RESPONSES to GLOBALIZATION in GERMANY and the UNITED STATES Seven Sectors Compared

Research Report GERMANY ANDTHE GLOBALIZATION IN Seven SectorsCompared UNITED STATES RESPONSES TO AICGS ResearchReportNo.10 Contemporary GermanStudies The JohnsHopkinsUniversity American Institutefor Carl Lankowski Edited by American Institute for Contemporary German Studies The Johns Hopkins University

AICGS Research Report No. 10

RESPONSES TO GLOBALIZATION IN GERMANY AND THE UNITED STATES Seven Sectors Compared

Edited by Carl Lankowski

i The American Institute for Contemporary German Studies (AICGS) is a center for advanced research, study, and discussion on the politics, culture, and society of the Federal Republic of Germany. Established in 1983 and affiliated with The Johns Hopkins University but governed by its own Board of Trustees, AICGS is a privately incorporated institute dedicated to independent, critical, and comprehensive analysis and assessment of current German issues. Its goals are to help develop a new generation of American scholars with a thorough understanding of contemporary Germany, deepen American knowledge and understanding of current German developments, contribute to American policy analysis of problems relating to Germany, and promote interdisciplinary and comparative research on Germany.

Executive Director: Jackson Janes Research Director: Carl Lankowski Development Director: Laura Rheintgen Board of Trustees, Cochair: Steven Muller Board of Trustees, Cochair: Harry J. Gray

The views expressed in this publication are those of the author(s) alone. They do not necessarily reflect the views of the American Institute for Contemporary German Studies.

This AICGS Research Report is made possible through a generous grant from the German Program for Transatlantic Relations and the Fritz Thyssen Foundation. Additional copies are available at $5.00 each to cover postage and processing from the American Institute for Contemporary German Studies, Suite 420, 1400 16th Street, N.W., Washington, D.C. 20036-2217. Telephone 202/332-9312, Fax 202/265-9531, E-mail: [email protected], Web: http://www.aicgs.org

ii C O N T E N T S

FOREWORD...... v

ABOUT THE AUTHORS...... ix

THE POLITICS OF GLOBALIZATION IN GERMANY AND THE UNITED STATES U.S. IMMIGRATION POLICY Philip Martin and Susan Martin...... 1

IMMIGRATION POLICY IN INTEGRATED NATIONAL ECONOMIES Thomas Bauer and Klaus F. Zimmermann...... 15

GLOBALIZATION AND LABOR MARKETS: A VIEW FROM THE UNITED STATES John Schmitt...... 31

GLOBALIZATION AND LABOR MARKETS: A VIEW FROM GERMANY IN THE EUROPEAN UNION Reiner Hoffmann...... 47

HIGHER EDUCATION IN AN ERA OF GLOBALIZATION Daniel Fallon and Mitchell Ash...... 67

INNOVATION AND GLOBALIZATION: A U.S.-GERMAN COMPARISON David B. Audretsch and Maryann P. Feldman...... 79

GLOBAL CAPITALISM AND THE POLITICS OF SOCIAL POLICY REFORM IN GERMANY AND THE UNITED STATES Elmar Rieger...... 101

TAX POLICY IN A GLOBAL ECONOMY: ISSUES FACING EUROPE AND THE UNITED STATES Gary Hufbauer...... 121

CHALLENGES OF GLOBALIZATION FOR GERMAN TAX POLICY Ullrich Heilemann and Hans Dietrich von Loeffelholz...... 131

iii INFRASTRUCTURES FOR GLOBALIZATION: TRANSPORT, TELECOMMUNICATION AND ENERGY SUPPLY Rudolf Petersen...... 147

INFRASTRUCTURES FOR GLOBALIZATION Henry L. Michel...... 169

iv F O R E W O R D

This research report is the first of two that will issue from an eighteen- month project undertaken with the generous support of the Fritz Thyssen Foun- dation. The sequel, to be published later this year, is Governing Beyond the Nation-State: Global Public Policy, Regionalism or Going Local?, which, as the title implies, focuses specifically on governance issues. Though integral to the project funded by Thyssen, the five corresponding papers were presented as a group at a special workshop in March 1999 and for that reason is published separately. A condition and a set of challenges. Globalization was never restricted to the economic dimension. After all, for most of this century, a world political system existed prior to a world economy. In ways both subtle and direct, cultural influences conveyed through film and mass media are contributing to the creation of global consumer markets. The technology of mass international communication is facilitating the development of transnational societies. Temporary trans-border travel made possible by developments in transportation infrastructure is taken for granted by a growing number of individuals, either as business people, tourists, migrant workers, or family members. Indeed, the shape of tomorrow’s economy will be contingent upon developments in all of these dimensions and more. Yet, there is no point in denying the centrality of economic globalization to the whole process. Mobile capital is transforming the spatial configuration of the economy and the relationship between public and private sectors, and is compelling adaptation in all institutions. The Euro-Atlantic area, by which I mean primarily EU-Europe together with the United States and Canada, is a crucible and platform for these dynamic developments. All of the dimensions to which allusion has just been made are present in unparalleled density in this area. In that sense, this project can claim to generate insights with at least modest claim to generalizability within and even beyond the Euro-Atlantic world. Because of their economic size, international position and geographical location, Germany and the U.S. will play a central, if not necessarily a “leading” role in achieving fruitful adaptations of the institutional nexus most important for their welfare and democratic stability. Globalization has created a political challenge of the first magnitude and it is mainly for political reasons that national governments are called upon to act. Publics have come to hold politicians accountable for the performance of the economy as a surrogate for sustaining a way of life. But measured against the gains accruing to an increasingly broad middle class from ca 1950 to ca 1975, politicians are ever less able to capture and redistribute the fruits of economic

v development for their constituencies. Moreover, other aspects of globalization have raised questions about the shape and identity of the polity to be served. Consequently, systemic change is on the agenda, i.e., change in the aims, mo- dalities and interrelationships among key institutions. With these papers, we hope to contribute to providing a more accurate picture of the dimensions of globalization and the challenges it addresses in the first instance to Germany and the United States. We are also interested in their adaptive capacities as seen in the range of institutional responses to the condition of globalization. Part of this adaptive capacity consists in the ability of the political system to project and adopt credible reforms, wherever needed. And we are also interested in the role to be played by supra-national organizations and/or regimes in strategies of governance. Following our core interest in institutional adaptation, this report offers analyses of seven key sectors. A very brief signal pointing to the insights and/or recommendations to be found in the papers in this volume is given along with this list of the sectors selected for analysis:

Immigration. Philip Martin and Susan Martin demonstrate that national conceptions of immigration differ significantly, but in each case the rhetoric of debate requires moderation. Thomas Bauer and Klaus Zimmermann call for greater attention to high-skilled immigrants—among this group “virtual immigration” via telecommuting may come to play a much greater role as a substitute for moving, thus confounding conventional concerns.

Labor markets. So far, a coalition of political forces supporting further integration in world markets has eluded American politicians and one of the reasons may be that the gains from trade are actually smaller than conventional wisdom believes, argues John Schmitt. To Reiner Hoffmann a national solution to unemployment does not seem likely in Germany; the EU will play a decisive role, but reform should strive for re- rather than deregulation.

Education. Mitchell Ash and Daniel Fallon argue that, overall, the two countries face common problems and will share a similar future that nevertheless permits cultural differences. Germany is entering the era of mass higher education, a stage achieved in the United States in 1968. Germany’s challenge consists in differentiating both the structure and financing of its institutions of higher education. America’s lies in accepting some international standardization of credentials and curricula. Innovation. David Audretsch and Maryann Feldman point out that the

vi transatlantic economic debate mistakenly suggests a trade-off between jobs and welfare. There is a third option that combines German traditions of know-how and skills acquisition with American institutions facilitating commercialization of knowledge through entrepreneurship.

Welfare institutions. Because the trend toward increased international market integration is reversible, Elmar Rieger implies that social programs should be evaluated in terms of the support they generate for this process. Germany has done better here. But Germany and America remain divided on the ethos of labor markets as well as the scope of entitlements, factors that, when taken together, go a long way toward explaining the paralysis in discussions addressing needed social policy reform in Germany.

Taxation. There is disagreement over whether tax bases in all important revenue categories are becoming more mobile. Gary Hufbauer thinks they are and foresees that neither technical fixes nor international cooperation (even within the EU) will affect this trend. Tax systems will be redesigned to attract mobile firms that provide good jobs and financing public pension systems will become increasingly difficult. Ullrich Heilemann and Hans Dietrich von Loeffelholz see little change in Germany’s tax structure that is attributable to globalization, but agree with Hufbauer that provision of public goods must be factored in. They part company again in the high value they attach to such goods as skilled labor, local amenities and social peace.

Infrastructure. Rudolf Petersen’s paper is a critical assessment of the trend he identifies toward increasing globally oriented infrastructure. From the perspective of resource economics, policies that encourage it are misguided. He emphasizes pathological synergies between the components of infrastructure created by the advent of global information technology. Petersen welcomes the increased attention devoted to such resource issues in a global perspective by the new “Red/Green” German government. From an American perspective, Henry Michel approaches the same topic with an entirely different mood. He fully embraces the “globalization game” and identifies the infrastructure deficits that must be addressed in order to play that game well.

A joint and multidisciplinary team. The German and American participants in this project were trained in economics, political science, law, and engineering. Whatever their academic training, one characteristic of the group is the seasoning that comes from significant experience in policy settings. I meant to exploit this

vii resource and this mix of qualifications comprises an essential strength of the survey. Project participants were charged with producing interpretive essays that considered their subjects broadly. As a result, the reader will not find typically academic studies in this volume. Participants drew upon the insights of their disciplines, but often ventured further in making sense of globalization in their assigned sectors. No attempt was made to impose a single definition of globalization on the team. The approach was rather to encourage each author to tell us what globalization means as he or she worked through his/her sector. In addition to the Fritz Thyssen Foundation, Responses to Globalization in Germany and the United States also received support from the German Marshall Fund of the United States, Lufthansa Airlines, and the German Program for Transatlantic Relations. AICGS is grateful to each of them for their help in realizing this project.

Carl Lankowski November 1999 Research Director

viii A B O U T T H E A U T H O R S

Mitchell Ash is professor of Modern History at the University of Vienna, Austria. He is the editor of German Universities Past and Future: Crisis or Renewal? (Berghahn Books, 1997), the first volume in the AICGS series, “Policies and Institutions: Germany, Europe and Transatlantic Relations.”

David B. Audretsch is the Ameritech Chair of Economic Development and director of the Institute for Development Strategies at Indiana University. Before coming to Indiana University, he was research professor at the Science Center for Social Research, Berlin. He is founder and editor of Small Business Economics: An International Journal.

Thomas Bauer studied economics at the University of Munich and received his doctorate in 1997. From 1997-1998 he visited Rutgers University under the auspices of a Feodor Lynen Fellowship of the Alexander von Humboldt Foundation. In September 1998 he joined the Institute for the Study of Labor (IZA) in Bonn as senior research associate.

Daniel Fallon is professor of Public Affairs and professor of Psychology at the University of Maryland, College Park. He is the author of numerous articles on higher education and comparative higher education, including The German University: A Heroic Ideal in Conflict with the Modern World (Colorado Associated Universities Press, 1980).

Maryann P. Feldman is a research scientist at the Institute for Policy Studies at the Johns Hopkins University, where her primary focus is technological change and economic development. She has served as a consultant to local, state and federal government as well as private industry.

Ullrich Heilemann is the vice-president of the Rhenish-Westphalian Institute for Economic Research (RWI) in Essen, Germany. He is also professor of Economics at the University of Duisburg.

Reiner Hoffmann is the director of the European Trade Union Institute, the research division of the European Trade Union Confederation, Brussels. Before coming to ETUI, Mr. Hoffmann worked for the Economic and Social Committee (ECOSOC) of the European Community.

ix Gary Hufbauer resumed his position as Reginald Jones Senior Fellow at the Institute for International Economics in September 1998, a position he held between 1992 and 1997. From June 1997 until September 1998, he was the Maurice R. Greenberg Chair and Director of Studies at the Council on Foreign Relations in New York. Before joining the Institute for International Economics, he was the Marcus Wallenberg Professor of International Financial Diplomacy at Georgetown University.

Philip Martin is professor of Agricultural and Resource Economics at the University of California-Davis and chair of the University of California’s Comparative Immigration and Integration Program. He also co-chairs Migration Dialogue, a not-for-profit organization dedicated to providing timely and nonpartisan migration analysis.

Susan Martin is director of the Institute for the Study of International Migration at Georgetown University. She served as executive director of the U.S. Commission on Immigration Reform and director of Policy Research and Programs at the Refugee Policy Group. She has taught at Brandeis University and the University of Pennsylvania.

Henry Michel, a retired engineer, is chairman emeritus of Parsons Brinckerhoff, Inc. He was recently honored with one of engineering’s most distinguished commendations, Honorary Membership in the American Society of Civil Engineers. Michel is also a senior lecturer at the Massachusetts Institute of Technology and an industry professor at New York Polytechnic University.

Rudolf Petersen heads the Transportation Division at the Wuppertal Institute for Climate, Environment and Energy. Dr. Petersen has participated in studies on the environmental aspects of passenger and freight transportation and the reduction of urban air pollution. He is also a lecturer on the environmental effects of combustion engines at the University of Essen.

Elmar Rieger is presently working as a research professor at the Center for Social Policy at the University of Bremen. Prior to this appointment, Dr. Rieger was John F. Kennedy Fellow at Harvard University. His main areas of interest are comparative and historical welfare state research, European integration and agriculture. He recently finished an evaluation of the proposals of the European Commission for reforming the Common Agricultural Policy.

x John Schmitt is a labor economist at the Economic Policy Institute, Washington. Dr. Schmitt has written extensively on inequality, unemployment and the minimum wage and is a co-author of The State of Working America 1998-99 (Cornell University Press, 1998).

Hans Dietrich von Loeffelholz is head of the Public Economics Division of the Rhenish-Westphalian Institute for Economic Research (RWI) in Essen, Germany. He is also visiting professor at the Ohio Wesleyan University (OWU), Delaware, Ohio, and adjunct professor of public economics at the Universities of Bochum and Dortmund.

Klaus Zimmermann is the newly appointed director of the German Institute for Economic Research (DIW) in Berlin. He also serves as director of the Institute for the Study of Labor (IZA) in Bonn and as co-director of the Labor Economics Program of the Center for Economic Policy Research (CEPR) in London and is a professor of Economics at the University of Bonn.

xi xii THE POLITICS OF GLOBALIZATION IN GERMANY AND THE UNITED STATES: U.S. IMMIGRATION POLICY Philip Martin and Susan Martin

INTRODUCTION

Immigration policies are the mix of international, national and local rules and programs that aim to facilitate the admission and integration of some foreigners and prevent the entry and stay of others. This paper examines U.S. policies on legal immigration, refugees and asylum seekers, and unauthorized migration to highlight similarities and differences in the migration challenge facing the industrial democracies. There is dissatisfaction with immigration and integration policies in both Germany and the U.S. Immigration and integration issues were second only to unemployment among the domestic issues debated in the 1998 German elections, and immigration and integration issues have been contentious in states such as California, which approved Propositions 187 (illegal immigration) in 1994 and 227 (bilingual education) in 1998. About 7.3 million foreigners lived in Germany in 1998, making foreigners about 9 percent of the German population. By comparison, the U.S. had about 27 million or 10 percent foreign-born residents. If current trends continue, the foreign/foreign-born share of residents is expected to rise in both Germany and the U.S. in the 21st century, to 17 percent in Germany and 15 percent in the U.S. by 2030. On a normal day, some 70,000 foreigners arrive in the United States. Most are welcomed at airports and borders: over 60,000 are nonimmigrants who come to the U.S. as tourists, business visitors, students, and foreign workers. Another 2,500 arrivals are immigrants and refugees, persons that the U.S. has invited to join American society as permanent residents. Finally, there are about 5,000 unauthorized aliens. About 4,000 are apprehended every day, most along the U.S.-Mexican border just after entry, but at least 1,000 elude detection at the border, or slip from legal to unlawful status after legal entry, as when a tourist goes to work. The United States is a nation of immigrants. Under the motto “e pluribus unum,” from many one, U.S. presidents frequently remind Americans that they share a common experience: they or their forebears left another country to begin anew in the U.S. Immigration permits immigrants to better themselves and strengthens the U.S., which is why the U.S. Commission on Immigration Reform spoke for most Americans when it asserted in 1997 that “a properly

1 Responses to Globalization in Germany and the United States: Seven Sectors Compared regulated system of legal immigration is in the national interest of the United States.” Despite the generally rosy view of America as a land of immigrants, the arrival each day of the equivalent of a small city has become a contentious policy reflecting basic ambivalence about current immigration. Often forgetting how contentious immigration was when their ancestors arrived in the U.S., Americans fear that the country has lost its absorptive capacity. Immigration often becomes an issue in which the loudest voices sometimes come from the extremes of “no immigrants” and “no borders.” For example, the Federation for American Immigration Reform (FAIR) calls for a five-year stop to “mass immigration” so that, during the pause, recent arrivals and Americans would have time to adjust to each other. At the other extreme, the Wall Street Journal advocates a five-word constitutional amendment: “there shall be open borders.” The editorials of the leading U.S. business paper advocate high levels of immigration chiefly for economic reasons, while ethnic and religious organizations advocate more immigration for other reasons. There are middle-of-the-road remedies for immigration problems. We argue that a better understanding of the facts promotes fine-tuning rather than radical changes in immigration policy. Toward that aim, this paper first sets out the global contexts in which decisions on U.S. immigration policy are taken, and it then outlines specific issues to be considered in six principal areas: legal immigration, including permanent and temporary admissions; refugee and asylum policy; unauthorized migration; integration of immigration; the federal immigration system; and relations with source countries of immigration.

GLOBAL CONTEXTS

Three global trends have particular importance for decision-making on immigration matters: growing economic integration and globalization; changing geo-political interests in the post-Cold War era; and increasing transnationalism as migrants are able to live effectively in two or more countries at the same time. Economic trends influence both legal and illegal migration patterns. For example, growth in multinational corporations puts pressure on governments to facilitate the inter-country movements of personnel. At the same time, and in a much more disturbing trend, alien smuggling has emerged as a multinational corporate activity that reaps an estimated gain of $5-7 billion per year. Such regional and international trade regimes as NAFTA and the General Agreement on Trade and Services (GATS) also affect migration trends, permitting freer movement of persons providing international services from signatory countries.

2 Philip Martin and Susan Martin

Further, the development of new technologies facilitate both virtual and actual migration of people, ideas and work and, at least in the information technology field, creates a seemingly insatiable demand for infusion of foreign professionals with state-of-the-art skills. The post-Cold War era also presents new opportunities as well as new challenges for migration regimes, particularly regarding refugee movements. While many refugee situations have been resolved as Cold War inspired conflicts came to an end, thereby permitting large-scale repatriation, rabid nationalism and government collapse continue to cause massive flight. At the same time, the principles of asylum and non-refoulement (non-return to places of persecution) appear to be under growing attack in Europe and North America. The third trend affecting migration policies is transnationalism. Partly because of the technological revolution discussed above, migrants can far more easily today live in two societies at the same time, maintaining contacts with their home communities very inexpensively. Perhaps the most visible aspect of transnationalism is the growing acceptance of dual nationality. Money flow between immigrants and those who remain at home is another important aspect. Remittances often exceed any other form of trade, investment or foreign aid available to the source countries of migrants. Given these significant economic, social and foreign policy trends, the U.S. and other nations face new challenges and must begin to think more creatively about their migration policies. In the following sections, we set out the major U.S. policy issues in need of such attention.

PERMANENT IMMIGRATION

The United States admits about 900,000 legal immigrants each year, up from about 600,000 per year in the 1980s (not counting those legalized under the 1986 amnesty), 450,000 per year in the 1970s, and 330,000 per year in the 1960s. As immigration was increasing, the major countries of origin changed, from Europe to Latin America and Asia. Immigrants are persons who are entitled to live and work permanently in the U.S. and, after five years, to become naturalized U.S. citizens. The four principal bases or doors for admission are family reunification, skills, diversity, and humanitarian interests. By far the largest admissions door is for relatives of U.S. residents; in 1996, two-thirds of the 916,000 immigrants were granted entry because family members already resident in the U.S. formally petitioned the U.S. government to admit them. The second-largest category of immigrants in 1996 was humanitarian: 14 percent of the immigrants were refugees and

3 Responses to Globalization in Germany and the United States: Seven Sectors Compared asylees (see below for further discussion). The third group, about 13 percent, were immigrants and their family members admitted for economic or employment reasons; the U.S. in 1990 raised the annual quota on immigrants admitted for economic reasons. Finally, the fourth door admitted diversity immigrants; 6 percent of the flow were foreigners from countries that have not recently sent large numbers of immigrants to the U.S. America continues to celebrate its immigrant heritage, with mass naturalization ceremonies on July 4, the annual celebration of U.S. independence, associating immigration with the founding of the United States. More practical benefits of immigration are argued as well:

• Immigrants contribute to the economic well-being of the U.S. through their skills, hard work, entrepreneurial instincts, social security tax payments, and/or willingness to take jobs unwanted by Americans.

• Immigrants invigorate the social and cultural life of the country, as witnessed by the diverse cuisine, literature, music, dance, and other art forms brought by newcomers.

• Immigrants are a constant reminder to natives of what is special about the U.S. as a country that attracts so many foreigners.

• Immigrants renew city neighborhoods that have often fallen upon bad times, creating new businesses, buying homes, and promoting community cooperation.

• Immigration strengthens U.S. economic and political ties with other nations and our ability to compete in a global economy and provide international leadership.

Of course, immigration is not without its detractors, who make one or more of the following arguments:

• Immigration adds to U.S. population growth and, therefore, to environmental and related problems.

• Immigrants depress wages and working conditions, especially hurting unskilled U.S. workers, including previously arrived immigrants who can easily be displaced by new immigrants willing to work at lower wages.

4 Philip Martin and Susan Martin

• Immigrant workers willing to work at low wages can slow the modernization and globalization of the U.S. economy.

• Some immigrants want public support to retain their language and culture, provoking concerns that programs—such as bilingual schooling and preferences for minorities—contribute to the “dis-uniting” of America.

While the debate about overall admissions is often framed in pro- and anti- immigration terms, the reality is different. Immigration can be more effectively seen as a series of trade-offs between competing goods. For example, it is often argued that large-scale immigration is necessary to “save” social security systems in the industrial countries. Immigration can play a role in increasing social security revenues by adding more taxpayers than beneficiaries, but much higher levels of immigration would be needed to make a difference in the demography of the country. Yet, if the composition of the immigrant flow remains unchanged, and many more unskilled immigrants enter, immigration may make it harder for some disadvantaged U.S. workers, including the immigrants already in the U.S., to climb the job ladder. In this case, the competing goods are high levels of benefits for retired persons who are living longer, versus the competing good of restricting immigration to protect especially low wage workers. Deciding how to weigh the competing goods of benefits for retirees and protecting U.S. workers can be a contentious issue. Many of those concerned about immigration are more concerned about the composition of the flow than the number of immigrants. During the past twenty years, there have been persistent calls for a shifting of admission numbers from family categories, under which many immigrants with less than a high school education enter, to skills-based ones that attract more highly educated immigrants. In particular, reformists propose limiting immigration to nuclear family only.1 Proponents of extended family migration counter that admission of extended family serves not only humanitarian purposes but economic ones as well. Extended families often work or live together, strengthening the household economy of members who would otherwise live in poverty. In the U.S., most of the immigrants admitted for economic reasons are chosen by U.S. employers. There are some clear advantages to such a system. Not surprisingly, rates of employment among these immigrants are very high since they already have jobs and, generally, a supportive employer. It is also argued that employers are the best judge of the economic contributions an individual can make. A checklist, as used in a point system, may identify would-be migrants with academic skills, but these individuals may not have the

5 Responses to Globalization in Germany and the United States: Seven Sectors Compared more difficult to measure capabilities, such as an ability to work in teams, that employers find valuable. To hire a foreign worker as a permanent resident, the employer must undertake a recruitment process that meets Department of Labor (DOL) guidelines and demonstrate that no minimally qualified U.S. worker is available. The process normally requires an attorney’s help, and the wait for approval can be several years, first at DOL and then at the Immigration and Naturalization Service (INS). Employers and immigrants are frustrated by the delays, and tend to use temporary visa categories to bridge the gap between the decision to hire the worker and the government’s grant of permanent resident status. As a result, the recruitment process is often a farce, the employer having already hired the foreign worker. Hence, the current system serves the needs of neither employer nor the domestic U.S. work force. A federal Commission on Immigration Reform (CIR) proposed a trade-off: employers could more quickly and easily hire the immigrants they wanted if they paid a substantial ($10,000) fee to a fund that would provide scholarships for U.S. workers willing to be trained to fill the jobs going to foreigners. CIR argued that market forces would be a better determinant than the unwieldy bureaucratic process of a business’ need for the foreign worker.

TEMPORARY WORKERS

Temporary work categories are increasingly important as the vehicle for admission of foreign workers, particularly professionals, executives and managers. Each year, almost 300,000 visas are issued to temporary workers and their family members. In addition, an unknown number of foreign students are employed either in addition to their studies or immediately thereafter in practical training. The growth in the number of foreign professionals admitted for temporary stays reflects some of the global economic trends discussed above. In fast changing industries, such as information technology, having access to a global labor market of skilled professionals is highly attractive. Also, as companies contract out work, or hire contingent labor to work on specific projects, the appeal of temporary visas rather than permanent admissions is clear. Some foreign firms, understanding that it may not be possible to undertake an entire project off-shore, obtain temporary work visas to the U.S. so their employees can complete the job at the U.S. client’s facilities. The temporary programs also give employers and employees a chance to test each other before committing to permanent employment. Multinational corporations find the temporary

6 Philip Martin and Susan Martin categories useful in bringing their own foreign personnel to work or receive training in the U.S. As with other immigration matters, there are trade-offs in using temporary admission categories. While they may help increase business productivity and even generate job growth, they also render the foreign workers more vulnerable to exploitation and may, thereby, depress wages and undermine working conditions for U.S. workers. Generally, the foreign worker is tied to a specific employer who has requested the visa. Loss of employment may also mean the threat of deportation. Moreover, because the temporary visa is so often a testing period, the foreign professional may put up with any conditions imposed by the employer, fearing loss otherwise of the chance at permanent resident status. The trade-offs are even more apparent with regard to admission of unskilled workers. There have been persistent calls for a large-scale guest-worker program to meet the seasonal needs of U.S. perishable crop agriculture, which is now heavily reliant on unauthorized workers. Consumers want to pay low prices for fruits and vegetables, and they also want farm workers to have decent wages and working conditions. Are the savings on fresh produce due to immigration worthwhile? Immigrant farm workers earning low wages by U.S. standards are nonetheless better off in the U.S. than at home. Over time, though, their point of comparison is the U.S. standard of living, not what they left in their home country. U.S. farmers are also better off now, enjoying higher profits and therefore higher land prices. But, with ready availability of cheap labor, farmers may be refraining from investing in technology that might reduce still further the costs of produce. The critical issues are which of the two goods is more valuable— cheaper food or higher farm wages—and what time frame should be used in assessing impacts—today or some time in the future. The way these questions are answered is a major determinant of U.S. immigration policy, especially with respect to Mexico.

REFUGEES AND ASYLESS

The United States remains one of the major countries offering permanent resettlement to refugees in third countries as well as asylum to those arriving directly. The number of refugees resettled in the U.S. varies each year, determined annually by the president in consultation with Congress. For FY99, for example, the president has authorized admission of up to 78,000 refugees: 48,000 from Europe, divided almost evenly between nationals of the former Yugoslavia and the former Soviet Union; 12,000 from Africa; 9,000 from east Asia; 4,000 from the near east/south Asia; 3,000 from Latin America/

7 Responses to Globalization in Germany and the United States: Seven Sectors Compared

Caribbean; and 2,000 geographically unallocated. Actual admissions in FY98 numbered 76,786, with ex-Yugoslavs and ex-Soviets representing about 70 percent of entries. In the U.S., asylum applicants may apply directly to the INS (called affirmative applications) or during a removal hearing in immigration court when apprehended at a port of entry or in the interior of the U.S. (called defensive applications). In the case of affirmative cases, INS may grant asylum or refer the case to an immigration judge for further adjudication. Although there are no limits on the number of persons who can obtain asylum (with the exception of those applying under a special program for Chinese protesting China’s coercive population control policies), the U.S. permits a maximum of 10,000 asylees to adjust to permanent residents each year. In FY97, the latest year for which complete statistics are available, about 50,000 asylum cases were filed with INS as affirmative cases. These new cases came on top of a pending caseload of more than 450,000 cases. About 20 percent of the cases that reached final decisions in FY97 were approved by INS. In total, INS granted asylum in slightly more than 10,000 cases, representing almost 16,000 individuals. During the same period, the immigration court received almost 84,000 cases. The majority (75,000) were referred by the INS asylum office, with a much smaller number applying as a result of apprehension. The immigration court approved about 30 percent of all of the cases in which it made a final determination on the merits. Admission of refugees and asylees is governed by the Refugee Act of 1980, as amended. The Refugee Act had three principal aims: 1) to place U.S. policy more firmly in compliance with international standards for protecting refugees, in part by dropping the Cold War-driven definition of a refugee as someone fleeing a communist state; 2) to institute permanent mechanisms for making resettlement and asylum decision, rather than maintain reliance on ad hoc statutory and discretionary processes; and 3) to establish rules regarding the eligibility of refugees for assistance and the reimbursement to be afforded states and private agencies for services provided to refugees. Despite the statutory changes to de-link refugee decisions from ideology, even after the fall of the Soviet Union and the collapse of communism in most parts of the world, U.S. refugee admissions continued to reflect Cold War priorities. Until very recently, more than 80 percent of refugees admitted to the U.S. came via orderly departure programs directly from Indochina or the former Soviet Union. Only a very few slots were available for refugees referred for resettlement by the United Nations High Commissioner for Refugees (UNHCR).

8 Philip Martin and Susan Martin

The asylum system, in particular, came under increasing criticism for the seeming ideological basis for decisions to grant asylum, with the U.S. government appearing to grant refugee status readily to Nicaraguan asylum seekers and denying refugee status to El Salvadorans and Guatemalans.2 The migration of many Central Americans to the U.S. in the late 1980s produced an asylum crisis, which was eventually “resolved” by having the U.S. government agree to re-examine rejected asylum applications filed by Salvadorans and Guatemalans, and to permit those who did not file because of the low approval rates to apply for the first time. In addition, an Asylum Officer Corps was established in April 1991, so that independent trained adjudicators within INS would hear asylum claims. Mounting backlogs of cases and concerns about fraudulent applications led to further reform in 1995, particularly a streamlining of processing to permit new cases to be heard within six months. The reforms were implemented on a “last-in, first-out” basis in order to send a clear message that strong cases would be quickly approved but abusive ones would be as quickly rejected. As a result, the cases in the backlog remained without adjudication. Most of the 400,000 Central Americans caught in the U.S. asylum system— neither accepted nor rejected—had by then been in the U.S. for a decade or more. Many had been granted various statuses that permitted them to remain in the U.S. during the conflicts in their countries. These temporary, ad hoc statuses were extended after peace came to their countries, largely because their remittances were so important to the economic recovery of their homelands. For many years, however, no steps were taken to regularize their status in the U.S. despite a clear unwillingness to remove them. Experience shows that, in the U.S. case, failure to make hard decisions at one point in time simply requires even harder decisions later. By the time the U.S. decided to end temporary protection for Central Americans, many had been in the U.S. for more than a decade and had U.S.-born citizen children, U.S. employers, and other ties to the U.S. that made it difficult to promote repatriation. It was not until 1998 that the Nicaraguan Adjustment and Central American Relief Act (NACARA) was enacted to give many of the Central Americans the opportunity to become permanent residents. NACARA, originally introduced as the Victims of Communism Act, reflected the long-standing ideological strains of U.S. policy. Under NACARA, about 150,000 Nicaraguans and 5,000 Cubans who arrived in the United States by December 1, 1995 were granted full amnesty. By contrast, the estimated 200,000 Salvadorans and 50,000 Guatemalans covered by NACARA had to demonstrate that it would be an extreme hardship if they were forced to return home.

9 Responses to Globalization in Germany and the United States: Seven Sectors Compared

UNAUTHORIZED MIGRATION

In October 1996, there were an estimated five million illegal aliens who had established long-term residence in the United States, and their number was growing by 275,000 a year. About 60 percent of the unauthorized migrants in the U.S. were believed to have slipped across the Mexico-U.S. border, entering the United States without inspection. The other 40 percent entered the United States legally, often as tourists, and then violated the terms of their entry by staying too long or working in the United States. In addition, about one to two million migrants enter and often work illegally during the course of any year, but do not establish long-term residence. These data suggest that over 2 percent of U.S. residents are unauthorized migrants, but they are concentrated in a few states. Some two million of the unauthorized foreigners in 1996 were in California (40 percent, making 6 percent of California residents unauthorized), followed by 700,000 in Texas (14 percent), 540,000 in New York (11 percent), 350,000 in Florida (7 percent), 290,000 in Illinois (6 percent), and 135,000 in New Jersey (3 percent). The INS estimated that there were about 2.7 million unauthorized Mexicans in the U.S., followed by 335,000 El Salvadorans, 165,000 Guatemalans, and 120,000 Canadians; there were an estimated 70,000 illegal Poles. The U.S. has tried a number of measures to reduce illegal immigration, but has not yet found an effective formula for reducing unauthorized entry and employment. Two extremes mark the ends of the control spectrum. At the one end are so-called island strategies, in which control efforts are focused on borders and ports of entry, and there is little enforcement inside the country. At the other extreme are the continental strategies that evolved in Western Europe, in which border controls are buttressed by internal residence and work permit systems. The U.S. abandoned the pure island model in 1986, when the Immigration Reform and Control Act for the first time made it unlawful for U.S. employers to knowingly hire illegal foreign workers. Employer sanctions did not deter illegal entries and employment, primarily because the INS was slow to establish effective strategies and assign inspectors to enforce them, and because unauthorized workers found it easy to purchase false documents to present to employers and thus satisfy the letter of the law. External controls still dominate. The INS has a budget of $3.8 billion for FY99, which supports 29,000 employees, of whom two-thirds work in enforcement, including almost 9,000 as Border Patrol agents. Most INS enforcement efforts are aimed at deterring illegal entries along the Mexico-U.S. border. Beginning with Operation Hold the Line in El Paso in 1993, the INS has

10 Philip Martin and Susan Martin moved agents to the border, and used their presence, plus lights and fences, to deter illegal entries, rather than to apprehend those who enter the U.S. It is very hard to evaluate the effectiveness of the four INS intensive border control operations—Gatekeeper in California, Safeguard in Arizona, Hold the Line in west Texas, and Rio Grande in east Texas. Early evaluations in El Paso concluded that the unauthorized entrants most likely to cause local problems were deterred, including street merchants, teens and car thieves, but that migrants headed toward the interior of the U.S. simply went around the places with intensive controls. It is clear that the cost of entering the U.S. illegally has increased; smugglers fees have risen from $300 to $500 to $600 to over $1,000, but it is not clear that migrants intent on illegal entry have been deterred. However, in a particularly unfortunately consequence of the new strategy, more migrants attempting entry are dying after being abandoned by smugglers in the desert. The U.S. and Mexico have greatly increased their cooperation to reduce crime in border areas, to discourage the transit through Mexico of non- Mexicans attempting to illegally enter the U.S., and to better understand the dynamics and characteristics of Mexicans in the U.S. Mexico has specialized police forces, including Grupo Alpha and Beta, that aim to reduce crime against migrants waiting to illegally enter the U.S., but they also can detect and report on third country nationals attempting entry into the U.S. In Summer 1998, the U.S. and Mexico cooperated on a public affairs campaign that warned of the dangers of attempting illegal entry through the desert.

CONCLUSION

As this review has shown, making durable immigration policies is difficult because immigration involves trade-offs between competing rights or goods, but immigration debates are often conducted in starkly absolute terms. Positions are characterized as pro-immigration or anti-immigration with little consideration to nuance. Moreover, the debate is marked too often by exaggerated claims that make it hard to win broad public support for any sensible immigration policies. There are clear similarities and differences between the U.S. and Germany in how each country assesses the trade-offs. Clearly, national conceptions of immigration differ significantly. Immigration is an integral part of U.S. history and culture. Even with concerns about today’s immigrants, most Americans would agree that immigration overall has been in the national interest of the United States. The U.S. debate tends to be about how many and which immigrants, not whether to have immigration. By contrast, and despite similar

11 Responses to Globalization in Germany and the United States: Seven Sectors Compared proportions of foreign born populations, Germany does not see itself as a country of immigration and still debates whether to admit immigrants. These differences are clear in the statements of national leaders:

• SPD Interior Minster Otto Schily, in December 1998: Germany has “reached the limits, the point where we have to say we cannot bear any more. The majority of Germans agree with me: Zero immigration for now. The burden has become too great. I would not even dare publish the costs that stem from immigration. The Greens say we should take 200,000 more immigrants a year. But I say to them, show me the village, the town, the region that would take them. There are no such places.”

• President Clinton in June 1998: “I believe new immigrants are good for America. They are revitalizing our cities. They are building our new economy. They are strengthening our ties to the global economy, just as earlier waves of immigrants settled the new frontier and powered the Industrial Revolution. They are energizing our culture and broadening our vision of the world. They are renewing our most basic values and reminding us all of what it truly means to be an American. [Americans] share a responsibility to welcome new immigrants, to ensure that they strengthen our nation, to give them their chance at the brass ring.”

Despite these differences in approach, both countries find themselves dealing with global trends that have brought large-scale migration to their shores. Both countries are also constrained by their democratic systems and constitutional principles in the choice of ways to regulate and control this migration. Hence, even with their different conceptions about immigration, they have much to share in terms of specific policies, practices and administrative structures. Even more, both countries would benefit from a more nuanced policy debate that permits full discussion of the trade-offs inherent in immigration as well as the global contexts in which 21st century immigration policies will be made.

BIBLIOGRAPHY

Castles, Stephen and Mark Miller. 1998. The Age of Migration. New York: Guilford Press. Cornelius, Wayne A., Philip L. Martin and James F. Hollifield. Eds. 1994. Controlling Immigration: A Global Perspective. Stanford, CA: Stanford University Press.

12 Philip Martin and Susan Martin

Fuchs, Lawrence H. 1990. The American Kaleidoscope: Race, Ethnicity and the Civic Culture. Hanover, NH: Wesleyan University Press of New England. Isbister, John. 1996. The Immigration Debate: Remaking America. West Hartford, CT: Kumarian Press. Migration News. Monthly since 1994. Summary of the most important world wide immigration and integration developments of the preceding month: [email protected] or http://migration.ucdavis.edu. Portes, Alejandro and Ruben G. Rumbaut. 1996. Immigrant America: A Portrait. Berkeley: University of California Press. Smith, James and Barry Edmonston. Eds. 1997. The New Americans: Economic, Demographic, and Fiscal Effects of Immigration. Washington: National Research Council. U.S. Commission on Immigration Reform. 1997. Becoming an American: Immigration and Immigrant Policy. Washington: U.S. Commission on Immigration Reform.

ENDNOTES

1 Others agree that the extended family categories should be curtailed but they argue for their transfer to nuclear family categories that are heavily backlogged. Currently, spouses and minor children of legal immigrants must wait at least forty-two years for admission as permanent residents. 2 In actuality, most Nicaraguans were also denied asylum, but the INS often did not record the denials in order to postpone making a decision on removal.

13 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared

14 Thomas Bauer and Klaus F. Zimmermann

IMMIGRATION POLICY IN INTEGRATED NATIONAL ECONOMIES Thomas Bauer and Klaus F. Zimmermann1

INTRODUCTION

The current debate on the growth of the global economy has mainly dealt with the increased trade flows in the 1980s and 1990s induced by global reductions of trade barriers, the rapid transmission of technology across countries and highly mobile capital. A growing literature analyzes various aspects of the effects of integrated economies, i.e., the effects of globalization on welfare, the labor market and inequality. (See for example the 1995 symposium on “Income Inequality and Trade” and the 1998 symposium on “Globalization in Perspective” in the Journal of Economic Perspectives.) However, the question of increased mobility of labor has been widely neglected in the debate on integration in the world economies. Migration is an essential part of globalization. Comparable to increased world trade flows, OECD countries experienced rising immigration flows in the 1980s and the beginning of the 1990s. However, since then the immigration numbers have been decreasing. Figure 1 indicates this development for selected OECD countries. In all countries immigration increased strongly in the late 1980s up to about 1993. Then the growth in immigration stopped and almost all countries exhibit a negative trend in immigration flows. Given these numbers and the growing discussion about the economic effects of globalization, several questions arise. Is there a link between the increased international mobility of goods, technology, and capital, and the development in international migration? Are there similarities in the economic effects of globalization and labor migration? Can we trace recent changes in immigration policy to the economic effects of globalization? In the following section we discuss theoretical and empirical investigations of the link between the growth of the global economy and the mobility of labor, and provide an account of the labor market effects of globalization and the immigration of labor. In the third section we analyze German immigration policy in the last decade with a special reference to the concerns of the most important German political parties. In the final section we discuss an immigration policy that seems necessary to deal with the economic effects of a globalized economy.

15 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared

GLOBALIZATION AND THE MIGRATION OF LABOR

The Effects of Integration on Labor Migration The development of increasingly integrated economies is largely characterized by the reduction of global trade barriers resulting in increased trade of commodities, high capital mobility, the transmission of technology across countries, and the development of multinational firms which can produce and hire labor almost all over the world. In the following, we discuss the theoretical links between these developments and labor migration and survey the existing empirical evidence on the relationship between trade and migration. According to the standard trade model, trade is a substitute for international migration. According to the Heckscher-Ohlin model of factor price equalization, the removal of trade barriers leads to country specialization in producing the goods for which countries have a relatively abundant supply of input factors and thus have a comparative cost advantage. Assume two countries, a developed country with relatively many skilled workers, and a developing country with relatively many unskilled workers. Assume further that there are two goods, one that is produced by skilled workers and one that is produced by unskilled workers. Producers in both countries have the same technology. In this setting trade is determined by the factor endowments of the two countries: the developed (developing) country will import the good that is produced by unskilled (skilled) workers and specialize in the production of the good produced by skilled (unskilled) workers. Trade between these two countries will reduce the wages of unskilled workers in the developed country and increase the wages of skilled workers, and vice versa for the developing country. In the long run and under specific assumptions (see Bhagwati and Dehejia (1994) and Martin and Taylor (1996) for a discussion of these assumptions) factor prices for skilled and unskilled workers across the two countries are equalized. In general, the basic trade model states that trade or the mobility of production factors between countries will result in equalized factor prices. However, if factor prices are equalized, the incentive to migrate disappears and trade can be seen as a substitute for international migration. The empirical evidence regarding factor price equalization and the substitutional relationship between labor migration and trade is not as clear as it appears in the theoretical model. (See Schiff (1996) for a discussion of the standard trade model and the question whether there is a substitutional or complementary relationship between trade and migration.) Several empirical studies have found that trade and migration are complements instead of substitutes, at least in the short and medium run. (Rotte and Vogler (1998)

16 Thomas Bauer and Klaus F. Zimmermann provide a recent review). Two lines of argumentation have been brought forward to explain these empirical results. First, our understanding of the determinants of international migration is far from being complete. (See Bauer and Zimmermann (1998) for a recent survey of theoretical and empirical analyses of migration.) The existing empirical evidence shows that expected wage differentials have a significant effect whenever we observe large migration flows between two countries. However, the reverse conclusion is not obvious, since we cannot observe large migration flows whenever huge wage differentials are present. Furthermore, theoretical models of migration decisions suggest that the desire to overcome capital constraints and income risks in less developed countries could lead to international migration flows even in the absence of expected wage differentials (Stark, 1991). Second, the assumptions underlying the factor price equalization theorem are questioned frequently and empirical studies on the effect of increased trade on factor prices provide no clear picture of the relationship between increasing trade and equalization of factor prices. (See Freeman (1995) for a recent survey.) One of the most restrictive assumptions is that developed and less developed countries have access to the same production technology. Political stability, the infrastructure, technological advantages, or scale economies can offset the comparative advantage of developing countries in the production of labor-intensive commodities. On the other hand, political instability and market imperfections in developing countries can hinder factor price equalization and provide additional migration incentives. Finally, as predicted by the basic model, trade liberalization creates new employment and higher earnings in the developing countries, giving individuals and families the means to finance migration that they could not afford in the past. Furthermore, there is increasing evidence that, once individuals have migrated from a particular sending to a particular receiving country, migration becomes a self-perpetuating process, because the costs and risks of migration are lowered by social and informational networks (Bauer and Zimmermann, 1998; Massey, 1990). Finally, there are forces in the globalization process that could diminish the substitutional relationship between trade and migration. New informational technologies and trade itself provides potential migrants with more and better information concerning the cost and potential benefits of migration. The availability of better information reduces the risks and costs of migration and therefore fosters migration.

