Free Trade in the Age of Economic Discontent ; Comparative Advantage under Globalization

Free Trade in the Age of Economic Discontent; Comparative Advantage Under Globalization

Dr. Michael Sakbani is a professor of economics and Finance at the Geneva campus of Webster-Europe. He is a senior international consultant to the UN system, European Union and Swiss banks. His career began at the State University of NY at Stoney Brook, then the Federal Reserve Bank of New York followed by UNCTAD where he was Director of the divisions of Economic Cooperation, Poverty Alleviation, and UNCTAD`s Special Programs. Published over 120 professional papers.

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Saturday, September 24, 2014

Free Trade in the Age of Economic Discontent;     Comparative Advantage under Globalization

By

Dr. Michael Sakbani

The populist rhetoric on free trade

In the 2016 Presidential campaign of the US there seems to be a quasi transpartisan rejection of the Free trade agreements such as the Atlantic and Pacific treaties under negotiations as well as NAFTA. The Republican candidate, Mr. Trump, has been railing against trade agreements which he claims benefit China and other exporters and cause job losses in the US [1]. This is hardly in line with the traditional free trade views of the Party and its establishment. Similarly, the Democratic candidate Hillary Clinton is distancing herself from her previous views on free trade and these agreements proper, as she comes under the combined pressure of the Trade Unions and the observed populous rejection of such deals, especially in the Mid-West, which is now labeled the Rustbelt of the country. Indeed, the US economy has witnessed a hollowing out of industrial jobs in many localities and drift of wages towards lower-paying service jobs[2].

 Empirical surveys by trade economists contest these impressions and show a net job increase over the past two decades[3].  Moreover, most trade economists have documented empirical evidence on the positive impact of trade in the US on productivity. This obtains via an 18% increase in labor productivity, which accounts for about a quarter of total factor productivity [4], There is plausible evidence that trade helps to the spread of technical progress [5], An almost uncontested fact is that trade increases consumer welfare on account of the increased variety and availability of goods and their lower prices[6].  There is also evidence on increased investment driven by inflows of Foreign Direct Investment through strategic positioning of international firms [7] And last, but not least, the taming of inflation in our times on account of the lower prices of imports.

Why is it then, that there is a populist rejection of free trade and a questioning of its benefits?

 The classical setting of the law of Comparative Advantage

Economists since David Ricardo`s work in 1817 have adhered to the law of Comparative Advantage and its growth complement through investments in  industries with new jobs higher on the technical ladder than the ones they replace. This implies four things: one, new advanced technology is accessible to all firms, two, dismissed workers can take on higher -skill jobs created by the new technology, three, factors of production are largely immobile and fourth, firms are likely to choose to invest where jobs were lost. In our world today, these assumptions are rather ambiguous.

To throw into sharp relief these ambiguities, it is appropriate to place the world the economy in the context of globalization and the observed behavior of global firms since 1990.

Technical progress has since the late 1980`s been capital and knowledge-intensive. Robotics have replaced man and rendered many manual jobs obsolete. Thus, labor-saving has been an important characteristic of recent technology. The new technology requires, however, education and informatics skills beyond the previously acquired education of many workers. We are consequently witnessing an increased marginalization of lower-skilled workers in the global economy. This is reinforced by the increased importance of services in international trade and even its more exigent demands for skills. Trade in services has rendered services quite mobile, a fact that classical economists did not reckon with. In addition, the global firm has itself become mobile and non-beholding to any specific state. Its preferred location is where its costs, especially labor costs are less.

 

To be sure, there has been a net increase in jobs. But the evidence on net job growth cannot be taken on face value. Created jobs are the result of the trend growth in the internal economy as well as international trade. None of the econometric studies has successfully disentangled this confluence and identified the causal independence in a satisfactory way.

Technology in the global economy is not necessarily available to all firms as the theory implies. It is the giant global firms that usually develop or own the technology. These firms having perfect mobility, will not necessarily locate the new jobs in the same locations as the replaced jobs. It is observed that global firms seek a maximum increase in their equity capital by decreasing their costs any way they can. When Jack Walsh left General Electric, he had an enviable record in increasing GE equity value and was hailed as one of the great captains of industry. His $421 million package upon leaving was a testimony to the behavior of global firms and their ethos. Mr. Walsh accomplishment was in cutting tens of thousands of jobs and gutting middle management as well as reducing expenditure on R &D to develop new products. His successor came into a weakened firm with few new products in line and a lot of business outside its core competence in various places.

In a competitive global economy, discharged laborers are not all employable because of their prior educational and skill profiles. On the other hand, in particular, training older discharged workers and endowing them with new skills is not always feasible and is costly; often it is cheaper to go elsewhere. In addition, since the new capital and information-intensive technologies are labor-saving, there is the demand for labor is cut down and it is likely that discharged laborers will face structural unemployment. We see evidence of that in the decline of men`s participation in the labor- force. In other words, the closure of global firms inflicts often likelihood of creating structural unemployment for those marginalized by globalization. Adding to that the empirical observation that global big firms create relatively fewer jobs than small and medium-size firms[8], the conclusion that employment has not improved in the last decade has become obvious. Moreover, the increased importance of global firms with their entrenched ethos and practices is making unemployment the great economic problem of our times.

