THE RACE TO THE BOTTOM HYPOTHESIS: AN EMPIRICAL AND THEORETICAL REVIEW Daniel W.

Drezner The Fletcher School Tufts University December 2006

The prediction

The race-to-the-bottom (RTB) hypothesis has been a common public critique of economic globalization. As David Vogel and Robert Kagan observe, The political influence of the race to the bottom imagery has been considerable.1 This approach combines a positive theory of regulation with a strong normative disapproval of the predicted outcome.2 This theory assumes that the pressure for convergence comes from the mobility of trade and capital flows,3 and that the size of these flows overwhelms the ability of the state to act contrary to market forces. In the past thirty years, capital has become increasingly footloose, to the point where states cannot halt capital mobility even if they tried.4 In such a world capital will seek the location where it can earn the highest
1

David Vogel and Robert Kagan, eds., The Dynamics of Regulatory Change: How Globalization Affects National Regulatory Policies (Berkeley: University of California Press, 2004), p. 2. 2 For accessible overviews of the argument, see Richard McKenzie and Dwight Lee, Quicksilver Capital (New York: Free Press, 1991); Richard Falk, State of Seige: Will Globalization Win Out? International Affairs 73 (January 1997): 123-136; Alan Tonelson, The Race to the Bottom (Boulder: Westview Press, 2000). 3 Though the RTB hypothesis focuses largely on capital flows, traded goods act as a proxy for more efficient capital investments made in other countries. 4 See John Goodman and Louis Pauly, The Obsolescence of Capital Controls? World Politics 46, No. 1 (1993), pp. 50-82; Sebastian Edwards, How Effective are Capital Controls? Journal of Economic

rate of return. High rates of corporate taxation, strict labor laws, or rigorous environmental protection lower profit rates by raising the costs of production. Capital will therefore engage in regulatory arbitrage, moving to (or importing from) countries with the lowest regulatory standards. States, fearing a loss of their tax base, have no choice but to lower regulatory standards in order to avoid capital flight.

History, scope and predictions

While some scholarly advocates for this approach still exist, its current prominence is largely due to its long intellectual history and its recurrent popularity among the commentariat. Scholars in the social sciences have been fretting about races to the bottom for centuries. Adam Smith warned in The Wealth of Nations about limits to the states power to tax mobile factors of production:

The proprietor of stock is a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was assessed to a burdensome tax, and would remove his stock to some other country where he could either carry on his business or enjoy his fortune more at his ease. By removing his stock he would put an end to all the industry which it had maintained in the country which he left.5 More recently, scholars across the social sciences have put forward variations of the RTB hypothesis. Economists have extended this hypothesis in models of regional
Perspectives 13, No. 1 (1999): 65-84. 5 Adam Smith, The Wealth of Nations, (New York: The Modern Library, 1937), p. 800. On other 18th and 19th century fears about globalization, see Samir Amin, The Challenge of Globalization, Review of International Political Economy 3, No. 3 (1996), pp. 216-259; Emma Rothschild, Globalization and the Return of History, Foreign Policy No. 115 (1999): 106-116.

policymaking in a federal state.6 Political scientists that focus on the structural dependence of the state on capital have made similar arguments on the effect of globalization on state policies, echoing Marxist theories of the state.7 Business school professors have used a version of this hypothesis to explain why corporations with mobile factors of production can ensure a friendly regulatory environment.8 Legal scholars have also used this model to argue against decentralizing regulatory powers to lower-level jurisdictions.9 Scholars that posit the race to the bottom usually marry the RTB hypothesis to a pronounced normative disapproval of the outcome.10 Karl Polanyi offered the most eloquent description of the effects of a race to the bottom. His thesis in The Great Transformation was that once the market is permitted to organize some of society, the inevitable result was a society operating as an adjunct to the market.11 He argued that this inevitably leads to a race to the bottom: To allow the market mechanism to be sole director of the fate of human beings would result in the demolition of society. Nature would be reduced to its elements, neighborhoods and landscapes defiled, rivers

Charles Tiebout, A Pure Theory of Local Expenditures, Journal of Political Economy 64, No. 5 (1956), pp. 416-424 7 Charles Lindblom, Politics and Markets (New York: Basic Books, 1977); Robert Bates and Da-Hsiang Donald Lien, A Note on Taxation, Development, and Representative Government, Politics & Society 14, No. 1 (1985), pp. 53-70; Adam Przeworski and Michael Wallerstein, Structural Dependence of the State on Capital, American Political Science Review 82, No. 1 (1988), pp. 11-29; Wallerstein and Przeworski, Capital Taxation with Open Borders, Review of International Political Economy 2, No. 3 (1995), pp. 425-445. 8 Dale Murphy, The Structure of Regulatory Competition: Corporations and Public Policies in a Global Economy (New York: Oxford University Press, 2004). 9 William L. Cary, Federalism and Corporate Law: Reflections upon Delaware, Yale Law Journal 83, No. 4 (1974), pp. 663-705. 10 There are some exceptions. Libertarians and public choice theorists argue that jurisdictional competition has welfare-enhancing and democracy-enhancing effects. See Viktor Vanberg, Globalization, Democracy, and Citizens Sovereignty: Can Competition Among Governments Enhance Democracy? Constitutional Political Economy 11 (Winter 2000): 87-112. 11 Karl Polanyi, The Great Transformation (Boston: Beacon Press, 1944), p. 57.

