Foreign Affairs
Questions of Fairness
Robert H. Wade
Economic Justice in an Unfair World: Toward a Level Playing Field. Ethan B. Kapstein. : Princeton University Press,, 2006, 272 pp.$27.95Summary: In "Economic Justice in an Unfair World", Ethan Kapstein sets out admirably to define a global system that would guarantee opportunity for all states. But on the key issue -- free trade -- he subverts his own efforts by clinging to simplistic neoliberal dogma.
Robert H. Wade is Professor of Political Economy at the London School of Economics and Political Science and the author of Governing the Market.
IN SEARCH OF A JUST INTERNATIONAL ECONOMIC ORDER
"The predatory attitude has become the habitual and accredited spiritual attitude," the economist Thorstein Veblen said of the late nineteenth century. The same holds true today. A few years ago, Paul Volcker, the former chair of the Federal Reserve, remarked that "corporate greed [had] exploded beyond anything that could have been imagined in 1990." Paul O'Neill, the former U.S. treasury secretary, recently described the corporate world today as "an ethical vacuum space."
Yet even in a climate apparently so uncongenial to ethics, "global poverty" has shot up to the top of the agenda of international public policy since the late 1990s. The United Nations gave tangible expression to this new global mood in 2000 when it created the Millennium Development Goals and made "eradicating extreme poverty and hunger" the first of them. A recent report by the Organization for Economic Cooperation and Development identified an emerging "global anti-poverty consensus."
Academics who write about globalization and development usually avoid ethical questions. Ethan Kapstein's new book, Economic Justice in an Unfair World, marks an important exception: it is explicitly about ethics. And although indirectly, it arrives at a skeptical view of this "global anti-poverty consensus."
Focusing on poverty is inadequate, Kapstein argues, because it does not put relations between states front and center. "It is governments," he writes, "that sign treaties and agreements, impose sanctions and boycotts, and make war and peace, and it is governments that -- for good or for bad -- are ultimately accountable for their actions at home and abroad." In other words, a theory of global distributive justice must emphasize relations between states and the kinds of economic arrangements states subscribe to. Individuals are not the only moral agents; states are also moral agents, with duties and responsibilities to one another as well as to their citizens.
Kapstein's goal is to present an alternative framework of global justice, one that centers on equality of opportunity among states. He refers to this framework as "liberal internationalism" and calls for an international economic system that is "inclusive, participatory, and welfare-enhancing for all." This order, Kapstein writes, "would give the smallest and poorest states greater voice in the system than they have at present," including in the governance of international organizations.
Building on the work of the political theorist Charles Beitz, Kapstein distinguishes two different social compacts: the domestic one between a state and its citizens, which expresses a society's basic principles of economic justice, and an international one among states, which determines the context in which countries pursue their domestic compacts. Some theorists of international relations hold that relative power, especially military power, shapes the international compact entirely. But Kapstein points out that powerful states do not always operate with a bit-better-than-the-law-of-the-jungle morality. In fact, they often forgo immediate relative gains in the interest of building a system of interactions that all participants view as reasonably fair. The resulting stability of expectations brings benefits for powerful states while increasing the common good. By way of evidence, Kapstein cites studies of the Tokyo and Uruguay Rounds of trade negotiations finding that the most powerful countries did not press their full advantages. Steered by the goal of promoting greater market access for all countries, they gave up more than they got.
The social arrangement that, in Kapstein's view, guarantees inclusiveness and participation and is "welfare-enhancing for all participants" is a global regime of free trade. In other words, free trade is the social arrangement that has the potential to best achieve justice in interstate relations and to fulfill each state's domestic social compact.
