IPS Modeling Races to the Bottom

8/3/2019 IPS Modeling Races to the Bottom

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MO DELING RACES TO THE BOTTOM

Miles Kahler

Grad ua te School of Interna tional Relations an d Pacific Stu d ies

Univer sity of Californ ia, San Diego

9500 Gilman DriveLa Jolla, CA 92093-0519

ema il: mk ahler@ucsd .edu


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MODELING RACES TO TH E BOTTOM

Miles Kahler

Jagd ish Bhagwati and Robert E. Hud ec, editors. Fair T rade and

Harmoniz ation: Prerequisit es for Free Trade? V olum e I: Economic

An alysis; V olum e II: Legal A nalysis. Cambridge: MIT Press, 1996.

David Vogel. Trading Up: Consumer and Environmental Regulation in a

Global Econom y . Cambridge: Harvard University Press, 1995.

Steven K. Vogel. Freer M arkets, M ore Ru les: Regulatory Reform inAdvanced Industrial Countries. Ithaca: Cornell University Press, 1996.

The adv ance of global and regional economic integration, although

far from comp lete, has p rodu ced new sources of international economic

conflict and a new a gend a for internat ional econom ic institut ions. Policy

regimes that w ere formerly guard ed as dom estic have, through a p olitical

d yna mic, become subject to inten sified interna tional scru tiny. On the one

hand , regulations and practices that had been viewed as innocuou s are now

portr ayed as bar riers to market access. The labels of d isguised protectionism

or non -tariff barrier have been ap plied to a longer an d longer list of policies,

subject to harm onization through international negotiation an d un ilateral

national action.

On the other hand , supp orters and beneficiaries of the w ide array of

protective regulatory regimes that have grow n u p in the past tw o d ecades--

labor, environm ental, and consum er pr otection in particular--have voiced


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their alarm at and opp osition to the a dvan ce of economic forces that could

un derm ine these regimes. At the center of their anxieties is harm onization

of a different kind : the erosion of these painfully constru cted regulatory

regimes un der th e pressur es of international econom ic competition and

capital mobility. These fears, usu ally labeled a race to the bottom, have

become significant d rivers of the debat e over intern ational economic policy

and the app ropriate scope of international rules.

Apart from the grow th of global economic integration, two trend s

have mad e these anxieties sharper over the past tw o decades. Deregulation

ma y characterize some sph eres of economic policy in the ind ustr ialized

countries, but regu lations designed to p rotect the environm ent, consum ers,

and (less consistently) labor have only grown . At the same time, those

ent renched regu latory acquis hav e become targets of grow ing criticism by

business and conservatives in d omestic politics. As the rich coun tries have

regulated, developing economies have open ed to foreign trad e and

investm ent, on a scale not seen since 1914. For intern ational capital (and

mu ltinational corporations) a credible exit option to economies w ith sharp ly

d ifferent (and usu ally less stringen t) levels of regu lation has open ed.

Regulatory competition seemed less of a threat wh en the m ajor trad ing and

investment p artners of the OECD w ere other indu strialized countries with

similar p atterns of regulation; mu ch of the rest of the w orld w as relatively

closed to foreign investment an d h ostile to trade prom otion. The sea chan ge


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since 1980 has been a w idening of the internationa l regulatory gap between

econom ies that hav e become far more open to trad e and investm ent.

Debate in the United States before app roval of the North American

Free Trade Agreem ent (NAFTA) was perva d ed by th e image of footloose

capital--Ross Perot's "giant su cking sound "--and un fair comp etition from an

un der -regulated Mexican econom y. Futu re negotiations for a Free Trade

Agreem ent of the Am ericas are stalled in th e U.S. Congress becau se of a

dead lock on the imp lications of trade w ith developing coun tries. Democrats,

by and large, refuse to grant fast-track negotiating au thority to the Presiden t in

the absence of labor an d environmental side agreements; Repu blicans prefer

to keep such issues out of trad e legislation. Perceptions of a regulatory race to

the bott om w ill continu e to shap e political conflict over th e consequen ces of

international economic integration or globalization.

Ap art from its role in shap ing respon ses to globalization, the image

of a race to the bottom (RTB) is also central to tw o imp ortan t theor etical

debates, one prim arily international, the other bridging international and

d omestic politics. For those who argu e that globalization will prod uce policy

convergence among n ational governm ents, regulatory arbitrage on the p art of

econom ic actors is one of the centr al engines. In this view, econom ic

open ness in the form of growing cross-bord er trad e and capital flows forces

the ad option of comm on p olicies that ar e also less interventionist.

Governm ents that d o not p articipate in the race to the bottom risk isolation

on a h igh-cost mou ntaintop , eroding th e comp etitiveness of their economies.


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Critics of this reading of globalization contest the evidence for policy

convergence and argu e that regulatory comp etition may even p rodu ce a race

to the top: greater regulatory stringency rather than less.1

A broad er d ebate links international and dom estic politics throu gh

the consequences of jurisd ictional comp etition an d political devolution. As

Sw ire points out, the race to the bottom is a poor label for regulatory or

jur isdictional comp etition, since it collapses a positive (less stringent) w ith a

norm ative (less desirable) evaluation.2 For many stu den ts of fed eral systems,

jurisdictional competition and the regulatory change that it produces increase

economic welfare: the race to the bottom is in fact a race away from the

heights of over-regulation. For others, however, the comp etition amon g

states or localities with in nation al econom ies replicates the sam e destru ctive

beggar-thy-neighbor p attern th at can occur at the internationa l level. The

out come is a level of regu lation that is not d esired by an y of the competitors.

