By Marshall Auerback, a market analyst and Research Associate at the Levy Institute
In the post-Cold War era, the dominant force in the development of the world economy has been globalization. The inexorable trend toward greater global integration took somewhat of a hit with the onset of the Asian Financial Crisis of 1997/98, but momentum was clearly re-established with China’s entry into WTO. Distance simply evaporated as a concept. Businesses moved to China, India, Latin America, and other emerging markets in search of cheaper places & ways to produce goods & services for the Western economies. Several hundred million people in underdeveloped economies were lifted into urbanization from centuries of debilitating rural poverty.
At the same time, globalization created losers or at least relative losers. Revolutionary technological advances enabled an unprecedented outsourcing binge by American companies seeking to maximize profits by employment of low cost foreign labor. The scale of the outsourcing has been made possible because of advances in technology, global trade treaties and capital account liberalization.
For all of the vaunted gains in profitability, it is unclear that globalization has been the huge win-win, as its apologists all argue. Internationally, the richest 5 percent of people receive one-third of total global income, as much as the poorest 80 percent, according to research by Professor Branko Milanovic, a visiting presidential professor at CUNY’s Graduate Center and a senior scholar at the Luxembourg Income Study Center. While a few poor countries are catching up with the rich world, the differences between the richest and poorest individuals around the globe are huge and likely growing.
And domestically, U.S. workers have been semi-permanently replaced by low cost foreign workers. Prior to these great advances in technology, displacement of the current labor force could only have occurred through immigration of workers into the country. The upshot is that a huge number of Americans have experienced stagnant wages and incomes for over a quarter of a century. Trade agreements have exacerbated this problem, and the results of this unconcern are evident today in the campaigns of Donald Trump & Bernie Sanders.
Trump, however, has taken this one stage further with his hardline stance on immigration. For all of the media attention being devoted to walls along the Mexican border, or an outright ban on Muslim immigration, there is method to Trump’s madness, which goes well beyond racism (even though there is much of that in his rhetoric). By linking immigration and trade, however crudely, Trump has exposed the broader paradox and inherent contradictions which lurk between the two.
Historically, immigration law has concerned itself with many considerations, the most of which is the displacement of US workers. By contrast, advocates of free trade ignore this consideration, or blithely suggest that the resultant unemployment in a displaced sector (e.g., the automobile industry), is a “negative externality”, which is generally offset by the resultant gains in competitive efficiency, and lower cost goods. Cheap imports, then, outweigh the displacement of workers.
But we do not extend this logic to immigration, or we would move straight to a policy of open borders. Historically, the answer to the question as to why we do not have open borders is because it would substantially drive down the wages of American workers. Low costs for traded goods is okay; low cost labor, not so good (at least that is implicit in the application of our current immigration policy).
Businesses have sought to evade this inconvenient immigration restriction via offshoring manufacturing facilities, the result of which has been the displacing of U.S workers by low cost foreign labor. The economic impact subverts the policy goal behind American immigration policy. In many respects, it mirrors the impact of a hypothetical open borders policy, in effect creating a “synthetic immigration”, which has the impact of reducing employment and lowering wages as investment is increasingly outsourced abroad.
Globalisation advocates argue that the resultant profits to US corporations spur re-investment, which in turn creates employment. In reality, the profits that accrue to US corporations do not go toward domestic re-investment (and, hence, more jobs), but to increasing investment abroad (that is, of course, when they are not using corporate cash to buy back stock and inflate share prices and CEO executive compensation). In fact, it’s worse: Ex China, the evidence is strong that corporations have been net savers. Companies increasingly using their record high profits relative to GDP to buy stock. That means they are actually liquidating. That fact has been masked by acquisitions. And this is a long-standing trend. It was evident in the US as of the early 2000s.
To offset the economic drag that outsourcing and synthetic Immigration impose, policymakers have been pursuing a reckless and increasingly ineffective program of Quantitative Easing (QE) in unprecedented amounts both absolutely and relative to GDP. This policy, designed to stimulate consumption and ultimately investment by pumping up housing and stock markets, have resulted instead in a weak real economy with persistently high underemployment and non-existent wage growth.
In regards to free trade, we think nothing of displacing tens of thousands of automobile workers in Michigan because we attach primacy to the goal of being able to buy the cheapest cars available (the theory being that the resultant savings will generate sufficient demand elsewhere to offset the impact of displaced workers). The implicit assumption is that this “good” outweighs all other considerations, even though the relative consumption problem that occurs as one person buys the lower cost good creates a consumption equivalent to Keynes’s “paradox of thrift” – insofar as consumers fail to realize that if they all do it then many more of them ultimately end up unemployed or underemployed.
Consider a thought experiment: imagine a country that had only one worker and that worker was the sole consumer. It is obvious the worker would understand that by consuming foreign made goods produced by the synthetic immigrant, he would soon have no income and as a consequence, no consumption. In the real world, people want to maximize their welfare and most do so by maximizing current consumption, which is said to be one of the benefits underlying free trade. Maximizing current consumption means purchasing the lowest priced goods at any particular level of quality. In that way, the volume of consumption can be increased and one’s utility maximized. Relative consumption behavior increases this behavior. One’s (call him Joe) sense of values quickly decays when he sees his neighbors increasing their utility at his expense. The neighbor’s foreign-made flat screen TV is so nice and was so cheap that Joe decides he must have one too even though as a union member he well understands his purchase will result in a job loss in the U.S.
