PART ONE
Globalization is one of the most charged issues of the day. It is everywhere in public discourse ? in TV sound bites and slogans on placards, in web-sites and learned journals, in parliaments, corporate boardrooms and labor meeting halls. Extreme opponents charge it with impoverishing the world's poor, enriching the rich and devastating the environment, while fervent supporters see it as a high-speed elevator to universal peace and prosperity. What is one to think?
Amazingly for so widely used a term, there does not appear to be any precise, widely-agreed definition. Indeed the breadth of meanings attached to it seems to be increasing rather than narrowing over time, taking on cultural, political and other connotations in addition to the economic. However, the most common or core sense of economic globalization ? the aspect this paper concentrates on - surely refers to the observation that in recent years a quickly rising share of economic activity in the world seems to be taking place between people who live in different countries (rather than in the same country). This growth in cross-border economic activities takes various forms:
International Trade: A growing share of spending on goods and services is devoted to imports from other countries. And a growing share of what countries produce is sold to foreigners as exports. Among rich or developed countries the share of international trade in total output (exports plus imports of goods relative to GDP) rose from 27 to 39 percent between 1987 and 1997. For developing countries it rose from 10 to 17 percent. (The source for many of these data is the World Bank's World Development Indicators 2000.)
Foreign Direct Investment (FDI). Firms based in one country increasingly make investments to establish and run business operations in other countries. US firms invested US$133 billion abroad in 1998, while foreign firms invested US$193 billion in the US. Overall world FDI flows more than tripled between 1988 and 1998, from US$192 billion to US$610 billion, and the share of FDI to GDP is generally rising in both developed and developing countries. Developing countries received about a quarter of world FDI inflows in 1988-98 on average, though the share fluctuated quite a bit from year to year. This is now the largest form of private capital inflow to developing countries.
Capital Market Flows. In many countries (especially in the developed world) savers increasingly diversify their portfolios to include foreign financial assets (foreign bonds, equities, loans), while borrowers increasingly turn to foreign sources of funds, along with domestic ones. While flows of this kind to developing countries also rose sharply in the 1990s, they have been much more volatile than either trade or FDI flows, and have also been restricted to a narrower range of 'emerging market' countries.
Overall observations about globalization. First, it is crucial in discussing globalization to carefully distinguish between its different forms. International trade, foreign direct investment (FDI), and capital market flows raise distinct issues and have distinct consequences: potential benefits on the one hand, and costs or risks on the other, calling for different assessments and policy responses. The World Bank generally favors greater openness to trade and FDI because the evidence suggests that the payoffs for economic development and poverty reduction tend to be large relative to potential costs or risks (while also paying attention to specific policies to mitigate or alleviate these costs and risks).
It is more cautious about liberalization of other financial or capital market flows, whose high volatility can sometimes foster boom-and-bust cycles and financial crises with large economic costs, as in the emerging-market crises in East Asia and elsewhere in 1997-98. Here the emphasis needs to be more on building up supportive domestic institutions and policies that reduce the risks of financial crisis before undertaking an orderly and carefully sequenced capital account opening.
Second, the extent to which different countries participate in globalization is also far from uniform. For many of the poorest least-developed countries the problem is not that they are being impoverished by globalization, but that they are in danger of being largely excluded from it. The miniscule 0.4 percent share of these countries in world trade in 1997 was down by half from 1980. Their access to foreign private investment remains negligible. Far from condemning these countries to continued isolation and poverty, the urgent task of the international community is to help them become better integrated in the world economy, providing assistance to help them build up needed supporting institutions and policies, as well as by continuing to enhance their access to world markets.
Third, it is important to recognize that economic globalization is not a wholly new trend. Indeed, at a basic level, it has been an aspect of the human story from earliest times, as widely scattered populations gradually became involved in more extensive and complicated economic relations. In the modern era, globalization saw an earlier flowering towards the end of the 19th century, mainly among the countries that are today developed or rich. For many of these countries trade and capital market flows relative to GDP were close to or higher than in recent years. That earlier peak of globalization was reversed in the first half of the 20th century, a time of growing protectionism, in a context of bitter national and great-power strife, world wars, revolutions, rising authoritarian ideologies, and massive economic and political instability.
In the last 50 years the tide has flown towards greater globalization once more. International relations have been more tranquil (at least compared to the previous half century), supported by the creation and consolidation of the United Nations system as a means of peacefully resolving political differences between states, and of institutions like the GATT (today the WTO), which provide a framework of rules for countries to manage their commercial policies. The end of colonialism brought scores of independent new actors onto the world scene, while also removing a shameful stain associated with the earlier 19th century episode of globalization. The 1994 Uruguay Round of the GATT saw developing countries become engaged on a wide range of multilateral international trade issues for the first time.
The pace of international economic integration accelerated in the 1980s and 1990s, as governments everywhere reduced policy barriers that hampered international trade and investment. Opening to the outside world has been part of a more general shift towards greater reliance on markets and private enterprise, especially as many developing and communist countries came to see that high levels of government planning and intervention were failing to deliver the desired development outcomes.
China's sweeping economic reforms since the end of the 1970s, the peaceful dissolution of communism in the Soviet bloc at the end of the 1980s, and the taking root and steady growth of market based reforms in democratic India in the 1990s are among the most striking examples of this trend. Globalization has also been fostered by technological progress, which is reducing the costs of transportation and communications between countries. Dramatic falls in the cost of telecommunications, of processing, storing and transmitting information, make it much easier to track down and close on business opportunities around the world, to coordinate operations in far-flung locations, or to trade online services that previously were not internationally tradable at all.
Finally, given this backdrop, it may not be surprising (though it is not very helpful) that 'globalization' is sometimes used in a much broader economic sense, as another name for capitalism or the market economy. When used in this sense the concerns expressed are really about key features of the market economy, such as production by privately-owned and profit-motivated corporations, frequent reshuffling of resources according to changes in supply and demand, and unpredictable and rapid technological change. It is certainly important to analyze the strengths and weaknesses of the market economy as such, and to better understand the institutions and policies needed to make it work most effectively. And societies need to think hard about how to best manage the implications of rapid technological change. But there is little to be gained by confusing these distinct (though related) issues with economic globalization in its core sense, that is the expansion of cross-border economic ties.
Conclusion. The best way to deal with the changes being brought about by the international integration of markets for goods, services and capital is to be open and honest about them. As this series of Briefs note, globalization brings opportunities, but it also brings risks. While exploiting the opportunities for higher economic growth and better living standards that more openness brings, policymakers - international, national and local ? also face the challenge of mitigating the risks for the poor, vulnerable and marginalized, and of increasing equity and inclusion.
