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Multinational Corporations, Capital Mobility and the Global Neo-Liberal Regime:

Effects on Northern Workers and on Growth Prospects in the Developing World


James Crotty, Gerald Epstein and Patricia Kelly
January 1998

Appeared in:
Seoul Journal of Economics
Winter 1997

James Crotty and Gerald Epstein teach at the Economics Department of the University of Massachusetts,
Amherst Campus. Patricia Kelly teaches Economics at Quinnipeac College. They would like to thank James
Burke and Esra Erdem for excellent research assistance and the Economic Policy Institute for financial
assistance. David Gordon, Ilene Grabel, Keith Griffin, Tim Koechlin, Robert Pollin and Jim Stanford provided
helpful comments on an earlier draft. Work on this paper was done in conjunction with the Economic Policy
Institutes Project on Globalization and Progressive Economic Policy. A related paper by the same authors will
appear in a book organized by the Project to be published by Cambridge University Press.

Concern that global economic integration might impede the development of social progress within
nations is nothing new. Marx wondered whether the process of globalization would crush incipient revolution
in his "small corner of the planet". Today we wonder whether the recent acceleration of globalization will
crush all national aspirations for egalitarian and sustainable development.
In this paper we analyze two related aspects of the current globalization process. The first is the relation
between the activities of multinational corporations (MNCs) -- especially foreign direct investment (FDI) -- and
the economic well being of workers in the North. In particular, we ask whether the increase in capital mobility
associated with the world-wide movement of liberalization, deregulation and privatization that we refer to as the
Neo-liberal global regime (NLR) has contributed to the problems of high unemployment, wage stagnation and
rising inequality that have plagued Northern workers since the early 1980s.
The second concern of the paper is the impact of the evolution of the NLR itself on economic well being
in the North and South. Here we make two basic arguments. First, Neo-liberal institutions and practices tend to
generate inadequate global aggregate demand (AD) growth and thus high global unemployment, unleash
destructive competitive processes, and weaken governments ability to regulate business in the public interest.
Since all these effects are harmful to workers, it is not surprising that countries in which ordinary citizens have
fared best in the past twenty years are countries that have resisted the adoption of Neo-liberal institutions and
policies. Second, the forces of global Neo-liberalism are now so powerful that it has become difficult if not
impossible for countries to maintain non-Neo-liberal economic structures. We support this proposition by
examining the collapse of the Swedish economic model in the early 1990s, and the long-standing attack on
the East Asian model that recently culminated in the onset of the current Asian crisis.
We focus on the effects on MNCs and FDI on Northern workers in sections I through IV of the paper.
Sections V-VII deal with the even broader question of the impact of the NLR itself on prospects for strong and
equitable economic growth around the globe.

I. Five Views on the Effect of Capital Mobility on Economic Performance
We identify five views of the likely effect of MNCs and FDI on the trajectory of the world economy.
We label these views "The Race to the Bottom", "The Climb to the Top", "Neo-liberal Convergence", "Uneven
Development", and "Much Ado about Nothing". According to "The Race to the Bottom" view (Bluestone and
Harrison, 1982; Barnet and Cavanagh, 1994; Greider, 1997), capital will increasingly be able to play workers,
communities and nations off against one another, threatening to run away if demands for tax, regulatory and
wage concessions are not forthcoming. In this perspective, increased capital mobility benefits corporations,
while workers and communities lose. A modified version of this view is that the winners in the race to the
bottom will include highly educated and skilled workers, and those in privileged professions, no matter where
they live. The losers will be the less killed and the unemployed everywhere.
"The Climb to the Top" view takes the opposite position. It suggests that multinational corporations are
attracted less by low wages and taxes than by highly educated workers, good infrastructure, high levels of
demand and agglomeration effects arising from the clustering of companies in a particular location. According
to this view, competition for FDI will lead countries in both the North and the South to try to provide well
educated labor and high quality infrastructure in order to retain and attract foreign investment (Reich, 1992).
Thus footloose capital and national competition for FDI will induce a global climb to the top.
This climb to the top could lead to the outcome represented by "Neo-liberal Convergence". This is the
widely held mainstream belief that free mobility of multinational corporations, in the context of deregulation
and free trade, will produce increased living standards in all countries. This process will, moreover, transfer
capital and technology from North to South, thereby raising the standards of living of those in the poorer
countries at a faster rate than those in the wealthier ones, eventually generating a world wide convergence in
living standards ( ).
These same processes could, however, lead to the outcome envisaged in the fourth view, "Uneven
Development". "Uneven Development" holds that some regions of the world will grow at the expense of others.
For decades the dominant version of this view was the theory of imperialism: if the South integrated itself with

the North, the North would grow at the expense of the South. Now, the reverse fear holds: by forcing Northern
workers to compete with cheap Southern labor, an integrated world economy will help the South grow at the
expense of the North ( .
The previous four views take for granted that FDI and MNCs have a substantial effect on national
economies. In contrast, the "Much Ado About Nothing" view (Krugman and Lawrence, 1994; Gordon, 1988)
asserts that FDI and MNCs play a rather modest role in global economics. Adherents argue that FDI is still a
relatively small percentage of national income and most of it is between rich countries; thus, FDI can generate
neither convergence nor a race to the bottom.
Which of these views is correct? We cannot provide a complete answer, nor, we suggest, can anyone
else, given the current state of knowledge.
In this paper is present a framework for thinking about these
questions and develop a set of hypotheses about them which only future research can fully assess.
We argue that foreign direct investment is neither inherently good nor bad; its effects are
conditioned by the overall national and international context within which capital mobility occurs. When
FDI occurs in the context of high aggregate demand and tight labor markets, effective regulatory institutions,
and non-destructive competitive processes, it may indeed have a positive impact on nations and communities.
Absent these conditions, FDI can have destructive economic and political consequences on both home and host
For example, during the 1960's in the US, outward FDI was of roughly the same order of magnitude
relative to the size of the economy as in the 1990's. In the high employment, high growth era of the 1960's, FDI
was more likely to increase exports from domestic companies, rather than substitute for them (Epstein, 1993).
But even when FDI led to domestic plant shutdowns, equivalent replacement jobs were much easier to find for
workers and communities. As a result, the threat to run away did little to lower wages or shrink the tax base. By
contrast, in the 1990's, with a chronic shortage of good jobs, government budgetary problems, and emaciated
unions, workers and governments are much more likely to be adversely affected by capital flight and its threat.
We believe that within the structures of the current "Neo-liberal"global economic regime increased

capital mobility is contributing to a race-to-the-bottom tendency. Within the Neo-liberal regime, there are
strong secular forces which destroy the preconditions required for FDI to benefit workers and communities.
These forces arise from key components of the Neo-liberal regime such as financial liberalization, privatization,
increased labor market "flexibility", trade and investment liberalization, and austerity macro policy.
To be sure, at this point both capital mobility and the Neo-liberal model or Washington consensus
have spread themselves unevenly around the globe. But as the NLR strengthens, negative effects of FDI and
capital mobility will spread to more countries and communities, as the recent Asian crisis makes clear. So
while our view is relevant to the explanation of current phenomena, it is, perhaps, more important as a
cautionary tale about the future.

II. How Mobile Are the MNCs?
Many economists subscribe to the view that MNC's and FDI have little impact on national economic
activity in general or on the development of the three largest problems facing Northern workers since the end of
the Golden Age in the 1970s -- wage stagnation, high unemployment, and rising inequality.
Their argument
against the "race to the bottom" view in the North has a number of components. First, as noted, most FDI
continues to go to the wealthier countries rather than to the low wage countries in the South. Second, even when
FDI does go to the Southern countries, econometric studies show that wage and tax costs are relatively
unimportant determinants of investment, compared with market size, political stability, and infrastructural
investment. If FDI is not primarily attracted by lower wages and taxes in the South, how can it be driving down
wages and taxes at home? Third, even if investment were mostly going to the South and were primarily
attracted by low wages and taxes, FDI still constitutes a relatively small percentage of Northern investment.
Evidence can be mustered in support of all of these arguments. While there is an undeniable upward
trend in the share of FDI flows going to developing countries in the recent period, more than 60% of the flows
still go to the developed countries. Similarly, in 1994, developing countries held only about 25% of the stock of
the world's FDI. This percentage is actually below what it was in the 1960-1970 period when 31% of FDI was

located in the developing world. The stock of FDI is spread unevenly across the developing countries, with the
least developed, lowest wage economies getting only 0.5% of the world's FDI (UNCTAD, 1997, and earlier
However, it is important to recognize that there are serious problems with this data, perhaps the most
important of which is that MNCs increasingly engage in international activities that do not necessarily involve
foreign direct investment. These include licensing, joint ventures and outsourcing (UNCTAD, 1995, 1997;
Feenstra and Hanson, 1996; UNCTAD, 1997). We do not yet know how to incorporate these activities into a
single measure of the overall international mobility of MNCs, but their growth would certainly suggest that
standard measures of FDI underestimate the activities of MNCs.

