Liberation from the shackles of space

The new book “The Great Convergence” by Richard Baldwin is a contribution to globalization studies, economics of development, and trade economics. I more confidently speak of the former two than of the third but I think that even that could be justified.

There are several aspects of Baldwin’s book that are worth emphasizing. The first is a novel and persuasive way of defining the three historical eras of globalization as made possible successively by the reduced cost of transporting (i) goods, (ii) information, and (iii) people. The story goes as follows. When transportation of goods was perilous and expensive, production and consumption coincided geographically: communities consumed whatever they produced. As we know from even the most developed pre-modern societies like Rome, trade was limited to luxury items and wheat. But Rome was an exception: in most pre-modern societies trade was minimal.

Then came the Industrial Revolution that importantly for our story lowered transportation cost of goods. This made shipment of goods to faraway destinations possible and gave us the first globalization, or the “first unbundling” as Baldwin calls it: goods were produced “here” and consumed “there”.  This also gave us other things that economists take for granted: development as national production of goods through all its stages, trade as consisting of nation A exporting a good to nation B, theory of growth that sees nations advancing from production of food to manufactures. Although Baldwin does not say it, practically all the tools of modem economics are still influenced by the way the first unbundling occurred.

The second unbundling (and the second globalization) comes when the control and coordination of production is done “here” but actual  production of goods is done “there”. Notice the difference: first you unbundle production and consumption, then you unbundle the production itself.  The unbundling of production was made possible thanks to the IT revolution that allowed companies to design and control processes from the center while delocalizing the production to hundreds of units or subcontractors dispersed around the world. These are the famous “global supply chains”. Reduced cost of transportation of information (basically, ability to coordinate and control regardless of distance) is for the second unbundling what reduced cost of shipment was for the first.

A couple of things are worth noticing regarding the second unbundling. First, huge importance of institutions. When globalization was just exports of goods, institutions in the country to which the goods were exported did not matter much: whether institutions “there” were good or bad, the exporters were paid (about) the same.  This is no longer the case with the second unbundling.  When the production is delocalized, the quality of institutions, infrastructure or politics  in the recipient country matters enormously to the center. If designs are stolen, produced goods impounded, travel of people between the center and the offshore location made difficult, the entire production structure of the company collapses. For the center, the quality of institutions in the offshore location becomes  almost as important as the quality of institutions locally.

Second, technological progress in the offshore locations now takes an entirely different hue than in the past. While in the past developing countries  were trying to induce foreign investors to share their know-how, now the center (mother company) has all incentives to make sure the best technology is used because the offshore location has become an integral part of the center’s production chain.  This is an enormous change: rather than begging or incentivizing the rich country’s company to transfer technology, now the owner of that technology is herself keen to transfer to the offshore location as much of it as possible.

The great convergence from which the book takes its title, that is the remarkably fast growth of Asia, can thus be understood to have been made possible by an improvement in institutions and much greater transfer of technological know-how. And with both being directly related to the second unbundling. To put it simply: Asia grew thanks to globalization.

Baldwin’s story here clearly links with development economics. The old-fashioned view of development was “stage-based”: following upon the way England, and later US and Japan developed, it viewed countries as going through the import-substitution stage with significant tariff protection, then developing exports of simple manufactures and gradually moving into more sophisticated products. This was the idea that underlay most of development policy between the 1950s and 1980s. South Korea, Brazil and Turkey were the best examples. But in the 1990s, with the second globalization things changed. What became crucial for success was no longer to develop by own economic policy through various stages, but to become part of the global supply chains organized by the center (the “North”).

Baldwin’s argument changes the way we interpret Asia’s success in the current era: China, India, Indonesia, Thailand  are not repeating Korea’s experience, but are the trail-blazers of a new way to development that, by integrating one’s economy to the “North”, leapfrogs over several technological and institutional stages. To grow, it becomes crucial to be part of global supply chains. The most successful countries in the second globalization are those that due to institutional factors, skill and cost of their labor, and geographical proximity to the “North” are able to become an integral part of “Northern” economy. Baldwin’s  interpretation inverts (rightly, in my opinion) the old dependencia paradigm which held that “delinking” was the way to develop. On the contrary, getting “linked” is what made Asia traverse in a remarkably short  span of time the road from absolute poverty to middle income status.