Even when poverty is falling overall, there can be regional or sectoral increases about which society needs to be concerned. Over the last century the forces of globalization have been among those that have contributed to a huge improvement in human welfare, including raising countless millions out of poverty. Going forward, these forces have the potential to continue bringing great benefits to the poor, but how strongly they do so will also continue to depend crucially on factors such as the quality of overall macroeconomic policies, the workings of institutions, both formal and informal, the existing structure of assets, and the available resources, among many others. In order to arrive at fair and workable approaches to these very real human needs, government must listen to the voices of all its citizens.
PART TWO
Does More International Trade Openness Increase World Poverty?
Rather than leading to economic benefits for all people, it (economic globalization) has brought the planet to the brink of environmental catastrophe, social unrest that is unprecedented, economies of most countries in shambles, an increase in poverty, hunger, landlessness, migration and social dislocation. The experiment may now be called a failure."
-Extract from the Sienna Declaration, prepared by the Board of Directors of the International Forum on Globalization (IFG), and signed by over 40 organizations in 20 countries.http://web.archive.org/web/20001202013000/http://www.twnside.org.sg/title/siena-cn.htm
There is no greater problem facing the world at the beginning of the 21st century than that of world poverty. This section first looks at what happened to world poverty over the last decade. It then asks how greater openness to trade might affect poverty by its effect on economic growth, an important (though far from unique) influence on poverty. Here the evidence suggests that more openness has a positive effect on per-capita income, and so should tend to reduce poverty. Of course openness to foreign trade is far from being the only or most important influence on economic growth, and so the temptation to overstate the importance of globalization (as both its vehement opponents and supporters tend to do) should be resisted. The next section considers how greater trade openness might affect poverty through another channel, its effect on inequality.
World poverty trends over the last decade?
Progress on poverty reduction over the last decade was troublingly slow. The number of people living on US$1 a day or less fell slightly from about 1.3 billion in 1990 to 1.2 billion in 1998. (We concentrate on the income dimension of poverty.) Because the population of developing countries rose over this period, the proportion of the population living in poverty ? the poverty rate ? fell a little more quickly, from 29 percent to 24 percent. (See Table 1.) The trends for people living on less than US$2 a day were similar: absolute numbers rose slightly from 2.7 to 2.8 billion between 1990 and 1998, while the poverty rate fell from 62 to 56 percent.
Poverty reduction performance was also extremely uneven. Poverty fell by most in East Asia, whose 1.8 billion people represent over a third of the population of developing countries. Here the poverty rate was almost halved, while the number of people earning US$1 a day or less was reduced by some 174 million, the largest and most rapid reduction in poverty in history. Though much of the reduction in poverty occurred in China, most countries in the region shared in the steep fall. Poverty rose in 1998 in the countries hit by financial crisis, but by less than had been initially feared. An unexpectedly strong rebound in growth in the region in 1999, raised hopes that poverty in East Asia would resume its historical decline.
Poverty outcomes were much less cheering in other developing regions. Total numbers under US$1 a day increased in all other regions. South Asia, which contains over a quarter of the developing world's population, did experience a modest 4 percentage point decline in poverty rates. Poverty rates were broadly flat in Latin America, Sub-Saharan Africa, and the Middle East and North Africa. Both poverty numbers and poverty rates increased sharply in the Europe and Central Asia region, in particular among the countries making a difficult transition from socialism to a market economy.
Economic Growth and Poverty Reduction
Why were there such large differences in poverty reduction around the developing world ? and what these differences have to do with globalization? Part of the answer to the first question is poverty is significantly affected by economic growth, the pace of increase in the total output of goods and services in the society. Figure 1 illustrates how the pace of poverty reduction in different developing regions in the 1990s was associated with growth. Poverty fell most in East Asia, the fastest growing region. It rose most in the Former Soviet Union, where per-capita income fell the most. A recent World Bank study of a large sample of countries estimates that on average growth in the income of the poor (defined as the bottom fifth of the population) rises about one-for-one with the growth rate of overall per-capita income in a country. (Dollar and Kraay, 2000)
Of course poverty is affected by many factors other than growth. For example, poverty may increase even where there is growth, because there is an increase in inequality. Gaining a deeper understanding of other influences on poverty, including changes in inequality, is a vital task for research. However there is no reason to think that the beneficial effect of growth on poverty reduction will be systematically offset by increases in inequality.
Figure 2 shows the lack of any systematic association between growth on the one hand and changes in inequality (measured by the Gini coefficient) on the other for a large sample of countries over several decades. The widespread fear that in poor countries growth must come at the expense of equity is not supported by the facts. The evidence also suggests that the positive link between overall growth and incomes of the poor has not changed in recent decades, when globalization was more pronounced, than in earlier ones when it was less so.
More open trade raises per capita incomes ? and the incomes of the poor
There is a growing consensus in empirical studies that greater openness to international trade has a positive effect on country per-capita income. (Figure 3. Trade openness in the figure is adjusted to remove the influence of geographical factors.) A recent study by Frankel and Romer (1999) estimates that increasing the ratio of trade to GDP by one percentage point raises per-capita income by between one-half and two percent. Numbers of other studies reach similar conclusions, though the estimated size and statistical significance of the effects vary. (See for example, Edwards (1998) or, for a more skeptical assessment, Rodrik (1999).)
These results are consistent with economic theories about the effects of international trade going back at least 200 years. The oldest and most widely agreed is that trade lets an economy make better use of its resources, by allowing imports of goods and services at a lower cost than they could be produced at home. In particular trade enables developing countries to import capital equipment and intermediate inputs that are critical to long run growth, but which would be expensive or impossible to produce domestically. From this perspective exports are the price the economy pays to get access to these valuable imports. Other possible benefits include more intense competition, which obliges local firms to operate more efficiently than under protection, and greater awareness of new foreign ideas and technologies.
What of the impact of freer trade on the incomes of the poor? As noted above, recent work suggests that higher average incomes in a country are generally associated one-for-one with higher incomes of the poor. The same work finds that this link applies to income increases caused by more trade: in other words, the impact of trade on the income of the poor is generally the same as that on per-capita incomes. Thus, for example, a 10 percent increase in the trade to GDP ratio could ultimately raise per-capita income by 5 percent (cautiously taking the lower bound of the estimates by Frankel and Romer), and one would in general also expect a 5 percent rise in the income of the poor.
But it is important to underline that there is nothing guaranteed about this outcome. Many other factors can influence both growth and poverty. Further, the success of a trade opening is itself often affected by the macroeconomic climate, the quality of institutions and other factors.
Improving the payoff from trade opening, minimizing unemployment
Trade liberalization 'works' by encouraging a shift of labor and capital from import-competing industries to expanding, newly competitive export industries. The unemployment caused by trade opening is therefore expected to be temporary, being offset by job creation in other sectors of the economy. The loss of output due to this transitional unemployment (called the social adjustment cost of trade opening) is also usually expected to be small relative to long run gains in national income due to opening. Or, put another way, these adjustment costs are expected to be small compared to the costs of continued economic stagnation and isolation without opening up.
