(This essay was published in Hong Kong Economic Journal on 19 October 2016.)


In the quarter century between 1980 and 2005, the world embraced the free market policies of Milton Friedman. A new age of globalization was ushered in. Economic integration of trade flows, capital flows, and migration took place at an accelerated pace. Living standards rose sharply, while life expectancy, infant mortality, educational attainment, and democracy improved, and absolute poverty declined. These are not coincidences.


Starting with China in 1979, many large closed economies became open to freer trade flows. As a consequence, a vast labor force, hitherto not part of the world economy, was now integrated into it through trade. In Europe, deep regional economic integration took place embracing trade flows, capital flows, migration, and the creation of the Eurocurrency. On a global scale, financial markets also became more integrated among the rich economies and to varying degrees in some of the emerging economies. China’s financial and currency markets were opened to a very limited degree during most of this period.


Global integration has undoubtedly improved people’s lives. But it also has other characteristics or consequences.


First, the entry of a vast unskilled labor force into the world economy suddenly made the existing stocks of physical capital, highly skilled workers, and prime real estate scarcer, producing windfall returns on these investments. The wages of unskilled workers, however, stagnated worldwide.


This situation has been the source of rising inequality between labor incomes and of non-human capital incomes in many rich economies. Labor’s share of national income has been falling while (non-human) capital’s share has been rising, especially after globalization accelerated. Very often, the ownership of non-human capital (physical capital and prime real estate) is distributed much more unequally than labor incomes.


Today’s unskilled workers in the rich countries may view the rising inequality in labor incomes as somewhat legitimate, but be suspicious about the rise in capital returns. This, they may easily conclude, is evidence that globalization appears to work only in the interest of the elites.


But the rising return to capital is a result of its temporary scarcity. The stagnancy of unskilled wages and rising returns to human and non-human capital are two sides of the same coin. They are the dual manifestations of the same economic process. Over time both human and non-human capital will adjust, restoring the original equilibrium. What is not clear is how long this process will take and what society would do in the interim to compensate those left behind.


A lesson from history might be found in the Black Death in Europe in the years 1346-53 that wiped out about 30-60% of the population. This had the effect of making labor scarce relative to capital (mostly agricultural land). Wages rose and land rents fell throughout Europe. Some have argued that it spawned labor-saving technological advances and created an Agricultural Revolution in productivity gains.


Like the Black Death, the scale and speed of the recent globalization were vast and unexpected. Few thought the emerging economies, and especially China, could have made such big strides and over such a short period of time that the world economic and political order had to shift. The huge impact has left everyone unprepared.


Second, notwithstanding the vast scale of the integration of the emerging economies into the world trading system, the whole episode should still be viewed primarily as a one-off event. It produced a one-time blip (albeit a big and long one) in the trajectory of an on-going process of global economic integration that had resumed after the end of World War II. China’s entry and accession to the WTO was probably the single most important event that happened in this period because of the scale of her economy and the rapidity of her growth. China was by far the biggest miracle in East Asia and in human history.


Eventually the rising returns to all forms of capital will moderate and return to their original levels. How long this will take depends on how quickly the supply sides respond. Physical capital can be accumulated through investments, learning can augment human capital, and real estate can be increased through land development and building.


Physical capital is likely to adjust most rapidly. Human capital associated with skilled augmentation will take decades. If investment in education and training take place quickly enough, the augmentation would take at most one generation. Human capital can also be augmented in some regions by allowing appropriate migration.


The supply response of prime real estate will depend on location and regulatory controls. In prime locations with high population densities, the response will often be slow. Restrictive regulatory controls will further limit supply. Divisive politics will slow down the adjustment process to rebuild all forms of human and non-human capital.


Recent research showed that America lost almost 6 million manufacturing jobs in net terms between 1999 and 2011, at least one-fifth of which was the direct result of competition from China. The affected American workers  either swelled the ranks of the unemployed or, more often, left the workforce. Lost factory jobs also had a depressing effect on aggregate demand (and thus non-manufacturing jobs) in the affected areas. In total, up to 2.4 million jobs may have been lost, directly and indirectly, as a consequence of imports from China (see Autor, Dorn and Hanson, 2013, 2016).


Other recent studies of rich countries in general have found that the rising share of (non-human) capital income can be attributed entirely to the increase in rental income from residential housing rather than income from other forms of (non-human) capital. This means the supply of housing is far less responsive than the supply of physical capital. It confirms the significance of regulatory controls on housing supply as a critical factor in the rising inequality of non-human capital incomes (see Piketty 2014, Karabarbounis and Neiman 2014, Rognlie 2015).


The failure of government policy in this is largely one of negligence, although some would go so far as to claim that governments have been corrupted. The advocates of globalization could also be flawed for failing to appreciate the length of time the market adjustment process takes to work. Again, no one anticipated so many large emerging economies to open up so rapidly. The vast scale of the shift was truly beyond imagination.


Third, the problems associated with globalization are not solely economic, but also relate to political economy.


The focus on jobs lost ignores the benefits of cheaper imports enjoyed by hundreds of millions of consumers in the advanced countries over this period. A recent study of 40 countries shows that people on high incomes would lose 28% of their purchasing power if borders were closed to trade. But the poorest 10% of consumers would lose 63% of their spending power, because they buy relatively more imported goods. A less open world would hurt the poor most of all (see Fajgelbaum and Khandelwal, 2015).


Contrary to what the critics of globalization say, increased trade flows have benefitted not only the elites but also the working class, who are also consumers. Both the elites and all others have seen their purchasing power improve. The aggregate consumption benefits dwarfs the economic value of job losses.


In principle, the losers in globalization could have been more than adequately compensated by the gains accruing to consumers. Unfortunately, this compensation did not take place and this is one of the main causes of the political fallout in many rich societies.


