Will
the nation-state survive
globalization?
Foreign Affairs;
New York; Jan/Feb 2001; Martin Wolf;
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80 |
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Issue: |
1 |
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Start Page: |
178-190 |
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ISSN: |
00157120 |
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Subject Terms: |
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Classification Codes: |
9180: International |
Abstract:
The modern form of
globalization will not spell the end of the modern nation-state. Today's growing integration of the world
economy is not unprecedented. Similar trends occurred in the late nineteenth
century. The proposition that globalization makes states
unnecessary is even less credible than the idea that it makes states impotent. If anything, the exact opposite
is true, for at least 3 reasons: 1.The ability of a society to take advantage
of the opportunities offered by international economic integration depends on
the quality of public goods. 2. The state
normally defines identity. 3. International governance rests on the ability of
individual states to provide and
guarantee stability.
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Copyright
Council on Foreign Relations Jan/Feb 2001 |
DEFINING GLOBALIZATION
A SPECTER is haunting the world's governments-the specter of globalization.
Some argue that predatory market forces make it impossible for benevolent
governments to shield their populations from the beasts of prey that lurk
beyond their borders. Others counter that benign market forces actually prevent
predatory governments from fleecing their citizens. Although the two sides see
different villains, they draw one common conclusion: omnipotent markets mean
impotent politicians. Indeed, this formula has become one of the cliches of our
age. But is it true that governments have become weaker and less relevant than
ever before? And does globalization, by definition, have to be the nemesis of
national government?
Globalization is a journey. But it is a journey toward an unreachable
destination-"the globalized world." A "globalized" economy
could be defined as one in which neither distance nor national borders impede
economic transactions. This would be a world where the costs of transport and
communications were zero and the barriers created by differing national
jurisdictions had vanished. Needless to say, we do not live in anything even
close to such a world. And since many of the things we transport (including
ourselves) are physical, we never will.
This globalizing journey is not a new one. Over the past five centuries,
technological change has progressively reduced the barriers to international integration.
Transatlantic communication, for example, has evolved from sail power to steam,
to the telegraph, the telephone, commercial aircraft, and now to the Internet.
Yet states have become neither weaker nor less important during this odyssey.
On the contrary, in the countries with the most advanced and internationally
integrated economies, governments' ability to tax and redistribute incomes,
regulate the economy, and monitor the activity of their citizens has increased
beyond all recognition. This has been especially true over the past century.
The question that remains, however, is whether today's form of globalization
is likely to have a different impact from that of the past. Indeed, it may
well, for numerous factors distinguish today's globalizing journey from past
ones and could produce a different outcome. These distinctions include more
rapid communications, market liberalization, and global integration of the
production of goods and services. Yet contrary to one common assumption, the
modern form of globalization will not spell the end of the modern nation-state.
THE PAST AS PROLOGUE
TODAY'S GROWING INTEGRATION of the world economy is not unprecedented, at
least when judged by the flow of goods, capital, and people. Similar trends
occurred in the late nineteenth and early twentieth centuries.
First, the proportion of world production that is traded on global markets
is not that much higher today than it was in the years leading up to World War
I. Commerce was comparably significant in 1910, when ratios of trade
(merchandise exports plus imports) to GDP hit record highs in several of the
advanced economies. Global commerce then collapsed during the Great Depression
and World War II, but since then world trade has grown more rapidly than output.
The share of global production traded worldwide grew from about 7 percent in
1950 to more than 20 percent by the mid-1990s; in consequence, trade ratios
have risen in almost all of the advanced economies. In the United Kingdom, for
example, exports and imports added up to 57 percent of GDP in 1995 compared to
44 percent in 1910; for France the 1995 proportion was 43 percent against 35
percent in 1910; and for Germany it was 46 percent against 38 percent in the
same years. But Japan's trade ratio was actually lower in 1995 than it had been
in 1910. In fact, among today's five biggest economies, the only one in which
trade has a remarkably greater weight in output than it had a century ago is
the United States, where the ratio has jumped from 11 percent in 191o to 24
percent in 1995. That fact may help explain why globalization is more
controversial for Americans than for people in many other countries.
