House of Lords Enquiry on Globalization

Submission by Diane Coyle to the House of Lords Select Committee on Economic Affairs, Inquiry into the Global Economy, January 2002

I focus here on one aspect of a huge subject, the role of corporations in globalisation. The reason is that many myths have developed around multinationals, and they are in danger of swaying the political debate in ways that would harm the poorest of the poor and damage business.

ŒGlobalisation¹ is such a broad term that it can mean many things; it is, despite this potential for wooliness, characterised by a starkly polarised debate.

Its critics say globalisation increases inequality, pollutes the environment, causes economic instability, exploits workers and undermines the ability of governments to raise taxes and finance public spending and welfare. Such strong claims are clearly affecting the political climate. Public opinion reveals a deep scepticism about trade, financial flows and migration.

Yet there is a wealth of economic evidence demonstrating that globalisation brings great benefits as well as imposing some costs. It fosters a higher rate of sustainable growth thanks to increased efficiency, growth which translates into longer, healthier lives and improved living standards.

What¹s more, the evidence also shows that many of the charges against globalisation are misguided. It does not, for example, inevitably increase the inequality of incomes. Trends in income distribution have not been as negative as they are usually portrayed. Nor does globalisation in itself exacerbate poverty. The effects of increasing openness depend critically on the circumstances of individual contries and the policies they follow. There is similarly no evidence that governments are losing power to multinational corporations or other agents of globalisation, or that there is a Œrace to the bottom¹ in environmental or labour standards or taxation.

The chasm between the economic evidence and the popular view has perhaps emerged because global flows, of goods, capital or people, can indeed have adverse results whenever there are market failures or regulatory weaknesses. Policy needs to help limit or reduce the costs of globalisation.

It is vitally important that such policies be implemented. For the alternative, a backlash that would roll back some forms of international economic integration, could reverse some of the tremendous gains that have already occurred.

Big companies are clearly at the forefront of public suspicions, as reflected in both the non-fiction and fiction bestseller lists. Their behaviour has certainly changed radically, and very visibly, in response to globalisation.

The production of goods (and some services) by companies of all sizes but especially big corporations is being organised increasingly on a global basis. This is reflected in the growth in trade in intermediate goods, the goods which are inputs or components in the production process, and in the significant expansion of outsourcing. Components now account for nearly a third of world trade in manufactures.

Corporate ownership too has become more international. The clearest reflection of this is in the increased stock of foreign direct investment (FDI). There have been astonishing surges in FDI, in 1983-89 and again since 1993. This is mainly a phenomenon that has taken place within the OECD, with more than 60 per cent of the world stock of FDI in 1997 located in North America or the European Union, but flows of foreign direct investment to developing countries have also increased.

This increase occurred during the 1990s, and slowed down at the end of the decade. Greater macroeconomic stability compared with the 1980s helps explain why some developing countries started to capture a bigger share of the investment flows. There is also evidence that middle-income countries have increasingly been able to offer potential investors a pool of skilled labour. Multinationals are not drawn only by low wages, but also by labour skills and the presence of other firms in the same business generating the know-how that allows clusters of similar businesses to flourish. If low wages alone were enough of an attraction, more FDI would have flowed to the poorest countries in Africa, rather than predominantly to a small number of middle-income countries in Asia and Latin America.

In principle companies could choose to exploit workers in developing countries. But the evidence strongly suggests that workers in export sectors almost always have better wages and conditions than their compatriots in other types of work, which is the relevant standard of comparison. Workers in developing countries would almost certainly be made worse off by the imposition of industrialised country labour standards. Similarly it is very hard to find any evidence of a Œrace to the bottom¹ in labour standards triggered by competition for foreign investment. If anything, the reverse is true: exploiting workers reduces the pool of labour available to the investor and thus damage competitiveness.

Better labour standards would help poor countries, and the poor within them, but they must be set at appropriate levels and command wide support. Otherwise they will only be partially applied, pushing workers into unregulated sectors with lower wages and even worse conditions.

In addtion to reorganising their production globally, companies are also changing their business methods and organisational structures. Brands and business models have become more international. Internal structures are changing to reflect the internationalisation of the business. Cross-border mergers and acquisitions have grown dramatically in number and scale, although this is closely linked to the business cycle and is therefore likely to slow down.