The limited amount of existing empirical work on the employment effects of trade liberalization in developing countries broadly confirms these expectations. (See World Bank, 1997; Matusz and Tarr, 1999). Nevertheless, while adjustment costs are usually small in relative terms, they can still be a serious issue in many countries because they are often concentrated in a geographical area or in a few industries. They will also tend to be felt 'up front', while benefits will tend to be spread out over future periods. Carefully designed social-safety net and educational or retraining programs to help the most vulnerable affected groups are thus an important complement for trade reforms in many cases.
The potential costs of trade opening can also be either reduced or worsened by the overall context of policies in which reform is undertaken. High macroeconomic instability (big fiscal deficits, high and volatile inflation, volatile real exchange rates) can aggravate the unemployment costs of trade opening by fostering uncertainty, which can prevent firms from investing in the export sectors that are supposed to create new jobs.
A premature capital account liberalization in a country with large fiscal deficits can have a similar effect, by inducing large capital inflows, causing the country's exchange rate to rise, thus making its exports uncompetitive. The collapse of structural reforms in the 'Southern Cone' countries of Latin America at the end of the 1970s is partly attributed to this kind of inappropriate sequencing of reforms. Extremely stringent job security regulations may prevent firms hit by import competition from laying off workers, driving them into bankruptcy, as appears to have been the case in Peru in the 1980s.
PART THREE
Does More International Trade Openness Worsen Inequality?
"Globalization is leaving perilous instability and rising inequality in its wake...it has dramatically increased inequality between and within nations......"
-Jay Mazur, Foreign Affairs, January/February 2000
Does globalization worsen inequality within countries?
Does freer trade increase income inequality within countries, perhaps sufficiently to offset any benefits to the poor from higher overall per capita income? Figure 4 suggests that there is no simple association between changes in trade openness and changes in inequality. Certainly there are many well known cases of countries where inequality has risen as they became more integrated into the world economy. Wages of high school educated males in the U.S. fell 20 percent between the mid 1970s and mid 1990s.
Income inequality increased in countries such as Argentina, Chile, Colombia, Costa Rica and Uruguay after they liberalized trade at different times in the last three decades. China, one of the fastest integrating countries, also experienced one of the largest increases in inequality, although growth was fast enough to still massively reduce poverty.
But, as Figure 4 suggests, there are also about as many cases where inequality fell with more trade openness. (This is another way of presenting the fact noted in the discussion of trade and poverty, that in general more trade openness raises incomes of the poor as much as per capita incomes.)
It has to be said that our knowledge of what factors systematically influence income distribution is extremely limited. Nevertheless, the lack of any systematic empirical association between trade opening and changes in inequality across countries is quite consistent with standard theory. This suggests that trade opening will tend to increase demand for the factor of production that is relatively abundant in the liberalizing country, but scarce in the outside world, thereby increasing its wage. Conversely, opening will cut the wage of the factor that is relatively scarce in the country but more abundant in the world. This theory is consistent with the US experience, where the wages of skilled workers (relatively abundant in the US, more scarce elsewhere) rose relative to wages of unskilled workers (abundant in the outside world.) But it is also consistent with the experience of some East Asian countries, with relative abundance of unskilled workers, where distribution became more equal. Thus one would expect to see the lack of any pattern in Figure 4. (And of course there are many cases that fail to meet the predictions of the simple theory altogether.)
Much more importantly, trade liberalization is also not the only factor that may be expected to influence the demand for factors of production, and hence their incomes. Other potential factors include technological change, investment patterns, changes in relative productivity, or changes in institutional conditions, for example the declining importance of trade unions, or changes in the implicit contract between workers and employers. In the US, the most intensively studied country, most studies typically attribute only a small part of the fall in low-skilled wages to the influence of trade. (See for example, Burtless et al (1998) or Collins (1996), who concludes that trade and immigration together account for up to 2 percentage points of an 18 percentage-point rise in wage inequality) These studies typically conclude that technological change was a much bigger factor.
Policies to help the vulnerable deal with economic change
Though researchers differ about how far they attribute changes in demand for different groups of workers to international factors, most agree that restricting foreign trade and investment would be a very costly means of assisting affected workers. More direct forms of assistance that help workers adapt to new forms of work and acquire new skills are preferable. Facilitating this transition requires lifelong access to education, training and retraining for all workers. Safety nets based on cushioning workers during temporary periods of unemployment and a return to the same job are becoming increasingly outdated.
Instead, workers need to be empowered to adapt to constant economic change, to succeed in multiple career paths and to choose periods of self employment. The development of efficient capital markets allows individual workers to build financial assets and independence, facilitating the movement between jobs and protecting incomes in times of crisis. Similarly, portable pensions, healthcare and other services will increasingly become part of the worker protection structure. Finally, policymakers need to foster productivity growth as this is the key driving force behind rising wages. Suitable policies include investment in research and development, efficient capital markets (particularly for venture capital) and high levels of education and training.
Has globalization increased inequality between countries?
The distribution of per-capita income between countries has become more unequal in recent decades. For example, in 1960 the average per-capita GDP in the richest 20 countries in the world was 15 times that of the poorest 20. Today this gap has widened to 30 times, since rich countries have on average grown faster than poor ones. Indeed, per capita incomes in the poorest 20 countries have hardly changed since 1960, and have fallen in several. But greater openness to trade is unlikely to explain why poor countries on average grew less quickly than rich ones, since, as noted above, openness fosters higher not lower incomes. On the contrary there is some evidence (Ades and Glaeser, 1999) that greater trade openness has tended to reduce inequality between countries. Figure 5 shows that while rich countries have on average grown faster than poor ones, poor countries that are open to trade have grown slightly faster than rich ones, and a lot faster than poor, closed countries.
One can also adjust information on the distribution of income across countries to reflect differences in their population. This is important because some poor countries with very large populations (China, Indonesia) have grown very rapidly. Thus the relative standing of large groups of people in developing countries has improved even as the relative standing of many countries has declined. The distribution of income between countries adjusted for population shows little significant change over the last couple of decades, with some studies showing modest increases in inequality, and some modest decreases.
PART FOUR
Is Globalization Causing A 'Race To The Bottom' In Environmental Standards?
"By promoting economic growth without adequate environmental safeguards, trade increases the overall scale and pace of resource consumption; promotes adoption of high-consumption, high-polluting lifestyles; and prompts countries to seek international advantage by weakening, not raising, environmental protections."
-Sierra Club, Statement to USTR Committee
If globalization promotes growth, won't that mean more environmental degradation?
