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America and Free Trade Is Ricardo Still Right?
As an American who has always believed in the merits of free trade, I had an important question to answer after my India trip: Should I still believe in free trade in a fiat world? Here was an issue that needed sorting out immediately-not only because it was becoming a hot issue in the presidential campaign of 2004 but also because my whole view of the flat world would depend on my view of free trade. I know that free trade won't necessarily benefit every American, and that our society will have to help those who are harmed by it. But for me the key question was: Will free trade benefit America as a whole when the world becomes so flat and so many more people can collaborate, and compete, with my kids? It seems that so many jobs are going to be up for grabs. Wouldn't individual Americans be better off if our government erected some walls and banned some outsourcing and offshoring?
I first wrestled with this issue while filming the Discovery Times documentary in Bangalore. One day we went to the Infosys campus around five p.m. -just when the Infosys call-center workers were flooding into the grounds for the overnight shift on foot, minibus, and motor scooter, while many of the more advanced engineers were leaving at the end of the day shift. The crew and I were standing at the gate observing this river of educated young people flowing in and out, many in animated conversation.
They all looked as if they had scored 1,600 on their SATs, and I felt a real mind-eye split overtaking me.
My mind just kept telling me, "Ricardo is right, Ricardo is right, Ricardo is right."
David Ricardo (1772-1823) was the English economist 226
who developed the free-trade theory of comparative advantage, which stipulates that if each nation specializes in the production of goods in which it has a comparative cost advantage and then trades with other nations for the goods in which they specialize, there will be an overall gain in trade, and overall income levels should rise in each trading country. So if all these Indian techies were doing what was their comparative advantage and then turning around and using their income to buy all the products from America that are our comparative advantage-from Corning Glass to Microsoft Windows-both our countries would benefit, even if some individual Indians or Americans might have to shift jobs in the transition. And one can see evidence of this mutual benefit in the sharp increase in exports and imports between the United States and India in recent years.
But my eye kept looking at all these Indian zippies and telling me something else:
"Oh, my God, there are so many of them, and they all look so serious, so eager for work. And they just keep coming, wave after wave. How in the world can it possibly be good for my daughters and millions of other young Americans that these Indians can do the same jobs as they can for a fraction of the wages?"
When Ricardo was writing, goods were tradable, but for the most part knowledge work and services were not. There was no undersea fiberoptic cable to make knowledge jobs tradable between America and India back then. Just as I was getting worked up with worry, the Infosys spokeswoman accompanying me casually mentioned that last year Infosys India received "one million applications" from young Indians for nine thousand tech jobs.
Have a nice day.
I struggled over what to make of this scene. I don't want to see any American lose his or her job to foreign competition or to technological innovation. I sure wouldn't want to lose mine. When you lose your job, the unemployment rate is not 5.2 percent;
it's 100 percent. No book about the flat world would be honest if it did not acknowledge such con-
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cerns, or acknowledge that there is some debate among economists about whether Ricardo is still right.
Having listened to the arguments on both sides, though, I come down where the great majority of economists come down-that Ricardo is still right and that more American individuals will be better off if we don't erect barriers to outsourcing, supply-chaining, and offshoring than if we do. The simple message of this chapter is that even as the world gets flat, America as a whole will benefit more by sticking to the basic principles of free trade, as it always has, than by trying to erect walls.
The main argument of the anti-outsourcing school is that in a flat world, not only are goods tradable, but many services have become trad-able as well. Because of this
change, America and other developed countries could be headed for an absolute decline, not just a relative one, in their economic power and living standards unless they move to formally protect certain jobs from foreign competition. So many new players cannot enter the global economy-in service and knowledge fields now dominated by Americans, Europeans, and Japanese-without wages settling at a newer, lower equilibrium, this school argues.
The main counterargument from free-trade/outsourcing advocates is that while there may be a transition phase in certain fields, during which wages are dampened, there is no reason to believe that this dip will be permanent or across the board, as long as the global pie keeps growing. To suggest that it will be is to invoke the so-called lump of labor theory- the notion that there is a fixed lump of labor in the world and that once that lump is gobbled up, by either Americans or Indians or Japanese, there won't be any more jobs to go around. If we have the biggest lump of labor now, and then Indians offer to do this same work for less, they will get a bigger piece of the lump, and we will have less, or so this argument goes.
