Globalisation presumes sustained economic growth. Otherwise, the process loses its economic benefits and political support.
Paul Samuelson
Globalisation is a process of interaction and integration among the people, companies, and governments of different nations, a process driven by international trade and investment and aided by information technology … Governments also have negotiated dramatic reductions in barriers to commerce and have established international agreements to promote trade in goods, services, and investment. Taking advantage of new opportunities in foreign markets, corporations have built foreign factories and established production and marketing arrangements with foreign partners. A defining feature of globalisation, therefore, is an international industrial and financial business structure.
Levin Institute of International Relations
What does globalisation mean in concrete terms? One of its high priests, the International Monetary Fund (IMF), opined in its 2008 Overview that people had ‘become more globalised’, noting,
• The value of trade (goods and services) as a percentage of world GDP increased from 42.1 per cent in 1980 to 62.1 per cent in 2007.
• Foreign direct investment increased from 6.5 per cent of world GDP in 1980 to 31.8 per cent in 2006.
• The stock of international claims (primarily bank loans), as a percentage of world GDP, increased from roughly 10 per cent in 1980 to 48 per cent in 2006.1
The central premise of economic globalisation is, according to the IMF, ‘that global markets promote efficiency through competition and the division of labour – the specialisation that allows people and economies to focus on what they do best. Trade enhances national competitiveness by driving workers and economies to focus their efforts where they have a competitive advantage.’ These theoretical underpinnings of globalisation are not new; as far back as 1817 David Ricardo published his theory of comparative advantage to explain why countries engage in international trade.2 Notice however that the IMF speaks of competitive advantage without specifying whether this advantage is absolute or comparative. But as Ricardo shows, this is a crucial distinction.
Ricardo was trying to improve on his friend Adam Smith’s theory of absolute advantage,3 which, in turn, was a better (if imperfect) justification for international trade than mercantilism, the policy of growing an economy through exporting more goods and services than you import. Smith argued that mercantilism could not benefit all countries at the same time because one nation’s exports are another nation’s imports. Instead, he advocated that countries should specialise according to their absolute advantage, determined by a simple comparison of labour costs. Clearly, though, some nations might have no absolute advantage in anything, meaning that, while some will gain from international trade with absolute advantage, the gains may not be mutually beneficial.
In other words, concentrating production in countries with absolute advantages in everything is really just another form of mercantilism: the higher-cost countries will have to import all they consume, while the low-cost countries, enjoying an absolute advantage, will accumulate reserves – unless their currency rises, in which case their purchasing power will have risen at the expense of the absolutely expensive country that had to import goods and services.
Ricardo’s refinement of this argument was to introduce the idea of comparative advantage. He argued that, for mutually beneficial international trade, a nation should concentrate resources only on industries where it had a comparative advantage, that is, on those industries in which it had the greatest competitive edge. He even went as far as to suggest that national industries which were, in fact, profitable and internationally competitive should be jettisoned in favour of the most competitive industries, the assumption being that subsequent economic growth would more than offset any economic disadvantage from closing these down.
Ricardo attempted to prove his theory that international trade is beneficial by using a simple numerical example relating to the trade between England and Portugal in wine and cloth. In an address to the International Economic Association in 1969, Paul Samuelson famously called the numbers used in this example the ‘four magic numbers’.
A country is said to have a comparative advantage in the production of a good (or service) if its cost of production relative to another good is lower than is the case in other countries. This may arise because of natural advantages – for example, Portugal’s climate is conducive to the production of wine – or because of long accumulated know-how and technical expertise. A country should be left to specialise in the production of commodities where it has a comparative advantage. For Ricardo, the essence of mutually beneficial international trade is not the absolute difference in production cost between countries, but the comparative difference in costs between two goods in two countries.
All other things being equal, a country tends to specialise in and export those commodities in the production of which it has maximum comparative cost advantage or minimum comparative disadvantage. Similarly, the country’s imports will be of goods having relatively less comparative cost advantage or greater disadvantage.
Ricardo explained his theory with the help of the following (theoretical) assumptions.
1. There are two countries and two commodities.
2. There is perfect competition both in commodity and factor (labour) markets.
3. The cost of production is expressed in terms of labour – i.e. the value of a commodity is measured in terms of labour hours/days required to produce it. Commodities are also exchanged on the basis of the labour content of each good.
4. Labour is the only factor of production other than natural resources.
5. Labour is homogeneous – i.e. identical in efficiency in a particular country.
6. Labour is perfectly mobile within a country but perfectly immobile between countries.
7. There is free trade – i.e. the movement of goods between countries is not hindered by any restrictions.
8. Production is subject to constant returns to scale.
9. There is no technological change.
10. Trade between two countries takes place on barter system.
11. Full employment exists in both countries.
12. There is no transport cost.
Here’s how the four magic numbers play out.
