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659 February 1, 2010

Globalization: Curse or Cure?

Policies to Harness Global Economic Integration to
Solve Our Economic Challenge
by Jagadeesh Gokhale

Executive Summary

Globalization holds tremendous promise to negotiations stalled, bilateral and regional trade
improve human welfare but can also cause con- agreements may come to dominate that process.
flicts and crises as witnessed during 2007–09. Regardless of how globalization progresses, policy-
How will competition for resources, employment, makers in developed nations remain concerned
and growth shape economic policies among devel- about whether domestic output and employment
oped nations as they attempt to maintain produc- growth can recover as rapidly as after recessions
tivity growth, social protections, and extensive past. Those concerns are magnified by prospective
political and cultural freedoms? population aging in developed countries.
The processes associated with economic glob- Intensifying foreign competition and employ-
alization—such as free trade, business outsourc- ment uncertainty could provoke calls by industry
ing, capital mobility, and so on—generate con- lobbyists and displaced workers for additional
siderable public apprehension because of the government protections. And worker migration
economic uncertainty they portend. But cross- toward developed nations will continue, spurred
national production supply chains have now by wage differentials between developed and
become so extensive that the recession-induced developing countries. Younger immigrants may
decline in global trade is causing considerable eco- eventually help developed nations to ease the eco-
nomic distress in developed countries. nomic challenge posed by population aging, but
In contrast, emerging countries—especially immigrants are often viewed as competing for
Brazil, Russia, India, China, and South Korea—have jobs, adding to public welfare costs, and reducing
experienced only modest declines in economic social cohesion. This paper offers policy recom-
growth. As those nations continue to advance eco- mendations for developed nations to reduce
nomically and output growth in developed nations globalization’s negative effects and, indeed, har-
recovers, the process of globalization will resume. ness it for solving aging-related economic chal-
But with the Doha round of multilateral trade lenges.

Jagadeesh Gokhale is senior fellow at the Cato Institute. His research focuses on entitlement reform, labor produc-
tivity and compensation, U.S. fiscal policy, and the impact of fiscal policy on future generations. This paper is a
longer version of his article “Globalization, Economic Crisis, and the New 21st Century World Economic Order,”
in A New Conservative Agenda for the 21st Century (forthcoming).
For developed pressure for social and trade protections in
economies, Introduction many developed countries.
According to standard economic theory,
competition from Cross-national economic integration however, globalization can improve citizens’
foreign producers through trade has been ongoing for centuries welfare in both developed and developing
but has accelerated significantly during the countries. In developing countries, expanding
is not a new last two decades. Many people cite the consis- trade and capital flows permit increased spe-
phenomenon. tent support of free trade and financial flows cialization in production and expansion of
by the United States through its military employment among low-wage workers—their
umbrella and maintenance of dollar stability most abundant resource. Hence, at least theo-
as key factors for promoting globalization. retically, structural adjustments to trade liber-
However, several other factors and events were alization policies should pose few problems for
also important: the fall of the Iron Curtain, developing nations because positive economic
the introduction of the North American Free growth would generate expanding economic
Trade Agreement, the internal integration opportunities for most citizens. Moreover,
and expansion of the European Union, the greater openness to foreign capital inflows
introduction of the euro, the growth surge could foster better financial, institutional, and
and opening of Chinese and Indian econ- corporate governance and economic policy-
omies to world trade, and rapid advances in making frameworks in developing countries—
information technology during the 1980s the so-called “collateral benefits” of globaliza-
and 1990s. These events successively led to a tion.
reorganization of production operations In reality, however, globalization has pro-
across many industries to save costs by duced winners and losers among low-wage
employing cheaper offshore labor, utilizing workers in developing countries.1 Indeed, evi-
economies of scale, and extending vertical dence from the 1980s and 1990s suggests that
integration by including foreign-based pro- globalization in developing countries has
duction processes—practices known as “busi- mainly benefitted more highly skilled and edu-
ness process outsourcing.” cated workers rather than low-wage workers.2
Apart from increased trade in goods and This has created a mass perception that pro-
services, globalization also involves migration globalization policies are intended to benefit
by both labor and capital to areas and coun- particular population segments rather than
tries where wages and potential investment the nation as a whole. Another problem is that
returns are higher. Workers in developing financial liberalization (as distinct from trade
nations tend to seek better wages and living liberalization) has induced mal-investment of
conditions in developed ones, but immigrants capital inflows because of risk-mispricing by
are often viewed by natives in developed lending institutions, creating economic insta-
nations as “stealing jobs,” upsetting cultural bility and crises.
norms, and reducing social cohesion. In addi- For developed economies, competition
tion, firms that elect to make use of cheaper from foreign producers is not a new phenome-
foreign labor by relocating plants offshore are non. The abandonment of the Bretton Woods
criticized for out-migrating capital and out- fixed exchange rate regime during the early
sourcing jobs to developing countries. Thus, 1970s exposed both producers and consumers
economic adjustments associated with global- to currency fluctuations. For example, the
ization are often decried as reducing workers’ reduction of U.S. inflation by Reagan-Volker
economic security in developed countries and monetary policies during the early 1980s
subjecting developing ones to “imperialist caused a steep increase in the dollar’s interna-
capitalist” exploitation. These views motivate tional value, making foreign goods cheaper for
and support tight immigration restrictions Americans and American goods costlier for
and capital controls, and increase political foreigners. Imports of Japanese cars, electron-

ics, and other goods generated large U.S. trade diversifying their investment portfolios—it
deficits and forced structural adjustments in also exposes them to the effects of other
the U.S. economy, which continued to move nations’ economic policies and offshore eco-
away from manufacturing and toward services nomic shocks, as the global financial and eco-
during the 1980s and 1990s. nomic crisis of 2007–09 revealed in abun-
But the increased pace of globalization dance. Besides managing the domestic effects,
since then is feared for its potential to cause globalization also raises questions about inter-
higher unemployment and wage stagnation national economic policy coordination, crisis
or declines in developed economies. This management, and cross-national re-regula-
could happen for three reasons: the out- tion of “systemically important” sectors such
migration of capital, in-migration of labor, as financial services.
and competition from low-wage foreign In addition, appropriate policy responses
workers via their exports of cheaper consumer to globalization by developed countries must
goods and services to developed nations. To take into account the formidable demo-
avoid unemployment or significant income graphic challenges that they already face.
losses, workers in developed nations must Their aging populations imply much larger
further improve their skills and move to sec- future shares of unproductive citizens who
tors with higher-value-added jobs. If dis- must be supported. Can the benefits of glob-
The increased
placed workers are not rapidly absorbed by alization be harnessed to help meet those pace of
other sectors, social unrest, demands for larg- challenges? Which policies will help to maxi- globalization is
er welfare payments, and demands for in- mize those benefits and promote both faster
creased protectionism will emerge, which may economic growth and income security? Now feared for its
slow the globalization process and prevent that the 2007–09 economic crisis appears to potential to
full realization of its potential economic ben- be ebbing, which policies are likely to emerge
efits. for regulating risks in financial markets and
cause higher
This has already happened in the wake of creating an appropriate “world economic unemployment
the deep recession of 2007–09. Lawmakers in order” for the 21st century? and wage
developed nations are narrowly focused on This paper provides an overview of the
achieving a quick economic recovery through current state of knowledge and thinking on stagnation or
interventions in goods, services, and labor mar- these issues—mainly, but not exclusively, declines in
kets. The short-term policy response to the from the perspective of developed nations. It developed
recession has been to adopt large deficit- begins by looking at the basics of globaliza-
financed stimulus programs and targeted pro- tion and what it means for developed and economies.
tectionist measures to spur an economic developing nations and their populations. It
revival.3 These include bailouts of domestic then explores public concerns about how
manufacturers, “short-time” employment pro- wages, employment, immigration, and com-
grams, and expenditure-switching “trade reme- munities are affected by globalization and
dies” to boost domestic output and employ- considers the merits of alternative policy
ment. The latter policies will slow the recovery approaches. The paper then looks at the roles
of trade and capital flows and will slow global- played by capital flows, trade imbalances,
ization. Robust and sustainable economic and financial liberalization. The penultimate
growth can only be restored with the resump- section discusses the issue of aging popula-
tion of trade and capital flows—that is, by tions and how globalization can be har-
restoring the globalization process that has nessed to mitigate the looming fiscal chal-
been temporarily stalled. lenge it presents for developed nations.
Although globalization increases the abili- Finally, the paper considers the implications
ty of nations and market participants to of the new world economic order that some
reduce their overall risk exposures—via firms analysts believe will emerge once the current
diversifying their input sources and investors global economic crisis has abated.

