Comparative Institutional and Policy Advantage

Abstract

Many expect globalization and regional economic integration to force domestic institutions and policies to converge toward some efficiency-mandated minimalism. Applying basic trade theory to national institutional and policy systems clarifies, however, that the greater force is tax competition (broadly conceived), as abetted by ideology and transmitted and magnified by international financial mobility. Trade actually furthers institutional and policy diversity; and international finance per se tends to reinforce that. Tax competition for global capital, contrarily, does create fiscal pressures, but wholly independently of the efficiency of taxation or tax-financed public activity. However, the political integration that accompanies European economic integration provides a policy-making forum for surmounting the collective action problem of tax competition, sometimes turning economic globalization opponents into political Europeanization proponents. The analysis also highlights three broader conclusions. First, export or output growth or specialization in particular sectors suggests only comparative, not necessarily absolute advantage. Second, trade and, less surely, capital integration tend to reinforce domestic equilibria that sustain existing networks regardless of their efficiency. Third, economic integration partly offsets short-run costs of inferior networks, further dampening any efficiency-based pressures for convergence.