Globalization and Its Impacts On Developing Countries

Adam Smith on his famous work Wealth Of Nations wrote that, "The discovery of America and that of a passage to the East Indies by the Cape of Good Hope are the two greatest and the most important events recorded in the history of mankind."

He reasoned that- " Uniting in some measure, the most distant parts of the world, by enabling them to relieve one anther's wants, to increasing one anther's enjoyment and to encourage one anther's industries, their general tendency would seem beneficial.

However, later Smith himself recognized the depredation of imperialism and colonialism on many countries.

John Maynard Keynes, in his essay National Self Sufficiency argued, "economic entanglements through trade and finance added to global destabilization - let good be homespun whenever it is reasonably and conveniently possible, and finance be national."

After the Great Depression, he changed his mind and championed for open trade.

Joseph Stiglitz, in his book Globalization and Its Discontents argues that the pro-globalization policies have the potential of doing a lot of good, if undertaken properly and they incorporate the characteristics of each individual country. Countries should embrace globalization on their own terms, taking into account their own history,culture, and traditions. However, if poorly designed—or if a cookie-cutter approach is followed—pro-globalization policies are likely to be costly. They will increase instability, make countries more vulnerable to external shocks, reduce growth, and increase poverty.

After the 1999 World Trade Organization (WTO) ministerial meeting collapsed amidst protests, rioting and tear gas in Seattle,it has become increasingly difficult for international economic organizations to meet without attracting a large crowd of protesters. These protesters are mainly from developed countries who represent labor organizations worried about jobs as a result of companies moving to the South, US and EU farmers who are anxious to defend their large subsidies, activists who vehemently denounce corporate capitalism or NGOs who are concerned about the negative environmental impacts of globalization. However, there are only a few people who represent the developing countries. Economists so far have failed to provide a convincing case whether globalization is beneficial or detrimental to the poor.

The Doha Round also known as the Doha Development Round of trade negotiation was launched in 2001 hoping that increasing trade and integration would help the developing countries prosper and enable them to address their own development challenges like poverty, illiteracy, and poor infrastructure among others. However, as of 2008 talks have stalled over a divide on major issues, such as agriculture, industrial tariffs and non-tariff barriers, services, and trade remedies between the developed nations like the USA, Japan, the EU and big emerging economies like Brazil, India, China and South Africa. The most recent round of negotiations, July 23-29 2008, broke down after failing to reach a compromise on agricultural import rules. And negotiations are not expected to resume until 2009.

So, what is this buzzword and how has it affected the developing countries so far?

What is Globalization?

When used in an economic context, the United Nations defines globalization as the reduction and removal of barriers between national borders in order to facilitate the flow of goods, capital, services and labour...although considerable barriers remain to the flow of labour...

Globalization, generally means enhanced trade and financial integration, has been one of the most important factors that has helped the Asian Tigers, China and India to attain GDP growth rates over 5% and lift millions of people out of poverty and underdevelopment. Globalization promises prosperity through division of labor and specialization based on comparative advantage. India is reaping the benefits of globalization mainly from the service sector while China is benefiting from the manufacturing sector. Not only has North-South trade increased but the South-South trade is also increasing in recent years. China has been able to reduce poverty, based on the standard $1-a-day measure, by more than 400 million between 1990 and 2000. Since the wave of globalization started in the 1980s, according to the World Bank, the number of people living on $1 a day or less declined from 1.5 billion to 1.1 billion in absolute terms between 1981 and 2001. Furthermore, according the IMF, world trade has grown five times in real terms and its share of world GDP has risen from 36% to 55% since 1980. We have not seen progress of this scale since the Industrial Revolution.

Sadly, the benefits of globalization have not been even across the world. Some countries like the US have faced win-lose situations, others like China have faced win-win situations, and many countries from Africa and South Asia have faced lose-lose situations.

