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Just linkage: The power of positive sanctions

International Trade and Labor Standards: A Proposal for Linkage
Christian Barry and Sanjay G. Reddy
(Columbia University Press, New York: 2008)

by Michael Pollak

This is an important book. It could change how people think. It could even affect the world—and even if it does neither, it’s kind of a dazzling argument just by itself. But because it is dense and maieutic, I’m afraid that very few people will read it if they aren’t persuaded beforehand that it will be worth their effort. So my goal in this review will be to summarize the authors’ argument in bold strokes in order to make people curious enough to read it in its full form.

The problem linkage is supposed to solve

Many books have been written on the question of whether globalization is good or bad. This book starts with this question of moral evaluation but takes it in a new direction. Having read seemingly every polemic on the subject, the authors claim they have distilled out the common evaluative principle shared by all sides. This they call Proposition O (as in the Objective): international economic system A is morally better than system B if it better improves the lot of the least advantaged (and worse if it makes them worse off).

Globalization has been created in large part by a cumulative succession of international agreements. As soon as we initial one, we start the round of negotiations on its successor. It has become an article of faith among globalization’s supporters that such continual revision is a necessity. As they put it, economic liberalization is a bicycle that has to keep moving or it will fall over. So the moral question then becomes, What would be the best way to reform our agreements to best advantage the least advantaged? This then brings us to the argument about linkage.

Linkage is the idea that the best way to reach Objective O would be to make raising labor standards, i.e., wages and working conditions, a condition of membership in the system of international economic cooperation. The beauty of the idea is how direct it is. If you want to make the poor less poor and exploited, then raise their wages and improve their working conditions. And if globalization is such a powerful force—perhaps the only other thing its critics and supporters both agree on—then yoking that power to raising those standards sounds like a pretty great idea.

There’s only one big obstacle: at the moment, almost everyone who has given it some thought believes linkage is a terrible idea. It is one of the rare areas of agreement between orthodox economists and critical left activists. The general consensus is that linkage as it is normally conceived would punish the people it is supposed to help and give new leverage to the powerful to frustrate and abuse them.

This is what makes this small and unassuming book feel like such a Copernican revolution. It sets out to prove we’re all wrong.

The problems with linkage

So why does everyone (including me before I read this book, even though I'm a friend of one of the authors) start out thinking linkage is such bad idea? It’s generally considered to be unjust, to be economic nonsense, and to be unfeasible.

Let’s start with unjust. Linkage as it is usually conceived means giving ultimata to poor countries—that if they don’t shape up by a specified deadline, we’ll cut down their access to rich country markets, thus making them even poorer. So first we blame the victims, and then we punish them.

This brings us to why linkage is considered to be economic nonsense. As thus described, linkage can only reduce trade, and it focuses those reductions on the poor. There’s nothing that increases trade or growth; there’s only downside. If there is an original sin in economics, this is it. On top of that is the argument that low wages are the factor advantage of developing countries. Take that away, and we’ve made it impossible for them to compete.

Then there are the feasibility arguments. Sweatshops are hard to stamp out even in advanced countries. How on earth can we expect countries without efficient bureaucracies or infrastructures to root them out? Some economists argue that sweatshops are an unfortunate but inevitable part of the first stage of economic take off; they were certainly rife during the industrial revolution. If we outlaw something that can’t be stopped, won’t that simply transform poor exploited workers into poor, exploited illegal workers, giving them even less protection than they have now?

On top of all that are the arguments that linkage is imperialist. First on cui bono grounds, it’s generally supposed that the main power behind linkage is unions in developed countries with explicitly protectionist agendas. Secondly there is the differential preference argument. All countries want both economic growth and better working conditions, but if forced to make a make a choice, it seems rational for a poor country to sacrifice almost everything to growth, while in a country which has already provided for all its primary needs, it would make sense for people to think that improving the quality of life might now be more important than adding wealth. Linkage is thus seen as one more instance when poor countries would suffer to satisfy the luxury tastes of the rich, except this time for morality instead of for sugar or tea. The same argument is often pitched in terms of cultural imperialism. That is to say, the labor standards that are appropriate for a country to strive for differ depending on its level of development. To impose one set of standards, the ones appropriate to the rich countries, as if they were universal is the very definition of cultural imperialism.

