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Winners and losers from globalisation within nations

Gains and Pains from Trade

The two key gains from trade

  • Consumer gain (higher consumer purchasing power): Consumers in each nation get something from abroad for less than they would pay at home. This means lower prices and a wider variety of goods to choose from.

  • More productive economy (shifting resources to nation’s most competitive sectors): Additional gains come from the production side of the economy as the import competition and export opportunities that come with free trade tend to shift productive resources (labour, capital, etc) into the economy’s more productive sectors, i.e. the sectors where the nation has a comparative advantage.

The two key gains from trade “amplifiers”

  • Greater scale economies & agglomeration economies. Higher volume production tends to lower per-unit production costs. And, agglomeration of economic activity in particular regions boosts productivity by allowing ‘spill overs’ that make each firm more productive. For example, firms cluster in Silicon Valley in part because of the knowledge spillover over between firms in close proximity.

  • Upgrading: opening up to trade often induces “skill upgrading” by workers, improved management techniques, better governance, higher quality products, etc.

Other gains from trade that appear over time (so-called “dynamic gains” from trade)

  • Investment: Trade creates new investment opportunities and thus stimulates investment-led growth.

  • Innovation: Trade opening may induce innovation which drives productivity and growth which in turn supports long term growth.

  • Trade and peace: “Crudely put, sales people are usually reluctant to fight their customers”, or “to know me is to love me”. Empirical evidence for this trade-peace connection is strong, but difficult to know whether the peace causes the trade, or the trade causes the peace. The basic problem is that people tend to trade with nearby nations, but they also tend to go to war with nearby nations.

Pains from trade

The Iron law of price changes is that anytime a relative price changes, someone loses and someone wins. This is why globalisation – which moves domestic prices towards international prices – ALWAYS causes gains and pains.

Two key sources of pains from trade

  • Relative prices change (without production shifts).

  • The price changes lead to a restructuring of production and employment and this creates “adjustment costs” for the workers who lose their jobs and the firms that are downsized or driven out of business by the lower prices. Drilling down on the price-change-pain: the first involves the distinction between producers and consumers.

  • Producers lose from lower prices (which are driven down by import competition), but consumers gain from the same lowering of prices.

The second is on the supply-side and involves the “prices” of productive factors like capital and labour. Note that “wages” are the reward to, or price of labour, and “profits” are the reward to, or price of capital.

  • The demand rises for the type of labour that is most important in the sectors that expand as a result of trade (the export sectors) and this tends to raise the price of such labour.

  • The demand for the type of labour used most intensively in import competing sectors tend to fall and this tends to pull down these wages.

For example, China’s export sector uses unskilled labour very intensively and so the price of Chinese unskilled labour rose rapidly.

Alt Average Manufacturing Wage in China

Source: TACNA, http://tacna.net/mexico-vs-china/

The US’s most competitive sectors are those that employ highly educated workers while its least competitive sectors employ low-education workers. Globalisation has provided more opportunities and thus boosted the wages of the highly-educated, but globalisation has also led to more competition for the least-educated workers. The impact on wages can be seen in the chart below.

Alt US average weekly earnings 2014

Turning to the restructuring ‘change pain’, things are simpler.

  • People who work in sectors that face more competition due to globalisation are those who have to change jobs, retire early, and/or move to a new city to get a job. The workers in expanding export sectors, by contrast, do not typically bear such “adjustment” costs.

  • The adjustment cost can also fall on firms that go broke, or significantly shrink as a result of the trade opening.

Pains from trade amplifiers

These one-time pains of trade (so-called ‘static’ pains from trade) may be amplified by other effects.

  • Trade may draw developing nations into producing goods where technological progress is slow, or sectors where scale economies are absent.

  • Nations that focus on exporting natural resources can get trapped in spirals of poverty, violence, and/or political tyranny. This is called the ‘natural resource curse’ (i.e. exporting natural resources often fosters corruption and poor governance). Note that this is not universal. Australia and Norway, for example, are primarily natural resource exporters yet they have escaped the natural resource curse.

Globalisation’s hard reality

When it comes to globalisation, the rule is: no pain, no gain. This is why the politics of compensation always arises in the context of globalisation. When a nation opens up to trade, the losers ask for compensation. Normally the net economic gain is positive, so in principle winners could compensate losers, but in some nations, like the US, the politics blocks the types of sharing-and-caring government programmes that are common in other advanced nations, like Canada, Japan, and Western European nations.

Note that even the losers can win if the dynamic gain is large enough. But even then, some will gain more than others. By the same token, if the dynamic losses are large enough, all may lose.

Theory alone cannot answer the net-gain question – it’s a matter for empirical analysis done on a case-by-case basis.

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This article is from the free online course:

International Affairs: Globalisation

The Graduate Institute of International and Development Studies