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Martin Wolf: Location, location, location
By Martin Wolf
Published: September 24 2002 20:05 | Last Updated: September 24 2002 20:05
Martin Wolf

Both opponents and proponents of globalisation agree on one thing: that borders no longer matter as once they did. That view is mistaken. Borders have never mattered so much. Two or three centuries ago, the most important determinant of most people's fate was the class into which they were born, closely followed by their sex. Today, where one is born matters far more.

As those in the property business have long said, what matters is location, location, location. Opportunities for "life, liberty and the pursuit of happiness" depend more on where one lives than on anything else. After two centuries of divergence, one finds in the contemporary world a huge range in the quality of jurisdictions from the honesty of Singapore's government to the corruption of Nigeria's, from the democracy of Switzerland to the despotism of Iraq and from the wealth of the US to the poverty of Sierra Leone.

A few years ago, the World Bank estimated that a bus driver in Germany enjoyed a standard of living 13 times as high as a bus driver in Kenya. The skills needed to drive around Frankfurt are probably less than needed to cope with Nairobi. Try telling the average Kenyan this is a borderless world. Yet why do borders matter quite so much? And how far might global economic integration change this?

The answer to the first question is cumulative divergence. Economically successful countries invest more in the skills of their people. A growing supply of skills not only raises returns to physical capital and unskilled labour, but allows all economic activities to run more efficiently than elsewhere.

Economic advances are promoted by - and, in turn, strengthen - a high-quality institutional environment, one that protects property rights, offers an honest and effective bureaucracy and independent judiciary and provides decent infrastructure, health and public education. A high-quality jurisdiction also follows policies that motivate people to be productive.

For countries in a virtuous upward spiral, success breeds better government, which breeds yet more success. For countries in a poverty trap, the reverse process is at work. Unhappy pasts and poor geographical positions create a vicious spiral of poor-quality government, low growth, low skill formation and back to poor-quality government.

Now turn to the impact of global economic integration. By the mid-20th century, gaps in wages between the high-income countries and the rest had become wide enough to make some developing countries highly competitive in labour-intensive manufactures. The success of east Asia, including China, in exploiting this opportunity helps explain the reductions in numbers of absolutely poor and in global inequality over the last two decades reported by Xavier Sala-I-Martin of Columbia University in an important recent paper.*

Unfortunately, other opportunities to trade have had far less impact. Mineral exports tend to create export enclaves and waste, with revenues consumed by profligate governments. Botswana's has been a rare exception. Markets for traditional tropical agricultural commodities are saturated, while those for temperate commodities are distorted by high agricultural protection in high-income countries.

Capital flows do not change these patterns, because they go overwhelmingly among the relatively rich or to the more successful among the poor. Alan Taylor and Maurice Obstfeld of the University of California note that a century or so ago, two-way capital flows were rare, with the US the only significant exception.** Today, they note, "foreign asset distribution is much more about asset 'swapping' by rich countries - diversification - than it is about the accumulation of large one-way positions." While the US is the world's largest creditor, it is also its biggest net debtor.

In 1900, note professors Obstfeld and Taylor, developing countries in Asia, Latin America and Africa accounted for 33 per cent of global liabilities. Today, that figure is only 11 per cent, an all-time low. In 1913, close to half of all direct investment and portfolio equity flows went to countries whose incomes per head were less than 40 per cent of the US level. Today, the share of the cross-border flows of direct and equity investment that go to such relatively poor countries is little over 10 per cent, even though a bigger fraction of the world's population is located in such countries.

According to the latest World Investment Report from the United Nations, the share of developing countries in the stock of inward direct investment is higher than in overall capital, at 32 per cent. But 60 per cent of this is in Asia. Africa has just 2.3 per cent of the world's inward stock of FDI. Investors shun low-quality jurisdictions, regarding them as places that offer poor and risky returns.

So capital is invested where rich people live. In 2000, measured at purchasing power parity, investment per head in the high-income countries, with 900m people, was just over $6,000; in middle-income countries, with 2.7bn people, it was $1,350; in low-income countries, with 2.5bn people, it was under $400. High-income countries invest 15 times as much per head, in real terms, as low-income ones. Much the same is true of investment in education.

Naturally, the hundreds of millions of people trapped in bad locations have a desperate desire to escape. But controls on migration are very tight in high-income countries. This is the most evident respect in which borders matter: people are prevented from crossing them.

Borders are desperately important. International economic integration has an ameliorating impact, particularly via expanded trade in manufactured goods. But there is too much protection still left in the world, particularly, but not solely in agriculture. Moreover, capital flows from rich countries to other rich ones or to the already successful among the poor.

As a result, a large proportion of humanity find itself locked inside bad locations with poor policies and worse governance. Big changes are needed if the opportunities afforded by economic integration are to become real for a larger proportion of the world's population. The starting point has to be with turning those vicious spirals of governance and economic performance into virtuous ones. On the world's ability to achieve this largely depend hopes for a wider spread of successful development.

*The World Distribution of Income, NBER Working Paper 8933;

** Globalisation and Capital Markets, NBER Working Paper 8846.

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