What would be the third globalization? The ultimate (at least from today’s perspective) unbundling will come with the ability of labor to move seamlessly. This will happen when the costs of moving labor become low. For many operations that require physical presence of a person, the cost of temporarily moving that person to a different location is still high. But if the need for physical presence in a faraway location is solved  through remote control, as we already see in the cases of doctors performing operations remotely,  then labor may become globalized too. The third unbundling, that of labor (as an input in the production process) from its physical location, makes us think of migration and labor markets very differently: if tasks which now require physical presence of a worker can be done remotely by a person at any point on the globe, then migration of labor may be of much smaller importance. Through the third unbundling we can achieve a global labor market that may mimic the way the world would look with a fully free migration.

By placing today’s globalization in the context both of the previous globalization and of what may be the next one, Baldwin allows us to see the economic progress of the past two centuries as a continuum driven by the successive facilitations of movement of goods, information, and people. It also allows us to glimpse a utopia where everything can be quasi instantly and almost costlessly moved around the globe: the ultimate  victory over the constraints of place and location.   

Full text of my New Republic interview

[This is the full text of my interview with Vincent Bevins. An edited version was published in The New Republic.]

 

Let's start with the obvious question. Does the elephant graph explain the victory of Brexit and Trump? Are globalization's losers rebelling against the system that has been in place since the 1980s?

Yes, I think that it largely does explain Brexit and Trump. Why? Because it shows in very stark terms that people in the lower parts of rich countries’ income distributions have seen fewer benefits of globalization compared both to the people in Asia (against whom they often compete in global supply chains) and compared to the people in their own countries’ tops of the distributions. You just cannot undo these two facts. The first (the rise of Asia and China in particular) is plain to everyone; the second is implicit in the rise of inequality in almost all OECD countries between 1980 and up to the financial crisis. So I think the facts, displayed in the “elephant chart”, are incontrovertible.

What is a matter of discussion is whether the primary cause for these facts was globalization or not. The other two “contestants” are technological change (that helped more skilled workers to the detriment of the less skilled) and economic polices like reduction of tax rates.

My opinion is that all three factors played a role, but that both technological change and economic polices responded to globalization. The nature of recent technological progress would have been different if you could not employ labor 10,000 miles away from your home base. Economic polices too would have been different if you had relatively closed economies of the 1960s and 1970s with capital controls.

I agree with Dani Rodrik when he sees globalization as fundamentally reducing the field of feasible economic policies for each nation-state. This seems to me obvious when you consider how much more similar economic polices across the world are today than, say prior to the 1980s. Today, most countries have abandoned capital controls, almost all currencies are convertible, tariff rates are much lower, the role of foreign capital much greater, government subsidies to industries negligible compared to what they used to be.

And why? Because we have created an international economic architecture that takes globalization not only as given but as a desirable objective in itself. And I agree with that.

You agree how? You think globalization is a desirable objective?

Yes, I agree with it as I consider desirable any policy that is “inclusive” in the sense that it opens the field of action to greater number of participants. This is not an instrumental view of globalization. It does not say, globalization is better because it raises incomes (which, I think, on balance, it does). It says globalization is better because it reduces obstacles between people in the world. I think that ideologically one you can be against globalization only on two grounds: one is “localism” where one cares only about his or her narrow community and does not want to interact with the rest of the world, another is “nationalism” which more violently opposes “us” to “them”. An example of the former would be religious communities, an example of the latter would be North Korea. 

The problems with globalization arise from the fact that gains from it are not (and can never be) evenly distributed. There would be always those who gain less than some others, or those who lose even in absolute terms. But to whom can they “appeal” for redress? Only to their national governments because this is how the world is politically organized. Thus national government have to engage in  “mop up” operations to fix the negative effects of globalization. And this they have not done well, led as they were by the belief that the trickle-down economics will take care of it. We know it did not.

