Rick Messick (Moderator), World Bank

David Jessup, Executive Director, New Economy Information Service

Seymour Martin Lipset, Professor, George Mason University

Adrian Karatnycky, President, Freedom House

John D. Sullivan, Executive Director of the Center for International Private Enterprise of Public Policy

Thomas Palley, Assistant Director of Public Policy, AFL-CIO

Discussion

We have come here this morning to hear about Dollars and Democracy, the latest project of The New Economy Information Service. My name is Rick Messick, and I am going to be moderating today's discussion. First we will hear from David Jessup, the principal author of the study, and then we will listen to some commentary on the paper from our group of distinguished panelists. On my left is Professor Seymour Martin Lipset, most recently of George Mason University, who will speak first. Then we will hear from Adrian Karatnyski, the President of Freedom House. He will give you a brief description of the Freedom House methodology, which, as those of you know who have seen the study, divides countries into free, partly free and not-free categories. This will be followed by commentary from Tom Palley of the AFL-CIO, and John Sullivan of the Center for International Private Enterprise, Tom representing the labor point of view, and John speaking from a business point of view. As many of you know, the Center for International Private Enterprise is the U.S. Chamber of Commerce's arm to promote free markets abroad. With these brief remarks, I'd like to introduce David Jessup, our principal author, who will summarize the study that you now have in your hands.

David Jessup, Executive Director, New Economy Information Service

Thank you, Rick. First I want to acknowledge two people in the room who contributed to this paper—Kristin Jenkins, who did much of the research, and Brian Robertson, who did a lot of the editing. Both are associates at the New Economy Information Service. Today marks the tenth anniversary of the fall of the Berlin Wall. It was the approach of the commemoration of that historic transition to democracy that sparked this research study. We were curious about the transition to democracy, wondering what had happened to the various countries in the developing world in this new age of global competition. Specifically, we wanted to know about the performance of countries that are ranked by Freedom House as free, not-free, or partly-free. We wanted to know how these countries did when it comes to competing for export market share and for direct foreign investment share during this past ten year period.

We found what we consider to be a disturbing pattern. We discovered—and this is the main finding of the report—that as a group, the democratic countries in the developing world (and here I'm using "democratic" pretty much synonymously with the "free" category of Freedom House) are losing ground to the more authoritarian countries when it comes to competing for U.S. trade and investment dollars, and to a lesser extent, for world trade and investment dollars.

The findings of the study are probably easiest to see in the export data on page eleven of the document in Table 1. It shows that when you look at developing country exports to the United States—all except oil, which we excluded for obvious reasons—there's been an 18.5 percent decline in market share for the developing democracies.

When you look at strictly the manufactured goods section, it becomes even more dramatic. Many economists believe that for developing country economic success it is most important to develop manufacturing products for export. In this area there was an even sharper decline of 21.6 percent in market share.

When you look at the world as a whole, the picture is much the same. The source for statistics on world exports is the World Bank—what they call "merchandise exports"—and the definitions here are slightly different from those used by the Census Bureau. But even here, in terms of total exports to the world from the developing countries, we found a decline in market share of the developing democracies. The not-free countries gained about ten points, and the partly-free countries gained about ten points.

There is considerable irony in the fact that with the new freedom after the fall of the Berlin Wall ten years ago, which helped usher in this period of global economic boom, it was the developing democracies that benefited least from that boom.

In terms of direct foreign investment, the figures are a lot more tenuous, for two reasons. First, U.S. direct foreign investment goes to many fewer countries than U.S. purchases of imported goods. In addition, the data we received from the Bureau of Economic Analysis is full of little qualifiers and exclusions—apparently in some cases they refuse to report direct foreign investment because it might reveal information about individual companies that they wish to keep private. So we had a lot fewer countries to deal with here, and because of that, we almost didn't include direct foreign investment in this report.

Nevertheless on pages sixteen and seventeen, the findings tell a slightly different story. The developing democracies basically held their own throughout this period. They gained 1.8 percentage points in share of U.S. direct foreign investment, but lost 4.4 percentage points in their share of direct foreign investment flowing into these countries from the world as a whole.

The main story here is the shift in market share from the partly-free to the not-free countries. Basically, China and Malaysia gained tremendously, mostly at the expense of Brazil. Brazil has traditionally been, within the developing world, the country that is the biggest recipient of U.S. direct foreign investment. Its share fell quite a lot during this period in which China and Malaysia picked up. Even Mexico's share fell a small amount, which surprised us a bit.

Regarding export data, we also looked at some regional differences, which are summarized in the report, as well as some industry differences. We actually ranked the industries in terms of those that had the least amount of purchases from developing democratic countries. The footwear industry came out the worst on this scale, and I'll return to that toward the end of these remarks.

The question then arose, "How do we account for these rather sobering results?" The first thing we wanted to do was to rule out the possibility that this may just be due to a statistical fluke. So we looked at the data in a variety of ways. We knew that some of these countries, for example, had changed their freedom status between 1989 and 1998, so we divided them and ran separate numbers for both groups of countries. There are some that started and ended the decade with the same freedom status but changed in the intervening years. So we actually did a year-to-year comparison, even though we weren't comparing the same countries through the time period. We looked at where they stood from year-to-year.

We also decided to exclude China and Mexico from the data because those are the two largest U.S. trading partners in the developing world. We even did a study on a per capita basis, reasoning that although China exports a large number of products to the U.S., it might not seem so much when you consider that China is the largest country in the world. So we looked at exports on a per capita basis as well.

I won't go into detail on any of these breakdowns right now, but after looking at the data in all these ways, we concluded that although there were some differences in degree, the same pattern or trend held up, no matter how we looked at the data.

So the question then became, "Why is this happening?" Here, I'm afraid we may have raised more questions than we answer, which is one of the reasons we wanted to get this panel together today to stimulate some thought and discussion about this, to seek some explanations, and maybe even open some new avenues of research.

