Mexico and the World
Vol. 2, No 4 (Fall 1997)
http://www.profmex.org/mexicoandtheworld/volume2/4fall97/chap1.html

Chapter 1

The Political Economy of Open Regionalism

Introduction

What combination of market forces and public policies cause existing economic and social gaps to widen or narrow during the integration process? The regions of North America exhibit widely different levels of income, productivity, and social access. Our goal is to explore the positive and negative consequences of increased trade and investment liberalization, migratory pressures, and the diffusion of new technologies and infrastructure, as they are altering the economic and social la ndscape of Canada, Mexico, and the United States. We term this the problem of asymmetrical integration. This chapter will provide a framework to compare and contrast integration experiences of subregions at different levels of development from a political economic perspective. The approach is intended initially for cases in North America and the Caribbean Basin. It is used to show how ­ within each subregional entity as well as between its neighbors ­ different patterns of integration affect g rowth, distribution, and political change, especially through increasing or decreasing economic and social imbalances that already exist.

A conceptual model is applied in which each locality chosen is regarded as an "open developing economy" engaged in trade with adjacent areas, the rest of the nation, its integration partners (as in the case of NAFTA), and the rest of the world. It is possible to study a region in terms of its integration with the rest of the national economy, even when it is not directly located in a border area, recognizing that regional and global integration go well beyond border relationships. Howev er it is also recognized that regions located on both sides of national boundaries have particular characteristics that both facilitate and complicate the national integration process. Issues explored are the gains (and possible losses) from trade and gr owth (broken down by politically-relevant socio-economic group), the effect of growth on distribution, the use of the political process and institutional reform to affect economic policies, and the likely repercussions of resulting policy changes on subse quent patterns of economic growth and distribution. We hope to offer plausible new approaches to domestic policy and regional cooperation that will reinforce the benefits of integration and reduce the costs, so that market forces reinforced by wise publi c policies will lead to upward convergence in productivity and income, benefiting all participants through an equitable distribution of the benefits and costs of adjustment. This policy approach is called "open regionalism" with "social ac cess."

Political-Economic Characteristics:

The Prime Mover--Technology--Leading to Structural Change for Competitiveness:

In recent decades a new technological revolution has dramatically altered conditions in the market place, forcing a readjustment of much of the industrial structure of North America, opening up new areas of growth and closing old ones. Increased t rade and financial mobility are accompanying and accelerating this process. The changes are driven by investors pursuing higher profits; workers seeking more reliable employment; and governments responding to the growing demands of their constituencies f or "entitlements" over against the greater need for fiscal responsibility in an internationalizing capital market. This is evident by looking at the evolving pattern of production and infrastructure in each of the three North American countries over the past few decades. It is a main point of this volume that national overviews are not enough. They show averages rather than specific impacts that work themselves out in terms of social and political responses in decentralized systems. Individu al subregional cases reveal what lies beneath general trends, as specific sectors, regions, and social groups have their own asymmetries.

The path of change can be demonstrated by using benchmark figures on value added by economic sector (Gross Domestic Product and Gross Regional Product), employment by sector, and factor income at the national, regional, and local level. Value adde d figures show the level of production growth and the pattern of change in output and employment among economic sectors. Value added per employed worker reveals the proximate pattern of productivity growth over the same period. The distribution of value added into profits/interest/rent and wages/salaries reveals the functional distribution of income accompanying growth with structural change. Relative price figures permit one to determine how much the observed changes in income may be due to changes in the terms of trade and how much to physical output and productivity growth. The most difficult information to obtain concerns the functional distribution of income (breakdown of value added by sector into returns to capital, land, and labor). However t hese are the minimal levels of information needed to reveal the relative pattern of production, productivity, and income distribution of the subregions studied. For each subregional case it is useful to identify and characterize the performance of at lea st the key industrial activities (including agriculture, commerce, construction, education, and public services) covering both leading and lagging sectors. Output and employment figures will permit a disaggregation of the process of growth with structura l change and price and income data will give some evidence of the incidence of costs and benefits. Tradables and nontradables should be included, recognizing that in many cases nontradable services represent a large and growing share of employment, incom e, and expenditure. (Most of the new jobs created in recent decades have been in so-called "nontradables" including service occupations. Most of the jobs lost to structural change are in "tradables" and especially in manufacturing oc cupations.)

