"Globalisation seemingly erodes governments’ ability to redistribute wealth"

Here's an interesting post on Vox by G. Bertola and A. Lo Prete:

"Globalisation seemingly erodes governments’ ability to redistribute wealth. This column presents new evidence of the tradeoff between integration and redistribution, showing that financial development has filled in where government has receded. The current crisis may pose political challenges to both financial development and economic integration."

Before we go on, let me say one thing. I would expect, and I hope, that as countries get wealthier, government spending and welfare spending will go down. That's my libertarian side. How low, time will tell. But I also preface this on the following: that the people on the bottom rung of income and the middle class getting wealthier. In essence, there can only be a cutback in government spending if people are wealthier and capable of weathering life's vicissitudes on their own. That's one reason I'm a Democrat. I'm for a robust, to use the word of the day, social safety net. Truthfully, I believe that would actually help us through this crisis we're in now, as people wouldn't be as terrified as they currently are. As it is, there's clearly not a panic like in the 30s.

So, let's see what they say:

"The current global financial crisis highlights the vexed issues of what role national governments should and do play in an internationally integrated economic system. In Dani Rodrik’s (1998) classic analysis of data from the 1960s to the early 1990s, openness to international trade was found to be associated with a larger share of government in GDP."

More International Trade= More Government as measured by percentage of GDP. That's interesting.

"Government policies meant to shelter citizens from risk may indeed be more important in countries where international market access fosters opportunities to trade but also exposes workers to more frequent and intense shocks."

Creative Destruction increases, so to speak, leaving workers more subject to changing jobs and careers. However, the first statistic just said that government was growing. It didn't divide it up, did it?

"More recent and precise data on social expenditure in 18 OECD countries confirm Rodrik’s observation. In Figure 1, the fraction of GDP spent on such policies is larger in OECD countries that import and export more, perhaps because they are small and near to each other or because they choose to deregulate international trade.

Figure 1. Public social expenditure and trade openness

It would be nice to know which it is. However, this seems to say that there is more social spending in countries with more trade.

"Another mechanism is relevant, however. Redistribution may be more useful in more open economies but national governments are less powerful if economic integration allows private agents to seek more lenient taxes and more generous subsidies across countries’ borders. Competition among systems (Sinn, 2003) may reduce the viability of collectively enforced national policies, making income redistribution negatively associated with international openness. It is not difficult to find such a relationship in the data."

Wait a second, this sounds like the opposite.

"In Figure 2, we plot deviations from countries’ means of social expenditure and openness, which capture reasons for countries to be permanently more or less open, or more or less inclined to social expenditure. The relationship is negative. This suggests that as technological progress and multilateral trade liberalisation have made borders less of a barrier to economic activity, the scope of redistribution policies has become smaller.

Figure 2. Public social expenditure and trade openness, deviation from means

The line seems to be pointing down now. That's the opposite direction, isn't it? The countries are spending more, but the spending is more concentrated?

"As an increasingly globalised economic system increases the risk households face and makes it harder for governments to enforce redistribution policies, something has to pick up the slack. Our CEPR Discussion Paper 7048 finds that, controlling for country and time effects, the negative association between openness and redistribution illustrated in Figure 2 is more pronounced when and where financial markets are better developed. As globalisation progressed, financial development substituted for government policies. In theory, this makes a lot of sense. Financial markets must indeed be more important if international competition makes it difficult to implement social protection schemes while introducing new sources of income risk. In a more risky world, absent heavily redistributive national welfare states, credit and insurance volumes have to increase."

I thought that government expenditure was going up. So, it's going up, but the countries are spending less on the social safety net. Is that the thesis? Then what are they spending more on?

"Globalisation increases aggregate incomes but erodes redistribution, and it could decrease welfare if it were not accompanied by better insurance against new and larger risks. In our empirical work, following Jappelli and Pagano (1994), we proxy the accessibility and efficiency of household financial markets by loan-to-value ratios – the percentage of a house purchase price that may be financed by mortgages. Available indicators are significantly and sensibly related to openness and social policy developments. Over time, loan-to-value ratios increased from about 75% on average in the 1980s to about 90% in the 2000s. They differed sharply across countries in the 1980s, when loan-to-value ratios already exceeded 80% in the UK and the US but were only slightly above 50% in Italy and Greece. By the late 1990s, the loan-to-value ratios in all our OECD countries exceeded 70%, and by the early 2000s they ranged up to 115% in countries such as the Netherlands.

