As indicated in a previous article and my new book, Developed Nations and the Economic Impact of Globalization, the world needs globalization now more than at any time in its history. Developed economies require access to external markets to climb out of the economic hole the 2007 financial crisis and policy mistakes have dug. The developing countries need foreign trade and investment to develop their economies. Global cooperation and diplomacy are essential to address the flashpoints in the Korean Peninsula, South and East China Seas, Eastern Europe, the Middle East and North Africa. Immigration is needed in the West to sustain long-term economic growth and innovation because of an aging and declining population.
However, governments’ inability to address protracted low rates of economic growth and unemployment is giving rise to protectionism and populism in the West. The UK’s Brexiteers won because the majority of Britons did not like the EU’s immigration policies, which allow migrants to settle in the country. Donald Trump won the US presidency in part because of his anti-globalization rhetoric, accusing the establishment of selling out American workers to other countries for higher profits. Far-right parties gained popularity in Europe because of the huge influx of migrants from the Middle East and Africa who were blamed for rising crime rates and terrorism, burdening the social net, taking away jobs, and a host of other problems.
Western countries, particularly the US, accuse China and other developing nations of unfair trade practices, stealing jobs, closing factories, and not playing by ‘universal rules’
Western countries, particularly the US, accuse China and other developing nations of unfair trade practices, stealing jobs, closing factories, and not playing by “universal rules.” They demand a ban or restriction on goods from these countries. US Secretary of State Rex Tillerson is recruiting India and other Asian nations to join the US in containing China’s “assertiveness” or “aggression” in the South China Sea.
A brief history of protectionism and populism
It was protectionism and populism that caused the Great Depression and World War II. Industrial overcapacity from the “Roaring 20s” slowed economic growth, and governments reduced spending to balance budgets, which contracted economies further. Attempting to protect whatever industries remained, Western governments introduced import restriction policies (i.e. 1930’s US Tariff Act, popularly known as the Smoot-Hawley Tariff). Falling domestic demand and exports culminated in the Great Depression.
The governments of the day were unable to reduce unemployment, estimated at over 25%, giving opportunistic politicians an excuse to play the blame game to gain power. Adolf Hitler successfully spread the “Big Lie,” blaming the Jews for Germany’s economic woes and other problems. The majority of Germans believed it because the Jews were the “haves” and the ethnic Germans were the “have-nots.” Racial hatred extended to “inferior” races (i.e. Slavs, Poles, Russians, etc.), culminating in German aggression in Europe, which led to World War II.
Today’s rising protectionism and populism are replaying the same movie; far-right political parties in Europe and the xenophobic American population are demanding that restrictions be put on imports and immigration. With politicians rallying to their cause, racially motivated crimes have risen dramatically in the West. Trump tearing up or threatening to withdraw from negotiated trade agreements has exacerbated global economic woes, including those of the US. His decertification of the Iran nuclear (negotiated by Iran and the Permanent Five + Germany) and threat to bomb North Korea could lead to a military conflict, perhaps even World War III.
It was massive spending on the war effort that ended the Great Depression. Able-bodied men were recruited or drafted into the armed forces to fight in World War II, while women and men unfit to fight were hired to produce arms or engage in other activities, resulting in full employment.
Some historians and international relations experts believe a war between rival powers is inevitable today for the same reasons. However, today’s world is different from that of the Great Depression era because the antagonists possess massive quantities of both conventional and nuclear arms, which are capable of destroying the world.
Moreover, the world economies are increasingly intertwined. China needs natural resources from Russia, Brazil, the Middle East. Australia and other energy- and commodity-producing nations to power its huge manufacturing sectors. The Chinese and Americans are literally joined at the hip with China being the factory (and market) for US firms.
No nation can do it alone on addressing climate change and nuclear weapons proliferation. By withdrawing from the Paris climate accord to please the domestic coal and oil industries, Trump will only worsen pollution at home. And the US cannot stop North Korea’s nuclear weapons program without killing millions of Asians and Americans.
For these reasons, the Thucydides Trap would not happen today, but governments do face a policy dilemma.
Domestic vested groups and the public in the US and Europe demand de-globalization, putting their elected officials in a policy dilemma. There is little doubt that Trump and his European counterparts know full well that international trade, investment, immigration and diplomacy are the keys to addressing the world’s economic, geopolitical and environmental issues. But they put themselves in a corner with their own campaign rhetoric.
How can globalization help create a solution to these problems? A simplified demonstration of unfettered trade might help.
Unfettered international trade
International trade is based on the notion of comparative advantage, a theory developed and articulated by the 18th-century British political economist David Ricardo. He observed that because of differences in geographical location, each nation is differently resource-endowed, taking England and Portugal as an example . England has a climate allowing it to raise sheep, resulting in gaining a relative efficiency in wool production. Portugal has the environment to grow grapes, allowing it to produce quality wine efficiently. Given the differences in relative efficiencies or comparative advantages, Ricardo concluded that Portugal and England would gain by trading with each other. A numerical example from the economics textbook written by Campbell McConnell, Stanley Brue and Sean Flyn might help to explain why trade benefits both countries. Suppose:
- England can produce either 30 units of wool or 30 units of wine and Portugal makes 15 units of wool or 30 units of wine.
- Both countries incur constant production cost: To cost 1 unit of wine to produce 1 unit of wool in England. But Portugal must give up 2 units of wine to gain 1 unit of wool.
- Agreed terms of trade: 1.5 units of wine for 1 unit of wool, England gets more for its wool and Portugal pays less.
Country Pre-trade Specialization Trade Post-trade Gains
England 18 wool 30 wool -10 wool 20 wool +2 wool
12 wine 0 wine +15 wine 15 wine +3 wine
Portugal 10 wool 0 wool +10 wool 10 wool 0 wool
10 wine 30 wine -15 wine 15 wine +5 wine
In this simplified example, both England and Portugal gain because of the latter’s comparative advantage in producing wine. This is because taking advantage of a Portugal comparative advantage improves resource allocation efficiency and innovation, culminating in economies of scale or increasing productivity. In this demonstration, the relative inefficient industries in England and Portugal are eliminated, increasing output from 50 to 60 units of both goods.
Increasing productivity reduces production costs and prices, raising real income or the purchasing power of consumer money income. For example, average US family income increases by almost $1,000 annually from US-China trade alone, allowing American consumers to buy more which in turn encourages new investment. Moreover, low prices cap inflation rates which in turn allows central banks to maintain low interest rate policies, both are important drivers of consumption and investment. Trade can also improve people’s understanding of each other thereby increasing trust because business relations require human interaction.
That said, however, trade does not benefit everyone and is at the center of the globalization debate in the West. Indeed it is being accused of being the root cause of unemployment, immigration, income inequality, climate change and a host of other economic, geopolitical and social problems.
Why globalization has not turned out the way its proponents expected will be the topic of the next article.