Globalization policies may disintegrate world economy

GENEVA: Forces "driving" the globalization process have distinct limits, with some of them now approaching these limits and others of which the limits are already in sight. Constructing policies around such an "unreachable goal" may ultimately lead to the disintegration of the global economy, according to US academic William Milburg.

The combination of technological, organizational and political limits to globalization may already constitute dominant forces in the regionalism that characterizes much international economic activity, from trade to international economic policy, as evidenced by the importance of European, North American and Asian regional agreements over the past five years, Milburg adds.

The extraordinary growth of TNCs and their ubiquity and economic power, with a relatively small number of them having achieved considerable command over global resources while pursuing their narrow commercial objectives, bring them into conflict with national governments and their wide-ranging economic, social and political objectives. This raises important questions about the existing responsibilities of nation states and TNCs, says Mica Panic. The Cambridge academic (and author of several studies and books on interdependence) wonders whether national authorities may not be justified in demanding more from TNCs, in terms of wider economic and social responsibilities, than they do from small national enterprises.

The views of Milburg, Panic and other experts from academia and international organizations are contained in the book, Transnational Corporations and the Global Economy, published by Macmillan Press, London of the papers at a UN University/WIDER (World Institute for Development Economics Research) conference on TNCs, edited by Richard Kozul-Wright and Robert Rowthorn.

Another chapter author in the volume, Michael Mortimore of the Economic Commission for Latin America and the Caribbean (ECLAC), analyzes the Mexican experience of liberalized external trade, massive TNC investments and TNC-centric industrialization, as compared to the TNC-associated one in Japan and Korea.

In the Mexican model, the TNC investments have created modern plants, with productivity levels matching those in advanced economies, and led to a mushrooming of manufactured exports, especially of automobiles and electronic equipment destined for the US.

But the outcome has also been that many local suppliers have been driven out of business as the economy has been liberalized and there has been little genuine transfer of technology, which remains firmly in the hands of externally-based TNCs. This, Mortimore says in the paper originallypresented at the 1995 UN University/WIDER conference on TNCs, bodes ill for the future. This assessment is at variance with the view presented in the World Investment Report (WIR) of 1995.

Uneven development

Challenging the contemporary strong globalization thesis for trade liberalization and a diminishing role of the state, based on a view of "global integration" in the half-century before 1913 when such policies ostensibly prevailed and created a "golden age of economic growth and rapid convergence", Paul Bairoch and Kozul-Wright find little evidence for the claims about the past era.

Except for a brief decade or so in the 19th century, for three decades before 1913, trade policy in the developed world was one of "islands of liberalism surrounded by a sea of protectionism", while that in the developing world, as a result of direct colonial rule, was "an ocean of liberalism with islands of protection." And there was "uneven" industrialization in the advanced economies, while in the developing world, the deindustrialization process (which began under colonial rule) continued and accelerated.

"The internationalization of finance capital, which dominated the earlier globalization process as much as in the contemporary era, appears to be strongly related to a process of uneven development, often reinforcing existing differences in the world economy rather than bringing about convergence," Bairoch and Kozul-Wright conclude.

William Milburg, in a chapter titled "Globalization and its limits", has noted that though it has acquired a wide array of usages, the term, "globalization" is being used institutionally to describe the spread of capitalism worldwide, and as a synonym for liberalization (domestic and foreign) and greater openness of economies. But none of the various notions of globalization describes any dramatic shifts in the world economy, but simply the continuation of longer-term trends.

A strictly global economy, Milburg points out, is one dominated by TNCs and financial institutions operating independently of national boundaries or domestic economic considerations - a world where goods, factors of production and financial assets would be almost perfect substitutes everywhere in the world, and where a national economy will no longer be identifiable and nation states can no longer be considered distinct economic identities with autonomous decision-making power.

Increasing interdependence

But there can be little doubt that the world economy is very far from such a supra-national paradigm, and the current situation is one of increasing interdependence between countries where cross-border linkages have reached an extent where economic developments in one country are influenced significantly by policies and developments outside its boundaries.

While the growth of international trade since the Second World War has been an important element of increasing interdependence, the cross-border exchange of goods does not qualitatively change the nature of interdependence.

Rather, globalization is a phenomenon of greater capital mobility, associated with increased international flows of investment and finance, with foreign direct investment (FDI) and international portfolio flows as the two prongs of capital mobility.

