Globalization: State of the Art and Perspectives

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Globalization

Is the state weakened by globalization? Does national economic policy converge under the competitive pressure of globalization? Who is gaining or losing from globalization, and why? For the last ten years, these questions have been in the focus of the public debate and political science research. Meanwhile research has produced substantial empirical analyses on many aspects of globalization leading to a substantiation of some arguments and to a weakening of others. In view of the increasingly differentiated research on globalization, a host of international experts in the field are brought together to systematically present the core fields and results of research on globalization. The chapters follow an actor-centred approach and are theoretically guided empirical analyses. Each chapter presents the international state of the art of research on globalization on the respective issue area as well as the individual author’s cutting edge. The areas covered in this volume include an analytical overview on globalization research, fiscal policy adjustment to globalization, tax competition, international monetary policy, transnational policy regimes, governance through private business and public–private partnerships, developing countries, regionalism and trade liberalization in transformation countries. For each of these issues, the chapters introduce the relevant theoretical approaches and analyse the empirical findings. This volume will be of interest across a number of related subject areas including international political economy, international relations, comparative politics, international economics and area studies. Stefan A. Schirm is Professor of Political Science at the University of Bochum, Germany, where he holds the Chair for International Relations.

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Globalization State of the art and perspectives

Edited by Stefan A. Schirm

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© 2007 Selection and editorial matter, Stefan A. Schirm; individual chapters, the contributors All rights reserved. No part of this book may be reprinted or reproduced or utilized 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 Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-96226-5 Master e-book ISBN

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Contents

List of figures List of tables List of contributors Preface 1 Analytical overview: state of the art of research on globalization

xi xii xiii xv

1

STEFAN A. SCHIRM

2 The development of the debate: intellectual precursors and selected aspects

22

ANDREAS BUSCH

3 Fiscal policy and adjustment: adjusting fiscal policy to globalization – testing theoretical approaches

40

REIMUT ZOHLNHÖFER

4 Taxation and cooperation: international action against harmful tax competition

61

THOMAS RIXEN

5 Money and power: markets and governance in international monetary policy

81

HUBERT ZIMMERMANN

6 Political transnationalization: the future of the nation-state – a comparison of transnational policy regimes EDGAR GRANDE, MARKUS KÖNIG, PATRICK PFISTER AND PAUL STERZEL

98

x Contents 7 Business and governance: transnational corporations and the effectiveness of private governance

122

DORIS FUCHS

8 Public–private partnerships: unlike partners? Assessing new forms of regulation

143

TANJA BRÜHL

9 Political conditions for economic growth: globalization and developing countries

162

JOACHIM BETZ

10 Regionalism in the world economy: building block or stumbling stone for globalization?

183

ANDREAS DÜR

11 Transformation and trade liberalization: the integration of the transition countries into the world economy

200

THILO BODENSTEIN

Index

219

Figures

2.1 7.1 7.2 7.3 11.1 11.2 11.3

Publications per year on globalization, 1985–2004 Cost-benefit function for two companies Point of maximum net benefit Agreement upon a common standard Non-tariff barriers to trade, 1993 and 2000 Executive constraints and trade openness International aid and trade openness

24 129 131 133 208 211 212

Tables

1.1 1.2 1.3 1.4 3.1 4.1 10.1 11.1

Growth of world trade compared to world real GDP Growth of foreign direct investment inflows compared to world real GDP Share of OECD countries in world trade and foreign direct investment Governmental total outlays as percentage of GDP Configurations of electoral competition Tax competition as asymmetric dilemma Eight scenarios on trade policy Founding elections and foreign economic openness

3 4 4 9 49 70 191 211

Contributors

Joachim Betz is Senior Research Associate at the German Institute of Global and Area Studies in Hamburg and Professor of Political Science at the University of Hamburg. Previously he worked as a Research Associate at the University of Tübingen, Germany. Thilo Bodenstein holds the Jean Monnet Chair at the Jean Monnet Centre of Excellence, Freie Universität Berlin. He received his PhD at the University of Konstanz and was a Senior Researcher at the Centre for Development Research at the University of Bonn. Tanja Brühl is Assistant Professor of Political Science with a focus on Peace and Conflict Studies at the University of Frankfurt am Main. Previously she was Research Associate for Comparative Politics at the University of Frankfurt and Teaching Assistant at the TU Dresden. Andreas Busch is Reader in Politics and International Relations in the Department of Politics and International Relations at the University of Oxford and Fellow at Hertford College, Oxford. After a Kennedy Fellowhip at Harvard University and his post-doctoral thesis (Habilitation) he taught at the University of Heidelberg, Germany. Andreas Dür is a Lecturer in the School of Politics and International Relations, University College Dublin. He holds a PhD from the Department of Political and Social Sciences at the European University Institute in Florence, Italy. Before taking up his current position, he was a Postdoctoral Fellow at the Mannheim Centre for European Social Research in Germany. Doris Fuchs is Professor of Political Science and Chair of the Department of International Relations and European Integration at the University of Stuttgart. Prior to joining Stuttgart, she has taught at the HandelshochschuleLeipzig Graduate School of Management, the University of Munich, Louisiana State University and the University of Michigan. Edgar Grande holds the Chair for Comparative Politics at the GeschwisterScholl Institute for Political Science of the University of Munich. He is also the director of the Munich research centre on “Reflexive Modernization”,

xiv Contributors funded by the German Research Association (DFG). Previously he was Professor of Political Science at the Technische Universität München and was DAAD Chair in German and European Politics at the University of Toronto. Markus König is Researcher at the Chair for Comparative Politics at the Ludwig-Maximilians-University Munich. He studied political science, sociology, social psychology and economics at the University of Hannover. Patrick Pfister is Researcher at the Chair for Comparative Politics at the Ludwig-Maximilians-University Munich. He studied political science, sociology and communication studies at the Universities of Bamberg (Germany) and Kingston upon Thames (UK). Thomas Rixen is Research Associate at the International University Bremen (IUB) and a member of the Collaborative Research Center “Transformations of the State” funded by the German Science Foundation (DFG). He studied Political Science and Economics in Bonn, Paris, Hamburg and at the University of Michigan, Ann Arbor. Stefan A. Schirm is Professor of Political Science at the University of Bochum, where he holds the Chair for International Relations. Previously he taught at the Universities of Munich and Stuttgart, was Research Associate at the Institute for International Relations of the Stiftung Wissenschaft und Politik (SWP) and John F. Kennedy Fellow at the Center for European Studies, Harvard University. Paul Sterzel is Researcher at the Chair for Comparative Politics at the LudwigMaximilians-University Munich. He studied political science, economics and history at the Universities of Freiburg (Germany) and Rennes (France). Hubert Zimmermann is DAAD Visiting Associate Professor at Cornell University. Previously he taught at the University of Bochum, worked as Editor at the Institut fuer Zeitgeschichte (Bonn) and wrote his PhD at the European University Institute, Florence. Reimut Zohlnhöfer is Assistant Professor at the Institute of Political Science at the University of Heidelberg. Previously he has worked at the Center for Social Policy Research (Bremen) and was a John F. Kennedy Memorial Fellow at the Center for European Studies, Harvard University.

Preface

This volume assesses the state of the art of political science research on economic globalization. Since globalization has been one of the core issues for political science research in the last ten years, it seemed necessary as well as promising to analyse its most important results. The intention of this volume is to present the international state of the art of globalization research as well as the specific expertise of the contributors in this book. Therefore, nearly all chapters follow the same structure in dedicating their first part to the assessment of the theoretical and empirical state of the art while exploring the projects and approaches of the respective author in the second part. With this double-edged structure the volume differs from most other publications, because it not only encompasses the cutting edge of the authors involved, but also systematically assesses the results of international political science research on core issues of globalization. All chapters are characterized by theoretically guided empirical analysis. Although certainly not all elements of globalization research are considered to the same degree, this volume gathers the most important topics, approaches and results. This project started with a call for papers within the German political science community. Therefore, the authors of this volume come from Germany, but have all spent part of their professional career abroad, mostly at American, British or Canadian universities. The 15 papers selected originally among 30 proposals submitted to the call, were presented, commented and discussed at a book-making workshop in November 2005 in Arnoldshain near Frankfurt. I am grateful to the Fritz-Thyssen Foundation for funding the workshop. The authors deserve special compliments on thoroughly revising their papers in light of the comments received and the participants for the productive and stimulating discussions. Routledge was immediately interested in the idea of assessing the state of the art of research on globalization and has professionally embraced the project. I would like to thank the anonymous reviewer for valuable comments. Special thanks also go to Karsten Ronit for valuable comments on all papers and to Gitta Lauster and Christa Landsberger for competently and enthusiastically helping with editing and formatting the manuscripts. Stefan A. Schirm

1

Analytical overview State of the art of research on globalization Stefan A. Schirm

1 Questions, hypotheses and theoretical approaches Is the state being weakened by globalization? Does national economic policy converge under the competitive pressure of globalization? Who is gaining or losing from globalization, and why? For the last ten years, these questions have been in the focus of public debate and political science research. Meanwhile, research has produced substantial empirical analyses on many aspects of globalization, leading to a substantiation of some arguments and to a weakening of others. While the coverage of globalization in the media is often still shaped by special interests and myths, political science has achieved cognitive progress in several instances. These advances in political science research benefited from economics and included several fields of political science, especially “international relations”, “comparative politics” and “political economy”. In view of the increasingly differentiated research on globalization, this volume attempts to systematically present the core fields and results of research on globalization focusing on the advances made in the last ten years. The aim of this introductory chapter is to deliver a selective overview of the most important issues and results of research and to delineate the links between the core topics. This chapter does not attempt to introduce the following specialized chapters, a task which is undertaken in each of these chapters. The overview will be guided by three arguments. First, research on globalization is increasingly based on connecting the above-mentioned fields of political science into “international political economy” (see Frieden and Lake 2000; Grieco and Ikenberry 2003; Oately 2006; Schirm 2004a), thus leading to a partial integration of formerly more separated approaches to the study of empirical questions. Second, research has been increasingly converging around an actor-centred and theoretically guided approach to the empirical analysis of globalization. Third, contrary to the dominant focus in the mid-1990s on the “weakening of the nation-state”, globalization research recently centres around the persistent role and autonomy of national politics and institutions vis-à-vis globalization. Theoretical approaches to globalization are based on different claims in political science and often recur to economics and sociology. One way to distinguish the approaches is to focus on the theoretical role globalization plays as an

2

Stefan A. Schirm

analytical variable. Part of the studies conceptualizes globalization as a dependent variable in analysing how power, ideas, institutions or interests cause and shape globalization. These works employ such theories as neorealism, liberalism, constructivism and institutionalism. In other parts of research, globalization is conceptualized as an independent variable in the analysis, for example, of the reform of the welfare state, of the convergence or divergence of national economic policies and global economic governance. Studies focus on the impact of globalization on the state, interest groups and societies and on the questions on governmental autonomy in economic policy making vis-à-vis global competition. These works are often guided by theories of the state, by institutionalism (“varieties of capitalism”), approaches from economics (trade theories etc.), societal norms (constructivism) and interests (liberalism). Another way to structure the multitude of theoretical approaches to globalization is to examine the different cognitive goals pursued: (1) If the impact of globalization on state and society is to be explained, then globalization is mostly analysed as a structural, ideational or power-related phenomenon. (2) If the – converging or diverging – reactions to globalization are to be analysed, then national policy autonomy, interests, institutions and societal values build the explicative focus. (3) If multilateral forms of governing globalization (such as international organizations and global governance) shall be examined, then theories are employed which focus on cooperation and conflict (such as neorealism and regime theory), on public-private-partnership-hypotheses, principal-agentarguments and on the potential domestic causes (such as interests and norms) for the foreign economic policy responses of governments. These questions and arguments are often connected in such a dense way that they can hardly be separated clearly. Most of today’s research is characterized by actor-centred approaches, which emphasize the role of governments, international organizations, private business, non-governmental organizations and so on. as the driving or reacting forces vis-à-vis globalization. Therefore, in large parts of research, globalization is no more examined as an anonymous structure, as a “process without a subject” (Hay 2002: 379). The theoretically guided analysis of empirical questions has increasingly benefited from recurring to economics in the last years. Authors such as Frankel, Frieden and Rogowski, Garrett, Hall and Soskice, Mosley, Swank and so on. integrate approaches from political science and economics reaching from qualitative to quantitative methods (see also Chapters 7, 10 and 11). Recently, the question on the causes of our knowledge on and perception of globalization is also frequently examined. This “ideational matter of globalization“ (Rosamond 2003: 669) is largely studied through discourse analyses, which focus on the meanings attached to globalization beyond its empirically measurable dimensions and processes. Normative approaches to research on globalization, which could often be observed in the mid-1990s, have ceded and given way to analytical approaches. Therefore, the precondition is now given to reach conclusions on the possibilities for the future governance of globalization based on plausible proof and reasoning on the causal implications globalization had so

Analytical overview 3 far. Summing up, research on globalization today shows a refreshing cognitive pragmatism by avoiding normative interpretations and pretentious postulates on the superiority of single theories. Instead, research focuses on the – often competing – uses of theoretical approaches in order to explain empirical puzzles. This chapter is structured as follows. The next section delineates the dimensions and causes of globalization as well as the most important divisions on its interpretation. I then turn to the interlinked core elements of research in the last ten years and to their theoretical conceptualizations as well as empirical findings: the debate on the convergence and divergence of national economic policies, the question of a “weakening of the state”, a “race to the bottom” of welfare and environmental standards and the discussion about the advantages and disadvantages of free trade for national economies and specific interest groups. These sections are followed by a short appraisal of research on the possibilities of multilateral and private governance of the world economy. The chapter ends with conclusions on the perspectives for further research.

2 What is globalization? The different definitions of globalization in the research community increasingly converge around a common understanding of globalization as an integration of markets, a cross-border interconnectedness of economic spaces and thus a denationalization of economic processes. Therefore, economic globalization shall be defined here as the increasing share of private cross-border activities in the total economic output of countries. With this basic definition, globalization can be measured as the share of foreign trade, foreign direct investment and financial transactions in the gross domestic product of a country or a region and as a share in the world product. This definition encompasses the magnitude and the development of economic globalization beyond individual perceptions, non-economic aspects of transnationalization (such as culture) and political “globalization” (on global governance, see section 6). The data clearly show that the share of crossborder activities in national product(s) has risen considerably in the last decades and therefore give empirical substance to the claim of an increasing integration of national economies (see Tables 1.1 and 1.2). The numbers also show the limits of globalization (and the consequences of the stock market and regional financial crises for FDI flows after 2001). However, while the share of cross-border activities increased, the largest part of Table 1.1 Growth of world trade compared to world real GDP Annual growth %

1988–1995

1996–2003

2004–2007

World real GDP World trade, volume

3.2 6.6

3.7 6.1

4.9 8.3

Source: IMF 2006: World Economic Outlook, Statistical Appendix, Washington, DC: 251. Online. Available www.imf.org/external/pubs/ft/weo/2006/01/pdf/statappx.pdf (accessed 26.5.2006).

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Stefan A. Schirm

Table 1.2 Growth of foreign direct investment inflows compared to world real GDP Annual growth % 1986–1990 1991–1995 1996–2000 2001 World GDP FDI inflows

10.1 22.8

5.2 21.2

1.3 39.7

2002

2003

2004

⫺0.8 –⫺3.9 ⫺12.1 12 –40.9 ⫺13.3 –11.7 2.5

Source: UNCTAD 2005: World Investment Report 2005, Geneva: 14.

national product is still and persistently created and consumed within national economies. It is also interesting to note that globalization possesses a regional focus, as more than two-thirds of world trade, foreign direct investment and financial transactions occur between the industrialized countries of the OECD (Organization for Economic Cooperation and Development) plus some emerging economies such as Brazil and Malaysia (see Table 1.3). Therefore, accurately spelt, globalization is an “OECDization plus”. The problem of many developing countries seems not to be a negative impact of globalization but instead, no impact at all because they are (nearly) not affected by globalization. Research shows a widespread consensus on the crucial role of governmental decisions regarding the causes of globalization. Technical novelties such as the internet, the containerization of trade and new financial instruments on stock markets doubtlessly eased the cross-border activities of private actors. But increased globalization since the 1970s would not have been possible without the decisions of national governments to liberalize world trade, to open financial markets and to de-regulate markets in general (on the causes of globalization see Garrett 2000; Hirst and Thompson 1996: 1–98; Schirm 2002a: 33–56). International governmental organizations such as the World Trade Organization (WTO), its predecessor, the General Agreement on Tariffs and Trade (GATT) and the International Monetary Fund (IMF) played a decisive role for the reduction of trade barriers and for the stabilization of growing financial flows (debt and Table 1.3 Share of OECD countries in world trade and foreign direct investment Share %

1990

1995

2000

2002

2003

2004

2005 1st quarter

Export of goods and services Import of goods and services FDI inflows FDI outflows

71.8

71.3

71.9

70.58

69.1

69.2

68.7

78.8

72.3

74.6

73.7

73.1

73.1

72.9

– –

66.0 88.0

88.4 –

85.8 86.1

93.7 74.3

– 55.6

– –

Source: Trade: own calculations based on data from OECD 2006: Main Economic Indicators, in www.oecd.org/dataoecd/55/27/18628014.pdf (accessed 18. 4. 2006); FDI: own calculations based on data from OECD 2006: OECD Factbook: Economic, Environmental and Social Statistics, in: caliban.sourceoecd.org/vl=4285439/cl=19/nw=1/rpsv/factbook/data/11–02–01-t02.xls;caliban.sourceoecd. org/vl=4285439/cl=19/nw=1/rpsv/factbook/data/11–02–01-t03.xls (accessed: 18.4.2006) and UNCTAD 2005: Handbook of Statistics, in: www.unctad.org/en/docs/tdstat30_enfr.pdf (accessed: 30.04.06).

Analytical overview 5 investment). Therefore, globalization has been an intended process with which the involved governments aimed at stimulating national and worldwide growth. This strategy of liberalization corresponded to the change in the economic policy paradigm in the 1970s and 1980s in many industrialized countries away from (neo-)Keynesianism (see Gourevitch 1987; Hall 1987; Helleiner 1994: 123–68; Schirm 2002a: 57–101). In sum, globalization has been crucially a result of decisions made by democratically legitimized governments on the national level and of agreements reached in international organizations, which were also dominantly influenced by the democratically legitimized governments of industrialized countries. Thus, liberalization can also be reversed, if voters wish it so. Several positions mark the interpretation of the consequences of globalization (see the overviews in Drezner 2001; Held and McGrew 2000; Morton 2004; Rosamond 2003). They shall be subsumed under two groups in the following: 1

2

One group of authors argues that the state is weakened by globalization because it is limited to its territory while the private actors of globalization move across borders and can thus evade the control of the state with more ease. Susan Strange (1996: 65) articulates this position when stating that Transnational Corporations (TNCs) increasingly possess a “parallel authority alongside governments in matters of economic management”. Kenichi Ohmae (1995) even sees the “The End of the Nation State” and the “Rise of Regional Economies” approaching. According to Vincent Cable (1995), the state is “diminished” by a “loss of economic power”. These hypotheses of a weakening of the nation state dominated the debate in the 1990s. A second group of authors considers these arguments on the implications of globalization as exaggerated and sees the state as politically capable to shape globalization. Daniel Drezner (2001: 78) concludes after a review of empirical results of research on globalization that TNCs are embedded to a higher degree in national political institutions than often claimed and that states can decide on the degree of adjustment to globalization: “globalization is not deterministic”. Robert Wade had already opposed the argument of a de-nationalization of the economy in 1996 and wrote: “reports of the death of the national economy are greatly exaggerated”. Mosley (2000) and Garrett (1998b) acknowledge the pressure by global financial markets on the state to conduct a stability- and world market-orientated policy, but observe autonomy in other areas such as diverging policies with regard to the use of governmental budgets and latitude for different party politics. After the analysis of several case studies, Linda Weiss concludes that globalization has indeed strengthened the relevance of political institutions for socio-economic changes (Weiss 1998, 2003). Summing up, research is controversial as to the form of changes brought by globalization but agrees upon an increasing integration of national economies.

Globalization constitutes a new challenge for the nation state insofar as it exposes national governments to changed costs and benefits for economic policy

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Stefan A. Schirm

decisions. These changes stimulate an adjustment to the expectations of global markets in order to retain or attract increasingly mobile resources (Frieden and Rogowski 1996; Garrett 1998a; Schirm 2002a: 33–56; Wolf 2004). With this impact, globalization as the growing share of cross-border activities in the total economic product changes the conditions for governmental as well as private actions. States and companies compete more and on a global scale for comparative advantages and markets due to the increased mobility of capital, technology and production. This does not necessarily imply a weakening of the state. Even if governments lose influence on transnational actors, they are not necessarily weakened with regard to basic tasks of the state such as the provision of suitable conditions for growth and wealth. Obviously states can be affected by global competition in different ways and to different degrees (see above). With regard to the public interest in economic wealth and welfare, globalization implies changing constraints for governments through a modification of the costs and benefits of specific economic policies. Economic success as a core element of a government’s chances for sustaining its power and for re-election is increasingly dependent on a successful use of mobile resources. Protectionist and interventionist policies seem to reach only suboptimal results in the long run compared to approaches orientated towards the world market. A combination of export-led growth and protectionism, like in China in the 1990s, links interventionism and world market orientation but seems to be viable only temporarily and is subject to considerable pressures as the liberalizations show, which China has been and still is undertaking in the course its membership of the WTO (see Saich 2000). The connection between wealth and world market integration is underlined by the fact that those countries which integrated most into the world economy are also those with the highest level of wealth – the industrialized countries. At the same time, the countries showing a poor performance with regard to wealth are often those with a low degree of openness to world markets. This long-term correlation between the degree of participation in world markets in form of direct investment, financial transactions as well as trade on the one hand and the level of wealth on the other is empirically substantiated in numerous studies on industrialized as well as developing and newly industrializing countries (see e.g. Frankel 2000; Oatley 2006: 366f; Wolf 2004: 143, 161; Dollar and Kray 2001; The Economist 29 September 2001: 10–15). Thus, wealth and growth seem to correlate positively with openness to world markets. Obviously, this connection does not imply that all domestic groups in a given country benefit to the same degree. The internal distribution of wealth and growth is only partially driven by the form of a country’s global integration (see section 5), but instead is predominantly shaped by the national distribution of political power and by socio-economic structures. These can be very asymmetrical, especially in many newly industrializing and developing countries (see Chapter 9).

Analytical overview 7

3 The debate on convergence and divergence Research has reached a widespread consensus on the competition-enhancing effects of globalization for states and companies. First, companies have to adjust to global competition if they wish to compete on world markets into which their home markets are increasingly integrated. Second, states are also increasingly competing with each other on the world market for locational advantages for investment and production (see Cerny 2000; Garrett 1998a; Krugman and Obstfeld 2003). As globalization eases the cross-border movement of resources, the incentive for governments rises to adjust their economic policies to the expectations of transnational actors in order to participate in the dynamics of the world markets (Epstein 1996: 219). The hypothesis deriving from these implications of globalization is that economic policies will converge around a common (neo-) liberal paradigm (see Drezner 2001; Yamamura and Streeck 2003 and Chapter 2 in this volume). In fact, many industrialized and newly industrializing countries have shown a tendency towards stability-orientated liberalization and away from the formerly often dominant interventionist and (neo-) Keynesian policies. Examples of this tendency abound: beyond all differences, Margaret Thatcher and François Mitterrand were the front runners in turning away from (neo-) Keynesian recepies in Europe in the 1980s. Tony Blair’s New Labour in Great Britain and the socialist as well as the conservative governments in France continued the market-orientated tendency in the last decade – obviously embedded in different national institutional settings. Mexico has been the front runner in liberalizing the former model of interventionist and protectionist industrialization, followed by other countries such as Argentina and Brazil in Latin America. At the same time, considerable space for the divergence of national economic policies has been observed within this trend towards world market orientation (see Busch 2004: 90; Cox 2001; Drezner 2001; Lütz 2004; Scharpf and Schmidt 2000). Clear differences in regulating labour markets, taxation and social welfare can be noticed when comparing western European countries. While Great Britain continued to be more liberal and the Netherlands as well as Denmark have restructured their welfare systems but maintained high social security levels, Germany has only moderately reformed recently. A comparison of the United States with continental European countries also shows persistent national autonomy in choosing social and economic courses. The trade barriers in Europe and the US (for agricultural products, for instance) exemplify that domestic pressures by protectionist lobby groups can still be stronger than the incentives and pressures for liberalization set by globalization. Thus, states do not have to adjust to globalization if they do not wish to do so and if they are willing to bear the costs, such as higher price-levels for protected goods and potentially less economic dynamic due to less competition. The causes of the persistent divergence of national economic and social policies and of the form of national reactions to globalization seem to be the institutions and norms given in the respective societies (see Hall and Soskice 2001; Holzinger and Knill 2005; Weiss 2003: 302f; Scharpf and Schmidt 2000;

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Schirm 2002b). The body of literature dealing with these questions can be subsumed under the rubric of “varieties of capitalism”. “VoC” research concentrates on the diverging forms of regulating the economy by the government and public-private action in such policy fields as the labour market, the banking system, education and public administration. Another relevant topic is the question of whether trade unions and employer associations have an institutionalized influence on economic development as they do in corporatist countries such as the Netherlands and Germany. In these “coordinated market economies”, the interest of corporatist organizations in the status quo may prevail over the interest of, for example, the unemployed in liberalizing the conditions for dismissals, which may prevail in “liberal market economies” such as in Britain. Societal norms as collective expectations about appropriate behaviour by the government also seem to have a strong influence on the form of political reactions towards globalization. If, for example, the norm of “collective solidarity” dominates over the norm of “individual responsibility”, then crisis-ridden companies can expect governmental help to a higher degree than pressure to adjust to new circumstances. It is interesting to note that Denmark and the Netherlands reached fundamental reforms through a re-definition of the societal norm of “solidarity” by adding the norm of “reciprocity”. In these countries, the recipients of “collective solidarity” (transfer payments), such as the unemployed, have to show a higher degree of “solidarity” with the society today in the form of, for example, social work, geographical mobility and lower levels of transfer payments (see Cox 2001). Thus, the differences between societal norms and institutions contribute to the understanding of persistent national divergence with regard to globalization. Another important endogenous determinant for national policies towards globalization is the partisan composition of governments. Party politics matter with regard to liberalization because social democratic parties seem to be less prone to undertake the first steps to liberalization than conservative parties (see Garrett 1998b; Kastner and Rector 2005 and Chapter 3 in this volume). Summing up, empirical studies on “varieties of capitalism” point at a tendency towards a convergence around stability-orientated liberalization but also emphasize persistent divergence concerning the regulation of specific policy areas among the countries of the OECD.

4 Race to the bottom? A large part of research on globalization empirically examines the hypothesis that the state is weakened with regard to its ability to maintain specific standards and social provisions. The argument is that the government in industrialized countries is forced to lower its share in total spending, leading to a reduction of the level of social spending and of environmental standards due to the increased pressures from global competition with developing and newly industrializing countries. Both aspects have been widely studied and can meanwhile be evaluated in a more differentiated way. Regarding the “strength” of the state in form of its access to the financial resources of a given country, the share of the state in total output has not diminished in the last decades (see Table 1.4).

Analytical overview 9 Table 1.4 Governmental total outlays as percentage of GDP

Germany France UK Sweden USA

1990

1995

2000

2002

2005

44.5 49.3 42.2 61.9 37.1

48.3 54.4 45.0 67.7 37.0

45.1 51,6 37.5 57.4 34.2

48.0 52.6 41.7 58.4 36.3

46.8 53.9 44.9 57.2 36.6

Source: OECD 2005: Economic Outlook 78, Statistical Annex, Table 25, General government total outlays, in: ocde.p4.siteinternet.com/publications/doifiles/122005021P1-T61.xls (accessed:28.4.2006).

Contrary to the hypothesis of falling levels of taxation and of the states’ share in GDP, in Europe, the states with the highest taxes and the highest share of governmental outlays in GDP were also among those with the highest degree of openness to world markets. Denmark and Sweden are examples of this correlation. In principle, global (financial) markets seem not to react negatively to the share of the state in GDP but to budgetary deficits, because they tend to trigger inflation, which corrodes the value of financial assets (see Garrett 1998a; Mosley 2000). From a different angle, Garrett and Mitchell (2001) show in an empirical comparison of OECD countries that increases in foreign trade and in openness towards global financial markets went hand in hand with lower levels of governmental expenditure. However, spending for welfare provisions was not reduced. In addition, increased integration into global markets neither correlated with a reduction of capital taxation, nor with a shift of taxation from capital to consumption. Therefore, the hypothesis of a reduction of the states’ share in total GNP and of levels of welfare spending was not substantiated by this study either. Research on this subject does not show an overall clear picture. In an analysis of the respective literature, Genschel (2004: 633) concludes that neither does welfare spending show a “race to the bottom” nor do persistent national differences mean that globalization does not have any effects at all. Research also points at another crucial feature of the welfare–competitiveness nexus: The competitiveness of nations apparently does not depend primarily on the level of the states’ revenues or expenditures, but instead on their quality. The question is not whether or not there is “more” or “less” on the input-side, but whether the state can perform more efficiently on the output-side of its activity. The reforms of the welfare state in Sweden, the Netherlands and Denmark are examples of the compatibility of the redistributive-egalitarian thought of welfare and the liberal-individual basis of (global) competitiveness. In these countries, reforms pursued the goal of increasing flexibility on the labour market and social security in order to boost competitiveness without weakening the welfare state in its strategic substance (see Benner and Vad 2000; Cox 2001; Scharpf and Schmidt 2000; The Economist – A Survey of the Netherlands, 4 May 2002). Several studies conclude that welfare provisions often served as preconditions for the public acceptance of the structural change necessary for higher global

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competitiveness (see Rieger and Leibfried 2003; Ruggie 1982; Swank 2003). The argument is that a country has to undertake structural reforms in order to better compete on world markets and that these reforms are politically more acceptable if the “losers” of adjustment are compensated by transfer payments. Empirically, openness in trade and investment does not preclude high levels of welfare expenditures. However, the increased mobility of capital leads to an easing of tax evasion and might indeed trigger a shift in taxation away from mobile factors and towards immobile factors such as labour. This raises questions on fairness and legitimacy which could be answered, for example, within the European Union or the OECD by multilateral agreements on the taxation of mobile capital in order to control evasion through mobility (on tax competition, see Chapter 4). The second part of the “race to the bottom” hypothesis can not be confirmed empirically either: there was no substantial reduction of environmental and social standards in the industrialized world due to increased foreign trade and investment (see Antweiler et al. 2001; Drezner 2001; Rajan and Bird 2001: 12; The Economist Survey 29 September 2001: 24). A “race to the bottom” caused by competition with countries which possess lower and therefore less costly standards could mostly not be observed. Instead, examples abound for the strengthening of those standards in developing and newly industrializing countries – reaching from the Kyoto Protocol over ILO-standards (International Labour Organization) to the inclusion of social and environmental standards in the multilateral negotiations of the WTO ever since the meeting in Seattle in 1999 (see Oately 2006: 363–81; Senghaas-Knobloch 2005; Ruloff 2002 and Chapter 9 in this volume). Regional associations such as the European Union (EU) and the North American Free Trade Agreement (NAFTA) also include environmental and social standards and contributed to different degrees to higher standards in the less developed member states. Both Mexico in the case of NAFTA and the new eastern European members as well as Portugal, Spain and Greece in the case of the EU have higher standards today than before their economic opening and integration (see Hartmann 2005; LSE European Observatory on the Social Situation 2005). Thus, multilateral agreements have led to a “race to the top” in these cases. Obviously, these are spotlights on a general trend whose complete presentation would have to include exceptions and the differentiation between product- and production-related standards. Summing up, research on the “convergence-divergence” and the “race to the bottom” hypotheses shows that the state is not weakened by globalization in its fundamental tasks, such as the provision of macroeconomic wealth. Only when defined as a (neo-) Keynesian state can it be considered as weakened by globalization due to the limits to the efficiency of, for example, deficit spending set by global markets (see Garrett 1998a, 2000; Schirm 2002a). However, if the state is defined in a more fundamental way as being responsible for the political framework for economic prosperity, then it might be able to perform even better on this responsibility by more efficiently using the dynamics of globalization through pursuing market liberalization and embedding it in welfare provisions.

Analytical overview 11 In order to pursue such a course, the state (the government) might have to overcome resistance by those groups which benefit from upholding the status quo. Thus, a “strong” state can also be defined as “a state, which can implement its goals against special interests in a given society” (Morisse-Schilbach 2005: 33). From this perspective, the state might even be strengthened by globalization – for example if liberalization and privatization induced by globalization reduces the influence of special interests on the state and their grip on its resources. Another aspect in which globalization may stimulate a strengthening of the state following the above definition are the incentives brought by global competition to reform traditional (for example corporatist) structures. A reduction of the institutionalized influence of trade unions and employer associations on economic policy can be observed in the process of labour market flexibilization. Another way to increase the autonomy of the government vis-à-vis special interests is the transfer of regulative competences to independent regulatory agencies for markets which were formerly dominated by public companies and/or oligopolies as, for instance, in some cases in telecommunication, post, railway and energy markets (see Schirm 2001; Weiss 1998).

5 Interest groups, free trade and distribution A major part of research on globalization deals with the question on who is affected in which way by economic integration. Specific policy areas and interest groups are in the analytical focus here. Like any other new economic development, globalization may lead to structural change and thus produces “winners” and “losers”. Frieden and Rogowski argue that a liberalization of trade as an “exogenous easing of international exchange” (1996: 26) leads to a higher remuneration of formerly abundant resources (such as capital in the industrialized countries) and to a lower remuneration of formerly scarce resources (such as labour in industrialized countries). This further development of the Stolper–Samuelson Theorem from economics allows analysis of the consequences of trade liberalization for the positions of politically relevant interest groups and power structures in a given country (on trade theory, see Chapter 11). The share of employees and capital owners whose jobs and profits depend on the competitive situation of their companies on the world market increased with the growth of the share of foreign trade in total economic output. In Germany and the Netherlands, for example, the share of Exports in GDP rose from 27 per cent (NL: 51 per cent) in 1980 to 33 per cent (NL: 67 per cent) in 2000 and 40 per cent (NL: 71 per cent) in 2005.1 The political interest of sectors producing competitive products and that are heavily involved in trade basically favours liberalization and world market orientated policies. These sectors and the respective interest groups structurally depend on easy access to cheap components from abroad for their production and on the openness of foreign markets, which would be jeopardized if their government raised trade barriers, because the negatively affected countries would probably retaliate with equally raising barriers. At the same time, it is in the structural interest of these sectors to further ease

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access to other markets, for example, through successful WTO negotiations. The economic and political relevancy of this “exporter group” increased with the growth of its share in total GNP and with its improved opportunities to transfer production abroad. This latter “exit option” and the pressure to compete on world markets give transnational actors additional political power vis-à-vis governments (see Milner and Keohane 1996: 244; Schirm 2002a: 48–9). The “exit option” and their cross-border way of operation can give TNCs more influence on governments, as was often pointed out in the 1990s (see Strange 1996). According to more recent studies, this potential increase of the power of private business might have been exaggerated in the literature (see Chapter 7). Structurally opposed to these positions is the interest of those companies or sectors involved in non-competitive production (Frieden and Rogowski 1996). This group is not interested in liberalization because its products are either not traded internationally (“non-tradables”), such as local services, or because it fears imports because its products are not competitive, as is the case in large parts of European agricultural and textile industries. Therefore, governments see themselves as exposed to opposite pressures by lobby groups when it comes to trade negotiations. Globalization partly eliminates the classical divide between employers and employees because both sides increasingly share similar interests depending on the competitive position of the respective sector or company. This implies a new challenge for corporatist organizations because they have to represent diverging interests – for example in Germany, the Union of Metal Workers (IG Metall) and the Association of Metal Employers (Arbeitgeberverband Gesamtmetall) both have to represent the interest of the export-orientated automotive companies and the interest of the protectionist steel-producing sector. The issue of the varying impact of globalization on sectors and interest groups is one of the focal points in research and leads directly to trade theory (see Chapters 3, 10 and 11). In this field, approaches from political science and economics often interlink. Results show empirically that trade liberalization is mostly beneficial on the aggregate because competition, mobility, division of labour and innovation lead to a more efficient allocation of resources, which in turn allows production to occur at those sites where it is most cost-efficient (see Frankel 2000: 59–63; Siebert 2003). The hypothesis is well known since David Ricardo that the use of comparative advantage through free trade increases the wealth of nations. New trade theory as in publications by Paul Krugmann (Krugman and Obstfeld 2003) and Jagdish Bhagwati (2004) develops on the simplistic hypotheses of neoclassical approaches and explains why the largest part of world trade today occurs between countries which produce similar products (this is between industrialized countries). This form of trade is not driven by traditional comparative advantages (like between developing and industrialized countries) but instead by consumer preferences and economies of scale relevant in intra-industry trade, as seen in the case of exports and imports of cars between Germany and France. New trade theory also explains strategic trade policy which might enhance wealth by directly or indirectly subsidizing national or regional champions such as Airbus in Europe and Boeing in the US.

Analytical overview 13 What trade theory has argued for a long time can also be observed within the context of globalization: there is a clear correlation between openness to trade and the wealth of a nation (see above). This is only partially due to the abovementioned static gains from free trade which occur through a more efficient allocation of resources and specialization. In addition, wealth is stimulated by dynamic gains from competition and economies of scale, which allow lower price levels due to mass production and therefore lead to higher purchase power (see Krugman and Obstfeld 2003). New trade theory also explores the influence of the political process (lobby groups, party competition) and political institutions on trade policy, production and locational advantages. Besides the “direct” production factors such as labour and capital, recent studies substantiate the relevance of political stability, educational systems, legal protection of economic activity and governmental surveillance of fair competition (see the literature on “varieties of capitalism” above, on new institutional economics in Williamson 2000, and on institutions in developing countries in Chapter 9 of this volume). The lack of appropriate political institutions can lead to failed liberalization which does not contribute to increasing wealth. Examples of the relevance of institutions are those developing countries which liberalized their financial markets without having appropriate institutions for controlling their banking and stock market systems and were thus often crisis prone (on the causes of the financial crisis in Asia and Latin America see Desai and Said 2004).

6 Global economic governance One of the core topics of research on globalization has been the possibilities for governing the world markets. The questions in this area focus on the role of international economic organizations, on the influence of private business and non-governmental organizations (NGOs) and on the relevance of public–private partnerships (PPPs) as new forms of governance. The analysis of these actors and processes with regard to their performance in shaping globalization constitutes the research field of “global economic governance” (see Schirm 2004b). Multilateral governmental organizations like the International Monetary Fund, the World Trade Organization and the World Bank have been studied for a long time already and thus belong to the traditional body of research of political science. Analyses of regional cooperation such as the EU, NAFTA and the Common Market of the South (Mercosur) also belong to the area of research on multilateral economic cooperation between states. With regard to the analysis of globalization in the last ten years, several studies examine questions on the contribution to and management of liberalization by multilateral organizations (see Bird 2003; O’Brien et al. 2000; Shaffer 2005). Besides the performance of the IMF, the WTO and the World Bank with regard to national and global economic developments, a core issue of several studies is the democratic legitimacy of this form of governance – a question also raised concerning NGOs (see below and Scholte 2003). The question why international economic organizations have not improved their capacity for more effective governance is only increasingly

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addressed by political scientists in the last years even though a necessity for reform became clear with the financial crises and trade disputes in the 1990s. In explaining the lack of reform, analyses focus, for example, on the divergence of governmental positions towards global governance based on different societal norms and interests (see Schirm 2005). For a better management of economic crises and conflicts, an explicit dialogue on diverging national attitudes on the role of the state vis-à-vis the economy (“arguing”) seems as decisive as do more efficient mechanisms to balance diverging material interests (“bargaining”). Research shows a growing consensus towards the necessity of a better political architecture for the world economy due to the widely acknowledged empirical relevance of economic crises (see Drezner 2003; Higgott 2004: 9; Rodrik 2000 and Chapter 5 in this volume). Regional integration as “regional economic governance” plays a crucial role for research on globalization insofar as it allows the observation of liberalization processes as well as their political management on a geographically smaller but often economically deeper scale than on the global level (on regionalism, see Katzenstein 2005). In addition, foreign trade and investment occur to a very high percentage within and among regional groupings. For example, intra-EU trade was two-thirds of total member state trade between 1995 and 2005 and intra-EU FDI was 70 per cent of all FDI by member states in 2004 (European Communities 2005; Eurostat 2006). Thus, a part of the large body of research on regionalism (especially large on the EU) deals with the same questions as do parts of research on globalization. A direct connection between both levels of integration can be observed in studies on the question whether regionalism constitutes a “building block” (because of its liberalizations) or a “stumbling stone” (because of the discrimination against non-members) for globalization (see Chapter 10 in this volume and the review in Nesadurai 2002). In sum, regional cooperation seems to have made an important contribution with regard to economic liberalization: The European Single Market, as well as NAFTA and Mercosur triggered the economic efficiency and the political acceptability of national economic reforms by embedding them in multilateral agreements and “tying the hands” of national governments (see Schirm 2002a; Spindler 2004). Thus, the regional cooperation of the liberal type (“open regionalism”) of the 1990s can be considered a “building block” for globalization. Several studies have been conducted on the influence of private actors – business and NGOs – on global economic governance. One focus of research has been the hypothesis that TNCs have gained power and autonomy vis-à-vis the state in governing economic processes and increasingly evade governmental control. While this hypothesis dominated in the 1990s, recent studies show a more differentiated picture of the structural, ideational and material power of private business, emphasizing the interdependence between states and TNCs (see Chapter 7). New governmental instruments for the governance of increasingly transnational private actors and their legitimacy as well as efficiency have also been at the core of research. One of the most prominent topics was the study of a possible tax on currency and stock market transactions in order to

Analytical overview 15 prevent or slow down speculative movements – a measure with doubtful feasibility (on the so-called “Tobin Tax” see Palma 2004). A stronger participation of non-governmental organizations in global economic governance was considered in parts of the literature as an appropriate means to compensate for the supposedly weakened capability of governments to govern globalization. Including civil society groups such as transnational environmental organizations, unions and human rights groups into global governance mechanisms, promised to increase the efficiency and the legitimacy of governance beyond the nation state (see Cuttler et al. 1999; Scholte 2003). The capacity of these NGOs to set agendas, to mobilize public opinion and to establish direct contact to affected parts of the society (“grass roots”-approach) contributed to the emergence of NGOs as influential actors in the last ten years. While their issue-specific competence and societal embeddedness was often assessed positively, the thematical one-sidedness and lack of inner-organizational democracy and transparency is seen in contrast to the ability of democratically elected governments to pursue a broadly legitimized balancing of interests (see Chapter 8). An important part of research on global economic governance examines the possibilities for governing globalization through private actors and public–private partnerships. In analysing rule making by private business, several authors have focused on the increasing relevance of rating agencies such as Moody’s and Standard and Poor in evaluating the creditworthiness of private actors as well as states (see Sinclair 2005). These forms of private governance partly seem very efficient but lack democratic legitimacy (see Pauly 2002; Hall and Biersteker 2002). A solution for this dilemma might be reached with PPPs, which are characterized by the participation of private as well as governmental actors. An often-studied example is the UN Global Compact, which aims at selfbinding TNCs under UN guidance, for example to invest only in countries which sustain certain minimum standards for human rights and environmental protection (see Rieth 2004 and Chapter 8 in this volume). Research on transnational regimes and PPPs has progressed quite far, for example on genetically modified food, the internet and taxation of intra-firm trade, and leads to the conclusion that the state’s capacity is indeed transformed by globalization but that its ability to govern has not been reduced fundamentally, if new intergovernmental and public–private mechanisms for governing globalization are taken into account (see Chapter 6).

7 Perspectives for globalization research In the last ten years, political science research on globalization has been characterized mainly by actor-centred and theoretically guided empirical analyses, which often crossed the boundaries between the fields of political science such as comparative politics, international relations and political economy with regard to the theories employed and the topics studied. Thus, the investigation of global economic integration has triggerd an increasing integration of political

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science fields. After having focused on the “weakening of the state” in the 1990s, empirical studies have recently come to the widespread conclusion that national policies and institutions continue to have autonomy and capacity towards globalization. Policies, politics and circumstances changed under the influence of globalization but the state is not fundamentally weakened and continues to be able to shape the world economy, although increasingly in cooperation with other states and non-state actors. With these features of globalization research confirmed, the three arguments from the first section of this chapter could be substantiated. Thus, globalization research has made considerable cognitive progress compared to some aspects of the state of the art of the mid-1990s, but also shows several explorable fields for future research. First, it would be worthwhile trying to systematically link the various theoretical approaches into a “theory of globalization”. This task is certainly tricky because the variety of approaches has not precluded research to advance on the subjects studied in the last decade. Therefore, a combination or even synthesis of theoretical approaches must be done without narrowing down and simplifying at the expense of their explanatory power. This would be counterproductive. Second, several specific issue areas are still especially in need of research. While the impact of globalization seems widely studied, the possibilities and obstacles to shape and govern globalization still offer questions in need of theoretically informed empirical answers. In this regard, the conceptualization of the efficiency and legitimacy of public and private forms of governance will be crucially dependent on assumptions about the role of politics in the economy and about the interaction between individual freedom and collective solidarity. It seems important to include these basic political questions without leaving analysis in favour of normative postulates. Societal attitudes in the affected countries are not static but also changed in the last decade and should therefore equally be included in the analysis. With regard to its position within political science, globalization research is situated “right in the middle”, for example in the rationalism–constructivism debate, in examining the changing role of the state, in investigating the power of institutions, in the opening of the “black box” of the state by analysing endogenous causes for foreign economic policy positions of governments and, last but not least, in conceptualizing and analysing changes in the form and distribution of power on the national, international and transnational levels. Continuing interdisciplinary work also bears interesting perspectives for the future research on globalization. Systematically further connecting political science fields seems as promising as using approaches from sociology (for instance in “cosmopolitan political science”, see Beck and Grande 2004; Grande 2006) and from economics (for instance “new institutional economics”, see Williamson 2000). The last ten years have shown that not only did theoretically guided empirical analyses contribute to increasing our knowledge about globalization, but also interdisciplinary work within and beyond political science.

Analytical overview 17

Note 1 Eurostat 2006: europa.eu.int/comm/eurostat.com (accessed 23 April 2006), data for Germany: own calculations based on Statistisches Bundesamt: Verwendung des Bruttoinlandproduktes, in: www.destatis.de/indicators/d/lrvgr02ad.htm (accessed 20 April 2006).

Bibliography Antweiler, W., Copeland, B.R. and Taylor, M.S. (2001) “Is Free Trade Good for the Environment?”, The American Economic Review, 91/4: 877–908. Beck, U. and Grande, E. (2004) Daskomopolitische Europa, Frankfurt/M.: Suhrkamp. Benner, M. and Vad, T.B. (2000) “Sweden and Denmark: Defending the Welfare State”, in F.W. Scharpf and V.A. Schmidt (eds) Welfare and Work in the Open Economy. Vol. II: Diverse Responses to Common Challenges, Oxford: Oxford University Press: 399–466. Bhagwati, J. (2004) In Defense of Globalization, Oxford: Oxford University Press. Bird, G. (2003) The IMF and the Future. Issues and Options Facting the Fund, London: Routledge. Busch, A. (2004) “The Resilience of National Institutions: The Case of Banking Regulation”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave Macmillan: 87–107. Cable, V. (1995) “The Diminished Nation-State: A Study in the Loss of Economic Power”, Daedalus 124: 23–53. Cerny, P. (2000) “Political Globalization and the Competition State”, in R. Stubbs and G.R.D. Underhill (eds) Political Economy and the Changing Global Order, 2nd edn, Oxford: Oxford University Press: 300–9. Cox, R.H. (2001) “The Social Construction of an Imperative: Why Welfare Reform Happened in Denmark and the Netherlands but not in Germany”, World Politics, 53/3: 463–98. Cuttler, C.A., Haufler, V. and Porter, T. (eds) (1999) Private Authority and International Affairs, Albany, NY: State University of New York Press. Desai, M. and Said, Y. (eds) (2004) Global Governance and Financial Crises, London: Routledge. Dollar, D. and Kray, A. (2001) Trade, Growth, and Poverty, Washington, DC: World Bank. Drezner, D.W. (2001) “Globalization and Policy Convergence”, International Studies Review, 3/1: 53–78. –––– (2003) “Clubs, Neighborhoods and Universes: The Governance of Global Finance”, University of Chicago, paper prepared for the Annual Meeting of the American Political Science Association. Epstein, G. (1996) “International Capital Mobility and the Scope for National Economic Management”, in R. Boyer and D. Drache (eds) States Against Markets. The Limits of Globalization, London: Routledge: 193–210. European Communities (2005) External and Intra-European Union Trade, Statistical Yearbook, Data 1958–2004: 90–95, Online. Available epp.eurostat.cec.eu.int/ cache/ITY_OFFPUB/KS-CV-06–001/EN/KS-CV-06–001-EN.PDF (accessed 25 April 2006). Eurostat Visual Applications: EU-Direktinvestitionen – Hauptindikatoren, Online. Available europa.eu.int/comm/eurostat.com (accessed: 25 April 2006)

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Frankel, J. (2000) “Globalization of the Economy”, in J.S. Nye and J.D. Donahue (eds), Governance in a Globalizing World, Washington, DC: Brookings Institution Press: 45–71. Frieden, J.A. and Lake, D.A. (2000) International Political Economy. Perspectives on Global Power and Wealth, London/New York: Routledge. Frieden, J.A. and Rogowski, R. (1996) “The Impact of the International Economy on National Policy: An Analytical Overview”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 25–47. Garrett, G. (1998a) “Global Markets and National Politics: Collision Course or Virtuous Circle?” International Organization, 52/4: 787–824. –––– (1998b) Partisan Politics in the Global Economy, Cambridge: Cambridge University Press. –––– (2000) “The Causes of Globalization”, Comparative Political Studies, 33/6–7: 941–91. Garrett, G. and Mitchell, D. (2001) “Globalization, Government Spending and Taxation in the OECD”, European Journal of Political Research, 39: 145–77. Genschel, P. (2004) “Globalization and the Welfare State: a Retrospective”, Journal of European Public Policy, 11/4: 613–36. Gourevitch, P. (1987) Politics in Hard Times. Comparative Responses to International Economic Crises, Ithaca, NY: Cornell University Press. Grande, E. (2006) “Cosmopolitan Political Science”, The British Journal of Sociology, 57/1: 87–111. Grieco, J.M. and Ikenberry, G.J. (2003) State Power and World Markets. The International Political Economy, New York: Norton. Hall, P.A. (1987) “The Evolution of Economic Policy under Mitterrand”, in G. Ross, S. Hoffmann and S. Malzacher (eds) The Mitterrand Experiment. Continuity and Change in Modern France, Cambridge: Cambridge University Press: 54–72. Hall, P.A. and Soskice, D. (2001) “An Introduction to Varieties of Capitalism”, in P.A. Hall and D. Soskice (eds) Varieties of Capitalism. The Institutional Foundations of Comparative Advantage, Oxford: Oxford University Press: 1–68. Hall, R.B. and Biersteker, T.J. (eds) (2002) The Emergence of Private Authority in Global Governance, Cambridge: Cambridge University Press. Hartmann, K. (2005) Umweltstandards in Europa nach der Osterweiterung, BadenBaden: Nomos. Hay, Colin (2002) “Globalisation as a Problem of Political Analysis: restoring Agents to a ‘Process without a Subject’ and Politics to a Logic of Economic Compulsion”, Cambridge Review of International Affairs, 15/3: 379–92. Held, D. and McGrew, A. (2000) “The Great Globalization Debate: An Introduction”, in D. Held and A. McGrew (eds) The Global Transformation Reader, Cambridge: Polity Press: 1–45. Helleiner, E. (1994) States and the Reemergence of Global Finance. From Bretton Woods to the 1990s, Ithaca, NY: Cornell University Press. Higgott, R. (2004) “Multilateralism and the Limits of Global Governance”, Working Paper, 134, Warwick: Centre for the Study of Globalisation and Regionalisation. Hirst, P. and Thompson, G. (1996) Globalization in Question. The International Economy and the Possibilities of Governance, Cambridge: Polity Press. Holzinger, K. and Knill, C. (2005) “Causes and Consequences of Cross-National Policy Convergence”, Journal of European Public Policy, 12/6: 775–96.

Analytical overview 19 Kastner, S.L. and Rector, C. (2005) “Partisanship and the Path to Financial Openness”, Comparative Political Studies, 38/5: 484–506. Katzenstein, P.J. (2005) A World of Regions: Asia and Europe in the American Imperium, Ithaca, NY: Cornell University Press. Krugman, P.R. and Obstfeld, M. (2003) International Economics. Theory and Policy, 6th edn, Boston, MA: Addison-Wesley. London School of Economic and Political Science, European Observatory on the Social Situation (2005) Health Status and Living Conditions in an Enlarged Europe, Final Report, London: LSE. Lütz, S. (2004) “Convergence Within National Diversity – A Comparative Perspective on the Regulatory State in Finance”, Journal of Public Policy, 24/2: 169–97. Milner, H.V. and Keohane, R.O. (1996) “Internationalization and Domestic Politics: A Conclusion”, in R. Keohane and H. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 243–58. Milner, H. V. and Judkins, B. (2004) “Partisanship, Trade Policy, and Globalization: Is There a Left-Right Divide on Trade Policy?”, International Studies Quarterly, 48: 95–119. Morisse-Schilbach, M. (2005) “Globalisierung und die These vom Souveränitätsverlust des Staates – Forschungsstand und Perspektiven”, Dresdner Arbeitspapiere Internationale Beziehungen, 13, TU Dresden. Morton, A.D. (2004) “New Follies on the State of Globalisation Debate?” Review of International Studies, 30/1: 133–47. Mosley, L. (2000) “Room to Move. International Financial Markets and National Welfare States”, International Organization, 54/4: 737–73. Nesadurai, H. (2002) “Globalisation and Economic Regionalism: A Survey and Critique of the Literature”, Working Paper, 108/02, Warwick: University of Warwick, Centre for the Study of Globalisation and Regionalisation. Oately, T. (2006) International Political Economy. Interests and Institutions in the Global Economy, 2nd edn, New York: Pearson Education. O’Brien, R., Goetz, A.M., Scholte, J.A. and Williams, M. (2000) Contesting Global Governance, Multilateral Economic Institutions and Global Social Movements, Cambridge: Cambridge University Press. Ohmae, K. (1995) The End of the Nation State. The Rise of Regional Economies, New York: Free Press. Palma, G. (2004) “Mexico, Korea and Brazil. Three Paths to Financial Crises”, in M. Desai and Y. Said (eds) Global Governance and Financial Crises, London: Routledge: 120–57. Pauly, L. (2002) “Global Finance, Political Authority, and the Problem of Legitimation”, in R.B. Hall and T.J. Biersteker (eds) The Emergence of Private Authority in Global Governance, Cambridge: Cambridge University Press: 76–90. Rajan, R.S. and Bird, G. (2001) “Economic Globalisation. How Far and How Much Further?” World Economics, 2/3: 12. Rieger, E. and Leibfried, S. (2003) Limits to Globalization. Welfare States and the World Economy, Cambridge: Polity Press. Rieth, L. (2004) “Corporate Social Responsibility in Global Economic Governance”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave: 177–92. Rodrik, D. (2000) “Governance of Economic Globalization”, in J.S. Nye and J.D. Donahue (eds) Governance in a Globalizing World, Washington, DC: Brookings Institution Press: 347–66.

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Rosamond, B. (2003) “Babylon and on? Globalization and International Political Economy”, Review of International Political Economy, 10/4: 661–71. Ruggie, J.G. (1982) “Territoriality and Beyond: Problematizing Modernity in International Relations”, International Organization, 47/1: 139–74. Ruloff, D. (2002) “Wie ‘grün’ ist die WTO? Umweltschutz als Anliegen des Welthandels”, Internationale Politik, 57/6: 37–42. Saich, T. (2000) “Globalization, Governance, and the Authoritarian State”, in J.S. Nye and J.D. Donahue (eds) Governance in a Globalizing World, Washington, DC: Brookings Institution Press: 208–28. Scharpf, F.W. and Schmidt, V.A. (eds) (2000) Welfare and Work in the Open Economy (Vol. I: From Vulnerability to Competitiveness; Vol. II: Diverse Responses to Common Challenges), Oxford: Oxford University Press. Schirm, S.A. (2001) “Wie Globalisierung nationale Regierungen stärkt. Zur politischen Ökonomie staatlicher Antworten auf Globalisierung”, in C. Landfried (ed.) Politik in einer entgrenzten Welt, Köln: Verlag Wissenschaft und Politik: 133–50. –––– (2002a) Globalization and the New Regionalism. Global Markets, Domestic Politics and Regional Cooperation, Cambridge: Polity Press. –––– (2002b) “The Power of Institutions and Norms in Shaping National Answers to Globalization: German Economic Policy after Unification”, German Politics, 11/3: 217–36. –––– (2004a) Internationale Politische Ökonomie. Eine Einführung, Baden-Baden: Nomos. –––– (2004b): “The Divergence of Global Economic Governance Strategies”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave Macmillan: 3–21. –––– (2005) “Der Einfluss von Interessen und Normen auf nationale Positionen zur Global Economic Governance”, Zeitschrift für Politikwissenschaft, 15/3: 825–47. Scholte, J.A. (2003) “Civil Society and the Governance of Global Finance”, in A. Krizsan and V. Zentai (eds) Reshaping Globalization. Multilateral Dialogues and New Policy Initiatives, Budapest: Central European University Press: 285–312. Senghaas-Knobloch, E. (ed.) (2005) Weltweit geltende Arbeitsstandards trotz Globalisierung, Münster: LIT Verlag. Shaffer, G. (2005) “Governance and the WTO: A Comparative Institutional Approach”, in M. Barnett and R. Duvall (eds) Power in Global Governance, Cambridge: Cambridge University Press: 130–60. Siebert, H. (2003) “On the Fears of the International Division of Labour. Eight Points in the Debate with Anti-Globalizationers”, in: H. Siebert (ed.) Global Governance. An Architecture for the World Economy, Heidelberg: Springer Verlag: 4–21. Sinclair, T.J. (2005) The New Masters of Capital, Ithaca, NY: Cornell University Press. Spindler, M. (2004) “New Regionalism and Global Economic Governance”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave Macmillan: 235–53. Strange, S. (1996) The Retreat of the State. The Diffusion of Power in the World Economy, Cambridge: Cambridge University Press. Swank, D. (2003) “Withering Welfare? Globalisation, Political Institutions, and Contemporary Welfare States”, in L. Weiss (ed.) States in the Global Economy, Cambridge: Cambridge University Press: 58–82. The World Bank (2003) World Development Indicators WDI, Data Query, Online. Available devdata.worldbank.org/data-query/ (accessed 24 May 2006).

Analytical overview 21 Wade, R. (1996) “Globalization and its Limits. Reports of the Death of the National Economy are Greatly Exaggerated”, in S. Berger and R. Dore (eds) National Diversity and Global Capitalism, Ithaca, NY: Cornell University Press: 60–97. Weiss, L. (1998) The Myth of the Powerless State, Ithaca, NY: Cornell University Press. –––– (2003) “Is the State Being Transformed by Globalization?” in L. Weiss (ed.) States in the Global Economy: Bringing Domestic Institutions Back In, Cambridge: Cambridge University Press: 293–317. Williamson, O.E. (2000) “The New Institutional Economics: Taking Stock, Looking Ahead”, Journal of Economic Literature, 38: 595–613. Wolf, M. (2004) Why Globalization Works. The Case for the Global Market Economy, New Haven, CT: Yale University Press. Yamamura, K. and Streeck, W. (eds) (2003) The End of Diversity? Prospects for German and Japanese Capitalism, Ithaca, NY: Cornell University Press.

2

The development of the debate Intellectual precursors and selected aspects Andreas Busch

1 Introduction The term “globalization” has undergone an amazing career over the last decadeand-a-half, both in the academic and public discourse.1 There hardly seems to exist a facet of public life that cannot be linked to this term: be it domestic conflicts regarding the need for political reforms and the necessity of redesigning social security systems; structural economic change and the shift of economic power to the emerging economies of South and South East Asia; debates about the fairness of global trade or its increasing de-materialization; the threat to cultural diversity presented by global media power and tourism – all this is mentioned in one breath with “globalization”, even if that link is often more one of mashing things together than of providing proper explanations. Given how often it is used, it is perhaps less surprising that the term is also hotly contested. While some have called it a “key concept” for analysing the present social and political condition, to others it seems a myth; and yet again others ask for the justification of “globalization” if developments and change in reality vary quite a lot around the globe. We might also be surprised to find that there is no agreement on the definition of what constitutes globalization. Some examples may serve to illustrate this: Globalization, simply put, denotes the expanding scale, growing magnitude, speeding up and deepening impact of transcontinental flows and patterns of social interaction. (Held/McGrew 2002: 1) [. . .] globalisation means the partial erasure of the distinctions separating national currency areas and national systems of financial regulation. (Strange 1995: 294) Globalisation of industry refers to an evolving pattern of crossborder activities of firms involving international investment, trade and collaboration for purposes of product development, production and sourcing, and marketing. These international activities enable firms to enter new markets, exploit

The development of the debate 23 their technological and organisational advantages, and reduce business costs and risks. Underlying the international expansion of firms, and in part driven by it, are technological advances, the liberalisation of markets and increased mobility of production factors. (OECD 1996: 9) A social process in which the constraints of geography on social and cultural arrangements recede and in which people become increasingly aware that they are receding. (Waters 1995: 3) Globalization, we can conclude, is no clearly defined concept, and, as the aforementioned examples demonstrate, its use varies from concentration on specifically economic phenomena to very general social effects on a global scale. Beyond the very general insight that globalization denotes a continuing process of accelerated and deepened social interaction on a global scale between formerly politically independent units (from which mutual influence follows), little agreement exists concerning the characteristics of globalization. Whether it constitutes a process of a historically new quality or not; whether states caused it or whether markets are the dominant actors; whether the economic, the social or the political sphere is the main area of concern; whether it is a development to be applauded or to be contested – all these questions remained unanswered. While this may initially be a cause for puzzlement to the uninitiated, the lack of a generally accepted definition can also be regarded as a precondition for the astonishing success and the career of the term globalization. For it allows countless actors and positions a common, if vague, point of reference. Throughout academia, scholars from a huge variety of subjects have therefore contributed to the debate on globalization, especially from the areas of: • • • • • •

international relations (e.g. Clark 1999; Lawson 2002), comparative political economy (e.g. Berger and Dore 1996; Garrett 1998), international political economy (e.g. Strange 1986; Schirm 2002), political theory (e.g. Gray 1998; Kagarlitsky and Clarke 1999), sociology (e.g. Waters 1995; Goldthorpe 2002) and economics (e.g. Rodrik 1997; Glyn 2006).

The astonishing productivity of this debate has produced a remarkable output of printed matter which seems to justify calling it an academic growth industry. The list put forward here is exhaustive neither with regard to authors nor to subjects. Besides the various facets of social scientists, philosophers, geographers, lawyers, management theorists and historians have contributed to the discussion of globalization (see further references in Busch 2003: 5ff.). As Figure 2.1 demonstrates, book and article publications discussing globalization show a steep upwards trend over the last 15 years, and only recently seem to stabilize on a high level – at (according to the database used) about 1,000 to 1,200 publications per year.2

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1,600 1,400 1,200 IBSS

1,000

Articles First WorldCat (Books)

800 600 400 200

8 19 8 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04

87

19

86

19

19

19

85

0

Figure 2.1 Publications per year on globalization, 1985–2004.