Second, by the late nineteenth century many countries had already opened
their capital markets to international investments, before investments, too,
collapsed during the interwar period. As a share of GDP, British capital
investments abroad-averaging 4.6 percent of GDP between 1870 and 1913-hit
levels unparalleled in contemporary major economies. More revealing is that the
correlation between domestic investment and savings (a measure of the extent to
which savings remain within one country) was lower between 1880 and 1910 than
in any subsequent period.
Historical differences exist, however. Although current capital mobility has
precedents from the pre-World War I era, the composition of capital flows has
changed. Short-term capital today is much more mobile than ever before.
Moreover, long-term flows now are somewhat differently constituted than in the
earlier period. Investment in the early twentieth century took the form of
tangible assets rather than intangible ones. Portfolio flows predominated over
direct investment in the earlier period (that trend has been reversed since
World War II); within portfolios, stocks have increased in relative importance
to roughly equal bonds today. And finally, before 1914, direct investment was
undertaken largely by companies investing in mining and transportation, whereas
today multinational companies predominate, with a large proportion of their
investment in services.
Today's high immigration flows are also not unprecedented. According to
economists Paul Hirst and Grahame Thompson, the greatest era for recorded
voluntary mass migration was the century after 1815. Around 6o million people
left Europe for the Americas, Oceania, and South and East Africa. An estimated
ten million voluntarily migrated from Russia to Central Asia and Siberia. A
million went from Southern Europe to North America. About 12 million Chinese
and 6 million Japanese left their homelands and emigrated to eastern and
southern Asia. One and a half million left India for Southeast Asia and
Southwest Africa.
Population movement peaked during the 1890s. In those years, the United
States absorbed enough immigrants to increase the U.S. population from the
beginning of the decade by 9 percent. In Argentina, the increase in the 1890s
was 26 percent; in Australia, it was 17 percent. Europe provided much of the
supply: the United Kingdom gave up 5 percent of its initial population, Spain 6
percent, and Sweden 7 percent. In the 1990s, by contrast, the United States was
the only country in the world with a high immigration rate, attracting
newcomers primarily from the developing world rather than from Europe. These immigrants
increased the population by only 4 percent.
As all of this suggests, despite the many economic changes that have
occurred over the course of a century, neither the markets for goods and
services nor those for factors of production appear much more integrated today
than they were a century ago. They seem more integrated for trade, at least in
the high-income countries; no more integrated for capital--above all for
long-term capital-despite important changes in the composition of capital
flows; and much less integrated for labor.
So why do so many people believe that something unique is happening today?
The answer lies with the two forces driving contemporary economic change:
falling costs of transport and communications on the one hand, and liberalizing
economic policies on the other.
THE TECHNOLOGICAL REVOLUTION
ADVANCES in technology and infrastructure substantially and continuously
reduced the costs of transport and communications throughout the nineteenth and
early twentieth centuries. The first transatlantic telegraph cable was laid in
1866. By the turn of the century, the entire world was connected by telegraph,
and communication times fell from months to minutes. The cost of a three-minute
telephone call from New York to London in current prices dropped from about
$250 in 1930 to a few cents today. In more recent years, the number of voice
paths across the Atlantic has skyrocketed from loo,ooo in 1986 to more than 2
million today. The number of Internet hosts has risen from 5,000 in 1986 to
more than 30 million now.
A revolution has thus occurred in collecting and disseminating information,
one that has dramatically reduced the cost of moving physical objects. But
these massive improvements in communications, however important, simply continue
the trends begun with the first submarine cables laid in the last century.
Furthermore, distances still impose transport and communications costs that
continue to make geography matter in economic terms. Certain important services
still cannot be delivered from afar.
