite its size and recent economic growth success, it should probably be placed with the less-developed countries because of its still relatively low level of global engagement.
3 See Palley, T.I. [Reference Palley2000], “The Economics of Globalization: A Labor View,” in Teich, Nelson, McEnaney, and Lita (eds.), Science and Technology Policy Yearbook 2000, American Association for the Advancement of Science, Washington, DC.
4 See Palley, T.I. [2002b], “Domestic Demand-Led Growth: A New Paradigm for Development,” in Jacobs, Weaver and Baker (eds.), After Neo-liberalism: Economic Policies That Work for the Poor, Washington, DC: New Rules for Global Finance. Also published as “A New Development Paradigm: Domestic Demand-Led Growth,” Foreign Policy in Focus, September, http://www.fpif.org/
5 See Palley, T.I. [2005b], “Labor Standards, Democracy and Wages: Some Cross-country Evidence,” Journal of International Development, 17, 1–16.
6 Using U.S. data to estimate wage curves, Palley (Reference Palley1998c) reports that the minimum wage has a ripple effect that reaches through the bottom two deciles of the wage distribution. Using U.S. micro data, Wicks-Lim (Reference Wicks-Lim2006) reports the minimum wage has a ripple effect that reaches the bottom 15 percent of the workforce.
7 For a more extensive discussion of the economics of minimum wages, see Palley, T.I. [Reference Palley1998b] “Building Prosperity from the Bottom Up: The New Economics of the Minimum Wage,” Challenge, 41 (July–August), 1–13.
8 For a discussion of the economics of capital controls, see Palley, T.I. [Reference Palley2009c], “Rethinking the Economics of Capital Mobility and Capital Controls,” Brazilian Journal of Political Economy, 29 (July–September), 15–34. For a discussion of the Tobin tax, see Palley, T.I. [Reference Palley2001a], “Destabilizing Speculation and the Case for an International Currency Transactions Tax,” Challenge, (May–June), 70–89.
9 For a discussion of the economics of controlling capital inflows by requiring deposits with central banks, see Palley, T.I. [Reference Palley2005c], “Chilean Unremunerated Reserve Requirement Capital Controls as a Screening Mechanism,” Investigacion Economica, 64 (January–March), 33–52.
10 See Gallagher, K. [Reference Gallagher2010b], “Obama Must Ditch Bush-era Trade Deals,” Comment Is Free, Thursday, July 1, http://www.guardian.co.uk/commentisfree/cifamerica/2010/jun/30/obama-bush-us-trade
11 See Ostry, J.D. et al. [Reference Ostry, Ghosh, Habermeier, Chamon, Qureshi and Reinhart2010], “Capital Inflows: The Role of Controls,” Research Department, International Monetary Fund, February 19, http://www.imf.org/external/pubs/ft/spn/2010/spn1004.pdf
