Karl Aiginger Director Austrian Institute of Economic Research (WIFO) Karl Aiginger

How Globalization Works: Seventeen Theses on Its Impact on Trade, FDI, Income and Welfare

1 Definition and Dimensions ature, these regions are often called We tentatively define globalization as developed versus developing coun- the extension of the horizon of ac- tries, or North versus South. tion. Economic strategies, but also While globalization has been an social relations, knowledge, and cul- important topic for a long time, there ture cease to be limited by national are several new aspects, as stressed in borders; they become international Pichelmann and Vengelers (2005): and finally global. – the weak economy in the EU ver- Within the economic realm, glo- sus the buoyant growth of the balization implies a larger horizon for world economy1 trade, production and sourcing as – the emergence of new players, with well as for physical and financial in- especially large labor forces and vestment. The origin of goods con- relatively high technical capaci- sumed widens, also for intangible ties activities and services, specifically – information and communications information, technology, organiza- technologies, which allow knowl- tion, culture and finally for the socio- edge to be codified, boosting the economic model. The choice of the tradability of goods and services location for living and working – a and causing vertical fragmenta- topic covered by the term “mobility” tion; there is a specialization ac- within an integration area and by the cording to Ricardo for segments of term “migration” outside – is espe- the production cycle instead of for cially important. complete goods In comparison to the related con- – the extension of the division of cept of integration, globalization by labor to services – considered definition refers to regions which are nontradable until recently; this very different from each other, not includes audiovisual, cultural, only because they are far apart, but business and training services; because they have different cultures, services are easier to relocate, economic systems, and income levels. since they require fewer resources, If we want to discuss the impact less space and less equipment of globalization on incomes and – greater migration and labor mo- wealth, it is important to distinguish bility between impacts for all countries, the – the imposition of changes on world (W), and then separately for farmers, workers and firms by the the poorer countries (P), and for the Doha round and WTO developed countries (R). In the liter-

1 In the five years from 2002 to 2007, the world economy will have expanded by 25% (including the predicted value for 2007), while European growth will only have amounted to 10% .

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2 The Advantages of in all countries. Disequilibria may re- Globalization sult in the short run (unemployment Economic theory tells us that global- rises in sector A, labor is not trans- ization – in parallel to all forms of in- ferred into sector B), and unemploy- tegration and openness – will increase ment may become persistent under incomes in both (P) and (R) regions specific circumstances (rigidities). and a forteriori also in the world (W). Theory states that the losers can The driving forces are the following: be compensated, since gains are larger (i) an increasing variety of products, than losses (“net welfare increases”). inputs, sources, (ii) the diffusion of Usually, however, compensation does technologies and best practice, (iii) not take place. the convergence of per capita in- comes, and (iv) risk diversification 4 Disadvantages of (inputs, outputs, and assets). Further- Globalization: more, welfare increases more than Asymmetric Cases Most critiques of globalization start from the assumption that some coun- tries reap the advantages of globaliza- tion while others suffer. Interestingly, people in the rich countries often claim that R are the losers, while the arguments for unbalanced globaliza- tion tend to hint at necessary condi- tions for poorer countries to make globalization beneficial for P. GDP or incomes, due to cheaper in- “Unfair” advantages of R might be puts, increasing variety and choices. the following: – asymmetric trade and investment, 3 The Disadvantages of giving firms in R a first-mover Globalization: advantage A Symmetric Case – multinational firms usually have It makes sense to analyze first the case their headquarters in R, and the of countries which are more similar, economic and political interests or where the trade effect is rather bal- of location of headquarters shapes anced. Even in the balanced case the outcome there are winners and losers in R and – firms with headquarters in R ex- in P. In the rich countries, the high- tract rents in P and transfer prof- skilled groups win, while the low- its to R, giving rise to arguments qualified tend to lose; in the poor re- about expropriation and unfair gions the opposite happens. This is prices due to fact that the original scarcity – the poor countries specialize in of low-skilled labor is reduced, since low value added goods, with a low labor-intensive goods will be im- income elasticity (development trap) ported in R. – social dumping (child labor etc.) Second, the speed of change and and environmental degradation its implied short-run burden increases occur in P

