Presentation to Hamilton Branch of the NZIIA, July 20, 2004.

Keywords: Globalisation & Trade;

In late 2003 I was awarded a three year Marsden Grant to study globalisation and New Zealand’s role in it. Globalisation is a topic I have been long working upon, developing out of my earlier study of the New Zealand economy summarised in my book In Stormy Seas: The Post-War New Zealand Economy, whose theme was that the fate of New Zealand will be largely a consequence of what happens overseas, together with our ability to seize the opportunities and manage the problems. This paper sketches the research program, and looks at one of the issues – international trade.

What is Globalisation?

Many writers avoid defining globalisation analytically, instead characterising it by a series of phenomenon such as increasing trade, or capital flows, or logos, or international inequality; or to particular international institutions such as the World Trade Organisation or the International Monetary Fund and the World Bank or the European Union, or multinational corporations; or to particular policies such as free trade, liberalised capital movements, and so on. The London Economist described globalisation as ‘international capitalism’: many anti-globalisers might agree, perhaps adding ‘together with US hegemony’, or even ‘imperialism’.

Stanley Fischer, one time chief economist at the IMF, describes globalisation as ‘the ongoing process of greater interdependence among countries and their citizens’. Joseph Stiglitz, who held a similar position at the World Bank, defines globalisation as ‘the closer integration of countries of the world as a result of lowering transportation and communication, costs, and the removal of artificial man-made barriers.’ Both are focussed on contemporary phenomenon. But it is important to take a historical perspective. Scholars argue that nineteenth century globalisation was in many ways a more powerful and pervasive phenomenon that late twentieth century, at least among peoples of European origin because their migration was unrestricted.

Moreover it was not just an inter-nation phenomenon. Indeed it would be ahistoric to think of the states of the beginning of the nineteenth century to be similar to those of today. The modern nation-state was a creation of the globalisation process of the times, as it integrated regions and made central government and national markets possible. The ‘United’ States of American became a more meaningful concept when canals and railways brought the states together.

In the end a simple phenomenon-based definition like Fischer’s, may be the most fruitful. We follow Stiglitz, albeit also covering the nineteenth century, with globalisation is the closer integration of nations and regions.

However, for an economist, a definition is not sufficient. We need a process, a mechanism which underpins the phenomenon. The Marsden research program is organised around the analytical proposition of globalisation is the consequences of the reductions in the costs of distance.

That these falls have been dramatic is easily demonstrated by considering the world centred on New Zealand. One hundred and fifty years ago it took three and more months to sail from Britain to New Zealand – carrying goods, people and information. Changes since then has reduced the shipping time to about three weeks, quartering the effective distance in the world. But people, and light valuable goods can fly to Britain in under two days, a reduction of more than 98 percent. Information can be zipped around the world virtually instantaneously.

If these changes do not seem spectacular enough, think of the changes for meat and dairy products. One hundred and fifty years ago, one could not ship them to Britain at all. The introduction of refrigeration reduced the cost of distance from – effectively – infinity, to a small proportion of the products’ costs of production, and transformed New Zealand’s economy and society.

This recognition of the crucial role of the costs of distance provides an analytic foundation which allows one to explore rigorously many aspects of the modern world from a historical perspective, and to consider possible scenarios for the future of the world and of New Zealand. Not only economics scenarios: among those on which I am pondering are:

– the role and future of nationalism since it largely began as a nineteenth century phenomenon associated with the regionalisation and globalisation. The leads to a practical question of the possibility of cultural convergence in the future – that is that national and regional differences will largely disappear.

A related, but partially distinct issue is

– the role and future of the state which, as we know it today, is dependent upon a reach over its region and therefore accumulated power as falling costs of distance increased its practical reach. What will happen to the state as costs of distance fall and policy issues become international rather than national? Will the state continue to exist? A better form of the question might be what kind of states will we have in the future and what kind of supra-national organisations? The immediate practical question is that of policy convergence, the possibility that in the future all countries will have largely the same policies, at least in some areas – especially economic ones.

I have some tentative views on these issues, but fortunately the Marsden grant is for three years, so I can spend a lot more time reading and investigating and thinking before I come to a definitive conclusion. Perhaps you would like to invite me back then to tell you what I think.

Why Is There Trade?

In the interim, I want to talk about the narrower issue of trade policy, where I can use the formal models of economics to progress our understanding. My focus tonight will be on ‘global connectedness’ which is at the centre of the government’s economic policy: The Growth and Innovation Strategy. For those interested in international relations, trade and trade policy is at the interface with domestic economic relations.

Historically, until perhaps a couple of hundred years ago, most international and inter-regional trade occurred on the basis of absolute advantage, that is the trade occurred because the purchasing country was not able to produce the product very efficiently itself. Examples include spices from East Asia, gold from the Americas and wool from Britain. The costs of distance – the acquiring of the unique products from distant lands – added to the end price, but it did not affect the location of production.

Two or three hundred years ago, trade based on comparative advantage began to develop in which a particular country or region chose not to produce something it could, but produce something else which it could do more efficiently and which it would exchange for the first product. So New Zealand could produce machinery, but instead it specialised producing pastoral products which it exchanged for machinery produced in Britain, which similarly specialised by not being self-sufficient in food.

The costs of distance are important for such international trade, because they influence location of production. For instance, New Zealand had negligible prospects as a meat or dairy exporter until refrigeration which, in effect, reduced the cost of transporting the products to Britain from infinity to a tiny fraction of the costs of production (especially with the addition of telegraph and steamships).

