Figure 4.1 - Not yet available
 

National implications of international capital flows

    If it is indeed correct, as we have argued, that capital tends to flow to rapidly growing, technologically progressive, advanced and newly industrializing countries, then there are major implications for developing countries experiencing an outflow of resources. First, and most obvious, the transfer of savings abroad implies a lower rate of domestic investment. Second, this, in turn, leads to a lower rate of growth of output and incomes. Third, the outflow of capital will tend to raise profit rates and interest rates in developing countries and this, fourth, is likely to result in a higher share of profits and a lower share of wages in the national income. That is, inequality is likely to increase not only internationally but also nationally. The shift in the national distribution of income in favour of profits implies, fifth, that real wages will rise less rapidly than average income, which itself will be growing at a slower rate because of the outflow of capital.

    The capitalist class within the developing countries will benefit from this process. They will enjoy a higher share of total income. They will experience a rate of growth of their income faster than the national average. They will benefit from a higher rate of return on their savings and investment, whether their assets are held at home or abroad. The working class, on the other hand, whether employed in factories or on farms, will bear the full cost of adjusting to structural disequilibrium. The share of wages in national income will fall. The rate of growth of real wages will be less than the rate of growth of national income and considerably less than the rate of growth of profit and interest income. They will be the only losers.
 

Flows of professional, managerial and technical personnel

    The working class, however, is not homogeneous. Some workers may be able to avoid the costs of adjustment described in the previous paragraphs by migrating abroad. This is likely to be easier for highly skilled workers--professional, managerial and technical personnel--than for relatively unskilled ones. Here again, there is a paradox.

    It is widely believed that skilled labour is very scarce in developing countries, and in one sense this obviously is true. Medical personnel (doctors, dentists, nurses, surgeons), relative to population size, are less abundant in developing than in developed countries. The same is true of engineers, natural scientists, accountants, economists and other social scientists. This relative scarcity, however, is not translated into incomes which can attract professional, managerial and technical personnel from the developed countries. On the contrary, uninhibited market forces would lead to a large net outflow of skilled labour from poor countries. Even with obstacles to immigration in the developed countries the brain drain from developing countries is widely acknowledged, as their scarce skilled personnel migrate to rich countries where skilled labour is abundant but where nevertheless incomes of skilled labour are high. If left to its own devices, the global economy would operate in such a way that human capital systematically would be transferred from poor to rich countries. Just as in the case of international flows of savings, brain drain increases international inequality between developed and developing countries.

    The outflow of professional, managerial and technical personnel from developing countries has several effects. First, it raises the incomes of the migrants. Second, assuming the outflow is of more than marginal significance, it lowers the average incomes of those left behind. 31

    Third, it raises the incomes of the professional, managerial and technical personnel left behind. That is, the distribution of wages and salaries shifts in favour of highly skilled labour and human capital and against relatively low skilled labour. Finally, since there has been no rise and possibly a fall in average incomes, the redistribution of income in favour of the highly skilled results in an absolute decline in the incomes of the low skilled. Brain drain, in other words, contributes to the impoverishment of the lowest income groups in the poorest countries.
 

Flows of unskilled labour

    The argument so far is that in the absence of deliberate policy interventions the developed countries would tend to attract from the developing countries both finance capital (savings) and human capital (highly skilled workers) to the detriment of unskilled workers and poor people generally in developing countries. Of course there have been policy interventions--many poor countries impose controls on outflows of capital and virtually all rich countries have controls on inflows of labour--but the interventions are never wholly successful and the economic forces that transmit international inequality continue to operate even if their consequences are somewhat attenuated.

    The same economic forces that attract finance and human capital from poor countries also attract unskilled labour. That is, the dynamic economies act as magnets attracting all mobile resources from the less dynamic economies. In the case of unskilled labour, however, the flow from poor to rich countries reduces inequality both internationally and within the sending country (while increasing it within the recipient country). Thus the international migration of relatively low skilled labour offsets the distributional consequences of the migration of capital and highly skilled labour. Given liberal policies toward the free movement of capital and highly skilled labour, it is important that there should also be liberal policies toward the free movement of unskilled labour.

    Unfortunately, however, policies in the developed countries tend strongly to discriminate against immigration of unskilled labour as compared to the migration of professional, managerial and technical personnel. As a result, the developing countries are forced to bear a double burden. They lose finance and human capital which are vital to their future development while being forced to retain unskilled labour which they have in great abundance and which can contribute relatively much less to their future development. Moreover the loss of finance and human capital when combined with the involuntary retention of unskilled labour results both in greater inequality in the distribution of income within developing countries and in lower real wages of low skilled workers. In this way the actual operation of the international economic system tends to frustrate human development in the poorest and least dynamic economies.
 

