October 30, 2006
The global middle cries out for reassurance
By Lawrence Summers
Against all odds, we are living in a time of plenty. Neither the after-effects of September 11 2001 nor a tripling in oil prices has prevented the world’s economy from growing faster in the past five years than in any five-year period in recorded economic history.
Given this recent performance and the pricing-in by world markets of an optimistic outlook, one might have expected this to be a moment of particularly great enthusiasm for the market system and for global integration.
Yet in many corners of the globe there is growing disillusionment.
From the failure to complete the Doha trade round to pervasive Wal-Mart-bashing, from massive renationalisation in Russia to the success of populists in Latin America and eastern Europe, we see a degree of anxiety about the market system that is unmatched since the fall of the Berlin Wall and probably well before.
Why is there such disillusionment? Some anti-globalisation sentiment can be seen as a manifestation of resistance to the US arising from the Bush administration’s foreign policy misadventures. But there is a much more troubling source: the growing recognition that the vast global middle is not sharing the benefits of the current period of economic growth – and that its share of the pie may even be shrinking.
Two groups have found themselves in the right place at the right time to benefit from globalisation and technological change. First, those in low-income countries, principally in Asia and especially in China, who are able to plug into the global system. The combination of low wages, diffusible technology and the ability to access global product and financial markets has fuelled an economic explosion.
It is important to remember that the period between the late 18th and early 19th centuries in Britain and continental Europe was called the Industrial Revolution for a reason. For the first time in human history, the standard of living of one generation was demonstrably better than the one before: in a single lifespan, real per capita incomes doubled and then doubled again. If one looks at the growth rate of China during the past 30 years, living standards are increasing at a rate that will lead to a hundred-fold improvement over a single human lifespan. The impact cannot be overstated.
Second, it has been a golden age for those who already own valuable assets. Owners of scarce commodities have seen their returns rise prodigiously. People running businesses that can take advantage of globalisation to source labour less expensively and sell to larger markets have seen their incomes rise far faster than incomes generally. Certainly those in the financial sector in a position to benefit from the asset revaluations associated with globalisation have prospered.
Everyone else has not fared nearly as well. As the great corporate engines of efficiency succeed by using cutting-edge technology with low-cost labour, ordinary, middle-class workers and their employers – whether they live in the American midwest, the Ruhr valley, Latin America or eastern Europe – are left out. This is the essential reason why median family incomes lag far behind productivity growth in the US, why average family incomes in Mexico have barely grown in the 13 years since the North American Free Trade Agreement passed, and why middle-income countries without natural resources struggle to define an area of comparative advantage.
It is this vast group that lacks the capital to benefit from globalisation and is desperately seeking either reassurance or a change in course. Yet without its support it is very doubtful that the existing global economic order can be maintained.
Let us be frank. What the anxious global middle is told often feels like pretty thin gruel. The twin arguments that globalisation is inevitable and protectionism is counterproductive have the great virtue of being correct, but do not provide much consolation for the losers. Nor can they rally support for policies that maintain, let alone promote, international integration.
Economists rightly emphasise that trade, like other forms of progress, makes everyone richer by enabling them to buy goods at lower prices. But this offers small solace to those who fear their jobs will vanish.
Education is central to any economic strategy, but there is a limit to what it can do for workers in their 40s and beyond. Nor can education be a complete answer at a time when skilled computer programmers in India are paid less than $2,000 a month.
John Kenneth Galbraith was right when he observed: “All of the great leaders have had one characteristic in common: it was the willingness to confront unequivocally the major anxiety of their people in their time. This, and not much else, is the essence of leadership.” Meeting the needs of the anxious global middle is the economic challenge of our time.
In the US, the political pendulum is swinging left. The best parts of the progressive tradition do not oppose the market system; they improve on the outcomes it naturally produces. That is what we need today.
There are no easy answers. The economic logic of free, globalised, technologically sophisticated capitalism may well be to shift more wealth to the very richest and some of the very poorest in the world, while squeezing people in the middle.
