CONSEQUENCES OF GLOBALIZATION FOR DEVELOPING ECONOMIES
Muhannad El-Mefleh
National University
This paper investigates the consequences of globalization for developing economies in terms of its impact on employment and real wages, poverty and income inequality, economic growth and competitiveness, and the governmental role in economics. The major findings of this paper are that (1) the IMF emphasis on fiscal policy discipline before making institutional reforms was a major mistake that led to higher unemployment rates, poverty, and lower real wage rates; (2) poverty in terms of absolute numbers continues to increase except in East Asia and the Middle East; (3) income inequality between the advanced industrialized countries and developing countries, and within individual countries is increasing; (4) developing countries that are more integrated with the world economy are producing a better growth rate than countries that have less integrated economies; and (5) governments in developing economies deregulate labor markets, reduce government spending on social services, open their economy for foreign trade and investment, and privatize public assets.
The purpose of this paper is to in investigate the consequences of globalization for developing economies in terms of its impact on employment and real wages, poverty and income inequality, economic growth and competitiveness, and the government role in economics. Linkages of the economy of one nation to other nations come in the form of goods and services flows, capital and labor flows, technology and information flows, and financial flows. Nations are endowed with different economic resources, people have different tastes, and different products require different technologies or resources. Therefore, trade can benefit the participants by increasing competition and consequently reducing the potential of monopoly power, and by increasing specialization and division of labor which raises productivity.
Globalization means, in the context of this paper, an unrestricted flow of merchandise, services, investments, ideas, but not people between nations. Also, it implies internationalization of corporate strategy in production, marketing, and research. The rise of IMF control over the developing world economies was the result of the debt crisis of the the1980s. The increase of oil prices in late 1970s and the contractionary monetary policy of the U.S. during 1979-1982 period led to the increase interest rate, and consequently, indebted developing countries found themselves unable to service their debt. Continual refinancing was the only way to avoid default. The IMF was ready to take charge, and the developing countries had no choice but to accept the austerity measures of the structural adjustment program designed by the IMF. Private banks and government lenders would not extend loans without the IMF austerity measure being implemented by the developing countries. The structural adjustment program consists of contractionary fiscal and monetary policies, a decrease in public sector employees, and deregulation of labor market for flexible real wages. The program also eliminated food subsidies, increased agricultural prices, depreciated currency, privatized state assets, ended export support strategy and import substitution policy, and opened the economy permitting foreign trade and investment (for more details see Elliot 1999.) The structural adjustment program led to increased poverty, flight of financial capital to developed countries, increased globalization of the world's exchange and capital market, and an undermined economic development programs in the developing countries (Gill and Law 1988.) According to Cavanagh, Welch, and Retallak (2000) more than 100 developing countries have accepted the implementation of the austerity measures since 1980. The IMF believed that the private sector is more efficient than public sector in providing services and developing countries need to have a balance budget. The consequences of the globalization impacted employment and real wages, poverty and income inequality, economic growth and competitiveness, and the government role of the new global era. Also, globalization has an impact on women, child labor, branding, technological advancement, industrial clustering, environmental regulations, agricultural subsidies, and financial instability in developing economies.
EMPLOYMENY AND REAL WAGES
The implementation of IMF austerity measures by developing countries led to deregulation of the labor markets and made their economies more attractive to foreign investment. These changes in labor laws made it easier for firms to layoff workers, and propelled real wage flexible downward. Also, some governments discouraged or made it illegal for labor to form a union. These measures benefited capital at the expense of labor, failed to reduce unemployment, and moved workers from low productivity activities to unemployment.
Contractionary fiscal policy reduces the ability of a government to play a role in reducing unemployment. In developing countries, government employees represent a significant portion of the total employment in the economy. Nicaragua, Kenya, Uganda, Yemen, Zambia, and Nigeria are examples of draconian cut in government employees according to Lloyd and Weissman (2001). Downsizing the government sector by privatization as a part of austerity measures increased unemployment by laying off workers in the enterprises targeted for privatization to make those enterprises more profitable and attractive to private investment. After a short period of privatization, private employers did the second round of layoffs.