the dollar’s strength. The fact that foreign
A Brief Tour of the Issues exporters and governments deposited their
dollar earnings in U.S. securities—effectively
The process of globalization has been investing the funds back in American compa-
ongoing for centuries, occurring in distinct nies or U.S. government debt—helped to sus-
waves. The first modern wave occurred after tain U.S. domestic investment, to increase
1870 but ended as World War I began in demand for U.S. goods and services, and to
1914, followed by the Great Depression that maintain worker productivity despite a secular
prompted sharp increases in protectionism. decline of U.S. national saving after the early
During the first globalization phase, growth 1980s.
in world trade averaged 4 percent per year. Views about how globalization affects eco-
Today, however, we are witnessing globaliza- nomic development have undergone a dra-
tion at an unprecedented pace: world trade matic change. Four decades ago, globalization
has grown at 11 percent per year since 1973, was blamed for uneven development across
increasing from about 22 percent of world nations, benefitting already-rich nations at the
gross domestic product to 42 percent today. expense of poor ones through industrial
During the same period, annual capital flows agglomeration—the concentration of produc-
have surged even faster, from 5 percent of tive enterprises in “North” (developed) coun-
world GDP to 21 percent today.4 tries, where they reaped the benefits of being
These two modern phases of globalization near markets for intermediate and final goods.
would probably have occurred more slowly With the reduction of transport costs and
without explicit promotion and protection innovations in information and communica-
under an “economic order.” Protection for tion technologies, the uneven development
trade routes, charters for private companies to appears to be reversing itself. To the detriment
engage in global trade, rules of law and prop- of low-skilled workers in developed nations,
erty rights in colonies, and so on, were provid- more companies and industries find it prof-
ed by Great Britain during the pre-1914 phase. itable to relocate operations in “South” (devel-
In today’s phase, the United States provides a oping) countries, which now have sizable mar-
security umbrella, the dollar as a stable reserve kets and cheap labor and other inputs.6
currency, a strong pro-free-trade ideology, and This worries policymakers in developed
a significant pro-globalization influence on countries, even though the evidence of its
the policies of international bodies for conflict potential harm is mixed: major developed
resolution, trade rules, economic assistance, economies such as the United States have
and so on.5 experienced sizable capital inflows, and immi-
After the 1980s, several developing econo- gration into developed nations has not been
mies dollarized or pegged their domestic cur- restricted to low-skilled workers. Indeed, the
The relocation of rencies to the U.S. dollar or took other steps to recent spurt in globalization is associated with
low-skill jobs stabilize their currencies. These measures pro- an increased divergence in labor productivity
moted global financial integration by increas- growth across nations, leading some analysts
to developing ing investor confidence in the safety of their to believe that the earlier hypothesis of uneven
nations worries funds and in their ability to repatriate profits international gains from globalization retains
policymakers from abroad. A stable and strong dollar pro- relevance.7
moted non-U.S. countries to export more Standard economic theory favors special-
in developed goods and services, which motivated them to ization in production and free trade. Given
nations, but the support pro-globalization policies. Although world prices of factors and goods, nations
evidence for its the dollar’s strength created correspondingly (especially small ones) benefit from moving
large U.S. trade deficits, a strong U.S. economy away from their existing production configu-
potential harm and low unemployment after 1982 kept the lid ration toward producing more of those goods
is mixed. on protests by U.S. exporters who were hurt by that are cheaper to produce domestically rela-

tive to their world prices; that is, to reap the do not favor a return to old economic poli- There is clear
“gains from specialization.” If they simultane- cies of state control that limit employment- evidence that
ously open their economies to world trade— generating private entrepreneurial activities.9
exchanging goods produced at lower cost for Do policymakers favor free trade? Evident- openness to trade
ones that are cheaper to produce abroad—they ly so, especially among developed economies— is associated
can benefit from the “gains from trade.” as shown by the free trade zones in Europe and
Permitting both types of gains maximizes citi- North America.10 Despite the fact that greater
with larger
zens’ welfare given the nation’s endowment of openness undercuts a government’s ability to governments.
productive factors. Furthermore, opening the finance larger budget expenditures (tax bases
economy to foreign investment provides addi- shrink faster in response to higher taxes), there
tional resources and technology, accelerating is clear evidence that openness to trade is asso-
the development of natural and human re- ciated with larger-sized governments. Exam-
sources, which eventually accelerates overall ples of such patterns are provided by Nordic
economic growth. countries that engage in free trade but main-
Thus, economic theory posits that open tain large social insurance programs.
trade would benefit a nation’s more abundant One reason why free trade is associated
productive resources. In developing countries, with larger-sized governments is that open-
low- and intermediate-skilled workers are ness to trade and financial flows exposes citi-
more abundant, while in the developed world, zens to external economic shocks, potentially
capital owners and high-skilled workers are causing economic crises. However, there is lit-
the predominant resources. The losers would tle systematic evidence that financial global-
be their counterparts: high-skilled workers in ization by itself leads to deeper and more costly
developing countries and low-skilled workers economic crises. That is because, historically,
in developed countries.8 However, although most financial integration has occurred across
one would expect financial capital to flow developed countries with well-developed fi-
from developed to developing nations—the nancial markets. Indeed, economic crises have
latter with higher potential returns on invest- been tamer and less frequent among devel-
ments—financial capital has flowed into the oped nations during the current phase of
United States, on net. Economic theory pro- globalization compared to the one before
vides no clear predictions about how the ben- 1914.11 That suggests such nations have con-
efits of financial inflows would be distributed tinued to develop better financial and other
within nations, developed or developing. As institutions to minimize the effects of off-
discussed later, a nation’s abundant factor shore economic shocks. But how far do they
does not necessarily benefit from financial lib- yet have to go? It is noteworthy that although
eralization. The outcome depends on the mix vulnerability to periodic economic crises has
of skills, technology, and capital intensity in mostly been a feature of developing countries,
production processes. the most recent crisis emanated from the
Who among the public favors free trade? United States and has affected developed and
Is this consistent with the expected winners developing countries simultaneously.
and losers? Survey evidence confirms that the The story seems to be different for emerg-
potential beneficiaries from globalization— ing economies that lack well-developed finan-
high-skilled workers—favor increased global- cial sectors. Although trade globalization usu-
ization in developed countries. In developing ally has a positive effect on emerging market
countries, however, the evidence on attitudes economies, financial globalization may not.
toward globalization is mixed, partly because Financial globalization has historically been
low-wage workers have so far benefitted only associated with greater economic volatility in
a little from globalization, and not without recipient countries—especially small ones. As
long delays. What is clear, however, is that discussed in the section on capital flows,
most worker groups in developing countries although allowing foreign direct and portfolio

investment permits greater specialization in economic policies.13 Thus, globalization pre-
production and increases trade volumes, it also sents a Catch-22 for developed economies:
increases exposure to other countries’ exports, although cheaper imports enhance consumer
currency fluctuations, economic shocks, and welfare, low-wage workers could bear the brunt
policy changes. A sudden increase in foreign of the costs through less employment, stag-
financial inflows can be destabilizing if domes- nant wages, and the financial burden and asso-
tic lending institutions fail to prevent increases ciated distortions of additional social insur-
in investment in risky domestic sectors and ance provisions.
enterprises. Then, any onset of pessimistic eco- Thus, globalization holds implications for
nomic expectations among the public has a many economic issues such as wage growth,
larger potential for becoming self-fulfilling, employment, immigration, job security, work-
leading to a crash. One study finds the likeli- er skill acquisition, capital flows, labor pro-
hood of financial globalization–induced crash- ductivity, and economic volatility. The follow-
es to be higher when trade costs are high. This ing sections discuss the policy implications of
suggests that opening up financial sectors in globalization in each of these areas.
developing nations would lead to less econom-
ic volatility (and lesser demands for social pro-
In developed tections by the public) if it were preceded by Wages and Employment
countries low- trade liberalization.12
and intermediate- Finally, although globalization leads to Reality is at odds with the theoretical
greater demands for social insurance protec- expectation that low-wage workers in devel-
skilled workers tion by loser groups—for example, low-wage oping countries would benefit from global-
are faced with workers in developed nations—it makes financ- ization. The experience of developing coun-
ing larger social insurance expenditures more tries is mixed—intermediate-skilled workers
stagnant wages or difficult because trade and financial openness have mainly benefitted from expanding busi-
at least increasing itself renders cross-country tax competition ness process outsourcing, while wages in
wage differentials more intense. Taxing capital income to some low-skilled sectors have stagnated or
increase revenues would trigger capital flight, declined. In addition, high-skilled workers
when compared reducing capital per worker and, therefore, and entrepreneurs have also benefitted from
with high-skilled labor productivity and earnings. That means access to foreign capital and export promo-
workers. the burden of a tax imposed directly on capital tion policies. The resulting economic growth
income is shifted onto workers. Taxing high- has therefore been associated with higher
wage workers instead would cause tax evasion inequality, at least in the short term.14
and avoidance through less work. And it would In developed countries, however, low- and
induce skilled workers to emigrate, given the intermediate-skilled workers are faced with
already high marginal taxes that they face in stagnant wages or at least increasing wage dif-
developed countries: such workers are general- ferentials when compared with high-skilled
ly more internationally mobile than low-wage workers. This is consistent with theoretical pre-
workers and have more ways of disguising and dictions and has occurred despite net inflows
shifting their incomes to non-taxed sources. of capital as in the case of the United States—
Thus, the factors demanding social protec- suggesting that most such inflows are directed
tions the most—intermediate- and low-skilled at high-capital-intensity industries that mostly
workers—must either pay more taxes now (that employ high-skilled workers. The reorienta-
is, self-insure) or transfer the tax burden on to tion of production operations for relocating
future workers through higher explicit or some components offshore, also known as ver-
implicit government debt. Alternatively, gov- tical integration, has affected many levels of
ernments could limit exposure to offshore eco- workers in developed countries. These workers
nomic shocks by reducing the degree of trade must retool, re-educate themselves, and move
and financial sector openness via protectionist to sectors with higher-value-added jobs that