Some critics argue that since increased trade and foreign direct investment stimulate higher growth in developing countries, this must lead to more industrial pollution and environmental degradation. Some pollutants such as acid emissions or particulate matter are empirically observed to have an 'inverted U curve' relation with income: pollution first rises as countries advance from low to middle level incomes, before falling again as countries attain high incomes. Is pollution an inevitable price for economic development?
It should be noted in passing that this is an argument against economic growth in general, rather than against globalization specifically. Is it true, however, that growth in developing countries must necessarily be accompanied by severe environmental degradation? Recent evidence suggests a more subtle and complex relationship between economic development and environmental protection. Empirical observation of an 'inverted U' in some instances says little about the environmental policies underlying the observation, or the potential for better policies to 'flatten' or eliminate it. Thus it is striking that many developing countries have already turned or are turning the corner in the fight against pollution at much lower levels of income than the rich countries did in their day.
A recent World Bank study of organic water pollution finds that pollution intensity falls by 90 per cent as per capita income rises from $500 to $20,000, with the fastest decline occurring before the country reaches middle income status (Figure 6. Hettige, Mani and Wheeler, 1998). Average air quality in China has stabilized or improved since the mid-1980s in monitored cities, especially large ones - the same period during which China has experienced both rapid economic growth and increased openness to trade and investment.
It seems there is no hard and fast rule that a certain level of development will be associated with a certain level of pollution. Much depends on the environmental policies countries pursue. Indeed, many developing countries appear to have found that the benefits of pollution control outweigh the costs and are adopting innovative, low-cost strategies to limit pollution while also expanding economic growth. For example, new pilot projects based on public disclosure of information about factory pollution have had significant success in reducing pollution in Indonesia and the Philippines.
Moreover, openness to trade and investment can provide developing countries with both the incentive to adopt, and the access to, new technologies, which may provide a cleaner or greener way of producing the good concerned. For example, much foreign investment is for export markets. The quality requirements in those markets encourage use of the latest technology, which is typically cleaner than old technologies. A World Bank study of steel production in 50 countries found that open economies led closed economies in the adoption of cleaner technologies by wide margins, resulting in the open economies being 17 percent less pollution-intensive in this sector than closed economies (Wheeler, Huq and Martin 1993).
This discussion suggests that developing countries may be able to achieve high levels of economic growth and high levels of environmental performance long before they reach the income levels of the industrialized countries. This is not to say that there are no tradeoffs between growth and the environment. Even with good environmental policies and clean technologies, continued increases in output may tend to increase the total volumes of various kinds of pollutants in many cases. Every society has to decide for itself on the relative value it places on economic output and the environment. The point about international openness, though, is that in general it appears to make this tradeoff less painful for developing countries, allowing more environmental protection for the same amount of growth, or more growth for the same amount of environmental protection.
Will liberalization devastate sensitive environmental sectors?
A second related concern is that trade and investment liberalization in environmentally-sensitive sectors such as forestry and fishing will exacerbate existing overuse of resources. Over-use of a natural resource may occur when there is a policy regime of open access and the overall costs to society of its use are not fully reflected in the price paid by private users (for example individual fishermen do not consider the impact of their activities on global fishing stocks).
Opening the activity to international trade and investment may then exacerbate the irreversible loss of environmental resources. An important question here is that if one's concern is to protect a scarce environmental resource then why tax or regulate only international trade in the product? In the ideal case, taxing or regulating both international and domestic trade in the product without discrimination will usually be a more efficient or effective way of protecting it. Often, however, developing countries do not have the institutional capacity to put in place these more ideal, non-discriminatory environmental protection policies. In some cases, then, not opening the sector for the time being may turn out to be the only realistic 'second-best' policy, while the institutional and regulatory capacity for better quality environmental protection is built up.
Will competition for investment cause developing countries to become 'pollution havens'?
Another concern relates less to environmental outcomes and more to environmental regulation. It is argued that increased international competition for investment will cause countries to lower environmental regulations (or to retain poor ones), a "race to the bottom" in environmental standards as countries fight to attract foreign capital and keep domestic investment at home. However there is no evidence that the cost of environmental protection has ever been the determining factor in foreign investment decisions. Factors such as labor and raw material costs, transparent regulation and protection of property rights are likely to be much more important, even for polluting industries.
In East Asia in the 1970s, for example,. the fast growing "Tigers" (Korea, Taiwan (China), Singapore and Hong Kong) began to export more of certain highly polluting sectors, while Japan began to reduce its exports in these sectors. However, this trend diminished in the 1980s, and a stable pattern emerged with the Tigers importing somewhat more than they export in the highly-polluting sectors. A similar pattern occurred in trade of polluting sector products between North America and Latin America. In China the share of the five dirtiest industries in total industrial output has fallen, while imports of pollution intensive products have actually increased. (World Bank, 1997).
Countries do not become permanent pollution havens because along with increases in income come increased demands for environmental quality and a better institutional capacity to supply environmental regulation. One World Bank study of 145 countries identified a strong positive correlation between income levels and the strictness of environmental regulation (Figure 7. Dasgupta, Mody, Roy and Wheeler, 1995).
Indeed the so-called "California Effect" in the US demonstrates that there is nothing inevitable about a 'race to the bottom.' After the passage of the US 1970 Clean Air Act Amendments, California repeatedly adopted stricter emissions standards than other US states. Instead of a flight of investment and jobs from California, however, other states began adopting similar, tougher emissions standards. A self-reinforcing "race to the top" was thus put in place in which California helped lift standards throughout the US. Vogel (1995) attributes this largely to the "lure of green markets" - car manufacturers were willing to meet California's higher standards to avoid losing such a large market and once they had met the standard in one state, they could easily meet it in every state.
Openness and environment friendly policies
It seems there is no simple one-way story of globalization necessarily causing environmental damage. When combined with innovative formal and informal domestic regulation, trade and investment liberalization can instead help to raise rather than lower environmental standards. Rising incomes increase the ability and willingness of countries to protect their environments. Openness to foreign trade and investment can improve access to new, cleaner technologies and sharpen the incentives to adopt them to remain competitive. Economic openness can be combined with reforms that directly address environmental objectives, such as removing subsidies for environmentally harmful activities, creating local environmental institutions to monitor and protect sensitive sectors, and introducing innovative and cost-effective approaches to formal environmental regulation, such as tradable pollution permits and other market-based mechanisms. These formal regulations can be accompanied by informal regulatory mechanisms such as the publication of easily understood information on pollution and its impact, together with education of local communities about environmental problems.