On the basis of the above assumptions, Ricardo explained his comparative cost difference theory by taking the example of England and Portugal as two countries and wine and cloth as two commodities. The principle of comparative advantage is expressed in labour hours by the following table.
1 unit of wine |
1 unit of cloth |
|
England |
120 |
100 |
Portugal |
80 |
90 |
Portugal requires fewer hours of labour for both wine and cloth production. From this it could be argued that there is no need for trade as Portugal produces both commodities at a lower cost. Ricardo, however, tried to prove that Portugal stands to gain by specialising in the commodity, in this case the production of wine, where its comparative advantage is larger. Similarly, England should specialise in the production of cloth, because its comparative disadvantage is lesser than in wine.
To prove the Ricardian contention that comparative cost-based trade benefits both participants, though one of them has a clear absolute cost advantage in both commodities, we need to work out the domestic exchange ratio.
Let us assume these two countries enter into trade at an international exchange rate (terms of trade) of 1:1. At this rate, England specialising in cloth and exporting one unit of cloth gets one unit of wine. At home it would be required to give 1.2 units of cloth for one unit of wine, which is worse. England thus gains 0.2 of cloth, so wine is cheaper from Portugal by 0.2 unit of cloth. Similarly, Portugal gets one unit of cloth from England for its one unit of wine traded as against 0.89 of cloth at home, thus gaining extra cloth of 0.11. Here both England and Portugal gain from the trade, as England gives 0.2 less of cloth to get one unit of wine and Portugal gets 0.11 more of cloth for one unit of wine.
In this example Portugal specialises in wine, where it has a comparative advantage, leaving cloth for production in England in which the latter has a comparative advantage. On this basis, comparative cost theory states that each country should produce and export those goods in which they enjoy most cost advantage and import those goods where they suffer most cost disadvantage.
In reality, however, things didn’t work out as Ricardo had predicted. Economist Joan Robinson4 has pointed out that, following the opening of free trade with England, Portugal endured centuries of economic underdevelopment: ‘the imposition of free trade on Portugal killed off a promising textile industry and left her with a slow-growing export market for wine, while for England, exports of cotton cloth led to accumulation, mechanisation and the whole spiralling growth of the Industrial Revolution’.
Robinson also argues that Ricardo’s required conditions – such as full employment and a lack of trade deficits and surpluses – were not relevant to the real world. Nor did his theory take into account that some countries may be at different levels of development, raising the prospect of unequal exchange, which might hamper a country’s development, as in the case of Portugal.
While it is true that specialisation and trade according to relative cost of production can benefit all parties, the conditions under which it actually will, requires preconditions that do not currently exist in the real world. The idea that countries manage who produces what within their borders in coordination with each other is particularly flawed, given that the decision unit in capitalist economies is the company, an institution designed to support its own shareholders rather than coordinate economic policy and planning more widely. Ricardo’s theory of comparative advantage implicitly assumes the existence of industry and trade policy at a national level. It does not presume that business decisions are or should be made independently by entrepreneurs on the basis of viability or profit.
Despite its obvious flaws, Ricardo’s model – morphed into the more general concept of competitive advantage – has had a significant influence on the laissez-faire international trade policy that has dominated the last fifty years.
World trade increased strongly from 1960 to 2015,5 as many countries dismantled or reduced their barriers to trade through bilateral agreements and later under the auspices of the World Trade Organization (WTO). Governments were sold on the idea that global trade benefits everyone, and that the obvious benefits to consumers of being able to buy cheaper goods made in low-cost countries would raise standards of living. Rarely was it acknowledged that, in order to consume such cheap imports, consumers also need to be producers who sell enough to pay for their goods.
According to the IMF,
Global markets also offer greater opportunity for people to tap into more diversified and larger markets around the world. It means that they can have access to more capital, technology, cheaper imports, and larger export markets. But markets do not necessarily ensure that the benefits of increased efficiency are shared by all. Countries must be prepared to embrace the policies needed, and, in the case of the poorest countries, may need the support of the international community as they do so.
In fact, developing countries have done remarkably well from the explosion in international trade, but they were not the ones in need of help. Rather, more traditional economies have often borne the brunt, including the US. Consider, for example, the case of the dramatic decline in decently paid manufacturing jobs there. In a speech in Cleveland, Ohio in 2015, the chair of the US Federal Reserve Board, Janet Yellen, bemoaned the loss of manufacturing jobs: ‘Unfortunately, the number of US manufacturing jobs has been generally decreasing since its peak in the late 1970s …This painful trend reflects a number of long-term challenges faced by domestic manufacturers, including the relative costs of labour and investment in producing domestically versus abroad.’6
The loss of jobs is an inconvenient truth for the argument that globalisation delivers win-win benefits, with American manufacturing in rude health while its citizens also benefit from cheaper imports. In fact, data published by Susan Houseman and her colleagues in 2011 shows that once you take out computers, the picture is much more complex.7 The big increases in manufacturing output recorded in the US, even as employment plummeted, were partly due to statisticians adjusting upwards the output for quality improvements such as computing power in the technology sector. If you strip this out, manufacturing output in the US has been stagnant. However, this point has gone largely unnoticed and the assumption remains that the increases reflected healthy productivity growth.
