Race to the bottom

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In government regulation, a race to the bottom is a theoretical phenomenon that is said to occur when competition between nations or states (over investment capital, for example) leads to the progressive dismantling of regulatory standards. This theory, also called downward harmonization, states that this reduction of regulation, welfare, taxes, and trade barriers will increase poverty, and drive the poor to the few remaining areas that retain protections. In the end this theory argues that this will force the last remaining states to drop their protections in order to survive.

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[edit] History

The term "Race to the bottom" was coined by US Supreme Court Justice Louis Brandeis in the 1933 case, Ligget Co. v. Lee (288 U.S. 517, 558-559).[1][2][3] In the late 19th century Joint-stock company control was being liberated in Europe. Countries engaged in competitive liberal legislation to allow local companies to compete. This liberalization reached Spain in 1869, Germany in 1870, Belgium in 1873, and Italy in 1883. The same effect was happening in the US, when states were competing to attract firms to incorporate in their state--competition described by some of the time as "race to efficiency", and others, such as Justice Louis Brandeis, as the "race to the bottom". [2]

Schram explains that the term "race to the bottom":

“ ...has for some time served as an important metaphor to illustrate that the United States federal system--and every federal system for that matter--is vulnerable to interstate competition. The "race to the bottom" implies that the states compete with each other as each tries to underbid the others in lowering taxes, spending, regulation...so as to make itself more attractive to outside financial interests or unattractive to unwanted outsiders. It can be opposed to the alternative metaphor of "laboratories of democracy." The laboratory metaphor implies a more sanguine federalism in which [states] use their authority and discretion to develop innovative and creative solutions to common problems which can be then adopted by other states."[3] ”

In 1932 Brandeis also coined the term “laboratories of democracy” in the New State Ice Company v. Liebmann case (285 U.S. 262, 311). With these two opinions Brandeis helped develop what were to become controlling metaphors for thinking about the potential and pitfalls of federalism.[3]

[edit] Basis in game theory

Races to the bottom can be described in game theory by the prisoner's dilemma game. This is an exercise where the optimal outcome for the entire group of participants results from cooperation of the participants, but is put in danger by the fact that the optimal outcome for each individual is to not cooperate while the others do cooperate.

An economic example of racing to the bottom is tax competition between nations. Each nation may see benefits in having a high tax on corporate profits in order to promote income equality between investors and the working class. However, nations can benefit individually with a lower corporate tax rate relative to the other nations in order to attract businesses away from the other nations. This action would hurt all nations except the one that undercut the others. In order to maintain the equilibrium, each of the other nations would have to lower their corporate tax rates to match the "defector" (the nation that first lowered the tax rate). The end result is that each nation adopts a lower corporate tax rate (which is less favorable in terms of promoting income equality). The optimal option for everyone would be an agreement to maintain tax harmonization.

[edit] Occurrence and limitations

The occurrence of races to the bottom is mitigated by the costs of moving investment and production between countries, by persistence of comparative advantages (such as skilled workforces, infrastructure or proximity to natural resources), and by the presence of minimum standards, rules or conventions which prevent them.

Races to the bottom can also occur between the states or administrative regions within nations, which often seek to attract businesses and jobs on the basis of a favourable regulatory environment. The extent of such intra-national races is limited by the power and inclination of central national governments to act against them.

In practice, races to the bottom appear to be rarer than some critics of globalisation have feared. States are often willing to maintain regulatory regimes even if they lose certain investment or industries as a result.

[edit] Implications

In its early stages, a race to the bottom can be of immediate benefit to all parties, in situations where laws are genuinely and inefficiently burdensome.

In general, however, these contests regularly work to undermine the ability of governments to enforce labor standards such as workers' compensation, or to raise taxation in order to fund social services and correct externalities (such as pollution and social degradation).

According to this theory, races to the bottom between sovereign states can also undermine democratic accountability, since the elected governments are no longer economically capable of passing legislation which enforces environmental or labour protections that are more stringent than those current in neighbouring countries.

Some economists believe, however, that "races to the bottom" can help ameliorate poverty, for if businesses can operate for less money, they can cut prices while maintaining their profit margins[citation needed].

[edit] Causes and responses

The dismantling of tariffs and other trade barriers, facilitated by the rules set within the World Trade Organization, and encouraged (in the global South) by US influence through the World Bank and the International Monetary Fund, may have removed an important constraint on races-to-the-bottom; without protected domestic industries, countries are more dependent on liquid investment capital. One solution to this problem is to employ international fora, such as the WTO, to set satisfactory environmental and labor rules at a global level.

