The Law and Economics of Globalisation: New Challenges for a World in Flux

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The Law and Economics of Globalisation

The Law and Economics of Globalisation New Challenges for a World in Flux

Edited by

Linda Yueh University of Oxford, UK

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© The Editor and Contributors Severally 2009 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library Library of Congress Control Number: 2009928592

ISBN 978 1 84542 195 3 Printed and bound by MPG Books Group, UK

P EE

Contents List of figures List of tables List of contributors 1

Introduction Linda Yueh

PART I

2 3

4

5

7

8

1

CHALLENGES OF INTERNATIONAL ECONOMIC LAW: WTO AND GLOBAL TRADE

The legitimacy of WTO law Thomas Cottier Constitutionalism and the regulation of international markets: how to define the ‘development objectives’ of the world trading system? Ernst-Ulrich Petersmann Negotiation or litigation? The curiously evolving governance of the WTO Kamala Dawar and Peter Holmes Global trade policy in the new century Razeen Sally

PART II

6

vii ix x

11

49

93 118

ISSUES CONFRONTING GOVERNANCE AND ENFORCEMENT

The development of IMF and World Bank conditionality Axel Dreher How globalisation improves governance Federico Bonaglia, Jorge Braga de Macedo and Maurizio Bussolo Intellectual property enforcement in a global economy: lessons from the BRIC nations Robert C. Bird

v

161 193

225

vi

The law and economics of globalisation

PART III

9

10

11

12

EVALUATING GLOBALISATION, THE GLOBAL ECONOMY AND ECONOMIC GROWTH

Dark matter. Does it matter? Graeme Chamberlin

243

Two scientists for every man, woman and dog in America? How sustainable is globalisation? Raphael Kaplinsky

279

Globalisation of the world economy: potential benefits and costs and a net assessment Michael D. Intriligator

299

International economic law and economic growth Linda Yueh

Index

315

335

Figures 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 5.13 5.14 7.1 7.2 7.A1 9.1 9.2 9.3 9.4 9.5

9.6 9.7

Anti-dumping measures Most frequent users of anti-dumping measures Distribution of GATS commitments across groups of Members, March 2005 Number of notified SPS measures, 1995–2001 Number of notified TBT measures, 1995–2001 Average applied tariff rates in developing countries, 1981–2005 Countries with capital controls Share of total tariff reduction, by type of liberalisation, 1983–2003 Unilateral tariff cutting in east Asia, 1980–2001 WTO members; countries that had signed the GATT RTAs in force by date of entry into force Noodle bowl syndrome in east Asia Noodle bowl syndrome in Africa Noodle bowl syndrome in the Americas A map of the links between globalisation, governance and national economic performance Corruption determinants Sample and estimated probabilities for the ICRG index Estimates of intangible investment by asset class in the US economy Business investment as a share of output, including and excluding estimates of intangible spending The US current account US foreign assets and liabilities The US international investment position as a proportion of GDP and its implied ratio based on US current account performance The US international investment position excluding the impact of exchange rate changes The US international investment position excluding the impact of ‘other’ changes

vii

124 125 125 126 126 128 131 133 134 135 138 141 142 143 195 200 220 246 247 249 250

251 252 253

viii


9.8

A puzzle in the US external position, positive investment income and a falling net asset position The rate of return on US foreign assets and liabilities The calculated rate of return on three broad classes of US foreign assets The calculated rate of return on three broad classes of US foreign liabilities A breakdown of the US IIP into three main asset classes A breakdown of US investment income into three main asset classes The official IIP and the IIP based on capitalising investment income (dark matter) in the US Recalculating the US current account using net exports of dark matter The contribution of reinvested earnings to the rate of return on direct investment The US terms of trade index (2000 5 100) US foreign direct investment assets and liabilities at current cost and market prices The US IIP on a current cost and market value basis Ratio of market price to current cost for US direct assets and liabilities The time path of US direct investment overseas and direct investment into the US Growth of GDP and exports from onset of rapid growth: China, India, Japan and Korea US and China trade balances Foreign direct investment to developing countries, 1990– 2004 World trade, 1950–2007 World GDP, 1950–2007 Growth rate of real per capita GDP and initial income, 1960–1995 Growth rate of real per capita GDP and initial income, 1996–2004

9.9 9.10 9.11 9.12 9.13 9.14 9.15 9.16 9.17 9.18 9.19 9.20 9.21 10.1 10.2 12.1 12.2 12.3 12.4 12.5

254 254 255 255 256 257 259 260 262 264 265 266 267 268 281 283 316 317 317 326 326

Tables 5.1 5.2 5.3 5.4 5.5 5.6 5.7 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 7.1 7.2 7.3 7.4 7.5 7.A1 7.A2 7.A3 7.A4 7.A5 7.A6 12.1 12.2

Bound and applied tariff rates Tariff rates in different regions Frequency of NTBs in developing countries 1989–2000 National regulatory changes on FDI, 1992–2005, by region World ranking in ease of doing business, 2007 Indicators for trading across borders, 2007 Percentile world rank of governance indicators for Asian countries, 2006 Conditions in IMF stand-by and extended arrangements, 1964–92 Distribution of World Bank conditions, 1980–88 Conditions in World Bank programs, 1980–88 Conditions in World Bank adjustment loans per sector, 1980–88 Conditions in World Bank Country Assistance Strategy Papers (17 programs), 1998–2000 Distribution of IMF Structural Conditions, 1987–99 Conditions in IMF Stand-By Arrangements (36 programs), 1999–2001 Conditions in IMF PRGF Arrangements (31 programs), 1999–2001 Corruption and explanatory variables: simple correlations Globalisation and corruption: OLS results Additional controls: cultural variables Globalisation and corruption: OLS and IV results Corruption and openness: comparative results Full ICRG and TI country samples Summary statistics, ICRG and TI samples Historical variables (for ICRG sample) Globalisation and corruption: OLS and ordered PROBIT results PROBIT results, interpretation of the coefficients PROBIT results, elasticities Aggregate reserves and currency trading, 1977–1998 Asian economies in comparative perspective before the Asian financial crisis ix

123 123 129 130 151 152 153 164 169 170 172 177 180 181 185 204 205 208 211 212 213 215 216 219 219 221 321 322

Contributors Robert C. Bird, Department of Marketing and Law, University of Connecticut, USA Federico Bonaglia, OECD, France Jorge Braga de Macedo, New University of Lisbon, Portugal Maurizio Bussolo, The World Bank, USA Graeme Chamberlin, Office for National Statistics, UK Thomas Cottier, World Trade Institute, University of Berne, Switzerland Kamala Dawar, University of Amsterdam, Law School, The Netherlands Axel Dreher, University of Goettingen, Germany, KOF Swiss Economic Institute, Switzerland, and CESifo, Germany Peter Holmes, Department of Economics, University of Sussex, UK Michael D. Intriligator, The Milken Institute, Department of Economics, University of California, Los Angeles, USA Raphael Kaplinsky, Department of Policy and Practice, The Open University, UK Ernst-Ulrich Petersmann, Law Department, European University Institute, Italy Razeen Sally, European Centre for International Political Economy, Brussels and on leave from the London School of Economics and Political Science, UK Linda Yueh, Department of Economics, University of Oxford, and Centre for Economic Performance, London School of Economics and Political Science, UK

x

1.

Introduction Linda Yueh

Globalisation is a phenomenon that has become pervasive in a world in which national boundaries are continually crossed by movement of people, goods, services, communication, among others. As the global sphere becomes more traversed, the dimensions of the global system become all the more important to understand, particularly in the face of the evolution of international economic law and growing global economic integration. This book aims to analyse the legal and economic issues confronting the global economic system and contribute to a better understanding of the law and economics of globalisation in the twenty-first century. The volume comprises a collection of papers by economists, lawyers, and other experts who critically assess key aspects of globalisation through examining the emerging issues and challenges from the viewpoint of their respective discipline. The chapters highlight the legal and economic challenges confronting the global system, including issues lying at the intersection of fields. Each article with its own and sometimes interdisciplinary lens will add to the overall cross-disciplinary argument by stressing how the challenges in the global system arise from the unique nature of international law as well as stem from the reach of globalisation into areas previously thought to be national concerns, including legal development, economic growth, and institutional structures. How the challenges are addressed will influence the development of the norms, institutions and scale of the global system. International economic laws and rules, though they have always existed, take on a formal institutional form of the World Trade Organization (WTO) established in 1995. The WTO was created as a product of the Uruguay Round of multilateral trade negotiations and supersedes the previous General Agreement on Tariffs and Trade (GATT) which had governed much of the post-war period. By July 2008, it counts 153 member countries, accounting for the near totality of world trade. Member countries have different terms of accession, but all subscribe to the principle of non-discrimination in trade arrangements among other members that characterises the spirit of the multilateral trading system. Although the coverage of the WTO is limited and a new round of trade liberalisation talks was 1

2


launched within a decade of its inception in 2001 (the Doha Round), there are several notable traits of the WTO that herald an era of international economic laws, rules, and enforcement. The rollback of the WTO would mark a reversion away from a rules-based global trade system where even powerful countries submit to the WTO dispute adjudication procedures to one that is again dominated by the bargaining power of nations, which would necessarily disadvantage poorer and borrower nations. The WTO and the other main economic supra-national organisations – the Bretton Woods institutions of the World Bank and the International Monetary Fund (IMF) – play a notable role in shaping economic globalisation as well as governance and economic growth. The United Nations constitutes another significant set of supra-national organisations, some of which are geared at economic development, for example, United Nations Industrial Development Organisation (UNIDO), but are less pertinent to global economic governance as compared with the Bretton Woods institutions and the WTO. Other notable international financial institutions (IFI) include the Bank for International Settlements (BIS) and regional ones such as the Asian Development Bank. Notably, the ‘Washington Consensus’, which referred to the stance taken by the World Bank and IMF, emphasised a belief in free markets which held sway particularly in the 1980s and 1990s and governed the economic policies and choices of many developing countries. This approach dictated the tenor of the poverty alleviation projects and liquidity provided by these institutions to developing countries, which came under much criticism during the financial crises experienced in the late 1990s. Likewise, the trade liberalisation principle embodied by the WTO had a direct effect on the policies and even laws of member countries. However, the WTO was felt to not have benefited developing countries as much as rich ones, which culminated in the Doha Round becoming known as the ‘development round’ whose remit was to even out the gains from globalisation. As global bodies, the implementation of their policies is necessarily at the national level. As such, the effects of the global economic system range from influencing legal reforms and governance arrangements, to the economic growth and development paths of affected countries – usually developing ones. The influence of the international organisations is undeniable. International economic laws, regulations and rules, therefore, are a key facet of globalisation as are the policies promulgated by the IFIs, particularly for developing countries. The challenges confronting international economic law matters significantly for economic development as countries increasingly rely on the global economy as a source of growth. Indeed, the law and economics literature focuses on the economic analysis of laws, which has understandably emphasised the impact of domestic

Introduction

3

laws given the later and more recent development of international economic law. However, the potentially significant effect of international economic rules warrants a similar investigation. Therefore, the economic analysis of international economic law forms part of the mandate of this volume, extending the law and economics literature from the analysis of the economic impact of domestic laws to one encompassing international laws of growing importance as global integration proceeds apace in the twenty-first century. How globalisation evolves and its ultimate sustainability will be related to not only the economic but also legal challenges faced, at both the international and domestic levels. Many of the chapters highlight the multilayered legal system at the international, regional and national levels. The development of the international economic system will depend on its integration into these various levels and an appreciation of the resultant political and economic ramifications. Likewise, international trade and economic growth policies will also require a multilayered approach that factors in the implications of this evolving system of economic governance. This volume covers the cutting edge issues in law and economics in the realm of globalisation, and its findings and recommendations for reform hold implications for the development of the global system at a time when the world is increasingly inter-connected but still feeling its way around the strictures and gaps in international laws and the supra-national institutions. The book is divided into three sections. The first focuses on the challenges confronting international economic law, the WTO and global trade; the second on issues arising in governance and enforcement; while the third shifts to evaluating globalisation and economic growth in such a global system. In the first section, the chapter by Cottier queries the bases for the legitimacy of WTO law. The expansion of international economic regulations culminating in the WTO created new legal foundations, including a dispute resolution mechanism, that has attracted criticism. He outlines the bases for questioning the legitimacy of the WTO, particularly in terms of the effects on developing countries, which were similar to the criticisms levied at the Bretton Woods institutions and the Washington Consensus. The complaint centres on the WTO not achieving its goal of promoting shared prosperity, but rather that its laws do not offer adequate differentiation between rich and poor countries which has caused objections to arise in both developed and developing countries. Procedurally, there are also objections raised regarding a lack of democratic legitimacy of the WTO, such as WTO law encroaching upon other domestic regulatory fields not sufficiently represented in trade negotiations and the imbalance in which

4


the system is tilted toward large trading partners who have the resources and expertise to negotiate and impose sanctions where authorised. The result is a call for limiting the WTO to its existing boundaries and the refusal of courts to grant direct effect to WTO law, including the United States and European Union. Cottier compellingly argues that the problems of legitimacy are in many ways a result of the stance taken by WTO members, who have the prerogative, and indeed should aim, to address and reform the system of international governance which is layered upon the domestic system in the globalised economy. Petersmann’s contribution further examines this issue and seeks to address the constitutional problems of national and intergovernmental economic governance. By situating the constitutional arguments in the context of the criticisms of the WTO by poor countries, Petersmann also argues for a shift from the paradigm of ‘member-driven governance’ in the WTO to one that defines development as individual freedom, consumer-driven competition and autonomous development of human capacities that is protected by constitutional rights which limit the abuse of power at national and international levels. By so doing, he effectively establishes that multi-level market governance requires multi-level constitutionalism and that international economic law should promote freedom, rule of law and peaceful international cooperation for the benefit of citizens. The next two chapters in this section shift from the legal perspective to a cross-disciplinary one and a view derived from international political economy to add to the picture of WTO law and global trade. The fifth chapter continues the discussion regarding the governance of the WTO, but from the interdisciplinary perspective of a lawyer and an economist. Dawar and Holmes examine the imbalance in the institutional structure of the WTO that has arisen as a result of the strength of the dispute settlement mechanism which has been successful while the political decisionmaking capacity of the WTO has experienced paralysis. The WTO and its dispute settlement body (DSB) have encouraged a number of criticisms, though. These include allowing trade law to override other economic and social priorities; developing case law when member states have not explicitly agreed the issue; and downplaying the focus on trade liberalisation that should be the core of the WTO mandate. They argue that the DSB has responded to the criticism by becoming more textual in its interpretations, but is struggling to remain within its mandates due to the gaps in parts of the trade agreements. By drawing on comparisons with the EU supra-national system, Dawar and Holmes persuasively argue for further politically-oriented institutional reform of the WTO so that the success of the DSB does not presage its failure. In this vein, the next chapter by Sally attempts to make sense of trade policy developments and liberalisation in

Introduction

5

the new century. He examines the attacks on the Washington Consensus, reviews the record on trade and financial liberalisation particularly in the developing world, and proposes a framework for multi-track trade policy that proceeds, often simultaneously, on unilateral, bilateral, regional and multilateral bases. In the context of a criticised global system, this political economy approach that draws on past lessons elegantly manoeuvres the multi-level global system. And, it could thus define how trade policies are likely to be formulated in the future. The first section therefore examines the foundations of international economic law, particularly the WTO and the evolution of global trade policy, while raising several issues at the frontier of this subject. The legitimacy, constitutional structure, and governance of the WTO and the implications for global trade are investigated. Importantly, reforms are proposed to secure better foundations for the legality of the global economic system. The second section of the book proceeds to examine issues confronting governance and enforcement resulting from the global system, particularly for developing economies. First, Dreher sets out the expansion in IMF and World Bank conditionality since the 1960s from an economic perspective. Conditionality refers to policies that are prescribed for developing countries receiving assistance from these global organisations. He argues that the expansion in conditionality follows from the accelerating globalisation in the past four decades, and leads to the globalisation of economic policies which exceeds the mandate of these bodies. It is particularly so when the policies are derived from the dominant shareholders of these institutions, which are western economies and most often applied to developing and transition countries. By interesting contrast, the economists, Bonaglia, de Macedo and Bussolo, argue that globalisation causes improved governance, but not through the explicit prescriptions of the global economic institutions. Using a large cross-section of countries over 20 years, they show that increased openness to international trade and global integration positively affects the quality of domestic institutions. They find that global integration leads to less corruption in the domestic economy – an important dimension of the globalisation and governance nexus. The mechanisms for this effect are trade policy, sensitivity of international investors to corruption, and openness-related differences in the costs of institution building. This important argument connects the global system indirectly to the domestic institutions that explicit policies have attempted to influence. In other words, whereas the policies and prescriptions of the supra-national organisations have not always been successful in reforming domestic institutions, the process of globalisation itself leads to improvements in

6


domestic institutional quality as countries vie to be competitive and take advantage of the benefits of the global economy. The final chapter in this section is by Bird who takes a legal perspective on the issue of the influence of international economic law on domestic systems. In particular, he examines the enforcement of intellectual property rights (IPRs) in the so-termed major emerging economies – the BRICs: Brazil, Russia, India and China. He shows that despite the strong international law governing IPRs, weak enforcement in these significant developing countries holds lessons for enforcing international economic law in a global economy. Bird demonstrates the weakness of coercion and instead proposes several alternative methods based on the policies, politics and legal systems of the BRICs. He is a proponent of a role for multinational corporations themselves to adopt strategies minimising imitation, improving the incentives for domestic companies in those economies to promote IPRs, and capitalising on the specific elements of the legal culture to increase protection of IPRs. The overall lesson is that coercion does not improve enforcement at the national level. Similar to the economists’ perspective, it is not the direct prescriptions that give rise to effective enforcement of international economic law either. Understanding the situation of particular countries and sometimes the indirect effects of international norms would be more relevant in fashioning policies. The third section of the volume tackles this point head on. Three chapters by economists evaluate different key aspects of the global economy and the ultimate sustainability of globalisation in the present system. The editor, an economist and lawyer, concludes the volume by examining the economic effects of international economic law on the growth prospects of the global economy. The contributors identify the salient, cutting edge issues to be considered in assessing the state of the global economy and the likely course and consequences of globalisation. Chamberlin starts off the section with a compelling look at one of the tough challenges for evaluating the global economy and the sustainability of its growth prospects, namely, the issues concerning the measurement of economic activity in a globalised world. He identifies two components of what has been termed ‘dark matter,’ that is, the measurement of intangibles and the influence of globalisation on the trade of those intangibles. For example, a big puzzle has been why US direct investment overseas has a much higher rate of return than foreign direct investment in the US itself. Is it because US firms not only purchase physical capital, but transfer their superior in-house software, R&D blueprints, organisational know-how and management acumen, and so on to their foreign affiliates? If these intangible exports (referred to as dark matter because they are not seen except through their impact on investment incomes) were measured,

Introduction

7

then the US external position may actually be more sustainable then conventionally thought. Using the experiences of the US economy, the chapter discusses the importance and validity of these issues and concludes that once understood, these issues can be tackled and an accurate picture formed as to the prospects of an evolving global economy. Kaplinsky’s chapter questions the sustainability of globalisation in light of four factors which have the potential to disrupt its progress, as was the case at the end of the nineteenth century. First, the disruptive potential of China and India; second, the environmental sustainability of continued globalisation; third, the insecurity of the logistical arteries of globalisation; and fourth, the countervailing political forces unleashed by growing inequality across the globe. He effectively outlines the causes and consequences of these forces unleashed by the very success of expanding globalisation, but concludes that just as nineteenth century internationalism could not proceed without disruption, it is unlikely that ever-deepening globalisation in the twenty-first century could do so. In a similar vein, Intriligator sets out his vision as to what economic globalisation entails. He then evaluates the potential benefits and costs of globalisation, but also considers the ways in which international cooperation and global institutions could better work to address those costs and challenges. He believes that there are both positive and negative aspects to globalisation; that the positive features derive from the increased competition across borders, but also that there are negative aspects such as growing inequality that can lead to conflict. Intriligator concludes that it is reform or creation of new global institutions which foster international cooperation which can redress the downsides of globalisation and ensure its progress. The economists’ viewpoint therefore brings the volume back full circle to the start of the book where the lawyers sought ways in which to strengthen the institutions and bases of international economic law to secure the continued trajectory of globalisation. The volume is then concluded by Yueh, who evaluates the effects of international economic law on economic growth in the globalising world. She sets out the ways in which law affects the models of economic growth undertaken by countries, particularly developing ones, and assesses the evidence of economic development in the current rules-based global system. Yueh highlights the effect on two factors thought to be crucial for long-run economic growth: technological progress and institutions. She analyses the direct and indirect effects of international law on technological advancement and institutional development, and assesses the limitations of such laws and also the way in which globalisation encourages the voluntary adoption of rules governing global markets. She concludes that one of the most significant benefits of globalisation is the imposition of a

8


rules-based global system that has the potential to level the playing field for developing countries attempting to gain from operating in the global economy. International economic law can also promote legal reforms, allowing developing countries to not only leapfrog technologically but also in terms of institutional development. This process, however, is fraught with challenges, particularly if informal institutional arrangements centred on trust and social capital are overlooked. An area which warrants continual examination is the cost of technology transfers, which have a direct impact on economic growth and which has become governed by international economic law. Globalisation has benefited the global economy in numerous ways, and the role of international economic law has the potential to transform the operation and prospects of the global economy in this new century. By drawing on legal and economic concepts and utilising the experience of developed countries like the US and regional groupings such as the EU as well as the lessons from the BRICs and other developing countries, this volume has presented the cutting edge issues confronting globalisation and the global economy. The different and cross-disciplinary lenses of the contributors have together wrought a volume that highlights the overlapping issues in this area and the benefits of viewing the global economic system from a range of perspectives. The foundations of international economic law rely on an evolving appreciation of economic processes, while the continuation of global economic prosperity in turn increasingly depends on the global rules-based system. It appears that globalisation, therefore, can be better understood by utilising a law and economic analysis. This volume provides a start to the process of assessing the new challenges confronting a globalising world in flux.

PART I

Challenges of international economic law: WTO and global trade

2.

The legitimacy of WTO law Thomas Cottier

INTRODUCTION The eighth General Agreement on Tariffs and Trade (GATT) cycle of Multilateral Trade Negotiations (Uruguay Round 1986–1993) brought about a substantial increase and expansion of multilateral rules and disciplines in international trade regulation. Beyond refining existing agreements, new regulatory areas were added, in particular the General Agreement on Trade in Services (GATS) and the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). A new framework agreement, establishing the World Trade Organization (WTO), created new legal foundations under which Members, the Secretariat and dispute settlement have been operating since 1995 (WTO 1999). Most importantly, the GATT dispute settlement mechanism was strongly reinforced. For the first time in international law, a two-tier system with the possibility of appealing the decision was introduced, removing the requirement for a positive consensus of Members. Incentives to comply were reinforced. Failing the implementation of rulings, complainant Members are not only entitled to obtain compensation in terms of market access rights; they are also entitled, subject to additional proceedings, to suspend market access rights and thus exercise economic sanctions within the multilateral framework of the WTO (Cottier and Oesch 2005: 143–194). These mechanisms both contain unilateral actions, but also reinforce multilateralism as they enjoy the blessing of Members. These achievements of the Uruguay Round have contributed greatly to the overall and impressive growth of world trade in the past decade. Millions of daily transactions are based upon the rules which have emerged over the past 50 years, offering legal stability and predictability in international trade relations. At the same time, the results of the Uruguay Round raised issues of legitimacy of WTO rules. Two main lines can be observed. On substance, they mainly relate to the issue of distributive justice in industrialised and developing countries alike. On procedures, arguments mainly address the shortcomings of the negotiating process and its unbalanced relationship to judicial dispute settlement. They challenge the legitimacy of WTO law mainly from the point of view of democratic accountability. 11

12


It may be argued that the multilateral system, for all the above reasons, is in serious crisis, if not in decline. Have the fundamentals of the Pax Americana, established after World War II, come to an end? Is the world falling back to bilateralism and perhaps unilateralism in the twenty-first century, putting at risk what has secured prosperity and peaceful relations among Members during the past 50 years of international trade? Is the world forgetting the lessons learnt from the failures of the League of Nations and the Versailles Treaty, which John M. Keynes expounded in his profound criticism of the power-based and retributive Post World War I order in 1919 (Keynes 1919)? Has civil society lost faith in multilateralism and its philosophy of creating equal conditions of competition? Do we truly face a crisis of legitimacy of the WTO, or are the causes to be found elsewhere? How can problems best be addressed in a forward-looking manner? It is important to address these issues during a period when the WTO risks falling apart due to lack of support and widespread and diffuse public beliefs in its unfairness in light of enhanced global competition and its impact on society around the world. The issue of legitimacy of the multilateral trading system of the WTO is therefore of profound importance. It has been widely discussed from different angles, law, economics and international relations, without conclusive results (Elsig 2007). This chapter takes up the matter from the perspective of multilayered governance, essentially looking at domestic and international processes and outputs in tandem. It offers a viewpoint and some suggestions for incremental structural reform from the point of view of constitutional theory.

THE CHALLENGES International trade regulation drew little public, or even academic, attention during the post-war period and the GATT years. Tariff negotiations were a matter for specialists. They were happy to conduct their business out of the limelight of world politics and the global stage. Things began to change with the advent of disciplines and rules on non-tariff measures, following the Kennedy Round and subsequent cycles. This culminated in the adoption of the WTO and the Uruguay Round Agreements. The debate until the Ministerial Meetings of Seattle and Singapore may be characterised by fears of a fatal attraction of the WTO: the advent of powerful dispute settlement and enforcement threatened to intrude into related policy areas, such as the protection of the environment, and to enlarge the jurisdiction of WTO rules to encompass labour standards, competition and investment law and policies. The difficulty of clearly separating different policy areas produced the risk of encroaching upon other fields

The legitimacy of WTO law

13

of international law. Environmental, cultural and human rights lawyers were afraid that standards henceforth would be defined by ignorant trade lawyers and economists (Cottier, Pauwelyn and Buergi 2005). Developing countries were afraid of losing flexibility and what came to be called policy space in shaping appropriate economic policies. They refused to adopt the so-called Singapore issues and declined to participate in negotiations on multilateral disciplines on competition and investment protection. A wide range of trade-and issues has been discussed in the literature, way beyond trade and environment; they have been largely left to be dealt with by case law of panels and the Appellate Body without substantially involving competent international organisations in the process of decisionmaking. In this debate and under enhanced scrutiny, the legitimacy of the WTO has been questioned on several grounds. The debate may be briefly summarised as follows. On substance, the main arguments relate to the status of, and impact on, developing countries, and in particular, the poor and the impact on least developed countries. These countries question the benefits resulting from the Uruguay Round, criticism comparable to that voiced vis-à-vis the Bretton Woods institutions and the Washington consensus of unilateral liberalisation and privatisation in the past. Such criticism partly addresses the results of the Uruguay Round and the obligations to implement them at home in developing countries (for example, Raghavan 1990). The WTO does not live up to its goal of promoting welfare and prosperity. Gains do not necessarily trickle down and the WTO thus contributes to an increasing divide between the rich and poor within countries as much as between countries. The structures implied by the WTO prevent countries from reducing poverty (Pogge 2005: 725). WTO law does not offer adequate differentiation between industrialised and developing countries. Special and differential treatment remains formal and without much impact on the ground. While the GATT and GATS follow the principle of flexible and progressive liberalisation, minimal standards set in the field of intellectual property are considered illegitimate as they prevent countries in development from benefiting from welfare-enhancing, creative activities commensurate with their level of development. Developing countries, it is argued, are subject to levels of protection which industrialised countries only adopted gradually and not at the outset. Also, it is argued that intellectual property protection is anathema to free trade and that it was an error to inscribe monopoly rights into the framework of the WTO in the first place. Partly, and more vigorously, the scepticism of developing countries has translated into objections to further expansion and liberalisation upon completion of the Round. Subsequent Ministerial Conferences witnessed the refusal to address labour standards, competition, investment

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and general rules on government procurement. The so-called Singapore issues faced challenges from developing countries and non-governmental organisations alike; also, they did not enjoy full support in industrialised countries. It was strongly felt that the WTO should stay within its existing boundaries. The Doha Development Agenda, adopted in December 2001, suffers comparable difficulties, albeit they are mainly caused by reluctance to substantially liberalise market access in agriculture and reduce domestic support on the part of industrialised countries, in particular the United States, the European Union and Japan. Short of adequate commitments in an area that suffers from 50 years of arrears following a de facto exclusion of agriculture from trade rounds, developing countries likewise are unwilling to undertake further market access commitments in nonagricultural products and services. Overall, they are under the impression that the WTO system does not pay adequate attention to their needs and aspirations. In addition, the entry of the People’s Republic of China to the WTO in 2001 has altered the fundamentals of trade and adds to the current reluctance to liberalise further in a period of booming international trade and pressures from Chinese imports. As a result, Members have turned away from pursuing their interests within the multilateral system and have largely been engaged in negotiating bilateral preferential agreements in the last decade. Most of these agreements are not fully compatible with the disciplines and conditions set out by the GATT and GATS. Criticism and doubts are also being voiced in industrialised countries. Workers losing jobs due to restructuring and outsourcing of production to more competitive regions face the downside of globalisation and question the legitimacy of open markets. Competition is accepted within a given community, but rejected in relation to countries operating under lower social standards and salary structures. Competition between unequals is perceived as unfair, and calls for enhanced protection for goods and services are being heard. Farmers are exposed to similar challenges, but are much more protected at borders and benefit from extensive programmes of domestic support. In procedural terms, the main objections relate to a lack of democratic legitimacy of the WTO and the imbalance created between negotiations and dispute settlement. The shift from addressing tariffs to second- and third-generation issues of non-tariff barriers including domestic regulation greatly expanded the number of stakeholders who did not form part of the inner circles of the GATT clubs. It raised increasing concerns as to the legitimacy of the WTO from the point of view of deliberate democracy (Krajewski 2001). First, it is argued that Government officials negotiate far-reaching obligations which unduly restrict the freedom of democratically elected legislators – the more so as WTO law tends to encroach upon


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other regulatory fields which are not sufficiently represented in trade negotiations. Second, the WTO is characterised by highly inefficient and uneven negotiations. They do not produce timely results with more than 150 Members negotiating on average. At the same time, the system lacks democratic accountability as major decisions tend to be taken by a small group of leading countries. This used to be the United States and the European Union. It now includes Brazil and India as key players. China is bound to join this group soon. Others are more or less condemned to follow in multilateralising results, despite the consensus principle, which in theory allows all Members alike to block decisions, but which in reality cannot be used by all to the same extent. Third, the elaborate and efficient system of dispute settlement has created an imbalance between negotiations and judicial decision-making. Members are not in a position to effectively react to precedents set by way of appropriate legislative response. The concept of trade rounds renders incremental changes of the law virtually impossible. Moreover, it is argued that developing countries are at a disadvantage in dispute settlement as they still lack expertise and the necessary resources to use the system fully to their own benefit. Moreover, the system is biased towards large trading partners as only they have at their disposal the necessary market size and power to impose effective trade sanctions authorised upon failure of another party to adjust its regulations and practices to WTO law. Finally, within countries, trade policy formulation often remains a matter for the executive branch. It is strongly influenced by producer interests and lobbies. The WTO does not require governments to take all pertinent domestic positions into account in trade policy formulation. Views expressed, and interests defended, by diplomats in Geneva, are by no means necessarily those reflecting the interests of large segments of the population. Finally, the challenges to WTO law also translate into the refusal of courts to grant direct effect to WTO law in most jurisdictions around the globe. Both the United States and the European Union have barred such effect in general terms. This chapter will deal with the main arguments in due course. Before doing so, it is important to address and clarify the understanding of the concept and notion of legitimacy, and how it relates to legality and the law.

PERCEPTIONS OF LEGITIMACY Trust and Voluntary Compliance with the Law The pairing of legality and legitimacy is relevant since the operation of the law essentially depends upon the match between the two. Overall, law

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essentially relies upon the trust and confidence of a given community. In the long run, it can work only where such trust and confidence in a given system exists, and thus rules are followed on a voluntary basis, short of coercion and the use of force. Most rules, both domestic and international, depend upon voluntary compliance in daily life. Coercion and constraint back them up; they are – other than in the Austinian tradition of legal theory – not a prime, but an additional qualification of law. Trust and confidence and thus voluntary compliance in return depend upon the perception that the law responds to basic precepts of justice and fairness and draws its inner authority from these qualities.1 This is particularly true for the decentralised structure of international law. Thomas Franck emphasises the importance of fairness, entailing legitimacy and distributive justice for the largely voluntary operation of international law (Franck 1988; 1995: 25). States comply with their obligations because they see the benefits of doing so. In weighing the pros and cons of compliance, the legitimacy perceived is a major factor. Binding rules considered to be unfair and unjust tend to be ignored in international relations unless pressures to comply are exerted. This is equally true for the multilateral trading system. It cannot effectively work and operate on a daily basis, providing the foundations of millions of transactions, without being perceived to be basically fair, and thus legitimate. Legality and Legitimacy On substance, law is considered legitimate to the extent that it is in line with prevailing basic moral views in a given society, most of which find expression in basic principles and fundamental rights. Tensions between legality and legitimacy of a rule are therefore often solved within the law by taking recourse to overriding rights, the concept of equity and the protection of good faith. The doctrine of abuse of law, preventing the formal application of a rule beyond its very scope and purpose, amounts to an important last resort in bringing legality in line with legitimacy. Vice versa, law also contains moral perceptions and protects people from being exposed to moral judgements negatively affecting legal positions. For example, we may condemn the content of speech, but freedom of speech and thus the law protects persons from prosecution and legally imposed disadvantages. Lawyers are mainly concerned with the legality of rules within a given constitutional system. The legitimacy of a rule is assessed as a matter of legality against overriding legal and constitutional principles, including human rights and general principles of law. Legitimacy and legality therefore mostly coincide, as illegitimate rules are constitutionally unlawful at


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the same time. Questions of legitimacy beyond the realm of constitutional law arise in legal philosophy when it comes to tyranny and recourse to natural law and justice, and the right to resistance when formal law and values fundamentally differ and the legal order breaks down during periods of revolution. In the contractual, non-hierarchical and highly fragmented field of international law, the relationship of law and morality is more complicated. A constitutional framework is lacking, and none of the basic categories of natural law offer a suitable framework to analyse the legitimacy of rules in international law and of the WTO in particular. Vice versa, international law offers less protection against morally-based judgement and action taken by governments. For example, protection of self-determination and intervention is difficult to sustain under strong public and morally-based pressures on governments to take action. Thomas Franck discusses legitimacy in international law within a framework of the four paradigms of a required community, social contract, free assent and compliance (pacta sunt servanda). Legitimacy of a rule is essentially understood in terms of a given quality which is assessed in terms of determinacy, symbolic validation (communication of authority), coherence and adherence or respect for basic rules (such as the Vienna Convention on the Law of Treaties), and principles, including jus cogens, in terms of both substance and procedures (Franck 1998: 25–46; 1988). In doing so, it would seem that Franck reverts to categories inherent to the nature of good law, and derived from experience in domestic law in a constitutional context. Robert Howse emphasises that legitimacy in international law transgresses the formal principle of consent and an enquiry into underlying values is required (Howse 2001: 600–604), what Joseph Weiler termed social legitimacy of rules as a ‘broad, empirically determined, societal acceptance of the system’ (Weiler 2001: 80–81). The lawyer, trained in a positivist tradition of international law, thus needs to turn to domestic law principles, philosophy, economics, political science and international relations theory. Assessing legitimacy inherently requires an interdisciplinary approach. It rapidly reaches the limits of a particular discipline. This also makes it a difficult task to undertake. In international relations theory, legitimacy largely depends upon underlying theories which in turn are strongly influenced by different traits of political philosophy as applied and adapted to international relations (Elsig 2007). Political scientists have established the distinction between input and output legitimacy (Scharpf 1999; Keohane and Nye 2001: 282–287). Input legitimacy assesses procedures by which rules and decisions are made and adopted. It is here that in my view issues of democratic

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legitimacy loom large, albeit they cannot be strictly separated from output legitimacy. Tests of inclusiveness and participation, and fairness of discourse are applied in pluralist conceptions of accountability ideally established in domestic Western constitutionalism. In Europe, the debate on input legitimacy informs the critique of decision-making in the European Union and the quest to enhance democracy. It has been one of the intellectual foundations of the gradual increase in the role and functions of the European Parliament. It is equally applied to assess the legitimacy of international organisations such as the WTO. Output legitimacy, on the other hand, assesses the effect of rules on society at large (Scharpf 1999; Schimmelpfennig 1996). Yardsticks applied include justice, fairness, welfare and the respect for human rights. They strongly depend upon underlying political and economic philosophies and vary. The realist schools, largely ignoring the impact of law, assess international relations in terms of power relations. Institutions are created to represent the power of certain sponsors and assist in controlling international relations. Realism tends to disregard the issue of legitimacy as largely irrelevant. Idealist schools, on the other hand, operate within a framework of established and aspirational values of regional and global governance. Fairness and justice, and thus legitimacy, are of major importance to them (for example, Pogge 2005; Caney 2005). In economics, legitimacy is essentially assessed in terms of the welfare-enhancing effects of a particular system, beyond the philosophy of division of labour, comparative advantage and free trade (Smith 1776; Ricardo 1819). It essentially builds upon economic theory and needs to stand up to empirical verification and testing. Liberal schools stress the protection of civil liberties and property (for example, Petersmann 1997; Frankel 2000). Translated into the field of international economic relations, market access, equal conditions of competition and protection of intellectual property rights loom large (Elsig 2007: 83). Social democratic and cosmopolitan schools emphasise the importance of redistribution of wealth and of cosmopolitan values in the process of globalisation (for example, Pogge 2005; Beitz 1979; Barry 1973, 128–133). The effects of distributive justice are an important factor informing the legitimacy of international relations. The effects on distribution of wealth of a particular system are concerns which are essentially shared with moral philosophy (Caney 2005: 102–141). The way a system treats its poorest members amounts to a critical yardstick for assessing the legitimacy of international economic law and the multilateral trading system (Pogge 2005: 717). In reality, policies often combine different strands of political theory (Moravcsik 2004). It is fair to say that legitimacy in international relations is informed by all the factors discussed above: the impact of power,


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the dependence of international law upon voluntary compliance and limited enforcement, input methods of inclusive, deliberate and accountable decision-making, output responding to liberal and social-democratic principles and values. They all frame the – often competing – yardsticks against which the legitimacy of the WTO system will be assessed. Given this panoply, we are left with a number of underlying conceptual problems. Legitimacy may relate to a particular rule, or to a system as a whole. When discussing the legitimacy of WTO law, should we look at individual rules, examining to what extent they comply with the qualities of good law? Or, should we look at the system as a whole? While the former adopts a constitutional approach, the latter places a particular legal system in a broader societal and economic context. Both can be observed. In assessing the legitimacy of the WTO, Robert Howse looks at the underlying welfare economics and theory of free trade as well as undertaking a detailed examination of Appellate Body rulings according to the criteria of coherence and consistency (Howse 2001). It is submitted that an examination of legitimacy of WTO law should primarily focus on the system as a whole. There are inevitably winners and losers, and legitimacy cannot depend upon the eye of the individual beholder. Assessing legitimacy has to be undertaken from a long-term viewpoint, and must take into account long-term implications and dynamics of the system of WTO law as a whole or of its major parts or subsystems, such as nondiscrimination or the protection of property rights. The examination of legitimacy of individual rules in turn may be better assigned and left to constitutional theory and law, from which, in the long run, international law will not be excluded in an overall coherent system of multi-layered governance. Thus, the interpretation and application of specific rules in the WTO relates to the overall system and its underlying legitimacy; as such, it remains within the bounds of law. The Doctrine of Multilayered Governance We are also puzzled by the problem of the extent to which we are entitled to apply the same criteria in assessing the legitimacy of domestic and international law (Elsig 2007: 79). The two appear to belong to different worlds. International law rules emanate from a complex process involving a great variety of different actors: powerful and weak States, and democratic and authoritarian governments. Contemporary international law does not prescribe domestic structures of States. Rather it treats them as a black box under the doctrine of sovereignty and self-determination. Power plays a key role in shaping positive international law. In assessing the legitimacy of rules of international law, we need to take the complex

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and imperfect nature of international law into account. We cannot simply refer to concepts of legitimacy developed for mature domestic systems, such as the Westminster model of deliberative democracy, or even to those of direct democracy where final decisions rest with the majority of citizens. International law operates in a harsh environment where power continues to play a key role. It functions in an environment where many of its subjects do not fully live up to the ideals of democracy. Moral perceptions, for example, responsibility vis-à-vis fellow humans, cannot be uniformly defined independently of proximity and distance. Thus, the ideal benchmark cannot be set. When assessing the legitimacy of a particular international organisation, we need to relate it to the realities of underlying systems of governance, taking into account all their deficiencies. At the same time, international law tames power and shares the main virtues of law in containing the exercise of power, in creating legitimate expectations as to conduct and in stabilising human interaction. Discussions of legitimacy of international law cannot abstract from prevailing ideals and goals of good governance in general: government based upon the rule of law, separation of powers, the protection of human rights and responsiveness to democratic accountability. Citizens exposed to the impact of international law will not be prepared to apply entirely different standards from those against which they judge the legitimacy of domestic or regional governance. Human conduct is not judged fundamentally differently when it belongs to domestic or international realms. Human nature does not alter whether it plays out at home or abroad. Social legitimacy of norms does not fundamentally differ and relies upon the origin of a particular rule or system. The standards and yardstick underlying legitimacy in a given society – including the international community of WTO Members – thus cannot be fundamentally different in domestic and international law. Rather, it is a matter of graduation within an overall framework responding essentially to the same criteria and yardsticks of legitimacy. This is a strong argument for bringing about coherence between domestic and international law. The perception of graduation supports an overall and coherent constitutional approach to assessing legitimacy, yet takes into account the different nature of community and the level of decentralised governance. Confronted with the challenges of the WTO, international lawyers have set out to assess the underlying problems in terms of constitutional theory (Cottier and Hertig 2003; Petersmann 1995; Peters 2007a). The effort is part of a broader movement to overcome the classical and conceptual divide between international and domestic law of the Westphalian system of nation states. It essentially comprises the field of human rights and international economic law. In both areas, a controversial debate on


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constitutionalisation of international law is taking place. While many and competing concepts of constitutionalism are employed and some suggest refraining from using the term (Howse and Nicolaïdis 2003; Cass 2005), the effort shares the common concern of looking at international law and domestic law in a coherent manner (Cottier and Mavroidis 2003: 353–356; Cottier and Hertig 2003). Influenced by the traditions of federalism, lawyers focus on the interaction and the allocation of powers between different layers of governance. It is essentially a matter of finding appropriate criteria for the allocation of regulatory powers to different layers of governance – global, regional, domestic, and local – and of defining the proper interaction of these layers (Jackson 2003; 2006). This model of constitutionalisation offers an appropriate framework of analysis, without prejudging one way or the other as to how powers should be allocated in the end. The crucial point is to conceive international, regional and domestic levels as a single and ideally coherent regulatory architecture of multilayered governance. Multilayered governance stands for the proposition of a process and direction. It does not stand for the idea of a world government, or world legislature. But it builds upon potential spillovers between the domestic and international spheres and seeks what Eric Stein called ‘creative, idiosyncratic arrangements commensurate with the respective level of integration’ (Stein 2001: 534). From a legal and constitutional law perspective, it is proposed to assess the legitimacy of international law rules on the basis of a doctrine of multilayered governance. The point here is that legitimacy should not be, and cannot be, assessed for the WTO in isolation. Rather, rules and regulations on the level of international law are seen as part of an overall regulatory system which operates on and within different layers. These layers, comprising local, sub-national, national, and possibly regional, and global rules, can be looked upon as a five-storey house (Cottier and Hertig 2003: 261). These layers of governance interact and are complementary to one another. The upper floors generally exert control over the lower floors and make sure that they behave within certain bounds. The model, however, is not necessarily centralist, but leaves ample room for decentralisation and for safeguards to preserve essential values on all floors alike. Taken together, these layers form a complex system of vertical checks and balances, seeking to compensate on one layer for deficiencies inherent to another. The issue of legitimacy of the WTO therefore needs to be assessed within a broader framework and cannot be separated from issues of legitimacy affecting the Members and the nation state or regional arrangements, such as the European Union. Given the fundamentals of domestic democratic governance, democratic legitimacy is often placed exclusively, even as applied to international

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organisations. The transposition of domestic structures to both regional and international organisations appears to reflect democratic ideals as the sole rational source of proper legitimacy. This can certainly be observed in debates on the European Union, and it is no coincidence that democratic accountability looms as a prime challenge of theory to the present-day WTO. A closer look, however, reveals that the law on all layers of governance is not exclusively based upon democratic accountability even in fully developed democracies operating under a constitution. Many of the yardsticks of legitimacy discussed relate to substance and outcomes, and not to procedures that determine how outcomes are brought about. Some may even reduce or off-set input-driven legitimacy based upon participation and political deliberation. The protection of fundamental rights, while crucially dependent upon democracy in the long run and an essential prerequisite for democracy, runs counter to majority votes and rulings in conflict. The protection of individuals and of minorities is at the heart of human rights protection, sourcing its legitimacy from individual values, in particular the protection of human dignity, rather than democracy. The same holds true for the application of general principles of law. They are essentially judgemade and reflect longstanding patterns of human experience. If they are ignored, justice cannot be served. They do not depend upon majority ruling of a demos. We recall in this vein the doctrine of separation of powers and of checks and balances as a major organisational source of law. Also, there is customary law, albeit to a decreasing degree. It derives its legitimacy from a common belief in the legal community, informally formed and brought about outside the organised channels of decision-making. Finally, the law also derives legitimacy from its stability and the fact that it allows for predictability and stability, quite independent of its content. Keeping peace has been one of the key functions of law, in particular of international law, irrespective of how the settlement was brought about. We recall that important post-war constitutions, in particular in Germany and Japan, were imposed. They stood the test despite an almost total lack of input legitimacy in terms of the categories discussed today. Besides democracy, the law therefore derives legitimacy from additional sources of fairness and functions. To summarise, it entails human and fundamental rights, general principles of law, the rule of law, legal security and keeping the peace. These different sources of law can be found on all layers of governance, albeit to a varying degree. Democratic majority rule is most prominent in a local domestic context, while preserving peace, stable relations and protection of human rights is more prominent on the level of international law, with democratic accountability limited to derived and indirect responsibilities of the diplomatic process. Agreements and consensus are more frequent on the international level, but are not absent in a domestic


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context. The role of general principles and judge-made law will be of less importance to the local and domestic levels where the law emanated from directly elected and accountable bodies under a given constitution. And yet, it also exists. Much as the yardsticks of legitimacy cannot be neatly separated between domestic and international spheres, it is also impossible to categorically distinguish separate forms and sources of human conduct. We should take this into account as we turn now to the functions and legitimacy of the WTO, properly speaking.

THE FUNCTIONS OF THE WTO WITHIN MULTILAYERED GOVERNANCE Progressive Liberalisation and Non-discrimination (Negative Integration) The constitutional framework of the WTO operates as an instrument of progressive liberalisation of goods and services regulated on other layers of governance (Cottier and Oesch 2005). Neither the GATT nor the GATS and thus the WTO as a whole amount to free trade agreements. Tariffs and preferential treatment for domestic producers in services are the lawful instruments of trade regulation and protection. Members, in a process of claims and responses, gradually reduce tariffs on goods and work towards the creation of level playing fields by granting national treatment in services. The binding of commitments exerts constitutional functions, as Members are prevented from unilaterally withdrawing concessions short of compensation in other areas, with a view to maintaining general levels achieved in terms of market access. The regime allows countries to adopt and agree to country-specific solutions, commensurate with needs and levels of development. To what extent this can be achieved depends upon political will. It also depends upon pressures exerted by powerful demandeurs. Provisions protecting non-trade concerns allow Members to limit the application of general principles and the operation of quantitative restrictions and non-tariff barriers. Rules on transparency ensure that legislation and important decisions, both administrative and judicial, are properly published; in the field of technical barriers to trade, transparency even includes the right to comment on draft regulations of Members. The principles of non-discrimination assure both horizontal and vertical equality of domestic and foreign products. The principle of most-favoured nation (MFN) obliges Members to grant the same level of market access to all Members alike, subject to exceptions under Article XXIV GATT and Article V GATS. The principle of national treatment obliges Members to grant treatment no less favourable to foreign goods

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upon customs clearance in domestic markets. In the field of services, such obligations only extend to commitments positively made in lists of concessions. National treatment, like other provisions of the WTO, is subject to a number of exemptions which allow Members to pursue other and equally legitimate policy goals. In addition, Members are entitled to take recourse to safeguard measures should imports threaten domestic industries under well-defined criteria. The fundamental principles emanating from the principle of equality can be seen as coordinating principles between States. The WTO prevents Members from arbitrarily discriminating among their peers. The principles, however, can also be explained in terms of multilayered governance, exercising checks and balances in relation to nation states. From this perspective, WTO law is essentially an answer to the failure of other layers of governance properly to address external relations unilaterally without falling into the rent-seeking protectionism called for by domestic producers and powerful lobbies at home. It essentially seeks to prevent and correct such practices. By doing so, it seeks to stabilise international relations. The promotion of peaceful relations has been at the heart of promoting multilateral disciplines since World War II. Placing WTO law thus, in a context of multilayered governance, also clarifies that legitimacy of rules is not exclusively based upon democratic accountability and participation. Such an understanding of the general principles of WTO law is reflected in economic theory, stressing the lock-in effect of the WTO agreements for governments, protecting them against protectionist claims. This is inherent in a rights-based approach stressing market access rights and equal conditions of competition (Petersmann 1995: 178–182; Stoll 1997: 113–114). Others explain it in terms of a combination of a conflict management strategy of keeping the peace and a rights-based approach, resulting in what they call political liberalism (Howse and Nicolaïdis 2003). In his critical appraisal of legitimacy of the WTO, Howse attributes essential merits and legitimacy to the principles of non-discrimination in the struggle against protectionism. ‘From this viewpoint, protectionism represents a xenophobic response to one’s own political/economic challenges, a tendency to blame the “other” for our troubles and to impose the costs of our own choices on the “other”. Free trade rules find substantive legitimacy in disciplining such xenophobic, discriminatory responses’ (Howse 2001: 370). It is interesting to note that the function of non-discrimination in the WTO is comparable to the functions of non-discrimination in EU law as well as under constitutional liberties in domestic constitutions (Peters 2007). The Four Freedoms in EU law, as well as economic liberty (Wirtschaftsfreiheit in German or Swiss constitutional law) and the interstate commerce clause of the US Constitution share comparable functions


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of limiting powers to discriminate on subsequent regulatory levels in federal states, however they go beyond non-discrimination and equally entail the requirement of proportionality: restrictions should not go beyond what is necessary to achieve a stated regulatory purpose. In WTO law such requirements are partly enshrined in applying restrictions to national treatment. The point is that these parallels support the perception of comparable, albeit different levels of governance, each seeking to exert certain restrictions on autonomous and possibly arbitrary regulations of commerce. The legitimacy of these provisions is essentially drawn from historical experience. Absent such disciplines, legislative processes tend to favour domestic constituencies, which often control legislative powers. The principles of the WTO, much as those of EU law and constitutional guarantees, thus derive legitimacy from the fundamental principle of equal conditions of competition and from historical experience, that short of such principles, policies and domestic law risk producing protectionist, rent-seeking effects which cannot be justified by other equally legitimate policy goals (Heiskanen 2004). The emphasis therefore is upon the idea of vertical checks and balances (Peters 2007a: 273). The principles compensate for deficiencies in domestic democratic processes as these do not inherently take into account the interests of those not represented by the electorate. WTO law, in other words, addresses a structural failure inherent to the principles of representation. It ensures that democratic processes take into account interests that are not formally represented. WTO law, much as GATT and its bilateral predecessors, was designed to avoid a repeat of Smoot-Hawley tariff policies, which were logically and unilaterally developed to protect the interests of domestic producers in the 1930s (Cottier and Oesch 2005: 14–23). Structurally, the constellation is comparable to international and constitutional protection of human rights and fundamental liberties. It parallels the compensatory functions of constitutional courts in preserving rights of those not, or not strongly, represented in the legislature (for example prisoners or foreigners) (Ely 1980:135–180). It is found, on the international level, in the doctrine and concept of compensatory constitutionalism. It assigns to international instruments constitutional functions, which properly cannot be assumed by such constitutions, fully taking into account policies of subsidiarity and decentralisation to the strongest extent possible (Peters 2007a: 279). The operation of constitutional guarantees on equal conditions of competition does not depend upon democratic legitimacy in terms of deliberative bargaining processes. They are essentially protected by courts. The same holds true for the WTO. The fundamental principles of the WTO are essentially protected by way of dispute settlement. It is no coincidence that the main rulings of the first decade of the Appellate Body relate to the operation

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of basic principles of non-discrimination. These rules enjoy a high level of legitimacy even among critical observers such as Robert Howse (Howse 2001: 374–394). Importantly they enjoy legitimacy even though they do not depend upon consensus and consent by Members affected and may even be brought about by majority rulings within panels and the Appellate Body. It is remarkable that the judicial branch of WTO governance emerged as the mainstay of contemporary legitimacy and thus of trust and confidence in the system, rather than the political bargaining process. In terms of output, it should be noted that the principles and processes of the WTO have led to enhanced shares of foreign trade for developing countries (WTO 2007; WTO 2008). Their share has been steadily growing in recent years relative to the growth in high income countries. Developing countries today account for some 34 per cent of world trade, in addition to some 8 per cent generated by Chinese exports (WTO 2008). In terms of growth rates, the average rates of growth in exports of developing and developed countries exceed those of industrialised countries (WTO 2008). Over the last 10 years developing economies have grown faster than in any period since 1965 (World Bank 2007: 1). From 2002 to 2006, they amounted to some 15 per cent, and 25 per cent for China. The same holds true for least developed countries with 20 per cent growth, albeit their share has remained minimal, amounting to less than 1 per cent of world trade (WTO 2008; see also WTO 2007). The point is that development and trends overall have been in the right direction. The system has produced the results which can realistically be expected from the WTO framework and its principles. Obviously, the small shares of the least developed countries remain a major concern, and efforts to enhance their shares require additional and special efforts of affirmative action beyond the application of WTO principles. The main objection to WTO legitimacy relies upon the observation that the principles and rules of the WTO do not bring about distributive justice (Pogge 2005). In the long run, they allow countries to develop and enhance trade shares and prosperity. The post-war experiences of Europe and of Japan are cases in point. Today, we observe similar patterns in emerging economies, in particular Brazil, China and India (WTO 2008; the BRIC-club also includes Russia, an impending Member of the WTO). WTO rules, however, are not designed to steer domestic processes of distributive justice. This is partly due to the limits of international law, respecting all forms of government alike. International law in general has been weak in redistribution, and the concept of equity has essentially been limited to territorial and marine allocation and to procedural principles of fairness (Jenks 1964; Kolb 2003). Social and economic rights, guaranteed under international conventions, are notoriously weakly implemented and


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enforced. The failure to bring about domestic redistribution is a weakness of traditional and contemporary international law. It is essentially linked to the underlying concept of sovereignty and self-determination which to a large extent bars foreign intervention beyond treaty obligations. Problems of legitimacy are thus attributable to the nature of public international law. They are not specific to the WTO. It is difficult to challenge the WTO in this respect without challenging, at the same time, the fundamentals of contemporary public international law, challenging the resources privilege which is based upon the principle of sovereignty, self-determination and permanent sovereignty over natural resources (Pogge 2005: 737). The challenges relating to losses of jobs due to international competition rest on similar complaints focusing on the impact on distribution. Change and adjustment are inherent to a society based upon division of labour and competition. The dilemmas of free trade are well known and changes affect persons whether they be workers, consumers or citizens in different ways (Moon 2000: 27–29; Cottier and Oesch 2005: 3; Stiglitz 2006). In comparing gains and losses, Howse opines that the benefits may not justify the losses incurred, in particular if they are linked to the loss of personal identity, which cannot easily be offset by financial measures or retraining. At the same time, he argues that non-trade related measures may be more efficient in compensating negative effects. Despite a very critical attitude, Howse ultimately subscribes to the principles of the WTO faute de mieux (Howse 2001). From the point of view of legitimacy, the key question is whether WTO law prevents Members from pursuing distributive policies at home. This is partly the case, and constraints exist (Cottier 2007: 587–614). National treatment does not allow for local content rules under the TRIMs Agreement. There are limits to the use of subsidies for purposes of redistribution, provided that the subsidy exerts a trade-distorting effect. The abolition of non-actionable subsidies, mainly under pressure from developing countries, should be reviewed from this angle. Importantly, the system as a whole is capable of undertaking the necessary adjustments. For example, it was necessary to adjust the TRIPS Agreement with a view to facilitating access to essential drugs (Abbott et al. 2007: 199–207). The effort of effectively combating climate change and bringing about mitigation and adaptation requires a review of the interpretation of a number of provisions, in particular those relating to production and process methods (PPMs) (Howse and Regan 2000: 253–261). The same holds true in defining the relationship to other international agreements and organisations (Cottier and Oesch 2005). Coherence is far from being achieved, again partly due to insufficient foundations in international law to interface different regimes. It is also a matter of bringing about appropriate concepts

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of graduation in terms of defining obligations to sign on to instruments, in defining possible variable geometry or in shaping rules in a manner commensurate with levels of social and economic development. These changes can be made within the existing system and do not raise fundamental questions of legitimacy if Members show a willingness to take up these issues. Refraining from doing so, however, may impact on the system as a whole and jeopardise its long-term sustainability in the triangle of social, economic and ecological goals. In general, however, WTO law does not prevent countries from adopting adequate safety networks, and providing welfare benefits and assistance during structural adjustment. It is submitted that adequate networks are in fact a political precondition for liberalisation. It is no coincidence that in post-war history, trade liberalisation has been most successful when linked to the evolution of the welfare state. And it is no coincidence that trade liberalisation stalls under neo-liberal policies that seek to reduce safety nets for workers and citizens. The equation of open market and social policies in tandem also explains why developing countries, in the absence of such networks and of effective internal systems of taxation, have been more reluctant to accept liberalisation than industrialised countries, with the exception of trade in agriculture. Standard Setting (Positive Integration) The main objections relate to rules positively prescribing domestic regulations and conduct of government (Esty 2002; Howse 2001). It is impossible to draw a clear line between the traditional patterns of negative integration, discussed above, and positive integration. Many rules delineating room for manoeuvre, for example in the field of trade remedies, cannot be clearly ascribed to one or the other category suggested by political science. Agreements generally contain elements of both negative and positive integration. This is true for disciplines on anti-dumping which has been mainly of interest to developing countries suffering arbitrary market access restrictions. The same holds true for food standards under the SPS Agreement. Its thrust is not to render market access more difficult, but to facilitate it by taking recourse to internationally agreed and harmonised standards. The problem for developing countries is not one of principle, but of lack of resources and know-how to effectively defend their interest in front of international standardisation bodies. The field that has faced the most serious challenges to legitimacy has been the protection of intellectual property rights (IPRs), which the TRIPS Agreement, in combination with the Berne and Paris Conventions, essentially defines on the basis of laws adopted in industrialised countries


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(Cottier 2005). Members are obliged to implement these provisions together with minimal standards in domestic law accordingly. As a matter of principle, the critique is not sustainable. The lack of appropriate protection as well as excessive protection of intellectual property both create trade distortions and result in market access restrictions. It is therefore not appropriate to argue that IPRs have no place in a system promoting freer trade. Moreover, the adoption of intellectual property standards amounts to a long-term investment in creating fair conditions of competition from which domestic producers will also eventually benefit. It will, in the long run, close gaps in legal cultures and create level playing fields. The problem, however, is one of degree and timing. A strong argument can be made that the TRIPS Agreement does not adequately reflect levels of development of countries and imposes uniform standards irrespective of levels of competition. Efforts to seek better rules and graduation, replacing the insufficient concepts of special and differential treatment, should therefore be developed by taking into account economic indicators in defining whether or not a particular rule on IPR should be implemented in domestic law (Cottier 2006). For the time being, developing countries may note that industrial countries pursue policies of benign neglect. No complaints have been brought against developing countries except where serious problems have been caused by competitive industries beyond their infant stage. With these qualifications, the TRIPS Agreement plays a meaningful part within the structure of multilayered governance. The same line of reasoning, it is submitted, would hold true for rules on competition and investment protection. Establishing minimal standards for competition would assist developing countries in implementing effective remedies against the abuse of intellectual property rights. It is likely that these goals will not be readily achieved without international support as domestic private sectors often tend to oppose or hamper the autonomous adoption of competition rules. Minimal standards on investment protection as well as minimal labour standards linked to such rules would assist in reducing pressures on beneficial arrangements for investors which governments today are often unable to avoid in promoting economic development. Again, it is a matter of looking at positive integration from the viewpoint of multilayered and mutually complementary governmental structures. It is difficult to see how they would illegitimately impair social and economic development. Negotiations and Dispute Settlement In assessing input legitimacy, it is important to state that the WTO operates as an intergovernmental organisation. By its very nature, it has not

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been conceived as a body of democratic decision-making, and clearly the two are not in love at first sight (Stein 2001). Yet, intergovernmental negotiations are a deliberative process par excellence. They largely respond to a process of claims and responses, entailing consultation, learning, convincing and pressuring (Odell 2005). Delegations negotiate trade concessions bilaterally and multilaterally. The process of rule-making follows stages of fact finding, defining negotiating positions, consultation and bargaining. Inclusiveness is extensive and often protracts the negotiating process. Negotiating powers essentially follow market size, geopolitical impact and the power of the pen which, in return, is based upon the quality and quantity of the human resources a Member is able to make available. Power inevitably plays an important role, essentially defined by market size. The system depends upon the lead taken by major trading partners, and agreements are often prepared by a small group, formerly even the US and the EC alone. The problem of leadership, however, is not different from any polity. Powerful players are influential under any system of decisionmaking; it may be tempered but not fundamentally altered. The problem thus is not one of the WTO, but of the relationship between power and law in general. Addressing it will require the strengthening of constitutional structures within the organisation. We shall come back to this point when discussing possible reforms. Democratic accountability of international organisations depends upon domestic democratic accountability of Members (Keohane and Nye 2001). Delegations operate under instructions of governments and are therefore accountable. Representatives of democratic governments enjoy derived and indirect democratic legitimacy as they are accountable to a democratically elected government. The lack of accountability, where it exists, is a matter of domestic structures and cannot be attributed to the organisation and its legitimacy as an intergovernmental body. Rather, challenges to lack of accountability relate to the problem that civil society, in particular non-governmental organisations (NGOs), as well as other affected international organisations (IGOs) are not sufficiently involved in light of the impact of decisions made and rules adopted. Again, this is a problem which is difficult to solve within existing structures and requires substantial constitutional reform. We argue that the principles of negative integration assume important constitutional functions which find legitimacy in exercising checks and balances. They do not call for particular democratic legitimacy and stand in their own right as legal principles emanating from the principle of equality. It is a different matter when it comes to positively setting regulatory and uniform standards. Efforts at harmonisation of the law amount to positive integration. Compared to domestic law, this is much closer to legislation


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than the operation of constitutional principles. As a corollary, democratic participation enters the field. Indeed, it was with the advent of positive integration, such as the elaboration of the TRIPS Agreement, that the criticism of democratic deficiencies in the WTO process was mainly voiced. It did not occur to the same extent during the GATT years. The main objections to positive integration relate to the asymmetrical structures of negotiations. The principles of negative integration have been in place for a long time. They are mainly applied and refined in dispute settlement in a process of trial and error. Negotiations on matters relating to positive integration are often based on and sourced from domestic law and regulations in industrialised countries. Developing countries lack domestic experience in the field and therefore seek to postpone international negotiations until such experience has been gained at home. The problem is a real one, and needs to be addressed in designing appropriate support and undertaking research efforts and cooperation of like-minded countries. We shall come back to this in reviewing the role of the WTO Secretariat. Finally, the structure of dispute settlement clearly offers fair and equitable procedures to all parties to the dispute alike. Developing countries, moreover, enjoy the benefit of judicial assistance from the advisory centre on WTO Law in Geneva (ACWL), an international organisation dedicated to supporting these countries in trade disputes.2 The possibility of hiring legal advice and law firms in dispute settlement provides for arms-length dispute settlement procedures. The problem of high costs of attorney fees, inherent to complex international disputes, should, with all due respect, be compared to the economic stakes of a dispute and the potential gains to be made from having trade barriers removed by the defendant party. Power and market size, however, influence dispute settlement when it comes to adopting trade sanctions in response to failed compliance. The effectiveness of such sanctions (withdrawal of concessions) essentially depends upon the market size. Smaller countries – developed and developing alike – therefore suffer from systemic disadvantages. The problem is real and needs to be addressed in structural reform.

HOME-MADE PROBLEMS The functioning of the WTO reveals a number of problems which need to be addressed in reform. Overall, however, it is difficult to expect more within the existing, classical structures, as an intergovernmental organisation. As long as we remain within the traditional paradigm, it is difficult to challenge its legitimacy. Such findings do not preclude moving ahead, seeking a new paradigm within the doctrine of multilayered

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governance. Before doing so, however, it is important to assess the extent to which problems are home made and need to be addressed first by the governments of Members. Distributive Justice It was seen that WTO law partly restricts distributional policies at home and should be reviewed to this effect. By and large, however, increasing gaps in terms of income and wealth are much more attributable to national law and policies and to trade policies pursued by Members, than to the effects of WTO law properly speaking. It should be recalled that GATT has not prevented States from developing welfare policies. To the contrary, it may be argued that trade liberalisation was successful because it has been accompanied by the welfare state and social security networks in industrialised countries. Studies of the advent of neoliberal policies in recent decades should not ignore that the architecture of the Post World War II order was based upon the philosophy of the New Deal in the United States and emerging welfare states in Western Europe. Compared to levels of protection in the field of agriculture, it is indeed amazing to see that governments have so far largely failed to respond adequately to such challenges. Much of the reaction to globalisation, which increasingly informs politics in industrialised countries, for example by restricting migration, or efforts to prevent outsourcing, is due to a lack of imaginative domestic policies towards a new deal appropriate to meet the challenges of globalisation other than by imposing restrictions on trade and falling back into protectionism. Problems of legitimacy of the WTO mainly arise in relation to developing countries that have lacked the means to accompany trade liberalisation with welfare policies. The reduction of tariff rates in successive rounds eroded existing taxation without being replaced by proper domestic and non-discriminatory tax systems. The same problem arises when newly acceding developing and transitional economies are forced to substantially reduce tariffs and liberalise services without being offered complementary support in building domestic welfare structures. To a large extent, this is the responsibility of demandeurs, simply seeking to improve market access rights without looking at long-term costs and the potential for destabilisation and the perceived erosion of legitimacy of the WTO which is unable to translate within a reasonable period into better living conditions for the majority of the population. Likewise, the refusal of industrialised countries to substantially lower levels of protection in agriculture hampers the pursuit of distributive policies in developed countries. The agricultural policies of the West lack a cosmopolitan perspective and hold millions of


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poor farmers hostage to subsistence. Trade, not aid, is what is required, but this call remains unheard within the democratic constituencies of the West. Liberalising agricultural policies is at the heart of the WTO agenda and principles. Members, however, do not allow this to happen and take effect. By so doing, they undermine the legitimacy of the WTO law, albeit driven by nationalistic domestic policies at home. To some extent, the responsibility also rests with developing countries. The imposition of neoliberal policies, the neglect of agriculture and the needs of rural populations, the failure to use existing scope and space for social policies and adjustment at home are causes which cannot be ascribed to WTO law, but remain within the responsibilities of national governments. True, they were partly induced by the lending policies of international organisations, in particular the IMF and the World Bank, and donor governments operating under what has been termed the Washington consensus of unilateral trade liberalisation and privatisation without taking into account the specific needs of developing economies. To a large extent, however, the governments of developing countries themselves are to be blamed for policies undermining the potential of the international trading system to enhance welfare at home. Again, the refusal to negotiate investment protection standards and competition policies in international law, accompanying and flanking the exclusive rights of the TRIPS agreement, as well as the refusal to negotiate on labour standards, has been a missed opportunity to this effect. While it is understandable in terms of defending national sovereignty and the interest of governments, the policy shows a lack of concern for distributive goals which the international system could assist by pursuing fairness at home. The same is true when it comes to refuting negotiations on transparency in government procurement. It amounts to a refusal to work towards principles of good governance to the benefit of domestic tax payers. Most of the problems giving rise to criticism and challenges of the legitimacy of the multilateral trading system are therefore home-made. The same can be observed for the rule of law and for democratic participation. Democracy Begins at Home WTO law, operating within weak structures of international law and subject to power relations, has not been strong enough in international law to overcome these shortcomings of detrimental national power politics. It is not the legitimacy of WTO law which should be questioned, but how governments use existing policy spaces in terms of purely national interests and refrain from taking into account cosmopolitan values. We argue that this is mainly due to the domestic structures of decision-making

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in Member countries of the WTO, both industrialised and developing. The agendas of governments are essentially defined by producer interests. They often fail to take into account other concerns to a sufficient degree. Authoritarian governments, in addition, often define policies without consulting the private sector and fail to rally even producers to the cause of trade liberalisation. These structures reflect badly on the legitimacy of the WTO as they call into question the input legitimacy of the Organization, which leaves domestic decision-making entirely to domestic constitutional structures and procedures. It pays a price for treating sovereigns in terms of a black box. The question thus arises of whether WTO law should address the issue of input legitimacy by way of defining minimal procedural standards of domestic participation and debate which Members are obliged to respect and translate in domestic decision-making relating to the subject matter of international trade regulation. The Rule of Law Begins at Home Apart from an obligation to provide transparency and make available courts to deal with international trade, the judicial implementation of WTO law is entirely left to Members (Cottier and Nadakavukaren Schefer 1998: 84–88). Generally, it is a matter for courts to decide to what extent principles of consistent interpretation or of giving direct effect to WTO should be followed or not. Partly, such as in the case of the United States, such recourse is barred by legislation. There are many reasons for the reluctance to grant direct effect in leading jurisdictions, including the EC. In effect, they also limit legal protection and the reinforcement of the judicial branch and the rule of law in developing countries. First, courts fear major battles with the executive branch and the legislators, mainly in view of the fact that agricultural policies are often not compatible with WTO law. The implementation therefore is left to legislators, including the filters which accompany it to soften rough edges. Separations of power and checks and balances are a legitimate concern which could, however, be addressed in a much more differentiated manner than wholesale rejection of direct effect. It would be perfectly possible to give direct effect to appropriate rules while denying it to others with the argument that implementation, due to political and financial implications, needs to be left to the political process (Cottier 2007). Well developed doctrines of monism applicable outside the field of WTO law offer ample guidance to this effect. Second, judicial policies are informed by mercantilist principles, seeking to secure reciprocal access to the law. Finally, reluctance to grant direct effect – besides flawed arguments that WTO law is not sufficiently precise – rests on an implied assessment that the law lacks


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appropriate democratic legitimacy. Direct effect places WTO law beyond domestic law, and judges are reluctant to grant such authority to rules elaborated within a purely intergovernmental process (Cottier 2007). The issue of direct effect therefore boils down to a pertinent test of legitimacy of the law. There is, in the end, a lack of trust and confidence, limiting voluntary judicial compliance in the field. The limits of democratic legitimacy have imposed limits to judicial review. Under a doctrine of multilayered governance, both therefore need to be developed in tandem in coming years.

ENHANCING PARTICIPATION OF STAKEHOLDERS Challenges to the legitimacy of the WTO partly need to be addressed on the level of WTO law; partly they are matters of domestic law and policy. The question arises of the extent to which these challenges can be taken up within existing structures and the extent to which more radical steps towards reform should be contemplated within a philosophy of multilayered governance. We look first at regulations seeking to remedy regulatory deficits on the level of domestic law and procedures. We then turn to structural reform of WTO proceedings with a view to strengthening the process and to bringing about new designs of checks and balances within the system of multilayered governance. Some of the suggestions remain within the structure of intergovernmental cooperation; others transgress it and incrementally move towards constitutional structures. Rights of Domestic Participation The quest for democracy at the level of international law again runs into the difficulty of facing a number of fundamentals of contemporary international law which render meeting such goals a structurally difficult task. The advent of parliamentary assemblies in the Council of Europe and subsequently in the European Union offer important exceptions to the general principle that governments represent States in international organisations. International law operates under the assumption that democracy takes place at home, and processes of policy and decision-making draw legitimacy from domestic deliberation and structures of majority voting. This holds equally true for the WTO. The prime effort to bring about democracy and thus legitimacy in particular in areas of positive integration therefore must start with domestic procedures of Members. The legitimacy of WTO law in that respect thus mainly depends upon domestic structures of WTO Members, and in particular of key players. Structures of governance in the

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Members, in particular in the United States, the European Union, Brazil, India and Russia by and large will define overall levels of democratic legitimacy of WTO law. The WTO simply reflects the realities, shortcomings and achievements of democratic governance at home (Bacchus 2005). The prime responsibility rests with domestic constitutional law to assure that all stakeholders are appropriately able to participate in trade policy formulation. Diplomats in Geneva are bound to defend interests defined in legitimate domestic processes. The more this is the case, the more legitimate are interests defended and compromises reached. The less this is the case, the less likely is WTO law to be considered legitimate. Doctrines on the domestic effect of its rules, in particular whether or not direct effect should be granted overriding domestic law in the long run, will largely depend upon the play of democratic governance in the membership at large. Primary efforts therefore should be undertaken to enlarge democratic participation under domestic constitutional law which, as was seen, has traditionally been the domain of the executive branch. Ideally, it may be argued that all concerns of democracy and input legitimacy should be realised by means of domestic procedures. Yet, given the state of affairs in many Members and the lack of democratic traditions, it is necessary to proceed in parallel both in prescribing domestic rules, and in defining appropriate rules of participation on the level of the WTO in tandem. Conceptual difficulties under contemporary international law, however, do not preclude seeking to support democracy at home by means of additional WTO disciplines. Much as WTO law prescribes rules on transparency and on judicial review, it should also turn to prescribing minimal requirements of democratic participation in domestic trade policy formulation. Efforts to this effect can be based upon basic precepts of a right to democracy as argued for in modern international law (Franck 1998). The trade policy review mechanism therefore should address the issue of the extent to which trade policy formulation at home is transparent and inclusive of stakeholders, and how diverging interests are expressed. Procedures and processes could be monitored by the international community and the WTO Secretariat in particular. Recommendations could be made to governments and legislators. WTO law could provide for an obligation to hear different stakeholders, producers, investors, workers and consumers. In shaping such procedural rules, the role of national NGOs should be properly reflected (Charnovitz 2005). WTO law should oblige Members to offer fair hearings to relevant NGOs and take arguments put forward by these organisations into account, as much as they consider producer interests. As a matter of WTO law, they should have standing before domestic courts assessing procedures and trade policy measures taken. The process should also entail a procedural obligation to


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assess the implications and effects of policies on other Members and on international stability. The violation of such rights would render measures incompatible with obligations under international law and may give rise to dispute settlement and the withdrawal of concessions. Development and training programmes could support inclusive trade policy formulation and offer capacity building and technical assistance to this effect. The Role and Position of IGOs and Global NGOs Trade regulation inherently affects, and encroaches upon, other regulatory areas. Within governments, policy coordination is a prime goal and requirement, and conflicts may be anticipated by proper inter-agency cooperation. However, the expertise and knowledge available in other specialised intergovernmental organisations should be put to work more effectively in assessing proposals and regulations adopted. The present practice of granting observer status, essentially excluding access to negotiating fora, does not offer a satisfactory solution. Organisations should be called upon to provide evidence and advice, and to be involved in impact assessment (Charnovitz 2005; Keohane and Nye 2001). To this effect, the structures of these other organisations need to be designed in such a manner as to allow the management and secretariat to speak for the membership with some authority. Recourse to such organisations in dispute settlement for the purposes of fact-finding offers a good starting point and should be further developed to encompass negotiations as well. Hearings could be held before negotiating fora and experts should cooperate with the secretariat and delegations advising Members in the negotiating process. More extensive rights could be contemplated in the long run within a system of weighted voting as described below, recognising a self-standing function of international organisations in the conduct of international relations. A comparable and parallel regime could be designed for NGOs defending the interests of the global commons and thus not particularly focusing on the domestic affairs of Members. They should be heard before WTO in the process of trade negotiations. Given their expertise, they can play a useful role in the process of impact assessment of proposals made and in the review of policies implemented. In parallel, globally active NGOs in policy areas under dispute before the WTO should obtain standing in dispute settlement, and be entitled to bring cases and to intervene on the side of claimants and defendants. There will, of course, be many objections to this course of action and enlargement of the WTO community. First, NGOs are not subjects of traditional international law limited to States and governmental organisations. Opening up the system to NGOs

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inherently entails the corollary need to explicitly include business interests and thus to give standing to multinational enterprises. Governments may lose control over trade policy formulation as a consequence, and it will be even harder to reach agreement on the basis of consensus. Second, it is difficult to define criteria for eligibility and legitimacy of relevant private actors and players in the field. At this juncture, we again are faced with the dilemma that traditional perceptions of international law are no longer able to reflect the complexity of the modern world. An organisation which is limited to governmental control, short of taking into account concerns and voices of the private sector at large, is no longer able to bring about levels of input legitimacy and involvement which will sustain structures and policies in the long run. It is time for a paradigm shift. We cannot argue in favour of open and transparent policy-making at home without developing appropriate and corollary disciplines operating on the international level itself. There are two sides to the coin, and they need to be complementary. We may well end up with procedures and dispute settlement open to the private sector. Instead of playing behind the scenes, private operators may be overtly involved in negotiations and dispute settlement. Once we realise the long-term benefits of such involvement, it will be a matter, not impossible to achieve, of defining proper rules for securing an overall balance of power between different actors. It will be possible to learn from domestic legal systems, the legitimacy of which is essentially based upon access to politics and access to courts by private actors competing between themselves and with the government on the basis of the rule of law. A Parliamentary Assembly in WTO These efforts may also be accompanied by the creation of a Parliamentary Assembly in the WTO (Shaffer 2005; Mann 2005; Hilf 2005).3 Less a matter of replacing decision-making in the diplomatic process, it may serve as a forum for interaction and exchange among national parliamentarians and their international networks. The benefits of such contacts, in terms of education and knowledge transfer, should not be underestimated. It may greatly assist in democratic trade policy formulation at home. It fosters know-how and knowledge on trade-related matters in parliament as some members may acquire special expertise and understanding. International contacts among their peers allow them to form independent opinions. It may help to create cosmopolitan understanding for the problems and concerns of others, so often lacking when it comes to serving a particular electorate. It may, in due course, be ascribed certain powers which may expand as experience grows. The evolution of the European Parliament


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as well as the experience of the Council of Europe in forming policies offers prospects which are equally valid for long-term evolution in global international organisations. Experience shows that exposure to common problems in such fora feeds back into national parliamentary and political processes (Council of Europe) or it enhances the legitimacy of law and results achieved (European Parliament).

CHECKS AND BALANCES WITHIN THE WTO Enhanced participation both at home and within the WTO in terms of democratic deliberation and accountability cannot be achieved without reform of the political process at large. Simply increasing the number of players under the present structures will suffocate the negotiating process and the WTO, and must be met with utmost caution. If legitimacy calls for greater involvement of stakeholders, it is evident that checks and balances require reform at the level of the secretariat as well as in the process of decision-making in the WTO (Cottier 2007a). Secretariat and WTO Commission Working in what has been described as a Member-driven organisation, the WTO secretariat has been operating under the assumption of a strictly serving body. This assumption, which is far from reflecting the real and implicit impact of the body of experienced professionals securing the institutional memory of the organisation, should be reviewed. The Secretariat of the WTO should be given the mandate and the right to develop appropriate initiatives, to table proposals, to review policies and to initiate dispute settlement in the defence of the multilateral system. Much could be learned from the experience of the EC Commission in terms of appointing executive staff members and defining responsibilities. It is submitted that the systemic interest of a majority of Members would be better served with an active secretariat under the supervision of what could be a commission composed of individuals recruited from Members on a rotating basis, dedicated and obliged to serve the interests of the multilateral system, and not those of their countries of origin. The model is different from suggestions to create a directorate composed of major Members due to a mandate to serve the goals of the multilateral system, and not to represent national governments. Second, the formula would allow including medium-sized and smaller trading nations in rotation. Commissioners would be mandated to jointly make proposals to the membership, to steer the negotiating process, and to manage different branches of the

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organisation, including extensive operations on aid for trade and technical assistance programmes. Weighted Voting Consensus-based diplomacy at the WTO is widely viewed as a mantra of democratic governance of the multilateral organisation. It is widely seen as an important factor legitimising the WTO. Indeed, all Members enjoy the right to block a decision, whatever the subject matter and whatever the level. On the surface, it appears as the epitome of sovereign equality and is close to the ideals of one state one vote, whatever the size and political impact (Ziegler and Bozon 2007: 15). Members therefore are reluctant to review this mantra. A closer look, however, reveals a number of shortcomings, and a high price to be paid. First, trade negotiations are held hostage to tacit agreement of all Members, which inevitably adds to the time it takes to come to an agreement. Trade Rounds are bound to run for a decade and do not allow for substantial interim results. Pending such results, governments are under pressure to pursue the avenue of preferential agreements. Today, these agreements extend way beyond the original idea of regional integration. They encompass a host of transcontinental agreements with interested and interesting partners. The policy not only erodes MFN and multilateralism, it also erodes the position of the least developed countries left aside. Moreover, it is much more difficult for target developed countries to tame special requests from bilateral agreements which have been barred in and by the multilateral forum of the WTO. Second, consensus does reflect real powers in the Organisation. Breaking or upholding it is possible for major players at all times, but not for medium and smaller countries. They may block once or twice, and will then find themselves isolated in due course. Consensus in reality is a system of informal weighted voting which gives core competence to a small group of essential key players, currently the United States, the European Union, Brazil and India. Tomorrow, it will include China. Third, the right to block consensus entails serious policy dilemmas at home. Governments may be under pressure to block a decision, but unable to do so taking into account the overall interests of the country and economy. It may be difficult to explain the non-use of blocking power to a powerful constituency without losing essential support. Finally, consensus diplomacy renders legislative response to dispute settlement decisions virtually impossible. For all these reasons, a review of consensus diplomacy should be contemplated. The WTO has left behind consensus in the field of dispute settlement with great success. Panels and the Appellate Body decide by


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majority. A losing party is no longer in a position to block the adoption of a Panel report. What was not conceivable during the GATT years has become reality. Perceptions and attitudes have changed. It is not impossible to achieve a similar process in the field of political decision-making. It may be introduced gradually, leaving major decisions still to consensus, and gaining support over time as confidence and trust in the system grow. Models taking into account the percentage of world trade in goods and services, the openness of the economy (the ratio of imports to domestic production) and the size of the population in defining voting rights and assessing voting powers are able to bring about a fairly balanced system between industrialised and developing countries (Cottier 2007: 217–260; Cottier and Takenoshita 2003; Cottier and Takenoshita 2007). Moreover, it is important to recall that trade policy does not follow block politics, but operates on the basis of variable geometries and variable coalitions commensurate with the interests at stake in a particular sector. Weighted voting therefore offers a more rational and transparent model of decision-making. It allows governments to defend their interests, but also to accept defeat in the best of democratic traditions based upon majority ruling. Again, it is a matter of converging patterns of domestic traditions and political culture at the international level and working towards an overall system which operates under comparable premises of democratic governance. People will benefit from a reinforced and more stable multilateral system, from the possibility of a continued stream of decision-making and agreements, and legislative response to dispute settlement rulings. Governments will no longer see a need to engage in transcontinental preferential agreements in order to promote the trade agenda to the same extent as they do today, creating and distorting trade at the same time. Multilateral Trade Sanctions Reform should also address the structural imbalances in enforcing dispute settlement decisions. Medium-sized and small Members have little incentive to take up cases due to lack of retaliatory powers. The system currently operates as a purely bilateral system of dispute settlement, although Members may jointly bring cases as a group of complainants. Reform should allow for the joining of cases at the level of implementation and for joining in the withdrawal of trade concessions failing the removal of legislation or measures which are detrimental to parties not originally claimant to the dispute. When the Dispute Settlement Body of the WTO, based upon findings by a panel or the Appellate Body, decides that the law and practices of a Member are in violation of WTO obligations,

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third parties equally affected by that legislation should also be entitled to impose the withdrawal of concessions up to a certain amount to be defined in arbitration, if the losing member does not comply with the ruling within the reasonable period of time defined. An accumulated recourse and use of such a right is likely to have preventive effects and encourage members towards compliance. It equally may encourage smaller nations to bring complaints and see their chances for successful outcomes and implementation improved. The right would thus rebalance the current bias in favour of large trading partners and enhance the possibility for smaller nations to successfully obtain the removal of trade barriers having a negative effect on a larger group of exporting countries. It would improve the legitimacy of the overall system. Prescribing the Direct Effect of WTO Law Finally, enhanced participation in democratic processes and the development of checks and balances within the WTO commensurate with principles of constitutional law will allow the problem of domestic judicial implementation to be addressed. It is conceivable to define areas of direct effect as a matter of WTO law which today, with the possible exception of Article XX of the Government Procurement Agreement, are entirely left to national law. Obligations to grant direct effect could be compensated for by trade concessions and made part of the bargaining process. This would solve the underlying problem of reciprocity and strongly reinforce the presence of WTO law in the daily life of the law around the world in accordance with constitutional principles of multilayered governance and more effective legal protection to the benefit of legal security of private operators and traders (Cottier 2007: 305–330).

