A quarterly magazine of the IMF

December 2002, Volume 39, Number 4

The reality of globalization

Theodore H. Moran

Brookings Institution Press, Washington, 2002, v + 196 pp., $46.95/�34.75 (cloth), $18.95/�13.95 (paper).

Attitudes toward foreign direct investment (FDI) have vacillated considerably over time. By and large, outside the communist world, the public favored FDI until the 1960s, when multinational corporations began to draw public criticism for earning their profits at the expense of host countries and dictating their policy agenda to local governments. This change in attitude was followed by the nationalization of foreign assets in many developing countries. After the 1980s debt crisis, FDI regained favor as a more stable alternative to often volatile short-term debt. In recent years, multinational corporations have once again become the targets of vociferous attacks, especially on social and environmental grounds.

Theodore H. Moran focuses on the social impact of foreign companies and their contribution to the development of host countries. The great strength of his book is its large quantity of solid, detailed, and up-to-date empirical evidence. In fewer than 200 pages, the author covers a large field, ranging from the quality of jobs offered by foreign firms operating in developing countries, to concrete strategies for attracting FDI and industrial activity in general, and core labor standards and the institutional mechanisms through which they may be applied.

Moran dispels the notion that most FDI is concentrated in low-wage activities. He presents industry-specific stock, flow, and wage statistics that show that relatively high wage activities outnumber low-wage investment by more than 10 to 1. In host countries whose governments provide suitable educational and physical infrastructure and encourage national and international competition, foreign firms tend to move into increasingly high wage and high value-added production. While many factories do have deplorable labor conditions, Moran shows that it is largely a matter of financial self-interest for firms to take the steps necessary to attract and maintain a more contented and better-trained labor force. Indeed, one of the pillars of successful development is the subcontracting and local purchases by multilateral corporations, which lead to the expansion of dynamic industrial clusters. For its part, the host government must liberalize imports and provide good macroeconomic policies, the necessary infrastructure, and training opportunities—which Moran calls a "building up" rather than a "trickling down" approach to incorporating foreign direct investment into national development. Such a strategy also benefits local firms—whose social and environmental standards are generally lower than those of foreign companies—by eventually creating incentives for them to improve their performance.

In the countries that export capital, the author shows that the complementarity between outward investment and exports is strong. These countries' interests are best served by policies supporting investment, accompanied by programs designed to compensate individuals who lose as a result of FDI abroad. The book will be of interest to readers concerned with the pros and cons of core labor standard enforcement in developing and transition countries. On balance, Moran favors voluntary mechanisms over enforcement through the World Trade Organization to bring about such changes.

Beyond Sweatshops should be mandatory reading for anyone interested in the reality rather than the rhetoric of globalization.

Guy Pfeffermann
Chief Economist and Director of
Economics Department, IFC

Correcting the failures of the past

Sakiko Fukuda-Parr, Carlos Lopes, and Kahid Malik (editors)

Capacity for Development
New Solutions to Old Problems

London, United Kingdom/Sterling, Virginia, published by Earthscan in association with the United Nations Development Program, 2002, x + 284 pp., �48.00/$79.95 (cloth), �17.95/$29.95 (paper).

This book reexamines the problems associated with capacity building and their possible solutions, bringing together the views of eminent development professionals, academics, and policymakers. Drawing on analyses carried out in the 1980s and 1990s, it explores ways to make technical assistance less expensive and less dependent on foreign experts with little accountability to the recipient countries. It attributes the failure of donors' past efforts to two factors: first, donors have ignored existing local and national knowledge (including that of civil society groups), and, second, technical cooperation has been driven not so much by recipient countries' needs as by donors' priorities.

The design of policies, institutions, and programs that can help developing countries achieve sustainable capacity building will have to take into account the existing momentum for societal transformation, the importance of local ownership of policies and capacity to achieve national goals, the asymmetry of donor-recipient relationships (which has resulted in a lack of commitment on the part of recipients), and the developing countries' need for access to new technologies.

