Globalization: State of the Art and Perspectives

Globalization

Is the state weakened by globalization? Does national economic policy converge under the competitive pressure of globalization? Who is gaining or losing from globalization, and why? For the last ten years, these questions have been in the focus of the public debate and political science research. Meanwhile research has produced substantial empirical analyses on many aspects of globalization leading to a substantiation of some arguments and to a weakening of others. In view of the increasingly differentiated research on globalization, a host of international experts in the field are brought together to systematically present the core fields and results of research on globalization. The chapters follow an actor-centred approach and are theoretically guided empirical analyses. Each chapter presents the international state of the art of research on globalization on the respective issue area as well as the individual author’s cutting edge. The areas covered in this volume include an analytical overview on globalization research, fiscal policy adjustment to globalization, tax competition, international monetary policy, transnational policy regimes, governance through private business and public–private partnerships, developing countries, regionalism and trade liberalization in transformation countries. For each of these issues, the chapters introduce the relevant theoretical approaches and analyse the empirical findings. This volume will be of interest across a number of related subject areas including international political economy, international relations, comparative politics, international economics and area studies. Stefan A. Schirm is Professor of Political Science at the University of Bochum, Germany, where he holds the Chair for International Relations.

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Globalization State of the art and perspectives

Edited by Stefan A. Schirm

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© 2007 Selection and editorial matter, Stefan A. Schirm; individual chapters, the contributors All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-96226-5 Master e-book ISBN

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Contents

List of figures List of tables List of contributors Preface 1 Analytical overview: state of the art of research on globalization

xi xii xiii xv

1

STEFAN A. SCHIRM

2 The development of the debate: intellectual precursors and selected aspects

22

ANDREAS BUSCH

3 Fiscal policy and adjustment: adjusting fiscal policy to globalization – testing theoretical approaches

40

REIMUT ZOHLNHÖFER

4 Taxation and cooperation: international action against harmful tax competition

61

THOMAS RIXEN

5 Money and power: markets and governance in international monetary policy

81

HUBERT ZIMMERMANN

6 Political transnationalization: the future of the nation-state – a comparison of transnational policy regimes EDGAR GRANDE, MARKUS KÖNIG, PATRICK PFISTER AND PAUL STERZEL

98

x Contents 7 Business and governance: transnational corporations and the effectiveness of private governance

122

DORIS FUCHS

8 Public–private partnerships: unlike partners? Assessing new forms of regulation

143

TANJA BRÜHL

9 Political conditions for economic growth: globalization and developing countries

162

JOACHIM BETZ

10 Regionalism in the world economy: building block or stumbling stone for globalization?

183

ANDREAS DÜR

11 Transformation and trade liberalization: the integration of the transition countries into the world economy

200

THILO BODENSTEIN

Index

219

Figures

2.1 7.1 7.2 7.3 11.1 11.2 11.3

Publications per year on globalization, 1985–2004 Cost-benefit function for two companies Point of maximum net benefit Agreement upon a common standard Non-tariff barriers to trade, 1993 and 2000 Executive constraints and trade openness International aid and trade openness

24 129 131 133 208 211 212

Tables

1.1 1.2 1.3 1.4 3.1 4.1 10.1 11.1

Growth of world trade compared to world real GDP Growth of foreign direct investment inflows compared to world real GDP Share of OECD countries in world trade and foreign direct investment Governmental total outlays as percentage of GDP Configurations of electoral competition Tax competition as asymmetric dilemma Eight scenarios on trade policy Founding elections and foreign economic openness

3 4 4 9 49 70 191 211

Contributors

Joachim Betz is Senior Research Associate at the German Institute of Global and Area Studies in Hamburg and Professor of Political Science at the University of Hamburg. Previously he worked as a Research Associate at the University of Tübingen, Germany. Thilo Bodenstein holds the Jean Monnet Chair at the Jean Monnet Centre of Excellence, Freie Universität Berlin. He received his PhD at the University of Konstanz and was a Senior Researcher at the Centre for Development Research at the University of Bonn. Tanja Brühl is Assistant Professor of Political Science with a focus on Peace and Conflict Studies at the University of Frankfurt am Main. Previously she was Research Associate for Comparative Politics at the University of Frankfurt and Teaching Assistant at the TU Dresden. Andreas Busch is Reader in Politics and International Relations in the Department of Politics and International Relations at the University of Oxford and Fellow at Hertford College, Oxford. After a Kennedy Fellowhip at Harvard University and his post-doctoral thesis (Habilitation) he taught at the University of Heidelberg, Germany. Andreas Dür is a Lecturer in the School of Politics and International Relations, University College Dublin. He holds a PhD from the Department of Political and Social Sciences at the European University Institute in Florence, Italy. Before taking up his current position, he was a Postdoctoral Fellow at the Mannheim Centre for European Social Research in Germany. Doris Fuchs is Professor of Political Science and Chair of the Department of International Relations and European Integration at the University of Stuttgart. Prior to joining Stuttgart, she has taught at the HandelshochschuleLeipzig Graduate School of Management, the University of Munich, Louisiana State University and the University of Michigan. Edgar Grande holds the Chair for Comparative Politics at the GeschwisterScholl Institute for Political Science of the University of Munich. He is also the director of the Munich research centre on “Reflexive Modernization”,

xiv Contributors funded by the German Research Association (DFG). Previously he was Professor of Political Science at the Technische Universität München and was DAAD Chair in German and European Politics at the University of Toronto. Markus König is Researcher at the Chair for Comparative Politics at the Ludwig-Maximilians-University Munich. He studied political science, sociology, social psychology and economics at the University of Hannover. Patrick Pfister is Researcher at the Chair for Comparative Politics at the Ludwig-Maximilians-University Munich. He studied political science, sociology and communication studies at the Universities of Bamberg (Germany) and Kingston upon Thames (UK). Thomas Rixen is Research Associate at the International University Bremen (IUB) and a member of the Collaborative Research Center “Transformations of the State” funded by the German Science Foundation (DFG). He studied Political Science and Economics in Bonn, Paris, Hamburg and at the University of Michigan, Ann Arbor. Stefan A. Schirm is Professor of Political Science at the University of Bochum, where he holds the Chair for International Relations. Previously he taught at the Universities of Munich and Stuttgart, was Research Associate at the Institute for International Relations of the Stiftung Wissenschaft und Politik (SWP) and John F. Kennedy Fellow at the Center for European Studies, Harvard University. Paul Sterzel is Researcher at the Chair for Comparative Politics at the LudwigMaximilians-University Munich. He studied political science, economics and history at the Universities of Freiburg (Germany) and Rennes (France). Hubert Zimmermann is DAAD Visiting Associate Professor at Cornell University. Previously he taught at the University of Bochum, worked as Editor at the Institut fuer Zeitgeschichte (Bonn) and wrote his PhD at the European University Institute, Florence. Reimut Zohlnhöfer is Assistant Professor at the Institute of Political Science at the University of Heidelberg. Previously he has worked at the Center for Social Policy Research (Bremen) and was a John F. Kennedy Memorial Fellow at the Center for European Studies, Harvard University.

Preface

This volume assesses the state of the art of political science research on economic globalization. Since globalization has been one of the core issues for political science research in the last ten years, it seemed necessary as well as promising to analyse its most important results. The intention of this volume is to present the international state of the art of globalization research as well as the specific expertise of the contributors in this book. Therefore, nearly all chapters follow the same structure in dedicating their first part to the assessment of the theoretical and empirical state of the art while exploring the projects and approaches of the respective author in the second part. With this double-edged structure the volume differs from most other publications, because it not only encompasses the cutting edge of the authors involved, but also systematically assesses the results of international political science research on core issues of globalization. All chapters are characterized by theoretically guided empirical analysis. Although certainly not all elements of globalization research are considered to the same degree, this volume gathers the most important topics, approaches and results. This project started with a call for papers within the German political science community. Therefore, the authors of this volume come from Germany, but have all spent part of their professional career abroad, mostly at American, British or Canadian universities. The 15 papers selected originally among 30 proposals submitted to the call, were presented, commented and discussed at a book-making workshop in November 2005 in Arnoldshain near Frankfurt. I am grateful to the Fritz-Thyssen Foundation for funding the workshop. The authors deserve special compliments on thoroughly revising their papers in light of the comments received and the participants for the productive and stimulating discussions. Routledge was immediately interested in the idea of assessing the state of the art of research on globalization and has professionally embraced the project. I would like to thank the anonymous reviewer for valuable comments. Special thanks also go to Karsten Ronit for valuable comments on all papers and to Gitta Lauster and Christa Landsberger for competently and enthusiastically helping with editing and formatting the manuscripts. Stefan A. Schirm

1

Analytical overview State of the art of research on globalization Stefan A. Schirm

1 Questions, hypotheses and theoretical approaches Is the state being weakened by globalization? Does national economic policy converge under the competitive pressure of globalization? Who is gaining or losing from globalization, and why? For the last ten years, these questions have been in the focus of public debate and political science research. Meanwhile, research has produced substantial empirical analyses on many aspects of globalization, leading to a substantiation of some arguments and to a weakening of others. While the coverage of globalization in the media is often still shaped by special interests and myths, political science has achieved cognitive progress in several instances. These advances in political science research benefited from economics and included several fields of political science, especially “international relations”, “comparative politics” and “political economy”. In view of the increasingly differentiated research on globalization, this volume attempts to systematically present the core fields and results of research on globalization focusing on the advances made in the last ten years. The aim of this introductory chapter is to deliver a selective overview of the most important issues and results of research and to delineate the links between the core topics. This chapter does not attempt to introduce the following specialized chapters, a task which is undertaken in each of these chapters. The overview will be guided by three arguments. First, research on globalization is increasingly based on connecting the above-mentioned fields of political science into “international political economy” (see Frieden and Lake 2000; Grieco and Ikenberry 2003; Oately 2006; Schirm 2004a), thus leading to a partial integration of formerly more separated approaches to the study of empirical questions. Second, research has been increasingly converging around an actor-centred and theoretically guided approach to the empirical analysis of globalization. Third, contrary to the dominant focus in the mid-1990s on the “weakening of the nation-state”, globalization research recently centres around the persistent role and autonomy of national politics and institutions vis-à-vis globalization. Theoretical approaches to globalization are based on different claims in political science and often recur to economics and sociology. One way to distinguish the approaches is to focus on the theoretical role globalization plays as an

2

Stefan A. Schirm

analytical variable. Part of the studies conceptualizes globalization as a dependent variable in analysing how power, ideas, institutions or interests cause and shape globalization. These works employ such theories as neorealism, liberalism, constructivism and institutionalism. In other parts of research, globalization is conceptualized as an independent variable in the analysis, for example, of the reform of the welfare state, of the convergence or divergence of national economic policies and global economic governance. Studies focus on the impact of globalization on the state, interest groups and societies and on the questions on governmental autonomy in economic policy making vis-à-vis global competition. These works are often guided by theories of the state, by institutionalism (“varieties of capitalism”), approaches from economics (trade theories etc.), societal norms (constructivism) and interests (liberalism). Another way to structure the multitude of theoretical approaches to globalization is to examine the different cognitive goals pursued: (1) If the impact of globalization on state and society is to be explained, then globalization is mostly analysed as a structural, ideational or power-related phenomenon. (2) If the – converging or diverging – reactions to globalization are to be analysed, then national policy autonomy, interests, institutions and societal values build the explicative focus. (3) If multilateral forms of governing globalization (such as international organizations and global governance) shall be examined, then theories are employed which focus on cooperation and conflict (such as neorealism and regime theory), on public-private-partnership-hypotheses, principal-agentarguments and on the potential domestic causes (such as interests and norms) for the foreign economic policy responses of governments. These questions and arguments are often connected in such a dense way that they can hardly be separated clearly. Most of today’s research is characterized by actor-centred approaches, which emphasize the role of governments, international organizations, private business, non-governmental organizations and so on. as the driving or reacting forces vis-à-vis globalization. Therefore, in large parts of research, globalization is no more examined as an anonymous structure, as a “process without a subject” (Hay 2002: 379). The theoretically guided analysis of empirical questions has increasingly benefited from recurring to economics in the last years. Authors such as Frankel, Frieden and Rogowski, Garrett, Hall and Soskice, Mosley, Swank and so on. integrate approaches from political science and economics reaching from qualitative to quantitative methods (see also Chapters 7, 10 and 11). Recently, the question on the causes of our knowledge on and perception of globalization is also frequently examined. This “ideational matter of globalization“ (Rosamond 2003: 669) is largely studied through discourse analyses, which focus on the meanings attached to globalization beyond its empirically measurable dimensions and processes. Normative approaches to research on globalization, which could often be observed in the mid-1990s, have ceded and given way to analytical approaches. Therefore, the precondition is now given to reach conclusions on the possibilities for the future governance of globalization based on plausible proof and reasoning on the causal implications globalization had so

Analytical overview 3 far. Summing up, research on globalization today shows a refreshing cognitive pragmatism by avoiding normative interpretations and pretentious postulates on the superiority of single theories. Instead, research focuses on the – often competing – uses of theoretical approaches in order to explain empirical puzzles. This chapter is structured as follows. The next section delineates the dimensions and causes of globalization as well as the most important divisions on its interpretation. I then turn to the interlinked core elements of research in the last ten years and to their theoretical conceptualizations as well as empirical findings: the debate on the convergence and divergence of national economic policies, the question of a “weakening of the state”, a “race to the bottom” of welfare and environmental standards and the discussion about the advantages and disadvantages of free trade for national economies and specific interest groups. These sections are followed by a short appraisal of research on the possibilities of multilateral and private governance of the world economy. The chapter ends with conclusions on the perspectives for further research.

2 What is globalization? The different definitions of globalization in the research community increasingly converge around a common understanding of globalization as an integration of markets, a cross-border interconnectedness of economic spaces and thus a denationalization of economic processes. Therefore, economic globalization shall be defined here as the increasing share of private cross-border activities in the total economic output of countries. With this basic definition, globalization can be measured as the share of foreign trade, foreign direct investment and financial transactions in the gross domestic product of a country or a region and as a share in the world product. This definition encompasses the magnitude and the development of economic globalization beyond individual perceptions, non-economic aspects of transnationalization (such as culture) and political “globalization” (on global governance, see section 6). The data clearly show that the share of crossborder activities in national product(s) has risen considerably in the last decades and therefore give empirical substance to the claim of an increasing integration of national economies (see Tables 1.1 and 1.2). The numbers also show the limits of globalization (and the consequences of the stock market and regional financial crises for FDI flows after 2001). However, while the share of cross-border activities increased, the largest part of Table 1.1 Growth of world trade compared to world real GDP Annual growth %

1988–1995

1996–2003

2004–2007

World real GDP World trade, volume

3.2 6.6

3.7 6.1

4.9 8.3

Source: IMF 2006: World Economic Outlook, Statistical Appendix, Washington, DC: 251. Online. Available www.imf.org/external/pubs/ft/weo/2006/01/pdf/statappx.pdf (accessed 26.5.2006).

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Stefan A. Schirm

Table 1.2 Growth of foreign direct investment inflows compared to world real GDP Annual growth % 1986–1990 1991–1995 1996–2000 2001 World GDP FDI inflows

10.1 22.8

5.2 21.2

1.3 39.7

2002

2003

2004

⫺0.8 –⫺3.9 ⫺12.1 12 –40.9 ⫺13.3 –11.7 2.5

Source: UNCTAD 2005: World Investment Report 2005, Geneva: 14.

national product is still and persistently created and consumed within national economies. It is also interesting to note that globalization possesses a regional focus, as more than two-thirds of world trade, foreign direct investment and financial transactions occur between the industrialized countries of the OECD (Organization for Economic Cooperation and Development) plus some emerging economies such as Brazil and Malaysia (see Table 1.3). Therefore, accurately spelt, globalization is an “OECDization plus”. The problem of many developing countries seems not to be a negative impact of globalization but instead, no impact at all because they are (nearly) not affected by globalization. Research shows a widespread consensus on the crucial role of governmental decisions regarding the causes of globalization. Technical novelties such as the internet, the containerization of trade and new financial instruments on stock markets doubtlessly eased the cross-border activities of private actors. But increased globalization since the 1970s would not have been possible without the decisions of national governments to liberalize world trade, to open financial markets and to de-regulate markets in general (on the causes of globalization see Garrett 2000; Hirst and Thompson 1996: 1–98; Schirm 2002a: 33–56). International governmental organizations such as the World Trade Organization (WTO), its predecessor, the General Agreement on Tariffs and Trade (GATT) and the International Monetary Fund (IMF) played a decisive role for the reduction of trade barriers and for the stabilization of growing financial flows (debt and Table 1.3 Share of OECD countries in world trade and foreign direct investment Share %

1990

1995

2000

2002

2003

2004

2005 1st quarter

Export of goods and services Import of goods and services FDI inflows FDI outflows

71.8

71.3

71.9

70.58

69.1

69.2

68.7

78.8

72.3

74.6

73.7

73.1

73.1

72.9

– –

66.0 88.0

88.4 –

85.8 86.1

93.7 74.3

– 55.6

– –

Source: Trade: own calculations based on data from OECD 2006: Main Economic Indicators, in www.oecd.org/dataoecd/55/27/18628014.pdf (accessed 18. 4. 2006); FDI: own calculations based on data from OECD 2006: OECD Factbook: Economic, Environmental and Social Statistics, in: caliban.sourceoecd.org/vl=4285439/cl=19/nw=1/rpsv/factbook/data/11–02–01-t02.xls;caliban.sourceoecd. org/vl=4285439/cl=19/nw=1/rpsv/factbook/data/11–02–01-t03.xls (accessed: 18.4.2006) and UNCTAD 2005: Handbook of Statistics, in: www.unctad.org/en/docs/tdstat30_enfr.pdf (accessed: 30.04.06).

Analytical overview 5 investment). Therefore, globalization has been an intended process with which the involved governments aimed at stimulating national and worldwide growth. This strategy of liberalization corresponded to the change in the economic policy paradigm in the 1970s and 1980s in many industrialized countries away from (neo-)Keynesianism (see Gourevitch 1987; Hall 1987; Helleiner 1994: 123–68; Schirm 2002a: 57–101). In sum, globalization has been crucially a result of decisions made by democratically legitimized governments on the national level and of agreements reached in international organizations, which were also dominantly influenced by the democratically legitimized governments of industrialized countries. Thus, liberalization can also be reversed, if voters wish it so. Several positions mark the interpretation of the consequences of globalization (see the overviews in Drezner 2001; Held and McGrew 2000; Morton 2004; Rosamond 2003). They shall be subsumed under two groups in the following: 1

2

One group of authors argues that the state is weakened by globalization because it is limited to its territory while the private actors of globalization move across borders and can thus evade the control of the state with more ease. Susan Strange (1996: 65) articulates this position when stating that Transnational Corporations (TNCs) increasingly possess a “parallel authority alongside governments in matters of economic management”. Kenichi Ohmae (1995) even sees the “The End of the Nation State” and the “Rise of Regional Economies” approaching. According to Vincent Cable (1995), the state is “diminished” by a “loss of economic power”. These hypotheses of a weakening of the nation state dominated the debate in the 1990s. A second group of authors considers these arguments on the implications of globalization as exaggerated and sees the state as politically capable to shape globalization. Daniel Drezner (2001: 78) concludes after a review of empirical results of research on globalization that TNCs are embedded to a higher degree in national political institutions than often claimed and that states can decide on the degree of adjustment to globalization: “globalization is not deterministic”. Robert Wade had already opposed the argument of a de-nationalization of the economy in 1996 and wrote: “reports of the death of the national economy are greatly exaggerated”. Mosley (2000) and Garrett (1998b) acknowledge the pressure by global financial markets on the state to conduct a stability- and world market-orientated policy, but observe autonomy in other areas such as diverging policies with regard to the use of governmental budgets and latitude for different party politics. After the analysis of several case studies, Linda Weiss concludes that globalization has indeed strengthened the relevance of political institutions for socio-economic changes (Weiss 1998, 2003). Summing up, research is controversial as to the form of changes brought by globalization but agrees upon an increasing integration of national economies.

Globalization constitutes a new challenge for the nation state insofar as it exposes national governments to changed costs and benefits for economic policy

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Stefan A. Schirm

decisions. These changes stimulate an adjustment to the expectations of global markets in order to retain or attract increasingly mobile resources (Frieden and Rogowski 1996; Garrett 1998a; Schirm 2002a: 33–56; Wolf 2004). With this impact, globalization as the growing share of cross-border activities in the total economic product changes the conditions for governmental as well as private actions. States and companies compete more and on a global scale for comparative advantages and markets due to the increased mobility of capital, technology and production. This does not necessarily imply a weakening of the state. Even if governments lose influence on transnational actors, they are not necessarily weakened with regard to basic tasks of the state such as the provision of suitable conditions for growth and wealth. Obviously states can be affected by global competition in different ways and to different degrees (see above). With regard to the public interest in economic wealth and welfare, globalization implies changing constraints for governments through a modification of the costs and benefits of specific economic policies. Economic success as a core element of a government’s chances for sustaining its power and for re-election is increasingly dependent on a successful use of mobile resources. Protectionist and interventionist policies seem to reach only suboptimal results in the long run compared to approaches orientated towards the world market. A combination of export-led growth and protectionism, like in China in the 1990s, links interventionism and world market orientation but seems to be viable only temporarily and is subject to considerable pressures as the liberalizations show, which China has been and still is undertaking in the course its membership of the WTO (see Saich 2000). The connection between wealth and world market integration is underlined by the fact that those countries which integrated most into the world economy are also those with the highest level of wealth – the industrialized countries. At the same time, the countries showing a poor performance with regard to wealth are often those with a low degree of openness to world markets. This long-term correlation between the degree of participation in world markets in form of direct investment, financial transactions as well as trade on the one hand and the level of wealth on the other is empirically substantiated in numerous studies on industrialized as well as developing and newly industrializing countries (see e.g. Frankel 2000; Oatley 2006: 366f; Wolf 2004: 143, 161; Dollar and Kray 2001; The Economist 29 September 2001: 10–15). Thus, wealth and growth seem to correlate positively with openness to world markets. Obviously, this connection does not imply that all domestic groups in a given country benefit to the same degree. The internal distribution of wealth and growth is only partially driven by the form of a country’s global integration (see section 5), but instead is predominantly shaped by the national distribution of political power and by socio-economic structures. These can be very asymmetrical, especially in many newly industrializing and developing countries (see Chapter 9).

Analytical overview 7

3 The debate on convergence and divergence Research has reached a widespread consensus on the competition-enhancing effects of globalization for states and companies. First, companies have to adjust to global competition if they wish to compete on world markets into which their home markets are increasingly integrated. Second, states are also increasingly competing with each other on the world market for locational advantages for investment and production (see Cerny 2000; Garrett 1998a; Krugman and Obstfeld 2003). As globalization eases the cross-border movement of resources, the incentive for governments rises to adjust their economic policies to the expectations of transnational actors in order to participate in the dynamics of the world markets (Epstein 1996: 219). The hypothesis deriving from these implications of globalization is that economic policies will converge around a common (neo-) liberal paradigm (see Drezner 2001; Yamamura and Streeck 2003 and Chapter 2 in this volume). In fact, many industrialized and newly industrializing countries have shown a tendency towards stability-orientated liberalization and away from the formerly often dominant interventionist and (neo-) Keynesian policies. Examples of this tendency abound: beyond all differences, Margaret Thatcher and François Mitterrand were the front runners in turning away from (neo-) Keynesian recepies in Europe in the 1980s. Tony Blair’s New Labour in Great Britain and the socialist as well as the conservative governments in France continued the market-orientated tendency in the last decade – obviously embedded in different national institutional settings. Mexico has been the front runner in liberalizing the former model of interventionist and protectionist industrialization, followed by other countries such as Argentina and Brazil in Latin America. At the same time, considerable space for the divergence of national economic policies has been observed within this trend towards world market orientation (see Busch 2004: 90; Cox 2001; Drezner 2001; Lütz 2004; Scharpf and Schmidt 2000). Clear differences in regulating labour markets, taxation and social welfare can be noticed when comparing western European countries. While Great Britain continued to be more liberal and the Netherlands as well as Denmark have restructured their welfare systems but maintained high social security levels, Germany has only moderately reformed recently. A comparison of the United States with continental European countries also shows persistent national autonomy in choosing social and economic courses. The trade barriers in Europe and the US (for agricultural products, for instance) exemplify that domestic pressures by protectionist lobby groups can still be stronger than the incentives and pressures for liberalization set by globalization. Thus, states do not have to adjust to globalization if they do not wish to do so and if they are willing to bear the costs, such as higher price-levels for protected goods and potentially less economic dynamic due to less competition. The causes of the persistent divergence of national economic and social policies and of the form of national reactions to globalization seem to be the institutions and norms given in the respective societies (see Hall and Soskice 2001; Holzinger and Knill 2005; Weiss 2003: 302f; Scharpf and Schmidt 2000;

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Schirm 2002b). The body of literature dealing with these questions can be subsumed under the rubric of “varieties of capitalism”. “VoC” research concentrates on the diverging forms of regulating the economy by the government and public-private action in such policy fields as the labour market, the banking system, education and public administration. Another relevant topic is the question of whether trade unions and employer associations have an institutionalized influence on economic development as they do in corporatist countries such as the Netherlands and Germany. In these “coordinated market economies”, the interest of corporatist organizations in the status quo may prevail over the interest of, for example, the unemployed in liberalizing the conditions for dismissals, which may prevail in “liberal market economies” such as in Britain. Societal norms as collective expectations about appropriate behaviour by the government also seem to have a strong influence on the form of political reactions towards globalization. If, for example, the norm of “collective solidarity” dominates over the norm of “individual responsibility”, then crisis-ridden companies can expect governmental help to a higher degree than pressure to adjust to new circumstances. It is interesting to note that Denmark and the Netherlands reached fundamental reforms through a re-definition of the societal norm of “solidarity” by adding the norm of “reciprocity”. In these countries, the recipients of “collective solidarity” (transfer payments), such as the unemployed, have to show a higher degree of “solidarity” with the society today in the form of, for example, social work, geographical mobility and lower levels of transfer payments (see Cox 2001). Thus, the differences between societal norms and institutions contribute to the understanding of persistent national divergence with regard to globalization. Another important endogenous determinant for national policies towards globalization is the partisan composition of governments. Party politics matter with regard to liberalization because social democratic parties seem to be less prone to undertake the first steps to liberalization than conservative parties (see Garrett 1998b; Kastner and Rector 2005 and Chapter 3 in this volume). Summing up, empirical studies on “varieties of capitalism” point at a tendency towards a convergence around stability-orientated liberalization but also emphasize persistent divergence concerning the regulation of specific policy areas among the countries of the OECD.