Still, looking only at standard measures, one can see that FDI flows are growing rapidly. Figure 1 shows
the increase of FDI relative to other measures of international interactions in the period since 1985. Clearly,
FDI has been growing much more rapidly than trade and other measures of economic activity. FDI is a
relatively small percentage of domestic investment in most regions, but there has been a big jump in the
importance in FDI inflows in most regions of the world. In the developing world in particular, there was more
than a doubling of the share of investment accounted for by inward FDI between the period 1981-85 and 1993
(UNCTAD, 1995). Finally, to understand the effects of FDI, it is important to look at gross FDI flows --
inflows plus outflows -- as well as net flows; we argue in section IV that under current conditions capital
mobility per se, with its effect on job turnover or job churning, can have significant impact on wages, income
distribution and the incidence of unemployment. Table 1 shows how gross FDI relative to the stock of capital
has changed in recent years in different regions of the world; it demonstrates that gross capital mobility has
increased dramatically.
In Asia, for example, it has almost quadrupled, while in the developing economies it
has more than doubled.
Why is capital mobility rising so rapidly now? The standard explanation, favored by mainstream and
heterodox economists alike, is that dramatic reductions in transactions and communications costs spurred by the
revolution in computer technology dramatically reduced the cost of creating or enlarging multinational

production systems (See Barnet and Cavanaugh, 1994). While technological change is undoubtedly important,
recent years have also witnessed enormous change in what has been called the enforcement structure within
which cross-national economic transactions take place (Epstein and Gintis, 1992).
The domestic and
international institutions and rules which secure the property rights and enhance the prerogatives of
multinational corporations have undergone a revolution in the last twenty years at least as dramatic as changes
in technology and transaction costs. There has been a substantial increase in both developed and developing
countries' willingness to accept multinational capital without restrictions, and to enter into treaties to protect the
rights and privileges of foreign investors, real and financial . The North American Free Trade Agreement, while
one of the most significant multilateral treaties offering protection to foreign investment, is by no means the
only such recent agreement. Over the period, 1991-1996, 95% of the 599 changes in countries regulatory FDI
regimes were in the direction of liberalization. They mostly involved the opening of industries previously
closed to FDI, the streamlining or abolition of approval procedures and the provision of incentives (UNCTAD,
1997, p. xviii). The enforcement structure has also been enhanced by bilateral investment treaties signed for the
protection and promotion of investment. As of January 1, 1997, there were 1,330 such treaties involving 162
countries, a threefold increase in five years. Approximately 180 such treaties were concluded in 1996 alone.
Moreover, the OECD continues its efforts to formulate a broad investment agreement -- the Multilateral
Agreement on Investment. Also of importance was the conclusion of the Uruguay Round of Multilateral Trade
Negotiations and the establishment of the World Trade Organization (WTO). While the Uruguay round failed
to achieve one grand treaty dealing with foreign direct investment, the UNCTAD concluded that the agreement
"is of major importance for the investment climate around the world..." (UNCTAD, 1994, p. 278).
This dramatic improvement in the effectiveness of enforcement structures helps explain the growth of
FDI in recent years, and suggests that this upward trend is likely to continue, if not accelerate. In addition, the
promotion by international agencies and others institutions of Neo-liberalism of the idea that FDI is essential
for successful development has increased the desire of countries around the globe to attract and retain FDI.
Meanwhile, the disintegration of the Soviet Union, and the evident discrediting of its economic model, along

with decades of attempted sabotage of non-Neo-liberal development models by the U.S. and various
international organizations has dramatically enhanced the TINA view prevalent among today's governments --
There Is No Alternative to relentless liberalization, privatization and unrestricted integration into world
markets. Finally, the rising demand for inward FDI has also improved the bargaining position of capital relative
to labor, and undermined the ability and willingness of governments to create and maintain institutions and
regulations that force FDI to enhance national economic independence and well-being.

III. The Effects of FDI and MNCs: Theory and Evidence
While most mainstream theorists subscribe to the Neo-liberal convergence (Sachs and Warner, 1996) or
much ado about nothing schools of thought (Lawrence, 1994; Krugman and Lawrence, 1994; Slaughter, 1995),
there are a number of interesting mainstream models which predict uneven development rather than
convergence from the joint impact of capital mobility and technological change (Krugman and Venables, 1995).
Johnson and Stafford (1993) also develop a model which shows that as technological development permits
more outsourcing, the average real wage can fall while skilled wages rise. Markusen and Venables (1996)
present a model of trade and investment in North and South which can be used to generate a number of
possible outcomes: these include uneven development and a race to the bottom in which skilled labor becomes
better off relative to unskilled labor in both the North and South. Another possibility is that as capital moves
from the North to the South, skilled labor in the South becomes better off and skilled labor in the North
becomes worse off. A recent book on globalization and labor markets by Dani Rodrik (1997) is especially
important. Though Rodriks model is neoclassical and assumes full employment, he concludes that gross capital
mobility and trade, even between countries with similar levels of income, increases the elasticity of the demand
for labor, and thereby negatively effects labors share of income.
In short, there are numerous mainstream models of MNCs, trade, and technological change which allow
for the possibility of either uneven development or a race to the bottom. Even within mainstream theory,
Neo-liberal convergence is only one of a number of possible outcomes, and, therefore, it has no

theoretical priority over alternative views.
Turning to econometric evidence, a number of economists, both mainstream and heterodox, have
investigated the effects of FDI and technical change on the average level of real wages, inequality, and
employment. Many early influential studies presented evidence that MNC's and FDI had only a small impact on
inequality in the U.S. (Lawrence and Slaughter, 1995; Slaughter 1995). Feenstra and Hanson, on the other
hand, argue that the common definition of FDI used by Lawrence and Slaughter and others is too narrow. They
adopt a broader definition of MNC outsourcing which includes imports by multinationals as well as the imports
of intermediate or final goods used in the production of, or sold under the brand name of, domestic firms. Using
this definition, Feenstra and Hanson found a substantial negative effect of "outsourcing" on the demand for
unskilled labor in the U.S. According to their estimates, "outsourcing" can account for 30-50% of the
increase in the skilled labor share of wage income (Feenstra and Hanson, 1996 p. 243). While their analysis
uses U.S. data, it is likely that similar results could be obtained in other OECD countries. Clearly, more
econometric work will be required to more definitively establish the effects of FDI.

IV. An Alternative Framework for Analyzing the Effects of Foreign Direct Investment and
Multinational Corporations in the Neo-liberal Regime
In this section we propose an alternative framework for thinking about these issues. We argue that the
growth of the NLR fundamentally altered the environment that conditions the effects of FDI on the lives of
working people. As a result, capital mobility now contributes to wage stagnation, high unemployment and
inequality in the North.
The general outline of our argument is as follows. We take an institutionally contingent "bargaining" or
"conflict" view of the industrial relations process through which wages, working conditions and job
requirements are determined, a view especially well suited for analyzing core Northern industries. In this view,
the relative power of labor and capital are profoundly affected by AD, the institutional environment within
which bargaining takes place, and the "competitive regime". In the institutional environment or rules of the

game we include the legal, judicial and regulatory framework of bargaining , including restrictions on the
domestic and international mobility of real capital, the character of enforcement of government regulations; the
strength of unions, whether bargaining is done on a firm, industry or national level; the norms, conventions and
informal understandings that shape the bargaining process; and the social wage that determines the fallback
position of workers when bargaining fails.

The rise of the NLR contributed in complex ways to key changes to the bargaining process that were
harmful to Northern labor: it reduced the incomes available to be divided between the bargainers by lowering
AD growth and raising the rentier share of income; it created a more destructive competitive environment that
led firms to adopt aggressive anti-worker bargaining strategies; and it reduced workers ability to resist
corporate aggression.
We argue that in the NLR, forces operating to raise AD are structurally weak, while competitive
pressure on firms to lower costs through downsizing or "labor shedding," speedup, and wage cutting are
structurally strong. Given the sluggish growth of AD, competition-induced downsizing and speedup are
creating a slow trend growth in the demand for labor. Even normal patterns of labor supply growth, therefore,
generate persistent problems of excess labor supply, which appear in the form of "disguised" unemployment in
countries -- both North and South -- without an adequate social wage.
Moreover, countries such Russia, India,
China and the nations of Eastern Europe that were previously insulated to a substantial degree from the global
capitalist marketplace are now in a slow, uneven, and incomplete process of integrating themselves within it.
Many of these countries have substantial quantities of skilled and educated workers who are low priced by
OECD standards and thus provide MNCs with an attractive substitute for Northern workers. The NLR is
creating secularly high unemployment in the North and elsewhere, destroying the institutions that sustained
Northern workers' economic and political power in the Golden Age regime, and making capital flight easier and
more attractive.
Workers bargaining power has thus been eroded by a dramatic rise in workers fear of job loss, and an
ongoing deterioration in their fallback position or exit option. Rising fear of job loss was caused not only by the