are “safer”—that is, less vulnerable to soon exposure to external economic shocks implies
being outsourced. greater economic uncertainty facing workers.
There is robust evidence that foreign com- Indeed, there is clear evidence that worker per-
petition is positively related to innovation ceptions of economic insecurity are height-
and vertical linkages with foreign firms.15 ened in industries with more foreign direct
One study attributes the within-industry investment activity.20
shift away from unskilled workers (in France) It is not surprising, therefore, that the in-
to an increase in the share of imported inputs creased globalization should be accompa-
from 9 percent in 1977 to 14 percent in nied by calls to expand social insurance pro-
1993.16 Another study shows that which tections for workers and limit the pace of
workers gain and which lose depends on globalization through protectionist policies.
inter-country differences in rates of saving Some observers advocate enhanced social in-
and capital accumulation relative to their surance support on moral grounds.21 Given
respective population growth rates. High-sav- the danger of government creep and ever-
ing countries eventually enjoy higher capital increasing generosity of social protections at
intensity, enabling high-skilled workers to taxpayer expense, proposals for expanding
capture rents from employment. This implies such protections against the undesirable
that globalization redistributes such high- effects of globalization should be subject to
rent jobs, inducing greater cross-country rigorous scrutiny by weighing costs against
inequality in labor productivity and wage lev- benefits: that is, whether the income security
els.17 Empirical studies on the U.S. economy they purchase is worth the costly distortions
suggest that outsourcing low-skilled work to output, employment, and consumption
abroad has resulted in a relative shift of em- that they bring about from increases in taxes
ployment demand toward high-skilled work- for financing them. Demonstrating that the
ers by between 15 and 33 percent across benefits of enhanced social protections
industries.18 would exceed the costs of funding them is
The conventional understanding is that usually very difficult, but such considera-
globalization increases income inequality in tions are usually ignored in the policymaking
the developing world. However, one study process.
suggests that such growth in income inequal-
ity is an inter-country rather than a within-
country phenomenon, and that the impact Immigration
of globalization has been to reduce overall
inter-country inequality by raising incomes Some observers are concerned that greater
of those developing countries that opened globalization will be accompanied by immi-
their economies to foreign trade and finan- gration of low-wage workers into developed
cial integration.19 Thus the appearance of economies. However, it is not the absolute lev-
greater income inequality from globalization els of wages in developed and developing It is not
arises because incomes of non-globalized countries that is relevant, but differentials surprising
countries have stagnated or declined. between them at different skill levels. In devel-
The structural adjustments in labor mar- oped countries, wage premiums associated that increased
kets implied by these changes can be very dif- with higher education and skills have in- globalization
ficult for some worker groups and could take creased rapidly during the last three decades. should be
a long time to complete. Such ongoing adjust- That would suggest inter-country wage differ-
ments generate higher frictional unemploy- entials would be highest for those with inter- accompanied by
ment that can persist for decades. The contin- mediate and high skills. Indeed, the evidence calls to expand
ual downward pressure on wages, increasing suggests Mexican migrants to the United
specialization, and potentially higher output States are more educated on average and
social insurance
and consumption volatility from increased occupy the middle and upper portions of the protections.

Traditional wage distribution in Mexico, confirming that subsidies or other types of social insurance to
welfare conjecture.22 native low-wage workers. However, global
Furthermore, in both the United States competition for skilled workers is likely to
payments build and Europe (especially Germany), immigra- become more intense with growing needs
immigration tion is not found to adversely affect natives’ among developed nations to support their
wages and employment because the two work- aging populations. Nations that seek limits
pressure and er groups are not close substitutes in employ- on immigration through a head tax are likely
generate more ment. Rather, new immigrants are similar to to lose better-qualified immigrants to other
unemployment by and compete with earlier immigrants. Many countries. Besides, such a tax would not nec-
studies have suggested that immigration leads essarily attract high-human-capital workers
reducing the to lower wages for native workers. However, a due to borrowing constraints—because most
overall demand recent study that adopts a more comprehen- of the wealth of such immigrants is tied up in
for workers. sive and dynamic method in evaluating the their future earning capacity. Rather, it
issue finds a large positive impact of immigra- would attract already wealthy but not neces-
tion on the wages of nonimmigrant workers sarily highly educated immigrants. Further-
in the United States.23 more, although this policy is intended to
Another issue is that immigrants impose attract high-skilled workers, it runs contrary
costs on federal, state, and local welfare pro- to the “ability to pay” principle of public eco-
grams. Indeed, the payment of a “replacement nomics—a graduated head tax favoring high-
wage” (e.g., traditional welfare payments) for human-capital immigrants imposes higher
which both natives and immigrants qualify costs on low-skilled immigrants who would
without working builds immigration pressure lose opportunities to acquire skills and
and simultaneously generates more unem- become more productive over time.
ployment by reducing the overall demand for
workers and reducing their willingness to
work.24 The Management of
If developed nations elect to provide “Community Effects”
some form of income support (this paper is
agnostic as to the wisdom of that choice), Ill-conceived policies in developed econo-
then they should remove the perverse incen- mies—such as awarding welfare benefits
tive against labor market participation by unrelated to employment—can result in
transitioning—in a deficit-neutral manner— higher unemployment among citizens and
to a “wage subsidy” program for native and more immigration, with many new immi-
immigrant workers patterned on the U.S. grants ending up unemployed. These policies
Earned Income Tax Credit. The drawback, of compound the problems already facing
course, is that gradually phasing out the immigrants, such as language barriers and
subsidies at higher wage levels introduces a insufficient education. Those are the two
corresponding work disincentive. However, biggest obstacles that prevent them from
because wage subsidies are focused on work- becoming economically self-sufficient. Two-
ers rather than on welfare recipients, they thirds of low-wage U.S. immigrant workers
increase total employment and, most likely, are not proficient in English, 30 percent have
output as well in the economy, as compared not completed high school, and 18 percent
to welfare benefits that are not contingent have less than a ninth-grade education.25 In
on employment. Europe, 40 percent of immigrants originate
One proposal for regulating the number from another European Union (EU27) coun-
of immigrants entering developed countries try, whereas the rest originate in near equal
is to levy a head tax on immigrants—graduat- parts from Asia, Africa, and America.26 The
ed by skill or qualification levels. This would diversity of immigrants in Europe generates
enable developed countries to finance wage an entirely new set of issues pertaining to

social and cultural segregation and low eco- What is the best way to increase worker
nomic mobility because of language barriers. skills? Under competitive labor markets, firm
Difficulties in finding jobs and alienation owners and managers have poor incentives to
from the social mainstream can lead both train workers because of the risk of them
immigrant and domestic low-wage workers to quitting soon after acquiring new skills. That
become involved in black markets and crime. seems to call for government-run job train-
Policy reforms should therefore aim to create ing programs. But independent government
an economic environment for attracting programs are generally unsuccessful in
high-skilled foreign-born workers and en- increasing workers’ productivity and wages
couraging quicker assimilation of low-skilled because such training is divorced from pro-
immigrants into the national economic and ductive activity. Should the government sub-
cultural mainstream. The latter is a key ele- sidize or regulate firms so as to promote on-
ment for improving immigrants’ economic the-job training? The answer based on recent
productivity, especially across their successive studies seems to be “no.”
generations. Indeed, some analysts argue that Under the more usual noncompetitive
in view of developed nations’ prospective labor market conditions (created by transac-
need for young workers in key non-tradable tions costs, asymmetric information about
service sectors such as health care, better stew- workers’ existing skills, inability to observe
Recent evidence
ardship of such “community effects” is an the degree of shirking on the job, and so on), does not, on
urgent public policy concern.27 Similar to the firms can extract rents by setting wages below balance, support
wage subsidy program above, if developed workers’ productivity levels. If more rents can
nations choose to publicly provide job train- be extracted from higher-skilled workers, government
ing, education, and youth programs, then firms have an incentive to train workers, even subsidies or
those programs should be reformed so as to in general rather than just firm-specific skills.
lessen perverse incentives and ease the nega- This directly undermines the case for govern-
regulations to
tive effects of globalization. However, as dis- ment job-training subsidies. Government increase job
cussed below, there are serious questions subsidies would also be ineffective because training by
about the benefit of such programs, even if within-firm training levels are difficult to ob-
they undergo reform. serve. firms.
Thus, some analysts suggest regulating the
Job-Training Programs amount of on-the-job training that workers
Although most measures of human capi- must receive—perhaps by setting minimum
tal consider just the level of formal schooling, criteria—say, hours or dollars spent per less-
training on the job is just as important for educated and low-skilled workers on training.
determining workers’ skill levels. Indeed, the However, such regulation is also unlikely to
importance of such training is likely to prove effective: recent studies suggest that
increase in developed countries as rapid tech- wage differences explained by differences in
nological progress accelerates skill-obsoles- schooling and workplace experience are only
cence and competition from foreign workers slightly reduced when the amount of job train-
intensifies the need to move to higher-value- ing is accounted for.28 And if government job-
added jobs that are less vulnerable to out- training regulations become too draconian,
sourcing. Hence, upgrading skills continu- they can distort the amount of training offered
ously during one’s career is likely to gain by firms or increase the gap between worker
importance for workers in developed nations compensation and productivity, leading to
in order to minimize unemployment spells suboptimal outcomes, not only for worker
and avoid earnings declines. The increase in training but also employment.29 Thus, recent
intra-cohort skills-based wage differences evidence does not, on balance, support govern-
since the 1980s has also raised the impor- ment subsidies or regulations to increase job
tance of upgrading low-wage workers’ skills. training by firms.