While FDI has grown, the recent growth is consistent with longer-run trends, and does not mean production is fully globalized, since the activities of national and international firms have also grown. And despite the growth of TNCs over the past 20 years, FDI still accounted for only 4.3% of gross fixed capital formation globally in 1993; the total stock of FDI as a share of world output reached a post-war peak of 8.5% in 1991, which was still below the 1913 level. In 1992, sales of TNC foreign affiliates, at $4.8 trillion, were slightly more than total world exports of goods and non-factor services, but still less than one-fifth of world GDP at factor cost; TNC employment accounted for only 3% of the world labour force in 1992.

And much of the expansion of FDI in the 1980s was inservice industries which tend to be organized along more traditional lines than manufacturing. Most FDI since the 1980s has been among developed countries. And while inward FDI to the developing countries shot up during the early 1990s, this was almost entirely due to the opening-up of China to FDI, and the remainder of the flows being concentrated in about 10 other countries.

As for financial flows, the massive increase in aggregate portfolio transactions, both in absolute terms and relative to net capital flows, suggests that "a very large proportion of international portfolio transactions are short-term, involving round-tripping of capital and very rapid reversal of asset positions."

And while net capital flows to developing countries picked up rapidly in the early 1990s, they have been concentrated in a small number of countries. Much of such flows were also in the form of liquid portfolio investment, with the share of FDI in net capital flows falling from 80% in 1975-82 to almost 50% in 1991-94. This was primarily due to a sharp increase in portfolio flows to Latin America.

While in general, the growth of international financial transactions may be expected to exceed that of trade and investment, since simple hedging of each position would need multiple transactions, the pace of growth over the last two or three decades has been far in excess not only of that of real variables, but also of what might be expected from prudential management of risks. Between 1982 and 1988, the annual increments in the stock of world financial assets averaged about $3,800 billion, while the average annual level of fixed capital formation was around $2,300 billion.

Reviewing trends in the world economy, Milburg points out that while globalization of production and finance is not significantly more pronounced than in the immediate pre-World War I period, it has increased in degree rapidly, if unsteadily and unevenly, over the last twenty years. While firms play a central role in this process, and movement of firms and capital across borders in pursuit of profits is inherent, this does not explain the market-specific and geographically uneven globalization process. Rather, many factors, including primarily government policies, but also technological and organizational knowledge, and global macroeconomic trends, have served to promote, constrain or channel the globalization process by influencing the behaviour of firms and markets.

Technology, particularly computers and the ability to transmit information, has enabled firms to move beyond economies of scale and exploit economies of scope. Financial institutions have also been globalized, reinforcing the tendency for financial transactions "to become self-motivating, independently of the services required by the process of trade and foreign investment."

In terms of macroeconomics, the floating exchange rate system, together with the way monetary policy is conducted in major economies, has added to the growth of global financial activity, not only by generating opportunities for speculation and arbitrage profits, but also by increasing the need to diversify and hedge against risks arising from greater volatility of exchange and interest rates.

Liberalization wave

In developed countries, liberalization of FDI regimes has progressed much faster than trade. With FDI becoming increasingly difficult to distinguish from portfolio equity investment, liberalization of cross-border equity flows has been tantamount to liberalization of FDI.

And while the liberalization wave swept the developing world in the 1980s, and developing countries have been liberalizing their trade and their investment policies towards attracting new, inward, "green-field" FDI, financial liberalization has been much more rapid. Privatization has also served to deepen the integration of countries into the global system of production and finance by encouraging capital inflows and bringing about foreign ownership of state-owned enterprises.

But the presence of such powerful globalizing forces does not mean that the state of a "fully globalized economy" will be reached soon. In fact, each of the forces driving the globalization process has distinct limits.

Technological capabilities, even in an era of growing TNC importance, continue to be nation-specific, and national systems of innovation continue to vary widely.

The level of government support for innovation activities also varies across countries. In 1990, more than one-half of R & D in France, Italy, the UK and the US was government-funded. In Germany, the government supported about 35% of R & D and in Japan, public spending accounted for just over 20%. While firms may be stateless in terms of loyalty to a sovereign political body, most international firms continue to reflect the ethos of their home-country management and shareholders, and corporate control continues to carry a strong national profile.

And while globalization may be rapidly approaching organizational and technological limits, limits to complete liberalization of policy are already visible. And, as globalization occurs, there is an increase in demand for, and social benefit from, "international public goods" - infrastructure projects and training. Addressing this problem on a global level would require an unrealistic degree of central control.