The productivity growth figures identify those activities in which rising value added per worker take place ­ contributing positively to the production space (and income space) that would permit a rising standard of living to be enjoyed by the popu lation as a whole. The figures also reveal sectors of stagnant and even falling value added per worker, where growth is either extensive (no rise in the value of output per worker, as holds in many assembly plants and maquiladoras) or declining. It is important to relate the productivity and output performance figures to both exogenous and endogenous influences. Changing patterns of international competition, imported technology, and the impact of shifts in the terms of trade in the world market are all exogenous factors. Endogenous growth elements have to do with those linkages and induced shifts in product and process technology, learning by doing, and economies of scale that are particularly relevant to emerging markets of developing regions , where growth with structural change involves important positive feedbacks.

Also endogenous is the provision of infrastructure that links local markets to broader regional patterns of exchange and global integration. For gains from trade to induce growth, there must be a continual adjustment to shifts in the economy’s dyn amic comparative advantage. This calls for local and regional cooperation to reduce transaction costs and increase the responsiveness of decision-makers to changing conditions, including the diffusion of productivity growth and social access (both elemen ts of "open regionalism" strategies). In some cases it is possible to take advantage of specific micro-studies at the local or sectoral level that shed light on key indicators of productivity growth (or decline), especially in terms of the appl ication of new technologies and patterns of production. For example a closer look at the impact of economic integration in North America on the trinational growth of two-way trade in autos and auto parts, and the effect of plant location and outsourcing on wages and salaries, and profits in the automobile industry can be very revealing.

The growing interdependence in autos and auto parts production among the three countries of North America is partly a response to the increased competitiveness from suppliers in Asia and elsewhere. It is necessary to place subregional and North Am erican behavior in a global framework in order to select out the role of regional and global integration in bringing about changes in output, employment, and income at the local level. To do so will require information about the impact on the local econo my of the patterns of global trade and investment and, where relevant, on migration. Since integration includes increasing exchange between the subregional locality (and its individual industries and workers) and the rest of the nation and region (as in NAFTA), it is useful to have some estimate of the patterns.

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Market opening can lead to uneven growth paths both within and between regions. Some "emerging regions" are growing faster than their high-income advanced industrial counterparts. Some social and gender groups are experiencing more impr ovement in productivity and income than others. Losing regions, sectors, and social groups might even be experiencing "immiserizing growth" (if the demand for their goods and services is sufficiently inelastic so that relative prices are driven down more than output grows, leading to a decline in their value added and income). This can be a mere consequence of competitive market forces at work, rather than any application of asymmetrical market power or political conspiracy of the strong again st the weak. Growth that widens inequality can lead to new "transaction costs" (e.g. insecurity of life and property, market failure, rising defense costs--including "protection" blackmail). Here efforts to share benefits and spread costs at the outset, through the formation of new social pacts, might reduce the subsequent costs of market breakdown. The absence of security at various points in an integrating world system can lead to the relocation of productive opportunities and the proliferation of crime.

Finance and Investment Impact and Macro-Economic Shocks: The completion of markets during the process of economic liberalization and opening (which is part of the "open" aspect of "open regionalism") leads to a wholesale adjustment of financial institutions and financial flows, moving from households, sectors and regions in which accumulation exceeds physical investment to those which borrow in order to consume and invest. The financial intermediation process and the gr owth of banks and non-bank financial institutions has been celebrated for its role in facilitating growth and development (by Goldsmith, Shaw, and McKinnon in his earlier work) and for its susceptibility to market failure but clearly the integration proce ss tends to begin with trade and finance. Unfortunately it can also be a heavily destabilizing process, as we have seen twice in the past decade and a half for Mexico and Latin America, and in numerous cases in the history of debt default abroad and busi ness cycles at home.

