Coping With Globalisation (Routledge Advances in International Political Economy)

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Coping With Globalisation (Routledge Advances in International Political Economy)

Coping with Globalization Globalization is dramatically reshaping policy landscapes, thereby creating new opportunities

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Coping with Globalization

Globalization is dramatically reshaping policy landscapes, thereby creating new opportunities and threats for governments and firms. Since the resultant restructuring of policy spaces asymmetrically distributes benefits and costs across countries, sectors, firms and factors-of-production, there is a need to cope with globalization. This volume examines the strategic options available to firms and governments, the political, institutional, ideational and economic factors which lie behind specific coping strategies, and the lessons which can be distilled and applied to other areas. Drawing together a panel of international experts, the volume examines issues such as: • • • • • •

Globalization and federalism Trade, monetary and fiscal policies Environmental regulations and the strategies of multinational enterprises Techno-nationalism versus techno-globalism Globalization and telecommunication policy Prospects for races to the bottom

This rigorous and original examination of the problems posed by globalization is essential reading for all those interested in globalization, international business and international political economy. Aseem Prakash is Assistant Professor, Department of Strategic Management and Public Policy at the School of Business and Public Management; Department of Political Science; and The Elliott School of International Affairs, The George Washington on University. He is the author of Greening the Firm: The Politics of Corporate Environmentalism and coeditor of both Globalization and Governance and Responding to Globalization. Jeffrey A.Hart is Professor of Political Science at Indiana University, Bloomington. His publications include Rival Capitalists, Globalization and Governance (co-edited with Aseem Prakash) and Responding to Globalization (co-edited with Aseem Prakash).

Routledge advances in international political economy 1 The future of the nation-state Essays on cultural pluralism and political integration Edited by Sverker Gustavsson and Leif Lewin Co-publication with Nerenius and Santérus Publisher AB, Sweden 2 Classical liberalism and international economic order Studies in theory and intellectual history Razeen Sally 3 Coping with globalization Aseem Prakash and Jeffrey Hart 4 Responding to globalization Aseem Prakash and Jeffrey A.Hart

Coping with Globalization Edited by Aseem Prakash and Jeffrey A.Hart

London and New York

First published 2000 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an imprint of the Taylor & Francis Group This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to” © 2000 Aseem Prakash and Jeffrey A.Hart All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data Hart, Jeffrey A. Coping with globalization/Aseem Prakash and Jeffrey A.Hart. p. cm. —(Routledge advances in international political economy). Includes bibliographical references and index. 1. International economic relations. 2. Competition, International. 3. Economic policy. I. Prakash, Aseem. II. Title. III. Series. HF1359.H37 2000 337–dc21 99–048710 ISBN 0-203-46616-0 Master e-book ISBN

ISBN 0-203-77440-X (Adobe eReader Format) ISBN 0-415-22863-8 (Print Edition)

To our colleagues at The George Washington University


List of tables and figures


List of contributors




Coping with globalization: an introduction ASEEM PRAKASH AND JEFFREY A.HART

1 27


A race to the bottom or governance from the top? DEBORA L.SPAR AND DAVID B.YOFFIE



Convergence and sovereignty: policy scope for compromise? SYLVIA OSTRY



Environmental regulations and the global strategies of multinational enterprises ALAN M.RUGMAN AND ALAIN VERBEKE



Globalization and federalism: governance at the domestic level ALFRED C.AMAN, JR.




Technonationalism and cooperation in a globalizing industry: the case of flat-panel displays JEFFREY A.HART, STEFANIE A.LENWAY, AND THOMAS P.MURTHA



Dialing for dollars: institutional designs for the globalization of the market for basic telecommunications services PETER COWHEY AND JOHN RICHARDS






Marketing money: currency policy in a globalized world BENJAMIN J.COHEN



Does globalization sap the fiscal power of the state? ROBERT T.KUDRLE


Coping with globalization: a conclusion JEFFREY A.HART AND ASEEM PRAKASH




Tables and figures

Tables 5.1 Market shares of flat-panel displays by major application, 1997 (in percentages) 5.2 Revenues of top LCD producers worldwide in 1997 (in millions of dollars) 5.3 Department of Defense FPD funding plan (in millions of dollars) 6.1 FCC benchmark levels and transition periods 8.1 Coping with tax challenges

123 124 137 167 217

Figures 0.1 Coping strategies: a framework 3.1 Competitiveness, trade and the environment 3.2 A classification of environmental management challenges 3.3 The impact of environmental regulations on strategies of multinational enterprises 8.1 The role of selected taxes in total government revenue

7 81 86 87 203


Alfred C.Aman, Jr., Dean and Roscoe C.O’Byrne Professor of Law, School of Law, Indiana University, Bloomington. Benjamin J.Cohen, Louis G.Lancaster Professor of International Political Economy, Department of Political Science, University of California, Santa Barbara. Peter Cowhey, Professor, Graduate School of International Relations and Pacific Studies, University of California, San Diego. Jeffrey A.Hart, Professor, Department of Political Science, Indiana University, Bloomington. Robert T.Kudrle, Professor, Hubert. H. Humphrey Institute of Public Affairs and School of Law, University of Minnesota, Minneapolis. Stefanie A.Lenway, Professor, Carlson School of Business, University of Minnesota, Minneapolis. Thomas P.Murtha, Associate Professor, Carlson School of Business, University of Minnesota, Minneapolis. Sylvia Ostry, Distinguished Research Fellow, Center for International Studies, University of Toronto. Aseem Prakash, Assistant Professor, Department of Strategic Management and Public Policy, School of Business and Public Management; Department of Political Science; and The Elliott School of International Affairs, The George Washington University. John Richards, Associate, McKinsey & Co., Silicon Valley office. Alan M.Rugman, Thames Water Fellow in Strategic Management, Templeton College, University of Oxford. Debora L.Spar, Associate Professor, Department of Business, Government, and International Economy, Harvard Business School. Alain Verbeke, Professor of International Strategic Management and Public Policy, Solvay School of Business, University of Brussels. David B.Yoffie, Max and Doris Starr Professor of International Business Administration, Harvard Business School.


This volume is the second in a series of three that examines the impact of economic globalization on governance institutions across countries and issues areas. We have been interested in understanding the changing nature of international political economy of which economic globalization is both a cause and a consequence. We began preliminary discussions on this subject in the Spring of 1995 focusing on four key questions: is economic globalization a fad, how best to conceptualize it, how did it originate, and what may be its implications? Subsequently, we added a fifth question: how to cope with globalization? To systematically examine these questions, we organized two joint panels, “Governance Structures for the Twenty-First Century,” at the San Diego convention of the International Studies Association, April 16–20, 1996, a workshop in Indianapolis, Indiana, October 12–13, and another workshop in Alexandria, Virginia, July 31–August 1, 1998. Three edited volumes have emerged from these deliberations: the first volume, Globalization and Governance, from the San Diego conference and the Indianapolis workshop; the second and the third volumes, Coping with Globalization and Responding to Globalization, from the Alexandria workshop. These volume are multidisciplinary, with the authors representing the disciplines of political science, economics, law, international business, and business strategy. Globalization and Governance focuses on how economic globalization impacts the extant governance institutions at multiple levels. Coping with Globalization seeks to understand how actors, both governments and firms, can cope with globalization across issue areas. The premise is that since globalization creates “winners” and “losers,” there is a need to cope with it. Responding to Globalization examines how different countries have responded to the challenges of the increasing levels of global economic integration. Many books on globalization recommend either resisting it or embracing it. Coping with Globalization does neither. Not being an advocacy piece, it focuses on conceptual issues germane to thinking about coping strategies of both firms and governments. We start from the assumption that globalization processes are restructuring policy spaces, thereby creating opportunities and threats for various actors. Thus, the volume examines how globalization


impacts a given actor’s set of opportunities and threats, what strategies are available to the actor, what political, institutional, ideational, and economic factors are behind specific coping choices, and what lessons can be distilled and generalized to other actors or issue areas. The bulk of the financial support for the Alexandria workshop was provided by the Center for the Study of Global Change, Indiana University, Bloomington. We received additional support from the School of Law, East Asian Studies Center, Department of Political Science, Center for the Study of International Relations, Center for International Business Education and Research (all Indiana University), The Elliott School of International Affairs, School of Business and Public Management (The George Washington University), and Center for International Business Education and Research (Purdue University). Matthew Krain provided valuable administrative support. The following presented papers at the Alexandria workshop: Alfred C. Aman, Jr., Marie Anchordoguy, Reba A.Carruth, Nazli Choucri (in absentia), Benjamin J.Cohen, Beverly Crawford, Michele Fratianni, Jeffrey A.Hart, Robert T.Kudrle, Stefanie A.Lenway, Chung-in Moon, E.Philip Morgan, Sylvia Ostry, John Ravenhill, Fernando Robles, Alan M.Rugman, Steven Solnick, Debora L.Spar, Steven Weber, and Dali L.Yang. The workshop participants received valuable comments from the following discussants/ session chairs: Howard Beales III, Thomas L.Brewer, Nathan Brown, John Daniels, Herbert J.Davis, Bruce Dickson, Harvey B. Feigenbaum, Kenneth Flamm, Jeffrey A.Hart, Virginia Haufler, Peter J. Katzenstein, Matthew Krain, D.Jeffrey Lenn, Catherine L.Mann, James R. Millar, Theodore H.Moran, Susan M.Phillips, Adam S.Posen, Aseem Prakash, Pradeep Rau, John Ravenhill, Scheherazade S.Rehman, Susan Sell, David Steinberg, and Susan J.Tolchin. In particular, we are indebted to Peter J.Katzenstein who carefully read and commented on every paper. The papers were revised in the Fall/Winter of 1998. Two book manuscripts, Coping with Globalization and Responding to Globalization, were submitted for review in January 1999. Based on the feedback from the anonymous reviewers, the papers were revised again in Summer 1999 and the revised manuscripts were accepted for publication in August 1999. As we look back, editing this volume has been a very enriching and intellectually stimulating experience. It helped us to better understand the changing nature of the international political economy, in particular the key theoretical and empirical issues involved in the study of globalization. We dedicate this volume to our colleagues at The George Washington University who supported us in numerous ways, and made our efforts rewarding and enjoyable. Aseem Prakash and Jeffrey A.Hart August 1999

Coping with globalization An introduction1 Aseem Prakash and Jeffrey A.Hart

This volume examines the challenges posed by economic globalization to business and public policy and how governments and firms may address them. We begin with the premise that actors seek to cope with economic globalization because they perceive it as changing their economic and political landscapes, thereby creating new opportunities and threats. Unlike many other works on the subject, this volume does not advocate either resisting globalization (Boyer and Drache, 1996; Mittelman, 1996; Gills, forthcoming) or embracing it (Ohmae, 1991). Everyone does not benefit from economic integration; there are “winners” and “losers.” Since the distribution of its costs and benefits is asymmetrical across countries, sectors (Midford, 1993), firms (Milner, 1988), and factors (Rogowski, 1989), there is a need to “cope” with it.2 Firms and governments, the relevant actors in this volume, may choose not to respond to every opportunity or threat. When they choose to respond, their actions may be inefficient, ineffective or inequitable, only serving to accentuate the maladaption. Thus, the first issue addressed in this volume is: how does globalization impact a given actor’s set of opportunities and threats, and consequently, should the actor respond? Second, what strategies are available to the actor? Actors could cope either individually or collectively, or some combination of both. They could modify extant institutions or create new ones. Strategies available to firms and governments may also differ—firms are mobile while states are not, and states can theoretically retreat to autarchy while firms cannot. On the other hand, both firms and governments can restructure—firms can outsource their components and governments can privatize/outsource production of public services.3 Third, why should firms and governments choose specific coping strategies? What are the political, ideational and/or economic factors behind these choices? Fourth, assuming that these strategies have well-defined objectives, what is our assessment for their future success? Finally, what lessons can be distilled and generalized to other actors or issue areas? Economic globalization is not an inexorable and/or irreversible process. Its impact is not ephemeral; it is causing long-term structural changes in the global economy, especially in the nature and extent of integration of factor,


input and final product markets (for an opposing view, see Chase-Dunn, 1994). Non-economic dimensions of globalization also pose policy challenges that overlap with those created by economic globalization.4 We will focus here only on the implications of economic globalization because we believe that there is better empirical evidence on the impact of economic globalization than other forms of globalization (Strange, 1996; Rodrik, 1997). Defining economic globalization Economic globalization (henceforth globalization) is the increasing integration of input, factor and final product markets coupled with the increasing salience of multinational enterprises’ (MNEs) cross-national value-chain networks. MNEs are the key agents of globalization. The importance of MNEs in global trade can be empirically verified by observing, inter alia, the ratio of intra-firm trade to global trade. As the World Investment Report (UNCTAD, 1997) indicates, this ratio has been increasing steadily since the end of World War II and now exceeds 50 percent. The implication is that many final products are now composed of inputs procured from different countries. The critical function of resource allocation that was previously undertaken by markets or state planning agencies is increasingly being undertaken within the MNE system. Further, since value-chains lead to the development of “rent-chains” (Baron, 1995), MNEs impact the domestic politics of multiple countries. In our view, the rise of the cross-border value-chains is the critical discontinuity between economic integration since the 1980s and previous eras, constituting the defining characteristic of globalization. Traditionally, MNEs have been viewed as synonymous with foreign direct investment (FDI) (to cite a few, Vernon, 1966; Hymer, 1976; Dunning, 1993; for a review of MNE theory, Caves, 1996), However, MNEs access foreign territories for securing inputs and for selling final products through a variety of means, FDI being one of them. MNEs are now increasingly entering into longterm contracts with other firms that fall short of mergers or ownership. These contracts include alliances, joint ventures, licenses, research and development (R&D) consortia, and dedicated suppliers. The term value-chain networks is, therefore, more appropriate to describe this wide gamut of relationships and their impact on market integration. The fact that value-chains and rent-chains spread across countries does not imply that MNEs should always diffuse their activities (say, R&D) across locations. MNEs face conflicting pulls to concentrate and disperse different elements of their value-chain networks (Porter, 1985; Prahalad and Doz, 1987). In some instances, economic imperatives (such as economies of scale) may require concentrating activities in a given location while political considerations (the locational subsidies or other requirements) lead to locating them in some other place or spreading them across locations. Thus, the decisions on value-chain management—in how many sites should an activity


be undertaken, where to locate these sites, and how to co-ordinate activities across sites—reflect the specific economic and political imperatives of functioning in a given industry. Globalization and Internationalization Is globalization different from internationalization? Milner and Keohane, for example, prefer to use the term “internationalization”: Measurable flows, such as the vast increases in international capital movements over the last few decades, reflect more basic shifts in the costs of international transactions relative to domestic transactions. Indeed, shifting opportunity costs are more fundamental than the flow themselves: the potential for international movements of capital, in response to shifts in interest rates or changing expectations about exchange rates, can exert profound effects on national economic conditions even if no capital movement actually takes places… In this volume, therefore, internationalization is measured by such indicators as changes in trade as a proportion of gross domestic product (GDP) or the ratio of a country’s net foreign investment to its total domestic assets. Internationalization, as used in this volume, refers to the processes generated by underlying shifts in transaction costs that produce observable flows of goods, services, and capital. (1996:3–4) Other scholars prefer to use the term “globalization” to describe the same phenomena. Some view globalization as having two components: one, market integration or internationalization (similar to the definition of globalization adopted in this volume); and two, the evolution of a global mind-set among key decision-makers.5 A global mind-set implies that managers do not limit their visions to a given country or region in deciding their value-chain management strategies or the attributes of the products they wish to manufacture or sell. In the literature on international business managerial orientations have been given greater importance than in the social sciences. For example, Perlmutter (1969) differentiates among three categories of managerial attitudes and orientations: ethnocentric, polycentric and geocentric. Employing this classification, one could hypothesize that managers in international firms have polycentric perspectives while in global firms they have geocentric attitudes. The development of a global or geocentric mind-set is engendered by the reconfiguration of the economic, political and social landscapes, by both deterritorialization and reterritorialization of the policy spaces. One could argue that the increasing flows of ideas across countries are key agents (or independent variables) of globalization, playing important roles in redefining the various identities possessed by actors and their relative salience (Polanyi,


1957; Appadurai, 1996; Scott, 1997). Globalization, therefore, has important cultural and ideational dimensions. Notions such as the spread of Anglo-Saxon capitalism, policy convergence, or harmonization can also be included as indicators of economic globalization since they result from evolved or imposed common identities. The flow of ideas is indeed important for shaping identities and giving legitimacy to market integration. We, however, view the flow of ideas as being embedded in flows of factor inputs, services, and final products.6 Developing a global identity or a mind-set, adopting an Anglo-Saxon model of capitalism, and policy convergence or harmonization can be conceptualized as one of the many coping strategies (and therefore dependent variables for the purposes of this volume) at the firm and government levels, with the processes of globalization being the independent variables. Of course, in the medium to the long run, coping strategies may themselves affect the pace and extent of globalization. For example, as Ostry suggests in Chapter 2, the widespread adoption of rules and institutions premised on “deep integration” will facilitate market integration and further develop cross-border value-chains. Thus, while acknowledging the importance of ideas directly relevant to commerce, this volume adheres to the view that globalization combines deepening market integration with increased salience of cross-national value-chains. Some scholars suggest that in an internationalized economy, nation-states remain the key units for political and economic decisions, and governments continue to have the capacities and willingness to exercise policy-making power within their jurisdictions (see Kudrle’s chapter in this volume; Mittelman, 1996). Security issues requiring active state involvement remain important in world affairs. In contrast, a globalized economy functions in a post-Westphalian paradigm where governments lack the capacities and willingness to enforce policies within their jurisdictions. Kobrin, for example, argues that “national markets are fused transnationally rather than linked across borders” (1997:148). Consequently, the primacy of “methodological nationalism” does not hold in world affairs and governance is articulated at various levels of aggregation, the national level being one of them (Cerny, 1997; 1999).7 Along similar lines, and from a business perspective, it could be contended that international firms, though operating in multiple countries, still fly the flag of a given country. Their critical functions—R&D, systems of innovation and corporate finance—continue to carry distinct imprints of the parent country. If national character leads to national loyalties, governments begin to have incentives to defend and promote domestic firms and home-based MNEs.8 Global (or transnational) firms, on the other hand, cannot be associated with any particular country. They represent “footloose capital,” locating their critical activities in countries that best serve their interests (Ohmae, 1991).9 Yet another perspective is provided by Kobrin (1991) who differentiates between internationalized and integrated firms. The former produce in a single


country and sell to independent distributors in other countries or procure inputs from independent suppliers from other countries. Integrated firms, in contrast, internalize all these activities within their administrative hierarchies. They exhibit high ratios of intra-firm exchanges of inputs, technology and final products. Instead of taking sides in the globalization versus internationalization debate where they are treated as end-states, this volume views globalization as a process of market integration, primarily through the establishment of value chains that are increasingly dispersed geographically. If internationalized and globalized economies are conceptualized as end points of a continuum, most industrialized countries and MNEs are between these extremes, depending on the policy arena or industry sector. The power of governments has diminished in certain areas but governments still have instruments to respond to globalization (Helleiner, 1994; Cohen, 1996; Evans, 1997; Falk, 1997). MNEs retain their national character (Pauly and Reich, 1997) even though their critical functions are being spread across countries. The Westphalian system has weakened but the post-Westphalian world order (if at all) has not yet begun. Three important research questions therefore are: (1) Why have governmental powers and capacities diminished differently across issue areas? (2) How have governments chosen to address this perceived loss of power? and (3) Why are some MNEs more global (and less international) than others, and what are the causal variables to explain this variation? Another conceptual issue needing clarification is the relationship between regionalization and globalization. Specifically, is regional integration a “building bloc” or a “stumbling bloc” to global integration (Gilpin, 1987; Lawrence, 1995; Ohmae, 1995)?10 Market integration is unlikely to be uniform across countries and sectors; some countries within a region may be more integrated among themselves than with the rest of the world. Further, this could vary across industries. Regional integration could be due to either “natural” causes such as geographical proximity or conscious policy mechanisms such as establishing trading blocs. Firms and governments may choose to adopt coping strategies at different levels of aggregation— subnational, national, regional, or global (Prakash and Hart, 2000). Conscious regionalization, which could take the form of adopting regional corporate strategies, establishing regional trading blocs or adopting a common regional currency, is therefore one category of strategy adopted by firms and governments to cope with globalization. Coping strategies: a framework Globalization processes are redefining economic and political spaces, thereby creating new opportunities and threats. Some policies, institutions, structures or strategies of firms and governments may continue to be effective and some may not—their “vulnerability” and “sensitivity” differ across issue areas


(Keohane and Nye, 1977). The new equilibrium may not be stable, efficient, or fair. Importantly, coping strategies may bestow asymmetrical benefits and impose asymmetrical costs across actors. They may also represent rent-seeking in various guises. Coping strategies are, therefore, political outcomes. Several important issues arise: what explains the variations in the design and efficacy of coping mechanisms adopted by governments and firms across issue areas? Under what conditions are the choices of coping mechanisms predominantly determined by external (“third-image”) factors, internal (“second-image”) factors, and strategic choices of policymakers? How can external constraints be “unpacked” in terms of their impact on policymakers? What influences the level of autonomy of agents (policymakers in firms or governments) in relation to internal and external structures? For example, if countries are converging to an Anglo-Saxon model of capitalism across policy realms, one can conclude that agents have little autonomy in choosing macroeconomic and “macrostructural” (Dunning, 1997) coping mechanisms. If they are not converging, the influence of domestic factors and strategic choice is perhaps significant (Berger and Dore, 1996). At the next level, it is critical to examine the pace, sequencing and characteristics of coping policies. Perhaps, at this level, internal constraints and strategic choices have a greater influence in relation to external constraints. To structure this discussion, we present a framework that draws upon literatures in organizational theory, business strategy, law and international political economy. An important question in these literatures is to explain variations in organizational structure and strategy. The causal variables identified lie in the external environment (Burns and Stalker, 1961; Emery and Trist, 1965; Lawrence and Lorsch, 1969), technology (Woodwards, 1965; Perrow, 1967), scale of operations (Blau, 1970), and strategic choices of policymakers (Child, 1972; Granovetter, 1985). In this introductory chapter, we focus on external and internal constraints on governments and firms and examine how they empower or enfeeble policymakers in devising coping strategies. Because policymakers are self-interested actors with their own objectives and endowments, coping strategies also reflect their preferences. Coping strategies could be directed at the external environment, the internal environment or a combination of both. The coping response can be expected to vary across issue areas since the coping requirements, the external and internal constraints, and perhaps even the strategic objectives of policymakers are different. Of course, over time, coping responses can be expected to impact globalization processes (the exogenous forces that upset the status quo and need to be coped with), the objectives and endowments of policymakers, and internal and external constraints.11 This discussion is summarized in Figure 0.1.


Figure 0.1 Coping strategies: a framework

External Constraints The external environment is important because countries are seldom autarchic, having some sort of exchanges with the external world. Firms, of course, are constrained by their external economic environment (consumers, shareholders, suppliers, distributors, creditors and debtors) and non-economic environment (organs and agencies of governments, non-governmental organizations and the media). For countries, external factors include dependence on foreign markets for selling products and securing raw materials, on capital and stock markets for raising (or investing) capital, and on other countries for assuring national security. Countries have to negotiate with multiple external actors such as other governments, MNEs and other economic actors, international organizations and non-governmental organizations. To cope with globalization, many inter national organizations seem to propound specific perspectives, discouraging experimentation with other perspectives. Thus, epistemic constraints are embedded in their policy guidelines. An example is the debate on establishing a currency board in Indonesia to combat the loss of confidence in the Indonesian currency, the rupiah. The International Monetary Fund


(IMF) strongly opposed this idea and eventually Indonesians were forced to toe the IMF’s line. Thus, one set of ideas (currency boards) was not deemed desirable to cope with globalization. How do external constraints influence coping strategies of countries and firms? Child (1972) identifies three types of constraints imposed on firms by the external environment and we can extend Child’s insights to understand external constraints for countries as well. These are: variability, complexity and stress. Environmental variability is a function of the frequency, the degree and the direction of change. Consider a firm in an industry that is witnessing frequent reorganization in terms of buy-outs, spinoffs, mergers and alliances (therefore, a high frequency of change). This leads to significant redistribution of market shares among key firms (therefore, a high degree of change). The direction of change is not clear—in some regions, concentration ratios are rising while in others they are decreasing. Since the external environment is highly variable, policymakers may be disinclined to adopt strategies with long lock-in periods. They will perhaps adopt incremental approaches while waiting for the turbulence to settle down. Further, to impart stability for internal functioning, they may have incentives to devise institutional buffers interfacing with the external environment. Environmental complexity refers to the heterogeneity in and the knowledgeintensity of demands from the external environment. Policymakers have limited abilities to monitor and understand the implications of such demands. Some demands may also be in conflict. Thus, to monitor and respond to complex external environments, policymakers are likely to establish specialized internal institutions. For example, to cope with the turbulence of financial markets (and the sophisticated nature of financial instruments) policymakers may establish specialized institutions manned by experts. This is not to argue that decision-making will become technocratic, devoid of politics. Rather, the internal political economies of countries will now be articulated within a new framework suggested by the technical experts.12 Power is likely to shift from generalists to specialists. Once established, whether such institutions will persist is a different question, in part dependent on whether the institutional actors succeed in developing a domestic constituency that supports their existence. Environmental stress is a “threat” posed by the processes of globalization to countries or firms. The degree of the threat depends on the magnitude of retaliation likely for non-compliance and the urgency of meeting these demands. For example, an international rating agency may threaten to lower the rating of the sovereign debt unless some corrective actions are taken quickly to reduce the budgetary deficit. The magnitude of the threat is a function of the dependance on foreign markets for funds (the cost of funds being a function of country’s rating). The urgency depends on the time for the country’s next review by the raters. If a country is significantly dependent on foreign capital, the costs of non-compliance are likely to be high and coping


responses need to be implemented quickly (Moon, 2000). Policymakers, therefore, have incentives to centralize decision-making and discourage pluralistic participation in shaping coping strategies. For example, corporatist structures in small open economies with centralized decision-making encourage dialogue among peak associations of labor and capital to cope with rapid economic change (Katzenstein, 1985). Importantly, they create the institutional basis for hierarchically articulated pluralism, not the grass-roots variety that is evident in the United States. Having identified the three components of the external environment, we wish to emphasize that policymakers may perceive the external environment differently. They may also have some options to select their own external environment—if a firm does not want to remain in an industry with high variability, it could rearrange its business portfolio. Further, the external environment is not always a given; actors may have capacities to influence structures—the literature on business “capture” of regulatory and policymaking institutions is well established (Bernstein, 1955; Kolko, 1963; Stigler, 1971). Or, in the international sphere, countries may have some capacities to influence international institutions and other rule-making bodies. Thus, external constraints in a given industry or policy arena influence, not determine, the choice of coping mechanisms. Internal Constraints The choice of coping strategies, their timing, sequencing, and the pace of implementation also depend on internal constraints faced by policymakers (Shonfield, 1965; Katzenstein, 1978; Zysman, 1983; Hall, 1986; Hart, 1992). These constraints include policymaking rules and procedures, voting rules, distribution of veto points, interest-group dynamics and organizational “slack” (Cyert and March, 1963).13 As “public choice” scholars point out, voting rules have a crucial bearing on the final outcome of collective endeavors (Mueller, 1989). Rules and procedures structure policy processes, often asymmetrically empowering actors. They often determine who votes, who could veto and what weights different votes have in final outcomes. For example, the United States Administrative Procedures Act (APA) requires regulators to seek input on proposed regulations from affected parties. This empowers interest groups that may have the resources to impact the electoral processes. On the one hand, the APA makes policy processes equitable, but on the other hand, it slows down their implementation. In general, institutions and procedures influence how individual preferences are transformed into collective outcomes. If domestic institutions empower the executive over the legislature and the judiciary, and the federal government over the state or provincial governments, policymakers can be expected to be less constrained in choosing coping strategies. In highly decentralized systems that require provinces to


ratify major decisions, the federal government can be expected to face difficulties in adopting policies that entail large scale structural changes. As Aman points out (Chapter 4), the recent judgments of the United States Supreme Court on the subject of federalism have furthered a trend that increasingly empower states over the federal government, potentially reducing the latter’s flexibility to cope with globalization, especially in its negotiations with international actors. The same logic can be employed to understand firm-level coping mechanisms. Different systems of capitalism have different perspectives on the division of power between the shareholders and other stakeholders. Laying off workers or closing factories is easier in the Anglo-Saxon model than in the German model. Thus, macro-institutional structures have a crucial bearing on firm level strategies. However, even in the United States, many states have passed laws making it difficult for firms to make decisions without consulting other stakeholders: Recent court decisions and new legislation have weakened the so-called “business judgement rule,” which vests management with exclusive authority over the conduct of the company’s affairs… At last count, at least 29 states have adopted statutes that extend the range of permissible concerns by boards of directors to a host of non-shareholder constituencies, including employees, creditors, suppliers, customers, and local communities…the well-known Delaware Supreme Court decision in Unocal, although requiring corporate directors to show that a “reasonable” threat exists before fighting hostile takeovers offers, nonetheless allowed a number of concerns to affect the determination of such “reasonableness,” including, “the impact [of the takeover] on ‘constituencies’ other than shareholders…”. (Donaldson and Preston, 1998 [1995]:184–5) Domestic policy outcomes are critically influenced by the relative power of the potential “winners” and “losers,” the distribution of costs and benefits (concentrated versus diffused), and the ability of affected parties to undertake collective action (Lowi, 1964; Wilson, 1980). Thus, an important challenge for policymakers is to mobilize a winning coalition that supports the new policies. This may require them to make concessions, modify policies and/or make sidepayments. Domestic “slack” or underutilized resources then become an important resource at their disposal, giving them some discretion in responding to various pressures, in postponing divisive policies until favorable political climate can be created, and “paying off” the losers. As suggested earlier, these insights can be extended to discuss the politics of firm-level coping strategies as well.


Policymakers and Strategic Choice How policymakers respond to processes of globalization depends on the external and internal constraints as well as their preferences and endowments. Though business managers often wish to remain in the good books of the financial markets, especially the key institutional investors, they still have some leeway in devising strategies that serve their interests.14 Since the ultimate objective of most politicians is re-election or maintenance of their regimes, they can be expected to choose the coping instruments accordingly.15 Politicians facing re-elections can be expected to postpone decisions that impose sizeable costs concentrated on few constituencies. However, once elected they may seek to implement policies they previously opposed, the recent experiences in South Korea and Brazil being cases in point. The exercise of strategic choices by policymakers is evident when they employ external constraints to push their internal agenda and vice-versa (Putnam, 1988; Mastanduno, Lake and Ikenberry, 1989; Evans, Jacobson and Putnam, 1994). In recent years the governments in Italy, Greece and Portugal have used the desirability of joining the euro as the external constraint to push through domestic budgetary reforms and perhaps overturn the “embedded liberalism” compromise (Ruggie, 1982).16 In particular, exogenous shocks provide opportunities to policymakers to forge new domestic coalitions and push through controversial policies (Haggard and Maxfield, 1996). Further, since there could be conflicting pressures from the external environment, policymakers could strategically choose the mechanisms that best serve their objectives. For example, in the recent crisis in East Asia, most governments were under pressure from the IMF to “reform” their domestic financial institutions while retaining some degree of openness on their capital account. In the midst of this crisis, Paul Krugman suggested that in some circumstances, countries may be better off with capital controls: In short, Asia is stuck: its economies are dead in the water, but trying to do anything major to get them moving risks provoking another wave of capital flight and a worse crisis. In effect, the region’s economic policy has become hostage to skittish investors. Is there anyway out? Yes, there is, but it is a solution so unfashionable, so stigmatized, that hardly anyone has dared suggest it. The unsayable words are “exchange control”. (1998:1–2) To be fair to Krugman, other notable economists have also supported, albeit conditionally, the idea of capital controls. For example, Bhagwati acknowledges that the cases for free trade and free capital flows are not identical, primarily because of the speculative element in the latter. He notes that:


Capital flows are subject to what the economic historian Charles Kindleberger of MIT has called “panics, manias, and crashes.” In a classic response to these concerns, Milton Friedman famously argued that speculative flows would tend to be “stabilizing,” hence welfare enhancing, because the speculators who betted against the “fundamentals” would be wiped out in the marketplace. But the unfortunate fact is that speculation can be self-justifying. The fundamentals may change to reflect the speculation. (1998:A38) Given this epistemic divergence among key external actors on the usefulness of capital controls, President Mahathir Mohammad established currency controls in Malaysia. He also used this issue in his political battle with the ousted deputy, Anwar Ibrahim, who was closely identified with IMF prescribed policies. Though subsequently Krugman retracted his views, President Mohammad strategically invoked Krugman to push his own agenda. Policymakers may also strategically employ internal constraints to ease demands from external actors. For example, during the NAFTA negotiations the Clinton administration managed to include side-agreements on labor and environmental issues (that Mexico opposed) on the grounds that they were necessary for building a winning coalition in the Congress.17 Competitive and cooperative strategies Processes of globalization reconfigure policy landscapes, upsetting the status quo. In devising coping strategies, policymakers are constrained by structures internal and external to their organizations. Coping strategies may seek to relax or modify internal and/or external constraints. When multiple policymakers are required to cope with similar issues, they could act competitively as well as collaboratively. Benjamin Cohen’s chapter is instructive on this count. He explores how governments may cope collectively as well as individually with the challenges posed by growing deterritorialization of money. When addressing issues of global finance, we often think of money as effectively insular; each currency is sovereign within the territorial frontiers of a single state or monetary union. In fact, cross-border competition among currencies has become increasingly prevalent. Money today is effectively deterritorialized, posing a new and critical challenge to national monetary authorities. So long as governments remain the main issuers of money, the state still retains a degree of monetary sovereignty. However, where once existed monopoly, we now find oligopoly—a finite number of autonomous suppliers (national governments) all vying ceaselessly to shape and manage demand for their respective currencies. Globalized money, at its most basic, is a political contest for market loyalty.


Cohen points out that like firms in an oligopolistic industry, states have only a limited number of strategies available to defend their currency’s market position. Inter alia, these include policies of market leadership, market preservation, market followership, alliance and neutrality. All involve some combination of persuasion and coercion designed to influence user preferences —in effect, to “sell” a particular brand of money. He analyzes both the conditions that determine state choice among the alternative strategies and the factors determining their practical success or failure. Factors external to governments, domestic constraints and strategic choices of policymakers are the variables Cohen uses to explain strategy selection. For example, why countries of the European Union have chosen to join or stay out of the monetary union, an example of market alliance among countries, can be fully explained only when constraints internal and external to countries as well as strategic choices of the policymakers are taken into account. Cohen identifies a menu of strategies, competitive and cooperative, that governments can adopt to cope with deterritorialization of money. One such competitive strategy that could be employed in multiple sectors is participating in a “race to the bottom”: competitively lowering standards to attract “footloose” capital, ever ready to “exit” (Hirschman, 1970). The contention is that the increasingly mobile MNEs search for lower levels of wages or regulation, forcing national governments either to converge towards lower standards or lose the economic benefits that MNEs can bring.18 Of course, the MNEs are seeking to cope with the globalized stock markets where institutional investors continually appraise their financial performance. To cut costs, they have incentives to shop around for low taxes, cheap labor and lax regulations. In the process, however, the crucial functions of governance effectively slip from the grasp of national governments. Their eroded sovereignty reduces their capacities and willingness to enforce stringent environmental, health, safety, and labor laws. To curb such races, states could seek to cooperatively establish supra-national institutions—“governance from the top”; the new rules of the game could mitigate incentives for governments to participate in such races. Consequently, governments that were locked into “prisoner’s dilemma” types of payoff structures create new rules, whereby “defection” or competitive lowering of standards is no longer a “dominant” strategy. Debora Spar and David Yoffie’s chapter identifies conditions under which globalization processes create “races to the bottom” and “governance from the top”. Races are due to similar coping strategies adopted by firms and governments: to remain competitive, one needs to cut costs. Spar and Yoffie suggest that races may occur when border controls are minimal while regulations and factor costs differ across national markets. Once these necessary conditions are met, races are most likely to occur when products are relatively homogeneous, cross-border differentials are significant, and both the sunk and transaction costs are minimal. Note that factors external and internal


to a country together create conditions for races to the bottom. Spar and Yoffie hypothesize that governance from the top is more likely when there are significant negative externalities, races to the bottom cascade through consecutive stages, and there are domestic coalitions with an interest in curbing such races. Thus, factors external to an industry (pressure from interest groups), internal to it (structural characteristics of the industry), and initiatives of key policymakers together lead to the evolution of such governance mechanisms. Since MNEs are allegedly the main abettors of races to the bottom, it is instructive to examine the theoretical bases of such races from a business strategy perspective. As suggested earlier, there is a widespread (incorrect) belief that MNEs are relocating to developing countries with lax environmental laws (Low and Safadi, 1992; Prakash, Krutilla, and Panagiotis, 1996; for an opposing view, Daly, 1993). Nevertheless, there are fears that to stem the “industrial flight” from developed countries with stringent laws to “pollution havens” in developing countries, the former will have to dilute their environmental laws. These allegations were vocally stated during the debates on NAFTA and more recently, on granting “fast-track” authority to President Clinton. In this context, adopting a resource-based view of the firm, Alan Rugman and Alain Verbeke’s chapter examines how MNEs are coping with environmental regulations that differ across jurisdictions. Some MNEs can afford to ignore environmental regulations while others must develop new green capabilities, given that the costs of adhering to them are non-trivial in most industries. They correctly note that most MNEs need a coherent strategy to relate their traditional commercial functions to environmental laws, particularly in light of the media power of environmental non-governmental organizations (NGOs). Environmental regulations differ not only among countries but also within countries. The authors present a framework that identifies five different levels of environmental regulations that firms need to examine: local, subnational, national, regional, and multi-lateral. The salience of various levels varies across four categories of firms: domestic, home-based exporters, home-based centralized MNEs, and decentralized transnational MNEs. It has been argued that stringent environmental regulations help firms since they enable them to look for efficiencies and capture the “low hanging fruit” (Porter and Van der Linde, 1995). Further, if policymakers correctly predict the future course of international regulations, home firms having “first-mover” advantages are better prepared to compete in world markets. On this count, there is a “double-dividend” from strict regulations (cleaner environment and increased profits) since they are “win-win” for firms as well as governments. Rugman and Verbeke critique the contentions on first-mover advantage. They question whether such advantages (primarily in response to domestic regulations) are critical given that, in some instances, firms may benefit by


postponing their investments. In fact, late-mover advantages may be reaped when there is high uncertainty about the evolution of environmental regulations. We have previously suggested that in responding to highly variable environments, firms may postpone major structural changes and opt for policies with short lock-in periods. Governance from the top could manifest as formal international organizations with specific mandates as well as the not-so-formal international regimes and institutions (Krasner, 1982; Young, 1986). Some of the key institutions of international economic governance were formed in the mid-1940s with an objective of preventing a repeat of the Depression of 1930s. The key causes of the Great Depression were the competitive devaluation of currencies, a race to the bottom and protectionism.19 To curb incentives for protectionism, the General Agreement on Tariffs and Trade (GATT) was established in 1947. The GATT has done an admirable job of reducing trade-barriers (fostering shallow integration) and has initiated important steps to roll-back non-tariff barriers (deep integration). In Chapter 2, Sylvia Ostry describes how deep integration is a strategy adopted by states to cope with the processes of globalization and the new incarnation of the GATT, the World Trade Organization (WTO), is the institutional mechanism to carry out this task. Such deep integration reflects the properties of SparYoffie’s notion of governance from the top. The increasing integration of the world economy after World War II, primarily through increased cross-border trade, was facilitated by reductions in tariff barriers. However, with the increasing role of MNEs such shallow integration is proving insufficient for further integration, primarily because some governments continue to discriminate against firms of foreign origins. Or, broadly speaking, in some countries the systems of industrial organizations provide restricted access to domestic markets for foreign firms. This issue was very salient during the Structural Impediments Initiative negotiations between the United States and Japan in 1989. To ensure a level playing field, there were demands to harmonize economic institutions internal to both countries. The pressures for convergence or deep integration can be grouped into two broad categories: “natural” or market-led, and policy-led. Market forces, constituting the external constraints for policymakers, include technological change and competition among jurisdictions for mobile factors of production, especially capital and knowledge. Policy-led or planned convergence was initiated by the American multi-track trade policy of combining unilateralism, bilateralism, minilateralism and multilateralism. Due to American prodding, the Uruguay Round launched the deeper-integration agenda in the negotiations on services and other new issues. Post-Uruguay negotiations have continued this thrust which is now also a central focus of policy in many regional fora. Further, with the information and communication technology revolution, the onset of “investor capitalism” and the growth of electronic commerce, there is pressure for system convergence (perhaps towards Anglo-Saxon Capitalism),


deep integration being a conscious step (and also a natural step, as Ostry correctly points out) in this direction. However, the benefits of deep integration are contested in the domestic sphere. In particular, WTO’s dispute settlement procedure, an essential institution in making deep integration functional, is viewed as encroaching upon domestic sovereignty. While the pace, extent and sequencing of planned convergence depend on the strategic choices of and internal constraints on policymakers, its agenda is strongly influenced by external actors as well, mainly the MNEs and international non-governmental organization (INGOs). Conflicts between MNEs and INGOs, the fundamental conflict stemming from the erosion of sovereignty, and the distributional impact of globalization present a formidable challenge for policymakers pursuing deep integration as a coping strategy. Governance from the top and deep integration require domestic political support. Domestic institutional structures, therefore, become key variables affecting the abilities of the federal government to mobilize such support. As discussed previously, one of the key resources national governments possess is constitutional flexibility to devise new policies through appropriate legislative or executive measures. Alfred Aman points out in Chapter 4 that the United States Supreme Court has not been helpful in this context; it has stepped in to redefine important constitutional parameters (especially pertaining to the Commerce Clause and the Tenth Amendment) of federalism by empowering the states. He believes that the Supreme Court has taken an unnecessarily rigid view of the federal-state relationship. Further, the Supreme Court has encroached upon the political arenas by interpreting laws that should have been dealt with by the legislature. To the extent that this trend continues, it will enfeeble the federal government, leaving it with less autonomy to respond to the demands of globalization, both domestically and internationally. His conclusion is that just as the Supreme Court of the early days of the New Deal went too far in imposing a nineteenth-century conception of the economy on law-makers, the current majority on the Supreme Court risks creating similar problems with its approach to federalism. As discussed previously, one of the enduring themes in the globalization literature is the declining capacity and willingness of governments to intervene in economic activity. Increasing capital mobility implies that governmental attempts to tax capital create incentives for firms to pack up and leave. Thus, the threat of capital-mobility constrains governmental efforts to raise taxes. Governmental programs are often viewed as inefficient, further reducing the legitimacy of high taxation to finance them. Taxes are also viewed as “crowding out” private investment, thereby increasing the cost of capital for the private sector. In Chapter 8, Robert Kudrle examines whether globalization has indeed diminished the fiscal power of the state, and if so, how states can cope with it. There is a burgeoning literature on international taxation issues that has paralleled the more general literature on globalization. Kudrle marries


them systematically with an explicit focus on how state action is constrained and what options are available to governments. He focuses on two sets of questions: (1) has globalization resulted in a race to the bottom in the taxation of labor and capital incomes, and, if so, (2) what sort of coping mechanisms can states employ to counter these trends? Specifically, Kudrle examines five tax categories: (i) capital taxation, (ii) personal income taxation, (iii) taxation on consumption, (iv) social security taxation, and (v) new taxes—“green taxes” and the Tobin tax. He concludes that with modest governance from the top, in the form of policy coordination, states can still exercise substantial power to tax both capital and labor incomes. Coping strategies in high-technology sector One of the hallmarks of economic globalization is the increased technologicalintensity of traded goods and of the different activities in the value-chains. The fast pace of technological innovation coupled with increasing R&D costs is leading to the restructuring of many industries. The perception is that most high-technology industries cannot sustain more than a couple of players, hence the need to be global in scope (Kobrin, 1995). Strategic trade theory suggests that in industries with supernormal profits and steep learning curves (this characterizes high-technology industries), the first-movers reap substantial profits (for a review, see Hart and Prakash, 1997). Further, it is suggested that domestic “architectures of supply” in such industries that governments can help to create, provide competitive advantages to “domestic” firms in terms of timely and cost-effective access to critical inputs (Borrus and Hart, 1994; also, Porter, 1990; Palan and Abbot, 1996). Which firms will be the winners in global markets and whether national governments can empower home-based MNEs remains a debated question in the literature. Government support includes domestic macro-economic and macro-organizational policies (industrial, trade, environment, education) as well as interventions in international negotiations to ensure that home-based MNEs have access to markets and investment opportunities abroad. International interventions can take place in bilateral, minilateral or regional, and multilateral fora that are engaged in establishing new institutions for governance from the top or modifying extant ones. As Ostry points out in Chapter 2, the debates during the Uruguay Round of the GATT and the continued debate on the Multilateral Agreement on Investment under the auspices of the Organization for Economic Cooperation and Development suggest that governments seek to ensure that the new rules of international commerce and investment are beneficial to their firms. New or reformed “free” and “fair” trade and investment regimes are high on the international economic agenda. However, Rugman and Verbeke point out in Chapter 3 that since some countries have comparable levels of inwards and outwards FDI flows, the role of governments in defending home-based MNEs becomes


problematic. They contend that instead of regimes based on power or domestic politics, most MNEs and governments favor rule-based international trade and investment regimes which do not simply reflect a state’s power relative to others, or a particular industry’s influence in domestic politics. A rule-based international regime for FDI would require national treatment for foreign firms in every member country. The pattern of competition differs among industries, even within the hightechnology sector. With industry groups as the unit of analysis, Porter (1986) distinguishes between multi-domestic industries (in which the competitive position of a firm in a given country is independent of its position in other countries) and global industry (in which in the competitive position of a firm in a given country is significantly influenced by its position in other countries). He argues that the competitive strategies of firms in multi-domestic industries are country-specific, while in global industries firms need to integrate their value-chain competencies across countries. Since hightechnology industries are global in scope, they require a global strategy. Two crucial issues, therefore, are: (1) Can governments meaningfully intervene to support their home-based MNEs’ global strategies? And (2) if they can, should they? In Chapter 5, Hart, Lenway and Murtha examine the business and policy dimensions of a crucial high-technology industry—Flat-Panel Display (FPD)— specifically, whether “technonationalism” is a viable government strategy to support domestic firms. Technonationalism implies a desire to replicate key parts of the technology commercialization processes using “domestic” capabilities. The objective of a technonationalist policy is to equip domestic firms to compete in global markets. FPD are thin screens used predominantly in laptops and notebook computers. With a decline in their prices, they have begun to replace Cathode Ray Tube (CRT) displays in computers. It is projected that ultimately FPDs will replace all CRTs. Hence, the FPD industry has significant ramifications on a wide gamut of high-technology industries. FPDs are also key components of electronic systems essential for military preparedness. On this count, the strength of the domestic FPD industry has national security implications as well. Japan leads the world in both product and process technology in advanced displays. The Korean industry in advanced displays got started in the mid-1990s by adopting Japanese production methods and using Japanese tools. The Korean government began to worry about the extent to which the Korean display industry had become dependent on Japanese tools. Similar concerns were voiced in the United States. The Hart, Lenway and Murtha chapter illustrates the difficulties in pursuing technonationalist policies in a highly globalized industry. Their preferred coping strategies at the firm level are: (1) “Wintelism” in which domestic firms own industry standards but share them with cross-national production networks, and (2) developing abilities to


tap into competencies dispersed around the globe. The two strategies overlap; the latter, however, does not require that domestic firms define industry standards. The chapter concludes by decrying the technonationalist perspective adopted by the United States Department of Defense and by hypothesizing that firms that are less exposed to international competition (primarily defenseoriented firms) are more likely to be technonationalists. An argument against technonationalism does not imply that governments no longer have legitimate roles in safeguarding the commercial interests of homebased MNEs. An important role for governments is to ensure that such interests are taken into account in establishing international regimes and institutions. This becomes important as the levels of cross-border integration differ across countries—the more globalized countries want deeper integration while the less globalized countries seek to retain some measure of government control over the domestic economy. In this context, Cowhey and Richards’ chapter examines how states (or supra-states as in the European Union—EU) should address the incomplete globalization of telecom markets—fully globalized markets entail freedom of entry and the promotion of effective competition. This issue is important because of a wide divergence in the preferences of states (primarily acting as safeguarders of national monopolies) on the desirability of complete globalization. They describe how the dominant powers (the US and the EU) are working towards increasing levels of integration of telecom markets. Three types of strategies are being adopted by the US Federal Communications Commission (FCC) and the EU: establishing multilateral regimes, taking unilateral initiatives, and a mix of both. The preferences of the FCC and the EU for the three routes differ, mainly because of their different domestic political economies. Thus, Cowhey and Richards view the coping strategies of governments as a function primarily of internal constraints faced by policymakers. Structure of the volume This volume has three parts. Part One focuses on conceptual issues pertaining to the coping strategies of governments and firms. Debora Spar and David Yoffie examine conditions that facilitate races to the bottom and governance from the top. Sylvia Ostry discusses the politics of deep integration, focusing on the challenges for the WTO. Alan Rugman and Alain Verbeke discuss how MNEs can cope with environmental regulations that differ across jurisdictions. Alfred Aman probes the implications of the recent US Supreme Court judgments on the federal government’s ability to devise effective coping strategies. Part Two focuses on coping strategies in the high-technology sector. Jeffrey Hart, Stefanie Lenway and Thomas Murtha examine techno nationalism as a coping strategy in the FPD industry. Peter Cowhey and John Richards discuss the role of the FCC in inducing other countries to agree to an international


telecommunications regime that creates some sort of a level playing field for American companies. Part Three focuses on coping strategies in two arenas: currency policy and fiscal policy. Benjamin Cohen examines strategies to cope with the deterritorialization of currencies while Robert Kudrle discusses whether economic globalization saps the fiscal power of the state, under what conditions, and how governments can respond to it. Notes 1 We thank the participants of the Alexandria workshop (July 31–August 1, 1998) for their input. Alfred Aman, Lisa Hansel, Virginia Haufler, Bob Kudrle, Debora Spar, Susan Sell, and the anonymous reviewers provided useful comments on the previous drafts. Research and editorial assistance of Jun-ho Kim, Sue Seeley, Jennifer Baka, and David Herman is gratefully acknowledged. 2 For a discussion of coping strategies across countries, see Prakash and Hart (2000). 3 See Ostrom and Ostrom (1977) and Aman (1999) in this context. 4 For a discussion on various dimensions of globalization, see Prakash and Hart (1998; forthcoming). 5 We thank Peter Katzenstein for this point. 6 Scholars adopting the perspectives of Foucault, Gramsci and Habermass view ideas as key factors in furthering market integration. The roles of the global media and entertainment industries, in particular, have been carefully examined. The contention is that the monopoly of MNEs over information flows tends to create cultural hegemony and “manufactured consent” in favor of continued market integration (to cite a few, Poster, 1995; Babe, 1996; Gerbner, Mowlana, and Schiller, 1996, Perry, 1998; Douglas, 1999). An important issue for future research then is: how do the flows of ideas (as independent variables) impact the crossborder flows of inputs, factors and final products (dependent variables)? 7 In the context of domestic political economy, Ostrom, Tiebout, and Warren (1961) have argued that public goods, governance function being one of them, can be provided efficiently at multiple levels, the country-level being one of them. Thus, methodological-nationalism may not hold in the domestic political economy as well. On a legal perspective on how globalization is leading to denationalization, see Delbruck (1993) and Aman (1998). 8 We owe this point to Virginia Haufler. 9 For measuring the degree of internationalization/globalization of firms, see Sullivan (1994); Ramaswamy, Kroeck, and Renforth (1996); UNCTAD (1997); and Makhija, Kim and Williamson (1997). 10 We thank Alan Rugman and John Ravenhill for encouraging us to clarify this point. 11 We are treating globalization processes as independent variables. For a discussion on globalization processes as dependent variables, see Prakash and Hart (1999). 12 A similar argument has been made to explain the influence of epistemic communities on environmental policy issues (Haas, 1999).


13 The “second-image reversed” tradition views internal factors as dependent variables and external factors as independent variables. In this perspective, international actors impact domestic politics and hence foreign policies (Gourevitch, 1978; Katzenstein, 1978). While acknowledging the impact of external factors on internal constraints and vice-versa, we do not privilege one over the other. Their relative salience is a function of many variables including the characteristics of the industry or a policy arena and of the policymakers. 14 In addition, policymakers within firms or governments may pursue different objectives. Hence, there are collective action dilemmas at the policymakers’ level as well. 15 As Aman argues in Chapter 4, the recent Supreme Court decisions that increasingly empower states over the federal government reduce the abilities of the policymakers to exercise strategic choice. 16 It is suggested that increasing exposure to global economy may in fact require more governmental intervention to compensate the losers, perhaps leading to an expansion of the welfare state (Cameron, 1978; Pierson, 1996; McGinnis, 1999). 17 On the other hand, NAFTA also locked-in Mexican economic reforms—an example of policymakers strategically employing external constraints to push through internal reforms. We owe this point to Virginia Haufler. 18 The subject of the power of MNEs versus governments (both home and host) is vast. To cite a few, Vernon (1971), Gilpin (1975), Hymer (1976), Stopford and Strange (1991). For a review, see Rugman and Verbeke (1998). 19 Importantly, there was also an expansion of the welfare state which is supposed to be a victim in the current round of the alleged races. We owe this point to Bob Kudrle.

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Part I

This part focuses on key conceptual issues regarding how globalization is reconfiguring policy spaces and the strategies of governments and firms to cope with it. Debora Spar and David Yoffie examine conditions that facilitate “races to the bottom” and “governance from the top”. Sylvia Ostry focuses on the politics and dynamics of “deep integration” and the challenges they pose for the World Trade Organization (WTO). Alan Rugman and Alain Verbeke discuss how multinational enterprises (MNEs) can cope with environmental regulations that differ across jurisdictions. Alfred Aman probes the implications of the recent United States Supreme Court rulings on the subject of federalism and their impact on the abilities of the federal government to devise effective coping strategies. One of the enduring themes in globalization literature is the retreat of the state, its eroding sovereignty and, consequently, its reduced capacities to enforce stringent environmental and labor laws. Further, globalized stock markets and an increasing scrutiny of firm performance by sophisticated investors are forcing MNEs to cut costs. As Spar and Yoffie note, these pressures on MNEs and governments are viewed as contributing to races to the bottom: the increasingly mobile MNEs search for lower levels of wages or regulation, thereby forcing national governments to converge towards lower standards. Such races, therefore, enfeeble national governments to perform the crucial functions of governance. To curb harmful races, international regimes and institutions could be established. Such governance from the top creates new rules, mitigating incentives for governments to participate in these races. What facilitates such races? Spar and Yoffie suggest that the necessary conditions for races to occur are: (1) minimal border controls, and (2) regulation and factor costs that differ across national markets. Given the necessary conditions, races are most likely to occur when products are relatively homogeneous, cross-border differentials are significant, and both sunk and transaction costs are minimal. To check such races, governance from the top is more likely when there are significant negative externalities, races cascade through consecutive stages, and there are domestic coalitions with interests to curb such races.


Varying regulations across jurisdictions that increase transaction costs for MNEs could also constitute non-tariff barriers. Trade-led economic integration during post-World War II was facilitated by reductions in tariff barriers —“shallow integration.” With the increasing role of MNEs, shallowintegration is proving insufficient and there is a need to harmonize domestic regulations—“deep integration.” Is greater uniformity in domestic regulations desirable and possible? Sylvia Ostry answers in an affirmative. She views deep integration as a strategy of both states and MNEs to cope with globalization and the WTO as the institutional mechanism for implementing it. The pressures for convergence of domestic regulations could be “natural” or policy-led. Natural forces include technological change and inter-country competition for attracting MNEs. The information and communication technology revolution, the onset of “investor capitalism,” and the growth of electronic commerce also create incentives for countries to converge towards common models of market and industrial organization. Planned convergence has taken place through unilateralism, regionalism and multi-lateralism initiatives. The Uruguay Round launched the deeper-integration agenda in the negotiations on services and other new issues. Post-Uruguay negotiations have continued this thrust which is now also a central focus of policy in many regional fora such as the North American Free Trade Agreement and the European Union. While planned convergence depends on government action, its agenda is strongly influenced by non-governmental players such as the MNEs and international non-governmental organizations. To make deep integration functional, international regimes need to have some teeth. However, as the debate on the WTO’s dispute settlement procedure indicates, such institutions are viewed as encroaching on domestic sovereignty. Thus deep integration, an essential step to further market integration, runs into structural issues embedded in the Westphalian system. It is instructive to examine the subject of “race to the bottom” and “governance from the top” from a business strategy perspective. Adopting a resource-based view of the firm, Alan Rugman and Alain Verbeke examine how MNEs are coping with environmental regulations that differ across jurisdictions. As environmental issues have become salient in policy discourses, environmental regulations have appeared at various levels of aggregation, and this imposes significant transaction costs on firms. How should MNEs then respond? Rugman and Verbeke suggest that environmental strategies of firms could vary with their dependance on foreign markets for securing inputs or for selling products. To systematically understand these issues, the authors identify five levels of environmental regulations (local, subnational, national, regional and multilateral) and four kinds of firms (domestic, home-based exporters, home-based centralized MNE and decentralized transnational MNE). Their contention is that one-size-fits-all is not a prudent strategy for MNEs to cope with the complexity of environmental


regulations and their own operations. Critically, they suggest a careful examination of how environmental regulations may impact MNEs’ configurations of firm-specific advantages and country-specific advantages. Since the costs of adhering to environmental regulations are significant in most industries, only some MNEs can perhaps afford to ignore them while others must develop new green capabilities to respond to them. The pursuit of tough environmental laws is not win-win for governments and MNEs. In this context, the authors critique the recent literature on “firstmover advantage” that suggests that MNEs can gain advantages by adopting stringent environmental policies. They question whether first-mover advantage (primarily, in response to domestic regulations) is critical given that, in some instances, firms may benefit by postponing their investments. In fact, late-mover advantages may be reaped when there is high uncertainty about the evolution of environmental regulations. Moves towards deep integration or establishing international regimes require domestic political support. As discussed in the framework presented in the introductory chapter, domestic institutions become key variables that impact the abilities of the federal government to mobilize such support. In this context, Alfred Aman suggests that national governments require constitutional flexibility to devise coping strategies and to mobilize support for them. For example, national governments have coped with domestic challenges such as regulatory reforms, deregulation and privatization through appropriate legislative measures. To effectively cope with international challenges, they require similar legislative flexibility. Instead, the United States Supreme Court has limited their degree of freedom; redefined important constitutional parameters (the Commerce Clause and the Tenth Amendment, in particular) of federalism by empowering the states. Aman argues that the Supreme Court has taken a rigid view of the federal-state relationship. It has encroached upon the political arenas by interpreting laws that should have been dealt with by the legislature. Consequently, the Supreme Court has enfeebled the federal government by constraining its abilities to devise legislative mechanisms to cope with globalization.

1 A race to the bottom or governance from the top? Debora L.Spar and David B.Yoffie

One of the central characteristics of globalization is the spread of business enterprises and business interests across international borders. Markets once considered peripheral or exotic are now often viewed as integral to a firm’s success; and a global corps of businesses has replaced the once-scattered legion of expatriate firms. As corporations increasingly define their markets to encompass wide swathes of the globe, cross-border flows of capital, technology, trade and currencies have skyrocketed. Indeed, the cross-border activities of multinational firms are an integral piece—perhaps the integral piece—of globalization. They are also, in some quarters at least, highly controversial. One of the controversies centers on the impact of global mobility. According to some scholars, the corporate scramble for ever-wider markets has a deep dark side. In addition to creating the efficiencies and scale for which globalization is frequently lauded, it may create a deleterious “race to the bottom,” a downward-spiral of rivalry that works to lower standards among all affected parties. As described by its proponents, the dynamic behind these races is straightforward and compelling. As capital and corporations spread across the international economy, their constant search for competitive advantage drives down all those factors that the global players seek to minimize. Tax rates are pushed down;1 labor rates are pushed down; health and environmental regulation are kept to a bare minimum. In the process, crucial functions of governance effectively slip from the grasp of national governments and corporations and capital markets reap what societies and workers lose. Corporate efforts to cope with globalization, in other words, deny national governments some of their own means of adjustment. As the pace of global competition accelerates, moreover, pressuring corporations to raise their margins and lower their costs of production, the search for low costs and lax regimes should get even worse. Forced to compete in an ever-tighter market, firms will have ever greater incentives to race towards whatever bottoms they can find. But do such races actually occur? The evidence, it appears, is considerably murkier. In some cases, multinational firms have undeniably chased after lower costs and less restrictive environments; they have chosen to align themselves


with repressive regimes and to venture wherever labor conditions and labor rights are pushed to their lowest possible level. Yet there is also evidence that, under some conditions, multinational firms have pushed, even compelled, host countries to abide by international regulations and adopt more stringent local standards. It is these incongruities that form the core of this paper. Specifically, it appears from preliminary research that races to the bottom are indeterminate affairs. Sometimes firms and states do scramble in a downward spiral of everlower regulation and factor costs. Yet sometimes they resist the temptations, and even force each other towards higher plateaus of common standards. The challenge for scholars is to determine what drives such highly disparate outcomes. That, in a very preliminary way, is what this paper attempts to do. Rather than trying to prove that races exist, or tracing evidence of races in any particular area, we have tried here simply to launch a thought experiment of sorts; to examine why races to the bottom might occur and what aspects of globalization can produce or curtail them. In particular, we attempt to describe when the mobility of technology and capital will tend to lower global standards and undermine national governance, and when these same forces will serve either to strengthen global standards or enhance the prospects for national or supranational governance. Specifically, we suggest that races to the bottom can only occur when border controls are minimal and regulation and factor costs differ across national markets. Once these preconditions are met, races will be most likely to occur when products are relatively homogeneous; cross-border differentials are significant; and when both sunk costs and transaction costs are minimal. These hypotheses can be summarized as follows: Races to the bottom will only be possible where • border controls are minimal; and • regulation and factor costs differ across national markets Given these conditions, races to the bottom are most likely to occur when • • • •

products or key inputs are homogeneous; cross-border differentials are significant; sunk costs are minimal; and transaction costs are minimal.

