World 3.0

by Pankaj Ghemawat

  Additionally, even if concentration measured appropriately is high or increasing, that need not indicate an absence of competition. In some situations, even two competitors can be a large number. Think, for instance, about the “airliner wars” between Boeing and Airbus. The high fixed costs associated with developing new aircraft now run into tens of billions of dollars, creating a very large wedge between full costs and marginal costs—and a lot of room for prices to fall. These tendencies are amplified by the cyclicality of the industry and the price sensitivity of the airline customers who, as a group, fail to cover their full costs in most years. In addition, the noncommercial objectives of the two players (and the governments that subsidize them) and the high corporate stakes, given that both are focused on aerospace and can't easily get out of each other's way, put further pressure on pricing. And finally, there is the simple fact that the two players have a high degree of antagonism toward each other. For all these reasons, one expects tough rather than soft competition between the two.

  The more general point is that instead of focusing on concentration, one needs to look more broadly at industry structure—and if there is a small number of competitors, at their profiles as well. Industrial organization (IO) economists have long emphasized the importance of structural analysis that goes beyond a focus on the number and size distribution of competitors. And business economists, most prom- inently Michael Porter, have extended IO's list of structural determinants of rivalry—and added an emphasis on behavioral determinants as well. I should add that these aren't just academic niceties. Such frameworks for industry and competitive analysis are what many business school students get taught—and what many businesses actually employ to analyze their competitive environment.25

  From a globalization-related perspective, then, the key public policy issue is how opening up is likely to affect overall competitive intensity rather than just concentration. As discussed in the previous chapter, cross-border integration almost invariably intensifies competition, that is, improves the I in the ADDING value scorecard. And the example of autos discussed in this chapter indicates that in addition to reducing bloated margins in formerly cozy oligopolies (e.g., in North America), cross-border integration seems to have wrought real improvements in cost efficiencies, quality, and design over time—which can be thought of as improving some of the other components of the ADDING value scorecard as well.

  None of this is meant to suggest that there aren't some hard cases—some situations, typically characterized by high concentration and low distance sensitivity, where opening up does not, by itself, adequately address structural problems or barriers to competition. Thus in the airliner industry, Airbus is a direct result of investments by European governments aimed at creating some competition for Boeing. In the case of iron ore, big steelmakers and steelmaking countries have responded by looking for new sources of supply around the world, effectively increasing cross-border integration rather than closing off borders. While this solution will take some time to work, an influential United Nations study sees a surge in global iron ore supplies from 2012 onward, and a drop in prices.26

  To take another example that has generated many headlines, rare earths are a set of seventeen natural elements that are required in small quantities in electronics displays and a variety of green technologies. China accounts for 37 percent of the world's proven reserves but 95 percent of world output.27 This dominance dates back to heavy Chinese investments in rare earth production in the 1980s that flooded world markets, depressing prices and inducing mines in the United States and elsewhere, already under pressure because of their environmental impact, to shut down. Perhaps this was just what Deng Xiaoping had in mind when he said, “Arabia has oil, China has rare earth.”28

  But what initially looked like a bargain for the rest of the world—import cheap materials and let China deal with the pollution—has turned increasingly sour as China has begun exercising its market power. China began cutting exports in 2006 and reduced its export quota by 40 percent in July 2010, causing prices outside China to soar.29 The Chinese justify these moves on the basis of environmental protection, but foreign critics allege their real aim has been to pressure manufacturers of products containing rare earths to move production to China. In late 2010, tensions rose sharply as a territorial dispute with Japan led to shipments there and, later, to the West, to be held up in Chinese ports.30

  The race is on now to rebuild a supply chain not controlled by the Chinese, but that may take a decade or longer and require some cross-border restrictions (e.g., on acquisitions of U.S. mines by Chinese competitors). But the point, as in iron ore, is not to turn one's back on globalization. Thus, Japan, which had already started an aggressive rare earth recycling program, agreed in late 2010 to partner with Vietnam on developing production there.31 More broadly, trade in rare earths will continue to be important in the long run because of the uneven distribution of reserves and the efficiency and environmental benefits of concentrating production at larger, more sophisticated mines.

  But in most problematic cases, especially ones where distance sensitivity isn't as low, one doesn't need to set up new competitors to address structural problems: more standard policy instruments such as antitrust policy and price regulation should suffice. And remember that the total incidence of problematic cases is far fewer than globaloney-based intuitions would suggest.

  Having pointed out the potential benefits—in a few cases—of governmental intervention aimed at containing or reducing market power, it is important to add that national governments actually do much to compound market power. In iron ore, Australia and Brazil are interested in keeping prices high, at the expense of (mostly foreign) customers and global welfare, because that fattens governmental tax revenues as well as mining companies' profits. In rare earths, the problem is not company concentration but country concentration and governmental muscle flexing. In a number of other natural resource sectors, governments actually rely on formal export cartels: OPEC provides a multilateral example and the American Natural Soda Ash Corporation a unilateral one.

