The Unequal Effects of Globalization

April 12, 2024

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Pinelopi Koujianou Goldberg with Greg Larson. The Unequal Effects of Globalization. Cambridge: The MIT Press, 2023.

For much of the past century, the United States has been a world leader in promoting free trade. During that period, most Americans probably took it for granted that the country benefited from having foreign markets for our products, while making foreign products available to American consumers. The idea that trading relationships should be a win-win for both parties was a pillar of economic theory. It was deeply rooted in the basic insight of free market economics, that economic actors prosper by dividing their labor between different forms of production and engaging in free exchange. If individuals and firms do so, why not countries? Let each country export the things it can produce most efficiently while importing the things it does not.

In recent decades, however, the increase in global trade has raised concerns about unequal economic effects. Globalization creates winners, to be sure, but maybe it also creates too many losers, notably manufacturing workers who lose their jobs to lower-wage foreign laborers. Donald Trump has gone so far as to assert that the United States as a country is losing from free trade, and we should return to an era of tariff barriers to protect our industries.

This short but timely book is based on a lecture that principal author Pinelopi Goldberg gave at the Stockholm School of Economics in 2019. At the time, she was chief economist of the World Bank Group.

Trends in globalization

Goldberg begins by identifying two main features of the “age of globalization.” The first is the historic decline in protective tariffs after World War II. The second is technological developments that lowered the costs of transportation and communication. As a result, “world exports, fairly constant in the nineteenth and early twentieth centuries, began rising after World War II and accelerated dramatically in the late 1990s and early 2000s—a period now known as hyperglobalization that coincided with the emergence of global value chains (GVCs).” In global value chains, many different countries play some part in designing, producing and/or marketing a finished product.

Since the United States has its own very large consumer market, it relies less on exports than many smaller economies do. The export share of its economy increased only from 4 percent to 9 percent between 1945 and 2014. But in recent years, the U.S. has imported more than it exports.

Economists have disagreed over how much of globalization to attribute to technological change, as opposed to policy changes. Recently, more have emphasized technological change, but Goldberg makes a case for policy effects, for several reasons. Tariffs are still falling in many developing countries, and the impact of that change is amplified by the increasing complexity of global value chains. Policy changes affect trade in other ways besides tariffs too, such as by setting standards that assure consumers that products produced in other countries are safe to use.

Global trade has slowed somewhat since the Global Financial Crisis of 2008. Goldberg says that it is too early to say if this will turn out to be a long-term trend. Even if trade should decline between distant countries with troubled relationships, such as the U.S. and China, trade within world regions like Europe or the Americas might still thrive. “GVCs may partially or entirely relocate their operations to different parts of the world…, and regionalism may become the new form of globalization.”

Many countries have experienced a growing backlash against international trade agreements. Backlash in the United States led the Trump administration to put tariffs on selected goods, especially steel and aluminum, electronic devices, and certain Chinese consumer products like vacuum cleaners. He promises additional tariffs if reelected.

Goldberg reports a drop from 80 percent to “slightly more than 65 percent” from 2002 to 2014 in the share of Americans who believed that trade was good for the economy. Increasing disenchantment with trade is one factor contributing to Trump’s MAGA movement. One research study reported that less educated whites were especially likely to leave the Democratic Party if they lived in counties affected by increased Mexican competition after NAFTA.

Some of the new resistance to trade arises from perceptions that our trading partners do not always play fair.

There are…many complaints that market access in some developing countries is limited, that many developing country governments give subsidies and other unfair advantages to local firms and state-owned enterprises, and that some countries, especially China, engage in forced technology transfer or the outright theft of intellectual property.

Of course, even fair trade could create winners and losers. Economists and policymakers want to know if international trade worsens economic inequality.

Trade and global inequality

The impact of global trade on inequality is not simple. Goldberg stresses the importance of distinguishing inequality across countries and inequality within countries.

Taking inequality across countries first, the book makes this claim: “There is substantial evidence and widespread consensus among economists and economic historians that global inequality has decreased dramatically in recent decades, especially in the decades since World War II.” The main evidence for a decline in global inequality is a reduction in the portion of the world’s population living in extreme poverty. The income distribution for the world population shows declining frequencies at the lowest end. In that respect, at least some very poor countries are looking a bit more like richer countries, a phenomenon economists call convergence.

