Dani Rodrik's weblog

Saving globalization from its cheerleaders

A few months ago I published an oped in the Financial Times arguing that in order to sustain globalization we need to change the way we go about negotiating international agreements. I emphasized that the binding constraint on globalization is the narrowing of policy space for countries, not inadequate market opening.

Here is a longer paper which makes the case in fuller form. An excerpt from the introduction

In this paper I present a forward-looking evaluation of globalization. I accept as my premise that globalization, in some appropriate form, is a major engine of economic growth .... But I will argue that several paradoxical features require us that we rethink its rules. First, ... globalizations’ chief beneficiaries are not necessarily those with the most open economic policies. Second, globalization has come with frequent financial crises and considerable amounts of instability, which are both costly and in principle avoidable. And third globalization remains unpopular among large segments of the people it is supposed to benefit (especially in rich countries).

It is not that these features have gone unnoticed in the recurrent debate on globalization. In fact, we can talk of a new conventional wisdom that has begun to emerge within multilateral institutions and among Northern academics. This new orthodoxy emphasizes that reaping the benefits of trade and financial globalization requires better domestic institutions, essentially improved safety nets in rich countries and improved governance in the poor countries. With these institutions in place (or in construction), it remains safe and appropriate to pursue a strategy of “more of the same, but better:” continue to open markets in trade and finance, while strengthening institutions. Enhanced trade adjustment assistance (and perhaps more progressive taxation) in the advanced countries, the Doha trade agenda, IMF surveillance over exchange rate policies, the World Bank’s governance agenda, “aid-for-trade, and international financial codes and standards are some of the visible markers of this approach.

This strategy is predicated on the presumption that insufficiently open markets continue to pose an important constraint on the world economy. Its proponents’ concerns therefore center on the question: what institutional reforms are needed at home and internationally to render further market opening politically acceptable and sustainable?

But is this presumption really valid? I shall argue here that lack of openness is (no longer) the binding constraint for the global economy. I will provide a range of evidence on trade and capital flows that indicates the obstacles faced by developing countries do not originate from inadequate access to markets abroad or to foreign capital. The gains to be reaped by further liberalization of markets are meager for poor and rich countries alike.

This leads me to an alternative approach to globalization, one that focuses on enhancing policy space rather than market access. Such a strategy would focus on devising the rules of the game to better manage the interface between national regulatory and social regimes. A good argument can be made that it is lack of policy space—and not lack of market access—which is (or likely to become soon) the real binding constraint on a prosperous global economy. This argument can be buttressed both by current evidence from rich and poor countries, and by reference to historical experience with the previous wave of globalization.

But what do we mean by policy space and can we really create it without running into the slippery slope of creeping protectionism? By the end of the paper, I hope I will have given the reader some reason to believe that an alternative conception of globalization—one that is more likely to maintain an enabling global environment than the path we are on currently—is worth thinking about and potentially workable.

Comments are welcome and appreciated.

UPDATE: Thank you all for the comments, and paine, Steveb, and Andrew in particular for the corrections.

Monkeys, trees, and the product jungle

Here is a picture of the kind you do not see very often in economics:

What it shows is the pattern of specialization of different parts of the world, and how different commodities are related to each other in product space according to a particular metric of proximity.

The work in question is a collaboration between my friend and colleague Ricardo Hausmann and the well-known physicist Albert-Laszlo Barabasi, along with two graduate students (Cesar Hidalgo and Bailey Klinger), and has just been published in Science magazine. You can download it here.

How does this framework help us think about development and specialization? As Ricardo would say, think of the product space as a forest, goods as trees, and entrepreneurs as monkeys. Countries develop as monkeys jump from tree to tree. Trees further away are harder to jump to. Some parts of the forest are denser than others. What trees you have monkeys on today determines where your monkeys will be tomorrow. And it goes from there.

No Cecily, do not omit the chapter on the rupee

In the "importance of Being Earnest" by Oscar Wilde, Miss Prism assigns her ward Cecily a book on Political Economy, but advises her that she may omit the chapter on the rupee, which Miss Prism finds "somewhat too sensational." In his latest column, Arvind Subramanian tells us it would be a mistake if we did the same today. For the recent travails of the Indian currency present a wonderful illustration of how democracy can generate the correct policy outcomes. 

