Globalization

In economic content globalization can be defined as a process in which geographic distance becomes a factor of diminishing importance in the establishment and maintenance of cross border economic, political and socio-cultural relations. (Lubber, 2004:1) It defines an economic development by means of transaction of goods and services between untries, international investments and the liberalization of all these actions. Becoming a trend widespread around the world, globalization can be described as a net connecting many overseas countries by the help of economic, financial, political, environmental, social, cultural and technological links, markets and people. According to William Greider globalization is like a wondrous new machine" that reaps as it destroys. "Huge and mobile, "like the machines of modern agriculture, but vastly more complicated and powerful...running over open terrain and ignoring familiar boundaries. As it goes, the machine throws off enormous mows of wealth and bounty while it leaves behind great furrows of wreckage. But, no one is at the wheel. The machine has no wheel or internal governor to control the speed and direction. It is sustained by its own forward motion and guided mainly by its own appetites. The machine is modern capitalism driven by the imperatives of global industrial revolution, creating the drama of a free running economic system that is reordering the world". (Greider, 1997:11) It is possible to say that the common point of all of the definitions above is liberalization. The economic and technological developments have provided countries with the liberalization of trade.

Components of Globalization
The main components of globalization can be stated as follows: International trade, Foreign direct investments, Multinational companies, Production networks, Knowledge technologies and knowledge society, Deregulation. Until 1970s central capitalist welfare state has reached the borders of massive roduction/consumption system, the margins of takings have decreased, the restlessness among workers have increased, the industrial investment has moved towards speculative activities, unemployment and inflation rates have reached to a level never seen before and a drastic competition have started between countries. In the central capitalist welfare states these facts have caused the investments to move towards more suitable or strategic places. Therefore the technological advance has been accelerated and this has eased the formation of new services and communication links for globalization. The main fact for capital stock has become the recomposition productive/speculative multinational capitals according to the world scale, which means the abolition of the obstacles in its transaction area. This process has eventuated between many dynamic variables that intersect each other in many dimensions. In spite of the existence of many variables the basic rationale is restructuring the multinational capital that is organizing in international level full liberalization. As the capital is reshaped in international scale, as seen in previous

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processes, it has become an obligation to redefine the developing or ndeveloped countries. Neoliberalism, neomodernism, postfordism as the restructuring of production process has been the pronunciations of this reconstruction. (Besides, being an element giving direction to global economic, social and political system as well as the multinational/transnational companies, it is also defined as neocorporativism. The analysis and reality ruling the world today is defined as flexible labor, flexible capital accumulation, flexible labor market, flexible production and flexible companies. Thus, globalization, which is the extending of the transaction area of the capital, has provided the liberal and classical economy to come to order again (neo). According to this theory, economics, together with its internal dynamics, produces more effective and rational solutions without any external interference. The spreading and deepening of the market relations in the world scale has required all the economies to participate in the fact) Besides the reshaping of capitalization has gained its latest form where the interference of government into the economic life is restricted, the public enterprises functioning in economic life are privatized and public expenditures are reduced and financial and commercial deregulation have become rising values in free market. International conference on Business, Economics and Management, The change and transformation processes observed in economic, political and cultural fields can be summarized as follows: Globalization of capital and the becoming of external trade a precondition for economic development, Regional integrations such as the European Union and nternational organizations have become a necessity. Also politics have moved ver/beyond a scope of nation states, therefore the process of political globalization has been celerated. Local governments and civil society organizations have been attached much more importance and the mentality of participating in democracy has spread over. Transnational or multinational huge companies have undertaken a role in indwelling this process as a world system since they physically own todays technology and capital. Financial globalization has become the area where economic globalization improved in a massive manner. Although integration has given rise to important progresses in trade, this process is not as fast as of those in financial activities and direct investments. The globalization has developed in an unbalanced way all around the world. In a larger scale, there is a less equitable distribution of income.

Today the approaches to globalization can be studied as the hyperglobalists, skepticals and transformation lists by following the classification made by Held, McGrew, Goldblatt and Perraton. (Held, McGrew, Goldblatt and Perraton, 1999:3) Hyperglobalists are also called as the fundamentalists (radicals). According to the supporters of this idea, the nationstate is the product of the industrial civilization and has lost its importance parallel to the globalization period. As the market mechanism works more rationally than the governments, today the global market is replacing with politics. Now the markets are more powerful than governments. The regression of the states authority can be observed regarding the increasing spread of the other institutions, unions and local/regional authorities. Hyperglobalists think that the world society is substituting (or will substitute) the traditional nationstate and new social organizations have started to appear. (Aktan, 2005) However the ones taking place in this group do not present a homogenous character. For example, neoliberals are pleased with the success of the market and individual autonomy on the power of state

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while on the contrary the neoMarxists (or radicals) of the same group consider the contemporary globalization as the representative of pressurizing global capitalism. In spite of all the differences in these ideological approaches, they share the opinion that there exists a gradually increasing integrated economy. Hyperglobalists believe that this period creates losers as well as winners. On one side there is the rise of a new global division of labor interchanging the traditional center and peripheral form, on the other side the presence of anascending anachronism between the south and north draws attention. Despite this background governments have to handle the social results of globalization. It may be possible for globalization to bind the polarization between the winner and the loser in the global economic order. At least according to the neoliberal idea it is not possible for global economic competition to end up in a zerosum production. Even though the position of some groups gets economically worse due to the global competition, almost all countries have a comparative advantage in the production of some goods. NeoMarxists and radicals do not support such an optimist belief. They think the global capitalism creates an inequality both among the nations and inside the nations. However they are of the same opinion that it is difficult and oldfashioned to establish social security by the hands of the traditional welfare state. Scepticals are also known as globalization opponents and they just support the opposite ideas with the hyperglobalists. They put forward that nothing is new in the world we are living. By looking at the past of globalization (19 th century) they tell that even in that period an important transaction of money and goods has come about. Today in spite of many countries strict national border controls, they claim that people did not use passports in the 19 th century. So this is just a return to past, not a new process. According to the scepticals, globalization is a simple term used by some of those whose aim is to wish to form the minimal government and state to demolish the welfare state. Some of the members of this group have qualified globalization as the tyranny of megacompanies that run after profit or as a geoeconomical imperialism. In the point of scepticals view globalization is not something unexpected but it is exaggerated and has been made a myth by the hyperglobalists. The world economy has integrated less than it did in the past. Besides, national governments are not the passive victims of internationalization. In addition to this, regionalism is not a station for globalization it is just the opposite, an alternative The world is moving towards a division around new thoughts instead of a global civilization. Globalization will bring about new conflicts in different cultures, different civilizations and different regions, but absolutely not integration. The inequality in world economy will give rise to fundamentalists or aggressive nationalism. Finally, scepticals believe globalization process is not a phenomenon occurring as a result of economic or technological developments but it is an ideological attitude. Transform mationalists, the group in which Giddens is, consider globalization as the political power behind the social, political and economic changes reshaping modern societies and the world order.There is no longer a distinction between reign/international and interior affairs there is a new integrated global market at the moment. The economy has been more bound to services sector. Knowledge, entertainment, communication and most important of all service concerning electronics and finance have become the most significant sectors in economy.

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Transformationalists accept thatthe national states have reconstructed their authorities and power. However they refuse the hypothesis of yperglobalists that the end of the independent nation state has come and of scepticals that nothing has changed. Transformation lists stand close to hyperglobalists rather than scepticals., GLOBAL ECONOMY, STRATEGY AND COMPETITION Global Strategy It is necessary to make a choice among some strategic dimensions in order to form a worldwidecompany. These can be explained in five groups like access to the market, standardization and presentation of goods, the origin of value added activities, marketing approach and competition acts.These elements may vary according to the multinational or global strategy that the company will follow. For instance, a multinational company makes an effort to maximize its local competitive advantages, income and profit whereas a global firm tries to maximize its intensive activities taking place in different parts of the world by integration. In this sense multinational companies perform their activities in every country, but global companies decide on where to perform which activity and so make an integration. Companies may be in need of internationalizing due to the factors related to market, costs, competition and politics. The reasons lying behind these general titles can be examined as the reasons to attack and reasons to defend Reasons to attack: To search a new market, To aim to reach high profits by reducing costs, To satisfy the top managements growing and spreading ambition. International Conference on Business, Economics and Management, Reasons to defend: To protect the owned local original market, To protect the other markets, To guarantee the supply of raw materials, To obtain technology, Geographical differences, To form a basis for new activities.

According to the common definition of ten global mangers from four continents, global companies must have the following three characteristics: 1. There must be a global strategy including a production, logistic, marketing, research and development plan to become a global company. Such a company proceeds its activities in an integrating manner with no boundaries. 2. A global company should have a sensitive distribution system that can perfectly meet the needs of the local people. It also should follow a main

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principle, value and working system and exactly apply these to the regions where they perform their activities. 3. Global firms must establish equilibrium between their global plans and local sensivities.This is the major matter for such a firm. Therefore it must have a clear and easily understood philosophy and its employees must believe in the fact that they can apply these principles. Global Competition In fact, competition is a kind of behavior special to mankind. However in the various fields that shape our lives, it can be defined in various ways. Economists, lawyers and businessmen have different definitions for the competition concept. According to the simple capitalist economy definition accepted by the economists, competition is determination of price and production with the sellers and buyers in the same market freely. In this context, the market in which competition will occur can be defined as the place where supply and demand meet and freely act. Functioning of the market economy depends on a healthy milieu. In competitive economics, competition can be described as a process of contrast relationships or as a race among economic units whose aim is to reach certain economic goals like financial income, the amount of sale and the share in the market. In the international markets success criteria are mentioned with different comments. Adam Smith said that a countrys chance to succeed in export is bound to high productivity. David Ricardo stated that in the international trade every country can be successful by transferring its resources to its most productive industrial branches. This idea of Ricardo was in time interpreted once more by Hecshler and Ohlin. After the Second World War technological developments had increased and the elements used in production in different countries were very much alike. And when globalization was added to these facts the concept of international competitive superiority came out. With the international competition power it has been accepted that the competition power is multidimensional and it means much more than the average power of the companies individually. The content of this subject has been formed by many institutional, technological and production structures, qualified labor and economic circumstances. The competitive power of a country is the level of that country to compete with other countries goods in quality and price context. This power is a precondition for increasing production and productivity, to improve life standards and develop employment. There are three different choices for a firm that is willing to access a foreign market. The first one is exportation by producing goods in its homeland and selling them to another country. The second one is to make a license agreement with the country the market of which it is wishing to enter by giving permission to using her technology and brand. The third one is making foreign direct investments in the market. Foreign direct investment means flow of international capital. Establishing a firm in a foreign country enlarges the main firm. One of the most important characteristics is that the

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main firm keeps both the possession and management of the branch or subsidiary under its control. The branch of the company is granted special rights by the main company, but it leaves the most of its income/profit partly or completely to the main company. In these foreign direct investments the one who owns the physical capital in the foreign country and managing it is called the multinational company. (Oksay, 2003) Why do they produce some goods not only in one country but more? This is a question of location.According to the location the resources determine theory the place of production. For example, the mining of aluminum is done orebed of the metal is. But the processing of it is done where electricity is cheap. Similarly transportation costs and trade barriers are the effective factors on deciding the place for production. Why the production in different places is done by the same company but not many companies? This is a question of internationalization. Some problems may occur if the main country produces really fine goods. Some coordination matters may take place because of the uncertainty of supply and demand. The changing prices in the countries can be considered as a risk for both sides. Multinational companies are important means of lending and borrowing money. Thinking that the capital will return, they usually supply the countries that their subsidiaries are in with capital. This process makes the foreign direct investments an alternative to international credit procedures The seven competition standards which have come out in the 1990s and are important in the companies globalizing are as follows The quality of product and production Variety for maximum preference Adaptation The speed and easiness in access Punctuality in innovation Low costs Global obtainability As a result, the strategy is the key point of progress and creates advantages in competition. Strategy is about differing companies from their rivals. A good strategy is related to the structural evolution of the industry. Although it is risky to apply global strategy, many companies have improved their methods of planning, controlling and applying. Otherwise they cannot understand the nature of competition and make the necessary investments and change.

The Effects of Globalization

The worlds integration offers new opportunities to developing countries, but it also brings out some important risks. These risks form the source of the main idea of the globalization opponents. The basic supporting thought of the antiglobal act is that globalization will affect those countries culture and International Conference on Business, Economics and Management, nature. Besides, peoples immigration will cause uncertainties and security problems will increase. It is neither realistic nor sensible to ignore globalization. It should be admitted globalization is being lived as a

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historical reality and in fact it depends on the countries how much they will benefit from it. The economic integration on a global basis has made countries dependent to each other. Therefore countries occasionally gather so as to take some measures about putting the world trade in order. World Trade Organization (WTO) is the outcome of such a gathering. Today WTO controls approximately 90% of the world trade. However it is being criticized for negatively affecting the developing countries trade and giving rise to poverty. Developing and underdeveloped countries form of the organization. Multinational companies help globalization of production and consumption by their activities. They also bring out both positive and negative results by their financial, technological and production power. Thus, as it can be seen below, sometimes a result can be positive and negative at the same time. For instance, multinational companies may introduce technology to underdeveloped countries (positive effect). But this technology may not be suitable for those countries yet (negative effect). Positive Effects: They help to increase the world trade. They finance development. They help the financing of international debts. They contribute in the improvement of liberal trade by removing obstacles like tariffs. They have the opportunity to introduce technology to underdeveloped countries. They decrease the cost of a product by supporting production. Negative Effects: As a result of foreign direct investments, they cause loss of jobs in the main country of the company. Therefore employment decreases. As production shifts to foreign countries the unqualified workers in the central country lose their comparative superiority, unless new or higher technology is introduced. They increase the number of oligopolistic groups that decline liberal entrepreneurship. The number of debtors increases. They limit the wages of workers. They increase the gap between rich and poor. Flexibility, one of the principle elements of globalization, has some properties that can change the structure of competition and employment. Usually the workers of flexible job types cannot be socially well protected. This situation is good for the employer but bad for the employees. Working styles are important factors in determining the salaries. Multinational companies prefer the countries where the wages are low.