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Unfair advantages of P or nonacceptable they want to lure firms by low taxes pressure on labor in R might be come and subsidies. from Third, the volatility of the devel- – dumping, undervaluation of cur- opment might increase, as the experi- rency ence of financial crises in Asia, Mex- – “unfair, prolonged, policy-depen- ico, Argentina and Turkey demon- dent” wage advantages strates. – possible subsidization of labor-in- tense sectors in R (export promo- 6 The Empirical Evidence 2: tion) Intracountry Income – wage pressure on R (the “are- Differences wages-set-in-Beijing debate”) Inequality within countries is increas- Therefore, interestingly often both R ing. This holds for P, for rural incomes and P believe that they are the losers versus cities. This development might of globalization, even if both are prob- not follow from globalization alone; it ably in the long run net winners. The is aggravated natural disasters or civil reason for this is that the negative wars and stems from the lack of edu- consequences of globalization tend to cation and bad domestic policies. The be visible and concentrated, while the burden of change imposed asymmet- benefits are dispersed and the origin rically on regions and persons, how- of the advantages is not attributed to ever, adds to existing inequalities and globalization, but to innovation, man- might further destabilize regions. agement and prudence. The rising inequality holds for poor countries, it might even be seen 5 The Empirical Evidence 1: as typical or indispensable in takeoff Cross-Country Income periods (unequal development hy- Differences pothesis). However, it also held for It is not easy to summarize the huge most R in the 1990s. As to the causes literature on equality and inequality in rich countries, rising inequality of nations and persons in a few sen- may come from globalization (pro- tences. My reading, however, is that duction and exports of labor-inten- the inequality of per capita incomes sive and low-skill goods is lost in R) across countries is decreasing. This or from technology change. This is an process is slow and nonlinear, but sig- intensive and controversial debate in nificant. There is one important ex- economics. ception: Africa is falling back instead The trend toward rising inequal- of catching up. ity seems to have leveled off in late Second, profits rise relative to the 1990s or since, and may have been wage bill. The reason for this is that reversed in some countries lately. capital is more mobile and more pow- erful. It has a large and increasing 7 The Empirical Evidence 3: bargaining power. Globalization in- Openness and Growth creases the options, and capital can More open countries tend to grow use it for threats (to relocate firms), faster. This is specifically the case which governments want to preempt; for GDP. The results for per capita

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income might be less, if high growth omy. This has to be compared with attracts migration. There is, however, 10% due to integration within also the opposite claim that net im- Europe. The remaining 70% stem migration and abundant labor stimu- from increased production (use of late growth (more GDP, less GDP resources). per capita). 9 The Growth Evidence: 8 Globalization Impact: 2002–2007 (Including Empirical Results for Forecast) the EU The growth experience among re- In summarizing the impact of global- gions has become surprisingly differ- ization on Europe, we follow Pichel- ent over the past five years. We cal- mann and Veugelers (2005). culate figures for the five years from The EU has by and large defended 2002 to 2007, including the current its world market share (in contrast to WIFO prediction for 2007: its share in world GDP). EU-trade is – the world economy is growing by balanced, leaning to the positive 4% per annum (cumulative over specifically for the EU-15. The EU five years: 28%) generates a trade surplus of 1% of – Europe is growing by 2% per an- GDP in business services (where out- num (cumulative: 8%) sourcing is suspected). – China is growing by 9% per an- There is no significant outflow of num (cumulative: 68%) investment into low wage countries. – the new Member States are grow- Employment is increasing somewhat, ing by 4% per annum (cumula- with losses occurring in manufactur- tive: 27%) ing. Inward FDI in EU is increasing – the U.S.A. is growing by 3% per slightly in the EU-15 and more in the annum (cumulative: 20%) EU-10. In the long run, the U.S. growth path Unemployment of low-skilled labor imposes some risks on the world is high but decreasing. Net immigra- economy with its twin deficits, lack tion is increasing and is now higher of internal savings and overvalued than in the U.S.A.; it is low-skill im- house prices, but strategies for a soft migration. landing and international coordina- The exports of the EU and those tion are to be discussed elsewhere. of China and India are complemen- tary (Pichelmann and Veugelers, 10 European 2005). The trade deficit with Asia is Underperformance fully compensated by a surplus with European underperformance with the U.S.A. and with the new Mem- respect to growth and employment ber States and the “new” neighbors. generation is not related to globaliza- Pichelmann and Veugelers (2005) tion. It comes from internal reasons, present a very convincing statistical like insufficient macromanagement, record of globalization for Europe: of neglect of the Lisbon strategy and es- the increase in European living stan- pecially low investment in the future dard over the past 50 years, 20% are (research, education, lifelong learn- due to integration in the world econ- ing, and modern technologies. Maybe

