What went wrong?

Liberalizing international trade will lift all boats, since the losers from globalization can easily be compensated.


Read Part 1: Making Globalization work for all: The Challenge

There is perhaps no argument that economists agree upon more readily than that free trade generally increases overall economic welfare (New York Times, 2015; Alston et al., 1990). This unnuanced view, however, has been taken to its extremes over the last few decades, especially since the early 1980s by the rise in predominance of the paradigm that the market alone should regulate itself. Even though the old trade models in the tradition of David Ricardo, Eli Heckscher and Bertil Ohlin never disputed that there are winners and losers from liberalizing international trade, it was argued that the benefits would outweigh the costs. Yet, exactly how compensation would be provided by the winners to the losers was only an afterthought for most economists. In reality, compensation was barely forthcoming. Moreover, arguing that there were winners elsewhere in the country did not help the left behind.

While the era of trade liberalization began with the General Agreement on Trade and Tariffs (GATT) after the Second World War, there has been a striking acceleration of economic and financial globalization after 1980. From 1947 onwards, average tariff rates had already been reduced from 15% to 10% in the 1980s and to about 5% in 2010, as stated by Sebastian Dullien in a basic research paper (Dullien, 2018). From the 1970s onwards, countries increasingly pushed for the liberalization of non-tariff trade barriers, such as regulations and technical standards, and in some cases went even further than the rules stipulated by the World Trade Organization (WTO). A new era started in the 1990s and early 2000s when the integration of many formerly communist countries into the WTO caused a shock to many Western countries, and even more so the integration of the People’s Republic of China with its abundant and cheap workforce.

While benefits from the increase in global trade were visible to consumers in the form of new varieties of goods and lower prices, it had become apparent that many people employed in former manufacturing industries saw their jobs being outsourced to new countries. The compensation mechanism, which economists had paid little attention to until then, was either nonexistent or ineffective. In the U.S. the famous manufacturing belt between New York and Indiana, once the economic powerhouse, came to be known as the rust belt in the 1980s. Recently, its name has changed again and the region has come to be known as the “Opioid Belt,” as drug related mortality rates have surged there over the past decade (Washington Post, 2019). Indeed, recent research has linked the election to Donald Trump in 2016 to the opioid crisis, which has been most severe in counties that have been hit hardest by deindustrialization (Monnat, 2016; Monnat and Brown, 2017).

With its huge supply of labor, the emergence of China shifted global trade patterns. Yet, the China shock may have had a particularly strong impact on the US. In Germany, which has a relative balanced of trade with China and runs an overall current account surplus, loss in some sectors may have been compensated more extensively by larger gains in other sectors. Labor market disruptions, on the other hand, also seem to have been driven by the rise of new low-cost competitors in Eastern Europe. As Jens Südekum and his international colleagues have reported, these disruptions also seem to have occurred in regions with major import-competing industries (as in the US), while regions specialized in export-competing industries experienced significant employment gains (Dauth et al, 2014).

However, even though overall employment might thus have benefitted from the past decades of trade integration, the regionality of the shocks have apparently increased the support for parties of the far-right in Germany (Dippel et al, 2019). For the 2019 European election, a study by the DIW economists Christian Franz, Marcel Fratzscher and Alexander S. Kritikos (2019) found that the vote share of the populist right-wing party AFD was particularly high in regions which experience high vulnerability with respect to globalization and digitalization.

The huge impact of the last three decades of hyper-globalization might be best analyzed by looking at how each part of the global income distribution fared between 1988 and 2008. The major winners are the emerging global middle class, in particular in China and India, and the top percent in rich Western countries. While these two groups have seen their real incomes increase, the clear looser of globalization seems to have been the former (lower and) middle-class in much of Europe and the US. Although the exact numbers are still subject to analysis and debate, recent research suggests that the very rich by far outperformed all other groups, with real incomes of the global top one percent growing at twice the rate as the bottom 50 percent (Lakner and Milanovic, 2013; Alvadero et al., 2018).

Read Part 3: Making Globalization work for all: New Economy in Progress


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