The Globalization Paradox

Democracy and the Future of the World Economy

Dani Rodrik October 2011

The magic of markets?

Milton Friedmans pencil story, retold

Three related paradoxes

Markets have worked best where governments have been strong, not weak The greatest benefits of globalization have gone to those who have opened up selectively (the mosquito net approach) Globalization works best when it is not pushed too far

The building blocks: three key ideas

The extent of the market is limited by the scope of workable regulation/governance
A corollary to: Adam Smiths The division of labor is limited by the extent of the market. Markets need a wide range of non-market institutions. They are not self-creating, self regulating, self stabilizing, self-legitimizing. Markets cannot work properly and be politically sustained in their absence.

The main locus of legitimate governance remains the nation state.

That is where democratic deliberation resides Transnational forms of global governance likely to remain weak at best

There are legitimate differences across nation states on the shape that regulatory institutions ought to take
Differences in history, culture, levels of income result in divergences in needs and preferences

The history of globalization viewed through the prism of a trilemma

Hyperglobalization Golden Straitjacket

National sovereignty

The Gold Standard model: narrow domestic policy space in macro, financial, tax, structural and other domains to minimize impediments to free flow of capital and goods

The history of globalization viewed through the prism of a trilemma

Hyperglobalization Golden Straitjacket

National sovereignty

Democratic politics

Problem: historically, this model has not been compatible with democracy (Great Britain 1931, Argentina 2001, Greece today?) Thomas Friedmans Coke and Pepsi analogy

The history of globalization viewed through the prism of a trilemma

Hyperglobalization

National sovereignty Bretton Woods compromise

Democratic politics

The Bretton Woods compromise: maximize democratic legitimacy at home Keynesian macro policies + welfare state + economic restructuring

The history of globalization viewed through the prism of a trilemma

Hyperglobalization

National sovereignty Bretton Woods compromise

Democratic politics

An explicitly incomplete globalization: Keynes and capital controls; The GATT model in trade

The history of globalization viewed through the prism of a trilemma

Hyperglobalization

Inadequate regulation

Inadequate legitimacy

National sovereignty Bretton Woods compromise

Democratic politics

Problems of the post-1990 model: push for hyper-globalization without the institutional infrastructure WTO + financial globalization Failures of legitimacy (trade) and of regulation (finance)

The history of globalization viewed through the prism of a trilemma

Hyperglobalization Global governance

National sovereignty

Democratic politics

A third alternative: global governance Requires significant restraint on national self-determination and therefore regulatory, institutional, and policy diversity

The political trilemma of the world economy

Hyperglobalization Golden Straitjacket National sovereignty Bretton Woods compromise Democratic politics

Global governance

Pick two, any two

The European Union: the exception that proves the rule

Objective: construct a regional version of global governance to underpin single European market Impressive institutional achievements
European Parliament, European Commission, European Court of Justice, Acquis communautaire (100,000 + pages) ECB and Eurozone

Yet institutional incompleteness has left the EU badly exposed to the crisis
The EUs misfortune is that the financial crisis caught it halfway in its process of institutional integration

Implications of EUs incomplete political union: a comparison with the U.S.

California shares a common currency with the rest of the U.S., just as Greece and Ireland does with the Eurozone But when the state of California becomes insolvent:
Californians automatically get welfare checks and other transfer payments from Washington CA borrowers do not get shut out of credit markets
because they operate under a federal legal regime and the state cannot interfere in their operations

The Federal Reserve stands ready to act as a lender of last resort to any Californian bank CA interests are represented in Washington and push for remedies (e.g., fiscal spending) Californians can easily move and seek jobs elsewhere in the U.S.

In return, there is no expectation that Washington, DC will bail the state govt. out
no bail out is rendered credible by above mechanisms, which limit the economic/political fallout

Implications of EUs incomplete political union: a comparison with the U.S.

Because the state of CA has no sovereign powers, it is effectively just like any other borrower The quid pro quo in the U.S.:
CA has given up its sovereignty and has accepted the reach of federal laws and regulations In return, CA is part of the governance structure in Washington

None of these things is true in Eurozone Consequently, a crisis within the Eurozone is more costly both in economic and political terms
Ad hoc arrangements to extend credit rather than automaticity Protracted financial crisis and deeper economic recession Mutual resentment on both sides
Complaints of German selfishness versus transfer union

... which ultimately threaten the survival of Eurozone

The political trilemma applied to the Eurozone

Golden Straitjacket Sustainable economic union Fiscalpolitical union National sovereignty Break-up of Eurozone Democratic politics

Either more political union, or less economic union

Globally, national sovereignty isnt withering away anytime soon

The balance of global forces is becoming more centrifugal The supply of global leadership will be in short supply Therefore we need to moderate our ambitions on global governance

Declining role of U.S. in global economy EU likely to remain preoccupied with own matters China and the other emerging powers place, if anything, greater emphasis on national sovereignty

Global governance light

A set of traffic rules that create policy space to allow:

rich nations to provide social insurance, address concerns about labor, environmental, health, and safety consequences of trade, and shorten the chain of delegation poor nations to position themselves better for globalization through economic restructuring all nations to create financial systems and regulatory structures more attuned to their own conditions and needs

Policy space need not be result in slippery slope to protectionism

The misleading analogy of global commons: open trade and financial policies are semi-private goods Democratic politics can malfunction, but it is locals who pay the bulk of the costs
e.g., agricultural subsidies

Improved deliberation at home, not external constraints, is the right answer to democratic malfunction