Based on other sources, however, such as Krugman and Wells’s Macroeconomics and Branko Milanovic’s Global Inequality, I believe that a generalization linking globalization and declining inequality needs to be carefully qualified. A decline in absolute poverty may not reduce inequality if the rich people of the world are also getting richer, as they have been. Only if poorer countries have higher rates of economic growth than richer countries can inequality across countries go down. In some developing countries, notably China and other countries in Eastern Asia, global trade has facilitated rapid enough growth to narrow the income gap with more developed countries. In other parts of Asia, as well as in Latin America and Africa, that is generally not the case.

Another way of looking at global inequality is to examine where along the global income distribution the greatest income growth is occurring. Based on data from 1980 to 2016 analyzed by Piketty, Saez and Zucman, the largest income growth has been experienced by the world’s richest 1%, the next largest by the poorest 40%, and the least growth by the middle-income group in between. That middle group consists mainly of the middle classes in the more advanced economies. That raises the question of whether the benefits of global trade experienced by the world’s rich and poor have occurred at the expense of those in the global middle.

Trade and within-country inequality

Has global trade increased inequality within countries, especially our own? Here too, the answer is not simple. The effects on workers and consumers are somewhat different, and most adults are both.

In general, workers in more developed economies have greater skills and higher wages, as well as lower birth rates, while developing countries have an abundance of low-skilled labor. Traditionally, economists have reasoned that when developing countries export the products of their labor, their own workers should benefit, but the least skilled workers within more developed countries should be hurt by the competition. In the 1990s, economists attributed the growing wage gap between skilled and unskilled workers more to the demands of new technologies. But they turned their attention to the role of trade in the deteriorating situation of many American workers after Chinese imports began to surge. In 2000, the U.S. enacted the United States-China Relations Act, which granted China permanent normal trade relations status; China joined the World Trade Organization the following year. Goldberg says that “even if one does not fully accept the claim that the China shock was the main driver behind the decline of US manufacturing employment, it is clear that it changed the relative positions of workers employed in certain industries and/or living in certain regions.”

In theory, workers in regions where jobs are lost to foreign competition can move to areas where more successful industries are creating jobs. But such mobility is in fact limited, since pulling up stakes and starting a new career in midlife is not easy.

On the other hand, economic theory predicts that many people stand to gain from foreign imports as consumers. They can get access to finished goods produced at lower cost abroad. They may also get lower prices on goods produced domestically, if producers pay less for imported inputs like raw materials, and if producers pass those cost savings on to consumers. (A good argument against tariffs is that they tend to negate these consumer benefits by taxing imports.)

Whether producers do in fact pass cost savings on to consumers may depend on how much competition they face in their industries. Dominant firms may have the market power to increase profit margins rather than share those benefits with consumers or workers. “Firms participating in GVCs typically pass a smaller share of the realized cost savings on to their consumers (in the form of lower prices) as well as a smaller share of their higher profit margins on to workers (in the form of higher wages).”

Considering the effects of trade on workers and consumers together, price benefits for consumers are likely to be spread rather evenly over the population, while wage losses are more likely to hit low-skilled workers in certain regions. That leads to the conclusion that the net effect of trade has been to increase inequality within developed countries, both by increasing the profits of wealthy shareholders and reducing employment prospects and wages in some segments of the working class.

Complementary effects of technology and trade

Having recently reviewed Mordicai Kurz’s Technology and Market Power, I am struck by similarities between his analysis of technology and this book’s analysis of trade. Kurz argues that the emergence of new technologies creates opportunities for innovative firms to monopolize technical knowledge and use the resulting market power to raise profit margins. Government can either constrain that process with egalitarian public policies, as it did for much of the twentieth century, or else facilitate it with more passive policies, as it has done since the 1980s.

New technologies and globalization have gone hand in hand in recent decades, making it hard for economists to distinguish their effects. Both have created opportunities for dominant firms to achieve market power and higher profit margins, enhancing the benefits for shareholders while limiting the benefits for consumers and workers.

Both new technologies and global trade have impacted negatively on low-skilled workers, but in somewhat different ways. New technologies raise the skill requirements of many jobs, leaving less skilled workers at a disadvantage. Global trade puts less skilled workers in competition with workers from developing countries.