4 Race to the bottom? A large part of research on globalization empirically examines the hypothesis that the state is weakened with regard to its ability to maintain specific standards and social provisions. The argument is that the government in industrialized countries is forced to lower its share in total spending, leading to a reduction of the level of social spending and of environmental standards due to the increased pressures from global competition with developing and newly industrializing countries. Both aspects have been widely studied and can meanwhile be evaluated in a more differentiated way. Regarding the “strength” of the state in form of its access to the financial resources of a given country, the share of the state in total output has not diminished in the last decades (see Table 1.4).

Analytical overview 9 Table 1.4 Governmental total outlays as percentage of GDP

Germany France UK Sweden USA

1990

1995

2000

2002

2005

44.5 49.3 42.2 61.9 37.1

48.3 54.4 45.0 67.7 37.0

45.1 51,6 37.5 57.4 34.2

48.0 52.6 41.7 58.4 36.3

46.8 53.9 44.9 57.2 36.6

Source: OECD 2005: Economic Outlook 78, Statistical Annex, Table 25, General government total outlays, in: ocde.p4.siteinternet.com/publications/doifiles/122005021P1-T61.xls (accessed:28.4.2006).

Contrary to the hypothesis of falling levels of taxation and of the states’ share in GDP, in Europe, the states with the highest taxes and the highest share of governmental outlays in GDP were also among those with the highest degree of openness to world markets. Denmark and Sweden are examples of this correlation. In principle, global (financial) markets seem not to react negatively to the share of the state in GDP but to budgetary deficits, because they tend to trigger inflation, which corrodes the value of financial assets (see Garrett 1998a; Mosley 2000). From a different angle, Garrett and Mitchell (2001) show in an empirical comparison of OECD countries that increases in foreign trade and in openness towards global financial markets went hand in hand with lower levels of governmental expenditure. However, spending for welfare provisions was not reduced. In addition, increased integration into global markets neither correlated with a reduction of capital taxation, nor with a shift of taxation from capital to consumption. Therefore, the hypothesis of a reduction of the states’ share in total GNP and of levels of welfare spending was not substantiated by this study either. Research on this subject does not show an overall clear picture. In an analysis of the respective literature, Genschel (2004: 633) concludes that neither does welfare spending show a “race to the bottom” nor do persistent national differences mean that globalization does not have any effects at all. Research also points at another crucial feature of the welfare–competitiveness nexus: The competitiveness of nations apparently does not depend primarily on the level of the states’ revenues or expenditures, but instead on their quality. The question is not whether or not there is “more” or “less” on the input-side, but whether the state can perform more efficiently on the output-side of its activity. The reforms of the welfare state in Sweden, the Netherlands and Denmark are examples of the compatibility of the redistributive-egalitarian thought of welfare and the liberal-individual basis of (global) competitiveness. In these countries, reforms pursued the goal of increasing flexibility on the labour market and social security in order to boost competitiveness without weakening the welfare state in its strategic substance (see Benner and Vad 2000; Cox 2001; Scharpf and Schmidt 2000; The Economist – A Survey of the Netherlands, 4 May 2002). Several studies conclude that welfare provisions often served as preconditions for the public acceptance of the structural change necessary for higher global

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competitiveness (see Rieger and Leibfried 2003; Ruggie 1982; Swank 2003). The argument is that a country has to undertake structural reforms in order to better compete on world markets and that these reforms are politically more acceptable if the “losers” of adjustment are compensated by transfer payments. Empirically, openness in trade and investment does not preclude high levels of welfare expenditures. However, the increased mobility of capital leads to an easing of tax evasion and might indeed trigger a shift in taxation away from mobile factors and towards immobile factors such as labour. This raises questions on fairness and legitimacy which could be answered, for example, within the European Union or the OECD by multilateral agreements on the taxation of mobile capital in order to control evasion through mobility (on tax competition, see Chapter 4). The second part of the “race to the bottom” hypothesis can not be confirmed empirically either: there was no substantial reduction of environmental and social standards in the industrialized world due to increased foreign trade and investment (see Antweiler et al. 2001; Drezner 2001; Rajan and Bird 2001: 12; The Economist Survey 29 September 2001: 24). A “race to the bottom” caused by competition with countries which possess lower and therefore less costly standards could mostly not be observed. Instead, examples abound for the strengthening of those standards in developing and newly industrializing countries – reaching from the Kyoto Protocol over ILO-standards (International Labour Organization) to the inclusion of social and environmental standards in the multilateral negotiations of the WTO ever since the meeting in Seattle in 1999 (see Oately 2006: 363–81; Senghaas-Knobloch 2005; Ruloff 2002 and Chapter 9 in this volume). Regional associations such as the European Union (EU) and the North American Free Trade Agreement (NAFTA) also include environmental and social standards and contributed to different degrees to higher standards in the less developed member states. Both Mexico in the case of NAFTA and the new eastern European members as well as Portugal, Spain and Greece in the case of the EU have higher standards today than before their economic opening and integration (see Hartmann 2005; LSE European Observatory on the Social Situation 2005). Thus, multilateral agreements have led to a “race to the top” in these cases. Obviously, these are spotlights on a general trend whose complete presentation would have to include exceptions and the differentiation between product- and production-related standards. Summing up, research on the “convergence-divergence” and the “race to the bottom” hypotheses shows that the state is not weakened by globalization in its fundamental tasks, such as the provision of macroeconomic wealth. Only when defined as a (neo-) Keynesian state can it be considered as weakened by globalization due to the limits to the efficiency of, for example, deficit spending set by global markets (see Garrett 1998a, 2000; Schirm 2002a). However, if the state is defined in a more fundamental way as being responsible for the political framework for economic prosperity, then it might be able to perform even better on this responsibility by more efficiently using the dynamics of globalization through pursuing market liberalization and embedding it in welfare provisions.

Analytical overview 11 In order to pursue such a course, the state (the government) might have to overcome resistance by those groups which benefit from upholding the status quo. Thus, a “strong” state can also be defined as “a state, which can implement its goals against special interests in a given society” (Morisse-Schilbach 2005: 33). From this perspective, the state might even be strengthened by globalization – for example if liberalization and privatization induced by globalization reduces the influence of special interests on the state and their grip on its resources. Another aspect in which globalization may stimulate a strengthening of the state following the above definition are the incentives brought by global competition to reform traditional (for example corporatist) structures. A reduction of the institutionalized influence of trade unions and employer associations on economic policy can be observed in the process of labour market flexibilization. Another way to increase the autonomy of the government vis-à-vis special interests is the transfer of regulative competences to independent regulatory agencies for markets which were formerly dominated by public companies and/or oligopolies as, for instance, in some cases in telecommunication, post, railway and energy markets (see Schirm 2001; Weiss 1998).

5 Interest groups, free trade and distribution A major part of research on globalization deals with the question on who is affected in which way by economic integration. Specific policy areas and interest groups are in the analytical focus here. Like any other new economic development, globalization may lead to structural change and thus produces “winners” and “losers”. Frieden and Rogowski argue that a liberalization of trade as an “exogenous easing of international exchange” (1996: 26) leads to a higher remuneration of formerly abundant resources (such as capital in the industrialized countries) and to a lower remuneration of formerly scarce resources (such as labour in industrialized countries). This further development of the Stolper–Samuelson Theorem from economics allows analysis of the consequences of trade liberalization for the positions of politically relevant interest groups and power structures in a given country (on trade theory, see Chapter 11). The share of employees and capital owners whose jobs and profits depend on the competitive situation of their companies on the world market increased with the growth of the share of foreign trade in total economic output. In Germany and the Netherlands, for example, the share of Exports in GDP rose from 27 per cent (NL: 51 per cent) in 1980 to 33 per cent (NL: 67 per cent) in 2000 and 40 per cent (NL: 71 per cent) in 2005.1 The political interest of sectors producing competitive products and that are heavily involved in trade basically favours liberalization and world market orientated policies. These sectors and the respective interest groups structurally depend on easy access to cheap components from abroad for their production and on the openness of foreign markets, which would be jeopardized if their government raised trade barriers, because the negatively affected countries would probably retaliate with equally raising barriers. At the same time, it is in the structural interest of these sectors to further ease

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access to other markets, for example, through successful WTO negotiations. The economic and political relevancy of this “exporter group” increased with the growth of its share in total GNP and with its improved opportunities to transfer production abroad. This latter “exit option” and the pressure to compete on world markets give transnational actors additional political power vis-à-vis governments (see Milner and Keohane 1996: 244; Schirm 2002a: 48–9). The “exit option” and their cross-border way of operation can give TNCs more influence on governments, as was often pointed out in the 1990s (see Strange 1996). According to more recent studies, this potential increase of the power of private business might have been exaggerated in the literature (see Chapter 7). Structurally opposed to these positions is the interest of those companies or sectors involved in non-competitive production (Frieden and Rogowski 1996). This group is not interested in liberalization because its products are either not traded internationally (“non-tradables”), such as local services, or because it fears imports because its products are not competitive, as is the case in large parts of European agricultural and textile industries. Therefore, governments see themselves as exposed to opposite pressures by lobby groups when it comes to trade negotiations. Globalization partly eliminates the classical divide between employers and employees because both sides increasingly share similar interests depending on the competitive position of the respective sector or company. This implies a new challenge for corporatist organizations because they have to represent diverging interests – for example in Germany, the Union of Metal Workers (IG Metall) and the Association of Metal Employers (Arbeitgeberverband Gesamtmetall) both have to represent the interest of the export-orientated automotive companies and the interest of the protectionist steel-producing sector. The issue of the varying impact of globalization on sectors and interest groups is one of the focal points in research and leads directly to trade theory (see Chapters 3, 10 and 11). In this field, approaches from political science and economics often interlink. Results show empirically that trade liberalization is mostly beneficial on the aggregate because competition, mobility, division of labour and innovation lead to a more efficient allocation of resources, which in turn allows production to occur at those sites where it is most cost-efficient (see Frankel 2000: 59–63; Siebert 2003). The hypothesis is well known since David Ricardo that the use of comparative advantage through free trade increases the wealth of nations. New trade theory as in publications by Paul Krugmann (Krugman and Obstfeld 2003) and Jagdish Bhagwati (2004) develops on the simplistic hypotheses of neoclassical approaches and explains why the largest part of world trade today occurs between countries which produce similar products (this is between industrialized countries). This form of trade is not driven by traditional comparative advantages (like between developing and industrialized countries) but instead by consumer preferences and economies of scale relevant in intra-industry trade, as seen in the case of exports and imports of cars between Germany and France. New trade theory also explains strategic trade policy which might enhance wealth by directly or indirectly subsidizing national or regional champions such as Airbus in Europe and Boeing in the US.

Analytical overview 13 What trade theory has argued for a long time can also be observed within the context of globalization: there is a clear correlation between openness to trade and the wealth of a nation (see above). This is only partially due to the abovementioned static gains from free trade which occur through a more efficient allocation of resources and specialization. In addition, wealth is stimulated by dynamic gains from competition and economies of scale, which allow lower price levels due to mass production and therefore lead to higher purchase power (see Krugman and Obstfeld 2003). New trade theory also explores the influence of the political process (lobby groups, party competition) and political institutions on trade policy, production and locational advantages. Besides the “direct” production factors such as labour and capital, recent studies substantiate the relevance of political stability, educational systems, legal protection of economic activity and governmental surveillance of fair competition (see the literature on “varieties of capitalism” above, on new institutional economics in Williamson 2000, and on institutions in developing countries in Chapter 9 of this volume). The lack of appropriate political institutions can lead to failed liberalization which does not contribute to increasing wealth. Examples of the relevance of institutions are those developing countries which liberalized their financial markets without having appropriate institutions for controlling their banking and stock market systems and were thus often crisis prone (on the causes of the financial crisis in Asia and Latin America see Desai and Said 2004).

6 Global economic governance One of the core topics of research on globalization has been the possibilities for governing the world markets. The questions in this area focus on the role of international economic organizations, on the influence of private business and non-governmental organizations (NGOs) and on the relevance of public–private partnerships (PPPs) as new forms of governance. The analysis of these actors and processes with regard to their performance in shaping globalization constitutes the research field of “global economic governance” (see Schirm 2004b). Multilateral governmental organizations like the International Monetary Fund, the World Trade Organization and the World Bank have been studied for a long time already and thus belong to the traditional body of research of political science. Analyses of regional cooperation such as the EU, NAFTA and the Common Market of the South (Mercosur) also belong to the area of research on multilateral economic cooperation between states. With regard to the analysis of globalization in the last ten years, several studies examine questions on the contribution to and management of liberalization by multilateral organizations (see Bird 2003; O’Brien et al. 2000; Shaffer 2005). Besides the performance of the IMF, the WTO and the World Bank with regard to national and global economic developments, a core issue of several studies is the democratic legitimacy of this form of governance – a question also raised concerning NGOs (see below and Scholte 2003). The question why international economic organizations have not improved their capacity for more effective governance is only increasingly

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addressed by political scientists in the last years even though a necessity for reform became clear with the financial crises and trade disputes in the 1990s. In explaining the lack of reform, analyses focus, for example, on the divergence of governmental positions towards global governance based on different societal norms and interests (see Schirm 2005). For a better management of economic crises and conflicts, an explicit dialogue on diverging national attitudes on the role of the state vis-à-vis the economy (“arguing”) seems as decisive as do more efficient mechanisms to balance diverging material interests (“bargaining”). Research shows a growing consensus towards the necessity of a better political architecture for the world economy due to the widely acknowledged empirical relevance of economic crises (see Drezner 2003; Higgott 2004: 9; Rodrik 2000 and Chapter 5 in this volume). Regional integration as “regional economic governance” plays a crucial role for research on globalization insofar as it allows the observation of liberalization processes as well as their political management on a geographically smaller but often economically deeper scale than on the global level (on regionalism, see Katzenstein 2005). In addition, foreign trade and investment occur to a very high percentage within and among regional groupings. For example, intra-EU trade was two-thirds of total member state trade between 1995 and 2005 and intra-EU FDI was 70 per cent of all FDI by member states in 2004 (European Communities 2005; Eurostat 2006). Thus, a part of the large body of research on regionalism (especially large on the EU) deals with the same questions as do parts of research on globalization. A direct connection between both levels of integration can be observed in studies on the question whether regionalism constitutes a “building block” (because of its liberalizations) or a “stumbling stone” (because of the discrimination against non-members) for globalization (see Chapter 10 in this volume and the review in Nesadurai 2002). In sum, regional cooperation seems to have made an important contribution with regard to economic liberalization: The European Single Market, as well as NAFTA and Mercosur triggered the economic efficiency and the political acceptability of national economic reforms by embedding them in multilateral agreements and “tying the hands” of national governments (see Schirm 2002a; Spindler 2004). Thus, the regional cooperation of the liberal type (“open regionalism”) of the 1990s can be considered a “building block” for globalization. Several studies have been conducted on the influence of private actors – business and NGOs – on global economic governance. One focus of research has been the hypothesis that TNCs have gained power and autonomy vis-à-vis the state in governing economic processes and increasingly evade governmental control. While this hypothesis dominated in the 1990s, recent studies show a more differentiated picture of the structural, ideational and material power of private business, emphasizing the interdependence between states and TNCs (see Chapter 7). New governmental instruments for the governance of increasingly transnational private actors and their legitimacy as well as efficiency have also been at the core of research. One of the most prominent topics was the study of a possible tax on currency and stock market transactions in order to

Analytical overview 15 prevent or slow down speculative movements – a measure with doubtful feasibility (on the so-called “Tobin Tax” see Palma 2004). A stronger participation of non-governmental organizations in global economic governance was considered in parts of the literature as an appropriate means to compensate for the supposedly weakened capability of governments to govern globalization. Including civil society groups such as transnational environmental organizations, unions and human rights groups into global governance mechanisms, promised to increase the efficiency and the legitimacy of governance beyond the nation state (see Cuttler et al. 1999; Scholte 2003). The capacity of these NGOs to set agendas, to mobilize public opinion and to establish direct contact to affected parts of the society (“grass roots”-approach) contributed to the emergence of NGOs as influential actors in the last ten years. While their issue-specific competence and societal embeddedness was often assessed positively, the thematical one-sidedness and lack of inner-organizational democracy and transparency is seen in contrast to the ability of democratically elected governments to pursue a broadly legitimized balancing of interests (see Chapter 8). An important part of research on global economic governance examines the possibilities for governing globalization through private actors and public–private partnerships. In analysing rule making by private business, several authors have focused on the increasing relevance of rating agencies such as Moody’s and Standard and Poor in evaluating the creditworthiness of private actors as well as states (see Sinclair 2005). These forms of private governance partly seem very efficient but lack democratic legitimacy (see Pauly 2002; Hall and Biersteker 2002). A solution for this dilemma might be reached with PPPs, which are characterized by the participation of private as well as governmental actors. An often-studied example is the UN Global Compact, which aims at selfbinding TNCs under UN guidance, for example to invest only in countries which sustain certain minimum standards for human rights and environmental protection (see Rieth 2004 and Chapter 8 in this volume). Research on transnational regimes and PPPs has progressed quite far, for example on genetically modified food, the internet and taxation of intra-firm trade, and leads to the conclusion that the state’s capacity is indeed transformed by globalization but that its ability to govern has not been reduced fundamentally, if new intergovernmental and public–private mechanisms for governing globalization are taken into account (see Chapter 6).

7 Perspectives for globalization research In the last ten years, political science research on globalization has been characterized mainly by actor-centred and theoretically guided empirical analyses, which often crossed the boundaries between the fields of political science such as comparative politics, international relations and political economy with regard to the theories employed and the topics studied. Thus, the investigation of global economic integration has triggerd an increasing integration of political

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science fields. After having focused on the “weakening of the state” in the 1990s, empirical studies have recently come to the widespread conclusion that national policies and institutions continue to have autonomy and capacity towards globalization. Policies, politics and circumstances changed under the influence of globalization but the state is not fundamentally weakened and continues to be able to shape the world economy, although increasingly in cooperation with other states and non-state actors. With these features of globalization research confirmed, the three arguments from the first section of this chapter could be substantiated. Thus, globalization research has made considerable cognitive progress compared to some aspects of the state of the art of the mid-1990s, but also shows several explorable fields for future research. First, it would be worthwhile trying to systematically link the various theoretical approaches into a “theory of globalization”. This task is certainly tricky because the variety of approaches has not precluded research to advance on the subjects studied in the last decade. Therefore, a combination or even synthesis of theoretical approaches must be done without narrowing down and simplifying at the expense of their explanatory power. This would be counterproductive. Second, several specific issue areas are still especially in need of research. While the impact of globalization seems widely studied, the possibilities and obstacles to shape and govern globalization still offer questions in need of theoretically informed empirical answers. In this regard, the conceptualization of the efficiency and legitimacy of public and private forms of governance will be crucially dependent on assumptions about the role of politics in the economy and about the interaction between individual freedom and collective solidarity. It seems important to include these basic political questions without leaving analysis in favour of normative postulates. Societal attitudes in the affected countries are not static but also changed in the last decade and should therefore equally be included in the analysis. With regard to its position within political science, globalization research is situated “right in the middle”, for example in the rationalism–constructivism debate, in examining the changing role of the state, in investigating the power of institutions, in the opening of the “black box” of the state by analysing endogenous causes for foreign economic policy positions of governments and, last but not least, in conceptualizing and analysing changes in the form and distribution of power on the national, international and transnational levels. Continuing interdisciplinary work also bears interesting perspectives for the future research on globalization. Systematically further connecting political science fields seems as promising as using approaches from sociology (for instance in “cosmopolitan political science”, see Beck and Grande 2004; Grande 2006) and from economics (for instance “new institutional economics”, see Williamson 2000). The last ten years have shown that not only did theoretically guided empirical analyses contribute to increasing our knowledge about globalization, but also interdisciplinary work within and beyond political science.

Analytical overview 17

Note 1 Eurostat 2006: europa.eu.int/comm/eurostat.com (accessed 23 April 2006), data for Germany: own calculations based on Statistisches Bundesamt: Verwendung des Bruttoinlandproduktes, in: www.destatis.de/indicators/d/lrvgr02ad.htm (accessed 20 April 2006).

Bibliography Antweiler, W., Copeland, B.R. and Taylor, M.S. (2001) “Is Free Trade Good for the Environment?”, The American Economic Review, 91/4: 877–908. Beck, U. and Grande, E. (2004) Daskomopolitische Europa, Frankfurt/M.: Suhrkamp. Benner, M. and Vad, T.B. (2000) “Sweden and Denmark: Defending the Welfare State”, in F.W. Scharpf and V.A. Schmidt (eds) Welfare and Work in the Open Economy. Vol. II: Diverse Responses to Common Challenges, Oxford: Oxford University Press: 399–466. Bhagwati, J. (2004) In Defense of Globalization, Oxford: Oxford University Press. Bird, G. (2003) The IMF and the Future. Issues and Options Facting the Fund, London: Routledge. Busch, A. (2004) “The Resilience of National Institutions: The Case of Banking Regulation”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave Macmillan: 87–107. Cable, V. (1995) “The Diminished Nation-State: A Study in the Loss of Economic Power”, Daedalus 124: 23–53. Cerny, P. (2000) “Political Globalization and the Competition State”, in R. Stubbs and G.R.D. Underhill (eds) Political Economy and the Changing Global Order, 2nd edn, Oxford: Oxford University Press: 300–9. Cox, R.H. (2001) “The Social Construction of an Imperative: Why Welfare Reform Happened in Denmark and the Netherlands but not in Germany”, World Politics, 53/3: 463–98. Cuttler, C.A., Haufler, V. and Porter, T. (eds) (1999) Private Authority and International Affairs, Albany, NY: State University of New York Press. Desai, M. and Said, Y. (eds) (2004) Global Governance and Financial Crises, London: Routledge. Dollar, D. and Kray, A. (2001) Trade, Growth, and Poverty, Washington, DC: World Bank. Drezner, D.W. (2001) “Globalization and Policy Convergence”, International Studies Review, 3/1: 53–78. –––– (2003) “Clubs, Neighborhoods and Universes: The Governance of Global Finance”, University of Chicago, paper prepared for the Annual Meeting of the American Political Science Association. Epstein, G. (1996) “International Capital Mobility and the Scope for National Economic Management”, in R. Boyer and D. Drache (eds) States Against Markets. The Limits of Globalization, London: Routledge: 193–210. European Communities (2005) External and Intra-European Union Trade, Statistical Yearbook, Data 1958–2004: 90–95, Online. Available epp.eurostat.cec.eu.int/ cache/ITY_OFFPUB/KS-CV-06–001/EN/KS-CV-06–001-EN.PDF (accessed 25 April 2006). Eurostat Visual Applications: EU-Direktinvestitionen – Hauptindikatoren, Online. Available europa.eu.int/comm/eurostat.com (accessed: 25 April 2006)

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Frankel, J. (2000) “Globalization of the Economy”, in J.S. Nye and J.D. Donahue (eds), Governance in a Globalizing World, Washington, DC: Brookings Institution Press: 45–71. Frieden, J.A. and Lake, D.A. (2000) International Political Economy. Perspectives on Global Power and Wealth, London/New York: Routledge. Frieden, J.A. and Rogowski, R. (1996) “The Impact of the International Economy on National Policy: An Analytical Overview”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 25–47. Garrett, G. (1998a) “Global Markets and National Politics: Collision Course or Virtuous Circle?” International Organization, 52/4: 787–824. –––– (1998b) Partisan Politics in the Global Economy, Cambridge: Cambridge University Press. –––– (2000) “The Causes of Globalization”, Comparative Political Studies, 33/6–7: 941–91. Garrett, G. and Mitchell, D. (2001) “Globalization, Government Spending and Taxation in the OECD”, European Journal of Political Research, 39: 145–77. Genschel, P. (2004) “Globalization and the Welfare State: a Retrospective”, Journal of European Public Policy, 11/4: 613–36. Gourevitch, P. (1987) Politics in Hard Times. Comparative Responses to International Economic Crises, Ithaca, NY: Cornell University Press. Grande, E. (2006) “Cosmopolitan Political Science”, The British Journal of Sociology, 57/1: 87–111. Grieco, J.M. and Ikenberry, G.J. (2003) State Power and World Markets. The International Political Economy, New York: Norton. Hall, P.A. (1987) “The Evolution of Economic Policy under Mitterrand”, in G. Ross, S. Hoffmann and S. Malzacher (eds) The Mitterrand Experiment. Continuity and Change in Modern France, Cambridge: Cambridge University Press: 54–72. Hall, P.A. and Soskice, D. (2001) “An Introduction to Varieties of Capitalism”, in P.A. Hall and D. Soskice (eds) Varieties of Capitalism. The Institutional Foundations of Comparative Advantage, Oxford: Oxford University Press: 1–68. Hall, R.B. and Biersteker, T.J. (eds) (2002) The Emergence of Private Authority in Global Governance, Cambridge: Cambridge University Press. Hartmann, K. (2005) Umweltstandards in Europa nach der Osterweiterung, BadenBaden: Nomos. Hay, Colin (2002) “Globalisation as a Problem of Political Analysis: restoring Agents to a ‘Process without a Subject’ and Politics to a Logic of Economic Compulsion”, Cambridge Review of International Affairs, 15/3: 379–92. Held, D. and McGrew, A. (2000) “The Great Globalization Debate: An Introduction”, in D. Held and A. McGrew (eds) The Global Transformation Reader, Cambridge: Polity Press: 1–45. Helleiner, E. (1994) States and the Reemergence of Global Finance. From Bretton Woods to the 1990s, Ithaca, NY: Cornell University Press. Higgott, R. (2004) “Multilateralism and the Limits of Global Governance”, Working Paper, 134, Warwick: Centre for the Study of Globalisation and Regionalisation. Hirst, P. and Thompson, G. (1996) Globalization in Question. The International Economy and the Possibilities of Governance, Cambridge: Polity Press. Holzinger, K. and Knill, C. (2005) “Causes and Consequences of Cross-National Policy Convergence”, Journal of European Public Policy, 12/6: 775–96.