So what happened to all those jobs? Globalists argue that automation has been the root cause, with robot-driven productivity both pushing growth and taking traditional manufacturing jobs. And, according to Houseman et al., automation did happen in manufacturing; we look at its effects in more detail in Chapter 2. However, the extent of its impact, especially in the US, is questionable, as reported by Quartz.com in 2018: ‘Consider the shuttering of some 78,000 manufacturing plants between 2000 and 2014, a 22 per cent drop. This is odd given that robots, like humans, have to work somewhere. Then there’s the fact that there simply aren’t that many robots in US factories, compared with other advanced economies.’8
Remarkably, while Germany installed more robots per worker than the US, a study by German academics found that only 274,000 manufacturing jobs were lost in Germany between 1994 and 2014 because of robots, this in a sector that still makes up around a quarter of the economy.9 Germany lost only 19 per cent of its manufacturing jobs between 1996 and 2012, compared to a third lost by the US. Korea, France and Italy also lost fewer such jobs even though they used more robots per hours worked. Conversely, low-robot-intensive economies such as the UK and Australia saw faster declines in their manufacturing sectors.10
When we consider, for example, that the US production of motor vehicles dropped from around 13 million in 1999 to 11 million in 2017, it’s difficult to identify a boom in manufacturing output or productivity growth attributable to robots. And if booming robot-led productivity growth wasn’t displacing factory workers, then, according to Houseman et al., ‘the sweeping scale of job losses in manufacturing necessarily stemmed from something else entirely’. Instead, a good part of the job losses in sectors such as autos is attributable to the rising share of imports.
In other words, contrary to the globalists’ thesis, the role of trade in displacing workers is a bigger contributing factor than its defenders are willing to admit.
Of particular importance is China’s emergence as a major exporter, which US leaders had encouraged. This has been evidenced in a wealth of research. A study by economists David Autor, David Dorn and Gordon Hanson found that the parts of the US hit hard by Chinese import competition saw manufacturing job loss, falling wages and the shrinking of their workforces.11 It also found that compensating employment gains in other industries never materialised. The authors drew on detailed studies of the local impact of trade with China to estimate conservatively that at least a quarter of the collapse in manufacturing jobs in the US between 2000 and 2014 was caused by trade with China. These conclusions were mirrored in a second paper, which estimated that competition from Chinese imports cost the US as many as 2.4 million jobs between 1999 and 2011.12
The US National Bureau of Economic Research published a report in 2012 on the decline in manufacturing due to the integration of China into the trading system. They summarised their findings as follows:
According to the Bureau of Labor Statistics, US manufacturing employment fell from 19.6 million in 1979 to 13.7 million in 2007 … This paper finds a relationship between the sharp decline in US manufacturing employment that occurs after 2001 and US conferral of permanent normal trade relations on China in October 2000. This change in policy is notable for eliminating uncertainty about potential increases in tariffs rather than changing the actual level of tariffs … these employment declines are associated with relative increases in US imports from China, the number of US firms importing from China, the number of Chinese firms exporting to the United States, and the number of US–China importer-exporter pairs … Second, we show that elimination of uncertainty is associated with suppressed job creation as well as exaggerated job destruction. The relative importance of the former indicates that analyses of the effect of international trade on domestic employment that focus solely on job destruction may be inadequate … estimates of employment loss persist even when controlling for industry attributes which might be linked to trends in technical change, particularly industry capital and skill intensity.13
In 2017 an Economic Policy Institute report concluded that, since China entered the WTO in 2001, its trade surplus with the US had grown from $83 billion to $367 billion in 2015. That is to say, the US went from rough self-sufficiency up until the 1980s, to outsourcing a lot of its production to low-cost China, at the inevitable cost to American jobs and wages.14 US manufacturing employment dropped 18 per cent between March 2001 and March 2007.
Figure 1.1: Manufacturing employment, percentage change 1990–2014
Why did China have such a big impact on US manufacturing employment sparked by granting China Permanent Normal Trade Relations (PNTR) in 2000 and China’s accession to the WTO in 2001 – set in motion by Bill Clinton? Because when China joined the WTO, it became a fully protected member of the globalised trading community, reducing the risk that the US might retaliate against the Chinese government’s mercantilist currency and protectionist industrial policies by raising tariffs. International companies that set up shop in China therefore enjoyed the benefits of cheap labour, as well as a huge competitive edge from the Chinese government’s artificial cheapening of the yuan.
Having peaked around 1977, US manufacturing employment has been steadily retreating for decades, with losses accelerating round about the time of China’s accession to the WTO. This is replicated throughout the advanced economies, as shown in Figure 1.1 above.