increased incidence of actual job loss, but by relentless corporate downsizing and increased capital mobility,
both within and between countries, which have raised the level of job churning -- cycles of job loss followed by
unemployment, then reemployment, usually at an inferior job. This has created an environment in which the
mere threat to downsize or to run away is increasingly credible, and where even modest rates of downsizing
and capital flight can keep workers and unions perpetually weak. It is our contention that all these factors
creating unemployment, fear of job loss, wage stagnation and rising inequality are likely to increase in intensity
as the NLR solidifies.
Changes in the Mode of Competition and the Institutional Environment of the Bargaining Process
The idea of a competitive regime and its affect on economic performance is discussed in Crotty
(1993). In the "corespective" competitive regime of the early post World War II Golden Age, cooperating
oligopolistic firms in key Northern industries took advantage of fast market growth and limits on both domestic
and international competition to generate substantial, dependable profits and rents. Under the institutions and
practices characteristic of the Golden Age, firms could accumulate capital without the excessive concern
experienced in the NLR that national AD would fail to grow, that importers would steal their customers, that
financiers would take huge chunks of their profit, or that investment would be made prematurely obsolete by
the outbreak of fierce cost cutting battles over market share. High rates of investment and productivity growth
followed. Strong unions, government support for the maintenance of a fair share for labor, distributive accords
or understandings between capital and labor, and sustained full employment produced strong real wage growth,
an increasingly generous social wage, and held inequality in check. Strong real wage growth in turn helped
sustain the rate of growth of AD.
This regime broke down in the 1970s and early 1980s, partly from internal contradictions to be sure, but
partly under the pressure of the increasingly open national borders associated with the globalization process. It
was eventually replaced by a new regime of "anarchic" or "coercive" competition (Crotty 1993). The stronger
the NLR becomes and the more mobile capital becomes, the more destructive competition will become.
Corporate response to these altered circumstances differed substantially across the OECD, though as

time goes on the general direction of strategic change is becoming ever more convergent. We focus on the
American response because, ideally suited to Neo-liberal ideology, it is clearly a harbinger of developments to
follow around the OECD. The two most important aspects of corporate America's new competitive strategy in
the late 1970s and early 1980s was the choice of conflictual rather than cooperative relations with labor and a
withdrawal of support for an effective social "contract" that assured both full employment and the maintenance
of an adequate social wage. The retreat from a full-employment macro policy and an attractive social wage
severely weakened labor's bargaining power at the firm level, while new corporate policies of "speed up" and
labor saving organizational and technical change poured recruits into the reserve army of unemployed workers.
The corporate attack on labor included a war on unions, political support for stripping workers of their legal
rights, the widespread use of replacement workers during strikes for the first time in the post World War II era,
outsourcing and FDI.
It is crucial to analyze the effects of technical change on Northern labor markets in light of this
competitive regime shift and the subsequent move to anti-worker corporate strategies. Under severe
competitive pressure, companies took advantage of union weakness, a more business oriented government
judicial and regulatory framework, and advances in information processing and computerized machine control
to invest in technologies that helped them implement their anti-worker strategies. Where neoclassical
economists posit exogenous technical change that just happens to be skill-biased, we see instead an
endogenous process in which corporations under intense competitive pressures chose to develop and\or
adopt technologies that helped them reduce labor costs through downsizing, speedup and wage cuts.
Technical change in the 1980s probably was on balance skill-biased, though no more so than in previous
decades (Mishel and Bernstein, 1993). But it's distinctive characteristic was that it was labor-saving and labor
disempowering as well. As such, it was ideally suited to help implement the more antagonistic industrial
relations strategies of the new competitive regime with their emphasis on wage cutting for all skill levels except
those at the top of the distribution. This strategy has contributed to both the sharp decline in median real wages
in the US in the past 15 years as well as to the rise in wage inequality of the period. Blue collar workers may

have been the earliest victims of these changes, but white collar labor has been hit hard in recent years. This
perspective is consistent with the "shifting wage norms" hypothesis presented in Howell (1994) who
demonstrates that the 1980s shift to both wage cutting and skill upgrading took place primarily between 1979
and 1983 in the US, before the bulk of the information processing investment took place, and therefore was
strategically rather than technologically driven.
Looking at wage determination in this bargaining framework helps undermine the Much Ado about
Nothing view of MNCs in two important ways. First it suggest that the debate over the effects of FDI has
focused on the wrong variable. Within a bargaining model what matters to outcomes is not unemployment per
se, but the perceived threat of job loss. In the new environment of high trend unemployment and constant job
churning due to greater capital mobility, corporate downsizing, and rising job loss from imports, the threat
effect caused by FDI and outsourcing may be substantial even if FDI and outsourcing are not very large.
Brofenbrenner (1997) reported on a US survey covering 1993 through 1995, which showed that 50% of all
firms and 65% of manufacturing firms who were targets of union organizing campaigns threatened to close
down and move if their workers unionized. Though only 12% of those firms which ended up unionized
subsequently shut down, workers found the threats credible -- where threats were made, unions lost a larger
percent of elections. In the current environment, plant closings by even a few firms can create a wide-spread
fear of job loss. Polls show that workers in the US live in constant fear that they will lose their jobs; in 1996 the
New York Times reported that 46% of those polled were worried that someone in their household would lose
their job within the next year.

Second, adherents of the Much Ado about Nothing view argue that since most FDI is still within the
North, it cant hurt Northern workers. But the threat effect of FDI depends on gross as well as net mobility.
At times like the present when there are never enough good jobs available, all experience of job loss, even job
churning, creates job insecurity. Outward FDI creates job loss. Inward FDI does bring new jobs, but it is not
costless to the workers, communities, and nations that get them. They must compete for these jobs against other
workers, communities and nations by offering wage cuts, disavowal of unions, and tax breaks. This

competition for the jobs created by inward FDI thus itself contributes to a race-to-the-bottom process
that bids down wages, worsens job conditions and cuts corporate tax revenues. And as we have seen, gross
FDI is large and growing rapidly. In the North, it almost doubled between the early 1980s and the early 1990s
and is almost three times the size of net FDI.
Global Aggregate Demand Growth
We know that global AD growth has in fact been relatively sluggish in the quarter century since the end
of the Golden Age and the birth of the NLR -- in spite of the high growth rates experienced in Asia over this
period. In Europe, for example, real GDP has grown since 1973 at about half its previous post war, so that even
with relatively slow measured productivity growth, unemployment has risen to double digit or depression-era
levels. Outside East Asia, the Neo-liberal era has been a low growth, high unemployment era. But is growth
likely to pick up substantially in the coming years?
Consider the components of global AD. If our argument about labor-saving organizational and technical
change in the North is correct, unless Northern AD growth picks up substantially, high unemployment and
stagnant wages will continue to constrain the growth of consumption spending. Investment spending in the
North has also grown at a modest pace in the past 20 years, and there are no strong reasons to believe that its
trend rate of growth will increase substantially. Export growth had been rapid, but whether such growth can be
sustained is an open question. Should the current collapse in Asia continue for an extended period, prospects for
rapid global AD growth will be even dimmer. Indeed, belief that we may be entering an era of global deflation
and persistent aggregate excess supply is growing rapidly. Deflation in the global market for goods is already
with us.
Therefore, hope that future global AD growth will accelerate has to rest primarily on a belief that
government macro policy -- North and South -- will be substantially more expansionary than it has been in the
past 20 years. Yet there are many reasons to believe that macro policy is likely to be even more restrictive in
the future than it has been in the recent past.
First, central banks around much of the world have adopted the Neo-liberal credo that pursuit of low

inflation is their sole responsibility. In much of the South, this belief has been reinforced by the threat and
reward structure of the IMF and the World Bank. Using the leverage gained by the Asian crisis, Neo-liberal
forces are now in the process of imposing anti-growth monetary policy across that region. Second, the
enormous buildup of government debt in the hands of both domestic and foreign rentiers over the past two
decades has given them enormous power to punish both fiscal and monetary authorities who adopt
expansionary policies. Third, both internal and external pressure has mounted in virtually every country to put a
stop to the ongoing rise in government deficits and debt-to-GDP ratios brought on by the slow growth and
rising unemployment of the Neo-liberal era. The upper limit on allowable government deficits in the Maastricht
Treaty is but one important reflection of this restrictive pressure. In much of the South, rentiers, international
organizations, and domestic elites have put enormous pressure on governments to follow "responsible" fiscal
policies that guarantee low growth. And, in the aftermath of the current crisis, we can expect deflationary fiscal
policies to be imposed by the IMF across Asia.
In sum, it seems unlikely that expansionary macro policy will cause an acceleration of AD growth
capable of counteracting the effect on wages, unemployment and inequality of labor-saving technical,
organizational and strategic change and increases in the global supply of labor should the Neo-liberal regime
continue to expand and solidify. The Wall Street Journal expressed this view when it led off an article on the
obsession with low inflation and deficit reduction shown by policy makers around the globe with the following
sentence: "In the global economy, austerity reigns" (4\10\96).
Changes in Enforcement Structures and the International Rules of the Game
Until the late 1970's many countries, both in the North and the South, imposed numerous conditions and
controls on the entry and domestic operations of MNCs. Up to that time, laws and policies to ensure national
control over FDI were predominant, even in economies favoring foreign investment (Fatouros, 1996, p. 47). As
we have seen, this is now changing dramatically. The general trend is toward much stronger protection for
foreign investors and increasing constraints on the ability of host governments to regulate their activities. By
weakening host governments ability to see to it that FDI contributes to national economic objectives, the

evolution of enforcement structures is making it more and more difficult for states to achieve equitable national
development. The effect of all the new agreements deregulating MNC activity will be to enhance the bargaining
position of mobile capital relative to workers and governments.
Thus, our alternative framework suggests that workers in the North can expect to continue to experience
wage stagnation, high unemployment, rising inequality and deterioration in the social wage as the NLR
strengthens and capital mobility continues to rise.