Economic outcomes in pluralist societies arise from the interaction of different interest groups and institutions. Take the actors in this saga of the rupee each with distinct but legitimate objectives: the RBI, which is concerned with preserving monetary autonomy; the Commerce Ministry, which has to be mindful of the interests of exporters; the Finance Ministry, which is keen to promote financial efficiency and integration but is also acutely sensitive to safeguarding the public finances; and finally, the Economic Advisory Council to the Prime Minister, which presumably takes a broader view, aggregating and weighting the interests of each of these actors.

How did the process play itself out? The saga unfolds in three acts.

In act one, we had the RBI that, partly out of policy decisions to liberalise the capital account, especially for external commercial borrowings (ECBs), found itself in the unenviable situation of struggling to preserve monetary autonomy; the autonomy it needed to combat what seemed then (around April) like incipient but potentially damaging inflationary pressures. It responded by letting the exchange rate go, and the rupee quickly appreciated by about 10 per cent.

The consequences were predictable and predicted. The resulting appreciation led to a clamour for help from exporters. A spate of studies also started to suggest that the Indian growth machine would slow down because of the appreciation. So, in act two, the Commerce Ministry, announced a package of financial assistance—comprising duty drawbacks and cheap credit—amounting to Rs 1,400 crore.

While the budgetary consequences of this package are not immediately large or fiscally fatal (less than 0.1 per cent of GDP), it must nevertheless have been discomforting to the finance ministry—especially if the package were to set a precedent for future episodes of appreciation—which is justifiably keen to reassure a sceptical world that its stated fiscal targets will be met. The finance ministry has probably also come to recognise the tension between its objectives of furthering financial integration and maintaining fiscal prudence: increased capital inflows inevitably entail additional fiscal costs either in the form of sterilisation (to prevent appreciation) or explicit assistance to exporters (to address appreciation). Thus, in act three, the EAC recommended that the government should clamp down on ECBs, thereby trying to head off some of the future pressures for rupee appreciation.

The EAC’s intervention has been especially noteworthy as a contrast to the recent Mistry Report, which made a strong ideological case, with little empirical substantiation, for faster capital account convertibility. The EAC’s advice, on the other hand, seems to have been sensitive to the experience of the last few months, demonstrating the system’s capacity for learning by doing and, indeed, learning from over-doing.

Exemplary indeed. Something for central banks and treasuries elsewhere to ponder upon, and for all those democracy pessimists in the blogosphere to take note.

Why publish in a journal if you can disseminate online?

A new paper by Glenn Ellison documents something that I have suspected for some time. Economists in top departments are publishing less in top field journals. In addition, economists at Harvard's department of economics--which Ellison and many other consider to be the top department in the country at the moment--are publishing fewer papers in the top general interest journals. (The Quarterly Journal of Economics, which is sort of a house journal at Harvard, seems to be the exception.) The explanation?

Several pieces of evidence bolster the view that one factor contributing to these trends is that the role of journals in disseminating research has been reduced. One is that the citation benefit to publishing in a top general-interest journal now appears to be fairly small for top-department authors. Another is that Harvard authors appear to be quite successful in garnering citations to papers that are not published in top journals. The fact that the publication declines appear to be a top-department phenomenon (as opposed to a prolific-author phenomenon) suggests that a top-department affiliation may be an important determinant of an author’s ability to sidestep the traditional journal system.

This concerns me as an editor of REStat, but it is fairly consistent with my own experience.

If it is July, it must be time to think about teaching...

This is no joke. Most people think academics get to take the summer off to vacation as they please. Even some of the better informed think the summer is just for research--with students and teaching as far from the mind as possible. The fiction is also reflected in academic salaries, which are paid for nine months of work. In principle, we do not get paid over the summer since we are not supposed to be doing any work for our institutions.

If it were only so! It is hot as hell in Turkey (yes, I can at least get away from Cambridge during the summer months...) and I am busy preparing my course syllabus for the Fall. We have to turn in our course reserve lists in early August, and if you are revising your course in any way--as I am--this means getting busy right about now.

This gives me occasion to meditate about the nature of teaching economics in a public policy school.

There is a standard mold for teaching economics to undergraduates and to doctoral students. Look at syllabi for courses in international trade in leading universities, and you will see very few differences. That is because there are some standard textbooks to follow, and because (at the doctoral level) there is a clear academic literature that has to be taught.

