Globalisation, wages, jobs and myths

By Gerard Jackson
web posted October 1998

Though a great deal has been written and said about globalisation, especially in the media, it is rare for anyone to attempt a definition. Yet without a clear and reasonable understanding of its meaning it is impossible to carry out a rational discourse on the subject. This has allowed the enemies of the market, and particularly free trade, to demonise the word. They have shamelessly used it to exploit fear and ignorance, falsely claiming that it lowers real wages, destroys jobs, causes financial crises, creates social tension and undermines national sovereignty. None of these accusations are true. Nevertheless, they seem to have been elevated in the public mind to the status of self-evident truths. (No wonder the vast majority of Australians favour tariffs). On the other hand, it must be said that most free marketeers, at least in Australia, have done really nothing to dispel these myths, seemingly contenting themselves with dining behind closed doors with cynical politicians in the peculiar belief that this will somehow disabuse the Australian public of its economic errors. While this tactic may have given these marketeers an inflated sense of their own importance, its only success has been to leave the field open to rabid interventionists who successfully exploited this opportunity to once again mislead the public.

Globalisation is generally presented as something new, if not alien. A mysterious and independent process created by a post-Cold War world dominated by freewheeling capitalism. A process that defies governments, national frontiers, cultures and even economic laws. A process to which we must submit much as the ancient Caanites submitted to Moloch. All of this is very melodramatic and very wrong. The truth, fortunately, is much more banal. Far from being a sweeping new force in world affairs globalisation is just a handy word for the internationalisation of trade and capital. The other name for this process is free trade.What many fear today was common place a hundred years ago. Globalisation is no more damaging or destabilising now then it was in the 1890s.

That the latter part of the nineteenth century and the early part of the twentieth should be a period noted for rising globalisation will no doubt come as a surprise to many, especially those who are convinced that only computerised networks made the globalisation of, for example, capital possible. Many would argue, however, that the amount of capital flows and the speed by which they can be switched is unprecedented and gives speculators the opportunity to profit from the rapid selling and buying of currencies which in turn triggers financial crises. Moreover, greater mobility of capital means that companies can quickly move from high-age to low-wage countries thus forcing down real wages in the former countries while exploiting 'cheap labour'. As we shall see, none of this holds water.

Two fundamental things are largely missing from the globalisation 'debate': economic reasoning and a historical perspective. The historical angle can be dealt with very quickly. The period 1800 to 1913 witnessed rapid rates of growth in foreign trade which saw world trade grow at a far faster rate than global output. Foreign trade raced ahead at rates of 29 to 64 per cent for certain decades, translating into per capita growth rates of 23 and 53 per cent, even though global output is estimated to have grown at only 7.3 per cent a decade during this period. (It should be remarked that the growth in trade did not really 'take-off' until the 1850s). By 1913 the per capita volume of foreign trade was 25 times greater than its 1800 level while per capita output was only 2.5 times as great, meaning that in 1913 the ratio of foreign trade to global output was more that 11 times its 1800 rate. Estimates put the proportion of foreign trade to total output in 1913 at 33 per cent and about 3 per cent for 1800. This is a colossal increase by any measure.

There is no doubt that the nineteenth century increase in international trade and the specialisation of labour and capital upon which it was based could not have taken place without large-scale capital flows. The very thing that is subject to so much harsh and ill-informed criticism today. Some idea of the scale of these capital flows can be gained from Britain's experience. Between 1870 and 1914 her capital exports averaged 4 per cent of GDP; they averaged 7 per cent from 1905 to 1913, reaching 9 per cent the following year. By 1914 her total foreign investments came to a staggering 20 billion pounds. During the whole of this period Britain had been the world's largest creditor nation. The size of the period's capital flows are particularly remarkable once we adjust them for purchasing power and relate them to the size of global income. What is also of interest is the direction of these capital flows. In the case of Britain over 50 per cent of her investments 1914 were concentrated in Europe, the US and the dominions, with the US enjoying about 22 per cent of the total.

Coming to the present we find that opposition to globalisation invariably turns out to really be opposition to free markets. Overall, the kind of charges levelled against the alleged evils of globalisation turn out on closer examination to be no different from those levelled against the free market. In other words, attacks on globalisation are really masking attacks on capitalism. In the words of Bob Santamaria, one of Australia's most prominent interventionists and monetary cranks, "Capitalism is the real enemy". Geoffrey Barker is another statist fundamentalist with an obvious loathing of economic reasoning. A journalist with the Fairfax stable, Barker's usual ideological tactic is to dismiss market economic analysis as "free market fundamentalism". This approach, apparently, is all that is needed to demolish any free-market argument. Unfortunately, much of the economic rot that Barker is well noted for regurgitating seems to be largely accepted by the public. So when a bigoted economic illiterate like Barker uses The Australian Financial Review (9/12/97) to parrot anti-globalisation propaganda, you can bet he is preaching the equivalent of the party line.

