A quarterly magazine of the IMF

June 2001, Volume 38, Number 2

Although many commentators say we are living in a time of unprecedented global integration, the world economy was actually more integrated at the end of the nineteenth century. Despite increasing integration in some respects, today's world is in many ways fragmented and without coordination.

We read everywhere that international integration is proceeding rapidly as the result of the increased flow of trade, capital, money, direct investment, technology, people, information, and ideas across national boundaries. International integration implies the adoption of policies by separate countries as if they were a single political unit. The degree of integration is often tested by seeing whether interest rates or share prices or the prices of goods are the same in different national markets.

If we define integration as providing equal economic opportunities, however unequal the initial endowments and achievements of members of the integrated area, the world was more integrated at the end of the nineteenth century than it is today. Although tariff barriers in countries other than the United Kingdom were higher then (20 to 40 percent, compared with less than 5 percent now), nontariff barriers were much lower; capital and money movements were freer under the gold standard (that is, without the deterrent to trade of variable exchange rates); and the movement of people was much freer: passports were rarely needed and citizenship was granted easily.

Functions of an integrated system

Today, the four functions carried out by an integrated international system aiming to achieve development are fragmented. These are (1) the generation of current account surpluses by the center (that is, the dominant power); (2) the conversion of these surpluses by financial institutions into loans or investments on acceptable terms; (3) the production and sale of producer goods and up-to-date technology; and (4) the maintenance and, when necessary, use of military power to keep peace and enforce contracts. Before 1914, these four functions were exercised by the United Kingdom as the dominant power; between the wars, there was no international order, with the United Kingdom no longer being able, and the United States not yet willing, to accept these functions; for a quarter of a century after World War II, they were exercised and coordinated by the United States. But today we live in a schizophrenic, fragmented world without coordination. The current account surpluses were generated in the 1970s by a few oil-rich Gulf sheikdoms, later by the Federal Republic of Germany and Japan, and more recently—since the reunification of Germany—mainly by Japan. Financial institutions have mushroomed all over the world; they are not only in London and New York but also in Tokyo, Hong Kong SAR, Singapore, Frankfurt, Amsterdam, Zurich, the Cayman Islands, the Isle of Jersey, the British Virgin Islands, Cyprus, Antigua, Liechtenstein, Panama, the Netherlands Antilles, The Bahamas, Bahrain, Luxembourg, Switzerland, and elsewhere. And the economically strong countries such as Germany and Japan were strong partly because they did not spend much on the military.

Nontariff barriers to trade imposed by the member countries of the Organization for Economic Cooperation and Development (OECD) and restrictions on international migration have prevented fuller global integration. The result is deflation, unemployment, and slow or negative growth in many countries of the South. But the present fragmentation provides us, for the first time, with the opportunity to coordinate these four functions and to build a world order based on equality rather than dominance and dependence. It is a challenge to our institutional imagination to design ways to implement this new order.

Between 1870 and 1914, the world was integrated unwittingly. By imposing fewer objectives on government policy, and by accepting what, in retrospect, appeared to be irrational constraints—such as the gold standard and, consequentially, fixed exchange rates and lack of freedom to pursue expansionist monetary policies, and the discipline of balanced budgets—different countries were integrated into a single world economy. It was dominated by one power, the United Kingdom. Domestic policies were severely constrained by the need to adhere to the gold standard. Today the principal constraints on national policies are created by the activities of multinational companies and banks.

Later, many objectives of government policy were added to the night-watchman-state's duty to maintain law and order: among them were full employment, economic growth, price stability, wage maintenance, reduced inequality in income distribution, regional balance, protection of the natural environment, and greater opportunities for women and minorities. The rejection of constraints, such as fixed exchange rates and limits on the discretion of monetary and fiscal policies, led to greater integration of national economies by encouraging full employment and creation of the welfare state; but, at the same time, it led to international disintegration. Such disintegration is, however, entirely consistent with a high degree of international interdependence. For interdependence exists when one country by unilateral action can inflict harm on (or provide benefits to) other countries. Competitive protectionism, devaluation, deflation, or pollution of the air and sea beyond national boundaries are instances. A nuclear war resulting from international disintegration would be perhaps the ultimate demonstration of interdependence.

Interdependence is measured by the costs of severing the relationship (or the benefits of developing it). The higher the costs to one country, the greater is the degree of dependence of that country. If a small country benefits more from the international division of labor than a large country, its dependence is greater. If both partners to a transaction were to incur high costs from severing economic links, there would be interdependence.

Five qualifications

International interdependence is often said to be strong and to have increased. International trade is taken to be an indicator of interdependence, and its high and, with some interruptions, rapidly growing values are accepted as evidence of the increasing interdependence of nations. Between 1820 and 1992, world population increased 5-fold, income per head 8-fold, world income 40-fold, and world trade 540-fold (Maddison, 1995). Sometimes international financial flows are taken as the measure of interdependence. But five important qualifications to the notion that today's globalization is unprecedented, large, and increasing should be pointed out (see Streeten, 1989; and Wade, 1996).

