The Future of Globalization

Explorations in Light of Recent Turbulence

Ernesto Zedillo

• Publisher: Routledge
• Year: 2014
• Print ISBN: 9780415771849
• eBook ISBN: 9781134003181
• Topic: Business
• Subtopic: Business General
• Index: Business

Erudite and topical, this well balanced treatment, with essays from world renowned contributors including the former President of Ireland – Mary Robinson, Jagdish Bhagwati and Nobel prize winner Joseph Stiglitz, considers the forces that propel globalization and those that resist it. Local and regional experiences from Bangladesh, China, India, Latin America and the Middle East are analyzed along with some of globalization's most potent risks.

Giving voice to sophisticated and illustrative reasoning, The Future of Globalization offers useful insights into the extraordinary human achievement brought about by increasing international economic integration, interdependence and interconnectedness, and shows how this has been a powerful force for the progress of humankind. The contributors take stock of the debate on globalization and explore ways to make globalization more beneficial for individuals, communities and countries, as well as ways to reduce its insufficiencies and mitigate the risks it faces.

This book will benefit all students of economics, political science and international relations, among others, and is useful to courses that focus on globalization and its impacts.

Part I

Forces that propel, forces that resist

1 Missing ingredients of globalization

Hernando de Soto

Capitalism’s hour of greatest triumph is its hour of crisis. The fall of the Berlin Wall ended more than a century of political competition between capitalism and communism. Capitalism virtually stands alone as the only feasible way to rationally organize a modern economy. At this moment in history, no responsible nation has a choice. As a result, with varying degrees of enthusiasm, third world and former Soviet nations have balanced their budgets, cut subsidies, welcomed foreign investment, and dropped their tariff barriers. Unfortunately, however, their efforts have been repaid with bitter disappointment. From Russia to Venezuela, the past half-decade has been a time of economic suffering, tumbling incomes, anxiety, and resentment.

Three major obstacles keep the third world and former communist nations from benefiting from capitalism: 1) an inefficient division of labor in the local informal market; 2) an accompanying insufficient level of specialization in the expanded market; and, most notably, 3) a lack of an effective legal framework to protect property rights. Two-thirds of the world’s population continues to live with these shortcomings, leaving many emerging market countries without the mechanisms needed to produce capital and enhance productivity.

The key to overcoming these inefficiencies is to address the third obstacle: the lack of a coherent, standardized property system. As I will show, an integrated formal property system, accessible to all, allows for broad specialization and division of labor throughout the economy, enabling the creation of an expanded market network and surplus capital.

Contrary to some misconceptions, the difficulties some newly capitalist countries have faced have nothing to do with so-called deficiencies in cultural or genetic heritage. Would anyone suggest “cultural” commonalities between Latin Americans and Russians, who in the last decade have shared the same political, social, and economic problems? Rather, successful capital formation depends upon developing strong domestic institutions—principally a sound legal framework and a comprehensive property right system—to create economic value. Developing and former Soviet countries possess enormous economic resources—which my colleagues and I at the Institute for Liberty and Democracy estimate at US$9.3 trillion of dead capital—but they lack the institutional development needed to unlock the invisible potential of these assets. Until the mechanisms to tap these substantial resources are in place, globalization will remain inequitable and the economic reforms underway will open doors only for small and globalized elites, leaving out most of humanity.

This state of affairs is relatively easy to correct, provided that governments are willing to legally integrate the informal sector into the broader economy and to allow the majority of developing countries’ citizens to convert their work and savings into capital. Ultimately, the key to addressing the three obstacles rests upon the creation of formal representation through standardized property arrangements and enforceable contracts. This process allows people to lose their anonymity and specialize in the broader economic system—which, in turn, boosts productivity. Similarly, formal representation of property rights fosters the creation of capital and allows the developing world to tap its vast hidden resources. In this regard, an integrated property system would provide the mechanisms needed for actors in the extralegal system to legally fix the economic potential of their assets so that these can be used to produce, secure, or guarantee greater value in the expanded market.

The extralegal sector

The extralegal sector is omnipresent in developing and former Soviet countries. Walk down most streets and you are bound to bump into extralegal shops, currency exchange, transport, and other services. Even many books for sale have been printed extralegally. Entire neighborhoods have been acquired, developed, and built on the fringes of, or in direct contravention of, government regulations. Throughout Latin America, my colleagues at the Institute for Liberty and Democracy have found that at least six out of eight buildings are in the informal, undercapitalized sector and that 80 percent of all real estate is held outside the law. According to most estimates, the extralegal sectors in the developing world account for 50 to 75 percent of all working people and are responsible for between one-fifth and two-thirds of the total economic output. By 2015, more than fifty cities in developing countries will have five million or more people, with most living and working extralegally.