Occasional Paper 2 -    Globalization and the Developing World: An Essay on the International Dimensions of
                                           Development in the Post-Cold War Era

    The main elements of a domestic development strategy focused on human development can be readily described. 32 The cornerstone of the strategy is growth with equity. Growth is a precondition for sustained human development. But growth is not necessarily or automatically translated into human development. Growth must be equitable to ensure that human development progresses at an equal or faster pace. Equity in the distribution of income can be promoted through an expansion of employment; by widening access to education and skill formation; by improving access of the poor to productive assets both through redistribution of existing assets and by helping the poor to create and possess new assets; and by direct, well-targeted income subsidies to those of the very poor who do not benefit from an expansion of employment opportunities. The strategy requires increased public expenditure on basic education and health; an enabling environment for private and non-governmental enterprises that encourages the full use of their potential for developing human resources; efficient and profitable operation of public enterprises; a reduction in the rate of population growth; and the provision of equal opportunities for men and women.

    Our purpose in this chapter is to focus on domestic actions that developing countries should take to cope with two contrasting situations. In the first case it is assumed that the unfavourable international circumstances of the 1980s continue so that an underlying assumption of the above strategy--viz., a friendly international environment with adequate flows of resources and technology from the developed to developing countries--is not fulfilled. How might developing countries achieve their human development objectives under such circumstances? In the second case it is assumed that the unfavourable international circumstances of the 1980s are reversed. In this scenario the new and more favourable international economic order helps human development in the developing countries, but it also raises new problems that the developing countries have to confront. We will identify some of these problems and suggest ways of dealing with them.

    Before discussing these two alternatives it should be emphasised that the better of the two alternatives would be to reverse the unfavourable circumstances in the international environment. This depends however on reforms and policy changes in both the developed and developing countries. The main reforms required in the developing countries were outlined in Chapter 2. These include reforms of their trade regime; economic coordination and the promotion of trade among developing countries; and greater diversification of production and exports.

    An improvement of the international environment does not depend on the policies of the developing countries alone. There must also be fundamental reforms in the developed OECD countries. They must accelerate their growth; reduce non-tariff barriers, especially those that discriminate against exports in which the developing countries have a comparative advantage; permit preferential access to their trading blocs of exports from developing countries, especially exports in which the very poor countries have a comparative advantage; solve the international debt problem in an equitable way; improve the world capital market and the system of foreign aid; and encourage greater international mobility of labour. This is a large menu and one must anticipate that not all of these reforms will be implemented, and certainly not all at once.
 

Development priorities in an unfavourable international environment

    It might be tempting to suggest that in an unfavourable international environment the developing countries should reduce their emphasis on human development and instead concentrate on the ordinary business of managing the economy in order to obtain as much stability and growth as possible. This in effect is what many developing countries did when they were hit by an economic crisis at the beginning of the 1980s. Events have shown that this was an inappropriate response.

    One of the virtues of giving priority to human development is that it is a relatively inexpensive way of achieving rapid growth. This is now widely recognized. Investment in human development is at least as productive as investment in physical capital and, moreover, the benefits from expenditure on human development tend to be more equitably distributed than the returns from investing in physical capital. Thus the greater is the scarcity of resources, the more sensible it is to concentrate expenditure on human development.

    Growth however is essential. A shortage of external resources will have to be offset partly by adopting less expensive ways of generating growth (e.g., by a relatively greater allocation of resources to human development) and partly by greater efforts to mobilise domestic resources.

    Many countries in the 1990s continue to suffer from a structural imbalance in their external accounts. The elimination of these imbalances and the stabilisation of the economy are preconditions for a resumption of rapid growth. In the absence of a favourable international environment stabilisation inevitably will be painful because it will entail a substantial reduction in aggregate demand. There is however no alternative to this. Efficient growth cannot be sustained for long in the presence of serious macroeconomic imbalances in the external accounts.

    Reform of the trade regime in developing countries, outlined in Chapter 2, usually is an important component of a stabilisation programme and a key policy for eliminating external imbalances. It helps promote exports, especially exports to other developing countries. It reduces the incentive for capital flight, often a major contributor to external disequilibrium. It also helps attract direct foreign investment.