  In agriculture, one finds not only export cartels (which can be rationalized at least in terms of national self-interest), but also protection of a sort that hurts national as well as global welfare by restricting competition. Think back to the restrictions on sugar imports discussed in chapter 3, which help U.S. sugar producers but impose much larger costs on the rest of the U.S. economy. Protectionism based on tariffs and quotas is less visible in manufacturing and services but administrative barriers such as differences in standards, red tape, and processing delays loom large, particularly in services, where commitments to liberalization are intrinsically complex to set up and enforce.32 In addition, foreign ownership is often restricted in “sensitive” sectors such as defense and media.An ironic footnote: some of the most explicit restraints on cross-border competition are to be encountered in services that are vital to globalization such as air travel (where entry is often restricted by bilateral aviation treaties) and ocean shipping (where pricing is cartelized).

  More controversially, intellectual property (IP) laws can also be seen as governmentally enforced restrictions on competition. The justification for such laws is clear—to ensure incentives for the development of IP. Still, economists are very clear that this is not a first-best solution: once knowledge has been developed, its use by one person or entity doesn't affect others' ability to use it as well, so unrestricted use is what would maximize social welfare. In fact, this is why Thomas Jefferson, the first overseer of U.S. patent policy, originally opposed the granting of any patent protection at all—before settling on protections much more limited than those currently in place. And when one sees phenomena such as thirty-nine pharmaceutical companies suing the South African government for violating their patents on exorbitantly priced anti-HIV retrovirals, or companies trying to patent traditional knowledge of the curative properties of Amazonian plants or patent trolls trying to hold up or even wreck collab
orative efforts like Linux, one starts to realize that treating IP rights as absolute for the (limited) duration may not even be a second-best solution.

  Also keep in mind that many governmental entities (e.g., public enterprises) and processes (e.g., public procurement) are largely if not entirely exempt from the bracing effects of competition. Layer on top of that the possibilities of inert, incompetent, or venal bureaucrats—a possibility particularly emphasized by the Chicago school given its faith in the irreducible selfishness and, frankly, amorality of human nature—and you are handed a reminder of the limits to regulation. Market failures have to be balanced against governmental failures.

  All this suggests that while a government may need to intervene in market processes to preserve competition, it must be very careful that it doesn't end up becoming the principal restraint on competition. And despite the paranoia on display in the cartoon at the beginning of this chapter, openness isn't part of the problem but a key part of the solution. It generally increases the effective number of competitors, and therefore enables competition instead of inhibiting it.

  Thus, openness often reduces the need for regulation. Any remain-ing problems with concentration or, to be more exact, the intensity of competition can, in highly distance-sensitive industries, generally be addressed within the domestic sphere. Low distance sensitivity, in contrast, while relatively rare, may require regulation at the border, or across borders. But in both cases, the possibility of governmental failures suggests a highly focused approach to trying to regulate small-numbers problems. In particular, when dealing with natural monopolies or oligopolies—situations in which small numbers reflect real efficiencies—cures that impair efficiency may be worse than the conditions they are trying to alleviate. For example, instead of breaking up a natural monopoly, it is usually better to subject it to price regulation.33

  This emphasis on openness distinguishes World 3.0 from World 1.0, and the emphasis on regulation distinguishes it from World 2.0: note the broad principle that government has dual functions in World 3.0. The specific prescriptions presented here prefigure some of the more general ones that will emerge as we look in the next few chapters at other market failures and fears. But for now, we can check off at least one argument in the antiglobalizer's tool box as more of a molehill (if that) than a mountain. Far from being harmful, globalization is generally a huge help in dealing with small-number problems—in the limited number of situations where they are a real concern.

  Chapter Six

  Global Externalities

  Source: Arcadio

  THIS CHAPTER considers a second form of market failure that globalization is charged with exacerbating: externalities—specifically, environmental externalities. The cartoon deftly captures the antiglobalization screed that globalization is causing an ecological catastrophe, and adds the twist that that benefits business. The underlying idea is that market transactions fail to price in harms ranging from air and water pollution to depletion of natural resource stocks to global warming. And as a result of this externalization of ecological harms, we see too much of them.

  Environmentalists have devised rather varied responses to this ecological meltdown. Many deploy a World 2.0 mind-set, at least in terms of their focus on cross-border phenomena (they don't like the unregulated markets of World 2.0): they call for global accords while often railing against multinational companies and multilateral institutions such as the World Trade Organization (WTO) and treating international summits as important venues for protest. There is also a “dark green” fringe that seems inclined to return to World 0.0's local self-sufficiency and to end cross-border trade, especially in food products. Appeals for national standards and national enforcement, à la World 1.0, are also common, but these tend to have less novelty value.