V. National Institutions Matter
Having argued that all nations have had to confront debilitating economic pressures emanating from the
emerging Neo-liberal global regime, we wish to emphasize that there are enormous differences across
countries in the institutions, structures and social and political priorities that intermediate between firms,
workers and governments on the one hand, and MNCs, international rentiers, international
organizations and global markets on the other. We believe that these structures have made a significant
difference in the way national economies have experienced global economic forces and responded to them.
Many nations in both North and South have been hurt badly by the impact of the Neo-liberal regime, while
others have been able to operate reasonably effectively within it. Thus, it is not possible to enunciate
universally applicable principles concerning the effects of globalization in general or FDI and MNC's in
particular on workers, citizens or national economic performance: the character of these effects is
institutional and regime contingent. However, it must also be acknowledged that the national institutions
that have protected workers from many of the harmful affects of globalization over the past twenty years
are deteriorating under Neo-liberal pressures; no national economy has come through the experience of
increased global integration with its institutional structure and its economic performance unscathed.
Consider first the proposition that institutional structures filter and transform even as they transmit the
effects of globalization on national economies. In the South, the state-guided economies of the East Asia
have taken advantage of increased global openness to industrialize and grow. Their institutions enabled them to

interface with global markets on terms that have been, until recently, favorable to them. In contrast, most other
developing nations, particularly those in Latin America and sub-Saharan Africa, have suffered stagnation and
rising inequality in the past 15 years. In general, those countries in the South which have followed the Neo-
liberal guidelines or the "Washington consensus" most faithfully have fared worst under globalization
while countries that have performed best have done so using anti-Neo-liberal models.. But, as explained in
section VII, it is also true that East Asia is currently moving toward greater international openness and less
effective state intervention. Even prior to the onset of the recent Asian crisis, the pressures of Neo-liberalism
-- exerted through markets as well as by MNCs, the US government, the IMF and World Bank, the
WTO and GATT, and powerful MNCs -- were becoming increasingly difficult for developing countries to
resist. The story in the North is similar. All countries have been affected by the pressures of
globalization in recent decades, but some, by virtue of distinct institutions and political values, were been able
to protect both workers and citizens from the worst effects of global competition for much of the period.
Consider again the institutional bargaining process through which wages and working conditions are
determined in the North. On the one hand, in the past two decades workers have fared best in those countries in
which powerful institutions and regulations, such as national or industry-wide bargaining between unions and
management groups and government legislation to influence wages, benefits and working conditions, have
restricted the freedom of capital to dictate the terms of industrial relations. Structures matter. On the other
hand, globalization is almost certainly contributing to a decline in the ability of anti-Neo-liberal
structures to protect Northern workers' interests.
Both dimensions of the current reality are clearly presented in a recent survey of research on
comparative industrial relations by Locke, Kochan and Piore.
In all countries covered in this study, the individual enterprise has emerged as an increasingly important
locus for strategy and decision-making on human resources and industrial relations. This implies that
managers ... have been the driving force for introducing changes in employment practices in recent
years. This was not always the case. In the past, in most European countries and in Australia, national

or industry-level union\management bargaining or even tripartite negotiations with government
established basic wages, benefits and conditions of employment. (1995, p. 144)
They note that: "In almost every country covered in the study, various government regulations and norms
governing recruitment, dismissal\redundancy, lay-offs and the allocation of labor have been relaxed or modified
so as to give individual employers greater discretion" (p. 145); "Everywhere unions are in decline and
management is resurgent" (p. 147); and "in all countries, there was a resurgence in inequalities in income or in
employment opportunities" (pp. 151-52).

VI. The Neo-liberal Regime, FDI and the Destruction of the Swedish Economic Model
To see how FDI and Neo-liberal structures can interact with one another to create an economic and
political crisis for workers, we first consider the case of Sweden, one of the outstanding Northern success
stories of the Post WWII era. In the next section we look at the effect of globalization on South Koreas version
of the East Asian economic model.
Swedish MNCs have always been a dominant force in the domestic economy, accounting for 69% of
manufacturing employment in 1970. Yet in the Golden Age FDI was probably helpful to Swedish workers and
the Swedish economy. Outward FDI was modest through the 1970s. Given Swedens record of sustained full
employment, FDI was not a threat to domestic jobs, and under a centralized bargaining structure that had the
allegiance of corporate leaders, it did not restrain wages or disrupt the ongoing decline in inequality. To the
extent that outward FDI helped facilitate and maintain a high level of Swedish exports (through the
maintenance of effective marketing and distribution networks), it helped Swedish firms take advantage of
technical change, gain economies of scale, and achieve higher productivity growth rates than would have been
possible if production were primarily for the small domestic market. At worst, FDI did not prevent the
Swedish economy from posting an outstanding post war economic performance. Its impressive combination of
sustained low unemployment and an egalitarian income distribution was maintained through most the 1980s.
However, by the early 1980s global instability, world recession and a falling domestic profit rate began

to exacerbate emerging strains in the Swedish corporatist economic system. While unemployment remained
extremely low, inflation picked up, creating problems in the crucial export sector. By the mid 1980s Swedish
MNCs had become openly antagonistic to the set of traditional relations and mutual obligations connecting
business, labor and the state that had come to be known as the "Swedish model." Lindbeck points to the onset of
an ideological offensive by capital in the early 1980s designed to replace corporatist arrangements with a
more free market oriented position (1997, p. 1277). Employers first pulled back from the centralized
bargaining system. Sweden's "long-standing solidaristic wage policies followed throughout most of the 1970s
gave way somewhat as business pushed hard to decentralize bargaining structures and to lower labor costs"
(Locke, Kochan and Piore, 1995, p. 151). They also pressured the state to deregulate the economy.
The threat of capital flight (moving operations overseas) and capital strike (refusing to invest at home)
are two key structural sources of power business can use to pressure labor and the state to bend to its will. The
ability of Swedens MNCs to flee the domestic economy through outward FDI and to substitute foreign for
domestic investment gave them leverage over labor (through the threat to jobs and wages) and the government
(by making its traditional economic objectives impossible to attain). This leverage was magnified by technical
change that made FDI easier, and by the evolution of the new global regime, which created external pressures to
liberalize. Outward FDI was both a major contributor to the deterioration of Sweden's economic performance
in the 1980s and, especially, the 1990s, as well as a powerful weapon used by capital to force its Neo-liberal
political and economic policies on the rest of society. As Wilde noted:
In seeking to move away from corporatist arrangement and to reduce the level of taxation (and
with it social expenditure), the greatest threat of powerful employers is to move out of the country
altogether, and this places a tremendous constraint on the ability of a social-democratic government to
maintain corporatist arrangements (1992, p. 11).

Sweden's MNCs virtually fled the country in the second half of the 1980s. This created enormous
pressure on both labor and the state to accept the MNCs Neo-liberal economic and political agenda. Between
1981 and 1992 outward FDI averaged an astounding 13.1% of domestic investment while inward FDI was just
3.2% of domestic investment (Glyn, 1995, p. 44). But the "flow of outward FDI during the 1986-1990 period

was almost five times higher than in the 1981-1985 period," so that the "Swedish share of the MNCs production
had fallen to below 40 per cent by 1990," down from 61% just four years earlier, and from 72% in 1978
(Blomstrom and Kokko, 1994, p. 5 and p. 34). Outward FDI went from one percent of GDP in the early 1980s
to two percent by 1985, then sky rocketed to an unprecedented six percent (or 28% of all investment) by 1989.
MNCs were directing the high profits of the late 1980s to finance outward FDI rather than domestic investment.

