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Globalization of Capital and National Policymaking

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Title: Globalization of Capital and National Policymaking
extracted text: Globalization of Capital and
National Policymaking
STEVEN R. HALL

Abstract
Through a combination of economic, political, and technological changes, capital has
become increasingly mobile across borders. This globalization of capital markets has
created constraints on national policymaking. Fearing the loss capital inflows and the
destabilizing effects of capital outflows, governments have incentives to avoid enacting policies that investors dislike. Applied across countries, this creates pressure for
governments to compete for capital inflows by progressively reducing regulatory
and tax burdens. Ultimately, this could lead to a race to the bottom that ends in complete deregulation. Yet, scholarship shows that while this pressure on governments
exists, there has not been complete convergence of policy across countries. Instead,
there remains persistent divergence as states do maintain some autonomy across a
number of policy choices. This essay explores how recent research explains this interaction between the globalization of capital and national policymaking autonomies.
Financial crises in the United States and Europe have challenged our understanding of how systemic risk can and should be managed in a world of mobile capital.
Moving forward, scholars must build on the lessons from these crises.

INTRODUCTION
The growth of international trade flows in the post-WWII era has been staggering; the World Trade Organization estimates that between 1950 and 2007,
real-world exports grew at a rate 6.2% per annum, nearly twice the rate of the
era of globalization that ended with the beginning of World War I.1 Moreover,
the trend has only accelerated in recent years, with world trade flows growing at a rate of 7.3% per year between 1980 and 2011.2 Yet, during this time
period, a more compelling development has been the staggering increase
in cross-border capital flows, dwarfing trade flows in magnitude. Between
1982 and 2006, global stocks of foreign direct investment (FDI) increased
1. World Trade Organization. (2008). World Trade Report 2008: Trade in a globalizing world. Retrieved
from http://www.wto.org/english/res_e/booksp_e/anrep_e/wtr08-2b_e.pdf.
2. World Trade Organization. (2013). World Trade Report 2013: Factors shaping the future of world trade.
Retrieved from http://www.wto.org/english/res_e/booksp_e/world_trade_report13_e.pdf.
Emerging Trends in the Social and Behavioral Sciences. Edited by Robert Scott and Stephen Kosslyn.
© 2015 John Wiley & Sons, Inc. ISBN 978-1-118-90077-2.

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from roughly 5% to over 25% of world gross domestic product.3 Even these
stock measures of FDI understate the rapid expansion of capital movements.
Broner et al. (2013) find that gross capital flows are many times larger than net
capital flows, much more volatile, and subject to sudden reversals. How has
this enormous change in the dynamics of the international economy altered
the scope of national policymaking?
Even before the reversals in the developing world such as the Asian Crisis
in 1990s and financial crises in the United States and Europe after 2000, concern in advanced industrialized economies over the power and importance
of capital markets mounted. Noted Clinton political strategist, James Carville
quipped: “I used to think if there was reincarnation, I wanted to come back
as the President or the Pope or a .400 baseball hitter. But now I want to
come back as the bond market. You can intimidate everyone.” The power
of financial markets and mobile capital flows came to be seen as both pervasive and irreversible. Large and sudden capital outflows loomed as a threat
to any policy choice that might diverge from the preferences of investors.
Applied across countries, this dynamic created a potential “race to the bottom” where, in order to retain capital, states would be forced to remove policies that placed anything other than minimal burdens on capital owners.
Despite the initial concern that capital mobility has eroded national
policy autonomy, subsequent research has shown that states still have
latitude in a broad range of economic policy choices. Divergence in taxation,
social spending, environmental regulation, and even macroeconomic policy
remains present in the international system as a function of differing national
preferences and institutional arrangements. The recent financial crises in the
United States and Europe, however, have demonstrated the vulnerability of
the advanced economies to the risks created by globalized capital.
FOUNDATIONAL RESEARCH
Scholars of international political economy (IPE) have come to regard international capital mobility as an essential characteristic of the international
system. In part, this reflects a deliberate political process of capital account
liberalization that gained momentum in advanced industrialized countries
in the 1980s. Driven by domestic political conflicts over the impact of capital flows, these countries increasingly responded to pressures from interest
groups to remove restrictions on cross-border movements (Quinn & Inclan,
1997). This process was also hastened by the deterioration of government
ability to stop such movements. Both financial innovations, that is, the rise
3. World Trade Organization. (2008). World Trade Report 2008: Trade in a globalizing world. Retrieved
from http://www.wto.org/english/res_e/booksp_e/anrep_e/wtr08-2b_e.pdf.