    Stabilisation programmes are not necessarily incompatible with the protection of the poor and the continuation of policies for human development. Indonesia is a case in point. Its response to an adverse external shock was orthodox, rapid and large in magnitude. The primary instruments used to stabilise the economy were two substantial exchange rate adjustments, massive fiscal retrenchment and strict monetary policy. These were followed by a reform of the trade regime and tax system and liberalisation of physical controls over trade and industry. The general purpose was to improve the efficiency of resource use. The egalitarian outcome of the adjustment programme was due to several of its specific features. While public expenditure was reduced, there were no cuts in spending on services for the poor. While large, often capital-intensive, public investment programmes were canceled, public investment in labour-intensive projects under the regional development programme was encouraged. The tax system was made significantly more progressive. The adjustment in the exchange rate helped reduce inequality between urban and rural areas by shifting relative prices in favour of agriculture. The improved incentives for agriculture were translated into a relatively egalitarian pattern of rural growth because of reasonable equality of access to productive assets and infrastructure. The distribution of income actually improved and the incidence of poverty declined during the period of adjustment, i.e., between 1984 and 1987, a rare achievement for a country restructuring its economy. 33

    Indonesia's experience illustrates several important lessons. Even major readjustments can be organised in such a way that the burden falls on the more privileged groups while the poor are protected and their prospects for human development are actually improved. Contrary to widely held opinion, reform of the trade regime and other policies to increase the long run efficiency of resource use can be introduced in such a way that they also help short run stabilisation. During the transition period, when livelihoods are most at risk, it is possible to protect the incomes of the poor and maintain human development programmes even when there is an unavoidable decline in aggregate public expenditure. The key to success is accurate targeting of expenditure on the priority social sectors.

    The last point is of critical importance. Many items classified as social expenditure are in fact of low priority. Examples include much public expenditure on higher education that produces few skills of use to a developing country, expenditures on expensive curative medical services that have little effect on raising longevity or improving the general health of the population, and housing subsidies for the urban middle class. In many countries public subsidies for these services are larger than subsidies for the more basic social services such as primary and secondary education, preventive medicine and child nutrition programmes. 34

    Improved targeting however is neither easy nor inexpensive. There is always likely to be political and bureaucratic resistance to change. In addition, in many countries there is a genuine lack of the information needed to improve the accuracy of targeting. Sustained effort and possibly a commitment of a significant volume of resources may be required to overcome these obstacles.
 

Adjusting to a favourable international environment

    The emergence of a favourable international economic environment as a result of policy changes in both developed and developing countries will not necessarily solve all the problems of adjustment faced by developing countries. For example, a rise in demand in the OECD countries for the exports of developing countries might encounter supply bottlenecks. This could well occur in countries where the structure of production is dominated by industries that were created in the past under the hothouse conditions of inappropriate import substitution policies. Such countries will not be able to take advantage of opportunities for expanded trade until they undertake the painful process of restructuring production in line with their comparative advantage.

    Particularly important are the adjustments developing countries must make to compensate for the effects of international movements of capital and labour. In Chapter 4 the paradox of capital moving from where it is scarce to where it is relatively abundant was discussed. The emergence of a more liberal international economic system could well aggravate this problem by reducing restraints on the movement of capital and highly skilled labour. The apparently inexorable forces behind the perverse movement of factors of production are sometimes reinforced by inappropriate policies in the developing countries. The overvaluation of the exchange rate is one such policy which tends to reduce the inflow of foreign capital and encourages the outflow of domestic savings. A reform of the trade regime along the lines suggested in Chapter 2 would weaken these tendencies.

    The argument in Chapter 4 that the return on capital tends to be higher in the developed countries than in the developing ones is particularly true of the modern sectors of the economy which compete for internationally mobile capital. It is likely that in other sectors of a developing economy--e.g., in small peasant agriculture, handicrafts and in enterprises using traditional processes--the return on investment may be very high. The problem is that there is no institutional framework that enables these activities to compete for internationally mobile capital. As a result, potentially highly profitable activities remain underdeveloped. This problem could be remedied if it were possible to create an institutional framework that brings savers and investors together. If this were done it might be possible to blunt the forces that produce the perverse international movement of capital. What is needed is a low cost system of financial intermediation between the owners of capital and small producers isolated in the traditional sector. The difficulty is that the cost of intermediation probably would be high, at least in the initial phase, otherwise suitable institutions would have emerged more or less spontaneously. Still, it may be that the divergence between private and social costs and benefits is so great that public financial support in the form of guarantees or even outright subsidies can be justified.

    It was further argued in Chapter 4 that skilled labour also tends to move from developing countries, where it is scarce, to the advanced countries, where it is abundant. One consequence of this is that the distribution of income becomes less equal in the developing countries. In addition, the outflow of highly skilled labour makes the task of human development even more difficult because the developing countries are forced to compete with the rich countries for the doctors, engineers, scientists and teachers needed to develop their health and education services and their technological capabilities. This problem too is likely to become worse with the continued development of a more liberal international economic system.

    The migration of highly skilled labour is a drain on the resources of the developing countries--a brain drain--because the exporting country does not receive revenues to compensate it for the cost of supplying the skills. If there were a mechanism that enabled developing countries to recover the full cost of producing "brains", then there would be no drain at all; skilled labour would be a profitable export consistent with the comparative advantage of the country concerned.