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we have to add insufficient flexibility Turkey, shows just how dynamic the (flexicurity), the lack of vision, trust, “neighborhood” is: the GDP of this strategy, consensus. A tentative – al- area is predicted to increase as fast as beit not sufficient – proof for this is that of the U.S.A. the lack of a current account deficit of the EU. 13 Integration and Globalization 11 Net Benefits for Europe Experience for Austria from Growth in China, Austria has experienced a dramatic India Prevail experience of openness: Trade open- Specifically the buoyant business cli- ness increased from 50% to 75% in mate stemming from increasing world ten years (1995–2005, goods, ex- trade is important for solving the Eu- ports plus imports) after stagnating ropean underemployment problem for 15 years. Three forces were in- and for increasing flexibility. Labor volved in the acceleration: member- market reforms work better in peri- ods of rising demand, and fiscal debts can be reduced without crisis if ex- port demand rises. Finally, invest- ment in the future can be financed if profits rise. 12 Globalization Worldwide versus Globalization in a Wider Europe (Global versus Neighborhood) ship in the EU, the opening of Eastern For Europe in general and for Austria and Southeastern Europe, and the specifically, “neighborhood globaliza- shifting role for Austria at the center tion” may be as important as rising of a dynamic region. trade with Asia. For Austria, trade Austria has clear net benefits from with Eastern Europe amounts to 12% its new openness: The trade balance of GDP (exports plus imports) as deficit leveled off, starting from a compared to 6% for trade with Asia deficit larger than 5, % of GDP. Direct and 3.5% for trade with the U.S.A. investment flows in percent of GDP Integration in a wider Europe is a rose from 1.6% in 1992 to 6% in sort of globalization, since it is the in- 2005, and here again, the past deficit tegration of very different per capita eroded: outward stock equals now in- incomes. However, it happens within ward stock. Third, the high-tech def- a very small geographical sphere. icit is leveling off; export unit values Austria is located at a welfare ridge: now equal those of imports. wages 500 km east of Austria amount The labor-intensive industries are to 25% of Austrian wages; at a dis- the losers. Unemployment has in- tance of 1,000 km, they are 10%. creased, and differences in unemploy- The forecast of the wiiw for a “wider ment between unskilled and skilled Europe” defined as the EU-25 plus workers are growing. All this follows Southeastern Europe, Ukraine and the predicted short-run impact of

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globalization if macroeconomic pol- fined). The deficits with the EU-15 icy and investment in the future are are fully compensated by net invest- not very active in a specific period ments; direct investment with the (1995–2005, see thesis 15). U.S.A. and Asia are negligible. 14 Double Strategy: 15 Consequences for Wider and Nearer Economic Policy Globalization for Austria Some strands of economic policies The trade balance of Austria with are becoming less effective. This hold eastern countries is highly positive: for trade barriers and investment in- The export share to the east rose centives, specifically those discrimina- from 2.5% in 1992 to 6.7% in 2005; ting between domestic and foreign in- imports rose from 1.9% to 5.8% in vestment, the use of exchange rates the same period. The trade balance to stimulate the economy or to cor- with Asia is negative: The export rect imbalances. On the other hand, competition for direct investment is increasing and now relies less on direct subsidies and more on offering physical infra- structure or even more intangible in- frastructure (legal system, education, innovations system). Tax competition increases (spe- cifically business taxes, manager tax load). share increased from 1.6% in 1992 We should furthermore not forget to 2.5% in 2005; imports increased that demand and growth policy from 2.8% to 3.8% in the same (macroeconomic policy and growth- period. Austria switched into a net enhancing strategies) are needed if export position with the U.S.A., with wages increase less than productivity export shares increasing from 0.6% and if domestic profits are used in 1992 to 2.5% in 2005; imports for foreign investment. Competition only expanded from 1.1% to 1.3%. policy has to be enforced vigorously Austria’s deficit with the EU-15 to reap benefits from the lower prices shrank from 4% to 2%. of imported goods. The overall conclusion is that the If business taxes are reduced and rising deficit with Asia is more than income taxes in the highest segment compensated by the surplus with are not to increase, the tax load on Eastern Europe plus exports to the consumption, energy, wealth and U.S.A., which is partly feasible only interests have to increase, and/or due to vertical division of labor with government expenditures have to be the east. curtailed. The balance of outward versus inward direct investment has also lev- eled today. Half of the outward flows go to Eastern Europe (narrowly de-

