FROM THE OFFICE OF PUBLIC AFFAIRS

Thank you for that warm introduction and thank you for inviting me here today. You have been a great public servant, a national treasure and a fount of foreign policy wisdom. I want to congratulate you on all you have done to found this Institute and guide it over the last several years, following a career as one of the United States' most distinguished diplomats spanning the administrations of eight U.S. Presidents.

The Institute's eponym, the Honorable James Baker III, said this Institute should "build a bridge between the world of ideas and the world of action." By involving both policy makers and scholars, the Institute improves the debate on key policy issues and contributes to the formulation, implementation and evaluation of both domestic and international policy. The Baker Institute is a valuable and distinguished center of learning, and I am pleased to be with you here today to discuss the challenges the next Administration-whichever it may be-will face in the global economy.

We live in an exciting time. New information technology has ushered in an economic transformation as profound as that of the Industrial Revolution of the 19^th century. Along with sound fiscal and monetary policies, it has been the largest single factor in our remarkable increase in productivity, which has given us a high rate of GDP growth with very low unemployment and low inflation. It has helped make the United States a high performance economy, powered by technology, driven by ideas, rewarding the value of innovation, flexibility and enterprise and attaining ever better living standards for its people. Here in the United States, we are in the midst of the longest economic expansion in our nation's history. By the end of this fiscal year, we will have achieved three straight years of unified budget surpluses, totaling well over $400 billion.

Information technology has also been a driving force behind globalization. This is the first time in history that we have had a knowledge-based economy. This has enormous implications within the United States for how we educate our children, train our workers, communicate with each other, and do our shopping. It has an impact on businesses, as knowledge-based products have high fixed costs, yet low marginal costs.

The technology revolution also has profound implications for the world in which we live. In the new global economy, trade barriers are falling, the market for capital is international, access to information from around the world is instantaneous, and economies are increasingly interconnected. Our economy has benefited enormously from our active involvement in the new global economy. A recurring lesson of the history of international economic affairs is that countries that open their economies to the outside world enjoy better economic performance than those that attempt to go it alone do. This lesson was well-understood by this Institute's namesake, James Baker, who played an important role in launching the G-7, encouraging international cooperation and reaching the successful free trade agreement between the U.S. and Canada.

It has been a touchstone of the Clinton Administration since its earliest days that globalization is happening, that it cannot and should not be arrested, and that it offers limitless potential for raising quality of life for the global population as a whole. But this Administration has also stressed the need to make global economic integration work for all people. Ultimately, a global economy that fails to benefit large parts of the world will fail every one of us. In that sense, the question is not whether we should welcome the emergence of a truly global market economy-we should-but rather what kind of global market economy we should work to build.

There are those who have genuine concerns about globalization's implications, concerns manifested by the protests in Seattle and Prague. Some of them say that globalization is not good for developing countries, for they have not benefited as much as they should have while the wealthy nations have grown wealthier. Others say that while the economy may be improving, the environment is suffering. And still others say that while corporations may be getting rich, working people are not doing so well.

I disagree with all of these assertions and believe that those who argue that globalization has failed are badly wrong. The rising divergence in national incomes that we see today is not because more countries are integrating themselves with the global economy; it is because so many countries are not.

Still, those of us who support global development must heed and respond to these concerns. People in developing countries are at risk of falling further behind in a highly competitive, integrated, knowledge-based global economy. They must not be ignored. In that regard, the next Administration will need to address people's fears about globalization by demonstrating that we can create an interconnected global economy that is increasing prosperity and genuine opportunity for people everywhere.

A successful global economy must respect core labor standards. We cannot ignore this issue-not when oppressive labor practices and child labor practices are a reality around the world. We must work to protect and improve the environment as we expand trade. We are committed to finding solutions that are win-win, that benefit both the economy and the environment, such as cutting-edge clean technologies. Lastly, we must ensure that open trade does indeed lift living standards in a world where nearly half the human race, 2.8 billion people, lives on less than $2 a day.

Globalization poses an historic opportunity, yet also many concomitant challenges. Let me discuss three broad categories of challenges that I believe the next Administration must address in order to foster continued growth and prosperity in the global economy: first, ensuring a strong and stable flow of global capital; second, opening borders and markets to increased global trade; and, third, helping the poorest countries to ensure that no one is left behind.

A well-functioning system for ensuring a strong and stable flow of capital to developing economies will be a very important part of building a successful, truly global, economy. Access to global capital helps to finance trade. It is a vehicle for new technology, and a creator of new economic opportunities.