    There have been proposals for an international system to compensate developing countries for the emigration of skilled labour to developed countries. Proposed solutions include transferring part of the revenues from income tax paid by emigrants to the developing countries from which they came. No progress has been made toward working out a practical system of compensation and it is highly unlikely that a solution will emerge in the foreseeable future. The response of the developing countries has ranged from inaction to bans on the emigration of people with selected skills. The latter have usually been cumbersome to administer and unjust in their effects. The rich and the powerful have usually found ways to circumvent the controls.

    The problem would largely disappear if the developing countries were able to recoup from the beneficiaries the cost of higher education. At present, in most countries, there is an enormous difference between what the individual pays to acquire skills and the actual cost incurred by the society at large in providing skills. That is, taxpayers provide generous subsidies to the minority of the population--often a privileged minority--who have access to tertiary education. This could be rectified if developing countries were to charge the full cost of providing advanced training and higher education.

    This solution however has its own problems. Only the rich would be in a position to acquire expensive skills and they would have a strong incentive to migrate in order to reap the full return on their investment. This would drive up the wages and salaries of skilled personnel. The developing countries would then find it even more difficult to compete with the rich countries for the skilled personnel needed for their human development and production programmes. These problems, while serious, are not insuperable. For example, a two-tiered system of tuition charges for higher education could be introduced. Those paying the full cost would be free to use their skills in the international market. Heavily subsidised tuition would be available to those who commit themselves to national service for a specified period of time. Before the expiry of this period one could buy one's passport and migrate abroad on payment of the difference between the two rates of tuition, with some adjustment made to take into account the unexpired part of the commitment to national service.

    A scheme such as this would eliminate public subsidies in developing countries for the production of skills that benefit the rich countries. It would end the arbitrary, ineffective and unjust alternative of administrative controls over the emigration of skilled labour. It would reduce the current overinvestment in certain types of low priority tertiary education. Finally, it would protect domestic human development activities in the developing countries from direct competition with the rich countries for the services of highly skilled personnel. 35
 

The distribution of income and human development

    An improvement in the distribution of human capabilities--overall and in each component of human development taken separately--should be as important for policy as an improvement in the average level of human development. Because of lack of data, the human development index (HDI) published in the annual Human Development Reports does not take into account the distribution of longevity, knowledge and living standards among individuals, groups (women and men) or regions, although in principle there is no reason why it should not do so. Ideally the human development index should be distributionally adjusted to capture both the change in the average level of human development and the change in the distribution of the components of human development among the population. It was shown in the Human Development Report 1991 that the ranking of countries according to a distributionally adjusted human development index is quite different from the ranking based on an unadjusted index using only averages. An improved distribution of the components of human development in a country would have the effect of increasing the distributionally adjusted index faster than the unadjusted index. On the other hand, if a country were to experience increased inequality in the distribution of the components of human development, the distributionally adjusted index would increase more slowly than the unadjusted index.

    The Human Development Report 1991 contains estimates of distributionally adjusted human development indices for 53 countries, of which about 30 are developing countries. Estimates for other countries cannot be made because of insufficient information. Even the distributionally adjusted indices in the 1991 publication are based on adjustments of only one of the components of human development, viz., income. 36

    Human development programmes in the developing countries should place emphasis both on raising the average level of human development and improving the distribution of human development. The issue is important because there is evidence that in some countries with a good overall human development record the distribution of income and possibly the distribution of other components of human development have become worse in recent years. The most important example is China, the country with the largest positive difference between its rank on the human development index and its ranking in terms of per capita GNP. Beginning in 1982 the distribution of income in China became significantly more unequal and there is fragmentary evidence that the distribution of longevity may also have become worse. 37

    China grew very rapidly during the 1980s. Recall the estimates of world inequality presented in Table 1.1. These estimates are based on an assumption that all persons in a country have the same income. Under this assumption, the rapid growth in China--a very poor country--would have a favourable effect on estimated changes in the world distribution of income. If however a technically correct estimate of global inequality could be made by ranking each person according to his or her per capita income, the changes in growth and distribution in China would have an indeterminate effect on the estimated change in world income distribution: the positive effect of a higher average income might be offset by the negative effect of increased inequality within China. Similarly, the effect of the changes in China on a properly constructed world inequality index of human development would be equally ambiguous: improvements in the average might be offset by greater dispersion around the average. For progress in global human development it is not enough that the gap between the developed and the developing countries be reduced. The gap between the rich and the poor within the developing countries must also be reduced. At the very least it must not increase.
 