Table 1.1: Urban manufacturing employment in China, 2000–14
Coincidentally, in the same period, China has been aggressively taking global market share in manufacturing and, in contrast to the West, manufacturing employment has boomed, even in the face of technology and robots, rising from 32 million in 2000 to 79 million in 2014 for urban workers (see Table 1.1). In addition, rural manufacturing workers increased from 14.5 million to 23.6 million from 2003 to 2014.
Why does China not exhibit the trend of declining manufacturing employment? The key reason is clear: the liberalisation of the economy associated with China’s entry into the WTO led to a huge surge in China’s share of global exports and particularly its share of global manufacturing exports, which tripled from 6 per cent in 2000 to 18 per cent in 2012. In contrast, over the same period the US share fell by half, from 18 to 9 per cent.15
The fact is, the globalisation lobby has rarely stated clearly and precisely what they mean by globalisation, nor do advocates differentiate between gains from trade due to absolute cost advantages or from relative or comparative cost advantages. This is because either they do not understand the difference, or if they do, it does not help their case to acknowledge that specialising according to absolute cost means whole nations may lose out. And although comparative advantage is a better justification for trade, as we saw from scrutinising Ricardo’s four magic numbers theory, even this does not stand up to scrutiny in the real world.
This does not prevent globalisation’s backers from drawing the related false conclusion that putting up barriers to trade is harmful to those that do so. The received wisdom is that restricting international trade – protectionism – will have adverse consequences, for example, raising the prices of imported goods to the detriment of consumers. Broader issues of fairness, or winners and losers, tend not to figure in their arguments. Calculations that the loss of cheap imports might be more than compensated for by the re-establishment of higher-paid jobs in the importing nation go largely unmade.
Nobel laureate Joseph Stiglitz is a prominent critic of globalisation as currently practised. For Stiglitz, globalisation can be either a success or a failure, depending on its management: there is potential for success when it is managed by national governments embracing the characteristics of each individual country; there is a failure when it is managed by international institutions such as the IMF.16 He argues that international institutions such as the IMF and WTO are not democratic, do not play the role of a world government and too often favour the interests of big multinational businesses and the financial community.
In the US concerns have also been raised about the North American Free Trade Association (NAFTA), established in 1994 between the US, Canada and Mexico. Writing twenty years later, former US congressman David Bonior claimed that NAFTA had led to ‘a fundamental change in the composition of jobs available to the 63 per cent of American workers without a college degree’ and a ‘ballooning’ trade deficit with the other signatories.17 Manufacturing jobs have either been lost or subject to downward pressure on wages as workers are forced to compete with poorly paid workers elsewhere. Workers made redundant from higher-paid manufacturing jobs have also flooded the market for already lower-paid service jobs, while the threat of further manufacturing shutdowns has effectively closed off wage bargaining, fuelling income inequality. In addition, governments focused solely on improving ‘labor-market flexibility’ in the name of deregulation have pursued policies that privilege employers’ interests over those of workers, by hampering employees’ ability to organise.
The Labor Department’s Trade Adjustment Assistance program, which documents this trend, reads like a funeral program for the middle class. More than 845,000 workers have been certified under this one narrow and hard-to-qualify-for program as having lost their jobs because of offshoring of factories to, and growing imports from, Mexico and Canada since NAFTA.
The result is downward pressure on middle-class wages as manufacturing workers are forced to compete with imports made by poorly paid workers abroad. According to the Bureau of Labor Statistics, nearly two out of every three displaced manufacturing workers who were rehired in 2012 saw wage reductions, most losing more than 20 per cent.
And, for America’s remaining manufacturing workers, NAFTA put downward pressure on wages by enabling employers to threaten to move jobs offshore during wage bargaining. A 1997 Cornell University study ordered by the NAFTA Commission for Labor Cooperation found that as many as 62 per cent of union drives faced employer threats to relocate abroad, and the factory shutdown rate following successful union certifications tripled after NAFTA.
This is hardly news; in the early 1990s a spate of studies resulted in an academic consensus that trade flows contributed to between 10 and 40 per cent of inequality increases. Indeed, since NAFTA’s implementation, the share of national income collected by the richest 10 per cent has risen by 24 per cent, while the top 1 per cent’s share has shot up by 58 per cent.18
Some advocates of NAFTA-style pacts acknowledge that they cause the loss of some jobs, but argue that workers win overall by being able to purchase cheaper imported goods. However, when the Center for Economic and Policy Research applied the data to this theory, they found that reductions in consumer prices had not been sufficient to offset losses in wage levels. They found that American workers without college degrees had most likely lost more than 12 per cent of their wages to NAFTA-style trade, even accounting for the benefits of cheaper goods. This means a loss of more than $3,300 per year for a worker earning the median annual wage of $27,500.
