Everybody wins, except for most of us: What economics teaches about globalization

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ISBN-10: 1932066330
ISBN-13: 9781932066333

Paperback, $14.50, 148 pages, 6″ x 9″
Published by the Economic Policy Institute (November, 2008)

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Table of Contents

Executive Summary
Introduction

Chapter 1. There’s globalization and there’s inequality
Chapter 2. The hard to measure, hard to deny, threat effect
Chapter 3. Theory and practice: predicting and estimating trade’s effect on wages
Chapter 4. The offshoring of service-sector jobs: more of the same, but more so
Chapter 5. Benchmarking the costs of globalization

Conclusion
Appendix
Endnotes
References

Executive Summary

A wide gulf exists today in American politics. On one side are voters anxious about globalization and its impact on their ability to make a good living. On the other are economists, policy makers, and pundits who maintain that trade is good for the economy and that the only problem it raises is that its large benefits are too broadly diffused throughout the population for any single voter to notice.

And so these policy makers and opinion leaders have taken it upon themselves to educate the American public about the benefits of the globalization status quo, resting their effort heavily on the suggestion that “all economists believe” globalization is good for American workers.

The problem for this approach is that those worried about what the integration of a rich U.S. economy and a much poorer global economy means for their living standards have a better grasp of the underlying economics. Open the international trade textbook and one will find two key predictions about this global integration: it can indeed harm the majority of American workers, and it actually does have a natural constituency—the most economically privileged Americans. Not for nothing is economics called the dismal science.

Given these textbook predictions, it should come as no surprise that the two starkest economic developments of the past 30 years—rising inequality and the increasing integration of the United States into a poorer global economy—are causally connected. The debate among researchers who have delved into this topic is generally not a disagreement about the predicted direction of trade’s influence but rather an empirical argument about the size of its contribution to the historic run-up in inequality seen over the past several decades. Some economists think trade explains a major portion of the rise in inequality; others believe that it explains very little. A large majority pegs the contribution somewhere between 10% and 40% of the total rise in inequality in the 1980s and early 1990s. This book shows that its influence has only become stronger since.

To date, the redistributive effect of trade has largely been a response to global integration of the manufacturing sector. The impact of the rise of trade in services, a sector once thought to be largely insulated from global competition, is starting to come into focus. Offshoring of service work potentially gives globalization a much larger lever with which to affect domestic labor market outcomes, and it could have huge implications for the future shape of earnings for American workers.

A key contribution of this book is simply to translate the costs of globalization for workers on the losing end into easily understandable terms: dollars per worker (or household). Using the best practices identified in the earlier trade andwages debate, this book finds that the annual losses to a full-time median-wage earner in 2006 total approximately $1,400. For a typical household with two earners, the loss is more than $2,500. These losses are as high or higher than other economic costs commonly presented as much more damaging to American families, such as the cost of health care, spikes in gasoline and fuel oil prices, the cost of a child’s four-year college education, or the funds needed to remedy a possible shortfall in the future of Social Security.

To deal with a harm as large and widespread as that imposed by globalization, we need to think much more ambitiously about public policy that re-links aggregate and individual prosperity, a policy that uses all the levers available: social insurance, public investment, fairer economic rules, and redistribution when other tools fail to provide egalitarian outcomes. Further, despite much protestation to the contrary, the globalization status quo is at least as stingy to the poor trading partners of the United States as it is to American workers. There is no real danger to progressive goals in calling for its complete upending.

So far we have been content to allow globalization without compensation to proceed apace. This complacency has already hurt us, and the damage will only grow in the future.

Introduction

Globalization and the new economic insecurity

It was 1995, in the middle of Bill Clinton’s first administration, and Robert Rubin, his new Treasury secretary, was pondering the lessons of his first big political fight. The Mexican government had been on the brink of default, but initial strong support in Congress for his rescue effort had deteriorated day by day. In the end he had had to put aside congressional approval and act on his own by tapping $20 billion in discretionary Treasury Department funds. In the future, he concluded, the key to political support would be public support:

At some point during the second term, Secretary of State Madeleine Albright and I discussed holding joint public meetings around the country to try to improve how public understanding of global issues…affect people’s lives. Regrettably we never did this, but some kind of ongoing public education campaign is badly needed to change the politics around all these concerns….On trade, for example, dislocations are very specific and keenly felt—and lead to strong political action—but the benefits of both exports and imports are widely dispersed and not recognized as trade-related, and thus haven’t developed
the level of political support they require. (Rubin and Weisberg 2003, 37-38)

It is regrettable that Secretary Rubin never mounted his public education campaign,
but not because American workers, from waitresses and office assistants and auto workers to software engineers, lawyers, and stock brokers, were deprived of an economics lesson. It is regrettable because he may have missed a chance to learn that the misinformed people in need of enlightening actually understand textbook trade economics just fine.