From the perspective of this column, a high loan-to-value ratio is a good thing. Borrowing allows households within countries to buffer the ups and downs of international competition without having to rely on collective redistribution and makes it possible to reap the fruits of globalisation in terms of overall competitiveness. For individual households, it is beneficial to be able to borrow a lot and go bankrupt upon negative income shocks. But there can be too much of a good thing."

So, people are going into debt to keep up their standard of living, because Government money to them has gone down. This sounds like Robert Reich.

"If individual repayment risk is not properly packaged and diversified, financial market development can be a source of aggregate instability. Financial markets are indeed in trouble and, if our perspective on past developments is correct, their fragility does not bode well for globalisation. The breakdown of private financial markets excites calls for stronger redistribution. If redistribution is national (as it has to be as long as politics are national), it will only be sustainable if national borders become less permeable to economic activity."

So, let's see. If governments have to spend more on their citizens, they will have to trade less. Does that follow?

"Researchers will be looking carefully at signs of such reversals. Not only financial market development, but also trade and social policies will change as a consequence of the current economic turmoil. The character of these developments may foster confidence in the structural character of the empirical relationships we detect in our paper, which could so far be spuriously driven by trending factors other than those we focus on."

I guess we'll have to wait and see.

"And policymakers should also be keenly aware of these mechanisms. The path that led to the Great Depression was paved by protectionism and an increasing role of government. Rescuing financial institutions fosters confidence, but using the rising power of governments in the current financial storm to bail out manufacturers distorts competition and reduces confidence in further economic growth. To steer clear of the Great Depression path in a world where redistribution is no longer very effective and financial markets are key to the sustainability of international integration, we must develop an internationally coordinated financial regulation framework and avoid retracing backwards decades of international integration and financial development."

Now it sounds like they're warning against this inevitability, and arguing that trade be kept going, otherwise we''ll have a depression.

Let's take stock:
1) As countries trade more, governments get bigger
2) But less goes to the social safety net
3) People go into debt because of the loss of income from government
4) If the social safety net needs more spending, then it might be necessary to trade less
5) Trading less is bad, because it can lead to a depression

Why did the social safety net go down?
A. Capitalists got richer, and cut wages and benefits and influenced the government to get out of their way. Is that it?

Well, Martin Wolf is not going to like the no trading idea, and neither do I. I take it that they don't as well. Fortunately, I have Dani Rodrik on my blog. Let's see what he says:

"Economic theory and intuition suggest that as economies become more globalized, the ability of governments to undertake redistributive policies and to engage in social spending erodes. After all, a large part of the tax base--corporations, financial intermediaries, and skilled workers in particular--become internationally mobile and can evade taxes needed to finance those public expenditures. "

I would think that as countries get wealthier, the hope would be that the people would get wealthier, so that there would be less need for a social safety net, although there will always need to be one, and the certainty that it's there if needed. Rodrik's thesis seems to be as well that Capitalists command more of the wealth and workers lag behind due to the growing wealth and power of the Capitalists.

"This is important because historically countries that are more exposed to international trade have actually had larger public sectors, in part to insulate their citizens from shocks originating from abroad. This fact, along with the lack of an obvious decline in the overall tax take in major advanced economies, has led many observers to think that the hypothesized decline of the welfare state has not in fact taken place."

I don't think that the welfare state has gotten smaller. Does anyone? We've just lived through the largest increase in government spending ever it seemed like.

"Another interesting argument Bertola and Prete make is that private finance seems to have partly filled the whole left by public transfers. The claim is that more developed financial markets are able to supply the insurance and consumption-smoothing provided traditionally by the welfare state in very open economies. They use the share of house prices financed by mortgages as an indicator of financial development."