Just as the Federal Housing Administration’s effort to make owner-occupied housing more available after the second world war was a crucial part of the policy approach that permitted the Marshall Plan to go forward, so also our success in advancing international integration will depend on what can be done for the great global middle.
Our response will affect not just the livelihoods of millions of our fellow citizens but also the prospects for continuing global integration, with all the prosperity and stability it has the potential to bring.
The writer is former US Treasury secretary
This column will appear monthly
Martin Wolf: Larry’s first column addresses a fundamental question: how do we sustain political support for globalisation when so many feel threatened by it? That, in turn, must depend on how we do ensure that most people expect gain rather than pain. Attentive readers will remember that my column of September 5 (“Share Gains with Globalisation’s Losers”) and the subsequent debate on this forum addressed some of these issues.
I have the following observations on Larry’s argument.
First and foremost, the world economy may be global but politics are national. Consent must be won at the national level. In democracies processes that enrich the few, rather than the many, are hard to sustain. That is a part of the explanation for the sad political history of much of Latin America. If ownership of valuable resources is concentrated, openness to trade tends to generate greater inequality. Popular parties will then be protectionist, while the parties of elites will support free trade. The policies of the former tend to make their country poorer, but enjoy the support of the majority. The policies of the latter tend to make their country richer, but have the support of a minority. This is a recipe for unending conflict between populist politics and authoritarian economics.
Second, Larry lumps together the middle classes in high-income countries with those (rich, poor and middle class) who live in middle-income countries. The former are politically powerful: ultimately, their votes will determine the openness to trade of countries that remain the world’s largest and richest markets. The citizens of middle-income countries are, however, politically impotent.
This difference has important implications for the sustainability of globalisation.
Rich countries are overall winners from globalisation and (partly for that reason) have the resources to help those of their citizens who are not gainers. Their politicians need to find policies that are both better targeted and less costly than protectionism.
Meanwhile, middle-income countries whose terms of trade deteriorate (i.e. the prices of their exports fall as a result of the entry of new competitors) can be outright losers from the present wave of globalisation. Their disappointed citizens may, in response, pull the policies of their countries in a protectionist direction (as is happening now in parts of Latin America). But that will not halt globalisation, because their economies are quite unimportant: at market prices, Latin America’s GDP is the same as the UK’s. The policy options for these countries are very limited, partly because the resources available to their governments are constrained, partly because their governments are ineffective and partly because they cannot change the international environment: if China’s entry drives down the prices of the manufactures they used to produce, they must adjust, one way or the other.
The good news is that those with the power to slow globalisation also have the political power to ensure that its costs are more equally shared within their societies if they wish to exercise it. Devising those policies is then the big challenge for sensible politicians in high-income countries.
The bad news is that those without political power have little room for policy manoeuvre. Until China and India develop further, many middle-income countries may find themselves squeezed between these rising giants and the technological prowess of the high-income countries. I have much less faith than Robert Wade in the ability of the government of, say, Mexico to alter this simple reality.
Posted by: FT Forum - Martin Wolf | October 30th, 2006 at 7:45 pm | Report this commentRobert Wade: Larry Summers says: “The economic logic of free, globalised, technologically sophisticated capitalism may well be to shift more wealth to the very richest and some of the very poorest in the world, while squeezing people in the middle.” A new study by Peter Edward presents confirming evidence (Edward, P. 2006, ‘Examining Inequality: Who Really Benefits from Global Growth?’, World Development, V. 34, N.10, 1667-1695). Of the increase in world consumption between 1993 and 2001 between 50 and 60 per cent accrued to those in the top 10 per cent of world PPP income in 1993, of whom four-fifths lived in the (old) OECD and most of the rest in Latin America.
This is the Matthew Effect with a vengeance - To him that hath shall be given. Most of the rest of the increase accrued to the burgeoning middle class of China. Hardly any accrued to those living on less than $1-a-day, though ‘hardly any’ in percentage terms may have been sufficient to push enough people up to between $1-a-day and $2-a-day that the number under $1-a-day fell while the number between $1 and 2-a-day rose.
