August 10, 2018

Further Thoughts on Dani Rodrik’s Critique of “Hyperglobalization”

Daniel Griswold

Senior Research Fellow

Harvard economist Dani Rodrik is one of the more heterodox voices in today’s debate on trade and globalization. He’s not a Trumpian protectionist, nor is he a Milton-Friedman-style “globalist” (like me) who advocates unabashedly for free trade and free markets.

Rodrik appears often on op-ed pages and has garnered more than 100,000 followers on Twitter. In his much discussed book from 1997, “Has Globalization Gone Too Far?” and his latest, “Straight Talk on Trade,” he’s carved his niche as someone who is not opposed outright to globalization, but who thinks it has been allowed to run amok, inviting the kind of backlash from the right and the left that we are seeing today. As Vox put it recently, Rodrik warned us “that tensions around global trade would lead to greater divisions between the ‘winners’ and ‘losers,’ ideologies that have crystallized in Brexit and the election of Donald Trump.”

Just as Rodrik attempts to dampen enthusiasm for the globalization parade, let me share my skepticism about his skepticism about globalization. Earlier this year, I noted my reservations in a review of Straight Talk on Trade. In this little essay, I want to plumb deeper into several other points Rodrik made in his book that should not be left unchallenged.

Trade’s “winners and losers”

A common theme in Rodrik’s work is that economists have ignored or downplayed the impact of globalization on the “losers” — workers who have lost their jobs, or industries that have shrunk because of global competition. In fact, any undergraduate econ textbook will show that a reduction in trade barriers will cause a loss of producer surplus for the import-competing industry. The true economic insight is that the gain in consumer surplus is almost always much greater and that society as a whole is better off with free trade.

Yet Rodrik dismisses the broader societal gains and instead focuses exclusively on the re-distributional aspect of trade. In one passage in his recent book, Rodrik recounts how he spoiled the neat story a fellow professor who trying to convey to his students on the benefits of trade. Rodrik asked the class if they would approve a trade policy change that resulted in taking $200 from Nicholas and giving $300 to John. The class, according to Rodrik, went silent.

The problem with Rodrik’s hypothetical is that it lacks the context that he would rightly insist on elsewhere. People are generally against taking from one person and giving to another without knowing the reason behind it. Otherwise, it looks a lot like stealing. If I had been the host professor, I would have started by noting the curious detail that the $200 quite miraculously becomes $300 through the policy change. Here we have in a nutshell the miracle of trade. Yes, resources do shift from one party to another because of changing patterns of trade and output, but at the same time the pie grows larger. Society as a whole is better off.

What’s also missing from Rodrik’s story is how the policy change came about. If Nicholas loses and John gains from repealing a trade barrier, then doesn’t that mean that at some point in the past it was Nicholas who gained at John’s expense when that trade barrier was first imposed? And so here we have in a nutshell the negative impact of protection. When a barrier is imposed, the protected party (in this case Nicholas) gains $200, but only by imposing a cost of $300 on John. The $100 loss in total societal wealth is what an economist would call the “deadweight loss” of trade barriers — lost efficiency for both producers and consumers.

To translate this into an all-too-real example, President Trump’s Section 232 steel tariffs have had the effect, in Rodrik’s classroom model, of delivering $200 in benefits to the steel industry by extracting $300 from consumers and steel-using industries and their workers. Those tariffs deliver real if arguably temporary benefits to the steel industry and its workforce, but only by imposing even greater costs on the rest of society. We’ve achieved income redistribution that is both questionable in its justice and that comes at the cost of a deadweight loss to the U.S. economy.

If a change in trade policy either way is going to result in a one-time transfer of resources, shouldn’t we have a built-in bias toward reducing trade barriers? After all, free trade benefits the nation as a whole while it leaves Americans free as consumers and producers to make their own arrangements in the marketplace, free of government intervention. By stigmatizing any policy change that has the effect of leaving some people worse off and others better off, Rodrik is biasing trade policy toward the status quo.

Milton Friedman and China

In a section entitled, “Milton Friedman’s Magical Thinking,” Rodrik singles out the late University of Chicago economist as representing misguided faith in free markets. In contrast to his own nuanced thinking, Rodrik characterizes Friedman’s approach as, “Let the government simply enforce property rights and contracts, and –presto! — markets can work their magic.” For Friedman and his followers, the government is the enemy, when in Rodrik’s view, all successful economies are mixed: “Governments must invest in transport and communications networks; counteract asymmetric information, externalities, and unequal bargaining power; moderate financial panics and recessions; and respond to popular demands for safety nets and social insurance.”