The NAFTA data poses a significant challenge for proponents of globalisation. Bonior, himself the House of Representatives Democratic whip during the vote on NAFTA in 1983, is honest enough to recognise that the agreement was not all it was cracked up to be. Not so much because it caused a loss of US jobs, although arguably it did, but because in practice more trade does not always lead to the winners being willing and able to more than compensate the losers. They might if governments of high-cost countries were tough enough to extract good terms from low-cost countries in a fair quid pro quo. But with NAFTA this did not happen. Either Congress and President Clinton simply accepted the prevailing economic orthodoxy of the free traders, even if based on a set of unrealistic assumptions, or they knew that only part of the population would directly benefit but hoped that a trickle-down wealth effect from the main beneficiaries to the rest would eventually compensate for the loss of well-paid manufacturing jobs. Or most disturbingly, they simply carried out the wishes of big business and finance because of the power of the lobbyists and the need to cover election campaign costs.
Another defence of NAFTA and other globalising pacts is that any short-term frictional adjustment costs of unemployment or lower-wage re-employment for workers whose jobs have been outsourced abroad will be offset by the long-term benefits, as the next generation is channelled into the higher-productivity activities that a country specialises in. Unfortunately, the short term is becoming a bit long in the tooth. Stiglitz claimed that ‘one of the reasons we [America, but also applicable elsewhere] are in such bad shape is that we have mismanaged globalisation’. Free-trade theory ‘only says that the winners could compensate the losers, not that they would. And they haven’t – quite the opposite. This is one of the reasons that the real median income of male workers is lower than it was forty years ago.’
In finance, people joke that a long-term investment is often a short-term investment that went wrong. Perhaps the same goes for economic theory.
The fact is, the step-up in the pace of globalisation of the past quarter-century has created winners and losers, and the winners have, by and large, opted to pocket the gains rather than redistribute some of them to compensate the losers. By and large, the winners have been workers in developing countries, and the captains of industry and finance in the developed world whose earning power has been linked to the boost in profitability from outsourcing production and servicing to lower absolute cost countries.
Among other things, this has led to the unprecedented phenomenon that our children’s generation looks set to be the first in modern times to end up worse off than its parents’, after taking into account higher debt and lower housing affordability. Real median incomes of those aged 15–24 were the same in 2014 as in 1979.19
The picture is not much better for the wider working-age population, nor is this confined to America. Even the European model of success, Germany, is subject to the same phenomenon. Real wage growth averaged a paltry 0.43 per cent per annum from 1992 to March 2019, boosted in the early years by German unification,20 while real GDP per capita rose from $32,337 in 1990 to $46,987 in 2017.21
Of course, pay restraint has been a factor driving Germany’s competitiveness and export machine. It is the only Western country that has managed to maintain a strong manufacturing base and benefited, as a country, from increased world trade. The question is, as for all Western countries, to whom have those benefits accrued?
While the opening of China to the global production chain has caused a structural decline in Western manufacturing jobs, this does not by itself disprove the benefits of greater international trade. But the evidence of stagnant real wages and the declining share of labour income versus profits in the economic pie, as well as rising income inequality, are hardly consistent with the optimists’ belief that new higher-productivity jobs will more than compensate the losers from globalisation. It simply has not happened.
At the same time, the IMF applauds the concomitant explosion in the financial industry:
The world’s financial markets have experienced a dramatic increase in globalisation in recent years. Global capital flows fluctuated between 2 and 6 per cent of world GDP during the period 1980–95, but since then they have risen to 14.8 per cent of GDP, and in 2006 they totalled $7.2 trillion, more than tripling since 1995. The most rapid increase has been experienced by advanced economies, but emerging markets and developing countries have also become more financially integrated. As countries have strengthened their capital markets they have attracted more investment capital, which can enable a broader entrepreneurial class to develop, facilitate a more efficient allocation of capital, encourage international risk sharing, and foster economic growth.22
No doubt increased trade necessitates a more extensive global financial infrastructure, including, for example, an increase in banks’ capacity to finance trade, corporate restructuring and cross-border reorganisation and takeovers. But we also understand now that international risk sharing also means international contagion and recession when too much risk accumulates in the global financial system. Perhaps one can have too much of a good thing.
There are of course many attractive aspects to a globalised world. It is true that it enables communication across the planet and, combined with the Internet and digital communication, it has democratised access to information. In theory at least it should put more pressure on tyrants and vested interests that benefit from monopolising information. It is also true that it has brought countless people in the developing world out of poverty. Real wages in India and China have risen strongly between 1990 and 2014. The gap is stark between the emerging and developing markets of the G20, where real wages almost tripled between 1999 and 2017, and the developed countries, where real wages rose by only 9 per cent. If we look at individual countries, over the decade 2008–17 real wages have risen 5–9 per cent in Canada, the US and France, but have actually fallen by about 5 per cent in the UK and Italy. Contrast this with China, where real wages almost doubled over the period.23
While the number of workers living in extreme poverty in low- and middle-income countries has fallen from 1.3 billion in 1993 to 700 million in 2018, thanks to China’s high economic growth,24 the global middle class has expanded from about 1 billion people in 1985 to 3 billion in 2015. Most of this growth has come from the Asia Pacific region.25 The developing world’s middle class surged by 870 million between 1991 and 2013. These are indeed impressive figures. However, while they suggest that inequality has narrowed between countries, it doesn’t change the fact that inequality has skyrocketed within countries, as we shall see later.
