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Journal of Economic Perspectives—Volume 14, Number 1—Winter 2000 —Pages 177–186
How Far Will International Economic
Integration Go?
Dani Rodrik
drew a vivid picture of an integrated world economy at the pinnacle of the
gold standard. While sipping his morning tea in bed, Keynes reminisced
nostalgically, the Englishmen of his time could order by telephone various com-
modities of the world, invest in far-off places, purchase unlimited amounts of
foreign currency or precious metals, and arrange for international travel without
even requiring a passport. Keynes, who was writing in the aftermath of a devastating
world war and was anticipating a period of economic turbulence and protection-
ism— correctly, as it turned out— considered this a lost era of great magniﬁcence.
What will a latter-day Keynes, writing a century from now, say about today’s
global economy with its unparalleled prosperity and integration (illustrated by
Figure 1)? Will she bemoan, as the original Keynes did, its collapse into disarray and
autarky yet again? Or will she look back at the tail end of the 20th century as the
era that launched a new process of internationalization? Since economists rank
second only to astrologers in their predictive abilities, the correct answer is that we
have no idea. The best that one can do is speculate wildly, which is what I am about
to do.
In these speculations, I will use the term “international economic integration”
rather than “globalization,” for two reasons. First, while not as trendy, my preferred
term has a distinct meaning that will be self-evident to economists. Globalization, by
contrast, is a term that is used in different ways by different analysts. Second, the
term “international economic integration” does not come with the value judge-
y
Dani Rodrik is Professor of International Political Economy, John F. Kennedy School
of Government, Harvard University, and Research Associate, National Bureau of
Economic Research, both in Cambridge, Massachusetts. His e-mail address is
^
&
.
I
n a famous passage from
The Economic Consequences of the Peace
, Keynes (1920)
dani_rodrik@harvard.edu
178 Journal of Economic Perspectives
Figure 1
World Exports/GDP
(
in 1990 constant dollars, percent
)
Source:
Maddison (1995), Tables G-2, I-4.
ments—positive or negative—that the term “globalization” seems to trigger in
knee-jerk fashion.
How Much More Integration Could There Be?
The natural benchmark for thinking about international economic integration
is to consider a world in which markets for goods, services, and factors of produc-
tion are perfectly integrated. How far are we presently from such a world?
The answer is that we are quite far. Contrary to conventional wisdom and
much punditry, international economic integration remains remarkably limited.
This robust ﬁnding comes across in a wide range of studies, too numerous to cite
here.
1
National borders, such as the U.S.-Canadian one, seem to have a signiﬁcantly
depressing effect on commerce, even in the absence of serious formal tariff or
nontariff barriers, linguistic or cultural differences, exchange rate uncertainty, and
other economic obstacles. International price arbitrage in tradable commodities
tends to occur very slowly. Investment portfolios in the advanced industrial coun-
tries typically exhibit large amounts of “home bias;” that is, people invest a higher
proportion of assets in their own countries than the principles of asset diversiﬁca-
tion would seem to suggest. National investment rates remain highly correlated
with and dependent on national saving rates. Even in periods of exuberance,
capital ﬂows between rich and poor nations fall considerably short of what theo-
retical models would predict. Real interest rates are not driven to equality even
among advanced countries with integrated ﬁnancial markets. Severe restrictions on
the international mobility of labor are the rule rather than the exception. Even the
1
See in particular Feldstein and Horioka (1980) and Helliwell (1998).
Dani Rodrik 179
Internet, the epitome of technology-driven internationalization, remains parochial
in many ways; for example, Amazon.com feels compelled to maintain a distinct
British site, Amazon.co.uk, with different recommendations and sales rankings
than its American parent.
While formal barriers to trade and capital ﬂows have been substantially re-
duced over the last three decades, international markets for goods, services, and
capital are not nearly as “thick” as they would be under complete integration. Why
so much trade in goods and capital has gone missing is the subject of an active
research agenda in international economics. The answers are not yet entirely clear.
But at some level there is no mystery. National borders demarcate political and
legal jurisdictions. Such demarcations serve to segment markets in much the same
way that transport costs or border taxes do. Exchanges that cross national jurisdic-
tions are subject to a wide array of transaction costs introduced by discontinuities
in political and legal systems.
These transaction costs arise from various sources, but perhaps the most
obvious is the problem of contract enforcement. When one of the parties reneges
on a written contract, local courts may be unwilling—and international courts
unable—to enforce a contract signed between residents of two different countries.
