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The great globalisation lie

Third way evangelists presented globalisation as inevitable and advantageous to all. In reality, it is neither, and the liberal order is paying the price
December 12, 2017
Listen: Dani Rodrik speaks to Prospect's Tom Clark about the pitfalls of hyper-globalisation 

Not so long ago, the argument over globalisation was seen as done and dusted—by parties of the left as much as of the right.

Tony Blair’s 2005 Labour conference speech gives a flavour of the time. “I hear people say we have to stop and debate globalisation,” Blair told his party. “You might as well debate whether autumn should follow summer.” There would be disruptions and some might be left behind, but no matter: people needed to get on with it. Our “changing world” was, Blair continued, “replete with opportunities, but they only go to those swift to adapt” and “slow to complain.”

No competent politician today would be likely to urge their voters not to grumble in this way. The Davos set, the Blairs and the Clintons are all scratching their heads, asking themselves how on Earth a process they insisted was inexorable has spun into reverse. Trade has stopped growing in relation to output, cross-border financial flows have still not bounced back from the global crisis of a decade ago, and after long years of stasis in world trade talks, an American nationalist has ridden a populist wave to the White House, where he disavows all efforts at multilateralism. Those that were cheerleaders of hyper-globalisation at the turn of the century stand no chance of understanding where it has gone wrong without realising how little they understood the process they were championing.

Back in 2005, in that same Blair conference speech, there was scope for doubt, and “no mystery about what works: an open, liberal economy, prepared constantly to change to remain competitive.” What of social solidarity? Would globalisation sweep it away? Blair insisted it could survive, but only if it were repurposed. Communities could not be allowed to “resist the force of globalisation”; the role of progressive politics was merely to enable them “to prepare for it.” Globalisation was the foregone conclusion; the only question was whether society could adjust to the global competition.

Blair and company were so certain not just because the world was going their way, but also because they had one very strong argument on their side: comparative advantage. It was not a new argument; in fact, it was 200 years old. But it was very much in fashion, and it did have real logical force: trade enabled specialisation, and a country that specialised in what it’s good at would be better off as a whole.

Read: Will globalisation go into reverse?

The cheerleaders, however, more or less forgot that caveat about “as a whole.” Moreover, they slipped casually from talking about trade in goods, to liberalisation in finance, where the argument was always different and more doubtful. Without pausing, they lurched from lowering “at the border” barriers, such as import tariffs or quotas, to more politically intrusive initiatives to harmonise regulations behind the border—investment rules, product standards, patents and copyrights—where it’s much less clear why cross-country integration should be expected to leave all nations better off.

No wonder the greatest beneficiaries of globalisation were nations like China that eschewed the official rules and danced to the beat of their own drum. It and other Asian countries engaged the world economy but did so on their own terms: they employed trade and industrial policies prohibited by the World Trade Organisation, managed their currencies, and kept tight controls on international capital flows. They experienced remarkable economic growth and lifted hundreds of millions from poverty as a result.

But in the established industrial economies, the record was much more mixed. The main beneficiaries of the post-1990 rules of globalisation were the corporations and professional elites. No doubt, the hyper-globalisers believed their case. But they overstated it to the point of complete distortion, and were blindsided by the inevitable backlash from their fellow citizens—citizens who have latterly proved less “slow to complain.”

History lessons

Contrary to Blair’s assurances, globalisation is a reversible process, and one that has indeed at times been reversed. There have been plenty of hiccups and worse. Heights of integration were reached at the turn of the 20th century that make that earlier period, in many ways, comparable to today. Under the Gold Standard regime, national currencies could be freely converted into fixed quantities of gold, and capital flowed without hindrance across borders. The regime not only encouraged capital flows but also trade, by removing currency risk: merchants could safely take payment from anywhere in the system without worrying about exchange rates shifting about. By 1880, the Gold Standard and free capital mobility were the norm. People were free to move, too, which they did in large numbers from Europe to the New World. Just as today, improvements in transport and communication technologies—the steamship, railroad, telegraph—greatly facilitated the movement of goods, capital, and workers.

A backlash was not long in coming. As early as the 1870s, a decline in world agricultural prices produced pressure for a resumption of import protection. With the exception of Britain, all European countries raised agricultural tariffs towards the end of the 19th century. In many cases agricultural protectionism also spread to manufactured goods. Immigration limits also began to appear in the late 19th century. In 1882, the United States Congress passed the infamous Chinese Exclusion Act, and restricted Japanese immigration in 1907. Later, in the 1920s, the US established a more general system of immigration quotas.