Both new technologies and global trade challenge policymakers to mitigate the detrimental effects of rising inequality. Goldberg’s policy proposals are much less detailed than Kurz’s, but she does advocate regionally targeted measures to give more help to displaced workers. She also shares Kurz’s concerns about market power:

[T]he dramatic growth of firms profits in light of globalization demands greater focus and policy action… First and foremost, addressing the recent increase in firm markups demands greater attention to how these large global firms are taxed and regulated.

Both these books represent some shift in economists’ views of these twin forces of economic change, technology and trade.  More economists seem to be turning away from passive acceptance of market outcomes and toward more active interest in mitigating their least desirable effects.

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Arguing with Zombies (part 3)

April 16, 2021

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Note: I have also revised part 2 to present the the IS-LM model of interest rates more clearly.

Here I will discuss two other areas where Paul Krugman feels he is arguing with bearers of zombie ideas—climate change and social inequality.

Climate change

Krugman targets three familiar objections to doing anything about climate change: “Climate change is a hoax. Climate change is happening, but it’s not man-made. Climate change is man-made, but doing anything about it would destroy jobs and kill economic growth.” Economists have most to say about the third objection, but all three may be perpetuated out of economic self-interest. Krugman notes that the most prominent climate change deniers are profiting in some way from fossil-fuel industries. Economic ideology is also a factor. “Rigid free-market ideologues don’t want to believe that environmental concerns are real” because the solutions require some form of government intervention in the market. Krugman considers the issue so pressing that it requires a moral as well as scientific response. Because “climate denial is rooted in greed, opportunism, and ego,” it is both foolish and downright evil.

From the standpoint of economics, the most straightforward way to stop people from doing something is to make it more costly. Like many economists, Krugman recommends a carbon tax on fossil fuels. He does not want to rely on it exclusively, however, because its costs to the public make it a hard sell politically. Also, more positive incentives can be useful in encouraging the transition to renewable forms of energy. He welcomes the general approach of the “Green New Deal” proposed by progressive Democrats, which emphasizes investments and subsidies rather than taxes. He argues that reductions in carbon emissions:

…could be achieved with a combination of positive incentives like tax credits and not-too-onerous regulation. Add in investments in technology and infrastructure that support alternative energy, and a Green New Deal that dramatically reduces emissions seems entirely practical, even without carbon taxes. And these policies would visibly create jobs in renewable energy, which already employs a lot more people than coal mining.

The deniers, of course, support neither new taxes nor incentives, preferring to do nothing about the problem.

Krugman seems most interested in technological fixes facilitated by economic incentives, and less interested in the possibility of new lifestyles that consume less energy. Some environmentalists may contest his claim that carbon emissions can be cut by two-thirds without any reduction in energy consumption. But whether or not we consume less energy, I think there will be plenty of goods and services we can consume, so I agree with Krugman that intelligent responses to climate change are compatible with continued economic expansion.

Economic inequality

Krugman complains about an “inequality-denial industry” comparable to climate change denial. Too many economists and politicians have ignored or minimized the evidence of rising economic inequality, which is especially a problem in the United States. What has been happening for the past forty years is in sharp contrast to the “broad-based prosperity” of the decades following World War II. “Over that period incomes of all groups rose at roughly the same rapid clip, more than 2.5 percent annually.” Since then, not only has income growth been slower overall, but what growth has occurred has been much more concentrated at the top of the distribution.

What has become known as the “Krugman calculation” asks what percentage of the overall rise in average income has gone to the top 1 percent. The answer is about 70 percent. He argues that other ways of presenting the income numbers obfuscate rather than clarify the issue. In contrast to our cherished notions of a classless society or land of opportunity, it is the rich who are mainly getting richer, and “America stands out as the place where economic and social status is most likely to be inherited.”

In various essays in his chapter on inequality, he attacks popular explanations for inequality that fail to address what he thinks is the real problem. The first attributes it to the widening wage gap between more and less educated workers. There is some truth to that, but the college educated constitute a much larger percentage of the population—35% counting bachelors degrees and above—than the 1% who are really thriving. He attributes the “rise of a narrow oligarchy” not to increasing education, but to increasing power.

Similarly, technological change is not mainly what is holding back the average American worker. Technological change used to translate into increasing productivity and higher wages. That connection has been broken, but not by industrial robots. “There is a growing though incomplete consensus among economists that a key factor in wage stagnation has been workers’ declining bargaining power–a decline whose roots are ultimately political.” American workers have become far less unionized than workers in many other democracies, although Krugman does not get into the specific reasons for that.