Comparing the Economic Effects of Globalization and Labor Migration In the last two decades the development of labor markets in advanced countries was marked by a declining demand for low-skilled workers. In the

17 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared

United States this development manifested itself in falling real wages of low- skilled workers and increased income inequality. Due to relatively inflexible labor markets, this development resulted in increased unemployment of low- skilled workers in Europe. Public debate on both sides of the Atlantic identifies globalization of the world economy and immigration pressure as two of the main sources of this development. With respect to the globalization debate, the Heckscher-Ohlin model has been used to explain the unfavorable development of the unskilled labor market. If developed countries import commodities from developing countries produced by unskilled labor and export commodities produced by skilled labor to these countries, the factor price equalization theorem predicts decreasing wages of unskilled and rising wages of skilled workers in the developed countries. In the case of downward rigid wages, as in the European context, trade will lead to rising unemployment of unskilled workers and a shortage of skilled workers. However, both explanations of the reduced demand for unskilled labor relative to skilled labor are qualitatively similar to the effects of a skill-biased technological change, and, as we will see below, to the effects of the immigration of unskilled labor. Empirical analyses of the effects of trade on the labor market essentially follow two different approaches. (See Freeman (1995) for a detailed description of these approaches and a discussion of their advantages and problems.) One approach is to use data on the factor content of import and export industries to estimate the change in factor endowments which is due to trade. The empirical evidence of these kind of studies is mixed (see Borjas, Freeman and Katz, 1992; Sachs and Shatz, 1992; and Wood, 1994, 1995). The second approach is to use price data to explore whether increased imports from less-developed countries reduce the price of goods produced by low-skilled workers in the developed countries. If this is the case, the demand for unskilled labor in the developed countries will fall and decrease their wages or increase their unemployment. The empirical results using this approach (see Freemann (1995) for a survey) suggest that trade has only a minor impact on the wages and employment of unskilled workers. The effect of trade on the German labor market has been investigated by Lücke (1996), Haisken-DeNew and Zimmermann (1997) and Winter-Ebmer and Zimmermann (1998). Lücke (1996) cannot identify relevant effects of the relative price of unskilled-labor intensive goods on wages. Haisken-DeNew and Zimmermann (1997) study wage and mobility effects of trade and migration. They find that wages are negatively affected by a relative increase in imports (relative to exports). Winter-Ebmer and Zimmermann (1998) find that trade does not affect wages at all, and hardly affects employment.

18 Thomas Bauer and Klaus F. Zimmermann

Complicated economic processes determine whether one can expect gains from immigration and which groups will receive them. Assuming a qualitatively homogeneous labor force, the standard competitive framework predicts that immigration will increase the overall supply of labor. This shift can readily increase total welfare, but also tends to drive down the wage rate. Under the assumption that labor is heterogeneous, the key issue for the evaluation of the wage and employment effects of immigration on natives is whether foreign workers are substitutes or complements to native workers. In general, one might expect that the higher the substitutability of foreign for domestic workers, the more likely an increase in immigration would cause a decline in the domestic labor force’s wages. More sophisticated theoretical models analyze the labor market effects of immigration with imperfect labor markets in the receiving countries (Brecher and Choudhri, 1987; Schmidt, Stilz, and Zimmermann, 1994; Bauer and Zimmermann, 1997). In the case of minimum wages, which already caused unemployment in the receiving country, increased immigration may just widen the gap between the minimum wage and what would have been the market wage, leading to higher unemployment. Of particular importance in the German context is the case where wages may not be downwardly flexible due to the behavior of unions. In the theoretical model developed by Schmidt, Stilz and Zimmermann (1994), which considers heterogeneous labor and downwardly rigid wages due to the behavior of unions, the labor market effects of immigration depend on the reaction of the union and the degree to which skilled and unskilled labor are complements. In this model, immigration of unskilled labor produces gains for skilled natives, but wages decline and unemployment increases for unskilled natives. To what extent natives benefit in the aggregate from unskilled immigration depends on the concrete situation, i.e., the reaction of the unions and the degree of complementarity between unskilled and skilled labor. In the case of immigration of skilled labor, both wages and unemployment of natives will decline, and total income of natives will increase. The existing empirical literature on the labor market effects of immigration could be differentiated into studies using simulation methods and those using econometrics. (See Bauer (1998), Bauer et.al. (1998), and Zimmermann (1994, 1995, 1997) for various surveys.) Calibrating the model of Schmidt, Stilz and Zimmermann (1994) using German data for 1993, Bauer and Zimmermann (1997) showed that in the case of unskilled immigration of 10 percent of the German labor force in 1993, income losses of natives could approach as much as 5 percent of national income. In the case of skilled immigration there could be substantial gains due to the improvement of the employment possibilities of unskilled natives (up to 4 percent of national income at the unemployment rates

19 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared of 1993). Furthermore, they showed that the distributional effects of immigration could be quite dramatic. It appears that capital always benefits from immigration and that these benefits increase with the share of skilled immigrants. Both types of labor could lose substantially from immigration depending on the respective substitution coefficients. For instance, if 10 percent of the native work force immigrates and all immigrants are skilled, skilled native workers win 5.4 percent of their initial income. The loss of unskilled native workers is calculated at DM 62 billion or 21 percent of their initial income in the case of unskilled immigration. An increasing literature analyzes the wage and employment effects of immigration using econometric techniques. Most studies find that immigration hardly affects native wages and employment, at least not negatively, but rather exhibits a positive correlation (Bauer et. al., 1998). It should be noted that similar studies in the U.S. were mostly unable to find remarkably negative effects of immigration on the labor market situation of natives (Friedberg and Hunt, 1995).

GERMAN MIGRATION POLICY

Increasingly, economic historians argue that the convergence of living standards across countries in the period between 1850 and 1914 has been the result of a globalization process similar to the process we observe since the 1980s (Williamson, 1998). This literature also shows that the economic effects of this globalization were similar to those we have observed in the 1980s and 1990s, namely a significantly increasing inequality. Williamson (1998) argues that this development caused a more restrictive immigration and trade policy prior to World War I. From 1988 to 1992 Germany experienced a sharp increase in immigration flows (see Figure 1). Figure 2 shows the structure of the immigration flow to Germany since 1988 by immigration status. It appears that immigration between 1988 and 1996 has been dominated by east-west migration and by a heavy inflow of asylum seekers and refugees. A large part of the east-west migrants were ethnic Germans, who moved directly to Germany. Since 1989 Germany also receives so called “New Labor Migrants” which consists of temporary migrants (Werkvertragsarbeiter, Seasonal Workers, and Gastarbeitnehmer) who immigrate through special bilateral agreements Germany signed with several East European countries. (See Bauer and Zimmermann (1997) for a detailed discussion of this type of temporary immigration.)

20 Thomas Bauer and Klaus F. Zimmermann

Since 1992, immigration to Germany has decreased again due to a more restrictive immigration policy of the German government, consisting of a coalition between the CDU/CSU and the FDP. Figure 2 shows that this decrease mainly can be traced to a decreased number of asylum seekers and Aussiedler. In the case of Aussiedler and asylum seekers there have been explicit changes in immigration policy. In 1993, the government amended the constitution and changed the asylum law, giving Germany the possibility of sending back asylum seekers immigrating from member states of the European Union or from other safe countries defined in the new law. As Germany is surrounded by safe countries, asylum seekers theoretically could enter Germany only by air or sea. The decrease in the immigration of Aussiedler is due to administrative barriers set up by the German government since 1990. Since July 1990, ethnic Germans must apply for immigration in their country of origin. In 1993, a new law was passed, which sets a quota of 225,000 Aussiedler per year. Finally, in 1996 a German language test was introduced for potential ethnic German immigrants from the former USSR. Under the new legislation, ethnic Germans only receive an immigration permit if they can prove a certain command of the German language (Dietz, 1998). In the case of the “New Labor Migrants” the quota of immigration permissions under the bilateral agreements have been reduced steadily since 1992. Finally, the decreased number of refugees can be explained by the end of the civil war in one part of the former Yugoslavia. Particularly, German asylum policy must be considered with joint migration policy of the European Union in mind. EU migration policy since 1988 has been marked by two developments. First, since the original Treaty of Rome of 1957, internal migration within the EU has been liberalized steadily, finding its conclusion in Article 8a of the Single European Act. This Act requires the achievement of free movement of people, capital, goods and services from January 1, 1993, which implies the abolition of controls at the interior borders of the EU. Second, with respect to immigration from outside the EU there have been increasing efforts to establish a collective and more restrictive policy. (See Zimmermann (1994, 1995) for a comprehensive discussion of the immigration policies of the EU and its individual members.) The necessity of a common EU migration policy is founded primarily on the requirements of a common European market, as the abolition of interior borders results in a dependency of each member state on the immigration policy of the other states. The EU path towards a joint migration policy started with the Schengen Accords of June 1985 (Schengen I) and June 19, 1990 (Schengen II) and the Dublin accord of June 15, 1990, and have been continued with the Maastricht Treaty, ratified in 1993.

21 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared

The main objectives of these initiatives have been the elimination of internal border checks, consistent and tighter external border controls, a unified visa policy, and the coordination of different national asylum policies. The latest major step in the evolution of this policy is the Treaty of Amsterdam, which came into force in May 1998. Article 63 of the treaty mandates a closer cooperation in the fight against illegal migrants, the elaboration of joint norms regarding the acceptance of asylum seekers, the definition of prerequisites for the immigration and residence of persons from countries outside the EU, and the rights and conditions under with immigrants of one EU member country can reside in another member country. However, the Amsterdam Treaty explicitly rejected setting a fixed time schedule for the adoption of these measures. It is interesting to examine the migration concepts of the German political parties. Until 1998, the CDU/CSU (the conservatives) had governed Germany together with the FDP (the market-oriented liberals), while the SPD (the Social Democrats) and Bündnis 90/Die Grünen (the Greens) formed the major opposition parties. In 1996, the FDP and Bündnis 90/Die Grünen, acting separately, proposed new immigration laws. Both concepts called for an immigration quota and selection of immigrants following the Canadian and Australian point system (Frankfurter Allgemeine Zeitung, 1996; Süddeutsche Zeitung, 1995, 1996). This point system was supposed to consider humanitarian and economic interests, demographic developments, as well as the situation of the German labor and housing markets. Differences in the proposals of the two parties can be found only in the importance of different policy interests to which the points should be allocated. Bündnis 90/Die Grünen gave priority to humanitarian motives and family reunification over economic interests. In contrast, the proposal of the FDP favored social and economic aspects. The SPD has no uniform proposal for immigration policy. Instead, there are two groups within the SPD which adhere to different concepts. One group is in favor of an immigration law similar to the point system proposed by the FDP and Bündnis 90/Die Grünen. Regarding the allocation of points among different groups of immigrants, the position of this group lies somewhere between the positions of the FDP and that of Bündnis 90/Die Grünen. The position of the other SPD group is more similar to that of the CDU/CSU, arguing that there is a necessity neither for a new immigration law, nor for additional immigrants. According to their view the existing immigration regulations guarantee sufficient control of the immigration flows. Furthermore, an immigration law would imply the acceptance of additional migrants, but in the face of the high unemployment rates in Germany, immigration in addition to the immigration guaranteed by the existing laws (the immigration of ethnic Germans, war refugees, asylum seekers, and individuals immigrating through the family

22 Thomas Bauer and Klaus F. Zimmermann reunification program) could not be justified (see also Kanther, 1996; Hailbronner, 1996). After the SPD election victory of September 1998, the new minister of the interior, Otto Schily, referring to the above arguments, announced that the new government will not prepare a new immigration law in the near future. The tendency of the major German parties towards a more restrictive immigration policy leads to the question of whether the recent globalization process and the huge immigration flows in the early 1990s resulted in rising tensions in the German population against additional immigration and whether these tensions could partly explain changes in migration policy. Table 1 shows the share of Germans asking for a total stop of immigration for different immigrant groups for the period from 1990 to 1996. It is of particular interest that the development of the tensions against additional immigrants is different between western and eastern Germany. Whereas the share of West Germans opting for an immigration stop is constant or decreasing between 1990 and 1996, the share of East Germans opting for a total stop sharply increases for all groups of immigrants. Since East Germans experienced a sharp increase of unemployment and inequality since unification, the latter result seems to support Williamson’s arguments (1998). Empirical studies of attitudes towards foreigners in Germany (Gang and Rivera-Batiz, 1994) and the UK (Dustmann and Preston, 1998) show that negative attitudes towards foreigners decrease with education and occupational status and increase with age. However, the results with respect to the effect of being unemployed are mixed.

INTERNATIONAL COMPETITION FOR HIGH-SKILLED WORKERS – AN IMPORTANT NEW FACTOR IN MIGRATION POLICY REFORM

So far, the discussion has shown that the globalization process most likely will result in increased immigration flows to the developed countries, at least in the short and medium run, and that trade and immigration could lead to increased income inequality or a rise in the unemployment of unskilled workers, even though the empirical evidence regarding the latter is mixed. Most countries facing this development have reacted with increasing restrictions on immigration. However, we must ask whether this restrictive policy is the right way to deal with the effects of globalization. A comprehensive ban on free labor mobility would not solve the problems of unskilled workers resulting from liberalized trade, since it would not alter the effects of liberalized trade. Furthermore, such a policy would lead to increased immigration pressure, resulting in high costs for the respective countries to protect their borders.

23 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared

Instead of restricting migration, one alternative would be to allow free mobility of labor across countries. In the short and medium run this would most likely lead to increased immigration of unskilled workers, resulting in increased inequality and/or higher unemployment of unskilled workers in the developing countries. In the long run, factor prices across countries could be expected to equalize and the incentives for migration to disappear. However, it is doubtful whether the increasing social tensions arising from such a development would allow the respective governments to sustain such a policy long enough for factor prices to equalize. Again, this policy is not able to solve the problems of increased inequality or increased unemployment for unskilled workers. A second alternative would be selective immigration that would restrict the immigration of unskilled workers while promoting the immigration of skilled workers. This policy would lead to an increased supply of skilled workers, which lowers wages for this type of workers and decreases the excess demand for skilled workers caused by liberalizing trade. If unskilled and skilled workers are complements, the increased employment of skilled workers will increase the demand for unskilled workers, increasing the wages of the latter, or, in more rigid labor markets, decreasing their unemployment. Two major questions remain for the case of a selective immigration policy. First, how should such a selective migration policy be organized? In general, there are two possibilities. (See Bauer (1998) and Bauer and Zimmermann (1999) for a detailed discussion.) The first is to adapt a point system, similar to those in Canada, Australia, and, more recently, in Switzerland. The main deficiencies of such policies are that (i) the existing management techniques of a point system are not able to address unexpected events, like recessions; (ii) the time lag between collecting and analyzing labor market data on occupational shortages and the actual landing of immigrants could lead to the selection of the wrong migrants; and (iii) that there are no reliable empirical techniques to identify shortages in particular occupations. The second possibility is to auction the right to immigrate to potential migrants or native firms. To economists, the idea that the right to immigrate should be given out by an auction is quite appealing, because an auction selects migrants according to their ability and willingness to pay. This selection mechanism will efficiently identify those migrants who have a large capacity to produce goods of high economic value while working in the receiving country. A point system also discriminates among migrants by their economic value, but an auction will in addition self-select those persons who have the best chance to be economically successful. In general, this observation holds irrespective whether the immigration visas are auctioned to potential migrants or to native firms.

24 Thomas Bauer and Klaus F. Zimmermann

The second main question is whether the receiving country should allow permanent or only temporary migration. Permanent migration normally implies that selected high-skilled workers will immigrate together with their family. However, empirical evidence suggests that family members could end up as unskilled workers, an outcome that would result in problems similar to those under an unregulated immigration regime. This problem could be avoided by allowing only temporary migration, since a government could then restrict the immigration of family members more easily. Temporary migration would further allow a government to increase its efforts in educating native workers, as it has been the case in Germany during the guestworker regime.

CONCLUSION

Globalization (especially trade and its labor content) and migration are two sides of the future of western economies. From one perspective, the most crucial threat of globalization is “virtual migration” through the Internet, in which trans-border telecommuting could seriously impact on local employment. While the immediate pressure is currently on the labor market of the low- skilled, virtual migration will also affect the skilled labor markets. Hence, there is no way to ignore the pressure. We have argued that the best response is to open up economies as far as possible, to speed up the adjustment processes in the countries and to enable new market forces to develop new products and employ both skilled and low-skilled workers. Selective immigration policies are a first step in this direction. They enable governments to test the respective strategies and to convince voters that the transnational integration of national economies is in the best interest of their countries.

REFERENCES

Bauer, T. 1998. Arbeitsmarkteffekte der Migration und Einwanderungspolitik. Heidelberg: Physica-Verlag. Bauer, T., B. Dietz, K. F. Zimmermann, and E. Zwintz. 1998. “Migration: The German Case,” mimeo., IZA, Bonn. Bauer, T., and K. F. Zimmermann. 1997. “Integrating the East: The Labor Market Effects of Immigration,” in S. Black (ed.): Europe’s Economy Looks East: Implications for Germany and the EU. Cambridge: Cambridge University Press, 269-306. Bauer, T., and K. F. Zimmermann. 1998. “Causes of International Migration: A Survey,” in C. Gorter, P. Nijkamp, and J. Poot (eds.): Crossing Borders: Regional and Urban Perspectives on International Migration. Aldershot et.al.: Ashgate, 95- 127.

25 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared

Bauer, T., and K. F. Zimmermann. 1999. “An Immigration Law for Germany,” mimeo., IZA, Bonn. Bhagwati, J., and V. Dehejia. 1994. “Free Trade and Wages of the Unskilled: Is Marx Striking Again?” in: Bhagwati, J., and M. Kosters (eds.): Trade and Wages. Washington D.C.: American Enterprise Institute, 36-75. Borjas, G., R. B. Freeman, and L. Katz. 1992. “On the Labor Market Effects of Immigration and Trade,” in G. Borjas and R. B. Freeman (eds.), Immigration and the Work Force. Chicago: University of Chicago Press, 213-244. Brecher, R. A., and E. U. Choudhri. “International Migration versus Foreign Investment in the Presence of Unemployment,” Journal of International Economics, 23, 1987, 329-342. Dietz, B. 1998. “Ethnic German Immigrants from Eastern Europe and the former Soviet Union in Germany: The Effects of Migrant Networks,” mimeo., Osteuropa-Institut, München. Dustmann, C., and I. Preston. “Attitudes to Ethnic Minorities, Ethnic Context and Location Decisions,” paper presented at the CEPR conference Metropolitan Economic Performance, Lisbon (Portugal), October 1998. Feenstra, R. C. “Integration of Trade and Disintegration of Production in the Global Economy,” Journal of Economic Perspectives, 12, 1998, 31-50. Freeman, R. B. 1995. “Are Your Wages Set in Beijing?”, Journal of Economic Perspectives, Vol. 9 (3), 15-32. Friedberg, R. M., and J. Hunt. “The Impact of Immigrants on Host Country Wages, Employment and Growth,” Journal of Economic Perspectives, 9, 1995, 23-44. Gang, I., and F. Rivera-Batiz. 1994. “Unemployment and Attitudes Towards Foreigners in Germany,” in G. Steinmann and R. Ulrich (eds.): The Economic Consequences of Immigration to Germany. Heidelberg: Physica-Verlag, 121-154. Hailbronner, K. “Es bleibt nicht viel zu regeln übrig,” Frankfurter Allgemeine Zeitung, 26. April 1996, Nr. 98, 14. Haisken-DeNew, J. P., and K. F. Zimmermann. 1994. “Wage and Mobility Effects of Trade and Migration,” forthcoming in W. Dewatripont and A. Sapir (eds.), International Trade and Employment: The European Experience. Oxford: Oxford University Press. Kanther, M. “Deutschland ist kein Einwanderungsland,” Frankfurter Allgemeine Zeitung, 13. November 1996, Nr. 265, 11. Lederer, H. W. 1997. Migration und Integration in Zahlen: Ein Handbuch. Bonn: Beauftragte der Bundesregierung für Ausländerfragen. Lücke, M. 1996. Has Trade with Low-Wage Countries Hurt Unskilled Labor in West Germany? mimeo., Kiel, Institute of World Economics. Martin, P.L., and J. E. Taylor. 1996. “The Anatomy of a Migration Hump,” in OECD (ed.): Development Strategy, Employment and Migration. Paris: OECD. Massey, D. S. “Social Structure, Household Strategies, and the Cummulative Causation of Migration,” 1-26, Population Index, 56, 1990. OECD. 1998. SOPEMI – Trends in International Migration: Annual Report. Paris: OECD.

26 Thomas Bauer and Klaus F. Zimmermann

Rotte, R., and M. Vogler. 1998. “Determinants of International Migration: Empirical Evidence for Migration from Developing Countries to Germany,” IZA Discussion Paper No. 12, Bonn. Sachs, J., and H. Shatz. “Trade and Jobs in U.S. Manufacturing,” 1-84, Brookings Papers on Economic Activity, 1, 1994. Schiff, M. 1996. “Trade Policy and International Migration: Substitutes or Complements?” in OECD (ed.): Development Strategy, Employment and Migration. Paris: OECD, 23-41. Schmidt, C. M., A. Stilz, and K. F. Zimmermann. “Mass Migration, Unions, and Government Intervention,” Journal of Public Economics, 55, 1994, 185-201. Stark, O. 1991. The Migration of Labor. Oxford: Basil Blackwell. Williamson, J. G. “Globalization, Labor Markets and Policy Backlash in the Past,” Journal of Economic Perspectives, 12, 1998, 51-72. Winter-Ebmer, R., and K. F. Zimmermann. 1998. “East-West Trade and Migration: The Austro-German Case,” IZA Discussion Paper No. 2, IZA, Bonn. Wood, A. 1994. North-South Trade, Employment and Inequality. Oxford: Clarendon Press. Wood, A. 1995. “How Trade Hurt Unskilled Workers,” 57-80, Journal of Economic Perspectives, 9. Zimmermann, K. F. 1994. “The Labour Market Impact of Immigration,” in S. Spencer (ed.): Immigration as an Economic Asset: The German Experience. Stoke-on- Trent: Trentham Books. Zimmermann, K. F. 1995. “Tackling the European Migration Problem,” 45-62, Journal of Economic Perspectives, 9. Zimmermann, K. F. 1997. “Die Einwanderungskonsequenzen unterschiedlicher Einwanderungspolitiken,” in D. Sadowski and K. Pull (eds.), Vorschläge jenseits der Lohnpolitik – Optionen für mehr Beschäftigung II, 297-316. Frankfurt, New York: Campus.

ENDNOTES

1 Correspondence: Prof. Dr. Klaus F. Zimmermann, IZA, P.O. Box 7240, 53072 Bonn, Germany. Prepared for the American Institute for Contemporary German Studies (AICGS) project on Regulating the Post-Westphalian World: The Politics of Globalization in Germany and the United States, Washington D.C., USA. We are grateful to the participants at the May 1998 project meeting for their insightful comments and suggestions on an earlier version.

27 Responses to Globalization in Germany and the Unite States: Seven Sectors Compared

Table 1: Share of Germans, Asking for a Total Stop of Immigration*

1990 1991 1992 1996 Aussiedler from East Europe West Germany 20.4 10.1 10.1 11.5 East Germany - 11.9 10.9 17.7 Asylum Seekers West Germany 30.4 21.6 23.8 21.7 East Germany - 15.2 18.1 21.1 Labor Immigrants from the EU West Germany 13.3 9.8 9.0 12.1 East Germany - 25.5 24.0 37.7 Labor Immigrants from outside the EU West Germany 34.1 28.4 28.1 31.3 East Germany - 39.3 36.1 49.3

Source: ALLBUS, own calculations.

28 Thomas Bauer and Klaus F. Zimmermann

29 Responses to Globalization in Germany and the United States: Seven Sectors Compared

30 John Schmitt

GLOBALIZATION AND LABOR MARKETS: A VIEW FROM THE UNITED STATES John Schmitt1

INTRODUCTION

One of the central tenets of international economic theory is that trade, migration, and capital flows are major determinants of the national distribution of income. Textbooks of international economics argue that trade is potentially beneficial to all residents of all countries involved, but these same textbooks also note that the costs and benefits are not always evenly shared.2 The strange political economy of globalization—which has the power to unite trade unions with their employers and liberal environmentalists with the likes of Pat Buchanan—has apparently led many international economists to forget, or at least to downplay, the distributional lessons of their discipline. U.S. economists who were drawn to international economics precisely because of the key role that the international economy plays in the national allocation of resources spent much of the 1990s arguing that U.S. workers have little to fear from opening up the U.S. economy; that jobs gained from expanded exports would more than compensate for those jobs lost to imports; that cheaper imported goods would raise real wages more than import competition would lower wages; and, that, in any event, the exposure of the U.S. economy to world markets is too small to warrant major concern. U.S. workers, however, have generally reached different conclusions. After a sustained string of victories for “globalization,” which included the ratification of NAFTA and the creation of the World Trade Organization, the road to greater economic integration now appears largely blocked in the United States. Congress has rejected the Clinton administration’s bid for “fast track” authorization to negotiate an expansion of NAFTA to include Chile and the Clinton administration has shelved plans to push for ratification of the Multilateral Agreement on Investment (MAI). This paper seeks to outline the main links between the process of expanding international economic integration, widely referred to as “globalization,” on the one hand, and the labor market, the principal determinant of the national distribution of income, on the other. The second, and longest, section of the paper briefly reviews the many channels that connect the international economy to the domestic labor market. Given space constraints, the paper only sketches the nature of each link, summarizing some of the relevant research in each case in order to provide an idea of the order of magnitude of the various effects. The third section attempts to place the theoretical and empirical evidence on

31 Responses to Globalization in Germany and the United States: Seven Sectors Compared globalization in the context of the broader literature on rising wage and income inequality. The fourth section concludes with some thoughts about the political economy of globalization, including some implications for the future of the “welfare state.”

LINKS BETWEEN GLOBALIZATION AND THE LABOR MARKET

Economic theory establishes a large number of potential channels through which the international economy can affect national labor markets. This section reviews those channels that act most directly on labor markets through trade, capital flows and migration. The coverage of potential channels seeks to be comprehensive, but the discussion of each channel typically only includes a small portion of the relevant research.3 While the list here is long, it excludes at least one important aspect of globalization—the possibility that international capital markets might constrain the macroeconomic options available to national economies by rendering monetary policy ineffective (for example, in the case of a fixed-exchange-rate regime) or by limiting the scope of fiscal policy (because of the threat of large-scale capital outflows, for example).

Trade Trade in manufactures is the starting point for the U.S. debate on globalization. Economic research on the impact of trade on wages and employment has generally taken one of three approaches. First, much of the research, especially by labor economists, has focused on the impact on employment and wages of the quantities of imports and exports of final goods in import-competing and export-oriented industries. A second body of research—primarily the domain of trade economists and more rooted in traditional trade theory—has analyzed the effect of the prices of internationally-traded final goods on domestic wages. Finally, some economists have argued that the increasingly complex nature of the international division of labor has created substantial opportunities for “outsourcing” of manufacturing processes through trade in intermediate goods used in manufacturing.

Quantities The reasoning behind the quantity-based approach is simple. Rising demand for exports creates jobs in export-oriented industries; while imports destroy jobs in competing industries. Given the chronic U.S. trade deficit over the last two decades, these analyses generally show a substantial negative

32 John Schmitt impact of foreign trade on domestic employment and, indirectly, on domestic wages. Scott, Lee and Schmitt (1997), for example, link industry-level trade data to the direct and indirect employment required to produce a dollar’s worth of output in each of almost 200 industries. They estimate that the expansion of imports to and exports from the United States that took place between 1979 and 1994 lowered domestic employment opportunities by about 2.4 million jobs, relative to a situation where the import and export shares in total industry output remained at their 1979 level. Most, but not all, of the foregone job opportunities were in manufacturing. As Scott and Rothstein (1998) argue, even if macroeconomic policy counteracted the job losses in practice, the substantial loss of manufacturing jobs and their substitution by generally lower-paying service-sector jobs put significant downward pressure on the wages of U.S. workers, particularly those without a four-year college degree. Murphy and Welch (1990) and Borjas, Freeman and Katz (1991) converted industry imports and exports into changes in the “supply” and “demand” for workers in affected manufacturing industries from the 1960s through the late 1980s. These analyses focused on the wage effects of trade. Borjas, Freeman and Katz found that the trade deficit explained 15-25 percent of the rise between the late 1970s and the mid-1980s in the earnings of college-educated workers relative to high-school-educated workers.4 Murphy and Welch concluded that: “[t]he evolving pattern of international trade is perhaps a primary cause of recent wage changes.”

Prices Trade economists, however, have generally argued that the theoretical foundations of the quantity studies are weak. Two deficiencies loom largest. First, the quantity approaches have not pinned down the reason for the expansion of imports. An increase in an industry’s imports may reflect a lowering of trade barriers or an expansion of world supply, events that would have an important impact on domestic prices, employment patterns, and wages. An increase in imports, however, may also simply represent a response to a rise in domestic demand that the domestic industry cannot fulfill as cheaply as foreign suppliers—a development that has very different implications for the domestic economy. A second problem with the quantity approach is that it ignores the central role that changes in international prices, not quantities, play in trade theory. To take an extreme example, quantities of imported oil changed little in 1974-75, but the change in world oil prices, nevertheless, had a profound effect on the domestic economy.

33 Responses to Globalization in Germany and the United States: Seven Sectors Compared

The proliferation of “price studies” all draw on the Stolper-Samuelson theorem, which holds that opening a domestic economy to foreign trade (through the reduction in a tariff, for example) will reduce the income of factors used intensively in the production of import-competing goods. The basic reasoning is that industries competing with cheaper imports will be forced to cut costs and that factors used disproportionately in the import-competing industries (typically, less-skilled labor) will bear the burden in the form of lower wages. Since the factor that is used intensively in the production of the now cheaper product will have to absorb all of the relative price change, the change in relative factor price will have to be larger than any product price change induced by trade liberalization. Sachs and Shatz (1995) find that trade-induced changes in prices can account for a substantial portion of the growth during the 1980s in the earnings differential between nonproduction and production workers in the United States. Schmitt and Mishel (1996) estimate that relative price changes may account for 8-28 percent of the growth between 1979 and 1989 in the college- versus high school-worker premium and between one-third and all of the rise over the same period in the nonproduction- versus production-worker premium. Krueger (1996) concludes that the price evidence for the 1990s is consistent with trade being responsible for the entire rise in the wages of skilled- relative to less-skilled workers in the current decade.5 The empirical evidence on Stolper-Samuelson effects is, however, on the whole mixed,6 with the most difficult problems involving the measurement of international prices. While trade economists tend to prefer price studies, most of the public debate around NAFTA focused on numbers generated by the quantity studies. Political economy considerations probably weighed heavily in the choice. An important feature of the price studies is that they are embedded in the traditional Heckscher-Ohlin framework, which assumes full employment. As such, the price framework cannot be used to show job gains or job losses due to trade. Given that the run-up to the NAFTA vote included a recession and two years of a “jobless recovery,” job numbers resonated with voters and their representatives. The price studies probably further constrained proponents of NAFTA, since to show that trade was not responsible for growing wage inequality in the 1980s, such studies also had to demonstrate that trade had not changed relative prices, which is to say that trade had not generated any efficiency gains either.

Outsourcing Both the quantity and the price studies analyze final goods. As Feenstra (1998) has observed, however, the increasing “disintegration” of

34 John Schmitt manufacturing frees firms to divide production into discrete processes, some of which can be outsourced. The most natural candidates for outsourcing are processes that are intensive in their use of less-skilled labor. Feenstra and Hanson (1996) show an important increase after 1972 in the volume of imported intermediate goods used in production of U.S. manufactures. They estimate that the rise in outsourcing accounted for about 20 percent of the increase in the nonproduction worker share of the wage bill during the 1980s.

Capital Flows Mundell’s (1957) classic paper on international capital mobility established the principle that the free movement of capital has the same impact on wages as free trade in final goods. In principle, then, the strong emphasis in recent trade agreements on liberalizing capital flows can lead to the same kinds of distributional difficulties for less-skilled workers in U.S. manufacturing industries. These impacts of capital flows on domestic resource allocation and distribution occur almost entirely independently of the short-term effects of capital flows that have received at least some share of the blame for the current financial crisis in East Asia. Nevertheless, surprisingly little empirical research has attempted to study the economic and distributional effects in developed economies of inward and outward capital flows in the forms of foreign direct investment, portfolio investment and private, bilateral and multilateral lending. One important and still understudied aspect of capital mobility relates to the relative immobility of labor. The liberalization of capital flows has made it more difficult for nations to tax capital and has resulted in a shift in the tax burden toward less-mobile labor, with further implications for the national distribution of income.

Immigration Documented immigration increased substantially in the United States in the 1980s and 1990s, raising the foreign-born share of the population from 6.2 percent in 1971-80 to 9.3 percent in 1991-96.7 While estimates vary, undocumented immigration also probably increased significantly over the same period. The available data suggests that immigrants cluster at the high and the low ends of the educational-attainment spectrum. In 1996, for example, about 36 percent of immigrants had less than the equivalent of a high school degree, compared to 10 percent of the native-born population; about 27 percent of immigrants, however, had the equivalent of a four-year college degree, which compares favorably with the 28 percent figure for the native-born population. All else constant, economists would expect the increase in the supply of immigrant workers to depress wages of native-born and immigrant workers

35 Responses to Globalization in Germany and the United States: Seven Sectors Compared already in the United States. Given that immigrants disproportionately have low levels of formal education, economists would also expect that the supply effects would be strongest on the wages of less-educated workers. The empirical evidence on the impact of immigration on the wage distribution is mixed. Borjas (1994) concludes a review of the recent literature by noting that “. . . although there is only a weak negative correlation between the presence of immigrants in a local labor market, immigration may have been partly responsible for the decline in the earnings of unskilled native workers that occurred during the 1980s.” In another review of the literature, DeFreitas (1998), however, argues that the recent research provides little support for the idea that immigrants have depressed wages of native-born workers (though he does believe the evidence suggests that recent immigrants have depressed the wages of earlier immigrants). DeFreitas explains the results by suggesting that immigration does not simply increase the supply of labor. Immigrants also increase the demand for domestically-produced goods and services that “generate multiplier effects . . . through the economy.” He also speculates that “. . . the growth of immigrant concentrations in cities like New York, Los Angeles and Miami draws foreign capital here, as businesses in their homelands seek to become part of these expanding markets.”

Threat Effects A final link between globalization and the labor market is the “threat effect.” Employers’ credible threats to relocate plants, to outsource portions of their operations and to purchase intermediate goods and services directly from foreign manufacturers can have a substantial impact on workers’ bargaining positions. The use of threats is widespread, but difficult to document. In a unique study of union organizing drives from 1993-95, Bronfenbrenner (1996) found that “. . . over 50 percent of all employers made threats to close all or part of the[ir] plant[s] during the organizing drive.” The impact of such threats, however, is much harder to demonstrate. Given their pervasiveness— Bronfenbrenner found that employers in relatively immobile industries such as construction, health care, education, and retail raised threats to relocate in 36 percent of organizing drives—these threat effects could conceivably have a greater impact on wages than actual trade, capital or migration flows.

Taking Stock Globalization has an enormous potential to affect the domestic labor market. Economic theory and a large and growing body of research suggests that the economic integration of the last twenty years has had an important negative impact on the wage and income distribution and employment

36 John Schmitt prospects of the majority of U.S. workers. Even strong advocates of further economic integration acknowledge some of the costs of globalization. Former Clinton economic adviser, Laura Tyson (1997), for example, judges that “[o]pinion is shifting toward the view that globalization has had a ‘moderate’ effect—perhaps accounting for one-fourth to one-fifth of the nearly 20 percent rise in the wage differential between skilled and unskilled labor—and the estimate of this effect has been creeping up over time.” The preceding discussion outlines multiple channels through which the global economy acts on the wages and employment opportunities of domestic workers. Taken together, the potential impact on the national wage and income distribution might ultimately exceed Tyson’s estimates.

GLOBALIZATION IN CONTEXT

The preceding discussion outlined the links between the international and the national economy. This section seeks to place the evidence on globalization in the context of the broader debate over inequality. Many economists argue that even if globalization accounts for 20-25 percent of increasing inequality, this amounts to only a “small” impact relative to other causes of inequality (especially technological change, but also the deterioration of domestic labor market institutions such as unions and the minimum wage) and relative to the efficiency gains from greater integration.

What is Small? Those who maintain that the effects of globalization are small implicitly argue that we must weigh these minor distributional costs against what they assert to be “large” efficiency gains. This position, however, sidesteps several issues that are central to the public policy debate over globalization. The first is the question of what is small. Wages for workers at the tenth percentile fell 15 percent in real terms between 1979 and 1997; wages for workers in the nintieth percentile rose about 6 percent over the same period. Twenty percent of the 21 percentage-point growth in the wage gap would represent a four percent increase in the real wage for workers at the bottom, relative to the actual real wage at the end of the period. Governments are hard-pressed to point to any policy capable of raising the real wages of so many workers by such a magnitude. Second, the consensus view may underestimate the distributional impact of globalization. Current estimates rest on an array of research papers, each of which generally examines only one of the many channels discussed in the preceding section. If the data permitted it, a more holistic view of the effects of

37 Responses to Globalization in Germany and the United States: Seven Sectors Compared globalization might push the consensus figure higher. Moreover, two of the channels that are most difficult to measure may ultimately have the biggest effect on domestic wages and employment: the role that trade competition has on the pace and the terms of domestic technological innovation and the “threat” effect that probably magnifies the direct impact of foreign trade, outsourcing and foreign direct investment. Third, a near corollary of the proposition that the wage and employment effects of trade are small is that the corresponding benefits are also small. Trade theory is clear that the efficiency gains flow directly from the reallocation of domestic resources away from less efficient and toward more efficient uses. The reallocation requires separating workers from less efficient industries and lowering the relative wages of workers with less desirable skills. If relative prices, relative wages, and overall employment patterns do not change much, efficiency cannot be improving much. A fourth and closely related problem is that even if empirical research finds only small effects of trade, that same research has also had a difficult time establishing large benefits from trade. Rodrik (1997), an advocate for freer trade, has pointed out that “[e]conomics is notoriously bad at quantifying forces that most people believe are quite important. For example, no widely accepted model attributes to postwar trade liberalization more than a very tiny fraction of the increased prosperity of the advanced industrial countries.” Finally, even if correct, the suggestion that the net effects of trade are “small” ignores that the gross losses and gains that produce this small net outcome are potentially large. The “average” net effect of trade is not the experience of every worker in every industry. Absent adequate means for channeling benefits from the winners to the losers (full-employment policies, a well functioning social safety net, retraining, and so on), calculations of the net effects of policies will fail to carry much political weight.

