Bhagwati on the WTO

Jagdish Bhagwati, a prominent advocate for free trade, served on a group of experts that advised the director general of the WTO on future chage needed at the organization. He summarized his own views on the subject in a short article entitled Reshaping the WTO. (Note: this is a relatively short and accessible paper.)

Bhagwati argues that there several fallacious criticism of the WTO be promoted by otherwise well-meaning NGOs like Oxfam and Action aid. These include the following:

• "Poor countries suffer from systematic rich-country “hypocrisy” leading to “double standards” in trade policy, with the rich countries having more trade barriers than the poor ones."  Bhagwati notes that developed nations in fact have much lower levels of tariff protections than developing nations do.
  
• "While trade liberalization by rich countries is beneficial, for the poor countries trade liberalization does not bring benefits." Bhagwati argues that the scholarship and empirical evidence argues to the contrary, despite the repeated claims of a small number of economists. Also, he argues that protection given to 'infant industries', which is the primary alternative to liberalizing trade, tends to be indiscriminate in nature, stifles the competitiveness of the industry, and becomes politically entrenched. In his view the infant industry argument "...has always been indulged to excess whereas experience shows otherwise."

• "Agricultural subsidies in the rich countries are keeping the developing world poor." Bhagwati notes that 45 out of 49 LDCs are net importers of food and thus benefit from the agricultural subsidies of other countries. He argues that middle income countries with large agricultural exports, who are negatively impacted by these subsidies, have been trying to link this issue to the welfare of poorer nations for political convenience. 

The Erosion of Non-Discrimination: Bhagwati feels that the proliferation of Preferential Trade Agreements (PTAs) between nations has eroded the norm of non-discrimination between nations that was established under GATT. Bhagwati would expand on this argument in his 2008 book Termites in the Trade System: How Preferential Trade Agreements Undermine Free Trade. In his 2005 paper he argued:

All economists now recognize the resulting “spaghetti bowl” problem, as I have christened it. The world trading system is charcaterized by a chaotic criss-crossing of preferences, with a plethora of different trade barriers applying to products depending on which countries they originate from. This is a fool's way of doing trade—not only does it destroy the efficient allocation of resources, but it flies in the face of the fact that today it is becoming almost impossible to define which product is whose. It is hard to believe that sensible men in charge of trade policy today, including the USTR, the EU Trade Commissioner and other luminaries of trade are so unmindful of the fact that, in the name of free trade, they are damaging the world trading system through discriminatory PTAs as much as the protectionists did in the 1930s.

Encroachment of Unrelated Agendas: The other problem Bhagwati sees for the WTO is the lobbying by rich nations to attach other issues, such as protections for intellectual property right, to the WTO's rules. He sees PTAs as a means for these nations to insert these issues into the international agenda and build legitimacy for the inclusion of issues into the WTO. 

 Yet another threat to the multilateral trading system arises from the ability of rich-country lobbies to capture, through use of PTAs and the design of S&D preference schemes, the trade liberalization process to advance their unrelated agendas. These lobbies pretend, of course, that “fair trade” and respect for “collective preferences”—both self-serving phrases that conceal the pernicious nature of the demands—require that their pet concerns such as labor standards be worked into trade agreements and institutions such as the WTO.  

This has united the major developing countries such as India and Brazil, both led by democratically elected progressive leaders, against the inclusion of such extraneous issues into trade negotiations and institutions. The Free Trade Agreement of the Americas (FTAA) has also been held up by Brazil, which insists correctly on confining it to trade liberalization, while the United States wishes to corrupt the FTAA with several extraneous issues. Revealingly, none of the many PTAs among the poor countries ever include these extraneous issues—their inclusion arises only when the U.S. and the EU are members.

Bhagwati on MNCs

In his book, In Defense of Globalization, Jagdish Bhagwati devotes quite a bit of attention (11% of the book's total length) to the role of corporations. In general, Bhagwati argues that foreign corporations have a positive impact on the developing nations in which they set up operations, though this impact could be enhanced. However, corporate lobbying activities in their home countries with regard to trade rules in their home nation and international bodies can have a negative impact on developing nations. Some of his key points are listed below.

