Free Trade

In Praise of Globalization

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Donald Trump criticizes globalization and word trade.
  • Why it matters

    Why it matters

    The negative view of globalization by part of the population might bring populist politicians into power and lead to protectionist measures, hampering world trade.

  • Facts

    Facts

    • As a whole, globalization has not increased global inequity, but rather dramatically diminished it.
    • The percentage of people living on less than $1.90 per day – the World Bank’s global poverty line – collapsed from 44 percent in 1981 to just 13 percent in 2012.
    • Social welfare states such as Germany risk becoming a magnet for economic refugees, but they also can be a sensible complement to global free trade.
  • Audio

    Audio

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Donald Trump strikes a nerve among Americans when he slams globalization. Real wages, after all, have stagnated for decades, while corporate profits have gone through the roof. The white middle class of blue-collar workers and small business owners was left behind. Its members now are seeking shelter in the protectionist promises of the Republican presidential candidate.

Such political forces are also gathering on the fringes in Europe, fueled by a chronic euro crisis that gradually has robbed the last optimists in southern Europe and France of all hope and has radicalized jobless industrial laborers. Euro-skepticism and opposition to global free trade have become intertwined.

Were economists mistaken in their assessments of free trade’s impacts? Must one again fear the neoliberals who aim to assist the powerful and the rich in exploiting the working class?

While free trade, in general, does improve economic prosperity, according to the theory, it is not a rising tide that lifts all boats.

As it turns out, the assessments of economists were not wrong, but those of some politicians were. When John F. Kennedy said that rising tides lift all boats, he certainly did not ask an economist. For more than half a century, the so-called factor price equalization theory has been at the center of economic theory on global free trade. And while free trade, in general, does improve economic prosperity, according to the theory, it is not a rising tide that lifts all boats.

General economic improvements only occur in the sense that the winners are able to compensate the losers, and still have something left – and not in the sense that all citizens prosper without such compensation.

This is because the factors of production, such as wages for similar types of work and capital returns, tend to become equalized across common markets. Thus, workers in industrialized nations cannot profit, even if global economic tides rise on average. Just the opposite: their boats sink somewhat in the global market’s system of communicating vessels – at least compared to where they would have been.

I have drawn attention to this phenomenon in scores of articles in newspapers and trade publication since the 1990s, predicting the dramatic distributive consequences for the West of the Iron Curtain collapse, the same ones broadly bemoaned today.

China, the former Soviet Union and once heavily communist India alone represented 43 percent of mankind joining global trade – and becoming competition for the 16 percent of humanity living in OECD industrial nations. This immediately upended the relative shortage of labor and capital in the world’s market economies. Western workers emerged the losers of globalization, businesses and asset owners the winners.

With few exceptions, the fall of the Iron Curtain has, relatively speaking, lowered the income trend in the entire West. The entry of China, the former Soviet Union as well as India on the global market has also led to a dramatic increase of labor supply, to the detriment of workers and benefit of businesses and capital owners.

It made no sense for Germany to oppose this trend with collective bargaining or minimum-wage laws; that would only boost unemployment and exacerbate inequity. Former Chancellor Gerhard Schröder was able to reverse this trend with his ‘Agenda 2010,’ which made it less attractive financially to be unemployed.

It is true that factor price equalization created more inequality in China and other developing countries. But that is merely a temporary trend identified by American economist Simon Kuznets – in which market forces first accelerate economic inequality in a developing economy before reducing it.

As a whole, globalization has not increased inequity worldwide, but rather dramatically diminished it. This is because 45 percent of the world’s population was freed from the bitter poverty of communism. The percentage of people living on less than $1.90 per day – the World Bank’s global poverty line – collapsed from 44 percent in 1981 to just 13 percent in 2012.

There is probably no greater virtue of globalization than that.

 

25 p20 Less Poverty-01

 

All of these factor price equalization impacts are playing out in the global economy. For instance: as low-wage countries specialize on labor-intensive goods, while high-wage countries specialize in capital- and knowledge-intensive processes. Wages are rising for the former and falling for the latter.

This effect is intensifying because capital from high-wage locations is migrating into low-wage locations. In the process, a common labor market is forged – without labor even needing to relocate.

But labor does migrate, intensifying the impacts even more. Markets often overreact, of course, because high-wage labor locations coincide with regions that have high standards of living and generally high levels of social services. Unbridled migration, however, has an overly strong effect because it is driven by wage differences as well as social welfare entitlements.

The social welfare state essentially becomes a magnet for economic refugees. The resulting excessive and damaging migration, in turn, will erode social welfare systems if they are not reeled in. Former British Prime Minister David Cameron attempted – in vain – to alert European politicians to this danger.

So what does all this mean? Certainly not that trade barriers should be re-erected. For the most part, the impacts are tolerable and have been partially absorbed by social welfare states. In a sense, social welfare states make free trade and profits possible because they compensate and placate the losers.

Germany is among the strongest redistributors of income, according to OECD statistics, by using its tax system to reallocate wealth from the highest to lowest tax brackets. This makes possible the country’s large disparity of gross income, which is necessary for successful participation in global trade. It also enables relatively equal net income in Germany compared with other countries.

As a whole, Germany is a solid and successful model for using its social welfare system as a sensible complement to global free trade – for which we have our prosperity to thank. Germany’s Achilles heel, obviously, is the magnetic pull of its social welfare system for economic migrants.

Germany, in collaboration with its European partners, must work on a solution. The country also should consider reversing its minimum-wage policy, which goes against ex-Chancellor Schröder’s reforms and its positive effects on unemployment.

But globalization’s impact on Germany, and the world, largely has been a positive one. Donald Trump might take note. Instead of turning toward protectionism, it might do him well to call for an expansion of the U.S. social safety net. Such a move would help to spread American prosperity among its masses.

 

To contact the author: gastautor@handelsblatt.com

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