CONCLUSIONS In assessing the legitimacy of the WTO, we encounter different nonexclusive strands and traits. These include the contribution of WTO law to economic growth and prosperity among nations, the contribution to stability and peaceful relations, the impact of transparency and of relations based upon the rule of law and the possibility of peaceful dispute settlement, and the ideals of participatory decision-making and democratic accountability. These strands and traits are not unique to the WTO. They are inherent and common to all legitimate legal regimes, but they may vary in terms of predominance and importance. While democratic governance and accountability are of particular and predominant importance


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in domestic systems of democratic governance, the functions of securing peaceful relations and growth on a rule-based system are predominant in the WTO. It is important not to see the issue of legitimacy of the WTO in splendid isolation. The WTO forms part of a system of multilayered governance. It cannot be separated from domestic structures, either on the national or the regional level, as the case may be. Together, they form a system of multilayered governance which, as a whole, needs to respond to the different strands of legitimacy. From this perspective, the current WTO enjoys and deserves high levels of legitimacy when we look at it from the point of view of outputs over time. Most of the challenges to legitimacy – defined in terms of trust and confidence and voluntary compliance – are not substantiated. The principle of negative integration – essentially delineating what governments are and are not allowed to regulate – is directly based upon functions of keeping peaceful relations by securing mutual access to markets. Case law relating to equal conditions of competition and non-trade concerns enjoys a high level of legitimacy and trust. Unresolved problems exist, and examples relate to climate change or labour standards and human rights. They can be solved in negotiations or by case law. Substantial problems are encountered where WTO enters into regulation of positive integration, positively prescribing rules of conduct to be implemented in domestic affairs. With the decline of tariff barriers and the shift towards non-tariff barriers and domestic regulation, issues of democratic legitimacy and accountability have arisen and will not go away. This chapter argues that most of the problems relating to input legitimacy are home-made in WTO Members: the tradition of trade policy as a matter of foreign policy traditionally under the prerogative of the executive branch, the predominance of producer interests, often combined with a lack of other private sector participation. These structures and deficiencies equally form part of the system of multilayered governance. They negatively impact upon the legitimacy and reputation of the WTO representing the global trading system. The question therefore arises of the extent to which WTO can and should seek to influence domestic procedures in trade policy formulation and implementation. Much as the GATT has prescribed rules on domestic transparency and judicial protection, minimal standards relating to democratic trade policy formulation and impact assessment should be developed. In addition, it is suggested that democratic governance on the level of the WTO be reinforced, in particular with a view to addressing positive integration: the participation of IGOs, NGOs and the private sector, and the creation of a Parliamentary Assembly. Importantly, reinforcement of deliberative modes beyond intergovernmental interaction and cooperation

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requires enhanced leadership in the organisation with a stronger proactive role for a rotating WTO Commission and the Secretariat. A shift to weighted voting among Members, replacing the current forms of informal weighted voting, is vital to balance more extensive participation with efficient management and conclusive decision-making. Overall, the effort seeks to further strengthen the legitimacy of the WTO, support domestic processes in policy-making and in courts, and overall to contribute to a more coherent system of multilayered governance of which democracy amounts to a crucial, but not an exclusive, factor of legitimacy in regulating a globalised economy. Partly, suggestions can be pursued within existing structures. Partly they envisage a new constitutional framework able to cope with the challenges of the twenty-first century beyond an outdated Westphalian system of nation states. Historians will recall the past: John Maynard Keynes outlined in 1919 a post-war order which was utopian at the time, and dedicated his book to a future generation (Keynes 1919). It took yet another war with the loss of more than 50 million human lives to overcome the realist perceptions of the day and to implement his ideas on multilateralism and trade regulation. We must not wait for another shock before further developing and enhancing the legitimacy of the WTO. Indeed, the adoption of a two-tier system of binding dispute settlement, not at all anticipated in the Uruguay Round and held utterly utopian at the time, demonstrates that short of a major shock, Members of the WTO and the political process are able to bring about a proper paradigm shift. It is time to follow up in reforming political decision-making with a view to further enhancing the overall legitimacy of the WTO.

NOTES The author is most indebted to Lena Schneller, Research Fellow, for valuable comments and assistance in preparing this chapter. 1. Tom Tyler masterfully summarised the relationship. ‘If people view compliance with the law as appropriate because of their attitudes about how they should behave, they will voluntarily assume the obligation to follow legal rules. They will feel personally committed to obeying the law, irrespective of whether they risk punishment for breaking the law. This normative commitment can involve personal morality or legitimacy. Normative commitments through personal morality means obeying the law because one feels that the authority enforcing the law has the right to dictate behaviour’, Why People Obey the Law, 3–4 (1990), quoted by Franck (1995: 25). 2. See http://www.acwl.ch/e/index_e.aspx (last visited 6 August 2008). 3. See also Recommendation 3a of the Declaration on the rule of law in international trade of the 69th Conference of the International Law Association, ILA Report of the SixtyNinth Conference, London, 193/194.


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REFERENCES Abbott, Frederick M, Thomas Cottier, and Francis Gurry (2007), International Intellectual Property in an Integrated World Economy, Austin/Boston/Chicago: Aspen Publishers, Wolters Kluwer Law & Business. Bacchus, James (2005), ‘A Few Thoughts on Legitimacy, Democracy, and the WTO’, in Ernst-Ulrich Petersmann (ed), Reforming the World Trading System. Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 429–36. Barry, Brian (1973), The Liberal Theory of Justice, Oxford: Oxford University Press. Beitz, Charles (1979), Political Philosophy and International Relations, Princeton: Princeton University Press. Caney, Simon (2005), Justice Beyond Borders. A Global Political Theory, Oxford: Oxford University Press. Cass, Deborah (2005), The Constitutionalization of the World Trade Organization, Oxford: Oxford University Press. Charnovitz, Steve (2005), ‘The WTO and Cosmopolitics’, in Ernst-Ulrich Petersmann (ed), Reforming the World Trading System. Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 437–45. Cottier, Thomas (2002), ‘A Theory of Direct Effect in Global Law’, in Armin von Bogdandy et al. (eds.), European Integration and International Co-ordination. Studies in Transnational Economic Law in Honour of Claus-Dieter Ehlermann, The Hague: Kluwer Law International, 99–123. Cottier, Thomas (2005), Trade and Intellectual Property Protection in WTO Law: Collected Essays, London: Cameron May. Cottier, Thomas (2006), ‘From Progressive Liberalization to Progressive Regulation’, 9 Journal of International Economic Law 4, 779–821. Cottier, Thomas (2007), The Challenge of WTO Law: Collected Essays, London: Cameron May. Cottier, Thomas (2007a), ‘Preparing for Structural Reform in the WTO’, 10 Journal of International Economic Law 3, 497–508. Cottier, Thomas, and Christophe Germann (2001), ‘The WTO and EU Distributive Policy: the Case of Regional Promotion and Assistance’, in Grainne de Burca and Joanne Scott (eds), The EU and the WTO: Legal and Constitutional Issues, Oxford: Hart Publishing, 185–209. Cottier, Thomas, and Maya Hertig (2003), ‘The Prospects of 21st Century Constitutionalism’, in Armin von Bogdandy and Rüdiger Wolfrum (eds), 7 Max Planck Yearbook of United Nations Law 1, 261–322. Cottier, Thomas, and Petros C. Mavroidis (2003), ‘Concluding Remarks’, in Thomas Cottier and Petros C. Mavroidis (eds), The Role of the Judge in International Trade Regulation. Experience and Lessons for the WTO, Michigan: The University of Michigan Press, 349–57. Cottier, Thomas, and Krista Nadakavukaren Schefer (1998), ‘The Relationship between World Trade Organization Law, National and Regional Law’, 1 Journal of International Economic Law 1, 83–122. Cottier, Thomas, and Matthias Oesch (2005), International Trade Regulation: Law and Policy in the WTO, the European Union and Switzerland, London: Cameron May & Bern: Stämpfli Publishers.

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Cottier, Thomas, Joost Pauwelyn, and Elisabeth Buergi (2005), Human Rights and International Trade, Oxford: Oxford University Press. Cottier, Thomas, and Satoko Takenoshita (2003), ‘The Balance of Power in WTO Decision-Making: Towards Weighted Voting in Legislative Response’, 58 Aussenwirtschaft 2, 171–214. Cottier, Thomas, and Satoko Takenoshita (2007), ‘Decision-making and the Balance of Power in WTO Negotiations: Towards Supplementary Weighted Voting’, in Stefan Griller (ed), At the Crossroads: The World Trading System and the Doha Round, Wien: Springer-Verlag, 181–229. Ehlermann, Claus-Dieter, and Lothar Ehring (2005), ‘Are WTO Decision-Making Procedures Adequate for Making, Revising, and Implementing Worldwide and “Plurilateral” Rules?’, in Ernst-Ulrich Petersmann (ed), Reforming the World Trading System. Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 496–522. Elsig, Manfred (2007), ‘The World Trade Organization’s Legitimacy Crisis: What Does the Beast Look Like?’, 41 Journal of World Trade 1, 75–98. Ely, John Hart (1980), ‘Democracy and Distrust: A Theory of Judicial Review, Cambridge, MA: Harvard University Press. Esty, Daniel (2002), ‘The World Trade Organization’s Legitimacy Crisis’, 1 World Trade Review 1, 7–22. Franck, Thomas (1998), Fairness in International Law and Institutions, Oxford: Oxford University Press. Franck, Thomas (1988), ‘Legitimacy in the International System’, 82 American Journal of International Law 4, 705–59. Frankel, Jeffrey (2000), ‘Assessing the Efficiency Gains from further Liberalization’, in Roger B. Porter et al. (eds), Efficiency, Equity, and Legitimacy: Multilateral Trading System at the Millennium, Washington, DC: Brookings Institution Press, 81–105. Heiskanen, Veijo (2004), ‘The Regulatory Philosophy of International Trade Law’, 38 Journal of World Trade 1, 1–36. Hilf, Meinhard (2005), ‘How Can Parliamentary Participation in WTO RuleMaking and Democratic Control Be Made More Effective? The European Context’, in Ernst-Ulrich Petersmann (ed), Reforming the World Trading System. Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 413–20. Howse, Robert (2001), ‘The Legitimacy of the World Trade Organization’, in Jean-Marc Coicaud and Veijo Heiskanen (eds), The Legitimacy of International Organizations, Tokyo/New York/Paris: United Nations University Press, 355–407. Howse, Robert, and Donald Regan (2000), ‘The Product/Process Distinction – An Illusory Basis for Disciplining “Unilateralism” in Trade Policy’, 11 European Journal of International Law 2, 249–89. Howse, Robert, and Kalypso Nicolaides (2003), ‘Legitimacy through “Higher Law”? Why Constitutionalizing the WTO is a Step Too Far’, in Thomas Cottier and Petros Mavroidis (eds), The Role of the Judge in International Trade Regulation, World Trade Forum 4, 307–48, Michigan: Michigan University Press. Jackson, John H. (2003), ‘Sovereignty-Modern: A new approach to an outdated concept’, 97 American Journal of International Law 4, 782–802. Jackson, John H. (2006), Sovereignty, the WTO, and Changing Fundamentals of International Law, Cambridge: Cambridge University Press.


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Jenks, C. Wilfred (1964), The Prospects of International Adjudication, London: Stevens & Sons Ltd. Keohane, Robert O., and Joseph S. Nye Jr. (2001), ‘The Club Model of Multilateral Cooperation and Problems of Democratic Legitimacy’, in Roger B. Porter et al. (eds), Efficiency, Equity, Legitimacy: The Multilateral Trading System at the Millennium, Washington, D.C.: Brookings Institution, 334–50. Keynes, John Maynard (1919), The Economic Consequences of the Peace, reprinted in The Collected Writings of John Maynard Keynes Vol. 2, Cambridge: Cambridge University Press, 1971. Kolb, Robert (2003), Case Law on Equitable Maritime Delimitation: Digest and Commentaries, The Hague/London/New York: Martinus Nijhoff Publishers. Krajewski, Markus (2001), ‘Democratic Legitimacy and Constitutional Perspectives of WTO Law’, 35 Journal of World Trade 1, 167–8. Mann, Erika (2005), ‘A Parliamentary Dimension to the WTO: More than Just a Vision?’, in Ernst-Ulrich Petersmann (ed), Reforming the World Trading System. Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 421–8. Moon, Bruce E. (2000), Dilemmas of International Trade, Boulder: Westview Press. Moravcsik, Andrew (2004), ‘Is There a “Democratic Deficit” in World Politics? A Framework for Analysis’, 39 Government and Opposition 2, 336–63. Odell, John S. (2005), ‘Chairing a WTO Negotiation’, in Ernst-Ulrich Petersmann (ed), Reforming the World Trading System. Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 469–96. Peters, Anne (2006), ‘Compensatory Constitutionalism: The Function and Potential of Fundamental International Norms and Structures’, 19 Leiden Journal of International Law, 579–610. Peters, Anne (2007), ‘Die Strukturähnlichkeit der Diskriminierungsverbote im Menschenrechtsbereich und im Welthandelsrecht’, in Stefan Breitenmoser et al. (eds), Human Rights, Democracy and the Rule of Law, Liber amicorum Luzius Wildhaber, Zurich: Dike-Verlag, 551–93. Peters, Anne (2007a), ‘The Globalization of State Constitutions’, in Janne Nijman and André Noellkamper (eds), New Perspectives on the Divide Between National and International Law, Oxford: Oxford University Press, 251–308. Petersmann, Ernst-Ulrich (1995), ‘The Transformation of the World Trading System through the 1994 Agreement Establishing the World Trade Organization’, 6 European Journal of International Law 2, 161–221. Petersmann, Ernst-Ulrich (1997), ‘Constitutionalism and International Organizations’, 17 Northwestern Journal of International Law and Business, 398–469. Pogge, Thomas (2005), ‘Recognized and Violated by International Law: The Human Rights of the Global Poor’, 18 Leiden Journal of International Law 4, 717–45. Raghavan, Chakravarthi (1990), Recolonization: GATT, the Urguguay Round & the Third World, Malaysia: Third World Network. Ricardo, David (1819), The Principles of Political Economy and Taxation, reprinted, London: J. M. Dent & Sons Ltd./Charles E. Tuttle Co., Inc., 1973. Sampson, Gary (2005), ‘Is There a Need for Restructuring the Collaboration among the WTO and UN Agencies so as to Harness their Complementarities?’, in Ernst-Ulrich Petersmann (ed.), Reforming the World Trading System.

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Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 523–34. Scharpf, Fritz W. (1999), Regieren in Europa: Effektiv und demokratisch?, Frankfurt a.M.: Campus Verlag. Schimmelpfennig, Frank (1996), ‘Legitimate Rule in the European Union. The Academic Debate’, 27 Tübinger Arbeitspapiere zur Internationalen Politik und Friedensforschung, available at http://tobias-lib.ub.uni-tuebingen.de/volltexte/2000/150/pdf/tap27.pdf (last visited 6 August 2008). Shaffer, Gregory (2005), ‘Parliamentary Oversight of WTO Rule-Making: The Political, Normative, and Practical Contexts’, in Ernst-Ulrich Petersmann (ed), Reforming the World Trading System. Legitimacy, Efficiency, and Democratic Governance, Oxford: Oxford University Press, 381–408. Smith, Adam (1776), An Inquiry into the Nature and Causes of the Wealth of Nations, edited by E. Cannen, Chicago: University of Chicago Press, 1976. Stein, Eric (2001), ‘International Integration and Democracy: No Love at First Sight’, 95 American Journal of International Law 3, 489–534. Stiglitz, Joseph (2006), Making Globalization Work, London: Penguin Books. Stoll, Peter-Tobias (1997), ‘Freihandel und Verfassung. Einzelstaatliche Gewährleistungen und die konstitutionelle Funktion der Welthandelsordnung (GATT/WTO)’, 57 Zeitschrift für ausländisches öffentliches Recht und Völkerrecht 1, 83–146. Weiler, Joseph (2001), ‘The Rule of Lawyers and the Ethos of Diplomats: Reflections on WTO Dispute Settlement’, in Roger B. Porter et al. (eds), Efficiency, Equity, Legitimacy: The Multilateral Trading System at the Millennium, Washington, DC: Brookings Institution, 334–50. World Bank (2007), World Development Indicators 2007, available at http://web. worldbank.org/ (last visited 6 August 2008). World Trade Organization (1999), The Legal Texts: The Results of the Uruguay Round of Multilateral Trade Negotiations, Cambridge: Cambridge University Press. World Trade Organization (2008), World Trade Report 2008, Geneva: World Trade Organization. World Trade Organization (2007), World Trade Report 2007, Geneva: World Trade Organization. Ziegler, Andreas, and Yves Bozon (2007), ‘How to Reform WTO Decisionmaking? An Analysis of the Current Functioning of the Organization from the Perspectives of Efficiency and Legitimacy’, in NCCR TRADE Working Paper May 2007, 1–23, available at http://www.nccr-trade.org/working-papers (last visited 6 August 2008).

3.

Constitutionalism and the regulation of international markets: how to define the ‘development objectives’ of the world trading system? Ernst-Ulrich Petersmann

INTRODUCTION: ECONOMIC AND DEMOCRATIC CONSTITUTIONALISM AS ‘CATEGORICAL IMPERATIVES’? Scientific conceptions – for instance, of international economic law – often operate as intellectual barriers to alternative, possibly more realistic conceptions. Just as a fly inside a bottle may see neither the glass barrier nor the way out, so can power-oriented conceptions of international law impede mutually beneficial cooperation among free citizens across national frontiers.1 The economic theory of markets, human rights and democratic constitutionalism are European inventions par excellence that have spread over the entire world. Yet, the normative foundations underlying these European institutions are not universally shared. Just as the welfare of Florence during the Renaissance was closely linked to its Republican constitutions and to its open economy, so are the linkages between constitutions, open markets and economic welfare in the EU obvious to Europeans. For example, not only are all 27 member states of the European Community (EC), just as all 47 member states of the Council of Europe, committed to the need for ‘European constitutional law’, as acknowledged in the judicial interpretation of the European Convention on Human Rights (ECHR) by the European Court of Human Rights (ECtHR), and of the EC Treaty by the European Court of Justice (ECJ), as ‘constitutional charters’ protecting fundamental freedoms and constitutional democracy. All European states also participate in the worldwide negotiations on far-reaching legal reforms of the law of the World Trade Organization (WTO) as the international 49

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legal order and ‘economic constitution’ of a liberal (that is, liberty-based) world trading system.2 Yet, interdisciplinary discourse about international markets, their legal regulation and political governance remains difficult because – unlike in other areas of law (such as constitutional law aiming at ‘constitutional justice’, tort law aiming at ‘corrective justice’, social law aiming at ‘distributive justice’) – economists, lawyers, political scientists and governments do not agree on how to define the objectives of international cooperation. More than 200 years ago, in his essay on The Contest of Faculties (1798), the philosopher Immanuel Kant explained why the constitutional reforms resulting from the democratic British, American and French revolutions offered objective evidence of progress in the history of human civilization and of the development of human ‘faculties’. Even though Kant admitted the uncertain future of the constitutional reforms introduced by the revolutions in France and the United States, he perceived the public enthusiasm about the constitutional limitations of abuses of monarchical powers as empirical evidence of the progressive nature of these reforms.3 Today, the widespread citizen support for the ‘common market freedoms’ and other ‘fundamental freedoms’ guaranteed by European constitutional law can be viewed in a similar way as empirical proof of the moral and rational powers of peoples to struggle for more effective protection of their human rights to liberty and self-government. According to Kant, human beings have moral obligations to transform power-oriented into rules-based cooperation across frontiers based on constitutional guarantees of individual freedom, liberal trade and social justice. This ‘categorical imperative’ is reflected in the 2007 Lisbon Treaty on European Union and in its Charter of Fundamental Rights; yet, it remains far from being realized in worldwide economic relations and international law, which are rightly criticized for their ‘constitutional failures’ to protect more effectively consumer welfare, open markets, citizen rights and social justice. The purpose of this contribution is not only to help practitioners to review the theoretical assumptions of their power-oriented, international economic governance. Also the often too separated economic, legal and political ‘faculties’ need to cooperate more in clarifying the complex interrelationships between global markets, democratic constitutions and international legal limitations of ‘market failures’ so as to protect more effectively individual and democratic self-development and rule of law across national frontiers.

Constitutionalism and the regulation of international markets

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‘CONSTITUTIONAL ECONOMICS’ AND DEMOCRATIC CONSTITUTIONALISM: DEVELOPMENT AS FREEDOM, CONSUMER-DRIVEN COMPETITION AND PROTECTION OF HUMAN RIGHTS Philosophers, lawyers and economists have long since emphasized that liberty, markets and democracy risk destroying themselves unless they are protected by constitutional restraints on abuses of power. In order to overcome this ‘paradox of liberty’ and avoid conflicts between our rational long-term interests and emotional short-term temptations, individual decisions (for example, by Ulysses when approaching the island of the sirens) as well as collective decisions (for example, by a democratic majority that wants to hand over the power to a dictator, as in Germany in 1933) need to be restrained by self-imposed rules (‘hands-tying’) of a higher legal rank.4 History confirms that, without such constitutional rules, economic markets for the supply of private goods – just as political markets for the collective supply of public goods – risk entailing restraints of competition, monopolization and other abuses of market power. Individual and collective liberty and the proper functioning of markets thus depend, paradoxically, on legal restraints of individual and collective powers through national and international rules of a higher (‘constitutional’) rank.5 Economists distinguish two basic governance mechanisms for the correction of ‘market failures’ as well as of ‘government failures’, whose different structures and dynamics require careful coordination:6 hierarchical organizations (such as firms, states, international organizations) and decentralized market competition (for example, price competition as spontaneous information mechanism, allocation-, coordination-, and sanctioning-mechanisms forcing suppliers to become sensitive to preferences of consumers). Organizations pursue agreed objectives through hierarchical rules, decision-making procedures and institutions that differ fundamentally from market mechanisms (for example, for the decentralized coordination of international movements of goods, services and capital among billions of self-interested individuals). In our modern world of global integration, almost half of the people in less-developed countries (LDCs) continue to live on less than 2 dollars per day and remain confronted with unnecessary poverty. Even though market competition tends to become ever more intense and to offer more opportunities, worldwide economic cooperation lacks effective constitutional safeguards protecting consumer welfare, non-discriminatory competition, poverty reduction and respect for human rights. Markets are characterized by rivalry among autonomous actors and, due to the tensions between global economic integration and national polities, give rise to ever more complex ‘market governance problems’

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(for example, collective action problems regarding global public goods and transnational externalities that cannot be unilaterally ‘internalized’ by national policies). Efficient market competition is no gift of nature but depends on rules and government interventions constituting open markets, defining rights and obligations of market actors, correcting market failures and supplying public goods. Constitutional economics7 has convincingly criticized the ‘constitutional ignorance’ of neoclassical welfare economics and trade theory, for instance their often unrealistic assumptions of perfect knowledge and competition, factor mobility, ‘optimal’ government corrections of market failures, and authoritarian definitions of ‘social welfare functions’ by aggregating diverse individual preferences; like public choice theory, constitutional economics asserts that – just as democracies are not sustainable over time without ‘constitutional democracy’ – market economies cannot properly function without respect for human rights (normative individualism) and ‘economic constitutions’ protecting consumer-driven, non-discriminatory competition, citizen rights and social justice against the inherent tendencies of self-interested competitors and governments to distort competition by abuses of private and public power.8 Hence, inside constitutional democracies, there tends to be broad agreement among economists and constitutional lawyers that trade and trade law are mere instruments for promoting individual and social welfare as defined in national constitutions. Yet, there exists no corresponding consensus for answering the question: what are international trade and international trade law for? From Welfare Economics to Ordo-liberalism: Promotion of Consumer Welfare Requires Legal Order Economists refer to markets as processes and geographical spaces where goods and services compete and in which the market forces of demand and supply tend to bring about equilibrium prices. Neo-classical welfare economics often assumes perfect competition and omniscient, omnipotent and benevolent governments maximizing social welfare through optimal interventions (such as strategic trade policy). Even if market failures are admitted (for example, in case of abuses of market power, external effects, asymmetries in information, or non-supply of public goods like social justice), welfare economists often ignore the legal preconditions of efficient competition and the authoritarian premises of their assumptions, for instance if ‘economic welfare’ is defined as ‘total welfare’ (rather than general consumer welfare) and discretionary rights of the rulers to redistribute income among domestic citizens by legally limiting the rights of consumers for the benefit of powerful producer lobbies.


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Modern ‘law and economics’ literature9 and ‘institutional economics’10 examine the manifold interrelationships between legal rules and economic welfare (for example, in terms of transaction costs), for instance the contribution of contract law, corporate law and property rights to the efficient functioning of markets, or of liability rules, individual access to courts, litigation rules and law enforcement procedures as legal incentives for decentralized internalization of external effects and for spontaneous protection of market participants against other market failures. They emphasize that what are traded in markets are not physical resources but legal rights to have, use, or transfer scarce resources. Ordo-liberalism11 focuses on the interdependence of economic, legal and political orders, and of related (economic, political and legal) theories about social order, so as to better protect competitive markets by means of a coherent legal protection of the ‘constituent principles’ and ‘regulative principles’ without which undistorted competition cannot unfold and general consumer welfare cannot be effectively protected.12 Whereas welfare economics proceeds from competition within a given set of rules, ordo-liberal economists also review the legal and political rules according to which economic and political ‘games of competition’ must be played in order to promote general consumer welfare rather than particular, mutually conflicting producer interests (such as in protecting rents at the expense of consumer welfare).13 Central themes of ordo-liberal economists and lawyers are the search not only for an economically efficient legal and political order but also for a socially just market economy: which welfare-increasing choices among the basic legal rules of the game may enable more efficient choices within rules without endangering the social consensus necessary for economic and democratic liberalization processes? The ordo-liberal approach attempted to translate the philosophy of the classical economists into the language of the law in order to define and create the legal framework necessary for decentralized coordination of individual supply and demand through a properly-functioning price system and undistorted competition. Yet, the ordo-liberal focus on the need for non-discriminatory trade and competition rules remained confronted with the diverging constitutional traditions of discrimination, such as national sovereignty to maintain discriminatory border restrictions and legislative discretion to regulate different economic sectors in different ways so as to maintain and favour political majorities. From Public Choice Theory to Constitutional Economics: Promotion of General Citizen Welfare Requires Citizen Rights and Constitutional Order Empirical evidence shows that there is often a wide discrepancy between economic theories (for example, on maximizing consumer welfare,

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‘productive efficiency’ and ‘allocative efficiency’) and the reality of economic policies. Public choice theory14 questions whether government institutions have the power, information and motivation for correcting the manifold market imperfections, for instance because individuals are likely to pursue their self-interests in political markets no less than in economic markets; hence, government regulations are often ‘captured’ by rent-seeking interests in redistributing income for the benefit of the regulated industries in exchange for political support of the regulators.15 In response to such ‘public choice’ concerns, modern constitutional economics emphasizes the need for limiting and regulating government powers (such as monetary, taxing, spending and regulatory powers) through agreed constitutional rules so as to constrain legislative, administrative and other government failures by designing a ‘constitution of liberty’ that maximizes general citizen welfare.16 Likewise, economic law emphasizes that the ‘private law society’ (F.Böhm) and private law as the ‘science of liberty’ (C. von Savigny) depend on constitutional controls of private and public power and on constitutional rights which, as in the EC’s common market law and in EC competition law, empower individuals to defend their market freedoms and non-discriminatory competition as citizendriven coordination and discovery processes in national and international courts. Constitutional economists emphasize not only (like institutional economists) the functional dependence of efficient market competition on liberty rights (for example, freedom of profession, freedom of contract, freedom of consumer choice), property rights (for example, in savings, investments and traded goods), non-discriminatory market access rights (as in EC law), and on legal security (such as pacta sunt servanda, due process of law, access to courts) as legal preconditions for efficient agreements on market transactions and reduction of transaction costs. They also argue that people can realize mutual gains not only from voluntary contracts in economic markets but also from constitutional contracts in political markets enabling citizens to escape from prisoners’ dilemmas. Constitutional theories of justice (from Immanuel Kant up to John Rawls) explain why rational citizens should protect their basic liberties and other human rights through long-term constitutional rules limiting post-constitutional legislative, administrative and other decision-making processes by ‘constitutional principles of justice’, which should protect peaceful cooperation among citizens also across national frontiers.17 Only general citizen interests (for example, in equal human rights) and general consumer interests (for example, in non-discriminatory competition), but not protectionist self-interests of producers are in the rational self-interest of all citizens. Hence, constitutional consensus on special interest rules remains unlikely


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because it would be neither efficient nor in the rational long-term interests of consumers, for instance if citizens have to choose among the long-term rules constituting competition, fairness and social justice (for example, in the 2007 Lisbon Treaty on European Union) behind a ‘veil of uncertainty’ about their individual future positions (for example, as winners or losers in competition, as beneficiaries of special privileges, or as taxpayers financing protection rents and legal guarantees of social justice). Both political markets (democracy) and economic markets are confronted with the same basic constitutional problem, that is, how markets can be constrained by agreed legal rules to be responsive to general citizen interests. Just as voluntarily agreed market transactions and non-discriminatory market competition can promote general consumer welfare, so can mutually agreed constitutional rules and democratic procedures promote general citizen welfare. Constitutional economists have elaborated additional techniques facilitating ‘rational choices’ and agreement on ‘social contracts’ necessary for protecting consumer sovereignty and citizen sovereignty, such as negotiations ‘behind a veil of uncertainty’ and ‘competition among jurisdictions’ enhancing the capacity of democratic governments to serve the common interests of their constituents by limiting the scope for rent-seeking.18 By placing constitutional liberties and other agreed core values beyond the power of majoritarian politics, and by protecting a decentralized ‘private law society’ enabling voluntary cooperation, constitutional citizen rights and open markets facilitate individual consent to the basic constitutional rules. The constitutional recognition of the ‘indivisibility’ of human rights reflects the economic recognition of the remarkable empirical connections and mutually reinforcing character of economic, legal and political freedoms.19 Such constitutional perceptions of economic law are in line with the empirical evidence in many OECD countries that high constitutional, labour and social standards can reinforce rather than undermine successful trade performance and capital inflows.20 The high decision-making costs of consensus requirements make democratic majority decisions inevitable. As majority decisions are replete with opportunities for special interests to exploit the rest of the population, majoritarian democracy remains sustainable only as constitutional democracy limiting abuses of majority decisions, for example, by means of equal human rights and other constitutional guarantees for institutional ‘checks and balances’ and non-discriminatory open markets. International integration law, such as the EC and WTO limitations on discriminatory border restrictions and on discriminatory internal restrictions, has increasingly assumed constitutional functions for limiting constitutional failures at national levels, for instance by protecting the individual market freedoms

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inside the EC (for free movements of goods, services, persons, freedom of establishment, capital movements and related payments) against welfarereducing, national border restrictions. Just as constitutional rights are necessary inside democracies for protecting citizens vis-à-vis abuses of power by their own governments, so are constitutional citizen rights necessary also for limiting the perennial abuses of foreign policy powers and of intergovernmental collusion in restricting mutually beneficial cooperation among free citizens across national frontiers. From Constitutional Nationalism to Functionally Limited Multilevel Constitutionalism Most lawyers, politicians and governments outside Europe continue to favour ‘constitutional nationalism’ in view of the power-oriented nature of international relations. Hence, international economic relations and international economic law continue to be shaped by power politics (for example, on reciprocal market access for agricultural and industrial goods from developed countries); likewise, most international theories of justice (for example, by J. Rawls) focus on social justice inside constitutional democracies rather than in the anarchic international relations. It is mainly among the 27 EC member states and the 47 member states of the ECHR that functionally limited guarantees of European constitutional law are increasingly limiting abuses of national government powers and other ‘constitutional failures’ inside nation states (such as their welfare-reducing border discrimination against foreign goods and foreign citizens). Since the Constitutions (sic) establishing the International Labour Organization (ILO) and UN Specialized Agencies committed to the promotion of human rights (like the World Health Organization, the Food and Agricultural Organization, the UN Educational, Scientific and Cultural Organization), there are also an increasing number of international ‘constitutional rules’ legally committing governments to respect for human rights and constituting international rule-making, executive and judicial governance mechanisms protecting mutually beneficial cooperation among citizens across frontiers.21 Multilateral trade negotiations in the WTO, for instance, are no longer only ‘member-driven’ by states, but also strongly influenced by the expertise and advice of the WTO Secretariat, the already more than 220 dispute settlement reports of WTO dispute settlement bodies interpreting and progressively developing WTO rules, by regional actors (like the EC), the regular inter-parliamentarian meetings during WTO ministerial conferences, and by civil society and ever more non-governmental organizations.


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From Market Integration to Policy Integration: does Democratic Legitimacy Require Anchoring ‘International Market Governance’ in Human Rights? The increasing move from ‘negative’ to ‘positive’ integration in the EU and WTO illustrates the functional need and political pressures to reduce the adjustment costs of market integration through policy coordination aimed at reducing transaction costs, discriminatory market access barriers, regulatory competition, and of adjustment costs. International governance – for instance, by rule-making, rule-implementation and adjudication at the international level – raises legitimacy problems and constitutional problems which often cannot be solved by transferring the constitutional methods applied inside constitutional democracies to the international level of functionally limited international organizations. Some organizations – like the World Bank, the OECD and the EU Commission – have committed themselves to ‘principles of good governance’ (such as transparency, democratic participation, accountability, effectiveness, coherence) so as to legitimize their international governance and integration law.22 Yet, such functional and technocratic justifications have been criticized as being insufficient for protecting human rights and constitutional democracy from being undermined through intergovernmental collusion and international organizations far away from most citizens and from their parliamentary representatives.23 UN human rights bodies and the ILO have, therefore, endorsed civil society calls for developing human rights approaches to the interpretation and application of international economic law, taking into account the human rights obligations of all UN member states under the UN Charter as well as under general international law to respect, protect and fulfil human rights at home and abroad.24 Many economists, since Adam Smith, rightly emphasize that economic efficiency requires rule of law and respect for justice (ubi commercium, ibi jus).25 Markets and human rights proceed from the same value premise that individual autonomy (human dignity) must be respected; that values can be derived only from the individual and his consent (normative individualism); and that both economic markets as well as political markets serve the same human rights function of promoting personal self-development. The information, coordination and ‘sanctioning functions’ of market mechanisms are ultimately based on decentralized dialogues among citizens about the value, production and distribution of scarce goods and services.26 An increasing number of empirical studies confirm that the economic welfare of most countries, and the consumer welfare of their citizens, are related to their constitutional guarantees of freedom, property

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rights and of decentralized dialogues about ‘supply and demand’:27 ‘individual rights are a cause of prosperity’.28 Since economic welfare can be increased by ‘successful struggle for rights of which the right to property is the most fundamental’,29 ‘almost all of the countries that have enjoyed good economic performance across generations are countries that have stable democratic governments.30 This focus of constitutional economics on empowerment of individuals is in line with the long-standing emphasis by many economists – from Adam Smith via Friedrich Hayek up to Nobel Prize-winning economist Amartya Sen – that market economies and economic welfare are mere instruments for enabling and promoting individual freedom as the ultimate goal of economic life and the most efficient means of realizing general welfare.31 ‘Economic considerations are merely those by which we reconcile and adjust our different purposes, none of which, in the last resort, are economic (except those of the miser or the man for whom making money has become an end in itself).’32 Modern theories of justice increasingly postulate that ‘basic equal freedoms’ as ‘first principle of justice’, and constitutional ‘difference principles’ as ‘secondary principles of justice’ justifying preferential treatment of disadvantaged individuals whose personal self-development requires special, social assistance, should be applied not only inside nation states (as postulated by John Rawls) but also in ‘international democracies’ (like the EC) and for the benefit of poor people in third countries.33 International human rights law only provides for minimum standards based on the recognition that, depending on society’s resources and democratic preferences, the constitutional protection of ‘negative freedom’ (for example, from arbitrary government interference) and ‘positive freedom’ (for example, in terms of real individual capacity to live the life one has reason to value) may legitimately vary among countries, as reflected in their often differing catalogues of human rights and other constitutional rights. Constitutional Economics, Human Rights and Constitutional Pluralism: a New Research Agenda Constitutional democracies recognize ‘inalienable’ human rights as birthrights of every human being deriving from respect for human dignity, liberty and for the basic needs for personal self-development, including economic freedoms (such as freedom of profession and property rights) as legal preconditions for producing goods and services that can be exchanged for other goods and services necessary for individual survival and social cooperation among free citizens. This moral and constitutional foundation of modern human rights law is not inconsistent with


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economic theories explaining the historical bottom-up struggles of citizens for human rights (for example, in the English, American and French Revolutions during the seventeenth and eighteenth centuries) as rational responses to market failures and to government failures so as to internalize external effects of arbitrary governmental restraints of economic and political competition. Just as economics emphasizes that the legitimacy of economic markets derives from satisfying general consumer interests (rather than protectionist self-interests of producers), so do human rights emphasize that the democratic legitimacy of political markets derives from serving general citizen interests as defined by human rights (rather than the self-interests of political entrepreneurs claiming to produce collective public goods). Hence, consumers in economic markets as well as citizens in political markets have rational self-interests in defining more precisely the ‘limiting constitution’ needed for protecting equal freedoms and non-discriminatory competition against abuses of power, as well as the ‘enabling constitution’ needed for promoting efficient supply of private and public goods meeting the individual and democratic demand of free citizens. The numerous parallels and interrelationships between the voluntary exchange paradigms (‘consumer sovereignty’) of market theories, the constitutional contract paradigm (‘citizen sovereignty’) of democratic theories, and modern conceptions of inalienable human rights have given rise to an increasing amount of research on the similar value premises, similar constitutional problems and complementary functions of human rights and non-discriminatory market competition.34 As social traditions, democratic preferences and national constitutions legitimately differ among countries, international law must respect ‘constitutional pluralism’, including the sovereign right of constitutional democracies to disregard, for legitimate constitutional reasons, their ‘primary obligations’ under international law subject to the ‘secondary’ international law rules on state responsibility. The ECJ, in its judicial interpretation of the intergovernmental EC Treaty guarantees of free movements of goods, services, persons, capital and payments as ‘fundamental individual freedoms’ of EC citizens, increasingly balances and delimits the EC’s market freedoms with other human rights and constitutional rights of citizens as protected by national constitutions and by the ECtHR.35 The ECtHR has, likewise, recognized that citizens must be constitutionally protected by fundamental rights not only in their individual economic activities (for example, as owners and sellers of private property rights), but also in their collective, private economic activities (for example, in economic companies and trade unions) producing and consuming scarce resources.36 The 1969 Vienna Convention on the Law of Treaties stipulates explicitly (for instance, in its

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Preamble and Article 31) that international treaties must be interpreted ‘in conformity with the principles of justice and international law’, including ‘universal respect for, and observance of, human rights and fundamental freedoms for all’. Hence, also UN human rights bodies, other worldwide organizations and international courts emphasize that – as inside the EC – international economic law and market freedoms (for example, as protected by the WTO legal and dispute settlement system) must remain consistent with universal human rights obligations of all UN member states and with their often diverse constitutions and democratically agreed principles of justice.

MULTILEVEL MARKET GOVERNANCE REQUIRES MULTILEVEL CONSTITUTIONALISM Economic and political markets emerge wherever personal autonomy and diversity of individual capacities and preferences of citizens (such as investors, producers, traders, consumers) are respected and legally protected by rules. Since Aristotle’s comparative analysis (in his Politeia) of constitutional systems and (in his Nicomachean Ethics) of universal and particular principles of justice (such as reciprocal, corrective and distributive justice), constitutionalism and theories of justice emphasize that rules risk remaining ineffective over time unless they are perceived as just. Modern theories of justice (for example, by John Rawls) explain why constitutional agreements on basic equal liberties (as ‘first principle of justice’ deriving from human rights) cannot remain stable without complementary, constitutional ‘difference principles’ (as ‘second principle of justice’) justifying rewards for services contributing to the common good as well as differential treatment of disadvantaged members of society.37 The universal recognition by all 192 UN member states of national and international legal obligations (under the UN Charter, other UN, regional and national human rights instruments and so on) to respect, protect and promote ‘inalienable’, ‘indivisible’ human rights requires evaluating international law and the international economic order in terms of their contributions to the enjoyment of human rights. From such human rights perspectives, the state-centred system of ‘international law among states’ is increasingly criticized for its lack of democratic legitimacy, its failure to protect human rights effectively in many UN member states, as well as for its authoritarian treatment of private producers, investors, traders and consumers as mere objects of intergovernmental regulation rather than as legal subjects and democratic owners of the world trading system.


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‘Constitutional Failures’ and ‘Governance Failures’ in the World Trading System The ‘Westphalian system of international law among states’ evolved as an ‘international law of coexistence’ protecting state sovereignty, as well as an ‘international law of cooperation’ based on intergovernmental agreements and organizations, without regard to the democratic legitimacy of governments and without effective safeguards of human rights. As emphasized by Kofi Annan in his final address as UN Secretary-General to world leaders assembled in the UN General Assembly on 19 September 2006, this statecentred international legal system has proven to be ‘unjust, discriminatory and irresponsible’ because it has failed to effectively respond to the three global challenges to the United Nations: ‘to ensure that globalization would benefit the entire human race; to heal the disorder of the post-Cold War world, replacing it with a genuinely new world order of peace and freedom; and to protect the rights and dignity of individuals, particularly women, which were so widely trampled underfoot.’ According to Kofi Annan, these three challenges – ‘an unjust world economy, world disorder and widespread contempt for human rights and the rule of law’ – entail divisions that ‘threaten the very notion of an international community, upon which the UN stands.’38 As individual and social welfare depends ever more on a rules-based, worldwide division of labour, citizens and parliaments must hold ‘member-driven governance’ accountable for these obvious ‘government failures’ in the collective supply of international public goods, just as consumer-driven economic competition is necessary for forcing private producers of goods to respond efficiently to consumer preferences. Rational individuals commit themselves to ‘constitutional principles’ in order to reduce conflicts inside their own minds (for example, between human passions and rationality) and in their social relations. All UN member states have adopted national constitutions and have committed governments to ‘universal respect for, and observance of, human rights and fundamental freedoms for all’ (Article 55 UN Charter). Yet, just as UN law does not provide for effective legal and judicial remedies against the widespread violations of human rights, so does WTO law fail to effectively protect consumer welfare and the rights of private producers, investors, traders and consumers as the main actors in international trade and the worldwide division of labour. The more state-centred rules and ‘member-driven governance’ fail to empower and protect citizens and their human rights effectively, the stronger becomes the need for ‘constitutionalizing’ foreign policy-making in the WTO, similar to the rightsbased constitutional restraints in European economic law protecting

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citizens against abuses of trade and economic policy powers by their own governments.39 Constitutional democracies have responded to the obvious ‘constitutional failures’ in international relations by reinforcing national constitutions and European constitutionalism without effectively limiting intergovernmental power politics by worldwide international constitutionalism. The Prevailing Post-War Paradigm of Constitutional Nationalism and ‘Embedded International Liberalism’ Many constitutional democracies, like most non-democratic states, emphasize the limited mandate of intergovernmental organizations and distrust intergovernmental rule-making in non-transparent organization. The US Congress, for example, has a long tradition of refusing to ratify multilateral treaties, to incorporate intergovernmental rules into domestic legal systems, and to allow domestic citizens to invoke and enforce such rules in domestic courts. In most democracies, the Lockean paradigm of rights-based democracy for domestic policies has never been fully applied to the domain of foreign policies; politicians justify the ‘Lockean dilemma’ of broad discretionary foreign policy powers by the power-oriented character of international relations and by the need for defending ‘national interests’ against the self-interests of other international actors. Yet, this ‘national interest perspective’ may conflict not only with the collective supply of ‘global public goods’; many foreign policy powers also operate by taxing and restricting domestic citizens in welfare-reducing ways (for example, by imposing tariffs and welfare-reducing non-tariff barriers on thousands of consumer goods); hence, inadequate constitutional restraints on discretionary foreign policy powers risk undermining domestic constitutional restraints (for example, if administrative import protection is used as a substitute for distributing ‘protection rents’ without parliamentary approval of such subsidization). Building on the centuries-old English and American common law tradition of protecting equal freedoms of traders, competitors and consumers against ‘unreasonable restraint of trade’ and ‘coercion’, all constitutional democracies in Europe and North America have introduced comprehensive national and European competition rules based on common core principles, reflecting the European and American historical experience that abuses of private power may be no less dangerous and welfare-reducing than abuses of public power.40 As emphasized by the US Supreme Court, ‘antitrust laws [. . .] are the Magna Charta of free enterprise. They are as important to the preservation of economic freedom and our free enterprise system as the Bill of Rights is to the protection of our fundamental


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freedoms.’41 Yet, notwithstanding this emergence of an ‘economic constitution’ protecting common markets, non-discriminatory competition and consumer welfare against abuses of private economic power inside the EC and the United States, most countries lack an equivalent ‘economic constitution’ limiting abuses also of foreign economic policy powers (for example, in the trade policy area). The foreign policies of most countries continue to be based on the post-war paradigm of intergovernmental, reciprocal tariff liberalization and domestic regulatory autonomy, without effective protection of non-discriminatory international competition and citizen rights against private and public restraints of international competition and discrimination against foreign goods, services, persons and investments.42 The Successful European Experiment in Multilevel Constitutionalism All the 47 member states of the Council of Europe have accepted the judicial transformation of the ECHR into a ‘constitutional instrument of European public order’,43 just as all 27 EC member states and their association partners in Europe have accepted the judicial transformation of EC law into a supranational European constitutional law protected by the ECJ as a constitutional, administrative and economic court.44 Inside Europe, national constitutionalism is increasingly supplemented by European constitutional guarantees among states as well as of cosmopolitan citizen rights vis-à-vis national and foreign governance powers: EC law constitutes legislative, executive and judicial EC governance mechanisms and constitutionally limits multilevel economic governance inside the EC and in its 27 member states. EC competition law is an integral part of EC constitutional law guaranteeing ‘an open market economy with free competition’ (Articles 4, 98, 105, 157 EC Treaty) based on ‘a system ensuring that competition in the internal market is not distorted’ (Article 3g); the EC Court explicitly recognizes that EC competition law protects not only economic efficiency and consumer welfare, but also individual freedom as a constitutional ‘principle of freedom’ (Article 6 EU).45 Free movements of goods, services, persons, capital and related payments, non-discriminatory conditions of competition, as well as social and other rights are constitutionally protected in EC law as ‘fundamental rights’46 and integral parts of the EC’s economic constitution. The single European market would never have become a reality without this legal empowerment of ‘market citizens’ and without their direct access to national and EC courts enabling the private enforcement of the EC’s common market rules vis-à-vis governmental and private restrictions and discrimination.

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The World Trading System as Power Politics in Disguise: need for Constitutional Reforms of ‘Member-Driven Governance’? On the worldwide level, UN law continues to operate as an intergovernmental legal system that has so far failed to effectively realize its declared objectives of promoting and protecting human rights, democratic peace, worldwide economic welfare and social justice. The Preamble to the WTO Agreement defines its objectives mainly in economic terms. Idealists therefore view the WTO as an instrument for promoting economic welfare through trade, non-discriminatory conditions of competition and efficient use of policy instruments. Realists counter that GATT and WTO rules and negotiations are no less used for justifying trade protection, trade discrimination and the redistribution of income for the benefit of rent-seeking interest groups. The 45 years of GATT and WTO cotton, textiles and agricultural agreements discriminating against exports from less-developed countries (LDCs), and the lack of economic rationality of many WTO rules (for example, on discriminatory anti-dumping measures, agricultural export subsidies), illustrate the ambivalence of the economic functions and political exceptions of GATT/WTO rules. The reciprocity principle underlying the WTO objective of ‘reciprocal and mutually advantageous arrangements directed to the substantial reduction of tariffs and other barriers to trade’ (Preamble WTO Agreement) is based more on political than on economic rationales. In the Doha Round negotiations, realists blame the lack of reciprocity (for example, between the EU offer for agricultural market access, the US offer for agricultural domestic support, the offers by the 22 LDCs cooperating in the ‘G20’ for industrial goods and services) as the major stumbling block preventing a ‘grand bargain.’ Economists counter that the ‘balance of concessions’ may exist only in the eyes of the negotiators; in terms of consumer welfare, the alleged ‘reciprocity advantages’ may be smaller than the opportunity costs of delaying and risking the successful conclusion of the Doha negotiations. Some objectives in the Preamble of the WTO Agreement – such as recognition of the ‘need for positive efforts designed to ensure that developing countries, and especially the least developed among them, secure a share in the growth in international trade commensurate with the needs of their economic development’ – reflect principles of distributive justice and solidarity. Similar objectives had already been accepted in Article XXXVI of GATT 1947, for example ‘that individual and joint action is essential to further the development of the economies of less-developed contracting parties and to bring about a rapid advance in the standards of living in these countries’ (Art. XXXVI:1,d). The still marginal share of the leastdeveloped among the LDC’s (LLDCs) in world trade, and the widespread


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poverty of almost half the people living in LDCs on less than 2 dollars per day, confirm that ‘member-driven trade governance’ has failed, in far too many countries, to effectively protect consumer welfare, poverty reduction and other citizen interests. The role of WTO law suffers from the same ambivalence as WTO politics. Idealists claim that ‘member-driven governance’ serves the ‘public interest’, and that ‘global governance’ can be effectively controlled by ‘global administrative law’ and constitutional nationalism.47 Realists counter that consumer welfare, human rights and other constitutional safeguards of citizen interests are neither mentioned nor effectively protected in WTO law. WTO negotiations are driven by producer interests, bureaucratic and political interests; citizens, their human rights and consumer welfare are treated as marginal objects of benevolent governance, resulting in widespread alienation of citizens and democratic distrust vis-à-vis intergovernmental power politics in the WTO. When I joined the GATT Secretariat in 1981 as the first ‘legal officer’ ever employed by GATT, most GATT officials and trade diplomats claimed that GATT should continue to operate ‘pragmatically’ without a Legal Office and without participation of legal officers in GATT negotiations and dispute settlement proceedings. It was only in 1983 that the EC agreed to the establishment of a GATT Legal Office on the condition that its first director could only be an experienced trade diplomat without thorough legal training. As several GATT panel proceedings had found against the EC’s agricultural subsidies and restrictions in the late 1970s and early 1980s, EC Trade Commissioner Willy de Clerq continued to claim that ‘GATT must never become a court’. GATT Director-General Arthur Dunkel, recognizing the power-struggles by economists and diplomats opposed to sharing their powers with lawyers in GATT negotiations and dispute settlement proceedings, kept the GATT Legal Office under his direct supervision and directly located next to the Director-General’s office inside the GATT Secretariat. Yet, following several GATT dispute settlement findings against US antidumping measures during the Uruguay Round, Dunkel gave in to the request by US Trade Representative Carla Hills to transfer responsibility for dispute settlement challenges of antidumping, countervailing duty and safeguard restrictions from GATT’s Legal Office to a ‘Rules Division’ directed by bureaucrats eager to prevent independent legal advice. The continuing distrust vis-àvis rule of law in international trade, as illustrated by the insistence of EC and US governments that domestic courts must not directly apply WTO law, illustrates that ‘member-driven’ trade governance remains dominated by political, bureaucratic and protectionist self-interests without adequate safeguards for rule of law among private economic actors, general citizen interests and consumer welfare.

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CAN THE WTO DELIVER A ‘DEVELOPMENT ROUND’? INTERGOVERNMENTAL NEGLECT OF CONSUMER WELFARE, GENERAL CITIZEN INTERESTS AND NON-DISCRIMINATORY COMPETITION Since LDCs became the majority of the contracting parties to the General Agreement on Tariffs and Trade (GATT) in the 1960s, they have insisted in all ‘GATT Rounds’ of multilateral trade negotiations on their ‘special and differential treatment’ (S&D) as being ‘essential to further the development of the economies of the less-developed countries’ (Article XXXVI GATT). The 2001 Doha Declaration launching the ‘Development Round’ of multilateral trade negotiations in the WTO listed more than 20 different objectives of these ongoing negotiations, including the elaboration of multilateral competition, investment and environmental rules aimed at limiting market failures as well as government failures distorting the world trading system. At the 2003 WTO Ministerial Conference at Cancun, some of these ambitious objectives (such as trade-related competition and investment rules) had to be abandoned in response to objections from LDCs.48 The more than 60 regional trade agreements (RTAs) concluded since 2003 illustrate that RTAs are increasingly perceived not only as alternative fora for trade liberalization, but also for trade regulation and non-economic integration. The initiatives for transforming RTAs into, for instance, an ASEAN Community, a Southern African Community, Andean, Central and South American Economic Communities reflect the European experience that the success of regional trade liberalization and economic integration may depend on embedding it into a broader constitutional framework of ‘just rules’, ‘fair procedures’ and ‘integration law’ supported by citizens, business and other non-governmental constituencies. The evolution of the international economic order into a ‘layered legal system’ raises questions as to the relationships between the different private and public, national, regional and worldwide levels of law. Inside the EC’s common market, national governments were forced – by citizens, parliaments and courts – to integrate the different layers of private and public, national and intergovernmental economic law into a mutually coherent constitutional system ‘founded on the principles of liberty, democracy, respect for human rights and fundamental freedoms, and the rule of law, principles which are common to the Member States’ (Article 6 EU). In contrast to this citizen-oriented focus of European economic law, the WTO Agreement and WTO bodies treat citizens and non-governmental organizations as mere objects of benevolent trade governance, without individual rights to hold their own governments accountable for their


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frequent violations of WTO rules. Also parliaments in most WTO member countries and in the EC do not effectively control intergovernmental negotiations and rule-making in the WTO.49 Hence, the influence of rentseeking interest groups on periodically elected politicians (for example, in the US Congress, the EC and many WTO member states) is disproportionately stronger than the legal and democratic accountability of trade diplomats for promoting general consumer welfare and protecting individual rights of private participants in international trade. The universal recognition of ius cogens and of ‘inalienable’ human rights as erga omnes obligations has made individuals legal subjects of international law with an ‘inalienable core’ of human rights. Notably in Europe, the intergovernmental structures of international economic law are increasingly limited by human rights obligations and by supranational powers of international courts and institutions. WTO law has, likewise, hierarchical structures that assert legal supremacy not only visà-vis domestic laws (cf. Article XVI:4 WTO Agreement); they introduce vertical legal hierarchies and constitutional ‘checks and balances’ also among the institutions and different levels of primary and secondary law of international organizations (cf. Articles IX, XVI:3 WTO Agreement). They increasingly limit regional agreements (cf. Articles XXIV GATT, V GATS), bilateral agreements (cf. Article 11 of the WTO Safeguards Agreement, the WTO Agreement on Textiles and Clothing) and unilateralism through multilateral legal and institutional restraints (for example, in Articles 16, 17 and 23 DSU) with citizen-oriented functions for the protection of freedom, non-discrimination, rule of law and welfare-increasing cooperation among producers, investors, traders and consumers across national frontiers. Yet, as long as citizens have no effective legal and judicial remedies against the frequent violations of WTO obligations by their own governments, protectionist collusion all too often prevails. Citizens increasingly challenge the democratic legitimacy of this intergovernmental exclusion of citizen rights and the intergovernmental neglect of consumer welfare and other general citizen interests in the WTO. Representatives of international organizations, like the EC Commission and WTO Director-General Pascal Lamy, emphasize the political advantages of empowering self-interested citizens and ‘cosmopolitan constituencies’ (Pascal Lamy) in support of the collective supply of international ‘public goods’ (like an efficient world economy) that cannot be unilaterally produced by national governments. Citizens and lawyers increasingly reject the non-democratic view that UN law should be interpreted exclusively from the perspective of ‘sovereign equality of states’ (Article 2 UN Charter) without equal regard to the legally binding UN commitments to ‘principles of justice’ and ‘respect for human rights

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and for fundamental freedoms for all’ (Articles 1, 55). Sociological and constitutional approaches to international law have emphasized long since that all legal rules and governmental organizations, including international law and intergovernmental organizations, derive their legitimacy from their instrumental function to protect individual rights and citizen interests. The ‘policy approach’ to international law, as advocated also by the president of the International Court of Justice Rosalyn Higgins and the former president of the WTO Appellate Body Florentino Feliciano, rightly perceives international law not only as a system of intergovernmental rules, but also as legal decision-making processes in which individuals, non-governmental organizations and parliaments must increasingly participate (for example, by submitting ‘amicus curiae’ submissions to WTO dispute settlement panels, convening regular inter-parliamentary conferences at WTO ministerial meetings since 1999).50 The more individuals have rights and duties under international human rights and humanitarian, economic and social law, the more it becomes anachronistic for trade diplomats to alienate and exclude citizens – as the main actors in international trade and “democratic owners” of the WTO – from participation in the WTO legal system. Constitutional economics confirms that empowering self-interested citizens (like producers, investors, traders, consumers) by individual rights and obligations is the most effective incentive for mutually beneficial cooperation among citizens and for the decentralized limitation of ‘market failures’, in the economy no less than in the polity.51 Institutional economists likewise claim that open-access societies have proven to be preconditions for maintaining democracy: ‘sustaining competitive democracy is possible only in the presence of economic competition’.52 As virtually all WTO member states have adopted national constitutions and international obligations committing their respective governments to the protection of human rights and citizen interests, diplomats have no mandate to abuse their foreign policy powers by disenfranchising their own citizens through intergovernmental collusion. The UN Charter (for example, Article 1) and the Vienna Convention on the Law of Treaties (for example, its Preamble) require interpreting treaties and settling disputes ‘in conformity with the principles of justice and international law’, including ‘universal respect for, and observance of, human rights and fundamental freedoms for all’. As WTO rules must be interpreted ‘in accordance with customary rules of interpretation of public international law’ (Article 3 DSU), lawyers and judges may reasonably argue that ‘the basic principles . . . underlying this multilateral trading system’ (in terms of the Preamble to the WTO Agreement and numerous other WTO provisions) include the universal human rights obligations of all WTO Members, as emphasized by UN human rights bodies. This chapter argues that the human rights obligations


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of all WTO members should also guide the preferential treatment of LDCs in future ‘Doha Round’ agreements and their domestic implementation, notably in the more than 100 less-developed WTO member countries where large parts of the population suffer from unnecessary poverty. The WTO development objectives should be defined in terms of ‘human development’ and individual rights, and the rights and obligations of WTO Members should be differentiated in accordance with ‘principles of justice’. This does not mean transforming the WTO into a human rights organization. Yet, WTO bodies should respond constructively to the increasing challenges by human rights bodies, citizens and their representative institutions of ‘diplomatic trade governance’, secretive rule-making, disregard for human rights in WTO deliberations, exclusion of citizens as legal subjects of WTO law, and bureaucratic distribution of ‘protection rents’ without effective parliamentary control. For instance, WTO Members and WTO bodies could acknowledge their existing human rights obligations and pledge to cooperate with citizens and their representative institutions as the democratic owners of the WTO and the main actors in international trade relations.

THE ‘HUMAN RIGHTS APPROACH’ TO INTERNATIONAL TRADE ADVOCATED BY THE UN HIGH COMMISSIONER FOR HUMAN RIGHTS AND THE ILO All WTO Members have obligations to respect, protect and promote human rights under international law (for example, the UN Charter, UN and regional human rights conventions) and other human rights instruments (in national laws). The UN Declarations on the ‘right to development’53 define development in terms of enjoyment of human rights: ●

● ●

●

The right to development is an inalienable human right by virtue of which every human person and all peoples are entitled to participate in, contribute to, and enjoy economic, social, cultural and political development, in which all human rights and fundamental freedoms can be fully realized (Article 1). The human person is the central subject of development and should be the active participant and beneficiary of the right to development (Article 2). All human rights and fundamental freedoms are indivisible and interdependent; equal attention and urgent consideration should be given to the implementation, promotion and protection of civil, political, economic, social and cultural rights (Article 6:2). States should take steps to eliminate obstacles to development resulting from failure to observe civil and political rights, as well as economic, social and cultural rights (Article 6:3).

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The fulfilment of most human rights (for example, to food, health, education) depends on access to scarce goods and services (such as drinking water, cheap medicines, health and educational services). Also enjoyment of civil and political human rights (for example, personal freedom, rule of law, access to justice, democratic self-government) requires economic resources (for example, for financing democratic and law-enforcement institutions). The widespread, yet unnecessary poverty, health problems and legal insecurity (for example, of the more than 1 billion people living on 1 dollar a day or less) bear witness to the fact that many UN member states and UN law have so far failed to realize the UN objective of ‘universal respect for, and observance of, human rights and fundamental freedoms for all’ and ‘creation of conditions of stability and well-being which are necessary for peaceful and friendly relations among nations’ (Article 55 UN Charter). Even though international trade is essential for increasing the availability and quality of scarce resources, UN human rights bodies have, until recently, neglected international trade law or, as in a report for the UN Commission on Human Rights of 2001, discredited the WTO as ‘a veritable nightmare’ for developing countries and women.54 Human Rights Dimensions of WTO Law: the Reports by the UN High Commissioner of Human Rights In response to the widespread criticism of the anti-market bias of such ‘nightmare reports’, the UN High Commissioner for Human Rights (UNHCHR) has published more differentiated reports55 analyzing human rights dimensions of the WTO Agreements on Trade-Related Intellectual Property Rights (TRIPS), the Agreement on Agriculture, the General Agreement on Trade in Services (GATS), international investment agreements, non-discrimination in the context of globalization, and on the impact of trade rules on the right of everyone to the enjoyment of the highest attainable standard of physical and mental health. The reports call for a ‘human rights approach to trade’ which (i) (ii) (iii) (iv)

sets the promotion and protection of human rights as objectives of trade liberalization, not exceptions; examines the effect of trade liberalization on individuals and seeks to devise trade law and policy to take into account the rights of all individuals, in particular vulnerable individuals and groups; emphasizes the role of the State in the process of liberalization – not only as negotiators of trade law and setters of trade policy, but also as the primary duty bearer of human rights; seeks consistency between the progressive liberalization of trade and the progressive realization of human rights;

Constitutionalism and the regulation of international markets (v) (vi)

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requires a constant examination of the impact of trade liberalization on the enjoyment of human rights; promotes international cooperation for the realization of human rights and freedoms in the context of trade liberalization.

The UNHCHR emphasizes that, because every WTO Member has ratified one or more UN human rights conventions and has human rights obligations also under general international law, human rights may be ‘relevant context’ for the interpretation and application of WTO rules. According to the UNHCHR, the needed human rights approach to international trade must recognize as ‘entitlements the basic needs necessary to lead a life in dignity and ensure their protection in the processes of economic liberalization’; these entitlements cannot be ‘left subject to the whims of the market.’ The UNHCHR differentiates between obligations to respect human rights (for example, by refraining from interfering in the enjoyment of such rights), to protect human rights (for example, by preventing violations of such rights by third parties), and to fulfil human rights (such as by taking appropriate legislative, administrative, budgetary, judicial and other measures towards the full realization of such rights). As recourse to trade sanctions for promoting respect for human rights abroad can aggravate the problems of the people concerned, the UNHCHR reports analyze the human rights dimensions of trade liberalization, trade restrictions and other trade regulations in a broader perspective, emphasizing both potential synergies as well as potential conflicts between human rights and trade rules. As enjoyment of human rights depends on availability, accessibility, acceptability and quality of traded goods and services, the relevance of WTO rules for the collective supply of public goods (like access to low-priced goods and services), for limitations of ‘market failures’ (for example, inadequate supply of public goods like essential medicines for poor people), and for protection and fulfilment of human rights is acknowledged and discussed. The reports underline that, what are referred to – in numerous WTO provisions – as rights of WTO Members to regulate, may be duties to regulate under human rights law (e.g. so as to protect and fulfill human rights of access to water, food, essential medicines, basic health care and education services at affordable prices and so on). The UNHCHR suggests, inter alia, ● ●

to recognize the promotion of human rights as an objective of the WTO; to encourage interpretations of WTO rules that are compatible with international human rights as progressively clarified e.g. in the ‘General Comments’ adopted by UN human rights bodies;

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The law and economics of globalisation ● ●

to carry out ‘human rights assessments’ of WTO rules; and to strengthen intergovernmental protection of human rights so that trade rules and policies promote the human rights and basic needs of all.

The 1998 ILO Declaration on Fundamental Principles and Rights at Work: the Expanding Scope of an ‘Inalienable Core’ of Basic Rights Human rights are increasingly acknowledged today in national constitutions as well as in the law of worldwide organizations (like the UN, the FAO, WHO, UNESCO) and regional economic integration agreements (like the EC Treaty, the 2000 Cotonou Agreement, the 2001 Quebec Ministerial Declaration on a Free Trade Area of the Americas) as international erga omnes obligations of states and intergovernmental organizations with an ‘inalienable’ and ‘indivisible’ jus cogens core. The 1996 WTO Declaration on core labour standards helped to reach consensus in the International Labour Organization (ILO) to adopt, on 18 June 1998, the Declaration on Fundamental Principles and Rights at Work which recognizes that all Members, even if they have not ratified the Conventions in question, have an obligation, arising from the very fact of membership in the Organization, to respect, to promote and to realize, in good faith and in accordance with the Constitution, the principles concerning the fundamental rights which are the subject of those Conventions, namely: (a) freedom of association and the effective recognition of the right to collective bargaining; (b) the elimination of all forms of forced or compulsory labor; (c) the effective abolition of child labor; and (d) the elimination of discrimination in respect of employment and occupation.56

The ILO Declaration and other modern human rights instruments57 confirm that – in addition to the longstanding prohibitions of genocide, slavery, apartheid and torture – there is an increasing core of additional human rights which must be respected as erga omnes obligations. Since the end of the cold war, this international jus cogens continues to expand, as recognized by international courts,58 notwithstanding divergent views on the precise scope and definition of such ‘inalienable human rights’. Human rights law evolves from national and regional legal systems into a worldwide ‘constitutional public order’ limiting all governance powers and requiring to interpret international and national laws as a functional unity for promoting and protecting ‘human self-development’ as defined by human rights. Human rights instruments recognize that human rights need to be mutually balanced and implemented by democratic legislation which


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may legitimately vary from country to country. International courts have elaborated legal ‘balancing principles’ (like non-discrimination, necessity and proportionality of governmental limitations of freedom and other human rights); courts emphasize the need to respect the ‘margin of appreciation’ which national parliaments may enjoy in their domestic legislation protecting and promoting human rights. As human rights also protect individual and democratic diversity, views on the interpretation of government obligations to respect, protect and fulfil human rights may legitimately differ among countries. In view of the limited mandate of international organizations, there are also diverging views on whether, and to what extent, international organizations should not only respect human rights, but also protect and fulfil human rights. Yet, such differences of view over the interpretation and legal protection of human rights do not change the fact that citizens have become subjects of international law and should no longer be treated by trade diplomats as mere objects of their trade management. Liberal Trade Rules, Like Human Rights, Should Focus on Human Self-Development The reports by the UNHCHR identify potential synergies between trade rules and human rights: ‘trade liberalization is generally a positive contributor to poverty alleviation – it allows people to exploit their productive potential, assists economic growth, curtails arbitrary policy interventions and helps to insulate against shocks’.59 Also intellectual property rights may act as incentives for innovation in the pharmaceutical industry and for the transfer of technology to less-developed countries. Yet, the UNHCHR emphasizes the potential conflicts between ‘existential’ human rights and ‘instrumental’ WTO rules (such as on protection of intellectual property rights and investor rights), for example if trade rules lead to higher prices (of food, seeds, pharmaceutical products and so on), cause unemployment, or entail ‘market failures’ in the supply of essential medicines for tropical diseases. According to the High Commissioner, the needed ‘human rights assessments’ of trade rules and trade policies must focus on the rights and basic needs of vulnerable individuals and of the most disadvantaged communities whose human rights risk to be adversely affected most in the process of trade liberalization. The macroeconomic objectives and state-centred rules of WTO law nowhere refer to human rights. The High Commissioner, therefore, emphasizes the need for using WTO rules (for example, on S&D for LDCs), WTO safeguard clauses and WTO ‘exceptions’ for actively promoting

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mutually coherent interpretations of WTO law and human rights so as to enhance ‘human development’. The UNHCHR criticizes the lack of guidance and of monitoring mechanisms in WTO law for ensuring the taking into account of human rights. The reports do, however, not identify concrete conflicts between human rights and WTO law. In view of the citizen-oriented functions of WTO rules for enabling citizens to increase their welfare through mutually beneficial trade transactions, for enhancing the domestic use of efficient (for example, non-discriminatory) policy instruments, and for protecting the priority of non-economic values (as reflected in the numerous ‘public interest clauses’ in WTO law), conflicts between the flexible WTO rules and human rights appear unlikely on the level of international principles. Even if the WTO objective of ‘sustainable development’ and the numerous WTO ‘exceptions’ appear to offer enough policy space for taking into account human rights obligations of WTO Members, WTO law in no way ensures that human rights obligations are actually taken into account in the legislative and administrative implementation of WTO rules and in their judicial protection. WTO diplomats and WTO judges have a longstanding preference for avoiding human rights discourse in WTO bodies. More than 35 WTO Members (including the USA) have not ratified the UN Covenant on Economic, Social and Cultural Rights. In view of the narrow limitation of the ‘terms of reference’ of WTO dispute settlement bodies to the ‘covered WTO agreements’, it remains controversial in WTO law whether – in WTO dispute settlement proceedings – the parties to the dispute may invoke human rights law not only as relevant context for the interpretation of WTO rules, but also directly for justifying departures from their WTO obligations (for example, in the case of US trade sanctions in response to human rights violations in Myanmar).

CONSTITUTIONALISM AND THEORIES OF JUSTICE: ARE THEY RELEVANT FOR CLARIFYING THE DEVELOPMENT AND HUMAN RIGHTS DIMENSIONS OF WTO PRINCIPLES AND RULES? As international human rights prescribe only minimum standards for legal protection of individual and democratic self-development, many judges of international human rights courts (like the ECtHR and the InterAmerican Court of Human Rights) are reluctant to describe their judicial function as ‘constitutional’; they rather emphasize the need for respect, by international judges, of the ‘margin of appreciation’ of national constitutional democracies regarding their respective ‘balancing’ of human


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rights and other constitutional rules and democratic legislation. For, in most constitutional democracies as well as in the EU, constitutional law provides for more comprehensive guarantees of ‘fundamental rights’ and democratic governance than they are provided for in worldwide UN human rights instruments. By contrast, the WTO guarantees of freedom, rule of law and nondiscriminatory conditions of competition tend to go far beyond national legal guarantees of economic self-governance of free citizens on the basis of private law and national market economies. While WTO Members define WTO law from the perspective of the rulers as being ‘Member-driven’, the universal human rights obligations of all WTO Members argue for emphasizing the citizen-oriented ‘constitutional functions’ of many WTO guarantees of freedom, non-discrimination and rule of law, including ‘the dispute settlement system of the WTO (as) a central element in providing security and predictability to the multilateral trading system’ (Article 3 WTO Dispute Settlement Understanding 5 DSU). Of course, none of the supporters of ‘international constitutionalism’ claims that international ‘treaty constitutions’ constituting and limiting international rule-making, executive and judicial powers for the collective supply of international public goods (like a rules-based world market) are, or should become, constitutions in the same sense as national constitutions. In line with the diverse national constitutional traditions, constitutional approaches to multilevel governance differ inevitably. For instance, the notion of a ‘WTO constitution’ is increasingly used in view of: (a)

the comprehensive rule-making, executive and (quasi-) judicial powers of WTO institutions;60 (b) the ‘constitutionalization’ of WTO law resulting from the jurisprudence of the WTO dispute settlement bodies;61 (c) the domestic ‘constitutional functions’ of GATT/WTO rules, for example, for protecting constitutional principles (like freedom, nondiscrimination, rule of law, proportionality of government restrictions) and domestic democracy (for example, by limiting the power of protectionist interest groups) for the benefit of transnational cooperation among free citizens;62 (d) the international ‘constitutional functions’ of WTO rules, for example, for the promotion of ‘international participatory democracy’ (for example, by holding governments internationally accountable for the ‘external effects’ of their national trade policies, by enabling countries to participate in the policy-making of other countries)63 and of the enhancement of ‘jurisdictional competition among nation states’64 and ‘the allocation of authority between constitutions’;65 or

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(e)


in view of the necessity of ‘constitutional approaches’ for a proper understanding of the law of comprehensive international organizations which have used the term ‘constitution’, as well as constitutional methods and principles, for more than 80 years (see, for example, the ‘Constitutions’ – sic – establishing the ILO, WHO, FAO and UNESCO).66

All these constitutional approaches agree that the WTO should not be simply viewed in narrow economic terms (for example, as an institution promoting economic welfare through trade liberalization). WTO rules and policies also pursue political as well as legal objectives that are no less important than the economic benefits from liberal trade, as illustrated by the guarantees of private ‘rights to import and export’, of private access to independent courts and rule of law in the 2001 WTO Protocol on the accession of China and the 2006 WTO Protocol on the accession of Vietnam. The introduction of rule of law in China and of a system of independent trade courts (supervised by a chamber of the Chinese Supreme Court specializing in WTO law) illustrates that the WTO Agreement is one of the most revolutionary ‘transformation agreements’ in the history of international law. What is the relevance of such ‘constitutional dimensions’ of WTO law for defining the development objectives of national and international economic law and jurisprudence? The American legal philosopher Ronald Dworkin begins his recent book on Justice in Robes with the story of United States’ (US) Supreme Court Justice Oliver Wendell Holmes who, on his way to the court, was greeted by another lawyer: ‘Do justice, Justice!’ Holmes replied: ‘That’s not my job’.67 Similarly, WTO Members emphasize the limited terms of reference of WTO dispute settlement panels ‘to examine, in the light of the relevant provisions in (. . . the covered agreement(s) cited by the parties to the dispute), the matter referred to the DSB . . . and to make such findings as will assist the DSB in making the recommendations or in giving the rulings provided for in that/those agreement(s)’ (Article 7 DSU). As WTO law includes no explicit reference to justice and human rights: should WTO Members, WTO judges and domestic courts apply WTO law without regard to justice, just as economists perceive trade law as a mere instrument for promoting economic welfare? Does the separation of the judicial power from the legislative and executive powers require that, as postulated by Montesquieu, decisions of international and national courts must always conform to the exact letter of the law as understood by the legislator? Does the frequent emphasis by governments on the ‘memberdriven’ character of WTO law, and the frequent recourse to the Oxford English Dictionary in the case-law of WTO dispute settlement panels and the Appellate Body, confirm the view that, also in WTO law, judges must


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apply the positive law literally without regard to whether the applicable rules lead to a just resolution of the dispute? WTO Law Must be Interpreted in Conformity with ‘Principles of Justice’ Law, according to Lon Fuller, orders social life not only by ‘subjecting human conduct to the governance of rules’; law also aims at establishing a just order and procedures for the fair resolution of disputes.68 This understanding of law as a struggle for just rules and fair procedures goes back to legal philosophy in Greek antiquity. Its application to international relations remains contested by power-oriented, ‘realist’ politicians and lobbyists benefiting from foreign policy discretion under state-centred rules of international law. Yet, all UN member states have committed themselves in the UN Charter ‘to establish conditions under which justice and respect for the obligations arising from treaties and other sources of international law can be maintained’ (Preamble). They have defined the purpose of the UN as, inter alia, ‘to bring about by peaceful means, and in conformity with the principles of justice and international law, adjustment or settlement of international disputes or situations which might lead to a breach of the peace’ (Article 1, para.1 UN Charter). All UN member states have also accepted membership in the International Court of Justice (ICJ) as ‘the principal judicial organ’ of the UN for the peaceful settlement of international disputes (Article 92 UN Charter). Just as individual rights of ‘access to justice’ (in terms of access to courts, fair trial, effective remedies, legal aid to the needy and so on) are recognized in many constitutional and human rights instruments, so have international courts progressively developed procedural and substantive principles of justice in their judicial interpretation and application of international law rules.69 In the Vienna Convention on the Law of Treaties (VCLT), most WTO Members have explicitly affirmed ‘that disputes concerning treaties, like other international disputes, should be settled by peaceful means and in conformity with the principles of justice and international law’, including ‘universal respect for, and observance of, human rights and fundamental freedoms for all’ (Preamble VCLT). WTO law and its DSU regulate ‘the dispute settlement system of the WTO’ (Article 3) as a multilevel system with compulsory jurisdiction for (quasi) judicial settlement of disputes at intergovernmental and domestic levels. Yet, hardly any of the more than 220 WTO dispute settlement reports has referred to ‘principles of justice’; most domestic courts, also in the EC and the United States, tend to ignore WTO obligations and WTO dispute settlement rulings. This incoherence in the multilevel ‘judicial governance’ of international trade disputes runs counter not only to the basic idea of rule of law and of rules-based,

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democratic governance, but also to the underlying economic rationale of the WTO objective of ‘providing security and predictability to the multilateral trading system’ (Article 3 DSU). For the economic value of investments, trade transactions and consumer welfare is reduced if producers, investors, traders and consumers can no longer rely on legal security. Since Adam Smith’s explanation of the Wealth of Nations as being dependent on their respective laws and institutions, lack of rule of law is widely recognized as one of the principal causes of corruption and waste of scarce resources; the Latin-American economist de Soto, for example, explains much of the economic poverty in Latin America by inadequate protection of property rights, which operates as a disincentive for borrowing, investments and enjoyment of human rights.70 The WTO’s neglect of the legal protection of individual rights (other than intellectual property rights and the ‘rights to trade’ protected in the 2001 WTO Protocol on the Accession of China) reflects the inefficient and non-democratic nature of ‘memberdriven WTO governance’ focusing on discretionary trade policy powers of governments rather than on legal empowerment of private producers, investors, traders and consumers. Public Discourse about the Justice of WTO Rules may Contribute to Rendering WTO Rules more Effective and more Democratic Rules that are not perceived as just are unlikely to remain effective over time. The rhetoric of protectionist lobbies calling for import protection against ‘unfair trade’, the power politics driving reciprocal bargaining in the WTO, and the pervasive poverty in many less-developed WTO countries have contributed to widespread doubts about the justice of WTO rules.71 Constitutional democracies and the 2007 Lisbon Treaty on European Union emphasize the need for supplementing ‘representative democracy’ by ‘participatory democracy’ and ‘deliberative democracy’ so as to promote self-government based on rules to which rational citizens can consent. The WTO Agreement explicitly recognizes, in its Preamble, ‘basic principles and objectives . . . underlying this multilateral trading system’. Some of these principles are specified in WTO provisions, for instance in the GATT (for example, Articles III.2, VII.1, X.3, XIII.5, XX (j), XXIX.6, XXXVI.9) and other WTO agreements on trade in goods (for example, Article 7.1 Agreement on Customs Valuation, Article 9 Agreement on Rules of Origin), services (Article X GATS) and trade-related intellectual property rights (in the Preamble of the TRIPS Agreement, Articles 8 and 62.4). The WTO requirement of interpreting WTO law ‘in accordance with customary rules of interpretation of public international law’ (Article 3.2 DSU) refers not only to formal interpretative principles (such as lex


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specialis, lex posterior, lex superior) aimed at mutually coherent interpretations, based on legal presumptions of lawful conduct of states, the systemic character of international law, and the mutual coherence of international rules and principles. The customary law requirement (as recognized in the Preamble to the Vienna Convention on the Law of Treaties) of interpreting treaties ‘in conformity with principles of justice’ also call for clarifying the substantive principles of justice underlying WTO law, like freedom, non-discrimination, rule of law, independent third-party adjudication and preferential treatment of LDCs. The basic WTO principle of progressive liberalization and legal protection of liberal trade can be justified by all ‘liberal’ (that is, liberty-based) theories of justice, such as ● ● ● ●

utilitarian theories defining justice in terms of maximum satisfaction of individual preferences and consumer welfare; libertarian theories focusing on protection of individual liberty and property rights; egalitarian concepts defining justice more broadly in terms of equal human rights and democratic consent; and international theories of justice based on sovereign equality and effective empowerment of states to increase their national welfare through liberal trade.72

Hence, the diversity of libertarian, egalitarian or utilitarian value preferences should not affect recognition that the WTO guarantees of freedom, non-discrimination and rule of law – by enhancing individual liberty, nondiscriminatory treatment, economic welfare and poverty reduction across frontiers – reflect, albeit imperfectly, basic principles of justice. In terms of the Aristotelian distinction between ‘general principles of justice’ (like liberty, equality, fair procedures, promotion of general consumer welfare) and particular principles of justice requiring adjustments depending on particular circumstances,73 WTO rule-making and WTO dispute settlement procedures can also contribute to ‘corrective justice’ and ‘reciprocal justice’, just as the special, differential and non-reciprocal treatment of less-developed WTO Members in numerous WTO provisions may contribute to ‘distributive justice.’ Engaging in public discourse on the justice of WTO rules and rule-making will reduce public distrust in the WTO and contribute to clarifying the ‘principles underlying this trading system’. Universal Human Rights as ‘Principles of Justice’ and ‘Balancing Principles’? As every WTO Member has accepted obligations under international law to protect and promote human rights, the WTO system, like any domestic

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legal and political system, will be increasingly evaluated (for example, by civil society) from the perspective of respect for human rights. It seems unlikely that the intergovernmental WTO Councils and the WTO Secretariat will respond to the UN proposals to adopt a ‘human rights approach to trade.’ In view of the insertion of human rights clauses into ever more regional trade agreements among WTO Members, it may, however, only be a matter of time until WTO dispute settlement bodies will be requested by complainants or defendants to interpret WTO rules with due regard to the human rights obligations of the WTO Members concerned. Such human rights clauses have rarely been invoked, so far, and call for non-discriminatory regulations (for example, of health risks, supply of public services) rather than for discriminatory trade restrictions. The case-law of the European courts confirms that concerns of trade diplomats – that human rights arguments may render trade disputes less predictable – are unwarranted. Over the past 50 years, there have been less than a dozen of ECJ judgments reviewing trade restrictions in the light of human rights and, generally, deciding in favour of interpretations of trade rules in conformity with the human rights obligations under national constitutions and the ECHR. The universal recognition of human rights illustrates that every legal system rests not only on rules but also on general principles promoting the overall coherence of rules. In examining the potential impact of human rights as ‘relevant context’ for interpreting WTO rules, WTO dispute settlement bodies should distinguish the following three different kinds of trade regulations:74 ●

●

International trade measures for promotion of human rights abroad must respect the ‘sovereign equality of states’, the legitimate diversity of their national human rights laws, and the often harmful effects of trade restrictions on citizen welfare and the enjoyment of human rights. The increasing recourse to UN human rights law as the ‘objective standard’ for differentiating trade preferences for LDCs may entail future WTO disputes on whether such trade differentiation can be justified in terms of human rights. WTO disputes over import restrictions for protection of human rights at home – for instance, over the EC’s import restrictions on hormone-fed beef, asbestos and the US restrictions on gambling services – illustrate that WTO rules grant importing countries broad regulatory discretion regarding restrictions of imported goods with potential risks for human welfare and human rights. As UN human rights conventions prescribe minimum standards that do not prevent WTO Members from accepting higher human rights standards in regional and national human rights laws, the WTO-consistency of


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import restrictions designed to protect the human rights of domestic citizens may be legitimately influenced by arguments based on regional and national human rights rather than only UN human rights law. WTO law recognizes that ‘public morality’ and ‘public order’ may legitimately vary from one community to the other.75 Hence, WTO dispute settlement bodies have to respect the legitimate ‘margin of appreciation’ of the national authorities concerned to define ‘public morality’, ‘public order’ and human rights in conformity with national and regional democratic preferences. Non-discriminatory WTO rules regulating intellectual property rights, technical and health standards, competition, environmental and investment rules, public services, private access to financial assistance in the context of trade-facilitation, and the administration of a WTO Register for private geographical indications may give rise to legal challenges whether such WTO rules are themselves consistent with national constitutional rights. WTO rules and WTO dispute settlement proceedings should respect the legitimate diversity of ‘balancing principles’ which national and international courts (like the EC Court and the ECtHR) apply in examining whether the regulation of economic freedoms and other economic rights are consistent with human rights. The balancing principles may differ in case of WTO obligations protecting private rights of market participants, such as ‘rights to trade’, procedural rights, property rights and judicial remedies.