Globalization versus Technology Those who argue that effects of trade on inequality are small generally also maintain that the real culprit is technological progress. In simplified terms, technology is supposed to drive inequality by rewarding workers who work well with computers (especially those with a four-year college degree) and by punishing workers who do not work well with computers (especially those with only a high school degree or less). While a comprehensive critique of the technology explanation is beyond the scope of this paper,8 several problems with the technology thesis warrant consideration here. First, as Figure 1 demonstrates, real wage levels for the vast majority of U.S. workers have been stagnant or falling since the end of the 1970s. Even

38 John Schmitt workers at the ninetieth percentile of the wage distribution saw their wages rise only about 6 percent in real terms between 1979 and 1997. This picture of the wage distribution suggests that economic developments are pulling down the middle and the bottom of the wage distribution, while the top is just managing to hold its own. On its face, the technology explanation seems more consistent with a situation where skill-biased technological change would be pulling up the wages of those at the top, while leaving the wages of those at the middle and bottom behind (but not necessarily falling). The simple picture in Figure 1, therefore, appears more consistent with the idea that globalization weighs more heavily in recent wage developments than does technological innovation. Of course, the data in Figure 1 have been adjusted for inflation using the Consumer Price Index (CPI), which has been attacked recently for overstating inflation. The most commonly cited figures suggest that the CPI may overestimate inflation by about one percentage point per year. If the CPI does overstate inflation—and doubts remain about the size and, in some cases, even the direction of biases9—real wage growth over the last two decades has been considerably better than what is suggested in Figure 1. Those critical of the CPI generally acknowledge that the mismeasurement problems are no worse today than they were in earlier decades. If this is true, then the CPI also underestimated real wage growth by about one percent per year in the “golden age” of wage growth prior to 1979. So, even if wages did not start falling in real terms after 1979, they still decelerated sharply. At best, after 1979, real wages were flat or rising at a slower pace than they had in earlier decades. This marked deceleration in real wage growth is more consistent with the economic logic of globalization than it is with a “technological revolution.” A second problem with the technology thesis is closely related to the real wage argument: it is difficult to reconcile a technological boom with the sharp deceleration in U.S. productivity growth that took place after the mid-1970s. Between 1947 and 1973, growth in labor productivity in the non-farm business sector averaged almost three percent per year; since 1973, the average annual growth rate in productivity has been barely more than one percent per year. A convincing case for technology’s role in rising wage inequality must explain how an acceleration in the pace of technological innovation succeeded in profoundly altering relative wages, but failed to have any measurable, positive effect on labor productivity. As with the CPI, labor productivity measures have come under attack in recent years. Since much of the alleged problems with the labor productivity measures are closely related to problems with the CPI (particularly, how real output is measured), the basic arguments used to put the CPI critique into perspective also apply here. The constant mismeasurement of productivity

39 Responses to Globalization in Germany and the United States: Seven Sectors Compared

40 John Schmitt implies, at least, a considerable deceleration in the rate of productivity growth after 1973, a deceleration that seems inconsistent with an acceleration in technological progress. Some critics, however, argue that the productivity measure is becoming increasingly less accurate because of the rise in the share of services in total output. Without entering into a discussion of the merits of this view, the magnitude of the mismeasurement that the serious proponents of this position put forth would eliminate, at most, only half of the deceleration in measured productivity growth since 1973.10

Other Sources of Inequality Globalization and technology are certainly not the only potential explanations for rising wage and income inequality. A large and growing body of research points to changes since the 1970s in key labor and product market institutions, including unions, the federal minimum wage, the deregulation of major industries, the privatization of many state and local government activities, and the long-term shift in production and consumption away from manufactured goods and toward services. Estimates of the exact impact of the deterioration of these institutions on wage and employment outcomes vary. The decline in unionization rates and union power in the 1980s consistently appears to explain 20 percent or more of the increase in inequality between more- and less-skilled male workers.11 The decline in the real value of the minimum wage may have had an even larger impact on rising inequality among women.12 The long-term shift away from relatively high-paying employment in manufacturing toward relatively low- paying employment in services may account for as much as a third of the increase in inequality, though it is difficult to separate the industry shifts from the contemporaneous drops in unionization rates, changes in the real value of the minimum wage, and trade deficit effects.13 Deregulation and privatization appear to have had smaller effects, accounting for less than 10 percent of the recent increase in inequality,14 though research in this area is sparse. Domestic product market institutions provide important insights into the economics of globalization. These domestic institutions are embodied in antitrust law, labor law and regulatory policy related to competition, pollution, consumer safety, worker health and safety, and other issues. They also respond to long-term social and cultural patterns of consumption and investment. Together, these institutions define the “real world” markets in which economic actors function. These institutions also strongly influence the domestic allocation of resources, relative prices, relative wages, employment patterns, and, ultimately, the distribution of income. A central feature of “globalization” is the restructuring of the institutions—tariff and nontariff barriers, and labor,

41 Responses to Globalization in Germany and the United States: Seven Sectors Compared environmental, health and safety, and other regulations—that set the parameters for product markets in internationally traded goods. Since changes in domestic product markets can have profound effects on employment and wages, we should expect no less from changes in international product market institutions. The various changes in the domestic institutions in the 1980s (weaker unions, lower minimum wage, more deregulation, greater privatization, and fewer jobs in manufacturing) have a common feature: they all served to undermine the bargaining power of workers with respect to their employers. The economic process of globalization, articulated through the channels spelled out in the preceding section, strongly complements these changes in domestic institutions by exposing domestic workers to direct and indirect competition (through import competition, outsourcing, the threat of relocation, and so on) with foreign workers, many of whom earn substantially lower wages.

POLITICAL ECONOMY OF GLOBALIZATION AND FUTURE OF SOCIAL SAFETY NETS

Trade is a fundamental problem of political economy. Even if standard trade theory accurately describes the world, efficiency gains from trade only have the potential to benefit all members of a domestic economy. The problem facing economists and politicians interested, for efficiency reasons, in expanding trade is to use the gains from trade to put together a coalition of political forces that make further integration possible. So far, politicians seeking such a coalition have failed to achieve it. Several factors help explain their limited success. First, many proponents of freer trade, capital flows and migration have been unwilling to admit that such policies have substantial costs for at least a portion of societies involved. The public debate in the run-up to NAFTA often featured NAFTA proponents that were unwilling to admit that even a single job would be lost as a result of the treaty. This attitude has certainly undermined the credibility of the pro-liberalization forces in the eyes of much of the public. Since the enactment of NAFTA, proponents of further integration appear to have recognized this credibility gap and have generally been more willing to discuss the potential costs of future trade agreements. Second, further economic integration poses what Vobruba (1998) has called the “globalization dilemma”: a welfare state is necessary to effect the kind of redistributional program required to compensate the losers in further globalization, but further globalization undermines the ability of national

42 John Schmitt economies to pay for an expansive welfare state. Rodrik (1997) makes this argument forcefully on both theoretical and empirical grounds. Third, the gains to trade may be smaller than integrationists believe, providing a smaller budget than necessary to put together a successful coalition of social forces. As Rodrik has noted, many economists’ belief in the strong gains from trade flows more from theoretical models and just plain faith than persuasive empirical research. The bigger the gains from trade, of course, the easier it will be to “bribe” opponents. A continued inability to put together such a coalition, however, might constitute evidence that the economic gains from trade, capital and labor integration are smaller than the economics profession generally believes.

REFERENCES

Baker, Dean. 1998. Getting Prices Right: The Debate Over the Consumer Price Index. Armonk, N.Y.: M.E. Sharpe. Borjas, George J. 1994. “The Economics of Immigration.” Journal of Economic Literature, vol. 32, no. 4, pp. 1667-1717. Borjas, George J., Richard B. Freeman, and Lawrence F. Katz. 1991. “On the Labor Market Effects of Immigration and Trade.” National Bureau of Economic Research Working Paper No. 3761. Cambridge, MA: NBER. Burtless, Gary. 1995. “International Trade and the Rise in Earnings Inequality.” Journal of Economic Literature, vol. 333, pp. 800-16. Camarota, Steven A. 1998. Center for Immigration Studies. Unpublished tables. Card, David. 1996. “The Effect of Unions on the Structure of Wages: A Longitudinal Analysis.” Econometrica, vol. 64, pp. 669-88. DeFreitas, Gregory. 1998. “Immigration, Inequality, and Policy Alternatives,” in Dean Baker, Gerald Epstein, and Robert Pollin (eds.) Globalization and Progressive Economic Policy. Cambridge: Cambridge University Press. Dinardo, John, Nicole Fortin, and Thomas Lemieux. 1996. “Labor Market Institutions and the Distribution of Wages, 1973-1992: A Semi-Parametric Approach.” Econometrica, vol. 64, pp. 1001-44. Feenstra, Robert C. 1998. “Integration of Trade and Disintegration of Production in the Global Economy.” Journal of Economic Perspectives, vol. 12, no. 4, pp. 31-50. Feenstra, Robert C. and Gordon H. Hanson. 1996. “Globalization, Outsourcing, and Wage Inequality.” American Economic Association Papers and Proceedings, vol. 86, no. 2, pp. 240-45; with unpublished errata supplied by authors, September 1996. Fortin, Nicole M. and Thomas Lemieux. 1997. “Institutional Changes and Wage Inequality : Is there a Linkage?”, Journal of Economic Perspective, pp. 75-96.

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Freeman, Richard. 1993. “How Much Has De-Unionization Contributed to the Rise in Male Earnings Inequality?” in Sheldon Danzinger and Peter Gottschalk (eds.), Uneven Tides. New York: Russel Sage. Griliches, Zvi. 1997. “Comments on Sichel.” Review of Economics and Statistics. p. 371. Krugman, Paul R. and Maurice Obstfeld. 1991. International Economics: Theory and Policy. New York: Harper Collins. Lee, David S. 1998. “Wage Inequality in the U.S. during the 1980s: Rising Dispersion or Falling Minimum Wage?” Industrial Relations Section Working Paper No. 399, Princeton University. Madrick, Jeff. 1997a. “The Cost of Living: A New Myth.” New York Review of Books, March 6. Madrick, Jeff. 1997b. “The Cost of Living: An Exchange.” New York Review of Books, June 26, pp. 65-67. Mundell, Robert A. 1957. “International Trade and Factor Mobility.” American Economic Review, vol. 47, pp. 321-35. Murphy, Kevin M. and Finis Welch. 1990. “The Role of International Trade in Wage Differentials,” in Marvin Kosters (ed.). Workers and Their Wages: Changing Patterns in the United States. Washington, D.C.: American Enterprise Institute. Peoples, James. 1998. “Deregulation and the Labor Market,” Journal of Economic Perspectives, vol. 12, no. 3, pp. 111-30. Rodrik, Dani. 1997. Has Globalization Gone Too Far? Washington, D.C.: Institute for International Economics. Sachs, Jeffrey D. and Howard J. Shatz. 1995. “International Trade and Wage Inequality in the United States: Some New Results. Unpublished paper, Harvard University. Scott, Robert E., Thea Lee, and John Schmitt. 1997. “Trading Away Good Jobs: An Examination of Employment and Wages in the U.S., 1979-94.” Economic Policy Institute Briefing Paper, Washington, D.C.: Economic Policy Institute. Scott, Robert E. and Jesse Rothstein. 1998. “American Jobs and the Asian Crisis: The Employment Impact of the Coming Rise in the U.S. Trade Deficit.” Economic Policy Institute Briefing Paper, Washington, D.C.: Economic Policy Institute. Schmitt, John and Lawrence Mishel. 1996. “Did International Trade Lower Less- Skilled Wages During the 1980s? Standard Trade Theory and Evidence.” Economic Policy Institute Technical Paper. Washington, D.C.: Economic Policy Institute. Slaughter, Matthew. 1998. “What are the Results of Product-Price Studies and What Can We Learn from Their Differences?” National Bureau of Economic Research Working Paper 6591. Cambridge, Mass.: National Bureau of Economic Research. Teulings, Coen N. 1998. “The Contribution of the Minimum Wage to Increasing Wage Inequality: A Semiparametric Approach,” unpublished paper, University of Amsterdam. Tyson, Laura. 1997. “Inequality Amid Prosperity,” The Washington Post. July 9, p. A20.

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Vobruba, Georg. 1998. “Globalization,” presented at conference on “Germany’s Competitive Capacity: Reassessing the Role of Labor Market Institutions in the New Economy,” Economic Policy Institute, Washington, D.C., October 22-24.

ENDNOTES

1 The author thanks Rob Scott and participants at an AICGS seminar for many helpful comments. 2 See, for example, Krugman and Obstfeld (1991): “. . . trade has substantial effects on the income distribution within each trading nation, so that in practice the benefits of trade are often distributed very unevenly.” (p. 39) 3 For a more complete review of the evidence on globalization and the labor market, see Burtless (1995) and two recent symposia in the Journal of Economic Perspectives, Summer 1995 and Fall 1998. 4 Borjas, Freeman, and Katz found that the effect “diminished with improvements in the trade balance during the late 1980s.” 5 Krueger notes that his results are also potentially consistent with some forms of technological change. 6 For a review of nine “price” studies see Slaughter (1998). 7 See Borjas (1994) and Camarota (1998). 8 Papers that find an important role for technology include: Autor, Katz and Krueger (1998); Bound and Johnson (1992); Berman, Bound and Griliches (1994); and Berman, Bound and Machin (1998). For a critical view of this literature, see DiNardo and Pischke (1997); Handel (1997); Mishel, Bernstein, and Schmitt (1998); and Howell (1994). 9 For an alternative view on the CPI, see Madrick (1997a, 1997b); Baker (1998). 10 See Griliches (1997). One other point that is particularly relevant in the context of international comparisons is the observation that productivity growth rates in most European economies—which are presumably struggling with the same measurement difficulties—substantially exceed those in the United States. 11 See Card (1996) and Freeman (1993). 12 See DiNardo, Fortin and Lemieux (1996), Fortin and Lemieux (1997), Lee (1998), and Teulings (1998). 13 See Mishel, Bernstein, and Schmitt (1998), Chapter 3. 14 See Fortin and Lemieux (1997) and Peoples (1998).

45 Responses to Globalization in Germany and the United States: Seven Sectors Compared

46 Reiner Hoffmann

GLOBALIZATION AND LABOR MARKETS: A VIEW FROM GERMANY IN THE EUROPEAN UNION Reiner Hoffmann

INTRODUCTION

It should be acknowledged that in view of the conditions imposed by EMU, national labor and employment policies are no longer sufficient to overcome mass unemployment and shape structural change. This can only be achieved from a European standpoint. For this reason, this paper deals with the subject of globalization and German labor markets not only from a German national perspective, but also in an essentially European context. Labor markets in Germany and in Europe are experiencing a fundamental structural change. For proof of the dramatic situation in the labor markets today, one need look no further than to the over eighteen million people without jobs and the ever increasing number of long-termed unemployed (rising to over 50 percent of the unemployed in some areas, in contrast to only 10 percent in the U.S.) in the European Union. Europe’s average employment level (those who have jobs as a percentage of those who are able to work) has fallen from about 62 percent to 60 percent. This is clearly below the American employment level of 70 percent, and the Japanese level of 78 percent. The reasons for the continuing unemployment crisis that began in the mid-1970s are complex. Though economic trends have always had an effect on unemployment, the tremendous pace of structural change is of much greater significance and has been intensified by globalization. Framed by new technology and production methods as well as advancing globalization, the European Commission’s report on employment (1996) showed that, year for year, about 10 percent of the global employment opportunities in the EU had undergone restructuring. And new jobs created in new industries and in the service sector have not been able to compensate for the continually declining number of jobs in various sectors of older industries. Furthermore, ever since the beginning of the 1980s, even high rates of Gross National Product (GNP) growth have not been sufficient to ensure a high employment rate. “In the second half of the 80s, employment never rose significantly above 1 percent in any of the Member States that did not achieve an annual average growth of 3 percent” (European Commission, 1996). This had already been acknowledged in the Commission’s Green Paper on European social policy:

47 Responses to Globalization in Germany and the United States: Seven Sectors Compared

Despite the efforts made in Europe over the last century, it can no longer be assumed that an economic policy, which promotes growth, will automatically lead to full employment. It is generally accepted that the European problem will remain with us throughout a deep structural crisis that will most likely prevent a return to full employment in the near future provided that the policy does not take an entirely new direction (Commission 1993a, p. 17).

A new direction must also be taken at the European level. This was finally recognized by the heads of state and government of the fifteen member states at the summit meeting in December 1994 in Essen, where employment and an active labor market policy were established as political priorities. This initiative owes its existence to the recognition that beyond the implementation of the Maastricht convergence criteria of economic and monetary union (EMU), a clear reduction in unemployment was required. The spirit of Essen suffused the inter-governmental conference on the revision of the Maastricht Treaty. An employment chapter was enshrined in the new EU (Amsterdam) Treaty, which the trade unions in particular had been demanding for a long time (ETUI 1997). With the adaptation of specific guidelines for EU employment policy at the EU jobs summit meeting in Luxembourg in November 1997, use of the new employment chapter was already being planned in advance of the ratification of the Amsterdam Treaty by the member states. The employment chapter owes much to the election of a new French government and was facilitated further by the election victory of the Labour Party in Great Britain. Similarly, Germany’s new government made it very clear at the EU Vienna summit in December 1998, that EMU implied increased coordination of economic, tax and employment policies among EU member states. It also gave high priority to forging a European employment pact.

GLOBALIZATION AND EMU: CONSEQUENCES FOR LABOR MARKETS

Globalization of the economy is the key phrase at the heart of the new economic and social challenges. In fact, beyond the empirical reality of globalization as a genuine economic trend is its function as an omnipresent and ideological keyword used by employers and the researchers who support them. Evidence of this is seen in discussions in Europe or in the so-called Standort- Debatte in Germany where labor standards are considered to be too high. Certain aspects of this debate merit a critical analysis.

48 Reiner Hoffmann

Increasing foreign direct investment is often at the center of the debate on globalization. The following diagram gives an overview of the patterns of foreign direct investment within the trilateral region. Developments between 1985 and 1992 undoubtedly show an increase in the degree of internationalization of direct foreign investment. At the same time, it is also clear that direct investment is concentrated within, and relatively evenly across the trilateral region. Figures show 260 billion dollars worth of direct investment made in Western Europe by North America against 270 billion dollars invested in North America by Western Europe. At the same time however, there is a clearly higher level of direct investment within Western Europe itself (Hickel 1998, p. 190). Moreover, the German example shows that the increase in global trade is closely connected with the increase in direct investment abroad. The motivation for German foreign investment has been primarily to open up and secure markets (between 60 percent and 80 percent according to a representative survey by the IFO Institute 1996), while wage costs, along with many other factors, accounted for some 10 percent. It is therefore hardly surprising that 80 percent of direct investment by German firms is spent in OECD countries, particularly in EU countries (in line with Germany’s focus on exports), that is to say, in high-wage countries. At the beginning of the 1990s however, exactly 15 percent of direct investment abroad which involved German capital went to the so-called low-wage countries in the Asia-Pacific region and only 3.8 percent was spent in central and eastern Europe (Jungnickel, cited from Altvater/ Mahnkopf 1996, p. 257). In Europe, and against a background of the economic developments outlined here, it is clear that wage costs are not excessively high when viewed in global terms. Indeed, there has been a demonstrably favorable development of unit labor costs for companies, i.e., overall wages compared to labor productivity. For example, while the German economy, compared to the economies in Great Britain, the U.S. and Japan, demonstrates a favorable development in unit labor costs between 1980 and 1995, an international comparison shows the overall trend in unit labor costs to be favorable for business. This is further indicated by an exorbitant increase in profits that was partially hampered by the rise in the value of the Deutsche Mark (DM) (Hübner/ Bley 1996). The debate on “Eurosclerosis” concerns excessively high labor regulation standards in continental Europe, which lead to an increase in employment costs and undermine competitiveness. Arguments in this debate, and in the debate on globalization, must address the empirical fact that in the often-quoted British counter-example, unit labor costs during the Thatcher 1980s were higher than

49 Responses to Globalization in Germany and the United States: Seven Sectors Compared

50 Reiner Hoffmann those in Germany and France. Furthermore, between 1970 and the end of the 1980s, it was precisely those Western European countries that boasted the highest standards of living (Denmark, the Benelux countries, Germany, and France) and recorded not only the greatest real wage increases, but also the highest labor productivity. This is in striking contrast to Great Britain and the U.S. (cf. Deakin 1997). According to the IFO (1996), by 1995 unit labor costs had fallen in France to an index value of 86.8, and in Germany to 87.8, while in Great Britain during the Thatcher era they fell to only 97.6, in the U.S. to only 99.2 and in Japan to 90.2 (1980 = 100). This situation is especially clear when Germany (FRG) is compared with the U.S. Whereas nominal wages in both countries rose by approximately 100 percent between 1980 and 1994 (105 percent in the U.S. and 99.3 percent in Germany), real wages in the same period rose by 11.6 percent in the U.S. and by 34.7 percent in the Federal Republic of Germany, while unit labor costs in the U.S. rose by 72 percent and by 42.2 percent in the FRG. The reason for this contrasting development was the different rate of increase in labor productivity, which rose by 16.5 percent in the U.S. but by 40.4 percent in the FRG over the period under consideration (all data from Kuda 1996). The fact that these figures are reminiscent of the comparison between the EU and the U.S. is reflected in a comparison of the average annual rate of growth of macroeconomic labor productivities, which in the period from 1986 to 1995 were 1.9 percent for the EU (EU-15), but only 0.8 percent for the U.S. (from Schubert 1997, p. 1). The highest labor productivity and the highest labor productivity growth rates “are to be found precisely where the highest wages and highest social security contributions, the highest income taxes and the most expensive and generous social welfare benefits are paid. Countries like Sweden and the Netherlands rank highest not only in terms of their social welfare benefits and labor costs, but also in terms of their labor productivity” (Krätke 1996, p. 15). Similarly, the employment crisis in Western Europe can hardly be blamed primarily on the globalization of world trade where the EU’s export share is only 8 percent or by the decentralization strategies of multinationals. If the loss of jobs through decentralization were balanced by safeguarding and indeed increasing the number of jobs through strategies to retain and open markets by internationalizing production, then the export-intensive countries of Western Europe would benefit most. Nevertheless, the OECD study on globalization concludes that international trade and direct investment have only a minor impact on employment (OECD 1996, p. 10). Considering the demand for labor alone, the decisive factor in the employment crisis in the internal market is highly capital-intensive production, particularly in Central and Western Europe, not high productivity. This dampens the job-creating effects of

51 Responses to Globalization in Germany and the United States: Seven Sectors Compared significantly reduced investment (relative to profit levels), whereas the employment miracle in the U.S. can be attributed to the fact that the growth rates for labor productivity are below those for production. This in turn was largely possible as a result of the development of the personal services sector, which is particularly underdeveloped in Germany. The high number of job seekers on the supply side of the European labor market was a second cause of persistent large-scale unemployment in the 1990s and is often neglected in debate. Reduced demand provoked a sharp rise in unemployment from the mid-1970s throughout the 1980s. Globalization only played a limited role in this, in that an influx of immigrants in the 1960s and 1970s contributed to a higher labor supply. Furthermore, the growing demand for jobs was bolstered by baby boomers who were entering the labor market, but more significant was largely the result of a growing employment rate among women (cf. the European Commission (EC) 1996, p. 23). This was a very welcome consequence of the process of modernization in society. Indeed, the employment problem would have been all the more dramatic if the European employment rate of slightly above 60 percent throughout the 1990s (except in Sweden and Denmark) equaled that of the U.S. at 72 to 75 percent. A genuinely new factor in the current process of internationalization that is typical of the globalization cliché is the internationalization of money and financial capital. This is the release or so-called unleashing and disembedding of money as money and not as a means of exchange, circulation or payment (cf. Altvater/Mahnkopf 1996, pp. 129 ff). It is the transition to what is termed casino capitalism. This is a form of capitalism in which real production plays an apparently ever decreasing role, but in which there remains interdependence between the spheres of money capital and production due to the circulation of monetary capital and productive and goods capital being consumed with each other. In this respect, the processes associated with the globalization of money in the context of embedding also involve regional and national production processes. In addition, the current processes involved in the internationalization of money capital and the possibilities for making production more flexible internationally are being given a tremendous boost by the development of new information and communications technologies. The creation of a common internal market and European monetary union is also seen as a response to advancing globalization. With the realization of a large common internal market without trade restrictions, not only should international competitiveness make Europe stronger, but this should at the same time bring about new growth potential leading to positive developments in the labor market. Even though a total of 9 million jobs were created in the EU between 1986 and 1990, about 4.4 million jobs were lost between 1991 and

52 Reiner Hoffmann

1996 and the unemployment rate rose to 11 percent. Clearly, the expectations of the Commission’s employment policy are far from being fulfilled. Hence, globalization safely can be ruled out as a primary cause of unfavorable developments in the labor market. Rather, the restricted increase in economic growth of only 1.6 percent between 1991 and 1996 (although there was noticeable growth of 3.3 percent from 1986 to 1990) and a considerable increase in productivity rank high among the fundamental causes of the employment crisis. The extent to which the final shape of monetary union, which came into force on January 1, 1999, will contribute to an employment miracle, or prove to be a job killer, is pure speculation. The monetary convergence criteria have certainly restricted possibilities for the European states to facilitate employment policy, particularly with regard to public spending programs. On the other hand, there is no doubt that progress toward convergence over recent years has clearly been successful in fighting inflation. This, in turn, has made it possible to bring down interest rates, a development that has had a generally positive effect on the whole economy.

FULL EMPLOYMENT UNDER ALTERED SOCIO-ECONOMIC CONDITIONS

Against the background of the current employment situation and far- reaching structural changes to the labor market in the member states of the union, it is necessary to rethink the traditional concept of full employment in the context of a European employment strategy. The concept of full employment which is based on the so-called standard employment relationship and which corresponds to the traditional image of male skilled workers is becoming increasingly less realistic. A new understanding of the term “full employment” is now required, which, to a far greater extent, and against a background of the altered socio-economic conditions, takes into account new and challenging forms of employment. In particular, the increasing scope of “atypical” employment, whether part-time, piecemeal or fixed-term, all of which are found in one form or another throughout the European Union, requires a structure that goes beyond the traditional concept of normal working conditions. But the neo- liberal concept of deregulation is hardly promising, as the British example among others teaches us. What is necessary is a new social vision of working conditions, a European concept of labor-related regulatory reform that corresponds to the altered requirements of both employers and female employees.

53 Responses to Globalization in Germany and the United States: Seven Sectors Compared

Part-time employment in Germany rose from three million jobs at the beginning of the 1980s to over 5.9 million by 1997, including just under 17.5 percent of the workforce. These figures place Germany in the middle of the European spectrum. Among employed women, 90 percent have part-time positions and represent the largest group to be so employed. The rising number of women who are available for work is due not only to economic factors, but is also the result of broader transformations of social organization and at least to some extent to improved equal opportunities for women with regard to recruitment into the job market. Furthermore, this increase is an indication of the altered understanding of the role of women in the gender-specific division of labor. Nevertheless, now as before, discrimination continues to exist, as does opposition to reform, as a result of efforts to reduce unemployment and as the consequence of promoting equal rights (Rubery 1999). A labor market and employment policy that is oriented towards normal working conditions does no justice to equal rights for women. To ensure equal rights, a practicable concept for full employment should take into consideration the increasing number of women who are coming into the job market. Ultimately, it is also social and cultural changes and the pluralization of lifestyles which affect the labor market and which demand a different concept of employment. The Green Paper on European social policy by the European Commission states amongst other things, that “the profound process of transformation into the post-industrial society can no longer be reversed.” This begs the question, “What will society look like in the future, and what role will labor play in that society?” (Commission 1993 pp. 17 ff.). It would be foolhardy to draw the conclusion that such a debate would distract from the urgent goal of overcoming mass unemployment. To the contrary, this premise would hinder the possibilities of actively proceeding with the further development of the certainly imperfect yet distinctively European social model and the development of a European labor market offensive. In other words, the European integration process and preparation for EMU can be exploited to this end, to form an offensive concept in order to react to the basic and long-lasting changes in the structure of the labor market. A great deal of flexibility that takes into account the various interests of the female workforce and that supports new demands made by business requires reform of labor market institutions, not their abolition.

54 Reiner Hoffmann

ALLIANCE FOR JOBS: THE APPROACH OF THE NEW GERMAN FEDERAL GOVERNMENT

In January 1999 the new federal government introduced its first annual economic report with the program title, “Fresh Paths towards a Better Economy.” The most important aim of the new government was the “reduction of the level of unemployment, which is far too high.” Drawing on experiences from other European countries and in the context of three closely related elements—the economy, trade unions and polices in the fight against unemployment—the initiative aims not only at reforming labor markets and social welfare institutions, but also at bringing commerce and industry, the trade unions and the new government to the table in an alliance for jobs. In its report, the government advocates a policy of wage moderation for the social partners, in the context of reductions of taxes on profits and assets. Page eighteen of the report deals again with distribution of income. Among other things, it states: “. . . the relative position on distribution in the previous year clearly shows a more favorable shift in favor of companies and capital gains. Salaries and wages in real terms increased by 1.6 percent. By comparison, the sharp rise in gross income from business activities and assets (8 percent) exceeded expectations with an actual increase of 9 percent.” The government estimates the current jobs deficit in Germany to be over six million. It is not sufficient, in their view, to base this only on registered unemployed figures. The figure “must also include those people whose jobs are supported by the state who are in the so-called ‘secondary labor market,’ as well as those who benefit from other labor market policy measures” (p. 10). Policy-supported labor market segmentation in Germany emphasized clear gaps in productivity within the economy as a whole. Measured in nominal gross national product per employee, total economic productivity in 1998 in East Germany hovered around 60 percent of the West German level. The considerable competitive disadvantage of the East German Länder was due, among other things, to the fact that wage increases far exceeded the increase in productivity. “The income of workers who were not self-employed per worker in 1998 was around 74 percent of the West German level . . . The unit labor costs were therefore, on average, far higher than in West Germany. In 1998 wage costs per unit of production in East Germany were about 24 percent above the West German level, after having reached a difference of about 23 percent in 1997” (p. 10). In 1998 for the first time there was a clear improvement in the labor market. At the end of December 1998, 4.1 million people were registered as unemployed. This meant a fall of 300,000 against the previous year. In West

55 Responses to Globalization in Germany and the United States: Seven Sectors Compared

56 Reiner Hoffmann

Germany the number of unemployed people was at almost 2.9 million, which was 180,000 lower than the previous year. In the eastern Länder the number of unemployed people fell by approximately 150,000 from almost 1.3 million. This was predominantly attributed to increased use of labor market policy measures that had been vigorously followed. In all, after three years of declining wage unit costs, Germany can learn from a restrictive wage policy (p. 20). For 1999 it is calculated that, due to the slowdown in growth, the number of people employed in Germany will increase only slightly. Demographic trends will ease the labor market situation in Germany, as an overall decline in the number of people of employable age is anticipated. The estimated 4.1 million jobless corresponds to an unemployment rate of around 10.5 percent of the workforce. This means a reduction of only 0.6 percent (11.1 percent) over 1998. “With a yearly average of the number of unemployed people at just under 2.8 million, the unemployment rate for West Germany was around 9 percent, compared to 9.4 percent over the year. With over 1.3 million unemployed people in 1999, the unemployment rate in the eastern provinces fell to around 17.2 percent of all employable people from the previous year’s 18.2 percent. The projected economic growth rate of 2 percent is far too low for significant reduction in unemployment. In this situation, labor market policy has an important role to play” (p. 34). In common with the preceding Christian Democratic-led government, the Red-Green coalition considers the creation of additional jobs to be a vital national task that requires ever greater European commitment (p. 38). EMU already prompts particularly strong coordination of fiscal policies not only among EU member states, but also among the Group of Seven (G7). Coordination and cooperation means that the single macroeconomic policy areas—monetary, finance and wage policies—work together without conflict so that more job creation results from price stability (p. 39). At least according to the European Commission, it is a matter of an appropriate mix of supply and demand policy at the national and European levels. Hence, strengthening of domestic economic growth should top the agenda of European authorities. As has been officially recognized since the Essen summit, a coherent employment strategy consists of coordinated national and European employment policy efforts. Two initiatives—the alliance for jobs, training and competitiveness and the European employment pact proposed by the German government— comprise the most recent articulations of this principle. The Red/Green agenda for the alliance for jobs, training and competitiveness refers to twelve areas for action:

1. long lasting reduction in the statutory non-wage labor costs as well as

57 Responses to Globalization in Germany and the United States: Seven Sectors Compared

structural reform of social security; 2. distribution of work designed to promote employment and flexible working times, enabling overtime to be reduced (working-time banks) as well as the development and promotion of part-time work; 3. company tax reform, especially to ease the burden on medium-sized enterprises by January 2000; 4. improvement of innovation and competitiveness in business enterprises; 5. greater flexibility in early retirement schemes, respecting existing legal age limits for retirement, pay agreements and company-specific regulations; 6. wage policies that support job creation; 7. improved access to venture capital by small and medium-sized enterprises; 8. enhanced opportunities for employee participation in company equity- sharing and profit-sharing schemes; 9. involvement of employees in the promotion of innovation and competitiveness; 10. further progress in removing structural barriers to firm start-ups and business development; 11. opening of new areas of employment and training for poorly qualified workers; and 12. expansion of the scope of labor market policy instruments to be deployed in the battle against youth and long-term unemployment.

A pay policy oriented towards medium-term productivity development deserves special attention. Though labor costs continue to be a most important component of the national economy, it is well known that wages also comprise the most important single element of aggregate demand, i.e., private consumption. Addressing employers, the report is emphatic in stating that if wage growth lags behind productivity increases in the medium term, unemployment cannot be fought with wage restraint, as has been the case since 1996 in West Germany. The past three years have shown that this reaction offers no solution to the employment problem. The point has been made before the White Paper, “Growth, Competitiveness and Employment” (Commission 1993), argued that since the beginning of the 1980s in Europe real wages have constantly lagged behind productivity growth—indeed much more so than in the United States. During the same period, employment has lagged significantly behind performance in the United States.

58 Reiner Hoffmann

That said, in the EMU context, indications are that in view of different levels of productivity and the different growth rates in productivity across EU member states, greater differentiation of pay levels are necessary, as are EU- wide pay settlements (p. 50). The same ménage is conveyed explicitly in the German government’s alliance for jobs paper in the chapters on “European integration” and “European employment policy.” Turning now to action at the EU level, the German government’s proposal for a European employment pact may be summarized in four imperatives:

1. coordinate economic, financial, monetary, and currency policies more tightly; 2. improve implementation of the employment policy guidelines and the national employment policy action plans; 3. reform structural policies required for the functioning of goods, services and capital markets within the single market and for increasing business competitiveness; and 4. develop the details of the European employment pact and outline the “Essential Features of the Employment Policy,” including the identification of the decisive instruments for coordination at a European level (p. 69).

EMPLOYMENT PACTS IN EUROPE: EXPERIENCES IN IRELAND, ITALY, PORTUGAL, AND BELGIUM

An alliance for jobs is in no way a German specialty. It has been frequently overlooked, until recently, that similar initiatives have been in existence for many years in several other EU member states. Such institutionalized forms of concertation constitute the very foundations of industrial relations in the Scandinavian countries and in the Netherlands. Indeed, social pacts, which have not led to further erosion of industrial relations, but to their further development and stabilization, while also strengthening macroeconomic coordination, have also been agreed upon in countries with a lesser degree of institutionalized concertation, such as Ireland, Italy, Portugal, and Belgium (Fajertag and Pochet 1997). Any comparison between and analysis of the efforts to develop social pacts in various European countries must take into account the still existing differences between national systems of regulation, especially with regard to industrial relations. In the following section, the experiences of Ireland, Italy and Portugal are briefly outlined and some conclusions drawn in relation to the European employment pact discussed in the concluding section.

59 Responses to Globalization in Germany and the United States: Seven Sectors Compared

In Ireland, under the pressure exerted by the catastrophic labor market situation, the employers’ federations and the government concluded a Program for National Recovery back in 1987. This was followed by the Program for Economic and Social Progress (1991-1993) and the Program for Competitiveness and Work (1994-1996). Taken together the pacts seek to modernize the economy and industrial relations through a wide-ranging development process. In the Program for Competitiveness and Work (PCW), total pay increases of 8.25 percent for the period 1994 to 1996 were negotiated, against the background of a forecasted 7.5 percent increase in the price index. Alongside the preservation of real earnings, the PCW placed emphasis on fostering employment and creating new jobs. However, its successes proved no more than modest. It is true that the level of the national debt was further reduced and the rate of inflation in Ireland has fallen to 2.5 percent. The unemployment rate—11.8 percent—is still high, but significantly lower than in 1993 (15.6 percent). Even so, the Irish agreements deserve our attention, particularly because of their approach to fostering economic enterprise and vocational training measures at the local level. In the closing months of 1996, a new national agreement, Partnership 2000, was concluded and was ratified by the unions in January 1997. In brief, this agreement retained the same priorities as other agreements but with different emphases—the development of partnership structures at the workplace level, protection of living standards and development of measures to tackle the prevailing experiences of social exclusion. In Italy a major contribution to stabilizing industrial relations was made by the “social pact” concluded in 1993 between the trade unions, the employers and the government. The agreement provides for two rounds of meetings per year between the three groups. In the spring round of talks the guidelines for public expenditure, the forecast inflation rates, GDP, and employment growth are laid down, while the autumn round is held to discuss the measures required for implementation of the budgetary policy goals. This consultation with the social partners is intended to give the trade unions a maximum degree of indirect participation in macro-economic developments. This “concertation policy” was accepted by the center-right coalition, the transitional government and continued by the “Olive Tree” coalition. Of particular importance in the context of this agreement are the solidarity contracts (contratti di solidarietà) which are regarded as an instrument for remedying the employment crisis by means of work-time reductions. Compensation for loss of income due to less working time varies between 50 and 70 percent depending on the company’s size and the sector involved. Funds allocated for redundancy payments may be used to finance this kind of measure. Also under the terms of the “new social

60 Reiner Hoffmann partnership” a compromise was reached, after much controversy, on the reform of the pension system. The consultation among the government and the social partners led, in September 1996, to a major agreement, the Pact for Employment. Questions relating to working hours and flexibility of working relations were tackled comprehensively in this agreement. The Pact for Employment aims to:

• strengthen and extend the effectiveness of pro-employment policies; • promote new infrastructure investments; • strengthen human capital via initial and continuing training; • render labor market instruments more appropriate; and • review certain forms of employment relations.

In Portugal, too, the political changes that followed the parliamentary and presidential elections seemed to lead to a change of direction in the labor market policy debate. In January 1996 a tripartite agreement was signed between the UGT (a trade union confederation), the employers’ federations and the government. The principal components of this agreement included a reduction in the normal statutory working week to forty hours in conjunction with the introduction of a provision for flexibility and a general guideline for the 1996 collective bargaining round—a 4.5 percent nominal pay increase, alongside projections for inflation of 3.5 percent and productivity increases of 2 percent. The CGTP (the other major trade union federation) considered the agreement to be unacceptable from both an employment policy and free collective bargaining standpoint and therefore did not sign it. Already under the neo-liberal government of Prime Minister Cavaco Silva, a medium-term “economic and social agreement” had been signed in the Permanent Council for Social Concertation by the employers’ federations and the two trade union confederations (CGTP and UGT). This had been preceded at the end of the 1980s by widespread protests against the policy of deregulation conducted by the government. The tripartite agreement is also viewed as an expression of the new government’s hopes of reviving the dialogue with the trade unions. It was intended as the point of departure for further negotiations on a strategic agreement combining measures in various policy fields designed to achieve, in the medium term, greater competitiveness, growth in employment and improved social cohesion. The extent to which the tensions between the trade union confederations (CGTP and UGT) can be relaxed will also depend on the success of this agreement. A significant factor here is the Maastricht convergence criteria and the austerity policy conducted to meet them, for this has been explicitly rejected by the CGTP. Also of considerable significance is

61 Responses to Globalization in Germany and the United States: Seven Sectors Compared the agreement on collective bargaining in the public sector signed by the UGT (FESAP and STE) and the CGTP (Frente Commun). This stipulates a maximum working week of 39 hours and further phased reductions designed to lead ultimately to a 35-hour week. It is also intended that negotiations should be held to decide on measures for the reduction of “precarious” employment contracts. On December 20, 1996, the government, the main employers’ federations and UGT signed the wide-ranging “Agreement on Social Consultation,” which provides for measures regarding the promotion of employment, incomes policy, education, and vocational training, among other things. The agreement is planned to run until 1999 and has direct significance for the 1997 pay round insofar as it specifies a reference figure of 3.5 percent for nominal pay increases. The experiments with “social concertation” in Belgium have not to date, as far as the trade unions are concerned, produced significant effects in employment policy terms, while the wage freeze decreed by the government for 1995 and 1996 represented a clear case of interference in the process of free collective bargaining. Back in May 1993, after heated discussion and controversy, an agreement between the trade unions and the employers was concluded. This covered the employment of young workers (under age twenty- six), accompanying measures in the event of company restructuring, career breaks, and the introduction of part-time work combined with part-time early retirement starting at the age of fifty-five. The tripartite negotiations in April were intended to achieve a “Contract for the Future of Employment.” However, one of the national union confederations, the FGTB, declared it was unhappy that the draft pact contained no adequate guarantees on job creation. After the idea of a national pact had fallen through, the government adopted three framework laws on competitiveness and employment, the future of social security and budget policy which, by and large, included all the major points of the draft pact. Under the new legislation, future pay developments must be in accordance with those in France, Germany and the Netherlands—Belgium’s three most important trading partners.

CONCLUSIONS:PROSPECTS FOR A EUROPEAN EMPLOYMENT PACT

Labor markets in Europe are in the throes of structural change and curbing mass unemployment still constitutes one of the greatest challenges facing the European Union. Though the effects of globalization, deriving in particular from more acute international competition, should not be underestimated, experiences in numerous European countries nonetheless show that neo-liberal

62 Reiner Hoffmann deregulation of labor markets is not an appropriate response to structural change. Rather, various experiments conducted in the EU member states, and the initiative for a “jobs alliance” in Germany, indicate that structural problems in the labor markets can be tackled more effectively by means of social dialogue. Now that monetary union is in place, individual national initiatives are quite simply inadequate. Relatively stable industrial relations have always represented a central component of the European social model, though there can be no denying that this model currently stands in urgent need of modernization. Under conditions of economic and monetary union and increasing globalization there is an ensuing need to develop supranational structures to complement the existing national ones. The adoption of the so-called “Employment Title” in the Amsterdam Treaty creates for the first time a real opportunity for steps to be taken at European level to tackle the employment crisis and modernize labor markets. The new title does not merely acknowledge that employment policy is a matter of common interest for the EU member states; it also stipulates the development of a coordinated European employment strategy. To this end, concrete European employment policy guidelines were adopted for the first time in November 1997 for incorporation by the member states into national action plans to be submitted, on an annual basis, to the EU Council of Ministers. At the EU Council meeting held in Vienna in December 1998 it was further agreed to devise a European employment pact for presentation by the German presidency at the Cologne summit in June 1999. The idea of such a pact is not new but is based on ideas which—as shown—have in some countries led to employment policy successes with the active involvement of the social partners and which have simultaneously contributed to regulation of labor markets and social security systems. European-level initiatives along similar lines had been earlier proposed by Commission Presidents Delors and Santer, but were given no real follow-up. The medium-term employment pact agreed upon in Cologne has enabled the achievement of a new quality at the European level, in pursuit of three goals:

1. From a macroeconomic standpoint it is a question of achieving a smooth and tension-free interplay of fiscal and monetary policy and pay developments. 2. The employment policy guidelines based on the Amsterdam employment chapter are to be developed and made more effective. 3. Structural reforms to improve competitiveness and the operation of markets for goods, services and capital are to be stepped up.

The qualitatively new element consists of the so-called macroeconomic dialogue, intended to achieve a successful policy mix, 63 Responses to Globalization in Germany and the United States: Seven Sectors Compared

64 Reiner Hoffmann incorporating fiscal, monetary and income policy components. The European Central Bank will also be a party to this dialogue, to be held twice a year. The involvement of the ECB is in keeping with an important trade union demand. While not denying the need for the European Central Bank to remain independent in the presence of a single currency, the unions have stressed that this body should not seek exclusively to achieve price stability, but should at the same time pursue, as an equally important goal, non-inflationary growth geared to raising the employment level. Though it is not possible to analyze here in detail the “three pillars” of the European employment pact (see diagram), two central conclusions of significance in the context of the globalization discussion may be drawn from the European experiences. First, to some extent, the process of European integration and monetary union represent answers to the process of globalization. They entail the creation of new supranational instruments enabling the implementation of new levels of regulation, which, in the context of a global economy, will become increasingly important. The need for an integrated employment and macroeconomic strategy and for international coordination was indeed also stressed at the G-8 meeting of employment ministers in February 1999. Secondly, it can be clearly shown that mere deregulation of the institutions of the labor market is an inappropriate response to the spread of globalization. The European experience offers precise examples of how to strengthen the social dialogue at supranational level. The formulation, implementation and evaluation of the employment policy guidelines strengthen the position of the social partners by giving them new tasks and functions at both the national and the supranational level. At the beginning of this year the International Labor Organization in Geneva stated that social dialogue, a well-conceived macroeconomic policy mix and a problem-oriented labor market policy are the factors which, in several European states, have led to a relatively successful employment policy. Approaches of this type lend themselves to the modernization of labor markets under conditions of globalization, with a view to raising the level of employment as a means of combating and ultimately overcoming the scourge of unemployment.

REFERENCES

Altvater,E., Mahnkopf, B. 1996. Grenzen der Globalisierung, Münster. Bundesministerium der Finanzen. 1999. Neue Wege zu mehr Beschäftigung der Bundesregierung, Bonn.