With such an amount of written work, it seems obvious that no survey article – such as the present one – can claim to depict the whole breadth of the debate. We therefore aim considerably lower here: first, we want to draw attention to the intellectual environment of the debate on globalization, by pointing out previous discussions that provide input into (above all the political science side of) the debate on globalization; then, selected aspects of that debate will be discussed, taking core positions and the hypotheses they rest on into account, also with a view to their theoretical underpinnings. The chapter concludes with a provisional résumé of the debate and an assessment thereof.

2 Intellectual precursors of the globalization debate Even a debate as comprehensive as that on globalization does not emerge out of thin air. It is influenced by and refers to debates that went on before in the social sciences. This section argues that there are three such debates that provide a substantial input into the arguments over globalization or are directly linked to it. They are sociological theories of differentiation and modernization; discussions in international relations theory about the role of the state; and the debate in the field of comparative government about the relationship between domestic and foreign policy.

The development of the debate 25 2.1 Theories of differentiation and modernization Since the beginning of industrialization at the beginning of the nineteenth century, theories have predicted the necessary convergence of the different cultures in Europe as a consequence of this development. At an early stage, this topic was addressed by Saint-Simon who, in the spirit of utopian internationalism, advocated a pan-European government – in a journal fittingly entitled The Globe (Waters 1995: 5ff.). Through Comte, Saint-Simon’s ideas influenced Emile Durkheim, who developed them further into his theory of structural differentiation of society. Sociologists of the structural-functionalist school extended this line of argument: industrialization, they argued, would increase a society’s wealth and thus provide incentives for other societies to imitate, leading to the spread of industrialization, eventually over the whole world. Further consequences would flow from this: a process of “modernization” would lead to societal differentiation, eventually prompting value change, individualization, secularization and rationalization: “As industrialization spreads across the globe, it carries modernization with it, transforming societies in a unitary direction” (Waters 1995: 13). This development was already predicted almost clairvoyantly by Karl Marx and Frederic Engels more than 150 years ago. In the Communist Manifesto, they deduced the process of globalization of production and consumption as well as the emergence of a global market from the logic of the capitalist mode of production: “The need of a constantly expanding market for its products chases the bourgeoisie over the whole surface of the world” (Marx 1977: 224). Their industries would process raw materials drawn from all over the globe, and their products “are consumed not only at home, but in every quarter of the globe” (ibid.). During this process, the prediction then went, the capitalist system would spread across the whole world, due to its superior economic efficiency: The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all, even the most barbarian (sic) nations into civilization. The cheap prices of its commodities are the heavy artillery with which it batters down all Chinese walls, with which it forces the barbarian’s intensely obstinate hatred of foreigners to capitulate. It compels all nations, on pain of extinction, to adopt the bourgeois mode of production; it compels them to introduce what it calls civilization into their midst, i.e., to become bourgeois themselves. In one word, it creates a world after its own image. (ibid.: 30)

2.2 The role of the state in international relations The theory of international relations also has points that link it to the debate about globalization. The “realist” or “Westphalian” paradigm had always been state-centred in its analysis, positing a priori that states (and more recently

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“nation states”) are the key actors in international relations. Their interaction has been described as akin to a “billiard-ball model”, with the structure of the international system (i.e. anarchy and the distribution of power) determining a state’s actions. Over the course of the last 30 or so years, however, a number of developments have altered the scene in international relations, and consequently the discipline started a “search for a new paradigm” (Cerny 1996). Two major developments are discernible: on the one hand, the distribution of power between states has changed, if compared to the situation after the Second World War, when a bipolar world order emerged and the United States had a hegemonial position in the West. But already at the end of the 1960s, discussions started about how “interdependence” would influence the states in the system (Cooper 1968; and Keohane/Nye 1977). In the 1980s, the debate about the world “after hegemony” followed, culminating in the discussions about the perceived “decline” of the United States. The theory of international relations had to come to terms with the fact that even a state as powerful as the United States was no longer able to completely determine its own fate. The other major development was the emergence of new actors in international politics in a process labelled “transnationalization”: states no longer had a monopoly in this area, but had to deal with the interference of “nongovernmental” players such as transnational firms and international organizations. As a consequence, explanatory models exclusively focusing on states began to look narrow and obsolete. Already in his 1980 book The Study of Global Interdependence, James Rosenau predicted far-reaching consequences leading to a transformation and “even a breakdown of the nation-state system as it has existed throughout the last four centuries” (Rosenau 1980: 2). After the sea-change in world politics at the beginning of the 1990s, the once orderly world system seemed to come apart completely. Its “turbulence”, as Rosenau now described it, was characterized by the simultaneous existence of a “statecentric” and a “multi-centric” world. The latter was composed of a subset of the state system, international organizations, state bureaucracies and transnational actors such as multinational corporations. These changes pertained in theoretical ways in the ascent of the constructivist research paradigm in international relations, focusing on the role of non-material “social facts” such as ideas, norms, cultural identity and arguments (about the theoretical foundations and the results of the constructivist research programme see e.g. Finnemore and Sikkink 2001). Among the empirical results of this “third debate” in international relations are the influence of “identity issues” on the behaviour of states (see Katzenstein 1996) and the importance of non-state actors such as NGOs, activist groups or “epistemic communities” acting as “norm entrepreneurs” (see Haas 1992; Risse et al. 1999). 2.3 The relationship between domestic and foreign policy The relationship between domestic and foreign (or international) policy is of interest to scholars of both international relations and comparative government.

The development of the debate 27 The old debate about which of the two was dominating the other was ended in the 1960s in favour of empirical research on the relationship between the two, searching for the “domestic sources of foreign policy” (Rosenau 1967). One of the main criticisms levelled by scholars of comparative government against the theory of interdependence in international relations was the fact that influence of interdependence on domestic policy was acknowledged, but not analysed (Keohane and Milner 1996: 7). They therefore reversed Rosenau’s question, asking for the “international sources of domestic politics”. So they claimed: The international system is not only a consequence of domestic politics and structures but a cause of them. Economic relations and military pressures constrain an entire range of domestic behaviours, from policy decisions to political forms. International relations and domestic politics are therefore so interrelated that they should be analysed simultaneously, as wholes. (Gourevitch 1978: 911) The era after the macroeconomic shocks of the 1970s, when the post-war international economic order began to dissolve, seemed a particularly interesting time to pursue that question. David Cameron’s (1978) study on the expansion of the public economy demonstrated that the more countries were exposed to the pressures of international competition through a high degree of economic openness, the more they tended to have a big public economic sector. Peter Katzenstein showed that in small European states political stability and economic flexibility are inextricably linked: since they were exposed to fluctuations in the international economic sphere that were beyond their control, they developed corporatist economic institutions as an “institutional mechanism for mobilizing the consensus necessary to live with the costs of rapid economic change” (Katzenstein 1985: 200). Today, the analysis of international influence on domestic policy is a firmly established research area in comparative government (see Keohane and Milner 1996; Garrett 1998; Chan and Scaritt 2002). By way of summing up one can say that the debate about globalization is fed from a variety of sources in the social sciences. Sociological theory, international relations theory, comparative government and economics all have discussions that link to the topic of globalization. Against this background one should not be too surprised that very different associations to this term exist and it must seem questionable whether a common definition of it will ever be agreed on. However, the lack of the latter seems so far not to have adversely affected the creativity and output of research on the topic – quite the contrary!

3 Positions and hypotheses As a consequence of the exploding amount of publications concerning globalization, several attempts were made to try and categorize the contributions and thus facilitate a more structured debate. One should not be too surprised, given what was stated earlier, that no general agreement could be found in this either: positions

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were grouped into the categories liberal, sceptic and moderate (Busch 1999), hyperglobalist, sceptic and transformationalist (Held et al. 1999), liberal, social democratic and rejectionist (Sally 2000), and globalist and sceptic (Held and McGrew 2000). The main distinguishing criterion in these classifications turns out to be the question of whether globalization is being perceived as an event that fundamentally alters the conditions under which states act or not. The semantics are sometimes puzzling here, since the frequently used term “sceptic” can refer both to the consequences of globalization (especially as far as state capacity is concerned) and to the validity of the globalization hypothesis. The question concerning the nation state’s capacity to act under conditions of globalization consequentially has been declared the central focus of the whole debate by a number of authors – so far a consensus has been emerging in this multi-faceted debate in recent years (see e.g. Berger 2000: 52; Gourevitch 2002: 313; Zürn 2002: 240; and Busch 2003: 22). But whether this capacity to act is indeed under threat (and what consequences this would have for the self-conception of democratic governance), is again contested. Those who see the state’s capacity to act threatened by globalization emphasize the following aspects: conditions for economic policy have changed substantially over the course of the last three decades, and this fundamentally impinges upon the concept of the “modern” or “Westphalian” state characterized by “independence from without and exclusive sovereignty within” (Hintze 1970: 478).3 After the Second World War, controls over movements of currency and goods had allowed the state to siphon off rents from capital owners to finance public and welfare state spending (Scharpf 1996). After the breakdown of the Bretton Woods System of fixed exchange rates and the demise of currency controls, states had lost the command over the setting of domestic interest rates to the international financial markets and had to yield to their “tyranny” (Eichengreen 1997). In the sphere of fiscal policy, the state’s room for manoeuvre was also strongly curtailed, since globalization enforced a shift of taxation from the (highly mobile) factor capital to the (less mobile) factor labour. As a consequence, it was argued, states were faced with the unpalatable choice between either running permanent public deficits or declining international competitiveness of the domestic economy due to excessive labour costs. Deregulation and transnationalization further reduced the capacity for active state policy, and in terms of welfare state measures, that globalization would lead to cut-throat competition and a “race to the bottom”. Consequently, authors arguing for this position spoke of the “erosion” of the nation state (Hilpert 1994), its “retreat” (Strange 1996) or even of its “end” (Ohmae 1995). The line of argument advanced by supporters of the “globalism” thesis was, however, contested by a string of authors and from a variety of perspectives. Some pointed out that markets required a strong regulatory state in order to function well, and that therefore the demise of the state was neither likely nor in the interest of the markets (Boyer and Drache 1996). Besides this more theoretical argument, authors of a more empirical persuasion also questioned the decline scenarios of the globalists. They emphasized that the development over the last decades was not as unique as claimed, and that global economic integra-

The development of the debate 29 tion was at a similar level at the beginning of the twentieth century (Hirst and Thompson 1996). A number of studies also questioned whether the restriction of state capacity was quite as drastic as sometimes stated: they found that tax competition between states, caused by globalization and international capital mobility, was not quite as pronounced and negative as expected, and that therefore the consequences for welfare systems were not either. Rather, it was argued, these systems demonstrated a remarkable degree of resilience and a capacity for adaptation, and party political preferences for taxation and redistribution could still be implemented (Garrett 1998; Swank 2002). Furthermore it could be shown that the costs of welfare state interventions in the economy through taxation were often balanced by positive externalities such as a high level of social stability and a well-trained workforce – and that these advantages were also recognized and appreciated by the owners of highly mobile capital. As a consequence, authors from this group have tended to see state capacity in a more positive light, speaking of “new tasks” for the state (Sassen 1998) and declared the thesis of the powerless state a “myth” (Weiss 1998).

4 Theoretical approaches In order to analyse globalization beyond the merely descriptive sphere, we need a theoretical basis from which we can model the relationship between increasing globalization and the effect this has on state capacity. Even if many contributions to the debate only mention their assumptions in this respect implicitly, there are basically two theoretical approaches that are being used in this context. They lead, however, to opposite predictions concerning the directions developed industrial societies will presumably take as a reaction to the challenges of increasing – mainly, but not exclusively – economic integration. One predicts a trend towards convergence, the other a scenario of stable or even increasing diversity of policy. With respect to state capacity (understood mainly as policy self-determination) we would expect it to shrink under the former scenario, while it would not be affected in the latter. This section describes both approaches as well as the assumptions upon which they build. 4.1 Convergence Theoretical considerations postulating a trend of convergence of state action are rooted on the one hand in the theory of international trade, on the other hand in theories of interjurisdictional or intergovernmental competition. The first approach builds on the factor-proportion theorem (also known as the Heckscher–Ohlin Theorem) and posits a relationship between a country’s factor endowment and the structure of its foreign trade linked to differences in comparative costs. According to this, a country will tend to export goods with whose production factor it is relatively abundantly endowed, while it will tend to import such goods whose production factors are relatively scarce domestically. The reason is that a relative abundance in capital will cause the capital-abundant

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country to produce capital-intensive goods more cheaply than a labour-abundant country. Building on this standard economic theory, Ronald Rogowski some time ago developed a political science model to explain the emergence of societal cleavages (Rogowski 1989). Starting from rather simple assumptions about the domestic political process4 and with the help of the Stolper–Samuelson Theorem (see Chapters 1 and 11) Rogowski was able to put forward hypotheses about the effects of increasing economic openness in order to explain the different political developments, coalitions and cleavages in late nineteenth century Britain, Germany and the United States. In work done collaboratively with Jeffry Frieden Rogowski undertook a – plausible – extension of this model to the process of globalization (Frieden and Rogowski 1996). In doing so, they strove to explain the policy preferences of the relevant domestic actors, the policies carried out, and the development of national political institutions, claiming that the power of an interest group to assert its preferences varies with its mobility – or rather that of its factor of production. The group that can more credibly threaten to exit will increase its negotiation power and have its preferences implemented. Globalization will therefore lead to government policy adapting to the interests of capital owners (the most mobile factor of production), and since this adaptation will take place everywhere, policy convergence is the result. The second approach focuses on government action under conditions of competition and arrives at similar conclusions (see Kenyon 1997). The fundamental assumption is that governments compete for mobile capital (which looks for the highest net yield). This leads to an equalization of net yields across countries and tax competition between states trying to provide the best business environment (see Schulze and Ursprung 1999). The degree of competition depends on the mobility of all factors of production. But it is not only the extent of taxation that influences yield expectations of capital – labour, social, and environmental regulations also play a part in this competition. For, since regulations impose costs, firms will try to minimize such costs. Therefore (and with the same logic as in the case of taxation) equalization will be the result in these areas as well. Which direction this competitive equalization between states will take – a “race to the bottom” with a downward spiral of regulatory intensity and a convergence on the smallest common denominator, or a “race to the top” with escalating regulation as a consequence of competition – depends on a variety of factors and is not relevant in the present context.5 In conclusion we can say that while the models outlined in the preceding paragraphs differ with respect to their precise mechanisms, they posit the same effect of growing economic integration on domestic policy: either through a change in the domestic balance of power or through direct change in government policy, a convergence of policies and institutions will result from the change in external economic circumstances.

The development of the debate 31 4.2 Diversity Quite the contrary, development as the consequence of external change is what other theoretical approaches, which focus on the stability of specific national characteristics, would lead us to expect. According to these theories (which give special emphasis to differences in policy styles, the resilience of institutional arrangements and the path dependence of decisions more generally), continued or even increased diversity of policy outputs and institutional structures will be the likely result. One of the first analyses to take such a perspective was probably Andrew Shonfield’s book on “Modern Capitalism” (Shonfield 1965). Shonfield explained in his extensive empirical analysis the differences in economic policy between the United States, France, Britain and the Federal Republic of Germany primarily with reference to the different attitudes with which national political and economic actors approached the economy. These attitudes, Shonfield stated, were largely based on culturally specific orientations deeply rooted in the national history. While differences between them were often small and diffuse, over time they amounted to a significant order of magnitude. Translating these diffuse differences into more manageable variables in the area of policy-making and policy implementation has been the merit of the concept of national “policy styles” (Richardson et al. 1982; see also Vogel 1986). These national policy styles differ on the one hand on the dimension of problem-solving, and on the other hand with respect to the relationship between government and the other actors in the decision-making process. While the former can be either anticipatory or reactive, the latter can be consensual or impositional (Richardson et al. 1982: 13). These distinctions result in a typology of national policy styles which have (in addition to institutional factors) a significant influence on policy. Attitudes and orientations, more generally – cognitive aspects and “ideas” – thus play a significant role in the nationally specific approaches and implementations of policy (on the role of ideas in policy making see e.g. Braun and Busch 1999). Especially implementation is an area in which national policy styles show great perseverance, as studies of public administration have shown: Policy styles and policy networks in public administration are firmly rooted in nationally specific legal, political and administrative institutions which are the result of long historical processes and show great stability over time. Most of these institutions are linked to each other in one way or another which further stabilizes them. (Waarden 1993: 206) Institutional stability is therefore high and cannot be easily changed through shifts in political power: [T]o portray political institutions simply as an equilibrium solution to the conflicting interests of current actors is probably a mistake. Institutions are

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Andreas Busch not simply reflections of current exogenous forces or micro-behaviour and motives. They embed historical experience into rules, routines, and forms that persist beyond the historical moment and condition. (March and Olsen 1989: 167f.)

Under conditions of such stability we would also expect increases in international integration to induce no major changes, with respect to both institutions and policy content: “Given this strong rootedness, these institutions are not easily changed and with them national regulatory styles.” (Waarden 1995: 362) The most general and perhaps theoretically most sophisticated form of this argument can be found in the concept of path dependency which is derived from the transaction cost and institutional school of economics.6 This approach describes how processes can over time (through positive returns to scale, network externalities and feedback effects) achieve highly stable equilibria (lock-in) where the cost of fundamental change is prohibitively high and such change accordingly very rare. Economic models of that ilk have in the past been used to explain technological developments and decisions about the location of industries (see Arthur 1989; Krugman 1991), and have recently been successfully applied to political science topics, with a special focus on the dynamics increasing returns to scale and self-reinforcing processes have on social interaction (see Pierson 2004). Political decisions, according to this line of argument, carry a substantial historical legacy which consists of past political investments and decisions, thus severely limiting choice in the present. By raising the cost of path change, this also contributes to the stability of the originally chosen path. In addition, the disproportionate importance of changes at an early stage is being emphasized, as is the existence of “critical junctures”.7 Seen from such a perspective, one would expect states to further pursue their historically developed paths even under conditions of increasing international integration, thus leading not to convergence, but to constant and perhaps even increasing diversity of political and policy decisions. 4.3 Theory and reality Both expectations of convergence and of diversity thus have convincing and coherent theoretical models that can be put forward in their favour. Empirical studies, however, intended to adjudicate between the rival approaches, often arrive at more complex results which do not fully support either of the two scenarios. One example of this is the area of state regulation of the banking system – a policy area that is characterized both by the emergence of “24/7” world wide market operation and historically very different starting conditions in terms of institutional and market structures, making it an ideal test case for the convergence hypothesis. An empirical study of four highly developed OECD countries (USA, UK, Germany and Switzerland) over the 1974 to 1999 period, however, fails to conclusively support or reject either of the competing hypotheses and

The development of the debate 33 presents a mixed picture (Busch 2003; forthcoming). Differentiating between content, process and institutional components leads to somewhat clearer results: while partial – but clearly less than complete – convergence can be detected in terms of the content of regulation, continuous divergence in terms of both the political process and with regard to institutional setups must be stated. We find therefore that inter- and supranational agreements lead to a degree of equalization in the dimension of policy, the dimensions of national politics and polity remain largely immune to change. The hypothesis put forward by Frieden and Rogowski (1996) about the increasing influence of capital owners is thus not supported. A recently conducted meta-analysis of studies about policy convergence – which, however, also includes studies of Europeanization – comes to the similar conclusion that results vary strongly according to policy area, countries and time period considered, and that it is often difficult to clearly categorize a process of convergence or diversity (Heichel et al. 2005).

5 Conclusion The debate about the consequences of globalization, after more than a decade, does not seem to be nearing conclusion any time soon. And there are good reasons for this, both in academic and in general political regard: for the latter the challenge is to determine what degree of self-determination a democratic society can reasonably expect to achieve, and how a state’s legitimacy is affected if its capacity to provide “classical” state services is perhaps severely diminished. For the academic debate the challenge is to overcome disciplinary restrictions and to improve our understanding of the national and international political changes triggered by the advent of globalization. If we look at the debate so far, we can quite clearly distinguish various phases. A first wave – that popularized the term and put it on the academic agenda – took up relatively crude stances on globalization that today seem exaggerated both with respect to the positive (e.g. Ohmae 1990) and negative (e.g. Strange 1986) consequences of globalization. It was followed with some delay by a second wave which focused on the collection of empirical facts, which then allowed critical examination of the claims of the first wave (such as Hirst and Thompson 1996; Beisheim et al. 1999). Building on these data and with a view to the stalemate mentioned above with regard to theoretical models trying to explain the consequences of globalization, a third wave of the literature then undertook detailed sectoral studies concerning welfare state or regulatory policies, often in a comparative perspective (e.g. Scharpf and Schmidt 2000a, b; Busch 2003). Forming the diverse results of that third wave into a coherent and theoretically consistent state of knowledge about globalization will be the task of a fourth wave that is so far still outstanding. Peter Gourevitch (2002: 313) has rightly pointed out that the debate about globalization has increased the importance of international relations for scholars of comparative government, while the importance of knowledge about the internal workings of political systems has conversely risen for scholars

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of international relations. But the cooperation over long-established (even sub-)disciplinary boundaries – and even the sheer knowledge about what is happening on the other side of the fence – is something that is evidently still capable of further improvement, but faces the difficulties of increasing professional differentiation. Research concerning globalization is even more than one-and-a-half decades into the debate still very active, as the figure in the beginning of this article demonstrates. Certainly we now know more about this complex phenomenon than we did a decade ago when jubilation and scepticism about globalization existed side by side without either having a solid and detailed empirical foundation for their often far-reaching claims. There is criticism that attempts to formulate a general theory of globalization by international relations scholars have failed so far and that our knowledge about the causes and origins of globalization – and systematic empirical facts about it – still have to be regarded as low (Zürn 2002: 235, 239). But we should consider whether the stakes are not raised too high in demanding this: after all, precious few “general theories” exist in most of social science, and the competing views and perspectives on globalization so far seem to have spurred on research rather more than hindered it. In comparative government we can also not speak of a stable and comprehensive state of knowledge about globalization so far. But many of the studies of the abovementioned “third wave” have resulted in increased scepticism towards the originally far-reaching hypotheses about policy convergence and a regulatory “race to the bottom”, and they have tended to emphasize the importance of national political institutions in this process, which work as “national filters” of globalization (see Busch 2004, 2003: 547ff.; Drezner 2001; Weiss 2003). Perhaps it is best to see research on globalization as engaged in a process of maturation in which we can observe consolidation as well as concentration and an emerging focus on a subset of the initial research questions. Not least the contributions assembled in this volume seem a good example of this. At the same time, however, important open questions and desiderata continue to exist, such as a clearer distinction between the analysis of the origins of globalization (what caused it?) and the consequences of globalization (what did it cause?). Both aspects promise to leave a lot of space for further creative research efforts in this area, guided by the hope for the big breakthrough – or, failing that, that for the steady accumulation of knowledge.

Notes 1 This chapter partially draws on the author’s previous work on globalization (Busch 1999, 2003). For constructive criticisms and suggestions on a previous version of this chapter, I am grateful to the participants of the workshop on globalization in Arnoldshain, November 2005, and in particular to Tanja Brühl and Stefan Schirm. 2 The figure is derived from data of three bibliographic databases which were queried for the title words “globalisation” and “globalization”. They are the International Bibliography of the Social Sciences (IBSS) as well as the databases “WorldCat” (books) and “ArticleFirst” (journal articles) of the Library of Congress. Originally conducted in

The development of the debate 35

3 4 5

6

August 2001, the dataset was updated in September 2005 for the years ranging from 2001 to 2004. All translations from German language texts, unless otherwise indicated, are by the author. Rogowski (1987: 1123) merely makes two assumptions: Those who profit from change will try to push it, while the losers will try to stop or delay it. Citizens who benefit materially now or in the future are able to extend their political influence. See for this the seminal work by Vogel (1986). Illustrations of the (in Vogel’s terms) “Delaware effect” (race to the bottom) and “California effect” (race to the top) in different international attempts at cooperation can be found in Genschel and Plümper (1999), who also outline the conditions under which each of the two is likely. An overview is Williamson (1994). Douglass North describes the attractiveness of the concept of path dependence as follows: The promise of this approach is that it extends the most constructive building blocks of neoclassical theory – both the scarcity / competition postulate and incentives as the driving force – but modifies that theory by incorporating incomplete information and subjective models of reality and the increasing returns characteristic of institutions. (North 1990: 112)

7 Some examples from prominent political science contributions may serve to illustrate these mechanisms. The work of Stein Rokkan (2000) about the comparison of European societies, for example, demonstrates that small differences in starting positions can yield substantial differences over longer periods of time, while Putnam (esp. 1993: 179–81) shows the same for the comparative study of sub-national units. The importance of critical junctures and the stability of structures once they have been established is also evident in the development of European party systems. While fundamental social cleavages initially triggered the founding of political parties, the ensuing development is marked by inertia which impeded the emergence of new parties and caused a “freezing” of the party systems along the cleavages of the early twentieth century (Lipset and Rokkan 1967).

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–––– (2004) “National Filters: Europeanisation, Institutions, and Discourse in the Case of Banking Regulation”, West European Politics 27: 310–33. (Special issue on Policy Change and Discourse in Europe, ed. by Claudio M. Radaelli and Vivien A. Schmidt.) –––– (forthcoming) Banking Regulation and Globalization, Oxford: Oxford University Press. Busch, A. and Plümper, T. (eds) (1999) Nationaler Staat und internationale Wirtschaft. Anmerkungen zum Thema Globalisierung, Baden-Baden: Nomos. Cameron, D.R. (1978) “The Expansion of the Public Economy: A Comparative Analysis”, American Political Science Review, 72: 1243–61. Cerny, P.G. (1996) “Globalization and Other Stories. The Search for a New Paradigm in International Relations”, unpublished thesis, Leeds: Dept. of Politics, University of Leeds. Chan, S. and Scarritt, J.R. (eds) (2002) Coping with Globalization: Cross-national Patterns in Domestic Governance and Policy Performance, London: Frank Cass. Clark, I. (1999) Globalization and International Relations Theory, Oxford: Oxford University Press. Cooper, R. (1968) The Economics of Interdependence, New York: McGraw-Hill for the Council on Foreign Relations. Drezner, D.W. (2001) “Globalization and Policy Convergence”, International Studies Review, 3: 26. Eichengreen, B. (1997) “The Tyranny of the Financial Markets”, Current History, 96: 377–82. Finnemore, M. and Sikkink, K. (2001) “Taking Stock: The Constructivist Research Program in International Relations and Comparative Politics”, Annual Review of Political Science, 4: 391–416. Frieden, J.A. and Rogowski, R. (1996) “The Impact of the International Economy on National Policies: An Analytical Overview”, in R. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 25–47. Garrett, G. (1998) Partisan Politics in the Global Economy, Cambridge: Cambridge University Press. Genschel, P. and Plümper, T. (1999) “Wettbewerb und Kooperation in der internationalen Finanzmarktregulierung”, in A. Busch and T. Plümper (eds) Nationaler Staat und internationale Wirtschaft. Anmerkungen zum Thema Globalisierung, BadenBaden: Nomos: 251–75. Glyn, A. (2006) Capitalism Unleashed: Finance, Globalization, and Welfare, Oxford: Oxford University Press. Goldthorpe, J. (2002) “Globalisation and Social Class”, West European Politics, 25: 1–28. Gourevitch, P. (1978) “The Second Image Reversed: The International Sources of Domestic Politics”, International Organization, 32: 881–912. –––– (2002) “Domestic Politics and International Relations”, in W. Carlsnaes, T. Risse and B.A. Simmons (eds) Handbook of International Relations, London: Sage: 309–28. Gray, J. (1998) False Dawn. The Delusions of Global Capitalism, London: Granta. Haas, P.M. (1992) “Introduction: Epistemic Communities and International Policy Coordination”, International Organization, 46: 1–35. Heichel, S., Pape, J. and Sommerer, T. (2005) “Is there Convergence in Convergence Research? An Overview of Empirical Studies on Policy Convergence”, Journal of European Public Policy, 12: 817–40.

The development of the debate 37 Held, D. and McGrew, A. (eds) (2000) The Global Transformations Reader. An Introduction to the Globalization Debate, Cambridge: Polity Press. –––– (2002) Globalization/anti-globalization, Cambridge: Polity Press. Held, D., McGrew, A., Goldblatt, D. and Perraton, J. (1999) Global Transformations. Politics, Economics and Culture, Cambridge, Oxford: Polity. Hilpert, U. (1994) “Das politische Risiko erfolgreicher Partizipation an neuen Weltmärkten. Zum Problem tendenzieller Erosion staatlicher Steuerungskompetenz bei erfolgreicher Integration in die internationale Arbeitsteilung”, in U. Hilpert (ed.) Zwischen Scylla und Charybdis? Zum Problem staatlicher Politik und nicht-intendierter Konsequenzen, Opladen: Westdeutscher Verlag: 87–106. Hintze, O. (1970) “Wesen und Wandlung des modernen Staats”, in O. Hintze (ed.) Staat und Verfassung. Gesammelte Abhandlungen zur allgemeinen Verfassungsgeschichte, 3rd edn, Göttingen: Vandenhoeck & Ruprecht: 470–96. Hirst, P. and Thompson, G. (1996) Globalization in Question. The International Economy and the Possibilities of Governance, Cambridge: Polity Press. Kagarlitsky, B. and Clarke, R. (1999) New Realism, New Barbarism: Socialist Theory in the Era of Globalization, Recasting Marxism, London: Pluto Press. Katzenstein, P.J. (1985) Small States in World Markets. Industrial Policy in Europe, Ithaca, NY: Cornell University Press. –––– (1996) The Culture of National Security: Norms and Identity in World Politics, New Directions in World Politics, New York: Columbia University Press. Kenyon, D.A. (1997) “Theories of Interjurisdictional Competition”, New England Economic Review, March/April: 13–28. Keohane, R.O. and Milner, H.V. (eds) (1996) Internationalization and Domestic Politics, New York, Cambridge: Cambridge University Press. Keohane, R.O. and Nye, J.S. (1977) Power and Interdependence: World Politics in Transition, Boston, MA: Little Brown. Krugman, P. (1991) “History and Industry Location: The Case of the Manufacturing Belt”, American Economic Review, 81: 80–3. Lawson, S. (ed.) (2002) The New Agenda for International Relations: From Polarization to Globalization in World Politics? Cambridge: Polity Press. Lipset, S.M. and Rokkan, S. (1967) “Cleavage Structures, Party Systems and Voter Alignments: An Introduction”, in S.M. Lipset and S. Rokkan (eds) Party Systems and Voter Alignments, New York: Free Press: 1–64. March, J.G. and Olsen, J.P. (1989) Rediscovering Institutions. The Organizational Basis of Politics, New York: Free Press. Marx, K. (1977) Selected Writings, ed. by D. McLellan, Oxford: Oxford University Press. North, D.C. (1990) Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. OECD (1996) Globalisation of Industry. Overview and Sector Reports, Paris: OECD. Ohmae, K. (1990) The Borderless World. Power and Strategy in the Interlinked Economy, London: Collins. –––– (1995) The End of the Nation State: The Rise of Regional Economics, London: HarperCollins. Pierson, P. (2004) Politics in Time: History, Institutions, and Social Analysis, Princeton, NJ: Princeton University Press. Putnam, R.D. (1993) Making Democracy Work: Civic Traditions in Modern Italy, Princeton, NJ: Princeton University Press.

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Richardson, J.J., Gustafsson, G. and Jordan, G. (1982) “The Concept of Policy Style”, in J.J. Richardson (ed.) Policy Styles in Western Europe, Boston, MA: Allen and Unwin: 1–16. Risse, T., Ropp, S.C. and Sikkink, K. (eds) (1999) “The Power of Human Rights: International Norms and Domestic Change”, Cambridge Studies in International relations, 66, Cambridge: Cambridge University Press. Rodrik, D. (1997) Has Globalization Gone Too Far? Washington, DC: Institute for International Economics. Rogowski, R. (1987) “Political Cleavages and Changing Exposure to Trade”, American Political Science Review, 81: 1121–37. –––– (1989) Commerce and Coalitions: How Trade Affects Domestic Political Alignments, Princeton, NJ: Princeton University Press. Rokkan, S. (2000) Staat, Nation und Demokratie in Europa. Die Theorie Stein Rokkans aus seinen gesammelten Werken rekonstruiert und eingeleitet von Peter Flora, Frankfurt am Main: Suhrkamp. Rosenau, J. N. (ed.) (1967) Domestic Sources of Foreign Policy, New York: Free Press. –––– (1980) The Study of Global Interdependence, New York: Nichols. Sally, R. (2000) “Globalization and Policy Response: Three Perspectives”, Government & Opposition, 35: 237–53. Sassen, S. (1998) “Zur Einbettung des Globalisierungsprozesses: Der Nationalstaat vor neuen Aufgaben”, Berliner Journal für Soziologie, 8: 345–57. Scharpf, F.W. (1996) “Föderalismus und Demokratie in der transnationalen Ökonomie”, in K. von Beyme and C. Offe (eds) Politische Theorien in der Ära der Transformation, Opladen: Westdeutscher Verlag: 211–35 (PVS special issue no. 26). Scharpf, F.W. and Schmidt, V.A. (eds) (2000a) Welfare and Work in the Open Economy. Volume I: From Vulnerability to Competitiveness, Oxford: Oxford University Press. –––– (2000b) Welfare and Work in the Open Economy. Volume II: Diverse Responses to Common Challenges, Oxford: Oxford University Press. Schirm, S.A. (2002) Globalization and the New Regionalism. Global Markets, Domestic Politics, and Regional Cooperation, Cambridge: Polity Press. Schulze, G.G. and Ursprung, H.W. (1999) “Globalisierung contra Nationalstaat? Ein Überblick über die empirische Evidenz”, in A. Busch and T. Plümper (eds) Nationaler Staat und internationale Wirtschaft. Anmerkungen zum Thema Globalisierung, BadenBaden: Nomos: 41–89. Shonfield, A. (1965) Modern Capitalism. The Changing Balance of Public and Private Power, London, New York, Toronto: Oxford University Press. Strange, S. (1986) Casino Capitalism, Oxford: Blackwell. –––– (1995) “The Limits of Politics”, Government and Opposition, 30: 291–311. –––– (1996) The Retreat of the State: the Diffusion of Power in the World Economy, Cambridge: Cambridge University Press. Swank, D. (2002) Global Capital, Political Institutions, and Policy Change in Developed Welfare States, Cambridge: Cambridge University Press. Vogel, D. (1986) National Styles of Regulation: Environmental Policy in Great Britain and the United States, Ithaca, NY: Cornell University Press. Waarden, F. van (1993) “Über die Beständigkeit nationaler Politikstile und Politiknetzwerke. Eine Studie über die Genese ihrer institutionellen Verankerung”, in R. Czada and M.G. Schmidt (eds) Verhandlungsdemokratie, Interessenvermittlung, Regierbarkeit. Festschrift für Gerhard Lehmbruch, Opladen: Westdeutscher Verlag: 191–212. –––– (1995) “Persistence of National Policy Styles: A Study of their Institutional

The development of the debate 39 Foundations”, in B. Unger and F. van Waarden (eds) Convergence or Diversity? Internationalization and Economic Policy Response, Aldershot: Ashgate: 333–72. Waters, M. (1995) Globalization, London: Routledge. Weiss, L. (1998) The Myth of the Powerless State, Ithaca, NY: Cornell University Press. –––– (2003) States in the Global Economy: Bringing Domestic Institutions Back In, Cambridge: Cambridge University Press. Williamson, O.E. (1994) “Transaction Cost Economics and Organization Theory”, in N.J. Smelser and R. Swedberg (eds) The Handbook of Economic Sociology, Princeton, NJ: Princeton University Press: 76–107. Zürn, M. (2002) “From Interdependence to Globalization”, in W. Carlsnaes, T. Risse and B.A. Simmons (eds) Handbook of International Relations, London: Sage: 235–54.

3

Fiscal policy and adjustment Adjusting fiscal policy to globalization – testing theoretical approaches Reimut Zohlnhöfer

1 Introduction Comparative research on the determinants of fiscal policy developments in Organization for Economic Cooperation and Development (OECD) democracies has produced consistent but somewhat unexpected evidence over the last years: Since the mid-1980s, almost all OECD member states have adopted tax reforms which stipulated cuts to the tax rates, particularly for businesses, and a broadening of the tax base (see Devereux et al. 2002; Steinmo and Swank 2002; Ganghof 2005). According to quantitative research, these reforms were hardly influenced by the partisan complexion of the respective governments (Steinmo and Swank 2002). These findings contravene the fact that differences in the partisan complexion of governments in the post-war period have led to tax systems which still differ remarkably throughout the OECD world: for example, countries predominantly governed by Social Democratic parties exhibit high tax ratios, while the rule of Liberal or Conservative parties led to significantly lower tax burdens (Wagschal 2005: 390–5). It is not only on the revenue side of the budget, however, that partisan differences seem to wane; on the expenditure side as well, it seems to be of declining importance which parties are in government. A particularly important case in point is social spending, the largest item of expenditure in the OECD democracies. Until the mid-1980s, that is during the phase of welfare state expansion, clear partisan patterns could be observed: Social Democratic as well as Christian Democratic parties tended to increase social spending, while Liberal and Conservative parties tended to limit the growth of the welfare state. Since the 1990s, however, the relevant quantitative studies fail to find a systematic relationship between changes in social spending and the partisan complexion of government (Garrett and Mitchell 2001; Huber and Stephens 2001; Schwartz 2001; Kittel and Obinger 2003). The same results are produced by quantitative studies analysing other areas of government expenditure, for example subsidies (Obinger and Zohlnhöfer forthcoming). In a substantial part of the literature, globalization, particularly the internationalization of financial markets, is held responsible for the decline of partisan effects in fiscal as well as social policies. However, in many contributions it

Adjusting fiscal policy to globalization 41 remains largely unclear how the external challenges are transformed into policies at the national level (Schwartz 2001: 20f.). This is at least partly due to the fact that most of the relevant theoretical as well as empirical research focuses on the results of adjustment processes. Therefore, most studies investigate whether a “race to the bottom” or convergence has occurred (as an overview see Schulze and Ursprung 1999), while the process of adjustment itself is hardly ever analysed (Zürn 2002: 243). This is unfortunate because such an investigation of the political processes of adjustment is particularly suitable in order to understand the impact of political variables on nation states’ adaptations to globalization. This chapter will deal with the theoretical question, in what way do changes in the international political economy trigger changes of national fiscal policies. In the next part of the chapter, the most important theoretical contributions to this field are presented and briefly discussed. Building on this discussion, my own model of adjustment processes to economic globalization is presented in the third section. My model takes as a starting point the fact that reforms to adjust to the challenges of globalization still need to be adopted by national institutions. Therefore, I start from the actors with formal veto powers and model their preferences. Afterwards, hypotheses about the adjustment processes and their results in different settings are derived from the model which are tested by a comparative analysis of fiscal policy developments in Germany and the United Kingdom since the 1980s (section 4). The final section concludes.

2 Models of domestic adjustment processes to changes in the international economy 2.1 The models of Rogowski and Frieden The classic model dealing with the impact of foreign trade on domestic politics was developed by Ronald Rogowski (1989). Rogowski was primarily interested in how changes in foreign trade impact on domestic political alignments. Nevertheless, his reflections are also important for the purpose of this chapter because they lead one to expect that the domestic coalitions formed in reaction to changes in foreign trade also influence the processes of economic policy adaptation to the challenges of the international economy. Rogowski’s starting point is the so-called “Stolper–Samuelson Theorem” that explains which factors of production experience benefits or losses due to the liberalization of foreign trade or other exogenous changes relevant for trade (like changes in transport costs etc.) – given the assumptions of the Heckscher–Ohlin trade model hold. Stolper and Samuelson argue that the owners of the factor a country is poorly endowed compared with the rest of the world benefit from protection while the owners of the relatively abundant factor are harmed by closed borders. The liberalization of trade therefore harms the scarce factor while the abundant factor benefits. Therefore, Rogowski argues, the owners of the scarce factor will opt for protectionism, while the owners of the abundant factor will favour free trade. Moreover, he assumes “that those who enjoy a sudden increase in wealth and income

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will thereby be enabled to expand their political influence as well” (Rogowski 1989: 5). This is a critical assumption since it implies that the beneficiaries of a change in the conditions of foreign trade (changes in tariffs, transport costs etc.) also experience an increase in domestic political influence which they can use to further change the economic policy framework in their favour. Jeffry Frieden (1991: 435) has applied the same logic to an increase in capital mobility. According to Rogowski’s and Frieden’s models, the following should thus be expected for fiscal policy adjustments to economic openness: The option to invest abroad in capital-poor countries, which was only created by increasing openness, will boost capital owners’ domestic influence in capital-rich countries and will thus enable them to push through far-reaching fiscal policy changes in accordance to their interests, for example tax cuts. Frieden (1991), however, has objected that this logic may well explain the relevant developments adequately in the long run but that in the short or medium term different coalitions would emerge along sectoral cleavages. Since real capital cannot easily be moved from one use to another (i.e. it is specific to a certain sector), owners of real capital in capital-rich countries do not benefit from an increase in capital mobility in the short run. Therefore, at least in the short term, owners of real capital in labour-intensive sectors in capital-rich countries have the same interests as their workers because due to the establishment of foreign trade with labour-rich countries the prices of commodities that are produced labour-intensively decrease in the capital-rich country which hurts both groups equally. In contrast, the owners of financial assets do have the option to invest profitably in capital-poor countries. Thus, at least in the short run the interests of capital owners can diverge. What is more important for the purpose of this chapter, however, is how Frieden models the political process. Like Rogowski, he tries to identify winners and losers in an increase of economic openness. The interests and economic importance of these groups then determine the way a country adjusts to economic openness. In a later contribution, Frieden and Rogowski (1996) have extended their “rudimentary model of the political process” (Rogowski 1989: 4) and have added a number of institutional features. They mainly focus on the question of which institutions incite politicians to pursue free trade policies, which increase aggregate welfare, even though the politicians’ re-election may be put at risk by the resistance of interest groups that are negatively affected by the liberalization. They conclude that “[g]overnments will be more likely to respond to such pressures [for reductions of barriers to trade; RZ] to the extent that they more accurately represent the broad social interest in the aggregate; can make credible commitments to compensate potential losers; and have relatively longer timehorizons.” (Frieden and Rogowski 1996: 45) Frieden’s and Rogowski’s approaches are fascinating because of the theoretical elegance with which they derive actor preferences from simple economic models. This is also their main merit. Nevertheless, their utility as a framework for empirical research on nation states’ adaptation to globalization is limited. For example, they fail to consider the fact that governments have to decide in cases

Adjusting fiscal policy to globalization 43 of conflict between the demands of capital owners who might threaten to invest abroad and the wishes of voters the majority of whom are often not willing to accept welfare cuts or tax cuts for enterprises. This blind spot is particularly serious because governments depend on the consent of the voters and not – at least not directly – on the cooperation of multinational corporations. Moreover, governments more often than not act on their own and not as pure agents of the interests of certain groups or the median voter. These relations remain unexplored in Rogowski’s and Frieden’s models. In addition, their discussion of the role of institutions remains exceedingly abstract. Put simply: their model of the political process is under-complex.1 2.2 Bridging the gap to institutionalist approaches: Garrett and Lange Geoffrey Garrett and Peter Lange (1996: 69) are certainly correct in pointing out that – against Frieden’s and Rogowski’s expectations – no existing political system will translate the economic policy demands of the beneficiaries of globalization into government policy in their entirety, not even when the economic importance of the exposed sectors increases significantly. Instead, Garrett and Lange argue that the institutional structure of a political system determines to what extent a change of preferences on the part of the actors (which are modelled along the lines of the Rogowski and Frieden approaches) leads to adjustment reforms. They expect that, first, democracies are more likely to adapt than authoritarian regimes. Second – and more important for the considerations presented here which focus on OECD democracies – the readiness to adjust is related to the electoral system according to Garrett and Lange. They argue that all electoral systems are biased against the competitive sectors of the economy that favour adjustment. This bias is expected to be smallest in proportional representation systems which thus should be more likely to see adaptation. Third, the number of veto-players should be low if adjustment reforms are to be adopted, and, fourth, an independent central bank should trigger reforms. Regarding industrial relations, reforms are seen to become more likely the weaker trade unions are, particularly in the public sector. Garrett’s and Lange’s contribution builds a bridge between Frieden’s and Rogowski’s simple (or even simplistic) models of the political process and more recent institutionalist approaches to adjustment reforms. This is certainly an achievement. What is lacking in the Garrett–Lange approach, however, is a theoretical explanation of why we should believe that adjustment reactions are mainly determined by the institutions discussed. What is more, the modelling of actor preferences which is taken from Frieden and Rogowski is rather simplistic and might be misleading in empirical research. Therefore, I now turn to theoretical approaches that were derived from empirical studies.

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2.3 Theoretical approaches derived from empirical research The emphasis on the role of institutions for nation states’ adaptations to the challenges of globalization links Garrett and Lange with a number of other approaches. Contrary to Garrett and Lange, but also contrary to Rogowski and Frieden, the main interest of these approaches is empirical. Theory-building is often inductive. Moreover, these approaches aim at explaining economic policy reactions to globalization and not at explaining the decision to liberalize trade (as was the case with Rogowski, for example). A very good example is the work of Fritz W. Scharpf (2000a). For him, institutions play an important role. That is true for the formal institutions of the state, but also for industrial relations and welfare state regimes. Nevertheless, Scharpf argues that the relationship between institutional capabilities and economic success is contingent, that is that certain institutions are helpful in some circumstances, but dysfunctional in others. He therefore stresses the importance of external challenges in addition to institutions: “even though institutional differences may provide very powerful explanations for the success or failure of national policy responses, these explanations can be formulated only with regard to specific types of challenges” (Scharpf 2000a: 22). For the challenges of globalization he shows that the welfare regime determines to a large part which problems a country faces and which solutions are feasible. This kind of reasoning does not allow Scharpf to formulate generalizable hypotheses concerning nation states’ adaptations to the challenges of globalization. Moreover, the preferences and motivations of actors remain vague. Governments seem to be seen as actors that are mainly engaging in problem solving rather than in pursuing ideological goals or securing their re-election. But these assumptions are not defended in theoretical or empirical terms. Stefan Schirm’s (2004: 141–4) approach starts from the observation that globalization impacts three different levels: (1) Due to the increasing capital mobility corporations can punish national economic policies by withdrawing capital, thus potentially provoking economic crises; (2) The growth of the exposed sector of an economy is accompanied by the growing importance of market-liberal interests in economic policy-making; (3) Governments can hardly use policy instruments that focus mainly on the domestic market anymore because these instruments have massively lost effectiveness in times of open markets. Nevertheless, these mechanisms do not operate identically in all countries. Rather, the direction and speed of adjustment reforms depends on two core variables according to Schirm, namely norms and institutions. With regard to institutions, Schirm focuses on those institutions that link government and society, particularly those that link government and social partners (trade unions, business associations). Schirm (2004: 139) expects corporatist countries, in which interest groups exert large impacts on any government’s economic policy, to fail to adapt as long as the interest groups do not accept liberal economic policy positions. Dominant norms are defined as “ideas about how a society should be organized and which principles it should follow that reach sufficient commonality (among the citizens) and specificity (with regard to their meaning)

Adjusting fiscal policy to globalization 45 in order to form constraints for policy-making” (Schirm 2002: 223). As long as values of solidarity and consensual policy-making dominate in a country, governments will have a hard time adopting liberal reforms. The emphasis on core societal values (which also shape electoral competition) is an important contribution to the debate. Furthermore, the distinction of different mechanisms via which globalization influences economic policymaking (crises, interests, instruments) is valuable. On the other hand, the reasons why (corporatist) institutions and norms should be the most important variables for the explanation of adjustment processes remain unclear. Furthermore, the conditions, under which actors in corporatist networks change their positions, and which might transform corporatist institutions from an instrument of blockade into a window of opportunity for adaptation, need further elaboration. Finally, one might doubt the explanatory power of the variable “norms”. Previous research has shown that political discourse, that is the presentation of reforms as necessary and as normatively appropriate, that is embedded in the core societal values, can matter significantly for the success of adjustment reforms (V. Schmidt 2002: 257ff.). Governments in turn can at least try to influence the political discourse to a certain degree: whether a reform is seen as normatively appropriate and in line with what Schirm calls “norms” is not an objective fact. Rather, parties and governments can shape political discourses in such a way that their reforms are perceived to be compatible with these norms (see Cox 2001). Vivien A. Schmidt (2005; see also 2002) has also presented a theoretical framework to explain the adoption of adjustment reforms. Similar to Scharpf her starting point is the policy legacy which varies from country to country and which renders countries vulnerable to the globalization challenges in different ways. Thus, the challenges are somewhat filtered by the policy legacy. According to Schmidt, policy change becomes possible as a crisis unfolds. Whether or not governments react to a crisis depends first on the institutional setting and second on the actors’ preferences. Regarding the political system, Schmidt distinguishes between single-actor systems which allow hierarchic steering and multi-actor systems which have to rely on bargaining between the different actors. She expects far-reaching reforms to be more difficult to adopt in the latter kind of political systems. Furthermore, concerning preferences, the respective actors must be willing to adopt reforms in order to overcome the crisis. This willingness cannot be taken for granted, however, and Schmidt expects Social Democratic parties ceteris paribus to be less willing to engage in liberal economic reforms than their bourgeois rivals. But even when the actors are willing and able to adopt reforms as a reaction to economic crisis they still have to make sure that the reforms are accepted by the voters. Whether governments are successful in this respect depends to a large degree on the government’s political discourse which, if successful, convinces the voters of the necessity as well as the normative appropriateness of the reforms. Schmidt’s model can indeed explain significant parts of adjustment reforms in a large number of countries, as her empirical research shows. Since she

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focuses on the questions, if, how and when political discourse matters, the other parts of the model (which she herself calls “background conditions to discourse“ (V. Schmidt 2005: 3)) are somewhat under-specified. This is particularly the case for the questions, why, when and how actor preferences change. Moreover, it is surprising that actors that might be able and willing to establish a “counterdiscourse” are not taken into account. However, the success of a government’s political discourse might significantly depend upon the existence and credibility of such a “counter-discourse”, which in turn might be related to patterns of electoral competition. All in all, this brief survey of theoretical models should have made clear that a large number of highly stimulating approaches exists that deal with the questions of why and how nation states adjust to globalization in economic policy. What is more, these approaches do have a certain explanatory potential. At the same time, some weaknesses have also become evident. For example, the model of the political process which is at the heart of the influential contributions by Rogowski (1989) and Frieden (1991) is too simplistic. At times, other contributions fail to make entirely clear why specific explanatory variables have been chosen and – most importantly – why and when the preferences of decisive actors (particularly governing parties) change under the conditions of globalization. Therefore, in what follows I will briefly present my own model that tries to reduce the theoretical deficiencies observed in the existing literature.

3 Globalization and national adjustment: theoretical considerations The model2 presented here takes as a starting point that reforms, adjusting to external challenges, need to be adopted in the regular political process the logic of which is formally unchanged even under conditions of globalization. Therefore, it is obvious to start the theoretical considerations with the actors whose agreement is required for a change in the status quo, that is veto-players in George Tsebelis’ (2002) terminology. These actors must formally accept any reform adapting a country’s political economy to globalization – whatever the economic necessity or urgency of the reform. Therefore, veto-players are the most plausible starting point for modelling policy-making processes – under conditions of closed economies as well as under conditions of globalization. If globalization systematically induces national adjustment reforms which must be accepted by the veto-players, globalization must primarily influence vetoplayers’ preferences. Thus, it does not suffice to identify the actors whose agreement is necessary for a change of the status quo. It is also necessary to specify the conditions under which they will actually agree on a change of the status quo. In order to do so, veto-players’ preferences must be endogenized. Since veto-players in (European) OECD democracies are usually political parties, their preferences can best be modelled by using the findings of research on political parties. In the literature, two main aims of parties are distinguished (Müller and

Adjusting fiscal policy to globalization 47 Strøm 1999; Beyme 2000: 25f.): (1) policy pursuit and (2) vote-maximization.3 Since parties – as made clear in the introduction – succeeded in enacting policies in accordance with their ideological-programmatic orientation up until the 1980s (M. Schmidt 1996) and the hypotheses concerning the impact of globalization on fiscal policy explicitly argue that the vanishing of partisan differences since the 1980s is due to external challenges, that is parties are still willing to make a difference, but they are no longer able to do so (Kitschelt 2000). It can be assumed that parties still attempt to enact policies in accordance with their programmatic stance. The reforms which are discussed as adequate adjustments to the challenges of economic globalization necessitate more far-reaching programmatic revisions on the part of Social Democratic parties as compared with Liberal or Conservative parties (Huber and Stephens 1998; Iversen 2000; Hall 2002). A revision of the programmatic position of Social Democratic parties, however, can only be expected when a deterioration of the economic performance violates prominent programmatic goals of the parties and when Social Democrats believe that the economic problems are caused by the failure to adapt to the new context of the political economy. Thus, when traditional instruments fail to reach the programmatic goals and the Social Democratic parties believe that this is due to the failure to adjust to external challenges, a modification of the instruments is to be expected. The reforms aiming at an adjustment to external challenges may, however, violate other Social Democratic goals (e.g. redistribution). Therefore, a substantial deterioration of the economic performance will most likely be needed to initiate a revision of the programmatic position of the Social Democrats. By the same token, the reforms adopted by Social Democratic parties can be expected to be only moderate. In addition, Social Democrats will be seeking more eagerly than their contenders for alternative ways of adjustment. Those alternative “third ways” are supposed to allow coping with the external challenges without having to sacrifice other important policy goals. Carles Boix (1998) for example has argued that in an era of globalization Social Democratic parties might pursue the twin goals of economic growth and income equality not by redistribution and Keynesian demand management any more but by investment in human capital which would boost employees’ productivity and thus positively affect the primary income distribution. Thus, the following expectations can be formulated as partisan hypotheses: 1

2

3

Other things being equal, Social Democratic parties will adjust later and more moderately to globalization than bourgeois, particularly Liberal and Conservative parties because these policies more often than not necessitate a revision of traditional Social Democratic policy commitments. Ceteris paribus, Social Democratic parties are more likely to adopt adjustment reforms when the realization of important programmatic goals is endangered or the goals are already violated. Social Democratic parties will attempt to find alternative adjustment paths. Thus, at least small partisan differences are likely to continue to exist.

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Reforms impose transition-costs on voters, which tend to increase with the scale of the respective reform (Scharpf 2000b: 769). Thus, extensive reforms endanger the re-election of the current government. Therefore, party competition tends to prevent all parties from adopting far-reaching changes (Zohlnhöfer 2003a: 55). Furthermore, most of the adjustment reforms are likely to be unpopular among the voters. Note, however, that the voters’ evaluation of any given reform – and in turn its electoral risk – depends in part on the core societal values or “norms”, to use Schirm’s terminology.4 As was shown above, Conservative and Liberal parties do not need to revise their programmatic positions to the same extent as Social Democratic parties in order to adapt to globalization. On the other hand, liberal economic policies are even riskier for them than for traditional pro-welfare parties, particularly in the area of social policy. According to a “Nixon-goes-to-China” logic it could even be argued that Social Democratic parties have an easier time reforming the welfare state and curbing social spending (see Ross 2000; Zohlnhöfer forthcoming). Therefore, it can be assumed that even Liberal or Conservative parties hesitate to enact extensive changes. They will only dare to adopt far-reaching adjustment reforms when an economic crisis puts their re-election at risk that cannot be solved with incremental reform.5 Depending on the respective configuration of party competition, governing parties face rather different electoral consequences of far-reaching and/or unpopular reforms, which in turn will affect their willingness to adopt those reforms in the first place (see Kitschelt 2001, and Table 3.1). For example, if a government’s rivals in the electoral competition lack economic policy credibility, reforms are easier to enact than in a situation in which the opposition can credibly claim to be able to pursue successful economic policies without harmful cuts. At the same time, governments will try to minimize the electoral backlash of unpopular reforms, that is they will engage in the politics of blame avoidance (Weaver 1986). There are numerous blame avoidance strategies. For example, governments might produce some kind of political business cycle, that is implement unpopular reforms right after the election and adopt popular measures before the next. They might also design reforms in a way that obfuscates the unpopular parts or they may try to share the responsibility for unpopular reforms with the opposition or important interest groups (see Zohlnhöfer forthcoming). Finally, they might try to convince the voters of the necessity and appropriateness of the reforms in an elaborate political discourse, thus influencing public opinion (V. Schmidt 2002, 2005). If the government’s policies succeed in terms of economic performance as well as electoral appeal they may even force the opposition to modify its programmatic stance. Parties that have suffered electoral defeats which are perceived to have been caused by their own economic policy positions may be particularly eager to imitate the government’s economic policies. From these considerations the following hypotheses concerning party competition can be derived: 4

The adoption of far-reaching adjustment reforms is more likely to take place, other things being equal, when the economic performance deteriorates and puts the governing parties’ re-election at risk and the governing

Non-existent

Left-libertarian competitor

Source: Kitschelt 2001.

Denmark, Sweden

Examples

Great Britain

Above average

Chances to enact unpopular Large policies

Strong

Netherlands, Belgium

Below average

Weak

Medium

Very strong

Liberal party

Strong

Market-liberal/Conservative Market-liberal/Conservative Christian Democrats and party party Liberals

Configuration 4

Germany, France, Austria

Low

Strong

Weak

Christian Democrats/ paternalistic Conservatives

Libertarian vs. authoritarian Libertarian vs. authoritarian (Capital vs. labour still matters)

Main competitor of social democracy

Capital vs. labour (libertarian vs.authoritarian exists)

Configuration 3

Capital vs. labour

Configuration 2

Main cleavage

Configuration 1

Table 3.1 Configurations of electoral competition

50

5

6

Reimut Zohlnhöfer parties consider the reforms as reasonable reactions to the economic problems, that is they perceive that the deterioration of the economic performance is caused by the previous failure to adjust. The respective configurations of party systems influence the governing parties’ inclination to adopt extensive reforms. Adjustment reforms will be particularly unlikely in countries with two or more large pro-welfare state parties and only weak Liberal or Conservative parties. In contrast, unpopular reforms may be easier to realize in configurations with a strong marketliberal party and a Social Democratic party which lacks credibility as a defender of the welfare state (Kitschelt 2001). Parties will try to avoid an electoral backlash of unpopular reforms. If the political system or the system of interest intermediation allow, they will try to build “social pacts” with interest groups or try to make the opposition take over part of the responsibility. Moreover, governments will communicate the alleged inevitability and the normative appropriateness of the reforms.

Whether the parties in government can actually implement their reforms also depends on the respective country’s institutional setting, that is on the existence or otherwise of further institutional veto-players like second chambers who can veto or dilute legislation.6 If these institutional veto-players exist and behave policy-orientated (I would suggest calling them “cooperative veto-players”), a dilution or even a veto will occur, if the substance of the proposed reform is not preferred over the status quo by the institutional veto-player. What is more, if the institutional veto-player is controlled by an opposition party (I would suggest talking about “competitive veto-players” in this constellation), strategic considerations concerning the competition for votes may play an additional role. Therefore, in this constellation a reform attempt can fail even though all vetoplayers prefer it to the status quo in policy terms if at least one veto-player expects to improve his prospects for the next general election by a non-decision. Thus, two veto-player hypotheses can be put forward: 7

8

The larger the number of veto-players and – more importantly – the greater the distance among the veto-players in policy terms (in Tsebelis’ terminology: the smaller the congruence of the veto-players), the smaller the scale of the adjustment reforms will be. When an institutional veto-player is controlled by the opposition (“competitive veto-players”), adjustment reforms will only occur if all vetoplayers prefer the reform to the status quo and if none of the veto-players expects electoral advantages from a blockade.

