A Note on the Race to the Bottom

by Don Boudreaux on November 29, 2005

in Myths and Fallacies

Among the most frequently heard complaints against globalization is the "race to the bottom" argument.  In particular, this argument alleges that globalization undermines governments’ abilities to tax and regulate in the public interest.

Quite simply, the argument goes, if the likes of Chad and China have lower tax rates and fewer burdensome regulations, enterprise will flee to such havens, abandoning western nations with higher taxes and more regulations.  Western governments, in response, will have no choice but to reduce taxes and eliminate many regulations, resulting in the provision of too few social services and too few worthwhile regulations.

My point here is not to review this "race to the bottom" argument.  I content myself by mentioning that the evidence is against it.  A good summary of this evidence is in Douglas Irwin, Free Trade Under Fire, 2nd ed., 2005.)

I write, rather, to point out that that part of the "race to the bottom" argument that says that globalization forces western governments to reduce welfare-state activities (such as taxpayer-funded health care) is inconsistent with the argument that Wal-Mart and other U.S. employers are able to pay lower wages because the government provides workers with Medicaid and other welfare-state benefits.

If this argument were true — that is, if it were true that taxpayers subsidize Wal-Mart’s and other American employers’ hiring of workers, thus keeping wage rates lower than otherwise — then welfare-state measures such as Medicaid would attract employers.  Countries with the most generous welfare-state benefits would be magnets for employers.  Governments would then compete amongst themselves to offer ever-greater welfare-state benefits.

Of course, for reasons explained elsewhere — here, here, and here — Cafe Hayek doesn’t buy the argument that welfare-state benefits are a subsidy to employers.

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Don November 29, 2005 at 1:52 pm

Funny that I was just reading that a South African firm passed on the opportunity to invest in a tobacco leaf processing joint venture with the Malawi government. The firm stated, that the investment climate in Malawi is not conducive. We never hear about multi-national companies forgoing investment opportunities abroad although these decisions happen every moment of every day. It seems the race to the bottom is slowed by things such as a desire for confidence in the law, a stable, uncorrupted government, adequate infrastructure, an able work force, protection of property rights, etc.

John P. November 29, 2005 at 4:02 pm

"Governments would then compete amongst themselves to offer ever-greater welfare-state benefits."

This is akin to what states and municipalities do now to attract businesses. For example, the government one town over (in PA) spent $7 million in the mid-1990s to build a parking deck for the employees of a company it wanted to attract, so that they wouldn't have to park on the street (and so that the wooed company wouldn't have to build a deck).

CJ November 29, 2005 at 7:43 pm

If you don’t believe the race to the bottom argument, take a look at the insurance and reinsurance industry.

The tiny island nation of Bermuda with about 60,000 people has become one of the three largest insurance and reinsurance centers of the world. Nearly all of the new formations of reinsurance companies during the last 15 years have been in this tiny island nation. The investors are mostly American, and these companies generate most of their revenue in the United States. They are also staffed largely with Americans, who were recruited from companies in US markets such as New York.

Why are these companies in Bermuda rather than in the US? TAX and regulation. Especially tax. Their tax advantage (not paying it) gives them a competitive advantage over US based companies. All new reinsurers are now formed in Bermuda or other tax–advantaged countries.

The problem is that the US taxes profits rather than sales. Locate your company outside the US and you can enjoy the US market without carrying any of the tax burden.

Don November 30, 2005 at 9:48 am

The business policies of Bermuda encourage corporate domiciles but have virtually no effect on the movement of jobs (a thousand or so corporate executives move to Bermuda temporarily). Payroll taxes and other assorted taxes still flow to US taxing jurisdictions. What is avoided is corporate income taxation, which has been proven over and over to be borne by consumers. So without having to pay for a tax passed through to them, consumers of insurance are wealthier. So what society doesn't receive in social payments, it receives in lower insurance costs.

RP November 30, 2005 at 7:40 pm

This isn't a stable state (i.e. drawing taxes off better paid employees to provide government subsidies to Wal-Mart employees).
Presumably, someone has to create the wealth *before* it can be redistributed…it's not clear Wal-Mart employees are creating wealth equivalent to what they consume. If more and more folks find themselves in Wal-Mart type jobs, you would see a decline in what the government could provide (delayed by borrowing).

ANM December 1, 2005 at 4:02 am

I think the "race to the bottom" argument is most common (and most plausible, but still misleading) in terms of environmental laws.
I was speaking to an acquaintance about this "race to the bottom" BS, saying that if the UN decreed, say a global minimum wage, then companies would just move to countries with sufficiently productive workers. Being a "social justice" liberal (he wants to go to Brandeis), he didn't agree.

Glenn December 2, 2005 at 7:28 pm

Usually Wal-Mart or McDonalds jobs are just first rung, but where diligent workers can still rise into management.

Redistribution is the killer of the incentive that makes diligence desirable.

The more productive an individual, the less he costs society – indeed we all benefit way more than if he produced little.

Subsidies and unlimited Govt must end and will enrich those most in need better from the capital going into jobs versus being wasted by Govt overhead.

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