Inflation (Finance) ; Trade ; Free trade ; Economic development

anonymous

English

Research Papers in Economics

new research world, and there is much to
learn, with potentially new guideposts for
the conduct of monetary policy.
Q: How does globalization influence economic
performance?
A: Globalization affects economies in two
broad ways. The first largely involves the
private sector, where self-interest and incen-
tives lead companies and individuals to effi-
ciently produce what consumers want.
Globalization means more competition,
greater specialization and expanding mar-
kets, which increase productivity and spark
innovation. They, in turn, raise living stan-
dards. Adam Smith became the father of
modern economics by bringing the world
this brilliant insight in his book The Wealth
of Nations.
The second way globalization raises
living standards—less heralded though no
less important—is by disciplining the pub-
lic sector. Because globalization entails
greater mobility for factors of production, it
puts governments in direct competition for
the planet’s productive resources—capital,
labor, businesses and ideas. Nations that
run their economies more effectively will
benefit by attracting more of those
resources; those that shackle the private
sector will see key factors of production
drain away.
Q: Can you measure globalization’s impact on
public policies?
A: Economic performance is influenced by
how governments raise taxes, spend money,
regulate business, treat investment, encour-
age innovation, enforce the rule of law and
protect property rights through the judicial
system. Policies regarding money and infla-
tion, international trade and investment,
immigration, energy, education and labor—
they, too, have an impact on the economy.
And don’t forget the issue of stability—the
consistency of policies over time.
Researchers at the World Bank, the
Fraser Institute, Harvard University, the
Heritage Foundation, Transparency
International and other think tanks have
done excellent work in rating nations on a
wide range of policies. Harvard’s Institute
for Strategy and Competitiveness, for exam-
ple, tells us that the United States, the
Netherlands and Singapore offer the best
environment for innovation, while
Bangladesh, Peru, Nigeria and Romania are
the worst.
With all these data, we can probe for
links between globalization and policy. The
management consulting firm A.T. Kearney
and Foreign Policy magazine publish a
globalization index, ranking roughly 60
countries from least to most globalized.
The U.S. comes in fourth, behind
Singapore, Switzerland and Ireland. Iran
comes in last. 
Q: And you found?
A: In general, the countries that are more
globalized tend to pursue better economic
policies. They don’t do it because they’re
more enlightened, although they may well
be. They do it because it is the way to hold
OnTheRecord
Q: What do you mean by globalization?
A: The term describes the freer movement
of goods, services, people and ideas across
international borders. It’s been going on all
around us for quite some time, but it has
accelerated in the last decade or two. 
Trade between countries as a percent
of gross world product has risen from just
15 percent in 1986 to nearly 27 percent
today. As a percent of gross world product,
the stock of foreign direct investment has
nearly quadrupled since 1986, and the
stock of portfolio investment is up by a
multiple of eight.
We’re not only seeing more trade and
investment but also more personal con-
tacts. In 1950, just one visitor arrived in
another country for every 100 residents. By
the mid-1980s, there were six; today, the
number is double that.
Global communication is where we
see some of the biggest advances. The
spread of the Internet, e-mail, computers
and cell phones connects an increasingly
multilingual global economy. Since 1991,
international telephone traffic has more
than tripled, while cell phone subscribers
have grown from virtually zero to 1.8 bil-
lion people—30 percent of the world’s
population—and Internet users will soon
top 1 billion.
This rapid globalization is changing
the way the U.S. economy works. So we
have to change our thinking. The old ana-
lytical models and policy rules are no
longer adequate in a world where geo-
graphic and political barriers are no longer
economic barriers. When Richard Fisher
became Dallas Fed president in 2005, he
shifted our research focus to globalization.
Over the past year or so, the economics
team has begun to delve into various
aspects of globalization. It’s an exciting
A Conversation with W. Michael Cox
Globalization and Public Policy
Dallas Fed chief economist W. Michael Cox discusses how the increasing integration of the world
economy goes hand-in-hand with sound money, efficient regulation and other policies that pro-
mote economic growth and freedom.
SouthwestEconomy FEDERAL RESERVE BANK OF DALLAS • MAY/JUNE 2006 8and attract the mobile factors of production
that will make their economies more com-
petitive, spur growth and job creation, and
improve their living standards.
Q: Can you give us a specific example?
A: Inflation. From 2001 to 2003, the most
globalized quarter of nations had average
annual inflation of just 2.3 percent. The
average inflation rate rose to 3.1 percent for
the second group, 6.2 percent for the third