A third explanation Krugman rejects is a decline in working-class family values, with fewer men marrying or staying married and supporting their families. Although today’s working-class families are indeed troubled in many ways, he argues that “the symptoms of social decline we see in working-class America are the result, not the cause, of declining opportunity.”

Krugman agrees with Enrico Moretti, author of The New Geography of Jobs, that structural changes in the economy have congregated more educated workers together in thriving regions, leaving many parts of the country behind. But even there, political policies have aggravated the inequality. Republican states have been making cuts in education and refusing to expand Medicaid. “Trumpland is in effect voting for its own impoverishment.”

Krugman introduces the concept of power relations to account for the inequality that more traditional economic variables fail to explain. He uses the term three times, most notably when he says that “the idea that free markets remove power relations from the equation is just naive.” Yet none of the essays in this collection discuss it in any depth, analyzing the dynamics of power or its possible redistribution. I also noticed that the index to his 600-page Macroeconomics text has no entry for the words power, power relations, bargaining power or oligarchy. This suggests a new frontier for mainstream economics, even for liberal economists like Krugman. The modern field of economics developed out of what used to be called “political economy.” Is it time to revive that broader perspective?

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The Technology Trap (part 2)

August 10, 2019

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Carl Benedikt Frey uses the distinction between labor-replacing and labor-enabling technologies to explain why industrialization can have quite different short-term effects on jobs, wages, and the demand for labor. The Second Industrial Revolution did more than the first to raise labor demand, create good jobs, and increase labor’s share of national income. Here I will take a closer look at that process for the United States in the twentieth century.

New technologies

Based on the research of Michelle Alexopoulos and Jon Cohen, Frey identifies electricity and the internal combustion engine as the most important general-purpose technologies of the Second Industrial Revolution. Both originated in the late nineteenth century but were widely applied in the twentieth. Both were essential to what became the country’s largest industry by 1940, automobile production.

A distinct “American system” of manufacturing was substantially boosting productivity by the 1920s. The model-T Ford was the first product to be assembled without any hand labor for fitting pieces together, since machine tools could now produce completely standardized and interchangeable parts. Another innovation was “unit drive”–machines with their own electric motors–which “allowed factory workflows to be reconfigured to accommodate assembly line techniques, as machinery could now be arranged according to the natural sequence of manufacturing operations.”

Electricity also enabled the production of new home appliances, “such as the iron (first introduced in the market in 1893), vacuum cleaner (1907), washing machine (1907), toaster (1909), refrigerator (1916), dishwasher (1929), and dryer (1938).” These time-savers made it easier for women to enter the labor force, earning money with which to buy more of the products being made.

The internal combustion engine revolutionized transportation, as the share of households with cars went from 2.3% in 1910 to 89.8% in 1930. The share of farms with tractors went from 3.6% in 1920 to 80% in 1960. The Federal Aid Highway Act of 1956 created better highways for cars and trucks to travel. Economists have attributed over a quarter of the increase in productivity between 1950 and 1970 to spending on highways.

Frey summarizes:

America’s great inventions of the period 1909–49 were predominantly of the enabling sort. Some jobs were clearly destroyed as new ones appeared, but overall, new technologies boosted job opportunities enormously. Indeed, gigantic new industries emerged, producing automobiles, aircraft, tractors, electrical machinery, telephones, household appliances, and so on, which created an abundance of new jobs. Vacancies rose and unemployment fell as the mysterious force of technology progressed.

Wages and working conditions

In general, wages rose along with productivity from 1870 to 1980. Since this hasn’t been true throughout history–and especially not lately–we have to say that rising productivity is helpful but not sufficient to produce wage increases. Frey suggests that concerns about worker turnover were one motive for employers to raise wages. “[T]he assembly line could be slowed if an experienced worker quit and was replaced by someone who could not initially keep pace.” Keeping labor peace in the face of worker organization and agitation was another motive.

A democratic society can also legislate on behalf of workers, especially if middle-class voters identify with their concerns. That was more the case during the Great Depression, when New Deal legislation supported worker interests. The National Labor Relations Act of 1935 guaranteed the right to organize and bargain with management, and the Fair Labor Standards Act of 1938 defined the standard work week as 40 hours and required employers to pay overtime for additional hours.