I used the expression ‘chose’ to describe the exchange arrangement. Practically the market signals favour the exchange, so it is individual consumers which ‘chose’. However there is also choice in public policy, because a country can suppress trade by border regulation via import controls and tariffs. Many did. New Zealand was lucky that for much of the last two centuries the British food market was open to it, although equally potentially lucrative markets in North America and Europe have been and still are closed, as has increasingly the British market since the Second World War.

New Zealand policy has been fixated on comparative advantage trade. Any economist who has mastered its formal theory cannot be impressed by the elegance of the central idea that specialisation is beneficial, and there are gains from allocating resources to the specialist industries. Many who have not mastered the theory support the policy conclusion of free trade either for ideological reasons or because they or the employers are personal beneficiaries – or both.

However when we come to measure the gains from improved allocation arising from the removal of tariffs and import controls, we find they are generally small, say less than 1 percent of total output. To give an example where economic policy based on this theory came a terrible cropper, one only has to recall the reforms of the 1980s where a 25 percent increase in GDP was promised from improved allocation, but never delivered.

It is true that reductions in tariffs will benefit some activities and people, but only at the expense of detriment to others. Which is one of the reasons why the protection is fought over so bitterly. (Sometimes a large industry in one small country can be markedly damaged by protection and export subsidisation in another, to the detriment of the first country as a whole. Nothing I say here implies that New Zealand will not markedly benefit from a reduction in world agricultural protection, a topic to which I return.)

The Case for the Open Economy

If the allocation gains from the ‘free’ trade are small why pursue it if one is not ideologically or self-interestedly inclined? At is issue is that of an open economy strategy, which is not the same as a free trade one. However, one may have to practice the latter in order to pursue the former, for unless there is some mutual disarmament of protection no one country can have a viable external sector. I give two arguments for the open economy which do not rest upon the formal models of comparative advantage.

The first involves consumer choice. Economists are having a lot of trouble measuring consumer choice, so let me give an illustration of how it works. I was struck when I was in Washington on my Fulbright fellowship, that none of the three grocery stores I used sold soft cheeses such as Brie and Camembert (although at a mega-store the choice was greater — probably about as much as in my local New Zealand supermarket). The choice was limited to hard cheeses and Philadelphian. Apparently most American cheese goes into pizza, but additionally the payment system to American dairy farmers gives little incentive to develop new cheeses.

External interference also reduces choice. The US recently tried to restrict further the entry of imports of New Zealand lamb into their domestic market. To shorten a long – and, for our diplomats, difficult – story, following a WTO ruling the US was not allowed to. The outcome is that the NZ lamb industry is now working with the US lamb industry to jointly expand the market for lamb, thus increasing the choice of meat on the American dinner table.

It hardly need be added that no country generates all the world’s new products – all the new possibilities, all the new varieties – so restricting their supply from imports is to the detriment of consumer choice. That gives one benefit of an open economy.

The second benefit arises from the choice aspect and some further factors I will discuss shortly. The result is that exports (and imports) grow faster than GDP. In the last 25 years they have grown about twice as fast. Now the basic rule – be it in economics or the TAB – is bet on fast horses. Over time economic sectors grow at different rates, some above average, some at the national average and some below. The above average growth sectors pull the rest of the economy along. Suppose you have an sector which is about a third of the economy and growing twice as fast. Of course you should back it. And that is what an open economic strategy is about – betting on a fast horses.

(Not to mention that the import sector is also growing twice as fast as the economy – you try to stop the locals demanding all the choice of the rest of the affluent world has, you try to stop them not travelling. To pay for those imports of goods and services, we need exports.)

Competitive Advantage and Inter-Industry Trade

As mentioned there are other factors as well as choice which has been driving that rapid growth of exporting, and which generate trade quite different from that based on absolute or comparative advantage. What we call ‘competitive advantage’ was happening in the nineteenth century, but we have only recently seen it significant on an international scale. Reductions in the costs of distance facilitated regional integration, the precursor of global integration.

The regional integration generated inter-regional trade on the basis of comparative advantage, that is there was regional specialisation. But it also generated a different sort of inter-regional trade, which is much less intuitive. You can see this in New Zealand by the location of the industrial breweries. Once, when the cost of carting barrels around was expensive, every reasonable sized town had one or two breweries, which provided for the local region. Today there fewer – especially of the bigger ones – and each supplies the whole country. Thus Dunedin based Speights trucks beer to Auckland consumers and Auckland breweries sell their products in the South. This is counterintuitive: imagine beer tankers passing each other on the Desert Road taking their marginally different products in opposite directions.

This sort of trade requires low costs of distance, but it also requires economies of scale in production (they are virtually prohibited in the theory which justifies comparative advantage), and it requires consumers wanting variety – of wanting choice. The differentiation is quite small. If there is no Speights the Auckland imbiber does not give up drinking beer altogether but switches to what he considers a marginally inferior product.

This regional trade of almost likes is so common we hardly think about it. But in the last fifty years a similar phenomenon as been happening internationally. Two countries may trade almost identical products. US airlines fly Airbuses, while European ones fly Boeings. Of course they are different planes, but the world would not come to an end if only one is available. (Note however economists argue that the competition between the two producers results in innovations which benefit the consumer, so that separate companies produce much the same product is not a case for amalgamation and monopoly.) Another example is that Germans buy Renaults and the French Volkswagens. Wine stores in New Zealand or any other wine producing country produce further examples.

This trade between countries of almost like products is called ‘intra-industry trade’. Internationally, it hardly existed before the second world war, but has been rapidly growing since, and today makes up about a quarter of merchandise trade. (The other quarters are oil, other primary products, and manufactures traded for primary products.)

