May 5, 2008
A strategy to promote healthy globalisation
By Lawrence Summers
Last week, in this column, I argued that making the case that trade agreements improve economic welfare might no longer be sufficient to maintain political support for economic internationalism in the US and other countries. Instead, I suggested that opposition to trade agreements, and economic internationalism more generally, reflected a growing recognition by workers that what is good for the global economy and its business champions was not necessarily good for them, and that there were reasonable grounds for this belief.
The most important reason for doubting that an increasingly successful, integrated global economy will benefit US workers (and those in other industrial countries) is the weakening of the link between the success of a nation’s workers and the success of both its trading partners and its companies. This phenomenon was first emphasised years ago by Robert Reich, the former US labour secretary. The normal argument is that a more rapidly growing global economy benefits workers and companies in an individual country by expanding the market for exports. This is a valid consideration. But it is also true that the success of other countries, and greater global integration, places more competitive pressure on an individual economy. Workers are likely disproportionately to bear the brunt of this pressure.
Part of the reason why US workers (or those in Europe and Japan) enjoy high wages is that they are more highly skilled than most workers in the developing world. Yet they also earn higher wages because they can be more productive – their effort is complemented by capital, broadly defined to include equipment, managerial expertise, corporate culture, infrastructure and the capacity for innovation. In a closed economy anything that promotes investment in productive capital necessarily raises workers’ wages. In a closed economy, corporations have a huge stake in the quality of the national workforce and infrastructure.
The situation is very different in an open economy where investments in innovation, brands, a strong corporate culture or even in certain kinds of equipment can be combined with labour from anywhere in the world. Workers no longer have the same stake in productive investment by companies as it becomes easier for corporations to combine their capital with lower priced labour overseas. Companies, in turn, come to have less of a stake in the quality of the workforce and infrastructure in their home country when they can produce anywhere. Moreover businesses can use the threat of relocating as a lever to extract concessions regarding tax policy, regulations and specific subsidies. Inevitably the cost of these concessions is borne by labour.
The public policy response of withdrawing from the global economy, or reducing the pace of integration,is ultimately untenable. It would generate resentment abroad on a dangerous scale, hurt the economy as other countries retaliated, and make us less competitive as companies in rival countries continue to integrate their production lines with developing countries. As Bill Clinton said in his first major international economic speech as president, “the United States must compete not retreat”.
The domestic component of a strategy to promote healthy globalisation must rely on strengthening efforts to reduce inequality and insecurity. The international component must focus on the interests of working people in all countries, in addition to the current emphasis on the priorities of global corporations.
First, the US should take the lead in promoting global co-operation in the international tax arena. There has been a race to the bottom in the taxation of corporate income as nations lower their rates to entice business to issue more debt and invest in their jurisdictions. Closely related is the problem of tax havens that seek to lure wealthy citizens with promises that they can avoid paying taxes altogether on large parts of their fortunes. It might be inevitable that globalisation leads to some increases in inequality; it is not necessary that it also compromise the possibility of progressive taxation.
Second, an increased focus of international economic diplomacy should be to prevent harmful regulatory competition. In many areas it is appropriate that regulations differ between countries in response to local circumstances. But there is a reason why progressives in the early part of the 20th century sought to have the federal government take over many kinds of regulatory responsibility. They were concerned that competition for business across states, and their ease of being able to move, would lead to a race to the bottom. Financial regulation is only one example of where the mantra of needing to be “internationally competitive” has been invoked too often as a reason to cut back on regulation. There has not been enough serious consideration of the alternative – global co-operation to raise standards. While labour standards arguments have at times been invoked as a cover for protectionism, and this must be avoided, it is entirely appropriate that US policymakers seek to ensure that greater global integration does not become an excuse for eroding labour rights.
To benefit the interests of US citizens and command broad political support, US international economic policy will need to focus on the issues in which the largest number of Americans have the greatest stake. A decoupling of the interests of businesses and nations may be inevitable; a decoupling of international economic policies and the interests of American workers is not.
The writer is the Charles W. Eliot university professor at Harvard University
Lawrence C. Marsh: We all seem to have forgotten basic economics in general and international trade theory in particular. What happen to the issue of the efficient allocation of resources? Since when do tariffs, trade restrictions and other methods of distorting prices help increase the welfare of society?
Free trade brings in more competition forcing businesses to improve their productivity and efficiency and to lower prices.
Would poor people be better off without all those low priced products from China sold at WalMart?
Since everyone is a consumer, everyone benefits from lower prices. Lowering prices is the most democratic policy a country can pursue, because it helps everyone and not just some special interest group or a particular group of workers.
What about the retired and elderly on Social Security? Don’t they benefit from lower prices just like everyone else? Why does the debate about trade always seem to ignore them?
When I took international economics in graduate school it was all about comparative advantage and resource allocation. How did the debate become centered on jobs and wages?
The number of jobs in our economy is the responsibility of monetary and fiscal policy and not trade policy.
The quality of jobs depends upon education. Modern economies require significantly higher levels of appropriate skills. Workers who have not done anything to increase their personal productivity should not expect wage increases anymore than companies that have not offered new or better products at lower cost should expect profit increases. Government policy should help people enhance their jobs skills.
To be honest the system that Adam Smith described so well is not designed to help the capitalist or the worker. A company with high profits and a worker earning high wages both induce competition from others to drive down their profits and wages respectively. It is ironic that the consumer who does nothing other than show up at the store offering the best quality product at the lowest price is ultimately the winner. From this perspective the system should be called “consumerism” instead of “capitalism.”
