Is Globalization Headed for the Rocks?

IMGXYZ562IMGZYXDiscussants included Kevin Hassett, of the American Enterprise Institute, Branko Milanovic, of the World Bank, and Thomas Palley, from Economics for Democratic and Open Societies.  Carnegie’s George Perkovich, who served as moderator, invited the speakers to comment on the challenges globalization poses and how those challenges might be met.

Mr. Hassett opened his remarks by asking the audience to step back from the polarized positions typically taken up in the debate over globalization.  Given the lack of consensus on which data and methodological techniques should be used to measure the impact of globalization, it is curious that proponents and opponents defend their positions and attack their opponents’ with such certainty.  Furthermore, at first glance it appears that globalization is delivering substantial benefits: per capita global income is increasing and the percentage of the world’s population living below the poverty lines of $1 and $2 a day established by the World Bank is falling. 

So why is the debate over globalization so charged?  Mr. Hassett suggested that the disparate positions on the topic have deep historical and philosophical roots stemming from fundamentally different visions of what constitutes a just society.  Today those different visions manifest themselves as populism and neo-classicalism, according to Mr. Hassett.  Populists are skeptical of the concentrations of power that arise in a market economy and fear power imbalances will lead to exploitation of laborers by capitalists.  Neo-classicists believe that a worker’s value should be determined by that worker’s productivity- compensation should be commensurate with marginal product.

While Mr. Hassett conceded that markets do occasionally fail, he argued that capital is not the enemy of labor that populists make it out to be.  Rather, capital accumulation enhances the productivity of labor and boosts labor’s wages.  In support of this point, Mr. Hassett pointed to a recent cross-country study he co-authored that found a strong negative relationship between capital taxes and blue-collar wages; in other words, countries with lower taxes on capital tend to have higher blue-collar wages, all else being equal.  Actively intervening in markets with the intention of protecting laborers, for example by increasing taxes on capital, may therefore be counterproductive.  Mr. Hassett suggested that a progressive consumption tax would be a more effective way of redistributing income without discouraging valuable capital investments.

Mr. Milanovic began by highlighting some broad characteristics of the current surge of globalization that distinguish it from the last period of rapid global economic integration, which took place between 1870 and 1914.  He noted that while trade and capital flows have both increased dramatically, people are less free to migrate around the globe.  Yet despite the fact that nationality is determined arbitrarily and is increasingly difficult to change, roughly 60% of the variation in individual incomes in the world can be explained by nationality alone.  This number has increased dramatically since 1870.  The result is a world in which most income inequality is due to inequality between nations and in which circumstances appear to matter more than effort in determining individual outcomes.

The most salient feature of globalization in rich countries, according to Mr. Milanovic, has been increased pressure on low and medium-skilled workers, brought about primarily by increased trade and outsourcing.  Welfare states built on large, homogenous middle classes have thus come under stress.  One policy response has been a tightening of rich country borders- the terms Fortress America and Fortress Europe are illustrative of this trend.  The fact that rich countries are more averse than ever to immigration at a time when migratory pressures are stronger than ever reflects a serious failure of globalization, which has fueled migration pressures by failing to deliver benefits to poor countries.  Mr. Milanovic argued that relaxing migration restrictions would do more to reduce global poverty than all current aid programs combined.

The most notable change brought about by globalization in the developing world has been the stark divergence between the few developing countries that have benefited from globalization, such as China and India, and the vast majority of developing countries that have not.  Interestingly, this has taken place despite widespread policy convergence across the entire developing world.  Mr. Milanovic warned that one of the most serious risks posed by this disturbing paradox is that economic failure could become associated with moral or intellectual deficiency.

In conclusion, Mr. Milanovic suggested that solving the challenges created by globalization would require a new global social infrastructure.  New institutions are needed to enable modest redistributions of incomes, greater migration and reform of pro-rich rules of the game on an international scale.