We asked, for example, "What does this say about government policy?" We all know that the U.S. government has promoted trade with China and Mexico, and that certainly has bolstered the figures for those two countries. On the other hand, government policy puts economic sanctions on a number of countries, so there's sort of a double-edged sword which cuts both ways when it comes to government policy.

What about the policies of the democratic countries themselves? Are they doing something wrong which limits their chances of success in these two areas? Again, we couldn't find much data to bolster this possibility. In fact, when we looked at some of the research being done by people like Dani Rodrik, it appears that democracies are quite attractive places in which to put investment and purchase exports. Democracies are generally attractive places in which to do business. And when we looked at Transparency International's transparency index measuring corruption, we found that the developing democracies ranked ahead of the more authoritarian countries. So that is not a likely explanation for these results.

We wondered whether U.S. businesses prefer dealing with dictatorships. That doesn't appear to be the case in any conscious way. I'm sure there are developing democracies that don't have a very good business climate, and I'm sure there are authoritarian countries that do have a good business climate. But those particular instances don't explain the overall pattern. Businesses make these kinds of decisions with whole host of criteria in mind, everything from the quality of suppliers, to market access, to exchange rate stability. In some cases, export volumes are controlled by U.S. quotas.

And as John Sullivan reminded me in a conversation a day or so ago, a lot of these decisions about investment are made in accordance with the size of the market of the foreign countries. So there are many reasons for these investment decisions. We don't think that there's necessarily any active discrimination democracies going on—at least none that we can find any evidence for.

We also wondered whether wage levels might explain the findings. This seems logical, especially considering Taiwan and South Korea, which does a lot to explain the fall in the developing democracies' market share. Wages certainly have gone up in those two countries. But there are still plenty of low-wage countries in the developing world that would seem to be able to compete in the area of wages.

So we end up not being too sure of why this decline in market share is happening. Perhaps we will get some further ideas for research from the panel. We suspect we will have to look at the results on a industry-by-industry basis to be better able to understand what is happening.

The next questions that arise are, "Does any of this matter?", and "What difference does it make?" Some might argue that we have no control over these trends anyway. Trade and investment are going to go where they want to. We don't want to impose some sort of managed trade, and therefore, there is nothing to worry about—this trend is just going to be what it is.

There are others who would argue that trade and investment, to the extent that they lead to economic development, will help the authoritarian countries democratize. And there is a whole tradition of theory and research related to that argument. We don't find that explanation very compelling, and there are other theorists and researchers who have reached the opposite conclusion—that economic development is no way sufficient to bring about democracy. There are too many countries which developed but which did not democratize for this theory to hold up.

On the other hand, there are some studies which suggest that the failure to develop economically can destabilize democratic countries if they haven't reached a certain level of development. That is one of the reasons we think that this research matters. Perhaps the danger is not so dramatic now when we are still in an economic boom period of prosperity. But as things dampen down a bit, and some of these democracies which haven't been as successful face a declining economic situation in the world, then we might see some destabilization or reversion to authoritarianism. So we think the findings are important for that reason.

We also think the results matter on moral grounds. People in the United States are very proud of the role we played in bringing about democracy in the world. We think they will be disturbed to see that so much of our purchasing power is going to non-democratic countries or partly-democratic countries. We believe that's valid cause for concern.

A third reason that it matters may be found on pro-business grounds. The 1997 world economic crisis was a wake up call. People are concluding that investment may be more risky and recovery slower in some of these less democratic countries. This has now become a factor which may change the way business purchases and investments are made abroad.

Turning now to the final point, I will discuss some recommendations concerning what might be done. We made a number of suggestions in the paper. I won't have time to mention them all, but let me highlight a few of them.

One is that the developing democracies themselves should consider developing a greater group consciousness as players on the world stage. I was happy to discover last night some information that some of these countries have taken our advice four months before we gave it. Here is the Sana'a Declaration from Yemen, where the National Democratic Institute held a conference with a group of emerging democracies. Their statement says that "The international community should renew its commitment to countries working to build democratic institutions and processes and dedicate the resources for this task. In particular, the donor community and the international financial institutions in considering loans, aid and debt policy, should give priority to those countries implementing political, as well as economic, reforms." And that is precisely one of the recommendations that we put forward in our paper here.

Another policy option that the free, developing countries ought to look at is this whole area of linkage between trade and freedom of association criteria. Until now, most developing countries have rejected this idea out of fear that it is simple protectionism—a way to get jobs back to the Unites States. But when you look at the results of this study, it become apparent that this sort of linkage would do far more to help the developing democracies compete for these trade and investment dollars than it would to serve protectionist ends. So we're suggesting that the developing democracies might take a new look at what kind of global trade rules would best serve their interests.

With regard to our own government, we made several points. One has to do with economic sanctions. There is a big move afoot now in Congress to drastically reduce economic sanctions. We think that ought to be done very carefully with a lot of consideration for the consequences. This legislation is aimed against state and local government policies that reject goods from, say, Burma or other countries they choose to boycott. This legislation is saying that is not kosher, but we wonder why it is proper for companies to have the full freedom to "discriminate" and choose who they want to do business with, while state and local governments are not allowed such freedom to chose. Why shouldn't state and local governments be afforded that same freedom? They are also consumers.

Second, we might revisit the whole issue of foreign aid. It has been declining under the "trade-not-aid" policies that both parties have adopted as their own, one a little bit more than the other. We think we need we need trade and aid, and not just aid that helps democracies compete economically, but aid that helps them further develop their own democratic institutions -- the rule of law, civil society and so forth. This would be in addition to helping struggling democratic forces in authoritarian countries. We would hope that aid would be greatly increased for those types of projects.

Another thought, which is not in the report, involves the trade missions that often originate in this country. Government and business leaders go hand-in-hand to visit leaders in the developing world. The ones that go to China often make the news. We're wondering whether there couldn't be trade missions specifically targeted to the developing democracies, making the point that we want to fortify and strengthen those countries in the trade and investment game.