So rich world governments, in say the US and Western Europe, failed to “mop up” globalization's mess, and then discontent with the global system rose? What could they have done to clean up the mess?

Perhaps it is easy to say it with hindsight, but they could have argued for trade pacts that would pay more attention to workers’ standards rather than to the protection of intellectual property rights and patents. The skewed nature of these treaties obviously reflected domestic, and even global, power relationship between capital and labor. In other words, we should have had more ILO and less MIGA and WTO. Rich countries, and especially the US, could have paid more attention to the quality of education and tried to not only equalize access to the best schools but make public schools’ quality similar to the quality of private schools. You may say that it is a generally desirable policy that has little to do with globalization: I agree, but I also think that it would have reduced the number of “losers” because it would have enabled larger swaths of the population to successfully complete globally.

During the US election, a rather strange and heated debate took place between liberals that insisted the rise of Trumpism could be blamed on 'economic anxiety' or on racial resentment, as if it had to be one of the two. How would you theorize the relation between economic motivations for voter rebellion and other perhaps complementary causes for the huge transformations we saw in 2016? Do economic problems cause racism or nativism to emerge, for example? Historically how has this usually worked when inequality gets out of control?

I really do not think that the causality runs one way only: either from economic problems to racism, or from racism to economic problems. I think that the two work together. But I think that it was always wrong to blame support that Trump has received only on racism or misogyny. By doing this, one commits two mistakes: first, writes off that portion of the population as “irredeemable” since their racism or misogyny makes them impervious to any rational argumentation; and second, entirely plays down economic factors and thus fails to propose any change in economic policy. The view that nativism alone was responsible for the rise of right-wing populism in the US, or even more bizarrely the view held by some that the “losers” in rich countries should not complain because they are better off than workers in China, were just wrong answers to a very real problem.

 

This kind of an interpretation has received strong pushback in the United States since Trump's victory, with mainstream Democratic supporters calling it either hopelessly leftist or tantamount to rationalizing away racism. Others point to the fact that many rich people supported Trump (as admittedly often supported other Republican candidates). What do you make of this criticism?

I do not understand the pushback. Do they really believe that Trump, Brexit, Le Pen, the rise of many right-wing populist parties in Europe etc. have nothing to do with economics? That suddenly all these weird nationalists and nativists got together thanks to the social media and decided to overthrow the established order? People who believe  this remind me of  Saul Bellow’s statement that “a great deal of intelligence can be invested in ignorance when the need for illusion is strong”.

Can you briefly explain those two types of forces that you say often lead to reductions in inequality when the gap between rich and poor gets especially large, the benign and the malign? What are they, and what is the causal mechanism that leads the explosions in inequality to lead to one or another?

I divide the forces that reduce inequality into malign and benign. The principal malign force in the modern era was war. It reduced inequality not only through destruction of physical assets but also through increase in taxation that was necessary to maintain war effort and to raise mass armies. The role of war in that respect is quite well known.

The benign forces that reduced inequality in rich counties between either the New Deal or the end of WW2, and the 1980s were mass education, trade unions, socialist political parties, high taxes and social transfers, and technological progress in the instances where it was pro-poor, that is where it helped low-skilled labor more that high-skilled.

I do not think that many of these forces will remain operative in the near future. For example, trade unions have been decimated, not only by anti-labor legislation  but also by the movement away from massive factories that brought large numbers of workers together in one place (the so called “Fordism”) to much more skill-heterogeneous service sectors with much smaller sizes of units.

Mass education will not play the same role either: it was a force for equalization when rich countries moved from 6 or 7 years of average education to 13 today, but from 13 years of education, you are not going to move to 20. So this is where quality of education rather than mass education becomes crucial.

Finally, I do not think that yet higher taxes and transfers are any longer accepted by the majority of the electorate. This may be due to a much more skeptical view that today’s generations have of government’s ability to use money effectively.