Analytical overview 19 Kastner, S.L. and Rector, C. (2005) “Partisanship and the Path to Financial Openness”, Comparative Political Studies, 38/5: 484–506. Katzenstein, P.J. (2005) A World of Regions: Asia and Europe in the American Imperium, Ithaca, NY: Cornell University Press. Krugman, P.R. and Obstfeld, M. (2003) International Economics. Theory and Policy, 6th edn, Boston, MA: Addison-Wesley. London School of Economic and Political Science, European Observatory on the Social Situation (2005) Health Status and Living Conditions in an Enlarged Europe, Final Report, London: LSE. Lütz, S. (2004) “Convergence Within National Diversity – A Comparative Perspective on the Regulatory State in Finance”, Journal of Public Policy, 24/2: 169–97. Milner, H.V. and Keohane, R.O. (1996) “Internationalization and Domestic Politics: A Conclusion”, in R. Keohane and H. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 243–58. Milner, H. V. and Judkins, B. (2004) “Partisanship, Trade Policy, and Globalization: Is There a Left-Right Divide on Trade Policy?”, International Studies Quarterly, 48: 95–119. Morisse-Schilbach, M. (2005) “Globalisierung und die These vom Souveränitätsverlust des Staates – Forschungsstand und Perspektiven”, Dresdner Arbeitspapiere Internationale Beziehungen, 13, TU Dresden. Morton, A.D. (2004) “New Follies on the State of Globalisation Debate?” Review of International Studies, 30/1: 133–47. Mosley, L. (2000) “Room to Move. International Financial Markets and National Welfare States”, International Organization, 54/4: 737–73. Nesadurai, H. (2002) “Globalisation and Economic Regionalism: A Survey and Critique of the Literature”, Working Paper, 108/02, Warwick: University of Warwick, Centre for the Study of Globalisation and Regionalisation. Oately, T. (2006) International Political Economy. Interests and Institutions in the Global Economy, 2nd edn, New York: Pearson Education. O’Brien, R., Goetz, A.M., Scholte, J.A. and Williams, M. (2000) Contesting Global Governance, Multilateral Economic Institutions and Global Social Movements, Cambridge: Cambridge University Press. Ohmae, K. (1995) The End of the Nation State. The Rise of Regional Economies, New York: Free Press. Palma, G. (2004) “Mexico, Korea and Brazil. Three Paths to Financial Crises”, in M. Desai and Y. Said (eds) Global Governance and Financial Crises, London: Routledge: 120–57. Pauly, L. (2002) “Global Finance, Political Authority, and the Problem of Legitimation”, in R.B. Hall and T.J. Biersteker (eds) The Emergence of Private Authority in Global Governance, Cambridge: Cambridge University Press: 76–90. Rajan, R.S. and Bird, G. (2001) “Economic Globalisation. How Far and How Much Further?” World Economics, 2/3: 12. Rieger, E. and Leibfried, S. (2003) Limits to Globalization. Welfare States and the World Economy, Cambridge: Polity Press. Rieth, L. (2004) “Corporate Social Responsibility in Global Economic Governance”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave: 177–92. Rodrik, D. (2000) “Governance of Economic Globalization”, in J.S. Nye and J.D. Donahue (eds) Governance in a Globalizing World, Washington, DC: Brookings Institution Press: 347–66.

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Rosamond, B. (2003) “Babylon and on? Globalization and International Political Economy”, Review of International Political Economy, 10/4: 661–71. Ruggie, J.G. (1982) “Territoriality and Beyond: Problematizing Modernity in International Relations”, International Organization, 47/1: 139–74. Ruloff, D. (2002) “Wie ‘grün’ ist die WTO? Umweltschutz als Anliegen des Welthandels”, Internationale Politik, 57/6: 37–42. Saich, T. (2000) “Globalization, Governance, and the Authoritarian State”, in J.S. Nye and J.D. Donahue (eds) Governance in a Globalizing World, Washington, DC: Brookings Institution Press: 208–28. Scharpf, F.W. and Schmidt, V.A. (eds) (2000) Welfare and Work in the Open Economy (Vol. I: From Vulnerability to Competitiveness; Vol. II: Diverse Responses to Common Challenges), Oxford: Oxford University Press. Schirm, S.A. (2001) “Wie Globalisierung nationale Regierungen stärkt. Zur politischen Ökonomie staatlicher Antworten auf Globalisierung”, in C. Landfried (ed.) Politik in einer entgrenzten Welt, Köln: Verlag Wissenschaft und Politik: 133–50. –––– (2002a) Globalization and the New Regionalism. Global Markets, Domestic Politics and Regional Cooperation, Cambridge: Polity Press. –––– (2002b) “The Power of Institutions and Norms in Shaping National Answers to Globalization: German Economic Policy after Unification”, German Politics, 11/3: 217–36. –––– (2004a) Internationale Politische Ökonomie. Eine Einführung, Baden-Baden: Nomos. –––– (2004b): “The Divergence of Global Economic Governance Strategies”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave Macmillan: 3–21. –––– (2005) “Der Einfluss von Interessen und Normen auf nationale Positionen zur Global Economic Governance”, Zeitschrift für Politikwissenschaft, 15/3: 825–47. Scholte, J.A. (2003) “Civil Society and the Governance of Global Finance”, in A. Krizsan and V. Zentai (eds) Reshaping Globalization. Multilateral Dialogues and New Policy Initiatives, Budapest: Central European University Press: 285–312. Senghaas-Knobloch, E. (ed.) (2005) Weltweit geltende Arbeitsstandards trotz Globalisierung, Münster: LIT Verlag. Shaffer, G. (2005) “Governance and the WTO: A Comparative Institutional Approach”, in M. Barnett and R. Duvall (eds) Power in Global Governance, Cambridge: Cambridge University Press: 130–60. Siebert, H. (2003) “On the Fears of the International Division of Labour. Eight Points in the Debate with Anti-Globalizationers”, in: H. Siebert (ed.) Global Governance. An Architecture for the World Economy, Heidelberg: Springer Verlag: 4–21. Sinclair, T.J. (2005) The New Masters of Capital, Ithaca, NY: Cornell University Press. Spindler, M. (2004) “New Regionalism and Global Economic Governance”, in S.A. Schirm (ed.) New Rules for Global Markets. Public and Private Governance in the World Economy, New York/Houndmills: Palgrave Macmillan: 235–53. Strange, S. (1996) The Retreat of the State. The Diffusion of Power in the World Economy, Cambridge: Cambridge University Press. Swank, D. (2003) “Withering Welfare? Globalisation, Political Institutions, and Contemporary Welfare States”, in L. Weiss (ed.) States in the Global Economy, Cambridge: Cambridge University Press: 58–82. The World Bank (2003) World Development Indicators WDI, Data Query, Online. Available devdata.worldbank.org/data-query/ (accessed 24 May 2006).

Analytical overview 21 Wade, R. (1996) “Globalization and its Limits. Reports of the Death of the National Economy are Greatly Exaggerated”, in S. Berger and R. Dore (eds) National Diversity and Global Capitalism, Ithaca, NY: Cornell University Press: 60–97. Weiss, L. (1998) The Myth of the Powerless State, Ithaca, NY: Cornell University Press. –––– (2003) “Is the State Being Transformed by Globalization?” in L. Weiss (ed.) States in the Global Economy: Bringing Domestic Institutions Back In, Cambridge: Cambridge University Press: 293–317. Williamson, O.E. (2000) “The New Institutional Economics: Taking Stock, Looking Ahead”, Journal of Economic Literature, 38: 595–613. Wolf, M. (2004) Why Globalization Works. The Case for the Global Market Economy, New Haven, CT: Yale University Press. Yamamura, K. and Streeck, W. (eds) (2003) The End of Diversity? Prospects for German and Japanese Capitalism, Ithaca, NY: Cornell University Press.

2

The development of the debate Intellectual precursors and selected aspects Andreas Busch

1 Introduction The term “globalization” has undergone an amazing career over the last decadeand-a-half, both in the academic and public discourse.1 There hardly seems to exist a facet of public life that cannot be linked to this term: be it domestic conflicts regarding the need for political reforms and the necessity of redesigning social security systems; structural economic change and the shift of economic power to the emerging economies of South and South East Asia; debates about the fairness of global trade or its increasing de-materialization; the threat to cultural diversity presented by global media power and tourism – all this is mentioned in one breath with “globalization”, even if that link is often more one of mashing things together than of providing proper explanations. Given how often it is used, it is perhaps less surprising that the term is also hotly contested. While some have called it a “key concept” for analysing the present social and political condition, to others it seems a myth; and yet again others ask for the justification of “globalization” if developments and change in reality vary quite a lot around the globe. We might also be surprised to find that there is no agreement on the definition of what constitutes globalization. Some examples may serve to illustrate this: Globalization, simply put, denotes the expanding scale, growing magnitude, speeding up and deepening impact of transcontinental flows and patterns of social interaction. (Held/McGrew 2002: 1) [. . .] globalisation means the partial erasure of the distinctions separating national currency areas and national systems of financial regulation. (Strange 1995: 294) Globalisation of industry refers to an evolving pattern of crossborder activities of firms involving international investment, trade and collaboration for purposes of product development, production and sourcing, and marketing. These international activities enable firms to enter new markets, exploit

The development of the debate 23 their technological and organisational advantages, and reduce business costs and risks. Underlying the international expansion of firms, and in part driven by it, are technological advances, the liberalisation of markets and increased mobility of production factors. (OECD 1996: 9) A social process in which the constraints of geography on social and cultural arrangements recede and in which people become increasingly aware that they are receding. (Waters 1995: 3) Globalization, we can conclude, is no clearly defined concept, and, as the aforementioned examples demonstrate, its use varies from concentration on specifically economic phenomena to very general social effects on a global scale. Beyond the very general insight that globalization denotes a continuing process of accelerated and deepened social interaction on a global scale between formerly politically independent units (from which mutual influence follows), little agreement exists concerning the characteristics of globalization. Whether it constitutes a process of a historically new quality or not; whether states caused it or whether markets are the dominant actors; whether the economic, the social or the political sphere is the main area of concern; whether it is a development to be applauded or to be contested – all these questions remained unanswered. While this may initially be a cause for puzzlement to the uninitiated, the lack of a generally accepted definition can also be regarded as a precondition for the astonishing success and the career of the term globalization. For it allows countless actors and positions a common, if vague, point of reference. Throughout academia, scholars from a huge variety of subjects have therefore contributed to the debate on globalization, especially from the areas of: • • • • • •

international relations (e.g. Clark 1999; Lawson 2002), comparative political economy (e.g. Berger and Dore 1996; Garrett 1998), international political economy (e.g. Strange 1986; Schirm 2002), political theory (e.g. Gray 1998; Kagarlitsky and Clarke 1999), sociology (e.g. Waters 1995; Goldthorpe 2002) and economics (e.g. Rodrik 1997; Glyn 2006).

The astonishing productivity of this debate has produced a remarkable output of printed matter which seems to justify calling it an academic growth industry. The list put forward here is exhaustive neither with regard to authors nor to subjects. Besides the various facets of social scientists, philosophers, geographers, lawyers, management theorists and historians have contributed to the discussion of globalization (see further references in Busch 2003: 5ff.). As Figure 2.1 demonstrates, book and article publications discussing globalization show a steep upwards trend over the last 15 years, and only recently seem to stabilize on a high level – at (according to the database used) about 1,000 to 1,200 publications per year.2

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1,600 1,400 1,200 IBSS

1,000

Articles First WorldCat (Books)

800 600 400 200

8 19 8 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04

87

19

86

19

19

19

85

0

Figure 2.1 Publications per year on globalization, 1985–2004.

With such an amount of written work, it seems obvious that no survey article – such as the present one – can claim to depict the whole breadth of the debate. We therefore aim considerably lower here: first, we want to draw attention to the intellectual environment of the debate on globalization, by pointing out previous discussions that provide input into (above all the political science side of) the debate on globalization; then, selected aspects of that debate will be discussed, taking core positions and the hypotheses they rest on into account, also with a view to their theoretical underpinnings. The chapter concludes with a provisional résumé of the debate and an assessment thereof.

2 Intellectual precursors of the globalization debate Even a debate as comprehensive as that on globalization does not emerge out of thin air. It is influenced by and refers to debates that went on before in the social sciences. This section argues that there are three such debates that provide a substantial input into the arguments over globalization or are directly linked to it. They are sociological theories of differentiation and modernization; discussions in international relations theory about the role of the state; and the debate in the field of comparative government about the relationship between domestic and foreign policy.

The development of the debate 25 2.1 Theories of differentiation and modernization Since the beginning of industrialization at the beginning of the nineteenth century, theories have predicted the necessary convergence of the different cultures in Europe as a consequence of this development. At an early stage, this topic was addressed by Saint-Simon who, in the spirit of utopian internationalism, advocated a pan-European government – in a journal fittingly entitled The Globe (Waters 1995: 5ff.). Through Comte, Saint-Simon’s ideas influenced Emile Durkheim, who developed them further into his theory of structural differentiation of society. Sociologists of the structural-functionalist school extended this line of argument: industrialization, they argued, would increase a society’s wealth and thus provide incentives for other societies to imitate, leading to the spread of industrialization, eventually over the whole world. Further consequences would flow from this: a process of “modernization” would lead to societal differentiation, eventually prompting value change, individualization, secularization and rationalization: “As industrialization spreads across the globe, it carries modernization with it, transforming societies in a unitary direction” (Waters 1995: 13). This development was already predicted almost clairvoyantly by Karl Marx and Frederic Engels more than 150 years ago. In the Communist Manifesto, they deduced the process of globalization of production and consumption as well as the emergence of a global market from the logic of the capitalist mode of production: “The need of a constantly expanding market for its products chases the bourgeoisie over the whole surface of the world” (Marx 1977: 224). Their industries would process raw materials drawn from all over the globe, and their products “are consumed not only at home, but in every quarter of the globe” (ibid.). During this process, the prediction then went, the capitalist system would spread across the whole world, due to its superior economic efficiency: The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all, even the most barbarian (sic) nations into civilization. The cheap prices of its commodities are the heavy artillery with which it batters down all Chinese walls, with which it forces the barbarian’s intensely obstinate hatred of foreigners to capitulate. It compels all nations, on pain of extinction, to adopt the bourgeois mode of production; it compels them to introduce what it calls civilization into their midst, i.e., to become bourgeois themselves. In one word, it creates a world after its own image. (ibid.: 30)

2.2 The role of the state in international relations The theory of international relations also has points that link it to the debate about globalization. The “realist” or “Westphalian” paradigm had always been state-centred in its analysis, positing a priori that states (and more recently

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“nation states”) are the key actors in international relations. Their interaction has been described as akin to a “billiard-ball model”, with the structure of the international system (i.e. anarchy and the distribution of power) determining a state’s actions. Over the course of the last 30 or so years, however, a number of developments have altered the scene in international relations, and consequently the discipline started a “search for a new paradigm” (Cerny 1996). Two major developments are discernible: on the one hand, the distribution of power between states has changed, if compared to the situation after the Second World War, when a bipolar world order emerged and the United States had a hegemonial position in the West. But already at the end of the 1960s, discussions started about how “interdependence” would influence the states in the system (Cooper 1968; and Keohane/Nye 1977). In the 1980s, the debate about the world “after hegemony” followed, culminating in the discussions about the perceived “decline” of the United States. The theory of international relations had to come to terms with the fact that even a state as powerful as the United States was no longer able to completely determine its own fate. The other major development was the emergence of new actors in international politics in a process labelled “transnationalization”: states no longer had a monopoly in this area, but had to deal with the interference of “nongovernmental” players such as transnational firms and international organizations. As a consequence, explanatory models exclusively focusing on states began to look narrow and obsolete. Already in his 1980 book The Study of Global Interdependence, James Rosenau predicted far-reaching consequences leading to a transformation and “even a breakdown of the nation-state system as it has existed throughout the last four centuries” (Rosenau 1980: 2). After the sea-change in world politics at the beginning of the 1990s, the once orderly world system seemed to come apart completely. Its “turbulence”, as Rosenau now described it, was characterized by the simultaneous existence of a “statecentric” and a “multi-centric” world. The latter was composed of a subset of the state system, international organizations, state bureaucracies and transnational actors such as multinational corporations. These changes pertained in theoretical ways in the ascent of the constructivist research paradigm in international relations, focusing on the role of non-material “social facts” such as ideas, norms, cultural identity and arguments (about the theoretical foundations and the results of the constructivist research programme see e.g. Finnemore and Sikkink 2001). Among the empirical results of this “third debate” in international relations are the influence of “identity issues” on the behaviour of states (see Katzenstein 1996) and the importance of non-state actors such as NGOs, activist groups or “epistemic communities” acting as “norm entrepreneurs” (see Haas 1992; Risse et al. 1999). 2.3 The relationship between domestic and foreign policy The relationship between domestic and foreign (or international) policy is of interest to scholars of both international relations and comparative government.

The development of the debate 27 The old debate about which of the two was dominating the other was ended in the 1960s in favour of empirical research on the relationship between the two, searching for the “domestic sources of foreign policy” (Rosenau 1967). One of the main criticisms levelled by scholars of comparative government against the theory of interdependence in international relations was the fact that influence of interdependence on domestic policy was acknowledged, but not analysed (Keohane and Milner 1996: 7). They therefore reversed Rosenau’s question, asking for the “international sources of domestic politics”. So they claimed: The international system is not only a consequence of domestic politics and structures but a cause of them. Economic relations and military pressures constrain an entire range of domestic behaviours, from policy decisions to political forms. International relations and domestic politics are therefore so interrelated that they should be analysed simultaneously, as wholes. (Gourevitch 1978: 911) The era after the macroeconomic shocks of the 1970s, when the post-war international economic order began to dissolve, seemed a particularly interesting time to pursue that question. David Cameron’s (1978) study on the expansion of the public economy demonstrated that the more countries were exposed to the pressures of international competition through a high degree of economic openness, the more they tended to have a big public economic sector. Peter Katzenstein showed that in small European states political stability and economic flexibility are inextricably linked: since they were exposed to fluctuations in the international economic sphere that were beyond their control, they developed corporatist economic institutions as an “institutional mechanism for mobilizing the consensus necessary to live with the costs of rapid economic change” (Katzenstein 1985: 200). Today, the analysis of international influence on domestic policy is a firmly established research area in comparative government (see Keohane and Milner 1996; Garrett 1998; Chan and Scaritt 2002). By way of summing up one can say that the debate about globalization is fed from a variety of sources in the social sciences. Sociological theory, international relations theory, comparative government and economics all have discussions that link to the topic of globalization. Against this background one should not be too surprised that very different associations to this term exist and it must seem questionable whether a common definition of it will ever be agreed on. However, the lack of the latter seems so far not to have adversely affected the creativity and output of research on the topic – quite the contrary!

3 Positions and hypotheses As a consequence of the exploding amount of publications concerning globalization, several attempts were made to try and categorize the contributions and thus facilitate a more structured debate. One should not be too surprised, given what was stated earlier, that no general agreement could be found in this either: positions

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were grouped into the categories liberal, sceptic and moderate (Busch 1999), hyperglobalist, sceptic and transformationalist (Held et al. 1999), liberal, social democratic and rejectionist (Sally 2000), and globalist and sceptic (Held and McGrew 2000). The main distinguishing criterion in these classifications turns out to be the question of whether globalization is being perceived as an event that fundamentally alters the conditions under which states act or not. The semantics are sometimes puzzling here, since the frequently used term “sceptic” can refer both to the consequences of globalization (especially as far as state capacity is concerned) and to the validity of the globalization hypothesis. The question concerning the nation state’s capacity to act under conditions of globalization consequentially has been declared the central focus of the whole debate by a number of authors – so far a consensus has been emerging in this multi-faceted debate in recent years (see e.g. Berger 2000: 52; Gourevitch 2002: 313; Zürn 2002: 240; and Busch 2003: 22). But whether this capacity to act is indeed under threat (and what consequences this would have for the self-conception of democratic governance), is again contested. Those who see the state’s capacity to act threatened by globalization emphasize the following aspects: conditions for economic policy have changed substantially over the course of the last three decades, and this fundamentally impinges upon the concept of the “modern” or “Westphalian” state characterized by “independence from without and exclusive sovereignty within” (Hintze 1970: 478).3 After the Second World War, controls over movements of currency and goods had allowed the state to siphon off rents from capital owners to finance public and welfare state spending (Scharpf 1996). After the breakdown of the Bretton Woods System of fixed exchange rates and the demise of currency controls, states had lost the command over the setting of domestic interest rates to the international financial markets and had to yield to their “tyranny” (Eichengreen 1997). In the sphere of fiscal policy, the state’s room for manoeuvre was also strongly curtailed, since globalization enforced a shift of taxation from the (highly mobile) factor capital to the (less mobile) factor labour. As a consequence, it was argued, states were faced with the unpalatable choice between either running permanent public deficits or declining international competitiveness of the domestic economy due to excessive labour costs. Deregulation and transnationalization further reduced the capacity for active state policy, and in terms of welfare state measures, that globalization would lead to cut-throat competition and a “race to the bottom”. Consequently, authors arguing for this position spoke of the “erosion” of the nation state (Hilpert 1994), its “retreat” (Strange 1996) or even of its “end” (Ohmae 1995). The line of argument advanced by supporters of the “globalism” thesis was, however, contested by a string of authors and from a variety of perspectives. Some pointed out that markets required a strong regulatory state in order to function well, and that therefore the demise of the state was neither likely nor in the interest of the markets (Boyer and Drache 1996). Besides this more theoretical argument, authors of a more empirical persuasion also questioned the decline scenarios of the globalists. They emphasized that the development over the last decades was not as unique as claimed, and that global economic integra-

The development of the debate 29 tion was at a similar level at the beginning of the twentieth century (Hirst and Thompson 1996). A number of studies also questioned whether the restriction of state capacity was quite as drastic as sometimes stated: they found that tax competition between states, caused by globalization and international capital mobility, was not quite as pronounced and negative as expected, and that therefore the consequences for welfare systems were not either. Rather, it was argued, these systems demonstrated a remarkable degree of resilience and a capacity for adaptation, and party political preferences for taxation and redistribution could still be implemented (Garrett 1998; Swank 2002). Furthermore it could be shown that the costs of welfare state interventions in the economy through taxation were often balanced by positive externalities such as a high level of social stability and a well-trained workforce – and that these advantages were also recognized and appreciated by the owners of highly mobile capital. As a consequence, authors from this group have tended to see state capacity in a more positive light, speaking of “new tasks” for the state (Sassen 1998) and declared the thesis of the powerless state a “myth” (Weiss 1998).

4 Theoretical approaches In order to analyse globalization beyond the merely descriptive sphere, we need a theoretical basis from which we can model the relationship between increasing globalization and the effect this has on state capacity. Even if many contributions to the debate only mention their assumptions in this respect implicitly, there are basically two theoretical approaches that are being used in this context. They lead, however, to opposite predictions concerning the directions developed industrial societies will presumably take as a reaction to the challenges of increasing – mainly, but not exclusively – economic integration. One predicts a trend towards convergence, the other a scenario of stable or even increasing diversity of policy. With respect to state capacity (understood mainly as policy self-determination) we would expect it to shrink under the former scenario, while it would not be affected in the latter. This section describes both approaches as well as the assumptions upon which they build. 4.1 Convergence Theoretical considerations postulating a trend of convergence of state action are rooted on the one hand in the theory of international trade, on the other hand in theories of interjurisdictional or intergovernmental competition. The first approach builds on the factor-proportion theorem (also known as the Heckscher–Ohlin Theorem) and posits a relationship between a country’s factor endowment and the structure of its foreign trade linked to differences in comparative costs. According to this, a country will tend to export goods with whose production factor it is relatively abundantly endowed, while it will tend to import such goods whose production factors are relatively scarce domestically. The reason is that a relative abundance in capital will cause the capital-abundant

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country to produce capital-intensive goods more cheaply than a labour-abundant country. Building on this standard economic theory, Ronald Rogowski some time ago developed a political science model to explain the emergence of societal cleavages (Rogowski 1989). Starting from rather simple assumptions about the domestic political process4 and with the help of the Stolper–Samuelson Theorem (see Chapters 1 and 11) Rogowski was able to put forward hypotheses about the effects of increasing economic openness in order to explain the different political developments, coalitions and cleavages in late nineteenth century Britain, Germany and the United States. In work done collaboratively with Jeffry Frieden Rogowski undertook a – plausible – extension of this model to the process of globalization (Frieden and Rogowski 1996). In doing so, they strove to explain the policy preferences of the relevant domestic actors, the policies carried out, and the development of national political institutions, claiming that the power of an interest group to assert its preferences varies with its mobility – or rather that of its factor of production. The group that can more credibly threaten to exit will increase its negotiation power and have its preferences implemented. Globalization will therefore lead to government policy adapting to the interests of capital owners (the most mobile factor of production), and since this adaptation will take place everywhere, policy convergence is the result. The second approach focuses on government action under conditions of competition and arrives at similar conclusions (see Kenyon 1997). The fundamental assumption is that governments compete for mobile capital (which looks for the highest net yield). This leads to an equalization of net yields across countries and tax competition between states trying to provide the best business environment (see Schulze and Ursprung 1999). The degree of competition depends on the mobility of all factors of production. But it is not only the extent of taxation that influences yield expectations of capital – labour, social, and environmental regulations also play a part in this competition. For, since regulations impose costs, firms will try to minimize such costs. Therefore (and with the same logic as in the case of taxation) equalization will be the result in these areas as well. Which direction this competitive equalization between states will take – a “race to the bottom” with a downward spiral of regulatory intensity and a convergence on the smallest common denominator, or a “race to the top” with escalating regulation as a consequence of competition – depends on a variety of factors and is not relevant in the present context.5 In conclusion we can say that while the models outlined in the preceding paragraphs differ with respect to their precise mechanisms, they posit the same effect of growing economic integration on domestic policy: either through a change in the domestic balance of power or through direct change in government policy, a convergence of policies and institutions will result from the change in external economic circumstances.

