Economic Globalization: Time to Make It More Inclusive

Next week, we will publish our “Globalization Report 2018”. As in the previous reports, we can show that globalization and international trade have positive impacts on economic growth in the participating economies. At the same time, this does not imply that every single person or region benefits. Compensating the economic losers from globalization and international trade is a key challenge for the future global economic development.

Economic integration promotes economic growth

The basic conviction of almost all economists is the strong belief, that an increase in economic integration between different countries has a positive impact on economic growth in each of these countries. There are many reasons for this belief:

• Lower trade barriers increase the international division of labour and by this the production possibilities.
• Cross-border exchange of labour and capital results in higher overall productivity, because these factors of production are used in the regions and companies where they can produce the largest value added.
• Producing for a global market reduces the costs per unit due to the advantages of mass production.
• Increasing competition with foreign companies forces suppliers to reduce their costs of production via technical progress.

Two words of the initial statement are important: First, all participating economies benefit from globalization. So globalization is not a zero-sum-game. Second, we are talking about countries – that is the macro-level – and not individuals. Looking at the micro-level, economic globalization produces not only winners.

Economic integration is changing prices in all countries

Apart from increasing economic growth in all participating countries, economic integration also changes the levels of scarcity in all countries. And once we have changes in scarcity, we have changes in prices – also in the prices of labour and capital. Hence globalization automatically produces winners and losers in all countries.

One simple way demonstrate such changes in prices due to open borders is the global labour market. The point of departure for the following argument is the fact, that advanced economies such as Germany have a relatively small supply of labour – at least small if we compare Germany with China or India.

In case of closed borders and no international migration, wages in Germany are relatively high. By contrast, Chinese wages are relative low due to the abundance of labour supply.

If we allow cross-border exchange of labour force, workers are supposed to migrate from China to Germany. According to our economic textbook theory, migration takes place until wages in Germany and China have the identical level in both countries. In Germany, the increase in labour supply causes a reduction of wages.

In reality, however, China’s workforce is less mobile than suggested in our textbooks. Moreover, advanced countries such as Germany often make efforts to close their borders to foreign workers. Due to these two factors, no mass migration from China to Germany takes place.

What happens, though, is the outsourcing of labour-intensive production from production sites with high wages, such as Germany, to low-cost locations such as China. This puts downward pressure on wages in Germany, especially in low qualified jobs.

International trade is changing wages in all countries

Because of the abundance of labour supply, China has a competitive advantage in producing labour-intensive goods. Specialisation in the production of labour-intensive goods increases the demand for labour in China and hence Chinese wages and employment are rising.

Germany has a competitive advantage in producing capital-intensive and technology-intensive goods. Due to international trade, Germany reduces the production of labour-intensive goods. The result is a reduction of employment and wages in Germany.

These relationships are not only theory. In 2013, Autor, Dorn and Hanson published a well-known paper. They showed, that in the US imports from China have caused a reduction of wages and employment in those regions with high imports from China. Other studies show the same results for Germany.

Economic Globalization – Who wins, who loses?

If the analysis so far is right, we are able to identify the potential winners and losers of increasing globalization in advanced countries such as Germany, France and the UK. Talking about potential losers, we are talking about labour – especially unskilled or low-skilled labour. And we are talking about persons, companies or regions which are in competition with suppliers from emerging low-wage economies – especially Asia and Eastern Europe.

I am convinced, that it is necessary to find better ways to distribute the benefits from increasing globalisation and international trade so that everybody can profit from deeper economic integration. There are many possible ways to make globalization inclusive for all:

• The most important instrument is the tax and transfer system.
• In addition, it is necessary to promote a more equal distribution of opportunities and capabilities, for example, by providing further training programs for workers so as to facilitate their transition to industries which are benefiting from globalization.
• Moreover, governments could use special funds to support companies or regions to adjust to the structural changes caused by globalization. Examples for such funds are the U.S. “Trade Adjustment Assistance” and the “European Globalization Adjustment Fund”.

Conclusion and outlook

No matter which measures we finally choose: If we are not able to improve the distribution of economic benefits due to globalization and international trade, there will be serious social and political tensions in advanced economies.

There is a growing empirical evidence showing that the fear to be a potential loser of economic globalization strengthens right-wing political parties and other anti-globalization parties. Economically, such a voting behavior is a threat because it could result in protectionism and trade wars. And from a societal point of view, a strong political polarization is a danger to social cohesion.

Literature:

Impulse paper: Economic globalisation – Who’s winning, who’s losing out? Gütersloh und Turin 2017: https://static1.squarespace.com/static/54c95cbee4b03749141be705/t/5a002a528165f5564ade30f0/1509960292641/paper+1+web.pdf