Race to the bottom
Encyclopedia
A race to the bottom is a socio-economic concept that is argued to occur between countries as an outcome of regulatory competition
, progressive taxation policies and social welfare spending. When competition becomes fierce between nations over a particular area of trade and production, countries are given increased incentive to dismantle currently existing regulatory standards.
A race to the bottom may also occur within a country (such as between businesses, states or counties), but, in theory, this should occur less frequently, because the central government has recourse to enact legislation slowing or halting the race before its effects become too pervasive.
enacted a liberal corporation charter, which charged low fees for company registration and lower franchise tax
es than other states. Delaware
attempted to copy the law to attract companies to its own state. This competition ended when Woodrow Wilson
as Governor tightened New Jersey's laws again through a series of seven statutes.
In academic literature the phenomenon of regulatory competition reducing standards overall was argued for by AA Berle and GC Means in The Modern Corporation and Private Property
(1932) while the concept received formal recognition by the US Supreme Court in a decision of Justice Louis Brandeis
in the 1933 case Ligget Co. v. Lee (288 U.S. 517, 558–559). In the late 19th century Joint-stock company control was being liberalised in Europe, where countries were 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 United States, when states were competing to attract firms to incorporate in their state—competition described by some at the time as "race to efficiency", and others, such as Justice Louis Brandeis
, as the "race to the bottom".
Schram explains that the term "race to the bottom":
In 1932 Brandeis also coined the term “Laboratories of Democracy” in New State Ice Co. v. Liebmann
(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.
In the corporate context, Brandeis' "race to the bottom" metaphor was updated in 1974 by William Cary
, in an article in the Yale Law Journal
, "Federalism and Corporate Law: Reflections Upon Delaware," where Carey argued for the imposition of national standards for corporate governance
.
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 governments. Each government may benefit from higher tax revenues by having a high tax on corporate profits. However, governments can benefit individually with a lower corporate tax rate relative to the other governments in order to attract businesses away from the jurisdictions of other governments. This action would hurt all governments except the one that undercut the others. In order to maintain the equilibrium, each of the other governments would have to lower their corporate tax rates to match the "defector" (the government that first lowered the tax rate). The end result is that each government adopts a lower corporate tax rate and thus collects less revenue overall. Assuming the foundational premise is correct, the optimal option for all governments would be an agreement to maintain tax harmonization
. However, it has been countered that the government who provides the most efficient services, including regulatory structure and welfare spending, will win through competition, and that race-to-the-bottom is not the norm, but applies only to special situations such as extradition and atmospheric pollution.
A race to the bottom can occur in deregulated private industries as well. One such example would be the subprime mortgage crisis
. Banks assume repayment risk when they issue mortgages, but can charge higher fees by originating mortgages to less credit-worthy. Novel financial products, coupled with securitization of mortgages and credit default swaps led to a race to the bottom of lending standards and risk management. Counter-arguments show that subprime lending was heavily influenced by government-backed loans, which were intended to help the needy who also tend to be less credit-worthy. It is difficult to ascertain whether race-to-the-bottom applies to a given situation or not.
s (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.
, or to raise taxation in order to fund social services and correct externalities
(such as pollution and social degradation).
s and other trade barriers, facilitated by the rules set within the World Trade Organization
, and encouraged (in the global South
) by United States 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 forums, 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 on the part of consumers.
Another potential remedy is 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. 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.
and those supporting fair trade
companies. An example: in response to reports that British supermarkets had cut the price of banana
s, 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."
Regulatory competition
Regulatory competition, also called competitive governance or policy competition, is a phenomenon in law, economics and politics concerning the desire of law makers to compete with one another in the kinds of law offered in order to attract businesses or other actors to operate in their jurisdiction...
, progressive taxation policies and social welfare spending. When competition becomes fierce between nations over a particular area of trade and production, countries are given increased incentive to dismantle currently existing regulatory standards.
A race to the bottom may also occur within a country (such as between businesses, states or counties), but, in theory, this should occur less frequently, because the central government has recourse to enact legislation slowing or halting the race before its effects become too pervasive.
