The Globalization Paradox Revisited

According to the Globalization Paradox, globalization limits the freedom of choice for national governments. Capital mobility in particular induces tax competition, thus putting downward pressure on capital taxes. However, while capital mobility introduces the inefficiency of tax competition, it makes the allocation of capital more efficient. Whether national welfare and tax-financed public good provision increase or decrease through capital mobility depends on country characteristics. These characteristics include the relative capital endowment, the availability of taxes on fixed factors such as land and the preference for the public good. We compare the two second best settings of a closed economy and an economy with capital mobility to show that the relative capital endowment determines whether the net effect of capital mobility is positive. Fixed factor taxes have the potential to improve welfare by defusing the globalization trilemma through a reduction in the need for capital taxation.