World 3.0

by Pankaj Ghemawat

  It has long been known that imports of capital goods—machinery, equipment, and so forth—boost productivity by facilitating adoption of new technologies. More recent evidence suggests that imports—and inbound FDI—may facilitate innovation as well as imitation.25 Exports (and outbound FDI) are correlated with rapid productivity growth as well, and the more recent evidence, in particular, suggests that this is partly because foreign markets serve as learning labs.26 In addition, openness also seems to increase the rate at which more efficient firms replace less efficient ones. Since such turnover, especially among small firms, accounts for more productivity growth in countries such as the United States than upgrading by establishments that continue operating, this is no small matter.27

  To fully appreciate the possibilities associated with a faster productivity growth rate over time, consider two initially identical countries, one of which liberalizes and one that does not. If liberalization yields a one-off gain of, say, 0.5 percent of GDP, then the country that liberalized will be 0.5 percent larger than the one that didn't—forever. But if liberalization yields 0.5 percent faster productivity growth, the country that liberalized will be 5 percent larger than the other in ten years, and more than 25 percent larger in fifty!

  To conclude this section, recall that standard estimates of the economic gains from merchandise trade—for example, the 0.5 percent of global GDP cited earlier—focus on the first two components of the ADDING value scorecard, adding volume and decreasing costs, and omit the others. Including the other components (as well as exploiting the expanded set of policy levers identified in the previous section) should, to my mind, push the estimate well past 1 percent of global GDP, to 2–3 percent or more.

  More speculatively, the expanded conception of value might afford a better handle on how openness could benefit developing countries in particular. As Pascal Lamy explained to me, most of the action in standard models of the gains from trade involves price reductions, effectively locking in the biggest benefits for those who spend the most—that is, rich countries. Greater emphasis on scale economies, differentiation, the intensity of competition, risks, and knowledge development, he felt, might increase not only assessments of the potential gains from trade but also affect the fraction estimated to accrue to developing countries.28

  Not by Merchandise Trade Alone

  The ADDING value scorecard can be applied not only to merchandise trade, but also to other types of cross-border flows. Services are the most obvious extension: they account for roughly two-thirds of global GDP but only one-fifth of global trade, leaving trade in services only about an eighth as intense as trade in merchandise. While some services are intrinsically untradable—think of the market for haircuts—services' overall level of trade intensity appears to be much lower than it could be. Policy restrictions are particularly pronounced in transportation and professional services.29

  Service liberalization commitments require a sophisticated system of rules and regulation whose effects are hard to quantify. The few academic studies that have nonetheless attempted to calibrate their effects using CGE models tend to conclude that a given percentage cut in services barriers would produce greater gains than those from a comparable cut in merchandise trade barriers.30 In addition, these studies, like the ones cited in the previous section, focus on a subset of the economic gains identified by the ADDING value scorecard and therefore presumably understate total economic gains. And finally, because of improvements in cross-border service delivery enabled by information technology, it is possible to argue that the potential gains from liberalizing trade in services are increasing over time—unlike the decreasing estimates for gains from merchandise trade liberalization cited at the beginning of this chapter.

  Beyond trade in products and services, there are also cross-border flows of capital, people, and knowledge. Let's start with capital. It might seem strange to talk right now about the benefits of cross-border capital flows. But it is important to distinguish among different types of capital flows. Foreign direct investment (FDI)—foreign companies buying, setting up, or reinvesting in businesses in a country—represents a long-term commitment even if the rate at which such commitments are entered into varies greatly from year to year. FDI helps transfer knowledge and information as well as capital, and functions, like trade, as a channel for product market integration with the prospect of ADDING value just as broadly.31

  Other cross-border capital flows offer a narrower set of gains focused on exploiting international differences in the cost and marginal productivity of capital as well as diversifying risk. Such flows are also capable, however, of increasing volatility, because they don't simply vary from year to year: they can and often do go into reverse. So such capital flows do have to be managed, although it is rarely optimal to manage them to zero. These points are discussed further in chapters 7 and 8. For now, I offer two conclusions. First, some degree of cross-border capital mobility makes fundamental sense despite contagion risk; managed properly, such capital flows add to rather than detract from the gains from globalization. And second, even if there was a move to staunch such flows or associated speculative activity, that would not eliminate the need exposed by the crisis for better cross-border coordination of financial markets. Such coordination would represent further finance-related globalization, albeit of another sort.

  Turning next to cross-border labor flows, prior work suggests that the potential for gains is simply enormous. CGE-style estimates of the benefits to eliminating all restrictions on cross-border labor mobility are on the order of 100 percent of global GDP or more, rather than 1 percent!32 This will seem less surprising if we remember that productivity in rich countries is several dozen times as high as in poor ones. Migrants from poor countries to rich ones close a substantial part of that gap when they move and can take advantage of rich countries' superior capital, technology, and institutions—and contribute to those countries' general labor supply, specific skill/occupational categories, the diversity of goods and services available there, and levels of entrepreneurial activity.