4 Testing the theoretical model: explaining British and German fiscal policies since the 1980s In the following, the theoretical model just presented will be applied to explain fiscal policies in the United Kingdom and Germany since the 1980s. The neces-

Adjusting fiscal policy to globalization 51 sary variation in the partisan complexion of government is secured by changes of governments in both countries. Moreover, Germany and the UK vary sufficiently with respect to electoral competition and veto-player constellations to check the plausibility of the model. Before going into the case studies it is necessary to emphasize that different countries might be vulnerable to external challenges in different ways due to diverging welfare state regimes (EspingAndersen 1990) and national variations in their respective political economies (Hall 2002). Thus, even similar external challenges may lead to diverging problems and different adjustment reforms (Scharpf 2000a; Hemerijck and Schludi 2000). What is more, not all countries are integrated into the world economy to the same degree. This is also relevant for a comparison between Great Britain and Germany. World market integration – measured via the index of capital exchange controls (since 1979) and foreign trade as a percentage of GDP – was similar. Nevertheless, Great Britain differed markedly from Germany in that the UK displayed tremendous foreign economic policy problems over most of the post-war period which led to regular current account deficits and which culminated in 1976 when the Labour government had to apply for a bailout by the International Monetary Fund. Both countries also differed with regard to the main fiscal policy indicators, that is the tax ratio and total government expenditure as a share of GDP, at the beginning of the period of observation. The latter indicator averaged 42.8 per cent in the UK and 46.9 per cent in Germany in the years after the first oil price shock (1974–1979) (data from OECD 2001: 68). The development of the tax ratio was more volatile: in 1979, when Margaret Thatcher came to power, the British tax ratio stood at 32.2 per cent, much lower than the German one (37.1 per cent). When Helmut Kohl came to power in Germany three years later, the German tax ratio (36.8 per cent) was lower than the British one (39.1 per cent) (data from OECD 2004: 67). For the empirical analysis these differences do not pose a significant problem, however, because the theoretical model does not presuppose uniform starting conditions. Rather, these differences are taken into account in a “contextualized comparison” (Locke and Thelen 1995) which is based on a detailed “systematic process analysis” (Hall 2003) of the relevant policy-making processes. Moreover, the diverging starting conditions are of importance for the application of the model because they might induce an economic crisis earlier in one country than in the other which – according to hypotheses 2 and 4 – should trigger earlier adjustment reforms in the crisis-ridden country. 4.1 Fiscal policy in the United Kingdom, 1979–2005 The far-reaching transformation of the British political economy since the Conservatives under Margaret Thatcher came to power in 1979 also remarkably shaped fiscal policy: the statutory rates of direct taxes were cut massively in the 1980s and remained at an internationally competitive level ever since, while the steep increases of indirect taxes, a radical privatization programme and cuts in a

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number of expenditure programmes helped to reduce budget deficits and public debt. However, the changes in the area of budgetary policy were not as farreaching and sustainable and depended more on the partisan complexion of government than the changes in the field of taxation. How could this radical reform programme be enacted and stabilized? The partisan complexion of government did indeed massively influence the scope and timing of the reforms (hypothesis 1). The Conservatives enacted far-reaching tax reforms which were supposed to secure “that British business has the backing it needs to compete in world markets”, as John Major’s first Chancellor of the Exchequer, Norman Lamont (1993: col. 185), put it. Thus, the competitive pressures of globalization played an important role for these policies and they did so as early as the late 1970s when the Labour Party was still a far cry from accepting the necessity of this kind of reform. Labour only revised its economic policy positions fundamentally in the 1990s and even then (in line with hypothesis 3) some of its economic policy instruments differed from the Conservatives’ (see Zohlnhöfer 2006): In contrast to the days of Thatcher and Major, Tony Blair’s and Gordon Brown’s fiscal policies aimed at ameliorating the position of the least well-off members of society. Since Labour accepted the alleged imperatives of globalization, however, the instruments used to attain that goal focused on the supply-side of the economy. In accordance with Boix’s (1998) idea of a human capital investment strategy, the Blair government invested in education and emphasized the re-integration in the labour market by means of incentives to take up low paid jobs and an increase in employability. Redistribution was also on the agenda but it had to take a back seat because of the perceived restrictions of globalization. Electoral competition also played the expected role. In line with hypothesis 4, the programmatic shift in the Conservative Party in the 1970s has to be interpreted as a reaction to the Tory’s bitter election defeats in 1974 which were – at least in the view of the Tory’s right wing – caused by the Heath government’s failure in economic policy. The perceived economic policy disaster of the early 1970s thus gave rise to an electoral crisis which made Margaret Thatcher’s rise to the party leadership possible, who in turn saw radical reforms as a reasonable – actually as the only viable – reaction to the economic problems. The failure of Keynesian coordination under the Wilson and Callaghan administrations at the end of the 1970s, symbolized by the IMF bailout and the “winter of discontent” (see Scharpf 1987: 109ff.), finally facilitated Thatcher’s victory in the 1979 general election and even allowed her to credibly claim that there existed no alternative to her economic policies. In a similar way, the transformation of the Labour Party can be explained by the electoral and in certain areas also economic success of the Conservative policies. After 18 years in opposition, in view of a transformation of the British political economy that could not be reversed and given a seemingly high acceptance of the Conservatives’ economic reforms among the voters, the incentives for Labour to revise its economic policy positions were irresistible. Furthermore, in accordance with hypothesis 7, the adoption of comparatively radical reforms

Adjusting fiscal policy to globalization 53 was not impeded by veto-players, which hardly exist in the British political system. Resistance from within the governing parties, for example revolts of the “wets” in Thatcher’s first cabinet or back bench rebellions in the Blair years, did not exert much influence either due to the particularly high centralization of the decision-making processes in fiscal policy. Instead, electoral competition turned out to be the greatest obstacle for the implementation of far-reaching fiscal policy reforms for both governments. Nevertheless, party competition was much less intense in Britain than in Germany. In the 1980s and early 1990s, the Labour Party was seen as incompetent and not credible in fiscal policy by a large part of the electorate because of its economic policy failure in the late 1970s and its radical election manifesto of 1983. After 1997, the same is true for the Conservatives that have failed to build up a credible fiscal policy position until 2005. In line with hypothesis 5, this weakness of the respective opposition parties made the adoption of controversial reforms easier for British governments. Nevertheless, both parties still tried to avoid punishment for unpopular reforms by the voters (hypothesis 6). Since neither the option of collusion with the opposition nor of a pact with the social partners exists in the British context, the governments massively relied on three blame avoidance strategies (see Zohlnhöfer forthcoming): timing of popular and unpopular measures according to the idea of a political business cycle, policy design so as to obfuscate unpopular measures (e.g. failure to index benefits or tax allowances to inflation) and the use of a political discourse that was supposed to emphasize the necessity and appropriateness of the reforms in an era of integrated markets. 4.2 Fiscal policy adjustments to globalization in Germany Contrary to Great Britain, which was a leader with regard to cuts to direct taxes, Germany experienced only very moderate tax rate cuts in the 1980s and 1990s (for the following see Zohlnhöfer 2001, 2003b; Ganghof 2004). Only at the beginning of the twenty-first century were the top income tax rate and the corporation tax rate approaching the British levels. Nevertheless, it is worth noting that even though the German corporation tax rate of 25 per cent is below the British rate (30 per cent) since 2001, German corporations have to pay additional taxes (local business tax and solidarity surcharge). The total German business tax rate which takes into account all three taxes stands at around 39 per cent and is thus way above the British level (Sachverständigenrat 2005: 364). Therefore, a further reduction of the business taxes is still on the agenda. In contrast, the Kohl government succeeded in consolidating the budget, at least in the 1980s. After unification, however, both governments failed to reduce budget deficits significantly and sustainably – despite skyrocketing social security contributions and a privatization programme which parallels the British example in terms of its radicalism. Can the German reform path be explained by the theoretical model presented above? The fact that Germany saw tax cuts at all in the 1980s can be explained by the partisan complexion of the Federal government since the Social

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Democratic opposition fiercely opposed even the moderate cuts that were finally enacted. This finding is in line with hypothesis 1. But why didn’t the Kohl government adopt more far-reaching reforms? The main reason was electoral competition that impeded reforms in different ways. On the one hand, the CDU/CSU came to power with a rather moderate reform programme. The reasons for this lack of radical reform ideas are manifold. First, the deterioration of economic performance in Germany in the 1970s was much less severe than in pre-Thatcher Britain where a decade-old debate on “British decline” was going on. Second, the Christian Democrats believed that the deterioration of the economic situation was solely related to the government participation of the Social Democrats because when the CDU/CSU had lost power in 1969 the German economy was booming and unemployment was extremely low. Therefore, the Christian Democrats did not see the need to revise their own economic policy positions. Third, the defeats in four consecutive Federal elections failed to trigger a more radical economic policy programme because the defeats were not perceived to have been caused by the economic policy stance. Fourth, the CDU/CSU were not in the same way deprived of power as were the Conservatives in the UK since they were able to influence policies over the Bundesrat to an increasing degree in the 1970s. On the other hand, the economy went fairly well after the coming to power. Thus, the government did not see a need to radicalize their reforms prior to 1990. Therefore, the moderate German reform output corresponds with hypothesis 4. From the mid-1990s at the latest, economic performance began to deteriorate dramatically. This deterioration particularly impacted on tax policy. In the first years after unification, the government had tried to help economic recovery in East Germany by granting many new tax exemptions while tax rates remained high. This approach failed dramatically as the tax base eroded and tax progression decreased. Most relevant actors related this failure with the previous lack of adjustment to globalization while other countries had adapted in the form of tax cuts and base-broadening (Ganghof 2004: 74, 87). At the same time, the deterioration of economic performance put the Kohl government’s re-election at risk. Again in line with hypothesis 4, this led to a radicalization of the coalition’s fiscal policy reforms: tax rates were cut, welfare benefits curbed significantly and many state-owned enterprises were sold off. As far as these reforms needed the approval of the Bundesrat, (which made the Bundesrat a competitive vetoplayer since the SPD held the majority in the second chamber since 1991) the government had to make remarkable concessions to the opposition. The most important tax reform project, the tax reform 1997/98, was even completely blocked in the Bundesrat. The fact that a Social Democratic party diluted or even blocked more far-reaching adjustment reforms corresponds with the expectations of hypothesis 1 about partisan differences as well as hypothesis 7 and 8 on (competitive) veto-players. In a similar way we can explain the red–green coalition’s fiscal policy under Oskar Lafontaine which put particular emphasis on redistribution. The SPD had not suffered a sufficiently dramatic electoral crisis in the 1980s or 1990s to force it to revise its economic policy instruments.

Adjusting fiscal policy to globalization 55 Even though the Social Democrats had lost four consecutive Federal elections, they were remarkably successful at the sub-national (Länder) level which made it impossible to argue that the party’s economic policy programme was obsolete. It is more difficult to explain the policy change the red–green coalition itself implemented one year after it had come to power. Instead of focusing on redistribution, the new minister of finance, Hans Eichel, aimed at reducing tax rates to an internationally competitive level. To understand this policy pattern, the inner-party cohesion of the SPD and the agenda-setting position of the minister of finance have to be taken into account. Given the strong position of ministers in Germany, it made a large difference when Oskar Lafontaine, a traditional Keynesian, was replaced by the modernizer Hans Eichel.7 At least the modernizers in the SPD, which came to dominate fiscal policy after Lafontaine had resigned in early 1999, related the dismal German economic performance in the 1990s and particularly the persistently high unemployment which was seen by the SPD as the most pressing problem to the lack of fiscal policy adjustment to globalization. Therefore, these politicians perceived cuts to the top income and corporate tax rates as particularly urgent (hypothesis 2). Under the impression of the economic crisis that was unanimously perceived to be related to the challenges of globalization, the policy positions of the competing parties in tax policy thus converged. Nevertheless, the red–green coalition’s plans were less far-reaching than those of the bourgeois opposition, particularly regarding the top income tax rate (hypothesis 1), and the leftist government also chose policies that Christian Democrats and Liberals would not have picked, for example concerning the funding of the tax reform and concerning certain spending items like education (hypothesis 3). The fact that the top income tax rate was cut further than the red–green coalition had originally planned was due to a bourgeois Bundesrat majority. In this case, the increase in the number of veto-players led to a more far-reaching reform – in contrast to what hypothesis 7 would lead one to expect. In the area of budgetary policy that is much less constrained by globalization, cooperation between the parties was mostly absent. This finding is not at all surprising given Germany’s configuration of electoral competition and the country’s core societal norms among which equality plays a very important role (hypothesis 5). Cooperation between government and opposition (e.g. via the Bundesrat) failed to materialize in the area of budget consolidation due to the intense electoral competition. Thus, the government had to obfuscate its consolidation measures as far as possible (hypothesis 6), for example via dubious ad hoc cuts or the intensification of privatization efforts (see Zohlnhöfer forthcoming).

5 Conclusion The disappearance of party politics as a determinant of differences in OECD democracies’ fiscal policies is often related to growing economic globalization. However, in many of the relevant contributions, it remains unclear how globalization impacts on the national political processes. On the one hand, this is

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because most research focuses on the results of the adjustment while the adjustment processes are not considered. On the other hand, the existent theoretical approaches exhibit some deficiencies. For example, Rogowski’s and Frieden’s influential models of the political process can be criticized as simplistic, while the models of a second group fail to make entirely clear why specific explanatory variables have been chosen and how the preferences of decisive actors (particularly governing parties) change under conditions of globalization. Therefore, a new model of political adjustment to globalization was presented that builds on some of the earlier work. The model takes as a starting point the fact that reforms to adjust to the challenges of globalization still need to be adopted by national institutions. Therefore, the model starts from the actors with formal veto powers (mostly political parties) and models their preferences (policyseeking, vote-maximization). It is concluded that far-reaching reforms to adapt national political economies to globalization only occur in case of a significant deterioration of economic performance, coinciding with a previous failure to adjust to economic globalization, which threatens to jeopardize the electoral or programmatic goals of the political actors. In the last section, the model was briefly applied to analyse fiscal policies in Great Britain and Germany since the 1980s. It turned out that the model is indeed able to explain the respective policy processes. In both countries, centreright governments adopted the initial adjustment reforms against the fierce opposition of Social Democratic parties in the early 1980s (hypothesis 1). The fact that the reforms went much further in Britain than in Germany can be explained by the smaller economic problems in Germany at that time that generated fewer reform incentives via electoral competition (hypothesis 4). In addition, the configuration of electoral competition that makes unpopular reforms much more difficult in Germany than in Britain (hypothesis 5) as well as the larger number of veto-players in Germany particularly in the 1990s (hypotheses 7 and 8) helps to explain the much faster adoption of reforms in the United Kingdom. Social Democratic parties only accepted the alleged “imperatives” of globalization after having experienced remarkable crises. In the case of the Labour Party the numerous electoral defeats were perceived to be related to the party’s economic policy stance, particularly its “tax-and-spend-image”, while the modernizers in the SPD perceived Germany’s dismal economic performance to be caused by the previous failure to adjust (hypothesis 2). Therefore, the perception of economic challenges stemming from globalization in both cases led to a convergence of party position. Nevertheless, partisan differences are still existent, albeit smaller than before (hypothesis 3). It turns out that the Labour party was able to make a clearer difference on the expenditure side of the budget than the SPD, which could well be due to institutional as well as budgetary reasons. Of course, this brief overview cannot be taken as a serious test of the model of policy-making under conditions of economic globalization presented above. Nevertheless, the empirical evidence makes it seem worthwhile to engage in a more stringent test.

Adjusting fiscal policy to globalization 57

Notes 1 In addition, the foreign trade models which these contributions are based on (mostly the Heckscher–Ohlin or Ricardo–Viner approaches) are not beyond criticism since they only explain trade of commodities belonging to different sectors (inter-sectoral trade). Models explaining intra-sectoral trade (commodities belonging to the same sector are being traded), for example the model of monopolistic competition, cannot always identify winners and losers of trade ex ante (Feuerstein 1993: 289). This poses a problem for Rogowski and Frieden because in that case it is also impossible to determine supporters and opponents of adjustment reforms. 2 For a more extensive presentation of the model see Zohlnhöfer (2005). 3 Sometimes, three different aims of parties are discussed, namely policy pursuit, vote maximization and office seeking. For simplicity’s sake, in the following only policy pursuit and vote maximization will be discussed. This is justified because “vote maximizing parties and office maximizing parties cannot be differentiated meaningfully any more” (Beyme 2000: 25; my translation). 4 Norms can thus in principle impact on adjustment reforms. Nevertheless, it does not seem necessary to include them as an independent variable in the present model. First, norms are likely to be represented in institutional arrangements. This is particularly true for so-called “process norms” that deal with the inclusiveness of the political process (Schirm 2005: 831). Second, norms are reflected in the programmatic stances of the parties. Both variables, institutional arrangements and party competition, are included in the model. 5 It may even be the case that a party is voted out of office because of economic mismanagement before it realizes that the policy instruments it used were ineffective under the conditions of open markets. 6 Inner-party cohesion can also play a remarkable role. However, its effects are not always theoretically straightforward because they depend on the decision rules within the parties (see Zohlnhöfer 2003a). 7 Ganghof (2004) points to the important role constitutional questions played in the reform process, particularly the question of how much top income and corporation tax rate constitutionally would be allowed to differ. According to his interpretation the SPD would not have accepted the far-reaching cuts to the top income tax rate that were finally adopted had the constitutional restrictions been absent.

Bibliography Beyme, K. von (2000) Parteien im Wandel. Von den Volksparteien zu den professionalisierten Wählerparteien, Wiesbaden: Westdeutscher Verlag. Boix, C. (1998) Political Parties, Growth and Equality, Cambridge: Cambridge University Press. Cox, R.H. (2001) “The Social Construction of an Imperative. Why Welfare Reform Happened in Denmark and the Netherlands but not in Germany”, World Politics, 53: 463–98. Devereux, M.P., Griffith, R. and Klemm, A. (2002) “Corporate Income Tax Reforms and International Tax Competition”, Economic Policy, 17: 450–95. Esping-Andersen, G. (1990) The Three Worlds of Welfare Capitalism, Cambridge: Polity. Feuerstein, S. (1993) “Monopolistische Konkurrenz und intrasektoraler Außenhandel”, Wirtschaftswissenschaftliches Studium, 22: 286–90. Frieden, J.A. (1991) “Invested Interests: The Politics of National Economic Policies in a World of Global Finance”, International Organization, 45: 425–51. Frieden, J.A. and Rogowski, R. (1996) “The Impact of the International Economy on

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National Policies: An Analytical Overview”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 25–47. Ganghof, S. (2004) Wer regiert in der Steuerpolitik? Einkommensteuerreform zwischen internationalem Wettbewerb und nationalen Verteilungskonflikten, Frankfurt/New York: Campus. –––– (2005) “Konditionale Konvergenz. Ideen, Institutionen und Standortwettbewerb in der Steuerpolitik von EU- und OECD-Ländern”, Zeitschrift für Internationale Beziehungen, 12: 7–40. Garrett, G. and Lange, P. (1996) “Internationalization, Institutions and Political Change”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 48–75. Garrett, G. and Mitchell, D. (2001) “Globalization, Government Spending and Taxation in the OECD”, European Journal of Political Research, 39: 145–77. Hall, P.A. (2002) “The Comparative Political Economy of the ‘Third Way’”, in O. Schmidtke (ed.) The Third Way Transformation of Social Democracy, Aldershot: Ashgate: 31–58. –––– (2003) “Aligning Ontology and Methodology in Comparative Research”, in J. Mahoney and D. Rueschemeyer (eds) Comparative Historical Analysis in the Social Sciences, Cambridge: Cambridge University Press: 373–404. Hemerijck, A. and Schludi, M. (2000) “Sequences of Policy Failure and Effective Policy Responses”, in F.W. Scharpf and V.A. Schmidt (eds) Welfare and Work in the Open Economy. Vol. 1: From Vulnerability to Competitiveness, Oxford: Oxford University Press: 125–228. Huber, E. and Stephens, J.D. (1998) “Internationalization and the Social Democratic Model. Crisis and Future Prospects”, Comparative Political Studies, 31/3: 353–97. –––– (2001) Development and Crisis of the Welfare State. Parties and Policies in Global Markets, Chicago, IL: The University of Chicago Press. Iversen, T. (2000) “Decentralization, Monetarism, and the Social Democratic Welfare State”, in T. Iversen, J. Pontusson and D. Soskice (eds) Unions, Employers, and Central Banks. Macroeconomic Coordination and Institutional Change in Social Market Economies, Cambridge: Cambridge University Press: 205–31. Kitschelt, H. (2000) “Citizens, Politicians, and Party Cartellization: Political Representation and State Failure in Post-Industrial Democracies”, European Journal of Political Research, 37: 149–79. –––– (2001) “Partisan Competition and Welfare State Retrenchment. When do Politicians Choose Unpopular Policies?” in P. Pierson (ed.) The New Politics of the Welfare State, Oxford: Oxford University Press: 265–302. Kittel, B. and Obinger, H. (2003) “Political Parties, Institutions, and the Dynamics of Social Expenditure in Times of Austerity”, Journal of European Public Policy, 10: 20–45. Lamont, N. (1993) Budget Statement, in Parliamentary Debates House of Commons, 16 March 1993, 6th Series, Vol. 221, London: Her Majesty’s Stationary Office: col. 169–96. Locke, R. and Thelen, K. (1995) “Apples and Oranges Revisited: Contextualized Comparisons and the Study of Comparative Labor Politics”, Politics and Society, 23: 337–67. Müller, W.C. and Strøm, K. (eds) (1999) Policy, Office, or Votes? How Political Parties in Western Europe Make Hard Decisions, Cambridge: Cambridge University Press.

Adjusting fiscal policy to globalization 59 Obinger, H. and Zohlnhöfer, R. (forthcoming) “The Real Race to the Bottom: What Happened to Economic Affairs Expenditure after 1980”, in F.G. Castles (ed.) The Disappearing State? Cheltenham: Edward Elgar. OECD (2001) Historical Statistics 1970–2000, Paris: OECD. –––– (2004) Revenue Statistics 1965–2003, Paris: OECD. Rogowski, R. (1989) Commerce and Coalitions: How Trade Affects Domestic Political Alignments, Princeton, NJ: Princeton University Press. Ross, F. (2000) “‘Beyond Left and Right’: The New Partisan Politics of Welfare”, Governance, 13: 155–83. Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung (SVR) (2005) Die Chance nutzen – Reformen mutig voranbringen, Jahresgutachten 2005/06, Stuttgart: Metzler-Poeschel. Scharpf, F.W. (1987) Sozialdemokratische Krisenpolitik in Europa, Frankfurt/New York: Campus. –––– (2000a) “Economic Changes, Vulnerabilities, and Institutional Capabilities”, in F.W. Scharpf and V.A. Schmidt (eds) Welfare and Work in the Open Economy. Vol. 1: From Vulnerability to Competitiveness, Oxford: Oxford University Press: 21–124. –––– (2000b) “Institutions in Comparative Policy Research”, Comparative Political Studies, 33: 762–90. Schirm, S.A. (2002) “The Power of Institutions and Norms in Shaping National Answers to Globalisation: German Economic Policy after Unification”, German Politics, 11/3: 217–36. –––– (2004) Internationale Politische Ökonomie, Eine Einführung, Baden-Baden: Nomos. –––– (2005) “Der Einfluss von Interessen und Normen auf nationale Positionen zur Global Economic Governance”, Zeitschrift für Politikwissenschaft, 15: 825–47. Schmidt, M.G. (1996) “When Parties Matter: A Review of the Possibilities and Limits of Partisan Influence on Public Policy”, European Journal of Political Research, 30: 155–83. Schmidt, V.A. (2002) The Futures of European Capitalism, Oxford: Oxford University Press. –––– (2005) “The Role of Public Discourse in European Social Democratic Reform Projects”, European Integration Online Papers, 9/8. Online. Available eiop.or.at/eiop/ texte/2005–008a.htm (accessed 24 May 2006). Schulze, G.G. and Ursprung, H.W. (1999) “Globalisation of the Economy and the Nation State”, The World Economy, 22: 295–352. Schwartz, H. (2001) “Round up the Usual Suspects! Globalization, Domestic Politics, and Welfare State Change”, in P. Pierson (ed.) The New Politics of the Welfare State, Oxford: Oxford University Press: 17–44. Steinmo, S. and Swank, D. (2002) “The New Political Economy of Taxation in Advanced Capitalist Democracies”, American Journal of Political Science, 46: 642–55. Tsebelis, G. (2002) Veto Players: How Political Institutions Work, Princeton, NJ: Princeton University Press. Wagschal, U. (2005) Steuerpolitik und Steuerreformen im internationalen Vergleich. Eine Analyse der Ursachen und Blockaden, Münster: Lit Verlag. Weaver, R. Kent (1986) “The Politics of Blame Avoidance”, Journal of Public Policy, 6: 371–98. Zohlnhöfer, R. (2001) Die Wirtschaftspolitik der Ära Kohl, Opladen: Leske+Budrich. –––– (2003a): “Der Einfluss von Parteien und Institutionen auf die Staatstätigkeit”, in

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H. Obinger, U. Wagschal and B. Kittel (eds) Politische Ökonomie. Demokratie und wirtschaftliche Leistungsfähigkeit, Opladen: Leske+Budrich: 47–80. –––– (2003b) “Mehrfache Diskontinuitäten in der Finanzpolitik”, in A. Gohr and M. Seeleib-Kaiser (eds) Sozial- und Wirtschaftspolitik unter Rot-Grün, Wiesbaden: Westdeutscher Verlag: 63–85. –––– (2005) “Globalisierung der Wirtschaft und nationalstaatliche Anpassungsreaktionen. Theoretische Überlegungen”, Zeitschrift für Internationale Beziehungen, 12: 41–75. –––– (2006) “New Labours Finanz- und Wirtschaftspolitik: Sozialdemokratie durch die Hintertür?” in A. Kaiser and S. Berg (eds) New Labour und die Modernisierung Großbritanniens, Augsburg: Wißner: 13–43. –––– (forthcoming) “The Politics of Budget Consolidation in Britain and Germany: The Impact of Blame Avoidance Opportunities”, West European Politics. Zürn, M. (2002) “From Interdependence to Globalization”, in W. Carlsnaes, T. Risse and B.A. Simmons (eds) Handbook of International Relations, London: Sage: 235–54.

4

Taxation and cooperation International action against harmful tax competition Thomas Rixen

1 Introduction Under conditions of globalization, economic activities cross national borders. Meanwhile, the power to tax is bound to the nation state. Factors of production, most importantly capital, can move to those locations with the lowest tax burden. International factor mobility thus puts national tax systems under competitive pressure. Most research has perceived international tax competition as an independent variable that triggers certain consequences for the nation state. It focuses on national reactions to exogenously given competitive pressures. In particular, it has addressed the question of the nation state’s ability to pursue socially desirable policies under conditions of international tax competition. A common fear is that tax competition will constrain governments’ autonomy to design their fiscal policies according to the preferences of their electorates. Tax competition could lead to a “race to the bottom” of tax revenues and ultimately of social and environmental standards and policies. As will be shown in this chapter, these fears are partially warranted. On the one hand, an overall race to the bottom that has sapped the fiscal power of the state has not materialized until now. Total tax ratios, measuring tax revenue in proportion to national income, have remained stable. On the other hand, tax competition has become a serious constraint on national tax autonomy. While it did not incur a serious drop in total tax revenue, it does force governments to change the structure of their tax systems. As will be shown in this chapter, they had to adjust the ways in which they pursue and balance the central tax policy goals of equity and efficiency. Tax competition does restrict governments’ ability to pursue tax policy according to their own national preferences. One important source of competitive pressure derives from the possibilities of multinational enterprises to make use of international tax rate differentials without relocating real economic activity. Many countries, in particular socalled tax havens, bid for companies to incorporate subsidiaries on their territory that serve only or primarily as tax-saving vehicles. Such “mailbox companies” can, for example, be used to accumulate “paper profits”. The tax haven subsidiary, where no real economic activity takes place, is assigned a share of the company’s profit. The profit that has been generated somewhere else is subject

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to a zero or only nominal tax rate in the haven country. Besides corporations, wealthy individuals can also profit from the offers of tax havens, for example by keeping their assets in offshore savings accounts without informing their home countries. Since such practices impose constraints on national tax autonomy it should not come as a surprise that Organization for Economic Cooperation and Development (OECD) governments decided to fight them. In 1996, they initiated a project against “harmful” and “unfair” tax competition that is targeted against the “poaching” of other countries’ tax bases (OECD 1998). In fact, however, the initiative has surprised most observers of international tax policy. The folk wisdom in the field maintains that most countries guard their national tax sovereignty very jealously so that effective international cooperation is hard to establish. This is supposedly one of the reasons why the literature usually perceives tax competition as an independent variable. However, besides unilateral adaptations to exogenously given tax competition, countries can, in principle, also regulate that competition. The degree of tax autonomy loss is not exogenously given, but can be endogenously determined or at least cushioned if countries succeed in creating effective international rules that regulate or even curb tax competition. In this perspective, tax competition becomes a dependent variable. Even though there are already some international initiatives aiming at a regulation of tax competition, these have hardly been investigated by social scientists. This chapter therefore intends to undertake a theory-driven empirical analysis of the OECD project against harmful tax practices that was initiated in 1996. Before I come to this, the following section reviews the existing literature on tax competition. Section 3 will then present a simple game theoretic model of tax competition to derive hypotheses on the preconditions of successful tax cooperation, its expected development and potential conflicts of interest that will arise. These hypotheses will then be tested against the empirical record of the OECD project. Effective regulation of international tax competition will be shown to be both theoretically demanding and empirically difficult. The peculiar characteristics of tax competition make effective collective action difficult to establish. The OECD project does not reach its main goals. Nevertheless, some progress in the fight against unfair tax competition is made. Section 4 summarizes.

2 Existing research on tax competition Research on international tax competition is a booming academic business. The number of publications has skyrocketed in recent years and the debate has diversified into various strands.1 Most contributions come from economists aiming at the development of ever better theoretical models. But political science has also developed an interest in the issue. Here, I cannot give a comprehensive account of this body of literature. Instead, I will restrict myself to mapping the main lines of the debate. First, the standard models of tax competition are outlined (2.1). Subsequently, the main empirical insights into whether tax competition is a real

Taxation and cooperation 63 constraint on governments’ tax policy autonomy or not, and the prevailing arguments for both positions are summarized (2.2). Finally, I argue that one reaction of governments, that is attempts at international regulation of tax competition, has not received sufficient attention in research. The few existing contributions are presented (2.3). 2.1 Theories of tax competition Tax competition arises, if states use their tax policy strategically, in order to attract mobile economic goods and factors of production. The academic occupation with tax competition has its origin in theories of fiscal federalism. Tiebout (1956) developed a model in which tax competition leads to an efficient allocation of public goods. Like producers compete for consumers on (private) goods markets, jurisdictions are assumed to compete for mobile taxpayers. In a process of “voting with the feet”, taxpayers can chose among different packages of public goods in return for different tax levels. In equilibrium, they will end up in those jurisdictions where they receive their preferred quantity and quality of public goods. Everyone pays exactly the price corresponding to his or her demand of public services. Subsequently, most economists have argued that this model rests on assumptions that are too restrictive.2 Most importantly, it neglects the existence of “fiscal externalities”. In tax competition among small open economies, an increase of the tax burden on the mobile factor in one country will lead to an outflow of this factor and a corresponding inflow into other jurisdictions. A country’s tax policy creates externalities that have an effect on other countries. Since every government will only consider its own individual situation, which is ameliorated by the inflow, the existence of externalities creates incentives to lower the tax burden. The end result is a tax burden on mobile factors that is too low in all jurisdictions. Consequently, there will be an underprovision of public goods everywhere (Zodrow and Mieszkowski 1986; Wilson 1986). Today, this view of tax competition has become the standard model and has subsequently been extended by introducing further tax instruments. If governments may also tax the immobile factor, labour, then it is optimal for them to shift the entire tax burden from mobile capital to labour. In such models, the general result of an underprovision of public goods remains the same because the additional taxes on labour cannot make up the revenue lost from capital taxation. Competition spills over to labour taxation (Bucovetsky and Wilson 1991). As can be shown in various other model extensions (see Wilson 1999), this result can be generalized according to the “selection principle”. As long as the state concentrates only on the provision of those goods and services that cannot efficiently be produced on private markets, then a reintroduction of competition through the “backdoor” of “systems competition” among governments will necessarily decrease overall public welfare (Sinn 1997). The standard model thus predicts a “race to the bottom” in the provision of socially desired public goods. This can only be avoided if fiscal externalities were internalized through

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a complete harmonization of tax systems or a centralization of the power to tax at a supranational level. An important extension of the standard model concerns country size (in terms of population). If the assumption of identical country size is dropped, then it can be shown that small states can profit from tax competition. The intention of such models of “asymmetric tax competition” is that small states can gain a lot of foreign capital relative to their population by a reduction of taxes, while large states have relatively little to win, but a lot of capital to lose. Thus, the theoretical expectation is that small countries will lower their taxes more than large ones. Small states can “win” tax competition; their welfare increases in relation to a situation without tax competition. However this is accompanied by a welfare loss in large countries, which is larger than the gain of the small ones (Bucovetsky 1991; Wilson 1991; see also Dehejia and Genschel 1999). This model can explain why basically all tax havens in the world are small. Becoming a tax haven is only attractive for small countries. In contrast to these welfare economic models of detrimental tax competition, there are political economy models in which tax competition is beneficial. According to the “public choice” school, governments do not pursue the correction of market failures and the maximization of national welfare but rather maximize tax revenue. In “Leviathan” models, tax competition has positive effects since it limits politicians’ discretion to distribute inefficient rents to particularistic interest groups. Overall, there will be an efficiency-increasing curtailment of the public sector, which is seen to be in the public interest (Brennan and Buchanan 1980). Subsequently, various models taking an intermediate position between the welfare economic position and the public choice view were developed. In these models it is assumed that, on the one hand, competition may induce a government to a better orientation at general public interest. On the other hand, the existence of fiscal externalities in the welfare-theoretic sense, making perfectly efficient equilibriums impossible, is also considered. Ultimately, there is a trade-off between both effects of tax competition; the evaluation depends on the relative weight accorded to each (Edwards and Keen 1996; Persson and Tabellini 2000: 305–37). In summary, it shows that the evaluation of tax competition is dependent on the assumptions one makes about preferences pursued by governments. Irrespective of that, however, all models predict a decrease in tax burdens for mobile tax bases with a relatively higher burden on immobile factors.3 2.2 The empirical record of tax competition The question is how far these theoretical expectations hold in reality. Although there is general agreement on the empirical development of tax policy, the opinions on how far this is caused by tax competition vary widely. First, it is undisputed that since the end of the 1970s and the middle of the 1980s the nominal tax rates were lowered. From 1975 to 2005 the tax rate on corporate income of OECD countries fell on average from around 50 per cent to around 30 per cent,

Taxation and cooperation 65 the top personal income tax rate from almost 70 per cent to below 50 per cent (Ganghof 2006a: chapter 1). However the nominal rates on their own hold no information about effective tax burdens. These can only be assessed if the rates are considered in relation to the tax base. And indeed, the effective marginal tax burdens remained almost unchanged. Almost all countries have pursued a policy of lowering the nominal rates but simultaneously broadening the tax base (“tax cut cum base broadening”). According to Steinmo and Swank (2002: 643f.), the effective marginal rate on capital on average only decreased from 38 per cent in 1981 to 36 per cent in 1995. Marginal effective labour taxation rose from 36 per cent to 40 per cent in the same period. Thus, there was no “absolute convergence” to a very low or even zero level of taxation as the hypotheses of a general race to the bottom would lead one to expect. Nevertheless, moving beyond averages, the distribution of effective tax rates across countries exhibits a pattern of “relative convergence”. The variance in the distribution of tax rates has decreased (Hays 2003). Different explanations for this empirical pattern have been put forward in the literature. Since the effective tax burden on capital has not gone down, some authors argue that tax competition did not have any effect on national tax policy formation (Steinmo 2003; Garrett and Mitchell 2001). During the 1980s, they argue, governments came to learn that policies of combining high nominal rates with selective saving and investment incentives were inefficient. Such attempts to manipulate saving and investment, leading to a quite narrow tax base, had been used to pursue various distributive and allocative goals. Due to a “paradigm shift” from “equity” to “efficiency”, policymakers increasingly focused on the divergent tax burdens in different sectors of the economy that resulted from the selective incentives. These came to be viewed as harmful distortions in the allocation of capital. The abolition of the selective incentives, that is the general broadening of the tax base that should be accompanied by lowering the rates, was viewed as the best reaction to the problem. This move was seen to be a “market-conforming” policy. Thus, in this interpretation, the observed tax reforms are not caused by pressures from tax competition, but are the result of responses to internal challenges. The international diffusion of the idea of market-conforming taxation since the 1986 US tax reform – and not the external challenge of tax competition – can explain the relative convergence of effective tax rates (Steinmo 2003; Steinmo and Swank 2002). This is a correct portrayal of the political rhetoric of tax reforms in recent years. However, there is evidence that it is at best an incomplete explanation of tax policy developments. First, it is not true that a policy of “tax cut cum base broadening” is the only “market-conforming” reform that is available to policymakers. Rather, it can be shown that another option is to levy a high tax on “pure profits” and to exempt the “normal return” on capital. Pure profits are those returns that lie above the return for an alternative risk-free investment (e.g. government bonds), whereas the normal return to capital is just that regular rate of return (see e.g. Slemrod and Bakija 2004: 203f.). Normal returns should remain tax-free, whereas pure profits should be subjected to tax. The advantage

66 Thomas Rixen of such a system is that, under closed economy conditions, taxing away pure profits does not cause any misallocation of capital. In contrast to that, taxing normal returns distorts investment decisions. It is therefore desirable to tax pure profits at high rates and exempt normal returns from taxation (Przeworski and Wallerstein 1988). Such a differentiation is also desirable under an equity perspective, since pure profits often consist of windfall gains, whereas the normal return of capital only represents a saver’s willingness to postpone current consumption. Under closed economy conditions the differential tax treatment of these two kinds of capital income is an equally efficient alternative to a policy of “tax cuts cum base broadening”. While both systems are market-conforming, the first allows for a progressive rate structure whereas the latter does not (for a more detailed account of this see Ganghof 2006b). One could understand the original system of high nominal rates coupled with selective incentives for saving and investment as attempts to approximate, albeit very imperfectly, a system of a differentiated tax treatment of pure profits and normal returns. Thus, if the observed tax reforms were really motivated by a “paradigm shift” towards efficiency only, then the tax cut cum base broadening approach would not have been the only possible reform. Rather, we should (also) have seen political efforts to further develop a differential treatment of different kinds of capital income, for example in the form of “cash-flow taxes” that have for a long time been discussed as the most desirable reform of capital taxation. Since there was no country that adopted the alternative path, the actual development of tax policy cannot solely be attributed to the diffusion of the ideal of market-conforming taxation (Ganghof 2006a; 2006b; Haufler and Schjelderup 2000: 306f.). One plausible explanation points towards the influence of international tax competition. First of all, if we take into account that under open economy conditions countries don’t compete for marginal investments but for discrete investment objects, for example from multinational enterprises, then the effective marginal tax rates, which remained constant, are not the decisive factor. Rather, since the investor will invest in the specific location where he can realize the highest after tax rate of return for the entire object, the effective average tax rate becomes the relevant indicator.4 Since average tax rates have indeed decreased since the 1980s this is a first hint at a possible influence of tax competition on the observed tax reforms (see Devereux and Griffith 2003). To the extent that investment decisions in reality are of a discrete nature, governments cannot enforce differential tax treatment of pure profits and normal returns on international investors. This can be further substantiated if we, second, take into account that nominal tax rates are more important in practice than the sceptics of tax competition assume. By means of different techniques, such as the manipulation of internal transfer prices or debt instead of equity financing, multinational enterprises can shift their profits to low-tax countries and assign their losses to high-tax countries, without moving their real investment location (for an overview of such techniques, see Gresik 2001). It has been shown that such

Taxation and cooperation 67 “profit shifting” plays an important role in the tax planning strategies of multinational enterprises (Hines 1999; Bartelsman and Beetsma 2003). For highly profitable enterprises, whose gains are made up to a large extent of pure profits, the decision to shift income will depend on nominal tax rates (Haufler and Schjelderup 2000), which are equal to effective rates for pure profits. Thus, profit shifting creates competitive pressures to lower nominal rates. If we further acknowledge that many governments cannot afford to forgo tax revenue due to existing budget deficits and the demands of their electorate, the decrease in nominal rates has to be financed by broadening the tax base. Even if that is to the disadvantage of less profitable and less mobile firms (Devereux et al. 2002: 483).5 Third, the sceptics of tax competition ignore an important aspect of the distribution of tax rates across countries. Small countries have lower tax rates and have reduced them further than big countries (see e.g. Sorensen 2000). Corporation tax rates are correlated significantly to country size. Thus, country size is a good explanatory variable for the absence of absolute and the presence of relative convergence, which is the pattern predicted by the model of asymmetric tax competition (Ganghof 2006b). Finally, it can also be confirmed that the tax burden on labour relative to capital has increased since the mid-1980s (Winner 2005: 681f.). In conclusion, there are good reasons in support of the notion that tax competition, even though it has not yet led to a general race to the bottom, is a reality. While the international diffusion of ideas about market-conforming tax reforms may have played a complementary role, there are very strong arguments for the case that tax competition has been an important driver behind observed national tax reforms in the 1980s and 90s. In addition to these contributions that try to locate reasons for the (non-) convergence of tax systems at the international level, there are also contributions focusing on the national level. This body of literature starts from the observation that all policy reactions to actual or perceived competitive pressures have to pass through the regular domestic democratic process (see also Chapter 3). The general idea is that there are clear incentives for governments to engage in tax competition, but the race to the bottom has not materialized because institutional and political conditions in the countries made a change of the status quo impossible or difficult. Basinger and Hallerberg (1998) show that only those countries with at most one institutional veto-player carried out tax reforms, whereas countries with more than one veto-player did not cut their taxes. Subsequently, they have refined this model, so that national reactions are not only determined by the institutional and political configuration within the country but also by the respective constellations in competitor countries (Basinger and Hallerberg 2004). Wagschal (1999), who constructs a tax reform indicator that represents the frequency and extent of tax reforms in OECD countries, obtains similar results. Tax reform activity is lower in those countries with a smaller number of veto-players. Hays (2003) investigates the role of different parliamentary systems. According to his regression results, a tax cut can be more easily instituted in capital-rich majority democracies than in capital-poor consensus

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democracies. Some of these results have been criticized. Ganghof (2006a: chapter 8) shows that, if country size is included, the veto-player variable will not have any explanatory power for the variance of corporate tax rates. This is different with respect to personal income taxation, where he finds a significant relation between the number of veto-players and the extent of tax cuts. Overall, empirical research shows that there was no general race to the bottom. Nonetheless, tax competition presents a relevant constraint on the autonomy of governments to set their tax policy as they wish. In particular, governments compete for the location decisions of highly profitable multinational enterprises and the assignment of profits from these companies. It has further been shown that the challenges differ from country to country. Small countries can profit from tax competition by becoming tax havens, while large countries are vulnerable to competitive pressures. In addition, national institutions mediate the effects of tax competition. This may explain divergent national adjustment paths. However, the causal influence attributed to these factors is subject to debate. 2.3 Tax competition and international cooperation An assumption made in the entire literature presented so far, is that states accept tax competition to be an unalterable fact. Only national reactions to tax competition, treated as exogenously given, are analysed. This view neglects the possibility of states regulating international tax competition by means of international cooperation. States cannot only react unilaterally to tax competition, but they also set the rules of the tax competition game. How far tax competition restricts tax policy autonomy is not determined exogenously but can be endogenously influenced by governments. And indeed, governments do undertake efforts to regulate tax competition. Besides the OECD project against harmful tax competition, to which I will turn in the following, there are also initiatives within the European Union. Apart from the directive on interest taxation (European Community 2003), in force since 2005, there is also a “code of conduct for business taxation” (European Community 1998). Both the EU’s code of conduct and the efforts of the OECD are concerned with so-called harmful and unfair tax competition. They aim at abolishing tax practices designed to poach foreign tax bases. As we saw above, such tax regimes can be accessed by multinational enterprises through “profit shifting”. The respective national policies are considered to be harmful and unfair because they do not require taxation to be linked to any real economic activity that should be the legitimate basis of taxation. Since the respective regimes create much of the competitive pressure on the tax systems of OECD states, it is reasonable for governments to target precisely these practices by trying to establish international rules against them (see Devereux et al. 2002: 453, 473ff.). In the existing literature, however, only very few authors argue in favour of a regulation of tax competition. In economics there are a handful of authors in the German “ordo-liberal” tradition discussing the need and possible content of a

Taxation and cooperation 69 framework of rules for tax competition (see e.g. Kerber and Vanberg 1995; Vanberg 2000). However these contributions are of an entirely conceptual nature. They refer to the conditions of tax competition in purely theoretical terms and abstract from existing institutional conditions and material chances of implementing such policies. The existing empirically orientated analyses of international tax cooperation come from political scientists and deal with tax harmonization within the European Union (see Genschel 2002; Radaelli 1997). The efforts to introduce a common withholding tax on interest income were unsuccessful at first because of the diverging interests of small and big member states. As has been explained above, small countries can profit from tax competition. Therefore, agreeing on cooperation amounts to solving an asymmetric prisoners’ dilemma or even deadlock game. An additional problem making agreement difficult is the fact that there are many tax havens outside the European Union. As long as it is possible for flight capital to move to locations outside the European Union, an agreement of member states alone will be more or less ineffective (Bernauer 2000: 215–59). Despite these difficulties, a directive on interest taxation was finally agreed upon. With her slightly modified model of an “asymmetric dilemma”, which refined existing explanations and allows for the possibility of side payments, Holzinger (2005) explains this result.

3 An analysis of cooperation against harmful tax competition in the OECD The approaches just sketched have successfully used game theory to derive statements about the chances of cooperation from the strategic structure of the issue area under discussion. With such an approach, the difficulties but also the chances of establishing cooperation against harmful tax competition can be represented in a stylized fashion. The game-theoretical treatment enables the analyst to examine the implications of various interest constellations and structural conditions for the development of cooperation or conflict among actors. Intentional individual action is linked to a certain situation structure derived from the respective policy area. In constructing the game, individual preferences are usually derived from theory and then treated as exogenously given. Precisely this often-criticized simplicity is one of the major strengths of game theory because it enables us to concentrate on the most important characteristics of the situation and to arrive at potentially generalizable statements (Scharpf 1997: 36–50; Snidal 1985: 44). But the existing research has exclusively focused on the European Union. Therefore, I will in the following attempt a game-theoretic treatment of the OECD project against harmful tax competition.6 Such an analysis is missing so far. Webb (2004) employs a constructivist approach. Other authors are not interested in a theory-driven investigation but focus on a description of the politics surrounding the project (Kudrle 2003; Thomas 2002). Thus, the game-theoretic analysis can complement and improve our understanding of this particular attempt of regulating tax competition.

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3.1 A simple model and four hypotheses I will proceed in a deductive fashion. I will first collect the insights of gametheoretical accounts of tax competition to construct a very simple model of the tax cooperation game. I intentionally keep the model simple and use a purely economic definition of governments’ interests. This rudimentary model allows me to specify theoretical expectations about the initiation, the institutional form and the development of cooperation against harmful tax competition. Subsequently, the actual empirical record of the OECD project against harmful tax competition is presented, in order to assess the explanatory power of the model (3.2). The standard models of tax competition tell us that governments would be collectively better off if they avoided tax competition. But an individual country can be even better off if everybody else cooperated and it did not. There are, however, individual incentives to deviate from the cooperative solution. So far the situation of tax competition is similar to that of the well-known prisoners’ dilemma. In addition, the incentives of small and large countries diverge. Small states can win tax competition and thus prefer unregulated competition to common cooperation. For them, the situation is a deadlock game. Overall, the strategic structure is that of an asymmetric dilemma between big countries with prisoners’ dilemma preferences and small countries with deadlock preferences.7 The following 2 ⫻ 2 matrix (see Table 4.1) depicts the strategic structure. As can be seen in the matrix, the situation of regulated tax competition that would result from common cooperation (C/C) is collectively preferred over the status quo of common defection. However, the individually rational and dominant strategy is to defect. The equilibrium solution of the one-shot game is (D/D), the collectively worst outcome. In order to employ the game for the analysis of real-life attempts at establishing cooperation, it has to be conceptualized as a repeated game, since governments are in long-term interactions with each other. According to the “Folk Theorem” in repeated games any result, including the cooperative one, can be stabilized as equilibrium.8 But even in a repeated game the cooperative solution is not self-enforcing, since there is an individual incentive for all countries to deviate from the cooperative solution in any round of the game. Consequently, the general theoretical expectation is that establishing cooperation will be very difficult. This leads to the following hypothesis: Table 4.1 Tax competition as asymmetric dilemma Small country

Big country

Cooperate (C) Defect (D)

Cooperate (C)

Defect (D)

4/2 5/0

0/5 1/3

Taxation and cooperation 71 1 The establishment of effective cooperation is unlikely. The probability of regulatory attempts to fail is high. This general statement about the difficulty of initiating cooperation can be developed further. In reality, there are not only two but many countries. This complicates cooperation even further. Those states not joining the cooperative venture can exploit the other states. Under the assumption that capital is perfectly mobile the defection of a single country could frustrate the other actors’ cooperative efforts. If only one country would not abstain from offering unfair tax privileges to taxpayers, the total amount of internationally mobile capital would immediately flow to that country. In order to avoid this, the group of cooperators would thus have to cover all states of the world. While the assumption of perfect capital mobility is exaggerated, it is certainly not very far off the mark with respect to competition for financial services and portfolio investments. These are precisely the kinds of investment flows the OECD project focuses on. Therefore it is justified to assume that the group of states that can successfully cooperate without being exploited by outsiders would consist of almost all states of the world. It is thus not to be expected that a “minilateral” coalition can successfully initiate the fight against tax competition (Genschel and Plümper 1997: 635ff.).9 Rather, the group of cooperators must be encompassing: 2 Efforts to cooperate must be multilateral. The fact that small countries can benefit from tax competition by becoming tax havens leads to the following prediction concerning the constellation of interests: 3 The main cleavage will be between small countries (tax havens) and big countries. Efforts to regulate tax competition, if they will be pursued at all, will be initiated and promoted by big countries. Small states will try to stay outside of any cooperative venture. Consequently, the prospects for successful cooperation are not bright at all. There is no individual incentive for small states to enter into an agreement to regulate or curb tax competition. At the same time, since cooperation will necessarily have to be multilateral, their cooperation is required. From the perspective of game theory the small states are clearly in the stronger position. Nevertheless, establishing cooperation is not impossible. The cooperative solution would become attractive for small countries, if they were compensated for their observance of the rules against harmful competition. As has been shown above, the gain realized by small states in tax competition is smaller than the loss incurred on big countries. Thus, successful regulation of tax competition should bring enough additional gain for big countries to compensate the small ones. There is room for side payments that would make everybody better off.

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The cooperative solution would internalize the external costs that tax havens impose on big countries. In order to realize this Coase (1960) solution, the parties have to engage in bargaining. In the example of the above game, the collectively best result would be attainable if the big country made a side payment of 1 to the small country. Both players would realize a pay-off of 3. Because of the side payment the small country would be willing to forgo the strategy of defection.10 From the necessity of side payments we can derive the following hypothesis: 4 The winners of cooperation will employ side payments to compensate the losers. However, it is not possible to predict more precisely the type of side payments that will be used. Several kinds are plausible. They could also be mixed. For one, it is conceivable that big countries will actually use the additional gains from successful cooperation to compensate small states. They could also try to pressure small states into cooperation by threatening negative sanctions. The side payments could also be employed across different policy fields (“issue linkage”). This would in general open up a bigger space for bargained solutions. Finally, one could also imagine an indirect compensation, which consists of the big states making concessions on the scope of the regulations to be implemented.11 In order to test these hypotheses, the following subsection outlines the empirical record of the OECD project. 3.2 The OECD project against harmful tax competition In 1996 the G-7 ministers of finance decided to launch an initiative against harmful tax competition. They mandated the OECD to propose effective measures against the negative effects of unfair tax practices (Owens 1998: 230). The OECD came up with several suggestions that were published in a report entitled “Harmful Tax Competition: An Emerging Global Issue” (OECD 1998). Right from the start the focus within this project has been limited to unfair competition for highly mobile activities such as financial service centres or portfolio investments. The OECD made it clear that the project was not about tax competition on real direct investment. Such competition is not necessarily considered as bad and a country should remain free to deliberately design its own tax rates. Conventional tax systems with low rates that are granted equally to all taxpayers are not targeted by the report (OECD 1998: para. 40f.). Rather, the project aims at “unfair” tax practices that are defined as attempts to “poach” the tax base of other countries. Poaching is defined to be the intentional design of a country’s tax system in order to frustrate the application and enforcement of another country’s tax laws (OECD 1998: 29ff.). The OECD differentiates between two types of unfair tax practices. First, a tax haven is a country that offers itself to non-residents in order to evade or avoid taxation in the home country. The decisive criterion for a tax haven is that it offers tax shelter without requiring any substantial economic activity to take

Taxation and cooperation 73 place in the country. If a country’s tax law makes it possible to book certain transactions in the country for tax purposes, despite the fact that they do not create an adequate added value, then this criterion is met. So-called mailbox companies are the generic types of such an avoidance scheme. Another important characteristic of a tax haven is that it is unwilling to exchange information with home countries (OECD 1998: paras 29, 52). A second unfair tax practice is to offer so-called “preferential tax regimes” to foreign investors that are not available to domestic investors (OECD 1998: para. 57ff.). There is positive discrimination on behalf of foreign investors in that they are treated more favourably than domestic taxpayers. Through this “ring-fencing“ the high-tax countries try to protect themselves from the negative revenue implications of general rate cuts, but at the same time try to compete against tax havens for foreign capital. This attempt at self-protection indicates, according to the OECD, that preferential tax regimes are unfair to other countries. By raising the issue of preferential tax regimes the OECD targets its own members (OECD 1998: para. 57ff.). With these definitions of harmful tax practices the OECD project is aimed at precisely those kinds of regimes that are to a large extent responsible for the competitive pressures that governments experience, as we have seen in section 2. The goal of the project was to get commitments from countries to remove the harmful features of their national tax systems and to make effective information exchange possible. In order to reach that goal the OECD pursued a “naming and shaming” approach (Eden and Kudrle 2005: 122). It developed and published a blacklist of 35 tax havens (OECD 2000: para. 17) asking them to formally commit to removing the harmful features from their tax systems. The OECD threatened to implement “defensive measures” in the form of more restrictive tax treatment of foreign investments if the tax havens would not be willing to submit to the demands (OECD 1998: para. 85ff.). Likewise, 47 preferential tax regimes in OECD member countries were listed that should be evaluated and removed in a process of peer reviews (OECD 2000: para. 11). The OECD emphasizes the importance of an approach that is inclusive of all countries. In particular the defensive measures should be implemented collectively. Only such an encompassing approach could ensure that fighting harmful practices will not be harmful to the cooperators themselves. The fear is that the tax bases would flow to those countries that are unwilling to make commitments (see e.g. OECD 1998: para. 138). The listed tax havens objected to the policy pursued by the OECD, decrying it as an undue interference into their national tax sovereignty. They argued that western industrialized countries had originally advised them, through institutions like the International Monetary Fund (IMF) and the World Bank, to specialize in offering financial services. Now that they had developed a strong financial sector, the very same countries were planning to take it away from them. In addition, they complained about the lopsidedness of the approach. While OECD member countries were not threatened with any countermeasures if they didn’t comply, they were (Easson 2004: 1062ff.). In 2001, the United States joined the tax havens in some of their criticisms. The Clinton administration had been one of the initiators and most ambitious supporters of the project.

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But the newly elected Bush government altered that policy. In a newspaper article Finance Minister O’Neill argued that the USA did not want to interfere with the tax sovereignty of other countries. Instead of trying to force tax havens to change their tax systems, the project should focus only on the exchange of information. “In its current form, the project is too broad and it is not in line with this Administration’s tax and economic priorities” (O’Neill 2001). Libertarian interest groups had played an important role in the government’s policy change. Among them, the group “Freedom and Prosperity”, sponsored by the Heritage Foundation, had been particularly active. This small “think tank” succeeded in positioning its critique in the media (see e.g. Mitchell 2000) and raising public interest for the OECD’s plans. After the US intervention, the approach becomes less confrontational. While the OECD does not withdraw the blacklists, it assures tax havens that it will not implement defensive measures until all OECD countries have removed the identified preferential regimes from their tax systems (OECD 2001: para. 32). Thus, the tax havens do not have to fear defensive measures as long as OECD members like Switzerland and Luxembourg – which abstained from the project, but were blacklisted – still employed their preferential regimes. The less antagonistic approach is also evidenced by the creation of the “Global Forum on International Taxation”, in which both OECD member countries and tax havens discuss the further development of the project (OECD 2004b). Tax havens that declare their intention to cooperate with the demands are offered technical, administrative and financial help in the restructuring of their tax systems by OECD countries, the World Bank and other International Organizations (OECD 2001: para. 44ff.). Despite the change to a less confrontational approach, the (now limited) demands against tax havens were held up. They are still required to change their national laws and administrative practices so that access to financial information is granted (OECD 2004a: para. 29ff.). Despite their criticism, most of the tax havens give in to the demands of the OECD. Only a handful of countries still refuse to cooperate. In 2004, only five uncooperative tax havens were left: Andorra, Liechtenstein, Liberia, Monaco and Marshall Islands (OECD 2004a: para. 27). The big majority declared that they would progressively allow for more effective exchange of information. In the future, this will be implemented through specific bilateral agreements on information exchange. These treaties should follow a model agreement that was developed within the Global Forum (OECD 2002). The information exchange will be on request, but the agreements will take precedence over possibly existing bank secrecy provisions (OECD 2004a: para. 24). A few agreements of this type have already been concluded and several are currently negotiated (OECD 2005: para. 16). With respect to preferential tax regimes of member countries, 45 of the initially identified 47 could be removed from the blacklist.12 The remaining two preferential tax regimes, one in Switzerland, the other in Luxembourg (OECD 2004a: para. 15), cause problems, since the countries are not willing to remove them. So far, their status remains unclear. Officially, they need to be further investigated (Easson 2004: 1074).

Taxation and cooperation 75 3.3 Assessment of the model Overall, the simple model of cooperation as an asymmetric dilemma can explain essential features of the OECD project against harmful tax practices. First of all, it is indeed very difficult to establish cooperation and come to an agreement on the regulation of harmful tax practices. Countries engage in confrontational bargaining, which does not lead to the institutionalization of an effective and enforceable arrangement (hypothesis 1). Instead, the OECD installs a process of peer reviews hoping to achieve progress through legally non-binding “naming and shaming”. Governments try to act within a broad multilateral framework so that cooperating actors cannot be exploited (hypothesis 2). It is interesting to note that the OECD explicitly uses the same reasoning for the necessity of a multilateral approach that underlies the model. Apparently, the project’s designers have used the asymmetric dilemma game as the blueprint for action (see Owens 1998). As stated above, the model cannot predict which kind of side payment will be employed. Clearly, all three kinds can be observed (hypothesis 4). The tax havens are offered technical and administrative assistance (positive side payment). Due to US intervention there are concessions on the scope of the project. But the tax havens are also successful in pushing through more favourable treatment in that they manage to make their own commitments dependent on OECD countries’ commitments to abolish preferential tax regimes (indirect compensation). Finally, the OECD also employs threats to sanction non-cooperation (“defensive measures”). The expected cleavage between big and small countries can clearly be observed (hypothesis 3). The main conflict is between small tax havens and big OECD countries. However, the diverging interests of big and small countries can only partially explain their actual willingness to cooperate. The model predicts a higher willingness to cooperate of big countries than of small countries. In reality, however, most small tax havens declare their intention to cooperate with OECD demands rather early on. It proves to be more difficult, in contrast to the model’s predictions, to get a firm commitment from the big country USA. On the other hand, in conformity with the model, there are also small countries such as Switzerland and Luxembourg trying to refuse cooperation. This is particularly interesting since these are small countries and tax havens within the OECD. While most small non-OECD members submit to the demands, the small members are resilient.

4 Conclusion Overall, the success of the OECD project against harmful tax practices is limited. Concerning multinational enterprises’ tax optimization strategies, responsible for a major share of competitive pressures on countries’ tax systems, there is basically no progress at all. Tax havens remain free to offer tax shelters to corporate taxpayers. The increased requirements for transparency and information exchange cannot remedy that. A multinational’s tax optimization is

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not reliant on confidentiality in the haven country. On the contrary, they would rather demand transparency themselves in order to preempt potential suspicions that they were involved in any illegal transactions. Concerning tax evasion and avoidance of individual taxpayers the project achieved better results. While it is too early to come to a final judgement on the effectiveness of the bilateral information exchange agreements, the very fact that tax havens had to give in to demands is a progress over the status quo. Tax havens’ acceptance of information exchange may have a deterrent effect on taxpayers already.13 The very limited progress achieved is in accord with the general hypothesis of the asymmetric dilemma model that it is difficult to establish successful cooperation against harmful tax competition. Nevertheless, there are also a few aspects that this model cannot explain. One major deviation from theoretical expectations is the behaviour of the US government. According to the model this big country should not have any interest to hollow out the initiative. The reason for nevertheless doing so can be found on the domestic level. After the change of government business lobbies could more easily make their opposition to the OECD project heard (Kudrle 2003: 69). Such a capture of government by special interest groups points to the need to extend the model by integrating domestic level politics (see Putnam 1988). Further, the model does not predict commitments from tax havens to be extracted so easily. An obvious explanation for this deviation could be the power differentials between OECD members and non-members. In any case, the fact that Switzerland and Luxembourg react differently to non-OECD tax havens makes such an explanation plausible. The behaviour of tax havens within the OECD shows that the model does correctly predict the interests of small tax havens. However, this interest is not the only factor affecting their actual (un-) willingness to cooperate. This is also determined by power differentials. Another interesting aspect is small countries’ success at extracting concessions from OECD countries. The empirical material suggests that they were able to do so because they accused the OECD of double standards. While tax havens were threatened with sanctions, OECD members with preferential tax regimes were not. The successful usage of this normative argument suggests that certain conceptions of legitimacy – and not only power and interest politics – had an influence on the policy process and outcome. Despite these explanatory gaps – resulting from the purely economic definition of interests – the very simple model presented here can explain surprisingly many of the observed features of the OECD initiative against harmful tax practices. In addition to that, as these last tentative remarks illustrate, it also has informative content with respect to those aspects that it cannot account for. It invites speculation about potential alternative or complimentary explanations and thus provides guidance to further research. The asymmetric dilemma model is a very good starting point for a better understanding of international cooperation against tax competition.

Taxation and cooperation 77

Notes 1 Very good overviews on the most important contributions are presented by Oates (1999; 2001), Wilson (1999) and Haufler (2001). 2 For example, Tiebout assumed lump-sum taxes. Thus, the redistribution of income through progressive taxation would be impossible by definition. In contrast to that, in this chapter the term “public good” includes socially desired redistributions. 3 Even if I do not deal with them here, it should be noted that there is a third group of models in which, due to agglomeration effects, the existence of high transportation costs or other market imperfections, the race to the bottom does not result. An overview of such models is contained in Wildasin and Wilson (2004). 4 In the models presented above investors can break down their investments into infinitesimal parts. Thus, every part of the invested sum will earn the going market rate of return. Accordingly, it will be taxed at the effective marginal tax rate. Under this assumption, the average tax rate would not be the relevant indicator. 5 Especially for newly established enterprises, which are not yet profitable, the old system with high saving and investment incentives would be advantageous. In contrast, the tax cut cum base broadening policy privileges “old” capital. 6 This is part of a project the author is currently undertaking. For first results and a more detailed development of the theoretical model and the empirics, see Rixen (2005). 7 This is basically the same strategic structure that is proposed by Holzinger (2005). For more on the generic preference orderings and interest constellations such as “deadlock”, “assurance” or “prisoners’ dilemma”, see Scharpf (1997: chapter 4). For a detailed derivation and discussion of countries’ preferences in tax competition, see Rixen (2005: 7–31). 8 Due to the deadlock preferences of the small country this is only true if we allow for the possibility of side payments, that is the big state would have to buy the small state out of its defection. They have to come to a bargaining solution. In technical terms, we move from uncooperative to cooperative game theory. The difference between the two is precisely the fact that side payments are possible in cooperative game theory (see Scharpf 1997: 116–50). 9 Such games can best be depicted in so-called Schelling (1978: 213–25) diagrams. For the case at hand, such diagrams are contained in Rixen (2005: 11f.). 10 The numbers used here are purely hypothetical. What exactly the solution would be depends on various factors such as bargaining power or the existence of focal points and so on. 11 Strictly speaking, such indirect compensation is not a side payment because it leads to efficiency losses. By downsizing the object of cooperation the solution is interior to the Pareto frontier. 12 Eighteen preferential tax regimes were abolished, 14 were changed so that they are now considered acceptable, and in the case of 13 regimes the conclusion was that they were not harmful after all (OECD 2004a: para. 12). It has been questioned whether countries have really abolished their preferential tax regimes, or rather have only rearranged them slightly in order to get OECD approval (see Webb 2004: 815f.). 13 There appears to have been a significant reduction in offshore business in some havens. For example, Dominica’s last offshore bank has been closed. The number of offshore banks in Antigua has dropped from 60 four years ago to 15 today. The Bahamas are said to have lost a quarter of its banks (Easson 2004: 1065, who cites sources from the region as evidence).

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Bibliography Bartelsman, E.J. and Beetsma, R.M.W.J. (2003) “Why Pay More? Corporate Tax Avoidance through Transfer Pricing in OECD Countries”, Journal of Public Economics, 87: 2225–52. Basinger, S.J. and Hallerberg, M. (1998) “Internationalization and Changes in Tax Policy in OECD Countries. The Importance of Domestic Veto-players”, Comparative Political Studies, 31/3: 321–52. –––– “Remodeling the Competition for Capital: How Domestic Politics Erases the Race to the Bottom”, American Political Science Review, 98/2: 261–76. Bernauer, T. (2000) Staaten im Weltmarkt. Zur Handlungsfähigkeit von Staaten trotz wirtschaftlicher Globalisierung, Opladen: Leske+Budrich. Brennan, G. and Buchanan, J.M. (1980) The Power to Tax. Analytical Foundations of a Fiscal Constitution, Cambridge: Cambridge University Press. Bucovetsky, S. (1991) “Asymmetric Tax Competition”, Journal of Urban Economics, 30: 167–81. Bucovetsky, S. and Wilson, J.D. (1991) “Tax Competition with Two Instruments”, Regional Science and Urban Economics, 96: 329–41. Coase, R.H. (1960) “The Problem of Social Cost”, The Journal of Law & Economics, 3: 1–44. Dehejia, V.H. and Genschel, P. (1999) “Tax Competition in the European Union”, Politics & Society, 27/3: 403–30. Devereux, M.P. and Griffith, R. (2003) “Evaluating Tax Policy for Location Decisions”, International Tax and Public Finance 10: 107–26. Devereux, M.P., Griffith, R. and Klemm, A. (2002) “Corporate Income Tax Reforms and International Tax Competition”, Economic Policy, 17: 451–95. Easson, A. (2004) “Harmful Tax Competition: An Evaluation of the OECD Initiative”, Tax Notes International, 34: 1037–77. Eden, L. and Kudrle, R.T. (2005) “Tax Havens: Renegade States in the International Tax Regime”, Law & Policy, 27/1: 100–27. Edwards, J. and Keen, M. (1996) “Tax Competition and Leviathan”, European Economic Review, 40: 113–34. European Community (1998) “Conclusion of the ECOFIN Council Meeting on 1 December 1997 concerning Taxation Policy – Resolution of the Council and the Representatives of the Governments of the Member States on a Code of Conduct for Business Taxation – Taxation of Savings”, Official Journal, C 2: 2–5. –––– (2003) “Council Directive 2003/48/EC of 3 June 2003 on Taxation of Savings Income in the Form of Interest Payments”, Official Journal, L 157: 38–48. Ganghof, S. (2006a) The Politics of Income Taxation. A Comparative Analysis of Advanced Industrial Countries, Colchester: ECPR Press. –––– (2006b) “The Politics of Tax Structure”, Working Paper, 06/1, Cologne: Max Planck Institute for the Study of Societies. Online. Available www.mpi-fg-koeln. mpg.de/pu/workpap/wp06–1/wp06–1.html#ueber1 (accessed 27 March 2006). Garrett, G. and Mitchell, D. (2001) “Globalization, Government Spending and Taxation in the OECD”, European Journal of Political Research, 39: 145–77. Genschel, P. (2002). Steuerharmonisierung und Steuerwettbewerb in der Europäischen Union, Frankfurt: Campus. Genschel, P. and Plümper, T. (1997) “Regulatory Competition and International Cooperation”, Journal of European Public Policy, 4/4: 626–42.

