The Impact of Global Trade on Workers and Policy Responses: A Critical Analysis of Robert Z. Lawrence’s Perspective

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I have to build a study case Resist the binge Author: Robert Z. Lawrence Date: July-August 1996 From: Foreign Affairs(Vol. 75, Issue 4) Publisher: Council on Foreign Relations, Inc. Document Type: Article Length: 1,587 words Content Level: (Level 4) Abstract: Kapstein ignores several other factors as he blames workers’ problems on global trade. Technological change is surely biased toward higher-skilled workers. Compounding the problems are slow service productivity growth in the US, overregulation in Europe and disastrous monetary policies in Japan. International trade has only a minor effect on workers’ woes. Governments should launch programs to help workers keep up with change, but expansionary fiscal policies will only lead to spiraling inflation. Full Text: Kapstein is correct in saying that the problems of workers in the developed world are serious. I agree, too, that ignoring their plight could have tragic political consequences. But by overstating the effects of the world economy and ignoring the other sources of these problems, Kapstein could well promote the tragedy he seeks to avoid. I also take strong exception to his proposal that governments increase spending. Expansionary fiscal policy would severely set back the progress governments are finally making in bringing their expenditures in line with their revenues. First, expansion driven by a fiscal stimulus is not needed. To the degree that there is insufficient demand in the developed countries – in Europe and Japan, but not the United States – domestic monetary policies are quite adequate for the task. Second, demand-side expansion can do little to solve the structural supply-side problems about which Kapstein is concerned. Economic growth is fundamentally limited by the expansion of productive capacity. Any demand expansion beyond that capacity will translate purely into inflation. WAGGING THE DOG Kapstein argues strongly that serious labor market problems such as slow productivity growth, growing inequality, and rising unemployment in the developed countries reflect the increasing influence of the world economy on local conditions. As every student of statistics knows, however, correlation should not be confused with causation. Globalization has increased at a time of poor domestic performance, but is globalization truly culpable or just an innocent bystander? Globalization is important in Western economics. International trade and investment have expanded rapidly, but consider some facts about the United States. Eighty-eight percent of the goods and services Americans buy, they produce themselves. Eighty-two percent of Americans are employed in sectors Eke government, construction, nonprofit organizations, services, utilities, and wholesale and retail trade, in which international trade is barely a factor. Moreover, America’s international interaction with developing countries remains even smaller. In 1994, U.S. non-oil imports from developing countries amounted to just 3 percent of GNP; exports to developing countries were just 2.5 percent. Employment in the foreign affiliates of U.S. multinationals in developing countries is less than 5 percent of overall U.S. manufacturing employment. I am not saying this interaction has not grown rapidly or even that its effect at the margin may not be greater than these numbers suggest, but to point only to trade with developing countries as the source of workers’problems is to wag a very large dog with a rather small tail. Most problems in the developed economies would exist even if those economies were not increasingly open to trade and investment. Similarly, most of the remedies require changes in domestic policies unconstrained by international forces. By focusing on the convenient scapegoat of international trade, Kapstein gives short shrift to other important problems, some unique, some shared, that developed countries confront. He overlooks the fact that in the United States, slow domestic productivity growth in service sectors not exposed to trade has led to wage stagnation; that in Europe, sclerotic labor markets and overextended government regulations inhibit structural change, regardless of whether the source is internal or external; and that in Japan, the current recession reflects the aftermath of a splurge sparked by domestic monetary policy, and the recession’s persistence stems from failures to deregulate domestic markets and deal with a domestic banking crisis. Kapstein is also too cavalier about the fact that in all countries these problems have been compounded because technological change has shifted demand away from the less-skilled and less-educated workers. With very few exceptions, economists who have studied the impact of trade with developing countries on labor markets conclude it plays a relatively minor role.