Asset price inflation is another source of political conflict that has fuelled enmity against the elites. The problem is especially acute in major metropolitan areas where real estate, and especially housing, values have appreciated since the 1990s. Asset price inflation not only redistributes wealth in favor of the existing rich (the current establishment), it also redistributes it from the young generation towards the older one, thus fuelling intergenerational conflict that shakes up the social contract that is present in most societies. It tears at the social fabric that keeps society together.


It is interesting to note that in the US the enmity is targeted at Wall Street, but in Hong Kong it is targeted at property developers. This is not surprising because according to Johnson and Kwak’s 13 Bankers (2010) the US banking industry is highly concentrated. In Hong Kong there are only a handful of large property developers. But the economic forces underlying the appreciation of asset values are the same and do not depend on any specific or designated industry for its delivery.


Then there is the political economy of globalization. Economic losses are primarily concentrated among a small segment of the population in a few affected areas, and there are those who have lost their jobs and do not have their own homes. By contrast, economic gains are spread throughout the population and across the country. This alters drastically the politics at the locality and how people lobby and vote. Dispersed beneficiaries do not translate into effective lobbies and votes and have no impact on politics; concentrated losers do.


Moreover, a media that regards a few hundred lost jobs and a failed factory in an affected area to be more newsworthy than tens of millions of satisfied customers spread across a country also delivers biased reports about the effects of globalization. It helps amplify the adamant voices of concentrated interests and ignores those that are silent. Political influence is clearly not correlated with the total economic value that is dispersed, but with how locally concentrated value is deployed.


Fourth, in Europe, unfettered internal migration and the straitjacket of a common currency have complicated the situation. The result is to compel an even deeper level of integration even though governments do not have sufficient capacity to respond to serious domestic dislocations.


Milton Friedman, the most powerful voice for globalization, had deep reservations about adopting a common currency and unfettered migration. As the pioneering advocate of free-floating exchange rates, Friedman argued in favor of allowing the exchange rate to adjust to restore external imbalances. Monetary and fiscal policy could then regain autonomy and be used to preserve the internal balance that affects inflation and employment.


Friedman also argued that it was only justified to allow the unfettered migration of labor across national borders if these movements were not motivated to take advantage of welfare subsidies. As long as there is subsidized welfare, the incentives for migration would be distorted and society would eventually find it unaffordable and rebel against it. This is the origin of all xenophobic hatred, anger and discrimination.


The Europe project has now imploded on itself. Time will tell if her members will one day again march united under one banner.


The objectives of deep economic integration are to enlarge freedom of choice and promote economic prosperity. And by so doing to improve the lot of the poor in the world. This goal has been achieved. It also sought to reduce the size of government, but not eliminate it. Even back in 1962, Milton Friedman insisted the state had a positive role in maintaining monetary stability and in supporting low-income families through his original idea to introduce the negative income tax.


The pace of globalization was accelerated by the political changes that took place in many countries – China, the UK, the US and the former Soviet Union.  In 1979, Deng Xiao Ping started market reforms in China, which over the next quarter century lifted hundreds of millions of people out of poverty. In the same year, Margaret Thatcher was elected Prime Minister in Britain and initiated her radical reforms and a long period of growth. A year later, Ronald Reagan was elected President of the United States and also embraced free market policies. Within a decade, the Berlin Wall fell and the Soviet Union subsequently disintegrated, creating a score of new states.


These events happened in an era characterized by reliance on competitive market forces within an open economy, a stable macroeconomic environment, and assured property rights – factors that together enabled rapid economic growth. For one-quarter century the ideas of Milton Friedman commanded the attention of economic policy makers. They have no doubt created social and political stresses in some economies. But these are largely a result of the vast scale of change that took place over a short period of time as large emerging economies forged forward.


The most rapid improvement in living standards in human history has now slowed down. The reputation of globalization has been somewhat tarnished by the rising political voices of those who are suffering, and by critical intellectuals who were never its friends. Eight years after the financial meltdown in 2008, world economic growth is progressing very slowly and productivity is not improving well.  Halting globalization and trade growth will only make it more difficult to help those who need assistance.


For now, free market ideas are temporarily out of favor in the corridors of power. Hillary Clinton has disowned the Trans Pacific Partnership that she once supported. Donald Trump threatens protectionism, and wants to bring the jobs back home from China and build a wall on the border to keep Mexicans out. Theresa May told her party: “If you believe you’re a citizen of the world, you’re a citizen of nowhere. You don’t understand what the very word ‘citizenship’ means.” But if the UK begins to turn away all the immigrant talents that have come to call London home, then Britain would have exited Europe to nowhere.




D H Autor, D Dorn, G H Hanson, “The China Syndrome: Local Labor Market Effects of Import Competition in the United States,” American Economic Review, 2013, 103(6): 2121–2168.


D H Autor, D Dorn, G H Hanson, “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade,” NBER Working Paper No. 21906, January 2016.


P D Fajgelbaum and A K Khandelwal, “Measuring the Unequal Gains from Trade,” Quarterly Journal of Economics, Forthcoming, November 2015.


S Johnson and J Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Pantheon, New York, 2010.


L Karabarbounis and B Neiman, “The Global Decline of the Labor Share,” The Quarterly Journal of Economics, 129 (1), 2014, pp. 61–103.


T Piketty, Capital in the Twenty-First Century, trans A Goldhammer, The Belknap Press of Harvard University Press, Cambridge, 2014.


M Rognlie, “Deciphering the Fall and Rise in the Net Capital Share: Accumulation or Scarcity?” Brookings Papers on Economic Activity, Spring, pp. 1–54, 2015.



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