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16 Proactive Policies Can 17 Summary Increase Positive 1. Globalization is not a panacea, it Net Benefits is a necessary but not sufficient con- Benefits can be increased and disad- dition for growth and welfare im- vantages can and should be limited by provement. prudent proactive policy. Many inter- 2. Net gains also need political and national organizations and economists macroeconomic stability, i.e. a high forget this in their recommendations. investment-to-GDP ratio, a reli- I would label the recommendation to able legal system, investment in liberalize, deregulate and globalize human capital, physical infra- the economy, and then wait for the structure in P, investment in positive results in investment, inno- R&D, education and lifelong vation and employment generation learning in R. to come up the “Paris Consensus.” 3. Globalization increases the im- The problem of this consensus is that portance of economic policy. These the recommended strategies – while policies are different from the hopefully positive in the long run – past: proactive policies, the en- have a restrictive impact on demand forcement of positive externali- and employment in the first stage ties, retraining, competition pol- (“pains precede gains”). If macro- icy. Subsidies are less important; management does not cope with these strategies preventing structural problems, cumulative downward change become very costly under forces may prevent the positive results globalization. of higher productivity and a better 4. Globalization increases the speed of division of labor. change; this is a burden. However, Managing globalization properly globalization also increases choices in developing countries includes poli- and welfare. cies to 5. The possibility that for some R – reduce poverty, foster education, losses dominate gains is unlikely but fight against corruption possible. However, pains can pre- – encourage endogenous forces cede gains, and the political weight – limit volatility of losers can be greater than that of – introduce minimum social and the winners. environmental standards 6. The possibility that for some P the Managing globalization properly in losses are higher than the gains is developed countries (R) implies not unlikely, but could be pre- – upgrading the skills of unskilled vented by domestic policies and labor international organizations. – distributing the burden of change 7. Properly managed globalization is a fairly win-win situation. Preventing glo- – managing change in a forward- balization is impossible and would looking manner create a lose-lose situation. Global- – stimulating growth by increasing ization increases the scope (and R&D, education and lifelong changes the instruments) of eco- learning nomic policy. Laissez-faire globali- zation and following the Paris

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Consensus result in political risks, 9. For Austria “neighborhood” globali- backlashes and conflicts. zation is at least as important as 8. Multinational organizations should world-wide globalization, though not only press for liberalization, differences across sectors exist, privatization and deregulation, and relations with and policy at- but also for proactive education poli- tention to the fast-growing Asian cies, regional policies and macro- countries are important, too. õ management.

References Aiginger, K. and A. Guger. 2005. The European Socio-economic Model. In: Giddens, A. Global Europe, Social Europe. Mason, P. 2001. Globalisation: Facts and Figures. IMF Policy Discussion Papers. October. Pichelmann, K. and R. Veugelers. 2005. Rising International Economic Integration: Opportunities and Challenges. The EU Economy 2005 Review. European Commission. ECFIN. Brussels. November. Sala-i-Martin, X. 2004. The Disturbing Rise of Global Income Inequality. NBER Discus- sion Paper. April. Snower, D. 1999. Inequality of Earning. CEPR Discussion Paper 2321. December.

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