Kapstein believes that free trade can generate the highest attainable economic growth -- because it maximizes the scope of opportunity and equalizes opportunities for all potential participants -- and that high economic growth is good for the poor as well as the nonpoor. But he is also aware that despite the expansion of free trade, the growth rates of poor countries have not converged with those of rich countries, as free-trade advocates had predicted they would (the experiences of East Asia and, more recently, South Asia notwithstanding). Some of the continuing disparity -- owing to persistent low growth in a majority of poorer countries -- results from domestic politics and policies and from geography. But a good part, Kapstein argues, is due to the fact that rich countries have rigged the trade regime; far from being a level playing field, it is distinctly tilted against producers in poor countries.
CONSENSUAL WISDOM
Kapstein presents a justice-serving reform agenda that he hopes will come to constitute a "fairness consensus." He rules out the agency of a global or supranational authority or an imperial power, arguing for interstate negotiation as the only viable means of reaching substantive, durable agreements. For agreements to be substantive and durable, they have to be considered fair. To be considered fair, they have to be seen as mutually advantageous. And states will see an agreement as mutually advantageous when it enables each of them to maintain its own domestic social compact -- in other words, when the agreement respects a state's sovereignty over social norms.
The first and most important element of an international compact, in Kapstein's view, is a free-trade regime that offers a level playing field. "Fortunately, a resource redistribution mechanism exists that is welfare-enhancing for all participants, and it is called free trade," he writes. Instituting this free-trade regime requires removing all the devices by which rich countries make it difficult for poor countries to specialize according to their comparative advantages -- especially barriers against agricultural and textile goods from developing countries.
But at the same time, the new trade regime must give more explicit recognition to "diffuse" or "relaxed" reciprocity in trade negotiations, rather than "tit-for-tat" or "strict" reciprocity. The latter is fine for trade negotiations between economic equals, such as the United States and the European Union. However, developing countries -- precisely because they are developing, with much lower incomes and economic capabilities -- should not be expected to make equivalent concessions. On the other hand, they should also not expect special and differential treatment -- that is, to be exempt from all reciprocity obligations (as many are demanding). Fairness requires that they participate in the negotiations and assume some obligations.
After trade, the second main feature of Kapstein's international compact is aid. Despite what the World Bank and many other observers and institutions preach, aid should be focused not on poverty reduction but on strengthening the capacity of poor countries to participate on a level playing field. This implies a large shift from present allocation priorities (primary education, basic health care, and the like) in favor of investment in ports, railways, and the customs and patents bureaucracies.
Third, since migration and remittance payments will become even more important for developing countries in the future, Kapstein argues for the creation of an umbrella regime covering issues related to migration, bringing consistency and justice to policies that are now determined by each state. That regime should establish arrangements to lower the presently high costs charged to transmit worker remittances, so as to raise the net amounts flowing from rich to poor countries. (Labor standards also have a place, but only as part of a comprehensive development strategy that raises productivity and growth: rich states that require poor states to comply with international standards have a duty to help them pay for such compliance.)
Fourth, Kapstein believes that international investment, especially foreign direct investment (FDI), also needs to be subject to an umbrella regime. He endorses something like the aborted Multilateral Agreement on Investment (MAI), which proposed to institute a code of conduct for governments' treatment of foreign investors. Such an agreement would bring a longer time horizon to bear on negotiations between multinational corporations and host governments. As the time horizon lengthened, the prospects for fairness would improve, since each side would become less tempted to treat each investment as a one-off deal and try to maximize the advantage it got from it.
One of the most important goals of such an international-investment agreement, in Kapstein's view, should be to limit or eliminate subsidies paid by governments in order to attract FDI. (The most glaring fault of the proposed MAI was to ignore this issue.) Investment subsidies are a prisoner's dilemma: each state has an interest in cooperating with other states to minimize investment subsidies, but because each state also wants to maximize the amount of FDI it receives, it has an incentive to defect from the agreement -- to the benefit of foreign investors and to the cost of the states.