The main reason the lump of labor theory is wrong is that it is based on the assumption that everything that is going to be invented has been invented, and that therefore economic competition is a zero-sum game, a fight over a fixed lump. This assumption misses the fact that although jobs are often lost in bulk-to outsourcing or offshoring-by big individ-
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ual companies, and this loss tends to make headlines, new jobs are also being created in fives, tens, and twenties by small companies that you can't see. It often takes a leap of faith to believe that it is happening. But it is happening. If it were not, America's unemployment rate would be much higher today than 5 percent. The reason it is happening is that as lower-end service and manufacturing jobs move out of Europe, America, and Japan to India, China, and the former Soviet Empire, the global pie not only grows larger-because more people have more income to spend-it also grows more complex, as more new jobs, and new specialties, are created.
Let me illustrate this with a simple example. Imagine that there are only two countries in the world-America and China. And imagine that the American economy has only 100 people. Of those 100 people, 80 are well-educated knowledge workers and 20 are less-educated low-skilled workers. Now imagine that the world goes flat and America enters into a free-trade agreement with China, which has 1,000 people but is a less developed country. So today China too has only 80 well-educated knowledge workers out of that 1,000, and it has 920 low-skilled workers. Before America entered into its free-trade agreement with China, there were only 80 knowledge workers in its world.
Now there are 160 in our two-country world. The American knowledge workers feel like they have more competition, and they do. But if you look at the prize they are going after, it is now a much expanded and more complex market. It went from a market of 100 people to a market of 1,100 people, with many more needs and wants. So it should be win-win for both the American and Chinese knowledge workers.
Sure, some of the knowledge workers in America may have to move horizontally into new knowledge jobs, because of the competition from China. But with a market that
big and complex, you can be sure that new knowledge jobs will open up at decent wages for anyone who keeps up his or her skills. So do not worry about our knowledge workers or the Chinese knowledge workers. They will both do fine with this bigger market.
"What do you mean, don't worry?" you ask. "How do we deal with the fact that those eighty knowledge workers from China will be willing
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to work for so much less than the eighty knowledge workers from America? How will this difference get resolved?"
It won't happen overnight, so some American knowledge workers may be affected in the transition, but the effects will not be permanent. Here, argues Stanford new economy specialist Paul Romer, is what you need to understand: The wages for the Chinese knowledge workers were so low because, although their skills were marketable globally like those of their American counterparts, they were trapped inside a stifled economy.
Imagine how little a North Korean computer expert or brain surgeon is paid inside that huge prison of a nation! But as the Chinese economy opens up to the world and reforms, the wages of Chinese knowledge workers will rise up to American/world levels.
Ours will not go down to the level of a stifled, walled-in economy. You can already see this happening in Bangalore, where competition for Indian software writers is rapidly pushing up their wages toward American/European levels-after decades of languishing while the Indian economy was closed. It is why Americans should be doing all they can to promote more and faster economic reform in India and China.
Do worry, though, about the 20 low-skilled Americans, who now have to compete more directly with the 920 low-skilled Chinese. One reason the 20 low-skilled Americans were paid a decent wage before was that, relative to the 80 skilled Americans, there were not that many of them. Every economy needs some low-skilled manual labor. But now that China and America have signed their free-trade pact, there are a total of 940 low-skilled workers and 160 knowledge workers in our two-country world. Those American low-skilled workers doing fungible jobs-jobs that can easily be moved to China-will have a problem. There is no denying this. Their wages are certain to be depressed. In order to maintain or improve their living standards, they will have to move vertically, not horizontally. They will have to upgrade their education and upgrade their knowledge skills so that they can occupy one of the new jobs sure to be created in the much expanded United States-China market. (In Chapter 8 I will talk about our society's obligation to ensure that everyone gets a chance to acquire those skills.)
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As Romer notes, we know from the history of our own country that an increase in knowledge workers does not necessarily lead to a decrease in their pay the way it does with low-skilled workers. From the 1960s to the 1980s, the supply of college-educated workers grew dramatically, and yet their wages grew even faster.
Because as the pie grew in size and complexity, so too did people's wants, and this increased the demand for people able to do complex work and specialized tasks.
Romer explains this in part by the fact that "there is a difference between idea-based goods and physical goods." If you are a knowledge worker making and selling some kind
of idea-based product-consulting or financial services or music or software or marketing or design or new drugs-the bigger the market is, the more people there are out there to whom you can sell your product. And the bigger the market, the more new specialties and niches it will create. If you come up with the next Windows or Viagra, you can potentially sell one to everyone in the world. So idea-based workers do well in globalization, and fortunately America as a whole has more idea-driven workers than any country in the world.