polluted, military safety jeopardized, the power to produce food and raw materials destroyed.12 During the current era of globalization, public intellectuals have been enthusiastic promoters of the RTB hypothesis. Arthur Schlesinger, Jr., argued in the pages of Foreign Affairs that, the computer turns the un-trammeled market into a global juggernaut crashing across frontiers, enfeebling national powers of taxation and regulation dragging down labor standards and denying nations the shaping of their own economic destiny. Alan Tonelson avers, current globalization policies have plunged a great majority of workers into a great worldwide race to the bottom, into a nowin scramble for work and livelihoods with hundreds of millions of their already impoverished counterparts across the globe.13 Politicians, particularly in the developed world, have also embraced this belief. In a recent example, U.S. Senators Byron Dorgan and Sherrod Brown argued in a Washington Post op-ed that, The new mobility of capital and technology, coupled with the revolution in information technology, makes production of goods possible throughout much of the world. The result has been a global race to the bottom as corporations troll the world for the cheapest labor, the fewest health, safety and environmental regulations, and the governments most unfriendly to labor rights. Implicitly or explicitly, this theory is at the root of most of the anti-globalization sentiment voiced in Seattle and elsewhere.14
12 13

Ibid, p. 73. Arthur Schlesinger, Jr., Has Democracy a Future? Foreign Affairs, New York, September/October 1997, pp. 7-8, and Alan Tonelson, The Race to the Bottom (Boulder: Westview Press, 2000), p. 15. See also Robert Kuttner, Rules That Liberate, The American Prospect, May 1997, and William Greider, A New Giant Sucking Sound, The Nation, December 31, 2001. For why public intellectual prognostications should not necessarily be taken at face value, see Richard Posner, Public Intellectuals: A Study of Decline (Cambridge: Harvard University Press, 2001). 14 Jeffry Frieden, Global Capitalism: Its Fall and Rise in the Twentieth Century (New York: W.W. Norton, 2006), pp. 466-468. For specific examples, see Lori Wallach and Michelle Sforza, Whose Trade Organization? Corporate Globalization and the Erosion of Democracy (Washington: Public Citizen, 1999); Jerry Mander and Edward Goldsmith, eds., The Case Against The Global Economy (San Francisco:

The specific predictions of the race-to-the-bottom hypothesis are clear and concise. If globalization really does induce a race to the bottom in regulatory standards, three trends should be observed. First, countries that are more open to trade and investment should have fewer regulations affecting the costs of production. Once barriers to trade and investment are lowered, nation-states must cope with the threat of capital exit in response to burdensome regulations. Over time, more open economies should have lax regulatory standards. Second, there should be a strong negative correlation between inward capital flows and the rigor of a countrys regulatory standards. The core of this hypothesis is that corporations, being profit maximizers, will locate to areas where the costs of production are minimized. Since a stricter regulatory standard presumably raises the costs of production, corporations will seek the lowest possible standards in which to produce.15 Third, when one government lowers its regulatory standards to attract greater investment, other open economies will follow suit. According to the RTB hypothesis, states have no choice but to lower their standards or face the perils of capital exit.

Sierra Club Books, 1996); Robin Broad, ed., Global Backlash: Citizen Initiatives for a Just Economy (New York: Rowan & Littlefield, 2002). 15 RTB predictions about the welfare state more generally are mixed. Scholars such as Dani Rodrik, Sven Steinmo, and Peter Katzenstein point out that increased exposure to global markets should generate more demands on the welfare apparatus, because of the distributional effects of globalization. This implies that welfare expenditures should be positively correlated with globalization, which is what Rodrik finds. However, RTB theorists point out that states are constrained from raising the revenue to finance these demands due to a race to the bottom in the taxation of mobile factors of production, and the reluctance of capital markets to extend credit to countries that run persistent budget deficits. This makes point predictions difficult, since at different stages of this argument, state expenditures are increasing, then budget deficits are increasing, and then welfare expenditures are declining. See Rodrik, Has Globalization Gone Too Far?; Sven Steinmo, The End of Redistribution? International Pressures and Domestic Tax Policy Choices, Challenge 37, No. 6 (1994), pp. 9-17; Peter Katzenstein, Small States in World Markets, (Ithaca: Cornell University Press, 1985). Finally, Layna Mosleys research suggests that capital markets do not particularly care about welfare expenditures or taxation, because the more micro-side a policy indicator is, the less important it is to long-term interest rate levels. Layna Mosley, Room to Move: International Financial Markets and National Welfare States, International Organization 54 (Autumn 2000), p. 760.

