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Globalization and Neo-Liberalism: How Much Does Capital Mobility Restrain Governmental Policy? Ronald Rogowski UCLA Daniel Tannenbaum Federal Reserve Bank of Philadelphia

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Background: Convergence Debate Free movement of capital constrains government policy. –Keohane and Nye (1977) –Rodrik (1997) “golden straitjacket,” “race to the bottom”

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Divergence? Garrett (1998) Cai and Treisman (2005)

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Quick Look

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Empirical Work: Mixed Evidence Schulze and Ursprung (1999) Swank and Steinmo (2002)

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Our Contribution Our theoretical framework –Worker/voter elects policy based on utility maximization. Policy preference (ideology) and wages –Capitalist invests: first restricted to home country, then allowed to invest in other countries; simply seeks maximum return Our results –Capital mobility is generally welfare-diminishing, except in few cases of unequal countries. –Policy convergence among equal countries, increasing in number of countries. –Limited convergence among unequal countries.

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The Model Downsian unidimensional policy space Capitalists and voter-worker have exogenous policy preferences: x L, x K [0,1] Single good is produced Production function: Y = (1–(x K –x i ))(1–D)L K 1- –x i is the voter-elected policy –D is the natural disadvantage (e.g. climate, natural resources, landlocked)

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The Model: Voter-Worker Utility consists of wages plus ideology Wages are just MPL in standard Cobb-Douglas formulation Standard quadratic loss function; a and g are constants which represent how “ideological” the voter is – that is, how attached she is to her bliss point.

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Capital is Confined to the Home Country The capitalist must invest in her home country. The voter-worker must select a policy that maximizes utility.

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A Global Market for Capital: Equal Countries Now suppose two equal states exist and a rational capitalist must allocate the two countries endowments (one unit of capital for each country) to maximize total output: Y 1 + Y 2 Let [0,1] be the share of capital going to the first country and (1- ) go to the second. The capitalist will invest such that: Y 1 / = Y 2 / (1– ) which, since the two countries are equal, means:

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A Global Market for Capital: Equal Countries A Cournot model for global capital: –Each country knows the capitalist’s demand for investing in their country. The capitalist’s demand depends on each country’s policy. –Generalized to n countries. The demand for investing in the i-th country is: –Each country, however, does not know what policy choice the others will make. –In the Nash equilibrium, countries choose the same policy:

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A Global Market for Capital Comparative statics for equal countries. Number of countries Equilibrium policy of each countryWagesIdeology Utility (Wages+Ideology)Rent of capital n=10.33330.22220.88891.11110.1111 n=20.41670.27780.82641.10420.1389 n=30.44440.29630.80251.09880.1481 n=100.48330.32220.76641.08860.1611 n=1000.49830.33220.75171.08390.1661 n ∞ 0.50.33330.751.08330.1667 Our constants take the following illustrative values: α=2/3, labor’s optimal policy (xL) is 0, capital’s optimal policy (xK) is 1, a=g=1, K/L=1, and D=0.

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A Global Market for Capital: Equal Countries In the new equilibrium, each nation winds up with the single unit of capital it had originally – but it has had to shift its policy to maintain that capital. The loss in ideological utility is not compensated by the gain in production and wages. Countries converge to a more capital-friendly policy.

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Comparative Statics: Equal Countries Equal countries: four different scenarios. Case RegimeEquilibrium policyWagesIdeologyUtility (Wages + Ideology)Rent of capital (1) Immobile capital0.33330.22220.88891.11110.1111 (1) Mobile capital0.41670.27780.82641.10420.1389 (2) Immobile capital D=0.10.30.180.911.090.09 (2) Mobile capital D=0.10.3750.2250.85941.08440.1125 (3) Immobile capital xL=0.10.43330.28890.88891.17780.1444 (3) Mobile Capital xL=0.10.51670.34440.82641.17080.1722 (4) Immobile Capital L=50.19490.07600.96201.03800.1900 (4) Mobile Capital L=50.24370.09500.94061.03560.2375

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Equilibrium Results: Equal Countries For these countries (equal in wealth, natural advantage, and ideology), –the competition for capital produces (identically) capital-friendlier policies, the capital-friendliness of the equilibrium is increasing in the number of competing countries, and yet the equilibrium outcome leaves each country with exactly the same endowment of capital (and hence the same capital-labor ratio) as it had in isolation. –This outcome is welfare-diminishing for the representative voter in each country, since policy changes but capital endowment does not. Owners of capital are however better off in all countries, precisely because policy has become friendlier to them.

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Unequal Countries We study the equilibrium for countries with different characteristics. –We can’t solve explicitly, but we can derive reaction functions and solve numerically.

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Unequal Countries: An Example

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Comparative Statics: Unequal Countries Comparative statics for unequal countries. CaseRegimeEquilibrium Policy UtilityWagesRent of CapitalCapital Share i = 1i = 2i = 1i = 2i = 1i = 2i = 1i = 2i = 1i = 2 (1)Immobile Capital D 1 =0.1, D 2 =0 0.30.331.091.11110.180.22220.090.111111 (1)Mobile Capital D 1 =0.1, D 2 =0 0.36240.421.07091.12010.20220.30070.1257 0.40210.5979 (2)Immobile Capital x L1 =0.1, x L2 =0 0.43330.331.17781.11110.28890.22220.14440.111111 (2)Mobile Capital x L1 =0.1, x L2 =0 0.5250.4031.19091.08740.37150.24980.1553 0.59790.4021 (3)Immobile Capital L 1 =5, L 2 =1 0.19490.331.03801.11110.07600.22220.19000.111111 (3)Mobile Capital L 1 =5, L 2 =1 0.2510.36791.04841.06240.11140.19770.1887 0.73810.2619

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Equilibrium Results: Unequal Countries in poor countries: greater policy change, improvement in voters’ (but diminution in capitalists’) welfare; in rich countries: less policy change, improvement in capitalists’ (but diminution in voters’) welfare; in naturally disadvantaged countries: greater policy change, improvement in capitalists’ (but diminution in voters’) welfare; in naturally advantaged countries: less policy change, improvement in voters’ and in capitalists’ welfare; in initially capital-unfriendly countries: about the same proportionate policy change as in capital-friendly ones, diminution of voters’ welfare, improvement of capitalists’ welfare; in initially more capital-friendly countries: improvement in voters’ and capitalists’ welfare.

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Conclusion and Further Research Voters’ welfare improves only in –Poorer countries –Naturally advantaged countries –Exogenously more capital-friendly countries If voters were concerned only with wages, we would have full policy convergence to the capitalists’ preferences. But because of an ideological resistance, voter’s do not fully accommodate the capitalist. Equal countries converge; unequal countries converge only partially.

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