## Factors Driving Global Economic Integration

_IMF News, August 25, 2000_

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## Bibliographic details
- Published: August 25, 2000

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### Overview and central thesis
- Global economic integration has trended upward over centuries through trade, factor movements, and communication of knowledge and technology, with particularly rapid acceleration during the past half century.
- Three fundamental, interacting drivers of economic integration:
  - Improvements in transportation and communication technology (reducing natural barriers).
  - Changing tastes that favor the benefits of integration.
  - Public policies that shape the pace and character of integration (reducing or increasing artificial barriers).

### Human migration
- Historical role:
  - Migration was the predominant mechanism of interaction for most of human history.
  - Evidence from DNA: all modern humans descended from common pre-human ancestors in Africa roughly one million years ago.
  - Major prehistoric migrations include the settlement of Eurasia and the crossing into the Americas roughly ten thousand years ago.
- Modern patterns and drivers:
  - Mass migrations driven by wars and turmoil are distinct from economic-motive family/individual migration, though overlap exists.
  - U.S. immigration surge: greatest from end of the Civil War to start of World War I, especially early 1900s (see Charts 1 and 2).
  - Transportation cost and risk declines (19th–20th century steamships; by 1907 passage cost down to a couple of months’ wages) reduced deterrents and enabled back-and-forth migration.
  - Since World War I, pace of immigration to the U.S. slowed because:
    - Income differentials narrowed for Europe-to-U.S. migration.
    - Public policy restrictions became decisive (Chinese Exclusion Act of 1882; National Origins Act of 1924).
- Policy implication:
  - Public policies are often responsive to tastes and technology; migration policy materially shapes migration flows.

### Trade in goods and services
- Theory and limits:
  - Hecksher-Ohlin-Samuelson view: trade in outputs can substitute for factor mobility under restrictive conditions; in practice barriers to trade (natural and artificial) prevent full factor price equalization.
- Historical evolution:
  - Ocean-going sailing vessels (late 15th century) expanded horizons but high transportation costs persisted well into the 1800s.
  - Steam-powered iron ships (second half of 19th century): shipping cost across the Atlantic probably less than one-fifth of what it had been at the start of the century.
  - Interwar period: collapse in world trade amplified by increased tariffs, notably U.S. Smoot-Hawley tariff of 1930.
- Postwar era (past five decades):
  - Real world GDP rose at somewhat more than a 4 percent annual rate; developing countries grew in per capita terms at about the same pace as industrial countries.
  - Real living standards (real per capita GDP) improved on average about three-fold in just half a century.
  - Volume of world trade in goods and services rose from barely one-tenth of world GDP in 1950 to about one-third of world GDP in 2000.
  - Trade expanded at nearly double the pace of world real GDP over the postwar era.
- Drivers of postwar trade integration:
  - Dramatic reductions in artificial barriers (tariffs, quotas) and substantial reductions in natural barriers (transportation/communication).
  - Examples of transport and communication improvements:
    - Air cargo emerged as a major factor in the past fifty years for time-sensitive goods.
    - Ocean shipping costs have fallen substantially (perhaps by a factor of four or five); supertankers and containerization expanded scale without crew increases.
    - Communications costs for voice, text, and data have dropped enormously, greatly affecting trade in services.
- Quantitative thought experiment (back-of-envelope):
  - If effective average trade barriers fell from 35 percent to 5 percent for the United States, standard trade elasticities suggest imports would rise by roughly 2 percent of U.S. GDP — much smaller than the actual U.S. import share rise from under 5 percent in 1950 to nearly 15 percent in 2000.
  - Accounting for global, mutually reinforcing barrier reductions could plausibly explain a doubling in world trade relative to world GDP (imports from 6 percent to 12 percent; combined imports and exports from 12 percent to 24 percent). Actual world trade shares rose by a tripling.
- Structural note:
  - Extent of trade relative to GDP today is, by some measures, not much greater than a century ago, but sectoral composition shifted: around 1900 roughly two-thirds of GDP was goods-producing; by late 20th century roughly two-thirds was services, implying greater goods trade relative to goods output today.
- Forward-looking observations:
  - Further absolute reductions in transportation costs are constrained (costs cannot go negative); proportional pace of reduction likely slows.
  - Communications technology still undergoing rapid revolutions — large continued impacts expected, especially for services.
  - Policy agenda:
    - Industrial countries should address remaining hard cases (especially agriculture) and restrictions on services trade.
    - Developing countries should reduce remaining import restrictions and seek reductions by industrial countries on products where developing countries have comparative advantage.