Finally, to the private sector. We noted in our report that a number of companies that import merchandise into the U.S. have developed codes of conduct. Many of these codes of conduct support freedom of association as something these countries should favor in their policies for outsourcing abroad. And yet, when you look at the statistics that we have here, such as those for the footwear industry, they have increasingly shifted their production and imports to the countries that don't allow any freedom of association. So we ask the question, "If these codes have any meaning, shouldn't these decisions shift to a different pattern?" And shouldn't companies start revealing what proportion of their imported goods come from each of the developing countries in the world?

We also believe that consumers should have a wider choice. And when I go into the store and try to find my type of tennis shoe that isn't from China, it's a hard thing to do. It takes a lot of time. And that's true of a lot of other products as well. It's even harder when you buy from a mail-order catalog or when you buy from the Internet. At least in the store you have a label to look at. When shopping on-line you often don't have a clue where those products are made. So we would look forward to legislation that would require labeling of country of origin in both catalog sales and Internet sales as a way to help consumers have a wider choice.

We suggest there are also bottom-line reasons for businesses to shift more toward democratic countries. These are good places to do business. And I think in the long run, business will prosper more if there are stable, democratic countries with the rule of law and a growing internal market that comes about from workers being better able to raise their own wages and their own prosperity through freedom of association.

So in summary, I would say that as a nation, we have been understandably proud of our role in helping to bring about democracy in the world—on this anniversary, especially. And so now we need to start putting our money where our values are. Thank you.

Seymour Martin Lipset, Professor, George Mason University

One of the interesting things about these results, as I think David's comments indicate, is that they go against what we would like to find, which perhaps adds to the argument that they are actually valid. You know Max Weber, the sociologist and economist, once said that every scholar has a party line. It's not just a party line, but his theory, his background, what he's done. And he concluded, therefore, that whenever he did research, he was biased to get the results in the direction he wanted. And Weber then suggested that if you find what you want, redo it—do it again. However, if it contradicts what you believe, then it's probably true.

And so this study is a case where one can say that it is probably true. The effort—which I've been involved in for a long time—to correlate characteristics of countries with behavior, particularly economic patterns with political patterns, especially democracy, often produce contradictory results, results which sometimes shift from one study to another with the introduction of new variables.

We found several things in looking at democracy in more well-to-do countries, more economically productive countries: better education, and Protestant backgrounds. These correlate with democratic regimes. But then you get two others, one of which showed up very early. Monarchy. A long time ago when I was looking at the countries which had been democratic earlier or later, were stable or not, it turned out that the biggest variable, or the variable which correlated most highly, was whether the country was a monarchy.

Monarchies were much more likely to become democratic than republics. And in fact, at that time, in the early fifties, the only two long-term stable democracies which were republics were the United States and Switzerland.

But all the others, Scandinavia, the low countries, the British countries, were all monarchies. One plausible explanation is that retention of monarchy indicates that the shift to democracy occurred gradually and without violence. And so you shifted more easily over to a constitutional regime, whereas where you had revolutions, that destabilized things and made democracies subsequently unstable.

Another correlation which held up in both economic and political systems was the British connection. It turns out the variable which correlates most with whether a country is democratic or not is whether the country has been under British rule. Countries which were under Britain were much more likely to be democratic than countries which had been under France or Spain or the Dutch or the Russians. And again, this can be explained, or at least you can plausibly identify factors that account for it.

A very good Stanford economist named Robert Hall has recently come up with a very sophisticated statistical study on the correlates of economic growth. And he finds that the two factors which explain most of the correlation are the British connection and latitude. That is, people under Britain have done better, and countries which are further north, up to a point, have done better.

Well this creates all kinds of problems. Are you going to recommend recreation of monarchy? Actually the Spaniards did it, and it helped. And once I was talking about this in Chile while Pinochet was there, and the Chileans got interested and started to say, "We could use a Spanish king!" Of course, their relationship to Spain was different from the other Latin-American countries.

In any case, this raises the whole question of the need for research. And in relation to the current study, there is one area of data which need to be looked at more thoroughly, and that is political risk analysis. The Dollars and Democracy paper raises questions about what companies do. Political risk analysis has become a new discipline, a new kind of industry. Henry Kissinger has a firm which is quite big and makes a lot of money doing political risk analysis, and they do reports for companies.

If you invest in Indonesia, for example, you can get a report that describes what the prospects are and whether it will be stable and you will get your money's worth. They gather a lot of information on the kinds of factors which go into this decision, and they feed this information to companies. This is not just for academic purposes. In fact, since the development of political risk analysis coincides with the period we're talking about, it may be that the advice being given has had some impact on this these trade and investment decisions.

The biggest issue of concern raised by the Dollars and Democracy paper is this question of free society and labor: labor movements, wages and so forth. In the early studies of the relationship between democracy and economic growth, there was an effort to test the notion whether a strong labor movement, while a good thing in itself, could have adverse consequences on growth.

These early studies didn't show a negative effect. But this new study may actually reflect a relationship. It may indicate that a strong labor movement which benefits the workers and benefits democracy might possibly have a negative impact on the economy, in terms of growth and competition—for obvious reasons. To decide whether this is true will require number of case studies. Boycotts of countries that don't respect worker rights are based on moral considerations, and the question is whether the right thing morally is also the right thing economically.

Adrian Karatnycky, President, Freedom House

First I would like to commend the authors of this report. David Jessup made the point that the study raises many more questions than it answers, which I believe underscores its extreme importance.

We really are in a terra incognita. People use the terms "globalism," and the "democratic wave," and so on. But research that correlates these two phenomena has been neglected by both governments, by the private sector, and even many of the international institutions. It is difficult for governments and international institutions to make judgments about whether a country is free, partly free, or not free. And so perhaps we shouldn't be surprised at the paucity of data on these kinds of trade patterns.

