The Tendency to Underestimate the New Globalization
Despite this economic drama, the greatest of our time, America’s politicians and even academics have consistently underestimated the effects of globalization, looking inward for explanations of events when the major drivers are global. America is so used to being the center of attention, the “number one country,” that it hasn’t been able to fathom the magnitude of global changes taking place around it.
The underestimation goes back to the 1970s, when the United States first started to slip from its post–World War II preeminence. The 1970s were a repeated international comeuppance to the United States. First, the U.S.-centered international monetary system collapsed in 1971 as the nation abandoned its pledge to convert foreign-owned dollars into gold at the fixed price of $35 per ounce. Two years later, oil prices began to soar, both because of the newly organized power of Middle East producers and because global economic growth began to hit up against the depletion of traditional petroleum supplies. Then, in 1975, the United States lost the war in Vietnam, putting into perspective the limits of U.S. conventional military power. Fourth, in the second half of the 1970s, Japan began to penetrate U.S. consumer markets in automobiles and electronic appliances, showing dramatically that America’s vaunted technological leadership could be rapidly overcome through technology transfers to Asian industries combined with Asian-based innovations.
These international realities should have become the focus of U.S. politics by the end of the 1970s. They did not. The U.S. debate turned almost entirely on domestic issues. Rather than focusing on the various new international dimensions of the U.S. economic crisis of the 1970s—monetary policy, resource scarcity, foreign competition—the Reagan “diagnosis” put all of the focus on cutting the size of the federal government, as if this were in the least responsive to the challenges of rising competition from abroad.
How Alan Greenspan Misjudged Globalization
As Federal Reserve chairman from 1987 to 2006, Alan Greenspan presided at the Fed during the rise of the new globalization. Yet, like Reagan, he basically misunderstood or neglected this crucial phenomenon on repeated occasions. By treating the United States as a closed economy, he continually overlooked the severe risks of his own policies and thereby helped stoke several financial crises, including the megameltdown of 2008.
Greenspan was fixated on a key point: that as much as he pushed down interest rates to spur consumer spending and housing purchases, U.S. inflation remained low. He considered this a miracle of U.S. productivity, that the economy had a new growth potential because of a surge of innovation in the “new economy” of information technology. His staff repeatedly demurred, saying that such a surge of productivity could not be found in the data. Greenspan persisted, however, insisting that low inflation could be explained only by the elusive productivity miracle.
He missed the real point, and with serious adverse consequences: inflation was being held down not by a productivity miracle but by the surge of consumer goods that were arriving from China. As U.S. consumers increased their demand for consumer goods, China scaled up its supply, setting up factories almost overnight to take advantage of the voracious U.S. appetite. The more Greenspan put his foot on the monetary accelerator, the more he stoked a runaway consumption and housing binge. His policies were therefore a core part of America’s excess spending, which led up to the financial crash of 2008.
Had Greenspan been correct that America was enjoying a productivity boom, the country would have been experiencing a surge of growth of GDP, wages, and employment. National output would have been running ahead of consumption spending. Savings rates would have been rising. Of course, the opposite was occurring: America’s GDP growth was sluggish; wages were stagnant; and employment was flagging. Although manufacturing employment was relatively stable from 1990 to 1998 at around 17.2 million workers, between 1998 and 2004 the floor fell through the labor market, with a loss of 3.2 million manufacturing jobs.7 All of these adverse outcomes suggest that it was imports from abroad, rather than a productivity surge, that was the main reason for low inflation. The Federal Reserve’s easy monetary policy succeeded in creating manufacturing jobs, but in China, not in the United States.
The Fed’s policies did create around 1 million U.S. jobs in construction between 2002 and 2006, but they proved to be evanescent.8 With the Fed’s foot to the monetary pedal, U.S. interest rates hit rock-bottom levels, causing the demand for mortgages to soar. Wall Street began to securitize mortgages and sell them off to other financial pools such as pension funds, foreign banks, and insurance companies. As everybody now knows, the lucrative fees earned by everybody involved in packaging securities led to the collapse of lending standards—and ethical standards—in the mortgage sector.
There are two lessons here. The first is that monetary policy cannot solve America’s employment problem. Greenspan tried again and again, through cheap credits, and Ben Bernanke is doing the same. This is a hopeless, self-defeating strategy. Temporary jobs in construction can be created through a Fed-led housing bubble, but when the bubble bursts we are left with the reality that America’s manufacturing employment has fallen further under the weight of foreign competition and America’s lack of global competitiveness. The second lesson is that ignorance or neglect of globalization repeatedly comes back to haunt us. Unless we focus on the reality that the United States is now tightly integrated into the global economy and connected with more than 6 billion other people in a worldwide production network, we’ll keep failing to restore prosperity in a meaningful and sustainable manner.