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Commission of the European Communities. 1993. Growth, Competitiveness, Employment – White Paper, Luxembourg. European Commission. 1996. Employment in Europe 1996, Brussels. European Commission. 1997. Employment in Europe 1997, Brussels. Fajertag, G., Pochet, P., eds. 1997. Social Pacts in Europe, Brussels. Foden, D. 1997. “Europe and employment – high priority but modest progress,” in Gabaglio, E., Hoffmann, R. European Trade Union Yearbook 1996 (Brussels, 1997). Hickel, R. 1998. Standort-Wahn und Euro-Angst, Reinbeck bei Hamburg. Hübner, K., Bley, A. 1996. Lohnstückkosten und internationale Wettbewerbsfähigkeit, Marburg. Ifo-Institut. 1996. Ifo - Schnelldienst Nr. 20. Krätke, Michael. 1997. “Globalisierung und Standortkonkurrenz,” in: Leviathan. Nr. 2. Westdeutscher Verlag, S. 202-232. Kuda, R. 1996. Arbeitsplätze, Produktivität und Einkommen, Hektographiertes Manuskript, Bonn. OECD. 1996. Globalization of Industry, Overview and Sector Reports, Paris (OECD - Publication Service). Schubert, L. 1997. The “European model” for growth and competiveness, Paper, prepared for the conference “Creating employment in Europe,” Brussels 16 - 17 January 1997. TRANSFER – European Review of Labor and Research, Quarterly of the ETUI. 1998. Final steps towards the EURO, Volume 4, Number 1, Antwerpen.

66 Daniel Fallon and Mitchell Ash

HIGHER EDUCATION IN AN ERA OF GLOBALIZATION Daniel Fallon and Mitchell Ash

As the economies of nations such as the United States and Germany continue to blend into a more integrated global economy, emergent markets create increasing pressure for standardization across nations and within nations. In higher education these pressures are manifested first and most clearly on curricula and certification requirements, and secondarily on the functional development of an educated workforce. In the United States and in Germany new wealth is now being created more by information, management, services, and technology than by the mainstays of the preceding industrial revolution: agriculture, heavy industry and manufacturing. This distinctive shift in resource production can be called a new economy, and it thrives upon stable governments, international legal conventions, transparency in the flow of information, and other features that are characteristic of the ideals of modern democracies. At the same time the new economy requires a critical mass of intellectual capital, and this requirement sustains pressure toward a high level of education for the general citizenry. In the United States and in Germany there has been since 1960 a stunning increase in participation among citizens in higher education. The phrase “mass higher education” is commonly used to refer to this phenomenon, but it is poorly understood, and is sometimes casually used to describe structural inadequacies such as overcrowded classrooms. It is deserving of a more precise definition. For example, one might define mass higher education as a situation in which more than 50 percent of citizens twenty-five years of age or older report some exposure to education beyond the secondary school level. This measure is easy to obtain in the U.S. because every year since 1900 the United States Bureau of the Census has asked a sample of citizens: “How many years of schooling have you completed?” The responses have been tallied by age group, and routinely aggregated for citizens twenty-five years of age or older. By this measure, the U.S. crossed the threshold of mass secondary education (50 percent reporting more than eight years of schooling) in 1910, and of mass higher education (50 percent reporting more than twelve years of schooling) in 1968. Strictly comparable figures do not exist for Germany, but available evidence implies that Germany does not yet have mass higher education, although it is rapidly approaching that milestone and likely to experience it within a few years. In the Federal Republic of Germany, enrollment in institutions of higher education increased by more than a factor of ten from the early 1950s to the early 1980s, rising from about one hundred thousand students to more than one million. Reflecting the democratization of its society and the integration of its

67 Responses to Globalization in Germany and the United States: Seven Sectors Compared economy into the world economy, the character of the student body also changed dramatically. By the mid-1980s about 40 percent of the students in German universities were women, and those from what might reasonably be considered the “working classes” comprised almost 15 percent. In 1950 the proportion of persons in Germany who were the right age to attend the university and who did attend was about 5 percent, and by 1980 that number had increased to more than 25 percent. These changes were in keeping with global trends in advanced market economies and were symbolic of a more inclusive, more participative, German political economy. Although the phrase “mass higher education” is occasionally heard in Germany, the term “mass university” is more common. It is valuable to distinguish the idea of higher education, which encompasses a broad range of institutions and purposes, from the idea of the university, which is characterized by specific Humboldtian principles, especially the authority to award the Ph.D. and other doctoral degrees. Mass higher education enjoys wide acceptance in the U.S., in part because it has developed as a diverse highly differentiated collection of very different kinds of institutions, providing many different alternatives to students at varying prices and with varying accessibility. In Germany, which largely lacks such alternatives, attention has been focused on the one most visible institution: the university. In fact, in Germany today more than 70 percent of students in higher education are enrolled in universities. The remainder are in teacher education colleges, schools of theology, art academies, comprehensive technical colleges (Fachhochschulen), and specialized institutions. This is in stark contrast to the U.S. where about 20 percent of students in higher education are enrolled in universities, and the remainder are in comprehensive four-year colleges or in two-year community colleges. The long-term trends toward an increasingly better educated population have occurred along with fundamental changes in the underlying political economy. It is not scientifically possible to say whether one of these changes caused the other, and in any case approaching the question in this way may not be analytically valuable. Nonetheless it is possible to describe the emerging political economy of the West in the context of globalization, and to assert confidently that mass higher education is essential to its maintenance. Therefore, mass higher education will be a feature of both United States and German societies in the foreseeable future. As many commentators have noted, sometimes sardonically, more years of education do not automatically mean better education. Particularly in terms of the challenges of globalization, important questions still need to be addressed concerning the content of mass higher education, the forms it will take, and whether the necessary changes can be accomplished gradually or will require

68 Daniel Fallon and Mitchell Ash radical reform. Policy analysis, including considerations of history and political culture, is needed to answer these questions.

HISTORICAL PERSPECTIVES

The national boundaries of both the United States and Germany have changed since 1900, and both nations participated in two world wars with profound consequences for each of the two nations, especially Germany. Education, by its very nature, is highly dependent upon political and social infrastructure. Therefore, the political, social, and economic foundations for the educational systems of the two nations have an enduring effect on the nature of the lively discourse about higher education currently underway in both countries. In the U.S., the debate over expansion of the franchise for education has historically centered on whether education can be considered a “private” or a “public” benefit. Of course, education is beneficial for both individual and community ends, but the nature of American democracy has required public consent to public finance, and thus has stressed justification for support in terms of public consequences. For example, at the height of the industrial revolution in the U.S., in the late 19th century, there was consensus that primary schools could be supported by tax dollars. Initially, secondary schools were widely regarded as preserves for a social elite, and there was extensive resistance to the idea of paying for them with public tax dollars in the same way as for grammar schools. State courts, especially in Michigan, ultimately established a firm legal basis for universal public secondary education. Public expenditures for higher education accelerated in the latter part of the 19th century when its purpose was firmly grounded in the public benefits of support for agriculture and engineering. That franchise was greatly extended, and further democratized, when veterans of the Second World War were granted benefits by the U.S. Congress in 1945 to pursue higher education at government expense. The current structure of higher education in the U.S. is a direct outgrowth of the broad democratic political economy that supports it. The diversity of the polity, and its responsiveness to changing economic circumstances, accounts in large measure for the differentiated missions of higher education, delivered through a complex mix of “private” and “public” institutions, two-year and four-year colleges, and research universities. One of Germany’s great gifts to the world has been the reforms in Prussia affected by Wilhelm von Humboldt at the beginning of the nineteenth century. These not only created the persuasive academic basis for the modern research university through the founding of the University of Berlin in 1810, but also

69 Responses to Globalization in Germany and the United States: Seven Sectors Compared included the restructuring of secondary education through Humboldt’s elaboration of the school plans for the Lithuanian territories. In a thoroughgoing radical reform, Humboldt’s design drove poorly educated teachers out of the secondary schools, to be replaced by students educated at the new university. Humboldt envisioned an evolving state, subject to continual improvements over time, in which wise ministers nurtured a fiercely independent academic resource, the university, which, in turn, provided even wiser ministers to successive governments. The rapid adoption of Humboldt’s basic designs for universities and for gymnasia can best be explained by the exceptional persuasiveness of their logic, and their suitability to the political economy of the emerging German nation state. By the turn of the century, however, a widening gap yawned between the ideals of Humboldt’s conception and two modern realities: the rise of the modern system of specialized, often large-scale research and the parallel growth of an expert society with increasing demand for academically trained, but not necessarily broadly educated professionals. One response in the Imperial era (1870-1914) was a remarkable diversification of higher education through the creation of new academies for middle-level professionals, such as elementary school teachers and social workers, and the enhancement of the standing of existing technical academies to be co-equal with that of the universities. A second response was to reconstruct Germany’s research system by adding prestigious extra-university establishments such as the institutes of the Kaiser Wilhelm Society (KWG) to the existing mix. Interestingly, the leading spirit behind the KWG, theologian and science manager Adolf von Harnack, cited Humboldt in support of new institutions that actually undermined the Humboldtian ideal of the unity of teaching and research. In the Weimar era (1919-1933), Humboldt’s name was again invoked, this time as part of a rhetoric with which a culturally conservative professorate tried to defend its traditional standing in the face of what they took to be symptoms of modern decadence, such as overspecialization and the pursuit of mere knowledge without unifying values or a meaningful “world view.” Under Nazism the professors’ claims to leadership as well as the freedom of teaching and research disappeared, due to political manipulation but also to the passive acceptance or active collaboration of many German academics with the regime. Upon the upheaval in German society at the conclusion of the Second World War, a combination of events led to the development of two temporarily successful but ultimately untenable systems of higher education. In the Federal Republic of Germany the Ordinarienuniversität of the late 19th century was nostalgically idealized as a model. In the German Democratic Republic, the Humboldt tradition was at first co-opted and then systematically undermined in

70 Daniel Fallon and Mitchell Ash keeping with Marxist theories for asserting control of the means of production, which required the functional separation of research from teaching. At first the massive expansion of the universities in the Federal Republic of Germany (FRG) was supported by a consensus that crossed the entire political spectrum. In contrast to the cultural conservatives of the Weimar era, conservative modernizers in the 1950s sought to raise the number and quality of academically qualified professionals, while liberals and social democrats spoke of a right to higher education for all. After the student revolts of the late 1960s, however, this consensus evaporated. The inherent dissonance in the FRG between the elite Ordinarienuniversität and the increasing economic and political diversity of the burgeoning numbers of new university students led to rapid change by the early 1970s. One of the consequences was the sharp politicization of factions within the university, which continues to make achievement of a consensus solution elusive today. Lack of agreement on basic principles within the higher education community inhibited allocation of greater resources toward budgets for higher education. At the same time, federal planners projected decreasing enrollments in future years, basing their numbers strictly on birth rates and not anticipating broader participation in higher education. The result was wildly mistaken projections that vastly underestimated the current and future size of the student body. These two factors are the fundamental causes of the chronic underfunding that plagues German universities to the present day. In the German Democratic Republic (GDR), the name “Humboldt” was applied as a symbol to an ideology of socialist humanism that only barely masked the actual reversal of the ideals for which Humboldt had stood. In protest of the ongoing communist restructuring after 1945, a group of courageous, disciplined and well-organized students left the University of Berlin and succeeded in forming in the western sector of the city a new institution, The Free University of Berlin, in 1948. The communist authorities promptly renamed the original University of Berlin the Humboldt University of Berlin, a name it has carried from 1949 to this day. However, the unity and freedom of teaching and research were replaced in the GDR by the primacy of Marxism-Leninism and an ever-increasing rigidity of study programs to make them better suited to a planned economy. Reforms introduced in the 1960s did not lead to mass education in the GDR, but rather to the destruction of any remnants of the traditional system and the installation of a “new intelligentsia” loyal to the communist party. This successful politicization, along with the weakness of the planned economy, was primarily responsible for the widespread stagnation of the GDR universities in the 1980s.

71 Responses to Globalization in Germany and the United States: Seven Sectors Compared

The dissolution of the GDR in the early 1990s led to a comprehensive restructuring of higher education in the East, along lines compatible with universities in the West. The ironies here are obvious to many. The last GDR minister of higher education and the current minister for science and art in Saxony, Hans Joachim Meyer, spoke in 1991, in an ironic reference to Nietzsche, of a “transvaluation of values”; a higher education system that had been widely regarded as in deep crisis in the late 1980s suddenly became the best of all higher education systems. More ironic still, the term used for the wholesale transfer of West German institutions was “renewal.” Some innovations long proposed in the West, such as efforts to support interdisciplinary research and teaching programs and better cooperation between universities and extra-university research institutes, were introduced in the new German Länder. The chance, however, to use this extraordinary historical event as an opportunity for reform in the German system as a whole was largely missed.

GLOBAL STABILIZATION

Many observers feel that the debate over university reform in Germany today is nonconstructive, if not completely paralyzed, because of the magnitude of the financial, political and social problems it poses. At the same time, the need for functional reform is widely recognized, and many different small reform efforts are proceeding in various settings. Increasing globalization is beginning to have an effect on higher education in both the United States and Germany, pushing both nations toward a more orderly interface of their systems of higher education. The mechanism forcing more comprehensive solutions is a form of standardization, the process by which different structures inescapably merge to facilitate necessary transfer of goods and information. In the U.S., for example, public pressure has led to virtual universal acceptance of courses taken at the beginning levels of university by universities everywhere. Thus, a course in introductory psychology taken at an open-enrollment community college in one state will be accepted toward a degree by a prestigious selective-enrollment research university in another state. Similar facilitation of transfer between, say, Fachhochschulen, Berufsakademien and Universitäten, has begun to take place in Germany. Finally, among nations, there is an increasingly sophisticated knowledge of comparative higher education systems that is making it easier for students of either country to study in either Germany or the United States, and to have their courses and their credentials recognized in both places. Much of the pressure

72 Daniel Fallon and Mitchell Ash resulting in these functional changes is occurring outside of universities and governments. An example is the work of the Ringberger Kreis in Germany, which advocates a sophisticated differentiated higher education structure in Germany, with precise equivalents to the United States academic degrees of B.A. and M.A. Such cross-national standardization seems clearly to be driven by the increasing globalization of the political economy in which we live. The new economy, with its emphasis on information, is rapidly developing new technologies that are likely to accelerate cross-national standardization in higher education. Generically called distance education, university-based academic courses are increasingly being offered to students via electronic means on the World Wide Web. Unlike their predecessors on videotape and audiotape, the new courses permit authentic interaction and dialogue between instructor and student as instruction proceeds and have thus secured a following among even renowned scholars at outstanding universities. Security procedures have been mastered to permit academic quality control even when students are admitted to the course from remote locations in nations remote from the scholar’s office. These courses result in the accumulation of grades and credits that can be applied toward degree requirements, and can be transferred from one institution to another. The fact that they can be taught by professors in any nation and taken by students in any nation is likely to lead eventually to the adoption of international academic standards for what constitutes a course and appropriate academic performance by a student.

FINANCING

Perhaps the most important problem facing modern political economies as they move to enable mass higher education is the issue of cost. In this arena the differences between the United States and Germany are very large. Guided by its own history Germany has provided higher education at public expense. Humboldt viewed state and society as different expressions of the same phenomenon, in much the same way that Aristotle did. It never occurred to him to think of state and society as different entities; citizens were inevitably parts of society, and the society was the state. In turn it was the state’s responsibility to ensure that the society could function and thus the state must provide education for the citizens. The U.S., however, was a democracy long before it became a state. The revolution that created the U.S. made explicit through its constitutional structures that state and society were different, and that the state was subservient to the society it served. This has made the financing of education intimately dependent upon democratic processes in the U.S.

73 Responses to Globalization in Germany and the United States: Seven Sectors Compared

The distinction between “public” and “private” universities in the United States has been a topic of considerable fascination, and much fantasy, for German observers. One common stereotype encountered with high frequency in German public media and in general discussion is that the truly excellent universities in the United States are private universities that charge high tuitions and are thus accessible almost exclusively to an elite. Public universities, in contrast, are often regarded as facing the same problems of quantity and quality as German universities. This misconception has little basis in current or historical fact and is a significant impediment to serious cross-national consideration of higher education issues. In fact, since 1945 most “private” universities in the United States have pursued a strict policy of need-based admission, in which applicants are admitted exclusively on academic merit, and financial aid is then applied to ensure that every student who is admitted may attend, regardless of family income. Furthermore, since 1945 the policies of the federal government have resulted in significant public financing of private universities, almost all of which also receive financial support from the governments of the states in which they are located. At the same time, “public” universities have since 1970 become increasingly less dependent upon financial support from the states that created them, and receive today on average less than one-third of their annual budgets from legislatively appropriated tax dollars. Virtually all public universities now charge significant fees (tuitions) collected directly from students. Some private universities charge very low tuitions, and some public universities charge very high tuitions. There are outstanding universities of the highest academic excellence in private and public sectors, just as there are also mediocre universities in both. The financing of higher education in the U.S. is surprisingly similar for both private and public universities, and everywhere includes a mix of funds from four sources: (a) federal government; (b) state government; (c) the student; and (d) private contributions from individual philanthropists, charitable foundations, and business or industry. The gradual emergence of a pluralistic form of financing of higher education in the United States is a direct result of mass higher education. Secondary education is different for two reasons. First, students in secondary education live for the most part in the homes of their parents and the schools are, therefore, local. It is appropriate for such schools to be supported by local taxes, usually based upon property assessments. Second, secondary education is less expensive than higher education, and the costs can be kept within understandable limits for local governmental budgets. Neither of these conditions hold in the same way for higher education.

74 Daniel Fallon and Mitchell Ash

Higher education is by its nature usually removed from the locality of the student. There are good educational reasons for students to leave their parents’ homes and take up residence at or near the university they attend, and there is historical precedent for this pattern extending over many centuries. This makes it difficult to support universities based upon the tax revenues of localities, such as the cities or towns in which they are located. The tax base must be broader, which forces state or federal support. Second, higher education is more expensive. As a labor-intensive industry, one must compete for intellectual capital of a peculiarly special kind. Productivity is also inherently limited, as it always is in service industries highly dependent upon personal interaction. Research universities are capital intensive as well, requiring extensive laboratories, clinics, instrumentation, and libraries. The expense of higher education at the state level was affordable in the U.S. from public revenues as long as the numbers of students were relatively small. As the system began to accommodate more students, especially after 1969, the costs outran the abilities of the state governments to provide adequate financing. Compensatory financing was provided by a remarkable increase in federal support, primarily in the form of student aid, and in a requirement that students and their families assume a part of the financial burden. Although the financing of higher education in the United States is dynamic and not yet entirely settled, it seems clear that the final solution for this society characterized by mass higher education will be a pluralistic one, with a mixture of public and private charges. A pluralistic system of finance for higher education has some perhaps surprising benefits for the core activities of higher education. When all of the financing for an enterprise comes from a single source, then the financing authority necessarily gains extraordinary control over the enterprise. If a state government provides 100 percent of the budget for a local university, for example, this relationship facilitates the intrusion of the state into matters that are the traditional preserve of academic authority, including teaching and research. State governments can require that certain courses be taught. In actions that encroach on academic freedom, they can also prescribe elements of the curriculum within certain courses. They can direct that research be focused on immediate practical ends, and can discourage curiosity-driven inquiry. They can prescribe workload requirements that may be dysfunctional to the inherent purposes of a university. If finances come from many different sources, however, then the academic community has greater opportunity to preserve its own integrity and autonomy. German universities are currently struggling with the problems associated with financing higher education. The reasons for this struggle are quite similar

75 Responses to Globalization in Germany and the United States: Seven Sectors Compared to those that have caused the shifting pattern of financing in the United States, and are mirrored in other western nations facing the same developments. Germany must also face squarely the question of the fundamental role and mission of the university. History has bequeathed Germany a relatively rigid structure of higher education that has been overtaken in the latter 20th century by a dynamic democratic society and a political economy quite different from its founding premises. It is likely that the forces of globalization will continue to push Germany towards a more differentiated structure of higher education and a more pluralistic system of financing. Discussions currently underway in Germany concerning revisions in the university framework legislation (Hochschulrahmengesetz) reflect these external pressures, explicitly invoking the concepts of private higher education, greater choice for students among types of institutions, multiple sources of financing, local control of admissions, and sanctions against long-term students. It should be noted, however, that prospects for private universities in Germany appear to be quite limited; there have been some successful foundings, such as Witten-Herdecke and several Fachhochschulen, but these are such special cases, attracting relatively few students that they seem unlikely to contribute to a general solution for higher education in Germany. They may exert some competitive pressure on the public universities in some respects, but are not likely to be seen as credible genuine alternatives. This is due in part to restrictive taxation, foundation and inheritance laws that make it extremely difficult to raise funds in the necessary amounts. A more fundamental reason, which also accounts for the legal limitations, is that Germans continue to regard higher education as a public good and, therefore, to view its financing as the responsibility of the state. Perhaps the primary inhibiting factor for reform in Germany is that German scholars and the German public are not uniformly convinced of the value of mass higher education. On the contrary, the function of university education in Germany is hotly contested, with some voices calling loudly for a return to greater selectivity and invoking misperceptions of the American elite universities as well as mythical idealizations of the Humboldtian tradition. When former minister Jürgen Rüttgers pronounced in one of the debates about framework legislation that “Humboldt is dead,” loud protests came from both students and professors. In this context accessibility and excellence are viewed as mutually exclusive. There is as yet no solid basis in German political culture for the claim, quite obvious to most Americans, that it is not only possible, but necessary to combine relatively open access and high quality in higher education and research.

76 Daniel Fallon and Mitchell Ash

It is legitimate to ask whether everyone, even in the new economy, should have a university education, and a reasonable answer is no. That is why we stress the importance of distinguishing between university education and higher education. In the new economy it is indeed reasonable to assume that everyone should have a higher education, i.e., some education beyond the level of secondary school. In the United States there are rich opportunities for pursuing higher education in institutions that are not universities. In Germany there are not. Therefore, a priority for Germany must be to increase the variety of opportunity in higher education that is not centered exclusively in the university.

GLOBALIZATION: COMMON PROBLEMS AND A COMMON FUTURE

The obvious increasing interdependence of national societies within a globalizing economy will ultimately bring about a standardization of higher education in economically advanced nations, especially in the United States and Germany. Already faculty and students are beginning to work more successfully within a higher educational structure that recognizes similarities in their workload, their course designs, and their credentials. The forces of globalization are likely to push Germany toward a more differentiated structure of higher education and its finance, and at the same time push the U.S. toward an accommodating standardization of its credentials and curricula relative to international norms. It is a mistake to think of globalization as the victorious domination of one culture over another. Although some may claim that globalization is simply a code word for “Americanization,” the U.S. is no more immune to the forces of worldwide economic development than Germany or any other nation. In a global environment all national cultures will compromise with international realities, but fundamental differences between German and American political culture will remain. Competing globalization projects may emerge, or geographical spheres of influence, such as Europe and North America, may produce differing models within a more transparent global system. Nonetheless, human society faces a common future with common problems. Therefore, the standardization of higher education as a consequence of globalization will benefit not only Germany and the U.S., but also the world at large.

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78 David B. Audretsch and Maryann P. Feldman

INNOVATION AND GLOBALIZATION: A U.S.-GERMAN COMPARISON David B. Audretsch and Maryann P. Feldman1

INTRODUCTION

Globalization has brought large-scale economic changes that affect the competitive advantage of advanced economies. Germany and the United States provide contrasting models for comparing the way that economic systems respond to a single underlying economic force. Each country has a distinct set of institutions that determine the organization of economic activity and the potential to realize and profit from innovation. These institutions responded differently to globalization which, in turn, determined the ability of the economy to adapt and to restructure and innovate. These, in turn, led to large differences in economic performance. Ever since its famous Wirtschaftswunder, or economic miracle, of the 1950s the rest of the world has associated Germany with remarkable prosperity and stability, providing both high employment and wage rates. The German model of a Sozialmarktwirtschaft (social market economy) generated not only the material wealth found on the other side of the Atlantic, but also provided the high degree of social services and security found elsewhere on the European continent. Germany’s approach demonstrated that capitalism could not only generate a high and equitable standard of living, but that it could also have a friendly face. That the bottom would drop out of such a successful economic model has sent shock waves both throughout Germany and beyond its borders.2 As of December 1998, German unemployment exceeded four million people, or 10.6 percent of the labor force,3 the highest level since the pre-Nazi Weimar Republic.4 One of the country’s most widely read weekly magazines, Stern, responded with the headline, “Germany before the Crash?” and warned of unemployment levels exceeding five million people.5 Unemployment of such proportions threatens the once solid economic basis upon which postwar German democracy had been built. One of the most serious daily newspapers in the country, Die Zeit, pointedly asked, “Will Bonn become the Weimar Republic?”6 Such concerns reflect a social mood that is troubled and questioning. The public’s confidence in the economy and the government’s ability to manage the crisis has considerably weakened. This shaken confidence led to the defeat of the CDU and the reigning Bundeskanzler, Helmut Kohl, and

79 Responses to Globalization in Germany and the United States: Seven Sectors Compared the election of the SPD challenger, Gerhard Schröder, as a result of the September 1998 federal election. As economic growth stalled and unemployment began to ratchet upwards in the early 1990s, German reunification was frequently cited as the culprit. However, at the end of the decade, it is clear that the burden imposed on the West German economic model by absorbing eighteen million people from the former German Democratic Republic is not singularly responsible for Germany’s current problems. At the heart of the German crisis is an economic model that once served as the engine driving the Wirtschaftswunder but more recently has bogged the country down by impeding necessary structural change. An economic system that is no longer viable in the West has been rigidly imposed on the five new Bundesländer. By contrast, the United States has enjoyed the lowest levels of unemployment in decades. Labor markets are increasingly characterized by a shortage of workers, especially skilled workers. However, the wage and income gaps in the U.S. have continued to widen, which threatens social cohesion and sustainability. The U.S. has succeeded in generating new jobs, but the benefits have not been universally enjoyed, not evenly distributed. Most notable is the creation of a new economic ghetto occupied by the “working poor”—those who work full time at near minimum wage with minimal employment benefits, low job security and little chance for advancement. These two national economic experiences reflect widely different ways of organizing the economy and have dictated alternative responses to the global economic order during the past fifty years. This paper focuses on one particular aspect of Germany’s Sozialmarktwirtschaft and America’s entrepreneurial model—the way in which the systems of innovation have responded to the onslaught of globalization in the last decade. The systems of innovation embedded in the two distinct economic models have been traditionally thought to yield different sources of comparative advantage for Germany and the U.S. Typically, studies concluded that Germany held the comparative advantage in industries with a high level of human capital and skilled labor, such as machine tools, metalworking and automobile production. These industries tend to exhibit incremental rather than radical innovation. By contrast, the United States held the comparative advantage in high-technology industries that were based on radical, science-based innovation, such as computers, software and biotechnology. In the following, we discuss the process of innovation and then situate the German and American political economies with respect to globalization, according to some leading factors associated with innovation. We conclude by discussing an emerging economic model that leverages knowledge-based activity for broad based economic growth.

80 David B. Audretsch and Maryann P. Feldman

WHY DOES INNOVATIVE ACTIVITY MATTER?

Innovation is a critical process underlying growing dynamic changes in advanced market economies. Economic value is created through innovation that may involve new products, new processes or changes in organization. In contrast to a lowest-cost-competitive strategy based on reducing production to a simple essential element, innovation adds value by better addressing consumer needs. Profits arise from economic rents attributable to perceived value. Innovation changes the basis for competition in an industry and creates new industries. Most importantly, innovation begets further innovation in order to serve evolving consumer demand. To create value from innovation requires the input of skilled labor. Skilled labor facilitates the search for new and improved ways of doing things. This act brings about technical progress, which is one of the most important factors in explaining gains in real income.

THE TRADITIONAL VIEW

During the postwar era most trade and economic investment activity was confined to Europe and North America, and only at a later stage to a few of the Asian countries, principally Japan and the “Asian Tigers.” Comparative advantage was generally attained through large-scale production, which facilitated low-cost production through exploiting scale economies. Competitive low-cost advantage is based on large-scale mass production of standardized products. The relatively small domestic markets in Germany, as throughout most European countries, posed a serious threat to postwar competitiveness. However, Germany developed two strategies to compensate for restricted domestic markets. The first strategy was to develop export markets outside of the domestic market. This internationalization allowed German companies to take advantage of scale economies. The second was to rely on skilled labor and high levels of human capital to produce products that, although they might cost more, were of superior quality (Streeck, 1991; and Sorge, 1991). Large transnational corporations thrived in the postwar era on this dual strategy basing comparative advantage on large-scale production, itself made possible by superior management and organization combined with high-skilled labor. By and large, the comparative advantage of German producer was in moderate- technology products in traditional industries, such as machine tools, automobile parts, metalworking, chemicals, and the food industry.

81 Responses to Globalization in Germany and the United States: Seven Sectors Compared

Characterizations of German innovative activity have typically focused on its incremental nature. In his study on national systems of innovation, Nelson (1992) concludes that German success in innovative activity lies in incremental improvements in products and processes in existing industries. The bias towards incremental innovation over radical innovation in the German economic model is the direct result of long-term commitments between workers and firms, low worker mobility and a bias in financial institutions towards existing firms and technologies (Ifo Institute, 1997). According to Drtouzos, Lester and Solow (1989), Streeck (1991), and Sorge (1991), an institutional structure emphasizing consensus and long-term commitments has given Germany the capabilities to incrementally improve upon existing technological trajectories. Ergas (1998) was among the first to classify the national system of innovation in Germany as being diffusion-oriented. He defines the German approach to innovation as follows: “Closely bound up with the provision of public goods, the principal purpose of these policies is to diffuse technological capabilities throughout the industrial structure, thus facilitating the ongoing and mainly incremental adaptation to change” (p. 450). In addition, he argues that “diffusion-oriented policies seek to provide a broadly based capacity for adjusting to technological change throughout the industrial structure. They are characteristic of open economies where the state, bearing the interests of the firms in mind, aims at facilitating change rather than directing it.” As Streeck (1991), Sorge (1991), Audretsch (1989) and others have pointed out, the most significant feature of the German economic model is the depth and breadth of investment in human capital and the enhancement of workforce skills. In the German approach, workers are trained to possess the capabilities and competencies to increase the value of existing technologies through incremental and continuous improvements in products and processes. Embodied in the average worker is a high level of human capital. By contrast, the national system of innovation in the United States has been typically characterized as being focused on radical or breakthrough innovative activity (Nelson, 1992; Ergas, 1998). Training workers to possess the competencies to produce goods on existing technological trajectories is given lower priority than educating fewer workers to develop new ideas that lead to the creation of new products, processes and even industries. Innovations can be considered to be incremental when they are compatible with the core competence and technological trajectory of the firm (Teeceand Pisano, 1994). The implementation of such incremental innovations does not require significant change in the firm or its personnel. By contrast, a radical innovation can be defined as extending beyond the boundaries of the core competence and technological trajectory of the firm. Implementing a radical

82 David B. Audretsch and Maryann P. Feldman innovation would require significant restructuring in the firm and its personnel. The managed economy was designed to absorb change within a given technological paradigm, and hence, the typical firm excelled at incremental innovation. By contrast, in the entrepreneurial economy, the capacity to break out of the technological lock-in imposed by existing paradigms is enhanced.

POSTWAR COMPETITIVE ADVANTAGE

The industry life-cycle theory introduced by Raymond Vernon (1966) links trade and foreign direct investment to the stage of the life-cycle. No direct implications regarding the relevance of radical versus incremental innovations appear to prevail. But a more thoughtful examination of the framework of the industry life-cycle approach suggests that the relative importance of radical versus incremental innovations is shaped by this cycle. Several versions of what actually constitutes the industry life cycle have been advanced. For example, Oliver Williamson (1975, pp. 215-216) has depicted the industry life cycle in three terms:

Three stages in an industry’s development are commonly recognized: an early exploratory stage, an intermediate development stage, and a mature stage. The first or early formative stage involves the supply of a new product of relatively primitive design, manufactured on comparatively unspecialized machinery, and marketed through a variety of exploratory techniques. Volume is typically low. A high degree of uncertainty characterizes business experience at this stage. The second stage is the intermediate development state in which manufacturing techniques are more refined and market definition is sharpened, output grows rapidly in response to newly recognized applications and unsatisfied market demands. A high but somewhat lesser degree of uncertainty characterizes market outcomes at this stage. The third stage is that of a mature industry. Management, manufacturing, and marketing techniques all reach a relatively advanced degree of refinement. Markets may continue to grow, but do so at a more regular and predictable rate . . . established connections, with customers and suppliers (including capital market access) all operate to buffer changes and thereby to limit large shifts in market shares. Significant innovations tend to be fewer and are mainly of an improvement variety.

83 Responses to Globalization in Germany and the United States: Seven Sectors Compared

While not explicitly stated by Vernon (1966) or Williamson (1975), the role of R&D does not stay constant over the industry life cycle. In the early stages of the life cycle, R&D tends to be highly productive, so that there are increasing returns to R&D. Indeed, radical innovation tends to initiate new industries. In addition, the costs of radical innovation tend to be relatively high while the cost of incremental innovation and imitation tend to be relatively low. Because innovation in newly emerging industries tends to be more radical and less incremental, it is more costly to diffuse for economic application in lower-cost locations. By contrast, as an industry evolves over the life-cycle, the cost of radical innovation tends to increase relative to the cost of incremental innovation and imitation. Strong diminishing returns to radical innovative activity set in. This is not the case for incremental innovation and especially imitation. An implication is that it requires an increasing amount of R&D effort to generate a given amount of innovative activity as an industry matures over the life cycle. At the same time, it requires a decreasing amount of R&D expenditures to transfer new technology to lower cost locations, because innovation activity tends to become less radical and more incremental (Dosi, 1982 and 1988; and Nelson, 1990 and 1995). This means that information generated by R&D in mature industries can be transferred to lower-cost locations for economic commercialization. By contrast, the knowledge resulting from R&D in newly emerging industries cannot be easily transferred to lower-cost locations for economic commercialization. Thus, under the managed economy incremental innovative activity along with diffusion played a more important role. This type of innovative activity, while often requiring large investments of R&D, generated incremental changes in products along the existing technological trajectories. In the entrepreneurial economy, the comparative advantage of the high-cost location demands innovative activity earlier in the life-cycle. Early stage innovative activity consists of radical innovation, which is more involved in creating and developing new technological trajectories rather than following existing technological trajectories. In perhaps the most famous version of the industry life cycle model, introduced by Raymond Vernon, it was assumed that (1) the U.S. was the sole technological leader and the sole economic leader; (2) Germany was a follower, and (3) industries evolve over a technological life cycle, which is technologically driven by a declining innovative output from a constant input of new technological knowledge. As the technological leader, the United States experienced relatively high productivity, high average wages and non-wage benefits. According to Giersch, Pacque and Schmieding (1992), the German

84 David B. Audretsch and Maryann P. Feldman

Wirtschaftswunder was fueled to a considerable extent by relatively low labor unit costs and an undervalued currency. Thus, technology developed in the U.S. could simply be adapted. The end result was lower unit costs of production and international competitiveness in Europe. This implies that radical innovation can and will disperse. As Germany caught up to the technological frontier with the United States, German wages and non-wage income ultimately surpassed U.S. levels. For example, in 1995 the mean manufacturing employee compensation (including insurance and other employee benefits) was $25.71 per hour in Germany and $16.73 in the U.S.

THE IMPACT OF GLOBALIZATION ON COMPETITIVE ADVANTAGE

Germany’s postwar comparative advantage in the traditional industries has been lost in the last decade for two reasons. The first has to do with globalization, or the advent of competition from not just the emerging economies in Southeast Asia but also from the transforming economies of Central and Eastern Europe. While the uncertainties of the Cold War and internal political instabilities rendered transnational activities too risky during the first four postwar decades, this is less the case today. Costs of production, particularly labor costs, are considerably lower in these countries and jobs have moved to these locations. At the same time, the potential labor force of about 500 million in China and 350 million in India will put pressure on any increase in wage rate. The second factor triggering the loss of the traditional comparative advantage in Europe has been the communications revolution. New communications technologies have triggered a virtual spatial revolution in terms of the geography of production. The (marginal) cost of transmitting information has been reduced to virtually nothing. Confronted with lower cost competition in foreign locations, producers in the high-cost countries have three options apart from doing nothing and losing global market share: (1) reduce wages and other production costs sufficiently to compete with the low-cost foreign producers; (2) substitute equipment and technology for labor to increase productivity; and (3) shift production out of the high-cost location and into the low-cost location. Many European and American firms that have successfully restructured resorted to the last two alternatives. Substituting capital and technology for labor, along with shifting production to lower-cost locations has resulted in waves of corporate downsizing throughout North America and then Europe. This strategy has generally preserved the viability of many of the large

85 Responses to Globalization in Germany and the United States: Seven Sectors Compared corporations. As the record levels achieved in the 1990s by both European and American stock indexes indicate, the companies have not generally suffered. For example, between 1979 and 1995 more than 43 million jobs were lost in the United States as a result of corporate downsizing.7 This includes 24.8 million blue-collar jobs and 18.7 million white-collar jobs. Similarly, the 500 largest U.S. manufacturing corporations cut 4.7 million jobs between 1980 and 1993, or one quarter of their work force. Perhaps most disconcerting, the rate of corporate downsizing has apparently increased over time in the U.S., even as the unemployment rate has fallen. During most of the 1980s, about one in twenty- five workers lost a job. In the 1990s this has risen to one in twenty workers. This wave of corporate downsizing has triggered cries of betrayal and lack of social conscience on the part of the large corporations. But it is a mistake to blame the corporations for this wave of downsizing that has triggered massive job losses and rising unemployment in so many countries. These corporations are simply trying to survive in an economy of global competitors who have access to lower cost inputs.

COMPETITIVE ADVANTAGE BASED ON INNOVATION

There is, however, an alternative that requires neither sacrificing wages to create new jobs nor restrictive manipulations of the labor market to maintain wage levels and the social safety net. This third alternative involves shifting economic activity out of the traditional industries where the high-cost countries of Europe and North America have lost their comparative advantage and into those industries where the comparative advantage is compatible with both high wages and high levels of employment—knowledge-based economic activity. A recent body of empirical evidence clearly suggests that R&D and other sources of knowledge not only generate externalities, but studies by Audretsch and Feldman (1996), Jaffe (1989), Audretsch and Stephan (1996), Feldman (1994a and 1994b), and Jaffe, Trajtenberg and Henderson (1993) suggest that such knowledge spillovers tend to be geographically bounded within the region where the new economic knowledge was created. That is, new economic knowledge may spillover but the geographic extent of such knowledge spillovers is limited. The idea that geographic location is important to innovative activity in a world of e-mail, fax machines and cyberspace may seem surprising and even paradoxical.8 The resolution of the apparent paradox lies in a distinction between knowledge and information. Information, such as the price of gold on the New York Stock Exchange, or the value of the yen in London, can be easily codified and has a singular meaning and interpretation. By contrast, knowledge 86 David B. Audretsch and Maryann P. Feldman is vague, difficult to codify and often only serendipitously recognized. While the marginal cost of transmitting information across geographic space has been rendered invariant by the telecommunications revolution, the marginal cost of transmitting knowledge, and especially tacit knowledge, rises with distance. Von Hipple (1994) demonstrates that highly contextualized, uncertain, tacit, or what he terms sticky knowledge is best transmitted via face-to-face interaction and through frequent and repeated contact. Geographic proximity matters in transmitting knowledge, because as Kenneth Arrow (1962) pointed out some three decades ago, such tacit knowledge is inherently “non-rival” in nature, and knowledge developed for any particular application can easily spillover and have economic value in very different applications. As Glaeser, Kallal, Scheinkman, and Shleifer (1992, p. 1126) have observed, “intellectual breakthroughs must cross hallways and streets more easily than oceans and continents.” Together, globalization and the telecommunications revolution have drastically reduced the cost of transporting not just material goods but also information across geographic space. High wages are increasingly incompatible with information-based economic activity, which can be easily transferred to a lower cost location. By contrast, the creation of new ideas based on tacit knowledge cannot easily be transferred across distance. Thus, the comparative advantage of the high-cost countries of North American and Western Europe is increasingly based on knowledge-driven innovative activity. The spillover of knowledge from the firm or university creating that knowledge to a third-party firm is essential to innovative activity. Such knowledge spillovers tend to be spatially restricted. Thus, an irony of globalization is that even as the relevant geographic market for most goods and services becomes increasingly global, the increased importance of innovative activity in the leading developed countries has triggered a resurgence in the importance of local regions as a key source of comparative advantage.

