UCSC Review Winter/Spring 1994
Global Economics: Declaration of Interdependence
The battle in Congress over the North American Free Trade Agreement galvanized the public's attention in a way that economic issues rarely do. It pitted economists arguing for free trade and open markets against union leaders and environmentalists lobbying for job protections and strict enforcement of regulations. Get ready for more. Like it or not, one of the telling characteristics of today's global economy is that the links forged by international trade and finance have made economics everyone's business. Here, UCSC economics faculty weigh in on the trends and tradeoffs of global interdependence.
In an economic sense, the world today is smaller than it has ever been. High-speed transportation moves goods and services in record time. Communications technology has made it possible for investors to make lightning-quick deals halfway around the globe. International trade agreements have blurred borders and eroded protectionism, and European leaders are pursuing economic integration to an unprecedented degree.
Free trade and integrated financial markets are the essence of the global economy. The value of goods traded internationally has soared since World War II, from less than $100 billion a year in 1948 to nearly $4 trillion in 1992. The sheer volume of money moving between countries today is more powerful than any single government's monetary policies, and investors are much more likely to have assets in another jurisdiction than they were even ten years ago. These changes have political implications, too. "As financial markets have become integrated, countries have a greater interest in each other's political systems and prosperity," says economics professor Michael Dooley, a former research economist with the International Monetary Fund. As another UCSC economist described it, the global economy is like a hug--the tighter countries hug, the less likely they are to swing at each other.
What's happening in the world is a reflection of the economist's dream coming true. "Economists have been trying to convince politicians for years that free trade and open markets are the way to go," says associate professor of economics Michael Hutchison, who studies international finance. "Trade allows countries to concentrate on doing what they do best and import the rest of what they need from countries that can produce those goods better or more cheaply. With free trade you get more dynamic, stronger economies with higher incomes, and that increases the demand for goods."
How did we get here? Although the emergence of the global economy seems sudden and rapid, economists say recent events are rooted in policies enacted after World War II. The United States emerged as the sole economic victor of the war with two very good reasons to aggressively pursue international free trade policies: It needed to restore economic well-being in Western Europe and Japan, where stability and prosperity were deemed crucial weapons in the defense against communism, and it wanted to develop markets for U.S. goods and services. The first round of the General Agreement on Tariffs and Trade (GATT) was signed in 1947 to promote worldwide cutting of tariffs and to bolster international trade. Since the 1940s, tariffs have fallen from an average of 40 percent to 5 percent.
"Trade has always been important, and after the war it was generally believed that countries would get along better and become richer if they traded with one another," says Dooley. "In general, that's been true."
The example of NAFTA Over the next decade, the North American Free Trade Agreement (NAFTA) will encourage trade among the United States, Canada, and Mexico by phasing out tariffs on 99 percent of goods. Economists believe NAFTA touched a nerve in part because of misconceptions about changes in the labor force--layoffs and job displacement are routinely blamed on trade despite evidence that technological innovations have displaced many more workers. In an unusually evocative term, labor economists refer to such upheaval in the labor force as "churning." They do not dismiss the pain it causes, but they see a parallel between the anxieties people feel about today's changing economy and the radical transformations that took place a century ago.
"Industrialized nations are focused now on manufacturing, but in the last century we were losing agricultural jobs like crazy," says Economics Board chair Nirvikar Singh. "Technology made it possible for us to produce enough food for everyone with far fewer people. It's the same now with manufacturing--we can make all the material goods we need with a smaller proportion of the labor force. Now job growth is concentrated in services."
Economists concede that hundreds of thousands of American jobs will be lost to Mexico in industries where Mexico enjoys comparative advantage. But the expectation is that the net effect will be negligible because a similar number of relatively high- paying American jobs will be created as Mexico grows richer and demands more American products. Mexico's economy is only 5 percent the size of the economies of the United States and Canada combined, and most economists believe that Americans have much more to gain from Mexico as a consumer than they have to fear from Mexico as a competitor.
Environmentalists opposed NAFTA because they fear that boosting trade will intensify production with little regard for the environment. After all, industrialized countries are the world's biggest polluters--what if developing nations follow in their footsteps, consuming resources at an unsustainable rate and polluting the air, water, and soil? At minimum, environmentalists want export nations to comply with the environmental standards of countries they sell to, but they would rather see policies reformulated so that prices reflect the actual cost of resource depletion and environmental degradation.
Economists, who prefer to rely on market forces to smooth out social and political wrinkles, respond that prosperity fosters higher environmental standards. And many bristle at what has been called "eco-imperialism"--the notion of compelling nations to meet American standards of environmental safety. "The United States became as wealthy as we are by pillaging the environment. Who are we to say that the developing world can't do the same things we did?" asks assistant professor of economics Lori Kletzer. "The developed world didn't get to where it is by being clean. It amounts to telling Mexico 'We want to keep you poor because it's going to keep us clean.' There's got to be some middle ground."
The price of protectionism The NAFTA example points out that multinational economic agreements require countries to do some serious soul-searching about the costs of participating in a global economy.
"One of the central tenets of a market economy is people have to adapt. People don't like to see that there's a tradeoff, but there is," says Dooley. "There will be winners and losers. Some people will be hurt very badly. The tension is between changing and not changing. We could stay the same--we'd get a little poorer each year, but we'd be stable."
But there's a price attached to stability, too. Protectionist policies such as tariffs, quotas, and subsidies are typically adopted to save American jobs that are vulnerable to low-wage foreign competition. But reduced competition translates into higher prices for consumers. For example, a recent study by the Institute for International Economics found that the cost to consumers of saving jobs in 21 heavily protected industries averages $170,000 per job per year, even though the jobs paid an average of only $7.76 an hour. Similar studies a decade ago put the cost of protecting a single job in specialized steel at $1 million a year.
Protectionism has ripple effects throughout the economy, affecting production and investment and resulting in costs that far exceed the wages and benefits paid to workers whose jobs are saved. "It makes more sense to pay for retraining and extended unemployment benefits to help people facing layoff," says economics professor Kenneth Kletzer. "Preserving their current jobs distorts the pattern of employment and harms consumers and workers in other industries."
There's more to come Associate professor of economics Kwok-Chiu Fung, who recently spent eighteen months as the chief trade economist for the President's Council of Economic Advisers under George Bush and Bill Clinton, says concerns about job losses and the environment are being integrated into trade discussions to an unprecedented degree."Free trade benefits the country as a whole, but there are winners and losers," says Fung, who spearheaded analysis of NAFTA for both presidents. "The winners will outweigh the losers, which is why economists generally favor free trade, but we need to induce people to move out of industries that we can't compete in." As for the environment, Fung notes that negotiators during the recent GATT talks promised environmentalists that the next round of discussions will focus on their issues.
In the meantime, the latest GATT agreement, which involves 117 countries, comes before Congress this spring. Despite the high costs of protectionism, free trade remains a hard sell, and economists concede that support for GATT and other trade pacts may ultimately depend on the ability of governments to manage the human and environmental consequences of their agreements.