Occasional Paper 2 -    Globalization and the Developing World: An Essay on the International Dimensions of
                                           Development in the Post-Cold War Era

    At the end of the Second World War there was not one world economy but several. The world was fragmented and divided into a number of poorly integrated and even unintegrated groups that included the Sterling Area, the Franc Zone, the economies tied to the US dollar and the Council for Mutual Economic Assistance (CMEA), which linked the Soviet Union and the socialist economies of Eastern Europe. Tariffs, quotas and other barriers to commerce were high; controls on capital and currency movements were stringent; exchange rates were unresponsive to market forces and in many countries there were multiple exchange rates or their equivalent. During the last four decades, however, the fragmentation of the world into several economies has diminished and large parts of the world have become economically and financially quite closely integrated.

    Tariffs were substantially lowered in a series of negotiated stages. "By the early 1980s, the tariff level had gone down to 4.9 percent in the United States, 6.0 percent in the European Economic Community, and 5.4 percent in Japan." 38 The developing countries, largely exempt from the discipline and obligations of GATT, maintained higher tariff rates but in those countries, too, tariff rates fell, slowly at first and then at an accelerating rate. As a result, international trade revived and indeed the volume of world trade increased more rapidly than world production. The ratio of exports (or imports) to gross domestic product consequently rose in most countries.

    Capital flows among the developed countries and from the developed countries to Latin America and the other now independent developing countries rose substantially, led by direct private investment and followed in the 1970s by commercial bank lending. Most capital flows, however, as we have seen, took place among the developed countries and indeed there was a tendency for the net resource flows to developing countries to be negative.39 Much of the growth in trade and in investment was spearheaded by the transnational corporations and the international banks which rose to prominence during the post-war period. In the financial sphere, exchange controls were largely removed, particularly in the developed countries, and this permitted funds to flow rapidly from one country to another and encouraged the integration of the major equity and bond markets.

    Finally, during the period of most rapid growth in the developed countries even the beginnings of an international labour market became evident, particularly for managerial, professional, technical and highly skilled labour but not excluding unskilled labour. In fact it was argued above that incomplete globalization or partial world economic integration of labour markets has actually accentuated international inequality in the distribution of income. International mobility of human capital has resulted in a flow of doctors, academics, engineers and other professionals from developing countries where they are poorly paid (by international standards) to wealthy countries where they are well paid. This brain drain has narrowed salary differentials between rich and poor countries and in doing so, has increased income inequality within developing countries, raised the cost of providing basic health and education services for the mass of the population and thereby slowed down human development in some developing countries. Globalization thus has not been an unmixed blessing.

    Despite all the caveats that should be made--particularly the rise of non-tariff barriers to international trade and the possible implications of regional groupings of various sorts--the world is coming close to creating a single, unified global economy for the first time in human history.
 

Globalization and the state as an economic entity

    The state as an economic entity arguably reached the peak of its power in the middle decades of the 20th century. It is now under attack simultaneously by contradictory forces, supranationalism (including globalization and regionalisation) and subnationalism. We shall want to explore the implications for human development of the weakening of the state, beginning with an examination of the attack from above: globalization.

    Integration of states into something approximating a single, unified international economic system not only has increased their openness in a conventional sense, it also has weakened the ability of the state to impose its will on other economic actors, notably business firms with subsidiaries in a number of countries, employed persons with internationally marketable skills and investors with access to international capital markets. Even the limited globalization that we observe today has greatly increased the mobility of goods, assets and individuals and this in turn has made it more difficult for the state to impose its authority on persons and entities that fall, theoretically, under its jurisdiction.

    Internationalisation of currency markets has made it more difficult for central banks to control the money supply. Integration of bond markets has made it more difficult for the state to determine nominal rates of interest and the term structure of interest rates. Transfer pricing by transnational corporations has made it easier for enterprises to shift their profit tax liabilities from countries where taxation is high to countries where it is low. Similarly, the ability of large firms to locate their fixed investment almost anywhere in the world has reduced the power of the state to regulate industry be it through taxation, the imposition of minimum wage legislation, environmental controls, health and safety provisions or anything else. It would be an exaggeration to claim, say, that Australia vis-à-vis the world economy has no more control over its economic affairs than has Arkansas vis-à-vis the U.S. economy, but we are rapidly moving in that direction. International markets have eroded political sovereignty; the state increasingly is unable to act unilaterally on economic matters and achieve its objectives. Just as Keynesian macroeconomics no longer is possible in one country, so too have conventional microeconomic interventions become more difficult to sustain. British politicians may protest the dilution of the UK's sovereignty by the growing economic influence of the European Community, but they will protest in vain. National sovereignty over economic affairs is destined to go the same way as states' rights in the United States. There is no turning back from the consequences of liberalisation, market processes and technological change.