Most rich nations participate in intra-industry trade. However among the industrial nations New Zealand is near the bottom (on some measures Australia is a little lower), more like a developing country than a rich one. In public policy, intra-industry trade is almost off our radar screen.

The economics of competitive advantage is curious. It is easy to explain why New Zealand exports meat and dairy products in terms of the natural advantages of climate and geography, but how does one explain that the world’s biggest mobile phone producer is based in Finland? (Finnish boys were too shy to speak directly to girls so they needed mobiles is one implausible explanation) What the theory of competitive advantage suggests is that very often an industry will settle in a particular location almost by accident. Once it is there it will remain in the region, providing the business continues to innovate, to maintain its competitive advantage.

Can New Zealand get into the intra-industry trade business more effectively than it has in the past
can it get a better balance between comparative advantage and competitive advantage? In my view that is much of what the government’s Growth and Innovation Strategy is about. Its vision has New Zealand exporting pharmaceuticals to Europe, IT to the US and films to Hollywood as well as importing pharmaceuticals, IT and films from them.

The strategy’s difficulty is that it is not obvious how to identify the future Nokias. Perhaps we should not even try, but instead make sure that we provide the right environment for such businesses to germinate, grow and flower. Much of this environment is the same as one would apply to comparative advantage industries: good low compliance cost governance, a quality labour force, well functioning and generous capital markets, a great environment for science technology and innovation, and the right support (and profitability) for selling overseas. But there are differences reflecting the peculiarity of the new businesses.

The Consequences of China

By way of background we need to consider the impact of China on world trade. It is likely that China is going to set the international price level for general manufactures in the future, although of course other events such as political turbulence, could invalidate that prediction. However their costs will probably not rise, because manufacturing workers can be supplied from the Chinese rural hinterland in unlimited numbers.

Why does not China – or more precisely Chinese price levels – already dominate the world? First China is only just learning to be a manufacturing exporter. Second, it has only just joined the WTO, which means it has only just got entitled to the lower tariffs associated with most favourable nation status. Moreover, soon these manufacturing tariffs will come down as a result of a successful Doha round. They may come down even further insofar as China enters into Free Trade Agreements – . not just what New Zealand is negotiating, for Australia is standing outside the door.

So whether we have just a Doha round settlement, or whether it is compounded but an Australian-China FTA (and a New Zealand-China one) the prospects for our general manufacturing industry are not optimistic. New Zealand’s strong intra-industry trade relationship – with Australia – is largely based on general manufacturing exports. At the moment we get preferential access to Australia, and they to us. As Australia’s MFN tariffs come down, as Australia negotiates other FTAs, New Zealand loses that preferences, It looks like that New Zealand’s exports of general manufactures to Australia may decrease in importance.

In part it will be replaced by food and other commodity exports to China (and the rest of Asia). Were that all to happen, we would see a considerable contraction in the manufacturing sector (an effect reinforced by reduced New Zealand tariffs as a result of the Doha round and any Free Trade Agreements we enter into). The government has a more challenging objective than to let manufacturing contract. It aims to shift the sector into the part of the market where there is not direct competition with low wage Chinese and other such manufacturers.

Typically such enterprises will depend upon high skills and high technology, and continually advancing skills and advancing technology. That is what the manufacturing component of its Growth and Innovation Strategy was about, indeed that is its ambition for all sectors. Now this presentation is not one on industrial policy – although you can see it that is integrally a response to twenty-first century globalisation. So let me then make but three comments about it.

The first is that it is clear the new industrialisation requires a different government support strategy. A high tech industry like biotechnology is quite different from general manufacturing like making paper cups. We still to get our policy head around this, but so do most other countries. It is always easier to think about the well established past than the future.

My second comment is that the new industries will be more into intra-industry trade and competitive advantage than the current ones. Given the sorts of products they are likely to be, we will be exporting them more to North America and Europe, so the Australian market share will diminish.

Third, I am unsure whether the distinctions between primary, secondary, and tertiary industry are as useful as they were once. When Fonterra uses a component of milk to make a pharmaceutical is it in the primary or secondary sector? If it sells the intellectual property in the process to another company in exchange for royalties is it in the service industry?

(There may be a more general point here. Very often international definitions ones have to be carefully adapted to New Zealand’s circumstances. We are wrong to do simple comparisons of ourselves with other economies without adjusting for circumstances.)

Globalisation Trends and their Impact on New Zealand

Trends already evident in globalisation to suggest where New Zealand might be going. Centrally, the costs of distance are likely to continue to fall, even if it only involves consolidation of known technologies and no new ones. There are a couple of caveats. First the costs of distance have been raised by the additional costs from the prevention of terrorism. The second caveat is we have to assume that liquid fuels continue to be plentiful. This is not so much the danger of a temporary shortage due to, say, terrorism, real enough though they are, but the world’s oil reserves are not unlimited, and alternatives such as bio-fuels may not be cheap when the hydrocarbon reserves run out.

What will the falling costs of distance mean? Different products face different costs of distance, and those costs change differently. At the very least New Zealand needs to distinguish between:
– the costs of moving information (broadband);
– the costs of moving people (such as tourists);
– the costs of moving high valued relatively light products (airfreight);
– the costs of moving dense products (shipping).

The implication is that the balance between different exports will change. (And we can influence their fall via our external infrastructure: the broadband, the airports and the seaports.)

There is another cost of distance which is also coming down: the cost of protection. We will see further reductions in tariffs and the removal of other interferences to trade as a result of the Doha Round. It should also eliminate dumping of agricultural surpluses including those of dairy products into third markets, although the barricades against agriculture imports in Europe, North America and Japan will not be entirely eliminated – we will have to wait for the next trade round for their full elimination.

