Dani Rodrik often thinks more like a political economist (which was the initial focus of the dismal science) than the development economist he professes to be, which I consider to be a plus. That perspective enables him to frame issues in ways that sometimes escape other observers.
Many discussions about economics often boil down to differences in values, with one camp advocating efficiency, the other fairness. The efficiency types have had the upper hand for the last couple of decades, but going too far in that direction, particularly when it runs afoul of perceived equity, can undermine the entire system. Behavioral finance experiment have repeatedly found that participants will reject deals that leave them better off if they feel the other side has been too greedy. The opportunity to punish their opponent becomes more valuable to them than the payoff from cooperating.
Although Rodrik’s comments below focus on trade, its implications extend beyond that.
From Rodrik:
Those who are puzzled by globalization anxiety and attribute it to collective irrationality (see Tyler Cowen’s piece in the NYT) overlook a fundamental aspect of markets–their “embeddedness.” What I am referring to is the idea that successful markets need to be embedded in a larger set of man-made rules and governance structures. Markets need regulation, stabilization, and legitimation because they are not self-regulating, self-stabilizing, or self-legitimizing. The success of modern capitalism is due as much to the institutions that govern markets–political democracy above all–as it is to the power of markets themselves.
It is important to understand this because it provides an important clue as to why domestic and international trade are different. Domestic trade takes place within thoroughly embedded markets; there are clear rules and they apply to all transactions equally. International trade, on the other hand, is conducted in only weakly embedded markets: the rules either do not exist or apply unevenly. I believe this is the fundamental reason why their consequences are often perceived so differently.
Let me make this concrete. If Harvard fires me and hires Tyler Cowen instead, I would feel bad for sure. But I would not blame Tyler or Harvard, because I would assume that the decision was made on fair grounds: we compete under the same ground rules, and if Tyler beat me to it, it must be because he deserves it.
But suppose instead that Harvard hires John Plagiarizer, who has a much longer vita and larger citation counts than either one of us, because… well because he is a flagrant plagiarizer. I think I would have pretty good reason to feel cheated.
An extreme example? Let me make it less so. Suppose that I am an experimental psychologist instead of an economist and the person Harvard hires in my place is someone who has accumulated a long vita by virtue of not having to abide by human subjects review standards. (You can find out a lot about human behavior through torture.) Would I not feel treated unfairly? You bet I would.
The international trade counterpart of this hypothetical is the worker who loses his job because his company decides to move to a country where, say, labor rights are routinely violated. So the “us” and “them” characterization that Tyler attributes to irrational nativism perhaps has more to do with the absence of a common set of international rules on labor standards, environment, consumer safety, and so on.
By overlooking the problems created by trade in instances where regulatory arbitrage does play an important role, we miss the opportunity to celebrate the kind of globalization where such arbitrage doesn’t play a role. The latter type of trade probably constitutes the bulk of world trade. But because economists do not make this important distinction, they have no language or ability with which they can respond appropriately to the uneasiness out there–except for calling it irrational.
And by the way, Harvard cannot fire me because I have tenure (as does Tyler). Which makes any pontification on our part about job anxiety a very poor guide to reality.
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“What I am referring to is the idea that successful markets need to be embedded in a larger set of man-made rules and governance structures. Markets need regulation, stabilization, and legitimation because they are not self-regulating, self-stabilizing, or self-legitimizing. The success of modern capitalism is due as much to the institutions that govern markets–political democracy above all–as it is to the power of markets themselves.”
It is quite refreshing to read someone stating the obvious (for the reality-based crowd, that is) in such an elegant manner.
Move over Grover!
This is a PR stunt.
Rodrick is completely out of his depth. What he is advocating is feel good explanation of the problems of globalization in the context of public perception.
There are a myriad of problems with globalization above and beyond regulatory arbitrage, that itself, in the end, is almost unenforceable.
But this is what we get from the Ivy League Oligarchy that has given us our last 3 presidents and soon to be a fourth.
There’s a further aspect to the problem Rodrik discusses.
The corporations who take advantage of loosened labor and environmental regulations (and let’s be honest: all of the outsourcers do this) are buying their way out of the system.
They use their investment and management capabilities to buy their way out of the domestic regulatory system, thus, through wage arbitrage, obtaining increased profits, while evading rules that are still in effect “back home”.
This is a big part of contemporary inequality. The corporate elites are financially rewarded (with an ever increasing portion of the pie) for skirting/shirking/evading the rules that we, “back home”, still have to follow.
I think this is part of the collapse of confidence here at home. The law abiding workers of the USA are being screwed by their betters who are so rich and powerful that they don’t need to be law abiding. This is, in effect, in terms of American laws, a massive and unprecendented surge in law breaking by elites.
It is generally the case, in my view, that poor & corrupt societies have low quality elites, prone to predatory and corrupt practices. There is low investment in social capital or the common good because it would threaten their relative position.
I think under globalization our elites have degenerated in quality in a spectacular fashion. That is part of the debt boom, the cultural part. The widespread decline of the middle class is yet another.
I’ve brought up this point in the form of a question “Does free trade include shoplifting?”. There have been several large fencing rings that have had the highest possible ebay ratings, and the thieves were very responsive to the market.
But my larger point is whether it is OK as long as I steal from nameless individuals in China – and Pollution is a property violation, inflation steals value (the artificial interest and exchange rates), and just general contract violations (“we’ll take your farm for this factory but you will have a nice job in exchange”).
Mattel found that even if you theoretically own everything and the contracts say don’t use toxic paint, they get toxic paint.
I’m for free trade, and I’ve put it in words that Ron Paul simplified – you don’t need 10,000 pages for a free trade agreement. We both hate NAFTA and the WTO.
Reading “Free Lunch” by Johnston, any agreement is usually to protect the entrenched interests – and actually would prevent more businesses than would be created. But he makes the point several times that subsidy is not free trade. Having the taxpayers bear the cost of externalities is also not free trade.
This gets comic. Jim Puplava on his show complains that if Bankruptcy judges can modify mortgages contract terms that no one will every loan money again. (They won’t except at traditional 20% down with a pay stub which is a good thing). But he is worried about the CDS market and they are all contracts. And will go into bankruptcy. Where judges will modify contract terms.
I think people’s instincts are right – the highly structured experiments (also something like the Monty Hall paradox) don’t represent the real world in the sense that if someone is benefiting too much even if you benefit, there is usually an externality or something else making someone poorer. Sometimes it is possible for people to be lucky, but more often disparate results indicate cheating.