Grinding the poor
Sep 27th 2001
From The Economist
print edition
Sceptics charge that globalisation especially
hurts poor workers in the developing countries. It does not
FOR the
most part, it seems, workers in rich countries have little to fear from
globalisation, and a lot to gain. But is the same thing true for workers in
poor countries? The answer is that they are even more likely than their
rich-country counterparts to benefit, because they have less to lose and more
to gain.
Orthodox
economics takes an optimistic line on integration and the developing countries.
Openness to foreign trade and investment should encourage capital to flow to
poor economies. In the developing world, capital is scarce, so the returns on
investment there should be higher than in the industrialised countries, where
the best opportunities to make money by adding capital to labour have already
been used up. If poor countries lower their barriers to trade and investment,
the theory goes, rich foreigners will want to send over some of their capital.
If this
inflow of resources arrives in the form of loans or portfolio investment, it
will supplement domestic savings and loosen the financial constraint on
additional investment by local companies. If it arrives in the form of new
foreign-controlled operations, FDI, so much the better: this kind of
capital brings technology and skills from abroad packaged along with it, with
less financial risk as well. In either case, the addition to investment ought
to push incomes up, partly by raising the demand for labour and partly by
making labour more productive.
This is
why workers in FDI-receiving countries should be in an
even better position to profit from integration than workers in FDI-sending countries. Also, with or without inflows of
foreign capital, the same static and dynamic gains from trade should apply in
developing countries as in rich ones. This gains-from-trade logic often arouses
suspicion, because the benefits seem to come from nowhere. Surely one side or
the other must lose. Not so. The benefits that a rich country gets through
trade do not come at the expense of its poor-country trading partners, or vice
versa. Recall that according to the theory, trade is a positive-sum game. In
all these transactions, both sides—exporters and importers, borrowers and
lenders, shareholders and workers—can gain.
What,
if anything, might spoil the simple theory and make things go awry? Plenty, say
the sceptics.
First,
they argue, telling developing countries to grow through trade, rather than
through building industries to serve domestic markets, involves a fallacy of
composition. If all poor countries tried to do this simultaneously, the price
of their exports would be driven down on world markets. The success of the East
Asian tigers, the argument continues, owed much to the fact that so many other
developing countries chose to discourage trade rather than promote it. This
theory of “export pessimism” was influential with many developing-country
governments up until the 1980s, and seems to lie behind the thinking of many
sceptics today.
A
second objection to the openness-is-good orthodoxy concerns not trade but FDI. The standard thinking assumes that foreign capital
pays for investment that makes economic sense—the kind that will foster
development. Experience shows that this is often not so. For one reason or
another, the inflow of capital may produce little or nothing of value,
sometimes less than nothing. The money may be wasted or stolen. If it was
borrowed, all there will be to show for it is an insupportable debt to
foreigners. Far from merely failing to advance development, this kind of
financial integration sets it back.
Third,
the sceptics point out, workers in developing countries lack the rights, legal
protections and union representation enjoyed by their counterparts in rich
countries. This is why, in the eyes of the multinationals, hiring them makes
such good sense. Lacking in bargaining power, workers do not benefit as they
should from an increase in the demand for labour. Their wages do not go up.
They may have no choice but to work in sweatshops, suffering unhealthy or
dangerous conditions, excessive hours or even physical abuse. In the worst
cases, children as well as adults are the victims.
Is trade good for
growth?
All
this seems very complicated. Can the doubters be answered simply by measuring
the overall effect of openness on economic growth? Some economists think so,
and have produced a variety of much-quoted econometric studies apparently
confirming that trade promotes development. Studies by Jeffrey Sachs and Andrew
Warner at Harvard, by David Dollar and Aart Kraay of the World Bank, and by
Jeffrey Frankel of Harvard and David Romer of Berkeley, are among the most
frequently cited. Studies such as these are enough to convince most economists
that trade does indeed promote growth. But they cannot be said to settle the
matter. If the application of econometrics to other big, complicated questions
in economics is any guide, they probably never will: the precise economic
linkages that underlie the correlations may always be too difficult to uncover.
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This is
why a good number of economists, including some of the most distinguished
advocates of liberal trade, are unpersuaded by this kind of work. For every
regression “proving” that trade promotes growth, it is too easy to tweak a
choice of variable here and a period of analysis there to “prove” that it does
not. Among the sceptics, Dani Rodrik has led the assault on the pro-trade
regression studies. But economists such as Jagdish Bhagwati and T.N.
Srinivasan, both celebrated advocates of trade liberalisation, are also pretty
scathing about the regression evidence.
Look
elsewhere, though, and there is no lack of additional evidence, albeit of a
more variegated and less easily summarised sort, that trade promotes
development. Of the three criticisms just stated of the orthodox preference for
liberal trade, the first and most influential down the years has been the
“export pessimism” argument—the idea that liberalising trade will be
self-defeating if too many developing countries try to do it simultaneously.