Solving the problems

So how can the idea of linkage be fixed in order to make these very solid objections melt? First we have to take them seriously because they’re all true. Any linkage proposal that did what they describe would be monstrous, stupid and pointless.

This then brings us to the heart of this book, what the authors call their “constructive procedure.” In Chapter 4, they treat every plausible objection that has ever been made against linkage as variants of what they call the five Standard Objections:

1. Linkage is self-defeating or inconsequential;

2. Linkage is an inferior means of promoting the goals it is intended to promote;

3. Linkage creates an unfair distribution of burdens;

4. Linkage is context blind and politically imperialistic; and

5. Linkage is infeasible.

Unlike my breezy summary above, their treatment is extraordinarily painstaking. Between this chapter and Chapter 6, where they respond to each objection, I can’t think of an argument they’ve left out.

The goal of the constructive procedure is to see if a linkage proposal can then be constructed that meets all the objections. Let’s start with sanctions. Punishing the poor is outrageous and absurd. But what if, instead of negative sanctions, we had positive sanctions? What if, instead of punishing poor countries for not improving labor standards, we rewarded them for improving them? And in addition to rewarding them, we offered them material assistance to do it? And what if these positive sanctions, rather than restricting the market, expanded it?

That would change a lot, no? Well that’s the core of their reconstructed linkage proposal. We all know the developing world still faces substantial barriers to crucial exports. This linkage proposal is based on a fundamental swap: developing countries who make substantial progress in improving their labor standards would be rewarded with increased export access to rich country markets. That way poor countries wouldn’t be punished for failure, they would be rewarded for success. The global market wouldn’t be constricted by linkage, it would be expanded. And the burden for making these changes would be borne by the rich countries, not the poor.

At one stroke this changes the entire meaning of linkage, and the authors build on this new beginning. To deal with the objection that linkage is context-insensitive, they propose a benchmarking system. That is, an agency of experts would be set up to determine in a serious statistical fashion what the comparative state of labor standards in each country was at time zero. Progress in each country would then be measured in terms of improvement from that base.

This would also remove the problem of unions or industries in the developing world using linkage for protectionist purposes because the agenda wouldn’t be set by them. In the Barry-Reddy model, anybody could forward information about violations to the agency, but it would be just that, information; it wouldn’t be in the form of charges, as violations are handled in the present WTO. It would be the linkage directorate which prioritized and evaluated such claims. For Barry and Reddy, the sine non qua of any truly legitimate international system is that it is objective and rule-based, and for that an independent legal apparatus of this sort is essential. Furthermore, in a system whose goal was improvement and not punishment, every country would be given ample time to address violations, with full credit given for all good faith efforts, and assistance given to such efforts. Again, the money for these inspections and analyses and assistance would come from the rich countries, because that would only be just. It would also be efficient. It would strengthen each country’s administrative capacity while at the same time improving both monitoring and results.

Shared interests

Under this conception, linkage isn’t clash of interests but rather a coordination of shared interests. It is assumed that both rich countries and poor countries want to improve the lives of the least advantaged, the rich because they say so and spend billions of dollars to that end every year on aid, and the poor countries because it’s their citizens. The point of setting up a linkage system is to help both attain a joint goal by fundamentally changing the situation of incentives and disincentives that each developing country faces. Making this a focus of funding also holds forth the prospect of reducing aid waste through coordination. This summer’s global aid meeting at Accra made clear just how vast the room is for such savings. Vietnam, a developing country that is doing relatively well, hosted 791 aid delegations in 2005, more than two every day of the year. In extremely poor countries where the bulk of the state budget comes from aid, competing aid agendas seem to make sound governance and democracy almost impossible in principle.

