Tuesday, August 01, 2006

Globalization: theory and an example

From Economist's View, excerpts from a recent paper by Harvard economist Richard Freeman on how globalization is affecting worldwide labor markets. Some key points: a doubling of the global labor pool in recent decades has changed the ratio of capital to labor significantly. The increase in available labor has a significant high-skill component, which will impact highly educated workers in the west, particularly in science and technology.

Following the Freeman excerpts, I quote from an article in today's WSJ, which discusses how rapidly China has moved up the manufacturing value chain. They will soon surpass Germany to become the number 3 producer of automobiles. Given that China produces several times more engineers per year than the US, working for a fraction of western salaries, it is no surprise to me (despite predictions from just a few years ago) that they can climb the value chain so quickly. The final claim, soon to be overturned, is that China can only copy, but not innovate.

Some earlier posts on China development here, here and here.

Freeman: At first, the advent of huge numbers of workers from India and China into the global capitalist system seemed to offer a boon to most workers in advanced countries. The labor force is less skilled in the global giants than in the advanced economies. According to the Heckscher-Ohlin model, skilled workers in the advanced countries would benefit from the new trading opportunities while only the relatively small number of unskilled workers would lose. If all workers in the North were sufficiently educated, they would avoid competing with low paid labor overseas and benefit from the low priced products produced there. Competition from low wage workers in China and India might create problems for apparel workers in Central and Latin America or for South Africa, but not for ... the advanced North. Similarly, the “North-South” trade model that analyzes how technology affects trade between advanced and developing countries implied that trade would benefit workers in the North, who had exclusive access to the most modern technology. More low wage workers in the developing world would lead to greater production of the goods in which the South specialized, driving down their prices.

Tell it to Lou Dobbs! The off shoring of computer jobs, the US’s trade deficits even in high technology sectors, and the global sourcing strategies of major firms have challenged this sanguine view. The advent of China, India, and the ex-Soviet Union shifted the global capital-labor ratio massively against workers. Expansion of higher education in developing countries has increased the supply of highly educated workers and allowed the emerging giants to compete with the advanced countries even in the leading edge sectors that the North-South model assigned to the North as its birthright.

...the global labor market changed greatly in the 1990s due to the advent of China, India, and the ex-Soviet bloc to the world economic system. During the Cold War era, these countries had trade barriers, self-contained capital markets, and little immigration to the advanced countries – all of which isolated their labor markets from those in the US and the rest of the capitalist global world. The collapse of Soviet communism, China’s decision to “marketize” its economy, and India’s rejection of autarky, greatly increased the supply of labor available to the global capitalist system. I estimate that if China, India, and the ex-Soviet bloc had remained outside of the global economy, there would be about 1.46 billion workers in the global economy in 2000 (figure 1). Because those countries joined the rest of the world, there were 2.93 billion workers in the global economy in 2000. Since twice 1.46 billion is 2.92 billion, I have called this “The Great Doubling”... The effect of this huge increase in the work force changed the balance between labor and capital in the global economy. ...

I estimate that as result of the doubling of the global work force the ratio of capital to labor in the world economy in 2000 fell to 61 percent of what it would have been in 2000 before China, India, and the ex-Soviet bloc joined the world economy. ... By giving firms a new supply of low wage labor, the doubling of the global work force has weakened the bargaining position of workers in the advanced countries and in many developing countries as well. Firms threaten to move facilities to lower wage settings or to import products made by low wage workers if their current work force does not accept lower wages or working conditions, to which there is no strong labor response. The result is a very different globalization than the IMF, World Bank, and other international trade and financial organizations envisaged two decades or so ago when they developed their policy recommendations for the world economy.

...Countries around the world, including the new giants, have invested heavily in higher education, so that the number of college and university students and graduates outside the US has grown rapidly relative to the number in the US. ...

But highly populous low wage countries have also invested heavily in higher education. Indonesia, Brazil, China, India – name the country – have more than doubled university student enrolments in the 1980s and 1990s (Freeman, 2006). China has made a particularly large investment in science and engineering, so that by 2010 it will graduate more PhDs in science and engineering than the US. While the quality of graduate training is higher in the US than in China, China will surely improve quality over time. India has produced many computer programmers and engineers. ...

Comparative advantage, comparative advantage, wherefore art thou, oh comparative advantage?