IS VERSUS OUGHT
Anyone who wants an introduction to questions of moral economic philosophy would do well to start with his book. Kapstein writes in lucid prose, without the turgidity that often renders the subject as inviting as a cold bath. He makes a long-overdue challenge to the West's consensus that the aim of aid and of developing countries' own development efforts should be to reduce poverty, and that this reduction should be achieved not via industrialization and economic growth but by policies focused on poverty. The implicit suspicion here is that the elite consensus around poverty reduction owes a lot to the comforting way it directs attention to "the poor" as a category outside of larger power structures and inequalities. It deflects attention from the enduring injustices at the international level, such as rich-country protectionism. It also avoids the task of building self-aware, internally articulated national economies in the developing world with industrial capacities that might challenge those of the developed world.
But Kapstein's lucidity sometimes comes at the cost of engagement with empirical evidence. Kapstein tends to mix up empirical and normative statements, "is" and "ought to be." For example, in his discussion of the most important reform domain of all -- trade -- he adopts a standard neoliberal position: developing countries should liberalize trade indiscriminately and integrate fully with the world economy. Unfortunately, this position is rooted in the most fundamentalist kind of thinking in economics.
The free-trade faithful believe in the ability of an all-determining market mechanism to deliver prosperity and peace in perpetuity. "Free trade" has become the shibboleth between insiders and outsiders, competents and incompetents. The fundamentalist mindset is at work in the very language: people who do not subscribe to free trade are "protectionists," who believe in "protectionism." As with "communism" and "terrorism," the "ism" implies a coherent and standard package of beliefs, in Manichaean opposition to the true faith. Hence, Kapstein avows, "It is difficult to be just a little bit of a protectionist" -- either a free trader or a protectionist, with us or against us. Martin Wolf, arguably the most influential economic journalist in the world, frequently issues warnings through his books and Financial Times columns about "the enemies of liberalism" and "the enemies mustering both outside and inside the gates."
But this framing is misleading. Protection is one instrument of industrial policy among many. And like any powerful instrument, it can be used well or it can be used badly.
The problem with Kapstein's position is that he assumes that the empirical evidence on free trade as an engine of efficiency and economic growth is well established; it is not. Kapstein also assumes that there would be harmony between an international social compact based on free trade and domestic social compacts that reflect citizen preferences; in fact, tension is more likely.
The argument for free trade holds up as clearly as Kapstein thinks it does only when the alternative is no trade. The causal links between freer trade (lower tariffs and fewer quantitative restrictions on imports) and faster trade growth and between faster trade growth and faster economic growth are not well established. For example, India's growth rate began to pick up in the 1980s, but most of the "openness" reforms did not begin until the early 1990s. Similarly, China's rapid reduction of the number of people in the country living in extreme poverty has had little to do with trade expansion and a lot to do with agricultural reforms. Meanwhile, ever since most Latin American countries broke with their earlier import-substituting regimes and started emphasizing privatization, deregulation, trade, and financial liberalization in the 1980s, their growth has been roughly half of what it was in the decades of "bad" import-substituting industrialization.
Nor is it well established that countries that specialize in areas of their (present) comparative advantages will enjoy better economic performance. Brazil is unlikely to benefit from the continuing collapse of its manufacturing sector (a collapse on an eastern European scale) and the reallocation of resources into soy beans, timber, and other such commodities. Robust evidence shows that the dominant process in successful development is not specialization but diversification -- the expansion of capacities across a wider range of products.
The evidence from the catch-up phases of Japan (195073), South Korea (195590), and Taiwan (195590) -- arguably the most successful developers in history -- is that those countries used protection well, as one of several instruments of industrial policies aimed at accelerating the diversification and upgrading of their economies faster than "the free market" would have. They were also picky about incoming FDI; Japan and South Korea, in particular, tended to buy foreign technology rather than allow in foreign firms, in a way presumably Kapstein would not approve of. As for the separate question of whether industrial policies made an important difference, the evidence is more contested, for it involves disentangling complex causalities. But there is a fairly strong prima facie case that they did work.