The evidence

There are a number of regulatory arenas where the race to the bottom is hypothesized to occur, but the bulk of the empirical work has focused on labor and environmental regulations. Policy journals are replete with claims that globalization is causing downward pressure on wages and a race to the bottom in labor and environmental standards.16 The evidence strongly suggests that these assertions are flatly wrong. If the RTB hypothesis is true for labor standards, one would expect to find worsening standards in those countries most exposed to trade and foreign investment. The effect should be especially pronounced in export processing zones (EPZs). These are geographically bounded areas commonly established in less developed countries to attract foreign investment. To invest in these areas, governments offer inducements such as duty-free imports and exports, infrastructure investment, and reduced regulatory interference. This could include exempting the EPZ from any labor and environmental legislation. Naomi Klein argues that, with seventy countries competing for the exportprocessing-zone dollar, the incentives to lure investors are increasing and the wages and standards are being held hostage to the threat of departure. The upshot is that entire countries are being turned into industrial slums and low-wage ghettos, with no end in sight.17 If there is a race to the bottom, it should be most pronounced in EPZs.
16

See, for example, Kathleen Newland, Workers of the World, Now What? Foreign Policy No. 114 (1999), pp. 52-65; Ethan Kapstein, Workers and the World Economy, Foreign Affairs 75, No. 3 (1996), pp. 16-24. 17 Naomi Klein, No Logo (London: Flamingo, 2000), p. 208. Quoted in Martin Wolf, Why Globalization Works (New Haven: Yale University Press, 2004), p. 240.

There is little empirical evidence to support the race-to-the-bottom hypothesis. Anecdotal examples can be given of corporations moving production to countries because of cheap labor and, implicitly, lax labor standards.18 These observations contrast, however, with other cases in which such standards are immaterial to the choice of investment locale.19 A 1996 OECD report reviewing this issue concluded: There is no evidence that freedom-of-association rights worsened in any of the countries that liberalized trade. The strongest finding is that there is a positive correlation between successfully sustained trade reforms and improvements in core standards.20 A follow-up report in 2000 came to the same conclusion.21 The data on export processing zones also fails to support the image of a race to the bottom. Some countries Pakistan, Bangladesh, Panama, and Zimbabwe exempt their EPZs from regulation covering core labor standards. However, contrary to the RTB hypothesis, this failed to put pressure on other countries to relax labor standards in their EPZs. Several countries, including the Dominican Republic and the Philippines, reversed course in the mid-nineties, introducing labor standards in their EPZs when none previously existed.22 Statistical tests support these assessments. The only studies to find a negative correlation between ratification of core labor standards and export performance failed to

18

See, for example, International Confederation of Free Trade Unions, Behind the Wire: Anti-Union repression in the export processing zones, <http://www.icftu.org/english/tncs/etnexpzo.html>, accessed January 26, 2000. 19 Debora Spar, Attracting High Technology Investment: Intel's Costa Rican Plant, FIAS Occasional Paper No. 11, World Bank, Washington DC, April 1998. 20 Organization for Economic Cooperation and Development, Trade, Employment, and Labour Standards: A Study of Core Workers Rights and International Trade (Paris, OECD, 1996). 21 International Trade and Core Labour Standards (Paris: OECD, 2000). 22 Dorsati Madami, A Review of the Role and Impact of Export Processing Zones, Policy Research Working Paper No. 2238 (Washington, DC: World Bank, 1999), p. 49.

include any control variables.23 Dani Rodrik regressed textile exports (as a measure of labor-intensive activity) against an array of labor and human rights standards, as well as several control variables. He found that labor standards had no consistent effect on the pattern of exports.24 Later studies have also demonstrated a weak to non-existent correlation between labor standards and export patterns.25 There is no evidence that corporations direct their investment to countries that have lower labor or environmental standards. The bivariate relationship between foreign direct investment and labor standards is strongly positive, given that in the past decades more than 90% of FDI occurs in OECD countries, which have the highest labor standards.26 Multivariate tests show no correlation between foreign direct investment and labor standards.27 An International Labor Organization report reveals no evidence that countries with strong trade union presence have suffered any loss of investment in their EPZs.28 A World Bank survey notes a strong positive correlation between higher occupational safety and health conditions and foreign investment in EPZs. In-depth reviews of EPZs where labor standards are abused reveal that the problem is insufficient
23

Jai S. Mah, Core Labor Standards and Export Performance in Developing Countries. The World Economy 20 (September 1997): 773-785. 24 Dani Rodrik, Labor Standards in International Trade: Do They Matter and What Do We Do About Them? In Robert Z. Lawrence, Dani Rodrik and John Whalley, eds., Emerging Agenda for Global Trade (Washington: Johns Hopkins University Press, 1996). 25 Cees Van Beers, Labour Standards and Trade Flows of OECD Countries, The World Economy 21, No. 1 (1998), pp. 57-73; Robert J. Flanagan, Labor Standards and International Competitive Advantage, presented at The International Labor Standards Conference, Stanford University, Stanford, CA, May 2002. For a summary of this literature, see Drusilla K. Brown, International Trade and Core Labor Standards, Discussion Paper 2000-05, Department of Economics, Tufts University, Medford, MA, January 2000. 26 OECD, Trade, Employment, and Labour Standards; Paul Q. Hirst and Grahame Thompson, Globalization in Question, second edition (Cambridge: Polity Press, 1999). See also David Vogel, Trading Up (Cambridge: Harvard University Press, 1995). 27 Nathan Jensen, Nation-Sates and the Multinational Corporation: A Political Economy of Foreign Direct Investment (Princeton, NJ: Princeton University Press, 2006); Dani Rodrik, Globalization and Labor, in Richard Baldwin et al eds., Market Integration, Regionalism, and the Global Economy (Cambridge: Cambridge University Press, 1999); Hye Jee Cho, Political Risk, Labor Standards and Foreign Direct Investment. Paper presented at UCLAs CIBER Doctoral Reseach Seminar, Ventura, CA, June 2002. 28 International Labour Organization, Labour and social issues relating to export processing zones. (Geneva: ILO, 1998).