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of the Euromarkets and the use of transfer pricing by multinational corporations allow capital to be moved in ways that are prohibitively expensive for
governments to regulate or stop (Goodman & Pauly, 1993). Andrews (1994)
contends that capital mobility can be regarded as a structural feature of the
international system in the narrow sense used by structural realists.
One immediate conclusion by scholars about the impact of these changes
stems from the Mundell-Fleming model, the so-called Unholy Trinity. This
is the idea that states cannot simultaneously maintain three policy goals:
fixed exchange rates, capital mobility, and monetary autonomy. Instead,
governments may only choose two of the three targets. With capital mobility
ensconced as unalterable feature of the international system, governments
are forced to choose between fixed exchange rates and monetary autonomy.
This tension played a role in the end of the Bretton Woods system of fixed
exchange rates in 1973. Further, Frieden (1991) argues that these conditions
shape domestic political conflicts over the level and variability of exchange
rates.
However, capital mobility has potentially much more wide-ranging
impacts on policymaking than monetary policy. Bates and Lien (1985) argue
that owners of mobile assets possess a unique bargaining advantage against
governmental authorities (and, by extension, other constituencies within
the state). By moving their assets outside the jurisdiction, they can escape
taxation. Because revenue-seeking authorities need a deep tax base, they
have incentives to strike bargains with the owners of these assets to keep
them in place. This gives the owners of mobile assets a great deal of power
over decision-making, potentially to the collective detriment of those who
own immobile assets. While Bates and Lien discuss owners of cows in
Edwardian England, a modern analog is the operation of professional sports
franchises in cities in the United States. The owners of pro teams use the
threat of relocation to extract ever larger public financing commitments
for new stadium and infrastructure projects. The availability of competing
offers from other cities serves to underscore this advantage and increase the
concessions franchises that are able demand. This dynamic has been called
the Delaware Effect, referring to the incentives created by Delaware’s laws of
incorporation. Competition among jurisdictions to attract owners of mobile
capital creates a race to the bottom in taxation and regulatory burdens.
In the 1990s, scholars suggested that this dynamic had essentially
eliminated key macroeconomic policy options available to governments,
particularly those favored by parties on the left. Garrett and Lange (1991)
allowed that supply-side remedies remain available to governments but
argued that capital mobility eliminates the governments’ ability to pursue independent fiscal and monetary policies that match their partisan
preferences. The combination of tightly integrated goods markets and the

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rapid adjustment of financial markets to government decisions means that
attempts to manage aggregate demand result only in destabilizing flows
through the current and/or capital accounts. Indeed, some even suggested
that, owing to globalization, the state itself faced fundamental challenges
both to its efficiency in providing public goods and its institutional
legitimacy (Cerny, 1995).
Despite considerable initial consternation over the seemingly irresistible
power of mobile capital, subsequent research has demonstrated that the
effect of financial globalization to be less pervasive than race to the bottom
accounts suggest. In the area of macroeconomic policy, capital mobility has
reduced over time the differences in policy choice between governments of
advanced industrialized countries, more perhaps for monetary policy (Boix,
2000) than for fiscal policy (Cusack, 2001). Yet, the effect of capital mobility
on macroeconomic policy appears to be conditional on a number of domestic
arrangements, such as the use of capital controls, choice of exchange rate
regime, and independence of the central bank (Clark & Hallerberg, 2000;
Clark, Reichert, Lomas, & Parker, 1998; Oatley, 1999).
In the realm of tax competition, extensive research has been devoted to what
is essentially a nonfinding, that tax rates in small open countries are not in
fact driven to zero. Gordon (1992) suggests that the interaction of double taxation conventions with the presence of dominant capital exporters creates a
Stackelberg leader–follower dynamic; large countries set corporate taxes at
higher levels than suggest by optimal tax theory allowing small countries to
follow suit. Gordon and Bovenberg (1996) find that information asymmetries
between foreign and domestic investors may help explain why tax rates on
capital have not been driven down farther. Indeed, empirical studies of the
effect of capital mobility find either no effects on taxation (Swank, 1998) or
even increases resulting from integration (Quinn, 1997). Swank and Steinmo
(2002) do find of evidence of capital mobility lowering statutory tax rates on
capital income, but not average effective tax rates. Downward pressure on
capital taxes may be felt more strongly in developing countries (Wibbels &
Arce, 2003).
Subsequent research on the relationship between capital mobility and
taxation has focused on how domestic politics mediates the impacts of
globalization. Hays (2003) finds that the constraints of mobile capital are felt
more deeply in states with majoritarian institutions. Basinger and Hallerberg
(2004) suggest that while states do respond to tax changes in competing
states, the presence of institutional veto players and ideologically opposed
constituencies limits convergence in tax policy. Similarly, Plümper, Troeger,
and Winner (2009) find that budget constraints and equity norms limit the
response of states to competitive pressures to reduce taxes on capital income.