group and 10 percent for the least global-
ized quarter. This is no accident. The much-
respected Economic Freedom of the World
index, developed by the Fraser Institute,
shows that more-globalized nations tend to
pursue sounder monetary policies. 
Inflation is largely a monetary phe-
nomenon, but globalization changes the
economic environment in which central
banks operate. Money is probably the most
mobile factor of production—it can now
cross borders with a click of a computer
mouse. Open capital and foreign exchange
markets allow investors to move funds
quickly in search of the highest rates of
return, net of inflation. Nations that don’t
want to lose out wisely toe the line by
adopting new anti-inflationary policies.
Q: What about other public policies? 
A: Globalization raises the bar. The world’s
most globalized nations tend to have fewer
restrictions on international trade, more
open capital markets, fewer and better-
administered regulations, a more favorable
corporate tax environment and better poli-
cies to promote innovation.
Where you find the greatest degree of
globalization, you also find policies that
support more accountability in the private
and public sectors, courts that recognize
property rights and enforce the rule of law,
governments that are run more effectively
and are less corrupt, and government poli-
cies that tend to be more stable.
The pattern is remarkably regular—
step by step, as countries become more
globalized, they are more likely to pursue
the policies that contribute to successful
market economies. Of course, there is a
chicken-and-egg question of whether glob-
alization improves public policy or nations
with better policies are more successful at
globalization. It’s probably both. 
Q: Are all policies positively linked to globaliza-
tion?
A: An important exception is labor policies.
In general, labor market flexibility doesn’t
improve with globalization, although the
United States and other countries at the very
top of the globalized rankings tend to have
better policies, with the fewest restrictions
on hiring and firing. 
The United States doesn’t penalize
companies when workers lose their jobs,
while employers in many other countries
face significant burdens. The cost of giving
advance notice, severance and other penal-
ties, measured in terms of workers’ pay, is
165 weeks in Brazil, 112 weeks in Turkey,
90 weeks in China and 79 weeks in India.
The importance of nimble labor markets in
today’s increasingly interconnected world is
still something policymakers in many coun-
tries must learn.
Other exceptions involve fiscal policy.
Government transfers and subsidies become
more common as nations become more
globalized, and personal income taxes be-
come more burdensome as well. The most
globalized nations have had some success
in reducing the size of government. Beyond
that, though, governments tend to get big-
ger as nations become more globalized. 
Why does fiscal policy tend to worsen
with globalization? There are no definite
answers, but the explanation might be as
simple as factor mobility. When immigra-
tion laws prevent workers from voting with
their feet, governments can tax individuals,
then use the money for transfers and subsi-
dies to attract more mobile resources. Such
policies aren’t sustainable in the long term,
and many governments need to get their
fiscal act under control.
We don’t know about some other poli-
cies—immigration, energy and education,
for example. Indicators on these don’t exist.
On balance, though, the world does have
the answer about globalization, factoring in
both the private and public sectors.
Q: So why are so many people in America and
elsewhere uneasy about globalization? 
A: It’s partly because globalization, like new
technology, brings economic change.
Whether we’re talking about innovation or
opening markets, economic change creates
anxiety because it means some jobs, compa-
nies and industries will fade while others
rise to take their place. 
It’s also because globalization isn’t
well understood. People often can see the
downside of globalization—in, say, lost
jobs—but even when they see an economy
growing strongly with low inflation, they
don’t necessarily attribute the good times
to globalization.
Using data from the World Bank and
Fraser Institute, we can show that, for the
world as a whole, per capita income and
economic freedom have both been increas-
ing as globalization has spread in recent
decades. We should celebrate, not deni-
grate, globalization because it generally
reflects better government policies, leading
to higher living standards and freer people.
A more detailed exploration of this topic
can be found in “Racing to the Top: How
Global Competition Disciplines Public
Policy” in the Dallas Fed’s 2005 annual
report. It’s available on the Bank’s web site
at www.dallasfed.org.
FEDERAL RESERVE BANK OF DALLAS • MAY/JUNE 2006             SouthwestEconomy 9
“Rapid globalization is changing the way the U.S. economy
works. So we have to change our thinking.”

Globalization and public policy: a conversation with W. Michael Cox

http://dallasfed.org/assets/documents/research/swe/2006/swe0603e.pdf

Globalization and public policy: a conversation with W. Michael Cox

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