The relationship between trade and investment liberalization and environmental standards is still a relatively new area of study. Much work needs to be done to understand the linkage between foreign investment and environmental standards. Are all multinational companies raising standards? If not, what forms of investment do raise standards? Why? What is the impact of technology transfer? Similarly, much more needs to be done to understand the strengths and weaknesses of environmental management techniques in different developing country conditions.
link
Globalization is one of the most charged issues of the day. It is everywhere in public discourse ? in TV sound bites and slogans on placards, in web-sites and learned journals, in parliaments, corporate boardrooms and labor meeting halls. Extreme opponents charge it with impoverishing the world's poor, enriching the rich and devastating the environment, while fervent supporters see it as a high-speed elevator to universal peace and prosperity. What is one to think?
Amazingly for so widely used a term, there does not appear to be any precise, widely-agreed definition. Indeed the breadth of meanings attached to it seems to be increasing rather than narrowing over time, taking on cultural, political and other connotations in addition to the economic. However, the most common or core sense of economic globalization ? the aspect this paper concentrates on - surely refers to the observation that in recent years a quickly rising share of economic activity in the world seems to be taking place between people who live in different countries (rather than in the same country). This growth in cross-border economic activities takes various forms:
International Trade: A growing share of spending on goods and services is devoted to imports from other countries. And a growing share of what countries produce is sold to foreigners as exports. Among rich or developed countries the share of international trade in total output (exports plus imports of goods relative to GDP) rose from 27 to 39 percent between 1987 and 1997. For developing countries it rose from 10 to 17 percent. (The source for many of these data is the World Bank's World Development Indicators 2000.)
Foreign Direct Investment (FDI). Firms based in one country increasingly make investments to establish and run business operations in other countries. US firms invested US$133 billion abroad in 1998, while foreign firms invested US$193 billion in the US. Overall world FDI flows more than tripled between 1988 and 1998, from US$192 billion to US$610 billion, and the share of FDI to GDP is generally rising in both developed and developing countries. Developing countries received about a quarter of world FDI inflows in 1988-98 on average, though the share fluctuated quite a bit from year to year. This is now the largest form of private capital inflow to developing countries.
Capital Market Flows. In many countries (especially in the developed world) savers increasingly diversify their portfolios to include foreign financial assets (foreign bonds, equities, loans), while borrowers increasingly turn to foreign sources of funds, along with domestic ones. While flows of this kind to developing countries also rose sharply in the 1990s, they have been much more volatile than either trade or FDI flows, and have also been restricted to a narrower range of 'emerging market' countries.
Overall observations about globalization. First, it is crucial in discussing globalization to carefully distinguish between its different forms. International trade, foreign direct investment (FDI), and capital market flows raise distinct issues and have distinct consequences: potential benefits on the one hand, and costs or risks on the other, calling for different assessments and policy responses. The World Bank generally favors greater openness to trade and FDI because the evidence suggests that the payoffs for economic development and poverty reduction tend to be large relative to potential costs or risks (while also paying attention to specific policies to mitigate or alleviate these costs and risks).
It is more cautious about liberalization of other financial or capital market flows, whose high volatility can sometimes foster boom-and-bust cycles and financial crises with large economic costs, as in the emerging-market crises in East Asia and elsewhere in 1997-98. Here the emphasis needs to be more on building up supportive domestic institutions and policies that reduce the risks of financial crisis before undertaking an orderly and carefully sequenced capital account opening.
Second, the extent to which different countries participate in globalization is also far from uniform. For many of the poorest least-developed countries the problem is not that they are being impoverished by globalization, but that they are in danger of being largely excluded from it. The miniscule 0.4 percent share of these countries in world trade in 1997 was down by half from 1980. Their access to foreign private investment remains negligible. Far from condemning these countries to continued isolation and poverty, the urgent task of the international community is to help them become better integrated in the world economy, providing assistance to help them build up needed supporting institutions and policies, as well as by continuing to enhance their access to world markets.
Third, it is important to recognize that economic globalization is not a wholly new trend. Indeed, at a basic level, it has been an aspect of the human story from earliest times, as widely scattered populations gradually became involved in more extensive and complicated economic relations. In the modern era, globalization saw an earlier flowering towards the end of the 19th century, mainly among the countries that are today developed or rich. For many of these countries trade and capital market flows relative to GDP were close to or higher than in recent years. That earlier peak of globalization was reversed in the first half of the 20th century, a time of growing protectionism, in a context of bitter national and great-power strife, world wars, revolutions, rising authoritarian ideologies, and massive economic and political instability.
In the last 50 years the tide has flown towards greater globalization once more. International relations have been more tranquil (at least compared to the previous half century), supported by the creation and consolidation of the United Nations system as a means of peacefully resolving political differences between states, and of institutions like the GATT (today the WTO), which provide a framework of rules for countries to manage their commercial policies. The end of colonialism brought scores of independent new actors onto the world scene, while also removing a shameful stain associated with the earlier 19th century episode of globalization. The 1994 Uruguay Round of the GATT saw developing countries become engaged on a wide range of multilateral international trade issues for the first time.
The pace of international economic integration accelerated in the 1980s and 1990s, as governments everywhere reduced policy barriers that hampered international trade and investment. Opening to the outside world has been part of a more general shift towards greater reliance on markets and private enterprise, especially as many developing and communist countries came to see that high levels of government planning and intervention were failing to deliver the desired development outcomes.
China's sweeping economic reforms since the end of the 1970s, the peaceful dissolution of communism in the Soviet bloc at the end of the 1980s, and the taking root and steady growth of market based reforms in democratic India in the 1990s are among the most striking examples of this trend. Globalization has also been fostered by technological progress, which is reducing the costs of transportation and communications between countries. Dramatic falls in the cost of telecommunications, of processing, storing and transmitting information, make it much easier to track down and close on business opportunities around the world, to coordinate operations in far-flung locations, or to trade online services that previously were not internationally tradable at all.
Finally, given this backdrop, it may not be surprising (though it is not very helpful) that 'globalization' is sometimes used in a much broader economic sense, as another name for capitalism or the market economy. When used in this sense the concerns expressed are really about key features of the market economy, such as production by privately-owned and profit-motivated corporations, frequent reshuffling of resources according to changes in supply and demand, and unpredictable and rapid technological change. It is certainly important to analyze the strengths and weaknesses of the market economy as such, and to better understand the institutions and policies needed to make it work most effectively. And societies need to think hard about how to best manage the implications of rapid technological change. But there is little to be gained by confusing these distinct (though related) issues with economic globalization in its core sense, that is the expansion of cross-border economic ties.
Conclusion. The best way to deal with the changes being brought about by the international integration of markets for goods, services and capital is to be open and honest about them. As this series of Briefs note, globalization brings opportunities, but it also brings risks. While exploiting the opportunities for higher economic growth and better living standards that more openness brings, policymakers - international, national and local ? also face the challenge of mitigating the risks for the poor, vulnerable and marginalized, and of increasing equity and inclusion.
