Globalization: The Rise of International Trade and Integration of World Capital Markets Global dimensions of business Today Wal-Mart is the largest employer in Mexico. Is this good for Mexican consumers? Workers? Businesses? Is this good for American consumers? Workers? Businesses? Wal-Mart shareholders? General Electric once employed >300k people in the US. Through outsourcing and off-shore production, it now employs <100k. Is this good for American consumers? Workers? GE shareholders? Is this good for foreign consumers? Workers? 2 1
World trade and output since 1950 Source: Bergoeing and Kehoe, Trade theory and trade facts 3 US trade since 1870 (Exports+Imports)/GDP Source: Bergoeing and Kehoe, Trade theory and trade facts 4 2
Roadmap v Ricardo s Model: The case for free trade v Second: Who wins, who loses? If free trade is such a good idea, why are so many people against it? v Trade and Wage Inequality 5 Gains from trade? Virtually all economists believe trade is good: Consumers buy products from cheapest source, increasing their standard of living Production moves to most efficient locations, raising productivity Bottom line: Trade is a positive-sum game 6 3
Ricardo s model of trade Productivities fixed Comparative advantage: When a country has a lower opportunity cost of producing a good, it has a comparative advantage. Each country should produce the good in which it is comparatively most productive 7 Ricardo s model: basics Two countries (US, Mexico), two goods (apples, bananas), one input (labor) Productivities (output of one unit of labor): Apples Bananas Labor US 20 10 100 Mexico 5 5 100 US has to give up 2 apples to produce 1 banana. Mexico has to give up 1 apple for 1 banana US has absolute advantage in production of both goods Mexico has comparative advantage in Bananas 8 4
Ricardo s model: Mexico s possibilities bananas 500 500 apples 9 Ricardo s model: details We want to compare free trade (no tariffs) with no trade (prohibitive tariffs) Extreme, but makes the point Consumption is a composite of the two goods: c = a 0.75 b 0.25 Translation: consumers spend 75% of income on apples, 25% on bananas Producers maximize profit Competitive: no monopolies 10 5
Ricardo s model: numbers Free Trade No Trade US Price of apples (p a ) 0.05 0.05 Price of bananas (p b ) 0.0667 0.10 Wage (w) 1 1 (dollar) Consumption of apples (a) 1500 1500 Consumption of bananas (b) 375 250 Aggregate consumption (c) 1061 958 Mexico Price of apples (p a ) 0.05 0.2 Price of bananas (p b ) 0.0667 0.2 Wage (w) 0.3333 1 (peso) Consumption of apples (a) 500 375 Consumption of bananas (b) 125 125 Aggregate consumption (c) 354 285 11 Ricardo s model: impact of trade Aggregate consumption up in both countries Production changes: US shifted to apples Mexico shifted to bananas No change in labor ( jobs ) by assumption Shows up as increase in productivity: Real GDP = consumption at world prices GDP rises in both countries Y = AL: rise in Y shows up as rise in A 12 6
Ricardo s model: summary Mexican consumers are better off Opportunity set is strictly larger Mexican production is more efficient Shift production to bananas, at which it is relatively more productive than the US Similar arguments work for the US, too Both sides benefit Free trade equivalent to increase in TFP All conclusions extend to more complex models 13 Impact of NAFTA on Mexico: What do you think happened? Mexican auto manufacturing Mexican garment manufacturing Mexican corn farmers 14 7
Mankiw Quote: A political nightmare " A burgeoning trade in services provides an important output for US expertise in sectors such as banking, engineering, and higher education. The ability to buy less expensive goods and services from new producers has made household budgets go further, while the ability of firms to distribute their production around the world has cut costs to consumers. The benefits from new forms of trade, such as in services, are no different from the benefits from traditional trade in goods. Outsourcing of professional services is a prominent example of a new type of trade. When a good or service is produced at lower cost in another country, it makes sense to import it rather than to produce it domestically. This allows the US to devote its resources to more productive purposes. Economic Report of the President, 2004 15 Outsourcing America s Advantage? Any American whose end product or service could be cheaply end expeditiously returned to the US will face the possibility of being outsourced to India. India s highly educated, English-speaking workforce of programmers, engineers, and scientists will eventually compete against more crucial American jobs. It would only be a matter of years before America s technological superiority is permanently outsourced. Letter to the editor, WSJ Jan.15, 2004 16 8
How big an effect? (Economist Feb 19,2004) " At the time of NAFTA there were dire predictions that millions of US jobs would be sucked to Mexico. " Instead the US created 22 million jobs in the following 7 years. " The best-known analysis, by Forrester Research, a consultancy, estimates that 3.3m American serviceindustry jobs will have gone overseas by 2015 " Barely noticeable when you think about the 7m-8m lost every quarter through job-churning. " And the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-numbing functions of code-writing. Trade and Wage Inequality " Wage inequality has increased tremendously in the US since 1970 s " Many in the media blame this rise on increased trade (globalization). " One reason for this suspicion is that the timing coincides pretty well: trade has been booming at the same time inequality was increasing (since 1980 s) " Economists have also studied this link. " These studies find very little connection. 9
Evolution of Wage Distribution I Evolution of Wage Distribution 2 10
Change in Residual Wage Inequality Interpreting these Graphs " This last figure suggests that inequality has increased in every part of the wage distribution. " In other words, the impact of the force that increased inequality has been felt equally throughout the distribution. " One can see why trade would affect wages at the bottom end, which is the most common argument you hear " But why should it affect wages everywhere? There seems to be no obvious reason. " Read Krugman (1995) for a detailed analysis. " Read the economist article for a recent update on Krugman s analysis (2008) 11