These widespread changes have given rise to a number of claims about the increased, and by implication unchecked, power of multinational corporations. But there is no evidence that governments are losing power to multinationals. Take taxation, for example. It has become a commonplace amongst some critics of globalisation to say that the increasing freedom of capital to cross national borders is undermining the ability of governments to raise the taxes they need to finance their basic functions, and especially the provision of social insurance and basic welfare.

Multinational companies weighing up their foreign direct investment decisions do often explicitly compare the tax rates and the public services offered in a range of competing host countries. The pressure of competition means companies are usually seeking to contain or cut their costs.

Meanwhile governments are more and more competing with each other as well, in order to attract capital and retain skilled labour, and low taxation is one area of competition. Pessimists forsee three possible outcomes.

First, general levels of taxation and public expenditure could be lower than citizens would wish. Secondly, governments might distort the pattern of expenditure systematically towards the kinds of public goods and services that are valued by highly mobile firms and individuals, while ignoring those that are valued by the less internationally mobile. Thirdly, tax rates could end up higher for these immobile factors such as unskilled labour than is either efficient or fair, undermining the progressivity of the income tax system and under-taxing capital.

These are the fears. What about the evidence? It does not offer much support for the pessimists¹ case.

Even though the 1980s are widely thought of as a tax-cutting period, in the industrialised countries the tax burden continued to rise steadily, as it had risen in the 1970s.

Corporate tax revenues also climbed although the share of business taxes in that burden fell in a number of countries. As profits themselves were rising, the effective tax rate on profits probably fell in some countries, but certainly not all. What took the strain in those countries were mainly taxes on employment, which rose in Canada, Germany and Japan.

Overall, though, there is only weak evidence that greater mobility of capital has resulted in systematic changes in the tax structure, and no evidence at all that it has resulted in a fall in overall revenues compared to earlier periods. If anything, the continuing upward drift in the share of taxes in GDP suggests there may be a strong tendency for government to grow. If so, forces for reductions in some taxes due to globalisation could be a helpful corrective.

Taxation is not the only contentious area. Some critics diagnose a similar Œrace to the bottom¹ in environmental standards as a result of governments competing for foreign investment. But just as in the case of taxation the evidence does not back up the claim of declining standards. In fact, internationally mobile firms tend to use cleaner technology than others.

In another controversial area, the protection of intellectual property in global markets, the issues are different. Here the worry is not that powerful companies could play governments off against each other, but that governments of developed countries are protecting their own corporations, the owners of a vast amount of intellectual property, against the interests of the citizens of the poorer countries. The moral issue is very clear when the intellectual property in question is a drug patent, for example.

the intellectual property in question is a drug patent, for example. The design of an appropriate intellectual property regime has to find the best point on a trade-off between offering innovators enough protection to ensure the process of research and development continues in future, and not providing so much protection that demand for innovative products in new markets is curtailed.

Globalisation extends the markets for such products, increasing the potential reward to any innovator whether or not those new markets offer the same degree of intellectual property protection as the home market. It would be wrong for industrialised country governments to insist all these new benefits from globalisation should accrue to the existing patent holders. On the contrary, the benefits should be shared. There is, for example, no reason why companies making AIDS drugs should expect to be able to charge as high a price as they might like in developing countries.

But globalisation also makes it easier for imitators to compete with the innovating company in its existing markets. It is valid for industrialised country governments to seek to bar reimports of pirated software or CDs.

Finding the right balance is inevitably an empirical matter. There is no reason to believe that point has been reached, but of course negotiations between governments over the appropriate global intellectual property regime are still very much a live issue.

The prevalence of myths and errors about the facts of globalisation are having a malign effect on public debate. It is at times when the economy is changing rapidly that thorny political issues start to intrude into economic analysis. A recession offers changing circumstances of a particular kind, arousing tensions because of redundancies and corporate restructuring.

However, in recent years changes driven by technology and globalisation have also made the economy politically exciting again ­ exciting enough to get people rioting in the streets, at least before the terrorist attacks of 11 September.

Of course it is always true that economics, or even deep technical change, does not happen in a vacuum, but is constantly interacting with specific institutions and policies. So for example when commentators or campaigners talk about Œthe market¹ whether demonizing or sanctifying it, one has to ask: which market? The institutions matter at any time.