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As well as the developing countries, developed countries have some problems with the global competition. The countries feeling under pressure form mergers and joint ventures. Daimler Chrysler, Briefly globalization is a frequently used term in economics, politics and social life for the last 25 years. It has its own supporters and opponents it has good sides and bad sides. Some has concluded that globalization is a source of wealth, while some said it is an instrument for imperialism. Although it was meant to integrate nations, it separated them and in some instances formed great social gaps instead, especially the North and the South. It has advanced the foreign direct investments against the national interests according to nationalists. Therefore it has been claimed by nationalism fans. Global competition has been affecting countries economies, social policies and legislations. The mentality of gathering capital has changed. Labor has been under the pressure of flexibility. Multinational companies bring money, labor and investments to foreign countries however they cannot help forming a shift in the equilibrium. Globalization can be positively evaluated when a product is cheap and of good quality, easily obtained, special for everyone, etc But small enterprises may not be successful in producing such products as well as the transnational big companies, so this may lead to Globalization-Threat or Opportunity Developing countries: How deeply integrated? Globalization means that world trade and financial markets are becoming more integrated. But just how far have developing countries been involved in this integration? Their experience in catching up with the advanced economies has been mixed. Chart 2a shows that in some countries, especially in Asia, per capita incomes have been moving quickly toward levels in the industrial countries since 1970. A larger number of developing countries have made only slow progress or have lost ground. In particular, per capita incomes in Africa have declined relative to the industrial countries and in some countries have declined in absolute terms. Chart 2b illustrates part of the explanation: the countries catching up are those where trade has grown strongly. Consider four aspects of globalization:

Trade: Developing countries as a whole have increased their share of world trade from 19 percent in 1971 to 29 percent in 1999. But shows great variation among the major regions. For instance, the newly industrialized economies (NIEs) of Asia have done well, while Africa as a whole has fared poorly. The composition of what countries export is also important. The strongest rise by far has been in the export of manufactured goods. The share of primary commodities in world exportssuch as food and raw materialsthat are often produced by the poorest countries, has declined. Capital movements depicts what many people associate with globalization, sharply increased private capital flows to developing countries during much of the 1990s. It also shows that (a) the increase followed a particularly "dry" period in the 1980s (b) net official flows of "aid" or development assistance have fallen significantly since the early 1980s and (c) the composition of private flows has changed dramatically. Direct foreign investment has become the most important category. Both portfolio investment and bank credit rose but they have been more

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volatile, falling sharply in the wake of the financial crises of the late 1990s. Movement of people: Workers move from one country to another partly to find better employment opportunities. The numbers involved are still quite small, but in the period 1965-90, the proportion of labor forces round the world that was foreign born increased by about one-half. Most migration occurs between developing countries. But the flow of migrants to advanced economies is likely to provide a means through which global wages converge. There is also the potential for skills to be transferred back to the developing countries and for wages in those countries to rise. Spread of knowledge (and technology): Information exchange is an integral, often overlooked, aspect of globalization. For instance, direct foreign investment brings not only an expansion of the physical capital stock, but also technical innovation. More generally, knowledge about production methods, management techniques, export markets and economic policies is available at very low cost, and it represents a highly valuable resource for the developing countries.

The special case of the economies in transition from planned to market economiesthey too are becoming more integrated with the global economyis not explored in much depth here. In fact, the term "transition economy" is losing its usefulness. Some countries (e.g. Poland, Hungary) are converging quite rapidly toward the structure and performance of advanced economies. Others (such as most countries of the former Soviet Union) face long-term structural and institutional issues similar to those faced by developing countries.

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Source: IMF World Economic Outlook Databases: (May 2000), Direction of Trade 1/ Excludes oil exporting countries.

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Does Globalization Increase Poverty and Inequality? During the 20th century, global average per capita income rose strongly, but with considerable variation among countries. It is clear that the income gap between rich and poor countries has been widening for many decades. The most recent World Economic Outlook studies 42 countries (representing almost 90 percent of world population) for which data are available for the entire 20th century. It reaches the conclusion that output per capita has risen appreciably but that the distribution of income among countries has become more unequal than at the beginning of the century. But incomes do not tell the whole story broader measures of welfare that take account of social conditions show that poorer countries have made considerable progress. For instance, some low-income countries, e.g. Sri Lanka, have quite impressive social indicators. One recent paper2 finds that if countries are compared using the UNs Human Development Indicators (HDI), which take education and life expectancy into account, then the picture that emerges is quite different from that suggested by the income data alone. Indeed the gaps may have narrowed. A striking inference from the study is a contrast between what may be termed an "income gap" and an "HDI gap". The (inflation-adjusted) income levels of todays poor countries are still well below those of the leading countries in 1870. And the gap in incomes has increased. But judged by their HDIs, todays poor countries are well ahead of where the leading countries were in 1870. This is largely because medical advances and improved living standards have brought strong increases in life expectancy. But even if the HDI gap has narrowed in the long-term, far too many people are losing ground. Life expectancy may have increased but the quality of life for many has not improved, with many still in abject poverty. And the spread of AIDS through Africa in the past decade is reducing life expectancy in many countries. This has brought new urgency to policies specifically designed to alleviate poverty. Countries with a strong growth record, pursuing the right policies, can expect to see a sustained reduction in poverty, since recent evidence suggests that there exists at least a one-to-one correspondence between growth and poverty reduction. And if strongly propoor policiesfor instance in well-targeted social expenditureare pursued then there is a better chance that growth will be amplified into more rapid poverty reduction. This is one compelling reason for all economic policy makers, including the IMF, to pay heed more explicitly to the objective of poverty reduction. How Can the Poorest Countries Catch Up More Quickly? Growth in living standards springs from the accumulation of physical capital (investment) and human capital (labor), and through advances in technology (what economists call total factor productivity).3 Many factors can help or hinder these processes. The experience of the countries that have increased output most rapidly shows the importance of creating conditions that are conducive to long-run per capita income growth. Economic stability, institution building, and structural reform are at least as important for long-term development as financial transfers, important as they are. What matters is the whole

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package of policies, financial and technical assistance, and debt relief if necessary.

Components of such a package might include:

Macroeconomic stability to create the right conditions for investment and saving Outward oriented policies to promote efficiency through increased trade and investment Structural reform to encourage domestic competition Strong institutions and an effective government to foster good governance Education, training, and research and development to promote productivity External debt management to ensure adequate resources for sustainable development.

All these policies should be focused on country-owned strategies to reduce poverty by promoting pro-poor policies that are properly budgetedincluding health, education, and strong social safety nets. A participatory approach, including consultation with civil society, will add greatly to their chances of success. Advanced economies can make a vital contribution to the low-income countries efforts to integrate into the global economy:

By promoting trade. One proposal on the table is to provide unrestricted market access for all exports from the poorest countries. This should help them move beyond specialization on primary commodities to producing processed goods for export. By encouraging flows of private capital to the lower-income countries, particularly foreign direct investment, with its twin benefits of steady financial flows and technology transfer. By supplementing more rapid debt relief with an increased level of new financial support. Official development assistance (ODA) has fallen to 0.24 percent of GDP (1998) in advanced countries (compared with a UN target of 0.7 percent). As Michel Camdessus, the former Managing Director of the IMF put it: "The excuse of aid fatigue is not credibleindeed it approaches the level of downright cynicism at a time when, for the last decade, the advanced countries have had the opportunity to enjoy the benefits of the peace dividend."

The IMF supports reform in the poorest countries through its new Poverty Reduction and Growth Facility. It is contributing to debt relief through the initiative for the heavily indebted poor countries.4 An Advanced Country Perspective: Globalization Harm Workers Interests? Anxiety about globalization also exists in advanced economies. How real is the perceived threat that competition from "low-wage economies" displaces workers from high-wage

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jobs and decreases the demand for less skilled workers? Are the changes taking place in these economies and societies a direct result of globalization? Economies are continually evolving and globalization is one among several other continuing trends. One such trend is that as industrial economies mature, they are becoming more service-oriented to meet the changing demands of their population. Another trend is the shift toward more highly skilled jobs. But all the evidence is that these changes would be taking placenot necessarily at the same pacewith or without globalization. In fact, globalization is actually making this process easier and less costly to the economy as a whole by bringing the benefits of capital flows, technological innovations, and lower import prices. Economic growth, employment and living standards are all higher than they would be in a closed economy. But the gains are typically distributed unevenly among groups within countries, and some groups may lose out. For instance, workers in declining older industries may not be able to make an easy transition to new industries.

What is the appropriate policy response? Should governments try to protect particular groups, like low-paid workers or old industries, by restricting trade or capital flows? Such an approach might help some in the short-term, but ultimately it is at the expense of the living standards of the population at large. Rather, governments should pursue policies that encourage integration into the global economy while putting in place measures to help those adversely affected by the changes. The economy as a whole will prosper more from policies that embrace globalization by promoting an open economy, and, at the same time, squarely address the need to ensure the benefits are widely shared. Government policy should focus on two important areas:

education and vocational training, to make sure that workers have the opportunity to acquire the right skills in dynamic changing economies and well-targeted social safety nets to assist people who are displaced.

Are Periodic Crises an Inevitable Consequence of Globalization? The succession of crises in the 1990sMexico, Thailand, Indonesia, Korea, Russia, and Brazilsuggested to some that financial crises are a direct and inevitable result of globalization. Indeed one question that arises in both advanced and emerging market economies is whether globalization makes economic management more difficult (Box 1). Does globalization reduce national sovereignty in economic policy-making? Does increased integration, particularly in the financial sphere make it more difficult for governments to manage economic activity, for instance by limiting governments choices of tax rates and tax systems, or their freedom of action on monetary or exchange rate policies? If it is assumed that countries aim to achieve sustainable growth, low inflation and social progress, then the evidence of the past 50 years is that globalization contributes to these objectives in the long term.

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In the short-term, as we have seen in the past few years, volatile short-term capital flows can threaten macroeconomic stability. Thus in a world of integrated financial markets, countries will find it increasingly risky to follow policies that do not promote financial stability. This discipline also applies to the private sector, which will find it more difficult to implement wage increases and price markups that would make the country concerned become uncompetitive. But there is another kind of risk. Sometimes investorsparticularly short-term investors take too sanguine a view of a countrys prospects and capital inflows may continue even when economic policies have become too relaxed. This exposes the country to the risk that when perceptions change, there may be a sudden brutal withdrawal of capital from the country. In short, globalization does not reduce national sovereignty. It does create a strong incentive for governments to pursue sound economic policies. It should create incentives for the private sector to undertake careful analysis of risk. However, short-term investment flows may be excessively volatile. Efforts to increase the stability of international capital flows are central to the ongoing work on strengthening the international financial architecture. In this regard, some are concerned that globalization leads to the abolition of rules or constraints on business activities. To the contraryone of the key goals of the work on the international financial architecture is to develop standards and codes that are based on internationally accepted principles that can be implemented in many different national settings. Clearly the crises would not have developed as they did without exposure to global capital markets. But nor could these countries have achieved their impressive growth records without those financial flows. These were complex crises, resulting from an interaction of shortcomings in national policy and the international financial system. Individual governments and the international community as a whole are taking steps to reduce the risk of such crises in future. At the national level, even though several of the countries had impressive records of economic performance, they were not fully prepared to withstand the potential shocks that could come through the international markets. Macroeconomic stability, financial soundness, open economies, transparency, and good governance are all essential for countries participating in the global markets. Each of the countries came up short in one or more respects. At the international level, several important lines of defense against crisis were breached. Investors did not appraise risks adequately. Regulators and supervisors in the major financial centers did not monitor developments sufficiently closely. And not enough information was available about some international investors, notably offshore financial institutions. The result was that markets were prone to "herd behavior" sudden shifts of investor sentiment and the rapid movement of capital, especially short-term finance, into and out of countries.

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The international community is responding to the global dimensions of the crisis through a continuing effort to strengthen the architecture of the international monetary and financial system. The broad aim is for markets to operate with more transparency, equity, and efficiency. The IMF has a central role in this process, which is explored further in separate fact sheets.5 accompanied by trade tensions and problems of financial instability should not come as a surprise, ...... The surprise is that these problems are not even more severe today, given that the extent of commodity and financial market integration is so much greater. " One possibility in accounting (for this surprise) is the stabilizing role of the institutions built in the interim. At the national level this means social and financial safety nets. At the international level it means the WTO, the IMF, the Basle Committee of Banking upervisors. These institutions may be far from perfect, but they are better than nothing, judging from the historical correlation between the level of integration on one hand and the level of trade conflict and financial instability on the other."6 (parentheses added)

As globalization has progressed, living conditions (particularly when measured by broader indicators of well being) have improved significantly in virtually all countries. However, the strongest gains have been made by the advanced countries and only some of the developing countries. That the income gap between high-income and low-income countries has grown wider is a matter for concern. And the number of the worlds citizens in abject poverty is deeply disturbing. But it is wrong to jump to the conclusion that globalization has caused the divergence, or that nothing can be done to improve the situation. To the contrary: lowincome countries have not been able to integrate with the global economy as quickly as others, partly because of their chosen policies and partly because of factors outside their control. No country, least of all the poorest, can afford to remain isolated from the world economy. Every country should seek to reduce poverty. The international community should endeavorby strengthening the international financial system, through trade, and through aidto help the poorest countries integrate into the world economy, grow more rapidly, and reduce poverty. That is the way to ensure all people in all countries have access to the benefits of globalization.

There are many components of Globalization. Banking & Foreign Direct Investment (FDI) is the most important components of Globalization. So we basically discussed both of the components.

Overall trends and developments in FDI

Global foreign direct investment (FDI) flows grew substantially in 2005 over those in 2004. As in the late 1990s, that growth was spurred by cross border mergers and acquisitions (M&As). Recent increases in FDI have been concentrated in certain

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sectors and regions/countries, and the level of concentration of FDI worldwide has also risen again. Furthermore, investments by collective investment funds (e.g. private equity and hedge funds) a relatively new source of FDI have been growing. As investments by these funds often have a shorter time horizon than those by more conventional transnational corporations (TNCs), current FDI growth may not be sustainable. In addition, the way in which the rise in global FDI flows is measured, does not necessarily translate fully into capital formation in host economies, as data on FDI flows include items unrelated to investment in production capacity. This section discusses recent trends in FDI, its composition and characteristics, as well as some issues related to FDI statistics.