Big Corporation vs Small Countries: Bhagwati argues that the image of small nations facing big corporations, to the extent that it based on comparisons of the sales volumes of large corporate sales to the GDPs of small nations, is fallacious. He notes that sales volumes are gross figures while GDP measures value added in an economy, which is just portion of the gross activity in a nation. Therefore, comparing corporate sales to national GDP is comparing apples to oranges. A corporation's value added is only a fraction of its gross sales and, if these figures are compared to national GDPs, the supposed size disparity diminishes considerably.

Exploitation of Workers: Bhagwati argues that there is no evidence that multinational corporations  pay workers less than the prevailing wage or seek out nations with poor labor rights. To the contrary, he points to empirical research that shows that the opposite occurs. As discussed in a previous post, multinational corporations pay a wage premium of about 10% (and US affiliates can pay from 40-100%) over local wages. Other research by David Kucera shows that nations with higher unionization rates and less episodes of labor repression tend to have higher inflows of foreign direct investment. Noting research into the effect of environmental policies on multinational investment ( Smarzynska & Wei, and  Levinson) that finds little evidence of these corporations locating in places with lower environmental standards, Bhagwati argues that multinationals are not engaged in the 'Race to the Bottom' that they are often supposed to be in.

In discussing the question of hours and working conditions in foreign owned plants that violate international norms,  he notes that domestic regulations and common practices may may be more lax for good reason. Here he cites Kristof and WuDunn's NYT article "Two Cheers for Sweatshops" that described workers in so-called sweatshops as very happy to have a job for what they considered to be good pay and an opportunity to earn more of it by working long hours.

Spillover Effects: Bhagwati argues that multinational have what are called spillover effects when local firms learn better production techniques and management practices from multinationals. This occurs through observation,word of mouth, and, more importantly, from  workers and managers moving between domestic and foreign owned firms.

Effect of Bad Politics: Many of the supposed bad effects of multinationals are, in Bhagwati's view, the result of bad policies in the host nation. He notes that there are two dominant practices regarding social legislation in developing nations. The laws are either practically nonexistent, or they are excessively generous with little or no effort made to enforce them. In the latter case, the laws may have been only symbolic in nature when passed, or they may simply be out of date and are no longer considered desirable. Yet, they remain on the books because it is not worth the political cost to change them. Therefore, when a seemingly lenient set of rules is established for multinationals, say as is the case in an export promotion zone, it may represent a politically expedient means of policy change or experimentation.

Bhagwati sees  policies aimed at inward growth or import substitution as another example of bad politics. When governments try to encourage foreign direct investment aimed at supplying products to the domestic market (usually one protected by import tariffs and/or quotas) as opposed to the global market, they create a situation in which less employment and spillovers will occur. Multinationals, viewing the direct investment as a path around the tariffs and quotas, will seek to minimize the amount of work done in the host nation (perhaps assembling  the minimum number of imported parts to qualify as "domestic" production) and will not need to bring in their most productive techniques and practices.

Corporate Lobbying at Home: This is where Bhagwati sees corporations as having a more malign effect on developing nations. Corporate political influence in their home nations is more of a problem because their home governments tend to be fairly powerful, especially in the case of the US. Also, in this venue, the developing nations are at a disadvantage because they are largely shut out from the home nations' political process. Bhagwati points to the push to have protections for intellectual property included in the WTO as a trade-related issue. He sees this as an opening of the doors for other lobbying groups to have their issues labeled as trade-related and to take advantage of the WTO's enforcement mechanisms to coerce the governments of developing nations. This will not only force developing nations to acquiesce to unfavorable policies on the trade-related issues, but threatens to undercut the WTO's main efforts on trade liberalization itself.