So when Larry talks of the “global middle class” being squeezed he is talking about the vast majority of the world’s population, and the even bigger majority of the world outside the OECD and China. This should qualify any easy assertion that “globalization works”, to borrow a phrase from the title of Martin Wolf’s 2004 book, Why Globalization Works.
Larry also says: “[W]ithout its [the global middle class’] support it is very doubtful that the existing global economic order can be maintained.” The point can be made more analytically. Income and wealth inequality up to some very high limit is good for the rate of profit and the concentration of capital ownership, and bad for legitimacy. And vice versa. Elites are likely to sponsor measures that lower inequality only when their legitimacy is seriously threatened. We see fluctuations in after-tax inequality over time in response to the degree of threat to the capitalist order or to the survival of particular states. Nutritional conditions and life expectancy improved in the British working class during the First and Second World Wars, even including the military, as the British elite sought to ration out scarce commodities, including food, in ways which much improved on non-war working class living conditions, or so I am informed. But despite the past two decades’ increase in the world-wide $2-a-day poverty headcount and the increase or constancy (not fall) of world income inequality (the fast rise of China and India notwithstanding), inequality has haardly begun to feature as an issue of global or even national policy discussion.
Ironically, the Chinese and Russian Executive Directors were about the most strenuous opponents on the Board of the World Bank doing a World Development Report about “inequality”, and gave way only when assured that it would only be about ‘inequity’, meaning inequality of access to opportunities, not about inequality of outcomes. The Chinese and Russian governments are having a particularly hard time navigating the trade off between profits and legitimacy.
Finally, Larry says that ‘the combination of low wages, diffusible technology and the ability to access global product and financial markets has fuelled an economic explosion’ in Asia, especially in China. The problem here is that low wage labour is available all over the place, not just in Asia, and diffusable technology is, from the supply side, diffusable all over the place. Asian economies have certainly benefitted from being able to access global product and financial markets (especially as compared to a ‘no access’ counterfactual). But they have adopted policy regimes that depart in major ways from the principles that Larry keenly promoted from the US Treasury, whose spirit is caught in his remark in this column, ‘protectionism [note the ‘ism’, as though it is a creed, like communism] is counterproductive’.
The governments of the successful economies (think Japan, Taiwan, South Korea, Singapore for starters) have in practice adopted a variety of policy instruments to accelerate the national integration of the economy, as a complement to Larry’s central interest in ‘international integration’. In the first three, these policy instruments included managed trade regimes with substantial amounts of protection confered in line with a larger development strategy. Larry refers to ‘middle-income countries without natural resources struggl[ing] to define an area of comparative advantage’. I suggest that the struggle to define and exploit areas of comparative advantage in the context of increasing competition in world markets may - in non-minnow economies - involve a more pro-active directional thrust from the state (the direction established through state-business-union collaboration) than Larry would be happy to endorse. Again, see my Governing the Market 2004.
Posted by: FT Forums | October 30th, 2006 at 8:04 pm | Report this commentJim O’Neill: Larry’s article is a really good, balanced addition to the growing awareness of the challenges from sustaining globalization. There are two things I would like to add.
Firstly, if the improved profit performance in some of the “old economies” results in increased productivity, as it seems to be doing in Japan and Germany, then it is likely to result in increased employment opportunities for all, as we are seeing some signs of. This mitigates some of the hole that the global middle fears.
Secondly, our central banks face a potentially trickier time going forward and they perhaps they may need to apply even more wisdom in their approach to monetary policy than their admirable efforts in recent years. In circumstances of some signs of increase in wages, it is incumbent on central banks to not mistake a rise in wages, possibly justified by increased productivity, as a threat to inflation.
Obviously, given their mandate to maintain the low inflation achievements of the recent past, they must be watchful but if rising productivity in the “old “economies is a positive benefit of globalization, increased wages would help the global “middle” and it is will not be necessarily inflationary.
