Journal of Policy Modeling26 (2004) 513–517

Globalization and growth — looking inthe wrong places

Dani Rodrik∗

John F. Kennedy School of Government, Harvard University, Cambridge, MA 02318, USA

Available online 25 May 2004

Keywords: Gloablization; Growth; Institutional discontinuities; Labor mobility

1. Introduction

I am going to be mildly unresponsive to the original questions that were askedby Dominick, and were supposed to be talking about. In fact, now that I think ofit I am going to be unresponsive to my original title as well, but I don’t think thatis going to make me an outlier in this panel.

As Jagdish Bhagwati said, the notion of globalization has really become verymuch of a buzzword. But I think that as economists, when we think about glob-alization and talk about it, we have a fairly good idea of what it is that we aretalking about. Most of the time we are talking about unification of markets andconvergence in prices of goods, services, capital, and various assets, and that isthe right way to think about it.

Now, with that basic economic notion of globalization as background I wantto make three points, coming back at the end to some of the questions Dominickasked. The first point that I want to make is that today the most important bar-riers to globalization in the sense I just mentioned actually do not rise from thetraditional border type measures that we think of, such as government-imposedimport tariffs, quantitative restrictions, or restrictions on the flow of foreign capital.The most important barriers actually are what I call “institutional and jurisdictionaldiscontinuities.” That is, the underlying diversity of national institutionalarrangements is a much more significant source of transactions costs at the border

∗ Tel.: +1 617 495 8833; fax:+1 617 496 5747.E-mail address: dani rodrik@harvard.edu (D. Rodrik).

0161-8938/$ – see front matter © 2004 Society for Policy Modeling.doi:10.1016/j.jpolmod.2004.04.006

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today than the traditional trade restrictions. The only significant exception to thatrule is in the area of labor mobility, to which I will return later.

My second point is that a complete elimination of these institutional discontinu-ities and transaction costs that arise from institutional diversity is neither feasiblenor desirable, so that an agenda that tries to squeeze out the last drop of efficiencygains from convergence in prices is really an agenda that is neither feasible nordesirable.

On a more hopeful note, my third and last point is that even within the limitsof this, somewhat restricted notion of globalization, I think there are areas wherethe returns to the reform of the existing rules are actually quite large. However, weare actually not exploiting those margins where the bang for the buck is greatestand are stuck in areas where the returns are actually relatively low.

2. The most important barriers to globalization are institutionaldiscontinuities

The first point is really about the relative importance of policy barriers at theborder versus institutional transactions costs. Our best estimates right now of themagnitude of total trade costs among advanced countries suggest that these aresomething of the order of 40% in ad-valorem terms. This number is, of course,many times higher than the actual tariffs, and if you want to think about the latterto be of the order of 5%, we are talking about total costs that are a multiple of thetariff costs. The question, of course, is where do these other costs come from. Ithink they result from various transaction costs associated with institutional andjurisdictional discontinuities as one moves across national boundaries.

Some examples of these are the transaction costs that are imposed by differencesin the choice of national currencies, information and implementation costs that arecreated by differences in national product standards and other standards such asenvironmental standards, food safety standards, and the whole range of institutionaland standard choices. There are also contract enforcement problems associatedwith differences in legal institutions, which are a particularly severe barrier in thecase of international capital flows. The basic point is that such discontinuities andthe transactions costs that they create at the border are really a fundamental barrierto full globalization and price convergence, and that in many areas these are muchmore important than the traditional tariffs and nontariff barriers per se.

Now, the question is whether we have to live with these differences. I think theanswer is that there are good reasons for these discontinuities. This underlyinginstitutional diversity and different choices with regard to rules and regulations doserve a useful function. Let me just give very quickly three reasons why I thinkthese differences do exist. One is that institutional diversity is often grounded indifferences in social preferences, and that societies often chose a different pointalong the trade-off between, say, equity versus opportunity. This creates differencesin the selection of social welfare institutions, product market institutions, and so

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forth. Here there is a clear analogue with the literature on local public finance, wherewe understand that, since tastes for public goods differ in different communities,there is a trade-off between reaping the scale economies in the provision of publicgoods as against providing appropriately targeted benefits. So we say that it isnever going to be optimal to provide the same public good to everybody. The samerules and regulations will not necessarily be the right thing for all. There is thesame kind of trade off with regard to national institutions.

3. Elimination of institutional discontinuities is neither feasible nordesirable

The second set of reasons why I think we have these differences arise fromhistorical trajectories and the path dependence of institutions. Often, different partsof institutional clusters tend to be complementary and mutually supporting, andthat you can get locked in to peculiar institutional arrangements both for good andbad reasons. Particular types of institutional configurations, particular financialmarket arrangements call for a complementary set of labor market institutions,which in turn call for a particular set of corporate governance arrangements. Wecan see the results in the differences in the US versus Japanese versus Europeanmodels.

Third, and particularly close to my heart, is the fact that when countries are atvery different stages of development, their desirable institutional arrangements, Ithink, are going to be very, different. Think of China, for example. This is clearly acountry that has a very different set of institutional arrangements, and it is hard toargue that if it had adopted a shock-therapy-type transition immediately to moreAmerican-style institutions, its performance would have been much better. Thereis an old literature here going back at least to Gerschenkron about how catchingup might require institutional heterodoxy, and there is also a much more recentliterature that countries at different levels of economic development might needto have very different institutions in the areas of product markets, labor markets,financial markets, public finance, and so forth.