We are attempting in this study to see how a subregional financial structure evolves and articulates with the rest of the host country, its neighbors, and the international system, and how that can be associated with vulnerability of activities whi ch are sensitive to the sharp movement of real interest rates and exchange rates--as in the case of Canada (rise and fall of Canadian dollar), Mexico (fall, rise, and fall of the peso) and the U.S. (rise and fall of the dollar vis a vis other hard currenc ies). All of this plays havoc on real and financial decision-making, and especially on the process of medium and long-term accumulation and investment ­ which are central to the readjustment of the productive structure of the economies being considered, not to mention those whose livelihoods depend on such economies. In addition, inflation and the price level, as well as the change in relative prices (e.g. tradables and nontradables) resulting from increased exchange, are important elements to consider in the studies.

The investment decision-making process is more than the interregional and international movement of physical and financial capital; it has to do with the spatial locus of decision-making and the scope of economic processes ­ and is as much psycholo gical as financial process (dealing with, as Keynes termed it, "animal spirits"; it involves expectations about subregional behavior, interacting with new technological opportunities and challenges of competitiveness, subject to the kind of unce rtainties which are part of the process of trying to cement new regional structures and social groups, many of which speak different languages and have different and often conflictive histories. How the process is addressed case by case, and subregion by subregion, will depend on the group involved ­ but the subject is central to our concern about development. The investment decision must consider the relationships among labor, capital, technology, exports and imports, and how they influence domestic an d international institutions both public and private.

It is increasingly important to examine the implications of growing interdependence for the subregional economy’s vulnerability to macroeconomic shocks. Changes in trade policy, sharp changes in macroeconomic behavior through business cycles, vari ations in monetary policy and interest rates, inflationary behavior and the real exchange rate (often influenced by monetary policy which may in turn be influenced by shortcomings in fiscal policy) all have major importance for activities dependent on &qu ot;open regionalism" across national borders or in separate policy domains (e.g. local fiscal, environmental, social, and even non-tariff policies affecting major tradables, as well as the treatment of investments and finance among regions). Such is sues have assumed much greater relevance since the recent recessions in the three North American economies, the peso meltdown, and swings in regional trade, finance, and balance of payments.

Labor Market Impact: The level and pattern of employment have changed accordingly. As a result there seems to be a growing polarization of the work force, with immigrants being attracted to high wage regions and to more productive educatio n and skill-formation so as to receive a premium over unskilled wages. It is quite possible that in many cases there will be an initial polarization of income levels and social structures resulting from the challenge of competitiveness. The polarization may be along racial lines, or by age and gender group. For this reason, we encourage attempts to provide data on the structure of employment by industrial sector, by occupational skills, and for wage (and nonwage) benefits, including by social group if possible, as they have evolved over time, or at least for benchmark periods, in the subregions studied. In some important cases migration into or out of the region or sector is a key element in the process of restructuring, as the changing supply of labo r responds to changing patterns of demand. The new technologies have often facilitated the mobility of labor perhaps more than they have lowered the cost of interception of undocumented migrants. Responses of labor organization to the new challenges of open regionalism are part of this process and should be considered to the extent possible ­ especially where this is relevant to the case involved.

Trade Impact: One clear manifestation of the new order has to do with changing availability of imports and new markets for exports, and ways in which this has been altered by trade policies (such as GATT, NAFTA, the CBI, and bilateral agree ments). These changes present challenges and opportunities for the existing structure of production and employment, and for regional configurations that can be adapted to take advantage of them. Clearly there are costs as well as benefits ­ inevitable a s they may seem to those who see a "silent integration" occurring as the market conditions change. The opportunity cost of not responding to the opportunities for profits (and for higher wages for those who respond) becomes too high to prevent some from taking advantage, bringing about adjustments often before society approves, or before the political forces either recognize them or respond.