Putting together all these effects results in the likely outcome that exports will be a great proportion of New Zealand production, and imports a greater proportion of its expenditure. Moreover, a greater proportion of exports will be of services – with tourism being supplemented by broadband services (many of which we cannot even envisage today) and receipts from royalties on intellectual property. Service exports already make up a quarter of our export revenue. In the not too distant future it may make up about a third.

More controversially, my expectation is that the contribution of the primary sector, including further processing, will decline from its current 45 percent of all export revenue to nearer a third too. This reflects my historian’s sense of the long term decline. As recently as 1965 pastoral products alone generated 95 percent of export revenue.

That means the remaining (roughly) third will come from intra-industry trade, mainly from the manufacturing sector. Mind you, that prediction is partly obscured by the ambiguity of definitions between primary and secondary industries.

In this presentation I have only had time to explore some aspects of international trade. I have not been able to report on the work I have been doing on the service industry, or on international capital flows or on international migration. I have only hinted that there is important work to be done on cultural nationalism and on the nation state and its relation to supranational organisations. You will have guessed that I am approaching these issues from both an analytic and a descriptive perspective, and a historical and contemporary one together with some account of likely future trends.

All I can hope in a limited presentation such as this is to demonstrate the Marsden Fund’s wisdom in backing research on the exciting topic of globalisation, and indicate how lucky I am that they allowed me to do that research.

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The Constitutional Underpinnings of the United States Economic Performance.
Presentation to a Fulbright New Zealand Meeting, August 3 2004.

Keywords: Globalisation & Trade;

I am not going to spend a lot of time thanking Fulbright New Zealand for its generous and visionary grant. The real value is demonstrated by its influence on my thinking. Today’s lecture and my subsequent work is the gratitude.

In 1767, shortly after she came to power following a coup, Catherine the Great wrote a manifesto in which she said Russia covered a wide area (albeit much less than today). She went on that the extent was such that it ‘requires absolute power vested in the ruler’. What Catherine did not know was that on the other side of the world, another country was solving the same problem of territorial extent by focusing on the decentralisation of power rather than its centralisation.

In the middle of the eighteenth century. United States per capita production was much the same as that of Russia, although it is very difficult to measure such things. Today US material output per person it is about six times as high, and even that magnitude may not capture the difference of the quality of life in the two nations. It is not my intention to argue that the difference is solely due to the different governance arrangements, but we know it matters. Ironically, we relearned the lesson just a decade ago, when Russia shed communism. The hope had been it would flourish: sadly it has not. The most important reason for the failure was it did not have the governance on which economic success depends.

That the United States discovered such a system over 200 years earlier is astonishing, all the more so if one recalls how primitive the United States pre-revolutionary economy was by the standards of today, as I learned visiting Mount Vernon, the home of George Washington. (One of the advantages of a Fulbright fellowship is that it allows one a bit of sightseeing.) Over the years I have visited many stately homes, the surrounding land of which is farmed by modern methods. What makes Mount Vernon unusual is that piety for Washington has meant the surrounding land has been restored to what it was like when he farmed there, a task greatly helped by the preservation of his detailed instructions on farm management.

Washington’s farm preceded the agricultural revolution, so my sightseeing turned into a lesson in economic history. It reminded me of a feudal estate not unlike those I read about in nineteenth century Russian literature: it depended on serfs – indentured servants and slaves – who with animals were the main sources of power; it used pre-industrial technologies – using rotational cropping and manure rather than fertilizer to replenish the soil exhausted from earlier tobacco plantings; the farm was largely self-sufficient, producing onsite things which today would be ‘outsourced’, in the modern jargon.

Later while walking over Monticello, Thomas Jefferson’s stately home, my companion, Herman Schwartz, a political economist from the nearby University of Virginia which Jefferson founded, remarked that ‘they were closer to the medieval economy than the modern one’. Neither he nor I were insulting the United States. We were trying to capture just how long ago these events occurred, to judge them in their ancient terms and not our modern ones.

Washington and Catherine the Great are contemporaries of Captain James Cook, born within a few years of 1730. Although we think of the United States as ‘the New World’, the American Revolution occurred 150 years after the Mayflower sailed in 1620. The European settlement of the US is a couple of hundred years older than New Zealand’s. By the time of Washington, Jefferson and the Revolution, it had a well established organic settlement – and certainly not a hollow society.

A thriving organic society influences the political process, as did pre-revolutionary America. But it will tend to be conservative. There was a strong movement for a totally decentralised agrarian based society, whose individual settlements would have considerable autonomy. The compromise immediately after the Revolution was a ‘Confederation’ of thirteen separate and sovereign states. From the vantage of today, such arrangements seems absurd, but two hundred years ago the European continent was a dominated by numerous principalities, and even large states such as Britain, France and Russia did not have the reach of government control they have today.

The factors which pushed towards a United States of America began, perhaps, with the Revolutionary War in which the Americans liberated themselves for the British Crown. It was a near thing that the locals – underfed, under-equipped, underpaid, sick, demoralised and deserting – won it. The commanders of the Continental Army were notable more for vanity than competence – with Washington the notable exception. Fortunately for the Americans the British commanders were worse. There was a plan to kidnap the British commander, General Clinton, by sneaking up on him as he dozed in his New York garden which backed on the Hudson River. Washington’s aid-de-camp, Alexander Hamilton, scotched the plan with ‘it would be to our unique misfortune since the British government could not find another commander so incompetent to send in his place.’

