GLOBALIZATION, a term commonly used to refer to the free flow of goods and services, capital, technology, and knowledge, is generating renewed interest in the international economics literature. There are perennial arguments regarding whether globalization is a positive phenomenon, especially as it relates to developing countries. The World Bank has expressed strong support for globalization as a tool for promoting economic growth and reducing poverty (World Bank 2001). Sachs and Warner (1995) have suggested that openness in terms of trade liberalization and reduced economic distortions raises economic growth rates among low-income countries and leads to a convergence of per capita incomes with the higher per capita incomes of developed countries. In other words, openness leads to beta convergence. Many developing countries, such as China and India, have shown rapid economic growth and poverty reduction as a result of their open economy policies since the 1990s. In addition, Dollar (1992) examined the relationship between economic performance and trade openness and concluded that openness to trade enhances economic growth.
On the other hand, there is conflicting evidence indicating that globalization may actually harm developing countries in various ways. Slaughter (1997) shows that trade liberalization can lead to income divergence. An empirical study done by UNCTAD (1995) shows that, except for a few developing countries in Asia, there was divergence rather than convergence between rich and poor countries during the last two decades as a result of trade liberalization. In Lustig's study (1998), wages of skilled workers increased by more than 15 percent while those of unskilled workers fell by a similar margin as a result of free trade. In low-skill and low-income countries, it has been argued that free trade will drive unskilled workers out of the job market, lower their wages, and/or reduce employment opportunities in sectors related to free trade.
To a certain extent, the impacts brought on by globalization would appear to depend very much on local socioeconomic conditions. For instance, Borzenstein et al. (1998) show that foreign direct investment is growth-enhancing if the country has the human capital to take advantage of technology spillovers from foreign direct investment. Carkovic and Levine (2002) found robust positive effect of foreign direct investment on economic growth, after controlling for country-specific factors and other growth determinants such as national income, school attainment, and domestic financial development. On the other hand, Alfaro et al. (2004) argue that a country will benefit from foreign direct investment if the country has well-developed financial markets. In another study, Agenor (2004) has suggested that at low income levels, globalization seems to bring more adverse effects to the poor. However, when these countries have achieved a certain threshold level of income, greater integration may reduce poverty through the possibility of institutional and basic economic reforms.
Recent literature has shown that it is important for a country to create complementary local conditions, such as efficient financial markets and quality human capital, in order to exploit the spillovers induced by globalization. This article examines two new elements that have been receiving greater attention among growth researchers since the early 1990s, namely, the qualities of both institutional and social capital.
The principal objective of this article is to examine empirically the role of institutional and social capital in the process of globalization on economic development. Our approach analyzes not only whether globalization has contributed to convergence or divergence of incomes across countries but also whether the actual income levels in individual developing or developed countries have been enhanced by globalization. (1) A secondary objective of the article, to the extent that social capital and/or institutional capital are found to be significant factors in defining expected levels of country income, is to identify potential areas of additional government research, policy formation, and potential intervention to promote economic development. …