Trends, patterns and characteristics

a. Global FDI Global FDI inflows rose by 29% to $916 billion in 2005, compared to a 27% increase in 2004 (figure I.1), largely reflecting a significant increase in cross-border M&As, both in value and in number of deals. FDI inflows increased in both developed and developing countries. The concentration of FDI flows between certain countries remains high, even accentuating somewhat since 2000 for developing countries and since 2003 for developed countries (figure I.2). However, its level is considerably lower than in the 1980s when not many countries received FDI inflows on any significant scale, or in the late 1990s when FDI distribution was particularly distorted by large-scale M&As. Even though concentrated, FDI inflows nevertheless grew in 126 out of 200 economies in 2005, compared to 111 economies in 2004. Growth in 2005 was broadbased geographically as in the previous year, but higher in developed than in developing countries. Thus, despite record inflows into developing countries, the share of developing countries in world FDI inflows fell slightly (to 36%), therebyincreasing the gap in FDI inflows between developed and developing countries to over $200 billion in 2005.1 The United Kingdom was the largest recipient of FDI in 2005, ahead of the United States, China and France (annex table B.1). The value of cross-border M&As a key mode of global FDI since the late 1980s started to pick up in 2004 following three years of decline, while their number has been growing since 2002 (annex tables B.4-B.7). On the other hand, greenfield FDI projects fell after increasing for two consecutive years (annex table A.I.1). 2 Diverging trends between cross-border M&As and Greenfield FDI are not surprising, because, to some extent, companies tend to consider these two modes of market entry as alternative options.

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Inward FDI in developed countries had already started to increase in 2004, after three years of significant decline between 2000 and 2003. That decline was mainly due to sluggish growth in the developed countries, in particular in the euro area and Japan. While developed countries other than those of the European Union (EU) contributed tothe growth of inflows in 2004, the increase in 2005 was particularly marked in the EU (97%), most notably in Germany, the Netherlands and the United Kingdom, each of which experienced an increase of more than $40 billion (more than $100 billion in the case of the United Kingdom). The five largest host economies in 2005 the United Kingdom, the United States, France, the Netherlands and Canada in that order accounted for 75% of total FDI inflows to developed countries. Inward FDI in developing countries rose by another 22% to $334 billion, following a 57% growth in 2004. Compared to other capital flows, FDI inflows remain the largest component of net resource flows to developing countries (figure I.3) and their share rose in 2005. While all developing regions experienced an increase in FDI flows, Africa saw a rise of 78%, with record inflows of $31 billion. Flows to West Asia reached $34 billion, an 85% increase over the previous year, and to

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South, East and South-East Asia they increased by 20%. In Latin America and the Caribbean, on the other hand, there was only a 3% increase, a much lower rate than in 2004 when flows to the region rose by 118% after four consecutive years of decline. FDI inflows in the 50 least developed countries (LDCs) recorded a historic high of $9.7 billion, mainly due to a significant rise in flows to Cambodia, the Democratic republic of the Congo, the Gambia, Guinea-Bissau and Mauritania, in each of which inflows more than doubled. Overall, FDI had been less concentrated and has not fluctuated widely since the mid-1980s compared to developed countries. Brazil, China, Hong Kong (China), Mexico and Singapore that have been the five largest host developing economies almost every year since 1996 accounted for some 48% of total flows to developing countries. In South-East Europe and the Commonwealth of Independent States (CIS), FDI inflows remained almost at the same level as in 2004, at around $40 billion. While

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there was a considerable increase in inflows in Ukraine, in other major recipient countries (Bulgaria, Kazakhstan, Romania and the Russian Federation) they declined. Global outflows in 2005 showed a somewhat different picture than did inflows, declining by 4% to $779 billion. It should be pointed out in this regard that the divergence in trends in FDI inflows and outflows reflects differences in the way countries compile FDI data. The size of earnings repatriated by a number of United States parent companies in 2005 partly explains, for instance, the divergence noted for that year: repatriated profits from foreign affiliates of United States firms are recorded in United States FDI data as negative outflows, while the host countries of these affiliates do not necessarily take into account reinvested earnings in their FDI data. Developing countries as emerging sources of FDI strengthened their global position further in 2005, investing $117 billion in 2005 4% more than in the previous year. The most notable growth of outflows was from West Asia: FDI outflows more a doubled, to $16 billion, backed by huge amounts of petrodollars and strong economic growth. Flows from South, East and South-East Asia declined by 11%, although China saw a sixfold increase in outward investments, amounting to $11 billion, while the other giant in this region, India, experienced a decline, after an almost twofold increase the year before. FDI outflows from Latin America and the Caribbean rose by 19%, to $33 billion, led by Colombia and Mexico (excluding offshore financial centres). Outflows from South-East Europe and the CIS rose modestly, with flows from the Russian Federation declining somewhat. Altogether, transition economies and developing countries invested a total of $133 billion abroad, the largest amount since 2000. The changes discussed above reflect recent FDI trends and changes in the geographic patterns of FDI flows. There are also significant long-term changes in the relative positions of countries and regions as hosts and home bases for FDI. Indeed, over the past few decades, the geography of FDI has undergone some major shifts, as noted below:

Over the past few decades the share of the Triad (the EU, Japan and the United
States) in total world inward FDI flows and stocks has fluctuated at around 60-70%. However, within the Triad, there has been a marked shift towards the EU. The share of the EU in FDI inflows into the Triad was 75% in 2003-2005, compared to 62% in 1978-1980 (table I.1). The EU which now also includes eight economies formerly classified under Central and Eastern Europe today accounts for almost half of global inward and outward flows and stocks. The rise of the EU in outward FDI flows and stocks is even more pronounced. Conversely, the importance of the United States in both inward and outward FDI flows and stocks has declined: since the beginning of the 1980s for outward FDI and the beginning of the 1990s for inward FDI (table I.1). Japan, which had emerged as an important source of FDI in the 1980s, has declined considerably in importance as an outward investor over the past 15 years, but gained somewhat as a recipient. However, it remains marginal as a host country.

Developing countries have gained in importance as recipients of FDI in terms of

both inward flows and stocks (table I.1). Their share in total world inflows rose from an average of 20% in 1978-1980 to an average of 35% in 2003-2005, though the performance of the different regional groups was uneven. The share of African

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countries gradually fell, from 10% of total inflows to developing countries in 19781980 to around 5% in 1998- 2000, but in the past few years it has recovered. The share of Asia and Oceania, particularly South, East and South-East Asia, increased rapidly driven partly by flows to China which appeared on the FDI scene only in the late 1970s until the end of the 1990s and then slowed down somewhat in the early 2000s. Latin America and the Caribbean region has experienced a noticeable decline from its dominant position of the 1970s and early 1980s. And so far it has not recovered to its previous level, even though FDI flows to the region are again on the rise.

Data on FDI outflows from developing countries point to the increasing dynamism
of this group of countries as sources of FDI. Their share in global outward FDI stock has fluctuated between 8% and 15% over the past 25 years, while their share in outflows points to a clearly increasing trend. Negligible or small until the mid-1980s, such flows from developing countries amounted to $117 billion, or about 15% of world outflows in 2005 (annex table B.1). Their FDI outward stock increased from $72 billion in 1980 to $149 billion in 1990 and to more than $1 trillion in 2005. More importantly, a number of developing countries have emerged as significant sources of FDI in other developing countries (chapter III), and their investments are now considered a new and important source of capital and production know-how, especially for host countries in developing regions. The increasing importance of FDI from developing countries reflects stronger ownership advantages of developingcountry firms, related somewhat to the growing importance of their home countries in the world economy, as demonstrated by various indicators. For example, developing countries accounted for over half of global output at purchasing-power parity value in 2005,5 for more than 40% of world exports, and for two thirds of global foreign exchange reserves. According to the competitiveness rankings of the worlds economies, in 1986 there was only one developing economy (Turkey) among the 20 most competitive economies, and by 2005 the number had increased to five: Taiwan Province of China, Singapore, the Republic of Korea, the United Arab Emirates and Qatar in that order (World Economic Forum 2005).

In the case of South-East Europe and the CIS, where FDI to and from most
economies started to increase from the early 1990s onwards in the wake of their transition to market economies, their share in both inward and outward flows and stocks, albeit very small, is on the rise. Within the region, the Russian Federation has always occupied a dominant position in FDI inflows as well as outflows. The emergence of developing countries and the transition economies of South-East Europe and the CIS as significant outward investors one of the above-mentioned significant changes in the pattern of FDI

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and the development implications of this phenomenon are discussed in detail in Part Two of this Report. b. Sectoral analysis: revival of FDI in natural resources The sectoral breakdown of FDI data is available for only a limited number of countries, and at most up to 2004, which prevents a comprehensive sectoral analyses of FDI. According to available data, the overall sectoral distribution of FDI in 2004 remained almost the same as in previous years (annex tables A.I.2-A.I.5). However, data on various forms of FDI by sector especially cross-border M&As show that in 2005 the primary sector gained in importance, in terms of both target and acquiring industries (figure I.4), while both manufacturing and services declined. Nevertheless, services remain the dominant sector in cross-border M&A deals ( WIR04). By contrast, FDI in manufacturing is on a downward trend, recording its lowest share ever of cross-border M&A sales and purchases in 2005 (excluding 2000, when the largest ever M&A deal of Vodafone-Mannesmann distorted the distribution, mainly in favour of services) (figure I.5). On the other hand, the growth of FDI in the primary sector, especially in mining activities, is very recent if viewed over the past 25 years and indeed dramatic. Cross-border M&A sales as well as purchases in this sector rose more than sixfold, and the sectors share in both sales and purchases reached close to the peak attained in 1987-1988 (figure I.5 for sales). 6 FDI in mining (including oil and other mining), which accounts for the bulk of the primary sector, has been largely responsible for the recent growth of global FDI. Current FDI growth seems to be led primarily by a few specific industries, rather than being broad-based sectorally. Specifically, in 2005, oil and gas, utilities (e.g. telecommunications,

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energies), banking and real estate were the leading industries in terms of inward FDI. For the first time since 1987 (M&A data are available only from that

year onwards), the petroleum (includes oil and natural gas) industry became the largest FDI recipient, accounting for 14% of all cross-border M&A sales, followed by finance and telecommunications the latter two partly as a result of further liberalization in some countries (chapter II) (annex table B.6). These three activities accounted for more than one third of the total value of M&A deals. They were closely followed by real estate, which has also become an important recipient of FDI since 2004 following the liberalization of FDI entry by various countries (WIR05). Considerable FDI also went to service industries such as construction, transport and software businesses that were responsive to economic growth in 2005 as in the previous year. In manufacturing, FDI in the industries related to primary products rose: for example, cross-border M&As in oil refining doubled and those in rubber and plastic goods quadrupled, while in metals industries they rose sixfold (annex table B.6). Metals, telecommunications and real estate also attracted more greenfield FDI than in 2004.7

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In terms of outward FDI, according to cross border M&A purchase data, the petroleum industry was dwarfed by the special finance industry comprising investment and commodity firms, including private equity firms and hedge fund investors (discussed in section 3.c). This special finance industry alone accounted for more than 30% of total cross-border M&A purchases in terms of value in 2005 (annex table B.6). The petroleum industry was the second largest acquiring industry, followed by telecommunications. Sectorally, FDI in the primary sector (natural resources, in particular, mining) has recovered slightly in the past few years, after a considerable decline in importance over the past two decades or more, while the services sector continues to capture an increasing share of FDI. A corollary of this is a further decline of the manufacturing sector in total FDI flows and stock. This is the same scenario for both inward and outward FDI, and in all groups of economies (annex tables A.I.2-A.I.5).

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c. Trends in international production International production, as measured by estimates of global FDI stock and of sales, assets, value-added, employment and exports by foreign affiliates, grew further in 2005 (table I.2). Given the important role of cross-border M&As and their rise in 2005, part of the expansion of international production and related assets and activities represents a shift of such assets and activities from domestic firms to TNCs rather than an addition to host countries output, employment and value added. However, the shift may itself contribute to a growth in host countries production capabilities over time due to possible sequential FDI aimed at expanding acquired production facilities (section 3 below). The number of TNCs worldwide has risen to about 77,000, with at least 770,000 foreign affiliates (annex table A.I.6). More than 20,000 of the TNCs originate in developing countries. FDI has grown faster than domestic investment (gross fixed capital formation), and FDI stock continues to rise. Thus the share of international production in world output, as measured by the share of value added of foreign affiliates in world GDP, is rising and is estimated to have been 10% in 2005, compared to 7% in 1990. On the assumption that a dollar of FDI stock from any home country leads to the same amount of international production everywhere, and based on past estimates of the relationship between FDI stock and foreign sales, employment and value added, respectively, TNCs based in developing countries and in South-East Europe and the CIS are estimated to have accounted for about $2.6 trillion in sales, employed 7.4 million workers and generated more than $500 billion in value added outside their home countries in 2005. (For individual country data on international production, see annex tables B.8- B.19). The degree of transnationality of host countries both developed and developing, as well as the transition economies of South-East Europe and the CIS measured by

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UNCTADs Transnationality Index, fell somewhat in 2003 reflecting a decline in FDI flows in that year. Significant differences continue to prevail in the degree of transnationality of different countries in all three groups, but the most and least transnationalized countries have remained the same in each host group as in the previous year. Some small developing countries experienced large changes in their ranking in 2003. The most significant changes were for Costa Rica, up from ranked 21 in 2002 to 13 in 2003, and the Dominican Republic, down from 13 in 2002 to 20 in 2003 The most transnationalized economy of all in 2003 was Hong Kong (China), followed by Ireland and Belgium. The increase in global FDI flows in 2005 was driven by many factors: macroeconomic, microeconomic (corporate) and institutional. The most important factor at the macroeconomic level has been continued economic growth.8 At the microeconomic level, a surge of financial flows to collective investment institutions (e.g. private equity funds, hedge funds) led to massive crossborder investments by these funds. At the institutional level, although a number of restrictive measures are being adopted to discourage takeovers, favourable conditions in financial and stock markets prompted the growth of cross-border M&As. However, data on FDI flows and stocks should be interpreted with caution, taking into account a number of issues related to FDI statistics. A rise in global FDI flows, for instance, does not necessarily mean increased productive capacities in host economies, as explained in the next section.

Some issues concerning FDI statistics: what is behind the numbers?

