II Empirical evidence and policy suggestions

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Welfare models, inequality and economic performance during globalisation

Pasquale Tridico

Globalisation: causes and consequences, a brief overview

Globalisation has been one of the most debated topics in at least the last two decades by scientists of different disciplines such as economics, politics, sociology, business, anthropology, engineering and transport studies, and environmental studies, among others. In fact, the emergence of globalisation is widely relevant to the subject of human lives from different perspectives concerning incomes, wealth, consumption habits, production, institution, governance, infrastructures, transports, and technology, etc. However, globalisation is still a generic term, which, in most of the definitions, is identified as a process of the intensification of, for instance, trade, capital mobility, finance, and labour. By contrast, there are authors such as Hay and Wincott (2012) who disagree with such a definition of globalisation and would rather define globalisation as a process not only of the intensification of those flows but also of extensive increase at a planetary level of trade, capital and labour mobility, and technological exchange (Held et al., 1999). Because evidence of this second type of definition of globalisation is missing and not all countries in the globe are part of the globalisation process (quite the opposite; globalisation interests a limited, yet increasing, number of countries), they conclude that it would be more appropriate to speak about regionalisation rather than globalisation. For instance, trade, capital and labour mobility particularly increased in the European Union (Europeanisation), among advanced and emerging economies (trans-regionalism), or among North American countries (with regional agreements such as NAFTA), etc. Hence, the interpretation of globalisation remains quite controversial and remains an on-going and evolutionary process. The figure below attempts to show the asymmetry of globalisation or essentially the intensification of the process in primarily advanced economies during 1980-2006 (i.e., until the eve of the financial crash in 2007), which is considered the period during which globalisation intensified tremendously.1

Nonetheless, while it is true that globalisation interests more advanced (and increasingly more emerging economies, typically BRIC countries)2 and less poor economies, it is objectively impossible to deny the intensification of this process and the increase in the number of countries involved in the global economy in the last two decades. The figure below is the simplest representation of this kind of globalisation. In particular, a first big wave of globalisation, identified purely according to the intensive definition, took place after 1970, which a new international monetary scenario, the change in oil prices and the beginning of the European Monetary Systems, may have generated. However, this first wave of globalisation was unstable and the process of intensification declined during the 1980s. Finally, the process of intensive globalisation, accompanied often by the extensive inclusion

100 Pasquale Tridico

Capital mobility in terms of FDI

Figure 5.1 Capital mobility in terms of FDI

Source: The World Bank database

of more and more countries in the process, steadily took place at the end of the 1980s, when several institutional, geopolitical and technological changes occurred. I tend to particularly underline the importance of the following six changes to the process of globalisation:

  • 1 The political (and to some extent also ideological) change that occurred during the 1980s, particularly in the United States and Great Britain with the new administrations of Reagan and Thatcher. These two political leaders were able to shape the international political consensus to some extent that the change towards globalisation required. This change occurred initially in the USA and the UK and later was promoted with the help of the major international organisations such as the International Monetary Fund and the World Bank, which were very close to the Washington administration (Stiglitz, 2002) at the international level, along with a new political economic doctrine which became known as the “Washington Consensus”.
  • 2 The financial deregulation that occurred in particular under the stimulus and the policies of the two administrations of Reagan and Thatcher mentioned above, first in the USA and in Great Britain and later in many advanced and developing economies. The financial deregulation contributed to both extend capital globally in search of higher profits and intensify the economy with finance and financial tools so that economies across the world soon became attracted to the process of financialisation.
  • 3 The fall of Berlin Wall in 1989 (and the following dissolution of the Soviet Union in 1991), which caused the end of the Cold War and the end of the division between the East and West of Europe (and in a way of the East and West of the World) with the significant inclusion of the former communist economies in the global economy (or to be more precise, in the economic system of Western Europe, North America and other few advanced economies).
  • 4 The deepening of the process of integration of the European Union (which in a way is connected with the previous item), which culminated with the Maastricht Treaty, introducing capital mobility along with the liberalisation of trade, service, goods and labour in an important and large market such as the European Union.
  • 5 The tremendous challenges posed by the technological progress that brought about the ICT revolution and all the other great innovations introduced in transport and in telecommunications then contributed to reduce transportation costs enormously.
Globalisation in terms of trade intensification Source

Figure 5.2 Globalisation in terms of trade intensification Source: The World Bank database

6 The take-off (during the 1980s and 1990s) of several emerging economies in terms of economic growth, often identified with the term BRIC.