History
The concept of a regulatory "race to the bottom" emerged out of the late 19th and early 20th century experience with charter competition among US states to attract corporations to domicile in their jurisdiction. In 1890 New JerseyNew Jersey
New Jersey is a state in the Northeastern and Middle Atlantic regions of the United States. , its population was 8,791,894. It is bordered on the north and east by the state of New York, on the southeast and south by the Atlantic Ocean, on the west by Pennsylvania and on the southwest by Delaware...
enacted a liberal corporation charter, which charged low fees for company registration and lower franchise tax
Franchise tax
Franchise tax is a tax charged by some US states to corporations with a nexus with those states. The common feature of a state's franchise tax is that it is not based on income...
es than other states. Delaware
Delaware
Delaware is a U.S. state located on the Atlantic Coast in the Mid-Atlantic region of the United States. It is bordered to the south and west by Maryland, and to the north by Pennsylvania...
attempted to copy the law to attract companies to its own state. This competition ended when Woodrow Wilson
Woodrow Wilson
Thomas Woodrow Wilson was the 28th President of the United States, from 1913 to 1921. A leader of the Progressive Movement, he served as President of Princeton University from 1902 to 1910, and then as the Governor of New Jersey from 1911 to 1913...
as Governor tightened New Jersey's laws again through a series of seven statutes.
In academic literature the phenomenon of regulatory competition reducing standards overall was argued for by AA Berle and GC Means in The Modern Corporation and Private Property
The Modern Corporation and Private Property
The Modern Corporation and Private Property is a book written by Adolf Berle and Gardiner Means published in 1932. It explores the evolution of big business through a legal and economic lens, and argues that in the modern world those who legally have ownership over companies have been separated...
(1932) while the concept received formal recognition by the US Supreme Court in a decision of Justice Louis Brandeis
Louis Brandeis
Louis Dembitz Brandeis ; November 13, 1856 – October 5, 1941) was an Associate Justice on the Supreme Court of the United States from 1916 to 1939.He was born in Louisville, Kentucky, to Jewish immigrant parents who raised him in a secular mode...
in the 1933 case Ligget Co. v. Lee (288 U.S. 517, 558–559). In the late 19th century Joint-stock company control was being liberalised in Europe, where countries were 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 United States, when states were competing to attract firms to incorporate in their state—competition described by some at the time as "race to efficiency", and others, such as Justice Louis Brandeis
Louis Brandeis
Louis Dembitz Brandeis ; November 13, 1856 – October 5, 1941) was an Associate Justice on the Supreme Court of the United States from 1916 to 1939.He was born in Louisville, Kentucky, to Jewish immigrant parents who raised him in a secular mode...
, as the "race to the bottom".
Schram explains that the term "race to the bottom":
In 1932 Brandeis also coined the term “Laboratories of Democracy” in New State Ice Co. v. Liebmann
New State Ice Co. v. Liebmann
New State Ice Co. v. Liebmann, 285 U.S. 262 , was a case in which the Supreme Court of the United States held that due process prevented a state legislature from arbitrarily creating restrictions on new businesses only on the claim that their markets affected a public use.The New State Ice Company...
(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.
In the corporate context, Brandeis' "race to the bottom" metaphor was updated in 1974 by William Cary
William L. Cary
William Lucius Cary served as chairman of the U.S. Securities and Exchange Commission between 1961 and 1964.Chairman Cary graduated Yale University in 1931 and later served with the Office of Strategic Services in the former Yugoslavia and Romania during World War II. He was a Dwight Professor of...
, in an article in the Yale Law Journal
Yale Law Journal
The Yale Law Journal is a student-run law review affiliated with the Yale Law School. Published continuously since 1891, it is the most widely known of the eight law reviews published by students at Yale Law School...
, "Federalism and Corporate Law: Reflections Upon Delaware," where Carey argued for the imposition of national standards for corporate governance
Corporate governance
Corporate governance is a number of processes, customs, policies, laws, and institutions which have impact on the way a company is controlled...
.
Political theory
Races to the bottom can be described in game theoryGame theory
Game theory is a mathematical method for analyzing calculated circumstances, such as in games, where a person’s success is based upon the choices of others...
by the prisoner's dilemma
Prisoner's dilemma
The prisoner’s dilemma is a canonical example of a game, analyzed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interest to do so. It was originally framed by Merrill Flood and Melvin Dresher working at RAND in 1950. Albert W...
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
Tax competition
Tax competition, a form of regulatory competition, exists when governments are encouraged to lower fiscal burdens to either encourage the inflow of productive resources or discourage the exodus of those resources...
between governments. Each government may benefit from higher tax revenues by having a high tax on corporate profits. However, governments can benefit individually with a lower corporate tax rate relative to the other governments in order to attract businesses away from the jurisdictions of other governments. This action would hurt all governments except the one that undercut the others. In order to maintain the equilibrium, each of the other governments would have to lower their corporate tax rates to match the "defector" (the government that first lowered the tax rate). The end result is that each government adopts a lower corporate tax rate and thus collects less revenue overall. Assuming the foundational premise is correct, the optimal option for all governments would be an agreement to maintain tax harmonization
Tax harmonization
Tax harmonisation refers to the process of making taxes identical or at least similar in a region. In practice, it usually means increasing tax in low-tax jurisdictions, rather than reducing tax in high-tax jurisdictions or a combination of both. The best example is the European Union where all...