A ‘HUMAN RIGHTS APPROACH’ TO THE DOHA DEVELOPMENT ROUND AGREEMENTS? From constitutional and economic perspectives, the main causes of the unnecessary poverty in so many WTO member countries lie at the national level of government policies and economic regulation. The state-centred focus of international law and the lack of effective safeguards for the protection of human rights contribute to the fact that so many governments abuse trade policy powers for their protectionist self-interests rather than for the promotion of consumer welfare, general citizen interests and poverty reduction. The ‘member-driven’ Doha Round negotiations focus more on harmful trade policy practices in developed countries (like agricultural and cotton subsidies) than on limiting ‘policy space’ in LDCs. A human rights approach should design trade liberalization agreements as instruments for promoting consumer welfare and protecting economic and social rights, notably in non-democratic and poor countries without effective human rights guarantees; for, governments calling for

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distributive justice in the WTO should prove their own commitment to justice as defined by human rights. Democratic Trade Governance must Serve the Interest of all Citizens and their Human Rights The human right to democratic self-government requires, inter alia, that governments should publicly explain to their citizens the contribution of their economic policies to the promotion of human welfare and human rights. If LDCs claim preferential treatment in the WTO, they should meet their burden of proving (for example, in their periodical reports for the WTO ‘Trade Policy Review Mechanism’) how their trade restrictions and other trade policy measures contribute to the human development of their citizens. Development and human rights bodies should assist in such ‘human rights assessments’ and democratic review of national trade policy measures. Such promotion of ‘deliberative democracy’ could contribute to reviewing welfare-reducing trade restrictions and the alternative use of more efficient policy instruments, including development-oriented reforms of WTO rules empowering not only producers, traders and investors but also consumers and workers exposed to the adjustment costs of import competition. As all future WTO negotiations depend on consensus by LDCs and by democratic parliaments, the necessary ‘development focus’ of future agreements is more likely to be approved if ‘development commitments’ focus more credibly on trade-related adjustment problems and protection of citizen interests and human rights in LDCs. Reciprocal Justice must take into Account Social Adjustment Capacities in LDCs Trade liberalization tends to promote the quantity, quality and diversity of goods and services, competition and the efficient use of scarce resources. A general exemption of LDCs from the WTO’s reciprocity principle could therefore impede economic development in LDCs. Nonreciprocity should depend on the adjustment problems and adjustment capabilities in LDCs. As the UN defines the 49 LLDCs by their low GDP, their ‘human resource weakness’ and ‘economic vulnerability’, the 32 WTO Members with LLDC-status deserve exemption from reciprocal liberalization commitments. The EC’s offer of a ‘Round for Free’ for 58 additional LDCs from Africa, the Caribbean and the Pacific was justified on similar grounds (such as their ‘small, weak and vulnerable economies’). The ‘upper income developing countries’ cooperating in the ‘G20’ group have made their market access commitments subject to various conditions


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aimed at enhancing their adjustment capabilities, such as additional export opportunities in agriculture, protection of food security and rural development in LDCs, and liberalization of international movements of natural services suppliers. Since more than 70 per cent of poor people in LDCs live in rural areas, LDCs legitimately insist that their farmers must be protected against the trade distortions caused by the high agricultural protectionism in developed countries. Distributive Justice requires Special and Differential Treatment (SDT) and ‘Aid for Trade’ Many of the ‘small, weak and vulnerable’ WTO Members cooperating in the ‘G90’ group emphasize the need for SDT for dealing with their special development challenges such as preference erosion, dependence on commodities and food imports, rural development, food security and supply side limitations. Increasing their export capabilities through ‘aid for trade’ and non-reciprocal liberalization of import barriers (for example, for cotton) in developed countries has been recognized as a crucial component of a future ‘Doha bargain’.76 The 2001 Doha Declaration further recognizes that ‘technical cooperation and capacity building are core elements of the development dimension of the multilateral trading system’, and ‘sustainably financed technical assistance and capacity building programmes have important roles to play’.77 The WTO General Council’s ‘Framework Agreement’ of July 2004 called more specifically for ‘developing countries and in particular least developed countries to be provided with enhanced Trade-Related Technical Assistance and capacity building to increase their effective participation in the negotiations, to facilitate their implementation of WTO rules and to enable them to adjust and diversify their economies’.78 Yet, many of the 88 proposals by LDCs for making SDT provisions in the WTO Agreements more ‘precise, mandatory and operational’ have remained controversial because their focus on ‘policy space’ left their contribution to promotion of human development, human rights and welfare-increasing trade for the benefit of citizens in LDCs doubtful. Corrective Justice Calls for Empowering and Protecting LDCs and their Citizens in the WTO Dispute Settlement System The compulsory WTO dispute settlement system has transformed the ‘GATT 1947 bicycle’, driven by bi-level trade negotiations at home as well as at intergovernmental levels, into a ‘WTO tricycle’ driven also by the additional wheel of ever more WTO dispute settlement rulings clarifying and progressively developing WTO rights and obligations. Over the past

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years, LDCs have become the main users of the WTO dispute settlement system. Notably in the area of agricultural subsidies (such as EC subsidies for sugar, US subsidies for cotton), they have successfully used the WTO dispute settlement system not only for enforcing their rights, but also for improving their bargaining position in the Doha Round negotiations.79 Just as protection of human rights depends on procedural guarantees of ‘access to justice’ (in terms of both access to courts and effective remedies, including legal aid for the needy), so does the contribution of WTO law to ‘sustainable development’ in LDCs also depend on effective access of LDCs to the WTO dispute settlement system. WTO law promotes this access by two different kinds of SDT provisions: provisions specifying how generally applicable principles should be implemented in cases involving LDCs (for example, WTO provisions on composition of dispute settlement panels, determination of a ‘reasonable period’ for implementing dispute settlement findings), like WTO provisions compensating the lack of financial and legal resources of LDCs in WTO dispute settlement proceedings (for example, Article 27.2 DSU, the Advisory Center for WTO Law), have proven effective and need to be further extended. However, procedural privileges exclusively available for LDCs only (cf. Articles 3.12, 21.2, 21.7 and 8 DSU) have been invoked only reluctantly and with limited success.80 Effective use of the WTO dispute settlement system by LDCs is closely linked to effective legal and judicial remedies at national levels, as illustrated by the private rights to initiate WTO dispute settlement proceedings pursuant to Section 301 of the US Trade Act and the corresponding EC Trade Barriers Regulation, which have enhanced ‘private-public partnerships’ and available ‘legal resources’ in WTO litigation. Proposals for introducing special WTO remedies for LDCs (such as financial damages and attorney’s fee awards) remain controversial. The still limited number of LDCs actively using the dispute settlement panel, appellate and arbitration procedures of the WTO illustrates the need for additional financial, technical and legal assistance and ‘capacity building’ for the benefit of LDCs, which often lack a citizen-driven, transparent rule-of-law system limiting domestic and foreign power politics.

CONCLUSION: ‘SUSTAINABLE DEVELOPMENT’ AS INDIVIDUAL EMPOWERMENT AND PROTECTION OF HUMAN RIGHTS Similar to the focus of human rights on empowering individuals and people and protecting their rights against domestic abuses by their own


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governments, WTO law should focus on empowering private economic actors and consumers by protecting their rights against welfare-reducing abuses of trade policy powers at national and international levels. In the 2001 Doha Declaration, WTO Members ‘recognize[d] the need for all our peoples to benefit from the increased opportunities and welfare gains that the multilateral trading system generates’. This contribution has suggested that these citizen interests – in order to reduce poverty and the welfare-reducing protectionism of governments more effectively – must be legally protected more effectively by defining the WTO objective of ‘sustainable development’ in terms of human rights and by empowering ‘WTO citizens’ as legal subjects and democratic owners of the WTO legal system. This focus on empowerment of individuals is in line with the long emphasis by economists – from Adam Smith via Friedrich Hayek up to Nobel Prize-winning economist Amartya Sen – that market economies and economic welfare are mere instruments for enabling and promoting individual freedom as the ultimate goal of economic life and the most efficient means of realizing general welfare. It also reflects the universal recognition – in UN human rights conventions – of ‘the inherent dignity and of the equal and inalienable rights of all members of the human family (as) the foundation of freedom, justice and peace in the world’. As emphasized by moral and constitutional theories of justice, national and international law are mere instruments for promoting human freedom as ‘first principle of justice’ and moral ‘golden rule’.81 As governments and WTO dispute settlement bodies are legally required to interpret international treaties ‘in conformity with principles of justice’ as defined also by universal human rights, WTO Members should recognize for the world trading system what the World Bank has long since recognized for its development assistance: ‘Sustainable development is impossible without human rights’, just as ‘advancement of an interconnected set of human rights is impossible without development’82 and without a mutually beneficial world trading system protecting individual rights to produce, invest, trade and consume on the basis of rule of law and respect for human rights. This does not mean transforming economic organizations into human rights organizations. Yet, European economic integration demonstrates that open markets and ‘integration law’ can, and should, reinforce promotion of freedom, rule of law and peaceful international cooperation for the benefit of citizens.

NOTES 1.

Cf. Wittgenstein (1953), who defined the aim of his philosophy as ‘showing the fly the way out of the bottle’ (para 309).

86 2.

3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18 19. 20. 21. 22. 23. 24. 25.

26. 27.

28. 29. 30. 31.

The law and economics of globalisation Cf. Petersmann, ‘Multilevel Trade Governance Requires Multilevel Constitutionalism’, in Joerges and Petersmann (2006, pp. 5–57); Petersmann, ‘WTO Negotiators and Academics Analyze the Doha Development Round: Overview and Introduction’, in Petersmann (2005, 3–36). Kant (1970, 176 ff.). On this paradoxical dependence of liberty on psychological pre-commitments and constitutional restraints see e.g. J. Elster (2000). See e.g. Barnett (2000) and Petersmann (1991). Cf. e.g. Hayek (1973, at 46). Cf. McKenzie (1984); Buchanan (1987). Cf. Vanberg (2001); Gerken (1999); Petersmann (2006). See e.g. Kaplow and Shavell (1999). See e.g. North (1990). See e.g. Vanberg (1998). Cf. e.g. Petersmann (1991 at 63–8). The game metaphor was used by Hayek (1960, at 229) in order to emphasize the dependence of competition on rules and the unpredictability of particular outcomes of competition. Cf. Mueller (1988). On the redistributive nature and ‘politicization’ of government regulations of the economy, and the inseparable unity of the economy and the polity, see e.g. Lee and McKenzie (1987). See e.g. McKenzie (1984); Buchanan (1987). For a survey of the literature see e.g. Vanberg (2001). Cf. Petersmann (2003). Cf. Vanberg (2001). Sen (2000, at 6, 11) (‘Freedoms of different kinds can strengthen one another’). Cf. OECD (1996, at 111–12). See Petersmann (2006b). See e.g. World Bank (1995); OECD (1995); European Commission (2001). Cf. Radaelli (1999); Joerges, Mény and Weiler (2002). Cf. Petersmann (2004). The founding father of economics, Adam Smith, justified his ‘system of natural liberty’ on considerations of both economic welfare and justice: ‘Justice is the main pillar that upholds the whole edifice. If it is removed, the immense fabric of human society . . . must in a moment crumble into atoms’ (A. Smith, The Theory of Moral Sentiments (1790/1976), 167). Cf. Petersmann (2006). See e.g. the annual reports on ‘Economic Freedom in the World’ published by the Fraser Institute in Vancouver, which emphasize the empirical correlation between economic freedom, economic welfare, relatively higher average income of poor people and, with a few exceptions (such as Hong Kong), political freedom. Already Adam Smith’s inquiry into the Nature and Causes of the Wealth of Nations (1776) had concluded that the economic welfare of England was essentially due to its legal guarantees of economic freedom, property rights and legal security for investors, producers, traders and consumers. Olson (2000, p. 43). See Pipes (1999, p. 291). Olson (2000, p. 187). See Sen (2002, e.g. chapter 17) on ‘markets and freedoms’. Sen conceptualizes freedom as similar to the budget of a utility-maximizing individual: The more individual freedom, the larger is individual welfare. Such constitutional definitions of ‘Pareto-efficiency’ complement the moral and legal Kantian ‘categorical imperative’ of maximizing equal freedoms of individuals in national, transnational and international relations. On legal protection of ‘market freedoms’ in national and European constitutional law, see:


32. 33. 34. 35.

36.

37.

38. 39. 40.

41. 42. 43. 44. 45. 46

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Petersmann, ‘Human Rights and International Trade Law’, in Cottier, Pauwelyn and Bürgi (2005, 29–94). Hayek (1960, at 35). Petersmann (2003). Cf. Cottier, Pauwelyn and Bürgi (2005); Abbott, Breining-Kaufmann and Cottier (2006). The scope of judicial protection of the EC Treaty’s economic freedoms dynamically evolved in response to their judicial balancing with non-economic rights and national sovereignty, as illustrated by the explicit revision by the EC Court of its judicial interpretation of Arts. 28ff EC Treaty in 1993 (judgments in the Keck/Mithouard cases) which limited the scope of these prohibitions of quantitative trade restrictions to product-related measures (i.e. no longer covering non-discriminatory national sales modalities). It remains controversial to what extent ‘market freedoms’ should be construed as liberty rights protecting market access and prohibiting disproportionate national restrictions (e.g. for goods), or only as rights to non-discriminatory treatment across frontiers (e.g. for access of workers to national social systems, freedom of investments subject to non-discriminatory, national regulations). Cf. Emberland (2006). Only few provisions of the ECHR explicitly protect also rights of ‘legal persons’ (e.g. Article 10 ECHR: freedom of expression, Article 1 of Protocol 1: private possessions and property rights) and complaints ‘from any person’ (Article 34 ECHR). Yet, the ECtHR has construed many rights protected by the ECHR (such as Article 6: right to a fair trial, Article 8: right to protection of one’s home, Article 11: freedom of assembly, Article 13: right to effective remedies, Article 41: right to request compensation for non-material damage), as well as corresponding obligations of governments (e.g. under Article 1 to secure the fundamental rights ‘to everyone within their jurisdiction’, including economic actors and companies from outside Europe), as protecting also rights of companies. Rawls (1999a). In addition to these two ‘principles of justice’, Rawls also acknowledges the need for a property-owning democracy empowering citizens to manage their own affairs by taking part in decentralized social cooperation, as well as the need for a welfare state assisting those who lose out through accident or misfortune. For international relations, however, Rawls proposed only an international law among sovereign states, based on tolerance vis-à-vis non-democratic but decent people, that appears to remain far behind today’s universal recognition of human rights. The speech of Kofi Annan is reproduced in UN document GA/105000 of 19 September 2006. Cf. Joerges and Petersmann (2006). On this common dilemma of market economies and democracy, and on the replacement of the rights-based common law criteria by efficiency-based economic criteria (such as absence of output and price restrictions) in modern US antitrust law, see Amato (1997); Gerber (1998). United States v Topco Assoc. Inc., 405 US 596, 610 (1972). On this post-war paradigm of ‘embedded international liberalism’ see: J. Ruggie, ‘International Regimes, Transactions and Change: Embedded Liberalism in the Postwar Economic Order’, in: Krasner (1983, 195–231). This concept continues to be used in many judgments of the ECHR since the Court’s decision in Loizidou v Turkey (preliminary objections), Series A No 310 (1995) 20 EHRR 99 § 75(2). Cf. Von Bogdandy and Bast (2006). Cf. Monti (2002). See e.g. Case 240/83, ADBHU, ECR 1985 531, para. 9: ‘the principles of free movement of goods and freedom of competition, together with freedom of trade as a fundamental right, are general principles of Community law of which the Court ensures observance.’ Especially the freedom of movements of workers and other persons, access to employment, and the right of establishment have been described by the EC Court

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47. 48. 49.

50.

51. 52. 53. 54.

55. 56. 57.

58.

59. 60. 61. 62.

63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73.

The law and economics of globalisation as ‘fundamental freedoms’ (Case C-55/94, Gebhard, ECR 1995, I 4165, para. 37) or as ‘a fundamental right which the Treaty confers individually on each worker in the Community’ (Case 22/86, Heylens, ECR 1987, 4097, para. 14). Cf. Krisch and Kingsbury (2006). Cf. Petersmann (2005). On this lack of effective parliamentary control of WTO politics inside most WTO member countries (with the exception of the US Congress and the Swiss Parliament) as well as in the EC, see Baron Crespo (2006) and the recent comparative study: The Role of Parliaments in Scrutinising and Influencing Trade Policy. A Comparative Analysis prepared for the European Parliament (European Parliament December 2005). See, e.g., R. Higgins, ‘Conceptual Thinking About the Individual in International Law’, in New York Law School Review, 24 (1978), 11–29; W.M. Reisman, ‘A Judge’s Judge: Justice Florentino P. Feliciano’s Philosophy of the Judicial Function’, in: Charnovitz, Steger and Van Den Bossche (2005, at 3–10). Cf. Petersmann (2006). North (1990), and his recent NBER working paper A Conceptual Framework for Interpreting Recorded Human History (2006). See The United Nations and Human Rights 1945–1995 (UN 1995, 322–4). ‘Globalization and its Impact on the Full Enjoyment of Human Rights’, ECOSOC document E/CN.4/Sub.2/2000/12 of 15 June 2000, at paragraph 15. Apart from a reference to patents and their possibly adverse effects on pharmaceutical prices (depending on the competition, patent and social laws of the countries concerned), the report nowhere identifies conflicts between WTO rules and human rights. For a discussion of these reports (with references for the following quotations) see Petersmann (2004). ‘ILO Declaration on Fundamental Principles and Rights at Work’ (ILO 1998, 7). E.g. the 1989 UN Convention on the Rights of the Child (ratified by more than 190 states) and the 1993 Vienna Declaration of the UN World Conference on Human Rights, in which more than 170 UN member states recognized that ‘the universal nature of (human) rights and freedoms is beyond question’ (para.1). See the broad interpretation of UN human rights as international ius cogens, and as constitutional limitation of intergovernmental powers also of UN bodies, by the EC Court of First Instance in Cases T-315/01 (Kadi v Council and Commission) and T-306/01 (Yusuf v Council and Commission), judgments of 21 September 2005, [2005] CMLR 1334. UN document E/CN.4/2002/54, para. 33. Jackson (1998). Cass (2005). Petersmann (1991); McGinnis and Movsesian (2000); Gerhart (2003, 1–75), contrasts the ‘inward-looking, economic vision of the WTO’ in helping member countries addressing internal political failures with the ‘external, participatory vision of the WTO’ helping WTO members to address concerns raised by policy decisions in other countries. See, for example, Gerhart (2004). See McGinnis (2004). Trachtman (2006). See, for example, E.U. Petersmann, ‘Multilevel Trade Governance Requires Multilevel Constitutionalism’, in Joerges and Petersmann (2006). Dworkin (2006, chapter 1). Fuller (1969, 96). Cf. Franck (1995). H. De Soto (2000). Cf. Beviglia-Zampetti (2006). For overviews of these theories see: Garcia (2003); Petersmann (2003); Kapstein (2006). Cf. Aristotle, Nicomachean Ethics (1999), (ed. M. Ostwald), book five.

Constitutionalism and the regulation of international markets 74. 75. 76. 77. 78. 79. 80. 81.

82.

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For a detailed explanation see: E.U. Petersmann, ‘WTO Dispute Settlement Practice 1995–2005: Lessons from the Past and Future Challenges’, in Taniguchi et al. (2007). See e.g. the footnote to GATS Article XIV(a) which states: ‘The public order exception may be invoked only where a genuine and sufficiently serious threat is posed to one of the fundamental interests of society.’ Cf. ABC of Aid for Trade (Cuts International, 2007). WT/MIN801)/DEC/W/1, paras. 2, 38. WT/L/579. See Petersmann, ‘Strategic Use of WTO Dispute Settlement Proceedings for Advancing WTO Negotiations on Agriculture’, in: Petersmann (2005). See F. Roessler, Special and Differential Treatment of Developing Countries under the WTO Dispute Settlement System, in Ortino and Petersmann (2004). On Kant’s moral ‘categorical imperatives’ for acting in accordance with universal laws (‘Act only in accordance with that maxim through which you can at the same time will that it become a universal law’), for respecting human dignity by treating individuals and humanity as ends in themselves (‘So act that you use humanity, whether in your own person or that of another, always at the same time as an end, never merely as a means’), and for respecting individual autonomy (‘the idea of the will of every rational being as a will giving universal law’) and individual right (‘Any action is right if it can coexist with everyone’s freedom according to a universal law’), and on Kant’s theory of the antagonistic human nature promoting market competition and national and international constitutional guarantees of equal freedoms, see e.g. Wood (1999); Petersmann (1999a). World Bank (1998), Development and Human Rights. The Role of the World Bank, Washington, DC: World Bank 2.

REFERENCES Abbott, M., C. Breining-Kaufmann and C. Cottier (2006), International Trade and Human Rights: Foundations and Conceptual Issues, Ann Arbor, MI: Michigan University Press. Amato, G. (1997), Antitrust and the Bounds of Power, Oxford: Hart. Baron Crespo, E. (ed.) (2006), The Parliamentary Dimension of the WTO, European Parliament, Strasbourg, June. Beviglia Zampetti, A. (2006), Fairness in the World Economy: US Perspectives on International Trade Relations, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Bogdandy, A. and J. Bast (2006), Principles of European Constitutional Law, Oxford: Hart. Buchanan, J. (1987), ‘Constitutional Economics’, in J. Eatwell, M. Milgate and P. Newman (eds), The New Palgrave Dictionary of Economics, New York: Norton. Cass, D.Z. (2005), The Constitutionalization of the WTO, Oxford: Oxford University Press. Charnovitz, S., D. Stegerd and P. Van den Bossche (eds) (2005), Law in the Service of Human Dignity: Essays in Honour of Florentino Feliciano, Cambridge: Cambridge University Press. Corden, W.M. (1974), Trade Policy and Economic Welfare, Oxford: Clarendon Press. Cottier, T., J. Pauwelyn and E. Bürgi (2005), Human Rights and International Trade, Oxford: Oxford University Press.

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De Soto, H. (2000), The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, New York: Bantam. Dworkin, R. (2006), Justice in Robes, Cambridge: Cambridge University Press. Elster, J. (2000), Ulysses Unbound, Cambridge: Cambridge University Press. Emberland, M. (2006), The Human Rights of Companies, Oxford: Oxford University Press. European Commission (2001), Governance in Europe – A White Book, EC, Brussels. Franck, T. (1995), Fairness in International Law and Institutions, Oxford: Oxford University Press. Fuller, L.L. (1969), The Morality of Law, New Haven, CT: Yale University Press. Garcia, F.J. (2003), Trade, Inequality and Justice: Toward a Liberal Theory of Just Trade, New York: Transnational. Gerber, D. (1998), Law and Competition in Twentieth Century Europe: Protecting Prometheus, Oxford: Oxford University Press. Gerhart, P.M. (2003), ‘The Two Constitutional Visions of the World Trade Organisation’, University of Pennsylvania Journal of International Economic Law, 24: 1–75 Gerhart, P.M. (2004), ‘The WTO and Participatory Democracy: The Historical Evidence’, Vanderbilt Journal of Transnational Law, 37: 897–934. Gerkin, L. (1999), Von Freiheit und Freihandel. Grundzüge einer ordo-liberalen Aussenwirtschaftstheorie, Tübingen: Mohr Verlag. Guyer, P. (2000), Kant on Freedom, Law and Happiness, Cambridge: Cambridge University Press. Hayek, F.A. (1960), The Constitution of Liberty, London: Routledge. Hayek, F.A. (1973), Law, Legislation and Liberty, vol. 1, London: Routledge. Hayek, F.A. (1984), ‘Reflections on Constitutional Economics’, in R.B. McKenzie (ed.), Constitutional Economics, Lexington, MA: Lexington Books. Jackson, J.H. (1998), The World Trade Organisation: Constitution and Jurisprudence, London: Royal Institute of International Affairs. Joerges, C., Y. Mény and J.H.H. Weiler (eds) (2002), ‘Symposium: Mountain or Molehill? A Critical Appraisal of the Commission White Paper on Governance’, Jean Monnet Working Paper 6/2001, Harvard Law School. Joerges, C. and E.U. Petersmann (2006), Constitutionalism, Multilevel Trade Governance and Social Regulation, Oxford: Hart. Kant, I. (1970), Political Writings, ed. H. Reiss, Cambridge: Cambridge University Press. Kaplow, L. and S. Shavell (1999), ‘Economic Analysis of Law’, NBER Working Paper No. 6960, National Bureau of Economic Research, Cambridge, MA. Kapstein, E.B. (2006), Economic Justice in an Unfair World, Princeton, NJ: Princeton University Press. Krasner, S.D. (ed.) (1983), International Regimes, Ithaca, NY: Cornell University Press. Krisch, N. and B. Kingsbury (2006), ‘Introduction: Global Governance and Global Administrative Law in the International Legal Order’, European Journal of International Law, 17: 1–15. Lee, D.R. and R.B. McKenzie (1987), Regulating Government. A Preface to Constitutional Economics, Lexington, MA: Lexington Books. McGinnis, J.O. (2004), ‘The WTO as a Structure of Liberty’, Harvard Journal of Law and Public Policy, 28: 81–8.


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McGinnis, J.O. and M.L. Movsesian (2000), ‘The World Trade Constitution’, Harvard Law Review, 114: 511–605. McKenzie, R.B. (ed.) (1984), Constitutional Economics, Lexington, MA: Lexington Books. Monti, G. (2002), ‘Article 81 EC and Public Policy’, Common Market Law Review 2001, 613. Mueller, D. (1988), Public Choice II, Cambridge: Cambridge University Press. North, D.C. (1990), Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. OECD (1995), Participatory Development and Good Governance, Paris: OECD. OECD (1996), Trade, Employment and Labour Standards, Paris: OECD. Olson, M. (2000), Power and Prosperity, New Haven, CT: Yale University Press. Ortino, F. and E.U. Petersmann (2004), The WTO Dispute Settlement System 1995–2003, Dordrecht: Kluwer. Petersmann, E.U. (1991), Constitutional Functions and Constitutional Problems of International Economic Law, Fribourg: Fribourg University Press. Petersmann, E.U. (1999a), ‘How to Constitutionalize International Law and Foreign Policy for the Benefit of Civil Society?’, Michigan Journal of International Law, 20: 1–30. Petersmann, E.U (1999b), ‘Competition-Oriented Reforms of the WTO World Trade System – Proposals and Policy Options’, in R. Zäch (1999) (ed.), Towards WTO Competition Rules, Zurich: Helbing, pp. 43–71. Petersmann, E.U (2001a), ‘Constitutionalism and WTO Law – From a StateCentered Approach towards a Human Rights Approach in International Economic Law’, in Robert E. Hudec (ed.), The Political Economy of International Trade Law, Liber Amicorum, Cambridge: Cambridge University Press. Petersmann, E.U. (2003), ‘Theories of Justice, Human Rights and the Constitution of International Markets’, Symposium on the Emerging Transnational Constitution, Loyola Law Review 2004, 37, 407–60. Petersmann, E.U. (2004), ‘The “Human Rights Approach” Advocated by the UN High Commissioner for Human Rights and by the ILO: Is it Relevant for WTO Law and Policy?’, Journal of International Economic Law, 605–28. Petersmann, E.U. (ed.) (2005), Reforming the World Trading System, Oxford: Oxford University Press. Petersmann, E.U. (2006a), ‘Human Rights, Markets and Economic Welfare’, in: F. Abbott, C. Breining-Kaufmann and T. Cottier (eds), International Trade and Human Rights, Ann Arbor, MI: Michigan University Press, pp. 29–67. Petersmann, E.U. (2006b), ‘State Sovereignty, Popular Sovereignty and Individual Sovereignty: From Constitutional Nationalism to Multilevel Constitutionalism in International Economic Law?’, EUI Working Papers Law No. 2006/45, European University Institute, Florence. Pipes, R. (1999), Property and Freedom, Princeton, NJ: Princeton University Press. Radaelli, C. (1999), Technocracy in the EU, Oxford: Oxford University Press. Rawls, J. (1999a), A Theory of Justice, revised edition, Cambridge, MA: Harvard University Press. Rawls, J. (1999b), The Law of Peoples, Cambridge, MA: Harvard University Press. Rosen, A.D. (1993), Kant’s Theory of Justice, Ithaca, NY: Cornell University Press. Sen, A. (2000), Development as Freedom, New York: Knopf.

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Sen, A. (2002), Rationality and Freedom, Cambridge, MA: Harvard University Press. Taniguchi, Y., A. Yanovich and J. Bohanes (eds) (2007), The WTO in the Twenty-First Century: Dispute Settlement, Negotiations and Regionalism in Asia, Cambridge: Cambridge University Press. Trachtman, J. (2006), ‘The WTO Constitution: Toward Tertiary Rules’, European Journal of International Law, 623–45. UNDP (2000) (ed.), Human Development Report 2000: Human Rights and Human Development, New York: United Nations. Vanberg, V.J. (1998), ‘Freiburg School of Law and Economics’, in P. Newman (ed), The New Palgrave Dictionary of Economics and the Law, vol. 2, New York: Norton, pp. 172–9. Vanberg, V.J. (2000a), ‘Der konsensorientierte Ansatz der konstitutionellen Oekonomik’, in H. Leipold and I. Pies (eds), Ordnungstheorie und Ordnungspolitik, 251–76. Vanberg, V.J. (2000b), ‘Globalization, Democracy and Citizens’ Sovereignty: Can Competition Among Governments Enhance Democracy?’ Constitutional Political Economy, 11: 87–112. Vanberg, V.J. (2001), The Constitution of Markets, London: Routledge. Viscusi, W.K., J.M. Vernon and J.E. Harrington (1997), Economics of Regulation and Antitrust, 2nd edn, Boston, MA: MIT. Wittgenstein, L.J.J. (1953), Philosophical Investigations, Oxford: Blackwell. Wood, A.W. (1999), Kant’s Ethical Thought, Cambridge: Cambridge University Press. World Bank (1995) (ed), Governance and Human Rights, Washington, DC: World Bank. World Bank (2000) (ed), World Development Report 2000/2001: Attacking Poverty, Washington, DC: World Bank. World Bank (2001) (ed), Globalization, Growth and Poverty: Building an Inclusive World Economy, Washington, DC: World Bank.

4.

Negotiation or litigation? The curiously evolving governance of the WTO Kamala Dawar and Peter Holmes

INTRODUCTION Within five years of the creation of the WTO it was already becoming apparent that the institution’s stability was at risk because of an emerging imbalance in its constitution (Holmes 2001). The political decision-making capacity of the WTO was in paralysis while the judicial element in the form of the Dispute Settlement Body (DSB) was proving to be remarkably successful. Within this set up were contained the seeds of major problems: an international body making decisions over some of the most sensitive international economic and political issues, including literally some life and death issues, with no political element, is a recipe for crisis. The 2001 Doha Round of negotiations was supposed to rectify this imbalance, but as is well known the talks have progressed extremely slowly. While there has been substantial progress on one area, TRIPS,1 the overall slow pace of WTO negotiations forms the backdrop to this paper. Jackson (2006: 4) observed ‘I think the [Dispute Settlement Body] is the most powerful of all the economic organizations that exist. A tension has developed between this dispute settlement system and the rest of the organization.’ This chapter continues to focus on this particular tension by examining how the DSB has reacted to its position within this imbalance – which is even more exposed than in 2001. The chapter argues that the Appellate Body has reacted politically, in a style intended to defuse some of the controversy it has generated. The thesis of this chapter is that the Appellate Body, faced with increasing accusations of judicial activism, has adopted a strategy that might be termed ‘judicial restraint’. In its early years the Appellate Body, drawing on the Vienna Convention on the Law of Treaties (VCLT), allowed itself to draw broadly on the whole corpus of international law to ‘clarify’ the meaning of ambiguous WTO texts. In recent times it has taken a much more narrow approach to the 93

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WTO texts themselves. However by doing this, it has only solved one of the three problems facing it. The WTO and its DSB had been accused of three things: 1. 2. 3.

allowing trade law to override other economic and social priorities; developing judge made law in circumstances where the Member states had not been explicit about what they had agreed; and consistent with 2 but not with 1, an alternative strand of opinion (well articulated by Claude Barfield of the American Enterprise Institute) accuse the DSB of downplaying the need to focus exclusively on the responsibility of the WTO to promote trade liberalization.

Clearly any attempt to minimize the exposure to one of these allegations runs the risk of exacerbating the others. Indeed there is some truth in the claim of Barfield (2001) that the Appellate Body has used a broad legal philosophy to take the edge off some of the liberalisation oriented disciplines on regulatory measures in WTO agreements but to the extent that the Appellate Body reverts to a narrower approach, it runs the risk of increasing concerns under the first point. The chapter develops this argument by beginning with a brief comparison of the parallel between the EU and the WTO, noting the similarities and differences. Within the EU, a trade regime has evolved into a system of law that affects domestic rules. In the early years judicial activism could be seen filling political gaps left by the Council of Ministers in the EU. But the crucial difference is that the EU does have a Council of Ministers, whereas any changes in the rules of the WTO have to be agreed in the same manner as changes in the EU Treaties, in effect, in intergovernmental conferences. The EU has a way out of its paralysis but the WTO does not. After this comparative analysis, the chapter summarises the situation before Doha before examining what has happened since then. Any existing political paralysis has intensified. The chapter argues that the original analysis is still relevant, but in Part 2 the question of how the WTO’s live judicial system has reacted to the continuing moribund nature of the politics is developed. The chapter argues that the DSB, particularly the Appellate Body, have responded to the political challenge in a very circumspect manner. It has retrenched its creative nature to satisfy some critics. This moves it closer to the literal or ‘textual’ approach to treaty interpretation defined by Trachtman (1999), rather than the expansive perspective put forward by Pauwelyn (2003). However, in moving to a less activist position in some legal respects, the DSB still faces the other problem, namely that it may be enforcing the actual trade disciplines

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in a more narrow-minded way. Consequently this is creating political problems of a different kind.

THE EU AND THE WTO: A ‘CONSTITUTIONAL’ COMPARISON This section examines the ways in which Member states of the EU and the WTO have tied their hands in matters of trade policy and have tried to extend this strategy to include domestic policies that may affect trade. It begins by focusing on the institutional arrangements in the EC and WTO which seek to bind decision-making to conform to a set of preagreed rules which we loosely refer to as the constitution of the WTO, following Jackson (1998). We do not want to enter here into the debates about whether the WTO is truly a ‘constitutionalised’ entity. Cass (2005) provides a deep analysis of this issue, arguing that it may be problematic to use this term as a constitution implies a fully legitimated arrangement.2 Howse and Nicolaides (2002) also caution against the idea. They argue that the notion of constitutionalisation implies that there is a deeper global commitment to liberalism and free trade than is actually the case and given the structure of decision-making they doubt that it would ever be possible to entrench a broader set of values. Economists tend to adopt a simpler approach in which binding rules on decision-making can be called a constitution. Dixit (1998) has argued that the constitutional arrangements have two effects: First, they lay down a set of rules for the conduct of economic policy that will constrain the freedom of decision-makers. Second, procedures are also set out for settling disputes when cases arise which are not covered by the rules laid down initially. For example, voting rules and decision-making procedures are created alongside judicial or other arbitration procedures that are seen to be legitimate. The result of this process is that systems will have certain rules which cannot easily be changed and are therefore widely perceived to be binding upon all parties. At the same time they create binding procedural mechanisms for the evolution of the rules. Governments might wish to bind themselves to rules that they cannot easily escape or change several reasons. And the macro-economics literature is full of examples where policy-makers can gain by tying their hands in macro policy in order to gain credibility, and this is an increasing theme in trade policy. Dixit points out that while it is naive to assume that people are wholly ignorant of the consequences of their decisions, these actors may nevertheless make some mistakes, and need to revise the rules in the light of experience.

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Nevertheless, there are other reasons for tying one’s hands in trade policy that can be defended from a number of perspectives.3 However, the WTO ‘hand tying’ structure is rather different from the EU; a key difference lies in the greater reliance placed upon the WTO dispute settlement mechanism to resolve what are rather fundamental political problems about how far domestic policies must be adapted to the needs of global market access. The second function of a ‘constitution’ is less developed in the WTO than the EU. Whilst the EU has a fully developed political context surrounding the purely legal dimension of its DSB, the European Court of Justice (ECJ), the WTO does not. The EU has jurisdiction over a wide range of subjects. Its legal system is mandated to give full weight to considerations other than trade liberalisation per se. The EU has more elaborate rules about rules, a political mechanism for developing rewriting or reinterpreting its contract, whilst the WTO has a legal dispute settlement mechanism that has to interpret the GATT/WTO covered agreements in a stable and predictable manner, even when these texts are at best ambiguous. However, despite the use of ‘creative ambiguity’ on behalf of the negotiators to achieve a settlement, WTO dispute settlement bodies are not required to determine if such ambiguity is deliberate. What is required is a determination of whether the meaning of a text is ambiguous after applying the customary rules of treaty interpretation and in light of the evidence and arguments presented by the parties to the dispute. The Marrakesh Agreement stated that only the General Council (GC) or the Ministerial Conference have the right to interpret the agreements.4 However, as stated in the Understanding on Rules and Procedures Governing the Settlement of Disputes: The WTO DSU [Dispute Settlement Understanding] establishes an integrated system permitting WTO Members to base their claims on any of the multilateral trade agreements included in the Annexes to the Agreement establishing the WTO. For this purpose, a Dispute Settlement Body (DSB) will exercise the authority of the General Council and the Councils and Committees of the covered agreements.

If it is to make recommendations the Appellate Body must interpret the WTO Agreements. The primary tool for interpreting international treaties when the wording of provisions is open-textured, or contains an ambiguity or conflict of rules and principles, is the 1969 Vienna Convention on the Law of Treaties (VCLT).5 The most specific provision is Article 31(3) (c) which states that any relevant rules of international law applicable in the relations between the parties shall be taken into account, together with the context. This expresses the principle of ‘systemic integration’


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whereby international obligations are interpreted with reference to their normative environment. This principle addresses the absence of unity in an international system where treaty negotiation has predominately been a diplomatic exercise conducted by technocrats with a narrow field of expertise in the regulatory issues covered by the treaty. Article 31(3)(c) serves the indispensable function of connecting the separate treaty provisions to each other as aspects of an overall aggregate of the rights and obligations of States. Yet despite the use of the VCLT, the consequences of not having a political mechanism within the WTO system to amend and rework the texts of the provisions continue to be of concern. The EU has largely succeeded in creating such a mechanism.

DECISION-MAKING IN THE WTO AND THE EU: THE POWER OF THE DISPUTE SETTLEMENT SYSTEM Decision-making at the WTO corresponds only to the EU in its Treaty change mode. The EU Treaties empower the Council of Ministers to make decisions qua Council, with some legislative power in the hands of the parliament and even the Commission where there is direct Treaty power or delegated power. The key feature of the WTO is that all its core rules or its ‘covered agreements’ are in the form of Treaties. Although the General Council is empowered to act in the intervals between ministerial meetings, major decisions including the move to modify one of the agreements in any significant way must be undertaken by the ministerial meetings. In principle, the General Council can act with less than total unanimity of all Members, but this does happen. Paradoxically the only context in which WTO commitments can be set by majority voting is where the agreements create obligations to use international standards. Bodies such as the ISO and the Codex Alimentarius can sometimes agree standards by majority voting. Cass (2005:185) refers to this as ‘outsourcing rule making’ and more broadly says: ‘the relationship between the law and politics in the WTO is awry and there is no self-correcting mechanism to act as a counterweight to judicial activity’ Siedentop (2000:117) argued that both the EU and the WTO Member governments use the traditional executive prerogatives of the state designed for making foreign policy in order to make agreements about ‘trade’ matters that increasingly impinge upon domestic regulations. Indeed, as Cass notes, the foreign policy method may be used to transfer the decisionmaking to another body rather than to make substantive decisions.

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This technocratic approach is much more circumscribed by accountability mechanisms within the EU. It is clear that the EU system distinguishes very sharply between normal legislative action via the Commission, the Council and the parliament, and on the other hand those Treaty changes which are decided in the classical way that foreign policy is made – with most of the internal processes of the EU’s decision-making suspended. Thus, even if the Council of Ministers meets in secret, draft legislation is published, circulated and debated in the European Parliament, and in some national parliaments, and if there is delegation to the standards body, this can be modified by normal procedures. Treaty changes, on the other hand, are negotiated in private and rarely offered to the public or parliaments until the final draft text on a more-or-less take it basis. The WTO lacks this rule making capability. This creates ‘gaps’ in the covered agreements which can be filled in ways other than through negotiation. Yet the function of WTO adjudicative bodies is to resolve disputes over obligations undertaken, not to substitute for negotiators and re-write, reduce or supplement the agreed text. As Pauwelyn (2005) has noted, the WTO DSB has ruled out the possibility of declaring that there is no applicable WTO law in a given case, for example because the texts are imprecise or contradictory, by invoking the concept of ‘non liquet’. To do so would in effect award the case to the respondent. Barfield (2002) has called for this to be used. It would undoubtedly lessen the intrusiveness of WTO jurisprudence, but would weaken the disciplines. Moreover Barfield’s critics have noted that the highly judicial mode of decision-making was adopted precisely because the problems of the political/diplomatic approach under GATT, (Cass (2005: 135)). There is only one exception to the generalisation of political paralysis as regards the issue of access to essential medicines. In 2005 the membership of the WTO agreed to amend the TRIPS agreement to allow countries to import low cost drugs otherwise patent protected. This shows us that if there is agreement the members can modify their treaties, but there is generally insufficient consensus to allow this to happen.

THE DEMOCRATIC DEFICIT DEBATE If there is a ‘democratic deficit’ in the EU it is even more profound in the WTO, as Howse (2003) has noted. The WTO continues GATT’s tradition of making decisions not by voting but by consensus. Where consensus is not possible, the WTO agreement allows for voting on the basis of ‘one country, one vote’ in specific situations. An interpretation of any of the multilateral trade agreements can be adopted by a majority of


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three-quarters of WTO Members. Decisions to amend provisions of the agreements can be adopted through approval either by all Members or by a two-thirds majority depending on the nature of the provision concerned.6 But there is no mechanism to call a vote (as in the EU before 1987). Despite the veto rights everyone has in WTO decision-making, developing countries continue to object to the disproportionate de facto weight of the US, Japan and the EU. Representatives from these countries, for their part, argue that they account for most trade. The US would oppose a voting system in which very populous undemocratic countries could out-vote the US and its allies. National political actors were until recently rarely involved in the discussion of new GATT/WTO agreements before they were agreed, and many of the parties who have to sign are not involved in the discussions until the last minute. Parties have been known to sign a deal that each Member can present as a victory for their diplomacy at home, yet each have the common understanding that the substance will be decided in a second round of discussions. Under the GATT regime, developing country Members could accept their exclusion from the decision-making in the GATT ‘club’ knowing they had a double opt-out. Not only were additional agreements plurilateral and thus voluntary, but the dispute settlement mechanism was not binding. Under the GATT, a positive consensus was needed to adopt reports, so any one party could prevent the formal adoption of a decision. Under the WTO DSU, the panel reports are automatically adopted, unless there is consensus to the contrary. This ‘reverse consensus’ makes the decisions very difficult to reject, although a mechanism was created for parties to appeal rulings to an Appellate Body. Taken together with the WTO principle of the single undertaking, it is clear that the intention is for all Members to accept all the WTO acquis,7 and that these rules are intended to bind. Developing countries who did not like the WTO agreements had little choice but to sign or be excluded from the WTO, but once they are Members all Member states have a veto, individually in principle and in practice as groups. And in the absence of an opt out, and with binding DS, states have no choice but to veto what they (or their domestic constituencies). The significance of a binding DSB was probably not fully appreciated at the time. Weiler (2000:13) notes: From interviews with many delegations I have conducted it is clear that, as mentioned above, they saw the logic of the Appellate Body as a kind of SuperPanel to give a losing party another bite at the cherry, given that the losing party could no longer block adoption of the panel. It is equally clear to me that they did not fully understand the judicial let alone constitutional nature of the Appellate Body. And yet the Appellate Body is a court in all but name.

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The anomaly of the negotiated text is that the Members formally denied the Appellate Body the right to interpret the rules of the Treaty, explicitly giving that power to the General Council. Article IX of the Marrakesh Agreement Establishing the World Trade Organization provides that: [T]he Ministerial Conference and the General Council shall have the exclusive authority to adopt interpretations of this Agreement and of the Multilateral Trade Agreements. In the case of an interpretation of a Multilateral Trade Agreement in Annex 1, they shall exercise their authority on the basis of a recommendation by the Council overseeing the functioning of that Agreement. The decision to adopt an interpretation shall be taken by a three-fourths majority of the Members.8

Nevertheless, the GC has to accept decisions of the Appellate Body unless there is a consensus against. The Appellate Body can therefore ‘pre-empt’ much of the work of the rest of the WTO, for example deciding if a preferential agreement violates the Article XXIV provisions governing regional trading arrangements. Weiler (2000: 13) writes ‘De Jure the DSU leaves the final interpretation of the Agreements in the hands of the General Council and Ministerial Conference. De facto, unless the Organization is to break the hallowed principle of consensus, that power has shifted to the Appellate Body.’ By contrast the ECJ was explicitly given the right to interpret EC law. Its doctrine of supremacy and direct effect of EC law proved somewhat controversial but in Weiler’s terms they were very quickly ‘accepted’. The EU has evolved in a complex and structured way. The delicate balance between inter-governmentalism, supra-nationalism and judicial activism is set in a context of 50 years of some form of legitimacy, and the balance between trade and non-trade objectives is not left to the ECJ alone. The EU is hardly without critics. It is therefore not surprising that the WTO should also be a highly contested institution. It is frequently accused of being undemocratic, but at one level it is too democratic. Any Member state can veto any decision. However the result is a stalemate where ambiguities are left to be resolved by a judicial process that, despite its many merits, cannot be said to be democratic in either a procedural or substantive sense. Pauwelyn (2005: 345) argues that the curious balance within the WTO’s structures was no accident. The strong Dispute Settlement Mechanism (DSM) was needed to offset the political blockage, but the strong DSM implies a need for retention of veto rights for rule changes. But he goes on to argue the need for judicial restraint:


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Given the need to maintain the consensus rule – at least until levels of socialization and support for the WTO project have matured – there is an absolute need for WTO panels and the Appellate Body to be warned against judicial activism, of the type the early European Court of Justice engaged in.

KEY EXAMPLES OF THE DISPUTE SETTLEMENT SYSTEM As noted above, the covered agreements are treaties usually negotiated under pressure by diplomats, vaguely worded and lacking an effective secondary legislative or executive function. Pauwelyn argues that as membership expands ‘If anything, new WTO agreements are destined to be even more vague than before’. Hence the WTO system relies disproportionately on its dispute settlement mechanism. Interviews with trade negotiators from the early 1990s suggest that they did not all fully appreciate the significance of the obligations they had taken on. As one trade representative noted of the GATT: Perhaps it was dangerous to take too academic or too legal a position on any GATT Article, considering the fact that negotiation results usually were not based on academic or legal considerations.9

Ambiguities in wording are an inherent feature of diplomatic negotiations, so all parties can claim victory, but in this case ambiguity was combined with a commitment to a binding dispute settlement system. Clearly part of the problem is that from the perspective of the lawyers, the negotiators of the Uruguay Round did not do their job properly. Ambiguous agreements were signed without anyone appreciating the consequences of them being subject to a legalistic interpretation. The Appellate Body has drawn on the Vienna Convention to insist that it must first and foremost make a literal reading of the wording of the agreements, which may well not have been drafted to take such weight. It would be virtually impossible for the Appellate Body to base a decision on the ‘intentions’ of the parties since many or most of the signatories of most of the agreements were not there when they were signed! Shapiro (1999), comparing the ECJ and the US Supreme Court, notes that even where a tribunal set up to interpret an agreement that has one specific aim in mind introduces a ‘balancing test’ to take account of other objectives, as indeed the Appellate Body has done, it will start off with a bias in favour of the objectives of the agreement of which it is guardian. Shapiro points out that a constitutional court has most legislative power

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when the texts it interprets are vague and when there is limited scope for the body that agreed it to meet and amend (which may have been a reason for the initial vagueness). Unanimity is needed at the WTO to re-open agreements once made. At the heart of the Uruguay Round was a desire to prevent governments from circumventing their trade obligations by introducing ‘grey area’ measures – or non-tariff barriers – that might not have been specifically declared to be illegal. Consequently, many of the new disciplines of the WTO agreements concerned domestic regulatory policies. For example, both the US and developing countries feared that spurious health and safety concerns might be invoked to create barriers to agricultural trade when quotas were removed or tariffs cut. The addition of trade in services necessarily brought domestic regulation into the field in a way that had rarely been invoked in the GATT. Hence disputes often involve not so much trade measures, but ‘domestic measures’ deemed to be infringing in some way the WTO commitments. Yet paradoxically, the most successful part of the WTO is widely acknowledged to be the working of the dispute settlement mechanism. The controversy concerns whether it is doing more than it was created to, particularly when – in the transition from the GATT to the WTO – the dispute settlement body has been forced to enter the realm of policing domestic regulation as well as trade policy per se. In this section we shall discuss the way the Appellate Body in particular fills gaps and go on to contrast on two areas, one involving regulation and the other involving trade policy. Filling Gaps One way for gaps to be filled is for the DSB to ‘read’ into the text of a covered agreement an obligation or right that is not present in the text, for example, by extrapolating from the text a different provision of the covered agreement. This occurred, for instance, in the Mexico Soft Drinks Case when Mexico appealed the Panel’s decision that there was no legal basis to interpret the provision to exclude any government action which was taken to enforce international treaty obligations from the scope of Article XX(d).10 In the absence of text to qualify and therefore clarify whether both national and international obligations were covered by this provision, Mexico noted in this argument that the words ‘laws’ and ‘regulations’ are expressly qualified in other provisions of the covered agreements. Consequently, Mexico argued that the absence of qualifying language in Article XX(d) implied that the terms ‘laws or regulations’ must therefore include both international and national agreements.11 The Appellate Body decided otherwise however. It concluded that Mexico had


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no right to take WTO-incompatible measures in the attempt to force the US to comply with an international agreement (the NAFTA).12 The difficulty is that when the Appellate Body is called upon to fill gaps in WTO provisions, when settling a WTO dispute, it must resolve any ambiguity in the text of the covered agreements in a manner that which neither supplements nor diminishes rights and obligations signed up to by the Members of the WTO. Article 3.2 of the Understanding on Rules and Procedures Governing the Settlement of Disputes states: The dispute settlement system of the WTO is a central element in providing security and predictability to the multilateral trading system. The Members recognize that it serves to preserve the rights and obligations of Members under the covered agreements, and to clarify the existing provisions of those agreements in accordance with customary rules of interpretation of public international law. Recommendations and rulings of the DSB cannot add to or diminish the rights and obligations provided in the covered agreements.

Appellate Bodies have overturned panel conclusions because the WTO DSB was not delegated the task of filling in gaps in the covered agreements. For example, in EC-Poultry the Appellate Body found that as the bilateral agreement being referred to by the parties to the WTO dispute was manifestly not a WTO covered agreement, it could not be applicable law in the dispute within the WTO. The applicable law was the relevant WTO GATS schedule because the legal provisions relevant to the parties to the dispute under the WTO Agreement were necessarily WTO legal provisions.13 This was because the bilateral agreement could not be applied to the detriment of the rights and obligations contained in a covered agreement. In EC-Bananas, the Panel and Appellate Body interpreted a waiver with an explicit reference to the Lomé Convention but without applying the Lomé Convention, in order to avoid modifying the WTO Members’ rights and obligations.14 Bartels (2001) identifies a further strategy used by the Appellate Body to be the a contrario technique which consists of first establishing that there was no express prohibition on a particular course of conduct, before going on to adopt a new norm approving this conduct. The Appellate Body employed this technique when concluding that parties can be represented by private counsel: . . . nothing in the Marrakesh Agreement Establishing the World Trade Organization (the ‘WTO Agreement’), the DSU or the Working Procedures, nor in customary international law or the prevailing practice of international tribunals, which prevents a WTO Member from determining the composition of its delegation in Appellate Body proceedings.15

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Domestic Regulation The DSB has to determine when domestic measures which may affect trade are nevertheless legitimate under the rules. The WTO was not designed to preside over a process of international legal harmonisation or ‘positive integration’, with the exception of TRIPS. But it comes close to creating a mechanism for enforcing common standards in the SPS agreement. Here, Article 3, for example, states that: 1. To harmonize sanitary and phytosanitary measures on as wide a basis as possible, Members shall base their sanitary or phytosanitary measures on international standards, guidelines or recommendations, where they exist. . . 2. Sanitary or phytosanitary measures which conform to international standards, guidelines or recommendations shall be deemed to be necessary to protect human, animal or plant life or health, and presumed to be consistent with the relevant provisions of this Agreement and of GATT 1994. 3. Members may introduce or maintain sanitary or phytosanitary measures which result in a higher level of sanitary or phytosanitary protection than would be achieved by measures based on the relevant international standards, guidelines or recommendations, if there is a scientific justification . . .

This introduces a ‘safe haven’ provision for those Members using recognized international standards, while the burden of proof is placed on those Members introducing higher standards for scientifically justifiable reasons. In the beef hormone case the Appellate Body had to decide on whether a higher standard was justified when the US complained to the WTO DSB about the EU ban on all sales of growth hormone treated beef. The WTO panel concluded that the EU had no scientific evidence with which to justify not using Codex standards. On appeal, the Appellate Body stated that while the EU certainly had a right under the SPS agreement to set any safety standard it liked – there were some provisions regulating this right. First, the regulations and the objective must be linked, and second that there was some scientific evidence of the existence of a reduction in risk to human health because of the EU’s ‘Codex-plus’ standard. The Appellate Body concluded that these conditions were not met by the EU. Initially, the EU would not comply and the US was authorised to apply sanctions. A new dispute subsequently emerged when the EU produced new scientific evidence of possible risk, which the US did not recognise by removing its penalties. Thus equally problematic is the issue of what is to happen when a case like this is decided and the parties do not wish to comply with the recommendations of the DSB. There is little doubt that Member states of the WTO had not agreed whether a negative ruling should lead to automatic compliance or the automatic payment of ‘compensation’, for example,


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the ‘withdrawal of concessions’. This can be illustrated using the Japanese Alcoholic Beverages Case,16 which as Wille (1998) notes, set a very major precedent: The most important question, and the one whose implications were overlooked, was how to design a test for Article III:2 that does not encroach upon the fiscal sovereignty of the Contracting Parties to the Agreement. As the Panel in Malt Beverages stated, “[it is] imperative that . . . determinations [made] in the context of Article III . . . not unnecessarily infringe upon the regulatory authority and domestic policy options of contracting parties.” The Panel and the Appellate Body, however, employed a test that restricts the fiscal sovereignty of the Contracting Parties both prior to and during a dispute.

The Appellate Body in this case declared: [T]he intention of the drafters of the Agreement was clearly to treat the imported products in the same way as the like domestic products once they had been cleared through customs. Otherwise indirect protection could be given.17 Moreover, it is irrelevant that ‘the trade effects’ of the tax differential between imported and domestic products, as reflected in the volumes of imports, are insignificant or even non-existent; Article III protects expectations not of any particular trade volume but rather of the equal competitive relationship between imported and domestic products. Members of the WTO are free to pursue their own domestic goals through internal taxation or regulation so long as they do not do so in a way that violates Article III or any of the other commitments they have made in the WTO Agreement.

Any domestic regulation is subject to this test and a violation can be shown even with no proof of injury here. With this case under its belt a WTO Panel addressed Canada’s complaint against French rules outlawing all use of asbestos, wherever produced. In this high profile case Canada brought a complaint to the WTO DSB, against France’s decree banning all asbestos from its markets which resulted in the WTO DSB deciding whether the French decree banning the sale of asbestos, including imports, constituted an illegitimate barrier to trade. Canada claimed that the French regulation banning the use of all asbestos products violated the GATT because it discriminated between asbestos and other building materials. In this case the Appellate Body held that the import ban was ‘necessary’ on public health grounds. While the then EU Trade Commissioner Pascal Lamy praised the Appellate ruling as showing that ‘[l]egitimate health issues can be put above pure trade concerns’ (CEC 2001), a more cynical perspective would be to argue that the WTO was trying to respond to public criticism about its intrusiveness into areas of social policy by supporting the right of Members to protect their citizens and their

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environment, and in effect support the right for Members to exercise their sovereignty, in a case which had fairly minimal cost to the principles of international trade liberalization. Further, while few would quarrel with the Appellate Body’s judgment on the scope of the Article XX exceptions, there are serious grounds for questioning whether the WTO should be deciding on what public health measures of this kind are acceptable and what are not. In the case of the SPS agreement it is very difficult for the WTO to avoid having to make such judgments. The SPS Agreement effectively commits countries to accepting into their markets any product produced to Codex Alimentarius standards unless they can show that there is scientific evidence that any more restrictive regulations in place are likely to reduce risk. In the Beef Hormones Case, the Appellate Body ruled that an EU ban on the sale of beef treated with growth hormones (wherever produced) violated the WTO rules because on the one hand, Codex had approved this method of rearing cattle, and on the other, the EU could not show any scientific evidence of a risk if such beef were consumed. The Appellate Body could not draw back from the requirement of the SPS agreement which mean that the WTO will have to decide what is and is not appropriate scientific evidence on which a measure can be based. The Members of the WTO had agreed that scientific evidence should be the basis of SPS measures; there was no consensus that public perceptions of risk should be treated as cause for action in their own right. Yet the fundamental problem remains that the WTO’s dispute settlement system has to resolve enormously sensitive issues as public and environmental safety. Most famously, in US-Shrimp Turtle the Appellate Body took a progressive approach when it reaffirmed that WTO law is not to be read ‘in clinical isolation from public international law’.18 It followed an evolutionary interpretation of the relevant treaty terms, taking into account the ‘contemporary concerns of the community of nations’19 as reflected in other treaties. In so doing, it relied on treaties that were not binding on all the parties to the dispute, let alone all WTO Members.20 This approach was similar to that of the Appellate Body of EC-Hormones when they stated that ‘. . . nothing in the DSU limits the faculty of a panel freely to use arguments submitted by any of the parties – or to develop its own legal reasoning – to support its own findings and conclusions on the matter under its consideration . . .’21 In both cases the impact of the decision was to give notice that a principle was established that a wide range of environmental or public health issues could be used to justify trade restrictions, provided that certain conditions were met. This gave considerable satisfaction to those environmental NGOs and legal commentators who have argued that while


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specific Articles of the WTO DSU limit the jurisdiction to claims which arise under the WTO covered agreements,22 there is no explicit provision identifying the scope of applicable law. Pursuant to Article 31(3)(c) of the VCLT, reference can be made to outside treaties when interpreting WTO rules – if they reflect the common understanding of all WTO Members. Vindicated by this conclusion, some authors, most notably Pauwelyn (2001; 2003), have argued vigorously that while it is indisputable that the WTO only has jurisdiction to decide claims under WTO covered agreements, this does not dictate that WTO panels are unable to reference other public international law sources. However, this verdict was not without its critics, particularly within the US pro-free trade camp, who see the covered agreements signed up to by the Members being slowly expanded during the settlement of trade disputes. Indeed, the DSB’s route since then has been more circumspect particularly in highly emotive cases, and its rulings more narrowly focused on the ordinary meaning of the Treaty text. It is still performing a variety of judicial activism, but its strategy has been to narrow down its scope as much as possible. This type of judicial restraint acts as a self-defence against those critics concerned with the de facto use of the deferred power that has been invested in the hands of the DSB. The issue of the use of amicus curiae briefs is an interesting case in point. Wanting to put their views directly to WTO Panels and/or the Appellate Body, some NGOs have chosen to send amicus briefs to the WTO DSB. In the 1998 US-Shrimp case, the Appellate Body ruled that Panels had the right to accept unsolicited amicus briefs. It went on to confirm this in the 2000 US-Lead and Bismuth II dispute when the Appellate Body stated that it too had the right to receive amicus briefs. Yet in the 2001 EC-Asbestos dispute, the Appellate Body adopted a special procedure to receive amicus briefs, and this procedure was posted on the WTO web site (although the tribunal ultimately rejected all applications for leave to file such briefs). The actions of the Appellate Body in EC-Asbestos drew strong criticism from many WTO Members, particularly developing countries, at a special General Council meeting held in November 2000 to consider the amicus issue. Subsequently the Appellate Body has treated the amicus issue much more cautiously. While affirming its right to receive such briefs, the Appellate Body has invariably made an unqualified statement to the effect that the individual briefs received were not of assistance in the disposition of that particular appeal. Then in the March 2004 decision in US-Softwood Lumber VI, the panel rejected the amicus submission outright with the justification that there was an ‘absence of consensus among WTO Members on the question of how to treat amicus submissions’.23

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This strategy of judicial restraint was also apparent during the Soft Drinks case. Here the Appellate Body took the narrowest view and slice of the dispute that was possible without actually declining its jurisdiction over the case. In doing so, it fragmented the case and consequently avoided pinning down the theoretical scope of applicable law in the WTO. The Appellate Body refused to examine NAFTA provisions, because they were not part of the covered agreements. Nor would the Appellate Body examine case law of the Permanent Court of International Justice or even the wider dispute behind the case, and consequently avoided many of the issues of controversy. This is clear from the brevity of its final report.24 The DSB also made a 180 degree turnaround from the heady days of the US-Shrimp Turtle case during the EC-Biotech Products case. Here the Panel found that it was not necessary to take a position on the question of whether the precautionary principle is a recognised principle of general or customary international law, in order for it to dispose of the legal claims before it.25 Despite the controversial nature of this case, the use of the wording of ‘not necessary’ is difficult to comprehend in the context of this case. That is, a position should have been taken by the Panel, on the grounds that if the precautionary principle has become a general principle of law, or a rule of customary international law, it must be taken into account in the interpretation of the SPS Agreement under Article 31.3(c) of the VCLT. Throughout the EC-Biotech rulings, the DSB steered a clear course through most of the controversial issues. For example, in addition to the issue of the precautionary principle, the Panel expressly stated26 that the dispute did not concern the question of whether biotech products in general are safe or not or whether the conclusions of the EC scientific committees regarding the safety of specific biotech products are scientifically valid or not.27 The complainants also raised the question of likeness of biotech and conventional products, but the Panel again found it unnecessary to address this issue, along with whether the EC has a right to require pre-marketing approval of biotech products or not or whether the EC approval procedures requiring a product-by-product assessment of risks are WTOconsistent or not.28 When the EC raised the question of the relevance of other rules on international law to the interpretation of the applicable WTO agreements in this dispute, it did so with reference to the VCLT provisions which require that the relevant rules of international law be taken into account when interpreting treaties. In addition to referencing the precautionary principle as customary international law, the EC defence included, inter alia, particular reference to multilateral environmental agreements, including the 1992 Convention on Biological Diversity (CBD), the 2000 Cartagena Protocol on Biosafety of 200029 and certain definitions of terms developed by international standard-setting bodies.30


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In response to the EC argument, the Panel noted that the use of the word ‘shall’ indicates that Article 31.3(c) places an obligation on a treaty interpreter to take other international law rules into account.31 The use of the word ‘shall’ is customarily interpreted by courts to be significantly stronger than the term ‘should’ or ‘may’.32 Article 31.3(c) is therefore legally binding and aims, as noted above, to enhance the consistency of international law rules and contributes to avoiding conflicts between those rules. In line with the US-Shrimp Turtle findings, the Panel concluded that the term ‘rules of international law’ in Article 31.3(c) is broad enough to encompass ‘all generally accepted sources of public international law’ including treaties, customary international law rules33 and general principles of international law.34 However the Panel then took the unprecedented step of narrowing down the scope of Article 31.3(c) of the VCLT so that it was limited to take account of only those rules of international law ‘applicable in the relations between the parties’.35 Further minimising the potential impact of this provision, the Panel also held the definition of ‘the parties’ to only include those states that have consented to be bound by the treaty being interpreted. In this case: all 150 Members of the WTO.36 As many commentators have since argued, this finding appears in practice, to exclude the possibility of a Panel being obliged to have take account of any other treaties in the interpretation of WTO Agreements, since it is highly unlikely that all 150 WTO Members would be parties to another treaty, other than the UN Charter. The DSB is going to continue to solve more and complex new issues. It is being called upon to decide, most notably under Article XX exceptions, what other agreements justify overriding trade priorities. As noted below, this will be just as sensitive in the area of services. Anti-dumping Another area of controversy is anti-dumping. A high proportion of recent dispute settlement cases have involved successful complaints by developing countries that the EC and above all the US have been abusing the provisions on anti-dumping. The Appellate Body has been striking down anti-dumping measures, and in effect achieving something that liberal trade negotiators have failed in. The recent WTO DSB decisions on antidumping violations clearly indicate that the Appellate Body still has the occasional will to flex its judicial muscle. But it is also the case that this is not an issue which has the same level of public pressure or awareness as a decision on domestic environmental regulation. Unknown to most outside of trade policy circles, GATT/WTO Member states have long been resorting to very complex methods to make it easier to uphold findings of dumping against exporters. Under GATT/WTO

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rules ‘anti-dumping duties’ may be imposed if exports are found to have caused injury to domestic producers as a result of being sold in the export market at below the ‘normal value’ in the home market, that is, ‘dumped’. Not only are the definitions such as ‘normal value’ problematic, but calculating dumping margins is highly controversial, as the WTO Members have found. While it has been suggested that the EU and the US had negotiated the Uruguay Round Agreement on Anti-dumping (ADA) in such a way that they intended the agreement to prevent the DSB redoing the anti-dumping authorities’ calculations,37 the Appellate Body has interpreted the ADA as allowing them to do so. The implications of this have surfaced in the so called ‘zeroing’ dispute. The issue is a complex one. In a nutshell, when importing countries calculate whether goods have been ‘dumped’ they compare the export prices charged with the so called ‘normal value’ in the home market.38 Goods sold below normal value are ‘dumped’, (and can be targeted with duties if ‘injury can be shown to have been caused). However there is a problem in estimating an average dumping margin when there are many transactions. Traditionally trade ministries have typically calculated average dumping margins by only counting goods sold below normal value and ignoring those sold at or above normal value. This is known as ‘zeroing’ and the EC and the US clearly thought that they had signed a Uruguay Round ADA that allowed them to carry on doing it. But in a series of cases against the EC and the US, developing countries have persuaded the Appellate Body to ban zeroing. The EC has accepted this after a fight and is now pursuing the US. This an area in which many commentators believe the Appellate Body has been at best creative and at worst ignored the agreement. In substance however, there is probably a balance of opinion that welcomes the curtailing of what is perceived as an inefficient and unfair obstacle to developing country market access to developed countries. But the process by which it has been achieved is a curious and little known one. Unbeknownst to most anti-globalization activists, the ‘Zeroing’ disputes illustrate how the Appellate Body can refine its reasoning without directly overruling itself – and in confrontation with the Members (Voon 2007). Here the Appellate Body held that the United States’ unwritten model zeroing methodology was a measure that could be challenged and that this methodology violates Article 2.4.2.39 The legal arguments concern certain articles of the ADA. The WTO website states: Article 17 [of the ADA] establishes that the Dispute Settlement Understanding is applicable to disputes under the AD Agreement. However, Article 17.6 establishes a special standard of review to be applied by panels in examining disputes in anti-dumping cases with regard both to matters of fact and questions of


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interpretation of the Agreement. This standard gives a degree of deference to the factual decisions and legal interpretations of national authorities, and is intended to prevent dispute settlement panels from making decisions based purely on their own views.40

The question has been how much deference is due to national authorities and while this chapter has not taken a position on this issue, it has shown that there is a growing body of opinion that claims the Appellate Body has made ‘decisions based purely on their own views’. Alford (2006: 217–18) contends that the Appellate Body went well beyond its mandate to review legal issues. It rather engaged in an ‘unprecedented’ factual reassessment of the evidence before the Panel. For him, the Appellate Body Report ‘cast serious doubt on the continued viability of the mandatory/discretionary doctrine’ in US-Zeroing (EC). Concerned US officials argued that: The Appellate Body Report was being applauded in some quarters because it had gone beyond what negotiators could have achieved. However, that was just another way of saying that the Report had added to or diminished rights and obligations actually agreed to by Members.41

This implies that the DSB has gone beyond the mandate of the covered agreements rather than simply changed directly. What is striking about the anti-dumping story is that there are indeed negotiations proceeding on this issue as part of the Doha ‘Rules Negotiations’. Here the US is actively proposing a revision of the ADA to restate the acceptability of zeroing.42 But the rules negotiations are as stuck as the rest of the Doha Round. And so the Rules are being made by the Appellate Body. Other Cases There is no space to review the whole of WTO jurisprudence but some comment is in order on other areas. In the few services cases43 that have been heard the panels and the Appellate Body have caused some controversy by taken a rather narrow focus emphasised the liberalisation commitments. The US was allowed to keep its on-line gambling laws with very minor modifications to remove one discriminatory element, but only after the Appellate Body had ruled that they were obstacles to trade and made its own evaluation of whether these were necessary to protect public morals.44 Meanwhile Mexico was told it had to enforce competition law in telecoms, even though at Cancun it was decided not to negotiate on trade and competition. Meanwhile in agriculture the Appellate Body has demanded that the EU and the US liberalise their sugar and cotton

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subsidy regimes, even though these parties had demanded that this be part of a further negotiation process.45 The DSB is reminding the Member states what it sees as their liberalisation obligations even as they hesitate in the talks.

CONCLUSIONS This chapter has put forward a picture of the WTO DSB as struggling to stay within the boundaries of its legal mandate because of the gaping holes in parts of the covered agreements. In most instances it has been unable to respond adequately despite its capacity because of the unreceptive political climate within the sovereign states of the Members. Nevertheless, the Member states have remained unable to act collectively so the Appellate Body has had to continue to fill in the gaps. This tension has not gone unnoticed amongst either the WTO’s Membership or the Appellate Body itself. Perhaps the cautionary comments of North (1993) on the evolution of economic institutions are appropriate here: the actors involved learn from experience but do not have perfect information about what they are doing, and do not always get it right first time. Jackson (2006) comments that a complex Treaty like the WTO agreement may need to be interpreted dynamically: If it is more like a constitution than a contract or bilateral treaty, then different techniques of interpretation may be necessary, such as evolutionary, purposive, or teleological interpretation.

This is certainly the approach of the ECJ. But can it be extended to the WTO? Weiler (2000:15) noted that ‘Panels and the Appellate Body fulfill the same function and cover the same issue based on similar norms that national courts and the ECJ fulfill in the European Union.’ However, the big difference is that in the EU the ECJ sits at the head of a complex and subtle political process. No-one would suggest that the WTO has a demos or a polity that can or should make rules for all Members. Weiler (1999: 374) observed: As the convergence process progresses, the simplistic dream of ‘constitutionalizing’ the GATT in structural terms and in some ways using the EU as a ‘model’ for the WTO (and for other transnational regimes) through the advocacy of Article 177-type procedures, will become far more nuanced. European constitutionalism is undergoing a certain crisis and reformation conditioned by the tension and gap between its legal imperatives and its social and political reality.


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The Appellate Body decision in Hormones, which clawed back some of the more audacious aspects of the Panel, was apparently mindful of the problems of giving binding constitutional force to standards adopted by faceless officials and enforced by adjudicatory bodies whose legitimacy is a matter of some considerable delicacy. This sounds familiar.

The challenges he identified have become harder rather than easier since he wrote this. The negotiations have stalled (at the time of writing) and the lack of consensus seems to reflect fundamental disagreements rather than simply the incompetence of the negotiators (Lamy 2003). The DSB has continued filling the gaps in agreements but if in responding to the challenge raised by commentators such as Pauwelyn, Howse and others, it has back-pedalled from its early form of judicial activism that drew heavily on other sources of law, it has continued to go its own way. In response to those demanding curbs on the judicial power of the DSB, the influence of non-trade concerns has been increasingly narrowed down from the approach taken in US-Shrimp Turtle. In anti-dumping the Appellate Body was able to flash its judicial muscle perhaps because the wider network of global civil society activists tend not to engage in the dumping disputes between different WTO Members. This is also one of the few areas where negotiations have been quietly proceeding in the background of the Doha Round. However unless the Round succeeds it will increasingly be jurisprudence not negotiations that determine the evolution of AD policy. This narrowing of judicial focus does not solve the source of the legitimacy problem. In its early years the creativeness of the Appellate Body played a role in softening the WTO’s legitimacy problem in the eyes of civil society – but at the expense of raising more doubts about the legitimacy of the Appellate Body itself. By refocusing itself on its trade priorities the Appellate Body now faces the risk of reviving accusations that the WTO as a whole is nothing but a neo-liberal project, even if its activity on agriculture and anti-dumping has made it friends in developing country trade ministries. The rise of protectionist sentiment in the US could make it harder to guarantee acceptance of decisions that go against US trade policy. Indeed paradoxically the Appellate Body’s focus on ensuring that countries respect their trade obligations might even chill the negotiations as countries are afraid that any new obligations will be given an expansive interpretation going beyond what they thought they had signed up for, whilst liberalisation can be extracted from the north without reciprocal concessions. This chapter has not attempted to put forward a solution to the problems identified except to agree that an effective dispute settlement system requires sensitivity to the political context. Where there is fundamental

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disagreement over the aims of the WTO, the DSB cannot create such agreement. Nevertheless, if the negotiations fail, the pressure on the DSB will be even greater. The issue will be whether it chooses to follow the early lead of the ECJ in promoting integration and trade even when the politicians fail to do so, as in the anti-dumping and agriculture cases, but to the exclusion of non-trade topics within the WTO. Alternatively, the WTO DSB could simply come to be seen as an increasingly remote and neo-conservative choice of dispute settlement forum in an environment where there are an increasing number of regional, bilateral and specialist bodies of law with alternative arbitration bodies to choose from. This may be increasingly perceived to be more sensitive to social issues and more appropriate to the changing needs of governments, NGOs and trade lawyers. That is, if the Members do not act to eliminate this constitutional imbalance, what was once seen as the jewel in the WTO crown could gradually lose much of its relevance and role.

NOTES This chapter was written in July 2007. 1. Amendment of the TRIPS Agreement Decision of 6 December 2005, http://www.wto. org/english/tratop_e/trips_e/wtl641_e.htm. 2. Cass draws on the work of Weiler and his analysis of the constitutional status of the EU as we have tried to do. 3. Including for instance, mercantilism: if you remove trade barriers, others will too. Howse and Nicolaides (2002) have argued that what may be labelled as a pre-commitment of a public interest-motivated government to tie its own hands in the future in dealing with interest groups, could in reality be a commitment to tie the hands of its political opponents, and the groups they represent, should they win a democratic victory in the future. 4. See Article XI Para 2 of the Marrakech Final Act. ‘The Ministerial Conference and the General Council shall have the exclusive authority to adopt interpretations of this Agreement and the Multilateral Trade Agreements.’ 5. This came into force in 1980. See: untreaty.un.org/ilc/texts/instruments/english/conventions/1_1_1969.pdf. 6. But such amendments may only take effect for those WTO Members which accept them. See Agreement Establishing The World Trade Organization, Article X, Amendments. 7. Though it is clear from FISC that no-one knows what these are until the Appellate Body decides! 8. Article IX(2) The Marrakesh Agreement. 9. Statement by the representative of the US to the Committee on Regional Trade Arrangements, WT/REG/M/15, 13 January 1998, para. 16. 10. Article XX(d), inter alia, provides that nothing in the GATT shall prevent the adoption or enforcement by any contracting party of measures necessary to secure compliance with laws or regulations that are ‘not inconsistent’ with the provisions of the Agreement. 11. Mexico’s appellant’s submission. Para 129. 12. The Appellate Body stated that the term ‘laws and regulations’ in this paragraph did not include obligations with international obligations unless these laws and regulations


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have been incorporated from international agreements into the domestic legal system, or have ‘direct effect’ in the domestic legal system. Mexico’s appellant’s submission. Para. 79. 13. European Communities – Measures Affecting the Importation of Certain Poultry Products, WT/DS69/AB/R, July 1998, para. 81. 14. European Communities – Regime for the Importation, Sale and Distribution of Bananas, WT/DS27/AB/R, September 1997, para. 167. 15. European Communities – Regime for the Importation, Sale and Distribution of Bananas, WT/DS27/AB/R, September 1997, para. 10. 16. Japan – Taxes on Alcoholic Beverages, WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/ AB/R. 17. Italian Discrimination Against Imported Agricultural Machinery, BISD 7S/60, para. 11. 18. This finding reiterates that of the Appellate Body in US-Gasoline. See Appellate Body Report, United States – Standards for Reformulated and Conventional Gasoline WT/ DS2/AB/R, 20 May 1996. 19. The Appellate Body was interpreting the term ‘exhaustible natural resources’, which it regarded as by definition evolutionary, necessitating regard to modern environmental treaties. United States – Import Prohibition of Certain Shrimp and Shrimp Products (US-Shrimp), WT/DS58/AB/R, adopted 6 November 1998, paras 129–130. 20. In US-Shrimp, the Appellate Body referred to the CBD in support of the arguments of the US, despite the fact that this Convention had not been either signed or ratified by the US. 21. Appellate Body Report EC – Hormones, para. 156; Appellate Body Report, US – Certain EC Products, para. 123. 22. WTO DSU Articles 1.1, 3.2, 7, 11, and 19.2. 23. Panel Report, United States – Investigation of the International Trade Commission in Softwood Lumber from Canada, WT/DS277/R, adopted 26 April 2004. 24. The Soft Drinks Appellate Body Report is 44 pages long. 25. See Panel Reports, EC-Biotech Products para. 7.89. 26. See Panel Reports, EC-Biotech Products, para. 8.3. 27. The only scientific issue raised was the scientific basis for the objections of some EC Member States, and this issue was raised in connection with this issue that the Panel consulted scientific experts. 28. Prévost has noted that the pre-marketing approval system itself was not challenged see Panel Reports, EC-Biotech Products, paras 7.1353 and 7.1693, despite the fact that such a system sits uncomfortably with the disciplines of the SPS Agreement. The SPS Agreement requires that a risk assessment must exist on which the relevant SPS measure (such as a marketing prohibition) is based. A pre-marketing approval system, however, prohibits the marketing of a product until such time as its safety is proven by means of a risk assessment. It can be seen as a provisional ban pending a risk assessment. However, as most countries maintain pre-marketing approval systems for particular products, it is possible that the Complainants wished to avoid opening this can of worms. See Prévost D, Opening Pandora’s Box: The Panel’s Findings in the EC-Biotech Products Dispute, Utrecht University. Forthcoming. 29. The Cartagena Protocol on Biosafety is a protocol to the UN Convention on Biological Diversity, covering the transboundary movement of living modified organisms. The EC argued that the Cartagena Protocol and the SPS Agreement should be interpreted and applied consistently as far as possible and that there are no a priori inconsistencies between the two treaties. See Panel Reports, EC-Biotech Products, para. 7.55. 30. The EC argued that there was a strong relationship between the SPS Agreement and these international bodies, as set out in Annex A(3) of the SPS Agreement. Panel Reports, EC-Biotech Products, para. 4.749. 31. See Panel Reports, EC-Biotech Products, para. 7.69. and para. 7.70. 32. See, for example, Article 2.2 TBT which states that Members shall ensure that technical

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33. 34. 35. 36.

37. 38. 39. 40. 41. 42. 43.

44. 45.

The law and economics of globalisation regulations are not prepared, adopted or applied with a view to or with the effect of creating unnecessary obstacles to international trade. The compulsory nature of this can be contrasted with the non-binding preamble to the TBT agreement which states that ‘no country should be prevented from taking measures necessary to ensure the quality of its exports, or for the protection of human, animal or plant life or health, or of the environment . . .’. See Panel Reports, EC-Biotech Products, para. 7.67. The Panel explicitly referred to the finding of the Appellate Body in US-Shrimp, WT/ DS58/AB/R para.158 and note 157. See Panel Reports, EC-Biotech Products, para. 7.68. See Panel Reports, EC-Biotech Products, para. 7.67. To support its finding, the Panel noted that Article 31.3(c) does not refer to ‘one or more parties’ or ‘the parties to the dispute’. It defined ‘party’ in Article 2.1(g) of the VCLT as ‘a State that has consented to be bound by the treaty and for which the treaty is in force’ and derived from this definition the conclusion that ‘parties’ in Article 31.3(c) refers to states which have consented to be bound by the treaty that is being interpreted and for which that treaty is in force. Source: senior EU trade negotiator. This is roughly equivalent to the full market price in the exporter – not the cost of production. Appellate Body Report, US – Zeroing (EC), WT/DS294/AB/R, circulated 18 April 2006, adopted 9 May 2006, [204]–[205]. http://www.wto.org/english/tratop_e/adp_e/antidum2_e.htm. DSB, Minutes of Meeting Held on 9 May 2006, WT/DSB/M/211 (12 June 2006). See for example the US ‘Proposal on offsets for non-dumped comparisons’ TN/RL/ GEN/147 27 June 2007. Panel Report, Mexico – Measures Affecting Telecommunications Services, WT/ DS204/R, adopted 1 June 2004, DSR 2004:IV, 1537, Appellate Body Report, United States – Measures Affecting the Cross-Border Supply of Gambling and Betting Services, WT/DS285/AB/R, adopted 20 April 2005. A 2007 compliance panel found that the US had still not removed the discriminatory element in its horse-racing laws. EC – Export Subsidies on Sugar (DS265, 266, 283), US – Upland Cotton (DS267).