Social and Institutional Role: For those who benefited from the old order, there are losses from change that cause a lethargic response or even open opposition because they earn "scarcity rents" (directly unproductive rent-seeking ) from the status quo. Newly emerging groups, recent immigrants, some of the more energetic minority members, and entrepreneurs in general tend to welcome the opportunities for more productive activities that can earn abnormal returns to the innovators ( innovation rent-seeking) and their employees. Even though such returns may well fall back as competitiveness grows, lowering prices as well as costs toward more normal competitive levels, there is a boomer mentality on the part of some that counteracts t hat reaction of others who wish to "keep things as they were" even though this may lead to costly obstacles to trade and investment, migration, and technology transfer. In the subregions studied, we encourage attempts to estimate such costs and benefits, which affect clearly identifiable groups; often some workers will win while others lose, as will some investors (e.g. more traditional one) and "go by the book" managers vis a vis others who are more entrepreneurial. Unfortunately, f or specific regions, there is no guarantee that for a given time period the balance will be positive; some may see more industries move out than in ­ more lowering of wages and employment than raising ­ while others will see a general upward thrust. Thi s is the political challenge that can be understood more clearly as the analysis spells out how the process is taking place and what some of the recent historical counterfactuals and alternative future trends might be as policies change.

Political Impact: The political process all too often lags far behind the market process and the forces leading to "silent regionalism," but it is central to the legitimization of the new flows. It plays a key role in building a bridge between interest groups. However, political structures tend to be defined by historical patterns of exchange and problems of social interaction and often have little to do with new challenges and opportunities. In such cases the private sector in terest groups played a leadership role in informing politicians of the new benefits from exchange (and often tended to minimize or even ignore the costs.) This was clearly evident in the case of U.S.-Mexican interdependence, in which labor markets, trade , investment, technological change, and demand patterns become highly interactive long before the political processes woke up to the phenomenon and began to recognize benefits as well as costs (there is still a tendency for many politicians, and especiall y those from disaffected regions, to focus on costs ­ especially in terms of labor/migration problem and the environment ­ often for good reasons from the viewpoint of opponents and their particular interests).

The political process can be shaped by NGOs and by the private sector (as was the case with the binational U.S.-Mexico business groups), or by the vision of the changing international system, the relentless integration of which, alongside the forma tion of new regional blocs, forced the North American central governments to see opportunities that had always been more evident to those with a more transnational vision beyond their respective borders. This helped to build support for the Canada-U.S. F ree Trade Agreement and binational business groups lobbied their governments for unilateral liberalization of U.S.-Mexico trade and investment that was the harbinger of NAFTA. Each of the subregional studies will paint, in a brief summary, a picture of t he ways in which the respective political institutions altered in response to the realities and potential for gains from greater subregional, region-wide (North American) and international interdependence.

It may well be useful in our studies to look at how the traditional political party structure has had to evolve to deal with the recent challenges of openness, regional integration, and competitiveness. It is a long time since the parties in North America dealt with free trade versus high tariffs as a central issue; openness worked for a nation that had a virtual monopoly on many of the leading technologies in important sectors, as well as an enormous ­ and regionally integrated ­ domestic market. The NAFTA debate and subsequent GATT and "fast track" issues have brought the issue to light but have also placed the sequencing of costs (which tend to precede benefits for many voters) squarely in front of candidates anxious to be re-elected . In addition, the attractiveness of subregional cooperation, particularly across borders (e.g. in the case of San Diego/Tijuana issues such as sewage disposal, a regional airport, treatment of the migration question, and other pressing practical matters ), tends to be more evident to local authorities than to those at the state or national level, and requires considerable voter education even at the local level. The politics of interdependence and international institution-building are being addressed i maginatively (especially in the European context, but also for emerging regions in the Americas and Asia) and form a rich and growing literature. It is necessary to draw upon insights from such analyses, as well as from practical experiences being studie d in this project. Hence it is useful to spend some time in each study on the new politics of integration ­ and particularly in innovative ways that are being developed to bridge the gap between satisfaction of local political responsibility (which becom es more important with democratization and decentralization of decision-making) and achieving the benefits of subregional cooperation and international exchange.

