JEFFREY D.
SACHS
Harvard University
ANDREW WARNER
Harvard
University
Economic Reform and the Process
of
Global Integration
WHEN THE
BROOKINGS Panel on Economic Activity began
in
1970, the
world economy roughly accorded with the idea of three distinct eco-
nomic systems: a capitalist first world, a socialist second world, and a
developing third world which aimed for a middle way between the first
two. The third
world
was
characterized
not
only by
its low levels
of per
capita GDP,
but
also
by
a distinctive economic
system
that
assigned
the
state
sector
the
predominant
role
in
industrialization, although
not the
monopoly
on industrial
ownership
as
in the
socialist economies.
The
years
between 1970 and
1995,
and
especially
the
last
decade,
have
witnessed
the
most
remarkable institutional
harmonization
and
economic
integration among
nations
in
world
history.
While
economic
integration was increasing throughout
the
1970s
and
1980s,
the
extent
of
integration
has come
sharply
into focus
only
since the
collapse
of com-
munism
in
1989.
In
1995
one dominant
global
economic
system
is
emerg-
ing.
The
common set of institutions
is
exemplified by
the new World
Trade
Organization (WTO), which was established by agreement
of
more than 120
economies,
with almost
all the rest
eager
to
join
as
rapidly
as
possible.
Part
of
the new trade
agreement
involves
a
codification
of
basic
principles governing
trade in
goods
and services.
Similarly,
the In-
ternational
Monetary
Fund
(IMF)
now
boasts
nearly
universal member-
ship,
with member
countries
pledged
to basic
principles
of
currency
convertibility.
Most
programs
of economic reform now
underway
in the
developing
world and in the
post-communist
world have as their
strategic
aim
the
1
2
Brookings Paper-s
on
Economic
Activity,
1:1995
integration of
the national economy with the
world economy. Integra-
tion
means
not
only increased market-based trade and
financial
flows,
but also
institutional harmonization with
regard
to
trade policy, legal
codes,
tax
systems, ownership patterns, and other
regulatory arrange-
ments.
In
each of
these areas, international norms
play
a
large
and
often
decisive role
in
defining the terms of the
reform policy. Most
recently,
China made
commitments on international
property rights and trade pol-
icy with a view
toward membership in the
WTO, and membership in
the
world system
more generally. Russian
economic reforms are
similarly
guided by the
overall
aim
of reestablishing the
country's place within the
world market
system.
In
several sections
of its April 1995 agreement
with
the IMF, the
Russian government
commits to abide
by
WTO
princi-
ples, even in
advance of membership.
The goal of this
paper is to document
the
process of global integration
and
to assess its effects
on
economic
growth
in
the
reforming countries.
Using
cross-country
indicators of trade
openness
as the
measures of
each country's
orientation to the world
economy,
we examine the
timing
of
trade
liberalization,
and the
implications
of trade
liberalization for
subsequent growth
and for the
onset or avoidance of
economic crises.
Of
course,
trade liberalization is
usually just
one
part
of a
government's
overall reform
plan for integrating
an
economy
with the
world
system.
Other
aspects
of
such a
program
almost
always
include
price
liberaliza-
tion, budget
restructuring, privatization,
deregulation,
and the
installa-
tion
of a
social
safety
net.
Nonetheless,
the international
opening
of the
economy
is
the
sine
qua
non of the
overall
reform
process.
Trade
liberal-
ization not
only establishes
powerful
direct
linkages
between the econ-
omy
and the
world
system,
but also
effectively
forces the
government
to
take
actions on
the
other
parts
of
the
reform
program
under the
pres-
sures of
international
competition.
For these
reasons,
it
is
convenient
and
fairly
accurate
to gauge
a
country's
overall reform
program
ac-
cording
to the
progress
of
its trade
liberalization.
Our
analysis
helps
to answer several debates
concerning
cross-coun-
try growth patterns.