The world’s first self-consciously populist movement arose in the US during the 1880s, in opposition to the Gold Standard. Why? Because although the system was fostering globalisation, it also created losers. Since the domestic money supply was linked to the quantity of gold, periods when gold was in short supply led to tight credit conditions and high real interest rates. In the latter part of the 19th century, the Gold Standard came to be associated with a deflationary effect, rather like the austerity policies of today. Farmers complained of being forced to sell grain cheap, at a time when freight rates and credit were expensive. Together with workers’ groups and western miners, they militated against northeastern financiers, whom they viewed as the Gold Standard’s beneficiaries—and the authors of their hardship.

The US populists would eventually be defeated, largely as a result of gold discoveries after the 1890s that reversed the deflationary pressure in the system. But the tug-of-war between the financial and cosmopolitan interests that upheld the Gold Standard, and the nationalist economic groups who bore its brunt would intensify. It came to a head in interwar Europe.

The old system soon fell apart amid the fighting in 1914, and the attempt to return to it in the 1920s proved unsustainable under the weight of economic crisis and political turmoil. As my Harvard colleague Jeffry Frieden has written, the reaction to mainstream politics then took two forms. Communists chose social reconstruction over the international economy, while fascists and Nazis chose national reassertion. Both paths took a sharp turn away from globalisation.

Gain vs pain

So why have advanced stages of globalisation—in the first half of the 20th century, and now again in the early-21st century too—proved to be so prone to backlash? The best place to start is with what should be the most straightforward case for the globalisers: liberalising border barriers on trade in goods.

There is little question that multiple rounds of multilateral trade negotiations after the end of the Second World War did a lot of good. Import tariffs and quotas on trade in manufactured goods were back then extremely restrictive; relaxing them allowed the world to reap serious gains. Furthermore, at first, this liberalisation affected trade mostly among relatively advanced economies, where wages and working conditions were not so different. The first signs of trouble started after developing countries began to join the world economy: because their low wages began creating distributional tensions in the importing countries.

All this is just as economics teaches. According to the celebrated Stolper-Samuelson theorem of trade theory, in places—like the US and western Europe—where skilled workers are plentiful, unskilled workers will see their wages decline under freer trade. Openness to trade always hurts some people in society, except in the extreme case (not relevant for any large economy) where the only things imported are things that are never produced at home. In theory, countries could always compensate their losers by redistributing from the winners, and in practice they sometimes did. With its extensive safety nets, Europe in the second half of the 20th century was relatively well prepared to deal with disruptive trade flows. In addition, trade negotiators initially carved out special regimes for garments and textiles exporters in the advanced economies, limiting their exposure.
"The gain to the US from Nafta: just 0.1 per cent of GDP. If the same effort had gone into creating decent jobs, would we have Trump?"
Even in the best of circumstances, however, freeing up trade caused pain as well as gain. After the 1980s, the balance began to look worse and worse. When tariffs (like taxes) are too high they distort economic behaviour more, and do more damage to prosperity. Back in the 1950s and 1960s, tariffs were often very high and so their reduction did much to grow the overall economic pie. But four or five decades later, in a world where typical tariffs were in single figures, the picture was different. If you’re starting off with the tariffs of the post-war era, the standard economic models suggest that to achieve an overall net gain of $1 in national income through liberalising trade, you could expect to see around $4 or $5 of income being reshuffled across different groups within a particular country. But under the tariffs that applied by the end of the 20th century, achieving that overall dollar of gain would be associated with as much as $20 being redistributed, implying the creation of an awful lot of losers. And what’s more, by the 1990s we were into an era of welfare state retrenchment rather than expansion. So it became less plausible than it used to be to believe that those losses will be compensated.

Let’s take Nafta, for example, which entered into force in 1994. A recent study of the labour market impact finds that an important minority of US workers suffered substantial income losses. Not surprisingly, the effect was greatest for blue-collar workers: a high-school dropout in heavily Nafta-impacted localities had 8 percentage points slower wage growth over 1990-2000 compared to a similar worker not affected by Nafta trade. Wage growth in the most protected industries that lost their protection fell 17 percentage points relative to industries that were unprotected initially. And the overall benefit of the agreement? According to most recent estimates, the net economic gain to the US was well below 0.1 percentage points of GDP—that is, less than one-tenth of one per cent of national income. Just think how much less likely President Donald Trump would be if all the political capital expended on an initiative which caused so much disruption to so many Americans, without appreciably growing the economy, had instead been deployed on industrial, skills or infrastructure programs that had delivered decent American jobs.