It is for these reasons that I believe that the key benign forces to reduce inequality in the future will consist in equalization of endowments. This means first, better access to high quality education for all so that the returns to education become more equal, and second, what I call “deconcentration” of capital ownership. The latter implies tax incentives to promote wider ownership of capital and includes also the schemes such as Employee Stock Ownership Plans.

If wage gaps between workers become less, and distribution of income from capital becomes more equal, then you can achieve relatively equal outcomes even without greater government role in redistribution of current income. If this is not done, the danger is that with the heavily skewed distribution of property that exists today in literally all rich economies, any increase in the capital share of national income translates directly into greater inequality in personal incomes. Then you either let inequality get worse or you need to increase redistribution of current income for which, as I said, there is no political appetite any more. You will be thus left without instruments to offset underlying increase in inequality,

 A lot of people on the US left are now yelling, "Bernie would have won!" and it seems that one way to read this phenomenon, using your book, is that they're arguing that we had a chance to counter-act this high-inequality moment with the 'benign forces' you describe, but that now with Trump voters may have unleashed malign forces, through attempts to de-globalize, or perhaps through trade wars or a real war. Does this interpretation make sense to you?

Yes, the interpretation does make sense to me although neither I nor anybody else can prove that Bernie would have won. But, as many people have written, this election took place at the time when many voters wanted to see a candidate for change, and Hillary Clinton was indeed a candidate for change in the fact that she is a woman, but practically in nothing else. And it seems that for many people that was not enough.

One of the more striking parts of your book is when you argue that the world's last great period of globalization and inequality actually came to an end because that inequality led to World War I, which itself destroyed globalization, lives, and property, bringing inequality back down. But you use the unexpected trio of Lenin, Hobson, and Ferguson and the 'imperialist competition' theory to explain the relationship. But this theory isn't very widespread, right? Why do you find it convincing?

There are, of course, almost as many theories explaining the World War I as theories explaining the fall of the Western Roman Empire. The imperialist theory was one of the first since it was formulated in parts even before the war started, and in parts during and just after the war. I find it persuasive because it puts the economic forces ahead of the others, such as political or military, and thus agrees both with I tend to believe in general (priority of economics) and more importantly with what was the spirit of that time. That time, say from 1870 to 1914, was just like ours, the time of huge technological progress and massive commercialization (or you may call it “commodification”) of labor, land etc. combined with globalization. It was an “economics time” par excellence.

In the barest possible terms, the Hobson-Lenin thesis is that high domestic inequalities implied lack of domestic aggregate demand (because the marginal propensity to consume of the rich is lower than that of the poor), and the excess savings looked for investment opportunities which they found only in overseas territories. Then, in other to protect their capital, whether directly invested there or in the form of government bonds, the capitalists called upon their countries’ military resources. We thus get the use of force to exact repayment of the debts (the “gunboat diplomacy”) in Tunisia, Egypt, Venezuela or, even better, to directly control territories, that is to create colonies. As Hobson wrote at the turn of the 20^th century, “the tendency of investors is to work toward political annexation of the countries which contain their investments”. 

Every powerful country in the 19^th or early 20^th century did that: not only England and France, but also Germany, Russia and the United States. Austria-Hungary did the same except it did it in Europe. It is this competition for the conquest of territories (resources and cheap labor) across the world, or to paraphrase AJP Taylor, “for the mastery of the world”, which led to the War.

The important part of the theory is that it shows how international conflict can be caused by purely domestic forces. This is why I discuss it in the context of the Kuznets waves, for it is, I argue, indeed high inequality that (indirectly) unleashed the malign forces of war which ultimately curbed its further increase. This will be, I hope, the lesson useful to remember now and in the future. It is not some kind of blind “blood and soil” imperialism that is often at the origin of the conflict, but imperialism which is responding to the well-defined interests of certain classes. Classes which in turn use the state power to further these interests.

In the book you say that, “Rising inequality indeed sets in motion forces, often of a destructive nature, that ultimately lead to its decrease but in the process destroy much else, including millions of human lives and huge amounts of wealth.” This is true outside of just World War I, correct?

