Week 3: Globalization I

- Rodrik, D. (1998) Why Do Open Economies Have Bigger Governments? Journal of

Political Economy 106(5): 997-1032.
- Burgoon, B. (2001) Globalization and Welfare Compensation: Disentangling the Ties
that Bind. International Organization 55(3): 509-551.
- Swank, D. and S. Steinmo (2002) The New Political Economy of Taxation in
Advanced Capitalist Democracies. American Journal of Political Science 46(3): 642-
655.
- Genschel, P., A. Kemmerling and E. Seils (2011) Accelerating Downhill: How the
EU Shapes Corporate Tax Competition in the Single Market. Journal of Common
Market Studies 49(3): 585-606.

Globalization: the process of economic, social and political international integration.

We mainly focus on the dimension of economic integration:

- Trade, capital migration

- Actual flows

- Policy restrictions

Economic indicator is the sum of imports + export as % of GDP. You can also attract
foreign investments for countries. Direct investment is an investment in a company where
you keep control of your investments.

Foreign investment and economic indicator are used as indicators for globalisation. Treaty of
Maastricht happened in 1991.

You need to distinguish between policy restrictions and actual flows of goods and capital. So
trade barriers or lowering capital restrictions. We look at policy restrictions and the actual
flows of import and export.

2 hypotheses on the impact of globalization

1. Efficiency hypothesis; 1) there is increased competion as a result of globalization.

Thus, you are interested in lower production cost. 2) because of the reduction of
barriers, you have an incentive to relocate your production elsewhere. Companies
because of access to other countries, they can move some parts of the production line
to other companies. Companies can move to other countries also to lower their
production costs. This would imply that the number of jobs would go down, so the
government will have an incentive to reduce rates of social contribution and taxes.
This will lead to a race to the bottom. Hence globalisation has a negative impact on
public spending. NEGATIVE IMPACT OF GLOBALISATION ON WELFARE
SPENDING.

2. Compensation hypothesis; if companies start to reduce their production costs, this

means insecurities for employees. They are more exposed to risks of becoming
 unemployed, or to get lower wages. The idea is that this will lead to higher demand
for social insurances, e.g. unemployment benefits. Higher risk leads to higher demand
for compensation by the government for the economic risk. Globalisation will have a
positive impact on welfare spending, because of the need. POSITIVE IMPACT OF
GLOBALISATION

Rodrik (1998) Why do open economies have bigger governments?

Aim/main question: What is the relationship between trade exposure (openness) and the
scope of government?

First expectation: Negative correlation because it is widely presumed that the effectiveness
of government is lower in economies that are highly integrated within the world economy.
 However, this does not seem to be the case empirically. I.e. Small, but highly open
economies in central and northern Europe have some of the world’s largest shares of
government spending.

Main argument/hypothesis: In line with the compensation hypothesis (increased demands

due to globalization). There is a positive relationship between an economy’s exposure to
trade and the size of its government.
 Explanation: government spending plays an important risk-reducing role in
economies that are exposed to significant amounts of external risk.
 This relationship is the strongest when the terms-of-trade risk is highest.

Dependent variables: Main dependent variable is government consumption. Government

size is measured by the share of government expenditures in GDP. Most relevant indicator
would be welfare spending, Rodrik is aware of this and uses it in a way.

Independent variable: openness and diversification.

 For openness he looks at imports/exports and their share as percentage of GDP. But
enormous argument that this is not sufficient: terms of trade. Openness matters to the
scope of government because of the role played by external risk. Government risk-
mitigating role: Governments consume a larger share of domestic output in
economies subject to greater amounts of external risk. Once external risk is
controlled for, openness does not seem to exert an independent effect on government
consumption. Because of globalisation, you are exposed to a broad market: volatile
(insecurity), more volatility in consumption. So economic risk should be combined
with openness.
 The other indicator he uses is concentration of production circles. What matters is not
the global stability, but the stability of the stream of earnings from domestic
production. With concentration you are more vulnerable if something happens on the
market. More diversified production/economy gives you a smaller risk. > interaction
term between openness (terms of trade) and diversification. The problem of high risk
as a result of a highly concentrated economy only matters if you have an open
economy.