A paper entitled 'Globalization and the Least Deeveloped Countries (LDC)' produced at the Istanbul Declaration on Least Developed Countries in July 2007 argued that due to their practical exclusion from economic and political processes — and other special constraints — many LDC s find themselves in a ‘globalization and exclusion trap’.

• According to the Human Development Report 2005, the poorest 40 percent of the world’s population — 2.5 billion people, living on less than $2 a day — now accounts for just five percent of all global income.

• The least developed countries' share of the world merchandise exports fell from nearly 3 percent in 1950 to below 1 percent in 2004

• The least developed countries contributed 0.69 percent of global output in 2005 even though they accounted for almost 12 percent of the world’s population.

• UNCTAD has estimated that the number of people living in poverty in the least developed countries will increase from 334 million in 2000 to 470 million in 2010. While growth is increasing and poverty is falling in some LDCs — especially in Asia — the incidence of poverty is increasing in others, most notably in Africa

Global Trade and Developing Countries

World trade stood at over $18 trillion in 2004, having grown at an average rate of 10.6 percent per annum between 1950 and 2000. Developing country trade has also risen rapidly in absolute terms, from $40 billion in 1950 to almost $6 trillion in 2004. Nevertheless, the developing country percentage share of total trade has remained almost unchanged during this period, at just under 32 percent.If China is excluded, the share of developing countries in global trade has actually fallen from 31 percent in 1950 to 25.7 percent in 2004, reflecting very uneven participation in the expansion of trade, and weak performance by many of the poorest countries.

Agriculture

Agriculture, and trade in agricultural products, is particularly important for developing countries. Agriculture forms the basis of many of these economies, underpinning their food security,export earnings and rural development. It contributes between 30 to 60 percent of their GDP, and between 25 and 95 percent of export earnings. Up to 90 percent of the labor force in many developing countries is employed in agriculture,mostly as smallholder farmers in rural areas.

However, these countries remain marginalized in global agricultural trade. Their share of world agricultural exports has dropped steadily, from 3.3 percent in 1970-1979 to 1.5 percent in 1990-1998. Their market share of many key agricultural commodities also fell significantly from the 1980s to the 1990s — by over 30 percent for such commodities as timber, coffee, tea and cocoa, and about 20 percent for cattle. Despite the dominance of agricultural products in the exports of developing countries, the overall picture is one where the majority of them are net food importers, as total imports are much larger than total exports. The resulting trade deficits are largely financed by foreign aid. As a result, these countries are especially vulnerable to fluctuations in commodity prices. In 2002-2003 alone, food imports increased by over $1 billion and reached $7.6 billion the year after, whereas exports only amounted to $2.2 billion.

There are a number of reasons that have contributed to the above situation.

1. Globalization of Markets and OECD subsidies The economies of developing countries now have to compete in a more fiercely competitive world market.The gradual removal of trade barriers, rising demand for higher quality products and higher standards, the continuous erosion of trade preferences and the costly compliance with the new trade rules hamper the competitiveness of producers in developing countries in both world and domestic markets.OECD agricultural subsidies increased in absolute terms from an average of $305 billion in 1986-1988 to $378 billion in 2004, exceeding the total income of 1.2 billion people living below the dollar-a-day poverty line.63 The hidden cost of this agricultural support falls disproportionately on the developing countries, whose consumers spend more on agricultural produce as a proportion of their income, while the benefits go mostly to a small number of farmers in developed countries. For example, in 2004, seven of Britain’s richest men collectively earned over $4 million a year in farm payouts from the EU. While most developing countries are net food importers and thus may not gain from further agricultural trade liberalization in the short term, because the removal of OECD subsidies would lead to higher world prices of basic foodstuffs, the WTO has already agreed to a revolving fund to assist affected countries. Moreover, such subsidies provide a disincentive for LDCs to invest in food production which could reduce their import dependency in the medium to long term.