The development of the debate 31 4.2 Diversity Quite the contrary, development as the consequence of external change is what other theoretical approaches, which focus on the stability of specific national characteristics, would lead us to expect. According to these theories (which give special emphasis to differences in policy styles, the resilience of institutional arrangements and the path dependence of decisions more generally), continued or even increased diversity of policy outputs and institutional structures will be the likely result. One of the first analyses to take such a perspective was probably Andrew Shonfield’s book on “Modern Capitalism” (Shonfield 1965). Shonfield explained in his extensive empirical analysis the differences in economic policy between the United States, France, Britain and the Federal Republic of Germany primarily with reference to the different attitudes with which national political and economic actors approached the economy. These attitudes, Shonfield stated, were largely based on culturally specific orientations deeply rooted in the national history. While differences between them were often small and diffuse, over time they amounted to a significant order of magnitude. Translating these diffuse differences into more manageable variables in the area of policy-making and policy implementation has been the merit of the concept of national “policy styles” (Richardson et al. 1982; see also Vogel 1986). These national policy styles differ on the one hand on the dimension of problem-solving, and on the other hand with respect to the relationship between government and the other actors in the decision-making process. While the former can be either anticipatory or reactive, the latter can be consensual or impositional (Richardson et al. 1982: 13). These distinctions result in a typology of national policy styles which have (in addition to institutional factors) a significant influence on policy. Attitudes and orientations, more generally – cognitive aspects and “ideas” – thus play a significant role in the nationally specific approaches and implementations of policy (on the role of ideas in policy making see e.g. Braun and Busch 1999). Especially implementation is an area in which national policy styles show great perseverance, as studies of public administration have shown: Policy styles and policy networks in public administration are firmly rooted in nationally specific legal, political and administrative institutions which are the result of long historical processes and show great stability over time. Most of these institutions are linked to each other in one way or another which further stabilizes them. (Waarden 1993: 206) Institutional stability is therefore high and cannot be easily changed through shifts in political power: [T]o portray political institutions simply as an equilibrium solution to the conflicting interests of current actors is probably a mistake. Institutions are

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Andreas Busch not simply reflections of current exogenous forces or micro-behaviour and motives. They embed historical experience into rules, routines, and forms that persist beyond the historical moment and condition. (March and Olsen 1989: 167f.)

Under conditions of such stability we would also expect increases in international integration to induce no major changes, with respect to both institutions and policy content: “Given this strong rootedness, these institutions are not easily changed and with them national regulatory styles.” (Waarden 1995: 362) The most general and perhaps theoretically most sophisticated form of this argument can be found in the concept of path dependency which is derived from the transaction cost and institutional school of economics.6 This approach describes how processes can over time (through positive returns to scale, network externalities and feedback effects) achieve highly stable equilibria (lock-in) where the cost of fundamental change is prohibitively high and such change accordingly very rare. Economic models of that ilk have in the past been used to explain technological developments and decisions about the location of industries (see Arthur 1989; Krugman 1991), and have recently been successfully applied to political science topics, with a special focus on the dynamics increasing returns to scale and self-reinforcing processes have on social interaction (see Pierson 2004). Political decisions, according to this line of argument, carry a substantial historical legacy which consists of past political investments and decisions, thus severely limiting choice in the present. By raising the cost of path change, this also contributes to the stability of the originally chosen path. In addition, the disproportionate importance of changes at an early stage is being emphasized, as is the existence of “critical junctures”.7 Seen from such a perspective, one would expect states to further pursue their historically developed paths even under conditions of increasing international integration, thus leading not to convergence, but to constant and perhaps even increasing diversity of political and policy decisions. 4.3 Theory and reality Both expectations of convergence and of diversity thus have convincing and coherent theoretical models that can be put forward in their favour. Empirical studies, however, intended to adjudicate between the rival approaches, often arrive at more complex results which do not fully support either of the two scenarios. One example of this is the area of state regulation of the banking system – a policy area that is characterized both by the emergence of “24/7” world wide market operation and historically very different starting conditions in terms of institutional and market structures, making it an ideal test case for the convergence hypothesis. An empirical study of four highly developed OECD countries (USA, UK, Germany and Switzerland) over the 1974 to 1999 period, however, fails to conclusively support or reject either of the competing hypotheses and

The development of the debate 33 presents a mixed picture (Busch 2003; forthcoming). Differentiating between content, process and institutional components leads to somewhat clearer results: while partial – but clearly less than complete – convergence can be detected in terms of the content of regulation, continuous divergence in terms of both the political process and with regard to institutional setups must be stated. We find therefore that inter- and supranational agreements lead to a degree of equalization in the dimension of policy, the dimensions of national politics and polity remain largely immune to change. The hypothesis put forward by Frieden and Rogowski (1996) about the increasing influence of capital owners is thus not supported. A recently conducted meta-analysis of studies about policy convergence – which, however, also includes studies of Europeanization – comes to the similar conclusion that results vary strongly according to policy area, countries and time period considered, and that it is often difficult to clearly categorize a process of convergence or diversity (Heichel et al. 2005).

5 Conclusion The debate about the consequences of globalization, after more than a decade, does not seem to be nearing conclusion any time soon. And there are good reasons for this, both in academic and in general political regard: for the latter the challenge is to determine what degree of self-determination a democratic society can reasonably expect to achieve, and how a state’s legitimacy is affected if its capacity to provide “classical” state services is perhaps severely diminished. For the academic debate the challenge is to overcome disciplinary restrictions and to improve our understanding of the national and international political changes triggered by the advent of globalization. If we look at the debate so far, we can quite clearly distinguish various phases. A first wave – that popularized the term and put it on the academic agenda – took up relatively crude stances on globalization that today seem exaggerated both with respect to the positive (e.g. Ohmae 1990) and negative (e.g. Strange 1986) consequences of globalization. It was followed with some delay by a second wave which focused on the collection of empirical facts, which then allowed critical examination of the claims of the first wave (such as Hirst and Thompson 1996; Beisheim et al. 1999). Building on these data and with a view to the stalemate mentioned above with regard to theoretical models trying to explain the consequences of globalization, a third wave of the literature then undertook detailed sectoral studies concerning welfare state or regulatory policies, often in a comparative perspective (e.g. Scharpf and Schmidt 2000a, b; Busch 2003). Forming the diverse results of that third wave into a coherent and theoretically consistent state of knowledge about globalization will be the task of a fourth wave that is so far still outstanding. Peter Gourevitch (2002: 313) has rightly pointed out that the debate about globalization has increased the importance of international relations for scholars of comparative government, while the importance of knowledge about the internal workings of political systems has conversely risen for scholars

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of international relations. But the cooperation over long-established (even sub-)disciplinary boundaries – and even the sheer knowledge about what is happening on the other side of the fence – is something that is evidently still capable of further improvement, but faces the difficulties of increasing professional differentiation. Research concerning globalization is even more than one-and-a-half decades into the debate still very active, as the figure in the beginning of this article demonstrates. Certainly we now know more about this complex phenomenon than we did a decade ago when jubilation and scepticism about globalization existed side by side without either having a solid and detailed empirical foundation for their often far-reaching claims. There is criticism that attempts to formulate a general theory of globalization by international relations scholars have failed so far and that our knowledge about the causes and origins of globalization – and systematic empirical facts about it – still have to be regarded as low (Zürn 2002: 235, 239). But we should consider whether the stakes are not raised too high in demanding this: after all, precious few “general theories” exist in most of social science, and the competing views and perspectives on globalization so far seem to have spurred on research rather more than hindered it. In comparative government we can also not speak of a stable and comprehensive state of knowledge about globalization so far. But many of the studies of the abovementioned “third wave” have resulted in increased scepticism towards the originally far-reaching hypotheses about policy convergence and a regulatory “race to the bottom”, and they have tended to emphasize the importance of national political institutions in this process, which work as “national filters” of globalization (see Busch 2004, 2003: 547ff.; Drezner 2001; Weiss 2003). Perhaps it is best to see research on globalization as engaged in a process of maturation in which we can observe consolidation as well as concentration and an emerging focus on a subset of the initial research questions. Not least the contributions assembled in this volume seem a good example of this. At the same time, however, important open questions and desiderata continue to exist, such as a clearer distinction between the analysis of the origins of globalization (what caused it?) and the consequences of globalization (what did it cause?). Both aspects promise to leave a lot of space for further creative research efforts in this area, guided by the hope for the big breakthrough – or, failing that, that for the steady accumulation of knowledge.

Notes 1 This chapter partially draws on the author’s previous work on globalization (Busch 1999, 2003). For constructive criticisms and suggestions on a previous version of this chapter, I am grateful to the participants of the workshop on globalization in Arnoldshain, November 2005, and in particular to Tanja Brühl and Stefan Schirm. 2 The figure is derived from data of three bibliographic databases which were queried for the title words “globalisation” and “globalization”. They are the International Bibliography of the Social Sciences (IBSS) as well as the databases “WorldCat” (books) and “ArticleFirst” (journal articles) of the Library of Congress. Originally conducted in

The development of the debate 35

3 4 5

6

August 2001, the dataset was updated in September 2005 for the years ranging from 2001 to 2004. All translations from German language texts, unless otherwise indicated, are by the author. Rogowski (1987: 1123) merely makes two assumptions: Those who profit from change will try to push it, while the losers will try to stop or delay it. Citizens who benefit materially now or in the future are able to extend their political influence. See for this the seminal work by Vogel (1986). Illustrations of the (in Vogel’s terms) “Delaware effect” (race to the bottom) and “California effect” (race to the top) in different international attempts at cooperation can be found in Genschel and Plümper (1999), who also outline the conditions under which each of the two is likely. An overview is Williamson (1994). Douglass North describes the attractiveness of the concept of path dependence as follows: The promise of this approach is that it extends the most constructive building blocks of neoclassical theory – both the scarcity / competition postulate and incentives as the driving force – but modifies that theory by incorporating incomplete information and subjective models of reality and the increasing returns characteristic of institutions. (North 1990: 112)

7 Some examples from prominent political science contributions may serve to illustrate these mechanisms. The work of Stein Rokkan (2000) about the comparison of European societies, for example, demonstrates that small differences in starting positions can yield substantial differences over longer periods of time, while Putnam (esp. 1993: 179–81) shows the same for the comparative study of sub-national units. The importance of critical junctures and the stability of structures once they have been established is also evident in the development of European party systems. While fundamental social cleavages initially triggered the founding of political parties, the ensuing development is marked by inertia which impeded the emergence of new parties and caused a “freezing” of the party systems along the cleavages of the early twentieth century (Lipset and Rokkan 1967).

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–––– (2004) “National Filters: Europeanisation, Institutions, and Discourse in the Case of Banking Regulation”, West European Politics 27: 310–33. (Special issue on Policy Change and Discourse in Europe, ed. by Claudio M. Radaelli and Vivien A. Schmidt.) –––– (forthcoming) Banking Regulation and Globalization, Oxford: Oxford University Press. Busch, A. and Plümper, T. (eds) (1999) Nationaler Staat und internationale Wirtschaft. Anmerkungen zum Thema Globalisierung, Baden-Baden: Nomos. Cameron, D.R. (1978) “The Expansion of the Public Economy: A Comparative Analysis”, American Political Science Review, 72: 1243–61. Cerny, P.G. (1996) “Globalization and Other Stories. The Search for a New Paradigm in International Relations”, unpublished thesis, Leeds: Dept. of Politics, University of Leeds. Chan, S. and Scarritt, J.R. (eds) (2002) Coping with Globalization: Cross-national Patterns in Domestic Governance and Policy Performance, London: Frank Cass. Clark, I. (1999) Globalization and International Relations Theory, Oxford: Oxford University Press. Cooper, R. (1968) The Economics of Interdependence, New York: McGraw-Hill for the Council on Foreign Relations. Drezner, D.W. (2001) “Globalization and Policy Convergence”, International Studies Review, 3: 26. Eichengreen, B. (1997) “The Tyranny of the Financial Markets”, Current History, 96: 377–82. Finnemore, M. and Sikkink, K. (2001) “Taking Stock: The Constructivist Research Program in International Relations and Comparative Politics”, Annual Review of Political Science, 4: 391–416. Frieden, J.A. and Rogowski, R. (1996) “The Impact of the International Economy on National Policies: An Analytical Overview”, in R. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 25–47. Garrett, G. (1998) Partisan Politics in the Global Economy, Cambridge: Cambridge University Press. Genschel, P. and Plümper, T. (1999) “Wettbewerb und Kooperation in der internationalen Finanzmarktregulierung”, in A. Busch and T. Plümper (eds) Nationaler Staat und internationale Wirtschaft. Anmerkungen zum Thema Globalisierung, BadenBaden: Nomos: 251–75. Glyn, A. (2006) Capitalism Unleashed: Finance, Globalization, and Welfare, Oxford: Oxford University Press. Goldthorpe, J. (2002) “Globalisation and Social Class”, West European Politics, 25: 1–28. Gourevitch, P. (1978) “The Second Image Reversed: The International Sources of Domestic Politics”, International Organization, 32: 881–912. –––– (2002) “Domestic Politics and International Relations”, in W. Carlsnaes, T. Risse and B.A. Simmons (eds) Handbook of International Relations, London: Sage: 309–28. Gray, J. (1998) False Dawn. The Delusions of Global Capitalism, London: Granta. Haas, P.M. (1992) “Introduction: Epistemic Communities and International Policy Coordination”, International Organization, 46: 1–35. Heichel, S., Pape, J. and Sommerer, T. (2005) “Is there Convergence in Convergence Research? An Overview of Empirical Studies on Policy Convergence”, Journal of European Public Policy, 12: 817–40.

The development of the debate 37 Held, D. and McGrew, A. (eds) (2000) The Global Transformations Reader. An Introduction to the Globalization Debate, Cambridge: Polity Press. –––– (2002) Globalization/anti-globalization, Cambridge: Polity Press. Held, D., McGrew, A., Goldblatt, D. and Perraton, J. (1999) Global Transformations. Politics, Economics and Culture, Cambridge, Oxford: Polity. Hilpert, U. (1994) “Das politische Risiko erfolgreicher Partizipation an neuen Weltmärkten. Zum Problem tendenzieller Erosion staatlicher Steuerungskompetenz bei erfolgreicher Integration in die internationale Arbeitsteilung”, in U. Hilpert (ed.) Zwischen Scylla und Charybdis? Zum Problem staatlicher Politik und nicht-intendierter Konsequenzen, Opladen: Westdeutscher Verlag: 87–106. Hintze, O. (1970) “Wesen und Wandlung des modernen Staats”, in O. Hintze (ed.) Staat und Verfassung. Gesammelte Abhandlungen zur allgemeinen Verfassungsgeschichte, 3rd edn, Göttingen: Vandenhoeck & Ruprecht: 470–96. Hirst, P. and Thompson, G. (1996) Globalization in Question. The International Economy and the Possibilities of Governance, Cambridge: Polity Press. Kagarlitsky, B. and Clarke, R. (1999) New Realism, New Barbarism: Socialist Theory in the Era of Globalization, Recasting Marxism, London: Pluto Press. Katzenstein, P.J. (1985) Small States in World Markets. Industrial Policy in Europe, Ithaca, NY: Cornell University Press. –––– (1996) The Culture of National Security: Norms and Identity in World Politics, New Directions in World Politics, New York: Columbia University Press. Kenyon, D.A. (1997) “Theories of Interjurisdictional Competition”, New England Economic Review, March/April: 13–28. Keohane, R.O. and Milner, H.V. (eds) (1996) Internationalization and Domestic Politics, New York, Cambridge: Cambridge University Press. Keohane, R.O. and Nye, J.S. (1977) Power and Interdependence: World Politics in Transition, Boston, MA: Little Brown. Krugman, P. (1991) “History and Industry Location: The Case of the Manufacturing Belt”, American Economic Review, 81: 80–3. Lawson, S. (ed.) (2002) The New Agenda for International Relations: From Polarization to Globalization in World Politics? Cambridge: Polity Press. Lipset, S.M. and Rokkan, S. (1967) “Cleavage Structures, Party Systems and Voter Alignments: An Introduction”, in S.M. Lipset and S. Rokkan (eds) Party Systems and Voter Alignments, New York: Free Press: 1–64. March, J.G. and Olsen, J.P. (1989) Rediscovering Institutions. The Organizational Basis of Politics, New York: Free Press. Marx, K. (1977) Selected Writings, ed. by D. McLellan, Oxford: Oxford University Press. North, D.C. (1990) Institutions, Institutional Change and Economic Performance, Cambridge: Cambridge University Press. OECD (1996) Globalisation of Industry. Overview and Sector Reports, Paris: OECD. Ohmae, K. (1990) The Borderless World. Power and Strategy in the Interlinked Economy, London: Collins. –––– (1995) The End of the Nation State: The Rise of Regional Economics, London: HarperCollins. Pierson, P. (2004) Politics in Time: History, Institutions, and Social Analysis, Princeton, NJ: Princeton University Press. Putnam, R.D. (1993) Making Democracy Work: Civic Traditions in Modern Italy, Princeton, NJ: Princeton University Press.

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Richardson, J.J., Gustafsson, G. and Jordan, G. (1982) “The Concept of Policy Style”, in J.J. Richardson (ed.) Policy Styles in Western Europe, Boston, MA: Allen and Unwin: 1–16. Risse, T., Ropp, S.C. and Sikkink, K. (eds) (1999) “The Power of Human Rights: International Norms and Domestic Change”, Cambridge Studies in International relations, 66, Cambridge: Cambridge University Press. Rodrik, D. (1997) Has Globalization Gone Too Far? Washington, DC: Institute for International Economics. Rogowski, R. (1987) “Political Cleavages and Changing Exposure to Trade”, American Political Science Review, 81: 1121–37. –––– (1989) Commerce and Coalitions: How Trade Affects Domestic Political Alignments, Princeton, NJ: Princeton University Press. Rokkan, S. (2000) Staat, Nation und Demokratie in Europa. Die Theorie Stein Rokkans aus seinen gesammelten Werken rekonstruiert und eingeleitet von Peter Flora, Frankfurt am Main: Suhrkamp. Rosenau, J. N. (ed.) (1967) Domestic Sources of Foreign Policy, New York: Free Press. –––– (1980) The Study of Global Interdependence, New York: Nichols. Sally, R. (2000) “Globalization and Policy Response: Three Perspectives”, Government & Opposition, 35: 237–53. Sassen, S. (1998) “Zur Einbettung des Globalisierungsprozesses: Der Nationalstaat vor neuen Aufgaben”, Berliner Journal für Soziologie, 8: 345–57. Scharpf, F.W. (1996) “Föderalismus und Demokratie in der transnationalen Ökonomie”, in K. von Beyme and C. Offe (eds) Politische Theorien in der Ära der Transformation, Opladen: Westdeutscher Verlag: 211–35 (PVS special issue no. 26). Scharpf, F.W. and Schmidt, V.A. (eds) (2000a) Welfare and Work in the Open Economy. Volume I: From Vulnerability to Competitiveness, Oxford: Oxford University Press. –––– (2000b) Welfare and Work in the Open Economy. Volume II: Diverse Responses to Common Challenges, Oxford: Oxford University Press. Schirm, S.A. (2002) Globalization and the New Regionalism. Global Markets, Domestic Politics, and Regional Cooperation, Cambridge: Polity Press. Schulze, G.G. and Ursprung, H.W. (1999) “Globalisierung contra Nationalstaat? Ein Überblick über die empirische Evidenz”, in A. Busch and T. Plümper (eds) Nationaler Staat und internationale Wirtschaft. Anmerkungen zum Thema Globalisierung, BadenBaden: Nomos: 41–89. Shonfield, A. (1965) Modern Capitalism. The Changing Balance of Public and Private Power, London, New York, Toronto: Oxford University Press. Strange, S. (1986) Casino Capitalism, Oxford: Blackwell. –––– (1995) “The Limits of Politics”, Government and Opposition, 30: 291–311. –––– (1996) The Retreat of the State: the Diffusion of Power in the World Economy, Cambridge: Cambridge University Press. Swank, D. (2002) Global Capital, Political Institutions, and Policy Change in Developed Welfare States, Cambridge: Cambridge University Press. Vogel, D. (1986) National Styles of Regulation: Environmental Policy in Great Britain and the United States, Ithaca, NY: Cornell University Press. Waarden, F. van (1993) “Über die Beständigkeit nationaler Politikstile und Politiknetzwerke. Eine Studie über die Genese ihrer institutionellen Verankerung”, in R. Czada and M.G. Schmidt (eds) Verhandlungsdemokratie, Interessenvermittlung, Regierbarkeit. Festschrift für Gerhard Lehmbruch, Opladen: Westdeutscher Verlag: 191–212. –––– (1995) “Persistence of National Policy Styles: A Study of their Institutional

The development of the debate 39 Foundations”, in B. Unger and F. van Waarden (eds) Convergence or Diversity? Internationalization and Economic Policy Response, Aldershot: Ashgate: 333–72. Waters, M. (1995) Globalization, London: Routledge. Weiss, L. (1998) The Myth of the Powerless State, Ithaca, NY: Cornell University Press. –––– (2003) States in the Global Economy: Bringing Domestic Institutions Back In, Cambridge: Cambridge University Press. Williamson, O.E. (1994) “Transaction Cost Economics and Organization Theory”, in N.J. Smelser and R. Swedberg (eds) The Handbook of Economic Sociology, Princeton, NJ: Princeton University Press: 76–107. Zürn, M. (2002) “From Interdependence to Globalization”, in W. Carlsnaes, T. Risse and B.A. Simmons (eds) Handbook of International Relations, London: Sage: 235–54.

3

Fiscal policy and adjustment Adjusting fiscal policy to globalization – testing theoretical approaches Reimut Zohlnhöfer

1 Introduction Comparative research on the determinants of fiscal policy developments in Organization for Economic Cooperation and Development (OECD) democracies has produced consistent but somewhat unexpected evidence over the last years: Since the mid-1980s, almost all OECD member states have adopted tax reforms which stipulated cuts to the tax rates, particularly for businesses, and a broadening of the tax base (see Devereux et al. 2002; Steinmo and Swank 2002; Ganghof 2005). According to quantitative research, these reforms were hardly influenced by the partisan complexion of the respective governments (Steinmo and Swank 2002). These findings contravene the fact that differences in the partisan complexion of governments in the post-war period have led to tax systems which still differ remarkably throughout the OECD world: for example, countries predominantly governed by Social Democratic parties exhibit high tax ratios, while the rule of Liberal or Conservative parties led to significantly lower tax burdens (Wagschal 2005: 390–5). It is not only on the revenue side of the budget, however, that partisan differences seem to wane; on the expenditure side as well, it seems to be of declining importance which parties are in government. A particularly important case in point is social spending, the largest item of expenditure in the OECD democracies. Until the mid-1980s, that is during the phase of welfare state expansion, clear partisan patterns could be observed: Social Democratic as well as Christian Democratic parties tended to increase social spending, while Liberal and Conservative parties tended to limit the growth of the welfare state. Since the 1990s, however, the relevant quantitative studies fail to find a systematic relationship between changes in social spending and the partisan complexion of government (Garrett and Mitchell 2001; Huber and Stephens 2001; Schwartz 2001; Kittel and Obinger 2003). The same results are produced by quantitative studies analysing other areas of government expenditure, for example subsidies (Obinger and Zohlnhöfer forthcoming). In a substantial part of the literature, globalization, particularly the internationalization of financial markets, is held responsible for the decline of partisan effects in fiscal as well as social policies. However, in many contributions it

Adjusting fiscal policy to globalization 41 remains largely unclear how the external challenges are transformed into policies at the national level (Schwartz 2001: 20f.). This is at least partly due to the fact that most of the relevant theoretical as well as empirical research focuses on the results of adjustment processes. Therefore, most studies investigate whether a “race to the bottom” or convergence has occurred (as an overview see Schulze and Ursprung 1999), while the process of adjustment itself is hardly ever analysed (Zürn 2002: 243). This is unfortunate because such an investigation of the political processes of adjustment is particularly suitable in order to understand the impact of political variables on nation states’ adaptations to globalization. This chapter will deal with the theoretical question, in what way do changes in the international political economy trigger changes of national fiscal policies. In the next part of the chapter, the most important theoretical contributions to this field are presented and briefly discussed. Building on this discussion, my own model of adjustment processes to economic globalization is presented in the third section. My model takes as a starting point the fact that reforms to adjust to the challenges of globalization still need to be adopted by national institutions. Therefore, I start from the actors with formal veto powers and model their preferences. Afterwards, hypotheses about the adjustment processes and their results in different settings are derived from the model which are tested by a comparative analysis of fiscal policy developments in Germany and the United Kingdom since the 1980s (section 4). The final section concludes.