Taxation and cooperation 79 Gresik, T.A. (2001) “The Taxing Task of Taxing Transnationals”, Journal of Economic Literature, 39/3: 800–38. Haufler, A. (2001) Taxation in a Global Economy, Cambridge: Cambridge University Press. Haufler, A. and Schjelderup, G. (2000) “Corporate Tax Systems and Cross Country Profit Shifting”, Oxford Economic Papers, 52: 306–25. Hays, J.C. (2003) “Globalization and Capital Taxation in Consensus and Majoritarian Democracies”, World Politics, 56/1: 79–113. Hines, J.R. (1999) “Lessons from Behavioural Responses to International Taxation”, National Tax Journal 52/2: 305–22. Holzinger, K. (2005) “Tax Competition and Tax Cooperation in the EU. The Case of Savings Taxation”, Rationality and Society, 17/4: 475–510. Kerber, W. and Vanberg, V. (1995) “Competition Among Institutions: Evolution within Constraints”, in L. Gerken (ed.) Competition Among Institutions, New York: St. Martin’s Press: 35–64. Kudrle, R.T. (2003) “Hegemony Strikes Out: The U.S. Global Role in Antitrust, Tax Evasion, and Illegal Immigration”, International Studies Perspectives, 4/1: 52–71. Mitchell, D.J. (2000) “OECD War on Low-tax Countries”, Washington Times, 20 August 20: B1. Oates, W.E. (1999) “An Essay on Fiscal Federalism”, Journal of Economic Literature, 37: 1120–49. –––– (2001) “Fiscal Competition or Harmonization? Some Reflections”, National Tax Journal, 54/3: 507–12. OECD (1998) Harmful Tax Competition. An Emerging Global Issue. Online. Available /www.oecd.org/dataoecd/33/0/1904176.pdf (accessed 11 January 2006). –––– (2000) Towards Global Tax Co-operation: Report to the 2000 Ministerial Council Meeting and Recommendations by the Committee on Fiscal Affairs: Progress in Identifying and Eliminating Harmful Tax Practices. Online. Available www.oecd.org/dataoecd/ 9/61/2090192.pdf (accessed 7 December 2005). –––– (2001) The OECD’s Project on Harmful Tax Practices: The 2001 Progress Report. Online. Available www.oecd.org/dataoecd/60/ 28/2664438.pdf (accessed 7 December 2005). –––– (2002) Agreement on Exchange of Information on Tax Matters. Online. Available www.oecd.org/dataoecd/15/43/2082215.pdf (accessed 7 December 2005). –––– (2004a) The OECD’s Project on Harmful Tax Practices: The 2004 Progress Report. Online. Available www.oecd.org/dataoecd/60/ 33/30901115.pdf (accessed 7 December 2005). –––– (2004b) A Process for Achieving a Global Playing Field. Global Forum on Taxation. Online. Available www.oecd.org/dataoecd/13/0 /31967501.pdf (accessed 7 December 2005). –––– (2005) Progress Towards a Level Playing Field: Outcomes of the OECD Global Forum on Taxation, Melbourne, 15–16 November. Online. Available www.oecd.org/ dataoecd/28/55/35670025.pdf (accessed 7 December 2005). O’Neill, P. (2001) “Confronting OECD’s Notions on Taxation”, Washington Times, 10 May 2001: A 15. Owens, J. (1998) “Curbing Harmful Tax Competition – Recommendations by the Committee on Fiscal Affairs”, Intertax, 26/8–9: 230–34. Persson, T. and Tabellini, G. (2000) Political Economics. Explaining Economic Policy, Cambridge, MA: MIT Press.

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Przeworski, A. and Wallerstein, M. (1988) “Structural Dependence of the State on Capital”, American Political Science Review, 82/1: 11–29. Putnam, R.D. (1988) “Diplomacy and Domestic Politics: The Logic of Two-Level Games”, International Organization, 42/3: 427–60. Radaelli, C.M. (1997) The Politics of Corporate Taxation in the European Union. Knowledge and International Policy Agendas, London: Routledge. Rixen, T. (2005) “Internationale Kooperation im asymmetrischen Gefangenendilemma: Das OECD Projekt gegen schädlichen Steuerwettbewerb”, Discussion Paper, 12, Wien: Wirtschaftsuniversität Wien. Online. Available www2.wu-wien.ac.at/taxlaw/ sfb/Working_Papers/workingpaper12.pdf (accessed 5 January 2006). Scharpf, F.W. (1997) Games Real Actors Play. Actor-centered Institutionalism in Policy Research, Boulder, CO: Westview. Schelling, T.C. (1978) Micromotives and Macrobehaviour, New York: Norton. Sinn, H.W. (1997) “The Selection Principle and Market Failure in Systems Competition”, Journal of Public Economics, 66: 247–74. Slemrod, J. and Bakija, J. (2004) Taxing Ourselves. A Citizen’s Guide to the Great Debate Over Tax Reform, Cambridge: MIT Press. Snidal, D. (1985) “The Game Theory of International Politics”, World Politics, 38/1: 25–57. Sorensen, P.B. (2000) “The Case for International Tax Co-ordination Reconsidered”, Economic Policy, 31: 429–72. Steinmo, S. (2003) “The Evolution of Policy Ideas: Tax Policy in the 20th Century”, British Journal of Politics and International Relations, 5/2: 206–36. Steinmo, S. and Swank, D. (2002) “The New Political Economy of Taxation in Advanced Capitalist Democracies”, American Journal of Political Science, 46/3: 642–55. Thomas, K.P. (2002) “The Politics of an Emergent Global Regime for Controlling Tax Competition”, Policy Studies Journal, 30: 270–84. Tiebout, C.M. (1956) “A Pure Theory of Public Expenditures”, Journal of Political Economy, 65: 416–24. Vanberg, V. (2000) “Globalization, Democracy, and Citizens’ Sovereignty: Can Competition Among Governments Enhance Democracy?”, Constitutional Political Economy, 11: 87–112. Wagschal, U. (1999) “Blockieren Vetospieler Steuerreformen?”, Politische Vierteljahresschrift, 40/4: 628–40. Webb, M.C. (2004) “Defining the Boundaries of Legitimate State Practice. Norms, Transnational Actors and the OECD’s Project on Harmful Tax Competition”, Review of International Political Economy, 11/4: 787–827. Wildasin, D.E and Wilson, J.D. (2004) “Capital Tax Competition: Bane or Boon”, Journal of Public Economics, 88/6: 1065–91. Wilson, J.D. (1986) “A Theory of Interregional Tax Competition”, Journal of Urban Economics, 19: 296–315. –––– (1991) “Tax Competition with Interregional Differences in Factor Endowments”, Regional Science and Urban Economics, 21: 423–51. –––– (1999) “Theories of Tax Competition”, National Tax Journal, 52/2: 269–304. Winner, H. (2005) “Has Tax Competition Emerged in OECD Countries? Evidence from Panel Data”, International Tax and Public Finance, 12: 667–87. Zodrow, G.R. and Mieszkowski, P. (1986) “Pigou, Tiebout, Property Taxation, and the Underprovision of Local Public Goods”, Journal of Urban Economics, 19: 356–70.

5

Money and power Markets and governance in international monetary policy Hubert Zimmermann

1 The current currency gamble In May 2005, the former US secretary of state, Henry Kissinger, was sent as an unofficial envoy to the PR China by the Bush administration. The message he reportedly conveyed was unusual: the American government urged Chinese authorities to revalue their currency by at least 10 per cent (Balls 2005). Looming in the background was the threat of protectionist legislation in the American Congress which had got increasingly restive about the enormous trade deficit the US was running with China for years. Embattled sectors of the American industry claimed that Beijing pegged its currency to the Dollar at an artificially low level and that this represented an unfair competitive advantage for Chinese exports. The trade deficit resulted in rapidly increasing foreign exchange reserves in China, most of them held in Dollar-denominated bonds. In March 2006, these amounted to more than $875 bn (The Economist 22 April 2006). And China was not the only country to accumulate a massive amount of Dollar assets. Its reserves were surpassed by those of Japan (up to $900 bn), and even Taiwan and South Korea both held more than $200 bn (Gimbel 2005). What worried observers about these enormous amounts held by Asian central banks was the possibility that these countries would start to diversify their reserves, triggering a contagious sell-off by private and official investors with the result of a rapid fall in the value of the Dollar (ECB 2006; Roubini and Setser 2004). This prospect has not only sparked intense debate among specialists and journalists; it has also induced the leading countries to expand the role of the International Monetary Fund (IMF) by giving it an official mandate to negotiate a solution to global imbalances (Giles and Guha 2006). One core element in many worst-case scenarios is that most of the Asian reserves are held in US treasuries, financing both the unprecedented American current account deficit and the huge budget deficit created by the economic policies of the Bush administration. A Dollar crash would force up American interest rates, making borrowing for the US government and consumers more expensive, with the possible result of a recession. In addition, export industries in Asia and Europe, the main engines of growth in these regions, would be strongly hit by a falling Dollar. Faced with this prospect, leaders of European

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countries have called for more state-guided governance in the international monetary system to regulate adjustment processes and control capital markets. Kenneth Rogoff, the former chief economist of the IMF, wrote: “If we don’t see any coordinated response on this one, it won’t bode well for global financial governance over the next decade.”1 Some analysts have advocated institutionalized coordination among the G-2, that is, the United States and the Eurozone (Bergsten 2005). However, the US and the United Kingdom, the main promoters of unregulated capital markets, would see none of that, arguing, like many economists, that market forces will correct any unsustainable imbalances over time, that current regulatory frameworks are sufficient and that state intervention would be counterproductive. At the moment of this writing (May 2006), US deficits and Dollar accumulation abroad both continue, despite a small Renmimbi revaluation in July 2005. This situation poses three interconnected sets of questions that form the core of the debate in the International Political Economy (IPE) on international monetary policy: 1) What are the requirements and chances for global governance in international monetary markets? Can international institutions, such as the IMF, play an effective and legitimate role in regulating global currency markets? 2) What is the role of private actors in currency markets and their governance? How will they react to the imbalances? 3) Who rules in monetary markets? Are states still capable of exerting authority? Who has monetary power? This chapter sums up the results of the most recent, theoretically informed research on these questions. It outlines the current debate on the relationship of states and markets in international finance and on the forms and prospects for international governance in this area. It then proceeds to discuss the question of monetary power using the debate about the US current account deficit as an empirical example. It will be argued that states remain the decisive actors in international monetary affairs and that the autonomy of state actors to pursue international and domestic preferences (which can be geopolitical, economic or electoral) is the main characteristic of monetary power. The main focus of this chapter will be on the politics of global currencies. Other aspects of financial globalization, such as the regulation of financial intermediaries, bond markets, rating agencies, global debt and so on, will be mentioned only briefly.

2 The state of the debate The liberalization of global financial markets is one of the most conspicuous results of economic globalization. Foreign exchange trading is now de-coupled from its traditional purpose of financing global trade. Its volume dwarfs the sums used for trade in goods and services. Direct investments, portfolio investments and foreign exchange transactions have exploded over the past 30 years (Aliber 2002: 60). The sheer size of these market forces seems to easily eclipse the impact of any possible intervention by central banks or governments. The volatility of capital has led many analysts to question whether states can still execute all the expansive tasks and fulfill all the commitments which they

Money and power 83 assumed during the twentieth century and which came to define the contemporary meaning of statehood.2 Already in 1969, Kindleberger quipped that “the nation-state is just about through as economic unit” (1969: 207). In one of her last books, Susan Strange, one of the pioneers in this field, claimed that states had retreated from the governance of financial markets, leaving a vacuum of authority (Strange 1996). Is there still any role for the “political” in the IPE of global monetary phenomena? Has the de facto legal sovereignty of states over the creation and regulation of international money been undermined by a loss in de facto autonomy (Bryant 2003: 205)? This debate on the role of the state and of politics in international monetary relations is probably the defining question among those IPE scholars dealing with monetary issues. However, the idea that states might not be the masters of the monetary game any more, and probably not even the decisive players, is of relatively recent vintage. Until the late 1970s most research on international monetary policy was clearly state-centric. In fact, states clearly determined outcomes in the international financial arena in the nineteenth and most of the twentieth century, although, as Helleiner (2004: 154–5) notes, the spread of mass-based democratic policies after the First World War forced decision-makers to accommodate domestic interest groups and ended the clear subordination of domestic to international objectives that had characterized the gold standard of the nineteenth century (Gallarotti 1995). The state-managed system of fixed-but-adjustable exchange rates that emerged in the Western World after 1945 preserved the dominant role of state actors, though more attention had to be paid to domestic actors trying to influence monetary policy-making, in particular central banks and internationally operating firms. The underlying objective of the postwar monetary system, usually termed the Bretton Woods System,3 was, in Ruggie’s widely accepted formulation, to permit “embedded liberalism”: the liberalization of international trade while at the same time preserving state autonomy in choosing domestic economic policies, most of them employing variants of Keynesian demand-side strategies (Hall 1989). This was guaranteed by capital controls whereas stability in international trade was to be achieved through stable exchange rates (Ruggie 1982). The Dollar became the globally accepted reserve currency, bolstered by the dominance of the US economy, the depth of its financial markets, and a pledge by the American government to back the Dollar with US gold reserves. Most advanced economies pegged their currencies to the Dollar. These pegs turned out to be highly beneficial for those countries. Many rapidly regained their competitiveness and profited from an over-valued Dollar. The multilateral control of currency markets obliterated the need for wideranging adjustment measures and gave most states a relatively high measure of autonomy regarding the impact of international exchange rate movements. However, the progressive liberalization of capital markets during the 1960s and 1970s made the pursuit of both stable exchange rates and such state autonomy difficult to achieve. The concept of the so-called “impossible trinity” (Oatley 2004: 273–6) is the standard explanation for this and it became the core reference point for most current theorizing on international monetary relations.

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The “impossible trinity” states that of the three fundamental state goals of macro-economic policy autonomy, free capital markets and fixed exchange rates, only two can be implemented at the same time.4 In particular, flexible exchange rates and open capital markets decisively curtail the space for autonomous fiscal policies by governments (Pauly 1997: 24). When currency markets became more volatile in the 1970s and 1980s, states had to either adjust their macro-economic policy to market expectations in order to stabilize the exchange rate or to give up their currency pegs and accept floating exchange rates. This second option was chosen by most industrial states since they privileged policy autonomy over the established rules. The causes for the progressive liberalization of capital markets and the breakdown of the fixed exchange rate system are still being debated. Helleiner (1994) identified state actors, in particular the United States and the United Kingdom, as the prime movers because they profited most due to their large financial markets. Similarly, Cerny (1995) argued that state efforts to render their economies more competitive exerted a powerful pressure towards the deregulation of capital. Others point to the role of markets and technology. The so-called EuroDollar market, a primarily London-based market, which allowed US firms access to foreign capital at a time of increasing restrictions in the US, became synonymous with the new power of non-state actors. In an influential article, David Andrews (1994) emphasized that capital mobility, caused by shifts in technology, market practice and national policy, became a structural variable, limiting decisively the autonomy of states in economic policy-making. Harris (2004) argues that the rising finance industries had the determining influence in forcing states to accept the new rules that were benefiting these industries. A third prominent explanation is the role of ideas towards which the constructivist turn in IR and IPE has steered many authors. McNamara (1998) claims that the emergence of a neo-liberal consensus, which stressed the superior efficiency of markets in the allocation of economic decisions, was instrumental in the acceptance of flexible exchange rates and the emergence of the euro, reflecting the successful anti-inflationary benchmark set by the German Bundesbank. In a recent article, Wesley Widmaier stressed the social construction of the “impossible trinity”: the postwar breakdown of interlocking wage, price, and currency guidelines cannot be reduced to such material trends as hegemonic decline, capital mobility, interdependence or technological changes [. . .] Far more significant were inter-subjective changes, not the least of which was the intensified Neoclassical redefinition of Keynesianism which obscured any common interests in state or societal cooperation to reconcile capital mobility, monetary stability, and policy autonomy. (2004: 449) In the same vein, Kirshner claimed that one of the main tenets of the “second Washington consensus” (Blyth and Spruyt 2003),5 the conception of low

Money and power 85 inflation, market liberalization and privatization as prerequisites for economic welfare, is based on self-reinforcing beliefs rather than unambiguous choices based on economic theory (Kirshner 2003). A similar argument from a different vantage point is offered by critical theorists using the Gramscian notion of hegemony, with a focus on the ideological leadership of global financial centres (Cafruny 2005). The debate on why states began to lose control over monetary markets is still ongoing and likely to be continued by historians. Whether it was the cause or the result of the switch to floating exchange rates, a new monetary orthodoxy, embodied in the second Washington Consensus, became the dominant ideology in international monetary relations. This new orthodoxy claims that macro-economic stability, liberalization of trade and capital markets and privatization are the path to growth and prosperity. Bretton Woods-style state intervention in currency markets was seen as counter-productive, costly and leading to the perpetuation of bad economic practice. Among the core institutional expressions of these ideas was central bank independence which was to lock in the anti-inflationary bias of neoclassical economics (Maxfield 1998; Thies 2004). Numerous authors have shown how these ideas became embedded in the reformed Bretton Woods Institutions, for example in the conditionality of IMF loans (e.g. Grabel 2003). The Washington Consensus still underpins the thinking of the most important actors in global finance. However, it is under sharp attack since the Mexican Peso crisis of 1994, the Asian financial crisis of 1997/1998, and the Argentinian debt default in 2001. Critical analysts assert that this orthodoxy benefits solely internationally mobile capital in the search of rapid gains at a relatively low risk, since tax payers bear the cost of adjustment necessitated by rampant speculation (Soederberg 2002). The new majority view, however, is that the causes for the crises are to be found in deficient domestic institutions. Thus, both the IMF and the World Bank increasingly take into account the prescriptions of institutional economics (Santiso 2004). Despite the anti-statist bias of the new monetary orthodoxy, the allegedly self-correcting forces of the market did not remove the need for states to intervene in foreign exchange markets – in fact, the volume of interventions increased vastly. Particularly the 1970s were characterized by monetary instability. The turmoil on the markets sparked a debate about the necessity for a provider for collective goods (or, in monetary terms, a lender of last resort) to overcome the dilemma of collective action in monetary relations. In other words, the question was whether the existence of a hegemon is a condition for functioning monetary markets or not. Hegemons, according to hegemonic stability theory, had allowed the development and persistence of working regimes benefiting all participants (Keohane 1984). As the United States perceived itself in decline during the 1970s, it abandoned its role as a stabilizer and monetary markets plunged into chaos. European monetary integration has been another phenomenon interpreted in this vein. According to Chang (2004), Germany’s role as a benevolent hegemon was essential in the creation of a monetary union. A similar argument is put forward by Kaelberer (2001), who argues that Germany, though not a traditional hegemon, exerted the dominant influence

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in setting the parameters of monetary integration because of the strength of its currency. Hegemonic stability theory has been attacked on theoretical and empirical grounds. Recent historical research has shown how the attempt, to reverse the negative American trade balance and to support sectoral interests, in particular agriculture, against the competition of the EC, became a driving force of the American decision to abandon the Bretton Woods System. Far from reflecting hegemonic decline, the continued pre-eminence of the Dollar due to the absence of alternative reserve assets gave Washington the leeway to change the rules of the game (Zimmermann forthcoming). The recent German flouting of the rules of the Stability and Growth Pact, which had been superimposed on European Monetary Union on German insistence, and the cool reaction of monetary markets also suggest that a responsible hegemon might not be an essential condition for a working monetary system. The reasons for the irresponsible behaviour of hegemons rarely result from pressures in the international system (which is the explanatory level used by the adherents of hegemonic stability theory). In effect, a system based on pegged exchange rates will require states to link their monetary policies at least to some degree to the rules governing the system; once this evaporates, the system will sooner or later disintegrate. And this can happen when states, particularly hegemonic states, see their domestic autonomy unduly constrained and/or domestic actors lobby successfully for a change in external monetary policies. This observation has led to research asserting the primacy of domestic factors in the formulation of aggregate monetary preferences. Frieden (1994, 2002) emphasized the decisive role of domestic sectoral interests in shaping monetary choices. He distinguished among import-competing producers, export-orientated producers, non-traded goods producers and the financial services industry. These groups have differing preferences regarding the desired level of the exchange rate and the volatility of the currency. Export-orientated and import-competing industries both prefer a weak currency; however, the former strongly support exchange rate stability whereas the latter are indifferent towards floating exchange rates. Exchange rate stability is also the preference of the financial services industries. Non-tradable goods producers tend to favour a strong currency because it lowers the price they have to pay for imported goods. Thus, capital flow and exchange rate changes have an asymmetric impact on various domestic interests and the response of states will be tailored to the groups with the most effective influence on governments and central banks. Frieden’s model is parsimonious and analytically rigorous; however, it cannot answer the question of whether the institutional system provides all actors with the same access. Furthermore, societal interests traditionally have relatively limited access to decisions on monetary matters, other than on trade. Even if they convince policy-makers of their views, it is far from clear whether these would have the autonomous capacity (or will) to act accordingly. The question of access to monetary policy-making by domestic actors has been dealt with in a comparative institutionalist study of monetary policy in

Money and power 87 Germany, Japan and the United States by C. Randall Henning (1994). He argued that private preferences depend on the closeness of links between the banks and the industry in a given country, with a high degree of closeness leading to a preference for a competitively valued, stable currency (Henning 1994: 6). Such a close relationship also leads to strong influence on the monetary decisions of governments since the private sector will represent a united and coherent front. This is the case in Germany and Japan, with the result that both favoured a competitively valued currency as preferred by concentrated domestic industries. There are no such close ties between banks and industry in the US. Thus, policymakers received conflicting signals and the Federal Reserve was oblivious to flexible exchange rates (Henning 1994: 329). This was a major reason why the United States was not interested in the creation of a new monetary system with more binding rules. Ad hoc arrangements such as the Plaza Accord of September 1985 and the Louvre accord of 1987 replaced the close cooperation of the Bretton Woods period. Most economists and monetary policy-makers were theoretically and normatively convinced that the “invisible hand” of completely liberated markets would result in the most efficient outcomes over the long run since market liberalization acts as external discipline on inherently expansionary government policies (Siebert 1998). Some ultra-liberals even maintained that governments should relinquish the issuance of money within their territory and leave that to private actors (Hayek 1976).

3 Global governance in monetary relations However, despite these extreme voices, governance still occurs in currency markets, although the scope and instruments of this governance have changed. Most analysts now agree that the image of the complete disempowering of states by markets, with state institutions relegated to the unenviable role of lenders of last resort in major bailouts, distorts reality (Weiss 1998; Busch 2003; Dieter 2005: 15). Even in today’s world of floating exchange rates, governments intervene frequently in one way or the other to influence exchange rates. Rather than being based on completely free-floating currencies, the present monetary order is best described as managed float. Governments can use many mechanisms to influence their external monetary conditions. Most of these involve domestic macro-economic adjustments. Kapstein has shown how coordinated domestic regulation has replaced the increasingly difficult coordination of different national policies. He maintains that “states have responded to financial globalization through the development of cooperation based on home country control” (1994: 2), that is, by regulating their domestic financial institutions in accordance with internationally shared rules. Echoing Kapstein, Cerny notes: “So what we have at this point is the continued relative importance of domestic prudential regulation and the patchwork and episodic character of international cooperation” (Cerny 2002: 214). Research on how the impact of financial globalization varies across countries, depending on the characteristics of national institutions and variations in basic economic structure is well advanced (Kitschelt et al.

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1999). In the case of China, as mentioned in the beginning, monetary policy is dominated by the promotion of an artificially low currency to boost exports and the accumulation of foreign exchange reserves (Eichengreen 2004). Chinese authorities have pursued these goals by closely steering the Dollar–Renmimbi exchange rate via capital controls and by investing heavily in US treasury bonds. The United States, however, exhibits a distinct preference for bilateral diplomacy and an emphasis on private actors, whereas Europeans and Asians continue to call for a strengthening of international institutions. But are state authorities still capable of creating a working governance structure? While it is true that monetary crises such as the Mexican Peso crisis sparked ad hoc multilateral attempts to contain their consequences, Cohen’s observation that states are more likely to cooperate against common aversions than to achieve common interests strikes a rather pessimistic note (Cohen 1996: 291; Pauly 1997: 18). According to this argument, cooperation happens only when things have gone wrong already. In addition, the relatively successful containment of these crises before they could do too much damage in American and European markets has lent renewed credence to the argument that the causes of financial collapse have to be found and fought in the affected national economies, not in the international arena. And finally, probably even more than in other fields of international relations, the free-rider problem looms large over every attempt at collective action in monetary policy where compliance can often not be observed directly and cheating is rather easy. International organizations and regimes are the standard answer to such collective action problems in the international realm. In international monetary policy, institutions such as the IMF and the Bank of International Settlements act as agenda-setters, they institutionalize policy ideas, lock in expectations, and lower the scope for freeriding. During the Bretton Woods era, contrary to the intentions of its creators, the IMF’s role was rather limited. Afterwards it assumed a new surveillance function, relying on the soft power of best practice and consultation (Pauly 1997). Yet after the Asian Financial Crisis of 1997/98, the efficiency and impartiality of this function was increasingly questioned. The world’s financial institutions appeared to be dominated by a very narrow range of actors, excluding most emerging market economies (Sohn 2005). As a consequence, adjustment costs had to be borne primarily by these countries (Higgott and Phillipps 2000). Recently, new institutional fora were created to tackle the problem of inclusion posed by the increasingly dynamic economies of former developing countries (Germain 2001; Walter 2005: 147). Examples are the G-20 and the Financial Stability Forum,6 which act as clearing houses for information and ideas and legitimize specific notions of best practice (Porter 2005a). However, in a somewhat contradictory manner, their underlying philosophies subscribe to the neoclassical paradigm, that is, keeping intervention in markets to a minimum (Soederberg 2002). Decision-making in these institutions is still dominated by the G-7 and thus not sufficiently representative (Wade 2002; Stiglitz 2002; Tabb 2004). In addition, the effectiveness of unbinding recommendations is dubious, since, at least against economically powerful countries, there are no effective

Money and power 89 sanctions. However, some of the most recent research has looked beyond statesponsored coordination, searching for new forms of governance. The often exaggerated dichotomy of states versus markets obscures how public and private actors create new webs of governance in the international monetary system because “states have recognized that they must work in partnership with private actors [. . .] to accomplish public policy objectives” (Dombrowski 1998: 14). Devolving the task of setting and implementing global rules to private actors seems an attractive idea in the international political economy since the rules are addressed mainly at private actors and the second Washington Consensus emphasizes that market regulation is best left to them (Börzel and Risse 2005: 205). They are also better informed about market conditions. Much of the research in this field has focused on banks (e.g. Busch 2003). However, as Dombrowski (1998: 22) rightly maintained, insurance companies, pension fonds, credit- rating agencies and hedge funds are new types of actors controlling enormous sums. These actors operate outside the frameworks of enforceable international rules and they are constrained only by very informal regimes (Hufschmid 2005: 282; Sinclair 2001). Private sector norms are transmitted via “standards and codes in legal and commercial practices that become so routine that they become part of the ‘reality’ that actors simply accept when they engage in market interactions” (Porter 2005b: 234). Major examples are the Basle I and Basle II Accords on capital adequacy standards for commercial banks. States still assume mediator roles, choosing between the different norms available in the global market place. There are important limits to the effectiveness of these forms of network governance. Their efficiency is limited to the micro-management of financial markets. While they might be successful in this task, global adjustment of the magnitude suggested by a disorderly correction of the US current account deficit is beyond the capacities of informal networks and current international organizations and regimes. Another one of these limits concerns the issue of democratic legitimacy. None of these structures are under effective democratic control (Schmalz-Bruns 2005; Börzel and Risse 2005). A governance architecture which gives equal voice to the interests of smaller players in the global financial arena is unlikely, given the resistance of the US and, to a lesser degree, Europe (Hufschmid 2005). The focus on public–private partnerships also obscures the differences among the state actors that dominate those networks. Many states remain almost completely excluded. International institutions, therefore, might help to resolve collective action problems among states but they often bestow asymmetric benefits. They are structures of cooperation and at the same time structures of power (Moe 2005: 215). The question of monetary power has been dealt with by the literature in only a very anecdotal way. However, in the international financial arena it is even more salient than elsewhere. In the rational choice variant of institutionalism, actors are assumed to be able to simply walk away if they see their interests violated (ibid.: 218). In international finance this is almost impossible in practice and it would be extremely costly to take this exit option. States (and the actors representing them) have to live with potentially enormous power

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differentials in monetary policy. How to conceptualize monetary influence and the way it interacts with existing governance structures is a question that research has only begun to tackle.

4 Monetary power As we have seen, a growing consensus emerged in the most recent literature that state power still matters greatly in the process of globalization (Gritsch 2005). In the final consequence, if one accepts that there is a problem of governance (or rather the lack thereof) in the present international monetary system, most empirical research indicates that it hinges on the willingness of the leading states to cooperate in the establishment of rules and thereafter also to implement and play by them. The interpretation that market forces will yield stable equilibriums in the long run inevitably leads to the question of monetary power. The reason is that while few would deny that states generally have lost some degree of control over financial markets, there is a wide divergence in the way different states have felt the impact of this development. Some have hardly seen their autonomy constrained and have even profited from the deregulation of capital markets. Others have been forced into often painful adjustment measures and into currency arrangements that require a specific set of policies to sustain, sometimes even the abandonment of the national currency.7 Monetary adjustment is usually costly, politically and economically. It might involve trade discrimination to fight substantial imbalances, capital controls to limit the impact of destabilizing cross-border capital flows, the forced appreciation or depreciation of currencies, or changes in macro-economic policies. A long time ago, Karl Deutsch defined power as the “least amount of nonautonomous change in one system [A] while producing the largest amount of non-autonomous change in another [B]” (Deutsch 1953: 46–59). It will be argued in this section that autonomy in choosing whether and how to adjust to changing conditions on monetary markets is the main characteristic of monetary power.8 International institutions can mitigate these effects but first, they tend to be of secondary importance in determining global financial policy and second, they bestow asymmetric benefits, as argued above. This “ex negative” concept of monetary power (i.e. the ability to avoid the effects of monetary power) offers a more useful definition than previous attempts which are often contradictory and hard to operationalize. One of the problems of measuring monetary power is that it cannot be defined in quantitative terms, as opposed to power in the economy which can be neatly expressed in terms of financial resources. Among the first attempts to disentangle the concept is the very well-known and useful distinction of relational and structural power introduced by the late Susan Strange. She argued that structural power (shaping the environment in which others have to operate) was more salient than relational power (getting others to do what one wants). The power conveyed by the possession of a top currency is one of the major bases of structural power (Strange 1988: 26). The core factor is to get access to credit: all poli-

Money and power 91 tics has to be financed and states which, for political or economic reasons, are judged not creditworthy by international or national markets will have major difficulties in pursuing their political preferences. However, Strange did not clarify systematically how the possession of relational or structural monetary power shapes outcomes. In rich historical detail, Jonathan Kirshner has shown how financial power can be used to get other countries to act in ways they would not have without this pressure (Kirshner 1995). In international monetary relations such blatant acts can be found only relatively rarely: examples are American attempts to force Germany and other countries to offset the foreign exchange losses of American troops in Europe (Zimmermann 2002), de Gaulle’s use of Dollar to gold conversions to undermine the Dollar, or the attempt of the Nixon administration to force Europe and Japan to revalue their currencies after August 1971. Most of these episodes involve very assertive, almost predatory policies. It is hard to imagine that this will be very frequent, particularly in the more diffuse environment of flexible exchange rates. Barnett and Duvall (2005) introduced the concept of institutional power which entails the power exerted by dominant actors in shaping the rules and procedures of institutions through which others act. A prime example is Germany’s push to tie a future EMU into a regulatory framework that is consistent with German monetary preferences. There is one common theme running through these attempts at defining (monetary) power: it is less the exercise of power but immunity against the pressure of contagious (sometimes state-induced) market movements which makes the difference. Re-interpreting Kirshner’s case studies, it is possible to argue that the susceptibility of the target countries to monetary pressure is at the root of an exercise of monetary power. As the US example shows, large countries can run deficits for a long time and are less susceptible to pressure to adjust, as are countries with sizeable foreign exchange reserves which might be used to steer markets towards the desired direction. That the most important component of states’ monetary power is the ability to preserve their autonomy follows, in a way, logically from the function of monetary systems: to permit the undisturbed flow of goods and capital across borders. In fact, the core interest of states with regard to monetary policy can be defined as an access to credit without a loss of autonomy to pursue their political and economic preferences. Private actors in the international monetary system, on the other hand, are motivated primarily by the goal of profit-maximization. Sometimes the goals of state actors and private actors overlap, sometimes they contradict each other. If they do not, for example, if strong domestic interests ask for changes in exchange rates, government autonomy is once again constrained. Effective monetary power assures that monetary policy provides an optimal environment for the most important private actors, while at the same time preserving state autonomy. If governments are forced to change their preferred policies and/or impose costs on private actors whose opposition might be politically costly, we can speak of forced adjustment. Avoiding it is the core of monetary power, as Cohen argues in a path-breaking article: “the greater a state’s capacity to avoid

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adjustment costs, relative to that of other states, the greater is its power on the macro-level” (Cohen forthcoming: 31). An illustration of this argument is the history of European monetary integration (for the following paragraph, see Zimmermann 2001). As mentioned before, the embedded autonomy for governments to pursue their preferred economic policies was a core element of the Bretton Woods System (Ruggie 1982). However, during the 1960s, American balance of payments deficits required European states to adjust their monetary policies increasingly to the Dollar. This was particularly true of Germany, which found itself torn between the necessity to support the Dollar and the “imported inflation” resulting from this support. Given the close trade links between the EC economies, German adjustment measures forced the other member states to follow suit, often in blatant contradiction to their political and economic preferences. The culmination of this was the ERM-crisis of 1992/1993. The EC members were furthermore confronted with incessant disruption of the European integration process due to differing movements of their currencies against the Dollar. A solution to this dilemma was regional monetary integration: the creation of a European currency that would isolate the member states from the fluctuations of the Dollar and restore some measure of autonomy (locating it not at the national but rather at the European level now). In fact, this was a core motive in all steps towards Economic and Monetary Union since the mid-1960s, as I have shown in detail elsewhere (Zimmermann forthcoming). In a similar vein, Grimes recently showed how Japanese policies on the internationalization of the yen were motivated by the goal of reducing the domestic economy’s “susceptibility to currency volatility and to capricious change in U.S. exchange rate policy” (2003: 193–4). Also, in recent years Asian countries have responded to what they perceive as limited inclusiveness, the lack of commonly agreed rules and an unfair division of burdens in international financial institutions by attempting to create a form of regional governance (Sohn 2005). The most prominent of these is the Chiang Mai initiative of May 2000 among the ASEAN countries as well as China, Japan and South Korea. It consists of bilateral swap agreements as emergency safeguards in the case of speculative crises (Hamilton-Hart 2003). Again, the attempt is to enhance policy autonomy by surrendering parts of it to a more legitimate regional forum. The new trend towards regional currency arrangements is a response to disparities of power.

5 Conclusions How can the notion of autonomy be used to analyse the American–Chinese conflict mentioned at the beginning of this chapter? Will China have to give up its strategy of export-led growth by accepting an involuntary revaluation of its currency? Or can it force the United States to bolster the Dollar by raising interest rates, strengthening private and public saving and accepting a slowdown of domestic consumption and lower growth rates? This is currently the most debated issue in international monetary policy. Both sides only have limited

Money and power 93 options to use relational power. In February 2006, Washington indicated that China might be formally branded a “currency manipulator” (Alden and Balls 2006). The threat of Congressional protectionism, however, has only been minimally effective in nudging China towards a more flexible Renmimbi rate. China has a potentially very powerful weapon: diversifying its reserves and triggering a Dollar adjustment with severe impacts on growth in the US.9 However, given its trade preferences this would be a self-defeating measure. In addition, it would lead to a rapid fall in the value of its Dollar reserves. In this sense, China (and other creditor countries) find themselves in a similar position to Germany at the end of the Bretton Woods System. This situation has led some analysts to argue that the world now experiences a Bretton Woods II System (Dooley et al. 2004). This would suggest the repetition of the Nixon strategy by the US as soon as domestic pressure over the negative trade balance becomes too strong. However, in the 1970s the danger of a precipitous withdrawal of funds by foreign investors was very low since no credible alternative to the Dollar existed. This is very different now, as Eichengreen (2004: 25) notes: the euro provides an attractive safe haven, backed by liquid financial markets. Thus, the US has lost a core element of its structural power. Its autonomy is therefore more constrained than in the 1970s. One indicator is that the initiative to enhance the role of the IMF in dealing with global imbalances, which was mentioned in the introduction to this chapter, came from the US government. It is too early to say whether this step, the proliferation of new regimes, such as the FSF, and the trend towards a regionalization of currency areas points to a swinging-back of the pendulum in the direction of stronger state management of international monetary relations. Yet, the increasing effects of global monetary imbalances on the domestic macro-economic autonomy of the big players in this area suggest just such a development.

Notes 1 www.globalagendamagazine.com/2005/kennethrogoff.asp (accessed 5 February 2006). 2 Some skeptics argue that the relative importance of global financial transactions is not exceptional if compared to the late nineteenth century (Hirst and Thompson 1999). However, this discounts the fact that the range of tasks assumed by states was much smaller at that time. 3 Andrews (2007), however, emphasizes that the Bretton Woods era actually witnessed at least four quite different monetary orders: the Treasury system (1945–1947); the Marshall system (1947–1958); the Kennedy system (1960–1968), and a two-tiered market system until 1971. 4 For an argument that “three out of three” are actually possible if underpinned by a global ideological consensus, see Widmaier 2004: 449. 5 The first Washington consensus was constituted by the ideas that underpinned the Bretton Woods System. 6 See: www.fsforum.org. 7 A major example is the Dollarization of some Latin American countries which introduced the Dollar as replacement for their own currency. See Helleiner 2003. 8 This argument echoes Cohen (forthcoming). 9 For an estimate see Freund/Warnock 2005.

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Money and power 97 Santiso, C. (2004) “The Contentious Washington Consensus: Reforming the Reforms in Emerging Markets”, Review of International Political Economy, 4: 828–44. Schmalz-Bruns, R. (2005) “Demokratie im Prozess der Globalisierung. Zur Demokratieverträglichkeit von Global Governance”, in M. Behrens (ed.) Globalisierung als Politische Herausforderung, Wiesbaden: Verlag für Sozialwissenschaften: 79–96. Siebert, H. (1998) “Disziplinierung der nationalen Wirtschaftspolitik durch die internationale Kapitalmobilität” in D. Duwendag (ed.) Finanzmärkte im Spannungsfeld von Globalisierung, Regulierung und Geldpolitik, Berlin: Duncker & Humblot: 41–67. Sinclair, T.J. (2001) “The Infrastructure of Global Governance: Quasi-Regulatory Mechanisms and the New Global Finance”, Global Governance, 7/4: 441–52. Soederberg, S. (2002) “The Emperor’s New Suit: The New International Financial Architecture as a Reinvention of the Washington Consensus”, Global Governance, 7/4: 453–67. Sohn, I. (2005) “Asian Financial Cooperation: The Problem of Legitimacy in Global Financial Governance”, Global Governance, 11: 487–504. Stiglitz, A. (2002) Globalization and its Discontents, New York: Norton. Strange, S. (1988) States and Markets, London: Pinter. –––– (1996) The Retreat of the State: The Diffusion of Power in the World Economy, Cambridge: Cambridge University Press. Tabb, W.K. (2004) Economic Governance in the Age of Globalization, New York: Columbia University Press. Thies, C.G. (2004) “Individuals, Institutions, and Inflation: Conceptual Complexity, Central Bank Independence, and the Asian Crisis”, International Studies Quarterly, 48: 579–602. Verdun, A. (2000) European Responses to Globalization and Financial Market Integration, London: Macmillan. Wade, R. (2002) “US Hegemony and the World Bank”, Review of International Political Economy, 9: 215–43. Walter, A. (2005) “Understanding Financial Globalization in IPE”, in N. Phillips (ed.) Globalizing International Political Economy, Houndmills: Palgrave: 141–64. Weiss, L. (1998), The Myth of the Powerless State, Ithaca, NY: Cornell University Press. Widmaier, W.W. (2004) “The Social Construction of the ‘Impossible Trinity’: The Intersubjective Bases of Monetary Cooperation”, International Studies Quarterly, 48: 433–53. Zimmermann, H. (2001) “The Fall of Bretton Woods and the First Attempt to Construct a European Monetary Order”, in L. Magnusson and B. Stråth (eds) From the Werner Plan to the EMU – a European Political Economy in Historical Light, Bruxelles: Peter Lang: 49–72. –––– (2002) Money and Security, Cambridge: Cambridge University Press. –––– (forthcoming) “Unravelling the Ties that Really Bind: The Dissolution of the Transatlantic Monetary Order and the Creation of a European Monetary System, 1965–75”, in M. Schulz (ed.) The Strained Alliance: Conflict and Cooperation in U.S.–European Relations from Nixon to Carter, Cambridge: Cambridge University Press.

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Political transnationalization The future of the nation-state – a comparison of transnational policy regimes Edgar Grande, Markus König, Patrick Pfister and Paul Sterzel

1 Globalization and political transnationalization: limitations of “global governance” research1 The following chapter focuses on the consequences of globalization for the development of statehood and the preconditions for governance. Despite differences concerning the details, the findings of political science research on the implications of (particularly economic) globalization on national politics (Weiss 1998, 2003; Held et al. 1999; Bernauer 2000; Scharpf 2000; Scharpf and Schmidt 2000; Lütz 2002; Busch 2003; Prange-Gstöhl 2004; Ganghof 2005; Wagschal 2005; Zohlnhöfer 2005) have clearly shown that the initially dominant hypotheses on the “retreat of the nation-state” and the “end of politics” (Guéhenno 1994; Ohmae 1990, 1995; Strange 1996) are empirically invalid. There is neither convincing evidence for a financial or regulatory “race to the bottom” in which wealthy multi-national corporations eventually prevail, nor are there any indications of extensive societal self-regulation beyond the nationstate, that is of “governance without government” (Rosenau and Czempiel 1992), completely replacing state interventions. Yet, the opposite thesis, according to which states single-handedly, or through intergovernmental cooperation, are capable of defending their capacity to act, of keeping societal lobbies at bay, and thus eventually maintaining or even strengthening their own position, cannot be convincingly substantiated either (see McGrew 2002; Schimmelfenning 2004). There are, however, numerous indications that globalization is contributing to a fundamental transformation of national governance, albeit in a complex manner. The establishment of abundant and manifold new structures and forms of governance beyond the nation-state is particularly significant in this context. The results of these developments, thus far observable, are complex institutional architectures of transnational order formation and rule implementation with pervasive implications for the preconditions of formulating and asserting national interests (Held 2004; Slaughter 2004). In this process, traditional structures and actors of political decision-making and policy implementation are being regrouped, recombined with other institutions and actors, and amalgamated into

Political transnationalization 99 a new architecture of political authority. During the past years, numerous concepts have been developed in order to analyse and define these new forms of governance. These are, among others, the concepts of the “network polity” (Ansell 2000), the “networked state” (Castells 1996), the “transnational state” (Beck 1997, 2002), “complex multilateralism” (O’Brien et al. 2000), “global civil society” (Lipschutz 2000), “global public policy” (Reinicke 1998), “global public policy networks” (Reinicke and Deng 2000), “global corporatism” (Kaul et al. 1999), the post-modern “Empire” (Hardt and Negri 2000), “transnational policy space” (Coleman 2005), and “complex sovereignty” (Grande and Pauly 2005a). In the public debate as well as in political science research, these new forms of governance beyond the nation-state are often subsumed under the term “global governance”. There are legitimate reasons for doing so, as all the aforementioned concepts first of all emphasize the increasing relevance of new institutions, levels and arenas beyond the nation-state, and, second, the increasing significance of non-state actors within these new forms of governance. At the same time, we must take into account the fact that the notion of “global governance” is burdened with numerous problems that imply refraining from its use as a scientific term in social science research on globalization. This particularly concerns the heterogeneity of the issues to which it is applied. “Global governance” is – as well as the term “governance” itself (see Benz 2004; Kjaer 2004; Schuppert 2005) – a particularly multi-faceted and complex term that has a variety of connotations in different contexts and that has become an object of intense self-reflection in political science (Hellmann et al. 2003; Behrens 2004, 2005). At present, normative as well as empirical-analytical research approaches are assembled under the umbrella of “global governance”. Normatively, “global governance” is used as a concept in opposition to neoliberal variants of globalization (Wolf 2004) and is generally combined with extensive suggestions for transnational institution-building and the democratic accountability thereof (see Held 1995, 2004; Zürn 1998, 2004; Brunnengräber et al. 2001; Deutscher Bundestag 2002; Messner 1998, 2005; Messner and Nuscheler 2003). These proposals, however, all suffer from an exaggerated “problem solving” and “institutional design” optimism and usually ignore the political limitations of governance beyond the nation-state resulting from international power asymmetries, national and international conflicts of interests and norms, deficits concerning national political capacities, and so forth (see Fach and Simonis 2000; Grande 2001; Grande and Pauly 2005b; Mayntz 2005; Schirm 2005). In summary, these normative concepts overrate the scope of global governance and the likelihood of its realization. In contrast, empirical research on “global governance” concentrates on actual processes of transnational institution-building (Young 1997; Väyrynen 1999; O’Brien et al. 2000; Held et al. 1999; Held and McGrew 2002; Behrens 2005; Grande and Pauly 2005a). The objective here is to analyse the preconditions, patterns, and results of institution-building processes beyond the nation-state, in contention to established neo-realist concepts of international relations on one

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side and idealistic schemes of “world governance” on the other. These analyses usually focus on individual institutions, types of actors and policy fields – such as international organizations (Barnett and Finnemore 2004; Karns and Mingst 2004; O’Brien et al. 2000), private actors (Cutler et al. 1999; Brühl et al. 2001; Hall and Biersteker 2002; Börzel and Risse 2005) or non-governmental organizations (Josselin and Wallace 2001; Brunnengräber et al. 2005), with a particular emphasis on foreign trade policy (Schirm 2002, 2004; Kahler and Lake 2003), on tax policy (Ganghof 2005; Genschel 2005; Wagschal 2005) and on environmental policy (Young 2002; Kanie and Haas 2004; Oberthür and Gehring 2006). In the course of the past years, it was thus possible to draw a very realistic picture of the prospects and limitations of governance beyond the nation-state, which noticeably differs from normative “global governance” concepts. However, these empirical analyses have major deficits as well. Owing to their concentration on individual organizations, types of actors and policy fields, they often exclude the (formal and informal) relations and interactions between organizations as well as the interdependencies between policy fields. Put simply, these empirical analyses tend to underestimate the (institutional and functional) complexity of global governance. Given the deficits of both variants of “global governance”, we hereinafter propose the concept of the transnational policy regime as an alternative for political science research on globalization. This approach specifically includes those aspects of transnational institution-building as empiric variables that are often either presupposed or ignored by “global governance” concepts. In the following, we will first introduce the concept of the transnational policy regime and subsequently operationalize it (section 2); the next step is to illustrate its potential with a number of empirical case studies (section 3). On this basis, the functioning and problems of transnational governance will be compared and analysed (section 4). We will conclude with the development of perspectives for future research on globalization (section 5).

2 The alternative: transnational policy regimes as a conceptual variable Considering the confusing diversity and deficiencies of research approaches operating under the term “global governance”, we suggest narrowing “global governance” down and reserving it for those normative approaches to which it owes its emergence and with which it is primarily associated. Furthermore, we propose a new analytical term for characterizing new forms of governance beyond the nation-state, a term which is open to a variety of empirical manifestations of transnational governance. It is thereby possible to use existing political science terms (“transnational”, “regime”), although this requires extending their definitory scope. In our view, it makes sense to refer to the new architectures of political authority as “transnational policy regimes”. This term emphasizes four dimensions of political institution-building beyond the nation-state: First of all territorial scope; second, constellations of participating actors and organizations;

Political transnationalization 101 third, demarcation criteria; fourth, institutional complexity and degree of integration. Transnational policy regimes thus differ from nation-states on the one hand and from international organizations on the other concerning the following attributes: •

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Transnational scope: they transcend the distinction between internal and external, constitutive for the age of the nation-state, and integrate different territorial levels of political action above and below the nation-state. Besides nation-states, a wide variety of international organizations, supranational forms of regional integration and international regimes can be constituents of transnational policy regimes. Accordingly, the territorial scope of such policy regimes is highly variable. Transnational actor constellations: they simultaneously integrate different types of state and non-state actors, different types of national and transnational interest groups and social movements in political decision processes. This results in very diverse actor constellations with an exceedingly variable distribution of functions. This extensive understanding of the term “transnational” is deliberate and goes beyond its general use in IR research (Mayntz 2000). Functional logic of constitution: transnational policy regimes are constituted on the basis of a functional problem orientation, whether within individual policy fields or spanning various policy fields. Their mutual point of reference consists of collectively perceived regulatory problems. Correspondingly, transnational policy regimes are primarily demarcated by functional aspects and not by territorial borders. However, they combine different logics of demarcation and restriction and significantly vary in this respect. Institutional regime character: transnational policy regimes are characterized by a highly variable institutional complexity and a “non-systemic quality” (Mayntz 2000) concerning their integration. Thus, they most suitably can be subsumed under the generic term of “regime”. In the past 20 years, “regime” has not only been used in IR research (Krasner 1983; Hasenclever et al. 2003) but increasingly in comparative politics as well (Eberlein and Grande 2003, 2005; Coen and Héritier 2006) as a general definition of ensembles of – formal and informal – institutions, organizations, actors, relations, norms and rules decisive for constituting and implementing collectively binding decisions. The degree of institutional complexity and the mode of integration of such regimes are consequently key variables in analysing transnational forms of governance.

In contrast to the “global governance” approach, the terminological precision and empirical openness of the transnational policy regime concept offers several advantages. Decisive in our view is the fact that the institutional architecture of transnational decision-making can be conceived of as a conceptual variable, in the same way that studies in the field of comparative government conceive the state (Nettl 1968). The structure and development of these institutional

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architectures can thus be comparatively analysed using a limited number of attributes. The comparison with conceptual approaches in comparative government is instructive in a further respect, as this branch of political science does not restrict the scope of analysis to dissecting individual institutions and regulatory mechanisms but aims at identifying more complex institutional forms and types of state. Accordingly, empirical analysis of new forms of governance beyond the nation-state should primarily focus on the typological conceptualization of the complex constellations of transnational policy regimes and on their categorization. It should thus be possible to differentiate various types of transnational policy regimes and, in a further step, to systematically relate them to their regulatory capacity on one side and to their legitimacy on the other. Analysing transnational policy regimes raises numerous research questions. These include not only the role of the nation-state but also the mode of institutional integration, the factors determining individual actors’ and organizations’ influence and participation potential, non-state actors’ functions, the role of norms and ideas for constituting and developing transnational institutions, the feasibility and determinants of democratic legitimacy and so on. As we cannot address all these questions, we will concentrate on three main issues that are also of relevance for “global governance” research: the institutional architecture of transnational policy regimes (2.1), the role of state actors (2.2), and the role of non-state actors in transnational policy regimes (2.3). 2.1 Institutional architecture “Institutions matter” – in national, as in transnational politics. Therefore, an analysis of the institutional architecture of transnational policy regimes is essential for establishing whether these new forms of political authority are capable of forming arenas for solving collective problems in a collectively binding manner. In this context, the investigation of the mode and intensity of institutional integration of various levels, institutions and arenas is of particular importance, as is the extent to which these complicated architectures are and can actually be a product of “institutional design”. Existing empirical analyses not only show that transnational arenas of political authority can adopt a multitude of institutional forms, they also indicate that their internal structure can generate considerable implications both for actors’ influence and for political problem-solving capacity in general. Specifically, an analysis of institutional architecture should focus on six aspects: (i) distribution and interconnectedness of competences; (ii) allocation and dependency of resources between actors; (iii) inter-organizational interfaces; (iv) forms and frequency of interaction between actors; (v) mechanisms of institutional integration; and (vi) path dependencies of the institutional development. 2.2 The role of state actors Transnationalization does not mean the end of state politics but a transformation of political authority. The decisive question therefore concerns the role nation-

Political transnationalization 103 states play in the new transnational policy regimes. This makes it necessary to determine the functions of nation-states. We thus have to analyse the influence nation-states have within transnational policy regimes and the factors that determine their influence. Particular attention has to be dedicated to power asymmetries and to their impact on the problem-solving capacities. Finally, we will consider the transformation of domestic politics in the context of transnational policy regimes. This is of particular importance not only for the policy dimension but for the politics and polity dimensions as well. Further issues concern the preconditions and forms of cooperation between nation-states in the new arenas of political authority. 2.3 The role of non-state actors Political science literature offers abundant evidence that non-state actors play a new role in transnational policy regimes (Cutler et al. 1999; O’Brien et al. 2000; Brühl et al. 2001; Cutler 2003; Börzel and Risse 2005; Porter 2005). Therefore, particular attention has to be accorded to the following issues: What are the organizational requirements for participation in transnational policy regimes? What role do non-state actors play in transnational policy regimes, how much influence can they attain? What consequences ensue from complex organizational problems and from non-state actors’ participation in transnational policy processes? In addition to the results of “global governance” research aforementioned, the exploration of these questions can particularly benefit from the conceptual as well as empirical work from five strands of research in political science and sociology: •

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First of all, the analyses of national and transnational policy networks and of new forms of interaction between state and non-state actors (Rhodes 1985; Mayntz 1993; Mayntz and Scharpf 1995): These studies have elaborated two aspects relevant for our line of argument. On the one hand, they emphasize the rapidly declining steering capacity of traditional, hierarchical “command and control” administration – due to an increase in functional complexity and territorial interdependence – and the consequent trend towards non-hierarchical network structures that integrate the stakeholders. On the other hand, they highlight the increased importance of societal selfregulation in the shadow of state control or including state actors. Second, the studies on “transnational relations” in IR research (RisseKappen 1995; Risse 2002), as well as on “transnational governance” in the context of comparative government (Vogel 1997; Kohler-Koch 1999). Both strands of literature also refer to the higher significance of societal actors in solving collective problems and they provide insights into the mechanisms of this increase in political salience. This not only concerns the usual pluralistic lobbying or neo-corporatist cartels. Rather, these analyses display a wide variety of new options for the participation of social interests in the

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Grande et al. production of public goods, ranging from autonomous self-regulation to the establishment of new, non-hierarchical connections and networks incorporating trans-, inter- and supranational actors (O’Brien et al. 2000; Brühl et al. 2001), and finally to “epistemic communities” (Haas 1993). Third, the manifold studies on the European Union’s multi-level system or on “multi-level governance” in the context of European integration (Scharpf 1999; Grande and Jachtenfuchs 2000; Hooghe and Marks 2001; Benz 2003): they all refer to the variety of new structures, actors, instruments and opportunities of the new “Empire Europe” (Beck and Grande 2004, 2005) and particularly emphasize the horizontal and vertical multiplication and coexistence of political authority. Fourth, the analyses on “governance beyond the nation-state” and on “complex global governance” (Gehring 1995, 2000; Zürn 1998, 2001; Slaughter 2004): this literature identifies the potential of international – quintessentially intergovernmental – cooperation for attaining at least partial control over the competition and incongruity problems resulting from globalization. International organizations, regimes and agreements are all means for achieving international, collectively binding regulation of collective problems. State actors play a decisive role herein as, according to the mentioned studies, they are the only actors with the necessary resources at their disposal. Fifth, the normative concepts of a “cosmopolitan democracy” (Archibugi and Held 1995; Held 1995; Archibugi et al. 1998; Held 2004) that attempt to free the state from the “territorial trap” of the nation-state perception, while, however, binding it to constitutional rules and federal principles of international control. In essence, such approaches emphasize two dimensions of the new architectures of political authority – the formal integration of the national level in transnational policy regimes and the necessity of their democratic legitimacy.

3 Governance in transnational policy regimes: empirical case studies In the following, we will attempt to demonstrate the potential of the transnational policy regime as a concept by means of an empirical analysis of structures and processes of collectively binding decision-making and implementation beyond the nation-state. To this end, we will present several case studies in selected transnational regulatory areas. Their selection is mainly based on two criteria. In a first step, such cases were chosen in which a demand for transnational regulation has been maintained in public debate on globalization. This demand for transnational problem-solving is primarily the result of an increasing incongruity between nation-states’ sphere of authority on one side and the broader territorial scope of the regulatory problem on the other (see Zürn 1998). From this group, such regulatory problems were then taken into account for which no trivial solutions apply, that is where cooperation between relevant

Political transnationalization 105 actors is complicated by conflicts of interest or values. With these criteria, we selected a total of seven case studies from various policy areas (research and development, environmental policy, as well as tax and fiscal policy) which are under particular pressure from globalization. Overall, we thus concentrate on the group of critical cases in which a particularly high demand for regulation has been maintained and where the conditions of a transnational constitution and implementation of rules are especially difficult, that is precisely those cases on which “global governance” research focuses. To start, we will give an overview of three case studies on taxation of transnational corporations (3.1), on the regulation of genetically modified food (3.2) and on Internet regulation (3.3), before proceeding with their comparative analysis.2 3.1 Intergovernmental networks: taxation of transfer pricing in transnational corporations The effects of economic globalization on tax policy are among the most widely discussed problems in globalization research. The focus of this debate – despite corporate taxation’s quantitatively rather marginal significance for overall internal revenue – is on the taxation of transnational (mobile) corporations. The background of the transfer pricing problem is that trade among related enterprises within a transnational corporation is not subject to free market rules. This enables enterprises to independently set the thus calculated prices, so-called transfer prices. As enterprises are increasingly organized across national boundaries, transnational corporations use this mechanism for “optimizing” – that is minimizing – their overall tax burden. They determine transfer prices so as to shift profits to low-tax countries and losses to jurisdictions with extensive depreciation opportunities. Thus, countries with high effective taxation forfeit considerable tax revenues. However, tax avoidance and evasion does not only affect high tax jurisdictions. As there is a range for every transfer price, transnational corporations are in a position to minimize them in order to reduce their overall corporate tax burden. Regulating this problem is neither effective unilaterally, nor by way of bilateral double taxation agreements otherwise customary in tax policy. Due to variations in tax rates between countries, such agreements actually and paradoxically turned out to be judicial precursors for enterprises’ legal profit-shifting (see Palan 2002). In this context, multilateral attempts at transnational regulation were initiated in the 1970s. Currently, 38 countries, the OECD and the European Union participate in the transnational transfer pricing regime. In addition, two transnational economic umbrella organizations (BIAC and UNICE) and a number of ad personam non-state actors have joined as experts. On the transnational level, the architecture is horizontally divided into three arenas: the Transfer Pricing Unit of the OECD, the EU Transfer Pricing Forum, and PATA, an intergovernmental cooperation between the tax administrations of Australia, Canada, Japan and the US. These arenas are only partly – as in the case of the OECD and the EU – institutionally linked and only partly organized towards a

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division of labour. In addition to institutional interlinkage, integration between the arenas is mainly based on overlapping memberships among nation-states. Within the arenas, the participating actors are integrated by three mechanisms: their mutual interest in problem-solving, a regime output the stakeholders consider effective and finally, the participants’ pragmatic and reciprocal orientations. Vertically, the transnational transfer pricing regime has three levels. Here as well, the national level – more precisely: national tax administrations – is the central, vertical interface. The essential resources for regulating transfer pricing issues are the nationstates’ tax monopolies, their economic capacity and, finally, the actors’ practical expertise. Tax monopoly is a central source of influence for nation-states and fundamentally sets them apart from non-state actors. The two remaining resources are closely linked: due to the fact that most transnational corporations are residents of major, economically powerful countries, actors from these countries have a head start concerning expertise and professional competence on transfer pricing issues. Despite their formal equality, the disproportionate distribution of the three resources results in a factual scaling of nation-states: The US, Britain, Germany and France are considered the most influential countries. However, it has to be taken into account that regulation addressees and other non-state actors have considerably more practical expertise than state actors. Within the scope of transnational cooperation, the nation-state’s role is that of a discussant and negotiator. The transnational level, however, is only essential in the decision-making phase and therefore, only accounts for a limited part of the overall policy process. Rule implementation in particular is left exclusively to nation-states. Here, the governance mode of hierarchical rule enforcement is maintained. The OECD and the EU play a role in interest aggregation and as secretariats. Moreover, the OECD advises tax administrations of non-member countries on practical transfer pricing audits and on the implementation of its transfer pricing standards. The central function of non-state actors within the transnational transfer pricing regime is assessing practical feasibility, (monetary) estimation of consequences and the discussed regulations’ efficiency. They evaluate regulations ex ante as to their conceivable consequences or generate ex post awareness if regulations do not have the intended effects. However, the extent to which they can influence depends on nation-states’ goodwill. Altogether, the transfer pricing regime can thus be termed an intergovernmental network of low complexity and integration. The member states’ sovereignty and their tax monopoly constitute the basis of a materially and institutionally rather unsophisticated form of intergovernmental cooperation dominated by inter-administration collaboration. 3.2 Complex regime: regulation of genetically modified food During the past years, we have witnessed a highly controversial public discussion on genetically modified food. Supporters praise product quality, cost advantages and innovation potentials; opponents warn of environmental and health risks. A political solution to this conflict involves regulating the production and

Political transnationalization 107 authorization of genetically modified food. The difficulty for nation-states lies in the fact that – due to globalization and the establishment of global trade with genetically modified crops since the mid-nineties – they are no longer in a position to adjust their policies solely along the lines of national environmental and human health aspects, but now have to consider global competition and trade issues as well. Since regulation requirements exceed individual countries’ capacities, an effective solution to the problem depends on successful cooperation among state and non-state actors at the transnational level. Due to sharply contrasting perceptions on the type and scope of risks involved in the new technology, a high degree of political contestation is a central feature of global GMO regulation efforts (see Skogstad 2005). The institutional architecture is characterized by a multi-level structure without a focal arena; rather, competences are distributed across a number of arenas and actors. Nation-states, international organizations and a multitude of non-state actors (farmers, NGOs, multinational corporations, professional associations, think tanks, etc.) are involved in the regulatory process. Within the transnational policy regime, horizontal and vertical interlinkages have developed between different institutions from various policy fields (agriculture, environment, healthcare, trade). The result is a “complex regime” composed of several functionally and institutionally overlapping arenas in which organizational interfaces are of particular importance (see Raustiala and Victor 2004). Different international institutions deal with the central issues of risk assessment and risk management. Due to path dependencies in the various policy fields, domain conflicts exist within the regulatory arena. One such conflict, for instance, concerns the environmentally driven Conference of the Parties of the Biosafety Protocol on the one hand, and the WTO with its trade agreements on the other, and relates to the interpretation and jurisdictional scope of rules and procedures in the GMO field. Standard-setting organizations are particularly important. The Codex Alimentarius Commission, a joint programme of the FAO and the WHO, is the decisive arena for the adoption of global standards for food safety. The fact that Codex standards serve as a reference for potential WTO dispute settlement procedures has increased the Commission’s significance within the regime complex. However, as the approved standards are mainly soft law and agreements have to be transferred into national law to become mandatory, state actors continue to play a major role in successful implementation. Non-state actors are present in all institutions and arenas. They bring in their expertise and interests at all policy-relevant levels and are sometimes even directly involved in decision-making processes (e.g. in the Codex Task Force on Foods Derived from Biotechnology). Concerning implementation, they monitor the enforcement of regulations at national and international levels, and some NGOs become politically active themselves, for example by establishing GMOfree zones at the local level. By establishing transnational networks and engaging in various civil society activities, they contribute to rising stakeholder integration in GMO regulation. Despite the considerable number of actors, the regulatory field is dominated by a bipolar conflict. Due to different risk

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perceptions regarding biotechnological products, the two major trading blocks, the EU and the US, have developed competing regulatory approaches and attempt to assert them at the global level by means of various international institutions. This leads to a broadening of existing resource imbalances and diminishes the chances for less developed countries which have just started establishing biosafety measures to get actively involved in global rule-making (see Coleman 2005). In sum, a shift from national to more regional and global regulations for genetically modified food can be observed, which results in a transformation of policy-making and leads to new forms of governance. 3.3 Organized anarchy: Internet regulation Due to its transnational technical infrastructure, the Internet is a paradigmatic example of the incongruity between the regulatory issue and national jurisdiction. In addition, the Internet is linked to a multitude of technical, political, legal and economic regulatory problems so that neither unilateral regulatory solutions nor the usual forms of intergovernmental cooperation are sufficient. In the following, our focus is on those problems that are associated with the Internet’s technical infrastructure: standards, security, and the Domain Name System (DNS). In these areas, Internet regulation is characterized by significant functional complexity, resulting in interdependencies between regulatory problems and in potential conflicts of policy goals – for example between open standards and data security. Furthermore, we observe significant discrepancies concerning regulatory interests – for example controversies regarding the appropriateness of institutional design (actors, actor types, levels, architecture) and of regulatory mechanisms (hierarchical, self-regulation, market mechanisms, hybrids). Moreover, the relevant actors have differing interests and preferences. The institutional architecture of Internet regulation is characterized by a profound complexity. It is, for example, difficult to assess the number as well as the types of participating actors. In addition, actors can fluctuate and show various forms of overlapping memberships (e.g. in private industry or civil society associations). Finally, regulatory mechanisms vary depending on the functional and territorial area which often results in an unclear allocation of competences (e.g. between the relevant EU directorates-general or within the Internet Corporation for Assigned Names and Numbers, ICANN). Due to its institutional complexity, Internet regulation can be best labelled “organized anarchy”, a concept Peters transferred from the field of organizational theory into transnational politics (Peters 2005). Therein, a multitude of new institutional approaches can be identified apart from traditional institutions. Altogether, Internet regulation shows considerable institutional experimentation, various examples of the emergence of new and novel institutions, as well as the adjustment of existing institutions to this relatively new regulatory field. Not surprisingly, interfaces between various regulation problems have become crucial. The institutional architecture and the roles of state and non-state actors vary according to the regulatory problem (standards, security, DNS). Standard-setting

Political transnationalization 109 is, to a large extent, done by novel technical organizations that compete with traditional standard-setting organizations such as the International Telecommunications Union. Internet standards are often non-proprietary and non-binding, but are comprehensively applied and thus prevalent. The institutional complexity is most distinct in the area of cyber security and the institutional architecture is still quite young. In contrast, DNS regulation appears to be firmly institutionalized despite repeated reforms and ongoing institutional competition. ICANN, centrally responsible for DNS regulation, is an example of the more or less successful integration of diverse stakes and actor types within one organization and of the employment of various regulatory mechanisms. Since the Internet’s commercialization in 1991, interests, activities and influence of private industry actors have significantly increased. However, due to institutional path dependencies, the technical nature of the Internet and their technical expertise, specialized technical actors continue to play a central role. In contrast, outside the US, civil society actors have not succeeded in exerting relevant influence. Despite the large number of non-state actors and contrary to differing hypotheses, Internet regulation, however, more often than expected takes place by direct or indirect recourse to state actors; correspondingly, state actors’ influence is higher than presumed. This is particularly the case concerning the US government which, due to its financial role in the development of the Internet, holds proprietary claims and is, for instance, ICANN’s contractor. The various self- and/or coregulative institutional arrangements usually stand and act in the shadow of national hierarchies (e.g. in the area of infrastructure regulation, the Internet Engineering Task Force or the World Wide Web Consortium). It seems plausible that this development will continue due to the ongoing establishment of the Internet as a critical infrastructure.