Barry and Reddy expound at length at what sort of negotiations would be necessary to produce a legitimate system of international cooperation. The main elements are that:

• the negotiations would have to be open and transparent (that is, not merely not secret, but publicized and debated, so that there would be political consequences for representatives who defied their countries’ public opinion);

• the largest possible spectrum of opinion would have to be consulted (meaning not only governments, but groups within the countries they represent and international NGOs, to supplement and remedy the limits of existing representation); and

• both the negotiations, and the agreement to participate in any agreement that resulted, would have to uncoerced.

This last would be the best guarantee that the devilish details of a linkage agreement actually served the interests of developing countries. If ratification were uncoerced, developing countries would presumably only agree to it because it advanced their interests. In fact, in many ways this proposal seems conceived as something for developing countries to consider putting forth themselves as a bargaining position in future WTO talks.

If all of these conditions were fulfilled perfectly, we would end up with a perfectly legitimate international agreement. In the real world, they will be fulfilled imperfectly. But the argument is that this should be the regulating ideal, and an agreement could be quite imperfect and still be a lot better than how the world is now without it.

Barry and Reddy envision such a linkage agreement only coming into force when a sufficient number of countries have ratified it, and that no developing country would be forced to abide by its terms until it individually agreed to. But of course it wouldn’t receive the aid and opportunities it held forth until it did. The presumption is that if the system works, it will be its own best persuasion for more to join.

Economic considerations

Having dealt in broad outlines with the justice, imperialism and feasibility objections, now let’s turn to the economic objections. Clearly the main one about there being no upside for growth has been dispatched. But there are several others still be to be addressed.

What about the idea that linkage removes the main factor advantage of the developing world, which is low labor costs? Barry and Reddy’s counter-argument employs a move that appears over and over in the economic passages of this book: this objection mistakes the situation of the individual (country or firm or laborer) for the situation of the class. It is true that an individual country or firm in the developing world would weaken their competitive position by increasing their labor costs. But the gap between the developing countries and developed countries as a whole is so huge that even quadrupling wages would barely make a dent in it. (This argument is reinforced by an extensive empirical appendix which shows that wages constitute a surprisingly tiny percentage of the price of most developing country export goods.)

This is also the fundamental reason why improving labor standards is something that is more easily attainable by collective action than by the actions of individual countries on their own. They are all facing a classic collective action situation, where competition between them undermines the ability of any one of them to advance interests they all share.

It’s easy to name another situation where this was once true, namely tariff barriers. It was difficult for any country to lower its tariff barriers when its rivals would not respond in kind. Economic theory says cooperation should not have been necessary because each country would have been better off if even if they had done it unilaterally without requiring any quid pro quo. But it was precisely because reality was less tractable than theory that GATT and the WTO were created. When all members agreed not to compete on tariffs if their competitors agreed as well, it changed the situation every country faced, and resulted in the massive collective lowering of tariff barriers. It advanced the interests of each through collective action of all.

The argument in this book is that labor standards present the same initial situation that gave rise to GATT. Competing for market share by lowering labor standards is the same as competing by raising tariff barriers—we would all be better off if we all didn’t do it. The obvious solution would seem to be a similar collective agreement, resulting in a similar increment in global welfare that will not take place in its absence.

This then brings us to a set of arguments which most of us who aren’t specialists in trade economics will never have heard of, but which occupy a large place in this book because (a) they remain after the more common arguments have been dispatched, and (b) they are the most technically sophisticated arguments, so they require more space. These are arguments by trade economists who are supporters of government intervention to raise labor standards in developing countries, but who believe that action by individual countries would be more efficient than collective action in preserving both the gains of trade and the sovereignty of nations. You might expect to find them grouped all together in Standard Objection 2 (“Linkage is an inferior means of promoting the goals it is intended to promote”) but in fact there are a little more spread out than that.

The first concerns Kyle Bagwell, Robert Staiger, and the case for requiring Kemp-Wan adjustments. But since this argument is chiefly concerned with import-competing industries, rather than export industries, it is to my mind rather on the edge of the standard linkage discussion (although central to trade and development economics). And since Kyle Bagwell is one of five commentators who contributes an essay at the end of the book, I think this debate is exhaustively covered in the book itself.

