Who gets richer from globalization?
Globalization, in fact, has a side effect: inequality increased in most countries following a decrease in tariffs. This includes both wage inequality between groups of workers and shifts of profits to highly productive firms at the expenses of smaller enterprises.
Trade openness was creating winners and losers within each country. In other words, the gains created by free trade were greatly benefitting some people at the cost of most. This justifies a political economy story behind protectionism, that in a Ricardian world would be completely irrational, where losers oppose to trade and winners promote it.
What is the solution, then? Could impeding trade be beneficial? Trade does increase the amount of resources in all countries. Giving it up also means giving up that extra wealth. Then, what is the solution? If we are able to recognize who loses from opening to trade, we can compensate them. The solution is redistribution.
In order to effectively redistribute, we need to understand who wins and loses, and how it happens. Melitz (2003), in one of the seminal contributions to the topic, picks up that challenge by looking at the supply side of the economy. He shows that when trade is opened, low cost producers are able to enter the domestic market driving less efficient firms out of business.
The resources dismissed by closing firms can be re-employed by the surviving enterprises, more productive, increasing their production and sales. Business anecdotes confirm this story of the differential effects of trade on firms profitability depending on their starting point.
The country is overall more productive, a desirable effect. At the same time the owners of the firms that are closing due to the spike in competition and their workers that have been laid off must not be ecstatic about the change. The challenge, then, is combining this efficiency of globalization with fairness and economic inclusion.
Some economic actors are better positioned to take advantage of low barriers to trade. Multinational firms, for instance, can move production to low-wage countries, while workers are passive recipients of such decisions.
Then, how do multinational firms navigate this system ensuring they are on the winning spectrum?
The multinational firm and its strategy
Multinational firms are key players in the global economy. The fall in trade and investment barriers, the technological innovation that makes transportation and remote management ever easier incentivizes the geographical dispersion of production (Antras, 2003; OECD, 2013).
Firms internationalize their production in search of lower wages, greater flexibility, looser regulatory boundaries, to tap into foreign markets and into their competitive advantage in certain aspects of production. Despite the efficiency of this process, does it happen at the expense of other members of society? What happens in the offshored country and what happens back home?
When production is outsourced in low-income countries, their firms can access a greater and richer market, their production increases, increasing the amount of workers employed, and they can acquire more sophisticated techniques and technologies. Is this a win for those developing countries?
According to the wide literature on Global Value Chains, there is a relationship between growing international outsourcing and increase in inequality in developing countries, along with the deterioration of other social variables such as labor vulnerability and women’s rights (Kaplinsky, 2000; Milberg and Winkler, 2013).
The greater bargaining power of multinational firms, in fact, allows them to impose conditions that are not necessarily beneficial to firms and workers abroad. The long term gains from inclusion in value chains impose short term burdens on current workers.
Once again, a trade off.
Which brings us back home. What happens to the workers in the country that has offshored its production?
What about the workers at home?
Hecksher and Ohlin first started the literature on the distributional effects of trade, followed by many others, including among the most important contributions Grossman and Rossi-Hansberg (2008). The common denominator in all these models is juxtaposing low-skilled and high-skilled workers to see the differential effect of trade openness on wages and employment.
In OECD countries, in fact, wage inequality increased together with unemployment for the least skilled following an increase in trade (Wood, 1994).
Most interestingly though, offshoring led to a rapid growth in employment for high-skill individuals, and a modest growth for low-skill jobs. The slowest was experienced by middle-skill employment. In other words, middle-income workers were the ones that lost from globalization.
The argument is that it is easier to offshore manual tasks, like product manufacturing, where practices are highly codifiable and transmittable. It is harder for headquarter services or R&D, where developed countries enjoy a comparative advantage both in techniques and protection of proprietary knowledge. It is also hard to offshore the lowest-skill services that often require geographical proximity.
For instance, how could you offshore the cleaning services of your office? Not only it is impossible, but the growth in high-skill and traditional office jobs runs parallel to the need for people that clean those offices.
Skilled individuals are benefiting from offshoring at the expense of middle-skill manufacturing jobs.
One of the beneficial effects of trade, predicted and welcomed by trade scholars, is the displacement of workers. As unprofitable firms are driven out of business, their workers are laid off and move to more productive ones. A win-win for workers and society at large.
However, neither those industries that enjoy a competitive advantage, nor exporters are able to immediately reabsorb trade-displaced workers (Menezes-Filho and Muendler, 2007). There is a level of inertia in labor adjustments.
Dix-Carneiro (2013), for instance, estimates that it might take several years (for some industries even more than a decade) for the majority of workers to be reabsorbed into the labor market following a trade reform and that the costs of their reallocation can reach almost three times their annual wage.
And inequality worsens if this transitional unemployment flows towards the informal sector, commonly displaying lower wages, benefits and job satisfaction.
The possible solution could be public support for this costly switch; some form of redistribution that helps people get back on their feet after these shocks.
Once again we are face with the principle that there is no free lunch. The benefits we all experienced from a globalized world come at the expense of some people. And despite anecdotes, empirical and theoretical research pointed out this fact, we decided to ignore it.
This is far from an argument in favor of protectionism. After all, free trade does make countries overall better off. But we need to decide what to do moving forward for those that bear the costs of a globalized society.
In a world that seems directed towards more closure, can we find other solutions that are both efficient, fair and, most importantly, inclusive?
Dix-Carneiro, R. (2014). Trade liberalization and labor market dynamics. Econometrica.
Feenstra R. (2004). Estimating the effects of trade policy. University of California, Davis, Department of Economics Working Papers.
Grossman, G. M. and Rossi-Hansberg, E. (2008). Trading tasks: A simple theory of offshoring. American Economic Review
Kaplinsky, R. (2000). Globalization and unequalization: What can be learned from value chain analysis? Journal of development studies.
Melitz, M. J. (2003). The impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica.
Menezes-Filho, N. A., & Muendler, M. A. (2011). Labor reallocation in response to trade reform (No. w17372). National Bureau of Economic Research.
Milberg, W. and Winkler, D. (2013). Outsourcing economics: Global value chains in capitalist development. Cambridge University Press.
OECD (2013). Interconnected economies: Benefiting from global value chains. Technical report. Meeting of the OECD Countries at the Ministerial Level. Paris 29-39 May 2013.
Ricardo, D. (1817). On the Principles of Political Economy and Taxation. London
Wood, A. (1994). North-South Trade. Employment and Inequality.