4 Characteristics of transnational policy regimes The comparative analysis of our case studies shows a number of differences and commonalities.3 This concerns the constitutional logics and demarcation problems of transnational policy regimes (4.1), their institutional architectures and development (4.2), as well as the roles of state and non-state actors (4.3). 4.1 Constitutional logics and demarcation problems of transnational policy regimes The transfer of decision-making competences from the nation-state to transnational policy regimes necessitates the renegotiation of a number of problems which the nation-state had solved by its territorial demarcation and the resulting membership criteria (see Rokkan 2000). Where the border of a transnational policy regime runs, who participates in decision-making processes and who is affected thereby – all these issues are contingent and have to be resolved. In summary: transnational policy regimes require political construction and constitution. Our case studies show that this results in typical problems and conflicts

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which, in turn, lead to ambiguities and to a pluralization of borders and demarcations that seem characteristic for the process of reflexive modernization on the whole (see Beck and Bonß 2001; Beck and Lau 2004). In order to better understand the demarcation mechanisms in transnational policy regimes, it is useful to distinguish four ideal types: functional criteria that refer to factual problems or collective concerns; territorial criteria based on geographical attributes; social criteria concerning actor-specific attributes and historical criteria that relate to mutual historical experiences and recollections (see Grande 2006). By and large, demarcation in transnational policy regimes is hybrid and flexible but displays a typical pattern: in all cases, the source for the initial regime formation is a regulatory problem, a functional impetus. This accounts for competence and participation boundaries in regimes with noncomplex structures, for example transfer pricing regulation. By contrast and due to its functional complexity, the case study on Internet regulation shows that external boundaries can be so diffuse as to make clear-cut demarcation impossible. Accordingly, the affiliation and participation issues are difficult to resolve. This ambiguity is increased because functional interdependencies with adjacent regulatory issues – for example trade or data protection – are becoming increasingly important. This requires the redefinition of the transnational policy regime’s external boundaries and shows that transnational policy regimes are not exclusively constituted and demarcated via a functional problem. In more complex regimes, institutionalization is based on overlapping criteria. For the organization of their internal structure and in order to increase their internal complexity, functionally defined institutional architectures revert to territorial and social criteria as demarcation mechanisms. Such cases demonstrate a sequential reorganization and an overlapping of institutionalized demarcation logics which is necessary for the secondary regime-formation, that is for the differentiation of the internal structure. While it is an empirical fact that the criteria of regime-formation and -demarcation overlap, the question of how they overlap is always political. Therefore, in the course of demarcation, restructuring and pluralization, the conflict over recognition, that the “national constellation” (Habermas 1998) had solved via territorial borders, is renewed. Political transnationalization suspends institutionalized, national conventions and creates new pressures. This transition from territorially to functionally defined political arrangements – that is, from the nation-state to transnational policy regimes – has thus not entailed a de-politicization as assumed by older functionalism in International Relations (primarily Mitrany 1966), but, on the contrary, a re-politicization of decisions. 4.2 Institutional architecture and institutional development in comparison In addition to the general features presented above, the transnational policy regimes we examined display a number of commonalities across policy and problem areas. First of all, they are all of very recent nature. The constitution of these new forms of political authority can be dated to the last 30 years and their

Political transnationalization 111 institutional consolidation to the 1990s. Transnational governance can thus be interpreted as a reaction to the expansion and intensification of (economic, ecological or technological) globalization processes. Furthermore, these new institutional architectures show a highly expansive dynamic. During their short history, they have continuously incorporated more regulatory problems, integrated more actors and widened their territorial scope. In this context, we can also observe a territorially orientated internal differentiation. Regionalization of different scope and integration density has become increasingly important in these vertically arranged multi-level structures – even outside Europe.4 Besides formal institutions, informal relations between actors are of constitutive significance for the functioning of transnational policy regimes. In many cases, formal and informal institutionalizations complement and superimpose each other; one arena of the transfer pricing regime (the PATA) was explicitly founded on informal relations. This shows that an analysis of transnational governance must not be limited to formal institutions. Finally, we find significant asymmetries concerning staff, financial and/or informational resources between the actors involved in transnational policy regimes, potentially resulting in considerable power imbalances. This applies to state actors, for instance the considerable influence asymmetries among OECD countries, as well as between these and less developed countries. But power imbalances can also play an important role among non-state actors. ICANN is an example of this, since civil society actors are underrepresented compared to the multitude of commercial stakeholders. The fact that the institutional architecture of transnational policy regimes markedly differ in many respects is actually more important than the stated commonalities. Although all transnational policy regimes are defined by a distinct problem reference, they show considerable variations regarding their functional composition. The transfer pricing regime focuses on a small and clearly defined number of regulatory problems, while others are explicitly omitted. This clearcut functional demarcation can also be interpreted as a strategy to enable cooperation and increase effectiveness. In contrast, a problem-related demarcation in the case of Internet regulation is hardly feasible. This applies to the relationship between the three regulatory problems concerning the technical infrastructure and, moreover, to interdependencies with adjacent regulatory problems (e.g. intellectual property rights). The institutional complexity of transnational policy regimes varies significantly as well. It ranges from simple, only partly integrated structures in tax and finance policy to complex multilevel systems – for example the regulation of genetically modified food – that integrate all actor types on different levels of action. The institutional architecture of Internet regulation reaches a level of complexity that makes it difficult to assess even for participating actors. Differences regarding institutional architecture also refer to actor constellations. The number of participating nation-states varies: in GMO regulation, 171 countries are represented in the Codex Alimentarius Commission, while in the transfer pricing regime there are only 38. There is also a striking divergence concerning participating actor types. Basically all state and non-state – private industry,

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private sector, technical – actor types are involved in GMO and Internet regulation, whereas primarily (nation-)state actors participate in the transfer pricing regime. There are various reasons for the differences between our case studies. On the one hand, the participation and problem-solving strategies chosen by state actors appear to be particularly important and on the other, the varying degree of transnationalization in each regulatory area. The transfer pricing regime, for example, shows an insignificant degree of transnationalization as well as an exclusive participation and problem-solving strategy, while GMO and Internet regulation are not only far more transnationalized but also more inclusive. The stated differences allow us to establish several types of transnational policy regimes, classified on a continuum according to the degree of their institutional complexity. One endpoint of this continuum is the “intergovernmental network”, as in the case of transfer pricing regulation: an institutionally noncomplex form of sovereignty-preserving cooperation on the transnational level. Owing to their informational resources, non-state actors are indispensable, but their potential for action and influence basically remains in the shadow of the nation-states. The other endpoint is the case of Internet regulation that best corresponds to the concept of “organized anarchy” or to the “garbage can model” (see Cohen et al. 1972; on the application to new forms of transnational governance Peters 2005). This model is primarily characterized by three criteria: actors’ inconsistent and ill-defined preferences, which to a certain extent are formed within the policy process; unclear instruments and technologies of problem-solving and a complex and fluid actor constellation. GMO regulation – termed “regime complex” or “complex regime” – is situated between these two extremes. It differs from established forms of “simple” international regimes due to the institutional overlaps between various arenas and to the fact that it integrates very diverse (state and non-state) actor types (see Young 2002; Raustiala and Victor 2004). 4.3 The role of state and non-state actors Many authors have labelled the nation-state the loser of globalization and were alarmed about its loss of decision-making power vis-à-vis non-state actors and/or international organizations. Indeed, our case studies have shown that in many regulatory areas, nation-states are no longer in a position to fulfill their own claim for collective problem-solving. But our analyses also maintain that the role of nation-states in transnational politics has often been underrated. Owing to their claim for collective problem-solving, their privileged access to financial resources (tax monopoly), their unique institutional apparatus and their legitimacy, nation-states remain the central actors in collectively binding regulation of social problems in transnational policy regimes. Because of their legal status, this is particularly the case for actual decision-making. Whereas decisions will indeed frequently be made within the scope of international organizations, regional associations or other transnational arenas, nation-states, however, are

Political transnationalization 113 typically involved therein and they often dominate the decision-making process – as in the case of transfer pricing. Altogether, we observe a highly elaborate and variable distribution of responsibilities between state actors, international organizations and non-state actors within the scope of transnational policy regimes. The separation of powers among different arenas seems to be most advanced in the case of the transfer pricing regime where we can ascertain a sophisticated functional and regional distribution of responsibilities. State actors’ various roles within transnational policy regimes are best demonstrated by the Internet regulation regime. This case is instructive in a further sense, namely that it was long regarded as the classic example of privatized collective rule. Our analysis shows that state actors have meanwhile recognized the social, political and economic significance of technical regulation, and that they make use of their influence on decisionmaking and rule enforcement. This can entail the retransfer of competences back to the national level – for instance in the area of Internet security. Nation-states still possess a legal monopoly vis-à-vis norm addressees. However, they are dependent on non-state actors’ resources and competences and are, moreover, inclined to cooperate with them on a permanent basis within transnational policy regimes. In all our cases, non-state actors are involved in decision preparation, formulation and implementation. There are various reasons for their participation: their information capacity, their practical expertise, their monitoring, mobilization and representation capacities, the fact that they increase transparency and credibility of political decision-making and so on. State actors basically have two motives for integrating non-state actors: first, the latter possess resources advantageous for problem-solving which nation-states themselves do not have at their disposal, or at least not sufficiently; second, participation of non-state actors can have a positive effect on the recognition of political decisions (O’Brien et al. 2000). From the perspective of state actors, two ideal types of integration and legitimization strategies can thus be identified: one, technocratic, the other, participatory. Within this scope, non-state actors can have a variety of functions, ranging from select hearings to numerous forms of organizational integration in privatepublic partnerships and hybrid organizations and finally to non-state standardsetting and rule-making (Börzel and Risse 2005). A differential examination of non-state actors’ activities regarding the phases of the political cycle (agendasetting, decision-making, policy implementation) reveals further remarkable regularities (Grande and Pauly 2005b): Non-state actors’ influence is generally highest during implementation and lowest in decision-making.

5 Summary and research perspectives Transnational institution-building is a crucial feature of an encompassing transformation of modern statehood, resulting in the redefinition of state responsibilities and in a fundamental change in the organization of collective rule-making. In the course of this transformation, the external and internal demarcation

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constitutive for the modern nation-state and the ensuing organization of international relations is perforated. New transnational political problems and arenas are emerging and being occupied by novel forms of political institution-building. In order to adequately evaluate these new institutional architectures, we developed the analytical concept of transnational policy regimes and explicitly differentiated it from the “global governance” concept characteristic of globalization research. Transnational policy regimes do not necessarily differ from “global governance” structures in every respect and they are not necessarily completely novel. On the contrary, the concepts empirically overlap in crucial areas. Furthermore, historical research on empires, states and bureaucracy has amply demonstrated that non-hierarchical forms of political governance, private actors, as well as cooperation between state and non-state actors played an important role in the production of public goods long before new forms of governance were discovered beyond the nation-state. However, there is a sound basis for the assumption that the importance of transnational rule-implementation has increased, that novel institutional architectures have emerged and that these do not merely represent an intermediary phase en route to a federally organized “world government” (see Höffe 1999). Likewise, there are many reasons for not reverting to the normatively overburdened concept of “global governance” for the empirical analysis of these new forms of transnational governance. In this chapter and on the basis of empirical case studies on Internet, GMO and transfer pricing regulation, we applied the concept of the transnational policy regime to the analysis of decisive characteristics of transnational politics. One result is the considerable variance, not only concerning the functional scope and institutional complexity of transnational governance, but also the role of state and non-state actors. All our cases show that the role of non-state actors is less significant than often assumed in political science literature and that nonstate actor rule-making is delegated and generally takes the form of sovereigntypreserving, non-binding soft law. Finally, the emergence of transnational policy regimes entails novel problems concerning the demarcation of political authority. This relates to external demarcation vis-à-vis other regulatory areas, to membership and integration issues, to the separation of competences among participating states and to the inclusion of non-state actors. In order to fully develop its analytical potential, the concept of the transnational policy regime has to be elaborated in several regards. The first conceptual task is to extend and differentiate the suggested typology of transnational policy regimes. The outlined types “intergovernmental network”, “complex regime” and “organized anarchy” are a first attempt to classify individual institutions, actors and regulatory mechanisms, as well as more complex institutional configurations of transnational governance. We believe we have identified three decisive basic types, but this list is hardly exhaustive. Indeed, it is highly plausible that more types of transnational governance will be found and that the established typologies can be further differentiated. The development of a qualitative standard for evaluating transnational institution-building is a second conceptual task. In this context, the problem of the

Political transnationalization 115 “global governance” approach is not so much its normative orientation. Rather, the normative principles formulated within the scope of this approach are too vague for developing explicit criteria for the evaluation of transnational institution-building and for the reorganization of transnational politics. Recent attempts (see Held 2004) to devise such normative principles are not yet convincing. In essence, the goal has to be the establishment of a theoretically and empirically based correlation between institutional configurations of transnational politics on one side and their legitimacy and effectiveness on the other. How effective are the different types of transnational policy regimes and what is their degree of democratic accountability? Which types are more effective, which are more legitimate? Is there a type that combines both aspects? Is there a correlation between the degree of institutional complexity and performance? Are there potentially more efficient and simultaneously more legitimate institutional architectures? Which criteria can help us evaluate this? Our case studies show that it is extremely difficult to develop such categorizations and evaluations. Although we recognize their importance, we therefore chose not to include precise designations in this chapter. A third, primarily empirical research requirement is the analysis of the internal and organizational preconditions of transnational governance. The (empirical) focus of globalization research predominantly concentrates on external aspects and will have to be redirected towards internal issues. Our empirical case studies have shown that the participation in transnational policy regimes entails specific requirements and consequences for the actors involved. This is what we term internal transnationalization. The analysis of these organizational repercussions that confront corporate actors as a consequence of their external transnationalization is an important new perspective for political science research on globalization. In this context, the interdependencies between external and internal transnationalization and the resulting dynamics will have to be studied as well. This agenda of unsolved problems and incomplete tasks of globalization research is certainly not exhaustive. However, it shows that an enormous amount of research lies before us. In our opinion, the concept of transnational policy regimes is a promising start for dealing with these issues. Ultimately, it might provide us with an essential component for an empirically founded theory of the transformation of statehood in an age of globalization.

Notes 1 This chapter is based on a research project headed by Edgar Grande, “Globalization and the future of the nation-state”. The project is funded by the Deutsche Forschungsgemeinschaft as a part of Research Center 536 on “Reflexive Modernization”. The authors are indebted to the participants of the workshop “Globalization – research status quo and perspectives” at Arnoldshain (November, 2005) and of our 536 Research Center workshop “Reflexive modernization of state and politics” in Munich (December 2005) for their suggestions and comments; and to Astrid Gernig for the translation of the manuscript.

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2 The remaining case studies within the scope of our research project deal with pharmaceuticals’ regulation, global climate protection, debt rescheduling and relief and antimoney laundering. 3 Four case studies had to be omitted due to shortage of space. They comprise further differences and confirm the commonalties, but do not change the overall picture. 4 As in International Relations research, the term “regional” here refers not to subnational, but to supranational territorial dimensions (typically large continental areas).

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Political transnationalization 119 Héritier (ed.) Policy-Analyse. Kritik und Neuorientierung, PVS-Sonderheft 24, Opladen: Westdeutscher Verlag: 39–56. –––– (2000) “Politikwissenschaft in einer entgrenzten Welt”, MPIfG Discussion Paper, 00/3. Online. Available www.mpi-fg-koeln.mpg.de/ pu/mpifg_dp/dp00–3.pdf. (accessed 26 May 2006). –––– (2005) “Governance Theory als fortentwickelte Steuerungstheorie?” in G.F. Schuppert (ed.) Governance-Forschung. Vergewisserung über Stand und Entwicklungslinien, Baden-Baden: Nomos: 9–20. Mayntz, R. and Scharpf, F.W. (eds) (1995) Gesellschaftliche Selbstregelung und politische Steuerung, Frankfurt/M./New York: Campus. McGrew, A. (2002) “Liberal Internationalism. Between Realism and Cosmopolitanism”, in D. Held and A. McGrew (eds) Governing Globalization. Power, Authority and Global Governance, Cambridge: Polity Press: 267–90. Messner, D. (ed.) (1998) Die Zukunft des Staates und der Politik: Möglichkeiten und Grenzen politischer Steuerung in der Weltgesellschaft, Bonn: Dietz. –––– (2005) “Global Governance. Globalisierung im 21. Jahrhundert gestalten”, in M. Behrens (ed.) Globalisierung als politische Herausforderung. Global Governance zwischen Utopia und Realität. Ein Lehrbuch, Wiesbaden: Verlag für Sozialwissenschaften: 27–54. Messner, D. and Nuscheler, F. (2003) “Das Konzept Global Governance Stand und Perspektiven”, INEF Report, 63, Duisburg: Institut für Entwicklung und Frieden. Mitrany, D. (1966) A Working Peace System, Chicago, IL: Quadrangle Books. Nettl, J.P. (1968) “The State as Conceptual Variable”, World Politics, 20/4: 559–92. O’Brien, R., Goetz, A.M., Scholte, J.A. and Williams, M. (2000) Contesting Global Governance: Multilateral Economic Institutions and Global Social Movements, Cambridge: Cambridge University Press. Oberthür, S. and Gehring, T. (eds) (2006) Institutional Interaction in Global Environmental Governance. Synergy and Conflict among International and EU Policies, Cambridge, MA: MIT Press. Ohmae, K. (1990) The Borderless World. Power and Strategy in the Interlinked Economy, New York: Harper Business. –––– (1995) The End of the Nation State. The Rise of Regional Economies, London: Harper Collins. Palan, R. (2002) “Tax Havens and the Commercialization of State Sovereignty”, International Organization, 56/1: 151–76. Peters, B.G. (2005) “Governance. A Garbage Can Perspective”, in E. Grande and L.W. Pauly (eds) Complex Sovereignty. Reconstituting Political Authority in the TwentyFirst Century, Toronto: University of Toronto Press: 68–92. Porter, T. (2005) “The Private Production of Public Goods. Private and Public Norms in Global Governance”, in E. Grande and L.W. Pauly (eds) Complex Sovereignty. Reconstituting Political Authority in the Twenty-First Century, Toronto: University of Toronto Press: 217–37. Prange-Gstöhl, H. (2004) “Wege zum Innovationsstaat. Der Wandel der Forschungs- und Technologiepolitiken in Deutschland, den Niederlanden, der Schweiz und Schweden im Globalisierungszeitalter”, unpublished thesis, Technische Universität München. Raustiala, K. and Victor, D.G. (2004) “The Regime Complex for Plant Genetic Resources”, International Organization, 58/2: 277–309. Reinicke, W.H. (1998) Global Public Policy. Governing without Governance, Washington, DC: Brookings Institution Press.

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Reinicke, W.H. and Deng, F. (2000) Critical Choices. The United Nations, Networks, and the Future of Global Governance, Ottawa: International Development Research Centre. Rhodes, R.A.W. (1985) “Power-dependence, Policy Communities and Inter-governmental Networks”, Public Administration Bulletin, 49: 4–29. Risse, T. (2002) “Transnational Actors and World Politics”, in W. Carlsnaes, T. Risse and B. Simmons (eds) Handbook of International Relations, London: Sage, 255–74. Risse-Kappen, T. (ed.) (1995) Bringing Transnational Relations Back In. Non-State Actors, Domestic Structures and International Institutions, New York: Cambridge University Press. Rokkan, S. (2000) Staat, Nation und Demokratie in Europa (Edited and introduced by Peter Flora), Frankfurt/M.: Suhrkamp. Rosenau, J.N. and Czempiel, E.-O. (eds) (1992) Governance Without Government. Order and Change in World Politics, Cambridge: Cambridge University Press. Scharpf, F.W. (1999) Regieren in Europa. Effektiv und Demokratisch? Frankfurt/M.: Campus. –––– (2000) “The Viability of Advanced Welfare States in the International Economy. Vulnerabilities and Options”, Journal of European Public Policy, 7/2: 190–228. Scharpf, F.W. and Schmidt, V.A. (eds) (2000) Welfare and Work in the Open Economy, 2 Vols, Oxford: Oxford University Press. Schimmelfennig, F. (2004) “Liberal Intergovernmentalism”, in A. Wiener and T. Diez (eds) European Integration Theory, Oxford: Oxford University Press: 75–94. Schirm, S.A. (2002): Globalization and the New Regionalism. Global Markets, Domestic Politics and Regional Cooperation, Cambridge: Polity Press. –––– (ed.) (2004) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave Macmillan. –––– (2005) “Der Einfluss von Interessen und Normen auf nationale Positionen zur Global Economic Governance”, Zeitschrift für Politikwissenschaft 15/3: 825–47 Schuppert, G.F. (ed.) (2005) Governance-Forschung. Vergewisserung über Stand und Entwicklungslinien, Baden-Baden: Nomos. Skogstad, G. (2005) “Contested Political Authority, Risk Society, and the Transatlantic Divide in the Regulation of Genetic Engineering”, in E. Grande and L.W. Pauly (eds) Complex Sovereignty. Reconstituting Political Authority in the Twenty-First Century, Toronto: University of Toronto Press: 238–60. Slaughter, A.-M. (2004) A New World Order, Princeton, NJ: Princeton University Press. Strange, S. (1996) The Retreat of the State. The Diffusion of Power in the World Economy, Cambridge: Cambridge University Press. Väyrynen, R. (ed.) (1999) Globalization and Global Governance, Lanham, MD: Rowman & Littlefield. Vogel, D. (1997) “Trading Up and Governing Across. Transnational Governance and Environmental Protection”, Journal of European Public Policy, 4/4: 556–71. Wagschal, U. (2005) Steuerpolitik und Steuerreformen im internationalen Vergleich. Eine Analyse der Determinanten, Ursachen und Blockaden, Münster: Lit. Weiss, L. (1998) The Myth of the Powerless State, Ithaca, NY: Polity Press. –––– (ed.) (2003) States in the Global Economy. Bringing Domestic Institutions Back In, Cambridge, MA: Cambridge University Press. Wolf, M. (2004) Why Globalization Works, New Haven, CT: Yale University Press. Young, O.R. (ed.) (1997) Global Governance. Drawing Insights from the Environmental Experience, Cambridge, MA: MIT Press.

Political transnationalization 121 –––– (2002) The Institutional Dimensions of Environmental Change. Fit, Interplay, and Scale, Cambridge: MIT Press. Zohlnhöfer, R. (2005) “Globalisierung der Wirtschaft und nationalstaatliche Anpassungsreaktionen”, Zeitschrift für Internationale Beziehungen,12/1: 41–75. Zürn, M. (1998) Regieren jenseits des Nationalstaates. Globalisierung und Denationalisierung als Chance, Frankfurt/M.: Suhrkamp. –––– (2001) “Grenzen nationalstaatlichen Regierens. Neue Aufgaben intergouvernementaler Foren”, Internationale Politik, 56/5: 25–30. –––– (2004) “Global Governance and Legitimacy Problems”, Government and Opposition, 39/2: 260–87.

7

Business and governance Transnational corporations and the effectiveness of private governance Doris Fuchs

Global governance is the political attendant phenomenon and aftereffect of globalization. Defined as “multi-actor, multi-level political decision-making”, global governance emphasizes political consequences of globalization as increased political capacities of non-state and supra-national actors. From the perspective of various observers, most notably business actors – particularly transnational corporations (TNCs) – are the major political beneficiaries of globalization. However, their capacities’ expansion has different dimensions: developments in activities and strategies in the field of lobbying, of agenda setting power and of discursive influence in public debate. The globalization literature draws attention to the new political role of business actors referring to the development of private governance and private authority in particular, wherein two forms of private governance are discussed: self-regulation by standards or codes of conduct, defined by economic actors, and co-regulation by cooperation between economic and public or civil society actors in terms of public-private partnerships or private-private partnerships. Besides offering a large variety of case studies presenting examples of self- and co-regulation, this literature is characterized by disputes over the effectiveness and associated legitimacy of those private governance institutions. This chapter aims at encouraging scientific discussion about the effectiveness of private governance by business actors. Starting from a demonstration of the state on the art to the political role of business actors within the globalized world, the account formalizes arguments regarding the expected effectiveness of private governance. In doing so, it emphasizes the rationalistic perspective, which is based on cost-benefit calculation, and is important from a business actor’s point of view. The pursuit of that perspective does not mean, however, that standards and values and also institutional contingencies do not count. Rather, they are integrated in the economic perspective in the course of this approach. In conclusion, this chapter illustrates briefly the attained insights by means of three examples of self- and co-regulation: the ISO 14000 Standard for Environmental Management Systems, the Forest Stewardship Council and the Global Compact.

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1 State of research on the new political role of business actors Globalization shows a series of characteristics which influence the distribution of political capacity between state and non-state actors (as well as between different political levels of decision making). Globalization is associated, for instance, with a decreasing importance of territorial jurisdiction, among other things caused by mobility of capital and with increasing significance of access to and control over transnational communication, financing and production networks as a source of power (Scholte 2000). Furthermore, increased complexities of social orders and persistent problems with economic growth have led to a loss of confidence in the abilities of politics, and to a larger orientation toward the needs and economic expertise of business. Simultaneously, corporations have grown to gigantic dimensions in the course of takeovers and mergers, so that at least on the surface it seems that evanescent governmental resources confront increasing economic resources. Against this background, it is not surprising that both scientific and popular literatures emphasize the increasing political role of business actors, TNCs in particular.1 In this context, functionalistic and power-theoretical approaches differ from each other. The former tends to ask which governance duties TNCs can and shall take over. Can they perform traditionally governmental tasks as good as or even better than national actors? This approach has developed from the originally normatively characterized conception of global governance, which defined global governance as a response to problems emerging from globalization. Its solutions implied cooperating governmental and non-governmental actors as a result of the shifts in political capacities discussed above (Rosenau and Czempiel 1992; Messner and Nuscheler 1996, 2003). More recent analyses of the functions business actors take on in governance do not necessarily share this a priori positive conceptualization of the contribution of non-state actors to governance any more. Compared to the power theoretically focused debate, however, they still maintain a substantially more optimistic undertone. The power-theoretical perspective regarding the change of the business actors’ political role comes from a rather analytical conception of global governance. It defines global governance as a consequence of the power shifts associated with globalization which set new opportunities and limits for state and non-state actors pursuing their respective interests in the political process (Hewson and Sinclair 1999; Fuchs 2005a; Levy and Newell 2004). Developing from this definition is the question of implications of these power shifts for the provision of public goods, democracy and social justice, whereby the normative aspects of cognitive interest move into the centre of the discussion again (Brand et al. 2000). Today, both perspectives have moved towards each other. However, there remain different focal points regarding focus and approach. Studies, which predominantly enquire into the tasks taken over by business actors within the new forms of governance, tend to concentrate on developments in rules and standards

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set by private actors. Studies focusing on the question of power, on the other hand, tend to consider a broader range of political activities by business actors and, thereby, contributions to governance. There, developments in business actors’ power of rule-setting illustrate only one dimension of the new political role of businesses. On this account, the following discussion will use this perspective in order to define the field before focusing on private rule-setting, namely private governance in the narrow sense, as core subject of both perspectives.

2 Dimensions of power of TNCs Studies with a perspective on power have pointed out the increasing but in some ways also fragile instrumental, structural and discursive power of TNCs (Fuchs 2005a, b; Levy and Egan 2000). Instrumental power, in these studies, is defined as the power deriving from an actor’s material resources, which is used to exert direct influence on decision makers. Transnational corporations wield instrumental power most notably through lobbying, which has expanded quantitatively and qualitatively in the course of globalization. Most importantly, they have substantively expanded their lobbying activities in supra-national decision making arenas, in which the resources available to business actors tend to open up a competitive advantage over civil society actors (Higgott et al. 2000; Ledgerwood and Broadhurst 2000).2 In addition to instrumental power, the structural power of business actors has been a subject of scientific research since the 1970s (Fagre and Wells 1982). The traditional conception of structural power primarily focuses on business actors’ power, accrued from mobility of capital, to influence governmental policy making by implicit threats of relocating investments. Critical observers bring forward the argument that this structural power has increased in the course of extended competition over investments between national as well as sub-national political entities (Strange 1998). Furthermore, changes in production and financing structures have enhanced the TNCs’ independence from producing countries. In addition, the increasing share of speculative finance capital in global capital flows denotes an expanding structural power of business actors (Brand et al. 2000). However, the evidence of quantitative studies regarding the development of structural power of business actors is not unambiguous (Ganghof 2005; Garrett 1998). Finally, one can also determine interesting changes in the discursive power of business actors. Discursive power follows from ideational systemic factors, and plays an increasingly important role due to the growing extent to which political decisions depend on the competition for power of definition within the public discourse (West and Loomis 1999; Hajer 2003). Their acquisition of legitimacy as a political actor, which is reflected by business’ increasing acceptance of an assumption of traditionally public duties, has strengthened the discursive power of TNCs (Fuchs 2005c). Discursive power is additionally invigorated by a multitude of the business actors’ activities which communicate social responsibility

Business and governance 125 and, thereby, serve the protection and fortification of legitimacy. Simultaneously, business’ legitimacy as a political protagonist is controversial; hence, one has to denote its discursive power as fragile (Prakash 2002). Discursive power might show the most interesting and extensive development of the TNCs’ political role; however, it has been least explored so far. The power of rule-setting, acquired by TNCs, finally brings together functionalistic and power-theoretical perspectives on business’ political role again, since the development and implementation of standards and codes of conduct is also a core subject of the functionalistic perspective. The extent of rule-setting through TNCs has made a dramatic quantitative and qualitative leap in recent decades.3 It is not an entirely new phenomenon. Examples of private governance had already existed in medieval times, as in maritime law or guilds (Cutler 1999). Corporatist institutions of European welfare states also often relied on self-regulation (Mayntz and Scharpf 1995). However, the number of self- and co-regulating institutions as well as the degree of autonomy and influence of business actors within these institutions has increased drastically since the 1980s. Today, there is a nearly unmanageable number of company- and sectorspecific, national and global standards and codes of conduct. Moreover, there is a multitude of formal and informal public–private partnerships and private–private partnerships. Scientists, however, not only emphasize quantitative but also particularly qualitative changes which are reflected in this development. They stress that non-state actors today hold a position of political authority which is based upon their pragmatic, moral and cognitive legitimacy, and provides their rule-setting activities with an obligatory quality (Cashore 2002; Cutler et al. 1999). Besides, they point out that many of those private governance institutions are located in areas beyond the business actors’ core activities (Weiser and Zadek 2000). Furthermore, they show that these private governance institutions are characterized by an increasing independence of private actors and by the decline of comparative influence through the state. This development partly follows from an expansion of self- and co-regulating institutions into the trans- and supra-national range in which the shadow of governmental hierarchy, characteristic of selfregulation in corporatism, is not given, or at least not to a comparable extent. Eventually, scientists observe that private governance institutions have an increasing influence on governmental regulation which leads to the attestation of a new political strength of business actors (Clapp 2001).

3 Structures, forms and contents of private governance As already said, self- and co-regulating institutions represent the most frequently discussed examples of private governance. They are established at public actors’ disposition or permission, or on private actors’ own initiative, and can be based upon formal agreement with a profoundly institutionalized cooperation, or upon informal practices of communication and collaboration. Particularly autonomous and coevally institutionalized forms of self-regulation have attracted the

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attention of scholars and politicians. On the one hand, they lead to the question why business regulates itself instead of – as often implied – avoiding regulation. On the other hand, those institutions lead to sceptical questions about their effectiveness and implication, most notably because most of them are based on voluntary participation, and in the eyes of critical observers often define comparatively weak criteria. The same applies for public–private partnerships and private–private partnerships, institutions of co-regulation in which private actors cooperate with public actors, or scientific with civil society actors. Basically, an increasing thematic focus can be observed within business’ activities regarding rule-setting. Whereas the first institutions of self-regulation concentrated on the environment, such as ISO 14000 or Responsible Care, social standards such as SA 8000 were developed or incorporated in existing standards in the following phase. In the last phase, eventually, the question of the business actors’ role regarding conflict prevention and processing was added, expressed for instance in the Kimberley process about diamond production or in the principles of “publish-what-you-pay”. Beyond, in terms of participation, one can observe a basic (even though not exclusive) trend from business specific selfregulation to cross-sector co-regulation (Nadvi and Wältring 2002). In addition to this fundamental development of self- and co-regulating institutions, individual sectors have extended their political role surpassingly and therefore attracted special attention in scientific research. In particular, the increasing influence of rating agencies – as a result of cumulative relevance of competition for investments – has been discussed critically (Hillebrand 2001, Sinclair 1999). The most recent studies have broadened this focus to coordination service firms in general, that is firms setting standards for corporate organization and processes in many parts of the world today, which thereby exert wide influence on economic and particularly social conditions (Nölke 2005).

4 Origin and implications of private governance With respect to the origin of self- and co-regulating institutions, the literature primarily points out the economic and normative motivations of business actors (Cutler et al. 1999). Thus, business actors become active in self- and co-regulation in order to demonstrate ecological and social responsibility as well as to avoid corresponding scandals and reduce economic risk. Accordingly, the Responsible Care programme of the chemical industry was developed and implemented in the context of Seveso and Bhopal. Simultaneously, normative changes and learning processes within the top management and/or staff underpin business actors’ motivation in implementing self-regulating institutions and participating in co-regulating institutions. The fact that corresponding normative changes also happen in society establishes an additional connection between normative and economic motives for business actors. Normative expectations by society in conjunction with the mediatization of politics can lead to the punishment of business misconduct through consumers and/or the development of new

Business and governance 127 regulations through politics. Under these conditions, the adoption of social responsibility is within the economic self interest of businesses, and serves the preservation of their License to Operate (Suchanek 2004). When asking for the implications of the increasing number of self- and co-regulating institutions, one has to distinguish between output, outcome and impact (Easton 1965). The particular standard is output; the actual change in business conduct achieved in the course of the standard’s implementation, that is the contribution to problem solving, is outcome; and additional economic, ecological, social and political externalities are the impact. The question about the effectiveness of private governance, the focus of this chapter, primarily refers to outcome. When analysing the effectiveness of private governance one further has to be aware that assumptions expressed in science and politics regarding the reasons for the emergence and the implications of private governance are often closely connected. Different assumptions about business motivation allow different conclusions regarding the consequences of private governance. Thus, participants in the debate who assume normative motives or the existence of sufficient economic incentives tend to expect that private governance can make an effective contribution to the provision of public goods. On the basis of this expectation, they additionally emphasize the advantages of governance decentralization in the context of fast changing, complex social requirements, as well as the advantages of using additional financial, technological and organizational resources with simultaneous exoneration from the state (Reinicke 1998; Scharpf 1991). Additionally, they appreciate the opportunity for proactive behaviour which private governance institutions offer business actors in connection with social and ecological problems (Sharma and Vredenburg 1998). Scientists and activists, who emphasize economic business motivations and, simultaneously, are not convinced that sufficient economic incentives exist for actual changes in business performance, rather expect that private governance is ineffective. A lack of sufficient economic incentives could result from information deficiencies, high transaction costs or other barriers to action on the part of consumers, for example. In this context, observers accentuate often vague process criteria of self- and co-regulating institutions regarding output, and lacking control and penalty mechanisms regarding outcome, and question to what extent participating business actors abuse self- and co-regulation only for image campaigns, particularly the “green”-, “blue”-, and “white-washing” of their business practices (Garrod 1998; Gibson 1999). Thus, scholars document that even prominent Codes of Conduct generally tend to be handled in a rather lax manner when it comes to implementation, and accordingly have led to worsening in environmental and social performance in some cases rather than an improvement (Haufler 2001; King and Lennox 2000; Moffet and Bregha 1999; Mirbach 1999). In addition, they broach the issue of the possible impact of private governance on political developments by referring to the point that self- and coregulating institutions can serve the purpose of avoiding or undermining more stringent and compulsory public regulation without having business actors actually conducting drastic improvements (Braun 2001). This is also the reason, by

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the way, that arguments, which make the claim that the existence of private governance is always an improvement when compared to non-existing public governance, do not hold. Simultaneously, critical observers argue that governance privatization by regulation institutions such as codes of conduct lead to the prevention of public participation and responsibility towards the public (Heinelt 2002). However, even if assuming purely economic motivation and a lack of economic incentives, the agenda-setting effect of private governance should not be underestimated. The fact alone that certain topics receive more attention by (top) management can lead to the realization of simple opportunities for improvement in practices. A fundamental problem of previous research regarding private governance, that particularly complicates the answer to the question of effectiveness, is the dominance of case studies about individual governance institutions which do not allow the creation of an overall picture. Comparative empirical analyses of the determinants of the effectiveness of self- and co-regulation are missing. The present analysis cannot show corresponding results either because of temporal and spatial limits. It will formalize ideas regarding factors, however, which are likely to influence the effectiveness of private governance in order to achieve a base for differentiated understanding of its potential for solving political problems, especially the provision of public goods.

5 The effectiveness of private governance As pointed out earlier, the question about the effectiveness of private governance eventually refers to changes in business conduct that are actually achieved in the course of the implementation of the agreed private standard, that is, outcome in Easton’s terminology. This outcome in turn is a function of the agreed standard, that is, of the output as well as of existing incentives and opportunities to meet standards, to outperform them, or to fail to comply. Hence, the first part of the following discussion will concentrate on output determinants of private governance, and the second part will discuss expected outcome determinants (for an analysis which focuses primarily on the output dimension see Macht and Rieth 2005). 5.1 Output Output of private governance, that is the determined standard, can be illustrated as a consequence of cost-benefit analyses of participating business actors. Institutional as well as material goods are usually characterized by a bulk of property rights which show different characteristics regarding their divisibility and usability (Fuchs 2003). Governance institutions, which at first sight serve the allocation of collective goods, have private benefits as well.4 If a company can reduce the risk of a scandal and therefore ecological and economic harm by, for example, introducing an environmental management system, then this environmental management system will generate not only better environmental quality as a

Business and governance 129 collective good but also a private benefit for the company. Also the basic improvement of a company’s image as Corporate Citizen, the prevention of expensive governmental regulation, or the opportunity to gain higher prices by using higher ecological and social standards add to this private benefit of private rule-setting. For business purposes it is reasonable to invest in private governance as long as the private benefits of the relevant governance institution exceed its private costs. Figure 7.1 shows this cost-benefit function for two companies A and B. The cost of investment in governance (Ca and Cb) increases with the stringency of a standard to an increasing degree. “Stringency” here means ecological and social claim of performance. Thus, one can differentiate between standards according to whether they define (only) process standards or performance standards as well and in terms of the ambition of the performance criteria. While first improvements in ecological and social areas generally can be attained with relatively low investments, marginal costs of improvement increase with rising standard stringency. The position of the cost function depends on technological and organizational characteristics of the company and can vary, for example due to the existence of economies of scale or differences in the know how of companies. Also, the private benefit of investments in governance institutions, for example in the form of a reduction in the risk of scandals, increases with such investments (BA and BB), to a decreasing degree however. While first investments can be expected to already deliver substantial improvements regarding the risk potential, further reductions in risk decrease with more investments. The different cost and benefit functions of companies follow from the fact that not all of them have the same opportunity of transforming governance investments into corresponding economic gains. Companies which are rather the object of NGO campaigns or new public regulation due to their company and brand image, sector characteristics, cultural origin or closeness to consumers, or which are more sensitively hit by political consumption strategies, can benefit g

Cb

Ca

BA

BB

SB

SA

Stringency

Figure 7.1 Cost-benefit function for two companies.

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more from private rule-setting than companies for which the different factors do not apply. Thus, socio-institutional path dependencies play a role as well. Today’s public perception of the chemical industry is based much more on its history than on current performance, for instance. Simultaneously, companies which operate in less competitive market segments due to market structure or product characteristics have better chances to economically benefit from investments in governance institutions than others. From this perspective, the benefits of the Kimberley Standard for trade in diamonds are highly privatizable for de Beers, for example. Differences in the proprietary structure can influence this utility function as well. Additionally, it has to be considered that the benefit function’s position is also influenced by deliberate and unconscious decisions regarding the valuation of risks and opportunities. In this respect, the top management’s normative perspective and therefore connected social and intra-corporate learning processes also have a bearing on the benefit function’s position (Nash and Ehrenfeld 1997; Cutler et al. 1999). Private governance will be the more stringent the more importance the top management ascribes to social and ecological dimensions of corporate policy. Eventually, the involvement of civil social or public actors influences the utility functions of participating businesses as well. Here, it is certainly expected that particularly the involvement of the civil society will lead to higher levels of governance investments when developing, implementing and enforcing a standard. This effect can be explained easily from the benefit point of view since the civil society’s participation usually implicates higher credibility and, therefore, higher private benefit. The same applies to participating public actors, admittedly to a somewhat lesser extent due to the – at least in some countries – growing concern about a potential capture of the state. Recapitulating, the following determinants about the business utility functions’ position regarding private governance investments can be observed: size of the company, proprietary structure, country of origin, host country, business history, range of products and brand image, sector, values of the executive board, affiliation in trade associations, competitive environment, civil society and/or state involvement (co-regulation). The perspective on cost-benefit functions of business actors demonstrates that a company will prefer an all the more stringent rule-setting, the higher the privatizable benefit of the rules and the lower the cost of required investments. When there is a high opportunity to privatize benefit of governance institutions and a low cost function, investments can be profitable for company A up to point SA, while investments for company B are only lucrative up to point SB. This is because company B cannot economically benefit from such investments as much and has higher costs (Figure 7.1). However from an economic point of view, the ideal point of investment would be attained earlier in each case, namely at the point of maximum net benefit which is shown in Figure 7.2 for company A with SA* (and, of course, can be equally determined for company B). The different cost-benefit functions point out that under private rule-setting exceeding the limit of a single company a compromise frequently will be

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g

CA

BA

SA*

SA

Stringency

Figure 7.2 Point of maximum net benefit.

needed. For our example, the stringency of the agreed standard, respectively the output of private rule-setting between companies A and B, would lie somewhere between SA* and SB*, including both ending points (SB* ≤ SAB ≤ SA*). In other words, there are three possibilities: an agreement on the minimum standard (SB* = SAB), a compromise on a standard between both ideal points (SB* < SAB < SA*), or an agreement on the maximum standard (SA*= SAB). Simultaneously, these thoughts show possible strategies of external actors to influence private governance output. Thus, NGOs or a “shadow of hierarchy” created by public actors can increase the cost of failure for business actors, and, therefore, move the companies’ benefit functions to the upper right. In this context, a focus by NGOs or public actors on companies of type B suggests itself since a movement of their benefit functions most clearly could improve the agreed standard.5 5.2 Outcome The three above-mentioned possibilities of output contain different implications for the implementation of the standard and, therefore, the outcome, respectively of the effectiveness of private rule-setting. In case of an agreement on minimum standard (SB*), the incentive arises for company A to invest beyond the standard. Such investments by A will be smaller, however, as a softer standard cannot be communicated with as much gain. When there is a compromise between the positions, incentives of non-compliance arise for company B, besides the incentives for A to exceed the standard. For the third model, the agreement upon a maximum standard, the incentive for company B not to comply with the standards is the largest. In this respect, the effectiveness of a standard should be thought of as a band of performance around the agreed standard SAB, which

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allows for both leaders and laggards (Figure 7.3). The direction of this band will depend on a number of factors. If agreed upon a minimum standard (SB* = SAB), the band will be to the right of the agreed point of investment (Figure 7.3a). When there is a compromise between both preferred positions (SB* < SAB < SA*), it will be both above and underneath the agreed standard (Figure 7.3b), and when a high standard is agreed upon, the band will be on the left of the point of investment (Figure 7.3c). The spread of the band below the standard will be influenced by the existence of monitoring and sanctioning mechanisms, among others. These will influence the negotiations on the stringency of the standard already, as company B will refuse to accept a high standard that is coupled with strong opportunities for monitoring and sanctioning. Thus, the actual effectiveness of private governance can clearly exceed the agreed standard or clearly lie underneath. When can one expect which form and direction of a performance band? Generally, tight performance bands are only probable within small groups of relatively homogeneous actors. However, as soon as we talk about sector or global standards, a relatively extended stretch should be expected. Although a handful of large companies control large parts of the world market within few sectors, there are still a number of smaller companies within most of the sectors so that the cost-benefit functions are heterogeneous. Particularly the roles of NGOs, whose resources for monitoring business performance are limited, as well as the boundaries of public receptiveness and reactivity regarding the revelation of “scandals” show that only the companies which so to speak stand in the first row of public perception feel public pressure in its whole extent. Also the factors which influence the direction of the band of performance can be identified. The agreed standard will depend on the power distribution among companies, control and penalty possibilities, as well as on costs associated with defection of individual businesses. Thereby it is assumed that the case of standard agreement is rare at the upper end of the performance spectrum. A highly ambitious standard which enables laggards’ defection only makes sense for leaders if neither the standard’s reputation is damaged nor their own. Such damage could result, after all, in case failure of standard performance by laggards becomes public. A highly ambitious standard without the opportunity of defection, that is with efficient control and sanctioning mechanisms, however, will hardly be acceptable for mass-market companies, and, as such, only be existent in case of a strong asymmetric power distribution in favour of companies with higher benefit functions. Moreover, one can expect that a group standard will be located closer to the left end of the performance band the less relative influence companies with high benefit functions have in negotiations, and the more sanctioning mechanisms are created. The latter will be needed more if the group is heterogeneous and big, that is the bigger the collective action problems within the group and the incentive to defect. In such situations, it is more likely to encounter rather low standards, respectively standards which secure the minimum performance and, simultaneously, give leeway to the better performance of businesses, and foster

SB*⫽SAB

(a) g

SAB

Stringency SB*⬍SAB⬍SA*

(b) g

SAB

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SA*⫽SAB

(c) g

SAB

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Figure 7.3 Agreement upon a common standard.

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the expansion of the performance band towards the right through incentive structures and learning processes. Hence, one can derive a minimum of effectiveness from the standard’s stringency in such situations and, simultaneously, consider a further potential positive momentum from learning processes and incentives to out-perform the standard. One should not infer standard effectiveness only from the good performance of individual leader companies, however. In other words, the usefulness of individual case studies or even surveys of a select range of companies (such as the biggest ones) or companies in the “first row” is limited here. Standards within the midfield of the performance band should be expected as a compromise solution which allows a certain range of actual conduct in both directions. However, leaders should have an interest in standards not being undercut too often and explicitly, and, thereby, losing their private benefit. Such standards can be found in situations in which informal control and penalty mechanisms exist due to group characteristics, and collective action problems remain manageable. The standard’s stringency itself provides an indication of its average effectiveness in such cases. However, due to their frequent focus on leaders or laggards, the value of case studies regarding individual companies or a select number of companies is limited here as well. Again, empirical studies would thus need to analyse the full range of relevant companies or an arbitrary sample. Eventually, there is a fourth not yet mentioned option of combination between output and outcome of private governance. Specifically, one may witness the formation of partial group standards. This will be the case in particular when the utility functions of company types such as A and B come apart widely, but, at the same time, company A has a sufficiently high benefit function to want to invest in governance. In this case, one would expect the introduction of a collective self- or co-regulating institution under company type A. With such a standard, one can assume a relatively narrow performance band and actual effectiveness of the respective governance institution close to the verbalized standard. However, this estimation is one of internal effectiveness of the standard, which will be at odds with external effectiveness, that is its spreading.

6 Illustration and implications The ideas on the effectiveness of private governance delineated above, particularly on the overall outcome described by the performance band, will be illustrated considering three concluding examples of self- and co-regulation: standard ISO 14000, Forest Stewardship Council (FSC) and Global Compact. 6.1 ISO 14000 The ISO 14000 standard refers to an internationally valid norm family created in 1996, which specifies criteria for the composition of a systematic environmental management system, and was developed by the International Organization for Standardization. Companies, specifically company facilities, which establish an

Business and governance 135 environmental management system according to ISO 14000, can be certified by private accredited auditors. Essential criteria in this process of certification are the compliance with legal regulations, active involvement of internal and external stakeholders, goal and process development of environmental management and the allocation of human resources. In 2004, more than 90,000 facilities in 127 countries were ISO 14000 certified. In the literature we find a substantial variance in evaluations of the effectiveness of ISO 14000 standard. Clapp (1998, 2001) and Krut and Gleckman (1998) see the standard’s effectiveness regarding the improvement of business’ environmental performance critically since goals of environmental management which transcend compliance with legal regulations are specified by the individual company itself.6 Hence, certification is also possible in cases of minimum performance improvement. Other empirical studies, however, found evidence of a positive effect of ISO 14000. Which gauge and direction would one expect regarding ISO 14000 on the basis of ideas raised in the previous section? The population of companies for which an ISO 14000 certification might be relevant is very big and is characterized by a large heterogeneity of cost-benefit functions. Simultaneously, internal control and compliance based on intrinsic motivation and peer pressure could hardly be enforced for this population. Under those conditions, one should expect a standard which determines the minimum limit of effectiveness and, simultaneously, protects it with the help of a sanctioning mechanism. In addition, leaders should raise the average standard effectiveness. And indeed, the ISO 14000 standard offers these characteristics. Instead of substantial performance requirements, it constitutes a minimum standard with a focus on processes, which is secured by an independent certification process. Simultaneously, it provides a framework for business performance above the standard via the possibility of private goal definition. Additionally, by emphasizing supply-chain management, the standard includes possibilities for leaders to encourage laggards to comply and advance their performance. 6.2 The Forest Stewardship Council The Forest Stewardship Council (FSC) is a partnership between economic and civil society actors in order to improve the sustainability of forest management. It develops standards for certification for the forestry and timber industries on the basis of ecological, social and economic performance and process criteria. Presently, approximately 50 million hectares of forest are certified in 60 countries. The FSC certificate is evaluated positively in literature. However, critical observers point out that the adjustment of global principles to national conditions has led to their weakening. Besides, they criticize that the FSC will not contribute to the rescue of the tropical rain forest since mainly plantations are certified in the relevant regions (Mirbach 1999). Basically, however, the FSC certificate is regarded as relatively stringent and effective in improving the sustainability of forest management, particularly compared to its competitors such as the PEFC and SFI certificates created by the European and American timber

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industries (Cashore et al. 2004; Gale 2002). The latter are similar to the ISO 14000 standard in their approach, as they define a minimum standard, which emphasizes process rather than substance. The number and heterogeneity of actors participating in the global timber product chain is very big. In consequence, a downwards protected standard negotiated among those actors with possibilities for out-performance would be the expected outcome. However, as addressed earlier, such a standard is difficult to enforce with civil society participation or initiative. Besides, civil society participation allows higher private benefit due to the increased credibility of governance investments. In turn, a more ambitious standard that may become possible or necessary on those accounts would require an institutionalized sanctioning mechanism due to the actors’ heterogeneity. However, actors with weaker performances will hardly agree upon such a standard. As pointed out above, the introduction of partial group standards is most likely under such circumstances. Indeed, this situation is reflected by the FSC certificate. As previously mentioned, the FSC is a type of governance institution, which stipulates relatively stringent principles for certification. Simultaneously, industry-created minimum standards have marginalized the FSC certificate in the market (Cashore et al. 2004, Fuchs 2006). Currently, only 4 per cent of global forests are FSC certified (Domask 2003). In this respect, the FSC certificate convinces in terms of internal effectiveness but suffers from lacking external effectiveness, the improvement of which cannot be expected without additional public pressure. 6.3 The Global Compact Finally, the Global Compact is a partnership between the United Nations and business, in which business actors are supposed to contribute to the solution of the challenges of globalization by spreading principles of human rights, social and environmental norms, and anti-corruption standards (see Chapter 8). The target population originally intended by Kofi Annan were primarily the TNCs. Between those, one would expect some differences among cost-benefit functions, but their heterogeneity would be lower than for a population which embraces the business community as a whole. In addition, the United Nation’s credibility encourages the enhancement of utility functions of participating companies. Through this larger population homogeneity as well as member visibility, one should expect a standard which is geared to the midfield of the performance band. These thoughts are at least partially reflected by reality. Compliance with the labour norms of the Global Compact is by no means self-evident within the global economy, even though these norms have existed as ILO norms for a long time. Likewise, any rejection of participation in corruption is connected with the possibility of contract loss to non-cooperating competitors. As such, the Global Compact is not a minimum standard. Simultaneously, there is no stringent minimum performance of involved companies due to the absence of control and enforcement mechanisms. In addition, there are various possibilities for out-

Business and governance 137 performance since companies can showcase their Best Practice models or participate in special initiatives. In addition, dialogues, local networks and exchanges on Best Practice try to improve the performance of weaker members. However, the Global Compact expanded in a relatively short period of time to a size of more than 2,000 companies; and also small and medium-sized businesses became members. The resultant increasing size and heterogeneity of the population led to insufficient functioning of internal monitoring and peer pressure processes. As a result, the reputation of the Global Compact suffered. The necessity of a larger protection of the Global Compact against non-compliance emerged, leading to changes towards a more stringent minimum standard by introducing some sanctioning mechanisms and a light fortification of complaint procedures. The above ideas and illustrations have demonstrated that the effectiveness of private governance depends on the band of performance created around a standard or norm, which results from implementation of the agreed output. To which extent one can infer that the actual effectiveness of self- and co-regulation from standard stringency or the performance of individual participating companies depends on amplitude and direction of this performance band. These characteristics, in turn, are influenced by the heterogeneity of cost-benefit functions of participating actors, opportunities of internal control and implementation, and public ability to allocate responsibility. Eventually, cost-benefit functions of business actors are, among others, dependent on their visibility and size, the cultural environment and institutional history of firms and sectors, the characteristics of the relevant market segment, the normative perspective of the top management, as well as existing information and technology regarding problems and problem solutions. The possibility of estimating the amplitude and direction of performance bands can make a contribution to improving the effectiveness of private governance. Understanding the determinants of these characteristics of performance bands allows us to influence them through initiatives aimed at decreasing collective action problems among companies or improving laggards’ governance capacities and incentives, for example. In this context, the importance of the micro-level, in particular the significance of learning processes and internal incentives for performance improvement in private governance institutions becomes apparent as well. On the macro-level finally, the analysis highlights the necessity of sufficient publicity for ensuring the effectiveness of private governance. Thus, the existence of private governance emphasizes the indispensability of information, education and media politics beneficial for a critical public. In other words, it forcefully calls for efficient meta-governance by the state. At the same time, the previous ideas and illustrations also explain why metagovernance cannot be expected from private governance institutions in general. Investments in meta-governance are difficult to translate into private benefits, which, among others, result from the public not expecting and demanding metagovernance from business actors. Among the aspects of private governance which most urgently have to be examined further, is the role of discursive power. After all, discursive power can

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shape the public debate on the effectiveness of self- and co-regulating institutions. Likewise, the role of structural power in determining the bottom line when it comes to standard development and implementation deserves attention. Structural power can also play a role with respect to the creation and effectiveness of alternative private or public governance institutions, after all. Thereby, it can lead to a change in the measuring rod placed against a specific private governance institution. Also, the role legitimacy plays in this context has to be examined. On the one side, the effectiveness of private governance benefits from the legitimacy of peer-based regulation in multiple ways. Clapp (1998) and Haufler (2001) argue for example that the “ownership” of regulation can lead to a better implementation through business and, therefore, to more effectiveness. In addition, the public legitimacy of private governance institutions is particularly important, if they are to be effective in influencing consumers’ choices (Kalfagianni 2005). This legitimacy and effectiveness perceived by the public can, in turn and as mentioned above, be influenced by the exercise of discursive power. In this respect, the interaction between effectiveness, legitimacy, and power offers a rich field for further research.

Notes 1 E.g. Balanyá et al. 2000; Beck 2002; Bowman 1996; Brühl et al. 2001, 2004; Drache 2001; Fuchs 2005a; Gill 2002; Higgott et al. 2000; Lawton et al. 2000; Klein 2000; Korten 1995; Strange 1996, 1998. 2 At the same time, public actors have more opportunities to withdraw from the influence of interest groups in such a context. In consequence, the degree of success in transforming lobbying activities into effective influence is difficult to estimate (Grande 2003). Moreover, the trend to individual lobbying activities by corporations or small coalitions of corporations means that a shift in influence can also be noticed among business actors, specifically between small and medium sized business actors as well as business associations on the one side and corporations on the other (Eising and Kohler-Koch 1994). 3 At first glance, the increasing number of companies participating in self- and coregulation means that they take on new rules. Thus, it may seem surprising to speak of the exercise of power by business actors in this context. The ability to decide or at least influence existence, substance and implementation of rules, however, represents an important facet of political power. This new rule-setting power by business actors can also be called a form of structural power, as it results from the position of TNCs in material transnational networks to a substantial degree. 4 The subsequent deliberations refer to the context of private governance, in which the pay off structure of a Prisoner’s Dilemma is present, especially environmental and social self- and co-regulation. They do not consider private governance in contexts in which you find the structure of a coordination game. 5 Technical support for company B by company A is possible in this context as well. 6 In addition, Clapp emphasizes the lack of participation of civil society and representatives of developing countries.

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8

Public–private partnerships Unlike partners? Assessing new forms of regulation1 Tanja Brühl

1 Introduction In international relations, norms and rules are less and less set and implemented by states alone. Instead, private actors, that is non-governmental organizations (NGOs) and business companies, are taking part in these processes. An example of these new forms of regulation is the World Commission on Dams in which delegates from states and intergovernmental organizations together with operators of dams and NGOs agreed on new standards on the construction of large dams. This way, massive conflicts on this issue, as had occurred since the 1980s, were to be avoided. At first sight, such models appear applaudable: private and public actors negotiate new norms and thus make a positive contribution to the future of humankind. But does this picture stand closer scrutiny? Which forms of public–private partnerships do exist, and how are they to be assessed? Do they contribute to a more effective and legitimate world order, or are they undermining the criteria of good governance as they enable the elites of the Northern hemisphere to assert their interests? What role, if any, can states still play in the future? This chapter discusses some of these issues. In so doing, I proceed in three steps: first, I demonstrate the diffusion of actors, that is the participation of civil society and private business actors in international political processes, and sketch the state of the art in International Relations referring to it. Subsequently, I use the Global Compact and a partnership in health policy (the GAVI vaccination programme) to analyse the legitimacy and effectiveness of such partnerships. And finally, I contrast their advantages with their shortcomings.