The ongoing d ebate between these tw o views of jurisdictional competition

influen ces a rang e of policies that extend beyond regu lation to distributional

and legal regimes. The tensions between th em are also displayed in the

evolution of regional institutions: the Treaty of European Union (TEU)

signed at Maastr icht reflected both the embrace of greater p olicy

harm onization at the level of the EU and an end orsement of the pr inciple of

subsid iarity, w hich comm itted the EU to a preference for nationa l and local

po licy choice (and p resu ma bly to some level of jur isdictional comp etition).3


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Although the p olitical pow er of the race to the bottom imagery is

clear, little else about these d ebates is. Mod eling of jur isdictional comp etition

and the race to the bottom has often been impr ecise. Contend ers have often

pr eferred to m ake the most expansive claims for one mod el over anoth er

rather th an specifying the conditions und er wh ich one outcome m ight occur

rath er than anoth er. Evidence ad van ced for the existence of RTBs or other

regulatory outcomes has been thin. Because competing p ositions have been

painted in terms of stark choices rather th an contingent ou tcomes, the p olicy

options suggested have often been unrealistic or undesirable.

In few areas has the gap between scholarship , imp ressive in both

quan tity and qu ality, and p olicy debates been so large. This exercise draw s on

that large and growing body (or bod ies) of scholarship to clear away the

u nd erbru sh covering a political min efield. First, mod els of regu latory

competition, which encompa ss the RTB, are evaluated an d, m ost importa nt,

their conditions and assu mp tions are assessed. The eviden ce for the existence

of a singu lar or plu ral RTB is assessed. The cond itions for regu latory

competition prod ucing greater regu latory laxity or stringency (a race to the

top , David Vogel's Californ ia effect, or NIMBYism) can th en be su ggested . By

the end , the clearing of und erbrush may leave little but the p olitical

minefield, wh ich p resents an en tirely d ifferent set of d ilemm as for those

prop osing policy options. We are left with a w orld in w hich the RTB

maintains a broad and pow erful political hold, even though its theoretical

and empirical foun dations are h ighly restricted.


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Jurisdictional comp etition and the race to the bottom

The debate over th e existence of a regu latory race to the bottom

among nations can best be framed by m odels draw n from the rich literature of

competition w ithin federal systems. Debates over devolution w ithin federal

systems, whether w elfare reform, environmental regu lation, or corp orate

charters, use the same term inology as deba tes about globalization: "pollution

haven s" and "ru naw ay plants" were first discovered w ithin the econom ies of

federa l states. These cases are easier tests for all var ieties of ju risd ictional

competition d riven by econom ic integration, since the economies of these

political units are far more integrated than th e global econom y. Both capital

and labor are far more m obile; the p olitical un its are also more

hom ogeneou s. These characteristics ma y qualify the find ings of these

mod els, but th ey also pr ovide a sharp er test of RTB claims: jur isdictional

competition should be fiercer; suboptimal ou tcomes that m ight emerge from

that competition should be clearer. At the same time, federal or national

legislation may constrain the race in w ays that may at first be invisible.

Most of these mod els dep end on a logic developed by Charles

Tiebout in his m odel of competition am ong local jur isdictions in th e

pr ovision of pu blic goods.4

In this mod el, consum ers are perfectly mobile

am ong jurisd ictions, and they select those localities that offer their pr eferred

bun dle of taxes and pu blic goods. As jurisd ictions choose the pu blic good s

bu nd les offered to attract citizen-consu mer s, a comp etitive equ ilibrium is


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established that provid es a Pareto-opt imal allocation of resour ces. Similar

mod els have been d eployed to estimate the effects of capital mobility on

levels of environmental regulation, a regulatory choice that is pitted against

higher w ages and/ or lower tax revenues in a set of comp etitive jurisdictions.5

If certain assu mp tions in these m odels are m et, jurisd ictional comp etition is

efficient and socially op tima l: localities d o not systematically lower their

environmental standard s in ord er to increase taxes or wage income. One key

assum ption is that th ese jurisd ictions are large enough to eliminate

environm ental externalities. Regulatory comp etition d oes not result in a race

to the bottom in these competitive situa tions; environm ental policy shou ld

therefore be set at the local level, as it is here, reflecting a mix of policies that

ma tch th e p references of a local electorate.

The other key assum ptions bu ilt into these models (and that of

Tiebout) are br oad ly political; if those cond itions are not m et, then

environm ental protection will not be set at Pareto-optimal levels. These

mod els rely on g overnm ent behavior th at is pu rely reflective of the

pr eferences of their hom ogenou s po pu lations. On e critic of Tiebout noted

that h e was n ot very clear on the m otivations of local governmen ts:

d emocratic governm ents might seek to maximize the w elfare of their

citizens; entrepr eneur ial governm ents could pu rsue objectives ind epend ent

of the general w elfare.6 In similar fashion, environmen tal policies wou ld be

sacrificed in th e mod el of Oates and Schwa b if govern men ts are assum ed to

maximize tax revenu e rather than repr esenting the median voter. If capital is


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taxed at a r ate above zero--and there are p olitical circumstan ces in which one

can imagine such an ou tcome--regulatory p rotection of the environm ent w ill

be sacrificed as govern men ts act to lure capital through ot her mean s. A

further ad justm ent that add s realism to the mod el--heterogeneous

pop ulations--may also und ermine optimal levels of environm ental

protection.7 Baum ol and O ates pose tw o coalitions--one of wage earn ers and

one of non-w age earners: if the p references of either are reflected in policy

trad e-offs the ou tcome will not longer be Pareto op timal.8 Governments that

are not d emocratic or have been captu red by p articular and p artial interests, in

sum , will not create efficient policy out comes wh en th ey set environm ental

policy in competition w ith other p olicies that expand w ages or consum ption.

Governm ents may be biased toward capital subsidies at the expense of

environm ental pr otection. Viewed intern ationally, these revised

assum ptions characterize a large nu mber of governm ents; the original

assump tions may ap pear overly restrictive.

These models of regu latory competition do n ot portr ay a race to the

bottom in either the positive or norm ative sense even w hen th eir political

assum ptions are revised. Und er the assum ptions noted, no overall lowering

of regulatory stand ard s is observed; rather, a simp le sorting p rocess takes place

that matches consumers or firms w ith localities that offer the d esired mix of

pu blic good s or tax and regu latory policies. In add ition, governmen ts are not

acting strategically in this per fectly comp etitive po licy market. If

environ men tal policy is ad justed in the interests of attra cting capital the


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governm ent is simp ly adjusting its policy m ix to a param eter that its behavior

cannot change. To introd uce a race to the bottom--a regu latory comp etition

that leaves jurisdictions w orse off than they w ould have been if they had set

policies cooperatively-- a government must be divorced from the preferences

of its own electorate, and it mu st act with th e policy choices of other

governm ents in view. Achieving its desired outcome is d epend ent on the

po licy choices of other localities. Govern men ts do not face only or even

primarily inwardtoward th eir own electorates, but outwardtoward other

governm ents and their policy choices.