A tariff is a hidden tax. A sales tax shows up on your store receipt. You see exactly how much you paid in taxes. When sales tax is too high, you can complain to your district representative or simply vote the incumbent out of office in favor of the candidate who promises to cut the sales tax. With a tariff you don’t even know you are paying it. It can take as much or more out of your dollar than the sales tax, but you don’t ever see it. Some believe that this lack of transparency is tantamount to taxation without representation. We dumped their tea in the Boston harbor and threw the British out when they tried putting an import tariff on tea. Yet now we absorb these hidden tariff duties as if they didn’t exist.
Does the tariff of 54 cents a gallon on imported ethanol really benefit the average consumer at the gas pump?
Since we all benefit from lower prices, it is unfair to put the cost of that benefit on a relatively small group of workers. Workers who lose their jobs to technology or to overseas competitors should be given special assistance. However, we should not impose tariffs or otherwise interfere with free trade. To do so would mean short-changing everyone to protect the jobs of a few. We need specific policies to assist workers who lose their jobs, but not policies that raise prices and, thereby, lower the real wages of all Americans.
Since our most productive and competitive companies can offer better jobs than our inefficient and uncompetitive ones, better jobs will be created to replace the ones eliminated. Whenever we can encourage more efficient production anywhere in the world, we are better off through lower world prices.
A common misconception about trade policy is that we would lose by unilaterally lowering our tariffs, and, therefore, we must require a tit-for-tat in tariff reduction in order to benefit. Nothing could be farther from the truth. In 1936 Lerner’s Theorem published in Economica proved that the damage caused by tariffs in the exchange of two products between two countries does not depend on which country’s government receives the tariff revenues. In other words, the price distortions and misallocation of world resources does not depend upon which government is responsible for the trade distortion. The world is equally worse off in either case. Even the revenues themselves do not help the country receiving them because they just inflate prices by a compensating amount.
If other countries insist on continuing their import tariffs and/or subsidies, they just hurt themselves by protecting inefficiency. If isolation from world trade was good, then Myanmar, North Korea and Cuba would be stellar performers and the Soviet and old Chinese economic systems would have succeeded.
Lawrence C. Marsh is Professor Emeritus at the Department of Economics and Econometrics, University of Notre Dame
Posted by: Prof. Lawrence C. Marsh | May 5th, 2008 at 11:19 pm | Report this commentAdrian Wood: Professor Summers seems to me to be fundamentally right, both in his diagnosis of the problem and in his suggested solution, but there may be a few points to add.
The ability of rich-country firms to deploy their managerial and technical expertise in poor countries tends to reduce the real wages of workers in rich countries, skilled and unskilled alike, both by reducing the supply of a complementary factor and by altering the terms of trade, since goods produced by rich-country workers are now made more cheaply elsewhere. (Some supporting theory and evidence can be found in an article by Edward Anderson, Paul Tang and myself in Oxford Economic Papers 2006.)
Everyone in rich countries, including workers, also loses from the terms of trade shift caused by increased demand for oil and other natural resources (though this hurts the land-scarce rich countries of Western Europe and Japan more than land-abundant rich countries such as the US). Rich-country managerial and technical experts gain a lot from their ability to operate world-wide, in principle more than rich-country workers lose, but as Professor Summers points out, they become harder to tax.
International action to raise labour standards, one of Professor Summers’ suggested solutions, would require the co-operation of China and other large Asian countries, which is hard to imagine. His solution of more co-operation on taxation would also be politically difficult, but seems more promising because it could be achieved largely by joint action by the rich countries, which are where most managerial and technical experts want to live (and which can force smaller countries to comply).
If tax co-operation were successful, what should the additional revenue be spent on in rich countries? Redistribution is one obvious option – lowering tax rates on workers, in particular. Another is to improve the supply of publicly provided complementary factors: not only economic infrastructure, but also the public amenities that make rich countries attractive places for managerial and technical experts to live and to do a lot of business, and from which workers also benefit.
Posted by: Adrian Wood | May 6th, 2008 at 10:10 am | Report this commentJim O’Neill: Larry’s interesting articles the last two weeks are starting to make me increasingly wonder whether the world is going to have to cope without the US in terms of expanding globalisation! While this seems perhaps a bit of an odd notion, when more and more of the leading US economists start to argue for new prescriptions to protect small parts of the US from the forces that have so helped the US, it seems to me that the US is in trouble. Having just returned from a trip to India - where I read Larry’s piece- and given the staggering potential there, I do find myself entertaining the question - at least in my head - whether the US will simply “miss out” on the next 50 years or so, the same way as some other big nations , including India, might have missed out much of the 50 years following the 2nd World War. Plenty of big population developing countries are really seeing the benefits of globalisation coming through more and more, and it should be deplored that western policymakers should do things to “protect” themselves from these exciting developments. It is ironic that it is becoming so “trendy” for many to adopt the line that Larry espouses here when for the first time I can recall in a long time, US based exports of automobiles are performing better than US imports of autos. This is a sign of how much the changing world can help solve the biggest problems of the US in the past 20 years, i.e. the inexorable rise of the trade deficit. Leading economists in the US should be championing this kind of evidence, not thinking of reasons to try and stop it.
Jim O’Neill is chief global economist and head of global economic research at Goldman Sachs
Posted by: Jim O'Neill | May 7th, 2008 at 4:30 pm | Report this comment