Management of Interdependence: The practical problem of reconciling winners and losers in the process of opening is a subject for both civil society and political institutions. It operates at the firm level in terms of new patterns of owne rship, management, worker participation from the shop floor to equity ownership (through pension funds and stock options) and in some cases to a more active role in innovation and management including even positions on the board of directors. "Open regionalism" is an analytical approach rather than a prescriptive slogan, dealing with the way in which institutions, societies, and regions respond to the challenge of international competitiveness so as to increase productivity and competitiveness through the diffusion of best-practice technology, while ensuring that there is an equitable social participation in the process beneficial to the particular region in which the activities take place. "Regionalism" reflects the need for coopera tion beyond specific local entities in order to take advantage of proximity of neighboring institutions and individuals, talent, capital, infrastructure, and markets, so as to realize greater competitiveness in the "open" international market in which the forces of change have inserted the local entities. The assumption is made that no locale is an island anymore. All are impelled, by the human search for a better life, and by those technologies which relentlessly facilitate exchange and lower transaction costs, to experience "silent integration." Hence the old orders will inevitably crumble. But many of them have values, attitudes, and social harmonies which have been painstakingly institutionalized over the centuries. Sometimes these took place at the cost of civil wars or revolutions (as in the U.S. and Mexico) and sometimes through a difficult process of federation of very different subregions (as in all three countries, including Canada).

The "management" of "open regionalism" is a slow and difficult process. NAFTA is a case in point. It leads to new coalitions, as in the case of Cascadia and the Southwestern corridor from Los Angeles to Ensenada; to the first efforts at cooperation between Arizona and Sonora; to efforts in Texas and Northeastern Mexico which are not (yet) part of our project. But also the management applies to major metropolitan areas like greater New York and Metropolitan Mexico City, and to outlying regions like Oaxaca, Chiapas, Newfoundland, and Arkansas which see a growing share of their activities, both economic and social (and political) governed by the mandate of international market forces and competitiveness, yet no less needing to p rovide social bridges to the future and safety nets for those less privileged and more wedded to traditions and structures that are challenged by the new international system. In our case studies there will be an effort to develop some of the more salien t pressures and responses to such management of interdependence, brought about by the forces of open regionalism, and to shed light on their social, political, and economic implications. The attempt to promote a subregion’s competitiveness or to retain t he edge that a region initially gained through a complex set of forces that fortuitously gave it technological leadership ­ such as Silicon Valley ­ is a central part of our project. While each case is different, it is nevertheless essential to shed ligh t on those factors which can augment competitiveness and quality of life, recognizing that growth and development are often endogenous and responsive to unique private and public sector initiatives. The same questions will be considered for each of the s ubregions studied: What are appropriate management approaches for competitiveness and positive social impact? How can they be consistent with a satisfactory response to the negative pressures that are the heritage of some regions more than others, and wh ich may be placing a major economic and fiscal drain on their ability to restructure and grow?

The Open Economic Regional Development "Model": It is evident that there is an implicit heuristic model underlying this approach ­ it is one of growth and development ­ an essentially socio-economic model of accumulation with inno vation and the advent of new opportunities that respond to positive entrepreneurial behavior. The endogenous aspects of growth are particularly relevant here ­ including those social and institutional conditions that facilitate an increase in what econom ic historian Walt Rostow once called yields and propensities. These two elements take away from the more mechanistic elements of so-called "growth theory" which in the past stressed increases in savings and investment, accumulatio n, and a rise in the ratio of both physical and human capital to labor. Certainly some of the data asked-for in the case studies facilitates the mechanistic approach. In addition there is the "open economy macro" approach in which regions and activities which offer a greater return to scarce resources (and especially mobile resources like financial capital and entrepreneurship) will tend to attract both financial capital and labor across borders or among regions (through migration and the spre ad of financial intermediation) in order to earn abnormal profits (at least until new levels of competition are achieved so that prices begin to approach marginal cost). There is the "endogenous growth" dimension in which a stress is placed on those elements (such as the explosive new technological genies) which give a once-for-all shift upward to growth functions and expansion paths (properly celebrated by Roemer and others). Sometimes these "endogenous" elements are associated with particular historical, cultural, or social customs (as is often the case with the "Asian miracle" literature), and can lead to a form of path-determinism which can be daunting, especially to more traditional growth modelers (with their one, two , or three factor models from Harrod/Domar to Solow), or to those who focus primarily on macroeconomic growth performance and smooth processes of change.