2 The privatization of world politics – reviewing of the state of the art For a long time, international politics had been an exclusive domain of states – they negotiated international treaties and coordinated their behaviour in international organizations. Since the 1990s, however, this has changed: non-state actors are increasingly gaining influence on international political processes and even participate in the establishment of international norms and rules. Thus,

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a “world of societies” has emerged besides the world of states (Czempiel 1993). But civil society actors, be they social movements or institutionalized NGOs, are not the only (apparently) new actors on the stage of international politics. Business firms and associations are also acting here. Today, these civil society and private business actors are more and more part of global governance together with states. Thus, a privatization of world politics can be observed (Brühl et al. 2001; Cutler et al. 1999). These structural transformations and the response of the academic discipline of International Relations deserve closer analysis. 2.1 NGOs: from deadheads to decision-makers At all times, individuals and societal groups sought to exert influence on political processes. However, their effort to influence international processes is also a new phenomenon. The number of NGOs operating internationally has increased sharply since the 1970s. Whereas only some 1,000 NGOs had been involved in world politics during the 1950s and 1960s, their number exploded within a short time span: in the mid-1970s, already more than 2,000 international NGOs were politically active, and nearly 5,000 towards the end of the decade. While the growth of NGOs slackened slightly in the 1980s, it gained new momentum in the 1990s. According to the Union of International Associations (UIA) estimates, roughly 11,400 international NGOs are operating in world politics today (UIA 2005). These estimations can be regarded as rather conservative since only those NGOs were counted which have been active over a long period in more than three states. The number of national and local NGOs is many times greater. The reasons for the NGO boom are commonly seen in (1) the expansion of market capitalism and liberal democracy as favourable background conditions for foundations of an NGO, (2) the technological revolution facilitating communication and reducing its costs, and (3) the opportunities for organization in international politics which have generally improved due to the end of the Cold War (Heins 2002: 63ff). Since the 1990s, local, national and international NGOs increasingly engaged in the international scene, especially around the United Nations (UN). At that time, the UN initiated a number of global conferences on several central issues. Thousands of NGO representatives attended the various summits and attempted to have their positions included in intergovernmental documents. After their official accreditation at the conferences, NGOs could at least temporarily sit with the negotiating parties and publicize their positions orally or in writing. Such direct influence by means of participation in international negotiation processes is supported through activities “from the outside”. NGOs engage in lobbying, launch campaigns and organize counter-summits (Brühl 2003: 42ff). They are especially successful if they succeed in credibly representing the interests of those affected and the common good (Take 2002: 90ff). However, attempts to gain direct influence by NGOs had already occurred much earlier. For example, at the beginning of the nineteenth century, some

Public–private partnerships 145 organizations such as the Anti-Slavery Society (1823) or the International Committee of the Red Cross (1863) were formed. One can even argue that the first NGOs sought to influence politics back in the Middle Ages: Christian order associations operated across borders (Skjelsbaek 1971).2 Some NGO representatives even attended international conferences (such as the Congress of Vienna, The Hague Peace Conferences etc.) and sessions of international organizations (such as the League of Nations). However, they were merely “deadheads” and could not directly participate in the conference proceedings. They only used informal contacts to exert influence (Brühl 2003: 46ff). It was the foundation of the UN which officially granted NGOs the opportunity to participate in intergovernmental negotiations – though limited to the Economic and Social Council and its subsidiary bodies (UN Charter, Article 71). Subsequently, the Council passed a number of resolutions defining the criteria for NGO accreditation to the UN. Accordingly, NGOs applying for participation in the UN must prove that their objectives are in line with those of the UN and that they have economic and social competences and represent the people. According to their respective objectives and tasks, NGOs are grouped into three categories with different participatory rights. While NGOs belonging to the highest category can even suggest agenda items, those of the lowest category can only issue oral or written statements in response to requests. At the outset, only a small number of NGOs made use of their newly created opportunities for participation: in 1948, only 41 NGOs were entitled to participate in UN negotiations. Twenty years later, the number had already risen to 317, and today, more than 2,700 NGOs possess the so-called consultative status and can thus take part in negotiations. More important than the growth of the number of NGOs with consultative status is the extension of their opportunities for participation. Over the last decades, states and international organizations have created ever more encompassing opportunities for NGO participation. Especially at the global conferences of the 1990s, NGOs were enabled to actively participate in many negotiations and represent their positions. By means of an extensive interpretation of the rules of procedure, NGOs could make themselves heard by intergovernmental negotiating bodies at these conferences and their preparatory and follow-up meetings to a unique degree unknown hitherto. While NGOs had previously been silent observers of negotiations, they can for the most part get actively involved in debates today. By means of oral and written statements, they can seek to argumentatively persuade state representatives. However, this trend towards the opening-up of negotiations to NGOs has been broken in two respects. First, there have always been situations in negotiations where NGOs were excluded. Especially in the final phase of negotiations when states were struggling over the precise measures to be agreed, NGOs were excluded. Second, the 2005 negotiations on UN reform were almost without exception marked by a high degree of intransparency and deficit opportunities for participation for NGOs. NGOs were not admitted to join the regular considerations but were only allowed to present their positions on the UN reform to the General Assembly for two days. These varying participatory opportunities can be

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explained by reference to a variable demand for the resources (such as knowledge, power and values) which NGOs can deliver to states (Brühl 2003). How is the (broken) trend towards more comprehensive participatory opportunities to be assessed generally? Various academic contributions from political science of the 1990s have regarded the emergence of NGOs on the international stage as immediately positive. NGOs were held to be able to increase the transparency of international negotiations and thus contribute to a democratization of the international system (Schmidt and Take 1997). They were held to thereby contribute to the emergence of a global public sphere (Klein et al. 2005: 49). In addition, NGOs were alleged to take up marginalized ideas, making them heard in the international arena. Thus, they would pose a counter-weight against the neoliberal orientation of the society of states or at least put neglected issues, such as the environment, on the agenda (Princen and Finger 1994). As norm entrepreneurs, NGOs would succeed in establishing new norms on the international level (Finnemore and Sikkink 1998). At the same time, as part of transnational networks, they would be important actors with a view to norm enforcement (Risse et al. 1999). States were held to be dependent on NGOs due to their mediating function between the local and international levels, providing important information (Walk and Brunnengräber 2000). However, this positive, in part even euphoric assessment of the contribution of NGOs changed increasingly. More and more, the shortcomings of NGOs were also discussed – especially in regard to their legitimacy. Their frequently undemocratic structures were criticized; it was pointed out that frequently, NGOs represented particularistic interests rather than the common good (Beisheim 2005). More and more, the focus shifted towards the fact that the (allegedly) marginalized were hardly better represented by NGOs as most of those participating in international conferences and organizations came from the industrialized nations, thus representing their interests (Scholte 2004: 216). Finally, it was argued that NGOs were not to be viewed as opponents of states. They rather represented a part of the extended state and contributed to its stability as a kind of forefield organization (Brand 2000). 2.2 International organizations and private actors: from confrontation to partnership Only shortly after NGOs, business associations also “discovered” the United Nations as a channel to exert influence. Thus, private business actors attended the UN Summit on the Environment and Development in Rio in order to have their positions considered in the international negotiations. They succeeded in inserting Agenda 21, the Program for Action on Sustainable Development, a chapter (Chapter 30) demanding a strengthening of the role of private businesses in sustainable development. While demands on private businesses and transnational corporations were also made (such as a less resource-consuming mode of production), their positive role in social and economic development was emphasized at the same time.

Public–private partnerships 147 Agenda 21 does not envisage a regulation of the private business sector but management together with private businesses. Thus, the 1992 Rio Summit does not just stand out as a signpost of the United Nation’s opening for NGOs but also for a new way of dealing with private business actors (Martens 2004). Less than 20 years earlier, the UN had made massive efforts to control transnational corporations and had, among other things, established the Center on Transnational Corporations (UNCTC) within the Secretariat for that purpose which had, inter alia, supported the establishment of a binding code of conduct for corporations (Paul 2001: 111). The UNCTC’s abolition in 1993 therefore is an expression of the new pattern of relations between corporations and the UN which was to be characterized by cooperation. This new UN policy of closer relations with corporations, initiated by Secretary-General Boutros BoutrosGhali, was consistently continued by his successor, Kofi Annan. At the 1999 World Economic Summit in Davos, he urged for a constructive and sustainable arrangement of globalization in cooperation between corporations and the UN. One year later, he set up the Global Compact (see below). From then onwards, the private economy was regarded as an important partner of the UN. Many specialized Agencies and special programmes, such as the UN Development and Environmental Programs (UNDP and UNEP), the Children’s Fund (UNICEF) or the World Health Organization (WHO), agreed on partnerships with private businesses. Partnerships are associations of different actors for the purpose of a joint policy function (Linder and Vaillancourt-Rosenau 2000: 5). Ideally, they consist of civil society, private businesses and (inter-)governmental actors (trisectoral partnerships), but frequently, only NGOs or corporations work together with international organizations (bisectoral associations). These different actors are subjects and objects of regulation at the same time.3 According to the differentiation suggested by the UN Secretary-General in his report on cooperation between the UN and private actors (United Nations 2001: 19), partnerships can perform five different tasks. In learning fora, private actors exchange their experience, thus producing comprehensive information and defining appropriate behaviour. Other partnerships serve the purpose of conscience-building and a successive development of new norms. Some partnerships were even established with the aim of standard-setting – here, concrete substantial objectives were to be agreed upon. With a view to norm implementation, partnerships also play a role in which technical assistance is especially important. And finally, there are partnerships which are to open up financial resources. After the UN had begun to cooperate more closely with private actors, Secretary-General Kofi Annan established a body of experts in spring 2003 which was to elaborate recommendations with a view to the future relations between civil society and the UN. In June 2004, this body, named after its President, Brazilian Head of State Fernando Cardoso, issued its report (Cardoso Report 2004). First, it contained the recommendation to simplify the accreditation procedure for NGOs. Second, it discussed in detail partnerships under the heading of “multi-constituencies”, urging for a strengthening of the private

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economy. However, the General Assembly reacted with reservations to the Cardoso Report’s recommendations. Since many states (e.g. China, Egypt and Cuba) opposed any extension of the participatory rights of NGOs, repeated attempts of the Brazilian government to have a resolution on the Cardoso Process adopted failed (Martens 2006: 3ff). In the following debates on UN reform, the Cardoso Report’s recommendations played no role either. This does not, of course, mean that partnerships no longer have any significance at all – quite the opposite: their number is increasing further. Why do states and international organizations invite civil society and private business actors to cooperate with them? The discipline of International Relations has given various answers. From a rationalist perspective, it is argued that states had realized the ineffectiveness of national and international (i.e. intergovernmental) management. Accordingly, states neither succeed in attaining the traditional goals of governance (such as security, legal stability, the development of a common identity and participation, and welfare, see Zürn 2001: 53) nor in responding appropriately to new challenges and transnational problems (e.g. environmental pollution, migration, smuggling of nuclear materials or terrorism, see Jachtenfuchs 2003: 496ff). States hope that this lack of problem-solving capacity can be reduced by cooperation with private actors and a shift of decision-making to other political levels. New forms of regulation, especially networks, thus serve to maintain or even expand the capacities for action (Benner et al. 2004). However, participation in networks can also aim at extending one’s own financial resources or control over specific (development) projects (see Dingwerth 2004: 78). For the UN, for instance, Jan Martin Witte and Wolfgang Reinicke attest that partnerships have become a necessity “in order to get the ‘job done,’ ” (Witte and Reinicke 2005: ix). Constructivist explanations have not addressed the question of an opening-up of international organizations. They simply point at the actual importance of NGOs in the genesis and enforcement of norms and deduce from the logic of appropriateness that the inclusion of private actors represents an adequate response to the observable diffusion of actors (Forschungsgruppe Weltgesellschaft 1996). One could argue that today, it has also become part of this logic of appropriateness that market-based regulation is an adequate strategy for problem-solving and should replace hierarchical governance. 2.3 Partnerships – a contribution to better governance? At first, the trend towards increasing standard-setting and norm implementation through partnerships was overwhelmingly applauded in International Relations (Reinicke 1998; Reinicke et al. 2000). By means of cooperation between societal, private business and state actors, the forces necessary for adequate problem-solving were held to be combined effectively. In that, NGOs would most importantly contribute by their expertise and closeness to the people while corporations would also provide material resources. As part of emerging global governance, however, partnerships would also contribute to more democracy as

Public–private partnerships 149 they shortened the chain of legitimation between citizens and decision-makers. By cooperation of different actors, much information could be gathered, providing for a comprehensive picture of reality and the opportunity to take more adequate measures to deal with problems (Reinicke et al. 2000: viii). In comparison to intergovernmental agreements, partnerships would also have a high degree of learning ability and (institutional) flexibility. As new actors adapted to altered political situations could enter into such partnerships, a process-orientated form of governance would be embodied which was characterized by a high degree of democracy (Benner et al. 2004: 200ff). In sum, by means of interdependence (the several partners needed each other to solve problems), flexibility (a high degree of learning by a multiplicity of actors) and complementarity (different actors in different bodies), they would contribute to better problem-solving (ibid.: 197). However, this positive picture has faced increasing opposition. Its criticisms range from a deviating assessment of the effectiveness of specific partnerships to general scepticism about this form of regulation. The latter refers to several aspects. The legitimacy of partnerships is questioned because they represented overlapping regimes which were not accountable (Czerny 1995). While in intergovernmental negotiation systems, states could still be held accountable, it was deemed unclear who, if anyone, took responsibility within partnerships and how this could be tied back to individuals (Koenig-Archibugi 2004). It could be argued that in last consequence, citizens could also “punish” private business actors for potential misbehaviour (e.g. by consumer boycotts etc.), but this would require a functioning control of partnerships (something rather unlikely in the face of lacking monitoring mechanisms in international relations). Moreover, partnerships only deal with selected problems, thus distorting political work. Priorities were set not for political reasons but according to which issues could be “sold”. Therefore, for instance, there were few partnerships for dealing with African problems compared to other issues. Finally, the competition for financial resources and “good” issues also led to fragmentation of the UN system since only some of its institutions were deemed attractive by private actors (Bull et al. 2004: 486ff). Therefore, Marina Ottaway (2001: 268ff) pleads for a replacement of the concept of partnership with that of corporatism since the latter would better cover inherent conflicts. Proponents of a critical standpoint further sharpen this argument, equating partnerships with a re-feudalization of the state. Compared with institutionalized procedures, partnerships were hard to control (Hirsch 2001: 110). One should continue to view partnerships as conflict-laden interactions since different actors pursued different interests within them: private business actors pursued an opening of markets while civil society actors sought to introduce social and environmental standards (Levy and Prakash 2003). Critics thus assume that partnerships do not contribute to a more efficient and legitimate world public order but further undermine existing (in deficit) structures, opening additional space to the power game (Whitman 2002: 52). How can such opposite assessments of the effect of policy networks be explained? First, besides different theoretical premises, they can be attributed to

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shortcomings with a view to definitions. Thus, a detailed consideration and definition of the central category of legitimation is lacking. Therefore, in his assessment of supporters of global policy networks, Klaus Dingwerth (2004: 76) concludes that their assessment is “hanging in thin air” He states: “Since the concept of legitimation and its diverse meanings [. . .] are not at all or only hardly put at issue, the theoretical justification for this claim is unsatisfactory“ (author’s translation). This statement is also valid for the critics of partnerships. Second, methodological problems can be identified. For the most part, the selection of cases does not stand up to the strict criteria of (positivist) scientific inquiry. Frequently, supporters of networks only show successful cases (as in the comprehensive project conducted by Reinicke et al. 2000). Thus, another selection of cases might lead to other results. Moreover, networks serve quite different functions (see above), a fact hardly considered by assessments of their efficiency and legitimacy (Dingwerth 2004: 81). In the face of the broad debate on the legitimacy of governance, this neglect of theoretical-conceptual foundations is surprising. Both political theory and International Relations contribute to this (Steffek 2003: 251ff). Political theory proceeds from a normative concept of legitimacy according to which specific conditions of legitimate governance can be identified ex ante. International Relations, by contrast, analyses when individuals or groups regard rules as legitimate and thus abide by them. In that, either myths and identities or democratic procedures can be the sources of legitimacy (ibid.). The latter are also taken up by Fritz Scharpf in his well-known distinction between the input and output dimensions of legitimacy (Scharpf 1998). The input dimension focuses on the participation of those affected. If all affected groups (stakeholders) take part in the setting of standards either directly or through their representatives, a decision is deemed legitimate. Accordingly, this dimension refers to democratic procedures. While in democratic states, the political community could traditionally participate in decision-making at least indirectly through elections, the relation between decision-making bodies and those affected by them is disrupted today. The output dimension of governance refers to the quality of decisions. If they solve problems, serve the common good and fulfil the criteria of distributive justice, they are deemed legitimate. Accordingly, existing policy networks must be analysed with a view to the contribution they make to (democratic) legitimacy. In that, decisive criteria are (1) how far those affected by a decision are involved in the setting of rules and whether this is in line with democratic standards (especially whether all partners have equal opportunities) and (2) to what extent regulation solves problems, serves the common good and justice.

3 Assessing selected partnerships To date, comparative analyses of the legitimacy of partnerships are lacking (Brühl and Liese 2004: 186). This gap cannot be closed here, but I will at least attempt to compare the legitimacy of two partnerships. I have selected the

Public–private partnerships 151 Global Compact and the GAVI vaccination initiative because the several actors have very different opportunities for action in these partnerships. While the Global Compact is about implementation of norms already agreed upon intergovernmentally, the partners in GAVI are involved in the formulation of both norms and policy. 3.1 Global Compact The Global Compact is a legally non-binding agreement between the United Nations and private actors, most notably companies, which is understood as a forum for dialogue and learning. The signatories of the Global Compact commit themselves to promote ten (previously nine) general norms referring to human rights, industrial relations, environmental protection and the fight against corruption by officially recognizing them and incorporating them in their business practices (Kell and Ruggie 1999: 3). The norms were derived from the Universal Declaration of Human Rights of 1948, the ILO’s Declaration on Fundamental Principles and Rights at Work of 1998 (and the ILO conventions on which it was based) and the Rio Declaration of 1992. Since these norms have not yet been sufficiently incorporated into legislation and protected by states, private actors are now involved in their implementation in order to strengthen their effectivity. In addition, the Global Compact is to support the UN by making the resources and competences of the private sector available to the institution. Besides, the private sector of developing countries and states in transformation is to be strengthened. Finally, additional private investments are to reinforce development (Zammit 2004: 57). The Global Compact envisages three instruments for achieving these goals: the members are to jointly consider in learning fora how the ten norms can best be integrated in business practices; these learning fora are organized by the Global Compact’s Secretariat in cooperation with local members; in the political dialogues, members discuss issues such as the fight against corruption, the spread of HIV/AIDS and a sustainable global economy. In partnership projects, the Global Compact supports institutional and knowledge-related capacity building in order to demonstrate how the norms can be observed (Ruggie 2003: 311). The Global Compact was signed in July 2000 by some 50 companies and a small number of NGOs (e.g. WWF International and Amnesty International). Meanwhile, the number of members has grown to nearly 2,500 companies and roughly 500 other partners (especially NGOs, but also many municipalities and universities, as well as other education institutions). Besides, some institutions of the UN, for instance its Environmental and Development Programs (UNEP and UNDP), the ILO, the UN Organization for Industrial Development (UNIDO) and the Office of High Commissioner for Human Rights (OHCHR) are also members of the Global Compact. Together with its Bureau, these UN institutions are regarded as the focal points of the Global Compact network. Some states also support the Global Compact. In order to participate in the Global Compact, the management of a company (or an NGO) must issue a

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personal letter to the UN Secretary-General and declare its support of the ten norms. By accession, the members commit themselves to observe and promote the ten norms. It is left to them to decide which steps to take for that purpose. However, they are required to report any progress they make. Initially, there were fairly precise criteria for this: companies were either to shortly summarize the measures they had taken (in no more than 500 words, so-called examples) or to submit more comprehensive studies on their success in implementing selected norms (case studies). These obligations, however, were fulfilled by companies only half-heartedly: by January 2002, only 30 companies had submitted reports, half of which did not even explicitly refer to the then nine norms (Hamm 2002: 21). Harsh criticism by various NGOs, together with the Global Compact Bureau’s insight that the Compact was being undermined, resulted in an adjustment of the obligation of publication. Since January 2003, reports on progress are required (Communication on Progress) which, besides a declaration of continued support of the ten norms, are to contain a description of the activities undertaken during the previous budgetary year and an assessment of improvements achieved thereby. These reports on progress are to be integrated into the ordinary company portraits (such as reports on sustainability and business) while only the electronic source is to be indicated to the Global Compact Bureau (Rieth 2004: 156). When a member has not submitted any report on progress within two years, it is listed on the Global Compact’s homepage as “inactive member”. Currently, more than 700 companies are assigned this status, more than a quarter of all private business members.4 The still insufficient fulfilment of communication obligations were also remarked upon by the SecretaryGeneral at the opening of the sixtieth General Assembly. Accordingly, in 2005, more than half of all Global Compact members have not submitted any report – even though roughly 80 per cent of multinational corporations had complied with their obligations (United Nations 2005: para. 28). Since its establishment, the structure of the Global Compact has repeatedly been adjusted. In January 2002, the UN Secretary-General established a scientific Advisory Council – officially in response to the growth and success of the Compact (Hamm 2002: 22). The Council is to advise the Secretary-General with a view to the functioning and further development of the Compact. Initially, companies were in the majority of the Council members (ten out of 17). Thereafter, the Council was expanded to comprise 20 members, 11 of which are companies, one NGO each responsible for the four norm areas, two representatives of trade associations responsible for the interests of workers, as well as two UN delegates and one envoy from the newly created fund for the interests of international organizations. These reforms were the result of the Global Compact Summit in June 2004 at which the Bureau of the Global Compact had been urged to elaborate recommendations for reform. After their publication by the UN Secretary-General, they entered into force on 12 August 2005. In the context of restructuring, the fund mentioned above was also established and is especially designed to finance publications. Besides, it was laid down that

Public–private partnerships 153 from now on, a summit meeting should be held every three years and local networks should meet annually in addition. A major reform refers to responses to non-compliance which (to a limited extent) is to be punished in the future. The “integrity measures” provide that allegations that a company has violated one of the ten norms be investigated by the Global Compact Bureau. If a violation is confirmed, a company can be relegated to inactive membership or, in the case of persistent norm violation, it can even be excluded from the Compact altogether. Hereby, the Global Compact has at least on paper taken a new direction than previously, each form of monitoring and sanctioning had been rejected by reference to the Global Compact’s character as an informal learning and dialogue forum. In the view of critical NGOs which have joined in the Alliance for a Corporate Free UN, however, this reform does not go far enough because a proper Global Compact monitoring body and sanctioning regime are still missing. It becomes clear here that assessments of the functioning and efficiency of the Global Compact are very contrary. What one views as an innovative policy instrument, others regard as selling-out of the UN. However, an analysis on the basis of the criteria mentioned above demonstrates that none of these assessments hits the point. With a view to the input dimension of legitimacy, a mixed picture can be drawn. On the one hand, the Global Compact is an institution which is open to all interested parties willing to support the ten core norms. At the same time, this openness is criticized by NGOs: they blame the UN for allowing companies known to be norm violators to join rather than forcing them to alter their behaviour first (Bruno 2002: 1ff). However, openness ends at the recruitment of the Global Compact Advisory Council. Its 20 members are appointed by the UN Secretary-General, and it is not clear who is entitled to make proposals for membership and which criteria apply to the selection of specific individuals or institutions. Decision-making in the Council itself is intransparent. It is also a negative that the different members of this trisectoral partnership have very unequal rights and duties. The UN has initiated the project, supports it by means of a small Bureau and invests it with substance by having identified the ten core norms. Companies commit themselves to observe and promote these norms and to report thereon. Five years after its establishment, it still remains unclear which role NGOs are to play in the Global Compact. They can state their experiences with a view to the Compact’s implementation, but there is no institutionalized space within which to respond to suggestions from civil society. Thus, in this partnership, NGOs are junior partners at best. With a view to the effectivity of the Global Compact (output dimension of legitimacy), two levels must be distinguished: compliance with the ten norms and the effects on the UN system. On request of the Global Compact Bureau, the success of norm implementation was analysed in summer 2004 by the counselling agency McKinsey (2004) which conducted a poll among members. Sixty-seven per cent of companies claimed to have adjusted their policies to the norms of the Compact, and 40 per cent stated that the Global Compact had itself effected this change. Special effectivity is accorded to the Global Compact in developing countries where 67 per cent of companies claimed that their attention

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had been drawn to their responsibility by the Compact. At the same time, however, McKinsey’s study points to the fact that the companies’ behaviour is not uniform and some expectations of the members were not met. Various NGO associations, such as CorpWatch or the Alliance for a Corporate Free UN, are more critical of the Global Compact’s success. On the one hand, they publicly blame specific companies by pointing at their norm-violating behaviour (Bruno 2002). On the other hand, they point out that an independent evaluation of business practices was necessary. Currently, however, this is impossible because the Global Compact lacks a monitoring mechanism. Such a mechanism would contradict the basic idea of the Compact which focuses on dialogue and concrete action, as one of the Compact’s “fathers” points out (Kell 2005: 72). The examples reproduced on the homepage of the Global Compact, he states, demonstrated that companies had adjusted their behaviour. Furthermore, a systematic analysis would be too expensive (ibid.: 73). Civil society organizations are not content with this argumentation. In addition, they point to the fact that more than half of the companies did not even fulfil their obligation of documentation (see above). They therefore request that a monitoring body be established which, if necessary, could impose sanctions against norm violators. As long as such an instrument was missing, they point out, the Global Compact would rather consolidate inappropriate behaviour (Utting 2000: 8, 2002). The establishment of integrity measures can be regarded as a cautious step to punish non-compliance. However, it remains to be seen how these measures will actually be implemented. Apart from the ten norms, the Global Compact has some further effects. It supported a breakthrough of public–private partnerships in international relations (Hummel 2004: 30). NGOs are critical of this development: in their view, the UN has not fulfilled its task to control business practices. With the Compact, they claim, the UN allowed companies to use the UN label for advertisement, making themselves appear to behave in accordance with the norms – possibly even against the facts (“bluewashing”, Bruno 2002). In its 2005 reform, the Global Compact Bureau also responded to this criticism and published more specific criteria for the use of the UN label. However, this only gradually reduces the danger of “bluewashing”. 3.2 The GAVI vaccination campaign Since the late 1990s, public–private partnerships have played an important role in global health policy. International organizations operating in this area, such as the World Health Organization (WHO) or the United Nations Children’s Fund (UNICEF), hardly conduct any programmes on their own but increasingly cooperate with private business actors.5 The privatization of health policy is an expression of the general opening of the UN to private business actors (Zammit 2003). At the same time, however, it is the result of a conscious WHO recruitment policy: when Gro Harlem Brundtland was elected WHO SecretaryGeneral, a woman came to head the organization who had already massively advocated cooperation with private actors as President of the World Commis-

Public–private partnerships 155 sion on the Environment and Development (Wulf 2004: 125). In her new function, she stuck to this tradition and led the WHO into numerous partnerships. Whereas the WHO had previously sought to control companies, it now aims at a cooperation characterized by dialogue and collaboration (Wulf 2004: 132). One of the most important partnerships in health is the Global Alliance for Vaccines and Immunization (GAVI). It had been initiated at the 2000 World Economic Forum when the Bill and Melinda Gates Foundation had publicly donated $750 million US for vaccination. GAVI seeks to support research on, and development of, new vaccines for developing countries, expand existing vaccination programmes and introduce new vaccines. The campaign was incited by the observation that the number of children vaccinated against the six major diseases had decreased since 1990. While 80 per cent of children had been vaccinated then, the figure dropped to 75 per cent ten years later. The situation in some African countries was particularly urgent: in Nigeria, for instance, the vaccination ratio dropped from 80 to 27 per cent. Accordingly, child mortality rose in these countries. In order to reduce it, WHO, UNICEF, the World Bank, the Rockefeller Foundation, some governments and the International Federation of Pharmaceutical Manufacturers Associations (IFPMA) have joined forces in the Global Alliance and established a fund (the Vaccine Fund) whose contributions come from both its private and (inter)governmental members. Developing countries can make a request to GAVI for support which, if approved, is financed from the Fund. A 16-member Administrative Council recommends how the resources are to be spent. In regard of its institutional design, the Council resembles the UN Security Council (Wulf 2004: 129): It has five permanent members: the Gates Foundation, the Vaccine Fund, WHO, UNICEF and the World Bank. The other members are states, business representatives and NGOs. This means that governments and NGOs are junior partners in these partnerships with smaller participatory rights than GAVI’s main sponsors and UN institutions. With a view to the input dimension of legitimacy, this means that not all of those affected by its decisions (especially the citizens of developing countries) can exert equal influence on GAVI’s vaccination policy. Furthermore, the Administrative Council’s decision-making procedures lack transparency. Even though there are publicly available session protocols, these do not reflect the discursive and negotiation processes. As in other partnerships in health, companies are alleged to be especially able to assert their interests in GAVI’s decision-making processes (Foladori 2004). Accordingly, compared with intergovernmental governance, a deterioration of the input dimension of legitimacy could be observed in these partnerships. The output dimension displays an ambiguous picture. Over its first five years, GAVI has, according to its own records, conducted vaccination campaigns worth roughly US$670 million in 70 states, thereby preventing 1.7 million disease-related deaths (GAVI 2005). With a view to its self-declared objectives (milestones relating to vaccination ratios and the eradication of specific diseases), GAVI also claims to be on the right track. This positive selfassessment contrasts with the observation that the vaccination campaign has not

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succeeded in lifting the average vaccination ratio beyond 75 per cent (Foladori 2004). Additionally, in its critics’ view, GAVI’s activities seem to miss the real problem (Wulf 2004: 130f): More than 60 per cent of its financial resources are spent on the development of new vaccines instead of working with existing cheaper substances and making more investments in preventative health policy (which make up only roughly one-third of available resources) (Foladori 2004: 90). Despite comprehensive funds, basic health services are only poorly endowed, thus being able to only insufficiently contribute to health. GAVI’s policy is alleged to be exemplary of a narrow, reductionist understanding of health policy (Richter 2003). Whereas the WHO and UNICEF have advocated a broad approach to health since the 1970s and in that context urged for improvement of the living conditions of the poor and for health provisions available to all, the partnerships’ health policy aims at product-orientated, selective measures such as vaccination campaigns or the fight against diseases by recourse to (new) medications (Buse 2004: 230). The more complex tasks “of the sustenance and improvement of health systems in developing countries [is left] to the increasingly consumed national health budgets and the scarce international development assistance.” (Wulf 2004: 138, author’s translation). Accordingly, in public health, partnerships may prevent the outbreak of specific diseases by vaccination campaigns, but at the same time they generally undermine an efficient health policy. In addition, it is conspicuous that in partnerships, companies are the most significant actors able to shape health policy in coordination with states by means of financial resources and vaccines whereas civil society actors are only marginally involved in such programmes.

4 Conclusions The two partnerships selected for illustration here show that the three actor groups are unequally powerful, enabling them to influence the functioning of the partnerships to a different degree. While the norms of the Global Compact had initially been set by states, the objectives and implementation of the vaccination initiative were negotiated jointly by states and intergovernmental organizations, economic and societal actors. How these negotiation processes were designed is unclear. Apparently, however, economic actors are better able to assert their interests than societal or intergovernmental ones. The lack of clarity with a view to partnership processes further demonstrates that the hypothesis, frequently stated in the literature on NGOs, that the inclusion of NGOs in negotiations automatically leads to more transparency and thus contributes to more democracy, does not hold in this form. On the contrary, it seems as if democratic principles of governance were undermined in policy networks even further than they are in “international governance” anyway, that is intergovernmental governance especially on the level of the international system (Brühl and Rittberger 2001). In partnerships, it is rarely made clear who can become a member under what conditions. As yet, more private business than civil society actors and more Northern than Southern

Public–private partnerships 157 institutions appear to participate in partnerships. Furthermore, the decisionmaking structures of partnerships are often intransparent. Therefore, partnerships in part acquire a bad reputation as networks of unelected technocrats whose input in international relations is little representative and thus increases existing asymmetries (Slaughter 2004). Finally, the accountability of private partners is not made clear. An analysis of the output dimension does not present a nice picture either. Even though progress can be observed with regard to a few partnerships, it remains questionable how long it will persist. Up to now, members can break out of partnerships without punishment as soon as they regard norm compliance as too costly: Monitoring and sanctioning instruments are missing because they allegedly are not in line with the principles of voluntariness and informality. They would contribute, however, to a more sustainable success of partnerships because they may represent an appropriate response to the variety of actor interests. It is frequently neglected in the literature on global governance that partners may pursue different (long-term) interests and that this may result in conflict. For instance, in the context of the vaccination initiative, the interests of businesses and the WHO or UNICEF may be similar in the short run, but in the long run, the actors pursue different interests (orientation of health policy towards a reduction of poverty or product advertisement campaigns). This will then lead to conflicts about objectives among the groups of actors (Zammit 2003: 60ff). Generally, it can be assumed that businesses tend to favour marketenabling rather than regulating rules (Levy and Prakash 2003) whereas civil society actors aim at the establishment of social and environmental standards. Close cooperation among unlike partners appears to result in the self-assertion of private businesses. Ann Zammit (2004: 61) therefore concludes: “Close relations between the UN and Big Business bear the danger of appropriation” (author’s translation). Accordingly, it becomes evident, first, that partnerships are composed of unequally powerful actors pursuing different interests: partners are unlike in regard to power and interests. Second, partnerships cannot unambiguously contribute to an alleviation of the legitimacy deficit either in its input or output dimensions. In the future, the negative concomitants of partnerships should be kept to a minimum. Anne-Marie Slaughter (2004) proposes that all networks should observe five different principles and norms. At first, in the interest of global deliberative justice, clear criteria for participation in networks should be identified and laid down. Thereby, the problem of unelected technocrats contributing to an asymmetry of power could be reduced. Furthermore, differences between the various actors should be recognized as desirable (i.e. legitimate) pluralism. By exchanging information, the actors should develop a positive solidarity with the forms of governance, laying the foundations for the principle of subsidiarity. Finally, a system of checks and balances should be established which would prevent despotism and create a system of balances of power. What such a system should exactly look like, on which precise procedures it may rest, is not detailed further. More research thereon is therefore urgent.

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Notes 1 I thank Elvira Rosert for her research and contribution to discussions, as well as the participants of the editing conference for their helpful comments. Henning Boekle edited the English text. 2 Exemplary for the debate on the historical roots of NGOs is Klein/Walk/Brunnengräber 2005. 3 Another form of regulation in which companies are both objects and subjects are selfobligations through which private business actors make the rules to abide by themselves. In the literature, up to six different forms of private regulation are distinguished, varying in their degree of institutionalization (Cutler et al.1999: 9ff): informal industrial practices and norms, coordination of behaviour, alliances and strategic partnerships, associations and private regimes. In general, these forms of private regulation are discussed under the heading “private authority” (see also Hall/Biersteker 2002). For an analysis of the contribution made by self-regulation, see for example Blowfield 2005. 4 www.globalcompact.org/ParticipantsAndStakeholders/non_communicating. html (accessed 14 March 2006). 5 For an overview, see for example DFID 2004.

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Public–private partnerships 159 Buse, K. (2004) “Governing Public–Private Infectious Disease Partnerships”, Brown Journal of World Affairs, X/2: 225–42. Cardoso Report (2004) Report of the Panel of Eminent Persons on United Nations–Civil Society Relations: We the Peoples: Civil Society, the United Nations, and Global Governance, New York: UN (A/58/817, 11. June 2004). Cutler, A.C., Haufler, V. and Porter, T. (1999) “Private Authority and International Affairs”, in A.C. Cutler, V. Haufler and T. Porter (eds) Private Authority and International Affairs, Albany, NY: State University of New York: 3–28. Czempiel, E.-O. (1993) Weltpolitik im Umbruch. Das internationale System nach dem Ende des Ost-West-Konflikts, München: Beck. Czerny, P.G. (1995) “Globalization and the Changing Logic of Collective Action”, International Organization, 49/4: 595–625. DFID Health Resource Center (Druce, N. and Harmer, A.) (2004) The Determinants of Effectiveness: Partnerships that Deliver. Review of the GHP and ‘Business’ Literature, London: DFID Health Resource Centre. Dingwerth, K. (2004) “Effektivität und Legitimität globaler Politiknetzwerke”, in T. Brühl, H. Feldt, B. Hamm, H. Hummel and J. Martens (eds) Unternehmen in der Weltpolitik, Politiknetzwerke, Unternehmensregeln und die Zukunft des Multilateralismus, Bonn: Dietz: 74–95. Finnemore, M. and Sikkink, K. (1998) “Norm Dynamics and Political Change”, International Organization, 52/4: 887–917. Foladori, G. (2004) “Can PPP cope with Social Needs?” Arizona State University: CSPO Working Paper. Online. Available www.cspo.org/products/papers/can_ppps.dot (accessed 17 March 2006). Forschungsgruppe Weltgesellschaft (1996) “Weltgesellschaft – Identifizierung eines Phänomens”, Politische Vierteljahresschrift, 37/1: 6–26. GAVI (Global Alliance for Vaccines and Immunization) (2005): Progress and Achievements. Online. Available /www.vaccinealliance.org/resources/FS_Progress___ Achievements_en_Jan05.pdf (accessed 17 March 2006). Hall, R.B. and Biersteker, T.J. (eds) (2002) The Emergence of Private Authority in Global Governance, Cambridge: Cambridge University Press. Hamm, B. (2002) “Der Global Compact – Eine Bestandsaufnahme”, in B. Hamm (ed.) “Public–Private Partnerships und der Global Compact der Vereinten Nationen”, INEFReport, 62, Duisburg: Institut für Entwicklung und Frieden: 17–39. Heins, V. (2002) Weltbürger und Lokalpatrioten. Eine Einführung in das Thema Nichtregierungsorganisationen, Opladen: Leske+Budrich. Hirsch, J. (2001) “Die Internationalisierung des Staates. Anmerkungen zu einigen aktuellen Fragen der Staatstheorie”, in J. Hirsch, B. Jessop and N. Poulantzas (eds) Die Zukunft des Staates. Denationalisierung, Internationalisierung, Renationalisierung, Hamburg: VSA Verlag: 101–38. Hummel, H. (2004) “Transnationale Unternehmen und Global Governance zwischen freiwilligen Partnerschaften und rechtsverbindlichen Regeln”, in T. Brühl, H. Feldt, B. Hamm, H. Hummel and J. Martens (eds) Unternehmen in der Weltpolitik, Politiknetzwerke, Unternehmensregeln und die Zukunft des Multilateralismus, Bonn: Dietz: 21–33. Jachtenfuchs, M. (2003) “Regieren jenseits der Staatlichkeit”, in G. Hellmann, K.D. Wolf and M. Zürn (eds) Die neuen Internationalen Beziehungen. Forschungsstand und Perspektiven in Deutschland, Baden-Baden: Nomos: 495–518. Kell, G. (2005) “The Global Compact. Selected Experiences and Reflections”, Journal of Business Ethics, 59: 69–79.

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Public–private partnerships 161 Scholte, J.A. (2004) “Civil Society and Democratically Accountable Global Governance”, Government and Opposition, 39/2: 211–33. Skjelsbaek, K. (1971) “The Growth of International Nongovernmental Organization in the Twentieth Century”, International Organization, 25/3: 420–42. Slaughter, A.M. (2004) “Disaggregated Sovereignty: Toward the Public Accountability of Global Government Networks”, Government and Opposition, 39/2: 159–90. Steffek, J. (2003) “The Legitimation of International Governance. A Discourse Approach”, European Journal of International Relations, 9/2: 249–75. Take, I. (2002) NGOs im Wandel. Von der Graswurzel auf das diplomatische Parkett, Opladen: Westdeutscher Verlag. UIA (Union of International Associations) (2005): Yearbook of International Organizations, Statistics, Online. Available www.diversitas.org/db/x.php?dbcode=v5&go= s&b=name&title=international%20NGO&sbmt=1 (accessed 10 March 2006). United Nations (2001) Cooperation between the United Nations and all Relevant Partners, in Particular the Private Sector, Report of the Secretary General, New York: UN (A/56/323). –––– (2005) Report of the Secretary-General on the Work of the Organization, New York: UN (A/60/1). Utting, P. (2000) UN–Business Partnerships: Whose Agenda Counts? Genf: United Nations Research Institute for Social Responsibility (UNRISD). –––– (2002) “‘Corporate Responsibility’: Alternativen zum Pakt mit den Vereinten Nationen”, Informationsbrief Weltwirtschaft & Entwicklung, 11–12: 4–5. Walk, H. and Brunnengräber, A. (2000) Die Globalisierungswächter. NGOs und ihre transnationalen Netze im Konfliktfeld Klima, Münster: Westfälisches Dampfboot. Whitman, J. (2002) “Global Governance as the Friendly Face of Unaccountable Power”, Security Dialogue, 33/1: 45–57. Witte, J.M. and Reinicke, W. (2005) Business Unusual. Facilitating United Nations Reform through Partnerships, New York: United Nations Global Compact Office. Wulf, A. (2004) “Wer gewinnt beim win-win-Spiel? Zu Risiken und Nebenwirkungen globaler Partnerschaften im Gesundheitssektor”, in T. Brühl, H. Feldt, B. Hamm, H. Hummel and J. Martens (eds) Unternehmen in der Weltpolitik, Politiknetzwerke, Unternehmensregeln und die Zukunft des Multilateralismus, Bonn: Dietz: 122–42. Zammit, A. (2003) Development at Risk. Rethinking UN-business Partnerships, Geneva: South Center. –––– (2004) “Die Vereinten Nationen und die Wirtschaft: Von der Polarisierung zur Partnerschaft”, in T. Brühl, H. Feldt, B. Hamm, H. Hummel and J. Martens (eds) Unternehmen in der Weltpolitik, Politiknetzwerke, Unternehmensregeln und die Zukunft des Multilateralismus, Bonn: Dietz: 44–73. Zürn, Michael (2001) “Political Systems in the Postnational Constellation”, in V. Rittberger (ed.) Global Governance and the United Nations System, Tokyo: The United Nations University Press: 48–87.

9

Political conditions for economic growth Globalization and developing countries Joachim Betz

1 Introduction Compared to the flood of studies covering the causes of economic globalization in general, their consequences for the macroeconomic and social steering capacity of nation states, the functioning of democracy and the cultural identity of societies and the necessity to partially replace lost state capacity by new forms of global governance, specific studies on the effects of globalization on developing countries have remained somewhat rare. Relevant articles in disciplinary journals and popular beliefs stress (a) the negative distributional impact of globalization on marginal regions, countries and social groups (b) the continuous restriction of already moderate governmental latitude in developing countries by the increasingly sharp competition for international investors, (c) the cultural invasion of private media from the West into developing societies (UNCTAD 1997; Deutscher Bundestag 1999; Gruppe von Lissabon 2001; Kozul-Wright and Rayment 2004). These assertions need not be wrong but they immediately raise the question, how small social groups in developing countries could prevail upon the masses that did not benefit at all from active integration into the world economy by lowering barriers to the free flow of goods and capital. This question is seldom convincingly tackled (see however Keohane and Milner 1996). Hinting at the World Bank and the International Monetary Fund as enforcement agents of a “global capitalist logic” does not really help very much because their programme conditions (asking for the removal of trade and capital restrictions) were seldom fully implemented (Mosley et al. 1991). In addition, their focus was macroeconomic stabilization and liberalization, but neither total integration into factor markets, nor proactive integration into the global value chains of Transnational Corporations (TNC)s. It only makes sense to discuss the “negative” consequences of globalization for developing countries, if these have actively tried to integrate into the global economy, but could not perform well on growth, productivity and technological development. It makes no sense, discussing the effects of globalization for closed economies or those, that did not undertake enough effort to participate in the global division of labour. Put differently: some states fell back because they glob-

Political conditions for economic growth 163 alized too little instead of too much (Bourguignon et al. 2002: 4). If nation states with active integration policies did not prosper, this may also have been caused by other factors. They might not have become attractive enough for international economic actors (because of an insufficient infrastructure, lack of human capital etc.) or deregulation and liberalization could not compensate deficiencies of the institutional structures (as for example weak protection of property, corruption etc.). Finally, local institutions might not have been adapted enough to the increasing risks of exposition to world market forces, or the existing educational system and labour regime did not allow additional groups to benefit from globalization (Srinivasan and Wallack 2004). In a similar way we must differentiate when dealing with allegedly shrinking latitude of developing countries in terms of social and economic policy in the age of globalization. Shrinking is only possible if non-negligible social activities existed beforehand or if autonomy in macroeconomic choices was given in addition, such a retrenchment may have been an outcome of structural defects of welfare systems, persistent and structural budget deficits and excessive international indebtedness, which would have forced adjustment even without economic globalization. To answer at least some of the questions raised, we need a sharply focused conception of economic globalization (globalization in other domains will not be covered). Globalization does not coincide totally with deregulation and liberalization and cannot be reduced to the acceleration of international economic transactions alone, if globalization also encompasses a new stage of the international division of labour. Only when societal relations are at least less determined by nation states than hitherto, when national boundaries become less important for economic transactions, when economic and political sovereignty of nation states is undermined from within by actions of globally interlinked actors, does the term globalization transport any new meaning (Reinicke 1997, 1998; Scholte 1997, 2000). Therefore, we cannot measure the progress of globalization by merely regarding the level of transborder movements of goods, capital and migrants (Hirst 1997; Hübner 1998). We have to define indicators that are able to reflect the new quality of economic interaction: 1

2 3

4

The rise of a global network of interlinked structures of production, the splitting-up of value chains, located at different production sites; thereby the growth of intra-industry and intra-firm trade as a share of total trade (Krugman 1995; Yeats 1998); A rising share of informational activities at the expense of material production; The emergence of a really unitary world financial market, leading to the erosion of the home bias for financial assets, the convergence of national interest rates, the withering-away of monetary and exchange rate autonomy of national agencies and the partial detachment of the financial from the real sphere (Albert et al. 1999); A diminishing capacity of national administrations to tax mobile production factors and for incurring budget deficits under the constraints of global competition for footloose investment;

164 5

Joachim Betz A convergence of welfare state structures towards market-friendly, more commoditized arrangements (Huber and Stephens 2001).

With regard to developing countries, I do not always possess enough data to answer the question, how far they are integrated in this sense into the globalizing economy. I will nevertheless try to give a preliminary answer in section 2. The debate on the incorporation of developing countries into the global economy is repeating – in a different context – in a certain sense earlier debates on the benefits of inward, respectively outward-looking policies, sense and limits of structural adjustment and the role of the state in the development. We shall deal with this debate in section 3, before we look more closely at the results of globalization processes on the economic dynamic and on the internal and international distribution of income (section 4). Thereafter (section 5) I will discuss whether the usually stressed causes for the diverging economic performance of developing countries during the globalization process (namely macroeconomic and structural reforms) really matter and (section 6) if and to what extent globalization in developing countries has eroded the autonomy of macroeconomic policies and led to a decline of social transfers. Finally (section 7) I will conclude with the thesis that the influence of globalization on developing countries has been exaggerated both in the positive and negative sense. I try to show that growth and social progress are more dependent on local decisions, national institutional arrangements and path dependency than usually asserted. If this conclusion holds, the result would be compatible with the sophisticated discussion about the impact of globalization on industrialized countries, which tried to demonstrate that this impact was mediated and filtered by factors like the partisan competition of governments, the strength of social blocks, the quality of informal and formal institutions and path dependency of former decisions on macroeconomic and social policy (Kitschelt et al. 1999; Huber and Stephens 2001; Swank 2002; Schmidt 2002).

2 The incorporation of developing countries into globalization According to the widespread belief of critical globalization studies, developing countries are more or less marginalized by the global economic integration and only benefit to a small degree from the increasing transnational exchange of goods and capital (UNCTAD 1997; Gruppe von Lissabon 2001; World Commission on the Social Dimensions of Globalization 2004). This is only partly correct. If I define integration of developing countries into the global economy by their share of international trade and capital movements, a distinction is visible. The share of exports in the GNP of developing countries has increased from the mid-1980s to the mid-1990s by 1.2 per cent p.a. (thereafter by 0.8 per cent p.a.), their part of total international private investment climbed – with some fluctuations – to 36 per cent (2003). The volume of international bank credits, portfolio investment and bonds was more volatile: lacking creditworthi-

Political conditions for economic growth 165 ness, developing countries did not figure as clients of these markets until the mid-1970s. Not every developing country did participate equally in this accelerated integration. The share of trade in GNP grew only slightly in North Africa, the Middle East, Sub-Saharan Africa and South Asia from 1990 to 2003 (before 1990 not at all), but markedly in Latin America and more so in East Asia. Today, only 22 developing countries with a declining share of trade in GNP can be identified, which is half the figure of the mid-1990s (World Bank 1996, 2005a). Developing countries have also become more incorporated into deeper forms of integration, namely in the splitting-up of value chains of manufactured products. A hard criterion for this phenomenon is their participation in the trade of intermediates and components (possibly in the context of intra-firm trade) and their share in the research and development of TNCs. According to scarce data, especially East Asian and Latin American countries participated in the trade of components, which was growing strongly (see below). Research activities of TNCs were concentrated (in order to obstruct unlicensed transfer of technology to other parties) at the headquarters in industrialized countries. But this has meanwhile changed because of cost advantages of skilled professionals in developing countries. The share of developing countries in the research activities of TNCs of US-American origin increased from 1994 to 2002 from 7.6 to 13.5 per cent (United Nations 2005). Affiliates of European TNCs show a similar picture. To be sure, research accrues mainly in a few countries in Asia (China, Singapore, South Korea) and – with some distance – in Latin America (Brazil and Mexico). Participation of developing countries in intra-firm trade increased distinctly, however, differing only slightly from their industrialized counterparts. Moreover, the integration of developing countries into the international capital markets has been growing since the beginning of the 1990s. If I take the share of private foreign investment and total capital flows in GDP as an indicator, I discover an increase from 0.3 to 1.5 per cent or 2.8 to 4.6 per cent of GNP in the case of poor countries, an increase of 0.7 to 2.5 per cent or 6.7 to 13.2 per cent in the case of middle income countries. There are, in addition, only minor variations between different regions, only North Africa and the Middle East received lower flows. Integration into international capital markets did not proceed smoothly and continuously; especially the East Asian crisis brought a distinct drop of private transfers, which did not totally recover till today. Nevertheless, only a few countries are decoupled from global financial markets: 13 economies registered a relative decline (compared to 1990) of direct investment in GNP, 16 in relation to total capital inflows. Usually, the importance of external capital sources increased significantly, although flows benefited a few countries disproportionally (see World Bank 2005a). Sixty per cent of private direct investment in 2004 was placed in China, Brazil, India, Mexico and Russia (World Bank 2005b). One should not forget, however, that these countries also account for a similar share of the population and the economic power of developing and transition countries.

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The structure of private capital flows to developing countries changed a lot in the last decades. While until the debt crisis, syndicated bank credits dominated in total flows, credit supply nearly evaporated until the end of the 1980s and only slowly recovered with the launching of the Brady Plan. Parallel to macroeconomic stabilization of debtor countries and their opening of the capital markets, they were replaced by portfolio investment and bonds (World Bank 2005c). In general, the share of equity capital increased at the detriment of debt flows. There was also a change in the quality of private direct investment in developing countries. In the past, it aimed at manufacturing units and at the supply of local markets, motivated by massive trade barriers in host countries. These “horizontal” investments were succeeded more and more by “vertical” investment, aiming at the splitting-up of the production process in geographically dispersed activities of value-adding (United Nations 1999; 2002). This splitting-up is driven by the varying local availability and costs of production factors. An indicator for the growing participation of developing countries in vertical investment is their global share in the trade of components and intermediate goods, which increased from 7 per cent in the beginning of the 1990s to 21 per cent in 2000; which was faster than in the case of industrialized countries (World Bank 2005c: 68). Still somewhat weaker are backward linkages of TNCs in developing countries with local suppliers, as outsourcing of these companies to the South still takes place mainly for labour-intensive, final production stages. The integration of developing countries into global financial markets accelerated in the 1990s because of falling communication costs and liberalization, but not to the same extent as in industrialized countries. Measured as a share of liabilities/claims towards other countries in GNP, the last decade brought a doubling. Nearly 75 per cent of foreign assets, however, are still owned by only four Asian countries (in the following order: China, South Korea, Malaysia and Thailand). Liabilities of the financial sector towards other countries are logically spread more widely (IMF 2005).

3 Globalization and development theory By screening the literature on the fate of developing countries in the era of globalization, the researcher quickly has a feeling of a “déjà vu”. Critical statements on the benefits and costs of globalization repeat the debate on the merits of the best international development strategy (import substitution versus export diversification), on the benefits of an export drive, based on foreign direct investment, on the proper role of the state and private actors (especially in the light of the East Asian experience) and on the pay-off of structural adjustment under the aegis of the Bretton Woods Institutions. Starting with the external economic strategy, I should be aware that most governments of developing countries chose for natural reasons (anti-colonial sentiments, weakness of traditional exports and superiority of Western corporations) a development strategy which aimed at rapid industrialization and the replacement of imports from the West by local production. This production was

Political conditions for economic growth 167 sheltered against external competition by high import tariffs and a host of nontariff barriers and supported by subsidized credits, overvalued exchange rates and the import of sophisticated technologies. The results of this strategic choice were not bad at first but they became progressively poorer with the production of investment and capital: excessive protection of local production by tariff walls undermined incentives for productivity improvements and encouraged industrial activities with little value adding. The artificial price reduction of capital and overvalued exchange rates reduced employment effects, damaged agriculture, undermined export competitiveness, stimulated technological dependence from TNCs and led to permanent balance of payments problems and to the debt crisis at the beginning of the 1980s (Hein 1998; Todaro and Smith 2003). This is all well known. Not so often stressed is the fact that the outcome of the substitution of imports was influenced by the size of the local market and the capacity of the state to push economic development ahead effectively, to implement its agenda against particular private economic actors, thereby obstructing these actors’ efforts to exploit state interventions for private gain and instead forcing them to become internationally competitive. Put differently: the varying effects of this development strategy in East Asia and other developing countries were due to a large extent to different interactions between state and private actors (Hein 1998: 263f.; Hayami 2001: 241). The failure of the substitution of imports led to different theoretical consequences: Radical dependency theorists believed that social revolution and radical dissociation from the world market was the only alternative for developing countries, others favoured selective dissociation, even deeper import-substitution and the reduction of the structural heterogeneity by redistribution of assets (Senghaas 1977; Elsenhans 1981), accompanied by measures to establish a New International Economic Order. Representatives of the economic mainstream pleaded for a transition to a world market-orientated strategy instead, an approach followed first and only from the 1960s onwards by the East Asian states. They were followed on a more or less voluntary basis after the onset of the debt crisis by quite a few other states. Their shift was theoretically backed by some (still naïve) studies trying to demonstrate the superiority of exportorientated development strategies (see e.g. Balassa 1978). This strategic recommendation did not stay unopposed: especially German authors (e.g. Fröbel et al. 1977) criticized these strategies of exploiting a “helpless industrial reserve army” by the establishment of Free Export Zones, where union activity was repressed, local labour laws were restricted and which did not establish linkages with the rest of the economy. Closely connected to the judgement of the adequate external economic strategy is the role which state interventions should play. An active role of state agencies was a necessary element of import-substitution policies and was therefore criticized as being part of the failure of this approach. Restriction of state influence by cutting budget deficits, a reduction of state intervention in the trade and financial system, the free levelling of prices and exchange rates, trimming of government debt and public sector undertakings also became the hallmarks of

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structural adjustment programmes carried out under the aegis of the Bretton Woods Institutions. The benefits of these programmes were reviewed controversially in the international debate: even though the overall evaluation of international financial institutions was basically favourable, critics hinted at stagnant investment rates, deindustrialization effects, a moderate broadening of exports, harmful ecological effects and a deterioration of the income distribution (Betz 1995). I will not try to make a final judgement on costs and benefits of these endeavours; suffice it to say that the factual development was slightly better than asserted by radical critics (Mosley et al. 1991; Killick 1995; Lustig 1995). A sustainable acceleration of growth did not happen, however, not even according to the most recent reports of the international financial institutions. Responsible for this outcome were an overloading of programmes with conditions, slow or missing reaction of economic agents to the new incentives and especially the low and sectorally different compliance of local governments, sanctioned only weakly by the World Bank and the IMF. Programme success above all depended on local “ownership” as some comparative international reviews could demonstrate convincingly (Callaghy and Ravenhill 1993; Haggard and Webb 1994; Deverajan et al. 2001). A lively discussion about the factors explaining the East Asian economic miracle paralleled this discussion. Here, also, the proper role of state and private markets was at stake. Representatives of the so-called revisionist school maintained that the state in East Asia not only took the form of a “night watch” but tried to propel industrialization by broad and selective interventions, partially by supporting the formation of conglomerates, partially by establishing public sector undertakings for the supply of private small and medium companies, always by directed credit and protection of local firms against foreign competition (Amsden 1989; Wade 1990). The only question is, whether the success of East Asian economies came about by these interventions or in spite of them. The success story can also be explained by the relative political and social stability in this region, by a proper macroeconomic management, an efficient bureaucracy, free of corruption and rent-seeking and by degressively declining state support always bound to make companies competitive in the world market. This is the interpretation of the World Bank (1993; also Ranis 1995; Hayami 2001). For a political scientist, it is challenging to ask, why selective interventions of state agencies in East Asia did not have the same devastating economic impact as elsewhere. After a long and heated debate, it seems obvious that markets do not arise naturally and function on their own but need to be embedded in a proper political-institutional, cultural and social setting. Structural adjustment only worked where reforms were “owned”, executed by strong state agencies and accompanied by compensatory measures to guarantee acceptance. This is also the starting point of the concept of “systemic competitive capacity”, favoured by the German Institute for International Development and pleading for a transformational development strategy based on social consensus, which alone is said to be sustainable in the era of globalization (Messner 1995).

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4 Effects of globalization on developing countries In discussing the incorporation of developing countries into globalization processes and their socio-economic effects on the South, these discussions witness a necessary resurrection because a deeper participation in the international division of labour requires the liberalization of trade and capital, deregulation of markets and privatization of companies. Critics of globalization assert that the income gap between the rich and the poor has grown nationally as well as between nation states. Sometimes, they also assert that the incidence of absolute poverty has grown (Afheldt 1995; Broad and Cavanagh 1995/96; Bauman 1997). According to an UNCTAD report, globalization has led to increasing disparities between labour and capital, between industrial companies and financial intermediates and between rent-earners and investors (UNCTAD 1997). Following a statement by UNDP, the richest quintile of the world population earned 30 times the income of the poorest quintile in 1960; in 1997, however, 74 times. UNDP also observes a significant increase of intrastate disparities (UNDP 1999). These assertions totally contradict the expectations of classical trade theories, according to which the removal of barriers for capital and trade between countries with divergent factor endowments should lead to the convergence of factor prices and thereby a levelling of disparities within and between national economies (Dollar 2004: 13). A problem with assertions of growing disparities is their proof on the basis of income in current dollars, not corrected by different purchasing power and on the basis of country group averages without regard to the size of populations. If both factors are taken into account, the growing disparities between Northern and Southern countries are dissipating, the global income distribution is improving (while setting apart internal distribution) markedly since 1978 – regardless which indicator is chosen. As a matter of fact, this effect is mainly a consequence of rapid growth in some populous Asian states, especially India and China (World Bank 2001; Sala-i-Martin 2002a; Chen and Ravallion 2004). By achieving this result, we can ignore statistical problems like the use of national accounts or household surveys in calculating consumption and income distribution within populations or country quintiles. Consideration of these refinements would lead to an even better global income distribution (Chen and Ravallion 2000; Bhalla 2002; Salai-Martin 2002b). It is fair to say that, according to the available evidence, the distribution of global income did not deteriorate since 1950, while the gap between economically successful and less successful states has grown. Unmistakably, the share of people living in absolute poverty has decreased in the last two decades. This fall was moderate, though, if consumption figures are used and it also varied quite a lot regionally (Chen and Ravallion 2004). The evidence for the development of internal income distribution in developing countries is ambivalent (Sala-i-Martin 2002b; Williamson 2002): data availability is sparse. In some national economies (China, Bangladesh, Malaysia and Thailand), distribution deteriorated, while rates shot up and absolute poverty was reduced considerably. Later, distribution in Thailand and Malaysia started

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to improve. In other economies, distribution either did not change at all (Brazil, Pakistan and India) or it improved (Indonesia) or deteriorated enormously in the economic downturn (Nigeria). These variations obviously do not have very much to do with the choice of the international economic strategy, but above all with the initial distribution of income, the income effects of the educational system and changes in the supply of labour (Bourguignon et al. 2002). There is also no systematic connection between an increasing trade share in GNP and the income share of the lowest quintile. Some economies which integrated rapidly into the world economy experienced a rising income share of the poor. Overall, there is no deterioration of income distribution in these economies (Dollar and Kraay 2001; Ravallion 2001; Dollar 2004). Panel data for income distribution do not show any significant influence of the economic opening of countries on income distribution (Dollar and Kraay 2000). Finally, there is not much evidence that globalization exerted a negative influence on inequality of wages. Wages in developing countries increased to the same extent during the 1980s and 1990s as in Northern countries; if only rapidly integrating developing economies are considered, this was even more the case (Freeman et al. 2001).