The higher interest rate, due to contractionary monetary policy to stabilize prices and exchange rates, made it harder for local firms, especially small ones, to acquire needed finance for expansion or survival. This rise in interest rate increased unemployment. The private sector, healthy local companies, and the new foreign-owned companies were not growing fast enough to absorb the rising unemployment.
The openness of the economies of developing countries to foreign investment and trade made it difficult for some of the local industries to survive in the face of far more sophisticated global corporation with superior financial resources and marketing strategies. This competition led to closing down some of the local companies which also contributed to the rise of unemployment.
In order for the developing countries to generate an accelerated growth rate and pay back their debt, they followed the instructions of the IMF by relying on export strategy and currency devaluations. Simultaneously, the efforts of developing countries to expand their exports of similar products of agriculture and minerals increased the supply of these products more than the demand growth for these products. This glut led to the decline of the prices of these products and consequently the deterioration of these countries' terms of trade. Some of these countries increased the volume of exports to compensate for the price declines of their exports, which made their terms of trade deteriorate even further. Examples are phosphate, coffee, shoes, cloths, and even oil. The result was a decline in GDP, wages, and revenue for these countries and decline in profit for their companies. Devaluation of currencies to stimulate exports made imports of capital equipment and energy needed for development more expensive and consequently weakened potential economic growth. According to the World Bank (2002), wages the last twenty years in the more globalized developing economies grew by 30%, while less globalized nations’ wages grew by 15%. During the same period the advanced industrialized countries’ wages grew by 20%.
The above policies reduced real wages, according to Cavanagh (2000), in Haiti, Sub-Sahara Africa, Costa Rica, and Hungary for example. Also, unemployment rates increased in the developing world rather than decreased. The decline in wage rate, increase in unemployment rate, and lack of social safety nets made the problems facing the developing world harder to bear.
POVERTY AND INCOME INEQUALITY
The shift of emphasis on production from local consumption to export-oriented products led to an increase in the dependency of developing countries on imported foods. The reduction and finally the removal of the price support of food items in order to have a balanced budget, and the price increase of imported food items due to devaluation of their currencies led increase poverty and social unrest in many countries, as was the case in Asia and South America. According to the World Bank Report (2000), the percentage of the poor in developing countries declined from 28.3% in 1987 to 24% in 1998 based on one dollar per day per individual; and from 61% to 56% based on two dollars per day per individual during the same period. However, these percentages are misleading because the decline in poverty was due to one country alone; China. Poverty in terms of absolute numbers continues to increase except in East Asia and the Middle East. According to Arnold (2001), most of Southeast Asia’s 500 million people (excluding China) live in rural areas and have a hard time dealing with lower wages and higher prices, due to their economic crisis in 1997-1998 and the IMF’s austerity measures implemented by their respective governments. Arnold continues to say that the poverty rate in Indonesia increased from 17% in 1996 to 26% in 1999. The export-oriented economic growth model is now facing serious questions about its viability. The export-oriented model may be appropriate when the world demand for the products of developing economies is rising, but the negative effect is that these economies are more vulnerable to the down phase of the global export cycle. Volatility in the world economy impacts developing countries more than the advanced industrialized economy.
The exported goods by developing countries have, in general, a highly inelastic supply curve relative to the manufactured products produced by the advanced industrialized countries. This inelasticity makes the developing economies vulnerable to the demand conditions. Consequently, a decline in the demand condition for a primary product will decrease prices substantially, which reduces their income from exports, which in turn increases unemployment and poverty. The value-added process for primary products must be used in developed economies to increase income and reduce poverty.
The gap between the richest twenty countries and the poorest twenty countries has doubled during the last forty years. However, the gap between the average income in advanced industrialized economies and the average income in developing economies declined during the same time period due to the rise in income in China and India, where they represent more than one third of humanity (see World Bank Report: 2000). Because economic openness increased the return on skills and education, it also increased wages in the sector where direct foreign investment increased. However, wages in the protected sectors declined. The need for better social services will reduce the tendency of the open economy to create inequality. In order for governments in developing countries to receive an extension in their loans from the IMF, many of these governments adopted pension reforms in the form of increasing the retirement age, increasing employees contribution, and increasing the minimum years of contribution needed to be eligible for benefits. These changes tighten the eligibility standard for disability benefits.
