Race to the bottom

The race to the bottom is a socio-economic concept that is argued to occur between countries, states, provinces or territories as an outcome of globalization, free trade, neoliberalism or economic deregulation. When competition becomes fierce between geographic areas over a particular sector of trade and production, governments are given increased incentive to cut business regulations, labor standards, environmental laws and business taxes.

Theory

Races to the bottom can be described in game theory by the prisoner's dilemma. This is an exercise in which the optimal outcome for the entire group of participants results from cooperation of the participants, but it 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 high tax rates on corporate profits, but governments can benefit individually with lower corporate tax rates relative to other jurisdictions in order to attract businesses to their own jurisdictions. In order to maintain equilibrium, each of the other governments would have to lower their corporate tax rates to match that of the government that first lowered the tax rate. The end result is that each government adopts a lower corporate tax rate and, therefore, collects less revenue overall. Assuming the foundational premise is correct, the optimal option for all governments would be an agreement to maintain tax harmonization.

A race to the bottom can occur in deregulated private industries as well. One such example would be the subprime mortgage crisis. Banks assume credit risk when they issue mortgages, but can charge higher fees by originating mortgages to the 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.

The occurrence of races to the bottom is mitigated by the costs of moving investment and production between jurisdictions; the persistence of comparative advantages such as skilled workforces, infrastructure, or proximity to natural resources; and the presence of minimum standards, rules or conventions which prevent them.^{[citation needed]}

History and usage

The concept of a regulatory "race to the bottom" emerged in the United States during the late 19th and early 20th century, when there was charter competition among states to attract corporations to domicile in their jurisdiction. Some described the concept as the "race to efficiency", and others, such as Justice Louis Brandeis, as the "race to the bottom". In 1890, New Jersey enacted a liberal corporation charter, which charged low fees for company registration and lower franchise taxes than other states. Delaware attempted to copy the law to attract companies to its own state. This competition ended when Governor Woodrow Wilson tightened New Jersey's laws through a series of seven statutes.

In academic literature, the phenomenon of regulatory competition reducing standards overall was argued for by A.A. Berle and G.C. 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.

Schram explains that the term "race to the bottom":

“

...has for some time served as an important metaphor to illustrate that the United States federal system—and every federal system for that matter—is vulnerable to interstate competition. The "race to the bottom" implies that the states compete with each other as each tries to underbid the others in lowering taxes, spending, regulation...so as to make itself more attractive to outside financial interests or unattractive to unwanted outsiders. It can be opposed to the alternative metaphor of "Laboratories of Democracy". The laboratory metaphor implies a more sanguine federalism in which [states] use their authority and discretion to develop innovative and creative solutions to common problems which can be then adopted by other states.

”

Brandeis's "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," in which Carey argued for the imposition of national standards for corporate governance.

In 2003, in response to reports that British supermarkets had cut the price of bananas, 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."

The left-liberal economist Paul Krugman has argued that wages in developing countries have risen as a direct result of businesses outsourcing jobs from developed countries to developing countries.

“

These improvements have not taken place because well-meaning people in the West have done anything to help — foreign aid, never large, has lately shrunk to virtually nothing. Nor is it the result of the benign policies of national governments, which are as callous and corrupt as ever. It is the indirect and unintended result of the actions of soulless multinationals and rapacious local entrepreneurs, whose only concern was to take advantage of the profit opportunities offered by cheap labor. It is not an edifying spectacle; but no matter how base the motives of those involved, the result has been to move hundreds of millions of people from abject poverty to something still awful but nonetheless significantly better.

”

See also

• Beggar thy neighbour
• Convergence (economics)
• Globalization
• Government failure
• Flag of convenience
• Free trade
• Prisoner's dilemma
• Supply and demand
• Tragedy of the commons

Further reading

• Grandy, C. (1989). "New Jersey Corporate Chartermongering, 1875-1929". The Journal of Economic History 49 (3): 677–92. doi:10.1017/S0022050700008810. JSTOR 2122510. 
• 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
• Kocaoglu, Kagan (March 2008). "A Comparative Bibliography: Regulatory Competition on Corporate Law". Georgetown University Law Center Working Paper. doi:10.2139/ssrn.1103644. SSRN 1103644. 
• Bacon, David (February 03 2003). "Anti-China Campaign Hides Maquiladora Wage Cuts". Zmag.org. 
• Hahnel, Robin (March 2000). "Houston, we have a problem: Challenging globalization". Z Magazine. 
• McClear, Sheila (March 2005). "Race to Bottom for Garment Workers". Z magazine. 
• McLean, Bethany (2010). All the Devils Are Here: The Hidden History of the Financial Crisis. Portfolio. ISBN 1-59184-363-4.