On the other hand, countries that adopted Kapstein's free-trade recipe frequently experienced a surge of imports, causing them to hit balance-of-payments constraints at a slower growth rate. They then frequently opened up their capital accounts in order to help finance their deficits. In the next round, they quite often experienced a debt crisis, prolonged stagnation, or both.
Just how far the current orthodoxy around free trade and neoliberalism has strayed from the empirical evidence can be suggested by a simple test. Which countries have had the fastest sustained growth rates since World War II? Japan (8 percent from 1950 to 1980), Taiwan (8.6 percent from 1960 to 1995), Hong Kong (7.7 percent from 1960 to 1995), Malaysia (6.9 percent from 1960 to 1995), Singapore (8.4 percent from 1960 to 1995), South Korea (8.1 percent from 1960 to 1995), Thailand (7.5 percent from 1960 to 1995), China (89 percent from 1980 to 2006), and India (6 percent from 1980 to 2006). Botswana, Ireland, and Vietnam are also in the same league. What is striking is that all but two of the 12 are in East or South Asia, and virtually all have maintained policy regimes that would mark them as serious failures by neoliberal criteria. Some of the worst pupils of neoliberalism have gotten high grades, while many of the best pupils have gotten low ones.
DEGREES OF OPENNESS
On the relationship between an international social compact based on free trade and investment and domestic social compacts expressing citizen preferences aggregated through political debate, Kapstein's assumed harmony ignores one of the basic tensions of liberal political theory: that a majority of citizens may not want free trade and investment. In the history of capitalism, the extension of the franchise has often generated demands for protection, market regulation, and the provision of welfare. Meanwhile, the extension of free trade and investment has often occurred under the thumb of authoritarian regimes, such as that of Augusto Pinochet in Chile.
Kapstein and other neoliberal champions sail past this tension by assuming that the optimal degree of openness for all countries -- developed and developing -- is fully open, and that any disruptions to the domestic social compact can be handled by "social safety nets." A more plausible view is that the optimal degree of openness varies from country to country, as well as within any single country over time. It depends on, for example, the existing condition of a country's social safety net and its level of industrialization. Countries normally move through stages, starting with natural-resource-based or labor-intensive products, moving on to medium-technology products and then some high-technology products. As the exigencies of learning and the severity of market failures vary from stage to stage, the amount of industrial policy support (including protection) should vary between sectors and over time, with support being reduced or eliminated as industries become competitive on the international market.
Today, one of the most pressing issues is how to design a set of trade rules that can balance the advantages that a more open trade policy would bring to China, other East Asian countries, and India with the much smaller advantages that it would bring to the majority of developing countries. The threat to the export and import-substituting industries of most of these latter countries comes mainly from Asian countries rather than the United States or Europe. It is at least arguable that just trade rules should permit privileged access in rich-country markets for products from small, poor countries in, say, Central America or sub-Saharan Africa, perhaps even in the form of an import subsidy paid by developed countries, complemented with massive aid to build up domestic industries in poor countries.
In any case, justice requires -- for reasons pertaining to both sovereignty and a state's ability to make use of opportunities -- that there be more leeway for countries to choose how open they will be. This implies a major reform of the central rules of the World Trade Organization (WTO). As the Harvard development economist Dani Rodrik has written,"The rules for admission into the world economy not only reflect little awareness of development priorities, they are often completely unrelated to sensible economic principles. WTO rules on anti-dumping, subsidies and countervailing measures, agriculture, textiles, trade related investment measures and trade related intellectual property rights are utterly devoid of any economic rationale beyond the mercantilist interests of a narrow set of powerful groups in the advanced industrial countries. The developmental pay-off of most of these requirements is hard to see."
Kapstein fails to see the inadequacy of the current rules because he accepts the standard neoliberal proposition that there are two kinds of exchanges: voluntary (associated with the market) and coerced (associated with the state). But states can enter into voluntary agreements with other states. Progress and justice require expanding the scope of the voluntary and shrinking the scope of the coerced. In the case of the WTO, governments have a choice whether to join or not. If they join, they must judge it fair, in the sense of mutually advantageous. As Kapstein says, "We can safely assume participation in the international trade regime must serve the interests of each negotiator better than nonparticipation."
