Far From Powerless

The latest World Economic Outlook from the International Monetary Fund says globalisation has served to accentuate the benefits of good policies and the costs of bad ones.

Why then do so many bewail the weakening of government? The answer is simple: they start from a deluded view of what government is for. They think of the st-ate as a wise and benevolent master whose job is to command the foolish and recalcitrant masses.

Such a government would indeed be constrained by globalisation. This is why countries with such ambitions such as members of the former socialist bloc have always attempted to control, if not eliminate, the interaction of their citizens with the rest of the world. Yet no sensible person should weep for the constraint imposed by international economic integration upon such ambitions. They should recognise the myth of the benevolent, all-controlling state as a mask for despotism. Instead, governments must be thought of as servants or perhaps partners. Their job is to provide the services their people need to live the lives they alone are entitled to choose.

What then, are the essential tasks of governments in an internationally integrated economy? And does globalisation prevent the state from achieving any of them?

The clearest lessons can be derived from the experience of developing countries because they have adopted such varying policies. The chart shows that income per head of developing countries, as a group, has hardly changed in relation to those of the advanced countries over the past 30 years. Developing countries remain very poor, but a number of economies Hong Kong, Taiwan, Chile, Malaysia, Indonesia, Thailand and China have started to close the gap quite rapidly.

How are these successful economies to be distinguished from the far more numerous failures? They do not, for example, all come from one civilisation, even though many are Asian. The IMF points to five determinants: the quality of governance, macroeconomic stability, openness to the world economy, the quality of investment, and the skills of the workforce.

Development is impossible where there is civil war or grossly exploitative, even murderous, government. That is evident. But even a proclivity for non-transparent and arbitrary interventionism will breed corruption, encourage lobbying for special treatment and subvert the law. Similarly, lack of macroeconomic stability undermines the confidence needed to undertake large-scale, long-term investment.

Openness to trade is perhaps most important of all, particularly for countries with small markets. Restrictions on profitable trade by African countries, for example, have led to a disastrous decline in their share of world trade from three per cent in the fifties to a mere one per cent today, Chile, by contrast, which has liberalised trade most completely, has the most successful economy in Latin America.

Quality of investment depends on several conditions, including the sophistication of financial intermediation; effective regulation of monopolies and the financial system; promotion of competition; protection of property; and limits upon normally inefficient state-owned enterprises.

Finally, the initial level of human skill has been significantly better in high growth countries than in less successful ones, with universal primary education particularly important.

These five points are merely a minimum agenda. But good governments can, or should, do more. In a recent paper (A framework for a development strategy in a market economy: objectives, scope, institutions and instrum-ents), Nicholas Stern and Joseph Stiglitz, chief economists of the European Bank for Reconstruc-tion and Development and the World Bank, add environmental regulation, aspects of health, the provision of a social safety net, policies to aid the transfer and development of technology, and systems to help promote savings.

For the most part, international economic integration will reinforce a states ability to deliver what is needed. This is automatically true of trade liberalisation. It is also true of macro-economic stability since capital flight will bring a profligate government to heel of improving the domestic environment for investment, and of constraining the worst abuses of government power.

Yet conflicts could arise. The most important of these is the fear that globalisation limits the capacity of governments to tax and regulate. To the extent that this is true, it has a beneficial side, since penal taxation and inefficient regulation will be curbed. But the ability to finance desirable public spending or impose necessary regulations, it is said, might also be reduced. But, in general, these worries are overdone.

Normally, people do not move in large numbers to escape the burden of taxation and regulation, provided the burden is not penal and they like what the taxes pay for. Moving countries is costly and risky. Direct and indirect taxes on labour income are far higher in most of Europe than in the US, but the skilled population is not flooding from the former to the latter. Capital, particularly portfolio capital, is far more mobile than labour. But companies will not move their entire stock of assets because of modest differences in levels of taxation or regulation, unless exactions become ruinous.

The proposition that the integration of world markets eliminates the capacity of states to tax and regulate is wrong. The government of an internationally integrated economy is far from powerless. It is merely somewhat constrained. On balance, competition among states within the global economy is beneficial. If states treat their people badly, there will be capital flight and, in extreme circumstances, even mass emigration of the more skilled.

The existence of many governments in a global economy can become problematic when the actions of one affects others. One obvious example is the environment. Then there is trade policy, where one countrys protection of vulnerable industry is anothers loss of vital export opportunity. Another is the failure to regulate financial institutions effectively.

Forget the myths that governments are impotent in an internationally integrated economy or that what they do is unimportant. The crucial question is how a multitude of often competing governments are to co-operate where that is necessary.

Half a century ago, an array of international institutions was created to help achieve precisely this. But their success depended on co-operation among a small number of largely like-minded western states. The challenge of the next half century is to make them more effective and more inclusive. It will be difficult. It must not be allowed to become impossible.

Martin Wolf