Mr. Palley began by distinguishing between globalization as a broad concept incorporating the diffusion of ideas and cultures and neo-liberal corporate globalization as a specific framework of institutions and rules designed to guide economic policies.  It is all but certain that the former will march forward, while the latter could face serious opposition if reforms are not made. 

Mr. Palley briefly outlined three views on neo-liberal globalization.  First, the “right” sees a sunny, flat world in which economic integration improves efficiency and expands opportunities, with gains enjoyed by all.  Second, the “center” identifies dislocation costs associated with liberalization in rich countries and recognizes that certain governance problems prevent openness and competition from raising living standards in the developing world.  According to Mr. Palley, both of these views regard the basic structure of neo-liberal globalization as sound; accordingly, they either call for no reforms or propose small adjustments to economic policy.  The third view of globalization described by Mr. Palley, with which he identified, was the “radical center.”  In contrast to the first two views, the “radical center” challenges the basic structure of globalization. 

Palley argued that neo-liberal globalization should be thought of as a political phenomenon as well as an economic one, since it carries serious implications for democracy, national sovereignty and the global distribution of political power.  Therefore, addressing unsatisfactory economic outcomes requires bold reforms of the political institutions that guide globalization.

Mr. Palley noted widening income inequality and the stubborn persistence of corruption in Africa as examples of the failure of neo-liberal globalization to deliver on its promises.  He challenged the underlying assumption of Thomas Friedman’s “Flat World” metaphor that economic competition takes place on a level playing field, arguing that the playing field has in fact been shaped by corporate elites to guarantee their continued success.  As an alternative metaphor, Mr. Palley offered “The Box.”  In this framework globalization, increasingly flexible labor markets and the privatization of formerly public institutions and services all box workers in and replace job security with uncertainty.  Mr. Palley pointed to the decoupling of wages and productivity in the US as evidence of the pressure exerted on workers since the adoption of neo-liberal economic rules in recent decades.  Since 1973 real wage growth in the US has stagnated despite the fact that productivity has steadily climbed.

Notable features of neo-liberal globalization that distinguish it from previous rounds of international economic integration include the mobility of capital, the liberalization of trade barriers and technological advancements that have enabled outsourcing in the service sector.  All these factors reinforce the constraints imposed on workers.  Furthermore, governments are also boxed-in by the mobility of investment and production and by the fear of financial disruptions, according to Mr. Palley.  As a result, the policy space available for governments to pursue greater unionization or tax reform, for example, has shrunk.

The reform agenda laid out by Mr. Palley focused on flipping the current balance of power between workers and corporations.  He called for a progressive government that would restore worker bargaining power, institute a full employment policy and create new incentives for corporations designed to push their interests closer to alignment with the national interest.  Impediments to this agenda could include a surge in nationalism fuelled by economic anxiety, allowing the ranks of American workers to swell with excessive numbers of immigrants and wrongly identifying the trade deficit as the root, as opposed to a symptom, of the country’s economic problems.

Discussion session

George Perkovich began the discussion by pointing out that Mr. Hassett had praised markets in an ideal, abstract sense but had not addressed the problem of market structuring and whether an adjustment of market rules was necessary. Hassett responded by giving an example from rural China. Setting up a factory in rural China is primarily an ad hoc negotiation with local officials. In such a situation, there are few formal rules in operation other than the laws of economics and yet the factories are very efficient in creating growth. This shows that few or no rules can work to produce prosperity and alleviate poverty, partially because local officials have the best interests of their community at heart. In addition, Hassett disputed the trends identified by Mr. Milanovic and Mr. Palley, including the decoupling between productivity and median wage, claiming they were not generally accepted as proven.

Palley defended the trends, citing data published by the Economic Policy Institute, which has tracked income inequality in the U.S. for decades. By all measures, whether the Gini coefficient or any other, inequality has been increasingly. Even Paul Krugman, previously a skeptic on this issue, has been converted and now writes regularly about inequality in The New York Times. Palley reemphasized the importance of the median income statistic because of its close historical relation to productivity. If one looks across the generations, today’s workers enter the labor market at a lower wage point and with a flatter wage profile over the course of their lifetimes. According to Palley, the income inequality debate is a closed one.