1. Technological Challenges Most of the developing countries are at an early stage of agricultural technology and the potential to increase productivity is enormous. They lack advanced technology like the farmers of rich countries have access to. New developments in biotechnology and bioenergy production may pose further threats to export-based growth in developing countries if the new technologies result in a sharp increase in productivity in more advanced economies, thereby pushing down prices in products competing with those of the developing countries.Therefore, it calls for substantial investment in irrigation and rural infrastructure.

Trade In Manufacturing and Services

The share of manufactured goods in developing countries exports was 33 percent for 2000-2003 percent excluding Bangladesh), mainly dominated by labor intensive products such as garments.Some of these countries have a strong comparative advantage in textiles, as the sector requires simple technology and unskilled labor. Partly because of quotas under the Multifibre Arrangement (MFA) until 2005, the industry grew rapidly. Since the expiration of the MFA, many of these industries have lost ground to larger and more competitive producers such as China, and as a result face job and export earning losses. Nepal lost 90% workers from the garment and textile industry after the end of Multi-Fiber Agreement (MFA) in January 2005.

The share of developing countries in global commercial services was just 0.4 percent of exports in 2002, and 1 percent of imports. However, this hides the importance of the service sector in the economies of the developing countries themselves. On average, the service sector comprises 41 percent of GDP in these countries and 18 percent of their total trade.In terms of GDP, it accounts for 65 percent in the Gambia, 45 percent in Benin, around 40 percent in Lesotho and Nepal and 38 percent in Rwanda. Because much of the service sector in the developing countries is in the informal sector it is also an important source of employment. In Bangladesh, Benin and the Niger, 30 percent of the labor force is employed in the service sector; in Djibouti, 50 percent; and in the Solomon Islands, 20 percent.While the majority of the service sectors in developing countries comprise of small-scale activities for the local market, export sectors of interest include tourism, construction, transport and health services.

Many developing countries are interested in greater services liberalization under Mode 4 of the WTO’s General Agreement on Trade in Services (GATS). Mode 4 covers the temporary movement of workers, and greater liberalization would potentially allow the workers from these countries to benefit more from ‘brain circulation’ and ‘brain gain’. However, the liberalization of labor has not been given the same level of attention as the liberalization of goods and other services. Little has been done which would enable them to obtain special priority in market access for commitments under Mode 4. To date, talks have focused on liberalization in the higher skilled categorieswhich could exacerbate concerns over ‘brain drain’.

Tarrif Barriers

Average tariffs applied by the OECD to developing country products are often considerably higher than those applied to other developed countries. Although border protection,including tariff and non-tariff measures, has declined substantially over the past three decades, it remains significant particularly in areas of agriculture and labor intensive industrial products where developing countries have a comparative advantage. Average agricultural tariffs are close to 10 percent in Canada and the United States, rising to more than 20 percent in the EU and Japan — barriers which when taken together are estimated to cost the developing countries the equivalent of $2.5 billion in potential export earnings per year.

Developing countries also face significant tariff escalation. Tariff escalation is particularly prevalent in tropical raw products such as coffee, tea, meat, hides and skins, fruits, cocoa and sugar. According to UNCTAD, these Non Tariff Barriers doubled in the period 1994-2004, and there has been a sevenfold increase in testing and certification requirements since the conclusion of the Uruguay Round. Some countries see the opportunity to gain greater market access by improving product standards. Rwanda is investing in improving its share of higher volume ‘fully washed coffee’ — for example,less than 7 percent of Rwandan coffee is ‘fully washed’ and such coffee canattract a higher market price of $3.18 per pound compared with the lower price for unwashed coffee of $1.96. However, the marked increase in the use of Non Tariff Barriers in recent years has often placed costly and unnecessary burdens on firms which struggle to meet technical, health or administrative requirements for their exports. Furthermore, these countries are often not included or cannot participate effectively in the various international standard-setting processes.

