Here, I explain why there is such discontent about globalization in the advanced countries. The indictment includes several “bills of particulars”:
• Globalization, as it has been managed, has contributed to growing inequality—including the evisceration of the middle class—even if it is not the only, or most important, force giving rise to this inequality.
• Globalization has contributed to the frequent crises that have marked the era of globalization—dramatized by the 2008 crisis, originating in the United States, which quickly became global.
• Globalization has contributed to the growth of powerful multinational corporations (MNC)—as powerful, in some ways, as nation-states—some of which have in turn contributed to environmental destruction.
• The intellectual property rules of globalization today have led to higher drug prices and reduced access to knowledge, favoring large multinational enterprises over smaller firms. Particular MNCs have pushed policies that, while they increase their profits and market power, may be adverse to the interests of society more generally, and because of their enormous power, the MNCs have often been successful, for instance, in trampling on rights to privacy, the rights of individuals to own their own data, or even their right to know whether the food they are eating contains genetically modified organisms (GMOs).3
Globalization, as it has been managed, will be shown to be guilty on each of these counts. But later, I argue that there are other ways of managing globalization, of shaping and responding to it, which avoid these serious pitfalls.
While the policies advocated by Trump and the other protectionists are deeply flawed—they are likely to make those that are suffering even worse off—it is important to understand why their message has had such resonance. Globalization was oversold, with the benefits exaggerated, the costs underestimated. The benefits to growth were smaller, the loss of employment and the increase in inequality greater. We can make globalization work. But that entails not just rewriting the rules of globalization. It entails making our market economy as a whole work for ordinary citizens. If the market economy is working mostly for the 1 percent, globalization will be too.
Chapter 1 describes the overselling of globalization in trade and chapter 2 in its other dimensions—not just the opening of markets to goods from abroad, but also the global integration of financial markets and the development of multinational corporations. It connects the dots, showing the role globalization has had in the evisceration of the middle class. There is thus more than a little truth in the criticisms of globalization as it has been managed. Chapter 3 explains why nostrums provided by Trump and other protectionists will fail. Finally, chapter 4 describes what it will take to ameliorate the discontent with globalization—how we can reconstruct globalization so that most citizens benefit.
Chapter 1
The Failures of Globalization
THE DISCONTENT WITH globalization in the advanced countries is palpable. As I noted in the introduction, large segments of society feel that their lives are not improving, and those perceptions are accurate: in many countries, such as the United States, even a majority have been experiencing near stagnation for more than a quarter century. Here, I explain the role that globalization has played. It is not the only force, but it is such a powerful force that even if there were no changes in technology—no advances, for instance, that enabled employers to replace unskilled workers with machines—globalization by itself could, and probably would, have led large numbers of unskilled workers to be worse off.
Globalization is about more than trade—it is also about the movement of capital, people, and ideas across borders. But because trade is at the center of current controversies—and because it illustrates so forcefully the issues at play—I begin the discussion focusing on trade.
OVERSELLING TRADE GLOBALIZATION
Economists’ belief in the virtues of free trade has been so deep and so long-standing that any economist who expressed skepticism was at risk of losing his “union card”—or at least his credibility as a serious economist. One of the earliest contributions of my thesis supervisor, Paul Samuelson, was to show that the country as a whole was better off as a result of trade liberalization—that is, overall national income was increased.1 This expanded on the earlier argument of David Ricardo about the gains from trade that arise when each country increases production in what it does relatively well; and that of Adam Smith, about the gains from trade that arise when each country specializes, so that it can get better and better at what it does.2
A Little White Lie: Trade Creates Jobs
The problem is that the story I’ve just told about the virtues of trade was not understood by most politicians, and those that did understand it thought it was too complicated. So, sometimes with the help of some economists, they told what they thought was a white lie—trade creates jobs. And when the evidence showed the contrary, they lost their credibility—and so did globalization.
The objective of trade policy is not to increase jobs—maintaining the economy at full employment is the responsibility of monetary policy (the Federal Reserve in the United States, the Bank of England in the UK )3 and fiscal policy (the setting of taxes and expenditure). The objective of trade policy is to increase standards of living, by increasing productivity.
If exports create jobs, as claimed by the U.S. trade representative (USTR—the U.S. “trade minister,” whose job is to design and sell trade policies), then imports destroy jobs. Over the long term, trade is roughly balanced; that is, on average, exports expand with imports. The goods that advanced countries export use less labor than what they import. The advanced countries import textiles and apparel, which require a lot of labor, and export advanced products like aircraft. But this means that if the United States, say, expands exports and imports by $100 million, the new imports destroy more jobs than are created by the new exports.