Diminishing costs of communications and transport were nevertheless pointing
toward greater integration throughout the last century. But if historical
experience demonstrates anything, it is that integration is not technologically
determined. If it were, integration would have gone smoothly forward over the
past two centuries. On the contrary, despite continued falls in the costs of
transport and communications in the first half of the twentieth century,
integration actually reversed course.
Policy, not technology, has determined the extent and pace of international
economic integration. If transport and communications innovations were moving
toward global economic integration throughout the last century and a half,
policy was not-and that made all the difference. For this reason, the growth in
the potential for economic integration has greatly outpaced the growth of
integration itself since the late nineteenth century. Globalization has much
further to run, if it is allowed to do so.
CHOOSING GLOBALIZATION
GLOBALIZATION is not destined, it is chosen. It is a choice made to enhance
a nation's economic well-being-indeed, experience suggests that the opening of
trade and of most capital flows enriches most citizens in the short run and
virtually all citizens in the long run. (Taxation on short-term capital inflows
to emerging market economies is desirable, however, particularly during a
transition to full financial integration.) But if integration is a deliberate
choice, rather than an ineluctable destiny, it cannot render states impotent.
Their potency lies in the choices they make.
Between 1846 and 1870, liberalization spread from the United Kingdom to the
rest of Europe. Protectionism, which had never waned in the United States,
returned to continental Europe after 1878 and reached its peak in the 1930s.
A new era of global economic integration began only in the postwar era, and
then only partially: from the end of World War II through the 1970s, only the
advanced countries lowered their trade barriers.
The past two decades, by contrast, have seen substantial liberalization take
root throughout the world. By the late 1990s, no economically significant
country still had a government committed to protectionism.
This historical cycle is also apparent in international capital investments.
Capital markets stayed open in the nineteenth and early twentieth centuries,
partly because governments did not have the means to control capital flows.
They acquired and haltingly solidified this capacity between 1914 and 1945,
progressively closing their capital markets. Liberalization of capital flows
then began in a few advanced countries during the 195os and 1960s. But the big
wave of liberalization did not start in earnest until the late 1970s, spreading
across the high-income countries, much of the developing world, and, by the
1990s, to the former communist countries. Notwithstanding a large number of
financial crises over this period, this trend has remained intact.
In monetary policy, the biggest change has been the move from the gold
standard of the 1870-1914 era to the floating currencies of today. The long-run
exchange-rate stability inherent in the gold standard promoted long-term
capital flows, particularly bond financing, more efficiently than does the
contemporary currency instability. Today's vast short-term financial flows are
not just a consequence of exchangerate instability, but one of its causes.
Yet governments' control over the movement of people in search of employment
tightened virtually everywhere in the early part of the last century. With the
exception of the free immigration policy among members of the European Union
(EU), immigration controls are generally far tighter now than they were a
hundred years ago.
The policy change that has most helped global integration to flourish is the
growth of international institutions since World War II. Just as multinational
companies now organize private exchange, so global institutions organize and
discipline the international face of national policy. Institutions such as the
World Trade Organization (WTO), the International Monetary Fund (IMF), the
World Bank, the EU, and the North American Free Trade Agreement underpin
cooperation among states and consolidate their commitments to liberalize economic
policy. The nineteenth century was a world of unilateral and discretionary
policy. The late twentieth century, by comparison, was a world of multilateral
and institutionalized policy.
TRADEOFFS FACING STATES
IRONICALLY, the technology that is supposed to make globalization inevitable
also makes increased surveillance by the state, particularly over people,
easier than it would have been a century ago. Indeed, here is the world we now
live in: one with fairly free movement of capital, continuing (though
declining) restrictions on trade in goods and services, but quite tight control
over the movement of people.
Economies are also never entirely open or entirely closed. Opening requires
governments to loosen three types of economic controls: on capital flows, goods
and services, and people. Liberalizing one of the above neither requires nor
always leads to liberalization in the others. Free movement of goods and
services makes regulating capital flows more difficult, but not impossible;
foreign direct investment can flow across national barriers to trade in goods
without knocking them down. It is easier still to trade freely and abolish
controls on capital movement, while nevertheless regulating movement of people.