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The coincidence of welfare state retrenchment with the evolution of capital
mobility has generated speculation that globalization also constrains social
spending. However, this may not be the case if owners of mobile capital
do not have preferences over the level of such spending (Mosley, 2000).
In fact, the compensation hypothesis holds that the increases in economic
volatility and insecurity created by globalization generate greater demands
domestically for social benefits. Indeed, research suggests that exposure to
FDI does increase individual perceptions economic insecurity (Scheve &
Slaughter, 2004); those who experience this insecurity are likely to lobby for
expansion of state benefits (Walter, 2010).
What then is the aggregate impact of capital mobility on social spending?
As with other policymaking areas, the literature finds little support for simple race to the bottom stories. Capital mobility’s effect on spending appears
to be contingent on a number of factors including the particular kind of
spending (Burgoon, 2001), the nature of cross-border capital flows (Hicks &
Zorn, 2005), and partisanship (Potrafke, 2009). The extent to which these
findings hold in developing countries is disputed as there evidence that
financial openness does lead to retrenchment (Kaufman & Segura-Ubiergo,
2001; Rudra, 2002) as well as evidence that it does not (Avelino, Brown, &
Hunter, 2005) and that the effect is conditional on levels of democracy
(Nooruddin & Simmons, 2009).
Another area where the pressure of competition for capital might plausibly
lead to a race to the bottom is environmental regulation. However, as with the
other policy choices, extant research shows that the impact of capital mobility
is not convergence on zero regulation. Konisky (2007) notes that while states
do respond to regulatory changes in competing states in ways that suggest a
race to the bottom, they also respond to increases in competitors’ regulations
indicating a race to the top. Saikawa (2013) shows that automobile-exporting
states respond to the pressure of international competition by raising emission standards. This ratcheting of environmental protections can indeed be
driven by the presence of foreign investors; increasing exposure to international investment has led to more stringent environmental enforcement in
China (Zeng & Eastin, 2007). More generally, Prakash and Potoski (2006)
demonstrate that the adoption of the environmental standards is associated
with the presence of inward FDI originating from states where environmental
enforcement is already stringent.
The methodological approach that unites much of the initial literature on
capital mobility involves the use of quantitative analysis with government
policy indicators as dependent variables and an indicator of financial
openness as an independent variable. The causal path that connects these
variables involves the preferences and choices of international investors.
Increasingly, research is focusing on how investors make choices, what

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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES

information they pay attention to, and what political variables they monitor.
To the extent that investors respond to policy choices, the pressure for
convergence will be driven be focused on these factors (Mosley, 2000).
Shambaugh (2004) notes that, particularly in developing countries, domestic groups exert pressure on policies that affect the specific kind of foreign
capital on which they are reliant. FDI flows seem to be more responsive to
institutional characteristics than policy choices (Ahlquist, 2006; Jensen, 2003;
Li & Resnick, 2003; Staats & Biglaiser, 2012). Similarly, sovereign borrowers appear to benefit if they have democratic institutions (Archer, Biglaiser,
& DeRouen, 2007; Biglaiser & Staats, 2012; Schultz & Weingast, 2003). Yet,
despite apparent indifference toward macroeconomic policy, FDI flows do
respond to protection of human rights (Blanton & Blanton, 2007) and labor
rights (Mosley & Uno, 2007). To ameliorate perceptions of institutional weakness and attract more FDI, emerging states can also join bilateral investment
treaties (Elkins, Guzman, & Simmons, 2006). Market indicators suggest that
portfolio investors pay more attention to partisan behavior (Bechtel, 2009)
and policy choices, such fiscal policy (Ahlquist, 2006) and policies protecting
shareholders (Mosley & Singer, 2008).
CUTTING-EDGE RESEARCH
While the effect of capital mobility on some aspects of policy autonomy may
have initially been overstated, its impact on systemic risk is only now becoming apparent. In the 1980s, the Savings and Loan Crisis, a financial crisis in
US real estate lending, led to a minor congressional scandal and large bailout
bill for US taxpayers, but left the US economy and the rest of the world more
or less unaffected. By 2007, with the deregulation of national financial markets and the liberalization of capital accounts, the impact of a second crisis
in the US mortgage market would be quite different. The subprime crisis in
the United States quickly spread abroad and helped trigger the eurozone crisis. Prior the these events, the contagion risk associated with capital mobility
seemed confined to the developing world, as seen in financial crises in Latin
America in the 1980s and East Asia in the 1990s. The profound damage to
the advanced economies after 2007 demonstrates the way that capital mobility transfers risks across borders even in seemingly well-regulated and stable
financial systems.
What makes this more confounding to IPE as a discipline is the emphasis in the literature leading up to the crisis on the seeming solution of the
problem of managing risk. Capital mobility has been viewed as creating a
race to the bottom as states weakened bank regulation in order to lure banking business to their jurisdictions; it has been argued that regulatory convergence solves the collective action problem allowing states to maintain

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financial stability (Kapstein, 1989). Subsequent research emphasized divergent preferences among states over regulation and the role of power in shaping harmonization, with the preferences of the United States and the United
Kingdom playing key roles (Oatley & Nabors, 1998; Posner, 2009; Simmons,
2001). Individual states’ decisions to seek out international harmonization
are also shaped by domestic political conflicts (Kerner & Kucik, 2010; Singer,
2004). Regardless of the determinants of regulatory convergence, the implication nonetheless is that the international financial system has ended up more
tightly regulated than it would be, if states were to regulate their financial
markets completely independently.
Yet, the very process of harmonization played a role in the duplication of
errors and misinformation across financial jurisdictions. Banks in the United
States and Europe made the risky choices that led to the financial crisis while
operating under the Basel Accords; indeed, the agreements on capital adequacy actually incentivized bank holdings of mortgage-backed securities. In
the government sector, public finance in the European Union was supposedly disciplined under the Stability and Growth Pact; however, even as states
such as Greece engaged profligate financial behavior, the risk premiums on
their borrowing converged with those of governments enacting more sound
policies. The resulting economic downturn has had profound implications
for national policy autonomy, in terms of regulating both the financial system
and, for European governments receiving bail-outs, explicit conditionality. A
number of scholars see the failure of IPE as a discipline to predict and explain
the crisis (Cohen, 2009; Drezner & McNamara, 2013; Katzenstein & Nelson,
2013), whereas more sanguine accounts see the possibilities for the discipline
in grappling with an exceptional event (Helleiner & Pagliari, 2011; Mosley &
Singer, 2009).
The cutting edge then lies in the unpacking of the complex relationship
among capital mobility, national autonomy, and the management of international financial risk. A number of promising approaches have emerged
in this vein. For example, network theory moves away from the traditional
actor-centric focus of IPE and examines the structure of social relationships.
Network analysis has been used to identify both the nature of contagion
paths across financial systems (Oatley, Winecoff, Pennock, & Danzman,
2013) and the channels of policy convergence pressure and learning diffusion
(Cao, 2012). Capital mobility has been traditionally thought of as having
uniform effects across countries; this approach has the potential to highlight
how these affects can be differentiated by network positions.
A second source of potential leverage on the issue of systemic risk is the
examination of the evolution of financial institutions. Hardie et al. (2013) note
the breakdown of the traditional dichotomy offered by the varieties of capitalism literature. The rise of market-based banking over relational banking