Thus, national sovereignty interferes with contract enforcement, leaving interna-
tional transactions hostage to an increased risk of opportunistic behavior. This
problem is most severe in the case of capital ﬂows, and has the implication that
national borrowing opportunities are limited by the
willingness
of countries to
service their obligations rather than their
ability
to do so. But the problem exists
generically for any commercial contract signed by entities belonging to two differ-
ing jurisdictions.
2
When contracts are implicit rather than explicit, they require either repeated
interaction or other side constraints to make them sustainable. Both of these are
generally harder to achieve across national borders. In the domestic context,
implicit contracts are often “embedded” in social networks, which provide sanc-
tions against opportunistic behavior. One of the things that keeps businessmen
honest is fear of social ostracism. The role played by ethnic networks in fostering
trade linkages, as in the case of the Chinese in southeast Asia, is a clear indication
of the importance of group ties in facilitating economic exchange.
3
Ultimately, contracts are often neither explicit nor implicit; they simply remain
incomplete. Laws, norms and customs are some of the ways in which the problem
of incompleteness of contracts is alleviated in the domestic sphere. To borrow an
example from Tirole (1989, pp. 113–114), what protects a consumer from the small
likelihood that a soda-pop bottle might explode is not a contingent contract signed
with the manufacturer, but that country’s product liability laws. International law
2
See Anderson and Marcouiller (1999) for empirical evidence which suggests that inadequate contract
enforcement imposes severe costs on trade.
3
Casella and Rauch (1997) were the ﬁrst to emphasize the importance of group ties in international
trade, using a model of differentiated products.
180 Journal of Economic Perspectives
provides at best partial protection against incomplete contracts, and international
norms and customs are hardly up to the task either.
This line of argument has important implications for the question of how
far international economic integration will go. If the depth of markets is limited
by the reach of jurisdictional boundaries, does it not follow that national
sovereignty imposes serious constraints on international economic integration?
Can markets become international while politics remains local? Or, to ask a
different but related question, what would politics look like in a world in which
international markets had nothing to fear from the narrower scope of political
jurisdictions? The rest of the paper will advance some answers to these ques-
tions, and in so doing lay out a framework for thinking about the future of the
world economy.
Caught in an International Trilemma
A familiar result of open-economy macroeconomics is that countries cannot
simultaneously maintain independent monetary policies, ﬁxed exchange rates, and
an open capital account. This result is fondly known to the cognoscenti as the
“impossible trinity,” or in Obstfeld and Taylor’s (1998) terms, as the “open-
economy trilemma.” The trilemma is represented schematically in the top panel of
Figure 2. If a government chooses ﬁxed exchange rates and capital mobility, it has
to give up monetary autonomy. If it wants monetary autonomy and capital mobility,
it has to go with ﬂoating exchange rates. If it wants to combine ﬁxed exchange rates
with monetary autonomy (at least in the short run), it had better restrict capital
mobility.
The bottom panel of Figure 2 suggests, by analogy, a different kind of tri-
lemma, one that we might call the political trilemma of the world economy. The
three nodes of the extended trilemma are international economic integration, the
nation-state, and mass politics. I use the term “nation-state” to refer to territorial-
jurisdictional entities with independent powers of making and administering the
law. I use the term “mass politics” to refer to political systems where: a) the
franchise is unrestricted; b) there is a high degree of political mobilization; and
c) political institutions are responsive to mobilized groups.
The implied claim, as in the standard trilemma, is that we can have at most
two of these three things. If we want true international economic integration, we
have to go either with the nation-state, in which case the domain of national
politics will have to be signiﬁcantly restricted, or else with mass politics, in which
case we will have to give up the nation-state in favor of global federalism. If we
want highly participatory political regimes, we have to choose between the
nation-state and international economic integration. If we want to keep the
nation-state, we have to choose between mass politics and international eco-
nomic integration.
None of this is immediately obvious. But to see that there may be some logic
How Far Will International Economic Integration Go? 181
Figure 2
Pick Two, Any Two
in it, consider our hypothetical perfectly integrated world economy. This would
be a world economy in which national jurisdictions do not interfere with
arbitrage in markets for goods, services or capital. Transaction costs and tax
differentials would be minor; convergence in commodity prices and factor
returns would be almost complete. The most obvious way we can reach such a
world is by instituting federalism on a global scale. Global federalism would
align jurisdictions with the market, and remove the “border” effects. In the
United States, for example, despite the continuing existence of differences in
regulatory and taxation practices among states, the presence of a national
constitution, national government, and a federal judiciary ensures that markets
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