The problem was not just that this flight of capital cost jobs, income and exports. Having renounced
their commitment to the domestic economy and to the institutions of the Swedish model, Sweden's MNCs
were hollowing out domestic manufacturing, exporting primarily the high value added, high-skilled parts of the
production process to their foreign affiliates while leaving lower skilled raw material processing and
intermediate goods production for their home operations. Blomstrom and Kokko argue that this FDI outflow
harmed the economy in numerous ways: the big MNCs now employ a lower share of high skilled workers than
the rest of Swedish industry; the fruits of Swedish R&D appear in their high-tech foreign operations rather than
at home; and there have been serious negative spillover effects on domestic suppliers and subcontractors.
Capital flight made it difficult for the state to continue to play its traditional role. Under business
pressure, the government began to dismantle important components of its regulatory apparatus. The domestic
financial system was deregulated in 1985, which forced domestic interest rate upwards, toward global levels.
Credit rationing had traditionally been one of the state's most important tools of counter-cyclical macro policy.
Thus, the deregulation of domestic financial markets drastically reduced the ability of the state to avoid
speculative booms and maintain full employment. Capital controls were weakened, then, in 1989, virtually
eliminated. The dismantling of capital flows in turn induced a huge inflow of short-term foreign funds. This
helped facilitate a subsequent explosion of credit-financed speculation, creating a cyclical upturn, but also over-
leveraged households and businesses. When this speculative boom eventually went bust, the financial fragility
it left behind constrained consumption and investment spending. In the absence of capital controls, funds
quickly left the country, putting downward pressure on the krona that the government resisted through the

maintenance of high interest rates right through the recession. The broad outline of this story will be familiar to
observers of the current Asian crisis.
The MNC-led business sector was now in a position to launch an all-out assault on the remaining
elements of the Swedish model. Glyn reports that their strategy was described by the Financial Times (8
November 1990), under the headline Business plans five-year campaign to end Swedish economic model, as
a plan to destroy the vestiges of the famed Swedish economic model, with its collectivist values of equality
and solidarity (1995, p. 53). Stripped of many of the tools traditionally available for use in resisting recession,
and pressured by its MNCs not to do so, the Swedish government turned its back on it's half-century old
commitment to full employment and embraced overly restrictive monetary and fiscal policy (in part in order to
converge to EC inflation rates as a prelude to hoped-for membership). The early 1990s saw the deepest
recession since the 1930s. Real GDP fell by 5% between 1990 and 1993 and unemployment rose to
unprecedented heights -- from 1.5% in 1990 to 9.5% in 1994. Yet the government maintained high interest
rates and restrictive fiscal policy.
There is no doubt that the Swedish model was destroyed by internal contradictions as well as external
pressures: rising capital mobility was hardly the only threat to its reproduction. But it seems reasonable to
conclude that the ability to flee the country gave Swedish MNCs enormous leverage in their successful
campaign to change the structures of domestic industrial relations and the role of the state in the economy. The
unprecedented flight of real capital in the 1980s, while to some degree a response to the economic strains that
had developed in the late 1970s and early 1980s, clearly helped create the economic crisis that severely
damaged the Swedish "model" in the 1990s and gave capital the power to shape the reconstruction of Swedens
political economy. Society was being forced to pay a high price, in terms of rising unemployment, falling real
wages, rising inequality, and a deteriorating social safety net, to enlarge capital's freedom to seek profit
wherever it saw fit.
Swedens recent decline demonstrates that within the Neo-liberal regime, the greater the importance of
MNCs in the economy and the weaker the state's control over cross-border capital flows, the greater the

economic and political damage that MNCs can cause to domestic economic performance.

VII. The Neo-liberal Regime and Development in the South: The End of the East Asian Model?
Under the heading National Institutions Matter we made the following arguments: the effects of the
NLR on individual countries are mediated by the distinctive institutions and practices specific to each; those
countries that have achieved the best economic progress for the majority of their people in the Neo-liberal era
are also countries that have consistently violated the principles embodied in the Washington Consensus; and,
the pressures of Neo-liberalism are everywhere eroding those mediating institutions that have protected the
interests of ordinary people from global forces generating wage stagnation, inequality, erosion of the social
safety net and slow growth. In this section we consider the history of East Asia to show that the last of these
arguments applies to developing nations.
Most of the developmental success stories of past three decades are in East Asia. Indeed, the outstanding
economic performance of Japan, Korea, Taiwan, China and others over recent decades, especially in contrast to
slow growth and high inequality in most other nations of the South, led to widespread recognition of an East
Asian economic miracle and admiration for what came to be known as the East Asian model of economic
development. Of course, recognition of the outstanding economic performance of these countries does not
imply support for all aspects of their political economy. For example, democratic processes are severely
constrained in many of these countries, attempts by workers to organize in support of higher pay or better
working conditions have at times been met with brutal repression, and corruption in the economy and polity are
not uncommon. Nevertheless, there is no denying that in countries such as Japan and Korea, enormous
economic progress has been made in recent decades and prosperity has been widely shared.
Though the East Asian model is anti-Neo-liberal, the nations involved integrated themselves to varying
degrees in international markets (though some, such as Korea and Japan, purposely minimized the role played
by foreign MNCs and inward FDI). Export-led growth is obviously not autarky. But they did so, at least until
recently, more or less on their own terms and in pursuit of their own economic interests, not in accordance with

IMF and US free-market dictates.
Contrary to popular Western belief, there is no single East Asian model -- each of the Asian miracle
countries selected a different development path. Yet they did share one thing in common. Not one of these
countries left its future development hopes to the vagaries of the unregulated market system. Development has
been guided in every case by some form of state-led industrial policy, utilizing credit allocation, regulated and
differential interest rates, government controlled Central Banks, prioritized and privileged industries and
technologies, coordination of investment plans, regulation of labor markets, high state spending on education
and infrastructure, managed trade, controls over the movement of money capital into and out of the country,
regulation of inward and outward FDI, and so forth.
This is not to say that the key to, or cause of, their high growth was government planning; innovative
private sector institutions and practices, such as the labor policies of the Japanese firm, the distinctive industrial
structure of the Japanese keiretsu and Korean chaebol, close bank-firm relations, and high savings rates were of
central importance as well. But the East Asian nations integrated state and private elements tightly enough, with
the state in ultimate control, to earn such labels as Japan Inc. and Korea Inc.
Because they adopted sensible state-led industrial policies rather than destructive Neo-liberal principles,
Asia became the only area of the globe to experience high rates of GDP and per capital GDP growth in the Neo-
liberal era. Should the rate of growth in Asia slow down substantially for an extended period, the fundamental
problem of inadequate global AD growth we have stressed in this paper would be seriously aggravated.
All of the East Asian models have evolved and adapted over time; no specific national political-
economic structure can remain effective across decades of growth and change. The very success of particular
policies and programs creates substantial structural change and generates impediments to further growth or to
distributional equity. For example, rising real wages in Japan and Korea made it necessary for domestic firms to
move production of low value-added goods out of the country, US threats of higher tariffs and lower quotas on
auto imports led Japanese firms to put more emphasis on FDI in the US and less emphasis on exports to the US,
and the enormous growth of Japanese financial institutions in the 1980s created internal pressure to loosen state

controls over financial capital flows. Moreover, as middle and working classes became more educated and
assertive, they fought for democratic political reforms, while stronger working class movements demanded a
greater share in national income. For a variety of reasons, then, in the late 1980s and 1990s it became necessary
to make significant changes in both state and private sector practices in all of the Asian countries. Over this
period, debates arose in every country over how the structures of the model should be adapted. Most of the
proposals for change involved some degree of deregulation.
Of course, the composition and perceived interests of various class strata had evolved over time as well.
Powerful domestic financial and industrial enterprises and wealthy and politically influential families, having
enriched themselves in the process of economic development through state-led industrial policy, now believed
that substantial deregulation, especially of domestic and international financial markets, rather than revision or
reform of state-controls was in their individual economic interest. The changes they pushed did not constitute a
coherent or viable stable model, nor a full Neo-liberal package; indeed, they maintained allegiance to those
dimensions of state regulation that continued to suit their interests.
Thus, the issue was not whether change was needed -- everyone agreed it was, but what form
change should take. The need to make substantial alterations in the various models of development arose
endogenously; it would have occurred even in the absence of external pressure. However, this internal pressure
for deregulation was strongly reinforced by the forces of global Neo-liberalism, which had increased in power
throughout the 1980s and 1990s. The US and other large Northern countries, important transnational industrial
firms and banks, global rentier interests, and world organizations like the IMF, the World Bank and the WTO
came together to pressure Asian nations in the direction of full-blown Neo-liberalism. The ultimate objective of
this array of Neo-liberal forces was the elimination of all aspects and variants of state-led industrial policy. The
East Asian model was to be outlawed. Their position, pursued with increased aggressiveness after the
dissolution of the Soviet Union, was that Neo-liberalism was now the only acceptable development model.
This brings us to the final proposition of section V: external Neo-liberal forces profoundly
influenced, and in some cases may even have determined, the outcomes of these national debates by

substantially altering the perceived costs and benefits attached to the various possible new development
strategies and structures available. In so doing, they empowered certain domestic class strata and weakened
others. In other words, external global forces deflected structural change away from evolution within the
tradition of the East Asian model, and toward the Neo-liberal path of deregulation, liberalization and
privatization. For those who backed a free-market model, Neo-liberal forces offered ideological support,
technical experts to support and help implement deregulation, and material incentives in the form of improved
relations with the IMF and World Bank, access to international loans on attractive terms, military support from
the US, and, most important, assured access to large Northern markets for their exports. To those who backed
continuity with the general principles of the East Asian model, they offered political hostility and economic
warfare. And, to state the obvious, it was the existence of the sophisticated structures of the NLR -- its markets
and other institutions -- that made liberalization a viable strategy.
The combined influence of this coalition of domestic elites and global forces turned out to be
determinate in what we might call Phase One of these Asian debates, the period from around 1980 through mid
1997. At different times and to different degrees in different countries, governments which had formally
regulated domestic financial markets, set interest rates, carefully monitored the allocation of credit, and
orchestrated investment policy began to cede these functions to the private sector. In like manner,
governments which had imposed controls on the movement of money capital across their borders, began to
loosen them. Thus, conditions were constructed that could easily lead to super-heated Keynes-Minsky
speculative boom and bust cycles; super-heated because if and when the inflow of foreign hot money became
substantial, it would accelerate speculative fever. And, in the absence of capital controls, the bust phase of the
cycle was likely to be exacerbated by a run on the currency by foreign and domestic investors. The downturn
might even be initiated by such a run. It should have been clear by the end of the 1980s to anyone not
ideologically blinded by Neo-liberal economic theory that if taken too far, deregulation of both domestic and
international financial markets could be a potentially deadly combination of reforms, particularly for countries
heavily dependent on international trade and thus subject to serious destabilization in the event of excessive