Both the economic and the humanitarian imperatives of a stronger international financial architecture were brought out very clearly in the recent financial crises in Asia and elsewhere. In very different parts of the world, millions of people who were just going about their business had their lives turned upside down -- because their countries' financial systems had been thrown into crisis. As a result, many now have an entirely reasonable conviction that millions of people should not have to live in fear of typhoons of man's own making. Particularly hard hit was the middle class in Asia, which had developed over the past two decades and was the basis for the democratic movement in countries from the Philippines and Thailand to South Korea and Taiwan.

The international community must work to make such crises less frequent -- and less costly -- in the future. And that, in turn, means having a clear understanding of what has caused them in the past.

There is now widespread agreement that the financial crises of 1997-98 were caused by two elements coming together. First, weakness in the fundamentals -- such as questionable banking systems, domestic credit bubbles supported by large amounts of short-term external debt, unsustainable exchange rates, or deteriorating fiscal positions -- resulting in a reassessment of the country's capacity to safely absorb foreign capital. And second, an element of panic, whereby the mode of domestic and foreign investors shifted from thinking about the economic health of countries to thinking about who would be the last out.

This understanding of such crises is increasingly informing the reform of the international financial architecture, which our Administration has led, in three fundamental ways:

• More effective means of preventing crises, through stronger surveillance, more focused on preventing the policies that enabled a panic in financial markets to have such effects.
• Safer policies in the emerging market economies, as global understanding and surveillance of economic risks have increased. Notably: the ratio of external debt has more than halved since 1996 in countries that have experienced liquidity crises and some fourteen countries have moved away from unstable pegged exchange rate systems.
• An IMF that is better equipped for modern crisis response. The IMF is increasingly oriented toward the provision of short-term, emergency finance, priced to discourage casual use, and encourage rapid repayment.

It is crucial that we remain vigilant and continue to work to put in place policies that will mitigate the risk of further financial crises. The next Administration will have an opportunity to continue to build on these efforts to strengthen the global financial system. We can work together with the international community to meet this challenge to prepare for and protect against the vicissitudes of the global market economy.

Another important element of globalization is the expansion of global trade flows. An open world trading system is a cornerstone of the new global economy. Opening up once isolated nations and untapped markets has produced enormous benefits and raised living standards around the world. Although severe poverty is still a reality for much of the world-particularly in sub-Saharan Africa-real incomes in developing countries are still fifty percent higher today than they were 15 years ago. In Asia, even accounting for the 1997-1998 crisis, the number of people living on less than a dollar a day has fallen by nearly 40 percent in the last ten years.

It will be important for the next administration to continue the Clinton Administration's commitment to the open world trading system. This commitment has been reaffirmed recently by the Clinton Administration's leadership, along with a bipartisan group of Senators and Representatives, in enacting legislation granting China permanent normal trade relations and legislation enhancing access to our markets for Africa and the Caribbean. The Administration has also actively negotiated within this hemisphere for a Free Trade Agreement for the Americas.

The Clinton Administration first made clear its support for lowering trade barriers when it pushed hard for passage of NAFTA, an agreement of particular importance here in Texas with your proximity to Mexico. Though there were many doubters at the time, NAFTA has been an important ingredient in the economic prosperity our nation has enjoyed during the past eight years. Here in Houston, state officials estimate that the city receives a yearly economic bonus from NAFTA of roughly $12 billion. More broadly, U.S. merchandise trade with Mexico since 1993 is up 141 percent, reaching $197 billion in 1999. As a result of the agreement, more than two-thirds of U.S.-Mexico trade is now duty-free. Of course, we still have work to do on labor, environmental and other issues. But NAFTA has taught us that we have far more to gain by working together.

Globalization also has benefits beyond the strictly economic. For example, globalization makes the world safer by reducing conflict. When people are working together for common prosperity in a rule-based system, they have enormous incentives to set aside their differences. The world is a better place than it would have been had we not had the last 50 years of increasing economic cooperation for trade and investment.

Globalization not only affects how countries behave toward one another, but also how they evolve internally. As a result, we have a profound interest in encouraging countries to open up to the international community. As countries open their economies, the need increases for a stronger rule of law, openness and accountability. Ultimately, this strengthens domestic forces and improves human rights. By engaging China, for example, the world's most populous country, we increase the chances that it will become a more open, more democratic and more constructive member of the global community in the 21^st century.

One of the challenges posed by open trade is the inevitable disputes that will arise from time to time. Let me take a brief moment to focus upon one such timely issue-the European Commission's decision to challenge the tax treatment of Foreign Sales Corporations (FSC) and to further contest U.S. efforts to revise its tax legislation to comply with the World Trade Organization's Appellate Body decision.