Income inequality between the advanced industrialized countries and developing countries and within countries is increasing due partly to economic globalization of free foreign trade and investment, privatization and IMF structural adjustment programs for developing countries. According to Mander and Barker (2002), cited studies show that the income of the richest 10% of the world increased by 8% while the income of poorest 10% declined by 25% during 1988-1993. The growing income inequality is rising even in the U.S., where the share of the income for the top 20% of income-receivers is increased from 40.6% to 47.2% from 1969 to 1999 while the share of income going to bottom 20% declined from 5.6% to 4.3% during the same period. Also, in the U.S. the share of the bottom 60% of income-receivers declined from 35.7% to 29.8% between 1969 and 1999 (see McConnell and Brue 2002.) Slaughter and Swagel (1997) argued that globalization has very little effect on income inequality in the advanced industrialized countries, but technology is the reason behind the increased compensation of high skilled workers.
Mander and Barker argued that the brief success of some Asian economies came as a result of following opposite policies prescribed to developing nations by the IMF. The authors blame the financial crisis of Asian economies of 1997-1998 to the free foreign trade, free movement of financial investment, and global corporations. Also, they argued that global trade and financial rules are designed to benefit capital at the expense of labor. The increasing participation in international trade and openness by China starting in 1978, Uganda in 1986, Vietnam in 1989, and India in 1991 accelerated economic growth and reduced poverty in these countries (Dollar 2001). But in most of developing world, the austerity programs led to mass suffering of the poor and to a concentration of ownership in the hands of the local elite and global corporations. The rise in the percentage of poor people will continue to threaten the stability of these countries.
The World Bank Report (2000) argued that developing countries were more successful when they increased their integration with the world economy. They produced a better growth rate and a reduction of poverty more than countries that had less integrated economies. On the other hand, one has to be careful when analyzing the impact of trade integration among the poorest, unskilled and semi-skilled workers in developing countries. The import of capital goods has a tendency to be a substitute input for labor. For example, the import of a bulldozer will replace the need for hundreds of manual laborers. The rise of unemployment did not prevent economic growth in some countries due to technology and capital equipment.
ECONOMIC GROWTH AND COMPETRITIVENESS
Economic growth theory is not a useful guide in helping the developing world create their strategy for growth. An open economy can generate and accelerate economic growth rate due to specialization and the use of imported advanced technology from the developed world. On the other hand, it is possible to show that a protection of domestic firms from foreign competition can accelerate economic growth. Relying on theory will not provide us with an optimal policy solution for economic growth; therefore, we will rely on an empirical result rather than a theoretical one.
The last wave of globalization started in late 1970s created the move toward privatization and openness for foreign trade and capital. Governments sold their shares in mines, factories, airlines, railroad, utilities, telecommunications sector, and other assets as part of privatization effort to achieve an accelerated growth rate. The developing world has a debt problem that started in early 1980s as a result of the substantial increase in interest rate, the recession of the industrialized world, and the decline of the prices of basic commodities. The private lenders, IMF, and the advanced industrialized governments refused to help solve the debt crisis of the developing world without restructuring their economy by privatization, devaluation of the currency, and opening their market for foreign trade and investment. When the developing governments sold their assets, the local elite and multinational corporations bought these assets.