THE AMERICAN KNOWLEDGE-BASED ENTREPRENEURIAL ECONOMY

What we described above is usefully conceived as search activity, or the creation and application of new ideas resulting in new economic knowledge. We also asserted that search activity cannot be transferred costlessly across geographic space. Economic activity engaged in the search process is inherently different from economic activity that is routinized. Routinized economic activity, by definition, is relatively certain. It is known what should be produced, how it should be produced, who will produce it, and for whom it will

87 Responses to Globalization in Germany and the United States: Seven Sectors Compared be produced. Search economic activity, however, is characterized by uncertainty. Inherent in search activity is uncertainty with respect to what actually should be produced, how it will be produced, for whom it should be produced, and who will produce it. Thus, search activity depends crucially on the creation of new ideas—that is, knowledge—and on the evaluation of that knowledge. New and small firms are particularly important because they provide the opportunity for people to implement new ideas that otherwise would be rejected or remain unexplored. In this way, new firms serve as agents of change. In an economy where comparative advantage is based on radical innovation, the ability of people to generate new ideas and pursue them is a central force generating high wages and an increasing standard of living. An economy whose comparative advantage is radical innovation requires a different industrial structure and a very different set of economic values. People who can create new ideas and implement them become highly valued. Because the global market for new products is virtually limitless, there is demand for workers, but the supply of workers able to produce innovative products is limited. Of course, the degree of uncertainty dictates that many of the new ideas, and therefore many new firms, will not, in fact, prove to be viable or successful. Those firms, and workers, abandon unsuccessful attempts and move on. Thus, the knowledge-based economy is in motion and is characterized by a high degree of mobility of people starting new firms to pursue, explore or implement new ideas. Those new firms that prove to be viable grow rapidly and expand employment. Those new firms based on an idea that is not viable will stagnate and ultimately exit the industry. What appears to be a turbulent and wasteful economy is actually the process by which new ideas are generated and explored, ultimately creating new high-paying jobs to replace those lost due to downsizing. The American industrial landscape has been transformed in a relatively short period of time from a static and rigid economy dominated by large corporations such as IBM, U.S. Steel and RCA to an economy in full motion where new firms are generating not just most of the new jobs, but also creating new industries. In the 1950s and 1960s it took two decades for one-third of the 500 largest corporations in America to be replaced. In the 1970s it took the entire decade to replace one-third of the 500 largest corporations. By contrast, in the 1980s, it took just five years. Perhaps even more impressive than the handful of new enterprises that grow to penetrate the elite club of corporate giants are the armies of startups that come into existence each year—and typically disappear into oblivion within a few years. In the 1990s there have been around 1.3 million new companies started each year in the U.S. The

88 David B. Audretsch and Maryann P. Feldman knowledge-economy is characterized by a high degree of turbulence. It is an economy in motion, with a massive number of new firms entering each year, but only a subset surviving for any length of time, and an even smaller subset, such as Microsoft and Intel, that ultimately become the new corporate giants. In the 1950s and 1960s the most important industries in the United States were steel and automobiles, along with other heavy manufacturing industries. In the present decade information technology has emerged as the largest U.S. industry. Information technology, which includes computing and communications, has grown by 57 percent during the 1990s, to $866 billion. In 1996 4.3 million workers were employed in information technology, at a mean wage level 73 percent higher than that prevailing in the private sector. Similarly, in Silicon Valley the mean wage level is 50 percent greater than in the rest of the country and at the same time, employment increased by 150,000 jobs, or 15 percent, between 1992 and 1996. The policy response to this new view of the knowledge production function has been to shift away from targeting outputs to focusing on inputs. In particular, this involves the creation and commercialization of knowledge. Examples include the promotion of joint industry, R&D programs, the transfer of technology from universities, education and training programs, and policies to encourage people to start new firms. As Saxenian (1985, p. 102) points out, “Attracting high-tech has become the only development game of the 1980s.” Justman (1995) and Justman and Teubel (1986) show how investment in scientific and technical infrastructure provides an important source of growth. The provision of venture and informal capital to facilitate the creation and growth of new firms has moved to center stage in policy debates (Hughes, 1997; Mason and Harrison, 1997). Laura Tyson (1994), former chair of the Council of Economic Advisors in the Clinton administration, emphasized the importance of government policies to promote entrepreneurship and new-firm startups. Audretsch and Feldman (1996) argue that industrial policies targeting the production and commercialization of new economic knowledge will have a greater impact on particular regions and will not diffuse rapidly across geographic space. They point out that knowledge spillovers are a key source of new knowledge generating innovative activity, but due to the tacit nature of that knowledge, knowledge flows tend to be geographically bounded. By creating regions of knowledge-based economic activities, government policies can generate highly concentrated innovative clusters. As long as the major policy issue was restricting large, oligopolistic firms in command of considerable market power, a federal or national locus of control was appropriate. This is because the benefits and costs derived from that market

89 Responses to Globalization in Germany and the United States: Seven Sectors Compared power are asymmetric between the local region where the firm is located and the national market, where the firm sells its product. Not only was production concentrated in one or just several regions, but the workers along with the ancillary suppliers also tended to be located in the same regions. These workers as well as the community at large share the fruits accruing from monopoly power. Systematic empirical evidence (Weiss, 1966) shows that wages are positively related to the degree of market power held by a firm, even after controlling for the degree of unionization. Higher profits resulting from market power are shared by labor. Thus workers and firms in the region have the same interest. As Olson (1982) shows, relatively small coalitions of economic agents benefiting from some collective action tend to prevail over a large group of dispersed economic agents each incurring a small cost from that action. The costs of organizing and influencing policy are relatively low for the small coalition enjoying the benefits but large for the group of dispersed economic agents. Government policies to control large oligopolistic firms with substantial market power were not likely to be successful if implemented on the local level. Rather, as Olson (1982) predicts, a regional locus of policy towards business tends to result in the capture of policy by the coalition of local interests benefiting from that policy. Only by shifting the locus of policy away from the region to the national level can the capture of policy by special interest groups be minimized. This is because the negative effects of market power in the form of higher prices are spread throughout the national market while the benefits accruing from that power are locally concentrated. Many economists interpret the downsizing of the federal agencies charged with the regulation of business as the eclipse of government intervention. But to interpret the retreat of the federal government as the end of public intervention is to confuse the downsizing of government with a shifting of the locus of government policy away from the federal to the local level. The last decade has seen the emergence of a set of enabling policy initiatives at the local level. This new type of industrial policy is decentralized and regional in nature. As Sternberg (1996) emphasizes in his review of successful technology policies in the four leading technological countries, the most important industrial policies in the last decades have been local not national. They have occurred in locations such as Research Triangle, NC (Link, 1995), Austin, TX and Cambridge (U.K.). Sternberg (1996) shows how the success of a number of different high- technology clusters spanning the four most technologically advanced countries is the direct result of enabling policies undertaken at the regional level. Eisinger asks the question, “Do American States Do Industrial Policy?” in a 1990 article published in the British Journal of Political Science. Lowery and

90 David B. Audretsch and Maryann P. Feldman

Gray (1992) confirm Eisinger’s affirmative answer by analyzing the impact of state industrial policy in the United States. They develop a new data set on gross state product and a new measure of state industrial policy activism. Their results suggest that the implementation of industrial policy at the state level tends to promote growth. In addition, Feller (1997, p. 289) points out that “in theory and implementation, state technology development programs—as in Texas, Ohio, New York, New Jersey, and Pennsylvania—may be viewed as bands on a wide spectrum from basic research to product development, with the ends reflecting quite divergent state strategies.” In an example, the Advanced Research Program in Texas has provided support for basic research and the strengthening of the university infrastructure, which played a central role in recruiting MCC and Sematech and developing a high-tech cluster around Austin. And, the Thomas Edison Centers in Ohio, the Advanced Technology Centers in New Jersey, and the Centers for Advanced Technology at Case Western Reserve University, Rutgers University and the University of Rochester have supported generic, pre-competitive research. This support has generally provided diversified technology development involving a mix of activities encompassing generic research, applied research, and manufacturing modernization through a broad spectrum of industrial collaborators spanning technology-intensive multinational corporations, regional manufactures and new-firm startups. This shift in the locus of policy is the result of two factors. First, because the source of comparative advantage is knowledge, which tends to be localized in regional clusters, public policy requires an understanding of region-specific characteristics and idiosyncrasies. As Sternberg (1996) concludes, regional strengths provide the major source of innovative clusters. The second factor is that the motivation now underlying government policy is growth and the creation of (high-paying) jobs, largely through the creation of new firms. These new firms are typically small and pose no oligopolistic threat in national or international markets. There are no external costs imposed on consumers in the national economy in the form of higher prices as in the case of a large oligopolistic corporation in possession of market power. There is no reason that the promotion of local economies imposes a cost on consumers in the national economy, so that localized industrial policy is justified and does not result in any particular loss incurred by agents outside of the region.

THE GERMAN RESPONSE

Germany has never been at a disadvantage in producing basic knowledge. However, the fundamental character of tacit knowledge, which involves high uncertainty, knowledge asymmetries and a high cost of transacting that

91 Responses to Globalization in Germany and the United States: Seven Sectors Compared knowledge, makes it difficult for the holders of that knowledge in Germany to appropriate its value. That is, it is difficult and costly to convince hierarchical bureaucracies in existing organizations of the perceived value of new ideas in a world of uncertainty and high asymmetries. Empirical evidence suggests that Germany has not generated a vibrant sector of new firms and new industries. An irony is that the small and medium- sized companies of Germany, the Mittelstand, were the backbone of the industrial structure throughout the period of postwar prosperity. But these mittelständische firms are typically family held in traditional industries. Innovation has been the competitive hallmark but the targeted industries have low growth potential. New firms in new industries are much rarer. One of the most repeated phrases on the pages of the business news over the last months has been what Helmuth Gömbel, research director of the Gartner Group in Munich, observed: “Put Bill Gates in Europe and it just wouldn’t have worked out.” Similar sentiment was expressed by Joschka Fischer, then parliamentary leader of the Green Party and now foreign minister in Germany, who laments, “A company like Microsoft would never have a chance in Germany.” Thus, although small firms have been a unique strength of postwar German industrial success, ironically, at the heart of the current German economic crisis are also small firms. Why has Germany been unable to grow the German equivalent of a Microsoft? Der Spiegel observed recently that “Global structural change has had an impact on the German economy that only a short time ago would have been unimaginable: many of the products, such as automobiles, machinery, chemicals and steel are no longer competitive in global markets. And in the industries of the future, like biotechnology and electronics, the German companies are barely participating.”9 A number of the core institutions of the German economic model that served as a catalyst for the Wirtschaftswunder in a routinized economy pose as barriers to entrepreneurship and structural change in an entrepreneurial economy. For example, a proclaimed virtue of the German banking system in particular and financial systems in general is that by allowing bank ownership of private companies, the companies avoid the types of liquidity constraints more commonly experienced by firms on the other side of the Atlantic. While the empirical evidence generally supports this view, it is also a double-edged sword, because it tends to be the large, incumbent companies—typically tied to existing technological trajectories in traditional industries—that receive a generous flow of cash from the banks. What has been overlooked is the difficulties that outsiders and entrepreneurs with new and different ideas about doing something have in procuring funding. At the same time there has been

92 David B. Audretsch and Maryann P. Feldman only negligible venture capital and informal capital markets developed to channel finance into projects involving new and different industries. Equity investment in small firms is scarce. Although the stock market established a regulated bourse for small firms in 1987, only seven small companies floated shares in 1993 and just four in 1994. Like most European countries, Germany does not allow companies that have not had five years of profit to post an initial public offering (IPO) on the traditional stock exchange. In reaction to the growing need for financing by new technology-based firms and exit options for venture capitalists a new market segment was established at the stock exchange in 1997 called Neuer Markt. In addition, traditional stock options were heavily taxed. However, tax laws have recently been amended to favor reinvestment of profit from shares. Without the ability to take the company public quickly, venture capitalists are wary of investing in start-ups. In addition, the lack of bankruptcy protection in Germany creates a strong disincentive for individuals to take the risks necessary to start a new company. Nor has the banking sector been a conduit of loans for new biotechnology ventures. In addition, very few tax credits are extended to make investment in high technologies less onerous for small companies, as has occurred in the United States. For example, a software firm that was founded in Bavaria, FAST, needed more capital to fund product development. But after having been turned down by financial and non-financial institutions alike, the founder, Matthias Zahn, is not only planning an Initial Public Offering on the NASDAQ, but also planning to move the company’s headquarters from Bavaria to Redwood City, California.10 This is no isolated example. Scores of entrepreneurs in newly emerging industries, ranging from computer software and hardware to biotechnology and visual reality have engaged in a kind of Auswanderung, or emigration, in order to appropriate the expected value of their technological knowledge. The research and education system, and in particular the universities, contributed to the slower and more rigid nature of German innovation. The university system restrains the activities of its professors and knowledge workers. As civil servants, strict regulations limit the amount of contract research or consulting work that faculty can accept, thus hindering the transfer of technologies to the private sector. In addition, a rigid employment structure raises to unacceptable levels the risk associated with joining or creating new ventures. If a start-up fails, its scientists will have great difficulty finding employment elsewhere at mid-career. Economic theory focuses on static economic welfare losses, but this is a type of dynamic economic welfare loss in the form of foregone technological knowledge and economic externalities that would otherwise have been accrued

93 Responses to Globalization in Germany and the United States: Seven Sectors Compared in Germany. That such technological knowledge in its early stages flows out from Germany reflects institutions and policies impeding entrepreneurship. Large tracts of Germany’s institutional matrix, ranging from finance to labor market and extending even to the education system were developed and excel in the transfer and application of technological knowledge in traditional industries but not in emerging industries. These types of institutions are conducive to channeling resources into economic activities where it is more or less known what is to be produced, how it should be produced and who should produce it. They are ineffective in channeling resources into search activity. Labor market institutions also may tend to impede the development of new firms pursuing different ideas. For example, SPEA Software is a new startup based near Munich.11 This developer of multimedia equipment boosted its sales by 60 percent last year to about 180 million DM and got Germany’s biggest-yet injection of venture capital. SPEA has been met with opposition from German unions because its 130 employees are not unionized and it does not yet belong to an employer’s association. It is thus not part of the centralized system of labor relations to which most of German industry belongs.12 Similarly, tax laws force the chief executive officers of new companies to start paying out dividends from earnings almost as soon as they appear, preempting high reinvestment policies. And bankruptcy laws in Germany make it clear that to start a new business and to fail is socially stigmatizing. After two bankruptcies the entrepreneur is left with the sole option of becoming an employee. He may not legally rely upon his experience from the bankruptcies to start a third new enterprise.13

THE COMING GERMAN ENTREPRENEURIAL RENAISSANCE?

Perhaps more than any other country, Germany has the capabilities required of a knowledge-based entrepreneurial economy. Its labor force and population are among the best educated and well-trained in the world. The communications and transportation infrastructures are also among the best in the world. German cities are cultural centers, devoid of ghettos, have a minimum of crime and generally enhance the spirit. Such cities could easily transform into clusters for knowledge-based economic activity. The five new Bundesländer are often viewed as posing a burden on the more prosperous western part of the country, but they are also a rich source for future entrepreneurship. People in the five new Bundesländer are less tied to the policies, institutions and ultimately the values that propelled West Germany to becoming one of the most prosperous countries in the world. Yet unification has created high levels of unemployment among the scientific elite. For example, 1,400 Ph.D.-level scientists became

94 David B. Audretsch and Maryann P. Feldman unemployed in Berlin-Brandenburg in 1994 and many found that their best employment opportunities were in entrepreneurial start-ups. The closure of many East German research institutions, such as the prestigious National Academy of Science and the state research centers, left many unemployed, yet highly-skilled researchers and academicians needing employment that could only be provided by the private sector. The federal and local (Länder) governments have been aggressive in initiating projects that foster entrepreneurship in general and target specific industries such as biotechnology. Germany also has established an impressive social safety net, which will prove to be an asset in an entrepreneurial economy. In the United States, a number of benefits, such as health and retirement, are typically linked to the firm where a worker is employed. There is considerable documentation that the perceived loss of such benefits is a barrier to mobility and a barrier to entrepreneurship. In Germany, where the social safety net is more extensive and less tied to the individual employer, such barriers to mobility and entrepreneurship are less important. Perhaps most importantly, there is a deep and long tradition of Handwerk, or craft work in the country, which provides a tradition for appreciating independent and creative self-employment. Thus, there are a number of compelling reasons to be optimistic about Germany finding its way out of the current unemployment problems. But it will need to combine its older traditions with a zweite Gründerzeit to modify the economic model, which has served the country so well during the postwar era.

CONCLUSIONS

Globalization has resulted in record postwar levels of unemployment in Germany and an unprecedented and growing wage gap in the U.S. The ensuing policy debate raging on both sides of the Atlantic presents policy makers with a rather depressing choice between what is characterized as the American Model versus the German Model. The American Model has generated millions of new jobs during the last fifteen years—but at the apparent cost of low wages and a weakening of the social safety net and social sustainability. By contrast, the German Model has maintained wages and the key institutional features of the Sozialmarktwirtschaft, but also at a cost—chronically high persistent rates of unemployment. This debate suggests that there is a policy tradeoff to be made. Policymakers can have one—jobs or Wohlstand—but only by sacrificing the other, and in any case, both social goals are unattainable simultaneously. There is, however, a new, emerging economic model that is largely overlooked in this policy debate. This third way is centered on shifting economic activity

95 Responses to Globalization in Germany and the United States: Seven Sectors Compared away from all the factors that globalization and the telecommunications revolution have rendered transportable across geographic space—first, physical capital and finance, and most recently information. The paradox of globalization is that by eliminating the cost of transferring information around the globe, economic activity based on routinized economic activity is no longer compatible with high wages. Rather, the comparative advantage of a high-wage Standort has shifted to knowledge-based economic activity, where location and geographic proximity matters more than ever. This new, emerging economic model combines the institutions generating knowledge and skills along with those diversifying the social risk involved in knowledge-based economic activity that were at the core of the German economic model, along with those institutions facilitating the commercialization of knowledge through entrepreneurship that has been pervasive in the American model.

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ENDNOTES

1. We are grateful to the participants at the May 1998 and November 9, 1999, project meetings for their insightful comments and suggestions on an earlier version of this paper. 2. David B. Audretsch, “How Germany Can Create Jobs,” Wall Street Journal Europe, 12 January 1999, Op-Ed page. 3. “Schroeder Treies for Consensus in Fight to Cut Jobless Rate,” New York Times, 8 December 1998, p. A8. 4. “Die Not von damals und der ‘Hungerkanzler’” Die Zeit, 14 March 1997, p. 92. 5. “Deutschland vor dem Absturz?” Stern, 13 February, 1997. 6. “Die Not von damals und der ‘Hungerkanzler’” Die Zeit, 14 March 1997, p. 92. 7. “The Downsizing of America,” New York Times, 3 March 1996, p. 1 8. According to The Economist, “The death of distance as a determinant of the cost of communicatiosn will probably be the single most important economic force shaping society in the first half of the next century,” “The Death of Distance,” The Economist, 30 September 1995. 9. Der Spiegel, number 5, 1994, pp. 82-83. 10. “German Innovation: No Bubbling Brook,” The Economist, 10 September 1994, pp. 75-76. 11. “Those German Banks and Their Industrial Treasures,” The Economist, 21 January 1994, pp. 77-78. 12. “Where’s the Venture Capital?” Newsweek, 31 October 1994, p. 44. 13. “Out of Service,” The Economist, 4 February 1995, pp. 63-64.

100 Elmar Rieger

GLOBAL CAPITALISM AND THE POLITICS OF SOCIAL POLICY REFORM IN GERMANY AND THE UNITED STATES Elmar Rieger

“The trial by market everything must come.” —Robert Frost, Christmas Trees

INTRODUCTION

At the end of the century Germany and the United States seem to be worlds apart. One knowledgeable American observer of the German situation, Professor Peter Hall of Harvard University, wrote that “those who argue that the German system is currently experiencing its greatest crisis since the war are probably correct” (Hall 1997: 313). Unemployment has climbed to levels resembling those of the Weimar Republic with no sign of relaxing. The dismal performance of the labor market puts a question mark on the so-called German model of a coordinated economy married to a transfer-rich welfare state. In the United States, however, the predominant mood is having reached the Promised Land of steady growth, very low unemployment and minimal inflation (Weber 1997). Compared to the situation ten years ago this reflects a remarkable turning of the tables. Despite disagreement of exactly what did the job, an American model of some sort or another was furnished with a big exclamation point as the better example for the world to heed. Leaving aside the metaphysics of models and the antics of their media- driven business cycle, the two countries do have one thing in common. The institutions of social policy have come under attack for very similar reasons. Means-tested anti-poverty programs seem to have lost their raison d’être. It is alleged that instead of offering a means of very last resort, they create incentives not to participate in labor markets, or assist in creating poverty traps. Their “benefits,” therefore, are thought to be more part of the problem than a solution to poverty and destitution. Also the claim that those social security programs catering to the needs of the middle classes hand out money to groups who should be able to care for themselves has gained influence in both countries. And finally, as the other side of the coin, with the renaissance of (stock) market capitalism the yardstick weighing costs and benefits of publicly produced social security and services has changed. In both countries the members of compulsory social insurance programs, in particular those for the elderly, think about the amount of benefits in terms of a return on their investment, which compares not very favorably with what they think they could get in the market for the hefty contribution rates they are forced to pay.

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At heart, these arguments are as old as the welfare state itself. This is not to deny their rationale or legitimacy. Practicability, or political feasibility in acting on them, is quite another matter. There is reason to believe that in a democratic polity the tandem of a competitive party system and a mature social policy state not only features some peculiar evolutionary risks but presents a different challenge to adjust to new economic realities than a polity with restricted social policies. This is all the more the case since social policy is also about something else. At issue are not only the social effectiveness and the cost efficiency of social policy. These are, in a way, matters that could be dealt with, at least in theory, in some straightforward way. But global capitalism revealed two aspects of social policies that did not get much attention until now. One is their role in the creation and destruction of jobs. The other is their part in producing acquiescence to freer trade. It is the individual, and essentially uncoordinated, decision making of companies old and new in the management of their personnel and the arrangement of their value chain, particularly the geographic location of its different parts, which in the final analysis adds up to outcomes of labor markets deemed to be good or bad in terms of the overall welfare of the population. Companies have a choice, even more so with the advent of global capitalism. The price they have to pay for labor in a given place will be of consequence. Despite all the talk about the “coordinated” German economy, basically it is the price of labor arrived at in competitive markets that determines job opportunities. All social regulations and all economic rights in the workplace will find their reflection in the price for labor, as will the individual’s skills, knowledge and motivation. Shifts in relative value of labor due to technological progress that do not result in appropriate changes in the price of labor will, in effect, result in unemployment. If, for whatever reason, price changes do not occur, this is unfortunate not only for those workers without jobs, but also for those interested in a better return on their investments. Notwithstanding all the hardware of globalization that free companies from governments—e.g., telecommunications and transportation systems—they still have to operate in a social policy context which gives workers opportunities to commit themselves to the job, to cooperate with the management of change or to resist (Wolff 1996). Conventional wisdom says that governments cannot turn off globalization at will because it is driven by a technology they cannot control. But hardware alone is, well, just hardware. It needs people to make use of it—entrepreneurs eager to explore new opportunities and workers being creatively responsive to them. And in that respect governments still play a major role. It should not be

102 Elmar Rieger forgotten that despite all the more than adequately efficient hardware available in their time, former incarnations of global capitalism actually were severely constrained (Williamson 1998). The trend toward growing world market integration is reversible (Krugman 1995: 328). One major factor accounting for this possibility is a political backlash driven by those groups whose incomes and status seem to be endangered by the dynamics of global capitalism and import competition. Imaginary or true, people act on their fears, and will easily find politicians eager to get their vote in return for protectionism—as has happened again and again in the past, in country after country. In the actual management of foreign economic affairs, free trade is an exception (Rieger/Leibfried 1998). People in the majority are risk averters and they think it “unfair” to allow anyone’s real income to be reduced significantly because of external effects governments can or should control “in theory.”1 This is a factor of major importance in particular within mass democracies with a competitive party system. However, the income maintenance motivation of tariffs and other barriers to trade so important in the past loses its rationale with the institutionalization of social policies properly. The secret of the success of GATT is the rise of the welfare state. There can be little doubt that the massive expansion of social security and income maintenance through public policies in the fifties and sixties was indispensable, since it allowed governments to get rid of protectionism. By implication, differences in social policies with regard to actually maintaining income and status will mean different possibilities for governments to engage their countries in policies of free trade and to accept the risk of import competition without having to fear punishment at the polls. The first question to be asked, therefore, is this: do the actual forms of social policy impede, or do they further the development and the maintenance of free and open markets—be it for labor or for goods and services? If they impede, what changes are necessary to make them more attuned to the realities of global capitalism and to the problems companies are confronted with in their predicament of constant restructuring? In answering this question a second one arises: does their particular efficacy in the different dimensions—job creation, freeing trade, but also social effectiveness and cost efficiency—add up in a linear way, or will there be trade-offs? The remainder of this paper expands upon these questions, before formulating (some) answers. The expansion proceeds in two ways. First, the manifestations of global capitalism in changing structures of industries’ and companies’ organization and what they mean for existing social policies are described in more detail. Second, selective information is provided on recent changes in the social policies of the two countries. Finally, the paper provides an explanation of the unexpected path social policy reforms have followed in

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Germany given the determination of global capitalism, and why in the U.S. the actual reforms, despite apparently obeying the imperatives of global capitalism, may have paradoxical consequences.

PATHS OF GLOBAL CAPITALISM

Changing Markets and Industries Technological innovations of the last two decades brought about sharp reductions in the costs of transportation and communication, thereby limiting the autonomous role of geography for industrial structure. Partly driven by these developments, and partly for reasons of their own, governments either in unison or unilaterally lowered barriers to trade. The internal deregulation of industries, albeit with uneven results if one looks across countries, was in most cases accompanied or followed by tariff reductions and abandonment of other controls on imports. The effects are well known. From 1983 onwards trade in goods grew twice as fast as output. The cumulative percentage increase of merchandise exports through 1993 amounted to 70.5 percent, the corresponding increase in output 34.6 percent (Preeg 1995: 12-3). Foreign Direct Investment (FDI) has become dominant in shaping the world economy. Not only politically, also economically, the year 1989 marked a threshold. For the first time sales of the foreign affiliates of multinational companies exceeded the value of world trade. Throughout the 1980s growth rates of FDI flows have been higher than those of world trade (Dunning 1997: 9). One of the effects of business’ globalization drive highly significant for social policy reform in particular is the increase in the degree of international contestability of markets.2 Costs of entry to foreigners have decreased, and the secular shift from an industrial to a service and information economy reduced the magnitude of unavoidable sunk costs, thereby also decreasing the costs of exit. In a historical perspective, however, tariffs and a broad range of functionally equivalent barriers to international commerce have brought about distinctive national structures of industry in which social policies became a powerful factor in shaping the organization of companies and determining their behavior both on the market place and in the political arena. It is, therefore, mainly this externally caused change in structural contestability of hitherto nationally fragmented and politically controlled markets that challenges the existing configuration of state and market and the institutional format of social policies. These two factors determine what sorts of problems countries have in adjusting to the new economic reality and how severe they are likely to be. Whereas in the past insulation of national economies facilitated the adoption of

104 Elmar Rieger labor market regulations and transfer systems, mostly in the form of social insurance programs, the new structure of markets and industries not only sets strict limits to distributive concerns, but also results in major social and political problems because of the now apparent incompatibility of fundamentally changed markets and still stagnant social policies. At question, however, is less the desirability of social goals, but more the ways and means of achieving them. One crucial feature of a sustainable configuration of social policies is the absence of any hidden, but cost-effective, regulation and cross subsidization. Stated negatively, social costs of regulated labor markets and inflexible wage rates make themselves felt in the form of high and persistent unemployment, widespread tax evasion, the evolution of a shadow economy, and a low attractiveness for FDI. Looked at positively, transfers to deprived social groups must come from outside of industry, i.e., the government, and be levied through the operation of the tax system (Siebert 1996). In addition, and assisting in the efficacy of global capitalism for social policy reform, the new macro-political environment also puts premiums on balanced budgets, low interests rates and lean government. Large-scale, state sponsored social security regimes and public systems of social welfare provision with their heavy emphasis on manpower seem out of sync with the new social and economic realities. No more is the creation of public employment a viable strategy in correcting labor markets. Market-based provision of social security and social services and incentive-based income maintenance match the new climate of fiscal austerity and productivity-enhancing deregulation much better. In addition, market- based production of social policy goods and the new emphasis on employment- related incentives promise to regain political dominance in the welfare state. To install real and quasi-markets in the provision of social welfare should bring beneficial effects of competition to the public sphere, thereby limiting the potential of public policies to invite policy capture by service providers, to attract influence activities by social groups and to induce opportunistic behavior. The attractiveness of this change is its autonomous and self- enforcing character, thereby limiting the risks of politicians to be punished at the polls. Direct intervention in the process by which people get an income, be it through minimum wage legislation or Earned Income Tax Credit (EITC) schemes, is apparently less prone to distortion since it presupposes employment. These and related measures do not wait until income is “delivered” to individuals by the market, only then redistributing it via taxes and transfers (Le Grand 1995, 153). Both regulation and wage subsidies leave markets intact, but alter the constraints (and opportunities) agents face (Barr 1992, 743). In a similar vein the introduction of quasi-markets, particularly in

105 Responses to Globalization in Germany and the United States: Seven Sectors Compared the provision of health care, is an attempt to harness the self-interest of those working in the system to the public good. It is not about suppression of self- interest and opportunism, but transformation of private advantage into socially desirable ends via the visible hand of the regulator setting the rules (Le Grand 1995, 159).

Companies’ Changing Work Places Technologically induced innovations prompted a blurring of the boundaries of the firm, giving additional validity to an observation already made by Jensen and Mecklenburg in 1976: “(. . .) most organizations are simply legal fictions which serve as a nexus for a set of contracting relationships among individuals” (310). Within firms market mechanisms are increasingly used, just as resorting to hierarchical mechanisms has become more common in organizing inter-firm relations (Picot/Ripperger/Wolff 1996). Firms are now using a wide array of collaborative arrangements; non-equity strategic alliances and inter-firm networks have become defining elements of business organization. Alliance capitalism is replacing hierarchical capitalism, putting premiums on the organizational capabilities of management, and thereby changing the focus of competitive advantage. Management and combination of assets have become as important as the possession of assets themselves (Dunning 1997: 15), Restructuring companies is neither something done once-and-for-all, nor is there a universally best organizational strategy and structure for all sectors and societies (Milgrom and Roberts 1995). The structure of value-adding activities both at home and abroad is constantly being realigned, fueled by the new micro- management of flexible production, continuous product improvement and competing heterarchies (Best 1990). The ability of employees to respond and to act upon unexpected events becomes a crucial variable of the efficiency of work practices (MacLeod 1995, 12, describing empirical evidence of Japanese labor management). Since this ability cannot be contracted upon ex ante, incentive management comes to the fore. The emphasis in organizational strategies and structures has shifted from coordination to motivation (Wolff 1999). Labor has been revalued as a source of knowledge and ideas, and its purely physical and mental properties have been depreciated. Labor management tools are undergoing a socializing revolution, stressing needs for a closer synthesis of interactive learning between employees situated at different stages of the value-chain. Incentive management has become the central focus of organizational strategies, reflecting not only the need for voluntary individual effort, but also the opportunities created by social policies. Social policy institutions, and, at least for some, new private wealth

106 Elmar Rieger generate exit options from the labor market (or disincentives to work, depending on the observer’s perspective). These, in turn, provide the material base for the increased salience of post-materialist values, thereby underpinning individual choice. Put in a different perspective, social policy regulations and transfers comprise a central element of morale and control of the non- contractual aspects of employment relationships. With regard to the general climate of the constellation in which social policy actors find themselves, governments have lost their focal point in state- business relationships, as have trade unions. The new constellation is marked by a structurally induced transition from adversarial and confrontational to collaborative and cooperative strategies. For example, nationalization and regulation strategies of state actors vis-à-vis multi-national companies or the use of strikes and lockouts to settle question of wages and of industrial relations have become almost self-defeating. Low costs of capital mobility and a high degree of import penetration in most product markets have made these strategies instruments of last resort. Not only inside the new firm, but also in the interaction between firms and the constituents of their environment, state actors, unions and public interest groups, cooperation has become the defining element. Incentive schemes have become central at both the macro-organizational (state) and micro-organizational (firm) levels. State actors are now involved in locational competition over FDI, and companies compete over highly skilled workers. The environment of social policies is changing. The kind of social structure conducive to comprehensive social security programs, be it in form of social insurance or means-tested income maintenance, has dissolved. Large and uniform employment-based status groups facing similar conditions of work gave way to a much more fragmented and individualized constellation. Families no longer serve as a sort of social backbone to labor markets dominated by men. Women have joined labor markets in large numbers—and will continue to do so if labor markets allow. Just as in employment, personal relations have become much more fragmented, discontinuous and heterogeneous. Earnings differentials, long assumed to be stable—an object to be corrected by social policies, or to narrow as educational opportunities widen and job skills become more diffused—have increased.

REALITIES OF SOCIAL POLICY REFORM

Global capitalism is not the only force expected to drive social policy reform. Endogenous factors have also made themselves felt in political debates on the future of social policy.

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Paradigm Breakdown? Since the seventies there has been a growing recognition that welfare statism is losing its raison d’être. Claims that social policy developments do not reflect the true needs of social groups any more, but have been transformed into “social pork” that redistributed from the poor to the rich, created poverty traps and became conducive for a new “culture of poverty” won broad support—first intellectually, then at the polls. Something had to be wrong if an economic miracle produces more and not less demand for social policy goods. At the same time “new” poverty risks were detected, making it more difficult to identify “deserving” poor. Next to questions of costs and budgetary viability of social policies the behavioral consequences of public income maintenance came to the fore in public discussions. The notion that social spending created its own demand and brought about widespread welfare dependency became increasingly popular. Since there are no means to effectively test the causal influence of social spending on incentives to work, anecdotal evidence and graphic descriptions of welfare abuse dominated the public discourse.3 The joint effect of incentive structures created by welfare state institutions and the information problems with regard to “true” preferences for social policy goods give welfare states efficiency functions which are largely separate from their declared social policy aims (Barr 1992, 742), producing a gap that has been greatly magnified by the new micro- and macro-realities of global capitalism. The notion of declining institutional control enjoys greater political support in the U.S. than in Germany. One reason is the size of means-tested programs in the U.S. compared to social insurance programs. Moreover, the split between types of welfare state programs reflects racial cleavages, undermining the sort of generalized solidarity necessary for redistributive social policies. Finally, the fragmented nature of the system of cash and non-cash benefits to low- income groups contributed to a sense of losing political (or institutional) control. Despite its “means-tested” nature, growth rates of this type of spending have been persistently higher than the growth rates of social security spending. After balancing the budget and putting the New Federalism in place as a means of enforcing institutional control over welfare through an automatic mechanism, social policies more in tune with the imperatives of global capitalism seem to prevail. Shifting responsibility for one’s maintenance from the public to the individual enhanced the compulsion to work directly in the case of workfare, and indirectly in the case of exit options provided by welfare. Of equal importance for the assertion of the labor market as the dominant source of income is the spectacular rise of EITC in the hierarchy of U.S. social policies. In terms of market conformity, in not providing incentives to disengage from the labor market, such a program is a very rational method of assisting people to

108 Elmar Rieger maintain their income. In addition the traditionally limited scope of both unemployment insurance and means-tested forms of income maintenance for the core groups of the workforce, their low replacement ratios, and the strict limits on the period of eligibility assist in bringing about and keeping alive a very effective labor market. Most importantly, current social policy programs do not work to prevent a scaling down of real wages in the face of major shifts in capabilities and skills. Employment is of crucial importance also with respect to social security in old age and in case of sickness, either in the form of membership in social insurance programs or in the form of fringe benefits. Both social insurance and occupational, company-based welfare operate through, and not against markets. In that respect U.S. social policies compare very favorably with German social policies. There is, however, a catch. If all forms of transfers and benefits become a direct function of employment, and if the state does not provide income independent of remunerative work, then people will resort to controlling employment.4 In the U.S. one traditional way to do so— unionization and closed shop policies—is blocked, partly for reasons of politics, partly on account of the secular shifts in industrial structure and company organization induced by technological progress. The other way to control opportunities created by labor markets is protectionism. In the U.S. wages and employment provide the main motive for protectionism, past and present (Eckes 1995). Given their social policy preferences, unlike European political leadership, American governments never had carte blanche to engage the country in free trade and to integrate the national economy into world markets. The democratic-populist rule of “no injury to domestic industry” pressured American governments either to modulate reductions in barriers to trade according to their assumed negative effects on employment, or to buy off resistance with side-payments in the form of the Trade Adjustment Acts and its various expansions, and other forms of compensating workers for the prospect of losing their job due to increased import competition (Bhagwati 1988; Tonelson 1994). The basic fact is that in order to export a country has to allow imports. The latter can have social costs (Rieger/Leibfried 1998). Again, imaginary or real, people act on what they think has consequences for them. Resistance to change is ubiquitous, but has political consequences when the source of a disturbance is assumed to be foreign (Krugman 1997). Global capitalism has greatly increased the rate of change, and in that respect popular demands for adjustment and assistance on the nation state by those negatively affected also grew. In particular in the U.S. the danger of a backlash has increased or, more accurately, operates continuously as a point of reference in the daily work of the White House and the International Trade Commission. In

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Congress protectionist demands are a constant, and any move toward freer trade is contingent upon putting social safeguards in place beforehand. The economic rationale and efficiency of compensatory programs is quite a different matter. The least one can say is that they are effective in buying off resistance of the most vocal members of the workforce, those older—and, therefore, having more to lose—and unionized (Decker/Corson 1995).5 In terms of spending, and compared to the overall size of the social budget of the U.S., these programs seem negligible. But politically they are indispensable, as President Clinton had to learn the hard way when he tried to win congressional approval for fast track authority. The social politics of trade of this sort are virtually absent in Germany. To be sure, there are still pockets of protectionism, for example in agriculture and in the declining heavy industries, steel, coal, and shipbuilding—and quite deep ones at that—but they are part of the structure of the German political economy, and not a daily irritant in the management of import and export policies.6 What accounts for this difference with the U.S. is precisely that feature most criticized in Germany, dubbed by Josef Joffe (Süddeutsche Zeitung) as the “full income society.” It is the transfer-rich welfare state engendering a climate of economic security for nearly all of the population, in stark contrast to what can be found in the U.S., which can explain the variation in the politics of trade. Very rarely, and then only in connection with the industries mentioned above, do trade related matters make any appearance in party platforms and electoral politics. Of course, in contrast to the U.S. situation, German industry since the 1870s has been strongly export-oriented and one would expect a broad willingness to accept imports as part of the deal. But that was not the case. Despite this export- orientation, tariff walls grew, and in the context of the Great Depression resulted eventually in the autarchic policies of the National Socialist regime (Hirschman 1945/1980). Closing the economy in order to shelter it from the volatility of world markets was not aberrant. In the mind of the contemporaries national political and social integration meant international economic disintegration (Röpke 1944). And in the first two decades after WW II social scientists still ruled out any move toward freer trade (Myrdal 1957; Deutsch/ Eckstein 1961). For reasons of not putting the newly founded democracy in jeopardy it was thought that the political primacy of social security would exclude any significant opening of the economy. But in the end it was exactly the move toward the so-called social market economy that allowed subsequent governments to get rid of price controls, quota systems and tariffs.7 Presently it is the comparatively easy and non-stigmatized availability of a broad range of benefits, which, despite being means-tested, reach even strata of the middle classes, that guarantee some sense of economic security outside the

110 Elmar Rieger labor market, and help people adjust to new situations by enabling them to invest in knowledge and skills (Leisering/Leibfried 1999). And despite some attempts at sharpening the teeth of “workfare” rules in recent years the system of unemployment insurance still includes an open-ended commitment to assist those without work and provides a broad range of measures including active labor market policies.8 More important however is the fact that the administration of labor markets and the administration of social assistance institutionally and financially are still separate. Fiscally and institutionally labor market administration is separate from both the federal government and local authorities. This means, among other things, that for those receiving social assistance benefits the rules that should compel them to work lack teeth, because case officers are unable to point them directly to jobs—and sanction subsequent behavior accordingly. In some ways this is a crude picture. But it helps explain why German workers consent in principle and in practice to free trade. But this willingness comes with a hefty price tag. First of all, social assistance and the benefits of labor market administration are part and parcel of a very costly welfare state. In 1996 spending on social protection in Germany amounted to 30.5 percent of GDP (Eurostat 1999). Nearly half of it goes to pensioners. Therefore, to argue that a welfare state of exactly this sort is a necessary condition for acquiescence vis-à-vis global capitalism is a non sequitur. Second, and more important, are the behavioral consequences of German social policies for the shop floor. In Germany there is still reason to describe the rationale of social policies as guaranteeing a “full income society”—notwithstanding the fact that it is a shrinking proportion of the population that can enjoy this feature. The stability of real wages despite the rise of mass unemployment indicates a labor market splitting insiders from outsiders, with the mechanisms of social policy reinforcing this split. Without further generous transfers provided by the parafiscally organized Federal Institute of Labor and the essentially community-based system of social assistance, popular resistance to the present system of wage settlement would be much stronger.9 The same is true for social regulation of employment and the rights it creates for employees in their workplace. In particular the labor courts have been very active in strengthening the economic rights of employees, and also in giving the unions strong levers in sanctioning companies for their behavior vis-à-vis settlement contracts (Rüthers 1996). Next to the comparatively high level of wages it is this over- regulation of the German labor market that constitutes a major barrier for creating new jobs. In addition, wages form a major part of the fixed costs of small companies, a factor of crucial importance in the highly contestable markets of the service, information and communication industries.

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The ability of German companies to experiment with new forms and structures of remuneration, including forms of linking pay to company performance, is strictly limited by employment law, court rules, and union presence. Strategies like those of the American Nucor Corporation, a highly successful newcomer in the old industry of steel manufacturing, are ruled out in Germany by the centralized system of wage settlement. Nominally, Nucor pays its employees only 60 percent of the average wage of the industry, but in effect doubles this average wage by the operation of a performance-based bonus system. In Germany, not only the structure of wages, but also all forms of performance- or profit-related remuneration of workers have to pass through the eye of a needle, i.e., they must win the consent of the two major actors of the corporatist system. The present structure of industrial democracy prevents both small and large scale experimenting with wages, in particular mixing market and public sources of income to create employment for the lower strata of the unemployed. This is not just the product of the present constellation of political forces. Different traditions of social philosophy play a major role in public policy making vis-à-vis competitive markets in the two countries. In Germany the focal point of social thinking is the material status of the individual in a collective. His consumption needs, or what is perceived to be his legitimate standard of living, guide public policy. The idea of a “living wage” is still thought to be a norm against which the efficiency of the economy in satisfying basic needs could be measured. Recent attempts at pricing the so called “630 DM” jobs—a type of marginal employment—out of the market and the struggle against “irregular,” i.e., short term employment, are fueled by notions of an “orderly” or “organized” economy. Of course, this reflects an extremely status quo-oriented and basically static philosophy. But it helps to explain why markets and competition in Germany always come second. There is not only the distrust of markets with regard to their distributional, or income generating capabilities, but also a deep-seated contempt of both the spirit, or ethos, and the peculiar instruments, or basic mechanisms, of the market economy. It is now, and, in a sense, always has been, a major problem in German social policy making that alliances of diverse interests can be formed around the idea that “the ultimate and only value by which conduct of their affairs is to be decided is good administration and provision for their needs by officials” (Weber 1994: 158). In stark contrast, in the U.S. the price of labor achieved in competitive markets is also thought to be the “right” price in normative terms. And the main standard of political significance for social policymaking is the “minimum”— the minimum wage and the poverty line. The individual is seen in abstract

112 Elmar Rieger terms, acting on the basis of some fundamental rights and solely responsible for the results.

The Social Arithmetic of the Welfare State Differences observed in both the dynamics and forms of social policy reforms can, perhaps, be explained by different stages of economic development in the two countries. With regard to both the transition to a service-based and an information-centered economy, Germany is a laggard, still exhibiting the main features of industrial society. Correspondingly, the organization of companies and the sort of employment they offer is not advanced enough to give the new forms of social policy (market-based, incentive-oriented, regulation-dominated, selective) sufficient driving force. In this perspective transition is a matter of time, not of substance. This would mean, basically, sooner or later all developed welfare states will follow the same trajectory towards a more market-based production of social policy goods and more selectivity and decentralization in the remaining public social policies. In a different perspective, however, the social structure of Germany employs some distinct features that bolster the traditional forms of social policy organization. A first inhibiting factor is the demographic structure, which favors the present structure of both old age and sickness insurance. The combination of a broad demographic shift and of near universal coverage rates in the basic social insurance systems produces a homogeneity of interests (and political outlook) which by itself makes for a quite conservative factor in the thinking about new departures in social policymaking.10 Pensioners comprise 24.8 percent of the total population, against 40.7 percent gainfully employed. In absolute numbers there are 20 million pensioners, and 21 million in private companies producing goods for the market, with 12 million in services and domestic trade. It is, therefore, not by accident that the two major German parties are nearly indistinguishable in their position on a reform of old age insurance, and only the smaller and much more programmatic parties of the Liberals and the Greens try to depart from the status quo by proposing market solutions or a basic flat rate system. A second inhibiting factor is the size of groups employed in the public provision of the social goods of the German welfare state. The sum total of civil servants, employees in the administration of social security and those employed in the health sector amounts to nearly eight million persons. To engineer a transition to more market-based and more selective programs one has to win over these groups. As far as one can see, there is virtually no discussion on how to make the transition possible. On the contrary, one can observe, for example,

113 Responses to Globalization in Germany and the United States: Seven Sectors Compared that the foreseeable employment effects of a more restricted access to spas as part of the benefits of sickness insurance prompted the prime minister of Bavaria to veto the proposal (which, by the way, was formulated by a minister of the federal government who is a member of his own regional party). Moreover, mass unemployment reaching members of the middle classes is not conducive to large-scale social policy experimentation. In short, coverage of social insurance programs determines political adjustment costs, and the homogeneity of the groups drawing income from the state determines the selection process for new social policy rules. The higher the coverage is, the higher the adjustment costs of a transition to a different regime. If there are only a few and highly uniform institutional structures of welfare state programs, then there is only a small chance for institutional experimenting and learning. If systems are more fragmented, and if governance structures are more decentralized, as is the case in the U.S., then we can expect a faster pace of adjustment to a new economic environment as spillover effects will be communicated rapidly across the public/private divide. Contrary to what we should expect with the advent of global capitalism, Germans try to adhere to traditional formulas in social policy. Even the small deregulatory initiatives undertaken by the Kohl government shortly before being voted out of office, were, in line with promises, rolled back by the Social Democrats. The language of class conflict and class struggle reappeared. Whereas in 1980, 25 percent of those interviewed were of the opinion that “class struggle” and “irreconcilable conflicts” exist between employers and employees, the figure rose to 44 percent in 1997 (Noelle-Neumann 1998). But this may be misleading. More to the point is Jan Roß of the weekly Die Zeit. Observing the broader picture in which the electoral triumph of the Social Democrats is only a small part, he drew the conclusion that in the struggle between market and welfare state the latter won; equality is back (1999). The real fight is between those who have a vested interest in social policies, and those who look for the market in terms of opportunities. In terms of numbers the first prevail. Despite global capitalism, it is domestic politics that shape policy answers. The electorate holds the ultimate political power in its hands; their composition, or the identity of the median voters, provides the cues to parties. And politicians have exclusively national constituents.