Extralegality is rarely antisocial in intent. The “crimes” extralegals commit are designed to achieve such ordinary goals as building a house, providing a service, or developing a business. Far from being the cause of disarray, living outside the law is the only way settlers have to regulate their lives and transactions. Informal sectors throughout the third world and in former Soviet countries buzz with hard work and ingenuity. Street-side cottage industries have sprung up everywhere, manufacturing anything from clothing and footwear to watches and handbags. There are workshops that build and rebuild machinery, cars, even buses. The new urban poor have created entire industries and neighborhoods that have to operate on clandestine connections to electricity and water. There are even dentists who fill cavities without a license.

Above all, contrary to their lawless image, people who engage in extralegal activity share the desire of members of civil society to lead peaceful, productive lives. Unfortunately, a number of obstacles prevent them from leading such lives.

The first obstacle: an inefficient division of labor locally

Economic specialization—the division of labor and the subsequent exchange of products in the market—is the source of increasing productivity and therefore “the wealth of nations,” according to the great classical economist Adam Smith. Smith employed his well-known pin factory example to highlight the productivity benefits of the division of labor. In this example, under normal circumstances, a single pin-maker cannot hope to make more than twenty pins in one day. However, when labor in the pin factory is distributed appropriately among a team of specialized laborers (one person buys the wire, another straightens it, and yet another hammers a head on each wire) those workers can make upwards of 48,000 pins in a day.

Aristotle earlier put forth a similar point. For Athens, he observed that the key source of production was the division of labor, enabling industry to succeed in the city relative to the surrounding provinces. For instance, when making sandals in the city, workers would specialize in the various stages of production: one would cut the leather, another would stitch it, and yet another would sew the pieces together into their final form. In contrast, there was no division of labor in the provinces. The same worker who built a window was the one who built your chair; the same person who built your door was the one who supplied your shoes. The lack of division of labor in the provinces impeded productivity relative to the more specialized Athens.

Today, a key constraint on distributing labor effectively and increasing productivity in developing countries is the lack of formal representation and enforceable contracts in the sizeable informal sector, where the majority of new employment takes place. Since 1990, according to the International Labor Organization, more than 85 percent of the new jobs in Latin America and the Caribbean have been created in the extralegal sector.

Unfortunately, without established law, extralegal businesses in the developing world can deal only with people they know and trust, such as family members or people from the local community. Seventy to eighty percent of the population in developing countries and even the former Soviet Union actually work in small to medium-sized family-organized enterprises. Such businesses have some key shortcomings that hinder their opportunities to divide labor adequately and reap the rewards of specialization. First, their size is limited by the size of the local family or community. Second, the constraint of selecting workers from only the local community inhibits a firm’s capacity to seek out workers with specialized skills. Accordingly, without the proper division of labor, businesses in the extralegal sector do not reach the productivity required to produce 48,000 pins, or for that matter, to compete with larger firms on either the national or the international level.

This contrasts sharply with firms in the developed world. These businesses are able to hire specialists from a market of anonymous people because the legal system adequately protects the interests of the firm, through limited liability and clear rules that safeguard assets and innovation. The legal system in developed countries thus promotes specialization across the broader economy. Indeed, as Adam Smith pointed out, the wider the market, the more minute the division of labor can be. And, as labor grows more specialized, the economy grows more efficient and productive, and wages and capital value rise. In many developing countries, by contrast, a legal failure that prevents enterprising people from negotiating with strangers defeats the division of labor and confines would-be entrepreneurs to small circles of specialization and low productivity.

The second obstacle: insufficient specialization in the broader market

The lack of division of labor locally thus inhibits specialization in the broader economy. Unfortunately, until citizens in the informal sector are able to participate in the broader national economy, overall developing country performance will remain lackluster, unable to gain from the productivity benefits of a large, specialized labor force. The key, as alluded to earlier, is to incorporate these extralegals into the national and global economy by giving them legal definition and formal representation. Here I will focus on how legal definition can overcome the second obstacle, the lack of broad market specialization.

Most of the developing world today lives outside the law because poorer countries lack the institutions to integrate extralegal citizens into the formal sector, fix their assets into fungible forms, make their owners accountable agents, and provide them with connecting and leveraging devices to allow them to interface productively and generate capital within a larger market.

Accordingly, people living in the informal sector develop a variety of extralegal arrangements to substitute for the laws and institutions they need to cooperate in an expanded market. These arrangements represent combinations of rules selectively borrowed from the official legal system, ad hoc improvisations, and locally devised customs, and they are held together by a social contract supported by the community as a whole and enforced by authorities the community has selected. While this allows extralegals to transact business with clarity in their local communities and villages, they lack the legal description, and thus identity, to transact more broadly in the national economy. Essentially, they are not in a position to specialize in a market of anonymous people.