Globalisation has also had a positive impact on inflation, partly through the availability of cheap manufactured imports from emerging markets and partly the restraining influence on Western wages of workers knowing jobs can be easily moved to cheaper locations. The supply of cheap goods and services has undoubtedly increased the purchasing power and standard of living of Western consumers, other things being equal. The problem is, this caveat is spectacularly inappropriate in this context. Globalisation does not just mean cheaper consumer goods. It rearranges all the means of production and their networks, with secondary effects on local producers dependent on the spending power of those engaged in the production of internationally tradable goods and services. This is another example of the multiplier effect – Keynes’s insight into the knock-on effects of an initial change in consumption or savings or any other large component of an economy.
The consequences do not stop with the private sector. Changes in aggregate income growth, as well as its composition and distribution, will inevitably affect public finances. Stagnating middle-class incomes in the developed world, coupled with a greater reliance on lower-paid work or government handouts, has also contributed to a structural deterioration in local and national government budgets.
Promoting globalisation over the last thirty years, however, has been a prime case of pushing against an open door. Rightly or wrongly, the inflationary 1970s led to the rejection of Keynesian economics and governments playing a major role in economies. The collapse of communism in 1989 not only physically liberated people, goods and money to move around the globe, but also constituted the proof, for many, of the supremacy of the Anglo-Saxon free-market model. In a global contest spanning three generations, the West had won by a knockout. The only other option, Keynes’s in-between social democratic state interventionism, had been tried and discredited.
In the circumstances the West turned to full-fat free-market capitalism as the only game in town. This promised the most efficient allocation of resources, guided by economist Adam Smith’s so-called invisible hand. Smith coined this metaphor to describe how economic agents acting out of self-interest in the market end up promoting the common good, even though that may not have been their intention. The problem is that the conditions Smith described no longer exist. For example, private businesses in sole proprietorships have largely been superseded by limited liability companies, in which ownership is dispersed among shareholders who delegate the running of the businesses to a professional managerial class with its own economic interests.
Similarly, the early version of capitalism described by neoclassical economists consisted overwhelmingly of agriculture and industrial production. The romantic view of the free marketeers has not adapted to the rise of tertiary industries, in particular finance. Unlike primary and secondary industries, finance is fundamentally pro-cyclical and not self-stabilising. It is the cuckoo in the nest. This is because its growth, through the promotion of credit and therefore debt, is inherently destabilising if this takes place at a greater rate than the real growth of the underlying economy.26 It is also easily prone to speculative excess: higher asset prices perversely attract more demand, fuelled by more credit created on the basis of higher asset prices. This mechanism is not inherently self-correcting as neoclassical economics would wish; quite the contrary.
At some point that is difficult to predict this out-of-control self-reinforcing spiral of debt-fuelled asset or commodity price inflation breaks, threatening a large reversal in prices, causing defaults and threatening debt deflation. This occurs either when the debt load becomes unserviceable, either because of a rise in interest rates or because marginal borrowers do not have the means to service their new debts, interrupting the rise in asset prices required as collateral for the loans, or because growth slows. At this point the whole process goes into reverse and starts to self-destruct as, lacking new buyers, asset prices start to fall, causing more debt to become unserviceable as incomes and confidence fall and asset values fall below the value of some of the loans they support. Defaults rise and debt write-offs lead to forced asset sales and further tumbles in asset values, the tightening of credit conditions and so on in a death spiral that requires the intervention of the state to avert disaster.
Contrary to classical economic theory, falling wages may not restore equilibrium or full employment because a fall in wages will lead to lower prices and profits and, as a result, bankruptcies because of debt. This in turn places further pressure on employment and wages, creating the conditions for a depression. This was also Keynes’s central argument for government intervention.
In short, the invisible hand guiding the economy to the most efficient allocation of resources can turn self-destructive. It is arguably the case that all booms and subsequent busts in history not caused by war or disease were caused by the unrestrained excesses of the financial industry – which includes the real estate sector. Nevertheless, it became increasingly obvious during the 1980s that no other system could compete with Western liberal democracy. And what economic system had the winning side employed to win the argument? The capitalist free-market model based on classical economics, including Ricardo’s theory of the benefits of greater international trade
But the world confused the collapse of communism with proof of the validity of the unfettered free-market system. It confused the failure of policies in the 1970s that led to inflation with the discrediting of Keynesian economics. And it rehabilitated economic theory born in a world that no longer existed, absolving the authorities of responsibility and the public of the need to make difficult political choices. Everyone, on the left as well as the right, swore allegiance to the market, at least if they were serious about getting elected. Political choices and elections became mild debates on nuances and personalities rather than the big fundamental issues of the past.
