Friday, October 31, 2008

Riffing on Krugman: The regulatory implications of his work on comparative advantage

As many are aware, this year's Nobel Prize in Economics went to Paul Krugman. According to some accounts, one of the accomplishments that garnered Krugman his prize was his work on international trade and comparative advantage. Basically, Krugman explained why it was that at the same time as Germany exports cars to Japan, Japan might also export cars to Germany. The reason is because Japanese cars have somewhat different characteristics than German cars, and this allows the dynamics of comparative advantage (aka Ricardo's Law) to manifest themselves within industries as well as across industries.

(In a sense, Krugmen can also be seen as offering a solution to the famous koan advanced by the ancient Chinese philosopher Gongsun Long, who asked, "Is a 'white horse' a 'horse'?" Krugman’s answer would seem to be: "it depends on if they are competing or substitute goods.")

But Krugman’s demonstration also has some important but heretofore overlooked regulatory implications. Since the 1990s, a diversity of scholars have begun exploring the structural relationship between regulatory systems and industrial systems. Examples include Hugh Collins’ book on Regulating Contract; Gunther Teubner’s essay on ‘Legal Irritants’; and on the other side of the Atlantic, Mark Roe’s work on the relationship between corporate governance, corporate financing and what he calls 'social democracy'. This suggests that there might be a symbiosis between the particular kinds of comparative advantages enjoyed by Japanese vis-à-vis German automakers and their respective regulatory systems, part of what is sometimes referred to as 'agglomeration effects'. (Whether it is the former that shapes the latter or vice versa doesn’t really matter, but the best interpretation of existing studies is that, contrast to the claims of institutional economics, industrial organization seems to shape regulation at least as much as the other way around.)

And if all this is in fact the case, it means that parts of Japan’s domestic regulatory environment may well be directly shaped by the domestic regulatory environments found in Germany. Moreover, they are not being shaped through dynamics of ‘convergence’ or ‘divergence’ – the dominant focus of the legal development literature – but through dynamics of complementarity. This hypothesis is supported by recent studies of labour regulation in the context of transnational production chains in East and Southeast Asia, which find that these production chains, which are very much structured by domestic regulatory systems of downstream regulatory environments, impose very different kind of regulatory pressures on upstream regulatory environments than they do on downstream sites.

Why is this significant? Well, for basically the same reason that Krugman’s work is significant. Krugman is sometimes credited with re-introducing ‘geography’ as a significant variable into American economic thought. The above syllogism suggests that geography might also be a significant albeit largely unrecognized variable in law as well. It suggests, for example, that a state or region or city’s legal and even constitutional capacities and capabilities may be significantly constrained by its (economic) relationship with other regulatory geographies.

We are used to thinking about and treating domestic regulation as a thing unto itself, one whose shape and effectiveness is determined primarily if not solely by the autochthonous ‘political will’ of the state or region in which it is found; we invariably see legal and political ‘development’ as simply a matter of ‘getting the institutions right’ (albeit with significant disagreement about what constitutes ‘right’ institutions). But it might not be so simple: Krugman’s demonstration suggests that the legal, constitutional and regulatory options available to many countries and regions, particularly those sporting more 'peripheral' economic activities, may be much more constrained than our developmental theories realize.

Mike Dowdle