W1: The Globalization Paradox (Dani Rodrik)

Introduction

Rodrik offers an alternative narrative in this book on globalization:

Markets and governments are complements, not substitutes. If you want more and

better markets, you have to have more (and better) governance.

Capitalism does not come with a unique model. Economic prosperity and stability can

be achieved through different combinations of institutional arrangements in labor

markets, finance, corporate governance, social welfare, and other areas.

Rodrik’s political trilemma: we cannot pursue democracy, national determination, and

economic globalization.

His opinion: Democracy and national determination should trump hyperglobalization. Not the end of

globalization though, this is the paradox: create a thin layer of international rules that

leaves substantial room for maneuver by national governments is a better globalization.

1: Of Markets and States: globalization in history’s mirror

This first chapter is about mercantilism and companies acting as states. Today we think more like

Adam Smith; they believe that economies flourish when markets are left free of state control.

Competition, rather than monopoly, maximizes economic advantage.

The dichotomy between markets and states is false and hides more than it reveals. Market

exchange, and especially long-distance, cannot exist without rules imposed from somewhere; where

there is globalization, there are rules.

What distinguishes mercantilism from later versions of capitalism is that the job fell by and large on

private entities. When private companies could no longer perform those tasks – either because they

became too weak or competition from other nations undercut their rents – the crown had to intervene.

A contemporary economist would say that Hudson’s Bay Company were reducing transaction costs

in international trade to enable a degree of economic globalization. Institutions are social

arrangements designed to reduce such transaction costs. They come in 3 forms:

Long term relationships, build through trust and long term companionship.

Belief systems or ideologies (think about tribes, religious groups etc.). These two work best

at local or small scale – don’t have to travel over large distances.

Third party enforcement by institutions. Think about protection of property rights or courts.

Markets are most developed and most effective in generating wealth when they are backed

by solid governmental institutions. Markets and states are complements, not substitutes.

Cameron concluded that governments had grown the largest in those economies that were the

most exposed to international markets. Why? Rodrik researches this and comes to the social

insurance reason: the welfare state is the flip side of the open economy.

International trade and Finance entail inherently higher transaction costs than domestic exchanges

Conclusion paragraph of this chapter: Markets are not self-creating, self-regulating, self-stabilizing or selflegitimizing. Every well-functioning market economy blends state and market. Hence global markets are

problematic: they can lack the institutional underpinnings of national markets and they fall between

existing institutional boundaries. This dual curse leaves economic globalization fragile and full of

transaction costs, even in the absence of direct restrictions on trade and cross-border finance.

 1 / 3

2: The rise and fall of the first great globalization

What made the seventeenth and eighteenth centuries the era of globalization?

New technologies – like canals, steamships etc.

Economic narrative changed as the likes of Adam Smith and Ricardo got some action.

From the 1870’s on, the adoption of the gold standard enabled capital to move internationally

without fear of arbitrary changes in currency values or other financial hiccups.

Two reasons from this book:

Convergence in belief systems among the period’s key economic decision makers.

Imperialism; as a type of third party enforcement with the governments of the

advanced countries as the enforcer.

The lesson: depending on where a country stands in the world economy and how trade policies align

with its social and political cleavages, free trade can be a progressive or a regressive force. Britain

was the industrial powerhouse of the world in the mid-nineteenth century and liberal trade policies

favored manufacturing interest and the middle classes. The US was an industrial laggard with a cost

advantage in slavery-based plantation activities, where liberal trade policies would have benefited

repressive, agrarian interests.

The globalization of the nineteenth century was not based as much on fair trade as is often portrayed.

Policies of empire – formal or informal – clearly promoted trade, but they were based on the naked

exercise of power by the metropolitan countries and hardly presented free trade in the true sense of

the term.

The gold standard: rested on a few rules. Each national currency had its gold parity, which pegged

its value rigidly to gold. E.g. a country with a deficit on its foreign balance of payments would lose

gold to its trade partners, and experience a reduction in its money supply. Under gold standard rules,

governments had no ability to muck around with monetary policy to alter domestic credit conditions,

because domestic money supplies were solely determined by gold and capital flows across national

borders.

The gold standard and financial globalization were made possible, just as with free trade, by a

combination of domestic politics, belief systems, and third-party enforcement. When these forces

weakened, so did international finance. It leaded to the collapse of the gold standard in the 1930s.

The gold standard had come under pressure before, in the 1870s. What was different this time? First

economics; union membership meant that a sustained monetary contraction due to a gold outflow

would result in sustained unemployment. Second politics; they could no longer remain aloof from

the political consequences of economic recession and high unemployment. Third, economics again.

Once financial markets question the credibility of a governments’ commitment to a fixed parity, they

become unstable speculative attacks: investors sell the domestic currency buy foreign currency

move capital out of country. If currency is devalued, they will make tons of money.

Britain’s fate with the gold standard shows that monetary and financial rules such as the gold

standard don’t mix well with a modern economy and modern polity (democracy).

Domestic politics proved equally powerful during the 1930s on the trade front.

To conclude this chapter: the world economy had outgrown the classical liberal economic

order, but didn’t find a right alternative just yet p.46 examples – fascist and communist –

attention on domestic nation building instead of world trade/closed the borders to trade.

 2 / 3

3: why doesn’t everyone get the case of free trade?

Martyn has a “killer argument” for free trade: he compares it to technological progress (p. 49). His

point does not take into account why the other country (in his example India red.) has advantage;

which is because of comparative advantage, according to Ricardo.

What Martyn did not take into account, is how we account for labor costs that go into producing

different goods. The true cost to society of labor used in an activity may be more or less than what

the employer directly bears and the consumer pays for. The first is the social cost and the second the

private costs.

In the economists jargon, the resources used in international exchanges must be valued at

their true social opportunity costs rather than at prevailing market prices. this is the same with

technology; think of supporting R&D of universities by governments or restricting technological

progress in auto industry for safety reasons.

In first year economics, the professor draws a schedule of supply and demand and what happens

when you remove tarrifs. Two important notes that the teacher won’t tell you:

Income redistribution is the other side of the gains from trade.

The size of the redistribution swamps the net gain (50 dollar of redistribution for every

1 dollar of gain).

Here lies a big difference with technological gains:

Technology sees competitiveness as beating a rival to a patent e.g. In free trade,

the competitive advantage could come from lower health and safety standards e.g.

Everyone gains from the invention of light bulbs or cars e.g., but trade always hits people

with low skill, little education and low mobility.

Technology will continue to be important in the future, however free trade has diminishing

returns as trade becomes freer and freer, with the consequence that the distributional

effects begin to loom larger and larger.

Last bit of the chapter is about how economists generally oversell globalization and present it as

an “always good” kind of thing – which it isn’t.

Powered by qwivy(www.qwivy.org)

 3 / 3