Francis Fukuyama captured the zeitgeist in his 1989 essay ‘The End of History’: ‘What we may be witnessing is not just the end of the Cold War, or the passing of a particular period of post-war history, but the end of history as such: that is, the end point of mankind’s ideological evolution and the universalisation of Western liberal democracy as the final form of human government.’27 As if, having solved the riddle of social organisation, there was neither room for further evolution nor for conflict based on ideology: we would all inevitably fall into line and practise the same economic faith.
Fukuyama, however, was smart enough to recognise when things were not quite going according to plan. In 2014, on the twenty-fifth anniversary of the publication of his original essay, he wrote a column in The Wall Street Journal to update his hypothesis: while liberal democracy still had no real competition from more authoritarian systems of government ‘in the realm of ideas’, he was nevertheless less idealistic than he had been ‘during the heady days of 1989’.28
The biggest problem for democratically elected governments in some countries was not ideological but ‘their failure to provide the substance of what people want from government: personal security, shared economic growth and the basic public services … that are needed to achieve individual opportunity’. Fukuyama also warned of ‘political decay’, in which corruption and crony capitalism erode liberty and economic opportunity.
In the heat of the late 1980s, it had been easy to confuse democracy with free-market economics; at the time they went hand in hand. In fact, neither requires the other. Russia and China, for example, have grown in leaps and bounds since each adopted some form of market economy without fundamentally changing political systems that remain autocratic. The West recovered from the Great Depression of the 1930s thanks only to massive state intervention. The ‘thirty glorious’ post-war years saw the creation of welfare states in various forms in the West, with relatively high tax rates and state intervention in economic affairs. This coincided with strong growth, free from the kind of extreme booms and busts we have increasingly witnessed more recently.
A decade before the fall of the Berlin Wall and the disintegration of the Soviet Union, China, under the leadership of Deng Xiaoping, started to dismantle its state-run communist economic system.
The start of China’s emancipation from economic communism was the ‘open door’ policy, begun in 1978. Deng understood that fundamental changes in economic organisation were required if China was to compete with the West. He dismantled collective farms, created free-trade zones and encouraged the foreign investment needed for modernisation. Privately owned businesses sprang up. The policy also permitted Chinese nationals to travel and learn abroad and return to China with newly acquired skills.
As more modern and mechanised farming methods took hold and peasants were incentivised to increase productivity, farming yields went up. Cereal production grew 86 per cent between 1986 and 2005.29 In turn, this released millions of agricultural workers to seek employment in the growing manufacturing sector. If proof were needed that economic liberalisation worked, China was on its way to double-digit growth rates by the time Deng died in 1997.
Deng’s separation of politics from economics was encapsulated in a quote attributed to him: ‘It does not matter if a cat is black or white, as long as it catches mice.’ Deng possessed the political skill and pragmatism to shepherd his reformist agenda through the Communist Party system. Revolution and the dictatorship of the proletariat now took second place to increasing trade, opening up China’s internal market, acquiring technology and management expertise, and, crucially, focusing on export-orientated growth. In 1982 Deng described this process as ‘building socialism with Chinese characteristics’, arguing that the true socialist revolution could only occur after the bourgeois/industrial phase of economic development, rather than straight from a peasant society.
By liberating the economy from the dead hand of state ownership and control of prices, the Chinese leadership allowed the economy to breathe, and growth took off. China’s accession to the WTO in 2001 cemented its integration within the global economy by providing maximum access to international trade. Even allowing for the size of China’s population, and for starting from such a low base, the numbers are staggering. In 1978 GDP per head was $156. From 1980 to 2018, China’s average real growth rate was 9.3 per cent,30 with a high of 15.2 per cent in 1984 and a low of 3.8 per cent in 1990. By 2018, per capita GDP had reached $9,770.31
In inflation-adjusted terms, Chinese wages have also grown very strongly, especially since the early 2000s when it joined the WTO. Annual manufacturing wages per head rose from 26,599 yuan in 2009 to 72,088 in 2018. Given that inflation has averaged about 2 per cent per year, this represents stunning growth in real wages, even though China has also massively introduced robots. Clearly, from a national perspective China has been one of the big winners of globalisation.
The story in the West is more complicated. While average pay has gone up over the last twenty years, albeit at a much weaker pace in real terms than for the Chinese, this masks the fact that most of the benefits from trade have accrued to a minority at the top of the income scale. Wages for workers at the lower end of income distribution have either stood still or in real terms gone backwards.