However, if developed nations choose to ers—thereby increasing earnings inequality
adopt public policies that support job train- over time.
ing, those policies should emphasize skill
acquisition in future growth sectors such as Primary and Secondary Education and
health care and elder care. For example, U.S. Youth Programs
government policies toward community col- Finally, there is an intergenerational com-
leges during the 1980s and 1990s appear to ponent to generating positive community
have successfully induced curricula geared effects among low-wage workers and immi-
toward changing local labor markets.30 grants. Promoting greater labor-force attach-
ments among adult workers helps in trans-
Wage Subsidies mitting skills, civic values, and a work ethic to
The earlier discussion suggested that, if their children. Complementary institutions
developed nations elect to provide some form for fostering better assimilation of migrants
of income support, replacing welfare payments and low-wage families over time and for their
with wage subsidies would remove work disin- successive generations are effective, integrated,
centives created by the former for workers with and competitive primary and secondary
low skills. Could wage subsidies also promote school systems for children.
skill acquisition by low-wage workers? The out- Second-generation immigrants often lag
come depends on how skills are generally behind their native counterparts in primary
acquired. If labor force attachments alone are and secondary school. School choice has added
sufficient for skill acquisition (learning by competition in the U.S. school system, forcing
doing), wage subsidies would result in more educators to turn out children who can either
skill acquisition by encouraging more work.31 enter higher education or start out strong in
However, if working and skill acquisition are the workforce no matter their background. Re-
rivalrous—more work implies less time spent cent research shows that competition between
on skill acquisition—then wage subsidies could schools (whether public, private, or charter)
reduce skill acquisition. These effects probably fosters innovation in teaching methods to
vary at different skill levels and change as work- effectively impart new skills that a changing
ers progress in their careers. labor market requires.33 Competition will con-
Hence the total impact of wage subsidies tinue to promote innovation in schooling,
Wage subsidies on skill acquisition is likely to be uncertain. resulting in new methods for assimilating
Studies on this issue support the “learning by immigrant cultures and teaching in settings
could result doing” method of acquiring skills—implying with growing diversity. Currently, in some
in more skill that wage subsidies could result in more skill communities, charter schools are using both
acquisition by acquisition by lower-wage workers directly, by Spanish and English to better assimilate re-
encouraging greater labor force participation cently immigrated populations.
lower-wage and more work by those already in the labor Recent evidence on government programs
workers by force.32 Thus, on balance, replacing tradition- points to only partial effectiveness of school-
al welfare payments with wage subsidies such to-work programs in increasing the skill levels
encouraging as the Earned Income Tax Credit program in of youth—for whom traditional adult job
greater the United States removes a disincentive for training programs also fail.34 In Germany, the
labor force low-wage workers to work and gain skill. A school-to-work programs take the form of
caveat, as one study suggests, is that because apprenticeship systems in different industries;
participation wage subsidies increase the opportunity costs in Japan they operate through contractual
and more work of acquiring skills at low wage levels but arrangements between schools and employers;
reduces those costs at wage levels where the in the United States, the 1994 School-to-Work
by those already subsidy is phased out, those subsidies would Opportunities Act operated until No Child
in the labor retard skill acquisition by low-wage workers Left Behind removed it in 2001. Such pro-
force. but encourage it for intermediate-wage work- grams, which are more prevalent in Europe

than in the United States, target high school the U.S. trade deficit remained at almost $700 The availability
and college graduates, integrating youth billion in 2008. However, trade deficit figures of cheap imports
employment, job training, and information offset gross imports and exports of goods, ser-
about labor market opportunities. The faster vices, and earnings each year. Taking the ratio from developing
transition from school graduation to employ- of the sum of imports and exports to GDP, countries had the
ment fosters stable labor-force attachments at which fully reflects the U.S. economy’s expo-
higher wages. Unfortunately, there is no evi- sure to foreign trade, produces the figure of 40
normal effect of
dence on how long the positive short-term percent in 2008. And even that large number is increasing
effects persist. In addition, time devoted to dwarfed by corresponding ones for major consumption and
these programs implies time spent away from European economies.
academic preparation for further education Trade imbalances correspond directly with reducing saving
that could boost career wages significantly.35 capital flow imbalances that restore “balance” rates among
Another facet could be student loans sys- to each country’s international transaction developed
tems (including loan repayment scheduling) accounts. Large U.S. trade deficits mean that
that reward the completion of schooling and world capital moves to the United States, on countries.
training, but some current programs in the net. Much of it is attributed to continued
United States, such as the GI bill, reward peo- investment by the Chinese government of its
ple for merely going to school rather than for trade surpluses in U.S.-denominated securi-
doing well and completing school. ties. However, in terms of gross financial flows,
Finally, policies that induce higher rates of most foreign investments in the United States
school dropouts—such as minimum wage laws are accounted for by capital flows from
and the provision of generous welfare benefits Europe, not from emerging markets: of the
unrelated to employment—should be revised.36 total Organization for Economic Co-opera-
Policymakers need to be careful to strike the tion and Development investment flows of
right balance between encouraging work and $33 trillion in 2007, $16 trillion were directed
encouraging the pursuit of more training, to the United States. Among the major Euro-
especially among younger workers. Too much pean economies in 2008, Italy, France, Spain,
emphasis on the former could degrade the lat- and the United Kingdom exhibited sizable
ter objective. Indeed, in the United States the trade deficits, but Germany and Sweden had
Personal Responsibility and Work Opportun- large export surpluses and corresponding net
ity Reconciliation Act of 1996 (better known as capital outflows.
welfare reform) induced many former welfare
recipients to begin working, but one study esti- Who Is Engaged in Financial
mates that it also reduced the probability of Integration?
college enrollment by 20 percent among un- Thus the availability of cheap imports
married females living in low-educated non- from developing countries had the normal
two-parent households.37 effect of increasing consumption and reduc-
ing saving rates among developed countries,
and increasing net capital flows toward the
Capital Flows largest developed countries—mainly the
United States. Thus, in contrast to the theo-
The export-oriented growth policies of retical expectation that capital would flow
China and other developing economies and from developed to developing countries with
the two-decade-strong consumption binge in cheap labor and growing product markets,
the United States and other developed nations capital moved in the opposite direction, on
led many developed economies to experience net, during the 1990s and 2000s. Moreover,
massive trade deficits. At its peak, the U.S. financial globalization is primarily a North-
international trade deficit equaled $760 bil- North phenomenon, enabling citizens of
lion in 2006. Despite an ongoing recession, developed nations to better diversify their

assets. Gross capital flows from North to achieve a specific percentage point reduction
South relative to total capital are far small- in inflation—suggest adverse output growth
er—just 15 percent of total global flows, effects from financial liberalization. That is,
although they have grown rapidly from their the sacrifice in output growth required to
1980s share of 5 percent. achieve a given decline in inflation has
Although economists agree about the increased, making output growth more
potential benefits of trade liberalization, they volatile after financial liberalizations.41 Thus,
differ on those of financial liberalization. it remains unsettled whether the fluctua-
Financial liberalization is just as difficult to tions in output growth increase or decrease
implement for developing countries today as it as a nation opens itself to freer trade and
was during the pre-1914 globalization phase. international financial integration.
Lacking mature financial sectors, emerging Second, consumption volatility (fluctuations
nations are unable to float their currencies if in consumption growth) should theoretically
they wish to attract foreign capital because decline with greater openness to foreign cap-
exchange rate volatility would reduce foreign ital inflows. Being averse to sudden declines
investment inflows. Hence, many choose to in their consumption and living standards,
peg their currencies to developed country cur- most people try to smooth them when faced
Although rencies—especially to the U.S. dollar.38 with negative income shocks. They do so by
greater economic borrowing when income is temporarily low
and financial Financial Integration’s Economic and saving the extra income when it is tem-
Effects—What are the Pathways? porarily high. Thus, larger foreign capital
integration Prominent economists such as Joseph inflows should allow risk-averse citizens to
permits Stiglitz and Jagdish Bhagwati believe that increase their ability to borrow and maintain
financial liberalizations by developing coun- smoother consumption profiles over time,
diversification, tries would most likely lead to financial collapse despite volatility in income and output. The
it also induces and that the “claims of enormous benefits from evidence, however, shows that greater finan-
greater free capital mobility are not persuasive.”39 The cial openness is associated with even larger
issue hinges not upon whether financial global- volatility of total national consumption (and
specialization in ization is inherently beneficial or not, but on consumption growth). That is, economic and
production and whether it can be implemented correctly in financial integration does not appear to con-
makes countries those countries. fer the benefit of improved risk-sharing and
Although greater economic and financial consumption-smoothing as economic theo-
susceptible to integration permits diversification from nar- ry predicts. This is consistent with findings
external economic row production bases, it also induces greater that—given uncertainty over the likelihood
specialization in production and makes that a country would default on its debt—
shocks. countries susceptible to external economic globalization opens some asset markets but
shocks. What are the pathways by which closes others, leading to imperfections in
financial flows can lead to increased eco- risk-sharing within and across countries.42
nomic volatility? For example, channels that provided credit to
First, the empirical evidence on the im- domestic households and firms before finan-
pact of greater financial openness on nation- cial liberalization may be reorganized when
al output growth is mixed: several studies liberalization opens other investment oppor-
find little empirical evidence that fluctuations tunities so that some sectors and consumers
in national output (and output growth) be- experience credit shortages and are forced to
come more pronounced with greater finan- downsize or consume less.
cial openness.40 However, studies on the Third, the evidence suggests that financial
short-term inflation/output gap tradeoff— integration induces stronger synchronicity of
the amount by which output growth must be income and consumption growth across
reduced below potential, on average, to countries, generating more coordinated busi-

