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Globalization of the World Economy:  LANCE TAYLOR

Read November 14, 1998 at the Autumn Meeting of the American Philosophical Society

Globalization, Liberalization, Distribution, and Growth:
Developing and Transition Economies


Processes of globalization and economic liberalization have accelerated rapidly in recent years. The most direct way to approach their effects on growth and income distribution in poor and middle-income economies is in terms of the three main components of the external balance of payments - foreign trade; "factor payments" such as wage remittances (an important contributor to local incomes in countries such as El Salvador with large emigrant populations), interest, and dividends; and flows of financial capital including direct foreign investment and portfolio movements. Then we can worry about linkages back to the rest of the economy. The gist of the message is that globalization has been associated with a decidedly mixed bag of goods and ills. It makes sense to explore the reasons why.

1. Capital flows

Capital inflows are required to finance external deficits on current account, or the sum of deficits in trade and factor payments. Beginning in the 1980s, about two dozen "emerging market" economies were able to tap private sources for such funds. Eight dozen other developing and post-socialist nations mostly rely on foreign aid (usually government-to- government transfers) for balance of payments support. That source has been dwindling steadily. In the mid-1990s, aid flows net of repayments amounted to less than $50 billion per year. More than 50 countries are classified as "low income" by the World Bank. Excluding China and India, they received about $20 billion of net inflows in 1995, almost all from official sources. Their combined GDP is on the order of $300 billion and population one billion. The implied average aid levels of 7% of GDP or $20 per capita are not likely to bolster their prospects for sustained income growth in the medium run.

In economic terms at least, globalization has brought few benefits to this diverse group of economies. In most of Africa and Central and South America, real per capita GDP peaked around 1980 and has been declining or stagnant ever since. Many poor countries still have their exports concentrated in commodities such as tropical beverages and minerals. Given recent price declines for such products, their growth prospects are not bright.

For the emerging markets, on the other hand, private capital inflows began to rise sharply in the mid-1980s, first in Southeast Asia and later in Latin America and Eastern Europe. By the mid-1990s, they exceeded $200 billion per year. In a mutually reinforcing process, inflows of funds were associated with removal of barriers to capital movements and deregulation of domestic financial markets. Some benefits were observed. Direct foreign investment in  export industries along with exchange rates pegged to a depreciating dollar after 1985 helped the economies of Southeast Asia grow at near double-digit rates for a decade prior to their payments crisis in 1997. In Latin America, readily available external finance permitted several countries to stabilize their exchange rates as essential "nominal anchors" in successful inflation stabilization programs.

However, as we all now know, private capital movements can be associated with substantial downside risks. Most emerging market economies in the 1990s had uncontrolled capital flows, virtually fixed exchange rates, and lax or pro-cyclical financial regulation. For a variety of historical reasons, their asset returns (bond interest rates, capital gains on real estate and equity) rose far above external borrowing rates. With exchange rates pegged and short- sighted profit maximization driving fund managers, "spreads" between soft currency returns and hard currency costs of credit widened, drawing in short-term capital that drove the returns higher still. National balance sheets went "long" on domestic assets and "short" on hard currencies -a perilous position if the local currency is devalued before the foreign loans are paid off.   Such balance sheet mismatches are inherently unstable, and must ultimately unwind. The wipe-out of Russia's financial system in the summer of 1998 is just the latest example. When international creditors flee (according to data from the Basle-based Bank of International Settlements or BIS, East Asia's reversal of capital flows in 1997 exceeded 10% of regional GDP), countries become illiquid in hard currency terms. Incompetent "rescue" efforts by the International Monetary Fund transformed illiquidity into insolvency by transferring niggardly quantities of funds (East Asia's "official" inflows in 1998 will be around a third of its 1997 losses) and "bailing out" external creditors instead of forcing them to "bail in" resources to keep national economies afloat. An international "lender of last resort" (or LLR) with the capability to manage crises of Asian or Russian magnitude does not exist.

There are proposals on the table to establish better surveillance and regulation of capital movements as the bases for effective LLR interventions at the global level, responding to the problems just discussed and the "trilemma" riddle posed by James Tobin in his paper for this symposium. For example, Eatwell and Taylor (1999) suggest that the BIS (a "central banker's bank" established in 1930 to recycle American loans which financed Germany's payments obligations from the Treaty of Versailles) should be expanded into a fully-fledged "World Financial Authority." If financial crises continue at the rate observed in the recent period, some such scheme will have to be adopted - the BIS is of interest in this context because it is an already existing international institution which can be readily expanded.

Finally, prior to their crises, the emerging markets had strong exchange rates and (as already noted) high interest rates domestically. This is not a mix of "macro" prices that is supportive of long-term growth. To see why, we have to consider look at the effects of liberalizing the current account.

2. Trade liberalization

A worldwide trend toward trade liberalization - removal of import protection and export subsidies - accelerated after the mid-1980s. According to received economic theory, the benefits of freer trade should take the form of greater economic efficiency and (presumably) faster output growth. The costs are mostly distributional, e.g. jobs lost in industries that can't compete under the new regime. Such "transitional" changes can presumably be offset by enlightened public intervention.

Unfortunately, there are macroeconomic problems with such stories. They are founded on hypotheses of assured full employment and effective working of the invisible hand. But as we have seen, current and capital account liberalization can be associated with currency crises that can derail economic growth for years. Even if such accidents are avoided, the high interest rate/strong exchange rate macro price combination noted above can easily create severe unemployment (for example, the unemployment rate in Argentina, one of the more "successful" liberalizing economies, is nearly 20%). In principle, import liberalization should be combined with currency depreciation to keep the trade balance in line. If liberalization and exchange appreciation are combined, output losses in at least some affected sectors are bound to follow.