volatility in the exchange rate.
In the second half of the 1980s, credit-fed speculative booms appeared across Asia. Banks and other
financial institutions feeding these booms became swept up in speculative euphoria as well. This was a major
change for countries such as Japan and Korea in which the state, in the tradition of the East Asian model, had
exercised tight control of the credit allocation process. Again at a pace that differed across countries, banks,
industrial and commercial enterprises, and wealthy individuals took advantage of the erosion of capital controls
to increase foreign borrowing.
This process accelerated in the 1990s. Foreign capital inflows to Asia rose dramatically as did the
portion of these flows represented by portfolio investment. The existence of significant cross-country
differences in interest rate levels quickened the pace of capital flows. Banks in Thailand or Malaysia or Korea
could borrow yen at exceeding low short-term interest rates or US dollars at moderately low rates, convert the
yen or dollars into local currency, and lend it to domestic borrowers at much higher rates. Large industrial firms
could also tap these sources of funds directly. Borrowing yen short term to invest in long-term US treasury
bonds became a fairly common practice. As long as the optimistic expectations of the speculative boom
continued, there were always more than enough domestic borrowers willing to pay even very high interest rates
for as much money as global markets could provide, and in the last few years at least, there was no shortage of
international investors anxious to lend to Asians.
One might have thought that the collapse of the Japanese bubble economy in the early 1990s, which
led to years of stagnation in what had been for decades one of the worlds fastest-growing economies, would
have alerted neighboring countries to the danger of domestic financial deregulation and a dramatic weakening
of government oversight of financial markets. On the contrary, the Asian speculative boom picked up intensity,
and in countries which relied much more heavily than the Japanese on short-term foreign borrowing.
Predictably (given their ideological fervor), this deregulation process and its effects on the regional and global
economy were certified as generally sound and healthy by the IMF, the World Bank, global investors and
mainstream economists, who said it increased global allocative efficiency and would create a higher regional

long-term growth rate. They continued to give the whole process their seal of approval right up to the day
disaster struck the region in mid 1997.
If global Neo-liberal forces can be said to have been extremely influential in determining the evolution
of the Asian economies in Phase One of their transformation, one might argue that they made a bold bid to take
direct control of Asias economic future in Phase Two -- the ongoing Asian economic crisis kicked off in
July 1997. Even Neo-liberalisms most persistent critics were shocked by the speed and audacity with which the
US, the IMF, and international capital attempted to usurp control over key economic decisions from legitimate
domestic agents in those countries hit hardest by the crisis. Though it is far too early to make predictions about
how this crisis will play itself out, at the moment it does not seem out of the question that global forces may end
up with near-Imperial control over the ongoing transformation of economic institutions and practices in several
Asian countries.
Korea is perhaps the crucial case, both because its economy is by far the largest of the most threatened
nations and because, next to Japan, it has produced the most impressive of the East Asian miracles. Though
no one would dispute that as of the mid 1990s Korea had a number of pressing economic problems that needed
to be addressed, its economic record was extremely impressive. Real GDP per capita had grown by about six
percent a year over the past two decades and real GDP growth averaged well over seven percent a year in the
1990s. Since inflation was low and the government budget was in surplus, the only troublesome real-sector
fundamental was the relatively large trade deficit after 1994, which combined with a contemporaneous
investment boom, contributed to the development of substantial excess capacity in key industries. On balance,
the economy was thought to be in fairly good shape and had been certified as fundamentally sound by the IMF
in 1997. Certainly, no respected observer predicted that serious problems would erupt in Korea in the
foreseeable future.
On the other hand, Koreas domestic financial deregulation process, begun in the early 1980s,
accelerated toward completion in the 1990s, and its borders were thrown open to short-term financial capital
flows, thereby eliminating the states ability to control speculation against the won. The 1994 to 1996 period

saw a burst of liberalization related to Koreas bid for membership in the OECD. According to Amsden and
Yoon: In 1995, South Korea made a Faustian bargain with the United States. In return for membership in the
prestigious OECD, it agreed to loosen almost all controls on financial institutions, both international and
domestic (New York Times, 11/27/97).
Financial deregulation did stimulate some elements of the Keynes-Minsky speculative process discussed
above. The late 1980s witnessed a bubble similar to, though less destructive than, Japans. For example, the
market value of Korean stock leapt from 9% of GDP in 1985 to 57% by 1988 (Woo-Cummings, 1997, p. 90).
By the mid 1990s the effects of the deconstruction of short-term capital controls became evident; between 1994
and 1996 foreign banks more than doubled their lending to South Korea, from about $50 billion to over $100
billion (New York Times, 12\22\97). Almost all the foreign borrowing was done by the private sector, and most
of it was short term. In contrast to other Asian nations, foreign credit to Korea appears to have been channeled
primarily into industrial expansion by Korean firms at home and around Asia, though an unknown percentage
of the loans was recycled by merchant banks into more traditional speculative activity.
By late 1997 Korean foreign debt had reached $160 billion. Almost 60% was short term, with about
20% due in the first quarter of 1998 (New York Times, 12\30\97). Borrowers had come to expect foreign
creditors to automatically roll the debt over as it came due. But the situation was now objectively precarious.
Excess capacity and falling profits had created problems in the quality of loans at many Korean banks. And a
number of merchant banks were burdened by non-performing speculative loans as well. The ability of Korean
companies and banks to pay off their foreign loans depended both on continued healthy earnings in local
currencies and the absence of a decline in the their exchange values. The boom had thus evolved to a fragile
phase, one that could easily be ruptured by any number of developments -- a slowdown in domestic growth,
further loss of export markets, or any other source of disappointing profits; rising domestic or international
interest rates; a decline in the price of stocks or real estate; a refusal, for any reason, of foreign banks to roll
over short-term loans, or a large fall in the value of the won and other Asian currencies. Yet no one seemed to
notice the potential danger. No one called attention to the gross irresponsibility involved in making the well

being of a country with a extremely high domestic savings rate dependent on massive short term capital inflows
and, therefore, on the whims of notoriously volatile global rentiers.
Of course, when the Asian crisis erupted there was a general flight of investor capital from Asian
markets and Asian currencies. Foreign banks now refused to roll the loans over. Real and financial asset prices
plummeted around the region, and exchange rates went into free-fall. After losing reserves in a futile attempt to
support exchange rates, countries raised interest rates to try to stop the panic. The initial declines in asset prices
in turn induced further forced asset sales by investors unable to meet their interest payments.
The Asian financial crisis pulled everyone down, the strong as well as the weak. The won lost about
20% of its value in the period before early December, when the IMF made its deal with Korea. Firms and banks
with large dollar or yen debt were pushed toward bankruptcy and their desperate demand for dollars and yen
kept downward pressure on the won. Interest rates rose again in response to a sharp upward re-evaluation of
risk, while banks pushed near default began to refuse to extend credit to smaller businesses. Economic growth
slowed and unemployment, almost unknown in post war Korea, rose -- from 2% in November to almost 3% in
December. A self-reinforcing cycle of declining growth, falling profits, rising unemployment, rising interest
rates, falling interest coverage ratios, and rising bankruptcies was now well under way.
As the world watched in amazement and fear, the excessive, ill-conceived deregulation of recent
years, induced in significant part by the bullying of external Neo-liberal forces, turned a number of Asian
countries from economic miracles to economic disasters in a matter of weeks! The New York Times
pointed to the transformation of South Korea from industrial giant to industrial pauper (11\22\97). Neo-liberal
economists, who had been denying for years that the success of the East Asian miracles had been created by
state-led industrial policy, insisting that it had been generated by free markets, now claimed that the crisis was
caused by the same powerful but inefficient state industrial policies whose existence they had previously
At this time (mid January 1998), only those most intimately involved with the negotiations leading to
the US-IMF rescue of Korea know how and why they evolved the way they did. We do know that in the first

week of December an initial agreement was announced by which the IMF, in concert with the US and Japan,
would provide the Korean government with carefully staggered foreign currency loans that would sum, in the
end, to about $25 or $30 billion. As the crisis deepened in the weeks after the agreement, the total grew to near
$60 billion. The Korean government apparently believed that a huge IMF loan was necessary to avoid the
economic problems that might follow large-scale defaults by Korean firms and banks on their short-term loans
from foreign banks. This fear of default must have been extraordinarily deep seated because the government
quickly agreed to virtually all of the IMFs unusually long list of unusually restrictive conditions.
It is not clear to all observers why the Korean government should have capitulated so quickly and
completely to conditions so severe that they have been universally described in the Western press as the
humiliation of Korea. First, all the debt was owed by private Korean businesses. The government could have
taken the position, consistent with well established Neo-liberal principles, that if one private party violates a
contract with another private party, that is no business of the state. Second, the dangers of mass default were
widely shared. A failure to roll over the debt would indeed have damaged Korea, and might have led to a
boycott by foreign investors (though history suggests that the boycott might evaporate once the economic crisis
ended). But it would also have caused substantial damage to European and US banks, and significantly
exacerbated the Japanese financial crisis. Moreover, it could have triggered a crisis and panic in the global
financial system. Thus, it was not as if only one of the bargainers was threatened by a failure to come to an
agreement. Given that both sides were under duress, and given that this was not public debt, it seems clear that
the Korean government could have improved its bargaining position by aggressively threatening default. Third,
when confronted with the full loss of their capital through default, many foreign banks might have been willing
to negotiate roll overs with the least vulnerable of the defaulting banks. The Korean government might well
have been able to impose a temporary moratorium on repayment coupled with a guarantee that payments would
be made, by the state if necessary, over an extended period. Fourth, in retrospect at least, it seems quite clear
that the problems that might have been caused by a failure of negotiations and subsequent default would not
have been more damaging to Koreas economic health and independence or to the value of the won than the