    The same points are true of flows of commodities across national frontiers. Smuggling of goods into and out of countries is a commonplace and occurs on a massive scale. Indeed overinvoicing of imports and underinvoicing of exports are frequently used devices to escape taxation and facilitate capital flight. But the most notorious example of the inability of the state to control the production and trade of commodities is of course narcotic drugs. In some countries such as Bolivia the illegal production of drugs, although unrecorded, accounts for perhaps a quarter of total output and at times for more than all other export earnings combined, but again unrecorded. Neither the exporting nor the importing countries have been able to restrict the trade; in fact it is growing rapidly. Indeed it has been estimated that the retail value of trade in illegal drugs exceeds international trade in oil and is second only to the weapons trade.40

    The flow of "bads" is equally difficult to control. External diseconomies produced in one country may adversely affect the citizens in another: pollution does not recognise national boundaries. Damage to the natural environment originating in one country may affect the globe as a whole (as in the case of depletion of the ozone layer in the upper atmosphere or the rise in average global temperature caused by burning fossil fuels and clearing tropical forests) or only neighbouring countries (as can happen with oil spills in the ocean, air pollution from power stations coming down as acid rain hundreds of miles away or the pollution of fresh water supplies caused by other countries upstream). The effects of nuclear disasters (as occurred at Chernobyl) can be felt for decades and over a very wide area. Globalization, in other words, implies not only the universal dissemination of goods but also the dissemination of "bads".

    Most pollution in the world is caused by economic activities in the developed countries,41 but the developing countries can be expected increasingly to add to the problem as their economies become ever more industrialised and urbanised and as their agriculture comes to rely more and more on chemical based technologies. A particular issue arises from the NIMBY (not in my back yard) phenomenon in developed countries. Greater consciousness in rich countries of the hazards to health of some industrial processes and greater concern about the deterioration of the environment have led them to impose relatively strict health, safety, waste disposal and environmental regulations. One response has been an attempt to shift to poor countries the costs of industrialisation in the rich ones. Examples include efforts to dispose of contaminated nuclear waste in developing countries, shipments of urban generated garbage to developing countries to be used as landfill and the transfer of particularly dangerous plants to developing countries (such as the chemical factory that exploded and caused death, blindness and intense suffering in Bhopal, India). While it would be wrong to oppose transfers of economic activities from rich countries to poor, or to impose identical health, safety and environmental standards worldwide, it would be equally wrong to condone an economic system under which what is unacceptable in the back yards of the rich is dumped unceremoniously in the front yards of the poor.

    Finally, the state also is losing control over the flow of labour across its borders. All countries attempt to regulate immigration, but their ability to do so has been weakened by closer economic integration. Compared, say, to the first half of this century, improved roads and overland transport, the low cost of air fares and the abundance of ocean shipping have made it easier, cheaper and faster for people to move from one country to another. Quite apart from legal migration, many millions of people cross international boundaries as refugees or as irregular, unrecorded, illegal migrants. In the end the state may have no alternative but to accept the situation, declare an amnesty and regularise the position of the irregular migrants, as happened in the United States.

    Thus in a great many ways the ability of the state to regulate its internal economic affairs has been weakened by the closer economic integration that has occurred during the last four decades. Supranational forces have begun to reduce the state to impotence. In the political sphere, arms technology and the militarisation of the oceans and outer space have gone so far that national borders now have very little relevance in ensuring the security of the state. In the Middle East, for example, national borders have provided very little protection for, say, Lebanon, Kuwait and Israel. From a military point of view, political boundaries have become largely irrelevant in most of the world.
 

The withering away of the state as the locus of economic control

    If globalization continues, as seems likely, one can anticipate that the power of the state will be further eroded. Of course at any given moment different states will have different capabilities; some will clearly be able to influence economic events more than others. At one extreme are countries such as Lebanon, Peru and Sri Lanka, where largely for political reasons--but for political reasons that are not unconnected to globalization in the wider sense--the state has been on the verge of disintegration and its ability to control the economy has been much diminished. At the other extreme are the larger developed countries such as Japan and the United States. They clearly have more control over their economic destiny than do most countries, particularly the small developing countries, but even in the large developed countries the ability to control economic events has declined. No one would pretend, for example, that the United States in 1992 is just as capable of regulating its internal economic affairs as it was in 1952. It clearly is not: globalization has made a difference.

    One of the paradoxes of the late 20th century is that the tendency of the state to intervene in economic affairs has increased--political rhetoric notwithstanding--at a time when the effectiveness of its interventions has declined. Where once the talk in developed countries was of "fine tuning" the economy, today the talk often is of a "battle against inflation", a "war on drugs", a possible "trade war" and even a "war against poverty". Precise interventions to make relatively minor adjustments to the domestic economy have been replaced by bludgeons attempting to cope with major shocks to the system. In the developing countries, of course, no one ever imagined that fine tuning was possible: it was recognized from the beginning that they were subject to strong external shocks over which they had little control.

