‘Hazardous obsession’ with global integration

by Chakravarthi Raghavan

Geneva, 18 April 2001 -- Developing countries should tailor their development strategies to their prevailing institutional strengths, and policy-makers looking to Washington and financial markets for answers are condemning themselves to eventual disillusionment, leading US economist and Harvard academic, Prof Dani Rodrik, has warned.

In a recent paper, ‘The Developing Countries Hazardous Obsession with Global Integration’, posted on his website , Rodrik, Professor at the Kennedy School of Government (Harvard University) and coordinates the research programme of the Group of 24 (developing country group at the Fund/Bank institutions) decries the perversion of priorities in the remarkable consensus on the imperative of global integration which he calls ‘The Refurbished Washington Consensus’.

Prof. Rodrik notes that foreign trade and investment have now become the ultimate yardsticks for evaluating actions of governments, including in relation to crime and violence, and shows the perversion of priorities behind the consensus on imperatives of global integration.

Openness to trade and investment is no longer viewed simply as a component of a country’s development policies, but has “mutated into the most potent catalyst” for economic growth. This ‘faith’ has spread from a handful of proselytizing academic economists to world leaders and policy-makers of all stripes, and incessantly repeated by senior officials of the WTO, IMF and other international agencies, as the surest way to achieve economic growth and poverty alleviation.

Insertion into the world economy is no longer a matter simply of removing trade and investment barriers, but involves a long list of admission requirements, “ranging from patent rules to banking standards”, and the apostles of economic integration prescribe institutional reforms that took today’s advanced industrial economies “generations to accomplish.”

“Global integration,” Rodrik comments, “has become for all practical purposes a substitute for development strategy,” and this is bad news for the world’s poor.

However, the new agenda is built on “shaky empirical ground” and is seriously distorting priorities of policy-makers. Compliance with these prescriptions would divert human resources, administrative capabilities and political capital of countries away from the more urgent development priorities such as education, public health, industrial capacity and social cohesion. It also undermines nascent democratic institutions by removing choice of development strategy from public debate.

Globalization, Rodrik stresses, is not a short-cut to development. Successful development strategies require a judicious blend of imported practices with domestic institutional innovations, and a domestic growth strategy, relying on domestic investors and domestic institutions.

The “integrationist faith” is crowding out serious thinking and efforts along these lines.. And reality has not been kind to the faith. Despite sharply lowered barriers to trade and investment, scores of Latin American and African countries are stagnating or growing less rapidly than in the heydays of import substitution; the fastest growing economies are those of East and S.E.Asia, China and India—all of whom espoused trade and investment liberalization, but did so in an unorthodox manner - gradually and sequentially, and after an initial period of high growth. But the disappointing outcomes of deep liberalization have been “absorbed into the faith with aplomb”, with global integration presented as requiring more than throwing borders open, but requiring a full complement of institutional reforms.

According to the World Bank economists, successful liberalization requires a whole laundry list: tax reforms, social safety nets, administrative reforms (to bring trade policy into conformity with WTO), institutional innovations to enhance credibility on permanence of reforms, labour market reforms for labour mobility, technological assistance to upgrade firms hit by imports, training programs to ensure availability of skilled workers for export-oriented firms and investors. And if benefits of trade liberalization fail to materialize, the pre- requisites keep expanding - for e.g. Britain’s Development Minister Claire Short recently added ‘universal provision of health and education’ to the list.

In the financial arena, complementary reforms have been pushed with greater fanfare. Viewing the Asian financial crises as caused primarily by weaknesses in prudential regulation, corporate governance and bankruptcy procedures, the G-7 are trying to establish international codes and standards on fiscal transparency, monetary and financial policy, banking supervision, data dissemination, corporate governance and accounting standards. Twelve of these standards have been prescribed by the Financial Stability Forum (created by the G-7) as the key for sound financial systems in developing countries - the FSF’s own compendium has 52 standards, raising the total to 64 - the primary motive being to make integration of the developing countries into global markets safe, “safe for themselves and other emerging markets.”

Considering how demanding the pre-requisites are, one might wonder whether the point of all this “is not to provide easy cover for eventual failure” .—blaming ‘slippage’ in implementation is more convenient than on poorly designed liberalization.

If Bangladesh trade reforms don’t produce large enough spurt in growth, the World Bank concludes it is due to lagging reforms in public administration or political uncertainty. And if Argentina is caught up in a confidence crisis, IMF blames inadequate structural reforms and advocates deepening them!