Host countries today generally welcome FDI, on the condition that it will lead to higher value added and/or higher rates of output growth in their economies. FDI flows are expected to represent funds for expenditure on capital formation in host economies. But in reality not all of the flows shown in FDI data represent external financial resources for investment, because they may have originated in that country itself in the first place (roundtripping), or because they are intended mainly for FDI in some other country (trans-shipping), as discussed below. And, even if they are transshipments, they do not necessarily translate into expenditures to build production capacity in host economies. Capital formation is the flow of expenditures that increase or maintain the real capital stock (sum of the value of capital goods used as factor inputs for production) in an economy. FDI that goes into new investment projects in an economy is part of this. However, FDI flows in the form of crossborder M&As in many cases simply end up transferring the ownership of production assets to the foreign investor and do not entail, at least in the short-term, any direct addition to capital stock in a host country (other than possible transfers of technology and know-how), as discussed in section 3 below. In addition, for different reasons, roundtripped investments, trans-shipped investments, as well as the bulk of investments in special purpose entities (SPEs) and in tax havens do not necessarily represent foreign investments in production capacity in host countries: they might eventually be used for productive investment in other, or even the originating, countries. The current FDI data, which include these kinds of investments, thus overestimate actual investment in production capacity. These issues are being extensively discussed by expert groups on FDI at the international level, in

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particular the Direct Investment Technical Expert Group 9 and the OECDs Benchmark Advisory Group,10 for the purpose of the revisions of the IMFs Balance of Payments Manual and the OECDs Benchmark Definition of FDI. Both groups set international guidelines for the compilation of statistics on balance of payments and international investment positions.11 these issues and problems were also underlined at an UNCTAD expert meeting held in Geneva in December 2005. FDI data should therefore be interpreted and used with all of these caveats in mind. More importantly, developing countries need to improve the quality of their FDI statistics a major challenge for many of them. Moreover, FDI data alone are not enough to assess the importance and impact of FDI in host economies. They should be complemented with statistical information on the activities of TNCs and their foreign affiliates (e.g. sales, employment, trade, research and development (R&D)). A new wave of cross-border M&As This section takes a closer look at the new wave of cross-border M&As, including the growing importance of collective investment funds particularly private equity funds and hedge funds in FDI and their contribution to the recent recovery of FDI flows. It also highlights some of the questions this phenomenon raises concerning future FDI flows. a. Recent trends Both the value and number of cross-border M&As rose in 2005, to $716 billion (an 88% increase) and to 6,134 (a 20% increase) respectively levels close to those of 1999, the first year of the latest cross-border M&A boom . While this high level of M&As reflected strategic choices of TNCs, it was also fuelled by the recovery of stock markets, which led to an increasing number of mega deals (each worth more than $1 billion in transaction value): in 2005, there were 141 such deals, than twice the amount recorded in 2004 and accounting for 63% of the total value of global cross-border M&As (table I.3 for individual deals see annex table A.I.7). These deals, the very large ones in particular, are typically concluded through the exchange of shares as a means of reducing the

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need for cash as well as for deferring or minimizing tax payments over capital gains. Indeed, some of them are impossible to effect by cash payment because of their sheer size. This is reflected in the increasing number of deals through an exchange of shares when cross-border M&As rise in value (table I.4). However, more recently, as noted below, due to the growth of FDI by collective investment institutions (e.g. private equity funds and hedge funds), M&As involving cash payment have also been on the rise. Although it is too soon to make exact comparisons, the present boom in crossborder M&As bears a number of similarities as well as differences with the previous one (table I.5). The value and number of M&As in 2005 were comparable to the averages in 1999-2001, as were the number of mega deals. The top three target countries in terms of shares of total sales by value the United Kingdom, the United States and Germany were the same as in the previous boom. On the other hand, there were some changes in the sectoral and industrial distribution of M&As in the two periods: the share of the primary sector was higher in the latest boom, at the expense of services this is reflected in the fact that the top three target industries in 2005 were mining, quarrying and petroleum. They pushed the two leading industrial categories in the previous M&A peak transport, storage and communications, and finance to the second and third positions respectively, and displaced business services from the top three. There are some noticeable differences in the factors underlying the present upsurge in cross border M&As, compared to those that drove the previous one. The financial markets and the dotcom boom no longer play key roles.

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Moreover, there is reason to believe that the present boom is driven primarily by strategic choices of firms in light of opportunities provided by economic growth, and that opportunistic factors play a smaller role in the current M&As. Thus the deals involve fewer industries than in the previous boom. Most cross-border M&As are undertaken within the same industry, except where new types of investors are involved, such as private equity firms (discussed later), that usually invest in any industry. B. Cross-border M&As versus Greenfield FDI Greenfield FDI refers to investment projects that entail the establishment of new production facilities such as offices, buildings, plants and factories, as well as the movement of intangible capital (mainly in services). This type of FDI involves capital movements that affect the accounting books of both the direct investor of the home country and the enterprise receiving the investment in the host country. The latter (or foreign affiliate) uses the capital flows to purchase fixed assets, materials, goods and services, and to hire workers for production in the host country. Greenfield FDI thus directly adds to production capacity in the host country and, other things remaining the same, contributes to capital formation and employment generation in the host country. Cross-border M&As involve the partial or full takeover or the merging of capital, assets and liabilities of existing enterprises in a country by TNCs from other countries. M&As generally involve the purchase of existing assets and companies. The target company that is being sold and acquired is affected by a change in owners of the company. There is no immediate augmentation or reduction in the amount of capital invested in the target enterprise at the time of the acquisition, except in some cases involving operations in which the direct investor already has an interest (see

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below). However, M&As may subsequently lead to an expansion (or reduction) of operations. If the acquisition is strictly an exchange of shares between residents and non-residents with no cash involved,12 there are no actual flows of financial capital. In the balance of payments, the exchanges of shares, which are recorded as inflows and outflows in the financial accounts of the two countries involved, should balance, resulting in no net inflow or outflow of financial capital. Such stock-swapping M&As accounted for 17% of total cross-border M&As in 2005 (table I.4). 13 It should be underlined, however, that even though FDI through M&As may not add directly to the total capital stock of a host country, it does add to foreign-owned capital stock (when domestic firms are acquired) and to international production. Thus, from the point of view of the outward investors, these are investments that add to their production capacities, and from a global point of view, they add to international production capacity

and cross-border production under the common governance of TNCs. More importantly, although most FDI through M&As does not represent a direct addition to the capital stock of countries, several factors must be taken into account in assessing its significance for capital formation and for development in host countries.

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c. An emerging trend: the rise in FDI by collective investment funds Investment firms, or collective investment institutions and schemes that include, among others, private equity firms and various financial investment funds (e.g. mutual funds, hedge funds) have recently become growing sources of FDI, mainly through cross-border acquisitions. This emerging trend is examined here, in particular with reference to private equity funds and hedge funds that are frequently used for FDI, and the transactions of which are recorded in FDI statistics. As long as cross-border investments of private equity and hedge funds exceed the 10% equity threshold of the acquired firm, these investments are classified and should be recorded as FDI, even if a majority of such investments are short term and are closer in nature to portfolio investments. Investments by these funds may be the latest examples of portfolio investment turning into FDI (Dunning and Dilyard 1999). Recent investments, however, involve a relatively long period of management by the funds themselves and have the characteristics of FDI. Further research is needed to better assess the true FDI or portfolio nature of such investments. Private equity funds are emerging as a new and growing source of investment, with a record amount of funds raised in 2005 $261 billion 14 about half of which were used for FDI.15 The investments are made primarily in companies in need of venture capital and in companies in distress, as well as in firms divested by large enterprises that prefer to concentrate on core competencies. Private equity firms are still largely concentrated in the United States and the United Kingdom, and the majority of the investments by private equity funds are still made in their home markets. But in recent years, such funds have expanded their business and investments into other countries and regions of the world. In 2005, 10% of all private equity funds raised were spent outside Europe and North America, in addition to global funds which are a mixture of funds raised in more than one country that accounted for another 20% (Private Equity Intelligence 2006, p. 9). In Europe, the single currency and the increasing integration of financial markets contributed to a significant increase in the importance of the private equity market (ECB 2005, p. 24). In Asia, companies with growth potential but in financial difficulty following the financial crisis (or a prolonged recession as in the case of Japan) have attracted such funds. In recent years, private equity funds have been joined by another type of funds hedge funds. These funds have also started to participate in buyout transactions and are in competition with traditional TNCs and private equity funds, with a record $1,200 billion raised in 2005. Provides an overview of the main characteristics of private equity funds and hedge funds and their investments. Private equity-financed FDI increased in 2005, but it is difficult to calculate exactly its share in total FDI inflows worldwide, as balance-ofpayments data do not distinguish between different types of investors. 16 The only available data are those on cross-border M&As by private equity funds, hedge funds and other similar investors.17 Such data suggest that such investments are rising: they reached a record $135 billion and accounted for as much as 19% of total cross-border M&As in 2005 (table I.6). These figures are even higher than those of the M&A peak period of the late 1990s and 2000. About 10% and 30% of the value and number, respectively, of these deals took place in developing countries, in particular developing Asia (figure I.7 for number of deals). Private equity funds normally obtain a majority of shares or full control and management of the companies they buy, and stay longer than other funds. Thus they are much more important for FDI than are hedge funds. The analysis that follows focuses on private equity funds. In 2005, the private equity market

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boomed worldwide, particularly in Asia, including Japan, and the EU. Historically low interest rates, high nliquidity of investors and the good performance of private equity funds led to an increase in investments in the funds. Half of the funds were venture capital funds. As in previous years, private equity firms in the United Kingdom and the United States accounted for the lions share of raised funds (85%) (Private Equity Intelligence 2006). In the United States, the private equity market traditionally has been of greater importance than in other countries. The majority of private equity funds invest in their own countries/regions. But a growing proportion of investments are now undertaken abroad. Often, private equity firms compete with traditional TNCs in acquiring foreign companies. In 2005, they were involved in several deals that included the largest buyouts in the world (table I.7). In many cases they invested jointly.18 In 2005, private equity firms invested abroad in various industries and sectors: for example in the services sector, including real estate, in Europe, the banking industry in developing Asia, and finance and leisure industries in Japan. In Germany, investments in real estate amounted to more than $13 billion. In general, in developed countries, the sectoral distribution of FDI by private equity firms is more or less equal between manufacturing and services sectors, but, unlike FDI overall or total cross-border M&As, the primary sector does not seem to be a significant target (figure I.8). In developing countries, the focus is more on services (80% of the total value). In developed countries, these firms invest largely in the food, beverages and tobacco industry in the manufacturing sector and in business activities (including real estate) in the services sector, while in developing countries and SouthEast Europe and the CIS their focus is more on finance and telecommunications. The increasing activity of private equity funds in cross-border investments raises questions about the implications of such investments for the long-term growth and welfare of the host economies. There is disagreement about the positive effects of private equity in the form of venture or risk capital (i.e. capital invested in firms with high growth potential but also a high level of risk). A recent study has shown that firms that receive external private equity financing tend to have a larger start-up size and can therefore better exploit their growth potential (Colombo and Grilli 2005). Investment in firms with high growth potential and high risk levels may appeal less to traditional investors, as the risk of such projects seems too large or too difficult to assess. Venture capital from foreign private equity firms may well help developing countries create firms that could become a Xerox, a Microsoft or an Apple of the future. However, the role of private equity funds in foreign acquisitions is particularly strongly debated when they invest in firms in distress. In a number of cases, private equity funds have been accused of putting companies up for resale within a short time period after squeezing profits out of them and laying off workers, or of slicing up and destroying companies. Sometimes, they have been referred to as heartless asset strippers,19 provoking a public outcry.

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For example, several such firms provoked public anger in the Republic of Korea (e.g. Newbridge Capital and Lone-Star, both United States private equity firms, when the former sold Korea First Bank in 2005 and the latter, Korean Exchange Bank in 2006). Similar examples are also prevalent in developed countries (e.g. Japan). One of the differences between FDI by private equity funds and that by traditional TNCs relates to the fact that the investment horizon of the former lasts, on average, only 5-6 years, while, in theory, traditional TNCs have typically engaged in expanding the production of their goods and services to locations abroad and have longer investment horizons. But more recently, TNCs have also increasingly been driven by short-term performance targets to meet shareholders expectations for high and rapid returns. The prospects for fund-raising and investment by private equity funds remain good for 2006. Some firms (e.g. KKR) even started to raise funds from stock markets by issuing shares. With growing expertise, such funds are increasingly investing abroad, driving FDI financed by private equity funds. New institutional investors from developing countries are also emerging. Examples include Capital Asia (Hong Kong, China), Dubai International Capital (UAE), H&Q Asia Pacific

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Hong Kong (China) and Temasek (Singapore). However, given the recent tendency of many such funds to use bank loans to finance private equity buyouts, a deterioration in the macroeconomic environment, especially a sharp increase in interest rates, could

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lead to difficulties for the private equity funds and slow down the dynamic development of their investment abroad. FDI by collective investment funds is a new form of foreign investment, which raises a number of questions that deserve further research. For instance, how does FDI financed by private equity funds differ from FDI by TNCs in its strategic motivations? Who controls such funds? And what are their impacts on host economies? 4. FDI performance and potential Some changes took place in 2005 (or the 2003-2005 average) of rankings by the UNCTAD Inward FDI Performance Index,20 reflecting uneven developments with respect to FDI inflows (annex table A.I.9). By country, as a result of continued large investments in its oil and gas industry, Azerbaijan still led the performance index ranking ahead of other small economies usually well represented among the leaders such as Brunei Darussalam, Hong Kong (China), Luxembourg, Malta and Singapore (table I.8). Estonia came fourth (having moved up from the 15th position in 2004 (or the 2002-2004 average). Among the top 20 performers by the index, 12 were developing economies and three were from the transition economies of South- East Europe and the CIS. Many high performers are oil- and gas-producing economies. By region, the group of developed countries suffered a decline in its relative position, reflecting large falls in FDI in some countries (table I.9). Within the group, the largest declines were in the EU, although significant gains were observed for the Netherlands and the United Kingdom (annex table A.I.9). On the other hand, the developing regions, with the exception of Latin America and the Caribbean, improved their ranking by the FDI Performance Index. The highest index was that of South-East Asia, but the sharpest rise was achieved by the North African region (with Sudan, Egypt and Morocco moving up in the rankings) and West Asia. South-East Europe also improved its index in 2005 (table I.9). The two candidates for EU accession, Bulgaria and Romania, figured among the top 30 (annex table A.I.9). In contrast to changes in rankings in the performance index, there were almost no changes in the rankings based on the Inward FDI Potential Index21 (annex table A.I.9 for rankings of all 141 countries). The top economies remain the same as in the previous year, almost in the same order. This reflects the stability of the structural variables comprising the Index. The United States and the United Kingdom ranked first and second, and 15 developed countries ranked among the top 20. Singapore, Qatar, Hong Kong (China), the Republic of Korea and Taiwan Province of China, in that order, were the developing economies that featured among the top 20 in the 2005 ranking. Comparing their inward FDI performance and potential using the UNCTAD indices, countries in the world can be divided into the following four categories: front-runners (countries with high FDI potential and performance) above potential (countries with low FDI potential but strong FDI performance) below potential (countries with high FDI potential but low FDI performance) and underperformers (countries with both low FDI

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- 36 -

potential and performance) (table I.10). There are some surprises for the first and last groups. While the first group included many developed countries and newly industrializing economies, in 2004 (2002-2004 average), the most recent year

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available for this analysis, countries such as Denmark, France and Switzerland were categorized as below potential. The last group consisted mainly of poor and lowincome developing economies, including LDCs and countries affected by economic or political crises. Performance in FDI outflows relative to the size of economies, as measured by the Outward FDI Performance Index, 22 showed only a few changes in country positions in 2005 as compared with those in 2004. Iceland and Hong Kong (China) head the list, and the composition of the top 10 economies was the same as that of the previous year (2004), with six developed countries, three developing economies and one transition economy from the CIS (Azerbaijan). In general, as in the case of inward FDI performance, small economies ranked relatively high in the Outward FDI Performance Index. Chapter III further discusses developments based on this index for developing countries.