First, if we consider the ratio of international trade to national income, the rapid growth of the postwar decades can be viewed as a return to pre-1914 values after the interruptions of two world wars, the Great Depression, and high levels of protection. (It is often said that globalization is irreversible. But history shows that it is highly reversible. After reaching a peak in the late nineteenth century, it retreated until after World War II.) The share of world exports in world GDP rose from 6 percent in 1950 to 16 percent in 1992. For the industrial countries, the proportion of exports in GDP increased from 12 percent in 1973 to 17 percent in 1992. For 16 major industrial countries, it rose from 18.2 percent in 1900 to 21.2 percent in 1913. (See Nayyar, 1995, pp. 3-4.) The latter increase was largely the result of dramatic reductions in transport costs, as well as of the decline in such trade barriers as tariffs and import quotas and of the opening of new markets such as China and Mexico. The comparisons in the ratios are very similar for particular countries. This increase in the trade/GDP ratios occurred in spite of a general increase in tariff protection between 1870 and 1913, especially during the last three decades of the nineteenth century. It was therefore not the result of trade liberalization. In the pre-1913 period of globalization, the role of the state increased rather than decreased.

The total ratios of trade to GDP are, however, misleading. Over the postwar decades, the share of services, including government services, in GDP increased enormously. Many of these are, or were until recently, not tradable. If we were to take only the ratio of international trade to the production of goods, it would show a substantial increase compared with not only the interwar period but also the period before 1913.

The second qualification to the notion that unprecedented globalization is now taking place is that the developing countries (and the groups within these countries) that have benefited from growing trade (and also from foreign investment, which is highly concentrated in East Asia, Brazil, Mexico, and now China) have been few, not more than a dozen, although their number has grown. Twelve countries in Asia and Latin America accounted for 75 percent of total capital flows, while 140 of 166 developing countries accounted for less than 5 percent of capital inflows (López-Mejía, 1999). A large share of foreign investment is made by firms from a handful of countries, in a narrow range of industries (UNCTAD, 1996). The large, poor masses of the Indian subcontinent and of sub-Saharan Africa have (at least so far) not benefited substantially from the growth of international trade and investment. In fact, the bulk of the international flow of goods, services, direct investment, and finance is between North America, Europe, and Japan. The least developed countries accounted for only 0.1 percent of total global investment inflows and for 0.7 percent of inflows to all developing countries. Africa in particular has been almost completely bypassed. The 80 percent of the world's population that lives in developing countries accounts for only 20 percent of world income (UNDP, 1997).

The third qualification is that direct foreign investment constitutes a smaller portion of total investment in most countries today than before 1914. Domestic savings and domestic investment are more closely correlated than they were then, implying that even finance capital is not very mobile. This is explained partly by the fact that government savings play a greater role today than they did in the past and partly by floating exchange rates, which increase uncertainties and are a barrier to long-term commitments. This qualification is reinforced by the fact that although gross capital flows are very large, net flows are not. Current account deficits and surpluses are now a much smaller proportion of countries' GDPs than they were between 1870 and 1913. During the 1980s, the United Kingdom ran a current account surplus that averaged 8 percent of GNP and invested it overseas, compared with 2-4 percent for the (west) German and Japanese surpluses (and the U.S. deficit). But the fact remains that this is surprising in view of the current preoccupation with the globalization of capital markets. The bulk of foreign investment has been the capital inflow into the United States and the outflow from Japan.

The fourth qualification is, as we have seen, that there is much less international migration than during 1870-1913. Barriers to immigration are higher now than they were then, when passports were unnecessary and people could move freely from one country to another to visit or work. Sixty million Europeans moved to the Americas, Australia, or other areas of new settlement. In 1900, 14 percent of the U.S. population was foreign born, compared with 8 percent today. (Electronic technology, however, has made labor mobility much less important than it once was.)

The fifth qualification is that it is not the volume or value or rate of growth of trade that should be accepted as an indicator of economic interdependence but rather the damage that would be done by the elimination of trade—that is, the effects on consumers' and producers' surpluses. These are difficult to measure. On the one hand, we know that much trade is conducted in only slightly differentiated goods, which could readily be replaced by similar domestic products without great loss to buyers or great increases in costs. There could, for example, be a large and rapidly growing trade in slightly differentiated models of automobiles, produced at similar costs, but there would not be much deprivation or loss if buyers had to substitute home-produced models for imported ones.

On the other hand, a small and slowly growing volume of trade could be of great importance and lead to substantial losses if it were cut off. Like a link in a bicycle chain, it could, though small, make a big difference to the working of the whole system. The United States, for example, depends heavily on quite small imports of manganese, tin, and chromium. Before World War I, trade was conducted largely as exchanges between raw materials and manufactured products, for which consumers' and producers' surpluses are large. Today the bulk of trade is intra-industry and even intrafirm trade of often similar manufactured products for which these surpluses are much smaller. Indeed, manufactured goods often contain parts from so many countries that it is not possible to attribute their origin to any one country.