REFERENCES Alford, R. (2006), ‘Reflections on US-Zeroing: A Study in Judicial Overreaching by the WTO Appellate Body’, Columbia Journal of Transnational Law 44, http:// ssrn.com/abstract5926909. Barfield, C. (2001), Free Trade, Sovereignty, Democracy: The Future of the World Trade Organization, Washington, DC: AEI Press. Barfield, C. (2002), ‘WTO Dispute Settlement System in Need of Change’, http:// www.aei.org/publications/pubID.14115/pub_detail.asp. Bartels, L. (2001), ‘Applicable Law in WTO Dispute Settlement Proceedings’, Journal of World Trade 35(3), 499–519. Cass, D.Z. (2005), The Constitutionalization of the WTO, Oxford: Oxford University Press. Craig P. and G. De Burca (1999a) (eds), The Evolution of European Law, Oxford: Oxford University Press. Dixit, A.K. (1998), The Making of Economic Policy: A Transaction Cost Politics Perspective, Boston, MA: MIT Press. Howse, R. and K. Nicolaides (2002), ‘Legitimacy through “Higher Law” Why


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Constitutionalizing the WTO Is a Step Too Far’ in T. Cottier and P.C. Mavroidis (eds), The Role of the Judge in International Trade Regulation: Experience and Lessons for the WTO, pp. 307–48. World Trade Forum, 4, Ann Arbor, MI: University of Michigan Press, 2002 (Studies in International Economics series). Howse R. (2003) ‘How to Begin to Think About the “Democratic Deficit” at the WTO’, in S. Griller (ed), International Economic Governance and NonEconomic Concerns: New Challenges for the International Legal Order, pp. 79–101, European Community Studies Association of Austria (ECSA Austria) Publication Series, 5. Wien; New York: Springer-Verlag, 2003. Jackson J.H. (1998), The WTO: Constitution and Jurisprudence, London: RIIA. Jackson J.H. (2006), ‘The Future Scope of WTO – Issues as seen in the Sutherland Report’, http://www.rieti.go.jp/en/events/bbl/06032301.html. Lamy, P. (2003), ‘The EU, Cancun and the Future of the Doha Development Agenda’, Journal for Common Market Studies Lecture, 28 October, http:// europa.eu/rapid/pressReleasesAction.do?reference5SPEECH/03/499&format 5HTML&aged50&language5EN&uiLanguage5en. McLachlan, C. (2005), ‘The Principle of Systemic Integration and Article 31 (3) (c) of the Vienna Convention’, ICLQ 54, pp. 279–320. North D. (1990), Institutions Institutional Change and Economic Performance, Cambridge: Cambridge University Press. Pauwelyn J. (2005), ‘The Sutherland Report: a Missed Opportunity for Genuine Debate on Trade, Globalization and Reforming the WTO’, Journal of International Economic Law 8(2), 329–46 Pauwelyn, J. (2003), ‘How to Win a WTO Dispute based on Non-WTO Law’, Journal of World Trade (37)6, 996. Pauwelyn, J.P. (2001), ‘Public International Law in the WTO System: How Far Can We Go?’, American Journal of International Law, 95(3). Prévost D., ‘Opening Pandora’s Box: The Panel’s Findings in the EC-Biotech Products Dispute’, Utrecht University, forthcoming in European Journal of Economic Integration. Shapiro, M. (1999), ‘The European Court of Justice’, pp. 321–46 in Craig and de Burca (1999a). Siedentop, L. (2000), Democracy in Europe, London: Allen Lane. Trachtman, J. (1999), ‘The Domain of WTO Dispute Resolution’, Harvard International Law Journal 40(2), 333. Voon, T. (2007), The End Of Zeroing? Reflections Following The Appellate Body’s Latest Missive, presented at The International Conference on WTO Dispute Settlement Held at the Asian Center For WTO And International Health Law And Policy, College Of Law, National Taiwan University, Taipei, 11 March 2007. Weiler, J.H.H. (1999), ‘The Constitution of the Common Market Place’, pp. 349–76 in Craig and de Burca (1999a). Weiler, J.H.H. (2000), ‘The Rule of Lawyers and the Ethos of Diplomats: Reflections on the Internal and External Legitimacy of WTO Dispute Settlement’, Harvard Jean Monnet Working Paper 9/00, www.jeanmonnetprogram.org/ papers/00/000901.rtf. Wille, S.B. (1998), ‘Recapturing a Lost Opportunity: Article III:2 GATT 1994 Japan-Taxes on Alcoholic Beverages’, European Journal of International Law, 9.

5.

Global trade policy in the new century Razeen Sally

To expect, indeed, that the freedom of trade should ever be entirely restored . . . is as absurd as to expect that an Oceana or Utopia should ever be established . . . Not only the prejudices of the publick [sic], but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it. (Adam Smith, Wealth of Nations) It tells them of freedom, and how freedom was won, and what freedom has done for them, and it points the way to other paths of freedom which yet lie open before them. (John Bright, on the repeal of the Corn Laws)

INTRODUCTION In the last six decades, expanding international trade and capital flows have progressively reintegrated the world economy in ever more complex ways. Policy and technological innovation have combined to produce what we now call economic globalisation. Post-1945 trade policy has been a constant battle between freer-trade and protectionist forces. Generally, liberalisation has been the trend, but it has coexisted uneasily with varieties of protectionism that have always assumed new and potent forms. Free traders, in the spirit of John Bright’s stirring words, were at their most optimistic in the 1980s and 1990s, when liberalisation spread fast across the developing world and the ex-command economies. Since then a note of caution and pessimism has set in, echoing perhaps the sober Scottish realism of Adam Smith. This chapter tries to make sense of trade-policy developments in the new century. It also tries to shed light on the prospects for further external liberalisation in current conditions, at a time when the ‘Washington Consensus’ attracts greater scepticism than it did in the 1980s and 1990s, and when the momentum of liberalisation has slowed down. How necessary is further liberalisation of trade and foreign direct investment? What obstacles lie in its path? What are its political requisites? What are the links with domestic economic reforms? What is the balance between unilateral 118

Global trade policy in the new century

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liberalisation and reciprocity (liberalisation through trade negotiations and agreements with donors)? The first section sets the scene by looking at the global climate for external liberalisation, including debates revolving around the Washington Consensus. The second section reviews the record of trade and Foreign Direct Investment (FDI) liberalisation, especially across the developing world while the third goes on to provide a frame for ‘multi-track’ trade policy, that is trade policy conducted, often simultaneously, on unilateral, bilateral/regional (preferential trade agreements – PTAs) and multilateral (World Trade Organisation – WTO) tracks. The fourth section signals lessons for future liberalisation.

THE GLOBAL CLIMATE FOR EXTERNAL LIBERALISATION There is less appetite for further liberalisation and associated structural reforms now compared with the heyday of the Washington Consensus in the 1980s and 1990s. Reforms have not been reversed, but their forward momentum has slowed. Governments are more sceptical and defensive about further liberalisation; and there has been relatively little in the way of ‘second-generation’ reforms (in domestic trade-related regulations and institutions) to underpin external liberalisation and boost competition. This applies to the West, and to most developing-country regions. In the developed world, pervasive agricultural protectionism continues, with an admixture of new protectionism directed against China. The West has no grand project for liberalisation in the early twenty-first century to compare with the Reagan and Thatcher reforms in the 1980s, or the EU’s Single Market programme in the late 1980s and early 1990s. Eastern-European countries are suffering from ‘reform fatigue’ after their accession to the EU. This is also the state of play in much of Latin America, Africa, south and southeast Asia. It is true of leading developing countries, notably Brazil, Mexico, South Africa and India. All have their real bursts of tradeand-FDI liberalisation behind them. In Russia, liberalisation has been put into reverse gear. This has also happened in other resource-rich countries enjoying a revenue windfall, for example, Venezuela and Bolivia. Overall, protectionist flare-ups and lack of reform momentum in the West have reinforced liberalisation-slowdown outside the West. China is the conspicuous exception: liberalisation proceeded apace before and after WTO accession, in what has been the biggest opening of an economy the world has ever seen. However, domestic political conditions for further liberalisation are now more difficult. Vietnam has

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followed in China’s tracks, with internal and external liberalisation accelerating in the run up to its WTO accession in 2006. A variety of factors accounts for liberalisation-scepticism today. There is much anxiety about globalisation, despite record growth across the world in this decade. Macroeconomic crises provided windows of opportunity for fast-and-furious liberalisation in the 1980s and 1990s, but that has not happened since the Asian and other financial crises of the late 1990s. Indeed, the latter may have brought about a popular backlash, and certainly induced more caution regarding further liberalisation. Also, further liberalisation entails tackling border and, increasingly, domestic regulatory barriers in politically-sensitive areas such as agriculture and services. Inevitably, this runs up against more powerful interest-group opposition than was the case with previous waves of (mainly industrialgoods) liberalisation. Individuals matter too: the new century has not yet brought forth a Cobden, Gladstone, Erhard, Thatcher or Reagan to champion free markets or free trade. Not least, the climate of ideas has changed, for prevailing weather conditions have become more inclement since the Washington Consensus reached its zenith only a decade ago. There is, now as before, an extreme anti-globalisation critique, a root-and-branch rejection of capitalism. But this is street theatre on the fringe. Of greater political importance is a more mainstream critique that accepts the reality of the market economy and globalisation, but rejects the comprehensive liberalisation associated (perhaps unfairly) with the Washington Consensus. Critics point to tenuous links between liberalisation, openness, growth and poverty reduction; wider inequalities within and between countries that result from globalisation; the damaging effects of large and sudden trade liberalisation in developing countries; the renewed emphasis on aid to poorer developing countries, without which trade liberalisation will not work; the need for developed-country liberalisation while retaining developing-country protectionism; and the need for more flexible international rules to allow developing-country governments to pursue selective industrial policies, especially to promote infant industries.1 Lastly, there is the pervasive fear – in the South as much as in the North – of being run over by an unstoppable Chinese export juggernaut. It is important to confront the liberalisation sceptics and industrial interventionists head on; to defend liberalisation to date, while accepting that its record is mixed; to make the case for further liberalisation; and to identify the political conditions that might make it succeed. Protectionism and industrial-policy intervention has mostly failed across the developing world: history, not just theory, should be a warning not to go down this route again.


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First, in-depth country studies by the OECD, NBER and World Bank, going back to the 1970s and 1980s, suggest strongly that countries with more liberal trade policies have more open economies and grow faster than those with more protectionist policies. These are much more reliable than superficial cross-country regression analyses (Bhagwati and Srinivasan 1999; Lal and Myint 1996). That said, even most of the latter point to large gains from trade liberalisation.2 Putting together calculations done by the World Bank and Angus Maddison, a snapshot of the developing world in the year 2000 reveals the following. There are about 25 ‘new-globalising’ developing countries (the World Bank’s term) with a total population of about 3 billion. Since 1980, this group registered massive increases in their trade-to-GDP ratios and real per-capita incomes, alongside big cuts in levels of tariff protection. In the same period, over 50 ‘less-globalised’ developing countries, with a combined population of about 1.5 billion, saw stagnant tradeto-GDP ratios, a modest increase in real per-capita incomes, alongside relatively modest cuts in average import tariffs. The – overwhelmingly Asian – new globalisers have also seen dramatic reductions in poverty and improvements in human-welfare indicators (such as adult literacy, infant mortality, life expectancy and nutritional intake). (World Bank 2002: 34, especially Table 1.1; Maddison 2003.) Second, it is not true that globalisation ‘excludes’ certain developing countries. Rather globalisation provides an enabling environment that some countries have taken advantage of and others have not. New globalisers in east Asia, south Asia (first Sri Lanka, and now India), central and eastern Europe, Latin America (notably Chile) and elsewhere have reaped the benefits through more market-oriented policies and institutions. They are narrowing the wealth gap with the West. This is why global poverty has been massively reduced (especially as a percentage of world population, and even in absolute numbers, despite a growing world population). Political disorder, macroeconomic instability, insecure property rights, rampant government intervention and high external protection have kept other countries ‘non-globalised’ and thereby retarded growth and development. Most of these countries are cursed with dysfunctional or failed states run by venal, thuggish, even murderous elites. None of this is ‘caused’ by globalisation. (Wolf 2004: ch 9; Henderson 2004b: 52–58) Third, NGOs and developing-country governments have been clamouring for one-sided liberalisation in the Doha round. Their interpretation of ‘development’ in the Doha Development Agenda is that it behoves developed countries to liberalise in areas that are protected against labourintensive developing-country exports. But developing countries should not reciprocate with their own liberalisation. What Oxfam and others fail to

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say is that developing countries’ own protectionist policies harm them even more than developed-country barriers. The World Bank estimates that 80 per cent of the developing-country gain from worldwide agricultural liberalisation would come from developing countries’ liberalisation of their highly protected agricultural markets. It is unskilled rural labour – the poorest of the poor – who would gain most as such liberalisation would reduce the anti-agricultural bias in domestic economies. (Oxfam 2002; Ingco and Nash 2004.) Fourth, the historical record is not kind to ‘hard’ industrial policies of the infant-industry variety. Infant-industry success in nineteenth-century USA and Germany is contested. In east Asia, its record is mixed at best in Japan, South Korea and Taiwan; non-existent in free-trade Hong Kong and Singapore; and failed in southeast Asia (for example, national car policies in Malaysia and Indonesia). In northeast Asia, there is scant evidence to show that protection of infants actually led to higher social rates of return and higher overall productivity growth (World Bank 1993; Little 1999). Southeast Asia’s conspicuous success is in FDI-led electronics exports – a result of drastically lower tariffs and an open door to inward investment. China, like southeast Asia, has grown fast through FDI-led exports, not infant-industry protection. Arguably, other factors – political and macroeconomic stability, competitive exchange rates, private property rights, openness to the world economy, education and infrastructure – were much more important to east-Asian success than ‘picking winners’. Finally, infant-industry protection in Latin America, south Asia and Africa has been a disaster not dissimilar to industrial planning in ex-command economies. Protected infants sooner or later ran into severe problems; and governments continued to subsidise and protect perpetual children. Such incestuous government-business links provided a fertile breeding ground for corruption. Besides, most developing-country markets are too small to support infant-industry promotion; and their states are too weak, incompetent and corrupt to efficiently administer the complex instruments required. Protectionism in the World: Unfinished Business Protectionism remains high around the world, even after six decades of liberalisation, first in developed countries and then in developing countries. There are pockets of developed-country protection – agricultural subsidies, peak tariffs and tariff escalation in agriculture and manufactures, anti-dumping duties, assorted regulatory barriers such as onerous product standards, and high restrictions on the cross-border movement of workers – that continue to damage developing-country growth prospects.


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But developing countries’ own protection on almost all these counts is much higher and more damaging. Average applied tariffs in developing countries are more than double those in developed countries, with much higher bound rates in the WTO (Table 5.1). South Asia, sub-Saharan Africa, the Middle East and north Africa have higher average tariffs than east Asia, Latin America and east Europe (Table 5.2). Bound and applied tariffs in agriculture are significantly higher than they are in manufactures. Developing countries have become bigger users of anti-dumping actions Table 5.1

Bound and applied tariff rates Bound

All goods Agriculture Manufactures

Applied

Developed economies

Developing economies

Developed economies

Developing economies

17.8 24.3 16.7

43.6 60.6 32.5

5.5 9.5 4.8

11.8 16.3 11.0

Note: Developed and developing economies by World Bank Definitions. Developed economies: category 3–4 (2002–2004) and developing economies: category 1–2 (1998–2004). Source: World Bank Trade Databases: http://siteresources.worldbank.org/INTRES/ Resources/469232-1107449512766/tar2005a.xls.

Table 5.2

Tariff rates in different regions

Country group or region

Applied

Bound

Agriculture Manufactures (applied) (applied)

High income economies Latin America and the Caribbean East Asia and Pacific South Asia Europe and Central Asia Middle East and North Africa Sub-Saharan Africa

5.5 9.9

17.8 41.2

10.6 14.9

3.3 9.0

10.5 17.8 7.8 18.0

29.5 66.5 13.2 34.6

16.8 19.1 14.0 22.5

10.5 17.2 6.7 16.9

13.4

61.5

17.2

12.9

Notes: The numbers are unweighted averages in per cent from 1998–2004. Regional definitions by the World Bank: http://web.worldbank.org/WBSITE/EXTERNAL/DAT ASTATISTICS/0,,contentMDK:20421402~pagePK:64133150~piPK:64133175~theSiteP K:239419,00.html. Source: World Bank trade databases: http://siteresources.worldbank.org/INTRES/ Resources/469232-1107449512766/tar2005a.xls.

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than developed countries (Figure 5.1). A few developing countries – notably India – have become much more frequent users of anti-dumping actions (Figure 5.2). Developing countries, with the exception of countries in transition and those that have recently acceded to the WTO, have far fewer multilateral commitments than developed countries in services (Figure 5.3). There has been a general increase in the use of technical, food-safety and other standards that affect trade, as indicated by the number of measures notified under the WTO’s TBT and SPS agreements. This is one – admittedly very rough – indication of regulatory barriers to trade. Developed countries account for over half of TBT and SPS measures notified, but what is also striking is the increasing number of measures notified by developing countries (Figures 5.4 and 5.5). Thus there is much unfinished business in terms of liberalising trade, capital flows and the cross-border movement of labour in the developing world. That said, external liberalisation is no panacea. In the short run, trade liberalisation reduces the anti-import, anti-export bias of trade taxes. That is the prelude to dynamic gains – including those from trade-related inward investment – that result in productivity improvements and growth. Capturing these gains, however, depends on additional factors: initial conditions for reform, including a country’s factor endowments and historical legacy; complementary domestic market-based reforms; and the state of and improvement in domestic institutions. The connection between opening to the world economy and domestic economic and institutional 200 150 100 50 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

High income countries

Developing countries

Note: Anti-dumping measures: by reporting Member. Classification of countries by World Bank Definitions. Source:

WTO, http://www.wto.org/english/tratop_e/adp_e/adp_stattab7_e.xls.

Figure 5.1

Anti-dumping measures


125

70 60 50 40 30 20 10 0

1995

1996

India

Note:

1998

United States

1999

2000

2001

European Community

2002

2003

Argentina

2004

2005

South Africa

Anti-dumping measures: by reporting Member.

Source:

WTO, http://www.wto.org/english/tratop_e/adp_e/adp_stattab7_e.xls.

Figure 5.2

120 100 80 60 40 20 0

1997

Most frequent users of anti-dumping measures

Average number of sub-sectors committed per Member 106 105 103

53

42

52

24

LeastDeveloping Transition Developing Developed Accessions developed & transition economies economies economies since 1995 economies economies only only

All members

Source: WTO (Staff Working Paper ERSD-2005-01) http://www.wto.org/english/res_e/ reser_e/ersd200501_e.doc.

Figure 5.3

Distribution of GATS commitments across groups of Members, March 2005

reform is particularly important: it is this that explains much of variation in economic performance in the developing world. This is not a new insight: David Hume and Adam Smith strongly linked free trade (broadly defined to include cross-border flows of capital and people) to domestic institutions and growth, all on the canvas of the long-run progress of commercial society. But this also begs difficult political questions. In essence, successful external opening depends crucially on domestic politics and

126

The law and economics of globalisation Developing countries Non-OECD developed countries OECD countries

600

500

400

300

200

100

0 1995

1996

1997

1998

1999

2000

2001

Source: OECD: COM/TD/AGR/WP(2002)21/FINAL, http://www.olis.oecd.org/ olis/2002doc.nsf/43bb6130e5e86e5fc12569fa005d004c/7b8815fac33fe88ec1256bed002e5cb7/ $FILE/JT00129244.PDF.

Figure 5.4

Number of notified SPS measures, 1995–2001

800 700

Developing countries Non-OECD developed countries OECD countries

600 500 400 300 200 100 0

1995

1996

1997

1998

1999

2000

2001

Source: OECD: COM/TD/AGR/WP(2002)70/FINAL, http://www.olis.oecd.org/ olis/2002doc.nsf/43bb6130e5e86e5fc12569fa005d004c/baacb7d0229000f9c1256cdf00418c0f/ $FILE/JT00140246.PDF.

Figure 5.5 Number of notified TBT measures, 1995–2001


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institutional capacity. Here there are very large and arguably increasing differences within the developing world.

TRADE-POLICY REFORMS: THE RECENT EXPERIENCE, WITH COUNTRY EXAMPLES Trade liberalisation has several definitions. Trade economists speak of moving to ‘neutrality’ of government intervention as between tradable and non-tradable sectors of the economy. They also speak of ‘getting prices right’ by aligning domestic prices with world prices of tradable goods. More broadly conceived, free (or free-ish) trade means the freedom to engage in international transactions, without discrimination. (Henderson 1992: 635) This exists nowhere – not even in Hong Kong, which maintains tight restrictions on immigration, though it is fully open to trade in goods and capital flows, and largely open to trade in services. If non-discrimination is the relevant criterion, all countries are still far from free trade, indeed more so than was the case in the late nineteenth century. Trade-and-investment liberalisation in the old OECD countries has taken place in small steps since the 1980s – not surprising, since these are largely open economies in which the bulk of liberalisation was done in the 1950s and 1960s. The exceptions are Australia and New Zealand. After over a century of protection, both opened decisively to the world economy in the 1980s. Developing countries have seen the most pronounced liberalisation trend in recent decades.3 Cross-border trade and capital flows – though not of people – have become freer. There is less discrimination between domestic and international transactions. Domestic prices of tradable goods and services are closer to world prices (though less the case in services than in goods). In terms of measures undertaken: import and export quotas, licenses, state trading monopolies and other non-tariff barriers have been drastically reduced. Tariffs have been simplified and reduced. So have foreign-exchange controls, with unified exchange rates and much greater currency convertibility, especially on current-account transactions. Foreign direct investment has been liberalised, with fewer restrictions on entry, ownership, establishment and operation in the domestic economy. And services sectors have been opened to international competition through FDI liberalisation, privatisation and domestic deregulation. Overall, trade and FDI in manufactured goods has been liberalised most; trade and FDI in services was liberalised later, and to a much lesser extent; and trade liberalisation in agriculture has lagged behind. Lastly, trade and FDI liberalisation has taken place in the context of wide-ranging macro

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35.0 30.0

28.7

29.6

27.7

Per cent

25.0 20.0

16.6

15.0

14.4 10.9

10.0 5.0 0.0 1981

1985

1990

1995

2000

2005

Source: World Bank trade databases: http://siteresources.worldbank.org/INTRES/ Resources/tar2005.xls.

Figure 5.6

Average applied tariff rates in developing countries, 1981–2005 (unweighted in %)

and microeconomic market-based reforms – roughly the ‘stabilisation and liberalisation’ package of the Washington Consensus, as described by John Williamson (Williamson 1993). Cumulatively, this has been a veritable policy revolution in developing countries and countries in transition. Before the 1980s, the 80 per cent of the world’s population who live outside the West lived overwhelmingly in countries with high levels of external protection, in addition to pervasive government intervention at home. By the mid 1990s, most of these people lived in much more open economies, in terms of both domestic and international commerce. Average applied tariffs in developing countries declined from 30 per cent in 1985 to 11 per cent in 2005 (Figure 5.6). Core non-tariff barriers declined correspondingly in all developing-country regions (Table 5.3). The bulk of regulatory changes on inward investment have been more favourable to FDI (Table 5.4). There has even been a trend in favour of capital-account liberalisation: 70 per cent of the developing countries in the IMF maintain capital-account restrictions today, compared with 85 per cent in the early 1990s (Figure 5.7). This liberalisation trend started in Japan in the 1950s, and then South Korea and Taiwan in the 1960s, at a time when most developing countries were tightening regimes of import-substitution and other forms of state intervention. The northeast-Asian Tigers promoted exports through selective liberalisation, while retaining considerable import protection and restrictions on inward investment. Later they gradually liberalised imports and FDI. Hong Kong returned to tariff-free trade and a fully


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Table 5.3 Frequency of NTBs in developing countries, 1989–2000 (per cent) Region East Asia and the Pacific Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

1989–1994

1995–1998

2000

30.1 18.3

16.3 8.0

5.5 15.3

43.8 57.0 26.0

16.6 58.3 10.4

8.5 13.3 2.3

Note: Figures are regional averages of percentage of tariff lines subject to core NTBs, including all types of quantity restrictions and price administration or control as well as monopolistic trading channels. Sources: For 1989–94 and 1995–98: IMF, http://www.imf.org/external/np/pp/ eng/2005/021505.pdf, citing B. Hoekman, ‘Economic Development and the WTO after Doha’, World Bank Policy Research Working Paper No. 2851, Washington, DC, World Bank, June 2002; for 2000: Cordell Institute, http://www.cordellhullinstitute.org/TPA/ Volume%207%20(2005)/Vol%207,%20No.%202%20-%20Thomas%20Dalsgaard%20on%20 Trade%20Reform%20&%20Revenue%20Loss.pdf, citing World Bank, ‘Global Monitoring Report 2004, Washington, DC, World Bank, 2004, Table 4.6.

open door to investment after the war. Singapore followed, though after a brief flirtation with protection (when part of the Malaysian federation). The other southeast-Asian Tigers (Malaysia, Thailand, Indonesia and the Philippines) liberalised significantly, on both trade and FDI, from the 1970s. The countries of Indochina started gradual and halting marketbased reforms in the 1980s. Vietnam accelerated trade-and-investment liberalisation in the run up to its WTO accession in late 2006. China’s historic opening dates back to 1978, but major trade-andinvestment liberalisation took off from the early 1990s. Since then, China has swung from extreme protection to rather liberal trade policies, indeed very liberal by developing-country standards. The crowning point of China’s reforms was its WTO accession in 2001. Its WTO commitments are by far the strongest of any developing country in the WTO. In south Asia, Sri Lanka pioneered external liberalisation in the late 1970s. India’s retreat from the ‘licence raj’ – its equivalent of Soviet-style central planning – began half-heartedly in the 1980s; but its decisive opening to the world economy dates back to 1991. Pakistan followed in the late 1990s. In Latin America, Chile pioneered radical external liberalisation in the 1970s. Other Latin American countries followed in the 1980s (notably Mexico) and 1990s (notably Brazil, Argentina and Peru). African liberalisation was slow in the 1980s and faster in the 1990s. South Africa had

130

Source:

99 1 24 – 63 1 12 – 17 – 8 – 26 1 –

108 2 17 1 79 1 22 – 14 – 4 – 39 1 –

106 6 22 2 62 3 12 – 18 2 4 – 28 1 –

UNCTAD, Reference Thomas Pollan (Economic Affairs Officer).

77 – 11 – 49 – 9 – 9 – 3 – 27 – 1

98 16 25 3 58 10 15 2 14 1 4 – 25 7 –

134 16 36 6 87 5 14 – 30 4 5 – 33 1 5

136 9 20 4 109 3 23 1 13 2 18 – 52 – 3

130 9 27 5 78 2 16 – 17 2 7 – 37 – 1

147 3 29 – 105 2 13 – 29 – 24 1 38 1 1

193 14 38 3 127 10 25 3 18 3 26 2 58 2 –

234 12 54 2 144 9 21 6 15 2 34 1 74 – –

218 24 45 3 139 20 43 2 16 11 35 4 44 3 1

234 36 54 6 144 27 46 11 26 9 34 1 37 6 1

164 41 40 4 92 30 42 11 7 14 15 1 28 4 –

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

National regulatory changes on FDI, 1992–2005, by region

More favourable Less favourable Developed countries More favourable Less favourable Developing More favourable economies Less favourable Africa More favourable Less favourable Latin America and More favourable the Caribbean Less favourable West Asia More favourable Less favourable South, East and More favourable South-east Asia Less favourable Oceania More favourable

World

Table 5.4


131

90

85 Developing countries 80

75 All countries 70

65

60

55 1980

82

84

86

88

90

92

94

96

98

2000

Note: (a) Based on a one (controlled) or zero (not controlled) classification (covering all capital account transactions), as provided by the AREAER. There was a definitional change from 1997 to 1998. Source: IMF Evolution report The IMF’s Approach to Capital Account Liberalization (2005), http://www.imf.org/external/np/ieo/2005/cal/eng/report.pdf; IMF, Annual Report on Exchange Arrangements and Exchange Restrictions (AREAR).

Figure 5.7

Countries with capital controlsa (per cent of total IMF membership)

a big opening of the economy in the run up to and after the end of apartheid. The countries of east-central Europe and the Baltic states had a ‘big bang’ transition from the Plan to the Market after 1989, which included massive liberalisation of trade and capital flows. This was less the case, and certainly more erratic, in Russia, other parts of the ex-Soviet Union and southeastern Europe. However, liberalisation has recently accelerated in some of these countries, for example, Romania, Bulgaria, Georgia and parts of the ex-Yugoslavia.

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MULTI-TRACK TRADE POLICY One way of cutting into trade-policy reform is to look at it on several tracks. Some reforms are carried out unilaterally; others reciprocally through (bilateral, regional, multilateral) trade negotiations, or in agreements with donors. Most developing countries now do trade policy on all these tracks concurrently, though the relative balance differs from country to country. What follows is a summary of the main features of ‘multi-track’ trade policy, especially in developing countries. It covers the WTO, PTAs and unilateral liberalisation, especially in Asia. Foreign aid has also been an important factor in trade-policy reforms – in some countries more than in others. That is also examined in this section. Unilateral Liberalisation I trust the government . . . will not resume the policy which they and we have found most inconvenient, namely the haggling with foreign countries about reciprocal concessions, instead of taking that independent course which we believe to be conducive to our own interests . . . let us trust that our example, with the proof of practical benefits we derive from it, will at no remote period insure the adoption of the principles on which we have acted. (Sir Robert Peel, announcing the repeal of the Corn Laws, House of Commons, 1846) Liberalise first, negotiate later. (Mart Laar, former prime minister of Estonia)

Compelling political and economic arguments favour unilateral liberalisation, with governments freeing up international trade and flows of capital and labour independently, not in the first instance via international negotiations. As any student of trade economics knows, welfare gains result directly from import liberalisation, which replaces comparatively costly domestic production and reallocates resources more efficiently, and spurs capital accumulation, economies of scale as well as longer-run dynamic gains such as the transfer of technology and skills.4 Similar and related arguments apply to the liberalisation of inward investment and the cross-border movement of people. Such gains come quicker through own, unconditional liberalisation than through protracted, politicised and bureaucratically cumbersome international negotiations. This Nike strategy (‘Just Do It!’) can make political sense too. Rather than relying on one-size-fits-all international blueprints, governments have the flexibility to initiate policies and emulate better practice abroad in experimental, trial-and-error fashion, tailored to specific local conditions. In David Landes’ words, it is ‘initiated from below


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and diffused by example.’ This was the preferred method of the classical economists from Smith to Marshall, and of the titans of mid-Victorian British politics (Sally 1998). In twentieth and twenty-first century conditions of democratic politics and vigorous interest-group lobbying, unilateral liberalisation is of course a much more difficult proposition than it was in the nineteenth century. But observers often forget that the recent trade-policy revolution outside the West has come more ‘from below’ than ‘from above’. The World Bank estimates that, between 1983 and 2003, about 65 per cent of developingcountry tariff liberalisation (a 21 per cent cut in average weighted tariffs) has come about unilaterally, with 25 per cent coming from the Uruguay Round Agreements and only 10 per cent from PTAs (Figure 5.8). True, many governments liberalised reluctantly as part of IMF and World Bank structural adjustment programmes. But the strongest liberalisers have been unilateral liberalisers, going ahead under their own steam without the need for much external pressure. Prominent among them are the east-Asian countries, now led by China, as well as Chile, Mexico, the eastEuropean countries, Australia, New Zealand and South Africa. Nearly all of India’s post-1991 liberalisation has been done unilaterally.

Multilateral agreements 25% Autonomous liberalisation 66%

Regional agreements 10% Source: World Bank, http://siteresources.worldbank.org/INTGEP2005/Resources/ GEP107053_Ch02.pdf.

Figure 5.8

Share of total reduction, by type of liberalisation, 1983–2003

134


20 18 16 14 12 10 8 6 4 2

19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00

0

China Philippines

Indonesia Singapore

Korea Thailand

Malaysia Vietnam

Note: The diagram shows tariff revenue as a share of import value over time. Source: Ando and Kimura (2005), cited in R. Baldwin ‘Managing the Noodle Bowl: The Fragility of East-Asian Regionalism’, 2006, http://www.sussex.ac.uk/Units/caris/CARIS/T. Carpenter-R.Baldwin-Sussex%20RTA%20Conference-Manage_CEPR_DP.pdf.

Figure 5.9

Unilateral tariff cutting in east Asia, 1980–2001

Unilateral liberalisation has been particularly strong in east Asia (see Figures 5.9 and 5.10 for unilateral tariff-cutting in selected countries). The bulk of trade-and-investment liberalisation by the first and secondgeneration Tigers of northeast and southeast Asia was done unilaterally. In the 1980s, the old ASEAN countries reduced import and inwardinvestment barriers simultaneously in order to attract Japanese manufacturing multinational enterprises (which relied on imports of capital goods and components for labour-intensive local processing and assembly of goods for export). This is how they inserted themselves into regional and global manufacturing supply chains, first in electronics and then spreading to other industries (for example, sport footwear, televisions and radio receivers, office equipment, electrical machinery, power and machine tools, cameras and watches, and printing and publishing). In the 1990s, China also undertook unilateral and simultaneous trade and inward investment liberalisation, and thereby inserted itself as the cheap-labour, final-assembly stage in these expanding supply chains. This in turn triggered additional unilateral liberalisation by the southeast-Asian countries. More openness to trade and FDI allowed the more advanced ASEAN

Global trade policy in the new century 160

135 149

150

2005

2007

140 140 113

120 99 100

89

80 60 40 20 0 1985

1990

1995

2000

Note: Countries having signed GATT 1985–1990 and countries having entered the WTO 1995–2007. Source: WTO http://www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm; http:// www.wto.org/english/thewto_e/gattmem_e.htm.

Figure 5.10

WTO members; countries that had signed the GATT

countries to move up to higher-value production of parts and components in ‘Factory Asia’, while more labour-intensive production migrated to China, and more recently to Vietnam. To repeat: these measures were not brought about by GATT/WTO, AFTA or other FTA agreements; rather they were unilateral responses to market conditions, resulting in market-led regional and global integration (Baldwin 2006a and 2006b and Athukorala 2006). China’s external liberalisation now matters most, for it is the biggest the world has ever seen, with the biggest spillover effect in Asia. Most of this was done unilaterally, before WTO accession. China’s WTO commitments, and its pragmatic, businesslike and constructive participation in the WTO since accession, are more the consequence than the cause of its sweeping unilateral reforms. Indeed, China is in many ways today what Britain was in the second half of the nineteenth century: the unilateral engine of freer trade. True, China is far from being the top dog Britain was in the nineteenth century. But it is now the most powerful signal-transmitter in the Asian neighbourhood. China’s opening not only spurred southeast-Asian liberalisation pre-Asian crisis; it probably helped to prevent liberalisation reversal post-Asian crisis. It has also encouraged

136


east-Asian countries to further liberalise at the margin post-Asian crisis – for fear of losing trade and FDI to China. Not least, China has probably had a knock-on effect on Indian opening to the world economy. India has recently accelerated its liberalisation of tariffs, and eased FDI restrictions in some services sectors. This has occurred outside trade negotiations, as was the case with previous Indian trade-and-investment liberalisation since 1991. Would this have happened, or happened as fast, if China had not concentrated minds? Probably not. For other east and south-Asian countries to take advantage of the opportunities offered by China’s global integration, and overcome moreexposed weaknesses caused by protectionist policies and weak institutions, there has to be further liberalisation and regulatory reform. This is less likely to come about through the WTO, PTAs and regional institutions such as ASEAN and SAFTA, and more likely to result from unilateral measures by individual governments in response to internal and external conditions. That is the best prospect for east-Asian countries to integrate themselves better into, and reap the benefits from, expanding regional and global supply chains. And that is the best prospect for south-Asian countries to insert themselves into these supply chains. That is not to say that China-induced unilateral liberalisation is a total solution. It is unlikely to induce further external liberalisation in the developed world, and least of all in the USA, EU and Japan. In the developing world, its results will inevitably be patchy and messy. For instance, unilateral liberalisation in east Asia, while strong in fragmentation-based manufacturing products that feature in global supply chains, has been weaker in other areas of manufacturing, very uneven in services and especially weak in agriculture. More generally, unilateral measures do not lock in liberalisation against future backtracking. Above all, they do not provide fair, stable and predictable rules for international commerce. On its own, unilateral liberalisation cannot slay protectionist dragons and solve international commercial conflicts. That leaves room for reciprocal negotiations and international agreements, that is, for the WTO and PTAs. Multilateral Liberalisation The great political virtue of multilateralism, far exceeding in importance its economic virtues, is that it makes it economically possible for most countries, even if small, poor and weak, to live in freedom and with chances of prosperity without having to come to special terms with some Great Power. (Jacob Viner) In recent years, the impression has often been given of a vehicle with a proliferation of backseat drivers, each seeking a different destination, with no map and no intention of asking the way. (The Sutherland Report)


137

Given the realities of modern politics – interest-group lobbying for protection, ingrained mercantilist thinking, the perception that liberalisation hurts the poor and vulnerable – unilateral liberalisation is often difficult to achieve in practice. The rationale of ‘multilateralised reciprocity’ is that GATT/WTO negotiations help to contain protectionist interests and mobilise exporting interests; and multilateral agreements provide fair, non-discriminatory rules for all. Perhaps the greatest utility of the WTO is that it provides a framework of rules to assist (mainly developing-country) governments that have strategically chosen to take their national economies in a market-oriented, globally-integrated direction. The accessions of China and Vietnam are textbook examples of how the WTO should work. That said, the standard raison ďêtre for multilateral rules-based trade liberalisation was easier said in the old GATT than done in the WTO. In many ways the WTO is the victim of its own success; of the successful conclusion of the Uruguay round and the huge transition from the GATT to the WTO.5 Multilateral liberalisation was successful during the GATT when the latter had a relatively slimline agenda (basically covering border instruments such as tariffs and quotas), club-like decision-making dominated by a handful of developed countries (especially the USA and EU), and the glue of Cold War alliance politics. It has proved spectacularly unsuccessful in the WTO. First, a much expanded post-Uruguay-Round agenda has broadened sectoral coverage and gone much deeper into politically-sensitive domestic regulation. The latter, compared with the GATT agenda, is technically more complicated, less amenable to the reciprocal exchange of concessions, administratively more burdensome and politically much more controversial. Second, hyperinflation of the membership (Figure 5.11) – to 150 at the last count – has almost crippled decision-making. The WTO has become much more politicised, buffeted by external criticism and with deep fissures among member governments. Windy rhetoric, adversarial point-scoring, political grandstanding and procedural nit-picking seem to have substituted for serious decision making. These are all symptoms of the ‘UN-isation’ of the WTO. And third, the unifying glue of the Cold War has dissolved. All the WTO’s structural problems have played into the failure of the Doha round (as at the time of writing). Six years of negotiations have delivered sound, fury and sundry political theatre, but next to nothing in terms of concrete results. This leaves the WTO in very serious trouble. The widespread perception is that multilateral liberalisation is going nowhere; there will be greater temptation to flout multilateral rules; many more sensitive cases will be taken to dispute settlement, which will come under

138


No. of RTAs

200 150 100 50

19

48 19 52 19 56 19 60 19 64 19 68 19 72 19 76 19 80 19 84 19 88 19 92 19 96 20 00 20 04

0

Year Source:

WTO, http://www.wto.org/english/tratop_e/region_e/summary_e.xls.

Figure 5.11

RTAs in force by date of entry into force

greater political strain; action is switching further and decisively to PTAs; and the world trading system is becoming shaped more by a messy, discriminatory patchwork of PTAs driven by power politics than by fair and balanced multilateral rules. The WTO is in seemingly inexorable drift in all the wrong directions – towards the easy politics of UN-style decision making and a World Bank-style aid agency for developing-country basket cases, and ever farther away from the hard politics of liberalisation and the rules that underpin it. To get the WTO out of its rut, its members need to do three things: restore focus on a core market-access and rules agenda, that is, progressive liberalisation of trade barriers, underpinned by transparent, nondiscriminatory rules; revive effective decision making; and, not least, scale back ambitions and expectations. First, a post-Doha agenda should shift emphasis from liberalisation to rules. The Doha round has shown that substantial multilateral liberalisation will be elusive in the future. That still leaves other liberalising avenues, notably PTAs and unilateral measures. More important than further multilateral liberalisation is safeguarding multilateral rules for open and stable international commerce. These rules, on tariff and non-tariff measures, at and behind the border, are indispensable. But they are under threat as a result of WTO malfunction. They can only be safeguarded and updated in a multilateral forum, not unilaterally, bilaterally or in regional clubs. Developed countries and advanced developing countries need them to guarantee access to each other’s markets. Poorer and weaker developing countries would be squeezed out and further marginalised without them. Given these common stakes, and once the dust of the Doha round


139

has settled, rules issues should take priority over further multilateral liberalisation.6 Second, nothing of substance can be achieved without mending the WTO’s broken decision-making mechanism. This does not depend fundamentally on reforming formal procedures; rather it depends on intergovernmental political will and informal decision making. This requires recognition of hard-boiled realities outside Geneva. About 50 countries (30 if the EU is counted as one) account for well over 80 per cent of international trade and an even greater share of FDI.7 This comprises the OECD plus about 20 developing countries that have been globalising rapidly and successfully (most of them in Asia, some in Latin America, and very few in Africa). These are the ones with workable governments, sufficient appreciation of own interests, negotiating capacity and bargaining power. They need to strike the key liberalising and rule-making deals. They must be active individually and in multi-country coalitions, ranging from informal, broad-based coalitions to smaller, issue-based ones such as the Cairns Group and the G20 on agriculture, and ‘Friends Groups’ on other issues. Within this outer core, there is an inner core of ‘big beasts’: the USA and EU, of course, but now joined by the increasingly influential developing-country majors, India, China and Brazil. Japan should be there too, but it punches well below its weight in the WTO. The old understanding of an EU-US duopoly driving the GATT/WTO enterprise no longer works. Especially important for the WTO’s future will be clearer, up-front US leadership, and constructive participation by China, India, Brazil and perhaps Japan. Of the developing-country majors, China’s role will be most important. Ultimately, in the absence of leadership by the Big Beasts, nothing in the WTO will move. These inner and outer cores must concentrate primarily on core market access in agriculture, non-agricultural goods and services, and related core rules (including anti-dumping, safeguards, subsidies, regional trade agreements and dispute settlement). New issues (such as the Singapore issues and trade-and-environment) should be dealt with plurilaterally through opt-ins or opt-outs. This would give developing countries the cushion to join negotiations only if and when they feel ready to do so. That leaves about 100 poorer and weaker developing countries – two-thirds of the membership. These countries must of course be consulted and will exercise influence through the African, LDC, ACP, G90 and other ‘common-characteristic’ groupings. But the plain fact is that they are very marginally involved in the world economy, and most have chronic misgovernment that often descends into ethnic strife, civil war and state collapse. Negotiating resources are also scarce; and there is little ability

140


and political will to implement WTO agreements. Hence these countries are unable to play more than a secondary and reactive role in the WTO. As is abundantly clear in the Doha round, they demand entitlements (such as maintenance of their tariff preferences and increased aid) but are not in a position to make credible negotiating proposals of their own. Providing these countries do not block negotiations, they should be accorded generous ‘special and differential treatment’ – WTO terminology for lower-level developing-country obligations on rules and market access. Through Most Favoured Nation status, they should have rights to whatever liberalisation is negotiated by others. At the same time, they should not be obliged to reciprocate with own liberalisation, nor should they be under pressure to sign up to other new obligations if they feel unready to do so. Third, given its huge political complications, the WTO must adapt to a more modest future. Even with the right dose of realism, there are narrower limits and diminishing returns to GATT/WTO-style multilateralism – for the reasons discussed earlier. Post-Doha, market-access and rulemaking negotiations should be more cautious and incremental; and trade rounds should probably become a thing of the past. There should be more emphasis on the WTO as an OECD-type forum to share information and ideas, and to improve transparency through mutual policy surveillance, especially for developing countries. Finally, in the absence of a powerful negotiating mechanism, dispute settlement should be exercised with judicial restraint and not extended further. It would be politically illegitimate and counter-productive to advance multilateralism through international public law without an underlying international political consensus. That is just the sort of ‘global-governance’ hubris to avoid. Bilateral and Regional Liberalisation We will work with can do, not won’t do, countries. (Robert Zoellick)

By July 2005, 330 PTAs had been notified to the GATT/WTO – 206 of them since the establishment of the WTO in 1995. Over 180 are currently in force, with many more expected to be operational soon. Of the PTAs in force, 84 per cent are free trade agreements (FTAs), with customs unions (CUs) and partial-scope agreements making up the rest. Bilateral (country-to-country) agreements account for over 75 per cent of PTAs in force and almost 90 per cent of those under negotiation. PTA activity has increased pace since 1999/2000, and even more so since the launch of the Doha round (WTO 2006; Crawford and Fiorentino 2005) (Figure 5.12). (See Figures 5.13 and 5.14 on PTA patterns in east Asia, Africa and the Americas.)

141 Vietnam Singapore Brunei

Malaysia

Indonesia

Philippines

Japan

The map shows FTAs signed or under negotiation in January 2006. East Asia is defined here as the ten ASEANs, China, Japan and Korea.

Laos

Korea

Figure 5.12

Noodle bowl syndrome in east Asia

Source: Richard Baldwin 2006: http://www.sussex.ac.uk/Units/caris/CARIS/T.Carpenter-R.Baldwin-Sussex%20RTA%20ConferenceManage_CEPR_DP.pdf.

Notes:

Thailand

Cambodia

Myanmar

HK

China

142

Guinea

Mali Senegal

Niger Burkina Faso

Cape Verde Gambia

Chad

CEMAC

SACU

Tanzania*

EAC

Angola

Kenya* Uganda*

Djibouti Ethiopia Eritrea Sudan

Somalia

IOC

Reunion

COMESA

IGAD

Mauritius* Malawi* Seychelles* Zambia* Comoros* Zimbabwe* Madagascar*

DR Congo

Egypt

Nile River Basin

Burundi* Rwanda*

Sâo Tomé & Principe Cameroon Central African Rep. Gabon Equat. Guinea Rep. Congo

ECCAS

South Africa CILSS Namibia* Botswana Swaziland* Arab Maghreb Union Lesotho Cross Border Initiative Economic and Monetary Community of Central Africa *CBI Permanent Interstate Committee on Drought Control in the Sahel Mozambique Common Market for Eastern and Southern Africa SADC East African Cooperation Economic Community of Western African Studies Inter-Governmental Authority for Government SADC: Southern African Development Community Indian Ocean Commission WAEMU: West African Economic and Monetary Union Southern African Customs Union * Indicates membership in CBI regional grouping

Mano River Union

Liberia Sierra Leone

Guinea-Bissau

Benin Togo Côte d’Ivoire

Ghana Nigeria

Algeria Libya Morocco Mauritania Tunisia

Figure 5.13

Noodle bowl syndrome in Africa

Source: World Bank (2005), World Bank Annual Report 2005: Global Economic Perspectives, Trade, Regionalism and Development Washington DC: World Bank, Chapter 2; Schiff and Winters (2003).

AMU: CBI: CEMAC: CILSS: COMESA: EAC: ECOWAS: IGAD: IOC: SACU:

WAEMU

Conseil de L’Entente

ECOWAS

AMU

143 CARICOM Trinidad &

-

Costa Rica

Panama

USA-CACM

Venezuela

Colombia

Mexico

Canada

ALADI

AC

Peru Ecuador

Chile

Bolivia

Argentina

Paraguay

MERCOSUR Uruguay

Brasil

USA-Chile

Bahamas Haiti

Figure 5.14

Noodle bowl syndrome in the Americas

Source: Inter-American Development Bank, ‘Trade and Cooperation: A Regional Public Goods Approach’, http://www.pecc.org/trade/papers/ vancouver-2002/estevadeordal.pdf.

Dominica Suriname Tobago Jamaica St. Lucia Belize St. Louis St. Kitts and Nevis Grenada Barbados Guyana St. Vincent & Grenadines Antigua & Barbuda

Dominican Republic

El Salvador Guatemala Honduras

CACM

Nicaragua

Canada-CA-4

USA

Non-reciprocal agreement CU-country

Customs union

FTAA

Reciprocal agreement CU-country

‘Second generation’ agreement

ALADI

Agreement under negotiation

‘First generation’ agreement

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Eastern Europe, Africa and Latin America have long been involved in PTA activity. East Asia, which previously relied on non-discriminatory unilateral and multilateral liberalisation, is now playing PTA catch-up, as is south Asia. All the major regional powers – China, India and Japan – are involved in Asian PTAs, as are the USA, EU, Korea, Australia, New Zealand, Hong Kong, other south-Asian countries and the ASEAN countries. Why this rush of recent PTA activity?8 Foreign-policy considerations loom large. PTAs are viewed as a means of cementing stronger political (as well as economic) links with favoured partners, for example, as a door opener to other strategic, security-related agreements. On the economic front, PTAs are a response to stalled multilateral liberalisation and a weak WTO. Indeed, they are seen as insurance policies against continuing WTO weakness: they secure preferential access to major markets; and are a means of managing and defusing trade tensions with powerful players. Not surprisingly, governments tend to present PTAs in a positive light. They are seen as part of a benign ‘competitive-liberalisation’ or ‘buildingbloc’ process. PTAs among small clubs of like-minded countries can, they argue, take liberalisation and regulatory reform farther than would be the case in a large, heterogeneous and unwieldy WTO. This can in turn stimulate multilateral liberalisation. For PTAs to make economic sense, they should have comprehensive sectoral coverage, be consistent with relevant WTO provisions (in Article XXIV GATT and Article V GATS), and preferably go beyond both WTO commitments and applied practice at home. In other words, they should involve genuine and tangible, not bogus, liberalisation. There should be strong provisions for non-border regulatory cooperation, especially to improve transparency in domestic laws and regulations in order to facilitate market access and boost competition. Rules-of-origin (ROO) requirements should be as simple, generous and harmonised as possible to minimise trade diversion and red tape.9 Strong, clean ‘WTO-plus’ PTAs should reinforce domestic economic and institutional reforms to remove market distortions and extend competition. Finally, non-preferential (MFN) tariffs should be low in order to minimise any trade diversion resulting from PTAs. Unfortunately, the above characterisation is the exception, not the rule, of PTAs in practice. The EU, the North American Free Trade Agreement (NAFTA) and the Australia-New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) are the exceptions. Most other FTAs and customs unions are weak, often falling short of WTO provisions. This is particularly true of South-South PTAs (that is, agreements between developing countries), but also holds for many North-South PTAs. These


145

tend to be driven by foreign-policy aspirations, but with justifications that are all too often vague, muddled and trivial, having little relevance to commercial realities and the economic nuts and bolts of trade agreements. This can amount to little more than symbolic copycatting of other countries’ PTA activity and otherwise empty gesture politics. In such cases economic strategy is conspicuous by its absence. The predictable results of foreign-policy-driven PTA negotiations light on economic strategy are bitty, quick-fix sectoral deals. Politically sensitive sectors in goods and services are carved out, as are crucial areas where progress in the WTO is elusive (especially disciplines on anti-dumping duties and agricultural subsidies). Little progress is usually made in tackling domestic regulatory barriers (for example, relating to investment, competition, government procurement, trade facilitation, cross-border labour movement, and food-safety and technical standards). These PTAs hardly go beyond WTO commitments, deliver little, if any, net liberalisation and pro-competitive regulatory reform, and get tied up in knots of restrictive, overlapping rules of origin. Especially for developing countries with limited negotiating capacity, resource-intensive PTA negotiations risk diverting political and bureaucratic attention from the WTO and from necessary domestic reforms. Finally, the sway of power politics can result in highly asymmetrical deals, especially when one of the negotiating parties is a major player. Latin America, Africa, the Middle East, the ex-Soviet Union now contain a hotchpotch of weak and partial PTAs. This is also the emerging picture in east and south Asia (Sally 2006c). Overlapping PTAs have different tariff schedules, rules of origin and implementation periods. This is often exacerbated by relatively high MFN tariffs and poor implementation. Restrictive rules of origin are especially troubling. EU, US and NAFTA rules of origin differ considerably from each other, and have different rules for different products (combining two or more criteria in myriad ways). Nearly all South-South PTAs have significant product-specific exemptions from uniform ROO criteria, a tendency to increasing product-specific ROO complexity, and high-cost certification procedures to determine the origin of goods. (WTO 2002; Estevadeordal and Suominen 2003). More generally, complex ROO requirements make no sense in a world where production of goods (and, increasingly, services) is fragmented, with different parts of the value chain located in different countries, and then integrated across borders through trade in components and other intermediate products. Inputs are sourced from many different countries that can supply them at lowest cost. Only then can exports be competitive. Globalisation accelerates this process, but complex ROOs

146


in several, overlapping PTAs throw a spanner in the works. Even subtle differences in rules of origin can raise business costs and divert trade and associated investment. These costs are much more onerous for small and medium-sized trading firms in developing countries than they are for large corporations in developed countries. The good news is that the global economy has become too integrated, and new intra-regional and cross-regional PTAs too porous, for the ‘new’ bilateralism and regionalism to presage a return to 1930s-style warring trade blocs. On the other hand, PTAs are probably not going to tear down the remaining protectionist barriers that matter, whether in North-South or South-South commerce. Nearly all have the hallmarks of trade-light agreements. Some might even come close to being ‘trade-free’ agreements. Consequently, PTAs will not be the driving force of regional economic integration or further integration with the global economy. On the contrary, the emerging pattern of ‘dirty’ FTAs threatens to be a force of economic disintegration – especially if the multilateral trading system weakens further. However, FTAs are a reality; they cannot be wished away; but they can be improved; and they can fit better with trade policy on unilateral and multilateral tracks. That calls for comprehensive, WTO-plus FTAs with simple, harmonised rules of origin. It is important to ‘multilateralise regionalism’, for example, by simplifying and harmonising rules of origin and tariff schedules, and (ideally) making preferences time-limited (after which they would be open to all comers on a nondiscriminatory basis). If this does not happen, ‘spaghetti bowls’ and ‘noodle bowls’ threaten to undermine regional and global production networks (Baldwin, 2006b). The Role of Donors10 Foreign aid, with conditions attached by the IMF, World Bank and other donors, has clearly played a big part in driving Washington Consensustype reforms in many developing countries. This has gone way beyond developing countries’ (relatively weak) liberalising commitments in the WTO and FTAs. Arguably, unilateral liberalisation has not been truly ‘unilateral’ when it has depended on donor policy preferences and aid with strings attached. The record of IMF stabilisation packages and World Bank structural adjustment packages has been mixed at best, and certainly disappointing compared with optimistic expectations in the 1980s (World Bank 1998a and 1998b). Often donor-driven reforms have proceeded in stops and starts, with reversals en route. Projected growth and poverty-alleviation effects have not materialised. The politics of aid is


147

even more dubious than its economics. ‘Conditionality’ is empty rhetoric when self-serving interests at both ends of the pipeline ensure that aid continues to flow, even when promised reforms are not delivered. And the perception that Western donors are imposing reforms on otherwise reluctant countries is hardly sustainable: local ‘ownership’ is lacking (to borrow aid jargon), and it invites a backlash and reform-reversal at home (Bauer 2000). The bottom line is that countries that have seen strong, sustained, unilateral liberalising reforms are those whose governments have driven reforms (‘from below’, as it were) rather than having them imposed by donors (‘from above’). Aid at its best has smoothed short-term adjustments; and donor conditionality has provided a ‘good housekeeping seal of approval’ – an international signal of reform credibility – more than anything else. In these countries (most in east Asia and eastern Europe, and a few in Latin America), aid has not been central to reform success. Where there has been more reliance on aid and donor conditionality, reforms have a far worse record. This applies to Africa in particular. Seen in this light, the new conventional wisdom on aid is wrong-headed and dangerous. The UN Millennium Project and the Africa Commission Report both propose to double or even triple aid between 2005 and 2015, particularly with Africa in mind. The UN idea – or rather, Jeffrey Sachs’s idea – is a new version of the old principle of aid: poor countries lack resources to invest, and donors have to fill this ‘financing gap’ with a ‘big push’ of investment if growth is ever to occur. (UN Millennium Project 2005 and Sachs 2005). A sudden and massive increase of aid threatens to repeat past mistakes and provide extra incentives to delay and derail, not promote, market-based reforms. Available evidence shows that aid does not improve the productivity of investment; it diverts funds to stimulate government consumption and current spending; it has a negative impact on domestic savings; and, by expanding the role of already dysfunctional governments, it breeds waste and corruption. In short, this approach is misguided top-down intervention (Easterly 2006). A softer version of aid optimism, associated with the World Bank, assumes that countries are poor because of bad policy choices and weak institutions, and that aid can lock in already-accomplished reforms and facilitate additional reforms (World Bank 1998b). This view is politically naïve, though a convenient fiction for elites who profit from the aid business. The main objection is that aid has not and probably will not be a good midwife to market-based reforms. On the contrary, aid is given more often than not to support failed policies; and there is a high incidence of repeat lending to governments without a good track record of marketbased reforms.

148


A particular version of the aid-to-reform idea is the ‘aid-for-trade’ scheme that is now discussed in the Doha round. No one has yet defined its modus operandi. Is it a structural adjustment programme, an unemployment insurance programme, a budget support programme, an industrial promotion programme, or something else? Whatever the purpose, the history of aid warns us of the perils of such a scheme. A basic problem with the idea is that countries should be protected from the market-based structural adjustment that trade liberalisation entails. That is in direct conflict with the reality of development. Preliminary Summary Strong trade-and-FDI-liberalising countries have relied overwhelmingly on unilateral opening. This has sometimes translated into stronger multilateral commitments and more flexible, pragmatic participation in the WTO. China and Vietnam are the textbook examples. But further substantial liberalisation through trade negotiations, whether in the WTO or PTAs, is unlikely. Finally, aid-induced liberalisation has not really worked: its political economy is highly dubious. Hence it is a mistake to rely even more on aid for further market-based reforms.

WHAT LESSONS FOR FUTURE LIBERALISATION? To recapitulate: the conditions for further liberalisation and associated structural reforms are more difficult today than they were in the heyday of the Washington Consensus. Reform complacency results from a postcrisis environment of buoyant growth and normal interest-group politics. There is dissatisfaction with previous reforms in parts of the developing world. Some anti-liberalisation ideas are enjoying a minor revival. Lastly, the politics of ‘second-generation’ trade-policy reforms is proving much more difficult than that of ‘first-generation’ reforms. The latter involve the reduction and removal of border barriers. This is relatively simple technically and can be done quickly – though politically these measures are rarely easy. The former are all about complex domestic (though trade-related) regulation, such as services regulation, regulation of food-safety and technical standards, intellectual-property protection, public procurement, customs administration and competition rules. These reforms are technically and administratively difficult, and take time to implement. They demand a minimum of capacity across government, especially for implementation and enforcement. Above all, they are politically very sensitive, as they affect entrenched interests that are extremely difficult to dislodge.


149

Still, there is a strong case for further market-based reforms in general, and for external liberalisation in particular. Reduction of what are still high barriers to trade, foreign investment and the cross-border movement of people holds out the promise of higher growth, and significant poverty reduction and improvements in human welfare. Stalled reforms and reform reversal threaten to deprive hundreds of millions of people of the life-chances they deserve. These are the stakes. Against this backdrop, the following challenges lie ahead: ●

‘First-division’ reformers: These are the 20–25 developing countries – the ‘new globalisers’ – that have already gone far with macroeconomic stabilisation, and internal and external liberalisation. They have plugged themselves into globalisation. Their task is to go further with dismantling border barriers to trade and opening the door to FDI. But their bigger challenge is to make much more progress on trade-related domestic reforms – the ‘structural’ and ‘institutional’ reforms where progress to date has been too slow. This entails tackling the second-generation issues mentioned above. What is needed is a culture of permanent, incremental reforms, mainly of the second-generation variety, that build on the foundations of first-generation reforms, so that the economy adapts flexibly to changing global conditions. That is easier said than done. The great difficulty lies in doing serious reforms in conditions of normal interest-group politics, without an economic crisis to concentrate minds. But the alternative is creeping sclerosis in times of plenty, and excessive reliance on a crisis for the next reform wave (Olson 1982 and OECD 2007). That cannot be good for long-term political, social and economic health. Such are the broad trade-policy priorities for first-division developing countries. In this context, the following points deserve emphasis. First, there needs to be a clearer link between trade policy, on the one hand, and domestic economic-policy and institutional reforms, on the other. Trade policy should be coupled strongly with competition-friendly measures to improve the domestic business climate. It should be better hitched to domestic reforms. For example, there should be ways of linking trade and FDI liberalisation, and trade-related regulatory reform, to measures to shorten and simplify regulations that hinder business at home. Such red tape includes procedural hurdles to overcome before starting a business, dealing with various licensing procedures, registering property, getting access to credit, employing workers, paying taxes,

150


protecting investors and bankruptcy procedures. Red tape directly affecting exports and imports include the documentation, time taken and costs of clearing goods through customs. These regulations are documented, classified and ranked in the World Bank’s annual Doing Business Report. Second-generation trade-policy reforms also depend on the quality of public administration and the rule of law (that is, the quality of the legal framework governing property rights and contracts, and their enforcement by the judicial system). These relate to some of the World Bank’s governance indicators and crosscountry rankings (World Bank 2007).11 (See Tables 5.5, 5.6 and 5.7 on business climate, trade and governance indicators for selected Asian and other developing countries.) Second, and following directly from the previous point, trade policy should be seen less through the prism of trade negotiations and international organisations, and (as argued above) more through the prism of the domestic economy. Second-generation reforms in particular are bundled up with domestic politics and economics; initiating and implementing them is overwhelmingly a domestic affair; and the scope for productive international negotiations and solutions is restricted. That is already becoming evident with the regulation of services trade and trade-related product standards, and of policies towards inward investment. It will become even more evident as global production networks and the movement of people across borders bite ever deeper into domestic institutions. As trade policy becomes evermore entwined with domestic policies and institutions, it follows that there should be more reliance on unilateral measures, including external liberalisation, and correspondingly less reliance on reciprocal liberalisation through the WTO and PTAs. Unilateral reforms should then be locked in through stronger WTO commitments. This should be the foundation for advancing national market-access and rule-making interests in the WTO. Governments should also exercise caution with PTAs, avoiding quick and dirty ones and only engaging in those that are comprehensive, WTO-plus, and clearly linked to competitionenhancing domestic reforms. Third, there should be much more policy transparency. Tradepolicy making is usually opaque. Too little is known and understood about the effects of this-or-that set of trade policies. Consequently, public discussion of policy choices is usually uninformed and misguided. One should add that this applies almost as much to developed countries as to developing countries. For example, antidumping and rules-of-origin procedures in the EU are shrouded in

151

1 4 12 15 24 30 50 76 83 91 101 107 107 112 113 120 123

9 13 44 36 74 110 103 59 135 97 29 92 92 45 120 111 168

5 60 32 12 105 22 128 93 175 63 160 116 116 172 95 134 99

1 23 17 49 43 131 148 132 86 84 111 129 129 102 116 85 153

13 58 48 20 67 68 24 88 29 38 134 171 171 44 109 112 121

7 2 13 36 3 36 48 68 84 48 97 48 48 156 80 36 68

2 3 12 33 4 64 64 19 83 165 64 15 15 81 62 33 51

2 3 105 89 56 106 91 146 168 128 158 81 81 126 139 165 110

Ease of Starting a Dealing Employing Registering Getting Protecting Paying doing business with workers property credit investors taxes business licences

World ranking in ease of doing business, 2007

1 3 18 50 21 13 29 94 42 63 60 112 112 155 70 79 41

4 1 21 26 63 10 92 154 20 40 133 175 175 19 112 177 141

2 15 1 44 54 11 13 51 57 121 39 102 102 81 136 137 136

Trading Enforcing Closing a across contracts business borders

Source:

The World Bank Doing Business database.

Note: The numbers correspond to each country’s aggregate ranking on the ease of doing business and on each of the ten topics that comprise the overall ranking.

Singapore Hong Kong Japan Thailand Malaysia Korea Taiwan Pakistan China Vietnam Sri Lanka Bangladesh Philippines Russia Brazil India Indonesia

Table 5.5

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Table 5.6

Indicators for trading across borders, 2007 Time Cost to Documents Time Cost to Ease of Documents for export for import for import trading for export (US$ (number) import (US$ across per (days) per borders export (days) container) container) (world (number) ranking)

Singapore Hong Kong Korea Japan Malaysia Taiwan Indonesia China Thailand Philippines Sri Lanka Vietnam Brazil India Pakistan Bangladesh Russia

1 3 13 18 21 29 41 42 50 57 60 63 70 79 94 112 155

4 4 4 4 7 7 5 7 7 8 8 6 8 8 9 7 8

5 6 11 10 18 13 21 21 17 17 21 24 18 18 24 28 36

416 525 745 989 432 747 667 390 615 800 810 669 1090 820 515 844 2050

4 4 6 5 7 7 6 6 9 8 6 8 7 9 8 9 13

3 5 10 11 14 12 27 24 14 18 21 23 22 21 19 32 36

367 525 745 1047 385 747 623 430 786 800 844 881 1240 910 1336 1148 2050

Note: The costs and procedures involved in importing and exporting a standardized shipment of goods are detailed under this topic. Every official procedure involved is recorded – starting from the final contractual agreement between the two parties, and ending with the delivery of the goods. Source:

The World Bank Doing Business database.

secretive, discretionary and ultimately arbitrary behaviour, with restricted external access to information. The situation is not much better elsewhere. What is lacking is what Patrick Messerlin calls a ‘culture of evaluation’ (Messerlin 2006). Independent think tanks and even government bodies should do much more detailed research and analysis on the costs and benefits of trade policies in different sectors of the economy, and then disseminate findings to the public. This would facilitate more informed, intelligent public discussion of policy choices (Messerlin 2006). One model to examine is that of the Australian Productivity Commission (formerly the Tariff Board). This is a governmental body, but it is independent and has


Table 5.7

Percentile world rank of governance indicators for Asian countries (Governance Matters 2007 – World Wide Governance Indicators 1996–2006), 2006 Voice and accountability

Singapore Hong Kong Japan Malaysia Taiwan Korea Brazil India Thailand China Vietnam Indonesia Sri Lanka Philippines Russia Bangladesh Pakistan

153

46.6 64.9 75.5 38.0 72.1 70.7 58.7 58.2 32.2 4.8 8.2 41.3 36.1 44.2 24.0 30.8 12.5

Political Government Regulatory stability/ effectiveness quality no violence 94.7 88.9 85.1 58.7 63.5 60.1 43.3 22.1 16.3 33.2 59.6 14.9 8.2 11.1 23.6 8.7 4.8

99.5 93.8 88.2 80.6 83.9 82.9 52.1 54.0 64.9 55.5 41.7 40.8 42.2 55.0 37.9 23.7 34.1

99.5 100.0 87.3 69.8 78.5 70.7 54.1 48.3 62.4 46.3 31.2 43.4 50.2 52.2 33.7 20.0 38.5

Rule Control of of law corruption 95.2 90.5 90.0 65.7 74.8 72.9 41.4 57.1 55.2 45.2 44.8 23.3 54.3 41.9 19.0 22.9 24.3

98.1 92.7 90.3 68.0 70.4 64.6 47.1 52.9 50.5 37.9 29.1 23.3 48.5 27.2 24.3 4.9 18.0

Note: Percentile rank indicates the percentage of countries worldwide that rate below the country (subject to margin of error). Higher values indicate better governance ratings. Percentile ranks have been adjusted to account for changes over time in the set of countries covered by the governance indicators. Source:

World Bank Governance Indicators.

statutory powers. It provides research and analysis on trade-related issues in Australia; and its conclusions do make their way into the public debate. The Tariff Board’s ground-breaking work did much to reveal the costs of protection to the Australian public back in the 1970s, at a time when Australia was a highly-protected economy. This generated much public discussion at the time, and in many ways prepared the ground for the radical opening of the Australian economy in the 1980s. Such ‘transparency boards’ could be set up at relatively low cost in developing countries. Taken together, these reform priorities are as much about simplicity and transparency as they are about liberalisation. The case

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●


for transparency has been made above. Simplicity is all about making complex bureaucratic procedures shorter, more predictable, and also more transparent. This would lessen the costs of doing business – for domestic and foreign traders and investors. Hence the importance of linking trade policy to nitty-gritty domestic reforms. Fundamentally, these reforms boil down to restructuring the state, away from the large overactive state that intervenes badly across the range of economic activity, and towards the limited state that performs a smaller number of core functions well. The latter should focus on providing and enforcing a framework of rules for market-based competition. To return to Michael Oakeshott’s distinction, the state should be an ‘umpire’ of a ‘civic association’, not an ‘estate manager’ of an ‘enterprise association’. ‘Lower-division’ reformers: These countries, overwhelmingly in the low-income and least-developed bracket, have higher border barriers than first-division reformers, in addition to bigger domestic obstacles to trade and investment. They are less globalised. Their first priority should be to reduce border barriers and simple non-border barriers (such as some red-tape procedures that give them low rankings in the World Bank’s Doing Business Report). They have less capacity than first-division reformers for implementing more complex second-generation reforms. These could wait until the easier reforms are done. The real dilemma is that countries at the bottom of this pile, especially among the least-developed countries, are mired in political instability and civil strife, with failed and failing states that do not perform the most basic public functions. Such countries do not have the capacity to implement even simple reforms. Aid-driven solutions have failed, but what is the substitute?

CONCLUSION The naysayers, from the hard and soft left, and the conservative right, hold that liberalisation has not delivered the goods. They argue for various forms of government intervention, at national and international levels, to tame ‘market fundamentalism’ and ‘neoliberal globalisation’. Interventionist ideas on trade (and aid) are not new; they hark back to pre-Adam Smith, ‘pre-analytic’ mercantilism (as Schumpeter called it). What they have in common is an age-old distrust of markets and faith in government intervention – what David Henderson calls ‘New Millennium Collectivism’.12 Such collectivist thinking is on the rise again. But it is still


155

wrong and dangerous. It glosses over the damage done by interventionist policies in the past, and misreads the recent and historical evidence. The latter shows that external liberalisation, as part of broad market-based reforms, has worked: countries that have become more open to the world economy have grown faster and become richer than those that have opened up less or remained closed. There is much unfinished business. Barriers to trade, and the crossborder movement of capital and people, remain high, indeed more so in developing countries than in developed countries. But a combination of material circumstances and changes in the climate of ideas makes marketbased reforms more difficult now than was the case a decade ago. The stakes, however, are too important for reform challenges to be avoided. While there is no imminent threat of global economic collapse, stalled reforms threaten to slow down globalisation’s advance, thereby depriving the world’s least advantaged people of the life-chances that globalisation offers. That would reinforce strong pressures, from an alliance of old-style protectionist interests and new-style ideological forces, for overactive government to restrict economic freedom and the operation of the market economy. That is why new-old collectivist ideas need to be countered with full force. Thus it falls to free trade’s friends to make a strong case for further reforms, including external liberalisation, and practically go about assembling reform coalitions.

NOTES 1. 2. 3.

4.

5. 6. 7.

See Stiglitz (2002), Chang (2002), Grunberg et al. (1999), Oxfam (2002), Rodrik (2001), Rodrik (1998), Sachs (2005). See, for example, Sachs and Warner (1995), Winters (2004a) and Winters (2004b). On the record of trade and FDI liberalisation as part of larger packages of marketbased reforms in developing countries and countries in transition, see Williamson (ed) (1993), Kuczynski and Williamson (eds) (2004), Lal and Myint (1996), Dean (1995), Drabek and Laird (1998), Henderson (1998), Michalopoulos (2001). On trade-policy trends in Asia, see Sally (2007), Sally (2006a: 181–233), Sally and Sen 2005: 92–115). Special Issue ‘Revisiting trade policies in southeast Asia’, Sally and Sen (eds.). There is the theoretical possibility of (usually large) countries being able to exercise long-run market power in international demand for certain goods. This enables them to shift the terms of trade in their favour by means of an ‘optimal tariff’. The corollary is that these countries should only lower tariffs if others reciprocate, in order to avoid worsening terms of trade. In reality, very few countries have such long-run market power. And retaliatory tariffs by other countries could nullify terms-of-trade gains. Thus – not for the first time – a neat theory turns out to have limited practical relevance. See Irwin, (1996: 106–115). The following argument draws on Sally (2006b). This is the gist of a recent thinkpiece by Simon Evenett. See Evenett (2007). Counting the EU as one, and stripping out intra-EU trade, ten countries make up about 70 per cent of world trade.

156 8. 9.

10. 11. 12.

The law and economics of globalisation The following account on PTA motives, advantages and disadvantages draws on World Bank (2005 and 2004). Rules to determine the country of origin of a good do not matter if there are zero tariffs, and matter little if trade takes place on a non-discriminatory (MFN) basis, as it is supposed to do in the GATT/WTO. But such rules do matter for PTAs, as they determine whether or not a good qualifies for duty-free or preferential-tariff entry to the market of a PTA member. This section draws on Erixon and Sally (2006: 69–77). See also World Bank governance indicators, www.worldbank.org. On the provenance and progress of these ideas, see Henderson (2001).

REFERENCES Ando, M. and F. Kimura (2005), ‘The formation of international production and distribution networks in East Asia’, in T. Ito and A. Rose (eds), International Trade, NBER-East Asia seminar on economics, vol. 14, Chicago: University of Chicago Press. First version, NBER Working Paper 10167. Athukorala, P. (2006), ‘Product fragmentation and trade patterns in east Asia’, Asian Economic Papers, 4 (3), pp. 1–27. Baldwin, R. (2006a), ‘Implications of European experiences with regionalism for future economic integration in Asia’, mimeo. Baldwin, R. (2006b), ‘Multilateralising regionalism: spaghetti bowls as building blocs on the path to global free trade’, The World Economy, 29 (11), pp. 1451–518. Bauer, P.T. (2000), ‘Foreign aid: abiding issues’, in P.T. Bauer (ed), From Subsistence to Exchange and Other Essays, Princeton NJ: Princeton University Press. Bhagwati, J. and T.N. Srinivasan (1999), ‘Outward-orientation and development: are revisionists right?’, Yale University Economic Growth Centre Discussion Paper, No. 806. Chang, H.J. (2002), Kicking Away the Ladder: Development Strategy in Historical Perspective, London: Anthem Press. Crawford, J.A. and R.V. Fiorentino (2005), ‘The changing landscape of regional trade agreements’, WTO Discussion Paper No. 8, 2005, from http://www.wto. org. Dean, J. (1998), ‘The trade-policy revolution in developing countries’, The World Economy, Global Trade Policy 1995. Drabek, Z. and S. Laird (1998), ‘The New Liberalism: trade-policy developments in emerging markets’, Journal of World Trade, 32 (5), pp. 241–69. Easterly, W. (2006), The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good, New York: Penguin. Erixon, F. and R. Sally (2006), ‘Trade and aid: countering New Millennium Collectivism’, Australian Economic Review, 39 (1), pp. 69–77. Estevadeordal, A. and K. Suominen (2003), ‘Rules of origin in the world trading system’, Paper prepared for the seminar on regional trade agreements and the WTO, 14 November, World Trade Organisation, Washington DC, available at http://www.wto.org. Evenett, S. (2007), ‘EU commercial policy in a multipolar trading system’, mimeo.


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Grunberg, I., I. Kaul, and M. Stern (eds) (1999), Global International Goods: International Co-operation in the 21st Century, New York and Oxford: Oxford University Press. Henderson, D. (1992), ‘International Economic Integration: Progress, Prospects and Implications’, International Affairs, 64 (4), pp. 633–53. Henderson, D. (1998), The Changing Fortunes of Economic Liberalism: Yesterday, Today and Tomorrow, London: Institute of Economic Affairs. Henderson, D. (2001), Anti-Liberalism 2000: The Rise of New Millennium Collectivism, London: Institute of Economic Affairs. Henderson, D. (2004a) Misguided Virtue: False Notions of Corporate Social Responsibility, London: Institute of Economic Affairs. Henderson, D. (2004b), ‘Globalisation, Economic Progress and New Millennium Collectivism’, World Economics, 5 (3), pp. 43–73. Ingco, M.D. and J.D. Nash (eds) (2004), Agriculture and the WTO: Creating a Trading System for Development, Washington DC: World Bank. Irwin, D.A. (1996), Against the Tide: An Intellectual History of Free Trade, Princeton NJ: Princeton University Press. Kuczynski, P.P. and J. Williamson (eds) (2004), After the Washington Consensus: Restarting Growth and Reform in Latin America, Washington DC: Institute for International Economics. Lal, D. and H. Myint (1996), The Political Economy of Poverty, Equity and Growth: A Comparative Study, Oxford: Clarendon Press. Little, I.M.D. (1999), ‘Trade and Industrialisation Revisited’, in I.M.D. Little, Collection and Recollections, Oxford: Clarendon Press. Maddison, A. (2003), The World Economy: Historical Statistics, Paris: OECD. Messerlin, P. (2006), Europe After the ‘No’ Votes: Mapping a New Economic Path, London: Institute of Economic Affairs. Michalopoulos, C. (2001), Developing Countries and the WTO, London: Palgrave. OECD (2007), Economic Policy Reforms: Going for Growth, Paris: OECD. Olson, M. (1982), The Rise and Decline of Nations: Economic Growth, Stagflation and Social Rigidities, New Haven: Yale University Press. Oxfam, (2002), Rigged Rules and Double Standards: Trade, Globalisation and the Fight Against Poverty, Oxford: Oxfam International, from http://www.marketradefair.com. Rodrik, D. (1998), The New Global Economy and Developing Countries: Making Openness Work, Washington DC: Overseas Development Council. Rodrik, D. (2001), ‘Trading in Illusions’, Foreign Policy, March/ April, from http://www.foreignpolicy.com/issue_marapr_2001/rodrick.html. Sachs, J. and A. Warner (1995), ‘Economic Reform and the Process of Global Integration’, Brookings Papers on Economic Activity, No. 1. Sachs, J. (2005), The End of Poverty: How We Can Make it Happen in our Lifetime, London: Penguin. Sally, R. (1998), Classical Liberalism and International Economic Order: Studies in Theory and Intellectual History, London: Routledge. Sally, R. (2006a), Chinese trade policies in wider Asian perspective, in Y. Yao and L. Yueh (eds.), Globalisation and Economic Growth in China, London: World Scientific Publishing. Sally, R. (2006b), ‘Trade policy 2006: a tour d’horizon’, World Economics, January–March, 49–71.

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Sally, R. (2006c), ‘FTAs and the prospects for regional integration in Asia’, ECIPE Working Paper 1, available at http://www.ecipe.org/publications/2006/ WPno1_06_Sally.pdf. Sally, R. (2007), ‘Trade policy in Asia’, ECIPE Policy Brief, No.1, from http:// www.ecipe.org/pdf/Policybrief_0107.pdf. Sally, R. and R. Sen (2005), ‘Whither trade policies in southeast Asia? The wider Asian and global context’, ASEAN Economic Bulletin, 22 (1), pp. 92–115. Including Individual Country Papers in Special Issue on Revisiting Trade Policies in Southeast Asia. Stiglitz, J. (2002), Globalisation and its Discontents, London: Allen Lane. UN Millennium Project (2005), Investing in Development: A Practical Plan to Achieve the Millennium Development Goals, New York: Earthscan. Williamson J. (ed) (1993), The Political Economy of Policy Reform, Washington DC: Institute for International Economics. Winters, A. L. (2004a), ‘Trade Liberalisation and Economic Performance: An Overview’, Economic Journal, 114 (February), pp. F4–F21. Winters, A. L. (2004b), ‘Trade Liberalisation and Poverty’, Journal of Economic Literature, 42 (March), No. 1. Wolf, M. (2004), Why Globalisation Works: The Case for the Global Market Economy, New Haven: Yale University Press. World Bank (1993), The East Asian Miracle, Washington DC: World Bank. World Bank (1998a), 1998 Annual Review of Development Effectiveness, Washington DC: World Bank Operations Evaluation Department, World Bank. World Bank (1998b), Assessing Aid: What Works, What Doesn’t, and Why, Oxford: Oxford University Press. World Bank (2002), Globalisation, Growth and Poverty: Building an Inclusive World Economy, Washington DC: World Bank, p. 34. World Bank (2004), Global Economic Prospects 2005: Trade, Regionalism and Development, Washington DC: World Bank/OUP. World Bank (2005), Regional trade agreements and development: upside potential and downside risks, Trade Note 24, September 13, available at http://www. worldbank.org. World Bank (2006), Doing Business in 2007, Washington DC: World Bank. World Bank governance indicators, from http://www.worldbank.org. WTO (2002), Rules-of-origin regimes in regional trade agreements, Background survey by the Secretariat, Committee on Regional Trade Agreements, WT/ REG/W/45, 5 April, available at http://www.wto.org. WTO (2006), International Trade Statistics 2005, Geneva: WTO. WTO (2007), Regional trade agreements: facts and figures, from http://www.wto. org/english/tratop_e/region_e/regfac_e.htm.

PART II

Issues confronting governance and enforcement

6.