Migration

Globalization and the temporary movement of low skilled workers can have a positive effects on the economies of developing countries. The temporary movement of lower skilled labor can offer positive benefits for developing countries,specifically in relation to skills upgrading, brain circulation, and remittances. Remittances play a significant role as a source of relatively stable external funding,and are also of greater importance to many developing countries than to other developing countries. It is estimated that remittances to all developing countries reached $167 billion in 2005. While the share of developing countries represents only a small part of this total — some $10.4 billion in 2004 — remittances account for a greater share of GNI in these countries compared with other sources of financing. Indeed, several countries including Bangladesh, Cambodia, Lesotho, Nepal,Sudan and Yemen have come to depend heavily on remittances as a source of foreign exchange. While remittances cannot substitute for ODA or for domestic social protection systems, they provide an important source of development finance for meeting immediate needs at the household level. However, the use of such remittances within a broader development framework, geared towards longer term productive activities, such as collateral for microcredit, remains a challenge. In addition, it will be necessary to continually monitor the negative incentive and dependency effects that remittances could create.

The importance of temporary worker schemes can be contrasted with the permanent migration of skilled workers — the so-called ‘brain drain’ — faced by many developing countries. Permanent migration can undermine the ability of a country to develop, leading to skills shortages in important sectors such as health,education, engineering and IT. While the severity of the brain drain effect varies significantly by occupation and country, it is notable that approximately 65,000 African born physicians and 70,000 African-born professional nurses were working overseas in a developed country in the year 2000, representing about one-fifth of African-born physicians in the world, and about one-tenth of African-born professional nurses.Between 1990 and 2000, the number of foreign born, highly skilled persons residing in OECD countries increased by 70 percent, compared to 28 percent for the lower skilled categories. For developing countries, the depletion of human capital stock has been problematic, given the particularly strong push factors involved in the brain drain.The intensity of the brain drain has increased for most developing countries since 1990, and around one in five people born in an LDC with a tertiary education was working in an OECD country in 2000.77 The emigration rate among the tertiary educated population has been conservatively estimated at 41 percent for the Caribbean region, 27 percent for Western Africa, 18.4 percent for Eastern Africa, and 16 percent for Central America. For some countries, the level of intensity is especially high, such as 83.8 percent in Haiti, 76.4 percent in Samoa, 67.5 percent in Cape Verde, 63 percent in the Gambia and 52.5 percent in Sierra Leone. This situation is particularly problematic given that developing countries are well behind other developing countries in terms of achievement of higher education levels and this gap is widening.The global labor market is increasingly integrated for skilled workers who are more accepted by receiving countries, can command higher wages, and who can relocate more easily. Australia, Canada and the United States have programs to attract skilled migrants, thereby exacerbating brain drain in developing countries. There are large recruitment campaigns in ‘at risk countries’ where the skill exodus is severe. Furthermore, the specifics of immigration laws and visa practices discourage brain circulation or temporary migration.

Current Trade Regime

The current trade regime gives little space for policymakers to address domestic concerns not addressed by (or even exacerbated by being a party to) the current trade regime. The present form of Doha Round is not pro-poor (development specific) and is beset with “liberalization” mindset. The agricultural subsidies, which is the most contentious issue, given by the US, the EU, and Japan to its handful of farmers is displacing millions of farmers in the developing countries. These countries have been adamant in promoting free trade but do not want to reduce agriculture subsidies. Since over 60% of the developing countries’ population depends on agriculture, it is a no-brainer that the fastest way they can attain their development goals is through development of the agriculture sector. For instance, alarmed by the rise in global food prices, the developing countries wanted to include provisions that would allow them enough policy space to tackle domestic price and supply volatility of essential items like food. India, along with other 33 countries, proposed an amendment called Special Safeguard Mechanism to allow policy space for them to respond to the effect of global volatility in trade of cotton and rice in domestic market. Failure to adjust this concern led to collapse of the latest Doha Round, which is unpleasant news. Note that agriculture trade accounts for just 10% of global trade but it remains the thorniest issue during trade negotiations.