Globalization, according to some definitions, means opening up to trade or liberalization. In the last decade, such liberalization was undertaken mainly by the former socialist countries, which turned away from central planning in order to link up with the world economy, and by the developing countries, which changed from import-substituting industrialization to export orientation accompanied by a partial dismantling of the state. This liberalization was not the result of entirely free choices, but was a response partly to global forces and to hopes of benefiting from global gains; partly to pressures exerted by the World Bank and the IMF when working with member countries on their stabilization and structural adjustment programs, as well as by the rich countries' support for doctrines of state minimalism.

Some OECD countries, however, have put up additional nontariff barriers, such as so-called voluntary export restraints; procedural protection, most notably in the form of antidumping actions; and specific subsidies to exports of goods and services competing with imports. The Multifiber Arrangement and the European Union's Common Agricultural Policy are blatantly protectionist devices. Other barriers have been raised against imports of steel, electronics, and footwear.

Trade is, of course, only one, and not the most important, of many manifestations of economic interdependence. Others are the flow of factors of production—capital, technology, enterprise, and various types of labor—across frontiers and the exchange of assets, the acquisition of legal rights, and the international flows of information and knowledge. The global flow of foreign exchange has reached the incredible figure of $2 trillion per day, 98 percent of which is speculative. The multinational corporation has become an important agent of technological innovation and technology transfer. In 1995, the sales of multinationals amounted to $7 trillion, with these companies' sales outside their home countries growing 20-30 percent faster than exports.

Conclusions

In addition to economic interdependence (trade, finance, direct investment), educational, technological, ideological, and cultural, as well as ecological, environmental, legal, military, strategic, and political impulses are now rapidly propagated throughout the world. Money and goods, images and people, sports and religions, guns and drugs, and diseases and pollution can now be moved quickly across national frontiers. When the global satellite communications system was established, instantaneous communication from any part of the world to any other became possible. It is not only the creation of a 24-hour money market that became possible but also the flashing of pictures of statesmen and film stars across the globe, making these faces more familiar to us than those of our next-door neighbors.

Although it is true that states are more constrained than they used to be—from above by global economic forces and from below by peoples (minorities, tribes, ethnic groups) asking for rights, participation, or independence—reports of their demise, as conveyed by the titles of such works as Sovereignty at Bay (Raymond Vernon), The Twilight of Sovereignty (Walter Wriston), and The End of the Nation State and The Borderless World (Kenichi Ohmae), are somewhat premature. The illusion of rapidly increasing globalization arises from a short time perspective covering only the last 30 or 40 years, at the beginning of which countries were exceptionally closed as a result of the Great Depression and World War II.

Views differ on the benefits and costs of the global mobility of such things as goods and services, finance, technology, and ideas. In a much-quoted passage, John Maynard Keynes (1933, page 237) wrote that "Ideas, knowledge, art, hospitality, travel—these are things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible; and, above all, let finance be primarily national." Today it is more fashionable to deplore the "cultural imperialism" or the "homogenization" of television and the mass media and the global spread of mass culture, and to attempt to confine culture to local knowledge, activities, and products while advocating free trade in material goods and services.

Neoliberals advocate free trade and a good deal of laissez-faire but not the free movement of people. The eighteenth-century French economist François Quesnay added to laissez-faire the concept of laissez-passer (unrestricted travel and migration), but this is forgotten today, perhaps because contemporary neoliberals fear that it would accelerate population growth (or reduce the pressures to reduce it) in the low-income countries providing the emigrants and therefore not contribute to raising their welfare, or that it would interfere with economic objectives (especially concerning the level and distribution of income), or cultural values, or social stability and cohesion, or security, in the countries receiving the migrants. But all these objections also apply to the free movement of goods and services. In any case, there is an inconsistency.

References:
John Maynard Keynes, 1933, "National Self-Sufficiency," Yale Review, Vol. 20 (Summer).
Alejandro López-Mejía, 1999, "Large Capital Flows: A Survey of the Causes, Consequences, and Public Responses," IMF Working Paper 99/17 (Washington: International Monetary Fund).
Angus Maddison, 1995, Monitoring the World Economy (Paris: Organization for Economic Cooperation and Development).
Deepak Nayyar, 1995, "Globalisation: The Past in Our Present," Presidential Address to the Seventy-Eighth Annual Conference of the Indian Economic Association, Chandigarh, December 28-30.
Dani Rodrik, 1997, Has Globalization Gone Too Far? (Washington: Institute for International Economics).
Paul Streeten, 1989, "International Cooperation," in Handbook of Development Economics, Vol. 2, ed. by Hollis Chenery and T. N. Srinivasan (Amsterdam: North Holland), pp. 1153-86.
United Nations Conference on Trade and Development (UNCTAD), 1996, World Investment Report 1996 (Geneva).
United Nations Development Program (UNDP), 1997, Human Development Report 1997 (New York and Oxford: Oxford University Press for the UNDP).
Robert Wade, 1996, "Globalization and Its Limits: Reports of the Death of the National Economy Are Greatly Exaggerated," in National Diversity and Global Capitalism, ed. by Suzanne Berger and Ronald Dore (Ithaca, New York; and London: Cornell University Press).

Paul Streeten is Professor Emeritus of Economics at Boston University and Founder and Chairman of the journal World Development. Among his books are Development Perspectives, First Things First, and Thinking About Development.