World 3.0

by Pankaj Ghemawat

  IO economists' interests shifted over this period as well, toward using game theory to research small-number interactions. This reflected not only interest in looking more rigorously at strategic behavior but also fascination with applying a new kind of math to economics.10 Considerable progress was made toward that substantive objective, but game-theoretic modeling also threw up a profusion of possibilities that undercut professional economists' interest in the broad Harvard-Chicago debate (as I learned from trying to publish on the topic in the late 1980s).11

  Even more significant, however, was the shift that took place in public sentiment. During the 1980s, as the conservatism of Ronald Reagan and Margaret Thatcher took hold, a wave of deregulation swept around the world and was seen as vindication of the Chicago School and its theories. This attribution was ironic—or so it seemed to Harvard-trained IO scholars—because much of the legislative impetus for the early deregulatory efforts in the United States came from liberal politicians, notably the late Edward Kennedy. The economists advising politicians like Kennedy held views closer to Harvard's than to Chicago's; they understood that while theoretical rationales for regulation existed, these rationales required case-by-case assessment. As Alfred Kahn, who as chairman of the Civil Aeronautics Board presided over the airline industry's deregulation in the 1970s, subsequently wrote in his textbook on regulation, “Industries differ, one from the other, and the optimal mix of institutional arrangements for any one of them cannot be decided on the basis of ideology alone.”12

  Be that as it may, in the court of public opinion at least, deregulation denoted victory for Chicago's views about market failures and, more broadly, about how to manage competitive processes: as little as possible. And reinforcement was supplied by the course of the Cold War.13 Facing a real threat from the Soviet Union, many Americans came to think of socialism as a dirty word, and advocacy of a bigger role for government as almost treasonous. The fall of the Berlin Wall and the collapse of the Soviet bloc in the early 1990s simply solidified beliefs that Chicago was right—beliefs that spread around the world.

  As a result, when Milton Friedman passed away in late 2006, Lawrence Summers, the quintessential Harvard economist when not in public service in Washington, included the following in his obituary, titled “The Great Liberator”:

  Not so long ago, we were all Keynesians. (“I am a Keynesian,” Richard Nixon famously said in 1971.) Equally, any honest Democrat will admit that we are now all Friedmanites … While much of his academic work was directed at monetary policy, Mr. Friedman's great popular contribution lay elsewhere: in convincing people of the importance of allowing free markets to operate.14

  Note here the association of the term free (not exactly a value-neutral term) with unregulated markets, the result of an impressive rhetorical push by Friedman and Hayek.15 While capitalism does depend on the freedom to engage in mutually beneficial exchange, freedom and unregulated markets hardly go hand in hand. In fact, there are numerous strands of evidence that suggest the opposite conclusion: the fact that governments supply some of the infrastructure required for markets to work; indications that World 0.0 societies with minimal governmental infrastructure tend(ed) not to have well-developed markets; the observation that countries today can still sustain high levels of openness alongside large amounts of state intervention (e.g., Scandinavia); and a large body of evidence suggesting that markets work better when participants trust each other than when they are entirely selfish.

  But it wasn't until the recent crisis, and the welter of additional evidence it presented that deregulation can go too far, that people started publicly reassessing Chicago's “victory,” at least in public. Paul Samuelson, Summers's uncle, opined in one of his last columns, published at the end of 2009, “Gone forever, one hopes, are the idiocies of Friedman-Hayek libertarian selfishness.”16 Even more recently, Nobel Prize winner and Harvard (or, more accurately, Cambridge) economist Amartya Sen pointed out that market fundamentalists appeared to be misreading their patron saint: “Adam Smith viewed markets and capital as doing good work within their own sphere, but first, they required support from other institutions—including public services such as schools—and values other than pure profit seeking, and second, they needed restraint and correction by still other institutions—e.g., well-devised financial regulations.”17

  People who forgot all this in the course of market mania are now being forced to relearn old lessons about market failures and how to counter them. Part II of this book discussed regulatory and nonregulatory responses to a range of market failures and fears, with a focus on managing the effects of (further) cross-border integration. It not only sought to formulate specific policy recommendations but also to explore the nexus between market failures and the cross-border integration of markets. It is time to pull together the threads of that inductive effort.

  Dual, Not Dueling, Choice Domains

  World 3.0 is an essential construct because focusing on just World 1.0 and 2.0 conflates questions of integration and regulation into a tug-of-war along a single dimension. Before the crisis, I too had tended to associate globalization with deregulation and high barriers at national borders with regulation within them. In my case, the food crisis of 2007 (replayed in 2010) forced me to think through situations where markets hadn't worked well but where the case for additional cross-border integration continued to be strong. This case really underlined for me the point that there were two distinct dimensions of choice, integration and regulation, to be taken into account, not just one.