The development of IMF and World Bank conditionality Axel Dreher

INTRODUCTION After World War II, the international community created the International Monetary Fund (IMF) and the World Bank, taking account of the growing interdependence of international economic markets. Since the 1970s, economic, social, and political globalisation has been accelerating rapidly (Dreher 2006a, Dreher, Gaston and Martens 2008), resulting in the potential for massive capital withdrawals from a country’s financial markets and infrastructure. In an attempt to battle this contagion, IMF and World Bank conditions rapidly expanded in number and scope. Arguably, the expansion of conditionality leads to the globalization of economic policies. When the IMF and World Bank export policies favored by their major Western shareholders to developing and transition countries, policies will to some extent become similar across the world. This is not what the Institutions have been created for. As the IMF and World Bank were founded in 1944, there was no consideration of intrusive conditionality now common under the International Financial Institutions’ (IFIs) programs. However, over time, conditionality gradually increased and became inseparably associated with IMF and World Bank loans. This evolution was never without critics.1 While there are those criticizing conditionality as overly intrusive (for example Williamson 1983), others claim it would be ineffective (for example Spraos 1986). As empirical studies have shown, a huge share of conditionality has indeed not been implemented as negotiated (IFIAC 2000, Dreher 2003). Moreover, there is substantial evidence that IMF and World Bank programs fall short of their targets and are abused for political reasons by either the borrower or the major principals of the IMF and World Bank.2 According to Dreher (2006b), compliance with conditionality slightly mitigates the negative impact of IMF programs on economic growth, while the overall impact, however, remains negative. As Dreher and Vaubel (2004a) show, IMF conditions do on average not affect the 161

162


main target and instrument variables typically included in IMF programs. Dollar and Svensson (1998) show that the effort invested by the World Bank in a conditional loan program has no impact on the probability of program success. Collier (1997) concludes that conditionality has failed, with borrowing governments’ decisions to reform being independent of the structure of (World Bank) programs. In spite of the poor track record of conditionality, the importance of conditions in IMF and World Bank programs continuously increased over time, with the number of conditions steadily rising. This increase in the number of conditions has been as heavily criticized as has the concept and the specific content of conditionality. In particular, structural conditionality has been criticized as a means of exporting neo-liberal, Washingtonbased policies to the developing world, resulting in a globalization of economic policies. The structural conditions included in IMF programs to a huge extent replicate conditions demanded by the World Bank. It has been argued by the IFIAC (2000) and Feldstein (1998), among others, that structural conditionality is simply not the IMF’s business. According to Feldstein, wide-ranging and micro-managed policy conditionality discourages crisis countries from turning to the Fund, thereby worsening crises. In the words of Radelet and Sachs (1998: 67–68), ‘most of the structural reforms, however, simply detract attention from the financial crisis. They have taken government expertise, negotiating time, and political capital away from the core issues of financial markets, exchange rate policy, and the like.’ Severe structural conditionality could make potential private lenders suspicious of a country’s political and economic situation, inducing them to lend less instead of more (Radelet and Sachs 1998). It has even been claimed the Fund simply lacks the expertise to engage in wide-ranging structural policy conditionality (see Goldstein 2000). In fact, Radelet and Sachs (1998) claim that structural conditionality has often been prescribed in the wrong cases and in wrong dosages. As one major problem in analysing the effects of the IFIs’ conditions, however, researchers outside Fund and Bank usually have to rely on crude proxies and what is generally perceived to be the IFIs’ conditionality. This is because data on IMF programs and World Bank Country Assistance Strategy (CAS) papers have only been publicly available since April 1998. Policies negotiated in the Banks’ adjustment programs are usually not published at all. A systematic description of detailed conditions included in different programs at different times does not exist. The aim of this chapter is therefore to provide such a description of changes in conditionality over time and differences between the Bank and Fund. This is presented in the next section. The final section provides a short summary and discusses the implications of the development of

The development of IMF and World Bank conditionality

163

IMF and World Bank conditionality for the globalization of economic policies.

DEVELOPMENT OF IMF AND WORLD BANK CONDITIONALITY In the beginning of the Fund’s operations, the only nation pushing for the inclusion of formal conditionality in IMF programs has been the US – the only country able to provide internationally accepted currency after the war. The IMF was created to provide short-term loans designed to stabilize a borrowers’ balance of payments – and not even the US wanted to attach detailed strings to those loans. Only if misbehavior would be flagrant they wanted to be able to reject drawings.3 However, possible deficit countries like the United Kingdom refused any kind of conditionality, so at Bretton Woods no ultimate decision on this matter was made. As the Fund started its operations, its Executive Board had to decide on whether to attach conditions to its loans. In 1948 the Board agreed that the Fund could ask its borrowers to implement conditions securing the revolving character of its resources. In 1951 the Executive Directors defined some formal criteria. The borrowing country was, however, free to decide with which instruments to achieve the targets. Starting in 1956, the Fund disbursed its loans in tranches to be better able to enforce conditions. In 1958, the IMF program with Portugal was the first to actually include binding performance criteria. It defined a credit ceiling, a maximum commitment level for public work programs and confined expenditures (Dell 1981, p. 12). As can be seen in the first column of Table 6.1, those conditions have been typical for the Fund’s first years in operation. Between 1964–69 programs included targets on monetary and fiscal policy. They aimed at reductions in relative price distortions. They tried to reduce current account deficits through import substitution and export promotion and set ceilings for budget deficits as well as floors for international reserves. Contrary to the Fund, the World Bank depended from the beginning of its operations on private capital. Therefore, in order to achieve high credit ratings it did lend only to countries where repayment seemed likely and certain macroeconomic conditions had been met. In spite of the project nature of most of the Bank’s lending operations prior to the 1980s most lending has not been unconditional. The Bank’s conditions covered public sector budget deficits, credit to the private sector, currency devaluations and reductions of the current account deficit through import substitution and export promotion (Kapur, Lewis and Webb 1997, p. 455). These

164

Table 6.1


Conditions in IMF stand-by and extended arrangements, 1964–92 1964–69

Number of programs

I. Monetary and financial policies 1. Limit on credit expansion a. Net domestic assets or total bank credit b. Bank credit to central government c. Bank credit to public sector 2. Interest rate policy 3. Target on foreign reserves II. Public sector policies 1. Restraint on central government expenditures a. Freezing, reduction or postponement of wage increases b. Freezing or reduction of government employee numbers c. Ceiling on current expenditures d. Transfers and subsidies e. Capital expenditure and net lending 2. Tax policy a. Improve or reform (tax) administration b. Reform of the tax system or tax basis c. Increase in taxes 3. Non-financial public enterprises a. Privatization b. Improve price structure

%

10

3 3

1 4

2

1969–78

%

105

(33) (33)

(10) (40)

(20)

1988–92

%

48

40

(83.33)

99

(94.29)

39 36

(81.25) (75)

70

(66.67)

16

(33.33)

7

(6.67)

7 6

(6.67) (5.71)

12 na

(25)

44 32

(91.67) (66.67) (66.67)

32

(30.48)

32

9

(8.57)

na

31

(29.52)

na

3

(33)

41 21

(39.05) (20)

na na

8

(80)

59 59

(56.19) (56.19)

na na

8

(80)

53

(50.48)

na

3

(33)

55

(52.38)

na 14

(29.17)

na 14

(29.17)

30

(28.57)


Table 6.1

(continued) 1964–69

c. Improve institutional efficiency 4. Reduction of deficit as per cent of GDP III. External debt policies 1. Control of public and publicly guaranteed debt 2. Reduction in arrears IV. Exchange and trade policies 1. Liberalization and reform of exchange rate a. Adjustable/crawling peg b. Flexible rates c. Fixed rates d. Devaluation of the currency 2. Liberalization and reform of trade system a. Import substitution b. Export promotion measures c. Capital account liberalization V. Structural adjustment measures 1. Developing and restructuring of a subsector a. Infrastructure, telecommunication and energy b. Agriculture 2. Protection of the poor 3. Wages and prices a. Wage guidelines or wage reform policies b. Reduction in price distortions Note:

%

1969–78

%

1988–92

%

na 42

11

5 5

(50) (50)

8 16

(40)

(10.48)

32

(66.67)

46 34

(95.83) (70.83)

28 47

(58.33) (97.92)

47

(97.92)

14 17 14 6

(29.17) (35.42) (29.17) (12.5)

9

(18.75)

9

(18.75)

39

(81.25)

17

(35.42)

11

(22.92)

6

(12.5)

(7.62) (15.24)

1

(10)

2

(20)

6

(5.71)

37 12

(77.08) (25)

5

(50)

12

(11.43)

36

(75)

% indicates the percentage of programs including a certain condition.

Sources:

165

Schadler et al. (1995), Killick (1986), Beverage and Kelly (1980).

166


conditions have been very similar to those of the Fund. Instead of serving completely different purposes, as intended, the institutions started to create significant overlap in their work. Due to the overlap in World Bank and IMF advice and conditionality, an agreement on the institutions’ primary responsibilities was made in 1966.4 According to this agreement, the Fund should be responsible for exchange rates and restrictive exchange practices, temporary balance of payments disequilibria and stabilization programs. The Bank was assigned the task to generate broader development strategies and pursue project evaluations. Financial institutions, capital markets, domestic savings and the financial position of the borrowing countries should remain areas of overlap. In 1968, a review of conditionality tried to limit the scope of the Fund’s performance clauses. However, in the following years, especially after the introduction of the Extended Fund Facility in 1974, IMF conditions became increasingly detailed. Conditions have no longer been confined to targets but referred to specific instruments in some detail (Gould 2001 p. 9). This was intended to give a borrowing country confidence that negotiated tranches would be available in the case of compliance with conditionality. Would only targets be negotiated, deviations could be due to external shocks. The money would then be withheld in spite of compliance. However, the focus on instruments increasingly reduced the borrowing country’s governments’ scope for independent policy. This is illustrated in column 1 of Table 6.1: between 1969–78 a broad range of areas was covered under the programs. Contrary to earlier programs, where expenditure restrictions were limited to restrictions on government’s wage bills and subsidies, the analysed arrangements demanded reductions in the number of government employees and set ceilings on government current and capital expenditures. A high percentage of programs covered reductions of transfers and subsidies. More than 50 per cent of the programs included tax increases and 11 programs included reductions in external payments arrears. While almost all Stand-By Arrangements now included limits on credit expansion, import substitution and export promotion measures started to lose weight. It is interesting to note that later IMF goals like poverty reduction and growth have not been covered under its earlier conditionality. World Bank conditionality, at the same time, predominantly aimed at improving management of money and credit, government expenditures and revenues, exchange rates and foreign debt. Conditions concerning import substitution have – contrary to earlier loans – no longer been included. Instead, export promotion measures were enhanced and restrictions on trade reduced. Often it was contracted to reduce tariffs and


167

subsidies. Moreover, whereas the World Bank’s focus until the 1970s has chiefly been on (government guaranteed) lending for private enterprises, between 1970–81 credit was granted independently of ownership if professional management was established (Kapur, Lewis and Webb 1997, pp. 480–84). This has been welcomed by borrowing countries’ governments, the majority of which had strong preferences for public investment. However, many policies included in the IFIs’ programs were not those preferred by borrowing countries’ governments. Some of them claimed that the increasing intrusiveness of conditionality would not be justified by the relatively small amounts of money provided.5 Developing countries protested that IMF conditions were not tailored to individual countries’ circumstances and that industrialized countries received its loans merely without conditionality. Their protests led to a second review of IMF conditionality in 1979. It was agreed that individual country’s priorities and characteristics should weigh more heavily in IMF programs. However, at the same time, a new kind of conditionality was introduced. In addition to performance criteria, which must be implemented to secure tranche releases, prior actions should be implemented before a program is presented to the Executive Board. Officially, these prior actions should secure that programs are in line with the targets of the IMF. However, governments frequently had to execute prior actions not critical for success of the programs in order to demonstrate their willingness to comply. In the years following the second conditionality review, supply side aspects gained weight in IMF programs. This led to greater Fund involvement into social and political belongings of developing countries. Compared to the 1970s, the IMF prescribed not only more detailed conditions but also paid out less money at the beginning of programs. Moreover, waivers were more difficult to achieve. At the same time, Bank staff increasingly became aware that its projects, even if individually successful, could not achieve growth if the borrowing country’s macroeconomic environment is deeply distorted. Previously, conditions did not aim at detailed changes. Instead, they were attached to the Bank’s loans to secure repayments. Its project lending did not provide it with the leverage to enforce detailed macroeconomic conditions. In order to increase its leverage, the Bank initiated structural program lending in 1980 and sectoral adjustment lending in 1983. Structural adjustment programs have not been meant to be permanent. Instead, adjustment should be achieved over a 3–5 year period (Kapur, Lewis and Webb 1997, p. 510). During this time internal and external deficits leading to high inflation and depleting reserves should be eliminated (Ferreira and Keely 2000, pp. 159–189).

168


Adjustment programs contain four types of conditions: legal actions, which are specified in legal arrangements, additional conditions which are requested by the World Bank president and are included in the staff’s mission report, preconditions which must be fulfilled before the Executive Board votes on the agreement and prior actions ‘voluntarily’ taken by borrowing governments (which would otherwise be included under formal conditionality). Between 1980–88, 34 per cent of the conditions included have been legal actions, 40 per cent were additional conditions, 8 per cent preconditions and 18 per cent prior actions (World Bank 1990, p. 10). The Bank’s first adjustment programs included conditions targeted at reducing structural balance of payments deficits. Conditions aimed at shifting resources to the tradable sector. They included designing countrywide investment plans, enhancing incentives for improved resource allocation, improving infrastructure, promoting exports and reducing protectionism (Kapur, Lewis and Webb 1997, p. 510). To promote supply, detailed microeconomic conditionality was included in those programs. An average adjustment program between 1980–82 included 34 conditions in total. This number rose to 35 in 1983–86 and 56 in 1987–90 (see Table 6.2). In 1991 the average number of conditions was 48 and rising thereafter (Kapur, Lewis and Webb 1997, p. 522). These conditions complemented those of the IMF since conclusion of an IMF arrangement usually is a precondition for the Banks’ adjustment lending. Table 6.2 shows the number of Bank conditions between 1980–88 by sector and region. As can be seen, 18 per cent of Bank conditions were fiscal and only 3 per cent monetary. Seventeen per cent referred to agricultural and 16 per cent to trade-related goals. More than 70 per cent of all conditions were not quantifiable and could therefore not objectively be evaluated (World Bank 1990, p. 10). Nevertheless, more than 90 per cent of structural adjustment loan conditions and 75 per cent of conditions included in sectoral adjustment loans were linked to tranche disbursement (McCleary 1991, pp. 197–214). Table 6.3 plots conditions included in World Bank programs between 1980–88. As can be seen, 80 per cent of those programs included conditions concerning fiscal policy. In the first years of structural adjustment lending reductions of budget deficits accounted for less than 1 per cent of Bank conditionality. However, those reductions were often included in contemporaneous IMF programs. Reductions of budget deficits had at that time primarily to be achieved by means of expenditure cuts (Chhibber and Khalilzadeh-Shirazi 1991, pp. 20–43). Most programs included conditions concerning amount and composition of expenditures, public investment and subsidies. Ultimately, adjustment programs tried to eliminate public subsidies completely (Chhibber and Khalilzadeh-Shirazi 1991, p. 32). Table


Table 6.2

Distribution of World Bank conditions, 1980–88 1980–82 1983–86 1987–90

Supply side, growth-oriented policy Trade Public enterprises Public institutions Financial sector Agriculture Industry Energy Social sector Other sectors Absorption reducing policy Fiscal policy Monetary policy Switching policies Exchange rate Wage policy All Number of programs Average number of conditions Sources:

169

1991

1980–88 (%)

no. % no. % no. % no. %

%

All Regions

Africa Asia Europe, Latin All Middle Amer. East, & North Carib. Africa

47 17 118 18 26 9 79 12 21 7 49 7 12 4 54 8 54 19 143 22 23 8 56 9 24 9 27 4 3 1 2 0 2 1 8 1

11 11 15 16 8 2 2 7 5

12 17 11 7 16 4 2 1 3

18 12 3 16 12 8 8 0 1

13 5 5 11 33 4 10 1 1

26 15 4 13 7 7 3 2 0

16 14 7 10 17 5 5 1 2

57 20 98 15 287 17 298 20 2 1 5 1 13 1 25 2

22 2

17 2

13 3

16 4

18 3

8 3 16 2 36 2 20 1 2 1 5 1 47 3 31 2 282 100 657 100 1725 100 1483 100 8 19 31 31

3

3

1

3

2

100

100

100

100

100

34

35

192 288 202 211 224 76 74 34 42

56

11 17 12 12 13 4 4 2 2

162 161 219 240 112 23 23 101 68

48

47

Kapur et al. (1997: 521), World Bank (1990, p. 7).

6.4 provides details. As can be seen, on average, expenditure reductions accounted for 2 per cent and reductions in investment for 4 per cent of conditionality between 1980–88. In the 199 programs covered, reductions in transfers and subsidies have been demanded 38 times. Quantitative targets for investment have rarely been defined. Instead, existing investment plans had to be revised or new plans had to be initiated. Increases in revenues were predominantly to be achieved through liberalization of public companies’ prices (Chhibber and Khalilzadeh-Shirazi 1991, p. 34). Moreover, processes for planning government budgets had to be strengthened. Overall, only 315 out of almost 8000 conditions referred to taxes (Table 6.4). Of

170


Table 6.3

Conditions in World Bank programs, 1980–88 (%)

Supply side, growth-oriented policy Trade Public enterprises Public institutions Financial sector Agriculture Industry Energy

79 76 57 52 63 46 28

Absorption reducing policy Fiscal policy Monetary policy Exchange rates

80 44 48

Source:

World Bank (1990, p. 5).

those, conditions to broaden the tax base, simplify existing tax systems and enhance administrative efficiency have been most prominent. According to Ferreira and Keely (2000, p. 169), later programs contained more detailed conditions on specific expenditure cuts. Since the Bank’s focus has over time been shifted to poverty reduction, cuts in areas such as education and health were then generally avoided. Instead, conditions on curtailing expenditure for government administration, the military and public employees’ pensions were more frequent. Conditions concerning international trade accounted for almost 16 per cent of all conditions and were included in 79 per cent of World Bank programs between 1980–88 (Table 6.2 and Table 6.3, respectively). In earlier programs the Bank demanded conversion of non-tariff trade restrictions to tariffs, primarily in order to reduce public deficits. Later, overall reductions of export and import restrictions, for example reductions in tariffs as well as their dispersion have been envisaged (Chhibber and KhalilzadehShirazi 1991, p. 30). Barriers concerning import substitution were only cautiously approached. Sometimes tariffs protecting domestic products have even been raised (Thomas 1991, pp. 47–71). Between 1980–93, 27 per cent of all conditions aimed to reform external trade (Ferreira and Keely 2000, p. 177). Between 1980–88, 2.5 per cent of these conditions tried to improve the exchange rate system. Such measures have been included in 48 per cent of all programs (Table 6.4). Reforms covering the financial system were included in more than half of the adjustment programs analysed (Table 6.3). In this area, the first


171

adjustment loans targeted mainly at liberalizing interest rates and credit allocation for political reasons (Gelb and Honohan 1991, pp. 76–99). In addition, programs aimed at institutional changes reducing interest rate subsidies and taxing financial transactions (Ferreira and Keely 2000, p. 176). Development of capital and money markets, recapitalization and mergers of insolvent banks, improved accounting standards and deposit insurance systems were all covered under Bank conditionality. Regulatory institutions were to get more power and some banks had to change their management (Gelb and Honohan 1991, p. 81). Moreover, conditionality aimed at increasing competition in the financial sector. The total share of financial conditions between 1980–93 has been 9 per cent (Ferreira and Keely 2000, p. 177). Between 1980–88 they were responsible for only 4 per cent of Bank conditions. Thereafter, they steadily gained relevance. In 1991, 16 per cent of all conditions have been financial. Those conditions were most prominent in Asia, where 16 per cent of the Bank’s conditions between 1980–88 covered this sector (see Table 6.2). Conditions relating to public enterprises have been included in 76 per cent of World Bank programs between 1980–88 (Table 6.3). More than 3 per cent of all conditions tried to enhance institutional efficiency (Table 6.4). Earlier programs stressed organization and management of firms and tried to increase supervision and evaluation of activities. Half of the programs included conditions on specific enterprises. Other prominent conditions concerned the number of employees, pricing of goods and services, access to subsidized credit, reduction in arrears and improved education of public employees (Nellis 1991, pp. 127–130). Enterprises whose losses increased the government’s budget deficit had to be restructured. Conditions have been shaped to reduce those losses by increasing prices (utilizing monopoly positions). In the first years of adjustment lending, sales or liquidation of specific public enterprises have been, however, less prominent. If the Bank asked for privatization, conditions did usually not refer to specific enterprises. Instead, formulation of investment plans has been included under conditionality (Nellis 1991, p. 114). In later programs, the Bank more frequently asked for the privatization of public enterprises. Overall, between 1980–93, 14 per cent of all conditions were related to those enterprises (Ferreira and Keely 2000, p. 176). In the agricultural sector, programs tried to improve incentives which were distorted in favor of the industry. About 17 per cent of all conditions have been in this sector (Table 6.4). They were included in nearly 60 per cent of structural and almost all sectoral adjustment loans (Knudsen and Nash 1991, p. 132, World Bank 1991, pp. 130–151). Frequently, producer prices as well as prices for inputs like water and fertilizer had to be raised. Subsidies had to be reduced. Resistance against government withdrawal

172 (1.8) (0.72) (2.52)

(3.96) (5.95) (1.44)

10

4 14

22 33 8

46 12 17

7 41

15

(5.46) (1.43) (2.02)

(0.83) (4.87)

(1.78)

6 (0.71) 27 (3.21) 86 (10.21)

(0.9) (3.24) (7.03)

%

5 18 39

no. 842

%

Social welfare

555

no.

Macro, public sector

12 8 1

3

2

6 6 13

169

no.

(7.1) (4.73) (0.59)

(1.78)

(1.18)

(3.55) (3.55) (7.69)

%

Financial

16 28 20

4 18

21

14 15 55

770

no.

(2.08) (3.64) (2.6)

(0.52) (2.34)

(2.73)

(1.82) (1.95) (7.14)

%

Trade

Conditions in World Bank adjustment loans per sector, 1980–88

Total number of conditions I. Monetary and financial policies 1. Limit on credit expansion 2. Interest rate policy 3. Reform of the financial system II. Public sector policies 1. Restraint on central government expenditures a. Ceiling on current expenditures b. Transfers and subsidies c. Capital expenditure and net lending 2. Freezing or reduction in expenditure arrears 3. Tax policy a. Privatization b. Improve institutional efficiency

Table 6.4

(3.51) (1.84)

11

(5.18)

31 21

(1.17) (2.67)

(1.67)

(1.84) (2.5) (5.51)

%

7 16

10

11 15 33

599

no.

Sectoral policies

88

41

125

8 98

46

13 37 214

2553

no.

(3.45)

(1.61)

(4.9)

(0.31) (3.84)

(1.8)

(0.51) (1.45) (8.38)

%

Natural environment

254

191

315

38 305

142

67 150 647

7723

no.

(3.29)

(2.47)

(4.08)

(0.49) (3.95)

(1.84)

(0.87) (1.94) (8.38)

%

Total

173

4. Reduction of deficit as per 9 (1.62) 14 (1.66) cent of GDP 5. Raise investment, 6 (1.08) 14 (1.66) design program or build institutional capacity III. Exchange and trade policies 1. Liberalization and reform 42 (7.57) 26 (3.09) of exchange rate 2. Liberalization and reform 123 (22.16) 130 (15.44) of trade system a. Import substitution b. Liberalization of imports 37 (6.67) 21 (2.49) c. Export promotion measures 31 (5.59) 47 (5.58) IV. Structural adjustment measures 1. Developing and restructuring of a subsector a. Energy 20 (3.6) 29 (3.44) Pricing and subsidies 14 (2.52) 11 (1.31) Entry, exit, expansion 1 (0.18) Other regulation 1 (0.18) 3 (0.36) (2.37)

4

(1.56)

(0.13)

1

12

(2.34)

18

11

2

28

(1.84)

(0.33)

(4.67)

(4.14) (0.59)

(5.92) (2.96)

7 1

10 5

47 31

56 25

(6.1) (4.03)

(7.27) (3.25)

(3.17) (1.67) (0.17)

1

(4.67) (3.51)

19 10

28 21

34 (20.12) 189 (24.55) 115 (19.2)

(2.37)

4

(2.08)

(1.02)

(1.76)

188

69

185

(2.43)

(0.89)

(2.4)

110 36 2 3

50 121

(4.31) (1.41) (0.08) (0.12)

(1.96) (4.74)

350 139 5 16

240 339

(4.53) (1.8) (0.06) (0.21)

(3.11) (4.39)

357 (13.98) 1231 (15.94)

53

26

45

174

(continued)

Subsector/firm restructuring Investment promotion and incentives Technology Subsector planning Other sector-specific policies b. Agriculture Pricing and subsidies Entry, exit, expansion Other regulation Subsector/firm restructuring Investment promotion and incentives Technology Subsector planning Marketing

Table 6.4

(0.18) (0.18) (0.18)

1 1 1

(0.12) (0.36) (0.36)

(0.48)

4 1 3 3

(0.48)

%

4

no.

Social welfare

6 4

(1.08) (0.72)

(1.31) (0.48) (1.78) (0.95)

11 4 15 8

59 (10.63) 164 (19.48) 35 (6.31) 57 (6.77) 1 (0.18) 6 (0.71) 2 (0.36) 21 (2.49) 10 (1.8) 34 (4.04)

(0.18)

%

1

no.

Macro, public sector

(1.18)

(1.78)

%

1 2 6

7

no.

(0.13) (0.26) (0.78)

(0.91)

%

Trade

2 4

3

(1.18) (2.37)

(1.78)

1 2 3

3

(0.13) (0.26) (0.39)

(0.39)

26 (15.38) 112 (14.55) 11 (6.51) 76 (9.87) 1 (0.13) 1 (0.59) 7 (0.91) 5 (2.96) 13 (1.69)

2

3

no.

Financial

(0.33) (0.17) (0.33)

(0.5)

%

1 8 4

6

(0.17) (1.34) (0.67)

(1)

85 (14.19) 44 (7.35) 2 (0.33) 4 (0.67) 11 (1.84)

2 1 2

3

no.

Sectoral policies

(0.31) (1.14) (0.39)

(0.55)

(0.31)

%

16 60 34

39

37

no.

(0.21) (0.78) (0.44)

(0.5)

(0.48)

%

Total

19 78 33

42

(0.74) (3.06) (1.29)

(1.65)

29 193 83

86

(0.38) (2.5) (1.07)

(1.11)

470 (18.41) 1306 (16.91) 96 (3.76) 436 (5.65) 15 (0.59) 39 (0.5) 38 (1.49) 97 (1.26) 88 (3.45) 212 (2.75)

8 29 10

14

8

no.

Natural environment

175

Source:

World Bank (1990).

Other sector-specific policies c. Industry Pricing and subsidies Entry, exit, expansion Other regulation Subsector/firm restructuring Investment promotion and incentives Technology Subsector planning (supply and demand issues Marketing Other sector-specific policies 2. Labor market reform and liberalization 3. Protection of the poor 4. Wages and prices a. Wage guidelines or wage reform policies b. Reduction in price distortions (3.24) (1.62)

18

9

(1.08)

6

(0.18)

(4.5) (1.98) (0.54) (0.72) (0.18)

25 11 3 4 1

1

(0.18)

1

7

8 (0.83)

(0.95)

(0.83)

(0.48)

4 7

(0.36)

(0.12) (0.12)

1 1

3

(0.83)

(4.51) (0.59) (0.83) (0.59) (1.07)

(0.95)

7

38 5 7 5 9

8

4

4

4

(2.37)

(2.37)

(2.37)

(0.59)

(1.18) (0.59)

2 1

1

(4.14) (1.78)

7 3

14

13

1

1

3

35 23 3 1 4

6

(1.82)

(1.69)

(0.13)

(0.13)

(0.39)

(4.55) (2.99) (0.39) (0.13) (0.52)

(0.78)

7

16

2 3

6

32 12 1 4 4

5

(1.17)

(2.67)

(0.33) (0.5)

(1)

(5.34) (2) (0.17) (0.67) (0.67)

(0.83)

14

56

29

10

3 15

20 11

28

169 18 13 29 32

61

(0.55)

(2.19)

(1.14)

(0.39)

(0.12) (0.59)

(0.78) (0.43)

(1.1)

(6.62) (0.71) (0.51) (1.14) (1.25)

(2.39)

64

160

74

30

8 20

26 26

69

390 83 32 55 71

131

(0.83)

(2.07)

(0.96)

(0.39)

(0.1) (0.26)

(0.34) (0.34)

(0.89)

(5.05) (1.07) (0.41) (0.71) (0.92)

(1.7)

176


from this sector was, however, quite strong. Therefore, such conditions were rare. Instead of privatization some programs included measures to deregulate markets, especially concerning private access. Reductions in import barriers referring to agricultural products have been frequent conditions. Liberalization of inputs was, on the other hand, rarely a condition for World Bank credit. Forty-six per cent of the programs contained conditions referring to the industry sector; 28 per cent referred to energy. Those accounted for about 5 per cent of all conditions, with the majority aiming at reducing subsidies and aligning prices. With respect to the industry sector these conditions have been, however, less stringent than in other sectors (Ferreira and Keely 2000, p. 162). Overall, between 1980–84 conditions focused primarily on international trade and the fiscal sector. Thereafter, conditions referring to the financial sector as well as privatization and institutional reforms gained importance. In 1987 it became obvious to the Bank that the adjustment process would take longer than previously anticipated. At the same time the perception became prominent that the poor should be better protected from adverse effects of the adjustment programs. Since then, Policy Framework Papers included assessments of the programs’ social consequences.6 Nevertheless in 1988 only one adjustment loan covered a poverty alleviation program; between 1980–87 there were two (Knudsen and Nash 2000, p. 136). Of all conditions between 1980–88 less than 1 per cent referred to protection of the poor (Table 6.4). Not until the beginning of the 1990s did poverty reduction became a central element of adjustment programs (Ferreira and Keely 2000, p. 188). Since then, gender equality is made a condition as well. In 1986, the IMF introduced its Structural Adjustment Facility (SAF). With the introduction of this facility, another kind of condition – structural benchmarks – has been established. If those conditions, which were not provided for under the IMF guidelines, are not met, access to credit tranches is not automatically terminated. Non-compliance with these benchmarks might lead Fund staff, however, to be more stringent if performance criteria are not achieved. Moreover, though the importance of structural benchmarks within the Fund is not clear, non-compliance can lead to program interruptions (IMF 2001, p. 17). Compared to traditional performance criteria structural benchmarks are much more microeconomic, which reflects, to some extent, the shifted focus of the Fund.7 Whereas its initial focus has been to provide short-term balance of payments support, it increasingly evolved to a development agency with a focus on growth in borrowing countries. Table 6.5 shows the distribution of the IMF’s structural conditionality between 1987–99. Overall, the by far greatest number of conditions extended


Table 6.5

177

Conditions in World Bank Country Assistance Strategy Papers (17 programs), 1998–2000 Number of conditions included in programs

I. Monetary and financial policies 1. Limit on credit expansion a. Net domestic assets or total bank credit 2. Reform of the financial system a. Closing of insolvent banks b. Restructuring/recapitalization of the banking system c. Introduction/restructuring of deposit insurance scheme d. Enhance surveillance and transparency e. Privatization of banks 3. Grant/improve independence to central bank 4. Inflation 5. Target on foreign reserves II. Public sector policies 1. Restraint on central government expenditures a. Freezing, reduction or postponement of wage increases b. Freezing or reduction of government employee numbers c. Ceiling on current expenditures 2. Freezing or reduction in expenditure arrears 3. Tax policy a. Improve or reform (tax) administration 4. Non-financial public enterprises a. Privatization b. Improve institutional efficiency 5. Reduction of deficit as per cent of GDP 6. Raise investment, design program or build institutional capacity

Number of programs including conditions

no.

%

no.

%

25 1 1

(6.36) (0.25) (0.25)

12 1 1

(70.59) (5.88) (5.88)

19 2 2

(4.83) (0.51) (0.51)

11 2 2

(64.71) (11.76) (11.76)

1

(0.25)

1

(5.88)

2

(0.51)

2

(11.76)

6 2

(1.53) (0.51)

6 2

(35.29) (11.76)

2 1 41 4

(0.51) (0.25) (10.43) (1.02)

2 1 16 3

(11.76) (5.88) (94.12) (17.65)

1

(0.25)

1

(5.88)

2

(0.51)

2

(11.76)

1 1

(0.25) (0.25)

1 1

(5.88) (5.88)

6 6

(1.53) (1.53)

5 5

(29.41) (29.41)

11 10 1 7

(2.8) (2.54) (0.25) (1.78)

10 10 1 7

(58.82) (58.82) (5.88) (41.18)

2

(0.51)

2

(11.76)

178


Table 6.5

(continued) Number of conditions included in programs

7. Expenditure management 8. Decentralization 9. Governance III. Exchange and trade policies 1. Liberalization and reform of trade system a. Liberalization of imports IV. Structural adjustment measures 1. Developing and restructuring of a subsector a. Infrastructure, telecommunication and energy b. Health and education c. Agriculture d. Land 2. Labor market reform and liberalization 3. Judicial reform 4. Maintain/ enhance security 5. Fight AIDS 6. Improve pension system 7. Protection a. Of the rights of women b. Of the poor/social sector 8. Wages and prices a. Reduction in price distortions 9. Improve business environment/ competition V. Improve database/ statistics VI. IFI related conditionality 1. Adhere to IMF programs 2. Adequate program implementation 3. Implementation of PRSP VII. Satisfactory macro framework Source:

CAS Paper, www.worldbank.org.

Number of programs including conditions

no.

%

no.

%

4 2 4 6 6

(1.02) (0.51) (1.02) (1.53) (1.53)

4 2 4 4 4

(23.53) (11.76) (23.53) (23.53) (23.53)

2 62 26

(0.51) (15.78) (6.62)

2 16 12

(11.76) (94.12) (70.59)

11

(2.8)

8

(47.06)

8 4 3 1

(2.04) (1.02) (0.76) (0.25)

7 4 3 1

(41.18) (23.53) (17.65) (5.88)

2 3 1 5 11 1 10 3 3 7

(0.51) (0.76) (0.25) (1.27) (2.8) (0.25) (2.54) (0.76) (0.76) (1.78)

2 3 1 5 10 1 10 3 3 7

(11.76) (17.65) (5.88) (29.41) (58.82) (5.88) (58.82) (17.65) (17.65) (41.18)

1 21 6 13 2 5

(0.25) (5.34) (1.53) (3.31) (0.51) (1.27)

1 13 6 13 2 5

(5.88) (76.47) (35.29) (76.47) (11.76) (29.41)


179

to the fiscal sector. Of these, 40 per cent referred to tax systems and tax administration, like the introduction of value added tax or implementation of excise taxes on all cigarettes. Expenditures and public sector management amounted for 30 per cent of fiscal sector conditions. Other areas covered have been civil service reform and debt management (IMF 2001, p. 27). During the Asian crisis, conditions referring to the financial sector gained importance. They amounted to almost 24 per cent of the Fund’s structural conditions between 1997–99. Of these, 20 per cent focused on the monetary policy framework, for example on changes in the system of reserve requirements and the introduction or modification of central bank laws to give the central bank more autonomy. 50 per cent of the financial conditions referred to banking regulations and supervision. A typical condition in this area has been the liquidation of a certain bank at a certain time. Financial liberalization amounted to about 10 per cent of financial conditionality (IMF 2001, p. 27). Another condition that gained importance since 1987 has been privatization. There, a typical condition was to privatize, for example, 80 enterprises at a fixed date. The importance of some formerly central areas, on the other hand, declined over time. The trade sector amounted for only 6 per cent of structural conditionality. Conditions have been evenly divided between tariff and non-tariff barriers and focused chiefly on the most restrictive aspects of borrowing countries’ trade regimes (IMF 2001, p. 9). Public enterprises and reforms of the exchange system also lost importance. Overall, structural conditionality has increased substantially after the introduction of the SAF. Between 1985–86 less than 20 per cent of upper credit tranche Stand-By and Extended Arrangements included conditions related to structural measures (IMF 2001, p. 8). At the end of the decade, such conditions have been covered under almost two-thirds of the arrangements whereas by the mid 1990s they were included in almost all programs. The average number of structural conditions per program year in 1987 has been two. In 1994 this number has increased to seven and between 1997–99, on average, there were 14 (IMF 2001, p. 9). The by far largest share of these structural conditions referred to benchmarks. However, with the introduction of new facilities, the number of binding conditions also began to rise. Between 1952–73, on average 4.23 binding conditions were included in IMF programs. This number rose to 7.13 between 1974–82 and 12.07 between 1983–1990. In 1991–95 it rose further to an average of 12.42 (Gould 2001, p. 6). The average number of performance criteria from 1995–99 was 12.4 of which 5.4 have been structural criteria (Goldstein 2000, Table 4). In Stand-By Arrangements publicly available, between 1999–2001 the average number of performance criteria was 8.3 whereas total conditions averaged 18.8.8 Poverty Reduction and Growth Facility arrangements included 23.4 conditions of which ten

180


were performance criteria. This increase in the number of conditions has partially been due to the Fund’s increasing scope. However, the number of conditions covering areas like exchange and trade systems as well as the fiscal and financial sectors also increased. Owing to this large number of conditions, it became increasingly difficult for borrowing countries to identify those conditions which were crucial for further Fund support. In many programs the boundaries between what was demanded by the Fund and a country’s own policies became blurred. In the beginning of the 1990s, the Fund’s critics increasingly claimed that IMF programs were anti poor. Even though the Fund tried to take this into account in more recent programs it generally did not establish pro poor measures under its conditionality. Poverty reduction is mentioned as a major goal in almost all recent programs. However, it is rarely covered by mandatory conditionality. Only structural benchmarks frequently included conditions to prepare action plans, increase allocations to the health sector or improve immunization of the population. Sectors like health and education have, however, usually been spared from budgetary cuts. Moreover, reductions of transfers and subsidies were normally no longer included in IMF programs. Table 6.6 and Table 6.7 plot conditions included in recent Stand-By and Poverty Reduction and Growth Facility (PRGF) Arrangements, respectively. As can be seen, compared to earlier periods, conditionality became much more detailed. Instead of relying on aggregate spending ceilings, the IMF included detailed conditions on the content of government expenditures. In this area, collaboration with the Bank was common.9 Between 1999–2001 more than 65 per cent of all evaluated Stand-By Arrangements included conditions concerning borrowing Table 6.6

Distribution of IMF Structural Conditions, 1987–99 (per cent)

Exchange system Public enterprises Fiscal sector Privatization Financial sector Trade sector Pricing and marketing Systemic reforms Social security Source:

IMF (2001a, p. 24).

1987–90

1991–93

1994–96

1997–99

11.4 11.9 22.7 3.4 13.0 18.4 7.9 2.8 2.8

10.8 5.7 27.8 6.8 13.6 11.6 9.7 4.3 2.3

3.4 6.8 31.0 13.6 14.7 7.4 8.8 4.8 3.4

2.4 5.7 24.7 15.6 23.6 6.0 5.1 6.3 4.3


Table 6.7

181

Conditions in IMF Stand-By Arrangements (36 programs), 1999–2001 Prior actions

Number of conditions (average)* I. Monetary and financial policies 1. Limit on credit expansion a. Net domestic assets or total bank credit b. Bank credit to central government c. Bank credit to public sector 2. Interest rate policy 3. Reform of the financial system a. Closing of insolvent banks b. Restructuring / recapitalization of the banking system c. Introd. / restructuring of deposit insurance scheme d. Promote competition and liberalization e. Basel standards/ IAS f. Enhance surveillance and transparency g. Privatization 4. Grant independence to central bank 5. Target on foreign reserves II. Public sector policies 1. Restraint on central government expenditures a. Transfers and subsidies

Performance Structural criteria benchmarks

113 (10.27) 296 % 5 (45.45)

(8.22) 260

All conditions

(10.4)

669 (18.58) % 36 (100)

% 35 (97.22)

21

% (84)

32 (88.89)

2

(8)

32 (88.89)

31 (86.11)

1

(4)

31 (86.11)

11 (30.56) 1

11 (30.56)

(2.78)

1

1 (9.09) 4 (36.36)

1 (2.78) 5 (13.89)

1

3

(8.33)

4 (11.11)

1

(2.78)

1

(2.78)

1

(2.78)

1

(2.78)

3 2

(8.33) (5.56)

1

(9.09)

2 20

(8) (80)

(2.78)

(9.09)

2 (18.18)

1

(2.78)

1

(2.78)

2 2

(8) (8)

2

(5.56)

7 1

(28) (4)

30 (83.33) 7 (63.64) 2 (18.18)

1

(9.09)

34 (94.44) 6 (16.67)

2 (5.56) 24 (66.67)

9 (25) 1 (2.78) 30 (83.33)

21 1

(84) (4)

34 (94.44) 9 (25)

1

(2.78)

182

Table 6.7


(continued) Prior actions

2. Freezing or reduction in expenditure arrears 3. Tax Policy a. Improve or reform (tax) administration b. Reform of the tax system or tax basis 4. Non-financial public enterprises a. Privatization 5. Reduction of deficit as per cent of GDP III. External debt policies 1. Control of public and publicly guaranteed debt 2. Control of maturity 3. Reduction in arrears IV. Exchange and trade policies 1. Liberalization and reform of exchange rate a. Devaluation of the currency 2. Liberalization and reform of trade system a. Liberalization of imports V. Structural adjustment measures 1. Developing and restructuring of a subsector a. Infrastructure, telecommunication and energy b. Health and education c. Agriculture

1


All conditions

(9.09)

8 (22.22)

1

(4)

10 (27.78)

3 (27.27) 1 (9.09)

5 (13.89) 1 (2.78)

12

(48)

17 (47.22) 2 (5.56)

1

(4)

(8.33)

14

(56)

16 (44.44)

3 (8.33) 30 (83.33)

13 1

(52) (4)

15 (41.67) 30 (83.33)

31 (86.11)

2

(8)

32 (88.89)

31 (86.11)

1

(4)

32 (88.89)

9

(36)

27 (75) 9 (25) 16 (44.44)

1

(4)

5 (13.89)

3 (27.27) 3 (27.27) 1 (9.09)

5 (45.45)

3

27 (75) 9 (25) 5 (13.89)

4 (36.36)

1

(9.09)

1

1

(2.78)

(2.78)

3 (27.27)

4 (11.11)

6

(24)

11 (30.56)

2 (18.18)

2

(5.56)

2

(8)

5 (13.89)

8 (72.73)

6 (16.67)

12

(48)

20 (55.56)

3 (27.27)

3

(8.33)

5

(20)

9 (25)

3 (27.27)

2

(5.56)

4

(16)

7 (19.44)

2

(5.56)

1 3

(4) (12)

2 (5.56) 5 (13.89)

1

(9.09)


Table 6.7

183

(continued) Prior actions

2. Labor market reform and liberalization 3. Protection a. Of the poor b. Of the environment 4. Wages and prices a. Wage guidelines or wage reform policies b. Reduction in price distortions VI. Improve database/ statistics

2 (18.18) 2 (18.18) 6 (54.55) 1 (9.09) 5 (45.45) 1

(9.09)


All conditions

1

(2.78)

1

(4)

2

(5.56)

2 1 1 2

(5.56) (2.78) (2.78) (5.56)

10 10 1 2 1

(40) (40) (4) (8) (4)

13 (36.11) 12 (33.33) 2 (5.56) 9 (25) 2 (5.56)

2

(5.56)

2

(8)

8 (22.22)

6

(24)

6 (16.67)

Notes: % indicates the percentage of programs including a certain condition. * The average refers only to programs reporting conditions in that category. Since programs not reporting them may actually not include any, the number for prior actions is probably overstated. Source:

Letters of Intent, www.imf.org.

countries’ financial sectors. Of these, 9 per cent aimed at liquidation of insolvent banks, 30 per cent included bank privatization. Conditions referring to the liberalization of the capital account, which have been included in almost 20 per cent of Stand-By and Extended Arrangements between 1988–92 (see Table 6.1) were no longer included. Compared with this period, the development of subsectors was more frequently covered. In PRGF arrangements, those conditions have been included in more than 60 per cent of the programs. In all periods the most important sectors covered were infrastructure, telecommunication and energy. Compared to 1964–78, restrictions on the government’s wage bills and reductions in external payments arrears have more frequently been included since 1988. Today, a major component of structural benchmarks is privatization of non-financial public enterprises. These conditions cover almost all kinds of public enterprises, independent of their size and importance for the borrowing country’s economy. This had been different at the beginning of the Fund’s adjustment lending where only small enterprises were privatized. At this time, conditions on public enterprises were not very comprehensive, reflecting the lack of adequate data. During the 1980s, the IMF tried to improve performance through

184


measures like performance contracts, labor force reductions as well as price and market reforms. Later, establishing commercial management and divestment became more frequent. World Bank economists have mainly designed these reforms under IMF programs. Fund conditionality often was supportive of measures contained in Bank-supported public enterprise reform operations. The selection of public enterprises to be reformed as well as the modalities and timetable were developed by the Bank as well. The Fund only assessed the macroeconomic impact of these reforms. Instead of quantitative targets general commitments to phase out subsidies have been used (Decressin et al. 1999, p. 170). Conditions not previously mentioned contain measures to protect the environment, the rights of women and labor market reforms. Fifteen per cent of the programs between 1999–2001 included conditions on issuing better and timelier statistics based on qualitatively improved data. Scope and nature of quantitative performance criteria covered under PRGF and Stand-By Arrangements have been similar. However, in addition to similar numbers of quantitative performance criteria PRGF arrangements included a larger amount of structural benchmarks and qualitative performance criteria. Due to the nature of PRGF arrangements its focus lies more on structural reforms. Such reforms have been included in almost 90 per cent of the programs. Compared with Stand-By Arrangements layoffs in the public sector, payments arrears, tax policy and public enterprises have more frequently been covered under PRGF conditionality. In these programs conditions aimed at reducing corruption and strengthening the judiciary were also included. Overall, conditions concerning reforms of the financial sector as well as privatization and restructuring of the public sector gained weight relative to exchange rate and trade liberalization. Unfortunately, it is not possible to compare the conditions described directly with the content of more recent World Bank adjustment programs. However, the Bank has usually made its Country Assistance Strategy (CAS) papers publicly available since July 1998. These papers compile possible projects and programs for individual countries over a two to three year range. Usually implementation of so-called triggers decides on the amount the World Bank is willing to lend to a country. Though CAS are generated with the assistance of country representatives they are not negotiated documents. They represent the Bank’s strategy for that country and disclose information on country authorities’ conflicting views. Table 6.8 provides an overview of conditions contained in recent CAS. Comparison to Table 6.4 emphasizes the changed focus. Though there have been financial conditions in earlier adjustment programs, the increased importance of these conditions over time is evident. The most


Table 6.8

185

Conditions in IMF PRGF Arrangements (31 programs), 1999–2001 Prior action

Number of conditions (average)* I. Monetary and financial policies 1. Limit on credit expansion a. Net domestic assets or total bank credit b. Bank credit to central government c. Bank credit to public sector 2. Reform of the financial system a. Closing of insolvent banks b. Restructuring / recapitalization of the banking system c. Introduc. / restructuring of deposit insurance scheme d. Basel standards/ IAS e. Enhance surveillance and transparency f. Privatization 3. Target on foreign reserves II. Public sector policies 1. Restraint on central government expenditures a. Freezing, reduction or postponement of wage increases b. Freezing or reduction of government employee numbers c. Military expenditure

91

7


All conditions

(7.58) 320 (10.32) 313 (10.1)

724 (23.4)

% (58.33)

% 31 (100) 31 (100)

(50)

1

(3.23)

% 31 (100) 31 (100)

19 (61.29)

19 (61.29)

30 (96.77)

30 (96.77)

3 6

% 19 (61.29)

(9.68)

7 (22.58)

3 19 (61.29)

(9.68)

21 (67.74)

1

(3.23)

2

(6.45)

3

2

(6.45)

3

(9.68)

4 (12.9)

2

(6.45)

2

(6.45)

1 1

(3.23) (3.23)

2 1

(6.45) (3.23)

1

(3.23)

(9.68)

4 1

(33.33) (8.33)

3 (9.68) 21 (67.74)

8 (25.81)

9 (29.03) 21 (67.74)

11 5

(91.67) (41.67)

27 (87.1) 2 (6.45)

29 (93.55) 13 (41.94)

31 (100) 14 (45.16)

4

(33.33)

1

(3.23)

1

(3.23)

1

(3.23)

10 (32.26)

2

(6.45)

2

(6.45)

11 (35.48)

2

(6.45)

186

Table 6.8


(continued) Prior action

2. Freezing or reduction in expenditure arrears 3. Tax Policy a. Improve or reform (tax) administration b. Reform of the tax system or tax basis c. Freezing or reduction of taxes d. Increase in taxes 4. Non-financial public enterprises a. Privatization 5. Reduction of deficit as per cent of GDP III. External debt policies 1. Control of public and publicly guaranteed debt 2. Control of maturity 3. Reduction in arrears IV. Exchange and trade policies 2. Liberalization and reform of trade system a. Liberalization of imports b. Export promotion measures c. Capital account liberalization V. Structural adjustment measures 1. Developing and restructuring of a subsector a. Infrastructure, telecommunication and energy b. Health and education c. Agriculture

Performance Structural criteria benchmarks 12 (38.71)

5 1

(41.67) (8.33)

2

(6.45)

2

(16.67)

2

(6.45)

2

All conditions

(6.45)

13 (41.94)

16 (51.61) 4 (12.9)

20 (64.52) 4 (12.9)

1

(3.23)

3

(9.68)

1

(3.23)

1 5

(8.33) (41.67)

5

(41.67)

1

(8.33)

1 4

(8.33) (33.33)

4

(33.33)

1

2

(16.67)

1

1

(8.33)

1

(3.23)

1

(8.33)

1

(3.23)

5

(41.67)

3

3

11 (35.48)

21 (67.74)

11 (35.48) 15 (48.39)

21 (67.74)

31 (100) 31 (100)

29 (93.55) 22 (70.97) 1 (3.23)

3

(9.68)

1 (3.23) 22 (70.97) 22 (70.97) 15 (48.39) 31 (100) 31 (100)

13 (41.94)

29 (93.55) 22 (70.97) 15 (48.39)

(3.23)

5 (16.13)

7 (22.58)

(3.23)

4 (12.9)

5 (16.13)

11 (35.48)

26 (83.87)

27 (87.1)

(25)

7 (22.58)

17 (54.84)

19 (61.29)

(25)

7 (22.58)

16 (51.61)

18 (58.06)

4 (12.9) 1 (3.23)

5 (16.13) 1 (3.23)

1

(3.23)


Table 6.8

187

(continued) Prior action

2. Labor market reform and liberalization 3. Judicial reform 4. Fight corruption 5. Protection of the poor 6. Wages and prices a. Reduction in price distortions VII. Improve database/ statistics

Performance Structural criteria benchmarks 2

1 1

(8.33) (8.33)

1 1

(8.33) (8.33)

2

(6.45)

(6.45)

All conditions 2

(6.45)

3 (9.68) 1 (3.23) 7 (22.58) 2 (6.45) 2 (6.45)

4 (12.9) 2 (6.45) 8 (25.81) 3 (9.68) 3 (9.68)

8 (25.81)

8 (25.81)

Notes: % indicates the percentage of programs including a certain condition. * The average refers only to programs reporting conditions in that category. Since programs not reporting them may actually not include any, the number for prior actions is probably overstated. Source:

Letters of Intent, www.imf.org.

frequent condition included in this area has been bank privatization (included in 35 per cent of the programs analysed). Reform of the judiciary has been envisioned in 11 per cent of the CAS under review. Other conditions that were not included in the 1980s referred, for example, to corruption and public safety. Measures designed to protect the social sector as well as conditions improving education and health also became more prominent. Conditions targeted at reduced government expenditures have gained relevance. They have been included in 20 per cent of the CAS. Moreover, these cuts were enhanced by measures included in IMF programs, compliance with which was part of conditionality in 35 per cent of the evaluated CAS. The satisfactory implementation of Bank projects has been included as a trigger condition in almost 80 per cent. Ten per cent referred to implementation of strategies covered under the borrowing country’s Poverty Reduction Strategy Paper, which is also the basis for credits under the IMF’s Poverty Reduction and Growth Facility.

SUMMARY AND CONCLUSIONS This chapter has presented a detailed description of IMF and World Bank conditionality. It has been shown that the nature of conditionality

188


has changed over time. Whereas the IMF was founded to provide shortterm balance of payments loans, its more recent programs aim to increase growth and reduce poverty in the borrowing countries. Over time, conditionality of IMF and World Bank converged. Both institutions have included many structural conditions in their recent programs. The huge number of conditions included under IMF and World Bank programs has frequently been attacked – by researchers, the public, and the IFI’s major shareholders. As a consequence, the IMF officially announced that it would reduce the number of conditions under its programs. According to the Fund’s new guidelines (as revised in September 2002), parsimony in the application of conditionality is one of five major principles that are key to effective program implementation (see IMF 2004). However, Killick (2004a) observed that there is only variable acceptance of streamlining conditionality among IMF staff, although management and Board seemed to endorse streamlining (while still supporting the principle of conditionality). The resulting reduction in the number of IMF conditions does consequently not seem to be universal. While there is evidence that the average number of conditions has declined in recent arrangements (IMF 2001b: 294, Abdildina and Jaramillo-Vallejo 2004), there seems to be no reduction in the number of conditions in programs with low-income countries. Especially in those low-income countries reliance on conditionality remains high (Killick 2004a). The World Bank, to the contrary, has recently reformed its structural adjustment lending. Instead of lending under the Structural Adjustment Facility, the Bank now intends to support countries’ own programs – without detailed conditions (Killick 2004b). Whether and to what extent the IFI’s conditions change in practice and how this affects the success of their programs is an important question for future research. While the aim of this chapter was to provide an overview of the development of conditionality, it is important to also understand the reasons for this development. Arguably, the development of conditionality as described above might be one major channel contributing to the ongoing process of economic globalization (see Dreher 2006a, Dreher, Gaston and Martens 2008). Recent research in Dreher and Jensen (2007), Stone (2008) and Dreher, Sturm and Vreeland (2006, 2009) clearly shows that the IMF and the World Bank are controlled by their major shareholders. It is shown that closer allies of the G7 countries receive IMF programs with fewer conditions.10 Temporary members of the UN Security Council receive more IMF programs (at fewer conditions) and more projects from the World Bank. When the G7 employ the IMF and the World Bank to reward their friends and punish their enemies, they are also likely to


189

induce the Fund and Bank to design conditions in their favor. In fact, Gould (2001) reports that even private banks can push the IMF to include conditions in their favor. All this implies that policies all over the world are likely to be more similar than they would be without the existence of the IFIs. Clearly, the IMF and World Bank have not been founded as a tool for expanding globalisation in the interest of the institutions’ major shareholders. The abuse of the IMF and World Bank bears important implications for reforming the IFIs. To prevent the abuse of the IMF and the World Bank, the institution’s main governing body – the Executive Board – must be made independent, much like central bank presidents have been given independence domestically in many countries. The Directors who sit on the Executive Board should be appointed for long, non-renewable terms, which do not coincide with the election cycles of the major shareholders. Only when the governance of the IFIs is freed from pursuing foreign policy objectives can we expect the institution to function according to its mandate. Clearly, economic globalization will most likely continue without the pressure of the IMF and the World Bank on their borrowing countries’ policies. However, democratically elected governments would be free to choose those policies they regard as being in the best interest of their country, without the (indirect) intervention of G7 countries via the Fund and Bank.

NOTES 1. 2. 3. 4. 5. 6.

7. 8.

Clearly, the Institutions’ conditionality is not the only part of their activities that came under fire. For recent discussion on how to reform IMF and World Bank see Meltzer (2006a, 2006b) and Krueger (2006). See, e.g. Dreher (2004), Dreher and Vaubel (2004b), Stone (2008), Dreher and Jensen (2007), Vreeland (2003). Such misbehavior would be, for example, if the Fund’s resources would be used to finance capital flights or rearmament (Dell 1981: 6). See ‘Fund-Bank Collaboration’, memorandum to the Members of the Executive Board from the Secretary to Department Heads from the Managing Director, 13 December 1966. However, it has been argued that governments sometimes include their preferred policies among the Fund’s conditions to increase their leverage over domestic opposition (e.g. Vreeland 1999). Policy Framework Papers have been prepared by the IFIs’ staff with collaboration of the member country. They included economic objectives and macroeconomic as well as structural policies for three-year adjustment periods supported under the IMF’s Enhanced Structural Adjustment Facility (ESAF). A detailed description of structural conditionality since 1987 can be found in IMF (2001a). Dreher and Vaubel (2004a, Table 1) report the number of performance criteria for each single year from 1956–2002.

190 9. 10.

The law and economics of globalisation For example, in Bolivia’s 1994 program a detailed Bank study served as input to the design of fiscal policy (Decressin et al. 1999, pp. 167–214). For a recent survey, see Steinwand and Stone (2008).

REFERENCES Abdildina, Zhanar and Jaime Jaramillo-Vallejo (2004), Streamlining Conditionality in Bank and Fund Supported Programs, Development Policy Forum ‘Conditionality Revisited’, World Bank. Beveridge, W.A. and M.R. Kelly (1980), ‘Fiscal Content of Financial Programs Supported by Stand-By Arrangements in the Upper Credit Tranches, 1969–78’, IMF Staff Papers, 27, 205–49. Bird, Graham and Thomas D. Willett (2004), ‘IMF Conditionality, Implementation and the New Political Economy of Ownership’, Comparative Economic Studies 46(3). Chhibber, Ajay and Javad Khalilzadeh-Shirazi (1991), ‘Public Finance’, in Vinod Thomas et al. (eds), Restructuring Economies in Distress – Policy Reform and the World Bank, Oxford: Oxford University Press, pp. 20–43. Collier, Paul (1997), ‘The Failure of Conditionality’, in: C. Gwin and J. Nelson (eds), Perspectives on Aid and Development, Overseas Development Council. Decressin, Jorg et al. (1999), ‘Moving Ahead with Structural Reform’, in H. Bredenkamp and S. Schadler (eds), Economic Adjustment in Low-Income Countries, Washington, D.C.: International Monetary Fund, pp. 167–214. Dell, Sidney (1981), ‘On Being Grandmotherly: The Evolution of IMF Conditionality’, Essays in International Finance No. 144, Princeton, N.J. Dell, Sidney (1982), ‘The Political Economy of Overkill’, in: J. Williamson (ed), IMF Conditionality, Cambridge, M.A.: Institute for International Economics, pp. 17–46. Dollar, David and Jakob Svensson (2000), ‘What Explains the Success or Failure of Structural Adjustment Programs?’, Economic Journal, 110(466), 894–917. Drazen, Allan (2002), Conditionality and Ownership in IMF Lending: A Political Economy Approach, CEPR Discussion Paper 3562. Dreher, Axel (2006a), ‘Does Globalization Affect Growth? Evidence from a New Index of Globalization’, Applied Economics, 38(10), 1091–110. Dreher, Axel (2006b), ‘IMF and Economic Growth: The Effects of Programs, Loans, and Compliance with Conditionality’, World Development, 34(5), 769–88. Dreher, Axel (2004), ‘A Public Choice Perspective of IMF and World Bank Lending and Conditionality’, Public Choice, 119(3–4), 445–64. Dreher, Axel (2003), ‘The Influence of Elections on IMF Program Interruptions’, The Journal of Development Studies, 39(6), 101–20. Dreher, Axel, Noel, Gaston, and Pim Martens (2008), Measuring Globalization – Gauging its Consequences, Berlin: Springer. Dreher, Axel and Nathan Jensen (2007), ‘Independent Actor or Agent? An Empirical Analysis of the Impact of US Interests on IMF Conditions’, The Journal of Law and Economics, 50(1), 105–24. Dreher, Axel and Roland Vaubel (2004a), ‘The Causes and Consequences of IMF Conditionality’, Emerging Markets Finance and Trade, 40(3), 26–54.


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Dreher, Axel, and Roland Vaubel (2004b), ‘Do IMF and IBRD Cause Moral Hazard and Political Business Cycles? Evidence from Panel Data’, Open Economies Review, 15(1), 5–22. Dreher, Axel, Jan-Egbert Sturm and James Vreeland (2009), ‘Development Aid and International Politics: Does Membership on the UN Security Council Influence World Bank decisions?’, Journal of Economic Development, 88, 1–18. Dreher, Axel, Jan-Egbert Sturm and James Vreeland (2006), ‘Global horse trading: IMF loans for votes in the United Nations Security Council’, European Economic Review, forthcoming. Feldstein, Martin (1998), ‘Refocusing the IMF’, Foreign Affairs, March/April, 20–33. Ferreira, Francisco H. G. and Louise C. Keely (2000), ‘The World Bank and Structural Adjustment: Lessons from the 1980s’, in Christopher L. Gilbert und David Vines (eds), The World Bank – Structure and Policies, Cambridge: Cambridge University Press, pp. 159–89. Gelb, Alan and Patrick Honohan (1991), ‘Financial Sector Reform’, in Vinod Thomas et al. (eds), Restructuring Economies in Distress – Policy Reform and the World Bank, Oxford: Oxford University Press, pp. 76–99. Goldstein, Morris (2000), IMF Structural Programs, Paper prepared for NBER Conference on ‘Economic and Financial Crisis in Emerging Market Economies’, mimeo. Gould, Erica R. (2001), ‘The Changing Activities of International Organizations: The Case of the International Monetary Fund’, Paper presented at the APSA 2001 conference, mimeo. International Financial Institution Advisory Commission, IFIAC (2000), Report of the International Financial Institution Advisory Commission. Washington, D.C.: US Government Printing Office. International Monetary Fund (2001a), Structural Conditionality in Fund-Supported Programs, 16 February, www.imf.org. International Monetary Fund (2001b), Conditionality in Fund-Supported Programs – Policy Issues, Washington, D.C. International Monetary Fund (2004) Fund Conditionality – A Provisional Update, IMF Staff Paper, Development Policy Forum ‘Conditionality Revisited’, World Bank. Kapur, Devesh, John P. Lewis and Richard Webb (1997), The World Bank – Its First Half Century, vol. 1, Washington, D.C.: Brookings Institution Press. Killick, Tony (2004b), Did Conditionality Streamlining Succeed? Development Policy Forum ‘Conditionality Revisited’, World Bank. Killick, Tony (2004b), ‘Conditionality and IMF Flexibility’, mimeo. Killick, Tony (1995), IMF Programmes in Developing Countries – Design and Impact, London: Routledge. Knudsen, Odin and John Nash (1991), ‘Agricultural Policy’, in Thomas Vinod et al. (eds), Restructuring Economies in Distress – Policy Reform and the World Bank, Oxford: Oxford University Press, pp. 130–51. Krueger, Anne O. (2006), ‘A Response to Allan Meltzer’, The Review of International Organizations, 1(1), 61–4. Loxley, John (1986), Debt and Disorder – External Financing for Development, Boulder and London: Westview Press. McCleary, William A. (1991), ‘The Design and Implementation of Conditionality’,

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in Thomas Vinod et al. (eds), Restructuring Economies in Distress – Policy Reform and the World Bank, Oxford: Oxford University Press, pp. 197–214. Meltzer, Allan H. (2006a), ‘Reviving the Bank and the Fund’, Review of International Organizations, 1(1), 49–59. Meltzer, Allan H. (2006b), ‘Reply to Anne Krueger’, Review of International Organizations, 1(1), 65–67. Nellis, John R. (1991), ‘Reform of Public Enterprises’, in Vinod Thomas et al. (eds), Restructuring Economies in Distress – Policy Reform and the World Bank, Oxford: Oxford University Press, pp. 127–130. Radelet, Steven and Jeffrey Sachs (1998), ‘The East Asian Financial Crisis: Diagnosis, Remedies, Prospects’, Brookings Papers on Economic Activity, 2, 357–371. Santiso, Carlos (2003), ‘Development Finance, Governance and Conditionality: Politics Matter’, International Public Management Network Journal, 7(1). Schadler, Susan (1995), ‘IMF Conditionality: Experience Under Stand-By and Extended Arrangements, Part I: Key Issues and Findings’, Occasional Paper 128, Washington, D.C.: IMF. Spraos, John (1986), IMF Conditionality: Ineffectual, Inefficient, Mistargeted, Princeton, N.J.: Princeton University International Finance Section, Department of Economics. Steinwand, Martin and Randall Stone (2008), ‘The International Monetary Fund: A Review of the Recent Evidence’, Review of International Organizations, 3(2), 123–149. Stone, Randall (2008), ‘The Scope of IMF Conditionality’, International Organization, 62(4), 589–620. Thomas, Vinod (1991), ‘Trade Policy Reform’, in Vinod Thomas et al. (eds), Restructuring Economies in Distress – Policy Reform and the World Bank, Oxford: Oxford University Press, pp. 47–71. Vreeland, James (2003), The IMF and Economic Development, Cambridge: Cambridge University Press. Vreeland, James (1999), The IMF: Lender of Last Resort or Scapegoat?, Manuscript, Yale University. Williamson, John (1983), ‘The Lending Policies of The International Monetary Fund’, in: John Williamson (ed), IMF Conditionality, Cambridge, M.A.: Institute for International Economic, pp. 605–60. World Bank (1990), ‘Adjustment Lending: Policies for Sustainable Growth’, Policy and Research Series 14, Washington, D.C.

7.

How globalisation improves governance Federico Bonaglia, Jorge Braga de Macedo and Maurizio Bussolo*

INTRODUCTION Globalisation, governance and economic performance affect each other in very complex mutual relationships, not least because of severe measurement difficulties. We try here to establish whether there is an effect of globalisation on governance and, even more specifically, to test how openness can affect the quality of domestic institutions. To do so, we survey available theoretical explanations of causal relationships between globalisation and governance. In the last 20 years or so, economists have changed their views on these relationships more than once. At the time of the fall of the Berlin Wall and after the disillusions of the inward looking economic policies of many developing regions in the world, the shared view was that liberal democracy had triumphed worldwide, Communism was over, and the advent of true global economic progress would be brought by free markets and minimal states. A ‘Washington Consensus’ based on these ideas had emerged. A few years later, innovative and cheaply available communication possibilities and the ensuing new economy revolution reinforced the view that the market and its globalising forces would bring huge benefits for all. However, the main problem of this Washington Consensus is that, even after repeated attempts, it has not really delivered a ‘Moscow Success’, or a ‘Latin American Miracle’. Indeed, even the East Asian one, which superficially looked like a diligent application of the Washington paradigm, had to sail through stormy waters. Due to these setbacks and their own scepticism for the standard recommendations, economists have reconsidered the important role of public intervention in fostering the 20-year long East Tigers’ booming phase; they have contrasted the recent mediocre growth performance of regions following orthodox recommendations, such as Latin America and Eastern Europe, with the success cases of China, India and others that joined the global economy in an unorthodox – gradual, sequential and still partial – manner; and many are persuaded that 193

194


effective states as well as efficient markets are both crucial ingredients for a successful human society. The issue on how state and market, yet another manifestation of globalization and governance, should be combined and whether institutional arrangements should be uniform across countries or wide local variations should be encouraged are still contentiously debated among international financial institutions.1 By investigating how globalisation influences governance, this chapter offers some interesting new evidence on a particular but potentially quite valuable dimension of their complex relationship. More specifically, we attempt to understand why increased openness and global integration should affect the quality of domestic institutions, and try to measure by how much. The chapter is organised in five sections: the next section discusses some stylised facts about the interaction between globalisation and governance emphasising some of the major difficulties researchers encounter in studying this subject and briefly reviews theories on the potential channels through which openness may influence governance quality. Sections 3 and 4 present our empirical assessment of the strength of these links. A final section concludes by summarising main findings and pointing out potential policy implications.

GLOBALISATION AND GOVERNANCE: FROM STYLISED FACTS TO THEORY Stylised Fact Figure 7.1 summarises links operating at the national level between globalisation, governance and economic performance. The top panel shows how a nation’s resource endowments and its productivity determine how fast it can grow and the level of its economic well-being in terms of income per capita (arrows 1 and 2). Feedbacks are possible: a richer country growing fast may invest more resources in scientific research and technology development, and thus enjoy higher productivity levels than a poorer, slow-growing economy; this explains why arrow 1 is double-sided. The bottom panel shows that, through trade, capital flows or migration, globalisation can influence the level of endowments available in an economy, or even, through international technology transfers, its productivity. Conversely a country’s endowments of natural resources, labour, and capital, as well as its geographic location and efficiency of its production structures may determine how much it trades with the rest of the world (arrow 3, which, like arrows 1, 2 have always been at the core of economic thought).

How globalisation improves governance Economic performance: per capita income levels, GDP growth rates

1

Productivity

Figure 7.1

2

Endowments

4

3

Globalisation

195

5

Governance

A map of the links between globalisation, governance and national economic performance

Similarly, a country with good governance, namely a democratic state with high-quality institutions, effective corruption-free accountable bureaucracies, and a flourishing civil society may likely increase the quality, if not the quantity, of its most important endowment: its own people. Once more, cause and effect can be swapped: well-endowed countries may evolve towards democratic forms of government more easily, or, at least, they may afford investing more resources to build well-functioning institutions (arrow 4). Recently new attention has been drawn towards arrow 5 and ‘how globalisation and governance interact to affect economic performance’ has become a topical question and the focus of the analysis of this chapter. Some interesting empirical stylised facts about arrow 5 have been highlighted in the literature. A clear pattern, for instance, linking government size and level of development has been identified long ago: richer economies on average have larger governments. Honouring a nineteenth-century German economist who first noticed it, this pattern takes his name: ‘Wagner’s Law’. Based more on historical observations than basic economic principles to make the inference, Wagner (1883) formulated a simple theory in which public expenditure growth was seen as a natural consequence of economic development. A very large literature followed and the validity of Wagner Law has survived recurrent scrutiny.2 A second empirical regularity is observed when government spending is measured across countries grouped according to their level of trade openness: countries trading more intensively have larger governments. It seems as if countries heavily relying on global markets tend to compensate the

196


ensuing risks they take with a bigger public sector. In fact, this is exactly the theory advanced by Rodrik (1999) who constructs a model where government size provides an indirect insurance against risks originating from global markets.3 By employing more people or through providing a social safety net, large governments partially insulate their citizens from global market fluctuations. Although contending theories may explain the size of the public sector, the simplicity of this model is appealing and its predictions are validated by empirical tests. Finally, another important relation is registered between GDP growth rates and trade openness: it seems that more open countries grow faster. The links between trade openness and growth are, however, much more complex and the debate among those who support globalisation as a positive growth factor and those who are more sceptical is not yet settled.4 Interestingly, if size of government expenditure is substituted for an index of the quality of the bureaucracy or for an index of perceived corruption, the above relationships are confirmed; once more, richer and more open countries display lower levels of perceived corruption, and hence better governance.5 In sum, one may be tempted to conclude that richer countries, as opposed to poorer ones, have a tendency to be more open to international trade and to have a larger and better public sector; or, in other words, that successful economies are able to combine the right mix of market and state, of globalisation and governance. However, these stylised facts point to broad connections with no indication of causality and, more fundamentally, they do not provide any clue on how, or why, the right combination of globalisation and governance could be achieved. Causality is one of the fundamental problems social scientists have to face when studying the relationship between economic performance, institutions and global markets, or any other economic relationship. On the one hand, many papers document how high quality institutions foster economic growth; on the other hand, evidence is accumulating on how developed countries may afford better institutions.6 Complexity is the other fundamental problem. The relationships we mentioned above connect pairs of variables; however, their links may be caused by the influence of other variables. Economic development, for instance, may be at the origin of a spurious relationship between government size and openness by simultaneously increasing the levels of both of them. Theory Explaining how globalisation affects governance and how it helps or hinders economic development raises the need to clearly identify causes

How globalisation improves governance

197

and effects and to take into account multiple factors. To do that we need to move from simple stylised facts to more complex theories and empirical tests. In particular, the central question we attempt to answer here is: why and by how much does openness influence the level of perceived corruption in a given country? On the surface, no relationship seems to link openness and corruption directly, and a brief digression on the theoretical determinants of corruption is useful before considering our results. Increased private gains are the main objective of corruption; however, among its crucial causes, we find economic as well as cultural and social variables. In a recent study, Treisman (2000) tests several hypotheses for the causes of corruption and offers a quite informative ranking of several corruption determinants.7 Clearly corruption is lower when its costs, including psychological and social, are higher than its benefits, and he finds that, on average, this is the case for those countries with Protestant traditions, those that are more developed and have higher quality governments. On the contrary, corruption is more pervasive when the state is federal, its democratic basis has been established only recently (less than 20 years), and, finally, when a country is less open to trade. More succinctly and using Klitgaard’s words, corruption thrives when monopoly power is combined with discretion and low accountability.8 Incentives to bribery do not arise in a society where all economic activities are carried out in a perfect competition setting with no single agent able to affect the price or the quantity of the product he sells or buys. By the same token, corruption is reduced when economic rents do not depend on the discretionary power of some public official, or when monopolistic economic activities as well as governments are subject to strict rules of accountability. Within this general framework, openness to international trade and capital flows may alter the balance between corruption costs and benefits through at least three mechanisms, which we now consider in turn. Krueger (1974) illustrates the first mechanism focusing on rent-seeking activities caused by quantitative restrictions on imports.9 In contrast to tariffs, quotas, and other official permissions to import generate considerable economic rents due to the monopolistic power they grant to legal importers. In order to appropriate these rents, agents may legally compete or embark in illegal rent-seeking activities such as bribery, corruption, smuggling and black markets. Krueger establishes that these rent-seeking activities induce an economy to operate at a level below its optimal, generate a divergence between private and social costs, and, thus, entail a welfare cost additional to that due to tariff restrictions. In successive papers, Bhagwati (1982) and Bhagwati and Srinivasan (1980) have generalised Krueger’s original idea to a whole array of Directly Unproductive, Profit-seeking (DUP) activities providing further arguments in favour of

198


trade liberalisation.10 More recently, Gatti (1999) presents some empirical evidence of the explicit link between restrictions on trade and capital flows and corruption.11 In fact, her empirical study aims at disentangling two effects of inward-oriented policies on corruption: the ‘direct policy distortion’ and the ‘foreign competition effect’. High barriers to international transactions directly encourage private agents to bribe public officials in exchange for favouritism, the first distortion, and, through the second effect, reduce competition between domestic and foreign firms so that margins for rent seeking, and corruption, are kept high. This second competition-reducing mechanism deserves some additional attention. Ades and Di Tella provide evidence that the level of rents in general, and market structure in particular, determine the degree of corruption intensity in an economy. Interestingly, they argue that changes in rent size due to variations in the degree of competition may have ambiguous effects on corruption.12 On the one hand, larger rents resulting from a low competition environment increase the amounts bureaucrats can extract as bribes; on the other hand, in such a situation, it becomes more valuable to a society to increase the monitoring and accountability of its bureaucracy (more on this below). Determining the correct sign of the net effect on corruption due to these two opposing tendencies may be theoretically important, however, looking at real world situations, one finds many examples of a positive connection between rents and corruption. A clear-cut case, cited by the authors, is that of oil-exporting countries: Nigeria, where 1980s oil exports generated about 80 per cent of government revenues and spurred a construction and import boom especially favouring the ruling party’s officials, provides a striking example of how rents cause corruption. These observations provide sufficient justification for Ades and Di Tella to build a model that links directly increased product market competition to lower rents and to lower corruption levels. In their model, three sets of variables determine corruption: wages of the bureaucracy, the level of monitoring, and the level of profits that, in turn, depend on the degree of competition. Bureaucracy wages and monitoring are indirectly captured by a society’s level of economic (GDP per capita and schooling, respectively) and political development (respect of political rights, an index from Gastil, 1982).13 Competition is proxied by the share of imports in GDP, the sectorconcentration of exports, and the distance from the world’s major exporters. For the same level of the other variables, countries less exposed to foreign imports, or with a large share of their exports attributable to natural resources, should suffer higher levels of corruption than those countries more integrated in world markets and with a differentiated export basis. Wei (2000), by explicitly considering differences in the costs and benefits of monitoring public officials due to the degree of international integration,


199

advances a final third mechanism linking globalisation to institutional quality.14 The basic idea is straightforward: improving the quality of institutions and their capacity to fight corruption depends on the amount of resources a society devotes to this end. A society invests more into building good institutions, the larger the benefits it receives or the smaller the costs. Given that foreign producers may divert their exports or investments from a national market to another more easily than domestic producers, one would expect corruption and bad governance to discourage international trade and capital flows more strongly than domestic commerce and investment. This differential effect of corruption induces stronger incentives towards good governance investments for those economies that are more open. Other things being equal and because of the resulting larger benefits, an economy more exposed to international markets would allocate more resources to fighting corruption and end up with a lower level of it compared with a more isolated inward-looking one. This model’s main result rests on two crucial assumptions. First, corruption must truly affect more severely international transactions than domestic ones. Wei (2000) provides justification for this arguing that, thanks to their better opportunities to do business elsewhere, foreigners enjoy stronger bargaining power vis-à-vis domestic agents. Alternatively, enforcement costs for international contracts, already starting at a higher level than those for domestic ones, increase more steeply with corruption. The second crucial assumption is concerned with the direction of causality: for Wei ‘being open’ comes before and independently of corruption, it is not a result of economic policy or business choices. In fact, it may be useful to examine further this general issue of causality for all the three openness-corruption links we have described. In the Krueger model, trade policy is exogenous and causality goes from trade barriers to corruption (or other rent-seeking activities) via a reduction of foreign competition and the creation of artificial rents in import regulated activities. In the Ades and Di Tella study, the degree of competition influences corruption, but this, in turn, by reaching certain intolerable thresholds, can provide incentives to alter the rules of competition. To overcome this circularity in their corruption regression, they measure import openness – a crucial proxy variable for competition – as if this was determined only by countries’ populations and land sizes. The identifying assumption here is that these variables affect corruption only through their effect on import openness, and that they cannot be altered by corruption. For the other variables – natural resources share in total exports or trade distance – the direction of causality does not present problems.

200


Finally, Wei’s solution to the causality problem is to consider two types of openness. The first, labelled natural openness, is the potential cause for corruption, and the second, residual openness, is the possible consequence of corruption. In his model, natural openness is determined by geographical measures, such as a country’s distance from major trading nations weighted by bilateral trade flows. Corrupt official erecting artificial trade barriers cannot alter this type of openness and will only affect what Wei calls residual openness. Our discussion of corruption determinants and causality issues is summarised in Figure 7.2. The three blocks on the left side represent three different sets of variables and the arrows depict the influences they exercise on corruption and each other. Apart from cultural and social variables and geography, all the other factors considered here can be affected by corruption, and this explains the double direction of the arrows. A complete model would take into account all of the variables and arrows and provide guidance on how to disentangle causality directions. However, as reported above, economic theories of corruption have not yet reached this ideal stage and we have to adopt several simplifying assumptions. In particular, in our empirical assessment, we introduce additional controls to avoid potential omitted variables bias: if, for instance, we knew that ethnic fractionalisation is strongly correlated with trade openness and determines low levels of corruption but is omitted from our regressions, then the positive influence we would attribute to openness should in reality be assigned to ethnic fractionalisation. Additionally, even if we consider economic policies as exogenous, we take into account potential reverse causality from corruption to other relevant economic variables and correct for this by using geographical determinants as instruments. Cultural and social variables

Economic policy environment

Geography

Figure 7.2

Economic variables: rents market structure, level of development, openness

Corruption determinants

Corruption


201

EMPIRICAL EVIDENCE: MODEL SPECIFICATION AND DATA The theories we briefly reviewed contribute to explain why openness has an effect on corruption; this and the next sections test these theories on data and offer an empirical assessment of how much openness influences corruption. The reduced form equations derived from the models described in the previous section and thus our estimations can be represented by the following equation or by some of its variations: 2 CORRUPTit 5 b0 1 b1 Opennessit 1 b2 log (GDPit) 1 b3 PolRit 1 b4 Otherit 1 b5 EcPolit 1 eit

(7.1)

Our focus is on the sign and magnitude of b1: the marginal effect of openness on corruption; however, as suggested by the theory on the causes of corruption, we introduce several additional explanatory variables. The level of development of a country, by influencing cultural attitudes towards corruption and by affecting the amount of resources that may be devoted to monitor public officials, is a key determinant of corruption levels and enters our equation in terms of Gross Domestic Product per capita (GDP). Similarly, a country’ score on basic political rights (PolR) may be a good proxy for its degree of accountability, another important factor explaining corruption. As shown above in Figure 7.2 and to avoid omitted variables bias, a series of other variables taking into account social and other causes for corruption is introduced in our empirical estimation (the Other variables we used are briefly described below). Finally, we test whether economic policy variables (EcPol), such as the degree of trade liberalisation or more general state intervention in the economy, have a direct effect on corruption. Among the Other variables group, exports’ sectoral concentration, trade remoteness, country size and additional ‘cultural’ traits are considered important independent determinants of corruption. Natural resource abundant countries will normally record sectorally concentrated exports, low degrees of competition, high rents, and widespread corruption. Less geographically remote countries are ‘naturally’ more open and need to invest more in institution building and are expected to show lower levels of perceived corruption.15 Small countries could more easily manage an efficient control over their territory and would therefore enjoy lower levels of corruption. Finally, certain important country characteristics such as their colonial past, religious tradition, ethnic composition as well as their

202


being a stable democracy have been frequently considered by studies on corruption and we add them to our list of controls. It should be noticed that Openness and GDP, at least, may suffer the problem of reverse causality; a corrupt bureaucracy may induce a lower degree of international integration by erecting discretionary barriers or even slow down the development process through excessive regulations and directly waste resources. If not corrected, reverse causality can be a serious drawback altering not only the magnitude of our bs 16 but also their meaning: instead of verifying whether openness or GDP influence corruption we would be picking up how much corruption affects our regressors. Endogeneity tests, described in the next section, have been carried out and fortunately the gravity of this problem does not seem too dramatic; however, we have performed standard two stage least squares estimations to provide convincing evidence that indeed openness exercises independent influence over perceived corruption effects. The problems of the selection of the instruments used in the first stage and the results of these estimations are detailed in the next section. A brief description of the data we used in our equations concludes this section. Quantitative studies of the determinants of corruption are relatively recent given that numerical measures for corruption have not been readily available in the past. In this study, we use two subjective indices of corruption as our dependent variable. These indices, produced for the use of international investors, are derived by standards questionnaires subjected to large random polls so that, by construction, they facilitate cross-country comparisons. In addition, their commercial value partially guarantees their accuracy. Objective indices would be preferable if they were measured consistently across countries and were independent of corruption itself. Consider, for instance, a measure such as reported fraud cases: its objective value may depend on country-specific definitions and local corruption-fighting systems so that a country with a true low level of corruption and efficient monitoring schemes may report more numerous fraud cases than a more corrupt country. Corruption indices used here are those produced by Transparency International (TI) and by the International Country Risk Guide (ICRG) of the PRS group. It should be noticed that we have rescaled these two indices to vary in a continuous interval between 0 and 10, where 10 reflect the best score, that is, the lowest level for corruption. Given that these two indices cover different country samples and time periods, we use both indices to test for robustness of our results. The TI sample contains yearly corruption data covering 53 countries for the period 1980–85, the same countries for 1988–92, and 75 countries for 1995–98. The ICRG sample includes 119 countries for the three periods of 1984–88, 1990–94, and 1995–98. Instead of using yearly


203

data, for both TI and ICRG, we calculated three year averages corresponding to the time intervals for which corruption indices were available. Due to the fact that yearly estimates for all our dependent variables and for all the countries covered by TI and ICRG do not exist, we preferred this averages approach to fill the gaps rather than restrict the sample to the few countries that present all the necessary data. In this way, we maximize cross-country variation while sacrificing little time variation. In Eq. (7.1), our initial measure for openness is given by the ratio of imports to GDP. The other economic variables, namely GDP per capita, the share of natural resource exports in total exports, government expenditure and consumption, and area17 were collected from the World Bank’s World Development Indicators.18 Remoteness is a weighted average of each country’s distance from its trading partners in which the weights are given by the share of exports of the country’s partners in global exports. Formally, it is constructed as: Remotenesskt 5 Si≠k wi log (distancek i), where: wi 5 exporti / Si≠k exporti

(7.2)

In fact, remoteness is a unilateral (not multilateral) measure of the distance of each country from a sort of economic geographic centre determined by the largest exporters in world trade. The political rights index – varying between 0 (worst score) and 10 (best score) – was obtained from Freedom House; ethnic fractionalisation and Protestant traditions dummies were derived from LaPorta, Lopez de Silanes, Shleifer and Vishny (1998); colonial past and democracy dummies were taken from Hensel (website) and Treisman (2000); the trade liberalisation index was kindly provided by the IMF, and geographical data (for example, distances, latitude, tropics dummy used to construct our instrumental variables) come from various sources.19 Table.7.A2 in the Appendix to this chapter presents summary statistics for the main variables used in our regressions. The number of observations for the ICRG and TI groups reflects the largest samples we were able to use in our most complete specification of Eq. (7.1), and it does not necessarily equal the sum across periods of all the countries covered by the corruption indices. Besides, the trade liberalisation index is only available for the 1995–98 time interval, and that explains the drop in the number of observations. A major difference between the ICRG and TI samples consists of the latter’s exclusion of a fair share of developing countries: this is noticeable in its higher mean for GDP per capita (TI’s GDP average is almost 30 per cent higher than that of ICRG). The large dimension of our samples provides

204


significant cross-country and time variation, resulting in high quality estimates of how globalisation improves governance, as claimed in the title.