Even when poverty is falling overall, there can be regional or sectoral increases about which society needs to be concerned. Over the last century the forces of globalization have been among those that have contributed to a huge improvement in human welfare, including raising countless millions out of poverty. Going forward, these forces have the potential to continue bringing great benefits to the poor, but how strongly they do so will also continue to depend crucially on factors such as the quality of overall macroeconomic policies, the workings of institutions, both formal and informal, the existing structure of assets, and the available resources, among many others. In order to arrive at fair and workable approaches to these very real human needs, government must listen to the voices of all its citizens.
PART TWO
Does More International Trade Openness Increase World Poverty?
Rather than leading to economic benefits for all people, it (economic globalization) has brought the planet to the brink of environmental catastrophe, social unrest that is unprecedented, economies of most countries in shambles, an increase in poverty, hunger, landlessness, migration and social dislocation. The experiment may now be called a failure."
-Extract from the Sienna Declaration, prepared by the Board of Directors of the International Forum on Globalization (IFG), and signed by over 40 organizations in 20 countries.http://web.archive.org/web/20001202013000/http://www.twnside.org.sg/title/siena-cn.htm
There is no greater problem facing the world at the beginning of the 21st century than that of world poverty. This section first looks at what happened to world poverty over the last decade. It then asks how greater openness to trade might affect poverty by its effect on economic growth, an important (though far from unique) influence on poverty. Here the evidence suggests that more openness has a positive effect on per-capita income, and so should tend to reduce poverty. Of course openness to foreign trade is far from being the only or most important influence on economic growth, and so the temptation to overstate the importance of globalization (as both its vehement opponents and supporters tend to do) should be resisted. The next section considers how greater trade openness might affect poverty through another channel, its effect on inequality.
World poverty trends over the last decade?
Progress on poverty reduction over the last decade was troublingly slow. The number of people living on US$1 a day or less fell slightly from about 1.3 billion in 1990 to 1.2 billion in 1998. (We concentrate on the income dimension of poverty.) Because the population of developing countries rose over this period, the proportion of the population living in poverty ? the poverty rate ? fell a little more quickly, from 29 percent to 24 percent. (See Table 1.) The trends for people living on less than US$2 a day were similar: absolute numbers rose slightly from 2.7 to 2.8 billion between 1990 and 1998, while the poverty rate fell from 62 to 56 percent.
Poverty reduction performance was also extremely uneven. Poverty fell by most in East Asia, whose 1.8 billion people represent over a third of the population of developing countries. Here the poverty rate was almost halved, while the number of people earning US$1 a day or less was reduced by some 174 million, the largest and most rapid reduction in poverty in history. Though much of the reduction in poverty occurred in China, most countries in the region shared in the steep fall. Poverty rose in 1998 in the countries hit by financial crisis, but by less than had been initially feared. An unexpectedly strong rebound in growth in the region in 1999, raised hopes that poverty in East Asia would resume its historical decline.
Poverty outcomes were much less cheering in other developing regions. Total numbers under US$1 a day increased in all other regions. South Asia, which contains over a quarter of the developing world's population, did experience a modest 4 percentage point decline in poverty rates. Poverty rates were broadly flat in Latin America, Sub-Saharan Africa, and the Middle East and North Africa. Both poverty numbers and poverty rates increased sharply in the Europe and Central Asia region, in particular among the countries making a difficult transition from socialism to a market economy.
Economic Growth and Poverty Reduction
Why were there such large differences in poverty reduction around the developing world ? and what these differences have to do with globalization? Part of the answer to the first question is poverty is significantly affected by economic growth, the pace of increase in the total output of goods and services in the society. Figure 1 illustrates how the pace of poverty reduction in different developing regions in the 1990s was associated with growth. Poverty fell most in East Asia, the fastest growing region. It rose most in the Former Soviet Union, where per-capita income fell the most. A recent World Bank study of a large sample of countries estimates that on average growth in the income of the poor (defined as the bottom fifth of the population) rises about one-for-one with the growth rate of overall per-capita income in a country. (Dollar and Kraay, 2000)
Of course poverty is affected by many factors other than growth. For example, poverty may increase even where there is growth, because there is an increase in inequality. Gaining a deeper understanding of other influences on poverty, including changes in inequality, is a vital task for research. However there is no reason to think that the beneficial effect of growth on poverty reduction will be systematically offset by increases in inequality.
Figure 2 shows the lack of any systematic association between growth on the one hand and changes in inequality (measured by the Gini coefficient) on the other for a large sample of countries over several decades. The widespread fear that in poor countries growth must come at the expense of equity is not supported by the facts. The evidence also suggests that the positive link between overall growth and incomes of the poor has not changed in recent decades, when globalization was more pronounced, than in earlier ones when it was less so.
More open trade raises per capita incomes ? and the incomes of the poor
There is a growing consensus in empirical studies that greater openness to international trade has a positive effect on country per-capita income. (Figure 3. Trade openness in the figure is adjusted to remove the influence of geographical factors.) A recent study by Frankel and Romer (1999) estimates that increasing the ratio of trade to GDP by one percentage point raises per-capita income by between one-half and two percent. Numbers of other studies reach similar conclusions, though the estimated size and statistical significance of the effects vary. (See for example, Edwards (1998) or, for a more skeptical assessment, Rodrik (1999).)
These results are consistent with economic theories about the effects of international trade going back at least 200 years. The oldest and most widely agreed is that trade lets an economy make better use of its resources, by allowing imports of goods and services at a lower cost than they could be produced at home. In particular trade enables developing countries to import capital equipment and intermediate inputs that are critical to long run growth, but which would be expensive or impossible to produce domestically. From this perspective exports are the price the economy pays to get access to these valuable imports. Other possible benefits include more intense competition, which obliges local firms to operate more efficiently than under protection, and greater awareness of new foreign ideas and technologies.
What of the impact of freer trade on the incomes of the poor? As noted above, recent work suggests that higher average incomes in a country are generally associated one-for-one with higher incomes of the poor. The same work finds that this link applies to income increases caused by more trade: in other words, the impact of trade on the income of the poor is generally the same as that on per-capita incomes. Thus, for example, a 10 percent increase in the trade to GDP ratio could ultimately raise per-capita income by 5 percent (cautiously taking the lower bound of the estimates by Frankel and Romer), and one would in general also expect a 5 percent rise in the income of the poor.
But it is important to underline that there is nothing guaranteed about this outcome. Many other factors can influence both growth and poverty. Further, the success of a trade opening is itself often affected by the macroeconomic climate, the quality of institutions and other factors.
Improving the payoff from trade opening, minimizing unemployment
Trade liberalization 'works' by encouraging a shift of labor and capital from import-competing industries to expanding, newly competitive export industries. The unemployment caused by trade opening is therefore expected to be temporary, being offset by job creation in other sectors of the economy. The loss of output due to this transitional unemployment (called the social adjustment cost of trade opening) is also usually expected to be small relative to long run gains in national income due to opening. Or, put another way, these adjustment costs are expected to be small compared to the costs of continued economic stagnation and isolation without opening up.
