The Political Economy of Globalization

The Political Economy of Globalization

The process of globalization had already begun in the late nineteenth century. Before World War I, trade and foreign investment were fairly globalized. Because of low political obstacles to international migration, labor markets actually were more globalized at the beginning of the twentieth century than at its end. The two world wars and the Great Depression between them interrupted the process of global market integration for about half a century. Thereafter, the process regained force and speed. Now, inexpensive, fast, and reliable communication and transportation enable producers of goods and some service providers in low-wage countries to challenge high-cost producers in rich countries on their home turf, but technological innovation resulting in falling prices and rising speed of intercontinental communication and transportation is not the only determinant of globalization. Political decisions in rich and poor countries alike contribute strongly to globalization, too. Tariffs and, to a lesser degree, nontariff barriers to trade have been reduced. Many countries try to find and exploit their comparative advantage, to realize economies of scale and gains from trade by looking for buyers and sellers everywhere. If trade between countries is truly free, then it promises to enrich all nations.

Since the publication of Adam Smith’s Wealth of Nations ([1776] 1976), we have known that the size of the market limits the division of labor and that the division of labor boosts innovation and productivity. In principle, globalization is the logical endpoint of the economic evolution that began when families switched from subsistence farming and household production to production for the market. As long as globalization is not yet completed-and it certainly is not yet-gains from trade remain to be realized by further market expansion. Because globalization adds to competitive pressure, however, it causes resentment, and because globalization springs from technological innovation and political decisions that promote free trade, these innovations and decisions attract resentment, too. The world is already globalized enough that national resistance does limited damage. Except for the United States, national resistance is more likely to contribute to a country’s decline than to derail the process of globalization.

Free trade is vulnerable. If foreigners are perceived as a cause of the need to adjust, then attacking free trade becomes politically attractive. After all, no politician benefits from the affection of foreigners who cannot vote. Of course, economists who insist on the benefits of free trade (even if your trading partner does not practice free trade) are right. Benefits include serving customers better at lower prices, but also faster growth of total factor productivity (Edwards 1998; OECD 2003, 89). The benefits of free trade, however, tend to be dispersed widely, whereas its costs (for example, certain bankruptcies and job losses) tend to be concentrated and more visible. Therefore, the political case against free trade may become very strong despite the weakness of the economic argument.

Who in rich Western societies is affected most by globalization? Although unskilled labor is much less expensive in poor countries than in rich countries, this difference does not necessarily provide poor countries and poorly paid labor there with a competitive advantage. Frequently, even unskilled labor is much more productive in rich countries than in poor ones. If the wage gap is neutralized by a countervailing productivity gap, unit labor costs are not affected by international differences in pay. If unskilled labor in rich countries is overpaid compared to unskilled labor in poor countries, however, then free trade reduces the demand for rich-country labor that is used intensively in the production of importable goods—that is, for low-skilled labor used in producing goods that compete with Western imports. The wages of low-skilled Western workers may suffer from downward pressure because their services have become more easily substitutable than previously (Rodrik 1997). This process might result in growing volatility of earnings and income inequality, as in the United States, or high unemployment, as in much of Continental Europe. Of course, unemployment is most likely to result from a combination of fierce international competition and rigid labor markets at home. Otherwise, trade is more likely to affect the composition of employment than its amount (Irwin 2002, 71).

Analysts dispute the degree to which either trade or technological progress has caused the predicament of unskilled labor in the West. Although the majority view (for example, Krugman 1996) blames most of it on technological progress, this conclusion is not entirely