(2) In the 1980s, during which Americans experienced widening inequality in their income levels, neither the quantities of imported goods nor the changes in prices the imports caused were large enough to give trade much of a role. Even those in the United States who believe trade to be significant suggest it explains no more than a fifth of the growth in the relative wages of educated workers. Almost all economists assign a much larger role to the technological changes associated with the introduction of computers and to the changes in management practices that have skewed demand toward more skilled workers while at the same time providing disappointing increases in productivity. Kapstein dismisses studies by me and others with the claim that trade induces technological change. He argues that “a significant share of new technology, for example, has been induced by foreign competition.” In fact, research on the effects of trade on both productivity growth and research-and-development spending confirms the maxim: sometimes a kick in the pants gets you going, and sometimes it just hurts. Some firms, typically in concentrated industries with surplus profits, are spurred to innovate and to spend more on research and development. But other firms, especially those in highly competitive industries, are more likely to respond to international competition by cutting back on investment. It turns out that most trade with developing countries occurs in sectors such as clothing and footwear that are highly competitive. This suggests that when it comes to trade with developing countries, the innovation caused directly by trade is relatively small; indeed, it is more likely to be slowed by trade than sped up. Moreover, to the extent that some trade does lower the wages of unskilled workers throughout the economy, it discourages labor-saving innovation. Kapstein’s account of the role of trade is also imprecise. Does he have in mind all international trade or just trade with developing countries? Since wages in developed countries are quite similar, it must be developing countries he has in mind when he invokes the Stolper-Samuelson theory to argue that trade lowers the welfare of the least-skilled workers in the developed countries. But at another point he talks about the investment-generating effects of trade in industries such as automobiles and steel, in which the developing countries are not major players. THE GROWTH CEILING I share with Kapstein the view that government should assist workers in adjusting to change. Training and education are crucial in helping workers adjust, but it is impractical and unrealistic to see them as the only answer. I also concur that the tax system should be used to boost the incomes of the working poor and facilitate job turnover. Europe’s strength is that it helps its poor; its problem is that its inflexible labor markets fail to create jobs. America’s strength is its flexibility and job creation; its problem is that the income of the least-skilled workers has been depressed. The ideal system would combine American efficiency with European compassion. A deregulated labor market and a generous earned income tax credit would do exactly that. Let wages be freely determined in the market, but let the government safeguard the workers through the tax system. Where I part company with Kapstein is on his call for coordinated expansionary fiscal policies. Indeed, I think his prescription of tight money and loose fiscal policies has it exactly wrong. Loosen money, perhaps, but keep fiscal policy tight. Currently, there may be some room in Europe and Japan for monetary expansion and, in my heretical view, in countries such as France even room for exchange rates to float. But soon this expansion in demand will strike the ceiling set by the supply capacity of the economy. In a fully employed economy, that capacity is equal to the rise in output per worker plus the growth of the labor force. Once that ceiling is reached, efforts to expand demand can only produce inflation. There is some controversy over whether the United States has already reached the maximum growth rate. I would err on the side of caution, but if you think more stimulus is called for, leave it up to the Federal Reserve. However, calling for bigger budget deficits and more public works programs could not be more wrongheaded. If the problem is slow productivity growth, the country surely needs more investment. But change the mix and not the size of public spending. Let fiscal policy contribute to supply growth by substituting public investment for public consumption, but not through bigger deficits. Increased government borrowing leads to higher interest rates and crowds out private investment. Public works programs delay market adjustments and fail to give workers the skills they need for viable long-run employment. Moreover, such fiscal expansion reinforces the tendency to deny the need for adjustments by piling up debt for future generations. The simple truth is that, notwithstanding Kapstein’s pronouncement, monetary and fiscal policies cannot “be structured in such a way as to ensure . . . that working people can earn a living wage.” Successful fiscal and monetary policies may keep inflation low and achieve full employment, but only increased productivity in the private sector can raise the marketplace earnings of working people. If these earnings are inadequate, redistribution may have a role. But bigger government deficits win only pass the burden to future generations. (2) For a more extensive discussion, see my single World, Divided Nations? The Impact of Trade on OEDC Labor Markets, Washington: Brookings Institution, forthcoming. Copyright: COPYRIGHT 1996 Council on Foreign Relations, Inc.

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