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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES

reduces the buffers on nonfinancial companies with broad implications for
national economic systems. Rixen (2013) highlights the role of shadow banking and offshore financial centers in exacerbating difficulties in achieving
effective financial oversight, both domestically and at the international level.
Attentiveness to new kinds of actors and transactions in the financial sector
will be key to understanding systemic risk.
Finally, how economic and political actors make decisions amid this
complexity remains an essential issue in understanding how events such as
the financial crisis of 2008 occur. Answering a call by Deeg and O’Sullivan
(2009) for greater explanation of the implementation of financial rules
by regulators, Nelson and Katzenstein (2014) combine rationalist and
sociological approaches more broadly to public and private actors alike in
the 2008 crisis. In situations of uncertainty (i.e., as opposed to situations
of risk were probability distributions over outcomes can in some sense be
objectively built), actors fall back on social conventions, increasing the role
of competition, learning, and emulation in the shaping of behavior.
KEY ISSUES FOR FUTURE RESEARCH
Naturally, the challenge in modeling the political economy of cross-border
financial crises is that they are rather difficult to predict. As Reinhart and
Rogoff (2009) observe, a consistent characteristic of the past 800 years of
financial crises has been a sort of myopia where such outcomes are generally
seen as inconceivable. Crises occur, in part, because regulators fail to observe
and forestall excessive risk-taking; however, actors in the private sector
make similar mistakes. The presence of two Nobel Prize-winning economists
did not prevent the collapse of Long-Term Capital Management in 1998; the
partners could not foresee a situation where “all correlations go to one.”
While prediction of particular crises may elude scholars, this challenge
should not prevent the building of a more nuanced understanding of how
capital mobility shapes both financial contagion and regulation at both the
domestic and international levels.
The dominant approach to understand capital mobility and national
policymaking has been the analysis of cross-sectional time series data with
countries as units. This approach may not be well suited to the relationship
between financial globalization and the management of risk. First, the unit of
analysis researchers must focus on has shifted from states to firms and even
the individual transactions that generate risks and propagate them across
borders. Relying on rationality as an assumption to allow aggregation to the
firm, sector, or even state level seems problematic at best in an age when even
Alan Greenspan (former Chairman of the US Federal Reserve, 1987–2006)
has been forced to reconsider its prevalence in the marketplace. Second,

Globalization of Capital and National Policymaking

9

while capital mobility is still understood to be exogenous, causality appears
to run in multiple directions among the choices of financial actors, financial
regulators, and government officials pursuing international agreements. It
seems then that methods other than regression analysis will likely be best
suited to approaching the question.
Acquiring data to analyze the question carries difficulties as well. First,
the nature of the financial transactions that give rise to these risks is complex. Arcane instruments such as synthetic collateralized debt obligations
played an important role in subprime crisis but were poorly understood by
a great many, including those who traded them. Second, these transactions
take place in large organizations. As financial institutions have increased in
size, incidents such as the London Whale affair at JP Morgan, where what
was ostensibly a hedging operation created multibillion dollar losses unbeknownst to CEO Jaime Dimon, have become more possible. Third, the ultimate difficulty for researchers is that the financial sector generates enormous
rents; firms in this industry are likely to view information about their behavior as proprietary.
Notwithstanding these daunting challenges, the social sciences must move
forward in exploring how globalization constrains and affects national
policymaking not only through the pressure of capital mobility but also
through the risk of catastrophic financial crises. To be sure, the depth of
the cross-border ties between national capital markets creates the potential
to unlock productive forces and improve economic well-being. However,
because of the possible negative outcomes recent crises have shown, we
must understand how these ties shape and affect the management of
contagion and systemic risk.