Theoretically, globalisation, or to be more precise, openness, was and is supported by the so-called mainstream neoclassical approach. Lewis (1980) and many economists such as Lucas (1993) and Bhagwati (2004) believed that trade is the engine of economic growth. Nevertheless, the experience of globalisation so far has shown that the performance of opened economies can vary consistently. The hypothesis that we are supporting in the paper is that openness per se, although it may be one of the indicators of competitiveness, is not an engine of economic growth. openness (defined as imports and exports as a percentage of GDP) and integration in the world economy should be accompanied by institutions, state strategies and particularly by a consistent welfare state that support internal cohesion and maintain external competitive advantages. According to Rodrik (1999), the best-performing countries are the ones that are integrated in the world economy with appropriate institutions that are able to support the impact of globalisation on the domestic market and social domestic issues. Countries with poor social institutions, weak conflict management institutions (which means poor welfare states) and strong social cleavages suffer external shocks and do not perform well in the world economy. Nevertheless, for most of the globalisation period, the USA has been an example of neoclassical economics, showing that globalisation does not necessarily need a strong welfare state. However, the current financial and economic crisis which started in the USA in 2007 and its consequences that are currently propagated in many advanced economies seems to show that the Rodrik argument still holds true:

The world market is a source of disruption and upheaval as much as it is an opportunity for profit and economic growth. Without the complementary institutions at home - in the areas of governance, judiciary, civil liberties, social insurance, and education, one gets too much of the former and too little of the latter

(Rodrik, 1999:96).

For Lucas (1993), international trade contributes to stimulate economic growth through a process of structural change and capital accumulation, as in the case of Ireland, where according to Walsh and Whelan (2000), a structural change had already taken place during the 1970s and created conditions that allowed the Irish economy to grow considerably in the 1990s and later in the 2000s. Capital accumulation is determined by “learning by doing” and “learning by schooling” in a process of knowledge and innovation spillovers. A country that protects its goods from international competition by raising tariffs on goods made with intensive skilled work will have as an effect a domestic increase in the price of goods that use intensive skilled work. Skilled workers’ wages will increase and R&D will be more expensive. Consecutively, investments in R&D will decrease, and growth will be affected negatively. On the contrary, deleting tariffs on those goods will cause a reduction in the price of goods that use intensive skilled work. R&D will cost less, and investments in R&D will increase, with positive effects on growth (Lucas, 1993). Policies should, therefore, address such problems and should create conditions for effective and substantial R&D investments.

This argument, however, does not take into consideration the inequality and uneven development caused mainly by liberalisation and trade intensification via wage differentials. This risk was already raised by Stolper and Samuelson: according to the Stolper-Samuelson theorem, market integration increases economic inequality and vulnerability because increased international trade raises the incomes of the owners of abundant factors and reduces the incomes of the owners of scarce factors. Since advanced industrial countries are more capitalintensive economies and abundant with skilled labour, trade is expected to be beneficial for capital-intensive economies and skilled labour and detrimental for unskilled labour, increasing income inequality, and for labour-intensive economies, increasing regional disparities.

Similarly, increased capital flows are expected to raise income inequality in advanced industrial economies because capital outflows from capital-rich countries to LDCs reduce domestic investment and lower the productive capability and demands for labour in these economies (Ha, 2008; Tsebelis 2002). Because a reduction in total capital in the production process increases the marginal productivity of capital and reduces the marginal effect of labour, capital outflows increase the income of capital relative to labour, increasing income inequality. In particular, because foreign direct investment (FDI) outflows from advanced industrial countries tend to be concentrated in industries with low-skilled labour in the home country (Lee 1996), rapidly rising FDI outflows often reduce the demand for low-skilled labour and increase income gaps in industrialised countries. In fact, several studies find that trade with less developed countries is associated with expanded income inequality in industrialised countries (Wood, 1994; Leamer, 1996; Rodrik, 1996; McKeown, 1999).

Empirically, it is interesting to observe FDI expansion, which experienced a strong increase in the 1990s due to liberalisation of capital mobility and then a collapse at the beginning of the 2000s due to the global uncertainty caused by the international events of September 11, 2001. A further and bigger increase in FDI flow can be observed immediately later and until the financial crash of 2007, with a peak in the FDI flows in 2006-07. The current crisis, marked by financial instability and depression, caused a further squeeze in FDI, which, however, remains at a much higher level than at the beginning of 1990s.

FDI in the world economy

Figure 5.3 FDI in the world economy

Source: The World Bank database

 
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