Most
important,
we
help
to resolve
the
widely
dis-
cussed conundrum
concerning
economic
convergence
in
the world
economy. Long-held
judgments
about
the
development process,
as well
as the
workhorse formal models of economic
growth, suggest
that
poorer
countries
should tend to
grow
more
rapidly
than
richer
countries
and
therefore
should close the
proportionate
income
gap
over time. The
Jeffrey
D.
Sachs
and Andrew
Warner
3
main
reason
for expecting
economic
convergence is that the
poorer
countries can
import capital
and modern
technologies
from
the wealth-
ier countries,
and thereby
reap the
"advantages of
backwardness." Yet
in
recent
decades, there has
been no
overall tendency for
the poorer
countries
to catch
up,
or
converge,
with
the richer
countries.
We
show that
this problem
is readily
explained by the
trade regime:
open economies tend to
converge, but closed economies do
not. The
lack of
convergence in
recent decades
results from the
fact that the
poorer
countries have been
closed to the
world. This is now
changing
with the
spread of trade
liberalization
programs, so that
presumably the
tendencies toward
convergence
will
be
markedly strengthened.
The
power of trade
to promote
economic
convergence is
perhaps the most
venerable
tenet of classical
and neoclassical
economics,
dating
back
to
Adam Smith. As
Smith's
followers have stressed for
generations, trade
promotes growth
through a
myriad channels:
increased
specialization,
efficient resource
allocation
according to
comparative
advantage, diffu-
sion of
international
knowledge through
trade,
and
heightened
domestic
competition
as
a
result of
international
competition.
I
This
paper
has three main
parts.
In the
first section we discuss the
patterns
and
chronology of trade
policy
reforms
in
the
postwar
period.
Viewed from the
perspective of world economic
history since
1850,
the
closed nature
of the
world
trading system
at
the end
of World War
II
was
a
historical
anomaly. The open trade of the late nineteenth and
early
twentieth centuries had
collapsed
following
two world
wars and a
global
depression.
Postwar
liberalization has
painstakingly
restored an
open
trading system somewhat
reminiscent
of
the
world
in
1900,
with
two cru-
cial differences.
First,
developing
countries
in
Africa and Asia are now
sovereign,
rather than
colonies
of the Western
powers.
Second,
the
world
economy
is
increasingly supported
by
international commercial
law agreed to
by individual
governments and
implemented
with the
sup-
port
of international
institutions such as
the WTO and the IMF.
1. Lucas (1988) and Young (1991) observe that standard trade theory predicts an effect
of openness on the level, not the long-run growth rate, of
GDP.
Of course,
a level
effect
can appear as a growth effect for long periods of time, since adjustments
in
real economies
may take place over decades. Some recent theory has introduced various forms of increas-
ing returns to scale with the result that openness can affect long-term growth as well as the
level of income. See Young (1991), Grossman and Helpman (1991), Eicher (1993), and Lee
(1993).
4
Brookings
Papers
on Economic
Activity,
1:1995
The
second section
examines the impact of postwar trade liberaliza-
tion on economic performance
in the developing countries. We demon-
strate the
basic proposition that
open trade leads to convergent rates of
growth, that is, to higher
growth rates in poorer countries than in richer
countries. The
importance of trade
policy
is demonstrated
in
several
cross-country growth
equations in which we hold constant other deter-
minants
of growth. We also show that
open
economies
successfully
avoid balance-of-payments
crises, while many closed economies even-
tually
succumb to such crises.
The third section reviews the
evidence
on
the success of trade
liberal-
ization programs after 1980.
First,
we
show that
in
many developing
countries
trade
liberalization has followed
a severe macroeconomic cri-
sis
(such as
a
debt crisis or
very high inflation).
