This article appeared in the NIRA Review, the journal of Japan's
National Institute for Research Advancement (Winter 1999)

THE REAL IMPORTANCE OF A GLOBAL ECONOMY

by Dean Baker

In recent years it has become fashionable for political figures to give speeches on "the growing importance of the global economy." It has gotten to the point that this phrase is a cliche that is rivaled for meaninglessness and repetition only by "a bridge to the 21st century." The United States is, and always has been, in a global economy. This does not mean that the government cannot maintain substantial control over the direction of the U.S. economy, nor does it mean that the United States does not have considerable discretion over the manner in which it integrates itself with the rest of world. The global economy is simply one of the factors that the government must consider in designing our economic policy, sort of like the weather.

Disingenuous and Real Arguments for Expanded Trade

Before explicitly discussing some of the key issues about the how the United States should integrate itself into the international economy, it is worth dispelling some of the most often repeated nonsense on this issue. It has become common for political figures to assert that "exports create jobs." President Clinton has often claimed that 30 percent, or more, of the jobs created in this recovery were due to exports.

While the statement "that exports create jobs" is true, the statement that "imports cost jobs" is true in exactly the same way. If 13,000 workers are typically employed to produce $1 billion in exports (the number the Commerce Department has used, adjusted for inflation), then $1 billion of imports represents 13,000 jobs that were lost in the United States. In this game of exports creating jobs and imports losing jobs, the net impact depends on the change in the trade balance. On that score we have seen a deterioration of $131 billion between 1992 and 1998. This means in the simple "exports create jobs" world, trade has cost the U.S. approximately 1,700,000 jobs over the first six years of the Clinton Administration.

Of course, more honest and knowledgeable individuals don't rely on this exports create jobs line to make the case for expanding trade. The more serious argument relies on either an economies of scale view, that by expanding the size of the market production costs fall, or the traditional comparative advantage view, that nations can gain by specializing in the goods they produce best.

Taking these in turn, the economies of scale view notes the enormous efficiencies that have been associated with the mass production of everything from toasters to computers. Machinery that can produce such items in vast quantities allows the cost for each unit to fall enormously. However, this sort of mass production can only be profitable, if the market is large enough to absorb huge quantities of output. For this reason, expanding trade to a world market will produce gains for everyone.

While there is clearly some element of truth in this view, it is questionable whether it really has much meaning in the context of the U.S. economy at the end of the 20th century. The U.S. economy by itself is already an enormous market. Furthermore, the United States presently has extensive trading relations with most nations. The idea that the per unit costs of cars or computers is going to fall further as a result of the small expansion in the size of this market that would result from removing more trade restrictions seems far fetched, at best. Clearly, most of the available economies of scale for U.S. producers have already been captured. While industry in developing nations may benefit from having access to the world market, the United States is not in the same position.

If the economies of scale view doesn't hold much water, there is still the standard economic argument for trade, comparative advantage. In this view, nations should specialize in producing the goods in which they are best, and export these goods to buy the other goods they need. The classic example (dating from Ricardo's work early in the 19th century) is that England should specialize in producing cloth, while Portugal specializes in producing wine. England then trades its surplus cloth to Portugal for that nation's surplus wine. This trade then makes both nations better off than if they had each tried to produce both wine and cloth.

The classic view of comparative advantage usually centered on specialization where natural factors played a large role in dictating the choice of goods. For example, Portugal's countryside is clearly more suited for growing grapes, while England and Scotland have vast expanses that are well-suited for grazing sheep. Over the last few centuries, the world has already taken advantage of most of the naturally dictated possibilities for comparative advantage. Farmers don't try to grow coffee in the Midwest and they don't try to grow wheat in Hawaii. In most cases (there are important exceptions) countries have long since adopted patterns of specialization that are dictated by natural factors.

The argument for comparative advantage at present does not rest on natural factors, rather it depends on economies being at different levels of development. Specifically, the poorer nations in the world have large pools of labor that can do the same tasks as many of the less skilled workers in the U.S. and other industrialized nations. Workers receive much lower wages in countries like Mexico, China, or Indonesia than do less skilled workers in the U.S. or Europe. This means that clothes, steel, cars, and other manufactured goods can often be produced at a much lower cost in developing nations than in the industrialized nations. The U.S. gains by purchasing these items from developing nations and then selling goods in which it has a comparative advantage. According to the theory, this would be goods that require relatively large amounts of capital and highly educated labor, such as airplanes and computer software.