Drawing on an article by Rodrik ("Sense and Nonsense in the Globalisation Debate", 1997 summer edition of the Journal of Foreign Policy), Barker tells us that Rodrik sets out the globalisation issues "with splendid clarity". (Coming from Barker, this kind of praise amounts to the kiss of death). Fortunately Rodrik's argument contains the bones of all the anti-globalists' points. Rodrik claims to have found a relationship between unemployment, globalisation and increasing demands for more welfare. This is just not true, particularly in the case of welfare. Increasing demand for welfare in Europe and America since the end of World War II has had nothing to do with foreign trade. No political party ever proposed increased social spending to compensate for the alleged costs of free trade. Does anyone really believe that it was the rising volume of foreign trade and capital flows that caused Johnson to implement his big-spending "Great Society" programmes? Observers should also take note of the fact that an increasing amount of social spending is going to pensions, health and education. None of which have anything to do with foreign trade. Quite frankly, this argument has no merit at all, except for anti-market journalists looking for a club with which to beat the market. The anti-market likes of Barker make a particular point of ignoring, if not actually denying, the enormous role that union-created unemployment plays in expanding the demand for more welfare.

Behind the welfare argument is the belief that globalisation (free trade) raises the level of unemployment in high-wage countries and lowers living standards. This is an old anti-free trade argument that has no substance at all. It can never be sufficiently stressed that free trade does not raise the volume of unemployment (our unions do that). What it does do is reallocate labour and capital to more efficient lines of production. It is this increased efficiency that raises welfare by providing cheaper goods and services thus increasing purchasing power. Protectionists, in all their guises, argue that by opening up our markets real wages, especially of the unskilled, will be driven down by 'cheap' foreign labour and capital outflows to 'cheap' labour countries. The first argument is based on the assumption that by importing cheap goods we are, in a sense, actually importing 'cheap' labour which therefore indirectly competes against unskilled domestic labour hence driving down its price.

This is a very plausible line of reasoning and is obviously based on the fact that the price of similar goods, including factors of production, tend to be equalised by the market process. The error here is the failure to realise that for prices to be equalised goods and factors of production must be free to move. This error has resulted in many people, including a number of economists, confusing the product of labour with labour services. It is quite possible, however, that in some circumstances certain types of foreign skilled labour can compete directly with similarly domestic labour without migrating. For example, the nature of computer technology has made it possible for Western companies to directly bid for the services of Indian programmers. So theoretically technology has made it possible to combine national markets for the services of this type of labour into a single international market place in which incomes will tend to be equalised because labour services will be hired directly instead of their products just being bought.

Free market economists should continually point out that in a free market there always exists a tendency for every factor to receive the full value of its marginal product. (For some strange reason Australian economics commentators sympathetic to the market never refer to this very important economic fact). Non-specific factors, labour in particular, have a general array of descending marginal productivities. The wage that labour receives tends to correspond to its market rate (assuming a free labour market), which is what it could get elsewhere. Furthermore, the more economically advanced the country, the greater the array of productivities and thus the smaller will be the discontinuities between them. America provides some interesting examples of this process. A 1985 US Department of Labour survey found retrenched workers in the textile industry were unemployed for an average of 13.3 weeks before finding work at similar wage rates.

The point is that factors cannot be paid less than their market rates for very long. In turn, real wages are basically determined by the amount of capital invested per head of the population. If there was no restriction on the international movement of labour wages would probably be quickly equalised as immigrant workers1 drove down the value of labour's product by expanding the domestic workforce. However, by importing the products of 'cheap' labour and not its services we actually raise domestic incomes: first, purchasing power is raised by the obvious effect of allowing consumers to purchase more for less expenditure; second, purchasing power is further augmented by releasing resources for use in more efficient capital combinations. Moreover, buying more imports raises the demand for exports and hence labour. The truth is that 'cheap' foreign labour has found itself 'shut out' by immigration laws which confine it to an area in which its marginal productivity, and hence real wages, is much lower than that of Western countries.

The Stolpert-Samuelson theorem predicts that free trade will lower the real income of relatively scarce labour that is producing tradable goods that can be bought from other countries in which similarly skilled but abundant ('cheap') labour is also being used in their production. The fallacy here is the implicit assumption that 'expensive' labour in the rich country is specific, i.e., it has no alternative use, or that it has extremely large discontinuities between its marginal productivities. But this is impossible. As we have seen, labour is faced with an array of the value of its marginal productivity's and these are the result of the country's capital structure. In other words, American labour, for example, is paid more than Mexican labour because America is a capital abundant country compared with Mexico. Importing cheaper Mexican goods, therefore, cannot bring about an unfavourable change in America's labour-capital ratio and thus drive down real wages rates.