Posted by: FT Forums | October 31st, 2006 at 10:48 am | Report this commentJoseph E. Stiglitz: Further globalisation is not inevitable.
I could not agree more with the thrust of Summers article: the global economic middle may be coming out on the short end of globalisation, and that the great challenge is to figure out how to ensure that they share in the benefits of globalisation. But there are two widely held misconceptions about globalisation which a casual reading of his article might reinforce.
First, he claims that “eonomists rightly emphasise that trade, like other forms of progress, makes everyone richer by enabling them to buy goods at lower prices.” As he points out, this is but one of the effects of trade: those who lose their jobs may be worse off. But even if there were full employment, economists have long explained that full economic integration with perfect markets would imply that unskilled workers everywhere in the world would receive the same wage - a wage which almost surely would be lower than their current wage. And even movements towards liberalisation will result in downward pressure on wages. The adverse effects in the developed country are the predictable and predicted effects of globalisation - effects which proponents not surprisingly have not advertised.
Secondly, he also argues that “globalisation is inevitable”. Yes, we will always be dependent on those outside our borders; but increasing globalisation is not inevitable. The extent of globalisation as measured by trade or capital flows to GDP was stronger before the First World War than it was in the interwar period. There was a retreat from globalisation - including the high Smoot-Hawley Tariffs imposed by the US. And there can be a retreat from globalisation again. As I point out in my book Making Globalization Work, unless we manage to make sure that there are more winners and fewer losers from globalisation, there could once again be a retreat.
One of the reasons that the developing countries were reluctant to enter into a new round of trade negotiations in Seattle in December 1999 was that the poorest had seen what had happened in the previous round, the Uruguay round; they had actually been made worse off. And they were afraid it could happen again. The Doha round is now stalled because the EU and the US reneged on the promises that they had made that this would be a development round.
All that standard economic theory says about globalisation is that (when it works well), the winners can compensate the losers; not that they will. And unfortunately, too often globalisation is used as an excuse for doing just the opposite of what Summer argues to persuasively needs to be done - strengthen progressive government programs to help those that are left behind.
Posted by: FT Economist Forum | October 31st, 2006 at 4:02 pm | Report this commentLawrence Summers: I am grateful Martin Wolf, Robert Wade, Joe Stiglitz and Jim O’Neill for their thoughtful comments on my column. The issues here are as difficult as they are important and we can all benefit from open minded debate.
Martin rightly highlights that all politics are local or at least national and takes me to task for conflating the problems of rich country middle classes and middle income countries by invoking the concept of the global middle. His valid point is that the rich countries have much more global political sway than the small ones do though I suspect a coalition of all middle income countries could have a real impact on global politics. My decision to highlight the common element derived from the sense that the nature of the policy problem is the same, for example, in the American Midwest and Mexico. It is to resist the King Canute temptation to wall off the rest of the world, to develop selective areas of comparative advantage, and to address insecurity.
Robert is characteristically sharp in his commentary. His Matthew effect comment misleads a bit since even with proportional growth absolute growth in consumption would be far and away greatest for the top 10 percent.
But on one of his more fundamental point we may disagree less than he supposes. I have for years been remarking that Bretton Woods economics takes a “field of dreams” approach to growth. Build an enabling environment and prosperity creating industries will come. I am intellectually honest enough to recognize the heterodox character of many of the great success stories and so am sympathetic to policy makers who want to go beyond creating an economic field of dreams and want instead to place some star players in key positions.
The difficulty comes in extrapolating from examples of success. Warren Buffett has been spectacularly successful acting in ways inconsistent with modern financial theory that emphasizes the benefits of diversification and the efficiency of the market. It would not be plausible to suggest that his record is simply a chance event. But I don’t think it would be responsible to recommend to all investors that they follow Buffett’s strategy of a few potentially high return companies and holding them. Not responsible because not everyone has Buffett’s capacity and the attempt to emulate him without his special skills and support could easily be catastrophic.