implementation of the IMFs reforms.
According to press reports, the US was in effective control of these negotiations; American officials
such as Robert Rubin and Lawrence Summers of the Treasury Department and Federal Reserve Chairman Alan
Greenspan, apparently called the tune. When a tentative agreement been achieved, the US held the deal up for a
number of days while it added numerous additional demands beyond those incorporated in the initial
agreement. It seems clear that the US government, representing the interests of its multinational enterprises and
wealthy investors, used the crisis to extort the Korean government into agreeing to a wish-list of structural and
policy changes designed not to save Korea, but to force Korea to accept the dominance of American
economic interests. If some domestic Korean interests supported important parts of the program, which they
did, so much the easier for the US.
The breadth and depth of IMF dictates were referred to in the press as unprecedented. Under US
pressure, the IMF had acted not as a partner in Koreas attempt to survive the crisis, but in a manner more
appropriate for an occupying military power. It demanded the total destruction of all remaining elements of the
East Asian model, and their replacement with Neo-liberal institutions and practices -- a transformation the US
had struggled with only partial success to impose on Korea for several decades.
It is also worth noting that while the problem loans at the center of the negotiations had been mutually
agreed to by domestic borrowers and foreign lenders, all costs of the rescue were to be borne by Koreans --
firms, banks, government, workers and citizens. Foreign banks were guaranteed by the IMF not to lose a penny;
IMF dollars would be immediately recycled their way. And this was by design, not necessity. The IMF could
have chosen to offer foreign banks partial repayment over an extended period of time, which would have been a
far better deal for them than the free-market alternative of default.
We list here some of the more important components of the agreement as culled from press reports.
Most have nothing to do with legitimate IMF objectives or with easing Koreas economic situation; many will
obviously make the crisis worse; and some simply reflect the wishes of US and other Northern corporate

We begin with the demand for austerity. Though this was standard IMF medicine, it was here applied to
a country which did not have the standard symptoms; unlike recipients of IMF aid in Latin America, Korea had
low inflation and its budget was in surplus. The IMF insisted on cutbacks in government spending, an increase
in (regressive) taxes, and a substantial rise in interest rates, which were already high in real terms. Initially the
real GDP growth rate was to be halved, from 6% in 1997 to 3% in 1998. Subsequent deterioration of the
economy under the agreement has led to revisions of the 1998 growth target to 1%, but private sources now
forecast a decline in GDP for 1998. The interest rate on three month corporate bonds, which was 12% in
November, rose to 30% in early January.
Other elements of the agreement reinforced austerity. The IMF demanded that problem banks be closed
rather than preserved through merger and the injection of public funds. The large-scale forced closure of banks
would obviously lower the supply of credit and disrupt essential bank-customer relations. The IMF also
required that all banks meet the BIS target of capital in excess of 8% of liabilities by March 1998, and that they
do so after deducting 100% of the value of nonperforming loans from their assets. While in mid January all but
two of Koreas commercial banks could meet the target using the interim rule, none of them could do so under
the 100% rule. The predictable effect of this IMF demand was a worsening of the ongoing credit crunch; to
meet it, banks had to refuse to roll over most of their loans. Small and medium size businesses were being
denied loans at any interest rate, so their bankruptcy rate has accelerated dramatically, causing yet further
deterioration in bank loan portfolios and even greater pressure on banks to deny credit. Even firms that were in
sound financial condition before the rescue are being forced to shrink or die by this disastrous IMF policy.
The combined effects of austerity macro policy and the banking reforms severely restrained domestic
demand. These initial problems then started a multiplier process creating further decline. One of the strongest
demands of the US and IMF is that Korea rewrite its laws restricting firms ability to layoff workers, an
important component of the traditional Korean lifetime employment policy. According to the agreement,
Korea must increase labor market flexibility so that massive layoffs could take place, an objective that has the
support of the chaebol. Though labor union resistance has thus far prevented changes in the law, unemployment

is rising rapidly anyway. The projected 1998 unemployment rate is now put as high as 7%, a terrifying
development in a country which has never know unemployment, which did not even have unemployment
compensation until 1995, and where only a tiny percent of unemployed receive any public compensation at all.
A January poll showed that four out of ten workers believed their jobs to be in serious jeopardy, a development
sure to sharply decrease the propensity to consume. And, because the won had fallen an additional 30%
following the IMF agreement, prices are rising and real wages are falling rapidly. We can see the multiplier at
work here; initial constraints on investment and government spending, along with rising bankruptcies, created
increased unemployment and fear of job loss, a collapse of consumer confidence, and falling real wages which,
in turn, are creating a rapid decline in consumption demand.
It must be stressed that at this point no one knows precisely how much of the IMF program will, in the
end, be implemented in Korea or how much resistance to its conditions, if any, Korean workers, businessmen
and government officials will offer. Still, we can say with confidence that if fully implemented for a prolonged
period, the IMF program will create austerity on a grand scale, and will increase, rather than relieve, Koreas
(and Asias) financial crisis. In June 1997 Korea had a reasonably sound real sector burdened with excess
capacity and financial problems -- a troubling but hardly catastrophic situation. The early Asian crisis
heightened financial fragility. What was then needed was a period of moderate growth and moderate interest
rates, with no increase in domestic or, especially, foreign indebtedness. Growth would create the cash-flow
needed to service debt; modest interest rates would permit debt service without destroying companies ability to
sustain themselves. Thus, the IMF recession-plus-high-interest rate program was a cure calculated to kill the
patient, not the disease, and likely to turn what was a serious problem into an economic, and perhaps political
and social, catastrophe.
That the US-IMF program was likely to devastate Korea was hardly a secret. A Business Week editorial
in December argued that the medicine Asia is being told to swallow may make it sicker. The IMF demands
that Asia cut growth and consumption. But that will hurt consumers, make for lower wages, and penalize the
poor rather than the rich (12\29\97). The Wall Street Journal reported that Joseph Stiglitz, former Chairman of

the Presidents Council of Economic Advisors and current chief economist for the World Bank, along with
prominent Wall Street economists, were wondering aloud whether the IMF is prescribing too much
austerity (1\8\98). Stiglitz cautioned that you dont want to push these countries into severe recessions,
which was exactly what the IMF programs were designed to do. The article noticed that relations between the
World Bank and IMF had become strained.
Other eminent economists agreed with Stiglitz. Jeffrey Sachs attacked the IMF program, calling it
folly and an indiscriminate punishment of Korea. He argued that the IMFs seal of approval is a seal of
doom (New York Times, 12\18\97). In his view: The region does not need wanton budget cutting, credit
tightening, and emergency bank closures. It needs stable or even slightly expansionary monetary and fiscal
policy to counterbalance the decline in foreign loans (New York Times, 11\13\97). Sachs believed that the
IMF was squeezing Korea so that foreign lenders could leave the field of battle unscathed. Looking back,
he said, its hard to imagine that the Korean won could have fallen any further if the IMF had punished the
lenders rather than the borrowers (New York Times, 1\8\98). Paul Krugman suggested that default would have
been better than the IMF program: it might have been better to let South Korea declare a moratorium on
foreign debt problems (New York Times, 12\18\97).
But the US-IMF program demanded far more than austerity and bank reform; it sought the complete
destruction of the Korean model and the opening of all Koreas markets to unrestricted exploitation by
foreign MNCs, banks and financial investors. The IMF demanded that the government end its control over
central bank policy, and give up its influence over the allocation of credit by the private sector; credit allocation
would henceforth be regulated solely by considerations of private profit. These steps would destroy the
governments remaining ability to direct credit and provide preferential interest rates to targeted firms and
industries, a cornerstone of the East Asian model. And experience suggests that independent central banks
follow policies designed to minimize inflation at the cost of growth and employment.
The program calls for the elimination of managed trade; tariffs and export subsidies are to be drastically
reduced or eliminated. This would end the ability of large Korean firms to use assured dominance of domestic