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doi:10.2307/4621751

STEVEN R. HALL SHORT BIOGRAPHY
Steven R. Hall is an Assistant Professor in the Department of Political Science
at Ball State University in Muncie, Indiana. His current research examines the
relationship between political stability and economic performance.
RELATED ESSAYS
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The Role of Data in Research and Policy (Sociology), Barbara A. Anderson
Global Economic Networks (Sociology), Nina Bandelj et al.
Globalization Backlash (Sociology), Mabel Berezin
Domestic Institutions and International Conflict (Political Science), Giacomo
Chiozza
Globalization: Consequences for Work and Employment in Advanced
Capitalist Societies (Sociology), Tony Elger

14

EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES

Global Income Inequality (Sociology), Glenn Firebaugh
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Animals (Anthropology), Sonja E. Koski
Why Do States Sign Alliances? (Political Science), Brett Ashley Leeds
Visualizing Globalization (Sociology), Matthew C. Mahutga and Robert
Nash-Parker
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National Policymaking
STEVEN R. HALL

Abstract
Through a combination of economic, political, and technological changes, capital has
become increasingly mobile across borders. This globalization of capital markets has
created constraints on national policymaking. Fearing the loss capital inflows and the
destabilizing effects of capital outflows, governments have incentives to avoid enacting policies that investors dislike. Applied across countries, this creates pressure for
governments to compete for capital inflows by progressively reducing regulatory
and tax burdens. Ultimately, this could lead to a race to the bottom that ends in complete deregulation. Yet, scholarship shows that while this pressure on governments
exists, there has not been complete convergence of policy across countries. Instead,
there remains persistent divergence as states do maintain some autonomy across a
number of policy choices. This essay explores how recent research explains this interaction between the globalization of capital and national policymaking autonomies.
Financial crises in the United States and Europe have challenged our understanding of how systemic risk can and should be managed in a world of mobile capital.
Moving forward, scholars must build on the lessons from these crises.

INTRODUCTION
The growth of international trade flows in the post-WWII era has been staggering; the World Trade Organization estimates that between 1950 and 2007,
real-world exports grew at a rate 6.2% per annum, nearly twice the rate of the
era of globalization that ended with the beginning of World War I.1 Moreover,
the trend has only accelerated in recent years, with world trade flows growing at a rate of 7.3% per year between 1980 and 2011.2 Yet, during this time
period, a more compelling development has been the staggering increase
in cross-border capital flows, dwarfing trade flows in magnitude. Between
1982 and 2006, global stocks of foreign direct investment (FDI) increased
1. World Trade Organization. (2008). World Trade Report 2008: Trade in a globalizing world. Retrieved
from http://www.wto.org/english/res_e/booksp_e/anrep_e/wtr08-2b_e.pdf.
2. World Trade Organization. (2013). World Trade Report 2013: Factors shaping the future of world trade.
Retrieved from http://www.wto.org/english/res_e/booksp_e/world_trade_report13_e.pdf.
Emerging Trends in the Social and Behavioral Sciences. Edited by Robert Scott and Stephen Kosslyn.
© 2015 John Wiley & Sons, Inc. ISBN 978-1-118-90077-2.

1

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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES

from roughly 5% to over 25% of world gross domestic product.3 Even these
stock measures of FDI understate the rapid expansion of capital movements.
Broner et al. (2013) find that gross capital flows are many times larger than net
capital flows, much more volatile, and subject to sudden reversals. How has
this enormous change in the dynamics of the international economy altered
the scope of national policymaking?
Even before the reversals in the developing world such as the Asian Crisis
in 1990s and financial crises in the United States and Europe after 2000, concern in advanced industrialized economies over the power and importance
of capital markets mounted. Noted Clinton political strategist, James Carville
quipped: “I used to think if there was reincarnation, I wanted to come back
as the President or the Pope or a .400 baseball hitter. But now I want to
come back as the bond market. You can intimidate everyone.” The power
of financial markets and mobile capital flows came to be seen as both pervasive and irreversible. Large and sudden capital outflows loomed as a threat
to any policy choice that might diverge from the preferences of investors.
Applied across countries, this dynamic created a potential “race to the bottom” where, in order to retain capital, states would be forced to remove policies that placed anything other than minimal burdens on capital owners.
Despite the initial concern that capital mobility has eroded national
policy autonomy, subsequent research has shown that states still have
latitude in a broad range of economic policy choices. Divergence in taxation,
social spending, environmental regulation, and even macroeconomic policy
remains present in the international system as a function of differing national
preferences and institutional arrangements. The recent financial crises in the
United States and Europe, however, have demonstrated the vulnerability of
the advanced economies to the risks created by globalized capital.
FOUNDATIONAL RESEARCH
Scholars of international political economy (IPE) have come to regard international capital mobility as an essential characteristic of the international
system. In part, this reflects a deliberate political process of capital account
liberalization that gained momentum in advanced industrialized countries
in the 1980s. Driven by domestic political conflicts over the impact of capital flows, these countries increasingly responded to pressures from interest
groups to remove restrictions on cross-border movements (Quinn & Inclan,
1997). This process was also hastened by the deterioration of government
ability to stop such movements. Both financial innovations, that is, the rise
3. World Trade Organization. (2008). World Trade Report 2008: Trade in a globalizing world. Retrieved
from http://www.wto.org/english/res_e/booksp_e/anrep_e/wtr08-2b_e.pdf.