ness cycles across developed and developing But if macro/monetary policies are successful
countries. in stabilizing world economies relatively soon,
Recent studies on the links between a such views may retain currency.
nation’s financial openness and output growth For developing countries, although finan-
(not output growth volatility) find a positive cial deepening increases the access of the
association, even after accounting for indi- poor to credit, dysfunctional legal systems
rect effects such as globalization-induced and unenforceable property rights reduce the
improvements in macroeconomic policies, amount of available collateral and com-
corporate governance, and so on. However, pound the credit market problems of adverse
the direction of causation—whether global- selection and moral hazard to limit the bene-
ization induces faster economic growth in a fits of increased foreign capital inflows. The
country or whether global capital flows are key culprits are corruption or “financial
attracted to countries that already exhibit repression” from government officials and
signs of emergent growth based on good eco- incumbent financial firms through political
nomic and political institutions—remains connections that siphon away large chunks
difficult to decipher.43 One study that exam- of financial investments for personal use.46
ines the connections between finance, eco- The channels by which financial liberaliza-
nomic growth, and capital market integra- tion can lead to crises are twofold: by inducing
tion over the long term concludes that mal-investment by banks and other lending
output growth and globalization are both led agencies, and by generating a fiscal shock. The
by prior development of a nation’s domestic first channel usually occurs because of risk
financial sector.44 A well-developed financial mispricing by domestic banks. In part, this
sector directly fosters economic growth but occurs because capital market liberalization
also fosters financial integration with foreign leads to expectations of higher asset prices,
institutions seeking to allocate capital effi- lower cost of capital, and higher incomes in
ciently. developing countries, which induces investors
to take on more risky projects.47 Subsequent
Obstacles to Continuing Financial investment losses turn lending booms into
Globalization in Developing Countries busts, starving even viable industries of capi-
As mentioned earlier, higher volatility of tal. If a financial panic ensues from wide-
consumption growth (and perhaps also out- spread bank failures, the loss of output and
put growth) associated with greater globaliza- employment can be quite large. Alternatively,
tion stimulates demand for greater govern- if the government faces a large fiscal imbal-
ment protections through larger social ance and cannot finance its debt—partly
insurance programs—welfare, unemployment because liberalizations involve reduction or A well-developed
protections, social security, health benefits, elimination of revenues from tariffs48—it often
and so on. But some analysts point out that exhorts or forces banks to buy more govern-
financial sector
financial integration and trade openness are ment paper. If investors subsequently lose directly fosters
more pervasive today than during the pre-1914 confidence in the government’s ability to economic growth
globalization era, yet we do not witness com- repay its debts, and they attempt to sell their
parably severe financial instability and political holdings of government securities en masse, but also fosters
pressures for trade restrictions as were com- the ensuing decline in the value of govern- financial
mon then because of institutional advantages ment bonds and increases in interest rates cre- integration
such as better macro-stabilization policies, ates a large hole on the asset side of bank bal-
social welfare systems, and stronger counter- ance sheets. That can lead to a decline in with foreign
vailing interests among high-skilled workers banks’ viability, a banking panic and, again, a institutions seek-
and capital owners.45 Admittedly these views decline in credit availability to viable firms.
are still evolving; many recent studies do not These factors prevent the world from effec-
ing to allocate
take into account the current economic crisis. tively being “flat” (that is, with lower barriers) capital efficiently.

If the payroll where capital flows are concerned. This lack of implying 1.5 workers per person aged 65 and
tax rate were flatness has been documented for East older.
European nations and Russia. Poor corporate Part of the reason for the projected increase
maintained at governance and high political risks pose barri- in age-dependency ratios is continued low
15 percent ers to obtaining the full benefits of financial European birth rates. The number of births per
globalization. Hence, the role of 21st century 1,000 females per year has declined from about
throughout, financial sector reforms designed to reduce 2.3 in 1970 to 1.8 in 1990, and to about 1.5
retiree living risk exposures of financial firms can be today. Demographers project European birth
standards would approached in two ways: The first, which will rates to increase only slightly through 2050.
likely be the main focus of the G-20 nations, is Another factor is increasing longevity: male
decline by 2050 to preventing international investors—mostly and female life expectancies at birth are pro-
just 88 percent of large businesses, pension and mutual funds, jected to increase by 7.1 and 5.8 years respec-
their 2010 level. investment banks, and so on—from assuming tively. The looming shortage of young workers
unwarranted risks in their international in- for generating adequate economic output for
vestment portfolios. supporting a massive increase in older popula-
A better approach would be to encourage tions ought to be a first-order concern of poli-
developing nations to improve their systems cymakers in developed economies.
of corporate governance, reduce ownership Assuming a strictly pay-as-you-go social
concentrations that encourage policies inimi- insurance system (inclusive of medical care for
cal to shareholder interests, improve public retirees), simple calculations under standard
and corporate accounting systems, and pro- productivity and demographic assumptions
mote better political and bureaucratic institu- show how much social insurance taxes must
tions to minimize corruption. Such measures increase to maintain retirees’ living standards
are more likely to reduce investment risks com- when the worker-to-retiree ratio declines.50
pared to simply constraining investors’ The calculations reported here for EU27 coun-
options. Indeed, the benefits of the latter mea- tries as a group are based on demographic and
sures are likely to accrue to both developing economic projections calibrated according to
and developed countries, the former enjoying two European Commission monographs.51
smaller risks of capital-inflow-induced crises, Under these assumptions,52 just maintain-
and the latter gaining from broader invest- ing European retirees’ living standards at their
ment options with lower risks. 2010 levels would require an increase in the
payroll tax rate from 15 percent to 22 percent,
an increase of almost 50 percent. Alternatively,
Population Aging in if the payroll tax rate were maintained at 15
Developed Countries: percent throughout, retiree living standards
would decline by 2050 to just 88 percent of
How Globalization their 2010 level. These two alternatives capture
Can Help in simple terms the dimensions of the eco-
nomic challenge for Europe as a whole be-
According to the 2009 Aging Report of the cause of an aging population. Note, however,
European Commission, the old-age population that the foregoing understates the true size of
dependency ratio will increase from 25 per- the challenge because it does not take account
cent today to more than 50 percent by 2050. of the projected faster growth of health care
That is, instead of four workers (aged 15–64) costs per person (because of population aging)
for each retiree (aged 65+), there will be just compared to productivity growth in Europe.
two among the EU27 by 2050.49 Spain, Italy, Increased immigration could provide an
Ireland, and Slovenia are projected to experi- alternative to higher taxes, with immigrant
ence extreme increases in old-age dependency laborers providing more revenue to Europe’s
ratios of between 57 and 60 percent by 2050, public retirement programs. However, the

increase in immigrants necessary to hold the ditures applies to the United States, perhaps
payroll tax rate at roughly its current level is even more strongly compared to Europe.
unlikely to be politically acceptable: under one Thus, maintaining living standards of
scenario, worker immigration would have to retirees but at the same time preventing pay-
be increased by 1.0 percent of the total popu- roll taxes from increasing rapidly (and per-
lation immediately, and the flow of additional manently) in developed economies is a chal-
immigrants would have to grow at 8 percent lenge that must be approached by alternative
per year through 2050. Under this scenario, means. One way would be to harness the
the payroll tax rate for maintaining retiree liv- forces of globalization to better exploit the
ing standards would have to increase to 17.3 cheaper factors, resources, and development
percent by the early 2030s, but would then potentials in emerging markets. Indeed,
decline back to 15 percent by 2050. Alter- some analysts hypothesize that vast pools of
natively, this increase in immigration would unemployed workers in developing countries
mean that retiree living standards would need can easily augment the developed world’s
only decline 4 percent from their 2010 levels labor supply without relocating.54
through the mid-2030s, but then recover back However, making full use of these re-
to 2010 levels by 2050.53 sources would require that the current South-
Under parallel calculations, the aging to-North direction of capital flows be reversed
Success will
problem appears to be even more urgent in and existing global imbalances in trade and require
the United States than in the EU27 because investment flows be reduced. But the success considerable
many among the latter have much younger of this strategy will require considerable
populations. Although the higher projected improvements in business conditions, eco- improvements
U.S. birth rate means that the domestic pop- nomic policymaking, corporate governance, in business
ulation of workers increases at a faster pace, and political stability in developing countries.
the retiree population increases even faster, Such reforms would clearly benefit those coun-
especially through 2030. The United States tries because, as discussed earlier, reforming economic
has a worker-to-beneficiary ratio of about 3.0 financial and trade institutions would enable policymaking,
today (as opposed to 4.0 for the EU27), but them to reap the benefits of openness—more
that declines to about 2.0 by 2030 (rather investment, faster output growth, and higher corporate
than by 2050 for the EU27). The rate of living standards—without hindrance by the governance, and
decline slows beyond 2030 in the United previously experienced shortcomings of eco- political stability
States because, with the baby-boomers re- nomic volatility and crises.55 Notwithstanding
tired, only increasing human longevity con- the fact that the current crisis emanated from in developing
tinues to depress the worker-to-beneficiary risk mispricing and mal-investments in the countries.
ratio. However, the social insurance system in United States, which will probably trigger reg-
the United States is less generous, with social ulatory changes, leaders contemplating the
insurance contributions at only 7.0 percent of nature of the new world economic order for
GDP today. the 21st century should continue to prioritize
Keeping all except demographic parame- the developmental objectives of financial sec-
ters the same and repeating the calculations tors in emerging markets.
as above shows that the U.S. social insurance
contribution rate would need to increase to
15 percent by 2030 and then decline back to New World Economic Order
about 8.0 percent by 2050. Thus the United
States would need to double the social insur- The recent economic crisis has led to a
ance contribution rate by the end of two sharp decline in international trade volumes
more decades in order to maintain retiree liv- and, despite lip service to eschew protection-
ing standards at today’s levels. Again, the ist policies, many nations have adopted a
caveat about rapidly rising health care expen- variety of targeted anti-competitive policies.