In the North-South model that trade economists use to analyze how technology affects trade between the advanced North and the developing South, the advanced countries monopolize cutting edge innovative sectors while developing countries end up producing traditional products. The greater the rate of technological advance and the slower the spread of the newest technology to low wage countries, the higher paid are workers in the North relative to workers in the South. The comparative advantage of advanced countries in high tech sectors is rooted in those countries having more scientists and engineers and other highly educated workers relative to the overall work force than developing countries.

In these sorts of analyses, the spread of higher education and modern technology to low wage countries can reduce advanced countries’ comparative advantage in high-tech sectors and adversely affect workers in the advanced countries as a result. Any country with a comparative advantage in a given sector can lose when another country can compete successfully in that sector. ... If a foreign competitor gains comparative advantage in industries that have particularly desirable attributes– that employ large numbers of highly educated workers and offer great opportunities for rapid technological advance – the country with the initial advantage has to shift resources to less desirable sectors – those with lower chance for productivity growth, with fewer good jobs, and so on. The usual assumption regarding high tech sectors is that only advanced countries have the educated work force necessary for competing in them. In the 1980s, Americans got worked up when Japan seemed to be producing better high tech products than the US.
In the 1990s the US worried about the competition between Airbus and Boeing in the manufacturing of aircraft. No one entertained the notion that China or India would become major players in high technology leading edge industries. ...

The advance of China and India into high tech has obsolesced these analyses. China has moved rapidly up the technological ladder; has greatly increased its high tech exports, and has achieved a significant position in research in what is purported to be the next big industrial technology – nanotechnology. Over 750 multinational firms have set up R&D facilities in China. China’s share of scientific research papers has risen greatly. While India has not invested as much in science and engineering as China, it has achieved a strong international position in information technology, also attracting major R&D investments, particularly in Bangalore. How can low income countries with few scientists and engineers relative to their work forces compete in high tech?

These countries have moved to the technological frontier because success in high tech depends on the absolute number of scientists and engineers rather than on the relative number of S&E workers to the work force. It isn’t how many engineers per person that produces a technological breakthrough as much as the total number of engineers working on the problem. ...

I have called the process of moving up the technological ladder by educating large numbers as “human resource leapfrogging” since it uses human resources to leapfrog comparative advantage from low tech to high tech sectors, contrary to the assumption of the North-South model. The low wages in these large populous countries, moreover, makes them formidable competitors for an advanced country because it gives them a potentially large cost advantage in attracting R&D. ...

In sum, the notion that US skilled workers need not worry about competition from equally skilled workers in low income countries because developing countries have fewer graduates per capita does not fit with reality. With an increased supply of highly educated persons from low wage developing countries, multinational firms can offshore high-skilled work and hire graduates from universities world wide; while large numbers of highly educated immigrants can come to the US to work.

WSJ: Raising the bar for competitors around the world, China is shifting its manufacturing resources to increasingly sophisticated goods, as shown by its rapid emergence as a global powerhouse in the auto-parts industry.

Just a few years ago, Chinese-made automotive components were plagued by a reputation for poor quality, and often cost more than U.S. or German parts. Detractors said the precision engineering required for the best parts was beyond the reach of inexperienced Chinese companies and their low-cost workers.

Last year, however, China for the first time exported more parts than its fast-growing auto industry purchased from abroad. Quality has improved so much that major Western auto makers like Volkswagen AG and DaimlerChrysler AG say they plan in coming years to buy billions of dollars of Chinese-made components -- such as brakes, fuel pumps, wheels and steering systems.

Those gains show how China continues to evolve as a manufacturer, posing new challenges for rivals in the U.S., Europe and Japan. After earning its stripes as a maker of simple consumer goods, such as furniture and textiles, China has branched out, quickly coming to dominate more labor-intensive parts of the consumer-electronics business, such as computer assembly, and moving into a broader range of industries.

The country's production of machinery and transportation equipment has surged, and export of those goods -- which range from auto parts to forklifts to vacuum cleaners -- totaled $352 billion last year, a fourfold increase from 2000.

Meanwhile, motor-vehicle production here has nearly tripled, and China is on pace to overtake Germany as the world's third-biggest auto maker. It has become the world's second-largest car market in terms of sales as millions of Chinese buy cars for the first time. Millions more are expected to do so as their incomes rise and car prices fall.

Now, "China competes in the entire range of products from telecom equipment to textiles," says Hafiz Pasha, director of the United Nations Development Program's Asia bureau.