In rejoinder, Hassett argued that per capita income has been increasing while the Gini coefficient has remained relatively stable. He acknowledged that inequality is rising but disagreed that the “little guy” is not sharing in the prosperity. Making such an assertion would require an economist not to take employment benefits into consideration and to place a disproportionate emphasis on variable factors such as energy prices. Hassett urged the audience to look at consumption to see how the median-income worker is faring. Since consumption among median-income workers has increased, one could argue that the distribution is becoming more even.

Palley admitted that the median income has risen slightly in recent years, but reminded the audience that this increase no longer corresponds to productivity, which has spiked. Maintaining this correlation should be the “iron law” of U.S. economic policy. Palley believed consumption equality was not a useful measure because this statistic obscures serious structural flaws in the U.S. economy, including the savings crisis and high levels of consumer debt. Such spending patterns are not sustainable and thus do not provide a firm basis for economic analysis.

Harley Balzer of Georgetown University expressed his reservations about relying on the good will of capitalists as a form of market self-regulation. He also questioned how Hassett could praise Reagan for the benefits of globalization when China’s growth began before he took office and India’s did not commence until after he left. Balzer asked what lessons the speakers might offer from the Chinese and Indian examples, short of suggesting systemic changes to globalization and its mechanisms. Hassett asserted that since poverty in rural China is decreasing, the Chinese must be doing something right: not all of these profits are being siphoned by corrupt local officials. On Reagan, Hassett admitted he was merely trying to be provocative with his previous statements, but highlighted that it was during the Reagan years that economists recognized that communism was a failed economic system.

Bert Keidel of the Carnegie Endowment addressed the issue of poverty reduction in China, which he attributed to two factors: land reforms supported by government pricing policies, and the disintegration of “separate citizenship” between rural and urban workers. Keidel disapproved of attempts to focus on productivity because the fastest way to increase productivity is to fire workers. This perspective can lead to perverse situations in which layoffs are considered a sign of economic recovery. Laid off manufacturing workers often find employment in service sectors, but many of those jobs have lower wages and worse benefits.

Inequality is a self-reinforcing cycle, with wealth inequality increasing income inequality and vice versa. Contrary to Hassett’s assertions, China has a strong government with strong regulations. The China experience should not be pointed to as evidence for ignoring the goal of social equity. The populist and neoclassical views should be fused. Hassett responded that the linkage between capital flows and wage increases is based on data from many countries, not just China.

A member of the audience next asked if the World Bank had a role in migration policy. Milanovic replied that since migration policy involves country laws, there is little for the Bank to do. Hassett agreed with Milanovic and worried that “rising walls” were a sign of problems on the horizon. Migration is a necessary equalizing force in global markets and is thus urgently important.

A student from the American Enterprise Institute asked if economists divided the workforce into productivity brackets as well as income brackets, suggesting that the income of the highest wage workers may not be rising as fast as their productivity dictates. Milanovic cited one study that showed there may be more competition for low-skilled, mobile workers than for skilled workers. Palley reiterated that it is difficult to measure productivity, but that CEOs were some of the worst performing workers in the labor market. At that level of management, compensation is not very closely tied to performance, and some of the weakest CEOs have the largest incomes.

Ron Blackwell of the AFL-CIO mentioned a recent article in the Financial Times by Lawrence Summers. Summers worried that while global elites and the global poor have benefited from globalization, the vast global middle class has been left out. This class has disproportionate political influence in rich countries. Summers argued for policies targeted at the middle, without which support for globalization will continue to erode. Milanovic agreed there is a squeeze on the global middle class that is being manifested in disagreements about migration policy. Hassett argued that globalization and outsourcing of jobs from rich countries should not be viewed as bad things if per capita real GDP is rising in the U.S. and rural Chinese are prospering. The problem in the U.S., according to Hassett, is that it is a high wage country with high taxes on capital. These factors weaken its ability to attract investment: the U.S. is even losing capital-intensive semiconductor plants overseas.