For example, when I arrived in the United States from Peru this past month, the customs officer asked me to identify myself. I replied, “I am the son of Alberto Soto de la Jara who comes from Arequipa in southern Peru.” The officer countered with a steely, aggressive stare. I then listed the people I know in the United States, including former President Bill Clinton and Governor Arnold Schwarzenegger, but the officer still glared at me coldly. Finally, he said “Your passport.” I handed it to him and he suddenly smiled warmly since he now could identify me. Bertrand Russell, the British philosopher, described this phenomenon. He said there are two types of knowledge in the world: knowledge by acquaintance and knowledge by description. All truth, however, is in description. In this particular case, I only became connected with the broader world, outside of my community of acquaintances, once I presented the customs official with my legal description, or passport.

The problem I faced before I presented my passport to the customs official is the problem confronted by most of the developing world today: a lack of legal definition. Globalization will not work for the majority of people in the developing world until they are able to enter this broader, legal web of anonymous people. Without legal clarity, there is no possibility of exchange in the expanded market, and, therefore, there is no possibility of getting credit. Credit is derived from the Latin credere, which means “to believe”. People are likely to believe, or have faith, in the good standing of their local acquaintances. But they are unlikely to have faith in the good standing of an anonymous person unless they are presented with some type of legal accountability.

The costs to remaining outside the law are therefore significant. Without formal institutions and laws, people lack incentives to seize economic and social opportunities to specialize within the broader marketplace. It is tremendously difficult for them to acquire legal housing, enter formal business, or find a legal job. Indeed, people who do not operate inside the law cannot hold property efficiently or enforce contracts through the courts, nor can they reduce uncertainty through limited liability systems and insurance policies or create stock companies to attract additional capital and share risk. Being unable to raise money for investment, they cannot achieve economies of scale or protect their innovations through royalties and patents.

Common standards in one body of law are thus necessary to create a modern market economy. Most of the world is a world without enforceable statements, and is based on localized beliefs, rather than facts. Localized beliefs work well if you are living and transacting business in a village where everyone else knows your identity, but not in the broader national and global context. Without enforceable statements, there is no liquidity and there is no possibility of separating family from business. Moreover, the lack of enforceable statements restricts interaction not only between the legal and extralegal sectors but also among the poor themselves. In this scenario, extralegal communities do interact with each other, but only with great difficulty. They are like flotillas of ships that remain in formation by navigating with reference to each other rather than to some common and objective standard, such as the stars or a magnetic compass.

Standard representations through enforceable statements can overcome these problems by enabling a web of connections between strangers. Legal representations allow people to lose their anonymity, trust one another, and transact and specialize in the broader economic system. This, in turn, boosts productivity and allows developing societies to overcome the first two obstacles to benefiting from capitalism: the lack of a division of labor locally and the ability to specialize in the broader economy. Additionally, formal representation of property rights fosters the creation of capital and allows the developing world to tap its vast hidden resources, as we will now explore.

The untapped resources in the developing world

Many people in developing countries hold resources in defective forms: houses built on land where ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them. Because the rights to these possessions are not adequately documented, these assets cannot be readily transformed into capital, cannot be traded outside of narrow circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.

This defective or dead capital, virtual mountains of it, lines the streets of every developing and former Soviet country. In the Philippines, by our calculation, 57 percent of city dwellers and 67 percent of people in the countryside live in housing that is dead capital. In Peru, 53 percent of city dwellers and 81 percent of people in the countryside live in extralegal dwellings. These figures are even more dramatic in Haiti and Egypt. In Haiti, according to our surveys, 68 percent of city dwellers and 97 percent of people in the country-side live in housing to which nobody has clear legal title. In Egypt, dead-capital housing is home to 92 percent of city dwellers and 83 percent of people in the countryside.

To the outside observer, the extralegal settlements that people inhabit may look like slums, but they are quite different from the inner-city slums of advanced nations. The latter consist of once-decent buildings falling apart from neglect and poverty. In the developing world, the basic shelters of the poor are likely to be improved, built up, and progressively gentrified. Whereas the houses of the poor in advanced nations lose value over time, the buildings in the poor settlements of the developing world become more valuable, evolving within decades into the equivalent of working-class communities in the West.

Indeed, in every country that my colleagues and I examined, the entrepreneurial ingenuity of the poor has created wealth on a vast scale—wealth that, in aggregate, also constitutes by far the largest source of potential capital for development. According to the data that my research team and I collected, block by block and farm by farm in Asia, Africa, the Middle East, and Latin America, most of the poor already possess the assets they need to make a success of capitalism.

By our calculations, the total value of the real estate held but not legally owned by the poor of the third world and former Soviet nations is at least US$9.3 trillion. This is a number worth pondering. It is about twice as much as the total circulating US money supply. It is very nearly as much as the total value of all companies listed on the stock exchanges of the world’s twenty most developed countries. It is more t...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of figures
• List of tables
• Contributors
• Preface
• Acknowledgements
• Abbreviations
• Introduction
• PART I Forces that propel, forces that resist
• PART II Trade, growth, and inclusion
• PART III Local and regional experiences
• PART IV Some of the risks: markets, finance, migration, and the environment
• Index