Althoug h th e mod els of jur isdictional regulatory comp etition

outlined th us far d o not includ e a strategic element, introd ucing one is not

d ifficult. A mod el of regu latory comp etition in the simp le form of a

pr isoner's d ilemm a can be constructed; with the app rop riate payoffs, the

comp eting nation s (or states or localities) will end w ith a non-Pareto op timal

equilibrium that could be im proved if they cooperate in choosing a higher

level of regulation.9 The mod el is familiar from oth er areas of intern ational

economic policy, particularly beggar-thy-neighbor trade policies and

competitive deva luations. Of course, w hether or not a pr isoner's d ilemm a

exists and w hether it results in a race "to the bottom " or some cooperative

ou tcome then become centra l qu estions. With different payoffs, one could

observe a "race to the top " (a comp etition for gr eater stringen cy).

Modeling this variant of the race to the bottom is dep enden t on tw o

sets of assump tions, one regarding firm behavior and a second regarding the


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behavior of governm ents. Capital (or firms) mu st be mobile and sensitive to

var iation in regulator y cond itions across jur isdictions. (This assum pt ion also

un d erlies the mod els of efficient sorting and regu latory competition d escribed

earlier.) In achieving their aims, governm ents seek to attract mobile

econom ic actors or factors (typically firm s or capital) and respond to the

regu latory choices of other govern men ts. Determ ining the significance of the

latter constituent of governm ent behavior is d ifficult, as m any stu dies of war

have d emonstra ted: d id a conflict begin because of the exogenous pr eferences

of a particular state or states or because of the comp etitive stru cture of the

state system? The competition between th e benign ima ge of sorting accord ing

to policy preferences and the d estructive comp etition of a race to the bottom

hinges in part on t he same emp irical evaluation.

Although the m odel outlined provides the dom inant image of the

RTB, regulatory comp etition m ay opera te throu gh tra de as w ell as capital

mobility and thr ough society as well as directly on governm ents. In the case

of trade, import comp etition is interpreted by import-comp eting firms (and

their w orkers) as the result of regulatory laxity in the exporting econom y.

International comp etition is employed as an argu ment for par allel

d eregulation at home, for harm onization toward equivalent stringency

abroad , or for trad e protection against social or environmental "dum ping".

Such p ressures for d eregulation are n ot dep endent on capital mobility or the

threat of exit by firms. Anoth er route to a regulatory race that may prod uce

subop timal outcomes depend s on the asymm etries in mobility between


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capital and labor und er current conditions of economic integration. That

asymm etry is reflected in altered bargaining p ower betw een capital and labor,

prod ucing changes in negotiation outcomes between the tw o. This alteration

in negotiation an d u ltimately political pow er can also be reflected in the

political process in other a reas of regulation, such as consu mer p rotection or

labor rights. In this case, cap ital mobility rem ains central, as in th e core

mod el of the RTB, but th e effect on governm ent is throu gh th e dom estic

political process rather than directly thr ough governmen ts responses to firms

or the p olicy choices of other gov ernm ents.

Although th ese alternatives are important su pp lements to the

mod el based on capital mobility and intergovernmental competition, they d o

not call into qu estion so explicitly the p ossibility that intern ational (or

interjurisd ictional) outcomes w ould not reflect th e u nd erlying political

pr eferences of their pop ulations. Both, therefore could be argu ed as falling

w ithin more ben ign competitive mod els that alter regulatory p olicies in line

preferences over enhanced r egulation and higher rates of economic growth .

In the case of the core RTB mod el, how ever, such a m isalignm ent is clear.

H owever, the cond itions und er wh ich the firm an d governm ental behavioral

assum ptions are likely to hold --firm mobility and sensitivity, governmental

sensitivity and competition--remain to be established.

In assessing firm contribu tions to regulator y competition of either

the ben ign or RTB variety, several variables are likely to be impor tant. First is

the contribut ion of regu latory policies to the pr od uction costs of the firm . In


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the case of environm ental p olicies, for exam ple, effects may be d irect (the

level of firm expend iture on comp lying with regulations) as w ell as ind irect

(the higher prices paid in a more regu lated environmen t for factors of

production).10 Offsetting these costs may be certain benefits from regulation,

d iscussed below, such as the comp etitive benefits of operating in a regu latory

regime to which one has adap ted. The emp irical evidence for the United

States suggests, as expected, wide sectoral variation in the costs imposed by

regu lation of d ifferent kinds. Presum ably, the threat of firm exit to the

economy as a w hole increases with p olicies (such as taxation) that affect a

large nu mber of sectors and have a large direct effect on costs.

If increased prod uction costs from regulation p rovide a pu sh for

firms to begin shopping among jurisdictions, transactions costs provide an

imp edim ent to firm mobility. A principal target of globalization skeptics has

been the claim th at firms are u niformly footloose across national bou nd aries.

For these critics, the hom e territory and , seconda rily, the hom e region,

remain overw helmingly imp ortant for most m ultinational corporations.11

These home countr y effects ran ge from b usiness cultur e to subsidies and

bailout guarantees, all serving to tie firms to localities and their governments.

Evidence is also strong that cross-border transaction costs rise sharply, a

further inh ibition to firm mobility. Agglomeration effects, illum inated by the

"new economic geography," provide p ositive advan tages to firms w ithin a

sector that m ay offset increased p rod uction costs. Althou gh those effects may


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be regional in scope they bias firm s toward concentrat ion rather tha n

dispersion.