Take one particularly prominent skeptic of the idea that globalization must be good for all American workers:

Last December…I was being driven to the Stockholm airport. Along the road we passed many of Sweden’s best
factories. They seemed to the tourist’s eye to have lost some of their bright glitter and busy-ness.…Now there is nothing that these factories can do which cannot be done almost as well in the Pacific Basin—and often with Asian labor at real wage rates only half that prevailing in Sweden. And surely much the same can be said about factories in Turin, Brussels, Birmingham, and Chicago.…Of course, the most resourceful Swedish and American operations can survive at some positive level. But all of us cannot be above average. As the billions of people who live in East Asia and Latin America qualify for good, modern jobs, the half billion European and North Americans who used to tower over the rest of the world will find their upward progress in living standards encountering tough resistance. (Bhagwati and Dehejia 1994)

This particular skeptic, however, probably wouldn’t benefit much from an educational campaign: he’s already won a Nobel Prize and essentially founded the modern discipline of economics. Paul Samuelson wrote these words after attending a Nobel jubilee in 1992, and they are a good summary of the textbook predictions of what happens to most workers living in a rich country when its economy integrates with a much poorer global economy.

While this integration generally makes both countries a bit richer, it has much more powerful effects on the distribution of income within each economy. For the United States, this redistribution swamps the efficiency gains for most workers, making them worse off not just compared to globalization’s winners, but in absolute terms.

Secretary Rubin’s focus on the national advantages of trade over its contribution to economic inequality is hardly unique. It’s almost impossible to find a mainstream politician or policy maker, or newspaper editorial board or reporter or TV commentator—of any ideological stripe—who doesn’t aver that trade is an all-around good thing; “win-win” is the most common formulation. But if you raise the point that trade redistributes income and creates some winners but many losers, a point predicted by standard economic theory and proven in empirical studies—you’re made to feel somewhat unseemly, that you and those people you’re concerned about should have stayed in school longer or have studied something different or just been smarter. In other words, when trade makes software engineers richer, that’s economics. When it makes Americans without a four-year college degree (the large majority of workers) poorer, that’s their own failure to adapt to the New Economy. And when trade agreements prohibit a country from copying the technology it buys, that’s good business. But if agreements required that each country protect the most basic rights afforded to its workers, that would be protectionism.

The economics of international trade are actually quite straightforward, and the first aim of this book is to introduce readers to the economic theory and studies that show us clearly that the trade story is not win-win but rather good news-bad news: good news for national incomes, bad news for many if not most individuals
and families, because their income is redistributed away from them and up the income ladder. The big unanswered question regarding globalization is what to do about the winners and losers—who gets what, when, how, and whether. That is, we need a real political debate about globalization.

Globalization’s place in modern American politics was secured in the furious debate over the North American Free Trade Agreement (NAFTA) in 1993. More recently, the growing gap between the very rich and the rest and the fragility of middle-class living standards have become part of the political conversation as well. Although inequality and insecurity are not all that new—numerous academic studies have demonstrated forcefully that they have been rising for roughly 30 years—what is new is their elevation as issues of prime political importance.

Help wanted: straighter talk on globalization

While economic theory argues that global integration leads to lower wages for the majority of American workers, at each stage in the trade debate policy makers, opinion leaders, and even progressive economists have often minimized these costs of globalization. Instead of, say, trying to inform the public that the real action of globalization in affecting U.S. workers is slower wage growth, not fewer jobs in the economy, they have chosen instead to say simply that “trade doesn’t affect jobs” and then let the silence afterward imply that fears about globalization are groundless. Why this group would misrepresent the true implications of globalization for American living standards is a tough question (the sociology of the economics profession and just flat ignorance on the part of many about the economics of international trade both surely play a role). But how these misrepresentations are expressed is easier to pinpoint. Watch for them.

The first how is conflating national income and national welfare. As global integration generally raises national income (gross domestic product, or GDP), many economists rest arguments for it there. If pressed, they often argue that concern about how this national income is distributed post-integration is just not their business—that’s politics, not economics. This is a dodge, pure and simple. Economists expressing a preference for global integration are, in fact, expressing a purely political or ethical preference, not a scientific judgment. Nothing in the discipline of economics tells us that a policy that raises national income but leaves some individuals better off and some worse off is one that raises national welfare.

The only criterion by which economists can make firm, value-free judgments about economic policies and trends is what is called the Pareto principle. Pareto optimality
results only when an economic change makes one person better off without harming anybody else. Clearly, the outcomes of globalization in the U.S. economy are not Pareto optimal.