But how do you teach international trade and trade policy to a group of students who will be policy makers and professionals in the real world--who are too sophisticated and well informed to treat as undergraduates, but for whom the typical doctoral course is useless because it covers the research frontier and not the tools for thinking about policy? 

This is a tough one, and even though I have thought about it for quite some time and experimented with different models over the years, it is a question that still baffles me. The international trade course that I teach is targeted at second-year MPAIDs, who have excellent training in microeconomic theory and econometrics. Somewhat paradoxically, this makes the challenge even greater. With a less well-prepared group, you can resort to the usual excuse: well, these students don't have much background in economics, so I have no choice to teach an essentially undergraduate course, with a few policy anecdotes thrown in. But the students who take my course have invested in heavy duty economics for a whole year (see here for their curriculum) and now deserve better. My hope is to train them beyond simply being able to understand what is in the WSJ, FT, or The Economist. They need to be able to evaluate critically what is in the policy-relevant academic literature and think creatively about policy options in light of that literature.

This is a lot more difficult than it may appear. The last few times I have tried to do this, I found myself teaching too much of a conventional doctoral economics type course--with lots of theory and so on. Students (rightly) complained that we did not have enough time left to get to discuss policy issues.

So this time around I am trying something different. I am organizing the syllabus around policy issues rather than the standard topic headings. So, rather than have a section in the syllabus on "theories of comparative advantage," the relevant headings become "why do countries trade what they do," and "does it matter?" Globalization strategies, China, WTO, and regional trade agreements get their own sections. (See here for the syllabus as it stands at present--minus the readings.)

You might say, what's the big deal? Well, the challenge is to teach an issues-oriented course while avoiding superficiality and still remaining rigorous and strongly grounded in the literature. I do not know if I will pull it off. Check back at the end of the Fall term.

And if you have any suggestions about additional topics for the course, do let me know. (But bear in mind that my colleague Federico Sturzenegger teaches a continuation of this course in the Spring, covering financial globalization.)

More good sense from Martin Wolf

Martin Wolf reviews two books that are sympathetic to trade protection, and he breaks rank with trade fundamentalists:

South Korea and Taiwan were exceptional cases. The argument that success will follow the overthrow of the neo-liberal consensus and the return of protection is nonsense. But the authors are right that those who argued that free trade alone is the answer were wrong. There are no magic potions for development. Developmental states can work. Many fail. But some may succeed.

Above all, developing countries should be allowed to try, and so learn from their own mistakes. Countries should be warned of the difficulties of following South Korea’s example, but allowed to do so if they wish.

Big and relatively successful developing countries, such as China and India, must participate in and be bound by global rules. They cannot be free riders. But the bulk of developing countries should be allowed to choose their own policies. Almost all will need to attract inward foreign direct investment. A few might still manage without it.

Chang is right that some of the constraints imposed upon developing countries, notably on intellectual property, are unconscionable. Most should enjoy the benefit of open markets from the rich, but be allowed to pursue their own paths, from laissez-faire to its opposite. They will make many mistakes. So be it. That is what sovereignty means.

Wow! This is the second thing Martin has written this summer that I completely agree with--and I am beginning to wonder if it is him or me...

By the way, the two books that he is reviewing are "How Rich Countries Got Rich...and Why Poor Countries Stay Poor" by Erik S. Reinert, and "Bad Samaritans: Rich Nations, Poor Policies and the Threat to the Developing World" by Ha-Joon Chang.

When good news for markets is bad news for the economy

The governing party in Turkey has just been re-elected with a comfortable majority of seats in the parliament, ensuring that it will return to power single-handed. Markets breathe a sigh of relief and the Turkish LIra appreciates, reaching a record high against the U.S. dollar.  Good news, or bad news?

Obviously good news for financial markets, but what about the real economy? If, as I have argued before, a competitive currency is good for economic growth, what do we make of the exchange-rate appreciation? 

What has just happened in Turkey is a common occurrence in emerging markets. Once you open up to capital flows and adopt a floating exchange rate regime, financial markets determine the value of your currency. And the better you are at managing the economy, the more you get "rewarded" with an appreciating currency--except that you would have been far better off without the reward. It is a veritable Catch-22.