The pre-crisis economic order was marked by ing to maintain low unemployment despite
continued negotiations of trade and finan- low U.S. national saving.
cial liberalization within the context of the The influence of developed nations (not
World Trade Organization’s Doha round. just the United States) on the policies of
However, the emergence of the so-called international lending and regulatory institu-
BRICK nations (Brazil, Russia, India, China, tions such as the World Trade Organization,
and South Korea) as economic powerhous- International Monetary Fund, and World
es—with increased negotiating power vis-à-vis Bank promoted trade agreements and pro-
developed nations—has stalled progress on vided conditional assistance to nations expe-
multilateral trade rules under the Doha riencing foreign exchange shortfalls during
round. Another feature of the pre-crisis order economic crises. The assistance was subject
was the dollar’s role as a global reserve cur- to nations introducing austere fiscal, mone-
rency, enabling the United States to maintain tary, and exchange rate policies for restoring
low borrowing rates, reap better trade terms, their economies to health. But those policies
and accrue seignorage benefits. Although the also promoted moral hazard among private
crisis has interrupted globalization, nascent individual and institutional investors, induc-
economic recoveries in developed nations ing greater risk-taking on international
and continued economic development of investments. Thus the economic incentives
BRICK nations means that the process will created by the institutional setup of the earli-
eventually resume. Finally, the pre-crisis eco- er economic order may have initiated a series
nomic order was marked by global imbal- of economic crises of which the one that
ances as financial flows moved primarily began with the financial panic of 2007–08 is
toward North countries, chiefly the United but the latest example.
States. The fact that the latest economic crisis
began in the U.S. subprime housing sector
United States as Hegemonic Defender of suggests inappropriate regulation (rather
Open Markets than nonregulation) of U.S. and global finan-
The pre-recession (2007–09) international cial institutions, but also hubris on the part
economic order was that of the United States of key policymakers about their ability to pre-
promoting and protecting international trade vent a financial sector meltdown from
and financial integration, almost by default as spreading to the real economy. This crisis has
it has been the only superpower since the late raised concerns about appropriate macro-
1980s.56 The dollar’s relative stability in inter- prudential regulation of financial enterprises
national markets, despite the emergence of the to contain their leverage ratios and risk expo-
euro as an alternative currency and despite the sures. But recent G-20 declarations notwith-
accumulation of massive current account standing, there appears to be no agreement
There deficits during the 1980s and 1990s, is the about how such international “super-regula-
appears to be result of a purely domestic objective of main- tions” and “peer-reviews” should be designed
no agreement taining price stability after the debilitating and conducted in order to maintain open
inflationary period of the late 1960s and trade and continued growth in financial inte-
about how 1970s. This made the dollar attractive as an gration. The confusion is understandable
international international reserve currency that many high- given that the goals of containing risk expo-
saving nations (China, oil exporters, Germany, sures while continuing an incipient econom-
“super- etc.) used as a “store of value.” Those nations’ ic recovery and extending global financial
regulations” and policies of investing trade surpluses in dollar- integration are fundamentally contradictory.
“peer-reviews” denominated financial assets supported the
United States’ other domestic policy goals of Toward a New Economic Order?
should be maintaining free trade and financial openness Because imposing tighter international
designed. by sustaining domestic investment and help- financial regulations may slow global recovery

from the current crisis, the new international investment, and provide assistance to finan- Forces that
economic order will take some time to emerge. cial institutions to enable resumption of would interrupt
The overt change following a severe financial lending activities. Although these supports
sector collapse and the recession-induced should be removed as economies recover, globalization and
decline in trade volumes has been the emer- they may not be fully reversed as the above- those that would
gence of the G-20 group of nations as the mentioned economic pressures from global-
steward of the global economy. However, the ization become more intense and unemploy-
promote it are
emergent order may remain quite similar to ment rates remain high. both present.
the pre-crisis economic order if the United Thus, forces that would interrupt globaliza-
States is successful in containing inflationary tion and those that would promote it are both
pressures and the dollar’s exchange value present: The recent financial crisis has weak-
remains unimpaired. That requires a timely ened the developed world economies, promot-
withdrawal of extraordinary monetary infu- ed “beggar-thy-neighbor” policies that benefit-
sions undertaken in 2008 to aid the U.S. and ed some nations at the expense of others, and
global economic recovery. In addition, reforms eroded support for continued globalization.
to eliminate massive fiscal imbalances in But regional interests may promote globaliza-
developed countries will be necessary to pre- tion in a fragmented form as countries seek to
vent taxes from escalating and maintain the maximize the advantages of international
younger generations’ incentives to continue trade and integration without any global pow-
investing in human and physical capital. er to enforce international laws, norms, and
Maintaining tax rates as low as possible is institutions. However, such a world economic
clearly a prerequisite for maintaining future order involves considerable uncertainty and
productivity growth and meeting emergent could ultimately turn out to be unstable.
challenges on many fronts: population aging, Distaste for the consequences of a breakdown
energy conservation, climate change, rising of the international economic order—what
health care costs, and so on. However, skepti- transpired after 1914 in terms of economic and
cism is growing about whether all of the physical destruction from two world wars—
daunting economic policy challenges can be may provide sufficient momentum to allow
met in a timely manner.57 the U.S.-led order to continue for a few more
At the microeconomic level as well, the decades. However, no nation appears capable
post-crisis economic order is unlikely to stop of stepping into the U.S. role as the United
the erosion of economic security for workers States did when Great Britain was economical-
in developed nations—indeed, quite the oppo- ly spent after World War II.58 The only candi-
site. If the new regulatory framework being dates are Europe, China, and India, but they
debated successfully preserves the process of are each either not interested or economically
global economic integration, workers in the and militarily not capable of successfully
developed world will continue to experience assuming the role of global hegemon.
heightened job insecurity and competition
from foreign workers. They would be forced to
adapt by acquiring new skills and being more Summary and Conclusion
mobile. Thus, policymakers in developed
nations will face increasing political pressures G-20 officials are likely to be concerned
to reduce these uncertainties via expanded about the need for reforms to better anticipate
social protections. and defend against future economic crises,
The economic crisis of 2007–09 has pro- restore balance to global financial flows, and
voked different responses from different introduce mechanisms for a smoother and
countries. Most have introduced economic more fool-proof process of risk determination
stimulus packages to extend unemployment to regulate cross-border financial flows and
assistance, expand public projects, support investments. Can and will such controls be

