A nation’s potential for economic investment, growth hinges on five key factors, study finds

Globalization is creating divisive tensions between developed and developing nations. Many fear globalization, blaming it for their societal ills. Yet, globalization has produced opportunity and improvements in social welfare for those nations able to take advantage of its benefits. Nations who fail to take full advantage of globalization may have only themselves to blame, according to a study in a forthcoming issue of the Journal of International Management (JIM).

Andrew Sobel
Andrew Sobel

“The importance of politics to economic activity is often neglected,” said Andrew Sobel, Ph.D. associate professor of political science in Arts & Sciences at Washington University in St. Louis. “A nation’s ability to spur economic development hinges on its success in the national political arena, on its ability to establish a stable democracy, to build a legal system that honors property rights and contracts, to build a professional civil service and provide effective government services.”

In his paper, “National Governance and Global Lending” (JIM, Volume 9, Issue 3, 2003), Sobel reveals a high correlation between certain factors in a country’s domestic political structures and its ability to attract global investment:

  • Government track record in honoring contracts
  • Rule of law, including a fair court system
  • Risk of property appropriation
  • Corruption in government
  • Bureaucratic quality, including a professional civil service
  • Type of regime (democratic vs. authoritarian, respect for political and civil liberties)

“Among developing nations today, there are several, such as India and Mexico, that are having some success in establishing domestic political conditions conducive to development,” Sobel said. “These nations are positioning themselves to take advantage of the benefits of globalization. They have created relatively stable political environments with rules of transition, promoted meritocracy in the bureaucracy, and stabilized property rights and contract procedures.”

The influence of politics upon economic activity and economic welfare is not limited to developing nations, said Sobel.

He points to Japan and Korea as examples of industrialized nations where economic crises and slowdowns can be traced to problems that are predominately political in nature.

“Cronyism between government officials and large financial lending institutions in Japan and Korea have constrained officials from making the difficult choices necessary to deal with a large overhang of rotten loans in the banking system,” Sobel said. “These problems, a direct outcome of corruption at the nexus of political and economic arenas, contribute to the uncertainty and risk that hinders investment and consumption in those two economies.”

More recently, corporate governance issues, including the accounting scandals at major companies such as Enron and WorldCom, are affecting economic activity in the United States. Investors have become gun shy because of a lack of confidence in a fair playing field. In terms of investor activity, this uncertainty may be more important than the threat of terrorism and war, he argues.

Regardless of a nation’s level of development, one factor that exerts a consistent influence on economic activity is a nation’s form of government. Generally, borrowers living under more democratic regimes, where political and civil liberties are more respected, have had more success in international capital markets, Sobel said.

“There are some cases where international investors are willing to invest in more authoritarian states but these have been rare cases, such as China, where investors are willing to take larger risks due to the size of the domestic market,” Sobel said.

And, while globalization has become the whipping boy of labor unions and other special interest groups worldwide, Sobel’s research suggests the benefits of globalization far outweigh the negatives. Many of the major arguments against globalization, he suggests, are misguided.

“People who complain about the loss of U.S. manufacturing jobs to lower wage countries should ask themselves whether they would really rather be living in the 1950s when America had lots of manufacturing jobs,” Sobel said. “There was far less concern about the loss of manufacturing jobs during the mid- to late-1990s when the economy was booming and unemployment was low. The loss of manufacturing jobs has less to do with globalization and more to do with a general downturn in the American domestic economy.”