Certainly, radical new technologies always create social and economic tensions, and winners and losers. There is no reason to expect this current wave to be any different.

Indeed, there are clear signs it can undermine some important established interests. After all, we already have in the past 10-20 years many examples of complacent corporate managements becoming extinct, and of direct political opposition movementsbeing organised via the Internet, not least the anti-globalization movement itself. Without being too starry-eyed and simplistic about it, the Internet has created a presumption of free access to information. So perhaps this is actually a time of rare opportunity for have-nots and underdogs.

The anti-capitalist campaigners would regard this as naive: they simply do not believe that the changes visibly taking place in the global organization of production can be in anything other than the interests of the big, bad corporations and shadowy global elites. It is hard to argue with the claim that there are some cynically exploitative corporations and self-serving international elites whose main purpose is cementing their own role. But it is a mistake to think they are in control of the process of change. In fact, they are the ones who have created the Frankenstein¹s monster.

There are two reasons for being optimistic about the possibility that the New Economy has the potential to go hand in hand with a fairer society, and that it is incorrect to make the usual presumption that it is even more likely than the old economy to exploit the weak and reward the strong.

First of all, in an economy where value is increasingly weightless – or in other words, in the intellectual and creative content or the simply personal content of goods and services – mental labour is becoming the key productive resource. The constraint on output is for the first time the human input, not land or capital. Nor is this key input simply academic prowess, as often implied; creativity and originality and emotional skills are just as important.

Secondly, face-to-face human networks are now of unparalleled importance, a fact that has profound ramifications. One aspect of this is the well-known clustering argument. In industries where the knowledge content is high, it is essential for people to see each other to exchange ideas. While many industries have formed geographic clusters in the past, the highest tech industries and the most sophistcated services like finance are the most geographically concentrated. Like universities, it is impossible to convey the ideas without the personal contact. Knowledge spillovers, on which the growth process is based, depend on physical presence.

People on both sides of the employment relationship are investing in long-term reputations and building a high level of trust. Reputation is necessarily taking the place of legal remedies because it is impossible to write complete contracts. There are three reasons for this. One is that it is impossible to foresee all or even most of the likely contingencies in today¹s subtle and intangible economic transactions. Another is that it is hard to verify the outcomes. And thirdly, there are inadequate legal mechanisms to enforce a decision on whether or not the contract has been fulfilled. Whereas complete contracts were feasible in much economic activity in the industrial era, they are hard to contemplate in most knowledge-intensive businesses.

The issue for companies is how best to organise these repeated human interactions and reputation-building, and how to retain the human capital of employees who have successfully built their own personal reputation, a reputation which has economic value.

This is all the harder because information technology is forging new internal structures in big companies, and dispersing more widely information about the organisation, revealing conflicts and controversies. Secrets, once a great source of hierarchical power, are now extraordinarily hard to keep. IT is making more employees aware of what¹s at stake and better able to talk back. The more they see of the inner workings of the corporation, the more they understand the executive emperors are wearing no clothes. The lack of respect for established authorities that commentators have identified in many contexts also applies within corporations. Corporate command and control hierarchies are just inappropriate now in many industries.

In other words, a successful economy is an increasingly high trust economy. Companies in many leading industries have already found out they can not control and exploit the value added by certain employees.

The principle also applies at less rarified ranks of the job market. For a service business like a retailer, or indeed a provider of public services, it is going to be a bad service unless the quality of the employment relationship makes staff satisfied with their work.

This intuition underlies the new interest of economists in social capital. It is another way of returning to the old truth that the institutions of the market economy matter a lot, and there¹s no such thing as a market in the abstract.

So the leading economies are heading towards the complete opposite of the dog-eat-dog capitalism portrayed by their newly-vocal critics. What is alarming is that by making up their minds, in the teeth of all the evidence, that international free-market capitalism inevitably makes poor people worse off, this movement will cause us to squander an opportunity to shape the kind of economy and society that will emerge over the next few decades. It is much harder to be as optimistic about the politics of technological transformation as about the economics.

This submission draws on previous work in which I have been involved, including a forthcoming report on globalization (by a number of authors) from the Centre for Economic Policy Research, and my latest book, ŒParadoxes of Prosperity¹.