A weaker criterion sometimes put forward by economists is compensated Pareto improvement. This criterion argues that if the outcome of an economic policy or trend even makes it possible to make everybody better off, then it should be embraced. Given that there are net national gains from global integration, compensated Pareto improvement says that they must be grabbed. But this is absolutely a judgment rooted in politics and values, not just economic logic. Unless one is willing to argue that taking a dollar from an apparel worker to give a dollar and change to Donald Trump is good for America, we can make no inference about the impact of global integration on national welfare until compensation for its costs actually happens.

In any case, compensated Pareto improvement as a guide to assessing economic policy is routinely violated. If professional economists were polled as to whether the Bush tax cuts should be financed with across-the-board cuts in government spending, a majority (or at least a strong plurality) would probably say no. Yet, judged from strict compensated Pareto improvement, this policy could be a clear winner: tax cuts financed by spending cuts should (trivially) boost overall national income. It’s time the profession started asking itself more seriously why compensated Pareto improvement applies so forcefully only to globalization.

Another key strategy for minimizing the costs of globalization is to scale them against inappropriate benchmarks. The most common comparison weighs the upward redistribution caused by globalization against the total redistribution that has occurred in recent decades. The problem with this comparison is that this overall rise in inequality has been so huge that even a non-majority part of it translates into thousands of dollars of losses for workers on the losing end, losses which repeat (and grow, as trade flows grow), year after year. Globalization might be a minority player behind the rise in inequality, but it’s not a minor one.

Lastly, there is a common distortion of the globalization debate in the United States that is rooted, at least, in a sound progressive concern: access to the U.S. market creates opportunity for the world’s poorest workers and must be safeguarded on these grounds. The concern is real and ethical, but it is not necessarily one well-served by obfuscation regarding globalization’s impact on American workers. Further, it’s a concern not at all well-served by the globalization status quo. While those expressing angst about globalization are frequently tarred as protectionists who want to choke off access to the U.S. market for exports from poor nations, the truth is that the globalization status quo provides this access only at a heavy price. This price is generally a radical reduction in the policy-making autonomy of U.S. trading partners, a reduction demanded in the treaties routinely mislabeled “free trade agreements.” These agreements generally make liberal access to the U.S. market contingent upon the adoption of a range of policies that are not necessarily trade-related but that are amenable to the global corporate class. Today’s warriors for the globalization status quo have little reason to preen about what they’ve delivered to the poor nations of the world, and progressives shouldn’t be at all queasy about calling for a fundamental re-thinking of the global trading system.

Compensation: How much, and how delivered?

There is an enormous chasm between the income losses felt by American workers on the wrong end of global integration and the solutions that are generally prescribed
to compensate them for their troubles. Ironically, even those advocating for workers harmed by globalization often end up demanding weaker medicine than the economics warrant.

An utterly appropriate demand in trade policy is that all trade agreements establish the adoption and enforcement of labor standards protecting workers’ rights as a precondition to favorable access to the U.S. consumer market. This is good economics and good politics, for a number of reasons. What it is not, however, is particularly protective of American living standards in the face of global integration.

Another appropriate reform of globalization as currently practiced concerns the utterly non-trade-related clutter (generally originating in demands from the corporate sector) that finds its way into almost all trade agreements, including agreements for membership in the World Trade Organization. Commitments to enforce U.S.-style intellectual property laws, the restructuring of financial sector regulations, and detailed protections of investor rights against expropriation (defined liberally at times to include any government policy that hurts profits) constitute the lion’s share of these agreements. Many advocates insist that the overweighing of corporate interests over all others has resulted in trade agreements that harm U.S. workers by straying too far from simple and clean trade liberalization. They also rightfully point out the irony: if you want free trade, why do you need all these agreements and protections?

Like the push for worker protections, the campaign against corporate clutter in trade agreements is good economics and good politics, but not particularly protective of American living standards in the immediate future. The first-order threat to the living standards of U.S. workers posed by integration of the United States and global economies stems from the very fact of this integration, not its terms. The terms of integration can lead to marginal improvements in outcomes for American workers (maybe more substantial improvements over a long time horizon). More important, these terms have great influence on the effect of global integration on less-developed countries. For these reasons, it is vital to get these terms right. Even when we do, however, the very fact that a comparatively rich and labor-scarce U.S. economy is merging with a poor and labor-abundant global economy will put pressure on the living standards of U.S. workers for decades to come.

If crafting fairer international rules of the game isn’t the answer, what is? Go back to what economics teaches about trade: it increases national income while simultaneously
redistributing it. We’d like to keep the increase while making sure the redistribution doesn’t leave large swaths of Americans worse off. The way to do this is through compensation, and the political and ethical case for this compensation is crystal clear. Global integration is driven by conscious policy decisions made by the government, and its utterly predictable outcome is reduced growth in living standards for many, even most. Just as when a homeowner has his or her house claimed by the government to make way for a public highway, ethical politics demands that compensation be paid to those who have their individual circumstances damaged in the name of the collective good.