The Bhagwati challenge

But the second thread doesn’t jump out at you the same way and is to my mind even more important. It is woven of three distinctly different and complex arguments by Jagdish Bhagwati and others who have followed in his footsteps: (1) an argument about “targeting,” and the preferability of correcting all economic distortions at their source; (2) an argument about the “two birds” theorem of administrative efficiency; and (3) an argument about using wage subsidies to offset the costs of raising labor standards. That might seem like a lot for one person, but actually it’s only the beginning. Bhagwati should probably be considered the opposer-in-chief of linkage and his presence sort of haunts the whole discussion. He has written more widely on the subject than anyone else and there is scarcely an argument I’ve mentioned (and many I haven’t) that he has not weighed in on. He is a ubiquitous presence in the footnotes. But the reason he is one of the most important figures in trade economics today is precisely because he has made repeated original contributions to the field. So it shouldn’t be a surprise that the deepest arguments against linkage are original with him.

However, unlike Bagwell, Bhagwati has never to my knowledge directly engaged the arguments in this book. So a reader is left distinctly curious as to what his reply might be to what seems like a sharp but friendly quarrel in a common cause. Unanswered objections look unanswerable, especially when they concern technical questions most of us have never asked. I’m sure Bhagwati has answers, and I for one would very much like to hear them.

First there’s the proposition that it is always better in principle to correct any domestic economic distortion at the source. The chief reason for this is that only then will the original misallocations of capital and labor be set entirely back to what they ought to have been. If a distortion is corrected with offsetting payments at a later stage, even though the costs to GDP may be fully offset, the fundamental misallocation will not be corrected.

Barry and Reddy have two responses to this. The first is that it is not at all clear that low labor standards can be understood as an economic distortion in the technical sense of the term. The concept of distortion requires that the costs suffered by producers be lower than the social cost; a stock example is pollution. But for this to be true of low labor standards, they would have to be a substantial cost to someone other than the two parties to the labor contract. If the cost falls entirely on the parties to the contract, then according to economic theory, it will be entirely represented in the price. Now understood like that, it’s not at all clear that there is a significant social cost in this technical sense of an externality. It seems reasonable to assume that the cost of low wages and working conditions is entirely perceivable by the worker, including even its chief indirect effects, which fall on his or her dependents. There’s certainly no disputing that low labor standards exact a cost on society in terms of health, education, development, etc. But calling that an externality may be double counting; the cost to society may be simply the aggregate of the costs to all contracting households. And if there isn’t a substantial social cost in the technical sense of the term, then the argument about correction at source is moot.

But even if we accept arguendo that there is a social cost in the technical sense to low labor standards; and that therefore it would be best policy to correct that at its source; that still wouldn’t be an objection to this reconstructed form of linkage. Labor standards under this proposal would be corrected directly at the source, by the country in which they happen, with precisely that end as a goal.

Secondly, there is the so-called “two birds” objection. This is based on a 1966 book by the Dutch economist Jan Tinbergen, On The Theory of Economic Policy, wherein he argued that efficient policy demands that you employ as least as many policy instruments as there are objectives. If you have fewer instruments than you have objectives, you lose degrees of freedom. You are forced to make trade-offs, and the maximum aggregate attainable will be smaller than if you could adjust each policy independently. In other words, it's hard to kill two birds with one stone; you’re better off with two stones. Bhagwati’s “two birds” objection to linkage is that maximizing the gains of trade and reducing disadvantage are two different goals, and that Tinbergen’s argument has thus proven it would be inefficient to pursue both using one institution. Better that the WTO focus exclusively on trade, and the ILO or some similar institution be used to raise labor standards.

