GLOBALIZATION AND PUBLIC FINANCE Joseph E. Stiglitz Athens December 3, 2004

GLOBALIZATION  The closer integration of the countries of the world, as a result of the lowering of transportation costs, communication costs, and man-made barriers  Has affected every aspect of modern economics - Including Public Finance

IMPACT OF GLOBALIZATION ON PUBLIC FINANCE Two major impacts: 1.A greater need for global collective action 2.Changes in the conduct of public finance within countries

A GREATER NEED FOR GLOBAL COLLECTIVE ACTION  Closer integration, greater interdependence requires more global collective action –More global public goods Health Environment Knowledge Political security Economic security –More global externalities Actions within a country have effects outside the country

BUT ECONOMIC GLOBALIZATION HAS OUTPACED POLITICAL GLOBALIZATION  Institutions to address global public goods are limited and imperfect: Lack of democratic governance Piecemeal approach Smokestack structure: - IMF governed by finance ministers and central bank governors, - WTO governed by trade ministers - Even though policies have far reaching cross-sector effects

CHANGES IN THE CONDUCT OF PUBLIC FINANCE WITHIN COUNTRIES Affects both tax policies and spending policies –Competition among countries –Affects elasticities of supply –Has contributed to greater need for redistributive programs –But has reduced the scope for redistributive programs –Problems posed by “race to the bottom” and “free-riding”

TIEBOUT MODEL Competition among communities (countries) results in efficiency in the provision of public services (and the raising of taxes to finance them), just like competition in private markets results in economic efficiency (Adam Smith’s ‘invisible hand’)

LIMITATIONS OF MARKETS But over past quarter century, we have come to understand limitations of Adam Smith’s ‘invisible hand’ (market failures). This provide rationale for public sector –And whenever information is imperfect or markets incomplete (that is—always), the reason ‘invisible hand’ often seems invisible is that it is not there (Greenwald-Stiglitz) Pursuit of self-interest (greed) did not lead to economic efficiency during the roaring 90s Led to massive misallocation of resources during boom And contributed to the depth of subsequent downturn (gap between actual and potential output around $1.7 trillion) –These market failures are particularly relevant in many goods that are normally publicly provided (like health)

LIMITATIONS TO TIEBOUT Imperfections of competition among communities (countries) even more imperfect—less reason to believe that it will lead to economic efficiency

GLOBALIZATION AND THE LIMITS TO REDISTRIBUTION With “perfect competition” there is no scope for redistributive taxation –Any attempt to impose redistributive tax on capital leads to capital migrating –Taxes can only be increased if there are commensurate benefits –Any attempt to provide better benefits, say for poor, results in a flood of in-migration –In migration may be easier to stop than capital flight, But not inside the U.S.—which is why the federal government has had to assume bulk of responsibility for redistribution And perhaps not in Europe Lesson from U.S.—Some scope for redistributive taxation at level of state –But Tiebout model has important lesson—globalization, increased mobility of capital and skilled labor, has reduced scope for redistribution

Limits to taxation: –Especially significant in area of capital taxation –General principle—tax rates should be related to elasticity of supply –Globalization has increased elasticity of supply of capital, as capital looks for best place in world to invest Less important when taxation is based on citizenship rather than residency (e.g. in U.S.) and when there is perceived to be large value in citizenship But with globalization, there is greater flexibility in citizenship and residency –Globalization has increased elasticity of supply of skilled workers, but probably it is less than the elasticity of supply for capital GLOBALIZATION AND THE LIMITS TO REDISTRIBUTION

 Competition for businesses Some positive benefits - Competition to provide good infrastructure - Competition to provide good public services (customs facilitation) - Competition to avoid excessive regulation But some negative consequences - Tax holidays and rebates  Net effect may be not to change location  But simply to reduce scope for business taxation - Inadequate environmental and worker protection regulations Negative consequences more likely when - There is corruption - Imperfections of democracy (campaign contributions) GLOBALIZATION AND THE LIMITS TO REDISTRIBUTION

Effects may be pervasive, because there is some redistributive element in many public sector programs –Such as social security (old age pensions) and health care –Will contribute to pressures for privatization and individual accounts All of this may have fundamental implications for the nature of our societies –And potentially, even adversely, affect overall well-being and economic growth –High return activities often are very risky, willingness to undertake risk may depend on the extent of social safety net

GLOBALIZATION AND THE NEED FOR STRONGER WELFARE SYSTEMS  Globalization has been associated with increasing inequality (in both developed and less developed countries) –Especially marked in the U.S.  Causal links: –Factor price equalization Lowers wages of unskilled workers in developed countries, as they compete (indirectly) with unskilled workers in developing countries New threat—even in more skilled areas (outsourcing) –Spread of skill intensive technology increases demand for skilled workers relative to unskilled workers –Asymmetries in liberalization—capital market liberalization without labor market liberalization increases bargaining power of capital

 At the same time, globalization has imposed greater adjustment costs –New trade rules –Fast pace of change in developing countries (China and India) Good for developing countries But pose challenges to developed countries GLOBALIZATION AND THE NEED FOR STRONGER WELFARE SYSTEMS

GLOBALIZATION—NEW OPPORTUNTIES AND NEW IMPEDIMENTS  Globalization opens up new opportunities but imposes new impediments to taking advantage of those opportunities  Especially WTO restrictions on industrial policies –Augmented by EU restrictions

INDUSTRIAL POLICIES  While they remain controversial, they have played an important role in almost all successful countries - In U.S, industrial policy is hidden inside Defense Department - Particularly important for countries that are ‘behind’  Globalization does represent opportunity to ‘free ride’ on research of other countries  But also means that others free ride on own expenditures  Problems of spill-overs arise in other areas of public expenditures, like education - May undermine public support

NEW OPPORTUNITIES  Basic principle—countries have more opportunity to take advantage of their absolute and comparative advantages  Expanded markets for goods and services –For instance, services for those retired from other countries

RESPONDING TO GLOBALIZATION Important for the public sector  To be aware of the new opportunities and new constraints  To redesign public taxation and expenditure programs to reflect these new opportunities and new constraints  needs to be aware of the changing costs and benefits resulting from globalization  Redesign is necessary if we are to avoid the downside risk of globalization and to capture the opportunities it provides to promote overall societal well being and growth