What does the evidence say about that?
Pessimism confounded
It does
not say that the claim is nonsense. History shows that the prediction of
persistently falling export prices has proved correct for some commodity
exporters: demand for some commodities has failed to keep pace with growth in
global incomes. And nobody will ever know what would have happened over the
past few decades if all the developing countries had promoted trade more
vigorously, because they didn't. But there are good practical reasons to regard
the pessimism argument, as applied to poor-country exports in general, as
wrong.
The
developing countries as a group may be enormous in terms of geography and
population, but in economic terms they are small. Taken together, the exports
of all the world's poor and middle-income countries (including comparative
giants such as China, India, Brazil and Mexico, big oil exporters such as Saudi
Arabia, and large-scale manufacturers such as South Korea, Taiwan and Malaysia)
represent only about 5% of global output. This is an amount roughly equivalent
to the GDP of Britain. Even if growth in the
global demand for imports were somehow capped, a concerted export drive by
those parts of the developing world not already engaged in the effort would put
no great strain on the global trading system.
In any
event, though, the demand for imports is not capped. In effect, export pessimism
involves a fallacy of its own—a “lump-of-trade” fallacy, akin to the idea of a
“lump of labour” (whereby a growing population is taken to imply an ever-rising
rate of unemployment, there being only so many jobs to go round). The overall
growth of trade, and the kinds of product that any particular country may buy
or sell, are not pre-ordained. As Mr Bhagwati and Mr Srinivasan argued in a
recent review of the connections between trade and development, forecasts of
the poor countries' potential to expand their exports have usually been too
low, partly because forecasters concentrate on existing exports and neglect new
ones, some of which may be completely unforeseen. Unexpected shifts in the
pattern of output have often proved very important.
Pessimists
also make too little of the scope for intra-industry specialisation in trade,
which gives developing countries a further set of new opportunities. The same
goes for new trade among developing countries, as opposed to trade with the
rich world. Often, as developing countries grow, they move away from
labour-intensive manufactures to more sophisticated kinds of production: this
makes room in the markets they previously served for goods from countries that
are not yet so advanced. For example, in the 1970s, Japan withdrew from
labour-intensive manufacturing, making way for exports from the East Asian
tigers. In the 1980s and 1990s, the tigers did the same, as China began moving
into those markets. And as developing countries grow by exporting, their own
demand for imports rises.
It is
one thing to argue that relying on trade is likely to be self-defeating, as the
export pessimists claim; it is another to say that trade actually succeeds in
promoting growth. The most persuasive evidence that it does lies in the contrasting
experiences from the 1950s onwards of the East Asian tigers, on one side, and
the countries that chose to discourage trade and pursue “import-substituting
industrialisation” (ISI) on the other, such as India, much
of Latin America and much of Africa.
Years
ago, in an overlapping series of research projects, great effort went into
examining the developing countries' experience with trade policy during the
1950s, 60s and early 70s. This period saw lasting surges of growth without
precedent in history. At the outset, South Korea, for instance, was a poor
country, with an income per head in 1955 of around $400 (in today's prices),
and such poor economic prospects that American officials predicted abject and
indefinite dependence on aid. Within a single generation it became a mighty
exporter and world-ranking industrial power.
Examining
the record up to the 1970s, and the experience of development elsewhere in East
Asia and other poor regions of the world, economists at the OECD, the World Bank and America's National Bureau of
Economic Research came to see the crucial importance of “outward
orientation”—that is, of the link between trade and growth. The finding held
across a range of countries, regardless of differences in particular policies,
institutions and political conditions, all of which varied widely. An unusually
impressive body of evidence and analysis discredited the ISI orthodoxy and replaced it with a new one, emphasising
trade.
The trouble with ISI
What
was wrong with ISI, according to these researchers? In
principle, nothing much; the problems arose over how it worked in practice. The
whole idea of ISI was to drive a wedge between world
prices and domestic prices, so as to create a bias in favour of producing for
the home market and therefore a bias against producing for the export market.
In principle, this bias could be modest and uniform; in practice, ISI often produced an anti-export bias both severe and
wildly variable between industries. Managing the price-rigging apparatus proved
too much for the governments that were attempting it: the policy produced
inadvertently large and complex distortions in the pattern of production that
often became self-perpetuating and even self-reinforcing. Once investment had
been sunk in activities that were profitable only because of tariffs and
quotas, any attempt to remove those restrictions was strongly resisted.
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ISI also often had an even more
pernicious consequence: corruption. The more protected the economy, the greater
the gains to be had from illicit activity such as smuggling. The bigger the
economic distortions, the bigger the incentive to bribe the government to tweak
the rules and tilt the corresponding pattern of surpluses and shortages.