Moreover, to support their anti-free trade case the likes of Rodrik would not only have to show that trade with low wages countries has increased significantly as a per centage of GDP (though this would not prove their case) but that the price of traded goods had fallen. The latter is very important because wage equalisation would be brought about by changes in the relative prices of goods. This means that the prices of tradable goods produced by unskilled American labour would have to fall. However, studies have conclusively shown that these price changes have not occurred. In any case, as I have already pointed, such price changes would not reduce real wages unless labour was specific. The anti-free trade argument on alleged falling wage rates in America is nailed by the fact that imports from counties whose wages are less than 50 per cent of American rates are only about 3 per cent of GDP compared with 2 per cent in 1960 when Japan and a good slice of Europe were in this low-wage category. In fact, in the early '60s the per capita income of every European country was less then the American poverty line of $3,000 a year. Why American wages were not driven down by 'cheap' European labour has never been explained by any protectionist. (Incidentally, in the 1920s many Europeans were demanding higher tariffs to protect themselves against more efficient high-paid American labour).

By now readers may have noticed that I have enclosed cheap labour in inverted commas. This is because I wanted to convey the fact that there really is no such thing in the sense that protectionists mean it. Labour can only be 'cheap' in relation to the value of its product. A well-known study by Stephen Golub, an American economist, found that though Malaysian, Filipino, Indian and Thai manufacturing wages in 1990 were only about 15 per cent of the American level, so was average productivity. What is particularly interesting, though not surprising, is that Filipino, Indian and Malaysian unit labour costs exceeded the US level. Economic analysis makes it clear that Asian labour is not so 'cheap' after all.

It should now be abundantly clear, even to ignorant anti- market ideologues like Barker, that it is ludicrous to blame free trade for rising social expenditure. It should be equally clear that free trade does not lower real wages or raise the level of unemployment. Nevertheless, it would be grossly misleading to suggest that free trade does not involve transitional costs. People do lose their jobs, firms do close down and some capital is lost. But it must be stressed that this happens all the time in every dynamic economy. New technologies, more efficient production techniques, etc., involve the same costs. Anti-free traders are being inconsistent, if not hypocritical, in ignoring this fact.

Barker picks up the Rodrik theme that free trade weakens social safety nets because the increasing mobility of capital is reducing the tax base. This is just plain wrong. If the tax base in rich countries is shrinking then so is their economies, meaning their living standards must also be falling. The likes of Rodrik claim that increased capital mobility also means less job security. These views are based on a very superficial view of the nature of capital. Capital is the material means of production, which consists of a complex heterogeneous structure. What Rodrik calls capital is the flow of savings that are converted into capital goods which are then integrated into the structure. When South Korea builds a chip plant in Britain, which it has done, it involves a considerable flow of capital. Now that the plant has been built it is 'trapped'; it is now part of Britain's capital structure. The same process takes place when Germany builds a car plant in China or Japan builds one in America. To claim, as Rodrik does, that these investments can be easily abandoned and thus do not provide job stability defies belief.

It is also argued that by opening up their economies richer countries will be forced to cut taxes and spending if they are to succeed in the international market place. (Countries do not compete in the economic sphere, firms do that). But there is no point in blaming a company for moving its operations offshore if domestic regulatory and tax policies reduce its competitive advantage. Critics seem unable to grasp that there really is a point where taxation and regulatory bodies will significantly retard growth. To hold free trade responsible for companies trying to escape onerous regulatory and tax regimes is like blaming surgeons for the existence of tumors. When these firms move they are really signalling that government policies are hindering economic growth.

One of Rodrik's solutions, apart from tariffs, to the phony problem of free trade is to (wait for it) impose a global tax on capital goods! This policy, as he well knows, would be guaranteed to reduce the international division of labour and capital which in turn raises global living standards. Such a policy would be a direct attack on the living standards of poor countries. And this is the man that the likes of Barker would have us take note of.

We can conclude that the charges levelled against free trade by Barker and his ilk do not stand up to scrutiny. Unfortunately, Barker's anti-market, anti-free trade drivel is a typical example of the lousy intellectual standards that govern the Australian media. While the likes of Barker dominate the media, the public will never be fully and honestly informed on the benefits of free markets. And people who are not properly informed cannot make informed decisions. But then, maybe they're not supposed to.

1This is not to argue that immigration will always drive down per capita income. It will not. In some cases it will actually raise it.

This piece originally appeared in The New Australian, No, 60, 6-12 January 1998

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