Foreign Policy
Spring 1998

International Economics: What Do We Know about Globalization?

By Jeffrey Sachs

The following abstract is adapted from Dr. Sach's article, originally published in the Spring 1998 issue of FOREIGN POLICY. All rights reserved.

In recent years, international economics has been increasingly taken up with one central question: How will national economies perform now that nearly all of the world is joined in a single global marketplace? As a result of changes in economic policy and technology, economies that were once separated by high transport costs and artificial barriers to trade and finance are now linked in an increasingly dense network of economic interactions. This veritable economic revolution over the last 15 years has come upon us so suddenly that its fundamental ramifications for economic growth, the distribution of income and wealth, and patterns of trade and finance in the world economy are only dimly understood.

The fastest-growing developing countries in the past two decades have been those that succeeded in generating new export growth, especially in manufactured goods. Economies that tried to go it alone by protecting their economy from imports through high trade barriers grew much less rapidly than more open export-oriented economies. In almost all cases of developing-country, export-led growth, the exports themselves have been part of a highly refined division of labor, in which final goods (e.g. automobiles, avionics, electronic machinery) are produced in multisite operations, with the labor-intensive parts of the production process reserved for the developing countries.

This kind of "new division of labor" in manufactures was inconceivable to early postwar development economists, who counseled protectionism as the preferred path for industrialization in poor countries. These economists simply could not conceive of the production process being a complementary relationship between advanced and developing countries. In the standard theory, then, both sides of the great income divide stand to benefit from globalization: the developed countries by reaching a larger market for new innovations and the developing economies by enjoying the fruits of those innovations while sharing in global production via multinational enterprises.

Another consequence of globalization is that many forms of international capital flows have risen dramatically. Foreign direct investment, portfolio investment through country funds, bank loans, bond lending, derivatives (swaps, options, forward transactions), reinsurance, and other financial instruments, have all grown enormously. Both developed and developing countries have increasingly opened their capital markets to foreign participation.

However, the Mexican crash and the East Asian financial crisis have shown that unfettered financial flows from advanced to emerging markets can create profound destabilization. These dramatic experiences are giving second thoughts in many quarters to the pressures for rapid liberalization of international capital flows. While the official Washington community still presses for liberalization of the capital market, voices are being raised for putting a "spanner in the wheels" to slow capital movements with an aim toward preventing financial market panics. Ideas include the taxation of international transactions; the direct limitation of short-term bank borrowing from abroad as a banking supervisory standard; and increased disclosure rules.

Perhaps no aspect of globalization has been more controversial than the alleged effects of increased trade on income distribution. Despite the hard work of economic researchers, there is still no consensus on these effects within the advanced and emerging markets. Clearly, the period of dramatic globalization (especially the 1980s and 1990s) has also been one of rising income inequality within the United States, and especially of a loss of relative income for low-skilled workers, consistent with basic trade theory. However, as with many important economic phenomena, the cause of this widening income inequality is almost surely multifaceted.

While trade might be one culprit, changes in technology, such as the computer revolution, might also have favored skilled workers over unskilled ones, thereby contributing to the rising inequality. Most researchers agree that a combination of factors has played a role in the widening inequality, and most of them, put the preponderant weight on technology rather than trade. They do this for one main reason: The share of U.S. workers that are in direct competition with low-skilled workers in the emerging markets seems to be too small to explain the dramatic widening of inequalities since the end of the 1970s. Less than 5 percent of the U.S. labor market—in apparel, footwear, toys, assembly operations, and the like—appears to be in the "direct line of fire" of low-wage goods from Asia.

Without question, globalization is also having deep effects on politics, and at many levels. Most important, the national marketplace is losing its relevance relative to international markets. This is causing a sea change in the role of the nation-state, relative to both local and regional governments on the one side and multinational political institutions on the other.

For instance, globalization has given a crucial impetus to internationally agreed-upon rules of behavior in trade, finance, taxation, and many other areas, thus prompting the rise of the wto and other international institution as the new bulwarks of the emerging international system. At the same time, communities, local governments, and regions within nations are increasingly asserting their claims to cultural and political autonomy. The nation is no longer their economic protector, and in peaceful regions of the world, the national government is no longer seen as a critical instrument of security. Consequently, regions as far-flung as Catalonia, Northern Italy, Quebec, and Scotland, as well as oblasts in Russia, provinces in China, and states in India, have taken globalization as their cue for more autonomy within the nation-state.

We are therefore in the midst of a startling, yet early, tug of war between polities at all levels. Where will the future of decision making, tax powers, regulatory authorities reside: with localities, subnational regions, nation-states, or multilateral institutions (both within geographic regions such as the European Union and at the international level)? To the extent that increased regulatory, tax, and even judicial powers shift to the international setting, how should and will international institutions be governed in the future. Will there be a democracy deficit, as is now charged about decision making in the European Union? What will be the balance of political power between the developed and developing countries, especially as population and economic balances shift over time in favor of the now developing world? And crucially, what will be the balance of power between democratic and nondemocratic polities at the world level? All of these issues are fresh, urgent, and likely to loom large on the research radar screens.

 

Sidebar: A Brief History of Panic

 

Further Reading

Peter Dicken, Global Shift: The Internationalization of Economic Activity (New York, NY: Guilford Press, 1992)

Robert Frank & Philip Cook, The Winner-Take-All Society (New York, NY: Simon & Schuster, Inc., 1995)

Gene Grossman & Elhanan Helpman, Innovation and Growth in the Global Economy (Cambridge, MA: MIT Press, 1993)

Paul Krugman, Development, Geography, and Economic Theory (Cambridge, MA: MIT Press, 1995)

Krugman & Robert Lawrence's  “Trade, Jobs, and Wages” (Scientific American, April 1994)

Kiminori Matsuyama, “Agricultural Productivity, Comparative Advantage, and Economic Growth” (Journal of Economic Theory, vol. 58, 1992)

John Maynard Keynes, “National Self-Sufficiency” in The Collected Writings of John Maynard Keynes. Volume XXI: Activities 1931–1939: World Crises and Policies in Britain and America (London: Macmillan, 1933)

Sachs & Steven Radelet, “Shipping Costs, Manufactured Exports, and Economic Growth” (Cambridge, MA:, HIID, unpublished)

Sachs & Radelet, “Asia’s Re-emergence” (Foreign Affairs, November/December 1997)

Jeffrey Sachs & Andrew Warner, “Economic Reform and Global Integration” (Brookings Papers on Economic Activity, 1995)

Sachs & Warner, “National Resource Abundance and Economic Growth,” an HIID development discussion paper

Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Oxford: Oxford University Press, 1993—first published in 1776)

World Investment Reports of the United Nations Conference on Trade and Development

As part of its project on “Integrating National Economies,” the Brookings Institution has published a series of 20 studies that provide a useful overview and analysis of governance issues on a wide range of topics, including national and global policies on competition, taxation, trade, and investment.