access to the global economy. As EPZs attract a greater number of foreign investors, labor conditions improve across the entire zone.29 The evidence is similarly weak when environmental conditions are analyzed. Statistically, two categories of tests have been tried. The first type tries to determine if environmental regulations adversely affects trade patterns. If this is true, it would support one leg of the RTB hypothesis, that strict environmental standards weaken the competitiveness of industry. The second type tests whether firms choose their investment locations based upon environmental regulations. The evidence on how environmental regulations affect competitiveness provides no encouragement for the race-to-the-bottom hypothesis. A battery of studies testing whether environmental regulations negatively affected economy-wide export performance in the seventies and eighties conclude there is no correlation.30 Using more recent data, only one study finds environmental regulations to have a statistically significant effect on the pattern of exports of OECD countries.31 This result has not held up to alternative specifications, however, suggesting it is not particularly robust.32 Analyses at the intra-industry level, which permit more precise testing of industries that are heavy polluters, also fail to support the RTB hypothesis.33
29

Ana Teresa Romero, Labour Standards and Exports Processing Zones: Situation and Pressures for Change, Development Policy Review 13 (1995): 247-276; Theodore Moran, Beyond Sweatshops: Foreign Direct Investment and Globalization Developing Countries (Washington: Brookings Institution, 2002). 30 J.M. Dean, Trade and the Environment: A Survey of Literature. in Patrick Low, ed.., International Trade and the Environment (Washington, DC: World Bank, 1992); Adam B. Jaffe, Steven R. Peterson, Paul R. Portney, and Robert N. Stavins, Environmental Regulation and the Competitiveness of U.S. Manufacturing. Journal of Economic Literature 33 (March 1995): 132-63. 31 Cees van Beers and J.C.J.M. van der Bergh, An Empirical Multi-country Analysis of the Impact of Environmental Regulations on Foreign Trade Flows, Kyklos 50 (February 1999): 29-46. 32 Mark N. Harris, Lszl Knya, and Lszl Mtys, Modelling the Impact of Environmental Regulations on Bilateral Trade Flows. The World Economy 25 (March 2002): 387-405. 33 James Tobey, The Impact of Domestic Environmental Policies on Patterns of World Trade. Kyklos 43 (May 1990): 191-209; Ravi Ratnayake, Do Stringent Environmental Regulations Reduce International Competitiveness? International Journal of the Economics of Business 5 (February 1998): 97-118.

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Tests of investment decisions yield similar findings. Again, anecdotes exist of countries such as Ireland purposefully lowering environmental standards in order to attract dirty industries. However, there is no appreciable evidence that other countries adopted this strategy in response to Irelands success.34 Looking at export processing zones, a World Bank study concludes that EPZ environmental laws are roughly consistent with host country legislation.35 Repeated statistical tests at the international level fail to find robust support for the RTB dynamic in explaining investment decisions.36 Indeed, there is some support for the opposite hypothesis: greater exposure to globalization leads to greater environmental protections. Nancy Birdsall and David Wheeler, examining the bivariate relationship between trade openness and environmental pollution in Latin America, conclude that the pollution-intensive industries were more likely to be located in the most protectionist countries.37 This correlation could be a

34

H. Jeffrey Leonard, Pollution and the struggle for the world product: multinational corporations, environment, and international comparative advantage (Cambridge: Cambridge University Press, 1988); Candice Stevens, Do Environmental Policies Affect Competitiveness? OECD Observer No. 183 (1993), pp. 22-25. 35 Madami, A Review of the Role and Impact of Export Processing Zones, p. 50. It should be noted, however, that these countries are far from paragons of environmental protection. 36 Gunnar Eskeland, and Ann Harrison, Moving to greener pastures? Multinationals and the pollution-haven hypothesis, World Bank Policy Research Working Paper No. 1744, March 1997; Raman Letchumanan and Fumio Kodama, Reconciling the conflict between the pollution-haven hypothesis and an emerging trajectory of international technology transfer. Research Policy, 29 (2000): 59-79; David Wheeler, Racing to the Bottom? Foreign Investment and Air Quality in

Developing Countries. Journal of Environment and Development 10 (September 2001) 225-245; Beata K. Smarzynska and Shang-Jin Wei, Pollution Havens and Foreign Direct Investment. NBER Working Paper No.8465, September 2001; Josh Ederington, Arik Levinson, and Jenny Menier, Trade Liberalization and Pollution Havens, NBER Working Paper No. 10585, June 2004. For an exception, see Yuquing Xing and Charles Kolstad,
Do Lax Environmental Regulations Attract Foreign Investment? Envoronmental and Resource Economics 21 (January 2002): 1-22. 37 Nancy Birdsall and David Wheeler, Trade Policy and Industrial Pollution in Latin America: Where are the Pollution Havens? Journal of Environment and Development 2, No. 1 (1993), pp. 137-149.