A
very
few
developing
countries have remained
relatively open
since World War II or since the
time
of
their
independence-Barbados, Cyprus, Malaysia, Mauritius,
Singapore, Thailand, and the Yemen Arab
Republic (North Yemen)-
but
most of the others opened
much later, mainly
in
the 1980s or 1990s,
and
usually
in
response to a
deep macroeconomic crisis.2 In many cases,
economic reform paid off
after a few years in terms of accelerated
growth of GDP. This is true in
all major regions of the world, including
sub-Saharan Africa. In a
small
number of
countries, however, a new
economic crisis ensued after the
start of full-fledged reforms. These set-
backs,
in
Chile
in the
early
1980s,
Venezuela
in
the
early 1990s, and
Mexico
in
late
1994,
seem to be related
to
financial
market liberalization
and
exchange
rate
mismanagement.3
We also
present evidence on the
growth
effects of reforms in
the post-
communist countries
of
eastern
Europe
and the
former Soviet Union.
Here too we
find evidence that
economic reforms lead to a renewal of
economic
growth. Strong reformers
seem
to
outperform
weak
reformers
both
in
terms of
a smaller decline
of
GDP
between
1990
and
1994,
and
in
terms of an earlier
resumption of economic
growth.
The
evidence is
necessarily fragmentary,
however, given
the
very
short
period
for
in
which the
reforms have been
in
operation.
2. Some
developing countries, such as Peru,
Sri Lanka, and several Central
American
countries,
were
rather open at
the
end of World
War
II,
but
then
moved into
a
prolonged
phase of import
substitution in the 1950s and
1960s.
3. See
Sachs,
Tornell, and Velasco (1995) and Warner
(1994) regarding
the
Mexican
crisis.
Jeffrey D. Sachs and Andrew Warner
5
Liberalization and Global Integration
before 1970
One
and one-half centuries ago, two close
observers of the capitalist
revolution in Western Europe made a pithy
prediction about the course
of global economic change. Marx and Engels
correctly sensed the un-
precedented efficiency of the industrial
capitalism that had emerged.
They predicted that as a result of superior
economic efficiency, capital-
ism would eventually sweep through the
entire world, compelling other
societies to restructure along the lines of
Western Europe. In the pun-
gent rhetoric of the Communist Manifesto
they expostulated that:
The bourgeoisie, by the rapid improvement
of all instruments of
production, by
the
immensely facilitated
means of
communication,
draws
all,
even the most
barbarian, nations
into civilization.
The
cheap prices
of
its
commodities are the
heavy artillery
with
which it batters
down all Chinese
walls,
with
which
it
forces
the barbarians' intensely obstinate
hatred of
foreigners
to
capitulate.
It
compels
all nations, on pain of extinction, to adopt
the
bourgeois
mode
of
production;
it
compels
them
to introduce
what it
calls civilization
into their
midst, i.e.,
to
be-
come
bourgeois
themselves. In one
word,
it creates a world after
its own
image.4
Marx and
Engels got
much
disastrously
wrong
in
their
predictions,
but they correctly sensed the decisive global
implications
of
capitalism.
As they foresaw, capitalism eventually
spread
to
nearly
the entire
world,
in a
complex
and sometimes violent
process
that
dramatically
raised worldwide living standards
but also
provoked
social upheaval and
war. It is often forgotten today,
in
the flush of
the
communist
collapse
after
1989, that global capitalism has emerged
twice,
at the end
of
the
nineteenth century as well as the end of the
twentieth century. The
ear-
lier
global capitalist system peaked around
1910
but
subsequently
disin-
tegrated
in the first half
of
the twentieth
century,
between the outbreak
of World War
I
and the end
of
World War
II.
The
reemergence
of a
global, capitalist
market
economy
since
1950,
and
especially
since
the
mid-1980s,
in
an
important
sense
reestablishes
the
global
market
econ-
omy
that
had
existed
one
hundred
years
earlier.
The first
episode of global capitalism,
of
course,
came about as much
through
the instruments of violent
conquest
and
colonial
rule as
through
economic
reform
and the
development
of international
institutions.
Starting
around
1840,
Western
European powers
wielded their
superior
4. Marx and Engels (1948, p. 225).