The principle of comparative advantage, which was explained by David Ricardo in early 19th century, is still the basic argument for economists advocating free trade. The basic argument of comparative advantage is that if every person or a country specialized in the things that have a lower opportunity cost for them than for others, the trade outcome will produce a higher GDP and higher standard of living. Comparative advantage comes from infrastructure, technology, capital, rich domestic market, legal framework, management, marketing network, finance, human resources, and low wages. According to Greider (2000) developing nations have comparative advantage in low wages only while the advanced industrialized countries have it in all others. Schwab and Smadja (1994) argued that access to cheap labor by Western European companies to East Europe, and Japanese firms to South East Asia, and U.S. corporations to Mexico created an opportunity for manufacturers. The increase of exports of manufactured products from developing countries created a tension between the low wage countries and high wage countries. Advanced industrialized countries' efforts to link trade with human rights, workers' rights and compensations, environmental standards, and social conditions appear seems to developing economies, with their high rate of unemployment, as a way to prevent them from using the major comparative advantage they have in the world market. The industrialized countries are using their comparative advantage fully in the areas of technology, management techniques, marketing, finance, and human resources. Japanese firms for example are known to make every effort not to transfer technology or hire local managers or locate research centers outside Japan. Globalization will create tensions, but if these tensions are managed well, then globalization can improve standards of living of all countries.
David Ricardo’s theory of comparative advantage is based on the assumption of full employment, constant costs (no economies of scale), and immobility of factors of production between countries. The international flow of capital and labor was insignificant in Ricardo’s time, but not in current conditions. Competitive advantage can be achieved in labor cost, economies of scale in new manufacturing technology, exchange rate, protection, distribution position, brand loyalty, and acceleration of product life-cycle. Labor cost and economies of scale are vulnerable to economic development, exchange rate fluctuation, new manufacturing technology, and protection in the export market. Japan used labor cost as a primary cost advantage, and then moved to invest in new technology that gave quality to their product and the benefit of economies of scale.
Global companies use cross-subsidization to compete successfully with other firms. This practice may create a challenge to local companies. The global company may use a small portion of its world-wide business in price competition if the global company has little to lose and much to gain, while the local company has to sacrifice some of its margin in its only market. Cross-subsidization is the use of accumulated financial resources in one market to fight fierce competition in another market. This practice is not dumping, but squeezing the competitor's margin to the point where spending on research and development (R and D) by the local company becomes a problem. Cross-subsidization leads to a reduction of the local company's market shares or in some cases to losses by the local companies to the aggressive global competitors. Cross-subsidies with economies of scale also give global companies a comparative advantage over local and small companies. Cross-subsidies with retaliation and brand-dominance describe some aspects of competition in a global market. International competition requires not just low cost manufacturing strategies but the ability to identify the global competitor's strategy. These strategies are building a strong domestic position, establish a presence in many countries, and pursuing strategy that is effective in each particular market. Competitive advantage can be achieved or gained from location, economies of scale which may require world-scale volume and global brand distribution.
Corporations have to think globally and cannot afford to think locally because price competition could be their elimination from the scene. Corporations have to think and build systems globally in the era of globalization. Companies need to develop a strong distribution position around the globe and brand name to gain competitive advantage. The shortening of product life-cycle makes new manufacturing technology an important instrument for gaining competitive advantage. Relying on protection (political solution) will give breathing space to local companies, but that reduces the incentive of the protected industries to invest in cost reducing technologies, and may over time increase the quality gap between the protected industry products and their world competitors. Price differences for the same product can be the result of collusion, trade restrictions, and different price elasticity for different groups of customers. These price differences can provide the tools needed for cross-subsidizations. Domestic oriented companies will have a difficult time surviving. Therefore, the best policy to fight this kind of cross-subsidization is by entering into the global competitors' major market. A global company seeking cost advantage can invest in developing countries to achieve competitive advantage. A company with a share leadership in one market (home market) and no international distribution is vulnerable to global companies entering the market and using price competition to eliminate the local company's profitability. Companies must be aware of global competition even when their manufacturing capability is local (see Hamel and Prahalad 1985 for more detail). Globalization can provide diversification for corporations, but it also adds larger costs associated with having to survive, since corporations need to go to the home market of their competitors to be effective dealing with the threat of cross-subsidization by their global competitors. The firms in developing countries lack access to the financial resources available to global corporations. Some of the developing countries, such as Jordan, sought out foreign corporations to buy out a significant share of the privatized sector in order to have access to the new technology and the money needed to pay off some of its debt.