    None the less, in both developed and developing countries the response to the growing impotence of the state has been ever greater efforts by the state to assert control through microeconomic interventions. This phenomenon cuts across ideological divisions and national boundaries; it is universal and reflects a reaction by policy makers to the diminished efficacy of national macroeconomic policies, a diminution caused by the process of globalization. Since macroeconomic measures are no longer as effective as they once were, national policy makers have shifted their attention to microeconomic measures. We thus have a proliferation of trade policies, disguised export subsidies, anti-dumping policies, tax incentives and penalties, specific sectoral policies, research policies, government procurement policies and a host of prohibitions, regulations and controls. Privatisation, or the sale of state owned enterprises to the private sector, is an important counter-example, but in general bureaucracy has flourished far beyond the wildest imagination of the early socialists and their critics. The expansion of state bureaucracies, however, has coincided not with an expansion of state power in the economic sphere but with a weakening of power.

    There are at least two implications of all this for human development. First, as we have seen, globalization has been accompanied by the gradual emergence of a truly international labour market. Human resources located in one country are able to move to another. Countries which incur the costs of human capital formation will not necessarily reap the full benefits. Particularly in developing countries, and particularly in the case of professional and technical workers, public expenditure on education and other forms of human development may be "wasted" because of the emigration of skilled labour. Governments may then be tempted either to restrict the freedom of movement of skilled labour (as in China) or to underinvest in tertiary education, particularly in scientific and technological education (as in Algeria, Tanzania and the Congo).

    Second, globalization implies increased competition and a consequent imperative to cut costs whenever possible. In general, competition obviously is highly desirable and few analysts would want to encourage monopoly, but if governments respond to competitive pressures in a short-sighted manner, there is a danger they will reduce expenditure on human development. In the short term expenditures on human development are a cost, occasionally a rather high cost, and these costs have to be financed out of taxation. There is always a temptation to reduce taxes in order to reduce costs and become more competitive. In the longer term, however, spending money on human development pays off handsomely. Indeed the returns to investment in people often are higher than the returns to investment in physical assets. Thus properly viewed, expenditure on human development is not an obstacle to greater competitiveness but a way for a country to increase its ability to compete in the global economy.

    Globalization, in other words, creates temptations--to skimp on higher education in order not to lose resources through brain drain and to run a low wage, low human development economy in order to keep costs low and international competitors at bay. Both temptations however should be resisted, for it has become evident that the developing countries which have given a high priority to human development--particularly those in East Asia--have prospered during the era of globalisation whereas those that have neglected human development have tended to lag behind.

Footnotes:
11 : Keith Griffin, Alternative Strategies for Economic Development, London: Macmillan, 1989, Table 4.5, p. 83.

12 : See Charles Oman, New Forms of International Investment in Developing Countries, Paris: OECD Development Centre, 1984.

13 : Korea Economic Institute of America, Korea Economic Update, Vol. 2, No. 2, Summer 1991, p. 2.

14 : See U.S. Survey of Current Business, August 1990, p. 64.

15 : Keith Griffin, op. cit.

16 : See Keith Griffin and John Knight, eds., Human Development and the International Development Strategy for the 1990s, London: Macmillan, 1990, especially Chapter 1.

17 : United Nations, World Economic Survey 1990, New York: United Nations, 1990, p. 160.

18 : United Nations, Economic Commission for Latin America and the Caribbean, Changing Production Patterns with Social Equity, Santiago, 1990, p. 34.

19 : See Keith Griffin, "Would Default on the International Debt be in the Common Interest of the North and South?", in The External Debt, Development and International Cooperation, Paris: L'Harmattan, 1988.

20 : See Keith Griffin, "Foreign Aid After the Cold War," Development and Change, October 1991.

21 : See, for example, the Report of the Independent Commission on International Development Issues (Brandt Report), North-South: A Programme for Survival, London: Pan Books, 1980, Ch. 15.

22 : Countries would of course (whether official aid donors or not) remain free to raise resources through national taxation and to transfer those resources to other countries (whether eligible for internationally financed aid or not). Thus there would be nothing to prevent the United States from continuing to give money to Israel, but such a resource transfer would not count as foreign aid and would not reduce the obligation of the United States to carry its fair share of the international aid burden.

23 : See, for example, Richard H. Adams, Jr., "The Economic Uses and Impact of International Remittances in Rural Egypt," Economic Development and Cultural Change, July 1991. 