I think World War I in the previous answer is probably the best example. But the role of economic interests in provoking conflict is endless, from military conquests in the ancient and medieval worlds that were motivated by the desire to get cheap labor through enslavement to, for example, US sugar manufacturers that, angry at Cuba’s nationalization, provoked the political estrangement of the two countries for more than half a century. So, the argument that economic interests often stand behind foreign policy moves is not, I believe, hard to make: we can read about it practically daily in the discussions of what Trump and people around him might or might not do in function of their pure economic interests. And then going from these economic interests to showing that often they become more acute under conditions of high inequality, simply because the stakes are greater, seems to me to be but an additional step.

So could we be entering another phase of history in which we experience chaos unleashed indirectly by inequality?

It would be too simplistic to say that income or wealth inequality alone unleashes the chaos. As argued in my book, inequality is one of key enabling factors, it is the background against which the economics and politics work. Inequality makes conflicts, both domestic and international, sharper and one should not forget that creation of a foreign conflict to better mask domestic conflict is a well-proven and much used tactic.

Right, the classic strategy of using outsiders or division to distract from domestic problems, arguably the classic tool in the demagogue's toolbox. Re-reading your book after Trump and Brexit, I remembered your short essay, “For whom the wall fell,” in which you showed that only 10% of post-communist countries successfully transitioned to capitalism and more democracy. Among liberal cosmopolitans in the US now, there seems to be the belief that a third major threat to their way of life – in addition to Brexit and Trump – is the rise of Putin and right-wing populism or neofascism  in Eastern Europe. Is it perhaps unsurprising that this would appear in these regions? Maybe these are other losers of the age of globalization rebelling against the dominant order, or do you disagree?

Yes, the rise of the right-wing populism (although I would not go as far as to call it  neo-fascism) in Eastern Europe, and especially in Russia, is a matter of concern. I must admit that I am not altogether surprised since I always thought that the revolutions of 1989 were nationalist revolutions first and democratic revolutions second. They were revolutions of national emancipation: for the “independent” countries against the Soviet Union which imposed on them the puppet governments, and for the then-republics of the Soviet Union, Czechoslovakia and Yugoslavia, against what each of them saw as an unfair deal or domination by the others. Russia under Yeltsin for example (when Russia was still part of the USSR) followed an entirely secessionist policy.

On top of that, you had in Russia, broadly speaking a failure of new capitalism to increase incomes and to create a broader middle class. Nationalism plus economic failure and exceedingly unequal distribution of wealth plus the feeling of humiliation after the end of  the Cold War provide an almost ideal breeding ground for the growth of aggressive and authoritarian nationalism. This is what we now have in Russia.

But this does not explain Poland which is, by far, the most successful country in transition to capitalism. You can explain Poland (and Hungary, and Slovakia) only if you realize that the 1989 revolutions had a large nationalist and clericalist component.

So it would make sense, from a very narrow economic perspective, to understand why Russia and other postcommunist countries would be less happy about the current order? Is the opposite true, that people in places like London, and New York, and California, may not know how well they've had it? You wrote in your book that a full half of the increase in US personal income inequality can be explained by New York, the San Francisco Bay Area, and Washington State. Historically, are the winners usually aware of their privilege sitting at the top of the pyramid, or is myopia common?

I think that myopia is very common, especially when you believe that what you have is fully deserved and that you are not only richer but morally superior. It was Hayek of all people who many years ago noticed that one of possibly fatal weaknesses of capitalism as actually practiced is that it tends to ascribe moral virtue to economic success. Let me quote him: “it bodes ill for the future of the market order that [identifying success with virtue] seems to have become the only defense of it which is understood by the general public.” If you believe this then you cannot understand anyone who questions the existing order; he must appear to you either as a brute or a villain. 

Should some countries cease to exist?

Working on global inequality makes you ask questions you would never ask otherwise simply because they would not occur to you. It is like going from a two-dimensional world to a three-dimensional: even the familiar suddenly appears unusual. 