### International capital movements and financial services integration
- Past assessments (Mussa and Goldstein, 1993) affirmed growing integration, especially for high-grade wholesale instruments and partial progress for developing countries.
- Recent developments and lessons:
  - Wholesale financial markets and high-grade instruments have become more tightly linked among industrial countries; EMU eliminated exchange rate fluctuations among participating countries and reduced interest rate spreads and volatility.
  - Japan experienced a spike in a “Japan premium” on international borrowing during 1997–98; government recapitalization and restructuring reduced the premium but some Japanese banks scaled back international activity.
  - Emerging market linkages became visible in crises: tequila crisis (1995); Asian/Russian/LTCM/Brazilian crises (1997–99) — massive gross private capital flows to emerging markets preceded crises; flows dropped precipitously and spreads spiked with crisis onset (see Chart 5).
- Policy lessons on exchange regimes and capital flows:
  - For countries highly open to private international capital flows, operating a pegged exchange rate requires demanding supporting policies (monetary, fiscal, well-regulated banking).
  - Experience: pegged exchange rates with open capital accounts proved unsustainable in several crises (Mexico, Thailand, Malaysia, Indonesia, Korea, Russia, Brazil), whereas some countries with strong commitments (Argentina, Hong Kong) maintained regimes.
  - Flexible exchange rates generally provided better shelter for some emerging markets (Singapore, Taiwan Province of China, South Africa, Mexico post-1995).
  - Maintaining some restrictions on private capital flows may be desirable for countries with weak financial systems; sudden imposition of controls in crisis differs from maintaining controls preexistingly.
- Composition and resiliency of capital flows:
  - Shift away from bank loans toward bonds, equities, and FDI suggests enhanced flexibility and resiliency; FDI flows to developing countries expanded and proved relatively stable in crises (see Chart 6).
  - However, the resilience claim for portfolio flows is premature; international financial system problems persisted in the late 1990s.
  - Domestic debt market development in emerging markets and recovery of net portfolio equity flows are positive signs.
- Market discipline and information:
  - Two conditions to improve discipline: full disclosure of debtor obligations (including off-balance sheet), greater transparency and accounting harmonization; and reducing perceptions of bailouts that blunt market incentives.
  - Policy recommendation: accompany liberalization with strengthened supervisory frameworks and upgraded risk management, not attempts to halt liberalization.
- Financial services globalization and technology:
  - Rapid advances in information and communications technology are reducing costs of producing and distributing financial services by factors of two or more within two-year periods.
  - Domestic financial sector boundaries (commercial banks, investment banks, insurers) are blurring; international consolidation and broader geographic scope of providers are accelerating.
  - Examples:
    - Dramatic fall in costs of stock exchange transactions; explosion of transaction volumes and retail investors.
    - Rising bank transaction volumes relative to nominal GDP.
  - Public policy largely facilitating these trends (e.g., U.S. Gramm-Leach-Bliley Act, EU directives, EMU incentives, liberalization in emerging markets).
- Worry and caveat:
  - Persuasive evidence linking openness in capital flows (especially portfolio flows) to stronger growth is less robust than for trade openness.
  - High openness to short-term capital can be dangerous for countries with weak macro fundamentals or fragile financial systems; prudent sequencing, regulatory strengthening, and supervisory upgrades are essential.

### The particular importance of communications and technology diffusion
- Communication as a channel of integration:
  - Not necessary to physically move goods to spread innovation — transmitting concepts and know-how suffices to drive adoption (noodles example).
  - Advances in communications (printing historically, modern digital communications now) dramatically increase the reach and durability of ideas and innovations.
- Implications:
  - Rapid declines in communication costs are a profound force for global integration and for accelerating innovation diffusion across sectors, most visibly in financial services but broadly applicable.
  - Keeping channels of communication reasonably open may be as critical as trading volumes for spreading useful innovations.

### Risk of reversal: lessons from the interwar period
- Interwar reversal:
  - Sharp contraction of world trade during the interwar period, especially early 1930s (Contraction of World Trade, 1929–33), exceeded the decline in economic activity.
  - Contributing factors: Great Depression, massive protectionism (Smoot-Hawley tariff of 1930 and retaliations), collapse of the international gold standard, capital controls and rising nationalism/isolationism.
  - Change in tastes and political attitudes played a central role (U.S. isolationism, National Origins Act, broader anti-foreign sentiment).
- Contemporary risk assessment:
  - Globalization has detractors (e.g., Seattle protests), but conditions are judged not ripe for a broad return to isolationism.
  - Postwar prosperity under policies favoring integration, and desire of currently less-integrated countries to join global systems, reduce probability of a repeat interwar-style reversal.
- Policy takeaways:
  - Political economy and public sentiment matter; maintaining public support for integration requires addressing distributional concerns and managing adjustment costs.

### The end of empire and voluntary integration
- Historical shift:
  - Pre-20th century empires channeled much integration within imperial domains; by the end of the 20th century most empires had dissolved.
  - Trade and capital flows that were once empire-directed now occur more diversifiedly across global partners (e.g., Britain’s trade shifted from colonies to European rivals; transition countries shifted trade away from the former Soviet bloc toward the rest of the world).
- Reasons empires declined:
  - Change in public policy and tastes (revulsion at war, oppression).
  - Technological changes that made imperialism an inefficient means to improve welfare; domestic development through investment became a more attractive path.
- Outcome:
  - Global economic integration is increasingly voluntary — driven by technology, tastes, and mutually beneficial incentives rather than conquest.
  - This voluntary nature provides reasonable assurance that fundamental forces driving integration will contribute to global economic improvement, absent policy backsliding.

### Key policy recommendations and implications (summary bullets)
- Continue to liberalize remaining barriers to trade, focusing on:
  - Agricultural protection in industrial countries.
  - Restrictions on trade in services enabled by communications advances.
- For capital account liberalization:
  - Sequence liberalization with strengthened macroeconomic policy frameworks and well-capitalized, regulated financial systems.
  - Improve transparency, off-balance sheet reporting, accounting harmonization, and prompt loss disclosure to enhance market discipline.
  - Avoid creating moral hazard via perceived bailouts; ensure credible frameworks for crisis management.
- Strengthen supervisory and regulatory frameworks to accompany financial innovation and cross-border financial services globalization.
- Invest in communications and transportation infrastructure in developing countries to reap further integration benefits.
- Address political economy and distributional consequences of integration to sustain public support and reduce risks of protectionist reversals.

*Italicized source attribution:* Factors Driving Global Economic Integration — by Michael Mussa, Economic Counselor and Director of Research, IMF; Presented in Jackson Hole, Wyoming at a symposium sponsored by the Federal Reserve Bank of Kansas City on “Global Opportunities and Challenges,” August 25, 2000.

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## References

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- [United States and the IMF](http://www.imf.org/external/country/USA/index.htm)
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_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp082500_