We are pleased that the House of Representatives this week passed legislation that repeals the FSC and replaces it with a tax regime that complies with the WTO ruling, as it is neither a subsidy nor is export contingent. The President signed this bill into law late Wednesday night. We regret that the European Commission has not accepted this legislation. Nonetheless, following recent bilateral negotiations, the European Commission agreed to pursue a review of the WTO consistency of this legislation first, and to hold in abeyance the imposition of retaliatory sanctions until the outcome of that review is known. I have been reassured that the Commission will adhere to this agreement. The stakes involved in this dispute are very high. Today, the EU published a general retaliation list of more than $4 billion. But they will now suspend efforts to retaliate while we seek to persuade the WTO that our new legislation is WTO-consistent. For this reason, it is critical that we continue working together to resolve our differences in a creative and consultative manner.

Finding ways to cooperatively resolve such trade disputes will continue to be a vital element in the success of the new global economy. One immediate challenge for the next Administration should be to resolve long-standing disputes with the EU on beef and bananas. But of broader importance will be finding the right formula for a new WTO global trade round. Nothing is more vital to sustaining the global economy than the successful launch and conclusion of a new Round to further reduce external tariffs, remove trade-distorting agricultural subsidies, deal with new e-commerce issues, and find ways to address new issues like competition and investment policy. It is also imperative to respond to labor rights and environmental concerns.

Open markets and open trade are critically important to lifting living standards and building shared prosperity. But they alone cannot carry the burden of lifting the poorest nations out of poverty.

In principle, the "new economy" holds out enormous potential for accelerating the convergence of the poorest countries, many of which have suffered from natural disadvantages as well as longstanding policy failures. Information technology could help isolated nations in Africa and elsewhere overcome the barriers of time and space in competing in global markets; and advances in biotechnology could help defeat the scourge of infectious disease. But when half of the world's population has yet to use a telephone, and 40 percent of African adults cannot read, there is perhaps an equal chance that technology will speed further divergence. The challenge is to help ensure the more inclusive outcome by fostering concerted action by the public sector in both industrial and developing countries, supported by the efforts of the private sector.

Countries will not be able to pull themselves out of poverty without rapid growth in their economies - and their economies will not enjoy rapid growth without joining the global market. The more integrated countries are, the more they will benefit from foreign direct investment and technology transfers.

It is important to concentrate greater attention on ways to more effectively address the development challenges faced by the world's poorest countries. International support needs to be targeted to countries with the infrastructure, institutions and proven capacity to deliver results. We know that when policies are good, external support can and does have a significant and positive impact. Let me touch on three key actions that the international community can take:

Countries committed to implementing the right reform policies will not be able to address the problems they face without financial assistance. Increasing the quantity, as well as quality, of global development assistance must be a global humanitarian imperative at a time when the total per capita health budget in many African nations is less than $5 per year. Yet, net official foreign assistance transfers per capita to Africa are now more than one third lower, in real terms, than they were in 1990.

We recognize that this is a challenge that the world's richest country has a particular responsibility to confront. The U.S. continues to be one of the largest contributors to the global development effort and the largest market for developing country goods. But Americans should not be satisfied with what we are now doing. Our defense budget last year was more than a $100 billion lower in real terms than it was in 1989; yet, rather than reinvest a portion of this dividend in forward defense of U.S. interests through foreign assistance, overall U.S. spending on international affairs has fallen by 40 percent since the mid-1980s.

Second, a broader reform of International Financial Institutions.

We are working with our G-7 colleagues and other members of the multilateral development banks on ways to further improve the development effectiveness of these institutions. Our approach advocates greater selectivity in lending, with increased focus on accelerating growth and reducing poverty in the poorest countries, a strengthened link between lending allocations and country performance, placing more attention on the provision of global public goods, and improved donor coordination and collaboration.

In Prague, we won G-7 agreement to press the multilateral development institutions on a series of proposals, notably (1) to increase substantially resources targeted for priorities such as education; (2) to increase World Bank funding for global public goods, including research on treatments and vaccines for HIV/AIDS, tuberculosis and malaria; and (3) a series of measures to make more effective the marginal dollar of development assistance that the institutions provide.

One of the most critically important steps that industrial nations can take is to relieve the world's poorest nations from the burden of massive debt. For the heavily indebted poor countries, debt relief is a crucial part of establishing a virtuous circle of poverty reduction and economic development.

The United States went a long way last week to providing the resources to relieve such debt when the President signed into law a bill to provide funding for the entire $435 million needed for the United States to do its share in debt relief this year for the world's poorest countries. It also gives the IMF the authority it needs to do its share, as well. Our nation took this step because we understand that making the global economy work for everyone is not a political nicety, but an economic, strategic and moral necessity. This action reinforces the leadership role of the United States in the global initiative for the Heavily Indebted Poor Countries-known as the HIPC initiative. Under this program, 32 (thirty-two) of the world's poorest countries could receive as much as $90 billion in overall debt reduction.

