Globalisation and Economic Sovereignty

Paper to the Wayne University Law School, October 21, 2004. (Revised)

Keywords: Globalisation & Trade;

The Economist’s Meaning of Globalisation

Globalisation (or globalization) is much discussed today, although popular sentiment is, by the standards of scholarly discourse, opinionated, uniformed, and confused. The growing consensus among economic scholars may be summarised as follows:

First, economic globalisation is defined as “the closer integration of national economies”, to which I would add “and regions” because internal integration is so similar to, but preceded, international integration. For instance, it is helpful to think of as the economic integration of the regions of the United States in the nineteenth century as a form of globalisation.

There is an ambiguity in the scholars’ definition. ‘Globalisation’ may refer to the process of globalisation, or it may refer to the degree of globalisation. The distinction can be important, especially when different time periods are compared. In the first half of the twentieth century the process of globalisation was quiescent or even reversed, but there was still a considerable degree of globalisation, that is interdependencies between economies. And if at the time the process was zero or negative, the level of globalisation was still higher than what it had been at the beginning in the first half of the nineteenth (when the process was more vigorous). Moreover, the interdependencies are multi-dimensional, so we see today far greater integration of trade and capital markets than labour markets.

Second, in contrast to the popular discourse, economic scholarship does not see globalisation as a recent phenomenon. A few argue that the process starts as early as the first European explorations in the fifteenth century, but the consensus is that globalisation begins in the early nineteenth century (say 1820). The process of economic globalisation was virtually non-existent in the first half of the twentieth century although, as mentioned, the degree of globalisation was somewhat higher than in the first half of the eighteenth century. There is debate whether the stagnation began in 1914 or up to thirty years earlier, but a general acceptance that it came to an end, and a new phase of globalisation began, shortly after the Second World War, say in 1950.

This pattern is illustrated by that all international trade was 1.0 percent of World GDP rising to 9.0 percent in 1929, but falling to 5.5 percent in 1950. In 1998 it was 17.2 percent, and is no doubt higher today. Other indicators – say of capital and labour flows – have the same general pattern but the timing of the turnarounds differ.

Third – and this is less explicit in the literature – globalisation is a consequence of the falling costs of distance. This is no surprise: national integration occurs when the connections between regions improve; trade based on comparative advantage is going to be negligible when the costs of transporting the goods are high.

There are two important implication here. As long as the costs of distance continue to fall, the process of globalisation will continue and the degree of globalisation increase. Indeed this will continue for a period after costs no longer fall, as it takes time to adjust to the opportunities they present. The implication is that not only will globalisation continue, but there is a sense that it is irresistible as long as it is driven by falling costs of distance. The policy issue is how to respond to the closer integration of nations, not how to prevent it. Despite Marx’s last thesis of Feuerbach we need first to understand it.

As an economist I am involved in the adapting of economic models to better understand the process. In my view many of the necessary formal models already exist, but they have to be applied differently. There is a tendency among economists to ignore the spatial: economies are treated as columns in a tabulation rather than places on a map. Yet globalisation is essentially about the changes to the spacial allocation of economic activity (and its related growth). There is a sense that the economic scholarship on globalisation will integrate space into economic theory more fundamentally than has occurred in the past.

This raises is the nature of the international economic units which economists study, and hence the dividing lines between the units. Most often in the study of globalisation the lines are geographical of boundaries, but as economists Alberto Alesina and Enrico Spoloare remind us in their The Size of Nations, while in the short term the boundaries may be treated as permanent, over the two hundred years of globalisation they are surprisingly fluid. Few boundaries that existed in 1820, other than those determined by sea are still boundaries today.

Even many of the boundaries of 60 years ago have been changed, and in today’s world there are a number of boundaries – or putative boundaries – across which there are, or have been recently (or there is the potentiality of) sites of significant conflicts: Chechnya; Cyprus; Israel-Palestine; Sri Lanka; Tibet; Timor; Ulster. (The troubles in Iraq are compounded by its geographical boundaries were imposed on a diversity of peoples after the First World War.) Less conflictually, but instructively, the development of the European Union has the effect of changing the significance of the internal boundaries of Europe.

The Meaning of Jurisdictional Boundaries

The European Union example leads to the second implication of the reducing costs of distance, and the resulting trade and factor mobility. The jurisdictional meaning of boundaries is changing, even where the there is no geographical dispute. A starting point for the discussion might be the Treaty of Westphalia of 1648 and the world order that evolved from it.