CONCLUSION

Robert Frost is right: “The trial by market everything must come.” But this does not mean that the market can actually force the decision. Robert Frost did

114 Elmar Rieger not sell his Christmas trees at the price offered. This was his decision. He knew its opportunity costs. The markets brought about by global capitalism are merciless in revealing the economic and the social costs of social policies—but also their benefits. However, and concentrating on the costs, it is true that countries can no longer put beyond the reach of world markets their domestic economic and social policy arrangements. But this fact as such is as true as it is meaningless—in the proper sense of the word. There are two problems involved. The first is that the very same signals of global capitalism and world market integration tell different stories to different people. And here lies all the difference. It means that in the end—and this is the second problem—economic rationality alone does not decide social policy reform. In a democracy, arguments, notwithstanding their soundness, do not decide. Numbers do. And people act on what they believe is true. Depending on the values they adhere to, signals transmitted by global capitalism have a different meaning for the various groups affected. To believe that the apparent realities of global capitalism provide uncontested parameters for reform on which politicians can act is a grave mistake. The facts of world market integration are acclaimed and notorious at the same time. Their claim that they provide self-evident normative standards on which officials should act in the interest of some common weal is an illusion. To further global capitalism, to assist in enhancing its opportunities is just one possible goal. Obviously there are others, and there is, from a social science point of view, no á priori reason to judge them nonsensical. “The distinctive characteristic of a problem of social policy,” Max Weber calls to our mind, “is indeed the fact that it cannot be resolved merely on the basis of purely technical considerations which assume already settled ends. Normative standards of value can and must be objects of dispute in a discussion of a problem of social policy” (1904/1949: 56). The politics of social policy reform are, at heart, Kulturkampf. All reform proposals intend to “really,” and not “fictitiously” increase welfare. All parties involved lay claim to this. The only thing social science can do is help actors realize that in social policy reform all action and all inaction in pursuit of some desired end will incur costs in terms of predictable losses of other ends. Which end actors should settle on is decidedly not a scientific question. However, if the question of the end is settled, social science can assist in bringing about a Realpolitik of social policy reform in the sense of having a plan to actually achieve its end, because it accounts for all possible resistance and the forces it can muster.

115 Responses to Globalization in Germany and the United States: Seven Sectors Compared

REFERENCES

Aho, C. M. and T. O. Bayard. 1980. “American Trade Adjustment Assistance after Five Years,” World Economy 3, 3: 359-76. Barr, N. 1993. The Economics of the Welfare State. Second Edition, London: Weidenfeld and Nicolson. Baumol, W. J., J. C. Panzar and R. D. Willig. 1982. Contestable Markets and The Theory of Industry Structure, New York: Harcourt Brace Jovanovich. Best, M. 1990. The New Competition: Institutions of Restructuring, Cambridge MA and London: Harvard University Press. Bhagwati, J. 1988. Protectionism, Cambridge MA and London: MIT Press. Bowman, Karlyn. 1999. Health Care Attitudes Today, Washington DC: American Enterprise Institute (Papers and Studies). Conybeare, J. A. C. and M. Zinkula. 1996. Who Voted Against the NAFTA? Trade Unions Versus Free Trade, World Economy 19, 1: 1-12. Corden, M. 1997. Trade Policy and Economic Welfare. Second Edition, Oxford: Clarendon Press. Decker, P. T. and W. Corson. 1995. International Trade and Worker Displacement: Evaluation of the Trade Adjustment Assistance Program, Industrial and Labor Relations Review 48, 4: 758-74. Deutsch, K. W. and A. Eckstein. 1961. National Industrialization and the Declining Share of the International Economic Sector, 1890-1959, World Politics 14, 2: 267- 99. Dunning, J. H. 1997. Alliance Capitalism and Global Business, London and New York: Routledge. Eckes, A. E. 1995. Opening American Markets. U.S. Foreign Trade Policy Since 1776, Chapel Hill NC and London: University of North Carolina Press. Epping, V. 1998. Die Außenwirtschaftsfreiheit, Tübingen: Mohr. Eurostat. 1999. Social Protection: Expenditure and Receipts 1980-1996, Luxembourg: Office for Official Publications of the European Union. Hall, P. 1997. The Political Economy of Adjustment in Germany, in: Frieder Naschold et al. (eds.), Ökonomische Leistungsfähigkeit und institutionelle Innovation. Das deutsche Produktions- und Politikregime im globalen Wettbewerb, Berlin: Sigma (WZB Jahrbuch), 293-317. Hirschman, A. O. 1945/1980. National Power and the Structure of Foreign Trade, Berkeley CA: University of California Press. Irwin, D. A. 1996. The United States in a New Global Economy? American Economic Association Papers and Proceedings 86, 2: 41-46. Jensen, M. C. and W. H. Meckling. 1976. Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, Journal of Financial Economics 8, 2: 305- 60. Krugman, P. 1995. Growing World Trade: Causes and Consequences, Brookings Papers on Economic Activity I: 327-77. Krugman, P. 1997. What Do Trade Negotitators Negotiate About? Journal of Economic

116 Elmar Rieger

Literature 35, 1: 113-120. Le Grand, Julian. 1995. Knights, Knaves or Pawns? Human Behaviour and Social Policy, Journal of Social Policy 26, 2: 149-169. Leisering, L. and S. Leibfried. 1999. Time and Poverty in Western Welfare States. United Germany in Perspective, Cambridge: Cambridge University Press. Lindbeck, A. and D. J. Snower. 1996. Reorganization of Firms and Labor-Market Inequality, American Economic Association Papers and Proceedings 86, 2: 315- 321. MacLeod, W. B. 1995. Incentives in Organizations: An Overview of Some of the Evidence and Theory, in: H. Siebert (ed.), Trends in Business Organization: Do Participation and Cooperation Increase Competitiveness? Tübingen: Mohr (Institut für Weltwirtschaft an der Universität Kiel): 3-42. Milgrom, P. and J. Roberts. 1990. The Economics of Modern Manufacturing: Technology, Strategy, and Organization, American Economic Review 80, 3: 511- 28. Murray, C. 1984. Losing Ground. American Social Policy, 1950-1980, New York: Basic Books. Myles, J. and P. Pierson. 1997. Friedman’s Revenge: The Reform of ‘Liberal’ Welfare States in Canada and the United States, Politics & Society 25, 4: 443-472. Myrdal, G. 1957. Economic Nationalism and Internationalism, Australian Outlook 11,1: 3-50. Noelle-Neumann, E. 1998. Ein Riß teilt das Land. Abschied vom sozialen Klima der Nachkriegszeit, Frankfurter Allgemeine Zeitung, November 18. Picot, A., T. Ripperger and B. Wolff. 1996. The Fading Boundaries of the Firm: The Role of Information and Communication Technology, Journal of Institutional and Theoretical Economics 152, 1: 65-79. Pierson, P. 1995. Fragmented Welfare States: Federal Institutions and the Development of Social Policy, Governance 8, 4: 449-78. Preeg, E. H. 1995. Traders in a Brave New World. The Uruguay Round and the Future of the International Trading System, Chicago IL and London: University of Chicago Press. Rieger, E. 1995. The Common Agricultural Policy, in: H. Wallace and W. Wallace (eds.), Policy Making in the European Community. Third Edition, Oxford: Oxford University Press. Rieger, E. and S. Leibfried. 1998. Welfare State Limits to Globalization, Politics & Society 26, 3: 363-390. Röpke, W. 1942. International Economic Disintegration, London: William Hodge. Roß, J. 1999. Die Rückkehr der Gleichheit, Die Zeit, Nr. 3, January 14. Rüthers, B. 1996. Beschäftigungskrise und Arbeitsrecht. Zur Arbeitsmarktpolitik der Arbeitsgerichtsbarkeit, Bad Homburg: Frankfurter Institut - Stiftung Marktwirtschaft und Politik. Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung. 1999. Vor weitreichenden Entscheidungen. Jahresgutachten 1998/99, Stuttgart: Metzler- Poeschel.

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Siebert, H. 1996. On the Concept of Locational Competition, Kiel: Institut für Weltwirtschaft (Kiel Working Paper No. 731). Tonelson, A. 1994. Beating Back Predatory Trade, Foreign Affairs 73, 4: 123-35. Weber, M. 1904/1949. “Objectivity in Social Science and Social Policy, in: id., The Methodology of the Social Sciences, New York: Macmillan: 50-112. Weber, M. 1994. Political Writings, Cambridge: Cambridge University Press. Weber, S. 1997. The End of the Business Cycle? Foreign Affairs 76, 4: 65-82. Williamson, J. G. 1998. Globalization, Labor Markets and Policy Backlash in the Past, Journal of Economic Perspectives 12, 4: 51-72. Wolff, B. 1996. Incentive-Compatible Change Management in a Welfare State: Asking the Right Questions in the German Standort-Debate, Cambridge MA, Harvard University (Center for European Studies): Working Paper Series #6.4. Wolff, B. 1999. Anreizkompatible Reorganisation von Unternehmen, Stuttgart: Schäffer-Poeschel.

ENDNOTES

1 This is, in a nutshell, Max Corden’s concept of the Conservative Welfare Function, an idea which is particular helpful for understanding actual trade policies (Corden 1997: 74-6). 2 For the classic treatment of this topic, albeit with no relation to globalization, see Baumol/Panzar/Willig (1982). 3 Nicholas Barr (1992, 745) has noted that since it is not possible to establish a counterfactual income distribution without welfare state transfers one could argue that cash benefits are not the cure for poverty but its cause—as Charles Murray (1984) has done to great effect. 4 For example increased dependency on employment as the only gate to health care means that labor market volatility has direct effects. In 1997 13 percent of those then covered by insurance reported that they had been completely without health insurance at some time during the past two years (Bowman 1999: 2). 5 For the beginnings of Trade Adjustment Assistance see Aho/Bayard (1980)), and for the social trade politics around NAFTA see Conybeare/Zinkula (1996). 6 It is not the case that all powers in foreign economic policymaking have moved to the European Union. The actual business of controling imports and promoting exports is still done in the national arena (Epping 1998). Vis-à-vis member states the European Union is not a force of its own, but a stick to use against the U.S. and Japan. 7 Agriculture in Germany and Western Europe were kept under protective shelters for the very reason that this sector couldn’t be brought into employment-related social insurance programs which were rapidly expanded in the 1950s. With regard to economic security tariffs were second best. In addition, it is the absence of democratically controlled politics on the European level which ensures for both

118 Elmar Rieger agriculture and the coal and steel industry that protectionism is kept in place (Rieger 1996). The share that people working in these sectors now have of the electorate is so small that in a democratic-parliamentary regime the votes necessary to bring about any protectionism costly to both consumers and tax payers simply would not exist. 8 The Sachverständigenrat, a board of advisers to the government who publishes an annual report on the economic situation of Germany, gives data on “hidden” unemployment—those with jobs financed totally or partially from public money (35):

Old Länder New Länder

Registered Unemployment 9.8 20.1 Hidden Unemployment 3.6 16.4 9 Contrary to stated intentions the majority of wage settlements apparently making provisions for a lowering of wages and increasing flexibility aims not at outsiders to get a job, but to guarantee those already employed their workplace (Sachverständigenrat 1999: 123). 10 On can argue that the wider spread of incomes in the United States would make it easier for politicians to win over large segments of workers now covered OASDH by baiting them with the promise of a more profitable, market based system.

119 Responses to Globalization in Germany and the United States: Seven Sectors Compared

120 Gary Hufbauer

TAX POLICY IN A GLOBAL ECONOMY: ISSUES FACING EUROPE AND THE UNITED STATES Gary Hufbauer

INTRODUCTION

The hallmark of a global economy is greater mobility of economic transactions and economic agents. Firms and households enjoy far more geographic choice for purchases of goods and services, for locations to invest, and for places to work and retire. These choices often spill across national borders, as firms and households seek to buy at the lowest price, to sell at the highest price, to invest at the preferred combination of risk and return, and to live in communities that best meet their needs. In the long run, the outcome of greater choice is more efficient economies and better living standards. Along the way, however, are numerous social challenges. Among these challenges is the threat to customary systems of taxation. In the “old days”—say before 1970—international commerce was largely confined to merchandise trade; multinational enterprises (MNEs) were a modest part of the world economy; and most individuals consumed and invested at home. In this setting, legislative bodies could set the tax rates on different types of transactions and agents without worrying too much about a disappearing tax base, or the balance between benefits and burdens for different categories of firms and households. The old days are gone forever. The enhanced mobility we have already seen between 1970 and 2000 only previews greater mobility in the next thirty years. The chart below offers a qualitative summary of mobility past, mobility present, and mobility future, as it affects major elements of the tax structure.

Tax Base Item Mobility in 1970 Mobility in 2000 Mobility in 2030 Wage & salary income Low Low Moderate Consumption of goods Low Moderate Moderate Consumption of services Low Low Moderate Investment income Low Moderate High Corporate profits Low Moderate High

The technologies underlying greater mobility are familiar, and require only brief description. Wage and salary income will acquire greater mobility in the next thirty years because any work that can be performed on the computer will in time be capable of remote performance: an individual in Bombay can sell her engineering services in Berlin. Physical migration may well remain tightly controlled, perhaps limited to professionals, family reunification, and some

121 Responses to Globalization in Germany and the United States: Seven Sectors Compared guest workers, but mental migration will be practically unlimited. Electronic commerce (e-commerce) will greatly increase the mobility of goods consumption as shoppers search websites for bargains far away, and as goods are delivered by private shippers such as FedEx and UPS. E-commerce will also enhance the mobility of services consumption as households buy education, entertainment, insurance, legal, and accounting services from distant suppliers. Falling airfares will enable households to spend more of their tourist and health dollars in distant locations. Investment income will become highly mobile as pension funds and brokerage firms develop worldwide networks and households seek to diversify their portfolios. Likewise, corporate profits will become even more mobile as dense intrafirm networks of purchases and sales enable multinational enterprises to shift production and distribution to locations with the highest returns, and maintain their financial accounts with a view to minimizing their taxes. Faced with these challenges, the taxman’s first reaction is to devise clever technical fixes, implemented on a national basis, designed to prevent tax base erosion. His next reaction is to think about international tax agreements that might enable participating countries to shore up their systems. Further down the taxman’s list are responses that would adjust the tax system to the new realities of the international economy. In the sections that follow, I explore these alternatives.

NATIONAL TECHNICAL FIXES

The basic weaknesses of national technical fixes are not their design flaws. Finance ministries and legislative committees are staffed with capable experts who can fashion good technical solutions to the problem of tax base erosion. The basic problems are political and administrative feasibility. Consider first the problem of political feasibility. As Cardinal Richelieu famously observed, the art of taxation is like pulling feathers from a duck without the squawk. A modern extension is that an old tax is a good tax, a new tax is a bad tax. Most technical fixes, however, entail measures that will be perceived as new taxes—after all, they respond to new technologies. And since new taxes are bad taxes, they cause a lot of squawking. A few examples illustrate this basic problem. In recent years, the notion of a “bit tax” on e-commerce was raised and rejected in Europe. Meanwhile, the U.S. Congress called for a standstill on new state taxes on e-commerce. Over several decades, many states have tried to tax mail order retail sales, with very limited success. About a decade ago, the Internal Revenue Service proposed a system of withholding at source, to cope

122 Gary Hufbauer with enormous underreporting of interest and dividend income. The proposal never made it through Congress, and instead was replaced by a system of backup withholding for proven tax cheats. Finally, for more than three decades, dating back to the 1960s, the U.S. Treasury Department has sought to end “deferral,” the compromise under which the active foreign income of U.S.- controlled subsidiary firms incorporated and operating abroad is not taxed until repatriated as dividends to the U.S. parent firm. These examples have two common political threads. In some cases, the technical fixes would increase the reporting and tax burdens on a very large number of individuals. In those cases, the agitated opposition of literally millions of taxpayers has doomed the proposed solutions. In other cases, the technical fixes would put important firms at a severe competitive disadvantage, relative to competing firms not subject to the same tax rules. This was especially true of proposals to end deferral, but it has also doomed efforts at taxing mail order sales within the U.S. Telecommunications giants effectively opposed bit tax concepts; in the future, parcel delivery firms will stoutly resist efforts to assess value-added or sales taxes on their cross-border deliveries. Next consider the problem of administrative feasibility. Extending the tax net to reach mobile transactions depends either on voluntary reporting or the cooperation of foreign tax authorities. (For more on international cooperation, see the next section.) Voluntary reporting in the U.S. and Germany may be high, compared to Italy or Spain. Nevertheless, “taxpayer morale” is probably declining everywhere, and without the cooperation of foreign tax authorities, more and more transactions will escape the tax net. Again, some examples are illustrative. It is thought that about three million civilian Americans live outside the United States, but only about 300,000 submit tax returns. On a worldwide basis, interest, dividends and capital gains are substantially underreported and account for a major portion of the billions of dollars of “errors and omissions” in national balance of payments accounts. Some states have tried to impose “use taxes” on resident purchasers of expensive items (such as autos and electronics) from out-of-state retailers—but use taxes have flopped as a source of revenue. This recitation of political and administrative obstacles does not mean that all technical solutions devised at a national level are doomed to fail. But it does mean rising frustration for the taxman as mobility comes to characterize wider swaths of the economy.

123 Responses to Globalization in Germany and the United States: Seven Sectors Compared

LIMITS TO INTERNATIONAL COOPERATION

The difficulties of preventing tax erosion through purely national measures will inevitably prompt a search for cooperative solutions at the international level. Sober words of caution are thus in order. The international problem is not a shortage of technical solutions. Ever since the Europe 1992 program was devised, the European Commission has offered numerous remedies for the tax anomalies between member states. In particular, the EC has tried to narrow national differences in value-added tax rates (by setting a band of 15-25 percent) and solve the thorny problem of border adjustments, and it has tried to reconcile different approaches to withholding on interest and dividend income. In the United States, the Multi-State Tax Commission has tried for decades to create a higher degree of tax cooperation between several states. In a volume published in 1992 (U.S. Taxation of International Income: Blueprint for Reform, Institute for International Economics, October 1992), Joanna van Rooij and I put forth several recommendations for improving collections on international portfolio income. Few of these efforts have done much to cope with the tax realities of a global economy. Why not? The central reason is that international cooperation on a significant scale confronts a combination of problems arising from zero-sum arithmetic and federalism. To be sure, almost everyone is happy when a notorious tax cheat is nailed. But the big money doesn’t come from a handful of high-profile tax cheats. It comes from thousands, even millions, of transactions that mix avoidance and evasion in varying proportions. The first point to emphasize has to do with tax convergence between national systems. H. David Rosenbloom, in a recent perceptive paper (“International Tax Arbitrage and the ‘International Tax System,’” forthcoming, Tax Law Review, Spring 1999), rightly emphasizes that there is very little tendency towards tax convergence, much less tax harmonization, even among OECD countries. To be sure, at a gross level, there are similarities. Most OECD countries have cut their top marginal corporate rates to the vicinity of 35 percent and their top marginal personal rates to the vicinity of 50 percent. And most (notably excluding the United States) have introduced some form of broad-based consumption tax (a value-added tax or a similar levy), alongside personal income taxes, corporate income taxes, and social security taxes. But similarities progressively vanish the closer one examines the critical details of national tax systems. Countries differ on personal deductions such as mortgage interest and child care, special provisions for retirement savings, taxation of fringe benefits, and so forth. They differ on rates of value-added taxation and

124 Gary Hufbauer social security levies. They differ enormously in the details of corporate taxation: investment tax credits, depreciation allowances, classic vs. integrated systems, etc. No country has a unique claim to the “right” tax system; in fact, every national system reflects the continually evolving mix of forces in a democratic society. Hence, in the year 2030, national tax systems will likely remain as different from one another as they are today. In terms of meaningful tax cooperation, these essential differences imply that one country or the other must surrender some important tax advantage when it enforces the system applied by its partner. To be sure, both countries may collect more revenue; but in the process, each country will anger important constituents who are asked to accommodate the tax rules of a foreign power. Examples will illustrate this dilemma. Ireland has dramatically narrowed its per capita income gap with the United Kingdom and continental Europe since joining the Economic Community in 1973. A key ingredient of Ireland’s success has been its system of tax holidays and low tax rates for foreign-owned subsidiaries that establish local operations. Pressure from the European Union on Ireland to adopt the European norms of corporate taxation has been stoutly resisted in Dublin. While certain local subsidies have been challenged by Brussels, Ireland’s current 10 percent rate on manufacturing firms, and its plans for an across-the-board corporate rate of 12.5 percent starting in 2003 are permitted under existing EU rules (see BNA, Daily Tax Report, 12 January 1999, p. G-4). Similarly, Puerto Rico has long enjoyed tax advantages under the U.S. Internal Revenue Code for pharmaceutical and other high-tech assembly operations. San Juan has vigorously, if not always successfully, resisted attempts by the U.S. Treasury to narrow these advantages. Banks in London and Luxembourg thrive on managing nonresident funds, free from the tax scrutiny of other European countries. Accordingly they resist any European-wide reporting or withholding system. As a technical matter it may be possible to devise revenue-neutral solutions to national differences of the kind illustrated—i.e., solutions that leave all national finance ministries equally well off (or even better off). But revenue- neutral solutions will still create losing constituencies, and in a democratic system losing constituencies can often block proposed changes in the tax law. The other structural reason why tax convergence will remain a distant goal finds its basis in the federal structure of the United States, Germany, the European Union itself, as well as important countries such as Australia, Brazil, Canada, and India. Briefly, federal governments find it difficult or impossible to agree at an international level on tax rules fashioned to constrain their states or provinces. Meanwhile, subfederal units are playing a larger role in economic life. Often the result is subfederal incentive schemes, operating through tax

125 Responses to Globalization in Germany and the United States: Seven Sectors Compared relief and investment subsidies, designed to attract national and multinational firms. The response rate to these incentives may be quite high. In fact, within the United States, response coefficients may be as high as ten, implying that a one percentage point decrease in the state corporate tax rate (or an equivalent subsidy) may induce 10 percent more investment than would have otherwise occurred. (For a review of the literature, see Gary C. Hufbauer and Dean A. DeRosa, “Costs and Benefits of the Export Source Rule,” Tax Notes International, vol. 14, no. 20, May 19, 1997.) Hence it is difficult for national finance ministries to lecture their state and provincial colleagues over the “foolishness” of tax and subsidy “giveaways.” It is even more difficult for national finance ministries to curtail the economic powers of subfederal units through international agreements.

SCOPE OF INTERNATIONAL COOPERATION

While these cautions severely limit the scope of practical international tax cooperation, they leave room for modest initiatives to cope with the challenges of a global economy. In the paragraphs that follow, I outline what I regard as the outer limits of feasible tax cooperation between the United States and the European Union in the next decade.

E-commerce One of the great revolutions of our time is the explosion of e-commerce. With e-commerce, households as well as firms can buy goods and services from a much larger field of suppliers than otherwise. The result will be an approximation to the model of perfect competition for goods and services ranging from wine and shoes to electricity to entertainment and education. Widening the market will bring substantial efficiencies in terms of larger sales by low cost suppliers; it will bring even greater efficiencies in terms of the more rapid diffusion of technologies for new products, new production methods, and better distribution systems. In order to realize these gains, national tax systems will need to accommodate cross-border production of goods and services sold direct to households. For goods, this implies a huge volume of small parcels; for services it means an enormous expansion of internet deliveries. The most practical way to accommodate e-commerce in the tax system is to adopt the origin principle of border tax adjustments for value-added and similar consumption taxes. Under the origin principle, taxes are not imposed on imports of goods and services, but they are imposed on exports. From an administrative standpoint, it is much easier to collect taxes on firms at the location of production than on households at the place of delivery. This is

126 Gary Hufbauer surely true for small parcels arriving in large volumes in the customs sheds of the world. It is even more true for services arriving by internet at the computers of millions of individual buyers. Under longstanding GATT and now WTO rules, however, value-added and similar taxes are typically adjusted at the border according to the destination principle: they are imposed on imports but not on exports (the exact reverse of the origin principle). In general equilibrium analysis, with flexible exchange rates, it makes no difference to a nation’s current account balance whether it adopts the origin or destination principle for border tax adjustments. But the fact that two principles have an equivalent effect on the current account in general equilibrium does not mean they have the same effect on individual economic sectors, nor does it mean that switching from one rule to another can be done without significant transition costs. (For an extended discussion, see Gary Clyde Hufbauer and Carol Gabyzon, Fundamental Tax Reform and Border Tax Adjustments, Institute for International Economics, 1996.) In short, the change from existing border tax adjustments under the destination principle to a system of no adjustments under the origin principle would be politically unpopular with important firms. Reciprocity between Europe and the United States would thus be critical, staged implementation would be necessary (e.g., sector by sector, starting with services and low-value parcels), and special exceptions might be needed for heavily taxed items like perfume, tobacco and alcoholic beverages.

Personal Income Taxes In the global economy of 2030, households will derive more of their income from sources outside their country of citizenship or residence. Interest, dividends and capital gains from abroad are already important and will become more so as pension funds continue to diversify their portfolios internationally. (According to the OECD, The World in 2020: Towards a New Global Age, 1997, p. 87, the pension funds in major OECD countries now invest between 5 and 35 percent of their assets internationally; these proportions could double in the next twenty years.) In addition, more individuals will derive service income (accounting, legal, engineering, design, consulting, etc.) from foreign clients, and they will earn rents on foreign properties. Finally, with the aging of Americans and Europeans, many more people will choose to spend their retirement years abroad, while drawing social security and other pension benefits from the country where they once worked. These incidents of mobility all play havoc with personal income tax systems—especially the U.S. system which claims to tax the worldwide income of all citizens, regardless where they

127 Responses to Globalization in Germany and the United States: Seven Sectors Compared reside. (In fact, the United States even claims to tax the income and estates of ex-citizens, for a period of ten years after they renounce their U.S. passports.) Between the United States and the European Union, it might be possible to bring a degree of order to the tax chaos by agreements that accomplished three objectives. The first objective is to devise a system of comprehensive reporting of interest, dividends, capital gains, rents and personal service income paid to residents of the other country. The system would need to be reinforced by backup withholding taxes on payments outside the net of treaty countries— otherwise fraudulent addresses would explode. The first step is to create a system of reporting and backup withholding taxes within Europe; and, as already noted, this initial step faces stiff resistance from Luxembourg and the U.K. banks. The second step is to negotiate an EU-U.S. accord; and, since member states retain competence over most tax matters, they would first need to agree on a common line among themselves. The second objective is to reach an EU-U.S. agreement that personal income taxes will be levied on the basis of residence, not citizenship. Residence would be determined by a factual test (e.g., country of citizenship unless the person spent more than 270 days in the tax year in the other country, meaning, in the case of Europe, a single member state). In other words, the great majority of expatriates would pay personal income tax to only one country, and there would be no withholding tax or foreign tax credits for income derived from sources in the other country. To reduce “gaming” between tax rules and health care provisions, residents would be eligible for publicly supported health care (e.g., Medicare) only in the residence country—the same place they pay personal income taxes. Again, an accord with these various dimensions presupposes that the member states can reach a common line among themselves—not an easy task.

Corporate Income Taxes The great preponderance of international tax law concerns the activities of firms, especially multinational enterprises (MNE) with corporate and branch operations in multiple countries. Multinational firms take investment decisions that affect hundreds of billions of dollars and shape millions of lives. Many MNEs derive more than a third of their earnings from sources outside the home country. Not surprisingly, given the importance of MNEs and the density of their transactions, today’s international tax regimes are deeply entrenched both in the law and the politics of OECD countries. The regimes will not be easily altered. Elsewhere, I have argued that the United States would do itself a national favor by adopting the key elements of territorial taxation. The territorial

128 Gary Hufbauer approach would focus attention on measuring and taxing corporate income earned in the United States, rather than the worldwide income earned by U.S. corporations and their controlled subsidiaries. (See U.S. Taxation of International Income: Blueprint for Reform.) There is practically no chance, however, that the U.S. Treasury or Congress will embrace these recommendations as a general template for redesigning the tax system. Nevertheless, it is remotely possible that elements of the approach could be negotiated between the United States and the European Union. Again, this would require a common line among the member states. Each country would tax the corporate income earned at home, but would not attempt to tax the income earned by subsidiary firms incorporated and operating in the other country. The two countries would negotiate rules for allocating expense, setting royalties and evaluating other transfer prices between corporate members. Inherent in this recommendation is the fundamental idea that each country would tolerate (within agreed limits) incentives the other country or its subfederal units might offer to attract investment and jobs. To ensure this degree of toleration, the European Union, its member states, and the United States (and its fifty states) would first need to reach agreement on much tighter rules setting maximum subsidy levels than now exist within the WTO. They would also need to agree on minimum across-the-board corporate tax rates—a subject not addressed in the WTO or other accords. The rules would need to cover subfederal as well as federal practices. Again, we are nearing the limits of practical politics—if not completely crossing the boundary.

CONCLUSION: ADJUSTING PUBLIC FINANCE TO PRIVATE MOBILITY

Taxes are compulsory payments to government for which the taxpayer receives no specific benefit. But the taxpayer is entitled to the general benefits of governance; and if the taxpayer is dissatisfied with the balance between public benefits and tax burdens, he may consider moving to another jurisdiction—another city, another state, another country. This fundamental observation was made in 1956 by Charles Tiebout (“A Pure Theory of Local Public Expenditures,” Journal of Political Economy, vol. 64, 1956). Forty years later, the costs of moving are rapidly falling and the opportunities for moving are greatly increasing, both for firms and households. The Tiebout Hypothesis applies not only locally but also globally. Jurisdictions that want to avoid a shrinking tax base and dwindling revenues must accordingly deliver quality government services at competitive costs. They must also pay more

129 Responses to Globalization in Germany and the United States: Seven Sectors Compared attention to the benefit/burden calculation for groups of firms and households, not just for society as a whole. Let me conclude this essay with brief comments on the benefit/burden calculation. In the decades ahead, enhanced mobility means that most jurisdictions will be left with few “cash cows” that can be taxed heavily without prompting their move to greener pastures. Instead, tax systems will necessarily be redesigned to attract mobile firms that provide good jobs. Public benefits will need to show up in quality education and other public services that appeal to skilled employees. Otherwise, the firms and the jobs will move, both physically and via the internet. These benefit/burden considerations will compel a number of micro adjustments in tax systems and public expenditure profiles. However, they will also force a major social challenge. Europe and the U.S. will find it increasingly difficult to extract large sums of money from the working population to pay generous social security and health benefits to vast numbers of retired citizens. In the decades ahead, the core redistribution component of current tax and expenditure systems—redistribution between working and retired citizens— will be severely challenged by the realities of the global economy. Peter G. Peterson brilliantly explores this theme in a new book (Gray Dawn: How the Coming Age Wave is About to Transform America—And the World, Random House, 1999). Until Europe and the United States convert their current pay-as-you-go social security and old-age health systems into fully funded plans (where each age cohort pays for its own retirement and health benefits), working people will find themselves paying stiff taxes to care for their elders. In the meantime, working Americans and Europeans must come to accept a significant drop in their after-tax incomes, or public old-age benefits must be curtailed, or firms and jobs will migrate to younger countries. Over the next two decades, these unpleasant choices will become the dominant challenge of public finance on both sides of the Atlantic.

130 Ullrich Heilemann and Hans Dietrich von Loeffelholz

CHALLENGES OF GLOBALIZATION FOR GERMAN TAX POLICY Ullrich Heilemann and Hans Dietrich von Loeffelholz

INTRODUCTION

Since the mid-1980s, discussions of German tax policy and its reform have very much been formed by a significantly changed international environment caused by globalization/internationalization of production, liberalization of financial markets, or just by international tax competition. Though all this was not completely new to a (once) small open economy and its immediate net effects have been negligible,1 the additional—actual or seeming—loss of fiscal autonomy and the influence on the tax reform discussion was considerable. Most participants now take it for granted that states compete2 for internationally mobile tax bases which are engaged in a permanent search for tax arbitrage; emigration of tax bases, particularly capital outflow, would enlarge the structural and fiscal problems of “high-tax” countries. To secure the level of public expenditure, tax rates for the less mobile factors would have to be increased or expenditure would have to be reduced. However, globalization is not the only change in the rules of the game. In Germany as in the rest of Europe, the pressure on tax policy is expected to grow with the deepening and widening of the European Union (EU). The shift to a single currency from 1999 onwards is expected to enhance competition in general and tax competition in particular. The strain will further increase with the integration of “low tax/low expenditure” eastern European states after 2000. In short, fears of tax erosion and evasion are widespread. Germany’s fears seem to be particularly justified. Since 1993 its tax revenues have lagged remarkably behind official forecasts and many people are eager to blame globalization for the loss of revenues3 and are demanding vigorous countermeasures. As in other industrialized countries, some are hoping that global tax competition will help tame the Leviathan, while others fear a loss of fiscal, social and wage autonomy with severe consequences for the disadvantaged and socially weak strata of society. In particular, rising “globalphobia”4 is leading to the advocacy of a high level of congruence and coordination of tax and social policies. Though the influence of globalization and the loss of national fiscal autonomy seem plausible, the real significance of this must be looked into more carefully. Two different lines of approach are adopted in the present paper. First we consider the extent to which German tax policies of the past decade have been affected by globalization—directly as well as indirectly (II). Starting with

131 Responses to Globalization in Germany and the United States: Seven Sectors Compared a short examination of the “globalized” environment, the paper recalls the main theoretical features which have been discussed as affecting tax policies during the last fifteen years. The second line of approach examines the relationship between globalization and various categories of German tax revenues between 1970 and 1997 (III). A particular question here is to what degree these revenue losses can be attributed to globalization. The paper ends with a summary and some policy conclusions, taking into account not only the potential prerequisites of globalization but also general expenditure prerequisites as well as the particular conditions created by German unification and EMU (IV).

GERMAN TAX POLICIES AND GLOBALIZATION

Globalization,5 as represented by a more or less unique expansion of trade (export and import volume, trade balance) and of Foreign Direct Investment (FDI), has shaped the German economy of the last twenty years (see Figure 1). Indeed, Germany had been a driving force in this process. It seems to be obvious that the mobility of resources involved not only had consequences for production and employment in Germany, but for German tax revenue and tax policy (and, of course, government expenditure) as well. Identification and attribution of such effects, however, is very difficult and questionable. What seems to be clear is that in the public discussion about the appropriate taxation of income or, more generally, about “direct” taxation as well as “indirect” or consumption taxation, arguments addressing increased competition on European and global markets have played a greater role since the mid-1980s.6 It gained additional momentum as a result of the fundamental tax reforms of the 1970s in the United Kingdom and in the 1980s in the United States, on the one hand, and by the establishment of the single market in core Europe in 1992 and widening tax loopholes for foreign investors as well as by creating tax havens in some European countries on the other.

Theoretical Deliberations Several theoretical arguments,7 which were convincing a priori, lent support to the view that tax competition and its policy reverberations were on the increase: the abolition of legal and tariff frontiers as well as the dramatic decrease of transportation and information costs not only make goods, services, and resources increasingly mobile, but taxpayers as well. Continually exploring possibilities for tax arbitrage, taxpayers would be likely to “emigrate” from high tax countries to low tax jurisdictions, taking with them taxable income and assets (and even jobs). As a consequence of mobile tax bases, particularly of capital and of skilled labor, national tax bases would erode and tax revenues

132 Ullrich Heilemann and Hans Dietrich von Loeffelholz diminish. This would force nation-states to make uncomfortable adjustments: either public debt would have to rise (possible, of course, only for a transition period), or the supply of public goods and fiscal transfers would have to be cut back, preferably in a way not upsetting the mobile tax base. In the end, tax competition would lead to a “race to the bottom” (i.e., to the lowest tax level), and national tax policy would be more and more determined by foreign tax havens. The risk is that mobile factors might be subsidized by tax loopholes and overt or hidden transfers,8 starting an international race for tax subsidies.9 The question, “Are your wages set in Beijing?” (Freeman 1995), could equally well be posed in the European context, “Are your taxes set in Dublin?” referring to one of the currently infamous European tax havens. Second round effects of tax losses (the effects in the winner countries like Ireland, the Netherlands, or Luxembourg are usually ignored in the analyses) would unfold on the expenditure as well as on the revenue side of the budget. As to expenditure, it is understood that it would have to be, more so than in the past, attuned to the preferences and aspirations of mobile taxpayers and the relation between the public and private sector would be increasingly governed by fiscal equivalence (“commodization”). More generally, the allocative functions of expenditure would govern the redistributive ones.10 Tax policy would become more and more “supply-side” oriented: taxation of capital/investment and skilled labor would have to be relieved while the burden on unskilled labor and consumption would grow. The share of “direct” taxes within the revenues would decline, compensated by rising “indirect” levies,11 particularly by social security taxes/contributions. So the entire tax system would become more regressive. At the same time, fears would arise that globalization was going to cause numerous losses of lower skilled jobs with the implication of even more taxes for even fewer tax payers. So a list of third and fourth round effects is easy to imagine—with stabilizing as well as destabilizing effects in the long run. Of particular importance here would be consequences for monetary policy and collective bargaining agreements and the different tax shifting possibilities and incidence results. However, these implications, whose order of magnitude is difficult to assess, tend to be excluded in the specific analysis of current theoretical discussions.

Tax Policies in Germany German tax policy of the past two decades—enacted with regard to EU-tax (harmonization) guidelines12—was shaped to a considerable degree in light of these arguments. Two qualifications, however, have to be made.

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First, policy was influenced less by an immediate reaction to globalization than by a more general mood favoring tax relief, particularly because taxes as percentage of GDP had soared between 1965 and 1980 from 6.6 to 38.2 percent—compared with 2.6 to 26.9 percent in the United States.13 Second, the course was not straightforward and several exemptions were made. At all events, the frequency of tax amendments, mostly of income and consumption taxation, increased. In the second half of the 1980s only eight tax modifications generating total tax relief of 42 billion DM were enacted (see Table 1), while the next five years—the first half decade after German unification—saw 15 amendments with total tax increases of 78 billion DM, the same number as in the subsequent three years (1995 to 1998), but with tax increases amounting to 40 billion DM. More and more amendments became necessary because parts of the given tax code were declared unconstitutional by the Bundesverfassungsgericht (German Supreme Court). The government used the decisions to achieve substantial (income and property) tax relief. This was particularly the case in 1992, 1996 and 1997.14 However, only five revisions were of macroeconomic importance, exceeding 2 percent of the total revenues or 1 percent of GDP. The reasons for this were various. Rigidities of the German political and public finance system played a role, as well as the requirements of fiscal stability demanded by European integration. Tax policy is orchestrated by the federal government, whose proposals must be confirmed by the federal states,15 which have different preferences and revenue sensitivities, also with regard to the level and structure of taxes and expenditure. Because of opposite majorities in the Bundestag and Bundesrat most of the time, this was usually a rather time-consuming bargaining process and solutions could not always be found. Moreover, the actual or assumed demand of German society and the German economy for public goods is relatively high, particularly in the interest of maintaining the high level of material and non-material infrastructure in western Germany and building it up in the new German states. The same thing applies to transfers. Almost 50 percent of total economic resources are disbursed to the federal, state and local levels and through the social security system, of which 20 percent is devoted to explicit interpersonal and generational/temporal redistribution. Hence, public expenditure (and the required revenue) plays an important macroeconomic role, and the beneficiaries are, of course, very reluctant to give up this income and readily express their discontent at election time. Accordingly, it took ten years to cut back the ratio of public expenditure from about 50 percent of GDP in 1980 to less than 46 percent on the eve of German unification in 1989. Since then it has

134 Ullrich Heilemann and Hans Dietrich von Loeffelholz been hiked up to 51 percent in 1993 and reduced again to 48 percent in 1998, whereas unification has cost five to six percent of GDP per year. Public expenditure is devoted mainly to transfers (50 percent in 1998), public consumption (40 percent), and investment (4 percent); in functional perspective, it is used for social security (55 percent), for defense and general administration (12 percent), traffic and communications, housing and economic improvement (10 percent) and for education (9 percent). Interest payments on public debt, which has soared since German unification from about 40 percent in 1990 to 60 percent of GDP in 1998, eat up 7 percent of GDP. In longer-term perspective, the functional pattern of public outlays in Germany has favored the least flexible kinds of expenditure—personal transfers— resulting in reduced flexibility in changing expenditure; it has been halved since 1970.16 German tax policy has been increasingly influenced by European requirements, particularly by the fiscal demands of the EMU as expressed in the Maastricht Treaty and the “convergence criteria” set forth in 1992 and sharpened in the 1996 “Growth and Stability Pact” for balancing national budgets. Though it does not aim at taxes directly, it substantially restricts the scope for cutting taxes, despite the fact that there were also a number of other reasons for refraining from doing so, particularly up until 1997 with respect to fulfilling the (fiscal) Maastricht criteria for Germany’s entrance to the EU’s monetary union. All in all, the scope for noteworthy net tax reductions has been and still is considerably limited, not least as a result of the limited macroeconomic medium term growth expectations of 2.5 percent, which cannot be expected to impact the 1999 unemployment rate of 11 percent very much. The federal government is assuming for its mid-term economic and fiscal projections that one has to reckon with 3.5 million unemployed until 2002, implying an unsatisfactory rate of nine percent of the workforce.17 Needless to say, further risks exist: the labor market and economic development in eastern Germany and the process of catching-up with western Germany. Even if eastern Germany can resume its convergence with the West, which has slowed in the last few years, the drain on Germany’s economic resources to promote this is expected to remain remarkably high at 5 percent of GDP for considerable time to come.