So there are a number of reasons — both positive and normative — as towhy these institutional discontinuities exist, and just as in the local public financearea, the effort to try to squeeze out the last bit of efficiency gains by trying toeliminate or harmonize these institutional differences represents a doubtful agenda.It is a misleading way of thinking about how we make progress, and yet theWTO’s negotiating agenda is increasingly concerned with harmonizing away theseinstitutional differences.

4. There are still areas of large unexploited gains

But as I said, and I am coming to my third and final point, even within a limited,more shallow type of globalization, I would claim there are still a lot of areas of

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unexploited gains. If you were to ask where is the biggest bang for the liberalizationbuck in terms of efficiency and poverty reduction in the world today, I think it isclearly not in the areas which dominate the discussions in the Doha Round or thediscussions in the international financial architecture. There are limited furthergains in the areas where a lot of the discussion has focused, such as in agriculturalliberalization.

Where the real big gains are is where the biggest border restrictions exist, andthat is in the area of labor mobility. It is relatively easy to see this because the pricewedges and the restrictions are so binding in the area of labor mobility that evena relatively small relaxation of restrictions on labor mobility would produce hugegains. That just follows simply from the well-known principle that the efficiencycost of any price wedge rises with the square of that wedge. When we are talkingabout goods and services at most we are talking about differences of one to twoin prices across countries. In the case of similarly qualified labor we are reallytalking of differences in the order of 1–5 or even 1–10 in some cases. So weknow that the margin that is going to pay off tremendously is the margin of labormobility.

What I am suggesting of course is not the complete elimination of barriers tolabor mobility, because this would contradict my earlier arguments. What I wantto say is that even a small scheme of labor mobility that would increase laborflows to the advanced industrial countries in the amount of 2%–3% of their totallabor force would provide overall gains to workers from developing countries thatare larger than all the Doha proposals together. The plan, however, would haveto be temporary because you also have to worry about what happens to the homecountries. You want to think about arrangements that would in a way circulateworkers and having incentives (both carrots and sticks) in the home and hostcountries that achieve a relatively high rate of return.

We can expand the range of examples of areas that we are not working onwhere the gains are actually much bigger than in the current agenda. For shortageof time I’ll give one very quick example, which is an agreement that would bancompetitive subsidization of foreign investment in the developing world. This isan obvious area where there are huge gains to be had. Currently, the large amountof subsidization by poor country tax payers of rich country shareholders is reallya big embarrassment, yet when people talk about investment agreements this isnot what is on the agenda. The point I am making is that the current agenda onglobalization is, in many ways, highly skewed and does not really focus on wherethe big gains are.

Just to conclude, my larger point is that we often think of globalization as thissimple, single thing. But in that pure form, with full unification of markets andcomplete price convergence, globalization is really quite unfeasible. Any practicalversion of it requires making decisions about the rules, and what parts of therules and agenda we want to push on. That is why when we are asked aboutglobalization, the right answer is the one that Mahatma Gandhi once gave whenon a visit to England he was asked by a British journalist what he thought about

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Western Civilization. Gandhi reflected a while, and said, “that would be a goodidea.” I think a well designed globalization would indeed be a splendid idea.

5. Response to Barro’s and Bhagwati’s comments

Just, very briefly, I want to make three points. One, Robert Barro said he didnot understand what the relationship is between institutional differences and dis-continuities, on the one hand, and trade liberalization, on the other. I think therelationship is that the trade liberalization agenda today actually has become theelimination of these institutional differences. That is what the WTO disputes andtrade negotiations are increasingly about. It is about the extent to which foodsafety rules or environmental regulations and other regulations are impinging ontrade, and which should have priority. This is increasingly what trade negotiatorsin various rounds are talking about. It is about harmonizing institutional rules; aclear example of that in the Uruguay Round was the TRIPS agreement, which setminimum patent lengths around the world.

With respect to labor migration, I am here very much with Jagdish Bhagwati.There is really nothing that suggests that we cannot be creative enough in solvingany possible adverse consequences of a relatively small relaxation of temporarymobility restrictions. It would be a tragedy if, just as labor unions are beginningto look at this area more warmly, conservative and libertarian economists were toraise concerns on “social” or “political” grounds. After all, this is one area wheregains from trade are still extremely high.

Finally, I think that the underlying political stress in the advanced countriesas this process goes on is a real issue. I think we underestimate the extent towhich in the earlier period of openness, the Bretton Woods era, the extensive setof social protections prevailing in different countries was the flip-side of the openeconomy. The Europeans had their welfare state; the Japanese had their productmarket regulations, recession cartels, and lifetime employment; and the US waslargely a closed economy. The relationship between the risks and vulnerabilitiescreated by openness and the demand for social protection is one that requires closeattention and political management. This issue has somehow receded from ourconsciousness. The challenge is how you combine the two at a time when there isalso considerable tax competition, and social protection schemes cannot really bepaid for through fiscal transfers. That is a really serious problem.