Taken together, these hypotheses imply a more nuanced combination of races to the bottom and governance from the top. They describe globalization as a complex process with no determinate outcome and few clear winners. Sometimes, the integration of capital flows and corporate structures can indeed


produce a deleterious spiral and an erosion of governance mechanisms. But sometimes, paradoxically perhaps, it can also culminate in increased governance and more stringent international standards. The challenge for both scholars and policymakers is to separate these effects and probe their disparate causes. Global races In an influential 1994 Foreign Affairs article, Terry Collingsworth, J.William Goold and Pharis J.Harvey laid forth a bleak logic of globalization. According to the authors, the advent of the global economy has enabled multinational companies to “escape” from developed countries’ labor standards and to depress working conditions and wages around the world. As corporations have ventured abroad, they have encouraged a fierce rivalry among the developing countries that seek to win their investment capital. To woo the multinationals, countries “compete against each other to depress wages” (Collingsworth et al., 1994:9). As a result “First World components are assembled by Third World workers who often have no choice but to work under any conditions offered them. Multinational companies have turned back the clock, transferring production to countries with labor conditions that resemble those in the early period of America’s own industrialization (1994:9). Or, in other words, a race to the bottom occurs, with global standards forced ever lower by the centripetal forces of multinational rivalry. Similar arguments mark much of the literature on globalization (Ruggie, 1995; Gill, 1995; Rosenau, 1995; Jackson, 1990). At the broadest level, scholars such as Cerny (1995), Strange (1996), and Falk (1997) have suggested that the expansion of new global actors, and particularly of global corporate actors, is serving to erode and transform the policy-making power of states. As Cerny (1995:610) writes: “[T]he capacity of industrial and financial sectors to whipsaw the state apparatus by pushing state agencies into a process of competitive deregulation or what economists call competition in laxity…has both undermined the control span of the state from without and fragmented it from within.” Falk (1997:125) echoes these sentiments, suggesting that as a result, in part, of market forces and technology, “[t] erritorial sovereignty is being diminished on a spectrum of issues in such a serious manner as to subvert the capacity of states to control and protect the internal life of society.” In all three authors’ work, there is a clear link between the globalization of firms and capital and the restriction of state power. This link is forged by the pressures that competing firms are able to exert on state policy: in other words, by a race to the bottom effect.2 More specific arguments focus on the impact of globalization on labor, particularly as governments feel compelled to abandon any labor subsidies or protection they might have offered in the past. The upshot of this literature is that countries may race to the bottom, lowering wages, reducing taxes and


watering down environmental standards to minimize the incentives for multinational firms to move their capital or technology overseas. Rodrik (1995), for example, suggests that global competition has decreased labor’s bargaining power by making the demand curve for labor progressively more elastic. Kapstein (1996) and Wood (1994) argue that the growth of trade unfettered by traditional government policies has slowed the pace of wage growth in the industrialized world and exacerbated the gaps between skilled and unskilled workers.3 Even Krugman and Venables (1995) offer some theoretical support for the proposition that expanded trade and reduced transportation costs can reduce wages in the industrialized world. Lee (1997:175) adds to this point the related proposition that governments, “keen to retain and attract foreign direct investment” will be forced to make concessions to multinational firms. Du Boff (1997) goes even farther, arguing that even “the mere threat by multinational managers to relocate production” is enough to wring concessions from workers and push Western wages towards “Chinese levels.” Even within the United States, scholars such as Sengenberger (1993) have noted how competition for corporate investment has forced cities and municipalities into debt and robbed them of policy tools previously at their disposal. In the environmental realm, numerous studies (Bond and Samuelson, 1989; Blake and Walters, 1976:159; Daly, 1993; Walter and Ungelow, 1979; Walter, 1982) have likewise suggested that international competition for investment will compel governments to create “pollution havens,” lowering their environmental regulation far below socially desirable levels.4 These havens, in turn, will lure multinational firms, causing them to flee from more stringent environments. The result of their migration will be laxer standards around the world, a dirtier environment, and a massive migration of jobs and capital from the industrialized states. Though this literature is extremely diverse, its proponents share a common preoccupation and a common fear. They are concerned, overwhelmingly, with the adverse impact of globalization and particularly with the impact of increased capital flows and corporate mobility. For all of these scholars, the race to the bottom is characterized by a continuous corporate search for less expensive factors of production and less onerous government regulation. Or as Donahue (1994:47) writes: “The world has become a huge bazaar with nations peddling their workforces in competition against one another, offering the lowest price.” The common fear of such studies is that, in coping with globalization, footloose corporations will increasingly be able to escape from regulation and constrain the policy options of national governments. As a result, corporate rates of taxation decrease; labor rates and labor conditions deteriorate; and society at large is bound to suffer. All of these forces and the full brunt of their effects will only be further enhanced by the accelerating pace of globalization. Daly (1993:27) is particularly emphatic on this point: “Unrestricted trade,” he argues, “imposes lower standards.”


This is the basic logic that connects globalization with race-to-the-bottom effects. Empirically, though, evidence of such races is more difficult to discern.5 Friedman, Gerlowski and Silberman (1992), for example, find that while firms do prefer to choose areas with relatively low wages, they also seem to prefer areas with higher rates of unionization. Coughlin, Terza and Arromdee (1991) essentially confirm this split finding, as does Bartik (1985). Freeman (1994a) disputes even the basic premise behind race-to-the-bottom effects on labor standards, finding no distinct link between higher labor standards and higher labor costs. In the environmental realm, where the bulk of research has been concentrated, the picture is at best murky. Knogden (1979), for example, finds no evidence that West German firms sought to escape higher levels of environmental regulation in the 1970s; Leonard (1988) finds that US firms that face the highest costs of complying with US pollution controls are no more likely than other firms to invest abroad; and Grossman and Krueger (1991) find that regulatory differences between the United States and Mexico have had only a minimal impact on firms’ investment decisions.6 In Chapter 3 of this volume, Rugman and Verbeke also paint a more complex picture, with the impact of environmental regulation varying sharply across different issues and firm competencies. Such a dearth of hard evidence might be taken as proof that races to the bottom do not exist and that the fears of their proponents are either unfounded or, more cynically, driven by other motives, such as protectionism or domestic policy agendas. Yet one must be careful not to jump too quickly to such conclusions. Finding empirical evidence of race-to-the-bottom effects is bound to be difficult under any circumstances, since so many variables and motives are involved. Firms choose locations for a wide variety of reasons: to expand markets, to be close to customers, to follow competitors and to reduce factor and regulatory costs. In most instances, it will be difficult to discern from aggregate data just which motives predominate and how important cost or regulatory reduction has been in prompting firms’ overseas movements. Even if aggregate data suggest, for instance, a major influx of foreign direct investment to lower-wage states, or an outflow from states that unilaterally raise their tax rates or regulatory standards, it is difficult to demonstrate that corporate movements were actually and singularly prompted by the wage rates or regulatory change. Case studies or survey data may be able to reveal the importance of these motives in slightly finer detail, but even here the results will be clouded by the source upon which they rely. Aware of race-to-thebottom accusations, most firms will probably be reluctant to admit to motives that they sense will be perceived as unsavory. For our purposes, there are also more specific problems with many of the empirical studies, particularly those coming from the areas of environmental economics or public sector finance. In general, their scope and interest are very narrowly defined. Much of the taxation literature (Janeba, 1998; Bond and Samuelson, 1989), for example, is concerned with determining how


various types of taxes affect capital flows; much of the environmental literature (McConnell and Schwab, 1990; Bartik, 1988) looks at firm movements within various jurisdictions in the United States, or at corporate responses to various combinations of tax and environmental policy (Oates and Schwab, 1988; Fischel, 1975; Ulph, 1996); literature from the field of local public economics tends to focus on efficiency trade-offs between incentives and taxation, while the international trade literature is primarily concerned with the welfare of single countries. While these studies are thus extremely useful in their own fields, they do not necessarily shed light on the broader question of whether or not races to the bottom can and do occur. Moreover, even if the empirical evidence is somewhat dismissive, races to the bottom remain a troubling element of the global economy. Theoretically, they are also quite plausible. Firms undeniably seek to increase profits and create competitive advantage, and if moving to less expensive or less onerous locations would serve these aims, it is only logical to expect them to do so. It is also reasonable to expect these cross-border movements to increase as globalization tears down older barriers to international flows of capital, people and technology. If these movements occur, and if they force governments to restrict their own policy options, then the outcomes, as Rodrik (1997) and others (Lee, 1996; Kapstein, 1996) have noted, are distinctly troubling. Even the possibility of race-to-the-bottom effects, in short, is important enough to demand continued attention and rigorous inquiry. At the same time, though, such inquiries must also not lose sight of a parallel possibility. Sometimes, it appears that the very same forces that lead to downwards spirals can simultaneously produce pressures for higher standards and increased levels of international governance (see Vogel, 1995). In other words, some races to the bottom have also let loose a countervailing force— supranational regulation, either by governments or by the firms themselves. Rather than directly competing for multinational investment, countries agree to common standards for the treatment of multinationals and common protocols for taxation. Rather than using wage differentials to stake out ground in the world textile trade, national governments negotiate to regulate this trade and parse out its pieces. In at least a few cases, governance from the top has mitigated races to the bottom. In the discussion below, we try to separate out these two effects and the relationship between them. What factors lead, theoretically, to a race to the bottom? And what can transform this dynamic into governance from the top? Racing to the bottom We begin with a definition. For our purposes, a race to the bottom is characterized by the progressive movement of capital and technology from countries with relatively high levels of wages, taxation and regulation to countries with relatively lower levels. Note here that races are not simply


equivalent to the workings of comparative advantage. They involve instead a more subtle and interactive process. Racing to the bottom implies first, that corporations from any country are moving to reap the benefits of other countries’ absolute cost advantages; and second, in the bleakest formulation, that states are consciously creating or deepening comparative advantage in order to woo multinational enterprises. If comparative advantage was the primary driver of races to the bottom, one should expect a continuous movement of capital across all industries, with multinational investment flowing to whatever country was relatively efficient in producing a traded good. Yet we know empirically that races to the bottom do not occur across all industries, and that local firms are often the beneficiaries (or losers) from shifts in comparative advantage. As comparative advantages evolve over time, it is not obvious that all multinational managers should jump on the next boat and set up shop in those nations. Against this backdrop, we then pose the central question of this inquiry; the central question, indeed, of the literature on race-to-the-bottom effects: Under what conditions, and in what areas, is a race to the bottom most likely to occur? Logically, the answers seem to fall into two distinct tiers: necessary conditions and facilitating factors. The necessary conditions for races to the bottom are fairly obvious. The first is simply mobility. As with any race, races to the bottom depend critically on the participants’ ability to move. Corporations can only launch a race to the bottom once they are free to move across national borders.7 This essential assumption is evident is many more formal treatments of races (Fischel, 1975; White, 1975). Practically, it also implies that races to the bottom can only occur where border controls are minimal. As countries remove barriers to trade and (particularly) investment, they fire the gun that allows corporations to race abroad. This general progression aligns with the empirical patterns of the industrial era. Prior to the liberalization of border controls, the majority of firms did the majority of their business within their home markets. Overseas operations were the province of only a small handful of firms, most of which went abroad primarily in search of scarce resources such as oil. Then in the wake of World War II, the international community launched a series of initiatives and institutions designed to open nations to the vicissitudes and rewards of expanded international trade. Global tariffs were gradually reduced under the auspices of the GATT; capital controls decreased first in the developed world and then in the developing nations; the protection of intellectual property rights was extended through a combination of bilateral pressure and multilateral rules appended to the GATT’s Uruguay Round. AS these controls were dismantled, foreign investment skyrocketed, rising from $58 billion in 1985 to $318 billion by 1996. Only against the backdrop of such mobility did races to the bottom even become a realistic possibility. By itself, however, the freedom to move is not sufficient to launch a full-scale race. For a race to occur, corporations must also have some incentives to


search for lower cost, more attractive locations: there must be lower taxes in an overseas location, or lower wage costs, less expensive inputs, less onerous regulation. If these factors are the same across borders, there is little incentive for firms to race across them.8 Instead, firms race only when regulation and factor costs are heterogeneous—and when this heterogeneity leaves gaps that can be turned to the firms’ competitive advantage. Or as some of the economic literature suggests (Wilson, 1996) races cannot occur if the economy is perfectly competitive and free of market imperfections. If governments were to tax perfectly efficiently, meaning that firms would be charged a tax equal to the costs that their operations imposed on society, firms would have little incentive to race competitively across boundaries (White, 1975; Fischel, 1975).9 At a minimum, therefore, racing to the bottom demands that two necessary conditions be met. Firms must be mobile and markets must be heterogeneous: that is, there must either be differential factor costs or regulatory differences which affect product costs. Without these conditions, firms either will not be able to move across international borders or will have no incentive to do so. Yet does the mere existence of these conditions ensure that such races will occur? Empirically, it seems not. Indeed, as mentioned above, numerous studies (Knogden, 1979; Leonard, 1988; Friedman, Gerlowski and Silberman, 1992) have demonstrated that even when the conditions for racing are ripe, races do not necessarily occur. Less formally, we can observe that races simply do not happen everywhere and in every industry. In today’s global economy, most firms are able to move across international borders with relative ease and governments employ heterogeneous policies across a wide spectrum of issues. Yet accusations of racing are rife in some industries, such as footwear, and virtually non-existent in others, such as semiconductors. Clearly there are other factors at work. We hypothesize that four variables raise the incentives for races to occur. While all four capture different elements of the interaction between firms and states in a global economy, we believe that races are most likely when multiple combinations of these variables are present. The first is what we label as homogeneity of products. In some industries, firms compete across a wide range of dimensions. They may have sharply different products, different marketing operations or research focus. For these firms, marginal cost differentials are unlikely to be all that important to their competitive performance. Intel, for example, does not compete with other semiconductor manufacturers by shaving a few pennies off the price of its Pentium chip. Merck does not undercut its rivals through cut-throat pricing on cancer drugs. These firms still compete, and they still worry about relative cost structures, but they are probably not predisposed to racing across the world in order to seize either a labor cost or a regulatory advantage. By contrast, firms that manufacture either homogeneous products or commodity inputs will be more inclined to leap for any advantages that


location-hopping might bring. If firms produce essentially the same product, and if their internal cost structures are similar, they will feel obligated to compete more at the margin, seizing whatever relative advantage they can find. Thus, firms such as Sony and Matsushita that produce television sets may well be tempted to search for lower labor costs in their assembly plants; and bulk chemical producers may look for regulatory gaps that help to reduce their relative costs. The more homogeneous the products in any industry, the more we would expect to see competition lured by races towards the bottom. An interesting twist here concerns the homogeneity of products within a firm’s production chain. Especially in developed economies, many firms produce high-profile branded goods: Nike shoes, for example, or Izod shirts. At the product level, these goods are not homogeneous. A customer may refuse, for example, to purchase anything but an Air Jordan shoe. Yet if we separate the marketing and distribution of these branded goods from their production, homogeneity becomes relevant once more. Only here, the homogeneity exists at the level of the supplier. Nike and Izod, after all, essentially still produce homogeneous goods—sneakers and t-shirts—that are sourced and assembled by a range of virtually interchangeable suppliers. Nike, for example, purchases nearly all its footwear from relatively small suppliers scattered across Asia. From Nike’s perspective, these suppliers are basically homogeneous. Nike can pick and choose among them, chasing whatever cost advantages a particular sub-contractor might provide. And because Nike acts as an oligopolist in its own market, it can pocket all the profit differential that lower-cost suppliers can offer. This combination of oligopolistic industry structure in the product markets combined with homogeneity of international suppliers in the factor markets sharply increases the incentives for Nike (and Reebok, and Izod, and indeed any firm from the mass apparel or footwear industries) to chase after lower-cost supply—that is, to race towards the bottom. Thus races can occur, not only when final products are homogeneous, but also when the producers of non-homogeneous products can disaggregate their own supply chain and wring advantages from the homogeneous components they employ. A second factor concerns the relative cost of regulatory differentials. The logic here is largely intuitive. If factor and regulatory costs vary widely across borders, and if these costs are important to the affected firms, then firms will have an incentive to follow these costs to their lowest possible point. If the differences are small and/or unimportant, firms will generally be more content either to remain where they are or to base any relocation decisions on a range of other factors. Consider, for example, the impact of regulatory variation on firms from two very different industries: toys and paper. For the paper firm, environmental regulation is a critical component of doing business. Under certain circumstances, therefore, it may well be in the paper firm’s interest to scour the globe for laxer regulatory regimes and to invest wherever environmental regulation is least stringent. In this case, a race to the bottom is poised to occur. For a toy producer, however, environmental regulation is


generally not that important. If being in a laxer regulatory regime does not affect the firm’s way of doing business, or even if it affects it in just a small way, then the firm is unlikely to move towards the laxer country. And no race to the bottom will ensue. This dynamic may help to explain why evidence of industrial flight to “pollution havens” is limited, despite the obvious logic behind such proposed flights. In most industries, it appears, the costs of complying with pollution control measures are simply not that high. (Robison, 1985; Cropper and Oates, 1992:698). The third and fourth factors relate to the economists’ well-worn notion of stickiness. In most cases, we know empirically that firms do not move with the ease suggested by economic models. Cost changes do not instantaneously manifest themselves in price changes; wage increases do not create instant layoffs; firms do not change suppliers or supply patterns to accord perfectly with their relative prices. Such stickiness is particularly relevant for investment decisions, since investment involves a considerable outlay of firm resources. In the race-to-the-bottom literature, there is an underlying sense that firms move at the speed of relative cost changes: that they hop across borders as soon as they perceive a financial advantage. Yet the stickiness of investment is bound to slow the pace of relocation. Most firms cannot switch plant locations at will; most will indeed incur substantial costs from any move across borders. The higher these costs, the stickier existing investments will prove to be. And stickier investments will decrease the momentum for any race to the bottom. In particular, we can imagine two kinds of stickiness that would affect firms’ propensity to race. The first is that which arises from sunk costs: the more expensive and capital-intensive that an operation is, the less likely its parent firm will be to relocate.10 The second comes from transaction costs: the more difficult and time-consuming that a move will be, the less likely it is to occur. Both of these points are largely intuitive, yet they explain considerable differences in industry structure and incentives. Consider again the gap that separates apparel firms from paper mills. An apparel firm is a highly labor-intensive venture, with only a limited amount of in-the-ground capital investment. It may lease a building or a few floors and own some machinery, the total cost of which can be as little as $100,000. To relocate its operations, or to open additional facilities in a new location, is not particularly daunting. The sunk costs are low, and the stickiness of the investment thus minimal. Similar characteristics would adhere to firms in the footwear industry and many low-technology assembly operations. A paper mill, by contrast, has much lower levels of labor intensity and correspondingly higher levels of capital intensity. Instead of housing primarily laborers and easily duplicated machinery, a paper plant (or a chemical processing plant, or semiconductor fabrication facility) typically contains highly specific machinery and complex interlocked processes. Such plants can be moved; they can also be closed in one location and supplanted by newer facilities


elsewhere. Yet the propensity for such changes is significantly lower than in the apparel industry, since the sunk costs of any particular plant are so much greater. We should expect, therefore, that paper mills will be less likely to race abroad than will apparel firms. They may still race, especially if regulatory gaps or lower input costs were to open up competitive advantages, but the threshold for their race will undeniably be higher. In industries with high sunk costs, the lure of pursuing lower-cost locations must be extremely high in order to incite a race to the bottom. Note, though, that even firms with high sunk costs are vulnerable to the lure of lower-cost locations. They just will move more slowly and less frequently towards these spots. For capital-intensive firms, “racing” is liable to take the form of discrete, lagged movements. Semiconductor firms, pharmaceutical firms and steel manufacturers will move across national borders to reap cost advantages, but primarily, it seems, to engage in greenfield investment. Intel, for example, has moved sequentially from the United States to Malaysia, Israel, the Philippines and Costa Rica, looking always for a combination of low-cost, high-skilled labor and favorable tax treatment. All of these investments, though, have been in addition to, rather than in place of, existing facilities. Like other capital intensive firms, Intel races—but slowly, and in large, distinctive, steps. A similar logic adheres to the stickiness created by transaction costs. As the literature on institutional economics makes clear, not all costs borne by firms are explicitly financial. There are also the invisible costs of friction: the costs of hiring new people, of training, of suffering a loss of productivity after introducing new technologies, of building contacts and a reputation, and so forth. All of these costs will be present, and frequently heightened, as firms move to new locations. As Wade (1996:80–81) notes, the higher these costs, the more reluctant firms should be to engage in race-to-the-bottom behavior. Logically, we might also expect some variation along with the size and market presence of a given firm. In most cases, large multinational firms will be better positioned to absorb the transactions costs entailed by a cross-border move. Smaller firms, with less international experience and fewer overseas contacts, will incur relatively higher transactions costs for the identical foreign investment. Firms with more sophisticated training needs or more specific production technologies will also tend to move more slowly. In general, though, the relationship here is directly parallel to that described with regard to sunk costs: as transactions costs diminish, the propensity for racing should increase. Taken together, these hypotheses sketch a two-tiered view of races and an argument that industry structure matters. In any industry, races can only occur when two key necessary conditions are met. Corporations must be free to move their capital and technology across borders and government regulation and factor costs must be heterogeneous across those borders. Once these conditions are in place, though, industry variation comes into play, meaning


that not all firms will be equally predisposed to chase each other towards the lowest common denominator. Firms will be most inclined to race when they produce homogeneous, commodity-type products; when the costs that matter most to them are sharply divergent across national borders; and when their sunk costs of investment and transaction costs of relocation are both relatively low. When these conditions are not in place, races to the bottom are less likely to occur. Moving towards the top Thus far we have described only how races to the bottom might be forestalled by the internal dynamics of various industries. Yet, as mentioned at the outset, there is another realm of possibilities. Races, once launched, might be curtailed by the imposition of external standards. A race to the bottom, in other words, can transformed by “governance from the top.”11 The most obvious conduits for this transformation, of course, are national governments. Governments can pass laws that raise standards unilaterally, or they can sign treaties to establish international standards, thereby preventing the heterogeneity that could otherwise facilitate races to the bottom. Governments, as Sylvia Ostry suggests in Chapter 2 of this volume, can also engage in processes of deep integration, harmonizing domestic institutions that are then coupled with some mechanism for multilateral governance. Many international agreements—such as the Multi Fiber Arrangement and the Montreal Protocol—conform to this pattern; much of the current literature in international relations examines why and how these arrangements are formed. For our purposes, though, the more intriguing instances of governance come directly from the multi-national enterprises themselves. They are cases of selfgovernance by private firms; cases in which the firms transform a race to the bottom into governance from the top. Theoretically, such reverse races are relatively easy to imagine. Consider the situation from the firm’s perspective. What drives any race to the bottom is rivalry and relative costs. Firms need to chase lower costs primarily to keep (or get) a cost advantage relative to their competitors. If everyone were to stop chasing, no one would be at a particular disadvantage. It is precisely the dynamic that describes cartels, the dynamic captured in Rousseau’s classic parable of the stag hunt. If firms were to cooperate and hold to a common standard the race would stop. In general, we might expect the prospects for such cooperation to be dim, just as most cartel efforts usually succumb to the pressures of competition and defection.12 Yet cases of this sort are actually quite common—more common by far than the race-to-the-bottom literature would suggest. In many instances, it appears, rules do triumph over races and firms choose to regulate their own international behavior. As early as 1981, for example, when pressure for environmental regulation was just beginning to spread around the world, the


International Chamber of Commerce (a private business group) passed its own set of environmental guidelines and supported the harmonization of global pollution regulations. After the 1984 disaster at Bhopal, the US-based Chemical Manufacturers Association enacted a set of environmental guidelines (known as Responsible Care®) that applied to all of the association’s 180 member firms. Similar guidelines were subsequently adopted by CEFIC, the European Chemical Industries Foundation (Baram, 1994). More recently, major producers of chemicals and pesticides adopted a voluntary, and apparently highly effective system, to ensure that exports of these substances followed certain well-defined rules and procedures (Victor, 1998). In the area of human rights and labor standards, private initiatives are also playing an increasingly important role. In 1997, for example, both the World Federation of Sporting Goods Industry and the US-based Sporting Goods Manufacturers Association pledged to eradicate child labor in the Pakistani soccer ball industry. Spurred by Reebok, a US firm which had been hard hit by accusations that it had purchased balls made by 12-year-old workers, all members of the private industry associations eventually agreed to establish a system of independent monitors to ensure that no children were involved in the production of soccer balls. The firms also joined forces in establishing schools and other programs for the former child workers.13 Similarly, public pressure in the United States has recently led to the formation of a private Apparel Industry Partnership, under which firms such as Liz Claiborne and LL Bean have agreed to ensure that all of their suppliers comply with specific workplace codes of conduct (Spar, 1998a; Posner and Clarizio, 1997). In the rug industry, importers in both the United States and Germany have agreed to monitor the source of the products they sell, affixing a “Rugmark” label to those carpets which are guaranteed to have been made without the use of child labor.14 And at the most general level, a number of major multinationals such as Toys ‘R’ Us and Avon announced in the spring of 1998 that their suppliers will henceforth need to comply with the provisions of SA8000, a certifiable set of labor and human rights standards. Note that all of these initiatives work to push either labor or human rights standards to a common, more elevated plane. They are also all the work of private firms or organizations, rather than of national or international governments. Clearly, such governance schemes must be approached with caution. They are not formal structures and lack enforcement mechanisms of any kind. They can easily disintegrate under some circumstances into public relations efforts and will always bear the stigma of this possibility. Yet they also have a number of advantages. They appear easier to forge than governmental structures, since the negotiation process involves fewer parties and does not have the same measure of public accountability as would a governmental initiative.15 They also, according to some evidence, actually have higher rates of compliance over a harder range of issues. (Victor, 1998; for an opposing argument, see Baram, 1994). And finally, from the firms’ perspectives, self-regulation can


simply be an effective means of restoring or enhancing profitability. If racing becomes too costly, or if firms fear that governments are prepared to impose collective regulation upon them, then self-regulation can make sense. By levelling the playing field, firms can solve the collective action dilemma that binds them all. They can also, as Krugman (1997) notes, use harmonized policies to shift the cost of compliance from producers to consumers: if all producers are held to the same standard, after all, the world price of their good is liable to rise. If firms are also already adhering to their own cross-national standards (a common practice for many firms from industrialized countries), then forcing other firms to agree to these same standards can convey a significant advantage (Vogel, 1995:6). Or as one US CEO recently commented in response to a US proposal to include environmental standards in trade legislation: “We already have environmental standards…we want a level playing field.”16 Cooperation under these circumstances can prove a powerful competitive weapon. Epilogue: the emerging realm of electronic commerce To a certain extent, races to the top simply sound more appealing than races to the bottom. As with cooperation in general, they imply a kind of harmonious outcome, a triumph of mutual concern over unilateral self-interest. In most of the race-to-the-bottom literature, this preference is explicit. The problem of races is defined as a competitive downwards spiral, while the solution of global governance is seen as a way to push all participants towards fairer, more just, and perhaps even more efficient outcomes. It is an appealing picture, but perhaps not entirely correct. Just as races to the bottom are a complicated phenomenon, so too is governance from the top. As with nearly all aspects of globalization, it appears, races in both directions are complex to prove and difficult to judge. In some cases, governance from the top may well offer welcome relief to the competitive spiral that dominates certain aspects of global investment. In some cases, though, it may also impose the wishes of a powerful minority upon the decisions of the broader group.17 This possibility exists regardless of whether governance occurs at the hands of states or through the private negotiations of firms. In this chapter, we have not tried to present definitive arguments about either races to the bottom or governance from the top. We have not tried to prove that either phenomenon exists, or that either is good or bad for the global economy and its various participants. Rather we have simply tried to link these two possibilities and the conditions that seem to surround and facilitate each one. Specifically, we have suggested that races to the bottom are only possible when border controls are minimal and regulation and factor costs vary across national borders. If these conditions are in place, then races are most likely to occur when products are homogenous, cross-border differentials considerable, and both sunk costs and transaction costs minimal. On the flip side, we have


also suggested that governance from the top remains a powerful tool for stopping or stemming race-to-the-bottom behavior. If either national governments or private firms can coordinate their activities in the global arena, they may well be able, not only to curb races to the bottom, but also, potentially, to ignite races towards the top. In the global economy, it thus seems, races to the bottom remain a definite possibility and a real concern. But they are intermediated and facilitated by a variety of factors, some of which accelerate the spiral’s pace and others which appear to curtail it. Any examination of races and any policy that seeks to correct them needs to take these factors into account. Against this backdrop, it is interesting to consider recent developments from the field of electronic commerce. Ever since the Internet burst into commercial prominence, discussions of its regulation have borne subtle hints of a race-tothe-bottom dynamic. Here, as elsewhere, the logic derives from the competitive interaction of multinational firms and the governments that hope to woo their technology and investment capital: governments will abdicate their regulatory responsibilities in cyberspace, the argument runs, because they fear that any regulation of this new area of commerce will force corporations to flee to other locales. What makes the logic particularly compelling is the ease with which this flight can probably occur. Because physical territorial borders have only limited applicability in the electronic realm, commerce and corporations can theoretically cross these borders easily, cheaply and perhaps even invisibly (Spar and Bussgang, 1996; Kuhlman and Mathiason, 1998; Huber, 1997). In terms of the hypotheses laid forth here, the mobility of capital should be particularly high in cyberspace, thus facilitating the start of a race to the bottom. Indeed, electronic commerce offers an intriguing fit with all of the hypotheses suggested above. Physical borders are less effective in cyberspace, since commerce and information can flow so freely across them. Data sent from one country to another need not pass through any formal customs procedure or border check. Identifying the source of data is not even always possible, since electronic packets are easily re-routed or repackaged through third countries. Transaction costs and sunk costs are also likely to be relatively small, since the physical capital involved in Internet commerce is generally confined to some computers, some servers and software—all of which can be moved from one location to another without involving either great difficulty or expense. Sunk costs are, of course, extremely high for the provision of an Internet infrastructure—for the wires or satellite connections that form the backbone for all electronic connec tions. But the majority of firms involved in Internet commerce only operate along this backbone, rather than constructing it themselves. Oddly, perhaps, firms involved in electronic commerce bear a certain resemblance to apparel or footwear producers. They are distinctly labor intensive and potentially highly mobile. It is too early to tell whether their


products will be homogeneous or not, but it is at least plausible that some will. If significant differentials were to emerge in national regulation of cyberspace, a race to the bottom might occur. Already, some elements of this race are evident. Due in large part to industry pressure, the US government has made clear its intention to limit the regulation of cyberspace to the barest minimum. In a Framework for Global Electronic Commerce released during the summer of 1997, the Clinton administration proclaimed that “governments must adopt a non-regulatory, market-oriented approach to electronic commerce…[G]overnments should refrain from imposing new and unnecessary regulation, bureaucratic procedures, or taxes and tariffs on commercial activities that take place via the Internet” (White House, 1997). Within a week, similar sentiments were quickly and vigorously echoed by policymakers in the European Union: at a Ministerial Conference, members of the EU jointly declared that “the expansion of Global Information Networks must essentially be market-led and left to private initiative…[P]rivate enterprise should drive the expansion of electronic commerce in Europe.”18 On the reverse front, efforts by European legislators to impose certain restrictions on the release of personal information conveyed or stored by electronic means have been met with vehement opposition from the US-based firms that still dominate the bulk of electronic commerce. Seeing any restrictions on data transfer as inimical to their business practices, US-based multinational firms have made clear that unilateral European privacy legislation could mean an exodus of electronic commerce from Europe. Such an exodus has already occurred on a smaller scale in Germany, where laws prohibiting the transfer of “hate speech” have constrained the commercial freedom of Internet service providers which, under the law, are liable for the communication they carry.19 In the United States, meanwhile, prohibitions on the export of sophisticated encryption technologies have caused firms to lobby massively against the policy and even to shift the encryption portions of their business out of the United States. In March of 1998, for example, Network Associates, a leading provider of encryption software, announced that its European customers would henceforth be serviced through the company’s Dutch subsidiary, which would in turn purchase independent technologies from a Swiss software producer. Formally, Network Associates neither transferred technology nor invested abroad. Yet it clearly shifted its business outside the United States and (theoretically) beyond the reach of US lawmakers. Finally, there is already evidence that some countries are offering themselves as “cyber-havens,” regulation-free locales from which firms can offer services that might be more difficult to establish elsewhere. The tiny island of Anguilla, for example, has been actively promoted as a site for financial services that might not pass regulatory muster elsewhere. Grenada and Belize have welcomed US companies that run online gambling operations which would be illegal if conducted within the United States.20 If such


regulatory differentials are perpetuated and expanded, affected firms may well be motivated to locate wherever the regulatory environment best suits their interests. The greater the flexibility attributed to regulatory differentials, the further and faster firms are likely to move. At this point, though, it is still far too early to tell whether regulatory differences will ever be large enough to launch a full-scale race to the bottom. Governments may just be unwilling to lower their regulatory barriers in some areas, and firms, in the aggregate, may choose to deal with these regulatory differences rather than escape from them. The key determinant, of course, will be whether the cost savings from locationhopping will be sufficient to compensate for the transaction costs incurred by such a move. Realistically, we would expect cyberspace for the immediate future to maintain its current state of creative anarchy. Fearful of quashing the energy let loose by the advent of electronic commerce, governments are likely to resist their regulatory tendencies and instead support the development and expansion of commercial activity in this new realm. In the short-to medium-term then, we might well expect electronic commerce to exhibit race-to-the-bottom tendencies, particularly because the dynamics of this emerging industry fit so well with the facilitating tendencies outlined earlier. Yet, with time, international governance may well come to cyberspace. Governments may move more aggressively into the regulatory arena, even at the risk of losing perhaps some Internet commerce, and firms may begin to cluster around nodes of self-regulation. Already, the allocation of domain names is the province of the private Network Solutions, Inc., and groups such as the Copyright Clearance Center offer to license and monitor the use of intellectual property in cyberspace. We will not be so foolhardy as to attempt to predict the ultimate outcome of these forces. Our hope, however, is that the hypotheses laid forth in this paper can help to structure debate and research on the prospects for races not only in cyberspace, but wherever globalization forces corporations and states to cope with one another. Notes 1 For an argument that races to the bottom do not occur in the arena of taxation, see the chapter by Kudrle in this volume. 2 On these points, see also Hirst and Thompson, (1996). 3 Numerous economists have rejected such arguments, claiming that trade is too small a portion of economic activity in industrialized states to be held accountable for wage shifts. See, for instance, Bhagwati and Dehejia (1994). 4 For a review of some of this literature see Levinson (1996); Leonard (1988). 5 Reviews of this literature include Lee (1997); Cropper and Oates (1993); and Pearson (1987).


6 For an early survey of these findings, see the collection of essays in Rubin and Graham (1982). 7 For a discussion of mobility, and its dangers, see also Daly (1993). 8 Except perhaps to service these markets with lower transportation costs. 9 Some economists take this notion even further, arguing that perfect competition among states can yield socially optimal outcomes. See Oates and Schwab (1988). 10 See Yoffie (1993) for a discussion of sunk costs in multinational investment. 11 Or as Vogel (1995) puts it, the “Delaware effect” is replaced by the “California effect.” 12 See Spar (1994); Finlayson and Zacher (1988). 13 See Steven Greenhouse, ‘Sporting Goods Concerns Agree to Combat Sale of Soccer Balls Made by Children,’ New York Times, February 14, 1997. 14 See Hugh Williamson, ‘Stamp of Approval,’ Far East Economic Review 158(5):26 February 2, 1995. 15 Freeman (1994b) also suggests that private standards are more market-friendly, since they essentially allow consumers to determine which standards they deem acceptable. 16 Quoted in Business Week, June 8, 1998, p. 35. 17 Indeed, many would suggest that policy harmonization is essentially a non-optimal outcome. See Krugman (1997); Bhagwati (1994); and Brown, Deardorff and Stern (1996). 18 Ministerial Declaration at Global Information Networks: Ministerial Conference Bonn 6–8 July 1997. Available at 19 See Kimberley A.Strassel, ‘PSINet to Shift Some Internet Operations out of Germany in Wake of Smut Ruling,’ Wall Street Journal, July 7, 1998; and Jordan Bonfante, ‘The Internet Trials,’ Time, July 14, 1997. 20 See Jehanne Henry, ‘Gambling Gauntlets,’ Wired, August 1997:80.

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2 Convergence and sovereignty Policy scope for compromise? Sylvia Ostry

Introduction No standard definition of the much-used word globalization exists (even though it first appeared in 1986). But there is growing agreement about the main features of globalization and the definition enunciated in the Introduction to this volume: “Increasing integration of input factor and final product markets coupled with the increasing salience of multinational enterprises crossnational value-chain networks” would elicit widespread agreement. An alternative to globalization is the term deep integration that refers to the ongoing process of ever-tighter linkages among countries that have proceeded in stages since the end of World War II. In the terms defined by the theoretical framework set out in the introductory chapters, the view presented here is that deep integration is the strategy adopted by states to cope with the processes of globalization. The World Trade Organization (WTO) is the institutional mechanism to carry out this task. The contrast with the General Agreement on Tariffs and Trade (GATT) is striking. The shallow integration of the early post-war decades was focused mainly on border barriers to trade flows. Reducing these barriers through successive rounds of GATT negotiations clearly involved some degree of constraint on governmental freedom of action but it was limited. Indeed, the original concept underlying the GATT was to maintain a balance between domestic priorities and international obligations. Global integration began to intensify in the 1970s and 1980s when the liberalization of capital flows and deregulation of financial markets steadily eroded the scope for national monetary and fiscal policies. But by the end of the 1980s a new phase of interdependence had begun, led by a marked increase in foreign direct investment (FDI) primarily in capital- and technology-intensive sectors and services. With international rivalry intensifying, global integration of production is growing as firms use the new information and communication technologies (ICT) to capture the economies of scale and scope stemming from geographic diversification. This third phase of integration was and is closely linked to the ICT revolution (and technological changes in transportation, especially


containeriz ation) which made it cheaper and easier to manage far-flung and widely dispersed production networks. And within service industries, rapid developments in these technologies increased tradability and enabled firms to allocate portions of the production process to foreign affiliates. The multinational enterprise (MNE) is today the main funnel for the three engines of growth: trade; capital; technology and the bidding war for FDI is ratcheting up. The impact of the ICT revolution goes beyond the deeper integration of production linkages. First, it shifts power to the consumer and this adds to the heightened rivalry among firms—and to the greater weight of consumer advocacy groups (about which more below). Further, the growth of global financial markets and the growing importance and international reach of institutional investors shifts power to shareholders—and to stockholder advocacy groups. This investor capitalism1 is very different from the managerial capitalism of earlier decades. And it’s far more easily exported from its home base in the United States. This is bottom line capitalism—or the “better, faster, cheaper treadmill” as one pundit has put it. Moreover, the full impact of the ICT revolution clearly has some distance to go and a fourth phase of global integration is now visible in the growth of electronic commerce. Reflective of the underlying movement in the technology trajectory from “hard” to “soft,” and the growing importance of “network markets,” especially telecommunications, this new world of cyberspace literally eliminates borders so that the term “domestic policy” could become an oxymoron! Be that as it may, the main issue for the subject at hand is that the steadily deepening integration of the global economy is, in effect, creating a momentum to a global single market. Of course we may never arrive at that destination but the pressure for system convergence— harmonization of domestic policies and institutions and the erosion of national sovereignty—will be fed by locational competition for investment and regulatory arbitrage by MNEs; global rivalry for finance and markets; and rapidly changing communications modes which are transforming market power dynamics and creating newly empowered global actors. These are all “natural” forces for convergence. But, of course, governments are part of the game and international economic policy in both multilateral and regional fora reflect the deeper-integration momentum. This paradigm is not confined to trade policy but, as Cohen spells out in Chapter 7, relates to monetary and other policies. As he puts it: “economic governance becomes less associated with the formal structures of government and more a product of competitive forces in the marketplace, involving governments as well as private-sector actors.” Hart, Lenway, and Murtha argue in Chapter 5 that technonationalism is a less effective governmental strategy for high-tech firms since deeper integration facilitates access to technological competencies dispersed across the globe. Thus the distinction between “natural” convergence and “policy” convergence is somewhat misleading since the two are interrelated, though


often in a complex and subtle fashion which reflects the nature of the policy process. And this process varies over time and among countries.2 While a full analysis of the interaction among the three main actors in international trade policy i.e. governments, MNEs and International Non-Governmental Organizations (INGOs), is well beyond the scope of this paper, the first part of the discussion will sketch out the main features of the role of the MNEs and some of the newer players, the INGOs, in shaping the global economic landscape. The rest of the paper will focus on the role of the WTO. The WTO is the first post-Cold War institution, and the Uruguay Round negotiations (the creator of the WTO) moved the main arena of trade policy “inside the border.” Unlike the Bretton Woods institutions, the WTO mandate involves a radical break with the past world of shallow integration. This discussion will assess the WTO’s mandate and capabilities as well as, albeit briefly, its relationship with its Bretton Woods sister institutions. This relationship, which is essential to improving global policy coherence, has taken on new urgency in the light of the turmoil in East Asia. The policy process of deeper integration Role of the MNEs The traditional lobby groups in the trade policy process included business, labor and agriculture—the Olsonian “distributional coalitions”—who vied for a share of the pie. While this was still the case in the Uruguay Round, the role of business, more precisely the role of American MNEs, in the move to a deeper-integration policy was very different from that in previous GATT negotiations. The negotiation to launch the Uruguay Round negotiation took almost as long as the entire Tokyo Round negotiations of the 1970s. The Americans had been trying to launch a new round since the early 1980s because of dissatisfaction with the results of the Tokyo Round and rising protectionist fury in Congress (mainly because of the overvalued dollar). After a number of near-failures, the Uruguay Round was launched in Punta del Este in September 1986 and formally concluded in Marrakesh, Morocco, in April 1994, several years later than the target completion date originally announced. The extraordinary difficulty in both initiating and completing the Round stemmed essentially from two fundamental factors: the nearly insuperable problem of finishing the unfinished business of past negotiations, most of all agriculture; and the equally contentious issue of introducing quite new agenda items, notably trade in services and intellectual property and, though in a more limited way, investment. The Europeans blocked the launch to avoid coming to grips with the Common Agricultural Policy (CAP) and a number of


developing countries were bitterly opposed to including non-traditional issues such as services and intellectual property because they involved negotiation of domestic policies and institutions, alien to the GATT world of shallow integration and considered a direct challenge to national sovereignty. Yet however difficult were the “traditional negotiations” concerned with the “leftovers” of previous rounds—the potholes and roadblocks such as agriculture, textiles, some sensitive tariffs and non-tariff barriers the direction was clear. The objective was the original GATT objective, the liberalization of trade by reducing or eliminating border barriers or their close domestic proxies. But the other part of the Uruguay Round, the so-called “new issues” of services, intellectual property and investment, was anything but traditional. The inclusion of these issues was demanded by the Americans to correct the basic structural asymmetry of the original GATT. In the post-war era, the term “trade in services” would have been an oxymoron and intellectual property was covered by the World Intellectual Property Organization (WIPO) and its predecessor agreements. For the “new issues,” barriers to access are not at the border and are not necessarily transparent but mainly involve domestic regulatory and legal systems. Trade in services grew much more rapidly over the 1980s than did merchandise trade, and the US was the leading exporter by a considerable margin. The same lead status was evident in investment and technology. US multinationals controlled 43 percent of the world stock of foreign investment at the outset of the 1980s and the American technology balance-of-payments surplus was well over $6 billion while every other OECD country was in deficit. Without a fundamental rebalancing of the GATT, it seems highly improbable that the American business community or politicians would have continued to support the multilateral system for much longer. The role of American multinationals in the ultimately successful launch of the Round was crucial. Confronted by failure to budge the EU and the hardline developing countries, and in an effort to increase pressure for a launch, Ambassador William Brock (then the USTR) in January 1985 asked the private sector advisory committees on trade negotiations to present their views on a new GATT round. The report contained some unpleasant results. The consensus on a new round was described as “moderate” at best (provided tough new measures, i.e. unilateralism, were also pursued). And support was contingent on the inclusion of the “new issues.”3 The main private sector advisory committee sprang to action. In cooperation with other US business groups it launched international initiatives in services and intellectual property and mobilized support in Europe and Japan. Indeed the only instance of effective involvement by European and Japanese firms in the Geneva activities is due to American business leadership.


On the intellectual property issue, which was probably the agenda item of highest priority to key sectors of the US business community, it is worth quoting at length from a speech by the chairman and CEO of Pfizer: In March of 1986, Ambassador Clayton Yeutter (USTR) called upon a group of us to work with our foreign counterparts to draw attention to the importance of intellectual property protection. Initially, I think Ambassador Yeutter hoped merely that business’ efforts would assist the US diplomatic position at the September 1986 ministerial meeting. What resulted was more lasting: a three-step process toward transnational business cooperation. Something we really haven’t had enough of. The first step had to do with US companies. We were a loose alliance of diverse businesses—strange bedfellows. We needed to define our objectives and strategies more clearly—that between pharmaceuticals, movies or computers, for instance, we had to try to become a more cohesive unit. Our group, which included 13 major American corporations, became known as “The intellectual Property Rights Committee,” or IPC. The members of the group agreed among themselves on three areas critical to any international accord: certainly, first a code of minimum standards for copyrights, trademarks, patents, and appellation of origin issues. And then, naturally, an enforcement mechanism. And finally, dispute settlement. Without detailed and complete agreement on all three areas, international intellectual property protection accords would be meaningless. As a second step, the IPC moved to forge a consensus with the business communities in Europe and Japan. They were natural and important allies. And, it was hoped, a joint agreement involving the U.S., Europe, and Japan might exert a positive influence on the actions of the developing world—where, all too often, the theft of intellectual property is rampant. At first, the two major industrial “umbrella” organizations—UNICE [the Union of Industries of the European Community] in Europe, and Keidanren in Japan—were reluctant to join the IPC initiative. They feared that intellectual property was too new a subject to become part of the GATT, and they felt initially that intellectual property was, in any case, ill-suited to the Uruguay Round of trade discussions. Three IPC arguments—and a great deal of discussion—turned the tide of Japanese and European sentiment. First, it had become clear that WIPO [the World Intellectual Property Organization]—the worldwide body with the responsibility to defend intellectual property—was inadequate to the task. As part of the UN system, WIPO identifies with the special interests of the very governments in the developing world who abet the theft of intellectual property. This is not to say that WIPO


does not continue to have an important role to play. It does, including— but not only—as the technical body concerned with intellectual property issues. Nevertheless, the GATT seemed the more appropriate means of administering the enforcement of international trading and investment norms. Second, the massive scope of intellectual property theft was explained and documented by the IPC to our friends abroad, as was the threat to the future prosperity of developed economies should intellectual property theft continue to soar. Finally, the IPC argued that—whereas WIPO and similar existing organizations lacked enforcement powers to combat this new form of trade distortion—much could result if a combination of minimum standards, enforcement mechanisms, and dispute settlement could be instituted through the GATT. Intellectual property theft could be rendered easily recognizable. Violations could be made subject to direct consultations and mediation. And, by diminishing the need for unilateral retaliation, a GATT-based solution would do much to restore a sense of calm to trade relations. IPC’s thoughtfully-argued case eventually won the day. Given the speed with which intellectual property issues reached the world stage, and the brief two-year period over which the “Trilateral” discussions occurred, what resulted was truly remarkable. In May 1988, UNICE, Keidanren, and the IPC met in Belgium to review intellectual property in the GATT. At the end of the session, an important three-way agreement emerged on all aspects of the subject. In the final report, the three business groups jointly stated their unequivocal support for including intellectual property protection in the Uruguay Round and set forth their proposals on minimum standards, enforcement mechanisms, and dispute settlement. This was the true multilateral approach that U.S. business had been hoping for.4 The relationship between government and business in the policy process is, of course, much more complex and varied than this example of the pivotal role of specific sectoral interests in the Uruguay Round. Business lobbies in importcompeting industries, such as textiles and clothing, sing from a very different song-book than the financial firms or pharmaceutical corporations. But in the sense that the “new issues” of the Uruguay Round catalyzed the momentum to deeper integration of the global economy, the role of the American MNEs leading the international lobby for services and intellectual property interests was qualitatively different from that of any other government-business interaction in the past. And the post-Uruguay negotiations in financial and basic telecommunications as well as high-tech products demonstrate the power and effectiveness of these global actors. (But, parenthetically, that power is no longer unchallenged. Thus it is of interest to note that the Uruguay Round


produced only limited results in investment because it was a lesser priority for the American business groups at the time. The subsequent move to fill the gap by promoting a Multi-lateral Agreement on Investment in the OECD has been an embarrassing flop. While there were many reasons for this policy mishap, perhaps the most significant is the growing clout of an anti-globalization lobby —or rather assembly of lobbies, of which more below.) There is now discernible a new trend in the role of some MNEs which suggests a further erosion of the influence of governments in the policy process. A paradigm of greater self-regulation is emerging in financial services and also the new marketplace of electronic commerce. In both instances the move to self-regulation stems from the acceleration of the global integration process and the inadequate adaptive capabilities of governments. The basic and familiar problem of governmental policy lag is now different by a quantum degree. In the financial sector there are a number of intergovernmental institutions such as the venerable Bank for International Settlements (BIS) created after World War I, the 1984 International Organization of Securities Commissions (IOSCO) and, most recently, the International Association of Insurance Supervisors (IAIS) formed in 1995. Two developments have increased the urgency for effective coordination among these different supervisory institutions: the growth of global financial conglomerates with extremely complex financial and corporate structures and, perhaps more importantly, the threat of systemic crises beginning in 1970s (with the collapse of Herstatt Bank) and accelerating in the 1980s and 1990s. The global operations of major financial institutions, the rapidly growing volume of transactions, and the expanding array of new products have outgrown the national supervisory systems on which the safety and soundness of the system rests. Global financial flows accelerate but there is no global forum for supervision which would cover all financial institutions as well as accounting and legal practices. In 1997 (before the Asian crisis erupted) the Group of Thirty, a private sector think-tank which specializes in financial market policy analysis, published a proposal for global self-regulation by the world’s major financial institutions.5 The G-30 reasoned that the need for private sector initiative in financial supervision stems not only from the growing mismatch between the global market and the national regulatory structures and the serious impediments to effective intergovernmental cooperation but also from governments’ inadequate knowledge infrastructure. The global financial institutions have far more sophisticated information and control systems and analytic models than do government regulatory bodies. Yet, of course, substantial uncertainty remains and shocks can threaten the system, given the speed of reaction time. The firms thus have a strong incentive to take the lead in developing global rules for effective management controls and establishing an institution for self-regulation. The proposal (which has been well-received by the intergovernmental organizations) does not suggest that self-regulation


should replace government supervision. Rather, new cooperative arrangements will have to be developed. But it seems reasonable to assume that the trend over the longer-term will be to increase the role of the firms since governments have been unable to mobilize the coordination of the diverse cluster of regulatory institutions (which are both public and private) and the public regulatory institutions lack the knowledge-base to cope with the accelerating change and volatility of global financial markets. The policy model of self-regulation and public-private partnership will not be appropriate to all sectors, of course. The current debate of the role of government in the regulation of electronic commerce, however, suggests that financial services are not unique. The stark choice which is presented by cyberspace libertarians—pure self-regulation or “big brother” government regulation—is misleading and unrealistic. But the new technology which created the Internet created a marketplace with uniquely low barriers to entry, low transactions cost and virtually limitless access to information, i.e. a decentralized medium ideally suited to self-regulation. Nonetheless, the role of government is essential in key areas such as privacy, intellectual property, taxation, etc.6 The global regulatory framework which eventually emerges will require negotiations not only among governments (probably in the WTO) but also among business groups and between both sets of actors. While these negotiations may be difficult, they are likely to be successful since both groups share common market-based objectives. The development of new norms and standards to strengthen the regulatory framework would provide an example of what Spar and Yoffie in chapter 1 term “governance from the top” as opposed to “a race to the bottom”—a charge most often levied by another group of actors, the INGOs. Role of the INGOs While the deeper-integration agenda at present largely reflects the agenda of the MNEs, the International Non-Governmental Organizations, or INGOs, are of increasing importance in the policy agenda and process. Virtually nonexistent at the onset of the century, they grew to over 500 by 1990 with most of the growth taking place after the Second World War. By way of comparison, intergovernmental organizations and states numbered around 300 and also grew, although at a far slower pace, after WWII as a result of post-war reforms in international policy and the demise of colonialism. So the INGOs are a relatively new but increasingly pervasive institutional phenomenon. The INGOs are very diverse in nature but have certain characteristics in common. They are part of a much broader phenomenon now receiving increasing attention under the rather broad and ill-defined term “civil society,” to include all manner of non-governmental institutions or even informal group interactions from philanthropic bodies and professional societies to community sports clubs. A distinction is sometimes made between community-based


associations organized around mutual social interests, and mass membership organizations—like the environmental, human rights, women’s groups—based on single interests and more akin to the traditional business and trade union lobbyists. These latter groups are, by definition, policy-oriented advocacy groups and thus more relevant in the context of this discussion. INGOs are flourishing today in large part because of ICT which permits rapid and inexpensive global networking. And they are very skilled in dealing with the media, especially television. They can be termed “transformational coalitions” that are less concerned with traditional interest-group concerns like the division of the pie than with the recipe for making it, and thus their agenda is often at odds with the other players, governments and the MNEs. In a sense they are post-Enlightenment, linked less by a rule of reason than by a rule of morality or values. An apt metaphor capturing the difference between the rationale of economics and that of ecology is the household, namely: “In economics—we try to understand what things we need to live a good life in our households. In ecology, we do the same for the larger household we call the Earth. Environmentalism, then, is the moral and political debate over how to reconcile these two households.”7 A rule of morality is not easily reconciled with the central tenets of economics, i.e. to maximize consumption and balance costs and benefits. The most prominent INGOs at present are the “greens” and their influence was already evident at the Marrakesh meeting which concluded the Uruguay Round in April 1994 and also established a Committee on Trade and Environment to report to the first World Trade Organization (WTO) Ministerial Conference in Singapore in December 1996. It is no accident that the green INGOs were the first to play a role in trade policy at the launch of the renewed multilateral rules-based trading system. In 1994 the implementation of the North American Free Trade Agreement (NAFTA) included specific environmental provisions: the first in trade history. And in 1994, the United Nations Conference on Environment and Development—the Rio Earth Summit—has been described as a watershed event for nongovernmental organizations by endorsing their role in international policymaking. They were actively involved in the preparatory process, in national government official delegations, and in drafting. New international alliances were launched, thus expanding their transnational scope. Perhaps most importantly over the longer-run, UNCED requested the UN’s Economic and Social Council (ECOSOC) to formalize the rules for INGO participation in the policy process of the United Nations institutions. The Report of the Working Group on the Review of Arrangements for Consultations with NonGovernmental Organizations was issued in July 1996 and spells out in considerable detail the status and role of NGOs in the UN system. The effort to draw a fine line between the role of member governments and the NGOs is reflected in the complex and detailed drafting during what were no doubt a


highly contentious series of meetings. Nonetheless, the report marks a major transformation of the post-war international policy-making architecture. As noted, and should be stressed, the influence of the INGOs as exemplified by the environmental groups, has been greatly enhanced by the ICT revolution, both through agile and skilled use of the media (especially television) and the low cost and global span of communication linkages such as e-mail. The environmental message is especially attractive to a younger generation searching for a moral cause and also (as the attack on the Multilateral Agreement on Investment or MAI demonstrated, see below) as a rallying point for a wide range of groups opposed to globalization. While the environmental movement is decades old, its impact on policy has been gathering force only in the past few years. NAFTA, Rio, Greenpeace’s stunning victory over Shell in 1995, the anti-MAI campaign are but a few examples. Of course such “victories” can be matched by equally significant “defeats,” such as the growing dismay that the post-Rio policy results have been less than expected. There is an ongoing struggle within the environmental movement between the more radical activists and the more pragmatic “realists” that promises to intensify, and the outcome is by no means clear. The “realists” have formed alliances with business in some sectors to add to the weight of “green” approaches in policy formation and to explore technical solutions to environmental problems. Business has become more open to collaboration in part because of shareholder pressure (see below). But it seems safe to assume that the traditional two-track policy of confrontation and consultation is likely to continue. More important, perhaps, is the growing North-South divide on many environmental issues—especially in the realm of trade. Since the most powerful INGOs are based in the OECD countries, and especially in the English-speaking countries, it is becoming less clear how “universal” their messages really are. For this and other reasons, indigenous INGOs are proliferating in some Latin American and Asian countries while Western INGOs are focusing more on Southern environmental problems. In some countries this has earned them the name “eco-imperalists.” The new information age has also transformed the impact of INGOs in consumer movements. Consumer activism is directed at changing the behavior of corporations by influencing the demand side of the equation—a potentially powerful instrument in fiercely competitive globalized markets. Like the environmentalist, consumer groups have existed for decades but have become much more effective because of the changes in technology. But not only has their mode of operation changed, so has their agenda. The corporate behavior most effectively targeted usually concerns labor practices, i.e. issues related to basic moral values of the INGOs home community. The campaign directed at Nike is emblematic of this new wave of consumer-led convergence.8 Akin to this type of consumer activism is shareholder activism which is taking the form of “ethical” or “green” funds.9 Corporations—especially those with global


brand names—must now factor these new consumer and shareholder pressures into their management strategies. Changing societal values and the increasing power of baby boomers as consumers and shareholders impacts the bottom line and therefore is bound to impact corporate behavior—and serve as a force for convergence. To conclude this discussion on non-governmental global actors—the MNEs and the INGOs—a few points are worth underlining. The first relates to the dominant role of the MNEs in shifting the trade policy focus “inside the border,” which is far more intrusive and erosive of sovereignty than the shallow-integration agenda of GATT and implies an ongoing pressure for “system” convergence. Another source for convergence stems from global capital markets and the spread of investor capitalism. The catalyst which launched the process was the deregulation and privatization policies beginning in the OECD countries in the late 1970s and then spreading globally in the 1980s and 1990s. A confluence of unrelated events (the growing clout of institutional investors; the East Asian crisis; European Monetary Union) are accelerating the global reach of investor capitalism and deepening the push for convergence to an “Anglo-Saxon” corporate governance model in which the stockholder is king.10 And, of course, the growing power of capital markets seriously constrains government macro policy, especially in smaller countries, and also increases the reliance of government on private sector self-regulation in many micro policy areas. Underlying the deepening integration of the global economy—as a necessary though not sufficient condition—is the ongoing revolution in ICT. Just as power has shifted to shareholders, the new technology greatly enhances the power of consumers and of advocacy coalitions. An increasingly important “unintended consequence” of the technology has been to raise the profile and power of INGOs, especially the environmentalists and the labor-human rights groups. These new transnational actors aim to play a much larger role in the policy process (in the WTO and the Bretton Woods institutions). They are increasingly important in the ongoing change in corporate governance, and most importantly, in nourishing the growing anti-globalization backlash. So where does this leave the other actor in the global arena—the sovereign state? The sovereign state is the only player at the policy table in the intergovernmental institutions. These institutions were, in a sense, a forum for pooling sovereignty. In the trade arena the result was the creation of a rulesbased trading system, first under GATT and now, fifty years later, in the WTO. The multilateral trading system after fifty years The GATT was but one building—undoubtedly the least impressive—in the post-war architecture of international economic cooperation. In contrast, the WTO is the first post-Cold War institution, its creation a tribute to the resilience of the liberal trading order. But there are profound differences


between the challenges which faced the GATT in the post-war decades and the role of the WTO in today’s global economy. The most difficult of these challenges concern the trade-off between domestic and international objectives. The creation of the GATT The United States took the leading role in building a new trading system. Memories of the protectionist battles of the 1930s, initiated by the notorious 1930 Smoot Hawley tariff, were still vivid. Cordell Hull, Roosevelt’s Secretary of State, had reversed the long-standing protectionist policy of the US in 1934 by the passage of the Reciprocal Trade Agreements Act (RTAA) which authorized the President to negotiate tariff reductions with foreign states on a non-discriminatory basis. Hull was convinced that freer international trade was essential to US prosperity, to world recovery and to the maintenance of world peace. From 1934 on, Hull’s vision became “the core mythology” of American foreign policy.11 The other major actor in the design of the post-war institutions, the UK, was also strongly influenced by the memory of the 1930s. British Lord Keynes and American Harry Dexter White, the fathers of Bretton Woods, saw the beggarthy-neighbor devaluations as pernicious as the tariff war of the 1930s. They agreed that a stable rule-based payments system required a stable rule-based trading system, and vice versa. But they were unable to agree on the norms and principles to construct such a system. Thus only the broadest generalities on trade were included in the International Monetary Fund’s Articles of Agreement. The trade negotiations followed a separate track. The disagreement between the British and Americans concerned two fundamental issues, non-discrimination, or the Most Favored Nation (MFN) rule, and the extent and nature of “escape clauses” to permit temporary import barriers for protection of the domestic economy. The British wanted to maintain their system of preferential treatment of Commonwealth Countries for political reasons. And, as stated in their 1944 White Paper on Employment Policy, they regarded the maintenance of full employment and the creation of the welfare state as more important than free trade. Even the Economist, the traditional champion of laissez-faire and free trade, declared “that it did not challenge the old principle that international exchange and division of labour leads to the highest possible national income, but modifications were necessary, because the modern community had acquired economic needs other than maximum wealth.”12 While there were some Americans, especially Keynesian academics, who shared that view, it was not the prevailing view of the elites. As Jacob Viner noted, “the zeal of the United States for the elimination of special and flexible controls over foreign trade is in large part explained by the absence of any prospect that the United States will in the near future devise or accept a


significant program for stabilization of employment or for the planning of investment, the confidence prevailing in this country that our competitive position in foreign trade and the exchange position in foreign trade and the exchange position of the American dollar will continue to be strong, and the availability of the cache of gold at Fort Knox to tide us over even a prolonged and substantial adverse balance of payments if perchance it should occur.”13 The depth of this transatlantic divide on the crucial issue of the role of government deserves underlining. There was no government-constructed postwar “social contract” in the United States. While an Employment Act was passed in 1946 (and the Council of Economic Advisers created as an instrument of the Keynesian policy approach), after the 1946 elections the Republicans dominated Congress and the role of the Council in this respect was somewhat limited. (Most of the American social contract was negotiated by the mass production unions in the golden age of growth, in other words it was largely privatized.) Furthermore, the European social contract involved more than Keynesian demand management: it included a commitment to income redistribution involving an expanded role of the state in both taxation and expenditure, alien to the historical and deeply embedded US conception of the government’s role. The New Deal represented a departure dictated by changed circumstances but not a fundamental transformation of the vision of the Founding Fathers. Thus the romantic ideal of the Hull vision was undergirded not by a widely held international consensus shared by the United States and the Europeans about the nature of the relationship between the trading system and domestic policy. Rather, as Jacob Viner noted, American support for the GATT stemmed primarily from trade and investment opportunities abroad because of America’s lead in the world economy. The separate trade negotiations between the US and the UK began in 1943. It was not until the end of 1945—well after Bretton Woods—that a document was released in Washington which included, among a number of proposals, a Charter for an International trade Organization (ITO) and the GATT, a sub-set of the broader institution. After several preparatory meetings and extensive negotiations, the ITO Charter was presented in 1948 to a meeting in Havana. The Charter of the ITO reflected the many compromises negotiated during the preparatory process. In contrast to the Bretton Woods institutions, weighted voting (according to economic clout) was dropped for a one-country, one-vote rule. Chapters on employment, development, anti-trust, investment, agriculture and a number of exceptions to liberal trade rules were included. The battles among both developed and developing countries were over exceptions and exceptions to exceptions. Even Commonwealth Preference was included under a “grandfathering” of existing preferential arrangements. But all the compromise and difficult negotiations leading to agreement in Havana were overtaken by events. At the time of the Havana meeting the Marshall Plan was launched. The trade and payments liberalization of the Marshall Plan institution, the Organization for European Economic