  As figure 12-1 (reproduced from chapter 1), reminds us, distinguishing between these two types of choices opens up a third possibility, World 3.0, that is qualitatively distinct from both World 1.0 and World 2.0.18 World 3.0 takes market failures seriously, as Harvard historically did, but explicitly accounts for cross-border interactions in formulating responses.

  Of course, the 2×2 game board in figure 12-1, while a significant improvement on the traditional tug-of-war, is still grossly oversimplified. After all, this book has discussed four broad types of cross-border flows and of distance, seven types of market failures and fears, and myriad responses. Even if we unbundle integration and regulation, associating a single binary choice with each is not enough. Integration and regulation have to be treated as vectors of choices, many of which can take on more values than “on” or “off.” And this combination of multiple dimensions and multiple options leads to an explosion of possibilities. For an illustration, note that the traditional 3×3×3 Rubik's cube has 43 quintillion possible permutations, versus “only” 3.7 million for the simplified 2×2×2 pocket cube—that is, more than 10 trillion times as many!

  Figure 12-1: Dual, not dueling, choices

  Optimization across uncountable policy possibilities is obviously impractical, although that is what economic models routinely assume. What can be offered here, based on explorations in the earlier chapters, are six broad propositions about the nexus between market failures and fears and market integration—propositions about how to manage World 3.0. And if “proposition” sounds too definite to you, think of them as heuristics to help with the search for better policy solutions in a complex, multidimensional policy space.

  Proposition 1: Market failures and fears need to be incorporated into analyses of integration

  We have seen that the traditional market failures of concentration (chapter 5), externalities (chapter 6), and informational imperfections (chapter 7) aren't the only problems that can arise in the cross-border context. Flows sometimes build into dangerous imbalances (chapter 8). Furthermore, the benefits of integration aren't always shared fairly, although globalization isn't the main culprit behind inequality and job insecurity (chapter 9). And even when fears are unfounded (as are most of the ones we saw in chapters 10 and 11), they can still represent real barriers to integration.

  Taking market failures and fears seriously requires incorporating them into the analysis upfront, instead of as an afterthought. The European Un
ion's envoy to the World Trade Organization, John Clarke, explains the differences in how analysts and policy makers approach trade liberalization: analysts tend to focus on the economic benefits associated with specific initiatives, while policy makers screen initiatives by looking first at the political pain they will create—and shelve ones that are deemed too painful even if the economic benefits being promised are very large. Paying attention to proposition 1 in the course of the analysis would yield findings more attuned to political realities instead of tone-deaf to them.

  Fears of exploitation deserve particular attention in this context. Choices concerning integration and regulation almost always mix opportunities to grow the economic pie with potential shifts in how it gets shared. Unless we are forthright—and honest—in making the distinction strategists call for between “creating value” and “claiming value,” we will at best achieve a brittle form of integration, riddled with suspicions of exploitation. And at worst, we may miss out on the major opportunities to create value to which World 3.0 directs our attention.

  Proposition 2: The cross-border integration of markets often helps correct market failures instead of compounding them

  Chapter 5 presented examples of situations in which allowing foreign competition alleviated the problems associated with excessive domestic market concentration. In chapters 6 and 7, we also saw how foreign technology and market access can help curb environmental damage in the face of externalities and how deepening trade in food products can reduce price levels and volatility under conditions of imperfect information. Chapter 8 indicated that managing certain kinds of imbalances, such as of labor, requires more rather than less cross-border integration. And chapters 10 and 11 highlighted the numerous political and cultural benefits of cross-border integration.

  This proposition is particularly worth emphasizing because many people associate cross-border integration with deregulation, and get very worked up about globalization-related market failures as a result. Opening up can, under certain conditions, substitute for regulation and restore markets to health—benefits that should be explored by applying the ADDING value scorecard to proposed integration initiatives to get a full sense of their potential.

  Proposition 3: In many other cases, integration has a negligible effect on market failures and therefore shouldn't be restricted

  We have seen that macroeconomic conditions in a given country are still determined more by country-specific factors than international influences (chapter 7), that large capital borrowing needs often reflect domestic deficits as much as trade deficits (chapter 8), and that technological progress is the main driver of changes in employment and income in developed economies, not cross-border integration (chapter 9). In such cases, decisions about integration should not be held hostage to outcomes for which they aren't responsible; they should focus instead on ADDING value.

  This point might seem fairly obvious. I highlight it here anyway because globaloney often leads us to assume globalization-related forces to be stronger than they actually are and, overlaid on our World 0.0/1.0 conditioning, to blame them for our plight. Further confounding matters is the fact that we face a number of problems that are global in scope, such as global warming, and turning our back on cross-border integration would do little to alleviate them. In all these cases, it is important to prevent our dissatisfaction with the general state of the postcrisis world from leading to knee-jerk, not to mention atavistic, moves to close off borders.