markets plus export production to take advantage of the productivity growth associated with economies of
scale, a practice that helped some Korean firms become major competitors to Northern MNCs in world markets.
Legal impediments to the foreign takeover of Korean firm and banks are to be eliminated by early 1998.
Even the prohibition against hostile foreign takeovers is to be ended. This represents such a great victory for
Northern multinational banks and nonfinancial corporations (who have been trying for decades to more deeply
penetrate Korean markets) and such a potential blow to Korean firms that they can be expected to try to find
ways to subvert its intent. Foreign ownership of Korean commercial banks would be especially devastating in a
system where large industrial firms have high debt/equity ratios even in normal times, and where bank-firm
relations are an integral part of the nations economic structure. The fact that the US and IMF insisted that these
changes be adopted without delay demonstrates that their goal is to dominate Korea, not help it.
Even if we accept for the sake of argument that it is in Koreas self interest to open its firms and banks
to foreign ownership, it would be completely irrational to do so in the midst of the crisis. Given the
enormous drop in the value of the won and the collapse of the Korean stock market, as of mid January domestic
enterprises could be purchased by American or European firms in their own currencies for about 30% of what
they would have cost just six months earlier. Under the headline Corporate Fire Sale Seen for Korea, the New
York Times foretold of a wave of foreign takeovers of its companies by American and other foreign
corporations (12\27\97). No one believed that the value of the won or stock prices were then at their
equilibrium values; practically everyone believed that these values would be substantially higher in the
intermediate, though perhaps not the near, future. Moreover, the desperate need of dollars and yen by many
large Korean businesses makes them likely to accept even absurdly undervalued bids for segments of their
business. No friend of Korea could possibly support this plank of the IMF program. What possible rational
explanation can be found for this seemingly absurd IMF demand other than the material self-interest of
Northern global interests?
The last IMF dictate we consider is the demand that the government remove all remaining restrictions

on cross border financial flows. Hereafter, foreigners will be able to invest in the Korean financial markets on
the same terms as citizens, and all restrictions on foreign investment by Korean nationals will be removed. Yet
the complete elimination of capital controls over even the shortest-term speculative loans and investments
appears to many observers to move Korea and the rest of Asia in precisely the wrong policy direction. The
Asian crisis was made possible by the absence of adequate controls over short-term international capital flows.
From about 1993 to 1996, excessive short-term credit flowed into Asia, financing speculation in real estate and
financial securities, and overinvestment in industrial capacity. Then, when the speculative boom weakened, as
all such booms eventually do, there was no way for affected governments to slow down the massive speculation
against Asian currencies that followed. (China is an exception; it maintains strict control over short-term capital
flows.) It was the collapse of these currencies that converted a difficult period into a severe crisis.
The damage done to Asian economies has caused many economists to reconsider their opposition to
controls over short-term capital flows.
The New York Times reported on extensive interviews about the Asian
crisis with economists attending the January meeting of the American Economic Association: a common
theme emerged that rules should be developed to discourage the sort of short-term borrowing that can suddenly
leave a country like South Korea over indebted to the industrial nations. Korea drew criticism for having
gradually eliminated restrictions on such borrowing (1\8\98). The article reported that even Stanley Fischer,
chief economist for the IMF, expressed approval of Chiles tight regulation of short-term foreign borrowing:
Chile had escaped a short-term debt crisis for more than a decade in part because that country had limited
short-term foreign borrowing. Having been part of the IMF team that required Korea to eliminate all controls
over cross-border money movement, at the AEA meetings Fischer suggested that governments in Korea and
Thailand place ceilings on how much their banks could borrow in foreign currency. Such IMF schizophrenia
is not unprecedented. The Fund briefly flirted with support for inward capital controls after the recent Mexican
peso crisis, only to revert to Neo-liberal orthodoxy view when the crisis was over.
It is risky to draw general lessons from the Asian crisis at this early stage. Still, some conclusions seem
warranted. First, recent events in Asia add credence to the belief that the complete deregulation of short-term

capital is a disastrous policy, especially for small or modest size economies. In concert with domestic financial
deregulation, it opens the economy to severe boom-bust cycles initiated or magnified by the instability of global
rentiers, who suffer from recurring bouts of euphoria and panic. Such cycles obviously make stable growth
impossible, but their crash phase, if severe enough, can make the nation vulnerable to external pressure to adopt
structural and policy changes that may not be in the countrys long-term interests.
Second, many economists who believe that short-term financial flows should be controlled by the state
also argue that longer-term financial flows and FDI should be free of such restraint. Our view is more nuanced
and contingent. We have argued that FDI can be helpful to ordinary people in both home and host countries, but
only if the supporting conditions are present. In Asia, Neo-liberal forces represented by the IMF, the US, and
multinational business, often in cooperation with segments of domestic economic elites, are using the crisis to
simultaneously force the area open to unrestricted real capital flows and destroy those conditions -- adequate
AD, effective state regulation of FDI, and non-destructive competition -- that would allow FDI to play a helpful
role in creating jobs and raising wages.
Third, the NLR is now in the process of eroding the basic right of the people of several Asian countries
to national economic self determination. Across Asia, under both authoritarian and democratic governments,
external forces acting solely out of self-interest have, at least temporarily, taken control of key economic
decisions from national political authorities. They demand that the citizenry suffer the pain of recession,
unemployment, falling wages, and deteriorating public subsidies so that global rentiers and MNCs can further
enrich and empower themselves. It might not be wholly inappropriate to suggest that Western imperialism is
creeping back into Asia in the wake of the current crisis.
Fourth, current events in Asia raise the question of whether global forces will allow any non-Neo-liberal
national economic model to survive. As events in Asia evolve over the next few years, perhaps TINA -- There
Is No Alternative -- will become a fact rather than a mere ideological tenet. On the other hand, as the pain of
the crisis spreads around Asia, there could be a political backlash against the entire Neo-liberal program. Only
time will tell whether the Asian crisis will strengthen or weaken the NLR.

Finally, most forecasts of Asian growth rates predict a sharp decline over the next few years. The Asian
crisis has already led to a one percentage point reduction in the consensus forecast for global income growth in
1998. But we know that even when Asian growth rates were the envy of the world, global AD was sluggish, too
slow to stop the rise in global unemployment. If Asian growth slows for an extended period, there could be dire
economic consequences for working people around the world.

VIII. Conclusion
Though this is not a paper about policy, a few broad policy conclusions are implicit in its analysis. We
have argued that the growth of the NLR and of increased capital mobility within the NLR have been
detrimental to the interests of Northern workers and to prospects for sustained, egalitarian growth in less
developed nations. But we do not oppose increased international economic integration per se. To the contrary,
we believe that trade and cross-border capital flows can be used to increase the economic well being of the
majority of people in both North and South provided they take place within an appropriate international and
domestic institutional and policy framework -- one that supports strong and sustainable economic growth and
low unemployment, maintains an appropriate power balance between capital, labor and the state, limits the
more destructive dimensions of competitive processes, and empowers democratic political processes to exercise
control over the broad contours of economic development.
We do not pretend to know the precise mix of markets and state and non-state regulatory processes that
would be appropriate for every country, but two lessons might be drawn from the economic experience of the
past two decades. First, nations must be permitted to possess far more regulatory power over domestic and
cross-border economic activity than is now possible under the NLR. Second, it would be far easier for
individual nations to achieve sustainable and equitable growth if the main institutions of the international
economic and financial system valued such growth over the interests of global rentiers and MNCs, and
supported rather than undermined such state economic regulation as was necessary to get the job done.


Table 1

The ratio of foreign-direct-investment inflows and outflows to gross fixed capital formation





All Economies





Developed Economies





Western Europe





Developing Economies





Latin America










S.E. Asia





Developing Economies
minus China




Source: UNCTAD, 1995,1997 World Investment Report, Annex table B5.


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1. In fact, there is an enormous amount of recent research on these issues, much more than we can review here.
See for example the excellent essay by Kozul-Wright, 1995.Also See the Journal of Economic Perspectives,
Summer 1995, and Federal Reserve Bank of New York, Economic Policy Review, January, 1995, Vol. 1, No. 1
for recent surveys of this rapidly growing literature.
2. For an extensive review of the evidence demonstrating that Northern workers have indeed suffered from
high trend unemployment, stagnant or only slowly rising wages, and rising inequality, see Mishel, Bernstein
and Schmitt, 1997; Federal Reserve Bank of Kansas City, 1994; and Federal Reserve Bank of New York, 1995.
All three sources also present and evaluate alternative explanations of the data.
3. On the other hand, some FDI actually behaves more like portfolio investment and it is not known whether
the share of such investment has been increasing over time.
4. To get a full picture we want a measure of mobility within nations as well; but this will have to await future
5. Epstein and Gintis (1992) propose the idea of an "international credit regime". Such a regime consists of
both an "enforcement structure" and a "repayment structure". The "enforcement structure" is the set of
institutions and practices, which creditors create internationally and in their home countries, to try to enforce
their credit relations. The "repayment structure" is the set of institutions and practices which debtor countries
try to establish to attract credit. In this paper, we will refer to the whole international credit regime as the
enforcement structure to simplify the terminology.
6. See also Fortin and Lemieux, 1997, for an institutionalist explanation of wage determination and wage
7. We thank John Eatwell for his insight on the subject of disguised unemployment.
8. Extensive US survey data on peoples attitudes about their employment status are reported in The New York
Times, 1996.
9. See James Crotty and Gerald Epstein, 1996, for a discussion of the economic and political arguments in
favor of capital controls.