Hence, on net, trade by itself destroys jobs. But if monetary and fiscal policy do their jobs, this isn’t a problem: the economy expands, creating new jobs to offset the jobs that are lost. The new export-sector jobs pay higher wages than the jobs in the import-competing sector that are lost. Trade increases productivity, and it is this increase in productivity that leads to higher living standards.
Thus, the standard theory recognized that the opening up of trade to cheap imports would result in the loss of jobs in the import-competing sectors; but, it assumed that new jobs would be created in the export sectors and that the economy would be able to stay at full employment.4 But this hasn’t always happened.
The True Story: Smaller Benefits Than Promised
Lower Growth, Increased Unemployment
The fact that globalization is seen as contributing to unemployment is perhaps the most important source of opposition to globalization. What went wrong is simple. Sometimes job destruction outpaces job creation, in which case globalization will be associated with an increase in the level of unemployment. Moving people from low-paid jobs in, say, textiles or apparel to unemployment lowers GDP. It doesn’t help growth. This problem of job loss becomes particularly salient when there is already high unemployment.
This is often the case in developing countries, as I pointed out in GAID, but is also true in advanced countries like the United States when monetary and fiscal policy aren’t working as they should, and there is thus a scarcity of jobs. This happens episodically when economies go into a recession. But typically, recessions are short-lived. Those who lose their jobs in the downturn get new jobs (though often at lower pay) in the recovery. Some European countries, however, have been plagued with long-term unemployment.
The Great Recession—beginning with the global financial crisis of 2008 which, in Europe, morphed into the euro crisis—has undermined faith in markets, in both their efficiency and their stability. The crisis came at a time that countries on both sides of the Atlantic were already struggling with the loss of manufacturing jobs. The crisis then exacerbated the problem: there were massive jo
b losses. The slow recovery from that crisis meant, for instance, that Americans were particularly sensitive to the job destruction that had followed the surge of imports from China after its admission to the WTO.5 Not only were jobs in industries competing with these imports destroyed, but as this happened, others in the community were affected, as housing prices fell and demand for nontraded goods and services (like haircuts, restaurant meals, car repairs, legal services, that are bought locally)6 decreased. As real estate prices fell, small businesses that used real estate as collateral for their loans were hit. Banks in these communities were also hit, and they responded by cutting lending, in a downward vicious circle.
Increased Risk
Advocates of globalization ignored other problems with globalization as well. Many of these “mistakes” were the result of the use of oversimplified models of the economy to guide policy. Oversimplified models, for instance, assumed markets worked so well that there was never a problem with unemployment—hence, they ignored a critical source of opposition to globalization. Oversimplified models led some economists to ignore too the many other ways in which markets differ markedly from the textbook stories, which assume perfect information and perfect competition. In these mythical worlds, markets work so well that there is never any reason for governments to intervene in the economy—there are, for instance, neither bubbles nor recessions. But it should be obvious that it is nonsensical to base any serious policy analysis on models making assumptions that depart so far from reality.7
The 2008 crisis brought home how globalization can increase the risks faced by firms and individuals. Indeed, most of the macroeconomic risks facing developing countries come from outside of the country—such as a sudden decline in the price of what they export, a sudden increase in the price of what they import, or a sudden increase in the global interest rate. Making matters worse, individuals and firms cannot insure themselves against many of these risks, nor can the risks be shared across society. These shortcomings have profound consequences. Consumers are worse off when they have to bear the consequent risks. Workers too may face greater insecurity. And firms, without insurance protection, may shift production toward safer activities with lower average returns and productivity. The result is that with imperfect risk markets all individuals may be worse off as a result of globalization.8
One particular risk relates to a country’s energy security. Gung-ho globalizers pretended that in the post–World War II era, borders don’t matter, and because they don’t matter, countries shouldn’t mind becoming dependent on others for energy (or food or any other essential item). But borders do matter, and for anyone who has forgotten, Trump has provided a powerful reminder.
Mexico has become heavily dependent on U.S. gas. The North American Free Trade Agreement (NAFTA), the pact between Canada, Mexico, and the United States, assured Mexico of the free flow of gas across the border. Trump, with his virulent and irrational anti-Mexican stance, is planning to build a very expensive wall, and some Mexicans worry that he could take actions that would interrupt the supply of gas; at the very least, it could be an important bargaining chip as he tries to force Mexico to pay for his ill-conceived wall.
So too Germany believed that with the collapse of the Berlin Wall, borders with the East would not matter. It has, as a result, become heavily dependent on Russian gas—a dependence with economic and political consequences. If Russia should suddenly shut off the gas, it could have disastrous effects for Germany’s economy. This scenario is not just a remote possibility or an economist’s nightmare; Russia did cut off the supply of gas to Ukraine in 2014. Germany might reason that it wouldn’t be in Russia’s economic interests to do this. But Russia (and its leader, Vladimir Putin) might have other concerns—such as inducing the West to remove sanctions imposed as a result of its blatant violation of international law with the invasion of Ukraine and the accession of Crimea. And of course, economists’ presumption that humans are always and everywhere fully rational is obviously wrong.