Policy developments
1. National policy changes The year 2005 saw intense discussions in many parts of the world on the merits of liberalization versus the need for economic protectionism. Most countries continued to liberalize their investment environment but others took steps to protect their economies from foreign competition or to increase State influence in certain industries. In particular, the Latin American oil and gas industries were the focus of attention culminating in the decision in Bolivia to nationalize its oil and gas industry in May 2006. A total of 205 policy changes were identified by UNCTAD in 2005 (table I.11). In terms of regional distribution, Africa accounted for 53 policy changes, followed by Asia and Oceania (48), developed countries (44), South-East Europe and the CIS (39) and Latin America and the Caribbean (21). The number of FDI-related changes in national laws was slightly lower than those reported for the past three years. This partly reflects a change in the methodology used by UNCTAD to gather the data.23 Most of the changes in 2005 made conditions ore favourable for foreign companies to enter and operate. The types of measures most frequently adopted were related to sectoral and cross-sectoral liberalization (57 policy changes), promotional efforts (51 policy changes), operational measures (22 policy changes) and FDI admission (19 policy changes). Fifty-one measures involved new promotional efforts, including various incentives aimed at furthering investment in certain economic activities. Greece, for example, introduced new incentives for investments in tourism and into R&D activities. Most of the changes reported were related to corporate income taxes, considered

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promotional measures and thus included in these statistics. A significant number of countries continued to lower these rates, a measure which may not only attract FDI but also benefit domestic enterprises. Rate reductions were most significant in Europe, where especially the new EU members continued to revise their corporate tax laws.24 There were also some cases in other regions. For example, Ecuador introduced tax breaks of 10-12 years for investment in selected industries such as agriculture or tourism.25 India introduced a law that grants foreign investors tax incentives for investing in special economic zones.26 Tax increases have been the exception, and were observed only in the Dominican Republic (25% 30%), Equatorial Guinea (25%35%), Lithuania (15%19%) and the Philippines (32%35%) (KPMG 2006). Some countries, such as Georgia, reformed their entire tax system and introduced flat taxes, an approach adopted also in several of the new EU member countries. Asia and Africa were the leading regions in terms of introducing further sectoral liberalization. Some countries decided to liberalize certain sectors for the first time. The Libyan Arab Jamahiriya, for example, permitted foreign banks to open branches or the first time. Other countries, such as Egypt, combined sectoral liberalization with the introduction of more favourable operational

measures.27 Nineteen countries introduced crosssectoral liberalization, allowing foreign ownership in several economic sectors. Botswana, for example, published a

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privatization master plan that provides a framework for follow-up privatizations. A number of countries also improved policies towards inward FDI. Israel linked a reform of its FDI admission procedure with the granting of expanded incentives. 28 Croatia and the former Yugoslav Republic of Macedonia set up one-stop shops for FDI admission, and New Zealand significantly raised the amount of investment for which no approval is needed (from $50 million to $100 million). Only three instances were noted of countries that enacted new policies to improve the legal protection of FDI. Colombia, most notably, introduced legal stability contracts to boost investor confidence. While policy changes that were favourable to FDI still dominated in 2005, the number of changes making a host country less welcoming to FDI was the highest ever recorded by UNCTAD. In fact, the share of less favourable changes has been rising steadily, from 5% in 2002 to 20% in 2005. The share was particularly high in Latin America, where two thirds of the observed changes implied less favourable measures vis--vis inward FDI (figure I.9).

New measures introduced have in many cases been linked to the exploitation of natural resources. Bolivia decided to nationalize its oil and gas sector in May 2006, while Venezuela continued to increase the control of the State-owned PDVSA over its oil production by renegotiating concession contracts with foreign investors. Consequently, a number of international oil companies agreed to sign new jointventure contracts transferring majority ownership of their concessions to the PDVSA and accepting a higher tax rate (chapter II.A.4). In Chile, a new law imposed a tax of 5% of operating profits on mining operators that produce more than 50,000 metric tons of copper per year. Argentina extended the economic emergency laws adopted in 2002 for one more year, through 2006. This gives the Government widespread powers to adopt economic measures by decree and, in particular, allows renegotiation of privatized utilities contracts (including tariffs). Various measures to make the environment for investment less welcoming were observed in other parts the world as well. For example, the

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Government of Eritrea closed down the investment promotion agency (IPA), suspended private importexport licences and limited the free transfer of foreign exchange. Mirroring the trend to tighten control over natural resource extraction, the Central African Republic suspended for an indefinite period the issuance of new gold and diamond permits and banned foreigners from entering mining zones. Some developed countries introduced changes to defend the position of national champions. The French Government, for example, declared that foreign control of companies operating in 11 industries of national interest should be prevented. 29 In addition, a number of cross-border M&As triggered intense political discussions in countries such as France, Italy, Spain and the United States. Those discussions did not result in regulatory changes, but had a negative impact on certain cross-border mergers (see chapter VI). The trend to increase controls on FDI has drawn the attention of the international media. UNCTADs data also suggest that the balance of more and less favourable changes to FDI is shifting somewhat. For the time being, the trend is mainly confined to a small number of countries and relates primarily to investments in natural resources. FDI changes at the regional level are further described in chapter II. 2. Recent developments in international investment arrangements The trend from previous years of expansion and increasing sophistication in international investment rule-making at the bilateral, regional and interregional level continued in 2005. The evolving system of international investment rules may contribute to creating an enabling framework for FDI. At the same time, managing the universe of multilayered and multifaceted international investment agreements (IIAs)30 becomes more demanding, in terms of keeping it coherent, ensuring its effective functioning and making it conducive to national development objectives. a. The IIA network continues to expand The universe of IIAs continues to grow. In 2005, 70 bilateral investment treaties (BITs), 78 double taxation treaties (DTTs) and 14 other IIAs were concluded. The total number of IIAs was close to 5,500 at the end of 2005: 2,495 BITs, 2,758 DTTs and 232 other international agreements that contain investment provisions (figure I.10). Several trends are worth noting in this context: ,A first observation concerns the geographicl distribution of IIAs. Asian countries are particularly engaged as parties to approximately 40% of all BITs, 35% of DTTs and 39% of other IIAs. Africa and South-East Europe and the CIS are generally more active than their Latin American counterparts in terms of BITs and DTTs, while Latin American countries are more active in concluding other types of IIAs, in particular free trade agreements. A second noticeable trend is the growing involvement of many developing countries in IIAs. At the end of 2005, they were party to 75% of all BITs (figure I.11), 58% of all DTTs (figure I.12), and 81% of other IIAs. Two developing countries (China and Egypt) were amongst the top 10 signatories of BITs worldwide (figure I.13). LDCs, although host to only 0.7% of global FDI inward stock, had concluded 15% of all BITs, 6% of DTTs and 15% of other IIAs (table I.12). IIAs between developing countries have increased substantially. For example, the total number of BITs among developing countries leapt from 42 in 1990 to 644 by the end of 2005. During the same period, the number of DTTs concluded between developing countries rose from 105 to 399, and the number of other IIAs from 17 to 86. Third, recent IIAs tend to become more sophisticated in content, clarifying in greater detail the meaning of certain standard

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clauses and procedural rules relating to dispute settlement. Furthermore, a growing number of agreements express more clearly the public interest involved in such matters as the protection of health, safety and the environment. 31 These treaties therefore mark a step towards a better balancing of the rights of foreign investors and respect for legitimate public concerns. This may contribute to a broader acceptance of these agreements by interested stakeholders and other segments of civil society.

Fourth, international investment rules are increasingly adopted as an essential part of free trade agreements (FTAs) and other treaties on economic cooperation (figure I.14). These other IIAs may cover services, intellectual property, competition, labour, environment, government procurement, temporary entry for business persons and transparency, among others. This broad coverage demonstrates a trend towards an integrated approach in dealing with interrelated issues in international investment

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rule-making. The investment provisions included in these IIAs differ in their nature, scope and content of obligations. While the total number of IIAs other than BITs and DTTs is still relatively small, they have almost doubled over the past five years. In addition, as of 1 May 2006, at least 67 agreements were under negotiation involving 106 countries (see annex tables A.I.15 and A.I.16). This suggests there will be an even more pronounced increase in such treaties in the near future. At least five FTAs with legally binding substantive investment provisions were concluded from January to May 2006. Finally, recent years have seen an increase in investor-State disputes. In 2005, at least 50 new cases were filed, bringing the total number of treaty-based cases to at least 226 by the end of 2005 (figure I.15). Some 136 out of a total of 226 cases were filed with the International Centre for Settlement of Investment Disputes (ICSID). Other disputes were initiated under the United Nations Commission on International Trade Laws (UNCITRAL) Arbitration Rules (67), the Stockholm Chamber of Commerce (14), and the International Chamber of Commerce (4) and ad-hoc arbitration (4), while the remaining case involved the Cairo Regional Centre for International Commercial Arbitration. At least 32 awards were rendered in 2005. While investment arbitration in general has helped to clarify the meaning and content of individual treaty provisions, some inconsistent decisions have also created uncertainty.32 Along with the observed rise of FDI from developing economies (see Part Two of this Report) there have also been a number of investor- State disputes involving TNCs from these economies (box VI.12). b. Systemic issues in international investment rule-making Greater diversity of IIAs in terms of their scope, structure and content reflects the flexibility that countries would like to have in choosing the partners to enter into an agreement, and to tailor

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individual agreements to their specific situations, development objectives and public concerns. Furthermore, more elaborated rules may enhance legal clarity regarding the rights and obligations. Multiple coverage under more than one IIA may also contribute to improving the investment climate in the host countries for FDI by creating a synergetic effect and filling possible gaps in the overall treatment of foreign investment. The increasing sophistication of IIAs also reflects the greater attention of policy-makers on the interface of different policy matters and the integrated treatment of those issues. By addressing investment together with other issues such as trade, services, competition, intellectual property and industrial policies in one and the same IIA, it becomes easier for countries to cover simultaneously different facets of investment activity, to set in place mutually reinforcing strategies to attract foreign investment and to avoid one policy being pursued at the expense of another. On the other hand, the growing diversity of IIAs also means that foreign investors and governments have to operate within an increasingly complex framework of

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investment rules. Establishing and maintaining the coherence of the IIA network may therefore become more challenging (box I.7). The complexity and rapid pace at which new IIAs are being concluded may create logistical problems for negotiating parties related to their lack of capacity, in particular for developing countries. Many lack sufficient financial resources and expertise to be able to assess fully and in time the implications

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THE GLOBALIZATION OF BANKING This Reports analyzes the role of international and local financial institutions in the ownership and performance of listed banks around the world. The concentrated patterns of ownership by financial institutions suggest that their objective is not portfolio diversification, but control of the banks to extract value from access to their funds. This suggestion is supported by empirical evidence on the cross-economy correlations between holdings by financial institutions and indices of institutional quality. It is further supported by regressions testing the impact of these variables on bank returns. Our evidence is consistent with strategic investments by international financial institutions to exploit institutional weaknesses in emerging economy banking systems. Such strategies could be implemented via the usual long-term banking relationships between international financial institutions and their multinational clients. Earlier studies of the impact of ownership structure on bank performance focussed on one economy or one ownership category. OHara (1981), Nicols (1967), Miles (1994), Mester (1989, 1993), and Cebenoyan et al. (1993) compared the performance of US banks controlled by shareholders with those that are mutually owned. Altunbas, Evans and Molyneux (2001) examined the impact of ownership structure on the performance of German banks. They found that privately-held banks have somewhat higher costs and lower profits than those with mutual or state ownership. Lee (2002) examined the impact of ownership structure on bank risk profiles. In a cross-economy comparison, La Porta et al. (2002) found that state ownership of banks is common, especially in emerging economies, but tends to retard financial and economic development. The privatization of banks might therefore benefit emerging economies. However, this would be true only if the privatization leaves banks with ownership structures and control mechanisms that motivate them to finance only economically productive projects and to monitor their management. Without effective regulation, disclosure and corporate governance, a switch to private ownership of banks might create new obstacles to economic development. For example, in discussing the 1997 Asian Financial Crisis, Delhaisie (1998) and Backman (1999) tell how bank depositors and taxpayers were exploited as privately-owned banks within corporate groups were looted via related-party transactions. Foreign investors might play a constructive role as bank owners, especially foreign financial institutions that could bring managerial and technical expertise, higher professional standards and access to international financial markets. International financial institutions indeed play an important role in the banking systems of many emerging economies. However, they often meet hostility from critics of globalization suspicious of their motives and from nationalists jealous of sovereignty. Our study provides empirical evidence on the role and impact of international financial institutions on banks around the world. Our first task was to build a comprehensive database of the ownership structure of all listed banks around the world that have reliable financial data. A preliminary review

