Is the free-market system good for developing countries? Is it actively harming their development? Or is there a third and better way? Nancy Birdsall says there are no easy answers in the debate over globalization –

Will globalization narrow the gap between rich and poor countries? Is it good for development in the world’s poor countries? Is it the key to achieving rapid declines in poverty around the world? Mainstream economists, once united on the merits of globalization, are now splintering into three groups – the cheerleaders, the cynics and the worried doubters.

None of these groups is antiglobalization as such, but the debate has intensified in recent years. It centres on how the global economic system (embodied by the World Trade Organization, the International Monetary Fund and the World Bank) ought to work, and what policies should be adopted by developed and developing countries. The economic and financial downturn that began in 2000 has only served to widen the differences.

The cheerleaders: let globalization roll

For economists the word “globalization” refers to the increasing integration of economies and societies, with the higher and faster flow of goods, services, finance, ideas and people across borders.

But it also refers, implicitly, to a set of policies that almost all economists hold dear: policies which emphasize the benefits of market transactions and thus of privatization, the dismantling of trade barriers and the deregulation of financial and other services.

In this sense globalization is about the spread of the liberal market system – a system which seemed to have triumphed just about everywhere by the close of the 20th century.

Most economists are, for most of the time, cheerleaders for the global integration of liberalizing, market-led systems.

They are joined by most heads of state, finance ministers, officials of the WTO, IMF and World Bank, members of the corporate and financial communities – and, in all probability, most readers of this magazine.

Globalization’s cheerleaders point to the tremendous declines in poverty in China and India that have accompanied the liberalization of their economies, their opening to foreign direct investment and their growing involvement in the global trading system. Their argument is straightforward. Integration into the global economy has brought rapid economic growth to China and India. Growth in these two big countries has pulled hundreds of millions of people out of poverty, as defined by the number of people living on $1 a day or less.

Indeed, the 1990s, a decade of global integration, brought the first ever decline in the number of people living in poverty – from about 1.2 billion worldwide to 1.1 billion, according to the World Bank. Those cheering globalization chant an almost holy mantra: trade is good for growth, and growth is good for the poor.

It is those countries that have successfully entered the global market and participated in globalization which have grown most in the past century or so, say the cheerleaders. They include Japan, beginning in the Meiji era between 1868 and 1912; the poorer countries of western Europe during the 19th century and then again in the post-World War II period of European integration; and, in the postwar era, Korea, Indonesia and Chile, among others.

Poverty remains highest in countries and regions – and for peoples – that are marginal to global markets, including many countries in Africa and some in south and central Asia, as well as the rural populations of China, India and Latin America.

Cheerleaders see the major task in these areas as the reform and adjustment of domestic policies, especially a reduction of the bureaucratic rents and insider corruption that undermine markets.

The cynics: the global rules are rigged

This minority group of economists is concerned that corporate and financial insiders are shaping the rules of the global system in their own narrow interests. The result is a system that is not fair (let alone efficient) and not friendly to development.

Their fear is echoed by development advocates, social activists, nongovernmental organizations working on environmental, labour and human rights issues and by much of the popular press. The cynics argue that, if globalization is to work for all, it is the global rules that have to be changed – not domestic policies and institutions.

The global trade system is the cynics’ best example. Citing the Common Agricultural Policy of the European Union and the recent Farm Bill in the United States, they say that political interests in the rich and powerful countries dominate good sense – these programmes subsidize farmers to the tune of $300 billion a year, six times the amount that rich countries spend on foreign aid.

Cynics worry that agricultural protectionism in rich countries will disguise itself in new health and environmental restrictions – as shown when west African producers of nuts lost $1 billion in exports as a result of a naturally occurring toxin.

The protection of textiles is the other example. The quota system with which rich countries protect textile workers from North Carolina to Milan is due to end at the beginning of 2005. But cynics predict that high tariffs and antidumping actions will still keep out exporters from poor countries.

The very process of complicated negotiations and dispute resolution puts poor and small countries with limited resources – to pay for the best lawyers, for example – at a disadvantage.

The resulting protection of agriculture and textiles is particularly pernicious because these are the sectors most likely to generate more and better jobs for the poor and unskilled in poor countries.

The cynics say that political constraints in rich and powerful countries also distort the way in which rules are implemented. Their most compelling example is the high cost of patented medicines in poor countries, which is made especially visible by the terrible impact of the AIDS pandemic in Africa.

Global trade rules – formalized in the WTO under the TRIPS, or trade-related intellectual property rights, agreement – aim to balance the incentives for inventors with the benefits of rapid, low-cost access to the resulting products. Cynics say that, even assuming that the TRIPS agreement itself strikes a good balance, its implementation has been rigged.

US pharmaceutical firms, they point out, have pressured the United States trade representative, Robert Zoellick, to threaten extra-WTO sanctions against poor countries such as South Africa and Brazil, which are prepared to use safeguards in the WTO rules to make and distribute products outside the patent system.

Only the public outcry – from nongovernmental activists – has protected these countries’ ability to minimize suffering and death among their own citizens.

Then there is international migration, the least liberalized of all markets. The rules that govern legal migration seem stacked against the poorest countries, and the weak and unskilled in those countries. Cynics decry the contrast between increased mobility and protection for global capital and the restricted, illiberal market for global labour.

The doubters and worriers: it’s complex

Doubters take the awkward position that life is complicated. Being economists, they have not given up on globalization altogether. But they doubt that more globalization, even with better rules, would produce the transformation that equitable and sustainable development implies.