5 Causes of variations in development in the age of globalization Empirical evidence allows the conclusion that the influence of globalization on the distribution of income was often exaggerated. Worldwide inequality is determined foremost by differences between and not within countries. Considering this fact, one could dismiss internal programmes for the redistribution of income as superfluous and rely on growth-inducing, inflation-dampening economic policies alone (as Dollar and Kraay 2001 and Sala-i-Martin 2002a do). However, such a prescription would ignore the substantial transition costs incurred by switching to more open and dynamic economic policies, especially in the presence of the ongoing segmentation of labour and factor markets (Lundberg and Squire 2003; Kanbur 2001). Yet to be explained are the varying benefits developing countries draw from their integration into world trade and world financial markets. International financial institutions claim that (besides transport and transaction costs) diverging restrictions of trade and capital flows are responsible for these variations (Bourguignon et al. 2002: 4; IMF 2005: 113). Investigating this assertion, I can indeed still discover considerable differences between developing countries in their tariff rates and the incidence of non-tariff barriers, although these trade restrictions were brought down markedly since the beginning of the 1980s (average tariff rates declined from 28 to 12 per cent). Tariff spread has been reduced, sometimes distinctly; the coverage of non-tariff measures remained more or less identical, though. As before, the average tariff level is rather high in South Asia, Sub-Saharan Africa, North Africa and in the Middle East, whereas Latin America and East Asia range only slightly above the prevailing standard in industrialized countries (Dollar 2004; World Bank 2005d). Pure free trade is

Political conditions for economic growth 171 therefore not a usual circumstance in the South. Economies with stronger trade restrictions, if population size is neutralized, exhibit a far lower measure of integration into the world trade system than others. Trade liberalization was always followed, with a certain time-lag, by a significant increase of the trade share in GNP (Sachs and Warner 1995; Dollar 2004). Investment regimes in developing countries have been increasingly liberalized, approval procedures were simplified, sectors hitherto closed to foreign corporations were opened and operation requirements were reduced. The regularly published World Investment Reports from UNCTAD show an almost monotonous picture of ongoing liberalization (United Nations 1998, 1999, 2005). Regionally, restrictions of investment have been lifted since the end of the 1980s, especially in Latin America and Asia but less in Sub-Saharan Africa, where restrictions were unimportant already (Prasad et al. 2004). With regard to the deregulation of the financial sector of developing countries, progress is identifiable since the end of the 1980s. Financial intermediaries achieved more latitude, the regulation and supervision of banks was improved, control of credit rates was liberalized, directed credit and bank holding of state securities were reduced. Slow progress was to be noticed in the privatization of financial institutions and the admission of foreign banks. Regional variations in deregulation remained intense and liberalization in total fairly lagged behind the example of the industrialized countries (Abiad and Mody 2003). As far as restrictions of international capital movements are concerned, I can still identify a more or less clear-cut division of the world: whereas no industrialized country imposed restrictions worth mentioning, 60 per cent of the developing countries did so. However, there was a moderate decline since the 1980s, when 80 per cent of the developing countries relied on restrictions (IMF 2005). It is often forgotten in the public debate that apart from the factors related to the liberalization and deregulation of trade and capital movements, other factors as well were responsible for the effective integration of developing countries into world markets and for the benefits they could draw from it. Essentially, these are (a) a stable macroeconomic framework reducing the volatility of inflation, exchange rates and budget deficits, (b) the provision and maintenance of an adequate infrastructure, especially in the transport and communication domain, (c) sufficient investment for the creation of human capital by hitherto excluded groups, and (d) efficient institutions for the protection of private property, for the enforcement of contracts, the prevention of infringements by public agencies and for corruption control (World Bank 1996, 2005c; WTO 2004; IMF 2003, 2005). According to a report by the World Bank (2001), exactly those developing countries which integrated into the world economy were showing a far more rapid growth in the 1990s (5 per cent) than countries with a low degree of integration (⫺1 per cent) or industrialized countries (2 per cent). The problem with these and similar reports is the definition of rapidly/slowly globalizing countries; the former are simply defined as that third of developing countries which was able to augment its share of trade most since 1980 (ibid.: 34). It is

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still open to question whether liberalization of the external account was not surpassed in its importance by other factors, namely sufficient internal economic dynamic, bringing about macroeconomic stability, the creation of efficient institutions and of social peace. This presumption becomes even more plausible, if the effects of specific liberalization policies are analysed. It is true that all successful economies did liberalize trade at some time and studies nearly always came to the conclusion that indicators of trade liberalization (tariff rates, coverage of non-tariff barriers, distortions of exchange rates, existence of trade monopolies) correlate positively with growth (overview in Bourguignon et al. 2002: 37 ff.; Baldwin 2003; Hallak and Levinsohn 2004; WTO 2004: 98ff.). However, these studies are characterized by two defects, namely endogeneity and missing variables. Developing countries with a poor economic performance are logically forced to protect their internal market; those with better performance can afford liberalization. The direction of causality is therefore undetermined. Moreover, reforms of external trade are enacted parallel to other reforms influencing the particular economic performance. Finally, the intensity of trade integration can increase by reasons more connected to population growth, technological development, capital accumulation and changes in the distribution of income than by actual trade policies (Williamson 2002). Therefore, it is not surprising that the results of the above-mentioned studies vary tremendously. More recent studies try to tackle these problems by neutralizing the factor geographical distance (Frankel and Romer 1999) or by taking institutional quality into consideration, with the result that the significant influence of trade policy on economic performance withers away (Harrison and Hanson 1999; Rodriguez and Rodrik 2000). In addition, trade regimes are not easily quantified. For that purpose, tariffs and non-tariff measures have to be valued and aggregated, their factual enactment must be determined; other trade-influencing measures (e.g. treatment of private foreign investment) must be considered. Trade regimes also have an influence on competition in the local market and on innovation. Some studies (most prominently Rodriguez and Rodrik) therefore argue that the positive or negative impact of trade policies is often highly overstated. More relevant for economic performance were, in the first instance, macroeconomic stabilization, the creation of efficient institutions, stimulation of local investment and measures to increase productivity. This is also the prevailing research consensus at the moment (Baldwin 2003). More difficult than presumed in orthodox trade theories (Stolper–Samuelson Theorem), is the nexus between trade liberalization, poverty and inequality. These theories would expect that less skilled workers benefited from opening because of the increasing demand for their manpower. Poverty and inequality should therefore decrease. It is obviously highly unlikely that trade liberalization leads to an increase in poverty, however, negative distributional effects can occur (Wood 1997; opposing view: Dollar and Kraay 2001). Orthodox theories assume that this is because of the immobility of the factor labour in developing countries, as developing countries often protect their labour-intensive sectors, so

Political conditions for economic growth 173 that trade opening there causes wage decreases; and because companies in the global competition, even if producing labour-intensive goods, need a high amount of skilled workers (World Bank 2005c: 146). Today, the effects of international direct investment on economic development are valued far more positively than formerly. But direct investment only contributes little to economic growth because its share in GNP is relatively low. Several studies are not able to detect any positive influence of direct investment on growth independent from other growth-inducing variables. Others see a positive effect only in combination with a minimum of human capital formation, sufficiently developed financial markets and active trade liberalization (World Bank 2005c: 138). However, a significant correlation between increasing direct investment and exports can be observed. Affiliates of TNCs are definitely more export-orientated than local firms, especially in developing countries with a strong opening of the trade regime. This more pronounced export bias also produces positive spill-over effects on local firms. It is also relatively undisputed that they exert a positive influence on the transfer of technologies to host countries. Their contribution to the financing of investment is also seen in a more positive light, as affiliates reinvest more than half of their profits locally and also have access to foreign funds at better conditions than local counterparts. Foreign investors usually also pay better wages than local companies, even in the same sector. This gap is only partially an effect of different company sizes or locations but unequivocally of higher productivity (Brown et al. 2002). Finally, foreign investors also respect agreed labour standards more than do local ones (Harrison and Scorse 2003). Nevertheless, we must not overestimate the economic importance of foreign direct investment: it contributes only marginally to capital building in developing countries, creates demand only for more qualified employees (its impact on the reduction of poverty is therefore negligible) and its influence on growth and productivity is only positive, if combined with an open trade regime, a developed financial system, if the formation of human capital allows the absorption of foreign technologies and if the productivity gap between foreign and local enterprises is not too big (Bhagwati 2004; Nunnenkamp 2004). In assessing the opening of capital accounts, the prevailing optimism until the mid-1990s was followed by a more sceptical mood, as frequent financial crises of even sound economies made clear that financial opening can increase economic instability by fluctuating capital flows, especially in cases of weak macroeconomic policy and less developed, respectively badly supervised domestic financial systems. In theory, well- functioning, internationally integrated financial markets produce significant economic benefits. The evidence for the connection between financial opening and economic growth demonstrates, however, that according to most studies (even those of the IMF) this link is weak or even negative. Country studies show that liberalization of the capital account is neither a necessary (India, China) nor a sufficient condition (Mauritius, Botswana) for growth acceleration (Prasad et al. 2004). The fact that financial liberalization is often badly sequenced and executed – this is the argument of the

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IMF – is also caused by the difficulty to conceptualize a liberalization of capital markets (IMF 2001).

6 Latitude of developing countries in economic and social policies It is a commonplace of the literature on the consequences of globalization in industrialized countries that the constraints of international competition are reducing taxing capacities of national authorities, enforcing budgetary discipline and diminishing leeway for active social policies. These assertions can safely be put aside in light of the results of various studies on the persistence of different national policies of economic and social policies in the age of globalization (Huber and Stephens 2001; Schmidt 2002; Swank 2002), The issue is whether the noticeable improvement of formerly unstable macroeconomic policies in developing countries (Rogoff 2003) can be attributed to globalization constraints. This is probably only partially the case because the volatility of economic growth did not decrease indiscriminately (Hnatkovska and Loyaza 2004). Inflation rates in developing countries went down considerably. In addition, balance of payments deficits only slightly declined; in the case of poorer countries they even increased. Budget deficits of developing countries were reduced from the mid-1980s until the end of the 1990s (the median went down from 7 to 2 per cent of GNP), but they started to climb again recently (up to 3 per cent of GNP). Little effort was made to reduce official debt. External indebtedness went down markedly (the debt service rate went down from 135 per cent in 1997 to 105 per cent in 2003). This improvement was concentrated to only a few debtors, whereas others (in the mid-income range) showed a slight deterioration. The improvement on the external front was, in addition, compensated by a massive increase of internal debts (World Bank 2005c). Finally, the partial improvement of the financial situation was often brought about by poorly sustainable measures (budgetary cosmetics, creation of parallel budgets, replacement of subsidies by government guarantees, reduction of public investment). The common conception that globalization also enforces budgetary discipline in developing countries (Haggard and Maxfield 1996; Stiglitz 2000) is therefore not shared unanimously (Mukand and Rodrik 2005; Tytell and Wei 2004). On the other hand, international investors do not see all public expenses and increasing deficits in the same light. They certainly value productivity-increased expenses for human capital formation and infrastructure differently to expenses for current government consumption and are able to distinguish between different forms of the financing of deficits (Garrett 1996). Tax reforms only rarely went very far in developing countries. Often, marginal tax rates were reduced, tax systems simplified, partial or complete systems of value-added taxation introduced and tax enforcement made more effective (World Bank 2005c: 73). Taxes on income and profits of developing countries did not change much from 1990 to 2002, however. For 47 states, for which I have fairly complete data, rates went down in 23 states and climbed in 24 states (see World Bank 2005a).

Political conditions for economic growth 175 This corresponds to the increase of budget expenses (in Latin America from 17.4 per cent of GNP in 1990 to 21.1 per cent in 2001), mostly because of more generous social services and transfers (Ocampo 2004). This immediately leads us to the influence of globalization on social expenses of developing countries. In this regard again, I cannot detect a race to the bottom (as asserted in ILO 2000). To begin with, systems of social security in developing countries were hardly sustainable, even without pressures through globalization. Most often, they offered only insular solutions for privileged groups, where a heavy drain on public budgets suffered from poor contribution discipline and were (before market orientated reforms) more or less insolvent (World Bank 1994). Social services in the educational and health sector and in infrastructure were also biased in favour of the privileged, did not guarantee geographically universal provision and were mostly of relatively poor quality (World Bank 2003). Empirically aggregate social expenditures in developing countries increased since the mid-1970s. But this does not mean that there were no crisisinduced declines in some countries/regions (ILO 2000). If we take social expenditures as a share of GNP, there are only two states showing a declining ratio during the 1990s. In East Asia, expenditures increased strongly, in Latin America, a historical record was achieved (2000/01: 13.8 per cent of GNP, 1990/91: 10.1 per cent) (Ocampo 2004). Instead of reducing social activities, globalization expanded them, also influenced naturally by democratization and intensified competition of political parties (see Betz 2004).

7 Concluding remarks Developing countries have recently been incorporated into the world economy to a far higher extent and in new stages of inclusion than beforehand. This inclusion, however, varied as much as measures to bring it about. The influence of globalization on growth and income distribution was better than often claimed, especially in regions with strong integration into the world economy. This positive outcome is less due to specific world market-friendly policies or their shortterm modification, but to secular growth- enhancing factors of different countries and regions. Thus, a whole decade of far- reaching economic reforms in Latin America has brought about progress in terms of declining inflation rates, increasing exports and growing attraction for private direct investment, but not in terms of growth, increase of investment rates and growth of economic productivity (Ocampo 2004). Developing countries in general were able to surpass their growth performance of the 1980s in the 1990s, but not the rates of the 1970s. The World Bank is trying to explain this somewhat frustrating experience by first stating persistent reform deficits and second stressing that results of better macroeconomic policies depend on a credible and stable institutional setting. The Bank is concluding in a kind of self-critique that the growth dividend of macroeconomic reforms has probably been exaggerated. Economic instability would not hinder investors to grasp investment opportunities, however, these

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opportunities should exist (World Bank 2005c: 110). This scepticism is in full accordance with the results of empirical studies on the benefits of one-stop, market-orientated reforms, which, if factors of institutional quality1 of the countries in question are taken into account, is more or less insignificant (overview in Betz 2003). Representatives of the Bretton Woods Institutions delivered rearguard battles against this evidence for a while (see e.g. IMF 2003), yet fell in line later (IMF 2005; World Bank 2005c). These institutional background factors also have a decisive influence on the economic performance of developing countries in the process of globalization, as our arguments above suggest and several case studies demonstrate empirically (Weiss 2003; Kohli 2004). Divergent national institutions also filter the extent to which global pressure can act on private and public actors. They also determine the competitiveness of local industries and their attractiveness for international capital. Social and political institutions are often fiercely defended and therefore highly persistent because they are the product of unequal economic power, status and influence, which benefiting groups are trying to protect. Institutions serving the interest of small elite segments alone and which can be traced back to disadvantageous legal traditions and/or arrangements of colonial exploitation and their maintenance (Acemoglu et al. 2004; Levine 2005) are obstructing investment, innovations and risk-taking, which are relevant for growth. Unequal distribution of economic power is also promoting the emergence of bad political institutions, which conserve the influence of a small elite and favour infringements of the executive. A new report of the Interamerican Development Bank shows convincingly how effective political participation enhances the quality of policies. This quality is advanced by stable political parties, a legislative body with sufficient policy-making capacity, an independent legal system and a competent administration (IADB 2005). Effective, growth-promoting institutions can be condensed to ideal types of political and social systems. Atul Kohli (2004) was exactly trying to do this and distinguishes (a) neopatrimonial states, where private and public spheres are hardly separated, which possess only weakly legitimized authority structures, hardly any restrictions on governmental arbitrariness and weak administrations (prototype: Nigeria); (b) cohesive capitalist developing states, equipped with centralized and purposeful authority structures, reaching deeply into the society and where state agencies have developed a strong alliance with industrial groups and are able to control the workforce (prototype: South Korea); and (c) fragmented multi-class states, where political authority is split and is based on a broad social alliance, where therefore enactment of decisions is strongly politicized (prototype: India). He argues that the existence and persistence of these arrangements can be traced back to divergent patterns of colonial domination, divergent ideologies after independence and different patterns of linkage between state agencies and interest groups. If institutions determine development progress in the globalized economy in the last instance, the question that arises is: What can be done to improve institutional quality? As a matter of fact, this quality, as measured by Daniel Kaufmann

Political conditions for economic growth 177 and his team, improved in only a few cases during the last eight years (Kaufmann et al. 2005). Nevertheless, this is no reason for overstated pessimism. Countries have successfully integrated into the world economy by quite different means. It is apparently only important to guarantee macroeconomic stability and competition, to give the right incentives, to cut rent-seeking of privileged groups and to create a level playing field for exports. The specific modalities of integration policies may vary. China liberalized its trade by creating special economic zones, where resident companies got imports and world prices, private direct investment was eased and got tax reductions. In India, liberalization was more gradual and sector-specific, occurring in capital and investment goods first. In Chile, capital controls were enacted in an otherwise ultraliberal setting (Rodrik and Subramanian 2003; World Bank 2005c). China found ways to protect property without transferring it to private actors completely. Finally, action in some sectors can compensate weaknesses elsewhere, like the high and persistent budget deficits in India and pension problems in China. These are only some examples. Sometimes, even small improvements of institutional quality led to much better economic results (Rodrik 2004). Specific institutional solutions are, however, strongly context- and path-dependent and must be adapted to the geographical, economic and political circumstances of the country in question. Economic institutions may be persistent but they are not carved in stone. History shows that wars, political transitions, but also grave economic crises bring about change. In the longer perspective, supporting factors have also been economic opening (with comparatively moderate effects), the liberalization of the political system, freedom of the press, and the improvement of educational standards and neighbourhoods to countries experiencing institutional change (IMF 2005). It is beyond doubt empirically that institutional improvements from outside (by conditional credits) are hardly a promising option. Developing countries have to find their own ways to benefit from the globalized economy.

Note 1 The most prominent and best researched institutional factors are ethnolinguistic fractionalization, the level of social capital, the existence, breadth and consensus of a middle class, the distribution of income, political stability but above all factors which restrict arbitrary actions of the executive, guarantee security of property, secure political participation and restrict rent-extraction by privileged groups.

Bibliography Abiad, A. and Mody, A. (2003) “Financial Reform: What Shakes It? What Shapes It?” IMF Working Paper, 03/70, Washington, DC: IMF. Acemoglu, D., Johnson, S. and Robinson, J. (2004) “Institutions as the Fundamental Cause of Long-Run Growth”, NBER Working Paper, 10481, Cambridge: National Bureau of Economic Research. Afheldt, H. (1995) “Ausstieg aus dem Sozialstaat? Gefährdungen der Gesellschaft durch weltweite Umbrüche”, Aus Politik und Zeitgeschichte, B25–26/95: 3–12.

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Albert, M., Brock, L., Hessler, S., Menzel, U. and Neyer, J. (1999) Die Neue Weltwirtschaft. Entstofflichung der Ökonomie, Frankfurt/M.: Suhrkamp. Amsden, A. (1989) Asia’s Next Giant: South Korea and Late Industrialization, New York: Oxford University Press. Baer, W. and Maloney, W. (1997) “Neoliberalism and Income Distribution in Latin America”, World Development, 25/3: 311–27. Balassa, B. (1978) “Exports and Economic Growth: Further Evidence”, Journal of Development Economics, 5: 181–9. Baldwin, E.R. (2003) “Openness and Growth: What’s the Empirical Relationship?” NBER Working Paper, 9578, Cambridge: National Bureau of Economic Research. Bauman, Z. (1997) “Schwache Staaten. Globalisierung und die Spaltung der Weltgesellschaft”, in U. Beck (ed.) Kinder der Freiheit, Frankfurt/M.: Suhrkamp: 315–32. Betz, J. (1995) “Einführung: Politische Restriktionen der Strukturanpassung in Entwicklungsländern”, in J. Betz (ed.) Politische Restriktionen der Strukturanpassung in Entwicklungsländern, Hamburg: Deutsches Überseeinstitut: 3–48. –––– (2003) “Die Qualität öffentlicher Institutionen und die sozioökonomische Entwicklung”, Nord-Süd aktuell, XVII/3: 456–67. –––– (2004) “Soziale Sicherung in Entwicklungsländern: Ein Überblick”, in J. Betz and W. Hein (eds.) Neues Jahrbuch Dritte Welt. Soziale Sicherung in Entwicklungsländern, Opladen: Verlag für Sozialwissenschaften: 7–31. Bhagwati, J. (2004) In Defense of Globalization, New Delhi: Oxford University Press. Bhalla, S. (2002) Imagine There Is No Country: Poverty, Inequality, and Growth in the Era of Globalization, Washington, DC: Institute of International Economics. Bourguignon, F., Coyle, D., Fernandéz, R., Giavazzi, F., Marin, D., O’Rourke, K., Portes, R., Seabright, P., Venables, A., Verdier, T. and Winters, A. (2002) “Making Sense of Globalization. A Guide to the Economic Issues”, CEPR Policy Paper, 8, London: Centre for Economic Policy Research. Broad, R. and Cavanagh, J. (1995–96) “Don’t Neglect the Impoverished South”, Foreign Policy, 101: 18–35. Brown, D.K., Deardorff, A.V. and Stern, R.M. (2002) “The Effect of Multinational Enterprises on Wages and Working Conditions in Developing Countries”, unpublished thesis, University of Michigan. Callaghy, T.M. and Ravenhill, J. (eds) (1993) Hemmed In. Responses to Africa’s Economic Decline, New York: Columbia University Press. Chen, S. and Ravallion, M. (2000) “How Did the World’s Poor Fare in the 1990s?” World Bank Policy Research Working Paper, 2409, Washington, DC: World Bank. –––– (2004) “How have the World’s Poorest Fared since the Early 1980s?” World Bank Policy Research Working Paper, 3341, Washington, DC: World Bank. Deutscher Bundestag (1999) Zwischenbericht der Enquete-Kommission. Globalisierung der Weltwirtschaft – Herausforderungen und Antworten, Berlin: Deutscher Bundestag. Devarajan, S., Dollar, D. and Holmgren, T. (eds) (2001) Aid and Reform in Africa. Lessons from Ten Case Studies, Washington, DC: World Bank. Dollar, D. (2004) “Globalization, Poverty, and Inequality since 1980”, World Bank Policy Research Working Paper, 3333, Washington, DC: World Bank. Dollar, D. and Kraay, A. (2000) Trade, Growth and Poverty, unpublished Manuscript, Washington, DC: World Bank. –––– (2001) “Growth is Good for the Poor”, World Bank Working Paper, 2587, Washington, DC: World Bank.

Political conditions for economic growth 179 Elsenhans, H. (1981) Abhängiger Kapitalismus oder bürokratische Entwicklungsgesellschaft. Versuch über den Staat in der Dritten Welt, Frankfurt/M.: Campus. Frankel, J.A. and Romer, D. (1999) “Does Trade Cause Growth?” American Economic Review, 89/3: 379–99. Freeman, R., Oostendorp, R. and Rama, M. (2001) Globalization and Wages, unpublished manuscript, Washington, DC: World Bank. Fröbel, F., Heinrichs, J. and Kreye, O. (1977) Die neue internationale Arbeitsteilung. Strukturelle Arbeitslosigkeit in den Industrieländern und die Industrialisierung der Entwicklungsländer, Reinbek: Rowohlt. Garrett, G. (1996) “Capital Mobility, Trade and Domestic Politics of Economic Policy”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 48–75. Gruppe von Lissabon (2001) Grenzen des Wettbewerbs. Die Globalisierung und die Zukunft der Menschheit, München: Luchterhand. Haggard, S. and Maxfield, S. (1996) “The Political Economy of Financial Internationalization in the Developing World”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 209–39. Haggard, S. and Webb, S.B. (eds) (1994) Voting for Reform. Democracy, Political Liberalization and Economic Adjustment, New York: World Bank. Hallak, J.C. and Levinsohn, J. (2004) “Fooling Ourselves: Evaluating the Globalization and Growth Debate”, NBER Working Paper, 10244, Cambridge: National Bureau of Economic Research. Harrison, A. and Hanson, G.H. (1999) “Who Gains from Trade Reform: Some Remaining Puzzles”, NBER Working Paper, 6915, Cambridge: National Bureau of Economic Research. Harrison, A. and Scorse, J. (2003) The Impact of Globalization on Compliance with Labor Standards: A Plant-Level Study, Washington, DC: Brookings Trade Forum. Hayami, Y. (2001) Development Economics. From the Poverty to the Wealth of Nations, Oxford: Oxford University Press. Hein, W. (1998) Unterentwicklung – Krise der Peripherie, Opladen: Leske+Budrich. Hirst, P. (1997) “The Global Economy – Myths and Realities”, International Affairs, 73/3: 409–25. Hnatkovska, V. and Loyaza, N. (2004) “Volatility and Growth”, World Bank Policy Research Working Paper, 3184, Washington, DC: World Bank. Huber, E. and Stephens, J.D. (2001) Development and Crisis of the Welfare State. Parties and Policies in Global Markets, Chicago, IL: University of Chicago Press. Hübner; Kurt (1998) Der Globalisierungskomplex. Grenzenlose Ökonomie – grenzenlose Politik? Berlin: Ed. Sigma. Interamerican Development Bank (IADB) (2005) The Politics of Policies. Economic and Social Progress in Latin America. 2006 Report, Washington, DC: IADB. International Labour Office (ILO) (2000) World Labour Report 2000, Genf: ILO. International Monetary Fund (IMF) (2001) World Economic Outlook, October 2001, Washington, DC: IMF –––– (2003) World Economic Outlook, April 2003. Growth and Institutions, Washington, DC: IMF. –––– (2005) World Economic Outlook, April 2005, Washington, DC: IMF. Kanbur, R. (2001) “Economic Policy, Distribution and Poverty: The Nature of Disagreements”, World Development, 29/6: 1083–94.

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Kaufmann, D., Kraay, A. and Mastruzzi, M. (2005) Governance Matters IV: Governance Indicators for 1996–2004, unpublished manuscript, Washington, DC: World Bank. Keohane, R.O. and Milner, H.V. (eds) (1996) Internationalization and Domestic Politics, Cambridge: Cambridge University Press. Killick, T. (1995) IMF Programmes in Developing Countries. Design and Impact, Overseas Development Institute, London: Routledge. Kitschelt, H., Marks, G. and Lange, P. (eds) (1999) Continuity and Change in Contemporary Capitalism, Cambridge: Cambridge University Press. Kohli, A. (2004) State-Directed Development. Political Power and Industrialization in the Periphery, Cambridge: Cambridge University Press. Kozul-Wright, R. and Rayment, P. (2004) “Globalization Reloaded: An UNCTAD Perspective”, UNCTAD Discussion Papers, 167, Genf: UNCTAD. Krugman, P. (1995) “Growing World Trade: Causes and Consequences”, Brookings Papers on Economic Activity, 1: 327–77. Levine, R. (2005) “Law, Endowments and Property Rights”, Journal of Economic Perspectives, 19/3: 61–88. Lundberg, M. and Squire, L. (2003) “The Simultaneous Evolution of Growth and Inequality” The Economic Journal, 113 (487): 326–44. Lustig, N. (ed.) (1995) Coping with Austerity. Poverty and Inequality in Latin America, Washington, DC: Brookings Institution Press. Messner, D. (1995) Die Netzwerkgesellschaft. Wirtschaftliche Entwicklung und internationale Wettbewerbsfähigkeit als Probleme gesellschaftlicher Steuerung, Köln: Weltforum. Mosley, P., Harrigan, J. and Toye, J. (1991) Aid and Power. The World Bank and Policybased Lending, 2 vols, London/New York: Routledge. Mukand, S. and Rodrik, D. (2005) “In Search of the Holy Grail: Policy Convergence, Experimentation and Economic Performance”, American Economic Review, 95/ 1: 374–83. Nunnenkamp, P. (2004) “Wachstumseffekte von Direktinvestitionen in Entwicklungsländern. Warum hohe Erwartungen häufig enttäuscht werden”, Die Weltwirtschaft, 1: 99–118. Ocampo, J.A. (2004) “Latin America’s Growth and Equity Frustrations During Structural Reforms”, Journal of Economic Perspectives, 18/2: 67–88. Prasad, E., Rogoff, K., Wei, S.-J. and Kose, M.A. (2004) “Financial Globalization, Growth and Volatility in Developing Countries”, NBER Working Paper, 10942, Cambridge: National Bureau of Economic Research. Ranis, G. (1995) “Another Look at the East Asian Miracle”, World Bank Economic Review, 9/3: 509–34. Ravallion, M. (2001) “Growth, Inequality and Poverty: Looking beyond Averages”, World Development, 29/11: 1803–15. Reinicke, W.H. (1997) “Global Public Policy”, Foreign Affairs, 76/6: 127–38. ––––(1998) Global Public Policy. Governing without Government? Washington, DC: Brookings Institution Press. Rodriguez, F. and Rodrik, D. (2000) “Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-National Evidence”, NBER Macroeconomic Annual 2000, Cambridge: National Bureau of Economic Research: 261–325 Rodrik, D. (2004) Getting Institutions Right, unpublished thesis, Harvard University. Rodrik, D. and Subramanian, A. (2003) “The Primacy of Institutions”, Finance and Development, June: 31–4.

Political conditions for economic growth 181 Rogoff, K. (2003) Globalization and Global Disinflation, Washington, DC: IMF. Sachs, J.D. and Warner, A. (1995) “Economic Reform and the Process of Global Integration”, Brookings Papers on Economic Activity, 1: 1–49. Sala-i-Martin, X. (2002a) “The Disturbing ‘Rise’ of Global Income Inequality”, NBER Working Paper, 8904, Cambridge: National Bureau of Economic Research. –––– (2002b) “The World Distribution of Income”, NBER Working Paper, 8933, Cambridge: National Bureau of Economic Research. Schmidt, V.A. (2002) The Futures of European Capitalism, Oxford: Oxford University Press. Scholte, J.A. (1997) “Global Capitalism and the State”, International Affairs, 73/3: 427–52. –––– (2000) Globalization. A Critical Introduction, Basingstoke/London: Macmillan. Senghaas, D. (1977) Weltwirtschaftsordung und Entwicklungspolitik. Plädoyer für Dissoziation, Frankfurt/M.: Suhrkamp. Srinivasan, T.N. and Wallack, J.S. (2004) Globalization, Growth, and the Poor, unpublished thesis, Yale University. Stiglitz, J. (2000) “Capital Account Liberalization, Economic Growth and Instability”, World Development, 28/5: 1075–86. Swank, D. (2002) Global Capital, Political Institutions, and Policy Change in Developed Welfare States, Cambridge: Cambridge University Press. Todaro, M.P. and Smith, S.C. (2003) Economic Development, Boston, MA: Addison Wesley. Tybout, J.R. (2000) “Manufacturing Firms in Developing Countries: How Well do They Do and Why?” Journal of Economic Literature, 38: 11–44. Tytell, I. and Wei, S.-J. (2004) “Does Financial Globalization Induce Better Macroeconomic Policies?” IMF Working Paper, 04/84, Washington, DC: International Monetary Fund. UNCTAD (1997) Trade and Development Report 1997, New York/Genf: UNCTAD. –––– (2002) Trade and Development Report 2002, New York/Genf: UNCTAD. UNDP (1999) Human Development Report 1999, New York: UNDP. United Nations (1998) World Investment Report 1998. Trends and Determinants, New York/Genf: UN. –––– (1999) World Investment Report 1999. Foreign Direct Investment and the Challenge of Development, New York/Genf: UN. –––– (2002) World Investment Report. Transnational Corporations and Export Competitiveness, New York/Genf: UN. –––– (2005) Transnational Corporations and the Internalization of R&D, New York/Genf: UN. Wade, R.H. (1990) Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization, Princeton, NJ: Princeton University Press. Weiss, L. (ed.) (2003) States in the Global Economy. Bringing Domestic Institutions Back In, Cambridge: Cambridge University Press. Williamson, J.G. (2002) “Winners and Losers Over Two Centuries of Globalization”, NBER Working Paper, 9161, Cambridge: National Bureau of Economic Research. Wood, A. (1997) “Openness and Wage Inequality in Developing Countries: The Latin American Challenge to East Asian Wisdom”, The World Bank Economic Review, 11/1: 33–57. World Bank (1993) The East Asian Miracle, Oxford: Oxford University Press. –––– (1994) Averting the Old Age Crisis. Policies to Protect the Old and Promote Growth, Oxford: Oxford University Press.

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10 Regionalism in the world economy Building block or stumbling stone for globalization? Andreas Dür 1 Introduction Since the early 1990s, countries around the globe have concluded a large number of bilateral and regional trade agreements.1 These agreements, whether they come in the form of free trade agreements or of customs unions, eliminate tariffs and possibly also other barriers to trade between the member countries, but leave in place the trade barriers with excluded countries. In two respects this development has relevance for the debate about the globalization of the world economy, which analyses the causes and consequences of an increasing worldwide division of labour and of booming world trade. On the one hand, regionalism may at least partly be a response to globalization. In this vein, Stefan Schirm (2002) argues that the process of globalization imposes reform pressure on nation states. Countries respond to this pressure with regional agreements, which enhance the economic efficiency and political acceptability of the reforms implemented. On the other hand, regionalism may have an impact on the process of globalization. A preferential trading area, independent of its type, produces trade discrimination, which runs counter to a further division of labour. In addition, regionalism possibly influences the process of multilateral trade negotiations, which has been one of the engines of globalization. This chapter focuses on the latter question about the effects of the creation of a preferential trade agreement on the trade relations of its members with nonmember countries and on the multilateral trading system. Do bilateral and regional free trade areas propel or hinder liberalization in the World Trade Organization (WTO)? Since the early 1990s, this question has fuelled a controversy between two opposing perspectives. On the one side, a whole series of authors defend the idea that the creation of a preferential trading area can be a building block for further liberalization. On the other side, others warn that regionalism can lead to protectionism and therefore should be regarded as a stumbling stone for globalization. Rather than supporting either side in this debate, my argument starts from the premise that advocates of both the building block and the stumbling stone perspective can refer to logically consistent arguments and mention empirical examples that support their respective positions. Both effects thus seem to be

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logically possible and also empirically relevant. I suggest that the lesson that should be learned from this state of affairs is that future scholarly analysis should concentrate on exploring and theorizing the circumstances under which the one or the other development is to be expected. To do so, it will be necessary to conceive of a theoretical argument that can integrate the expected effects of a preferential trading arrangement on the trade policies of both member and excluded countries. Only then will it be possible to understand the interaction between the strategies of the two sides: the strategy of the excluded countries in reaction to a regional agreement and the response of the member countries to the reaction of the excluded countries. In an attempt at theorizing this interaction, I first postulate that the reaction of an excluded state to discrimination depends on the distribution of bargaining power between itself and the member countries. Depending on the distribution of power, excluded countries choose among four possible strategies: membership application, call for non-discriminatory trade liberalization, creation of a rival trading block and threat of retaliatory measures. As long as member and excluded countries concur in their evaluation of the distribution of bargaining power, a building block scenario (such as an extension of the agreement, a nondiscriminatory reduction of trade barriers, or unilateral concessions by the member countries to avoid retaliatory measures) will evolve. When the two sides’ evaluation of the distribution of bargaining power differs, however, a stumbling stone scenario is to be expected. This can be a trade war or the emergence of rival blocks with increasingly high trade barriers. Before developing this theoretical argument in more detail, the chapter offers an overview of the building block and stumbling stone debate. In the third part of the chapter, I examine the empirical plausibility of the argument based on a short account of American trade policies over the last four decades.

2 Stumbling stone or building block? An overview of the debate After a first boom of regional agreements in the 1950s and 1960s, the process of regionalization slowed down in the following two decades. Only since the late 1980s has the number of bilateral and regional trade agreements again been on the rise. Initially, this new wave of regionalism was driven by the Single Market Programme in Europe and the preferential trade agreements between the European Union (EU) and surrounding countries. In the meantime, however, the trend has become global. In March 2006, the WTO consequently reported the existence of 193 customs unions and free trade agreements, of which more than half (102) have been created in the years since 2000 (World Trade Organization 2006). Only very few countries, such as Iran, Afghanistan and Mongolia, are at present not members of at least one free trade agreement. The WTO thus estimates that currently approximately half of world trade is conducted under preferential conditions. The new wave of regionalism differs from the preceding one in several respects. First, Asian countries – and here particularly China – are among the

Regionalism in the world economy 185 most active participants in the new wave, forming part of some 84 preferential agreements in early 2006. The first wave, by contrast, was largely limited to agreements in Europe, Africa and Latin America. Second, many of the newer agreements extend beyond continental borders, a development which increasingly puts into doubt the appropriateness of the term “regionalism”. Some examples for this development are the agreements between Japan and Mexico (2005), the European Free Trade Area (EFTA) and South Korea (2005), and the United States (US) and Australia (2004). Third, many agreements – and in particular those concluded by the EU and the US – go far beyond simple tariff concessions. They include, among other issues, rules for foreign investments, trade in services, the protection of intellectual property rights and public procurement. Finally, most of the new agreements are bilateral, which contrasts with the regional agreements dominating the preceding wave. The scholarly analysis of regionalism originally concentrated on the welfare effects of preferential agreements (Viner 1950; for an overview of more recent studies, see Lloyd and McLaren 2004). Economists applied different econometric models to establish whether in a specific case the trade diverting or the trade creating effects dominated. Only in the 1990s did scholars start to wonder about the dynamic effects of regionalism. The new question was: would preferential agreements facilitate or hinder further liberalization (see Bhagwati 1991; Krueger 1999; Winters 1999; Panagariya 2000: 317–25)? This question seemed crucial not least from the perspective of research on globalization: would regionalism undermine the process of globalization? The new debate was started by Paul Krugman (1991), who in the title of a study provokingly asked: “Is bilateralism bad?” Krugman justified the affirmative answer to his question with the argument that bilateral agreements would lead to the creation of rival trade blocks. With the potential for conflict among the rival blocks increasing, such a development would nearly inevitably lead to the deterioration of international trade relations. This pessimistic analysis was not least influenced by the perceived deadlock of the multilateral negotiations in the Uruguay Round (1986–1993), which should have been concluded in 1990. Krugman’s finding, however, was immediately challenged by Robert Lawrence (1991), who instead argued that regional agreements promote economic growth in member countries, and that regional blocks are more likely to accept multilateral liberalization than the individual member states on their own. Building on these two opposing poles, an intensive debate emerged, which I will briefly trace in the following section. 2.1 Regionalism as a stumbling stone The stumbling stone perspective argues that regional agreements can undermine the multilateral trade regime and unleash a protectionist spiral (Bhagwati 1992; Bhagwati and Panagariya 1996; Bagwell and Staiger 1998; Cadot et al. 1999; Saggi 2006). Regionalism reduces world welfare since discriminating trade agreements result in trade diversion, which again leads to welfare losses in both

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member and excluded countries (Viner 1950). Moreover, political logic suggests that governments should prefer agreements that are costly to excluded countries over those that are costly to domestic constituencies (Grossman and Helpman 2002: 199–232). Some authors thus predict that preferential liberalization should be compensated with an increase in the most-favoured-nation (MFN) tariffs of member countries. A frequently cited example that supports this argument is Israel’s decision to increase its MFN tariffs after concluding free trade agreements with the EU and the US (Panagariya 1999: 499). According to the advocates of this perspective, however, the danger that regionalism may induce member countries to follow protectionist trade policies in the long run is even more worrying. In these countries, firms often oppose enlargement or further multilateral liberalization since they profit from the exclusion of competitors from their markets. Illustratively, at present some developing countries are sceptical with respect to multilateral trade liberalization since they fear losing the advantages of having preferential access to the EU. In addition, it is possible that in a customs union, in which trade policy is determined centrally, protectionist interests are better able to push their demands than advocates of trade liberalization (Bilal 1998). Instead of initiating further liberalization, according to this argument, regional agreements thus lead to a stronger polarization of the world economy. Furthermore, regional trade agreements can make multilateral negotiations more difficult by diverting the attention of politicians away from the multilateral level and exhausting scarce negotiating resources. Even large countries with an efficient bureaucracy, such as the US, find it difficult to negotiate in several arenas at the same time (United States General Accounting Office 2004). This is all the more the case with trade negotiations increasingly covering very technical questions. The many, often slightly diverging rules that are contained in preferential agreements create a situation that can be compared with a “spaghetti bowl” (Bhagwati/Panagariya 1996). In such a situation, a multilateral agreement is made more difficult because too many diverging and possibly incompatible regulations exist. Finally, already the prospect of countries concluding preferential agreements may undermine the multilateral trading system (Bagwell and Staiger 1998). The principle of non-discrimination is one of the basic pillars of the multilateral trading system, which was established in 1947 with the General Agreement on Tariffs and Trade (GATT). This principle is so important because it makes sure that concessions that are made in multilateral negotiations are not undermined by concessions made in other arenas. In the absence of this certainty, countries will be more reluctant to make concessions in multilateral negotiations. Since regional agreements guarantee market access to at least some trading partners, countries that are members of such agreements are also less worried about the possibility of a breakdown of the multilateral trading system (Perroni and Whalley 2000). As a result, they may be tempted to adopt a high risk strategy in multilateral negotiations to maximize private gains, thereby risking a failure of the negotiations. A similar effect occurs if countries minimize the concessions they make in multilateral negotiations to have a better starting position in

Regionalism in the world economy 187 regional negotiations (Limão 2005). The slow progress of the Doha Development Agenda (2001–) and the difficulties that negotiators had in the Ministerial Conference of the WTO in Hong Kong (December 2005) to agree upon negotiating modalities, seem to support these pessimists. 2.2 Preferential agreements as building blocks for further liberalization On the other side of the debate, Lawrence (1991, 1996) was by far not the only one to argue that regional agreements can function as building blocks for further globalization (Summers 1991; Bergsten 1996; Baldwin 1997). As the declaration of the Ministerial Meeting of the WTO in Doha (2001) suggests, many decision-makers share this view as well. In this declaration, governments expressed their conviction that “regional trade agreements can play an important role in promoting the liberalization and expansion of trade.” (World Trade Organization 2001: 1). Both Pascal Lamy (2002) and Robert Zoellick (2002), the chief negotiators for the EU and the US at that time, defended the position that regionalism can lead to a competition of liberalization efforts and thus boost the process of multilateral liberalization also in other forums. Scholarly studies on the building block side mention a variety of arguments to support their position. Above all, they argue that negotiations among few countries are characterized by lower transaction costs than negotiations among nearly 150 countries in the WTO. Compared with the time-intensive negotiations of multilateral agreements, regional agreements thus have the advantage that they can be negotiated relatively easily. They even may be able to accommodate topics for which there are still no multilateral rules. A further advantage of preferential liberalization is that at the regional or bilateral level the implementation of compromises found can be monitored more easily. The more farreaching compromises, which thus can be attained in such negotiations, can then serve as models for the multilateral level. Testing a variety of solutions in different agreements can even help countries implement the best solution at the multilateral level. A different argument is that the formation of a customs union with a common commercial policy reduces the number of participants that must concur in multilateral negotiations. This may lower transaction costs at the multilateral level (Zahrnt 2005: 687). So far, however, only the EU negotiates as a (more or less) unitary actor in multilateral trading negotiations. Finally, if regional liberalization is attained, this increases the pressure on other countries to also undertake steps towards liberalization, since trade agreements may be an essential advantage to attract foreign direct investments. The end result is a process of continuous liberalization. In this view, therefore, the choice of regional agreements can even be seen as an expression of the desire of governments to obtain more far-reaching trade liberalization. Bilateral and regional agreements can also be a building block for further liberalization if they help weak governments to implement reforms and make them stable even in the face of strong domestic opposition. Firms may learn the

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advantages of liberalization once they experience limited free trade. If preferential free trade sets off a change in the economic structure of a country, an agreement can also shape the future trade preferences of a country. Uncompetitive sectors are destroyed by foreign competition, and thus no longer have a bearing on the country’s trade preferences. Other sectors, by contrast, profit from a larger market in a preferential agreement, and may use this advantage to attain economies of scale, which make them competitive at the global level (Chase 2005). This should make them support further liberalization. Together, these two effects should shift the trade preferences of a country towards greater support for trade liberalization. Finally, regional agreements can start a domino effect if excluded countries that are confronted with losses of market access demand negotiations to offset these losses (Oye 1992; Lazer 1999). These negotiations can lead to a liberalization of trade beyond the regional agreement. A domesticlevel explanation for this phenomenon can be built on the consideration that exporters will increase their lobbying efforts in countries that suffer from discrimination (Baldwin 1997; Dür 2004). These exporters ask their governments to engage in trade negotiations that help them regain lost market shares in a regional agreement. 2.3 The upshot of the debate In short, both sides can mention a whole series of mostly logically consistent arguments in support of their respective positions. Both sides also find at least some evidence to back up their arguments (Winters 1994; Krueger 1999). The creation of rival trade blocks in the various colonial empires in the 1930s serves as an empirical example that is taken to support the stumbling stone perspective. In the Uruguay Round, moreover, tariffs on goods for which developing countries enjoy preferential access to the developed countries’ markets were reduced less than other tariffs (Karacaovali and Limão 2005). One possible interpretation for this finding is that preferential trade relations hinder further liberalization. The advocates of the building block hypothesis, by contrast, refer to the fact that over the last decades countries have both concluded regional trade agreements and lowered tariffs in multilateral trade rounds. The difficulties with the current debate appear even more pronounced once it is recognized that the same event can result both in building block and in stumbling stone scenarios. The creation of the European Economic Community (EEC, 1957) led to both multilateral negotiations in the context of the GATT (building block) and to the creation of a rival trade block in Latin America (LAFTA, 1960), which had the objective of making Latin America less dependent on world markets (stumbling stone). A quantitative comparison of the tariffs of developing countries in the 1970s and 1990s, moreover, shows that throughout this period countries that participated in (effective) regional trade arrangements did not uniformly move either towards liberalization or protectionism (Foroutan 1998: 326). Some countries clearly reduced their trade barriers while others became more protectionist, a finding that suggests that membership in a

Regionalism in the world economy 189 regional agreement is neither a sufficient nor a necessary condition for an open and liberal trade regime. The debate between the two perspectives consequently seems to have reached a dead end. Since both effects can be empirically observed, it seems appropriate to shift the analysis away from the question of whether regionalism is a stumbling stone or a building block. Instead, the new focus should be on the factors that determine whether in a specific case the creation of a regional trade agreement leads to further liberalization beyond its borders or to intensified protectionist tendencies. Further liberalization can result when the creation of a preferential agreement leads to non-discriminatory liberalization (a reduction in the MFN tariff rate) or when the block accepts new members. Retaliatory measures or the creation of a rival trade block can also be building blocks for further liberalization, as long as the member countries of the block give in to the pressure exercised upon them. By contrast, retaliatory measures that lead to counterretaliation, the increase of the external tariff of the member states for other reasons, and the creation of rival blocks are scenarios that correspond to the stumbling stone logic. In the following section I will argue that which of these scenarios unfolds in a certain case depends on the interaction between the trade policies chosen by excluded and by member countries in the aftermath of the creation of a preferential trading area.

3 Regionalism and bargaining power For excluded countries trade and investment diversion are the most immediate consequences of the creation of a preferential trade agreement. As Jacob Viner (1950) demonstrated, discrimination often leads to a situation in which imports from outside the trading area are replaced by goods and services produced or provided within the area, an effect that is known as trade diversion. In order to remain competitive in such a situation, some foreign producers take up production within the borders of the agreement, which leads to investment diversion. How do excluded countries that must bear these costs react to the creation of a preferential trading area? In principle, countries that do not want to resign themselves to these costs can select among four strategies. For one, they can threaten to impose retaliatory measures should the member countries fail to compensate them for the losses. Alternatively, excluded countries may offer concessions in MFN negotiations to maintain access to the markets of the member states. Since generally several countries are negatively affected by a regional agreement, these countries can also unite and create a rival block. Finally, a country can try to enter the trading area or associate itself with it. My argument is that an excluded country’s choice among these strategies is determined by its bargaining power. In negotiations, the participant with the best alternative to negotiated agreement (known as BATNA after Fisher and Ury 1983; see also Moravcsik 1998: 61–3) tends to be most powerful. As the BATNA of an actor deteriorates, she starts to attach a higher value to a negotiated solution, leading to a decline in her bargaining power. At the same time,

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power resources from outside the negotiating context – such as military or financial means – most often cannot be employed to gain advantages in trade negotiations.2 Actors with a relatively bad BATNA thus will have to make more substantial concessions in a bargaining situation than those with a better BATNA. In trade negotiations, the BATNA is either the status quo, a unilateral increase in the trade barriers, or an agreement with a third country. The relative attractiveness of these different alternatives depends on a set of factors. First, the relative strength of the two most important domestic trade interests, namely import-competitors and exporters, is crucial. The stronger import-competing interests are relative to exporters, the more attractive becomes the option of a unilateral increase of trade barriers (and at the same time the threat with retaliatory measures). Such a country does not need an international agreement, since better access to foreign markets is only a subordinate goal. On the other hand, strong export interests make a unilateral strategy of increasing trade barriers unattractive. Such a country attaches great importance to the conclusion of an agreement with key export markets. Since empirically establishing the relative strength of the two interests is difficult, the balance of trade may be used as a shortcut. In this view, the higher the trade surplus, the stronger export interests should be politically. Obviously, this detracts away from other important factors, such as the political institutions of a country and the regional concentration of manufacturing plants within a country, which affect the ability of the two sides to overcome collective action problems. Political institutions, for example, can facilitate the aggregation of certain interests or increase the autonomy of decision-makers from domestic interests. Second, the degree of regional concentration of a country’s exports is important for the evaluation of the three alternatives. The more concentrated exports are within a certain region, the more difficult it is for a country to find a good alternative to an agreement with this region. Finally, the importance of trade relative to the economic size of a country is a factor that influences the attractiveness of the different alternatives. The less trade contributes to the country’s Gross Domestic Product (GDP), the higher the country’s bargaining power, because relatively fewer domestic interests depend on international trade (Hirschman 1945). The more important trade is, by contrast, the more difficult it is for a government to ignore trade interests. Based on these considerations, I argue that a country is most likely to use retaliatory measures if import-competing interests dominate over exporting ones, if exports are relatively dispersed across various markets and if its general trade dependence is low. By adopting retaliatory measures, a country tries to bring about a change in the trade policy of other countries without giving anything in exchange. Countries in which export interests are strong cannot pursue such a strategy, because they would suffer more from a trade war than the member countries of the agreement, particularly if the exports are concentrated within the region that formed the regional agreement. In such a situation, excluded states will strive for accession to the agreement or for an association

Regionalism in the world economy 191 agreement, even if such a step entails costs for some domestic interests. Such costs are probable since an alliance will accept new members only if the political benefits (through export gains) exceed the political costs (through increased competition for domestic import-competing firms). In the case of the EU, for example, an accession candidate has to adopt the complete acquis communautaire, without having been able to participate in its formulation. A country with intermediate bargaining power will opt for either multilateral negotiations (if exports are relatively equally distributed over different regions) or an alternative agreement (if exports are concentrated in another region). So far, the discussion has provided an explanation for the choice of a strategy by excluded countries in response to the creation of a preferential trading area. An explanation of the consequences of regionalism, however, is incomplete without consideration of the reaction of the member states to the strategy chosen by excluded states. I suggest that the interaction between the two sides can be captured with eight different scenarios, which are shown in Table 10.1. In the four scenarios of the left column, the excluded country’s strategy prooves successful. The resulting scenarios are compatible with the building block hypothesis. By contrast, the right column lists four scenarios in which the excluded country’s strategy is unsuccessful. In this situation, the excluded country either simply has to accept trade diversion or decides to risk a trade war or increasing commercial rivalry. These conflictive scenarios are only conceivable, however, if at least one of the countries involved fails to have complete information about the distribution of bargaining power or acts irrationally. Some historical examples illustrate the empirical relevance of these different scenarios. In 1932, the United Kingdom successfully used a threat to oppose the creation of a preferential trade agreement among the Benelux countries. The project consequently was only realized after the Second World War. A threat by Germany against Russia in the 1890s, by contrast, did not achieve its goal, resulting in a stumbling stone scenario. This case originated in an agreement between France and Russia in early 1893 that discriminated against German producers’ access to Russia. In a situation already heated up by earlier mutual tariff increases, the German Empire decided to impose retaliatory measures. Instead of giving in, Russia reacted with its own tariff increases against German goods, unleashing a trade war. The conflict could only be resolved by way of a trade agreement at the end of 1893, after German producers realized that they had Table 10.1 Eight scenarios on trade policy Excluded countries

Threat Rival agreement MFN negotiations Accession

Member countries React as expected

Do not react as expected

Agreement Overarching agreement MFN liberalization Enlargement

Trade war Rival blocks Status quo Status quo

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more to lose from a stumbling stone scenario than Russia did (United States Tariff Commission 1919: 476). Chile’s decision to join the Mercado Común del Sur (MERCOSUR) as an associate member is an example in which a rival agreement proved successful (Baldwin 1997: 871). Chile suffered from exclusion from the North American Free Trade Agreement (NAFTA) between the US, Mexico and Canada, but could not join that agreement. Once it decided to seek closer relations with MERCOSUR instead, the US started to show an increased interest in the negotiation of a Free Trade Area of the Americas (FTAA), and started serious negotiations to that effect in 1998.3 In other cases, the creation of rival agreements was less successful. The establishment of the EEC led Great Britain to push for the creation of a rival European Free Trade Area, hoping that by doing so it would be able to position itself better for future negotiations with the EEC. The initiative, however, was not successful: it failed to lead to a European-wide free trade agreement and thus did not spare Great Britain a later application for membership in the EEC. Calls for MFN negotiations proved to be a successful strategy in response to discrimination on more than one occasion. In the 1930s and 1940s, the US asked Great Britain for non-discriminatory tariff reductions, after the latter had signed the discriminatory Ottawa agreement with the Commonwealth states (1932) (Dür 2004). These negotiations established the basis for today’s liberal trade system. In the late 1950s and early 1960s, the US again used the same strategy in reaction to the creation of the EEC. I am not aware, however, of an empirical example of a call for MFN negotiations being rejected; it is thus possible that no empirical example for this theoretically conceivable scenario exists. By contrast, a whole series of successful applications for accession can be mentioned. The abolishment of tariffs within Prussia (1818) motivated several small German states to join this customs union (Pahre forthcoming: Chapter 11). The resulting customs union again had a similar pull effect on excluded states. Neither are examples of failed accession applications difficult to find. Shortly after the establishment of NAFTA, Chile wanted to join this free trade arrangement. Its effort, however, was not successful since the US Congress failed to delegate trade authority to the administration under President Bill Clinton (Baldwin 1997: 880). Only in 2002 did Chile and the US conclude a free trade agreement, after Chile had moved closer to MERCOSUR.

4 The US and regionalism: a case study So far, the chapter has demonstrated that the creation of a preferential trading arrangement can lead to a number of different scenarios. The following brief empirical analysis reveals that the argument that relates bargaining power to excluded countries’ choice among different strategies can offer a plausible explanation for US trade policies in reaction to regional agreements. In particular, I show how changes in American trade flows resulted in changes in US strategies. For this purpose, I distinguish three time epochs, namely the 1960s, the 1970s and 1980s, and the period since the early 1990s. My argument is that the

Regionalism in the world economy 193 US was relatively weak in the 1960s, but that since that time American bargaining power has substantially increased due to an increasingly negative trade balance and a greater concentration of exports in North America. Accordingly, the American strategy in response to discrimination has also become more assertive. Although no rigorous test of the argument, this empirical overview confirms the usefulness of the argument to explain the effects of regional agreements on trade relations between member and excluded countries. 4.1 MFN-liberalization in the 1960s In the 1960s, discrimination, especially in Europe, caused concerns in the US. At that time, the US had constantly high surpluses in its trade with Western Europe. The regional concentration of US exports in Western Europe was also very high, as evidenced by the fact that in 1960, as much as 36 per cent of American exports went to Western Europe (Deblock and Cadet 2001: 679). The prediction to be derived from the argument presented before, therefore, is that the US should not have been in a position to respond with either retaliatory measures or with a rival agreement to discrimination in Europe. Indeed, the US reacted to the creation of the EEC with a call for negotiations in the Dillon Round (1960–1962), even if originally with the hope for unilateral concessions by the member states of the EEC. In line with the argument, EEC member states did not accept this demand. The resultant failure of the Dillon Round sparked a discussion in the US about the best strategy in response to the establishment of the EEC (Winand 1993). In a report for Congress, the former Secretary of State Christian A. Herter and the former Undersecretary of State William L. Clayton went so far as to demand US membership in the EEC (Ilgen 1976: 175–6). In the end, however, the Kennedy administration decided to launch a call for negotiations based on the MFN principle. This strategy, it was hoped, would best protect US trade interests. The strategy was made possible when in 1962 the American Congress adopted the “Trade Expansion Act”, in which the US President received unprecedented authority to engage in negotiations with the EEC. Equipped with this authority, the US administration called for the start of the Kennedy Round, in which it achieved a reduction of European discrimination by way of mutual concessions (building block scenario). An episode, which is known as the Chicken War (1962–1963), demonstrates that American bargaining power at that time was not sufficient to achieve a reduction of European discrimination by way of retaliation. The starting point for this trade conflict, which remained limited to a few products, was the putting into place of new rules for the importation of poultry in the context of the establishment of the Common Agricultural Policy of the EEC. Within a few months it became clear that these regulations entailed major losses for American exporters of poultry. In reaction to strong pressure by American poultry producers, the US administration then imposed penalty duties against certain imports from EEC countries (see Talbot 1978). The aim was to put pressure on the EEC, hoping

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that it would change the Common Agricultural Policy. Instead of giving in, however, the EEC governments decided to counter-retaliate. One decade later, the US administration revoked the retaliatory duties, without having reached its goal. In this case, the US overestimated its bargaining power and adopted a policy that did not correspond to the actual distribution of power. The result was a stumbling stone scenario. 4.2 The increase in American bargaining power in the 1970s and 1980s Beginning in the 1970s, the bargaining power of the US steadily increased. For one, the American trade balance turned negative in the early 1970s. While initially accounting for less than 1 per cent of the American GDP, the deficit rose to between 1 and 3 per cent in the 1980s. In 1972, for the first time in the postwar years the bilateral trade balance with Western Europe was also negative. At the same time, the regional concentration of American exports in Europe decreased. The percentage of American exports going to Western Europe fell from 34.3 per cent in 1970 to 28.6 per cent in 1990 (Deblock and Cadet 2001: 679). Whereas for the US the markets of neighbouring countries and of countries in Asia gained in importance, European exporters became increasingly dependent on access to the US. Together, these developments allowed the US to react to discrimination in Europe more assertively. Consequently, in reaction to the enlargement of the European Community (EC) to include Great Britain, Ireland and Norway in 1973, the US demanded unilateral European concessions to compensate American exporters for their losses of market access. Whereas such requests had been rejected in the early 1960s, now the EC saw itself forced to give in at least partly to American demands. Due to their stronger dependence on the American market, European export interests asked their governments not to risk a trade war with the US (Dür 2004). Congress, in contrast, endowed the President with a formal instrument to react with retaliation to foreign trade measures that “unfairly” restricted market access for American exporters (Section 301 of the Trade Act of 1974). In this case, a regional European strategy paired with a more aggressive American response again led to a building block scenario, since the member states of the regional group were ready to accept the demands voiced by the excluded state. This tendency was confirmed by the American response to the deepening of European integration in the 1980s. American exporters again were anxious about their market access when European states started to remove the remaining barriers to intra-EC trade. Especially in areas such as telecommunications and financial services, foreign providers were anxious to make sure that the European Single Market would not have trade diverting consequences. The US therefore entered into bilateral negotiations with the EC, in which the Europeans accepted several American demands. The US, moreover, for the first time since the 1940s (with the exceptions of the sectoral US–Canada Automotive Products Agreement of 1965 and the US–Israel free trade agreement of 1985), decided to

Regionalism in the world economy 195 enter into a regional agreement. The Canadian–American free trade agreement, which was implemented in 1988, its later extension to Mexico as a result of the creation of NAFTA and the American participation in the Asia–Pacific Economic Cooperation (APEC) are all indicators of a changed American bargaining power. This change became possible by the decreasing importance of the European market for American exports. Since the European side answered with concessions to American demands the result was again a building block scenario. 4.3 The US and the new regionalism Since the mid-1990s, the US sees itself confronted with a new dynamic, which – instead of threatening American exporters’ access to the European market as before – jeopardizes American exports to emerging economies. The US is in a very strong negotiating position to react to these developments, even though trade has gained in importance for the American economy over the last years. For one, the US incurs a record deficit with nearly all regions of the world. In addition, nearly 40 per cent of American exports now go to the NAFTA countries, with Canada alone already being a larger market for American goods than the whole of Western Europe. The US uses this new position of strength to conclude bilateral agreements with countries in Central and Latin America, in the Mediterranean area, in the Middle East, in South Africa and in Asia, with the objective of reacting to and partly anticipating foreign discrimination. US trade policies themselves were one of the factors that stimulated this recent spread of preferential trade agreements. In the wake of the creation of NAFTA, several Latin American countries sought trade agreements with the US to forestall trade diversion (Baldwin 1997). With the US Congress unable to agree on the exact contents of new trade legislation, however, their hopes for agreements with the US were not fulfilled. Instead, they started to negotiate agreements among themselves and with third countries. Illustratively, Chile concluded agreements with Bolivia, Brunei, Canada, Central America, China, Colombia, Ecuador, the EU, MERCOSUR, Mexico, Peru, Singapore, South Korea and Venezuela. The proliferation of preferential agreements in turn created concerns among American exporters, motivating them to exert pressure on the American Congress to permit an agreement particularly with Chile. After Congress passed the necessary legislation in 2002, the US and Chile immediately concluded an agreement, which entered into force on 1 January 2004. At the same time, European plans for an agreement with MERCOSUR made negotiations for an America-wide free trade area more urgent. Finally, the EU agreement with South Africa (2000) was an important stimulant for the US’s pursuit of a free trade agreement with the Southern African Development Community (Whalley and Leith 2003). Whereas initially the US was mainly interested in agreements with Latin American countries, in the meantime the rapid spread of preferential agreements in Asia has re-directed American attention to this region. Even Japan, which before had completely relied on the multilateral trade system, has started to

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negotiate preferential agreements to preserve access to countries with preferential agreements (Manger 2005). The argument presented here suggests that the US will use its bargaining power to protect its exports by way of bilateral agreements also in Asian markets. Although currently the US only negotiates with South Korea in this region, a further increase in the number of American free trade agreements in Asia is thus to be expected. Given the shift in bargaining power alluded to above, it is not astonishing that the EU – and no longer the US as was the case in the 1960s – is now the trading entity that is most concerned about the defence of the non-discrimination principle. In a speech in May 2005, the EU’s Commissioner for Trade, Peter Mandelson, consequently stressed that the EU had to counter the risks inherent in the spread of regional pacts with a broad agreement in the framework of the WTO.4 If the EU is to act in line with its bargaining power, it will have to make concessions in the WTO negotiations to reach an agreement, which can protect its global trade interests. The situation then should again resemble a building block scenario with the various countries acting in accordance with their bargaining power.

5 Conclusion Is regionalism a building block or a stumbling stone for further trade liberalization? In other words, does the current spread of preferential trade agreements undermine or rather propel the process of globalization? I have argued that the debate which deals with these questions has ended in a standoff. Both the building block and the stumbling stone advocates can support their positions with logically consistent arguments and both also can muster at least some evidence to back up their arguments. My starting point therefore was to accept that both effects are empirically relevant, and that neither of the two metaphors can capture the complexity of the effects of regional agreements for the process of globalization. Only the integration of the two perspectives in a comprehensive model can yield a satisfying explanation of the available evidence. Regionalism can cause trade wars just as well as further liberalization. The direction of the effect, I submit, depends on the distribution of bargaining power between an excluded state and the member states of the regional agreement and the evaluation of this variable by both sides. The empirical analysis of US trade policy since the 1960s, although no rigorous test of the argument, has confirmed that this argument can offer a plausible explanation for the most important developments. Such a temporal comparison complements other studies that rely on cross-sectional comparisons instead. The analysis has revealed that with increasing bargaining power the strategy of the US in response to discrimination became gradually more assertive. The American strategies, however, nearly always corresponded to the actual distribution of bargaining power, which explains why mostly a building block and only in rare cases a stumbling stone scenario evolved. Before concluding, I have to point out two caveats to these findings. For one,

Regionalism in the world economy 197 the chapter exclusively dealt with trade policies; based on this discussion, conclusions about trade flows are not or only indirectly possible. Even if regional agreements have mostly led to political building block scenarios, it is possible that trade flows have become more regionalized, which would impede a further globalization of economic processes (Accominotti and Flandreau 2005 suggest that this occurred in the nineteenth century). Moreover, this chapter only dealt with regional trade agreements; what effects preferential financial arrangements (as planned in Asia) may have requires further analysis. Irrespective of these caveats, I hope that the chapter will contribute to the launch of a more fruitful discussion on the determinants of building block and stumbling stone scenarios.

Notes 1 Many thanks for constructive comments on an earlier version of this chapter to the editor of the volume and the participants of the workshop in Arnoldshain. 2 This simplification does not apply to negotiations between a large developed country and a small developing one. 3 Plans for such an agreement existed already before the creation of MERCOSUR. The creation of MERCOSUR, however, strengthened the American interest in an FTAA. 4 Peter Mandelson “Tilting the Global Balance: Asia’s New Trade Growth”, keynote speech, Singapore, 29 April 2005. Online. Available europa.eu.int/ comm/commission_ barroso/mandelson/index.htm (accessed 27 January 2006).