Data/methods: include not only OECD but also developing countries. In developing
countries there is not a (great) welfare state. In these countries there can be compensation
through creating more public jobs. But Rodrik admits that for OECD countries welfare
spending would have been best

Outcome(s): positive and significant effects, except for social security and welfare spending.
Spending on social security and welfare is significantly more sensitive to exposure to external
risk than government consumption, which is consistent with our theory a small (permanent)
increase in government consumption (as a share of GDP) would result in more stable incomes
in the overwhelming majority of countries.

Conclusions/implications: Public spending is a risk-reducing instrument on which there is

greater reliance in more open economies.
 More difficult to disentangle the relationship between government size and openness,
on the one hand, and economic growth, on the other
 Same bias would exist in a regression of growth on trade
 there may be a degree of complementarity between markets and governments
 Governments have expanded fastest in the most open economies, because
governments appear to have sought to mitigate the exposure to risk by increasing
the share of domestic output they consume.
 International trade has expanded significantly during the post-war period, and so has
the scope of government activity in most countries of the world  no coincidence.
 Scaling governments down without paying attention to the economic insecurities
generated by globalization may actually harm the prospects of maintaining free trade.

2. Burgoon (2001) Globalization and Welfare Compensation: Disentangling the Ties that
Bind
 Aim/question: Many lines of research follow the compensation hypothesis. All
perspectives, however, overlook important details about the nature of openness,
welfare efforts, and the politics connecting them. Greater economic openness should
constrain some elements of the welfare state, spur others, and leave still others
unaffected.
 Main argument/hypothesis: twofold argument.
Development: it matters if import competition comes from developed countries or
developing countries. Developing countries are more vulnerable/low wages,
employees in developed countries face tougher competition. This competition will
spark more concentrated demands for compensation and similar/less concentrated
opposition to such compensation.
 low wage openness ought to inspire more welfare expansion or less
contraction than general openness.
Groups at risk. The second argument states that groups put at risk by greater openness
will demand more public spending generally but will tend to focus most on active and
passive labor market policies, less on health, and less still on retirement and family
benefits geared to the elderly and youth dependents.
 Groups put at risk by greater openness demand more public spending
generally, specifically on active and passive labor market policies, less on
health care, less retirement and family benefits for elderly and young
dependents. From the side of the employees: argument trade-unions and
employees organisation. Not just that they ask for more spending, not on all
 programs: higher spending unemployment insurance and job training. But
because of globalisation they don’t want more health care benefits.
 Investors/producers and exposed will respond to greater openness by opposing
most expansions of public economy. Higher spending means higher taxes,
position is opposed spending welfare. But lower opposition against programs
that are leading to higher productivity, programs that favour labor training and
relocation policies. Do not favour family and retirement programs, and
strongly oppose passive labor-market policies.
 If we combine both sides, hypothesis would be higher spending on job-
training and relocation assistance.
 Dependent variable: He uses government consumption, spending on the welfare
state, but problem of dependent variable. He uses broad range of welfare programs.
Also, theoretical argument: just looking at the correlation of some measure of
globalisation and some measure of welfare spending is too simplistic. Result is
decision making in politics. He briefly discusses the argument of Pierson (WK2).
 Independent variable: it isn’t just about import/export, but distinction between
countries of origin. It matters whether imports come from developed
countries/developing countries. Because developing countries are more vulnerable.
Employees in domestic economy are exposed to tougher competition if you compete
with low wage countries
 Data/methods: Author distinguishes between general trade openness and low-wage
trade, and among government programs that more or less directly and immediately aid
vulnerable groups and that are more or less costly to exposed producers and investors.
 Four different patterns of compensation politics. Distinguish between general trade
openness and low-wage trade, and among government programs that more or less
directly and immediately aid vulnerable groups and that are more or less costly to
exposed producers and investors.
1. For welfare programs subject to strong compensation demands and investor
support or acceptance openness should inspire harmonious, one-sided politics
that expand welfare effort.
2. For welfare elements diffusely connected to compensation demands and
fostering high investor concern openness should inspire different one-sided
politics that retrench welfare.
3. For programs subject to strong compensation demands and high investor
hostility openness should spark more combative politics whose outcomes
depends on exogenous political forces like the power of left parties.
4. For welfare elements remote from both compensations demands and
investor fears greater openness should spurt few political struggles and little
change.
  Outcome(s): different elements of openness and welfare may be in tension for some
kinds of openness and some segments of welfare, in harmony for others, and wholly
independent for still others.
 Suggests that openness encourages bigger changes in some "worlds" of
welfare capitalism than in others.
 the evidence shows that openness has a slight effect on welfare outcomes and
that it is far from the most important determinant of welfare efforts in OECD
countries. But the links between openness and welfare are meaningful and
broadly consistent with a soft version of the arguments
 the relationship between openness and welfare is more predictably divers than
existing scholarship has led us to believe