While enactment of legislation supporting the HIPC initiative was a major step forward, we also need to ensure that real change takes place in these countries. The resources freed up by debt relief must be used effectively to reduce poverty and promote economic growth. Further, we need to ensure that countries that receive debt reduction take steps to avoid getting themselves into the same problem all over again. In that context, Secretary Summers recently suggested greater recourse to grant financing specifically for eligible HIPC countries to enhance future prospects for debt sustainability. This would permit us to provide support without saddling countries with more debt and would allow us to channel support to priorities such as HIV/AIDS that are not traditional development projects.

Although there is much that we can do, no set of actions taken by those of us in the industrial world will be sufficient. Developing nations must likewise do their part if our efforts are to have any chance of succeeding. Let me touch on four elements that are crucial to rapid economic growth in these countries:

• First, governments need to put in place the institutions and rules that will allow markets to function well. They must foster open markets, which in turn lead to trade and investment, the mechanisms through which managerial know-how and technology are transferred.
• Second, they need to make public investment with particularly high social returns such as health care and education, especially primary education. The Asian Tigers, for example, have made a priority of investing in people, primarily through education. This has been one of the major factors accounting for their incredible growth over the last 30 years and for their strong recovery from the recent Asian crisis.
• Third, governments need to promote an effective rule of law, through good governance, transparency and support for the emergence of a healthy civil society. Problems such as money laundering, inadequate bank supervision, and corruption undermine the credibility and efficiency of the international financial system. They also pose a threat to a strong development agenda in that they lead to distortions in the allocation of resources, curb productivity growth and incomes, and undermine financial systems and institutions. Combating these problems is an integral part of effective development and institutional capacity building that requires action at both a country and a global level. Multilateral Development Banks must give more attention to encouraging recipient countries to fight corruption, which drains the societies of developing countries and hinders their sustainable development.
• Fourth, governments must introduce and maintain sound macroeconomic policies in order to accelerate and sustain economic growth. Developing countries need to keep their budget balances small, inflation rates low, and their exchange rates at reasonable levels. A stable macroeconomy is crucial to establish an environment conducive to long-term investment, diversified production, and trade with the global economy.

Economic management is especially challenging in developing countries that rely heavily on natural resource exports, including oil. Sharp price fluctuations - up or down - make fiscal, monetary, and exchange rate management more difficult, and contribute to both economic and sometimes political instability in resource-rich countries. Somewhat paradoxically, resource-rich developing countries have recorded slower rates of growth than resource-poor countries since 1960. We need to find better ways to help oil-exporting countries manage their resources effectively, including by providing more transparent opportunities for foreign investment, while at the same time helping them to diversify into other products in order to reduce the possibilities for instability.

Both of these ingredients - international financial support and a commitment to reform by the developing countries -are necessary to achieve the goal of global economic integration and meet the challenge of poverty reduction in the poorest countries.

Yet, the responsibility to extend the benefits of globalization to all people by achieving the goal of successful global economic integration lies not only with the governments of industrial and developing nations, but also with our partners in the private sector. Those of us who believe in the benefits of an open global economy - and multinational corporations are obviously at the leading edge - have a particular responsibility to draw the poor into the global circle of prosperity.

There are two reasons the private sector ought to take proactive measures to integrate developing nations into the global economy. First, companies have a social responsibility to act as good corporate citizens. To this end, the United Nations recently launched its Global Compact, which was developed with the support of international labor and civil society groups. Like the Global Sullivan Principles, the Global Compact asks the private sector to adhere to several core values in the broad areas of human rights, labor and environment.

The second reason for companies to act as good corporate citizens is that it is in their self-interest to do so. Too many businesses still fail to grasp that there are five times as many consumers in the developing world as in the developed countries -- and many may be poor, but they are still a largely untapped market that is already improving dramatically.

The private sector has a real opportunity to join with the public sector in working on a range of issues that affects everybody from the wealthiest companies to the poorest children. Working in partnership, we can reduce risk and promote development by bringing the poor from the margins to the mainstream of the new global economy.

The next administration will confront the overarching economic and humanitarian challenge of our time: how to build a successful, truly global economy that works well for all the world's people. I am confident we can meet this challenge, with the support of our partners in the private sector, by continuing to promote open economies and strengthening the rules and institutions within which they operate, while also protecting those most vulnerable-the poorest nations, the environment and the rights of workers.