Another suggested method for avoiding races to the bottom is moral purchasing. Moral purchasing can influence decisions at the level of individual buyers, or it can involve forbidding or applying heavy tax, tariff and trade sanctions to nations that permit the export of offensive goods, re-directing revenues raised from such tax or tariff to combating abuses.

Standards-based tariffs represent another way to halt a race to the bottom. While conventional tariffs are designed to protect jobs in a particular industry or sector of the economy, standards-based tariffs are designed to protect country-wide standards such as labour standards and environmental standards. With standards-based tariffs, a product imported from a country with low labour and environmental standards will face a high tariff, while a product imported from a country with labour and environmental standards equal to or higher than the domestic standards will face no tariff. For producers, such tariffs remove the incentive to move a factory to the country with the lowest wage rates and most permissive pollution laws. For governments, such tariffs provide an incentive to raise their standards upwards, in order to gain entry into new export markets. For workers, such tariffs prevent the wage rate from falling down to the wage rate of the lowest country in the trading group. For consumers, such tariffs would undoubtedly raise prices since cheap imported goods from low-labour-standard countries would be replaced with expensive domestically produced goods (this is the price of protecting domestic labour and environmental standards).

Note that since standards-based tariffs only restrain exports from poorer countries to wealthier countries, global implementation would result in free trade between the world's wealthiest countries. Also note that such tariffs would result in free trade between newly-developing countries that had similar labour and environmental standards.

[edit] Corporate Law

In the US legal academia, corporate law is conventionally said to be the product of a "race" among states to attract incorporations by making their corporate laws attractive to those who choose where to incorporate. Given that it has long been possible to incorporate in one state while doing business primarily in other states, US states have rarely been able or willing to use law tied to where a firm is incorporated to regulate or constrain corporations or those who run them. (However, US states have long regulated corporations with other laws (e.g., environmental laws, employment laws) that are not tied to where a firm is incorporated, but are based on where a firm does business.)

From the "race" to attract incorporations, Delaware has emerged as the winner, at least among publicly traded corporations. The corporate franchise tax accounts for between 15 and 20 % of the state's budget.

There is a longstanding debate whether US corporate law is subject to a race to the bottom or a race to the top. At the heart of the debate lies the question whether the US states' corporate laws are desirable in their present state or not. Important proponents of the "race to the top" perspective have been Ralph Winter, Roberta Romano, Frank Easterbrook and Daniel Fischel. The "race to the bottom" perspective started with an article by William Cary in 1974 and has been developed further most importantly by Harvard Law School Professor Lucian Bebchuk. However, according to a critical appraisal by Harvard Law School Professor Mark Roe, the debate is misconceived, since Delaware's law has been shaped less by competition with other states than by pressure from the federal level. The empirical evidence does not conclusively support any of the theories.

In Europe, regulatory competition has long been prevented by the real seat doctrine prevailing in private international law of many EU and EEA member countries, which essentially required companies to be incorporated in the state where their main office was located. However, in a series of cases between 1999 and 2003 (Centros, Überseering, Inspire Art), the European Court of Justice has forced member states to recognize companies chartered in other member states, which is likely to foster regulatory competition in European company law.

[edit] Rhetoric

The phrase 'race to the bottom' is used sometimes in a pejorative context by those opposed to globalization and those supporting "fair trade" companies.

An example: in response to reports that British supermarkets had cut the price of bananas, and by implication had squeezed revenues of banana-growing, developing nations, Alistair Smith, international co-coordinator of Banana Link, said "The British supermarkets are leading a race to the bottom. Jobs are being lost and producers are having to pay less attention to social and environmental agreements."[4]

[edit] "Race to the top"

The phrase race to the top was coined in response to "race to the bottom"[5].

It is a process by which competition leads to the progressive improvement of goods and services provided to consumers. One example of the "race to the top" is the success of the computer industry in creating ever-faster and more powerful computers. The phrase may be used also in a more general sense of evolutionary trends gravitating towards the greatest common divisor.

[edit] Notes

  1. ^ Kelly, John E. (2002). Industrial Relations: critical perspectives on business and management. UK: Routledge. ISBN 0-415-22986-3. p. 192
  2. ^ a b Meisel, Nicolas. Governance Culture and Development: A Different Perspective on Corporate Governance. Organisation for Economic Co-operation and Development. ISBN 92-64-01727-5.  p. 41
  3. ^ a b c Schram, Sanford F. (2000). After Welfare: The Culture of Postindustrial Social Policy. NYU Press. ISBN 0-8147-9755-5.  p. 91
  4. ^ The Times Business Section, Monday 7th December 2003
  5. ^ Kocaoglu, Kagan (March 2008). "A Comparative Bibliography: Regulatory Competition on Corporate Law". (Georgetown University Law Center Working Paper). 


[edit] Further reading