HOW GLOBALISATION IMPROVES GOVERNANCE In this section, we present the main results of our empirical investigation on the links between globalisation and governance, or of openness on corruption. Simple correlations, the most basic statistical measure of quantitative relationship, are a good starting point and are shown in Table 7.1. Although they do not give any indication on causality, correlations in Table 7.1 represent a first approximate test for the corruption theories we described and offer an initial indication of the strength of the relationships. Openness, measured as a ratio of imports to GDP, is positively correlated with corruption: our data shows that countries with a higher degree of openness will, on average, also record lower levels of corruption. The same tendency applies, with stronger intensity, to the level of development. For each corruption index, two correlation values are shown in the table where the first is calculated using the full sample and the second using data from the last period only. In general, countries showing stronger accountability, proxied by the political rights index, lower sectoral concentration in their exports, lower geographic remoteness, smaller area, larger government involvement in their economy, and a high degree of trade liberalisation, also register low levels of corruption. Therefore, in all cases but for the Table 7.1

Corruption and explanatory variables: simple correlations ICRG

TI

Full sample Last period Full sample Last period LOG(M/GDP) [openness] LOG(GDP per capita) Political rights Oil-min exports Remoteness LOG(AREA) Trade liberalization index LOG(Government expenditure / GDP)* ICRG N. obs.

0.13 0.66 0.58 −0.25 −0.54 −0.01 – 0.49

0.14 0.68 0.65 −0.22 −0.52 −0.01 0.16 0.55

0.17 0.75 0.60 −0.19 −0.50 −0.11 – 0.44

0.14 0.82 0.63 −0.08 −0.52 −0.15 0.35 0.47

1.00 305

1.00 103

0.88 174

0.88 75

Note: * This variable is not available for all the observations included in the samples.


Table 7.2

205

Globalisation and corruption: OLS results

Estimation

(1)

Dependent var. Regressors C Log (M openness) Log (GDP per capita) Pol. rights Oil-min exports Remoteness Log (area) Trade lib. index LOG(gov expenditure / GDP)* R2 Number of obs

(2)

(3)

(4)

(1)9

(ICRG) −4.22 0.34 2.33 0.91 8.53 0.19 5.38

3.74 0.38 2.48 0.78 6.49 0.14 4.17 −0.73 −3.03 −0.89 −4.06 0.10 1.79

1.34 0.55 2.21 0.63 4.59 0.20 4.64 −0.13 −0.36 −0.60 −1.89 0.10 1.39

(2)9

(3)9

(4)9

TI −0.22 −12.67 0.51 0.57 1.98 2.72 0.60 1.70 4.35 9.12 0.21 0.10 4.50 1.78 −0.25 −0.72 −0.49 −1.49 0.11 1.44 −0.66 −0.84 0.51

−9.94 −11.26−14.57 0.53 0.60 0.45 2.53 2.06 1.33 1.61 1.62 1.55 7.57 5.85 5.09 0.09 0.10 0.06 1.65 1.68 0.82 −0.78 0.18 0.41 −1.65 1.19 0.58 −0.22 −0.20 −0.02 −0.83 −0.47 −0.04 0.01 0.07 0.03 0.13 0.61 0.20 0.00 0.02 1.45

1.49 2.59 0.49 0.55 0.60 0.61 0.63 0.64 0.70 0.73 305 305 103 103 174 174 75 75

Notes: * This variable is not available for all the observations included in the samples; t statistics are shown in italics below the estimates.

size of the government (more on this below), the sign of the relationship corresponds to that predicted by theories on the causes of corruption. More interesting results derived from multivariate OLS regressions are presented in Table 7.2. The parsimonious specifications in columns (1) and (1)9 indicate a positive impact of openness on the quality of governance, in our case a reduced level of corruption, for both samples. Our regressions are in linear-log specification, meaning that the dependent variable, corruption, is in linear format and the independent variables are in logarithmic format. In this specification we can interpret the bs as the marginal effect on corruption of a change in the logarithm of the dependent variable, or, as the marginal effect due to a relative (percentage) change in the independent variable in linear format.20 Using estimated coefficient from columns (1) and (1)9, the most basic specification of Eq. (7.1) predicts that a 10 per cent increase in import

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openness results in 0.03-point change in the corruption score (0.34 3 0.1) in the ICRG sample, and in 0.06-point change (0.57 3 0.1) in the TI case. This is a sizeable effect, especially when compared to the 0.09 and 0.17point changes due to a 10 per cent increase in log GDP per capita. Instead of an arbitrary 10 per cent change, it may in fact be more instructive to consider more realistic variations in the independent variables such as their observed standard deviations. This exercise results in a 0.18 reduction of corruption (0.34 3 0.53) for the ICRG sample and a 0.31 reduction (0.57 3 0.54) for the TI sample. To isolate the direct impact of openness on governance we need to consider other important simultaneous determinants of corruption: columns (2) and (2)9 introduce these additional controls to the basic specification. Controlling for dependence on oil and mineral exports, for remoteness and size does not change the overall picture. In these specifications a high explicative power is achieved, even if not all the included variables are significant at conventional levels. The basic results concerning openness and corruption are unchanged: the magnitude of import openness changes slightly and the coefficients remain statistically significant. Interestingly enough, while for the ICRG case dependence on natural resources, remoteness and, marginally, area, turn out to be significant determinants of corruption levels, these same variables do not appear to reach statistical significance in the TI case. Given a vast literature pointing to greater rent-seeking behaviour in natural resource abundant countries, and given that remoteness and area should influence negatively corruption according to the theories described above, one would expect these relationships to hold for both samples.21 Additionally, in the TI sample, openness has a much larger coefficient. These differences may originate for two reasons: the first has to do with the samples. The ICRG larger sample includes more countries than TI’s and these additional countries produce the differences in the regression results. The second source of difference may consist of variation in scoring methods between ICRG and TI so that countries, similar in their levels of openness and other explanatory variables, get different corruption evaluation by ICRG or TI. To check for these two possibilities we restrict ICRG sample to include just TI’s countries and re-run the regression in column (2). The results of this new regression (not displayed) show that ‘omitted’ countries do count; in particular, the restricted ICRG sample does not include enough oil exporting countries to allow a significant estimation of their effect on corruption; remoteness also loses significance due to the simple fact that the new sample mainly includes large world exporters, that is countries close to the economic geographic centre. However, it should be finally noticed


207

that, on a case by case basis, some variations in scoring methods have been identified and that they certainly contribute to the overall difference in the regression results across corruption indexes. The last two columns in each panel of Table 7.2 introduce policy variables as potential explanations of corruption. Columns (4) and (4)9 show how results vary when an index of trade policy liberalisation and a measure of the extent of government intervention, approximated by government consumption as a share of GDP, are introduced. Notice that since these variables are available just for the last period, columns (3) and (3)9 provide relevant comparable regressions. Basic findings are unchanged: the openness coefficient is slightly reduced (especially in the TI case), and trade liberalisation results insignificant for both ICRG and TI samples, whereas government size turns out to be not significantly different from zero just in the TI case. These results may at first appear surprising given the correlation indexes observed in Table 7.1 above. However, protection as proxied by the liberalisation index is fairly low for the most recent period we consider in our samples. Indeed, Gatti (1999) and Larrain and Tavares (2000) examined the effects of average protection and its sectoral dispersion and find very weak results confirming that trade protection may have some non-linear effect that becomes significant only when trade barriers are above certain levels. 22 As far as government size is concerned, this additional variable seems to make openness’ effect on corruption statistically insignificant in the TI sample. Various possible explanations for this can be thought of. First, the implicit endogeneity of government size with corruption: on the one hand higher public officials’ salaries should discourage corruption, on the other hand more pervasive state intervention in the markets may create artificial rents and strong incentives for corruption.23 Additionally, government size and openness are strongly correlated as shown by Rodrik and the introduction of the former in our regression may clearly affect the coefficient for the latter. Once more, if globalisation independently determines government size and corruption, then the coefficient of government size is wrongly estimated due to endogeneity bias. Recent empirical research on the causes of corruption and the quality of governments points out that a further series of social and cultural variables should be considered.24 In particular, the roles of ethnic fractionalisation, a colonial past, religious traditions, and long-term, stable democratic institutions are seen as important explanatory variables for the level of corruption. In Table 7.3 we add these additional cultural controls to specification (2) of the previous table. Table 7.3 shows that the coefficients on ‘protestant’ traditions, ‘democracy’ and ‘OECD’ membership are significant and show the right sign,

208

Table 7.3


Additional controls: cultural variables

Estimation

(2a)

(2b)

Dependent Var. Regressors C Log (M openness) Log (GDP) Pol. rights Oil-min exports Remoteness Log (area) Ethnic Frack. Colonial past Protestant Democracy OCED

R2 Number of obs

(2c)

(2d)

(2e)

(2a)9

(2b)9

ICRG

(2c)9

(2d)9

(2e)9

TI

2.00 0.45

1.97 0.45

3.39 0.43

1.64 0.41

2.83 0.92 5.86 0.14 3.70 −0.72 −2.69 −0.90 −4.07 0.11 1.82 0.73 1.67

2.83 0.92 5.81 0.14 3.61 −0.72 −2.67 −0.90 −3.74 0.11 1.75 0.73 1.66 −0.01 −0.05

2.54 0.77 4.89 0.10 2.80 −0.78 −3.06 −0.87 −3.99 0.09 1.45 0.41 0.89 0.10 0.39 1.54 4.99

2.19 0.89 5.11 0.08 1.93 −0.82 −2.98 −0.70 −3.16 0.00 0.06 0.76 1.57 0.18 0.71 1.40 4.36 0.75 2.82

0.26 −12.00 −11.78 −10.18 −11.17 −11.25 0.50 0.52 0.51 0.54 0.52 0.53 2.63 2348 0.70 1.84 3.86 9.02 0.06 0.10 1.42 1.76 −0.76 −0.82 −2.81 −1.80 −0.37 −0.33 −1.87 −1.20 −0.03 0.06 −0.48 0.59 0.71 1.62 1.44 3.25 0.31 1.32 1.31 4.26 0.65 2.54 1.17 3.44

2.49 1.84 8.68 0.10 1.73 −0.85 −1.85 −0.37 −1.21 0.07 0.62 1.62 3.23 0.10 0.23

2.60 1.58 7.36 0.09 1.48 −0.98 −2.40 −0.31 −1.15 0.06 0.63 1.23 2.45 0.23 0.58 1.75 6.96

2.57 1.48 7.03 0.03 0.45 −0.93 −2.18 −0.07 −0.26 0.06 0.64 0.78 1.48 0.31 0.82 1.53 6.16 1.10 3.62

2.60 1.46 6.53 0.03 0.40 −0.92 −2.11 −0.03 −0.12 0.06 0.56 0.82 1.50 0.32 0.84 1.52 6.13 1.10 3.60 0.14 0.38

0.56 0.56 0.60 0.66 0.68 0.66 0.66 0.71 0.73 0.73 287 287 287 240 240 171 171 171 168 168

Note: t statistics are shown in italics below the estimates.

whereas ‘colonial past’ is not significant and ‘ethnic fractionalisation’ is significant only for the TI sample but shows a wrong sign;25 overall adding these controls increases the R-squared of the regressions. Countries where the protestant faith is the largest religion, where democracy has been uninterrupted for the last 50 years, and that belong to the Organisation for Economic Co-operation and Development record lower levels of corruption. Table 7.3 also shows that the estimation of the effect of import openness on corruption is not strongly affected by these historical variables; actually, their introduction slightly increases its explanatory power.


209

It seems that these variables, by lowering the explanatory power of the GDP and political rights coefficients, are in fact accounting for deep institutional and social cross-country differences. It should be emphasised that these variables are all in dummy format, thereby they are really just labels used to describe a, sometimes quite loose, common characteristic of a particular group of countries. In fact, the only proper label is the ‘OECD’ one: this group of countries adopted common measures to fight corruption and is trying to enforce them through ‘peer pressure’ mechanisms.26 Rather than testing serious hypotheses on how, for instance, being a democracy may affect a country’s corruption level, these dummies provide an indication that our corruption theories are still incomplete. A last important issue to be considered here is that of reverse causality. As already pointed out, among the explanatory variables, Openness and GDP, at least, may not be fully exogenous and in this case our estimates would be biased. Fortunately, by identifying suitable variables (instruments) that are highly correlated with openness and GDP but that do not directly influence corruption, standard econometric techniques allow us to this problem. Suitable is the crucial attribute here. This means that we need new theoretically sound explanations for how openness and GDP are determined independently of corruption. In what follows we firstly briefly discuss the instruments selection issue, and then comment on the results from specification tests and finally on the endogeneity-corrected two-stage least squares estimates. A frequently used approach to instrument openness has its theoretical foundations in the well-established gravity equation that links bilateral trade flows to distances from major trading partners.27 According to this approach, a country’s degree of corruption-independent openness increases with its proximity to the largest world traders, or if the country’s official language is English. Conversely, the larger is the size of a country’s domestic market, proxied by its population, the lower its openness. The resurgence of economic geography in the late 1970s provides valuable instruments for the GDP variable. A series of recent papers study the strong links between geography and the level of economic development.28 They present empirical evidence on a positive correlation between GDP per capita and the absolute value of latitude. They argue that lower development at the tropics may be caused by poorer human health and by inferior productivity in agriculture. They also consider that winter frosts in temperate regions may boost agriculture productivity and thereby development. Geographical variables such as these are convincing instruments because their impact on corruption could only result through their influence on GDP. The absolute value of latitude, a dummy

210


for tropical countries, and time dummies provide us with a set of valid corruption-independent GDP instruments.29 In summary, Openness and GDP are the two possible endogenous variables, and population, English speaking dummy, area, and remoteness (for M) and latitude, tropics dummy, period dummies, and democracy (for GDP) are the eight potential instrumental variables. A well-known drawback of instrumental variables procedures is that of providing consistent but quite imprecise estimates when good instruments for the endogenous variables cannot be found. Therefore, the choice of instruments becomes rather important; this can be performed in two complementary ways: through a test of over-identifying restrictions (OID) or checking the relevance (that is, explanatory power) of the instruments. Based on these two criteria, our final selection results in the following list of instruments: tropics, population and time dummies; the other instruments have been excluded because they either exercise a direct effect on corruption (and not via the suspected endogenous regressors) or their explanatory power is too low. Once appropriate instruments have been selected, a proper endogeneity test on Openness and GDP can be conducted. A Hausman-Wu specification test is used here and its results reject endogeneity for both the ICRG and TI samples.30 Given that the Hausman-Wu test is sensitive to the choice of instruments and in order to provide final evidence on the independent influence of openness over corruption that is comparable to that of other studies, we proceeded to estimate regression (2) of Table 7.2 with a two-least squares method. Table 7.4 compares the results of the OLS and IV estimations. Using instrumented variables (IV) in a rather parsimonious specification of Eq. (7.1) slightly increases the magnitude of the estimated openness coefficients, which remain significant at the 1 per cent threshold for the ICRG sample at the 10 per cent for the TI sample. Even when potential reverse causality is accounted for, it clearly appears that, because of reduced rent-seeking, wasteful activities or due to their larger investment in institution building, countries more exposed to imports experience a lower level of corruption. In summary, our main empirical result, that the causal link from openness to corruption is strong and statistically significant, is robust to the introduction of a whole set of additional explanatory variables used in the literature on the causes of corruption, and it is not affected by sample bias. Table 7.5 confirms that our results are in the broad range of other studies’ estimations, providing further support to the thesis that corruption declines in more open societies.


Table 7.4

211

Globalisation and corruption: OLS and IV results

Estimation

(2)

Dependent Var. Regressors C Log (M openness) Log (GDP per capita) Pol. rights Oil-min exports Remoteness Log (area) Trade lib. Index LOG(gov expenditure / GDP)* R2 Number of Obs

(2)IV

(2)9

ICRG

(2)9IV TI

3.74 0.38 2.48 0.78 6.49 0.14 4.17 −0.73 −3.03 −0.89 −4.06 0.10 1.79

0.78 0.56 2.13 0.92 3.34 0.11 2.05 −0.78 −2.94 −0.76 −2.42 0.13 2.02

−9.94 0.53 2.53 1.61 7.57 0.09 1.65 −0.78 −1.65 −0.22 −0.83 0.01 0.13

−6.95 0.68 1.62 1.43 2.60 0.12 1.00 −0.40 −0.88 −0.39 −1.05 0.00 −0.02

0.55 305

0.54 305

0.64 174

0.59 174

Note: t statistics are shown in italics below the estimates.

CONCLUSION In this chapter, we have shown how openness lowers corruption, a specific yet rather important dimension of the globalisation and governance nexus. Microeconomic theory helped us identify trade policy, competition by foreign producers and international investors, and openness-related differences in institution building costs, as three major transmission mechanisms through which openness affects a country’s corruption levels. Examining a large sample of countries covering a 20-year period, we found robust empirical support for the fact that increases in openness do indeed cause reductions in corruption. The magnitude of the effect is also quite strong. After controlling for many cross-country differences, openness’ influence on corruption is close to one-third of that exercised by the level of development. Confirming results by Gatti (1999) and Larrain and Tavares (2000), we were not able to measure a significant direct effect from trade policy. We also found that, at least for the TI sample, the addition of government size

212

Table 7.5


Corruption and openness: comparative results

Study: Independent Variable: Dependent variables: b Openness b GDP b Openness × StDev of Openness b GDP × StDev of GDP

Ours ICRG

Larrain DiTella et al. et al. TI BI WCR ICRG

Wei BI

TI

0.34 0.91 0.18

0.57 1.70 0.31

1.08 1.21 0.74

0.62 2.44 0.56

0.9 0.5 0.92

1.28 1.47 0.82

1.6 1.25 0.93

1.03

1.82

1.28

1.67

0.23

1.54

1.95

Gatti ICRG

0.2 1.12

Note: Estimations from most similar specifications have been used to compare these studies.

among our explanatory variables decreases the magnitude of the openness effect and its statistical significance. Although this does not invalidate our findings – openness in the ICRG sample is unaffected by government size and it may as well be the case that this variable is caused by corruption – some caution should be used when drawing economic policy implications. First, reducing trade barriers may not bring immediate reductions in corruption. It is true that in the long run, more open economies, enjoying more foreign competition and investing abundantly in institution building, will register lower corruption levels; however, in the short run, domestic policies may be more valuable than pursuing globalisation at all costs. This may be especially important for poorer countries that may face serious trade-offs between complying with international agreements and investing in basic development infrastructures such as education, health, and social security. Second, our support for a positive effect of globalisation onto governance is based on a cross-section study, and it is well known that this type of analysis has several problems. Cross-country differences in the levels of the dependent variables are the central explanation for the variations in the dependent variable, and, no matter how many controls are added, it will always be possible that some additional relevant variable is missed or wrongly measured and that results are thus distorted. It is possible to account for many local characteristics, yet comparing China to the USA, or India to Argentina, will always be a bit stretched. This suggests that future research should focus on in-depth country specific case studies. As in the case of T.N. Srinivasan and J. Baghwati, who examine the links between openness and growth, we are confident that the virtues of outward orientation as quality enhancer for domestic institutions and growth will not be refuted.31


213

APPENDIX: COUNTRY LISTS, DATA SOURCES, AND DEFINITIONS Table 7.A1

Full ICRG and TI country samples

ICRG

TI

1984–89, 1990–94, & 1995–98

1980–85 & 1998–92 1995–98

Algeria Angola Argentina Australia Austria Bahamas, The Bahrain Bangladesh Belgium Bolivia Brazil Bulgaria Burkina Faso Cameroon Canada Chile China Colombia Congo, Dem. Rep. Congo, Rep.

Argentina Australia Austria Bangladesh Belgium Bolivia Brazil Cameroon Canada Chile China Colombia Czech Republic Denmark Ecuador Egypt, Arab Rep. Finland France Germany Greece

Same countries plus Bulgaria Costa Rica Côte d’Ivoire El Salvador Ghana Guatemala Honduras Iceland Jamaica Luxembourg Malawi Mauritius Morocco Nicaragua Paraguay Peru Romania Singapore Slovak Republic Tanzania

Peru Philippines Poland Portugal Qatar

Hong Kong, China Hungary India Indonesia Ireland Israel

Romania Saudi Arabia Senegal Sierra Leone Singapore Slovak Republic Somalia South Africa

Italy Japan Jordon Kenya Korea, Rep. Malaysia Mexico Netherlands

Costa Rica Côte d’Ivoire Cyprus Czech Republic Denmark Dominican Republic Ecuador Egypt, Arab Rep. El Salvador Ethiopia Finland France Gabon Gambia, The

Madagascar Malawi Malaysia Mali Malta Mexico Mongolia Morocco Mozambique Myanmar Netherlands New Zealand Nicaragua Niger Nigeria Norway Oman Pakistan Panama Papua New Guinea Paraguay

Turkey Uruguay

214

Table 7.A1


(continued)

ICRG

TI

1984–89, 1990–94, & 1995–98

1980–85 & 1998–92 1995–98

Germany Ghana Greece Guatemala Guinea Guinea-Bissau Guyana

New Zealand Nigeria Norway Pakistan Philippines Poland Portugal

Haiti Honduras Hong Kong, China Hungary Iceland

Spain Sri Lanka Sudan Suriname Sweden Switzerland Syrian Arab Republic Taiwan, China Tanzania Thailand

Togo Trinidad and Tobago India Tunisia Indonesia Turkey Iran, Islamic Rep. Uganda Iraq United Arab Emirates Ireland United Kingdom Israel United States Italy Uruguay Jamaica Venezuela, RB Japan Yemen, Rep. Jordon Yugoslavia, FR (Serbia/ Montenegro) Kenya Zambia Korea, Rep. Zimbabwe Kuwait Liberia Luxembourg

Senegal South Africa Spain Sweden Switzerland Taiwan, China Thailand Tunisia Uganda United Kingdom United States Venezuela, RB


Table 7.A2

215

Summary statistics, ICRG and TI samplesa Observations

ICRG Corruption Index Imports / GDP Gross private capital flows (GPKF) / GDP GDP per capitab Political Rights Government expenditure / GDP Government consumption / GDP Trade liberalisation index TI Corruption Index Imports / GDP Gross private capital flows (GPKF) / GDP GDP per capita b Political rights Government expenditure / GDP Government consumption / GDP Trade liberalisation index

Mean

Std. Dev

StD / Maximum Minimum Mean

281

5.79

2.25 0.39

10.00

0.00

281 281

35.02 9.55

22.27 0.64 16.48 1.72

181.03 160.35

6.29 0.03

6,647.56 6,799.99 1.02 28,527.14 6.02 3.39 0.56 10.00 30.68 12.70 0.41 96.97

364.87 0.00 9.13

281 281 215 215

15.36

5.88 0.38

48.06

4.36

105

6.38

2.07 0.32

10.00

1.00

164 164 164

5.10 31.58 10.13

2.66 0.52 18.17 0.58 14.20 1.40

9.65 151.19 92.95

0.00 6.21 0.13

8,547.20 7,172.52 0.84 28,527.14 7.03 3.14 0.45 10.00 31.39 11.58 0.37 62.73

463.06 0.00 12.27

164 164 124 124

15.51

5.54 0.36

38.27

3.65

75

6.32

1.89 0.30

10.00

1.00

Notes: a. All variables are averages of the three periods considered by ICRG (1984–88, 1990–94, 1995–98) and TI (1980-85, 1988–92, and 1995–98); except for the Trade Liberalization Index which is available only for the third most recent period. b. GDP is measured in thousands of USD at PPP exchange rates.

216

Table 7.A3


Historical variables (for ICRG sample)

Groups

Never Colony

Protest

Democracy

OECD

Members:

Austria Belgium China Denmark Ethiopia Finland France Germany Hungary Iran, Islamic Rep. Ireland Italy Japan Netherlands Portugal Spain Sweden Switzerland Thailand Turkey United Kingdom United States Uruguay

Bahamas, The Denmark Finland Germany Iceland Jamaica Netherlands New Zealand Norway Papua N. Guinea South Africa Sweden Switzerland United States

Australia Austria Belgium Canada Costa Rica Denmark Finland France Germany Iceland India Ireland Israel Italy Luxembourg Netherlands New Zealand Nigeria Sweden Switzerland United Kingdom United States

Australia Austria Belgium Canada Costa Rica Denmark Finland France Germany Greece Hungary Iceland Ireland Italy Japan Korea, Rep. Luxembourg Mexico Netherlands New Zealand Norway Poland Portugal Slovak Republic Spain Switzerland Turkey United Kingdom United States

Averages ICRG Group members Non members M-Openness Group members Non members GDP Group members Non members

6.3

8.2

8.1

7.9

5.3

5.2

5.2

4.8

33.6 32.9

38.9 32.6

36.7 30.0

35.2 32.7

12476.2 6675.9

17604.0 7400.3

19420.3 6519.7

18527.3 5170.3


217

Variables Sources and Definitions Governance – quality of institutions ICRG – Definition: Perceived corruption in Government INDEX. Unit: 0 to 6, higher scores denoting lower corruption levels. The original index has been re-scaled into a 0 to 10 scale. Coverage: yearly observation for 1984–00 (140 countries). Source: International Credit Risk Guide, 2000 TI – Definition: Transparency International’s Corruption Perceptions Index. Unit: 0 to 10, ten representing a perceived level of negligible bribery, while zero indicating very high levels of bribery. Coverage: 1980–85 average, 1988–92 average, 1995–00 yearly data (99 countries). Source: Transparency International (www.transparency.de) and Göttingen University (www.uni-goettingen.de/~uwvw). Globalisation – Openness M – Definition: Imports of goods and services as % of GDP. Unit: per cent. Source: The World Bank, World Development Indicators (WDI) CD ROM, 2000. LIB – Definition: IMF’s Trade Restrictiveness Index. Unit: 1 to 10, higher scores denoting less open trade regimes. The original index has been re-scaled so that higher values denote more open trade regimes. Coverage: yearly observation for 1997–00 (140 countries). Source: IMF. Additional controls GDP – Definition: Gross domestic product per capita. Unit: current international US$ PPP. Source: Global Development Finance and WDI. POLR – Definition: Freedom House’s Political Rights index. Unit: index ranging from 1 to 7. The original index has been re-scaled into a 0 to 10 scale, lower values denoting absence of political rights. Source: Freedom House (http://freedomhouse.org). OILMIN – Definition: Dummy for countries heavily dependent on fuel and mineral exports. Takes the value of one if the combined share of ‘fuel exports’ (as % of merchandise exports) and ‘ores and metals exports’ (as % of merchandise exports) is greater than 50 per cent. Unit: 0–1 dummy. Source: export data from WDI (2000). ETHNIC FRAC – Definition: Ethnic fractionalisation index. Unit: index ranging from 0 to 1 (combination of various measures of fractionalisation). Source: La Porta et. al. (1998). GOVCONS – Definition: General government consumption as % of GDP. Unit: per cent. Source: WDI (2000). COLONIAL PAST – Definition: Dummy for ‘ever a colony’countries

218


(OECD founder countries are excluded). Unit: 0–1 dummy. Source: Issue Correlates of War (ICOW) Project, Dr. Paul R. Hensel homepage at http://garnet.acns.fsu.edu/~phensel/icow.html PROTESTANT – Definition: Dummy for countries where Protestant religion accounts for more than one third of the population. Unit: 0–1 dummy, one denoting protestant countries. Source: La Porta et. al. (1998). DEMOCRACY – Definition: Dummy for democratic countries in all 48 years between 1950 and 1998. Unit: 0–1 dummy. Source: Treisman. (2000). OECD – Definition: Dummy for OECD member countries. Unit: 0–1 dummy. Source: OECD website. DISTANCE – Definition Bilateral distances. Unit: Km. Source: http:// www.eiit.org/Trade.Resources/TradeData.html#Gravity EXPORT Shares – Definition Export of goods and services as a share of world export of goods and services. Unit: per cent. Source: WDI (2000). LATITUDE – Definition: Distance from the Equator. Unit: degrees. Source: William Easterly database at http://www.worldbank.org. TROPICS – Definition: Dummy for tropical countries if absolute value of latitude is less than or equal to 23. Unit: 0–1 dummy. ENGL – Definition: Dummy for English speaking countries. Unit: 0–1 dummy. Source: La Porta et al. (1998). Addendum: Note on the Ordered PROBIT Estimation Table 7.A4 shows the results of estimating Eq (7.1) of the paper with the ordered PROBIT method next to those obtained earlier with the standards OLS method. Although the two estimation procedures are not strictly speaking comparable, it is possible to notice that b1 for the ordered PROBIT is still positive and significant, and that the sign and significance of the other regressors are maintained; in general then the new estimation method confirm the results obtained with the standard OLS. However, it should be emphasized that the b’s in the order PROBIT cannot be directly read as semi-elasticities, and that ascertaining their actual meaning requires some additional calculations. First of all, it should be recalled that the ICRG index, our dependent variable, is discrete and its higher values are associated to better performance in terms of lower corruption; the ordered PROBIT methods takes into account this peculiarity and its results correspond to the estimation of a theoretical probability distribution for the various values of the index. The sample probability distribution and the estimated probabilities are shown in the first two columns of Table 7.A5 and they are graphed in Figure.A1.


Table 7.A4

Globalisation and corruption: OLS and ordered PROBIT results

Estimation

OLS

Dependent Var.

Probit ICRG

Regressors C Log (M openness)

3.74 0.38 2.48 0.78 6.49 0.14 4.17 −0.73 −3.03 −0.89 −4.06 0.10 1.79

Log (GDP per capita) Pol. rights Oil-min exports Remoteness Log (Area) R2 Number of Obs

Table 7.A5

219

0.28 2.78 0.54 6.45 0.09 3.74 −0.47 −2.94 −0.55 −3.76 0.07 1.86

0.55 305

305

PROBIT results, interpretation of the coefficients

ICRG Rankings

Max Corruption. . . 0 1 2 3 4 5 6 7 8 9 Min Corruption. . .10 Total

Prob

Prob*

Marginal Effect of: Openness

GDP

0.980 1.310 2.300 11.480 9.180 28.850 8.200 13.400 11.800 3.610 8.850 100.000

0.082 0.233 0.666 6.428 7.797 36.544 12.538 20.638 11.730 1.758 1.587 100.000

−0.080 −0.192 −0.474 −3.248 −2.707 −5.001 0.726 3.963 4.542 0.988 1.483 0.000

−0.001 −0.004 −0.009 −0.061 −0.051 −0.094 0.014 0.074 0.085 0.019 0.028 0.000

220

The law and economics of globalisation 40

Prob Prob*

35 30 25 20 15 10 5 0 0

Figure 7.A1

1

2

3

4

5

6

7

8

9 10

Sample (Prob) and estimated (Prob*) probabilities for the ICRG index

This distribution is affected by changes in the regressors shown in the Table and, in general, we can say that the probability mass will shift towards higher values in correspondence of increases of explanatory variables that have a positive b. In other words, we can expect that an increase in openness, GDP per capita and political rights will produce a shift of the distribution towards higher ICRG grades, that is lower corruption values. To evaluate more precisely this shift we need to apply the calculations detailed above to each ICRG grade and the final results are shown in the rightmost columns of Table 7.A5. It appears clearly that increasing openness reduces the probability of a country to be assigned to the worst corruption group (a negative sign for the marginal effect) and increases the probability of belonging to the best group (a positive effect); indeed it seems that probabilities are reduced for the lower half of the ranking and increased for the upper half. A similar pattern is observed for the marginal effect of GDP per capita. Finally, Table 7.A6 shows calculations for the elasticities of corruption rankings with respect to two explanatory variables. These are calculated as in Eq. (7A.1) below. e5

0P [ Corruption 5 n ] /0X P [ Corruption 5 n ] /X

(7A.1)

Two features appear clearly. First, GDP per capita seems to influence the change in the shape of the probability distribution more intensively


Table 7.A6

221

PROBIT results, elasticities

ICRG rankings Max corruption. . .0 1 2 3 4 5 6 7 8 9 Min corruption. . .10 Total

Average Values of: Openness

GDP

2.917 3.250 3.250 3.407 3.286 3.443 3.530 3.530 3.389 3.614 3.546 3.440

6.917 7.250 6.964 7.393 7.786 8.000 8.410 8.311 9.208 9.750 9.787 8.306

Elasticities Openness GDP −2.842 −2.683 −2.314 −1.721 −1.141 −0.471 0.204 0.678 1.312 2.031 3.314

−12.672 −11.254 −9.322 −7.022 −5.081 −2.058 0.915 3.000 6.703 10.303 17.194

than openness, a result obtained with the OLS earlier estimation method; second, the effects seems non linear given that the elasticities show larger absolute values at the extremes than at the middle of the distribution.

NOTES * 1.

2.

3. 4. 5. 6.

We are grateful to Daniel Cohen, Marcelo Soto and participants to an informal OECD Development Centre seminar for helpful comments on an earlier version of this chapter. The usual disclaimer applies. See: World Bank, The East Asian Miracle: Economic Growth and Public Policy (New York: Oxford University Press, 1993) on East Asia, Inter-American Development Bank, Latin America After a Decade of Reforms: Economic and Social Progress 1997 Report (Baltimore, Maryland: The John Hopkins University Press, 1997) on Latin America, and Jorge Braga de Macedo, ‘Converging European Transitions’ (Technical Paper No. 159, OECD Development Centre, Paris, 2000) on Eastern Europe. Adolph Wagner, ‘Three Extracts on Public Finance’, in Richard A. Musgrave and Alan T. Peacock (eds), Classics in the Theory of Public Finance (London: Macmillan, 1958). For an interesting look at the Wagner’s Law see William Easterly and Sergio Rebelo ‘Fiscal Policy and Economic Growth: An Empirical Investigation’ (Reprints No. 1875 and Working Paper No. 4499, National Bureau of Economic Research, 1994). Dani Rodrik, ‘Why Do More Open Economies Have Bigger Governments?’, Journal of Political Economy 106 (October 1998): 997–1032. For a sceptical survey of the literature see Rodrigues and Rodrik, ‘Trade Policy and Economic Growth, A Sceptic’s Guide to the Cross-National Evidence’ (Working Paper No. 7081, National Bureau of Economic Research, 1999) and papers cited therein. The propositions in the text are illustrated by Figures 2 through 4 in Braga de Macedo (2001) which are based on the same data set used in this chapter. For a recent survey, see Janine Aron (2000) ‘Growth and Institutions: A Review of the

222

7. 8. 9. 10.

11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25.

26. 27.

The law and economics of globalisation Evidence’ The World Bank Research Observer 15 (February 2000): 99–135; for an interesting approach to the causality issue, see Daren Acemoglu, Simon Johnson and James. A. Robinson, ‘The Colonial Origins of Comparative Development: An Empirical Investigation’ (Working Paper No. 7771, NBER, 2000). Daniel Treisman, ‘The Causes of Corruption: A Cross-National Study’, Journal of Public Economics (forthcoming). Robert Klitgaard, Controlling Corruption (Berkeley and London: University of California Press, 1988). Anne Krueger, ‘The Political Economy of the Rent Seeking Society’, American Economic Review 64 (June 1974): 291–303. Jagdish Bhagwati, ‘Directly Unproductive, Profit-Seeking (DUP) Activities’, Journal of Political Economy 90 (October, 1982): 988-1002; J. Bhagwati and T. N. Srinivasan, ‘Revenue Seeking: A Generalization of the Theory of Tariffs’, Journal of Political Economy 88 (December, 1980): 1069–87. Roberta Gatti (1999) ‘Corruption and Trade Tariffs, or a Case for Uniform Tariffs’ (Policy Research Working Paper No. 2216, The World Bank, 1999). Alberto Ades and Rafael DiTella, ‘Rents, Competition and Corruption,’ American Economic Review 89 (September, 1999): 982–93. Raymond D. Gastil, Freedom in the World. Political Rights and Civil Rights, Westport, Connecticut: Greenwood Press, 1982. Shang-Jin Wei, ‘Natural Openness and Good Government’ (Working Paper 7765, NBER, 2000). As pointed out by Shang-Jin Wei (2000). Using readily available measures of openness and GDP per capita in a standard ordinary least squares estimation would produce biased coefficients. Since population is highly correlated with import openness, the logarithm of land area is a better measure of size for our purposes. World Bank, World Development Indicators, Washington, D.C.: World Bank, 2000. Rafael LaPorta, Florencio Lopez de Silanes, Andrei Shleifer and Robert Vishny, ‘The Quality of Government’ (Working Paper No. 6727, NBER); Paul R. Hensel homepage is at http://garnet.acns.fsu.edu/~phensel/icow.html. Since b 5 (∂Corr / ∂LnX) 5 [∂Corr / (∂X/X)]. See among others Aaron Tornell and Philip Lane, ‘The Voracity Effect’, American Economic Review 89 (March, 1998): 22–46. R. Gatti (1999) and Larrain Felipe and José Tavares (2000), ‘Can Openness Deter Corruption?’, mimeo, presented at the 1999 Northeast Universities Development Conference (NEUDC), held at Harvard University. Notice that the variable ‘government consumption’ includes public wages and salaries, and that it is notoriously difficult to have uniform and good quality data on public finance variables across countries. In particular D. Treisman (2000) and R. La Porta et al (1999). However the effect of ethnic fractionalisation on corruption is not clear. While recent investigations indicate high fractionalisation as a negative determinant of growth, studies focusing on the causes of corruption do not find such a clear-cut result. Gatti (1999), for instance, finds that fractionalisation is significant and reducing corruption. This finding is explained in terms of the increased difficulties bureaucrats encounter in extracting bribes from ethnic groups they do not belong to. This is elaborated in Braga de Macedo (2001). In appendix we show the countries forming the groups of ‘never a colony’, ‘protestant’, ‘democracy’, ‘OECD’ and their group averages for M-Openness, GDP, and corruption indices. The gravity model micro-foundations are found in Elhanan Helpman and Paul Krugman, Market Structure and Foreign Trade, Cambridge, MA: MIT Press, 1985 and Alan Deardorff, ‘A Theoretical Foundation for Gravity Model’, in Jeffrey Frankel, ed, The Regionalization of the World Economy, Chicago: University of Chicago Press, 1998.

How globalisation improves governance 28.

29. 30. 31.

223

Robert E. Hall and Charles I. Jones, ‘Why Do Some Countries Produce so Much More Output per Workers than Others?’, Quarterly Journal of Economics 64 (February 1999): 83–116; John L. Gallup, Jeffrey D. Sachs and Andrew Mellinger, ‘Geography and Economic Development’, International Regional Science Review 22 (August 1999): 179–232; Stanley Engermann and Kenneth Sokoloff, ‘Factor endowments, Institutions and Differential Paths of Growth among the New World Economies’, in Stephen Haber, ed, How Latin America Fell Behind, Stanford: Stanford University Press, 1997; David Bloom and Jeffrey D. Sachs, ‘Geography, Demography, and Economic Growth in Africa’, Brookings Papers on Economic Activity 2 (1998): 207–296; William Masters and Keith D. Wiebe, ‘Climate and Agricultural Productivity’, mimeo (available at http://www2.cid.harvard.edu/cidbiotech/ag/); William A Masters and Margaret McMillan, ‘Climate and Scale in Economic Growth’, Working paper No. 48, CID, Harvard University, 2000. Jeffrey D. Sachs, ‘Tropical Underdevelopment’, Working Paper No. 57, CID, Harvard University, 2000; and Acemoglu, Johnson and Robinson (2000). Time dummies provide indispensable time dependent variables. We carried out two types of tests: on the one hand, we checked for endogeneity of both variables and on the other hand for endogeneity of just one of the two. Results are not shown here but available upon request. T.N. Srinivasan and Jagdish Baghwati, ‘Outward-Orientation And Development: Are Revisionists Right?’, mimeo (available at http://www.columbia.edu/~jb38/papers.htm, 1999).

REFERENCES Acemoglu, D., S. Johnson and J.A. Robinson (2000), ‘The colonial origins of comparative development: An empirical investigation’, NBER Working Paper No. 7771. Ades, A. and R. Di Tella (1999), ‘Rents, competition and corruption’, American Economic Review, 89(4), 982–93. Aron, J. (2000), ‘Growth and institutions: A review of the evidence’, World Bank Research Observer, 15(1), 99–135. Bhagwati, J. (1982), ‘Directly unproductive, profit-seeking (DUP) activities’, Journal of Political Economy, 90(5), 988–1002. Bhagwati, J. and T.N. Srinivasan (1980), ‘Revenue seeking: A generalization of the theory of tariffs’, Journal of Political Economy, 88(6), 1069–87. Braga de Macedo, J. (2001), ‘Globalisation and institutional change: A development perspective’, OECD Development Centre, May 2001, (http://www.fe.unl. pt/~jbmacedo/oecd/VATICAN.html). Bloom, D. and J.D. Sachs (1998), ‘Geography, demography and economic growth in Africa’, Brookings Papers on Economic Activity, 1998(2), 207–95. Deardorff, A. (1998), ‘A theoretical foundation for gravity model’, in J. Frankel (ed), The Regionalization of the World Economy, Chicago: University of Chicago Press, pp. 7–32. Easterly, W. and S. Rebelo (1994), ‘Fiscal policy and economic growth: An empirical investigation’, NBER Reprints No. 1875 (also Working Paper No. 4499). Engermann, S. and K. Sokoloff (1997), ‘Factor endowments, institutions and differential paths of growth among the new world economies’, in S. Haber (ed), How Latin America Fell Behind, Stanford: Stanford University Press, pp. 260–306.

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Frankel, J. and D. Romer (1999), ‘Does trade cause growth?’, American Economic Review, 89(3), 379–99. Gallup, J.L. and J.D. Sachs (1998), ‘The economic burden of malari’, Center for International Development Working Paper No. 52, Harvard University. Gallup, J.L., J.D. Sachs and A. Mellinger (1999), ‘Geography and economic development’, International Regional Science Review, 22(2), 179–232. Gastil, R. (1982), Freedom in the World. Political Rights and Civil Rights, Greenwood Press, Connecticut: Westport. Gatti, R. (1999), ‘Corruption and trade tariffs, or a case for uniform tariffs’, Policy Research Working Paper No. 2216, World Bank, Washington, D.C. Hall, R.E. and C.I. Jones (1999), ‘Why do some countries produce so much more output per worker than others?’, Quarterly Journal of Economics, 1144(1), 83–116. Helpman, E. and P. Krugman (1985), Market Structure and Foreign Trade, Cambridge, MA: MIT Press. Klitgaard, R. (1988), Controlling Corruption, Berkeley and London: University of California Press. Krueger, A. (1974), ‘The political economy of the rent seeking society’, American Economic Review, 64(3), 291–303. La Porta, R., F. Lopez de Silanes, A. Shleifer and R. Vishny (1998), ‘The Quality of Government’, NBER Working Paper 6727. Larrain F. and J. Tavares (2000), ‘Can openness deter corruption? The role of foreign direct investment’, CEPR Discussion Paper No. DP6488. Masters, W.A. and M. McMillan (2000), ‘Climate and scale in economic growth’, Working Paper No. 48, Center for International Development, Harvard University. Masters, W.A. and K.D. Wiebe (2000), ‘Climate and agricultural productivity’, Working Paper, Center for International Development, Harvard University, October. Rodriguez, F. and D. Rodrik (1999), ‘Trade policy and economic growth, A skeptic’s guide to the cross-national evidence’, NBER Working Paper No. 7081. Rodrik, D. (1998), ‘Why do more open economies have bigger governments?’, Journal of Political Economy, 106(5), 997–1032. Sachs, J.D. (2000), ‘Tropical underdevelopment’, Working Paper No. 57, Center for International Development, Harvard University. Srinivasan, T.N. and J. Baghwati (1999), ‘Outward-orientation and development: Are revisionists right?’, mimeo, (http://www.columbia.edu/~jb38/papers.htm). Tornell, A. and P. Lane (1998), ‘The voracity effect’, American Economic Review, 89(1), 22–46. Treisman, D. (2000), ‘The causes of corruption: A cross-national study’, Journal of Public Economics, 76(3), 399–457. Wagner, A. (1883), ‘Three extracts on public finance’, in Musgrave, R.A. and A.T. Peacock (eds) (1958), Classics in the Theory of Public Finance, London: Macmillan. Wei, S.-J. (2000), ‘Natural openness and good government’, NBER Working Paper 7765, Cambridge, M.A. World Bank (2000), World Development Indicators, Washington, D.C.: World Bank.

8.

Intellectual property enforcement in a global economy: lessons from the BRIC nations Robert C. Bird

INTRODUCTION Globalization is a multi-faceted and powerful phenomenon. Globalization represents a political force that encourages the harmonization of values such as human rights and democratic governance. Globalization is also an economic force that promotes the worldwide integration of free markets. Goods and services, financial instruments, and intellectual property rights can now find an optimal buyer and seller match without regard to national borders. Technology and research and development skills become evermore rapidly disseminated. Globalization creates an environment of shared risk and reward among nations that is a natural consequence of economic interdependence (Seita 1997). There is some evidence that Brazil, Russia, India, and China, collectively known as the BRIC economies, will play a leadership role in shaping these forces of globalization. A 2003 study concludes that the BRIC economies may be larger in GDP terms than the entire current G6 within 40 years. If the study proves correct, Germany, France, Italy, and the United Kingdom may all be forced out of the elite G6 club by 2050, leaving only the United States and Japan remaining as two of the six largest economies in the world (Wilson & Purushothaman 2003). The BRIC economies are far from passive in influencing the global economy. Brazil, for example, ranks sixteenth in the world for quantity of imports and twentieth in the world for quantity of exports. In spite of this, Brazilian leaders have sustained a leading role in Doha-round agriculture negotiations and formed, in conjunction with India, the developing country negotiation block known as the G20. Brazil is also the most litigious developing country complainant bringing cases before the WTO and fourth most active overall in the world (Cross 2006). Brazil’s repeat player experience and non-developed country perspective can play 225

226


a representative role for developing nations before the WTO and in the global economy generally. The remaining ‘RIC’ economies are not to be left behind. For example, an emerging free trade agreement between the former Soviet republics envisions nomenclature standards and representation through Russian authorities, a testament as one author states, ‘to Russia’s leading role in the post Soviet world’ (Dragneva and Kort 2007). In addition to its coordinating efforts with Brazil under the G20, India has led developing nations on the unsuccessful fight to resist inclusion of intellectual property as a GATT issue and the creation of TRIPS (Bird 2005). Developing countries have looked to China for a leadership role in taking a favorable position on fairer access to patented medicines and protection of local know-how and cultural artifacts under TRIPS (Peerenboom 2006). The question remains not if, but rather to what extent the BRIC nations will place their imprint the global economy. There are few topics where the BRIC economies have been more influential than in intellectual property rights. By most western accounts protection of intellectual property rights by the BRICs has been unsatisfactory. Initially, the problem was lack of formal legal protection for these rights. Today, strong laws exist in the legal codes of all four economies, but weak enforcement has made such laws ineffective. The result is a business climate where industries susceptible to intellectual property copying, pharmaceutical, software, and publishing to name a few, have suffered major losses from well-organized piracy organizations. Ronkainen and Guerrero-Cusumano (2001) have concluded that intellectual property violations may be the single most significant threat to the competitiveness of firms doing business on a global scale. The obvious response has been for multinational enterprises to exert pressure on the BRIC governments, either directly or through governmental agencies, to comply with and enforce intellectual property laws. The experience of multinational enterprises in dealing with the BRIC economies teaches important lessons about the limitations of enforcement through traditional coercive methods. As this chapter will show, each nation has the ability to respond in different ways to external pressure. While the BRICs have not always been successful in resisting outward overtures, the examples provided here show that the United States and European nations cannot simply impose their will upon these emerging countries without a political or economic response. The greater the integration of the BRICs into global economic markets, the more resistant these economies will be to economic pressure from a single nation or industry. Developing nations, no doubt learning from the successful strategies of the BRICs, are becoming increasingly more adept

Intellectual property enforcement in a global economy

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at negotiating favorable intellectual property arrangements with foreign manufacturers (Caroll 2003). The result is that multinational enterprises and the developed nations that support them must consider alternative, non-coercive strategies to protect intellectual property rights in the BRIC economies.

THE DIFFERING POLITICAL AND CULTURAL HISTORIES OF THE BRIC NATIONS The BRIC nations emerge from radically different economic and political histories. Brazil obtained independence from Portugal in 1822 and experienced a surge of industrialization through much of the twentieth century. In spite of the oil shocks of the 1970s, Brazil’s GDP expanded 8 per cent on average from 1970 to 1980. In the 1980s, Brazil suffered from low commodity prices, inflationary pressures and high interest rates while at the same time making the transition from long-standing military intervention in governance to mainly civilian leadership. The 1990s and 2000s were marked with widely fluctuating growth rates, a depreciated currency, and poor administrative reforms (Kedia et al. 2006; Sweetwood 2002). Russia, by contrast, emerged from the disintegration of the Soviet Union in 1991 with little history of democratic governance and legal free markets. Russian leaders dismantled the centrally planned economy and distributed ownership of state enterprises to managers and other citizens. Private property ownership in Russia brought abuses through dubious loans-forshares schemes in which powerful citizens ‘purchased’ state assets from government officials in rigged auctions. The result was the emergence of a cadre of oligarchs who controlled most of Russia’s most valuable natural resources and industrial assets (McCarthy and Puffer 2006). Achieving independence in 1947, India has existed under a democratic government for centuries. In spite of a diverse economy, India has suffered from a command and control planning system that has generated large bureaucratic governments, inefficient production and distribution methods, and a stifling restriction on imports. This policy, known as the ‘license raj’ (Majumdar 2004), resulted in India’s share of international trade declining from 2.5 per cent in 1947 to 0.5 per cent in 1980. Weak returns on investments in large, capital-intensive projects arising from delay and cost overruns also contributed to India’s economic malaise. Increased borrowing and rapid overpopulation has resulted in an economy poised for growth but as yet unable to completely unshackle itself from the remnants of government planning (Kedia et al. 2006).

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Finally, China has attempted to weave together the economic benefits of a market economy with government social and political control of socialism. Forged in 1949, the People’s Republic of China has suffered from repeated attempts to jumpstart its economy. One of the most disastrous was Mao Zedong’s ‘Great Leap Forward’, a program of collectivization of agriculture and promotion of small-scale rural industry that after initial success wilted into an economic disaster. Forced production quotas resulted in products produced, such as steel, that were useless for market consumption (Kedia et al. 2006). Mao’s successor, Deng Xiaoping, brought economic reforms through opening its large market to foreign investment (Wall 2006). Deng’s pragmatism toward economics is captured in his widely-cited quote from the 1960s, ‘[w]hether a cat is black or white makes no difference. As long as it catches mice, it is a good cat’ (Harris 2006). Today, China uneasily blends socialist governance and market planning while continuing its efforts at economic reform.

A COMMON GROUND: THE TARGET OF PRESSURE FROM THE UNITED STATES TO IMPROVE INTELLECTUAL PROPERTY In spite of different histories, the treatment of intellectual property law and enforcement by all four BRICs remain underdeveloped, at least by American and European standards. As a result, all four BRICs have been subjected to coercive pressure from the United States. During the 1980s and at least as far back as 1971, Brazil’s intellectual property law lacked patent protection for pharmaceutical products and processes (Bass 2002). The Pharmaceutical Manufacturers’ Association (PMA) claimed that Brazil’s weak laws weakened their investments, impaired exports, and denied opportunities for further investment in Brazil. Claiming hundreds of millions of dollars in losses, the PMA chose the coercive route, seeking relief under Section 301 of the Trade Act of 1974 (Gad 2003). Section 301 and its subsequent enhancements give the President authority to impose retaliatory sanctions against a nation that engages in unfair trade practices (Yu 2000). Pursuant to the Act, the PMA filed a petition in 1987 with the United States Trade Representative (USTR), which is required to review whether a foreign country practice constitutes a barrier to US exports (Yu 2000). In 1988, President Reagan placed a 100 per cent tariff on $39 million dollars worth of Brazilian imports to the United States (Gad 2004; Bass 2002). Only when the Brazilian government announced that it would draft legislation protecting pharmaceutical products and processes and that it would ensure a bill


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would be presented to the Brazilian National Congress by 20 March 1991 did the US government lift the sanctions (Federal Register 1990). Russia has also experienced US pressure. In 1995, the USTR placed Russia on its Watch List in 1995 and then elevated Russia to its Priority Watch List in 1997 (Neigel 2000; Kuik 1999).While the US government encouraged Russia to join the Berne Convention in exchange for preferential trade status, the motion picture industry lobbied the US Congress to withhold ratification until Russia improved its copyright laws (Fleishman 1993). In November 2006, Russian and American trade representatives signed a ‘Side Letter’ formally known as the US-Russia Bilateral Market Access Agreement on Intellectual Property Rights (IIPA 2007a). This letter was negotiated in the context of Russia’s continuing efforts to accede to the World Trade Organization (WTO).1 The letter establishes a binding blueprint for Russia to improve intellectual property enforcement, strengthen various laws, and fully implement the TRIPS agreement (USTR Side Letter 2007). Cited by the International Intellectual Property Association (IIPA) as having the worst copyright piracy problem in the world, Russia remains on the USTR’s Priority Watch List and the IIPA watchdog group recommended earlier this year that it remain there until meaningful progress on intellectual property develops (IIPA 2007a). Furthermore, Russia is a major beneficiary of the US Generalized System of Preferences (GSP) program, designed to promote the economies of developing countries through the allowance of duty free products. Russia received GSP-linked trade benefits worth $429.8 billion in 2003 (Mertens 2006). The IIPA has recommended that the USTR suspend GSP benefits for Russia and the USTR remarked in its 2007 Priority Watch List document that the US is ‘reviewing Russia’s status as a beneficiary country under the US Generalized System of Preferences (GSP) Program’ (USTR 2006: 24; Mertens 2006). India led the charge against intermixing intellectual property and trade rights in the 1980s, refusing to even discuss the possibility of including patent protection in a GATT agreement (Taylor 1998). India’s resistance ended in 1989, during the same period when India depleted its foreign currency reserves due to an economic crisis. India sought badly needed assistance from the International Monetary Fund (IMF), an entity heavily influenced by the US. As a result of its IMF needs and other potential trade losses with the US, India ultimately relaxed its opposition to the TRIPS agreement, a major result of GATT, and acceded to its provisions (Foster 1998). US-based pressure towards India continued even after it agreed to follow the obligations of TRIPS. When the Indian government delayed in enacting enabling legislation, the United States sought redress through

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the WTO, which can ultimately authorize trade sanctions by one country against another, to compel India to amend its insufficiently strong patent legislation (Bird 2006). In 2000, pharmaceutical representatives demanded that the USTR place India on its Priority Watch List. As of 2007, India remains on the USTR’s Priority Watch List, citing weak copyright laws, inadequate enforcement, and slow judicial resolution of criminal actions (USTR 2007). The US has threatened China repeatedly with economic sanctions for its failure to protect intellectual property rights. After a 1979 agreement to treat one another’s patents and trademarks equally failed to protect US intellectual property rights (US-China Agreement 1979), the USTR placed China on its first Priority Watch List in 1989 (Hindman 2006). During the 1990s, China would accede to US pressure by enacting ever stronger intellectual property laws. When the US found the laws, or their enforcement, unsatisfying they would lobby the US government to impose sanctions. A last minute compromise between American and Chinese negotiators would avert a trade war and satisfy public opinion. Inevitably, as interest in piracy waned after the highly publicized agreement, America would again demand assistance from the government to aid them in protecting their intellectual property rights abroad (Bird 2006; Yu 2000). As of 2007, China remains on the USTR’s Priority Watch List (USTR 2007).

THE DIVERGING RESPONSES OF BRIC NATIONS TO AMERICAN PRESSURE In spite of current problems, the US has succeeded at least in part in improving the protection of intellectual property rights in the BRICs over the past 20 years. All four BRICs relented somewhat under US pressure to pass new laws and improve enforcement. The BRICs, however, are not simply compliant states. Each BRIC nation has developed its own successful strategy for resisting the unfettered will of the US. Of the four BRICs, Brazil has been by far the most masterful in counteracting the economic and political influence of the US over global intellectual property law. In 1997, Brazil enacted new legislation which included Article 68. Article 68 has a ‘local working’ requirement which permits a drug patent owner to be subject to compulsory licensing within three years after the patent is granted if, among other reasons, the patent owner fails to manufacture the product within Brazilian territory. The patent owner will be allowed to import the drug if the owner can show it is economically unfeasible to manufacture the medicine in Brazil (Brazilian Patent Law 1997). The law had the effect of lowering production costs on critical


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drugs (Marques 2005). The law also improved Brazil’s ability to develop local manufacturing capacity and expertise to manufacture the drug once the patent has expired (Schulz 2004). Article 68 has been credited with contributing to the reduction of prices of the key anti-retroviral AIDS drugs Efavirenz and Indinavir by 64 per cent and 77 per cent respectively (Passarelli and Terto 2002). The American pharmaceutical industry responded that Brazil’s actions would undermine efforts to develop new and improved treatments for important public health problems such as suppression of the HIV virus. If the Brazilian government issued a compulsory license breaking these critical patents, the industry said firms would not sell their next generation medicines in Brazil (Marques 2005). The US also responded by bringing a complaint against Brazil before the WTO, arguing that Article 68 contravened Article 27(1) of TRIPS, which requires that national patent protection cannot discriminate with regard to the locale of invention (WTO Dispute Settlement Body 2000). According to the USTR’s Special 301 report in 2001, Brazil’s claim that impairment of Article 68 would threaten its anti-AIDS program was inaccurate because Brazilian law already allowed for compulsory licenses for national emergencies such as AIDS-prevention under Article 71. The USTR described Article 68 as a job-creating protectionist measure and as a hidden trade barrier because it could require licensing for virtually any product (USTR 2001). Instead of simply defending Article 68 on the merits before the WTO, Brazil pled its case before the court of public opinion. Although Article 68 granted a compulsory license to any goods regardless of social importance, Brazil tied Article 68 to the deeply controversial AIDS-debate raging between developing countries and pharmaceutical enterprises. During this period 39 pharmaceutical firms were suing the South African government to stop it from importing generic versions of anti-retroviral drugs that were patented in South Africa (Passarelli and Terto 2002). The ill-timed lawsuit, which triggered a proliferation of global activism and significant damage to public opinion, was filed against a nation where 20 per cent of South Africa’s adult population, or 4.2 million people, were believed to be infected with the HIV virus (Russell 2000). Brazil used South Africa as a comparison point to parade its highly successful anti-AIDS program, implying that this program would be in jeopardy if the US succeeded before the WTO (Sanders 2005). AIDS activists and non-governmental organizations (NGO) accused the US government of profiting at the expense of infected Brazilians and commenced a signature campaign (Raghavan 2001). Brazil hosted a global meeting of NGO representatives and organized a march on the US consulate to protest the complaint, with

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similar demonstrations occurring in other Brazilian cities (Passarelli and Terto 2002). Brazil successfully lobbied for a United Nations Commission on Human Rights resolution affirming the right of access to medication. The US was the sole abstention of the 53 member body, every member of which voted to pass the resolution (Sanders 2005). Not satisfied with reframing the debate over Article 68 as a threat to low-cost anti-AIDS drugs, Brazil went on the offensive by filing its own complaint before the WTO challenging portions of the US patent code as non-compliant with TRIPS. Brazil challenged Title 30, Section 202, of the United States Code, which stated that products arising from small business or non-profit patent rights in inventions made with federal assistance shall be made substantially in the United States. Brazil also challenged the US provision stating that licenses arising from federally-owned inventions will be manufactured in the US. Apparently spotting an opportunity to apply pressure, India also joined the dispute claiming that it had a ‘systemic interest’ in the proceeding (Mota 2005). The combined pressure from Brazilian leadership, Brazil’s reprisal-WTO action, and NGOs forced the US to withdraw its original complaint from the WTO (Brennan 2001). The result of the efforts to modify Article 68 turned out to be, at least in the mind of one commentator, a ‘public relations disaster’ for the US (Raghavan 2001). Russia by contrast has not pressed its case in the court of public opinion but has rather resisted US pressure because of its unique political position. In the past, Russia’s lack of intellectual property protection was dealt with relatively leniently by the US compared to Brazil, India, and China. This may be due to the special interest that the US had in Russia during the 1990s. In the post-Soviet era the US emerged as a strong supporter of the Yeltsin government (Donaldson 2000). Government officials speculated that pressing Russia for stronger intellectual property protection would unnecessarily push the Russian government back towards strong state controls if its economy faltered (Neigel 2000). In addition, Russia has never been traditionally viewed as the robustly growing consumer market that has attracted businesspeople to China and India and to a lesser extent Brazil. Imports and exports for Brazil, China, and India generally exceed those of Russia (USITC 2006). Most recently, Russia plays a key role in the global political area on such controversial issues as the US war in Iraq, dissemination of nuclear technologies, and terrorism. Current and future US political administrations may not want to antagonize Russia unnecessarily, and Russia’s desired entry into the WTO may be one of the only places where the US may be able to exert meaningful leverage (Weir 2006). As a result, Russia’s political importance has helped enable it to avoid making the necessary changes in its political, judicial, and law enforcement systems to halt piracy. There is no single agency responsible for IPR


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enforcement nor is there a single policymaker in charge of enforcing intellectual property or establishing policy. Enforcement powers are scattered amongst many government agencies, with one entity having authority over plant licensing and entirely another settling copyright policy. A working government commission formed to address intellectual property problems has excluded right-holders from participation (IIPA 2007a). In a nation where copyright piracy ranks second to none in the world, Russian authorities have finally commenced raids against illegal optical disc plants. These raids, however, are rarely executed by surprise and often undertaken without the cooperation of the copyright holders of the pirated materials. The result has been that almost all of the optical disc plants raided over the last three years remain in operation. Furthermore, Russian authorities are apparently not above outright chicanery to hide the extent of piracy. The IIPA reports that when US government officials met Russian government officials in Moscow in late January 2007, all pirated products disappeared from store and market shelves or stores were closed. On 5 February, after the US delegation departed, pirated goods miraculously returned to these establishments (IIPA 2007a). The Russian government has the resources to suppress piracy, but lack of strong incentives or impending sanctions gives it little reason to do so. India may lack the economic power of China and the political importance of Russia in the eyes of the United States. That does not leave India, however, without an intellectual property resistance strategy. Although India has made significant strides in improving intellectual property rights, it has often done so only at the slowest possible speed. Once India formally agreed to adopt TRIPS and its associated intellectual property requirements, it moved toward compliance at a glacial pace. For example, TRIPS Article 70.8(a) required India to establish a patent office for receiving submissions for inventions. Yet, apparent procedural mismanagement of the enabling legislation caused the Indian Parliament to fail to adopt the necessary statutes to establish the patent office within the necessary time (Tomar 1999). The US responded by opening an investigation into India’s failure to effectively patent and filing a formal claim before the WTO. The WTO Dispute Settlement Body concluded that India failed to comply with TRIPS and India unsuccessfully appealed. A 2 March 1998 deadline for India to comply came and went (Tomar 1999). After three extensions granted by the US, India and the US finally agreed to a new April 1999 deadline to implement the necessary legislation. By March 1999, India’s legislature finally managed to pass an ‘emergency measure’ complying with TRIPS while the backlog of unprocessed patent applications exceeded 30,000 (Bird 2006).

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Drug firm representatives pressed the USTR again to place India on the Priority Foreign Country list in February 2000 (PhRMA 2000). Apparently anticipating this pressure India introduced a new patents bill in 1999 but was eventually shuttled away to a legislative committee pending further review. Another patent bill emerged again in 2002, but was drafted to allow India to grant a compulsory license of patented drugs in a national emergency (Ragavan 2003). In March 2005, over 5 years after the US applied direct pressure upon India to act, India finally enacted a patent law sufficiently protecting software, agricultural, and pharmaceutical products (Business Standard 2005). India’s procedural slowness is not limited to patent infringement. India has also been slow to enact optical disc regulations that would license factories, grant authority to conduct surprise inspections, and gather sample discs for forensic testing to prevent piracy. Legislation implementing these regulations has been under discussion for over 3 years with no immediate sign of passage. Copyright law amendments necessary to harmonize with leading treaties have made no progress, even with many years of discussion by a ‘core group’ in the Ministry of Human Resources Development and the release of a draft in early 2006 seeking public comment (IIPA 2007b). There appears to be little sign of Indian procedural speed increasing anytime in the future. The Chinese government, while no doubt able to manipulate global public opinion like Brazil or drag its legislative heels like India, has been the most direct of all when faced with pressure to conform from the US. In 1988, the USTR placed China on its Priority Watch List and China reacted with improvements to its intellectual property laws. In 1991, when dissatisfaction from American business generated even closer scrutiny of China’s intellectual property practices, the US government threatened to impose $1.5 billion in tariffs on a variety of Chinese goods. China by then had long since shed its isolationist practices and had significant trade connections with the US. Thus, China simply threatened those connections with retaliatory tariffs on American aircraft, chemicals, corn, cotton, and steel. After lengthy negotiations, China and the US reached a Memorandum of Understanding in January 1992 (1992 MOU), narrowly averting a costly trade war (Bird 2006; Yu 2000). After the 1992 MOU, China significantly improved its intellectual property laws by acceding to the Berne Convention for the Protection of Literary and Artistic Works and ratifying the Geneva Convention for the Protection of Producers of Phonograms Against Unauthorized Duplication of Their Phonograms. Yet, in 1994 the US again cited China’s lack of commitment to intellectual property protection and threatened to impose tariffs. China not surprisingly proposed its own tariffs against the


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US. Again, a last minute compromise between the nations averted a trade war (Bird 2006; Yu 2000). This repeating process of threat, counter-threat, negotiation, and last minute resolution has been rightfully characterized by Peter Yu as a ‘cycle of futility’. (Yu 2006: 904) The cycle continued throughout the 1990s as tariff threats by the US for failure to protect intellectual property met with threats of equally damaging Chinese counter-tariffs against US products. The cycle halted because of China’s accession to the WTO on 11 December 2001. China’s membership in the WTO requires the US to resolve any trade disputes with China, as with any WTO member country, through the mandatory WTO settlement process. This does not mean, however, that American businesses will not lobby for using the WTO as a coercive forum. In 2005, trade groups urged the US to file a complaint against China before the WTO because of inadequate intellectual property protection. Pressure from the US on non-intellectual property trade related issues continues to result in threatened counter-sanctions from the Chinese government (Yu 2006).

THE WEAKNESS OF COERCION AND THE PURSUIT OF ALTERNATIVE METHODS As the Goldman Sachs study predicts, the BRICs will in all likelihood increase their political and economic power over time. In addition, the BRICs will have increasing exposure to, and thus experience with, dealing with western governmental and business-related organizations. Both of these trends will inevitably contribute to the BRICs using increasingly sophisticated strategies to resist pressure from the US. Coercive tactics such as the threat of tariffs can force weaker nations to change behavior. However, there is little evidentiary support for the conclusion that unilateral economic sanctions achieve their stated policy goals over the long term (Stalls 2003; Leng and Wheeler 1979). Coercive tactics pressuring foreign interests can harm American interests equally or even more so. Trade sanctions can cause foreign nations to transfer lucrative government contracts to non-US producers and trigger tariffs that harm US importers. Coercive tactics also mobilize resistance against the coercing nation and generate hostility that is not easy to dissipate. Coercion can even remobilize otherwise-dormant interest groups eager to resist American or European global hegemony. Finally, coercion quite often fails to tackle the underlying issue, especially regarding sanctions involving intellectual property, of incentives for foreign citizens to produce and consume pirated goods (Bird 2006).

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Alternatives certainly exist for multinational corporations doing business in the BRICs. Manufacturers can inject characteristics into their goods that make them more difficult and costly to imitate. If the cost to imitate production proves difficult enough, pirates may move on away from pirating that good to cheaper options (Yu 2006). American producers can also educate local allied subsidiaries about the advantages of intellectual property rights. A Chinese firm might resist efforts by an American partner to shuttle off a portion of joint venture profits for design feeds of a good. If the American firm rephrases the concept in terms of teaching the Chinese firm that it could generate revenue by charging its own design fees, it might more easily agree to the American partner’s request (Yu 2006). Companies might even capitalize on cultural predispositions of foreign consumers. For example, in China the notion of shame is a strong and enduring norm. Suffering shame can bring ill-feeling towards oneself and one’s extended family (Bird 2006). A Chinese debt collector eschews the judicial system, preferring to publicly confront people in their homes and businesses while banging a gong and declaring for all to hear, ‘pay your debts!’ (Leggett 2000). Heinz Corporation used the shame norm in China when it suffered from massive pirating of its infant formula product. Instead of going to court, Heinz brought reporters (paying all expenses) to raids of the pirated product manufacturing plants and highlighted the poor quality and unsanitary conditions of the illegal facility. After the poor conditions of the pirated factories became public, Heinz reported no further serious problems with pirating of its infant formula in China (Donaldson and Weiner 1999). The challenge for US and European firms is when to apply a particular strategy. While the shaming strategy might be effective in swaying Chinese public opinion, it might not be nearly as effective in Russia, for example, where shaming norms carry less influence. Using the court system to achieve redress, while challenging in all four BRICs, might be measurably more effective in one nation compared to another. Similarly, the certainty and predictability of laws, known as ‘regulatory quality’, may vary widely amongst the BRICs (Habib and Zurawicki 2006; Kaufmann et al. 2005). The result is that even widely settled conclusions about the BRIC regulatory environment may vary widely between the BRICs as well as within different regions of each nation. Strategies might vary across industries doing business in the BRICs. Improving one’s product might be a promising strategy for reducing piracy in the manufacturing sphere but be far less effective for products like software that can be reproduced digitally at low cost. Some firms have ingeniously offered to produce an illegal factory from pirates or even


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adopt them as licensees instead of litigating to shut them down. This may be especially useful in industries where manufacturing facilities are expensive to create. Where manufacturing facilities are easy to build, using this strategy may result in pirates who simply accept the foreign firm’s payment and open up a new plant somewhere else (Yu 2006). Firms investing in BRICs must thus choose their intellectual property strategy according to the particular characteristics of their industry and target market.

CONCLUSION The BRIC nations cannot be ignored as emerging political powers. No longer just four of many developing nations, the BRICs have already gathered enough economic strength to resist American and European pressure on a variety of issues. Intellectual property rights has been one of the most contentious, and repeated coercive efforts by the US to protect these rights in the BRICs has only met with limited success. The US government and supporting interests must use alternative methods of protecting intellectual property rights in the BRICs. Such methods must view the BRICs not as weaker participants in the global economy, but as equals whose interests must be accommodated rather than suppressed. Intellectual property infringement can be viewed, among other ways, not as a problem of piracy but an opportunity for economic growth. Finding ways to benefit BRIC citizens and firms while also protecting US patents, trademarks, and copyrights will prove the most effective strategy in protecting intellectual capital for the long term.

NOTES A related version of this chapter was published in volume 5 of the Northwestern Journal of Technology and Intellectual Property. 1. Russia is not yet a member of the WTO and merely holds observer status (Binkert 2006).

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Ronkainen, I.A. and J.L. Guerrero-Cusumano (2001), ‘Correlates of intellectual property violation’, Multinational Business Review, 9(1), 59–65. Russell, S. (2000), ‘AIDS experts to meet in eye of epidemic / 20% of South Africa’s adults are infected’, San Francisco Chronicle, http://www.aegis.com/ news/sc/2000/SC000701.html, 7 July 2000. Sanders, A.K. (2005), ‘The development agenda for intellectual property: Rational human policy or “modern-day communism”?’, http://www.unimaas.nl/bestand. asp?id53827. Schulz, C. (2004), ‘The TRIPS agreement and intellectual property in Brazil’, American Society of International Law Proceedings, 98, 100–106. Seita, A.Y. (1997), ‘Globalization and the convergence of values’, Cornell International Law Journal, 30(2), 429–91. Stalls, J.D. (2003), ‘Economic sanctions’, University of Miami International and Comparative Law Review, 11(Fall), 115–72. Sweetwood, D.M. (2002), ‘Is Brazil’s economy coming back to life?’, Multinational Business Review,10(1), 54–9. Taylor, C.O. (1998), ‘Linkage and rule-making: Observations on trade and investment and trade and labor’, University of Pennsylvania Journal of International Economic Law, 19(2), 639–96. Tomar, D.K. (1999), ‘A look into the WTO pharmaceutical patent dispute between the United States and India’, Wisconsin International Law Journal, 17(3), 579–603. US-China Agreement (1979), Agreement on Trade Relations Between the United States of America and the People’s Republic of China of 1979, P.R.C.-U.S., 31 U.S.T. 4652, 7 Jul 1979. USITC (United States International Trade Commission) (2006), United States International Trade Commission: U.S. Trade Balance, by Partner Country 2006, at http://dataweb.usitc.gov/scripts/cy_m3_run.asp. USTR (United States Trade Representative) (2007), Office of the USTR, ‘2007 Special 301 Report’, http://www.ustr.gov/assets/Document_Library/Reports_ Publications/2007/2007_Special_301_Review/asset_upload_file230_11122.pdf. USTR (United States Trade Representative) (2006), U.S.-Russia Bilateral Market Access Agreement on Intellectual Property Rights, http://www.ustr.gov/ assets/World_Regions/Europe_Middle_East/Russia_the_NIS/asset_upload_ file148_10011.pdf. USTR (United States Trade Representative) (2001), Office of the USTR, ‘2001 Special 301 Report’, http://www.cptech.org/ip/health/ustr/special301.pdf. Wall, A.M. (2006), ‘Intellectual property protection in China: Enforcing trademark rights’, Marquette Sports Law Review, 17(Fall), 341–425. Weir, F. (2006), ‘US-Russia rift widening, despite pact’, Christian Science Monitor, http://www.csmonitor.com/2006/1121/p06s02-woeu.html, 21 November 2006. Wilson, D. and R. Purushothaman (2003), ‘Dreaming with BRICs: The path to 2050’, Global Economics Paper, No. 99, New York: Goldman Sachs. Yu, P.K. (2000), ‘From pirates to partners: Protecting intellectual property in China in the twenty-first century’, American University Law Review, 50(1), 131–242. Yu, P.K. (2006), ‘From pirates to partners (Episode II): protecting intellectual property in post-WTO China’, American University Law Review, 55(4), 901–1000.

PART III

Evaluating globalisation, the global economy and economic growth

9.

Dark matter. Does it matter? Graeme Chamberlin*

INTRODUCTION Waves of globalisation always present challenges to statisticians in their attempts to accurately measure the economy. First, in the post-war period there was strong growth in international trade. Second, economies not only became more open to goods and services but also to the trade in financial assets as the world’s financial markets became increasingly integrated. This chapter outlines a potential new challenge for statisticians from globalisation. Firm spending on intangibles relative to traditional machinery is arguably becoming more important in developed economies. Intangibles in themselves are difficult to measure, but if it is accepted that they can flow freely across borders it makes the job even harder for official statisticians. Dark matter refers to the unseen exports of these intangibles which could have important effects on international investment income flows and the international investment position of countries. If dark matter is important, and therefore something statisticians should immediately concern themselves with, it suggests two things. First, that the source of this dark matter, intangibles, are becoming more widespread. Second, that international trade in these intangibles has an important effect on an economy’s external position. The first half of this chapter, in reference to the US economy, suggests that dark matter does matter. However, in the second half the case against is made. First in looking for whether dark matter really exists and second in suggesting that certain key parts of intangible spending are not so important for the operation of a firm. The overall conclusion is that dark matter does not matter, and that statisticians do not need to concern themselves with devising new methods for measuring international transfers in intangible items. Some of the issues touched upon in this chapter have prompted much debate and interest on the measurement of the economy. The outcome of this debate has possible implications for how investment, output, trade and international investment are recorded in the national accounts and the balance of payments. 243

244


INVESTMENT: NOW YOU SEE IT, NOW YOU DON’T During the last 20 years the US and other major global economies have undergone profound changes. Prompted by technology and globalisation, service industries have become relatively more important in the share of domestic output and traditional industry less so. These types of structural changes provide a challenge to national statistics institutes to remain up to date and move with the times in the way the economy is measured. Otherwise a misleading or inaccurate picture is presented with obvious implications for policy-making. One particular area which has been sensitive in the transition to a service-based economy is the definition of investment. Capital expenditures are regarded as outlays that increase the capacity for future output. By contrast, current expenditures are those that are entirely used up in the production process, for example electricity. So the distinguishing feature of capital items is their asset property, that is, firms acquire them for the future flows of disposable resources they generate. According to the System of National Accounts (SNA), an internationally agreed set of standards that aims to provide consistency across countries, investment is on the whole a tangible affair. Investment is predominately firm spending on buildings, vehicles, equipment and machinery. But are these traditional asset classes still relevant for an economy like the US where new information and communications technologies (ICT) have become widespread and output is increasingly in services? ‘Not so’ is the response from a number of researchers, whose basic argument is that the definition of what constitutes investment should be updated to reflect recent structural changes in the economy. First, the advent of new technologies is likely to have changed what is regarded as ‘equipment and machinery’. Second, services sector firms are likely to have a different perspective of what constitutes investment than the production sector. In fact, as US manufacturing itself moves away from mass production of standardised products to more niche, higher technology and sophisticated markets it may also reconsider what is capital as opposed to current spending. In sum, spending on intangibles may increasingly matter. Nakamura (1999, 2001) defines intangible investment as private expenditures on assets that are necessary to the creation and implementation of new and improved products and processes. These include designs, software, blueprints, ideas, artistic expressions and so on and then the subsequent testing and marketing of new properties. He estimates that the

Dark matter. Does it matter?

245

US spends about 6–10 per cent of its GDP on intangible products, almost as much as on conventional plant and machinery. For the most part, official national accounts continue to treat these items as intermediate inputs. Products that are used up in the production process are current and not capital spending. The one exception is software, which is now widely treated as investment. There are also strong moves to reclassify R&D accordingly, with many national statistics institutions developing satellite accounts as a first step to fully implementing the change. But the overall criticism is that official data, in following a narrower definition of investment, fails to capture the increasingly important contribution of intangibles to the total. To date, Corrado, Hulten and Sichel (2006) have provided the most extensive estimates of intangible spending, which they refer to as knowledge capital, in the US. They define three broad groups. ●

●

●

Computerised information: knowledge embedded in computer programs and computerised databases. The major component, computer software, is already capitalised in the national accounts. Scientific and creative property: knowledge acquired through scientific R&D and non-scientific inventive and creative activities. With the exception of oil and gas exploration and architectural and engineering services these are currently expensed (intermediate) items in the national accounts. Economic competencies: knowledge embedded in firm-specific human capital and structural resources including brand names. No items in this broad class are recognised as firm assets.

Figure 9.1 plots their time series estimates of the broad categories of private sector intangible spending. It is clear that it represents a growing proportion of business output, but this trend is driven more by some knowledge asset classes than others. Computerised information, which importantly includes software developed in-house for a firm’s own use (known as own-account software) has unsurprisingly become more significant in the last two decades and especially with the advent of the ‘new economy’ in the late 1990s. However, it still represents a relatively small, despite growing, share of the total. Two components that have remained fairly stable in their shares are the brand equity part of the economic competencies category, and the scientific component of R&D. The first of these relates to advertising expenditures responsible for developing and maintaining brand names and also market research activities. Scientific R&D is primarily R&D in

246


16

14

Brand equity

Scientific R&D

Firm-specific resources

Non-scientific R&D

Computerised Information

% business output

12

10

8

6

4

2

1946 1948 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

0

Source:

Corrado, Hulten and Sichel (2006).

Figure 9.1

Estimates of intangible investment by asset class in the US economy

manufacturing, software publishing and the telecoms industries leading to a licence or patent along with mineral exploration. It is the other two parts of scientific and creative property and economic competencies that have been the main contributors to the rise in US intangible spending. Non-scientific R&D includes a broad range of items such as spending on the development of entertainment and artistic originals, new product development in the financial services sector, broader design spending, and R&D in the social sciences and humanities. In essence, Corrado, Hulten and Sichel (herein CHS) are attempting here to measure the R&D of the services and information sectors of the economy. Firm-specific resources consist of human capital such as the costs of developing workplace skills and organisational structure which is a broad array of spending on organisational change and development. This largely consists of management consultancy and an in-house or own account element based on executives’ management time. The growth in these items is also reflective of the move to a services-based economy,


247

28 Including intangibles 26

Excluding software Existing NIPAs

24

% business output

22 20 18 16 14 12 10

Source:

2003

2000

1997

1994

1991

1988

1985

1982

1979

1976

1973

1970

1967

1964

1961

1958

1955

1952

1949

1946

8

Corrado, Hulten and Sichel (2006).

Figure 9.2

Business investment as a share of output, including and excluding estimates of intangible spending

where these items such as training are regarded as relatively more important. CHS’s basic case for capitalising intangible spending it that these items do indeed have asset properties and to omit them in the light of recent structural changes in the US economy would give a too-narrow and wrong measure of investment. In fact, their results change the picture considerably. Figure 9.2 shows what happens to the share of investment in business output once intangibles are considered. It leads to a doubling of the ratio, and implies that investment trends over the last two decades have been much stronger than the official data suggests. A further important implication is that it changes the US productivity story, with capital deepening supplanting multi-factor productivity growth as the key driver. An analysis on the measurement of intangible spending and its repercussions for productivity measurement has been conducted for the UK by Giorgio Marrano et al (2006, 2007) with very similar conclusions. Accepting the premise of the CHS work, that intangibles are in fact

248


a form of new era of capital goods, would pose significant challenges to national statistics institutes around the world due to their characteristics. Intangibles are obviously not visible, and given that a lot of them are generated ‘in-house’ they cannot be easily verified or valued through market transactions. As they often exhibit non-rivalness, once created they can be shared among divisions, branches and foreign affiliates without cost which makes it difficult to appropriate transfers and returns. For example, royalties and licence payments are already included in trade flows but internal transfers of knowledge are not so their impacts are only picked up in profit (net income) flows. This last issue is a strong theme in the next sections and is really the crux of this chapter. It is already difficult to define and measure intangible investment spending, but once it is accepted that knowledge capital can flow easily across borders and multinational firms it becomes a very difficult job. Simply ignoring it might lead to a distorted picture of international trade and the international investment positions of different countries. This debate has already been raging for several years concerning the sustainability of the US large current account deficit. At the same time it is not a ‘given’ that all the intangible spending outlined by CHS should be capitalised in the national accounts. The cases for software and R&D have already been accepted but the large tranche relating to economic competencies raises a number of conceptual issues and for these it is not clear-cut that they will ever be reclassified from intermediate spending to investment.