Markets don’t appropriately “price” the cost to society of an interruption in the gas supply, and thus German firms, looking for the cheapest source of energy, turned to Russia. The failure to price this risk is an example of a market failure—one with consequences in the short run as serious as the failure to “price” the risk of global warming in the long run.9
Imperfect Competition
The standard models also assumed perfect competition—all firms were small—in spite of the fact that much trade is conducted by corporate behemoths which are larger than many countries and which often have marked market power. Walmart may use its market power in China to drive down producer prices, and then, when it enters other countries, like India or South Africa, use the benefits of this market power—the low prices at which it can acquire goods—to effectively drive small producers out of business.10 Standard results on the unambiguous desirability of free trade do not hold when there is imperfect competition.11 And yet, policy analysts have tended to ignore these effects, worried that it would open up a Pandora’s Box of special-interest claimants for protection.12
Dynamic Comparative Advantage
Perhaps the biggest mistake that globalizers made was that they paid too little attention to the long run (as is the case for most firms in our economy). They asked, what is the comparative advantage, the relative strength, of the economy today? Cheap labor in China meant that it had a comparative advantage in labor-intensive manufacturing. So, firms shifted their production from the United States to China.
In the past, this shift would have happened slowly. China simply wouldn’t have had the initial technological capacities: labor might have been cheap, but not cheap enough to compensate for the technology gap. But China invited American firms in, and these firms were able to couple their advanced technology with China’s cheap but often well-trained and disciplined labor. And of course, access to the potentially huge Chinese market made it even more attractive for foreign firms to set up shop there.
What happened next changed the course of globalization: China and other countries in East Asia learned, and they learned quickly. They developed their own technological capacities, which meant they still had a comparative advantage in labor-intensive industries even as their wages started to rise.
In manufacturing and many other sectors of the economy, firms learn how to increase productivity by doing, by actually producing. But there is an unappreciated converse of this proposition: if firms don’t produce, they quickly fall behind. As America shifted production of, say, thermos bottles to China, China learned how to produce even better thermos bottles at a lower cost. And thus, America, as it stopped producing, lost some of its technological advantage.
In essence, globalization’s advocates forgot about “spillovers”: the ways that learning in one firm spills over to another firm in the area.13 These spillovers also help to explain “clusters,” those dense groupings of high-tech firms in Silicon Valley today, or the new manufacturing enterprises in Ohio and Michigan at the beginning of the twentieth century.
History matters: twenty or thirty years later, after production has shifted to China, we can’t just say, let’s bring manufacturing back to the United States or Europe. While overall, America has a high level of technology and very skilled workers, in many specific areas we have neither the technology nor the skilled workers required. Of course, America and Europe could also learn. They could train a new coterie of workers. But that would require a concerted effort—beyond the ambit of any single firm. More likely, if production were to return, it would be based on new and different technology—in particular, the use of robots. These are areas where the advanced countries probably do have a comparative advantage. But—and this is key—bringing production back with these new technologies will not resuscitate the old manufacturing jobs; indeed, it is unlikely to create many jobs at all, and the jobs created will be mostly highly skilled jobs and in different places from where the jobs were lost. This doesn’t mean that t
he advanced countries shouldn’t try to recover manufacturing jobs, but only that they should have realistic expectations of the results.14 And bringing back manufacturing jobs can’t be at the core of any agenda to “make America great again,”15 or even a less nationalistic agenda of restoring shared prosperity.
Impact of the Exchange Rate: Currency Manipulation or Market Forces
A key factor in the changing competitive-advantage landscape is the exchange rate, which determines the relative value of one currency to another. The relatively high value of the dollar as compared to the Chinese renminbi (rmb, also known as the yuan) made competition with China especially difficult. As a result, China’s goods can be sold very cheaply in the United States.
A couple of factors led to a high value of the dollar. First, and most important, was the macro-economy in the United States. Beginning with Reagan and his tax cuts of 1981, the country ran large fiscal deficits—that is, the government was spending more than its income; and this was not offset by an increase in private savings within the country.16 So, to finance the increased deficit, the United States had to borrow from abroad; that is, there was a flow of capital into the country to finance the deficiency between what the United States was investing and its total national savings. But the flip side of this capital inflow is the trade deficit—imports exceed exports.
This is a basic truism of international macroeconomics: the current account deficit—which includes not just the difference between imports and exports of goods, but also of services17—equals the difference between domestic investment and savings. I’ll return to this several times in this chapter. Economists differ about many things; but they cannot and do not disagree about a truism such as this.
Globalization and Its Discontents Revisited Page 6