The Adam Smith address: What difference does globalization make?

SYNOPSIS:

In the discussion about the impact of world trade and capital flows on the economy, much misinformation has been offered from people unfamiliar with both economic analysis and economic data that are readily available. Globalization makes very little difference in the determinants of overall national income, and redistribution has not been from labor to capital but rather from less skilled labor to more skilled. International trade has played a minor role in this redistribution. The focus in the debate should be on the facts - not the pronouncements of so-called experts.

I am delighted and honored to be here, and deeply grateful to the National Association of Business Economists for presenting me with the Adam Smith award. This means more to me than you may think. I have been unusually noisy for a serious academic over the past few years, and some of what I have had to say has not been particularly popular. In fact, a story about me in the British newspaper The Guardian bore the headline, "Lunch with the irritating professor." It is a great source of comfort to me to know that the members of the NABE, while they may not always agree with everything I say, understand that my polemics have had a serious purpose - that I am not being irritating for its own sake, nor for the sake of the notoriety it brings, but rather because I am trying to rescue economic discourse from the rather sad state into which it has lately fallen.

WORLD TRADE, CAPITAL FLOWS AND THE ECONOMY

Today I want to talk about a topic that has been central both to my polemics and to some of my research over the past several years: the impact of growing world trade and capital flows - of "globalization" - on both the real economy and the way we look at that economy. This is hardly a new topic; indeed, we might argue that concerns over globalization are where economics as we know it began. As an amateur intellectual historian, I claim that modern economics actually dates from a few years before Adam Smith's Wealth Of Nations; the key breakthrough was not by Adam Smith but by his good friend David Hume, whose Of the balance of trade- which argued that trade imbalances are self-correcting - had many of the key features of good economic analysis. In particular, Hume's work even today retains one feature I have learned is often a good sign that you are on the right track: people who regard themselves as sophisticated about economics, but lack the patience or humility to actually learn anything about the subject, continue to find Hume's argument absolutely infuriating. Any 200-year-old idea that can still reduce self-important people to spluttering fury must have some merit!

But while international trade is hardly a new idea in economics, over the past fifteen years or so concerns about globalization have captured the imagination of the public - or perhaps I should say have captured the imagination of policy intellectuals, the small but influential minority that largely defines the conventional wisdom of the moment.

I'd like to illustrate the flavor of much recent debate about the subject by quoting a recent, typical sample of writing about globalization. This particular quote is from Michael Lind. As many of you may know, he is a young writer who has achieved considerable prominence in the past year, with a well-reviewed recent book about America's social and economic future and a new job as senior editor at The New Republic. Here is what he had to say in Harper's, last June:

"Many advocates of free trade claim that higher productivity growth in the United States will offset pressure on wages caused by the global sweatshop economy, but the appealing theory falls victim to an unpleasant fact. Productivity has been going up, without resulting wage gains for American workers. Between 1977 and 1992, the average productivity of American workers increased by more than 30 percent, while the average real wage fell by 13 percent. The logic is inescapable. No matter how much productivity increases, wages will fall if there is an abundance of workers competing for a scarcity of jobs - and abundance of the sort created by the globalization of the labor pool for U.S.-based corporations."

The writing here is unusually vigorous, but the ideas should sound familiar. What we have here is a picture of a world in which the mobility of goods and capital means that the old rules no longer apply, in which high productivity no longer means high wages, because there is always somebody elsewhere willing to do the same job for far less money. I chose Lind's version because of the colorful language and for some other reasons that will become clear in a moment, but I could have found more or less the same view in any of dozens of articles, by Lester Thurow, Robert Reich, Edward Luttwak, Sir James Goldsmith, etc.

What is nice about Michael Lind's version is that it is an unusually clear illustration of some typical features of the current concern about globalization.

CORRECTING THE ERRORS

The first thing that is obvious from this quotation, if you are at all familiar with U.S. economic data, is that Mr. Lind doesn't know much about economics. In particular, the passage I just quoted turns out to be a classic example of what happens when someone who doesn't understand what economic statistics mean or how to use them tries to sound like an economic expert.