New technologies also created safer and less physically demanding workplaces. “Machines meant the end of the most hazardous, dirty, and backbreaking jobs,” and disabling injuries were cut in half. “Belts, gears, and shafts [of the pre-electric factory] were the main sources of factory accidents, posing a constant danger to workers’ fingers, arms, and lives.”

The “Great Leveling”

In retrospect, the twentieth century up until about 1980 is noted not only for its greater prosperity, but its reduction in economic inequality. Inequality had increased between the American Revolution and the Civil War, as artisan jobs had been lost to factories, large fortunes were being amassed, and large wage gaps had opened up between the most successful urban workers and the masses of poor people both on the farms and in the cities. The late nineteenth century is, of course, known as the “Gilded Age” for its conspicuous consumption by wealthy capitalists.

The twentieth century was different:

As Americans in the middle and at the lower end of the income distribution became the prime beneficiaries of progress, inequality went into reverse. Along with every other industrialized nation, America saw the share of income accruing to people at the top, fall.

Here, explanations differ. Thomas Piketty has argued that the general trend of capitalism is toward greater inequality, and it takes some unusual shock to the system to interrupt that process. As summarized by Frey:

In Piketty’s world, there are no forces within capitalism that serve to drive inequality down. From time to time, however, macroeconomic or political shocks may disrupt the normal equilibrium. Two world wars and the Great Depression served to destroy the riches of the wealthy.

Without denying that such shocks have played a role, Frey does see forces within capitalism to generate equality, the first of which is investment in labor-enabling technologies. That creates the potential to empower and enrich workers. A high rate of unionization is helpful for realizing that potential. Beyond that, workers must be able to keep up with the skill demands of new technologies.

“The leading explanation for the great leveling comes from pioneering work by Jan Tinbergen that conceptualized patterns of inequality as a race between technology and education….” The enabling technologies of the twentieth century favored more skilled workers. Jobs like mechanic or electrician paid well, but only for those who had the skills to do them. Semi-skilled assembly-line work could also pay pretty well, for workers with the discipline, stamina and dexterity to keep up. That could have created a wide gap between a skilled few and the unskilled many, except for the fact that so many workers were acquiring at least the basic skills they needed for an advanced industrial economy.

[E]ven if technological progress favors skilled workers, growing wage inequality does not have to be the result. The return to human capital depends on demand as well as supply. As long as the supply of skilled workers keeps pace with the demand for them, the wage gap between skilled and unskilled workers will not widen. While a number of short-run events and government interventions contributed to the great leveling, the most pervasive force—and certainly the best documented one—behind its long-run egalitarian impact was the upskilling of the American workforce, which depressed the skill premium.

The percentage of young people who completed a high-school education went from 9% to 40% just between 1910 and 1935, and proceeded upward from there.

The combination of enabling technology and a more skilled population created the largest middle class the country had ever seen. But that made the shrinking of the middle class that occurred after 1980 all the more surprising and alarming. Frey calls this the “Great Reversal,” and that is the topic of the next post.

Continued

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Democracy and Prosperity (part 3)

July 19, 2019

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I have been discussing the symbiotic relationship between capitalism and democracy as described by Torben Iversen and David Soskice. So far I’ve ignored variations among advanced capitalist democracies. But the authors warn against using any one country–such as the United States in discussions of the “Washington Consensus”–as a model for how ACDs have developed or should develop.  The American version of the emerging knowledge economy is only one version, and one that has its origins in a certain kind of history.

Two paths to capitalist democracy

The symbiotic relationship between democracy and capitalism developed along with the industrial economy. One link between the two was human capital development. Industrialization required a labor force with at least some basic skills, such as reading and writing, and that required some commitment to democratic institutions such as the public school.

How was the political order to be broadened to include the opinions and interests of workers? In some countries, such as Denmark, Sweden, Netherlands, Belgium and Germany, pressure from the working class itself played a major role. In others, such as Britain, U.S., France, Australia, Canada and New Zealand, the initiative came more from modernizing elites who were challenging the power of agrarian interests unsympathetic to industrialization and democracy.

Those differences had their origins in preindustrial patterns of organization:

[T]he countries in which democratization was eventually the result of working-class pressure were organized locally on a quasi corporatist basis both in towns, with effective guild systems, and in the countryside with a widespread socially rooted semiautonomous peasantry, rural cooperatives, and/or dense rural-urban linkages…. [A]ll of these states were Ständestaaten in the nineteenth century—a system in which the different estates (including organized professions) played a direct role in governing. We therefore refer to the preindustrial political economy of these societies as protocorporatist.

