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A race to the bottom usually refers to an individual seeking a more favourable outcome at the expense of others by upsetting an equilibrium to their own favour, only to cause retaliation by the other individuals, resulting in all participants having an overall less favourable outcome. For example, some people may buy larger cars for safety in a collision. However, to keep up, an increasing number of drivers also buy heavier, less efficient cars, and so safety on the whole does not improve. This is a race to the bottom. The term only applies in cases where this competition results in negative results overall. Competition that results in overall improvements or benefits are referred to as races to the top or Leviathan models.

Contents

History

The term "Race to the bottom" was coined by Supreme Court of the United States Justice Louis Brandeis in the 1933 case Ligget Co. v. Lee (288 U.S. 517, 558-559).[1][2][3] In the late 19th century Joint-stock company control was being liberated 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 of the time as "race to efficiency", and others, such as Justice Louis Brandeis, as the "race to the bottom".[2]

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."[3]

In 1932 Brandeis also coined the term “laboratories of democracy” in the New State Ice Company v. Liebmann case (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.[3]

Basis in political theory

Races to the bottom can be described in game theory 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. The optimal option for all governments would be an agreement to maintain tax harmonization.

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 advantages (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' compensation, or to raise taxation in order to fund social services and correct externalities (such as pollution and social degradation).

According to this theory, races to the bottom between sovereign states can also undermine democratic accountability, since the elected governments are no longer economically capable of passing legislation which enforces environmental or labour protections that are more stringent than those current in neighbouring countries.

Causes and responses

The dismantling of tariffs 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 fora, 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. Moral purchasing can influence decisions at the level of individual buyers, or it can involve 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.

Standards-based tariffs represent another way to halt a race to the bottom. 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.

Corporate Law

In the United States legal academia, corporate law is conventionally said to be the product of a "race" among states to attract incorporations by making their corporate laws attractive to those who choose where to incorporate. Given that it has long been possible to incorporate in one state while doing business primarily in other states, US states have rarely been able or willing to use law tied to where a firm is incorporated to regulate or constrain corporations or those who run them. (However, US states have long regulated corporations with other laws (e.g., environmental laws, employment laws) that are not tied to where a firm is incorporated, but are based on where a firm does business.)

From the "race" to attract incorporations, Delaware has emerged as the winner, at least among publicly traded corporations. The corporate franchise tax accounts for between 15 and 20 % of the state's budget.

There is a longstanding debate whether US corporate law is subject to a race to the bottom or a race to the top. At the heart of the debate lies the question whether the US states' corporate laws are desirable in their present state or not. Important proponents of the "race to the top" perspective have been Ralph Winter, Roberta Romano, Frank Easterbrook and Daniel Fischel. The "race to the bottom" perspective started with an article by William Carey in 1974 and has been developed further most importantly by Lucian Bebchuk. However, according to a critical appraisal by Mark Roe, the debate is misconceived, since Delaware's law has been shaped less by competition with other states than by pressure from the federal level. The empirical evidence does not conclusively support any of the theories.

In Europe, regulatory competition has long been prevented by the real seat doctrine prevailing in private international law of many EU and EEA member countries, which essentially required companies to be incorporated in the state where their main office was located. However, in a series of cases between 1999 and 2003 (Centros Ltd. vs. Erhvervs- og Selskabsstyrelsen, Überseering BV v Nordic Construction Company Baumanagement GmbH, Kamer van Koophandel en Fabrieken voor Amsterdam v Inspire Art Ltd.), the European Court of Justice has forced member states to recognize companies chartered in other member states, which is likely to foster regulatory competition in European company law. For instance, in 2008 Germany adopted new regulations on the GmbH (Limited Liability Company), allowing the incorporation of Limited Liability Companies without a minimum captial of EUR 25,000 (though the earnings have to be retained until this threashold is arrived).

Rhetoric

The phrase 'race to the bottom' is used sometimes in a pejorative context by those opposed to globalisation and those supporting fair trade companies.

An example: 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."[4]

Notes

  1. ^ Kelly, John E. (2002). Industrial Relations: critical perspectives on business and management. UK: Routledge. ISBN 0-415-22986-3.  p. 192
  2. ^ a b Meisel, Nicolas (2004). Governance Culture and Development: A Different Perspective on Corporate Governance. Organisation for Economic Co-operation and Development. ISBN 92-64-01727-5.   p. 41
  3. ^ a b c Schram, Sanford F. (2000). After Welfare: The Culture of Postindustrial Social Policy. NYU Press. ISBN 0-8147-9755-5.   p. 91
  4. ^ The Times Business Section, Monday 7th December 2003

Further reading

See also

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