True, participation may serve states' interests better than nonparticipation, but that is not necessarily because participation brings large benefits; it may be because power asymmetries make nonparticipation a really bad option. A small number of rich and powerful states are able to wield "go-it-alone power" and present developing countries with ultimatums on terms extremely advantageous to themselves. Even China was faced with something like this choice in response to the U.S. Congress' constant changing of China's access to the U.S. market in accordance with wider geopolitical considerations; China decided to join the WTO on terms widely seen as adverse in order to bring some regularity to its access to the U.S. and European markets. Russia is facing the same problem now in its WTO accession talks: Washington keeps raising the bar and changing the entry conditions.
THE CASE AGAINST UNIFORMITY
In the end, Kapstein's analysis suffers from two basic problems. The first is that he does not give developing-country governments sufficient policy space to experiment with various policy regimes, including different degrees of openness. International economic justice should rely on rules that govern the interaction between different domestic regimes, rather than rules that require the same domestic regime of full openness. Of course, this is a more demanding task for rule makers and rule enforcers. One of the virtues of free trade and the free movement of capital is that they are very simple. But they are also unjust, particularly because (through mechanisms of increasing returns and learning by doing) they tend to generate strong geographic polarizations, with many developing countries on the losing end. An open-economy industrial policy, including varying degrees of openness to the global economy, can potentially help to offset these polarizing tendencies. But neither WTO rules nor Kapstein's liberal internationalism makes room for the kind of industrial policy that would be relevant to developing countries.
The second problem with Kapstein's analysis is that it treats all states the same. But we know that some states are much better at promoting development than others. The Princeton political scientist Atul Kohli has proposed a threefold typology. A "neopatrimonial state," in which the ruler treats state resources as his own (such as Nigeria and many other countries in Africa and the Middle East), is likely to make a mess of many instruments of industrial policy if given the latitude. A "cohesive-capitalist state" (such as South Korea and Taiwan up to around 1990) is likely to be much more effective at using dirigiste methods to upgrade and diversify the structure of its economy (although it may be no better at protecting human rights). In between these two types is the "fragmented-multiclass state" (such as many in Latin America and Southeast Asia), the capacity of which to implement strong industrial policy is more varied and more contingent.
Should the boundaries of policy space -- defined by WTO rules and World Bank and International Monetary Fund loan conditions -- vary according to the type of state, on the grounds that neopatrimonial ones are more likely to abuse policy space than cohesive-capitalist ones are? How could such rules be accommodated in the regimes of international organizations and in international agreements when there is such pressure to treat all states, or at least all developing economies, equally? Nigeria, after all, would not appreciate the World Bank's refusing to give it help with industrial policy on the grounds of its neopatrimonialism while the bank helped another country on the grounds that it had a fragmented-multiclass state moving toward cohesive capitalism. Such questions deserve more extended discussion. But the main point is simply that a typology of developing states should be fundamental to how we think about development policy. At present, it is not -- and Kapstein's commitment to universal rules obscures the need.
In thinking about these issues, we should also give up talk of "the developing world" in contrast to "the developed world," and talk instead of a "1:3:2 world" (one billion people live in the rich countries, three billion live in countries where growth rates are faster than those of the rich countries, and two billion live in countries where they are substantially slower). When will the states representing the slow-growing two billion link up with the states representing the fast-growing but low-income three billion to force changes in the rules of engagement in the international economy? Perhaps the state representatives of the fast-growing three billion -- when and if those states' average income reaches, say, two-thirds that of the rich countries -- will come to subscribe to neoliberal policy norms as the basis of a just world economic order. After all, most others have done the same as their states have come toward the top of the pile.