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function of the environmental Kuznets curve.38 If access to global markets leads to greater economic development, and development leads to greater environmentally protections, then globalization leads to a race to the top.39 Data on U.S. foreign direct investment in developed and developing countries reveals that U.S. firms invested a greater percentage of pollution-intensive industries in the countries with stricter environmental standards.40 In a 1996 review essay, Arik Levinson concludes: The conclusions of both the international and domestic studies of industry location are that environmental regulations do not deter investment to any statistically or economically significant degree.41 Reviewing the literature eight years later, Martin Wolf concurs: The great bulk of foreign direct investment continues to go to countries with high labour costs and strong regulatory regimes, not least on the environment.42 There have been three empirical responses to the lack of supporting evidence for the RTB hypothesis. One claim is that the RTB effect may not be economy-wide but nevertheless occurs in specific sectors. For example, the strongest evidence for the race

38

Gene Grossman and Alan Krueger, Economic Growth and the Environment, NBER Working Paper #4634, February 1994; Thomas Selden and Daqing Song, Environmental Quality and Development: Is there a Kuznets Curve for Air Pollution Emissions? Journal of Environmental Economics and Management 27 (September 1994): 147-162. 39 Vogel, Trading Up; Daniel T. Griswold, Trade, Labor, and the Environment. Trade Policy Analysis No. 15, Cato Institute, Washington, DC, August 2001. This phenomenon will be discussed more in the next chapter. 40 Repetto, Jobs, Competitiveness and Environmental Regulation; C. Leigh Anderson and Robert Kagan, Adversarial Legalism and Transaction Costs: The Industrial Flight Hypothesis Revisited, International Review of Law and Economics 20 (January 2000): 1-19. 41 Arik Levinson, Environmental Regulations and Industry Location: International and Domestic Evidence, in Jagdish Bhagwati and Robert Hudec, eds., Fair Trade and Harmonization: Prerequisites for Free Trade? (Cambridge: MIT Press, 1996). The evidence at the U.S. domestic level is more mixed than Levinson acknowledges. Levinson finds that strict regulations minimally deter investment. Increases in regulation by one standard deviation leads to, at most, a 1.8% decline in investment. However, a more recent analysis at the county level, however, does generate support for the RTB hypothesis. See Arik Levinson, Environmental regulations and manufacturers location choices, Journal of Public Economics 62, No.1 (1996), pp. 5-29; Randy Becker and Vernon Henderson, Effects of Air Quality Regulation on Polluting Industries. Journal of Political Economy 108 (April 2000): 379-421. 42 Wolf, Why Globalization Works, p. 233.

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to the bottom comes from looking at the case of shipping standards.43 Most shipping firms reregistered their ships in countries such as Liberia and Panama that established flags of convenience, with lax inspection regimes and poor labor safeguards.44 However, the story does not end there. First, OECD countries refused to lower their regulatory standards for shipping, preventing a true race to the bottom. Second, for regulatory issues of concern preventing oil spills, protecting dolphins, and improving labor rights on the high seas countries that house flags of convenience have been increasing their standards over the past decade in response to pressure from the developed world.45 The second empirical response is to argue that even if there is no race to the bottom per se, globalization has generated forms of competition-in-laxity or regulatory chill.46 This line of argument posits that in a counterfactual world with less globalization, there would be greater regulatory stringency for a given issue area. However, even proponents of this view acknowledge that the empirical barriers to demonstrating this type of RTB phenomenon are formidable. As Dale Murphy points out, the evidence for phenomena such as regulatory chill are elusive.47 The third empirical response is to suggest that even if the conditions for a race to the bottom have not existed in the past, they will exist in the future. For example, both mainstream economists and management theorists have posited that the explosion of offshoring and global sourcing is one harbinger of the disintegration of production
43

Elizabeth DeSombre, Flagging Standards: Environmental, Safety, and Labor Regulations at Sea (Cambridge: MIT Press, 2006); Murphy, The Structure of Regulatory Competition, chapter two. 44 William Langewiesche, The Outlaw Sea: A World of Freedom, Chaos, and Crime (New York: North Point Press, 2004). 45 DeSombre, Flagging Standards; Ronald Mitchell, Regime Design Matters: Intentional Oil Pollution and Treaty Compliance. International Organization 48 (Summer 1994): 425-458. 46 Murphy, The Structure of Regulatory Competition, p. 7. 47 Ibid.