2 Models of domestic adjustment processes to changes in the international economy 2.1 The models of Rogowski and Frieden The classic model dealing with the impact of foreign trade on domestic politics was developed by Ronald Rogowski (1989). Rogowski was primarily interested in how changes in foreign trade impact on domestic political alignments. Nevertheless, his reflections are also important for the purpose of this chapter because they lead one to expect that the domestic coalitions formed in reaction to changes in foreign trade also influence the processes of economic policy adaptation to the challenges of the international economy. Rogowski’s starting point is the so-called “Stolper–Samuelson Theorem” that explains which factors of production experience benefits or losses due to the liberalization of foreign trade or other exogenous changes relevant for trade (like changes in transport costs etc.) – given the assumptions of the Heckscher–Ohlin trade model hold. Stolper and Samuelson argue that the owners of the factor a country is poorly endowed compared with the rest of the world benefit from protection while the owners of the relatively abundant factor are harmed by closed borders. The liberalization of trade therefore harms the scarce factor while the abundant factor benefits. Therefore, Rogowski argues, the owners of the scarce factor will opt for protectionism, while the owners of the abundant factor will favour free trade. Moreover, he assumes “that those who enjoy a sudden increase in wealth and income

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will thereby be enabled to expand their political influence as well” (Rogowski 1989: 5). This is a critical assumption since it implies that the beneficiaries of a change in the conditions of foreign trade (changes in tariffs, transport costs etc.) also experience an increase in domestic political influence which they can use to further change the economic policy framework in their favour. Jeffry Frieden (1991: 435) has applied the same logic to an increase in capital mobility. According to Rogowski’s and Frieden’s models, the following should thus be expected for fiscal policy adjustments to economic openness: The option to invest abroad in capital-poor countries, which was only created by increasing openness, will boost capital owners’ domestic influence in capital-rich countries and will thus enable them to push through far-reaching fiscal policy changes in accordance to their interests, for example tax cuts. Frieden (1991), however, has objected that this logic may well explain the relevant developments adequately in the long run but that in the short or medium term different coalitions would emerge along sectoral cleavages. Since real capital cannot easily be moved from one use to another (i.e. it is specific to a certain sector), owners of real capital in capital-rich countries do not benefit from an increase in capital mobility in the short run. Therefore, at least in the short term, owners of real capital in labour-intensive sectors in capital-rich countries have the same interests as their workers because due to the establishment of foreign trade with labour-rich countries the prices of commodities that are produced labour-intensively decrease in the capital-rich country which hurts both groups equally. In contrast, the owners of financial assets do have the option to invest profitably in capital-poor countries. Thus, at least in the short run the interests of capital owners can diverge. What is more important for the purpose of this chapter, however, is how Frieden models the political process. Like Rogowski, he tries to identify winners and losers in an increase of economic openness. The interests and economic importance of these groups then determine the way a country adjusts to economic openness. In a later contribution, Frieden and Rogowski (1996) have extended their “rudimentary model of the political process” (Rogowski 1989: 4) and have added a number of institutional features. They mainly focus on the question of which institutions incite politicians to pursue free trade policies, which increase aggregate welfare, even though the politicians’ re-election may be put at risk by the resistance of interest groups that are negatively affected by the liberalization. They conclude that “[g]overnments will be more likely to respond to such pressures [for reductions of barriers to trade; RZ] to the extent that they more accurately represent the broad social interest in the aggregate; can make credible commitments to compensate potential losers; and have relatively longer timehorizons.” (Frieden and Rogowski 1996: 45) Frieden’s and Rogowski’s approaches are fascinating because of the theoretical elegance with which they derive actor preferences from simple economic models. This is also their main merit. Nevertheless, their utility as a framework for empirical research on nation states’ adaptation to globalization is limited. For example, they fail to consider the fact that governments have to decide in cases

Adjusting fiscal policy to globalization 43 of conflict between the demands of capital owners who might threaten to invest abroad and the wishes of voters the majority of whom are often not willing to accept welfare cuts or tax cuts for enterprises. This blind spot is particularly serious because governments depend on the consent of the voters and not – at least not directly – on the cooperation of multinational corporations. Moreover, governments more often than not act on their own and not as pure agents of the interests of certain groups or the median voter. These relations remain unexplored in Rogowski’s and Frieden’s models. In addition, their discussion of the role of institutions remains exceedingly abstract. Put simply: their model of the political process is under-complex.1 2.2 Bridging the gap to institutionalist approaches: Garrett and Lange Geoffrey Garrett and Peter Lange (1996: 69) are certainly correct in pointing out that – against Frieden’s and Rogowski’s expectations – no existing political system will translate the economic policy demands of the beneficiaries of globalization into government policy in their entirety, not even when the economic importance of the exposed sectors increases significantly. Instead, Garrett and Lange argue that the institutional structure of a political system determines to what extent a change of preferences on the part of the actors (which are modelled along the lines of the Rogowski and Frieden approaches) leads to adjustment reforms. They expect that, first, democracies are more likely to adapt than authoritarian regimes. Second – and more important for the considerations presented here which focus on OECD democracies – the readiness to adjust is related to the electoral system according to Garrett and Lange. They argue that all electoral systems are biased against the competitive sectors of the economy that favour adjustment. This bias is expected to be smallest in proportional representation systems which thus should be more likely to see adaptation. Third, the number of veto-players should be low if adjustment reforms are to be adopted, and, fourth, an independent central bank should trigger reforms. Regarding industrial relations, reforms are seen to become more likely the weaker trade unions are, particularly in the public sector. Garrett’s and Lange’s contribution builds a bridge between Frieden’s and Rogowski’s simple (or even simplistic) models of the political process and more recent institutionalist approaches to adjustment reforms. This is certainly an achievement. What is lacking in the Garrett–Lange approach, however, is a theoretical explanation of why we should believe that adjustment reactions are mainly determined by the institutions discussed. What is more, the modelling of actor preferences which is taken from Frieden and Rogowski is rather simplistic and might be misleading in empirical research. Therefore, I now turn to theoretical approaches that were derived from empirical studies.

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2.3 Theoretical approaches derived from empirical research The emphasis on the role of institutions for nation states’ adaptations to the challenges of globalization links Garrett and Lange with a number of other approaches. Contrary to Garrett and Lange, but also contrary to Rogowski and Frieden, the main interest of these approaches is empirical. Theory-building is often inductive. Moreover, these approaches aim at explaining economic policy reactions to globalization and not at explaining the decision to liberalize trade (as was the case with Rogowski, for example). A very good example is the work of Fritz W. Scharpf (2000a). For him, institutions play an important role. That is true for the formal institutions of the state, but also for industrial relations and welfare state regimes. Nevertheless, Scharpf argues that the relationship between institutional capabilities and economic success is contingent, that is that certain institutions are helpful in some circumstances, but dysfunctional in others. He therefore stresses the importance of external challenges in addition to institutions: “even though institutional differences may provide very powerful explanations for the success or failure of national policy responses, these explanations can be formulated only with regard to specific types of challenges” (Scharpf 2000a: 22). For the challenges of globalization he shows that the welfare regime determines to a large part which problems a country faces and which solutions are feasible. This kind of reasoning does not allow Scharpf to formulate generalizable hypotheses concerning nation states’ adaptations to the challenges of globalization. Moreover, the preferences and motivations of actors remain vague. Governments seem to be seen as actors that are mainly engaging in problem solving rather than in pursuing ideological goals or securing their re-election. But these assumptions are not defended in theoretical or empirical terms. Stefan Schirm’s (2004: 141–4) approach starts from the observation that globalization impacts three different levels: (1) Due to the increasing capital mobility corporations can punish national economic policies by withdrawing capital, thus potentially provoking economic crises; (2) The growth of the exposed sector of an economy is accompanied by the growing importance of market-liberal interests in economic policy-making; (3) Governments can hardly use policy instruments that focus mainly on the domestic market anymore because these instruments have massively lost effectiveness in times of open markets. Nevertheless, these mechanisms do not operate identically in all countries. Rather, the direction and speed of adjustment reforms depends on two core variables according to Schirm, namely norms and institutions. With regard to institutions, Schirm focuses on those institutions that link government and society, particularly those that link government and social partners (trade unions, business associations). Schirm (2004: 139) expects corporatist countries, in which interest groups exert large impacts on any government’s economic policy, to fail to adapt as long as the interest groups do not accept liberal economic policy positions. Dominant norms are defined as “ideas about how a society should be organized and which principles it should follow that reach sufficient commonality (among the citizens) and specificity (with regard to their meaning)

Adjusting fiscal policy to globalization 45 in order to form constraints for policy-making” (Schirm 2002: 223). As long as values of solidarity and consensual policy-making dominate in a country, governments will have a hard time adopting liberal reforms. The emphasis on core societal values (which also shape electoral competition) is an important contribution to the debate. Furthermore, the distinction of different mechanisms via which globalization influences economic policymaking (crises, interests, instruments) is valuable. On the other hand, the reasons why (corporatist) institutions and norms should be the most important variables for the explanation of adjustment processes remain unclear. Furthermore, the conditions, under which actors in corporatist networks change their positions, and which might transform corporatist institutions from an instrument of blockade into a window of opportunity for adaptation, need further elaboration. Finally, one might doubt the explanatory power of the variable “norms”. Previous research has shown that political discourse, that is the presentation of reforms as necessary and as normatively appropriate, that is embedded in the core societal values, can matter significantly for the success of adjustment reforms (V. Schmidt 2002: 257ff.). Governments in turn can at least try to influence the political discourse to a certain degree: whether a reform is seen as normatively appropriate and in line with what Schirm calls “norms” is not an objective fact. Rather, parties and governments can shape political discourses in such a way that their reforms are perceived to be compatible with these norms (see Cox 2001). Vivien A. Schmidt (2005; see also 2002) has also presented a theoretical framework to explain the adoption of adjustment reforms. Similar to Scharpf her starting point is the policy legacy which varies from country to country and which renders countries vulnerable to the globalization challenges in different ways. Thus, the challenges are somewhat filtered by the policy legacy. According to Schmidt, policy change becomes possible as a crisis unfolds. Whether or not governments react to a crisis depends first on the institutional setting and second on the actors’ preferences. Regarding the political system, Schmidt distinguishes between single-actor systems which allow hierarchic steering and multi-actor systems which have to rely on bargaining between the different actors. She expects far-reaching reforms to be more difficult to adopt in the latter kind of political systems. Furthermore, concerning preferences, the respective actors must be willing to adopt reforms in order to overcome the crisis. This willingness cannot be taken for granted, however, and Schmidt expects Social Democratic parties ceteris paribus to be less willing to engage in liberal economic reforms than their bourgeois rivals. But even when the actors are willing and able to adopt reforms as a reaction to economic crisis they still have to make sure that the reforms are accepted by the voters. Whether governments are successful in this respect depends to a large degree on the government’s political discourse which, if successful, convinces the voters of the necessity as well as the normative appropriateness of the reforms. Schmidt’s model can indeed explain significant parts of adjustment reforms in a large number of countries, as her empirical research shows. Since she

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focuses on the questions, if, how and when political discourse matters, the other parts of the model (which she herself calls “background conditions to discourse“ (V. Schmidt 2005: 3)) are somewhat under-specified. This is particularly the case for the questions, why, when and how actor preferences change. Moreover, it is surprising that actors that might be able and willing to establish a “counterdiscourse” are not taken into account. However, the success of a government’s political discourse might significantly depend upon the existence and credibility of such a “counter-discourse”, which in turn might be related to patterns of electoral competition. All in all, this brief survey of theoretical models should have made clear that a large number of highly stimulating approaches exists that deal with the questions of why and how nation states adjust to globalization in economic policy. What is more, these approaches do have a certain explanatory potential. At the same time, some weaknesses have also become evident. For example, the model of the political process which is at the heart of the influential contributions by Rogowski (1989) and Frieden (1991) is too simplistic. At times, other contributions fail to make entirely clear why specific explanatory variables have been chosen and – most importantly – why and when the preferences of decisive actors (particularly governing parties) change under the conditions of globalization. Therefore, in what follows I will briefly present my own model that tries to reduce the theoretical deficiencies observed in the existing literature.

3 Globalization and national adjustment: theoretical considerations The model2 presented here takes as a starting point that reforms, adjusting to external challenges, need to be adopted in the regular political process the logic of which is formally unchanged even under conditions of globalization. Therefore, it is obvious to start the theoretical considerations with the actors whose agreement is required for a change in the status quo, that is veto-players in George Tsebelis’ (2002) terminology. These actors must formally accept any reform adapting a country’s political economy to globalization – whatever the economic necessity or urgency of the reform. Therefore, veto-players are the most plausible starting point for modelling policy-making processes – under conditions of closed economies as well as under conditions of globalization. If globalization systematically induces national adjustment reforms which must be accepted by the veto-players, globalization must primarily influence vetoplayers’ preferences. Thus, it does not suffice to identify the actors whose agreement is necessary for a change of the status quo. It is also necessary to specify the conditions under which they will actually agree on a change of the status quo. In order to do so, veto-players’ preferences must be endogenized. Since veto-players in (European) OECD democracies are usually political parties, their preferences can best be modelled by using the findings of research on political parties. In the literature, two main aims of parties are distinguished (Müller and

Adjusting fiscal policy to globalization 47 Strøm 1999; Beyme 2000: 25f.): (1) policy pursuit and (2) vote-maximization.3 Since parties – as made clear in the introduction – succeeded in enacting policies in accordance with their ideological-programmatic orientation up until the 1980s (M. Schmidt 1996) and the hypotheses concerning the impact of globalization on fiscal policy explicitly argue that the vanishing of partisan differences since the 1980s is due to external challenges, that is parties are still willing to make a difference, but they are no longer able to do so (Kitschelt 2000). It can be assumed that parties still attempt to enact policies in accordance with their programmatic stance. The reforms which are discussed as adequate adjustments to the challenges of economic globalization necessitate more far-reaching programmatic revisions on the part of Social Democratic parties as compared with Liberal or Conservative parties (Huber and Stephens 1998; Iversen 2000; Hall 2002). A revision of the programmatic position of Social Democratic parties, however, can only be expected when a deterioration of the economic performance violates prominent programmatic goals of the parties and when Social Democrats believe that the economic problems are caused by the failure to adapt to the new context of the political economy. Thus, when traditional instruments fail to reach the programmatic goals and the Social Democratic parties believe that this is due to the failure to adjust to external challenges, a modification of the instruments is to be expected. The reforms aiming at an adjustment to external challenges may, however, violate other Social Democratic goals (e.g. redistribution). Therefore, a substantial deterioration of the economic performance will most likely be needed to initiate a revision of the programmatic position of the Social Democrats. By the same token, the reforms adopted by Social Democratic parties can be expected to be only moderate. In addition, Social Democrats will be seeking more eagerly than their contenders for alternative ways of adjustment. Those alternative “third ways” are supposed to allow coping with the external challenges without having to sacrifice other important policy goals. Carles Boix (1998) for example has argued that in an era of globalization Social Democratic parties might pursue the twin goals of economic growth and income equality not by redistribution and Keynesian demand management any more but by investment in human capital which would boost employees’ productivity and thus positively affect the primary income distribution. Thus, the following expectations can be formulated as partisan hypotheses: 1

2

3

Other things being equal, Social Democratic parties will adjust later and more moderately to globalization than bourgeois, particularly Liberal and Conservative parties because these policies more often than not necessitate a revision of traditional Social Democratic policy commitments. Ceteris paribus, Social Democratic parties are more likely to adopt adjustment reforms when the realization of important programmatic goals is endangered or the goals are already violated. Social Democratic parties will attempt to find alternative adjustment paths. Thus, at least small partisan differences are likely to continue to exist.

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Reforms impose transition-costs on voters, which tend to increase with the scale of the respective reform (Scharpf 2000b: 769). Thus, extensive reforms endanger the re-election of the current government. Therefore, party competition tends to prevent all parties from adopting far-reaching changes (Zohlnhöfer 2003a: 55). Furthermore, most of the adjustment reforms are likely to be unpopular among the voters. Note, however, that the voters’ evaluation of any given reform – and in turn its electoral risk – depends in part on the core societal values or “norms”, to use Schirm’s terminology.4 As was shown above, Conservative and Liberal parties do not need to revise their programmatic positions to the same extent as Social Democratic parties in order to adapt to globalization. On the other hand, liberal economic policies are even riskier for them than for traditional pro-welfare parties, particularly in the area of social policy. According to a “Nixon-goes-to-China” logic it could even be argued that Social Democratic parties have an easier time reforming the welfare state and curbing social spending (see Ross 2000; Zohlnhöfer forthcoming). Therefore, it can be assumed that even Liberal or Conservative parties hesitate to enact extensive changes. They will only dare to adopt far-reaching adjustment reforms when an economic crisis puts their re-election at risk that cannot be solved with incremental reform.5 Depending on the respective configuration of party competition, governing parties face rather different electoral consequences of far-reaching and/or unpopular reforms, which in turn will affect their willingness to adopt those reforms in the first place (see Kitschelt 2001, and Table 3.1). For example, if a government’s rivals in the electoral competition lack economic policy credibility, reforms are easier to enact than in a situation in which the opposition can credibly claim to be able to pursue successful economic policies without harmful cuts. At the same time, governments will try to minimize the electoral backlash of unpopular reforms, that is they will engage in the politics of blame avoidance (Weaver 1986). There are numerous blame avoidance strategies. For example, governments might produce some kind of political business cycle, that is implement unpopular reforms right after the election and adopt popular measures before the next. They might also design reforms in a way that obfuscates the unpopular parts or they may try to share the responsibility for unpopular reforms with the opposition or important interest groups (see Zohlnhöfer forthcoming). Finally, they might try to convince the voters of the necessity and appropriateness of the reforms in an elaborate political discourse, thus influencing public opinion (V. Schmidt 2002, 2005). If the government’s policies succeed in terms of economic performance as well as electoral appeal they may even force the opposition to modify its programmatic stance. Parties that have suffered electoral defeats which are perceived to have been caused by their own economic policy positions may be particularly eager to imitate the government’s economic policies. From these considerations the following hypotheses concerning party competition can be derived: 4

The adoption of far-reaching adjustment reforms is more likely to take place, other things being equal, when the economic performance deteriorates and puts the governing parties’ re-election at risk and the governing

Non-existent

Left-libertarian competitor

Source: Kitschelt 2001.

Denmark, Sweden

Examples

Great Britain

Above average

Chances to enact unpopular Large policies

Strong

Netherlands, Belgium

Below average

Weak

Medium

Very strong

Liberal party

Strong

Market-liberal/Conservative Market-liberal/Conservative Christian Democrats and party party Liberals

Configuration 4

Germany, France, Austria

Low

Strong

Weak

Christian Democrats/ paternalistic Conservatives

Libertarian vs. authoritarian Libertarian vs. authoritarian (Capital vs. labour still matters)

Main competitor of social democracy

Capital vs. labour (libertarian vs.authoritarian exists)

Configuration 3

Capital vs. labour

Configuration 2

Main cleavage

Configuration 1

Table 3.1 Configurations of electoral competition

50

5

6

Reimut Zohlnhöfer parties consider the reforms as reasonable reactions to the economic problems, that is they perceive that the deterioration of the economic performance is caused by the previous failure to adjust. The respective configurations of party systems influence the governing parties’ inclination to adopt extensive reforms. Adjustment reforms will be particularly unlikely in countries with two or more large pro-welfare state parties and only weak Liberal or Conservative parties. In contrast, unpopular reforms may be easier to realize in configurations with a strong marketliberal party and a Social Democratic party which lacks credibility as a defender of the welfare state (Kitschelt 2001). Parties will try to avoid an electoral backlash of unpopular reforms. If the political system or the system of interest intermediation allow, they will try to build “social pacts” with interest groups or try to make the opposition take over part of the responsibility. Moreover, governments will communicate the alleged inevitability and the normative appropriateness of the reforms.

Whether the parties in government can actually implement their reforms also depends on the respective country’s institutional setting, that is on the existence or otherwise of further institutional veto-players like second chambers who can veto or dilute legislation.6 If these institutional veto-players exist and behave policy-orientated (I would suggest calling them “cooperative veto-players”), a dilution or even a veto will occur, if the substance of the proposed reform is not preferred over the status quo by the institutional veto-player. What is more, if the institutional veto-player is controlled by an opposition party (I would suggest talking about “competitive veto-players” in this constellation), strategic considerations concerning the competition for votes may play an additional role. Therefore, in this constellation a reform attempt can fail even though all vetoplayers prefer it to the status quo in policy terms if at least one veto-player expects to improve his prospects for the next general election by a non-decision. Thus, two veto-player hypotheses can be put forward: 7

8

The larger the number of veto-players and – more importantly – the greater the distance among the veto-players in policy terms (in Tsebelis’ terminology: the smaller the congruence of the veto-players), the smaller the scale of the adjustment reforms will be. When an institutional veto-player is controlled by the opposition (“competitive veto-players”), adjustment reforms will only occur if all vetoplayers prefer the reform to the status quo and if none of the veto-players expects electoral advantages from a blockade.

4 Testing the theoretical model: explaining British and German fiscal policies since the 1980s In the following, the theoretical model just presented will be applied to explain fiscal policies in the United Kingdom and Germany since the 1980s. The neces-

Adjusting fiscal policy to globalization 51 sary variation in the partisan complexion of government is secured by changes of governments in both countries. Moreover, Germany and the UK vary sufficiently with respect to electoral competition and veto-player constellations to check the plausibility of the model. Before going into the case studies it is necessary to emphasize that different countries might be vulnerable to external challenges in different ways due to diverging welfare state regimes (EspingAndersen 1990) and national variations in their respective political economies (Hall 2002). Thus, even similar external challenges may lead to diverging problems and different adjustment reforms (Scharpf 2000a; Hemerijck and Schludi 2000). What is more, not all countries are integrated into the world economy to the same degree. This is also relevant for a comparison between Great Britain and Germany. World market integration – measured via the index of capital exchange controls (since 1979) and foreign trade as a percentage of GDP – was similar. Nevertheless, Great Britain differed markedly from Germany in that the UK displayed tremendous foreign economic policy problems over most of the post-war period which led to regular current account deficits and which culminated in 1976 when the Labour government had to apply for a bailout by the International Monetary Fund. Both countries also differed with regard to the main fiscal policy indicators, that is the tax ratio and total government expenditure as a share of GDP, at the beginning of the period of observation. The latter indicator averaged 42.8 per cent in the UK and 46.9 per cent in Germany in the years after the first oil price shock (1974–1979) (data from OECD 2001: 68). The development of the tax ratio was more volatile: in 1979, when Margaret Thatcher came to power, the British tax ratio stood at 32.2 per cent, much lower than the German one (37.1 per cent). When Helmut Kohl came to power in Germany three years later, the German tax ratio (36.8 per cent) was lower than the British one (39.1 per cent) (data from OECD 2004: 67). For the empirical analysis these differences do not pose a significant problem, however, because the theoretical model does not presuppose uniform starting conditions. Rather, these differences are taken into account in a “contextualized comparison” (Locke and Thelen 1995) which is based on a detailed “systematic process analysis” (Hall 2003) of the relevant policy-making processes. Moreover, the diverging starting conditions are of importance for the application of the model because they might induce an economic crisis earlier in one country than in the other which – according to hypotheses 2 and 4 – should trigger earlier adjustment reforms in the crisis-ridden country. 4.1 Fiscal policy in the United Kingdom, 1979–2005 The far-reaching transformation of the British political economy since the Conservatives under Margaret Thatcher came to power in 1979 also remarkably shaped fiscal policy: the statutory rates of direct taxes were cut massively in the 1980s and remained at an internationally competitive level ever since, while the steep increases of indirect taxes, a radical privatization programme and cuts in a

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number of expenditure programmes helped to reduce budget deficits and public debt. However, the changes in the area of budgetary policy were not as farreaching and sustainable and depended more on the partisan complexion of government than the changes in the field of taxation. How could this radical reform programme be enacted and stabilized? The partisan complexion of government did indeed massively influence the scope and timing of the reforms (hypothesis 1). The Conservatives enacted far-reaching tax reforms which were supposed to secure “that British business has the backing it needs to compete in world markets”, as John Major’s first Chancellor of the Exchequer, Norman Lamont (1993: col. 185), put it. Thus, the competitive pressures of globalization played an important role for these policies and they did so as early as the late 1970s when the Labour Party was still a far cry from accepting the necessity of this kind of reform. Labour only revised its economic policy positions fundamentally in the 1990s and even then (in line with hypothesis 3) some of its economic policy instruments differed from the Conservatives’ (see Zohlnhöfer 2006): In contrast to the days of Thatcher and Major, Tony Blair’s and Gordon Brown’s fiscal policies aimed at ameliorating the position of the least well-off members of society. Since Labour accepted the alleged imperatives of globalization, however, the instruments used to attain that goal focused on the supply-side of the economy. In accordance with Boix’s (1998) idea of a human capital investment strategy, the Blair government invested in education and emphasized the re-integration in the labour market by means of incentives to take up low paid jobs and an increase in employability. Redistribution was also on the agenda but it had to take a back seat because of the perceived restrictions of globalization. Electoral competition also played the expected role. In line with hypothesis 4, the programmatic shift in the Conservative Party in the 1970s has to be interpreted as a reaction to the Tory’s bitter election defeats in 1974 which were – at least in the view of the Tory’s right wing – caused by the Heath government’s failure in economic policy. The perceived economic policy disaster of the early 1970s thus gave rise to an electoral crisis which made Margaret Thatcher’s rise to the party leadership possible, who in turn saw radical reforms as a reasonable – actually as the only viable – reaction to the economic problems. The failure of Keynesian coordination under the Wilson and Callaghan administrations at the end of the 1970s, symbolized by the IMF bailout and the “winter of discontent” (see Scharpf 1987: 109ff.), finally facilitated Thatcher’s victory in the 1979 general election and even allowed her to credibly claim that there existed no alternative to her economic policies. In a similar way, the transformation of the Labour Party can be explained by the electoral and in certain areas also economic success of the Conservative policies. After 18 years in opposition, in view of a transformation of the British political economy that could not be reversed and given a seemingly high acceptance of the Conservatives’ economic reforms among the voters, the incentives for Labour to revise its economic policy positions were irresistible. Furthermore, in accordance with hypothesis 7, the adoption of comparatively radical reforms