At the core of its governance system was the principles of the state and sovereignty. Statehood involved dividing the world into territorial parcels each of which was ruled by a separate government. The state was sovereign, by which was meant that it exercised comprehensive, supreme, unqualified, and exclusive control over its territory. ‘Comprehensive’ meant that the state had jurisdiction over all the affairs in the country; ‘Supreme’ meant that it recognised no superior authority; ‘Unqualified’ meant that its right to total authority over its territory was treated as sacrosanct by other states; ‘Exclusive’ ruled out joint sovereignty.

Of course the Westphalian order is a historical phenomenon, and it is not hard to see how these principles, including the implicit notion that territories were eternal, have been breeched over the years. However the economist’s concern is, I think, more fundamental. In the modern world economy it may not be practical to exercise sovereignty in the way that was envisaged 350 years ago, for that was a world in which there was little international – between sovereign state – trade. Earlier I mentioned that as late as 1820 only one percent of the world’s output was traded, while today it is nearer 20 percent. Moreover, most of that trade was what an economist calls ‘absolute advantage’, the product could not be easily produced in the country in which it was consumed. Today comparative advantage trade (importing products that could be produced locally) and competitive advantage trade (exporting products very similar to that which are imported) are more important than absolute advantage trade.

To be provocative I sometimes compare international trade to a marriage where one gives up some autonomy in exchange other benefits. Similarly the benefits from international trade are such that a country gives up some sovereignty. Now of course there is the option of one night stands, although instructively most adults want something more permanent in their lives, and today most trading relationships tend to be based more on an ongoing rather than one-off basis. There may serial monogamy.

Where the parallel with marriage breaks down is that trade is multilateral. Most countries have substantial ongoing trading relationships with a number of partners – smaller economies sometimes seems to be in a harem.. This is even more compromising to sovereignty.

The Institutional Underpinning of Economic Activity

Efficient economic activity requires a set of institutional underpinnings. Typically in a modern state that includes laws which cover a multitude of facets of economic transactions, and the legal institutions to enforce them.

These particular underpinnings were not always there. Personal knowledge of the customer backed by custom and tradition were usually sufficient when trade occurred in a locality. With the falling cost of distance, the geographic range of trade increased, increasingly involving people who did not know one another well or at all. Trust-based institutions could no longer relied upon and it became necessary to impose a law-based underpinning. Moreover, as the costs of distance fell, the central government’s practical reach increased. It is no accident that the end of the nineteenth century saw the evolution of nation-states with increasing ranges of effective economic and commercial intervention across the territory.

The details of the development of the nation-state need not concern us here, but the extending of regulatory power within territories a century or so ago, is parallelled today by a similar worldwide extension, for that is what such institutions as the IMF and the WTO are about. Before looking at such multilateral arrangements it is worth considering the first step of bilateral equivalents, that is between two nations.

Just as there a gains from having a common regulatory framework within a nation there may be gains from aligning the frameworks between trading states. For instance, in the early 1970s New Zealand converted from imperial to metric measures – at some resource expense and discomfort to the public who had to learn a new system – because it would facilitate international trade. There is a potential problem here. Suppose New Zealand were to trade with only two nations which used different measurement conventions. What would New Zealand do?

As it happens, 80 percent of New Zealand’s exports go to country’s that use the metric system, so the answer was simple, once the acknowledgement of the importance of exports to New Zealand – about a third of output is exported. Larger countries have greater choice. The United States retains its own measurement system. Even so, one suspects most of its exports are metric, even if it imports are in American standard measures.

Notice how a problem which began as a bilateral issue – what measurement system should two countries between them use? – became multilateral – what should be the measurement system for the world? It is this point that the marriage analogy breaks down: international economic intercourse is promiscuous.

The multilateral agreements create a rule of law in international commerce, with benefits similar to national commerce from national rule of law. The advantages of a multilateral rule of law over a plethora of bilateral arrangements need hardly be listed. However the benefits of a settlement between two nations in dispute providing guidance to the remaining hundred plus nations should not go unmentioned.

Dejure and Defacto Sovereignty

Even so, multilateralism generates problems for a small country. Consider the aborted Multilateral Agreement on Investment (MAI). The logic was that cross-border investment would benefit from a set of rules, so that foreign investors would know exactly what was expected of them, if they were to invest in any country. Currently this is carried out on a country by country basis which must be exhausting and confusing for the multi-country investor. Why not have a common set of rules? Hence the proposed MAI.

The illustration I am using is hypothetical because the MAI proved unacceptable. In part it had been conceived by nations from the OECD, typically the net investors, who attempted to impose on the world an agreement designed for investor needs without consulting the net debtors. As it happens, the debtor countries dissented and the OECD discovered there was not quite the internal consensus they had assumed. (There were also some problems with the scope of the agreement to which I turn shortly.)