Improving the Effect of Corporations: Though he argues that corporations tend to have a benign effect on developing nations, Bhagwati argues that these benign effects can be improved (and the occasional malign effects lessened) by improving corporate social responsibility. This can be done by employing a combination of three mechanisms:

1. Social Norming: This occurs when corporations sign on to uphold sets of broadly defined goals. While they do not agree to take concrete steps and face no enforcement mechanism, the act of agreeing to certain social goals (and not others) focuses the corporation and its critics on what the corporation intends to accomplish.
2. Voluntary Codes: These codes entail better defined obligations that the corporation agrees to meet if it signs on the code. One of the key aspects of voluntary codes, in Bhagwati's view, is that there is a diversity codes promoted by different groups from which to choose. This will allow codes that represent the developing nations' point view to compete with those promoted by western groups. 
3. Mandatory Codes:  These are national codes that regulate how a nation's corporations act in other nations.  Though Bhagwati expects these to vary across nations, he expects that best practices will emerge over time and this may lead to the emergence of more universal mandatory code.

Jagdish Bhagwati's Defense of Globalization

One of the seminal defenses of economic globalization was provided by Jagdish Bhagwati's, appropriately titled, In Defense of Globalization. The book was first released in 2004 and then re-released in 2007 with a new afterword  that addressed new criticisms of globalization that had arisen in the interim.

The globalization that Bhagwati defends is economic globalization. He defines economic globalization as the "integration of national economies into the international economy through trade, direct foreign investment (by corporations and multinationals), short term capital flows, international flows of workers and humanity generally, and flows of technology" (Bhagwati, 2007, p. 3). However, throughout the course of the book it becomes clear that he is most committed to the defense of trade and foreign direct investment which he sees as part of an outward oriented economic policy strategy that is necessary for growth. Indeed, as discussed in a previous post, he is very critical of financial liberalization, which he terms Gung Ho International Financial Capitalism. As for flows of people across border, while he does call from more flexible immigration policies, when it comes to issues such as the treatment of domestic workers in Middle East countries, he sets these issues aside as separate from economic globalization.

This is not to suggest that Bhagwati is being inconsistent. In fact, once one understands that he is defending the liberalization of trade and foreign direct investment from domestic and international political meddling, many apparent inconsistencies in his argument vanish. For instance, Bhagwati is highly critical of protections for intellectual property rights that are being written into the WTO code. While he provides an argument against the soundness of the basic principle (i.e., that preventing the diffusion of intellectual property can be as bad as undermining the incentives of innovators to create it), he also regards adding side issues to the WTO as ultimately harmful to its primary function of enabling greater trade. Furthermore, he sees an imbalance in power and capability between Western nations and NGOs that will ensure that any WTO rules will reflect their interests and values more than those of developing nations and their much less affluent NGOs.

The bulk of the original book is aimed at defending globalization from charges that it creates onerous social effects, or as Bhagwati puts it, that globalization does not have a human face. Going through these various criticisms, Bhagwati argues that when nations pursue outward oriented growth, the benefits far outweigh the ill effects which are often exaggerated, nonexistent, or the result of other factors unrelated to increase trade and foreign direct investment.

Poverty: Bhagwati argues that economic growth is necessary to reduce poverty and that increased trade can lead to economic growth. While there may be obstacles that prevent the war from fully anticipating an economic growth of the nation, without economic growth, there will not be resources available to lift them out of poverty. Thus, in contrast to the cliché that “a rising tide lifts all boats”, is essentially arguing that without a rising tide it will be hard to lift anybody’s boat. As for the link between trade and growth itself, Bhagwati argues that outward oriented strategies of growth have proven themselves to be superior to inward oriented strategies such as import substitution industrialization.

Child Labor: With regard to child labor, Bhagwati argues that the prevalence of child labor in developing nations is largely the result of domestic factors that have little to do with globalization. Poor people in developing nations face incentives to send their children to work, rather than to school, that are unlikely to go away if the governments of these nations simply proscribe child labor, which is essentially what globalization critics call for. However, citing research into households in Vietnam, Bhagwati argues that, if parents receive more income because of increases in prices or wages due to outward oriented economic growth, then they are more likely to send their children to school.