Thomas Piketty argues that we have gone full circle. The top 1 per cent in America collected 25 per cent of income in 1929 at the height of the boom before the bust of the Great Depression, falling to 8.9 per cent in 1976 at the tail end of thirty years of growth, before rising once more to 23.5 per cent at the peak of the last boom before the financial crisis in 2007. In both the 1920s and 2000s there was a sharp increase in the level of debt, which was tolerated because of the belief in the self-correcting nature of markets.32
British real wages, while anaemic, did better in the twenty years up to the financial crisis but have paid the price since (see Figure 1.2). In countries like Greece and Italy real wages remain stubbornly below pre-crisis levels.
Figure 1.2: Median real wage growth, UK and US, 1988–2013
Perhaps most surprisingly, developed economies (like Japan and France) that failed fully to endorse free-market capitalism have shown far better real wage growth than Anglo-Saxon market ideologues predicted.
In the UK unemployment in the decades after the Second World War was low, hovering around 2 per cent from 1950 to 1970 before trending higher. Large-scale structural change came with the disappearance of manufacturing jobs after Margaret Thatcher came to power on an explicitly free-market agenda in 1979: a fall from 7 million jobs producing about 33 per cent of GDP in 1979, to around 3 million producing 13 per cent of GDP in 2008. This was a mirror image of the growth in the finance sector, which doubled to about 7 per cent of GDP from the 1970s to the start of the crisis. Since finance jobs enjoyed much faster wage growth than the rest of the economy, this temporarily dragged up the UK’s average wage growth (North Sea oil may have been another contributor), but when the financial crisis burst finance’s bubble, the UK’s underlying capacity for generating real wage growth was cruelly exposed.
In the Midlands and the north of England growth in government jobs helped to mop up the pool of otherwise unemployed labour, some of which had come from manufacturing. In fact, the UK employment market had a ‘good’ financial crisis. The unemployment rate never touched double digits and was back down to 5.6 per cent by the fourth quarter of 2014. According to Martin Wolf, a remarkable 73 per cent of the population between the ages of 16 and 65 were in employment, slightly above the pre-crisis peak.33 However, the bad news is that productivity has stalled. Output per hour worked has flatlined since the crisis, decoupling from the growth of the previous two decades and representing a period of stagnation unprecedented since at least the nineteenth century. At the same time, manufacturing was 4.9 per cent smaller than at the pre-crisis peak, while services were 8.1 per cent bigger.
In the US wages stagnated between 2000 and 2007, but real consumption rose by 20 per cent, financed by debt. And while unemployment oscillated widely between 4 and 10 per cent, and is once again below 4 per cent, this masks the fact that a growing proportion of the population has dropped out of the workforce altogether. Rather than breathing a sigh of relief that America appears to be approaching full employment, we should bemoan the fact that the percentage of the population in work has fallen to around 63 per cent, the lowest level since the 1980s and 2 per cent lower than before the crisis.
It is, of course, difficult to analyse fully the various factors that have contributed to the loss of secure high-paying manufacturing jobs in the West. As we have seen, apologists for globalisation point to technological change as the sole culprit as machines have displaced human labour. Others take a more nuanced approach. What nobody can deny is that the transfer of production to China has resulted in a massive trade imbalance. America’s trade deficit in manufactured goods went from virtually nothing in 1990 to several hundred billion dollars just twenty years later. Whereas the US lost about a third of its manufacturing jobs between 2000 and 2009, Germany lost only about 11 per cent. One reason for this is that manufacturing firms in Germany are often privately owned, maybe family businesses, more integrated into their local communities and likely to take a longer-term view of profit generation, so less likely to transfer production overseas.
Research by Harvard Business School’s Michael Porter, Jan Rivkind and Rosabeth Moss Kanter shows that the rise of globalisation went hand in hand with a change in how companies organised themselves and rewarded their senior management: ‘The basic narrative begins in the late 1970s and the 1980s. Through globalisation, it became possible and attractive for firms to do business in, to, and from far more countries. Changes in corporate governance and compensation caused US managers to adopt an approach to management that focused attention on the stock price and short-term performance.’34
In the UK manufacturing jobs shrank from 6.7 million to 2.7 million between 1979 and 2019. Going further back, in 1952 British manufacturing employed 40 per cent of the workforce and represented a third of the economy and a quarter of world manufacturing exports. This has collapsed to 8 per cent of the workforce and 2 per cent of global exports.35 While this does not amount to proof, it is further strong circumstantial evidence against those who deny globalisation’s responsibility for the hollowing-out of good middle-class jobs. This is particularly true in the English-speaking world, which has acted as the cheerleader for the uncontrolled relocation of investment and production to low-cost countries.
Far from being the panacea for all our economic ills, unfettered international trade based on outdated and outmoded neoclassical economic theory has instead sown the seeds of the West’s decline. Technological change has undoubtedly played a part in the loss of traditional manufacturing jobs, wage stagnation and an increasing reliance on a less stable services sector. However, on its own it cannot be held responsible for the scale of the decline. Instead, we need to challenge the orthodoxy that globalisation – or at least uncontrolled globalisation – is an inherent and inevitable force for good.