Leaving to one side the extreme toothlessness of the ILO to enforce its otherwise fine ideas, the main argument against the two birds objection is that it is a misinterpretation of Tinbergen. On Barry and Reddy’s reading, “independent policy instruments” are simply independently adjustable administrative processes. For them, Tinbergen’s argument doesn’t require separate institutions even for co-related goals. The ad absurdum argument is that if it did, every labor department in the world would be a logical impossibility. Barry and Reddy say that for Tinbergen, the really key difference is between “supporting” and “conflicting” covariance, which can only be determined empirically. Therefore his book cannot be used as the basis for an a priori objection, as is being done here. Lastly, Tinbergen himself seems to lend support to their argument insofar as he supported the proposal for an International Trade Organization put forth by Keynes at the original Bretton Woods Conference, which was a classic linkage plan that would have coordinated development and trade. (The ITO was no mere pipe dream. It would have become a foundation stone of the Bretton Woods system had it not been blocked by the US Senate.)

Lastly we come to the most important objection. In his classic 1963 paper, “Domestic Distortions, Tariffs and the Theory of Optimum Subsidy,” Bhagwati and his co-author V. K. Ramaswamy showed that there exists a first best policy mix for a developing country that allows it to improve labor standards and still retain the maximum gains from trade. This mix can be achieved by any country on its own through a properly designed wage subsidy, whereby companies which improve their labor standards are subsidized for precisely the amount by which this increases their labor costs. Bhagwati and Ramaswamy showed that under this system, the overall GDP of the country would rise above what it would have been otherwise and its labor standards would be improved.

Bhagwati and others have since built on this argument to say, in essence, See, you don’t need linkage—this paper proves it. And the reply of Barry and Reddy is, in essence, Yes, this does prove linkage isn’t theoretically necessary to improve labor standards. But that isn’t an argument against linkage, it’s rather an argument for it, analogous to the arguments that proved each country could benefit by unilaterally lowering tariffs. Bhagwati’s 1963 paper proves that it is possible to use incentives to raise labor standards without losing the gains from trade. Reddy argues in a technical paper appended in a footnote that this argument can be extended so that it continues to hold whether or not such countries coordinate their efforts. If that’s true, then theoretically there is no difference between the country providing the subsidy itself or having it provided by an international transfer regime—except that a net transfer would of course be an additional gain for the country. So Barry and Reddy are essentially arguing that revenue from increased market share, and assistance in raising labor standards, will together provide a functional substitute for Bhagwati’s wage subsidy. And behind this is the master point, which is that this plan will remove several disincentives which in real life hamper countries from attaining Bhagwati’s ideal situation just as they hampered countries from unilaterally lowering their tariffs.

Thus it seems at first sight that if Bhagwati consulted his own first principles he would have to conclude that this form of linkage—which is very, very different from the form he’s been fighting against all these years—would be something he would have to support. It will be interesting to see how he and other linkage opponents reply. In this fairly lengthy review, I have still only skimmed this book. There are many more arguments, they have many more parts, and I haven’t even touched on their implications. But my impression is that the authors carry their point. Of course, I don’t expect long-time opponents of linkage to become converts without putting up a fight, and I look forward to the ensuing debate. If the critics of linkage concede nothing else, I think they will at least agree that in Barry and Reddy they have found worthy theoretical opponents.

Reading instructions

There are two audiences for this book. The first is professional trade economists and philosophers of justice, for whom I think it should be required reading as one of the most important books of recent years. The second is everyone else interested in the subject who is in the mood to stretch.

For this latter group, I personally would suggest starting in the heart of the book with Chapter 6: “A Constructive Procedure—Identifying Linkage Proposals That Meet the Standard Objections.” If the argument grabs you and you read to the end, I think you’ll feel a natural desire to go back to the beginning in order to appraise it critically, to see if such a reversal of common wisdom can really withstand all objections. That’s what I had to do, because for me at least, it was impossible to fully appreciate all the little precisions of the early pages before I had loaded the entire argument into my mental database. So I proffer this method to save others time, because I think this dense, concise little book is an important one, and I want to encourage as many people to read it as I can.

Michael Pollak is a writer in New York.

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