Effects on Women: Bhagwati analyzes many of the criticisms by feminist groups in depth, so it is hard to summarize here. However, one piece of research he cites stand out. Black and Brainard (2004) look at wage discrimination in the US and find that the wage gap between men and women decreases in industries that face increased competition from trade. Therefore, to the extent that globalization exposes industries to greater competition, it should diminish any wage gap that is the result of non-economic (and, thus, inefficient) discrimination.

Exploitative Wages: The charge that globalization forces people to work for exploitative wages comes up in connection with effects on women and criticism of multinational corporations. Bhagwati cites several studies that show that, rather than paying their workers poorly, muiltinationals pay their workers a wage premium of up to 10% and that US affiliated multinational often pay a premium of 40 to 100% above the local market wage. One of the cited works, Brown, Deardorff, and Stern (2004), reviews a range of empirical work on the subject and concludes:

• It is true that, as a theoretical matter, multinationals can have an array of positive and negative impacts on host-country workers. However, as an empirical matter, some anecdotal evidence notwithstanding, there is virtually no careful and systematic evidence demonstrating that, as a generality, multinational firms adversely affect their workers, provide incentives to worsen working conditions, pay lower wages than in alternative employment, or repressed worker rights. In fact, there is a very large body of empirical evidence indicating that the opposite is the case. Foreign ownership raises wages, both by raising labor productivity, and by expanding the scale of production and, in the process, improves the conditions of work. Furthermore there appears to be some evidence that foreign-owned firms make use of aspects of labor organizations and Democratic institutions that improve the efficiency characteristics of their factor, the operations. (Brown, Deardorff and Stern, 2004, p 322)

In general, Bhagwati concludes that globalization does have a human face in the sense that it has a benign impact on most of the issues that concern its critics. However, it can have occasional unintended bad effects. He argues that the way to deal with these is, not to try to avoid them ahead of time by limiting the liberalization of trade or FDI, but to deal with them as they occur. One of the main reasons for taking a reactive approach is that the specific effects of changes in trade policy are difficult to predict, and many anticipated problems may not arise, while other unanticipated ones almost certainly will.

When a problem occurs, policy makers should either take steps to mitigate the negative impacts of the trade policy, or modify the policy. Bhagwati favors the first approach as generally being more efficient, but is surprisingly non-ideological about entertaining the possibility of the second.

Jagdish Bhagwhati and Gung-ho Global Finance

Jagdish Bhagwati is arguably the most prominent proponent of trade liberalization and globalization, and so he caused a bit of a stir when he came out against the complete liberalization of capital in 1998. In a Foreign Affairs essay entitled the "Capital Myth: The Difference between Trade in Widgets and Dollars" he criticized the push to liberalize financial markets and remove all restrictions on capital flows, something he would later call  'Gung-ho International Financial Capitalism.'  [Bhagwati has made this essay, along with other writings on the subject, available in PDF form on his faculty website] Talking about the push for free international capital flows, he says:

This is a seductive idea: freeing up trade is good, why not also let capital move freely across borders? But the claims of enormous benefits from free capital mobility are not persuasive. Substantial gains have been asserted, not demonstrated, and most of the payoff can be obtained by direct equity investment. And even a richer IMF with attendant changes in its methods of operation will probably not rule out crises or reduce their costs significantly. The myth to the contrary has been created by what one might christen the Wall Street-Treasury complex, following in the footsteps of President Eisenhower, who had warned of the military- industrial complex. (Bhagwati, 1998)

With regard to the problems associated with unfettered capital mobility, Bhagwati argues that capital flows, especially short term credit, are more prone to (in Kindleberger's terms) panics and manias than trade in goods and services. That is, that financial investors, working with incomplete information and subject to herding influences, are more likely to overestimate the returns and stability of a nation capital market (which producing a mania of capital inflows) and/or to underestimate the strength of a market when confronted with adverse news (which produces a panic in the form of sudden and massive capital outflows). 