How to Maximize the Gain while Minimizing the Pain?

Globalization is definitely good for the developing countries. It offers the only hope for them to meet development challenges on their own, i.e. not bank perennially on foreign aid. For this to happen, the current trade regime, which seems to put more emphasis on volume of trade rather than development specific outcomes of trade, has to be redesigned to address development challenges of the developing countries. This means trade should be viewed as a means to achieve development goals rather than taking it as an end in itself. Reduction of subsidies in the West will encourage farmers in the developing country to engage actively in agriculture, which not only means majority of the poor people returning back to farm, it also potentially allows developing countries to address the issue of food insecurity and starvation by relying more on their own farmers and less on food aid. Moreover, opening up of developing country’s markets will help attract investment, leading to increase in employment both in the agricultural and industrial sector.

The developing countries will also benefit enormously if the global labor mobility is increased through relaxation of migration rules in the West. If the Western countries allow temporary working permits, then along with increase in employment levels, there will also be increase in remittance inflows to the developing countries. For instance, the 11% reduction in poverty level in Nepal between 1994 and 2003 is attributed mainly to an increase in remittances inflows during that period.

For all this to occur, the current trade regime should not be partial towards developed nations and should embrace the concerns of developing countries.

Globalization promises great benefit to the developing nations. But for this to be effectively realized, the current global trading rules under the WTO have to be shifted from “liberalization” mindset to “development” mindset, which will provide policy space for countries to address their domestic concerns and help zero in on their respective development challenges.

For further information: - www.undp.org/poverty/docs/inclglob/LDCs_Istanbul_ENGLISH_final.pdf

Financial Globalization and its Impacts on Developing Nations

Financial globalization is understood as the integration of a country's local financial system with international financial markets and institutions. The integration demands the liberalizing the domestic financial segment and the capital account. It happens when there is an increase in cross-border capital movement, including an active participation of domestic lenders and borrowers in international markets and the use of international financial intermediaries, among the liberalized economies.

Financial globalization is a recent phenomenon. It first started in the 1970s when the huge amount of petrodollars fueled the capital inflows to developing nations. In the 1990s, the phenomenon boomed as emerging markets removed controls on private portfolio and bank flows.

Benefit

The main benefit of financial globalization for developing countries is the development of their financial system, which involves more complete, deeper, more stable, and better-regulated financial markets. A better-functioning financial system with credit flow is essential since it fosters economic growth. The financial globalization promotes financial development in two ways. First, financial globalization implies that a new type of capital and more capital is available to developing countries. Second, financial globalization leads to a better financial infrastructure, which mitigates information asymmetries and, as a consequence, reduces problems such as adverse selection and moral hazard.

Latest Development and Main Agents

The most important developments in financial globalization are the new nature of capital flows and the increasing use of international financial intermediaries.

Net capital flows to emerging economies have increased sharply since the 1970s. Capital flows went from less than U.S.$41 billion in the 1970s to about U.S.$320 billion in 1997.The composition of private capital flows also changed markedly. FDI grew continuously throughout the 1990s. Mergers and acquisitions,were the most important source of this increase. Net portfolio flows grew from U.S.$0.01 billion in 1970 to U.S.$82 billion in 1996. Yet, private capital does not flow to all countries equally. the top twelve countries with the highest flows are receiving the overwhelming majority of the net inflows. The unequal distribution of capital flows is consistent with the fact that income among developing countries is diverging.

The use of international financial intermediaries has increased significantly since the 90s. This internationalization is achieved through two main channels. The first channel is an increased presence of international financial intermediaries, mainly foreign banks, in local markets. For example, the assets and the proportion of assets held by foreign banks increased in East Asia, Eastern Europe, and Latin America between 1994 and 1999. Bond issuance in developing countries also increased substantially in 1993 and 1996, years of high capital inflows, while it decreased in 1998, when the Asian crisis spread to other regions. The second channel involves the use of international financial intermediaries by local borrowers and investors; these intermediaries are located outside the country. Companies from developing countries have been actively participating in the U.S. equity markets since the early 1990s. Again, the top six middle-income countries with the highest participation capture most of the activity among middle-income countries.