GOVERNMENTAL ROLE IN ECONOMICS
Governments in developing economies have been used as an instrument in the hand of IMF to change labor laws, reduce government spending on social services, open their economy for foreign trade and investment, and establish privatization. Governments around the world have played an important role in economic development. The government helped to build industrial parks, subsidize industries, provide tax incentives, award concessions (protection from imports), prohibit labor unions from forming, and provide low cost loans for desired investments. One cannot rely on low wages for economic development in the long run. Technology can overrun the low wage advantage, and global corporations will reallocate their facilities to other countries where concessions are higher and wages rate of the host country is no longer competitive with other places accessible to the global corporations [see Magaziner and Patinkin (1989) and Greider (1997).] If companies can move their production facilities freely, then companies will be reluctant to locate those facilities in countries with high taxes, high tariffs, and costly economic and social regulations. Foreign investment can bring necessary government reforms that cannot be achieved through internal means. Corporations and skilled workers will move to more profitable environments with richer opportunities and better quality of life. That move may create social unrest in even the most advanced economy through the loss of jobs and industries to other countries. This loss of jobs and industries will bring about a loss of tax revenue which is needed for the government to invest in the infrastructure.
The reduction of tariffs on imports robbed governments in developing countries from needed funds for investment in education, health, and other infrastructures. Tariffs were used in developing economies for revenue purposes and not for the protection of domestic producers as in the case of advanced industrialized countries. The developing countries replaced tariffs with sales taxes, which are regressive in nature, in order to compensate for the loss of revenue from tariffs.
According to Reich (1991) Global corporations are managed by managers who are economically driven and less connected with people or place. These managers are trying to maximize profit, and the government's job is to make it attractive, productive, easy, and economical for corporations to locate in that country. The spillover benefits of investment in sophisticated factories, equipment, and R and D in a given country are many. The spillover benefits are higher wages for workers in that country, more jobs, higher tax receipts, the opportunity for government to invest in education, and provide better health care. These spillover benefits will reduce poverty, provide training programs, and create more innovation and wealth. A country will be more successful over time if it can attract the more value-added activities with higher positive externalities. These large positive externalities can be achieved by investing in the labor force and the infrastructure and by learning how to negotiate effectively with global corporations over time.
Governments around the world are negotiating with global companies to locate their new factories, branch offices, headquarters, and laboratories in their respective countries. Global corporations expect to pay lower local taxes on their properties than local residents do. The tax breaks that governments give corporations to attract them will have a negative impact on the government's ability to finance public investment. Therefore, governments should be aware of endangering the quality of the workforce and the quality of life which are more important in the long run for economic growth, than tax concessions and subsidies. Also, if concessions increase labor intensive methods of production, then employment, GDP, and welfare of society will rise. But if concessions increase capital intensive methods, then not only GDP and corporate profit will rise but also unemployment, poverty, and income inequality as the case for many developing economies.
Large nations can bargain better than small nations; therefore, if small nations can pool their bargaining power behind one representative, they will have an easier time getting the investments needed without huge concessions. According to Reich (1991) Japan's Ministry of International Trade and Industry acted as an agent to acquire foreign technology licenses and paid nine billion dollars to acquire technology from the United States that cost more than 500 billion dollars to develop between 1956-1978. If developing countries can successfully pool their bargaining power, they can gain lower bargaining costs for each country as well as bargaining for investments that have large positive externalities. These countries can compete effectively with other large trading blocks for global investment. The pooling of their bargaining power will avoid zero sum investment bidding. Developed nations have the ability to outbid developing nations in terms of subsidies to attract investment. Subsidies to attract investment are positively related to unemployment rate but negatively related to the skill level of its labor force. If developing nation investment subsidies could be pooled and used more effectively to subsidize R and D in their own economies, their economies would benefit more than relying on global corporations. Global corporations are more adapted to the new reality of globalization; they are faster than governments. It is important to understand the way globalization changed corporations' conduct of their operation principles, location and size.
The advocates of the inevitability of globalization (deterministic view) may sacrifice the more comprehensive analysis needed in order to achieve given predictions. The consequences of their predictions are that policy makers have no choice but to implement policies based on tautology rather than careful analysis. In economics as a social science, no inevitability exists; rather, we have evolutionary trends that are likely possibilities but not inevitable.