There are exceptions of course. Argentina has deliberately avoided monetary policy orthodoxy, and its Central Bank is actively pursuing an undervalued currency (with the help of capital controls, price controls, and some fiscal restraint). China and some other Asian countries are intervening in currency markets to prevent appreciation and are accumulating huge reserves. But neither of these strategies is sustainable.

Is there a way out? I think maintaining a competitive currency under today's rules of the game requires a three pronged approach:

1. A large enough structural fiscal surplus to make room for looser monetary policy. A more competitive real exchange rate requires increased domestic saving relative to investment, and reduced national expenditures relative to income--and hence the need for a surplus.

2. A modified monetary policy framework, which gives explicit role to the value of the currency. The central bank will have to have a view as to what the appropriate range is for the exchange rate, and take action to move it there. This does not imply or require targeting a specific level of the real exchange rate, which would be much harder (if not impossible).

3. The use of tax and prudential instruments to reduce capital inflows and manage foreign-borrowing-led consumption booms (such as deposit requirements a la Chile or increased liquidity requirements on financial intermediaries).    

This is a tough menu. But let me know if you have better suggestions.

UPDATE: The day after I wrote this, the TL was hit by the global market sell-off and took a nose dive. Such is the way of international finance.

UPDATE2: Here is a longer version of the argument, written for Project Syndicate.

Globalization: we love it, we love it not...

The FT reports citizens of rich countries view globalization as an "overwhelmingly negative force." Respondents in France, Britain, and the U.S. are three times more likely to say that globalization is negative than to say that it is positive. Here is a summary of the report: 

 

The report is based on a FT/Harris poll "which surveyed more than 1,000 people online in each of the six countries."

I am not sure how seriously to take it. Here is another recent poll, with sharply divergent results:

This one is from the Chicago Council on Global Affairs and WorldPublicOpinion.org.  It shows an overwhelming majority of Americans think globalization is mostly good. 

So which is it?  Do American love or hate globalization? Or does it not matter, since none of the relevant decisions will be made by majority vote?

How real exchange rate policy can promote economic growth

My new paper on real exchange rates and growth is now online. Here is the summary in abstractese:

I provide evidence that undervaluation (a high real exchange rate) stimulates economic growth. This is true particularly for developing countries, suggesting that tradable goods suffer disproportionately from the distortions that keep poor countries from converging. I present two categories of explanations as to why this may be so, focusing on (a) institutional/contractual weaknesses, and (b) market failures. A formal model elucidates the linkages between the level of the real exchange rate and the rate of economic growth.

The paper is still raw, so comments are appreciated.

Trade policy as riding bicycles

I think it was Fred Bergsten of the Peterson Institute who first formulated the theory that trade liberalization is like riding a bicycle: you can never stop doing it, because if you do you will fall off, and that will be the end of it. The theory has been used to justify why there had to be a succession of trade negotiation rounds at the GATT/WTO. And now it is used to fend off the argument that further trade liberalization may not be an important priority for the world economy given how open it already is: you need to keep liberalizing, otherwise you risk giving up all the gains. The latest example of this line of reasoning comes from Dan Drezner (in response to a question from Kevin Drum):

The trouble with populism is (mostly) not about the remaining 10% of barriers to trade (though see below), it's about efforts to f$%& up the 90% of barriers that have been dismantled. The Baucus-Grassley-Schumer-Graham bill, for example, isn't about halting new trade openings -- it's about finding new ways to clamp down on existing openness.

Furthermore, this is never going to go away. Protectionism is a great way to reward concentrated interests with diffuse costs, so members of Congress will always have an incentive to act in this way. The current populist mood makes it easier to do it out in the open, but as Daniel Kono has shown, it will also be done behind closed doors as well.

This is why I'm so adamant about trade liberalization -- the status quo never stays the status quo, but creeps back ever so slowly towards economic closure.

As I have said before, beware when economists start talking in metaphors. I don't know whether the Bergsten rule was ever valid, but I am pretty sure it does not apply currently. The notion that if you start putting a few chinks on the existing trade policy architecture, you end up back in the 1930s is quite implausible--and totally unsupported by any empirical evidence that I know of. If the bicycle theory were true, most countries would have long ago driven a protectionist train right through the anti-dumping provisions of the GATT/WTO, a set of rules expressly designed to provide protection where none is needed.

I think the underlying political balance of interests favors an open economy in most countries of the world today, and it will take a major shock to get us back into rampant protectionism.