I think it's more like they thought that people had gone into debt, as Robert Reich does:

"Borrowing allows households within countries to buffer the ups and downs of international competition without having to rely on collective redistribution and makes it possible to reap the fruits of globalisation in terms of overall competitiveness. "

It does certainly seem that this is going to be diminished for a time.

"I am sure this argument made a lot more sense a year ago, when the authors were doing their original research, than it does now. It will take a while until we think of finance, and housing finance in particular, as a source of insurance and stability.

Bertola and Prete are aware of this of course. So they conclude thus:

Financial markets are indeed in trouble and, if our perspective on past developments is correct, their fragility does not bode well for globalisation. The breakdown of private financial markets excites calls for stronger redistribution. If redistribution is national (as it has to be as long as politics are national), it will only be sustainable if national borders become less permeable to economic activity.

Indeed. Welcome back to the political trilemma of the global economy."

How can we be welcomed back to a trilemma? Does it go away?

"Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches. I have an "impossibility theorem" for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full."

Is this logically impossible, or just a fact of life?

These three:
1) Democracy
2) National Sovereignty
3) Global Economic Integration
Can't exist simultaneously. Only two of three.

I don't see how this can be logically impossible, but let' see.

Here is what the theorem looks like in a picture:

It looks like a triangle. In what sense is a theorem?

: an idea accepted or proposed as a demonstrable truth often as a part of a general theory :

Okay. What's the general theory?

"To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs."

So it looks likes it 2 and 3 can't go together, since one is global, and one is national. What about free trade agreements? I suppose that there are always going to be unresolved issues, but 3 seems to be a matter of degree. What does "deep" mean? Complete?

"So what do we do?

One option is to go for global federalism, where we align the scope of (democratic) politics with the scope of global markets. Realistically, though, this is something that cannot be done at a global scale. It is pretty difficult to achieve even among a relatively like-minded and similar countries, as the experience of the EU demonstrates."

Get rid of countries. Forget it.

"Another option is maintain the nation state, but to make it responsive only to the needs of the international economy. This would be a state that would pursue global economic integration at the expense of other domestic objectives. The nineteenth century gold standard provides a historical example of this kind of a state. The collapse of the Argentine convertibility experiment of the 1990s provides a contemporary illustration of its inherent incompatibility with democracy."

Nations do that now. All agreements are trade offs. I don't understand the need for "only". Is this some kind of Kantian Argument?

"Finally, we can downgrade our ambitions with respect to how much international economic integration we can (or should) achieve. So we go for a limited version of globalization, which is what the post-war Bretton Woods regime was about (with its capital controls and limited trade liberalization). It has unfortunately become a victim of its own success. We have forgotten the compromise embedded in that system, and which was the source of its success."

I don't see why we should give it up. By that standard, we should certainly get rid of the UN. It couldn't stop The Congo, Sudan, or Rwanda, or about 30 other smaller wars. It has a terrible success rate. It's violations are beyond any forgetting, and involve abetting.

"So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man's land."

If you can give up some of each and compromise, it's not unsolvable or mutually contradictory in any way. He needs a Venn diagram or some other depiction of his "theorem". It looks more like a simple relationship between three chosen facets of human institutions. One could throw war, famine, ethic conflict into this mix, and really complicate things.

I'm perfectly content with his default position. As near as I can tell, it's what I actually believe. I wouldn't call it a theorem.

As for the Welfare State and Global Trade argument, I don't quite get it. It seems clear that government expenditures have risen. The only point that's worth considering is the basic argument that global trade has shifted power, wealth, and influence to one group of people at the expense of another. But I can think of lots of ways to correct that imbalance which don't involve Socialism, Communism, or any other debunked human arrangement. We have a Welfare State, Corporate Capitalism, and so does Sweden. It's merely a matter of emphasis, some of which is related to culture and trial and error, but all of which is related to Human Agency at bottom.

I don't feel near as disoriented as others do. The 1930s would have certainly disoriented me much more. So, maybe this comes down to basic assumptions of Human Agency, and the Existential Situation we find ourselves in, which is not near as dire as some must be presuming.