Corruption and controls go hand in hand. ISI
is not the only instance of this rule in the developing countries, but it has
proved especially susceptible to shady practices.
Today,
developing-country governments are constantly, and rightly, urged to battle
corruption and establish the rule of law. This has become a cliché that all
sides in the development debate can agree on. But defeating corruption in an
economy with pervasive market-suppressing controls, where the rewards to
illegality are so high, is extraordinarily hard. This is a connection that
people who favour closed or restricted markets prefer to ignore. Limited
government, to be sure, is not necessarily clean; but unlimited government,
history suggests, never is.
Remember, remember
On the
whole, ISI failed; almost everywhere, trade has
been good for growth. The trouble is, this verdict was handed down too long
ago. Economists are notoriously ignorant of even recent economic history. The
lessons about what world markets did for the tigers in the space of few
decades, and the missed opportunities of, say, India (which was well placed to
achieve as much), have already been forgotten by many. The East Asian financial
crisis of 1997-98 also helped to erase whatever lessons had been learned. And
yet the prosperity of East Asia today, crisis and continuing difficulties
notwithstanding, bears no comparison with the economic position of India, or
Pakistan, or any of the other countries that separated themselves for so much
longer from the international economy.
By and
large, though, the governments of many developing countries continue to be
guided by the open-market orthodoxy that has prevailed since the 1980s. Many
want to promote trade in particular and engagement with the world economy in
general. Even some sceptics might agree that trade is good for growth—but they
would add that growth is not necessarily good for poor workers. In fact, it is
likely to be bad for the poor, they argue, if the growth in question has been
promoted by trade or foreign capital.
Capital
inflows, they say, make economies less stable, exposing workers to the risk of
financial crisis and to the attentions of western banks and the International
Monetary Fund. Also, they argue, growth that is driven by trade or by FDI gives western multinationals a leading role in
third-world development. That is bad, because western multinationals are not
interested in development at all, only in making bigger profits by ensuring
that the poor stay poor. The proof of this, say sceptics, lies in the evidence
that economic inequality increases even as developing countries (and rich
countries, for that matter) increase their national income, and in the
multinationals' direct or indirect use of third-world sweatshops. So if
workers' welfare is your main concern, the fact that trade promotes growth,
even if true, is beside the point.
Yet
there is solid evidence that growth helps the poor. Developing countries that
have achieved sustained and rapid growth, as in East Asia, have made remarkable
progress in reducing poverty. And the countries where widespread poverty
persists, or is worsening, are those where growth is weakest, notably in
Africa. Although economic policy can make a big difference to the extent of
poverty, in the long run growth is much more important.
It is
sometimes claimed that growth is less effective in raising the incomes of the
poor in developing countries than in rich countries. This is a fallacy. A
recent study confirms that, in 80 countries across the world over the past 40
years, the incomes of the poor have risen one for one with overall growth (see
chart 4).
If all
this is true, why does global income inequality seem to be widening? First, the
evidence is not at all clear-cut. Much depends on how you make your
comparisons. An overall comparison of country aggregates—comparing rich
countries with poor countries—is generally more encouraging than a comparison
of the richest 10% of people in the world with the poorest 10%. In 1975,
America's income per head was 19 times bigger than China's ($16,000 against
$850); by 1995, the ratio had fallen to six ($23,000 against $3,700). On the
other hand it is true that Africa's income per head is rising more slowly than
America's: as a result, their income-gap ratio has increased, from 12 in 1975
to 19 in 1995. But it would be odd to blame globalisation for holding Africa
back. Africa has been left out of the global economy, partly because its
governments used to prefer it that way. China has embraced the global economy
with a vengeance—and see how well it has done.
Better than nothing
Statistical
difficulties aside, suppose it were true that global inequality is increasing.
Would that be a terrible indictment of globalisation, as sceptics seem to
suppose? Perhaps not. It would be disturbing, and extremely surprising, if poor
countries engaged in globalisation were failing to catch up—but they aren't, as
China and many other avid globalisers show. It would also be disturbing if
inequality across the world as a whole were rising because the incomes of the
poorest were falling in absolute terms, rather than merely in relative
terms—but this is extremely rare. Even in Africa, which is doing so badly in
relative terms, incomes have been rising and broader measures of development
have been getting better. It may be too little, but it is not nothing, merely
because other countries have been doing better.
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The
sceptics are right to be disturbed by sweatshops, child labour, bonded labour
and the other gross abuses that go on in many poor countries (and in the
darkest corners of rich ones, too). But what makes people vulnerable to these
practices is poverty. It is essential to ask if remedial measures proposed will
reduce poverty: otherwise, in attacking the symptoms of the problem, you may be
strengthening their underlying cause. It is one thing for the sceptics to
insist, for instance, that child labour be prohibited; it is quite another to
ensure that the children concerned go to school instead, rather than being
driven to scrape a living in even crueller conditions.
