Back to the Main ET Page

Economics focus

Trade disputes

Sep 16th 2004 From The Economist print edition

Nagging doubts about the benefits of globalisation, and a look at the evidence

WHEN David Ricardo, a 19th-century economist, criticised England's protectionist corn laws, he based his argument on the notion of “comparative costs”, these days called comparative advantage. The idea, in brief, is that all countries can raise their living standards through specialisation and trade. Even if one country can make everything more cheaply than every other it still gains from focusing on the goods in which its relative advantage is greatest—ie, in which it has a comparative advantage—and importing the rest. But trade in Mr Ricardo's day involved grain sent by ship from Germany, not computer code sent by e-mail from India. As the production of goods and, increasingly, services is “outsourced” or “offshored” to developing countries, many people in rich countries worry that this new development in international commerce will do them and their national economies more harm than good.

Does such trade defy Mr Ricardo's insights, or does it lead, just like the old-fashioned kind, to greater overall prosperity? Two papers in forthcoming issues of the Journal of Economic Perspectives, both by greatly respected economists, confront this question. The first paper* is by Paul Samuelson, a Nobel laureate whose textbook has introduced students to economics for decades. He paraphrases the defence of free trade by “economists John and Jane Doe spread widely throughout academia”:

Yes, good jobs may be lost here in the short run. But still total net national product ... Correct economic law recognises that some American groups can be hurt by dynamic free trade. But correct economic law vindicates the word “creative” destruction by its proof [sic] that the gains of American winners are big enough to more than compensate the losers.

Of course, says Mr Samuelson, Ricardo was right. Take the example of a poorer, less productive economy, and a richer, more productive one: say, China and America. In the classical model, trade does indeed benefit both economies. Though there are both winners and losers, the winners' gains exceed the losers' losses. Productivity gains in China's export sector raise total wealth in each country.

But, he adds, not so fast. Suppose the poor country, spurred by technical progress, improves productivity in the rich country's export goods: think of China's advances in semiconductors or India's in financial services. Then, says the theory, trade can turn entirely to the poor country's advantage. The improvement in productivity in the poor country can reduce the price of the rich country's exports by enough to make it worse off, despite the increased availability of cheaper goods. It may be that not just some Americans lose, but that the country as a whole is worse off.

Few mainstream economists doubt that this is possible, at least in theory. Mr Samuelson himself described the idea in the 1970s. Europeans worried about American growth in the 1950s for this reason, and Americans later worried about Japan. But evidence that it has been borne out in practice is thin. Mr Samuelson suggests that the move of textile manufacturing to the American South may have caused net losses in the North. Or that Malaysia's leap in rubber production may have had the same effect on Brazil. But both conclusions are uncertain, and there are not many other examples available.

Might the new wave of outsourcing to poor countries be different, and make rich countries poorer? On the empirical side, a paper† by Jagdish Bhagwati, author of a recent book on globalisation (and listed by Mr Samuelson alongside John Doe), Arvind Panagariya, his colleague at Columbia University, and T.N. Srinivasan of Yale provides more help. They show, also using classical trade models, that outsourcing is no different in economic terms from the trade that has been going on since Ricardo's time. The standard results still hold, including the possibility that a country's export prices could fall so much that it becomes worse off. Then the authors cast an eye over the empirical evidence.

No pain, no gain? How likely is offshoring to hurt America, they ask? Not very. The threat posed by Chinese and Indian innovation is overblown. The number of graduates likely to take white-collar jobs from westerners is nowhere near the 300m often said to be ready. As skills in China and India improve, trade with them will become more like that with other rich countries, from which America has historically benefited.

In any event, outsourcing abroad is too small to matter much. One of the most popularly cited estimates, by Forrester Research, is that 3.4m jobs will be outsourced by 2015. That may sound enormous, but it implies an annual outflow of only 0.5% of the jobs in the industries affected. In an average year, the American economy destroys some 30m jobs and creates slightly more, dwarfing the effect of offshoring.

The authors take a sanguine view about the quality of jobs that will replace those lost to outsourcing. American radiologists need not be condemned to flipping burgers when their work is shipped to Chennai. They can turn their skills to the obesity epidemic, or to the burgeoning field of plastic surgery. There is, surely, more than enough work to be done.

Does all this amount to a “proof” that trade can only help America's economy? No. But the marshalling of the evidence on outsourcing, such as it stands, should calm even the worst bout of trade jitters. Mr Samuelson's worries, for all his brilliance, can remain safely on the blackboard.

.