24: The August issue of the US Survey of Current Business publishes data on US direct investment abroad. The published profit rates must be interpreted with caution since they do not reflect differences across countries in risk, anticipated inflation or policies in host countries designed to attract foreign investment. Hence they are not accurate measurements of the marginal productivity of capital. Moreover, the data refer to foreign investment by only one country. None the less, they are suggestive. Also suggestive is the fact that reinvestment by foreign firms out of profits is lower in developing than in developed countries. In 1985-1989, for instance, the reinvestment rate of US firms was 28.8 per cent in developing countries as compared to 51.8 per cent in developed countries.

25: Keith Griffin and John Knight, eds., op. cit.; George Psacharopoulos, "Education and Development: A Review," World Bank Research Observer, Vol. 3, No. 1, 1988.

26: Robert E. Lucas, Jr., "Why Doesn't Capital Flow from Rich to Poor Countries?", American Economic Review, May 1990.

27: See Kenneth Arrow, "The Economic Implications of Learning by Doing," Review of Economic Studies, June 1962; Nicolas Kaldor, "Causes of the Slow Rate of Economic Growth of the United Kingdom," an Inaugural Lecture, Cambridge: Cambridge University Press, 1966; Allyn Young, "Increasing Returns and Economic Progress," Economic Journal, December 1928.

28: The classic article in this literature is Robert Solow, "Technical Change and the Aggregate Production Function," Review of Economics and Statistics, August 1957. A summary of empirical estimates of the residual is included in Keith Griffin, International Inequality and National Poverty, London: Macmillan, 1978, Ch. 1, Table 1, p. 17.

29: Joseph Schumpeter, The Theory of Economic Development, Cambridge: Harvard University Press, 1959, especially Chapter II. Also see Allen Oakley, Schumpeter's Theory of Capitalist Motion: A Critical Exposition and Reassessment, Aldershot, England: Edward Elgar, 1991.

30: For example, increasing returns is used to explain the predominance of intra-industry trade among countries with similar resource endowments, a phenomenon that cannot be explained if one adheres to the notion of production functions with diminishing returns.

31: This will be the case if skilled labour receives the value of its marginal product. The difference between the average and marginal products of skilled labour, which will be positive if there are diminishing returns to labour, accrues to other members of society. If migration reduces the supply of skilled labour more than marginally, the difference between average and marginal products (or the economic surplus) could be substantial.

32: For a detailed description see UNDP, Human Development Report, 1990 and 1991.

33: The evaluation of changes in the distribution of income is based on an analysis of household expenditure surveys as reported in World Bank, Indonesia, Poverty Assessment and Strategy Report, Washington, D.C., May 11, 1990.

34: In Kenya and Nigeria, for example, the public subsidy for university education is much higher than that for primary education.

35: While this is essentially a domestic policy, its implementation would be helped by cooperation from the advanced countries. In particular, an agreement not to employ migrants who have not discharged their commitment to national service would reduce the incentive to abscond. It is possible that after adopting the above policy many developing countries will find they do not have a comparative advantage in the production of specialised skills. They might discover that they would be better off having their own personnel trained abroad, possibly in other developing countries, and using the domestic resources thus saved for other human development activities.

36: Technical note 4 of the Human Development Report 1991 claims that the other two components, longevity and knowledge, are far more equally distributed than income. It also argues that high average longevity and knowledge can be attained only with a reasonably equitable distribution among individuals. These arguments are convincing only up to a point. It is possible for two countries with the same longevity to have a significantly different distribution of longevity among individuals. It is also possible for countries to experience changes in the distribution of longevity and knowledge over time. These differences and changes should ideally be reflected in the human development index.

37: A. R. Khan, Keith Griffin, Carl Riskin and Zhao Renwei, op. cit. 
38: Jagdish Bhagwati, Protectionism, Cambridge: MIT Press, 1988, p. 3.

39: The net resource flow on foreign investment in Latin America, i.e., direct and portfolio investment minus net payments of profits, averaged a negative $584.8 million a year (in 1987 prices) during the period from 1960 to 1987. (See UN ECLAC, Latin America and the Caribbean: Options to Reduce the Debt Burden, Santiago, 1990, p. 97.) There was also a negative resource flow on bank lending, as we have seen.

40: LaMond Tullis, Handbook of Research on the Illicit Drug Traffic: Socioeconomic and Political Consequences, Westport, Connecticut: Greenwood Press, 1991, p. 3.

41: For example, fossil fuel carbon "emissions per capita in developed countries are on average around 20-30 times those in developing countries." (J. Whalley, "The Interface Between Environmental and Trade Policies," Economic Journal, March 1991, p. 182.) Indeed just five developed countries (USA, USSR, Japan, West Germany and the UK) accounted in 1987 for 51 per cent of the world total of fossil fuel carbon emissions.