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necessary for races to the bottom to take place.48 Simply put, this thesis is impossible to falsify until the future is now. However, it is worth observing that the very management consultants who have hyped the offshoring phenomenon have also concluded that the transition to a truly global labor market and the extent of global labor arbitrage will be gradual.49 These empirical objections hint at the possibility that economic globalization has cast a slight pall on the upwards ratchet of regulatory stringency in the developed world. Even if one were to faithfully accept this possibility, however, there is no compelling evidence to support the assertion that globalization leads to a race to the bottom in regulatory standards. The few statistical studies that support the RTB hypothesis are not robust. Even in the sectors where a few states lower their standards as a gambit to attract capital, other governments did not feel compelled to follow their lead. The race to the bottom is a dog that does not bark. It is theoretically possible that a race to the bottom could occur at certain junctures for some parts of the global economy, in sectors where capital does not rely on specialized assets or skilled workers. The evidence to date, however, suggests it remains a theoretical possibility rather than a harbinger of the future. If anything, the reverse appears to be true. Without the recent wave of globalization, for example, the

48

Alan Blinder, Offshoring: The Next Industrial Revolution? Foreign Affairs 85 (March/April 2006): 113-128; David J. Levy, Offshoring in the New Global Political Economy, Journal of Management Studies 42 (May 2005): 685-693; Stephen S. Cohen and J. Bradford DeLong, Shaken and Stirred, The Atlantic Monthly 295 (January/February 2005): 112-117; Richard Freeman, What Really Ails Europe (And America): The Doubling of the Global Workforce, The Globalist, May 2005, accessed at http://www.theglobalist.com/StoryId.aspx?StoryId=4542. 49 McKinsey Global Institute, The Emerging Global Labor Market, June 2005. Accessed at http://www.mckinsey.com/mgi/publications/emerginggloballabormarket/Part1/Index.asp. See also Diana Farrell and Andrew Grant, Chinas Looming Talent Shortage, The McKinsey Quarterly 2005, no. 4; Gary Gereffi et al, Framing the Engineering Outsourcing Debate, Duke University, December 2005.

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exploitation of workers by firms would have been much greater in many parts of the globe.50

The theoretical flaws

The race to the bottom hypothesis makes several strong assumptions about the political economy of the nation-state in a world of perfect capital mobility.51 First, it assumes that corporations will always prefer lower regulatory standards. Second, it presumes that state regulations impose enough of a burden on producers to affect the location of production, regardless of differences in labor productivity. Third, it assumes that the state responds exclusively to the preferences of mobile capital and not to other constituencies such as voting blocs, bureaucracies, or interest groups. Finally, it assumes that no state has an economy large enough to endow it with market power vis--vis global capital. If this were the case, such a state would be able to set regulatory standards that raise the costs of investment above the market rate, yet still lure capital because of the potential profits from locating production in a large market. There are reasons to questioning all of these assumptions. Corporate preferences are more nuanced than a simple preference for abject deregulation. Firms will naturally push for stringent regulations to protect corporate assets. For example, U.S. multinationals especially entertainment, computer, pharmaceutical, and chemical
50

Jagdish Bhagwati, In Defense of Globalization (New York: Oxford University Press, 2004); Wolf, Why Globalization Works; Eric Edmonds and Nina Pavcnik, Child Labor in the Global Economy, Journal of Economic Perspectives 19 (Spring 2005): 199-220. 51 These are best summarized in Miles Kahler, Modeling Races to the Bottom, paper presented at the 1998 meeting of the American Political Science Association, Boston, MA. See also Hirst and Thompson, Globalization in Question, chapter one.

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companies strongly supported the establishment of an intellectual property rights regime within the WTO. Why was there strong corporate support for a significant ratcheting up of global standards in this issue area? U.S. firms faced a loss of profits from third world firms producing unlicensed knock-offs of patented merchandise.52 Multinational firms can also gain a comparative advantage from rigorous standards, or at least reduce the comparative advantage of competing firms. Corporations that are used to operating in strict regulatory environments have fewer adjustments to make if other countries ratchet up their regulatory standards. This gives them a cost advantage over domestic firms in host countries that raise their standards, providing the opportunity to expand market share and profits.53 Ronie Garcia-Johnson observed this behavior in her examination of U.S. chemical firms in Brazil and Mexico.54 Elizabeth DeSombre shows that although multinational firms may oppose increased regulation in their home country, once such regulations are enacted these firms will often switch their position on global regulatory standards. These bootleggers want all producers to face the same regulatory constraints internationally as they do domestically, in order to ensure a level playing field in the global market.55 Developing countries often resist the enhancement of regulatory standards not to attract foreign capital but to protect domestic industries, be it automobiles in Indonesia or timber in Canada.56
52

John Braithwaite and Peter Drahos, Global Business Regulation (Cambridge: Cambridge University Press, 1999), p. 203-4; Susan Sell, Power and Ideas: North-South Politics of Intellectual Property and Antitrust (Albany: SUNY Press, 1995), p. 130-137; Sell, Private Power, Public Law: The Globalization of Intellectual Property Rights (New York: Cambridge University Press, 2003). 53 Michael Porter and Claas van der Linde, Toward a New Conception of the EnvironmentCompetitiveness Relationship. Journal of Economic Perspectives 9 (Autumn 1995): 97-118. 54 Ronie Garcia-Johnson, Exporting Environmentalism: U.S. Multinational Chemical Corporations in Brazil and Mexico (Cambridge: MIT Press, 2000). 55 Elizabeth DeSombre, Domestic Sources of International Environmental Policy: Industry, Environmentalists, and U.S. Power (Cambridge: MIT Press, 2000). 56 See Graham, Fighting the Wrong Enemy, p. 143-44 on Indonesia, and Greg Mastel, A New Chance to Kill Lumber Subsidies, National Post, December 15, 2000, on Canada.