  Proposition 4: When integration does threaten to aggravate market failures, mix-and-match policies to try to preserve some of the benefits of opening up while curbing adverse effects

  We have seen that restrictions on short-term debt flows into and out of developing countries make more sense than broader restrictions on capital mobility (chapter 7), and that countries like the United Arab Emirates can welcome a large influx of foreign labor while applying distinct rules to particular classes of workers—and force foreigners to return home when their work is done (chapter 9). The general point is that if flows must be curtailed, the scope of such regulatory measures should be targeted narrowly to avoid unnecessarily giving up benefits of integration.

  Additionally, it is possible to allow openness along certain dimensions while restricting it on others, as indicated by the examples of politically repressive regimes that nonetheless manage to participate actively in world trade. The mix-and-match possibilities afforded by targeting policies to specific flows can also be augmented by tailoring policies to particular foreign countries, applying them for limited time periods, imposing caps on various flows, and so on. The example of the Rubik's cube cited earlier should convey a sense of how much this expands the policy space. Of course, taking advantage of all these possibilities requires shifting from a mind-set of a “closed” world in which all possibilities are enumerated in advance, and therefore attention is focused on selecting among them, to an “open” world that is too complex to consider exhaustively and that affords room to add value by coming up with creative strategic options, not just choosing optimally from a prespecified set of possibilities.19

  Proposition 5: Distance sensitivity is inversely related to the optimal scope of integrative and regulatory initiatives

  Lower levels of distance sensitivity tend to imply larger, more far-flung “natural” markets, expanding the optimal scope of efforts to boost cross-border integration. Compare markets for airplanes with markets for haircuts, for instance. And in terms of the costs of cross-border integration, when market failures do crop up, distance sensitivity is also a useful guide for figuring out the appropriate scope of regulation. Domestic regulation can usually address (primarily) domestic problems more effectively than restrictions on cross-border flows. Thus, if inequality is a major concern, domestic regulation is a better, more targeted way of tackling it than imposing restrictions on trade flows. And even international problems don't always require global solutions. Thus, with intermediate levels of distance sensitivity that imply that the scope of the market failure is regional, as tends to be the case for acid rain (chapter 6), regional cooperation is appropriate. Only very distance-insensitive problems like global warming from greenhouse gases require global responses, and even then one-size-fits-all policies agreed by worldwide consensus are seldom the right answer.

  The point about the optimal scope of regulatory initiatives, in particular, parallels Jagdish Bhagwati and V. K. Ramaswami's classic theory of domestic distortions and policy intervention: “If the market failure arises in domestic markets, then the appropriate policy intervention is the use of domestic policy directly targeted at mitigating the effects of the market failure, while free trade is maintained externally.”20 The difference is that Bhagwati and Ramaswami's analysis, like most of traditional theory, dichotomizes between home and abroad.21 Distance sensitivity captures additional information about how far, if at all, the effects of market failures extend beyond national borders and therefore provides some insight into the optimal scope of cross-border regulatory efforts.

  Proposition 6: Large integration opportunities often exist within as well as across national borders

  Thus, provincial border effects, while smaller than national border effects, still remain significant, as discussed in chapter 3. And even small countries (e.g., Belgium) often exhibit large internal distances across the CAGE dimensions. So, it makes sense to apply the propositions developed in this section to internal as well as external integration. The corollary is that multiple levels of government within a country can pursue integration, although they may also need to address market failures and fears such as concerns about inequality. Table 12-2 illustrates some of the integration initiatives that might be pursued at the provincial level.

  Such opportunities are worth highlighting because neither World 1.0 nor World 2.0 calls attention to them. Thus, world maps drawn from a World 1.0 or World 2.0 perspective would both shade one's own country in a single color (either the same color as the rest of the world in World 2.0
or a different color in World 1.0). What this final proposition suggests, instead, is coloring a country of special interest in several different colors on the map, rather than just one, in order to pick up on internal heterogeneity. Using maps and other devices to better envision World 3.0 is the topic of the next section.

  Envisioning World 3.0

  To begin improving your vision of the world, take stock of where you're coming from and what's unique about it. World 2.0 tricks us into thinking the world is the same regardless of one's vantage point, but the reality is that what is close and what is far depends on where you are and how you are looking at the world—whether at the country, company, or individual level.

  More specifically, maps of the world usually employ environmental reference systems, in which locations are specified with respect to objective features of the environment. What we need more of are rooted maps that employ egocentric reference systems—that is, maps that depict other countries in relation to a specific focal country, or that combine environmental and egocentric elements. In the remaining chapters, we'll see several examples of such maps.