Thursday, July 26, 2007

Globalization, Free Trade and Income Inequality

So many misconceptions abound as to globalization, free trade and inequality of incomes, even among so many "educated" and well informed people. The facts are very different from the perceptions and we see that so often today in our populist politicians clamoring to spread the notion that free trade/globalization is bad and that, I suppose, government welfare and high taxes are good.

I tend to think of Edwards who seems to be running his campaign on this notion and of course supported by any politician seeking union contributions. Other politicians, such as Obama, tend toward the same use of politically popular and incorrect statements on economics but since Edwards is from North Carolina I find him especially interesting to watch. [An aside, I am glad he is playing on the national stage and not a Senator wanna-be in NC right now.] The reality is that union workers are more middle class than poor and see free trade as a threat to their jobs - which in some sense is true especially for the UAW stuck with the misguided leadership of Detroit compared to the innovation of the Far East (Toyota, Honda, Kia) and the poor leadership of the textile and furniture industries of the United States.

I will expand on these thoughts later and present from facts at hand and especially refer to serious economic analysis for you to wade through but for now how about some summary from a recent IBD editorial, "The Backlash Against Globalization":

A Financial Times-Harris poll of more than a thousand people found that those in the U.S., Britain and France were three times more likely to think globalization hurts their country than helps it.

And "in response to fears of globalization and rising inequality," wrote Financial Times reporter Chris Giles, "the public in all the rich countries surveyed . . . want their governments to increase taxation on those with the highest incomes."

...Those who see the world "worse off" because of globalization must explain why, as global trade has surged over the last 30 years or so, the rate of poverty around the world has plunged.

As Surjit Bhalla, an economist affiliated with the Institute for International Economics, recently wrote: "World poverty fell from 44% of the global population in 1980 to 13% in 2000, its fastest decline in history. Global income inequality has dropped over this period and is at its lowest level since 1910."

But what about workers in rich countries like the U.S. who worry about inequality? Will higher taxes correct their so-called inequities? Not at all. U.S. economic inequality has virtually nothing to do with globalization or free trade, per se. It has everything to do with education and skills.

A recent study for the National Bureau of Economic Research found that those with a bachelor's degree can expect to earn $51,000 or so a year. Those with just a high school diploma earn $28,000.So the "income gap" is really an education and skills gap. And it's quantifiable: $23,000 a year, or nearly $1 million over a career spanning 40 years. Taking more money from people who did the right thing — went to school or pursued more high-level training — isn't the way to run an economy. That is, unless you want to run it into the ground.

Even so, globalization is a boon to all Americans. From 1980 to 2006, our total trade in goods and services soared 543%, from a mere $575 billion, or 20.6% of GDP, to $3.69 trillion, or 28%of GDP.

Has that huge swing decimated our economy? Hardly. We've created 46 million new jobs over that time. And personal disposable income after inflation has surged 64% to $27,770 from $16,938.

In a study released just last month, economists Matthew Slaughter, Grant Aldonas and Robert Lawrence found that American families gain as much as $15,000 a year due to globalization — that is, freer trade. The benefits are not illusory. They're real.

By the way, countries that raise taxes to punish the rich end up punishing only themselves. At least that's the growing economic consensus. The largest recent study, by economists at the 26-nation Organization of Economic Cooperation and Development, found "tax rates negatively correlated with economic growth." A large number of earlier studies bolster their findings.

In other words, higher taxes mean lower growth. And vice versa. Higher taxes aren't a solution to inequality. Nor is protectionism.

Globalization isn't without its problems, of course, but overall it has made all of us a lot better off. We should be talking about how to improve it — not how to kill it off by erecting trade barriers and raising taxes.

I will follow up on this constantly to try to erase the myths about free trade, freedom from regulation, and the power of free markets to find the right solutions to problems, and may I dare say, usually the most moral solutions to problems rather than a government or societal solution.

Two reflections on free trade theory or the theory of comparative advantage:

First, I strongly believe that the government does have a role and duty to step in and help financially and re-train those individuals and families who suffered from the consequences of rapid changes in their workplaces and industry environments due to the lack of foresight or the greediness of managers and owners who were unwilling to adjust in time to the realities of new market places.

Second, I believe that the theory of comparative advantage as postulated by David Ricardo, a contemporary of Adam Smith in the late 1700s-early 1800s, which explains why free trade is always the best solution is irrefutable. In lay terms, when two parties specializing in what they do best and then trade then they are both better off even if one side is better at all tasks. I will devote a full post to this one day as it is absolutely true without question. Look it up if you have doubts in the meantime.

And question all you hear and read about economics and business with a keen ear.

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