Yet it is essential for the policy community, as well as for the U.S. government, to pay more attention to these matters in their efforts to promote democracy. It is important to know how private investment dollars—as well as government funds through the Commerce Department's foreign missions and foreign trade representatives—are being spent. Too often, we look at foreign aid in a one-dimensional way, seeing only the hand-outs given from the taxpayer to alleviate extreme poverty. But the other forms of assistance that are taxpayer-funded deserve greater scrutiny.

David Jessup indicated some of these trends in this report, and I am quite surprised by some of the findings. Two countries seem to account for a large measure of the shift. One is Mexico in the partly-free category, which accounts for about eighty percent of the increase among the partly-frees. The second is China, which accounts for a very considerable portion of the increase among the not-free countries.

I don't want to suggest that there aren't other trends. In fact, some of these other trends are shocking. Look at the levels of foreign direct investment and export of manufactured goods to the United States over a ten-year period, and you will see declines in the following countries: South Korea, India, South Africa, Taiwan, Chile, Poland, Brazil. These are all countries which have moved in a more liberal direction economically, as well as politically. Why, then, is there this squeeze on them? Why has there been this decline in their levels of exports to the United States and possibly to other developed countries?

Our study, the Freedom House annual survey, is a non-partisan survey. We have an academic board on which Professor Lipset participates along with a broad range of scholars, some conservative, some liberal, and some social-democratic in orientation. We have a broad balance in the way we apply political judgments. Our survey correlates not only very well with the patterns that David has found, but it correlates very well with a Heritage Foundation study on economic freedom. Heritage has found that there's a high correlation between free societies and what they term free economies, which means lower tax rates, more open trade regimes, and a traditional, free market orientation. It seems to me that it would be worth putting some of these findings together. Does the Dollars and Democracy study show that more corporatist and controlled economies create circumstances of more favorable investment for certain corporate entities? That would be a fascinating and path-breaking development. In other words, further research may show that free markets are not good for international business. I think that this is another relationship that deserves more investigation.

These issues should be looked at by agencies which are not encumbered in the same way that the United Nations is when it comes to making judgments about whether countries are free or not-free. The Organization for Economic Cooperation and Development (OECD) is composed overwhelmingly of free countries. It could certainly do this kind of a report for all of the OECD countries and create a growing awareness within the governments of the OECD and of the private sector within these countries of the need to give a kind of an affirmative stimulus to investing in new and emerging democracies.

The one part of the report with which Freedom House has a sleight methodological problem is that the distinction we make between free and partly free countries is not entirely a distinction between good guys and bad guys. Clearly, there is a distinction between free and not-free countries in the way they treat their people, the levels of political rights, control of society and so on. But a lot of the partly-free countries are countries that are emerging out of dictatorship, trending in the right directions. They are also countries that are facing sometimes insurgent movements that disrupt and destabilize society. Our ratings are not based on government policy only.

Therefore, I would be a little more charitable in terms of viewing patterns related to partly-free countries as an indicator of some kind of undesirable effect. We really should be looking at the general direction in which the partly-free societies are moving. My final point is about calibrating. Even if we use this kind of data to suggest that we aim our trade missions to promote investment in countries that are moving towards democracy, it is difficult to calibrate. A lot of countries which are moving towards democracy are very fragile and somewhat unstable. It may turn out that after investing a lot of resources and people in those countries, businesses may encounter shifts in an undesirable direction. It is difficult to develop policies that can rapidly respond to what are longer-term trends. After all, a lot of the data you are looking at is on countries that have made their transition to democracy in the last five or ten years.

John D. Sullivan, Executive Director of the Center for International Private Enterprise of Public Policy

I have had little time to look at the report, not because of any fault of the authors, but because I was traveling and wasn't in Washington to read it. So, my remarks are limited to first impressions. And I'd like to start by agreeing with some of the elements in the report. (I always find it much nicer to start by agreeing with people, particularly if you're going to disagree later.)

The first thing I would agree with is that the report does raise more questions than it answers. The questions are excellent ones and have strong bearing on U.S. policy. I may have a slightly different take on the policy element than some of the other speakers. But I welcome the fact that we are now taking a look at these kinds of issues.

Our Center has two goals. One is promoting democratic development, the other is promoting market economics. And we see them as directly related, which takes me to David Jessup's point. I tend more to the Dani Rodrik school that democracy is a better investment and creates a better climate for business than perhaps the tone in some parts of the report would lead you to believe.

I would note that, with deference to Professor Lipset, there is a body of literature—his own included—which shows that there are no mechanical linkages between economic growth and democracy. That should not be a surprising finding to anyone that isn't engaging in a straw man approach, and I'm not suggesting the authors are. But many people do engage in this kind of straw man approach, saying, "Well, let's correlate economic growth and see whether that leads to democracy" and vice versa. This question has to be looked at in a much more complicated kind of fashion. And that has to do with the fact that there are critical points in countries' development.

With regard to economic reform in authoritarian regimes, there comes a point when the free flow of information, rule of law, and other things that are heavily correlated to developing a democratic society begin to have an impact. Unless those things are allowed to develop, the country's ability to participate in the development of, say, a knowledge economy, will be dramatically weakened. Brazil is a case in point. Brazil's Informatics law was one of the worst things they could have done to themselves, and it is a good example of a government acting in a most authoritarian fashion in the economic realm to develop "state champions"—which, of course, we now call "cronies." It depends on the choice of semantics, I guess.

A couple of other quick points. I agree with the point about Chinese reform and the WTO and the study cited in the NEIS report which was recently released by the American Enterprise Institute. One of the best things we could do from a policy point of view if we are really as concerned about China as the report indicates, is to encourage rapid Chinese accession to the WTO. Nothing would move China toward the rule of law more quickly than having to comply with internationally accepted accounting principles. Chinese governmental officials themselves—including no less a person than the Deputy Governor of the Bank of China—have admitted rampant corruption in their country.