The important questions, then, concern the tradeoffs confronting governments
that have chosen a degree of international economic integration. How
constrained will governments find themselves once they have chosen openness?
THREE VITAL AREAS
GLOBALIZATION is often perceived as destroying governments' capacities to do
what they want or need, particularly in the key areas of taxation, public
spending for income redistribution, and macroeconomic policy. But how true is
this perception?
In fact, no evidence supports the conclusion that states can no longer raise
taxes. On the contrary: in 1999, EU governments spent or redistributed an
average of 47 percent of their GDPS. An important new book by Vito Tanzi of the
IMF and Ludger Schuknecht at the European Central Bank underlines this point.
Over the course of the twentieth century, the average share of government
spending among Organization for Economic Cooperation and Development (OECD)
member states jumped from an eighth to almost half of GDP. In some high-income
countries such as France and Germany, these ratios were higher than ever
before.
Until now, it has been electoral resistance, not globalization, that has
most significantly limited the growth in taxation. Tanzi claims that this is
about to change. He argues that collecting taxes is becoming harder due to a
long list of "fiscal termites" gnawing at the foundations of taxation
regimes: more cross-border shopping, the increased mobility of skilled labor,
the growth of electronic commerce, the expansion of tax havens, the development
of new financial instruments and intermediaries, growing trade within
multinational companies, and the possible replacement of bank accounts with
electronic money embedded in "smart cards."
The list is impressive. That governments take it seriously is demonstrated
by the attention that leaders of the OECD and the Eu are devoting to
"harmful tax competition," information exchange, and the implications
of electronic commerce. Governments, like members of any other industry, are
forming a cartel to halt what they see as "ruinous competition" in
taxation. This sense of threat has grown out of several fiscal developments
produced by globalization: increased mobility of people and money, greater
difficulty in collecting information on income and spending, and the impact of
the Internet on information flows and collection.
Yet the competitive threat that governments face must not be exaggerated.
The fiscal implications of labor, capital, and spending mobility are already evident
in local jurisdictions that have the freedom to set their own tax rates. Even
local governments can impose higher taxes than their neighbors, provided they
contain specific resources or offer location-specific amenities that residents
desire and consume. In other words, differential taxation is possible if there
are at least some transport costs-and there always are.
These costs grow with a jurisdiction's geographic size, which thus strongly
influences a local government's ability to raise taxes. The income of mobile
capital is the hardest to tax; the income of land and immobile labor is
easiest. Corporate income can be taxed if it is based on resources specific to
that location, be they natural or human. Spending can also be taxed more
heavily in one jurisdiction than another, but not if transport costs are very
low (either because distances are short or items are valuable in relation to
costs). Similarly, it is difficult to tax personal incomes if people can live
in low-tax jurisdictions while enjoying the amenities of high-tax ones.
Eliminating legal barriers to mobility therefore constrains, but does not
eliminate, the ability of some jurisdictions to levy far higher taxes than
others. The ceiling on higher local taxes rises when taxable resources or
activities remain relatively immobile or the jurisdiction provides valuable
specific amenities just for that area.
The international mobility of people and goods is unlikely ever to come
close to the kind of mobility that exists between states in the United States.
Legal, linguistic, and cultural barriers will keep levels of cross-border
migration far lower than levels of movement within any given country. Since
taxes on labor income and spending are the predominant source of national
revenue, the modern country's income base seems quite safe. Of course, although
the somewhat greater mobility resulting from globalization makes it harder for
governments to get information about what their residents own and spend abroad,
disguising physical movement, consumption, or income remains a formidable task.
The third major aspect of globalization, the Internet, may have an
appreciable impact on tax collection. Stephane Buydens of the OECD plausibly
argues that the Internet will primarily affect four main areas: taxes on
spending, tax treaties, internal pricing of multinational companies, and tax
administration.