Adjusting fiscal policy to globalization 53 was not impeded by veto-players, which hardly exist in the British political system. Resistance from within the governing parties, for example revolts of the “wets” in Thatcher’s first cabinet or back bench rebellions in the Blair years, did not exert much influence either due to the particularly high centralization of the decision-making processes in fiscal policy. Instead, electoral competition turned out to be the greatest obstacle for the implementation of far-reaching fiscal policy reforms for both governments. Nevertheless, party competition was much less intense in Britain than in Germany. In the 1980s and early 1990s, the Labour Party was seen as incompetent and not credible in fiscal policy by a large part of the electorate because of its economic policy failure in the late 1970s and its radical election manifesto of 1983. After 1997, the same is true for the Conservatives that have failed to build up a credible fiscal policy position until 2005. In line with hypothesis 5, this weakness of the respective opposition parties made the adoption of controversial reforms easier for British governments. Nevertheless, both parties still tried to avoid punishment for unpopular reforms by the voters (hypothesis 6). Since neither the option of collusion with the opposition nor of a pact with the social partners exists in the British context, the governments massively relied on three blame avoidance strategies (see Zohlnhöfer forthcoming): timing of popular and unpopular measures according to the idea of a political business cycle, policy design so as to obfuscate unpopular measures (e.g. failure to index benefits or tax allowances to inflation) and the use of a political discourse that was supposed to emphasize the necessity and appropriateness of the reforms in an era of integrated markets. 4.2 Fiscal policy adjustments to globalization in Germany Contrary to Great Britain, which was a leader with regard to cuts to direct taxes, Germany experienced only very moderate tax rate cuts in the 1980s and 1990s (for the following see Zohlnhöfer 2001, 2003b; Ganghof 2004). Only at the beginning of the twenty-first century were the top income tax rate and the corporation tax rate approaching the British levels. Nevertheless, it is worth noting that even though the German corporation tax rate of 25 per cent is below the British rate (30 per cent) since 2001, German corporations have to pay additional taxes (local business tax and solidarity surcharge). The total German business tax rate which takes into account all three taxes stands at around 39 per cent and is thus way above the British level (Sachverständigenrat 2005: 364). Therefore, a further reduction of the business taxes is still on the agenda. In contrast, the Kohl government succeeded in consolidating the budget, at least in the 1980s. After unification, however, both governments failed to reduce budget deficits significantly and sustainably – despite skyrocketing social security contributions and a privatization programme which parallels the British example in terms of its radicalism. Can the German reform path be explained by the theoretical model presented above? The fact that Germany saw tax cuts at all in the 1980s can be explained by the partisan complexion of the Federal government since the Social

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Democratic opposition fiercely opposed even the moderate cuts that were finally enacted. This finding is in line with hypothesis 1. But why didn’t the Kohl government adopt more far-reaching reforms? The main reason was electoral competition that impeded reforms in different ways. On the one hand, the CDU/CSU came to power with a rather moderate reform programme. The reasons for this lack of radical reform ideas are manifold. First, the deterioration of economic performance in Germany in the 1970s was much less severe than in pre-Thatcher Britain where a decade-old debate on “British decline” was going on. Second, the Christian Democrats believed that the deterioration of the economic situation was solely related to the government participation of the Social Democrats because when the CDU/CSU had lost power in 1969 the German economy was booming and unemployment was extremely low. Therefore, the Christian Democrats did not see the need to revise their own economic policy positions. Third, the defeats in four consecutive Federal elections failed to trigger a more radical economic policy programme because the defeats were not perceived to have been caused by the economic policy stance. Fourth, the CDU/CSU were not in the same way deprived of power as were the Conservatives in the UK since they were able to influence policies over the Bundesrat to an increasing degree in the 1970s. On the other hand, the economy went fairly well after the coming to power. Thus, the government did not see a need to radicalize their reforms prior to 1990. Therefore, the moderate German reform output corresponds with hypothesis 4. From the mid-1990s at the latest, economic performance began to deteriorate dramatically. This deterioration particularly impacted on tax policy. In the first years after unification, the government had tried to help economic recovery in East Germany by granting many new tax exemptions while tax rates remained high. This approach failed dramatically as the tax base eroded and tax progression decreased. Most relevant actors related this failure with the previous lack of adjustment to globalization while other countries had adapted in the form of tax cuts and base-broadening (Ganghof 2004: 74, 87). At the same time, the deterioration of economic performance put the Kohl government’s re-election at risk. Again in line with hypothesis 4, this led to a radicalization of the coalition’s fiscal policy reforms: tax rates were cut, welfare benefits curbed significantly and many state-owned enterprises were sold off. As far as these reforms needed the approval of the Bundesrat, (which made the Bundesrat a competitive vetoplayer since the SPD held the majority in the second chamber since 1991) the government had to make remarkable concessions to the opposition. The most important tax reform project, the tax reform 1997/98, was even completely blocked in the Bundesrat. The fact that a Social Democratic party diluted or even blocked more far-reaching adjustment reforms corresponds with the expectations of hypothesis 1 about partisan differences as well as hypothesis 7 and 8 on (competitive) veto-players. In a similar way we can explain the red–green coalition’s fiscal policy under Oskar Lafontaine which put particular emphasis on redistribution. The SPD had not suffered a sufficiently dramatic electoral crisis in the 1980s or 1990s to force it to revise its economic policy instruments.

Adjusting fiscal policy to globalization 55 Even though the Social Democrats had lost four consecutive Federal elections, they were remarkably successful at the sub-national (Länder) level which made it impossible to argue that the party’s economic policy programme was obsolete. It is more difficult to explain the policy change the red–green coalition itself implemented one year after it had come to power. Instead of focusing on redistribution, the new minister of finance, Hans Eichel, aimed at reducing tax rates to an internationally competitive level. To understand this policy pattern, the inner-party cohesion of the SPD and the agenda-setting position of the minister of finance have to be taken into account. Given the strong position of ministers in Germany, it made a large difference when Oskar Lafontaine, a traditional Keynesian, was replaced by the modernizer Hans Eichel.7 At least the modernizers in the SPD, which came to dominate fiscal policy after Lafontaine had resigned in early 1999, related the dismal German economic performance in the 1990s and particularly the persistently high unemployment which was seen by the SPD as the most pressing problem to the lack of fiscal policy adjustment to globalization. Therefore, these politicians perceived cuts to the top income and corporate tax rates as particularly urgent (hypothesis 2). Under the impression of the economic crisis that was unanimously perceived to be related to the challenges of globalization, the policy positions of the competing parties in tax policy thus converged. Nevertheless, the red–green coalition’s plans were less far-reaching than those of the bourgeois opposition, particularly regarding the top income tax rate (hypothesis 1), and the leftist government also chose policies that Christian Democrats and Liberals would not have picked, for example concerning the funding of the tax reform and concerning certain spending items like education (hypothesis 3). The fact that the top income tax rate was cut further than the red–green coalition had originally planned was due to a bourgeois Bundesrat majority. In this case, the increase in the number of veto-players led to a more far-reaching reform – in contrast to what hypothesis 7 would lead one to expect. In the area of budgetary policy that is much less constrained by globalization, cooperation between the parties was mostly absent. This finding is not at all surprising given Germany’s configuration of electoral competition and the country’s core societal norms among which equality plays a very important role (hypothesis 5). Cooperation between government and opposition (e.g. via the Bundesrat) failed to materialize in the area of budget consolidation due to the intense electoral competition. Thus, the government had to obfuscate its consolidation measures as far as possible (hypothesis 6), for example via dubious ad hoc cuts or the intensification of privatization efforts (see Zohlnhöfer forthcoming).

5 Conclusion The disappearance of party politics as a determinant of differences in OECD democracies’ fiscal policies is often related to growing economic globalization. However, in many of the relevant contributions, it remains unclear how globalization impacts on the national political processes. On the one hand, this is

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because most research focuses on the results of the adjustment while the adjustment processes are not considered. On the other hand, the existent theoretical approaches exhibit some deficiencies. For example, Rogowski’s and Frieden’s influential models of the political process can be criticized as simplistic, while the models of a second group fail to make entirely clear why specific explanatory variables have been chosen and how the preferences of decisive actors (particularly governing parties) change under conditions of globalization. Therefore, a new model of political adjustment to globalization was presented that builds on some of the earlier work. The model takes as a starting point the fact that reforms to adjust to the challenges of globalization still need to be adopted by national institutions. Therefore, the model starts from the actors with formal veto powers (mostly political parties) and models their preferences (policyseeking, vote-maximization). It is concluded that far-reaching reforms to adapt national political economies to globalization only occur in case of a significant deterioration of economic performance, coinciding with a previous failure to adjust to economic globalization, which threatens to jeopardize the electoral or programmatic goals of the political actors. In the last section, the model was briefly applied to analyse fiscal policies in Great Britain and Germany since the 1980s. It turned out that the model is indeed able to explain the respective policy processes. In both countries, centreright governments adopted the initial adjustment reforms against the fierce opposition of Social Democratic parties in the early 1980s (hypothesis 1). The fact that the reforms went much further in Britain than in Germany can be explained by the smaller economic problems in Germany at that time that generated fewer reform incentives via electoral competition (hypothesis 4). In addition, the configuration of electoral competition that makes unpopular reforms much more difficult in Germany than in Britain (hypothesis 5) as well as the larger number of veto-players in Germany particularly in the 1990s (hypotheses 7 and 8) helps to explain the much faster adoption of reforms in the United Kingdom. Social Democratic parties only accepted the alleged “imperatives” of globalization after having experienced remarkable crises. In the case of the Labour Party the numerous electoral defeats were perceived to be related to the party’s economic policy stance, particularly its “tax-and-spend-image”, while the modernizers in the SPD perceived Germany’s dismal economic performance to be caused by the previous failure to adjust (hypothesis 2). Therefore, the perception of economic challenges stemming from globalization in both cases led to a convergence of party position. Nevertheless, partisan differences are still existent, albeit smaller than before (hypothesis 3). It turns out that the Labour party was able to make a clearer difference on the expenditure side of the budget than the SPD, which could well be due to institutional as well as budgetary reasons. Of course, this brief overview cannot be taken as a serious test of the model of policy-making under conditions of economic globalization presented above. Nevertheless, the empirical evidence makes it seem worthwhile to engage in a more stringent test.

Adjusting fiscal policy to globalization 57

Notes 1 In addition, the foreign trade models which these contributions are based on (mostly the Heckscher–Ohlin or Ricardo–Viner approaches) are not beyond criticism since they only explain trade of commodities belonging to different sectors (inter-sectoral trade). Models explaining intra-sectoral trade (commodities belonging to the same sector are being traded), for example the model of monopolistic competition, cannot always identify winners and losers of trade ex ante (Feuerstein 1993: 289). This poses a problem for Rogowski and Frieden because in that case it is also impossible to determine supporters and opponents of adjustment reforms. 2 For a more extensive presentation of the model see Zohlnhöfer (2005). 3 Sometimes, three different aims of parties are discussed, namely policy pursuit, vote maximization and office seeking. For simplicity’s sake, in the following only policy pursuit and vote maximization will be discussed. This is justified because “vote maximizing parties and office maximizing parties cannot be differentiated meaningfully any more” (Beyme 2000: 25; my translation). 4 Norms can thus in principle impact on adjustment reforms. Nevertheless, it does not seem necessary to include them as an independent variable in the present model. First, norms are likely to be represented in institutional arrangements. This is particularly true for so-called “process norms” that deal with the inclusiveness of the political process (Schirm 2005: 831). Second, norms are reflected in the programmatic stances of the parties. Both variables, institutional arrangements and party competition, are included in the model. 5 It may even be the case that a party is voted out of office because of economic mismanagement before it realizes that the policy instruments it used were ineffective under the conditions of open markets. 6 Inner-party cohesion can also play a remarkable role. However, its effects are not always theoretically straightforward because they depend on the decision rules within the parties (see Zohlnhöfer 2003a). 7 Ganghof (2004) points to the important role constitutional questions played in the reform process, particularly the question of how much top income and corporation tax rate constitutionally would be allowed to differ. According to his interpretation the SPD would not have accepted the far-reaching cuts to the top income tax rate that were finally adopted had the constitutional restrictions been absent.

Bibliography Beyme, K. von (2000) Parteien im Wandel. Von den Volksparteien zu den professionalisierten Wählerparteien, Wiesbaden: Westdeutscher Verlag. Boix, C. (1998) Political Parties, Growth and Equality, Cambridge: Cambridge University Press. Cox, R.H. (2001) “The Social Construction of an Imperative. Why Welfare Reform Happened in Denmark and the Netherlands but not in Germany”, World Politics, 53: 463–98. Devereux, M.P., Griffith, R. and Klemm, A. (2002) “Corporate Income Tax Reforms and International Tax Competition”, Economic Policy, 17: 450–95. Esping-Andersen, G. (1990) The Three Worlds of Welfare Capitalism, Cambridge: Polity. Feuerstein, S. (1993) “Monopolistische Konkurrenz und intrasektoraler Außenhandel”, Wirtschaftswissenschaftliches Studium, 22: 286–90. Frieden, J.A. (1991) “Invested Interests: The Politics of National Economic Policies in a World of Global Finance”, International Organization, 45: 425–51. Frieden, J.A. and Rogowski, R. (1996) “The Impact of the International Economy on

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National Policies: An Analytical Overview”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 25–47. Ganghof, S. (2004) Wer regiert in der Steuerpolitik? Einkommensteuerreform zwischen internationalem Wettbewerb und nationalen Verteilungskonflikten, Frankfurt/New York: Campus. –––– (2005) “Konditionale Konvergenz. Ideen, Institutionen und Standortwettbewerb in der Steuerpolitik von EU- und OECD-Ländern”, Zeitschrift für Internationale Beziehungen, 12: 7–40. Garrett, G. and Lange, P. (1996) “Internationalization, Institutions and Political Change”, in R.O. Keohane and H.V. Milner (eds) Internationalization and Domestic Politics, Cambridge: Cambridge University Press: 48–75. Garrett, G. and Mitchell, D. (2001) “Globalization, Government Spending and Taxation in the OECD”, European Journal of Political Research, 39: 145–77. Hall, P.A. (2002) “The Comparative Political Economy of the ‘Third Way’”, in O. Schmidtke (ed.) The Third Way Transformation of Social Democracy, Aldershot: Ashgate: 31–58. –––– (2003) “Aligning Ontology and Methodology in Comparative Research”, in J. Mahoney and D. Rueschemeyer (eds) Comparative Historical Analysis in the Social Sciences, Cambridge: Cambridge University Press: 373–404. Hemerijck, A. and Schludi, M. (2000) “Sequences of Policy Failure and Effective Policy Responses”, in F.W. Scharpf and V.A. Schmidt (eds) Welfare and Work in the Open Economy. Vol. 1: From Vulnerability to Competitiveness, Oxford: Oxford University Press: 125–228. Huber, E. and Stephens, J.D. (1998) “Internationalization and the Social Democratic Model. Crisis and Future Prospects”, Comparative Political Studies, 31/3: 353–97. –––– (2001) Development and Crisis of the Welfare State. Parties and Policies in Global Markets, Chicago, IL: The University of Chicago Press. Iversen, T. (2000) “Decentralization, Monetarism, and the Social Democratic Welfare State”, in T. Iversen, J. Pontusson and D. Soskice (eds) Unions, Employers, and Central Banks. Macroeconomic Coordination and Institutional Change in Social Market Economies, Cambridge: Cambridge University Press: 205–31. Kitschelt, H. (2000) “Citizens, Politicians, and Party Cartellization: Political Representation and State Failure in Post-Industrial Democracies”, European Journal of Political Research, 37: 149–79. –––– (2001) “Partisan Competition and Welfare State Retrenchment. When do Politicians Choose Unpopular Policies?” in P. Pierson (ed.) The New Politics of the Welfare State, Oxford: Oxford University Press: 265–302. Kittel, B. and Obinger, H. (2003) “Political Parties, Institutions, and the Dynamics of Social Expenditure in Times of Austerity”, Journal of European Public Policy, 10: 20–45. Lamont, N. (1993) Budget Statement, in Parliamentary Debates House of Commons, 16 March 1993, 6th Series, Vol. 221, London: Her Majesty’s Stationary Office: col. 169–96. Locke, R. and Thelen, K. (1995) “Apples and Oranges Revisited: Contextualized Comparisons and the Study of Comparative Labor Politics”, Politics and Society, 23: 337–67. Müller, W.C. and Strøm, K. (eds) (1999) Policy, Office, or Votes? How Political Parties in Western Europe Make Hard Decisions, Cambridge: Cambridge University Press.

Adjusting fiscal policy to globalization 59 Obinger, H. and Zohlnhöfer, R. (forthcoming) “The Real Race to the Bottom: What Happened to Economic Affairs Expenditure after 1980”, in F.G. Castles (ed.) The Disappearing State? Cheltenham: Edward Elgar. OECD (2001) Historical Statistics 1970–2000, Paris: OECD. –––– (2004) Revenue Statistics 1965–2003, Paris: OECD. Rogowski, R. (1989) Commerce and Coalitions: How Trade Affects Domestic Political Alignments, Princeton, NJ: Princeton University Press. Ross, F. (2000) “‘Beyond Left and Right’: The New Partisan Politics of Welfare”, Governance, 13: 155–83. Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung (SVR) (2005) Die Chance nutzen – Reformen mutig voranbringen, Jahresgutachten 2005/06, Stuttgart: Metzler-Poeschel. Scharpf, F.W. (1987) Sozialdemokratische Krisenpolitik in Europa, Frankfurt/New York: Campus. –––– (2000a) “Economic Changes, Vulnerabilities, and Institutional Capabilities”, in F.W. Scharpf and V.A. Schmidt (eds) Welfare and Work in the Open Economy. Vol. 1: From Vulnerability to Competitiveness, Oxford: Oxford University Press: 21–124. –––– (2000b) “Institutions in Comparative Policy Research”, Comparative Political Studies, 33: 762–90. Schirm, S.A. (2002) “The Power of Institutions and Norms in Shaping National Answers to Globalisation: German Economic Policy after Unification”, German Politics, 11/3: 217–36. –––– (2004) Internationale Politische Ökonomie, Eine Einführung, Baden-Baden: Nomos. –––– (2005) “Der Einfluss von Interessen und Normen auf nationale Positionen zur Global Economic Governance”, Zeitschrift für Politikwissenschaft, 15: 825–47. Schmidt, M.G. (1996) “When Parties Matter: A Review of the Possibilities and Limits of Partisan Influence on Public Policy”, European Journal of Political Research, 30: 155–83. Schmidt, V.A. (2002) The Futures of European Capitalism, Oxford: Oxford University Press. –––– (2005) “The Role of Public Discourse in European Social Democratic Reform Projects”, European Integration Online Papers, 9/8. Online. Available eiop.or.at/eiop/ texte/2005–008a.htm (accessed 24 May 2006). Schulze, G.G. and Ursprung, H.W. (1999) “Globalisation of the Economy and the Nation State”, The World Economy, 22: 295–352. Schwartz, H. (2001) “Round up the Usual Suspects! Globalization, Domestic Politics, and Welfare State Change”, in P. Pierson (ed.) The New Politics of the Welfare State, Oxford: Oxford University Press: 17–44. Steinmo, S. and Swank, D. (2002) “The New Political Economy of Taxation in Advanced Capitalist Democracies”, American Journal of Political Science, 46: 642–55. Tsebelis, G. (2002) Veto Players: How Political Institutions Work, Princeton, NJ: Princeton University Press. Wagschal, U. (2005) Steuerpolitik und Steuerreformen im internationalen Vergleich. Eine Analyse der Ursachen und Blockaden, Münster: Lit Verlag. Weaver, R. Kent (1986) “The Politics of Blame Avoidance”, Journal of Public Policy, 6: 371–98. Zohlnhöfer, R. (2001) Die Wirtschaftspolitik der Ära Kohl, Opladen: Leske+Budrich. –––– (2003a): “Der Einfluss von Parteien und Institutionen auf die Staatstätigkeit”, in

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H. Obinger, U. Wagschal and B. Kittel (eds) Politische Ökonomie. Demokratie und wirtschaftliche Leistungsfähigkeit, Opladen: Leske+Budrich: 47–80. –––– (2003b) “Mehrfache Diskontinuitäten in der Finanzpolitik”, in A. Gohr and M. Seeleib-Kaiser (eds) Sozial- und Wirtschaftspolitik unter Rot-Grün, Wiesbaden: Westdeutscher Verlag: 63–85. –––– (2005) “Globalisierung der Wirtschaft und nationalstaatliche Anpassungsreaktionen. Theoretische Überlegungen”, Zeitschrift für Internationale Beziehungen, 12: 41–75. –––– (2006) “New Labours Finanz- und Wirtschaftspolitik: Sozialdemokratie durch die Hintertür?” in A. Kaiser and S. Berg (eds) New Labour und die Modernisierung Großbritanniens, Augsburg: Wißner: 13–43. –––– (forthcoming) “The Politics of Budget Consolidation in Britain and Germany: The Impact of Blame Avoidance Opportunities”, West European Politics. Zürn, M. (2002) “From Interdependence to Globalization”, in W. Carlsnaes, T. Risse and B.A. Simmons (eds) Handbook of International Relations, London: Sage: 235–54.

4

Taxation and cooperation International action against harmful tax competition Thomas Rixen

1 Introduction Under conditions of globalization, economic activities cross national borders. Meanwhile, the power to tax is bound to the nation state. Factors of production, most importantly capital, can move to those locations with the lowest tax burden. International factor mobility thus puts national tax systems under competitive pressure. Most research has perceived international tax competition as an independent variable that triggers certain consequences for the nation state. It focuses on national reactions to exogenously given competitive pressures. In particular, it has addressed the question of the nation state’s ability to pursue socially desirable policies under conditions of international tax competition. A common fear is that tax competition will constrain governments’ autonomy to design their fiscal policies according to the preferences of their electorates. Tax competition could lead to a “race to the bottom” of tax revenues and ultimately of social and environmental standards and policies. As will be shown in this chapter, these fears are partially warranted. On the one hand, an overall race to the bottom that has sapped the fiscal power of the state has not materialized until now. Total tax ratios, measuring tax revenue in proportion to national income, have remained stable. On the other hand, tax competition has become a serious constraint on national tax autonomy. While it did not incur a serious drop in total tax revenue, it does force governments to change the structure of their tax systems. As will be shown in this chapter, they had to adjust the ways in which they pursue and balance the central tax policy goals of equity and efficiency. Tax competition does restrict governments’ ability to pursue tax policy according to their own national preferences. One important source of competitive pressure derives from the possibilities of multinational enterprises to make use of international tax rate differentials without relocating real economic activity. Many countries, in particular socalled tax havens, bid for companies to incorporate subsidiaries on their territory that serve only or primarily as tax-saving vehicles. Such “mailbox companies” can, for example, be used to accumulate “paper profits”. The tax haven subsidiary, where no real economic activity takes place, is assigned a share of the company’s profit. The profit that has been generated somewhere else is subject

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to a zero or only nominal tax rate in the haven country. Besides corporations, wealthy individuals can also profit from the offers of tax havens, for example by keeping their assets in offshore savings accounts without informing their home countries. Since such practices impose constraints on national tax autonomy it should not come as a surprise that Organization for Economic Cooperation and Development (OECD) governments decided to fight them. In 1996, they initiated a project against “harmful” and “unfair” tax competition that is targeted against the “poaching” of other countries’ tax bases (OECD 1998). In fact, however, the initiative has surprised most observers of international tax policy. The folk wisdom in the field maintains that most countries guard their national tax sovereignty very jealously so that effective international cooperation is hard to establish. This is supposedly one of the reasons why the literature usually perceives tax competition as an independent variable. However, besides unilateral adaptations to exogenously given tax competition, countries can, in principle, also regulate that competition. The degree of tax autonomy loss is not exogenously given, but can be endogenously determined or at least cushioned if countries succeed in creating effective international rules that regulate or even curb tax competition. In this perspective, tax competition becomes a dependent variable. Even though there are already some international initiatives aiming at a regulation of tax competition, these have hardly been investigated by social scientists. This chapter therefore intends to undertake a theory-driven empirical analysis of the OECD project against harmful tax practices that was initiated in 1996. Before I come to this, the following section reviews the existing literature on tax competition. Section 3 will then present a simple game theoretic model of tax competition to derive hypotheses on the preconditions of successful tax cooperation, its expected development and potential conflicts of interest that will arise. These hypotheses will then be tested against the empirical record of the OECD project. Effective regulation of international tax competition will be shown to be both theoretically demanding and empirically difficult. The peculiar characteristics of tax competition make effective collective action difficult to establish. The OECD project does not reach its main goals. Nevertheless, some progress in the fight against unfair tax competition is made. Section 4 summarizes.