Governm ent sensitivity to firm mobility is central to th e RTB

mod el. Even if such mob ility can be dem onstra ted, how ever, it is not clear

that th e political mark et in man y jurisdictions w ill reward silent m obility. As

Rose-Ackerman points ou t, Tiebout m odels have alerted stu dents of local

politics to the influence w ith w hich mobility endow s otherw ise "inactive" or

u norg anized sectors. Neverth eless, politics often concentr ates on voice and

organ ization: imm obile sectors thr eatened w ith political exploitation and few

exit op tions are often h ighly organized and vocal in their d ealings w ith

govern men t (retailers and bank ers at the local level, for exam ple).12 Th e

ad vant ages of mobility in this turb ulent p olitical ma rketp lace may be

overvalued.

If mobility does n ot insure governm ental sensitivity to the policy

pr eferences of capital, the cond itions u nd er w hich govern ments beh ave

strategically (and in a self-defeating fashion) tow ard other govern men ts and

their regu latory choices are even more difficult to estimate. Anecd otal

evidence within national boun dar ies ind icates that state and local

govern men ts actively compete to attract capital throu gh tax breaks and oth er

subsid ies; internation ally, the establishmen t of expor t-processing zon es and

other sp ecial regulatory regim es for foreign investm ent sug gest comp etition

am ong national governm ents as w ell. This competition is clearly uneven

across regu latory and policy dom ains. In order to dem onstrate a RTB


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govern men ts mu st offer concessions to cap ital that will sup ply capital in

excess of the p references of their pop ulations (distingu ishing such

competition from benign differentiation of jur isdictions), and governm ents

mu st redu ce levels of regulatory protection rather th an d eploying more

efficient and direct mean s of subsidizing capital.

For the p rop onen ts of a RTB, such a s Esty (1996) and Swire (1996)

the key explanations for governm ent behavior that pr odu ces such a

competition are information an d political market failures, most often captur e

of the government by a coherent and organized interest group . In the case of

environm ental regulation, governmen ts, it is argued , find it d ifficult to make

qu antitative welfare comp arisons (trading off environmental p rotection

w hose benefit lie in th e future against the short-term gains from attracting

investment) or estimate w hat level of environmental p rotection m aximizes

social welfare. Sw ire points to "intractable difficulties in measur ing peop le's

pr eferences in such an a bstract and comp licated p oint."13 Stewart argu es that

un certainty about th e values of one's comp etitors and their endogenou s

choice of stand ard s mak es pre-emptive comp etition m ore likely.14 He

ignores, however, the fact that m any regu latory policies are deep ly

entren ched and d ifficult to chan ge: policymakers are mor e often boun d

tightly in the short term rath er than aw arded w ide discretion.

More imp ortant than the informational d eficiencies of

governm ents, however, is the assum ption th at electorates do n ot control

policym akers effectively. As described earlier, mod els of beneficial regu latory


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competition w ere und ermined by political deviations from d emocratic

governm ents with hom ogeneou s pop ulations. In the RTB mod el, policy

choices reflect d isprop ortionately the p references those who w ish to attract

capital in th e interests of economic growth , but th e menu of options is

constrained by pop ular an tipathy to d irect capital subsidies. (Such a p olitical

constraint is the likeliest explanat ion for using en vironm ental regu lation or a

red uction in labor stand ard s rather than d irect capital subsidies.) Size of

political un it is unlikely to h ave a clear and systematic effect: policy in

sma ller jurisdictions is more likely to be accou ntab le to constitu ent

p references; it may also be mor e subject to captu re by particularistic interests.

Overa ll, how ever, beyond these broad generalizations, little theoretical or

emp irical attention h as been p aid to the p olitical prerequ isites of a RTB.

Rodriguez (1996) has suggested one hyp othesis on those cond itions: localities

w ith a more ind epend ent jud iciary are less likely to decide regulatory issues

in a way that respond s to interstat e comp etition. (This hyp othesis contains

assum ptions abou t the incentives of the jud iciary and its role in regulation.)

Similar hypoth eses about p olitical variables that w ould bias states towar d su b-

optim al regulatory comp etition--beyond captur e, lack of dem ocracy, and

heterogeneous pop ulations--would strength en pred ictions of w hen and in

w hat p olicy d oma ins RTB-style comp etition is most likely.

Empirical eviden ce of races to the bottom


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As Bhagaw ati and H ud ec note, without evidence of both firm

mobility in r esponse to regu latory differences and governm ental competition

in regu latory laxity, the ra ce to the bottom "could be a theoretical cur iosity."15

Environm ental regulation has received m ost of the attention from th ose

assessing th e eviden ce of RTB; as represen tative of other forms of regu lation

that h ave grow n in recent decades, these findings p rovide some ind ication of

RTB across a wid er ran ge of policies. A second bod y of evidence relies on

policy converg ence, which may be attribut able to sources other than an RTB.

N evertheless, if policy conver gence is absen t, the case for a RTB is

un derm ined. Finally, reverse comp etitive dyn amics are of central

imp ortan ce in testing the prevalence of races to the bottom . Races to the top

or N IMBYism (an un desirable comp etition in m ore stringent regu lation)

shed light, not on ly on the m odels un d erlying RTB, but also on th eir

frequency. Each of these bod ies of emp irical evidence cast d oubt on the RTB

as an imp ortant cau se of regu latory laxity in a setting of mu ltiple p olitical

jurisdictions.

Foot loose firm s and com petit iv e governm ents

In testing for the regu latory sensitivity of firm s in makin g decisions

on investm ent location, environmental p olicy has received by far the greatest

attention. Its rap id grow th since 1970 pr ovides an easy benchm ark for the

grow th in regulatory costs. Rafts of stud ies have examined both interstate

(within th e United States) and international effects of environmen tal

regulation.16 The empirical evid ence is d ecisive: "the literatur e as a wh ole


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pr esents fairly compelling evidence across a broad rang e of ind ustries, time

per iods, and econom etric specifications, that regulations d o not ma tter to site

choice."17 Stud ies of foreign d irect investment and investment location

w ithin the U nited States ind icate that, althou gh labor costs (unionization in

the U.S.) are significant in both cases, taxes wer e significant on ly in d omestic

decisions. N either internationally nor d omestically did there seem to be a

significant effect of environmental regulation.18 At best several heav ily

pollut ing sectors dem onstrat e signs of relocation in respon se to U. S.