In the same way, I would argue that for every heterodox success there are a dozen heterodox failures. And the countries whose economic policies attract the close attention of the IMF and the US Treasury are those in need of emergency loans because their policies have been unsuccessful. So while I am very open to the concept of activist policy to create comparative advantage I would insist that it be evaluated in the context of all the attempts successful and unsuccessful. And with this in mind I am closer to Martin than Robert on the efficacy of activist government.
Joe’s comments are, it seems to me, much more right on the theory than on its application. As he well knows trade agreements have reduced trade barriers in developing countries much more than in the US where they are already very low so it is far from obvious that agreements, as distinct from the technological improvements that have facilitated integration, have reduced US wages. I think Joe is at some distance from most professional opinion in his judgment that the Uruguay Round hurt the poorest countries.
I agree with Jim O’Neill’s points and suspect that through channels we do not fully understand globalization is related to the increases in productivity and the downwards pressures on costs that contributed to the US boom of the 1990s. Alan Greenspan was perceptive in exactly the way that O’Neill calls for in the 1995-1998 period. I wish I could be equally confident about central banks in Europe and Asia today.
Posted by: Lawrence Summers | November 2nd, 2006 at 12:54 pm | Report this commentMartin Wolf: Let me add one comment on Larry and one comment on Robert.
Larry suggests that if all the middle income countries of the world were to get together, it might amount to a potent coalition. The question then becomes who are these middle-income countries? The World Bank divides its middle income category, which contains 3.1bn people, into lower middle and upper middle. Lower middle income countries contained 2.5bn people in 2005 and had average incomes of $1,900 at market prices and $6,300 at purchasing power parity (US levels being $44,000 and $42,000, respectively). Upper middle income countries contained only 600m people and had an average income of $5,600 at market prices and $11,000 at PPP. But more than half of the people living in lower middle-income countries are now Chinese. So these are presumably not the people we are worrying about. I suspect that Larry’s middle consists mainly of countries in the Bank’s upper middle category: these are the ones being squeezed from below by China and from above by the high-income countries: Mexico is in this category, for example.
So what could these 600m people (less than 10 per cent of world population) actually do about their plight? They could pull out of world trade, of course, by returning to protection. But since they generate only about 7 per cent of global demand at market prices, I don’t think anybody would really notice. So the middle that matters for the survival of globalisation is much more the high-income countries’ middle class, than the world’s middle-income countries.
Robert argues that “the governments of the successful economies (think Japan, Taiwan, South Korea, Singapore for starters) have in practice adopted a variety of policy instruments to accelerate the national integration of the economy, as a complement to Larry’s central interest in ‘international integration’”. This is correct, at least up to a point (it is least true of Singapore and not at all true of Hong Kong, which Robert doesn’t mention in this list). But the question is what applicability this points has outside these specific east Asian examples.
Take Latin America, where most people would agree that experience has, indeed, been disappointing. Does this suggest that similarly heterodox policies might have been successful? As it happens, Chile is much the most successful Latin American economy over the past quarter century. Yet it has also been the most “orthodox”. There have also been heterodox experiments in Latin America even in this period, all of which have performed quite poorly.
My suggested conclusion from this is that, given their initial income levels, resources, opportunities, etc, Latin American countries had to go further towards creating good policy environments, institutions and human resources than the desperately poor, cheap-labour abundant China of the 1970s and 1980s and India of the 1980s and 1990s. The Latin Americans failed, almost universally, to do so. As a result, they also failed to generate sufficiently dynamic growth.
That seems to me to be at least as plausible a lesson from the actual Latin American experience as that something close to orthodoxy is bound to fail.
Posted by: FT Forum - Martin Wolf | November 3rd, 2006 at 7:35 pm | Report this commentJeffrey Frankel:
Posted by: FT Forum - Jeffrey Frankel | November 9th, 2006 at 9:48 am | Report this comment