Hamilton was an extraordinary person. By a stroke of luck Ron Chernow’s biography, a major contribution to American popular history, was published just as I arrived in America. Hamilton died at the age of 49, two hundred years ago last month, following a duel with Aaron Burr, then vice-president of the United States who was never prosecuted for the murder – once the Wild West was on America’s Atlantic seaboard. Hamilton’s early death meant he never wrote his memoirs, which disadvantaged him relative to other founding fathers such as Jefferson and James Madison, with whom he disputed the direction of US development. Chernow’s book is Hamilton’s defence.

Hamilton was born in the West Indies, twenty-five years younger than Washington. He was the illegitimate son of a Scottish merchant, his mother being unable to divorce an earlier partner. His precocity had a public subscription sending him to New York, where he took a law degree and married into high society. He read very widely, and wrote copiously – he could write a mind-boggling 5000 words in a night, presumably after a day’s work. Arguably Hamilton was the intellectual equal of – or superior to – Jefferson.

During the Revolutionary War, Hamilton, as aide-de-camp and confidential secretary to Washington, was in charge of the organisation of the Continental Army. Napoleon said an army marched on its stomach, and certainly the organisation of its supplies was a key element to its success. Washington and Hamilton were handicapped by the unwillingness of the States to provide the money for the purchase of supplies and payment of troops, in part because of the difficulties the States generally had of raising monies and the free rider effect of each State leaving the funding to the other twelve. So the Continental Army had to issue bonds and other financial instruments secured on the limited taxing power of the hardly existent United States of America. Inevitably the bonds were devalued, and there was inflation, a common accompaniment of war. Hamilton was at the time reading the works of philosopher David Hume who was also one of the earliest great economists (predating Adam Smith) especially on the theory of money. Hamilton must have been reading Hume’s theory at night, and watching its practice during the day.

After the Revolutionary War there was the possibility that the British would re-invade America. (They did so twice: in 1812 when the British Army committed the heinous crime of burning down the Library of Congress but was eventually defeated. In 1964 there was the successful invasion by the Fab Four.) It was obvious to Hamilton that to defeat a second prolonged British attack, the United States Army would need sound funding from a central government, so it was important to pay off old debts, and establish the foundations for fiscal and monetary stability.

A second military threat was that individual States in the Confederation might make war against each other, Such war might lead to Britain supporting one and France the other, but even if it did not, the costs would be high, as they were in the American Civil War over slavery, a hundred years later. Such disputes could be prevented by a strong central government, with weak States.

The possibility of inter-state feuds was not just theoretical. In 1784 there had been a commercial dispute between Maryland and Virginia over the taxing of shipping on the Potomac River between them. Madison had helped settle the matter, but the possibility of further disputes led to a convention in 1787 with the limited task of recommending revisions to the articles of confederation. Presided over by Washington with Madison attending every session and Hamilton many, including signing on behalf of New York, the convention instead submitted a constitution for a federal United States of America. It was adopted after public assemblies in most states agreed to it, although they wanted some extensions which focussed on indivdual liberty. The convention had set out a constitution which largely regulated relations between States and the federal authority. The popular assemblies proposed what eventuated as the first ten amendments (the Bill of Rights) which were adopted immediately.

The agreement to federate was a close run thing. A major contribution to the adoption of the Constitution was a set of closely argued essays explaining and defending it. The principal author of The Federalist Papers, as they are known, was Alexander Hamilton assisted by Madison and John Jay, who became the first Chief Justice of the United States. I had always promised myself I would read the essays if I ever had a long period in America. Now I know they rank among the great works of political theory – thankyou Fulbright New Zealand for the opportunity.

While I was reading about the origins of the American Constitution, on the other side of the Atlantic the Europeans were adopting their own constitution. There are interesting parallels in the contortions both sides got into in the weightings given to states. (The US solution of a House of Representatives based on population and a Senate in which each state has two votes is somewhat more elegant than the European Union resolution.) The size of the respective documents is instructive. My Penguin edition of the American Constitution comes to but 18 pages including the amendments. The propose European Constitution is 325 pages long.

Adopting the Constitution was followed by Washington becoming the first President in 1789. He appointed Hamilton as his, and the United States, first Secretary of the Treasury. Hamilton built his department into a power house. At one stage, including the Customs Service that it administered, it had more staff than the rest of the US government.

Hamilton used his position together with his interpretation of the constitution to strengthen the Federation. He consolidated fiscal revenue, having already ensure the constitution gave customs duties only to the Federal Government, thus weakening the States. He consolidated government debt and paid it off at nominal value – which did not make him popular among those who had sold their debt issued during the war for as little as 15 cents in the dollar, in the belief the bonds would never be redeemed. He arranged the assumption of the States’ debts by the central government, so that States would not have to raise revenue to redeem it. (The deal involved him agreeing to the Federal capital being located on the Potomac, rather than New York.) He used his customs position – the main source of revenue – to strengthen naval fortifications. He set up the Bank of America. He promoted manufacturing, not only by the high customs tariff, but encouraged investment in business.

Sadly, Hamilton fell out with Madison and Jefferson who thought he was too centralist. Washington tended to back his Treasury Secretary – perhaps his war experience also persuaded him of the importance of central fiscal management too. (Neither Madison and Jefferson fought in the Revolutionary War.) The fallout is a complex one with many dimensions. New York city based Hamilton saw the need for a sound monetary system whereas his indebted opponents from rural Virginia, were far more sceptical of money lenders. Moreover Hamilton was an Anglophile whereas they were Francophiles. I am shortening the story, but Hamilton’s admiration of late eighteenth century Britain, which he never visited, reminds us that one can think of a country’s political system as corrupt, but still admire the vigour of its industry, the vitality of its society and the achievements of its intellectual life.