Rule of law is essential to operating within the WTO structure. A country reaches a point at which its own domestic investment can't go forward unless it becomes a more rule-based and law-based society, which is an essential part of building a democracy.

Another think I would like to underline is that the report talks about the statistics for developing countries. But the overwhelming amount of U.S. foreign direct investment, indeed of foreign direct investment from all OECD countries, goes to developed democracies. There is a reason for this. Developed countries are where the best markets are. That is where the highest incomes are. That is where there is the best opportunity for doing business. So, what we are really looking at here are the residuals -- those countries, those markets, those cases where for a variety of economic and business reasons, which are in the developing world. And there are a number of countries that have moved from one category to the other, South Korea being one example.

Interestingly enough—and this is something that raises the kind of question I was talking about—until the collapse of the Korean economy, the financial meltdown, and the exposure of the real weakness of the rule of law for commercial transactions in South Korea, that country prohibited foreign direct investment in an awful lot of its industries. So, what does a low level of foreign direct investment indicate?

We have to look at these statistics in a lot more depth. There are several control variables, to borrow an academic term, that should be used. First, size of market has a huge impact on the flow of funds. It also has a huge impact on absorptive capacity. And absorptive capacity is one of the things that we really have to look at. If you look at the trends cited on pages thirty and thirty-one in the report, I think they don't support the idea that Poland is not doing well. A trip to Poland would show that it has doubled its share of exports to the U.S. market in ten years. That is not bad. Where Poland has lost, perhaps, is in overall market share. That is what we are looking at here--a percentage of the total flows. And those total flows of exports and imports are subject to a whole lot of things.

A second factor that should be considered in interpreting these statistics—particularly from a foreign policy point of view—is international trade agreements. All of Central and Eastern Europe now aspires to be in the European Union. From a U.S. policy perspective, that is a very good thing because that is what keeps the reforms on track and what probably best guarantees internal democracy in those countries. However, from the perspective of U.S. trade and U.S. foreign investment, EU membership extension is going to have an adverse impact. And unless you control for this kind of variable, you get some very misleading results, I believe. Again, I haven't had a chance to go through this data in depth. But I think that is part of the explanation.

To understand why some democracies do better than others, or why some partially-free countries do better than others, it is important to keep in mind the distinction between democratic and partly-free countries, particularly with regard to a country like Mexico.

You also have to look at the size of the informal sector as well as the size of the market. For example, unless Central America becomes a rule of law society with a very small informal sector, it will be difficult for those countries to attract foreign investment. A large informal sector is a sign of a very badly distorted economy and a very weak rule of law, and unless a country gets itself into a position where it is part of a common market for the region, it's very hard for countries the size of Guatemala, Nicaragua, Honduras, to really attract substantial investment—whether it's from the U.S., Canada or whomever else.

Lastly, I would highly recommend reading the Sana'a Declaration mentioned by David Jessup. CIPE was involved in a minor way in helping with that conference, and I concur strongly with a lot of the points that in the declaration, including the notion that if democratic countries, or partially democratic countries, are to make progress in attracting investment, nothing could better serve them than to stop making laws in secret, as even the Hungarian government does today. You cannot see a draft law in Hungary until it's been passed by Parliament. That's not an open democratic procedure. Again, you've got to make some distinctions here in terms of the way that you judge these countries.

Thomas Palley, Assistant Director of Public Policy, AFL-CIO

This is a fascinating study. The finding that both "Not Free" and "Partly Free" countries have gained at the expense of the "Free" is something that should be taken as the benchmark for future research. This is the study from which things should now proceed, and the onus is on the other side to disprove these findings.

I was struck by the fact, cited on page 9, that there has been a large increase in the number of free countries, and they include some pretty sizeable economies, such as South Africa, Chile, Taiwan, the Czech Republic, and Poland. All of these, even if they've lost a little bit individually, should have collectively increased the share of the "Free" category as a whole. Yet despite that, we still see the free countries losing ground. I am sure we will be able to add many control variables and make more sophisticated econometric studies of the issue, but prima facie the results look pretty robust.

Apologists for the existing system may find little that is troubling in these findings. The crassest among them will say, "Look, democracy is not our concern. We're not interested in what is going on in other countries, and therefore who cares." Others may take a more nuanced approach and even argue that the findings are a good thing. This is the sort of line we hear about China engagement, that engaging with these authoritarian countries promotes economic development, which in turn promotes political freedom.

I don't accept either of these arguments and am a critic of these positions. Let me explain why by outlining three propositions that explain why official policy should formally promote democracy.

Proposition I is that democracy is a good thing in and of itself, and therefore the spread of democracy ought to be encouraged as part of official policy.

Proposition II is that democracy is good for market economies.

Proposition III is that market economies do not, on their own, automatically promote democracy. Note that there is a tension between Propositions II and III.

I won't spend any time addressing Proposition I. It is an ethical argument which is pretty well known and which is hopefully supported by members of this audience, a U.S. audience. I would like to focus on Propositions II and III.

Proposition II claims that democracy is good for market economies and promotes good market outcomes. As trade unionists, our goal is to encourage development and grow the global economy. By doing so we can prosper by exporting to developing markets, and create jobs at home. And we get the opportunity to import better products at a lower price from developing countries. That is why we are engaged in the international trading system. There are gains to be had for us and for others.

The evidence is now growing regarding the benefits of democracy. So if we are going to reap those gains, we should encourage democracy because it is good for development. A recent paper by Dani Rodrik showed that democratic countries tend to pay higher wages. Another paper presented by Rodrik to the International Monetary Fund (IMF) yesterday [Institutions for High Quality Growth: What They Are and How to Acquire Them] showed that democracies tend to have more stable long run growth, less short run instability, respond better to what economists call exogenous shocks from the outside, and produce better distribution of outcomes. For all of those reasons, democracy is good for market economies.