The transition comes at a sensitive time for the U.S. and Europe, which have been finding it harder to hold on to high-paying manufacturing jobs. Employment in the U.S. auto-parts industry fell to about 644,000 in 2004 from about 721,000 in 2002, according to government figures.

More job losses could be on the way: Some major U.S. parts makers -- including Delphi Corp., which has plants in China -- have sought bankruptcy-court protection. And small and midsize suppliers, which often don't have the resources to set up lower-cost operations abroad, are facing growing pressure.

"In the past two years, Chinese bids for auto-parts orders have driven customer price targets to a level below our costs on some products," said Larry Denton, chairman and chief executive of Rochester Hills, Mich., parts maker Dura Automotive Systems Inc., at a recent government hearing in the U.S.

..."When we started exporting in 1997, people argued that you couldn't make" auto parts cheaper in China, says Jack Perkowski, chief executive of Beijing-based parts maker Asimco Technologies Ltd. "People also argued that China would never be a large car market."

Now, he says, "the conventional wisdom is that China can copy but not create. That's going to go too."


Anonymous said...

Hi Steve,

I'm a little more skeptical about China being able to create without the presence of strong IP laws, or at least uniformly enforced IP laws. The problem is not that the Chinese aren't original or stupid, the problem is that they're too smart :). It is far cheaper to just copy an idea then to do the grunt work to build it from the ground up. The costs of you being caught are minimal, and with everyone throwing everything they can to get into China, the pickings are great.

I work in HK, and I'm always amazed at how much China progresses everytime I go back to the mainland. But there are problems - it seems like there is just an immense waste of resources (especially in non-major cities like Zhu Hai). Too much money sloshing around, and probably too much corruption. I'm personally more optimistic about India then China, but I know that puts me in a distinct minority. I do predict, however, that both are going to face major road bumps on their way to industrialization. I just think that India is better equipped to deal with such problems.

Finally, the contrarian in me is looking to the US. It's been fashionable to relegate the US to a has-been doomed to obscurity, but I think people underestimate how open Americans are to innovation. My suspicion is that the sorts of innovations that will be important in the future will be similar to the Internet - highly dependent on network effects, and you would gain little from "storing" it in your own country. Just some thoughts, not really a well-developed theory or anything.

Steve Hsu said...


It's interesting to think about precisely which areas of innovation will be harmed by lack of IP laws. At the moment, it is probably a net plus for them to have weak IP protection as they try to catch up. In many areas, like software, I would claim the patent system here is broken. Rather than fostering innovation, it is simply injecting noise and overhead!

Anonymous said...

IP laws are value substracted. There's no evidence that their enforcement in a jurisdiction leads to more beneficial innovation.

Anonymous said...

The second way we have outsourced the construction of America is through globalization. Globalization is the condition that anything can be made anywhere and sold anywhere else, while capital moves freely and instantly from anywhere to anywhere. Global trade has been with us for millennia: we need only think of Spanish leather, Arabian horses, Baltic amber, Chinese silk, Egyptian linen, spices and gems from India, African gold and ivory, Mexican silver and Colombian emeralds. Indeed, one of the reasons Europe’s Dark Ages lasted so long was the cutting off of trade after the Muslim Conquests. There is nothing corrosive about importing what you want or need and cannot produce yourself, while paying for such imports by yourself exporting similar goods. Nor is there anything inherently corrosive about what economists call comparative advantage: concentrating on what you do best. When trading partners have no agenda beyond the economic, and both are economically responsible, it makes sense. It’s called trade.

Globalization is not trade. We do not trade with China, for example. China sells to us but neither buys from us no shows much interest in lowering her own barriers. Why should she? Even if we were to launch an effective boycott of Made in China consumer goods tomorrow, China can prosper for decades by developing its domestic markets (and in an Africa they’re aggressively buying into). After all, the factories are already up and running-a unique kind of potential Chinese autarky, supplied by foreigners.

Of course, China’s goal is not autarky: at least, not simple autarky. Nor is their goal physical conquest of other nations. Their goal is the limitless expansion of Chinese economic power, political influence and ability to compete for scarce resources such as oil.

And we have empowered them. Lenin said that the capitalists would sell them the rope with which the communists would hang them. He never imagined that we would borrow the money to buy the rope with which to hang ourselves.

Something to think about on your next trip to the mall, while you search in vain for products Made in America.

Finally, we have grossly compounded the damage of our economic practices by borrowing from foreign governments and Sovereign Wealth Funds.

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