THE US EXTERNAL POSITION: A PUZZLE Since the 1990s the US current account deficit has grown steadily as a proportion of GDP to now burgeoning levels. As Figure 9.3 shows, at the end of 2006 the US current account deficit was over 6 per cent of GDP. The chief driver has clearly been the trade in goods whereas the other components have remained fairly stable and generally netted out close to zero in recent years. The US has run a modest surplus, generally 0–1 per cent of GDP on its trade in services since 1980. Net-transfers primarily represent spending on supranational organisations, embassies and international aid and here the US continues to run a small deficit. Net-income flows partially represent net-remittances from foreign workers back to their country of origin, but the main component are net-flows resulting from the ownership of financial assets and direct investments. This has generally been positive,


249

2 1 0

% GDP

–1 –2 –3 Current account Trade in goods Trade in services Net-income Net-transfers

–4 –5 –6

Source:

2005

2002

1999

1996

1993

1990

1987

1984

1981

1978

1975

1972

1969

1966

1963

1960

–7

Bureau of Economic Analysis.

Figure 9.3

The US current account

implying that US citizens earn more on their holdings of foreign assets than vice-versa. A deficit on the US current account implies that US residents, be it households, corporations or government, are consuming more than domestic output. Basically the deficit implies that the US is living beyond its means, and to fund this situation it must either sell some of its assets overseas or borrow from the rest of the world and increase its stock of foreign liabilities. These offsetting transactions are recorded in the financial account of the balance of payments. The persistent and large US current account deficits have therefore required surpluses of an equal magnitude to be sustained in the financial account. The difference between a nation’s stock of foreign assets and liabilities is known as its international investment position (IIP) or sometimes as its net-asset position. To run a surplus on the financial account means that either foreign assets are being liquidated or foreign liabilities accumulated, so the manifestation of persistent and large US current account deficits should be a falling US IIP. Figure 9.4 shows that as a proportion of GDP both the US stocks of international assets and liabilities have grown over the decades representing growing world trade and the increasing openness and integration of global financial markets. However, in line with the evolution of the current account its net liabilities have grown faster giving the US an increasingly negative net-asset position. In Figure 9.5 the US IIP is plotted, and as a proportion of GDP it has

250


18,000 Assets

16,000

Liabilities

GDP

14,000

$ billions

12,000 10,000 8,000 6,000 4,000 2,000

Source:

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

0


Figure 9.4

US foreign assets and liabilities

moved from surplus of 10 per cent prior to 1980 to a deficit of 20 per cent by 2006. Much of the deterioration has occurred post 1990 in accordance with the growing trade deficit. But, the deterioration has not been as significant as implied by the current account. The dashed line in Figure 9.5 shows how the IIP would have changed since 1976 if it simply reflected the evolution of the current account; in this case the IIP would actually be in deficit to the tune of 45% of GDP in 2006. Accounting for the difference are several important valuation effects. First, exchange rates have an important bearing on the valuation of assets and liabilities denominated in foreign currency. According to Tille (2003) almost all the US’s foreign liabilities are in dollars but two-thirds of its foreign assets are in foreign currency. Therefore a US dollar appreciation is bad news for the IIP because in terms of domestic currency its assets are worth less but its liabilities are unchanged. Using information from Nguyen (2007) the US IIP is recalculated in Figure 9.6 excluding the impact of exchange rate movements. It can be seen that some of the sharp decline in the IIP between 1999 and 2003 can be attributed to the strength of the US dollar over this period, where it was buoyed first by the strength of the US economy and then by its status as a safe haven after the 9/11 terrorist attacks and the Afghanistan and Iraq wars. In the last few years the US dollar has weakened considerably and


251

20

10

% GDP

0

–10

–20

–30 IIP

IIP (implied)

–40

Source:

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

–50

Bureau of Economic Analysis and author’s calculations.

Figure 9.5

The US international investment position as a proportion of GDP and its implied ratio based on US current account performance

by increasing the value of foreign assets in domestic currency terms it has helped stem the fall in the US IIP. Second, movements in asset prices themselves are also important. For many types of financial assets it is quite easy to track these changes because they are readily traded and market prices are available. For foreign direct investment (FDI) the valuation is harder because the stocks are illiquid and there are no market prices. Capital gains and losses in net FDI stocks are therefore assumed to be the main component of the ‘other valuation effects’ when breaking down the change in the US net asset position. Subtracting these in Figure 9.7 shows in recent years that the IIP may have been even worse had it not been for capital gains on the US net stock of FDI. So where is the puzzle in the US balance of payments? The answer is in a comparison of US net-investment income (Figure 9.3) with the US IIP (Figure 9.5), with both time series shown in Figure 9.8. Remember, the US surplus in investment income means that US residents are earning more on their stocks of foreign assets than foreign residents are earning on their stocks of US assets. This surplus though has continued to be sustained despite the falling IIP. Hence the US is somehow managing to

252


0

% GDP

–5

–10

–15 IIP

IIP excluding exchange rates

–20

Source:

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

–25


Figure 9.6

The US international investment position excluding the impact of exchange rate changes

continuously generate positive income from an increasingly negative stock of assets. The next section investigates in more detail the sources of the US positive investment income.

FROM GLOBAL BANKER TO VENTURE CAPITALIST? Providing the official data is correct, and some of the arguments made in the next two sections would refute this, there is one explanation for the puzzle. Simply that the US earns a higher rate of return on its foreign assets than it pays out on its foreign liabilities. This is the only way it can continue to make positive investment income from a negative IIP. Figure 9.9 certainly supports this view; there is a persistent wedge between the rate of return on US foreign assets and liabilities. Further dissection of the IIP and investment income flows gives an easy understanding of where the US rate of return advantage comes from. In Figures 9.10 and 9.11 the rates of return on US assets and liabilities by


253

0

–5

% GDP

–10

–15

–20 IIP

IIP excluding other changes

Source:

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

–30

1989

–25


Figure 9.7

The US international investment position excluding the impact of ‘other’ changes

three main groups are plotted. On the stock of foreign assets the highest rates of return are achieved on direct investment, and the lowest on government receipts which is unsurprising. It is surprising though that the rate of return on US direct liabilities is so low; that is overseas direct investment in the US actually offers lower returns than other private investments. Direct investment does not just consist of purchases of plant and machinery overseas, but also larger equity (.10 per cent) stakes in companies. This level is deemed as sufficiently high to give the owner some control over how the business is run and the level of dividends. But it implies that larger share ownerships deliver lower returns than smaller ones which is a curious feature of the data. The IIP can also be broken down into the same three groups as presented in Figure 9.12. Despite the overall IIP moving into substantive negative territory the US has been able to maintain a surplus in the direct investment category, which just happens to be the asset class that delivers the highest rate of return. In line with budget and current account deficits the net asset holdings of other private investment and government bonds have fallen but the corresponding yields are much lower.


1.5

10

1

5

0.5

0

0

–5

% GDP

% GDP

254

-0.5

–10

–1

–15

–1.5 International Investment Position (lhs) Net investment income (rhs)

–20

–2

Source:

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

–2.5 1976

–25


Figure 9.8

A puzzle in the US external position, positive investment income and a falling net asset position

10 9 8 7

%

6 5 4 3 2 Assets Liabilities

1

Source:


Figure 9.9

The rate of return on US foreign assets and liabilities

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

0


255

14 Direct investment

Other private investment

Government receipts

12 10

%

8 6 4 2

Source:

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

0


Figure 9.10

The calculated rate of return on three broad classes of US foreign assets

14 Direct investment

Other private investment

Government payments

12 10

%

8 6 4 2 0

Source:


Figure 9.11

The calculated rate of return on three broad classes of US foreign liabilities

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

–2

256


15 10 5

% GDP

0 –5 –10 –15 –20

Source:

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1978

–30

1976

–25

1980

Government Other private investment Direct investment Total


Figure 9.12

A breakdown of the US IIP into three main asset classes

Breaking the investment income segment of the current account into the same three parts in Figure 9.13 concludes the story. Net government receipts have moved into substantial deficit in line with the IIP, but overall investment income remains positive due to the strong contribution of net direct investment income. The puzzle of the US external position is therefore answered by the economy acting like a venture capitalist, effectively increasing low interest bearing liabilities but maintaining a positive net asset position in a high rate of return direct investments. This venture capitalist analogy is taken from a paper by Gourinchas and Rey (2005). They note that the US rate of return advantage was established after the demise of Bretton Woods when the US ceased to be the world banker and refer to the US IIP as effectively a leveraged portfolio. However, the US substantial rate of return advantage in direct investments is a new puzzle.

DARK MATTER Alternative explanations have been offered for the US rate of return advantage in direct investment and its ability to continually generate positive income from an increasingly negative IIP. Many of these relate to


257

1.50 1.25 1.00 0.75

% GDP

0.50 0.25 0.00

–0.25 –0.50 Net investment income Net direct investment income Net government receipts Other private income

–0.75 –1.00

Source:

2006

2004

2002

2000

1998

1994

1996

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

1968

1966

1964

1962

1960

–1.25


Figure 9.13

A breakdown of US investment income into three main asset classes

measurement issues concerning various parts of the balance of payments. One theory raised by Hausmann and Sturzenegger (2006), which has ignited much debate, argues that the US IIP has been incorrectly measured due to ‘dark matter’. In the cosmos dark matter cannot be seen but only detected by its impact on other nearby objects. Extending the analogy to the US current account implies that the US is exporting products that cannot be seen, but its presence is picked up instead in investment income or profit flows. Hausmann and Sturzenegger identify three principle sources of dark matter. ●

●

Liquidity services: Foreigners are prepared to accept a low rate of return on US dollar assets because, like gold, they are effective as a medium of exchange in international markets. Having their currency as an international medium of exchange provides benefits to the US. Most notably it allows seignorage revenues to be generated on a relatively large scale. Insurance services: Differentials in interest rates on US assets and liabilities are partly due to risk premia. Low return US assets therefore embody sales of insurance services around the world, enabling investors to exchange riskier high return assets for lower return but safer assets. According to Stephen King (HSBC) emerging markets

258

●


specialise in manufacturing and commodity extraction whilst the US specialises in global credit allocation. Intangibles: According to Hausmann and Sturzenegger the largest source of dark matter is the capitalised returns to unaccounted assets. The US overseas assets are understated because there are large exports of intangibles that have been undervalued or not recorded. Here dark matter refers to the know-how, brand recognition and expertise, intellectual capital, business models, financial technology and so on that boost foreign direct investment income. Failing to acknowledge these transfers leads to an undervaluation of US assets held abroad. For example, Euro Disney may have cost $1 billion in physical direct investment to build, but is this a fair value for the business? Dark matter protagonists would disagree, once you add the branding, the unique business model and all the other acumen it is worth more than simply a theme park on the outskirts of Paris. Some of the profits generated by Euro Disney represent a return on these intangibles

Hausmann and Sturzenegger (HS) argue for a revaluation of the US IIP to reflect the impact of these implicit transfers of intangibles on the value of US foreign direct investment. They also state that such a move would be consistent with the positive flows of investment income the US generates. Through basing their revaluation of the IIP on the capitalisation of income streams the premise of the argument is that assets which pay more should be valued higher. IIP(t) 5 investment income (t) / r(t) The difficulty in this approach is selecting an appropriate interest rate (r) to discount investment income. HS use a constant rate of 5 per cent, implying a price-earnings ratio of 20, although little evidence is presented to justify this choice. In fact, the price-earnings ratio is generally far from stable over the business cycle. However, given that investment income flows have generally been positive it will have little impact on the sign of their IIP estimates, just on the magnitude. This is the most significant feature of their revaluation, instead of seeing the US IIP deteriorating it has actually always remained in surplus. This is shown in Figure 9.14. The difference between the official IIP and Hausmann and Sturzenegger’s re-estimation reflects the implicit valuation of the US stock of dark matter – predominately intangible investment that happens alongside direct investment but is not recorded in the official data. This positive stock of dark matter has been growing substantially


259

15 10 5 % GDP

0 –5 –10 –15 –20

Source:

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

IIP (dark matter) 1982

1980

1978

1976

IIP –25


Figure 9.14

The official IIP and the IIP based on capitalising investment income (dark matter) in the US

since 1984, and represented 20 per cent of US GDP by the end of 2006. It is interesting to note that before 1986 the US IIP was in greater surplus according to the official figures than those based on the capitalisation of investment income. This implies that prior to 1986 the US was a net importer of dark matter, or even an exporter of dark antimatter. These results are broadly consistent with the time path of intangibles investment estimated by CHS. If the Hausmann and Sturzenegger story of dark matter though is correct, it has far wider implications than just a revaluation of the IIP and it is for these reasons that it has attracted so much attention and debate between economists and policy makers. The revaluation of the IIP also requires a reassessment of trade flows and eventually an assessment of the overall sustainability of the US current account deficit. As explained earlier, in the second section of this chapter, the dynamics of the IIP are largely driven by the need to offset the current account in the overall balance of payments. If the US has been exporting large, but undetected and unrecorded, values of intangibles then suddenly incorporating estimates of these will change the picture significantly. Figure 9.15 does just this. It shows what the US current account would be if these exports of dark matter were included (where CA(t) 5 IIP(t) IIP(t-1)). Instead of running an increasing and some would say unsustainable deficit, the US has actually been quite close to balance throughout its entire recent history. Therefore talks of a painful correction in the US economy required to bring its trade deficit under control are wrong, or

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The law and economics of globalisation 2 1 0

% GDP

–1 –2 –3 –4 –5

Current account

Current account (dark matter)

Source:

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Figure 9.15

Recalculating the US current account using net exports of dark matter

at least premature. Furthermore, it imparts a strong necessity for statisticians to start recording the international trade in intangible assets. Otherwise policy-makers will be presented with an inaccurate picture of the economy.

COLD FUSION In 1989 two scientists at the University of Utah claimed to have created a tabletop nuclear reaction. Not being able to account for excess heat in their experiments they hypothesised that it was due to nuclear fusion. If their results were correct it raised hopes of a cheap and abundant source of energy. However, cold fusion gained a reputation as a pathological science after scientists failed to replicate the results, and a review panel set up by the US Department of Energy did not find the evidence persuasive. Could this analogy also apply to the finding of dark matter in the US balance of payments? A number of criticisms have been levelled at Hausmann and Sturzenegger’s conclusions. Most find it too hard to believe that global imbalances are simply a measurement issue, and that if official statisticians could incorporate international flows of intangibles into the balance of payments then the issue simply disappears. However, the debate has been useful as much of it has focussed on the difficulties in measuring the global economy and the sources of global imbalances.


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The purpose of this section is to look at some of these issues and offer a criticism to the Hausmann and Sturzenegger conclusions regarding the empirical significance of dark matter. Three main issues have been identified. Firstly, the accuracy of the investment income data and in particular the problems connected with profit shifting through transfer pricing within multinationals. Next the compilation of the IIP is reconsidered. Finally, assuming that the data is broadly correct, alternative arguments for the US rate of return advantage are proposed. Are the US Investment Income Data Correct? Hausmann and Sturzenegger make a strong assertion that the US investment income data is correct whereas the IIP data is wrong. Naturally it could be the other way around. Rather than the IIP underestimated it is net income that is overestimated, perhaps because profit flows overseas are not fully captured in the statistics? In two papers, Gros (2006a, 2006b) tries to account for why the US appears to be a black hole for inward investment that seems to make almost no return. He concludes that the rate of return advantage on direct investment experienced by the US reflects reinvested earnings. These are the differences between profits and dividends. The respective dividend rates are found to be similar, but reinvested earnings are substantial for US direct investments overseas and are almost zero for overseas’ direct investment in the US. The wedge in reinvested earnings is clearly shown in Figure 9.16, except during 2005 which is an interesting case that will be discussed later. One hypothesis is that foreign firms report low reinvested earnings in an attempt to reduce the profits made by their foreign affiliates in the US and reduce their US tax burdens. On the other hand, US firms operating overseas do not face such a large tax burden so have a smaller incentive to try and reduce their liability. This is achieved by using transfer pricing to shift profits between different parts of the production process in different countries. Changes to the structure of multinational companies have certainly eased the possibility of using transfer pricing to shift profits globally. Early multinational firms were horizontally integrated. The entire production chain was based in the same country, with each foreign affiliate simply a replication of the domestic production unit. Today’s multinational firm is in general vertically integrated. Here the production chain is specialised across countries, with each contributing a particular stage in the production of the good or service. As this involves international trade in semifinished products, the internal price at which this trade takes place and hence the value added recorded at each stage can be manipulated.

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2.00 US direct investment abroad

Foreign direct investment in the US

1.50

1.00

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Figure 9.16

The contribution of reinvested earnings to the rate of return on direct investment

And this is not the only way in which vertical supply chains have created difficulties for statisticians in measuring the domestic economy. According to Houseman (2007), the growth in off-shoring in US manufacturing is now generating a significant amount of Phantom GDP because statisticians lag behind rapid changes in product cycles. Essentially the growth of US manufacturing is overstated due to the way statistics treat off-shoring. The output of the manufacturing industry has grown not due to the efficiency of domestic production, but because of the cost reductions from moving production to low wage economies which are not fully incorporated into input prices. Consequently the US import deflator is too high, so in real terms value added is also too high. The problems seem to arise when cost reductions result from switching imports from one low cost foreign producer to another, for example Mexico to China, and especially when these imports come through a third country. In this case it becomes very difficult for statisticians to keep up with the lower costs obtained through off-shoring. The emergence of China as a large contributor to the international trade in manufactures has increased the significance of the problem. Houseman estimates that in this way an extra $66 billion in Phantom GDP has been created between 2003 and 2007. Although this represents


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only 0.5 per cent of US GDP, it is concentrated in the manufacturing sector and accounts for around 40 per cent of the gains in manufacturing output over the period. These are rough estimates, but as low wage emerging market economies move up the value chain the scope for off-shoring and the extent of the measurement error could become greater. It is also likely that off-shoring and the type of intangibles that are associated with dark matter are strongly linked. Foreign affiliates in a vertical production chain can be supported by associated exports of know-how, design, business models, management acumen, R&D and other technologies. Subsequent gains from off-shoring that are then booked back to the parent company can be partially viewed as a return on these intangibles. Hence, dark matter is even more important with trade increasingly dominated by multinational enterprises. A further problem which statisticians have to grapple with is that offshoring changes the structure of the economy so firms need to be reclassified between industries. For example, the biggest shift is companies moving from the production towards the distribution sector in the US as manufacturing is done overseas leaving the domestic operation as just a distributor of the final product. So, can profit shifting through transfer pricing (also known as toll processing) actually explain the puzzle of low re-invested earnings from direct investment in the US from overseas? Referring back to Figure 9.16 there is a large fall in US reinvested earnings on foreign direct investment in 2005. As Kozlow and Abaroa (2006) explain, this was a result of the American Jobs Creation Act (AJCA) of 2004. In an effort to give the US economy a boost this temporary act allowed US parent companies that received dividends from their foreign affiliates and used for specific reasons to be taxed at substantially reduced rates. The impact was clearly to increase the dividend rate, reduce the rate of reinvested earnings and repatriate profits back to the US. The impact of this temporary tax change seems to suggest that reinvested earnings are in fact very sensitive to international tax regimes and therefore it can be an issue in explaining the rate of return bias. However, there are two large contradicting points to this suggestion. Corporation tax rates in the US are not particularly high by global standards, especially compared to some major European economies. There does not seem to be strong evidence that there is a great incentive to shift profits away from the US for tax purposes. If transfer pricing were being used for this aim then foreign companies would in theory be inflating the prices they sell to their US affiliates. As a result US margins are squeezed relative to other margins in the global production chain and profits are shifted accordingly.

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115

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Figure 9.17

The US terms of trade index (2000 = 100)

Figure 9.17 is a plot of the US terms of trade, which is the ratio of export to import prices. If transfer pricing were being carried out in a significant way there would be an expected creep in import prices relative to export prices and a decline in the overall terms of trade. Calculations in Gros (2006) suggest, that in order to account for the scale of missing reinvested earnings in overseas’ direct investment in the US through transfer pricing would require an annual 10 per cent trend fall in the terms of trade. This is clearly not the case. In sum it appears that Hausmann and Sturzenegger’s results are strongly influenced by the low level of reinvested earnings from direct investment in the US from overseas. If it earned a similar rate of return to US foreign direct investment then net investment income, the current account and the IIP would all be weaker. How is the IIP Calculated and What Does it Tell Us? The BEA like all statistics agencies attempt to value flows and positions based on market prices when they are available rather than how these streams may be hypothetically valued. For many assets such as bonds, gold, equities or bank deposits it is relatively easy. Like traded goods and services they have observable market prices and transactions can be easily


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monitored. On the other hand, direct investments are not easy to value. They are infrequently traded, illiquid, and their present value is almost certainly different to the historical cost measure which simply records the value of the acquisition at the time it was made. Historical cost measures therefore need to be updated. The current cost approach simply does this by using information on the replacement value of the firm’s tangible assets. However, this neglects the contribution of intangible assets to the firm’s total value. Market price valuation of direct investment is therefore achieved using local stock market indices as a proxy. So, US equity markets are used to value overseas direct investment in the US, and foreign stock markets are used as a proxy to value US foreign direct investment. The assets and liabilities that constitute the US IIP in direct investment in both current cost and market prices terms are shown in Figure 9.18 and the overall net asset position in US direct investment in Figure 9.19. A number of issues in the market price approach are immediately apparent. Equity markets are notoriously volatile relative to fundamentals. In Figure 9.18 the dot com bubble and its subsequent deflation are clearly seen in the value of US direct investment assets and liabilities. As a result, it is wise to use equity markets cautiously. 5 000 Assets: current cost

4 500

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$ billions

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Source: Bureau of Economic Analysis and author’s calculations.

Figure 9.18 US foreign direct investment assets and liabilities at current cost and market prices

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10 8

% GDP

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Figure 9.19

The US IIP on a current cost and market value basis

In the equity market boom of the late 1990s analysts suggested that the large difference in market valuation of US corporations and the replacement value of their tangible assets was the implied value of the intellectual property and other intangible assets held by those corporations. However, between 1999 and 2002 the implicit value of these intangibles fell from 1$7 trillion to −$2 trillion in just three years. Tobin’s q (average) is simply the ratio of market value to the replacement cost of tangible assets. Theories based on q are an important part of the economics literature on the determination of investment because they relate value creation to investment spending. They are also popular conceptually because they can link investment behaviour to movements in the stock market. By using the market price and current cost valuations of US direct assets and liabilities from Figure 9.18 a q-based ratio for US foreign direct investment and overseas direct investment in the US is plotted in Figure 9.20. Because the two ratios are very similar it is an argument against the dark matter hypothesis. According to the theory it is the intangible assets that generate a superior rate of return from tangible assets. If the US rate of return advantage on direct investment is accounted for by this it should be the case that this ratio is higher for US originated direct investment, but this is not the case. Ratios of market value to current cost value of direct


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Ratio of market value to current cost

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Figure 9.20

Ratio of market price to current cost for US direct assets and liabilities

investment in and out of US do not support a large profit differential based on market valuations. A valid criticism of the current BEA methodology is in the use of local stock markets to value direct investment. Is the profitability of the foreign affiliate of a US company most likely to be represented by its parent company or the characteristics of ingenious firms? To a certain extent this rescues the dark matter argument. If the value of US foreign direct investment is partly the result of a flow of intangibles from its parent company, its value is more likely to be adequately captured using the US rather than the local stock market. The same reasoning, but applied vice-versa, would apply for direct investment in the US from overseas. This brings us back to the Hausmann and Sturzenegger argument that US IIP should be valued according to the capitalised value of net investment income. Although the BEA did investigate this possibility it decided against that course of action. One of the cited problems is that for the sake of consistency the measurement techniques suggested by Hausmann and Sturzenegger should lead to the revaluation of other domestic transactions. For example, the banking system borrows from the household sector and lends to businesses and households at a higher rate. Therefore the banking system has a net-liability with the household sector but at the same time its interest rate margins enable it to have a net income

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position. Should the negative position then be re-valued into a positive one with the revision treated as sales of dark matter to consumers of banking services, substantially increasing consumption and GDP? This would create a lot of subsequent distortions throughout the entire national accounts. Other (Conventional) Reasons for the US Rate of Return Advantage Kozlow (2006) proposes a number of explanations for the gap in the rates of return on US direct investment. ● ●

●

●

Evidence on business sector output growth state that US firms are generally more efficient. US companies are more established in foreign markets due to earlier entry (see Figure 9.21). Therefore the costs of mergers, acquisitions and start up costs weigh less on profits. Foreign firms in the US face greater competition and are relatively smaller. Most US direct investment is in Europe and Japan where product market competition is lower. Lower interest rates overseas reduce the necessary rate of return.

3.5 US direct investment overseas Foreign direct investment in the US

3.0 2.5

% GDP

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Source:


Figure 9.21

The time path of US direct investment overseas and direct investment into the US

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Dark matter. Does it matter? ●

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Economies of scale from accessing large US markets may increase the rate of return on home production compensating for the low rate of return on affiliate production. Differences in tax treatments affect the international attribution of profits (transfer pricing as already discussed)

An alternative proposition is that positive US investment income is being generated by the falling interest rate it pays on official government debt. This is visible in Figure 9.11 where the rate of return on US government liabilities has fallen in recent years. Until recently global financial markets were flooded with liquidity, enabling the US government to borrow cheaply. The ease at which the US has funded its twin deficits has probably contributed to the persistence and the size of global imbalances. Global imbalances are also the result of high saving rates in emerging markets and energy exporting countries looking to invest surpluses. The US has been an attractive destination for much of this finance for a number of reasons. ● ●

●

Domestic banking systems in emerging markets are underdeveloped and not capable of recycling surplus saving and funding investment. The need to generate currency reserves to fight off speculators and prepay debt. For example Asian reserves to protect against another crisis. US dollar represents a superior store of value in countries with unstable currencies and histories of high inflation.

In general, the US dollar as an international medium of exchange, store of value and risk free asset means that foreign investors are prepared to accept lower rates of returns for holding them. Consequently the US external position is quite vulnerable to an increase in the funding costs of interest bearing debt. Buiter (2006) though offers a sharply contrasting point of view in that once risk premia are taken into consideration there is no US rate of return advantage. The dark matter results of Hausmann and Schwarzenegger are therefore flawed, and simply represent the outcome of discounting risky income flows with a risk-free interest rate. At the time of writing he stated that spreads in financial markets are in fact so tight there is little room for a conventional risk premium. He also pointed to an issue in the balance of payments which might produce a positive bias in the measurement of US investment income. High interest earnings on emerging market debt are based on an accrual basis and are noted on the investment income account. This is even

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the case if the debt is non-performing and the interest is not paid. Any write-offs of accumulated interest are then presented as a debit on the financial account and investment income is unaffected. A more accurate description of investment income would emerge if these write-offs were netted against contractual interest payments instead.

I STILL DON’T SEE IT Following the already cited work in the US and UK the study of intangibles has moved forward. First, there is interest in extending the analysis to other countries, so new cross-country comparisons of investment can be investigated. Second, the impact on productivity has become a research question. In this case, how does a re-treatment of intangibles spending as investment rather than intermediate inputs affect productivity measures? In subsequent work both CHS and Giorgio Marrano et al. find the impact to be significant. For the US multifactor productivity is no longer the main driver of growth, but further capital deepening. In the UK the entire productivity trend of the economy is affected. Although at an early stage, work has also commenced on firm-level studies of intangibles spending and company performance. There is one topic though that has yet to be discussed in much detail. That is whether intangibles really should be counted as investment rather than intermediate inputs. CHS make their case by pointing to the asset properties of these types of spending. Firms only undertake them in order to increase their future productive capacity, hence they are investment. However, from my experience, this is not universally accepted and particularly so among national accountants. Intangibles spending can really be split into two main categories. The first are information and knowledge assets, relating to research and design and computerised information (software and databases). National accountants are in broad agreement that these do represent investment expenditures. Software, including that produced in-house by firms (ownaccount), have already been incorporated into the national accounts of most of the major OECD economies as part of the 1993 System of National Accounts (SNA). The next SNA makes a commitment for the same treatment of R&D expenditures. As a preliminary step to a full implementation most of the major national statistics institutions have developed, or are developing, satellite accounts. These allow data users to view what impact the reclassification will have on important economic variables like output and investment, whilst making sure the main national accounts are protected from any errors that might arise in implementing the new methodology.


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The branch of intangibles described as organisational capital, or economic competencies in CHS speak, is less likely to be adopted as investment. These refer to a broad range of corporate spending such as advertising, marketing, management consultancy and training. From both the US and UK studies these are significant in terms of the levels and growth of total intangible spending, and therefore on the results of the follow-up work on productivity and firm-level performance. Without doubt, excluding this large segment of expenditure weakens the importance of the intangibles agenda. This section raises a number of the practical and conceptual issues that might explain why statisticians are reluctant to change from the status quo for organisational capital. From the practical side of things it would be very difficult to clearly define which firm expenditures are current and which are capital. For most it is not a case of distinguishing between black and white. There is a possible case for almost all intermediate consumption actually having some asset property. And even if this could be achieved there will then be the problems of measurement and valuation which are particularly acute because much of the organisational capital of firms is developed in-house without recorded market transactions or prices. But even setting aside the practical difficulties there are two economic cases against. An important literature would suggest that many of the types of intangible spending identified by CHS are actually adjustment costs rather than investment. That is they are complimentary expenditures designed to help integrate new capital stock into the company, rather than part of the capital stock themselves. The other case is linked to the potential role of the entrepreneur in the theory of the firm. The neoclassical approach adopted by the intangibles studies leaves very little role for the entrepreneur, so a corporation is effectively run by its own organisational structure which in itself is a product of past spending on economic competencies. In alternative theories of the firm the conceptual argument for capitalising spending on economic competencies is weaker. The outcomes of these arguments are ultimately important for the way the economy is measured. If organisational structure is an asset of the firm then a broader notion of investment is required. And part of the profits banked by the firm will represent a return on this spending. From the global perspective international transactions in these products would need to be captured in trade statistics and international investment positions and the case for dark matter mattering is greater. Practical Difficulties in Measuring Spending on Organisational Capital When software expenditures were capitalised as part of SNA93 it created a problem of consistency because firms could invest in two different ways.

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Purchased software services are those bought or licensed off the shelf, or custom-designed from a specialist firm in the industry. As these involve market transactions it is fairly easy for firms to record their purchases in business surveys. Own-account software relates to that developed in-house specifically for use within the firm. Here there are no market transactions so it is difficult to measure the value of resources devoted to its creation as well as an internal rate of return. However, given the number of software professionals employed outside of the software industry own-account creation is seen as being increasingly significant, especially in certain industries where in-house software plays an important role in product differentiation such as financial services. So ignoring it altogether would lead to an inconsistency in the national accounts. For many economies like the US and the UK which have a large services sector own-account is as quantifiably important as purchased. Official business surveys though tend to do badly in recording this activity. A survey by the ONS found that only 20 per cent of firms correctly returned surveys of own-account software formation. A general problem is that firms have an incentive to expense these costs so they can be deducted from corporation taxes, meaning own-account payments are treated differently in company financial accounts than in the national accounts. It is conceivable that when filling in official surveys to the relevant national statistics institution firms use their financial records, so here it is obvious why own-account expenditures may be under-reported. Recognising these limitations the internationally recognised best-practice methodology is to use information on the supply-side, that is, an estimate of the labour and real resources costs committed, to form a proxy measure. A substantial proportion of organisational capital is likely to be created on an own-account basis. For example in-house training schemes and executive time directed toward corporate strategy are own-account versions of training and management consultancy. For organisational capital, defining own-account expenditures is potentially difficult and could, in theory, encompass a large amount of intermediate consumption. Therefore it is hard to know where to draw the line between capital and current expenditure. Training is considered to be a good example of intangible investment, clearly adding to the stock of human capital possessed by a firm’s workforce, but if the end is having labour with certain skills this is simply just one means of achieving it. For the sake of consistency all other means should also be considered as investment. Instead of hiring labour and paying to put it through a training scheme the firm may prefer to directly hire the labour with the skills it requires. If these skills are general, rather than firm specific, it is likely that labour will


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command higher wages. So should part of that wage payment be considered as an investment expense, that is, a payment towards improving the stock of human capital within the firm? Alternatively, a company with a strong HR department or recruiting network (head-hunters, recruitment firms and so on) may be good at screening staff, so the company is effective at hiring the staff with the necessary skills making training unnecessary. In this case effective recruitment policies could be an alternative to training. There is a large economic literature on the importance of matching and screening in the labour market. So therefore should a proportion of recruitment expenditure be considered an investment? One of the original studies on organisational capital by Prescott and Visscher (1980) emphasised the importance of matching jobs to employees and employees to teams. The case of training is just one example of how intangible spending is difficult to define. In the case of software, and elements of design it is a little simpler because the activity tends to be undertaken by certain clearly identifiable professions. For a great deal of organisational expenditure it is not so clear cut, and the danger is that a huge amount of intermediate spending can be argued to have asset properties. Not Investment but Adjustment Costs Cummins (2004) provides an altogether different reason as to why firms spend on intangibles. He argues that these are not a distinct factor of production such as physical capital or labour. Rather it is the glue that enables firms to generate value from their other inputs. This is an appealing argument. For example, suppose a firm buys a new software licence, and then sends the members of its workforce who lack the skills to operate it on a training course. In this situation, the software expenditure would be the investment; the supporting spending on training would be an adjustment cost that the firm pays to integrate the new capital with its existing capital and labour. The key point is that organisational capital is not like any other input. It simply defines how the other inputs are used and consequently how value is created. Cummins gives the example of Dell and Hewlett-Packard. There is little difference in their tangible stocks, but Dell’s unique business regimes and business models allow it to create extra value. Without this Hewlett-Packard cannot expect to replicate Dell’s tangible capital stock and expect to be as profitable. It makes no sense to think of intangibles or organisational capital as a distinct factor of production that can be purchased in the market. As they are so closely connected with traditional factor inputs their valuation as standalones is almost impossible.

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This perspective on organisational capital contrasts with the existing literature. This implies that firms can accumulate organisational capital in the same way as they would buy machinery. Instead, intangible capital typically results from the distinctive way companies combine the usual factors of production. This is very close to the traditional role of the entrepreneur which is discussed next. Entrepreneurship and Intangibles Theories of the firm have tended to play little attention to the role of the entrepreneur, most likely because it is difficult to model the judgement and decision elements involved. Classical models and descriptions of entrepreneurial activity and behaviour cannot be expressed in terms of maximising behaviour, hence it is often not thought of as a useful paradigm in the modern economics literature. Organisational capital is defined as the processes and routines that govern how a firm operates and combines factors of production and are considered to be part of its intangible assets. The same technology and labour may be available to a number of firms but some could be able to make better use of it than others. Based on this definition the concepts of organisational capital and entrepreneurship appear to perform similar functions, so are in a way competing theories. However, they are in essence two different factors of production. Organisational capital is intangible investment, whereas entrepreneurship is its own factor. Proponents of the view that entrepreneurial decision-making is at the heart of the firm point to two vital roles the entrepreneur plays that organisational capital cannot hope to replicate. The first is that judgement in the face of uncertainty requires a strong human element that a stock of organisational assets cannot perform. Second, entrepreneurs are important as market-makers, performing the function of bringing buyers and sellers together. In both of these cases the inadequacy of organisational capital in accounting for the way a firm operates is linked to the standard neoclassical framework that is adopted throughout economics. Neoclassical models are about simple optimisation. Each factor is hired up to the point where its marginal (revenue) product equals its marginal cost. As this is pretty much conventional wisdom it is not surprising that the entrepreneur is given short shrift and is neglected from the main theories of the firms understood by economists. This is simply because combining factors of production against the marginal principle requires no skill other than arithmetic. Casson (2004) argues that entrepreneurship is the missing component in several leading theories of the firm. It is in fact the key to the growth and


275

survival of the firm in a volatile environment as judgement is required for making decisions under uncertainty. In dealing with short term volatility, decisions are often undertaken by routines and procedures for collecting information and algorithms for deciding the best course of action. However, most key investments are the response to long-term volatility and these are not sufficiently alike and do not recur sufficiently often to be based on routine or procedure. These decisions are improvised as the information is difficult to anticipate and unknown. Here the entrepreneur comes into his own as somebody who can synthesise information from a diversity of sources to make risky decisions. This premise is at the heart of the main theories of entrepreneurship throughout the ages. Cantillion emphasises investment in hiring labour and capital in anticipation of future sales. Knight was more concerned about large-scale fixed investment and Schumpeter of the creation of entire new industries. Successful entrepreneurship is then sustained by the profits it creates. There will be some overlap between the short run and long run decisionmaking. Managerial and clerical employees will notice anomalies and imperfections in routines that can be improved, which may identify new investment possibilities in themselves. Routine and improvisation are not always substitutes but contain an element of complementary. It may also be a source of small business formation, that is, finding flaws in the routines and correcting larger businesses. A second core function of an entrepreneur is as a market maker, exhibiting the ability to bring producers and consumers together and identifying product innovations and refinements and changes in the patterns of demand. This is potentially an important role as often the market may not even have existed before the entrepreneur was identified. In the neoclassical perspective entrepreneurs once again play a more limited role and exist only to bring markets back into equilibrium. This is how they achieve their (super) normal profits. But it assumes that the market already exists and entrepreneurs are just arbitrageurs. Alternative and more radical theories of the firm promote entrepreneurship in creating markets rather than just equilibrating them. Neoclassical theory is heavily influenced by the presence of the Walrasian auctioneer, with the entrepreneur just the person who supplies the market. Despite refinements to include imperfect competition neoclassical theory still offers no explanation for where markets come from. The Walrasian auctioneer is also hard to justify, has anybody ever seen one? They incur no costs and information is free, they are monopolists but earn no margins between buying and selling prices, so they must just be altruistic

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figures existing to provide liquidity services to the market. In practise market-makers are important.

CONCLUDING COMMENTS There are two situations where statisticians would be concerned about dark matter. The first is if spending on organisation capital is reclassified from current to capital. This would dramatically increase the source of potential dark matter. Second, if international trade in intangible assets is found to be important in accounting for the value of direct investment and in generating investment income flows. Work by CHS and Hausmann and Sturzenegger suggest that both are important. Organisational capital is a significant part of the total intangible assets of the US business sector. And it has helped to generate positive investment income despite the officially measured international investment position being negative. However, there are strong cases for rejecting both and hence the significance of dark matter. Organisational capital is difficult to define and measure, and the conceptual case for treating it as investment is not clear cut or universally accepted. Part of the problem is that the economists that have made the running in measuring the intangible economy strongly rely on a neoclassical paradigm that allows them to treat intangible spending as a quasi fixed factor of production that can be accumulated just like conventional machinery. Alternative perceptions argue that intangibles are adjustment costs that cannot be treated as standalone investments; they exist simply to elicit output from other capital and labour. It is also suggested that a stock pile of past intangible spending could not substitute for the important role of the entrepreneur. If there is not a strong case for capitalising spending on economic competencies then the international trade in intangibles is likely to be much smaller. The actual importance of dark matter in international trade is also more questionable than Hausmann and Sturzenegger suggest. Their results are strongly dependent on the quality of investment income data, which is then arbitrarily capitalised to suggest that intangible exports are so great the US current account and international investment position are actually both in surplus. This seems hard to believe. The main problem appears to be the very low rate of return that direct investment in the US from overseas achieves. It is significantly lower than both US foreign direct investment, and also other private investment from overseas in the US. Gros referred to it as a black hole, finding that the gap in rate of returns were down to the presence and lack of a presence


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of reinvested earnings. This could, but it is hard to prove, reflect the use of transfer pricing within multinational firms to move profits between countries for tax purposes. The rate of return advantage enjoyed by the US may also exist for a host of reasons other than associated with exports of intangibles. Dark matter therefore does not matter too much for statisticians.

NOTE *

Although I work for the UK Office for National Statistics, it must be accepted that my views are personal and no way official or representative of the organisation.

REFERENCES Buiter, W. (2006), ‘Dark Matter or Cold Fusion’, Global Economics Paper No. 136, Goldman Sachs. Casson, M. (2004), ‘Entrepreneurship and the Theory of the Firm’, Department for Economics mimeo, University of Reading. Corrado, C., C. Hulten and D. Sichel (2004), ‘Measuring Capital and Technology: An Expanded Framework’, Finance and Economic Discussion Series 2004-64, Federal Reserve Board, Washington, D.C. Corrado, C., C. Hulten and D. Sichel (2006), ‘Intangible Capital and Economic Growth’, Finance and Economic Discussion Series 2006-24, Federal Reserve Board, Washington D.C. Giorgio Marrano, M. and J. Haskel (2006), ‘How Much Does the UK Invest in Intangible Assets?’, CEPR Discussion Paper No. 6287. Giorgio Marrano, M., J. Haskel and G. Wallis (2007), ‘What Happened to the Knowledge Economy? ICT, Intangible Investment and Britain’s Productivity Record Revisited’, Department of Economics Working Paper No. 603, Queen Mary University of London. Gourinchas, P-O. and H. Rey (2005), ‘From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege’, Paper presented at NBER Conference on G7 Current Account Imbalances: Sustainability and Adjustment. Gros, D. (2006a), ‘Foreign Investment in the US(II): Disappearing in a Black Hole?’, Centre for European Policy Studies Working Document No. 242. Gros, D. (2006b), ‘Foreign Investment in the US(II): Being Taken to the Cleaners?’, Centre for European Policy Studies Working Document No. 243. Hausmann, R. and F. Sturzenegger (2005), ‘US Global Imbalances: Can Dark Matter Prevent a Big Bang?’, Working Paper, Kennedy School of Government, Harvard University. Hausmann, R. and F. Sturzenegger (2006), ‘Global Imbalances or Bad Accounting? The Missing Dark Matter in the Wealth Nations’, Center for International Development Working Paper No. 124, Harvard University. Houseman, S.N. (2006), ‘Outsourcing, Offshoring and Productivity Measurement

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in US Manufacturing’, W.E. Upjohn Institute for Employment Research Working Paper 06-130. Kozlow, R. (2006), ‘Statistical Issues Related to Global Economic Imbalances: Perspectives on “Dark Matter”’, US Bureau of Economic Analysis mimeo. Kozlow, R. and P. Abaroa (2006), ‘US Multinational Companies, Dividends and Taxes’, Paper presented at the International Association of Official Statistics, Ottawa. Nakamura L. (1999), ‘Intangibles: What Put the New in the New Economy?’, Business Review, July/August, Federal Reserve Bank of Philadelphia. Nakamura, L. (2001), ‘What is the US Gross Investment in Intangibles? (At Least) One Trillion Dollars a Year’, Working Paper No. 01-15, Federal Reserve Bank of Philadelphia. Nguyen, E.L. (2007), ‘International Investment Position. Survey of Current Business’, July, Bureau of Economic Analysis. Prescott, E.C. and M. Visscher (1980), ‘Organization Capital’, The Journal of Political Economy, 88 (3) 446–61. Tille C. (2003), ‘The Impact of Exchange Rate Movements on US Foreign Debt’, Current Issues in Economics and Finance, 9 (1), Federal Reserve Bank of New York.

10.

Two scientists for every man, woman and dog in America? How sustainable is globalisation? Raphael Kaplinsky

INTRODUCTION In 1957, at a high point in the Cold War, the Russians launched the first satellite – the Sputnik. The fact that the Russians had got into space first came as a great shock to the Americans, who responded with a crash investment programme in the training of scientists and technologists. Jahoda calculated that if this increase in human resource investment had been sustained over the decades, by 1992 there would be two scientists for every man, woman and dog in America (Jahoda 1973). The first decade of the twenty-first century feels a little like 1957. To many it appears as if the momentum of globalisation is unstoppable. But a moment’s reflection suggests that a more cautionary attitude is in order. For one thing, the spread of globalisation is uneven. It is true that there has been an accelerating removal of barriers to trade (especially in manufactures) and the cross-border flow of capital and that this has been associated with a deepening in the breadth and intensity of economic integration. However, many barriers to cross-border integration persist, not least in controls over the flow of people, especially those with little education and skills. There is also little sign of the withering away of the nation state, although its functions and purview are nevertheless in a state of flux (Weiss 2002). For another thing, the idea that globalisation is unstoppable fails to take on board the experience of history. The last decades of the nineteenth century represented a similar phase of rapidly deepening global integration which also seemed unstoppable to many. Yet it came to an end in an abrupt and brutal form, with the loss of many millions of lives, and it was only half a century later that we entered a new phase of global integration (Kaplinsky 2005). In this chapter we will address four factors which caution against the triumphalism of the contemporary globalisation agenda. In each case, these 279

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represent countervailing forces which are endogenous to the system, that is, which arise out of the very success and extension of the global economy. The first of these factors is the disruptive potential of China and India; the second reflects the environmental sustainability of continued globalisation; the third focuses on insecurity and the sustainability of the logistical arteries of globalisation; and the fourth addresses the countervailing political forces unleashed by the patterns of inequality which result from the extension of globalisation.

THE DISRUPTIVE IMPACT OF THE ASIAN DRIVERS On current trends, China will be the second biggest economy in the world by 2016, and India the third largest by 2035. A cluster of other countries in the Asian region, such as Thailand and Vietnam, are also growing rapidly. These newly dynamic Asian economies can collectively be characterised as the ‘Asian Drivers’ of global change. The economic processes they engender are likely to radically transform regional and global economic, political and social interactions and to have a major impact on the environment. This is a critical disruption to the global economic and political order that has held sway for the past five decades. The two key Asian Driver economies are China and India. But they reflect very different growth paths. China is integrated into an outwardoriented regional economy, involving fine divisions of labour predominantly in manufacturing sectors. Its growing global presence is in large part a direct consequence of the extension of the global economy since to a very large extent its export boom reflects the participation by Chinese firms and China-based trans-national corporations (TNC) subsidiaries in global value chains. Nearly 60 per cent of China’s exports and more than 70 per cent of its exports of machinery and electronic products are classified for fiscal purposes as ‘processing trade’, involving the import of intermediates and capital goods (largely from the East Asia region) for the manufacture and assembly of final products for export (Fu 2003). In the case of India, export earnings are significantly driven by the incorporation of Indian software in global service sector value chains. But India’s manufactured exports are beginning to grow rapidly too. Although incorporated into the global economy in different sectors, China and India pose similar major and distinct challenges for the global and developing economies, for five major reasons. The first is as a consequence of their size. As Figure 10.1 shows, from the beginning of their growth spurts (1979 and 1992, respectively), neither GDP or export growth in the two largest Asian Driver economies were

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Growth of GDP (Constant US $ 2000) 4 3

Log GDP

3 2 2 1 1 0 1

5

9

13

17

21

25

29

33

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China (1979–2004)

Japan (1960–2004)

Korea, (1963–2004)

India (1992–2004)

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5

9

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17

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China (1979–2004) Korea, (1963–2004)

25

29

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37

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Japan (1960–2004) India (1992–2004)

Source: Calculated from World Bank, World Development Indicators, accessed electronically, September 2006.

Figure 10.1 Growth of GDP and exports from onset of rapid growth: China, India, Japan and Korea unique. In recent years other Asian economies (for example, Japan and Korea) have experienced similarly rapid growth paths. However, whilst China accounted for 20 per cent of the world’s population and India for 17 per cent in 2002, at no time did the combined population of Japan and

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Korea’s exceed four per cent of the global total. So, unlike the case of Korea and Japan, who could grow without severe disruption to the global economy, we have to suspend the ‘small-country’ assumption in the case of the Asian Drivers. The very high trade intensity of China’s growth makes the big-country effect particularly prominent in its case. Between 1985 and 2005, China’s exports rose from $50bn to $772 billion, transforming China into the world’s third largest trading nation. This trade intensity of growth is having a major impact on the terms of trade (Kaplinsky 2008a). As a consequence of a rapid growth in Asian Driver exports of manufactures, the prices of many manufactures either began to fall after the mid 1990s, or their rate of price-increase slowed considerably. At the same time, the embodied material content of these manufactured exports and their common heavy investments in infrastructure has led to a rapid and probably sustained rise in the demand for, and price of, commodities. The resultant change in the terms of trade challenges not just traditional growth strategies (which have historically favoured a move from the primary sector to industry), but the political coalitions in individual countries supporting this growth path. Second, the rise of the Asian Drivers has been associated with very significant, and growing, imbalances in the global economy. By 2006 these imbalances were most evident with respect to the US and China. Figure 10.2 provides data on their respective trade imbalances. The US – the world’s second largest trading economy – had sunk from a current account deficit of minus $113bn (minus 1.5 per cent of GDP) to minus $857bn (minus 6.5 per cent of GDP) in 2006. By contrast, in the same time-period, China’s current account surplus had grown from a mere £1.6bn (0.3 per cent of GDP) to $239bn (9.1 per cent of GDP). A related imbalance concerns financial flows. Arising in large part as a result of its growing current account surplus, by mid-2007 China held foreign exchange reserves in excess of $1.4trillion. These reserves are large, and compare with the total value of FDI stock in the US of $1.7trillion. Depending on how these reserves are utilised – for example, to buy up assets of large western firms – there is potential for substantial conflict and the possible impositions of controls over foreign ownership in the large previously dominant industrialised economies, undermining the mobility of global financial flows. The third reason why the Asian Drivers may disrupt the global economy is that China (especially) and India embody markedly different combinations of state and capitalist development compared with the industrialised world. Chinese enterprises have their roots in state ownership, usually arising from very large and often regionally-based firms (Nolan 2005; Shankar 2005). They reflect a complex and dynamic amalgam of property rights – ‘The ownership of each of China’s large SOEs [state owned


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–200

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–400 –600 –800 –1000

1995

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6

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China current account balance 300

2

50

0

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% GDP

Source: IMF, http://www.imf.org/external/pubs/ft/weo/2007/01/data/index.aspx, accessed 20 July 2007.

Figure 10.2

US and China trade balances ($bn and % GDP)

enterprises] has spread gradually among a variety of public institutions, each of which has an interest in the firm’s performance . . . [b]ased on the ‘ownership maze’ and vaguely defined property rights’ (Nolan 2005: 169). With access to cheap (and often subsidised) long-term capital, these firms operate with distinctive time-horizons and are less risk-averse than their western counterparts (Tull 2006). Indian firms are probably less distinct from the western model, but often include elements of social commitment which are largely alien to western firms (Humphrey, Kaplinsky and Saraph 1998). Associated with these complex forms of ownership and links to regional and central state bodies, Chinese firms often operate

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abroad as a component of a broader strategic thrust. This is particularly prominent in China’s advance in sub-Saharan Africa (SSA) in its search for the energy and commodities required to fuel its industrial advance (Kaplinsky, McCormick and Morris 2006). What this means is that Asian Driver firms tend to operate with much longer time-horizons and are less averse to risk than their western counterparts. Moreover, their base in low income economies means that they are not subject to the same pressures regarding corporate and environmental social responsibility, fuelling accusations by previously hegemonic western firms of ‘unfair practice’. The fourth reason why the Asian Drivers present a new and significant challenge to the global and developing economies is that they combine low incomes and low wages with significant innovative potential. This means that they are able to compete across the range of factor prices. The oft-stated belief (and hope?) that China will run out of unskilled labour is belied by the size of its reserve army of unemployed, estimated at being in excess of 100m compared to the 83m people employed in formal sector manufacturing in 2002 (Kaplinsky 2005). As Shankar observes, ‘China’s enormous labor reserves, with pay scales radically lower in the hinterland than the coast and in urban areas (the average income on the farm, where more than half of the Chinese population lives, is less than $25 per month), creates the equivalent of a country within a country; so, instead of Vietnam or Bangladesh replacing China as a labour-intensive haven, Hunan will replace Guangdong’ (Shankar 2005: 134). Moreover by 2030, India, also with a large reserve army of underemployed, is likely to have a larger – and younger – population than China. But China and India are not content to operate in this world of cheap labour and mature technologies, and are investing heavily in the building of technological capabilities. China, for example, overtook Japan to become the world’s second largest investor in R&D in 2006 (Keeley and Wilsdon 2007; Leadbeater and Wilson 2007). A fifth disruptive consequence of the rise of the Asian Drivers is their quest for secure supplies of raw materials. In the 2005–07 period this was an agenda largely played out in Sub-Saharan Africa (SSA), and largely in relation to access to energy. China became an active investor in the Sudan and Angola, in both cases in the search for secure oil supplies, and in both cases running against established policy agendas of the hitherto hegemonic western powers, and displacing western energy firms. In Sudan this led to an easing of the pressure over Dharfur; in Angola it allowed the government to escape pressure exerted by the Paris Club on transparency in government. In Angola, China and India competed directly for access to the fuel deposits, in other cases (as in West Africa) they concentrated on different countries. But it is not just oil that the Asian Drivers have


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targeted in SSA. China has become a heavy investor in the Zambian copper fields, and in various mineral sectors in South and West Africa. Similarly, it is not just in SSA or in oil that their resource hunger is likely to be felt as a disruptive factor. A shortage of softwood for the building industry in 2007 was a direct consequence of China’s demand for timber, and water, too, has begun to loom on the horizon as a potential source of competitive positioning. As a consequence of these impacts, the Asian Drivers are beginning to disrupt the ‘political compact’ which has underwritten the extension of globalisation in the post WW2 era. China and India are increasingly active in global institutions, demanding greater say in the regulation and shaping of the global economy. Their own experience belies the efficacy of the Washington Consensus policy agenda, and China and India provide a different policy role-model for many developing economies, with the possible rise of a ‘Beijing Consensus’ to rival the Washington Consensus (Ramo 2004). These dynamics represent a transition from a quasi-unilateral US-dominated world order to a multipolar power constellation. This is likely to lead to new turbulences and conflicts between the rising and the declining powers within the global governance system (Gu et al. 2008). None of these Asian Driver related factors – the large country effect on the terms of trade; trade and fiscal imbalances; the distinctive nature of Asian Driver firms; competition across the range of technology-intensity in trade and innovation; and the quest for resources – are in themselves likely to undermine the extension of the global economy. But, and largely as a consequence of their size, together they make up a significant disruptive challenge to the global order. In this context it is worth bearing in mind the lesson from history, since one of the primary reasons for the descent of the global economy into war in the early years of the twentieth century was the failure of the old imperial powers to allow a new entrant – Germany – to play a key role in the forming of global architecture. A similar challenge faces the global regime now that dynamic new entrants from the East are rising in the economic league and will soon be seeking to have this reflected in the role they play in the fashioning of the global political and institutional architecture.

THE ENVIRONMENTAL SUSTAINABILITY OF GLOBALISATION Writing in the first half of nineteenth century Ricardo built his theory of rent on the variable quality and diminishing marginal productivity of land. He argued that in the context of limited land in the UK, land-rents would

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become increasingly important and skew incomes towards unproductive landlords. This led him to oppose the Corn Laws which between 1815 and 1846 protected UK agriculture by placing tariffs on food imports. The abolition of barriers to food imports – that is, deepening globalisation – meant that the land frontier could be stretched, allowing economic growth in the UK (and elsewhere) to proceed without being constrained by a Malthusian squeeze on resources. In 1972, almost 150 years after Ricardo’s Principles of Political Economy (1817), and 175 years after Malthus’s 1798 Essay on the Principles of Population, a group of scientists published a book entitled The Limits to Growth (Meadows et al, 1972). The Limits to Growth revisited Malthusian principles and challenged Ricardo’s assumption of an unconstrained land frontier. It argued that natural resources are finite and that their shortage would ultimately undermine the sustainability of global growth. The Limits to Growth provoked a stormy response. It was accused of mindless projection (‘Malthus with a computer’), being too pessimistic about technological change and failing to recognise the importance of the price mechanism in fostering technical substitution away from scarce resources (Cole et al. 1973). But, by the new millennium, the easy dismissal of The Limits to Growth was being revisited, and as numerous authors point out (for example, Sachs and Santarius 2005), there are indeed physical limits to the sustainability of growth. These physical limits include both the exhaustion of resources, and the negative environmental spillovers which result from sustained growth. As a consequence there is an increasing crescendo of normative calls for economic slowdown and for the contraction of consumption, especially in high income economies (Sachs and Santarius 2005). Much of this recent literature fails to root environmental exhaustion and degradation in an analytical understanding of the nature of the accumulation process. The key to this is to be found in the works of Schumpeter, Smith and Ricardo (Schumpeter 1961; Smith 1776; Ricardo 1817). Schumpeter showed how the very breathing of the capitalist economy requires innovation – entrepreneurs, confronted by the intensity of competition which undermines profitability, escape these competitive pressures by introducing new products and processes. Innovation and expansion are the basis of the capitalist system; they are its internal motor. Writing some centuries before Schumpeter, Smith provided the key to understand how this accumulating motor of capitalism fuels a globalising economy. Using an example of a pin factory, Smith showed how the division of labour led to an increase in productivity. Moreover, he argued, ‘the division of labour depends on the extent of the market’ – that is, the bigger


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the market, the greater the division of labour, the greater the gains in productivity, and the higher the profit to the innovating capitalist. Ricardo’s contribution to this analytical story concerns the role played by differing national economies in this process of specialisation. His theory of comparative advantage provided the intellectual underpinning to globalisation by showing how if countries specialise in areas of relative advantage, there would be extensive mutual gains from global exchange and integration. In the latter decades of the twentieth century, new forms of corporate organisation and interchange developed to facilitate the reaping of specialisation and scale at a global level. In particular, elaborate global value chains were constructed to allow for the production of ‘world products’ through the manufacture and assembly of components produced in very large numbers in globally dispersed plants (Gereffi 2005; Kaplinsky and Morris 2001). These global value chains include the geographical specialisation not just of discrete physical processes, but increasingly also of the knowledge-intensive and service components of the design, production and delivery of an increasing range of diversified goods and services. The environmental challenge confronting the global economy in the twenty-first century thus takes two forms. The first is a reflection of physical aggregates. There are a growing number of mouths to feed, bodies to clothe and wants to satisfy. These place physical limits on the capacity of the biosphere to meet these needs. This has very little to do with the extension of globalisation itself other than the possibility that globalisation fosters growth, and growth fosters consumption. However, secondly, some of the demands placed on the biosphere not only reflect the physical aggregates of consumption (tonnes of food, steel, and so on), but also the manner in which these demands are met. Here, increasingly global value chains which make up modern production systems place enormous pressures on the environment. Take as an example, the issue of foodmiles in the retail sector. Global sourcing has become increasingly widespread. Typically, the fresh fruit and vegetable section of a supermarket in the UK contains a selection of products from Brazil, Costa Rica, the Dominican Republic, Guatemala and Peru in Latin America; Kenya, South Africa, Zambia, and Zimbabwe in SSA; India, Israel, Thailand and Turkey from Asia, and from a range of other countries as well. In so doing supermarkets have been able to abolish seasonality in our food consumption, with a range of attractive, (over-) packaged (and often tasteless) products available 364 days a year. But this tells only part of the foodmiles story. How much of the packaging, the print and inks, the components of the supermarket trolley, the lorries which deliver the products, the building materials in the chain and so on similarly depend on global supply chains? In each case, the different

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components of the chain have to be transported (and sometimes re-transported) over extensive distances. All of this global sourcing is at a cost to the environment. Some of this is a direct outcome of global transport, as in the case of the Exxon Valdez oil-spillage in Alaska during the 1990s. But the bulk of this negative environmental impact is indirect, particularly through the link between increased energy consumption and global warming. For much of this intricate system of global production depends on the low price of energy which makes it profitable to ship low-value added commodities and components around the world. Despite the claims of the hydrocarbon-lobby to the contrary, we now know that there is growing evidence of global warming, and that this is predominantly a consequence of increased carbon-emissions. We also are beginning to realise that one consequence of climate change is its disproportionate negative impact on poor people and low-income economies (Yamin 2004). If we are to respond appropriately to global warming, then carbonbased energy will have to be priced at its true environmental cost.1 But, if so, what will be the impact of this on the profitability of globalised production systems? How many activities which are currently profitable will be unattractive should energy prices be increased significantly? On the other hand, it is possible (and perhaps even depressingly probable) that despite the logic of forcing energy prices to a level which reflects its true environmental cost, consumer resistance and the power of the hydrocarbon lobbies to block an increase in prices makes this an unlikely outcome. In this case, energy-intensive global value chains are likely to worsen global warming and hence exacerbate global poverty and inequality. This outcome, as we will see below, also challenges the sustainability of globalisation. So, either way – be it through higher energy prices or through the impact on poverty and inequality – the energy-intensity of globalised production systems poses a threat to the continued expansion of the globalised economy.

INSECURITY AND LOGISTICS The onset and deepening of industrialisation witnessed the systematic application of science and technology to production. It has been an era of rationality, where status has been achieved rather than ascribed (Wilson and Wilson 1945). The expansion of industry coincided with the general weakening of religions and other belief systems built on the assumption of divine creation and the absoluteness of good and evil. For much of its history, the politics of industrialisation was built around class – organised


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labour and its political representations pitching itself against organised capital with the state either being an instrument of the dominant class, or an arena for the contestation of class power. The geography of industry was the geography of cities, the place of residence of the working class which had either been expelled from rural areas and agriculture or had voluntarily left the rural areas in the search of higher incomes and better life-chances. The second half of the twentieth century saw an explosion in the number and size of cities in the world. In 1950 there were 86 cities with a population exceeding one million. By the turn of the millennium there were more than 400 cities with a population exceeding one million, and it is likely that by 2015 that number will have increased to more than 550 (Davis 2006). But the cities of the twenty-first century are very different to those beasts of the post industrial revolution period extending up to the last decades of the twentieth century. Contemporary cities are no longer primarily places of residence for industrial employees and their families. They now account for more than half of the world’s population (UN-Habitat 2003) and are increasingly populated by very many unemployed people, who have been displaced from agriculture in the rural areas, displaced from industrial employment due to import competition or, more likely, just failed to find any form of productive employment. These urban slum-based communities are very different in character from the nineteenth and early twentieth century cities of the industrial world. As a consequence of the change in material basis of global cities, the social and political character of cities is altering. Belief systems are changing, and there has been an explosion of millenarian religions throughout the world – Pentecostal churches in Latin America, Africa and parts of the US, Islamic fundamentalism in the Middle East and parts of Asia and Hindu fundamentalism in South Asia. These are belief systems which believe in ‘magic’ solutions, and are built around moral absolutes. The political systems which they foster are less class-based institutions locked in verbal discourse and peaceful civil action, and more prone to the violent expression of needs, backed by millenarian belief systems. How does this demographic and political transition relate to the growth and sustainability of globalisation? First, in many respects they are the outcome of the very success of the global economy. The combination of marked differentials in productivity between the leading and lagging production systems and the openness of global borders has meant that globalisation has been the major cause of the marginalisation of much of the world’s population (see below). The urban slums are not so much made up of people left behind by globalisation, but those displaced by the efficiency of the leading producers. This drama is currently being played out both

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between economies and within economies. On the one hand, the efficiency of Asian Driver producers is squeezing competitors in other countries. For example, Chinese exports to Africa are, for example, displacing African workers from the clothing, footwear and furniture industries (Kaplinsky 2008b); and Chinese exports to the US are undermining Latin American and Caribbean exporters of manufactures to the US (Jenkins, Peters and Moreira 2008). On the other hand, similar processes are occurring within large countries, especially in the two major Asian Driver economies. In both China and India, the gap in incomes between the urban and rural areas is growing, with a massive overhang of un- and underemployed labour. There is another link between the changing nature of global demographics and the associated political processes, although this link is more contentious, it is one which sees a direct link between the hegemonic success of globalisation and the rise of global terrorism.2 The argument goes as follows.3 Through its ‘cultural’ extension of TV, films, printed media and especially advertising, globalisation has spread a pattern of behaviour and values which has become increasingly offensive to many ‘traditional’ belief systems. They also promote ‘wants’ which cannot be satisfied in their economic contexts, leading to frustration and crises of expectations. This has provided fertile soil for pre-modern and millenarian fundamentalist faiths. The response of some of these has been to attack the many manifestations of globalisation – the ‘World Trade Center’ (the name itself evokes the hegemony of global processes), tourist centres associated with western values (night clubs in Bali), airports and civil aircraft. It is true that the early generations of fundamental terrorism were led by and often populated by educated people, but the ‘sea’ in which they swam, and the subsequent generations of activists have increasingly included the marginalised masses living in these urban- and peri-urban slums. The question is what impact these oppositional groups will have on the sustainability of globalisation? The issue here is the extent to which the current waves of terrorism continue and/or intensify, and the degree to which they will target the manifestations of global interchange. We are in unknown territory here and it is a judgement call on both counts. My own conclusions are that in both cases the likely outcome will be inimicable to the sustained expansion of the global economy. That is, the incidence of terrorist actions are likely to grow rather than to subside, and secondly, that they will continue to target the logistical arteries of globalisation and the ideological manifestations of the globalising capitalist economy. The consequence will be to harden some of the arteries of the global system and to hamper the ease with which people, products and capital flow across national borders.


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UNEQUALISATION AND COUNTERVAILING POLITICAL FORCES Globalisation forces alterations in economic specialisation. The result is frequent and significant change in employment patterns, in work-organisation and institutional design. Perhaps more importantly, it has also led to significant changes in the pattern of income distribution. There are two key consequences of these related changes, both of which impinge on the sustainability of globalisation. The first is that life has become more insecure for many, including for articulate professionals in the high-income economies. Robert Reich, a sometime Secretary of State for Labor in the Clinton administration, wrote insightfully on this issue (Reich 1991). He observed that the US had a large and growing ‘underclass’; on top of this underclass, by definition, was an ‘overclass’. This, said Reich was not new, But what was new was the character of the in-between category – ‘the anxious class’. To a significant extent this growing anxiety and unease is a direct consequence of the imperative for continual ‘re-invention’ forced by global competition. Jack Welch, former CEO of General Electric (GE) in the US, was widely considered to be one of the select number of truly influential management innovators during the 1990s. His philosophy was to force a regular turnover of staff in all GE subsidiaries, however well they were performing. Managers were expected to evaluate and ‘weed-out’ the least-wellperforming group of employees on an annual basis, however competent they were in performing their allocated tasks. In the early years of the millennium, GE promoted a ’70:70:70 policy’ – 70 per cent of activities to be outsourced; 70 per cent of this outsourcing to be offshored (that is, sent abroad); and 70 per cent of this offshoring to go to low-wage economies. It is an agenda of uncertainty, distrust and fear. This is echoed in the worldview of the head of Intel, Andy Groves, who wrote a best-seller entitled ‘Only the paranoid survive’ (Groves 1996). In each case the prognosis was change – ‘reinvention’, ‘reorganisation’, ‘business process engineering’ in order to survive the pressures of international competition. It is a world of insecurity, fear and anxiety, and one which threatens to engender opposition to globalisation, the more so as the professional classes in the highincome economies are now being threatened by the offshoring of their own jobs to India and other lower-wage economies. It is not just that the changes induced by globalisation have led to widespread fear and anxiety (including amongst the articulate professional classes in high-income economies), but it has also resulted in growing inequality. There is a clear link between the extension of the global economy and patterns of income distribution, and in order to understand this we

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need to draw on three related sets of theory in economics – on rents, on the reserve army of labour and on the factor price equalisation theorem. We begin with Ricardo and Schumpeter on rent. As pointed out above, Ricardo and Schumpeter both placed considerable emphasis on rent in explaining the distribution of income. For Ricardo, rent was the charge which arose from the differential quality of land. It led to income being accrued by those owning more productive land, with the rent reflecting the differential in productivity between the productive and the marginal parcels of land. Those owning marginal land would, he argued, be driven down to Malthusian levels of subsistence. Schumpeter expanded this concept of differential access by throwing light on gaps arising from unequal access to constructed ‘innovation rents’. In both cases, rent-rich super-profits arose as a consequence of barriers to entry. In the case of land, there are limits to the availability of productive land. In the Schumpeterian framework, there are barriers to the ability to command the highest levels of technology, the most effective entrepreneurial capabilities, the most effective forms of organisation, and the most well-known products. The higher these barriers and the greater the differential in productivity, the greater the incomes accruing to those who are protected from competition. The contribution of Marx to this story is that he focused on the income recipients who are not able to hide behind these barriers (Marx 1876). Marx was concerned with returns to labour, and he argued that unemployment is a structural feature of capitalist development. Rising capital intensity – he referred to it as the organic composition of capital – displaced labour and created a reserve army of labour which ensured that wages were held down. Whether this process of wage compression occurs depends on the rates of investment, the rate of increase in capital intensity (usually reflected in productivity growth) and the growth in the labour force. As an observed reality, it is commonly believed that Marx got the numbers wrong, since most of the advanced capitalist economies were able to sustain both near-full employment and rising wages through the eighteenth, nineteenth and twentieth centuries. His ‘error’ was largely due to his overestimating the growth of the labour force. The final plank of this explanation of the link between globalisation and inequality is known as the Heckscher-Ohlin-Samuelson factor price equalisation theorem in mainstream economic trade theory (Heckscher 1919; Ohlin 1933; Samuelson 1948). It argues that free trade will lead to an equalisation of wages (and indeed returns to capital) as the forces of competition work through the system. Global competition drives out high cost producers and, indirectly, thus high-cost factors. This outcome occurs as a consequence of free trade, and irrespective of the mobility of factors.


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Now if we put these various strands together we can understand how it is that globalisation leads to growing inequality, and why levels of unequalisation have risen in recent decades. The argument goes as follows. Rising investments in innovation have led to increased differentials in productivity. ‘Productivity’ is to be understood not just in relation to physical output in relation to physical input, but also in processes, relations between firms and in returns to brandnames (Coca Cola) and celebrity identities (the David Beckham effect). These rising investments in innovation are protected by tightened intellectual property rights and are promoted by heavy investments in marketing (again, the David Beckham effect). The income recipients who are able to protect themselves from competition are, in a globalised world, able to reap enormous economies of scale, on a global level, and to garner significant incomes. They include skilled people and celebrities in both high-income and low-income countries. The flip side of this is that those who are unable to hide behind effective barriers to entry similarly find themselves in a large global pool, but in this case they are having to compete with a very large reservoir of similarly ‘rent-deprived’ actors. This is the reserve army of labour which Marx referred to.4 But whereas in Marx’s time and in the period before the late twentieth century the pool of labour was artificially constrained by restrictions on migration and on trade in final products, in recent decades these barriers have fallen and the rent-poor income recipients (essentially the unskilled and the semiskilled) have become increasingly subject to global competition. This is directly analogous to the removal of the corn laws in nineteenth century England which led to a fall in the incomes of agricultural landlords. A recent paper by Dew-Becker and Gordon highlights some astonishing trends in this distributional pattern. Focusing on the US between 1966 and 2001, they calculate that the median real wage grew by only 11 per cent in real terms, rising at 0.3 per cent per annum. This compares with an increase of productivity growth of 1.57 per cent per annum, and a growth in real incomes of the top one-tenth of the top one per cent (that is the 99.9th percentile) of 5.6 per cent per annum. They conclude that ‘[m]ore of the income change [between 1966 and 2001] accrued to the top one percent than the entire lower 50 percent, and more accrued to the top 1/100 percent than to the top 20 percent’ (Dew-Becker and Gordon 2005: 36). They identify two drivers of this inequality – the high incomes of ‘superstar’ celebrities, and the rapidly growing incomes of the senior management benefiting not just from high salaries, but also from incentive schemes. To this we must add a third component, but at the bottom end of the income spectrum. That is the compression of wages due to rising pressure from imports and, in some cases, immigrants flowing into the US from Mexico and elsewhere. Similar patterns of unequalisation have been experienced

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in almost every country of the world, including especially in China (which has moved from being one of the most equal to one of the most unequal countries) and the anglo-saxon economies of Australia, Canada, New Zealand and the UK which have embraced globalisation enthusiastically (Milanovic 2003; Kaplinsky 2005). The IMF’s World Economic Outlook in 2007 documented the fall in the share of labour in total incomes in all of the major high income economies and explained this as an outcome of competition from labour-rich low wage economies in the emerging world, particularly China and India (IMF 2007: Chapter 5). Whether these distributional trends last depends on the size and growth of the global labour pool. Mainstream economic analysis suggests that it will be a self-correcting problem. It argues that as the labour market in China, India and elsewhere in the emerging economy world tightens due to their rapid economic growth, wages will rise around the world. But, given the numbers involved, even if Marx’s rising organic composition of labour does not lead to a growing structural surplus of labour, the numbers involved suggest that this tightening labour market will take some time to manifest itself. To repeat the numbers cited earlier. China’s formal sector manufacturing labour force is less than 85 million, whilst that of the 14 largest OECD economies is less than 80 million. This contrasts with estimates of China’s reserve army of labour of over 100 million, with even larger numbers of labour entrants waiting to join the global economy in India. The IMF estimates that ‘the effective global labor supply quadrupled between 1980 and 2005, with most of the increase taking place after 1990’ (IMF 2007: 162). What does all this have to do with the sustainability of globalisation? The point is that the rich are increasingly confident and bold, with a widespread tendency to flaunt their wealth. We know from previous eras in economic and political history that the impetus for social change comes not so much from changes in absolute deprivation, but from relative deprivation (Runciman 1966), and it is this which perhaps above all threatens the sustainability of globalisation. The lessons of the nineteenth century provide an important backdrop in understanding these possible developments in the early twenty-first century (Williamson 1998). After five to six decades of growing global integration, the world economy turned inwards after 1914, and the outward momentum was only regained in the decades after 1950. In between saw a period of inward focus, and a reduction in economic integration. This reversal of global processes followed directly from the political consequences of very success of late-nineteenth century integration. Cheap grain imports into continental Europe led to a decline in agricultural profits. This resulted in the imposition of tariffs against agricultural imports in much


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of Europe. The mass migration of unskilled Europeans into the US as 60 million people, often literally walking across Europe, made their way to the US between 1820 and 1914, forced down relative wages in North America, and led to growing controls against migration. At the same time the competitiveness of European manufactures threatened the survival of the US’s nascent manufacturing sector. This resulted in the imposition of beggar-my-neighbour tariffs against manufactures during the 1930s.

CONCLUSIONS Both individual and institutional agency count in the shaping of history. In other words, no outcomes to historical processes can be predicted with any great sense of certainty since in large part history results from social action. Underlying forces may be at work, but how these play out, and over what time-period, may reflect a variety of factors. Some of these factors may be internal to the system, others may be exogenous in nature. Despite this inherent uncertainty, it is possible to point to some outcomes as being relatively likely, and others as being less so. The argument in this chapter has been that it is unlikely that globalisation will proceed along the unfettered trajectory of the last decades of the twentieth century. This is because of a number of factors which threaten this trajectory, each of which is internal to the unfolding of globalisation itself. These can be grouped into four categories – the disruptive impact of the rise of the Asian Driver economies; the environmental unsustainability of energyintensive global value chains; the global insecurity arising out of the spread of global production and value systems; and the countervailing forces arising as a consequence of the unequalisation which is inherent in an globalising economy. Each of these four factors holds the potential to not just disrupt the trajectory of the last decades of the twentieth century, but to reverse it or to push it into new directions (for example, limiting the globalisation of trade, but not of finance). Together, either because some of these factors are causally inter-related, or because they just happen to occur conjuncturally, they make the likelihood of a challenge to unfettered global integration even more likely. The possibility that there may be other factors external to the system – such as an environmental calamity or the mass spread of disease – only makes the likelihood of disruption more likely. Although we may have some measure of confidence in the prediction of these developments, we have much less confidence in what might spark such a change in direction, or how rapid and far-reaching these changes might be. For example, with hindsight, it is clear that the spread

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of internationalisation in the nineteenth century would be interrupted. But it was much less clear that this interruption would take the form of a four-year war which would result in the death of more than 20 million people, and even less that this war would be sparked by an assassination in Sarajevo. Similarly, it is difficult to predict what event, or what confluence of events might act to shift the trajectory and pace of globalisation. But, just as it was not possible for the Americans to produce two scientists for every man, woman and dog in America (even if some of them were children!), or that nineteenth century internationalisation would proceed without hindrance, so it is unlikely that the drive to ever-deepening globalisation in the twenty-first century will proceed without significant interruption.

NOTES 1. No realistic assessment of non-carbon based energy technologies suggests that they will arrest the carbon emissions of sustained global growth significantly. 2. I use the word ‘terror’ here in the particular sense of acts of violence which target noncombatant civilians. This definition includes both state-organised terror (for example, the bombing of civilians) and the acts of non-state terrorist cells. For many decades state-based military actions have been used to promote the spread of globalisation. The new factor is the use of non-state based terror to oppose its spread. 3. As in the discussion of the rise of millenarian religions (see above), I am here informed by Davis (2004). 4. It is also reflected in the writings of W. A. Lewis on the labour surplus economy (W. A. Lewis, 1954).

REFERENCES Cole H.S.D., C. Freeman, M. Jahoda and K.L.R. Pavitt (eds) (1973), Thinking About the Future: A Critique of the Limits to Growth, London: Sussex University Press and Chatto and Windus. Davis, M. (2004), ‘Planet of Slums: Urban Involution and the Informal Proletariat’, New Left Review, 26, 5–34. Davis, M. (2006), Planet of Slums, London: Verso. Dew-Becker, I. and R.J. Gordon (2005), ‘Where did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income’, Working Paper, 11842, Cambridge, MA: National Bureau of Economic Research http://www.nber.org/ papers/w11842. Fu, X. (2003), Exports, Foreign Direct Investment and Economic Development in China, London and New York: Palgrave Macmillan. Gereffi, G. (2005), ‘The Global Economy: Organization, Governance, and Development’ in Neil J. Smelser and Richard Swedberg (eds), The Handbook of Economic Sociology, 2nd edn, Princeton, NJ: Princeton University Press and Russell Sage Foundation, pp. 160–82.


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Groves, A.S. (1996), Only the Paranoid Survive, New York: Doubleday. Gu, J., J. Humphrey and D. Messner (2008), ‘Global Governance and Developing Countries: The Implications of the Rise of China’, World Development, Special Issue on Asian Drivers and their Impact on Developing Countries, 36 (2), 274–92. Heckscher, E. (1919), ‘The Effect of Foreign Trade on the Distribution of Income’, Economisk Tidskriff, 497–512, translated and republished in American Economic Association (1949), Readings in the Theory of International Trade, Philadelphia: Blakiston, pp. 272–300. Humphrey, J., R. Kaplinsky and P. Saraph (1998), Corporate Restructuring: Crompton Greaves and the Challenge of Globalisation, N. Delhi: Sage Publications Ltd. IMF (2007), World Economic Outlook, Washington, DC: International Monetary Fund), http://www.imf.org/external/pubs/ft/weo/2007/01/pdf/. Jahoda, M. (1973), ‘A Postscript on Social Change’, in H.S. Cole, C. Freeman, M. Jahoda and K. Pavitt (eds), Thinking about the Future, London: Chatto and Windus. Jenkins, R.O., E. Dussel Peters and M.M. Moreira (2008), ‘The Impact of China on Latin America and the Caribbean’, World Development, Special Issue on Asian Drivers and their Impact on Developing Countries, 36 (2), 235–53. Kaplinsky, R. (2005), Globalization, Poverty and Inequality: Between a Rock and a Hard Place, Cambridge: Polity Press. Kaplinsky, R. (2009, forthcoming), ‘China, Commodities and the Terms of Trade’, in D. Greenaway, C. Milner and Shujie Yao (eds), China and the World Economy: Consequences and Challenges, London: Palgrave. Kaplinsky, R. (2008), ‘What Does the Rise of China do for Industrialisation in Sub-Saharan Africa?’, Review of African Political Economy, 35 (115), 7–22. Kaplinsky, R. and M. Morris (2001), A Handbook for Value Chain Research, http://asiandrivers.open.ac.uk/Resources.html. Kaplinsky, R., D. McCormick and M. Morris (2006), ‘The Impact of China on SSA’, Agenda-setting Paper prepared for DFID, Brighton, Institute of Development Studies. Keeley, J. and J. Wilsdon (2007), China: The Next Science Superpower, London: Demos. Leadbeater C. and J. Wilson (2007), The Atlas of Ideas: How Asian Innovation can Benefit us All, London: Demos. Lewis, W.A. (1954), ‘Economic Development with Unlimited Supplies of Labour’, The Manchester School, May, reprinted in A. N. Agarwala and S.P. Singh (eds) (1958), The Economics of Underdevelopment, Oxford: Oxford University Press. Marx, K. (1876), Capital: A Critique of Political Economy, vol 1, London: Lawrence and Wishart (reprinted 1970). Milanovic, B. (2003), ‘The Two faces of Globalization: Against Globalization as We Know It’, World Development, 31 (4), 667–83. Nolan, P. (2005), Transforming China: Globalization, Transition and Development, London: Anthem Press. Ohlin, B. (1933), Interregional and international Trade, Cambridge, MA: Harvard University Press. Polaski, S. (2007), ‘U.S. Living Standards in an Era of Globalization’, Policy Brief 53, Washington, DC: Carnegie Endowment for International Peace. Ramo, J.C. (2004), The Beijing Consensus, London: Foreign Policy Centre. Reich R.B. (1991), The Work of Nations: Preparing Ourselves for 21st-Century Capitalism, New York: Simon and Schuster.

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Ricardo, D. (1817), The Principles of Political Economy and Taxation, London: Dent (reprinted 1973). Runciman, W.G. (1966), Relative Deprivation and Social Justice, London: Routledge. Sachs, W. and T. Santarius (eds) (2005), Fair Future: Resource Conflicts, Security and Global Justice, London: Zed Books. Samuelson, P.A. (1948), ‘International Trade and the Equalization of Factor Prices’, Economic Journal, 58, 163–64. Schumpeter, J. (1961), The Theory of Economic Development, Oxford: Oxford University Press. Shankar, R.O. (2005), The Chinese Century, Upper Saddle River: Wharton School Publishing. Smith, A. (1776), An Enquiry into the Nature and Cause of The Wealth of Nations, (4th edn), republished in 1976 by Oxford University Press, and edited by R.H. Campbell and A.S. Skinner. Tull, D.M. (2006), ‘China’s Engagement in Africa: Scope, Significance and Consequences’, Journal of Modern African Studies, 44 (3), 459–79. UN-Habitat (2003), The Challenge of the Slums: Global Report on Human Settlements 2003, London: James/Earthscan. Weiss, L. (ed) (2002), States in the Global Economy: Bringing Domestic Institutions Back In, Cambridge: Cambridge University Press. Williamson, J.G. (1998), ‘Globalisation, Labor Markets and Policy Backlash in the Past’, Journal of Economic Perspectives, 12 (4), Fall, 51–72. Wilson G. and M. Wilson (1945), The Analysis of Social Change: Based on Observations in Central Africa, Cambridge: Cambridge University Press. Yamin, F. (ed) (2004), ‘Climate Change and Development’, IDS Bulletin, 35 (3), Brighton, Institute of Development Studies.

11.

Globalisation of the world economy: potential benefits and costs and a net assessment Michael D. Intriligator1

INTRODUCTION AND PURPOSE Globalisation is a powerful real aspect of the new world system, and it represents one of the most influential forces in determining the future course of the planet. It has manifold dimensions: economic, political, security, environmental, health, social, cultural, and others. The focus here will be on the concept of ‘globalisation’ as applied to the world economy. The term was coined in the 1980s, but the concept is an old one that has different interpretations to different people. Partly as a result of these different interpretations, there are very different reactions to ‘globalisation’ with some policymakers, scholars, and activists seeing it as a force for advancing the world economy while others, again all three, seeing it as a serious danger to the world economic system. (For the former, supporting globalisation, see International Monetary Fund 1997; Ohmae 1990; International Monetary Fund 2002; Friedman 2000; Micklethwait and Wooldridge 2000; World Bank 2002. For the latter, opposing globalisation, see Greider 1997; Rodrik 1997; Bauman 2000; Gray 2000; Giddens 2000; Hutton and Giddens 2000; Hertz 2001; Bhagwati 2001; Stiglitz 2002; and Sullivan 2002. See also Salvatore (ed) 2004 and Gangopadhyay and Chatterji (eds) 2005 for further discussions of globalisation). There are three purposes of this chapter. First, it will clarify the notion of ‘globalisation’ as applied to the world economy. Second, it will evaluate both the potential benefits and the potential costs stemming from globalisation. Third, it will consider how the costs or dangers stemming from globalisation could be offset through wider international cooperation and the development of new global institutions (for related perspectives, see Soros 2002; Bourguignon et al. 2002; and Fischer 2003). The view taken here, representing the thesis of this chapter, is that there are both positive and negative aspects to globalisation, that some of its 299

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positive features stem from the effects of competition that it entails, and that some of the negative aspects that could potentially lead to conflicts could be offset by international or global cooperation through agreements on policy or through the development of new international institutions. Thus, while globalisation can cause international conflicts, it can also contribute to their containment through the beneficial effects of competition and the potential of global cooperation to treat economic and other threats facing the planet.