The point I want to make here, is that had some sort of MAI been agreed to by sufficient countries, New Zealand would have been in an invidious position, since almost certainly some provisions could have been unacceptable to it. Should it have assented to such an agreement or should it have rejected it?

A major factor in the public policy debate – but probably not in the public debate, because it may have been too complex and subtle – would have been how to evaluate the benefits of being in a bad agreement against the detriments of not being in it. To progress the illustration I shall accept the public policy framework that international investment is a good thing – although some of those who rejected the MAI do not think so.

The policy framework faces the following unpalatable choice. If New Zealand had stayed out of the MAI (despite just about everyone else agreeing to it) investors would observe that they were not as well covered by New Zealand (or that New Zealand’s parallel provisions were less well understood) and hence were less likely to invest in New Zealand (than they would if there was no MAI). On the other hand if New Zealand acceded to the MAI it would get the foreign investment, but it would also be subject to the downsides of the agreement.

This has all been hypothetical, although the general problem occurs in regard to many other international economic agreements and New Zealand has had to make difficult judgements, even when there are intermediate options such as agreeing to only some provisions, or agreeing with reservations.

But the illustration is enough to make the point that while New Zealand was exercising the de jure sovereignty set out in the Treaty of Westphalia, in fact it had much less choice. It is not just that using its supreme sovereignty New Zealand has agreed to international treaties – economic ones but also others: human rights ones for instance – which limit the supremacy of New Zealand government since supra-national laws and other institutions may over-rule it. In some cases New Zealand felt it had little option but to agree to an international treaty because it thought it better to be in the tent than out. But sometimes it may have preferred there was no treaty or a totally different one.

A case which is facing New Zealand at the moment may be the recently concluded free trade agreement between Australia and the US. (AUSFTA) Australia is New Zealand’s single largest export destination taking around 20 percent of total exports, although for some businesses and industries it is a far more important market. The investment links between the two countries are also substantial. All this is encapsulated in the ‘Closer Economic Relations’ (CER) agreement, which is an ongoing commitment to improve the integration between the two economies.

Inevitably, New Zealand will suffer as a result of AUSFTA because of the standard trade and investment diversion effects that limited free trade agreements generate. In the future, Americans are more likely to source from Australia than New Zealand than they did in the past, and they are also more likely to invest in Australia.

As a consequence, and in some quarters reluctantly, New Zealand sees itself having to negotiate a parallel free trade agreement with the US, to offset the diversion effects of AUSFTA. The reluctance arises because for various reasons a partial free trade agreement may not in itself be beneficial to New Zealand. (One IMF study concluded that an earlier version of AUSFTA may not be beneficial to Australia. There is nothing in economics which says free trade agreements are necessarily beneficial to those involved.)

Thus a small country like New Zealand finds itself in a world where its de facto sovereignty is compromised. It would be possible to revoke New Zealand’s agreement to the treaties it has signed – even those which have no such provision – and in that sense it retains de jure sovereignty. But thus far it has not, and is unlikely to do so, particularly since the revocation of one agreement – except on carefully argued and specifically relevant grounds – would undermine the international community’s trust in the country.

Now one might sat this limiting of de facto sovereignty on economic matters is an inevitable consequence of being small. So let me give an illustration from the largest economy in the world. When it is faced with a challenge under the rules established by the World Trade Organisation, the United States has a policy of vigorously taking a matter to the highest court in the disputes process and then accepting the final decision.

For instance in 1999 the US placed a tariff of at least 9 percent and up to 40 percent on New Zealand’s lamb exports despite an earlier agreement that the tariff was bound to (could not be higher than) only a few cents per kilo. The surcharge was entirely for domestic political purposes, but it may have cost New Zealand farmers up to $NZ45m over three years. New Zealand’s redress was to follow World Trade Organisation procedures. At each stage the WTO found in its favour. Having lost in the final court, the US, having stated it was bound by international trading rules, reduced the tariffs to the bound levels.

This case is not unique but rather reflects a fundamental strategy of the US. In effect it accepts there is a higher decision-making authority than the US. Why does it do so? In fact the US loses some, and it wins some,. (Its score recently was 23 wins and 23 losses.) So while some of its economic interests directly suffer, others directly benefit. But in a wider context, all benefit because they operate their international trading relationships under a rule of law.

The situation is all the more intriguing, because the US does not subject itself to the same discipline in all its non-economic affairs. The most recent spectacular example is that it invaded Iraq without the equivalent of the multilateral agreement which underpins economic relations.

An international rule of economic law makes sense for those economies involved in international trade. Of course the establishment of the regulations tends to favour the powerful. Among the dissenters against the Doha outcomes were those who thought it did not give poor countries enough., but it was designed for the interests of the rich countries.