Long-Term Effects of the New Globalization
The new globalization played a role in the recent boom-bust cycle in America, but its effects go even deeper. The integration of China, India, and other emerging economies into the global economy is causing a fundamental shift in income distribution, employment, investment, and trade. Even our domestic politics are being massively affected. I will focus on three overarching effects of the new globalization, each of which is globally transformative. These may be called the convergence effect, the labor effect, and the mobility effect.
The convergence effect refers to the fact that the new globalization provides the conduit for today’s emerging economies to leapfrog technologies, and thereby to rapidly narrow the income gap with the rich countries, and notably with the United States. When production systems are globalized, the developing countries learn rapidly about cutting-edge technologies coming from Europe, Japan, and the United States. China has made massive efforts not only to upgrade its production systems based on the advanced technologies imported from abroad, but also to master the imported technologies through learning by doing. One key government strategy has been to insist that foreign investors desiring to enter the Chinese market do so in a joint-venture partnership with a Chinese counterpart. The Chinese partner quickly masters the imported technologies and then branches out on its own. This process of deliberate and targeted technology transfer (or absorption, as it might be better described) helps account for China’s remarkable record of economic growth and technological upgrading. China’s growth has averaged around 10 percent per annum since 1980, enough to raise GDP twentyfold between 1980 and 2009.
The labor effect refers to the fact that China’s opening to global trade in 1978 was tantamount to bringing hundreds of millions of low-skilled workers into a globally integrated labor pool. The world’s total supply of relatively low-skilled workers thereby soared, pushing down the wages of low-skilled workers around the world. Of course, that didn’t happen all at once. At the start of China’s opening to global trade, most of China’s potential manufacturing workers were still peasants on farms in the rural areas of the country. They lacked the education, skills, complementary technologies, business capital, and physical proximity to ports to be much of a threat to apparel workers in North Carolina. Yet, over time, their skills were raised by a determined educational push led by the Chinese government and by
the efforts of the ambitious and hardworking Chinese themselves.
The technologies and capital to employ these new industrial workers were mostly imported from abroad, as foreign investors set up operations in China’s coastal cities that were designated “special economic zones.” The physical proximity to the new work was created as around 150 million Chinese workers left the countryside and migrated to the cities, where they could find better employment in the new manufacturing enterprises.9 Thus education, skills, technology, capital, and physical proximity came together in places such as Shenzhen, China, the coastal city that lies just north of Hong Kong, which grew from a small fishing village of some 20,000 residents in 1975 to around 9 million residents in 2010.10
The mobility effect refers to a basic asymmetry of globalization: the difference between internationally mobile capital and immobile labor. When capital becomes internationally mobile, countries begin to compete for it. They do this by offering improved profitability compared with other countries, for example, by cutting corporate tax rates, easing regulations, tolerating pollution, or ignoring labor standards. In the ensuing competition among governments, capital benefits from a “race to the bottom,” in which governments engage in a downward spiral of taxation and regulation in order to try to keep one step ahead of other countries. All countries lose in the end, since all end up losing the tax revenues and regulations needed to manage the economy. The biggest loser ends up being internationally immobile labor, which is likely to face higher taxation to compensate for the loss of taxation on capital.
Income Inequality and the New Globalization
In principle, the new globalization can ultimately be beneficial for the entire world. The rising productivity of China, India, and other emerging markets, and the falling transportation and communications costs worldwide, can raise incomes around the world.11 Clearly, the emerging economies can win in a big way, as they are able to boost productivity through technology inflows, attract internationally mobile capital, and raise real wages as workers are hired in new export industries. This success has been borne out in practice. Globalization has permitted China, India, and some other emerging economies to achieve the fastest economic growth rates in history.
The high-income countries, including the United States, Europe, and Japan, can also be winners. The newly emerging economies produce a wide variety of low-cost goods and services that we desire, and in turn we can export a wide variety of goods and services to the emerging economies. Sectors that have strong economies of scale will benefit from the expanded reach of the global market. This includes high-tech companies engaged in cutting-edge innovation (such as pharmaceutical companies and information technology companies) that make profits by creating and marketing information-based products and services. Google, Microsoft, Apple, Amazon.com, and others fit this mold. Trade can therefore allow for more specialization, increased innovation, and an expanded overall array of goods available to consumers in high-income countries.
Yet the gains are likely to be distributed unevenly within the high-income economies. High-skilled (and therefore high-income) workers are likely to benefit straightaway, while low-skilled (and therefore low-income) workers are likely to feel the pressure of tougher competition from abroad. For all broad segments of society to benefit from globalization, therefore, the winners have to help compensate the losers. High-income earners who enjoy a surge in income and wealth resulting from globalization should pay more in taxes to finance increased income transfers and public investments (for example, for job retraining) for those who are the losers.