The analysis in this process is iterative. The economic model interacts with a social and political system of relations. (They may be expressed as functional systems of relations, just as those in the economic process. However each system of relations is interdependent with the other. Hence the economic structure affects the social and political structure and vice versa.) How does each economic process interrelate to each relevant social process, group by group? A simplistic way of dealing with this is to relegate the issue to another discipline (like sociology or political science), just as the process of economic evolution is often relegated by other social sciences "to economists" and treated as exogenous. What we need to do for our subregions is to see how the economic and social process intertwine, at least in the salient segments (leading and lagging economic sectors, subregions, social groups) and how this interaction is mediated by public policy and private in stitutions (state and civil society). Some of our participants are actively building new institutions, often transregional, to deal with the challenges of open regionalism.

New Regional Formations: The litmus of the international system of exchange is the border region, or centers of export production, port cities (in which imports are readily available), and international financial centers. Not surprisingly, these are often far from capital cities or areas in which the nation state and its respective regions achieve some degree of reconciliation between their economic and social systems. That is why decisions in Washington, Ottawa, or Mexico City may have m ajor repercussions on Cascadia, the Southwest Corridor, Texas and Nuevo Leon, or New York. And it is why Mexico City itself may have little concern for its border regions, or for the affect of a major peso crisis on its increasingly exposed subregions th at depend for their livelihood on international trade and investment and the international market. Yet in order for such regions to adjust to the new challenges, our research groups have already documented ways in which they are restructuring their insti tutions on a transregional and transnational basis. They must deal with shock-absorbers in order not to be blind-sided by national (and international) policy changes or even rumors (such as recent Congressional loose talk about "withdrawal from NAFT A" or reneging on the $20 billion U.S. line of credit to bail out the peso or the kind of political posturing that is so familiar and irritating to Canadians who listen in to U.S. policy debates). Our studies should address such considerations, incl uding the move toward greater fiscal federalism ­ which has the disconcerting effect of shifting rising costs of the social safety net often to those regions least able to address the challenge out of short-term gains from exchange, because they begin at a disadvantage. These may impose a burden greater than their ability to retain revenues. This is why we are attempting to encourage the development of data series, or at least benchmark indicators, that indicate how the revenue and expenditure base has changed, how much of each is local, state, or federal responsibility and how this is likely to change, and how that will affect the region’s global competitiveness. New York and Mexico City are central here. In addition, regional coalitions are subject to severe fiscal problems, since their interests are more common than their revenue base, and there is little precedent for fiscal burden sharing. This should be of particular importance to the cases in the Northwest and Southwest.

An Iterative Process: Developing "Stylized Facts" for Each Region: We have touched on a number of issues, most of which will begin to be sketched out in the case studies. It is understood that with such a broad framework, it is i mpossible with the time and resources provided to prove specific relationships empirically. However we believe that more than a heuristic framework (or "virtual regional characterization") can be developed by the working groups for their respec tive cases. Each will focus on those issues which are central to their particular case. We will draw iteratively on the case studies, to modify the analytical framework and policy recommendations. An introductory chapter of the volume will introduce a generic political-economic model of a subregion facing the challenge of open regionalism. Different typologies will emerge. Clearly those of fairly "new" transborder regions, positioning themselves to compete in the emerging Asia/Pacific and N orth American markets, have a very different character and set of problems from those of older metropolitan centers such as New York and Mexico City. It is our hope that the discussions at Vancouver will help to shape the analytical framework of each cas e study. There is no question that the dialogue will contribute importantly to the formulation of a workable model that builds from micro to macro behavior and decision-making, in an increasingly interregional and international framework. We hope that t his synopsis, incomplete as it is, will begin to respond to questions already raised by the case study teams, dealing with conceptual issues, data gathering, information availability, and the unique experiences of specific cases which by their individuali ty facilitate the process of understanding comparison and contrast. Hopefully by looking at individual North American experiences, in terms of a general an analytical framework, we will be able to shed light on a global phenomenon that requires much more attention to the grassroots, yet without losing the forest for the trees.