  The sound and fury of dramatic protests—amplified by our emotional connection to “mother” nature—have cast significant haze (or shall I say smog) over environmental issues. The globalization bogeyman, in particular, is overdrawn. Most ecological problems still reside within countries or their immediate neighbors, making them amenable to regulation via the usual World 1.0 structures. And globalization's effects on the environment itself are mixed. For some pollutants and in some places, trade and cross-border integration probably make the environment cleaner, while in other cases they make the environment dirtier.

  The toughest cases to deal with from a policy perspective, irrespective of their causes, are the ones in which the environmental effects are highly negative and externalized, as in insensitive to distance. The potential for global warming as a result of greenhouse gas emissions is the example. But addressing such problems requires more cross-border coordination of policies, not less—albeit in more varied, imaginative ways than the World 2.0–inspired approach attempted at the Copenhagen Climate Change Summit of assembling 190 countries and expecting them to reach a legally binding agreement with bite. And it is worth adding that green innovation—with businesses presumably playing an important part and globalization providing high-powered incentives—is likely to be a central component of any feasible solution. Otherwise, preserving the environment would require a significant proportion of the world's population to take a permanent vow of poverty.

  The World 3.0 approach to the environment starts with market failures due to environmental externalities, superimposes on them an understanding of the geography of pollution (using, among other things, the notion of distance sensitivity), and seeks to identify and improve globalization's environmental effects, positive and negative. It does so, in part, by suggesting how countries can work together to address environmental harms in ways that more fully account for large differences in their positions and interests on key issues—and also reflect different possible ways of structuring their interactions.

  Bad Externalities

  Externalities arise when the price paid for something doesn't account for all the costs and benefits for all the people actually affected by the transaction. Positive or good externalities involve important uninternalized benefits, such as the knowledge spillovers discussed in chapter 4. And negative or bad externalities involve important uninternalized costs, of which pollution and other environmental harms are leading examples.

  Let me start with a very simple example of a negative externality. Say I run a homemade peanut butter–making business in my apartment. In my homestyle manufacturing process, I manually deshell all the peanuts and throw the shells out my window before grinding up the peanuts and making peanut butter. In the absence of any regulation, I can throw the shells out the window for free, so the price at which I'm willing to sell peanut butter doesn't have to account for the cost of cleaning up the mess I leave on my downstairs neighbor's balcony and on the street below. I offer you a good price and you enjoy my delicious peanut butter. Considering all of the costs and benefits “internal” to the transaction, we are both satisfied. But the “external” effects on my neighbors (not parties to our transaction) make them decidedly unhappy. Our little transaction has a negative “externality.”

  When externalities crop up, there are two basic ways of solving the problem. One option is changing ownership of the resources involved so as to internalize the externality—in this example, by making me buy the whole apartment complex and the street below, so I myself bear the cost of the mess I make. Alas, that's not feasible in this case, because I can't afford to buy up the whole area, and I certainly won't be given it for free. The other approach is to create a regulation that changes my incentives, like a tax that pays for the cost of cleaning up my mess or a rule that says nobody is allowed to throw garbage out the window. Either way, some regulatory authority must set and enforce a policy ensuring that I bear the full costs of my polluting production process. If I have to bear the full costs, I will have to increase my price, reducing my sales and shell volume, or change my production process. If the penalty is stiff enough, I will be forced to clean up or shut down.

  In this homely example, some auth
ority, ranging from my apartment association to the government, might be expected to act to restrict my behavior if it generates enough outrage. But what if I live on a national border and my peanut shells fall into another country? Or what if I power my peanut grinder by cutting down tropical rainforests and burning the trees, so my production process contributes to global warming? In those cases, my government is unlikely to solve the problem alone. In fact, my government might actually be happy for me to pollute some other country if it helps our national economy. Worse still, what if my country prohibits me from creating a mess at home but the country across the street lets me go ahead and pollute there for free, so that I move my little factory there and export the peanut butter back home? And what if somebody like the WTO forces my home country to accept the peanut butter I import from across the street even when my fellow citizens and our government already made it clear they don't want to contribute to such environmental destruction?

  There are many variations on this problem but the same fundamental market failure underlies all of them: if I can harm someone else without bearing the costs, I'm likely to keep doing so until some authority steps in to fix the problem. And when these kinds of harms cross borders, governments have to coordinate their responses to address them effectively. The more governments that need to be involved and the more diverse their interests, the harder it is to achieve effective regulation. This phenomenon creates the potential for globalization to harm the environment. Whether that actually happens or not is the question to which I turn next.