It is even possible that the whole world will end up losing from globalization if the surging income in the emerging economies leads to global environmental calamity—if China’s growth, for example, results in such a large increase in carbon dioxide emissions from coal use that global climate change accelerates catastrophically. Achieving the benefits of globalization therefore requires active international cooperation as well as internal cooperation.
Notice that internationally mobile capital (for example, a U.S. hedge fund that invests in China or a U.S. apparel company that may relocate abroad) gains in three ways from the rise of China. First, with the sudden, sharp boost of productivity in China arising from the inflow of technology (the convergence effect), major new investment opportunities in China that offer high rates of return are created. Second, with the surge in the global labor supply (the labor effect), wage levels around the world are bid down, leaving more corporate revenues as profits. Third, with governments around the world cutting corporate taxes and easing regulations to compete for internationally mobile capital, companies are enjoying a sharp fall in taxation.
All three effects favor U.S. corporate investors, but all three jeopardize U.S. workers. As U.S. business investments have shifted to the emerging economies, U.S. wage and employment growth has slowed. Similarly, the massive expansion of the global labor pool due to the inclusion of workers from China and India has put downward pressure on U.S. wages. And the race to the bottom in corporate taxation and regulation has led the U.S. government to cut corporate tax payments while cutting government programs that benefit workers (e.g., job training).
The winners include not only the owners of physical capital (who can shift operations abroad) and financial capital (who can invest funds abroad) but also owners of human capital, who can export skill-intensive services to the emerging economies. This includes Wall Street bankers, corporate lawyers, high-tech engineers, designers, architects, senior managers, and others with advanced degrees and who work in high-tech fields. Finally, athletes, performing artists, and brand-name products are all given a boost by an expanded global market. Many U.S. and European brands are now enjoying booms by expanding into the emerging economies, where hundreds of millions of consumers with rapidly rising incomes are eager to follow in the path of their Western counterparts.
Among American workers, the biggest losers by far are those with a low level of education. This is because most of the new entrants to the global labor market in China and India also have a high school diploma or less. These emerging-economy workers enter labor-intensive export sectors such as apparel cutting and stitching, shoemaking, furniture making, electronic appliance assembly, and standardized manufacturing processes such as plastic injection. As the prices of these globally traded labor-intensive products are pushed down, the wages of low-skilled workers in the United States are also pushed down. U.S. firms in those sectors also shift their operations to China, leaving their own workers unemployed or having to accept sharp cuts in wages to remain employed.
One of the key realities of the new globalization is the ever-expanding range of competition between U.S. and emerging-economy workers. Half a century ago, American workers did not have to fear much competition from abroad, least of all from low-wage countries. Transport and logistics costs were simply too high for American firms to source in Asian low-income countries. Moreover, most of those countries were closed to investment from the United States. Yet as transport, communications, and logistics costs began to fall, and as those economies opened to trade and investment, some low-tech industries could relocate factories abroad. As costs fell further, it became possible for even high-tech industries, such as computer and other advanced machinery manufacturing, to relocate just parts of the value chain—for example, final assembly operations—abroad. As costs fell still further, due mainly to the Internet, it became possible to shift back-office jobs, such as accounting and human resources operations, from the United States to India (favored over China because of its English-speaking workers), all enabled by the Internet. Now American workers compete directly with their counterparts in the emerging economies without companies’ needing to shift physical capital, only to have online connectivity.
A key result of the new globalization has therefore been a huge change in income distribution in the United States. Capital owners have been the big winners, enjoying a rise in pretax returns and a cut in the tax rate
s levied on them. Workers with low educational attainments have tended to lose, as they are directly in the line of competition from the emerging economies. And the federal government has exacerbated these trends. First market forces raised the incomes of the rich, and then the government, caught up in a race to the bottom with counterparts, cut both personal and corporate income taxes, thereby giving an added boost to the rich, while turning around to slash public spending for the poor.
Throughout the high-income economies, governments have cut the effective average tax rate (EATR) on corporate income, and the spread in effective tax rates across countries narrowed as well. Both the decline of EATRs and the narrowing of the spread of EATRs are shown in Figure 6.2 for nineteen high-income countries, including the United States. The careful statistical study from which this figure is taken demonstrates that “increased capital mobility (FDI) has a negative impact on the corporate tax rate.”12
The effective U.S. corporate tax rate shows the same decline as in other high-income countries. America’s EATR declined from 30 to 40 percent during the 1960s to less than 30 percent from the mid-1970s onward, and is currently under 20 percent (Figure 6.3). One part of that decline reflects the greater ability of U.S. companies to hide their profits in offshore tax havens, with the implicit or explicit support of the Internal Revenue Service. The upshot is a decline in the share of GDP paid in federal corporate taxes, from an average of 3.8 percent in the 1960s to just 1.8 percent in the 2000s.13
The Price of Civilization Page 9