Let me briefly describe the howlers in his statement. That 30 percent increase in productivity took place only in the manufacturing sector; anyone who has even a bit of familiarity with recent economic trends knows that vigorous manufacturing productivity growth has been offset by near-stagnation elsewhere. In fact, over Lind's period overall business sector productivity rose only 13 percent. The 15 percent decline in wages is similarly misleading, for at least two reasons: it omits growing benefits, and it applies only to blue-collar workers. A better indicator is real hourly compensation, which actually rose 2 percent. And it turns out that even the gap between 13 percent productivity increase and 2 percent compensation growth does not mean that labor's share in national income fell over the period; in fact, it rose slightly. (The discrepancy between productivity and compensation growth turns out to be an index number issue. Mainly, it is because the implicit deflator for business sector output gives a big weight to computers, which play little role in the CPI, while the CPI gives a big weight to housing, which is not part of business sector output.)

In other words, the massive redistribution of income away from labor and toward capital that is the core of Mr. Lind's argument is a figment of his imagination - it simply didn't happen. Nor is the fact that labor's share in income has been quite stable an esoteric fact: it's right there, where anyone can find it in a couple of minutes, in the Statistical Abstract of the United States.

Unfortunately, this example is not that unusual. Here we have someone who has heard or read some statistics that he thinks demonstrate the vast impact of globalization. He is sufficiently ignorant of the field that he does not know that the numbers are misleading; in fact, he does not even know that it is, shall we say, risky to base sweeping pronouncements about the world economy on numbers you have heard or read somewhere, without spending a few minutes checking out what those numbers mean and where they came from.

WHY THE ERRORS?

But there is a deeper question here. Mr. Lind is clearly a very clever young man, who happens neither to know much about economics nor to be willing to invest time in learning more. There is no shame in that: it's a big world out there, and nobody can be an expert on everything. But in that case, why should he think that it is appropriate and necessary for him to have strong opinions on the subject, and to lecture the rest of us on his uninformed musings?

I have wrestled with this issue a lot in recent years because Mr. Lind is by no means alone. He is only a new exemplar of a common type: the basically literary intellectual who has learned about economics from reading The Atlantic and watching McNeil Lehrer, and who despite being unwilling to probe more deeply - by, say, looking at a freshman-level textbook - feels ready to start pontificating about the world economy. These pontifications typically portray the world as a place of struggle, a struggle made far more intense by globalization. A few years ago the popular vision was of the "Head to Head" world economy, in which advanced nations were battling over who would control the industries of the future. These days the focus has shifted a bit to views like Mr. Lind's, in which the struggle is between capital and labor, or perhaps between the newly industrializing economies and the established industrial nations. In any case the visions are invariably dramatic and grim, far more so than the usual things economists say.

Why do basically uninformed people feel the need to make such pronouncements? I actually don't think that the answer is special interest politics. Oh, there are a few well-known Japan-bashers and anti-NAFTA advocates who are in effect hired guns, who run so-called think tanks that reliably think thoughts that conveniently fit the interests of their sponsors. But I believe the basic force driving the rhetoric about globalization that is now so pervasive in economic debate is something more subtle, yet perhaps more powerful: the fashion sense of policy intellectuals.

After all, stories like Mr. Lind's are exciting. If you attribute the economic woes of American workers to the global mobility of goods and capital, you can tie practically everything up in one glossy package: growing world trade, the rise of multinational corporations, the decline of the West, the Asian economic miracle, even the fall of Communism (which has made the world safe for global investors). Such stories have a sweep and glamor that is rare in economics - indeed, the way that talking about globalization allows one to combine a vision of vast global struggle with a sense of exotic travel brings to mind the early James Bond movies. And such stories have the additional advantage of allowing the writer or speaker to sound immensely sophisticated (because everyone knows that sophistication is measured by the frequency with which you can use the word "global").

Not surprisingly, people who are good at telling these stories have done very well in the world. Some have written best sellers; some have become internationally famous pundits; some have risen to Cabinet rank and beyond. I believe that the romantic thrill of stories about globalization is the main reason why such stories get told and repeated. Michael Lind is neither the first nor surely the last intellectual fashion victim, seduced by the glamor of global visions into trying to sound like an expert about a subject he does not understand.

Alas, the world economy is a stubbornly unromantic subject, at least in the hands of irritating professors like myself. Annoyingly, we insist on asking not whether a story about globalization is sexy or makes the teller sound suave, but whether it is true. And the fact is that most of what would-be sophisticates say about globalization isn't true.