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Multinational corporations could also prefer more stringent regulatory standards if strict standards are more consistent with a firms corporate culture. Economists, political scientists, and organizational scholars provide numerous motivations for multinational corporations to develop a strong corporate culture.57 One reason is that, as firms try to develop globally identifiable brands, they will be sensitive to any regulatory violations anywhere that could tarnish the brand image.58 Statistical tests show that multinational firms that establish single global standards for their production processes have higher market capitalization than firms with disparate national standards.59 Anecdotal evidence suggests that this is how the CEOs of multinational corporations think of their management style.60 A strong corporate culture will make firms reluctant to have different national units of a firm adhere to different sets of mores. There are numerous examples of corporate culture and concern about brand image affecting business preferences over regulatory standards. By the late nineties, more than 80 multinational enterprises had established social codes of conduct, with an overwhelming majority of these codes apply to all of a firms units and sub-contractors.61
57

For the economic motivations, see David Kreps, Corporate Culture and Economic Theory, in James Alt and Kenneth Shepsle, eds., Perspectives on Positive Political Economy (New York: Cambridge University Press, 1990). For the political origins, see Paul Doremus, William Keller, Louis Pauly, and Simon Reich, The Myth of the Global Corporation (Princeton: Princeton University Press, 1998). For the organizational take, see Herbert Simon, Administrative Behavior, Third Edition (New York: Free Press, 1976). 58 The Economist, Brands: Whos Wearing the Trousers? September 8, 2001; Deborah Spar, The Spotlight and the Bottom Line, Foreign Affairs 77 (March/April 1998). 59 Glen Dowell, Stuart Hart, and Bernard Yeung, Do Corporate Standards Create or Destroy Value? Management Science 46 (August 2000): 1059-1074. 60 For example, the chairman of the German insurance firm Allianz wrote in a Financial Times op-ed: At Allianz, the head office sees its role as defining the groups regulatory framework, setting group strategy and financial objectives. How to service local markets, however, is left up to our local subsidiaries. They know their markets much better than the central office in Munich. Henning Schulte-Noell, Europe Must Clarify Its Goals, Financial Times, 2 June 2002. 61 Ans Kolk, Rob van Tulder and Carlijn Welters, International Codes of Conduct and Corporate Social Responsibility: Can Transnational Corporations Regulate Themselves? Transnational Corporations, Vol. 8, April 1999, pp. 143-80. For a critique of such codes, as well as the corporate social responsibility movement more generally, see Aaron Chatterji and Siona Listokin, Corporate Social Irresponsibility, Democracy: A Journal of Ideas 3 (Winter 2007): 52-63.

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PepsiCo pulled its business out of Myanmar in 1997 because it did not want to be linked to that countrys repressive regime. General Electric was at the forefront in supporting the OECD Anti-Bribery Convention because it was uncomfortable with some units of the firm operating under a different set of ethical standards.62 In the case of environmental regulation, Aseem Prakash shows how corporate culture explains why some firms exceed mandated regulatory standards in the United States.63 This vulnerability of multinational corporations to activist pressure leads to a central irony. Anti globalization activists can shine a powerful spotlight on retrograde firms that violate core labor standards. Because these groups are successful at exposing occasional abuses, their claim that globalization leads to systematic abuses is wrong. The race to the bottom hypothesis also assumes that states respond only to the preferences of owners of capital. This assumption has a long tradition in political science, stretching back to The Communist Manifesto and including extensive writings in comparative politics about the structural dependence of the state on capital.64 There are several ways to vitiate this assumption, however. First, even relatively simple formal models of multiple governments trying to attract investment in a world of mobile capital do not produce race to the bottom effects. Ronald Rogowski shows that in a world of mobile capital, states that start out unfriendly to investment become even more hostile in
62

Kenneth Abbott and Duncan Snidal, Values and Interests: Rational Choice and the Use of International Legalization to Fight Corruption, Paper prepared for a Conference on Rational Choice and International Law, University of Chicago Law School, April 27-28, 2001. 63 Aseem Prakash, Greening the Firm: The Politics of Corporate Environmentalism (Cambridge: Cambridge University Press, 2000). 64 See Charles Lindblom, Politics and Markets (New York: Basic Books, 1977); Robert Bates and DaHsiang Donald Lien, A Note on Taxation, Development, and Representative Government, Politics & Society 14, No. 1 (1985), pp. 53-70; Adam Przeworski and Michael Wallerstein, Structural Dependence of the State on Capital, American Political Science Review 82, No. 1 (1988), pp. 11-29; Wallerstein and Przeworski, Capital Taxation with Open Borders, Review of International Political Economy 2, No. 3 (1995), pp. 425-445.); Daniel W. Drezner, Globalizers of the World, Unite! The Washington Quarterly 21 (Winter 1998): 209-225.