I am going to stop the Hamilton story here, except to mention some of the tributes. Article II of the Constitution states that no one shall be eligible to the Office of President ‘except a natural born Citizen or a Citizen of the United State at the time of the Adoption of this Constitution’. The now obsolete second provision was surely a recognition of the talented thirty-two year old. A second tribute is Hamilton’s portrait on the ten dollar note – a nice recognition of the man who did so much to give the US a sound currency. The third is that in the entrance hall of Monticello, Jefferson’s home there are busts of Voltaire, the French economist Turgot, and of Hamilton. In death his old enemy recognised the man’s greatness. The fourth tribute is Chernow’s biography, a solid read of 700 pages, which I recommended to anyone who enjoys good political biography – and, if you like a little spice with the salt of politics, there is at least one sex scandal.

The resulting governance of the United States is a complex mix of centralisation and decentralisation. The ‘Commerce Clause’ of the Constitution authorises Congress to remove barriers to trade, and prevents states from impairing the enforcement of contracts; the ‘Takings Clause’ forbids the expropriation of private property without compensation. Thus economic relations are largely left to reciprocal exchange based on market transactions, without restrictions of flows across state boundaries, while ensuring there is a rigorous rule of law and a sound fiscal and monetary system. This laid the platform for American capitalism and economic growth.

Economists Alberto Alesina and Enrico Spoloare, whom I hope to meet in Boston during the second leg of my Fulbright visitorship later in the year, argue in their The Size of Nations that middle size nations open to international commerce (that includes New Zealand) perform economically more effectively that larger ones. While there may be economies of size in some economic production processes which are reaped by large nations they are offset by diseconomies of governance. Large nations have difficulty managing the diversities in their population, while smaller economies offset their economic size disadvantage through international trade.

The counter-example is the US, which is both large and economically successful. Alesina and Spoloare argue that this exception arises because the US is organised in an economically decentralised way, a possibility which Catherine the Great overlooked. But, as I shall explain shortly, there may be disadvantages of governance if states have no significant taxing power.

This analysis sheds light on globalisation, which I am studying with Marsden Research Funding. While the topic is of popular contemporary interest, scholars see significant globalisation beginning in the nineteenth century, not long after the events I have just related. It began as a process of regional economies unifying into national economies. US regionalisation is a particularly interesting not only because of its scope, but because of the vast quantities of scholarship on it. Fulbright New Zealand gave me the opportunity to examine the regionalisation process on the spot, as it were.

The advantage of such visits is that it changes one’s perceptions. During the first leg I realised that as well as thinking about this regionalisation as step on the way to globalisation, one could see the US as a sort of mini-globalisation in its own right (if one is allowed to think of anything about the US as ‘mini’).

Consider a world of only America – more like it was in its nineteenth century isolationist phase. The globalised world that it encapsulates is one in which there is a central authority equivalent to the Federal Government, and relatively weak states. They would have no military power, little taxing power, and little control over commerce across their borders. Yet the central government would not have unlimited power, being restrained both by the courts and by an elected congress, while economic transactions would be regulated by the market. There are some useful lessons from such an idealisation, even if the world will not turn out like it.

The first is that whatever the drivers of the US economic performance – governance arrangements were only one of them – there is far less economic inequality between the states of America, than the states of the world. While there is considerable inequality within America as a whole, the differences between State are remarkably small, even by comparison with the states of Europe. It rises not only because there is more freedom of trade between the American States than generally, and the freedom of capital flows. There is also freedom of population movement. It may never have occurred to America’s founding fathers that they could have restricted internal migration but, that in any case they did not has meant that American labour could shift to where wages were higher, reducing the inequality between states.

This conclusion has a profound implication for a globalised world, if as seems likely in the foreseeable future, there are continued restrictions on migration. The degree to which international trade and capital flows can moderate inequality may be a matter of dispute among economists, but without a high degree of labour mobility there will be a higher inequality between nations, although not necessarily within each nation. This issue is now high on my ‘for further investigation’ research list. Fortunately, one of the people I shall be working with in Boston on the second leg is economist Jeffrey Williamson, a major contributor to research on globalisation, who has recently focussed on international migration.

This idealised characterisation of a globalised America also helps us to understand better the ‘convergence’ thesis. It has two elements. One is that globalisation will force policy convergence on nation-states so that many policies will become increasingly similar. I shant follow this issue here, because the American experience does not shed much light upon it, as their States do not have a lot of policy freedom because of their limited powers of taxation.

More pertinent is the issue of cultural convergence, the possibility that globalisation will result in the cultures of the world converging to a single global culture. The short answer that it has not happened in America, where there remains cultural differences by region, despite 200 hundred years of internal globalisation, and over 80 years of restrictions on external migration. The differences cannot be explained simply by the geography and history of the region, but require the addition of the culture of the people who came there. So America suggests the most extreme version of the cultural convergence thesis – that we shall all end up the same – does not hold.

I have compared the experience of American with that of Europe. Such comparisons are extremely useful for a social scientist, and indeed the European Union – which might be thought of as the United States of Europe delayed 150 years by the inertia of history – offers an alternative model of the globalised world with a weaker central government and more power held by nation-states, albeit it again with no restrictions on cross-border transfers of goods, capital and labour. I intend to sharpen this comparison as my Marsden research progresses.