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found that the state holds large blocks of bank shares in some economies, but that larger blocks are held by local financial institutions (henceforth, Lfi) and foreign financial institutions (henceforth, Ffi). Therefore, we classify the state, Lfi and Ffi as different types of owners, and group all the other owners as a fourth type. Within each economy, we compute the average holdings in banks by each type of owner. We then compute the cross-economy correlations between these averages for all pairs of owner types. Strikingly, this reveals a significantly negative correlation between the average ownership shares of all six possible pairs of owner types. (See Table 4.) This suggests that each type of owner tends to dominate bank ownership in one set of economies, but limits its ownership in the remaining economies. In turn, this suggests a struggle amongst different types of owners for the control of banks, presumably because control yields considerable benefits. Evidence consistent with these suggestions emerges from the average holdings by Lfi and Ffi in the banking systems of the economies in our database. Out of 74 economies, there are 27 where Lfi holdings in banks average at least 15 percent, while Ffi holdings average less than 15 percent in 21 economies, the reverse is true. In only 8 economies do both Ffi and Lfi holdings average at least 15 percent. This leaves 18 economies where both Ffi and Lfi holdings average less than 15 percent. In most of these 18 economies, we can identify institutional reasons for these low levels of investment by financial institutions. (See Table 5.) At the level of individual banks, there is even more extreme polarization of ownership by Lfi and Ffi. For 72.30 percent of the banks in our database, either a small group of Ffi (no more than 5) is in control, holding at least 20 percent of the shares, or a small group of Lfi is in control. (Moreover, the banking systems of most economies are dominated by financial institutions: in 56 out of 74 economies, at least half the banks are controlled by financial institutions in 50 of these 56 economies, all financial institution-controlled banks are controlled by Ffi only or by Lfi only. (See Table 8.) In our entire database of 834 banks around the world, we find no bank where both Lfi and Ffi hold a substantial block of shares. Thus, coalitions of financial institutions of one type appear to seek control of banks, avoiding substantial investments in banks indeed, in economies where the other type of financial institution is dominant. The extent of bank control by Lfi and Ffi might depend on the quality of business institutions (property security, contract security), political institutions (rule of law, official integrity) or legal institutions (legal system). Indeed, we find that state ownership of banks is negatively correlated with quality indices for each of these institutions. Lfi ownership and Ffi ownership are each correlated positively with both indices of business institutions. Surprisingly, they are correlated negatively with both indices of political institutions and with the index of legal nstitutions. (Are these correlations driven by search for higher returns? We test how the return on equity of individual banks is affected by ownership structure, in five regressions that each also include one of the above five institutional indices. (See Table 10.) Each index of business institutions has a significantly positive impact on the banks return on equity. The legal system index has a significantly negative impact so do the political indices, but with lower significance. Thus, the above-noted cross-economy correlations between bank ownership by financial institutions and institutional quality are indeed consistent with a search for higher returns by international financial institutions. In particular, our results offer a simple, but provocative, explanation for why Ffi tend to invest more in banks in economies

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with lower quality legal environments: such environments offer them higher returns. When we control for the quality of the legal system, we find that higher ownership by Ffi is associated with a significantly lower bank return across emerging economies, but with an insignificantly higher return across all economies. We would have expected Ffi to invest more in banks in emerging economies where they enjoy higher returns. Thus, our empirical results suggest that the return on equity paid to general shareholders represents only part of the return captured by Ffi when they invest in emerging economy banks. These results raise questions about the role of international financial institutions in economic development. Do they calibrate their investments around the globe to exploit the institutional inadequacies of emerging economies? Might they be exploiting their international contacts to siphon low-cost funds from banks in emerging economies, where institutions are too weak to protect the other shareholders? We conclude this paper by proposing an informal model that would yield these outcomes when international financial institutions behave rationally in setting up in long-term relationships with multi-national corporations we then suggest some testable implications of the model.

The Impacts Of Globalization In Bangladesh

The impact of globalization on poverty in Bangladesh How did globalization impact on the growth-poverty nexus described above? We attempt to answer this question in two parts: first, by examining the mechanisms through which globalization might have affected the growth process and, second, by identifying its impact on the employment opportunities of the poor. The impact of globalization on the growth process The preceding section has argued that the modest growth acceleration that occurred in the 1990s was led by small and medium enterprises in the non-farm non-tradable sectors. Furthermore, as these enterprises created new opportunities for wage employment, the rural poor benefited more than before since wage employment is more rewarding for them than the petty self-employment in which they have traditionally been engaged when looking for alternative employment opportunities outside agriculture. As a result, growth acceleration translated into a faster rate of poverty reduction as well. At the first sight, globalization would seem to have little to do with this process, since globalization has to do with a countrys relationship with the external world, whereas production of non-tradables is by definition geared towards the domestic market. But this view is too simplistic. Non-tradables may be produced for the domestic market, but they are not insulated from the countrys interactions with the outside world. Through a variety of transmission mechanisms, the parameters of globalization may deeply influence, for better or worse, the incentives for and the profitability of producing non-tradables. There are reasons to believe that Bangladeshs engagement with globalization i.e. her increasing integration with the world economy has

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helped the accelerated growth of non-tradables in two ways from the demand side, by boosting the demand for non-tradables, and from the supply side, by reducing their cost of production. In so doing, globalization has contributed positively towards engendering the growth process that led to faster reduction of poverty in the 1990s. It was noted in the preceding section that there were three proximate sources of enhanced demand for non-farm non-tradable goods and services in the 1990s viz., rapid expansion of the ready-made garments sector, increased flow of remittances from abroad, and a quantum jump in rice production in the late 1980s. Globalization has lent a helping hand to each of these proximate sources. The link of the first two sources with globalization is obvious enough. Since the ready-made garments industry is almost wholly export-oriented, its expansion indicates increasing integration with the world economy in the goods market. On the other hand, increased remittances sent by Bangladeshi workers working abroad stems from increasing integration in the factor market. To some extent, these processes of globalization were helped by conscious policy decisions to impart a greater degree of outward orientation to the Bangladesh economy. In particular, trade and exchange rate policies played an enabling role in this regard, by reducing the bias towards inward-oriented production of import. After a hesitant start in the early 1980s, this process took off in earnest later in the decade with the removal of quantitative restrictions on imports, which resulted in the elimination of very high scarcity premiums that import substitutes used to enjoy. New rounds of trade reforms undertaken in the early 1990s took this process further by reducing import tariffs to significantly lower and uniform levels. According to one calculation, the weighted average rate of nominal protection offered through import duties came down from 42 per cent in 1990-91 to 20 percent 1999-2000 .10 The combined effects of removal of quantitative restrictions on imports and reduction of import tariffs went a long way towards encouraging export orientation by reducing the bias towards import substitutes. Export orientation received further impetus through a variety of other measures of support offered by the government to the export-oriented firms. These measures included concessional credit, tax exemptions, duty drawback on imported raw materials, and provision of infrastructural facilities on preferential terms (for example, through the creation of export processing zones). All this was helped further by adopting a flexible exchange rate policy that prevented the incentive-dampening effect of overvaluation of the currency. In fact, for most of the 1990s, the real effective exchange rate experienced a modest depreciation, thereby raising the profitability of exports.11 Thus on the one hand, trade liberalization reduced the incentive for import substitutes, and thereby raised the incentives for both exportables and non-tradables. On the other hand, direct measures of support for export-oriented firms as well as exchange rate policy encouraged exportables vis--vis non-tradables. As a combined result of all these policy actions, the incentive structure moved decisively in favour of exportables in the 1990s relative to both importables and non-tradables. Policy-induced incentives were, however, not the only factor behind the success of readymade garments. A big role was played by external factors in particular, the Multi-Fibre Agreement (MFA) that had governed international trade in textiles since 1974. While restricting the overall flow of imports of cheap textiles from the developing to the developed world, the MFA did allow a number of LDCs (least developed countries) quota-based access to the large North American markets, especially for low value-added products. Bangladesh was one of the beneficiaries of this system as much as 70 per cent of Bangladeshs garment exports

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gained access to the large US market through this process. This, along with the privileges granted by the European Unions Generalised System of Preferences (GSP), played an important part in the rapid expansion of Bangladeshs garment industry in the 1990s. The empirical question of what are the relative contributions of external factors on the one hand and policy-induced changes in the incentive structure on the other towards promoting the garments industry of Bangladesh remains unresolved. There has been no quantitative study so far to separate out the two effects even in terms of broad orders of magnitude. There is, however, a general presumption among the observers of the Bangladesh scene that the external factors might have been the dominant ones. Be that as it may, what cannot be disputed is the fact that the ready-made garment industry is the prime beneficiary of the 10 This estimate excludes non-protective import taxes such as VAT, which are supposed to be imposed equally on both imports and domestic goods (although there is some evidence that in certain instances VAT was imposed specifically on imported goods, thereby offsetting at least in part the effect of tariff reduction.) 11 From the late 1980s to mid-1990s, real depreciation took place to the extent of 12 to 15 percent Although the process was reversed in the latter half of the decade, it is important that exchange rate depreciated precisely at the time when the fledgling export-oriented industries were trying to get a foothold in the world market. By the time the exchange rate appreciated, the foothold was already reasonably firm. 12 It is not being suggested that the incentive structure became biased in favour of exportables. In fact, there are indications that the structure of incentives still discriminates against exports relative to importables (Ahmed and Sattar, 2003). The point is simply that the pre-existing bias against exportables has been reduced to a considerable extent. process of globalization of Bangladesh even though one may not be able to judge how far this process was aided by domestic policies and how much by external factors. A similar conclusion holds regarding remittances. Domestic policies did help to the extent that the Government has tried actively to seek overseas employment opportunities for Bangladeshis and avoided overvaluation of the currency. But it was the external factor viz. demand for cheap labour in the oil-rich countries of the Middle-East and elsewhere that was the driving force. Whatever the relative contributions of different factors, however, the increased flow of remittances remains a globalization-driven phenomenon, operating through the factor market, just as the growth of RMG has been a globalization-driven phenomenon operating through the product market. This brings us to the third source of enhanced stimulus of demand in the 1990s namely the quantum jump in rice production that occurred in the late 1980s. One way of looking for any possible impact of globalization on this phenomenon is to judge how the process of trade liberalization might have affected the relative price structure in the product market. It is important to note in this context that although rice is in principle a tradable commodity, for all practical purposes it qualifies as a non-tradable in Bangladesh as its price tends to fall between import parity price and export parity price in normal conditions. As such, trade liberalization must have improved the relative price of rice (along with the price of all non-tradables) vis--vis importables by reducing the incentive bias that existed in favour of importables in the pre-liberalization era. On the other hand, the special incentives given to the export sectors as well as a slowly depreciating exchange rate must have reduced the incentive for rice production vis-vis exportables. The net effect on incentives in the product market is, therefore, difficult to judge.

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What is much clearer, however, is the incentive provided by trade liberalization through the input market. In fact, it is arguable that the major credit for bringing about the quantum jump in crop production in the late 1980s goes mainly to liberalization of markets for agricultural inputs, especially elimination of non-tariff barriers to the importation of cheap irrigation equipment. Because of import liberalization, which took effect in 1988, the price of shallow tube-well in particular came down drastically. Until about 1986, shallow tube-wells used to be distributed by the government at a subsidised price in order to promote more extensive use of irrigation. Liberalization provided an alternative, and from the point of view of government budget a much less expensive, method of achieving the same goal. In fact, the price of shallow tube-wells came down so much that the market price turned out to be almost 40 per below even the subsidized price of pre-liberalization era. This fall in price, combined with relaxation in siting restrictions, resulted in an enormous expansion in the extent of irrigated area. Between 1986 and 1996 irrigated area expanded twice as fast as in the period between 1978 and 1986. From an average of 2.3 million acres in the three-year period 1984-85 to 1986-87, total irrigated area jumped to an average of 3.5 million in the next three years an increase of nearly 50 percent. It is important to note that the benefit of irrigation expansion did not remain confined to the owners of shallow tube-wells, who were typically large and middle farmers, but also reached the small and marginal farmers who had to buy water from others. This is so, because the operation of market forces ensured lower prices of water following expansion of its supply. According to one estimate, the average water charge in nominal terms declined by 4 per cent during 1987-94 while the price of rice increased by 30 per cent, indicating a substantial fall in the real price of water (Hossain, 1996). The result was a broad-based expansion of irrigation coverage. The expansion of irrigated area brought about a correspondingly sharp increase in the use of fertilizer because of the wellknown fact that the productivity of fertilizer rises significantly when applied along with controlled irrigation. From an average of 1.2 million metric tonnes during 198485-1986-87 the use of fertilizer we nt up to an average of 1.7 million metric tonnes in the next three years representing once again nearly 50 percent increase as in the case of irrigated area.13 This expansion in the use of fertilizer occurred in a context where there was no significant decline in its price but its availability had much improved by the privatization of its distribution and internal market liberalization of fertilizer trade that had occurred a few years earlier. While internal market liberalization must have created an enabling condition fo r the expansion of fertilizer use, the stimulus to expansion must have come from the expansion of irrigated area itself boosted by liberalized import of irrigation equipment. The combined effect of much greater use of irrigation and fertilizer was reflected in the discrete jump in rice production that occurred in the late 1980s. Careful econometric investigation has confirmed the predominant role played by trade liberalization of irrigation equipment in boosting rice production in the late 1980s (Ahmed, 2001).14 As expected, the major determinant of fertilizer use was found to be irrigated rice area, and by far the most important influence on irrigated area was a dummy variable representing import liberalization around 1988-89. While the expansion of ertilizer use and irrigated area boosted rice production, this was partly offset by the loss of non-irrigated rice area. The net effect, however, was still strongly positive. Ahmed (2001) has estimated that the net effect of liberalization amounted to some 38 per cent of the incremental rice production between 1988-89 and 1996-97. Another way of looking at it is that without trade liberalization annual growth rate of rice