2 Existing research on tax competition Research on international tax competition is a booming academic business. The number of publications has skyrocketed in recent years and the debate has diversified into various strands.1 Most contributions come from economists aiming at the development of ever better theoretical models. But political science has also developed an interest in the issue. Here, I cannot give a comprehensive account of this body of literature. Instead, I will restrict myself to mapping the main lines of the debate. First, the standard models of tax competition are outlined (2.1). Subsequently, the main empirical insights into whether tax competition is a real

Taxation and cooperation 63 constraint on governments’ tax policy autonomy or not, and the prevailing arguments for both positions are summarized (2.2). Finally, I argue that one reaction of governments, that is attempts at international regulation of tax competition, has not received sufficient attention in research. The few existing contributions are presented (2.3). 2.1 Theories of tax competition Tax competition arises, if states use their tax policy strategically, in order to attract mobile economic goods and factors of production. The academic occupation with tax competition has its origin in theories of fiscal federalism. Tiebout (1956) developed a model in which tax competition leads to an efficient allocation of public goods. Like producers compete for consumers on (private) goods markets, jurisdictions are assumed to compete for mobile taxpayers. In a process of “voting with the feet”, taxpayers can chose among different packages of public goods in return for different tax levels. In equilibrium, they will end up in those jurisdictions where they receive their preferred quantity and quality of public goods. Everyone pays exactly the price corresponding to his or her demand of public services. Subsequently, most economists have argued that this model rests on assumptions that are too restrictive.2 Most importantly, it neglects the existence of “fiscal externalities”. In tax competition among small open economies, an increase of the tax burden on the mobile factor in one country will lead to an outflow of this factor and a corresponding inflow into other jurisdictions. A country’s tax policy creates externalities that have an effect on other countries. Since every government will only consider its own individual situation, which is ameliorated by the inflow, the existence of externalities creates incentives to lower the tax burden. The end result is a tax burden on mobile factors that is too low in all jurisdictions. Consequently, there will be an underprovision of public goods everywhere (Zodrow and Mieszkowski 1986; Wilson 1986). Today, this view of tax competition has become the standard model and has subsequently been extended by introducing further tax instruments. If governments may also tax the immobile factor, labour, then it is optimal for them to shift the entire tax burden from mobile capital to labour. In such models, the general result of an underprovision of public goods remains the same because the additional taxes on labour cannot make up the revenue lost from capital taxation. Competition spills over to labour taxation (Bucovetsky and Wilson 1991). As can be shown in various other model extensions (see Wilson 1999), this result can be generalized according to the “selection principle”. As long as the state concentrates only on the provision of those goods and services that cannot efficiently be produced on private markets, then a reintroduction of competition through the “backdoor” of “systems competition” among governments will necessarily decrease overall public welfare (Sinn 1997). The standard model thus predicts a “race to the bottom” in the provision of socially desired public goods. This can only be avoided if fiscal externalities were internalized through

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a complete harmonization of tax systems or a centralization of the power to tax at a supranational level. An important extension of the standard model concerns country size (in terms of population). If the assumption of identical country size is dropped, then it can be shown that small states can profit from tax competition. The intention of such models of “asymmetric tax competition” is that small states can gain a lot of foreign capital relative to their population by a reduction of taxes, while large states have relatively little to win, but a lot of capital to lose. Thus, the theoretical expectation is that small countries will lower their taxes more than large ones. Small states can “win” tax competition; their welfare increases in relation to a situation without tax competition. However this is accompanied by a welfare loss in large countries, which is larger than the gain of the small ones (Bucovetsky 1991; Wilson 1991; see also Dehejia and Genschel 1999). This model can explain why basically all tax havens in the world are small. Becoming a tax haven is only attractive for small countries. In contrast to these welfare economic models of detrimental tax competition, there are political economy models in which tax competition is beneficial. According to the “public choice” school, governments do not pursue the correction of market failures and the maximization of national welfare but rather maximize tax revenue. In “Leviathan” models, tax competition has positive effects since it limits politicians’ discretion to distribute inefficient rents to particularistic interest groups. Overall, there will be an efficiency-increasing curtailment of the public sector, which is seen to be in the public interest (Brennan and Buchanan 1980). Subsequently, various models taking an intermediate position between the welfare economic position and the public choice view were developed. In these models it is assumed that, on the one hand, competition may induce a government to a better orientation at general public interest. On the other hand, the existence of fiscal externalities in the welfare-theoretic sense, making perfectly efficient equilibriums impossible, is also considered. Ultimately, there is a trade-off between both effects of tax competition; the evaluation depends on the relative weight accorded to each (Edwards and Keen 1996; Persson and Tabellini 2000: 305–37). In summary, it shows that the evaluation of tax competition is dependent on the assumptions one makes about preferences pursued by governments. Irrespective of that, however, all models predict a decrease in tax burdens for mobile tax bases with a relatively higher burden on immobile factors.3 2.2 The empirical record of tax competition The question is how far these theoretical expectations hold in reality. Although there is general agreement on the empirical development of tax policy, the opinions on how far this is caused by tax competition vary widely. First, it is undisputed that since the end of the 1970s and the middle of the 1980s the nominal tax rates were lowered. From 1975 to 2005 the tax rate on corporate income of OECD countries fell on average from around 50 per cent to around 30 per cent,

Taxation and cooperation 65 the top personal income tax rate from almost 70 per cent to below 50 per cent (Ganghof 2006a: chapter 1). However the nominal rates on their own hold no information about effective tax burdens. These can only be assessed if the rates are considered in relation to the tax base. And indeed, the effective marginal tax burdens remained almost unchanged. Almost all countries have pursued a policy of lowering the nominal rates but simultaneously broadening the tax base (“tax cut cum base broadening”). According to Steinmo and Swank (2002: 643f.), the effective marginal rate on capital on average only decreased from 38 per cent in 1981 to 36 per cent in 1995. Marginal effective labour taxation rose from 36 per cent to 40 per cent in the same period. Thus, there was no “absolute convergence” to a very low or even zero level of taxation as the hypotheses of a general race to the bottom would lead one to expect. Nevertheless, moving beyond averages, the distribution of effective tax rates across countries exhibits a pattern of “relative convergence”. The variance in the distribution of tax rates has decreased (Hays 2003). Different explanations for this empirical pattern have been put forward in the literature. Since the effective tax burden on capital has not gone down, some authors argue that tax competition did not have any effect on national tax policy formation (Steinmo 2003; Garrett and Mitchell 2001). During the 1980s, they argue, governments came to learn that policies of combining high nominal rates with selective saving and investment incentives were inefficient. Such attempts to manipulate saving and investment, leading to a quite narrow tax base, had been used to pursue various distributive and allocative goals. Due to a “paradigm shift” from “equity” to “efficiency”, policymakers increasingly focused on the divergent tax burdens in different sectors of the economy that resulted from the selective incentives. These came to be viewed as harmful distortions in the allocation of capital. The abolition of the selective incentives, that is the general broadening of the tax base that should be accompanied by lowering the rates, was viewed as the best reaction to the problem. This move was seen to be a “market-conforming” policy. Thus, in this interpretation, the observed tax reforms are not caused by pressures from tax competition, but are the result of responses to internal challenges. The international diffusion of the idea of market-conforming taxation since the 1986 US tax reform – and not the external challenge of tax competition – can explain the relative convergence of effective tax rates (Steinmo 2003; Steinmo and Swank 2002). This is a correct portrayal of the political rhetoric of tax reforms in recent years. However, there is evidence that it is at best an incomplete explanation of tax policy developments. First, it is not true that a policy of “tax cut cum base broadening” is the only “market-conforming” reform that is available to policymakers. Rather, it can be shown that another option is to levy a high tax on “pure profits” and to exempt the “normal return” on capital. Pure profits are those returns that lie above the return for an alternative risk-free investment (e.g. government bonds), whereas the normal return to capital is just that regular rate of return (see e.g. Slemrod and Bakija 2004: 203f.). Normal returns should remain tax-free, whereas pure profits should be subjected to tax. The advantage

66 Thomas Rixen of such a system is that, under closed economy conditions, taxing away pure profits does not cause any misallocation of capital. In contrast to that, taxing normal returns distorts investment decisions. It is therefore desirable to tax pure profits at high rates and exempt normal returns from taxation (Przeworski and Wallerstein 1988). Such a differentiation is also desirable under an equity perspective, since pure profits often consist of windfall gains, whereas the normal return of capital only represents a saver’s willingness to postpone current consumption. Under closed economy conditions the differential tax treatment of these two kinds of capital income is an equally efficient alternative to a policy of “tax cuts cum base broadening”. While both systems are market-conforming, the first allows for a progressive rate structure whereas the latter does not (for a more detailed account of this see Ganghof 2006b). One could understand the original system of high nominal rates coupled with selective incentives for saving and investment as attempts to approximate, albeit very imperfectly, a system of a differentiated tax treatment of pure profits and normal returns. Thus, if the observed tax reforms were really motivated by a “paradigm shift” towards efficiency only, then the tax cut cum base broadening approach would not have been the only possible reform. Rather, we should (also) have seen political efforts to further develop a differential treatment of different kinds of capital income, for example in the form of “cash-flow taxes” that have for a long time been discussed as the most desirable reform of capital taxation. Since there was no country that adopted the alternative path, the actual development of tax policy cannot solely be attributed to the diffusion of the ideal of market-conforming taxation (Ganghof 2006a; 2006b; Haufler and Schjelderup 2000: 306f.). One plausible explanation points towards the influence of international tax competition. First of all, if we take into account that under open economy conditions countries don’t compete for marginal investments but for discrete investment objects, for example from multinational enterprises, then the effective marginal tax rates, which remained constant, are not the decisive factor. Rather, since the investor will invest in the specific location where he can realize the highest after tax rate of return for the entire object, the effective average tax rate becomes the relevant indicator.4 Since average tax rates have indeed decreased since the 1980s this is a first hint at a possible influence of tax competition on the observed tax reforms (see Devereux and Griffith 2003). To the extent that investment decisions in reality are of a discrete nature, governments cannot enforce differential tax treatment of pure profits and normal returns on international investors. This can be further substantiated if we, second, take into account that nominal tax rates are more important in practice than the sceptics of tax competition assume. By means of different techniques, such as the manipulation of internal transfer prices or debt instead of equity financing, multinational enterprises can shift their profits to low-tax countries and assign their losses to high-tax countries, without moving their real investment location (for an overview of such techniques, see Gresik 2001). It has been shown that such

Taxation and cooperation 67 “profit shifting” plays an important role in the tax planning strategies of multinational enterprises (Hines 1999; Bartelsman and Beetsma 2003). For highly profitable enterprises, whose gains are made up to a large extent of pure profits, the decision to shift income will depend on nominal tax rates (Haufler and Schjelderup 2000), which are equal to effective rates for pure profits. Thus, profit shifting creates competitive pressures to lower nominal rates. If we further acknowledge that many governments cannot afford to forgo tax revenue due to existing budget deficits and the demands of their electorate, the decrease in nominal rates has to be financed by broadening the tax base. Even if that is to the disadvantage of less profitable and less mobile firms (Devereux et al. 2002: 483).5 Third, the sceptics of tax competition ignore an important aspect of the distribution of tax rates across countries. Small countries have lower tax rates and have reduced them further than big countries (see e.g. Sorensen 2000). Corporation tax rates are correlated significantly to country size. Thus, country size is a good explanatory variable for the absence of absolute and the presence of relative convergence, which is the pattern predicted by the model of asymmetric tax competition (Ganghof 2006b). Finally, it can also be confirmed that the tax burden on labour relative to capital has increased since the mid-1980s (Winner 2005: 681f.). In conclusion, there are good reasons in support of the notion that tax competition, even though it has not yet led to a general race to the bottom, is a reality. While the international diffusion of ideas about market-conforming tax reforms may have played a complementary role, there are very strong arguments for the case that tax competition has been an important driver behind observed national tax reforms in the 1980s and 90s. In addition to these contributions that try to locate reasons for the (non-) convergence of tax systems at the international level, there are also contributions focusing on the national level. This body of literature starts from the observation that all policy reactions to actual or perceived competitive pressures have to pass through the regular domestic democratic process (see also Chapter 3). The general idea is that there are clear incentives for governments to engage in tax competition, but the race to the bottom has not materialized because institutional and political conditions in the countries made a change of the status quo impossible or difficult. Basinger and Hallerberg (1998) show that only those countries with at most one institutional veto-player carried out tax reforms, whereas countries with more than one veto-player did not cut their taxes. Subsequently, they have refined this model, so that national reactions are not only determined by the institutional and political configuration within the country but also by the respective constellations in competitor countries (Basinger and Hallerberg 2004). Wagschal (1999), who constructs a tax reform indicator that represents the frequency and extent of tax reforms in OECD countries, obtains similar results. Tax reform activity is lower in those countries with a smaller number of veto-players. Hays (2003) investigates the role of different parliamentary systems. According to his regression results, a tax cut can be more easily instituted in capital-rich majority democracies than in capital-poor consensus

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democracies. Some of these results have been criticized. Ganghof (2006a: chapter 8) shows that, if country size is included, the veto-player variable will not have any explanatory power for the variance of corporate tax rates. This is different with respect to personal income taxation, where he finds a significant relation between the number of veto-players and the extent of tax cuts. Overall, empirical research shows that there was no general race to the bottom. Nonetheless, tax competition presents a relevant constraint on the autonomy of governments to set their tax policy as they wish. In particular, governments compete for the location decisions of highly profitable multinational enterprises and the assignment of profits from these companies. It has further been shown that the challenges differ from country to country. Small countries can profit from tax competition by becoming tax havens, while large countries are vulnerable to competitive pressures. In addition, national institutions mediate the effects of tax competition. This may explain divergent national adjustment paths. However, the causal influence attributed to these factors is subject to debate. 2.3 Tax competition and international cooperation An assumption made in the entire literature presented so far, is that states accept tax competition to be an unalterable fact. Only national reactions to tax competition, treated as exogenously given, are analysed. This view neglects the possibility of states regulating international tax competition by means of international cooperation. States cannot only react unilaterally to tax competition, but they also set the rules of the tax competition game. How far tax competition restricts tax policy autonomy is not determined exogenously but can be endogenously influenced by governments. And indeed, governments do undertake efforts to regulate tax competition. Besides the OECD project against harmful tax competition, to which I will turn in the following, there are also initiatives within the European Union. Apart from the directive on interest taxation (European Community 2003), in force since 2005, there is also a “code of conduct for business taxation” (European Community 1998). Both the EU’s code of conduct and the efforts of the OECD are concerned with so-called harmful and unfair tax competition. They aim at abolishing tax practices designed to poach foreign tax bases. As we saw above, such tax regimes can be accessed by multinational enterprises through “profit shifting”. The respective national policies are considered to be harmful and unfair because they do not require taxation to be linked to any real economic activity that should be the legitimate basis of taxation. Since the respective regimes create much of the competitive pressure on the tax systems of OECD states, it is reasonable for governments to target precisely these practices by trying to establish international rules against them (see Devereux et al. 2002: 453, 473ff.). In the existing literature, however, only very few authors argue in favour of a regulation of tax competition. In economics there are a handful of authors in the German “ordo-liberal” tradition discussing the need and possible content of a

Taxation and cooperation 69 framework of rules for tax competition (see e.g. Kerber and Vanberg 1995; Vanberg 2000). However these contributions are of an entirely conceptual nature. They refer to the conditions of tax competition in purely theoretical terms and abstract from existing institutional conditions and material chances of implementing such policies. The existing empirically orientated analyses of international tax cooperation come from political scientists and deal with tax harmonization within the European Union (see Genschel 2002; Radaelli 1997). The efforts to introduce a common withholding tax on interest income were unsuccessful at first because of the diverging interests of small and big member states. As has been explained above, small countries can profit from tax competition. Therefore, agreeing on cooperation amounts to solving an asymmetric prisoners’ dilemma or even deadlock game. An additional problem making agreement difficult is the fact that there are many tax havens outside the European Union. As long as it is possible for flight capital to move to locations outside the European Union, an agreement of member states alone will be more or less ineffective (Bernauer 2000: 215–59). Despite these difficulties, a directive on interest taxation was finally agreed upon. With her slightly modified model of an “asymmetric dilemma”, which refined existing explanations and allows for the possibility of side payments, Holzinger (2005) explains this result.

3 An analysis of cooperation against harmful tax competition in the OECD The approaches just sketched have successfully used game theory to derive statements about the chances of cooperation from the strategic structure of the issue area under discussion. With such an approach, the difficulties but also the chances of establishing cooperation against harmful tax competition can be represented in a stylized fashion. The game-theoretical treatment enables the analyst to examine the implications of various interest constellations and structural conditions for the development of cooperation or conflict among actors. Intentional individual action is linked to a certain situation structure derived from the respective policy area. In constructing the game, individual preferences are usually derived from theory and then treated as exogenously given. Precisely this often-criticized simplicity is one of the major strengths of game theory because it enables us to concentrate on the most important characteristics of the situation and to arrive at potentially generalizable statements (Scharpf 1997: 36–50; Snidal 1985: 44). But the existing research has exclusively focused on the European Union. Therefore, I will in the following attempt a game-theoretic treatment of the OECD project against harmful tax competition.6 Such an analysis is missing so far. Webb (2004) employs a constructivist approach. Other authors are not interested in a theory-driven investigation but focus on a description of the politics surrounding the project (Kudrle 2003; Thomas 2002). Thus, the game-theoretic analysis can complement and improve our understanding of this particular attempt of regulating tax competition.

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3.1 A simple model and four hypotheses I will proceed in a deductive fashion. I will first collect the insights of gametheoretical accounts of tax competition to construct a very simple model of the tax cooperation game. I intentionally keep the model simple and use a purely economic definition of governments’ interests. This rudimentary model allows me to specify theoretical expectations about the initiation, the institutional form and the development of cooperation against harmful tax competition. Subsequently, the actual empirical record of the OECD project against harmful tax competition is presented, in order to assess the explanatory power of the model (3.2). The standard models of tax competition tell us that governments would be collectively better off if they avoided tax competition. But an individual country can be even better off if everybody else cooperated and it did not. There are, however, individual incentives to deviate from the cooperative solution. So far the situation of tax competition is similar to that of the well-known prisoners’ dilemma. In addition, the incentives of small and large countries diverge. Small states can win tax competition and thus prefer unregulated competition to common cooperation. For them, the situation is a deadlock game. Overall, the strategic structure is that of an asymmetric dilemma between big countries with prisoners’ dilemma preferences and small countries with deadlock preferences.7 The following 2 ⫻ 2 matrix (see Table 4.1) depicts the strategic structure. As can be seen in the matrix, the situation of regulated tax competition that would result from common cooperation (C/C) is collectively preferred over the status quo of common defection. However, the individually rational and dominant strategy is to defect. The equilibrium solution of the one-shot game is (D/D), the collectively worst outcome. In order to employ the game for the analysis of real-life attempts at establishing cooperation, it has to be conceptualized as a repeated game, since governments are in long-term interactions with each other. According to the “Folk Theorem” in repeated games any result, including the cooperative one, can be stabilized as equilibrium.8 But even in a repeated game the cooperative solution is not self-enforcing, since there is an individual incentive for all countries to deviate from the cooperative solution in any round of the game. Consequently, the general theoretical expectation is that establishing cooperation will be very difficult. This leads to the following hypothesis: Table 4.1 Tax competition as asymmetric dilemma Small country

Big country

Cooperate (C) Defect (D)

Cooperate (C)

Defect (D)

4/2 5/0

0/5 1/3

Taxation and cooperation 71 1 The establishment of effective cooperation is unlikely. The probability of regulatory attempts to fail is high. This general statement about the difficulty of initiating cooperation can be developed further. In reality, there are not only two but many countries. This complicates cooperation even further. Those states not joining the cooperative venture can exploit the other states. Under the assumption that capital is perfectly mobile the defection of a single country could frustrate the other actors’ cooperative efforts. If only one country would not abstain from offering unfair tax privileges to taxpayers, the total amount of internationally mobile capital would immediately flow to that country. In order to avoid this, the group of cooperators would thus have to cover all states of the world. While the assumption of perfect capital mobility is exaggerated, it is certainly not very far off the mark with respect to competition for financial services and portfolio investments. These are precisely the kinds of investment flows the OECD project focuses on. Therefore it is justified to assume that the group of states that can successfully cooperate without being exploited by outsiders would consist of almost all states of the world. It is thus not to be expected that a “minilateral” coalition can successfully initiate the fight against tax competition (Genschel and Plümper 1997: 635ff.).9 Rather, the group of cooperators must be encompassing: 2 Efforts to cooperate must be multilateral. The fact that small countries can benefit from tax competition by becoming tax havens leads to the following prediction concerning the constellation of interests: 3 The main cleavage will be between small countries (tax havens) and big countries. Efforts to regulate tax competition, if they will be pursued at all, will be initiated and promoted by big countries. Small states will try to stay outside of any cooperative venture. Consequently, the prospects for successful cooperation are not bright at all. There is no individual incentive for small states to enter into an agreement to regulate or curb tax competition. At the same time, since cooperation will necessarily have to be multilateral, their cooperation is required. From the perspective of game theory the small states are clearly in the stronger position. Nevertheless, establishing cooperation is not impossible. The cooperative solution would become attractive for small countries, if they were compensated for their observance of the rules against harmful competition. As has been shown above, the gain realized by small states in tax competition is smaller than the loss incurred on big countries. Thus, successful regulation of tax competition should bring enough additional gain for big countries to compensate the small ones. There is room for side payments that would make everybody better off.

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The cooperative solution would internalize the external costs that tax havens impose on big countries. In order to realize this Coase (1960) solution, the parties have to engage in bargaining. In the example of the above game, the collectively best result would be attainable if the big country made a side payment of 1 to the small country. Both players would realize a pay-off of 3. Because of the side payment the small country would be willing to forgo the strategy of defection.10 From the necessity of side payments we can derive the following hypothesis: 4 The winners of cooperation will employ side payments to compensate the losers. However, it is not possible to predict more precisely the type of side payments that will be used. Several kinds are plausible. They could also be mixed. For one, it is conceivable that big countries will actually use the additional gains from successful cooperation to compensate small states. They could also try to pressure small states into cooperation by threatening negative sanctions. The side payments could also be employed across different policy fields (“issue linkage”). This would in general open up a bigger space for bargained solutions. Finally, one could also imagine an indirect compensation, which consists of the big states making concessions on the scope of the regulations to be implemented.11 In order to test these hypotheses, the following subsection outlines the empirical record of the OECD project. 3.2 The OECD project against harmful tax competition In 1996 the G-7 ministers of finance decided to launch an initiative against harmful tax competition. They mandated the OECD to propose effective measures against the negative effects of unfair tax practices (Owens 1998: 230). The OECD came up with several suggestions that were published in a report entitled “Harmful Tax Competition: An Emerging Global Issue” (OECD 1998). Right from the start the focus within this project has been limited to unfair competition for highly mobile activities such as financial service centres or portfolio investments. The OECD made it clear that the project was not about tax competition on real direct investment. Such competition is not necessarily considered as bad and a country should remain free to deliberately design its own tax rates. Conventional tax systems with low rates that are granted equally to all taxpayers are not targeted by the report (OECD 1998: para. 40f.). Rather, the project aims at “unfair” tax practices that are defined as attempts to “poach” the tax base of other countries. Poaching is defined to be the intentional design of a country’s tax system in order to frustrate the application and enforcement of another country’s tax laws (OECD 1998: 29ff.). The OECD differentiates between two types of unfair tax practices. First, a tax haven is a country that offers itself to non-residents in order to evade or avoid taxation in the home country. The decisive criterion for a tax haven is that it offers tax shelter without requiring any substantial economic activity to take

Taxation and cooperation 73 place in the country. If a country’s tax law makes it possible to book certain transactions in the country for tax purposes, despite the fact that they do not create an adequate added value, then this criterion is met. So-called mailbox companies are the generic types of such an avoidance scheme. Another important characteristic of a tax haven is that it is unwilling to exchange information with home countries (OECD 1998: paras 29, 52). A second unfair tax practice is to offer so-called “preferential tax regimes” to foreign investors that are not available to domestic investors (OECD 1998: para. 57ff.). There is positive discrimination on behalf of foreign investors in that they are treated more favourably than domestic taxpayers. Through this “ring-fencing“ the high-tax countries try to protect themselves from the negative revenue implications of general rate cuts, but at the same time try to compete against tax havens for foreign capital. This attempt at self-protection indicates, according to the OECD, that preferential tax regimes are unfair to other countries. By raising the issue of preferential tax regimes the OECD targets its own members (OECD 1998: para. 57ff.). With these definitions of harmful tax practices the OECD project is aimed at precisely those kinds of regimes that are to a large extent responsible for the competitive pressures that governments experience, as we have seen in section 2. The goal of the project was to get commitments from countries to remove the harmful features of their national tax systems and to make effective information exchange possible. In order to reach that goal the OECD pursued a “naming and shaming” approach (Eden and Kudrle 2005: 122). It developed and published a blacklist of 35 tax havens (OECD 2000: para. 17) asking them to formally commit to removing the harmful features from their tax systems. The OECD threatened to implement “defensive measures” in the form of more restrictive tax treatment of foreign investments if the tax havens would not be willing to submit to the demands (OECD 1998: para. 85ff.). Likewise, 47 preferential tax regimes in OECD member countries were listed that should be evaluated and removed in a process of peer reviews (OECD 2000: para. 11). The OECD emphasizes the importance of an approach that is inclusive of all countries. In particular the defensive measures should be implemented collectively. Only such an encompassing approach could ensure that fighting harmful practices will not be harmful to the cooperators themselves. The fear is that the tax bases would flow to those countries that are unwilling to make commitments (see e.g. OECD 1998: para. 138). The listed tax havens objected to the policy pursued by the OECD, decrying it as an undue interference into their national tax sovereignty. They argued that western industrialized countries had originally advised them, through institutions like the International Monetary Fund (IMF) and the World Bank, to specialize in offering financial services. Now that they had developed a strong financial sector, the very same countries were planning to take it away from them. In addition, they complained about the lopsidedness of the approach. While OECD member countries were not threatened with any countermeasures if they didn’t comply, they were (Easson 2004: 1062ff.). In 2001, the United States joined the tax havens in some of their criticisms. The Clinton administration had been one of the initiators and most ambitious supporters of the project.