The resulting economic hardship may be beyond the powers of meliorative policies to offset. What is the empirical evidence on such matters? Output per worker (or labor productivity) and employment are useful indicators of economic performance. In one study, Pieper (1999) used a 30-country sample of data at the nine-sector level to show that during the post-1985 period of current and capital account liberalization only five Asian countries maintained growth rates of better than three percent per year in both overall employment and labor productivity. Their productivity expansion was balanced across sectors, with the rate in agriculture remaining high.

Off this Asian "high road," the typical Latin American pattern was rapid employment but slow productivity growth, while in Africa both rates were under three percent. In these regions, productivity performance dropped off sharply after 1985 in comparison to the previous period.

Finally, in almost all countries aggregate productivity growth correlated closely with the evolution of the output/labor ratio in manufacturing, with other sectors presenting no clear pattern.  The links between this evidence and trade and other forms of liberalization are not direct but are still suggestive:

First, manufacturing has always been the main focus of protection and many economists argue that productivity growth in that sector drives changes in the rest of the economy.   Insofar as this argument is correct, the deindustrialization observed in much of the developing world due to liberalization, exchange rate appreciation, and high interest rates and other symptoms of austere policy could have far-reaching adverse consequences.

Second, they could play out over an extended time period if a prior phase of creating domestic capacity to produce goods previously imported ("import substitution" in the jargon) is needed to lay the base for subsequent export expansion. This strategy was followed with great success by the United States last century and by Japan, Korea, and other Asian economies for many decades during this one. Countries with exploitable natural resources and/or cheap labor are partial exceptions to such a generalization, but such windfalls do not last forever.

Finally, the good productivity performance in the Asian economies prior to the recent crisis was associated with outward-oriented, but distinctly not liberal trade regimes - their long-term import substitution/export promotion efforts relied heavily on government intervention (for details see Amsden, 1989, and Wade, 1990). Their histories show that trade and other interventions are not always harmful; indeed, at least in terms of economic performance, they can promote substantial good.

3. Effects on income distribution

Two questions arise: Can we characterize the overall directions of distributional change under liberalization? If so, what can be said about the channels via which it occurs?   "Distribution" of course has many dimensions, including income flows, assets, and access to opportunities.  Because the relevant data are more readily available, we concentrate here on income inequality.  With regard to the first query, UNCTAD (1997), James Galbraith in this symposium, and other sources demonstrate that globalization has been associated with a trend toward increasing relative income inequality worldwide. The typical pattern is an increase in the income share of the top 10 or 20% of households, with all other deciles getting declining shares. According to Berry, Horton, and Mazumdar (1997) the exceptions are "countries with abundant labor, sufficiently educated (and with other necessary conditions present) to take advantage of international markets to expand labor-intensive manufactured exports, [which] showed some tendency for improving income distribution. In contrast, middle-income countries with comparative advantage in some skill-intensive products, and upper income countries, with comparative advantage in capital and skill-intensive areas, showed a definite tendency for worsening in income distribution. African economies whose comparative advantage lay in peasant production were expected to show an improvement ... but there mostly appears to have been a worsening in income distribution..." As noted above, African and other poor economies also had decreases in overall income levels over the past two decades.

With regard to channels, debate is open. One standard argument is that liberalization causes a "skill twist" against low wage labor in developing economies. More directly, Milberg (1997) stresses that the key factors are labor market institutions and employment growth. The latter responds to growth of aggregate demand, and can feed along the lines just discussed back into overall productivity growth. With capital market and financial liberalization, another commonly observed tendency is for the "functional" income distribution to shift from payments to labor (wages, salaries, earnings of unincorporated enterprises) toward payments to capital (profits, dividends, interest, rent).  Inequality of household income almost always rises after such a change, since its main beneficiaries are at the top.

4. Toward better outcomes in the future

Globalization and liberalization have rendered useless many traditional tools of economic policy - tariff and other forms of protection and industrial policy (including credit and other subsidies) more generally, fixed exchange rates, and barriers to destabilizing capital  movements.  It is frequently argued that the globalization genie cannot be put back in the bottle, and in today's political environment that may well be true. However, the American-led political campaign to reshape the world economy along libertarian lines may well stall out; indeed, informed observers such as the ex-Thatcherite political philosopher John Gray (1999) argue that it is bound to fail. If and when that happens, sensible interventionist policies such as those that supported the excellent performance of the Asian economies as discussed above may become feasible once again. It is hard to see how renewed per capita income growth in the poorest economies can happen unless a new global policy regime emerges in the medium term.


AMSDEN, ALICE (1989) Asia's Next Giant: South Korea and Late Industrialization, Oxford University Press, New York

BERRY, ALBERT, SUSAN HORTON, and DIPAK MAZUMDAR (1997) "Globalization, Adjustment, Inequality, and Poverty," Department of Economics, University of Toronto

EATWELL, JOHN, and LANCE TAYLOR (1999) International Capital Markets and the Future of Economic Policy, The New Press, New York

GRAY, JOHN (1999) False Dawn: The Delusions of Global Capitalism, The New Press, New York

MILBERG, WILLIAM S. (1997) "The Revival of Trade and Growth Theories: Implications for Income Inequality in Developing Countries," Center for Economic Policy Analysis, New School, New York

PIEPER, UTE (1999) "Openness and Structural Dynamics of Productivity and Employment in Developing Countries: A Case of De-Industrialization?" Journal of Development Studies, in press.

United Nations Conference on Trade and Development (UNCTAD 1997) Trade and Development Report, United Nations, New York

WADE, ROBERT (1990) Governing the Market: Economic Theory and the Role of the  Government in East Asian Industrialization, Princeton University Press, Princeton NJ


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