Kahid Malik argues that, even in those rare instances when policies and institutions are right, ignoring social issues will result in an unviable development path. A chapter on civic engagement and development argues that when citizens are actively engaged, a more accurate flow of information translates into better decisions and better implementation. Another chapter explores the social capital needs of industrial transformation, drawing on east Asia's experiences. Although the author, Sanjhaya Lall, concludes that certain elements of social capital can be fostered, he offers no recipe for how to do this.

The final section reviews the implications of technological transformation for knowledge, information, and national development. Sakiko Fukuda-Parr and Ruth Hill conclude that the electronic age is providing a new model of development cooperation by creating new channels for sharing knowledge, opening up access to information, and building capacity. Most important, this new environment is encouraging South-South flows of information.

This timely book is essential reading for all development professionals and policymakers concerned with capacity development.

Bassirou Sarr
Advisor,
IMF External Relations Department

Jagdish Bhagwati

Free Trade Today

Princeton University Press, Princeton, New Jersey, and Woodstock, Oxfordshire, England, 2002, ix + 128 pp., $24.95/�17.95 (cloth).

Douglas Irwin

Free Trade Under Fire

Princeton University Press, Princeton, New Jersey, 2002, x + 257 pp., $27.95 (cloth).

Jagdish Bhagwati and his former student Douglas Irwin have devoted much of their careers to defending free trade. In these two new books, they present fresh arguments and examples to support their position. Unlike other economists, trade economists are almost religiously committed to bringing their message to the public policy debate. Why are they willing to descend from their ivory towers? The answer becomes clear as the authors argue three essential points: free trade is good; however, this may not be clear to the general public; and groups with special interests are against free trade.

Trade economists generally agree that free trade does more than any other trade arrangement to improve national welfare. This remarkable consensus is supported by a theoretical tradition, to which Bhagwati has greatly contributed, and by historical evidence, as documented by Irwin. Free trade is thus much less susceptible to criticism than other policy recommendations of the so-called Washington consensus that are based largely on disparate lessons drawn from recent history and lack a coherent theoretical framework. Thanks, no doubt, to this meeting of minds, trade economists are less consumed by internal academic disagreements than other economists and can take the time to contribute to the public debate.

The virtues of free trade, however, are not always clear to the general public. Bhagwati reminds us that Paul Samuelson named comparative advantage as the most counterintuitive yet compelling proposition in the social sciences. To my mind, free trade has fallen victim to the increasing and unrealistic expectations that have accompanied its adoption in many countries. As these high short-term expectations are not met, the public becomes disappointed with the trade reforms themselves. Wisely, both authors clarify what free trade can and cannot achieve.

Free trade benefits the economy as a whole, but some groups may lose and thus have a powerful interest in opposing free trade. As a consequence, the political process tends to be biased against free trade. The trade economists' "public mission" is to reequilibrate the debate and articulate the reasons for free trade. It is a heroic battle of ideas against special interests.

Although both authors share the convictions noted above, they defend them in different ways. Bhagwati, an eminent trade theorist, uses deductive reasoning to show how specific arguments can be classified within a larger framework. Irwin, who is mostly an empirical trade economist and historian, documents several facts and from them draws general lessons. Two points suffice to illustrate the authors' different ways of arguing.

Bhagwati shows how standard trade theory can provide answers to many new concerns, such as the effects of trade on the environment. He describes how many criticisms of free trade can be grouped under the general objection that it is unambiguously beneficial in an ideal, frictionless world but could be harmful in the real world with all its imperfections. This conventional criticism has assumed new forms as the public worries about, say, the environment or labor standards. The argument seems so persuasive that even some supporters of free trade have misgivings about its effects. The answer to these doubts comes from an influential paper written in 1963 by Bhagwati and V.K. Ramaswami that shows it is not optimal to address domestic distortions with trade policy but rather with domestic policies coupled with free trade. The general lesson is that the instruments of trade theory can be used to analyze even new concerns and that free trade is still the preferred policy.