Take the convergence economics. In theory of growth convergence indicates the regularity that poorer countries tend to grow faster than richer countries because they can use all the knowledge and innovations that the richer have already produced. Simply put, when you are at the technological frontier, you need to invent something new all the time and you may grow at say, 1 or 1.5 percent per year. When you are below the frontier, you can copy and grow at the higher rate. (Of course, economists talk of “conditional convergence” because the theory assumes that all other factors, that in reality differ between the rich and poor countries, are the same.) Nevertheless, there is some evidence for conditional convergence in empirical studies and it is, for obvious reasons, considered a good thing.

Now, when you look more closely you realize that convergence is studied in terms of countries but in reality it deals with the convergence in living standards between individuals. We express it in terms of a poorer country catching up with the richer because we are used to doing our economics in terms of nation-states and implicitly assume that there is no movement of people between countries. But in reality convergence is nothing else but the diminution of income inequality between all individuals in the world. 

So, how best to achieve such a decrease in inequality between people? Economic theory, common sense and simulation exercises clearly show that it can be best done by allowing free movement of people. Such a policy would increase global income (as any free movement of factors of production in principle should), reduce global poverty and global inequality. It is immaterial, from a global perspective, that it might slower between-country convergence (as some recent results for EU indicate) because countries are, as we have just seen, not the relevant entities in global economics: the relevant entities are individuals and their welfare levels. If people’s incomes are more equal, it is wholly immaterial if the gap between the average incomes in A and B increases.  To see this point, think in the familiar terms of the nation-state: no one in his or her right mind would argue that people from the Appalachian in the US should not be allowed to move to California because the average income in the Appalachia might go down. In fact, both the average income in California and in Appalachia might go down, and both inequalities in the Appalachia and California might go up, and yet the overall US income would rise and US inequality would be less. 

The argument is identical for the world as a whole: a high-skilled Nigerian who moves to the United States might lower the mean income of Nigeria (and might also lower the mean income of the US), and might in addition cause both inequalities to go up, and yet the global GDP would be greater and global inequality would be less. In short, the world would be a better place. The objections to migration, namely that it might reduce the average income in recipient countries,  raised by Paul Collier in his book “Exodus” are immaterial because the real subject of our analysis is not the nation-state but the individual. 

Thus far the argument seems to me entirely incontestable. But then things get a bit messier. Pushing this logic further, and using the results of the Gallup poll that show the percentage of people who desire to move out of their countries, we find that in the case of unimpeded global migration some countries could lose up to 90 percent of their populations. They may cease to exist: everybody but a few thousand people might move out. Even the few who might at first remain, could  soon find their lives there intolerable, not least because providing public goods for a very small population may be exceedingly expensive. 

So, what?—it could be asked. If Chad, Liberia and Mauritania cease to exist because everybody wants to move to Italy and France, why should one be concerned: people have freely chosen to be better off in Italy and France, and that’s all there is to that. But then, it could be asked, would not disappearance of countries also mean disappearance of distinct cultures, languages and religions? Yes, but if people do not care about these cultures, languages and religions, why should they be maintained?  

Destroying the variety of human traditions is not costless, and I can see that one might believe that maintaining variety of languages and cultures is not less important that maintaining variety of the flora and fauna in the world, but I wonder who needs to bear the cost of that. Should people in Mali be forced to live in Mali because somebody in London thinks that some variety of human existence would be lost if they all came to England? I am not wholly insensitive to this argument, but I think that it would be more honest to say openly that the cost of maintaining this “worldwide heritage” is borne not by those who defend it in theory but by those in Mali who are not allowed to move out.

There is a clear trade-off between the maintenance of diversity of cultural traditions and freedom of individuals to do as they please. I would be happier  if the trade-off did not exist, but it does. And if I have to choose between the two, I would choose human freedom even if it means loss of tradition. After all, are traditions that no one cares about worth preserving? The world has lost Marcomanni, Quadi, Sarmatians, Visigoths, Alans, Vandals, Avars and thousands others.  They have disappeared together with their languages, cultures and traditions. Do we really miss them today?