Reflections on the failings of development policy over the last decade have increasingly focused on problems of governance and economic cronyism. At the IMF they are now talking about a second generation of reforms that puts in place good political structures, good governance structures, good judicial systems, good regulatory structures and so on. Democracy encourages all those sort of institutions, and for that reason democracy should be encouraged because it's part of good development policy.

Yet, proposition III maintains that markets don't automatically result in democracy—and that is something of a paradox. If democracy is good for markets, why don't markets result in democracy? David Jessup's paper confirms this Proposition. He found that countries like Indonesia, Malaysia, Mexico, Brazil, and Turkey—all of which are listed as partly free and which have been on the development path for quite some time—have not become free. This is yet another bit of empirical evidence supporting the proposition.

Why don't market economies necessarily promote democracy? The answer is because market economies are afflicted by a problem that economists call the prisoner's dilemma. In market economies each individual promotes their own self-interest without regard to others, but in doing so they may actually be led to a sub-optimal outcome. If I took account of your democratic interest I would make myself better off, but under market arrangements I have no incentive to do so.

Let me illustrate with the example of bribery. If I bribe and you don't, I'm better off. But if we both bribe, we are both probably worse off. My bribe cancels out your bribe, and our actions may distort the system, introduce corruption, and introduce cronyism. The market for bribery actually ends up promoting a sub-optimal outcome. This phenomenon is at work within market economies in the developing democracies, and public policy needs to respond to it.

I will finish with some remarks about how the union movement recommends that we respond. We believe that labor standards are a critical part of this puzzle. If we are to encourage democracy, if we want to encourage robust, healthy, market-based economic development, then we are going to need labor standards as part of the rules for global trade regimes. Why are they good development policy? First, because labor standards promote a good distribution of income, and by so doing they foster market development. You need robust large consumption markets to encourage development.

In addition, there is an implicit problem with a level playing field between capital and labor. The playing field today is simply not level. There is a stacked deck, and as a result, developing countries cannot grow the purchasing power that is needed to develop their market economies. Furthermore, not only do they suffer, the global economy suffers because it is marked by periodic crisis and global deflation. The developing countries target our markets; their whole policy is export-led growth. This creates a loss of jobs at home, which turns our workers against the international trading system. At the same time the developing countries are not getting real development because they end up with a kind of plantation economy based on export-led growth rather than development of real internal markets.

Another reason why labor standards are essential is their political impact. Everyone now knows about the problems of governance and economic cronyism in Southeast Asia which have become apparent over the last two years. Labor standards help promote domestic political development, and help promote the checks that can prevent cronyism from taking place. The history of our own political development suggests that these types of institutions are essential. They are going to be essential in the developing countries as well.

Finally, labor standards help promote the development of civil society by helping give voice to all the groups that are part of society—they actually help develop the conflict management institutions that are so necessary to a well functioning economy. Again, the events in South Korea help show this. Compare South Korea with Indonesia. Indonesia had absolutely no institutions for handling an economic crisis, whereas South Korea had begun to develop institutions for good governance. This helped them put in place a policy response to the financial crisis, and I think that's a very big reason why South Korea's recovery has been so different from Indonesia's.

Discussion

Lawrence Doherty, World Wide Responsible Apparel Production:

The World Wide Responsible Apparel Production (WRAP) is a certification program for apparel manufacturers worldwide, for production facilities. I don't know if we can draw a linkage between the decline in market share of exports of some of the countries in the study and the idea that the figures on foreign direct investment reflects that we are squeezing them out.

As Adrian mentioned, perhaps we are not squeezing them out but squeezing them down, and they are not benefiting from the fruits of economic development. We also have to look at the possibility that foreign direct investment should be reflected in the economic growth rates and GDP of these countries.

As one who lived in Brazil in for nine years, I would suggest that if you look at the kinds of foreign direct investment going into Brazil, it hasn't been geared toward creating more exports back to the United States market. It has been geared toward creating a national consumer base in Brazil's economy, which is apparent if you look at the high levels of investment in telecommunications under the privatization program. Brazil won't export its telecommunications products back to United States.

This has been a tremendous benefit of the liberalization of Brazil's economy and its opening up of the market, a benefit not for us but for Brazilians. They are creating a national consumer market by expanding and liberalizing their own market. We also see this in Mexico and some of the Asian countries that were mentioned. Foreign direct investment in countries may not have the objective of exploiting that labor market to export back to the United States and undercut higher wage costs, labor costs, and production costs here. Sometimes there is a genuine and sincere effort to exploit a market, a natural market of a hundred and sixty million people.

We should remember if we take a hundred and sixty million people in Brazil and eighty million people in Mexico, we have a consumer market the size of the United States. So we should look a little less arrogantly at how we correlate our economic data with our own perceptions, and it would be culturally arrogant to think that it is all being done for our sake or to undercut our economic ambitions.

Another point is that a factory certification program like WRAP is going to help industries promote good, socially responsible business practices worldwide, whether it is the apparel industry, as in my case, or some other industry. These programs are going to help introduce into many countries which don't have the same traditions and cultures that we do solid accountability and financial structure systems by voluntarily adopting these methods and their production. Since the governments themselves are not imposing these standards—even though they have good existing laws in practice—it is clear that unless the industries do it voluntarily and the manufacturers adopt and deploy these standards within their own environments, it's not going to be done. And that means there won't be an expansion of economic rights and freedoms, especially for workers on the factory floor.

For example, in the WRAP program we say that freedom of association is a critically important principle. In order to be certified, manufacturers have to recognize and respect the freedom of association of their employees. From that starting point, giving the employees—and therefore unions if they form unions—that kind of advantage, economic benefits will flow from that relationship in a factory environment where they can bargain collectively for higher wages and have better benefits based on the economic prosperity of their factory.