The
barriers to trade that many sceptics call for seem calculated to make these
problems worse. Some sceptics want, in effect, to punish every export worker in
India for the persistence of child labour in parts of the Indian economy. This
seems morally indefensible as well as counter-productive in economic terms. The
same goes for the campaign to hobble the multinationals. The more thoroughly
these companies penetrate the markets of the third world, the faster they
introduce their capital and working practices, the sooner poverty will retreat
and the harder it will be for such abuses to persist.
This is
not to deny that the multinationals are in it for the money—and will strive to
hire labour as cheaply as they can. But this does not appear to be a problem
for the workers who compete to take those jobs. People who go to work for a
foreign-owned company do so because they prefer it to the alternative, whatever
that may be. In their own judgment, the new jobs make them better off.
But
suppose for the moment that the sceptics are right, and that these workers,
notwithstanding their own preferences, are victims of exploitation. One
possibility would be to encourage foreign firms to pay higher wages in the
third world. Another course, favoured by many sceptics, is to discourage
multinationals from operating in the third world at all. But if the aim is to
help the developing-country workers, this second strategy is surely wrong. If
multinationals stopped hiring in the third world, the workers concerned would,
on their own estimation, become worse off.
Compared
with demands that the multinationals stay out of the third world altogether,
the idea of merely shaming them into paying their workers higher wages seems a
model of logic and compassion. Still, even this apparently harmless plan needs
to be handled cautiously.
The
question is, how much more is enough? At one extreme, you could argue that if a
multinational company hires workers in developing countries for less than it
pays their rich-country counterparts, it is guilty of exploitation. But to
insist on parity would be tantamount to putting a stop to direct investment in
the third world. By and large, workers in developing countries are paid less
than workers in rich countries because they are less productive: those workers
are attractive to rich-country firms, despite their lower productivity, because
they are cheap. If you were to eliminate that offsetting advantage, you would
make them unemployable.
Of
course you could argue that decency merely requires multinationals to pay wages
that are “fair”, even if not on a par with wages in the industrial countries.
Any mandatory increase in wages runs the risk of reducing the number of jobs
created, but you could reply that the improvement in welfare for those who get
the higher pay, so long as the mandated increase was moderate and feasible,
would outweigh that drawback. Even then, however, two difficult questions would
still need to be answered. What is a “fair” wage, and who is to decide?
What fairness requires
A
“fair” wage can be deduced, you might argue, from economic principles: if
workers are paid a wage that is less than their marginal productivity, you
could say they are being exploited. Some sceptics regard it as obvious that
third-world workers are being paid less than this. Their reasoning is that such
workers are about as productive as their rich-country counterparts, and yet are
paid only a small fraction of what rich-country workers receive. Yet there is
clear evidence that third-world workers are not as productive as rich-country
workers. Often they are working with less advanced machinery; and their
productivity also depends on the surrounding economic infrastructure. More
tellingly, though, if poor-country workers were being paid less than their
marginal productivity, firms could raise their profits by hiring more of them
in order to increase output. Sceptics should not need reminding that companies
always prefer more profit to less.
Productivity
aside, should “good practice” require, at least, that multinationals pay their
poor-country employees more than other local workers? Not necessarily. To hire
the workers they need, they may not have to offer a premium over local wages if
they can provide other advantages. In any case, lack of a premium need not
imply that they are failing to raise living standards. By entering the local
labour market and adding to the total demand for labour, the multinationals
would most likely be raising wages for all workers, not just those they hire.
In
fact, though, the evidence suggests that multinationals do pay a wage premium—a
reflection, presumably, of efforts to recruit relatively skilled workers. Table
5 shows that the wages paid by foreign affiliates to poor-country workers are
about double the local manufacturing wage; wages paid by affiliates to workers
in middle-income countries are about 1.8 times the local manufacturing wage
(both calculations exclude wages paid to the firms' expatriate employees). The
numbers come from calculations by Edward Graham at the Institute for
International Economics. Mr Graham cites other research which shows that wages
in Mexico are highest near the border with the United States, where the
operations of American-controlled firms are concentrated. Separate studies on
Mexico, Venezuela, China and Indonesia have all found that foreign investors
pay their local workers significantly better than other local employers.
Despite
all this, you might still claim that the workers are not being paid a “fair”
wage. But in the end, who is to make this judgment? The sceptics distrust
governments, politicians, international bureaucrats and markets alike. So they
end up appointing themselves as judges, overruling not just governments and
markets but also the voluntary preferences of the workers most directly
concerned. That seems a great deal to take on.