Recent Proposals and Draft Legislation Against this background, in 1995 and 1996,18 the federal government installed two commissions for elaborating proposals for a comprehensive reform of income taxes to be enacted from 1996 onwards. The first commission (Bareis-Kommission), formed by independent tax experts, was charged with

135 Responses to Globalization in Germany and the United States: Seven Sectors Compared elaborating proposals for tax relief in lower income brackets required by the Bundesverfassungsgericht in a 1992 decision; it proposed abolishing most tax expenditure for businesses and workers, in line with prevailing national and international tax policies for the past twenty years. The proposals were dismissed by the government as being too far-reaching and politically unfeasible. To channel the public discussion, the federal minister of finance commissioned a three party governmental committee, which adopted the approach of cutting the top rates and broadening the tax bases, but with more attention to political possibilities. These Petersberger Vorschläge were published in January 1997 and served as guideline for the government’s tax proposals released in spring 1997. They tried to unify fiscal requirements with the alleged economic (allocative) necessity of an overall, significant reduction of tax rates to an “internationally competitive” top level of 39 percent. In order to limit revenue losses due to rate reduction (85 billion DM per year), the tax base had to be broadened by a reduction of tax expenditure (revenue gains of 35 billion DM). However, a (net) tax reduction of more than 30 billion DM per year (0.7 percent of GDP) was not seen as feasible. Therefore it has been proposed to collect 20 billion DM via higher indirect taxes; whether and to what extent the amount should be financed by additional value-added taxes (VAT), where a one percent increase (to 17 percent) would contribute 16 billion DM per year, or excise taxes (e.g., on gasoline, tobacco, alcohol, energy) remained an open question and a central topic in the political struggle between the federal government and the opposition in the Bundestag and the Bundesrat.19 “Globalization” was also of importance in the debate. With often explicit reference to the international investor/taxpayer, it was argued that the system should be made more understandable and comparable, as well as more competitive.20 The proposals failed in the fall of 1998 owing to irreconcilable conflicts between the two chambers of parliament. After the federal election of September 27, 1998, the government sees— with even greater attention to the fiscal requirements of balancing the budget and to increasing demands for public investment for important functions like traffic and education – room for tax relief only in the order of about 15 billion DM (0.3 percent of GDP) and at the earliest in 2002. The proposals include cuts in tax rates and broadening personal and corporate income tax bases, on the one hand, and an increase of gasoline and energy tax (“eco-taxes”) to reduce the social security contributions, on the other.21 With respect to strengthening private investment and international competitiveness, the government plans a reform of self-employed income taxation by 2000. The main target is to limit the marginal top rate of personal income tax for the self-employed22 and corporation tax uniformly to 35 percent.

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In line with the general tax policy, revenue losses will be compensated by the closing of tax loopholes. To this extent, some exaggerated expectations and hopes of the private sector that they would gain from the tax cutting and base broadening will be have to be disappointed. Compared with the international situation (see Figure 2), the pitfalls of international tax comparisons aside, this looks rather attractive, at least at first glance. Despite the inevitability of “tax rate illusions,” —looking only at the numerical value of the tax rate, ignoring the different definitions of the tax base—the proposed reform is presented as an important sign that German tax policy is accepting the challenges of globalization and reacting to it as far as necessary and possible.

GERMAN TAXES AND THE GLOBAL ECONOMY

Though German tax policies have often referred to the necessities of a global economy and international tax competition, the actual influence of these developments and, even more important their factual meaning for investors and tax revenues, are still very much clouded.

Revenue Tendencies Between 1970 and 1997 German tax revenue increased in line with GDP growth of almost 6 percent per year on average (See Figure 3); wage taxes and VAT surpassed that rate (7 and 6.5 percent respectively); corporate tax and trade tax23 lagged behind the general economic development (4.5 percent each); and revenue from wage taxes even decreased by an average 3.7 percent annually. Taken together, wage tax and VAT gained additional shares of tax revenue and the share of personal income taxes correspondingly diminished. The overall tax quota as a percent of GDP decreased by 3 percentage points between 1970 and 1997 to an all-time low of less than 22 percent. In the same time period social security contributions soared by 7 percent to an all-time high of 20 percent. One might well be tempted to assume that these losses of mobile taxes and the gains of immobile taxes/contributions were due to globalization. However, the reasons for these shifts are manifold: they range from massive tax expenditure for backing the transition process in eastern Germany24 and the reform of the family transfer system,25 to the slow growth of the economy as a whole and persistently high unemployment, which absorbs 10 percent of all public resources. Though the effects of globalization cannot be ruled out completely, there is ample newspaper evidence of large and small companies widely using the existing possibilities of international tax planning and transfer pricing, reacting not only to “shareholder” pressure, but also to the obviously

137 Responses to Globalization in Germany and the United States: Seven Sectors Compared reduced costs of business tax minimization.26 Of course this provoked much anger from the public and from politicians—as Mr. Stoiber, head of the Bavarian state government lamented, it is not acceptable that the rich pay taxes in the Bahamas while sending their children to “free” schools and universities in Germany and delighting in heavily subsidized German opera productions.

Globalization and Tax Revenue in Germany Empirical evidence regarding the effective influence of globalization on tax revenues is small. One of the few analyses available is the well known study by Dani Rodrik. On the basis of panel estimates with annual data for France, Germany, the United Kingdom, and the United States, he analyzed the dependence of so-called effective tax rates on labor and on capital income as a function of the openness of these countries, represented by the foreign trade ratio of GDP. He found that with increasing openness, tax rates on labor income rise and rates on capital income decrease and with restrictions for capital movements as an additional parameter, the influence of openness is even stronger. As for tax revenue, in addition to openness, the influence of FDI and various representations of the tax base and its variations were tested for Germany over the period 1977-1996. The a priori expectation—a negative correlation between revenue and the (explicit) globalization indicator— evolved only for total tax revenue. Even then the effects were small. An increase of openness by one percentage point (from 23 to 24 percent of GDP) means on average a total tax revenue decrease by 0.4 percent or DM two billion per year. As for the revenue categories, globalization effects were either insignificant or resulted in a move in the opposite direction. The hypothesis of a negative correlation between tax revenues and foreign direct investment (FDI) was rejected not only for taxes on profits and capital, though the reaction of taxes is unrealistically high. Recursive regression estimates revealed that the reactions and the explanatory power of the equations did not change much over the years. If there have been revenue losses for Germany because of globalization, they must have been relatively small. The influence of FDI slightly increased, particularly on profit/capital income tax (on corporations and entrepreneurs, etc.); as to the proceeds of the corporation tax and total tax revenues, there too, the influence is very minor. As to the impact of openness, the expected negative influence could be identified neither for total tax revenue nor for the mobile single tax or any others.

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It would have been interesting to examine these findings with data used by Rodrik. Unfortunately, this was not possible. One can only surmise that the German evidence did not contribute to the “confirmation” of his hypothesis.

SUMMARY AND POLICY CONCLUSIONS

Since the late 1980s the consequences of globalization have been attracting increasing attention. Globalization has left its mark on German tax policies as well as on tax policies at the EU level. Of course, interest in this influence goes beyond immediate consequences for revenue: “globalization” might be seen, contrary to Dani Rodrik, as an equalizing force on government expenditure, deficits, and debts. Indeed, theoretical reasoning suggests that taxes have great influence on mobile capital—financial as well as human—and hence on fiscal revenue, and also on the level and structure of government expenditure and branches (See R.A. Musgrave: allocation, stabilization and redistribution). However, analysis is often hampered by limited scope, since it pursues, so to say, only the “price competition” approach and ignores the possibilities of “quality competition,” which may, despite the universality of some government services, justify high tax levels in industrialized countries like Germany. Though German tax policy of the last twenty years reacted to some degree to direct and indirect effects of international developments, other challenges were more significant with regard to shifts in tax policies, including the high elasticity of the German income tax system (“bracket creep”) requiring periodic tax reductions, German unification, and the requirements of the Maastricht Treaty and its successor. The government now envisages some tax reductions by 2002, but this can hardly be seen as an answer to globalization, particularly as the government is also enacting a unique program of eco-taxes. Indeed, as an analysis of the revenues of “mobile taxes” in Germany since 1970 reveals, no significant influence of globalization can be detected. Considerable losses of mobile taxes seem to be caused primarily by tax subsidies designed to foster investment in the new German states. Another source is the not always fair tax competition within the EU, which, all in all, probably caused several billion DM or one-digit percentage points of the revenue loss. However, the test result may not be final, as there are some hints of a greater influence of globalization in the future. Given the emigration of mobile taxes that has taken place already, the remaining potential is rather limited. As to policy reactions to these risks in general, a common tax code within the EU establishing guidelines and or at least imposing minimal rules for the

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“sensitive” parts of the tax systems seems more urgent. Though such regulation should leave freedom for national differences, the room to maneuver will be small. This also means that international tax coordination or even harmonization within the supposed “club” (as proposed by Robert Z. Lawrence et al.27) on a supranational, EU or global level could become more necessary, depending on the mobility of tax bases. However, it should not be overlooked that competition refers not only to taxes as costs for the private sector but also as prices for public goods, social consensus and cohesion of society. In brief, it implies that globalization could more and more relate to competition for quality of the public goods instead of prices. As a consequence, Germany, like other OECD-countries, will have to shift the discussion from “price competition” to “quality competition” without confusing this with a license to tax and spend.

Table 1: Tax Amendments in Germany 1985-19981 Revenue Increase/Loss(-)2 in Billion DM and Percent of Total Tax Revenue

Year Date DM % Year Date DM % Year Date DM % (bill.) (bill.) (bill.) 1985 June 26 -19.7 -4.4 1993 June 23 34.4 4.4 1998 May 26 0.2 0.0 Dec. 19 -1.1 -0.2 Sept. 13 -0.5 -0.0 June 23 -0.1 -0.0 Dec. 21 3.6 0.4 July 16 0.0 0.0 1986 May 15 -0.1 -0.0 Aug. 06 -0.1 -0.0 1994 May 26 -0.2 -0.0 Dec, 18 -1.1 -0.1 1987 July 14 -5.7 -1.2 June 24 -0.2 -0.0 Aug. 09 -0.1 -0.0 1988 July 25 -19.1 -3.5 Oct. 28 -0.1 -0.0 Dec. 20 9.3 1.8 Dec. 21 8.5 1.0 1989 June 30 -5.0 -0.9 1995 Oct. 11 19.0 -2.4 Dec. 22 -0.6 -0.0 Dec. 22 0.9 0.1 Dec. 28 0.0 0.0 1990 Feb. 22 -1.2 -0.2 June 25/26 -0.7 -0.1 1996 Dec. 20 9.4 1.1

1991 June 24 26.8 3.7 1997 April 18 ./. - August 18 5.8 0.7 1992 Feb. 25 4.8 0.6 Oct. 29 1.6 0.2 Aug. 25 -0.6 -0.0 Nov. 21 -7.4 -0.9 Nov. 09 4.0 0.5 Dec. 19 11.2 1.4 Dec. 21 -0.4 -0.2

Source: Federal Ministry of Finance. 1Up to 1990 the former Federal Republic of Germany. 2First year of taking effect.

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143 Responses to Globalization in Germany and the United States: Seven Sectors Compared

ENDNOTES

1 Cf. IMF, Annual report 1996. New York 1996, p.32. 2 Cf. the criticism of P. Krugman, Pop Internationalism. Cambridge, MA, and London 1996. 3 For details cf. U. Heilemann, H.D. von Loeffelholz and S. Renn, Erosion der Steuereinnahmen - Preis der Globalisierung der Wirtschaft. Theoretische und empirische Aspekte zur aktuellen Diskussion. RWI-Papiere. Forthcoming. 4 Cf. G. Burtless, R.Z. Lawrence, R. Litan, and R. Shapiro, Globaphobia: Confronting Fears about Open Trade. Washington, D.C., 1998. 5 For a detailed presentation of the phenomenon, its many causes, etc. cf. W. Reinicke, Global Public Policy. Governing without Government. Washington, D.C., 1998, pp.11ff. 6 Cf. Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung, Arbeitsplätze im Wettbewerb. Jahresgutachten 1988/89. Stuttgart und Mainz 1988, pp.116ff., K. Löbbe, R. Döhrn, H.D. von Loeffelholz et al., Strukturwandel in der Krise. (Untersuchungen des Rheinisch-Westfälisches Institut für Wirtschaftsforschung 9.) Essen 1993, pp. 56ff., and H.D. von Loeffelholz, Standortqualität der Bundesrepublik in steuerlicher Hinsicht. RWI-Mitteilungen 40 (1989), pp. 183ff. 7 Cf. H.-W. Sinn, Capital Income Taxation and Resource Allocation. Amsterdam 1987, D.E. Wildasin, Income Redistribution in a Common Labor Market. American Economic Review 81 (1991), pp. 757ff., and V. Tanzi, Taxation in an Integrated World. Washington, D.C., 1995, pp.12ff. With respect to Europe cf. H.-W. Sinn, Tax harmonization and tax competition in Europe. European Economic Review 34(1990), pp. 489ff. 8 Cf. P.B. Musgrave, Comments in Session on “Foreign Reactions to U.S. Tax Reform”. National Tax Journal 41 (1988), p.365; she spoke of tax competition implying the risks of “hidden agenda for luring foreign capital and subsidizing exports.” 9 Such a peril has been discussed among the G 7-countries already in the context of the tax reforms in the 1980s; nowadays it is receiving additional attention from the OECD which is currently speaking of tax competition as a “harmful issue.” It could imply demands for rigorous harmonization by administration, which would lead undoubtedly to the harmonizing of tax burdens on a relative high level, provoking further reactions to evade taxation. Cf. OECD (ed.), Tax Competition. An Emerging Harmful Issue. Paris 1998.

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10 This would happen despite the fact that “globalization” is sometimes assumed to increase the labor market difficulties, subsequently causing an increase of social security expenditure, cf. e.g., D. Rodrik, Has Globalization Gone Too Far? Washington, D.C., 1997, pp. 11ff. For a different, much less pessimistic view cf. IMF, pp.32ff. 11 The emphasis on taxation of consumption would seem to be favorable also from the point of view of trade within the European countries, given the destination principle based on the border adjustment with tax reimbursement. For instance, changing the tax structure in Germany from “direct taxes” (45 percent of tax revenues 1997; social security contributions excluded) to “indirect” levies (55 percent) through, say, hiking up Value Added Tax (VAT) by one percentage point (16 billion DM) and through corresponding reduction of income tax would it make unnecessary c.p. to shift parts of the “direct” burden via higher export prices to the global market. 12 These guidelines released by the EU-commission and aimed mainly at the functioning of the single European market to ensure free movement of goods, services, capital and labor within member states have therefore referred to harmonization of indirect taxation (rates and bases of VAT) and to a far lesser degree - with some minor exemptions - to direct taxation. For the history of EU-tax policy since the mid 1960s cf. L. Tsoukalis, The New European Economy Revisited. Oxford 1997, pp. 102ff. 13 Cf. OECD (ed.), Revenue Statistics 1965-1997. Paris 1998, p. 79. 14 On January 19, 1999, the Bundesverfassungsgericht made a fiscally and economically far-reaching decision which runs against the challenges of globalization; it decided that the income taxation of families was not in line with the Grundgesetz, particularly with its Article 6 which prescribes that marriage and the family stand under particular protection of the state. It obliges the legislators to correct the tax code by the year 2002, implying revenue losses of about (gross) 20 to 30 billion DM p.a. (almost 10 percent of income tax revenue). 15 Almost three-quarters of total tax revenues are assigned by the fiscal constitution jointly to the federal, state and local level. The proceeds stemming mostly from the (personal and corporate) income and the value added tax are (re-)distributed to the different levels with certain quotas; this leads to a ratio of 50 percent (federal level; 1997) to 38 percent (state level) to 12 percent (local level). The share of the states has increased since the 1960s, when it stood at 30 percent and was boosted particularly by German unification; the “loser” has been the federal level. For the long-term development of the fiscal federalism in Germany cf. U. Heilemann and H.D. von Loeffelholz, Fiscal Federalism in the FRG: A Critical Approach. In: H.-E. Scharrer, M. Smith and L. Waverman (eds.), Regional Economic Integration and the Workings of A Federal System. Centre for International Studies & Centre for Trade Policy and Law (4th Canada-Germany Symposium.) Toronto 1995, pp. 65ff. 16 Cf. H.D. von Loeffelholz and H. Rappen, Perspektiven und Optionen niedersächsischer Finanzpolitik in den neunziger Jahren. (Untersuchungen des Rheinisch-Westfälischen Instituts für Wirtschaftsforschung 11.) Essen 1994, pp. 61ff.

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17 Cf. U. Heilemann and H.D. von Loeffelholz, Fiscal Perspectives for the 14th Legislative Period. Germany After the Election. AICGS Research. Washington, D.C., December 1998, pp. 13ff. 18 For German tax policy in first half decade after German unification which was principally directed at financing the corresponding outlays out of the purses of social security systems cf. U. Heilemann and W. Reinicke, Welcome to Hard Times. The Fiscal Consequences of German Unity. Washington, D.C., pp. 42ff. 19 Another reason was the bias in favor of the upper income brackets increasing the already existing “lack of demand“ as well as the “lack of equality.“ 20 A fierce debate arose about the actual/factual differences in international taxation; it was pointed out that the effective rates in Germany are much lower than the nominal ones and insofar already “competitive.” Cf. the international comparison of effective tax rates on capital (and labor) in OECD (ed.), Economic Outlook No. 61. Paris 1997, pp. 19ff. 21 The two essentials are as follows. First, reduction of the income tax burden. It consists of three steps to be taken in 1999, 2000 and 2002: Second, to reduce social security contributions in the next three years by 0.8 percent each year from the current level of 42.5 percent of the wages (employer’s and employee’s portion together) to below 40 percent; it is going to decrease the revenues by about 45 billion DM; it will be financed completely by (higher) gasoline and energy taxes. This means a eco-tax hike of about 50 percent in relation to the given eco-levies. For details cf. U. Heilemann and H.D. von Loeffelholz, pp. 14ff. For an international comparison of eco-taxes cf. OECD (ed.), Environmental Taxes in OECD Countries. OECD Working Papers, 74, Paris 1998. 22 It is noteworthy that a reduction of the general top rate is planned from at present 53 percent (not including the solidarity surcharge of currently 5.5 percent on the tax liability) to only 48.5 percent. 23 The trade tax (Gewerbesteuer) amounting to almost 50 billion DM p.a. or 1.2 percent of GDP (figure 3) is a additional levy on the income of certain categories of the self- employed; it resembles the franchise tax levied in some states of the United States. 24 For details cf. U. Heilemann and H. Rappen, The Seven Year Itch? German Unity from a Fiscal Viewpoint. AICGS Research Report No. 6, Washington, D.C., 1997, pp. 2ff. 25 The transfers were subtracted from the tax revenues instead of being added to the public outlays implying a “cosmetic“ reduction of the tax share of GDP in line with the supply side tax policy; it was directed at reducing public influence on the allocation of economic resources. Cf. also footnote 16. 26 Cf. the various possibilities S.C. Gwynne, Just Hide Me My Money. TIME, December 14, 1998, pp. 38ff. 27 Cf. R.Z. Lawrence, A. Bressand and T. Ito, A Vision for the World Economy. Openness, Diversity, and Cohesion. Washington, D.C., 1996, pp.79ff.

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INFRASTRUCTURES FOR GLOBALIZATION: TRANSPORT, TELECOMMUNICATION AND ENERGY SUPPLY Rudolf Petersen

INTRODUCTION: WHAT’S NEW ABOUT GLOBALIZATION?

International trade and transnational economic activity as well as multinational companies have long existed, but in recent years national restrictions have all but vanished. Traditionally, international activities were subject to national or host market rules. Now, the role of the national government and its power to regulate economic activities is fading. At least until the international financial crisis of 1998, a broad consensus appeared to exist among statesmen, the banking community, leading economists, and industrialists that national governments should not interfere with the economic activities of the private sector. The current crisis reveals a preference for governmental intervention to rescue bankrupt private institutions. Presently, nearly all important European countries are governed by socialist or social democratic parties, which do not believe in the ability of the markets to solve all problems. Infrastructures have dramatically changed during the last decade and have facilitated globalization of financial services and of goods trade. But most of the transport activities still take place on the local and regional as well as national level, and decisions are dominated by those perspectives. The international aspects increasingly influence the decisionmakers, and the need to be prepared for globalization affects policy decisions locally as well. Being able to participate and to compete in the global economic race is a rationale deployed in debates on highway construction, increase in airport capacity, information policy, and energy taxation. The transport, energy and telecommunication sectors not only provide infrastructures for the globalization process; simultaneously, they comprise global markets themselves. Production of hardware—vehicles for transport, natural energy resources and telecommunication equipment—is one side of the business; organization, know-how and service is the other.

INFRASTRUCTURES FOR GLOBALIZATION

Global markets for goods and services comprise one element of globalization; local and regional relations are redefined by transnational and transcontinental markets. Economic and organizational integration of production facilities and distribution channels in distant countries is a further

147 Responses to Globalization in Germany and the United States: Seven Sectors Compared sign of globalization. The third element is the exchange of know-how in production and marketing, both by an exchange of staff members and by globally available information. In the history of trade, volume of goods flow used to be rather small and exchange relations were characterized by structural asymmetries. Traders bought specialties and made their profit by selling specific goods on distant markets where they were not yet available. The value of a product and the profit was based on the fact that it was a rare and very special product. Today’s globalization unites highly homogeneous product markets. Profit derives not from unique local and regional products but from regional differences in production costs. Cost advantages are reaped via low local labor costs and the economies of scale in development, production and distribution of goods and services. Globalization as we know it today is the organizational integration of economic processes over the continents. Management of global economic processes requires teleconnections by online telecommunication, as well as short travel and transport times. Advanced telecommunication and transport infrastructure are a requirement for globalization. The development of transport and telecommunication towards global networks can only be understood by considering regional and national structures. On the one hand, establishing global transport and telecommunication infrastructures can be seen as a geographical extension of previously local and regional networks. On the other hand, exchanges of information, persons and goods over large distances are structurally distinct from activities on the local and regional levels. Establishing advanced telecommunication technology is dissimilar from the gradual growth of contact that we know from near proximities. Both scenarios yield insights into globalization. Cost-effective teleconnections on a global scale could only be established because of cheap natural resources. Energy resources deserve special mention in this regard. Exchange of goods and persons by ships, motor vehicles and airplanes is based nearly exclusively on crude oil. In the telecommunication sector, the role of the energy market is less significant, but low energy prices have also contributed to the establishment of the existing comprehensive telecommunication system. Cheap energy resources have also contributed to the establishment of today’s modern satellite based telecommunication structures. Large energy and material resources have been consumed and will continue to be needed for systems which enable exchanging online-information from one point of the Earth to every other point. A quantitative analysis of resource needs for globalization related activities is rather difficult. Most structures that support global activities also find everyday use in the organization of life on the local and regional level.

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International shipping and international air transport are influenced by globalization, but national development is also intensified by the globalization process. The dynamics of technical development and the behavioral changes on the part of the users cause internal feedback loops between global technologies at the local as well as regional level. This effect is twofold: fast and cheap transport and telecommunication infrastructures initiate spatial reorientation of social and economic activities favoring longer distances. By the same token, new opportunities also transform social and economic activities in traditional geographical action domains. Moreover, in their role as facilitators of globalization, the transport, telecommunication and energy sectors have themselves been early products and services marketed worldwide. At work is an internal systemic logic: those products and services required for the global economy had to be established very early on all markets in order to guarantee compatibility. Compatibility both for transport terminals and telecommunication devices is enforced by similarity of products and services as well as establishment of uniform conditions governing the local market. Once in place, infrastructure created incentives for international organizational and financial cooperation. Economic actors benefiting from infrastructure have used their strength to penetrate local markets, taking advantage of their know-how and marketing.

GLOBAL TRANSPORT PERSPECTIVES

The automobile has transformed the structures and public space of every day life like no other product during the last century. In 1995 more than 650 million motor vehicles were in use worldwide, mostly passenger cars (about 500 million). Distribution between the wealthier and the poorer countries is very uneven. OECD countries with about 20 percent of the world’s population own about 81 percent of all passenger cars. Those 80 percent of people living in the poorer countries only own one-fifth of the world’s fleet; and these countries also account for only about one-fifth of global vehicle kilometers and roughly one-fifth of motor vehicle fuel consumed. OECD countries are also the major participants in global trade. The transport volume, expressed in passenger kilometers and ton kilometers, is highest between countries with high average income and high gross national product (GNP). The backbones of trade are shipment, truck transport and international air transport, which account for the parallel increase in business trips. The most frequented transcontinental transport connection is the North Atlantic route between Western Europe and the United States, which comprises the most important centers of economic activities. About one-third of global air

149 Responses to Globalization in Germany and the United States: Seven Sectors Compared passenger kilometers can be accounted for here; a similar share of world air transport relates to domestic North American flight activities, with the remaining third flown in the “rest of the world.” Between 50 and 70 percent of air transport demand relates to private, leisure and tourist activities. According to a Gallup inquiry in 1993 only 48 percent of all passengers in the U.S. were business travelers, the majority traveled for private reasons, a share that is constantly growing. The situation is similar for international flights from Germany. A discussion of global transport activity only from a business point of view would neglect the fact that globalization is driven by international tourism and international private travel. Tourism already claims the title as the world’s most important economic sector and biggest employer, exceeding even information and car production. International tourism contributes to the development of that global network of information and transport links that also promotes business links. It also works the other way round: those global infrastructures which enable economic investment and production facilities in distant countries and which enable control of global economic activity, respectively, also act as driving forces for international travel activities of private customers. Growth of air transport demand may be the most impressive figure to characterize the development of the globalization process. Worldwide passenger air transport has increased by a factor of about ten during the last thirty years. With current growth rates of about 5 percent per year that are expected to continue, passenger kilometers will double every fifteen years during the coming decades. The number of takeoffs and landings has not increased by the same figure compared to the number of passenger kilometers due to a trend of larger airplanes with higher seat capacity, and due to a special growth of demand for long distance flights. Instead of a 100 percent increase in fifteen years which is expected for passenger kilometers, only an increase of about 60 to 70 percent in the number of individual passengers can be expected. Passengers will travel longer distances and this leads to the kilometer increase. Because of the cited trend towards larger units, the capacity increase of airports can be limited to “only” 50 percent over the next fifteen years. In Germany, capacity problems exist mainly in Frankfurt and Düsseldorf, where capacity increases have been scheduled. There is a trend towards smaller regional airports in order to serve business travelers from the region, but the main commercial prospect lies in developing the tourist market with direct flights from German regions to sunny destinations around the Mediterranean Sea and the Canary Islands. Competition between German airports and airports in neighboring countries is stiff, as is competition between the large national carriers of

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Germany, France, Great Britain, Switzerland, and so on. Those national carriers—in public or private ownership—also stand for important home locations which are used as hubs within the international transport network. Frankfurt, Paris, London, etc. are the starting point for international connections of the respective national carriers. These main airports are served with feeder flights from smaller airports of a secondary German and European network. With the hub-and-spoke system, international destinations can be served cost effectively with large units, while for the shorter flights, smaller airplanes with less seat capacity can be used flexibly according to demand. About 63 percent of all takeoffs in German air transport relate to flight distances of up to 800 kilometers, with about 40 percent of all passengers. The figure of 63 percent is a most important one with respect to capacity of the airport runway; the figure of 40 percent is important for assessment of capacity of passenger facilities. For energy consumption and greenhouse gas emissions, the share of short distance air transport is far lower: only about 8 percent of all passenger kilometers can be accounted to flight distances below 800 kilometers. More than 90 percent of transport activity in terms of passenger kilometers relates to the medium range (in Germany mainly the tourist flights) and the long range (both business and tourist). Growth rates over long distances are highest in the air market. Although the dominant trend is consolidating the hub-and-spoke system, a pattern of decentralized point-to-point intercontinen- tal connections from secondary airports in Germany can also be observed. Connections linking Düsseldorf and Philadelphia, Berlin and Baltimore, Munich and points in Asia have been introduced in recent years though they have limited importance for the overall volume. In the air cargo sector some plans exist and investments have been made in special cargo facilities with diverse production and logistics. The U.S. Bechtel Corporation is involved in the development of an airport project, Berlin International, which in fact is in the state of Saxony-Anhalt, north of the provincial capital of Magdeburg. The idea is to establish Europe’s largest cargo airport, intended as a distribution center for international cargo for Europe and at the same time attract regional investments in production facilities near the runway. On a larger scale, there is a similar project in North Carolina which has been operating for about ten years. An important repercussion of globalization for local transport and spatial infrastructures is the subordination of local decisions to global market expectations. In effect, daily mobility demands over short distances are devalued although they make up by far the most trips. The global perspective makes the local perspective seem less important.

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TELECOMMUNICATION

With the telegraph, first used in 1847, information could be transmitted without delay. From 1877 on, telecommunication with spoken words by telephone was the next important step. Within a few decades, cable networks were established to link cities, countries and—due to the first transatlantic cable in 1858—even continents. The telex enabled offices to communicate written messages from 1930 on; the fax machine was already invented at that time although it didn’t enter the broad market before the 1960s. The 1970s saw the first analogue cellular phones for a still small private and commercial market, data transfers via cable, as well as cable TV. The number of telecommunication services exploded in the 1980s: fax machines became a must in all offices, on- screen text on TV, cheap and reliable remote control, video-conferencing, and several forms of city-call beepers were established in various niches of the telecommunication market. The 1990s offer even more services for the customers: voice mail, voice fax, the online newspaper, digital mobile phones, and, most important, the Internet as a combination of personal computers and telecommunication. Now, comprehensive global telecommunication is no longer a privilege of military services and big companies but is affordable by the common citizen—at least in the wealthier countries. But basically, all these services are also available on the markets of Third World and developing countries. Access to global information can be characterized by ownership rates of telecommunication equipment. In Germany,1 98 percent of households were equipped with TV sets in 1996, 30 percent had satellite TV receivers. Thirty- two percent of all households had access to personal computers in that year. At the beginning of 1999 the figures will be significantly higher. Eighty-nine percent of households had telephones—more than 40 million. The number of fax machines was 4.5 million, the number of cellular phones (“handy” in German) was 5.5 million and these figures will also have increased by now. Annual growth rates in the telecommunication sector are estimated to be 10 to 20 percent. In a recent study2 the material flows and some environmental consequences of this huge number of new devices for telecommunication in German households and offices have been evaluated. The TV sets, telephones, computers, copiers, etc., account for a total mass of 3,200,000 tons. With mass analyses of all important articles, i.e., a breakdown of the masses of iron, other metals, plastics, glass, chips, etc., total materials built into the telecommunication equipment have been calculated. But these directly built-in materials are only part of the problem. All materials have symbolic “Rucksacks”

152 Rudolf Petersen which contain all masses3 and energy resources needed for production of these goods “from cradle to grave.” A comprehensive balancing of these materials and energy flows has not yet been made. Estimates have been published for only a few aspects. Copper has been found to carry an “ecological Rucksack” of 500 kg for each kg in a product. Of the estimated 391,000 tons of non-ferrous metals in telecommunication products operated in Germany, the majority will be copper. A cradle-to-grave evaluation shows a gigantic material flow for this metal which is essential for all kinds of electric and electronic equipment. The mass figures given above are only for the products themselves, not for infrastructures and other related activities and facilities. The technologies and infrastructures behind the products and services have never been evaluated comprehensively. The European Commission is just preparing a study entitled “Eco-Balancing of the Information Society.” Thus, the idea that the information society is clean and environmentally favorable may turn out to be fictitious. So far, environmentalists have turned their criticism on heavy industry stacks spewing smoke and acid emissions, or on motor vehicles. Though the information sector has not yet become the focus of environmental groups, and even less of environmental policy, information infrastructures may be no less harmful to the environment than roads: the German telephone network consists of 169,000 km of copper cable, 300,000 km of glass fiber cable, and so on. The copper network alone contains 300,000 tons of copper, which results in an “ecological Rucksack”—with the factor mentioned above—of 150 million tons. The “hidden energy” of a personal computer has been calculated in several studies, with results between 13,400 MJ and 53,500 MJ (cited by the German Bundestag 1998). The U.S.-based MCC Corporation has estimated an energy consumption of 126,000 MJ for the production of a workstation. The MCC study notes particularly the high energy demand for the production of chips, as well as some serious environmental concerns regarding toxic emissions, waste and effluents. All that can be said confidently at present is that the real environmental costs of information technology are unknown. The same will be true for the social dimension, a topic that lies wholly outside the bounds of this chapter. Another research gap in the information sector concerns global satellite networks. More than 22,000 satellites have been launched during the last decades, with telecommunication being a major part of the current activities. Satellite history is reviewed in articles published by NASA historians.4 Since 1965, when EARLY BIRD became operational, telecommunication service prices dropped due to the fact that this kind of satellite provided almost ten times the capacity of the submarine telephone cables at almost one-tenth of the cost.

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According to the source, the price-differential was maintained until fiber-optic cables were laid in the late 1980s. Currently, a new initiative is being prepared to create a global optic-optic network 168,000 km in length—project OXYGEN. Although the consortium does not yet seem to have been successful in attracting financing,5 the project illustrates the reaction of the cable branch to the challenges of satellites. The consortium plans to go into operation with ninety-nine global access points in seventy-eight countries by 2000. Prices for data transfer are expected to drop significantly, as has begun to occur as the Atlantic Crossing went into commercial service in May 1998. The main advantage of satellites is seen in global point-to-point telecommunication based on cellular phones. The new Personal Communica- tion System (PCS) enables mobile word and data transmission via satellites (LEO), operating in low orbits of about 500 miles. But these low orbits limit the lifetime of the satellites so that continuous replacements are needed. In the recently published book,6 Factor Four—Doubling Wealth, Halving Resource Use, examples are given to demonstrate how advanced technologies can significantly reduce resource use. Referring to a source from 1994, the energy efficiency of a fax machine used only twice a day is shown to be better than for a conventional letter by a factor of two; for higher use frequencies of fifty times a day there is a factor of twenty compared to a letter. Referring to Schmidt-Bleek (see endnote), the material flow advantage of faxing an overseas message instead of sending a letter is estimated at a factor of twenty. For e- mailing, estimates from the Wuppertal Institute are cited, giving the material flow for a 10 gram letter from Germany to Colorado as being about one pound including paper production and transport. Calculating the material input for telephone lines, satellites and computers, and dividing it by the number of messages sent, the Wuppertal Institute calculated a material Rucksack of 5 g for a 10 kilobyte message, compared to one pound for a conventional letter. This would be a factor of one hundred!

CURRENT AND FUTURE ENERGY DEMAND: SUPPLY STRUCTURES

Since 1950, world energy consumption has increased from about 75 Exajoules7 by a factor of more than five, while the population has “only” doubled. About 85 percent of today’s demand is met by fossil fuels, producing the greenhouse gas carbon dioxide (see below). Thus, the world’s energy supply is based upon non-renewable resources that are limited in supply and cause irreversible damage to the globe. Those countries driving the global economy use most of the resources and cause most of the environmental damages.

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International energy data from 1994 have been analyzed in detail. Of the global supply, about 40 percent was from oil (51 percent of which for transport), 21 percent from gas, 24 percent from coal, 6.3 percent from nuclear energy, 2.7 percent from water power generation, and 6.5 percent from other sources. The consumption sectors are transport with about 21 percent (98 percent of which from oil), industry 38 percent, electric power generation 19 percent, and households and small businesses 23 percent. The regional distribution: OECD 54 percent, former Soviet Union and Eastern Europe 15 percent, “rest of the world” 31 percent. The numbers demonstrate that specific energy consumption in the various regions and countries of the world differs significantly. In 1990,8 the global average was estimated to be about 62 GJ per capita, with Luxembourg holding the top position with 383 GJ per person, in second place the U.S. with 317 GJ per person, then Sweden 232 GJ per person and Saudi Arabia 205 GJ per person. For reunified Germany, an average of 186 GJ per person was calculated, with the regions of former GDR showing a higher figure of 206 GJ per person than the Western FRG (180 GJ per person). According to German official sources,9 average energy consumption per capita in Germany has declined slightly since 1990 to 174 GJ per person in 1997. For the U.S., a value of 331 GJ per person is mentioned in this publication, referring to data from the International Energy Agency (IEA). Reduction in energy consumption in Germany has been characterized by the term “wall-fall profits,” which refers to the fact that in the former GDR energy efficiency both in the private sector and in the production sector was poor. Also in goods transport, energy consumption was high although rail had a very high share. Goods transport volumes specifically were much higher than in the West, while in passenger transport fewer kilometers were driven per capita. The passenger cars’ fuel consumption was lower in the GDR due to its smaller size. In Germany, crude oil accounted for about 40 percent of primary energy consumption in 1997, natural gas for 21 percent, black coal 14 percent, nuclear energy 13 percent, lignite 11 percent, others about 2 percent. In the U.S., data have been published10 with petroleum products showing a share of 40 percent of the 1993 primary energy consumption, natural gas 25 percent, coal 23 percent, nuclear energy 8 percent, and others (mostly hydroelectric power) 4 percent. Although the level of per capita energy consumption in the U.S. is nearly twice as high as Germany (331 GJ per person to 174 GJ per person), the relative structure of resource use seems to be very similar. Crude oil consumption per capita in 1997 has been estimated11 to be 1.547 kg for Germany and 2.780 kg for the U.S.—this is similar to the ratio of the total primary energy consumption

155 Responses to Globalization in Germany and the United States: Seven Sectors Compared between both countries. For Germany, transport energy consumption is underestimated in the air transport sector, because the balancing regulations require that the energy consumption of return flights be charged to the countries of destination. A true accounting of the air related energy consumption of German travelers would result in higher per capita figures.12 For the U.S., this effect also exists but its relative weight is smaller due to the far higher share of domestic flights. Energy consumption trends of the last few years still show an increase. Worldwide, from 1990 to 1995 an increase of 5.4 percent has been observed, with the U.S. above the average with 8.5 percent more, Europe only 3 percent more. For Asia, an increase of more than 27 percent has taken place, South America 21 percent, and Africa 13 percent. The higher growth figures of the developing countries must be seen together with their very low absolute levels: the U.S. energy consumption is about ten times higher than the South American average, and higher than the European average by a factor of 2.4. The African per capita consumption in only 4 percent of that of U.S. citizens, 8 percent of that of a German citizen and 9.6 percent of the European average. Asia— without Japan and Korea, affected mostly by China and India—also has a very low per capita consumption level that is about 5.4 percent of the U.S. average. Per capita energy consumption also continues to grow globally. The U.S. as the world’s largest consumer has increased its consumption by 3 percent, Japan by 11 percent, Europe less than 1 percent. European consumption growth came from Southern countries like Spain (plus 13 percent) and Italy (plus 4 percent), but also the more advanced countries like Great Britain (plus 3 percent), France (plus 4 percent) and even the Netherlands (plus 6.5 percent) still show increasing energy consumption. We can assume that the reduction in Germany (minus 7 percent) really is a consequence of reunification and the collapse of the inefficient East German economy. The data show that neither the U.S. nor the European economies have already reached the turning point from increasing to decreasing specific energy consumption. The advanced societies still need more energy per capita each year. Energy demand in the developing countries is increasing more rapidly due to two factors: growing population and industrialization. For China both factors resulted in a 30 percent increase of primary energy demand—a comparatively low level of about 10 percent of global consumption compared to 25 percent in the U.S. Africa exhibits a different trend: the continent’s slight increase in consumption was a consequence of population growth; the per capita figures did not change. From this it is hard to avoid the conclusion that economic development was not furthered at all. Energy consumption is closely related to economic growth.13 Growing economies all over the world show an increasing

156 Rudolf Petersen energy demand although the ratios of GDP to energy demand are quite different. For electricity generation, the average of the IEA countries shows an increase of 100 percent in fossil energy use with the doubling of GDP; for the transport sector it is about the same. Decoupling energy consumption from GDP has not yet been reached in the member countries of IEA. In Germany, the demand in GJ per 1,000 DM GDP has been reduced from 5.12 in 1991 to 4.63 in 1997—this could be called an improvement in energy efficiency.14 On the other hand, it is well known that GDP is a poor indicator of wealth when environmental matters are taken into account. This is not a correct indicator for sustainable development, counting only market transactions and neglecting long-term aspects. If economic growth were interpreted by this methodology, global development could encounter severe problems, e.g., with respect to energy-related greenhouse gas emissions. Both the development indicators and the development patterns of the past offer little guide for sustainability. Crude oil is the energy resource traded most globally. About 60 percent of the world production is transported by a fleet of about 300 large tankers— causing routine global maritime pollution by oil spills and severe disasters from time to time. About half of the global carrying capacity of 270 million tdw is by very large crude carriers of up to 275,000 tons. Transport costs dropped from about 60 percent of the load’s value in 1970 to about 5 percent some five years later, due to the introduction of the super-tankers and overcapacity.15 Freight rates have increased a little since that time but are still below $1.00 per barrel. Within the transport sector, air transport fuel shows the fastest growing energy demand, although, of course, motor vehicle demand is higher in absolute terms. Due to the growth expectations cited in the section on transport, the number as well as the size of the commercial airplanes will increase, providing nearly three times more seat capacity in 2016 than today.16 Specific fuel consumption will most probably not be improved more than 1 percent per year, which results in an absolute fuel consumption growth of about 100 percent over the next twenty years. A further area of concern within the transport sector is goods transport by trucks. According to the WEC Trend Scenario from 1995, truck energy consumption will exceed passenger car fuel use in 2020. Together, air transport and trucks will increase their fuel consumption share from 50 percent today to about 70 percent, because significant improvements in fuel economy are predicted for passenger cars. Alas, the current trends in specific fuel economy of passenger cars are rather different: while in the U.S. an average passenger car consumes about 2,300 liters per year, the European average is only half this amount.17 Fuel prices correlate negatively with fuel consumption of the cars,

157 Responses to Globalization in Germany and the United States: Seven Sectors Compared which is a result of car size and annual kilometers driven. Higher car density must also be taken into account: for the U.S., 510 passenger cars and 250 commercial vehicles per 1,000 have been counted, resulting in a motor vehicle ownership of 758 per 1,000 in 1995. For Germany, those data read 501, 45 and 548, respectively. Although U.S. industry and policy also work on highly efficient cars,18 the current market trends and the low fuel prices make a shift in market preferences very unlikely. Without adequate price strategies or enforced fuel economy standards, the U.S. will hardly be able to change its transport system towards a more sustainable structure, and may be very vulnerable both as an energy importer and a car exporter. If the U.S. had the passenger car fleets and the passenger car use of Europe, it would not have to import oil. If the car industry had a large home market for efficient cars it would be more competitive in the markets of the future. The recent fall in prices on the international oil market is counterproductive for consumer countries because it undermines both political measures and industry investments for higher energy efficiency. Policy interventions aimed at decoupling national fuel prices from international price fluctuations through programs such as variable eco-taxes may be a solution. Current global competition, on the other hand, may force the national governments also in Europe to let the national industries gain full advantage of the low energy prices, thereby conserving non-sustainable structures.