Writing on this in The Defense of Globalization, Bhagwati contrasted the Mexican Peso crisis with the Asian financial crisis. He argued, while that the Mexican crisis exposed fundamental problems in the Mexican financial system that may have warranted reactions from investors, the same was not true of the Asian crisis. The fundamentals of the Asians were fairly strong in comparison to other nations. While problems such as cronyism existed, these problems were generally previously known to exist and there was nothing in the crisis that suggested they had suddenly become acute. 

The problem in Asia in the 1990s, as Bhagwati (2004) sees it was that Asian banks were using short term capital inflows to finance long term domestic loans.  When the short term inflows suddenly turned into outflows, there was simply not enough cash (in foreign currency) to cover the outflow even though the long term loans were generally sound. Note that, in such a case, it makes sense for a lender of last resort to loan banks money to cover the short term outflows based on the strength of the long term loans. In fact, in the case of a panic, one can make money doing so (think Old Man Potter backing the bank during the panic in It's A Wonderful Life).

However, unlike the US, where the Federal Reserve can print all the dollars it wants and act as lender of last resort, the central banks of the Asian countries could not do so to the same extent as they print domestic currency, not dollars. So, once their supply of foriegn reserves was expended, central banks and their governments had to beg the dollars they could from the IMF and other countries. More importantly, they had to implement severe macroeconomic measures, notably raising interest rates and selling assets. These measures rippled through their economies undercutting its fundamental strength. Businesses, which carried debt and depended on access to credit to operate, were decimated (and those, formerly sound, long term longs to them were no longer quite so sound). Owners of assets were forced to sell to foreign purchasers at greatly reduced prices. 

In general, Bhagwati argues that the gains of financial liberalization, in terms of economic growth, are questionable. Many other countries, such as China, have grown without open capital markets (though this is eerily similar to claims by opponents of trade liberalization). Furthermore, if there are benefits, the results can be achieved by opening markets to foreign direct investment, which is inherently longer term and less mobile in nature, and, therefore, not as susceptible to panics.

In the end, Bhagwati attributes much of the push for unfettered financial flows to interest groups in the developed nations, particularly the financial sector in the US. This sector directly benefits from expansion of global credit markets and exerts great influence on the US government and the IMF. Bhagwati notes that US economists frequently move back and forth between the US financial sector and government positions. This elite network, along with the financial sector lobbying efforts, creates what he calls the Wall Street-Treasury Complex, whose effect describes as follows:.

This powerful network, which may aptly, if loosely, be called the Wall Street-Treasury complex, is unable to look much beyond the interest of Wall Street, which it equates with the good of the world. Thus the IMF has been relentlessly propelled toward embracing the goal of capital account convertibility. The Mexican bailout of 1994 was presented as necessary, which was true. But so too was the flip side, that the Wall Street investors had to be bailed out as well, which was not. Surely other policy instruments, such as a surcharge, could have been deployed simultaneously to punish Wall Street for its mistakes. Even in the current Asian crisis, particularly in South Korea, U.S. banks could all have been forced to the bargaining table, absorbing far larger losses than they did, but they were cushioned by the IMF acting virtually as a lender of first, rather than last, resort.

The last sentence suggests an argument that Bhagwati doesn't explicitly develop, i.e., that the IMF is not a good lender of last resort because of its motivation. The obvious the limiting factor on the IMF serving as lender of last resort is its  limited supply of funds (remember that when the Federal Reserve acts as lender of last resort in the US, it theoretically has an infinite supply of dollars).  Here, Bhagwati suggests that IMF is biased towards insulating foreign creditors from the downside of the crisis;  whereas an ideal lender of last resort would focus on minimizing the crisis in total (especially its long term impact n the economy) and remain neutral with regard to the distribution of losses. 

References:

Bhagwati, Jagdish. (1998, May 1). "The Capital Myth: The Difference between Trade in Widgets and Dollars."  Foreign Affairs. Retrieved February 4, 2014, from http://www.foreignaffairs.com/articles/54010/jagdish-n-bhagwati/the-capital-myth-the-difference-between-trade-in-widgets-and-dol

Bhagwati, Jagdish. (2004) "Chapter 13: The Perils of Gung-ho International Financial Capitalism." In Defense of Globalization. New York, NY: Oxford University Press.