Cooperation (OEEC), based on discrimination against the US, settled the issue of non-discrimination without debate. The ITO was not ratified after Havana by any country because all were waiting for the leader to ratify first. The President required another extension of negotiating authority in 1949 so decided not to send the ITO to Congress that year. However, opposition was building from many quarters—and support from few. As well, the Korean War had started. Interest in global cooperation had waned. Truman judged there was virtually no chance of approval of the Havana Charter and so decided not to seek Congressional approval. The basis for the judgment seems pretty plausible: no strong support (except among academics and some bureaucrats) but lots of strong opposition. Why did Bretton Woods get by Congress? And the Marshall Plan? No strong opposition, seems to be the answer. Bretton Woods was about money and the dollar. Americans were not worried about the dollar—as Viner noted, they knew there was lots of gold in Fort Knox. The Marshall Plan was about the Cold War. There was little opposition to the Cold War. But the domestic coalition for the ITO was too weak. There were too many loopholes, far too much government intervention for free traders, and too much free trade for protectionists, especially labor unions who formed a National Labor Management Council on Foreign Trade with some import sensitive industries. But the most effective business opposition was not based on fear of import penetration. As Diebold explains: “Their objection was that the Charter would do little to remove the trade barriers set up by foreign countries and might even strengthen some of them…. Moreover, the businessmen who took this view usually believed that the Charter went too far in subordinating the international commitments of signatory countries to the requirements—real or imagined—of national economic plans and policies.”14 Despite this opposition, American leadership in the trade arena did not fail with the death of the ITO. It was American initiative that launched the GATT in Geneva in 1947 as a prelude to Havana. The GATT, signed by twenty-three “contracting parties,” was never put to Congress. But GATT was much narrower in coverage, and because the commitments contained in the Agreement were less binding, it did not elicit the widespread opposition of the ITO. Its weakness was its strength—at least at the outset. Successive rounds of negotiations in the 1950s and 1960s reduced the tariffs erected in the disastrous 1930s. This was the “golden age” of trade liberalization, defined in terms of the reduction of border barriers. But over time the essential compromises embedded in the GATT came to erode the structure—like termites in the basement. The onset of a different mode of trade liberalization began in the 1970s with the Tokyo Round. the mid-decade OPEC oil shock had produced a new economic malady termed stagflation and a marked increase in so-called “new protectionism,” including voluntary export restraints (VERs), quasi-legal market sharing agreements (orderly marketing arrangements or OMAs), and


an explosion of subsidies to support declining industries, especially in Europe, adding to the enormous subsidy support in the Common Agriculture Policy or CAP. The GATT system was not equipped to handle either non-transparent measures such as VERs and OMAs or domestic declining industry strategies. The weak dispute-settlement mechanism added to American frustration with the system. The US administration’s response to the rise of the new protectionism was to begin the move of the trade policy agenda inside the border. The Tokyo Round included negotiations on trade-impeding barriers arising from domestic policies such as industrial and agricultural subsidies; government procurement and regulation of product standards, as well as a strengthening of anti-dumping rules to facilitate the use by business of their favorite remedy against “unfair” trade. Thus the focus of the Tokyo Round was, for the first time in GATT experience, no longer simply on reducing border barriers to trade. Rules governing domestic policy with trade spill-over were now on the table, highlighting differences in the extent and nature of government intervention in different counties. The Tokyo Round also launched another fundamental change: the legalization of the trading system. Perhaps increased legalization was inherent in the shift from reciprocal bargaining over tariffs to rule-making. But arguably more important was the changing nature of American trade policy. There was growing conviction among business groups and labor unions that other countries were engaged in unfair trade practices and that the “free ride” of the 1950s and 1960s had to stop. For the Administration, the best option seemed to be a strengthening of the trade remedy laws. Congress demanded detailed legalistic prescriptions to prevent circumvention by any future administration unwilling to defend “national interests.” One notable result of the Tokyo Round was the enormous increase in use of anti-dumping provisions by both the US and the EU (and an equally impressive rise in American countervailing actions against “unfair subsidies”) that marked the onset of the 1980s. This rise in the use of trade remedy laws was dubbed “administered protectionism.” The creation of the WTO As noted earlier, the shift of policy focus inside the border and the legalization of the system—were vastly expanded by the Uruguay Round. Indeed, one could argue that the change was qualitative not quantitative. The Uruguay Round marked the transition to the agenda of deeper integration which must cover trade, investment and technology flows and is far more intrusive and erosive of sovereignty. All future negotiations, whether multilateral, regional or bilateral will reinforce the move inside the border—and the push to a single global market. But it must be stressed that the Uruguay Round was only the first small step and, indeed, the Round is not over. The “built-in” agenda left over from the


negotiations involves the launch of new services negotiations in 2000 and also the remit from the 1996 WTO Ministerial Meeting in Singapore adds consideration of competition policy, investment and environment to the WTO’s mandate. This will entrench and extend the deeper-integration policy focus. A fundamental but little understood part of this new policy template relates to the legal system. A few examples are worth describing to illustrate this point, especially because there is far greater diversity of legal systems among present and potential member countries today than in 1948, at the creation of GATT. The first example concerns transparency now regarded as a pillar of the multilateral trading system. Yet, while it is today considered one of the basic rules governing that system, its genesis, captured in article X of the 1947 GATT, was based on American administrative law and was of little import at the time of the creation of the GATT.15 In 1946, while the negotiations for the new trading system were underway, the US Congress passed the Administrative Procedure Act or APA. In the September 1946 State Department document Suggested Charter for an International Trade Organization of the United Nations, Article 15, entitled “Publication and Administration of Trade Regulations—Advance Notice of Restrictive Regulations,” becomes Article 38 in the Havana Charter for the International Trade Organization (ITO) and Article X of the GATT which survived the death of the ITO.16 In Article X the title does not include “advance notice of restrictive regulations,” but otherwise there is no significant difference from the State Department drafting. By way of contrast, most other articles of the original American proposals involved considerable haggling and compromise, especially with the British. The Canadians, who participated in the negotiations from their launch in London in October 1946 to their conclusion in Havana in November 1947, in a memorandum to the Secretary of State for External Affairs, which tracks the negotiating process and the changes in each article at each stage, note that Article 38 “was not altered nor were any interpretive notes” required. The memo goes on to state: “This article imposes no obligations upon Canada not already complied with, and the general benefit to international trade needs no elaboration.”17 Evidently each of the fifty-six delegations at Havana felt exactly the same! Why this indifference and/or endorsation of the American position as a pillar of the new international trading system? There obviously is no way of definitively answering this question but a look at the nature and origins of administrative law are suggestive. Administrative law is not substantive but procedural. It establishes norms to control what government bureaucrats do and how they do it. It arose essentially because of the delegation of power from legislators to administrative bodies propelled by the expanded role of government in the industrialized countries that began in the 1920s and 1930s. While all Western countries developed administrative law regimes in the period after World War


I, the American system has some characteristics which distinguish it from continental European regimes and also from the English common law legal family. The American system reflects not only its common law roots but also its origins in the Revolution which created a unique diffusion of power among the three branches of government and a system of checks and balances intended to ensure against any accretion of power. This is significantly different from common law parliamentary systems in the UK, Canada or Australia which rest on legislative primacy and a strong executive. Among the more important distinguishing characteristics of the American system are greater use of independent regulatory agencies, often with quasi-judicial as well as quasi-legislative functions; greater emphasis on notice and comment and freedom of information laws; and a greater reliance on judicial review of the rule-making activity of administrative agencies or departments. By and large, the American system is more litigious and adversarial and hence more fact- or evidenceintensive. It is designed to limit the room for administrative discretion. Article X in the GATT replicates most of the American approach. The word transparency does not appear but the article spells out in detail the rules for “publication and administration” of trade regulations with the latter emphasizing the desirability (rather than necessity) of independent tribunals and judicial review. Perhaps this “dilution” reflected a compromise with the UK in earlier negotiations or a recognition by the State Department that some of the participating countries had not yet fully established their legal infrastructure. Be that as it may, the inclusion of Article X on transparency at the time of GATT’s origin appeared to be non-controversial to the drafters of the new system, because it mainly involved reporting tariff schedules. It was non-controversial because it was insignificant. The Tokyo Round nudged transparency a bit further. An “Understanding Regarding Notification, Consultation, Dispute Settlement and Surveillance” was adopted at the close of the Round. But it was the Uruguay Round that marked a radical transformation. The new issues give transparency a profoundly different meaning. It requires publication of laws and regulations and the mode of administration in services or, to a more limited extent, investment regimes. The agreement on TRIPS (trade-related intellectual property) included detailed enforcement procedures which mirror step-by-step the administrative and judicial mechanisms in the United States. Indeed, the TRIPS agreement underlines the transparency issue—the word is used as a heading in the relevant article. A separate council is established to which notification of regulations and administrative arrangements must be made, and this council is mandated to monitor compliance. Implementing these vastly expanded transparency requirements will present formidable difficulty among countries with systems that differ markedly from the “Western” legal families. For example, since the origin of administrative law in Western countries was the growth of government, and the raison d’etre


of the law was to constrain this expanding administrative power—to control the bureaucrats—this is hardly a trivial point. More significantly, in the present context, effectively monitoring that implementation would require a significant improvement in the capability of the WTO, about which more below. But before turning to that subject, another example of the legalization of the trading system illustrates how contentious this aspect of the new agenda can be. The second example of the trend to legalization, the protection of investment, is taken from a regional agreement—the North American Free Trade Agreement or NAFTA. The investment provisions of NAFTA included procedures for resolving disputes by which private parties as well as governments could take action, and adopted a very broad definition of investment expropriation, so broad that it could lead to investor claims against government regulation in, say, environmental or cultural or health areas which negatively affect the value of investment.18 (Some form of investment protection will be required in WTO negotiations on investment because there would be little business support for an agreement without it.) In the US property rights are protected by the Constitution and this meaning of expropriation is quite common in jurisprudence concerning “takings.” In international law the “taking” versus “regulation” distinction exists but the jurisprudence mainly covers conventional expropriation and not the question of where a “state action implemented for clear public policy purposes crosses over the line from non-compensable regulation to compensable taking.”19 In Canada, where constitutionally entrenched property rights do not exist, the extent of judicial control over government action is far less stringent than in the US and jurisprudence in the area of “takings” is quite different from that in the US. Since in a sense, any regulation might alter the relative costs and opportunities of companies but only a foreign company can seek compensation, several challenges by American companies in Canada have raised a political firestorm. And, indeed, it was the adoption of the NAFTA language on expropriation in the MAI which provided a powerful rallying point for opponents of the negotiations. The arcane legalism of “takings” was effectively transformed into an argument which touched the exposed nerve of sovereignty. It is worth underlining that even if cases under NAFTA are lost, it need not deter skilled lawyers from pursuing other such litigation to induce “policy” settlements. This example of the influence of lawyers on seemingly reasonable policy norms and principles suggests that the most significant import and export of trade agreements may well be legal systems! Indeed, one could argue that legalization creates its own built-in reinforcement—an endogenous growth process is launched (see dispute settlement below). Hardly an outcome intended at the creation of the GATT, fifty years ago, but very much a part of the WTO mandate. Which brings us to the most important issue—is that


mandate congruent with the WTO’s capabilities? Can the WTO provide the forum for reconciling deeper integration and sovereignty concerns? Conclusions: the WTO and globalization—the scope for policy compromise In the launch of the Uruguay Round there was recognition that the GATT would not provide an adequate foundation for the much more ambitious and comprehensive trading system embedded in the negotiating agenda. Thus the Punta Declaration established the FOGS negotiating group. FOGS was promoted by a coalition of middle powers, both developed and developing, since institutional issues were not a priority for either the US or the EU. The middle powers recognized that the alternative to a rule-based system would be a power-based system, and lacking power, they had the most to lose. None the less, the goals of FOGS were relatively modest: to improve the adaptability of GATT in order to respond to accelerating change in the global economy; to improve the “coherence” of international policies by establishing better linkages between the GATT and the Bretton Woods institutions; and most importantly to strengthen the enforcement of the trading system’s rules of the road by improving dispute-settlement arrangements. The creation of a new institution was not included among these objectives, and the proposal by Canada for a new institution—the World Trade Organization—was not put forward until April 1990. It was soon endorsed by the EU. The main reason for this change was growing concern about American unilateralism. The EU, which had opposed a strengthening of dispute settlement in the Tokyo Round, and took a position of benign neglect with respect to FOGS, became an active supporter of a new institution which could house a single, strong disputesettlement mechanism. The Canadian proposal was couched in terms of the substantive aspects of the Uruguay Round negotiations. As the press release announcing the Canadian proposal stated: “Developments in the substantive negotiations are now demonstrating that the Uruguay Round results cannot be effectively housed in a provisional shelter. It is also becoming clear that the post-Uruguay trade policy agenda will be complex and may not be adequately managed within the confines of the GATT system as it now exists” (Ottawa, April, 1990). The World Trade Organization turns the GATT from a trade agreement into a membership organization. But it is a minimalist institution forged solely on legal principles. It establishes a legal framework that brings together all the various pacts and codes and other arrangements that were negotiated under the GATT. Members of the WTO must abide by the rules of all these agreements as well as the rules of the GATT as a “single undertaking.” The most important element of the WTO—the jewel in the crown—is the greatly strengthened Dispute-Settlement Mechanism (of which more below). The WTO also


includes two institutional innovations proposed under FOGS: a Trade Policy Review body, as mentioned above, designed to highlight changes in the policies of member countries through published analytical studies, and a biannual Ministerial Conference, designed to raise the public and political profile of trade policy. As to the objective of greater coherence, the Final Act included only a hortatory declaration encouraging the Director General of the WTO to review possible cooperative mechanisms with the heads of the IMF and World Bank. Formal agreements specifying cooperation modalities between the WTO and the IMF and the World Bank were concluded in November 1996. They carefully detail who can attend which meeting, what information can be exchanged; and provide for the possibility of consultation between secretariats on trade policy-related issues. This minimalist-legal template for the WTO was probably the most that could have been achieved at the time. The premise of increasing substantive complexity on which the WTO was agreed was correct but seriously underestimated. As this paper has tried to demonstrate, the agenda of deeper integration is profoundly different in scope, complexity and contentiousness than the trade policy agenda of the post-war world. Yet the WTO is not significantly different in capabilities than the GATT. Two other differences between the two “institutions,” which also heighten the capability deficit, also deserve mention. First, despite its weakness, the GATT has been termed a bicycle that kept rolling along through successive negotiations. The GATT bicycle hogged the road—there weren’t any others in the way. Today, of course, there is plenty of traffic, some of it very speedy: regional limos, bilateral trucks and occasional unilateral tanks! Finally, and over the longer-term most fundamentally, the new disputesettlement system involves a supranational encroachment on sovereign terrain. For many who worked hard for a successful conclusion of the Uruguay Round, the dispute-settlement mechanism was a if not the major achievement of the negotiations. After all, what is the point of having new rules if they can’t be enforced? In choosing to greatly strengthen the dispute-settlement system they were right: there was no acceptable alternative. But not many understood the full implications of the new system. For example, the juridification of the process creates a built-in reinforcement of legalization. The tendency to appeal virtually all rulings already seems a part of the system and hence one would expect that more and more panel reports would be written for the Appellate body rather than the parties. In turn, this should shift the selection panels from trade-types to lawyers. And so on. Further, under the GATT, when the negotiated norms or rules were less binding, the decisions on disputes were less significant in the political domain. The binding nature of the WTO arrangement can catapult the decisions right into the centre of domestic politics. This greater power inevitably shines a spotlight not just on the WTO Dispute body decisions but also on the process of decision-making—there are


increasingly frequent demands for more “transparency” and “democratization.” These tensions between the polity and the economics of deepening integration has been well put in a recent paper on the current problems of defining European citizenship: “In Western liberal democracies public authority requires legitimation through one principal source: the citizens of the polity.”20 The comparison of the WTO with the European Union is not entirely overstretched. The dangers of the EU “democratic deficit” is that you can’t throw the scoundrels out so you target the whole institution. There are some who might argue the same case against the WTO: if they won’t “democratize” the system, then tear up the Contract. In sum, it’s difficult to disagree that the WTO needs strengthening and I will conclude with some suggestions for institutional reinforcement. Reinforcing the WTO The WTO is au fond like the GATT in being a member-driven organization without a significant knowledge infrastructure, i.e. a secretariat of highly qualified experts able to undertake research directed at policy analysis as in the OECD, the IMF and the World Bank. This analytic deficit virtually precludes policy discussion, and the important peer group pressure it generates, on the issues described above, such as regulatory convergence, the role of legal systems, the trade-off between domestic and international objectives and the crucial issue of the state-market frontier, i.e. all the basic aspects of the new agenda. Further, without the instrument of peer group pressure the transaction costs of achieving consensus in the WTO can be so high that more flexible and therefore speedier alternatives will be desirable. Moreover, in addition to the complexity and contentiousness of the issues and the high transactions costs of policy momentum, the size and disparate interests of the membership greatly add to the difficulty of achieving consensus. Equally important, with the entry of new members such as China and Russia, the lack of “transparency” threatens a serious overload of the already stretched and evidentiary-intensive dispute-settlement system. Although the notion of a shared vision of the post-war trading system is part romantic myth, the post-war elites did share enough basic ideas to serve as a context for policy dialogue and, of course, the Cold War was a powerful fount for cohesive purpose. While some may argue that there is far greater support for trade liberalization today than in 1948, as always the devil is in the details —what do we mean by “trade liberalization”? The most basic issues facing democratic countries—the domestic balance between market efficiency and other social and political objectives and the balance between these domestic objectives and international rules—were hardly a matter of vital concern in the border barrier liberalization after the war. Further, while the deeper-integration policy agenda was and will continue to be determined not only by


governments but also by MNEs, as has been stressed earlier other actors are now increasingly visible on the global stage, i.e. the INGOs, and where there are genuine and significant systemic differences in global optics, consensus will require difficult debate and dialogue and perhaps also institutional change in the WTO. So what reforms would be necessary to strengthen the WTO and ensure the sustainability of the multilateral rules-based system? There will be a wide range of views on this matter and my suggestions are not intended to be exhaustive—but perhaps may stimulate discussion. The first requirement to enhance the flexibility and adaptability of the WTO is to establish a smaller body or executive committee akin to the IMF Interim Committee or the World Bank’s Development Committee. A Uruguay Round attempt to establish a successor to the 1975 Consultative Group of Eighteen (CG18) unfortunately failed, mainly because of opposition from a number of developing countries who feared exclusion. But given the change in atmospherics since the late 1980s, in particular the much more widespread appreciation of the need for a global rules-based system, the time is now ripe for another effort. The next WTO Ministerial Meeting should propose that an Executive Committee of Ministers be established to provide overall guidance to the WTO in promoting the ongoing liberalization of the world trading system. The Executive Committee would be able to meet on a regular basis and, with the assistance of the Director-General and the secretariat, review current and prospective policy issues in order to advise the biennial Ministerial Conference which would retain full decision-making authority. With such a forum, at both a Ministerial and Senior Official level, the norms and principles of liberalization rather than the specifics of legalistic detail could be discussed and debated. It is essential to underline that forging a consensus in a smaller group aided by expert policy-analytic information is facilitated by peer group pressure. The Executive Committee can then play a role in promoting the extension of the consensus to the entire membership. In establishing such a committee, the most difficult problem, of course, is membership and the various formulae tried out in the Uruguay Round failed to secure agreement. But in establishing the Trade Policy Review Mechanism (TPRM), the FOGS Committee created a precedent for a possible formula. Thus different countries were subject to different review schedules on the basis of the member’s share of world trade. This same formula could be used for establishing a committee of reasonable size and rotating membership which would ensure that all countries and regions would be represented within a given time frame.21 Another function of the Executive Committee, supported by a high-quality (although not necessarily large), expert secretariat, would be the diffusion of knowledge in national capitals, another essential ingredient of consensusbuilding. Further, in order to keep up to date and reasonably small in size, the


WTO could not possibly generate all its policy analysis inhouse. Like most research bodies today, the WTO secretariat would have to establish a research network linked to other institutions such as the OECD, the Bretton Woods institutions, private think-tanks, universities and the like. Knowledge networks are key elements in promoting cooperation and coordination. This networking should also include other International Non Governmental Organizations (INGOs) such as business groups (the International Chamber of Commerce, for example), transnational environmental groups, international labor associations and intergovernmental organizations such as the ILO. Cooperative programs involving technical assistance in trade, legal and environmental issues could be launched with business and other organizations. This would enhance the possibility of achieving agreement on the “linkage issues” (environment and labor) to reduce the negative impact on trade policy and to generate mutually agreed proposals for improved transparency (the “democratic deficit”) of the WTO policy process. But over the longer-run it is essential that an environmental institution be established so that truly effective “coherence” in global policy is feasible. Issues like regulatory reform, competition policy, effective and transparent administrative law regimes and other institutional issues will require substantial administrative and legal adaptation in many member countries, especially because of the wide system diversity among current and prospective members. Thus the WTO will also have to greatly strengthen its currently minimal facilities for technical training in a wide range of areas. But even under the most optimistic scenario of enhanced resources, the WTO capabilities in training would be dwarfed by the technical assistance resources of the World Bank and, increasingly, the IMF. So some cooperative arrangement would be required—a good and practical example of coherence. But hardly sufficient. Because of recent changes in the policy orientation of the Fund and Bank, the problem of improved policy coherence has taken on very different dimensions. Both institutions (albeit for different reasons and not entirely in harmony) are shifting policy focus to issues of institutional infrastructure— domestic regulatory policies, “transparency,” the role of government, trade policies—essentially the same broad range of issues as the WTO. It’s probably not an exaggeration to assert that “IMF and World Bank programs not just in East Asia but in India, Latin America, Central Europe and Africa, have led to more systematic trade liberalization than bilateral or multilateral negotiations have ever achieved.”22 In the light of these developments the coherence agreements of 1996 would require significant changes to be meaningful. But real cooperation between the WTO and its sister agencies would require the upgrading of the WTO’s strategic knowledge assets. Which brings us back to the main point: the basic mismatch between the WTO’s capabilities and its mandate.


It is difficult to predict whether the political leaders of WTO member countries will recognize the need for significant reinforcement of the institution created to replace the ITO, the third pillar of the post-war architecture of international cooperation. The challenge is formidable, but so is the threat to the rules-based system. As argued earlier, deeper-integration forces are pushing in the direction of a global single market. The arguments for a single market are economic. Consumers would be able to buy the best products at the lowest prices anywhere and everywhere. The gains stem not only from the static, once-andfor-all efficiency gains from eliminating barriers but also, and more importantly, from dynamic efficiencies which would increase growth and create new jobs as global competition forced firms to restructure, network and innovate. A global single market would, in other words, de-link the economic optic of the nation-state and the global corporation. Global distribution of production would blur the national identity of any particular products. “Global” growth would increase, “global” consumers would benefit, but the distributional effects of these gains, the distribution of winners and losers both among and within countries, would affect the mobile factors of production, the land and, most of all, the labor of the nation-state. In addition to these distributional consequences, which are properly the domain of domestic policies, there are a growing number of voices that reject consumer sovereignty as the governing rule. Reconciling competing paradigms is not impossible—trade-offs are difficult but feasible—but not in the WTO as it is today. But if the WTO is strengthened, it will indeed be a prime institutional mechanism for states seeking to “cope with globalization.” Notes 1 Michael Useem, Investor Capitalism, Basic Books, New York, 1996. 2 Sylvia Ostry, Governments and Corporations in a Shrinking World: Trade and Innovation Policies in the United States, Europe and Japan, Council on Foreign Relations Press, New York, 1990. 3 For fuller exposition see Sylvia Ostry, The Post-Cold War Trading System: Who’s on First?, University of Chicago Press, Chicago, 1997, Chapter 6, pp. 175–200. 4 Governments and Corporations, op. cit., pp. 23–4. A similar strategy (led by American Express) was followed in the services sectors. 5 Group of Thirty, Global Institutions, National Supervision and Systematic Risk, Washington, D.C., 1997. 6 For a review of the main issues re self-regulation and government regulation, see OECD, Dismantling the Barriers to Global Electronic Commerce, Turku, Finland, November 19–21, 1997 (mimeo). 7 Robert S.Royal, ‘The Use and Abuse of Religion in Environmental Debate,’ American Enterprise Institute for Public Policy Debate, Newsletter, Feb. 1998. The





11 12

13 14 15

16 17


19 20 21 22

National Council of Churches in the US has been prominent in environmental lobbying. “Pressure Points in Global Warming”, New York Times, Dec. 7, 1997. See ‘Nike Pledges to End Child Labor and Apply U.S. Rules Abroad,’ New York Times, May 13, 1998 and ‘Asia’s Crisis Upsets Effort to Cut Sweatshop Blight,’ June 15, 1998. See Sustainable Development: Environmental Performance and Shareholder Value: Investors’ Survey, Noranda Inc., Toronto, May 1998 (mimeo). The results of a survey of European and North American financial institutions demonstrated the trend towards increasing importance of Sustainable Development and Ethics in the selection of companies for investment. In 1996 a new INGO—the International Corporate Governance Network—was formed to establish agreed principles and the OECD also issued a report on global governance principle. See Financial Times, July 13, 1998, p. 4. John A.C.Conybeare, Trade Wars: The Theory and Practice of International Commercial Rivalry, New York, 1987, p. 251. Karin Kock, International Trade and Policy and the GATT, 1947–1967, Stockholm, Almquist and Wiksell, 1969, p. 9. The desired “modification” was the right to take temporary trade restrictive measures when faced with balance-of-payments difficulties. Jacob Viner, ‘Conflicts of Principle in Drafting a Trade Charter,’ Foreign Affairs, July 1947, no. 4, pp. 621–2. William Diebold, Jr., The End of the I.T.O., Essays in International Finance, no. 16, October 1952, Princeton University, p. 14. This discussion on transparency is based on Sylvia Ostry, ‘China and the WTO: the transparency issue,’ UCLA Journal of International Law and Foreign Affairs (forthcoming). World Trade Organization, Guide to GATT Law and Practice, volume 1, Geneva, 1995, p. 309. Canadian Legation, Report of the Canadian Delegation to the United Nations Conference on Trade and Employment at Havana, Berne, July 13, 1948, p. 32 (mimeo). For a discussion of the “takings” issue, see David Schneiderman, ‘NAFTA’s taking rule: American constitutionalism comes to Canada,’ University of Toronto Law Journal 499 (1996), pp. 500–37 and Jon Johnson, The North American Free Trade Agreement: A Comprehensive Guide, Aurora, Canada Law Book, 1994, pp. 289– 333. Johnson, op. cit., p. 290. Joseph Weiler, ‘To be a European Citizen—Eros and Civilization,’ Faculty of Law, University of Toronto, April 1, 1998, p. 12 (mimeo). Robert Wolfe, ‘Global trade as a single undertaking: the role of ministers in the WTO,’ International Journal, LI: 4 (Autumn 1996). Lawrence Summers, ‘Why America needs the IMF,’ Wall Street Journal, March 27, 1998, p. A22. This is hardly the best route since none of the measures are bound in the WTO.

3 Environmental regulations and the global strategies of multinational enterprises Alan M.Rugman and Alain Verbeke

Introduction One under-researched aspect of globalization as it can affect multinational enterprises (MNEs) is the manner in which environmental regulations call forth new and different strategies. Some MNEs can afford to ignore environmental regulations while others must develop new green capabilities. The chapter explores the general conditions which determine the appropriate strategies for MNEs in a global environment where environmental regulations are of increasing importance. This chapter advances on a recent paper by Rugman and Verbeke (1998a). In that paper both domestic and international environmental regulations have been identified and the firm-level response to these analyzed. Also explored were the Porter and Van der Linde (1995) and “pollution haven” hypotheses. In this paper this work will be extended by a focus upon the environmental strategies of MNEs. First, we shall define globalization and then develop a framework for coping with globalization at firm and government levels. Second, we shall reinterpret recent work on firstmover advantages from an international perspective. Finally, we shall present a model of corporate strategy and environmental regulations, at the global level. Coping with globalization For globalization we use the definition proposed earlier in this book, namely that “economic globalization is the increasing integration of input, factor and final process markets.” The agent of globalization is the MNE. Its activities reflect an “increasing salience of cross-national value-chain networks in the global economy.” The 500 largest MNEs, 442 of which are from the “triad” economies of the United States, European Union and Japan, account for over half of the world’s trade, much of it intra-firm and about 80 percent of the world’s stock of foreign direct investment (United Nations, 1997). Although there may be winners and losers due to globalization it has long been recognized that the activities of MNEs are basically economically efficient, especially when their internalized organizational


structures overcome market imperfections of a transaction cost nature, such as the public goods nature of knowledge, buyer uncertainty and so on (Rugman, 1981). It has also been demonstrated that MNEs can improve global efficiency when they internalize markets in response to discriminatory exogenous government regulations (Rugman, 1981, 1996a). While the MNE is the key agent of globalization, and its activities are efficient, there may be potential asymmetrical distributional effects across countries and firms. For example, MNEs from smaller, non-triad economies may find it difficult to obtain access to larger triad markets and so they may push for free trade and investment liberalizing agreements. This was the rationale for Canada and Mexico to conclude NAFTA (Rugman, 1990, 1996b). It remains the rationale for the “deepening” agenda of multilateral organizations, such as the WTO, as demonstrated by Ostry (1997 and in this volume). This is because a rules-based system can help mitigate the size asymmetries and other aspects of the power-based triad and non-triad structure of the global economy. Since the degree of competitive rivalry amongst the triad MNEs itself leads to efficiency, the main burden of coping with globalization lies with the MNEs from smaller, non-triad economies. These MNEs are not helped by the discriminatory nature of government policies in triad-based countries, where strategic trade policy and industrial policy measures can impede market access. Such policies reduce the efficiency-benefits of MNE-based competition (Rugman, 1996b; Rugman and Verbeke, 1990). It is to address the variety of domestic subsidies and discriminatory policies that a multilateral agreement on investment (MAI) is needed. This would provide “national treatment” for MNEs, i.e. make them subject to the same application of government policies as home-based firms, while still permitting governments to have different policies. Due to the lack of such a multilateral set of investment rules, MNEs from smaller economies are drawn towards “regional” rules, as in NAFTA (Rugman, 1990; Rugman, Kirton and Soloway, 1999). In this sense, regional agreements are a means of coping with globalization. The complexity of environmental regulations from an MNE perspective The unit of analysis in this chapter is the firm, specifically the MNE. An MNE is defined as a firm operating across at least two country borders. The focus of attention is environmental regulations as they can affect corporate strategy. There are at least five levels of environmental regulations: (a) Multilateral rules established under the General Agreement on Tariffs and Trade (GATT) and World Trade Organization (WTO); (b) Regional-level rules, such as in the European Union and in NAFTA;


(c) National State-level rules, such as federal laws in Canada and in the United States; (d) Subnational rules, such as state and provincial laws; (e) Municipal or local regulations, in cases where these are not under provincial or state jurisdiction. Recent research in NAFTA confirms that the five levels of government regulations are all relevant (Rugman, Kirton and Soloway, 1999). However, there is in this regional context, evidence of movement towards some harmonization of policies. This movement is especially strong between national, subnational and regional environmental policies, for example as they affect the automobile and chemicals sectors, but also in agriculture, where the great majority of disputes have arisen. The main obstacle in the way to convergence of environmental regulations is the inability of the WTO (or even the OECD) to provide a multilateral forum where a common set of rules can be agreed. This is on the agenda probably for the next ten years at the WTO. As Ostry (1997 and in this volume) points out, the “deepening” issues of global integration are now the tough nuts to crack, mainly because they involve agreeing to a common role for governments in international trade and investment. The main legal instrument available, of national treatment, only provides for equal treatment of foreign and domestic firms, and it still allows nations to set different environmental policies. In short, the five levels of environmental regulation are likely to remain useful for analysis for some time to come. In terms of NAFTA, no evidence has been found of a “race to the bottom” (Rugman, Kirton and Soloway, 1999). Instead, a series of interviews showed that US and Canadian-based firms in automobiles, chemicals and agriculture were using the NAFTA regime of complex institutional responsiveness to improve their global competitiveness. To this extent the “regional” column of Figure 3.1 is becoming much more important. Related work by Vogel (1995) comes to much the same conclusion. Besides the five types of government and/or international authority inherent in these five levels of environmental regulations, there are other actors. Most important are environmental non-government organizations (ENGOs). These institutions have been very successful in lobbying governments to write environmental policy agendas. The ENGOs operate mainly at the local level (municipal and national). They also have been good at lobbying at regional level (over NAFTA) and at multilateral level (at Rio and Kyoto). In the latter case they use national organizations as a base to change country-level positions at the regional and multilateral forums. The ENGOs have been successful in changing the agenda of government policy towards one of regulation, away from a former private sector preference for deregulation and open world markets. Before the rise of ENGOs, mainly in the last ten years, the private sector itself was usually the major source of advice and research


used by governments. Now the frequent conflicts between ENGOs and corporations lead to great complexity in attempts to model the interaction between government policy and corporate strategy. This complexity is further complicated by the forces of globalization. These strategic issues for MNEs are more difficult than for domestic corporations when considering environmental regulations. There are at least four types of business affected by such regulations: (a) (b) (c) (d)

Domestic firms, which do not engage in foreign trade; A home-based firm which does some exporting; A home-based MNE, with centralized control over its subsidiaries; A decentralized “transnational” MNE, with a dispersed network of activities.

The nature of the five levels of government and the four types of firms affected by environmental organizations leads to the framework described in Figure 3.1. This framework was developed and applied to twenty-four NAFTA-related environmental cases by Rugman, Kirton and Soloway (1997, 1999). With the two axes of Figure 3.1 linking trade and the environment, the issue of global competitiveness is captured within each of the 20 cells of the matrix. For example, a Canadian forestry firm in row two (a home-based exporter) or row three (an MNE) can be affected by five different types of environmental regulations. These are: the GATT/WTO multilateral rules of nondiscrimination and national treatment; NAFTA regime procedures carried out by NAFTA’s Commission on Environmental Co-operation (CEC); Canadian federal-level environmental policy; provincial policies, as in British Columbia and Ontario affecting domestic and foreign firms; and even municipal regulations concerning waste disposal, chemical discharge in waters, use of land, etc. The three softwood lumber trade law cases of the last twelve years are in cells 8 and 13, reflecting the administration of US trade law at federal level. A newsprint firm, however, is also potentially affected by state-level newspaper recycling laws (in cells 9 and 14). The MNE in cell 14 has more strategic options than an exporting firm in cell 9. For example, the MNE can switch modes of market access from exporting to foreign direct investment in a swifter and more efficient manner than purely home-based firms. In terms of political science issues, one key aspect to be considered is the role of host-country managers in gathering intelligence about, and intervening in, legal systems and US judicial processes. They could engage local counsel and lobby relevant industry associations. Here an MNE in cells 13 and 14 can pass on such insights to strategic decision-makers at home, whereas an exporting firm has far less host-country information or intervention/lobbying opportunities (cells 8 and 9), apart from those provided by its distributors and customers. But perhaps the best-positioned firm is a transnational firm, with


Figure 3.1. Competitiveness, trade and the environment.

strategic autonomy from its host-country managers who may be able to lobby directly as domestic citizens and keep open access; these cases of “national responsiveness” are in cells 18 and 19 (Bartlett and Ghoshal, 1989). Here, a theory of how Canadian corporations and other stakeholders can influence the US regulatory process can be based on the theory of complex interdependence developed by Keohane and Nye (1989) and the particular role of MNEs in this process, as outlined by Rugman, Kirton and Soloway (1997, 1999). This new type of theory of trade and the environment can help to resolve such strategic issues. Each of the 20 cells of Figure 3.1 can be investigated as separate cases and then cross-linkages can be found between them. For example, in the softwood lumber case, the manner in which US business subnational actors have lobbied at the federal level (using US Senators such as Hatfield, Packwood and Bacchus) and influenced trade law decisions can be investigated. These issues link a cluster of cells such as 8, 9, 13, 14 and also potentially 7 and 12, when NAFTA dispute-settlement procedures are included. If the WTO were to improve on the GATT Subsidies Code then cells 6, 11 and 16 would also be involved. Purely domestic firms (usually small and medium-sized firms) in row one will not be affected directly by such international rules (although they could be competing in their home market with subsidized foreign firms, yielding an indirect effect). In order to provide comparisons and contrasts with the US-Canadian experience, it is worthwhile to consider environmental regulations from other areas, especially the EU. The EU has perhaps the most advanced institutional structure in the form of “eco-labels,” labels attesting to the environmental friendliness of a producer, as reported by Vogel (1995). The possible use of eco-labels as barriers to trade affecting Canadian firms can be assessed using


the framework of Figure 3.1, for example the impacts range across cells 2, 7, 12 and 17. The theoretical model can also incorporate key aspects of the theory of shelter (Rugman and Verbeke, 1990, 1998b). Shelter theory can be applied formally to environmental regulations as trade barriers. This requires an understanding of the institutions, market access, lobbying behavior, corporate adjustment and success or failure in overcoming green protectionism. In short, analysis using Figure 3.1 can describe how political and corporate strategies work and it can offer recommendations for public policy and private sector strategies to improve global competitiveness, as environmental issues assume increasing importance. The corporate strategy and the environment approach of Michael Porter can also be incorporated in the matrix of Figure 3.1. Porter and Van der Linde (1995) argue that it is good policy for a government to pass strict environmental regulation. Then firms based in that country (usually the United States) will have to develop new core competencies in environmentally sensitive manufacturing. Eventually, these firms can go abroad and use their strong home base as a staging ground to outperform other, less environmentally sensitive firms in global markets. This policy starts in cells 8 and 13 of Figure 3.1 and it may then spread into cells 7, 12, 6, 11 (if regional and multilateral organizations eventually spice up their environmental rules). The Porter policy presumes that other countries will not “compete” by inconveniently raising their own domestic environmental regulations too soon (before the US-based firms have geared up at home) and that the regional and multilateral organizations also follow along, rather than initiate new environmental regulations. Thus it is a matter of timing. If the US government is a first mover, it can spur US-based firms to be the first “green” MNEs and their environmental credentials should help them to outperform competitor firms on the world stage, once the world stage also becomes green. The problem with the Porter hypothesis, from a Canadian perspective, is that it is difficult to think of any sector where it could be applied. Virtually all Canada’s MNEs sell far more abroad than at home. The average ratio of foreign to total sales for Canada’s largest twenty MNEs is over 70 percent (Rugman, 1990). Thus, if the Canadian government were to impose tight new environmental regulations, Canadian-based MNEs would have to invest and restructure for a market which takes a minority of their sales. These firms would prefer to adapt their manufacturing to suit the environmental regulations of their major customers abroad (especially when the big market for Canadian firms is the United States). In short, as far as Canadian competitiveness is concerned, the Porter hypothesis is not relevant. By forcing Canadian-based firms to take on board stronger, new environmental regulations, the Canadian government would actually reduce the international competitiveness of such firms as it would change their strategic focus from their major markets and make them inward-looking instead of outward-looking.


These points were first developed by Rugman (1995, 1996b) and explored within the context of the Canadian forest products sector and associated environmental regulations. This, again, is an example of cells 8 and 13 in Figure. 3.1. At this point it may be useful to revisit the analysis of Figure 3.1 with the five levels of governmental environmental regulations and the four types of firms. A natural question to consider is which of these five levels is most important for which type of MNE? The answer is that it depends on the interaction of regulatory forces and firm strategies and that there are twenty different types of such interaction. There is no one best way. Yet, based on the analysis of this section, two generalizations are possible. First, the logic of the matrix in Figure 3.1 does not allow us to predict which of the five levels of regulation will become more important for specific types of firms. Nor can we predict if the five levels will converge, or expand, over time. These are questions based on a compliance to regulations view of MNE strategy. Instead, in this section we are explaining ways in which green capabilities may be developed. For example, the “beyond-compliance” policies of MNEs hint that MNEs are developing managerial skills in green capabilities. In turn, a firm-level (or industry-wide) launch of strategies that go beyond compliance towards green capabilities may lead to better treatment by government, and may serve to pre-empt stringent regulations. Second, the managers of most MNEs will need to develop corporate strategy simultaneously at several different levels of regulations. These include: responsible care at the national level, eco-labels at the EU regional level, ISO 14000 at the multilateral level, and so on. The specific balance of MNE corporate strategy will depend on an assessment of which level of regulations matters most to the overall organization and this, in turn, will depend upon how centralized or nationally responsive is the MNE’s overall strategy and structure. The manner in which an MNE solves such complex issues will itself lead to the development of a complex institutional/ organizational capability. Finally, this thinking can be related specifically to the chapter in this book by Debora Spar and David Yoffie. As stated earlier (with reference to the NAFTA pollution haven issue) we have not found any evidence of a race to the bottom, partly because the NAFTA regime (at the regional level) has been so effective, (Rugman, Kirton and Soloway, 1999). While MNEs would prefer to reduce the transaction costs of different levels of environmental regulations, the managerial reality is that there are these five levels for which strategies must be developed. Consequently, MNE strategy cannot be designed on the naïve assumption that there is a dominant multilateral WTO standard, or a strong regional or local one. The strategy needs to be tailored to the actual relevant regulation. Thus generalizations about MNE strategy and environmental regulations are difficult and case-by-case analysis is required.


Environmental regulations and first-mover behavior of MNEs One of the problems in the literature on corporate strategy and environmental regulations is the predominant focus on domestic government policy and local firms. But there is much more than cells 3 and 8 in the matrix of Figure 3.1. As an example of this problem we can consider an otherwise excellent state-ofthe-art review of work in the field of corporate strategy and environmental regulations by Chad Nehrt (1998). Nehrt’s article on first-mover advantages when environmental regulations differ between countries does an excellent job in describing the various factors that make imitability difficult, e.g. causal ambiguity, time compression diseconomies, asset mass efficiencies, the pre-emption of scarce resources, etc. However, from an international strategic management perspective, there are three problems arising from a divergence in environmental regulations across countries. These three elements, which build upon the most recent advances in international business theory, are not fully discussed in Nehrt’s article, although they are critical to the environmental strategies of MNEs. Indeed, MNEs are the major actors in industries affected by environmental regulations (e.g. chemicals, petroleum and heavy manufacturing) and they dominate world trade and investment, for example the world’s largest 500 MNEs account for over 90 percent of the world’s foreign direct investment and over half of its trade (Rugman and Hodgetts, 1995; Rugman, 1996b; and UNCTAD, 1997). First, we question whether maintaining first-mover advantages necessarily constitutes the critical parameter at the firm level, when environmental regulations differ between countries. The recent international business literature suggests that much of the strategic behavior of MNEs may be driven by the goal of maintaining options by postponing investments rather than by moving early (Kogut and Kulatilaka, 1994). This is especially important in cases of high exogenous uncertainty, when investments are delayable but not reversible. In this case, the key question is not necessarily whether to move early, but whether it makes sense to delay investments (Rivoli and Salorio, 1996). This is a rational strategy in cases where high uncertainty exists concerning the future evolution of environmental regulations or on the reaction patterns of relevant stakeholders such as consumers. Then the firm’s key strategic challenge is not to answer the question whether its own first-mover advantage could be maintained but whether postponing investments could lead a rival company to create such a maintainable first-mover advantage. Second, the “emerging paradigm” of pollution reduction would, according to Nehrt, result, at least partly, from requirements to be globally cost competitive or from global industry standards. This view, however, is not always consistent with managerial reality. In most cases, environmental performance is a by-product of efforts to improve industrial performance


(market share, profitability, etc.) Even if environmental performance is pursued for its own sake, it will be pursued only in those areas where it fits with firm-level organizational and technological trajectories, i.e. it is fundamentally path dependent (Florida, 1996). This is especially critical for MNEs which wish to gain economies of scope by transferring environmental best practices to all affiliates. Third, in practice, the large MNE at the end of the twentieth century is a network of operations with assets and capabilities dispersed over many countries. Most of the world’s large MNEs are characterized by high intra-firm trade, extensive internal knowledge transfers and multiple sophisticated coordinating mechanisms. Rugman and Verbeke (1990) demonstrate that managing across borders at present requires both capabilities of national responsiveness and capabilities of integration (leading to benefits of scale, scope, and exploitation of national differences). In other words, each MNE is faced with a particular configuration of firm-specific advantages (FSAs) and country-specific advantages (CSAs) associated with each subsidiary it operates (Rugman, 1996a). The issue then is not (as Nehrt suggests) whether a “firm A” is confronted with different national environmental regulations than “firm B”, whereby each firm’s home country imposes environmental regulations which somehow determine maintainability of competitive advantage. The real key question is how the overall FSA-CSA configuration of the respective firms is affected by different types of environmental regulations at various institutional levels. (We consider this point further in the next section.) This last point is clarified in Figure 3.2, which represents a classification of environmental management challenges, across two key parameters. The first parameter is the institutional level at which environmental regulations are imposed (national or international). The second parameter represents the firm’s configuration of assets and capabilities (concentrated or dispersed). Nehrt’s analysis is one whereby firms are fundamentally non-MNEs, with a concentrated configuration of assets and capabilities. It is primarily domestic environmental regulations which are critical to their competitiveness because they affect domestic production which is then exported or needs to compete with foreign imports. In other words, his analysis is useful for firms positioned in quadrant 1: non-MNEs, characterised by a concentrated configuration of assets and capabilities and faced mainly with domestic regulation from a home country government that may be different from the one prevailing in the home country of a rival. In reality, it is quadrants 2 and 4 which are relevant for MNEs. These firms have a configuration of assets and capabilities that is internationally dispersed and they need to take into account a wide set of environmental regulations at various institutional levels, both in home and host countries and arising from international regulatory activities (GATT, NAFTA, EU, OECD, etc.)


Figure 3.2. A classification of environmental management challenges.

The logic of Figure 3.2 is that Nehrt’s analysis is unlikely to be valid for (a) MNEs in general and (b) firms from small open economies which need to focus more on the environmental regulations of their main customers than on domestic environmental regulations (these include Canadian forestry firms selling most of their production to the United States, (Rugman, 1995)). In summary, the reality of international business is that the possible patterns of firm actions and reactions are much more complex than the options described in Nehrt’s framework, which does not take into account the complexities of international business. Rugman and Verbeke (1998a) present an analysis of some of these strategic complexities facing MNEs when responding to environmental regulations. We shall now review this framework. The implication of environmental regulations for MNE strategies As discussed in Rugman and Verbeke (1998a), the existing academic and practitioner literature provides a variety of lenses for managers to view environmental regulations at the MNE level. Figure 3.3 considers the impact of environmental regulations on the strategies of MNEs. Environmental regulations may affect an MNE’s overall FSA-CSA configuration as depicted in Figure 3.3. Senior MNE managers must decide to what extent specific environmental regulations weaken or strengthen the MNE’s present CSA configuration on the horizontal axis and its present FSA configuration on the


Figure 3.3. The impact of environmental regulations on strategies of multinational enterprises.

vertical axis. For further discussion, see Rugman and Verbeke (1998a and 1998b). In the environmental context, it should be remembered that MNEs may need to cope with environmental regulations at the five institutional levels, as described in Figure 3.1. The CSA axis can be related back to the five levels of government regulation in Figure 3.1. In previous work, related to analysis of the investment provisions of NAFTA, Rugman (1984) discussed how the CSA axis could be used as a “region-specific” axis, e.g. to capture the rules of origin and sectors exempted from the national treatment provision of NAFTA. In a similar manner, the CSA axis can be used to handle subnational and municipal environmental regulations, and also the conceptual possibility of a multilateral WTO agreement on the environment. We now consider the issues of the “pollution haven” and Porter cases, in terms of their impact on the FSA-CSA configuration of Figure 3.3. First, we shall consider how the declustering case can arise when environmental regulations change the CSAs and FSAs. Jaffe et al. (1995) analyzed the results of more than one hundred empirical studies on the possible linkages between environmental regulations and the competitiveness of US manufacturing firms. They found the overall effects of domestic environmental regulations to be largely neutral on both CSAs and FSAs, i.e. positioned in cell 1B (neutralneutral, or NN) of quadrant 1 of Figure 3.3, rather than in 1A (weakeningweakening, or WW) for most firms.


From an MNE perspective, the Jaffe et al. empirical evidence was surprising for two reasons. First, US environmental regulations often impose the use of specific control processes and technologies, rather than merely setting particular emission levels to be respected, in contrast to practices prevailing in most other nations. This should have led to a weakening of the affected MNEs’ FSA-CSA configuration. Second, business-government relations in the United States are often adversarial, as compared to European countries (Vogel, 1986). Consequently, regulators would ultimately pay little attention to the affected firms’ potential for developing green FSAs. These US environmental regulations, again relative to foreign firms, would suggest a weakening of US MNEs’ FSA configuration. The combination of the two elements discussed above would ultimately lead MNEs to shift to cell 1A of Figure 3.3. As a result, US-based MNEs could change their strategy by a shift to offshore production, i.e. an increase of outward FDI. This would allow US MNEs to avoid production in environmentally regulated industries in the United States. There would be an increase of imports into the United States from areas with low environmental regulation. This is a declustering case where the CSAs of the United States are weakened, as perceived by MNEs. The pollution haven case is in quadrant 3 of Figure 3.3. Here MNEs operating in pollution havens enjoy a strengthened CSA configuration, as compared to firms operating in countries with increasingly strict environmental regulations. However, there is little empirical evidence supporting the pollution haven case. The empirical work of Grossman and Krueger (1993) on the activity levels in Mexico and the maquiladora areas along the US-Mexico border demonstrates that US MNEs have not shifted production activities there in order to avoid environmental regulations in the United States. Furthermore, other empirical evidence also fails to support the claim that international trade flows are affected by environmental regulations (Walter, 1982; Pearson, 1987; Leonard, 1988; and Tobey, 1990). Environmental regulations could also be expected to have effects on inward FDI at the subnational level as they could affect the CSA-configuration faced by foreign MNEs, weakening the location advantages of some regions and strengthening those of others. For example, a difference in environmental regulation among states within the United States could lead to institutional competition to attract FDI. However, here again, the empirical evidence on the location of new branch plants in the United States by foreign MNEs suggests no such effect (Friedman et al., 1992). To summarize, this analysis of the pollution haven hypothesis reveals that environmental regulations at present appear to have little effect on the FSACSA configuration and the location decisions of MNEs. In turn, this suggests that MNEs design their production processes according to best global practices. MNEs operate in accordance with the most stringent environmental regulations prevailing in the relevant countries where they operate (Magretta,


1997). This is consistent with Levy’s (1995) empirical results on the environmental performance of MNEs. He finds that a higher degree of multinationality is associated with superior environmental performance, probably because external pressures from international environmental regulations increase more rapidly than the firm’s bargaining power. As discussed earlier Porter’s claim is that strict environmental regulations may actually strengthen the location advantages associated with the country imposing them, and may lead to a joint strengthening of the affected MNEs’ CSA-FSA configuration (in quadrant 4 of Figure 3.3). Using the analysis of Figure 3.3 we can see that Porter’s hypothesis is a case of an environmental innovation cluster. Yet quadrant 4 of Figure 3.3 is not realized by most MNEs. Why is this? Porter assumes that strict domestic environmental regulations can correctly anticipate international regulation trends and thereby stimulate domestic firms to re-think and redesign products and manufacturing processes. This will give these home-based firms a first-mover advantage internationally and may contribute to upgrading an entire cluster of industrial activity, including the different determinants of a national or local “diamond” (Porter, 1990). While a number of real-life examples suggest the relevance of quadrant 4 thinking (including the international competitive advantages of German firms in water pollution control technologies and US firms in hazardous waste management), there are three main reasons why Porter’s hypothesis is not a general case. First, it is unrealistic to assume that a national government could systematically shift profits to domestic firms or create spill-over effects to domestic clusters at the expense of rival companies through environmental regulations. Such regulations are unlikely to fit with the relevant firms’ histories of strategic choice and their distinctive internal resources and capabilities. Second, Porter’s views are only valid for countries with very large domestic markets where governments have sufficient power to significantly influence international regulation trends. In contrast, the small country case of Rugman (1995) is positioned in cell 1A of Figure 3.3. Even large MNEs in smaller countries do not benefit from tight domestic environmental regulations, since the relevant environmental regulations are those of their foreign customers. These firms from smaller countries need to monitor the environmental regulations of host countries, rather than those of the home country. Only rarely will a small country home government (like Canada) be able to anticipate international environmental trends for the benefit of home-based MNEs. As described in this paper’s first section, if the Canadian government were to impose tight new environmental regulations, Canadian-based MNEs would be faced with a substantial weakening of their FSA-CSA configuration and would have to invest and restructure for a market which takes a minority of their sales. These firms would prefer to adapt their manufacturing and possibly increase outward FDI to suit the environmental regulations of their major


customers abroad (especially when the big market for Canadian firms is the United States). In short, as far as Canadian MNEs are concerned, the Porter hypothesis is in cell 1A of Figure 3.3. In contrast, if the US government incorrectly anticipated consistency between its own standards and Canadian standards, this would be an inconsequential mistake for most US MNEs (cell 1B of Figure 3.3), given the relatively small size of the Canadian market compared to the US one. Third, if environmental policy is captured by inefficient domestic firms seeking shelter against foreign rivals, a quadrant 3 scenario will occur in Figure 3.3. Here, an artificial strengthening of CSAs for domestic firms is created which, however, does not lead to domestic innovation in FSAs. For example, Vogel and Rugman (1997) reviewed ten cases of environmentally related trade disputes between Canada and the United States and found that in nine of these cases environmental regulations were used to obtain shelter. This occurred in two ways: (i) by imposing discriminatory policies against imports as part of environmental regulations; (ii) by enforcing product standards that either completely restrict or place a significantly higher cost burden on foreign producers. Often, shelter is disguised as an environmental conservation measure (Rugman and Soloway, 1998). From a dynamic perspective, the logic of Figure 3.3 suggests that if MNEs are negatively affected by a foreign rival’s shelter policy (and thereby positioned in quadrant 1A) then the MNEs should attempt to move to quadrant 2 by developing new FSAs to compensate for the capture of foreign environmental policy and the weakening of their CSA configuration. From the analysis of FSA-CSA configurations arising from Figure 3.3 we can conclude that environmental regulations building upon the Porter hypothesis, and intended to generate a quadrant 4 scenario, may in fact lead to a cell 1A outcome. In addition, given the possible dynamics involved, some MNEs from smaller countries denied market access by shelter-type environmental policies may have to build up FSAs to offset weaker CSAs, as in quadrant 2 of Figure 3.3. These unforseen complexities of proposed environmental policy initiatives, such as the Porter hypothesis, should lead to second thoughts by policymakers and environmentalists who do not anticipate the full impact of changes in the FSA-CSA configuration on MNE strategy. Conclusions In this paper we have considered the issue of corporate strategy and environmental regulations from an international perspective. In order to develop analysis of the manner in which MNEs cope with environmental regulations we have proceeded on three fronts. First, we presented a descriptive framework that distinguished five levels of government regulation and four levels of corporate/firm strategy. We discussed examples of the complexities of public policy on environmental


issues, and corporate strategy, within this framework. Although mainly USCanadian examples were used, the framework is generalizable to handle many issues of coping with globalization. Second, we reviewed the key theoretical and empirical contribution of Chad Nehrt (1998) on the nature of first-mover advantages in the face of, mainly domestic, environmental regulations. We extended this work by raising issues of globalization which require modification to Nehrt’s work in order to take into account the complexities of green corporate strategies at the MNE level. Finally, we presented a conceptual framework to analyze the possible impacts of environmental regulations on the FSA-CSA configuration of individual MNEs. We concluded that most of the relevant literature describes various special cases, all of which can be adequately explained by our framework. Our main conclusion is that academic work on the impact of environmental regulations on firm strategies needs to recognise the importance of the MNE as the relevant unit of analysis. In this case it became critical, however, to build upon a solid knowledge of the complexity faced by MNE managers today. Future research in this area might build upon the conceptual frameworks developed here and attempt to apply them to sets of firms, industry and country case studies. We have started this process in related work. For example, the five levels of environmental regulations and four levels of corporate strategy have been tested across some seventy general NAFTArelated cases, and in detail across twenty specific NAFTA health and agricultural standards in Rugman, Kirton and Soloway (1999). The contributors to this book are respectively: an international management scholar, a political science professor and a lawyer. It is by such collaborative and interdisciplinary work that future research on the interaction of environmental regulations and corporate strategy must proceed. The more general issue of coping with globalization, which is the focus of the chapters in this book, also needs to be analyzed in a collaborative and interdisciplinary manner. The manner in which MNEs cope with different levels of environmental regulations is but one specific example of the agenda of this book. Bibliography Bartlett, C. and Ghoshal, S. (1989) Managing Across Borders: The Transnational Solution, Boston: Harvard Business School Press. Florida, R. (1996) ‘The move to environmentally conscious manufacturing,’ California Management Review 39(1):80–105 Friedman, J.D., Gerlowsky, A. and Silberman, J. (1992) ‘What attracts foreign multinational corporations? Evidence from branch plant location in the United States,’ Journal of Regional Science 32(4)(November): 403–18.