Beyond the border

Imports are only one source of disruption in labour markets, and typically not even the most important source. Demand shocks, technological changes and the ordinary course of competition with other, domestic firms typically produce greater labour displacement. Yet trade tends to be much more salient politically. It makes for an easy scapegoat, since politicians can point the finger at foreigners—Chinese, Mexicans, or Germans. But there is another, deeper issue that renders dislocation caused by trade especially contentious. Sometimes international trade involves competition that would be ruled out at home because it violates agreed norms. It’s one thing to lose your job to someone who competes under the same rules as you do. It’s another when you lose your job to a company that takes advantage of lax labour, environmental or safety standards abroad. Such competition can undermine important regulations and also tax rules through the back door. The concerns about fairness here go beyond the individuals directly affected. The broader community will be troubled when it sees fellow citizens being denied decent work as the result of “unfair” practices.

The hyper-globalisers, however, ignored such concerns. Instead, they doubled down and pushed for trade deals which were, in truth, no longer really about free trade at all. Their focus shifted to regulations beyond the border—restricting agricultural subsidies, standardising investment regulations, product standards, intellectual property rights, financial measures. All of these things are traditionally the product of institutional arrangements, or domestic political bargains. Suddenly, they came to be seen as trade barriers and subject to remake through trade agreements.

Details of trade regimes get very political, very fast in this terrain. Think, to take one real-world example which might resonate with British readers, of welfare standards in egg production. In some countries, there will be relatively more concern about caged hens and in others, more of a focus on cheap food. When Britain banned small battery cages at home, but was required by European Union rules to keep importing eggs from less-regulated Poland, British farmers were outraged. A few years later, when Britain succeeded in tightening the rules on cages across the EU, it was the turn of the Poles to feel furious.

Unlike conventional free trade, beyond-the-border harmonisation does not necessarily promise efficiency enhancements. There is no general theory to compare with Comparative Advantage to explain why unified food or banking regulations should, for example, in principle be able to work to the advantage of all countries. What harmonisation does entail, however, is sacrifice of national regulatory autonomy—and with it the ability to respond to the contours of individual economies and societies. Pacts governing cross-border investment and initiatives such as the TRIPS agreement, which has regulated intellectual property since 1995, were certainly what multinationals, financial firms, and big pharma wanted, and often obtained. Such agreements became contentious because they were viewed as privileging corporate interests over societal ones—and also as representing a direct assault on national democratic control.

Mad money

Perhaps the hyper-globalisers’ most egregious mistake after the 1990s was to promote financial globalisation. They took the textbook argument and ran amok with it. Free flow of finance across the world would, it was confidently predicted, set money to work where it could do most good. With free-flowing capital, savings would be automatically channeled to countries with higher returns; with access to the world markets, economies and entrepreneurs would have access to more dependable finance; and, ordinary individual savers would benefit, too, as they’d no longer be compelled to put all their nest eggs in one national basket.

These gains, by and large, simply never materialised; sometimes, the effect was the opposite of what was promised. China became an exporter of capital, rather than an importer of it, which is what the theory implied young and poor countries should be. Loosening the chains of finance produced a string of extremely costly financial crises, including that in East Asia in 1997. There is, at best, a weak correlation between opening up to foreign finance and economic growth. But there is a strong empirical association between financial globalisation and financial crises over time, as there has been since the 19th century, when freely moving international capital would flow with gusto into the Argentinean railways or some far-flung corner of the British Empire one minute, only to flee away from it the next.

Modern financial globalisation went furthest in the eurozone. Monetary unification aimed at complete financial integration, by removing all transaction costs associated with national borders. The introduction of the euro in 1999 did indeed drive down risk premiums in countries such as Greece, Spain, and Portugal, as borrowing costs converged. But what was the effect? To enable borrowers to run large current account deficits, and accumulate problematic amounts of external debt. Money flowed into those parts of the debtor economies that couldn’t be traded across borders—above all construction—at the expense of tradable activities. Credit booms eventually turned into the inevitable busts, and sustained slumps in Greece, Spain, Portugal and Ireland followed amid the global credit crunch.

Today, the economics profession’s views on financial globalisation is ambivalent at best. It is well understood that market and government failures—asymmetric information, bank runs, excess volatility, inadequate regulation—are endemic to the financial markets. Globalisation often accentuates these failures. Indeed, in the 1997 East Asian crisis those economies that kept more control of foreign capital survived with less damage. In sum, unconditional openness to foreign finance is hardly ever a good idea.

Most of the scepticism is directed at short-term financial flows, which are so given to crisis and excess, whereas long-term flows and direct foreign investment are generally still viewed favorably. Such investment tends to be more stable and growth-promoting. But it is not without its problems either. It produces shifts in taxation and bargaining power that are adverse to labour.

Why? Because for as long as wages are partly determined by bargaining, employers will benefit from having a credible threat: accept lower wages, or else we move elsewhere. There is some evidence that the decline in the labour share of national income is related to the threat of relocating production abroad. Furthermore, if capital becomes much more mobile than labour, then labour is left more exposed to local shocks. Workers with the lowest skills and qualifications, those least able to move across borders, are typically the most affected.