To anyone familiar with Friedman’s work, there was nothing magical in his approach to economics. He was a rigorous and empirical thinker, a Nobel laureate who studied the history of monetary policy and developed such durable theories as the permanent income hypothesis. It was that same clear thinking that led Friedman to question the ability of government actors to manage something as complex as the economic life of a nation.

Rodrik zeros in on a scene in Friedman’s justly famous TV series “Free to Choose” in which he retells the Leonard Read story of how a pencil comes together, not through central planning, but by thousands of people around the world whose activities are coordinated by supply and demand expressed through price signals. But, notes Rodrik, almost 40 years later most of the world’s pencils are produced in China! He sees it as a challenge to Friedman’s thinking that the pencil, a symbol of the fruits of the free market, is now being mass produced in what is still nominally a communist country with its mix of private enterprise and state direction. He concludes, “Thinkers like Friedman leave an ambiguous and puzzling legacy, because it is the interventionists who have succeeded in economic history, where it really matters.”

Is it really such a puzzle? China’s prowess in manufacturing pencils and lots of other items is not a challenge to Friedman’s view of markets but a confirmation of it. In the past era of Maoist central planning, China was not producing pencils or much of anything else that was of value in global markets. China’s extraordinary economic growth of the past four decades has not occurred because of the mixed nature of its economy, but because of its decisive shift away from centralized planning toward a more market-based system. Although the scale of its growth is unprecedented, because of its sheer size, China has been less successful at delivering a high standard of living to its citizens than the far more capitalistic and open economies of the United States, Western Europe, Hong Kong, Singapore, South Korea, and Japan.

As part of his focus on China as the central example of the superiority of a more mixed economic model, Rodrik states in passing that China is now the “world’s largest economy.” This is a misleading statement. As global trade wonks know, there are two ways of expressing a nation’s gross domestic product — in terms of the US dollar exchange rate, and in terms of purchasing power parity (PPP). The PPP approach requires that we convert the value of China’s non-tradable sector into Western prices. For example, a person in China can buy a haircut or a takeout meal for a fraction of the price an American would pay. If a person in China pays 7 yuan for a haircut, that would be equivalent to about $1.10 at the current yuan/$ exchange rate. But that same haircut would cost an American $15 at the mall. So to adjust for living standards, assuming the haircuts are of equal quality, the haircut in China would translate into $15 of GDP at purchasing power parity.

The PPP method is better for comparing living standards, or GDP per capita. But the exchange rate method is better for comparing the overall size of economies to each other, or the nation’s relative weight in the global economy, since it measures the ability of the people of a country to acquire goods, services, and assets in global markets. By the PPP method, China’s GDP is indeed larger than that of the United States. But according to the World Bank, which uses the exchange rate method for international GDP comparisons, China’s economy is still only about 63 percent as large as America’s. You can argue which method is better for a particular purpose, but Rodrik should explain his reasoning to his readers and let them decide.

Is globalization “tearing societies apart”?

Rodrik claims in his book that, “Hyperglobalization in trade and finance, intended to create seamlessly integrated world markets, tore domestic societies apart,” and he repeats, in more recent statements, that globalization is “tearing societies apart.” If he has provided real examples of this phenomenon, I’ve missed them. A true test of his hypothesis would depend on defining hyperglobalization, defining what it means for a society to be torn apart, and then looking for a real-world relationship between those two variables.

Let’s make a first pass at testing this hypothesis. According to the most recent surveys of economic freedom, such as those by the Cato Institute and the Heritage Foundation, the most globalized economies in the world in terms of their openness to trade and global finance would include Canada, Panama, New Zealand, Singapore, Hong Kong, and most nations of Western Europe. While those societies each have their challenges, it would stretch credibility to say they are being “torn part” by hyperglobalization.

On the other end of the spectrum, there are indeed nations and societies that are tearing themselves apart before our eyes. Those nations tend to suffer either from deep ethnic or religious cleavages — Yemen, Syria, South Sudan, and Mynanmar come to mind — or from socialism that has run amok — think Venezuela and Zimbabwe. In each of those places, it’s difficult to argue that the chief explanatory variable is too much liberalization of trade and investment flows. Rodrik’s prime example may be Greece, but its troubles are not caused by too much globalization, but instead by profligate government spending and disagreements with its Eurozone neighbors about the terms of a bailout.

The common thread in all these examples is a systematic mischaracterization by Rodrik of the nature of today’s globalization and its impact on nations and societies. The choice is not between “hyperglobalization” on the one hand and a sane, mixed economy model on the other. The choice is between expanding the freedom of people around the world to trade, to invest, and to move more freely across international borders, or to further restrict that freedom through tariffs and other barriers to commerce.