Irwin's book is a fascinating account of how institutions matter. For instance, he describes U.S. trade policy since the last century, focusing on the Great Depression. The 1934 Reciprocal Trade Agreements Act, implemented for the myopic reason of expanding the demand for exports through bilateral agreements, delegated the power to negotiate tariffs to the president, reducing considerably the veto power of the congress. This institutional change shifted the balance permanently in favor of free trade in the United States and, ultimately, in a large part of the world. It is a useful reminder for economists working in international financial institutions that how a crisis is solved is as important as solving it.

Overall, both books show how free trade almost always improves national welfare according to economic theory; moreover, in the few cases in which theory is ambiguous (for instance, free trade could worsen income distribution), there is no solid empirical evidence that free trade is harmful. The bottom line is that free trade should always be adopted.

Will these two books convert the unfaithful? Probably not. I suspect that several forces that are not yet fully understood shape attitudes toward trade. Many arguments could sound like St. Thomas's proofs of the existence of God: they are absolutely compelling if you are already a believer. Nonetheless, both books are excellent. They provide a fine mixture of solid theory and new evidence and will be useful to anybody interested in economic policy in general. They will also provide people who are convinced of the benefits of free trade with new arguments.

Antonio Spilimbergo
Economist
IMF Research Department

Worth enduring the smoke

Robert J. Barro

Nothing Is Sacred
Economic Ideas for the New Millennium

MIT Press, Cambridge, Massachusetts, and London, England, 2002, xix + 169 pp., $24.95/�16.95 (cloth)

This book isn't for everyone. Some will be put off by Barro's market fundamentalism, others by the application of economic analysis to areas often considered beyond the domain of economics. But for those outside these two groups, reading this collection of essays will be like sitting down with a bag of peanuts: intentions to limit yourself to just a few will soon fall by the wayside.

Barro's direct interventions in the policy arena have been limited; they have also been unsuccessful, as he reveals in several essays that deal with his advice to countries on choosing an exchange rate regime. In one, he describes being whisked away to Moscow from his Cape Cod vacation in the summer of 1998 to advise the Russian government. His advice that Russia set up a currency board was not taken. In another essay, he notes that his advice to South Korea to adopt the dollar as its currency and abandon its resistance to foreign ownership of the country's banks led him to be pilloried as a Yankee imperialist.

Undaunted, Barro continues to advocate extreme monetary arrangements for emerging markets and developing countries. For instance, he says that Mexico is an "excellent candidate" for dollarization, given its high degree of integration with the United States. Mexico's reluctance to give up the peso, Barro says, is "similar to its unwillingness to abandon public ownership of oil. If [Mexican President Vicente] Fox would give up both things, he would make a great contribution to Mexico." For Argentina, Barro recommends full dollarization combined with a free trade agreement with the United States.

Barro does note that currency boards can succeed only if there is "an effective economic team and a broader program that includes fiscal discipline, legal reforms, and improvements in the banking system." But he fails to add that the evidence is mixed on whether countries are indeed carrying out such reforms. Perhaps his view would be that, if countries cannot carry out these reforms under the straitjacket of a currency board, they would find them difficult to carry out under other exchange rate arrangements.

Why are some countries rich and others poor? This question is the topic of several essays. To Barro, the evidence shows that poor countries can raise their incomes by maintaining secure property rights, promoting the rule of law, fostering free markets domestically, and opening up to international trade. Macroeconomic stability helps, as do investments in education and health and some forms of infrastructure. What do not help growth are policies that Barro refers to as "soft"—promotion of democracy, education directed specifically at women, environmental protection, elimination of income inequality, and promotion of civic organizations and social capital.

Discussing debt relief for poor nations and his encounters with U2 lead singer Bono—who advocates such relief—Barro observes that it's "money for nothing." However, like many middle-aged men with teenagers to impress, he is pro-Bono.

Rounding off the book are vignettes of famous economists. Robert Lucas comes in for particular admiration, but even here cost-benefit analysis makes an appearance. Barro notes that when he was Lucas's colleague at the University of Chicago, he had a sign in his office "that said: 'No smoking except for Bob Lucas.' It was worth enduring the smoke to talk to Bob but not to any other economist-smoker."

Prakash Loungani
Assistant to the Director
IMF External Relations Department