3. Swank & Steinmo (2002) The New Political Economy of Taxation in Advanced
Capitalist Democracies

Corporate tax rate

- Statutory tax rate: The statutory tax rate is the percentage imposed by law;
the effective tax rate is the percentage of income actually paid by an individual or a
company after taking into account tax breaks (including loopholes, deductions,
exemptions, credits, and preferential rates).
- Tax base: A tax base is defined as the total value of assets, properties, or income in a
certain area or jurisdiction. To calculate the total tax liability, you must multiply the
tax base by the tax rate: 
Tax Liability = Tax Base x Tax Rate
- Effective tax rate: The effective tax rate is the average tax rate paid by
a corporation or an individual. The effective tax rate for individuals is the average rate
at which their earned income, such as wages, and unearned income, such as stock
dividends, are taxed. The effective tax rate for a corporation is the average rate at
which its pre-tax profits are taxed, while the statutory tax rate is the legal percentage
established by law.

 Aim/question: tries to test the efficiency hypothesis. Argue that internationalization,

domestic economic change, and budgetary pressures each prompt significant changes
 in tax policy; yet, together, they create a system of constraints on altering the level
and distribution of tax burden
 Dependent variable: taxation, tax rates. Story of the part of efficiency hypothesis.
Tax competition, a race to the bottom because of globalisation. They analyse a
number of tax rates, corporate income, consumption and from labour.
 Main argument/hypothesis: The general idea/argument: because of the tax
competition and because capital is relatively mobile: tax rates will go down. Things
that are less mobile like consumption/labour their tax rates would go up, in order to
compensate losses in tax revenues on corporate income. Tax competition on tax rates,
go down, but tax bases are broadened to compensate for this. Tax base has been
broadened because this is much less transparent: complicated (tax laws, all kinds of
deductions). So not clear what happens with tax base, but in many countries the tax
base has been broadened.
 Data/methods: a remarkable stability in the levels and distributions of tax burdens.
They argue that the tax impacts of internationalization are important, but in more
complex ways than globalization theory suggests. Three factors – internationalization,
domestic economic change, and budgetary forces – simultaneously constrain changes
in tax burdens and, together, help explain the complexity of tax policy outcomes.
The majority papers on tax papers is on corporate income, and they add consumption
and labour. 1981 to 1995 data from fourteen developed democracies to analyze the
determinants of taxation.
 Outcome(s): we argue that the tax impacts of internationalization are important, but
in more complex ways than globalization theory suggests. Three factors:
internationalization, domestic economic change, and budgetary forces simultaneously
constrain changes in tax burdens and, together, help explain the complexity of tax
policy outcomes.
 Negative effects of globalisation on taxes. Capital mobility and trade are
associated with cuts in statutory corporate tax rates.
 Positive effect of tax rate on consumption. but not with reductions in effective
average tax rates on capital income.
 No positive effect of taxes on labour income, because reduce labour taxes in
order to stimulate the labour market (and not unemployment). Capital mobility
is negatively associated with the tax components of labor costs. Domestically
structural unemployment leads to reductions in labor and capital taxes, while
public sector debt and societal needs raise taxes.
Capital mobility has not led—and is not likely to lead—to a “race the bottom” or the
evisceration of the revenue-raising capacity of the state: governments can (and do)
pursue moderately extensive social protection and public goods provision when they
and their electorates so choose. Overall, policy makers in contemporary democratic
polities have faced intensifying pressure to reform tax policy to promote economic
efficiency. They have, however, little room left for manoeuvre.