Globalization of Capital and National Policymaking

3

of the Euromarkets and the use of transfer pricing by multinational corporations allow capital to be moved in ways that are prohibitively expensive for
governments to regulate or stop (Goodman & Pauly, 1993). Andrews (1994)
contends that capital mobility can be regarded as a structural feature of the
international system in the narrow sense used by structural realists.
One immediate conclusion by scholars about the impact of these changes
stems from the Mundell-Fleming model, the so-called Unholy Trinity. This
is the idea that states cannot simultaneously maintain three policy goals:
fixed exchange rates, capital mobility, and monetary autonomy. Instead,
governments may only choose two of the three targets. With capital mobility
ensconced as unalterable feature of the international system, governments
are forced to choose between fixed exchange rates and monetary autonomy.
This tension played a role in the end of the Bretton Woods system of fixed
exchange rates in 1973. Further, Frieden (1991) argues that these conditions
shape domestic political conflicts over the level and variability of exchange
rates.
However, capital mobility has potentially much more wide-ranging
impacts on policymaking than monetary policy. Bates and Lien (1985) argue
that owners of mobile assets possess a unique bargaining advantage against
governmental authorities (and, by extension, other constituencies within
the state). By moving their assets outside the jurisdiction, they can escape
taxation. Because revenue-seeking authorities need a deep tax base, they
have incentives to strike bargains with the owners of these assets to keep
them in place. This gives the owners of mobile assets a great deal of power
over decision-making, potentially to the collective detriment of those who
own immobile assets. While Bates and Lien discuss owners of cows in
Edwardian England, a modern analog is the operation of professional sports
franchises in cities in the United States. The owners of pro teams use the
threat of relocation to extract ever larger public financing commitments
for new stadium and infrastructure projects. The availability of competing
offers from other cities serves to underscore this advantage and increase the
concessions franchises that are able demand. This dynamic has been called
the Delaware Effect, referring to the incentives created by Delaware’s laws of
incorporation. Competition among jurisdictions to attract owners of mobile
capital creates a race to the bottom in taxation and regulatory burdens.
In the 1990s, scholars suggested that this dynamic had essentially
eliminated key macroeconomic policy options available to governments,
particularly those favored by parties on the left. Garrett and Lange (1991)
allowed that supply-side remedies remain available to governments but
argued that capital mobility eliminates the governments’ ability to pursue independent fiscal and monetary policies that match their partisan
preferences. The combination of tightly integrated goods markets and the

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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES

rapid adjustment of financial markets to government decisions means that
attempts to manage aggregate demand result only in destabilizing flows
through the current and/or capital accounts. Indeed, some even suggested
that, owing to globalization, the state itself faced fundamental challenges
both to its efficiency in providing public goods and its institutional
legitimacy (Cerny, 1995).
Despite considerable initial consternation over the seemingly irresistible
power of mobile capital, subsequent research has demonstrated that the
effect of financial globalization to be less pervasive than race to the bottom
accounts suggest. In the area of macroeconomic policy, capital mobility has
reduced over time the differences in policy choice between governments of
advanced industrialized countries, more perhaps for monetary policy (Boix,
2000) than for fiscal policy (Cusack, 2001). Yet, the effect of capital mobility
on macroeconomic policy appears to be conditional on a number of domestic
arrangements, such as the use of capital controls, choice of exchange rate
regime, and independence of the central bank (Clark & Hallerberg, 2000;
Clark, Reichert, Lomas, & Parker, 1998; Oatley, 1999).
In the realm of tax competition, extensive research has been devoted to what
is essentially a nonfinding, that tax rates in small open countries are not in
fact driven to zero. Gordon (1992) suggests that the interaction of double taxation conventions with the presence of dominant capital exporters creates a
Stackelberg leader–follower dynamic; large countries set corporate taxes at
higher levels than suggest by optimal tax theory allowing small countries to
follow suit. Gordon and Bovenberg (1996) find that information asymmetries
between foreign and domestic investors may help explain why tax rates on
capital have not been driven down farther. Indeed, empirical studies of the
effect of capital mobility find either no effects on taxation (Swank, 1998) or
even increases resulting from integration (Quinn, 1997). Swank and Steinmo
(2002) do find of evidence of capital mobility lowering statutory tax rates on
capital income, but not average effective tax rates. Downward pressure on
capital taxes may be felt more strongly in developing countries (Wibbels &
Arce, 2003).
Subsequent research on the relationship between capital mobility and
taxation has focused on how domestic politics mediates the impacts of
globalization. Hays (2003) finds that the constraints of mobile capital are felt
more deeply in states with majoritarian institutions. Basinger and Hallerberg
(2004) suggest that while states do respond to tax changes in competing
states, the presence of institutional veto players and ideologically opposed
constituencies limits convergence in tax policy. Similarly, Plümper, Troeger,
and Winner (2009) find that budget constraints and equity norms limit the
response of states to competitive pressures to reduce taxes on capital income.