GLOBALISATION OF THE WORLD ECONOMY: AN INTERPRETATION ‘Globalisation’ will be understood here to mean major increases in worldwide trade and exchanges in an increasingly open, integrated, and borderless international economy. There has been remarkable growth in such trade and exchanges, not only in traditional international trade in goods and services, but also in exchanges of currencies; in capital movements; in technology transfer; in people moving through international travel and migration; and in international flows of information and ideas. One measure of the extent of globalisation is the volume of international financial transactions, with over $1.2 trillion flowing through New York currency markets each day, and with the volume of daily international stock market transactions exceeding this enormous amount. Globalisation has involved greater openness in the international economy, an integration of markets on a worldwide basis, and a movement toward a borderless world, all of which have led to increases in global flows. There have been several sources of globalisation over the last several decades. One such source has been technological advances that have significantly lowered the costs of transportation and communication and dramatically lowered the costs of data processing and information storage and retrieval. The latter stems from developments over the last few decades in electronics, especially the microchip and computer revolutions. Electronic mail, the Internet, and the World Wide Web are some of the manifestations of this new technology, where today’s $2,000 laptop computer is many times more powerful than a $10 million mainframe computer of a generation ago. A second source of globalisation has been trade liberalisation and other forms of economic liberalisation that have led to reductions in trade protection and to a more liberal world trading system. This process of wider liberalisation started in the last century, but the two world wars and the Great Depression interrupted it. It resumed after World War II through

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the most-favored-nation approach to trade liberalisation, as embodied in the 1946 General Agreement on Tariffs and Trade (GATT) that evolved into the World Trade Organization (WTO). As a result, there have been significant reductions in tariffs and other barriers to trade in goods and services. Other aspects of liberalisation have led to increases in the movement of capital and other factors of production. Some economists and historians have suggested that globalisation is little more than a return to the world economy of the late nineteenth and early twentieth century, of the century from the Congress of Vienna in 1815 to the outbreak of World War I in 1914. At that time borders were relatively open and there were substantial international capital flows and migrations of people, when the major nations of Europe depended critically on international trade as part of the colonial system. This is particularly the view of some British scholars, looking back to that period of British imperial dominance of the world economy. While there are some similarities in terms of trade and capital movements, the period of a century ago did not have some of the major technological innovations that have led to a globalised world economy today that is qualitatively different from the international economy of the last century. A third source of globalisation has been changes in institutions, where organizations have a wider reach, due, in part, to technological changes and to the more wide-ranging horizons of their managers, who have been empowered by advances in communications. Thus, corporations that had been mainly focused on a local market have extended their range in terms of markets and production facilities to a national, multinational, international, or even global reach. These changes in industrial structure have led to increases in the power, profits, and productivity of those firms that can choose among many nations for their sources of materials, production facilities, and markets, quickly adjusting to changing market conditions. Virtually every major national or international enterprise has such a structure or relies on subsidiaries or strategic alliances to obtain a comparable degree of influence and flexibility. As one measure of their scale, almost a third of total international trade now occurs solely within these multinational enterprises. With the advent of such global firms, international conflict has, to some extent, moved from nations to these firms, with the battle no longer among nations over territory but rather among firms over their share of world markets. These global firms are seen by some as a threat to the scope and autonomy of the state, but, while these firms are powerful, the nation state still retains its traditional and dominant role in the world economic and political system and is likely to remain in this role (Waltz 1999). Non-government organisations, the NGOs, have also taken a much broader perspective that, as in the case of the global firms, is often

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multinational or global. Even international organisations, such as the United Nations, the International Monetary Fund and World Bank, and the World Trade Organization have new global roles. Overall, multinational enterprises and other such organisations, both private and public, have become the central agents of the new international globalised economy. A fourth reason for globalisation has been the global agreement on ideology, with a convergence of beliefs in the value of a market economy and a free trading system. This process began with the political and economic changes that started in the 1978 reforms in China and then involved a ‘falling dominoes’ series of revolutions in Eastern and Central Europe starting in 1989 and ending with the dissolution of the Soviet Union in December 1991. This process led to a convergence of ideology, with the former division between market economies in the West and socialist economies in the East having been replaced by a near-universal reliance on the market system. This convergence of beliefs in the value of a market economy has led to a world that is no longer divided into market-oriented and socialist economies. A major aspect of this convergence of beliefs is the attempt of the former socialist states to make a transition to a market economy. These attempted transitions, especially those in the former Soviet Union and in Eastern and Central Europe have, however, been only partially successful. The nations involved and their supporters in international organisations and advanced western market economies have tended to focus on a three-part agenda for transition, involving: (1) stabilisation of the macroeconomy, (2) liberalisation of prices, and (3) privatisation of state-owned enterprise. Unfortunately, this three-part agenda, sometimes referred to as the ‘Washington Consensus’ and that I refer to elsewhere as the ‘SLP’ approach to transition fails to appreciate the importance of (1) building market institutions, (2) establishing competition, and (3) providing for an appropriate role for the government in a modern mixed economy. I have referred to this alternative three-part agenda in other publications as the ‘ICG’ approach to transition (Intriligator 1993a, b; 1996a, b; 1997; 1999). A fifth reason for globalisation has been cultural developments, with a move to a globalised and homogenised media, the arts, and popular culture and with the widespread use of the English language for global communication. Partly as a result of these cultural developments, some, especially the French and some other continental Europeans, see globalisation as an attempt at US cultural as well as economic and political hegemony. In effect, they see globalisation as a new form of imperialism or as a new stage of capitalism in the age of electronics. Some have even interpreted globalisation as a new form of colonialism, seeing the US as


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the new metropole power and most of the rest of the world as its colonies. In this view, the rest of the world supplies the US not only with raw materials and markets on a global basis, as in earlier forms of European colonialisation, but also with production facilities and labor, capital, and other inputs to the production process. Whether one sees globalisation as a negative or as a positive development, it must be understood that it has clearly changed the world system and that it poses both opportunities and challenges. It is also clear that the technological, policy, institutional, ideological, and cultural developments that have led to globalisation are still very active. Thus, barring a radical move in a different direction stemming from major changes in the current world system, as happened earlier with two World Wars, a global pandemic in the great influenza pandemic, and a Great Depression, these trends toward greater globalisation will likely continue or even accelerate in the future. One important aspect of these trends will be the growth in international trade in services that has already increased substantially but promises even greater growth in the future, especially in such areas as telecommunications, health, education, and financial and computer services. The result of these trends will be continued moves toward a more open and a more integrated world as it moves closer and closer to a planet without borders and to a more integrated, open, and interdependent world economy. The result will be even greater worldwide flows of goods, services, money, capital, technology, people, information, and ideas.

IMPACTS OF GLOBALISATION ON NATIONAL ECONOMIES Globalisation has had significant impacts on all economies of the world, with manifold effects. It affects their production of goods and services. It also affects the employment of labor and other inputs into the production process. In addition, it affects investment, both in physical capital and in human capital. It affects technology and results in the diffusion of technology from initiating nations to other nations. It also has major effects on efficiency, productivity, and competitiveness. Several impacts of globalisation on national economies deserve particular mention. One is the growth of foreign direct investment (FDI) at a prodigious rate, one that is much greater than the growth in world trade. Such investment plays a key role in technology transfer, in industrial restructuring, and in the formation of global enterprises, all of which have major impacts at the national level. They have been especially significant in China and later in India. A second is the impact of globalisation on

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technological innovation. New technologies, as already noted, have been a factor in globalisation, but globalisation and the spur of competition that it entails have also stimulated further advances in technology and sped up its diffusion within nations through FDI. A third is the growth of trade in services, including financial, legal, managerial, and information services and intangibles of all types that have become mainstays of international commerce. In 1970, less than a third of foreign direct investment related to the export of services, but today that has risen to more than half and it is expected to rise even further, making intellectual capital the most important commodity on world markets. As a result of the growth of services both nationally and internationally, some have called the current age as one of competence, underscoring the importance of lifelong education and training and the investment in human capital in every national economy.

THE BENEFITS OF GLOBALISATION STEMMING FROM COMPETITION It has already been noted that globalisation has both positive and negative effects. This section will focus on its positive effects of globalisation, stemming from competition, while the next will focus on its negative effects, which could lead to potential instabilities and conflicts. Finally, the last section will consider the potential for international cooperation to diminish or to offset these negative effects of globalisation. Globalisation has led to growing competition on a global basis. While some individuals and organisations fear competition, there are many beneficial effects of competition that can increase production or efficiency. Competition and the widening of markets can lead to specialisation and the division of labor, as discussed by Adam Smith and other classical economists writing in the eighteenth century on the benefits of a market system at the beginning of the industrial age. Specialisation and the division of labor, with their implications for increases in production, now exist not just at the national level but also on a worldwide basis. Other beneficial effects include the economies of scale and scope that can potentially lead to reductions in costs and prices and could result in continuing economic growth. Other benefits from globalisation include the gains from trade in which both parties gain in a mutually beneficial exchange, where the ‘parties’ can be individuals, firms and other organisations, nations, continents, trading blocs, or other entities. Globalisation can also result in increased productivity as a result of the rationalisation of production on a global scale and the spread of technology and competitive pressures for continual innovation on a worldwide basis.


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Overall, these beneficial effects of competition stemming from globalisation show its potential value in improving the position of all parties, with the potential for increased output and higher real wage levels and living standards. The result is a potential for greater human well being throughout the world. Of course, there is the distributional or equity issue of who does, in fact, gain from these potential benefits of globalisation. As one important case in point, however, China and India have benefited enormously from globalisation as a result of which hundreds of millions of its people have been lifted from poverty, with China becoming the factory for most of the world and India becoming the service center for most of the world.

THE COSTS OF GLOBALISATION AND POTENTIAL CONFLICTS Globalisation involves not only benefits, but also has costs or potential problems that some critics see as fraught with great peril. These costs could lead to conflicts of various types, whether at the regional, national, or international level. One such cost or problem is that of who gains from its potential benefits. There can be substantial equity problems in the distribution of the gains from globalisation among individuals, organisations, nations, and regions. Indeed, many of the gains have been going to the rich nations or individuals, creating greater inequalities and leading to potential conflicts nationally and internationally. Some have suggested the possibility of convergence of incomes globally based on the observation that the poor nations are growing at a faster rate than the rich nations. (Barro 1997). The reality, however, is that a small group of nations, the ‘tiger economies’ of East Asia, especially China, South Korea, Taiwan, and Malaysia as well as India growing at rapid rates, while the least developed nations of Africa, Asia, and South and Central America have been growing at a slower rate than the rich nations, leading to a bimodal ‘twin peaks’ distribution of incomes. (Quah 1996). The poor nations are thus becoming increasingly marginalised. The result has been not a convergence but rather, with several important exceptions, a divergence or polarisation of incomes worldwide. The rapid-growth economies of East and South Asia are joining the rich nations, but the poor nations are slipping even further behind. This growing disparity leads to disaffection and possibly even international conflicts as nations seek to join the club of rich nations and the have-not nations struggle with the have nations for their share of world output. This issue of distribution is a major challenge in the process of the globalisation of the world economy.

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A second cost or problem stemming from globalisation is that of major potential regional or global instabilities stemming from the interdependencies of economies on a worldwide basis. There is the possibility that local economic fluctuations or crises in one nation could have regional or even global impacts. This is not just a theoretical possibility as seen in the financial crisis in Asia, starting in Thailand in 1997 and then spreading to other Southeast Asian economies and even to South Korea, with delayed effects in Russia in its economic collapse of August 1998. These linkages and potential instabilities imply great potential mutual vulnerability of the interconnected nations of the global economy. A worldwide recession or depression could lead to calls to break the interdependencies that have been realized through the globalisation process, as happened in the Great Depression of the 1930s, with competitive devaluations, beggarmy-neighbor policies, escalating tariffs, other forms of protectionism, etc. The result could be economic conflict, gravitating to economic warfare and possibly even to military conflict, repeating the history of the interwar period of the 1930s that led to the largest war in human history. Such a scenario is not impossible, and glimpses of it were seen in the 1997–98 Asian financial crisis. A third type of problem stemming from globalisation is that the control of national economies is seen by some as shifting, in part, from sovereign governments to other entities, including the most powerful nation states, multinational or global firms, and international organizations. The result is that some perceive national sovereignty as being undermined by the forces of globalisation. Thus, globalisation could lead to a belief among national leaders that they are helplessly in the grip of global forces and an attitude of disaffection among the electorate. The result could be extreme nationalism and xenophobia, along with calls for protectionism and the possible growth of extremist or fundamentalist political movements, ultimately leading possibly to terrorism and potential conflicts. It is sometimes alleged that a cost of globalisation is unemployment in the high wage industrialised economies. The relatively low unemployment rates in many high wage nations and their high rates in many low wage nations would appear to disprove this allegation. National policy and technological trends are much more important determinants of employment than global factors. A related myth is that globalisation is threatening the social welfare provisions of some states, but other factors are much more important, including domestic fiscal policy and demographic trends. In both cases, globalisation is merely a convenient scapegoat for failures of national policy. It is important also to appreciate that the economic aspects of globalisation are but one component of its effects. There are potentially very


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important non-economic impacts of globalisation involving great risks and potential costs, even the possibility for catastrophe. One is that of security, where the negative effects of globalisation could lead to terrorism and conflicts, as suggested above, and even possibly another world war. Indeed, the very process of globalisation leading to integration of markets could make conflicts escalate beyond a particular region or raise the stakes of conflict, for example, from conventional weapons to weapons of mass destruction (Katona, Intriligator, and Sullivan, (eds) 2006). A second noneconomic area in which globalisation could lead to catastrophic outcomes is that of political crises, that could escalate from local to large-scale challenges. A third such area is that of the environment and health, where the greater interconnectedness stemming from globalisation could lead again to catastrophic outcomes, such as global warming and pandemics, repeating the great influenza pandemic of 1917–1918.

THE ROLE OF GLOBAL COOPERATION IN DEALING WITH GLOBAL THREATS AND IN CREATING A NEW POST-COLD WAR SYSTEM The last two sections have highlighted both the benefits and the costs stemming from globalisation. Some could see globalisation as a very dangerous negative development by focusing on its costs and the potential for conflict. Others, on the other hand, could see it as a positive development, one offering unprecedented opportunities. Both of these views contain some elements of truth, but each should be offset by the other in order to gain a full understanding of the impacts of globalisation. There are twin myths here, the optimistic one that globalisation leads to only positive outcomes and the pessimistic one that globalisation leads only to negative outcomes, and as noted already the literature on this subject is polarized into these two extreme viewpoints. Any objective treatment or net assessment, however, would have to recognise both the benefits and costs of globalisation. What is the net result of globalisation, when taking both benefits and costs into account? The answer depends crucially on the nature of the world system. In a world beset by conflicts, globalisation would probably have a net negative impact. Conversely, in a cooperative world, globalisation would probably have a net positive impact. Thus, globalisation represents a major challenge and at the same time an unprecedented opportunity in terms of the possibilities for conflict or cooperation. The challenge is to create a new world system in the aftermath of the cold war and the movements toward globalisation that would enhance its generally

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beneficial effects and that would minimise its actual or potential costs. The key to such a world system will be cooperation among the nations of the world and dynamic innovation, including the establishment of new institutions. The challenge of the present globalised and post-Cold War economy is comparable to the challenge facing the allied nation victors in World War II. The old world had been destroyed and a new world had to be created. Not one, but two world systems were created, in fact, one in the West and the other in the East. Both involved the creation of new institutions that would replace the ones that had been destroyed in the war. Each side had its own ideology and organisation, that in the West being market oriented and that in the East being socialist. Now, of course, the ideological divide has dissolved, and there is a convergence of ideology on the value of a market economy. A small group of Americans helped create a new world system for the West during the period from 1945 to 1955. One of the major participants was Dean Acheson, the US Secretary of State during part of this period. His memoirs are aptly named Present at the Creation, given his role in creating this new world system. Another was Will Clayton, who developed the blueprints for two of the basic institutions of the new world system. One was the Marshall Plan that was announced by General George C. Marshall at the Harvard commencement in 1947 and became the most successful aid program in history. The other was the General Agreement on Tariffs and Trade that evolved into the present World Trade Organization. These Americans, together with President Truman, George Marshall, and others created the institutions that brought the devastated nations of Europe into the world community. These institutions included the United Nations; the World Bank and the IMF; the Marshall Plan and OEEC (later to evolve into the OECD); GATT; NATO; and others. These institutions and the new world system that they helped create was most successful in bringing the nations of Europe, including both former enemies and devastated allies, into this new system and in promoting reconstruction and growth. The present post-Cold War period has some similarities to the one after World War II in that a new world system must be created. Such a system would have to take account of the new situation – that of a world not divided by ideology and one becoming increasingly integrated. The sequence of revolutions that began in Eastern Europe in 1989 led directly or indirectly to the end of the Cold War, the demise of the Warsaw Pact, the unification of Germany, the dissolution of the Soviet Union, and the attempted transition of the former socialist states to democracy and a market economy, with only mixed success. The West for its part has been only partially successful in establishing structures such as those developed


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after World War II to bring Russia, other former Soviet states, and Central and Eastern Europe into the world economic and political system. In some respects the treatment of the former Soviet Union and its former allies in the current period is unfortunately similar to the treatment of Germany after World War I rather than its more enlightened treatment after World War II when it was one of the recipients of Marshall Plan assistance and joined various European and international institutions. (Keynes, 1919, foresaw the disastrous consequences of the treatment of Germany after World War I). Overall, the challenge of globalisation will require truly cooperative efforts of the great nations, especially among the new great powers of the European Union, the United States, Canada, Japan, Russia, China, India, Brazil, and others. Their joint activity in establishing new political arrangements and institutions could go a long way to solving global problems, including the economic and other challenges stemming from globalisation. As was true in the earlier period of the creation of a new world, it will be necessary to reinvent existing institutions and/or to create new ones so as to deal with economic challenges, such as the problems of distribution and mutual vulnerability stemming from globalisation. These institutions must have global perspectives and responses and they will require substantial resources and enforcement mechanisms, including some elements of supranational decision-making and authority, along with appropriate transparency and accountability. Consider, for example, how global cooperation and new international institutions can treat the several problems identified earlier as costs or problems of globalisation. The first of these problems was that of the distribution of income and specifically the gains from globalisation both within and between nations. A supranational institution based on global cooperation could address this problem. It would, in effect, tax the nations gaining from globalisation and use the proceeds to provide financial and technical assistance to those losing from globalisation. This is already being done in a somewhat haphazard way through the World Bank and, in particular, its soft lending arm, the International Development Association (IDA) that provides subsidised loans to poor nations on more favorable terms than the World Bank provides. It should be done, however, on a more systematic basis, which would require either a new international institution or an expansion and change in the nature of the World Bank. The rich nations should be expected to support the establishment of such an institution as an investment in global stability, assuming they recognise the dangers of serious disparities in the worldwide distribution of income. The second of the problems identified earlier as stemming from globalisation was the fragility of the international economic system, leading to

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mutual vulnerability. Again, international cooperation and the development of new institutions or the expansion of existing institutions could address this problem. The International Monetary Fund could be instrumental in dealing with this problem. The IMF has played a key role in providing support to nations that have experienced instabilities, as in its support for Mexico during the peso crisis and its agreement to support South Korea during the East Asia financial crisis, although in other crises its actions have in fact aggravated rather than ameliorated the underlying problems. A regularised and more credible insurance against these risks would require a substantial augmentation of the resources of the IMF, the assets of which have not grown at the same rate as international financial exchanges. International cooperation could also lead to the implementation of the Tobin tax, a small tax on foreign exchange transactions that could play a valuable role in limiting destabilising currency speculation and, at the same time, provide important added funding for international organisations. The third of the problems identified earlier as stemming from globalisation was that of the perceived loss of sovereignty of national governments and political leaders. This development could lead to fear of the loss of ability of nations to determine their economic policies, political disaffection, and the rise of extremist politicians and political movements. The process of globalisation, however, need not lead to a loss of sovereignty. Once again, international cooperation can play a role in ensuring the sovereignty of national governments and a proper role for political leaders, drawing a firm line between what is in the province of these governments and their leaders on the one side and what is in the province of international organisations and multinational or global enterprise on the other. Participation in the establishment of the needed institutions to deal with these and other problems stemming from globalisation will, by itself, help political leaders to regain a sense of control over their futures and positions in the global community. For example, the regulatory regimes of nations and even international organisations have become more porous and more easily overcome through advances in technology. Examples include the lack of regulation of the global integrated capital market, of trade in information services that is widely expected to grow enormously, and of labor and environmental safeguards. Cooperation among nations and international organisations could offset these developments by themselves taking advantage of recent technological advances and using them to reassert control through cooperative activities. Overall, there are several possible vehicles for cooperation as a way of responding to the serious challenges of globalisation. One is the strengthening of existing international institutions. Another is the establishment


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of new institutions, as in the case of the World Trade Organization, which has a binding dispute settlement mechanism of a supranational character. A third is the establishment of larger entities, such as the expansion of the European Union, or loose combinations of nations to treat certain economic issues, such as the G-8 or the Asian Pacific Economic Cooperation (APEC). Global cooperation through formal or informal institutions provides an increasingly important mechanism to ensure the proper treatment of global problems, including those stemming from globalisation trends. Through such global cooperation it should be possible to ensure equity and stability in a globalised world, leading to economic growth for all, the transition to a market economy for former socialist states, and economic development for the poorer nations. Such cooperation is also the way to treat the noneconomic problems of globalisation, including those of environmental and health protection on a worldwide basis, freedom from political crises or instability, and global peace and security for the planet. The challenge will be to develop such new modes of cooperation and new institutions to deal with the challenges of globalisation.

NOTE 1. This chapter is a revised and expanded version of ‘Globalization of the World Economy: Potential Benefits and Costs and a Net Assessment’, Milken Institute Policy Brief, February 2003, with a shortened version having appeared in the Milken Institute Review, June 2003 as ‘Globalisation 101’. It was also published in Salvatore, Dominick (ed) (2004), ‘Special Issue on Globalization’ Journal of Policy Modeling 26 (June 2004) and in Gangopadhyay, Partha and Manas Chatterji, (eds) (2005), The Economics of Globalisation, Aldershot, Hants: Ashgate Publishing Co. I would like to acknowledge, with appreciation, comments on an earlier version of this chapter that I presented at a Gorbachev Foundation of North America conference on ‘globalisation of the World Economy’ as well as suggestions of colleagues at UCLA and the Milken Institute.

REFERENCES Acheson, Dean (1969), Present at the Creation: My Years in the State Department, New York: Norton. Agnew, John A. and Stuart Corbridge (1995), Mastering Space: Hegemony, Territory and International Political Economy, New York: Routledge. Archibugi, Daniele and Jonathan Michie (eds) (1997), Technology, Globalisation and Economic Performance, Cambridge: Cambridge University Press. Barro, Robert J. (1997), Determinants of Economic Growth: A Cross-Country Empirical Study, Cambridge, MA: MIT Press. Bauman, Zygmunt (2000), Globalization, New York, Columbia University Press.

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Berger, Peter L. and Samuel P. Huntington, (eds) (2002), Many Globalizations: Cultural Diversity in the Contemporary World, New York: Oxford University Press. Bhagwati, Jagdish N. (2001), The Wind of the Hundred Days: How Washington Mismanaged Globalization, Cambridge, MIT Press. Bourguignon, Francois et al. (2002), ‘Making Sense of Globalisation: A Guide to the Economic Issues’, Centre for Economic Policy Research, London, CEPR Policy Paper No. 8. Brittan, Sir Leon (1997), ‘Globalisation vs. Sovereignty? The European Response’, The Rede Lecture, Cambridge University, 20 February 1997. Clark, Ian (1997), Globalization and Fragmentation: International Relations in the Twentieth Century, New York: Oxford University Press. Drucker, Peter (1997), ‘The Global Economy and the Nation State?’, Foreign Affairs, September–October. Feenstra, Robert C. and Gordon H. Hanson (1996), ‘Globalization, Outsourcing, and Wage Inequality’, American Economic Review, 86. 240–51, May 1996. Fischer, Stanley (2003), ‘Globalisation and Its Challenges’, American Economic Review, 93, 1–30, May 2003. Friedman, Thomas L. (2000), The Lexus and the Olive Tree: Understanding Globalization, Anchor Books Edition, New York: Anchor Books. Gangopadhyay, Partha and Manas Chatterji (eds) (2005), The Economics of Globalisation, Aldershot, Hants: Ashgate Publishing Co. Giddens, Anthony (2000), Runaway World: How Globalisation is Reshaping Our Lives, London: Routledge. Gray, John (2000), False Dawn: The Delusions of Global Capitalism, New York: New Press. Greider, William (1997), One World, Ready or Not: The Manic Logic of Global Capitalism, New York: Simon & Schuster. Griffin, Keith (1996), Studies in Globalisation and Economic Transitions, London: ICS. Hertz, Noreena (2001), The Silent Takeover: Global Capitalism and the Death of Democracy, London: Heinemann. Hirst, Paul Q. and Graham Thompson (1996), Globalisation in Question: The International Economy and the Possibilities of Governance, Oxford: Blackwell Publishers. Hutton, Will and Anthony Giddens (eds) (2000), Global Capitalism, New York: New Press. International Monetary Fund (1997), World Economic Outlook: Globalization Opportunities and Challenges, Washington, DC, May 1997. International Monetary Fund (2002), Globalization: Threat or Opportunity?, Washington, DC, 12 April 2000 (corrected January 2002). Intriligator, Michael D. (1993), ‘What is the Future of the Russian Economy?’ (in Russian), Business World in Moscow, 17 February 1993. Intriligator, Michael D. (1993), ‘Reform of the Russian Economy: The Role of Institutions’, (in Russian), Business World in Moscow, 14 December 1993. Intriligator, Michael D. (1994), ‘Privatization in Russia Has Led to Criminalization’, Australian Economic Review, 2/1, 1994, 4–14. Also published in Russian in Problems in the Theory and Practice of Management, 6, 1994, 39–43. Intriligator, Michael D. (1996), ‘Reform of the Russian Economy: The Role of Institutions’, International Journal of Social Economics, 23 (10/11), 1996, 58–72. Intriligator, Michael D. (1996), ‘The Shocking Failure of Shock Therapy’,


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The Russian Magazine, September 1996, 30, 32–3. Also published in O.T. Bogomolov, (ed), Reforms in the Eyes of American and Russian Scholars, (in Russian), Russian Fund for Economic Literacy: Moscow, 1996. Intriligator, Michael D (1997), ‘What Russia Could Learn from China in the Transition to a Market Economy’, in Development in East Asia and Latin America, Los Angeles: Pacific Council on International Policy, 1997. Also published in Chinese in International Economic Review (Beijing), 5–6, 1997 and in Russian in Economic Science of Modern Russia, 3, 1998, 121–29. Intriligator, Michael D. (1999), ‘Fiddling while Russia Burns’, Transition Newsletter, World Bank, January–February, 1999. James, Harold (2001), The End of Globalization: Lessons from the Great Depression, Cambridge: Harvard University Press. Katona, Peter, Michael D. Intriligator and John Sullivan (eds) (2006), Countering Terrorism and WMD, London: Taylor & Francis. Keynes, John Maynard (1919), The Economic Consequences of the Peace, London: Macmillan. Kofman, Eleonore and Gillian Youngs (eds) (1996), Globalization: Theory and Practice, New York: Pinter. Krugman, Paul R. and Anthony J. Venables (1995), ‘Globalization and the Inequality of Nations’, Cambridge, MA: National Bureau of Economic Research, Working Paper Series, Number 5098. Mander, Jerry and Edward Goldsmith (eds) (1997), The Case Against the Global Economy, New York: Sierra Club Books. McBride, Stephen and John Wiseman (eds) (2000), Globalization and its Discontents, New York: St. Martin’s Press. McGrew, Anthony G., Paul G. Lewis, et al. (1992), Global Politics: Globalization and the Nation-State, Oxford, Cambridge, MA: Blackwell Publishers. Micklethwait, John and Adrian Wooldridge (2000), A Future Perfect: The Challenge and Hidden Promise of Globalization, New York: Random House. Mittelman, James H. (2000), The Globalization Syndrome: Transformation and Resistance, Princeton: Princeton University Press. Mittelman, James H., (ed) (1996), Globalization: Critical Reflections, Boulder: Lynne Rienner Publishers. Nye, Joseph S. and John D. Donahue (eds) (2000), Governance in a Globalizing World, Washington, DC: Brookings Institution Press. Ohmae, Kenichi (1990), The Borderless World: Power and Strategy in the International Economy, New York: HarperBusiness. Quah, Danny T. (1996), ‘Twin Peaks: Growth and Convergence in Models of Distribution Dynamics’, Economic Journal, 106, 1045–55. Robertson, Roland (1992), Globalisation: Social Theory and Global Culture, London: Sage. Rodrik, Dani (1997), Has Globalization Gone too Far?, Washington, DC: Institute for International Economics. Salvatore, Dominick (ed) (2004), ‘Special Issue on Globalization’, Journal of Policy Modeling, 26 (June 2004). Sassen, Saskia (1996), Losing Control: Sovereignty in an Age of Globalization, New York: Columbia University Press. Soros, George (2002), George Soros on Globalization, New York: Public Affairs. Stiglitz, Joseph E. (2002), Globalisation and Its Discontents, New York: W.W. Norton.

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Sullivan, Jeremiah J. (2002), The Future of Corporate Globalization: From the Extended Order to the Global Village, Westport, CT: Quorum Books. Spybey, Tony (1996), Globalization and World Society, Cambridge, MA: Polity Press. Toffler, Alvin and Heidi Toffler (1995), Creating a New Civilization: The Politics of the Third Wave, Atlanta: Turner Publishing, Inc. United Nations Conference on Trade and Development (1997), World Investment Report, 1997: Transnational Corporations, Market Structure and Competition Policy, New York, Geneva: United Nations. Waltz, Kenneth N. (1999), ‘Globalization and Governance’, The 1999 James Madison Lecture, PS: Political Science and Politics, December 1999. Waters, Malcolm (2001), Globalisation, 2nd edn, London, New York: Routledge. White, Randall (1995), Global Spin: Probing the Globalisation Debate: Where in the World Are We Going?, Toronto: Dundurn Press. World Bank (2002), Globalisation, Growth, and Poverty: Building an Inclusive World Economy, Washington DC: World Bank and New York: Oxford University Press.

12.

International economic law and economic growth Linda Yueh

INTRODUCTION There are numerous ways in which the system of international economic law affects models of economic growth and the course of economic development, particularly for developing countries which have under-developed legal systems and less influence than the developed countries which largely formulate those rules. The focus in the economics literature on the role of law and institutions in fostering economic growth presage the importance of international laws for economic growth (see for example, Acemoglu et al. 2005). In some ways, the global legal structure has come to the fore with the greater integration of the world economy since the early 1990s with the re-emergence of China and India and the fall of Communism in Eastern Europe and the former Soviet Union. In 1992, China’s ‘open door’ policy – whereby it opened its borders to international trade and investment – took off; a year after India experienced a balance of payments crisis in 1991 which triggered a change from inwardly-focused to externally-oriented growth. The early 1990s also marked the disintegration of the former Soviet Union and the re-engagement of particularly Eastern Europe with its European neighbours. The re-integration of these countries roughly doubled the global labour force, raising it to some three billion people, and thereby halving the world’s capital-to-labour ratio.1 The implications are manifold, including fuelling offshoring as multinational corporations move operations to developing countries to take advantage of lower costs and the higher returns to capital. Figure 12.1 shows the surge in foreign direct investment (FDI) during the 1990s to developing countries. This trend is accompanied by the conclusion of the Uruguay Round of global trade negotiations which resulted in the establishment of the World Trade Organization (WTO) in 1995. Under the previous system (GATT, the General Agreement on Tariffs and Trade), international trade already led the growth of the world economy, averaging over 10 per cent per annum while the global economy grew at just under 4 per cent for the 315

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100 Sub-Saharan Africa 90

Latin America & Caribbean East Asia & Pacific

80

Eastern Europe & Central Asia

70

US$ Billion

60 50 40 30 20 10 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Source:

IMF World Economic Outlook.

Figure 12.1

Foreign direct investment to developing countries, 1990–2004

past half century. Figures 12.2 and 12.3 show these trends. The WTO with its 153 member countries (as of July 2008) promulgated rules that bound members on issues of trade in goods, trade in services (GATS, the General Agreement on Trade in Services), intellectual property rights (IPRs) and even created a dispute settlement body (DSB) which has become an effective mechanism for enforcement of WTO law. Although the reach of the WTO is limited, it heralds the dawn of a global rules-based system, marking a shift toward harmonization of economic laws across nations. This is most evident in the area of intellectual property rights, where the TRIPS agreement (trade-related aspects of intellectual property rights), an annex to the WTO articles, notably modified the centuries old doctrine of independence and territoriality stemming from the Paris and Berne conventions of the late nineteenth century and promulgated a system in which harmonization governs. Intellectual property rights protection was changed from a heterogeneous regime where nations established and enforced their own laws to one where a uniform standard is to be applied in member nations and can be enforced before the DSB of the WTO (Yueh

International economic law and economic growth

317 50%

16

40%

12 30% 10 20%

8 6

10%

Annual Growth Rate

Trillion $ (in current USD)

14

4 0% 2 0 1950

Source:

–10% 1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

World Trade Organization.

Figure 12.2

World trade, 1950–2007 8

60

7 50

40

5 4

30

3 20

Annual growth rate (%)

Trillion $ (in 1990 USD)

6

2 10

0 1950

Source:

1 0

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Maddison (2001).

Figure 12.3

World GDP, 1950–2007

2007). Although implementation has been delayed for the least developed countries (LDCs), the shift has altered domestic prerogatives such as compulsory licensing and transformed domestic IPR laws which are superseded by international rules.

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These, and other, changes should not just be of interest to lawyers, but also to economists since the regime alters the incentives and costs of innovation which will affect the crucial area of technological advancement and therefore the long-run economic growth of nations. It serves as an important illustration of the argument of this chapter, which posits that the developments in international economic law will affect models of economic growth and the developmental strategies of developing countries, in particular. Developing countries tend to have under-developed legal systems, so the harmonization process is likely to introduce laws fashioned from more developed countries, for example, TRIPS is largely based on the US IPR system, or be subject to regulations and rules dictated by supra-national bodies dominated by developed countries, for example, the World Bank and International Monetary Fund (IMF). As the global system evolves to meet the needs of the ever closer integration of crossborder trade and investments in the process of economic globalization, the effects on economic growth should be considered. In other words, an economic analysis of international economic law will shed light on the impact of such laws on the path of economic development. The same economic analysis applied to domestic laws such as corporate governance or competition policy could be fruitfully undertaken for international laws, as the rules shaping globalization will influence economic development in a myriad of ways. The other supra-national bodies mentioned, such as the World Bank and IMF as well as the United Nations, are also important in understanding the global economic system. Their policies, though influential, are qualitatively different from the evolution of international economic law. The World Bank and IMF have been arguably more important than the decade-old WTO and they have been accordingly analysed and evaluated (see for example, Woods 2006). International economic law instead refers to the myriad of laws and customs which govern economic relations among actors from different countries, often with national legal implications. The effect of the development of international economic law is the focus of this chapter.

LABOUR AND CAPITAL The steady state or long-run level of income of a country is determined by its capital and population, which are functions respectively of its savings rate and the number and quality (human capital) of its workers (Solow 1956; Lucas 1988). Globalisation influences the factor accumulation process, namely, by introducing cross-border movements of factors


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through migration and outward investment of domestic savings as well as receipt of inward capital flows through foreign direct investment (FDI) or portfolio flows. International economic law affects this process in several ways. Indeed, the impact is also via a more subtle set of factors influencing the confidence of investors in foreign countries. In terms of labour, although some regions such as the European Union permit largely free intra-regional migration; internationally, controlled migration is the norm. Offshoring, though, often involves movement of personnel, particularly at the managerial level, so there can be a shift of talent, sometimes leading to the so-called ‘brain drain’ whereby developing countries lose skilled labour to the higher pay offered in developed countries (Commander et al. 2004). There are, moreover, competitive effects associated with factor price equalization, whereby wages in countries converge for the same traded goods and services, even without migration. Such competitive pressures result in displaced workers in shrinking sectors and movement of labour into expanding sectors that reflects the nation’s comparative advantage, for instance. In this integrated global economy, expanding sectors can be fuelled by foreign investors seeking to utilise a country’s comparative advantage, such as in the form of sub-contracting or setting up overseas subsidiaries. Offshoring, sub-contracting and such cross-border employment occur in the absence of explicit international laws and supra-national organizations can only suggest voluntary standards, for example, the International Labour Organization (ILO). With a generally lower level of protection for workers in developing countries, there is a concern expressed by developed countries that the competitiveness of those economies derives not from comparative advantage but from unfair employment practices. Recent debate in Western economies over the perceived unfair competition from countries such as China which they argue do not have adequate employment and health and safety standards is fuelling a global push for harmonization of labour standards and for these to be built into trade agreements. For developing countries with much lower incomes and standards of living, they are unlikely to lose their comparative advantage as a result, but it suggests a gap in international economic law where voluntary compliance is not always evident. Voluntary standards appear to work much better in managing international capital flows alongside international economic law; investment being the other factor influencing steady state levels of income. Foreign capital is particularly vital for developing countries which tend to not have high levels of savings due to poverty and consumption taking up a greater portion of disposable income as a result. Under-developed banking systems also inadequately channel savings into investment. Global capital, therefore, is viewed as an important supplement for low domestic savings

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to fuel domestic investment and capital accumulation which determines income levels, and obtaining it is often a priority for poor countries. For developing countries indebted to the IMF, moreover, trade and financial liberalization was a pillar of the Washington Consensus that was promulgated to promote free markets, so capital controls and related restrictions were not sanctioned. Nevertheless, capital does not flow freely across borders, redistributing savings to countries with low capital stock. Feldstein and Horioka (1980) discovered a positive correlation between domestic savings and domestic investment which should not occur if there were capital re-allocation across the globe from countries with high capital stock (rich countries) to ones with lower stock (poor countries) and thus higher returns to capital, as predicted by neo-classical economic growth models. Part of the reason undoubtedly is due to restrictions on foreign investment where even developed countries scrutinise significant deals and the higher risks of investing in emerging economies that can deter FDI. However, since 1995, the TRIMs (trade-related investment measures) Agreement of the WTO governs international investment based on the principle of non-discrimination (National Treatment in Article III), whereby governments should not discriminate between domestic and foreign firms or approve of investments that are conditional on favouring domestic products. The result of which is that foreign investors expect to be granted a level playing field for investment, conducting business and otherwise operating in another country. The reality is that numerous areas of cross-border investment are still subject to national scrutiny and the vagaries of domestic industrial policies in developed and developing countries alike. Ongoing discussions continue over TRIMs as one of the key areas that the WTO wishes to expand in the current trade round. Despite the recognised jurisdictional holes in the international legal system, private international capital flows has grown rapidly in the past two decades, driven by the cost savings of utilising global production and supply chains with the re-emergence of Asia and Eastern Europe and falling transport and communication costs, as seen in Figure 12.1. Indeed, voluntary adherence to best practice in corporate governance, such as including independent directors in Boards, occurs in order to attract foreign investment and know-how, as seen in Chinese reforms prior to sales of equity stakes in its large state-owned commercial banks. Portfolio or short-term capital flows typify the importance of voluntary compliance perhaps more so than long-term investments. Equity and other often speculative capital are more ‘footloose’ than FDI with its ‘sunk’ element. These capital flows have been substantially deregulated starting in the early 1980s. The effect is clearly seen in Table 12.1, showing


Table 12.1 Year

1977 1980 1983 1986 1989 1992 1995 1998 Source:

321

Aggregate reserves and currency trading, 1977–1998 Official reserves

Official reserves and gold

Daily global turnover

265.8 386.6 339.7 456.0 722.3 910.8 1347.3 1636.1

296.6 468.9 494.6 540.0 826.8 1022.5 1450.0 1972.0

18 83 119 270 590 820 1190 1500

Reserves/turnover (1)/(3)

(2)/(3)

14.5 4.7 2.8 1.7 1.2 1.1 1.1 1.0

16.2 5.7 4.2 2.0 1.4 1.2 1.2 1.3

Bank for International Settlements

that the daily global turnover of foreign exchange transactions has risen sharply. As it has risen much faster than international trade or foreign direct investment flows, the vast majority of exchange rate transactions appear to be connected with currency speculation or short term capital flows (‘hot money’). This capital is substantial and can flow around the world exceptionally quickly. This was seen in the rapid outflows of socalled ‘hot money’ in the Asian financial crisis of 1997–1998 when economies of East and Southeast Asia of Indonesia, Malaysia, The Philippines, South Korea and Thailand collapsed despite having fairly robust growth and inflation as well as budgetary positions (Table 12.2). In the aftermath of the crisis which spread across emerging markets, reaching Russia, Turkey, and Latin America and lasted until the early 2000s, calls for new international financial regulations were heard and resulted in the Financial Stability Forum (FSF) in the Bank for International Settlements (BIS), often called the ‘central banks’ central bank.’ The Basel standards introduced prudential rules governing banks, including capital adequacy ratios and limiting non-performing loans. These are not formal laws promulgated by the FSF and enforced by the BIS. Instead, they are standards that countries which wish to attract capital would adhere to in order to improve the environment for investors and gain their confidence which so often drives capital flows. This is particularly the case in the shadow of the failures of Asian economies that were thought to be stable countries recording strong growth rates. Emerging economies aim to meet the Basel standards to signal the soundness of their financial systems even when such adherence is not mandated by international law.

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Table 12.2

Asian economies in comparative perspective before the Asian financial crisis

Country

Real GDP growth, 1985–95 (%)

USA Germany Japan

2.8 2.1 3.1

4.8 3.1 2.2

−2.2 −3.3 −5.1

Argentina Brazil

1.3 2.6

514.9 740.0

−29.0 −5.9

Malaysia South Korea Thailand Indonesia Philippines

7.2 7.8 8.0 6.3 2.1

3.7 7.7 5.5 9.3 13.1

0.7 −0.1 2.3 1.2 0.3

Source:

Average inflation rate, 1980–95 (%)

Government budget deficit as % of GDP, 1996

IMF World Economic Outlook.

Therefore, just as international law is guided by norms as well as laws and treaties promulgated into national laws, the economic ones are seemingly no different, relying on both formal rules and voluntary adherence to standards. The influence of such laws on the factor accumulation process will affect economic growth, in particular the level of income that a country can expect to enjoy over the longer term. Whereas the effects on labour have been indirect, though there are calls for more explicit reform, the influence on capital has been more direct but also subtle by manipulating investor expectations. Notably, the gradual harmonization of regulations governing financial markets appears to accompany global financial integration. The market, however, responds less well to accepting uniform labour standards and may reflect the lesser integration of labour markets than financial ones worldwide.

TECHNOLOGICAL PROGRESS A crucial area where international economic law could influence longrun economic growth is in terms of the incentives and costs of achieving technological progress. Specifically, the potential for developing countries to cheaply imitate existing technology enables the ‘catch up’


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process whereby poorer countries will thus grow more quickly and converge with rich ones (Solow 1956). By adopting the technology of more developed nations, developing countries are able to reduce the cost of innovation and introduce productivity advances into their own economies. Especially when starting at low levels, developing countries are thought to be able to achieve growth at high rates and thus ‘catch up’ with developed ones. The domestic capacity to copy and utilise technological advancements produced by rich countries is of course necessary. Though this process hinges on not having to undertake the costly re-invention of the innovation and instead to obtain it cheaply. Compulsory licensing was a frequently used tool by countries such as India and mandated technology transfer agreements for FDI were also sought by nations such as China to achieve this end. With the introduction of a worldwide IPR regime, however, the cost of imitation will be at monopoly rates which are more costly, while there is perhaps the possibility of greater amounts of innovation diffused to developing countries if the risk of expropriation for the inventors is reduced through uniform IPR protection. The TRIPS agreement part of the WTO articles harmonised IPR laws for member countries and introduced a much more stringent set of requirements than what most developing countries had implemented in their own legal systems and altered the previous IPR regime which was governed by the Paris and Berne Conventions. The Paris and Berne Conventions of 1867 and 1871, respectively, provided a legal framework for IPRs in the international arena that lasted for more than a century. These embodied the two major doctrines relating to IPRs under international law. The first is territoriality, stating that property rights are to be governed by each state’s own laws. The second is the doctrine of independence, which states that the grant of property rights within one country does not have force in another. The needs of developing countries, particularly the least developed ones, for technology and industrialization seemed to justify a reduction of benefits to innovators by the LDCs’ governments. Two typical examples of limitations imposed on innovators included: (1) a patent could only be granted if the intellectual property was worked and exploited within the boundary of a country (a working requirement) and (2) the terms and royalties for licenses of intellectual property could be determined by the government in the absence of agreement by the innovator (compulsory licensing). International economic law is premised instead on the norm that the harmony or uniformity of laws is the ideal for the free flow of goods and services globally. Since 1995 with the creation of the WTO, LDCs have been compelled to eventually adopt TRIPS, which are closer to US

324


standards of protection. For instance, patent protection lasts for 20 years, copyright protection for 50 years, and trademark protection is initially granted for seven years but could be renewed indefinitely. This framework reinforces the view that the justification for granting IPRs is to present to the innovator some monopolistic return from an investment that will benefit society and which would otherwise not occur, with some provisions allowing for the issues of concern to developing countries. The WTO, in short, will require a set of international rules for intellectual property to become national laws while also providing enforcement through a dispute settlement mechanism, the Dispute Settlement Understanding under the WTO (DSU) and consultation process, the Dispute Settlement Body (DSB), to resolve disputes among nations over these international rules. A one-year transition period for developed countries to bring their legislation and practices into conformity with the TRIPS Agreement was provided. In contrast, developing countries and countries in the process of transition from a centrally planned into a market economy have a five-year period and LDCs, 11 years, which has since been extended. Developing countries that do not have product patent protection in an area of technology would have up to ten years to introduce such protection. Within the next few decades, every member should have adopted the guidelines of TRIPS. However, difficult problems remain, particularly in terms of implementation for developing countries. Common features of LDCs’ legal systems are that IPRs are subject to inconsistent coverage, uncertain terms of protection, arbitrary transferability, and inadequate enforcement. Early evidence shows that the developed nations use the dispute settlement mechanism more often than developing countries and always against developing countries (Geuze and Wager 1999). This is likely to be the result of developed countries having more inventions to protect and also the difficulties faced by developing countries in rapidly formulating an IPR system when their legal systems generally are under-developed. The effect of TRIPS on technology diffusion holds significant implications for economic growth. The justification for IPRs generally relates to the need to protect the incentive to innovate weighed against the social cost of allowing monopoly profits to accrue and the loss to society of not having free access to the protected goods. Nordhaus (1969), for instance, finds that the optimal patent policy equates the dynamic marginal benefit with the static marginal efficiency loss. Landes and Posner (1989) make similar arguments regarding the scope of protection, which they posit should be narrow in order to lower the cost of innovation. In the simplest case, the appropriate period of protection is that which allows the innovator to cover the risk-adjusted cost of innovative activity (Besen and


325

Raskind 1991). The breadth or scope of such protection will depend on the nature of the market (Klemperer 1990). Since the promulgation of TRIPS, it remains to be understood how the balance between innovators and the need for technology diffusion is struck. A regime which provides for technology diffusion with positive cost will necessarily result in higher costs of production for developing countries, although the amount of innovation made available to them might increase if companies feel more confident that their intellectual property will be protected in developing countries, thereby allowing for indirect diffusion as domestic companies are exposed to more costly but a wider set of innovations. The issue to consider is whether the benefits from innovation are evident, particularly with respect to developing countries, which would influence their long-run rates of economic growth. This is an empirical question that warrants detailed investigation when developing countries eventually implement the TRIPS regime as it is potentially one of the most significant shifts in economic growth models and the process of ‘catching up’. The initial evidence since the establishment of the WTO suggests that the convergence picture has not changed. Figure 12.5 plots the initial incomes of countries in 1996 against its average annual real growth rate of GDP per capita from 1996–2004. The lack of convergence is evident, as it was for the pre-WTO period from 1960–1995 shown in Figure 12.4. Over a shorter period of time, it is not surprising that there is less variation in growth rates seen in the flatter scatter plot in Figure 12.5, but the overall pattern remains that initial incomes are not negatively correlated with subsequent growth rates. This evidence is necessarily preliminary as although TRIPS came into force in 1995 and large emerging economies such as China adopted it upon accession in 2001, most LDCs are still in the transition period so that there is not yet uniform adoption. The first decade of its inception is perhaps not reliable as an indicator and further evidence will be needed to measure the trade-off between more costly and arguably greater amounts of innovation in the global economy. In any case, this important facet of international economic law will influence the process of long-run economic growth, particularly for developing countries seeking technological advances.

ECONOMIC GROWTH: INSTITUTIONS AND LAWS A notable shift in the economic growth literature is toward the inclusion of laws and institutional development as explanatory factors in growth models, as many of the other established factors influencing economic

326


Average annual growth rate, 1960–1995 (%)

8 6 4 2 0 0

5000

10000

15000

20000

25000

30000

35000

40000

–2 –4 –6 –8 Per capita GDP in 1960 (2000 USD)

Source:

World Penn Tables.

Figure 12.4

Growth rate of real per capita GDP and initial income, 1960–1995

Average annual growth rate, 1996–2004 (%)

50

40

30

20

10

0 0

5000

10 000

15 000

20 000

25 000

30 000

35 000

–10

–20 GDP per capita in 1996 (2000 USD)

Source:

World Penn Tables.

Figure 12.5

Growth rate of real per capita GDP and initial income, 1996–2004

40 000


327

growth appear not to be able to explain the differences in long-run growth rates among countries (see Rodrik et al. 2004). Numerous aspects of international economic law would affect domestic institutions and laws, again particularly of developing countries. Laws and Growth There are both theoretical and empirical perspectives on the relationship between law and markets that drives economic growth. At first glance, it may appear that some laws are less relevant to economic growth, such as the criminal law system. However, crime may well deter investment and social stability can be a determinant of location for risk-averse firms (see for example, Brock 1998). Thus, the functioning of the legal system across its various dimensions may well be relevant for economic growth, though the focus would presumably be on civil and commercial legal developments. From the theoretical perspective, the ‘invisible hand’ of the market works efficiently when there exists optimising agents transacting in a framework of well-defined property rights and sufficiently low or zero transaction costs (see Coase 1937). Law establishes those conditions. A legal system defines the property rights and the costs of transacting and exchange. From the empirical standpoint, these theoretical insights have been incorporated into the literature advocating the importance of laws and institutions in explaining persistent economic growth (see for example, Acemoglu and Johnson 2005; Acemoglu et al. 2005; Dam 2006). Institutional development was therefore considered to be important and the focus has shifted away from legal formalism and legal origin to some extent (see for example, Rodrik et al. 2004). For instance, Acemoglu and Johnson (2005) emphasise two types of marketsupporting institutions which are important for economic growth: property rights institutions which protect against expropriation by government, and contracting institutions which ease contract enforcement. International economic law arguably can add a further dimension to the market-supporting institutions that underpin successful economic growth. Although the limitations of the international legal regime mean that it is unlikely to do so to a significant extent at present, its potential to should be acknowledged. First, a fundamental difference between national and international laws is the less effective enforcement of the latter which requires countries to voluntarily relinquish sovereignty and be bound by such laws. Thus far, the decisions of the DSB of the WTO in interpreting trade rules have been able to bind even strong nations such as the US presumably due to

328


the greater benefit of adhering to a global rules-based system even if it goes against a nation’s narrow interest in one instance, for example, US and EU cotton and sugar subsidies. The success of the DSB suggests that enforcement of international economic law is feasible; thereby adding to the security of transactions provided by institutions associated with promoting economic growth. For instance, countries who believe that the TRIPS agreement has not been satisfactorily implemented can bring action before the DSB to force a change in the IPR regime of the allegedly offending country. The action would likely increase the confidence of corporations whose intellectual property had felt under threat and could enhance enforcement of IPRs in a country where the legal system is weak, for example, the recent action by the US against China with respect to the TRIPS agreement. This constitutes a direct instance of not only a change in domestic laws to comply with international norms but enforcement of the same, which could enhance the under-developed market-supporting institutions of emerging economies. There are, however, several limitations. The limited scope of international economic law means the enforcement before the DSB is of restricted scope. Unless the WTO Doha Round expands into areas of competition policy, government procurement policy and so on, the influence of the international legal system on domestic institutional arrangements will be narrow. Also, most jurisdictions such as the US and EU will not give direct effect to WTO law in its courts, so the process is that of most international treaties which require adoption by legislative bodies and action is taken on the basis of domestic legislation. The use of the DSB is further limited to states, so that individual actors are unable to seek enforcement or redress directly before the WTO. The clear contrast is with the EU whereby citizens of the member states can bring cases concerning European laws directly before European courts. Second, most trade rules will not cause revision of domestic laws. The requirement instead is of adherence to the principles of non-discriminatory and most favoured nation treatment of all WTO members, and other agreed provisions concerning trade and service liberalisation. Therefore, legal and institutional reform is less a matter of compulsion, but more related to a country’s development path and its attitude toward managing globalization. The present scope of international economic law will not, for instance, necessarily protect an investor against expropriation by a government through nationalization or improve contracting security since the functioning of a particular legal system is outside its purview law so long as the relevant laws are transparent with respect to the WTO principles. These two crucial aspects of market-supporting institutions are not necessarily altered by the international legal system.


329

Informal Effects on Markets Despite the lack of formal compulsion, there is an informal effect of possibly greater importance. As was discussed with respect to cross-border investments, the voluntary adoption of international standards to enhance a country’s attractiveness to global investors is evident in numerous respects, particularly with respect to corporation law and the governance of corporations. For instance, Hansmann and Kraakman (2001) argue that there is a convergence in corporate governance systems across countries. Certainly greater financial integration has led to uniform accounting standards being adopted, and sometimes modified by, both developed and developing countries to ease due diligence and increase confidence in overseas investment. For instance, international accounting standards are gaining prominence even for American firms. Also, companies from emerging economies appear to list on international bourses to demonstrate their quality by meeting more stringent standards than if they were to offer shares solely on domestic bourses, for example, Chinese enterprises such as China Life list in New York as well as domestically and voluntarily meet the higher disclosure requirements of the NYSE when ample funds are available on the domestic stock exchanges that tap into a remarkably high national savings rate (see Sun and Tobin 2009). Given the limitations of international economic law and the halting progress of the present round of WTO negotiations, the influence of global financial and banking standards may well have a greater effect than the laws governing trade in manufactured goods and, to some extent, services. If measured by magnitude alone, then capital flows dwarf international trade by a significant multiple, for example, trillions of dollars move through financial markets in a month while global trade would not reach that size in a year. Global financial markets are as intertwined as ever and financial centres such as London and New York set benchmarks for listing and disclosure that are followed worldwide as a result. This emulation includes the regulatory system of the UK, which until perhaps recently with the 2007 sub-prime fallout/credit crunch, was admired and often the subject of imitation by developing countries seeking to improve their own regulatory oversight and practices. Therefore, international economic law as well as regulations and standards in globalised capital markets play a part in the development of laws and market-supporting institutions which are of utmost importance in the course of long-run economic growth. Given this emphasis, it is probably not surprising that developing countries are urged to improve their legal systems and adopt good institutions and governance. However, legal and institutional reform takes time and few developing countries have a

330


complete legal system and set of formal institutions that govern markets well. Informal Institutions and Social Capital It is difficult for legal and institutional reforms to be effective without being situated within the institutional structures of a particular country. Due to the absence of a well-established legal system, developing countries tend to rely on informal institutional arrangements, such as utilisation of social capital or relational-based contracting whereby economic transactions are undertaken on the basis of trust. Even developed countries at the start of their marketisation relied on such relationships (see for example, Franks et al. 2003, who studied the development of 100 years of the UK capital market and found that ownership dispersion relied more on informal relationships based on trust than on formal systems of regulation). Enforcement, which is often a challenge in an under-developed legal system, can also be by means of social capital instead of courts. For instance, social sanctions and norms account for the success of microfinance institutions such as the Grameen Bank in Bangladesh. The high repayment rate is not due to threatened legal action, but on account of social capital in the community which acts to enforce the terms of the loan. In this way, the informal institution of social capital helps to enforce the formal terms of lending. By overlooking informal institutional arrangements which support the rule of law and other formal institutions, the extent of legal and institutional reform can be misjudged and developing countries could suffer from mis-fashioned policies as a result. In other words, as countries are increasingly evaluated on the quality of their institutions, poor legal systems are a common area of criticism of developing countries and aid or technical assistance can hinge on legal reform so leading to adoption of laws that may not suit the country. At the extreme, ‘transplanting’ legal systems that work in developed countries into less developed countries has not been successful (see Pistor et al. 2000 for the conclusion that legal systems transplanted into some two dozen newly transitioning economies were not successful in fostering economic growth). Therefore, even as international economic laws often do not explicitly transform and harmonize domestic corporation laws, the influence of the global rules-based system can be felt in other aspects of the legal and institutional development of countries that will affect their growth path. Permitting countries to adopt the appropriate elements from international laws and rules is likely to be more successful than expecting legal reform at a pace that is not commensurate with the level of development of poor


331

countries. There is significant potential for harmonisation of laws to benefit developing countries, but there are also notable pitfalls.

ASSESSING GLOBALIZATION, INTERNATIONAL ECONOMIC LAW AND ECONOMIC GROWTH The direct effect of international economic law on economic growth is evident in the transformation of the global IPR regime, while more indirect effects also exist to influence employment and investment. Domestic laws and institutions are also affected. Whether directly or indirectly, international economic law and the associated development in global financial standards will shape if not actually require reform of domestic laws and institutions. It is particularly the case in developing countries where international investors will expect legal safeguards in ever more closely integrated markets. There are several advantages but also challenges for economic development as a result. First, developing countries would not need to reinvent the ‘legal wheel’. Just as countries can leapfrog technological steps, they should be able to adopt international best practices to reform their legal systems and regulatory practices at a much faster pace than developed countries at a similar stage of development. Second, international economic law has as its premise a level playing field so that countries can negotiate on the basis of promulgated rules; for example, Brazil can bring the US before the WTO and win. Third, harmonisation tends to increase market access as there are few trade and investment frictions across borders, so that scale and learning are more available to developing countries. But there are also challenges, among which are the following issues to note. Uniform standards and rules tend to be those of developed countries such that the lagging systems in developing countries cannot cope with wholesale adoption but then become subject to criticism for their incomplete enforcement of the laws on the books. This has been seen with TRIPS. Secondly, although formal laws may become similar, informal institutions remain as disparate as ever. Judging development on the basis of institutional reform can overlook the informal workings of developing countries’ markets to their detriment in terms of aid or technical assistance. Thirdly, the playing field is still not level because countries are at different stages of development. The most competitive firms tend to be from rich countries, while poor ones will want to foster their own domestic firms to achieve industrialisation, but could find that the international rules-based system will make it more difficult to do so. Perhaps the most noteworthy benefit of globalisation in the twentieth and early twenty-first centuries is the establishment of international

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economic laws whose goals are to provide a rules-based global trading system at a minimum. This changes international economic transactions from ones where the mighty dictate the terms to the weak, though a level playing field is still some way off. Nevertheless, developing countries can take developed countries to task for violations of the rules before the WTO, fundamentally altering the previous unbalanced relationship between the rich and poor countries of the world where a trade complaint might be outweighed by concerns about losing an aid package. Having such a system of international economic law makes it all the more important to consider its implications on economic development and growth. This is particularly as the effects are most likely felt in developing countries with under-developed legal systems that are still evolving but are increasingly expected to meet the standards of those in developed countries in the eyes of globalised investors and corporations. There are numerous opportunities for developing countries to benefit from this global legal regime. There are also challenges to economic growth models as a result. By analysing the law and economics of international economic law, all countries would be better placed to evaluate the impact on their growth and development strategies as well as work on the reforms to gain the most from the improved governance of the global economy.

NOTE 1. This insight is from Richard Freeman.

REFERENCES Acemoglu, D. and S. Johnson (2005), ‘Unbundling institutions’, Journal of Political Economy, 113, 949–95. Acemoglu, D., S. Johnson and J. Robinson (2005), ‘Institutions as the fundamental cause of long-run economic growth’, in P. Aghion and S. Durlauf (eds), Handbook of Economic Growth, Amsterdam: Elsevier, pp. 385–472. Besen, S. and L. Raskind (1991), ‘An introduction to the law and economics of intellectual property’, Journal of Economic Perspectives, 5, 3–27. Brock, G.J. (1998), ‘Foreign direct investment in Russia’s regions 1993–95. Why so little and where has it gone?’, Economics of Transition, 6, 349–60. Coase, R. (1937), ‘The nature of the firm’, Economica, 4, 386–405. Commander, S., M. Kangasniemi and L.A. Winters (2004), ‘The brain drain: curse or boon?’ in R.E. Baldwin and L.A. Winters (eds), Challenges to Globalisation, Chicago: University of Chicago Press, pp. 235–78.


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Dam, K.W. (2006), The Law-Growth Nexus – The Rule of Law and Economic Development, Washington DC: The Brookings Institution. Feldstein, M. and C. Horioka (1980), ‘Domestic saving and international capital flow’, Economic Journal, 90, 314–29. Franks, J.R., C. Mayer and S. Rossi (forthcoming), ‘Ownership: evolution and control’, Review of Financial Studies. Geuze, M. and H. Wager (1999), ‘WTO dispute settlement practice relating to the TRIPS Agreement’, Journal of International Economic Law, 2, 347–84. Hansmann, H. and R. Kraakman (2001), ‘The end of history for corporate law?’, Georgetown Law Journal, 89, 439–68. Klemperer, P. (1990), ‘How broad should the scope of patent protection be?’, RAND Journal of Economics, 21, 113–30. Landes, W. and R. Posner (1989), ‘An economic analysis of copyright law’, Journal of Legal Studies, 18, 325–63. Lucas, Robert E., Jr. (1988), ‘On the mechanics of economic development’, Journal of Monetary Economics, 22, 3–42. Maddison, A. (2001), The World Economy: A Millennial Perspective, Paris: OECD. Nordhaus, W. (1969), Invention, Growth, and Welfare: A Theoretical Treatment of Technological Change, Cambridge, MA: MIT Press. Pistor, K., R. Martin and S. Gelfer (2000), ‘Law and finance in transition economies’, Economics of Transition, 8, 325–68. Rodrik, D., A. Subramanian and F. Trebbi (2004), ‘Institutions rule: The primacy of institutions over geography and integration in economic development’, Journal of Economic Growth, 9, 139–65. Solow, R. (1956), ‘A contribution to the theory of economic growth’, Quarterly Journal of Economics, 70, 65–94. Sun, L. and D. Tobin (2009), ‘International listing as a means to mobilize the benefits of financial globalization: Micro-level evidence from China’, World Development, 37(4), 825–38 (Special Issue on Law, Finance and Economic Growth in China). Woods, N. (2006), The Globalizers: The IMF, The World Bank and their Borrowers, Ithaca: Cornell University Press. Yueh, L. (2007), ‘Global intellectual property rights and economic growth’, Northwestern Journal of Technology and Intellectual Property, 5, 436–48.

Index Acheson, Dean 308 ADB see Asian Development Bank Africa 82, 119, 122, 129–30, 139, 140, 142, 144–5, 147, 289, 305 Africa Commission Report 147 AFTA see Asian free trade area aid policy 132, 147, 154 American Jobs Creation Act (AJCA) 263 Americas 140, 143 see also United States; Latin America; Canada Angola 284 see also Sub-Saharan Africa Africa Annan, Kofi 61 ANZCERTA see Australia–New Zealand Closer Economic Relations Trade Agreement APEC see Asian Pacific Economic Cooperation Argentina 125, 129, 212, 322 see also Latin America Aristotle 60 ASEAN (Association of Southeast Asian Nations) 134, 136, 144 Asia 121, 132, 135, 139, 280, 287, 289, 305, 322 Asian Development Bank (ADB) 2 Asian Drivers 280–85, 290, 295 Asian financial crisis 120, 135, 179, 306, 310, 321–2 Asian free trade area (AFTA) 135 Asian Pacific Economic Cooperation (APEC) 311 Australia 127, 130, 133, 144, 153, 294 see also OECD; developed economies Australia–New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) 144

Australian Productivity Commission (formerly the Tariff Board) 152–4 Baltic states 131 see also ex-Soviet Union Bangladesh 151–3, 330 see also Southeast Asia; ASEAN Bank for International Settlements (BIS) 2 Basel standards 321 see also Financial Stability Forum BEA see United States Bureau of Economic Analysis Beijing Consensus 285 Berne and Paris Conventions 28, 229, 234, 316, 323 BIS see Bank for International Settlements Bolivia 119 see also Latin America ‘brain drain’ 319 Brazil 15, 26, 36, 40, 119, 139, 151–3, 225–32, 234, 287, 309, 322, 331 see also BRIC; Latin America Brazilian Patent Law 230 Bretton Woods institutions 2, 3, 13, 163 BRICs (Brazil, Russia, India and China) 6, 8, 26, 225–37 Bright, John 118 Britain see United Kingdom Bulgaria 131 see also European Union; Eastern Europe; ex-Soviet Union Cairns Group 139 Canada 105, 294, 309 see also NAFTA Cancun 111 see also WTO Doha Round; Mexico

335

336


Caribbean, the 82, 129 see also Latin America Cartagena Protocol on Biosafety 108 ‘catch up’ in growth 322–5 Chile 121, 129, 133 see also Latin America China 14, 15, 26, 40, 76, 78, 119, 120, 122, 129, 133–7, 139, 144, 148, 151–3, 193, 212, 225–6, 228, 230, 232–6, 262, 280–85, 290, 294, 302–3, 305, 309, 315, 319, 323, 325, 328 see also BRIC; Asia; East Asia China Life 329 Clayton, Will 306 climate change 288, 307 Cobden, Richard 120 cold fusion 260 Cold War 279 comparative advantage 287, 319 see also Ricardo, David compulsory licensing 323 conditionality IMF 5, 147, 161–89 World Bank 5, 147, 161–89 constitutionalism 21, 25, 49, 51, 56, 60, 62–3, 74–5, 112 Convention on Biological Diversity 108 Corn Laws 286 Costa Rica 287 see also Latin America; Americas current account deficit (US) 248–77, 282–3 see also international investment position (IIP); twin deficits; global imbalances current account surplus (China) 282–3 see also global imbalances Customs Unions (CU) 140 ‘dark matter’ 6, 243, 256–77 de Clerq, Willy 64 de Soto, Hernando 77 Dell 273 Deng, Xiaoping 228 developed economies 123–6, 130, 154, 293 see also OECD developing countries see less developed countries

Doing Business Report 150–52 see also World Bank Dominican Republic, The 287 see also Latin America; Americas Dunkel, Arthur 64 Dworkin, Ronald 76 East Asia 121–3, 130, 133–6, 140–41, 144–5, 147, 280, 305, 320–21 see also East Asia and the Pacific East Asia and the Pacific 129, 316 East Asian ‘tiger economies’ 128, 134, 193, 305 see also South Korea; Hong Kong; Taiwan; Singapore Eastern and Central Europe 131, 302, 309 see also ex-Soviet Union Eastern Europe 119, 121, 123, 133, 144, 147, 193, 308, 315–16, 320 see also European Union; Eastern and Central Europe; ex-Soviet Union emerging economies 320–21, 325, 328–9 entrepreneurs 275–6, 286 Erhard, Ludwig 120 Estonia 132 see also Baltic states; ex-Soviet Union Europe see European Union European Community (EC) see European Union European Union (EU) 14, 15, 21–2, 35–6, 40, 49, 50, 55–8, 63, 67, 82, 94–9, 103–4, 106–12, 119, 125, 136–7, 139, 144–5, 150, 226, 235–7, 263, 294–5, 301, 303, 309, 311, 319, 328 Charter of Fundamental Rights 50 Commission 57, 98 common market law 53, 100 competition law 53, 62 constitutional law 62 Council of Europe 35, 39, 62 Council of Ministers 94, 98 EC Treaty 58, 62 European Convention on Human Rights (ECHR) 49, 56, 62, 80

Index European Court of Human Rights (ECtHR) 49, 58, 62, 74, 81 European Court of Justice (ECJ) 49, 58, 80, 81, 96, 100, 114 European Parliament 18, 39, 98 European Union (EU) law 24–5 Lisbon Treaty 50, 55, 77 Trade Barriers Regulation 84 ex-Soviet Union 131, 145, 226–7, 302, 308–9, 315 see also Russia; Eastern Europe; Baltic states Exxon Valdez 288 factor price equalisation see Heckscher-Ohlin-Samuelson factor price equalisation theorem Feliciano, Florentino 68 Financial Stability Forum (FSF) 321 see also Bank for International Settlements foreign exchange reserves 282 France 50, 105, 225, 302 see also European Union free trade 27, 95, 107, 118, 120, 122, 125, 127, 155, 292 see also international trade free trade areas (FTA) agreements 135, 140, 146 FTA see free trade areas G7 see Group of 7 Countries G8 see Group of 8 Countries G20 see Group of 20 Countries G90 see less developed countries GATT see General Agreement on Tariffs and Trade General Agreement on Tariffs and Trade (GATT) disciplines and conditions set out by 14 formation of 308 Kennedy Round 12 Legal Office 65 limit regional agreements 67 ‘special and differential treatment’ 66 Uruguay Round 11–13, 44, 102, 110, 133

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Uruguay Round Agreement on Anti-Dumping (ADA) 110 General Electric (GE) 291 see also Welch, Jack Georgia 131 see also European Union; Eastern Europe; ex-Soviet Union Germany 22, 51, 122, 225, 285, 308–9, 322 see also European Union Gladstone, William 120 global economic institutions see international financial institutions global imbalances association with Asian Drivers 282 measurement 260 result of 269 global integration 5, 135, 287, 294–5, 300, 307, 329 see also openness of the economy; global imbalances global supply/production chains 136, 261, 287, 320 global trade see international trade global warming see climate change Goldman Sachs 235 Grameen Bank 330 Great Depression 300, 303, 306 Great Leap Forward 228 Group of 7 Countries (G7) 188–9 Group of 8 Countries 311 Group of 20 Countries (G20) 64, 82, 139, 220 Groves, Andy 291 Guatemala 287 see also Latin America; Americas harmonisation in corporate governance systems 329 of labour standards 319 of laws 331 Hayek, Friedrich 57, 85 Heckscher-Ohlin-Samuelson factor price equalisation theorem 292 Heinz Corporation 236 Hewlett-Packard 273 Higgins, Rosalyn 68 high income countries see developed economies Hills, Carla 64

338


Holmes, Oliver Wendell 76 Hong Kong 122, 127–8, 144, 151–3 see also East Asia; Asia; China HSBC 257 Hume, David 125 IGOs see international organisations IMF see International Monetary Fund India 15, 26, 36, 40, 119, 121, 124–5, 133, 136, 139, 144, 151–3, 193, 212, 225–7, 229–30, 232–4, 280– 82, 284–5, 287, 290, 294, 303, 305, 309, 315, 323 see also BRIC; South Asia; Asia Indochina 129 see also Vietnam Indonesia 122, 129, 134, 151–3, 321–2 see also Southeast Asia; Asia; ASEAN informal institutions 330–31 see also social capital; Grameen Bank Information and communications technology (ICT) 244 Intel 291 see also Groves, Andy intellectual property rights (IPRs) 6, 18, 28–9, 225–37, 293, 316–17, 323, 328, 331 Inter-American Court of Human Rights 74 International Court of Justice (ICJ) 77 international economic laws and rules effects on economic growth 315–32 legitimacy of 18–23 limits of 26–7 see also World Trade Organisation international economic regulations see international economic laws and rules international financial institutions (IFI) 2, 161–92 see also Asian Development Bank; Bank for International Settlements; International Monetary Fund; World Bank International Intellectual Property Association (IIPA) 229, 233–4 international investment position (IIP) 249–77

International Labour Organisation (ILO) 56, 57, 72, 319 International Monetary Fund (IMF) 2, 33, 133, 146, 161–89, 229, 294, 302, 308–10, 318, 320 see also Bretton Woods institutions; conditionality international organisations (IGOs) 30, 37–9 international trade conditions 170 in information services 310 global trade policy 4–5, 132, 149 in goods 248 growth in exports 26 rules 70 regulation 12 in services 248, 304 shares of 26 see also World Trade Organisation IPRs see intellectual property rights Israel 287 see also Middle East Italy 225 see also OECD; European Union Japan 14, 22, 99, 105, 122, 128, 134, 136, 139, 144, 151–3, 225, 281–2, 284, 309, 322 see also OECD; Asia; East Asia Kant, Immanuel 50 Kenya 287 see also Africa; Sub-Saharan Africa Keynes, John Maynard 12, 44, 309 Lamy, Pascal 67 Larr, Mart 132 see also Estonia; Baltic states; exSoviet Union Latin America 119, 121–3, 129–30, 139, 144–5, 147, 193, 289–90, 305, 316, 321 see also Americas League of Nations 12 see also United Nations less developed countries (LDCs) 51, 64–6, 69, 79, 81–4, 124–8, 130–1, 139, 154, 167, 293, 316–7, 323–4 see also LLDCs

Index liberalisation autonomous 133 bilateral 140 in capital account 183 financial 179 in imports 132 of inputs 176 in investment 127, 132 linking trade and investment 149 multilateral 136–8 regional 140 in trade 4, 82, 94, 124, 127, 300 unilateral 134, 136 see also protectionism license raj 129, 227 LLDCs 64, 82 Lomé Convention 103 Malaysia 122, 129, 134, 151–3, 305, 321–2 see also Southeast Asia; Asia; ASEAN Malthus, Thomas 286, 292 Marrakesh Agreement 96, 103 see also World Trade Organisation Marshall, Alfred 133 Marshall, General George C. see also Marshall Plan Marshall Plan 308–9 Marx, Karl 292–4 Mexico 102, 111, 119, 129, 133, 262, 293, 310 see also Latin America; NAFTA Middle East 123, 129, 145, 289 see also North Africa multi-factor productivity growth 247, 270 NAFTA see North American Free Trade Area NBER (National Bureau of Statistics of the US) 120 New Deal 32 New Zealand 127, 133, 144, 294 see also OECD; developed economies; Oceania NGOs see non-governmental organisations non-governmental organisations (NGOs) 30, 35, 37–9, 56, 114, 231, 301

339

non-tariff barriers (NTBs) 12, 14, 23, 43, 62, 102, 129, 170, 179 North Africa 123, 129 see also Africa; Middle East North American Free Trade Area (NAFTA) 144 North Atlantic Treaty Organisation (NATO) 308 Northeast Asia see East Asia NTBs see non-tariff barriers Oceania 130 OECD see Organisation for Economic Cooperation and Development off-shoring 262–3, 315, 319 ONS see United Kingdom Office for National Statistics open door policy 315 openness of the economy 41, 120, 122, 134, 193–7, 199–217, 219–21, 249, 289, 300 Organisation for Economic Cooperation and Development (OECD) 55, 57, 126–7, 139, 208– 9, 270, 294, 308 organisational capital 274–6 Oxfam 122 Pacific, the 82 see also East Asia and the Pacific Pakistan 129, 151–3 see also South Asia; Asia pandemics 307 Paris and Berne Conventions see Berne and Paris Conventions Paris Club 284 Peel, Sir Robert 132 People’s Republic of China see China Peru 129, 287 see also Latin America; Americas Phantom GDP 262–3 Philippines, The 129, 134, 151–3, 321–2 see also Southeast Asia; Asia; ASEAN Portugal 227 see also OECD; European Union protectionism 24–5, 32, 54, 59, 65, 67, 75, 78, 81, 83, 85, 113, 118–22, 136–7, 146, 155, 168, 231, 306

340


PTAs see preferential trade agreements preferential trade agreements (PTAs) 133, 136, 138, 140–46, 150 private international capital flows 320 public international law 27, 68, 78 R&D 245–6, 248, 263, 270, 284 Rawls, John 56, 57, 60 Reagan, Ronald 120, 228 regional integration 135 regional trade agreements (RTAs) 66, 138 Reich, Robert 291 research and development see R&D Ricardo, David 285–7, 292 Romania 131 see also European Union; Eastern Europe ROO requirements see rules-of-origin requirements RTAs see regional trade agreements rules-of-origin (ROO) requirements 144–5, 150 Russia 26, 36, 119, 131, 155, 225–7, 229, 232–3, 236, 279, 306, 309, 321 see also BRIC; ex-Soviet Union Sachs, Jeffrey 147 SAFTA see South Asian free trade area Schumpter, Joseph 154, 275, 286, 292 Sen, Amartya 57, 85 Singapore 122, 129, 134, 151–3 see also Southeast Asia; Asia; ASEAN Smith, Adam 57, 58, 77, 85, 118, 125, 133, 154, 286–7, 304 Smoot-Hawley tariff policies 25 social capital 330 South and Central America see Latin America South Africa 119, 125, 129, 133, 231 see also Africa; Sub-Saharan Africa South Asia 119, 121–3, 129–30, 136, 144–5, 289, 305 South Asian free trade area (SAFTA) 136 South Korea 122, 128, 134, 144, 151–3, 281–2, 305–6, 310, 321–2 see also East Asia; Asia; OECD

Southeast Asia 119, 122, 130, 134–5, 321 see also ASEAN Southeast Asian ‘tigers’ 129, 134 see also Malaysia; Indonesia; Thailand, the Philippines southeastern Europe 131 see also Eastern and Central Europe Sri Lanka 121, 129, 151–3 see also South Asia Sub-Saharan Africa (SSA) 123, 129, 284–5, 287, 316 see also Africa; LDCs Sudan 284 see also Sub-Saharan Africa; Africa Sunderland Report, The 136 System of National Accounts (SNA) 244, 270–71 Taiwan 122, 128, 151–3, 305 see also East Asia; Asia; China tariffs 12, 14, 23, 32, 43, 62–4, 102, 121–4, 127–9, 133–4, 136–8, 140, 144–6, 152–3, 166, 170, 179, 197, 228, 234–5, 286, 294–5, 301, 306 see also World Trade Organisation; Smoot-Hawley tariff policies terms of trade global 285 US 264 Thailand 129, 134, 151–3, 280, 287, 306, 321–2 see also Southeast Asia; ASEAN Thatcher, Margaret 120 Tobin’s q 266 Tobin tax 310 transfer pricing 263–4, 269 Treaty of Versailles 12 Truman, Harry 308 see also Marshall Plan Turkey 287, 321 see also Middle East twin deficits 269, 285 United Kingdom (UK) 135, 225, 270– 71, 285–7, 294, 301, 329–30 Office for National Statistics (ONS) 272 United Nations (UN) Charter 61, 67, 77

Index Commission on Human Rights 70, 232 Food and Agricultural Organisation (FAO) 56, 72 General Assembly 61 law 61, 62, 67–8, 70 Millennium Project 147 Secretary-General 61 Security Council 188 United Nations Covenant on Economic, Social and Cultural Rights 74 United Nations Educational, Scientific and Cultural Organisation (UNESCO) 56, 72 United Nations Industrial Development Organisation (UNIDO) 2 World Health Organisation 56, 72 United States (US/USA) 14, 15, 30, 32, 36, 40, 50, 63, 99, 103–4, 106–11, 113, 122, 125, 136–7, 139, 144–5, 212, 225–6, 228–37, 243–72, 276–7, 279, 282–3, 285, 289–91, 293, 295–6, 302–3, 309, 322, 327–8, 331 Bureau of Economic Analysis (BEA) 264, 267 Congress 62 Constitution 24 Supreme Court 62, 67, 76 Trade Representative (USTR) 228–31 US Generalized System of Preferences (GSP) program 229 US-Russia Bilateral Market Access Agreement on Intellectual Property Rights 229 US Trade Act 84 Venezuela 119 see also Latin America Vienna Convention on the Law of Treaties (VCLT) 17, 59–60, 67, 77, 79, 93, 96–7, 107–9 Vietnam 76, 119, 129, 134, 137, 148, 151–3, 280 see also Southeast Asia; Asia; ASEAN Viner, Jacob 136

341

Wagner’s Law 195 Walrasian auctioneer 275 Washington Consensus 2, 3, 5, 13, 118–20, 128, 146, 148, 193, 285, 302, 320 Welch, Jack 291 West Asia 130 Westminster model of deliberative democracy 20 World Bank 2, 33, 57, 85, 133, 146, 147, 150, 153, 161–89, 302, 308–9, 318 see also Bretton Woods institutions; conditionality world trade see international trade World Trade Organisation (WTO) Advisory Center for WTO Law 31, 84 Agreement on Agriculture 70 anti-dumping 109–10, 124–5 Appellate Body 13, 19, 25–6, 76, 93, 99, 101–6, 110–13 Commission 44 Consensus-based diplomacy 40 Councils 80 Dispute Settlement Body (DSB) 4, 41, 56, 74, 76, 80, 93–4, 98–111, 113–14, 231, 233, 316, 324, 327–8 dispute settlement panels 40–42, 68, 76, 103, 105–9 Dispute Settlement Understanding (DSU) 67, 70–78, 83, 96, 100, 138, 311, 324 Doha Round (‘development round’) 2, 14, 64, 66, 69, 81, 83–5, 113, 121, 137–8, 140, 148, 328 General Agreement in Trade in Services (GATS) 11, 13, 14, 23, 67, 70, 77, 125, 316 General Council 97, 100 Government Procurement Agreement 42 law 3–4, 11, 13, 15, 19, 24–8, 32–5, 42, 65, 66, 73–6, 79–81, 85, 98, 316, 328 most favoured nation (MFN) 23, 40, 140 Preamble 60, 64, 68, 77, 78

342


principle of national treatment 23–4 principles of non-discrimination 23, 320 production and process methods (PPMs) 27 rules 11–12, 64, 67, 73–4, 77, 82 safeguard measures 24 Secretariat 31, 35, 56, 80 Singapore issues 13–14 Special and Differential Treatment (SDT) 83, 140 SPS Agreement 28, 106, 124, 126 TBT Agreement 124, 126–7 Trade Policy Review Mechanism 82 Trade-Related Investment Measures (TRIMS) 27, 70, 320

Trade-Related Aspects of Intellectual Property Rights (TRIPS) 11, 27, 28–9, 31, 33, 70, 77, 93, 98, 226, 229, 231–2, 316–18, 323–5, 328, 331 see also international trade WTO see World Trade Organisation Yugoslavia 131 see also European Union; Eastern Europe Zambia 284, 287 see also Sub-Saharan Africa; Africa Zedong, Mao 228 Zimbabwe 287 see also Africa; Sub-Saharan Africa Zoellick, Robert 140

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