Grossman, G.M. and Krueger, A.B. (1993) ‘Environmental impacts of a North American Free Trade Agreement,’ in Peter Garber (ed.) The U.S.-Mexico Free Trade Agreement, pp. 13–56, Cambridge, MA: MIT Press. Jaffe, A.B., Peterson, S.R., Portney, P.R. and Stavins, R.N. (1995) ‘Environmental regulation and the competitiveness of U.S. manufacturing: what does the evidence tell us?’ Journal of Economic Literature 33 (March): 132–63. Keohane, R.O. and Nye, J.S. (1989) Power and Interdependence, Glenview, IL: Scott, Foresman and Company. Kogut, B. and Kulatilaka, N. (1994) ‘Operating flexibility, global manufacturing and the option value of a multinational network,’ Management Science 40(1):123–39. Leonard, H.J. (1988) Pollution and the Struggle for the World Product, Cambridge, UK: Cambridge University Press. Levy, D.L. (1995) ‘The environmental practices and performances of transnational corporations,’ Transnational Corporations 4(1):44–67. Magretta, J. (1997) ‘Growth through global sustainability: an interview with Monsanto’s CEO, Robert B.Shapiro,’ Harvard Business Review 75(1)(Jan/Feb): 78–88. Nehrt, C. (1998) ‘Maintainability of first mover advantages. When environmental regulations differ between countries’, Academy of Management Review 23(1):77–97. Ostry, S. (1997) The Post Cold-War Trading System: Who’s on First? Chicago: University of Chicago Press. Pearson, C.S.(ed.)(1987) Multinational Corporations, Environment, and the Third World, Durham, NC: Duke University Press and World Resources Institute. Porter, M.E. (1990) The Competitive Advantage of Nations, New York: Free PressMacmillan. Porter, M.E. and Van der Linde, C. (1995) ‘Towards a new conception of the environment-competitiveness relationship,’ Journal of Economic Perspectives 9(4): 97–118. Rivoli, P. and Salorio, E. (1996) ‘Foreign direct investment and investment under uncertainty,’ Journal of International Business Studies 27:335–57. Rugman, A.M. (1981) Inside the Multinationals: The Economics of Internal Markets, New York: Columbia University Press. —(1990) Multinationals and Canada-United States Free Trade, Columbia, S.C.: University of South Carolina Press. —(1994) (ed.) Foreign Investment and NAFTA, Columbia, S.C.: University of South Carolina Press. —(1995) ‘Environmental regulations and international competitiveness: strategies for Canada’s forest product industry,’ The International Executive 37(5): 451–65. —(1996a) The Theory of Multinational Enterprises: Volume One of the Selected Scientific Papers of Alan M.Rugman, Cheltenham: Edward Elgar. —(1996b) Multinational Enterprises and Trade Policy: Volume Two of the Selected Scientific Papers of Alan M.Rugman, Cheltenham: Edward Elgar. Rugman, A.M. and Hodgetts, R. (1995) International Business: A Strategic Management Approach, McGraw-Hill, New York. Rugman, A.M., Kirton, J. and Soloway, J.A. (1997) ‘NAFTA, environmental regulations and Canadian competitiveness,’ Journal of World Trade 31(4):29–144. —(eds)(1998) Trade and the Environment: Economic, Legal and Policy Perspectives, Cheltenham: Edward Elgar.


—(1999) Environmental Regulations and Corporate Strategy: A NAFTA Perspective, Oxford: Oxford University Press. Rugman, A.M. and Soloway, J.A. (1998) ‘Corporate strategy and NAFTA when environmental regulations are barriers to trade,’ Journal of Transnational Management Development 3(3):231–51. Rugman, A.M. and Verbeke, A. (1990) Global Corporate Strategy and Trade Policy, London and New York: Routledge. —(1998a) ‘Corporate strategies and environmental regulations: an organizing framework,’ Strategic Management Journal 19:363–75. —(1998b) ‘Multinational enterprises and public policy,’ Journal of International Business Studies 29(1):115–36. Tobey, J.A. (1990) ‘The effects of domestic environmental policies on patterns of world trade: an empirical test,’ Kyklos 43(2):191–209. United Nations (1997) World Investment Report (Geneva: UNCTAD). Vogel, D. (1986) National Styles of Regulation: Environmental Policy in Great Britain and the United States, Ithaca, NY: Cornell University Press. —(1995) Trading Up: Consumer and Environmental Regulations in a Global Economy, Cambridge, MA: Harvard University Press. Vogel, D. and Rugman, A.M. (1997) ‘Environmentally related trade disputes between the United States and Canada,’ American Review of Canadian Studies 27(2): 271–92. Walter, I. (1982) ‘Environmentally induced industrial relocation to developing countries,’ in Seymour J.Rubin and Thomas R.Graham (eds) Environment and Trade: The Relation of International Trade and Environmental Policy, Ottawa, New Jersey: Allanheld, Osmun: pp. 67–101.

4 Globalization and federalism Governance at the domestic level Alfred C.Aman, Jr.

Introduction Globalization, the increasing integration of factor, input, and product markets coupled with the increasing salience of multinational enterprises, has affected the ways in which states at the national and local levels interact with the private sector. It also has influenced the kinds of problems deemed politically appropriate for collective, regulatory action. Various states have attempted to cope with globalization by downsizing and shifting, sometimes dramatically, from state regulatory regimes to increasing reliance on markets and market forces. As Spar and Yoffie point out in Chapter 1, governments in some developing countries may have also indulged in “races to the bottom” by competitively diluting their laws to attract foreign investment (for a critique of the race-to-the-bottom thesis in fiscal affairs, see Kudrle’s chapter). As a result of globalization pressures, deregulation, privatization and various forms of costbenefit analyses have dominated the regulatory reform agenda in the US as well as in many other countries. These kinds of reforms usually are legislative in nature. They represent current political choices on the part of government to repeal some statutes, reform others, or abolish some administrative agencies and streamline others. These kinds of statutory changes have their parallels in the private sector and they have not been the only kind of legal responses to the global economy. There have been shifts in constitutional philosophy and approach as well. At the private level, corporate change and reform during this period of increasing globalization often has been typified by greater decentralization. Many of the same economic pressures that drive companies to seek more efficient structures as well as production processes are affecting domestic governance as well. The relationship of state power to centralized power has been undergoing a resurgence of interest in the US and elsewhere. There has been an increasing trend not only towards markets and market approaches, but the devolution of governmental power to state and local levels. Welfare reform is an example of this in the US. But devolution of federal power is not restricted to the US.


Great Britain is devolving power to Scotland and Wales and devolution has played a role in the structural set-up of the settlement agreement involving Northern Ireland. Similarly, increased reliance on federalism doctrines, decentralization and devolution are at the heart of various proposed constitutional reforms and changes in Australia and Italy as well. Viewed as a form of decentralization aimed at positioning domestic legal regimes to govern and compete more effectively in the global economy, this trend towards devolution makes economic sense in an increasingly integrated global economy. But, as we shall see below, some of the fundamental changes taking place in the US have not only been the result of statutory actions by the US Congress, but constitutional interpretations by the US Supreme Court. Doctrines of federalism, long thought settled since the New Deal, are being revived and reinvigorated. As I shall explain below, how decentralization or devolution occurs at the federal level is crucial to the ability of policymakers to creatively design legal structures appropriate for global governance. If devolution occurs as a result of constitutional interpretations by the Supreme Court, the change that results is relatively more permanent and, as I shall argue, may be unduly restrictive. Federalism approaches that are too rigid come at a cost—the cost of decreasing law-making flexibility at the federal level. This is due, in large part, to the nineteenth century notions of sovereignty on which the Court bases its opinions. The decentralized results that these decisions require might be sensible, but the rationales and methods used by the Court to reach these results risk limiting the flexibility of policymakers—at both the federal and state levels—in the future. There are a number of assumptions inherent in the analysis of the recent federalism cases that will follow. First, I believe that whatever future global governance structures are created, they will have to have the capacity to harmonize with domestic legal regimes and vice versa, similar to what Ostry terms in Chapter 2 as “deep integration”. Flexibility should be the norm of all legal regimes at the local and the global level. This is because the distinction between the global and the local has collapsed. Policy spaces where the sovereignty of the state prevailed are fast disappearing (for example, see Cohen’s discussion in Chapter 7 on deterritorialization of money). There is no bright line to be drawn—no wholly distinct international or global conception of law and policy and one wholly local. A second assumption in my analysis is that future domestic law and policy will embody new combinations or at least different proportions of federal, state, local and private power. Just as bright lines between local and global have faded, distinctions such as public and private or state and federal no longer carry the same analytical power. For example, there once was a time when what was truly international or global involved issues of war and peace. These were clearly the federal government’s responsibility. Other issues, such as environmental and land use controls, were local, state concerns. Now, many


so-called domestic issues have global significance that go well beyond traditional war and peace questions. Local issues involving crime or the environment, for example, have direct links to and impact upon global issues and problems. In fact, as Rugman and Verbeke argue in Chapter 4, multinational enterprises now need a strategy to cope with regulations at multiple levels of aggregation such as subnational, national, regional and international. In short, the kinds of divisions of powers we once had between federal and state governments are not so easily captured by distinctions between state and federal or even public and private.1 Third, having said all of this, I do not wish to suggest that there is anything wrong with an emerging trend toward greater devolution of state power. I do, however, take issue with the manner in which these changes occur. As I shall argue below, I believe that, particularly at this point in history, constitutional flexibility should be emphasized. Thus, legislative change should be preferred over a kind of constitutional change that may seriously limit the ability of federal policymakers in the future to experiment with new, creative combinations of public, private, state, federal and local power. This chapter concludes that when choices of interpretive approaches to constitutional doctrines exist, those approaches that preserve, increase or further the flexibility of decision-makers’ responses to the global economy should be preferred. Policymakers should have reasonable flexibility to choose the types, pace and sequencing of instruments to cope with the challenges of market integration. Not unlike the New Deal era, when the Court had to confront new issues arising from society’s political responses to a newly emerging nationally integrated economy, the Court today decides issues against a backdrop of an increasingly integrated global economy. My analysis of recent federalism decisions will show that it is important that courts resist constitutional approaches that unnecessarily limit change and new powersharing approaches to new and old issues. While it may seem ironic, some of the deferential, constitutional interpretive approaches forged by the Court during the New Deal era may, in fact, be best suited for the political experimentation now necessary, especially if various levels of government and non-state actors are to adapt successfully to the realities of a global economy. But this is not to argue for a return to the New Deal so far as substance is concerned. There is no going back to the nineteenth or twentieth centuries or to the state-centric future courts and law-makers have envisioned for the greater part of this nation’s history. The emerging global economy requires experimentation and legal structures that provide the maximum degrees of flexibility. The globalizing state and federalism Since the founding of the republic, power in the United States has generally flowed from the states to the national government.2 As local


economies became more integrated with a growing national economy, the logic of Supreme Court decisions, particularly those after 1937, almost always resolved disputes between federal and state levels of governance in favor of national power.3 Post-New Deal, the outcome in cases involving the scope of the Commerce Clause of the Constitution seemingly had become such a foregone conclusion that it prompted then Justice Rehnquist’s quite pointed dissent in Hodel v. Virginia Surface Mining and Reclamation Assoc.:4 “Although it is clear that the people, through the States, delegated authority to Congress to ‘regulate Commerce…among the several States,’ one could easily get the sense from this Court’s opinion that the federal system exists only at the sufferance of Congress.”5 Indeed, he viewed the proposition that Congress, in our system of government exercises only power delegated to it as “one of the greatest ‘fictions’ of our federal system.”6 Chief Justice Rehnquist now speaks for a majority on the Court whose approaches to federalism issues are more receptive to arguments involving state autonomy that reject expansive readings of the Commerce Clause. Specifically, the Court has taken issue with attempts by the federal government to “commandeer” state bureaucracies to carry out federal mandates.7 Moreover, the Court has breathed new life into the Tenth Amendment maintaining, for example, that federal regulation of guns near schools is too local an issue to be supported by the Commerce Clause of the Constitution.8 While a good doctrinal argument can be made in support of the Court’s decisions in some of these cases,9 the reasoning in these cases suggests a shift in the Court’s methodology to such issues and its underlying philosophical approach to federal-state issues that transcends the facts of these cases. This shift in emphasis from federal power to state autonomy and power coincides with economic and political shifts in the global economy that also encourage decentralization of power; however, interpreting these changes in federal-state relations in a manner that diminishes the flexibility of federal and state policymakers to experiment with new regulatory and deregulatory approaches runs the risk of substantially undermining the range of policy alternatives and administrative structures that may be necessary for the global state to be effective.10 A global perspective on federalism As I will show below, the Court’s shift in the power relationships between the nation and the states and its underlying rationale for this change is likely to encourage more competitive models of the global state, at the expense of developing a more cooperative-based understanding of the state at both the national and the international levels. The emphasis on the individuality of states and their identities and power increases the transaction costs of reaching cooperative agreements that could apply to all states. In a sense, an extreme view of federalism would make national legislation as difficult as negotiating


multilateral treaties. This is not to argue that a race to the bottom is inevitable in such a situation,11—as Spar and Yoffie point out in Chapter 1, such races occur only in specific circumstances—but it does argue that creative, cooperative approaches to issues may be unnecessarily constitutionally excluded, when they should at least be politically possible. Moreover, the strong-state assumptions used by the Supreme Court in its analysis of federalism opinions, coupled with its emphasis on dual citizenship, cost and accountability do not sufficiently capture the heterogeneous quality of states as actors in today’s economy and the multicentric complexities of the relationships that now typify the transnational actors that states seek to influence. Nor does it capture the more cosmopolitan nature of citizenship today. A citizen of a state is, of course, a citizen of the US and a global citizen as well. Individuals carry all of these identities with them on a daily basis.12 The Court’s emphasis on democracy and accountability at the state level overestimates the degree of choice states have when working by themselves, especially when the problems involved simultaneously include state, federal and often international components. It also underestimates the cosmopolitan nature of citizens today, and the fact that individuals are able to differentiate among various levels of power that they believe are involved and with which they identify. Paradoxically, perhaps, globalization exerts a downward pull when it comes to the exercise of both federal and state power, providing incentives for more state autonomy and power and more local authority within states.13 At the same time, globalization also creates pressures from outside the nation-state to take actions that allow international solutions to problems such as ozone depletion or global warming.14 This is similar to what Spar and Yoffie in Chapter 1 term as “governance from above”. In addition, there are horizontal competitive forces at work as well, brought about by transnational corporations, with economic power sometimes approximating the power of a state and with the capability of locating their operations anywhere in the world. Indeed, a multicentric world, consisting of non-sovereign power centers pursuing their own private interests adds another important power dimension to federalism issues. As a consequence, issues involving sovereignty and democracy arise that go beyond the traditional discourse of federalism, as it has developed so far. This is true of citizenship issues as well, as citizens in a global world regularly function on multiple levels of political awareness. The downward pull of globalization Globalization encourages increasingly intense international competition among nations, states and cities to attract and keep industries that they believe can create economic growth in their areas. Though the location of a plant or manufacturing operation turns on numerous, primarily cost-related factors, low taxes, and the imposition of minimal regulatory costs on industries located in


these jurisdictions usually constitute important elements of a jurisdiction’s strategy to attract industry and jobs to a particular locale.15 The tax and regulatory policies devised on the local level to attract industries to a certain locale are often the result of decision-making processes that are more akin to local corporatism than more traditional forms of democracy. Indeed, one commentator has noted, based on a study of Japanese investment in the Midwest, that a kind of embedded corporatism best describes the process by which new investment is sought.16 This involves, among other things, “an activist local state working with the business class to attract foreign investment and thereby stimulate the local economy.”17 As a result of agreements among business, government and labor, substantial tax relief and various other economic and cultural incentives are commonly offered as forms of currency in this global competition for business18 (see, Spar and Yoffie’s chapter in this context). Individual states and municipalities within the US, eager to attract such new investment and to retain its current industries, have a great interest in gaining control of as many factors as possible affecting firms’ decisions to locate to or remain in the jurisdiction. They can create currency for global competition by being more efficient when it comes to providing services such as welfare more efficiently than neighboring states.19 Thus, closely related to global incentives for regulatory cost-cutting and the imposition of lower taxes at the federal, state and local levels is the increased desire of each particular jurisdiction seeking increases in economic investment to control its own costs. Relocating federal regulatory responsibility for costly regulatory programs in the individual states arguably gives states the opportunity to create more global currency by maximizing the efficiency with which they provide such services. There may, of course, be some forms of global competitive currency individual states should not be allowed to create.20 And there may be national interests that should take precedence over state concerns. Level playing fields are not necessarily sought by states when the primary motivation involved is competition. Moreover, a level playing field in the US alone does not solve the competitive problems of states that arise from competition from other parts of the globe. The multicentric aspects of the global economy stem from the fact that there are multiple state and non-state power centers capable of affecting where investments may or may not occur. All of these pressures militate in favor of decentralized decision-making. The pull from the top—national and international pressures Increasing a state’s power to control the costs imposed on its inhabitants and potential investors through devolution is, however, only one aspect of current federalism trends. There are also forces operating simultaneously to reinforce federal powers. National standards and approaches may be necessary to


prevent the creation of illegitimate global currency.21 They also are necessary to achieve certain levels of regulatory uniformity if businesses are to avoid a patchwork quilt of state rules and regulations.22 More important, there also are issues such as the environment, in which it is in the interest of nation-states to play an active regulatory role at the global level. Effective national participation at the global level requires a national “presence” in certain domestic areas affected by these global concerns. And indeed, international agreements and multilateral approaches have been increasing at a rapid rate.23 For example, if there were no effective national control over air pollution, it would be very difficult for the national government to speak for all fifty states and enter into serious negotiations at the global level. The ability of the national government to participate effectively in global issues at the international level can help mitigate the extremes of global competition. Along with the trend toward a devolution of federal power there is also an evolutionary trend involving the national government more directly in the responsibilities of international governance.24 At the national level, this trend toward multinational decision-making and problem-solving often expresses itself negatively in debates over the undue restriction of national sovereignty,25 but international cooperation and multinational agreements are nonetheless increasing.26 International cooperation and regulation highlight the importance of the national government’s ability to play an active role at the domestic level. To the extent that federal power is limited in this regard, enforceable international regulatory regimes are more difficult to create than when only one major decision-maker is involved.27 Horizontal forces and the transnational corporation Federalism traditionally is seen primarily in vertical terms.28 Usually, the flow of power involved is between state and federal centers of authority. A global perspective introduces not only an additional vertical level of power, namely the international level, but additional horizontal dimensions as well.29 A global perspective emphasizes the fact that states outside the US now play an increasingly important role when it comes to global competition and it also highlights the significant role non-state actors, such as transnational corporations, now play in influencing local legal regimes and policies. Their ability to render a sense of place relatively irrelevant when it comes to deciding where to locate its plant, for example, substantially undercuts the ability of individual governments, state or federal, to regulate the activities of such entities effectively. The fact that capital moves relatively freely from state to state also means that investment can sometimes leave as quickly as it may have come.30 The jurisdictional difficulties faced by states trying to influence such actors cannot be dealt with as it was during the New Deal, when federal regulatory regimes leveled the playing field nationwide, and that was usually good enough. There are now many other countries involved and


international approaches are necessary, if state intervention and a more cooperative approach to international governance is the goal.31 Of course, if a strong-state laissez-faire response is the goal, then maximum decentralization of power would further that kind of global economy. This is and should be a political decision, however, and not one that is simply the byproduct of constitutional dictates. In short, the transnational or horizontal character of these entities introduces an independent and significant power relationship into the equation that substantially undercuts the power of states to influence these entities in ways individual states believe further the public interest. The economic power that some of these entities possess and the structural economic issues or choices they can present for states and individuals, in some ways, makes them somewhat akin to states themselves.32 There is, in effect, a much more distinct, private power center that no longer can easily be neutralized by a set of uniform rules, even at the national level. Global citizenship Citizenship operates on multiple levels today. Legal residents who live in states are, of course, US citizens as well, but they often also identify their economic interests with the transnational corporation they work for or that invests capital in the community in which they live. On a more public interest level, local and national citizens increasingly are aware of the global implications of local or national decisions and these, too, are becoming a part of everyday politics. For example, the debate over the tobacco settlement has a global component to it. If the settlement makes it easy for companies to open new markets abroad, this factor does and should affect a local, domestic political response.33 Similarly, environmental regulation that moves certain industries offshore, thereby increasing global pollution, also should be factors at the state and federal levels of political discussion.34 Global citizenship involves multiple identities and the ability of citizens to differentiate among the various roles that different levels of government perform. At the same time, built into these multiple identities are often conflicting and conflicted responses to certain issues. What might further one’s local interest, might harm the global competitiveness of the entities that contribute to the economic health of an area or region. These are the kinds of trade-offs the political process makes on a regular basis, but it is important that all levels of government—municipal, state, federal and international—be involved in the decision-making mix as much as possible. A constitutional approach to the allocation of power issues involved in such issues that maximizes political choice at all levels of citizenship and government is preferable to one that forecloses important considerations from public debate, as well as the kind of debate that should occur within an individual as well as in society at large.


A global perspective on power allocation issues between federal and state governments thus provides us with additional criteria with which to evaluate the Court’s federalism decisions. It also creates additional concerns when it comes to global governance and the role of individual states in that process. As we begin to analyze concepts of federalism from a global perspective, democracy and public participation questions loom large. Traditional federalism responses and calls for a return to pre-New Deal days do not necessarily solve these problems, given the global dispersion of power that now exists. Just as it is impossible to recreate the sense of the private that existed in an earlier historic era, it is impossible to view states as independent units of power, unaffected by actors and problems that do not correlate with geographic boundaries. It may be that there needs to be more local control over certain issues, but there may also need to be new forms of governance and participation at the global level. Judicial approaches that unnecessarily limit these new possibilities may do more harm than good by, in effect, playing a role somewhat akin to the role the Court played as this country began, politically, to come to grips with the legal and economic implications of a national economy.35 Sovereignty, federalism and the court A rigid concept of state sovereignty emerges from the Court’s recent opinions declaring certain federal acts in violation of the Commerce Clause or the Tenth Amendment.36 A strong-state set of assumptions underlies the Court’s analyses in these cases, assumptions which may undermine future attempts to create the multilevel, fluid, governmental and private partnerships necessary for the globalizing state to be relevant, much less effective. The Court’s notion of state sovereignty is steeped in nineteenth century precedents and a consequent view of state power that conceptualizes individual states as separate and distinct from federal power and the power of other states. This conception of states is in stark contrast to the fluidity of state borders and the multicentric aspects of their make up today.37 Just as nation-states are not unified entities capable of devising their own solutions to problems entirely on their own, individual states also are an integral part of a global economy.38 The Court’s opinions also reflect an aspect of public choice theory by emphasizing accountability and cost as important bases for its decisions, especially when federal attempts to use the apparatus of states to implement federal policies are involved. In so doing, however, the Court emphasizes the importance of differentiating clearly between the levels of government responsible for these additional costs. In its view, democracy, freedom and liberty require that those who make decisions should bear its costs and be accountable to the electorate who must pay them.39 Unfunded mandates, in this sense, violate the spirit of democracy and undermine accountability for those who are responsible for its costs.40


History, accountability, cost and democracy are, of course, important considerations when viewed from a global perspective. Yet, the bright lines the Court draws between federal and state authority and the concept of sovereignty it employs is overly simplistic and rigid when it comes to the fluidity of the global economy and the flexibility required of local, state, federal and international policymakers today. Similarly, the approach the Court takes to federalism issues is steeped in a history that views the sovereignty of states as if all of the fifty states were separate, fully contained entities, similar to a conception of individualism that emphasizes liberty and independence, at the expense of community. The separate, distinctive character of states that the Supreme Court majority assumes in its analysis of federalism issues is reminiscent of treating states as if they were billiard balls rather than interconnected entities in a global web of economic and political activity. The present reality involves issues and problems that are not at all centered in any one nation-state, much less a sub-unit of that state. Sovereignty The Court’s self-contained, nineteenth century conception of state sovereignty is most apparent in Gregory v. Ashcroft.41 Discussing power and its allocation in the manner used by the Court has a quaint ring to it. More importantly, though, it has little to do with the way states operate today in a global economy. At issue in Ashcroft was Missouri’s mandatory retirement law for state judges. That law had been challenged as a violation of the Age Discrimination in Employment Act (ADEA) and the Equal Protection Clause of the 14th Amendment. In rejecting these arguments, Justice O’Connor, writing for the majority, found that the ADEA was not applicable to the case at bar, using a “plain statement” statutory interpretive approach to reach that result, one infused with federalistic values and constitutional assumptions. In so doing, Justice O’Connor emphasized the sovereignty of states in a fashion that suggested a zero-sum game approach to the allocation of federal and state power:42 As every schoolchild learns, our Constitution establishes a system of dual sovereignty between the States and the Federal Government. This Court has recognized this fundamental principle. In Tafflin v. Levitt…[w]e beg [a]n with the axiom that, under our federal system, the states possess sovereignty concurrent with that of the Federal Government, subject only to limitations imposed by the Supremacy Clause…. Justice O’Connor then goes on to quote from an 1869 case that describes the constitutional scheme of dual sovereigns in greater detail:43


[T]he people of each State compose a State, having its own government, and endowed with all the functions essential to separate and independent existence,’…‘[W]ithout the States in union, there could be no such political body as the United States.’ Not only, therefore, can there be no loss of separate and independent autonomy to the States, through their union under the Constitution, but it may be not unreasonably said that the preservation of the States, and the maintenance of their governments, are as much within the design and care of the Constitution as the preservation of the Union and the maintenance of the National government. The Constitution, in all its provisions, looks to an indestructible Union, composed of indestructible States. Texas v. White, 7 Wall. 700, 725 (1869), quoting Lane County v.Oregon, 7 Wall. 71, 76 (1869). The idea of sovereignty used by Justice O’Connor thus implies a boundedness or a division between the powers of states and the national government that is easy to discern. It is strongly anchored in a sense of place and it is typical of notions of sovereignty and the state that were especially prevalent in the nineteenth century.44 Such an approach, however, minimizes the overlap that can and often should exist between the two sovereigns with a strong all-ornothing sense of sovereignty. Yet, the Court believes that sovereignty, so conceived, has important policy roles to play. Not unlike the doctrine of separation of powers that prevents the aggregation of power by any one branch of government, federalism and state sovereignty can also further freedom and more. As Justice O’Connor notes:45 This federalist structure of joint sovereigns preserves to the people numerous advantages. It assures a decentralized government that will be more sensitive to the diverse needs of a heterogenous society; it increases opportunity for citizen involvement in democratic processes; it allows for more innovation and experimentation in government; and it makes government more responsive by putting the States in competition for a mobile citizenry…. Indeed, in the majority’s view, if our constitutional scheme is to work, such clear lines demarcating the powers exercised by the states must be drawn. “Just as the separation and independence of the coordinate branches of the Federal Government serve to prevent the accumulation of excessive power in any one branch, a healthy balance of power between the States and the Federal Government will reduce the risk of tyranny and abuse from either front.”46 These policy goals—heterogeneity, democracy, innovation and a mobile citizenry—when viewed from a global context, are not necessarily the same as when viewed solely as a function of federal and state power alone. Global competition and the desire to attract and retain private foreign


investment from transnational corporations is likely to encourage more homogeneity rather than difference, as most states seek to minimize public costs so as to maximize their ability to attract private investment. Democracy may very well be furthered by keeping certain issues local, but this may be at the expense of a more national democracy, one that also allows citizens an opportunity to vote and express themselves at the national level. Indeed, the kind of segmented citizenship that the Court espouses does not accord with the complex realities and multiple citizenship identities that the global economy produces.47 More important, public innovation, too, is likely to only take the form of minimal taxes and lower regulatory costs, though this, in turn, may encourage more private experimentation. Yet, the more that activities move from the public realm to the private sector, the greater the risk that local, global currency may be coined at the expense of the weakest members of society.48 The intense competitiveness that this model encourages may, indeed, encourage more mobility among citizens in their quest to find a modicum of financial stability. More likely, though, such mobility will occur at the higher end of the income spectrum, rather than the lower.49 Freedom in the sense of making national action more difficult to achieve may be enhanced, but at the expense of developing a more cooperative model of global capitalism at the international and national levels. Greater decentralization may lead to a race to the bottom,50 but more importantly, it raises the transaction costs involved in achieving more cooperative approaches to coping with the problems of global capitalism.51 The notion of sovereignty on which the Court’s rationale is based is closely akin to a metaphor of individualism, one that sees these separate governmental entities as having life and integrity all their own. Obviously one state entity may be influenced by another and, at times, the federal power takes precedence over the states, but the idea of an integral body resisting certain fundamental changes from without, especially at the state level, comes through very strongly. Just as good fences make good neighbors, bright lines between federal and state power prevent tyranny. Such an approach fails to consider that many of the private actors within states have power on the level of states themselves. The idea of a state’s integrity is at the basis of the majority’s opinion in New York v. United States.52 Once again, the Court is more concerned with the forms of power, rather than with structures that make it easy to exercise power in a flexible way. In this case, the Court dealt with the constitutionality of the Low-Level Radioactive Waste Policy Amendments Act of 1985. The Act in question was the result of various state efforts to devise a federal structure for the regulation of low-level waste that avoided federal pre-emption and retained a role for states to play. In many ways, the legislative process was akin to the negotiation and the enactment of a treaty, whereby the individual states involved retained considerable flexi bility when it came to meeting their


regulatory obligations. The Act was the result of a cooperative approach to federalism, one that allows states to maintain flexibility and the primary regulatory role in their traditional realm of protecting the public’s health and safety.53 The federal government set the basic standards which must be met, but rather than preempting state law, states chose the policies they believed best achieved these standards.54 As one commentator has noted, “in theory, the system allows states to experiment and innovate, but not to sacrifice public health and welfare in a bidding war to attract industry.”55 Specifically, Congress sought to achieve its federal goals by providing certain incentives to ensure that states provide for the disposal of radioactive waste generated within their borders. States were authorized to impose a surcharge on radioactive waste received from other states, a portion of which would be collected by the Secretary of Energy and placed in a trust account for those states who achieve a series of milestones in developing waste disposal sites.56 States were also authorized to increase the costs of access to sites to those states that did not meet federal guidelines, eventually denying them access altogether. None of these “incentives” violated the Court’s sense of state sovereignty. A third incentive, however, provided that “a state that fails to provide for the disposal of all internally generated waste by a particular date must in most cases take title to and possession of the waste and become liable for all damages suffered by the waste’s generator or owner as a result of the state’s failure to promptly take possession.”57 For the Court, this provision created constitutional problems.58 In rejecting Congress’ attempt to force certain states to take title to and possession of low-level waste, the Court emphasized that Congress could not force the states to regulate in certain ways or in effect to become agents of the federal government. Congress could regulate individuals, but not states, because states were sovereign:59 In providing for a stronger central government, therefore, the Framers explicitly chose a Constitution that confers upon Congress the power to regulate individuals, not States. As we have seen, the Court has consistently respected this choice. We have always understood that even where Congress has the authority under the Constitution to pass laws requiring or prohibiting certain acts, it lacks the power directly to compel the States to require or prohibit those acts. The allocation of power contained in the Commerce Clause, for example, authorizes Congress to regulate interstate commerce directly; it does not authorize Congress to regulate state governments’ regulation of interstate commerce. In the majority’s view:60 [The] take title provision offers state governments a “choice” of either accepting ownership of waste or regulating according to the


instructions of Congress…. Either type of federal action would “commandeer” state governments into the services of federal regulatory purposes, and would for this reason be inconsistent with the Constitution’s division of authority between federal and state governments. In short, unlike states that enter into a treaty and agree to enact certain enabling legislation to realize its goals, the Court’s concept of state sovereignty makes it impossible for the states to agree, in the federal legislative process, to take certain kinds of actions to carry out their promises. Once again, this concept of sovereignty is not an end in itself, but a way of securing ‘“the citizens the liberties that derive from the diffusion of sovereign power.”’61 Indeed, it is like the doctrine of separation of powers: “The Constitutional authority of Congress cannot be expanded by the “consent” of the government unit whose domain is thereby narrowed, whether that unit is the Executive Branch or the States.”62 Another recent federalism decision takes the principles of democracy, accountability and cost a step further. In Printz v. United States,63 the Court struck down the Brady Handgun Violence Prevention Act on grounds that the federal government was, in effect, commandeering the state’s enforcement apparatus to carry out a federal policy. There was little doubt that Congress had the power to regulate in this area, but it could not force states to carry out its mandates. Writing for the majority, Justice Scalia emphasized the structural rather than the textual nature of this decision.64 He also emphasized democracy and accountability:65 [We] held in New York that Congress cannot compel the States to enact or enforce a federal regulatory program. Today we hold that Congress cannot circumvent that prohibition by conscripting the State’s officers directly. The Federal Government may neither issue directives requiring the States to address particular problems, nor command the States’ officers, or those of their political subdivisions, to administer or enforce a federal regulatory program. It matters not whether policymaking is involved, and no case-by-case weighing of the burdens or benefits is necessary; such commands are fundamentally incompatible with our constitutional system of dual sovereignty. This case has no textual basis in the Constitution for its result, as Justice Stevens emphasized in dissent.66 More important, it relied, once again, on a concept of sovereignty that has little to do with global realities. Only Justice Breyer chose to see this case in comparative, if not global terms, noting that no other federal system in the world today would prevent the use of state enforcement powers in this way.67 The all or nothing quality of this approach, however, both overstates and understates what is at stake, when viewed from a global perspective. It


overstates what is at stake to the extent that it may seem that power is flowing permanently from one body to another, as power has flowed from the states to the federal level for over two hundred years. Yet, in a global economy, power arrangements should be more fluid and multi-governmental approaches often may be necessary in which the degrees of state, federal and international power may change over time. Constitutionalizing these decisions removes a good deal of this political flexibility. The debate over power levels can also understate what is at stake to the extent that it assumes there is any one clear, final answer which, once given, allows us to “get on with it.” A decision that concludes that it is either a federal one or a state issue overlooks entirely the fact that non-state actors, especially transnational corporations, are now major power centers, in many ways comparable to states. Thus, a concept of federalism that does not include a sense of how global power is allocated today runs the serious risk of undermining the very goals it seeks to further— democracy and liberty. It may be that moving some decisions to the national level can more easily neutralize inappropriate uses of private power. This may not always be the case, but constitutionalizing certain results can remove an important political option. The commerce power The ability of Congress to regulate at the national level, quite apart from issues involving the use of a state’s own enforcement apparatus, has also been limited by the Court’s view of the commerce power. In U.S. v. Lopez,68 the constitutionality of the Gun-Free School Zone Act of 1990 was at issue. This Act made it a federal offense “for any individual knowingly to possess a firearm at a place that the individual knows, or has reasonable cause to believe, is a school zone.”69 For the majority, this was “a criminal statute that by its terms has nothing to do with ‘commerce’ or any sort of economic enterprise, however broadly one might define those terms.”70 Moreover, for the majority, the argument that guns in a school zone may result in violent crime which substantially affects interstate commerce proves too much. “Thus, if we were to accept the Government’s arguments, we are hard-pressed to posit any activity by an individual that Congress is without power to regulate.”71 Indeed, the majority feared that a decision holding this Act to be within Congress’ Commerce Clause power would convert Congressional authority under that clause to a general police power of the sort retained by states. The Court thus concluded that the commerce power was not infinitely expandable, and that there are limitations “inherent in the very language of the Commerce Clause.”72 Justices Kennedy and O’Connor concurred, emphasizing the policy benefits of a governmental structure that divides power between federal and state authorities:73


The theory that two governments accord more liberty than one requires for its realization two distinct and discernable lines of political accountability: one between the citizens and the Federal Government; the second between the citizens and the States. This kind of separation was crucial for true accountability to occur: If, as Madison expected, the federal and state governments are [to] hold each other in check by competing for the affections of the people, those citizens must have some means of knowing which of the two governments to hold accountable for failure to perform a given function. Were the Federal Government to take over the regulation of entire areas of traditional state concern, areas having nothing to do with the regulation of commercial activities, the boundaries between the spheres of federal and state authority would blur and political responsibility would become illusory. These policy justifications for the textual interpretation given by the majority are very much based on a conception of the state as a unitary entity, where citizens clearly differentiate among those who exercise power. Of course, citizens of the states also have a vote at the federal level and the idea that they are easily fooled by the federal level of government at the expense of the states may not give sufficient credit to the discerning nature of the voters involved. But quite apart from the policy arguments, there is the broader claim that guns, violence and the global economy are all interrelated, especially when education is involved. In his dissenting opinion in U.S. v. Lopez,74 Justice Breyer takes a very different perspective on this case, focusing more on the school children involved in this case and on the interrelationships of education and the national economy and beyond. Indeed, he emphasized that education and business are directly related: “technological changes and innovations in management techniques have altered the nature of the workplace so that more jobs now demand greater educational skills.”75 Moreover, Justice Breyer was the only Justice to make the link between the national economy and global competition: “global competition also has made primary and secondary education economically more important. The portion of the American economy attributable to international trade nearly tripled between 1950 and 1980, and more than 70 percent of American-made goods now compete with imports…. At least some significant part of this serious productivity problem is attributable to students who emerge from classrooms without the reading or mathematical skills necessary to compete with their European or Asian counterparts.”76 Indeed, Justice Breyer has a global conception of competition. Every school child competes for jobs with other school children around the globe and local


jobs and prosperity turn on this competition. He notes “there is evidence that, today more than ever, many firms base their location decisions upon the presence, or absence, of a work force with a basic education.”77 For Justice Breyer, guns, education and business are interrelated: “the economic links I have just sketched seem fairly obvious.”78 He then questions “why then is it not equally obvious, in light of those links, that a widespread, serious and substantial physical threat to teaching and learning also substantially threatens the commerce to which that teaching and learning is inextricably tied?”79 For Justice Breyer, the links between local violence, education and success in the global economy are sufficiently direct to justify federal involvement. Though he takes a global perspective on the issues before him, his judicial approach to the commerce clause is reminiscent of Wickard v. Filburn.80 Though Justice Breyer is quick to add that his approach did not “obliterate the distinction of what is national and what is local,”81 his willingness to define the national interest by looking beyond national borders to an interdependent global economy, represents an approach that ultimately would vest most regulatory decisions at the federal level, should the national government decide to act.82 In short, globalization does not necessarily render concepts of state sovereignty based on place irrelevant, but when compared to the interests of a national government intent on being maximally competitive in a global economy, it is not wise to constitutionalize such political decisions when a national response is politically appropriate. Given the political nature of the decisions involved in passing an act of Congress, a flexible judicial response is required. Conclusion Perhaps the Court should not be faulted for analyzing federalism issues in a framework that is dominated by nineteenth-century concepts of federalism, embodied in nineteenth-century precedents. Yet, in the Court’s effort to reestablish what often appears to be a pre-New Deal position vis-à-vis national power, it is overlooking an aspect of New Deal judicial processes that remains highly relevant for the global state. Courts should avoid constitutionalizing issues when it is not necessary to do so. Indeed, though the Court may have been concerned with costs being imposed on states unnecessarily, such matters are best dealt with legislatively. Fragmentation need not be the most likely outcome of the global state and courts need not take the lead in sculpting the state of the future. They must, however, be sensitive to the need for the constitutional space to create and re-create the state in ways that further our evolving global consciousness. It is ironic that at the edge of the twenty-first century, the Court would opt for constitutional approaches that unduly limit legislative flexibility.83


Notes 1 For an extensive analysis of the public/private distinction in a global context, see Alfred Aman, The Globalizing State: A Future-Oriented Perspective on the Public/ Private Distinction, Federalism and Democracy, 31 Vanderbilt J. of Transnational Law 769, 816–19 (1998). 2 See generally, Phillip Kurlan ‘The role of the Supreme Court in American history: a lawyer’s interpretation,’ 14 Bucknell Rev., no. 3, 16–26 (1966). 3 See West Coast Hotel Co. v. Parrish, 300 U.S. 379 (1957) (the so-called switch-intime that saved nine case); see Frankfurter, Mr Justice Roberts, 104 U. Pa. L. Rev. 311, 314–15 (1955) (showing vote in West Coast Hotel was taken before legislation to expand court was proposed). 4 452 U.S. 264 (1981). 5 452 U.S. at 307. 6 Ibid. 7 See, e.g., Gregory v. Ashcroft; 501 U.S. 452 (1991); New York v. U.S., 505 U.S. 144 (1992). 8 U.S. v. Lopez, 115 S. Ct. 1624 (1995). 9 See Barry Friedman, Federalism’s Future in the Global Village, 47 Vand. L. Rev. 1441 (1994). 10 For a discussion of federalism advocating an alternate view, i.e. that federalism is an empowerment of the national government, see Erwin Chemerinsky, The Value of Federalism, 47 Fla. L. Rev. 499, 504 (1995) (“it is desirable to have multiple levels of government all with the capability of dealing with the countless social problems that face the United States as it enters the 21st century"). 11 See, e.g., Richard Revesz, Rehabilitating Interstate Competition: Rethinking the “Race to the Bottom” Rationale for Federal Environmental Regulation, 67 NYU L. Rev. 1210 (1992); but see, Daniel C. Esty, Revitalizing Environmental Federalism, 95 Mich. L. Rev. 570, 627–35 (1996). 12 See, e.g., Martha C.Nussbaum, Patriotism and Cosmopolitanism, in Joshua Cohen, ed., For Love of Country: Debating the Limits of Patriotism (Beacon Press, 1996) 2–20; see also, Kwame Anthony Appiah, Cosmopolitan Patriots, ibid., pp. 21–9. 13 See Alfred C.Aman, Jr., A Global Perspective on Regulatory Reform, 2 Ind. J. of Global Legal Stud. (1995), pp. 435–7. For an argument that much of what courts claim are rationales for federalism are, in reality, an argument for decentralized management instead, see Edward L.Rubin and Malcolm Feeley, Federalism: Some Notes on a National Neurosis, 41 UCLA L. Rev. 903, 914 (1994). 14 See Richard Benedick, Ozone Diplomacy—New Directions in Safeguarding the Planet (Cambridge, Mass.: Harvard University Press, 1991). 15 See R.Perrucci, Japanese Auto Transplants In The Heartland (New York: Aldine De Gruyter, 1994), pp. 41–76. 16 Ibid., pp. 125–45. 17 Ibid., p. 17. 18 Ibid., pp. 131–4. 19 See, Alfred C.Aman, Jr., Administrative Law For A New Century, in Michael Taggart, ed., The Province of Administrative Law (Oxford: Hart Pub. Co., 1997) p. 101.


20 For example, private prisons’ costs should not be lower because there are fewer constitutional protections available to prisoners. See, e.g., Fox Butterfield, Profits at Juvenile Prisons Earned at a Chilling Cost, NY Times, p. 1, July 15, 1998. 21 Ibid. See also, Daniel C.Esty, above, note 12; Diane P.Wood, United States Antitrust Law in the Global Market, 1 Ind. J.Global Legal Stud. 409 (1994). 22 See Daniel C.Esty, Greening the GATT (Inst. For International Economics, 1994) pp. 108–11; see also, J.William Hicks, Protection of Individual Investors Under U.S. Securities Laws: The Impact of International Regulatory Competition, 1 Ind. J. Global Legal Stud. 431 (1994). 23 For example, according to the Multilaterals Project at Tufts University, at least thirty-six major multilateral environmental treaties have opened for signature since 1972. . 24 Ibid. See also, Our Common Future. 25 See, e.g., the debate over sovereignty that occurred when the World Trade Organization was established; see also, Senate Committee on Commerce, Science and Transportation hearing on Fast Track legislation, 1997 WL 605646 (F.D.C.H.) (Sept. 30, 1997) (comments by Senator Ernest F.Hollings, D-SC). 26 For a public choice perspective on this overall increase in international agreements, see Enrico Columbatto and Jonathan Macey, A Public Choice Model of International Economic Cooperation and the Decline of the Nation State, 18 Cardozo L. Rev. 925 (1997). 27 See, e.g.; recent Congressional debate on the renewal of fast track authority, above, note 26. 28 Of course, it can be horizontal as well when, for example, states try to take advantage of other states. See, e.g., dominant commerce clause cases such as Kassel v. Consolidated Freightways Corp. 450 U.S. 662 (1981). These issues, however, involve only states and are controlled by the relationship of the state law to the Commerce Clause. 29 For a discussion of the power of transnational corporations and their impact on politics, see Susan Strange, The Retreat of the State—The Diffusion of Power in the World Economy (Cambridge Univ. Press, 1996), pp. 44–54 (“the progressive integration of the world economy…has shifted the balance of power away from states toward world markets. That shift has led to the transfer of some powers in relation to civil society from territorial states to TNC’s.” Ibid., p. 46). 30 Susan Strange, Casino Capitalism (Basil Blackwell, 1986). 31 See Group of Lisbon Report, Limits to Competition (MIT Press, 1995), pp. xi–xii. 32 See Susan Strange, above, note 31, p. 54, arguing that if one excludes war and peace, and focuses more broadly on day-to-day economic issues, TNCs have come to play a significant role in determining who-gets-what in the world system. 33 See generally, Allyn L.Taylor, An International Regulatory Strategy for Global Tobacco Control, 21 Yale J. Int’l L. 257 (1996). 34 See generally, Alfred C.Aman, The Earth As Eggshell Victim: A Global Perspective on Domestic Regulation 102 Yale LJ 2107 (1993). 35 See generally, Ellis Hawley, The New Deal and the Problem of Monopoly (Princeton University Press, 1969). See also, Archibald Cox, The Court and the Constitution (Houghton Mifflin, 1987), pp. 117–38.


36 See, e.g., New York v. U.S., 505 U.S. 144 (1992); Gregory v. Ashcroft, 501 U.S. 452 (1991); U.S. v. Lopez, 115 S.Ct. 1624 (1995); and Printz v. U.S., 117 S.Ct. 2365 (1997). 37 See realist international relations theory. 38 See generally, J.A.Camilleri and J.Falk, The End of Sovereignty (Aldershot: Edward Elgar). 39 See, e.g., U.S. v. Lopez, 514 U.S. 549, 577 (1995) (“Were the Federal Government to take over the regulation of entire areas of traditional state concern, areas having nothing to do with the regulation of commercial activities, the boundaries between the spheres of federal and state authority would blur and political responsibility would become illusory.”) See also, Printz v. U.S., 117 S.Ct. 2365, 2377 (1997) (“The Framers’ experience under the Article of Confederation had persuaded them that using the States as the instruments of federal governance was both ineffectual and provocative of federal-state conflict… [t]he Constitution thus contemplates that a State’s government will represent and remain accountable to its own citizens”). 40 Ibid. 41 501 U.S. 452 (1991). 42 501 U.S. at 456. 43 See, e.g., J.A.Camilleri and J.Falk, above, note 39. 44 See, e.g., Alexander B.Murphy, ‘The sovereign state system as a politicalterritorial idea: historical and contemporary considerations,’ in Thomas J. Bierster and Cynthia Weber, eds, State Sovereignty As Social Constructs, 1996, 81, pp. 100– 2. 45 501 U.S. at 458. 46 Ibid. 47 See, e.g., Dennis Conway, Are There New Complexities in Global Migration Systems of Consequence for the United States’ “Nation-State?”, 2 Ind. J.Global Legal Stud., 31, 35–43 (1994) (discussing international mobility, the world as an interconnected community and how individuals relate to and identify with more than one country at a time). 48 See generally, Gary Teeple, Globalization and the Decline of Social Reform (Toronto: Garamond Press, 1995), pp. 69–74; see also, William Greider, One World, Ready or Not (Simon & Schuster, 1997), pp. 360–87. 49 See generally, Saskia Sassen, The Mobility of Labor and Capital (Cambridge University Press, Cambridge, 1988). 50 See Daniel C.Esty, above, note 12, pp. 627–38. 51 See Edward Rubin and Malcolm Feeley, above, note 14. 52 505 U.S. 144 (1992). 53 As Justice White described it, in dissent: [The Act] resulted from the efforts of state leaders to achieve a state-based set of remedies to the waste problem. They sought not federal pre-emption or intervention, but rather congressional sanction of interstate compromises they had reached. [The] 1985 Act was very much the product of cooperative federalism, in which the States bargained among themselves to achieve compromises for Congress to sanction. [Unlike] legislation that directs


action from the Federal Government to the States, the [Congressional action] reflected hard-fought agreements among States as refereed by Congress. Ibid., p. 194. 54 Adam Babich, Our Federalism, Our Hazardous Waste, and Our Good Fortune, 54 Maryland L.R. 1516 (1995). 55 Ibid., p. 1533. 56 505 U.S. at 152. 57 Ibid., p. 153. 58 Writing for the majority, Justice O’Connor noted: “The actual scope of the Federal Government’s authority with respect to the states has changed over the years, therefore, but the constitutional structure underlying and limiting that authority has not. In the end, just as a cup may be half empty or half full, it makes no difference whether one views the question at issue in this case as one of ascertaining the limits of the power delegated to the Federal Government under the affirmative provisions of the Constitution or one of discerning the core of sovereignty retained by the States under the Tenth Amendment. Either way, we must determine whether any of the three challenged provisions of the Low-Level Radioactive Waste Policy Amendments Act of 1985 oversteps the boundary between federal and state authority…” 59 Ibid., p. 166. 60 Ibid., p. 175. It is interesting to note that New York was, of course, involved in the political process that produced this result. The Supreme Court, however, rejected arguments to the effect that New York had, in effect, consented to these federal regulations. (“Where Congress exceeds its authority relative to the States …the departure cannot be ratified by the “consent” of state officials.) Cf. dissent by White. 61 Ibid., p. 181. 62 Ibid., p. 182. 63 117 S.Ct. 2365 (1997). 64 Ibid., p. 2383. 65 Ibid., p. 2384. 66 Ibid., p. 2386. 67 Ibid., p. 2403 (“at least some other countries, facing the same basic problem, have found that local control is better maintained through application of a principle that is the direct opposite of the principle the majority derives from the silence of our Constitution. The federal systems of Switzerland, Germany and the European Union, for example, all provide that constituent states, not federal bureaucracies, will themselves implement many of the laws, rules, regulations, or decrees enacted by the central ‘federal’ body.”). 68 115 S.Ct. 1624 (1995). 69 Ibid., p. 1626. 70 Ibid., p. 1630. 71 Ibid., p. 1632.


72 73 74 75 76 77 78 79 80 81 82

Ibid., p. 1627. Ibid., p. 1638. Ibid., p. 1657. Ibid., p. 1660. Ibid. Ibid. Ibid. Ibid. 317 U.S. 111 (1942). 115 S.Ct. 1624 (1995) at 1660. One could argue that Justice Breyer’s approach proves too much, i.e. the links between global and domestic economies are so apparent as to assure a federal result. As this chapter has argued, the distinction between the global and various forms of the local has collapsed; this does not mean Congress must automatically act. It is not compelled to act. Rather, the issues are now political issues to be acted on in the political process, without such judicial intervention, as contemplated in Lopez. 83 Since this essay went to press, The US Supreme Court decided three cases in the 1998–99 term that substantially furthered the conception of sovereignty used in the federalism cases discussed above and continued the trend of increasing the power of individual states over the federal government in various contexts. In all cases, the Court invoked the principle of sovereign immunity to protect states from lawsuits based on violation of federal law.

Part II

Globalization processes are marked by the increasing salience of hightechnology industries in international economic activity. This part focuses on coping strategies of firms and governments with respect to the hightechnology sector. Jeffrey Hart, Stefanie Lenway and Thomas Murtha examine the efficacy of “technonationalism” as a coping strategy in the flat-panel display (FPD) industry. Peter Cowhey and John Richards discuss the political economy of telecom, in particular the role of the Federal Communications Commission (FCC) in promoting an international telecommunications regime that creates a level playing field for American companies The FPD industry is witnessing a struggle among firms based in different countries. Japan leads the world in both product and process technology in this industry. The South Korean industry, a latecomer, started by adopting Japanese production methods. US-based firms were also late-starters in this industry. Given the importance of this industry for national security, the United States Department of Defense (DOD) became involved in promoting it and lessening dependence on outside suppliers. However, as the Hart-LenwayMurtha chapter illustrates, there are policy challenges stemming from difficulties in harmonizing national security needs with business imperatives. Technonationalism—a policy to replicate critical parts of the technology commercialization processes using domestic capabilities—may serve national security objectives, but does not help domestic firms to compete in highly globalized industries. They argue that since technology development systems have become global, they require firms to co-develop products with appropriate business partners, irrespective of their country or origin. Instead of a technonationalist route to cope with the globalized nature of the FPD industry, the authors’ preferred strategies are: (1) “Wintelism”: domestic firms owning industry standards but sharing them with cross-national production networks; and (2) developing abilities to tap into competencies dispersed around the globe. The two strategies overlap; however, the latter does not require that domestic firms define industry standards. Cowhey and Richards examine how governments could address incomplete globalization of telecom markets. They view markets as fully globalized if they allow new entrants and provide a level playing field for all players.


Needless to say, there is a wide divergence in the preferences of states on the desirability of complete globalization. Some states, acting as safeguarders of (inefficient) national monopolies, are resisting new rules. National monopolies can reap high rents by levying exorbitant charges for terminating incoming calls from other countries. These inflated rates are a hidden tax on international commerce, perhaps of the order of 400–800 percent, and the FCC is focusing on reducing these rents. The authors describe how the dominant powers (the US and the EU) are working towards increasing levels of globalization of telecom markets. They analyze three types of strategies adopted by the FCC and the EU to achieve this objective: establishing multilateral regimes, taking unilateral initiatives, and a mix of both. They argue that the different preferences of the FCC and the EU for the three routes can be attributed to their domestic political economies.

5 Technonationalism and cooperation in a globalizing industry The case of flat-panel displays1 Jeffrey A.Hart, Stefanie A.Lenway and Thomas P.Murtha

Introduction Can government technology programs promote the successful commercialization of innovations without leveraging experience and learning accessible only outside the United States? We investigate this question in the context of US government efforts to jump-start a domestic flat-panel display industry from 1988 to 1998. Flat-panel displays (FPDs) are thin screens used predominantly in laptop and notebook computers. As FPD prices decline, they have migrated to the desktop and begun to replace CRTs as monitors for computers. FPDs are produced predominantly in Asia with current production divided between Japan (about 80 percent of displays used in notebook computers) and Korea, which has the remaining 20 percent of the market. While the annual value of production of all types of FPDs was about $14 billion in 1998 (Stanford Resources, 1998), by 2002 analysts expect that the FPD market will exceed $30 billion. A significant proportion of the increase in production capacity to meet the new demand may come from Taiwanese firms, which are planning to make major investments in anticipation of a shortfall in supply resulting from the Asian financial crisis. Because of the centrality of the technology to many high-tech and high-valueadded products and many kinds of electronic systems essential to military preparedness, policymakers in several countries have expressed concern about the strategic importance of the FPD industry to their national economies. The conventional view is that firms in Europe and the United States have been unable or unwilling, for the most part, to make the large and risky investments needed to compete in this particular market. Governments and firms in those two regions are concerned that they may be ceding too much technological leadership to Asia by not participating more directly in the design and manufacturing of advanced displays.2 In Korea, policymakers fear the possible economic weakness that could result from domestic firms’ dependence on Japanese manufacturing tools and materials. In Taiwan, government officials worry that laptop and notebook assemblers depend too much on Japan and


Korea for advanced displays. Although the Japanese government has not played a large role in the development of the industry, government officials express concern about industry volatility and the disruptive effects of the lack of standards and the appearance of sudden overcapacity accompanied by rapid price declines. As a result, governments, industry associations and individual firms have devised various strategies to enhance their ability to compete in global markets while reducing their perceived dependencies on other countries. In order for policymakers to garner the necessary broad-based political support, these interventions often have been motivated by what we call “technonationalism.” Technonationalism is a desire to replicate many aspects of the technology commercialization process using domestic capabilities as part of a broader strategy to keep up with the international competition in high technologies. Ironically, in a highly globalized industry in which cutting-edge understanding and experience with the technology is dispersed globally, like the one which currently characterizes flat-panel displays, technonationalism is counterproductive. While technonationalist policies constrain domestic firms to work with their domestic counterparts, the technology innovation system has become global in many industries and requires firms to co-develop products with the most capable business partners and the most demanding customers wherever they may be located in the world. Manufacturers also have to locate some piece of their value chain near a critical mass of competitors to benefit from the diffusion of tacit knowledge through professional networks of scientists and engineers. Technonationalist policies do not work in globalizing industries because politically imposed constraints prevent domestic firms from accessing knowledge embedded in management, R&D, and manufacturing located outside domestic markets. Globalization as the management of dispersed competence In this volume, globalization is defined as “a set of processes leading to the integration of economic activity in factor, intermediate and final goods and services markets across geographical boundaries, and the increased salience of cross-border value-chains in international economic flows (Prakash and Hart, 1999).” We have chosen to focus on a more restricted meaning of the term “globalization” in this chapter because the broader definition does not provide the necessary explanatory purchase. At the individual firm level, we define globalization as the need to identify, access and coordinate capabilities located in a variety of geographic locales to produce a globally competitive product. Globalization in this sense is the opposite of the idea of building a local architecture of supply. Instead of insisting that all or most of the building blocks of a particular product (or service) be available locally, the firm’s top management team leverages these capabilities wherever they exist in the


world. The needed inputs may include access to a world-class manufacturing facility to learn the demands that automation places on specific production tools or they may be intangibles like production engineering and process experience. In a globalized industry the managerial challenge involves coordination of the various aspects of the commercialization process, e.g. R&D, manufacturing and marketing that takes place in various countries. Architecture of supply One strand of theoretical work on industrial policy and international competitiveness stresses the continued importance of geography and geographic distance in limiting the diffusion of new technologies. This work emphasizes the importance of governmental policies designed to create and diffuse new technologies. One substrand of this literature focuses on the “architecture of supply” (Borrus and Hart, 1994; Hart and Prakash, 1997). According to this school of thought, international competitiveness is possible only when vital inputs are available to firms in a timely manner, in adequate amounts and at fair prices. To assure access to vital inputs, firms often locate their operations close to suppliers (or vice versa). Often, a few firms that are working to commercialize the same technology locate in the same region. Their suppliers tend to locate near them so that they can all take advantage of a common supply architecture. The idea of an architecture of supply is often used to explain the tendency of internationally competitive firms to locate specific activities in geographically concentrated in identifiable regions: e.g. Silicon Valley for semiconductor firms, Manhattan for international banks and investment firms, Prato, Italy, for high-fashion textiles and apparel firms, or Taiwan for laptop computer assembly firms. Since the supply architecture is built up around an innovating firm or group of firms, then these early entrants into the market may have an advantage associated with the difficulty of reproducing that architecture elsewhere. The dynamics of supply architectures in globalizing markets This notion of supply architecture, however, cannot incorporate an historically accurate picture of how firms compete in globally competitive industries. The domestic architecture of supply as described may be appropriate for the early stages of any new industry, especially high-technology industries. The rapid pace of change in the early stages of technology commercialization typically leads firms to cluster so that their managers and engineers can access networks though which tacit knowledge about product and process innovation flows. Historically, multinational corporations granted considerable autonomy to their foreign affiliates and allowed them to establish their own local supplier and customer relationships without interference from head-quarters. This


strategy involved replicating domestic architectures of supply on a country-bycountry basis. This method worked as long as industries were multi-domestic and competitors adopted a similar country-specific production and marketing strategy. However, with the increasing globalization of markets, managers discredited this strategy because it prevented firms from achieving economies of scale or scope (Kobrin, 1997). Now the managerial challenge for firms operating in global markets involves finding ways of maintaining close communication channels and coordinating their activities with both suppliers and customers as they become increasingly geographically dispersed. This need to coordinate dispersed activities has given rise to what Borrus and Zysman (1997) call the “Wintelist” strategy of forming “cross-national production networks.” Wintelism focuses on control over key technological standards rather than over production per se. A Wintelist firm will try to dominate its part of the market by pursuing a strategy to establish its product as the industry standard. It will then make information about technical standards available to firms that wish to develop complementary products, but it tries to maintain strict control and ownership over core technologies. A good example of this would be the way in which Microsoft attempts to dominate the market for both computer operating systems and application software by controlling the graphical user interface via its Windows family of operating systems, while sharing information with smaller firms about how to write software that works well with the Windows operating system. Another example is the way in which Intel Corporation has dominated the market for microprocessors by quickly replacing one generation of microprocessor with the next, while also making available to both hardware and software firms information about how to make useful add-on products for computers incorporating their microprocessors. Borrus and Zysman (1997) call this a strategy of “open but owned” standards. Wintelism has been internationalized as a result of the rise of cross-national production networks that US electronics firms adopted in response to competition from Japan. In cross-national production networks (CPNs), materials and components may be produced in one part of the globe and assembled in another. Sales and distribution of the goods may be in yet a third location. R&D and other related activities may be located in other countries. These activities can either be coordinated within a multinational corporation or through market transactions among providers of different parts of the valuechain. Wintelist strategies lead firms to create networked organizations able to leverage globally dispersed competencies without losing the flexibility to reconfigure their networks in response to new product generations or the introduction of product substitutes. The success of these strategies may require the firm to adopt the following tactics (among others):


1 Building telecommunications networks or infranets to assure the timely exchange of detailed business and technical information among the cooperating entities. 2 Locating warehouses and service bureaus of supplier firms near where they are assembled into finished products so that the location where a particular tool or component is built becomes not important. 3 Providing timely feedback from assemblers to component manufacturers about problems of delivery or component quality and from component manufacturers to tool manufacturers about productivity problems with a particular tool. 4 Exchanging the best available market forecasts about shifting customer demand between component supplier and assembler entities. We have discovered in the process of conducting field research on the global flat-panel display industry that precisely these practices have become commonplace in recent years. What we would like to do in the remainder of this paper is to show how this pattern of globalization changes the way national governments must think about their efforts to promote high-technology industries if they are to be effective in those efforts. We will illustrate this argument by looking at attempts by the US government to increase the participation of US firms at three points in the value-chains for flat-panel displays: 1 the development and commercialization of new tools; 2 high-volume manufacturing of displays; and 3 high-volume assembly of final products (in this case, laptop and notebook computers). The global flat-panel display market Although the primary application that drove the commercialization of FPDs has been laptop computers, other applications have proliferated over time. FPDs are used in personal digital assistants, digital cameras, rear projection TVs, Pachinko machines, small TVs, video cameras, car navigation systems, instrumentation and avionics systems. These applications include all sorts of flat panels, including super-twist-nematic liquid crystal displays (STN LCDs), thin-film-transistor (TFT) LCDs, electroluminescent (EL) displays, field emission displays (FEDs) and plasma display panels (PDPs). Table 5.1 shows breakdowns of demand for flat panels by type of end-use in 1997. The computer industry accounted for most of the demand for flat-panel displays, and primarily for use in laptop and notebook computers. After 1997, analysts project that flat-panel displays will be used increasingly as substitutes for CRT monitors for desktop computers (a much larger if slower growing market).