. However, it has been countered that the government who provides the most efficient services, including regulatory structure and welfare spending, will win through competition, and that race-to-the-bottom is not the norm, but applies only to special situations such as extradition and atmospheric pollution.
A race to the bottom can occur in deregulated private industries as well. One such example would be the subprime mortgage crisis
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
. Banks assume repayment risk when they issue mortgages, but can charge higher fees by originating mortgages to less credit-worthy. Novel financial products, coupled with securitization of mortgages and credit default swaps led to a race to the bottom of lending standards and risk management. Counter-arguments show that subprime lending was heavily influenced by government-backed loans, which were intended to help the needy who also tend to be less credit-worthy. It is difficult to ascertain whether race-to-the-bottom applies to a given situation or not.
Occurrence and limitations
Occurrence of races to the bottom is mitigated by the costs of moving investment and production between countries, by persistence of comparative advantageComparative advantage
In economics, the law of comparative advantage says that two countries will both gain from trade if, in the absence of trade, they have different relative costs for producing the same goods...
s (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.
Implications
In general, however, these contests regularly work to undermine the ability of governments to enforce labor standards such as workers' compensationWorkers' compensation
Workers' compensation is a form of insurance providing wage replacement and medical benefits to employees injured in the course of employment in exchange for mandatory relinquishment of the employee's right to sue his or her employer for the tort of negligence...
, or to raise taxation in order to fund social services and correct externalities
Externality
In economics, an externality is a cost or benefit, not transmitted through prices, incurred by a party who did not agree to the action causing the cost or benefit...
(such as pollution and social degradation).
Causes and responses
The dismantling of tariffTariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....
s and other trade barriers, facilitated by the rules set within the World Trade Organization
World Trade Organization
The World Trade Organization is an organization that intends to supervise and liberalize international trade. The organization officially commenced on January 1, 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade , which commenced in 1948...
, and encouraged (in the global South
Third World
The term Third World arose during the Cold War to define countries that remained non-aligned with either capitalism and NATO , or communism and the Soviet Union...
) by United States influence through the World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...
and the International Monetary Fund
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
, 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 forums, 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 on the part of consumers.
Another potential remedy is forbidding or applying heavy tax, tariff and trade
Tax, tariff and trade
The tax, tariff and trade laws of a political region, state or trade bloc determine which form of consumption and production tend to be encouraged or discouraged...
sanctions to nations that permit the export of offensive goods, re-directing revenues raised from such tax or tariff to combating abuses. 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.
Rhetoric
The phrase "race to the bottom" is used sometimes in a pejorative context by those opposed to globalizationGlobalization
Globalization refers to the increasingly global relationships of culture, people and economic activity. Most often, it refers to economics: the global distribution of the production of goods and services, through reduction of barriers to international trade such as tariffs, export fees, and import...
and those supporting fair trade
Fair trade
Fair trade is an organized social movement and market-based approach that aims to help producers in developing countries make better trading conditions and promote sustainability. The movement advocates the payment of a higher price to producers as well as higher social and environmental standards...
companies. An example: in response to reports that British supermarkets had cut the price of banana
Banana
Banana is the common name for herbaceous plants of the genus Musa and for the fruit they produce. Bananas come in a variety of sizes and colors when ripe, including yellow, purple, and red....
s, 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."
See also
- Tragedy of the commonsTragedy of the commonsThe tragedy of the commons is a dilemma arising from the situation in which multiple individuals, acting independently and rationally consulting their own self-interest, will ultimately deplete a shared limited resource, even when it is clear that it is not in anyone's long-term interest for this...
- Prisoner's dilemmaPrisoner's dilemmaThe prisoner’s dilemma is a canonical example of a game, analyzed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interest to do so. It was originally framed by Merrill Flood and Melvin Dresher working at RAND in 1950. Albert W...
- GlobalizationGlobalizationGlobalization refers to the increasingly global relationships of culture, people and economic activity. Most often, it refers to economics: the global distribution of the production of goods and services, through reduction of barriers to international trade such as tariffs, export fees, and import...
- Free tradeFree tradeUnder a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from...
- Flag of convenienceFlag of convenienceThe term flag of convenience describes the business practice of registering a merchant ship in a sovereign state different from that of the ship's owners, and flying that state's civil ensign on the ship. Ships are registered under flags of convenience to reduce operating costs or avoid the...
Further reading
- CM Yablon, 'The historical race competition for corporate charters and the rise and decline of New Jersey: 1880-1910' (2007) The Journal of Corporation Law |format=PDF| accessdate=2006-09-05}} |format=PDF| accessdate=2006-09-05}}