An important difference between the two governance arrangements is that the American constitution, as a result of its British heritage, has a strong common law element, while the European one is more code base as befits a the European Continent’s heritage. That partly explains the difference in the size of the two constitutions, and how Maddison, Hamilton and all could write a 400 page treatise to expound the principles of a – at that time – 10 page document.

The merit of common law – that is disciplined judge-made law – is that it enables adaption to new circumstances. There has been some 17 further amendments to the constitution since the first 10 of the Bill of Rights, but they have been mainly procedural. I doubt they would have disturbed Hamilton – excepting the eighteenth which proscribed alcohol, it being the only constitutional amendment to restrict freedom, and was repealed by the twenty-first. (Hamilton got into a bit of a tangle by imposing excise duties on whiskey). Perhaps Hamilton of would have mused over the sixteenth amendment which allowed income taxation, although Hamilton, Secretary of the Treasury, would have been much relieved.

That there have been so few non-procedural amendments is both a tribute to the Founders and to the ability of the American courts to interpret the Constitution for current conditions. (Even Hamilton did this, extending the scope of government business by the phrase that Congress had power to ‘provide for the … general welfare of the United States’.) Even so, two hundred years later we may ask whether the Constitution and subsequent arrangements are handicapping the United States to some extent.

I will not pursue, being outside my expertise, whether a constitution founded on the premise of defending the United States from invasion has the right checks and balances now the country has a global military reach. An alternative approach is implicit in the handling of the international economy, where the Constitution provides that it is Congress which has the power ‘to regulate Commerce with foreign Nations’.

In practice Congress would find it exceedingly difficult to exercise that power directly, so it delegates it to the President, binding itself that it will only accept or reject what the Executive negotiates, and not amend it. The result is the Executive has to negotiate any commercial treaty – say a free trade agreement – with members of Congress as well as with the potential trading partner. I was fortunate while in Washington to observe Robert Zoellick, the President’s Ambassador for Trade Negotiations (parallel to our Minister for Overseas Trade) interacting with members of the House of Representatives Agricultural Committee. He seemed to know each and their congressional district intimately, and his responses to their questions was almost a public negotiation.

When an American action under the international trading rules they helped create is challenged, they vigorously pursue their position up to the highest tribunal. For the record up to May 2004 they had won 24 and lost 24 such cases, although it looks as though they are about to lose the Brazilian case that their international dumping of cotton has broken international trading agreements to the detriment of other producers. Zoellick robustly rejects the Brazilian case, but if, as seems likely, the final tribunal rules against the US, the government will immediately cave in, telling the cotton farmers and their congressional representatives that America must obey international commercial law.

There are two lessons from this. The US is scrupulous about conforming to international commercial law, once it is determined. That is both the heritage from their Constitution, and the practical insight that even when business laws are not perfect it is wise to conform at least to the letter of them, for otherwise there is only the law of the jungle which – as we have seen in Russia – does not work well for business.

The second lesson is that Zoellick was relating to the congressmen individually, not to parties or their party leaders. Indeed it was hard to tell who belonged to which party in the select committee (other than by the seating arrangements). Unlike the New Zealand prime minister who commands Parliament, the American president may have a majority of his party in both the House and the Senate (as occurs with George Bush), but he does not have a governing majority. There is no certainty that representatives from the President’s party will vote for the his legislation. Instead for each bill, he must construct a majority from the individual representatives.

The consequences are evident in the two countries’ tax legislation. In New Zealand, the Minister of Finance backed by the Prime Minister, submits legislation to the parliament and relies on the governing majority in the House to pass the bill. The proposals may be scrutinised, and submissions may lead to changes in the legislation, but the changes only occur with the approval of the Prime Minister and relevant Minister.

In the US with the Founding Father’s separation of the executive from the legislature, and their belief that the legislators would be independent souls who, in the words of Edmund Burke, only owe their constituents their industry and judgement, there is no concept of party in legislative deliberations as New Zealanders know it. Any legislation requires the building up of a coalition of individual representatives, many of who will demand concessions for their vote.

Such concessions may make excellent political sense but they usually make little sense fiscal or economic sense, and the resulting American taxation regimen is a chaotic tangle of exemptions and concessions. When American economists complain about the inefficiency of their tax system, they are referring to a far less satisfactory one than that we have in New Zealand today, or even the one before the reforms under Muldoon.

Not only is the American tax system inefficient, but without party government it is harder to maintain fiscal discipline. The New Zealand fiscal system operates on the basis of a Minister of Finance who is a fiscal conservative, backed (hopefully) by an as committed Prime Minister. But just about everyone else is a fiscal liberal demanding increased spending and tax cuts. Its government (internal) deficit is always under pressure. Washington and Hamilton knew the problem, but it is compounded in the US by the executive not commanding parliament.

The recent willingness of the US Congress to abandon fiscal discipline is discomforting. Because the US issues the currency of international choice, the US dollar, the American deficit is easier to finance in the short and medium run. However in the long run a large American deficit pouring its dollars into the word economy will boost interest rates and inflation, and undermine confidence in the greenback.

I am astonished that American conservatives seem to have abandoned fiscal discipline as a prudent government goal. The policy stances along the US political spectrum seem to have flipped over, since it is the liberals who seem more concerned about the deficit. It was Bill Clinton who reined in the US internal deficit which Ronald Reagan’s administration triggered (although George Bush senior did make some headway). One of the conservative proposals – I do not know how serious it is – is to replace Hamilton on the ten dollar bill with Reagan. That would be to replace America’s first fiscal conservative with America’s most profligate fiscal liberal (the current administration possibly excluded).