Table 5.1. Market shares of flat-panel displays by major application, 1997 (in percentages)

The bulk of flat-panel displays sold from the 1980s to the present were LCDs. There has been a pronounced shift in demand away from the less expensive STN LCDs toward the higher performance TFT LCDs (Castellano, 1998; Young, 1998). One important factor in this shift is the reduction in prices of TFT LCDs as firms realize dynamic economies of scale, new manufacturers enter the market and new tools reduce the number of processing steps. The Japanese flat-panel display industry The main Japanese manufacturers of flat-panel displays are Sharp, Display Technologies Incorporated (DTI) (an IBM-Toshiba joint venture), NEC, Hitachi, Matsushita, Seiko-Epson, Optrex (a joint venture of Mitsubishi and Asahi Glass), Mitsubishi, Sanyo, Casio, Hosiden, and Fujitsu (see Table 5.2). Sharp has been the leader of this group since the beginning of LCD manufacturing in Japan. DTI is Sharp’s main competitor and has surpassed Sharp in the production of large TFT-LCD panels for laptop computers. Sharp sells a wide variety of display sizes based on a range of liquid crystal display technologies so that its revenues from all LCDs exceed those of DTI ($2.291 billion v. $1.125 billion). Hosiden has been the smallest, and possibly the weakest Japanese firm. Hosiden was an early innovator in TFT technology but had difficulty in making the transition to larger display sizes due to financial constraints. Hosiden lost its initial technical advantages to larger firms like Sharp and DTI. Philips of the Netherlands recently partnered with Hosiden to form a joint venture called Hosiden and Philips Display (HAPD) in order to satisfy Hosiden’s urgent need for an injection of additional capital and Philip’s desire to switch quickly from a double diode to a thin film transistor manufacturing process. The supply architecture for flat-panel manufacturing is stronger in Japan than in any other country. All the necessary tooling and materials activities are located in Japan and at least one Japanese firm is in each activity. For example, (1) Asahi and Nippon Sheet Glass make glass substrates for flat panels; (2) Nikon and Canon make large-area scanners and steppers for lithography; (3) NEC Anelva makes dry etching equipment; (4) Nitto Denko makes color filters and polarizers; (5) Dainippon Printing and Toppan Printing make advanced printing equipment for large-area flat panels; (6) Japan Vacuum


Table 5.2. Revenues of top LCD producers worldwide in 1997 (in millions of dollars)

Technology makes Indium Tin Oxide (ITO) films for transparent conductors; (7) Canon makes mirror projection systems; and (8) a variety of firms make fluorescent backlights. Even where Japanese firms are not strong, as in the manufacturing of liquid crystal chemicals, chemical vapor deposition (CVD) equipment, LCD driver chips, and high-performance glass, foreign firms headquartered their FPD businesses in Japan or entered into strategic alliances with Japanese firms to manage their global FPD business. Examples of this phenomenon include Merck Japan, Applied Komatsu Technology (AKT), Texas Instruments Japan, and Corning K.K. The rapid growth of the Japanese flat-panel display industry was propelled by private firm investment, especially by Sharp. Sharp outsourced cathode ray tubes for its television sets and was determined to make its next-generation displays in-house.3 In general, Japanese firms’ decisions to invest in FPD manufacturing facilities stemmed primarily from the importance of displays to their consumer electronics businesses. Managers in most Japanese FPD firms believed that display manufacturing capabilities were critical to their product differentiation strategies and that synergies existed between manufacturing displays and incorporating displays into final products such as notebook computers.4 Japanese government officials were, however, concerned that industry volatility would create economic instability and wanted companies to coordinate their investment plans to avoid massive surplus capacity accompanied by steep price reductions. Government officials were also concerned with the inability of firms to agree on standard substrate sizes. This lack of standards resulted in high tool costs because tool developers had to develop entirely new products for each substrate size and could not sell enough of one sized tool to benefit from economies of scale.


The Korean display industry The main firms in the Korean display industry are the big-three chaebol electronics firms—Samsung, Hyundai and LG (formerly called Lucky Goldstar).5 The chaebols are large, diversified industrial conglomerates that grew to their current size in Korea’s heavy industrial expansion period. After building their own STN LCD production facilities, Samsung, LG and Hyundai decided in the mid-1990s to invest in TFT-LCD production facilities. Since they were late entrants into the TFT business, they invested first in secondgeneration manufacturing plants and then quickly moved to third-generation technologies by purchasing the necessary tools and engineering advice from Japan. They made these decisions largely on their own without extensive governmental assistance, viewing it as a way of capitalizing on earlier investments in integrated circuit manufacturing and a way of diversifying out of the increasingly competitive markets for standardized memory products (DRAMs). Because of a perceived need to reduce dependence on Japanese production tools and to deal with problems of over-investment, the Korean government decided to involve itself in the organization of the industry and created a new organization called EDIRAK (the Electronic Display Industry Research Association of Korea). Through EDIRAK it could channel government research funds and build an industry consensus on future investments. The government did not have the power to impose its will on the firms, however, so despite a number of industrial promotion schemes, including funding of research and development through EDIRAK, the primary initiative for entry into the TFT-LCD markets remained with the firms themselves (Linden, Hart, Lenway and Murtha, 1998). The incipient Taiwanese display industry Because of the growing importance of the computer assembly business for Taiwan, the Taiwanese government and some of the larger firms have been considering major investments in the production of flat-panel displays for a number of years. In the Taiwanese government, the Industrial Technology Research Institute (ITRI) and ITRI’s microelectronics research laboratory, the Electronics Research and Service Organization (ERSO), assumed leadership by creating a research laboratory for flat-panel displays and by trying to establish a series of research and production consortia to encourage investment in TFT-LCD production. Prior to 1997, small Taiwanese firms like PrimeView and Unipac had built plants for producing STN displays and smaller TFT displays in relatively low volumes, and larger firms like Chunghwa Picture Tubes (a subsidiary of the Tatung Group) had invested in STN displays. These firms held back from investing in the production of larger TFT display because of difficulties they


had in forecasting market demand for different size displays while also coping with the considerable technological challenges posed by building current generation TFT plants. Taiwanese computer assemblers did not generally perceive a need for local suppliers of TFT displays, although they suffered somewhat during supply shortfalls of TFT-LCDs because display manufacturers tended to allocate scarce supplies to larger customers located in Japan and the United States (Linden, Hart, Lenway, and Murtha, 1998). Beginning in late 1997, a number of Taiwanese firms announced their intention to invest in production of larger TFT panels for laptops and notebooks. Toshiba licensed its third-generation TFT production technology to the Walsin Lihwa Group, which includes Taiwan’s third-largest integrated circuit firm, Winbond Electronics. IBM licensed its third-generation TFT technology to Acer Display Technology, the display subsidiary of Acer, Taiwan’s largest and most successful personal computer manufacturer. The biggest challenge that Taiwanese firms face now is finding the number of engineers that they need to staff the new manufacturing facilities. Each new plant is estimated to require at least 200 engineers and operators. Currently, press reports suggest that there are only about 300 TFT-LCD professionals in Taiwan (Commercial Times, Taiwan, 19 February 1998). The US display industry The main US firms that invested in manufacturing flat-panel displays as of 1997 were: IBM, Motorola, Micron, Xerox/dpiX, Planar-Systems, Inc., PlanarStandish, Candescent Technology Corporation (CTC), Optical Imaging Systems (OIS), ImageQuest, Plasmaco, FED Corporation and 3–5 Systems. Except for the first four firms listed, all of these firms were relatively small. Of the smaller firms, Planar has primarily invested in electroluminescent displays and works jointly with dpiX to package TFT-LCDs for military avionics systems. OIS manufactures displays for military customers and is trying to use up its surplus manufacturing capacity by producing sensors for the medical imaging market. OIS does not have any immediate plans to invest in high-volume production. Plasmaco became Matsushita’s plasma display panel R&D and production arm in 1996. Prior to that, the company manufactured monochrome plasma displays in small quantities. ImageQuest, a wholly owned affiliate of Hyundai, produced TFT displays for military endusers until December 1997 when Hyundai closed down the operation because of financial difficulties caused by the Asian financial crisis. 3–5 Systems specializes in smaller STN displays and will open an STN manufacturing facility in China in 1998. US firms had some important strengths in flat-panel displays. In TFT display manufacturing, IBM was clearly the strongest because of its successful joint venture with Toshiba. dpiX (a spinoff from Xerox) developed a very high-resolution display appropriate for the military, but too expensive


for most commercial applications. US companies like Applied Materials, Corning Glass, and 3M dominated their segments of the FPD tool and materials markets. With the exception of IBM and Plasmaco, managers of US FPD manufacturers believed along with US policymakers that it would be both possible and desirable for US firms to invest in commercial scale FPD manufacturing facilities in the US. Based in part on the US Defense Department’s experience in revitalizing the semiconductor industry in the late 1980s, policymakers believed that if they could help build up the US supply architecture to match the one in Japan, commercial scale production would follow. We will discuss below how this perception permeated the policy debates from 1988 to the mid-1990s, and how it crippled US government efforts to help US firms compete. The origins of US flat-panel display policy US backwardness in display manufacturing first came to be a political concern in the late 1980s when the national debate over high-definition television began. When politicians and key industrial leaders realized that Japanese firms had assumed the role of technological leadership in both HDTV and flat-panel displays, they argued that Japanese leadership might eventually threaten US leadership in advanced electronics, particularly in computers. The Bush Administration was not disposed to promote specific industries, but in this case its hand was forced by the Democrat- controlled Congress to fund research in advanced displays, largely through the High Definition Systems program of the Defense Advanced Research Projects Agency (DARPA) of the Department of Defense. From 1988 on, that program received annual allotments of around $50–60 million for this purpose (Hart, 1994). In the remainder of this paper we will discuss how US government intervention in the flat-panel display industry sprang from an inadequate understanding on the part of industry leaders, influential politicians and government officials of the requisites for building competitive enterprises in a global industry. Since many of the key technologies for LCDs were pioneered by US researchers, the inability or unwillingness of US firms to catch up with Asian firms was a cause of considerable puzzlement on the part of government officials. We will argue that this puzzlement stems from generalizing from previous successes in technology commercialization, especially in the semiconductor and computer industries when all the capabilities needed to develop a new technology were located in the US. To support our argument we will not only highlight the failures that are attributable to technonationalist excesses but also the successes that can be explained by the globalizationconforming strategies adopted by US firms that successfully entered the global FPD market. One can see this clash between technonationalist and globalist


perspectives in three main arenas: tools, display assembly and notebook assembly. The US display consortium: tools in the United States DARPA began funding research on FPDs in 1989 as part of the high-definition television program (DARPA, April 10, 1999). Officials in the Department of Defense argued that FPDs would be as integral to weapons systems as semiconductor chips and microprocessors. The most obvious applications involved replacements for the bulky and relatively short-lived cathode ray tubes (CRTs) in airplane cockpits, submarines, ships and tanks. The infantry of the future would also be equipped with head-mounted displays and wearable computers that would provide information about enemy location from a centralized information source. Soldiers would also carry rugged laptop computers into the field that would display important logistical, target and weapons status information and provide a communications link to command and control centers. Despite both this financial support and a successful antidumping petition against Japanese FPD producers, which triggered steep antidumping duties on TFT-LCDs, in the early 1990s, the US FPD industry showed no signs of keeping up with their Japanese competitors. Both DARPA and industry leaders looked to the role that Sematech played in revitalizing the US semiconductor industry, for some of the answers about what they needed to do to help US FPD manufacturers develop the capabilities to enter the highvolume segment of the FPD market. One obvious problem that the FPD industry appeared to share with semi-conductors was the need to establish and maintain a domestic supply infrastructure (Borrus and Hart, 1994). Sematech provided a model of how a public-private consortium would help to preserve an existing supply infrastructure that was having difficulty meeting the competition from Japan. It was not a very useful model, however, for demonstrating how to build an infrastructure from scratch. In December 1992, DARPA sent out a request for proposals for a publicprivate consortium that would help the US overtake Japan’s lead in FPD manufacturing. The consortium would facilitate development of the infrastructure of supply that would in turn provide the foundation for a commercially competitive US FPD manufacturing industry. Some of the consortium’s supporters expected that flat-panel displays would become the same kind of technology driver for the US electronics industry that the semiconductor industry was in the 1970s. Others were more cautious in their appraisal of the potential growth and importance of the industry, but were willing to try to get the industry going in the United States anyway, especially if that would help reduce dependence upon importing and adapting Japanese commercial FPDs for military weapons systems.


In July 1993, DARPA helped to assemble a coalition of FPD manufactures, including established companies such as Xerox, AT&T, and Texas Instruments, as well as smaller companies such as Optical Imaging Systems (OIS), Standish Industries, MagnaScreen, Photonics Imaging, Planar Systems and Plasmaco to create the US Display Consortium (Mentley, 1993). The consortium’s mission was to facilitate the creation of a domestic FPD industry by establishing a common manufacturing platform for FPD production and developing technical specifications for the next generation of FPD production equipment (USDC, May 28, 1998). FPD manufacturers, suppliers and customers would contribute to this process by participating in road-mapping, benchmarking and standard-setting activities. The USDC hoped to attract members by pooling the costs of R&D, thereby reducing the risks associated with developing new technologies. DARPA provided $20 million of the total of $24 million in R&D expenditures for USDC projects in FY 1993 by slicing $20 million off of the $100 million allocated for HDS programs. The USDC limited its membership to US-owned and controlled companies. Members had to have at least 50 percent US ownership. In order to interact directly with FPD tool and material suppliers, the USDC immediately organized this group into the SEMI-North American FPD Division. These suppliers (which also had to have at least 50 percent US ownership), could bid on USDC-sponsored development contracts. USDC rules specified that a USDC member would provide a beta site to help USDC equipment manufacturers integrate their tools into manufacturing lines. The USDC also organized other subgroups including: (1) the FPD Developers and Manufacturers (16 firms); (2) the Commercial Display Users Group (9 members); and the (3) the Military and Avionics Display Users (11 firms) (SEMI, April 9, 1997).6 Although DARPA provided $20 million to get the consortium off the ground and promised subsequent follow-up funding, DARPA would have only one seat on the consortium’s board of directors. Other board members included representatives of the staff, the display manufacturers, the display users and industry members. DARPA believed that industry leaders rather than government bureaucrats should establish priorities, set technology objectives and monitor progress. The governing board set general policies and made final decisions on the funding of projects. The technical board established research priorities, reviewed applications for funding, and made recommendations regarding which applicants should receive USDC contracts to the governing board. In addition to its governing and technical boards, the USDC had a small staff and a technical council. Peter Mills, the former Sematech chief administrator, agreed to get the USDC up and running. By March 1994 the USDC had awarded their first development contract worth $2 million to Photon Dynamics to develop a TFTLCD visual test inspection system. In June 1994, the USDC awarded Lam Research a $13.4 million contract to develop a dry etch system. The USDC


would provide about one-half the money needed to develop the tool and Xerox would help with process integration and testing the tool’s performance in pilot production. Lam’s CEO Roger Emerick promised to build a system superior to any other in the world (Electronic News, June 27, 1994). Lam had collaborated earlier with Sematech to develop the initial transformer-coupled plasma (TCP) technology for semiconductor production that, with USDC support, it would adapt for flat-panel display production. The USDC did not restrict the sales of tools developed by its contractors to USDC members. As long as members got first right of refusal, USDC contractors could sell all over the world to help ensure the financial viability of their FPD business. In addition, USDC members decided that any intellectual property developed with USDC funding would belong to the company that did the work. Peter Mills commented that, “burdening them [materials and equipment companies] with legal requirements and royalty payments was not consistent with that goal [building a robust equipment and materials industry]” (Mills, 1995). DARPA did require, however, that firms that received USDC funding for a specific tool would have to notify the USDC and DARPA if they were planning to license their technology abroad. DARPA renewed the USDC’s funding in 1995, raising it to $25 million. DARPA funding of USDC remained at the same level in FY 1996 but increased to $60 million in FY 1997 when Congress added $15 million to the $45 million requested by the Clinton administration. The federal government was scheduled to reduce its participation to 50 percent as the consortium matured (“San Jose Selected…October 8, 1993). By 1998, the USDC had given out thirty contracts for a total of about $90 million, one-half of which was funded by the development partner. Some of the initial project focus areas were: large-area chemical vapor deposition (CVD) tools, polymer coating, spacer technology, rapid thermal processing and laser annealing, automated handling of glass substrates, color filter manufacturing, and large-area lithography. The USDC charged membership fees for belonging to the consortium according to the size of the firm: $2,000 for firms with fewer than 100 employees, $5,000 for firms with 100 to 500 employees, and $10,000 for firms with more than 500 employees. Members were also expected to donate cash or equipment to offset the costs of running the consortium, and eventually to pay for 50 percent of the total costs. The matching funds came from the USDC development partners who had the responsibility for coming up with about 50 percent of the estimated cost of the tool development project. The company that provided the beta site for the tool was responsible for about 10 percent of the tool development costs, which could be deducted from its dues. This company also had the right to purchase the tool at an agreed upon “fair” market price. Discussions among the membership to determine where to place the initial priorities were difficult because of the diverging technological strategies of the


small US display manufacturers. TFT-LCD manufacturers wanted to focus on TFT-LCD technologies, plasma manufacturers on plasma, etc. Eventually, a limited consensus emerged on developing manufacturing technologies needed for a wide variety of types of displays. The USDC tried to make decisions on a consensual basis and pursued development projects that reflected the technical needs of members engaged in each of the FPD technologies. In its deliberations, the USDC board also tried to take into account the interest of companies like Motorola and Micron, which were not USDC members. While many important new technologies were developed with USDC financial support, very few of the USDC’s development partners were companies that were global competitors in the FPD materials and tool markets. A number of major US firms who were successful in penetrating these markets in Japan and Korea opted not to participate in the USDC programs: most notably Corning Glass.7 The most important US-owned firm involved in flat-panel manufacturing, IBM, was also not included in the any of the USDC’s research projects. Interestingly, IBM joined the USDC Commercial Users Group, rather than as a manufacturer. This meant that none of the participants in the USDC programs benefited from the knowledge that could be obtained by working with high-volume manufacturers. To the credit of the USDC staff, this shortcoming was recognized early on and efforts were made to correct the situation, but unfortunately those efforts were not successful. US-Korean cooperation in tools Even before the Korean firms were successful in 1995 and 1996 in seriously challenging the TFT-LCD Japanese producers, the USDC began to debate the possibility of linking up their development programs with the high-volume producers in Korea. The political basis for this cooperative effort between US and Korean research consortia was in part the result of the Korean government’s desire to reduce their companies’ dependence on Japanese tools and in part the leadership exercised by Kenneth Flamm. Flamm arranged a DoD mission to Korea in Spring of 1995 after receiving an invitation from the Korean government. DARPA staff members and other DoD staff members accompanied him on this trip. They visited all the major FPD manufacturers in Korea: Samsung, Hyundai, LG and Orion (a division of Daewoo that manufactured STN LCDs). According to Flamm, the South Koreans complained bitterly about the difficulty of purchasing color filters from Japan and paying very high prices for what they could get. They expressed concerns about getting access to other Japanese inputs in times of shortage. DoD had heard reports that MITI provided “administrative guidance” to Japanese materials and tool companies to assure that Japanese FPD manufacturers got first access to Japanese inputs.


When Flamm returned to the United States, he urged the USDC to get together with their counterparts in Korea. USDC finally agreed to pursue this in Spring 1996 after EDIRAK’s leadership approached the leaders of the USDC at a Society for Information Display convention to inquire about the possibility of sponsoring joint research projects that would bring US tool producers together with Korean FPD manufacturers. This kind of cooperative effort would provide US tool developers with the access that they needed to high-volume manufacturing lines in order to ensure that their tools work well in high-volume plants. By this time, however, Korean business representatives were not as worried about their dependence on Japanese suppliers as they were earlier. They told us that they had mostly good experiences in working with Japanese companies. Korean FPD manufacturers did not have confidence in US suppliers because very few of the latter had experience working with high-volume TFT-LCD producers and could not provide reliability guarantees. The Korean manufacturers’ preferences were driven by the need to ramp up their manufacturing lines as quickly as possible to remain competitive with Japanese firms. They believed that success required working with tools that had an established track record in high-volume production.8 Despite the skepticism of the Korean firms, EDIRAK officials pursued the idea of reducing dependency on Japanese suppliers by working cooperatively with USDC. EDIRAK/USDC joint funding of projects was one result of the memorandum of understanding between the two organizations negotiated in the first part of 1996. Twenty-three members of USDC visited Korea in October 1996 to discuss possible collaborative efforts. Proposals for the first round of projects were due in April 1997. Two projects were selected for joint funding in 1997, One went to the Accudyne Corporation to develop laser tools to cut substrates; MRS received the second grant to develop a new generation lithography tool. The failure of the lithography tool project to reach completion due to the decision taken by the MRS board to exit the FPD industry illustrates our argument about the negative impact of technonationalism on ability of the government to achieve its policy objectives. The President and CEO of MRS, Griffin Resor, had succeeded over the course of about nine years in building a company with a very distinctive and leading-edge tool for stepping and repeating flat-panel display designs over the large areas required for competitive production of FPDs. MRS had received $19.6 million from DARPA initially, and a $9.5 million contract from the USDC in 1997 to develop a fourth-generation lithography tool. MRS was responsible for raising about $5 million of the development costs of the new stepper. Under DARPA guidance, MRS used a special lens that was originally designed for military aerospace applications. The new tool was capable of stepping and repeating images of much higher resolution than those that could be obtained by using steppers designed for the production of integrated


circuits. Because of its potential for increasing both yield and throughput for large-sized TFT-LCDs, the MRS tool was of interest to some of the Korean high-volume producers, especially LG. As of mid-1997, before MRS received the USDC grant, a number of TFT-LCD manufacturers around the world had adopted the MRS stepper for use in their R&D pilot lines. By the end of 1997, the MRS stepper had been adopted in the manufacturing lines of only two lowvolume plants in the United States. As a result, MRS had no track record of working with a high-volume manufacturer. Therefore, it could not credibly answer questions from its prospective customers about such important issues as average “up time” of its machines, the mean time between failures, or the average speed with which it could process a substrate in a high-volume production line. There are a number of reasons why answers to these questions mattered to manufacturers. First, lithography accounts for a significant portion of total equipment outlays in a flat-panel display manufacturing facility. Steppers cost typically from $2– 4 million (MRS, 1997) per machine. They are used both for laying out the pattern of the pixels and thin-film transistors on the bottom plate of each TFTLCD and for fabricating the color filters for the upper plate of the display. More importantly, the productivity of the entire factory depends critically on the reliability of lithography equipment. When a stepper is down, no new displays can be started. Using redundancy to control for low reliability in lithography adds greatly to the cost of production. While this potentially negative impact on productivity is not unique to steppers, steppers are among the most expensive of the tools used to produce flat-panel displays and are therefore seen by manufacturing engineers to be particularly crucial to the productivity of any given plant. Because Korean firms were not first movers in TFT-LCD production, they were particularly eager to minimize their start-up costs. Given this, it was natural for them to opt to use tried and true Japanese tools from Canon and Nikon instead of the riskier tools available from US firms like MRS. Thus, for MRS to get a foothold in this market, it had to team up with at least one highvolume manufacturer, and, in the absence of governmental efforts to reduce risks, that manufacturer had to be willing to assume a higher risk than others in this crucial area. As this logic became apparent to USDC and EDIRAK, they worked out a plan whereby a Korean manufacturer would be subsidized during the time that it acted as a beta site for MRS steppers. This subsidy was necessary to compensate the manufacturer for taking on additional technological risks and provide some assurance that its financial exposure would be within acceptable limits. However, a number of other problems cropped up in the attempts of USDC and EDIRAK to implement this plan. First, there was the question of whether US funds could be devoted to an enterprise for which a foreign firm would act as a beta site. This did not violate DARPA guide lines but USDC officials were concerned that the DoD officials responsible for the High


Definition Systems program or the congressional committees charged with DARPA funding oversight might veto a US-Korean cooperative venture. Some DoD officials did not readily acknowledge that betasiting the tool in a small US firm would not provide MRS the necessary process and performance information that it needed to build a globally competitive tool. EDIRAK and the USDC tried to solve these problems by arranging for MRS to enter into a strategic alliance with a Korean company that would be eligible to receive EDIRAK funding Negotiations were well advanced to solve these problems when the Asia Crisis broke out and the plans had to be shelved. On March 31, 1998, the MRS board announced that the company was putting its USDC contract on hold and was redirecting its strategy towards the high-density printed circuit board interconnect market. We attribute this failure in part to the conflict between the basically nationalistic rationale for US R&D policies, especially those funded by the DoD, and the more “Wintelist” global strategies adopted by successful flat-panel suppliers and assemblers. Successful US tool suppliers In marked contrast with the USDC-EDIRAK story, US toolmakers like Applied Komatsu Technologies (AKT) and Photon Dynamics who have made it their business to service high-volume Japanese and Korean manufacturers have generally succeeded. While both companies were active in the USDC in its early days, both succeeded in their product development efforts through working directly with high-volume FPD manufactures. These firms are now solidly established in the industry. Any flat-panel display manufacturer that wants to be internationally competitive has to consider using AKT deposition tools and Photon Dynamics array testers, just as it has to consider Canon and Nikon lithography equipment. Applied Materials entered the FPD businesses in 1991, two years before the creation of the USDC. When management attention of most US FPD companies was focused on protecting the US FPD industry from Japanese competition, Applied Materials was working with Japanese FPD manufactures to figure out how to improve production yields. In 1991, when representatives from Toshiba and Sharp first approached Applied Materials about adapting some of their semiconductor tools for FPD production processes, Sharp and Toshiba had first-generation production lines that achieved about 10 percent yields. These low yields stemmed in part from the use of equipment that had been developed to manufacture solar cell batteries, which were not harmed by particle defects. In contrast, for TFT-LCDs, particle defects caused the transistors that switched individual pixels to fail. If more than five pixels out of over a million were defective, then the display would not meet quality control requirements and would be discarded.


When Applied Materials first began to look into making FPD production equipment, Applied’s engineers visited Sharp’s and Toshiba’s production facilities to learn about the manufacturing process. Based on their analysis, Applied decided to focus on chemical vapor deposition (CVD) tools because this was a key bottleneck in the production process. To develop the new CVD too, engineers from Applied Komatsu Technology (AKT) worked closely with their counterparts at Sharp and Toshiba to develop new cluster process engineering techniques that both reduced particle defects and sped up the production process. Feedback from Sharp and Toshiba about materials and equipment performance was critical to their ability to develop the new tool. In order to get the data that they needed, Applied needed to work with a FPD manufacturer that was producing seven days a week, three shifts a day. Only with this kind of usage could AKT’s engineers understand how to improve the CVD tool’s reliability. During the development process, Toshiba and Sharp also sent their engineers to work at AKT. After AKT introduced its first CVD tool in 1993, FPD yields went from about 10 percent to about 90 per cent. By 1994, AKT had the number one market share in Japan. Applied’s managers recognized that because most of their FPD customers were located in Japan, they would have to locate the headquarters of AKT there. The close proximity to their lead customers was important to ensure that AKT’s managers had the best information possible about FPD manufacturers’ strategies. Applied and Komatsu established the headquarters of AKT in Japan to get access to potential employees, but kept all of AKT’s manufacturing and assembly in Santa Clara, California, in a facility dedicated to FPD CVD tool production. Even AKT’s extremely close relationships with its customers, however, did not keep its managers from making serious misjudgments about the rate of change from one generation of equipment to the next. Applied’s managers had entered the FPD business thinking that it was like the semiconductor business and that substrate sizes like wafer sizes would remain constant over a relatively long period of time. Instead they found that in the FPD business substrate sizes grew quickly to increase display sizes and production efficiencies. Each increase in substrate size required significant engineering changes. This made it very difficult for Applied to enjoy the benefits of economies of scale and impossible to separate engineering from production. In order to anticipate future substrate size changes with more accuracy, AKT deepened its relationship with its customers, the display manufacturers and their customers, the laptop computer assemblers. Photon Dynamics was established in 1986 to make integrated-circuit test equipment for gallium arsenide chips. When this chip technology did not expand beyond a small niche market, the company shifted its strategic focus to flat-panel displays. With DARPA support, the company refocused its strategy on developing test equipment using machine vision to detect the faulty transistors that cause the pixel outages. The company received the first USDC


research grant to development its FPD inspection system. Its beta site partner for that contract was dpiX. In reflecting back on the USDC contract, Photon Dynamic’s CEO, Vincent Sollitto, described the situation near the end of the contract. By that time, Photon Dynamics had begun working on automation features which were a part of the USDC contract, but which were difficult to perfect because dpiX was running a relatively low-volume line that did not require automation. At that point, the USDC beta site coordinator at dpiX, who was also head of the oversight committee for the contract, agreed that Photon Dynamics had met its obligations to the USDC and signed off on the contract. Through this experience the company learned that the US customer requirements were so far removed from what commercial-scale users needed that USDC contracts were too much trouble for the money. Photon Dynamics made the most progress in their tool development joint work with LG. Through this collaboration the company learned that it faced two major challenges in adapting its products for a high-volume fabrication facility; first, reducing particulates that cause the pixel outages that the machine was designed to detect and second, developing automation software that was compatible with the industry’s standard automation software. Photon Dynamics and LG formed a joint task force to figure out how to reduce the particulate problem, which led to some relatively straightforward product design modifications. After the task force concluded its work LG ordered seven additional machines. In order to solve the software problem, Photon Dynamics stopped writing customized software, which it had begun to do during its first USDC contract for dpiX, and at significant expense hired programmers to develop a standard interface between the Photon Dynamics tool and high-volume automation systems for FPD production. US government efforts to encourage high-volume manufacturing of displays In February 1993, the chair of the Council of Economic Advisers, Laura D’Andrea Tyson, mentioned in a meeting with Robert Rubin, Chief of the National Economic Council (NEC), that she thought that, under the right conditions, the administration might want to intervene to help specific industries and that flat-panel displays might be a good example. After a briefing from industry executives and discussions with Rubin’s staff, the staff of the NEC sent a memorandum to Tyson and John Deutch, the Deputy Secretary of Defense for Acquisitions, noting their agreement to do a study of the rationale, objectives and budget for a program for FPDs. Deutch then delegated the task to Kenneth Flamm, his Principal Deputy Assistant Secretary for Dual-Use Technology Policy and International Programs (Carey, Young and Burrowes, 1994).


Table 5.3. Department of Defense FPD funding plan (in millions of dollars)

Flamm assembled a task force of people from a variety of government agencies: Defense, Energy, Commerce, Treasury and the CIA. Flamm, along with his deputy for dual-use technologies, Richard Van Atta, coordinated the work of the task force and briefed members of the National Economic Council (NEC) on a regular basis. Van Atta personally visited most of the FPD manufacturers in the United States, while Flamm received visits from firm representatives in his Washington office. Task force members conducted interviews and meetings with business representatives both in Washington and in the field in order to gather relevant information. The initial drafts of the final report were done by various task force members from different agencies.9 A final report was to have been made public after the April 1994 announcement but was not released until late September 1994 (DoD, 1994). Flamm announced a new initiative to promote the advanced display industry on April 28, 1994, which he called the National Flat-Panel Display Initiative (NFPDI). Flamm said the government would spend $587 million over five years on it (see Table 5.3). DARPA funding would be increased from $46 million in fiscal year 1994 to $68 in the next four fiscal years. Another $199 million was to be transferred from other government programs, including the Technology Reinvestment Project (TRP). In addition, $50 million would be allocated for building a second TFT-LCD manufacturing test bed. DoD funding for a second manufacturing test bed was motivated by the political success of the Michigan congressional delegation to insert a paragraph in a budget appropriation act authorizing federal funding of a pilot manufacturing facility for the production of TFT-LCDs. The paragraph was worded in such a way that only one firm, the Michigan-based OIS, could possibly qualify for the funding. When officials in the DoD saw the paragraph in the marked up version of the appropriations bill, they saw that the funding of OIS could be interpreted as a direct subsidy and hence might violate US treaty obligations under the GATT (now called the World Trade Organization). The paragraph was rewritten so that the allocated funds would be used to fund research and development (R&D) and not production and that there would be some sort of competition for the funds, but the language still gave an enormous advantage in any competition to OIS. As a result, the NFPDI included an additional $50


million in funding from ARPA to pay for a second TFT-LCD pilot plant. The competition for this second plant was won by a consortium of firms that included Xerox, AT&T and Standish Industries.10 A policy decision was made to spend funds authorized by Title III of the amended Defense Production Act (1992) for the insertion of new technologies into military systems. The problem that this decision was designed to solve was that acquisitions officers in the Department of Defense were required to “qualify” new technologies before they could be inserted into new or existing military systems. This was not required by law, but evolved simply as a prudent practice. The costs connected with qualification were usually borne by the defense contractors, but if not, they had to be paid out of program funding, which was a major disincentive for using new technologies, especially those commercialized by small firms that could not afford the costs of qualification. The NFPDI outlined a policy decision to allocate a portion ($30 million) of Title III funds for the qualification of TFT-LCDs for insertion into military systems. The same Michigan delegation members who supported the funding of OIS in the appropriations bill also supported the use of Title III funds to qualify TFT-LCD displays for insertion in military systems. About $6 million of the $30 million would go to Allied Signal Corporation to qualify OIS TFTLCDs for use in the former’s Apache helicopter program. The Department of Defense was quite proud of the new insertion program because they thought the small amount of spending for qualification expenses would succeed in opening up much larger military and civilian markets to US display firms. The unanticipated consequence of this program was that it discriminated against other display technologies such as CRTs and field emission displays which DARPA was also supporting and which were expected to compete for some of the same military applications. Some of the funds paid for the qualification of TFT-LCD displays produced in whole or in part by foreign-owned companies. A third part of the NFPDI was the funding of display technologies under the Technology Reinvestment Project (TRP). The TRP originated in proposals by Senator Jeff Bingaman (D, New Mexico) in the early 1990s. Bingaman’s proposals included funding for R&D consortia, outreach programs to help defense firms diversify into commercial markets, manufacturing extension centers to help diffuse existing technologies and best practices to US manufacturers, and regional technology alliances to promote the restructuring of defense-dependent regional economies (Stowsky, 1996, p. 13). The Clinton administration embraced Bingaman’s idea, in somewhat expanded form, as its response to the problem of “defense conversion”— reducing the negative economic effects of military downsizing in the wake of the end of the Cold War. On March 11, 1993, Clinton announced the TRP in a speech to the employees of the Westinghouse Electronic Corpor ation in Baltimore. The main idea behind the TRP was to use the concern over defense conversion to justify the channeling of new R&D funds through DARPA to


the defense community. The TRP was to ramp up quickly from around $70 million in the first year to over $500 million in its fifth year. The DoD was thus to be the main source of funding for the NFPDI, but a small amount of additional support would come from the Departments of Commerce and Energy. Funding of proposals would be competitive and would be disbursed through “agreements” rather than grants or contracts.11 According to Flamm, the flat-panel initiative would be “technology neutral. …We have no priority technologies. We are not picking technological winners here…if the technology changes, the program will have the flexibility to go with where the technology is moving” (Andrews, 1994; Bradsher, 1994a; Bradsher, 1994b; Gomes, 1994). The flat-panel initiative was linked to a larger policy change in the area of “dual use technology”: the Clinton Administration has developed a new technology strategy that promises to deal effectively with these major changes affecting our national and economic security in the 1990s. That strategy includes the dual use technology vision outlined by Secretary of Defense William Perry and Deputy Secretary of Defense John Deutch. At the heart of this vision are two key principles: • To reduce costs, and accelerate the introduction of new technologies into defense systems, DoD must make use of components, technologies and subsystems developed by commercial industry, wherever possible, and develop defense unique products only where necessary. • To capitalize on this acquisition strategy, DoD’s R&D efforts must focus on critical dual use technologies and capabilities that will continue to be advanced through industry’s efforts to remain competitive in commercial markets. Thus, even where the military applications are specialized or unique, the underlying technologies will be sustainable through commercial forces (DoD, 1994, p. 1–1). The report argued that the flat-panel display technologies were “critical dual use technologies.” The initiative also included a production target for the US flat-panel display manufacturing industry: This study judges that penetration of 15 percent of the world market (up from the current 3 percent) is both an achievable near-term goal and an appropriate point at which to consider whether a government flat panel display program should be redefined, reduced, or terminated. This level of market share is probably sufficient to nurture and sustain the critical mass of U.S. infrastructure suppliers needed for the long term success of the U.S. FPD industry [emphasis added], to permit industry to exploit continued government R&D investments in advanced display technology, and to satisfy DoD needs at acceptable costs. (DoD, 1994, pp. I–7 and I–8)


This paragraph is at the heart of our argument that the NFPDI was motivated by technonationalism. After the Republicans won control of the Congress in the 1994 elections, the Congress voted to cut spending on the TRP, the dual-use policies of the Clinton Administration came under attack, and the NFPDI lost its strongest advocate, Kenneth Flamm. Flamm returned to the Brookings Institution in September 1995 to finish a book on the semiconductor industry he had been working on prior to joining the Clinton Administration. His departure was also motivated partly by the desire to avoid fighting continuous battles with Congress to cut back the funding of the NFPDI and to abandon the administration’s dual-use policies. The deep cuts in the TRP meant that the $199 million that was supposed to be spent on focused R&D incentives out of the planned total of $547 million for the initiative was reduced to $25 million (see Table 5.3). Any hope of subsidizing a high-volume flat-panel manufacturing plant in the United States died with the TRP cuts. Although the ARPA High Definition Systems and USDC efforts continued with considerable Congressional support after 1994, the orphaned NFPDI faded into the background. DARPA funding for US production test beds did not result in US investments in high-volume production. The absence of US high-volume production created serious obstacles for USDC development partners who were constrained to beta-site their tools with US companies. Both OIS and dpiX steadily worked to build up their sales through military contracts and targeting the avionics and medical imaging markets. OIS produced only about 40,000 displays annually at peak capacity (compared with 1.5 million units produced annually in high-volume plants in Asia). DpiX, the Xerox FPD spinoff, competed head on with OIS in the avionics and medical imaging markets. They produced less than 80,000 units a year. This was more than enough USproduction capacity to meet military demand for high-performance displays but not enough for the firms involved to be able to compete with Asian firms for commercial applications. OIS, especially, struggled with getting its yields up and took a long time to before it could fill its orders. Malcolm Thompson, CEO of dpiX, focused on developing very high-quality displays with vivid colors, wide viewing angles and clear video pictures. These displays, however, cost about $10,000 for a 19" display which would have cost around $4,000 from a high-volume manufacturer at that time. The lack of formal relationships with high-volume manufacturers may explain the relatively slow progress that US producers (with the notable exception of IBM) were able to accomplish. A focus on low-volume production of mostly military displays prevented US manufacturers from taking advantage of the tacit knowledge that flowed through the networks of high-volume notebook manufacturers and their suppliers that helped managers in Asia to anticipate market shifts and allowed engineers to figure out how to solve process problems. IBM, the one US company with high-volume


production facilities through its strategic alliance with Toshiba, had access to these networks, in part because the company chose to locate its FPD manufacturing facility in Japan, but mainly because it decided from the outset to take the risk of investing in high-volume production. The mystery of IBM’s nonparticipation in US promotional efforts One of the puzzles we confronted when we undertook field research on the NFPDI was why IBM, the strongest US firm in the TFT manufacturing area, was not a central participant in the USDC or a beneficiary of any of the NFPDI programs during their short life span. We asked this question in interviews with both government officials and representatives of the firm. The answer was surprising. Most of the government officials we spoke to were themselves somewhat surprised at the nonparticipation of IBM, while also sharing some of the common stereotypes about the nature of IBM’s investments in this area. There was considerable confusion about the nature of the joint venture between IBM and Toshiba and how the responsibility for building the FPD business that IBM originally gave to their Japanese affiliate contributed to the competitive strength of the entire corporation.12 IBM originally developed an interest in entering the FPD business because of its stake in the computer monitor business. The company recognized that CRT might become obsolete if inexpensive flat-panel displays could be developed and that high-quality displays were an important contributor to the perceived value of computers. IBM wanted a manufacturing presence in whatever technology might replace or supplement CRTs for computer monitors. In the mid-1980s, IBM worked on gas plasma displays, but exited the plasma business because the plasma displays of that time were monochrome, too heavy and consumed too much energy for portable applications. They sold their plasma plant in New York state to a group of investors who formed Plasmaco (see the Plasmaco story above). When IBM engineers looked at Matsushita’s portable TVs with color TFT-LCD screens they saw the technology’s potential and redirected their efforts towards this technology. In a departure from traditional norms, from 1996 to 1988, IBM entered into an R&D alliance with Toshiba. Engineers from both companies spent the first year of the alliance working in Toshiba labs and the second year working in an IBM Japanese research facility in a clean room constructed specifically for the project. This alliance produced two 9.5" prototype displays in 1987 and a 14" TFT-LCD prototype in 1988. The 14" prototype sufficiently impressed IBM’s top management that they decided to go ahead with manufacturing. IBM’s monitor group in Raleigh, North Carolina, submitted a proposal to take on the manufacturing responsibilities for IBM’s TFT-LCD business. Jim McGroddy, the senior IBM official responsible for making the location


decision did not want to give this responsibility to the monitor group because he was afraid that they would sit on the technology in order to protect their CRT business. Given IBM’s financial constraints at the time, he also decided to extend the research relationship with Toshiba and create a manufacturing alliance that would use many of the same engineers who worked on developing the prototype. By leveraging their experience, McGroddy believed that IBM would ramp up production relatively quickly and with much less expense than would be involved in training an entirely new group of engineers. The IBM/Toshiba joint manufacturing venture, Display Technologies Incorporated, began production in 1991. In 1992, before the NFPDI, when DARPA was struggling to figure out how to encourage US production, IBM expressed a willingness to license DTI’s technology to a manufacturing consortium put together by AT&T and Xerox. IBM officials reported that DARPA did not like the idea of paying royalties to an entity located in Japan and was reluctant to fund the project. AT&T became frustrated with the politics involved in obtaining government funding and decided drop the DARPA project and entered into an alliance with a Japanese company that would transfer its FPD process engineering expertise to a US production facility. AT&T set up a pilot line at Bell Labs and used it to develop process engineering techniques. After an agreement with a Japanese firm fell through, the company approached LG, which expressed a serious interest in forming an alliance. In 1996, just after AT&T split into three companies, Bell Labs abruptly terminated the project as part of its effort to cut its expenses before it was spun off as a part of Lucent Technologies. In the interim, AT&T had joined with Xerox and Standish in one of DARPA’s production test beds while it was working on its pilot line. To meet its obligations in the DARPA project, AT&T did not have to manufacture displays. Instead it could meet the terms of the contract by working on techniques for attaching driver chips to displays in its Princeton lab. The global notebook computer industry The need for FPD manufacturers and tool suppliers to locate some of the key managerial and technical functions close to the heart of the industry does not appear to extend to computer assemblers. Notebook computer assemblers try to obtain components from the best component producers no matter where they are located. They do not require that component manufacturing take place near their assembly plants, but only that the supplier locate a warehouse and service facility nearby so that “just in time” or lean production techniques can be used. This is precisely the behavior that was described to us by representatives of two important notebook assemblers: Compaq Computers in Houston and First International Computer in Taiwan.13


During the period leading up to the announcement of the NFPDI, DOD analysts argued that US dependence on Japanese FPDs could compromise US economic and political security. They argued that the threat to US economic security would result if US computers assemblers like Compaq could not sell their computers because in times of shortage Japanese FPD manufacturers would allocate displays to Japanese computer assemblers, especially their internal computer units, first. During these periods, Japanese computer assembly companies would use this preferential access to displays to wrest market share away from their US competitors. Instead, we learned in our interviews that although FPD manufacturing capabilities may provide their in-house computer assembly units some advantages, the competitive strength of computer assemblers stems from more than just these manufacturing strengths. Our research indicated that, instead, the display manufacturing subsidiaries of vertically integrated companies behaved as much as possible like merchant suppliers of displays, insisting on their right to sell displays on the open market. Notebook assembly subsidiaries similarly insisted on their right to buy displays on the open market as well as purchasing them internally. The main reason for this was the need of both suppliers and assemblers to use the merchant market as a benchmark for price, quality and consumer demand, and as a check against the tendency of purely captive producers to ignore changes in the competitive environment. Computer assembly firms like Compaq and FIC, with no internal supplier of displays, were somewhat disadvantaged relative to more integrated firms like IBM and Toshiba because they could not dictate the design of a new display to their suppliers, although they could try to use their buying power to be persuasive. For example, IBM were able to introduce a 12” TFT-LCD display into their Thinkpad notebook computers before their competitors in part because they could source their displays from a new DTI manufacturing line. DTI’s risky move left their competitors with non-economic production facilities that were not optimized for 12” displays. These companies were at a competitive disadvantage until they built new third-generation plants optimized for larger display sizes. Thus, timing is of the essence and it is not entirely clear that an assembler with a captive display supplier will have any advantage in timing over an assembler who purchases displays on the merchant market. The success of both depends upon their ability to anticipate market trends or respond quickly to the first movers’ product innovations. More than manufacturing capabilities, this required FPD manufacturers to track the product preferences of their leading customers, which were not necessarily their internal customers, and to benchmark price, quality and consumer demand. This also required computer assemblers to understand a component’s trajectory so that they could design next-generation components, in our case, a larger display size, into their flagship products in a timely manner.


To compete with IBM, Compaq and FIC used different strategies to ensure their supplies of the most advanced displays. Compaq leveraged the competition among its suppliers to enhance its buyer power. Compaq also always tried to have at least two suppliers for a given component, and used its quantity purchases to transform each component into a standardized product to reduce its need for retooling and to keep prices down. The managers of FIC used personal networking to learn about technological developments in components as a reality check against announcements by marketing divisions about intentions to ship new products. They also used these networks to build trust relationships with their suppliers. These relationships were in part based on their willingness to buy extra displays in times of surplus in exchange for an assured allocation in times of shortage. Summary and conclusions We have argued in this paper that economic globalization affects the efficacy of both firm strategies and government policies. Firm strategies and government policies motivated by technonationalism will generally fail to achieve their stated goals in globalizing markets. Those consistent with a globalist stance of openness to the world, of flexibility in the choice of technologies and industrial partners, and of readiness to go anywhere to obtain the necessary market information, intellectual property, key personnel, and critical components are much more likely to succeed. Success, in this case, is measured in terms of international competitiveness of national firms. In this chapter we have used the experience of IBM, Applied Materials, Corning Glass and Photon Dynamics to illustrate the kinds of global strategies on which firms can build this success. These firms did not rely on government subsidies and worked with their most demanding customers to develop world class products. IBM, Applied Materials and Corning Glass headquartered their FPD businesses in Japan to track the rapid changes taking place in the industry. Their manufacturing, R&D, and marketing were dispersed throughout the world, including the US. By locating key managerial and technical operations in Japan, these companies were able to achieve one of the policy objectives identified by technology policy analysts; the development of FPD infrastructure companies that would build a dominant position in the global flatpanel display market. The competitive strength of these companies also contributed to US economic strength. Applied Komatsu’s sales in Japan created jobs in Santa Clara California where the CVD tools were assembled. DTI created lots of R&D projects for scientists and engineers at IBM’s Watson Labs in New York. Corning Glass did all the R&D for its new FPD glass products in Corning, New York. But without its sales force in Japan, the researchers in Corning would not have had a very clear idea about how to focus their efforts. These


firms’ abilities to manage these dispersed competencies ultimately created more high-value-added jobs in the US. These firms also participated in “Wintelist” networks that required a relatively high degree of openness either through licensing or some other form of open exchange of information. In the FPD case, we saw IBM working with Toshiba to tackle development and production problems. This alliance provided both companies with sufficient leverage to set de facto industry standards, especially after DTI began producing 12” displays. DTI also worked openly with Applied Materials to develop a CVD tool that would raise yields and productivity levels for the entire industry. There was no economic way that DTI could develop a proprietary CVD tool for itself and withhold its advantages from competitors. DTI’s partners would have to develop new product and marketing strategies to leverage any strategic advantage that they built during their early experience with the tool. While the FPD case clearly illustrates the limits to technonationalist policies and their incompatibility with the global technology innovation system, questions still remain about what political changes have to occur before government policies reflect these limits. Will the US government and US taxpayers accept the fact that if their goal is to support the development of the best new technologies, US public funds will have to flow to non-US companies? Or will a knee-jerk “buy American” spirit continue to shape governmental funding strategies. For US technology policies to be truly effective, they must be accompanied by a spirit of openness to foreign participation in domestic technological efforts—a spirit that was there at the beginning of the NFPDI but that got lost as time went on—and must eschew the narrow nationalism that unfortunately seems to come with the coalition building required to support funding of such efforts. The spirit of openness is beginning to be seen in older R&D programs like Sematech in the United States and the Fifth Generation Computer Project in Japan (Mathews, Cho and Cho, 1999). One can view the efforts in the United States and Korea to create a favorable political environment for USDCEDIRAK cooperation also as a step in the direction of openness. But the most direct way to improve the long-term prospects of domestic firms in globalizing industries via public policy is to support, wherever possible, the efforts of individual firms and groups of firms to develop new technologies and new products that are globally competitive. Wherever technonationalism gets in the way of this, it has to go. That leaves open the question of how to foster the spirit of openness that is the key element of what we call globalism. For internationally competitive firms and their managers, internationalization strategies are a response to the pressures of competing in an increasingly globalized market. Firms that are insulated from international competition, for whatever reason, are less likely to copy these strategies or to have a globalist spirit. To the extent that defenseoriented firms are insulated from international competition, they will remain in


the technonationalist camp. Similarly, defense agencies that work primarily with such firms will also tend to be technonationalist. The only way out of this bind, in our opinion, is to encourage defense agencies to do more of their business with internationally competitive firms. It is our view that they will catch the globalist spirit by doing this. That leaves, however, the problem of how they can convert their natural constituents in Congress and the federal bureaucracy to globalism. What is needed is a way of redefining national interests in an age of economic globalization. We offer this case as one of a growing number that might serve as the basis for such a redefinition. Notes 1 This is a revised version of a paper that was prepared for delivery at a conference on “Coping with Globalization,” sponsored by the Center for the Study of Global Change of Indiana University (with contributions from a number of other sponsors) and held in Alexandria, Virginia, July 31–August 1, 1998. Research for this paper was made possible by a grant from the Alfred P.Sloan Foundation. Research assistance for this paper was provided by Craig Ortsey. Please do not cite or quote without the written permission of the authors. 2 We shall demonstrate below that the conventional view was not completely accurate since a number of both US-based and European firms were major participants in display markets. 3 Interview with Sharp managers in Kobe, Japan, on June 6, 1997. 4 Interviews with managers of Japanese firms in November 1996 and June 1997. 5 A fourth chaebol, Daewoo, had investments in STN-LCD production and was attempting to become a global competitor in consumer electronics. Daewoo had not invested in TFT-LCD production as of 1997, but was investing in other advanced display technologies. We were unable to include Daewoo in this study. 6 The USDC said that there were 125 members of the SEMI-FPD Division of SEMI in a contemporary document but not all of these were members of the USDC. 7 The USDC had agreed to provide matching funds to Corning Glass to build a finished glass facility in the US. As of 1997 all of Corning’s FPD glass was finished in Shizuoka, Japan. FPD producers located in the US that use Corning’s glass pay a small duty on imports of finished glass from Japan. Even with the matching grant, Corning decided not to build the facility because the US FPD glass demand was so small that it could not meet internal rate of return targets. 8 Confidential interviews with US government officials in Washington DC, December 1995. 9 Interviews with Kenneth Flamm and Tom Kalil on December 18, 1995; and interview with Richard Van Atta on December 19, 1995. 10 Interviews with US government officials in Washington, DC, December 1995. 11 The designers of the program wanted to have more flexibility in funding than was possible through grants—where the recipient has no obligation to deliver anything to the government—and contracts—where the contractee has to prespecify a deliverable and is penalized for not providing it in a timely manner. Interview with Richard Van Atta on December 19, 1995.


12 Interviews with IBM and DTI managers on July 22, 1996; November 6. 1996; and June 2, 1997. 13 Interviews with Compaq managers on March 26, 1997 and FIC managers on May 26, 1997.

Bibliography Andrews, Walter (1994) “U.S. revamps FPD support to fuel industry,” Electronic News, May 2, p. 1. Borrus, Michael and Hart, Jeffrey A. (1994) “Display’s the thing,” Journal of Policy Analysis and Management, 13, 1:21–54. Borrus, Michael and Zysman, John (1997) “Globalization with borders: the rise of wintelism as the future of global competition,” Industry and Innovation, 42, 2: 141– 66. Bradsher, Keith (1994a) “U.S. to aid industry in computer battle with the Japanese,” New York Times, April 28, p. 1. —(1994b) “Pentagon tests new policy in subsidizing an industry,” New York Times, April 28, p. C1. Business Wire. “San Jose selected as site of flat panel display consortium,” (October 8, 1993). Accessed via Nexis/Lexis. Carey, John, Young, Dori Jones and Burrowes, Peter (1994) “Why Washington is anointing flat panels,” Business Week, May 16, p. 36. Castellano, Joseph (1998) Presentation delivered at Display Works ‘98, USDC Business Conference, San Jose, California, January 20. DARPA (Defense Advanced Research Projects Agency) (1999) High Definition Systems (HDS), available HTTP: http://www/ DoD (Department of Defense) (1994) Building U.S. Capabilities in Flat Panel Displays: Final Report of the Flat Panel Display Task Force, Washington, D.C. Available HTTP: Gomes, Lee (1994) “White House promises another $300 million for flat panels,” San Jose Mercury News, April 29, p. 1E. Hart, Jeffrey A. (1994) “The politics of HDTV in the United States,” Policy Studies Journal, 22, 3:213–28. Hart, Jeffrey A. and Prakash, Aseem (1997) “The decline of ‘embedded liberalism’ and the rearticulation of the Keynesian welfare state,” New Political Economy, 2, 1: 65– 78. Kobrin, Stephen J. (1997) “The architecture of globalization: state sovereignty in a networked global economy,” in John H.Dunning (ed.) Governments, Globalization and International Business, Oxford: Oxford University Press. Linden, Greg, Hart, Jeffrey, Lenway, Stefanie and Murtha, Tom (1998) “Flying geese as moving targets: advanced displays in Korea and Taiwan,” Industry and Innovation, 5, 1:11–34. Mathews, John, Dong-Sung Cho, and Tong-Song Cho (1999) Tiger Technology: The Creation of a Semiconductor Industry in East Asia, Cambridge: Cambridge University Press. Mentley, David E. (1993) “The Launch of the United States Display Consortium,” Electronic Display World, 13, 7:21–5.


Mills, Peter (1995) Solid State Technology, Accessed via Nexis/Lexis. MRS (1997) Annual Report. Prakash, Aseem and Hart, Jeffrey A. (1999) “Globalization and governance: an introduction,” in Aseem Prakash and Jeffrey A.Hart (eds), Globalization and Governance, pp. 1–24, London: Routledge. Semiconductor Equipment and Materials International (1997) “No Title,” available HTTP: Stowsky, Jay (1996) “America’s technical fix: the Pentagon’s dual use strategy, TRP, and the political economy of U.S. technology policy,” paper prepared for the Council on Foreign Relations, New York, February 23. USDC (United States Display Consortium) (1998) “No Title,” available HTTP: http:// Young, Ross (1998) Presentation delivered at Display Works ‘98, USDC Business Conference, San Jose, California, January 20.

6 Dialing for dollars Institutional designs for the globalization of the market for basic telecommunications services Peter Cowhey and John Richards1

The revolution in communications and information services is high on every analyst’s list of factors permitting or propelling the globalization of the world economy. This revolution creates a vastly greater ability to organize work and social, political and cultural networks on a global scale (Cairncross, 1997). But this new technological capability could only emerge after a revolution in the policies for the market in global communications and information services. Competition had to replace monopoly for technological possibilities to become market realities. Capped by the Agreement on Basic Telecommunications Services at the World Trade Organization in 1997 this market has undergone fundamental changes in organizing global competition rules over the past twenty years. Still, the communications revolution is far from complete from the perspective of globalization of the market. For our purposes the globalization of a market has two dimensions: (1) the increasing global integration of input, factor and final product markets along with the increasing salience of crossnational value-chain networks; (2) the promotion of effective competition in the global market. By these standards the market for communications services is still not effectively globalized. But these dimensions emphasize the links between domestic and cross-border production and distribution, the central role of MNEs in the globalization of telecom markets, and the ability of states to exercise what Spar and Yoffie call “governance from the top” in organizing international services markets. And they underscore the global economic welfare gains made possible by competition inducing efficient pricing and resource allocation decisions. This chapter examines the 1997 WTO Agreement as a pivotal agreement facilitating globalization by creating new property rights and competition rules in international telephony markets. We focus on the internal constraints driving US and EU policies in the negotiations over new rules for global telecom markets. That is, we highlight the internal constraints facing governments, how these constraints shape their negotiations strategies and the international institutions ultimately created. At the same time, we also highlight the role of external constraints—in this case the Most Favored


Nation (MFN) rules at the WTO—in shaping negotiations and institutional outcomes. More specifically, we argue that multilateral agreements cannot resolve all the critical competition questions in a market undergoing a rapid global transformation. While the omissions may be a result of the complexity of the task, in telecommunications markets it was a consequence of two other factors. First, the United States and European Union had many complementary interests but their domestic political economies gave them somewhat different priorities in regard to these interests. Internal constraints thus set the parameters for the coping strategies available to these two key actors. Second, the basic rules of the international institution used for the policy reforms, the World Trade Organization, limited the options for reconciling differences in priorities. External constraints, in this case in the form of existing international institutional rules, thus influenced bargaining outcomes in the WTO negotiations. Therefore, the synthesis for changes in global rules was a new multilateral trade agreement and unilateral international action by the US. Many question the complementarity of multilateral and unilateral initiatives (Bhagwati and Krueger, 1995), but the very nature of international institutions suggests why dual tracks often emerge. International cooperation on the globalization of markets through new multilateral rules for markets can improve global welfare, but theory and practical experience suggest that the terms of this cooperation are also likely to limit the total efficiency gains. Many solutions for transaction costs and other market failures are themselves costly,2 and each particular solution has different distributions of benefits and risks. So, reforming the international regime of markets that previously were open to limited competition will produce some welfare gains but will not help states reach a uniquely efficient regulatory solution. In short, at least for the largest trading powers there is an incentive and opportunity to craft complementary unilateral strategies to induce further market changes. Thus, multilateral agreements to cope with globalization may tacitly include expectations of complementary unilateral actions by major powers.3 This chapter shows why. The first part of this chapter makes our argument about the role of international institutions in the globalization of telecommunications markets. The second reviews the traditional telecommunications market and the political economy of the two key negotiating powers, the European Union and the United States. The third part analyzes the WTO negotiations on telecom services, and part four draws some lessons for our understanding of how nations cope with globalization.