Wolf Brueckmann of Amcham Germany suggested it was a mistake to link productivity and growth to median wages because this obscures important phenomena. High-skilled workers are gaining while low-skilled workers are losing, but this is not reflected in the median income. He urged greater attention to the link between education and rising wages. Palley acknowledged that education has long been an important element in our understanding of the effects of globalization: technological change has created a skill bias in the distribution of benefits. But recent data show that education is not necessarily a ticket to large income gains; at the same time, those lacking an education seem to be big losers from globalization. Palley emphasized that institutions matter. Productivity may increase the size of the “pie,” but institutions determine how the “pie” is divided.

Bronson Lee of the Gallup Organization pointed out that all panelists seemed to agree on the immigration issue. What would meaningful immigration reform look like and how would it dovetail with trade preferences? Palley remarked that the discussion had been focused on capitalism not globalization. This is appropriate because there are many forms of global capitalism. He emphasized that rules do work: to deny this fact is to reread America’s own economic history. The New Deal era saw the creation of the Federal Reserve System and the Securities and Exchange Commission, as well as the passage of many progressive labor and environmental laws. Palley argued we should extend this rules-based approach to the global economy. The debate should be about which forms of rules to adopt, and it is natural for those rules to evolve. The problem with globalization thus far is that we have been eroding our existing rules and allowing a lawless global economy to develop. As a consequence, we have lost leverage and are now locked into a situation in which there are very few rules. Palley believed this situation was designed by neo-liberals for their benefit.

Palley stated his opposition to open borders, which he predicted would lead to chaos. We should remember that the U.S. has been encouraging illegal immigration for 20 years, creating two classes of workers: those who are protected and those who are not. This state of affairs empowers employers, who can put the two groups of workers in competition with one another to drive down wages. The U.S. should create a safe haven for workers once they are in the country and give them equal protection under the law.

Hassett suggested that immigration is really a foreign policy issue and that most people miss this point. He cited a paper by Greg Mankiw of Harvard, which showed that the optimal tax on capital from the perspective of labor is 0%. If lawmakers want to develop a policy to help “the little guy,” they should institute a progressive consumption tax. He called for a “rational populism.”

Milanovic stated that the “build a higher wall” mentality was a signal of more far-reaching policy failures. Countries should open their borders to an extent that is consistent with stability and provide aid to improve conditions on poor countries, thus decreasing the demand for migration. He reminded the audience of the comparative age pyramids of Europe and the Middle East, which have flipped in recent decades. The Middle East will soon have a larger, younger population than Europe but will find itself at a 10:1 income disadvantage. This trend is clearly not sustainable.

A representative from the Millennium Institute worried that current trade theory is 100 years old, dating back to a time when there was neither mobile capital nor mobile labor. Today, half of world trade is intra-company trade not international trade. The current form of globalization may be based on the wrong model. In addition, contrary to Hassett’s contention, capital moves to find lower wages not lower taxes. Taxes themselves are not drivers of growth. The speaker was not convinced that there should be lower taxes on “brick and mortar” capital than on human beings.
 
A representative from the State Department reflected that nation states are losing power to those who control capital. She found it notable that none of the panelists had mentioned the WTO, an organization which she believed restricts the democratic uses of power in national states. Palley commented that while we still live in a world of nation states, this is no longer the economic reality. The scope of the ILO needs to be broadened within the international system. After the passage of NAFTA, however, it is harder to strengthen the rules-based system since the movement has been toward weaker standards in labor and other areas in international trade agreements.

In addition, Palley argued that a revamped system of international exchange rates, stronger capital controls, and new corporate agendas will be needed to improve the distribution of benefits from globalization. The current system is a force for unfair competition and encourages multilateral labor arbitrage. Prominent trade theorists, such as Robert Samuelson, have begun to speculate that trade does not necessarily lead to benefits for all. America’s gains from trade could shrink in the coming years as China and other Asian economies continue to strengthen. New trade tools will be necessary to deal with globalization’s increasingly complex effects.