"Unreachable goal"

And since an identity of interests between microeconomic actors and macroeconomic outcomes at global, rather than national, level is unlikely, the globalization process has repercussions for the interests of various social groups which exert, directly or indirectly, considerable political pressures on policy-making. These pressures may arise from the results of globalization - such as increased spread between wages of skilled and unskilled workers as a result of increased trade openness - or from heightened conflict between rival groups in different nations (such as automobile firms or commercial aircraft producers needing public support). And if global institutions do not offer the necessary degree of loyalty or accountability making for consensus-building, the institutional structures required to solve these conflicts would themselves reproduce discontinuities.

Recognizing the limits to globalization inherent in its political economy is not simply an academic debating point, "but an indication of [the] dangers of constructing politics around an unreachable goal."

Globalization is not a new feature of the world economy. Globalization in the period before 1913 produced a very uneven pattern of global economic development, exposing the limits of global economic integration. This subordination of policies to an unattainable ideal not only prevented many countries from finding adequate policy responses to the costs as well as opportunities of globalization, but ultimately led to the disintegration of the world economy.

In analyzing the roles of TNCs and nation states, Mica Panic focuses on the conflicts likely to arise between TNCs pursuing their narrow commercial objectives and national governments trying to discharge their wide-ranging economic, social and political responsibilities placed on them by their electorates.

In pursuit of narrow corporate objectives, TNCs have achieved such command over global resources, and such an impact on the international economy, as to raise serious doubts over the nation state as a form of political organization.

But unlike states, TNCs have no sovereign power, and their decisions can be blocked and overturned by the states in which they operate. TNCs cannot prevent an independent state from exercising sovereignty; they can only frustrate the exercise by making it costly in welfare terms. They have, however, to be taken into account in terms of national and international production, employment, distribution of income, trade, finance and policies, even questions of war and peace.

By operating at any one time in a number of different economic and political environments and by exploiting these differences, TNCs are even more powerful and unpredictable than oligopolies confined to a single country. Mainstream analysis and economics, however, do not attempt to incorporate TNCs into general analysis.

And while, outside mainstream analysis, there is a vast body of literature on TNCs, it is "predominantly descriptive in character... with little effort to analyze the extent to which the nature of international trade, factor flows and economic policy have been influenced by these enterprises in ways that purely national firms would never be able to do."

Literature on international economic integration has developed around concepts of openness, integration and interdependence - which, although each refers to a distinct aspect of linking different economies, are often used interchangeably, usage that is justified only if there is everywhere the same chain of events.

Where factors of production are mobile within countries, but immobile outside, the only way of integrating two or more economies is through trade. But once assumptions of international factor mobility are dropped, the sequence of events towards integration changes radically.

In such a situation, in terms of overcoming barriers to international trade, while various barriers – administrative (tariffs, subsidies and so on), geography, cultural and religious differences, inequalities of income and wealth, and corporate barriers - are insurmountable for national firms without the help of governments, TNCs face no such disadvantages. TNCs can get around administrative or geographic barriers to access and supply markets. Exchange controls become ineffective in preventing them from spreading globally. But they will avoid significant disparities in productivity, income and wealth, and hence markets in countries with low incomes are too small to attract TNCs.

Not textbook markets

Whatever else it may resemble, the environment in which TNCs operate has little in common with models of highly competitive markets (commonly assumed in economic textbooks). Given the rapid growth in number and extent of operation of TNCs, most of them coming from the developed economies, it is no wonder that they play such an important role in many countries, including in some of the world's largest and most industrialized economies.

The rise of TNCs has thus had a profound effect on the international division of labour and the distribution of gains and losses resulting from it. As past experience has shown, unequal gains from global specialization are likely to lead to the breakdown of the internationally integrated system.

"Yet this important condition is normally brushed aside in economic literature by assuming either perfect competition in commodity markets or perfect mobility of labour and capital once administrative barriers to trade are removed."

Globally, the strategies of TNCs are likely to evolve around broad objectives of protection of existing markets and entry into new markets. To achieve these goals, TNCs have little alternative but to engage in restrictive business practices both internally and in relation to their competitors. They will not, for example, export to a market where prices are high, if that market has an affiliate operating in it. Such corporate strategies (even within the EC) are the main reason why important price differences remain within different countries of the EC. For the same reason, freedom of international capital flows has not led to the
narrowing of differences in rates of return on capital investment in major industrial countries or in real long-term interest rates.

International allocation of resources and the welfare of countries are influenced by the decisions of parent TNCs, with their preference to concentrate R & D activities mainly in their home countries.

If the trading strategies of TNCs, following the abolition of administrative barriers to trade, can perpetuatemisallocation of resources, their investment decisions can create serious adjustment problems in some countries. Trade liberalization will enable TNCs to rationalize their production operations by reducing, eliminating or increasing production in various countries. This could lead to a fall in output, employment and incomes in the former and an improvement in the latter, whose external positions could worsen.