environm ental regulation. The evidence in other sph eres of regu lation is

somewhat more ambiguous. Low labor standard s do not appear to attract

mu ltinational investment; however, they do correlate w ith comparative

ad vant age in labor-inten sive good s. Rodrik hyp othesizes that regulatory

laxity in this case results in subcontracting and outsou rcing rather th an firm

relocation.19

Many of these studies are plagued w ith shortcomings in

measu rem ent and d ata: measu ring costs of comp liance is very d ifficult, since

man y observers argue that the principal bur den s of environm ental

regulation in the Un ited States derive from th e "exceptionally comp lex,

bur den some and costly character of its regulatory an d legal system."20

Levinson notes that stu dies of investmen t location can seldom rely on da ta at

the level of individ ua l establishments; most suffer from un certainty over

relative environm ental compliance costs and reliance on aggr egate data.21


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N evertheless, in environm ental policy the eviden ce of a craw l to the bottom,

mu ch less a race, is absent.

To explain th is app arent lack of firm m obility in respon se to

regu latory d isparities, one p rerequ isite for the RTB, one can retu rn to th e

original mod el and the issues of pr od uction costs (pu shing firms to relocate)

and tran sactions costs (restraining their mobility). Costs of compliance with

environm ental regulation may simply be too sm all a share of total cost of

pr odu ction in most sectors. Since most investment continu es to flow am ong

the ind ustrialized countries, the degree of feasible regulatory ar bitrage may be

small as well. In add ition, pollution-intensive ind ustries in th e OECD may be

mor e immob ile for other reasons, offsetting the cost adva ntag es of a d ifferent

regulatory setting. Another explanation, which points in the direction of

exporting stringency rather than racing tow ard laxity, is based on the

transaction costs of dealing with m ultiple stand ard s: given the importance of

ind ustrialized country m arkets, MNCs may choose to redu ce such costs by

operating globally with the most stringent standard s. In add ition, they may

calculate that even developing countries will in time adop t tough er

environmental standard s and it is less costly to stay in ad vance of that trend .22

N one of these explanations explain th e striking divergence between RTB

rhetor ic and this reality. Levinson su ggests collusion between politicians and

polluters to obtain regulatory breaks through trum peting threats of exit, an

explanation to which we shall retur n.23

R egulat ory comp etit ion and policy convergence


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20

Empirical investigation of the second RTB assumption--

governm ents sensitive to firm behav ior and to the competitive regulatory

moves of other governments--has hard ly been stud ied beyond the level of

anecdotes. As Klevorick notes, d espite the comp elling ana logy of a "race,"

little investigation ha s occurr ed of the relevant political ma rket: how

countr ies comp ete and h ow effective regu latory laxity is as an instru men t of

competition.24 The best indirect eviden ce of government behav ior wou ld be

given by policy converg ence. Even in regu latory dom ains wh ere the effect of

regu lation on firm costs is substan tial and tran spar ent, such as taxation and

finan cial regu lation (e.g., reserve req uirem ents or interest rate ceilings) and

the barr iers to mobility are relatively low, a race to the bot tom h as not

occur red . If a RTB had been comp leted, no tax havens, offshore banking, or

Delaware effect w ould remain; the "bottom" wou ld hav e been reached.

N evertheless, in these d omains, p articularly taxation, evidence of

jur isdictional competition forcing national p olicies shou ld more substantial

than in social regulation.25 Even here the eviden ce is mixed, how ever:

d espite pred ictions of a m ove awa y from capital taxation and a forced

har mon ization of tax systems, there is little evidence of the first trend in

OECD statistics (with th e exception of the Un ited States) and "no evid ence

that th e cacophon y in tax systems is declining on its own through tax

competition or imp licit cooperation."26 Of course, evaluating policy

convergen ce or the RTB in taxation is ma de easier by th e clear qu antitative

indicators at hand .


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21

In other d omains of regulation, evaluation of government

behavior and analysis of policy convergence is hamp ered by d isagreement

over the d imensions of policy that are at issue and by alternative explanations

for convergence that may exclud e a RTB or th e thr eat of exit by mobile factors

of pr od uction. Steven K. Vogel's account of regulatory chan ge in Britain and

Japa n is framed as an explicit challenge to a view of der egulation as a

consequence of comp etition amon g regu lators in the face of grow ing capital

mobility; w hat h e terms th e "mar ket-centered app roach" of some

globalization devotees inaccur ately portrays ma rkets as determining

regulatory outcomes rather than stimu lating national governments to

respon d in d istinctive ways, heavily influenced by "preexisting id eas and

institutions."27 H is claims of "reregu lation" accomp any ing liberalization

(greater comp etition) are d ifficult to evaluate, how ever, since measu res of

change on these dimensions are not provided. Reregulated systems may well

be m ore mar ket-conforming, wh ich wou ld be a significant change; they m ay

also fail, as hav e the efforts of Jap an's Ministry of Finance to m aintain its

position. Vogel does make the imp ortant point, however, that the

introdu ction of m ore competition (often treated as the core of deregulation)

may r equire governm ent intervention of a different sort. The experience of

Asian finan cial systems in the cur rent econom ic crisis prov ides a conclusive

examp le: successful liberalization of the capital accoun t requ ired enh anced

banking supervision and regulation.


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22

Vogel's argu men t has been echoed by oth er skeptics of inevitable

regu latory convergen ce d riven by th e RTB.28 To the d egree that convergence

has taken p lace, its sour ce cannot un iform ly be assum ed as ind uced by th e

threat of exit by m obile factors of prod uction, wh ether skilled an d

pr ofessional workers or footloose firm s. Emulation and oth er mechanisms

may also be at work.29

Econom ic integration a nd t he export of regulatory sta ndards

The resilience of regu latory regimes and the very m ixed evid ence of

regu latory convergen ce in the face of economic integr ation sup por ts a final

reason for the absen ce of a RTB: regu lation is not only a cost or burd en; firms

and governments may regard it as a benefit. This observation, hard ly a

novelty in the stu dy of regulation, is perhap s the m ost corrosive of a

gener alized RTB view. Even in finan cial regu lation, w here regu latory

arbitrage by finan cial institutions is readily observed, the world h as not

adop ted the standards of the Cayman Islands. As Herring and Litan point out,

regu latory comp etition is limited b y the ben efits for financial institutions of a

hom e base that can credibly guaran tee the safety and sound ness of its

finan cial system. If that gu arant ee is eroded, costs can mou nt. In recent years

Japan ese banks have d iscovered this in the premium s deman ded of them by

the interbank market. Regulation also provides the opportu nity for valuable

rents that can be dispensed by politicians. These benefits of regulations for

both regu lated and regulator p rovide at least the possibility for races away


23/41

23

from regulatory laxity and tow ard the maintenance and extension of

regulatory r egimes in the face of open bord ers.

