Does increased integration, particularly in the financial sphere make it more difficult for governments to manage economic activity, for instance by limiting governments’ choices of tax rates and tax systems, or their freedom of action on monetary or exchange rate policies? If it is assumed that countries aim to achieve sustainable growth, low inflation and social progress, then the evidence of the past 50 years is that globalization contributes to these objectives in the long term. In the short-term, as we have seen in the past few years, volatile short-term capital flows can threaten macroeconomic stability. Thus in a world of integrated financial markets, countries will find it increasingly risky to follow policies that do not promote financial stability. This discipline also applies to the private sector, which will find it more difficult to implement wage increases and price markups that would make the country concerned become uncompetitive.But there is another kind of risk. Sometimes investors—particularly short-term investors—take too sanguine a view of a country’s prospects and capital inflows may continue even when economic policies have become too relaxed. This exposes the country to the risk that when perceptions change, there may be a sudden brutal withdrawal of capital from the country. In short, globalization does not reduce national sovereignty. It does create a strong incentive for governments to pursue sound economic policies. It should create incentives for the private sector to undertake careful analysis of risk. However, short-term investment flows may be excessively volatile.Efforts to increase the stability of international capital flows are central to the ongoing work on strengthening the international financial architecture. In this regard, some are concerned that globalization leads to the abolition of rules or constraints on business activities. To the contrary—one of the key goa...