The cynic might say, she is not surprised – and note that most poor countries will, nevertheless, be made (only slightly?) better off by the implementation of the round. She will recall the parallel in the history of the domestic development of the rule of law. The powerful made laws to suit their own interests but over time the laws came to be extended to suit a wider group of people. (A nice example is that language fossil of ‘judged by one’s peers’. When the barons wrote that principle into the Magna Carta they did not have in mind that it would apply to their serfs – they meant literally that peers of the realm should be judged by peers of the realm and not by the king.)

The Rule of Law Across Boundaries

Even so there is an issue of what should the rule of international economic law cover. We have seen it reduces some sovereignty, but just how much sovereignty should it reduce? A partial answer has a good concept with an ugly name. ‘Subsidiarity’ is the principle that decisions should always be taken at the lowest practical level in the hierarchy. It is now a central principle of the European Union, so that Brussels may not make decisions which can be left to the individual member states, just as the German Federal Republic devolves political power to its constituent Lander (states).

Subsidiarity has a crucial role in the proliferating international agreements of the globalising world, maintaining that multilateral agreements should only cover that which is absolutely necessary, so maximizing national autonomy. The principle is not explicitly a part of the international negotiations, but it is there implicitly.

Unfortunately the application of the principle is vague. Is not leaving a local industry to supply the domestic market an example of subsidiarity? Were it applied, the entire system of world trade would fall apart.

An alternative approach might be define a principle as to those economic decisions which may be left to the nation-state. One possibility might be that international economic rules only apply to commercial transactions – that is voluntary market decisions. But where there is a non-market element than the state can be left to regulate them independently of international law. I shall give a couple of examples shortly, but the principle rests upon the notion that non-market regulation involves intervention by the state, fundamentally different from that provide by the rule of law which underpins commercial transactions.

Unfortunately there is some disagreement as to the line between commercial and non-commercial economic activity, not only along an ideological spectrum but between countries. This was evident in the MAI negotiations. Rich countries intensively regulate their health service sectors on the basis that the conventional market regulation is insufficient given various peculiarities of health care. For many, most evidently Europeans, that regulation covers supply-side regulation, including modes of ownership of core health providers. Essentially their view is health care provision is a non-commercial activity, with some commercial elements. For others – the US is an extreme example – there is much less supply-side regulation, and more private ownership of providers. Conversely their philosophy is of commercial provision withe non-commercial elements. The MAI could not resolve whether private health providers – say American hospitals – must be allowed to compete where the regime is public provider dominated.

If health may be a very difficult area for a economists, the provision of culture is more so. Many rich countries restrict ownership of the broadcasting media, and also sometimes of film making. Opportunities for foreign investment were contentious in the MAI, again reflecting differences in philosophy between commercial and non-commercial provision.

Thus, while suggestive, both the subsidiarity principle and the non-commercial principle, seem deficient in determining the extent to which jurisdictional boundaries may be over-ruled.

Bondaries and Population movements

There is one principle, however, where the boundaries remain intact, although – and intriguingly – that was not so true in the first century of globalisation. Nation-states generally claim the sovereign right to determine who may cross their boundaries. Population mobility is greatly restricted compared to trade and capital mobility, and compared to the nineteenth century.

There are some exceptions. Temporary movements for travel, tourism and education are not exceptions, since countries retain the right to determine who may come. The WTO is discussing the question of movement of natural persons for commercial purposes. The likely outcome is some compromise which moderates, but does not undermine, sovereignty. The biggest exception is that in principle the European Union requires full population movement within its boundaries, although there can be some phasing in.

Now the EU differs from the US in that it is a consortium of nation-states, in which individuals hold national passports and other nation-state citizen entitlements, unlike the US where they are derived from the federal government. (There is a proposal for an EU passport, although initially in parallel with the individual country passports.) Again this is a larger topic than can be traversed here. For the purposes of this paper we note that the boundary between nation-states still has an economic role – perhaps a very important one, illustrated by labour mobility’s significance in the nineteenth century and its crucial role in the development of the US economy.

Even so, the jurisdictional boundary as conceived in the Westphalian system is no longer robust. Economically it is not totally porous, even if that appears the ultimate outcome for ordinary trade and capital flows. Whether there will be a systematisation of a post-Westphalian system, rather than an ad hoc evolution to a not entirely coherent system, is unclear, even if we confine the focus to economics and ignore the political, the military and civil rights.

What we may be sure is that insofar as globalisation is about diminishing costs of distance, the meaning of location is changing, and a superstructure of notions founded on its base are changing– perhaps out of recognition. A crucial part of the superstructure has been governance based on some notion of sovereignty of the nation-state.

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