The limited amount of existing empirical work on the employment effects of trade liberalization in developing countries broadly confirms these expectations. (See World Bank, 1997; Matusz and Tarr, 1999). Nevertheless, while adjustment costs are usually small in relative terms, they can still be a serious issue in many countries because they are often concentrated in a geographical area or in a few industries. They will also tend to be felt 'up front', while benefits will tend to be spread out over future periods. Carefully designed social-safety net and educational or retraining programs to help the most vulnerable affected groups are thus an important complement for trade reforms in many cases.
The potential costs of trade opening can also be either reduced or worsened by the overall context of policies in which reform is undertaken. High macroeconomic instability (big fiscal deficits, high and volatile inflation, volatile real exchange rates) can aggravate the unemployment costs of trade opening by fostering uncertainty, which can prevent firms from investing in the export sectors that are supposed to create new jobs.
A premature capital account liberalization in a country with large fiscal deficits can have a similar effect, by inducing large capital inflows, causing the country's exchange rate to rise, thus making its exports uncompetitive. The collapse of structural reforms in the 'Southern Cone' countries of Latin America at the end of the 1970s is partly attributed to this kind of inappropriate sequencing of reforms. Extremely stringent job security regulations may prevent firms hit by import competition from laying off workers, driving them into bankruptcy, as appears to have been the case in Peru in the 1980s.
PART THREE
Does More International Trade Openness Worsen Inequality?
"Globalization is leaving perilous instability and rising inequality in its wake...it has dramatically increased inequality between and within nations......"
-Jay Mazur, Foreign Affairs, January/February 2000
Does globalization worsen inequality within countries?
Does freer trade increase income inequality within countries, perhaps sufficiently to offset any benefits to the poor from higher overall per capita income? Figure 4 suggests that there is no simple association between changes in trade openness and changes in inequality. Certainly there are many well known cases of countries where inequality has risen as they became more integrated into the world economy. Wages of high school educated males in the U.S. fell 20 percent between the mid 1970s and mid 1990s.
Income inequality increased in countries such as Argentina, Chile, Colombia, Costa Rica and Uruguay after they liberalized trade at different times in the last three decades. China, one of the fastest integrating countries, also experienced one of the largest increases in inequality, although growth was fast enough to still massively reduce poverty.
But, as Figure 4 suggests, there are also about as many cases where inequality fell with more trade openness. (This is another way of presenting the fact noted in the discussion of trade and poverty, that in general more trade openness raises incomes of the poor as much as per capita incomes.)
It has to be said that our knowledge of what factors systematically influence income distribution is extremely limited. Nevertheless, the lack of any systematic empirical association between trade opening and changes in inequality across countries is quite consistent with standard theory. This suggests that trade opening will tend to increase demand for the factor of production that is relatively abundant in the liberalizing country, but scarce in the outside world, thereby increasing its wage. Conversely, opening will cut the wage of the factor that is relatively scarce in the country but more abundant in the world. This theory is consistent with the US experience, where the wages of skilled workers (relatively abundant in the US, more scarce elsewhere) rose relative to wages of unskilled workers (abundant in the outside world.) But it is also consistent with the experience of some East Asian countries, with relative abundance of unskilled workers, where distribution became more equal. Thus one would expect to see the lack of any pattern in Figure 4. (And of course there are many cases that fail to meet the predictions of the simple theory altogether.)
Much more importantly, trade liberalization is also not the only factor that may be expected to influence the demand for factors of production, and hence their incomes. Other potential factors include technological change, investment patterns, changes in relative productivity, or changes in institutional conditions, for example the declining importance of trade unions, or changes in the implicit contract between workers and employers. In the US, the most intensively studied country, most studies typically attribute only a small part of the fall in low-skilled wages to the influence of trade. (See for example, Burtless et al (1998) or Collins (1996), who concludes that trade and immigration together account for up to 2 percentage points of an 18 percentage-point rise in wage inequality) These studies typically conclude that technological change was a much bigger factor.
Policies to help the vulnerable deal with economic change
Though researchers differ about how far they attribute changes in demand for different groups of workers to international factors, most agree that restricting foreign trade and investment would be a very costly means of assisting affected workers. More direct forms of assistance that help workers adapt to new forms of work and acquire new skills are preferable. Facilitating this transition requires lifelong access to education, training and retraining for all workers. Safety nets based on cushioning workers during temporary periods of unemployment and a return to the same job are becoming increasingly outdated.
Instead, workers need to be empowered to adapt to constant economic change, to succeed in multiple career paths and to choose periods of self employment. The development of efficient capital markets allows individual workers to build financial assets and independence, facilitating the movement between jobs and protecting incomes in times of crisis. Similarly, portable pensions, healthcare and other services will increasingly become part of the worker protection structure. Finally, policymakers need to foster productivity growth as this is the key driving force behind rising wages. Suitable policies include investment in research and development, efficient capital markets (particularly for venture capital) and high levels of education and training.
Has globalization increased inequality between countries?
The distribution of per-capita income between countries has become more unequal in recent decades. For example, in 1960 the average per-capita GDP in the richest 20 countries in the world was 15 times that of the poorest 20. Today this gap has widened to 30 times, since rich countries have on average grown faster than poor ones. Indeed, per capita incomes in the poorest 20 countries have hardly changed since 1960, and have fallen in several. But greater openness to trade is unlikely to explain why poor countries on average grew less quickly than rich ones, since, as noted above, openness fosters higher not lower incomes. On the contrary there is some evidence (Ades and Glaeser, 1999) that greater trade openness has tended to reduce inequality between countries. Figure 5 shows that while rich countries have on average grown faster than poor ones, poor countries that are open to trade have grown slightly faster than rich ones, and a lot faster than poor, closed countries.
One can also adjust information on the distribution of income across countries to reflect differences in their population. This is important because some poor countries with very large populations (China, Indonesia) have grown very rapidly. Thus the relative standing of large groups of people in developing countries has improved even as the relative standing of many countries has declined. The distribution of income between countries adjusted for population shows little significant change over the last couple of decades, with some studies showing modest increases in inequality, and some modest decreases.
PART FOUR
Is Globalization Causing A 'Race To The Bottom' In Environmental Standards?
"By promoting economic growth without adequate environmental safeguards, trade increases the overall scale and pace of resource consumption; promotes adoption of high-consumption, high-polluting lifestyles; and prompts countries to seek international advantage by weakening, not raising, environmental protections."
-Sierra Club, Statement to USTR Committee
If globalization promotes growth, won't that mean more environmental degradation?