Phil Fishman, AFL-CIO International Affairs Department:

I also want to congratulate the authors of this very important report, and I think it should, and hopefully will, encourage a discussion about the issues of trade and democratization which I believe is sorely needed.

The study suggests we ought to develop an American government policy that encourages trade with developing democracies at the expense of unfree countries, while making allowances for the complexities of situations of the partially free countries. Surely we can identify a whole host of countries in this world that are clearly not free, and which show disdain for democratization and freedom. We need to focus on ways we can encourage democratization at the expense of those governments that don't seem to want to go on this path.

There is much discussion now about developing carrots for countries to move them toward greater respect for freedom of association, worker rights, and human rights. And in fact we are participating in these discussions and we see a lot of promising movements in this direction.

For example, some of these discussions focus on increasing quotas for textile imports if countries agree to respect certain basic worker rights and other kinds of freedoms. This approach presumes that we can accept an increasing quota for imports into the American market. From the perspective of the labor movement, and also from a political point of view, we should look for ways to provide carrots, such as increased quotas, while at the same time decreasing quotas for a country like China, which doesn't accept any degree of freedom of association. In that way we engage the discussion in a way that can be much more serious. It would also encourage much greater support, not only from the American labor movement, but from consumers and other kinds of private organizations.

Finally, David Jessup's comments on the need to develop greater consciousness among developing democracies are very important. The fact that developing countries are moving towards democracy is surely something that the National Endowment Democracy (NED) ought to be encouraging, by holding these kinds of forums, encouraging this kind of discussion and encouraging the institutes to move towards a greater focus on these issues in their programs.

David Jessup:

Lawrence Doherty makes a good case that we have to distinguish between direct foreign investment that goes into a country to establish an export platform back to the U.S. and that which seeks to develop the recipient country's domestic market. I'm not sure how to distinguish that statistically. I hope there is a way, because that is a valid distinction. It relates to John Sullivan's point that you have to look at the size of these countries and size of their market to get the full explanation as to why direct foreign investment may be going there. I would only note that there are a lot of free countries which are also large—such as India, Philippines, Turkey, Thailand, Korea, South Africa—where market share has declined. All have substantial potential domestic markets, and they don't necessarily attract the same kind of investment that some of the more authoritarian countries do.

On the question of China and Mexico raised by Adrian Karatnycky, we took China and Mexico out of the data to see what would happen. As you would expect, the developing democracies which are free had a much greater share of the export market. However, the direction of that market share was still downward, even with China and Mexico out the data.

Several people raised the question of the partly free category and the fact that there are a lot of differences there. In this study, we considered that category very carefully. For example, we questioned whether Brazil—which was ranked as free for a long time and only recently got knocked down to a partly free category—really ought to be in that category. And on the other side, we looked at Thailand, which is ranked as free even though it just became free last year and there is a question about whether it might better be classified as a partly free country. So we ran the numbers after switching those two countries. What happened was that the trend we documented was made even more pronounced. That is because Brazil has lost considerable market share in both exports and investments, while Thailand has gained.

Regarding Mexico, we are all cheered by the direction that country is headed, and we hope that it will become more democratic. But Mexico is a long way from Brazil on this point. Unlike Brazil, Mexico has never been ranked as free, and it has a long way to go. And I suppose the question raised by this data is if Mexico were to become completely free, and trade unions—genuine trade unions—were to become more important there, and Mexico were to become more democratic, what would happen to trade and investment at that point? This data indicates it may start losing market share.

John mentioned China and the WTO. I hope our paper didn't convey the impression that we were in favor of China's entering the WTO. We didn't say that in the report. We did quote the AEI study, which argued that "China should be forced to accept administrative reform as a condition for WTO membership." And I thought that was a pretty amazing thing to hear coming out of that particular think tank. And it does correspond with some of the questions we raised in the report.

John Sullivan mentioned that the vast bulk of direct foreign investment flows to the developed democracies. That is true, as we said in the report. But we also made the point that the developed democracies are also losing market share, both in terms of exports and in comparison to the developing countries.

Seymour Martin Lipset:

Your comment about AEI seemingly contradicting itself brings us back to the question of American policy and American attitudes towards setting requirements for WTO membership. The United States is not exactly the best country on an international level to do it, and certainly the current political trends here are not going in that direction. So you have these student movements, you have some local governments and universities considering sanctions, but I doubt that you're going to have much success in pushing the United States and the American government to follow such policies.

Your other comment was that if Mexico becomes more democratic and the trade union movement becomes more aggressive and stronger, it might then lose investment and lose in foreign trade. Perhaps the next stage of useful research might be case studies which look at particular countries, especially the deviant cases—the countries which don't follow from the correlations—and see what factors are involved in those. Doing a case analysis is very much called for, because what a deviant case suggests is that there is some other variable, something else in the picture that you haven't thought of, or at least haven't included in your analysis. Then you have to explain why the exception is going in the opposite direction. In some ways the correlation may be less useful than to look at, except insofar as it sets up the framework for a deviant case.

Adrian Karatnycky:

In Washington among policy oriented institutes there is a kind of an imperative to make quick points about the implications of studies and to force policy-directed conclusions. In this case, because you are really uncovering new patterns and looking at them in new ways, the project deserves a lot more significant research. I hope that one of the results of this study will be to encourage studies by all tendencies and all currents of thought—including the AFL-CIO, and business community, and the international institutions—to look at these relationships.

One question that suggests itself from Lawrence Doherty's comment is whether large economic entities that are democratic tend to trade less in the end when compared with more tyrannical societies? It would stand to reason that if there is more middle class development, trade union activism and a better wage environment that creates internal demand, that these societies will respond to that rather than be export driven. More dialogue and research about this question ought to be stimulated by this study. I think this type of research should be welcomed, as well as the conclusions that result from it.