4. Genschel et al. (2011) Accelerating Downhill: How the EU Shapes Corporate Tax
Competition in the Single Market
 Aim/question: quantitative evidence to suggest that tax competition is stronger in the
EU than in the rest of the world, and explores qualitatively why tax coordination and
tax jurisprudence have failed to prevent a race to the bottom in tax rates
 Main argument/hypothesis: tax competition in the EU is shaped by 4 partly opposed
institutional mechanisms with a net effect to accelerate tax competition.
  Market integration > increase competitive pressures
 Enlargement > increase competitive pressures
 Tax co-ordination > decreases competitive pressures
 ECJ’s tax jurisprudence > may increase/decrease competitive pressures
There are two intersecting competitive effects:
 within group competition between EU15 states: integration effect
 Between groups competition, like with Asia.
 Data/methods: quantitative analysis
Outcome(s):
 Statutory taxes have fallen faster in the EU than in the rest of the world since
1990s. Evidence that the incidence of preferential tax regimes is high in the
EU. Finding for effective tax rates on labor income and consumption are
consistent with expectations. Internationalization has not resulted in a shift of
the tax burden to labor and consumption, but evidence suggests that
international capital mobility has sensitized policy makers to potential
economic costs of high labor taxes. Domestic economic and budgetary forces
play significant roles in tax policy change, especially in the case of labor
taxation.
 General tax rate competition is more pronounced in the single market (EU)
than in other parts of the world. While the integration effect of one market
(single market programme), one currency (monetary unification) and one law
as well as the enlargement effect of the recent accession of eastern countries
have both given a boost to corporate tax competition since the 1990s, the co-
ordination effect of corporate tax harmonization and the judicialization effect
of the tax jurisprudence of the ECJ have done little to counter it.
Concerns about efficiency and revenues have seemingly eclipsed the goal of
redistribution through remarkedly steeply progressive rates. But with stability in
levels and distribution of tax burdens.
 Conclusion: internationalization mattered in much more complex ways. This article
shows that corporate tax competition in the EU is both different and stronger than the
rest of the world.
 Predictions: future depends on development of the 4 institutional effects.
o The integration effect is unlikely to relax very much.
o the enlargement effect also seems unlikely to relax. Eastern enlargement was
the EU’s only major success in recent years. It is unpopular in some old
Member States, but the foreign policy rationale for further enlargement is
strong. Poor countries up for members: once admitted to the EU, the incentive
for them to engage in aggressive tax competition would be very high.
o The co-ordination effect is difficult to predict.
o The judicialization effect also difficult to predict. A lot depends on whether
the recent (moderate) softening of the ECJ’s corporate tax jurisprudence marks
just a temporary aberration from its earlier more activist case law, or a
permanent change towards more judicial self-restraint
 Critique
 Inadequate comparison of the EU with the rest of the world. EU is very
homogenous and a specific area: specific case
 Yes based on the descriptives you could have seen that there is a trend going
down in the tax rates. You wouldn’t need regression to show that, but one big
if. It could have been the case that the downward trend in the EU was changed
 by something else. Advantage of regression analysis is that you can control for
these other effects. But they don’t do that actually.
 Swank and Steinmo have a more advanced model taking in more effects.
Genschel only two times two years, small number of observations and without
any control variables.
 Exclude Luxembourg and Malta. Yes small countries, but they could have
included them. But they have an argument about small countries/large
countries and then they exclude them.