This behavior cascades because in the short-run the increased standard of living offered by low cost goods swamps the longer-term effects of chronic job losses. Thus, the paradox of consumption is the idea that a rational person in a one-person world would never behave in the same way as many rational utility-maximizing individuals behave even if the many understand the possible outcome. So, in the world of many individuals creeping Synthetic Immigration progresses as a result of the paradox of consumption until a crisis occurs. Of course, it is the responsibility of the sovereign to prevent the proliferation of the paradox of consumption and synthetic Immigration.
In periods prior to globalization, this was not a problem because displacement by immigrants generally began at the most menial level of the labor force, and policy changes adopted in the aftermath of each successive immigration wave (at least until 1965) generally prevented massive amounts of displacement and consequently, stopped the migration of jobs at the menial labor level. This is because immigration policy has generally considered the impact of immigrants on the domestic job market. The trade-off has widely been characterized as one between greater consumer happiness (lower prices) and job displacement, which is in marked contrast to the trade-offs we consider when introducing trade agreements.
The ethics debate regarding immigration is similar to that regarding trade. Should policy be constructed with respect to domestic or global welfare? For the most part, it seems as if domestic concerns dominated immigration policy; whereas trade policy, haunted by misconceptions regarding the Smoot-Hawley Tariff of the 1930s is generally obsessed with global considerations. Today false ideas about great prospects for exporting into the enormous Chinese market hinder national policy and enable employee displacement. Because of technological advances, today’s trade policies are effectively an immigration policy.
There are differences to be sure, but those differences work to the detriment of American workers. Typically low cost labor attracted long-lived capital investment. Today, Synthetic Immigration via global outsourcing leads to capital investment in the immigrant’s country (China) resulting in a greater capital stock there and increased competitiveness. So, in a very simple model, Synthetic Immigration means less revenue for the U.S. government but comparable expenses in the form of social welfare costs associated with under-employment and lower paying jobs, and correspondingly lower tax revenues. This process in turn has led budget austerians to call for greater cuts in Social Security, Medicare, state pension funds for public sector employees, the very social supports that have somewhat offset the deleterious impact of globalization.
It is and always has been the government’s duty to provide for and protect its citizens. Immigration policies differ everywhere and change as the government’s responsibility to its citizens is enforced. Protection of U.S. workers from synthetic immigrants is long overdue and the cost of government neglect is huge. And yet we never apply the same principles that underlie our immigration policy for trade. At least until now, where it has become a major feature of the Trump campaign, likely catapulting him to the GOP Presidential nomination this year.
So what is the right policy response? Clearly, there has been a backlash against trade agreements, such as the Trans-Pacific Partnership. As Thomas Frank recently noted:
Trade is an issue that polarizes Americans by socio-economic status. To the professional class, which encompasses the vast majority of our media figures, economists, Washington officials and Democratic powerbrokers, what they call “free trade” is something so obviously good and noble it doesn’t require explanation or inquiry or even thought. Republican and Democratic leaders alike agree on this, and no amount of facts can move them from their Econ 101 dream.
To the remaining 80 or 90% of America, trade means something very different. There’s a video going around on the internet these days that shows a room full of workers at a Carrier air conditioning plant in Indiana being told by an officer of the company that the factory is being moved to Monterrey, Mexico, and that they’re all going to lose their jobs.
And Trump has used this video in his campaign. As Frank has noted, “Trump is making a point of assailing that Indiana air conditioning company from the video in his speeches. What this suggests is that he’s telling a tale as much about economic outrage as it is tale of racism on the march.” And the reaction against immigrants may well appeal to racists, but it also overlaps with the economic concerns of people who have been displaced by decades of trade and immigration liberalization, both real and “synthetic”.
Outsourcing is the source of creeping synthetic immigration and synthetic immigration is the source of unemployment. Since unemployment is the source of the extended pay benefits provided by the government, perhaps the government should permanently tax the source of the unemployment—U.S. corporations producing abroad. Doing so will help restore a permanent incentive to invest in plant and equipment in the U.S. and create additional revenues to rebuild America’s decaying infrastructure (as one possible source of domestic employment). At the very least, we need to wean US policymakers off destructive monetary fixes that largely relied on indirect transmission mechanisms (such as QE) that subsidize financial intermediaries and create bubbles. Policymakers believed that human behavior would respond to increased prices of assets (Keynesian “Animal Spirits”) and the subsidization of consumption via unemployment benefits.
Those companies that first exploited the opportunities afforded by globalization and outsourcing did very well, because it provided them with a first mover advantage. Profits grew for those companies that exploited very low cost foreign labor and a much undervalued exchange rate relative to the dollar. At the extreme, all manufacturers must know that a rational public policy would reject outsourcing as un-American and destabilizing. That is certainly a sentiment that Trump continues to exploit in his campaign. As the putative GOP frontrunner says, “we have rebuilt China and yet our country is falling apart. Our infrastructure is falling apart … Our airports are, like, Third World.” (Frank, ibid)
As globalization has intensified, companies have increasingly competed with each other. Those with substantial low cost advantages have generally prevailed and eliminated competitors which sought to preserve well-paying American jobs. Therein lays the paradox of outsourcing. Again, it is the responsibility of the U.S. government to construct policies that stop or least restricts the cascading of outsourcing because of its adverse impact on employment in the U.S. and the negative incentives outsourcing imposes on domestic investment. We have historically considered these factors in our immigration policy. Why is trade so sacrosanct? The candidate who has been most persistent, however crudely and coarsely, in asking these questions is Trump. His unexpected success this election shows that populist backlash against the Washington Consensus is no longer the preserve of a lunatic fringe.