It ought to be axiomatic that even if this pattern were not as significant as the study suggests, we would want more investment in democratic societies even if the patterns did not obtain. It would be useful to have a dialogue to promote more investment in fragile emerging democracies, and to work with them to establish proper environments that could promote greater private investment.

I want to reemphasize the point that I made in my earlier remarks, that looking at what the Commerce Department is doing is very important. How much is being invested in terms of staff time in propping up trade and investment in more closed societies rather than more open societies? It is a completely separate entity from the foreign aid agencies, and is not usually included in the foreign aid calculations.

John Sullivan:

Let me first respond to the notion that we ought to be concerned about promoting investment in countries like India and the other countries which are arguably democracies—one could say that India may be sliding back now at this point. I don't know it that will show up in your data, Adrian, but the Pope certainly seems to feel that way. Nevertheless, India has got the framework of a rule of law.

One of the things that we have to keep in mind is that we may want this more than they do. It doesn't take a very long trip to India to realize that one of the major reasons that there hasn't been foreign direct investment going into India is that they don't want it. There is a huge debate going on in India, and it comes from the labor unions which are blocking investment. They do not want to see privatization of the companies and they do not want to see privatization of telecommunications because these companies are non-competitive, and if you lower the protectionist barriers and increase trade, they will have to restructure. Indian manufacturers are high cost producers in a low wage economy. That's the worst kind of environment for an investor.

South Africa is still ambivalent about attracting foreign direct investment. So we can't say that the onus is always, ipso facto, the investor. One has to look at the climate in the country and what these big democracies want. And if a developing democracy mistakenly takes the point of view that it should block foreign direct investment, one can't then conclude that a company is at fault for not investing.

Let me make another point on the paradox about markets leading to democracy. As I said before, it is not an automatic kind of thing. One has to want a developed economy in order to get one. And that requires economic reform, rule of law, and a number of other factors. Part of the answer to any paradox—and I think this goes back even before economics—can be found in the science of basic logical philosophy.

You can set up a paradox by stating assumptions. The assumptions stated here are that these countries were functioning markets in the way that we know them. A functioning market is not what I would call Indonesia. Indonesia had profound distortions in its economy due to monopolies. That alone, to anybody looking at it from the new institutional economics point of view, would rule it out. In addition, property rights are hardly respected in Indonesia and haven't been for a long time. They have one of the largest informal sectors in the developing world. To say that Indonesia's market economy didn't produce a democracy—and therefore we have a paradox—is to say that something that didn't exist didn't lead to the result that we would like. On labor, some distinctions need to be made. I am a big fan of much of the work done by the American Institute for Free Labor Development (AIFLD) and the current group at the AFL-CIO Solidarity Center. And I don't think there are as many differences in approach as you might assume from what I'm about to say. But just as we cannot simply imagine that having private enterprise makes you a market economy, so we must not assume that having a labor movement means that you have a free labor movement.

Mexico has had a labor movement for years. It is one of the most corrupt in the developing world and a barrier to democracy, a source of much of the cronyism in the Mexican economy. Similarly, if you look at Argentina, it is not true that the labor unions led to a more equal distribution of income. In fact, they led to a very skewed distribution of income, because they are state unions, not free unions. Similarly, we all recognize that a union in Soviet Russia was not a real union.

So as we look at developing countries let's not fall temptation to the idea that a union is a union is a union, any more than we would fall temptation to the idea that private sector automatically equals market economy.

Regarding the sanctions debate, the point in the report is sounds too much like a sarcastic one liner. I would urge you to revisit this. There is a policy debate here among people of good will. It is not simply a corporate-driven debate, unless one is willing to say that senators as respected as Hagle and Luger are simply getting calls from corporate command and control telling them to oppose sanctions. So I would urge you to rethink your position on sanctions and to look at the issue in a more global sense. There have been plenty of studies done by people who are not necessarily funded by business taking a much more nuanced view.

Last point. The percentage differences in market shares mask a lot of movement, and you have got to put in some controls for absolute values. As you look at market share as a percentage you have to control for the fact that there has been a tremendous increase in foreign direct investment and a tremendous decrease in loans and funds from the multinationals as well as from the foreign aid accounts. Development is now being driven far more by the flow of private sector funds, and it is a far larger number, which relates back to absorptive capacity. A country like Costa Rica may show a decline in percentage but nevertheless retain or increase its absolute number. There is only so much foreign direct investment, or portfolio investment, that such countries are able to absorb as compared to even one province in China. So there needs to be more nuance in interpreting this data.

Tom Palley:

I think at this stage we risk fracturing the discussion by getting into a debate about unions. The report was not about unions, it was about democracy and labor standards—and this doesn't refer to how unions function.

One thing that could be looked into further is the difficulty with export-led growth, which has long been claimed as a primary means of development. When you put more countries on line, and squeeze others out, there seems to be some tendency here for the unfree countries to be given more access to the market, and they are squeezing some of the others out. Part of the problem concerns global demand, the question of getting the world economy growing. The whole discussion of labor standards fits into this.

One comment about voluntary standards. Voluntary standards are good, and never enough. We can't have the poachers and game-keepers as one and the same entity.

David Jessup:

I would like to thank our panelists. I thought they did exactly what we hoped they would do—suggest some lines of research and explanation that will help increase our understanding about the trends shown in our report.

Just one last thought. Someone mentioned the information economy. We allude to this in our report as well, with the thought that the information economy needs democracy. The idea is that once this genie is unleashed, it will be harder and harder for the "not free" countries to restrain or control their populations. However, that hope is tempered by a blurb I just saw in the New York Review of Books. It mentioned that the Chinese government is trying to create an Internet restricted to China which would allow its citizens to participate in e-commerce and internal messaging in China, but would block them from having access to the wider World Wide Web. It is a China-wide web. The Chinese government is getting help in trying to design this system from America Online, Yahoo, and Microsoft. So I don't know how much free flow of information will result. But we still have our hopes.