  Of course, some readers may object that complete liberalization simply isn't in the cards. Yes, but the real point is that even moderate relaxation of current restrictions on labor mobility might yield economic gains substantially larger than the other dimensions of opening up discussed so far. Estimates that assume more reasonable (i.e., restricted) liberalization of cross-border labor flows still predict gains of several percentage points of GDP.

  That said, the readiness with which we can agree that complete labor liberalization is unlikely attests to the continued importance of barriers. These must be managed, but in a way that emphasizes integration—using some of the mechanisms for reducing cultural barriers discussed earlier—rather than interdiction. In other words, management isn't always code for moderation. Some developed countries, in particular, seem to have no real choice but to liberalize. Thus, the European Union is haunted by 50:50:50: the prediction that by 2050, 50 percent of its population will be fifty years old or older. Japan's demographics are even worse. The OECD has estimated that without large-scale immigration, U.S. living standards could drop by 10 percent, the EU's by 18 percent, and Japan's by 23 percent.33 Again, these are very large numbers! The challenge of balancing labor supply and demand is discussed at greater length in chapter 8.

  Finally, there is the matter of cross-border flows of knowledge. The flows already discussed can carry knowledge from nation to nation (whether embedded in traded products, transferred as a result of FDI, or vested in people), but knowledge can also move across borders in other ways (e.g., licensing, consulting, piracy). Also note that knowledge flows embody strong increasing returns to scale: unlike many other commodities, using knowledge in one place doesn't reduce the ability to use it elsewhere. (This is an example of a positive externality; negative externalities are tackled in chapter 6, with a focus on global warming.)

  On the one hand, cross-border knowledge flows are clearly already significa
nt: most countries are estimated to rely on foreign sources of technology for 90 percent or more of their productivity growth.34 For small, poor countries, this percentage approaches 100 percent. And based on R&D expenditures, only one country, the United States, can plausibly be argued to depend more on domestic than on foreign technology development.35

  On the other hand, knowledge is still quite localized. Thus, patents with inventors in different countries cite each other only 50 to 75 percent as much as patents with inventors in the same country.36 And a study of G7 countries estimates that a dollar of foreign R&D is worth 74 cents of domestic R&D at distances under 2,000 kilometers (within North America or Europe), 37 cents at distances between 2,000 and 7,500 kilometers (between North America and Europe), and 5 cents at even larger distances (between Japan and the other parts of the “Triad”).37

  Attempts have also been made to unpack this distance effect. The G7 study concludes that trade, FDI, and language skills all serve as channels for international technology spillovers. A study of OECD countries emphasizes that the ease of doing business in a particular country and the quality of its tertiary education system raise both the productivity of its own R&D and international R&D spillovers.38 And then there are issues of mind-set. Businesses, even within the same country, are notoriously prone to the “not invented here” syndrome—which is probably aggravated internationally by lack of familiarity and other cultural barriers discussed earlier. But the key point is that all these determinants of cross-border knowledge spillovers are amenable to policy influence.

  To understand the magnitude of the potential gains, consider a stylized calculation that ignores the distance-related effects just discussed and buckets R&D into “domestic” and “foreign.” An increase in cross-border spillovers by ten percentage points would overshadow domestic R&D efforts for all but the three top spenders on R&D—the United States, Japan, and China. Even for the United States, which accounts for over one-third of global R&D, the boost would come close to 20 percent of domestic spending. And of course, spillovers are even more vital for countries that are behind or are very small.

  In summary, the potential economic gains from liberalizing cross-border labor flows are very large and those from boosting services trade and knowledge flows also seem significant. Added to the economic gains from liberalizing merchandise, they probably push the potential gains from opening up past 5 percent of global GDP. The additional cultural and political benefits discussed in the next section supply a further boost.

  Beyond Economic Value

  To assess the cultural gains from openness, one must take cultural differences—and preferences for cultural diversity—seriously. This clashes with economists' aversion to “unnecessary” differences. Thus, even Jagdish Bhagwati, the distinguished trade economist, has suggested that “if everyone's alike, of course you're better off economically.”39 Whatever the intent, the effect is to get people freaked out about cultural homogenization.

  Such fears are unnecessary: as the last chapter indicated, cultural differences are alive and well in World 3.0, even between the United States and Canada. Chapter 11 elaborates on this point and on the potential for culture-related gains rather than just losses from increased interactions across cultural boundaries. One benefit is suggested by work in cognitive science on the advantages of different perspectives, frameworks, and the like—cognitive diversity—in problem solving.40 Given the international differences discussed in the previous chapter, national cultural diversity is likely to generate lots of cognitive diversity.