Many in the globalization debate have accepted this premise in principle, but the specific compensation measures they endorse are insufficient to meet thescale of the redistribution. Trade Adjustment Assistance (TAA), perhaps the best known program for aiding workers damaged by globalization, provides expanded unemployment benefits and payments for training to workers directly displaced by imports. An oft-recommended supplement to TAA is wage insurance, which would pay import-displaced workers some fraction of the difference between the wage they received at their old job and the wage at new employment.1 TAA and wage insurance are premised on the belief that the costs of globalization are both small and concentrated, consisting only of the adjustment period when workers displaced by imports have to find new jobs.

This book documents just how much larger the costs of globalization actually are to workers on the losing end. These costs consist not just of jobs displaced by imports but also of the reduced wages for workers subsequently competing with the displaced. The pull of globalization on living standards will get even stronger in the future. The service sector, once thought to be largely insulated from global competition, is beginning to see more and more of its output traded across national borders (accounting services and software programming, say).2 This offshoring of service work gives globalization a much longer lever with which to affect the U.S. economy, and it has huge potential implications for American workers. The scale of the coming costs from globalization for workers on the losing end requires much more serious thought about the scale of policy responses.

Thinking big

The years following World War II saw an embrace of Keynesian macroeconomics. The enduring lesson of this age was that allowing business cycles to run their course was wasteful, not palliative, and that responsible governments should use policy tools to fight downturns. In the first three decades of the postwar era, macroeconomic policy alone was able to smooth out much of the risk and volatility faced by American households. Hard times in this period generally came to them all at once, in the form of recessions, and good times were shared equally across the distribution of income and earnings.

The commitment to full employment provided much of the insurance against economic hardship that most households needed, both through high and rising wages and employer-based social insurance programs. While this coverage of social benefits and family-sustaining employment was never universal (nor in any way doled out fairly), for decades after World War II the trajectory at least was right and a larger number of workers enjoyed them as time passed.

In recent decades, however, the pursuit of full employment has faltered, and individual outcomes no longer correlate so tightly with the ups and downs of the broader economy as in the past. The breakdown of institutions that shared risk and benefits (unions and minimum wage floors) has conspired with globalization to erode the commonality of economic experience in America.

What the American economy needs today is a policy commitment as big as the embrace of Keynesian macroeconomic policy, a commitment driven by the recognition that there is no one American economy anymore. Instead, American households face vastly divergent struggles to carve out a secure economic future for themselves, and they are buffeted by arbitrary events outside their control.

To deal with a harm as large and widespread as globalization has wrought (and has the potential to inflict in coming decades), we need to think more broadly about public policy that re-links aggregate and individual prosperity, a policy that uses all the levers available to a government genuinely concerned about economic security for its citizens: social insurance, public investment, fairer economic rules, and redistribution when other tools fail to provide egalitarian outcomes.

This is not a new idea. The imperatives of globalization have been a primary force for creating and sustaining expansions of the welfare state and social democratic policies across much of the developed world. Perhaps because of chance or because of differences in our politics, this hasn’t happened in the United States, and instead we have been content to allow globalization without compensation to proceed apace. This book aims to show just how much this complacency has already hurt us and to spur action to keep the damage from growing.

The first chapter provides a birds-eye view of trends in globalization and inequality in the U.S. economy over the past 30 years. Greater flows of international goods, investment, and people have been accompanied by greater gaps a mong income levels. The growing gaps are not just the result of the rich getting richer faster, which they have; it’s also the result of the middle and the bottom falling.

The numbers tell the story, and these are detailed in Chapter 3, which explains the economic theories underlying the effect of trade flows on wages and examines and updates recent studies that have quantified the magnitude of the effect. But before getting into the hard-nosed economics, Chapter 2 looks at the phenomenon that is hard to quantify but theoretically important: the “threat effect,” or the impact on a worker’s bargaining position of the possibility of having his or her job displaced by imports.

Chapter 4 looks ahead to the potential impact of the relatively new practice of offshoring. Economics has yet to fully examine this phenomenon, but offshoring has the potential to intensify downward pressure on U.S. wages and, by turning comparative advantage on its head, even make the nation as a whole poorer.

Chapter 5 estimates in dollars the cost of globalization for the individuals and households adversely affected by it and provides a number of economic benchmarks (the cost of health care, college education, rising energy prices, Social Security reform) to put these costs in perspective. The final chapter sums up and makes policy recommendations.

Endnotes

1. A small wage insurance pilot program now exists under TAA.
2. See Delong and Cohen (2005) and Blinder (2007).