Some critics argue that since increased trade and foreign direct investment stimulate higher growth in developing countries, this must lead to more industrial pollution and environmental degradation. Some pollutants such as acid emissions or particulate matter are empirically observed to have an 'inverted U curve' relation with income: pollution first rises as countries advance from low to middle level incomes, before falling again as countries attain high incomes. Is pollution an inevitable price for economic development?
It should be noted in passing that this is an argument against economic growth in general, rather than against globalization specifically. Is it true, however, that growth in developing countries must necessarily be accompanied by severe environmental degradation? Recent evidence suggests a more subtle and complex relationship between economic development and environmental protection. Empirical observation of an 'inverted U' in some instances says little about the environmental policies underlying the observation, or the potential for better policies to 'flatten' or eliminate it. Thus it is striking that many developing countries have already turned or are turning the corner in the fight against pollution at much lower levels of income than the rich countries did in their day.
A recent World Bank study of organic water pollution finds that pollution intensity falls by 90 per cent as per capita income rises from $500 to $20,000, with the fastest decline occurring before the country reaches middle income status (Figure 6. Hettige, Mani and Wheeler, 1998). Average air quality in China has stabilized or improved since the mid-1980s in monitored cities, especially large ones - the same period during which China has experienced both rapid economic growth and increased openness to trade and investment.
It seems there is no hard and fast rule that a certain level of development will be associated with a certain level of pollution. Much depends on the environmental policies countries pursue. Indeed, many developing countries appear to have found that the benefits of pollution control outweigh the costs and are adopting innovative, low-cost strategies to limit pollution while also expanding economic growth. For example, new pilot projects based on public disclosure of information about factory pollution have had significant success in reducing pollution in Indonesia and the Philippines.
Moreover, openness to trade and investment can provide developing countries with both the incentive to adopt, and the access to, new technologies, which may provide a cleaner or greener way of producing the good concerned. For example, much foreign investment is for export markets. The quality requirements in those markets encourage use of the latest technology, which is typically cleaner than old technologies. A World Bank study of steel production in 50 countries found that open economies led closed economies in the adoption of cleaner technologies by wide margins, resulting in the open economies being 17 percent less pollution-intensive in this sector than closed economies (Wheeler, Huq and Martin 1993).
This discussion suggests that developing countries may be able to achieve high levels of economic growth and high levels of environmental performance long before they reach the income levels of the industrialized countries. This is not to say that there are no tradeoffs between growth and the environment. Even with good environmental policies and clean technologies, continued increases in output may tend to increase the total volumes of various kinds of pollutants in many cases. Every society has to decide for itself on the relative value it places on economic output and the environment. The point about international openness, though, is that in general it appears to make this tradeoff less painful for developing countries, allowing more environmental protection for the same amount of growth, or more growth for the same amount of environmental protection.
Will liberalization devastate sensitive environmental sectors?
A second related concern is that trade and investment liberalization in environmentally-sensitive sectors such as forestry and fishing will exacerbate existing overuse of resources. Over-use of a natural resource may occur when there is a policy regime of open access and the overall costs to society of its use are not fully reflected in the price paid by private users (for example individual fishermen do not consider the impact of their activities on global fishing stocks).
Opening the activity to international trade and investment may then exacerbate the irreversible loss of environmental resources. An important question here is that if one's concern is to protect a scarce environmental resource then why tax or regulate only international trade in the product? In the ideal case, taxing or regulating both international and domestic trade in the product without discrimination will usually be a more efficient or effective way of protecting it. Often, however, developing countries do not have the institutional capacity to put in place these more ideal, non-discriminatory environmental protection policies. In some cases, then, not opening the sector for the time being may turn out to be the only realistic 'second-best' policy, while the institutional and regulatory capacity for better quality environmental protection is built up.
Will competition for investment cause developing countries to become 'pollution havens'?
Another concern relates less to environmental outcomes and more to environmental regulation. It is argued that increased international competition for investment will cause countries to lower environmental regulations (or to retain poor ones), a "race to the bottom" in environmental standards as countries fight to attract foreign capital and keep domestic investment at home. However there is no evidence that the cost of environmental protection has ever been the determining factor in foreign investment decisions. Factors such as labor and raw material costs, transparent regulation and protection of property rights are likely to be much more important, even for polluting industries.
In East Asia in the 1970s, for example,. the fast growing "Tigers" (Korea, Taiwan (China), Singapore and Hong Kong) began to export more of certain highly polluting sectors, while Japan began to reduce its exports in these sectors. However, this trend diminished in the 1980s, and a stable pattern emerged with the Tigers importing somewhat more than they export in the highly-polluting sectors. A similar pattern occurred in trade of polluting sector products between North America and Latin America. In China the share of the five dirtiest industries in total industrial output has fallen, while imports of pollution intensive products have actually increased. (World Bank, 1997).
Countries do not become permanent pollution havens because along with increases in income come increased demands for environmental quality and a better institutional capacity to supply environmental regulation. One World Bank study of 145 countries identified a strong positive correlation between income levels and the strictness of environmental regulation (Figure 7. Dasgupta, Mody, Roy and Wheeler, 1995).
Indeed the so-called "California Effect" in the US demonstrates that there is nothing inevitable about a 'race to the bottom.' After the passage of the US 1970 Clean Air Act Amendments, California repeatedly adopted stricter emissions standards than other US states. Instead of a flight of investment and jobs from California, however, other states began adopting similar, tougher emissions standards. A self-reinforcing "race to the top" was thus put in place in which California helped lift standards throughout the US. Vogel (1995) attributes this largely to the "lure of green markets" - car manufacturers were willing to meet California's higher standards to avoid losing such a large market and once they had met the standard in one state, they could easily meet it in every state.
Openness and environment friendly policies
It seems there is no simple one-way story of globalization necessarily causing environmental damage. When combined with innovative formal and informal domestic regulation, trade and investment liberalization can instead help to raise rather than lower environmental standards. Rising incomes increase the ability and willingness of countries to protect their environments. Openness to foreign trade and investment can improve access to new, cleaner technologies and sharpen the incentives to adopt them to remain competitive. Economic openness can be combined with reforms that directly address environmental objectives, such as removing subsidies for environmentally harmful activities, creating local environmental institutions to monitor and protect sensitive sectors, and introducing innovative and cost-effective approaches to formal environmental regulation, such as tradable pollution permits and other market-based mechanisms. These formal regulations can be accompanied by informal regulatory mechanisms such as the publication of easily understood information on pollution and its impact, together with education of local communities about environmental problems.
The relationship between trade and investment liberalization and environmental standards is still a relatively new area of study. Much work needs to be done to understand the linkage between foreign investment and environmental standards. Are all multinational companies raising standards? If not, what forms of investment do raise standards? Why? What is the impact of technology transfer? Similarly, much more needs to be done to understand the strengths and weaknesses of environmental management techniques in different developing country conditions.
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