  But that is still an economic benefit. Openness can also add to cultural variety through inspiration (e.g., African inspiration of New World music and, recently, reverse flows), mixture (e.g., creole languages), transplantation plus adaptation (e.g., Balti curries from Birmingham), or transnationalization (e.g., the culture joining the global scientific community). Even more important, it can expand the variety available to individuals. As cultural economist Tyler Cowen notes, “Trade, even when it supports choice and diverse achievement, homogenizes culture in the following sense: it gives individuals, regardless of their country, a similarly rich set of consumption opportunities. It makes countries or societies ‘commonly diverse’ as opposed to making them different from each other.”41

  That sounds rather good from an individual perspective! In fact, a similar argument about the political benefits of openness—that it goes hand in hand with democracy and enriched political opportunities—has been made by people as diverse as Immanuel Kant, the philosopher; Joseph Schumpeter, the economist; and Seymour Martin Lipset, the political scientist. (Note that this has occurred without much fretting about the spread of democracy being unduly homogenizing.)

  The possible connections between openness and democracy rely particularly heavily on informational flows and include the freer exchange of ideas and increased political competition that result from openness, and the discouragement of autocracy by the transparency required to keep capital markets happy. While the actual connections aren't as clear as one would like, the weight of the evidence does suggest a positive relationship between trade and democracy.42

  That last conclusion is subject to a particular caveat: democratizing a country afflicted by a high degree of inequality may lead to a backlash against globalization (e.g., Bolivia in recent times). For this reason and others, chapter 9 explores at length the connections between economic inequality and openness. Particularly worth stressing here is the suggestion that domestic entrenchment of the sort that a closed economy is more likely to spawn than an open one significantly impairs overall economic performance. Thus, one study found that country growth varied positively with the wealth of self-made billionaires but negatively with heir-controlled wealth.43 In fact, high levels of the latter, typically found in countries with restrictions on inbound foreign direct investment, reduced growth by as much two percentage points a year! This is a huge effect, but its magnitude is less surprising if one recalls the earlier discussion of rent-seeking and its social costs.

  In addition to its domestic political ramifications, cross-border integration also seems linked to international political harmony. Specifically, the parts of the world that are isolated economically have also experienced far more military interventions by outsiders. The simplest way to see this is to look at the map in figure 4-2. The shading captures the number of disputes that countries are involved in at the WTO, with the darkest indicating more than a hundred. And the dashed line is drawn around the locations of 95 percent of all U.S. military interventions between 1990 and 2002.44 The map suggests that economic engagement and military trouble tend to be substitutes: if you don't get the one, you get the other.

  Figure 4-2: Trade frictions versus military frictions

  Source: Map shaded according to WTO disputes is from WTO website, http://www.wto.org/english/tratop_e/dispu_e/dispu_maps_e.htm; dashed line based on U.S. military interventions is from Thomas P. M. Barnett, The Pentagon's New Map: War and Peace in the Twenty-First Century, (New York: G.P. Putnam's Sons, 2004).

  Thomas Barnett, a U.S. military strategist who originally drew the dashed line, moved to the U.S. Defense Department in the wake of September 11, 2001, where he devised a set of rules for the “Functioning Core,” the relatively secure countries outside that line, to deal with the “Nonintegrating Gap,” the more troubled countries within it:

  First, we need to improve our immune-system response to 9/11-like shocks to the system that I like to call System Perturbations … Second, we need to firewall the Core off from the Gap's worst exports, like drugs, pandemics, terror … Third and most important tenet: the Core's big powers must come together to shrink the Gap progressively by tackling bad actors and security “sinkholes.”45

  This security-first approach did supply a geopolitical justification for the Iraq war, but partly as a result, there seems to be little appetite for further investments in “exporting security” to the Gap. That leaves open the option of stressing economic int
egration instead—the approach advocated in this book. Such integration may not work everywhere in the Gap but it can be pursued selectively: there is a world of difference between, say, Somalia, which is stuck in World 0.0, and Senegal. Progress might help reduce annual global military spending of $1.6 billion, or 2.7 percent of global GDP. Not to mention risks to life and limb. These and other political benefits of openness will be elaborated—and political fears dispelled—in chapter 10.

  In conclusion, recall that cultural and political suspicions about globalization—as well as about markets and other economic institutions—tend to vary inversely with how well people think they are doing economically. So tapping some of the potential gains from globalization that World 3.0 flags and that this chapter has tried to characterize more fully may be the best softener, in the long run, for general attitudes toward globalization.

  All Together Now

  Figure 4-3 summarizes the discussion so far as well as two additional considerations that favor further opening up. Let's examine these considerations in turn. First, pursuing more integration along one particular dimension can make it advantageous to push farther along other dimensions as well. While several such complementarities have already been mentioned in passing, it might help to look at a particular example in more detail. Take the link between trade and migration. One study suggests that doubling the number of immigrants from a particular country is associated with 9 percent higher imports from that nation.46 This is a substantial effect given the typically small shares of migrants in the total population. It implies that labor liberalization, in addition to producing large direct gains, would also generate substantial indirect ones by boosting trade. Yet the latter don't figure in the estimated gains from labor liberalization cited earlier in this chapter.