There are four main agents of financial globalization: governments, borrowers, investors, and financial institutions. All of them are assisting countries become more financially integrated.

Governments cut restrictions on the domestic financial sector and the capital account of the balance of payments. Before, governments used to regulate the domestic financial sector by restricting the allocation of credit through controls on prices and quantities. They also imposed several constraints on cross-country capital movements. Other methods of restrictions include restrictions on foreign exchange transactions, derivative transactions, lending and borrowing activities by banks and corporations, and the participation of foreign investors in the local financial system. There were periods of reversals in which restrictions were reimposed. The most substantial reversals took place in the aftermath of the 1982 debt crisis, in the mid-1990s, and after the Argentine crisis in Latin America.

There are several reasons for the liberalization by the governments. First, governments found capital controls increasingly costly and difficult to maintain effectively. Second, policymakers have become increasingly aware that government-led financial systems and non-market approaches have failed. Third, recent crises have heightened the importance of foreign capital to finance government budgets and smooth public consumption and investment. Moreover, foreign capital has helped governments capitalize banks with problems, conduct corporate restructuring, and manage crises. Fourth, opening up the privatization of public companies to foreign investors has helped increase their receipts. Fifth, although governments can also tax revenue from foreign capital, they might find this harder to do than with other factors of production because of its footloose nature. Sixth, governments have become increasingly convinced of the benefits of a more efficient and robust domestic financial system for growth and stability of the economy and for the diversification of the public and private sectors’ investor base.

Borrowers and investors, including households and firms, have also become main agents of financial globalization. By borrowing abroad, firms and individuals can relax their financial constraints to smooth consumption and investment. Firms can expand their financing alternatives by raising funds directly through bonds and equity issues in international markets and thereby reducing the cost of capital, expanding their investor base, and increasing liquidity. Also, borrowing countries benefit not only from new capital but also, in the case of FDI, from new technology, know-how, management, and employee training. More financing alternatives help foreign investors overcome direct and indirect investment barriers. And obviously, lenders expect to obtain higher returns for their investment.

Financial institutions play a major role in globalizing as well. the gains in information technology have diminished the importance of geography, allowing international corporations to service several markets from one location. the gains in information technology have had three main effects on the financial services industry: First, they promoted a more intensive use of international financial institutions. Second, they led to a major consolidation and restructuring of the world financial services industry. Last, they gave rise to global banks and international conglomerates that provide a mix of financial products and services in a broad range of markets and countries, blurring the distinctions between financial institutions and the activities and markets in which they engage.

The Development

Financial systems do not usually operate as desired because lenders confront problems of asymmetric information; lenders know less about the particular project than the borrower. Asymmetric information can lead to adverse selection and moral hazard. Adverse selection means that low-quality borrowers are the ones more likely to seek out funds in the market. Moral hazard means that, after obtaining the funds, borrowers have incentives to take risky positions or to use the funds in certain ways that are not beneficial to lenders.

Financial globalization helps improve the functioning of the financial system through two main channels: by increasing the availability of funds and by improving the financial infrastructure, which can reduce the problem of asymmetric information.

First, more capital is available. New sources of funds mean that borrowers not only depend on domestic funds but they can also borrow from foreign countries willing to invest in domestic assets. Thus, local and foreign investors enforce market discipline on private and public borrowers. Also more capital leads to a deepening and increased sophistication of financial markets, including an increase in the sources and uses of financing, and expands the scope of products, instruments, and services available to nationals. As a consequence, borrowers and lenders have more financial opportunities; more assets and liabilities of domestic borrowers and investors become available and transacted. More instruments and investors allow better risk diversification within and across countries.