These could happen even in the absence of TNCs, and inefficient national firms could go out of production because of competition unless they get time to adjust. But this last is why countries liberalize their trade gradually. But changes involving rationalization of production come rapidly where TNCs are involved. And once the investment and reallocation decisions of TNCs set in, they are difficult to reverse in conditions of economic openness.

Different responsibilities

Hence, in a world of TNCs and independent sovereign states, both the concept and the predictions of the familiar free- trade model need to be revised. The conflict between corporate and national interests is bound to have far-reaching implications for economic policy in general, well beyond the relatively simple issue of trade policy.

Referring to possible conflicts between TNCs and sovereign state, Panic points out that the differences in their respective preoccupations arise from their different responsibilities. The "international" character of a TNC sooner or later produces a situation where it is not clear what the national identity of the TNC is, and hence its concern for the "national interest" of the country where it operates is thrown in doubt. The board of a TNC is expected to maximize corporate profits, not the welfare of any state where it operates.

The existence of TNCs adds considerably to the uncertainty which is invariably present in macroeconomic management. While national firms can be expected to respond to different fiscal policies, the same is not true of TNCs. The latter's response would depend on which market they are supplying from the place where they are located. Unlike national firms, there is no guarantee that a TNC will undertake an investment in a country on the basis of the incentives of fiscal policy. It may even use the higher profits generated in one country to overtly, via FDI, or covertly, via transfer pricing, finance investment in another country.

There are similar uncertainties surrounding TNC reactions to a deflationary policy or an industrial policy undertaken by the government of a country.

TNCs could decide, on the basis of evidence available to them, that long-term prospects are more favourable in some other country than the one pursuing an industrial policy. National firms can be prevented from investing abroad, but TNCs can get around this through manipulation of their internal transfer price, thus increasing the burden of taxation on the national firms.

Again, while countries may want to expand their economies in a particular sector, TNCs might want to pull out of those activities in the country concerned, thus frustrating national efforts to diversify. Even the pace of technological change and international competitiveness have created problems between TNCs and governments.

TNCs, Panic further points out, are also in a position to frustrate the effectiveness of monetary policy significantly, since their source of funds is not confined to a single country. By their borrowing policies, they can nullify a central bank's effort to increase or reduce the money supply inside a country.

Similarly, TNCs can also frustrate income policies, used after the war in many industrialized countries. They can also similarly frustrate social policies.

There is nothing malicious in any of these actions of TNCs. Each is perfectly rational from a corporate point of view. But conflicts between a national policy and that of a TNC can arise out of differences in background and tradition between those running TNCs and those running national governments.

In developing countries, the presence of TNCs could give rise to a number of problems associated with the emergence of "dual economies" which are particularly difficult to solve. While conflicts can arise with national firms too, there can be little doubt that given their dominant position in many national economies, TNCs are able to exert considerable influence on government policies and significantly change economic and social policies.

Conflict

Thus, conflicts are likely to arise between TNCs pursuing narrow commercial objectives and national governments trying to discharge wider economic, social and political responsibilities placed on them by their electorates, says Panic. The impact of TNCs on national economic policies may be such as to seriously undermine the authority of the "nation" state - the only institution capable of providing economic and political stability, and without which TNCs would find it difficult to function effectively, and consequently justify their character.

This does not mean that TNCs have made governments irrelevant, even less that they have affected all states equally. Governments of large countries still retain considerable freedom to pursue policies in the national interest - their economies are much more self-sufficient than small economies and the size of their markets, combined with institutional uniformity and greater independence and predictability of policies, ensures that TNCs cannot afford to be excluded from them.

"Nevertheless," concludes Panic, "the ubiquity and economic power of TNCs raise important questions concerning the existing responsibilities of nation states and transnational corporations."

"Are electorates still justified in expecting national governments to effectively discharge the responsibilities which a larger form of political organization seems to require?"

"Equally important, are national authorities right to demand no more from TNCs in terms of wider economic and social responsibilities, than they do from small national enterprises?" This last question of Panic's appears to go to the heart of the debates on international investment and other multilateral rules, where there is a demand from the powerful home countries of TNCs that they should be able to get "national treatment", that is rights no less than those accorded to national or domestic firms and obligations no more than those required of national firms. (Third World Economics No. 191, 16-31 August 1998)


by : Chakravarthi Raghavan, the Chief Editor of the South-North Development Monitor (SUNS)from which the above article first appeared.