Purely Internet-based transactions-downloading of films, software, or
music-are hard to tax. But when the Internet is used to buy tangible goods,
governments can impose taxes, provided that the suppliers cooperate with the
fiscal authorities of their corresponding jurisdictions. To the extent that
these suppliers are large shareholder-- owned companies, which they usually
are, this cooperation may not be as hard to obtain as is often supposed.
It is also sometimes difficult to locate an Internet server. If one cannot
do so, how are taxes to be levied and tax treaties applied? Similar problems
arise with multinational companies' ability to charge submarket prices to their
subsidiaries abroad (so-called "transfer pricing" within
multinationals), which leaves uncertain the question of how and in which
country to levy the tax. This scenario suggests that classic concepts in the
taxation of corporations may have to be modified or even radically overhauled.
The overall conclusion, then, is that economic liberalization and technology
advances will make taxation significantly more challenging. Taxes on spending
may have to be partially recast. Taxation of corporate profits may have to be
radically redesigned or even abandoned. Finally, the ability of governments to
impose taxes that bear no relation to the benefits provided may be more
constrained than before.
Nevertheless, the implications of these changes can easily be exaggerated.
Taxation of corporate income is rarely more than ten percent of revenue,
whereas taxes on income and spending are the universal pillars of the fiscal
system. Yet even lofty Scandinavian taxes are not forcing skilled people to
emigrate in droves. People will still happily pay to enjoy high-quality schools
or public transport. Indeed, one of the most intriguing phenomena of modern
Europe is that the high-tax, big-spending Scandinavian countries are leading
the "new economy."
Governments will also use the exchange of information and other forms of
cooperation to sustain revenue and may even consider international agreements
on minimum taxes. They will certainly force the publicly quoted companies that
continue to dominate transactions, both on-line and off, to cooperate with
fiscal authorities. But competition among governments will not be eliminated,
because the powerful countries that provide relatively low-tax, low-spending
environments will want to maintain them.
The bottom line is that the opening of economies and the blossoming of new
technologies are reinforcing constraints that have already developed within
domestic politics. National governments are becoming a little more like local
governments. The result will not necessarily be minimal government. But
governments, like other institutions, will be forced to provide value to those
who pay for their services.
Meanwhile, governments can continue the practice of income redistribution to
the extent that the most highly taxed citizens and firms cannot-or do not wish
to-evade taxation. In fact, if taxes are used to find what are believed to be
location-specific benefits, such as income redistribution or welfare spending,
taxpayers will likely be quite willing to pay, perhaps because they either
identify with the beneficiaries, fear that they could become indigent
themselves, or treasure the security that comes from living among people who
are not destitute. Taxpayers may also feel a sense of moral obligation to the
poor, a sentiment that seems stronger in small, homogeneous societies.
Alternatively, they may merely be unable to evade or avoid those taxes without
relocating physically outside the jurisdiction. For all these reasons,
sustaining a high measure of redistributive taxation remains perfectly
possible. The constraint is not globalization, but the willingness of the
electorate to tolerate high taxation.
Last but not least, some observers argue that globalization limits
governments' ability to run fiscal deficits and pursue inflationary monetary
policy. But macroeconomic policy is always vulnerable to the reaction of the
private sector, regardless of whether the capital market is internationally
integrated. If a government pursues a consistently inflationary policy,
long-term nominal interest rates will rise, partly to compensate for inflation
and partly to insure the bondholders against inflation risk. Similarly, if a
government relies on the printing press to finance its activity, a flight from
money into goods, services, and assets will ensue-and, in turn, generate
inflation.
Within one country, these reactions may be slow. A government can pursue an
inflationary policy over a long period and boost the economy; the price may not
have to be paid for many years. What difference, then, does it make for the
country to be open to international capital flows? The most important change is
that the reaction of a government's creditors is likely to be quicker and more
brutal because they have more alternatives. This response will often show itself
in a collapsing exchange rate, as happened in East Asia in 1997 and 1998.