introduced appropriately? Or will regulators new technologies, the physical relocation of a
overshoot and lengthen the time of recovering large number of workers to developed coun-
from the current crisis and end up stifling tries is not necessary. A reversal of capital flows,
long-term economic growth? from North to South, would be necessary to
G-20 officials focused on designing an eco- employ those workers, increase their incomes,
nomic and financial regulatory order during and generate greater output for sustaining
several recent conclaves. Their September 2009 aging populations in developed countries as
conclave in Pittsburgh, Pennsylvania, released a well—a win-win result from increased global-
58-point resolution aimed at strengthening ization.61 Such a scheme would likely increase
financial regulations to ensure greater stability, incomes significantly despite a relatively small
openness, and transparency of financial insti- increase in cross-border worker migration.
tutions’ transactions and introduce periodic On social insurance. If developed nations
peer reviews and “early warning systems” to elect to provide support for low-wage work-
check if systemic risks are heightened.59 ers, that support should be based on policies
The resolution clearly indicates that G-20 that do not disincentivize employment and
officials are likely to focus on financial sector output. Welfare benefits without considera-
regulations because the last recession was trig- tion of employment effects should be reject-
The financial gered by poor investment decisions by the ed in favor of wage subsidies. The latter
crisis has largest multinational financial institutions. would increase employment and possibly
increased But the next crisis is unlikely to repeat the mis- output, on net, but only if wage subsidies are
takes of the current one. Changes in country phased out earlier along the income scale so
skepticism about profiles, of endowed resources, skills, work- as to minimize the work disincentives among
whether the force compositions, and so on are likely to intermediate skill workers. A second consid-
occur, indeed, more rapidly than in the past. eration is greater human capital acquisition
United States can G-20 lawmakers should, therefore, also con- through improved education and worker
avoid weakening sider ancillary objectives, given prospective training: better assimilation of immigrant
the dollar developmental needs of different countries. and low-wage populations into the national
The key issue facing developed economies and cultural mainstream, and transmission
through higher is future population aging. The key issue for of a good work ethic and civic values to the
domestic emerging economies is maximizing the use next generation. Policies for improving and
inflation. of their resource bases while minimizing sustaining such “community effects” would
volatility from openness to global trade and render prospective economic challenges of
capital flows. Both objectives appear to be developed countries easier to meet.
complementary rather than contradictory On capital flows. The new economic order
and should induce participants to accelerate appears likely to focus on subjecting private
the process of globalization. financial institutions to more stringent regu-
Several other areas should also be ad- lations so as to reduce their risk exposures. But
dressed: that would constrain global capital flows,
On immigration. The first Bretton Woods whereas the need is to expand them—and not
system adopted immigration limits to serve just in the short-term to hasten recovery from
national welfare state objectives and satisfy the current recession. The key for expanding
political preferences in democratic developed capital flows, especially toward “South” coun-
countries. Some analysts recommend that the tries, is reforming emerging countries’ finan-
next world economic order should achieve a cial systems: better corporate governance, less
“feasible globalization” via multilateral visa corruption, and growth-oriented macro-eco-
schemes to temporarily expand entry into the nomic policies. These reforms are in the inter-
advanced nations of a mix of skilled and ests of both developed and developing econ-
unskilled workers from developing nations.60 omies as the gains would flow to both. Indeed,
However, others believe that with the advent of the goal of expanding world financial flows,

especially within the South and from North to Aftermath (New York: Random House, 2008).
South, is consistent with the vision expressed
6. Paul Krugman and Anthony J. Venables, “Glob-
at the Pittsburgh G-20 summit—of a shift alization and the Inequality of Nations,” Quarterly
away from dependence on the United States as Journal of Economics 110, no. 4 (November 1995):
the “consumer of last resort,” toward greater 857–80.
participation by developing economies where-
7. Paul Beaudry and Fabrice Collard, “Globaliza-
in consumers with access to financial re- tion, Returns to Accumulation and the World
sources can enjoy better and more stable living Distribution of Output per Worker,” Journal of
standards. Monetary Economics 53, no.5 (2006): 879–909.
Other than the United States, no country
8. Globalization benefits all workers, on net, be-
or group of nations appears interested or is cause it reduces the prices of goods and services
capable of steering the global economy back through cheaper imports. Therefore, although
to normalcy and promoting further global globalization can make some workers worse off rel-
economic integration. But whether the ative to others, the collective absolute welfare of the
loser groups could, in principle, be improved.
United States can successfully pursue such a
course will depend on whether it can main- 9. Kevin H. O’Rourke, “Heckscher-Ohlin Theory
tain a strong domestic economy. The finan- and Individual Attitudes toward Globalization,” in
cial crisis has increased skepticism about Eli Heckscher, International Trade, and Economic
History, ed. R. Findlay et al. (Boston: MIT Press
whether the United States can avoid weaken- 2006), pp. 107–38.
ing the dollar through higher domestic infla-
tion. And doubts about political will among 10. Note that many so-called free trade agree-
U.S. lawmakers to soon reduce unfunded ments include protectionist provisions for main-
taining subsidies to certain domestic industries
social spending commitments to manage- and worker groups such as agriculture, steel, min-
able size are growing. Surmounting both ing, and so on.
challenges early is essential for maintaining
economic vitality through low taxes and pre- 11. Michael D. Bordo and Antu Panini Murshid,
“Globalization and Changing Patterns in the
serve progress achieved through globaliza- International Transmission of Shocks in Finan-
tion during the last five decades. cial Markets,” Journal of International Money and
Finance 25, no. 4 (2006): 655–74. This analysis
obviously excludes the recent financial and eco-
nomic crisis.
The author thanks Angela Erickson for extensive 12. Philippe Martin and Hélène Rey, “Globaliza-
and valuable research assistance. tion and Emerging Markets: With or Without
Crash?” American Economic Review 96, no. 5 (De-
1. Ann Harrison, “Globalization and Poverty: What cember 2006): 1631–51.
is the Evidence,” NBER Working Paper no. 12347
(June 2006). 13. Dani Rodrik, “Trade, Social Insurance, and the
Limits to Globalization,” NBER Working Paper
2. Pinelopi Koujianou Goldberg and Nina Pavcnik, no. 5905 (January 1997); and Anna Maria Mayda,
“Distributional Effects of Globalization in Develop- Kevin O’Rourke and Richard Sinnott, “Risk, Gov-
ing Countries,” Journal of Economic Literature 45, no.1 ernment and Globalization: International Survey
(March 2007): 39–82. Evidence,” NBER Working Paper no. 13037 (April
3. See Simon Evenett, “What Can Be Learned
from Crisis Era Protectionism: An Initial Assess- 14. Goldberg and Pavcnik, pp. 39–82.
ment,” Business and Politics 11, no. 3 (2004), http:
//www.bepress.com/bap/vol11/iss3/art4/. 15. Yuriy Gorodnichenko, Jan Svejnar, and
Katherine Terrell, “Globalization and Innovation
4. Frederic S. Mishkin, “Is Financial Globali- in Emerging Markets,” NBER Working Paper no.
zation Beneficial?” Journal of Money, Credit and 14481 (November 2008).
Banking 39, no. 2–3 (March–April 2007): 259–94.
16. Vanessa Strauss-Kahn, “The Role of Globali-
5. Robert J. Samuelson, The Great Inflation and Its zation in the Within-Industry Shift Away from

Unskilled Workers in France,” in Challenges to 28. Jill Constantine and David Neumark, “Train-
Globalization, ed. R. Baldwin and A. Winters (Uni- ing and the Growth of Wage Inequality,” Industrial
versity of Chicago Press 2004): 209–33. Relations (1996):491–510.

17. Beaudry and Collard, pp. 879–909. 29. Daron Acemoglu and Steve Pischke, “Beyond
Becker: Training in Imperfect Labor Markets,”
18. Robert C. Feenstra and Gordon H. Hanson, Economic Journal Features 109 (February 1999):
“Globalization, Outsourcing, and Wage Inequal- F112–F142.
ity,” American Economic Review 86, no. 2 (May
1996): 240–45. 30. John S. Levin, “Public Policy, Community Col-
leges, and the Path to Globalization,” Higher
19. Peter H. Lindert and Jeffrey G. Williamson, Education 42, no. 2 (September 2001): 237–62.
“Does Globalization Make the World More Un-
equal?” in Globalization in Historical Perspective, ed. 31. Note that income effects of wage subsidies
Michael D. Bordo, Alan M. Taylor, and Jeffrey G. generally discourage work effort at higher wage
Williamson (Chicago: University of Chicago Press levels.
for the NBER, 2003): 227–70.
32. James J. Heckman, Lance Lochner, and Ricardo
20. Kenneth Scheve and Matthew J. Slaughter, Cossa, “Learning-by-Doing vs. On-the-Job Train-
“Economic Insecurity and the Globalization of ing: Using Variation Induced by the EITC to
Production,” American Journal of Political Science 48, Distinguish between Models of Skill Formation,”
no. 4 (October 2004): 662–74. NBER Working Paper 9083 (July 2002). The study
cautions that the average effect of a wage subsidy
21. Edmund S. Phelps, “Raising the Employment on work and skill acquisition responses could
and Pay of the Working Poor: Low-Wage Employ- mask considerable heterogeneity across worker
ment Subsidies Versus the Welfare State,” AEA groups. However, low-wage workers would general-
Papers and Proceedings 84, no. 2 (May 1994): 54–58. ly work more and thereby acquire skills.