Some argu ments in favor of the benefits of regulation are n arrow ly

framed (environm ental services firms boom w hen environm ental

regu lation is stiffened); others are controv ersial, such a s Michael Porter's

claims that environmental regu lation m ay enh ance national comp etitiveness

by spu rring innovation and increasing resources devoted to research. Many

econom ists view these argu men ts, wh ich contain a "high r atio of speculation

and anecdote to system atic evidence," with considerable skepticism.30

Other m odels of a competition that results in more stringent

regulation are based on assump tions regard ing firm behavior that are

familiar from the RTB. Dav id Vogel (1995) posits a California (in cont rast to

Delaware) effect that exports higher stand ards of environm ental and

consum er protection as a result of economic integration . Vogel begins with

the simp le aggregate find ing that is so troubling to ad vocates of the RTB:

social regulation has increased over the past th ree decades as international

econom ic openn ess has grow n. He d oes not treat this as a pu zzle, but as a

possible causal relationship, although n ot one that h olds in every indu stry or

every country.

The mod el of firm behav ior that lies behind the California effect is

the m irror im age of the RTB. Firm s in the OECD econom ies are reliant on a

hom e base that is large and h ighly regulated (environm entally and in other

dom ains). The size of the OECD markets and their importan ce to most MNCs


24/41

24

is at the base of Vogel's argum ent. That market pow er has two subsidiary

effects: firm s seek to minimize tran saction costs by expor ting the h igher

stand ard s of their hom e econom y; they seek to m aximize their competitive

adv antage by maintaining regulatory standard s at home which they have

helped to set and to which they have adapted, standards w hich d isadvantage

rival firm s from less regu lated jurisdictions. Essentially, Vogel argu es that

the scale of the hom e cou ntr y ma rket in firm calculation s forces transa ction

cost considerations to the fore, rather than prod uction cost burd ens.

Vogel does not assign an au tomatic value to th e adv antages of

regu lation: some home coun try stringency ma y not be d esirable. H is imp licit

mod el suggests conditions und er w hich th e export of regulatory stand ards

w ould w eaken or fail. The policy preferences of the largest mar ket are for

greater regu latory stringency in this mod el: since affluence and social

regulation (environmental, consum er and labor) are strongly correlated, that

dim ension of the mod el is not likely to weaken rap idly. In other areas, such

as financial and telecomm un ications regulation, the d eregulatory bias of the

United States has produ ced a very d ifferent outcome. In add ition, the

leverage of these larger coun tries in r elevant international institutions

reinforces the market p ressures toward a ratcheting up ward of standard s.

At the level of firm calculations, dep end ence on the hom e econom y

(or econom ies with similar levels of regu lation) mu st remain for the

stand ard s effect to outw eigh the costs of hom e regu lation. In add ition the

contribution of hom e coun try regulation to prod uction costs must not


25/41

25

out weigh the transaction cost benefits of opera ting with similar stand ard s

abroad an d forcing competitors to meet those stand ard s at home. Taxation

pr obably does not p ass this cost/ benefit calculation in high-tax coun tries;

finan cial regulation m ay, although the ability to engage in regu latory

arbitrage through subsidiaries may perm it financial institutions to have th e

best of both w orlds. Much social regulation d oes seem to provide m ore

transaction cost advantages than p rodu ction cost disadvantages. Although

Vogel does n ot m ention it, the p olitical pow er of constituencies endorsing

home country r egulatory stand ards an d their export abroad can reinforce the

benefits to a firm in hew ing to a common standar d across diverse national

jurisdictions.

These conditions suggest a potentially widesp read ratcheting up of

regulatory stringency through market pow er and a process that run s counter

to th e RTB. Sw ire (1996) suggests th at Vogel's California effect cann ot cure all

environmen tal ills, but the export of standard s was n ot meant to d eal with

environm ental standa rd s in econom ies that are relatively closed, nor w ould

it app ly to relatively imm obile factors. Vogel's mod el answers a d ifferent set

of objections: economic open ness and capital mobility can serve regulatory

ends as well as un derm ining them.31

Imagined races to the b ottom and real policy dilemm as

The central race that w ill d rive the p olicy conflicts capt ur ed in RTB

rhetoric is a race between opening in th e developing world , an opening that


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26

has given capital in the indu strialized w orld a credible exit option, and

grow ing affluence that w ill be prom oted by such capital flows, affluen ce that

w ill eventu ally narrow the current regulatory gap between p oor and rich

nations. A second reality is a consequence of the enh anced credibility of the

exit option th at capital can claim, as well as increased trad e and imm igration:

an actu al or perceived increase in the elasticity of deman d for labor,

particularly less-skilled labor .32 The asymm etry in bargaining pow er between

capital and labor that r esults creates mu ch of the an xiety over shifting

political balances and p olicy outcomes that h ave dr iven the RTB d ebate. The

thr eat is not so mu ch to particular regu latory policies as to "dom estic

un d erstand ings that led to the adop tion of the policy. . . "33

Mu ch of the "reality" of the RTB is the in corpor ation of beliefs

abou t this intu itively app ealing ima ge into political conflict. As Rod rik

carefully notes in his argu men ts abou t labor elasticity, a perceived increase in

elasticity may h ave the same effects as a real increase. Throug hou t

considerations of the RTB, the significance of beliefs and perceptions are

par amou nt. In considering the comp etition amon g states to avoid becoming

"welfare magnets" after 1970, Paul Peter son d escribes states "acting as if they