Doubters argue that China and India are hardly paradigms of liberal, open economies – any more than were Korea, Taiwan and Malaysia in their years of miracle growth.

They worry that, in most countries and regions, the number of poor people continued to rise in the 1990s, heavily offsetting the gains made against poverty in China and India.

They note the meagre rate of growth of barely 1% per capita in the 1990s in Latin America, where the limited gains from global integration went to a privileged few who had a university education or a good sense of timing in shifting their assets abroad.

In sub-Saharan Africa the number of people is still increasing faster than the economic product. This is despite exchange rate reforms, the abolition of state monopolies and the “opening” of economies by reducing tariffs and export subsidies – all supported by repeated rounds of IMF “adjustment” loans and other official financing.

And what about the apparently endless “transition” to growth in countries of the former Soviet Union such as Ukraine, Belarus, Georgia and Russia itself? The doubters fear that the corruption associated with these countries’ privatization programmes has locked in privileges that will undermine competitive markets for years to come.

The doubters’ reservations are based on two textbook-style arguments. First, markets are imperfect and global financial markets particularly so. They are subject to extremes caused by the herd behaviour of investors and speculative market bubbles.

Emerging market economies, with their less resilient local financial markets and their warier creditors, are all too vulnerable to the panicked withdrawal of capital by investors – equivalent in scale and speed to a run on a bank.

This seems to be the case even when the overall management of their economies is reasonably sound. For these countries global trade has generally been a boon, but global finance over the past decade has mainly been a bust.

The resulting problems are not only a systemic threat to global financial stability. They are also bad news for the working poor and the nascent middle class in emerging markets. If global integration hurts these key constituencies too much or for too long, it may undermine democratic and other institutions and stir the resentment that feeds political instability, violence and even terrorism – risking the sustainability of the global market system itself.

Mexico, Thailand, Korea and Russia are recovering from the financial crises of the late 1990s. But their taxpayers will spend years financing the socialized public debt originally assumed by what John Maynard Keynes called the “rentier” class – private bankers and businesses. This will limit these countries’ ability to invest in health, education and infrastructure, which otherwise could build up their economies, accelerate growth and improve the lot of their poor.

In Argentina, Brazil and Turkey, the demands of the global market for fiscal responsibility – to minimize the risk of runaway public debt – brought several years of high real interest rates and high unemployment.

Argentina’s debt default is a special disaster from the point of view of its effects on poverty there. In this favoured child of liberalization and globalization in the 1990s, more than 50% of households in greater Buenos Aires are now living on less than $2 per capita per day.

Even if Brazil and Turkey manage to avoid defaulting on their debt, they have accumulated a debt burden that their taxpayers will be servicing for years to come. This will hurt even the poor, who after all consume most of their income and so pay the value-added taxes on which these countries heavily rely.

The doubters’ second argument is, ironically, that some markets work all too well. Markets reward those who already have productive assets – financial assets, land, physical assets and, perhaps most crucial in the technologically driven global economy, human capital. This means that globalization can leave poor countries as well as poor people behind.

Most poor countries lack the “assets” – the institutional and political infrastructure and the human capital – that support private risk-taking. This is because they lack stable political systems, secure property rights, adequate banking supervision and reasonable public services.

Local financial capital goes abroad if the risks are too big and the returns too low at home. This explains why most foreign direct investment goes to developed countries, and little to sub-Saharan Africa (see chart, above left).

The problem, say the doubters, is not that the poorest countries have failed to join the global economy. In fact, most are heavily engaged in global trade. Most, including those in Africa, have been “open” for at least two decades – if one uses the conventional measure of openness, the ratio of imports and exports to GDP.

But, having been highly dependent on primary commodity and natural resource exports in the early 1980s, they have lacked the institutional wherewithal to diversify into manufacturing – despite reducing their own import tariffs as much as most other countries.

Now they seem trapped in a vicious circle of low or unstable export revenue (as prices of cotton, cocoa and minerals continue to decline), weak and sometimes predatory government, insufficient human and financial resources to cope with terrible disease burdens, and institutional paralysis. Among all developing countries, those most dependent on primary commodity exports have failed to grow at all in the past two decades (see chart, left).

Despite fragile government efforts to undertake economic reforms and enter global markets, they too often fail to sustain reform or build adequate institutions. For them, success in global markets might be an outcome of future growth and development, but it does not look like the key missing ingredient.

The bottom line

The best case, unfortunately, rests with the doubters, who see no simple solution to making globalization work for all. Yes, root out corruption and liberalize markets in the poor countries. But do not rely on open markets alone, and watch out for the costs of open capital markets in particular.

Yes, fix the global rules. But do not expect that this alone will do. The poorest countries are so far behind that they may not be able to compete on a level playing field – at least without help to build their human capital and improve their local infrastructure and institutions. And the emerging market economies need domestic adjustments, not global protection, to defend them from the risks of heavy reliance on foreign capital.

The solution lies somewhere in the middle. Having swung to the extreme of free-market ideology in recent years, the pendulum is now swinging back. But it is far from clear where true equilibrium lies.

Nancy Birdsall is president of the Center for Global Development, a policy-oriented research institution in Washington, DC. Before launching the center in October 2001, she served for three years as senior associate and director of the Economic Reform Project at the Carnegie Endowment for International Peace. From 1993 to 1998 she was executive vice president of the Inter-American Development Bank.