THE FACTS OF THE ISSUE

Let me start by saying what is true. It is true that world trade is considerably larger as a share of world output than it was a generation ago, especially for the United States - although the United States is still considerably less open to trade than, say, Britain has been since the reign of Queen Victoria. It is also true that international capital movements have recently been large by historical standards - where by recently I mean since 1990 - and even so these flows are not so large compared with world income as those of the pre1913 world. The bottom line is that international mobility of goods and capital has indeed increased substantially, although it remains far from perfect.

But what difference does this mobility make? Let me assert two areas in which globalization makes very little difference to the economy.

First, in spite of globalization, the rate of growth in the overall standard of living of any large country is roughly equal to its rate of productivity growth period, full stop, end of story. It's not productivity nor its growth rate compared with other countries that matters; if our productivity grows at 1 percent a year, our real income will grow at about 1 percent per year, whether productivity growth elsewhere is zero or 4 percent.

Why am I so confident about this assertion? After all, growth in other countries can increase competition for my country's products, forcing us to cut their price. Doesn't this mean that our real income can decline even while our productivity grows? Yes, it does, but this is only part of the story. Growth abroad means increased competition, but it also means larger markets. The net effect on my country's real income can go either way; which way it goes depends on the details, but in any case can be measured by the effects on the terms of trade - the ratio of export to import prices. Foreign growth only hurts my country if it worsens my terms of trade.

Still, this does mean that real income is not necessarily tied to productivity, doesn't it? Yes, but the impact of a decline in the terms of trade depends on the share of trade in income. If America's terms of trade were to be cut in half - if the prices of our exports were to be halved compared with the prices of our imports - the reduction in real income would still be only 5 or 6 percent. So it would take huge changes in the terms of trade to loosen substantially the link between domestic productivity and the standard of living. And nothing like that has happened. In fact, America's terms of trade were virtually the same in 1994 as they were in 1974.

At this point someone is likely to object that productivity itself is not a purely domestic variable, that international competition can affect your productivity growth for example, by driving you out of the key industries of the future. But that brings me to my second assertion: as a practical matter, productivity is a purely domestic matter.

How can this be? Doesn't trade determine how many high-wage, high-productivity jobs you have? If foreign countries get the high-value sectors and we get the low-value sectors, doesn't this reduce our productivity? The answer once again is yes, but. Many people assume that it is easy to identify the "good, high-value-added" industries, and that a large part of international differences in incomes and wage rates has to do with who has these industries. In fact, it's not nearly that easy. There is some evidence for industry "rents" - for higher-than-average wages for equivalent workers, or for above-normal rates of return, but these rents are usually small. And when you try to estimate the impact of international competition on such industry rents in the United States, you invariably end up with estimates of less than 1/10 of 1 percent of the total wage bill. Again, for practical purposes productivity growth has nothing to do with international trade.

So if your concern is with the determinants of overall national income, the bottom line is that globalization makes very little difference. Real income depends on domestic productivity, which is determined by domestic factors: the fact that a larger share of output is exported and a larger share of consumption imported than used to be the case matters hardly at all.

Where, then, might globalization make a difference? Mainly to the distribution of income within our country. While the redistribution from labor to capital that figures so large in some peoples' minds has not happened, there has been a massive redistribution from labor to labor - from the less skilled or fortunate to those higher up the ladder. International trade has surely played some role in that redistribution. Along with most economists in this area, I would argue that it has played a distinctly secondary role: my version of that argument may be found in the latest issue of Brookings Papers. But let me not get into that here; let us simply say that the possible important impacts of globalization are both more limited than is widely believed, and affect different and more subtle aspects of the economy than simple-minded stories about how globalization changes everything would suggest.

CONCLUSION

It is important to focus on these real issues. But I believe that we cannot do so effectively unless we clear away some of the nonsense with which the whole issue of international economics has become infested. We need to end the romantic infatuation with the idea of globalization, the easiness with which anyone who uses the phrase "global economy" passes for a man of great sophistication. I have tried carefully explaining economic concepts like, say, comparative advantage; it doesn't work. What does work, sometimes, is ridicule. If you can make someone who imagines himself to be a deep sophisticate look silly, sometimes it gives him - or at least someone else who might be tempted to follow the same route - pause.

In that cause, let me offer to you a word. Some of you have probably heard it already. It is not original; it is what Washington friends of mine use to describe the kind of rhetoric that poor Mr. Lind has fallen into. The word is "globaloney. " Try using it on people you know: you may be surprised at its impact.

Originally published, 1.96