w ere in a competitive race w ith each other"; Steph en Sug arm an term s this

race "a fear, perha ps a fantasy."34

Swire concedes th at the "perception of a

prisoner's dilemma may w ell be more imp ortant than w hether one really

exists."35 And Steven Vogel argu es that "market p ressures are most

constraining w hen leaders believe them to be all-pow erful. . ."36


27/41

27

The resilience of these beliefs in a RTB d yna mic, wh en em p irical

evidence is anecdotal at best and coun tervailing outcomes are prom inent,

bears explanation. Levinson's political sup position--that p olluting ind ustries

and their p olitical spokesp ersons u se RTB rhetor ic to win dom estic regu latory

concessions--does not allow for the attachm ent that m any in th e

environmental, labor, and consumer protection movements display for the

RTB image. A more soph isticated p olitical explanation w ould p osit tw o

mirr or-image coalitions. On th e one han d , mu ch of U. S. d omestically based

ind ustry find s the RTB claim a useful lever to un derm ine burd ensome

regu latory regimes, as Levinson suggests. At the same time, a part of the

environmental, labor, and consum er movements also endorses the d angers

of an RTB as a means to extend th eir international reach throu gh u pw ard

harmonization of standards in other countries and thwarting trade

liberalization. Again st this "RTB" coalition is a weaker gr ou pin g of

intern ationally oriented bu siness that d ow np lays the significance of the RTB,

in ord er to maintain valu able governm ent subsidies (such as the Export-

Imp ort Bank) and an op en trad ing system; their tacit allies in the

environ men tal mov ement resist RTB rhetoric for exactly the reason th at

their business opp onents endorse it: the threat of dow nw ard p ressure on

d om estic regu latory regim es. The RTB is a usefu l political instru men t for

pa rts of both the pro-regu lation and anti-regulation coalitions. Its usefulness

ensures th at RTB w ill continue to serve as a d river in d ebates over responses

to econom ic integration. And that in turn ensu res that political resolutions


28/41

28

w ill be required, how ever spurious its economic status. As Tanzi noted w ith

regard to tax comp etition:

Economists have often argu ed th at in a w orld w ith mobile capital,

labor, particularly u nskilled labor, w ill have to bear a greater taxbur d en because it is a less mobile factor of prod uction than capital.

Although the economics of this conclusion m ay be right, the

politics of it is su rely worr isome. It is difficult to conceive of a

d emocratic society in w hich work ers agree to be highly taxed while

those w ho receive cap ital incomes are, even statu torily, taxed at low

rates. The world just d oes not operate this way. In reality, the real

inciden ce of the capital taxes might fall on labor if the statutory taxes

on capital lead t o the exodu s of capital and th us to a fall in real

w ages. But th is conclusion is not likely to imp ress politicians and to

d eterm ine political decisions.37

Given th e political mob ilization t hat th e RTB can create in favor of

less d esirable policies--whether regulatory har monization imp osed by more

pow erful states or an assau lt on d omestic regulatory regim es--the RTB can

only be dealt with by alterna tive policies that u nd ercut the political dyna mics

giving it pow er, not by d emon strations of its emp irical fragility.

The most rad ical means of dealing w ith the p erceived threat is to

end not only the RTB bu t all po licy competition in certain spher es. Rodrik,

for examp le, argu es that mar ket exchan ges have long been blocked in certain

dom ains, slave and child labor, for example. The GATT/ WTO permits

imp ort restrictions on prod ucts prod uced by either slave or prison labor, but

not child labor. Rodrik app roves of trad e restrictions to deal with cases of

conflict w ith "widely heldnorm s at h ome or . . .dom estic social arrangements

that enjoy broadsupport."38 Bhagw ati and Srinavasan en dorse a more

d emand ing test in cases of restricting m arket access to goods for ethical

reasons: if not sanctioned by th e WTO, the restrictions shou ld be "pa id for"


29/41


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30

system closer to institutional and regulatory comp etition, that comp etition

was n ot unrestrained.42

H arm onization to the level of more regu lated ma rkets is a favored

instrum ent of those constituencies in ind ustrialized societies wh o end orse

mor e stringent regulation in the interests of pr otecting the environm ent,

labor, or consum ers. For those who view regu latory comp etition as a means

of reaching m ore efficient ou tcomes that are better aligned w ith the

p references of local un its, har mon ization is both an inefficient and

un desirable means of attaining those goals. Strong argum ents are made that

efforts at har mon ization will sometimes, perversely harm the interests of

those it is designed to help . Coun tervailing du ties in the face of lower labor

standard s in d eveloping counties, for example, may lower w ages and w orsen

w orking cond itions in the country th at is the target of those du ties.

H arm onization can be ju stified in the case of clear and consensu al

agreement that regu latory comp etition should n ot be permitted in certain

dom ains or beyond a certain floor. In the Europ ean Comm un ity, for

example, the White Paper on Comp leting the Internal Market stipulated th at

"nations should not compete over stand ard s that m ight adv ersely affect the

pu blic's health and safety or environm ental qu ality"; in "essential" areas,

harm onization would still be required.43

Reaching consensus on th ose

"essential" areas, how ever, wou ld be d ifficult in m ost international settings,

w hen d efining imm oral practices is far from agreed. Even p roponen ts of

tougher regulation do n ot favor p re-emptive harm onization that w ould


31/41

31

pr event individu al localities or nations to enact standard s more stringent

than the harmonized stand ard . H armon ization may also be justified wh ere

cross-border externalities can be d emonstrated and Coasian bargains ar e

un likely to be forged, a consid eration of particular imp ortan ce for

environ men tal regulation. To label RTB concerns as "comp etitive

externalities," how ever, is to accept as d emon strated what is emp irically

d ub ious. If a cooper ative solu tion to regu latory comp etition is not

d emonstra ted to be welfare enhan cing, then "any ha rmon ization claim to

avoid such an 'externality' boils down to this: because w e are unable to make

opt imal d omestic political choices in the face of trad e comp etition, you mu st

change you r laws (even if doing so is not welfare enhan cing for you )."44

The core dilemm a rema ins: RTB is po litically pow erful, but

emp irically rare. Beyond th e limited instances w hen har mon ization of

stand ard s entails low negotiation costs and is justifiable on other grou nd s

(normative consensus, externalities), solutions m ust b e sough t that

encourage beneficial regulatory competition and provide insurance against

RTB. One solution is that of the Europ ean Union: perm itting regulatory

comp etition (in the form of m utu al recognition) within "wide band "

harm onization. Such harm onization provides a guarantee that any

comp etition toward more relaxed stand ard s will meet a commonly agreed

floor. At the same time, some of the benefits of regu latory comp etition--

satisfaction of different n ational preferences and r egulatory exp eriment ation

and inn ovation--are not entirely lost. Achieving even such "w ide band "