INTERACTIONS BETWEEN THE SECTORS

Transport, energy and communication systems have existed for thousands of years, but the technological and systemic parameters have changed dramatically. Transport vehicles and infrastructures have enabled people to travel a thousand miles per month on average, with some businessmen or travelers moving around the globe in one day. Goods distribution is nowadays precisely organized over continents. It is normal to buy Taiwanese computers in Munich, German beer in San Francisco and Californian wine in Hong Kong, as well as Norwegian mineral water in Saudi Arabia. International trade has made giant progress since the days of sailing ships and steam engines, and the transport volume has grown. As discussed above, transport, energy and telecommunication are basic factors of globalization. In each of these areas, technology and its system architecture come together, forming infrastructure. Transport, energy and telecommunication infrastructures integrate continuously, offering new chances for economic and social activities, but also creating new risks.

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Technologies induce new desires, influencing living conditions and changing life-styles. More than the sectoral technologies, the systemic nature of infrastructure and intersectoral synergies lead to new constellations to which people and enterprises react. From the moment when information traveled faster than people and goods, organization of transport changed dramatically. Information travels ahead of travelers and prepares the way for goods, making traveling and goods transport much more effective. On a local scale, transport telematics will help organize the routine daily trip from home to office by delivering online information about road conditions and ways to avoid congestion. Physical transport of people and goods may even become unnecessary: we can read the news online or download the latest CDs. Telecommunication allows us to disregard distances. By looking into the special offers of a computer shop in Hong Kong, a bookshop in London or seeing exciting films about tourist destinations, immaterial contacts are established that often materialize in physical transport later on, be it delivery of products or a sightseeing trip. While the capability of substituting information for transport is often discussed enthusiastically by those promoting tele- working, tele-shopping, teleconferencing, faxing and e-mailing, the induction effect of information on transport and energy demand is mostly neglected. The special quality that makes transport and telecommunication support globalization is international compatibility of products and services. One must ensure that a ticket sold in Germany is valid for traveling in the United States, and one must guarantee that a fax message transmitted from any place in the world can be read in any place in the world. Compatibility is a result of coordination and cooperation in multinational bodies, and it is in the interest of the involved parties to avoid costly errors and loss of time. Being able to pay with a credit card in any shop in the world and to make investments in Korea by signaling with a finger in Frankfurt are not only evolutionary steps in the telecommunication chain from the marathon runner to the telephone, but also provide a new dimension. Making an investment by buying stock can be observed by other investors all over the world, and it creates feedback loops. The complexity of reactions and the speed of reactions characterize system behavior. In the 1960s, Japanese, German and American car manufacturers were competing on different markets with very slow innovation cycles. Products and markets were developing slowly and the financial side of the business demanded stability and long-term planning. Nowadays, customers’ reactions are the object of permanent observation and influence the production spectrum instantly. Flexible production enables the manufacturer to change anything within an extremely short time and enables the

159 Responses to Globalization in Germany and the United States: Seven Sectors Compared marketing divisions to shift the interest from one market to the other; products can even be distributed within days according to international demands. But, this increase in speed and flexibility makes systems unstable. The more parameters that can be changed and the more changes that can be immediately implemented, the less predictable a system becomes. Also, transport and energy demand become less predictable. Speeding up transport and establishing total telecommunication offers advantages for those who have access but only positionally consider transport telematics with respect to information about congestion and preferable alternative routes. When too many people have access to this information and follow the recommendations, the partial advantage no longer exists. The alternate routes also get congested. To say it more abstractly, when information access is broadened, complexity of the system becomes so large that erratic reactions may occur. Experience has shown that complex social systems like urban transport cannot be managed centrally but consist of chaotic sub-systems which adapt to the actual situations. Inefficiency exists in traffic in Los Angeles as well as in Japan, and all previous approaches to manage the situation—in Los Angeles by adding another four or six highway lanes to the existing eight, in Tokyo by implementing new fees and regulations and speeding up public transport—have not resulted in planned rationality. When we imagine transferring the system architecture and the system behavior of transport in regions to an international scale, non-predictability and lack of steerability will most likely result in significant losses. Nevertheless, for the participants in regional transport there is both a technical need to do so and an internal economic logic. In a globalized society, such transnational imperatives may develop at the international level with the risk that energy consumption and environmental degradation will be multiplied.

ENVIRONMENTAL ASPECTS

The new global challenge with respect to the environment is global warming due to an anthropogenic increase in atmospheric CO2 concentration.

There is no serious doubt that our CO2 emissions cause additional greenhouse effects, associated with global climate changes. This paper will not discuss the expected changes in detail. Research is still ongoing about temperature increases, changes in rainfall and melting of polar ice masses, etc. With respect to globalization it will concentrate on the political and economic consequences of the global warming topic.19

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At the FCCC Conferences in Berlin in 1995, the follow-up in Geneva in 1996 and especially at the Third Conference of the FCCC member states in Kyoto in December 1997, an agreement was developed that obliges the industrialized countries to reduce their greenhouse gas emissions by an average of 5.2 percent by 2008/2010, compared to 1990 levels. The countries’ targets are different, with the U.S. agreeing to a reduction of 7 percent and the EU to 8 percent where again the contributions from the member states are averaged out. The EU ministers decided in Manchester in 1998 on the key. Germany has to reduce emissions by 21 percent, the southern European member states by less. The greenhouse gas problem and international negotiations could have severe consequences for the globalization process, although at the moment it is not clear whether and how they will come into force. One way or the other, the transport sector will be affected by this challenge.20 As an obvious consequence of the CO2 problem, use of fossil energy resources has to be reduced by the industrialized countries, implying measures to improve energy efficiency, either by implementing enforced standards or by economic instruments, e.g., eco-taxes. Both may increase fuel prices in the transport sector, affecting the price of transport in general and reducing the amount of goods and the number of passengers or reducing the average transport distances. Clearly, technological progress in energy efficiency will be fostered and new transport solutions will enter the market. Aircraft will become more efficient than under trend expectations; fast ships will be less attractive than slower ones. In the automobile sector, which is still the most important energy consumer in transport, highly efficient cars will improve their market chances. European and Japanese manufacturers may be better prepared to serve this demand than U.S. companies. Because the Kyoto agreement only indicates a first step towards international climate protection activities, which will be followed by further agreements in the next decade, energy efficiency as well as the development of regenerative resources can be expected to stay on the agenda for a long time. In Germany, the distribution of the reduction burden between the economic sectors is not yet clear. The position adopted by the federal government last year was that reduction targets can be met due to reunification (the “wall-fall profits”). At that time, policy consisted of declarations but no legally binding acts. Now, the prognoses have to be recalculated, and there are some indications that the reduction target requires special measures. This will be discussed in the next section. With the global climate issue, a new element is introduced into the global economic and political agenda which may affect the globalization process. This new issue may change the rules of the game, or not. Optimism with respect to

161 Responses to Globalization in Germany and the United States: Seven Sectors Compared sustainable development demands that a globalization of responsibility for the Earth’s future has taken place that will reverberate at the political level. But globalization has been driven to this point primarily by economic processes, and political leadership seems to have vanished. This may change again.

GLOBALIZATION AND SUSTAINABLE DEVELOPMENT: SOME CONCLUDING REMARKS

International companies, multinational production networks and global market distribution managers from different countries all over the world have created the conditions for global unification, facilitating a uniform lifestyle. In the fullness of time all people will speak English, make purchases with credit cards, buy the same brands, and offer their labor on open markets. Of course, this picture is a utopia, not reality. In reality, money, goods and tourists are free to travel, but not laborers. The United States is pressuring other countries to open markets and to liberalize trade but is not keen to see millions of poor unemployed immigrants. In reality, different ideas, education levels, religions, institutional set-ups, tastes, and political preferences still exist in the world. But if inequity is going to last and if regional values are going to be preserved, then globalization in the utopian perspective of progress, wealth and understanding is not a very convincing prospect. Some systematic obstacles to globalization seem to exist which go back to the fact that eradication of differences is not desired by all participants of the game. There is also an increasing awareness that the globalization game has both winners and losers. There are also indications that even if the poor countries very carefully follow the rules set by the masters of the game in the wealthy countries, they will never catch up. From this it is but a small step to the conclusion that the globalization game conserves social stratification between the richer and poorer parts of the world. There are structural advantages on the side of the wealthy countries that cannot be overcome by the poorer ones. Fast and reliable transport, comprehensive and easy telecommunication and cheap energy together fuel international economic cooperation. The new quality of international cooperation we call globalization is more than a consequence of technology and resources. It is driven by the removal of barriers and regulations on investments, financial flows and goods flows. The economic advantage for those who steer the developments appears to be huge. But for all the others an alternative to globalization is not in the offing. It is still questionable whether globalization is compatible with sustainable development. Though there is no consistent theory of sustainable development, encompassing environmental, social and economic aspects and including the

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North/South dimension and future generations, regionalism may be considered a common element of sustainability. It is very popular to see a bright global future coming with the information society. It was not possible in this paper to cover social issues and international distributional effects. Instead it has focused on globalization and its infrastructures with a special emphasis on the environment and on ecological sustainability, namely on the greenhouse effect caused by carbon dioxide emissions. A global economy based on fossil energy is not sustainable. Nor is a global economy that accelerates global material flows. Taking into consideration the systemic interaction between telecommunication, transport and energy demand, the information facet of globalization may turn out to be crucial for sustainable development.

GERMAN POLICY RESPONSES TO GLOBALIZATION

In the current political debate in Germany, reflected in the programmatic papers of parties and lobbying organizations, globalization is mainly understood as a challenge to German competitiveness—local companies have to struggle to maintain their position on international markets despite high costs for labor. Globalization is often blamed for the loss of employment because production facilities are closed down here and reopened in countries with cheaper labor costs. Although political rhetoric defines globalization as a challenge, the tone is basically defensive. The debate has the character of a fight that cannot be won. This is surprising in light of the excellent financial performance of Germany’s large companies. It is more understandable in the depressing atmosphere of persistent high unemployment.

Policy Positions of the Former CDU/CSU/FDP Government The previous government wished to support international trade, economic growth and competitiveness of German industry, giving these topics a higher priority than local and regional economies, as well as environmental and sustainability considerations. At the same time, sustainability is seen solely as the responsibility of the Ministry for the Environment and has not entered the general policy papers and press releases dealing with international trade, transport and energy. Moreover, the links and the conflicts between globalization needs and other political objectives are barely mentioned, much less seriously dealt with at all.

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Policy Positions of the SPD In its main programmatic paper21 for the federal elections, the SPD mentioned “globalization” under the heading “Strong Economy—New Employment.” It reads: “We want the German economy (Wirtschaft may also be translated as “business community”) to embrace the opportunities offered by globalization. Our answer to the globalization of the economic sector is a policy of internal reforms and international cooperation.” A different accent compared to the previous government position is set by the declaration: “Germany can’t win a race in cutting costs against the low-wage countries of the world.” To remain in international competition, Germany has to be more productive and better, also more innovative. The number one slogan is “strengthening education, training, research, and science.” With respect to telecommunication policy, the opportunity of the information society to improve participation in democratic and cultural life can be seen as another accent specific to the SPD. There are no special chapters on energy policy or transport policy; even environmental policy is described under the heading “Ecological modernization as an opportunity of the century for work and the environment,” indicating that the SPD wanted to leave other policy labels behind to better focus on economic, social and employment issues.22 The key slogans under this heading are research, development and marketing of new competitive, environmentally favorable products, new systems for more efficient and environmentally sound transport, measures to reduce CO2 emissions in transport, sustainable energy systems, renewable energies, and ecological urban development. Phasing out of nuclear energy “as fast as possible” and building the bridge to the solar age are other topics that illustrate a nearly futuristic vision of policy.

Current Debate on Energy Policy and Eco-Taxes The current German debate about higher energy taxes as part of a wider system of eco-taxes is a direct consequence of the voters’ shift from CDU/CSU/ FDP towards a coalition between SPD and the Green Party. As a central part of the coalition agreement, and following earlier commitments of SPD and the Green Party to eco-taxes, this issue was projected into the mass media within the first weeks of the new federal government and caused political disturbances. Traditionally, the energy sector is to a large extent in public ownership or under political influence. While the crude oil market is fully liberalized, fuels are heavily taxed, which establishes political prices paid by consumers. About 70 percent of the prices at the gas pump reflect the tax content. The coal sector in Germany is under direct political influence, with domestic coal production being protected by customs duties on imports and subsidies for marketing coal.

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Power generation and distribution networks are to a high extent also under public influence. The national energy markets are now being pried open to EU- wide competition and owners of networks are being forced to allow competitors to have their energy transported to other regions. A special area of conflict has been established by the new coalition’s plan to phase out use of nuclear energy. The Green Party aims at a quick withdrawal while the SPD majority talks about 20 or more years in order to avoid any financial compensation to the operating companies. Chancellor Schröder especially argues that the investments ought not to be touched and that the plants should operate until the end of their normal useful service life. Two aspects are being discussed in parallel. Though the government wants to phase out nuclear energy in Germany, it has to open the borders for energy from French nuclear power plants. The nuclear community is also quick to point out that the commitment for reducing CO2 emissions demands reduced consumption of fossil energy resources. Some studies from the Wuppertal

Institute argue that both the phasing-out of nuclear power plants and CO2 reduction targets can be achieved by higher energy efficiency and an increased use of renewable fuels. With respect to globalization, the German energy debate is interesting for several reasons:

• In both Germany and the European Union, the idea of eco-taxes is gaining acceptance. This will, in the long term, lead to higher energy prices on the markets and will slowly initiate shifts towards more efficient technologies and energy saving structures, as well as enforcing demand for renewable energies. • Though the existence of low price energy markets such as the United States and Third World countries, as well as the former Eastern Bloc, complicates the situation, competitiveness in energy-intensive products demands exempting some industries from eco-taxes and also influences the discussion, e.g., about diesel and gasoline for transport purposes. • Air transport benefits from low kerosene prices, because, due to international agreements, the fuel is not taxed; both national and international organizations have discussed the introduction of either national or international fees and taxes on kerosene. Among others GEF thought about international taxes on international air and maritime transport as a source for financing climate protection activities. Both the European Union institutions and German Parliament have declared their intention to end the tax freedom in air transport.

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ENDNOTES

1 Deutscher Bundestag, Bericht der Enquêtekommission “Schutz des Menschen und der Umwelt,” 1998. 2 Behrendt, S. u. a. (1998): Ökobilanzierung komplexer Elektronikprodukte, Institut für Zukunftsstudien und Technologiebewertung, Berlin, Heidelberg. 3 Schmidt-Bleek, F. (1994): MIPS-Ein neues Maß für den Umweltverbrauch - Wieviel Umwelt braucht der Mensch? Wuppertal Institute / Birkhäuser Verlag. 4 See Whalen, D. J.: Communication Satellites, Making the Global Village Possible, Http://www.hq.nasa.gov/office/pao/History/satcomhistory.html 16. 12. 1998. 5 Culver, Denise (1999): Project Oxygen Misses Fund Date; Interactive Week Online, Jan.11, 1999, Http://www.zdnet.com/intweek/news. 6 v. Weizsäcker, E.U., Lovins, A. B., Lovins, L. H. (1995): Faktor vier, doppelter Wohlstand - halbierter Naturverbrauch, München. 7 U.S.-EPA 1990: Policy Options for Stabilizing Global Climate. 8 German Federal Ministry for the Environment (1993): Climate Protection in Germany; National Report According to Chapter 12 of the UN Climate Convention. 9 Bundesministerium für Wirtschaft (1997): Energiedaten ´97/98. 10 World Almanac and Book of Facts 1995. 11 ARAL AG (1998): Verkehrstaschenbuch 1998/99. 12 Schallaböck/Köhn (1997): Perspektiven des Luftverkehrs in Nordrhein-Westfalen, Wuppertal Institute. 13 IEA (1997): Transport, Energy and Climate Change. 14 Bundesministerium für Wirtschaft 1997. For former West Germany the specific data have improved from about 3.7 GJ per 1.000 DM GDP in 1960 (prices of 1991) to 2.1 in 1990. In the same timeframe, transport related energy consumption increased from about 0.65 to about 0.80 GJ per 1.000 DM GDP. This illustrates: Modernisation of the economy tends to improve efficiency in production but increases specific energy consumption in transport, due to higher consumer demands both for goods and passenger transportation. 15 Shell (1995): Weltenergie - Daten und Fakten, Shell Briefing Service I/1995, Hamburg. 16 According to Boeing 1997 Current Market Outlook, cited in Schallaböck/Köhn 1997. 17 IEA International Energy Agency, Transport, Energy and Climate Change, Paris 1997. 18 PNGV Partneship for a New Generation of Vehicles, Program Plan, Dept. of Commerce, Washington 1994. 19 The description of climate policy in the beginning of this chapter is based upon work by Stefan Pfahl, Wuppertal Institute, to whom I am thankfully obliged. 20 Petersen, R./v. Weizsäcker, E. (1993): Mobility in the Greenhouse; UNEP Industry and Environment Vol 16 No. 1-2. 166 Rudolf Petersen

21 SPD-Programm für die Bundestagswahl 1998 “Arbeit, Innovation und Gerechtigkeit,” Beschluß des außerordentlichen Parteitages der SPD am 17. 4. 1998 in Leipzig. 22 One advertisement of the SPD contained only the words: Arbeit.Arbeit.Arbeit.

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168 Henry L. Michel

INFRASTRUCTURES FOR GLOBALIZATION Henry L. Michel

INTRODUCTION

Infrastructure is a term that is applied to a variety of elements in our society. Here I will address the physical, built-in-place infrastructure, which includes all elements that relate to:

Transportation - Marine: River/Canal/Sea/Ocean - Surface: Road/Rail - Air Environment - Water - Wastewater - Solid Waste - Industrial Waste Systems Power - Generation: Fossil/Nuclear/Hydro/Unconventional - Distribution Telecommunications

Infrastructure plays a growing role in globalization and highly developed nations such as the United States and Germany have made and continue to make major investments, not only within their own countries, but also in the less developed nations of the world.

HISTORY OF U.S. INFRASTRUCTURE

The North American continent was first settled by people of seafaring nations so it was not surprising that the earlier transportation modes were waterborne. The first settlements were along the sea coasts, then along river basins, which were supplemented with canal systems to permit linkages across other parts of the country. Roads basically provided the feeder systems to marine transport centers. As the interior opened up, road transport took on an increasingly important role. With the invention of the steam engine, the railroads became the main transport mode for opening up vast additional territories and formed the principal land links for the North American continent. It was not until the middle of this century that a truly national road system was

169 Responses to Globalization in Germany and the United States: Seven Sectors Compared created. This was soon followed by a dense network of air transportation facilities. In the absence of coordinated inter-modal planning, each mode competed vigorously against the other and tried to increase its market share. Speed and cost became increasingly critical criteria and transport infrastructure elements that could not compete on those terms fell into disrepair. The railroads took over from the canals; the car and the airplane provided better and cheaper passenger transport than the ships or the railroads, etc. The greater flexibility of road transport also had a major impact on our way of life. Until the advent of the automobile, transport systems had centralized destinations. Remember the old saying, “All roads lead to Rome?” With increased mobility, transportation has become heavily decentralized. Since all of our transport modes were privately owned and operated, the profit motive was the dominant force and there were no incentives to provide low priced services to benefit the public. Finally, the public sector, previously limiting itself to a rather benign or regulatory role, now had to take a greater interest. Special trust funds were created as repositories for earmarked taxes or user fees to finance or subsidize U.S. transportation. Thus, the present interstate highway system was built with 90 percent of the original costs (construction, land acquisition, etc.) paid by a Highway Trust Fund, which also paid up to 80 percent of the original costs as well as some operating costs of urban transportation systems, including urban rail and bus systems. Since the railroads were shedding their passenger service, the government “nationalized” rail passenger service under a government owned corporation, leaving the very efficient and profitable freight services (basically bulk freight carried on unit trains) in the hands of privately owned rail companies. Environmental aspects of our infrastructure were originally not an issue because low population density and vast land areas gave the natural environment ample opportunity to dilute and assimilate the pollution that we created. That changed dramatically when the industrial revolution resulted in siting heavy industry adjacent to waterways and when the agricultural revolution created heavy demands for chemical fertilizers, all of which overloaded the river basins with dangerous pollutants through run-off, thus endangering our drinking water supply systems. This was further exacerbated by discharges of untreated domestic wastes into those same bodies of water. Here again, the federal government had to step in. Since the creation of the National Environmental Protection Act (NEPA) thirty years ago, it has been contributing up to 70 percent of the costs of creating water treatment and distribution systems, sewage collection and disposal systems and solid waste collection/recycle/disposal systems. Those programs continue to give rise to increasingly more stringent standards.

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Power in the U.S. also had its origin with water. Water wheels were used to mill grains into flour and to provide power for textile mills along New England’s rivers and streams. Later, free-flowing waterways were dammed to create electricity. Wood-burning and coal-fired furnaces brought about the modern thermal power plant, now mainly fueled by oil or gas. The nuclear age introduced the nuclear power reactor, which is already being phased out in some parts of the world. The power sector in the U.S. has always been a private sector activity with government regulation of rates and service areas. One exception is the Tennessee Valley Authority (TVA), a government-owned entity chartered to develop flood control, irrigation, recreation, and hydro-electric power in the Tennessee River basin in the southeastern United States. Subsequently the TVA also added conventional and nuclear power facilities to its inventory. It is now operated as a private corporation with the U.S. government as its sole shareholder. Long-distance communications started in North America with Indian smoke signals and tom-tom drums, which may have been the fore-runners of Morse code. Then came code signals transmitted over continuous wires, the telephone, wireless communications, and ultimately the many wonders of information technology. All U.S. components of the communications industry—telephone, teletype, fax, radio, TV, satellite systems, etc.—have traditionally been privately owned and government licensed and regulated.

A REPORT CARD ON U.S. INFRASTRUCTURE

While the U.S. has been very efficient and forward looking in creating infrastructure, we have not done a good job in maintaining it. In 1998, the American Society of Civil Engineers (ASCE) issued a “Report Card for America’s Infrastructure.” It listed ten elements of our infrastructure and evaluated them on the basis of condition and performance: capacity vs. need and funding vs. need. The grading scale used was:

A = Exceptional B = Good C = Mediocre D = Poor F = Inadequate

And here are the results:

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Subject Grade Subject Grade Roads D- Drinking Water D Bridges C- Wastewater D+ Mass Transit C Dams D Aviation C- Solid Waste C- Schools F Hazardous Waste D-

The total investment needs for the next five years were estimated to be $1.3 trillion, an average of $475 billion for each of the next five years. Here is the breakdown of the evaluations (grouped into nine categories):

Roads & Bridges More than half of our roadways are in poor, mediocre or fair condition. More than 70 percent of peak-hour traffic occurs in congested conditions. It will cost $263 billion to eliminate the backlog of needs and maintain repair levels. Another $94 billion is needed for modest improvement—a $357 billion total. Nearly one of every three bridges is rated structurally deficient or functionally obsolete. It will require $80 billion to eliminate the current backlog of bridge deficiencies and maintain repair levels.

Mass Transit Twenty percent of buses, 23 percent of rail vehicles, and 38 percent of rural and specialized vehicles are in deficient condition. Twenty-one percent of rail track requires improvement. Forty-eight percent of rail maintenance buildings, 65 percent of rail yards and 46 percent of signals and communication equipment are in fair or poor condition. The investment needed to maintain present conditions is $39 billion. It would take up to $72 billion to improve conditions.

Aviation There are twenty-two airports that are seriously congested. Passenger air travel is expected to climb 3.9 percent annually to 827.1 million flights in 2008. At current capacity, this growth will lead to gridlock by 2004 or 2005. Estimates for capital investment needs range from $40-60 billion in the next five years to meet design requirements and expand capacity to meet demand.

Schools One-third of all schools need extensive repair or replacement. Nearly 60 percent of schools have at least one major building problem and more than half have inadequate environmental conditions. Forty-six percent lack the wiring to support computer systems. It will cost about $112 billion to repair, renovate and

172 Henry L. Michel modernize our schools. Another $60 billion in new construction is needed to accommodate the three million new students expected in the next decade.

Drinking Water Twenty-nine percent of community water systems did not comply with the Safe Drinking Water Act standards in 1993. The total investment need is $138.4 billion. More than $76.8 billion of that is needed immediately to protect public health.

Wastewater Only 60 percent of our rivers and lakes are safe for fishing or swimming. There are an estimated 300,000 to 400,000 contaminated groundwater sites. The United States needs to invest roughly $140 billion over the next twenty years in its wastewater treatment systems. An additional 2,000 plants will be needed by 2016.

Dams There are 2,100 regulated dams that are considered unsafe. There were more than 200 documented dam failures across the nation in the past few years. It would cost about $1 billion to rehabilitate documented unsafe dams.

Solid Waste Non-hazardous municipal solid waste will increase from 208 to 218 million tons by the year 2000, even though per capita waste generation will decrease from 1,606 to 1,570 pounds per year. Total expenditures for managing non- hazardous municipal solid waste in 1991 were $18 billion and are expected to reach $75 billion by the year 2000.

Hazardous Waste More than 530 million tons of municipal and industrial hazardous waste is generated in the U.S. each year. Since 1980, only 423 (32 percent) of the 1,200 Superfund sites on the National Priorities List have been cleaned up. The list is expected to grow to 2,000 in the next several years. The price tag for Superfund and related cleanup programs is an estimated $750 billion and is likely to rise to $1 trillion over the next thirty years.

In the fields of power and telecommunications, the regulatory environment has always allowed and even guaranteed a profitable return by tying it to a percentage return on fixed assets such as new power plants, new distribution networks, new switching systems, satellites, etc. With deregulation of the

173 Responses to Globalization in Germany and the United States: Seven Sectors Compared power sector and the break-up of the AT&T long lines monopoly, we are now in the early phases of unfettered competition and introduction of new and often improved technologies.

THE TRANSPORTATION EQUITY ACT FOR THE 21ST CENTURY

Summary On June 9, 1998, President Clinton signed into law the Transportation Equity Act for the 21st Century (TEA-21) authorizing highway, highway safety, transit, and other surface transportation programs for the next six years. TEA-21 builds on the initiatives established in the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA), which was the last major authorizing legislation for surface transportation. The new act combines the continuation and improvement of current programs with new initiatives to meet the challenges of improving safety as traffic continues to increase at record levels, protecting and enhancing communities and the natural environment as we provide transportation, and advancing America’s economic growth and competitiveness domestically and internationally through efficient and flexible transportation. Significant features of TEA-21 include:

• Assurance of a guaranteed level of federal funds for surface transportation through the fiscal year 2003 (ending September 30, 2003). The annual floor for highway funding is keyed to the actual receipts of the highway user taxes, funneled into the Highway Trust Fund. Transit funding is also guaranteed up to selected fixed amounts. All extant highway user taxes were extended at the existing rates when the legislation was enacted. • Extension of the Disadvantaged Business Enterprises (DBE) program, providing a flexible national 10 percent goal for the participation of business enterprises, such as small firms, owned and controlled by women and/or minorities in highway and transit contracting undertaken with federal funding. • Strengthening of safety programs across the U.S. Department of Transportation. New incentive programs, with great potential for savings to life and property, are aimed at increasing the use of safety belts and promoting the enactment and enforcement of 0.08 percent blood alcohol concentration standards for drunk driving and other safety related issues. • Continuation of the proven and effective program structure established for highways and transit under the 1991 landmark ISTEA legislation. Flexibility in the use of funds, emphasis on measures to improve the environment and the focus on a strong planning process as the foundation

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of good transportation decisions are continued and enhanced by TEA-21. New programs such as border infrastructure to strengthen the North American Free Trade Agreement (NAFTA), Transportation Infrastructure Finance and Innovation, and Access to Jobs target special areas of national interest and concern. • Investing in research and its application to maximize the performance of the transportation system. Special emphasis is placed on deployment of intelligent systems to help improve operations and management of transportation systems and vehicle safety.

Comment TEA-21 is generally limited to highway, railway and transit investments, with lip service to ferry boats in Alaska and Hawaii and no reference to airport improvements. Yet, TEA-21 is a major breakthrough since it creates a more balanced approach for investing not only in highways and bridges but also in transit systems, intermodal projects and in advanced technologies such as intelligent transportation systems. In 1999, we hope to have a similar act for aviation and also the renewal of our once successful environmental legislation. Another important feature is that it provides a guaranteed funding level of $198 billion over the five-year life of the act, which could top $218 billion if gasoline and other highway user tax receipts exceed earlier estimates. The act is the only major transportation investment vehicle in any western country. Only Japan and China have programs that approach the spending levels of TEA-21. However, according to the ASCE Report Card, we require $357 billion for roads and bridges alone, so TEA-21 will not even help us stay abreast and that does not account for major north-south road and rail realignments to deal with changing traffic patterns created by the North American Free Trade Agreement (NAFTA). In the 1960s the United States invested 3 percent of its GDP in transportation infrastructure, in the 1980s it spent only 1 percent.

GLOBAL COMPETITIVENESS

Professor Alan Aschauer (Elmer W. Campbell Professor of Economics at Bates College in Lewiston, Maine) has demonstrated that there is a direct correlation between growth in transportation infrastructure investment and growth in gross domestic product. So in order to become or remain competitive in the global market, the United States has to maintain and even upgrade its infrastructure—its total infrastructure. What must it do to remain locally and globally competitive? Tax-based financing will never completely meet tomorrow’s needs. Innovative financing, public/private partnerships and

175 Responses to Globalization in Germany and the United States: Seven Sectors Compared developer investment techniques are driving the growth in Asia and South America. Innovation financing and a new breed of financiers will be the outgrowth of the exploding needs for infrastructure investments. Traditionally we used to build it and they would come. Industrial and commercial investors used to follow the infrastructure. In the developing world they often have to provide the basic infrastructure: site access, power, etc. Gordon Wu’s Hopewell Holdings Ltd. was interested in developing building projects in the People’s Republic of China and ended up developing toll highways and power projects to fill a basic need. Local policies will have to be put into place to encourage and foster such investments, particularly in the developing countries. The United States also has to make research and development (R&D) a top priority. In Europe it is one of the top four priorities. In the U.S. it is not in the top ten. In TEA-21, there is only $2.2 billion set aside for R&D out of a total of $218 billion (just about 1 percent). Tax incentives and risk management techniques will have to be put into place in order to provide the research community the environment to produce original research as well as adaptive research borrowing from other industries. The construction industry is particularly backwards in the R&D field, but fortunately it has borrowed effectively from space, defense, petrochemical, electronics, synthetics, composites, and other industries. The U.S. must also improve the process to move R&D into application. Japan requires two years, but the U.S. needs six to ten years to bring construction related research into actual use. Improved communications and interactions between R&D communities (both industrial and academic) and regulatory bodies (building standards and codes), as well as improved protection of intellectual properties are helping to reduce the time delays. In the U.S. highway sector, private enterprise and academia, working with the association of all state highway departments (AASHTO) have facilitated introduction of innovation and shortened the delay to less than two years. Similar approaches are now being developed for accelerating innovation introduction to the buildings, civil engineering and environmental fields, but it will require much closer government (regulatory)/industry cooperation. The introduction of R&D and innovative contracting practices is also retarded by resistance to risk-sharing by the participating parties in infrastructure developments and the excessive costs of litigation, often acerbated by introduction of pseudo-scientific expertise. An approach to reduction of litigation would be through mandatory alternative dispute resolution. In the United States, $60 billion is spent on lawsuits each year. That’s more than $2,200 for every man, woman and child. About $5 billion of that relates to design and construction activities. And each $1 billion saved can

176 Henry L. Michel put 40,000 construction people back to work—or a total annual gain of 200,000 well-paid jobs in construction. Writing reasonable contracts for $5 billion of additional construction would be a better utilization of those lawyers. The United States must also leap-frog technologies into the 21st century rather than try to refine and up-grade obsolescence. Information technologies are leading the way, including the intelligent highway and the Internet. Historical examples of “leap-frogging” exist, particularly the rebuilding of the devastated economies of Europe and Japan after World War II. Facilities were created using state-of-the-art technologies in former war-torn countries, providing a considerable competitive advantage over many industries in victorious nations that did not have to rebuild their plants or infrastructure. Today, countries with underdeveloped or undeveloped communication systems don’t have to wait to be “wired up” and don’t have to try to protect their investments in expensive and out-dated networks. The U.S. must take advantage of greater inter-industry technological exchange, especially in the space industry, in satellite transmissions, in computer designs, and in non-conventional materials. Ways will have to be found to improve the exchange of ideas and knowledge developed by other industries. The components of industry that are directly involved in the creation of infrastructure are often quite unaware of usable developments in other industries and conversely, such other industries fail to see the market potential of some of their research because they have no clear understanding of the needs of those markets. Multi-modal, multi-industrial solutions are the answer, including electronic classrooms, video/Internet shopping, electronic tickets, and automated vehicles. Multi-industrial solutions will avoid solving tomorrow’s problems using yesterday’s solutions. Growth projections need to take into account the way we will conduct ourselves in the future, not simply a projection of statistics based on population growth forecasts. The number of highway lanes, rail mileage, airport runways, kWh consumption, classrooms, shopping centers, and office blocks will not rise at a particular rate, but will be directed by where and how we live, learn and work. Economic forecasters will have to relearn their skills. The advent of the 24-hour design office transmitting end-of-their-day data via satellites brings the promise of lower cost labor and overcoming labor- shortages. Multiple work centers—often in multiple overseas locations—will enable “round-the-clock” operations, alleviate labor shortages in “graying” communities, such as Germany and the United States, tap lower-cost markets, and bring the product closer to the consumer. Controls will be readily exercised from yet other remote locations including “at home” workstations that will

177 Responses to Globalization in Germany and the United States: Seven Sectors Compared enable managers to plan their time commitments to allow for the conduct of other/social responsibilities. Major industrial mergers such as railroad mergers and airline alliances will create larger capital bases for infrastructure investments, including deeper ports required for super container carriers. Increasingly high investments in infrastructure, plant and equipment as well as greater service responsiveness will lead to the creation of larger business units with the financial and economic power needed to grow and to survive decreased public sector support. Pooling of physical as well as financial resources to sustain the lengthy process of obtaining proper returns on investments will require a review of anti- monopolistic laws and regulations to allow orderly growth, while protecting the public interest. Tax reform is needed to encourage R&D expenditures and greater use of risk capital for new technologies such as solar and wind power and driverless vehicles. All new developments, and particularly the time and size of investments in such new technologies, are subject to competitive forces and geopolitical influences in the global infrastructure arena. Non-conventional power systems suddenly became financially attractive when the price of oil rose to $40 per barrel. OPEC was hoping for $100 barrels by the year 2000! The present price of less than $15 has temporarily wiped out all competing non- conventional power system investments. Long-term solutions such as tax reforms, changes in amortization schedules, subsidies, and clean and renewable fuel technologies will have to be promoted. Accounting practices must be reformed to consolidate life cycle budgeting, including the elimination of separate budgets for capital spending and maintenance/operating costs. The whole wished-for approach to sustainable development and life cycle planning founders on the approach to budgeting and accounting. Every governmental entity and every private sector unit is very careful in separating its expense budgets into two distinct categories—one for capital expenditures and another for maintenance and operating costs. The two are never combined, related or consolidated. The fact that sustainable development and proper life cycle planning often would result in greater initial costs, but frequently offset by dramatically lower maintenance and operating costs, is never revealed. Accounting changes to require the same care for the management of capital assets as for financial assets may be the answer.

THE FUTURE OF INFRASTRUCTURE

There will be big changes in the way we live and the way we work and where we live and where we work. Statistics will not help get answers to those

178 Henry L. Michel questions. Another issue with which we have to come to grips is that for far too long we have looked at the infrastructure in almost total isolation. There are many other industries involved and we need to redefine our approaches. For example, the space industry transports vehicles through airless space; the electrical industry transports energy across great distances; the data processing and telecommunications industries transport information at nearly the speed of light; and the hydrocarbon industry transports huge quantities of liquids and gasses across oceans and land masses through transnational pipelines. Stepping out of the box—in other words, discarding our systematic approaches—what do we see or what would we like to see?

• Automated vehicles, traveling in platoons or individually with no need for road signage, resulting in an increase in safety, a reduction of accident bottlenecks and improvement of the environment. • Multiple use of urban infrastructure, such as solid waste and other freight movements through rail transit systems during off hours. • Redesign of containers (cars, buses, transit vehicles, ferries) to allow for multiple use, such as the present use of airplanes for passengers and freight simultaneously. • Use of Geographic Positioning Systems (GPS) for instant location and guidance of all vehicles and containers. • Scenarios for major increases in the productive time usage of containers. For example, automobiles, usually with a single driver, are idle more than twenty hours a day, more than 85 percent of available time. Freight vehicles are moving without freight much of the time, returning empty after delivery. Four passenger units can be made convertible to freight— collapsing seats and loading with merchandise at destination, eliminating under-utilized space. Modularity will allow peak-off-peak capacity adjustments. • Multi-modal incidence response. Identification of on-coming weather delays and use of variable message signage to divert travelers from roadways to rapid transit or rail transport. Advance plan rail equipment availability and emergency vehicle positioning. • Instant carpooling of automated vehicles with single multi-modal reservation and fare collection systems with planned inter-modal transfers. • Universal computer-controlled driverless vehicles (cars, buses, trains, boats, etc.). • Miniaturized power plants for individual powerpack movements through urban airspace, including persons or packages for roof-top deliveries.

179 Responses to Globalization in Germany and the United States: Seven Sectors Compared

SUMMARY

Transportation Marine: River/Canal/Sea/Ocean Marine transport serves two very distinct markets: tourism and bulk transport. The principal issues are environmental (harbor and channel dredging material disposal, oil spills and waste disposal), structural (improved berthing and greater harbor depths) and inter-modal (good land-side transport access). U.S. policy is to subsidize navigation features (locks and channels) with municipal authorities or private shippers providing the terminal facilities financed with user fees. Ever-increasing sizes of ocean transport and cruise ships will require major new investments, which will result in consolidation of existing numbers of terminals.

Surface: Road The impact of congestion on the national economy is a major problem in every developed society. In the U.S., traffic congestion is estimated to cost about $370 billion a year. In the last twenty years the use of high occupancy modes of transportation has been a major topic among planners. As a result, the U.S. Congress passed the Intermodal Surface Transportation Efficiency Act (ISTEA) in 1991. This law gave the states legislative support to manage existing transportation systems more efficiently and intermodally. This support is continuing under the Transportation Equity Act for the 21st Century (TEA-21) signed into law in June 1998, which prescribes a process called “congestion management,” referring to a general transportation planning strategy. The principal goals of congestion management are to influence travel patterns and to effectively use existing roadway capacity, as opposed to merely constructing more roadways. The basic aim is to reduce the number of vehicles on the road and to shift the riding public to higher occupancy modes of travel, such as public transportation. All of this comes from the fundamental law of traffic engineering: “Adding more lanes to a congested corridor will only add more vehicles and therefore increase congestion.”

Surface: Rail In the United States, the trend is toward reductions in subsidies for support of passenger service and an absence of investment capital to build and maintain high-speed technologies. This strategy will result in limiting passenger rail improvements for suburban commuter and intercity passenger rail service. Freight rail is going through major consolidations and realignments to reflect

180 Henry L. Michel

NAFTA needs, but will continue as a highly profitable mode with limited government regulatory controls.

Air U.S. air service is highly competitive and expansion of airport facilities will largely be privately financed, repaid by user fees (concessionaires, catering, fuel charges, parking, etc.) and a federally imposed passenger charge (presently set at $3.00 per trip), collected and utilized by airport authorities. The major investment gap relates to inter-modality with only a handful of U.S. airports having convenient, user-friendly ground transportation links.

Environment There is a very strong movement towards private ownership of environmental systems. Water purification and supply systems are being purchased by private companies, often European. Solid waste collection, recycling and disposal systems are also seeing a major trend toward municipal contracts with privately owned service companies providing services.

Power The U.S. power sector has always consisted of a majority of private companies based on dispersed shareholding, regulated by the federal government. Subsidized power, generally from taxpayer financed hydroelectric facilities, is beginning to change its structure to be financially self-sustaining. Both the power-generating, as well as the power-distribution sectors are going through a phase of deregulation expected to increase the competitive pressures on previously franchised companies which had enjoyed local or regional monopolistic positions. Deregulation is also hastening the entrance of new independent power producers who will tailor their plants to a limited local market.

Telecommunications Telecommunications is the most rapidly growing infrastructure sector since government deregulation has eliminated local, national and international monopolies. The impact of those changes brought about by revolutionary advances in information technology (IT) has not yet been fully felt. It is clear, however, that IT will have a huge impact on where we live, where we work and how we learn. It will overtake many of the more conventional infrastructure elements and will force us to rethink our future planning. The federal government is now trying to stretch its planning horizon to thirty years in order to be better prepared to deal with rapid changes.

181 Responses to Globalization in Germany and the United States: Seven Sectors Compared

In conclusion, the U.S. needs to widen its focus. It must come to grips with the fact that we now live in a truly global world, where according to Daniel Yergin, the author of The Commanding Heights,

Capital sweeps across countries at electronic speed; manufacturing and the generation of services move flexibly among countries and are networked across borders; markets are supplied from a continually shifting set of sources. Ideas, insights, techniques all disperse among countries with increasing ease. Access to technology across national boundaries continues to grow. Borders are eroded as markets are integrated.

In order to move into the new century, we not only need to cross geographic and geopolitical boundaries, but also cross the artificial boundaries that separate industries. We need to form multi-national and multi-industry taskforces to tackle the challenges and to find borderless solutions to make this a better world.

182 AICGS Research Reports

Phillips, Ann. Seeds of Change in the German Democratic Republic: The SED-SPD Dialogue. Washington, D.C.: AICGS, December 1989.

Allen Christopher S. Democratic Politics and Private Investment: Fi- nancial Regulation in West Germany and the U.S. Washington, D.C.: AICGS, November 1990.

Mushaben, Joyce M. Identity without a Hinterland? Continuity and Change in National Consciousness in the German Democratic Repub- lic, 1949-1989. Washington, D.C.: AICGS, July 1993.

Holzmann, Robert. On the Economic Benefits and Fiscal Requirements of Moving from Unfunded to Funded Pensions. Washington, D.C.: AICGS, August 1997.

Heilemann, Ullrich and Hermann Rappen. The Seven Year Itch? Ger- man Unity from a Fiscal Viewpoint. Washington, D.C.: AICGS, January 1998.

Wagner, Helmut. Perspectives on European Monetary Union. Washing- ton, D.C.: AICGS, January 1998.

Lankowski, Carl, ed. Break Out, Break Down or Break In? Germany and the European Union After Amsterdam. Washington, D.C.: AICGS, April 1998.

Lankowski, Carl, and Simon Serfaty, eds. Europeanizing Security? NATO and an Integrating Europe. Washington, D.C.: AICGS, April 1999.

183 Responses to Globalization in Germany and the United States: Seven Sectors Compared

184 American Institute for Contemporary German Studies 1400 16th Street, N.W. Suite 420 Washington, D.C. 20036-2217 Tel: 202.332.9312 Fax: 202.265.9531

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