At the time of Ricardo in the early 19^th century, the world did not have great differences in the standards of environmental protection and social labor norms among industrial countries. Today, these standards are quite heterogeneous. Thus, there is a bias in favor of poorer, cheaper countries with lower standards, something that comparative advantage does not fully account for. The search for cost advantages usually results in choosing new locations, leaving behind pockets of industrial desolation in many countries with higher labor and environmental standards.   

 These phenomena observed under globalization necessitate extending social safety network by the governments at the same time that their fiscal base is eroded by the emigration of firms. Recently, it was reported that some major firms, Apple, Starbucks and IKEA for example, have found tax-havens in Ireland and other places via special tax-deals escaping paying taxes where their sales were. That means when jobs are lost to comparative advantage, it makes a difference which country lost jobs and which one gained jobs and what are the circumstances therein. Countries with high social safety standards will fare better than those with limited public aid and therefore the degree of public discontent will be lower. The public expenditure on retraining and retooling discharged labor is only .01 percent of the GDP in the US, but it is 6 times higher in Germany.

 Under globalization these propositions renders firms non -neutral with respect to job locations, which breaks the link between new technology and new investment in respect of geographic location, a cardinal implication of the classical trade theory.

Towards a critical evaluation of received wisdom

The global firms, especially US firms, are the great gainers from free trade, their profits and the bonuses of their executives are staggering [9]. These gains are contemporaneous with losses in many areas for many social segments. This dichotomy is generating populous resentment and angst among wide segments of society. The popularity of political figures like Mr. Trump in the US, Madame Le Pen and her“ Fronte Nationale” in France, the rise of extreme rightists in Germany and Austria together with the Brit-exit in the UK, are all manifestations of economic and political marginalization of populist classes. Many feel left out of the game. The result is to facilitate the rise in democracies of demagogic nationalistic populism, thereby jeopardizing the gains from trade and finance openness. To protect the economic gains of freer trade, the benefits must be spread more widely and global firms must meet some standards of social obligations.

There is a need for the economic profession, the international institutions of economic cooperation and business to revise the received trade theory, the prevailing practices of global firms and the dispensed economic advice in the light of these facts and to look carefully into the violations of the prerequisites of free trade.

Several things can be done.

With interest rates at a historical low and inflation under control, fiscal policies in many affected countries should embark on public investment and on encouraging parallel private investment, in infrastructure and clean green technology. The macroeconomic climate has profound implications on the labor markets and on arresting the observed decline in the participation rates of male workers in the labor force especially, in the US. One of the disturbing factors in the slow recovery from the 2008 crisis has been the simultaneous deflationary fiscal policies adopted by so many developed countries who are trade partners. With monetary policies reaching their limits, the global pattern of fiscal policies needs attention, it is an economic truth that nobody will fare well if trade partners are all deflating at the same time.

Another fiscal measure would be to invest in expenditure on rehabilitating the skills of discharged workers at higher standards than is currently practices, especially in the US and the UK.

Globalization has resulted in increasing the dominance of big oligopolistic firms all across: big banks, big service firms, big electronic firms, big informatics firms and so on. The cash coffers of these firms are enormous and their impact is unprecedented. Competition laws should breakup such concentration and increase competition and this needs international cooperation under globalization.

Globalization requires liberalization. The liberalization of financial markets and the unfettered movement of capital and labor are an integral part of the globalization scene. This liberalization has increased hot money movements and portfolio short term capital movements. In 1997, we saw in the Asian crisis the example of countries following the right macro policies tipping into crisis as a result of the disruption and sudden outflows of such short term finance. These countries were destabilized and went into a balance of payments and a currency crisis. International cooperation to taxing such movements would be appropriate in order to give a breathing space for the affected economies.

Finally, there should be international cooperation on taxing transnationals in accordance with the share of each country in total firm`s profits so that globalization, which imposes fiscal burdens on states, does not become an enabler of tax- evasion.

 Such measures would go a long way towards protecting openness and gains from trade under globalization.

(Geneva, September 20, 2016)

                              Notes 

G

[1] Donald Trump has made international trade in general and that with China in particular an essential part of his platform. For quotes and speeches, see On The Issues, 2016.

[1] For an excellent summary of the empirical evidence on US trade, see Office of the PresidentPresi9dent of the USA, The Economic Benefits of US Trade, Washington DC, 2015.On job losses see The Economist, April 2, 2016.

2] The Economist,   April 2, 2016.  See also Frankel & Romer, “Income Growth and Openness”, NBER, 1999. See also Office of the President, Op. Cit. (2015) p. 23.

[3] Idem, Office of the President, (2015),  p.3.

[4] Idem, p. 4. See also, Bernard, A. Bradford, J. “Exporting and Productivity in the US” Oxford Review of Economic Policy, 2004.

[5] Atkins, Khandelwal and Osman, Exportin and the Performance of the Firm, NBER, 2008, paper no. 20690. Broda, Christian Weinstein, “The Gains from Variety”, The Quarterly Journal of Economics, 121no. 2, pp. 541-585.

[6] Office of the President, Op. Cit.., (2015).

[7] Various empirical studies.

[8] Markus Gehring, “Why the EU is coming after Apple”, CIGI, September,       Free Trade