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production during this period would have been 1.4 per cent instead of the 2.5 per cent rate that was actually achieved. The forces of globalization are thus seen to have played a critical role behind all three sources of demand stimulus that led to accelerated growth in the 1990s and in the process led to faster reduction of poverty. There is some evidence to suggest that, in addition to acting on the demand side, globalization also helped the growth process from the supply side. The trade liberalization aspect of globalization played the critical role here. One of the reasons why the small and medium-scale enterprises in the non-farm non-tradable sector were able to respond to the stimulus of demand was that trade liberalization helped ease supply bottlenecks in the input market. Relevant data do not exist for all kinds of nontradable activities, but available information on small-scale manufacturing is quite suggestive in this regard. Small industries seem to have benefited from the liberalization of import of capital machinery and raw materials .They were especially helped in this regard by a structure of tariffs that favored raw materials and intermediate inputs more than final products. Thus, in 2001-02, average applied tariffs on raw materials and intermediate inputs were in the range of 11-12 per cent as against 26 per cent on final products.While most categories of industries benefited from lower tariff on inputs and higher tariff on final products, there are reasons to believe that small industries gained more than others. In a regime of import control, small firms find it difficult to compete with larger enterprises in claiming a fair share of foreign exchange to obtain the necessary inputs. They are then forced to obtain their inputs from domestic sources, where the price is higher, quality lower and supply limited. Therefore, when the import of inputs is liberalized, small firms tend to gain proportionately more. At the same time, they are spared, relatively speaking, the rigours of liberalizationinduced competition in the product market as their products happen to be only remote substitutes of imported items. 13 These figures on the use of irrigation and fertilizer are from Abdullah et al. (1995), appendix tables 5.4A and 5.3A respectively. 14 Further analysis of the policy reforms in agriculture and their impact can be found in This asymmetric effect of trade liberalization on small and large enterprises has perhaps some bearing on the fact that small-scale manufacturing activities handloom and cottage industries) have fared better than large-scale manufacturing in the postliberalization period. According to the national income statistics, the former is estimated to have grown at 9.2 per cent annually between 1991-92 and 1999-2000, while the latter (excluding RMG) grew at only 4.3 per cent (7 per cent, including RMG). If the situation of small-scale industries is symptomatic of small-scale enterprises in general, then the supply side benefit from trade liberalization must have been considerable. It is, therefore, reasonable to conclude that globalization has played an important role from both demand and supply sides to stimulate the small-scale non-farm non-tradable sector that was instrumental in accelerating both growth and poverty reduction in the 1990s. This is not to suggest, however, that globalization was the main force behind accelerated poverty reduction in the 1990s. To make any such claim would require quantitative analysis of the relative effects of various forces, including the forces unleashed by globalization, which is beyond the scope of the present paper. The only claim being made here is about direction rather than the magnitude of the impact of globalization.15

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Globalization and employment opportunities for the poor The growth-poverty nexus discussed earlier gives an indication of the major channel through which globalization has affected the employment opportunities for the poor. By boosting the non-farm non-tradable sector from both demand and supply sides, it has helped create new employment opportunities for the poor in this sector in the form of both self-employment and wage-employment, which were more remunerative than the petty self-employment in which they had traditionally been involved. But doubts have been expressed in some quarters regarding the employment-generating effect of globalization in Bangladesh. These doubts have stemmed from the available statistics on employment in general and manufacturing employment in particular. Some consideration of these issues is, therefore, in order. To start with the overall employment situation, the evidence from successive Labour Force Surveys shows that the pace of employment generation slowed down somewhat in the 1990s. Thus, while labour force grew at roughly the same rate in both 1980s and 1990s (about 3.4 per cent per annum), employment growth declined slightly from 2.7 per cent per annum in the first period to 2.3 per cent in the second. As a result, open unemployment has increased from about 2.8 per cent in 1990-91 to 4.9 per cent in 1999-2000 .6 Not 15 In a recent study, Mujeri and Khandkar (2002) tried to assess the quantitative impact of trade liberalization on poverty using a computable general equilibrium model. They found that complete elimination of tariffs would reduce rural poverty by about 4 per cent compared to the base scenario, which amounts to a pretty marginal impact. Their model did not, however, consider the demand side effects of the kind stressed in this paper. Allowing for these effects would presumably strengthen the impact, but it is difficult to speculate by how much. 16 Since 1989, Labour Force Surveys use two different definitions of the labour force. These are called the usual and the extended definitions, the difference being that many household type activities that do not count as work in the usual definition do so in the extended definition. Moreover, working age is defined alternatively as starting at the ages of 10 and 15 years. As a result, from 1989 onwards there are four different definitions of concepts such as labour force, participation rate, employment, unemployment, and so on. This has set a trap for researchers, and even government publications, which often mix up statistics based on different definitions. The figures quoted above are based on the usual definition of labour force of 10 years and above. surprisingly, the rise of open unemployment to an unprecedented level has raised concerns that globalization may not have improved the employment prospects for the poor, and may even have worsened it (Muqtada et al., 2002). The first point to note here is that whatever has happened in the era of globalization cannot necessarily be attributed to globalization, because other things may have had an effect as well. A couple of points are worth noting in this context. First, unemployment has been rising even before the 1990s. Thus, the rate of unemployment rate increased from 1.3 per cent in 1985-86 to 2.8 per cent by 1990-91, and the absolute number of unemployed people actually increased faster in the earlier period at the rate of 20 per cent per annum in the second half of the 1980s as against 10 per cent in the 1990s. Not too much should be read into these comparisons, though, because unemployment grew from a much lower base in the earlier period. But at the very least these figures confirm that rising unemployment is a continuation of an earlier trend one that did not worsen in the 1990s. Second, in order to see what lies behind this rising trend, it is instructive to look at the composition of the unemployed people. Labour Force Surveys reveal that open

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mployment afflicts mainly the educated youth. Thus, in 1999-2000 the highest incidence of unemployment was found among the 20-24 age group (11.2 per cent), followed by the 25-29 age group (4.1 per cent) (LFS 2000, table 5.3). Furthermore, the rate of unemployment increased almost monotonically with the level of education until the last category (Bachelors degree and above), when it declined somewhat. Those with no education at all had an unemployment rate of only 1.4 percent .oreover, nearly 80 per cent of the unemployed persons remained unemployed for more than a year (LFS 2000, table 5.6C). In a country without social security, it is unlikely that many of these unemployed people would belong to the really poor families. Unemployment in Bangladesh would thus seem to be essentially in the nature of search unemployment on the part of educated young men and women belonging to mainly non-poor households. On this interpretation, the phenomenon of rising unemployment says something about a growing mismatch between the evolving system of education and the structure of 14 employment opportunities. But it seems to have little to do with the impact of globalization as such, and to have little bearing on the evolving poverty situation. More pertinent statistics to consider in the context of globalization and poverty are measures of underemployment, the structure of employment, levels of remuneration, and so on. According to the Labour Force Surveys, the extent of underemployment has declined from 43 per cent in 1990-91 to 35.3 per cent in 1999-2000 ,7 At the same time, employment status has also improved, in the sense that the proportions of both self-employed and wage-workers have gone up relative to unpaid family workers Given the existence of massive underemployment, one would not expect real wages to respond strongly to improvement in overall employment prospects. Yet, real wages did increase in the 1990s, in all the major sectors, but especially fast in manufacturing .he combined import of all these statistics is that aggregate demand for labour did not decline in the era of globalization either in absolute terms or relative to earlier trend if anything, there seems to have been an overall improvement. The trend of manufacturing employment In addition to considering the overall employment situation, the debate on globalization in Bangladesh has also focussed on manufacturing employment in particular. This has been inspired partly by high-profile news stories about job losses in a number of large-scale import-substituting industries, especially in the public sector. Mainly, however, the debate has been fuelled by the findings of the Labour Force Surveys, which show that manufacturing employment has declined in both relative and absolute terms in the 1990s. Thus, under the usual definition of labour force of age 10 years and above, the number of workers engaged in manufacturing seems to have declined dramatically from 7.0 million in 1989 to just 4.1 million in 1995-96. This has raised concerns that globalization may be leading to de-industrialization in Bangladesh, with all the deleterious consequences for poverty this implies. However, careful analysis of data casts serious doubt on this pessimistic view. The first point to note is that the deindustrialization thesis rests on data that takes either 1989 or 1990-91 as the base, but the data for both these years are highly suspect. Successive

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Labour Force Surveys provide the following figures on manufacturing employment: 1983-84 1984-85 1985-86 1989-90 1990-91 1995-96 1990-2000 2.48 million 2.69 million 3.02 million 7.00 million 5.90 million 4.10 million 4.30 million

17 Underemployment is defined here as the proportion of workers (under the usual definition and of 10 years and above) working less than 35 hours a week. 18 The proportion of casual workers among wage-earners can be said to have either slightly increased or slightly decreased, depending on whether one uses the usual or the extended definition of labour force and whether one uses 1989 or 1990/91 as the benchmark for comparison with 2000. Either way, the change is marginal. Is Globalization good for Bangladesh? One night I was chatting on-line in a Yahoo chat room at home in Bangladesh Suddenly my grandfather came into my room and asked me, What are you doing now? Its 3 oclock in the morning, go to sleep. I told him, I cant go to bed now I am chatting please dont be angry with me. He surprisingly asked me, Whats that? I told him, I am talking to a teenage girl in Brazil. He seemed to think I had become mad. He was astonished to hear about online communication. His comment was, You have become too modern. Yes I agreed with him, but how are we modern? Bangladesh has a reputation as one of the poorest countries in the world. We struggle with poverty and hunger, but globalization gives us more freedom to fight poverty and hunger. However, Bangladesh has become a modern country after opening its borders to free trade and Investment. The idea of globalization and modernization was born out of the capitalist market mentality in the age of technology. Globalization occurs when an organization extends its activities to other parts of the world, actively participates in other markets, and competes against organizations located in other countries (Holton p.36). Bangladesh allows foreign companies to enter into our market. Our companies are also allowed to enter foreign markets. Globalization makes international borders vanish and increases competition in the market place. In the modern world, globalization also has an impact on our culture and social life. For example, MacDonalds introduced American fast food to other parts of the world. Foreign media introduces different cultures to the different nations. In my last essay, I discussed the disadvantages of globalization in Canada. Other countries, like Bangladesh benefit from opening their borders for trade and investment by increasing their modernity. Our history says that we have been behind from the modern world during the colonial rule, for our anti- globalization movement. Both Britain and Pakistan ruled Bangladesh for 200 years and 23 years respectively. They used their power to exploit the Bangladeshi people and there was no democracy or freedom. This kept us separate

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from the rest of the world and made it impossible for us to become a modern country. The birth of Bangladesh in 1971 was the first instance of an ethnic linguistic nationalist movement succeeding in creating a new state in the post-colonial period (Jahan, p12). Our independence gave us the opportunity to share knowledge with other nations and led us towards modernity. Globalization is increasing the living standards of poor people in Bangladesh. Industries from foreign investments create employment opportunities for a large number of people including young women who, for the first time, can visibly enter the male dominated public space. Because of the traditional cultural norms of behaviour for young women, they were not allowed to show their faces in pre-modernized Bangladesh. Foreign investment creates 10,000 new jobs every year in Bangladesh (Jahan, p.64). Foreign and export oriented industries are changing the economic and social scenario of Bangladesh which, results in an increase of living standards. Mr. Temple, World Bank Country Director for Bangladesh examined the 1990 average ratio of trade to GDP (Gross Domestic Product) in Bangladesh and explained that it has risen from 19 percent to 35 percent. He also described the story of a village woman whose life was changed for globalization. Hosne Ara Begum, a 40-years-old garments worker at Dekko Apparels Ltd hardly had a chance for a decent job Now [she] can not only to survive physically, but also dream of a future in which her school-going children [will] have much better prospects. Hosne Ara is not looking back anymore. She is striding forward to the future. For a Hosne Ara, the [introduction] of Bangladesh garments industry to the global market wasblessing. ere are many women like Hosne Ara who have found a better way of life. In most cases, these jobs have empowered women, who are now in greater demand for marriage and they receive more respect in their families because of their monthly income. Our women have made our society modern by breaking the traditional cultural norms. Increasing globalization is motivating the Bangladeshi people and increasing the modernity in our society. Motivation refers to the forces within a person that effect his direction, intensity, and persistence of voluntary behavior. (McShane, p62). Foreign investments create high paying jobs, which require more knowledge and skill, therefore motivating people to work for a higher education. Bangladeshi students are performing better than before. Advertisements for foreign products also motivate people. globalization allows foreign companies to advertise their products in our country. When people watch advertisements for expensive foreign products, they want to buy them even if they dont have the ability. This motivates people to strive for a higher education to increase their skill level thereby increasing their income. Personally I am motivated since I grew up in the Bangladeshi global environment. I came a long way for a higher education to fulfill my dream for a higher standard of living. Motivated Bangladesh people are making our country modern. Bangladesh has largely benefited from the transfer of technology. One nation cannot produce everything, because it has limited resources. globalization gave us the opportunity to use modern technology. We got world-class telecommunication technology, which was not possible without foreign investment. Foe example, a telephone company that had been monopolizing mobile telecommunication services since 1992, was diminished by the global movement. At that time only a few people

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were able to use it, for it was incredibly expensive and their services were below average. They also provided very few jobs in that sector. When some other foreign companies entered our market, the monopolist company lost its power. Now the competitive activity of many telephone companies has increased competition, peoples income levels, and employment opportunities, which in turn has substantially reduced poverty. Modern telecommunication technology connected us to the rest of the world. In comparison with the modern world, our country is also getting technological advantages like computers and the Internet, transportation and online banking. We are earning foreign currency and creating many new jobs by exporting computer software. Globalization has made a big social and economic change in Bangladesh. There can be no doubt that the result of globalization in Bangladesh has been positive. When my grandfather was in my age, it was a dream for him to use Internet. May be he never thought about todays modern technology. Most people in our country do not know what globalization is, but they got higher living standard for globalization. Finally, I hope we will be able to overcome poverty and hunger within very short and introduce Bangladesh as one of the best modern country in the world. . Evidence Shows Globalization Has Benefited the Poor According To, Frederick T. Temple, World Bank Country Director for Bangladesh Globalization is a hot topic these days, both internationally and in Bangladesh. The IMF and World Bank will hold their annual meetings in Washington at the end of September, and, as in Seattle, Prague and Genoa, anti-globalization protesters are gearing up to disrupt the meetings, which have already been compressed and rescheduled for two weekend days to minimize the impact of the protests on normal peoples lives and work in Washington. The protesters claim that globalization has hurt the poor. Here too in Bangladesh there are many who argue that the country has opened up to the world economy too fast and suffered in consequence. When I think of globalization in the context of Bangladesh, I think of a person like Hosne Ara Begum, a 40-year-old garments worker at Dekko Apparels Ltd. Hosne Ara, living with her unemployed husband and two children, who was driven out of her village in Comilla by poverty and hunger. With her limited education, she hardly had a chance for a decent job. However, she got a job two years ago at Dekko Apparels and now Hosne Ara can not only to survive physically, but also dream of a future in which her school-going children would have much better prospects. Hosne Ara is not looking back anymore. She is striding forward to that future. For a Hosne Ara, the access of Bangladeshs garments industry to the global market was a blessing. The worldwide globalization debate has been heated, but insufficiently guided by sound analyses of the issues. Fortunately, some good research is now beginning to be published, and my purpose in this article is to summarize some of the international evidence on the impacts of globalization on poor countries and poor people during the last two decades. You will see that the facts tend to refute most of the antiglobablizers contentions, but I will also note that the protesters have focused