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11 Transformation and trade liberalization The integration of the transition countries into the world economy Thilo Bodenstein 1 Introduction More than a decade ago, the former communist transition countries of Eastern Europe started a far-reaching political and economic reform process. With the fall of communism the East European trade system, the Council for Mutual Economic Assistance, came to an end. As well as facing the challenges of democratization and economic stabilization, transition countries had to re-integrate in global trade. Quick integration into world trade, however, was risky, yet indispensable given the dire state of post-communist economies. Opening economies for international trade generates losers which can put in danger the whole political and economic reform process and even stall democratization. The transformation literature, therefore, focused on the question of how to reconcile economic change and world market integration. In retrospect, the transition countries have chosen quite different solutions to this, mirroring different degrees of foreign economic openness after a decade. The political-economic literature identifies five main determinants for foreign economic openness, which could explain these differences among the transition countries. First, an optimal sequence of economic reform steps could reduce the overall cost of foreign trade reform, thus reducing the risk of reforms being stalled. Second, economic crises force governments to open their economies quickly to the world market in order to prevent economic depression and reduction of production. In the face of a crisis the costs of maintaining the status quo become unbearable for most societal actors, so that resistance to reform diminishes. Third, the modus of democratic transition itself creates institutional pathdependency which impinges upon subsequent foreign economic reforms. Fourth, related to institutional path-dependency is the emergence of veto-players who are considered to be a driving factor for foreign economic reforms. The logic behind this is that veto-players often do not have an interest in maintaining protectionism which serves other political actors’ constituent groups to the detriment of the whole economy. Fifth, international financial aid is either conditionally linked to trade reforms or is being used to ease the hardship of the losers of such reforms. Transition countries could be forced by financial aid to integrate into the world market or break domestic resistance by financial transfers.

Transformation and trade liberalization 201 This chapter starts with a brief description of three basic models of international economics, which explain how free trade can be beneficial for the countries involved. This section (two) is not meant to be an assessment of the actual performance of free trade in the transition countries, but it provides a basis for understanding the stakes of free trade for those countries. The third section gives an overview of political-economic models of foreign economic reforms and elaborates the main determinants enabling such reforms. The fourth section presents an empirical index of trade openness and discusses the record of trade reforms in the transition countries. Section five assesses empirically the relevance of the political-economic determinants. Section six concludes.

2 The benefits of international trade The increasing criticism of globalization stands in sharp contrast to the positive effects of trade postulated by early models of international trade. The key arguments in favour of international trade were developed by David Ricardo in the first half of the nineteenth century. According to Ricardo foreign trade promotes welfare through export specialization which allows countries a higher level of consumption. Countries do not need to have absolute advantage over their fellow competitors – it suffices to have comparative advantage to profit from foreign trade. We will discuss this point further below. Opening the economy for foreign trade, however, inevitably creates losers in those sectors which do not have comparative advantage. These re-distributional effects were not considered in the early trade models, but later developments took those effects explicitly into consideration, in particular the models by Heckscher and Ohlin as well as Samuelson and Stolper. There are two main reasons to engage in trade. First, economies of scale through larger markets diminish the average production cost per unit, so that producers can offer lower prices when accessing the world market (Ades/Glaeser 1999). A second and more basic class of models emphasize the difference of countries with respect to their technological capabilities. This point was taken up by David Ricardo (1963 [1817]) who shows how countries can exploit those differences by trading in order to increase their welfare. The key notion of his model is comparative advantage, by which countries can produce one good at lower opportunity costs than other goods at a given technology. Note that it is not important whether the trading partner could produce this good even cheaper or more efficiently, since this would imply absolute rather than comparative advantage. A central aspect of Ricardo’s theorem is that the economic benefits of trade accrue through quantitatively and qualitatively increased imports rather than through export per se (Samuelson 1962). Krugman and Obstfeld (2003: 21) use an example to clarify Ricardo’s concept of comparative advantage and the models discussed in this chapter. Assume there are two countries – Home and Foreign – each of which produces two goods A and B. The only production factor is labour. Let us further assume that Home needs one hour to produce a unit of A and two hours for a unit of B.

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Foreign uses six hours for the production of A and three hours for the production of B. At first glance, it is obvious that Home produces both goods more efficiently than Foreign and thus disposes of an absolute advantage. Is it sensible for Foreign to trade with Home? To simplify matters let us make the additional assumption that one unit of A is traded at the same price as one unit of B on the world market. According to Ricardo Home should specialize in the production of A, while Foreign produces B. Home can “produce” (import) good B cheaper by trading with Foreign than producing it domestically. In one working hour Home produces half a unit of B. In the same working hour Home could produce a whole unit of A and trade it against a unit of B on the world market. Likewise, Foreign may also profit from international trade though it disposes of neither good at an absolute advantage. In one working hour it produces one-sixth units of A and one-third units of B. Instead of producing A itself, it can produce one-third of B in an hour and trade it against one-third of A on the world market. This simple example shows that it is not necessary to dispose of an absolute advantage in order to benefit from trade. Home is more efficient at producing both goods, yet it also trades only one good, leaving the production of the other to Foreign. Ricardo’s model demonstrates the virtues of trade, although it discards potential immobility of production factors. Ricardo assumes total mobility of labour between both goods. Those who where hired in the production of the comparatively less efficient good before market opening switch to the production of the good with comparative advantage. In real life, however, this assumption most likely does not hold. Moreover, negative distributional effects due to market opening arise, for instance, through immobility of a factor or by the intensity by which factors are used. Heckscher and Ohlin (1991) introduced a more complicated model assuming two factors of production, Labour and Land. Land and Labour may be used in different intensities for the production of a good. If cloth and food were to be produced, Labour will be more intensive for the production of cloth and Land for the production of food. The respective shares of both factors depend upon the relative prices of Labour and Land. With increasing prices for Labour in comparison to Land, the latter factor will be used more intensively for the production of both goods. The distributional effect is obvious: since Land is used more intensively for both goods its marginal productivity decreases and so does the relative income of Land owners relative to the incomes of owners of Labour. A similar effect happens when countries engage in trade. First, trade induces the convergence of prices for cloth and food between both countries. Second, countries will specialize in those goods for the production of which the relatively abundant factor is more intensively used. If Home is Labour abundant, being a small and densely populated country, then it will specialize in the production of cloth rather than food. Land abundant Foreign, by contrast, will specialize in food production, for which Land is more intensively used. Since the relative prices of both goods converge on the world market the relative incomes of owners of Labour in Home rises as the incomes of Land owners fall. In Foreign

Transformation and trade liberalization 203 the opposite distributional effect is taking place. Consequently, the Heckscher– Ohlin model predicts gains from trade for owners of the relatively abundant factor, whereas owners of the relatively scarce factors lose. The specific factor model of Samuelson (1971) and Jones (1971) assumes three factors – Labour, Capital and Land – and two goods, that is manufacturing goods and food. Manufactured goods are produced using Labour and Capital and food using Labour and Land. Capital and Land are specific factors being employed in particular goods. Land is the mobile factor used in the production of both goods. The respective amounts of Labour used for manufacturing goods and food depend again upon the relative prices of both goods. Assume that trade leads to higher price increases for food in Home than for manufacturing goods, for Capital is scarce in Home in comparison to Land. The higher prices for industrial goods also induce higher wages and a shift of some parts of Labour away from food production towards manufacturing. The wage increase is inferior to the increase of prices for manufacturing goods, for the marginal productivity of each additional unit of Labour decreases. In a country which is abundant in Capital trade will increase the incomes of the owners of the specific factor Capital and lower the incomes of the owners of the specific factor Land. The distributional effect upon the mobile factor Labour is less obvious – the fall of the relative prices of food leaves them better off, while manufactured goods rise in price. The distinction between factors in the Heckscher–Ohlin and Samuelson– Stolper models is less clear than it seems to be (Neary 1978); this is rather a question of empirical assessment (Blanchard and Katz 1992). Labour is not necessarily mobile. Workers with high qualifications are specialized in an economic sector. Likewise, low qualified workers may not easily switch sectors. In a country specialized in high-technology production, low qualified labour bears the burden of trade opening. Our rough overview showed that in principle trade openness may enhance the welfare of a country. For the transition countries trade opening was a strategic component of their economic reforms process. The central question for foreign economic reforms was the likely distributional effects impinging on the fast opening of the foreign economic regime, irrespective of potential long-term gains. The next section discusses the political context variables which enabled foreign economic reforms despite distributional effects.

3 The political economy of trade liberalization World market integration of the transition countries was embedded in economic reforms and paralleled by democratic change. This dilemma did not exist, for instance, in Latin American, African or Asian transition countries. Against the background of multiple reform goals defined by the so-called “Washington Consensus” (Williamson 1994), an early debate emerged whether the countries should follow a shock-therapy strategy or pursue a gradualist approach. Proponents of shock-therapy emphasized the merits of the short window of opportunity which emerged after the collapse of socialism (Balcerowicz 1994),

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paralyzing opposition to reforms by the quick introduction of an overall reform package which would be difficult to roll back (Åslund et al. 1996). Gradualist scholars pleaded for a slow reform strategy, thus minimizing social and economic costs (Bhattacharya 1997; Marangos 2002; Dewatripont and Roland 1995). The main question for gradualists was the optimal sequence of gradual reforms that would allow for minimizing costs. An additional question was at which step of the sequence foreign economic reforms should take place. Within a gradualist strategy, macro-economic stabilization and domestic financial market reform set the stage initially (Lipton and Sachs 1990; Roland 2000; Rodrik 1989; Bhattacharya 1997). Macro-economic disequilibria such as high inflation and sky-rocking government debt were rampant in the transition countries at the beginning of the reform process. Those imbalances were a heavy burden for economic reforms, for inflation set the wrong price signals and growing government debts could have led to an appreciation of the domestic currency while the capital account was liberalized. Thus, the theoretical puzzle was whether current account liberalization should parallel macro-economic reforms or be postponed to a late stage of economic transition. Michaely, Papageorgiou and Choksi (1989), for instance, pleaded for the former. Funke (1993), McKinnon (1991) and Sachs (1989) pointed to the difficulties parallel macroeconomic and current account reforms would entail. Given enduring macro-economic imbalances, current account liberalization would take place under the wrong market signals. In addition, tariff revenues could finance part of the reform costs under the condition that trade quotas and licenses are to be abolished. The liberalization of the capital account should mark the final step of the economic reforms (Williamson 1999; Agénor and Montiel 1996). An optimal reform sequence would thus consist of early macro-economic stabilization and structural reforms, followed by current account liberalization and finally capital account liberalization. Even if an optimal reform sequence was to be followed, the actual reform track depends on further economic and political conditions. As for all economic reforms, current account liberalization is also path-dependent. In the case of the transition countries such path-dependencies are set by the socialist economic structures, hidden inflation and macro-economic imbalances (De Melo et al. 2001; Fischer and Sahay 2000). The degree and likelihood of current account liberalization, however, depends more narrowly on the depth of the economic transition crisis, the outcome of the first democratic elections and subsequent institutional settings as well as the influence of international lending organizations. Economic crises affect foreign economic liberalization through three different mechanisms (Bates and Krueger 1993; Rodrik 1995). First, economic crisis can alter actors’ perception of the costs of non-reform (Akerlof 1991). Harberger (1993) conceptualized this as Bayesian learning by which actors change their posture towards the status quo. Second, Labán and Sturzenegger (1994) as well as Fernández and Rodrik (1991) argue that with increasing individual ambiguity about the consequences of reform, a majority would vote against reform even though it would benefit from it. Deepening economic crisis, however, could

Transformation and trade liberalization 205 increase individuals’ tolerance to accepting ambiguity because the costs of protracting the status quo rise (Drazen and Eastery 2001). Third, interest groups might change their behaviour when they face economic crises. These models conceptualize the benefit of economic reform as a public good. Each actor is able to maximize its utility by refusing to contribute to the public good and shifting the costs of reforms to other actors (Alesina and Drazen 1991). Each actor thus has an interest in delaying reforms until others bear disproportionally high costs of reform. In the wake of economic crises, however, actors expect fast economic reforms, raising their readiness to share the costs of reforms, for they are also more likely to reap the benefits (Drazen and Grilli 1993). One caveat applies. It is not clear how deep a crisis must become in order to change actors’ expectations and behaviour. Not only a dire economic situation, but a very dire economic situation should qualify for crisis (Tommasi and Velasco 1996). This distinction is a question of empirical assessment, which should establish the crisis threshold triggering subsequent reforms. A further determinant of foreign economic reforms are critical junctures or so-called founding elections. They decide the likely outcome of reform at an early stage in the process. Founding elections, such as the first democratic elections in a formerly autocratic state, either continue the power of the former elites or allow a new elite access to government (Colomer 1995). Founding elections were the usual way regimes changed throughout post-communist Eastern Europe (Åslund 1994; Bunce 1994). Analysing market reforms in transition countries, Przeworski (1991) and Haggard and Kaufman (1995) show that elite change at a critical juncture had a decisive impact on the course of reform. Hellman (1998) put forward the idea of “partial reforms” which are deadlocked half-way by networks of early-reform winners. Moreover, founding elections also determine the new institutional design of a country, which shapes subsequent reforms (Shugart 1998). Critical junctures taken alone do not explain why new elites should have an interest in reform at all. Some scholars argue that democratic governments are more likely to postpone reforms when confronted with interest group pressure. The veto-player theory puts forward a similar stance claiming that the likelihood of policy change (i.e. reforms) correlates negatively with the number of vetoplayers, which is typically higher in democratic systems (Tsebelis 1995). Vetoplayer theory has been widely used for the analysis of reform in transition countries (Orenstein 2000; Treisman 2000). Hence, if democratic governments’ hands are “tied” by interest groups, then it is a puzzle why democracies yield better economic results and are more likely to adapt to new economic conditions than autocracies (Knack and Keefer 1995). One solution of this puzzle is a modified veto-player approach, which postulates convergence of veto-players on a reform agenda. Following a model by Persson, Roland and Tabellini (1997) veto-players increase the electoral accountability of democratic governments. A key assumption of this model is that parties converge on the median voter position in order to win elections. Although some of the voters belong to the losers of reform, the

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median voter should be better off as long as foreign economic liberalization improves welfare in the long run. One caveat applies, however. Parties do not unconditionally converge on the median voter, for they have a double electoral support function. On the one hand, parties have to offer a vector of policies that pleases the median voter, and on the other hand they have to meet the policy demand of interest groups in order to maximize campaign contributions (Grossman and Helpman 2001). Both support functions constitute a mutual trade-off: Interest group politics is expected to lower aggregate welfare, whereas policies for the median voter lowers the rents offered to interest groups. In the case of few veto-players, the government is free to determine the level of trade protection, thus generating rents for particular interest groups and lowering aggregate welfare. Since voters cannot directly observe the exact amount of interest group rents generated, the government does not face limits in increasing those rents and protecting trade more than the median voter would accept. Persson, Roland and Tabellini (1997) then assume additional veto-players, such as coalition partners. This option reduces the arbitrary scope of interest group politics in a government. If the government sets rents for interest groups too high, both the government and the veto-players risk being punished by the voters, for voters are not always able to distinguish between coalition partners. In this case, the veto-player may back the government and accept its share of interest group support, despite risking being ousted from government. Alternatively, the veto-player may force the government to reduce the level of interest group rents and pursue median voter-friendly politics, lowering the risk of being punished by voters. Consequently, if the government is not willing to concede a disproportionate share of interest group contributions to the veto-player, it will be forced to shift policies towards the median voter position. Increasing numbers of veto-players in the system, therefore, should also increase the likelihood of foreign economic reforms at the expense of interest groups under the condition that these benefit the median voter. Inspection of alternative strategies reveals that median voter convergence is the equilibrium in the presence of veto-players. This rather abstract illustration of the policy effect of veto-players raises the question of why democratic governments whose policy leeway is constrained by interest groups and voters nonetheless pursue welfare-enhancing policies to a greater degree than autocratic regimes. A final factor is the role of international lending institutions. They can enforce foreign economic liberalization by giving conditional financial aid. The World Bank and the International Monetary Fund (IMF) play a key role in economic liberalization, for their lending includes conditionality of trade reforms. At the beginning of the 1980s the World Bank made their Structural Adjustment Lendings conditional on trade reforms (Mosley et al. 1991). Likewise, the IMF introduced conditionality in its Structural Adjustment Facilities (Guitián 1995). Conditional aid, however, is a loosely defined notion. Stokke (1995) takes as a central feature of conditional aid the threat of reducing or even stopping aid if conditionality is not met. In practice this is achieved by trenching the credits.

Transformation and trade liberalization 207 Although the success of conditionality used by the Bretton Woods Institutions has generally been challenged (Taylor 1997), the theoretical literature on conditionality suggests several models accounting for its success. Casella and Eichengreen (1996) consider the time at which conditional aid is announced. Early announcement of aid uncovers the respective cost for actors – those with the highest status quo costs will readily agree with reforms as soon as international aid is announced. In a similar vein, Hsieh (2000) argues that international aid increases the likelihood of actors’ agreement by reducing their agreement costs, for they are partially covered by international aid. Both models conceptualize reform as a public good. International aid thus smoothes the asymmetries between actors’ cost profiles. Boone (1996) argues that the success of foreign aid hinges upon the kind of government in the receiving countries. Only liberal laissez-faire governments will not cheat on their obligations and comply with conditionality. The following sections will assess how the transition countries complied with the trade conditionality of the Bretton Woods Institutions.

4 How open is Eastern Europe? This section starts with an exploration of the degree of foreign economic openness in the transition countries. The communist countries of Eastern Europe were only weakly integrated into the global economy. Although their share of world industrial production reached 30 per cent, their international trade accounted only for 4 per cent of world trade (Oatley 2004). After the collapse of the communist system most transition countries found themselves in the unexpected situation of far-reaching foreign economic openness, because their state trade monopolies fell apart before they had time to erect new trade regulations (Wunner 1998). Creating foreign economic regimes by establishing tariffs and import and export laws was an immediate task for these countries, alongside the search for new export markets after the collapse of the Council for Mutual Economic Assistance. But before assessing the degrees of foreign economic openness achieved, we shall first discuss how openness can be measured at all. There are two ways of measuring foreign economic openness. Behavioural indices estimate the real trade flows of a country and deduce from this its degree of openness for foreign trade. Regulatory indices, by contrast, estimate the structure and weight of all tariff and non-tariff trade barriers, irrespective of a country’s real trade volume. An example of the former kind of index is the socalled trade quotient (Easterly 1993). It is defined as the sum of imports and exports of a country, divided by its GDP. The higher the share of the foreign economic sector in a country’s total economic activities, the more the country is integrated into the world market. A high trade quotient, however, does not necessarily imply absence of barriers to trade, for a country could be relatively closed and yet trade a lot because of comparative advantages in one sector. For instance Sachs and Warner (1995) present a dichotomous regulatory index that takes only non-tariff barriers into account. The advantage the latter has over

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behavioural indices is that it seems better able to provide information about a government’s willingness to open the foreign trade regime. In general, regulatory indices are better able to yield more concrete information about what drives governments’ willingness to open the economy than behavioural indices (Bodenstein et al. 2003). The transition countries’ real integration into the world market lagged behind for a while, and behavioural indices such as the trade-quotient indicated “closed” foreign trade regimes for most transition countries. Following a study by Quinn (1997) on capital account liberalization, a suitable way of coding trade openness is to sum up the non-tariff barriers reported by the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions. Considering average tariffs, however, is problematic for practical reasons, because tariffs in the transition countries were very volatile across time and sectors. The following figures and table use the Economic Liberalisation in the Transition Economies (ELITE) indicators which follow Quinn’s coding procedure (Bodenstein 2005). Figure 11.1 (Bodenstein 2005: 33) depicts the degree of trade openness of the transition countries for 1993 and 2000. Each non-tariff trade barrier is coded with 1, so that higher values show more closed foreign economic regimes.1 Countries situated above the diagonal reduced their non-tariff barriers to trade during the observation period. Figure 11.1 reveals an overall tendency towards trade liberalization with some noticeable exceptions. Latvia2 is one of the most open countries for trade in 2000, followed by Estonia and Armenia. The most closed countries remain 1

KAZ AZE

Trade openness 1993

0.8

EST

ALB

HRV CZE

HUN

UZB UKR BLR

SVK POL

RUS

MDA

GEO SVN ROM

0.6

MNG

BGR

ARM

0.4

LTU

0.2 KGZ

LVA

0 0

0.2

0.4

0.6

Trade openess 2000

Figure 11.1 Non-tariff barriers to trade, 1993 and 2000. Note Lower values depict higher degrees of trade openness.

0.8

1

Transformation and trade liberalization 209 Ukraine, Uzbekistan and Belarus. The new EU member states Czech Republic, Slovenia, Hungary and Poland occupy medium range positions. Poland’s trade regime can still be considered closed in 2000. The most successful countries in terms of trade liberalization defined as the difference between 1993 and 2000 are Estonia, Azerbaijan and Romania. Lithuania, Kyrgyzstan and Belarus, in contrast, imposed additional non-tariff restrictions on trade during the observation period. Generally speaking, most transition countries opened their trade regimes for the world market. A group of transition countries, however, either held their degree of openness constant after having initially opened up quickly, or even closed their foreign trade regimes. Geographical proximity to world markets – the EU in particular – gave rise to expectations of far-reaching trade reforms. The countries of the former Soviet Union, however, were in the vanguard of early reformers, whereas neighbouring countries of the EU kept their protectionist level for a while. The next section discusses which determinants account for these differences.

5 Empirical assessment: the determinants of foreign economic liberalization The literature on the determinants of foreign economic liberalization emphasizes the sequencing of reforms, economic crises, critical junctures, veto-players and the conditionality of international aid. How far do these factors explain the differences between transition countries? Starting with the assessment of an optimal sequencing strategy, macro-economic stabilization and structural reforms should precede trade and capital liberalization. Only a few countries pursued such a strategy. The Czech Republic, Croatia, Hungary, Poland and Slovakia stabilized their macro-economies at an early stage by lowering inflation rates and arresting the fall in GDP. Hungary and Poland, however, maintained high inflation rates for a while. Structural reforms were also initiated early, generally after the recovery of growth rates. Trade liberalization followed both reform steps with the exception of Slovakia which postponed trade liberalization after capital account liberalization. Estonia, Mongolia and Romania partially conformed to this sequence. Mongolia and Estonia suffered until 1998 from high inflation, Romania even longer than the observation period. A large group of transition countries liberalized their foreign economic regimes first (some even their capital accounts), and only at length embarked upon macroeconomic stabilization. Structural reforms followed even later. This group consists of Albania, Armenia, Kazakhstan, Kyrgyzstan, Moldova, Macedonia, Russia, Uzbekistan and Georgia. In terms of trade liberalization this strategy was less successful: only three of these countries – Kyrgyzstan, Armenia and Georgia – had open trade regimes by 2000. The group’s remaining countries stay closed. Ukraine and Azerbaijan opened their trade regimes without any accompanying reforms and as a result Ukraine fell back on the openness scale, while Azerbaijan remained only partially open. Slovenia, interestingly, focussed on macro-economic and structural reforms without large attempts at liberalizing foreign trade. Bulgaria,

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Belarus, Lithuania and Latvia were reluctant on all reform dimensions and pursued no obvious strategy. Latvia and Lithuania, however, belong among the most open countries, which may be partially explained by the fact that they had open trade regimes from the very beginning. In sum, there was no dominant sequencing strategy among transition countries. On the other hand, no transition country introduced a simultaneous “big bang” reform package with parallel macro-economic stabilization and foreign economic opening. The fact that some countries opened their trade accounts before macroeconomic stabilization shifts the attention to the role of economic crises. The depth of a crisis can be reasonably approached by high inflation rates and the drop of industrial production, followed by declining growth rates. A look at inflation rates reveals that high inflation delayed trade liberalization in cases such as Ukraine, Belarus, Kazakhstan and Uzbekistan, whose average inflation rates amounted to 600 per cent during the observation period. Armenia and Georgia are exceptions to this rule. In sum, however, high inflation is somewhat correlated with high degrees of protectionism. Two explanations might account for this. First, high inflation rates could impinge upon reform willingness over a longer period than the observation period here. Second, high inflation in the transition countries does not necessarily mean economic crisis, for even under communist rule their economies were inflation ridden. Thus, inflation would signal a dire state of economics, rather than crisis. As a second crisis indicator, industrial production, reveals a different picture. Transition countries that suffered from a decline in manufacturing also tend to be more open to foreign trade after a certain time period. This is one cause, for instance, of the high degrees of openness of Georgia and Armenia. A similar pattern is true for Lithuania, Latvia and Kyrgyzstan, where industrial production had also sharply declined. Hungary and Poland, by contrast, remained relatively closed, which can be traced back to their early recovering from output decline which reduced their incentives to open their foreign trade regimes quickly. Accordingly, the empirical record of the crisis hypothesis is mixed. Crisis in manufacturing production spurred trade reforms, which is not true for high inflation rates. Most transition countries opened their foreign trade regimes after having overcome the crisis. One sign of this is the correlation between GDP growth rates and openness – transition countries whose growth rates recovered subsequently opened their foreign trade. A further factor for trade reforms are critical junctures, in particular founding elections (Bodenstein and Schneider 2006). The following table shows the correlation between the outcome of founding elections and foreign economic openness. Data on founding elections are from Fish (1998), who coded them according to their outcomes (change of incumbent elite) and fairness (free elections, manipulation of elections). Free elections that were won by reformers are coded 4; manipulated elections and victory by former elites are coded 1. The table shows that transition countries in the fourth category have on average more open trade regimes than those in the first category. The most open countries, however, are those of the second category, which is mixed. One might

Transformation and trade liberalization 211 Table 11.1 Founding elections and foreign economic openness

Average trade openness (ELITE)

1

2

3

4

Azerbaijan Belarus Kazakhstan Moldavia Ukraine Uzbekistan

Albania Bulgaria Georgia Kyrgyzstan Mongolia Romania

Armenia Macedonia Russia Slovenia

Croatia Czech Republic Estonia Hungary Latvia Lithuania Poland Slovakia

0.777

0.467

0.659

0.537

Source: Author’s own based on datat from Bodenstein, Plümpel and Schneider, 2003.

question whether Romania would better fit into the first category. But even with a new positioning of Romania the result would not change. Consequently, founding elections have had an influence on trade reforms in transition countries, but they do not explain the whole story. Founding elections influence reforms through the institutional structure that emerges with them, in particular the structure of veto-players (Frye and Mansfield 2003). Veto-players, as defined by Tsebelis (2002), are powerful domestic actors such as presidents, second parliamentary chambers and coalition partners. Creating a veto-player index for all transition countries is very difficult, for most frequently

0.874286 0.8 0.734 Average trade openness

0.675385

0.677692 0.6324 0.579091

0.6

0.552535

0.4

0.2

0 1

2

3

4

5

6

7

Figure 11.2 Executive constraints and trade openness (source: author’s own based from Bodenstein, Plümper and Schneider, 2003).

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Thilo Bodenstein 1 BLR UKR

UZB

Trade openness 1993

0.8

SVK

RUS

HUN SVN POL CZE BGR AZE

MDA

KAZ

0.6

ROM

MKD

GEO

HRV

ALB ARM

0.4 LTU

0.2

LVA

1

2

MNG

EST

KGZ

3

4

5

International aid per capita (log)

Figure 11.3 International aid and trade openness (source: author’s own based from Bodenstein, Plümper and Schneider, 2003). Note Lower values depict higher degrees of trade openness.

change constitutions or governments. The following figure therefore relies on the “Executive Constraints” index provided by the Polity-IV database (Jaggers and Gurr 1995), which measures the institutional constraints under which governments operate. This measure comes close to the idea of veto-players. Executive Constraints are measured between 1 and 7, where 7 depicts strong constraints. Figure 11.2 shows the average trade openness in each category. The first category – those whose governments are least constrained by institutions – is on average also the most trade protectionist. The most open countries for trade are to be found in the seventh category, which levies the strongest constraints on governments. These countries are democracies whose governments are more constrained than their autocratic counterparts. The in-between categories show mixed results, although there is a trend for higher categories having on average more open trade regimes. Transition countries, however, might switch categories during the observation period. Thus, the first, second, fourth and sixth categories contain only 2–7 per cent of the sample observations. Most observations are in the third (15 per cent), fifth (20 per cent) and seventh (42 per cent) category, which account for 77 per cent of all observations. Comparing these three categories alone clearly shows higher degrees of openness with more constraining institutions. The final determinant of trade openness is international aid. Figure 11.3

Transformation and trade liberalization 213 shows the correlation between international aid per capita (including IMF and World Bank loans as well as bilateral loans) and trade openness. Figure 11.3 reveals a strong correlation between aid and trade openness. Countries receiving high amounts of international aid per capita are also more open on average. However, a closer look at IMF loans (not in figure) shows that these loans hardly facilitated trade reforms. The correlation would be inverse, which shows that recipients of IMF loans tend to stay even more closed. One reason for this might be the fact that IMF loans were mainly given according to strategic considerations (Lundborg 1998). Russia received a disproportionate share of loans since it was considered too important to be allowed to fail (Dabrowski 1998). In addition, IMF loans were closely linked to economic crises, intended in the first line to stabilize the macro-economy rather than to bring about trade reforms. Bilateral loans made up the largest share of international financial aid, which was better able to pursue medium- and long-term reform goals and was less strategically dispersed. Thus, Figure 11.3 mainly shows the foot-print of bilateral aid and its promotional impact on trade reforms.

6 Conclusion The opening of the foreign trade regimes of transition countries has in most cases succeeded. Some transition countries are clearly open to foreign trade, whereas a few others remain closed. While they may embark upon foreign economic reforms in future, the window of opportunity provided by regime change in the early 1990s is over. The transition literature discusses several factors which might spur reforms. A somewhat normative argument at the beginning of this debate was the role of an optimal reforms sequence, if a country chooses not to reform its economy with a single “big bang” strategy. The strategic sequence of a gradualist approach should minimize the overall costs of reforms and craft consensus on reforms among citizens. As it turned out in the transition countries, most of them did not integrate their trade reforms within a broader sequence of reforms. The few countries that did so may have done this randomly. As policy advice the sequencing literature may have been a good blueprint but as an empirical matter of fact sequencing does not describe or capture the reform strategies of most transition countries. As widely expected in the literature, the depth of the economic transition crisis should have spurred foreign trade reforms. There are some good empirical examples of this. Countries that suffered more from industrial output decline were more likely to open their foreign trade regimes than those who suffered less. On the other hand, the high inflation rates which are commonly seen as a crisis indicator do not correlate with far-reaching trade reforms. There are two interpretations for this. It could be that inflation was so rampant in the late communist period that it did not additionally worsen the perception of crisis in the early transformation years. Alternatively, most transition countries first brought their macro-economies into line before embarking upon foreign economic liberalization, a pattern which is not supported by the empirical analysis of reform sequences.

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More promising for the understanding of trade reforms is the theoretical contribution of transition studies emphasizing the role of critical junctures for reforms. The mode of transition impinges upon elite networks and creates new institutional structures framing future reforms. These institutions mainly provide for institutional checks and balances, and can also be described as a veto-player structure. Contrary to claimants of the “authoritarian advantage” for reform, the study of transition countries shows that democracies with veto-players were better able to bring about reform. Authoritarian structures, by contrast, tend to be stuck halfway or do not initiate reforms at all. International financial aid – bilateral aid in particular – also contributed to trade reforms. It was not loan conditionality that spurred reforms. Rather, the impact of conditionality was offset by the IMF’s tendency to grant loans strategically. The former socialist transition countries provided a good test case for various factors of reform. The dual economic and political transition was unique in Eastern Europe and in the countries of the Former Soviet Union. This allows for thorough study of the interplay between economic and political factors in the course of reform. In other regions it was much harder to get an insight into this relationship (Nelson 1994). As it turned out, political and institutional determinants were of key importance for triggering trade reforms. The question, however, of how far these reforms were economically beneficial for the transition countries is beyond the scope of this chapter.

Appendix 11.1: country codes Country

Code

Albania Armenia Azerbaijan Belarus Bulgaria Croatia Czech Republic Estonia Georgia Hungary Kazakhstan Kyrgyzstan Latvia Lithuania Macedonia Moldavia Mongolia Poland Romania Russia Slovakia Slovenia Ukraine Uzbekistan

ALB ARM AZE BLR BGR HRV CZE EST GEO HUN KAZ KGZ LVA LTU MKD MDA MNG POL ROM RUS SVK SVN UKR UZB

Transformation and trade liberalization 215

Notes 1 Bodenstein, Plümper und Schneider (2003) present each category used for the index construction. 2 Country codes are in the appendix.

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Index

accountability 99, 205; of private partners 157 actor constellation 111–12; transnational 6–7, 101 actors 156–7; costs for 207; domestic 30, 211; economic 31, 163; external 131; preferences 42–3; public 131, 143, 147; resources between 102–3; technical 109 actors, business 109, 125, 127, 138; discursive power of 124; motivations of 126; private 146–7, 154 actors, non-state 84, 105–9, 111–14, 123; role 102–3 actors, private 14–15, 100, 143, 146, 151, 166; inclusion of 148 adjustment reforms 42–3, 45, 48, 50, 56–7, 85; alternative paths 47; costs 92; political 41 Africa 185; transition countries 203 Agenda 21 146–7 agreement 186; association 191; best alternative to negotiated agreement (BATNA) 189–90; costs 207; on maximum standard 133 agriculture, European 12 America 91; bargaining power 193; financial deficits 81, 92; timber industry 135; trade balance 86; trade flows 192 American-Chinese conflict 92 Amnesty International 151 Annan, Kofi 136, 147 anti-inflationary benchmark 84 Argentina 7; debt default in 2001 85 ASEAN countries 92

Asian countries 166, 169, 184 Asian financial Crisis of 1997/1998 13, 85, 88 asymmetries 6, 75–6, 111, 157; benefits 89, 90 Australia 105, 185 authoritarian regimes 43; structures 214 autocracies 205–6 autonomy 16, 90, 92, 163; embedded 92; government 91; macro-economic policy 84; national 7; self-regulation 104 balance of payments problems 167 balance of power 30, 157 Bangladesh 169 bank credits, syndicated 166; international 164 banks 8, 87–8; commercial 89; state regulation of 32 bargaining 45, 72, 75; power 77, 184, 189–92 Basle I and II Accords 89 behavioural indices 207–8 Benelux countries 191 best practice 88; models 137 bilateral aid 212, 214 biotechnological products 108 blacklists 74 Blair, Tony 7, 52–3 blame avoidance strategies 48, 53 bluewashing 127, 154 borders 63; closed 41; continental 185 Boutros-Ghali, Boutros 147 Brady Plan 166 Brazil 4, 7, 165, 170; government 148

220

Index

Bretton Woods 87–8; era 93; Institutions 85, 166–8, 207; System 83, 86, 92–3; system breakdown 28 Brown, Gordon 52 Brundtland, Gro Harlem 154 budget deficits 52–3, 67, 81, 163, 167 budgetary policy 55; changes in 52 building block 183–4, 187–9; hypothesis 191 Bundesrat 54–5 Bush administration 74, 81 business 143–4, 157; associations 146; misconduct, punishment of 126; motivation 127; political role 124; practices 151, 154 business performance 132, 135; changes in 127 business, private 146–7; small and medium 168 Callaghan administration 52 Canada 105, 192 capital 13, 51, 61, 64–7, 71, 82, 163, 167; account liberalization 204, 208–9; controls 88; equity 166; flight 69; mobile 6, 10, 29–30, 42, 44, 63, 71, 84–5, 123–4, 164, 203; owners 42–3; sources, external 165; speculative 124; taxation 9, 63 capital flow 86, 165; cross-border 90–1; global 124; private 166; restrictions 170 capital markets 82, 85; international 165; liberalization of 83–4 capitalism, varieties of (VoC) 8, 13; modern 31 capital-poor consensus democracies 68 capital-rich majority democracies 67 Cardoso Report 2004 147–8 Center on Transnational Corporations (UNCTC) 147 central bank 81, 85; independent 43 Chile 192 China 6, 81, 88, 93, 148, 165–6, 169, 184; Chiang Mai initiative 92; internationalization of the yen 92 Christian Democrats 40, 54–5 civil society 147; actors 109, 111, 144,

149, 156–7; groups 15; organizations 154 Clinton administration 74, 192 closed economies 66, 162 coalition 41; fiscal policy reforms 54; partners 206, 211; red-green 55 Codes of Conduct 125, 127–8 Codex Alimentarius Commission 107, 111 Cold War 144 collapse of socialism 203 colonial empires 188 Common Market of the South see MERCOSUR Commonwealth states 192 communication 144; costs 166; obligations 152 Communist Manifesto 25 communist system 210; collapse of 200, 207, 213 comparative advantage 6, 12, 201, 207 comparative government 24, 26, 34, 102 compensation 77, 189; indirect 72 competences 102, 110, 145; decisionmaking 109; issue-specific 15; retransfer of 113 competition 81, 104, 135, 201; external 167; for financial services 71; foreign 188; gains from 13; global 7, 9, 11, 107, 163; intergovernmental 29; international competition 27; for international investors 162; of liberalization efforts 187; unfair 72; unregulated 70 compliance 128, 135 concessions 72, 75–6, 189 conditional aid 206–7, 209; loans 214 conferences, international 107, 146 conflict prevention 126 conflicts of interest 62, 99, 105 Conservative parties 40, 47–8, 52, 54 constructivism 2, 26 consumer boycotts 149 convergence 3, 10, 32–3, 41, 206; policy 30, 34; relative 65, 67; state action 29; of veto-players 205 cooperation 34, 69–70, 75–6, 87–8, 104, 107, 113, 147–9, 151, 154–5, 157;

Index 221 effective 71; forms of 103; gains from 72; institutionalized 125; intergovernmental 105, 108; international 35, 68, 76; structures of 89; transnational 106, 112 co-regulating institution 127, 134, 138 co-regulation 122, 128, 130, 137; crosssector 126 corporate policy, social dimensions 129–30 corporations 147–9; code of conduct 147; corporations 98; tax rate 53 CorpWatch 154 corruption 151 cost advantages 106 cost-benefit functions 129, 130, 132, 136–7 Council for Mutual Economic Assistance 200, 207 countermeasures 46, 73, 189 country size 64, 67–9, 70–1, 75; economic 190 credits 166; subsidized 167; trenching 206 critical junctures 32, 205, 209–10, 214 Cuba 148 cultural environment 22, 137; invasion of 162 currency 87–8; depreciation 90; domestic 204; manipulator 93; pegs 83–4 currency markets 84–5; global 82 current account liberalization 20, 204 customs unions 183–4, 186–7, 192 data security 108. 110 de Gaulle, Charles 91 deadlock 70; preferences 77 debt crisis 166–7 debt, international 163 decision-making 104–6, 148–50; intransparent 153; political 98, 112–13; process 109; structures 157; supra-national 124; transnational 101 defection strategy 70 defensive measures 74 demarcation 101; external and internal 113–14; functional 111; mechanisms 110; problems 109

democracies 40, 43, 123, 148, 211, 214; cosmopolitan 104; standards 150 democratic governments 205–6; legitimacy 89; policies, mass-based 83; principles of 156 democratic society 33; change 203; control 89; transition 200 democratization 146, 200 Denmark 7–9 deregulation 163; of markets 169 developing countries 4–8, 88, 111, 153, 162–6, 169, 188; disease 155; GNP 164; health systems 156 discrimination 189, 192–3 distributional effects 202–3; negative 162, 202 division of labour 183; international 162–3, 169 Doha Development Agenda 187 Dollar 83, 88, 91–2; adjustment 93; EuroDollar market 84; value of 81 Domain Name System (DNS) 108; regulation 109 domestic economy 30, 92 domestic policy 26, 30 East Asia 167, 170; crisis 165; economies 168 Eastern Europe 200, 214; communist countries 207; members 10; post-communist 205 ecological responsibility 126, 128; see also environmental economic crises 14, 48, 51, 200, 205, 209–10, 212; transition 204, 213 economic globalization 41, 47, 55, 82, 105–6, 162–3 economic integration 10–11, 28–30; global 15, 164 economic motivation 126–8 economic openness 27, 30 economic performance 47–8; depression 170, 200; deterioration of 50, 54, 56–7, 128; efficiency 14, 25; growth 10, 185; stabilization 200 economic policies 2, 5, 52, 84, 170; credibility 48; foreign 51; national 2–3, 7, 44; programme 55; reforms 14, 203–5

222

Index

economic wealth and welfare 6, 85 economies of scale 13, 188, 201 economy 13, 23, 43–4; global 207; international 41 education 8, 13, 52, 163, 170 effectiveness 115, 122, 127–8, 134, 136, 138, 143, 149–50, 153; of a standard 131 Egypt 148 Eichel, Hans 55 elections 43; democratic, first 205; Federal 54–5; founding 205, 210, 211 electoral competition 46, 49, 51–6 electoral defeats 48, 56; backlash 48, 50; Tory’s 52 elite 143, 205, 210; change 205; networks 214 emerging economies 22, 88 environmental management system 128, 134–5; ISO 14000 Standard 122 environmental organizations 15 environmental performance 127, 135 environmental pollution 148 environmental protection 15, 151 environmental risks 106 environmental standards 3, 8, 10: national 107 epistemic communities 26, 104 Europe 7, 9, 91; currency 92–3; states 92; welfare states 125 European Economic Community (EEC) 188, 192 European Free Trade Area (EFTA) 185, 192 European markets 88; Single Market 14 European societies, comparison of 35 European Union (EU) 10, 13, 68–9, 82, 104–6, 108, 184–7, 191; Monetary Union 86; Transfer Pricing Forum 105 exchange rates 83, 167; fixed 84; flexible 87, 91; floating 84–5, 87; losses 91; overvalued 167; reserves 81, 88, 91; stability 86; trading 82 excluded countries 183–4, 186, 188, 190–3 Executive Constraints index 211 exit option 89 expenditure 56; cuts in 52

expertise 105, 107; body of 147; practical 106; technical 109 exports 11, 88, 188, 190; competitiveness 167; concentration of 190, 193; development strategies 167; drive 166; Free Zones 167; industries 81; interests 190; markets 190, 207; specialization 201 failed accession applications 192 Federal Reserve 87 financial aid 200; international 200, 207, 212, 214; per capita 211–12, 212 financial institutions, international 92, 168, 170 financial markets 5, 40; control over 90; domestic 204; global 9, 163, 166; governance of 83; international 28; liberalized 13; liquid 93 financial resources 8, 90, 147–8, 156; competition for 149; privileged access 112 financial services industries 72, 86 Financial Stability Forum 88 fiscal policy 47, 52, 61; adjustments 53; developments 40–1; reforms 53 Folk Theorem 70 food safety, global standards 107 foreign economic regimes 16, 26–7, 203, 209; aid 207; assets 166; liberalization 204, 213; openness 200, 210, 211; reforms 200–1, 204–6, 212 foreign investments 14, 73; direct 4, 188; private 165; rules for 185 foreign investors 73; withdrawal of funds 93 foreign markets 11; access to 190 foreign trade regimes 14, 29, 41–2, 51, 57, 100, 208, 210; closed 208–9; opening 212; reforms 200, 213 Forest Stewardship Council (FSC) 122, 134; management certificates 135–6 France 7, 31, 106, 191 free trade 3, 12, 41, 170, 183, 186, 201; agreements 184; limited 188 Free Trade Area of the Americas (FTAA) 192 free-rider problem 88

Index 223 functional criteria 101, 108, 110; complexity 103 game theory 69–70; cooperative 77 Gates Foundation 155 General Agreement on Tariffs and Trade (GATT) 4, 186, 188 genetically modified food 15; crops 107; organisms 107, 112, 114; regulation of 105–6, 111 German Institute for International Development 168 Germany 7–8, 11–12, 30, 32, 51, 53, 56, 85, 91–3, 106, 191–2; Bundesbank 84; economic performance 55; East Germany 54; Federal Republic of 31; goods 191; monetary policy 86, 91 Global Alliance for Vaccines and Immunization (GAVI) 143, 151, 154–6 Global Compact 15, 74, 122, 134, 136–7, 143, 147, 151, 154; Advisory Council 153; Bureau 153; summit 152; undermining of 152 Global Compact norms 156; compliance 153; ten norms 151–2; violation of 153 global trade 107, 200; fairness of 22 goods 163; cross-border flow 91 governance 2, 87, 89–90, 108, 128, 150; beyond the nation state 100–2, 104; capabilities 137; economic 13–14; financial 82, 85, 93; global 14, 99–100, 114–15, 122–3, 144, 157, 162; institutions 129–30, 138; intergovernmental 155; international 156; investments 136; multi-level 104; new forms of 13, 99; private 122–8, 130, 134, 137–8; public and private 16; structures 88; traditional goals of 148; transformation of 98 government 55, 67, 75, 206; autonomy 2; control 14; debt 167, 204; democratically legitimised 5; expenditure 40; Federal 53; negotiation 149; outlays 9; partisan government 40, 47, 52–3, 56, 164; policy making 124; re-election 48;

regulation 125; resources 123; surveillance 13 gradualist strategy 204, 213 Great Britain 7–8, 30–1, 51, 53, 56, 106, 192; political economy 51, 53; transformation of 52 Greece 10 green-washing 127 Gross Domestic Product (GDP) 3, 9, 11, 51, 190, 207, 209; growth rates 210; world 3, 4 Gross National Product (GNP) 12, 165–6, 171 Heckscher-Ohlin trade model 41 hegemonic states 85–6 human capital, investment in 47, 52 human rights 15, 151; principles of 136 ICANN 109, 111 implementation 151; beyond the nation-state 104; of the standard 131 imports 201; and export laws 207; substitution policies 167 import-competing interests 190; domestic 191 incentives 70–1, 128, 131, 134, 167 inclusive regulation 112 income 169; equality 47; gap 169 income distribution 164, 168–70; internal 169; redistribution of 77 India 165, 170 Indonesia 170 industrial relations 44, 151 industrialization 25; rapid 166 industrialized countries 8, 10–12, 146, 164–6, 170 industry 87; globalization of 22 inflation 84, 209–10, 213; hidden 204; imported 92 influence 102–3, 109, 144–6; domestic political 42; source of 106 information 147, 149; capacity 113; exchange 73–6; activities 163 institutional architecture 99, 101–2, 107–9, 110–11, 114; design 33, 108, 205; political 100, 114 institutional interlinkage 102, 106–7

224

Index

institutions 7, 32, 44–5, 98, 102; beyond the nation state 99; constraints 69, 211, 215; international 88–90, 108; national 16, 56, 68, 87; political 190; private governance 125; structure 31, 43, 163, 214 integration 5–6, 113, 171; European 104; integrity measures 153–4 intellectual property rights 185 interdependence 100, 149 interest groups 2, 11, 30, 42, 44, 48, 50, 74, 205; domestic 83, 91, 190; politics 206; rents 206 interests 107, 123, 146; aggregation 106; conflict of 157; different 149; domestic 86, 191; national 98; violated 89 intergovernmental network 106, 112, 114 International Federation of Pharmaceutical Manufacturers Associations (IFPMA) 155 International Labour Organization (ILO) standards 10, 151; norms 136 International Monetary Fund (IMF) 4, 13, 51–2, 73, 81–2, 85, 88, 93, 162, 168, 214; annual report 208; loans 212; Structural Adjustment Facilities 206 International Organization for Standardization 134 international organizations 5, 26, 74, 88, 100–1, 104, 107, 112–13, 145–6, 148, 154; interests of 152 International Political Economy (IPE) 1, 82–4 international relations 15, 23, 25–7, 33–4, 88, 114, 143–4, 148, 150, 154, 157; monetary 91, 93; neo-realist concepts of 99 International Telecommunications Union 109 Internet 4, 15, 109; regulation 105, 108, 110–12, 114; security 113; standards 109 Internet Corporation for Assigned Names and Numbers (ICANN) 108, 109, 111

Internet Engineering Task Force 109 interventionist policies 6–7, 168 investment 77, 88, 124, 129, 167, 171; abroad 42; discrete objects 66; direct 72, 165–6; diversion 189; horizontal and vertical 166; portfolio 71–2, 82, 166 investors 169; international 66 Iran 184 ISO standards 126, 134, 136; effectiveness of 135 Israel 186 Japan 81, 91–2, 105, 185; monetary policy 87 joint policy function 147 Keynesian strategies 83–4; (neo-) Keynesian 5, 7, 10 Kimberley Standard 126, 130 Kissinger, Henry 81 Kohl, Helmut 51; government 53–4 Kyoto Protocol 10 labour 11, 13, 163, 169–70; abundant 30, 202; laws, restricted 167; markets 7–9, 52; Party 52–3, 56; supply of 170; taxation 63, 65 Lafontaine, Oskar 54–5 laggards 132, 133, 135, 137 Lamont, Norman 52 Latin America 7, 93, 165, 170, 185; financial crisis 13; rival trading block (LAFTA) 188; transition countries 203 leaders 132, 133, 135, 137 League of Nations 145 legal monopoly 113 legislation 151 legitimacy 13, 16, 33, 102, 115, 124, 138, 143, 153; conceptions of 76; deficit 157; democratic 104; dimensions of 155; of governance 149–50 legitimation 113, 150; chain of 149 lending institutions, international 85, 204, 206 liberal 28; democracy 144; economic policies 48; economic reforms 45; trade system 192

Index 225 liberalization 2, 5, 7–8, 10–11, 163, 166, 183, 189; economic 206; macroeconomic 162; multilateral 185, 187; preferential 186–7; of capital 85, 169 Liberals 40, 47–8, 55 lobbying 13, 124, 138, 188; business 76; pluralistic 103; protectionist 7 lock-in 32 Louvre Accord 87 Luxembourg 74–6 macroeconomic stabilization 162, 166, 204, 209–10 mailbox companies 61, 73 Malaysia 4, 166, 169 manufactured products 165, 203 marginal productivity 202–3 marginalized countries 164 market 6, 28, 82, 89, 130; American 88; capital 144, 166; developed countries 188; domestic 44; economies, coordinated 8; embedded 168; enabling 157; failures 64; intervention 88; larger 188; liberalization 85, 87; local 166–7; monetary 85, 88; movements 91; opening 202; private 63; reforms 205; regulation 89 market access 186, 189; loss of 188 Marx, Karl 25 MERCOSUR 13–14, 192 Mexico 7, 10, 165, 185, 192; Peso crisis 85, 88 MFN see most-favoured-nation Middle East 165, 170 Mitterand, François 7 mobility 8; of labour 202; of resources 6 monetary policy 88, 90; access to 86; integration 85; international 82–3, 89, 92 monitoring 132, 157; body 153–4; internal 137 most-favoured-nation (MFN): liberalization 193; negotiations 189, 192; tariffs 186 multilateral negotiations 185–8, 191; concessions in 186; trade 183, 187 multilateral trade regime 183, 185–6; liberalization 186; rounds 188

multinational enterprises 66–8 naming and shaming 73 nation state 46, 61, 83, 98, 101, 103–4, 106–7, 112, 114, 162–3; beyond the 100; membership criteria 109; role of the 102; sphere of authority 104 national politics 33, 55–6, 99; institutions 30 national welfare 64; global policy 154; health budgets 156; health risks 106–7 negotiation 132, 156, 192; intergovernmental 145; international 144, 146; regional 187; resources 186; solution 189; transaction costs 187 Netherlands 7–9, 11 networks 104, 150; corporatist 45; criteria for participation 157; local 153; non-hierarchical 103; participation in 148; transnational 146 Nixon administration 91 non-compliance 131, 154; responses to 153 non-discrimination 186; tariff reductions 192; trade liberalization 184 non-governmental organizations (NGOs) 13, 15, 26, 100, 129, 131–2, 143–4, 146–7, 151, 153, 155, 158; accreditation procedure for 147; associations 154; legitimacy 146; participatory rights 145; representatives 145 non-tariff barriers 167, 170, 207–9 norms 7, 45, 57, 104, 115, 126–7, 158; compliance 157; conflicting 99; dominant 44; entrepreneurs 26, 146; implementation 147–8, 151; international 143; private sector 89; societal 8, 48; violations 153–4 North Africa 165, 170 North American Free Trade Agreement (NAFTA) 10, 13–14, 192 Northern countries 169–70; institutions 156 open economy 63, 66, 208 opposition 48, 55; parties 50, 53; to reforms 204 optimal sequencing strategy 209, 212

226

Index

Organization for Economic Cooperation and Development (OECD) democracies 40, 46, 55, 64, 67, 74–7, 105–6, 111; countries 4, 8–10, 23, 32; governments 62; project 68–73 organized anarchy 112, 114 Ottawa agreement 192 overlapping memberships 106, 108 participation 6, 103, 115, 136, 144; boundaries 110; civil society 136; exclusive 112; opportunities for 145; potential 102; in the UN 145 participatory rights 155; of NGOs 148 partnerships 147–8; control of 149; in health 155; intransparent 157; legitimacy of 150; private-private 122, 125–6; private-public 113; public-private (PPPs) 2, 13, 15, 89, 122, 125–6, 143, 154 party politics 8, 50, 55; competition 13, 48, 53 PATA 105, 111 path dependencies 32, 102, 107, 130, 204; institutional 109, 200 peer pressure 75, 137 penalty mechanisms 127, 134; disciplinary restrictions 33 performance 136–7; band 131–2, 134, 137; improvement 137; social 127; standards 129 Plaza Accord 87 pluralization 110, 157 policy fields 11, 56, 98, 100–1, 105–8; change 55; national 31, 44; networks 150, 156 policy-making 51, 65, 108; constraints for 45 political authority 99, 103, 110 political discourse 45–6, 48, 53 political economy 23, 47; determinants 201, 215; national 56 political science 1; research 15 political stability 13, 27 politics 23, 124, 150, 191; domestic 41; international 143–4 Portugal 10 post-war period 40, 51; monetary system 83

poverty 169; reduction of 156–7 power 16, 123, 149, 190; asymmetries 99, 103, 111; differentials 76, 89; discursive 124–5, 137; distribution 6, 16, 26, 132; financial 91; institutional 91; monetary 90–1; shifts 123 preferences 46, 64, 69, 77, 112; of decisive actors 46, 56; economic 92; of electorates 61; monetary 86; party political 29; policy 30, 91; private 87 preferential access 188; to the EU 186 prices 201; convergence of 202; free leveling of 167; increase 203; reduction, artificial 167 prisoners’ dilemma 70, 77, 138 private benefit 129–30, 134, 136 private rule-setting 124, 129–31 privatization 11, 85, 144, 169; programme 51, 53, 55 problem-solving 148–9; capacities 102–3, 111–13; lack of capacity 148; transnational 104 production 200; costs 166; factors 13, 23, 29–30, 61, 163, 202–3; global network 163; high-technology 203; improvements 167; labour-intensive 42, 166; local 166; mass 13; non-competitive 12; quality 106; regional concentration 190; sheltered 167 production, industrial 158, 207, 210; decline 213 profit shifting 67–8; legal 105 profits 68; foreign trade 201; paper 61; pure 65–6 Program for Action on Sustainable Development 146 proportional representation systems 43 protectionism 41, 168, 188–9, 200, 209–10; Congressional 93; interests 186; legal 13; policies 6–7, 186; spiral 185 pro-welfare parties 48, 50 public goods 104, 114, 123, 127–8, 205 public perceptions 130, 132 public procurement 185 race to the bottom 8–11, 28, 30, 35, 41, 63–8, 77, 98

Index 227 rating agencies 15 redistribution 29, 54–5; of assets 167; effects 201 reform 45–7, 52, 56, 207, 209–10; costs 205, 213; macroeconomic 204; programme 54; resistance to 200; strategies 203–4; unpopular 48, 50, 53, 56 regional agreements 184–7, 189, 193 regionalism 14, 111, 184, 183, 185–6; consequences of 191; new wave of 184–5 regulation 33, 107, 126, 138, 150, 158, 186; domestic 87; indices 207–8; intensity 30; legal 135; market-based 148; mechanisms 101–2, 108; public 127; technical regulation 113; transnational 104–5 relational power 90–1, 93 Renmimbi exchange rate 88, 93; revaluation 82 rent 206; earners 169 reserve currency 83; Asian 81 resources 146; imbalances 108; material 148 Responsible Care programme 126 retaliatory measures 189–91 returns to scale 32 Rio Declaration of 1992 151 Rio Summit 1992 147 Rockefeller Foundation 155 Rogoff, Kenneth 82 rule-setting power 124–5, 138 Russia 165, 191–2, 212; former Soviet 209, 215 sanctions 75–6, 132, 153–4, 157; negative 72 saving and investment 66; incentives 65–6, 77 scandals 126, 132; risk of 129 Second World War 26, 28, 191 self-regulating institution 127, 134, 138 self-regulation 122, 128, 137, 158; autonomous 125; business specific 126; societal 98, 103 side payments 69, 71–2, 75, 77 Singapore 165

social and economic development 146; costs 204 social cleavages 25, 30, 35 Social Democrats 28, 40, 47, 54–6; opposition 53 social interests 103, 110, 126 social security 8–9; contributions 40, 53 soft law 114 solidarity 16; collective 8 South and South East Asia 22, 165, 170 South Korea 81, 92, 165–6, 185 Southern countries 169–71; institutions 156 sovereignty 106; of nation states 163 Spain 10 SPD 54–6 specialization 202–3 Stability and Growth Pact 86 standards 108, 113, 123, 125, 127–9, 147–8; agreement 132; anti-corruption 136; for certification 135; development 138; effectiveness 134; implementation 106, 113; minimum 131–2, 136; open 108; organizations 109; process 129; setting of 150; social and environmental 126, 149, 157; transnational 114 state 6, 10, 25, 145; capacity 28–9; intervention 82, 167–8; strong 8, 11; weakening of 5–6, 16 state actors 107–9, 111–14, 123; role of 102, 112 status quo costs 205, 207 steering capacity 103; hierarchic 45; social 162 stock markets 4, 14 Stolper Samuelson Theorem 30, 41 Strange, Susan 5, 12, 22, 33, 90–1, 124 stringency 129, 133; minimum standard 131–2, 137; rule-setting 130; standard 134 structural power 90–1, 93, 124, 138; adjustment 166–8; transformations 144 stumbling stone 180, 184–5, 188 Sub-Saharan Africa 165, 170 summit meeting 153 supply-chain management 135 sustainable economy 151; acceleration of growth 168; development 135, 146

228

Index

Sweden 9 Switzerland 32, 74–6 Taiwan 81 tariffs 42, 167, 170, 183, 207–8; abolishment of 192; concessions 185; external 189; on goods 188; increases 191; revenues 204; trade barriers 207 tax 40; autonomy loss 62; cash-flow 66; evasion and avoidance 10, 72–3, 76; lump-sum 77; monopolies 106, 112; optimization 75; payers 85; policy 111; preferential regimes 73–7; ratio 51, 61; reform project 52, 54; revenue 64, 67; sovereignty 62, 74; withholding 69 taxation 7; corporate 105; interest 68–9; of intra-firm trade 15; levels of 9; shift of 28 tax bases 64–5, 67, 73; narrow 65; poaching 68, 72 tax burdens 63–4; asymmetric 67; effective 65; marginal 65; optimizing 105 tax competition 29–30, 61–5, 67–8, 70, 71, 76–7; harmful 69–70, 72; international 66 tax havens 61–2, 64, 69, 71–7; uncooperative 74 tax policy 63; autonomy 67–8; development of 64; formation 65; international 62 tax practices: harmful 62, 75; unfair 71–3 tax rates 53–5, 57, 64–5, 72, 77, 105; corporate 68; cuts to 53; high 73; low 105; nominal 66–7; reduction 43, 55 tax reforms 65–7; market-conforming 65, 67 tax systems: conventional 72; national 61 technology 109; capabilities 201; dependence 167; imported 167; transnational infrastructure 108 territorial issues 101, 104, 108, 110, 123 terrorism 148 Thailand 166, 169 Thatcher, Margaret 7, 51–3 Tobin Tax 15 trade 4, 57, 190, 201–2; balance 190,

193; of components 165–6; dependence 190; discrimination 90, 183; diversion 185, 189, 191; domestic 190; flows 207; issues 107; liberalization 11–12, 41, 186, 188, 208–9; licenses 204; links 92; monopolies 207; negotiations 186, 190; openness 201, 203, 208, 210–11, 212; policy 12–13, 184, 191; preferences 93, 188; protection 110, 206, 211; quotas 204; quotient 207–8; reforms 206, 209, 211; restrictions 170–1; rival blocks 185, 188–9, 192; war 14, 190–1 trade agreements 152, 183, 191; preferential 183–6, 188–9, 191–2; regional 188–9 trade barriers 7, 11, 166, 183–4, 188, 207; removal of 169, 171; unilateral increase of 190 trade, international 164, 200–1, 207; liberalization of 83; relations 185; theory of 29 trade-off, mutual 206 transaction costs 127, 187 transfer of technology, unlicensed 165 transfer pricing 105–6, 111–13; regulation 110, 114; transnational 105 transformation 28, 113; of political authority 102; strategy 168 transition costs 48, 170 transition countries 165, 201, 204, 207–14; Asian 203; communist 200; reforms in 205 Transnational Corporations (TNCs) 5, 14, 26, 105–6, 122–5, 136, 138, 146–7, 162, 167; backward linkages 166; European 165; influence on government 12; research 165; taxation of 105 transnational governance 100, 111–12, 114; preconditions of 115 transnational institution-building 99–100, 113–15 transnational policy regimes 100, 101–4, 107, 109–10, 112–15; functional composition 111; networks 103 transnationalization 26, 102, 112; internal 115; political 110

Index 229 transparency 75–6, 113, 145–6, 156; lack of 15, 155 unemployment 8, 54–5 UNICE 105 unions 12, 15, 167, 144 United Kingdom 32, 82, 84, 191 United Nations (UN) 136, 144, 146–7, 151, 153–4; Children’s Fund (UNICEF) 147, 154–7; delegates 152; Development and Environmental Programs (UNDP and UNEP) 147, 151; fragmentation of 149; institutions 155; Organization for Industrial Development (UNIDO) 151; reform 145, 148; Secretary General 152–3; Security Council 155; Summit on the Environment and Development in Rio 146; UNCTAD report 169 United States 7, 26, 30–4, 73–4, 82, 84–5, 88, 105–6, 108–9, 185–7, 192; autonomy 93; Congress 192; current account deficit 89; economy 83; exchange rate policy 92; government 76; intervention 75; monetary policy 87; Nixon strategy 93; Tariff Commission 192; TNCs 165; trade deficit 81; trade policies 192 Universal Declaration of Human Rights 151 Uruguay Round 185, 188 vaccination campaigns 155–7 value chains 163, 165–6; global 162 veto-players 43, 46, 51, 53–4, 55, 68, 200, 206, 209, 211; in Germany 56;

hypothesis 50; index 211; institutional 50, 67; structure 214; theory 205 voters 43, 45, 48, 50, 53; median 206 vote maximization 47, 57 wages 203; in developing countries 170 Washington Consensus 203; first 93; second 84–5, 89 welfare 3, 29, 206; aggregate 206; benefits 54; cuts 43; economic position 64; losses 185; provisions 9; public 63; social 7; world 185 welfare state 2, 33, 40, 48, 50; regimes 44; structures 164; systems 163 Western corporations 166 Western Europe 193 white-washing 127 Wilson administration 52 window of opportunity 203, 212 workers 203; interests of 152 World Bank 13, 73–4, 85, 155, 162, 165–6, 168, 206 World Economic Forum 2000 155 World Economic Summit in Davos 1999 147 World Health Organization (WHO) 107, 147, 155–7; Secretary-General 154 world markets 7, 10–13, 188, 201–2, 209; forces 163; integration 6, 51, 200, 203; openness to 9; operation 32; strategy 167 world trade 4, 183–4; growth of 3; polarization 186; system 171 World Trade Organization (WTO) 4, 6, 10, 13, 107, 183–4; Ministerial Meetings 187; negotiations 12 World Wide Web Consortium 109