32/41

32

harm onization may be d ifficult at the global level in su ch contentious

dom ains as labor stand ard s and environm ental protection.

Second , rather than harm onizing standard s directly, harm onization

could be targeted at other end s that are likely to produ ce second -order

comp etition of the beneficial variety. For examp le, har mon izing and

rend ering mor e tran spa rent nat ional regulatory processes could increase

confidence that pr e-emp tive comp etition to attract investment w as not

un d erway and th at regulatory choices reflected nationa l preferences and not

those of a constricted set of interests. Just as h arm onization could be d eflected

away from standar ds, so regulatory comp etition could be directed aw ay from

levels of pr otection to inefficient m od alities of regu lation that often create

mor e burd ens for the regulated w ith fewer benefits for society as a whole.

Stewart, for examp le, argu es for action in the Un ited States to redu ce the costs

associated w ith the p eculiar Am erican style of environmenta l regulation--

litigious, adv ersarial, comm and -and-control-- by w ider u se of environm ental

contracting and market-based m easures.45

Given the m arket-based mod els employed by p roponents of

regu latory comp etition, it is striking th at so little attention ha s been given to

enh ancing the levels and qu ality of infor m at ion available in order to create

benign comp etitive environ men ts. In part anxieties over the RTB result

from weak u nd erstanding of regulatory burd ens and firm preferences.

Existing resear ch is limited by its reliance on aggrega te stud ies; firm -level dat a

on location decision is pa rticularly spar se. Given th e political utility of RTB


33/41


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34

search for red ucing pr odu ction costs.46 The export of standa rds m ay, as a

result, look even mor e attractive.

Cond itions for races to the bottom are stringen t; it is impossible to

state that they have not occurr ed in certain regu latory domains, among

certain jur isdictions. Evidence is slend er for a "race" rath er than a mo re

benign competitive p rocess that p rodu ces regulatory d iversity w ithout

persistent dow nw ard pressure on regulatory standard s in the large, rich

economies. The political bases for RTB claims, how ever, remain stu rd y, and

that p rodu ces a central policy d ilemm a (but not an un precedented one):

d ealing with a "threa t" that is mo re a set of beliefs or perceptions th an an

established emp irical reality. Aven ues exist for both honing our

un derstan ding of the circumstances und er wh ich an RTB may occur an d

un der min ing the sour ces of sup por t for less beneficial respon ses to the

"threat." Those options, wh ich combine regulatory competition with a

measur e of harm onization and market pow er with the export of stand ards,

may fail to attract sup port equivalent to the more intu itively app ealing RTB.

They should be regarded as imp ortant contend ers in the most imp ortant race,

how ever, against disillusionment w ith econom ic open ness and m isplaced

alarm over the erosion of regulatory stand ards.


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35

ENDNOTES

1 Garrett 1998 provides an excellent p resentation of th e skeptics' case.

2

Swire 1996.

3 Lenaerts 1995, 95.

4 Tiebout 1956.

5 Oates an d Schwab 1988, Baumol an d Oates 1988.

6 Bewley 1981, 716.

7 On this p oint, see Rose-Ackerman 's criticism of Tiebout (Rose-Ackerm an

1983, 62).

8 Bau mol and Oates 1988, 293-294.

9 Bhagw ati and H udec 1996, 171-72; Revesz 1992, 1213-1219. For a better

elaborated mod el of firm location u nd er competitive cond itions, see

Marku sen et al. 1995.

10

Jaffe et a l. 1995, 138.

11As only one examp le, Hirst an d Thompson 1996.

12 Rose-Ackerman 1983, 77.

13 Swire 1996, 98.

14 Stewart 1993, 2059.

15 Bhagw ati and Hud ec 1996, 173.

16 Jaffe, et al. 1995; Levin son 1996; Stew art 1993, 2061-2079.

17 Levinson 1996, 450.

18 Jaffe et al. 1995, 147-150.

19 Rodrik 1997, 46.


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36

20 Stewart 1993, 2041.

21 Levinson 1996,

22

Bhagw ati and Srinavasan 1996, 173-174; Levinson1996, 450-452; Jaffe et al.,

158.

23 Levinson 1996, 453.

24 Klevorick 1996, 461-462.

25 See Tanzi on th e effects of economic integrat ion on t axation.

26 Slemrod 1996, 288-291, 306.

27 Vogel 1996, 262, 256.

28 For examp le, man y of the contributor s to Berger an d Dore 1996.

29 Bennett.

30 Jaffe et al. 1995.

31 N IMBYism, less app licable to inter nation al regulator y comp etition than

Vogel's mod el, is another examp le of more stringent regulatory ou tcomes

(und esirably so) pr od uced in a context of jur isdictional comp etition.

32 Rodrik 1997, 16-25.

33 Leebron 1996, 58.

34 Peter son 1996, 117; Sugar man 1996, 136.

35 Swire 1996, 104.

36 Vogel 1996, 262.

37 Tanzi 1995, 138-139.

38 Rodrik 1997, 80.

39 Bhagw ati and Srinavasan 1996, 180.


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37

40 See Cass and Boltu ck 1996, 400-401.

41 Sapir 1996, 564-564.

42

43 Cited in Vogel 1995, 34.

44 Leebron, 1996, 59.

45 Stewart 1993, 2090-2097.

46 Spar 1998, 8.


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