THE CONTINUING IMPORTANCE OF STATES
A COUNTRY that chooses international economic integration implicitly accepts
constraints on its actions. Nevertheless, the idea that these constraints
wither away the state's capacity to tax, regulate, or intervene is wrong.
Rather, international economic integration accelerates the market's responses
to policy by increasing the range of alternative options available to those
affected. There are also powerful reasons for believing that the constraints
imposed on (or voluntarily accepted by) governments by globalization are, on
balance, desirable.
For example, the assumption that most governments are benevolent
welfare-maximizers is naive. International economic integration creates
competition among governments-even countries that fiercely resist integration
cannot survive with uncompetitive economies, as shown by the fate of the Soviet
Union. This competition constrains the ability of governments to act in a
predatory manner and increases the incentive to provide services that are
valued by those who pay the bulk of the taxes.
Another reason for welcoming the constraints is that self-imposed limits on
a government's future actions enhance the credibility of even a benevolent
government's commitments to the private sector. An open capital account is one
such constraint. Treaties with other governments, as in the WTO, are another,
as are agreements with powerful private parties. Even China has come to
recognize the economic benefits that it can gain from international commitments
of this kind.
The proposition that globalization makes states unnecessary is even less
credible than the idea that it makes states impotent. If anything, the exact
opposite is true, for at least three reasons. First, the ability ofa society to
take advantage of the opportunities offered by international economic
integration depends on the quality of public goods, such as property rights, an
honest civil service, personal security, and basic education. Without an
appropriate legal framework, in particular, the web of potentially rewarding
contracts is vastly reduced. This point may seem trivial, but many developing
economies have failed to achieve these essential preconditions of success.
Second, the state normally defines identity. A sense of belonging is part of
the people's sense of security, and one that most people would not want to give
up, even in the age of globalization. It is perhaps not surprising that some of
the most successfully integrated economies are small, homogeneous countries
with a strong sense of collective identity.
Third, international governance rests on the ability of individual states to
provide and guarantee stability. The bedrock of international order is the
territorial state with its monopoly on coercive power within its jurisdiction.
Cyberspace does not change this: economies are ultimately run for and by human
beings, who have a physical presence and, therefore, a physical location.
Globalization does not make states unnecessary. On the contrary, for people
to be successful in exploiting the opportunities afforded by international
integration, they need states at both ends of their transactions. Failed
states, disorderly states, weak states, and corrupt states are shunned as the
black holes of the global economic system.
What, then, does globalization mean for states? First, policy ultimately
determines the pace and depth of international economic integration. For each
country, globalization is at least as much a choice as a destiny. Second, in
important respects-notably a country's monetary regime, capital account, and
above all, labor mobility-the policy underpinnings of integration are less
complete than they were a century ago. Third, countries choose integration
because they see its benefits. Once chosen, any specific degree of
international integration imposes constraints on the ability of governments to
tax, redistribute income, and influence macroeconomic conditions. But those
constraints must not be exaggerated, and their effects are often beneficial.
Fourth, international economic integration magnifies the impact of the
difference between good and bad states-between states that provide public goods
and those that serve predatory private interests, including those of the
rulers.
Finally, as the world economy continues to integrate and crossborder flows
become more important, global governance must be improved. Global governance
will come not at the expense of the state but rather as an expression of the
interests that the state embodies. As the source of order and basis of
governance, the state will remain in the future as effective, and will be as
essential, as it has ever been.
[Author note]
MARTIN WOLF is Associate
Editor and Chief Economics Commentator at the Financial Times. This paper is
based on "The Nation State in a Global World," presented at the Harry
Oppenheimer Colloquium on Globalization, funded by the Ernest Oppenheimer
Memorial Trust, in Stellenbosch, South Africa, in February 2000. Excerpts will
appear in the winter 2001 issue of the Cato, journal.
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