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a borderless economy.65 Second, the assumption ignores the effects of democratic political institutions upon state responses to globalization. There is evidence that democracies respond to globalization by increasing resources for consumer, labor, and environmental protection.66 Furthermore, political institutions can insulate state decisionmaking from changes in the economic environment.67 The final assumption that all states are price takers vis--vis capital holds true for a majority of states in the international system. It does not necessarily hold for the great powers, however. Consumption has gone global along with production; multinational firms base their investment decisions not just on likely production costs, but also on access to sizable markets. States with large internal markets can use access to those markets as a lever over multinational corporations. This is particularly true after foreign direct investment has taken place. Firms with specific assets in the host country face large losses if they choose not to comply with that states regulatory standards. In states with large export markets, key suppliers, or production platforms, firms are more likely to make regulatory concessions than other states. The economic sanctions literature confirms these suppositions. George Shambaugh shows that foreign firms are far more likely to comply with the extraterritorial application of U.S. laws when they rely on the

65

Ronald Rogowski, Globalization Without Governance: Implications of Tiebout Models in a World of Mobile Factors. Presented at the 2000 annual meeting of the American Political Science Association, Washington DC, September 2000. 66 Dani Rodrik, Has Globalization Gone Too Far? (Washington: Institute for International Economics, 1997). 67 Peter Katzenstein, Small States in World Markets (Ithaca: Cornell University Press, 1985); Geoffrey Garrett and Peter Lange, Internationalization, Institutions, and Political Change, in Robert Keohane and Helen Milner, eds., Internationalization and Domestic Change (Cambridge: Cambridge University Press, 1996); Scott Basinger and Mark Hallerberg, Remodeling the Competition for Capital: How Domestic Politics Erases the Race-to-the-Bottom, presented at the 2000 annual meeting of the American Political Science Association, Washington, DC.

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U.S. as a significant export market.68 This holds true even if the firms home government opposes the sanctions. The desire to locate production in sizeable markets shows up in the data on American FDI. A 1996 survey by the U.S. Department of Commerce found that more than sixty percent of the production of U.S. corporate affiliates in developing countries is sold locally in the host country markets; less than twenty percent is exported back to the United States. In Mexico, which provides an ideal platform for re-exporting to the United States, only 28 percent of production by U.S. affiliates is exported to the United States; more than two-thirds is marketed in Mexico.69 The great fear of the race-to-the-bottom crowdthat multinational corporations locate production facilities in developing countries, extract local resources, and then re-export back to the developed world has not materialized. In fact, that type of activity characterizes less than ten percent of total U.S. investment abroad.70

Conclusion

It is impossible to state definitively that there will be no race to the bottom in the future. However, there is little evidence to support the allegation that a race to the bottom is currently taking place with regard to labor or environmental standards.71 The research
68 69

George Shambaugh, States, Firms, and Power (Albany: SUNY Press, 1999). Raymond J. Mataloni Jr., and Mahnaz Fahim-Nader, Operations of U.S. Multinational Companies, at < http://www.bea.doc.gov/bea/ai/1296iid/maintext.htm>, accessed July 31, 2000. Tonelson challenges this data in The Race to the Bottom, chapter 5. 70 Ibid. See also Daniel W. Drezner, Bottom Feeders. Foreign Policy 121 (November/December 2000): 64-70. 71 This does not mean that globalization does not exert a downward effect on wages. Indeed, neoclassical trade theory would predict this effect. Its magnitude, however, remains an open question. In 1998 the Presidents Council on Economic Advisors concluded that trade was responsible for at most 10-15 percent of the increase in wage inequality during the 1980s (Economic Report of the President Washington, DC: U.S. Government Printing Office, 1998, p. 241). Robert Lawrence and Matthew Slaughter go further,

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arms of multiple international organizations the OECD, ILO, and the World Bank, to name three have conducted studies investigating the claims that trade liberalization reduces regulatory standards, and found no support for the proposition. Academic analyses have come to the same conclusion. Indeed, if anything, there appears to be a positive relationship between trade flows, foreign direct investment, and effective regulation.

pointing out that when alternative explanations such as technological innovation and investments in education are factored into the equation, trade is found to have nothing to do with the slow increase in average compensation. Robert Z. Lawrence and Matthew Slaughter, International Trade and American Wages in the 1980s: Giant Sucking Sound or Small Hiccup? Brookings Papers on Economic Activity, No. 2, 1993, p. 165. See also Paul Krugman and Robert Z. Lawrence, Trade, Jobs and Wages, Scientific American, April 1994, p. 22-27; Matthew J. Slaughter and Philip Swagel, The Effect of Globalization on Wages in the Advanced Economies, IMF Working Paper, April 1997. It is worth observing that wage effects alone cannot explain FDI patterns in the past decade or two. Excluding the advanced industrialized states, more than 55 percent of foreign direct investment in 1998 went to five middle-income countries Brazil, China, Indonesia, Mexico and Singapore. The 48 least developed countries, which should be a magnet for firms interested in low wages, attracted less than 1 percent on all FDI. See International Trade and Core Labour Standards, p. 35.