22. Daniel Chiquiar and Gordon H. Hanson, “In- 33. Jeffrey S. DeSimone, Mark Holmes, and Nick
ternational Migration, Self-Selection, and the Rupp, “Does School Choice Improve School
Distribution of Wages: Evidence from Mexico Quality? Evidence from North Carolina Charter
and the United States,” Journal of Political Economy Schools, chap. 6 in Improving School Accountability:
11, no. 3 (April 2005): 239–41. Check•Ups or Choice, ed. Timothy J. Gronberg and
Dennis W. Jansen (Rockville, MD: Elsevier, 2006),
23. For example, Gianmarco I. P. Ottaviano and pp. 131–55.
Giovanni Peri, “Rethinking the Effects of Immigra-
tion on Wages,” NBER Working Paper no. 12497 34. David Neumark and Mary Joyce, “Evaluating
(August 2006); and Francesco D’Amuri, Gianmarco School-to-Work Programs using the new NLSY,”
I. P. Ottaviano, and Giovanni Peri, “The Labor Mar- NBER Working Paper no. 7719 (May 2000).
ket Impact of Immigration in Western Germany in
the 1990s,” NBER Working Paper no. 13851 35. David Neumark, “Alternative Labor Market
(March 2008). Policies to Increase Economic Self-Sufficiency:
Mandating Higher Wages, Subsidizing Employ-
24. Hans-Werner Sinn, “Migrations and Social ment, and Raising Productivity,” NBER Working
Replacement Incomes: How to Protect Low- Paper no. 14807 (March 2009).
Income Workers in the Industrialized Countries
against the Forces of Globalization and Market 36. Ibid.; and Stuart Landon, “High School Enroll-
Integration,” International Tax and Public Finance ment, Minimum Wages and Education Spend-
12 (2005): 375–93. ing,” Canadian Public Policy 23, no. 2 (June 1997):
25. Randy et al., “A Profile of the Low-Wage Im-
migrant Workforce,” Immigrant Families and 37. Dhaval M. Dave, Nancy E. Reichman, and
Workers Brief no. 4 (November 2003). Hope Corman, “Effects of Welfare Reform on Ed-
ucational Acquisition of Young Adult Women,”
26. Anne Herm, “Recent Migration Trends: Citi- NBER Working Paper no. 14466 (November
zens of EU-27 Member States Become Ever More 2008).
Mobile while EU Remains Attractive to Non-EU
Citizens,” European Commission: Eurostat, No- 38. Michael D. Bordo and Marc Flandreau, “Core,
vember 18, 2008. Periphery, Exchange Rate Regimes, and Globaliz-
ation,” NBER Working Paper no. 8584 (November
27. Phelps, pp. 54–58. 2001).

39. Jagdish Bhagwati, “The Capital Myth: The Dif- nent of retiree incomes, helping to maintain
ference between Trade in Widgets and Dollars,” retiree living standards. Usually, capital income is
Foreign Affairs 77, no. 3 (May–June 1998): 7. not considered when calculating the generosity of
social insurance programs by measuring items
40. M. Ayhan Kose et al., “Financial Globalization: such as the rate at which benefits replace pre-
A Reappraisal,” International Monetary Fund retirement labor earnings.
Staff Papers (April 2009).
51. “Paying for the Grey: The 2009 Aging Report,”
41. Alon Binyamini and Assaf Razin, “Inflation- European Economy (July 2008); and “Public Fi-
Output Tradeoff as an Equilibrium Outcome of nances in EMU,” European Economy (April 2008),
Globalization,” Israel Economic Review (December both from the directorate general for economic
2008); Frederic S. Mishkin, “Globalization, Macro- and financial affairs.
economic Performance, and Monetary Policy,”
Journal of Money, Credit and Banking Suppl. no. 41, 52. Prospective population growth is set to 0.3
no. 1 (February 2009): 187–96. percent per year (including current immigration).
However, the worker population is assumed to
42. Fernando A. Broner and Jaume Ventura, grow at negative 0.1 percent per year, whereas the
“Globalization and Risk Sharing,” NBER Working population of retirees, initially set at just 25 per-
Paper no. 12482 (August 2006). cent of the working population, grows at 1.6 per-
cent per year. These growth rates deliver an old-
43. Juan Carlos Hallak and Jim Levinsohn, age dependency ratio of 0.50 by 2050. The growth
“Fooling Ourselves: Evaluating the Globalization rate of the capital stock is set to 0.7 percent per
and Growth Debate,” in The Future of Globalization: year; capital’s share in output is set to be 35 per-
Explorations in Light of Recent Turbulence, ed. E. cent; total-factor productivity growth is set to 1.1
Zedillo (London and New York: Routledge, 2008). percent per year; and it is assumed that 75 percent
of capital is owned by the country’s retirees, the
44. Peter L. Rousseau and Richard Sylla, “Financial rest being owned by domestic workers and for-
Systems, Economic Growth, and Globalization,” eigners. Capital returns help to sustain retiree liv-
in Globalization in Historical Perspective, ed. M. ing standards, although with a growing number
Bordo, A. Taylor, and J. Williamson (Chicago: Uni- of retirees, the amount of capital per retiree would
versity of Chicago Press 2003), pp. 373–413. also decline under a fixed growth rate of the capi-
tal stock. The Social Security payroll tax rate is
45. Michael Bordo, Barry Eichengreen, and Doug- assumed to be 15 percent in 2010—calibrated
las A. Irwin, “Is Globalization Today Really Differ- according to the share of social contributions in
ent than Globalization a Hundred Years Ago?” GDP averaged over 27 EU countries.
Wirtschafts Politische Blätter 2 (2000): 121–29.
53. The medium-term increase in the payroll tax
46. Mishkin, “Globalization, Macroeconomic rate and decline in retiree living standards occurs
Performance, and Monetary Policy,” pp. 187–96. because the worker-to-beneficiary ratio continues
to decline for a few years after 2010 despite faster
47. Martin and Rey, pp. 1631–51. immigration. It takes more than three decades for
additional immigration and the associated
48. Joshua Aizenman and Yothin Jinjarak, “Glob- increase in the returns to capital to become sig-
alization and Developing Countries: A Shrinking nificant enough to fully offset the effects of a
Tax Base?” Journal of Development Studies 45, no. 5 declining worker-to-beneficiary ratio on retiree
(2009): 653–71. living standards.
49. The total dependency ratio, which includes 54. Ravi Jagannathan, Mudit Kapoor and Ernst
children and retirees as dependents, will increase Schaumburg, “Why Are We in a Recession? The
from 49 percent in 2008 to 75 percent by 2050 in Financial Crisis Is the Symptom not the Disease!”
the 27 European Union countries. NBER Working Paper no. 15404 (October 2009).
50. Note that this estimation is qualitatively dif- 55. Indeed, historical evidence in the area of labor
ferent than typical intergenerational transfer cal- regulations shows that although domestic pres-
culations, which assume that retiree living stan- sures gave rise to a latent appeal for labor regula-
dards will be maintained at the same level as those tions, nations acquiesced to these demands only
of retirees in 2010. The normal exercise is to inves- when their major trading partners had previously
tigate the implications of allowing retiree living passed comparable pieces of legislation. The out-
standards to grow with average economywide come was a level playing field in labor laws across
wages. It is different in yet another way: returns to trading partners. Such evidence of robust comple-
capital owned by retirees is an important compo- mentarities between trade and regulation stands in

opposition to the frequent claim, espoused in the erty at home for the sake of power abroad. See
late 19th century and echoed in the current wave of Niall Ferguson, Empire (New York: Basic Books,
globalization, that competitive forces drive labor 2002).
standards down in a race to the bottom. A similar
development may be feasible in other sectors as 57. Jeffrey Garten, “We Must Get Ready for a
well, driven by the need to expand access resources Weak Dollar World,” Financial Times, November
and markets located abroad. See Michael 30, 2009, p. 11.
Huberman and Christopher M. Meissner, “Riding
the Wave of Trade: Explaining the Rise of Labor 58. This point was also made by Deepak Lal in a
Regulation in the Golden Age of Globalization,” speech at the Metropolitan Club, Washington
NBER Working Paper no. 15374 (September 2009). DC, December 14, 2009.

56. The qualification is motivated by the ongoing 59. (G-20) “Leaders’ Statement: The Pittsburgh
debate among political economists about the Summit ” September 24–25, 2009.
nature of the United States as an imperialist pow-
er in seeking the glories of “empire.” Many 60. Dani Rodrik, “Feasible Globalizations,” in
American commentators on the left and the right Globalization: What’s New? Ed. M. Weinstein (New
argue against the United States pursuing goals York: Columbia University Press, 2005).
similar to those of Great Britain during the 19th
and early 20th centuries—to avoid sacrificing lib- 61. Jagannathan, Kapoor, and Schaumburg.


658. The Libertarian Vote in the Age of Obama by David Kirby and David Boaz
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657. The Massachusetts Health Plan: Much Pain, Little Gain by Aaron Yelowitz
and Michael F. Cannon (January 20, 2010)

656. Obama’s Prescription for Low-Wage Workers High Implicit Taxes, Higher
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655. Three Decades of Politics and Failed Policies at HUD by Tad DeHaven
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654. Bending the Productivity Curve: Why America Leads the World in Medical
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653. The Myth of the Compact City: Why Compact Development Is Not the Way
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652. Attack of the Utility Monsters: The New Threats to Free Speech by Jason
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651. Fairness 2.0: Media Content Regulation in the 21st Century by Robert
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650. Yes, Mr President: A Free Market Can Fix Health Care by Michael F.
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649. Somalia, Redux: A More Hands-Off Approach by David Axe (October 12,

648. Would a Stricter Fed Policy and Financial Regulation Have Averted the
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647. Why Sustainability Standards for Biofuel Production Make Little

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646. How Urban Planners Caused the Housing Bubble by Randal O’Toole
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645. Vallejo Con Dios: Why Public Sector Unionism Is a Bad Deal for
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643. Halfway to Where? Answering the Key Questions of Health Care Reform
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640. Thinking Clearly about Economic Inequality by Will Wilkinson (July 14,

639. Broadcast Localism and the Lessons of the Fairness Doctrine by John
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638. Obamacare to Come: Seven Bad Ideas for Health Care Reform
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636. Pakistan and the Future of U.S. Policy by Malou Innocent (April 13, 2009)
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633. Health-Status Insurance: How Markets Can Provide Health Security

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