Most of the institutional reforms, Rodrik agrees, are sensible ones - and in a world without financial, administrative or political constraints, there could be little argument on need to adopt them. But in the real world of scarce resources on all three fronts, choices have to be made and, from the perspective of insertion into the global economy, the choices have real opportunity costs.

It has been estimated that it costs any typical developing country $150 million, equal to a year’s development budget for many least-developed nations, to implement just three WTO agreements - on customs valuation, sanitary and phytosanitary measures and TRIPs. No costing has been done for implementing financial codes and standards, but clearly these would need even more serious diversion of fiscal and human resources.

Asks Prof Rodrik: should a government train more auditors and accountants - even if it means fewer secondary- school teachers or lower investments in primary education for girls? Should it focus energies on importing legal codes and standards or improving domestic institutions? A weak coalition government in Turkey, for example, spent several months last year to win support for a bill to provide foreign investors protection of international arbitration. Wouldn’t it have been better strategy for the long run to reform existing legal regime for benefit of foreign and domestic investors alike?

In the area of public health, should a government pursue tough policies on compulsory licensing and parallel imports of basic medicines, even if it runs foul of WTO rules? For industrialization, should a government just open up or emulate the East Asian experience of industrial policies - through export subsidies, directed credit and selective protection. And how much should be spent on social protection, given the constraints of market ‘discipline’? As insurance against sudden capital outflows, Peru’s Central Bank had to hold reserves for 15 months of imports, almost 1% of GDP - more than enough for a generous anti-poverty program.

How should a government focus its anti-corruption strategy - target the ‘grand’ corruption that foreign investors complain about or the petty corruption affecting the poor?

It is possible, notes Rodrik, that a China forced to protect rights of foreign investors becomes more inclined to protect human rights of its own citizens, but this is at best “a trickle-down strategy”. Shouldn’t institutional reforms be targeted directly at desired ends - rule of law, improved human rights or reduced corruption?

The rules for integration into the world economy, not only don’t reflect development priorities but are completely unrelated to sensible economic principles. “The WTO rules on anti-dumping, subsidies and countervailing measures, agriculture, textiles, TRIMS and TRIPs are utterly devoid of any economic rationale beyond the mercantalist interests of a narrow set of powerful groups in advanced industrial countries.”

The bilateral and regional trade agreements impose even tighter pre-requisites - for e.g the US Africa Growth and Opportunity Act requires use of US produced fabrics and yarns, thus preventing economic linkages among African countries themselves; the US-Jordan Free Trade Agreement has more restrictive provisions for IPRs than the WTO itself.

In each area of the pre-requisites for integration, the ‘globalization-above-all’ crowds out the “more development friendly”. Many institutional reforms may be desirable, but their priorities don’t coincide with priorities for a more full development agenda.

The Asian experience shows that a sound development strategy producing sustained growth over the medium- to long-term is far more effective for achieving integration than freeing up trade and investment and waiting for it to work its magic. Frequent incantation that economic salvation lies in greater integration with the world economy is “both misleading and hollow.” In any event integration into the world economy is not something policy makers control directly. Asking countries to increase their participation in world trade is as meaningful and helpful as asking them to improve their technological capabilities. Policy makers need to know what policies would produce these results, and whether prescriptions of current orthodoxy are up to this task.

The advice that lower trade barriers produce greater economic progress, and the studies cited in support, Prof Rodrik points out, turn out on closer look to be “flawed.” The classifications in such studies of ‘open’ or ‘closed’ trade policies are not based on actual policies, but indicators related to exchange rates and locations. There is a major gap between the policy conclusions typically drawn and what the economists have shown.

It is not that trade protection is inherently preferable to trade liberalization, but rather that benefits of trade openness are greatly oversold.  And deep trade liberalization can’t be relied upon to deliver high rates of economy growth, and don’t deserve the high priority received in development policies pushed by leading multilateral organizations, Rodrik says.

The evidence on benefits of liberalizing capital flows is even weaker. Financial markets are inherently unstable, subject to bubbles, panics, short-sightedness and self-fulfilling prophecies. There is plenty of evidence that financial liberalization is often followed by financial crash - but practically no evidence that higher rates of economic growth follow capital-account liberalization.

To be effective development strategies need to be tailored to prevailing domestic institutional strengths, and there is simply no alternative to a home-grown ‘business-plan’.

“Policy-makers who look to Washington and financial markets for answers are  condemning themselves to mimicking the conventional wisdom du jour, and to eventual disillusionment,” Prof Rodrik concludes. – SUNS4878

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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