Globalization of Capital and National Policymaking

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The coincidence of welfare state retrenchment with the evolution of capital
mobility has generated speculation that globalization also constrains social
spending. However, this may not be the case if owners of mobile capital
do not have preferences over the level of such spending (Mosley, 2000).
In fact, the compensation hypothesis holds that the increases in economic
volatility and insecurity created by globalization generate greater demands
domestically for social benefits. Indeed, research suggests that exposure to
FDI does increase individual perceptions economic insecurity (Scheve &
Slaughter, 2004); those who experience this insecurity are likely to lobby for
expansion of state benefits (Walter, 2010).
What then is the aggregate impact of capital mobility on social spending?
As with other policymaking areas, the literature finds little support for simple race to the bottom stories. Capital mobility’s effect on spending appears
to be contingent on a number of factors including the particular kind of
spending (Burgoon, 2001), the nature of cross-border capital flows (Hicks &
Zorn, 2005), and partisanship (Potrafke, 2009). The extent to which these
findings hold in developing countries is disputed as there evidence that
financial openness does lead to retrenchment (Kaufman & Segura-Ubiergo,
2001; Rudra, 2002) as well as evidence that it does not (Avelino, Brown, &
Hunter, 2005) and that the effect is conditional on levels of democracy
(Nooruddin & Simmons, 2009).
Another area where the pressure of competition for capital might plausibly
lead to a race to the bottom is environmental regulation. However, as with the
other policy choices, extant research shows that the impact of capital mobility
is not convergence on zero regulation. Konisky (2007) notes that while states
do respond to regulatory changes in competing states in ways that suggest a
race to the bottom, they also respond to increases in competitors’ regulations
indicating a race to the top. Saikawa (2013) shows that automobile-exporting
states respond to the pressure of international competition by raising emission standards. This ratcheting of environmental protections can indeed be
driven by the presence of foreign investors; increasing exposure to international investment has led to more stringent environmental enforcement in
China (Zeng & Eastin, 2007). More generally, Prakash and Potoski (2006)
demonstrate that the adoption of the environmental standards is associated
with the presence of inward FDI originating from states where environmental
enforcement is already stringent.
The methodological approach that unites much of the initial literature on
capital mobility involves the use of quantitative analysis with government
policy indicators as dependent variables and an indicator of financial
openness as an independent variable. The causal path that connects these
variables involves the preferences and choices of international investors.
Increasingly, research is focusing on how investors make choices, what

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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES

information they pay attention to, and what political variables they monitor.
To the extent that investors respond to policy choices, the pressure for
convergence will be driven be focused on these factors (Mosley, 2000).
Shambaugh (2004) notes that, particularly in developing countries, domestic groups exert pressure on policies that affect the specific kind of foreign
capital on which they are reliant. FDI flows seem to be more responsive to
institutional characteristics than policy choices (Ahlquist, 2006; Jensen, 2003;
Li & Resnick, 2003; Staats & Biglaiser, 2012). Similarly, sovereign borrowers appear to benefit if they have democratic institutions (Archer, Biglaiser,
& DeRouen, 2007; Biglaiser & Staats, 2012; Schultz & Weingast, 2003). Yet,
despite apparent indifference toward macroeconomic policy, FDI flows do
respond to protection of human rights (Blanton & Blanton, 2007) and labor
rights (Mosley & Uno, 2007). To ameliorate perceptions of institutional weakness and attract more FDI, emerging states can also join bilateral investment
treaties (Elkins, Guzman, & Simmons, 2006). Market indicators suggest that
portfolio investors pay more attention to partisan behavior (Bechtel, 2009)
and policy choices, such fiscal policy (Ahlquist, 2006) and policies protecting
shareholders (Mosley & Singer, 2008).
CUTTING-EDGE RESEARCH
While the effect of capital mobility on some aspects of policy autonomy may
have initially been overstated, its impact on systemic risk is only now becoming apparent. In the 1980s, the Savings and Loan Crisis, a financial crisis in
US real estate lending, led to a minor congressional scandal and large bailout
bill for US taxpayers, but left the US economy and the rest of the world more
or less unaffected. By 2007, with the deregulation of national financial markets and the liberalization of capital accounts, the impact of a second crisis
in the US mortgage market would be quite different. The subprime crisis in
the United States quickly spread abroad and helped trigger the eurozone crisis. Prior the these events, the contagion risk associated with capital mobility
seemed confined to the developing world, as seen in financial crises in Latin
America in the 1980s and East Asia in the 1990s. The profound damage to
the advanced economies after 2007 demonstrates the way that capital mobility transfers risks across borders even in seemingly well-regulated and stable
financial systems.
What makes this more confounding to IPE as a discipline is the emphasis in the literature leading up to the crisis on the seeming solution of the
problem of managing risk. Capital mobility has been viewed as creating a
race to the bottom as states weakened bank regulation in order to lure banking business to their jurisdictions; it has been argued that regulatory convergence solves the collective action problem allowing states to maintain