But if you are selling manual labor-or a piece of lumber or a slab of steel-the value of what you have to sell does not necessarily increase when the market expands, and it may decrease, argues Romer. There are only so many factories that will buy your manual labor, and there are many more people selling it. What the manual laborer has to sell can be bought by only one factory or one consumer at a time, explains Romer, while what the software writer or drug inventor has to sell - idea-based products-can be sold to everyone in the global market at once.
That is why America, as a whole, will do fine in a flat world with free trade-provided it continues to churn out knowledge workers who are able to produce idea-based goods that can be sold globally and who are able to fill the knowledge jobs that will be created as we not only expand the global economy but connect all the knowledge pools in the world. There may be a limit to the number of good factory jobs in the world, but there is no limit to the number of idea-generated jobs in the world.
If we go from a world in which there were fifteen drug companies and fifteen software companies in America (thirty in all) and two drug companies and two software companies in China (four in all) to a world
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in which there are thirty drug and software companies in America and thirty drug and software companies in China, it is going to mean more innovation, more cures, more new products, more niches to specialize in, and many more people with higher incomes to buy those products.
"The pie keeps growing because things that look like wants today are needs tomorrow,"
argued Marc Andreessen, the Netscape cofounder, who helped to ignite a whole new industry, e-commerce, that now employs millions of specialists around the world, specialists whose jobs weren't even imagined when Bill Clinton became president. I like going to coffee shops occasionally, but now that Starbucks is here, I need my coffee, and that new need has spawned a whole new industry. I always wanted to be able to search for things, but once Google was created, I must have my search engine.
So a whole new industry has been built up around search, and Google is hiring math Ph.D.'s by the bushel-before Yahoo! or Microsoft hires them. People are always assuming that everything that is going to be invented must have been invented already.
But it hasn't
"If you believe human wants and needs are infinite," said Andreeseen, "then there are infinite industries to be created, infinite businesses to be started, and infinite jobs to be done, and the only limiting factor is human imagination. The world is flattening and rising at the same time. And I think the evidence is overwhelmingly clear: If you look over the sweep of history, every time we had more trade, more
communications, we had a big upswing in economic activity and standard of living."
America integrated a broken Europe and Japan into the global economy after World War II, with both Europe and Japan every year upgrading their manufacturing, knowledge, and service skills, often importing and sometimes stealing ideas and equipment from the United States, just as America did from Britain in the late 1770s. Yet in the sixty years since World War II, our standard of living has increased every decade, and our unemployment rate-even with all the outcry about outsourcing- stands at only a little above 5 percent, roughly half that of the most developed countries in Western Europe.
"We just started a company that created 180 new jobs in the middle of a recession,"
said Andreessen, whose company, Opsware, uses au- 232
tomation and software to replace human beings in the operation of huge server farms in remote locations. By automating these jobs, Opsware enables companies to save money and free up talented brainpower from relatively mundane tasks to start new businesses in other areas. You should be afraid of free markets, argued Andreessen, only if you believe that you will never need new medicines, new work flow software, new industries, new forms of entertainment, new coffeehouses.
"Yes," he concluded, "it takes a leap of faith, based on economics, to say there will be new things to do." But there always have been new jobs to do, and there is no fundamental reason to believe the future will be different. Some 150 years ago, 90 percent of Americans worked in agriculture and related fields. Today, it's only 3 or 4 percent. What if the government had decided to protect and subsidize all those agricultural jobs and not embrace industrialization and then computerization? Would America as a whole really be better off today? Hardly.
As noted, it is true that as Indians or Chinese move up the value chain and start producing more knowledge-intensive goods-the sorts of things Americans have been specializing in-our comparative advantage in some of these areas will diminish, explains Jagdish Bhagwati, the Columbia University expert on free trade. There will be a downward pressure on wages in certain fields, and some of the jobs in those fields may permanently migrate abroad. That is why some knowledge workers will have to move horizontally. But the growing pie will surely create new specialties for them to fill that are impossible to predict right now.
For instance, there was a time when America's semiconductor industry dominated the world, but then companies from other countries came along and gobbled up the low end of the market. Some even moved into the higher end. American companies were then forced to find newer, deeper specialties in the expanded market. If that weren't happening, Intel would be out of business today. Instead, it is thriving. Paul Otellini, Intel's president, told The Economist (May 8, 2003) that as chips become good enough for certain applications, new applications pop up that demand more powerful and more complex chips, which are Intel's specialty.
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Once Google starts offering video searches, for instance, there will be demand for
Once Google starts offering video searches, for instance, there will be demand for