The different constitutional arrangements among European countries results in their having more efficient tax gathering systems. In his book Growing Public: Social Spending and Economic Growth Since the Eighteenth Century, the American economic historian Peter Lindert points out that Europeans are able to raise higher taxes to fund a more comprehensive welfare state than the US. He concludes that their ‘net social costs of transfers, and the taxes that finance them, are essentially zero. They do not bring the GDP costs that much of the Anglo-American literature has imagined. … high budget democracies show more care in choosing the design of taxes and transfers so as to avoid compromising growth. … Broad universalism in taxes and entitlements fosters growth better than the low-budget countries’ preferences for strict means testing and complicated tax compromises.’

America’s constitutional arrangements inhibit the development of the welfare state which other rich countries think normal. This is evident in the different arrangements over the funding and supply of health care. The American 45 percent share of public funding of total health spending (including aspirins and alternative medicines) is uniquely low among the rich countries, where typically the public share is in excess of 75 percent. Public health spending is so far off the American radar screen that Lindert does not analyse it, despite elsewhere the public health system being at the core of the welfare state: a kind of ‘Warehouse’, where everyone gets a bargain.

The US has been unable to persuade any other rich country to imitate its highly privatised health care system, in part because it is so inefficient. The US undoubtedly has some of the best medical treatment centres in the world and spends more per capita than any other country on health care. But the return on the spending is not great so that, for instance, Americans have average longevity among rich nations, despite all the additional expenditure. A privatised system has little incentive to push health promotion. Moreover, according to the law of diminishing returns, uneven coverage means that there is insufficient treatment of the poor where there are big gains, and relative over-expenditure on the rich, where health gains will be smaller.

The problems of the American health system are parallelled in its core education. Both are based on decentralised supply and finance, although the principle is applied in different ways. In the case of health care it is primarily a private insurance-based contributory system. Pre-tertiary education involves considerable local control, but that undermines any imposition of national standards, and the public funding – typically from county property taxes – tends to be inadequate. Americans grumbled to me about primary and secondary education – although so do New Zealanders: grumbling about education may be one of the marks of civilisation.

But Lindert’s book raises wider implications. He observes that while at the start of the twentieth century, the US was one of the world leaders in education, by the end of the twentieth century the international ranking of American students had fallen. In the latest Program for International Student Assessment (PISA) on 15 year olds, America was 14th out of 31 countries on reading scores, 18th on mathematics and 15th on science. (New Zealand was 3rd, 3rd, and 5th respectively.)

My tentative explanation – I hope to do more investigation during the second leg – is the deteriorating relative performance of the American education system parallels that of the health system. The US system is too decentralised. While parental involvement and a degree of local autonomy is important – New Zealand’s Tomorrow’s Schools was a step forward – centralised funding and national standards are needed. Because the Constitution in general, and Hamilton in particular, stripped the ability of States to raise significant revenue it has not been possible for them, largely dependent upon property and low sales taxes, to fund their schools adequately and equitably. While undergraduate programs in the tertiary sector often get bogged down making up for the failures of the secondary system, the US graduate programs are among the best in the world. That is because they are less dependent upon local finance and more responsive to international standards, at which point American-style supply and delivery come into their own.

While the inefficiency of the American health system is a burden on the economy which, arguably, may be offset by the vigour of American capitalism, the relatively weak performance of the US education system must be an even greater worry, insofar as it compromises the quality – and hence the productivity – of the workforce, and the ability of the economy to adopt the new technologies central to economic growth. Add the US government deficit undermining the integrity of the its dollar, and we may see a relatively diminished US economy in a globalising world.

The American constitution of 1787 is over 200 hundred years old. It was created in a pre-capitalist world, a world before Adam Smith’s Wealth of Nations was familiar, and a world without significant public social spending, for as Peter Lindert notes, there was little before the twentieth century. Its constitution has served America well in the past, it may serve it less well in the future.

On the other hand, we should never underestimate the ability of American capitalism to renew itself. That vigour and vitality came from that curious but admirable blend of Jeffersonian independence and Hamiltonian discipline. We can learn much from the combination. Only time will tell whether the synthesis will continue to be effective in a globalising world..

So what can we learn about future possible economic, political and social configurations of a globalised word? We can dismiss Catherine the Great’s vision of rule by a benevolent and enlightened autocrat. As she said herself, the problem is ‘delay occasioned by the great distances’, and effective distance has diminished greatly in the past two hundred years.

Hamilton’s vision may seem more possible: a world with a strong central executive checked by a robust democratic legislature and courts which enforce the constitution, a world in which economic transactions are largely regulated by the market. The difficulty with his vision is that it would be a world of weak nation-states.

As the experience of the European Union shows, it seems unlikely that nation-states will abandon their sovereignty to the degree that the states of the US did. There may be considerable policy convergence on matters of international (cross-border) commercial intercourse but more policy freedom within borders, especially given that nation-states are likely to maintain their powers to tax, not least because of the desire to promote social spending. However, taxation also funds military and other means of state repression and aggression.

Sovereignty and social spending probably also means that there will be restrictions on cross-border movements of people, even though national borders are porous to goods and services and capital. That will mean considerably more economic inequality between nation-states than is acceptable to idealists. (I am not sure yet what it means for inequality within nations.) Migration restrictions rule out the European Union model for a globalised world, in which nation-states maintain considerable powers, but allow people mobility.

At a later stage in the Marsden project I hope to look at the European arrangements as closely as Fulbright New Zealand has allowed me to look at the United States ones. I am most fortunate that they have enabled me to learn so much, and to be able to share what I learned with you.

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