Globalization of Capital and National Policymaking

7

financial stability (Kapstein, 1989). Subsequent research emphasized divergent preferences among states over regulation and the role of power in shaping harmonization, with the preferences of the United States and the United
Kingdom playing key roles (Oatley & Nabors, 1998; Posner, 2009; Simmons,
2001). Individual states’ decisions to seek out international harmonization
are also shaped by domestic political conflicts (Kerner & Kucik, 2010; Singer,
2004). Regardless of the determinants of regulatory convergence, the implication nonetheless is that the international financial system has ended up more
tightly regulated than it would be, if states were to regulate their financial
markets completely independently.
Yet, the very process of harmonization played a role in the duplication of
errors and misinformation across financial jurisdictions. Banks in the United
States and Europe made the risky choices that led to the financial crisis while
operating under the Basel Accords; indeed, the agreements on capital adequacy actually incentivized bank holdings of mortgage-backed securities. In
the government sector, public finance in the European Union was supposedly disciplined under the Stability and Growth Pact; however, even as states
such as Greece engaged profligate financial behavior, the risk premiums on
their borrowing converged with those of governments enacting more sound
policies. The resulting economic downturn has had profound implications
for national policy autonomy, in terms of regulating both the financial system
and, for European governments receiving bail-outs, explicit conditionality. A
number of scholars see the failure of IPE as a discipline to predict and explain
the crisis (Cohen, 2009; Drezner & McNamara, 2013; Katzenstein & Nelson,
2013), whereas more sanguine accounts see the possibilities for the discipline
in grappling with an exceptional event (Helleiner & Pagliari, 2011; Mosley &
Singer, 2009).
The cutting edge then lies in the unpacking of the complex relationship
among capital mobility, national autonomy, and the management of international financial risk. A number of promising approaches have emerged
in this vein. For example, network theory moves away from the traditional
actor-centric focus of IPE and examines the structure of social relationships.
Network analysis has been used to identify both the nature of contagion
paths across financial systems (Oatley, Winecoff, Pennock, & Danzman,
2013) and the channels of policy convergence pressure and learning diffusion
(Cao, 2012). Capital mobility has been traditionally thought of as having
uniform effects across countries; this approach has the potential to highlight
how these affects can be differentiated by network positions.
A second source of potential leverage on the issue of systemic risk is the
examination of the evolution of financial institutions. Hardie et al. (2013) note
the breakdown of the traditional dichotomy offered by the varieties of capitalism literature. The rise of market-based banking over relational banking

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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES

reduces the buffers on nonfinancial companies with broad implications for
national economic systems. Rixen (2013) highlights the role of shadow banking and offshore financial centers in exacerbating difficulties in achieving
effective financial oversight, both domestically and at the international level.
Attentiveness to new kinds of actors and transactions in the financial sector
will be key to understanding systemic risk.
Finally, how economic and political actors make decisions amid this
complexity remains an essential issue in understanding how events such as
the financial crisis of 2008 occur. Answering a call by Deeg and O’Sullivan
(2009) for greater explanation of the implementation of financial rules
by regulators, Nelson and Katzenstein (2014) combine rationalist and
sociological approaches more broadly to public and private actors alike in
the 2008 crisis. In situations of uncertainty (i.e., as opposed to situations
of risk were probability distributions over outcomes can in some sense be
objectively built), actors fall back on social conventions, increasing the role
of competition, learning, and emulation in the shaping of behavior.
KEY ISSUES FOR FUTURE RESEARCH
Naturally, the challenge in modeling the political economy of cross-border
financial crises is that they are rather difficult to predict. As Reinhart and
Rogoff (2009) observe, a consistent characteristic of the past 800 years of
financial crises has been a sort of myopia where such outcomes are generally
seen as inconceivable. Crises occur, in part, because regulators fail to observe
and forestall excessive risk-taking; however, actors in the private sector
make similar mistakes. The presence of two Nobel Prize-winning economists
did not prevent the collapse of Long-Term Capital Management in 1998; the
partners could not foresee a situation where “all correlations go to one.”
While prediction of particular crises may elude scholars, this challenge
should not prevent the building of a more nuanced understanding of how
capital mobility shapes both financial contagion and regulation at both the
domestic and international levels.
The dominant approach to understand capital mobility and national
policymaking has been the analysis of cross-sectional time series data with
countries as units. This approach may not be well suited to the relationship
between financial globalization and the management of risk. First, the unit of
analysis researchers must focus on has shifted from states to firms and even
the individual transactions that generate risks and propagate them across
borders. Relying on rationality as an assumption to allow aggregation to the
firm, sector, or even state level seems problematic at best in an age when even
Alan Greenspan (former Chairman of the US Federal Reserve, 1987–2006)
has been forced to reconsider its prevalence in the marketplace. Second,

Globalization of Capital and National Policymaking

9

while capital mobility is still understood to be exogenous, causality appears
to run in multiple directions among the choices of financial actors, financial
regulators, and government officials pursuing international agreements. It
seems then that methods other than regression analysis will likely be best
suited to approaching the question.
Acquiring data to analyze the question carries difficulties as well. First,
the nature of the financial transactions that give rise to these risks is complex. Arcane instruments such as synthetic collateralized debt obligations
played an important role in subprime crisis but were poorly understood by
a great many, including those who traded them. Second, these transactions
take place in large organizations. As financial institutions have increased in
size, incidents such as the London Whale affair at JP Morgan, where what
was ostensibly a hedging operation created multibillion dollar losses unbeknownst to CEO Jaime Dimon, have become more possible. Third, the ultimate difficulty for researchers is that the financial sector generates enormous
rents; firms in this industry are likely to view information about their behavior as proprietary.
Notwithstanding these daunting challenges, the social sciences must move
forward in exploring how globalization constrains and affects national
policymaking not only through the pressure of capital mobility but also
through the risk of catastrophic financial crises. To be sure, the depth of
the cross-border ties between national capital markets creates the potential
to unlock productive forces and improve economic well-being. However,
because of the possible negative outcomes recent crises have shown, we
must understand how these ties shape and affect the management of
contagion and systemic risk.

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STEVEN R. HALL SHORT BIOGRAPHY
Steven R. Hall is an Assistant Professor in the Department of Political Science
at Ball State University in Muncie, Indiana. His current research examines the
relationship between political stability and economic performance.
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