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attention on some important, valid oncerns. I will also offer a few observations about Bangladesh, but I dont have enough time for a thorough analysis of how Bangladesh might benefit from globalization. Globalization Trends Let me start with some information about globalization trends. Globalization in the roadest sense implies integration of economies and societies across the globe through flows of technology, trade and capital. Integration of production, accelerated crossborder investments and more trade are the logical outcomes of this process. While globalization involves a range of changes in the way countries and peoples interact, I would like to focus today primarily on the issue of openness to trade and investment and their impact on the living standards of people in developing countries like Bangladesh. Global trade has grown dramatically over the past three decades. Growth in exports worldwide outpaced growth in output every year between 1965 and 2000 by an average ratio of 1.5 to 1. Moreover, this ratio increased over time: after a pause in the mid-1980s, it jumped to nearly 2.5 to 1 in the 1990s -- to 3.1 to 1 in the case of Bangladesh. In just the past decade, the average ratio of trade to GDP in developing countries has risen from 29 percent to 43 percent, and from 19 percent to 35 percent for Bangladesh. In the process, developing countries have become more important players in the global marketplace. Their share of world trade has increased over the past 30 years -from about a quarter in 197072 to a third in 199799 -- and their share of trade in manufactures has more than doubled -- from about 15 percent to nearly 30 percent. As developing countries have increased their exports of manufactures, they have become less reliant on traditional exports of agricultural and mineral products. China in particular has increased its exports and imports, reflecting its policy decision to move from virtual autarky to active participation in the global economy after 1978. Chinas share of the global marketplace has risen to 3.5 percent, twice its share in the mid-1980s. This rapid expansion echoes that of South Korea and other East Asian economies during the 1970s and 1980s. India and several Latin American countries seem poised to make a similar jump in global trade participation. Globalization: The Issues The globalization debate revolves around the impacts of these trends, especially on poor countries and poor people. I would like to provide some evidence on three important questions: have countries that opened their economies experienced higher growth? has globalization increased the gap between rich and poor countries? And have the poor benefited from the growth that has occurred during the recent globalization era? As you will see, the empirical evidence doesnt support the protesters contentions that globalization has been bad for the poor.

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Globalization, Growth and the Rich-Poor Country Gap Lets start with globalization, growth and the gap between rich and poor countries. There is a growing consensus in empirical studies that greater openness to international trade has a positive effect on per capita income. A 1999 study by Jeffrey A. Frankel and David Romer estimates that increasing the ratio of trade to GDP by 1 percentage point raises per capita income by 0.52.0 percent. In a recently published paper David Dollar and Aart Kraay of the World Bank have examined data from 73 developing countries to study the impacts of the globalization era of the last two decades. They identified the top one-third of developing countries in terms of increases in trade to GDP over the past 20 years and labeled them the post-1980 globalizers. By definition, this group has had a particularly large increase in trade 104 percent, compared to 71 percent for the rich countries. What is striking is that the remaining two-thirds of developing countries have actually had a decline in trade to GDP over this period. The globalizing group has also cut import tariffs significantly by 34 points on average, compared to 11 points for the non-globalizers. The list of post-1980 globalizers includes some well-known reformers -- Argentina, Brazil, China, Hungary, India, Malaysia, Mexico, the Philippines, and Thailand. These countries have moved ahead on a wide range of reforms involving trade and investment liberalization, stabilization where necessary, and property rights reforms in the transition economies such as China and Hungary. Bangladesh qualifies as a globalizer under Dollar and Kraays definition. The recent globalizers have experienced an acceleration of their growth rates -- from 1.4 percent per year in the 1960s to 2.9 percent in the 1970s, 3.5 percent in the 1980s, and 5.0 percent in the 1990s, while rich country growth rates slowed down over this period. What about developing countries not in the globalizing group? They had a decline in the average growth rate from 3.3 percent per year in the 1970s to 0.8 percent in the 1980s and 1.4 percent in the 1990s. Thus, contrary to the protesters contention that the gap between rich and poor countries is growing as a result of globalization, during the 1990s the globalizing developing countries were catching up with rich countries, while the non-globalizers continued to lag further and further behind. Since the globalizing group includes some very large countries such as China, India and Brazil, the group as a whole has about 3 billion people. Globalization, Growth and the Poor Now let us turn to the issues concerning the relationships among globalization, growth and the poor. In a paper published earlier this year, Dollar and Kray used cross-country data to try to understand what is happening to the income of the bottom 20 percent of the population, as globalization proceeds. They found that there has been a one-to-one relationship between the growth rate of income of the poor and the growth rate of per capita income. In other words, percent changes in incomes of the poor are, on average, equal to percentage changes in average incomes. These results therefore do not support the contention that growth has been associated with increasing inequality during the recent globalization era. Dollar and Kray examined many variables that might explain cross-country differences in the extent to which growth accrues to the poorest, with little success.

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One of the variables they considered was trade volumes, but they found no evidence of a systematic relationship between changes in trade and changes in inequality. There is simply no relationship between changes in inequality and other measures of globalization used in economic literature. No doubt trade and investment liberalization has distributional consequences that is, there are winners and losers in the short run. However, the finding here is that the losers do not come disproportionately from the poor. In fact, the only countries that achieved large-scale poverty reduction in the 1990s are ones that have become more open to foreign trade and investment. In another study published this year, Shaohua Chen and Martin Ravallion estimate that in the countries that globalized during the post-1980 period, the number of absolute poor, defined as those living on less than $1 per day, declined by 120 million during the relatively short period between 1993 and 1998, while in the rest of the developing world, the number of poor increased by 20 million. A related finding about the wide diffusion of the benefits of globalization comes from another study published this year by Freeman, Oostendorp, and Rama, who looked at the effect of globalization on wages. Dollar and Kraays work focuses on the bottom 20 percent of the income distribution, who in many developing countries would not be wage earners. Wage earners are more likely to be in the middle of the income distribution. Freeman, et al used data collected by the International Labor Office. They found that the growth rate of wages has been twice as rapid in the globalizing developing countries identified by Dollar and Kraay, than in the non-globalizers, and faster than in the rich countries as well. More generally, they found that both foreign trade and foreign investment increase wages. Workers in general gain from openness, although of course there will be specific losers, particularly workers in heavily protected sectors who shared in the rents of protection. I have cited only a few of the studies on these issues, and I should point out that methodological difficulties with cross-country regression results suggest that their implications for causality should be treated with caution. However, I would like to quote an observation by P. Lindert and J. Williamson in a paper this year on the impacts of economic openness over a longer period of time. They state, The doubts that one can retain about each individual study threaten to block our view of the overall forest of evidence. Even though no one study can establish that openness to trade has unambiguously helped the representative Third World economy, the preponderance of evidence supports this conclusion. They go on to note the empty set of countries that chose to be less open to trade and factor flows in the 1990s than in the 1960s and rose in the global living-standard ranks at the same time. As far as we can tell, there are no anti-global victories to report for the postwar Third World. We infer that this is because freer trade stimulates growth in Third World economies today, regardless of its effects before 1940. The burden is thus on the antiglobalization protesters to show where closed economy strategies have worked and benefited the poor.

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Bangladeshs Trade Relations: The India Factor Before I turn to the anti-globalizers valid concerns, let me say a few words about Bangladesh. Bangladesh is classified among the globalizers in the Dollar and Kraay study, and the data shows that in Bangladesh, per capita GDP rose 2 percent for every 1 percentage point increase in the ratio of trade to GDP between fiscal 1990 and 2000. The World Bank has conducted empirical research on the impacts of trade liberalization in Bangladesh, and we believe the evidence demonstrates clear benefits and refutes the contention that Bangladesh liberalized too soon, too fast. However, whenever angladeshs trade policy is discussed, the India factor is raised. India is Bangladeshs largest trading partner, and policy-makers and the business community alike are oncerned about the growing bilateral trade deficit in Indias favor. Bangladeshs overall trade deficit with India grew from $888 million in 1994 to $2.7 billion in 1999. To complain about a large and growing trade deficit with a single partner is legitimate, particularly when that partner does not reciprocate Bangladeshs unilateral liberalization. Indias trade regime continues to be highly protectionist, with high barriers to potential exports from Bangladesh. But for Bangladesh to respond by halting or reversing its trade reform would be more damaging than the trade imbalance. Because India has a diversified manufacturing base and is a low-cost source of critical industrial raw materials and consumer goods such as rice, a large trade deficit with that country is not unexpected. It is in Bangladeshs interest to import raw materials and food items from the cheapest source. Following the 1998 floods, Bangladesh imported $600 million worth of rice from India. Imports from Thailand or elsewhere would have cost much more, adversely affecting the balance of trade. Since Bangladeshs overall external balances are on a sustainable path, a large trade deficit with India is not necessarily detrimental. Thus rather than halting or reversing its broader liberalization in response to Indias failure to reciprocate, Bangladesh would be better off pursuing bilateral and multilateral policy dialogue and examining options such as exporting gas. A good strategy would be to follow the example of Sri Lanka, the fastest reformer in South Asia. Sri Lanka started trade liberalization in 1977 and continued steady reform throughout the 1980s and 1990s. In fiscal 2000, it moved to a two-band tariff regime -- 10 and 25 percent -- abolishing export taxes and leaving quantitative restrictions only for non-trade reasons. (I should, however, note that because of the exigencies of the civil war, the government has imposed a 10 percent tariff surcharge in fiscal 2001, to be withdrawn in 2002). In an era of strong globalization and liberalization, Bangladeshs trade policies should mirror those of Sri Lanka, not India. TheProtestersAre Right: There Are Losers in Globalization So far I have marshaled empirical evidence indicating that the facts dont support anti-globalizers main contentions. But let me conclude by emphasizing that the protesters dont have it all wrong. They are correct in pointing out that there are losers in the globalization process, both among countries and within countries.

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Obviously some countries have grown faster than others during the recent as well as previous globalization eras. Many studies have shown that economic openness has been correlated with economic growth, but others have pointed out that caution needs to be exercised in interpreting these results, because many other factors such as institutions, policies, property rights, the rule of law and geographic location are also correlated with growth. A 1992 study by Ross Levine and David Renelt found that these factors tend to be highly correlated among themselves, and recent unpublished analysis by Francisco Rodriguez and Dani Rodrik shows that the robustness of the correlation between openness measures and growth declines as other variables are added to the analysis. Historically, open economies have also tended to be the ones with good policies and institutions, so it is difficult to isolate the effects of individual variables on growth. The common sense implication of these observations is that a country like Bangladesh cant expect to prosper in a globalizing environment only by further liberalizing its trade regime. It needs to pursue a more comprehensive program of institutional and policy reform. But we also need to remember the point made by Lindert and Williamson that I quoted earlier in the late 20th century globalization era, there have been no cases of countries that reduced their openness and simultaneously moved upwards in the global rank of living standards. The anti-globalization protesters are also correct that as growth has proceeded, there have been losers as well as winners within countries. Although the evidence presented earlier indicated that the losers do not come disproportionately from the poor, it nevertheless has to be a concern that some poor households are hurt in the short run by trade liberalization. It is thus important to complement open trade policies with effective social protection measures such as unemployment insurance and food-for-work schemes. However, I would like to emphasize that while governments should cushion the effects of economic adjustment on those affected, especially the poor, they should not prop up firms that cant compete in more open environments. Some firm failure is expected and essential for the efficient functioning of dynamic, open economies. This is what Schumpeter meant by the process of creative destruction. I would like to conclude by suggesting that the experience with globalization offers two central messages. First, globalization and openness to trade create winners as well as losers. The evidence I have presented indicates that the winners have far outnumbered the losers, both across the globe and within countries. The challenge is to put policies in place that will provide employment and adequate safety nets for the losers. a second, good policies matter even more in todays globalized world. The cost of inaction or policy weaknesses can be high leading to the marginalization of poor countries and further impoverishment of poor people. As Lindert and Williamson asserted the study on globalization I cited previously, The nations that gained the most from globalization are those poor ones that changed their policies to exploit it, while the ones that gained the least did not, or were too isolated to do so. Thus, for everybody in Bangladesh, including the poor, the problem is not the effects of globalization, but the possibility of being left out. Lets remember Hosne Ara, the garment worker I mentioned at the beginning of this article. Being left out means denying the Hosne Aras a chance to live better. How many Hosne Aras are there? A few millions? They perhaps dont know what globalization is, but they benefit from it.

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Advantages and Disadvantages of Globalization

Some Advantages Some Disadvantages Increased free trade between nations Increased flow of skilled and non Increased liquidity of capital skilled jobs from developed to developing nations as allowing investors in developed corporations seek out the cheapest nations to invest in developing labor nations Increased likelihood of economic Corporations have greater flexibility disruptions in one nation effecting to operate across borders all nations Global mass media ties the world Corporate influence of nationtogether states far exceeds that of civil Increased flow of communications society organizations and average allows vital information to be shared individuals between individuals and Threat that control of world media corporations around the world by a handful of corporations will Greater ease and speed of limit cultural expression transportation for goods and people Greater chance of reactions for Reduction of cultural barriers globalization being violent in an increases the global village effect attempt to preserve cultural Spread of democratic ideals to heritage developed nations Greater risk of diseases being Greater interdependence of nationtransported unintentionally states between nations Reduction of likelihood of war Spread of a materialistic lifestyle between developed nations and attitude that sees consumption as the path to prosperity Increases in environmental International bodies like the protection in developed nations World Trade Organization infringe on national and individual sovereignty Increase in the chances of civil war within developing countries and open war between developing countries as they vie for resources

Decreases in environmental integrity as polluting corporations take advantage of weak regulatory rules in developing countries

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Table: The Advantages and Disadvantages of Globalization

Increasing Gap between Rich and Poor Countries The Spread of Communicable Diseases Increased Transnational Crime Power of Global Corporations National Borders less Important Faster Global Financial Transactions Increased International Trade Increased Communications Different Cultures Through Music and Fashion International Cooperation Increased and Easier Overseas Travel Internet Communications

80%

60%

40% Advantage - 64 -

20%

0%

20%

40%

60%

80%

Disadvantage