Brave New World

Economist Larry Summers, in a two-part argument in the Financial Times in May, offered a strategy for “healthy globalization”. What is the disease he diagnosed, and the cure he offered? He argued that increasing numbers of Americans can “legitimately doubt whether the success of the global economy is good for them”. In this argument, the middle and working classes in the West are losing out as developing nations compete in product markets with increasingly sophisticated goods, compete for resources, and compete for footloose capital. The result is erosion of political support for openness to the rest of the world or, more grandly, “economic internationalism”. Summers’ prescription for health is international coordination of policies to prevent races to the bottom in financial regulation, labor standards and tax rates.

Responses to Summers’ argument have included further emphasis on the distributional concerns he raises for developed country populations and suggestions that the “liberal international economic order” is losing intellectual support, with Summers being characterized in a joint response by Devesh kapur, Pratap Mehta and Arvind Subramanian as the “canary in the intellectual mine”. These kinds of concerns have been around for a long time, though expressed more often by those who do not have as firm a grasp of economic principles as Summers. His argument is subtle, involving both distributional and efficiency issues, combined in a non-obvious manner. Essentially, he makes a case that uncoordinated national policy choices with respect to tax rates, financial regulations and labor standards — none of which pertains to conventional aspects of international openness (freedom of movement of goods, capital and, occasionally, labor) — may not only be inefficient from a global perspective, but have distributional impacts that favour wealthy owners of financial capital over unskilled labor (basically, workers) and many types of skilled labor, or owners of human capital (typically, the middle class).
Clearly, Summers is not advocating a retreat from trade or capital openness. Fixing the problems, he identifies, requires a completely different set of policy responses. His point is that failure to deal with international policy coordination where needed will lead to second best policy responses such as trade restrictions in the face of political demands for greater income security. Yet, the most important policy tools in the face of global competition are domestic. Workers earn rents from skills that cannot be supplied perfectly elastically.
Large global supplies of unskilled labor have been harnessed at previously unimaginable scales and even the not-so-rich countries have seen the impact: Consider the effect of China’s expanding manufacturing prowess on Mexican workers. The only long-term answer for those whose rents are being competed away is to increase their productivity through skill acquisition, i.e., education and training. This does not require international policy coordination. The short-term policy response has to involve some form of adjustment assistance, essentially a form of insurance in the face of accelerated change. Again, this is a domestic policy tool.
But what about the funding of education and insurance schemes? Traditionally, governments played a major role in this, via tax revenues. If these are being eroded by a race to the bottom, then we have a problem. Summers’ prescription of avoiding this race seems to have value, then. On the other hand, education and training that have private returns may be supported by well-functioning capital markets — one should not rule out such options. It may also be that the need for tax coordination is overstated. Within the US, California and New York are high-tax states. This has certainly led to some movement of capital and jobs to other states. Yet, they both retain important economic centres and have high average incomes: They have avoided a race to the bottom. Nor is there any call for (and no constitutional possibility of) protectionist policies at the state level, even when automobile manufacturing jobs have moved from Detroit to southern states.
In fact, no one argued that the economic rise of the American South was a political problem for the free movement of goods, capital and labour within the country. No one seems to have made the case that the rise of Europe was an economic or political problem for the US, or for the case for economic openness. Even the expansion of the European Union to include many significantly poorer countries has not been an issue. But Japan was more of a concern to the US when it began to produce and export very sophisticated products in the 1980s. And now it is China and India who are potential whipping boys. Why pick on Asia?
Towards the end of Shakespeare’s play, The Tempest, the young woman Miranda, seeing a group of people for the first time after a life of near-isolation, exclaims, “How many goodly creatures are there here! How beauteous mankind is! O brave new world that has such people in’t!” Unlike Aldous Huxley’s later ironic use of this phrase for his eponymous novel, Miranda’s attitude is that of genuine appreciation. International policy coordination may be a good thing in its own right. It should not be justified by being linked to economic openness, nor is it necessarily a precondition for healthy globalization. That precondition may instead be an acceptance of Miranda’s perspective, applied to our entire world.