International institutions, globalization and efficient markets We should expect that markets undergoing significant globalization will face new questions about market governance. For example, what are the rules about competition? What are the property rights of firms? In high-tech markets, where rapid technological change exacerbates the problems of slow governments, should public or private governance structures be used? These questions arise as value-added chains move across national borders, global markets increase in importance relative to domestic ones, and marked changes in competitive dynamics drive governments and firms to consider new strategies and policies in international markets. These dynamics should drive changes in global rules enshrined in international institutions. The conventional view of international institutions is that they enhance global welfare by helping states overcome the problems of incomplete contracting and market failure inherent in international cooperation (Keohane, 1984; Krasner, 1983; Zacher and Sutton, 1996; and Kapstein, 1989). In short, efficiency-enhancing international coordination is difficult given the uncertainty and informational asymmetries inherent in international markets, and international regimes render international cooperation possible because they reduce uncertainty and informational asymmetries. By providing clear rules of conduct, monitoring state adherence to international agreements, and enabling linkages between related issue areas, international institutions render interstate coordination possible, generate efficiency gains, and thereby help states move toward the Pareto frontier and efficient global markets. We agree with the fundamental insight of collective goods approaches: international institutions have the potential to enhance efficiency in global markets. But we do not believe that international institutions are always efficiency enhancing. International institutions have the potential for enhancing globalization and efficiency in world markets, but can also stifle globalization and restrict competition. An international regime creates or consolidates property rights as part of their governance structure for a global market.4 The literature on domestic property rights demonstrates that market development will be slower if stable and welldefined property rights are lacking.5 In particular, property rights are a necessary ingredient for the growth and development of markets because they lower the transaction costs of exchange and production while encouraging investment (North, 1981; North and Weingast, 1989; North, 1990; Weingast, 1993; and Barzel, 1997). Institutions, for example, played a central role in delineating property rights and thereby providing the basis for early modern trade (Spruyt, 1994; Greif, Milgrom and Weingast, 1994; and Milgrom, North and Weingast, 1990). International regimes dictate the rules and decision-making procedures governing international markets and define the rights of different economic actors in these markets, and thus establish property rights in international


markets. These enforceable property rights increase the efficiency of international markets and the wealth generated by these markets.6 At the same time, it is possible to define property rights in such a way as to encourage competitive inefficiencies in the marketplace. This is a central issue for antitrust law and the economics of industrial organization. The huge inefficiencies encouraged by the peculiar schemes of property rights for natural resources are classic examples of the problem (Adelman, 1996). Yet tampering with property rights to correct the problem creates instabilities in rights that themselves have costs. Thus, economists advise a transparent and rule-bound process to balance the conflicting concerns (Levy and Spiller, 1996). To facilitate the growth of global markets, states must thus either create property rights de novo or tinker with rights already in place. But in doing so they must wrestle with the possibility that consolidating property rights in traditionally monopolistic markets may further entrench some market inefficiencies. This was the case for the global telecommunications market: existing property rights were obviously inefficient yet created large political and economic incentives against restructuring. The strong political legacy of the traditional monopoly regime also meant it was politically impossible to define a uniquely efficient set of marketplace rules. Put differently, the increased globalization of international telephone markets did not end government tinkering with marketplace outcomes for domestic political purposes. Instead, national political leaders (and their political constituencies) took globalization into account while still fine-tuning global markets to manage constituency interests and other national policy goals. In terms of the framework of this volume, internal constraints thus set the ground rules under which national (and supranational) politicians would negotiate any new set of global rules. If international cooperation is both a spur and a limit to globalization then it is necessary to examine the negotiating dynamics for the regime. Where you start influences the options for where you end. And so does the identity of the parties who control the negotiating agenda. The international economic order designed around 1945 bore the strong imprint of the domestic political economy of the two countries that drove the negotiating dynamics—the United Kingdom and the United States (Cowhey, 1993; Richards, 1999). Today, global trade negotiations are strongly colored by the domestic political economies of the centerpieces of any WTO negotiation—the European Union and the United States.7 In particular, we focus on how similarities in their domestic political economies opened the way to new mixes of global rules, while at the same time constraining the subset of outcomes acceptable to both parties. In the third part we examine how the domestic political economies of the US and the EU drove the new policy equilibrium for global telecommunications markets. But in constructing the new global regime, even the most influential countries are not free to tailor a solution purely in light of


their mutual political interests. External constraints were also important; negotiating at the WTO implied a set of ground rules for any agreement on telecommunications services that significantly influenced the available set of solutions, as we shall show in part four. It was not easy to find a policy that both fit the WTO’s requirements and the demands imposed by the political economic situations of the US and the EU.8 To understand the negotiating problem and market challenges requires a review of the telecommunications market. The legacy of telecommunications monopolies The initial move to competition Obsolete regulation has hindered competition in the market for international telecommunications services for the past 150 years (Cowhey and Aronson, 1988; Cowhey, 1990). Until the 1960s, monopolists, largely owned by governments, provided virtually all telecommunications services. In theory, these monopolies could achieve huge economies of scale, foster expensive research, and cross-subsidize the provision of services for rural areas and the poor. Whatever the merits of this theory in the past, technological innovation reversed the economics of the market. The advent of corporate computer networks propelled the beginning of specialized competitors in “value-added” network services in the 1960s. This slowly expanded into allowing large corporations to run internal communications networks for all services linking their domestic and global offices. Until the 1984 breakup of AT&T there was insignificant competition in basic telephone services serving the general public, which was by far the largest part of the world communications market. Although there was halting movement to competition in these services in the late 1980s and early 1990s, there was only a general consensus on the virtues of competition throughout the industrial world in the mid-1990s. The forces supporting competition look like a cocktail of the ingredients cited in the literature on globalization. Large users of communications and computing systems in the corporate sector in all industrial countries became champions of competition in order to make it easier to use information technology to reform global production and distribution practices. Meanwhile, producers of information technology were also transforming their own global production systems, and thus became innovative users as well. Although large MNEs were certainly key players in the political coalition pushing liberalization, as Ostry points out, they were by no means the only set of relevant interests. The interests of high income households, which tend to vote in higher number than other income levels, were particularly important. Based on US and UK experience, political leaders discovered that most households saved enough from long-distance competition to compensate for any losses in


cross-subsidies for their local phone service (Cowhey, 1990b). And in the late 1990s the Internet made computer networking more relevant for all households, thereby making their interests closer to those of large business users. These forces created a common set of domestic political incentives for reforming global telecommunications networks, at least in industrial countries. The same sentiment spread to the industrializing countries that introduced privatization of their telephone systems and limited competition, especially in computer services and cellular telephones. Still, there was also a strong possibility that industrializing countries would defer general competition for many years because telephone companies still served as national champions subsidizing local equipment suppliers. They were also, after privatization, usually the largest firm on the national stock exchange, and thus their welfare was a matter of concern to finance ministries. Indeed, some countries had extended the period for monopoly phone services at the time of privatization in order to sweeten the terms for initial stock offerings. Poorer countries in the developing world remained highly skeptical of competition in light of their need to achieve massive network build-out, and many had not even privatized their phone companies.9 Moreover, implementation of competition in telephone services did not occur in most of Europe until 1998, and there was considerable skepticism about how rigorous this competition in Europe and elsewhere would be. Finally, foreign companies found it difficult to enter the already competitive markets for telecommunications in the US, Japan and other countries.10 This significant but highly flawed move toward competition left most companies and governments in the industrial world suspicious of their prospects for easy entry and effective competitive opportunities abroad. This suspicion prevailed among industrial countries, not just between industrial and developing countries. Indeed, global negotiations proved so problematic precisely because every government was reluctant to commit to anything more in a binding trade agreement without some way of coping with the hidden obstacles to competition that any dominant incumbent phone company could create. In short, inefficient existing property rights made introducing competition extremely difficult. Indeed, bundled together, the political importance of incumbent monopoly carriers and the significant barriers to entry for foreign providers threatened to stifle initiatives for greater competition and globalization in basic telecommunications services. International telephone services It takes a word of further explanation to understand the situation that shaped prospects for globalization. In 1995, the total global revenues from international phone services were approximately $50 billion, or about 10 percent of the total world market for telephone services. But this 10 percent share did not signal the true economic import of international services.


For decades, rules backed by the International Telecommunications Union favored the “joint supply” of international phone services using accounting rates. Accounting rates are the negotiated price for end- to-end international services created jointly by two national carriers. (Carriers conduct these negotiations and conclude a commercial contract to establish this accounting rate.) Each carrier theoretically contributes half of the international phone (or fax) service (for example, taking the international call from a hypothetical midpoint in the ocean and terminating the call to a local household in its country).11 For contributing this service the national carrier is entitled to a fee usually equivalent to half of the accounting rate. This is the settlement rate. (For the rest of this paper we shall refer only to the settlement rate because it is the economically relevant concept.) In effect, the traditional rules had given national carriers a property right to half of the revenues from any international phone call. Given that carriers negotiated the accounting rate on a bilateral basis, it is no surprise that these revenues entailed large economic rents. The settlement rate is not the end price to consumers; national carriers can, and do, further mark up the price for originating an international call. But the costs created by settlement rates influence the minimum price possible for the service. The key cost is the net settlement payment. A simple example can explain the concept. Suppose the US sends ten minutes of calls to Singapore at a settlement rate of fifty cents per minute and Singapore sends the US a total of five minutes of calls at this rate. Then, the net settlement payment from the US to Singapore in this period is $2.50. The US carrier must recover this payment of $2.50 from its own customers, a significant cost element in its pricing decision. The idea of joint supply by two national carriers under a settlement rate seemed logical in a world of national monopolies. But it was never economically necessary and, as competition emerged in some countries, it worked against, for example, the provision of end-to-end international services based on market costs by competitive carriers, as the next section explains. The limits of bilateral liberalization Even when the US introduced multiple international carriers on its half of the international connection after 1984 it quickly ran into an obstacle to promoting international competition that went far beyond other states’ devotion to monopoly. As long as monopoly, or token competition, prevailed in another country, its dominant carrier possessed market power. This market power could be leveraged into commercial advantage and anti-competitive activities on the route for international phone services between the US and the foreign carrier’s home country. (We shall explain why shortly.) The FCC had to design regulations to curb this danger. It did so by creating the proportionate return rule. Under the rule each US carrier was entitled to the same share of incoming switched international traffic from a country as it sent to the country.


This was a clever solution to the immediate problem. However, it unfortunately also scrambled economic incentives by using regulatory fiat to link the potentially distinct markets of inward- and outward-bound international traffic.12 The same balancing act made the FCC slow to use its discretionary power to permit increased foreign carrier entry into the US market for international phone services, and slower yet to waive US restrictions on foreign investment in basic telecom carriers. Even when the FCC adopted rules in 1995 to streamline its case-by-case liberalization of US restrictions on foreign investment, the Commission recognized that bilateral market openings would move more slowly than was ideal.13 These dynamics meant piecemeal liberalization did little to remove the perverse economic incentives created by the settlement rate system. In August 1997 (after over a dozen years of competition), for example, the FCC estimated that the average price of an international phone call from the United States was 88 cents per minute, compared to 13 cents for domestic long distance. These price differences existed despite negligible differences in the costs of transmission between the two types of calls. Although the US rates for international service were generally the lowest in the world, they were still grossly inflated. A major cause of these high rates was the exorbitant charge imposed by national carriers for terminating incoming calls from other countries. The average settlement rate paid by US carriers in 1996 was 39 cents per minute; outside the OECD area and Mexico the average cost for US carriers was well over 60 cents per minute in 1996.14 In contrast, the FCC believed that the efficient cost of termination (the function paid for by a settlement rate) was no higher than five to ten cents. In 1995 US carriers made $5.4 billion in net settlement payments to other countries, and this total was about $6 billion in 1997. Besides driving up rates for US consumers, the FCC calculated that roughly 70 percent of the total net settlement payments represented a subsidy paid by US consumers to foreign carriers. Moreover, changing patterns of international traffic (induced by the first beginnings of competition) suggested that the size of US net settlement payments would jump.15 Even allowing easier entry by, say, British firms into the American market would not achieve really effective competition in international services unless something was done about the settlement rate system and proportionate return rules. The FCC addressed this problem by issuing a “Flexibility Order” in 1996 that defined the conditions under which the FCC would waive the use of settlement rates and its proportionate return rules for international services (Federal Communications Commission, 1996). Under “flexibility,” international carriers could use many strategies to supply services, and thereby encouraged the growth of a “normal” market for the delivery of telecommunications. But there was a significant limit on the


use of “flexibility.” The FCC had to declare the home market of the foreign carrier to be effectively competitive for international services before it would permit “flexibility.” This put the FCC back into case-by-case bilateral liberalization, thereby greatly narrowing the potential for flexibility.16 Settlement rates massively above costs create the possibility of anticompetitive behavior in the provision of US international services that would harm consumers and erode market efficiency over time. These risks escalated if the FCC made it easier for foreign carriers to provide international telephone services originating from the US market. It is also important to note the mixed interests of the largest incumbent phone companies vis-à-vis the settlement rate system. Whether from competitive markets, like the US, or from a monopoly, like Singapore or Germany before 1998, there was no large phone company that was truly global in its supply and distribution strategies prior to the WTO deal. At best, they had various global joint ventures (usually more impressive on paper than in fact) with foreign telephone companies for providing advanced networking services to multinational corporations and a string of equity investments in local national phone companies. This parochialism had an important consequence: the big phone companies believed that user needs would force them to go global, but they did not earn their largest profit margins by executing global strategies. In particular, the biggest profits for most carriers came from providing international telephone services under the traditional regulations. Thus, an AT&T wanted to expand globally if it could win effective competitive opportunities in the domestic markets of foreign countries, but it was not sure that it had any interest in changing the basic rules for providing international telephone services between countries. Rather it preferred to tinker with the rules by getting the FCC to back it in bargaining for lower settlement rates (and thus lower net settlement payments) with other countries. This would rationalize jointly provided services, not fundamentally change the market. In contrast to other industries examined in this volume, the economic incentives created by the monopoly model thus actually cut against the creation of truly global MNEs in basic telephony. Meanwhile, even if an AT&T thought that there might be gains from changing the rules for international phone services to favor global competition, it thought that any feasible set of new rules would effectively favor phone companies from less competitive national markets over those from more competitive markets. Meanwhile, ironically, whatever AT&T’s fears about change, carriers from less competitive markets worried that any trade reform of the global market would destabilize their large profit margins from international services. Therefore, these carriers also lobbied their home governments to shy away from any liberalization of competition in international telephone services.


At the same time, the inflated prices for international phone services created by jointly supplied services were an attractive target for political leaders. It would be a political plum if US negotiators, for example, could plausibly claim that a trade deal so threatened the system of joint supply that it would dramatically lower prices for international phone calls. Of course, pursuit of this objective clashed with the caution of incumbent carriers. The effect of these political and regulatory problems regarding international telephone services meant there were two options for global negotiations. On the one hand, a multilateral regime promised to deliver large efficiency gains if it could deliver effective property rights for foreign direct investment in telecommunications services. This would at least allow all domestic markets to benefit from inflows of new foreign entrants with money, technology and management innovations. At the same time, everyone in industrial countries further concluded that such property rights required effective enforcement of competition rights by an independent regulatory authority. The next section shows why internal constraints facing politicians in the US and the EU made creating new competition rules for the global market so problematic. Domestic politics and international markets: the US and the EU Any analysis of the consequences of domestic political economies on global negotiations and markets poses a problem of scale. It is hard to cover all the players adequately. Luckily, reality can simplify the problem. In particular, there is a political logic to the negotiating process at the WTO: most countries do not decide on their “best efforts” at commitments in the negotiations until they have observed what kind of deal is made possible by the US-EU talks. Certainly this was true in the basic telecom negotiations.17 Thus, the key to the role of domestic political economy in these talks was to be found in these two protagonists. Our argument about the preferences of the US and the EU combines reasoning about domestic institutions with the logic of international strategic positioning. At the level of international strategic positioning, the US was particularly aware of competition and efficiency problems associated with the provision of international services. As the country with the largest commercial exposure to the international telecommunications market (over one-third of the world market) and the most diverse set of international traffic flows, the US lived with competition issues regarding international telecommunications services that had barely surfaced in most of the industrial world. The US thus insisted on two points. First, international services accompany any liberalization of domestic markets. Second, any WTO agreement had to include the large developing markets that were the highest growth markets for international services.


The EU, on the other hand, viewed issues on international telephony as primarily matters for EU directives, not WTO talks. The EU’s international traffic was, unsurprisingly, predominantly intra-European, and EU negoti ators naturally viewed this traffic as the jurisdiction of EU directives.18 And unlike in the US, where the billions of dollars paid by US carriers to foreign carriers in settlement payments complicated the incentives of firms and therefore the US government, the EU had only very selective and modest net payments outside the European Union. The EU thus viewed the global negotiation primarily as an exercise in securing unconditional access to the American market with a secondary objective of getting something close to that in Japan. It did not see the WTO as an avenue to undermine the old global cartel and improve the efficiency of markets for international phone services. Largely as a function of its key objectives, the EU did not view the involvement of developing countries as crucial to the success of the talks. The very different domestic institutions of the two powers buttressed these international differences and further limited the negotiating options. In the US, the division of powers and the logic of Congressional politics raised three critical issues. In each case the European Union had a different position. First, the division of powers in the US meant that the EU questioned the credibility of the US commitments, particularly on foreign investment.19 The US strategy relied on the FCC using its legal discretion to lift restrictions on foreign investment, and did not seek Congressional legislation to implement a WTO agreement. The EU team was much more concerned about how to judge the reliability of this commitment than any other item.20 In contrast, the division of powers between the EU and its member states created a credibility problem of concern to the US Washington feared that EU commitments at the WTO would not be implemented reliably by national governments. In particular, the US demanded that EU get member states to remove delays in implementing the EU directive that was to go into effect on 1 January, 1998. Second, Congressional incentives for foreign policy and international trade decisions shaped the US negotiating agenda. The short time horizon and small size of House districts means that Congress has difficulty claiming credit for large policy initiatives and that local concerns are always politically salient (Mayhew, 1974). This complicates the tasks of winning trade negotiating authority and ratification. In particular, at least in this negotiation, the US negotiating team needed a big deal to win Congressional backing. A small deal would not generate enough political interest to protect it against entrenched Congressional skeptics. While the US had crafted a strategy avoiding the need for legislative approval, the FCC could not hope to make such sweeping changes in regulations if Congress was opposed. And the US Trade Representative would lose Congressional backing for the rest of its trade agenda if the FCC forged ahead regardless of political criticism. A politically safe strategy needed three accomplishments. For one, it had to show that the agreement was reasonably comprehensive. Congress was


suspicious of deals that opened the US market without adequate coverage from all major markets. The US negotiating team thus had to win significant concessions from the industrializing countries of Asia, South America and Eastern Europe. A second requirement was to plausibly show that the agreement would lower the price of international phone services. This was a key benefit to trumpet to the press that would be hard for anyone to attack politically. Finally, it had to convince long-distance carriers that the agreement would not unreasonably expose them to anti-competitive behavior by foreign carriers entering the US market for international services. Congress would view a strong vote of “no confidence” (as opposed to cautious approval) by the long-distance carriers as a signal by that the WTO deal was suspect. Thus, domestic politics gave the US negotiating team the will to do what was economically correct—push for a “big deal” providing comprehensive reform of the world market and winning commitments from virtually all significant markets. In comparison, the EU preferred a more limited scope to the deal than that dictated by US domestic politics. The EU process of trade negotiation was as much about the negotiation among European states over the organization of the internal market (and the powers delegated to the EU) as it was about external commitments. Altering negotiating positions quickly and on ad hoc basis thus raises internal problems of re-negotiation and substantially raises the transaction costs of EU negotiations.21 The bigger and more complicated was the WTO deal, the tougher was the process of internal market negotiation. Third, the competition problems posed by global telephony markets exposed how domestic institutions shaped international regulatory options. Two examples are illustrative. First, whenever the US raised problems in regard to competition in international telephone services at the WTO talks, the EU responded that such measures might adversely affect the rights of European carriers entering the US market. Rather than support ex ante safeguards built into any WTO agreements, the EU preferred that actions by competition authorities could only be justified as a proportionate response to a clearly demonstrated problem. In short, the US could act against the problem only after it had surfaced in the market. Whatever the merits of the EU’s view as a WTO argument, its position ignored the realities of the regulatory process in a country with divided powers (McCubbins, Noll and Weingast, 1987; McCubbins, Noll and Weingast, 1989). Regulators in EU member states can improvise solutions speedily once delegated the power to do so. This is a characteristic of parliamentary systems (Cowhey and McCubbins, 1995). In the US, on the other hand, Congress has created limits on regulatory agencies use of power, meaning that the FCC must go through a lengthy rule-making and enforcement procedure before intervening in the marketplace. Waiting until a major problem arose meant FCC action might be hopelessly late in responding. The US thus preferred a WTO deal that authorized specific prior measures to prevent problems in the


international services market rather than relying on ad hoc enforcement to correct market distortions. A second example revolves around the EU preference for limited multilateral bargains as opposed to ad hoc bilateral negotiations. EU bargaining positions reflected the nature of the delegation of negotiating authority from member states to the EU, an over-riding imperative to stifle unilateral US trade initiatives, and the need for internal bargaining over external commitments. These three factors mean that the EU prefers limited multilateral arrangements that would stifle US unilateral forays, and tends to avoid bilateral bargaining outside the scope of predetermined delegations from member states. Moreover, supporters of a strong EU prefer multilateral trade agreements because they give the Commission an added claim to prompt jurisdiction over major domestic economic policies in EU member states. But these dynamics limited the options available to EU negotiators as the global talks wrestled with key competition issues. The WTO agreement The WTO pact on basic telecommunications services was a significant turning point for the world market. But it nearly failed to materialize because of how the internal constraints of the key negotiating partners interacted with the rules governing the WTO. Negotiations until 1997 For reasons explained previously, the EU initially favored leaving international telecommunications services off the table. And once put on the table the EU argued that they were no different than domestic telecommunications services. In contrast, the US was so worried about international services that it sponsored an informal negotiating group at the WTO to explore the competition issues surrounding international services. As explained previously, the competition issues posed by international telephone services largely depend on two conditions: the degree to which a foreign carrier faces competition in its home market and the degree to which settlement rates are significantly above efficient economic costs. The former determines whether the foreign carrier can use control of its bottleneck network facilities at home to employ anti-competitive tactics. The latter determines the financial significance, and thus financial incentives, of anticompetitive tactics. Everyone in the informal WTO group on international services agreed that there would be no problem in regard to international phone services if countries only had to open their markets to foreign carriers from countries that would permit across-the-board competition in all communications services subject to adequate regulatory safeguards. But the most favored nation rule of


the WTO (the same degree of market opening must be provided to all WTO members) prevented this deal. Any commitment to open the US market to Europe and Japan also opened it to Singapore, Brazil, Hong Kong, etc. As an alternative, the US offered a series of proposals that, within the color of the WTO rules, authorized the FCC to use some latitude to distinguish among competitive risks based on a foreign carrier’s market power in its home market. Different regulatory treatment would apply to carriers from different home markets. But no country would back a rule granting this kind of discretion for fear that it would weaken the core WTO principles of most favored nation and national treatment. Of course, most countries were also opposed to backing unilateral US initiatives that encouraged the FCC to dictate acceptable domestic regulatory arrangements elsewhere. The failure to reach agreement on what to do about international services meant the US almost failed to support the WTO agreement. The negotiation did not conclude in April 1996, as originally scheduled, primarily for this reason. The failure of the talks indicated that it had become clear that multilateral negotiations could not achieve a consensus between the US and Europe on how to restructure rules for the world market. The 1997 solution As negotiations resumed in summer 1996, some European governments quietly suggested that the WTO pact alone could cure the problem of international telephone services. As a result of a deepening European awareness of issues involving international phone services, they expected the EU to create counterpart rules to the FCC “Flexibility Order.” Therefore, together the US and European traffic would flow in ways that subverted settlement rates globally. Parallel regulatory action by the two trading powers would thus be a form of tacit backdoor initiative that might complement any multilateral deal. The European suggestion reflected a kind of sunny techno-optimism about globalization after the WTO pact that the US did not share for several reasons. First, even in industrial countries where competition in international services was a WTO commitment, it would take several years to generate enough competition to provide thorough alternatives to international settlement rates. Second, the industrializing countries (where international traffic growth is greatest) typically delayed the introduction of competition over periods from three to seven years in their WTO commitments. And the rest of the developing world made no or weak commitments in the WTO accord. The US recognized the WTO deal’s many virtues but decided in 1996 that it would have to revert to the path of bilateral liberalization rather than do nothing about the problem concerning international services. But in 1997 the US ultimately chose to pursue a third path: it decided to accept a WTO deal subject to two conditions. First, Europe had to join the US in making a final


major push to improve the market opening commitments of industrializing countries. Second, the EU and other industrial countries had to accept that the US was going to undertake a unilateral regulatory action outside the WTO that would apply to all countries—dubbed “benchmarks”—designed to knock the underpinning out of inflated international settlement rates. The US Government did not seek to negotiate this regulatory measure at the WTO. It simply declared that the new US policy would meet WTO obligations requiring competition regulations to honor the principles of MFN and nondiscrimination. The US did not demand that the other countries pledge backing for benchmarks, rather it sought agreement that they would agree to a WTO deal even if the US decided to press ahead unilaterally on benchmarks. The EU agreed on both points, and the result was a significant improvement in the WTO commitments on market opening by key industrializing countries. The unilateral regulatory initiative of the US caused a sensation because they directly targeted settlement rates. The benchmarks were price caps (i.e. legal limits on the maximum price) on the level of settlement payments that US carriers may pay to terminate their international traffic in other countries. If benchmarks worked they would remove the bulk of the economic rents that could fuel anti-competitive behavior in the market. (The details of the benchmarks, as implemented by the FCC in August 1997, are set forth in Appendix One.) One might ask why the US Government was sanguine enough about the success of benchmarks to undertake a WTO deal that did not specifically authorize benchmarks. There were three reasons for its confidence. Two of the reasons were important but technical. First, if there was a WTO challenge the US believed that benchmarks were fully compatible with most favored nation obligations because they were a least burdensome response to a competition problem.22 A second set of reasoning involved the timing of a WTO challenge. A challenge would take time. Indeed, the Chairman’s note on Accounting Rates at the conclusion of the WTO negotiations makes it doubtful that any country can bring a WTO challenge before January 1, 2000 (Arena, 1997). By this time, benchmarks would have largely accomplished their economic purpose. Third, as a matter of global strategy, the US negotiators also thought that melding the US commitments at the WTO to the introduction of “benchmarks” would provide both political and economic benefits. First, as a practical matter, the “benchmarks” were a big economic plus for US carriers, and the carriers recognized that “benchmarks” were more likely to withstand the predictable attacks by foreign governments if the US had created some measure of goodwill through a WTO agreement. Second, the shrinking of settlement rates by benchmarks would induce more dominant incumbent carriers around the world to drop their objections to “flexibility arrangements” more rapidly. Once the large rents on settlement rates eroded, even reluctant carriers might find


merit in a strategy based on cutting costs and stimulating demand through “flexibility.” In sum, benchmarks were a way for the US to solve a policy and political problem in regard to international services. With benchmarks in the works the US could accept a WTO deal. And it could be reasonably confident that a combination of benchmarks and the irreversible WTO commitments to opening the US market (thus boosting competition) would make it more likely that cost savings from benchmarks would contribute to lower prices for consumers. Ultimately, sixty-nine countries signed onto the WTO pact, including all of the OECD member nations. Commitments on opening markets covered about 85 percent of the world market for basic domestic and international telecom services. In the case of the OECD countries (with the exceptions of Korea and Mexico), the commitments covered almost all forms of domestic and international telecommunications services, and they included guarantees of foreign investment rights for new entrants. Moreover, they all agreed to a set of “pro-competitive regulatory principles” that created obligations for how national regulators would protect new entrants from anti-competitive behavior by incumbents with market power.23 Importantly, the WTO agreement made it possible for the FCC to argue that easier entry into the US market was now in the public interest because US carriers would have reciprocal rights in all of the major industrial markets. This was the key to ending the dilemmas created by a path relying solely on piecemeal bilateral liberalization. In short, the WTO pact was a remarkable achievement. But, as we would expect from our discussion of international regulatory institutions in part one, it was hardly in itself a panacea. The agreement in itself could not solve all the problems in regard to cross-border networks and services. And most countries outside the OECD world never dreamed that a WTO pact could upset traditional pricing arrangements for international services. Indeed, when the FCC finally imposed benchmarks in August 1997 the backlash showed how little change other countries had hoped for. Lessons for understanding globalization It is wise to be cautious about generalizing from a single case. But we think that the basic dynamics of international institutions and markets are not so radically different to make some attempt at generalization pointless. As a conclusion, we would suggest four points about this case that bear watching in other instances of coping with the globalization of markets. First, it is more important to look at the market consequences of policies than on their form. The final bargain at the WTO was an acknowledgment by the EU and Japan that the US had both economic and political reasons to tackle transition problems that went beyond the bounds of multilateral


consensus. Its WTO obligations make the US more accountable for the form that its unilateral initiatives take. But the globalization of this market (and, we think, others) will continue to rely on the interplay of multilateral reforms supplemented by unilateral American initiatives. The American role is partly a matter of opportunity created by its market power, but it is also a product of its domestic political economy. It is also a product of the constraints on policymaking imposed by the institutional rules of the WTO. Although internal constraints were thus the key determinants of policy choice and negotiating outcomes, external constraints were also important. Second, the new global regime for communications policy certainly reflects the power advantages of the industrial countries. The industrial countries are the world’s largest suppliers and users of communications and information services. Changing their approach to the global market is tantamount to making changes in the world market as a whole. But they would not have achieved a trade deal if the industrializing countries had fought it. In this case the industrializing countries had significance because of their high growth rates in key segments of the market, not because of their absolute size. The industrial countries, especially the US, saw the negotiation as an opportunity to force the issue of whether these markets would lock in a transitional path to fully competitive markets. Because of MFN obligations this was the moment when the industrial countries had the most latitude to get concessions. In short, if the industrializing countries had not come forward with good WTO offers there would have been no deal. They steadily improved their offers as the big trading powers turned the negotiation into a high-level political issue that made it possible to get a speedy resolution of tough domestic debates over telecommunications policy. This high-level diplomatic pressure was reinforced by market pressure as the industrial countries focused the attention of multinational users of advanced communications services, the international financial community and telecommunications investors on the decisions of the industrializing countries (Petrazzini, 1996). In essence, each industrializing country came to realize that its reputation as a good place to invest in communications services and as a host for multinational corporations was becoming identified with its position at the WTO talks. Given that telecommunications policy officials in these countries were charged with drawing billions of dollars in investment capital to upgrading their communications infrastructure, they slowly recognized that a commitment at the WTO would provide property rights for foreign investors and new market entrants that would bolster the credibility of their pledges to achieve a modern communications infrastructure. Third, the less developed nations had little to say about the new global rules. The choice of the WTO as a negotiating forum sidestepped the ITU, a forum whose diplomacy was more susceptible to the influence of smaller countries in a “one country, one vote” environment. And the industrial countries did not see them as crucial to any deal. So, these countries neither


faced major pressure to change their national policies nor could they alter the outcome of the WTO deliberations. Fourth, the WTO negotiation should be a sharp reminder that globalization does not signal an end to a major role for government regulation nor does it entail the abdication of national authority to international institutions. In the terms of this volume, it suggests that internal constraints continue to shape the rules governing globalizing markets more than other analysts of globalization might suggest. The WTO regulatory principles put national governments under significant obligations to use their competition powers to curb anticompetitive behavior by incumbent large carriers. And just as vitally, the principles explicitly endorse the right of governments to undertake regulatory schemes geared to assure achievement of universal communications service. Ultimately, as in Kudrle’s analysis of financial markets, the new regime for basic telecommunications services does not entail the end of domestic political autonomy in the pursuit of national policy objectives. It simply narrows the range of policy choices. Governments must be accountable to global markets, they need not be silent in response to the needs of their citizens. Appendix one: the FCC benchmarks Benchmarks are legally possible because the FCC’s authority to approve tariffs means that all settlement rates negotiated by carriers require approval by the FCC. The Order requires US carriers to negotiate settlement rates consistent with benchmarks. The achievement of benchmarks is to be phased in over time, with the speed of the transition depending on the national income level of the foreign country. The FCC expects proportionate progress toward the final benchmark during the time of transition, but it declined to set a precise test concerning progress. While the Order does not set out a standard enforcement policy, the FCC could instruct US carriers to pay no more than the benchmark rate or suspend all settlement payments until such time as compliance with the benchmarks has been achieved. Given the size of US payments to other countries this is significant bargaining tool. Table 6.1 summarizes the benchmarks. The Order grants additional transition time for countries whose loss of US settlement income in a given year would exceed 20 percent of national telecom revenues. Given the timing of the effect of benchmarks (the Order took effect on January 1, 1998 and the first “milestone” is January 1, 1999) the first critical point for a developing country is probably at the end of the first quarter of 1999. The benchmarks are tied directly to the WTO agreement by a simple rule. A foreign carrier will not have a transition period if its affiliate receives an US license to provide international facilities-based switched from the US to its home market. A condition for the use of the license for such traffic would be immediate compliance with the final benchmark rate (e.g. immediate


Table 6.1. FCC benchmark levels and transition periods

movement to 19 cents for a carrier from an upper middle income country). If carriers were later determined to be acting anti-competitively (in ways defined by the Order) the FCC would have the option of lowering the settlement rate to one consistent with best international practices (defined as eight cents per minute in the Order). The purpose of lowering settlement rates as a licensing condition is to remove the ability to use high profits off settlement rates to permit anti-competitive tactics. Notes 1 Peter Cowhey was directly involved in the policy decisions discussed in this paper. The views expressed are his alone, and do not necessarily reflect official US policy. John Richards, formerly Director of International Computer Services Research at the Stanford Computer Industry Project, wishes to thank the Sloan Foundation for supporting his research. 2 We assume that markets perform better if they are more competitive. All the usual caveats about distributional implications apply. 3 As Ostry (this volume) suggests, this is particularly true when key negotiating partners have divergent national regulatory and legal traditions. 4 The discussion of property rights draws on Richards, 1999. 5 Libecap defines property rights as “the social institutions that define or delimit the range of privileges granted to individuals to specific assets… ” Libecap, 1989, 1. 6 Note that we do not argue that international institutions define “efficient” property rights or that efficiency is the criteria by which international institutions are created, but merely point out that international institutions create wealth gains by providing property rights in international markets. 7 Although we agree with Ostry that domestic economic interests, in particular multinational enterprises (MNEs) were key drivers of the WTO accord on basic




10 11 12







telecommunications services, our analysis focuses on how domestic political institutions channeled the preferences of these private sector actors. William Drake and Eli Noam consider the proposition in Hufbauer et al. (1996) that the WTO pact may have only have ratified what would have occurred anyway. This view does not clash with our emphasis on domestic determinants of international regulatory regimes. But it does seem to miss the point that the WTO is a process for choosing some rough subset out of the universe of potential outcomes created by domestic politics. Their workforces typically were much better paid than the rest of labor, and the carriers had significant excess staffing. Thus, labor in these poorer countries was very skeptical of any reform. No one, including the Ministry of Post and Telecommunications, was satisfied with the degree of competition in the Japanese market in 1995. Settlement rates apply to switched international traffic (literally, services requiring the use of telephone network switches) offered on the public telephone network. Under the traditional system the economics of an international route depended on the “netting” of minutes. AT&T, for example, subtracts payments owed to it for terminating KDD traffic for under a settlement rate from the sum owed to the KDD for terminating AT&T’s outward bound traffic to Japan. Proportionate return rules reinforced the linkage of inward- and outward-bound routes. In 1995 the FCC formalized its rules governing foreign entry into the US market for basic telecommunications services in the form of the Effective Competitive Opportunities test. It believed this test was fairer than past practices and could eventually open the way to substantial opening of the US market. But it considered this route to be inferior to a good multilateral trade agreement. Foreign governments intensely disliked the test because they considered it an intrusive examination of their domestic regulatory practices. However, the ECO tests foreshadowed the regulatory principles adopted in the subsequent WTO agreement on telecommunications services. The Commission intentionally cast ECO in a manner designed to signal the rules it would consider necessary for a satisfactory WTO agreement. See Federal Communications Commission, 1995. These figures were calculated by the staff of the International Bureau of the FCC based on settlement rate data published by the Commission (Lande and Blake, 1997). The Commission did not object to a balance of payments deficit as long as it is a result of an efficiently priced market. Indeed, the US will surely run a payments deficit even with efficient pricing. At that time less than a half dozen countries (including Canada, the United Kingdom and Sweden) qualified for flexibility without special waivers from the FCC. Based on Cowhey’s notes from negotiating sessions between the US and the EU. It should be noted that Japan supported the WTO negotiations. But it, too, wanted to see what the two main players could agree upon before making its best offer. The United Kingdom did have a considerably more sophisticated view of the world market because of its competitive experience. However, the UK primarily sought to consolidate its position on the trans-Atlantic and intra-European routes and therefore decided to live with the costs of whatever else happened on other international routes.


19 The flexible legal arrangements favored by Aman in this volume would only worsen these credibility problems. 20 The EU, based on prior experience, believed the US promise that compliance by its state regulatory commissions would not be a major problem, especially after the passage of the 1996 Telecommunications Act that mandated competition in local telephone services. 21 Put comparatively, the EU member states ratify a tentative trade pact each time they authorize the Commission to make a new negotiating offer in a WTO negotiation. The Congress ratifies the US trade offer only at the conclusion of a negotiation although, of course, the Executive Branch tries to anticipate Congressional preferences. 22 MFN requires a country to offer the same level of benefits to all members of the World Trade Organization. MFN does not forbid countries to undertake competition policy measures whose practical impact may vary from carrier to carrier. 23 In this sense the WTO agreement supports Ostry’s contention that “all future negotiations…will reinforce the move inside the border.” See Ostry in this volume.

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Richards, John (1999) ‘Toward a positive theory of international institutions: regulating postwar international aviation markets,’ International Organization 53:1–37. Spruyt, Henrik (1994) The Sovereign State and its Competitors: An Analysis of Systems Change, Princeton, N.J.: Princeton University Press. Termin, Peter, with Galambos, Louis (1988) The Fall of the Bell System, Cambridge, MA: Cambridge University Press. Weingast Barry (1993) ‘Constitutions as governance structures: the political foundations of secure markets,’ Journal of Institutional and Theoretical Economics— Zeitschrift fur die Gesamte Staatswissenschaft 149, 1:286–311. Zacher, Mark with Sutton, Brent (1996) Governing Global Networks: International Regimes for Transportation and Communications, Cambridge, MA: Cambridge University Press.

Part III

This part identifies challenges posed by globalization and the coping strategies available to governments in two arenas: currency policy and fiscal policy. Benjamin Cohen examines strategies to cope with the deterritorialization of currencies while Robert Kudrle discusses whether economic globalization saps the fiscal power of the state, under what conditions, and how governments can respond to it. Cohen points out that when addressing issues of global finance, it is often assumed that currencies are sovereign within their respective territorial jurisdictions, whether within a single country or a monetary union. However, cross-border competition among currencies has become increasingly prevalent. Economic actors are no longer restricted to their home currency as they go about their daily business. Monetary sovereignty of states was predicated on governments being the main source of money. Where monopoly once existed in the supply of money, there is now an oligopoly. As a result, there are a finite number of autonomous suppliers—the national governments —vying to manage the demand for their respective currencies. Cohen points out that globalized money, in essence, is a political contest for market loyalty. How can governments cope with the growing deterritorialization of money? Cohen points out that like firms in an oligopolistic industry, states have only a limited number of strategies available to defend their currency’s market position. He identifies four categories of such strategies: market leadership, market preservation, market followership, and market alliance. All involve some combination of persuasion and coercion designed to influence preferences of users, either their own citizens or others. He analyzes both the conditions that determine state choice among the alternative strategies and factors determining their practical success or failure. Kudrle examines whether globalization has indeed diminished the fiscal power of the state, and if so, how can states cope with it. There is a burgeoning literature on international taxation issues that has paralleled the more general literature on globalization. Kudrle marries them systematically with an explicit focus on how state action is constrained and what options are available to governments. He examines two sets of questions: (1) has globalization resulted in a “race to the bottom” in the taxation of labor and capital incomes, and, if


so, (2) what sort of coping mechanisms can states employ to counter these trends? In terms of specifics, Kudrle examines five tax categories: (i) capital taxation, (ii) personal income taxation, (iii) taxation on consumption, (iv) social security taxation, and (v) new taxes—“green taxes” and the Tobin tax. There is an extensive discussion on both conceptual and empirical issues pertaining to coping mechanisms for these categories. He concludes that the fiscal challenges faced by high-income states pertain to their aging population, booming entitlements and declining savings rates and not a race to the bottom on tax policy. Further, the problems of fiscal degradation are self-induced and amenable to change through sound policies.

7 Marketing money Currency policy in a globalized world Benjamin J.Cohen

Introduction One of the most conspicuous manifestations of globalization in the contemporary era is the spread of cross-border competition among currencies. Over the last half century, linkages between national financial systems have grown increasingly tight: a particularly striking example of what Sylvia Ostry (this volume) calls “deeper integration” in today’s world economy. As a result of this deeper integration, the strict dividing lines between separate national monies have become less and less distinct. No longer are economic actors restricted to a single currency—their own home money—as they go about their daily business. More and more, whether at home or abroad, market agents are able to exercise effective choice in deciding what currency to use as medium of exchange, unit of account, or store of value. This is the new geography of money—the new configuration of currency space.1 The functional domain of each national money no longer corresponds precisely with the formal jurisdiction of its issuing authority. Currencies today have become increasingly deterritorialized, their circulation determined not by law or politics but rather by the dynamics of the global marketplace. This deterritorialization of money poses a new and critical challenge to states. With accelerating cross-border competition, governments find they can no longer control the use of money, by either their own citizens or others. In that sense, as in other areas of policy explored in this volume by Robert Kudrle and by Debora Spar and David Yoffie, a traditional dimension of national sovereignty is critically threatened. In effect, a key function of governance is rapidly slipping from the grasp of governments into the hands of market forces. As in other issue areas, therefore, policymakers are increasingly challenged to cope as best they can. To be sure, not all is lost for the conventional notion of monetary sovereignty. Money is fundamentally different from other issue areas where government is not a direct market actor, since even in an increasingly globalized setting the supply of money remains largely the privilege of the state. We are not yet in the world of “denationalized” currency advocated by


Nobel-laureate Friedrich Hayek (1990), where national monies would be replaced entirely by currencies issued competitively by private banks. Governments are still directly involved on the supply side of the market, remaining the principal source of money for all its various purposes. What is lost is the ability to control use: the demand side of the market. Monetary sovereignty thus persists but in severely altered form. Once monetary governance was organized more or less as a series of insular local monopolies, each state claiming absolute dominion within its own territory. Now, however, we find something much more like oligopoly—a finite number of autonomous suppliers, national governments, all vying ceaselessly to preserve or promote the use of their respective monies. In a globalized world, currency policy effectively becomes an unending contest for user loyalty. Like firms in an oligopolistic industry, states are compelled to shape and manage demand if they wish to defend market position. In short, they must market their money. Toward this end just a few broad strategies are effectively available to governments, as I shall outline below following a brief introduction to the new geography of money. A review of considerations that might be thought to determine the specific choices states make in response to currency deterritorialization suggests few opportunities for generalization. Neither economic nor political factors appear to offer a systematic basis for explaining government behavior in this regard. Generalization appears easier, however, when it comes to accounting for the practical success or failure of alternative policy choices. A review of available strategies underscores the critical role that user preferences now play in determining a government’s ability to attain its objectives. No strategy, whatever the reasons for its choice, can afford to ignore the imperatives generated by cross-border competition among currencies. The new geography of money When addressing issues of global finance, we are accustomed to thinking of money as effectively insular: each currency sovereign within the territorial frontiers of a single country or monetary union. In an era of spreading crossborder currency competition, however, nothing could be further from the truth. Governments have good reason to seek to preserve the principle of national monetary sovereignty. But in practice, increasingly, they have little choice but to learn how to cope with a loss of effective monopoly. Currency deterritorialization For a currency to be truly “territorial,” its functional domain would have to coincide precisely with the political jurisdiction of its issuing state—a very special case. The currency would have to exercise an exclusive claim to all the traditional roles of money within the domestic economy. There could be no


other money accepted for transactions purposes or used for the denomination of contracts or financial assets. And the government would have to be able to exercise sole control over the operation of the monetary system, dominating market agents. In matters of commerce, the equivalent would be described as “autarky”: national self-sufficiency. In truth, however, autarky is no more commonly achieved in monetary matters than it is in trade. As a practical matter, a surprising number of monies today have come to be employed widely outside their country of origin for transactions either between nations or within foreign states. The former is usually referred to as “international” currency use (or currency “internationalization”); the latter is typically described by the term “currency substitution” and may be referred to as “foreign-domestic use.”2 Reciprocally, an even larger number of monies now routinely face growing competition at home from currencies originating abroad. Both currency internationalization (CI) and currency substitution (CS) are a product of intense market rivalry—a kind of Darwinian process of natural selection, driven by the force of demand, in which some monies such as the US dollar or Deutschmark (soon to be replaced by Europe’s new single currency, the euro) come to be viewed as more attractive than others for various commercial or financial purposes. Cross-border circulation of currencies was once quite common prior to the emergence of the modern state system. More recently the practice has re-emerged, as declining barriers to monetary exchange have greatly expanded the array of effective currency choice. Competition between national monies is accelerating rapidly. As a result, the domains within which individual currencies serve the standard functions of money now diverge more and more sharply from the legal jurisdictions of issuing governments. Currencies have become increasingly deterritorialized. Regrettably, the full dimensions of today’s currency deterritorialization cannot be measured precisely. Since comprehensive statistics on global currency circulation do not exist, neither CI nor CS can be accurately or consistently documented with any degree of refinement. Partial indicators, however, may be gleaned from a variety of reliable sources.3 Though space limitations prevent their detailed reproduction here, some brief recapitulation can serve to underscore the impressive orders of magnitude involved. The clearest signal of the accelerated pace of CI is sent by the global foreign-exchange market where, according to the Bank for International Settlements (1996), average daily turnover has accelerated from $620 million in 1989 (the first year for which such data are available) to close to $1.3 trillion six years later—a rate of increase of nearly 30 percent per annum. A parallel story also seems evident in international markets for other financial claims, including bonds and stocks as well as bank deposits and loans, all of which have grown at double-digit rates for years. Using data from a variety of sources, Thygesen et al. (1995) recently calculated what they call “global


financial wealth”: the world’s total portfolio of private international investments. From just over $1 billion in 1981, aggregate cross-border holdings quadrupled to more than $4.5 billion by 1993—an expansion far faster than that of world output or trade in goods and services. The clearest signal of the accelerated pace of CS is sent by the rapid increase in the physical circulation of several major currencies, including especially the dollar, DM, and yen, outside their country of origin. For the dollar, an authoritative study by two Federal Reserve economists (Porter and Judson, 1996) puts the value of US bank notes in circulation abroad at between 55 and 70 percent of the total outstanding stock—equivalent to perhaps $250 billion in 1995. The same study also reckons that as much as three-quarters of the annual increase of notes in recent years has gone directly abroad, up from less than one-half in the 1980s and under one-third in the 1970s. Appetite for the greenback is obviously growing. Using a comparable approach, Germany’s Bundesbank (1995) has estimated Deutschmark circulation outside Germany at about 30 to 40 percent of total stock, equivalent to some DM 65–90 billion ($45–65 billion) at end-1994. In Asia, Bank of Japan officials are privately reported to believe that of the total supply of yen bank notes, amounting to some $370 billion in 1993, as much as 10 percent may now be located outside Japan (Hale, 1995:164). Combining these diverse estimates suggests a minimum foreign circulation of the three big currencies of at least $300 billion in all—by no means an inconsiderable sum and, judging from available evidence, apparently growing rapidly. The evidence also appears to suggest that a very wide range of countries is affected by the phenomenon, even if the precise numbers involved remain somewhat shrouded in mystery. According to one authoritative source, foreign bank notes account for 20 percent or more of the local money stock in as many as three dozen nations inhabited by at least one-third of the world’s population (Krueger and Ha, 1996:60–61). The same source also suggests that, in total, as much as one-quarter to one-third of the world’s circulating currency is presently located outside its country of issue (Krueger and Ha, 1996:76). These numbers clearly confirm the growing importance of both international and foreign-domestic use of money. Two main messages stand out. First, the scale of cross-border currency use is manifestly extensive, as well as growing rapidly, reflecting both the scope and intensity of marketdriven competition. Monetary circulation really is no longer confined to the territories of issuing countries. Strict autarky in currency relations is indeed a special case. Second, while the number of monies actually employed for either international or foreign-domestic purposes tends to be rather small, the number of those routinely facing rivalry at home from currencies abroad appears to be remarkably large. Deterritorialization also means that there is no longer a functional equivalence among national monies. Even though all currencies of sovereign states enjoy nominally equal status as a matter of


international law, some monies—to paraphrase George Orwell—clearly are far more equal than others as a matter of practical reality. Many monies, particularly in the developing world and so-called transition economies, face what amounts to a massive competitive invasion from abroad; others, especially those of the wealthiest industrial countries, are effectively immune from foreign rivalry at home. The population of the currency universe is in fact distinctly stratified. Topping the charts, quite obviously, is the US dollar, which remains by far the world’s most popular choice for both CI and CS. In effect, the dollar’s functional domain spans the globe, from the Western Hemisphere (where the accepted synonym for currency substitution is “dollarization”) to the former Soviet bloc and much of the Middle East (where dollars circulate widely as a de facto parallel currency). Next comes the DM, which until now has clearly dominated currency relations within much of Europe, including East Central Europe and the Balkans—a leading role that the euro is expected to take over from the DM as Europe’s monetary union formally comes into effect. And not far behind are the yen and a handful of other elite international monies, such as the pound sterling, Dutch guilder, and French and Swiss francs. Much lower ranked are the many currencies of poorer countries that are forced to struggle continuously for the loyalty of local users. Add these two messages together and a picture emerges that is strikingly at variance with the conventional imagery of strictly territorial money—a universe of increasingly intense competition as well as distinct hierarchy among currencies. Individually, national monies confront market forces that are increasingly indifferent to the barriers posed by political frontiers. Collectively, therefore, governments face a challenge to their monetary sovereignty that is unprecedented in modern times. Benefits of monetary sovereignty National monetary sovereignty, of course, continues to exist as a constitutive rule. It is the exceptional government that does not still seek to preserve, as best it can, an effective monopoly over the issue and management of money within its own territory. Production of money may not be an essential attribute of state sovereignty. Along with the raising of armies and the levying of taxes, however, it has long been regarded as such. It is easy to see why a monetary monopoly is so highly prized. Genuine power resides in the privilege that money represents. Four main benefits are derived from a strictly territorial currency: first, a potent political symbol to promote a sense of national identity; second, a potentially powerful source of revenue to underwrite public expenditures; third, a possible instrument to manage the macroeconomic performance of the economy; and finally, a practical means to insulate the nation from foreign influence or constraint.


At the symbolic level, a territorial currency is particularly useful to rulers wary of internal division or dissent. Centralization of political authority is facilitated insofar as citizens all feel themselves bound together as members of a single social unit—all part of the same “imagined community,” in Benedict Anderson’s (1991) apt phrase. Anderson stresses that states are made not just through force but through loyalty, a voluntary commitment to a joint identity. The critical distinction between “us” and “them” can be heightened by all manner of tangible symbols: flags, anthems, postage stamps, public architecture, even national sports teams. Among the most potent of these tokens is money, as Italian economist Tommaso Padoa-Schioppa has noted: John Stuart Mill once referred to the existence of a multiplicity of national moneys as a “barbarism”… One could perhaps talk of a tribal system, with each tribe being attached to its own money and attributing it magical virtues…which no other tribe recognizes. (Padoa-Schioppa, 1993:16) Money’s “magical virtues” serve to enhance a sense of national identity in two ways. First, because it is issued by the government or its central bank, a currency acts as a daily reminder to citizens of their connection to the state and oneness with it. Second, by virtue of its universal use on a daily basis, the currency underscores the fact that everyone is part of the same social entity—a role not unlike that of a single national language, which many governments also actively promote for nationalistic reasons. A common money helps to homogenize diverse and often antagonistic social groups. A second benefit of a territorial currency is seigniorage—the capacity a monetary monopoly gives national governments to augment public spending at will. Technically defined as the excess of the nominal value of a currency over its cost of production, seigniorage can be understood as an alternative source of revenue for the state, beyond what can be raised via taxation or by borrowing from financial markets. Public spending financed by money creation in effect appropriates real resources at the expense of the private sector, whose purchasing power is correspondingly reduced by the ensuing increase of inflation—a privilege for government if there ever was one. Because of the inflationary implications involved, the process is also commonly referred to as the “inflation tax.” Despite the economic disadvantages associated with inflation, the privilege of seigniorage makes sense from a political perspective as a kind of insurance policy against risk—an emergency source of revenue to cope with unexpected contingencies, up to and including war. Decades ago John Maynard Keynes (1924) wrote: “A government can live by this means when it can live by no other.” Generations later another British economist, Charles Goodhart (1995: 452), has described seigniorage as the “revenue of last resort”—the single most flexible instrument of taxation available to mobilize resources in the event of


an sudden crisis or threat to national security. It would be the exceptional government that would not wish to retain something like the option of an inflation tax. A third benefit derives from money’s potential impact on real economic performance—aggregate output and employment—as well as prices. So long as governments can maintain control of the supply or price of money within their own territory, they have the capacity—in principle, at least—to influence and perhaps even guide the overall pace of market activity. Money may be used to promote not only the government’s own narrowly drawn fiscal requirements but also the broad prosperity and strength of the state. It would be an exceptional government that would not wish to retain the familiar option of macroeconomic management too. Finally, an important benefit is derived in a negative sense—from the enhanced ability a territorial money gives government to avoid dependence on some other provenance for this most critical of all economic resources. Currency territoriality draws a clear economic boundary between the state and the rest of the world, promoting political authority. The closer government is able to come to achieving national monetary autarky, the better it will be able to insulate itself from outside influence or constraint in formulating and implementing policy. That sovereign states might use foreign monetary relations coercively, given the opportunity, should come as no surprise. As Jonathan Kirshner recently reminded us: “Monetary power is a remarkably efficient component of state power…the most potent instrument of economic coercion available to states in a position to exercise it” (Kirshner, 1995:29, 31). Money, after all, is simply command over real resources. If a nation can be denied access to the means needed to purchase vital goods and services, it is clearly vulnerable in political terms. The lesson is simple: if you want political autonomy, don’t rely on someone else’s money. Can deterritorialization be reversed? Thus we should not be surprised that states cling so resolutely to the idea of monetary sovereignty. What matters, though, is not formal principle but actual practice—and that depends not just on the supply of money but also on demand, over which governments today have decreasingly firm control. States exercise direct jurisdiction only over the stock of national currency in circulation.4 In an increasingly globalized world, not even the most authoritarian government can easily assure that its own money will always be preferred to currencies originating elsewhere. Can the deterritorialization of currencies be reversed? Reassertion of state control of demand for money as well as supply—a reterritorialization of currencies—is not impossible but would require a degree of governmental activism beyond anything that might be considered feasible in


practical terms. Neither unilateral nor collective action on the requisite scale seems likely in contemporary circumstances. Unilateral action, for example, would require each state to restore all of its own traditional monopoly by whatever means necessary, up to and including massive regulation of the convertibility of national money. The underlying authority for such an approach is unchallenged. Indeed, so long as the concept of absolute national sovereignty prevails as a juridical norm of global politics, autarky will always remain a viable option. As Louis Pauly (1995:373) has suggested, “states can still defy markets” if they wish. Defiance, however, would not come without a price. In today’s financially integrated world, opportunities for substitution between currencies continue to accelerate rapidly as markets grow for such innovative vehicles as swaps, options, and derivatives—all highly liquid stores of value that effectively facilitate user choice. Though not themselves money (as conventionally defined), derivatives are near enough in liquidity to amplify the velocity of currency circulation, thus further eroding the capacity of monetary authorities to regulate demand. Controlling the use of such instruments would obviously be difficult. Costs of reterritorialization, therefore, economic as well as administrative, would undoubtedly be astronomical—almost certainly higher than most governments would be prepared to tolerate politically. As a practical matter, unilateral initiatives to fully reterritorialize money would seem improbable except in the most dire of circumstances, such as a deep depression or national-security crisis. Moreover, they would also be highly damaging to the efficiency of financial markets and could trigger retaliatory restrictions elsewhere—a classic example of the sort of “race to the bottom” explored elsewhere in this collection by Spar and Yoffie. Alternatively states could try to “race to the top”—that is, to act collectively, aiming not to restore but to totally merge their individual monetary monopolies by creating a single world currency, as economist Richard Cooper (1984) has suggested. But the historical record (discussed at greater length below) shows how difficult it is to create or sustain a monetary union among even a limited number of sovereign states. How much more challenging would it be to negotiate a merger encompassing all, or even a majority, of the nearly two hundred countries around the globe? To ask the question is to answer it. A single universal money would not seem politically feasible either. In short, deterritorialization seems here to stay, however much states might prefer otherwise. Fewer and fewer governments are still able to enforce an exclusive role for their own money within established political frontiers. The state as oligopolist Not all is lost, however, so long as states remain dominant on the supply side of the market. Even if they can no longer compel use of their currencies, governments may influence demand insofar as they can


successfully compete, inside and across borders, for the allegiance of market agents. Practical authority may be retained insofar as user preferences can be swayed. In essence, therefore, monopoly has yielded to oligopoly. The role of states today has become not unlike that of competing firms in an oligopolistic industry—the state as oligopolist. This is as true for countries at the top of the currency hierarchy as it is at the bottom, In a world of increasing interpenetration of monetary domains, all governments find themselves driven to join the competitive fray, to preserve or promote market share for their product. Like oligopolistic firms, governments must assert influence by doing what they can, consciously or unconsciously, to shape and manage demand— in short, to market their money. Commercial rivalry between states is nothing new, of course. Governments have always contested one another for markets and resources as part of the great game of world politics. Nor is the idea that all states must now vie to attract diverse market agents any longer particularly novel. More than a decade ago, Susan Strange (1987:564) had already noted how the spreading globalization of world markets was pushing governments into a new kind of geopolitical rivalry, “competing for world market shares as the surest means to greater wealth.” More recently, Philip Cerny crystallized the idea in his notion of the “competition state”—governments “driven,” as he puts it, “by the imperatives of global competition to expand transnationalization” (Cerny, 1994:225). It is these imperatives that threaten “races to the bottom” in diverse areas of policy today. The competition state, however, participates in markets only indirectly, mainly as a catalyst to alter incentives confronting agents on both sides, supply as well as demand. What is unique about cross-border currency competition is that the state participates directly as the dominant actor on one side: the supply side. It is the government’s own creation, its money, that must be actively marketed. That direct involvement sharply distinguishes currency policy from other issue areas, such as fiscal policy or commercial policy, that are addressed in this volume by Kudrle, Spar and Yoffie, and Ostry. Parallels exist, of course, insofar as in the realm of money, no less than in matters of taxes or trade, government is compelled to cope with a serious threat to its ability to govern. Nonetheless, the challenge for policy is qualitatively different when the state itself is a major market player. Oligopoly provides a particularly apt analogy for the market for currencies because of oligopoly’s two key structural characteristics: interdependence and uncertainty. Both are inherent features of the traditional state system as well. In the state system, as in an oligopolistic industry, actors are sufficiently few in number so that the behavior of any one has an appreciable effect on at least some of its competitors; in turn, the actions and reactions of other actors cannot be predicted with certainty. The result is an interdependence of decisionmaking that compels all states, like rival firms, to be noticeably preoccupied


with considerations of long-term strategy. In this sense, producers of currency are essentially no different from producers of cars or computers. Moreover, like producers of cars or computers, currency producers compete via efforts to manage the demand side of the market—in effect, to “sell” their product. Their targets are the users of money, at home or abroad. Their aim is to sustain or enhance a money’s attractiveness to users, much as if currencies were goods to be sold under registered trademarks. As economist Robert Aliber has quipped, “the dollar and Coca-Cola are both brand names” (Aliber, 1987:153). In his words: Each national central bank produces its own brand of money…. Each national money is a differentiated product…. Each central bank has a marketing strategy to strengthen the demand for its particular brand of money. (Aliber, 1987:153, 156) Three key questions are prompted by this transformation of the market for money, from monopoly to oligopoly: What strategies are available to governments to market their particular brand of currency? What explains the choices that governments make among these alternative strategies? And what accounts for the success or failure of their choices? Choosing a strategy Like oligopolistic firms, governments have only a limited number of strategies available to shape or manage demand for their money. Choices among strategies, not surprisingly, reflect political as well as economic considerations, defying easy generalization. Strategies and tactics Broadly speaking, economic theory distinguishes between two contrasting approaches to the formulation of competitive strategy in an oligopolistic industry. Firm behavior can be either defensive or offensive—that is, designed either to build defenses against existing competitive forces; or, alternatively, to attack existing conditions in order to enhance market position. The former seeks to match the firm’s strengths and weaknesses to its environment, taking the structure of the industry as given. The latter seeks to improve the firm’s position in relation to its environment by actively influencing the balance of forces in the marketplace. Currency policy, too, can be either defensive or offensive, aiming either to preserve or promote market share. In turn, each approach may be pursued either unilaterally or collusively, yielding a total of four possible broad strategies. These are:


1 Market leadership: an aggressive unilateralist policy intended to maximize use of the national currency, analogous to predatory price leadership in an oligopoly. 2 Market alliance: a collusive policy of sharing monetary sovereignty in a monetary or exchange-rate union of some kind, analogous to a tacit or explicit cartel. 3 Market preservation: a status-quo policy intended to defend, rather than augment, a previously acquired market position. 4 Market followership: an acquiescent policy of subordinating monetary sovereignty to a stronger foreign currency via some form of exchange-rate rule, analogous to passive price followership in an oligopoly. Strategies, in their turn, require tactics. For governments, again, two broad possibilities are available—either persuasion or coercion. Though neither type of tactic is foolproof, each can be highly effective in influencing a currency’s market position. In practice, most governments make use of both in varying combinations, depending upon their choice of strategy, since the two types are not mutually exclusive. Persuasion is of course the standard approach of the private sector, where coercion is presumably illegal. In an industrial oligopoly, rival firms may enhance the appeal of their products via price cuts, quality improvements, aggressive advertising, or any number of similar marketing devices. In the global arena states can try to do the same by investing in their money’s reputation, acting to reinforce the attractiveness of a currency for any or all of the usual monetary purposes. The idea is to enhance confidence in the money’s continued usefulness and reliability—not something that can be accomplished quickly and certainly not without cost and effort. Considerable resources may have to be expended to establish or sustain a successful brand name. Several means of persuasion are possible. Most narrowly, use of a money might be encouraged by higher interest rates, convertibility guarantees, or special tax advantages on selected liquid assets. More broadly, governments can try to promote acceptance by facilitating expansion of a currency’s circulation—for example, by sponsoring development of asset markets denominated in their own money. Most fundamentally, a currency’s reputation may be buttressed by a credible commitment to “sound” monetary management, a characteristic that is highly prized in the Darwinian struggle among monies. Complementing all these is the possibility of coercion—legally, the unique privilege of sovereign governments in the modern state system. True, oligopolistic actors in the private sector may also resort at times to high-pressure tactics, such as compulsory tying arrangements or exclusive marketing schemes, but only insofar as the law allows and never backed by a legitimate threat of force. States, on the other hand, are the ones who actually make the


law and are the embodiment of coercive authority. The principle of political sovereignty permits governments, alone among economic agents, to rely on more than just the art of persuasion to defend market position. Indeed, coercion has long been a part of every government’s arsenal in monetary affairs, going back to the monopolization of monetary powers that began in the nineteenth century. Most prevalent are legal-tender laws and socalled public receivability provisions. Legal tender is the term given to any money that a creditor is obligated to accept in settlement of a debt. Public receivability refers to what currency may be used for remittance of taxes or to satisfy other contractual obligations to the state. Also available, in principle, are exchange and capital controls or other measures of financial repression. It may not be true that conventional territorial currencies would disappear completely in the absence of legal restrictions, as some economists have argued. But it is evident that without such measures the demand for many national monies, particularly those most challenged by competition from abroad, would be significantly reduced—for some, perhaps even to the vanishing point. What explains the choices that governments make among these alternative strategies and tactics? Economic considerations On a matter as inherently commercial as currency, one might expect states to weigh economic considerations quite heavily in deciding how to cope with the growing deterritorialization of money. In practice, however, economics appears to play a determining role only at one extreme of the geopolitical spectrum—among the tiniest specks of political sovereignty in the contemporary system. For states of any size or consequence at all, policy choices appear rather more complex. Very small or weak states really have little choice given the high fixed costs involved in administering a credible currency of their own. A substantial infrastructure is required to produce and manage a national money, implying substantial diseconomies of small scale. It is hardly surprising, therefore, that most of the world’s scattered mini-states prefer to do without a national money altogether, relying instead on the currency of a larger neighbor or patron—the most absolute form of market followership. All these, however, appear to be rather special cases, tiny enclaves or the deferential wards of powerful patrons. All are examples of what political scientist Robert Jackson (1990) calls “quasistates”: countries whose sovereignty is more juridical than empirical. Though legally constituted as nation-states and formally recognized by the international community, they lack the means or will to provide all the elements of practical governance or to insulate themselves effectively from foreign influence. Their political independence has always been much less than absolute. Hence little more is lost by a surrender of formal monetary authority, other than the


symbo lism of a national currency and the privilege of seigniorage. Giving up the standard instruments of macroeconomic management, money supply and the exchange rate, means little in the absence of a capacity to use such tools effectively. What about the non-special cases—the great majority of the world’s diverse population of states? There is of course no easy way to directly gauge the role of economics in such decisions, particularly given how recent the phenomenon of currency deterritorialization is. Indirect evidence, however, abounds in the empirical literature, permitting fairly strong inferences. Even though few studies explicitly address the spread of cross-border competition, work to date on closely related issues suggests little connection between strictly economic considerations and the strategies governments choose to manage demand for their money. Consider, for instance, the numerous studies that focus on the choice of exchange-rate regime, based on the familiar theory of optimum currency areas (OCAs). At issue here is what motivates a government to choose between a fixed or flexible exchange rate—in effect, between a strategy of market followership (subordination to a currency peg) or market preservation (the independence of a free float). For analytical purposes, policymakers are presumed to be concerned exclusively with macroeconomic performance: maximizing output and minimizing inflation in the context of an open economy subject to internal or external shocks. The standard approach is then to test for the influence of various economic criteria suggested by OCA theory that might motivate a government’s decision, emphasizing, in particular, conditions affecting the costs of balance-of-payments adjustment. Most prominently, these variables are thought to include wage and price flexibility, factor mobility, geographic trade patterns, the openness of economies, and the nature and source of potential disturbances. States are expected to demonstrate a preference for fixed rather than floating exchange rates to the extent that prices and wages are flexible, factors of production are mobile, trade interdependence is high, economies are open, and shocks tend to be synchronized rather than asymmetric. The same type of approach has also been used to test for the influence of economic criteria on the choice of market alliance as a strategy. Can the variables highlighted by OCA theory explain either the decision to form a monetary union—the main object of interest these days being, quite naturally, Europe’s newborn Economic and Monetary Union (EMU)—or else the ability of a monetary union, once formed, to survive? Such studies rest on impressive theoretical foundations. Results, however, greatly qualify the importance of economics as a motivating force in government choices among currency regimes. Indeed, there appears to be little in the historical record to suggest that the decision to form a monetary alliance is dictated principally, or even marginally, by economic considerations. As Paul De Grauwe has observed: “Not a single monetary union in the past came


about because of a recognition of economic benefits of the union. In all cases the integration was driven by political objectives” (De Grauwe, 1993:656). Among the few monetary unions currently in operation around the globe—the Belgium-Luxembourg Economic Union (BLEU), CFA Franc Zone, Common Monetary Area (combining South Africa with Lesotho, Namibia and Swaziland), and East Caribbean Currency Area—one (BLEU) grew out of the security needs of a small and vulnerable mini-state and the others from arrangements initially imposed by colonial powers. None was driven by economics. Likewise, in Europe today, after decades of debate, it has by now become abundantly clear that the purely economic case for EMU is inconclusive at best. The real issues, most sources concur, are unquestionably political, relating first and foremost to the Maastricht Treaty’s declared goal of an “ever closer union.” To its enemies as well as to its friends, the new euro is seen as a harbinger of eventual political integration. In the words of one careful survey: Although there are surely economic benefits to be expected from a monetary union, the main driving force for [EMU’s] resurgence remains the quest for the political integration of Europe…. The main objections to monetary union have also been largely political. (Fratianni, von Hagen and Waller, 1992:1–2) Nor do economic considerations seem to be decisive in determining the sustainability of a monetary union, as I have suggested elsewhere (Cohen, 1993). The variables highlighted by OCA theory suffice to explain neither the present success of today’s few existing unions nor the past failure of others, such as the East African Community in the 1960s or the Latin and Scandinavian Monetary Unions in the nineteenth century. Some regularities do appear to exist in the choice between market preservation and market followership. It seems fairly clear, for example, that the least flexible forms of exchange-rate rule—currency boards or singlecurrency pegs—are employed mostly by comparatively small open economies, especially those with a high degree of geographical or commodity concentration of trade, whereas greater flexibility tends to be preferred by states with more diversified economic relations. It also seems evident that looser forms of pegging are often associated with more advanced levels of financial development and sophistication of economic management. But beyond a few broad observations like these, little explanatory power is provided by such work. Concedes one recent study: Overall the country characteristics do not help very much to explain the countries’ choice of exchange rate regime. It might be that the choices are based on some other factors, economical or political. (Honkapohja and Pikkarainen, 1994:47–8)


Indeed. Should we be at all surprised that politics too might enter into so critical a decision? Political considerations In fact, political factors enter in two ways. First, the policy calculus is manifestly affected by domestic politics: the tug and pull of organized interest groups of every kind. As Jeffry Frieden has emphasized, “domestic distributional considerations are also central to the choice of exchange rate regimes” (Frieden, 1993:140). The critical issue is the familiar one of whose ox is gored. Who wins and who loses? The material interests of specific constituencies are systematically influenced by what a government decides to do with its money. Producers of tradable goods, for example, as well as internationally active investors, are all apt to be favored by a currency rule that maximizes the predictability of exchange rates. Exchange-rate volatility, for such groups, is an anathema. Domestically oriented sectors, by contrast, are more likely to benefit from stability at home and thus to attach higher priority to preserving as much national policy autonomy as possible. Such groups stand to lose most from a fixed parity, insofar as the regime reduces the flexibility of monetary policy. Government choices are bound to be sensitive to the interplay among such domestic political forces. Second, the calculus comprises much more than just macroeconomic performance alone. Plainly, political goals—symbolism, seigniorage, insulation —also figure in government choices, as the history of monetary unions certainly makes clear. Politics is involved not only in the formation of currency alliances. Political factors, the historical record suggests, dominate as well in determining whether an alliance, once formed, will manage to survive or not (Cohen, 1993). Most essential, it seems, is the presence of one or the other of two critical conditions: either a locally dominant state willing and able to use its influence to keep the union operating effectively; or, alternatively, a well-established fabric of related ties sufficient to make the loss of a separate national currency, whatever the costs involved, seem basically acceptable to each partner. In principle, monetary union requires an irreversible commitment on the part of every participating government—something that, in practice, may turn out to be difficult for sovereign governments to sustain in the face of ever-changing circumstances. To convince participants to stick to their bargain, should terms eventually prove inconvenient, strong incentives are required. These incentives may derive either from side-payments or sanctions supplied by a single powerful state or from the constraints and opportunities posed by a broader network of institutional linkages. Political goals obviously also figure in the choice between market preservation and market followership. Outside the few monetary unions now in existence, governments naturally remain sensitive to the scope of their discretion to pursue diverse policy objectives in the event of unforeseen


adverse developments, up to and including war. Few governments are naturally disposed to give up their “revenue of last resort” if they can help it; in an insecure world, most states quite logically would rather minimize their vulnerability to any possibility that their monetary dependence might be exploited. Policy flexibility, in short, is a defense against uncertainty. Hence many governments prefer to hold back from firm exchange-rate rules of any kind (market followership) rather than risk the necessity of reneging because of a unexpected change of circumstance. Over the quarter century since the breakdown of the Bretton Woods par-value system, there has been a steady trend away from formal pegs toward more flexible currency arrangements (market preservation). Some regularities appear to exist here too. There is good reason to expect, for instance, that the option of the inflation tax would be most attractive to governments plagued by unstable or divided polities, where tax collection is difficult and enforcement costs are high. Since the ability to extract seigniorage in turn depends on an effective monetary monopoly, which is easiest to maintain when the exchange rate is allowed to float, we should not be surprised as a result to find that resistance to pegging in practice tends to be greatest in countries with a high degree of political instability (Edwards, 1996). Once again, however, beyond a few broad observations like these, few generalizations seem possible given the vagaries of distributional or other political considerations. Politics is simply too difficult to model for systematic predictive purposes. Accounting for success or failure By contrast, generalization is rather easier when it comes to evaluating government strategies, whatever the reasons for any particular choice. The key is how official policies interact with prevailing market preferences. State actions that ignore or defy market sentiment—the attitudes and perceptions of the users of money—are bound to encounter serious resistance. Efforts that accommodate or cultivate popular sentiment, on the other hand, are much more likely to facilitate effective defense of a currency’s market position. The underlying reasoning is straightforward. Market sentiment matters because of the unique importance of psychology in the functioning of money. Recall the standard definition of money—in the words of one economics dictionary, “Anything which is immediately and generally acceptable for the discharge of a debt or in exchange for a good or service” (Rutherford, 1992: 305). The emphasis is on immediately and generally acceptable, a phrase that clearly implies judgment as much as fact. At issue is trust: sufficient confidence in a currency’s future reusability to persuade transactors of its present validity for payments and investment purposes. Indeed, money has no meaning at all apart from the reciprocal and collective faith that makes its circulation possible. The appeal of any single currency is directly related to the


number of agents that can be assumed will be prepared to hold or use it. The larger the network of transactors that can be counted on, the greater will be the economies of scale—what theorists call money’s network externalities—to be derived from relying on one currency rather than another. Money’s users do not have to be trained economists to sense the importance of a large transactional network. In a world of spreading cross-border competition, therefore, no currency will be embraced, no matter how vigorously its issuing government may campaign on its behalf, unless actors are confident that it will be subsequently accepted at face value by others. Government strategies are most likely to succeed if they can be effectively aligned with popular perceptions of prospective network externalities, expressly tailoring policy to opinion or opinion to policy. Strategies are least likely to succeed if they are premised on a false reading of a currency’s general acceptability. The importance of such considerations is evident from even a cursory survey of relevant historical experience. Market leadership Consider the strategy of market leadership. If adoption of another nation’s currency is an option restricted to just one extreme of the geopolitical spectrum, market leadership remains plausible only at the opposite extreme—a choice that cannot even be realistically contemplated except by a small handful of privileged governments with the most widely circulated monies. Not even among such governments, however, can success of an aggressive marketing approach be unequivocally assured. Much depends on the depth of loyalty among a currency’s present users, which in turn is a direct function of popular perceptions concerning the money’s future usefulness and reliability. The advantages of market leadership are clear. Wide international circulation amplifies all the benefits of traditional monetary sovereignty. Prestige is certainly enhanced by extensive cross-border use, as are opportunities for seigniorage at the expense of non-residents. Sustained foreign accumulation of banknotes generates the equivalent of an interest-free loan; additional subsidization is implied to the extent that foreigners are willing to tolerate lower interest rates on financial assets because of a currency’s broader acceptability—what economists call a “liquidity premium.” Macroeconomic policy flexibility is reinforced insofar as the national money can be used to finance international payments disturbances. And political power is strengthened by the opportunity afforded to exercise effective influence over dependent states. But disadvantages are evident as well, particularly as liquid foreign liabilities continue to accumulate over time, heightening the risk of sudden or substantial conversions into rival currencies. Policy will increasingly be constrained by the need to sustain market


confidence. No strategy of leadership can work if it proves inconsistent with the preferences of users. Apt examples are provided by the contrasting experiences of the United States and Great Britain after World War II. Both countries had currencies that were widely used internationally; neither was averse to policies that might bolster the market position of its money. On the US side, promotion of the dollar was somewhat incidental to the broader objective of rebuilding a monetary order shattered by the Great Depression and World War II. Nonetheless, Washington recognized the advantage of being able to finance foreign expenditures—be they for aid, investment or military purposes—in America’s own currency; and hence played the leading role in building a system of exchange rates and reserves, the Bretton Woods system, that would be based directly on the greenback. On the British side, intentions were more explicit and were openly intended to preserve as much as possible of the pound sterling’s once proud place in global finance. Principal emphasis was placed on reinforcing the sterling area, at the time the largest and most coherent currency bloc in the world. To preserve the bloc’s appeal for overseas members, London offered high interest rates and even, after devaluation of the pound in 1967, formal exchange guarantees on reserve balances. To discourage exit, foreign governments were threatened with a loss of access to Britain’s capital markets. What were the results? For its part, the United States found itself pushing against an open door. No one questioned the usefulness or value of the greenback. Thus little persuasion was needed to promote market demand. For Britain, by contrast, the challenge was far more difficult, given the parlous state of the country’s external accounts at the time. Loyalty to sterling could not be easily sustained in the face of inconvertibility and widespread devaluation fears, which raised serious doubts about the currency’s future acceptability; and in the end, London’s protracted efforts to prevent dissolution of the sterling area proved not just futile but embarrassing. Popular perceptions were accurately summarized in the satirical words of television celebrity David Frost: It’s a shame to see what has happened to sterling. Once, a note issued by the Bank of England proudly read: “I promise to pay the bearer on demand the sum of one pound.” Now it simply reads: WATCH THIS SPACE. Market alliance As an alternative to an aggressive unilateralist policy, market alliance offers the benefit of numbers—and thus the hope that the whole will, in effect, be greater than the sum of its parts. One common currency in lieu of several obviously offers a broader network of transactors and hence greater economies


of scale in use. The result, accordingly, should be an improvement of acceptability as compared with separate national monies. Though no direct method exists to estimate how market shares have been affected by today’s few examples of monetary union, it is hard to believe that user preferences have not been affected. Could anyone seriously argue that seven separate currencies in the East Caribbean or fourteen in francophone Africa would be as competitive as are one East Caribbean dollar or CFA franc? What of Europe’s new euro? Here, too, it seems not unreasonable to assume that aggregate demand will exceed that for the national currencies to be replaced. Indeed, in the opinion of many, the euro will soon become so popular that it might even challenge the hitherto leading role of the dollar at the top of the monetary charts. Even with Britain remaining for the time being on the outside (along with Denmark, Greece and Sweden), EMU will boast a combined economy comparable to that of the United States and an even greater portion of world trade—portending network externalities that seem destined to enhance the appeal of the euro, whether for CI or CS, at the expense of the greenback. The only question, it appears, is how pro-active “Euroland” will need to be to assure a significant gain of market share. For observers such as Fred Bergsten (1997), little further action is needed owing to the large domestic markets and extensive foreign trade ties of EMU members. Full parity with the greenback, or possibly even supremacy, is only a matter of time. More cautious analysis, however, suggests that widespread displacement of the dollar is unlikely in the absence of additional policy measures, including, in particular, initiatives to make Europe’s financial markets more integrated and less expensive (Cohen, 1998a:156–61; Portes and Rey, 1998). Because of the potentially high cost of switching activity from one money to another, market agents will have to be persuaded that there really will be cross-border networks of sufficient size before making a major commitment to the euro. Europe’s strategy of market alliance could succeed in marginally eroding the greenback’s popularity but, without further interventions by EMU governments, will almost certainly not be enough to eclipse it. Market preservation Market preservation is the natural response of governments determined to defend traditional monetary sovereignty against the encroachments of crossborder competition. Though local monopoly may be compromised, demand can still be contested. Experience makes clear, however, that loyalty to the national brand of money can be promoted successfully only if market sentiment is accurately assessed or cultivated by state authorities. Chances of success are least if states mainly rely on tactics of coercion rather than persuasion to protect market position. New or strengthened legal restrictions, in the absence of any more positive measures to build confidence


in a currency, are only likely to reinforce doubts about future acceptability. During Latin America’s peak inflation years of the 1980s, for instance, several governments in the region tried to suppress dollarization of their local economies by imposing exchange controls, forcibly converting foreigncurrency accounts held at domestic banks into local money. These included Bolivia and Mexico in 1982 and Peru in 1985. Little was done, though, to restrain their appetite for seigniorage, which of course was well understood to be a root cause of their inflations. In all three cases, therefore, the immediate response was a decisive vote of no confidence by the public: a clandestine flight of funds into accounts abroad that undermined rather than bolstered the market position of national money. Studies indicate that in the aggregate, taking account of deposits held in foreign as well as domestic banks, currency substitution in these countries actually increased rather than decreased after exchange restrictions were instituted (Brand, 1993; Savastano, 1996). In all three, the failed measures ultimately were abandoned. Nor are tactics of persuasion, in lieu of coercion, apt to do much better if they are limited mostly to measures that are transparently cosmetic in nature. Mere exhortation, for instance, will almost certainly be unable on its own to promote brand loyalty, no matter how clever the Madison Avenue techniques involved. Numerous examples exist of governments that have tried to transform currency policy into an exercise in political symbolism. A marketdriven invasion of foreign money can be treated as the equivalent of an overt military aggression; defense of the national currency may then be celebrated as a glorious stand on behalf of the “imagined community”—the ultimate expression of amor patriae. A case in point was Indonesia at the start of the Asian financial crisis in 1997 when the country’s money, the rupiah, first came under attack. Indonesian authorities responded with public-service advertisements showing a currency trader wearing a terrorist mask made of US $100 bills. “Defend the rupiah,” the notices urged. “Defend Indonesia.” Such techniques rarely achieve much, however, without more substantive measures to sway public opinion. Certainly the Indonesian gambit failed to prevented continued currency flight and eventually an 80 percent depreciation of the rupiah. Most likely to succeed are measures that directly enhance the prospective usefulness and reliability of a money—in particular, as indicated earlier, a policy regime that makes a credible commitment to “sound” monetary management. “Sound” in this context means policies that place a high priority on domestic financial stability. Above all, it means resisting the temptation to exploit the privilege of seigniorage: a voluntary limit on creation of money to underwrite public spending. Nothing is more effective in building or restoring confidence in a currency than fiscal self-denial—a “patience for revenue,” as one economist has put it (Ritter, 1995:134). Dramatic evidence was provided by Israel in the early 1980s, as well as more recently by several countries of the former Soviet bloc—including especially Poland and Mongolia—where


dollarization, initially triggered by hyperinflationary conditions, was subsequently reversed by determined programs of macroeconomic stabilization (Sahay and Vegh, 1996). Credibility does not come cheap, of course. Such programs may incur high costs in terms of lost growth or increased unemployment. But without them it may never be possible to sustain a currency’s reputation among prospective users. States must literally put their money where their mouth is if they are to have any hope at all of preserving market position. Market followership For some states, however, the game may not seem worth the candle. Despite the attractions of retaining a degree of policy flexibility, strenuous efforts to invest in brand loyalty may be dismissed as simply too expensive, either economically or politically. For such states only one option remains: market followership. Monetary sovereignty must be subordinated to a stronger foreign currency. Market followership is particularly attractive to countries with a long history of past inflationary excesses, as was the case in much of Latin America during the 1970s and 1980s. Empirical studies in the region clearly demonstrate a strong correlation between the duration of inflation and the durability of dollarization: the longer the value of a nation’s currency was allowed to erode, the more difficult it has been to reverse CS even once financial stability was restored (Savastano, 1996). In such circumstances subordination to a stronger foreign money, via a currency board or firm exchange-rate link, can accelerate the process of rebuilding confidence in a feeble national money. By “tying one’s hands,” credibility may be borrowed from abroad. Acceptability for the local money can be cultivated, in effect, by piggy-backing on the popularity of another. Perhaps the most conspicuous example has been provided by Argentina, which back in 1991—after years of inflation and a succession of worthless moneys—adopted a formal currency board as part of a stabilization program dubbed the Convertibility Plan. Despite subsequent tribulations triggered first by Mexico’s financial difficulties in 1994–95 and then by the more recent Asian crisis, the Convertibility Plan does seem to have succeeded in restoring Argentinians’ pride in their own national currency. Market followership is also attractive to countries vulnerable to uncertainty about the future of a newly created money, as in the successor states of the former Soviet Union after the end of the Cold War. Estonia and Lithuania, for example, have both made use of currency-board arrangements to successfully launch new national currencies after regaining their lost independence, with reputation imported through an unrestricted guarantee of convertibility at a fixed exchange rate. In time, of course, as loyalty to the national brand of money is gradually constructed or restored, the attractions of subordination may begin to pale as


compared with the advantages of more traditional monetary sovereignty. Lithuania, for example, has already begun a phased exit from the formal currency board it adopted in 1994. In this sense market followership may be seen as essentially a transition strategy, paving the way in time for more flexible arrangements that would afford governments a greater degree of discretion in policy. But even then the importance of respecting market sentiment is clear. Just as the decision to cede authority to a foreign currency may reflect an acquiescence to market forces, so the timing of any restoration must be sensitive to the attitudes and perceptions of money’s users. Premature optimism regarding prospective acceptability could do more harm than good to a currency’s general reputation. Conclusions What, then, can we conclude about the challenge of currency deterritorialization? Implications for governments may be read two ways. On the one hand, states have clearly lost their traditional monopolies. As compared with the old geography of money, national sovereignty has been severely compromised; the possibility of reterritorialization does not seem a realistic option. But on the other hand, states are still the dominant suppliers of money. Hence authority remains intact insofar as demand can be successfully managed. Moreover, governments retain a range of choice among alternative strategies and tactics, so long as they do not stray too far from the imperatives generated by cross-border rivalry among currencies. So is the glass half full or half empty? The reality is that the nation-state is no longer so powerful as it once claimed to be, but neither has it been as neutered as some more pessimistic scholars of globalization would have us believe. Rather, authority is now shared symbiotically between governments and market agents, all guided by the invisible hand of competition. Can this conclusion be generalized for other issue areas in today’s globalized world? To some extent, as indicated, money is sui generis—distinct not only because of the still central role that states play on the supply side but also because of the unique importance of psychology in the way money functions. Nonetheless, a core message emerges that seems close to universally applicable: as national economies become more and more deeply integrated, economic governance becomes less associated with the formal structures of government and more a product of competitive forces in the marketplace, involving governments as well as private-sector actors. This is not a matter of states versus markets but rather states as part of the market. Whatever the issue at hand, governments still have a vital role to play so long as they can master the basics of supply and demand.


Notes 1 For a general discussion of the geography of money and the contemporary spread of cross-border currency competition, see Cohen (1998a). For a specific introduction to the main themes addressed in this essay, see Cohen (1998b). 2 Useful sources on currency internationalization include Krugman (1992); Black (1993). General introductions to currency substitution include Giovannini and Turtelboom (1994); Mizen and Pentecost (1996). 3 Representative samples can be found in Thygesen et al. (1995); Eichengreen and Frankel (1996); Cohen (1998a). 4 Rivals to national moneys do exist, of course, but for the present mostly take the form of very local private monies that pose no serious threat to government dominance of supply. Matters could change, of course. Given the pace of change in cyberspace, for example, it is not at all difficult to imagine new and more threatening competitors eventually emerging if and when digital entries in computers—electronic cash or “e-cash,” as they are sometimes called—begin to substitute widely for bank notes and checking accounts as customary means of payment. In time, privately issued e-cash could become even more popular than national moneys, ultimately realizing Friedrich Hayek’s (1990) vision of “denationalized” money whether governments like it or not. Even that threat, however, will remain nothing more than hypothetical until e-cash, once introduced, can command the same general acceptability as conventional monies, a development that at the moment would appear still to be a long way over the horizon. Until that distant future, traditional state currencies will continue to dominate the supply side of the market. For more on the bourgeoning phenomenon of electronic commerce, see Spar and Yoffie, Chapter 1 of this collection.

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Padoa-Schioppa, T. (1993) Tripolarism: Regional and Global Economic Cooperation, Washington: Group of Thirty. Pauly, L.W. (1995) ‘Capital mobility, state autonomy and political legitimacy,’ Journal of International Affairs 48:369–88. Porter, R.D. and Judson, R.A. (1996) ‘The location of U.S. currency: how much is abroad?’ Federal Reserve Bulletin 82:883–903. Portes, R. and Rey, H. (1998) ‘The emergence of the Euro as an international currency,’ Economic Policy 26:307–32. Ritter, J.A. (1995) ‘The transition from barter to fiat money,’ American Economic Review 85:134–49. Rutherford, D. (1992) Routledge Dictionary of Economics, London: Routledge. Sahay, R. and Vegh, C.A. (1996) ‘Dollarization in transition economies: evidence and policy implications,’ in P.D.Mizen and E.J.Pentecost (eds) The Macroeconomics of International Currencies: Theory, Policy and Evidence, ch.11, Brookfield, VT: Edward Elgar. Savastano, M.A. (1996) ‘Dollarization in Latin America: recent evidence and policy issues,’ in P.D.Mizen and E.J.Pentecost (eds) The Macroeconomics of International Currencies: Theory, Policy and Evidence, ch. 12, Brookfield, VT: Edward Elgar. Strange, S. (1987) ‘The persistent myth of lost hegemony,’ International Organization 41: 551–74. Thygesen, N. et al. (1995) International Currency Competition and the Future Role of the Single European Currency, Final Report of a Working Group on European Monetary Union-International Monetary System, London: Kluwer Law International.

8 Does globalization sap the fiscal power of the state? Robert T.Kudrle

Introduction A voluminous literature now considers how much the power of the nationstate has been altered by the various processes known as globalization. One claim has especially alarmed thoughtful observers: external forces are eroding the capacity of the state to tax and spend as its own citizens wish and, in particular, to redistribute income. Fiscal competition may lead to a “race to the bottom” (e.g. Lawrence, Bressand and Ito, 1996:31; Frenkel, Razin and Sadka, 1991:213–14). Given certain assumptions, the logic is impeccable. Where factors of production (capital or labor) can earn more by crossing borders and they are free to do so, economic logic suggest that they will, all else equal. Of course, this is only loosely connected with the migration of particular businesses, for which the cost of capital cost or the taxation of firm profits only partially determines location. Moreover, individuals offering their labor services will not immediately abandon a familiar environment and web of social connections simply to earn higher material rewards elsewhere. But the incentives are clear. This dynamic implies that, as mobility increases, internationally out-of-step attempts to redistribute income to lower earners within the current nation-state would increasingly result in their literal abandonment as both capital and higher earners seek after-tax returns closer to their before-tax productivity by moving to other jurisdictions. In such circumstances states can also be expected to set their minimum levels of social support with some regard for the immigration of persons who are likely to be net drain on the fiscal system. Two views of the global fiscal challenge Some version of the capital and skilled labor mobility story prevails in most current discussions of the national fiscal implications of market globalization. But there is another. It begins with the recognition that all income from every source has individual claimants and that every person resides in one or more jurisdiction. The earnings from capital anywhere in the world do not simply


disappear, and, if international tax competition lowers the burden on capital, those earnings should increase. If the earnings are not hidden, they will enrich specific persons in specific jurisdictions who should therefore face increased tax liability. Moreover, international labor mobility for workers of every income level remains very low in virtually all countries, and policy variables under the control of the state can significantly encourage or retard that mobility. And even in Europe, where labor markets cannot be closed to citizens from anywhere in the EU, the taxation of assets remains fixed at the national level. Globalization has therefore changed government fiscal power very little. Although this chapter will deal with taxes beyond those levied on capital and labor, these somewhat stylized contrasting views of capital and labor mobility and their fiscal implications should be kept in mind as arguments and evidence are reviewed. As each tax is examined, attention will be paid to the basic impact of the tax as economists understand it,1 problems posed for the state by the present and projected role of the tax, and possible policy solutions. This chapter will make repeated use of the analogy between the nation-state and the US state within the federal union. The approach can illuminate both where a pivotal US federal role suggests the need for international cooperation or, where such cooperation appears unlikely, the need to find alternative solutions. Such analogous argument will be termed the “state-State” approach.2 A critical difference lies in the existence of a higher American political authority. If current US welfare devolution produces unsatisfactory results, for example, support would grow for the reassertion of the federal role.3 Such governance above the nation-state does not exist—even the EU commands very restricted fiscal resources and exercises only limited influence over member state fiscal policies. Two views of recent economic policy developments The two simplified positions underlying much thought about the impact of globalization on the fiscal power of the state frequently correspond to differing emphases in the interpretation of the evolution of economic policy, especially in the higher income countries, over the past twenty years. Much of the writing on globalization emphasizes many states’ defensive reactions to the attempts by others to attract foreign capital, and—although the evidence is mainly anecdotal—to appeal to internationally mobile and highly skilled managers and professionals. Many economists emphasize other factors. In their view, the general movement towards a greater emphasis on material rewards, including some reduced tax rates, grew largely from attempts to counter the slowdown in productivity growth after the early 1970s. The role of increased market forces in generating increased effort and better allocation was strongly buttressed by burgeoning studies in applied econometrics conducted in many countries. Countries learned from each other, and the


marked policy changes—including lower personal income tax rates, deregulation, and lowered barriers to trade and investment—were mainly generated by similar responses to common problems, including growing expenditure demands on government that saw the total tax share in GDP rise everywhere during the years 1965 to 1994. The rise was relatively modest in the US, from 24.3 to 27.6 percent, while the typical EU 15 state saw the share rise sharply from 28.3 to 42.5 percent over same period. From this second perspective, somewhat similar behavior grew far more from partially imitative responses to common challenges than from direct competition (Devereux, 1994:185). Once again, the two positions can be oversimplified, yet most of the writing relevant to globalization seems clearly to embrace one view more than the other. The previous contrasting emphases and much else in the discussion of globalization and taxes can be clarified by distinguishing two private behaviors and four kinds of public policy. Private actors can engage in avoidance and evasion while policies can fall into four categories: autonomous choice, adaptation, competition and cooperation. Firms and individuals can be expected to practice legal tax avoidance where doing so contributes to their objectives, notably wealth enhancement. This is perhaps the principal means by which taxes are assumed to drive—and in turn to be driven by—globalization. But another consideration plays an important role. Economic models of tax issues sometimes ignore the issue of lawbreaking, but it constitutes a large and growing problem in global tax matters (and within most national economies as well).4 Countering the illegal evasion of taxes must therefore play an important role in policy design. In the realm of public policy, autonomous choice will be used here to refer to the tax system that would prevail if each state could set its tax levels without regard for the rates set abroad. Some taxes in all states (e.g. most elements of personal income taxation in the United States) and most taxes in some states (e.g. most taxes in Japan) can be claimed to be set that way. Adaptation refers to the unilateral modification of taxes that results from increasing factor mobility; typically it implies a lowering of taxes to prevent resource loss. Competition means the use of tax advantages to attract mobile resources, mainly capital, to the national economy.5 Cooperation refers to formal agreement with other states. This chapter focuses on the experience, practices and prospects of the currently developed countries and especially on the United States and Europe, which account for over two-thirds of high-income GDP. Much of the alarm about fiscal competition has been sounded there, including fears about capital loss to poorer states; their fiscal systems are highly developed; they account for the overwhelming share of foreign investment ownership; and they cooperate extensively on tax matters, including the provision of comparable data to the OECD. Nonetheless, the implications of these rich state fiscal developments for the rest of world will not be ignored.


The following discussion treats five major tax categories: (1) capital taxation; (2) personal income taxation; (3) the taxation of consumption; (4) social security taxation, and (5) new sources of revenue. The first four categories accounted for 98 percent total US tax revenue in 1994 and over 96 percent of total revenue in the EU15 (OECD, 1996). Figure 8.1 shows several major tax categories. Capital taxation The issue of capital taxation is addressed first because it has received most attention in the globalization literature. Increasing capital mobility can be seen in many indicators (even leaving aside the staggering volume of foreign exchange transactions). For example, the stock of outward foreign direct investment as a percentage of GDP rose from 6.3 to 14.6 percent between 1980 and 1994 in the EU15, while the inward figures were 5.5 and 13.2 percent. The pioneering outward investor, the US, saw that figure rise only from 8.1 to 9.8 percent, while the inward figure more than doubled, from 3.1 to 7.7 percent (United Nations, 1997:339–40.) Annual cross-border securities transactions for most industrial countries went from less than 10 percent to more than 100 percent of GDP from 1980 to 1992 (IMF, 1995:80). Capital in most states is taxed in three main ways: capital earnings are taxed as part of individual income, the earnings of corporations are subject to special tax treatment, and the value of land and fixed physical assets is subject to a property tax. The latter will receive no direct attention here because the tax, while significant (about 5 percent of total OECD revenues in 1994) is typically levied by subnational governments and is constrained by competition among them. Tax incidence turns on the relative responsiveness of supply and demand with the less responsive side of the market bearing the greater share of the burden.6 In traditional tax theory, capital owners were assumed to bear the burden of national capital taxes because total real capital was in nearly fixed supply. Globalization radically changes the picture by increasing the relevance of the “state-State” analogy. American states operate in an essentially perfect national capital market. This implies that no tax applied to mobile capital will be borne by suppliers. Unusually high Nebraska property taxes, for example, could drive housing prices up and land rents down (because the land cannot move), but they cannot affect the long-run returns to people who own the buildings. The owners will insist on the same earnings on their invested capital in Nebraska as in other states. High taxation of capital would drive it out of the state until capital is sufficiently scarce that after tax returns are equalized with the rest of the country. The extra tax on capital would leave non-property owners in Nebraska both with less capital to work with—and hence lower earnings for both labor and land—and the entire burden of the tax they wanted somebody


Source: Organization for Economic Cooperation and Development, Revenue Statistics, 1965–1995. Paris: OECD, 1996. Figure 8.1. The role of selected taxes in total government revenue.

else to pay. When the profitability of an investment depends on other Nebraska-specific inputs or the local market, of course, the picture is more complicated, and such complications help explain persistently differing property taxes and corporation tax levels among the states.


If there were good information and no policy or exchange-rate risks, the Nebraska scenario would obtain for small states in the international economy. In fact, a huge literature focuses on both the continuing differences in interest rates internationally and the rather modest net capital flows among industrial countries. Imperfect mobility in response to apparently differing profit opportunities persists because of factors specific both to countries (such as political risk and information problems) and currencies (exchange-rate risk) (Frankel, 1992; Gordon and Bovenberg, 1996). The complex mix of competitive forces and varying constraints suggests an increasingly important element of the fiscal challenges posed by globalization: uncertain incidence. A tax levied at an unchanging rate may continue to generate revenue, yet its real economic effects may be difficult for observers to evaluate. A fixed world price for capital implies that the curve facing a country is completely flat, i.e. no capital will be available that does not yield rewards available elsewhere. But even where this applies to the supply and demand for loans, it provides only a partial guide to the incidence of taxation on specific businesses. The current international portfolio (non-controlling investment) market (including individual activity in foreign stock markets) differs from the internal US market in several ways. First, if the investment is in competitive enterprise, attaining appropriate information on the enterprise may be more expensive than at home; second, there are risks attaching to unanticipated (sovereign) government behavior that may change the net yield measured in the foreign currency. Third, the exchange rate may change. These three factors all tend to retard the international flow of capital, but there is a fourth factor that can cut sharply the other way. If the foreignness of the investment allows domestic tax liabilities to be avoided, then such activity is strongly encouraged. Assuming that earnings from all sources increase his personal tax liability, if Citizen could make an investment merely “foreign” enough—perhaps by employing a foreign “tax address”—to avoid earnings information being reported to his national authority, he would have an incentive to make such an investment even if the funds actually found their application back in his home country. Collaboration in such subterfuge is a central function of that scourge of the international economy, the “tax haven,” a term that implies some combination of low local taxes and transaction secrecy. Most observers divide tax havens into two groups: those that attract real activity to their territory and those that function mainly as financial switching stations and add little economic value. Of the forty-one tax havens identified by Hines and Rice (1994), thirty-four tiny havens (average population 200,000) accounted for 60 percent of activity measured by assets, equity or net income. Most of the largest economic powers, including the United States, ground their fiscal systems on the principle of “residence,” i.e. the principal tax obligation is owed to the home state of the factor provider. Other states, to varying degrees, employ the “source” principle that assigns primary rights to


the state where the economic activity takes place. In practice the conflict between the two principles is greatly reduced because all major residence systems cooperate with other states to allow corporate taxes paid abroad to be credited against what would otherwise be an obligation to the home government—an important de facto “source” element. These crediting states, including the US, also allow remaining tax liability to be deferred until the profits are actually brought back to the residence country, giving the affected firm an interest-free loan of that amount for an indefinite period. Thus, an approach that in its simplest form neutralizes foreign attempts to attract corporate capital through low corporate rates leaves them sensitive to such attraction after all. The tax havens allow activity assigned to havens by multinational corporations to go entirely untaxed at home when a firm’s overall tax payments abroad exceed its home country tax liability. Moreover, when the firm has residual corporate tax liabilities, profits that can be made to show up in tax havens can be cheaply redeployed rather than repatriated.7 Most states follow the residence principle for some or all financial or portfolio (non-controlling) investment made in their territory, and they do so in large part to avoid increasing the cost of capital in their own countries on the assumption that the supply curve they face is quite flat and is becoming more so over time. This concern can coexist with a substantial corporate income tax rate because policymakers understand that a corporate investment is a complex decision in which the impact of a few points of corporate tax may pale by comparison with many other international cost differences including transportation costs and (productivity adjusted) wage rates8—concerns that are definitionally absent in financial investments. Employment of the “state-State” analogy to consider the impact of competitive forces on fiscal globalization yields mixed evidence. The role of corporate tax revenue at the state level was as high (at about 4 percent of total state revenues) in 1989 as it had been in the 1950s. Despite the low level of state corporate rates, this suggests little competition. On the other hand, the state corporate share did drop in the 1990s (ACIR, 1994; Campi and Sullivan, 1998: 11). Another piece of evidence suggests less than ferocious interstate competition for business. All state and sub-state taxes levied on firms (not necessarily borne there), while dropping slightly over several decades (ACIR, 1981; Oakland and Testa, 1996) were estimated to have generated 70 percent more in revenue than the value of services provided to firms in the early 1990s (Oakland and Testa, 1996:15–16), sharply contradicting the theoretical prediction that competition would produce tax levels just covering the costs of services provided as a result of the “race to the bottom.”9 In light of the findings regarding the US, the recent global experience may not surprise. In an exhaustive study of ten major industrial countries over the period 1979–1994, employing several alternative measures of the corporate


income tax, Chennells and Griffith (1997) conclude that “effective tax rates have not fallen” nor has there been “a significant erosion of the capital base”(1997:80). The corporate income tax continues to be far more important in the United States than in Europe, yet the experience of neither area fits easily with predictions from globalization-fueled competition. Corporate taxes fell from 16.4 percent to 10.8 percent of the total US tax take between 1965 and 1980 and then fell much less in both absolute and percentage terms to 8.9 percent in 1994. In Europe the average share among the EU 15 fell from 6.9 percent in 1965 to 5.8 percent in 1980 and then rose to 6.4 percent in 1994 (OECD, 1996). Coping with capital taxation: policy and politics The reform of international capital taxation appears truly urgent in only one major area: portfolio investment. The current system appears to allow huge amounts of untaxed earnings by wealth holders in both rich and poor countries, despite a web of bilateral treaties on tax law enforcement that have grown up alongside the main treaties, which largely deal with tax-sparing (Barrett, 1997). The G7 meeting of May 1998 urged governments to use the same laws against tax evasion that they use against the laundering of drug money. Slemrod (1990) has suggested another straightforward reform. The residence principle should be retained on portfolio investments, but all states should agree to levy a uniform witholding tax that would be forgiven with evidence of tax compliance by the investor in the country of residence. Such an initiative would avoid tax competition for portfolio capital while at the same time solving the large and growing problem of tax evasion through foreign investment. In addition, some poor countries continue to practice source taxation of portfolio investment on grounds that it is the only way they can collect any tax revenue from non-corporate capital. Universal, refundable withholding would provide them with cheaper credit, a larger capital base, and greater tax revenue. The withholding proposal would be a far safer move for the developed countries if they acted together. Indeed the abandonment of withholding by the United States in 1983 was driven by perceived losses to other states’ capital markets. The new practice could be combined with simultaneous revocation of bilateral treaties for all non-cooperating states. As Tanzi has pointed out, however, such new tax agreements would be greatly facilitated if US negotiators were granted “fast track” authority (Tanzi, 1995:9), a dim prospect at the moment. Reform of corporate taxation appears less urgent. Good evidence is lacking that major states have set their rates at lower levels than they would otherwise prefer, but few states doubt they are losing significant revenue from profit-


shunting across jurisdictions. The bulk of world trade takes place within rather than among companies, and the manipulation of cross-border “transfer pricing” has been copiously documented. Unilateral policy improvements can include the negotiation of transfer price protocols on a firm-by-firm basis, a practice that the United States has used with some success (Hufbauer, 1992: 137–8; 149–150). Another US approach limits the profitability of tax havens by withdrawing tax advantages from resident firms when funds are piled up in havens as passive (i.e. financial) investments.10 Multilateral action also includes alternatives. One would introduce some international variant on interstate US fiscal relations in which corporate tax revenues would be assigned according to an agreed weighted formula employing local shares of sales, employment and assets. Transfer pricing would then become irrelevant as a source of tax liability. Even those who favor this as an ultimate solution admit that it would be extraordinarily difficult to negotiate (McLure, 1997:41–2). A simpler agreement may be more realistic: participating states would keep their corporate rates within a certain range to reduce the incentive for manipulation (Slemrod, 1990: 22–3; McLure, 1997:43). Any such agreement would also necessarily deal with the way income and cost allowances are handled and would force a consideration of similar accounting standards (the absence of such standards now make ratebased international corporate tax comparisons highly imprecise at best). Moreover, such an agreement should also allow states to lower their rates unilaterally up to a certain maximum amount per period because economists generally agree that the demise of the corporate income tax should be welcomed so long as it can be accomplished without conferring disruptive competitive advantage on pioneering states.11 Long-standing objections to the tax include uncertainty about incidence and the distortions that come from differential taxation of capital used in only part of the economy. These avenues of reform of capital taxation can be contrasted with recent proposals by the OECD in its Harmful Tax Competition: An Emerging Global Issue (1998) aimed at both tax havens and preferential tax treatment for foreign investment, including a failure to share information with residence countries. The report proclaims a series of guidelines as well as an institutional innovation, the Forum, that would implement them. The OECD attacks bank secrecy and a failure to share information, tax practices that are regarded as producing sham economies, and other unfair tax practices designed to lure real resources at the expense of other states. Harmful Tax Competition declares quite explicitly that low-value-added tax havens should simply be destroyed by treaty revocation (some are dependencies of OECD countries that would presumably help cope with the adjustment burden) and that other non-cooperators could have tax crediting withdrawn, at least on certain types of activity.12 It does not suggest compulsory withholding on debt instruments, which would require revision of the OECD Model Tax Treaty, and it explicitly rejects constraints on corporate


tax rates, apparently as an unwarranted intrusion into national decisionmaking. Unsurprisingly, the OECD proposes the same formidable retaliatory mechanism for non-cooperation as other reformers: immediate taxation at the home country rate, regardless of other taxes paid. It now appears likely that the avenues selected by the OECD will be explored before any other multilateral action is taken, although the continuing principal responsibility of the home country to discover the foreign capital earnings of its citizens clearly disadvantages the developing countries by comparison with the compulsory withholding approach. Politically, current momentum greatly to diminish the role of the tax havens should only increase as the general public gains understanding of the issues. The current system allows mainly upper income citizens to cheat on their tax payments because capital assets increase sharply with income as almost certainly does the ability to navigate the concealment possibilities of the global economy. The typical citizen’s ability to understand both the problem and possible solutions appears very high. Transfer price abuse may also catch hold. It was used with some success by the Clinton campaign in 1992 in the context of the very low levels of corporate taxes paid by foreign firms operating in the United States. Personal income taxation The previous section treated two aspects of personal income taxation: the ability to equate net capital earnings across jurisdictions and tax evasion. If Citizen can invest in ten countries, but lives in one and is subject to its tax authority, none of the ten can differentially tax Citizen’s returns in specific uses after all risk factors have been accounted for, but his own tax authority has the legal authority to tax his earnings from whatever source; only lack of transparency prevents that from happening. In this section of the chapter, the focus will shift to an individual’s earnings from labor services, which typically account for about 70 percent of a state’s personal income. The conclusion that a person’s entire income is the best single measure of the ability to pay and hence the “fairest” base for taxation to support general government has deep roots (Simons, 1938) and is widely accepted among the industrial countries.13 But high marginal tax rates also lead to inefficiencies in choices between work and other activities, among occupations, and in the choice between savings and consumption.14 Most countries lowered their highest marginal personal income tax rates during the 1980s and 1990s. These rates usually fell more than corporate tax rates did. Given the relatively low level of labor mobility by comparison with capital, this is the opposite result from what one would expect if such changes were driven mainly by international competition. In fact, the changes were more complex than a simple look at top rates reveals. Rate reductions were typically coupled with a broadening of the tax base through rejection of


previous exclusions and deductions that had forced higher rates and increased estimated inefficiency.15 Reforms were designed to increase efficiency while largely preserving revenue. One major concern with high marginal rates was (largely domestic) tax cheating. A number of factors, including a rapid growth in self-employment by professionals, caused confiscatory top rates to generate large-scale tax avoidance and evasion (Garrett, 1998). The growth of electronic commerce, to be discussed in the context of consumption taxes in the next section, will provide additional challenges. The combination of paperless business records —which are presently easy to alter invisibly—with products that often involve little in the way of inventory, as is the case of computer software, increase the challenge of auditing and therefore provide special temptations for tax evasion. Despite their continuing appeal on equity grounds, the use of high marginal tax rates in income taxation can be countered by three sets of efficiency objections: the behavioral choice distortions noted earlier—assuming the taxes are collected as intended; the temptation to engage in illegal activity, either at home (the underground economy for returns to labor) or abroad (largely unreported capital income under the typically prevailing residence taxation for non-corporate earnings); and a set of problems that result from increasing international labor mobility. Nearly all countries adopt a policy towards foreign labor earnings that corresponds unambiguously to the “source” as opposed to the “residence” principle. When coupled with the difficulties of collecting taxes on foreign assets, this means that when Citizen moves across a border in much of the world, all or nearly all of his taxable capacity is lost to his home country. Of all high income countries, only the United States claims an income tax obligation of its citizens everywhere and then modifies it to credit foreign income taxes paid based on bilateral treaties.16 Other states apparently yielded early on to claims that productive activity performed abroad was unconnected with obligations at home and to more pragmatic arguments from business that national firms would be competitively disadvantaged within foreign markets if their citizens had to pay higher tax rates than locals or nationals of third states. Such arguments have not gone unrecognized in the US and account for generous tax free living allowances, but the original principle has remained firm (Bhagwati and Wilson, 1989). Policy rationales concern the role of the state in developing the human capital from which the foreign earnings accrue17 and diplomatic protection abroad. US policy faces a formidable problem collecting much of the taxes due. Those who stay abroad for indefinite periods pay very little tax, and, even assuming the taxes owed can be identified, unless they try to renew their passports or US assets can be attached, the US government has little effective recourse (Musgrave, 1989; Doggert, 1997:90). But American policy is unrelenting. Even renunciation of US citizenship does not cancel income tax


obligations. Prior to 1996, persons deemed to have abandoned citizenship for tax purposes were taxed for ten subsequent years. Because motive was difficult to prove, the law was amended to apply to all previous citizens (and most permanent residents) whose tax liability over the previous five years reached income and net worth minima (US Congress, 1995; Doggert, 1997: 90). Other countries, including Canada and Australia, employ exit taxes, and Germany maintains taxes on ex-citizens for ten years if they go to low tax countries and meet certain criteria of continuing German connection (Doggert, 1997:91).18 Coping with labor mobility tax challenges The present situation for taxing personal income in the industrial countries can be viewed as ironic. Most states with the highest levels of income redistribution and the most elaborate public benefit systems appear less protected by both law and ideology from international competition for labor services exercised through personal taxation cuts than is the most ambivalent country, the United States.19 And while the problem now scarcely appears acute, it can only worsen. Many analysts predict that some coordination of intra-EC personal income tax structures will become inevitable in the coming years, although tax differences will frequently play a role secondary to gross earnings differences in deploying labor across European borders. Despite the freedom of EU citizens to take employment anywhere in the Union, few have so far, in part because of very high unemployment rates across most job categories. Purely national measures to protect the fisc carry risks. Although the US-style system of residual tax claimant appears to have worked well, in countries with lower incomes and higher taxes, similar practices could encourage permanent migration. The same argument applies to heavy exit taxes based on income or wealth; they could encourage permanent migration early in the career of potential high earners. And evidence suggests that those high earners may play a key role national economic progress. Not only do they pay far more in taxes than they take in government provided services (and would even at proportional rates), thus lightening the burden on others, they may make a uniquely important (marginal) contribution to raising others’ productivity (Murphy, Shleifer and Visnay; this argument is stressed in the context of migration by Tanzi 1995:34–5). Although those favoring tax cuts for high earners will constantly invoke the specter of emigration, the public will probably not become engaged until an anecdotal trickle becomes a well-documented stream. And even then, pressure towards coordination of tax rates rather than competitive reduction could be a likely outcome. A collusive outcome would be quite possible if Europe acted as one in dealing with the US (and perhaps Canada and a very few other states).


Consumption taxation The previous section argued that income taxation is generally held to be the fairest method of financing general government expenditures; not all agree. The equity case for consumption taxation rests on the observation that unconsumed income adds to general productivity by allowing additional investment.20 Moreover, from an efficiency viewpoint, the estimated negative impact of taxing savings and interest on capital accumulation counts against it. Consumption taxes can be levied in the production process, as a “direct” consumption tax such as the proposed Forbes “flat tax” or they can appear as an “indirect” levy, as in the EU value-added tax or the retail sales taxes of forty-five of the US states.21 The latter type is by far the most common in the world today, and because it raises the issue of collection on final transactions, it holds particular interest here. Indirect general consumption taxes were 7.9 percent of total US revenue in 1994; they were more than twice as important in Europe at 17.9 percent. Both also raise large revenues from selective taxes on particular products, notably alcohol, tobacco and gasoline. The 1994 US share was three quarters of general consumption taxes; in Europe it was half as much. See Figure 8.1. Were a state to replace income taxes entirely by consumption taxes, all problems of taxing the returns to foreign investments would disappear by assumption, but other problems would intensify. In both the United States and in Europe, quite different levels of sales and excise taxation have coexisted in adjacent territories without crippling the treasury of the higher rate state, but the problem increases with differences in taxation levels. And difficulties increase along the border, especially when the population is dense on the high tax side (Due and Mikesell, 1994:267–71). For this reason, the problem has been more acutely important in Europe and has impelled renewed consideration of coordinated VAT rates (Laughland, 1998:7). Increased population mobility as well as organized smuggling has played a role in the large estimated revenue shortfalls in high excise tax areas (Bartlett, 1998). The previous section mentioned electronic commerce as a factor facilitating undeclared income. But this innovation’s principal contribution to the state’s fiscal problem will likely come from difficulties caused in collecting product taxes.22 The challenge is three-fold: innovation in geographic scope (global penetration), innovation in transaction recording (electronic ordering and transaction recording), and innovation in means of payment (electronic cash). The “state-State” analogy is again very useful for clarifying the first two of these issues, and the US state situation is important in its own right as the site of all American sales taxation. All forty-five states that levy sales taxes on instate sales also employ a “use” tax system as a constitutional means of taxing “imports” into the state (for a thorough discussion of these issues, see Due and Mikesell, 1994; Fox and Murray, 1997). Administration and enforcement have always been problems; audits of businesses routinely find large amounts of use


taxes owing, and collections from final consumers are a small fraction of what is owed (Due and Mikesell, 1994: 267–71). States have sought to oblige outof-state sellers to collect the taxes due, but the legality of doing this has turned on “nexus”: the precise degree of outsider presence in the state that would legitimate such demands without unconstitutionally burdening interstate commerce. Before these issues could be definitively settled, the picture was further complicated by the striking innovation of Internet sales (Fox and Murray, 1997). Some, in both the US and elsewhere, advocate the Internet as a kind of spaceless free trade zone unencumbered by any taxes. Others, concerned mainly about revenue, see it as the target of special levies (Powell, 1997). Fiscal policy meeting most standards of equity and efficiency demands that it be neither. Goods and services either delivered by the net (such as software) or merely ordered through it (other catalog sales) should be subject to the same types and levels of taxation as competing products. For sales within the United States, this has led many analysts to conclude that extensive exposure to blandishments by out-of-state sellers over the net should be deemed by Congress to constitute a sufficient nexus for the insistence on the collection of use taxes by the seller. Where seller collection of sales taxes is not feasible, some countries may find it legal to mandate automatic recording of Internet purchases. Elsewhere, individual compliance by final purchasers through more intrusive reporting requirements and auditing also remains an option. In spite of the explosion of Internet commerce, neither the US states nor EU national authorities have yet moved strongly in this direction because revenue losses, while substantial, have been low relative to total tax yield (Due and Mikesell, 1994:259–66). Even if the US and the EU can attain satisfactory compliance with sales taxes on transactions wholly internal to their markets, dealing satisfactorily with the rest of the world will remain a challenge. For physical goods, customs procedures will continue to provide a check (Due and Mikesell, 1994:263; Grubert and Newlon, 1997:31–32), and some analysts have advocated government use of the records of financial intermediaries (mainly credit card companies) or common carriers—including Internet providers (US Treasury, 1996). Avi-Yonah (1997:55) has suggested the use of recently developed software that tracks the location of a purchaser when the order enters cyberspace. Whatever the general feasibility of seller collection of sales taxes, sales from anonymous sources should be avoidable. It seems consistent with US law to require that the source of imports—both goods and services—be established on national security grounds to assure that the commerce does not bolster the economy of an enemy state. A requirement that sellers provide some information on the nationality of their ownership structure, the geographic distribution of their facilities, and national provenance of their value added as a condition for the legal purchase of their products by the monitoring


country’s residents could provide valuable raw material for international cooperation to monitor tax avoidance by both buyers (sales and value added taxes) and sellers (personal and corporate income taxes). The third issue often discussed in this connection is electronic cash. There are a number of varieties (Helleiner, 1998), but the kind that many find most alarming involves techniques that make a transaction completely impossible to document. While this innovation would certainly cause difficulties for tax authorities, it might also be a problematic means of making a substantial purchase. Anonymous distance transactions with no possibility of third-party verification appear to lack all means for consumer protection. For these and other reasons, many have predicted that electronic money will be confined to purchases of modest value (Fox and Murray, 1997; Helleiner, 1998). Coping with consumption tax evasion Globalization may well breed increasingly strong and widespread public unease about the extent to which fellow citizens are illegally avoiding tax obligations through manipulation of the international economy. This may already be happening with respect to capital earnings. The avoidance of sales and excise taxes may raise less alarm if “everybody does it.” Nonetheless, not only will upper income groups tend to have more effective access to international electronic shopping for the foreseeable future, but they travel much more, further increasing opportunities. In addition, because goods and services taxes paid tend towards proportionality with respect to income, higher income people on that account alone can be expected to denude the fisc more severely on a per capita basis with enforcement laxity. So some stringency can presumably be made a popular issue in any state. Morever, organized business within a jurisdiction will push for stringency: especially if mandatory collection by major providing firms within a jurisdiction grows along with poorly monitored imports, irresistible political pressure will probably develop to level the pitch. Social security taxes Earmarked payroll taxes for social security were the single largest tax category in Europe in 1994 at 29.2 percent and the second largest after the personal income tax in the United States at 25.5 percent; they are largely borne by the employee regardless of statutory language (Rosen, 1999:267). The greater role in Europe reflects health care and other expenditures for the non-elderly, but pensions and care for an increasingly aged population have caused expenditures and taxes to rise in both areas. Currently, whether systems are self-financed or not, their link to globalization turns mainly on the implicit level of net taxation levied on upper income taxpayers where their impact interacts with the personal income tax.23


New taxes So far this paper has dealt solely with globalization’s impact on existing taxes. This section treats two taxes associated with globalization itself: “green” taxes and the Tobin tax. Green taxes If trade and investment lie at the heart of market globalizaton, global warming and ozone depletion symbolize direct globalization, the increasing importance of global spillovers from human activity anywhere (Kudrle, 1998). Economists have long argued that command and control techniques greatly increase the cost of environmental amelioration and, in a sharp reversal almost unimaginable in the 1970s, they have persuaded much of the environmental community to accept a market-based approach (Esty, 1994). An environmental tax corrects for distortions in production and consumption at the margin by altering the signals to which private agents respond. Green taxes envisioned to reduce global warming produced some huge revenue numbers—the US share of one scheme was estimated to yield more than 3 percent of GNP (Nordhaus, 1993:54).24 Inevitably, many have considered using these funds to lower tax rates elsewhere. For a number of years beginning in the early 1990s, this possibility generated a considerable body of writing on what came to be called the “double dividend.” The argument claimed that pollution taxes performed a function beyond improving society’s choices about pollution-intensive processes and products: they also allowed for a reduction in the inefficiencies connected with ordinary taxes (Repetto et al., 1992; Oates, 1993). Environmental improvement was not a free lunch, but it appeared to be heavily subsidized. Unfortunately, further research has shown that important issues were neglected in the original analysis and that green taxes typically add inefficiency (by increasing the inefficiency cost of existing taxes, despite the reduction in their rates to reflect the new revenue sources; for examples, see Oates, 1995; Parry, 1996). The apparent collapse of the “double dividend” should not be misunderstood. It does not imply that green taxes are a bad idea or that a price approach to alleviating pollution has been undermined. The intra-state use of green taxes will almost certainly grow; they offer cost-effective environmental improvement as well as a reduction in some other taxes. Additionally, green taxes may well be employed by nation-states to meet international pollution reduction goals when such targets are agreed. But a fully efficient global system with international trading of pollution permits awaits a comprehensive agreement that essentially assigns global property rights for pollution. Given the huge amounts of wealth at stake, early agreement is unlikely. Green taxes certainly do not represent the erosion of state fiscal power due to


globalization; instead they present an important opportunity to improve the functioning of the economy. The Tobin tax Even more than green taxes, which can be used in a closed economy, the “Tobin Tax” is a true product of globalization. It shares with green taxes, however, a purpose largely independent of revenue. Some years after the breakdown of the Bretton Woods system and in recognition of the subsequent instability of exchange rates, James Tobin proposed that a small tax be levied on international capital movements that “would automatically penalize shorthorizon round trips…A 0.2 percent tax on a round trip to another currency costs 48 percent a year if transacted every business day …But it is a trivial charge on commodity trade or long-term foreign investments.” (Tobin, 1996:xi). The tax has been discussed intermittently for more than twenty years but has never really been seriously considered. Although some experts still claim that a Tobin tax could give policymakers breathing space in a crisis (Eichengreen, 1996:295–6), other claims look more dubious. The added flexibility associated with a Tobin Tax in macro-economic policy appears modest; the range of financial instruments to which it need be applied for effectiveness remains unclear; a high level of agreement would be necessary to keep the supplying industry from shifting to non-cooperating national bases; it could actually increase market volatility by driving out more stabilizing than destabilizing speculation; and policymakers might increase their provocation of the markets in response to the extra protection (Eichengreen, 1996:276–8). The tax might also disappoint as a source of revenue. By encouraging a consolidation of markets, Tobin himself estimates that the amount of revenue collected could be as modest as $46 billion (Tobin, 1996:xvii) This is about 0. 7 percent of total 1994 OECD tax revenues. Moreover, Tobin wants something less than half of the proceeds collected from the major money market countries to go into a multilateral fund to help poor countries (countries without major markets can keep their proceeds). The dedication of revenues for development has been the source of much recent interest in the tax, but that could be a net political negative. Such application might strike many in the richer countries as a bad precedent as well as a source of conflict of interest, and the popular appeal of foreign aid is very low in many countries, particularly the United States. The burden of the tax will almost certainly fall on businesses that engage in international investment; both they and the international financial community can be expected strenuously to oppose it (Eichengreen, 1996:281).


