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Free Trade's Winners and Losers 8 November 2004
“All I hear from Washington is that trade is a win-win proposition. Then I look at our growing trade deficit and think about the 3,400 good people in our good factories that we had to let go and I want someone to show me where we have won."
The New York Times quotation of the day, 2 November 2004
Until last month, most mainstream economists saw the movement of jobs overseas as a “win-win proposition.” David Ricardo’s theories of comparative advantage, first published in 1819, represent economic bedrock, and seemed always to favor free trade over protectionism.
Eminent economists like Gregory Mankiw, the Chairman of the President’s Council of Economic Advisers, and Jagdish Bhagwati, the author of the book In Defense of Globalization, have relied on the foundation laid by Ricardo to make the point that we’re all better off as jobs move overseas to countries with lower wages. Customers pay less for the outsourced goods and services. The workers who are displaced, from textile mills or software companies, eventually find new jobs that pay even more.
An August 2003 report from the McKinsey Global Institute framed the orthodoxy this way:
“The United States has the world’s most dynamic economy and is fully able to generate new jobs … While still receiving services that employees were previously engaged in, the economy will now generate additional output, (and thus income) when these workers take new jobs.”
In September 2004, Paul Samuelson, the 89-year-old dean of mainstream economists, published a dissenting view in the The Journal of Economic Perspectives [JEP]. He demonstrated that there are cases where free trade is not beneficial for all participants. For example, there are situations where the threat of offshoring exerts significant downward pressure on domestic wage levels – workers must accept lower wages in order to keep their jobs. As he puts it in The New York Times:
"Being able to purchase groceries 20 percent cheaper at Wal-Mart does not necessarily make up for the wage losses [from offshore wage pressure]."
Bhagwati and several co-authors have already prepared a response to Samuelson, titled, “The Muddles Over Outsourcing."
Paul Samuelson and Jagdish Bhagwati in happier times -- 1994
The disagreement between these eminent economists is more in theory than in practice – both believe that the US has been historically well-served by trade. Both also advocate government policies, like retraining and wage insurance, to provide some buffer for workers who find their jobs sent overseas.
While there may be disagreement about whether trade and outsourcing is always good for developed countries like the US, there’s no dispute about the benefits of outsourcing for the developing economies that are receiving the jobs. Outsourcing undoubtedly helps poorer countries build sustainable economic development, and it does so without foreign loans or aid.
The World Bank and other aid organizations have not been very successful in helping poorer countries develop. Many developing economies are now hampered by the money owed to international aid agencies for projects that have failed. Trade in services, on the other hand, contributes to economic development in poorer countries while at the same time developing the local infrastructure and adding to global economic production. No loans or government agencies are involved.
Five years ago, for example, India’s per capita income was $440. By 2003 it had grown by 20% to $530. Remarkably, almost 65 percent of India’s income growth came between 2002 and 2003.
Src: World Bank, World Development Indicators Per Capita Income Growth in India, 1999-2003
This income level is a small fraction of average incomes in developed countries – the comparable income figure for the United States in 2003 was almost $38,000. While foreign aid projects may have provided some assistance in development, the market-based growth made possible by free trade has contributed enormously.
In his recent article, Paul Samuelson points out that even if wealthy countries lose jobs from offshoring, the gains to poorer countries are larger than the losses absorbed by more wealthy countries:
“Correct Ricardian theory does imply that worldwide real income per capita does gain …, so that winners' winnings will suffice worldwide to more than compensate losers' losings.”
From the perspective of countries like India or China or the Phillipines, outsourcing is the market route to faster development. As with most market solutions, it is efficient and difficult to control. Worldwide, the net income gains are positive, but there may be fewer winners in developed countries than in those that are developing.
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