As capital becomes mobile, it also becomes harder to tax. Governments increasingly have to fund themselves by taxing things that are less footloose: consumption or labour. Indeed, corporate tax rates—which Trump is currently engaged in cutting—have come down sharply in virtually all advanced economies since the late 1980s, sometimes by half or more. Meanwhile the tax burden on wages (social security charges, for example) has remained roughly constant, while rates of consumer and value added taxes (VAT) have very often increased.

So where next? The first thing to say is that we should not expect any early return to those 1990s expectations, of remorseless economic integration which paid politics no heed. Electorates just won’t wear it. The huge surge in support for populists of the left and right in the world’s democracies makes this plain. In countries where populists stand for election, on my calculations they attracted less than 10 per cent of the vote in the late 1990s, but that has surged to very close to 25 per cent in recent years.

If the old road is closed, which others lie open? The nightmare of a re-run of an outright, 1930s-style collapse in co-operation looks mercifully unlikely. Decades after the Soviet disintegration, nobody is going to be convinced by Stalinist “socialism in one country,” in the way that many leftists were back then. Nationalism remains a powerful force, but more stands in its way than it did in the 1930s. Today we also have much stronger international organisations, and although safety nets may be fraying at home, they still do more to cushion those adversely affected by trade than during the Depression years. Perhaps most importantly, the political power balance in advanced democracies today heavily favours groups that favour international trade and investment.

There is nonetheless another ugly scenario, which is considerably more likely: centrist elites fail to respond appropriately to the backlash, and this very gradually fuels more populism and protectionism. This would erode the openness of our economies to foreign products and perhaps ideas and, most importantly, it could erode liberal democracy too. This is a risk because of the contempt that the populists typically have for due process, protection for dissenting minorities, and checks and balances on “the will of the people” as they define it. An unhealthy element of nationalist chauvinism could easily creep in. Brexit and Trump are the harbingers of this scenario.
"Globalisation is shaped by the rules the authorities choose to enact, and the interests they privilege"
There is, however, another, much better, way forward: a democratic rebalancing. Stepping back from hyper-globalisation without slamming the door, while restoring greater national autonomy in the service of a more inclusive domestic order. What, more concretely, might this involve? Developing and applying the idea of “fair trade” for one thing. It is a notion economists find hard to warm to; many of them feel it smacks of disguised protectionism. But fair trade is already enshrined in trade laws in the form of anti-dumping and countervailing duties, which countries can use to hit back against nations that price exports in a predatory manner or subsidise them to gain market share. Sure, these so-called “trade remedies” undercut blocking certain exchanges, but they also enable political buy-in for an open trading system.

Had trade negotiators extended such remedies to what might be called “social dumping,” competing by undercutting on labour standards, for example, they may have afforded the world trade regime the popular support it sorely lacks. The hyper-globalisers, however, never entertained the idea. For them, comparative advantage was comparative advantage—regardless of whether it was produced by a country’s resources or its repressive institutions. Through Trump, Brexit and the resurgence of the populist left, they are today paying the price of their indifference. Those who wish to preserve an open, liberal order must now give some overdue thought to what sort of political processes can write fair trade rules that will not only apply, but also enjoy respect, across national borders. We can begin by designing trade agreements that enhance the legitimacy of the world economy in the eyes of the broad public, instead of pursuing the special interests of global corporations.

The fundamental thing to grasp is that globalisation is—and always was—the product of human agency; it can be shaped and reshaped, for good or ill. The great problem with Blair’s forceful affirmation of globalisation back in 2005 was the presumption that it is essentially one thing, immutable to the way that our societies must experience it, a wind of change which there could be no negotiating or arguing with. This misunderstanding still afflicts our political, financial and technocratic elites. Yet there was nothing preordained about the post-1990s push for hyper-globalisation, with its focus on free finance, restrictive patent rules, and special regimes for investors.

The truth is that globalisation is consciously shaped by the rules that the authorities choose to enact: the groups they privilege, the fields of policy they tackle and those they lay off, and which markets they subject to international competition. It is possible to reclaim globalisation for society’s benefit by making the right choices here. We can prioritise corporate tax co-ordination over stronger patent protections; better labour standards over special tribunals for investors; and, greater regulatory autonomy over the minimisation of behind-the-border transaction costs.

A world economy in which these alternative choices are made would look very different. The distribution of gains and losses across and within nations would be dramatically altered. We would not necessarily have less globalisation: enhancing the legitimacy of world markets is likely to spur global commerce and investment rather than impede it. Such a globalisation would be more sustainable, because it would enjoy more consent. It would also be a globalisation quite unlike the one we have at present.