Coping and cooperation A major factor underlying the inattention to many of the international tax problems outlined in this chapter may simply be their lack of urgency relative to more pressing or more important problems. This will change. Intra-European agreement on a range of personal income tax rates may well eventually follow apparently imminent constraints on the VAT and the corporate income tax (Laughland, 1998:1, 2); completely free factor movements and a common currency will have created an unprecedented quasi-state. Europe should move to shore up its effective authority over the resources under its nominal control, while seeking effective cooperation with other states. The forgiveness of residence taxes on labor services performed abroad has made the move to unity easier; nevertheless, it may be in Europe’s collective interest to reconsider that principle with respect to the outside world. In light of emerging evidence about large positive externalities from highly productive persons, the encouragement of local (i.e. European) skill application should be encouraged as it is by current US practice. Any evidence that such back-up taxation is causing significant expatriation might bring reversal. Considering the high-income countries as a group, what was earlier termed “adaptation” regarding personal tax rates, social security taxes, and consumption tax levels appear likely to prevail for the indefinite future. The continued importance and efficacy of these taxes does not turn on close international cooperation even where international interaction is significant. Such cooperation could certainly improve collection in the face of differing rates, however. Reciprocal exchange of information on sales transactions and foreign earnings could powerfully supplement self-declaration (or third-party reporting), but greater auditing expenses and steeper penalties for violation could counter its absence.25 The situation is more urgent for the taxation of capital earnings. Although the evidence is mixed about tax losses so far, most experts on global tax matters make two claims. First, absent international cooperation the effective taxation of capital will steadily erode. This means that the interaction of supply and demand will secularly shift the burden of the tax away from capital, no matter how the tax is levied. Second, unless cooperation comes, rates will also drop (Slemrod, 1990; Tanzi, 1995; McLure, 1997; King, 1997), although current evidence suggests this may happen slowly. Many are skeptical that effective action on capital taxation will be taken, but several forces appear to be coming together, and real change may be imminent. The US Treasury has long favored stronger action against tax havens, but its zeal is tempered by concern that US firms not be disadvantaged (Barrett, 1997). The introduction of the euro is focusing European attention as never before on differential advantages to member states and their firms. The bank secrecy practices of Luxembourg and the tax advantages for new capital offered by Ireland are both under attack (Laughland, 1998), as is the use of


Table 8.1. Coping with tax challenges

non-European havens. National governments are concerned both about their own tax losses and competitive advantages to firms based elsewhere in the EU. This determination will synergize with other efforts by the G7 and the OECD.


The major fiscal challenges posed by globalization to the nation-state and the major coping strategies presented in this paper are summarized in Table 8.1. Is there need for any further institutional innovation? Charles McLure has recently suggested a “GATT for Taxes” (McLure, 1997), but his observations concern capital taxation issues of the kind the OECD’s proposed Forum will apparently consider. Vito Tanzi, who heads the fiscal division of the IMF, has suggested consideration of a “World Tax Organization.” Despite its unfortunately alarming name, Tanzi assigns the new entity no tax-collecting role, only the functions of “surveillance, distribution of information and the provision of a forum for discussion” (Tanzi, 1998), also rather like the OECD proposal. Although both writers favor a universal organization, and the OECD includes only the higher income countries, the Forum is charged with extensive dialogue with non-member countries. Moreover, given the expected unease among the OECD countries about international tax cooperation anyway, the absence of redistributional pressure in next-step deliberations may prove an advantage. Overall, given the considerable powers of the individual state, the demonstrated feasiblity of bilateral cooperation on many issues, and the modest agenda for multilateral action, fiscal policy ranks for the foreseeable future as an area needing no more than what the Brookings Integrating National Economies Series terms “explicit harmonization” and frequently only “coordination” (Aaron et al., 1995:xxii) with all measures falling squarely into the sphere that Ethan Kapstein has called “cooperation based on home country control” (1994; 1996). All serious proposals appear to be examples of “[i] nternational cooperation used—as it has often been throughout this century— to bolster the sovereign state from the outside rather than undermine it” (Helleiner, 1998:390). On the other hand, any deeper general economic integration of the kind discussed by Ostry (this volume) should further facilitate fiscal cooperation.26 Closing observations This chapter has argued that tax competition has apparently had rather little impact on the tax base of the richer countries so far and that its likely future impact is frequently exaggerated. This conclusion fits with that of many analysts who have considered the overall fiscal challenges faced by the highincome states in coming decades—notably an aging population, entitlements, and a declining savings rate—and do not put international tax competition near the top. As Steuerle and Kawai argue, “these problems are practically all self-induced and amenable to change through sound fiscal policy. Unlike many problems, fiscal weakness is not a condition that is imposed from without but from within” (1996:15). States in the future may indeed garner less and less of their revenues from physical capital and an increasing share from human capital, the source of


most of the increase dispersion in “labor” earnings. And it may be difficult to assign causality to this development. If the decline comes following a satisfactory resolution to the current tax haven problem, confidence will be higher that it resulted more from changing conceptions of equity and attempts to increase savings than from international considerations. It must also be emphasized that shifts away from the taxation of capital and towards labor through consumption taxes have no necessary impact on the after-tax distribution of income. Shifts in the incidence of taxes can be countered by changes in their expenditure—although an increase in overall inefficiency is likely. This is confirmed by exhaustive studies of Smeedling and his colleagues who found a great variety of tax mixes corresponding to a wide range of before- and after-tax distributions of income among the OECD countries (1997:90–1). The importance of expenditure polices also plays a key role in Garrett’s recent argument (1998) that the impact of globalization on the most redistributive European states has been exaggerated. An additional point should be made in closing. This chapter has treated the weakening of the fiscal power of the state as an important sovereign loss that should be resisted and countered through international cooperation. Some see the situation otherwise. In particular, many economists, alert to the inefficiencies of current state taxes and expenditures and long exposed to the indictment of the state as a predatory “Leviathan,” regard individual and corporate escape from its clutches as both a just response to, and visible warning about, current state practices. Litan and Niskanen have recently expressed this view very well: an increasing number of firms and highly mobile (and highly skilled) individuals will face rising incentives…to move away from high-tax jurisdictions that are not providing a compensating (emphasis added) level of public services…. This will gradually intensify pressure on all governments…to search for the most cost-effective ways of delivering services) and to eliminate funding of unnecessary programs and subsidies, developments we both welcome. (1998:41) Such a claim conflates two ideas and forces a consideration of the state’s redistributive role. For decades economists have drawn a fairly sharp distinction between individual and firm interjurisdictional mobility to find an appropriate set of public goods, efficiently delivered (Tiebout, 1956) and the income support or redistributive function of the state. If the word “compensating” is taken with its ordinary meaning, then Niskanen and Litan apparently relegate the latter role to insignificance. Theirs is arguably an extreme view. Not incidentally, was Milton Friedman’s proposed negative income tax (1962:190–5) intended as a federal program from which upper income persons could not escape by moving across a state line. By ignoring


the distinction between two essential functions of the modern state, celebrants of international mobility essentially deny the legitimacy of a citizenry’s autonomous choice. The loose international cartelization of state activity favored here aims to preserve that choice as much as possible. This fundamental political difference will sharpen in the years ahead. Notes 1 The author thanks J.Howard Beales, Jeffrey Hart, Ethan Kapstein and Aseem Prakash for valuable comments on a previous version of this chapter. The chapter will necessarily sketch some of the basic efficiency and equity aspects of various taxes. No attempt can be made to deal with aspects of either set of issues that cannot be made clear enough to become part of political debate. See note 14. 2 Many writers on globalization have employed the analogy. Tanzi (1995) uses the approach tellingly to discuss fiscal issues. 3 National action in some spheres might be curtailed by judicial decisions. For an insightful discussion of the current legal struggles over US federalism, see Aman, this volume. 4 The director of the Internal Revenue Service estimates that annual unpaid taxes now account for $1,600 per capita in the United States (ABC News, 1998). 5 Tanzi (1995:7) also mentions adaptation and competition without offering a means of distinguishing between them. One baseline would define competition as the attempt by a state to augment its resources beyond the level that would be available in the absence of the relevant tax across the competing states. This distinction closely resembles Cohen’s defensive versus offensive response to competitive challenges (this volume). 6 The economic concept is price elasticity defined as the percentage change in quantity divided by the percentage change in price. The classic discussion of the role of elasticity in determining tax burden is Musgrave, 1959. 7 US rules that insist on immediate payment of corporate taxes on the earnings of passive (i.e. financial) investments (“Sub-part F” earnings) made in tax havens do not remove the advantage of leaving largely untaxed the principal (the originally shunted profits) from which these earnings accrue. For a discussion, see Hines and Rice, 1994, especially pp. 154–8). 8 For a sense of the order of magnitude of various cost considerations based on the US experience, see Fisher and Peters, 1998:13; 205–6. 9 For a critique of this concept and an examination of the evidence, especially as it pertains to environmental issues, see Klevorik, 1996; Levinson, 1996; Wilson, 1996. Some interesting hypotheses about “racing” are offered in Spar and Yoffie, this volume. It may be important to consider how any races discovered look from alternative viewpoints. To those at the bottom, for example, any race that provides them with more capital and technology probably just looks like a successful economic development strategy. For more, see the discussion in this book’s concluding chapter. 10 But see note 7.


11 The suggested approach could result in a shifting array of taxes analogous to the “crawling band” of international exchange-rate theory (see, e.g. Williamson, 1996). McLure (1997:43–4) has noted that an intra-EC agreement on corporate minima considered but rejected in 1974 would have locked countries into rates much higher than were subsquently adopted by most of them. Nearly two decades later, the Economic and Financial Council and the European Commission again rejected intra-EC corporate tax coordination on the grounds that it appeared unnecessary and unduly conflicted with subsidiarity (Tanzi, 1995:117). 12 Luxembourg and Switzerland issued strong dissents to the report, the latter acknowledging that it seriously considered exercising its veto. In essence, both states complained that one observer’s gratuitous secrecy was another’s laudable protection of privacy. 13 In recent years, partly for reasons connected with the difficulties of foreign investment income tracing, several countries in Northern Europe have aband oned the taxation of labor income and capital income at the same rates. Both the efficiency and equity aspects of this experiment deserve close attention, but they cannot be explored here (Sorensen, 1994). 14 As noted earlier, only a few technical issues of public finance and expenditure can be dealt with in this chapter. The point must be made, however, that economic distortions are not measured by changes in observed behavior. The introduction of an income tax, for example, may leave the number of hours worked by all participants unaltered; this means that the negative income effect of the increased tax take is just balanced by the substitution effect of the lowered net hourly wage. The latter still creates inefficiency. For an explanation, see any public finance textbook, e.g. Rosen, 1999:284–303. Increases in taxation that are thought to result in lower levels of work and savings understandably generate the most political reaction. 15 Although truly efficient taxation of all kinds would call for a huge set of nonuniform taxes, the best practical approach usually lies in applying a low uniform rate to a broad base. 16 Most notably, the United Kingdom, which shares a similar residence approach to corporate taxation with the US, takes the completely opposite approach to the taxation of labor services performed abroad. 17 In rejecting the claims of home governments to the income of citizens or previous citizens earning abroad, Hufbauer (1989) ignores compensation for home state contributions to earning capacity. However, he embraces a very similar logic a few years later in making the case for home country claims on foreign earnings of home-developed technology (Hufbauer, 1992:137). 18 Many countries levy net worth taxes as well as estate or inheritance taxes, although the yield is low. The US and some other countries place high wealth levies on those abandoning citizenship (Doggert, 1997:91). 19 Some would undoubtedly see the present situation as yet another example of America’s “extraterritorial impulse,” the tendency to extend its legal reach to wherever its interests are affected. 20 This argument goes back to John Stuart Mill and is stated forcefully by Irving Fisher (1942). Its importance may appear to be diminished by the existence of an international capital market, but the point is more conceptual than substantive.


21 The Forbes flat tax is similar to a standard VAT with a fixed annual rebate given to everyone out of general revenues. Instead, the flat tax assigns the tax burden on labor value-added to the individual worker as a personal tax. The scheme was developed by Hall and Rabushka (1983; 1995). Direct consumption taxes also levy a tax on higher than competitive returns to capital. See McLure, 1992. This chapter ignores the coverage differences between the consumption-based VAT and the typical state retail sales tax. The scope of the latter makes little theoretical sense; instead of covering all consumption purchases once (perhaps with some necessities excepted), it misses most consumer services while gaining a large percentage of total revenue from sales to businesses. 22 Opinions differ sharply about how much “cybercommerce” challenges the state (cf. Kobrin, 1997, and Helleiner, 1998); only the fiscal aspects of the challenge can be sketched here. 23 Immigration by the indigent elderly may increase costs, but even in the United States, where that phenomenon is most marked, the effect is very small and can be easily reduced by enforcing sponsorship requirements on younger relatives. The elderly may also emigrate to low-cost countries. This could cause states that “lose” their elderly to shift (in principle, a constant present value) tax liability to an earlier period in the taxpayer’s life. 24 Pollution taxes and the auctioning of pollution rights produce the same allocative result under certain assumptions. 25 For a discussion of the theory of tax evasion and policy responses with some references to the empirical literature, see Rosen 1999:327–32. 26 For additional remarks about the prospects for international cooperation, see the Conclusion of this volume.

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Coping with globalization A conclusion1 Jeffrey A.Hart and Aseem Prakash

This volume focused on the business and public policy responses to economic globalization—the increasing integration of factor, input and final product markets coupled with the increasing salience of cross-border value-chains of multinational enterprises (MNEs). It examined why and how actors seek to cope with globalization, linking these strategic to constraints internal and external to them and to the strategic choices of policymakers. Market integration is not a new phenomenon. Based upon the ratios of exports to national income and levels of capital flows, some scholars observe that the wealthier countries were more globalized on the eve of World War I than they are now (Hirst and Thompson, 1996; Rodrik, 1997). Market integration experienced a setback during the inter-war years which lasted until the end of World War II. Between 1950 and the late 1970s, increased trade became the dominant vehicle of global market integration. After the late 1970s, the relative depth and pervasiveness of cross-border economic linkages increased as MNEs became the main agents of market integration. One indicator of the change in the role on MNEs is the rising level of intra-company trade that now exceeds arm’s-length trade ($5.3 trillion versus $4.8 trillion in 1993; UNCTAD, 1996). The value-chains controlled by MNEs now span great distances, thanks to instant and cheap telecommunications technologies and lower bulk transportation costs. Traditionally, the growth in MNE activity was measured using data on foreign direct investment (FDI). However, FDI incompletely reflects the MNEs’ economic clout because MNEs can access foreign markets for procuring inputs and selling final products through a variety of other institutional mechanisms such as alliances, joint ventures and contracting. Still, using FDI data as the key indicator, MNE growth has been impressive. FDI has surged in recent years: from $1 trillion in 1987, FDI stock rose to $3.2 trillion in 1997. International production by MNEs’ foreign affiliates out-weighs exports as the dominant mode of servicing foreign markets ($5.2 trillion versus $4.9 trillion in 1992). Further, about one-third of their exports take place on an intra-firm basis, attesting to the importance of intra-firm linkages (UNCTAD, 1995). MNE-led market integration suggests that key decisions on resource allocation are increasingly taken within firms, not by markets or state planning


agencies.2 As Hart, Lenway, and Murtha point out in Chapter 5, statesponsored technonationalist strategies may not be effective in high-technology industries. This is because high-technology firms need access to competencies across the world and relying solely on domestic suppliers for accessing them (that technonationalist policies encourage) leads to competitive disadvantages. This does not imply that governments cannot influence resource allocation and that a “borderless world” is on the horizon. As Kudrle (Chapter 8), Spar and Yoffie (Chapter 1), and Cowhey and Richards (Chapter 6) have argued, the current levels of market integration do not suggest the end of the Westphalian era. Most MNEs continue to remain associated with specific countries (Hirst and Thompson, 1996; Pauly and Reich, 1997; Prahalad and Lieberthal, 1998). As the recent crisis in East Asia, Russia and Latin America suggests, governments still play important roles in market and corporate governance. For example, it is suggested that the reform of the Keiretsu-based or Chaebol-based industrial organizations—a prime structural cause of the current crisis—cannot take place without active governmental intervention. Thus, debates about the impact of globalization on extant modes of governance should not be framed in terms of competition among governments, markets and firms; rather in terms of the conditions under which governments intervene and what types of policy instruments best serve the goals of public policy and business strategy. Since governments’ influence over market processes, the levels of market integration, and cross-border dispersal of core competencies of firms vary across and within industries, issues for future research include: What causes such variations? Are they structurally determined or does strategic choice also play a role? Under what conditions is strategic choice possible? In short, how do governments and firms learn from the success or failure of past experiments in institutional change for shaping coping strategies? This volume conceptualizes globalization as a set of processes, exogenous variables, that are reconfiguring policy spaces, both by reterritorialization and deterritorialization. In Chapter 7, Benjamin Cohen contends that money, a traditional symbol of state sovereignty, is becoming deterritorialized. It is not uncommon that a country’s monetary space is “invaded” by foreign monies (Cohen terms this as currency substitution; for example, “dollarization” of the economy) or its money invades others’ policy spaces. Consequently, there is now an incomplete overlap between the functional and territorial domains of currencies. Instead of national monopolies, there is now an oligopoly. Since states derive significant benefits from monetary sovereignty, its erosion imposes costs, hence a need to cope with it. Oligopolies are marked by interdependence. Governments, therefore, have incentives to act collectively because outcomes of their coping strategies are influenced by the policies of other governments. We see deterritorialization of money as a sign of incomplete adaptation to the changing international economic environment on the part of national


governments. Governments that fail to inspire confidence in their management of the money supply, risk having their control of money ceded to the managers of the foreign currencies that displace the national currency. Cohen suggests four generic coping strategies for governments in the current system—market leadership, market alliances, market preservation and market followership. He also discusses the conditions under which they are most likely to succeed, the costs and benefits that flow from them for the governments, and what accounts for their success or failure. If deterritorialization of money creates conditions for “deep integration” in the monetary sphere, the potential advantages for central banks of retaining monetary sovereignty through market followership may not be significant, creating incentives for them to become “market leaders” or to enter into “market alliances.” Thus, an important learning is that states, although constrained, are not helpless in responding to the processes of globalization. Depending on characteristics of the issue area, they could respond alone or in conjunction with other states. Challenges to monetary sovereignty create high “stress” for governments, since it undermines their control over key aspects of economic policies. On this count, as the introductory chapter suggests, governments are likely to centralize their decision-making. Since threats of currency deterritorialization are pervasive, we do see a trend towards more technocratic decision-making regarding currency and monetary policies. Cowhey and Richards point out in Chapter 6 that globalization processes are reconfiguring the policy space of the telecom industry. The new telecom regime that the United States is championing to ensure truly competitive telecom markets imposes significant costs on Western Europe and the developing countries, at least in the short-run. The United States has an incentive to change the status quo because, in incompletely globalized telecom markets, US consumers provide huge subsidies to foreign telecom monopolies. Acceding to US demands implies that national telecom monopolies in Europe and the developing countries have to accept lower revenues in the short-term. Since theses monopolies are important economic actors (as the authors note, sometimes they have the highest market capitalization in the national stock market), short-term reductions in telecom revenues can have serious consequences for the domestic economy. Of course, in the long-run, everybody is better off with more efficient allocation of resources, hence the need for leadership. Nevertheless, the shortterm impacts may be serious enough to cause the affected parties to resist US proposals. Since coping with globalization by establishing a new telecom regime imposes asymmetrical costs and benefits across actors, the outcomes of reform attempts are political and therefore uncertain. At a broader level, any sort of deep integration or harmonization of domestic economic institutions has the potential to create a backlash. The recent experiences in transitional economies suggest that technocratic perspectives which ignore political factors are difficult to implement and


sustain. Institutions that have taken years to develop cannot be dismantled overnight. “Shock therapy” may not be the most effective policy in every situation. Further, as suggested in the introductory chapter, when faced with highly variable external environments, policymakers are unlikely to commit to large policy changes with long lock-in periods. The title of this volume is Coping with Globalization. The term “coping” is important for two reasons. First, though globalization is not inevitable or inexorable, there is widespread perception that it has ushered in significant structural changes in the world economy. Most societal actors, governments and firms in particular, are affected by it. Second, unlike many works on this subject that advocate either resisting or embracing globalization, this volume examines a wide array of strategies, without taking a normative position on the issue. The “winners” can be expected to embrace globalization and tout its benefits. They could also be expected to suggest that it is inexorable and inevitable, thereby invoking some kind of technological and structural determinism. Ironically, some ardent proponents of globalization seem to adopt a quasi-marxist position that technology determines the economic base and production arrangements (Ohmae, 1991). On the other hand, the “losers” often emphasize only the negatives of global market integration. As Spar and Yoffie discuss in Chapter 1, MNEs are accused of destroying the natural environment, abetting “races to the bottom,” and undermining the social fabric by creating new kinds of dependencies both in the developed and developing world. The critics of globalization recommend resistance, believing that globalization can be rolled back by appropriate political action, and predicating this on the assumption that markets still operate at the mercy of governments. The key targets for political action by the anti-globalization groups (other than the governments of proglobal nation-states) are international organizations such as the IMF, World Bank and WTO, regional trade and investment agreements such as the NAFTA or Mercosur, and emerging regimes such as the Multilateral Agreement on Investment. The main complaint of anti-globalists is that these organizations or regimes privilege MNEs over other societal actors, forcing governments to retreat from their legitimate economic and social functions (heralding the demise of the Keynesian state), particularly in redistributing income and wealth. This volume does not advocate either of the above positions. Firms and governments across policy arenas and industries are differentially impacted by globalization. Whether it is desirable to embrace, resist, or adapt depends on the perceptions of benefits and costs on the part of the impacted actors. We expect significant divergence of opinion even within the traditional categories of labor and capital interests on this subject. It is incorrect to assume that globalization privileges all capital over all labor, or that all firms will unequivocally support it. Some firms are more insulated from the effects of globalization than others. The same could be said for workers. Some firms and


workers will perceive themselves to be potential “winners,” others will not. Thus, an important implication is that since the effect of globalization can be expected to vary across and within industries and countries, a disaggregated analysis is necessary to understand its political economy. Ideas and interests In the introductory chapter, we presented a framework linking globalization processes to coping strategies of firms and governments. We suggested that to understand the choice, pace and sequencing of coping instruments, a focus on the preferences and endowments of policymakers is required. As variables exogenous to policymakers, globalization processes upset the status quo. In considering coping strategies policymakers take into account both selfinterests and organizational interests. Their choices are constrained by factors internal and external to their organizations. In firms, the top management is constrained by external markets and non-market pressures, and internal pressures from managers and workers. In governments, the executive is constrained by external or systemic factors as well as by domestic institutions and politics. Given these constraints, policymakers could adopt coping strategies that address issues external to their organization, internal to them, or both. Over time, such policies can influence internal and external constraints as well as the processes of globalization. This framework suggests that coping mechanisms are not structurally-determined and that the strategic choices of decision-makers play an important role. How do ideas and identities influence coping strategies?3 Ideas are beliefs held by individuals (Goldstein and Keohane, 1993) while identities are ideas about one’s social, cultural and economic coordinates. Should ideas and identities enter the equation as internal and external constraints that influence policymakers’ choices? As discussed in the introductory chapter, some argue that globalization should be viewed as having two components: market integration and the development of a global mind-set among policymakers in firms and governments. In this context, four categories of ideas can be identified. Ideas about: • • • •

desirable consumption patterns and life-styles roles of and relationship among governments, markets and civil society religious, environmental, human rights and moral issues organization of corporate and market governance

In this volume, the flows of ideas about consumption, roles of governments, and corporate governance are treated as embedded in the flows of goods, services, inputs and investments; they are not treated as a separate category of flows that impact market integration.4 For example, the globalization of the entertainment industry has led to increasing flows of ideas about desirable


consumption patterns (cultural imperialism, as some view it). Surging FDI diffuses notions of models of corporate and market governance across countries (for an excellent discussion, see Berger and Dore, 1996). The increasing power of the globalized stock markets and of ratings agencies such as Moody’s and Standard and Poor’s accelerate the acceptance of AngloSaxon managerial and accounting standards. Nevertheless, significant variations remain within and across countries on the desirable consumption patterns, roles of governments, trade-off between environmental issues and economic growth, and architectures for corporate governance. Along with globalization, there is a rising tide of localization manifesting as an upsurge in the civil society and in various forms of ethno-nationalism (Appadurai 1996; Crawford and Lipschutz, 1998). The global information infrastructures that enable MNEs to reduce transaction costs of managing cross-border valuechains, and their managers to leverage a global mind-set, also empower local groups to network and assert their identities. Ideas are not epiphenomenal in understanding the etiologies and impacts of globalization processes. We agree with Goldstein and Keohane (1993) that ideas and interests together explain political outcomes. However, with competing sets of ideas, strategic choices of policymakers play an important role in privileging one set over others (Mendelson, 1993).5 For example, to explain variations in the acceptance of Keynesian ideas across countries, Hall (1986) identifies three categories of interest-based explanations: economistcentered, state-centered, and coalition-centered. The economist-centered approach focuses on how the economics profession became interested in Keynesian ideas and then passed them along to politicians. Since Keynesian ideas identified interesting puzzles amenable to quantitative analysis, they served to constitute a viable research program for young economists. The statecentric approach focused on the differing levels of compatibility of Keynesian policy approaches to extant institutional structure; the more the compatibility, the higher the acceptance. The coalition-centered approach emphasized the power of ideas to mobilize winning coalitions, and hence assume salience for politicians. Thus, the three approaches provided interest-centered explanations for the varying success of Keynesian ideas. As Hall notes: It is ideas, in the form of economic theories and policies developed from them, that enable national leaders to chart a course through turbulent economic times, and ideas about what is efficient, expedient, and just that motivates the movement from one line of policy to another. Simply recognizing that ideas are important to the development of policy is not enough, however. All too often ideas are treated as purely exogenous variables in accounts of policy making, imported into such accounts to explain one outcome or another, without much attention to why those specific ideas mattered…if we want to accord ideas as explanatory role in the analyses of policy making, we need to know much more about the


conditions that lend force to one set of ideas rather than another in a particular historical setting. (1986:361 and 362) Ideas should not be viewed as tools employed by interested actors and as having no ontological status by themselves (Sandholtz, 1999). Their role in furthering or impeding the processes of globalization, in the selection of coping strategies, and in influencing their success or failure is an important project that needs to examined separately in the future. To retain the focus on coping responses, this volume assumes that the processes of economic globalization—material flows and the rising salience of MNEs—are exogenous variables, and ideas are mediating variables influencing and constraining the choice of coping mechanisms that decision-makers chose to employ. To elaborate, policymakers need support from policy elites and key interest groups to implement policies. Needless to say, ideas and opinions about the best course of action often diverge. For example, internal policy elites may believe that the IMF’s prescriptions for structural adjustment programs are beneficial for the country but may not have popular support for their views. Alternatively, external policy elites may argue that capital controls are harmful but domestic policy elites may still favor them. As discussed in the introductory chapter, there could also be disagreements within otherwise unified epistemic communities: e.g. some international economists may believe in temporary capital controls (Krugman and Bhagwati) while others may not (Summers and Fischer). There are usually many conflicting ideas and opinions that policymakers can draw upon. Which particular ideas are actually adopted is a function of many variables, including (among others) the personal preferences of the policymakers, their willingness and ability to entertain new ideas, and the relative political power of the proponents of various competing ideas. Ideas become part of coping because, eventually, choices of policy instruments need to explained and justified in terms of their likely impacts on the economy. In light of this discussion, important theoretical issues for further research include: • Why do policymakers have varying preferences towards a given coping strategy? • How has the end of the Cold War and the “victory” of capitalism affected the pace and the extent of market integration? • How has the increased strength of the American economy in the 1990s compared to the European and East Asian economies given legitimacy to the scaling back of statist models, empowering MNEs at the expense of other societal actors, thereby legitimizing MNE-led cross-border integration? • Is there a convergence towards the Anglo-Saxon model a part of the globalization processes or a consequence of it? (Berger and Dore, 1996).


One could also employ the Goldstein-Keohane (1993) framework to examine the role of ideas in global market integration. They identify three categories of ideas: world views, principled beliefs consisting of normative notions of right and wrong, and causal beliefs about cause-effect relationships rooted in shared consensus among elites. Ideas play the following roles in the formation of foreign policies (their insights could be extended to domestic policy as well): [I]deas influence policy when the principled or causal beliefs they embody provide road maps that increase actors’ clarity about goals or ends-means relationships, when they affect outcomes of strategic situations in which there is no unique equilibrium, and when they become embedded in political institutions. (Goldstein and Keohane, 1993:3) Based on the above framework, one could classify ideas about globalization into three categories: • World views about globalization and market integration. • Normative notions about the desirability or undesirability of market integration. • The link between the level of market integration and desired policy objectives such as employment, economic growth, environmental sustainability. Then, one could examine their impact on specific policies facilitating market integration. How have ideas about desirability of market integration and the link between market integration and domestic employment, impacted policy outcomes with multiple equilibria such as the granting fast-track authority to the President? What were the processes by which ideas impacted the fast-track policy dynamics? Clearly, the impact of ideas on globalization processes and their role as parts of globalization processes, constitutes an important area for future research. “Races to the bottom”: conceptual and empirical challenges An important component of the globalization discourse is the subject of “races to the bottom”. Debora Spar and David Yoffie discuss in Chapter 1 that MNEs are under pressure to cut costs and governments want to attract investments from MNEs, so there are incentives for governments to ease environmental or labor laws. Such races can be countered by establishing international regimes that set minimum standards across countries. Empirically, races to the bottom do not seem significant since developed countries with comparable levels of labor and environmental laws received 66 percent of FDI during 1996–96


(UNCTAD, 1997). A disaggregated analysis of FDI inflows to developing countries also suggests that most of it is not in pollution-intensive industries. As Rugman and Verbeke point out in Chapter 3, there is a literature arguing that firms should unilaterally adopt stringent environmental policies, thereby gaining first-mover advantages. The international trade literature also reports lack of conclusive evidence for “industrial flight” from developed countries to “pollution-havens” in developing countries (Low and Safadi, 1992). Scholars also point out that international trade has had a minor impact on lowering wages in the United States and other high-wage countries (Krugman, 1994). It could be argued that it is not the actual race to the bottom but the potential for it that serves to constrain governments and privileges capital over labor.6 In addition, there is plenty of anecdotal evidence suggesting firms relocate their factories to developing countries to cut labor costs. There is no dearth of politicians (or demagogues) eager to fasten upon such anecdotes, thereby creating concerns about such races. The potential for such races was a major issue during the NAFTA debate in the United States and President Clinton had to rely on Republicans to get the treaty ratified. A full-employment economy has not significantly toned down public concern as evidenced in the inability of President Clinton to persuade the Congress to grant him authority for fast-track negotiations. Races to the bottom and establishing mechanisms to curb them raise issues of equity. Turning a blind-eye to such races could hurt domestic labor in some industries while successfully curbing them may deny developing countries opportunities to industrialize. The latter is important because international organizations such as the World Bank and the IMF have persistently advised developing countries to shun import substitution, embrace open markets, and attract MNEs. Developing countries are advised to allow markets to determine their country’s comparative advantage. For most developing countries having abundant supplies of labor relative to capital, their comparative advantage lies within labor-intensive activities. Consequently, MNEs could have incentives to locate their labor-intensive activities in these countries. This discussion raises a fundamental question: how are the outcomes of races to the bottom different from those of comparative advantage? One strategy is to differentiate them in terms of causal variables. Though the outcomes may be similar in terms of low-factor and regulatory costs for the MNEs and a specialization in labor-intensive activities on the part of developing countries, they are the results of different forces.7 Comparative advantage may be natural or created. Races to the bottom are in the special category of created comparative advantages because governments consciously establish low regulatory standards or laxly enforce stringent standards to attract investment. If a labor surplus country has low labor costs, this does not constitute a race to the bottom if the government did not consciously seek to lower or suppress labor costs through policies such as


disallowing (or discouraging) unionization or giving access to MNEs to prison/ forced labor. However, it is methodologically challenging to tease out the relative impacts of labor surplus versus labor oppression on wage rates since countries where labor is allegedly oppressed are also usually abundant in lowskilled labor. For environmental issues, this discussion has different implications. Instead of environmentally-rich countries attracting pollution-intensive industries (analogous to labor surplus countries attracting labor-intensive industries), the pollution-intensive firms allegedly gravitate towards countries with degraded environments. The latter are also underdeveloped and have a comparative advantage in attracting “dirty industries” in terms of low relative price for environmental amenities,8 but obviously not in terms of the initial condition of the natural environment. This opens an old debate about operationalizing comparative advantage in terms of relative prices (that take into account both factors endowments and preferences) versus physical endowments only. If one employs the relative price method, outcomes of races to the bottom are not different from those resulting from specialization based on comparative advantage. However, if comparative advantage is defined in terms of physical endowments, then perhaps underdeveloped countries that are often poor in resources required for environmentally-sound processing of industrial waste products, should not attract pollution-intensive industries. The comparative advantage in relative prices is created by lax environmental laws— environmental amenities are priced too cheaply, even though the quality of the environment is precarious. This discussion suggests that assessing the efficiency and equity implications of races to the bottom versus those of pursuing specialization based on comparative advantage requires confronting many methodological and conceptual puzzles.9 Towards a new architecture of global governance Many chapters explore the possibilities of establishing or strengthening international regimes to cope with globalization. Spar and Yoffie (Chapter 1) discuss the conditions that facilitate “governance from the top”. Kudrle (Chapter 8) examines the possibilities of such governance to curb tax evasion. Cowhey and Richards (Chapter 6) suggest a new international regime to cope with incomplete globalization of telecom markets. Ostry (Chapter 2) presents WTO-led deep integration as the basis for a new international regime for trade and investment. Should such regimes be established? If so, how? Who should wield the rule-making, monitoring and enforcement powers? Will they remain state-centered or would MNEs and international non-governmental organizations (INGOs) also have significant roles? If so, will the democratization of such regimes (or lack thereof) impede their abilities to make and implement decisions?


Ostry correctly argues that the WTO suffers from an “analytic deficit”—not enough staff or budget to conduct needed analyses—as well as from a very large number of actors. To deal with the latter problem, she has suggested establishing an Executive Committee. However, this leads to another set of issues: international organizations (IOs) such as the WTO and the IMF are alleged to suffer from a “democratic deficit”—too much elite policy-making without mechanisms to make elites accountable to broader publics. International nongovernmental organizations (INGOs) are important contributors to globalization discourse. They criticize international organizations for not being transparent, democratic and accountable, and they lobby strongly for direct participation by INGOs in the deliberations of IOs. Any effort to exclude them from new or reformed regimes could accentuate the backlash to WTO-led deep integration. On the other hand, including them also risks further criticism that IOs are undemocratic, since INGOs tend to be just as elitist as IOs, if not more so. The abilities of national governments to create new international regimes are impeded by demands by INGOs for a “voice” (Hirschman, 1970) and by subnational pressures. There are concerns that to cope with globalization, governance may increasingly become concentrated with technical elites and at supranational levels, reducing opportunities for citizen participation. Brussels is remote to many citizens in the EU and similarly Washington, D.C., is remote to people in various parts of the world that are subjected to policies of the IMF and the World Bank. In this context, Alfred Aman’s essay (Chapter 4) is very instructive since he discusses constitutional obstacles for national governments to negotiate with international actors. He correctly notes that one of the key resources that the national governments could have is constitutional flexibility to devise new policies through appropriate legislative measures. To effectively cope with international challenges, national governments need domestic political support: international negotiations often require gains in some areas and concessions in others. However, the United States Supreme Court has stepped in to redefine important constitutional parameters, thereby empowering the states. As suggested in the introductory chapter, if the federal government cannot implement international agreements domestically or is faced with significant opposition from the states, its credibility is eroded. For example, unlike shallow integration that involves removal of border impediments such as tariffs, deep integration requires harmonization of domestic economic policies and institutions. If the federal government is enfeebled or straightjacketed by the Supreme court, it is constrained to undertake deep integration, and therefore becomes a less credible actor in the WTO. Aman’s chapter therefore attests the conclusions of many other chapters: domestic politics and institutions have crucial impact on the establishment and functioning of international regimes.


Notes 1 We thank the anonymous reviewers for their comments. 2 As per transaction cost theorists, we differentiate firms from markets (Coase, 1937; Williamson, 1975). Markets are institutional arenas for exchange while firms are actors undertaking such exchanges. 3 We thank Peter Katzenstein for encouraging us to examine this issue. 4 Many view ideas as key factors in furthering market integration. In particular, the roles of the global media industry and the “new media order” have been studied by world-systems and cultural studies scholars. The perspectives of Foucault, Gramsci and Habermas, in particular, have inspired this scholarship. These works seem as continuations of the intellectual discourse on “new international information order” that sprung up in the 1980s. The main contention is that the monopoly of the developed countries and the MNEs over cross-border information flows has resulted in cultural hegemony and “manufactured consent” in favor of continued market integration. Key recent works include Poster (1995), Babe (1996), Gerbner, Mowlana and Schiller (1997) and Perry (1998). 5 Keynes had noted, “the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist” (1936:383). John Stuart Mill’s observation, perhaps, needs to be considered along with Keynes’ famous quote: “ideas, unless outward circumstances conspire with them, have in general no very rapid or immediate efficacy in human affairs” (1845:503). 6 Milner and Keohane (1996:1) make a similar point. They note that a potential for international movements of capital by itself can have dramatic impact on national economies even if no capital movements actually take place. 7 Labor-intensive activities can lead to dead ends for economic development. Unless the country in question can find ways to make labor more valuable by raising the average level of skills in the work force, or unless it can make capital more plentiful domestically by reorganizing domestic capital markets, its workers will not escape from the combination of low wages and job insecurity that comes from knowing that the MNEs will move to lower cost locations whenever they must. 8 This could also be called the “Larry Summer perspective”: since people prioritize jobs and economic development over environmental degradation, such countries have a comparative advantage in attracting pollution-intensive industries. This debate also has implications for the political economy and ethics of international waste trade or trash trade that led to the Basel convention. 9 Kudrle notes (1999): Poor countries have low market wages, and policy interference other than fiscal redistribution can generally raise market incomes for some only at the expense of others’ market income. Policy support for labor monopolies is a question of degree, and there is a wide divergence between form and substance. Except for some child labor laws, rudimentary safety standards, and possibly some highly circumscribed rights for labor organization, a race to the top would look a lot like ‘a race to avoid competition from the poor


countries’. The same goes for environmental standards. Except for crossborder externalities—which admittedly are growing in importance—there are no obvious grounds to insist on minimum environmental standards if they conform with internal preferences. In summary, as Jagdish Bhagwati (no conservative, he) never tires of pointing out: low wages and a collective preference for goods and services other than those from the environment at low levels of income are as legitimate a source of comparative advantage as anything else.

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Abbot, J. 16 Adelman, M.A. 152 Agreement on Basic Telecommunications Services 1997 (WTO) 148, 152–2 Aliber, R.Z. 182 Aman, A.C. 9, 16, 93–114, 237 Appadurai, A. 3 Applied Komatsu Technologies 133; inaccurate forecasts 134; success in Asia 133 Applied Materials: in flat-panel display markets 126, 134; work with Japanese firms 133–4 architecture of supply 119; access to vital inputs 119; globalizing markets 119–21 AT&T 128

capital mobility 198–9, 203 capital taxation 203–7; corporate taxation 205–6; incidence 203, 204; methods 203; OECD proposals 207–7; portfolio investment 205; reform 205–7; steady erosion 215–16; tax havens 204–4 Caves, R.E. 1 Cerny, P.G. 3, 32, 181 chaebols 124 Chemerinsky, E. 111 Chennels, L. 205 Child, J. 7 Cohen, B.J. 5, 12, 173–198, 227–228 Cold War 64 Collingsworth, T. 32 Commonwealth: preferential treatment by Britain 62 competition: cross-border, among currencies 173; factor in race to the bottom 40; in telecommunications market 148, 228 competition rules: international telephony markets 148 competitive strategies 11–16 competitiveness, trade and environment 80 constraints on governments and firms 5–9 consumer movements 61–2; ethical funds 61–2 consumption taxation: collection by seller 211–12; electronic cash 212;

Bank for International Settlements 58 Baron, D.P. 1 basic telecommunications: global pressures 228; globalization of market 148–66; international services 154–4; legacy of monopolies 153–3; limits of bilateral liberalization 155–7; moves to competition 153–3; obsolete regulation 153–3; settlement rate 155 Berger, S. 5, 232 Bergsten, F. 192 Bhagwati, J. 10–11 Borrus, M. 119 Breyer, Justice 107, 109–10, 114



evasion 212; indirect 210; retail sales tax 210, 211 convergence 15, 27, 51–76 Cooper, R. 180 cooperative strategies 11–16 coping strategies: as dependent variables 3; as political outcomes 5; competitive vs. cooperative 12; constraints 5–9; see also external constraints, internal constraints; high-tech sector 16–18; influence of ideas and identities 230; reasons to seek xi; strategic choices by policymakers xi, 5, 10–11, 230 coping with tax challenges 216 Corning Glass: in flat-panel display markets 126; not member of US Display Consortium 130 corporate governance: role of governments 227 corporate income tax: ten-country study 204–5 Cowhey, P. 18, 148–171, 228 cross-border securities transactions: growth 203 cross-border trade 29 cross-border value chains 1 cross-national production networks 120 currency 11–12; acceptability 189–9; cross-border competition 173; post-war strategies of UK and USA 190–90; states’ defence of market position 174; world popularity of leading currencies 177 currency deterritorialization 173, 174–7, 227–7; irreversible 179–80; unquantifiable 175 currency internationalization 175; accelerated pace 175–6 currency policy 173–97;

Argentina 194; choice of strategies 182–8; domestic politics 188; economic factors 185–6; euro 192; evaluating strategies 189; exchange rates 186, 186, 188; former East Bloc states 194; Indonesia 193; Latin America 192–2; market alliance 183, 191–1; market followership 183, 194–4; market leadership 183, 190–90; market preservation 183, 192–3; political factors 188–8; small/weak states 185–5; tactics 182–4 currency substitution 175, 227; accelerated pace 176 cyberspace: variable levels of regulation 44–7 Daewoo 145 De Grauwe, P. 186–6 decentralized decision-making: pressures for 98 deep integration 15–16, 27, 28, 51; domestic political support 28; fostered by currency deterritorialization 228; World Trade Organization 51 deeper integration: INGOs, role of 59–62; multinationals, role of 54–59; national financial systems 173; policy process 54–62 Defense Advanced Research Projects Agency: 126, 127–34 Department of Defense funding of research: advanced displays 126; flat-panel displays 127–9, 136; US Display Consortium 128 Deutschmark: popularity 177 developing countries: advantages and disadvantages of laborintensive activities 235, 238


devolution in UK 94 Display Technologies Incorporated 122 dispute settlement: WTO mechanism 70–2 dollarization 177, 192, 193, 194, 227 Donahue, T. 32 Donaldson, T. 9 Dore, R. 5, 232 dpix, 125, 140 Du Boff, R. 32 Due, J.F. 211 Dunning, J.H. 5 eco-imperialism 61 economic globalization: assessment of effects xi–1; coping strategies xi, 4–11; definition 1–4; see also globalization economic growth: competition to create 98–9 economic policy developments 199–201 Effective Competitive Opportunities test 168 efficiency: role of international institutions 151, 152 electronic cash 196, 212 electronic commerce 43–7; evolution of network markets 53; self-regulation 58; see also information and communication technologies Electronic Display Industry Research Association of Korea 124 environmental groups: green international non-governmental organizations 61 environmental issues, 27–9; North-South divide 61 environmental management challenges 85– 6; classification 85 environmental non-governmental organizations: lobbying success 78–80 environmental pollution 236

environmental regulations 13–15, 41; barriers to trade 81–2; divergence across countries 83; effect on competitiveness 82; first-mover advantages 83, 89, impact on multinationals 76–91; interaction with firm strategies 80, 83; levels 77–9, 80; need for corporate strategies 83; no effect on foreign direct investment 88; trend to harmonization 78 environmental taxes 213–14 euro: potential challenge to dollar 192 European Union: position in WTO telecommunications talks 158–8, 160–60 Evans, P. 4, 10 external constraints on firms 6–8; complexity 7; stress 7–8; variability 7 Falk, R. 32 Federal Communications Commission 155–6; benchmarks 163–3, 166–6; Effective Competitive Opportunities test 168; Flexibility Order 156–6, 162; transition periods 166 federal vs. state powers 98 federalism: globalization 93–110; in USA 93, 95; shift to state autonomy in USA 97; stance of US Supreme Court 94, 97, 98 financial sector: intergovernmental institutions 58; self-regulation 58 first mover: advantages 13, 83, 89 fiscal challenges arising from globalization 198–225: coping strategies 216; positive effects 219


fiscal policy 198–225: definition of terms used 200; see also tax fiscal power of state: erosion by globalization 198–225; future problems 215–17 fiscal systems: principle of residence 204–4 Fisher, I. 221 Flamm, K. 135–136 flat-panel display industry: Asian dominance 117; global market 121–2; global notebook computers 141–3; Japan 122–4; Korea 124; market shares by major application 122; market size 117; strategic issues 117–18: Taiwan 124–5; USA 125–6, see also US flat-panel display industry; Wintelist practices 120–1 “footloose” capital 3, 12 Forbes “flat tax” 210 foreign direct investment 1, 88; increase 51 FPD industry see flat-panel display industry Fratianni, M. 186 Frieden, J. 188 Friedman, M. 219 G7 meeting, May 1998 205 General Agreement on Tariffs and Trade: contrasted with WTO 69–1; creation 62–5; shallow integration 51; systemic inadequacy 65, 69; tariff reduction 64; transparency 67 Gilpin, R. 4 global citizenship 100–2; inherent conflicts 100 global competition: link with national economy 109–10

global governance: federalism 94; pathways towards 236–5 global integration: growth 51 global mind-set 2 global mobility 29; adverse effects 29–2; positive effects 29–2 global notebook computer industry 141–3 global pollution regulations 41 global races 32–6; ambiguous evidence 33, 42 global single market: momentum caused by deep integration 53 global state: federalism and 95–101 global strategies: success in flat-panel display industries 143–4 global trade: growth 1 global trade negotiations: influence of UK and USA 152 globalization: adverse impacts 32–4; classification of ideas 233; communications revolution 148–170; components 2; coping strategies 6, see also coping strategies; currency policies 173–97; defined in relation to individual firms 118; definition 51; domestic governance 93–110; effect on labour 32–4; and federalism 93–110; fiscal power of state 198–225; fiscal problems 198–225; interaction with taxation 200; internationalization differentiated 2; multinationals as agents 76–8; opposition by greens 61; pressure on multinationals’ cost 26; regional intergration 4; variables 2–3;


weakening of state power 26; winners and losers xi, 229; see also economic globalization globalization of telecommunications market: property rights 152; role of international institutions 149–52 globalization processes 4, 6, 19; as independent variables 3 Goldstein, J. 230–233 Goodhart, C. 179 Goold, J.W. 32 governance from the top 12–16, 16, 29–45; global environmental regulations 41 government policymaking 3, 4 governments: role in corporate and market governance 227 Granovetter, M. 5 green opposition to globalization 61 green pressure on multinationals 85, 86, 88– 9 green taxes 213–14; objectives 213; weakness 213 Griffith, R. 205 Grossman, G.M. 88 Group of Thirty 54 Ha, J. 175 Haggard, S. 10 Hall, P.A. 231–1 harmonization: environmental regulations 78; lack of forum for agreement 78 harmonized policies: effect on prices 42 Hart, J.A. xi–25, 117–148, 226–240 Harvey, P.J. 32 Hayek, F. 174 Helleiner, E. 217 high-tech sector 16–18; competition 17 Honkapohja, S. 186 Hufbauer, G.C. 168, 221 IBM:

absence from US Display Consortium 130, 140–1; alliance with Toshiba 125–6, 140–1 ICT see information and communication technologies Ikenberry, G.J. 10 impact of environmental regulations on multinational strategies 87 information and communication technologies: deeper integration 62; effects 53; global integration 51–3; revolution 62 INGOs see international non-governmental organizations integrated firms 4 Intel Corporation: Wintelist strategy 120 intellectual property 55–7 Intellectual Property Rights Committee 56 interest rates: international differences 204 internal constraints on firms 8–9; interest-group dynamics 8; organizational “slack” 8; policymaking rules 8; veto points 8; voting rules 8 International Association of Insurance Supervisors 58 International Corporate Governance Network 76 international institutions: interstate coordination 151; potential for efficiency gains 151; property rights 151–1 International Monetary Fund: Articles of Agreement 62; contrasted with WTO 71, 73; cooperation with WTO 70 international non-governmental organizations; common characteristics 59; consumer movements 61–2; elitism 237; green INGOs 60; impact of global networking 60;


importance 237; increased numbers 59; role in deeper integration 59 International Organization of Securities Commissions 58 international phone services 154–5; focus of WTO talks 161–1; high prices 157–7; unilateral US benchmarks 163–3, 166– 6; WTO Agreement 1997, 148, 161–5 International Studies Association San Diego convention April 1996 ix International Trade Organization 63, 64 internationalization 2–4; meaning 2 internationalized firms: integrated firms differentiated 4 Internet: regulation 43 Internet commerce: tax considerations 211 investment: attracting 98–9 Jackson, R. 185 Jaffe, A.B. et al 87 Japan flat-panel display industry: collaboration with Applied Materials 133–4; main actors 122; rapid growth 123; strong supply architecture 122–3; US rivalry 127 Kapstein, E. 32 Katzenstein, P.J. 7–8 Kawai, M. 217 Keohane, R.O. 2, 5, 230–233 Keynes, J.M. 178, 238 Keynesian policy approach 231 Kirshner, J. 179 Kirton, J. 77, 78, 80 Kobrin, S.J. 4 Korean flat-panel display industry: link with USA 128–9; main actors 124

Krasner, S. 15 Krueger, A.B. 88 Krueger, R. 176 Krugman, P. 10 Kudrle, R.T. 16–16, 198–225, 238 labor-intensive activities in developing countries 235, 238 labor mobility 199 Lake, D.A. 10 Lam Research: US Display Consortium contract 128–9 Laughland, J. 215, 216 Lawrence, R.Z. 4 LCD producers: revenues in 1997 123 Lee, E. 32 legal regimes: need for flexibility 94 legalization of trading system 65–69 Lenway, S.A. 17–18, 117–148 Levy, B. 152 Levy, D.L. 88 Libecap, G. 166 Litan, R.E. 219 “local” issues: impact on global issues 94–6 managerial attitudes 2 market governance: role of governments 227 market integration: inter-war setback 226; pre-World War I 226; role of global media industry 238; role of multinationals 226, 227 market share of FPDs by major application 1997 122 Marshall Plan 64 Mastanduno, M. 10 Maxfield, S. 10 McLure, C. 216 Micron 125 Microsoft: Wintelist strategy 120 Mikesell, J.M. 211 Mill, J.S. 178, 221


Milner, H. xi, 238 Milner, H.V. 2 Mittleman, J.H. 3 MNEs see multinational enterprises monetary policy: oligopoly by state 180–2; see also currency policy monetary sovereignty 173–4; benefits 177–9; challenges for governments 228; constitutional support 177; control of money supply 177, 179; independence of states 178, 179; political symbol 177; public spending 177, 178–9 monetary union 186–6; motivated by security needs 186; sustainability 186 money see currency money supply: state oligopoly 171, 174, 180–2, 227 Moon, C. 8 Most Favored Nation rule 62 Motorola 125 Mueller, D.C. 8 multinational enterprises 1; access to host-country systems 81; access to markets 1–2; agents of globalization 1, 226; country-specific advantages 85; criticism of strategies 229; efficiency 76–8; firm-specific advantages 85; green options for managers 86; green performance standards 88–9; growth as indicated by foreign direct investment data 226; impact of environmental regulations 76–91; reasons for green performance 85; strategic behavior 83; triad economies 76–8 Murtha, T.P. 17–18, 117–148 National Flat-Panel Display Initiative (US) 136–9 national government:

link between states and global level 99 national security issues 3 natural convergence 53–4 Nehrt, C. 83–6 Niskanen, W.A. 219 North-South divide 61 Nye, J. 5 O’Connor, Justice: on state sovereignty 102–4, 113 Ohmae, K. xi, 3 oligopoly by state over money supply 171, 174, 180–2, 227 optimum currency areas 186, 186 Organization for Economic Cooperation and Development: capital tax reform proposals 207–7, 217, 220; tax Forum 207, 217 Ostry, S. 3, 15–16, 51–76, 236–237 Padoa-Schioppa, T. 178 Palan, R. 16 Pauly, L. 4, 180 Perlmutter, H.V. 2 personal income taxation: broader tax base 207–8; electronic commerce 208; foreign labor earnings 208; labor mobility 209; recent falls in highest rates 207–8; tax cheating 208; US policy 208–9 Photon Dynamics: first US Display Consortium contract 128, 135; strategic focus 134–5; success in Asia 133 Pikkarainen, P. 186 Planar-System, Inc., 125 Polanyi, K. 3 policy convergence 53–4 policymakers: strategic choices 5, 230, 232 political factors in slowing change 229 pollution haven 87, 88 pollution-intensive industries 236


Porter, M.E. 1, 13–15, 76, 82, 89–90 Prahalad, C.K. 1 Prakash, A. xi–26, 226–240 Preston, L.E. 9 property rights: definition 166; in Canada 68; international regimes 151; international telephony markets 148; monopolistic markets 152; protected by US Constitution 68 protectionism 15, 62 public/private distinction 93, 94, 95 Putnam, R. 10 “race to the bottom” 12–13, 29–45, 233–4; advantages of developing countries 235–4; ambiguous evidence 33–6; cost changes 38; definition 34–7; dilemma of control 235; effect on state policy 32; effect on wages 32; electronic commerce regulation 43; facilitating factors 30–3, 35–40; global mobility 29–2; heterogeneous markets 36; homogeneity of products 30, 36–9; large cross-border differentials 30; minimal border controls 30; mitigated by governance from the top 34, 40–4; mobility of firms, 30, 35, 36; necessary conditions 30–3, 35–8, 39–2; regulatory differentials 30, 37; result of fiscal competition 198; reversed by global regulations 41 regional integration: effect on globalization 4 Rehnquist, Chief Justice: views on federalism 97 Reich, S. 4 Rent-chains, 1 revenues of top LCD producers 1997 123 Richards, J. 18, 148–171, 228 Rio Earth Summit 60

Rodrik, D. 1 Rodrik, K. 32 Rogowski, R. xi role of selected taxes in total government revenue 201 Ruggie, J. 10 Rugman, A.M. 13–15, 76–93 self-regulation of markets 58, 59 Sengenberger, W. 32 separation of powers (US) 103, 108–9 settlement rate (telecoms): benchmarks applied 163, 166–6; definition 155; problems 156, 157; US initiative 163 shallow integration 15, 27; GATT 51 Sharp 122, 123 Shonfield, A. 8 Slemrod, J. 205 social security taxation 212–13 Soloway, J.A. 77, 78, 80 sovereignty: and convergence 51–76; monetary 173–4, see also monetary sovereignty; state 102–8, see also state sovereignty Spiller, P. 152 state oligopoly over money supply 171, 174, 180–2, 227 state sovereignty (US) 101, 102–8; benefits 103; commerce power 108; policy goals 103 Steuerle, E.C. 217 Strange, S. 1 Strange, S. 112, 181 strategic choices for policymakers 10–11 Summers, L. 238 sunk costs: effect on races 30, 38–1; electronic commerce 43–6 system convergence 62 Taiwan flat-panel display industry:


investment 124–5; main manufacturers 125 Tanzi, V. 205, 217, 220 tax: coping with fiscal challenges 216; illegal evasion 200; interaction with globalization 200; legal avoidance 200 tax evasion: suggested reform of laws 205 tax havens 204–4; limit on profitability 207; OECD proposals 207–7 taxation, new sources: green taxes 213–14; Tobin tax 214 technonationalism 117–145; access to vital inputs 119; definition 118; uncompetitiveness 115; weakness of policies 118 telecommunications industry market: competition 228; competition rules 148; institutional designs 148–170; property rights 148; see also basic telecommunications Texas Instruments 128 Thygesen, N. et al. 175 Tobin, J. 214 Tobin tax: pros and cons 214 Tokyo Round: focus on government intervention 65; legalization of trading system 65; negotiations 54 Toshiba: IBM link-up 125–6, 140–1 trade in services 55 transaction costs: effect on races 30, 38–1; electronic commerce 43–6 transnationals: economic power 100; intersection with local regimes 99–1 transparency 66–9; difficulty of implementation 68; required by Uruguay Round 67;

significance 67; under GATT 67 triad economies 76; strength vis-à-vis non-triad economies 77 UK: influence on global trade policies 152; preferential treatment of Commonwealth 62 UNCTAD, 1 Uruguay Round 65–7, 69; negotiations 54; “new issues” 55, 57 US Display Consortium: goals 128; membership 128; membership fees 129; non-participation of Corning Glass and IBM 130, 140–1; review of funding 129 US dollar: world popularity 177 US environmental regulations: emphasis on processes 87 US flat-panel display industry: DARPA 127–9, 132–3; Department of Defense funding 127– 38; government task force 135–6; link with Korea 130–3; main manufacturers 125, 128; origins of FPD policy 126–7; rivalry with Japan 127; slow growth in high-volume sector 139– 40; tools 128–9, 133–5; weapons systems application 127; see also US Display Consortium US Government: flat-panel display industry 117–45 US influence on global trade policies 152 US Supreme Court: concept of state sovereignty 101, 102– 4, 113; stance on federalism 94, 97, 98 USA:


constitutional changes 94; unilateral telecommunications regulation 163 Van der Linde, C. 76, 82 Verbeke, A. 13–15, 76–93 Vogel, D. 34 von Hagen, J. 186 Waller, C. 186 Westphalian system: weakened 4 Wintelism 115; in electronics industry 120; internationalization 120 Wood, A. 32 World Bank: contrasted with WTO 71, 73; cooperation with WTO 70 World Intellectual Property Organization 55, 56 “World Tax Organization” proposal 217 World Trade Organization: agent of deep intergration 51; barriers to consensus 71; cooperation with IMF and World Bank 70; creation 65–69; Dispute Settlement Mechanism 70–2; diversity of members’ legal systems 66; first Ministerial Conference 1996 60, 66; most favored nation rule 148–9, 161; need for reform 72–5; Punta Declaration 69; reinforcing power 71–5; structure contrasted with IMF, OECD and World Bank 71, 73; Tokyo Round 54, 65, 67; Uruguay Round 54, 55, 57, 65–7, 67, 69; waeknesses 71 World Trade Organization Agreement on Basic Telecommunications Services 1997 148, 152–2; EU and US positions 158;

international services 161–1; negotiations 158; 1997 solution 162–3; pre-1997 talks 161–1; signatories 164; unilateral US benchmarks 163–3, 166– 6; US negotiating policy 159–9; US proposals 162 Xerox 125, 128 Young, O. 15 Zysman, J. 8 Zysman, J. 120