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But the newly elected Bush government altered that policy. In a newspaper article Finance Minister O’Neill argued that the USA did not want to interfere with the tax sovereignty of other countries. Instead of trying to force tax havens to change their tax systems, the project should focus only on the exchange of information. “In its current form, the project is too broad and it is not in line with this Administration’s tax and economic priorities” (O’Neill 2001). Libertarian interest groups had played an important role in the government’s policy change. Among them, the group “Freedom and Prosperity”, sponsored by the Heritage Foundation, had been particularly active. This small “think tank” succeeded in positioning its critique in the media (see e.g. Mitchell 2000) and raising public interest for the OECD’s plans. After the US intervention, the approach becomes less confrontational. While the OECD does not withdraw the blacklists, it assures tax havens that it will not implement defensive measures until all OECD countries have removed the identified preferential regimes from their tax systems (OECD 2001: para. 32). Thus, the tax havens do not have to fear defensive measures as long as OECD members like Switzerland and Luxembourg – which abstained from the project, but were blacklisted – still employed their preferential regimes. The less antagonistic approach is also evidenced by the creation of the “Global Forum on International Taxation”, in which both OECD member countries and tax havens discuss the further development of the project (OECD 2004b). Tax havens that declare their intention to cooperate with the demands are offered technical, administrative and financial help in the restructuring of their tax systems by OECD countries, the World Bank and other International Organizations (OECD 2001: para. 44ff.). Despite the change to a less confrontational approach, the (now limited) demands against tax havens were held up. They are still required to change their national laws and administrative practices so that access to financial information is granted (OECD 2004a: para. 29ff.). Despite their criticism, most of the tax havens give in to the demands of the OECD. Only a handful of countries still refuse to cooperate. In 2004, only five uncooperative tax havens were left: Andorra, Liechtenstein, Liberia, Monaco and Marshall Islands (OECD 2004a: para. 27). The big majority declared that they would progressively allow for more effective exchange of information. In the future, this will be implemented through specific bilateral agreements on information exchange. These treaties should follow a model agreement that was developed within the Global Forum (OECD 2002). The information exchange will be on request, but the agreements will take precedence over possibly existing bank secrecy provisions (OECD 2004a: para. 24). A few agreements of this type have already been concluded and several are currently negotiated (OECD 2005: para. 16). With respect to preferential tax regimes of member countries, 45 of the initially identified 47 could be removed from the blacklist.12 The remaining two preferential tax regimes, one in Switzerland, the other in Luxembourg (OECD 2004a: para. 15), cause problems, since the countries are not willing to remove them. So far, their status remains unclear. Officially, they need to be further investigated (Easson 2004: 1074).

Taxation and cooperation 75 3.3 Assessment of the model Overall, the simple model of cooperation as an asymmetric dilemma can explain essential features of the OECD project against harmful tax practices. First of all, it is indeed very difficult to establish cooperation and come to an agreement on the regulation of harmful tax practices. Countries engage in confrontational bargaining, which does not lead to the institutionalization of an effective and enforceable arrangement (hypothesis 1). Instead, the OECD installs a process of peer reviews hoping to achieve progress through legally non-binding “naming and shaming”. Governments try to act within a broad multilateral framework so that cooperating actors cannot be exploited (hypothesis 2). It is interesting to note that the OECD explicitly uses the same reasoning for the necessity of a multilateral approach that underlies the model. Apparently, the project’s designers have used the asymmetric dilemma game as the blueprint for action (see Owens 1998). As stated above, the model cannot predict which kind of side payment will be employed. Clearly, all three kinds can be observed (hypothesis 4). The tax havens are offered technical and administrative assistance (positive side payment). Due to US intervention there are concessions on the scope of the project. But the tax havens are also successful in pushing through more favourable treatment in that they manage to make their own commitments dependent on OECD countries’ commitments to abolish preferential tax regimes (indirect compensation). Finally, the OECD also employs threats to sanction non-cooperation (“defensive measures”). The expected cleavage between big and small countries can clearly be observed (hypothesis 3). The main conflict is between small tax havens and big OECD countries. However, the diverging interests of big and small countries can only partially explain their actual willingness to cooperate. The model predicts a higher willingness to cooperate of big countries than of small countries. In reality, however, most small tax havens declare their intention to cooperate with OECD demands rather early on. It proves to be more difficult, in contrast to the model’s predictions, to get a firm commitment from the big country USA. On the other hand, in conformity with the model, there are also small countries such as Switzerland and Luxembourg trying to refuse cooperation. This is particularly interesting since these are small countries and tax havens within the OECD. While most small non-OECD members submit to the demands, the small members are resilient.

4 Conclusion Overall, the success of the OECD project against harmful tax practices is limited. Concerning multinational enterprises’ tax optimization strategies, responsible for a major share of competitive pressures on countries’ tax systems, there is basically no progress at all. Tax havens remain free to offer tax shelters to corporate taxpayers. The increased requirements for transparency and information exchange cannot remedy that. A multinational’s tax optimization is

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not reliant on confidentiality in the haven country. On the contrary, they would rather demand transparency themselves in order to preempt potential suspicions that they were involved in any illegal transactions. Concerning tax evasion and avoidance of individual taxpayers the project achieved better results. While it is too early to come to a final judgement on the effectiveness of the bilateral information exchange agreements, the very fact that tax havens had to give in to demands is a progress over the status quo. Tax havens’ acceptance of information exchange may have a deterrent effect on taxpayers already.13 The very limited progress achieved is in accord with the general hypothesis of the asymmetric dilemma model that it is difficult to establish successful cooperation against harmful tax competition. Nevertheless, there are also a few aspects that this model cannot explain. One major deviation from theoretical expectations is the behaviour of the US government. According to the model this big country should not have any interest to hollow out the initiative. The reason for nevertheless doing so can be found on the domestic level. After the change of government business lobbies could more easily make their opposition to the OECD project heard (Kudrle 2003: 69). Such a capture of government by special interest groups points to the need to extend the model by integrating domestic level politics (see Putnam 1988). Further, the model does not predict commitments from tax havens to be extracted so easily. An obvious explanation for this deviation could be the power differentials between OECD members and non-members. In any case, the fact that Switzerland and Luxembourg react differently to non-OECD tax havens makes such an explanation plausible. The behaviour of tax havens within the OECD shows that the model does correctly predict the interests of small tax havens. However, this interest is not the only factor affecting their actual (un-) willingness to cooperate. This is also determined by power differentials. Another interesting aspect is small countries’ success at extracting concessions from OECD countries. The empirical material suggests that they were able to do so because they accused the OECD of double standards. While tax havens were threatened with sanctions, OECD members with preferential tax regimes were not. The successful usage of this normative argument suggests that certain conceptions of legitimacy – and not only power and interest politics – had an influence on the policy process and outcome. Despite these explanatory gaps – resulting from the purely economic definition of interests – the very simple model presented here can explain surprisingly many of the observed features of the OECD initiative against harmful tax practices. In addition to that, as these last tentative remarks illustrate, it also has informative content with respect to those aspects that it cannot account for. It invites speculation about potential alternative or complimentary explanations and thus provides guidance to further research. The asymmetric dilemma model is a very good starting point for a better understanding of international cooperation against tax competition.

Taxation and cooperation 77

Notes 1 Very good overviews on the most important contributions are presented by Oates (1999; 2001), Wilson (1999) and Haufler (2001). 2 For example, Tiebout assumed lump-sum taxes. Thus, the redistribution of income through progressive taxation would be impossible by definition. In contrast to that, in this chapter the term “public good” includes socially desired redistributions. 3 Even if I do not deal with them here, it should be noted that there is a third group of models in which, due to agglomeration effects, the existence of high transportation costs or other market imperfections, the race to the bottom does not result. An overview of such models is contained in Wildasin and Wilson (2004). 4 In the models presented above investors can break down their investments into infinitesimal parts. Thus, every part of the invested sum will earn the going market rate of return. Accordingly, it will be taxed at the effective marginal tax rate. Under this assumption, the average tax rate would not be the relevant indicator. 5 Especially for newly established enterprises, which are not yet profitable, the old system with high saving and investment incentives would be advantageous. In contrast, the tax cut cum base broadening policy privileges “old” capital. 6 This is part of a project the author is currently undertaking. For first results and a more detailed development of the theoretical model and the empirics, see Rixen (2005). 7 This is basically the same strategic structure that is proposed by Holzinger (2005). For more on the generic preference orderings and interest constellations such as “deadlock”, “assurance” or “prisoners’ dilemma”, see Scharpf (1997: chapter 4). For a detailed derivation and discussion of countries’ preferences in tax competition, see Rixen (2005: 7–31). 8 Due to the deadlock preferences of the small country this is only true if we allow for the possibility of side payments, that is the big state would have to buy the small state out of its defection. They have to come to a bargaining solution. In technical terms, we move from uncooperative to cooperative game theory. The difference between the two is precisely the fact that side payments are possible in cooperative game theory (see Scharpf 1997: 116–50). 9 Such games can best be depicted in so-called Schelling (1978: 213–25) diagrams. For the case at hand, such diagrams are contained in Rixen (2005: 11f.). 10 The numbers used here are purely hypothetical. What exactly the solution would be depends on various factors such as bargaining power or the existence of focal points and so on. 11 Strictly speaking, such indirect compensation is not a side payment because it leads to efficiency losses. By downsizing the object of cooperation the solution is interior to the Pareto frontier. 12 Eighteen preferential tax regimes were abolished, 14 were changed so that they are now considered acceptable, and in the case of 13 regimes the conclusion was that they were not harmful after all (OECD 2004a: para. 12). It has been questioned whether countries have really abolished their preferential tax regimes, or rather have only rearranged them slightly in order to get OECD approval (see Webb 2004: 815f.). 13 There appears to have been a significant reduction in offshore business in some havens. For example, Dominica’s last offshore bank has been closed. The number of offshore banks in Antigua has dropped from 60 four years ago to 15 today. The Bahamas are said to have lost a quarter of its banks (Easson 2004: 1065, who cites sources from the region as evidence).

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Taxation and cooperation 79 Gresik, T.A. (2001) “The Taxing Task of Taxing Transnationals”, Journal of Economic Literature, 39/3: 800–38. Haufler, A. (2001) Taxation in a Global Economy, Cambridge: Cambridge University Press. Haufler, A. and Schjelderup, G. (2000) “Corporate Tax Systems and Cross Country Profit Shifting”, Oxford Economic Papers, 52: 306–25. Hays, J.C. (2003) “Globalization and Capital Taxation in Consensus and Majoritarian Democracies”, World Politics, 56/1: 79–113. Hines, J.R. (1999) “Lessons from Behavioural Responses to International Taxation”, National Tax Journal 52/2: 305–22. Holzinger, K. (2005) “Tax Competition and Tax Cooperation in the EU. The Case of Savings Taxation”, Rationality and Society, 17/4: 475–510. Kerber, W. and Vanberg, V. (1995) “Competition Among Institutions: Evolution within Constraints”, in L. Gerken (ed.) Competition Among Institutions, New York: St. Martin’s Press: 35–64. Kudrle, R.T. (2003) “Hegemony Strikes Out: The U.S. Global Role in Antitrust, Tax Evasion, and Illegal Immigration”, International Studies Perspectives, 4/1: 52–71. Mitchell, D.J. (2000) “OECD War on Low-tax Countries”, Washington Times, 20 August 20: B1. Oates, W.E. (1999) “An Essay on Fiscal Federalism”, Journal of Economic Literature, 37: 1120–49. –––– (2001) “Fiscal Competition or Harmonization? Some Reflections”, National Tax Journal, 54/3: 507–12. OECD (1998) Harmful Tax Competition. An Emerging Global Issue. Online. Available /www.oecd.org/dataoecd/33/0/1904176.pdf (accessed 11 January 2006). –––– (2000) Towards Global Tax Co-operation: Report to the 2000 Ministerial Council Meeting and Recommendations by the Committee on Fiscal Affairs: Progress in Identifying and Eliminating Harmful Tax Practices. Online. Available www.oecd.org/dataoecd/ 9/61/2090192.pdf (accessed 7 December 2005). –––– (2001) The OECD’s Project on Harmful Tax Practices: The 2001 Progress Report. Online. Available www.oecd.org/dataoecd/60/ 28/2664438.pdf (accessed 7 December 2005). –––– (2002) Agreement on Exchange of Information on Tax Matters. Online. Available www.oecd.org/dataoecd/15/43/2082215.pdf (accessed 7 December 2005). –––– (2004a) The OECD’s Project on Harmful Tax Practices: The 2004 Progress Report. Online. Available www.oecd.org/dataoecd/60/ 33/30901115.pdf (accessed 7 December 2005). –––– (2004b) A Process for Achieving a Global Playing Field. Global Forum on Taxation. Online. Available www.oecd.org/dataoecd/13/0 /31967501.pdf (accessed 7 December 2005). –––– (2005) Progress Towards a Level Playing Field: Outcomes of the OECD Global Forum on Taxation, Melbourne, 15–16 November. Online. Available www.oecd.org/ dataoecd/28/55/35670025.pdf (accessed 7 December 2005). O’Neill, P. (2001) “Confronting OECD’s Notions on Taxation”, Washington Times, 10 May 2001: A 15. Owens, J. (1998) “Curbing Harmful Tax Competition – Recommendations by the Committee on Fiscal Affairs”, Intertax, 26/8–9: 230–34. Persson, T. and Tabellini, G. (2000) Political Economics. Explaining Economic Policy, Cambridge, MA: MIT Press.

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Przeworski, A. and Wallerstein, M. (1988) “Structural Dependence of the State on Capital”, American Political Science Review, 82/1: 11–29. Putnam, R.D. (1988) “Diplomacy and Domestic Politics: The Logic of Two-Level Games”, International Organization, 42/3: 427–60. Radaelli, C.M. (1997) The Politics of Corporate Taxation in the European Union. Knowledge and International Policy Agendas, London: Routledge. Rixen, T. (2005) “Internationale Kooperation im asymmetrischen Gefangenendilemma: Das OECD Projekt gegen schädlichen Steuerwettbewerb”, Discussion Paper, 12, Wien: Wirtschaftsuniversität Wien. Online. Available www2.wu-wien.ac.at/taxlaw/ sfb/Working_Papers/workingpaper12.pdf (accessed 5 January 2006). Scharpf, F.W. (1997) Games Real Actors Play. Actor-centered Institutionalism in Policy Research, Boulder, CO: Westview. Schelling, T.C. (1978) Micromotives and Macrobehaviour, New York: Norton. Sinn, H.W. (1997) “The Selection Principle and Market Failure in Systems Competition”, Journal of Public Economics, 66: 247–74. Slemrod, J. and Bakija, J. (2004) Taxing Ourselves. A Citizen’s Guide to the Great Debate Over Tax Reform, Cambridge: MIT Press. Snidal, D. (1985) “The Game Theory of International Politics”, World Politics, 38/1: 25–57. Sorensen, P.B. (2000) “The Case for International Tax Co-ordination Reconsidered”, Economic Policy, 31: 429–72. Steinmo, S. (2003) “The Evolution of Policy Ideas: Tax Policy in the 20th Century”, British Journal of Politics and International Relations, 5/2: 206–36. Steinmo, S. and Swank, D. (2002) “The New Political Economy of Taxation in Advanced Capitalist Democracies”, American Journal of Political Science, 46/3: 642–55. Thomas, K.P. (2002) “The Politics of an Emergent Global Regime for Controlling Tax Competition”, Policy Studies Journal, 30: 270–84. Tiebout, C.M. (1956) “A Pure Theory of Public Expenditures”, Journal of Political Economy, 65: 416–24. Vanberg, V. (2000) “Globalization, Democracy, and Citizens’ Sovereignty: Can Competition Among Governments Enhance Democracy?”, Constitutional Political Economy, 11: 87–112. Wagschal, U. (1999) “Blockieren Vetospieler Steuerreformen?”, Politische Vierteljahresschrift, 40/4: 628–40. Webb, M.C. (2004) “Defining the Boundaries of Legitimate State Practice. Norms, Transnational Actors and the OECD’s Project on Harmful Tax Competition”, Review of International Political Economy, 11/4: 787–827. Wildasin, D.E and Wilson, J.D. (2004) “Capital Tax Competition: Bane or Boon”, Journal of Public Economics, 88/6: 1065–91. Wilson, J.D. (1986) “A Theory of Interregional Tax Competition”, Journal of Urban Economics, 19: 296–315. –––– (1991) “Tax Competition with Interregional Differences in Factor Endowments”, Regional Science and Urban Economics, 21: 423–51. –––– (1999) “Theories of Tax Competition”, National Tax Journal, 52/2: 269–304. Winner, H. (2005) “Has Tax Competition Emerged in OECD Countries? Evidence from Panel Data”, International Tax and Public Finance, 12: 667–87. Zodrow, G.R. and Mieszkowski, P. (1986) “Pigou, Tiebout, Property Taxation, and the Underprovision of Local Public Goods”, Journal of Urban Economics, 19: 356–70.

5

Money and power Markets and governance in international monetary policy Hubert Zimmermann

1 The current currency gamble In May 2005, the former US secretary of state, Henry Kissinger, was sent as an unofficial envoy to the PR China by the Bush administration. The message he reportedly conveyed was unusual: the American government urged Chinese authorities to revalue their currency by at least 10 per cent (Balls 2005). Looming in the background was the threat of protectionist legislation in the American Congress which had got increasingly restive about the enormous trade deficit the US was running with China for years. Embattled sectors of the American industry claimed that Beijing pegged its currency to the Dollar at an artificially low level and that this represented an unfair competitive advantage for Chinese exports. The trade deficit resulted in rapidly increasing foreign exchange reserves in China, most of them held in Dollar-denominated bonds. In March 2006, these amounted to more than $875 bn (The Economist 22 April 2006). And China was not the only country to accumulate a massive amount of Dollar assets. Its reserves were surpassed by those of Japan (up to $900 bn), and even Taiwan and South Korea both held more than $200 bn (Gimbel 2005). What worried observers about these enormous amounts held by Asian central banks was the possibility that these countries would start to diversify their reserves, triggering a contagious sell-off by private and official investors with the result of a rapid fall in the value of the Dollar (ECB 2006; Roubini and Setser 2004). This prospect has not only sparked intense debate among specialists and journalists; it has also induced the leading countries to expand the role of the International Monetary Fund (IMF) by giving it an official mandate to negotiate a solution to global imbalances (Giles and Guha 2006). One core element in many worst-case scenarios is that most of the Asian reserves are held in US treasuries, financing both the unprecedented American current account deficit and the huge budget deficit created by the economic policies of the Bush administration. A Dollar crash would force up American interest rates, making borrowing for the US government and consumers more expensive, with the possible result of a recession. In addition, export industries in Asia and Europe, the main engines of growth in these regions, would be strongly hit by a falling Dollar. Faced with this prospect, leaders of European

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countries have called for more state-guided governance in the international monetary system to regulate adjustment processes and control capital markets. Kenneth Rogoff, the former chief economist of the IMF, wrote: “If we don’t see any coordinated response on this one, it won’t bode well for global financial governance over the next decade.”1 Some analysts have advocated institutionalized coordination among the G-2, that is, the United States and the Eurozone (Bergsten 2005). However, the US and the United Kingdom, the main promoters of unregulated capital markets, would see none of that, arguing, like many economists, that market forces will correct any unsustainable imbalances over time, that current regulatory frameworks are sufficient and that state intervention would be counterproductive. At the moment of this writing (May 2006), US deficits and Dollar accumulation abroad both continue, despite a small Renmimbi revaluation in July 2005. This situation poses three interconnected sets of questions that form the core of the debate in the International Political Economy (IPE) on international monetary policy: 1) What are the requirements and chances for global governance in international monetary markets? Can international institutions, such as the IMF, play an effective and legitimate role in regulating global currency markets? 2) What is the role of private actors in currency markets and their governance? How will they react to the imbalances? 3) Who rules in monetary markets? Are states still capable of exerting authority? Who has monetary power? This chapter sums up the results of the most recent, theoretically informed research on these questions. It outlines the current debate on the relationship of states and markets in international finance and on the forms and prospects for international governance in this area. It then proceeds to discuss the question of monetary power using the debate about the US current account deficit as an empirical example. It will be argued that states remain the decisive actors in international monetary affairs and that the autonomy of state actors to pursue international and domestic preferences (which can be geopolitical, economic or electoral) is the main characteristic of monetary power. The main focus of this chapter will be on the politics of global currencies. Other aspects of financial globalization, such as the regulation of financial intermediaries, bond markets, rating agencies, global debt and so on, will be mentioned only briefly.

2 The state of the debate The liberalization of global financial markets is one of the most conspicuous results of economic globalization. Foreign exchange trading is now de-coupled from its traditional purpose of financing global trade. Its volume dwarfs the sums used for trade in goods and services. Direct investments, portfolio investments and foreign exchange transactions have exploded over the past 30 years (Aliber 2002: 60). The sheer size of these market forces seems to easily eclipse the impact of any possible intervention by central banks or governments. The volatility of capital has led many analysts to question whether states can still execute all the expansive tasks and fulfill all the commitments which they

Money and power 83 assumed during the twentieth century and which came to define the contemporary meaning of statehood.2 Already in 1969, Kindleberger quipped that “the nation-state is just about through as economic unit” (1969: 207). In one of her last books, Susan Strange, one of the pioneers in this field, claimed that states had retreated from the governance of financial markets, leaving a vacuum of authority (Strange 1996). Is there still any role for the “political” in the IPE of global monetary phenomena? Has the de facto legal sovereignty of states over the creation and regulation of international money been undermined by a loss in de facto autonomy (Bryant 2003: 205)? This debate on the role of the state and of politics in international monetary relations is probably the defining question among those IPE scholars dealing with monetary issues. However, the idea that states might not be the masters of the monetary game any more, and probably not even the decisive players, is of relatively recent vintage. Until the late 1970s most research on international monetary policy was clearly state-centric. In fact, states clearly determined outcomes in the international financial arena in the nineteenth and most of the twentieth century, although, as Helleiner (2004: 154–5) notes, the spread of mass-based democratic policies after the First World War forced decision-makers to accommodate domestic interest groups and ended the clear subordination of domestic to international objectives that had characterized the gold standard of the nineteenth century (Gallarotti 1995). The state-managed system of fixed-but-adjustable exchange rates that emerged in the Western World after 1945 preserved the dominant role of state actors, though more attention had to be paid to domestic actors trying to influence monetary policy-making, in particular central banks and internationally operating firms. The underlying objective of the postwar monetary system, usually termed the Bretton Woods System,3 was, in Ruggie’s widely accepted formulation, to permit “embedded liberalism”: the liberalization of international trade while at the same time preserving state autonomy in choosing domestic economic policies, most of them employing variants of Keynesian demand-side strategies (Hall 1989). This was guaranteed by capital controls whereas stability in international trade was to be achieved through stable exchange rates (Ruggie 1982). The Dollar became the globally accepted reserve currency, bolstered by the dominance of the US economy, the depth of its financial markets, and a pledge by the American government to back the Dollar with US gold reserves. Most advanced economies pegged their currencies to the Dollar. These pegs turned out to be highly beneficial for those countries. Many rapidly regained their competitiveness and profited from an over-valued Dollar. The multilateral control of currency markets obliterated the need for wideranging adjustment measures and gave most states a relatively high measure of autonomy regarding the impact of international exchange rate movements. However, the progressive liberalization of capital markets during the 1960s and 1970s made the pursuit of both stable exchange rates and such state autonomy difficult to achieve. The concept of the so-called “impossible trinity” (Oatley 2004: 273–6) is the standard explanation for this and it became the core reference point for most current theorizing on international monetary relations.

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The “impossible trinity” states that of the three fundamental state goals of macro-economic policy autonomy, free capital markets and fixed exchange rates, only two can be implemented at the same time.4 In particular, flexible exchange rates and open capital markets decisively curtail the space for autonomous fiscal policies by governments (Pauly 1997: 24). When currency markets became more volatile in the 1970s and 1980s, states had to either adjust their macro-economic policy to market expectations in order to stabilize the exchange rate or to give up their currency pegs and accept floating exchange rates. This second option was chosen by most industrial states since they privileged policy autonomy over the established rules. The causes for the progressive liberalization of capital markets and the breakdown of the fixed exchange rate system are still being debated. Helleiner (1994) identified state actors, in particular the United States and the United Kingdom, as the prime movers because they profited most due to their large financial markets. Similarly, Cerny (1995) argued that state efforts to render their economies more competitive exerted a powerful pressure towards the deregulation of capital. Others point to the role of markets and technology. The so-called EuroDollar market, a primarily London-based market, which allowed US firms access to foreign capital at a time of increasing restrictions in the US, became synonymous with the new power of non-state actors. In an influential article, David Andrews (1994) emphasized that capital mobility, caused by shifts in technology, market practice and national policy, became a structural variable, limiting decisively the autonomy of states in economic policy-making. Harris (2004) argues that the rising finance industries had the determining influence in forcing states to accept the new rules that were benefiting these industries. A third prominent explanation is the role of ideas towards which the constructivist turn in IR and IPE has steered many authors. McNamara (1998) claims that the emergence of a neo-liberal consensus, which stressed the superior efficiency of markets in the allocation of economic decisions, was instrumental in the acceptance of flexible exchange rates and the emergence of the euro, reflecting the successful anti-inflationary benchmark set by the German Bundesbank. In a recent article, Wesley Widmaier stressed the social construction of the “impossible trinity”: the postwar breakdown of interlocking wage, price, and currency guidelines cannot be reduced to such material trends as hegemonic decline, capital mobility, interdependence or technological changes [. . .] Far more significant were inter-subjective changes,