The reduction of public spending led to privatization of schools; the introduction of and increasing of school fees led parents of poor families to pull their children, mostly girls out of school. Some countries in Sub-Sahara Africa reduced the contact-hours of children in school and increased the teaching load for teachers in an effort to curtail spending. The impact of these kinds of cuts will be obvious in the future growth rate of productivity and innovations.
The IMF made an elimination of deficit spending by developing countries a priority condition of extending loans to these countries. The governments cut spending on all social services including health care by 50% in Africa during the 1980s. Not only public spending on health care services has been reduced but medical fees also increased which reduce the ability of the poor segment of society to access affordable treatments. Also, spending on preventive care, immunization, communicable diseases programs has been slashed according to Cavanagh (2000).
The reduction of government spending on environmental protection reduced the enforcement of environmental laws in Russia, Indonesia, Brazil and many other developing countries. The increasing competition between developing countries to attract foreign investment led to lowering or ignoring the environmental restrictions. The export oriented growth led to the extraction of timber and natural resources at an unsustainable rate. Lack of enforcement of environmental laws threatens the biodiversity of the planet.
It is widely recognized that the IMF emphasis on fiscal policy discipline before making institutional reforms was a major mistake that led to higher unemployment rates, poverty, and lower real wage rates, institutional instability, and economic instability in the developing countries. Developing countries need a financial regulatory body before opening their economy for foreign investment. Argentina has followed the IMF requirement since 1991. Their problems of rising unemployment, poverty (15 million out of 36 million are below the poverty line by early 2002 according to the Associated Press report in The Sacramento Bee, A12, February 4, 2002), recession, and the inability to service its debt, make the observer wonder if the austerity measures used by the IMF have any positive outcome. The Argentinean government pegged its currency to the dollar in 1991 which brought inflation under control; consequently, the appreciation of the dollar against the European currencies and the Euro during the last four years reduced the Argentinean competitiveness visa vie its own major trading partners. Therefore, many developing economies that pegged their currencies to any major currency should take the Argentinean experience into account when they assess and review the benefits and the costs associated with it.
Commodity agreements between consumer and producer nations would also be beneficial to developing economies if the producer and consumer nations agree about price floor and price ceiling. Using a buffer stock strategy, where there are funds set aside for buying when prices are below the price floor and selling when prices are higher than price ceiling, could help to maintain stable prices for the targeted products. This kind of agreement can be used for non-perishable and low storage cost products. Considering that developing countries have different cultures, ideologies, degrees of industrialization, important commodities for their economies, size of their economies, and income, commodity agreement will be harder to implement. It is not easy to duplicate OPEC. There is also the free rider problem even if these policies are implemented.
To alleviate poverty, government policies are needed to improve access to education, create a better investment climate, compensate older workers for job losses, create unemployment benefits, provide welfare benefits, ensure job retraining, and target programs to help the poor. Poorest countries need aid and debt relief to enable them to participate and gain from globalization. Developing economies would benefit greatly from more access to advanced economies (US, Japan, EU) and the elimination of the quota system that exists in the advanced economies.
Economic growth and the poor of developing nations will benefit greatly if the advanced industrialized countries of European Union, Japan, and the U.S. cut farm subsidies, which amount to hundreds of billions of dollars annually, and lower their agricultural trade barriers.
CONCLUSION
The IMF emphasis on fiscal policy discipline for developing countries before making institutional reforms was a misguided policy that led to higher unemployment rates, poverty, and lower real wage rates. The number of people in poverty continued to increase. Income inequality between the advanced industrialized countries and developing countries, and within individual countries is increasing. Governments in developing economies deregulated labor markets, reduced government spending on social services, opened their economies for foreign trade and investment, and privatized public assets. These actions led to a further increases in unemployment and poverty rates. The openness of these developing economies to foreign trade and investment should not be the goal by itself, but rather an instrument to be used wisely to reduce poverty and improve the standard of living. Other aspects of globalization will be worth investigation in depth in terms of their impact on women, child labor, branding, technological advancement, industrial clustering, environmental regulations, agricultural subsidies, and financial instability in developing economies.
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