There are several points that are important about this scenario that deserve attention. First, while standard economic theory indicates that the U.S. would gain from this pattern of trade, it also predicts that the gains would be quite small. Reasonable estimates of the gains from liberalized trade rarely exceed even 1.0 percent of GDP. This fact is acknowledged by honest advocates of expanding trade, such as Harvard's Dani Rodrick.

A second point is that a predicted outcome of this pattern of trade is a decline in the relative wages of less skilled workers. By importing goods that require a large amount of less skilled labor, we are reducing the demand for less skilled workers in the United States. This will lead to a relative decline in their wages. This is exactly what the United States has experienced in the last twenty years, as the three quarters of the work force without college degrees has seen a large relative, and absolute decline in their real wages. This decline cannot be attributable entirely to trade, but virtually all economists acknowledge that trade has been a factor.

It is important to recognize that the decline in wages for less skilled workers in not an accidental outcome of trade, it is the whole point. If the relative wages of less skilled workers did not decline, there would be no gains from trade. In other words, according to standard economic theory, expanded trade will provide small gains to the economy as a whole, but this will come at the expense of growing inequality. Most workers will actually end up losers in this picture.

Free Trade for Whom?

It is not surprising that large segments of the American population have opposed trade agreements like NAFTA and GATT. They rightly recognize that they stand little to gain by being placed directly in competition with workers in some of the poorest nations in the world. While the public may have little understanding of the theory of comparative advantage, they recognize that competing with Mexican workers who are paid $1 an hour will place downward pressure on their wages.

Higher skilled workers in the United States also understand this basic truth. However, these workers have considerably more political power and are therefore better able to direct the trade or immigration policies that affect their well being. For example, earlier this year there was a debate over the number of foreign doctors that should be allowed to enter the United States to practice medicine. The American Medical Association (AMA) argued for sharply limiting the entrance of foreign doctors, explicitly claiming that foreign doctors were depressing the wages of U.S. doctors. The AMA succeeding in getting regulations that sharply restricted the number of foreign doctors allowed to practice in the U.S..

It is worth noting that restrictions on the entrance of foreign doctors was never treated as a trade issue. In fact, the proponents of freer entry did not advance the argument that this would lower the cost of medical care to consumers and therefore provide economic gains. Rather they disputed the claim that foreign doctors depressed doctors wages and argued that instead they went to undeserved areas in inner cities and small towns. Both sides in the debate accepted the view that lowering the wages of doctors would be bad. The proponents of free trade were nowhere to be found in this dispute.

The debate over the entrance of foreign doctors shows clearly the class bias in trade policy. NAFTA, GATT, and other trade agreements did little to standardize medical training, accounting practices, legal procedures, or to make other changes that would give well paid professionals in the U.S. the opportunity to compete with relatively low paid professional workers in poor countries. Proponents of free trade, who come disproportionately from this protected minority of highly educated people, have shown little interest in freeing up trade in professional services.

Similarly, proponents of free trade in manufactured goods have been anxious to extend protectionism in other areas. Specifically, a major focus of trade policy has been to extend U.S. type copyright and patent laws throughout the world. Patents and copyrights are unambiguously forms of protectionism. In a free market, items subject to copyright or patent protection would sell for a small fraction of the protected price. In countries that don't enforce copyright laws, thereby allowing free market transactions, compact disks and video cassettes often sell for $1-2 each. By comparison their copyright protected price is in the range of $12-40. The economic loss associated with this type of protection is enormous. In fact, the static gains from eliminating patent and copyright protection would be hundreds of times as large as the gains from removing most existing restrictions on trade. Other types or trade restrictions rarely raise the price of a product by more than 10-15 percent.

Obviously there is a rationale for copyright and patent laws, but there is also a rationale for every other type of protection that has ever been imposed. There are alternative ways to support the artistic and intellectual work that is currently supported by copyright and patent protection. It is very questionable that the copyright and patent system provide the most efficient means os supporting this work. However, free traders are willing to uncritically accept protectionism in this case, without any real examination of the evidence that it provides gains for the economy.

In short, trade policy has not been an honest push for free trade across the board. Rather it has been a class biased quest to put less skilled workers in competition with low wages around the workers. The small economic gains from this expansion of trade go entirely to those at the top end of the income ladder. In this context, globalization has been and will be extremely important. It has been a tool for redistributing income upward. If it is allowed to continue in its current form, it will impose ever greater costs on the bulk of the working population of the United States.

Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.