The authors do not give any simple definition of corporatism, but I think of it as the opposite of rugged individualism. While classical British and American liberalism celebrates the self-interested individual, corporatism sees people more as representatives of strong group interests, such as guilds or churches. To make a long story short, the protocorporatist countries provided more fertile ground for the emergence of strong worker organizations.

Things were different in Britain and America:

The elite-project societies, in essence Anglo-Saxon (apart from France, which we discuss separately), functioned quite differently: well-developed property markets with substantial freedom of labor mobility, towns with limited local autonomy, and guild systems which had either collapsed (Britain) or had hardly existed (the settler colonies and the United States, minus the South). We refer to the preindustrial political economy of these societies as protoliberal.

In both kinds of countries, some democratization accompanied industrialization, but it took different directions. In the protocorporatist countries like Denmark and Germany, “effective training systems were built on guild and Ständestaat traditions and provided a large pool of skilled workers, which in turn led to unified labor movements with the capacity to extract democratic concessions from elites.” In the protoliberal countries like Britain and America, “the absence of either guild or Ständestaat traditions led to fragmented labor movements with privileged craft-based unions but no effective training system. Here democracy emerged as the result of industrial elites compelling a reluctant landed aristocracy to accept expansion of education and other public goods required for industrialization.”

Political representation

These two paths to democracy had consequences for electoral systems. Where the working class was highly unified and organized, the more socialist left came to be better represented in politics. The elites and other prosperous members of society might resist democratization until the demands of the working class became too strong to ignore. Then they supported a system of proportional representation rather than winner-take-all elections, to protect themselves against the possibility of a working-class majority. Some of these democratic countries (Germany, Austria, Italy) reverted to authoritarian rule for a time in order to counter a perceived threat from the left, but democracy eventually prevailed.

In countries like the United States and Britain, where organized labor was weaker and more politically divided, majority rule worked better for the modernizing elites and other beneficiaries of industrial capitalism.

In these cases industrial elites had little fear of the working class, but they had a strong incentive to expand public goods, especially education and sanitation, required for the development of an effective labor force (in part to circumvent union control over the crafts). The key obstacles to this project were landowners and more generally conservatives who had no interest in an expansion of public goods and who held strong positions politically, especially at the local level. Majoritarian democracy in these cases essentially emerged as a means to force the landed elites to accept major public investments in education and infrastructure needed for modernization. At the same time, a majoritarian system with a strong bias toward the middle classes effectively excluded the radical left from influence over policies.

Iversen and Soskice see a perfect correlation between the alternative paths to democracy and the electoral systems. The “protocorporatist” countries adopted proportional representation systems that gave worker parties more voice, while the “protoliberal” countries adopted majority-rule systems where major parties had to be more-or-less centrist to win a majority.

Inequality and educational opportunity

Democratic governments of different kinds have adopted many of the same policies to support the growing knowledge sectors of their economies, for example by liberalizing trade and investing more in education. All of them have experienced some increase in inequality as technological innovation has rewarded workers with the right skills and penalized those without them. However, they differ markedly in the extent of the inequality and the associated decline of economic opportunity. The U.S. Council of Economic Advisers introduced the term “Great Gatsby curve” to describe the inverse relationship between economic inequality and intergenerational mobility among countries.

In general, the countries with weak worker organization and majoritarian electoral systems now have relatively high economic inequality and relatively low social mobility. This is true of the United States, United Kingdom and France. Canada and Australia are more average in inequality and social mobility.

In contrast, the countries with strong worker organization and proportional representation systems now have relatively low economic inequality and relatively high social mobility. This is especially true of the Nordic countries: Finland, Norway, Sweden and Denmark. Germany is more average in inequality and social mobility.

I think this is an important finding, because it means that even in a world of global, hi-tech competition, countries have choices. Economic growth and global competitiveness do not necessarily require the extravagant executive salaries and tax cuts enjoyed by the American 1%! Nor do they require tossing aside former manufacturing workers without making provision for their economic security or retraining.

One of the biggest factors in economic opportunity is education, and here the international findings reflect badly on the United States. Here the authors use an index of educational opportunity based on such variables as the availability of vocational training, the public spending on preprimary education, the public/private division of higher educational spending, and the age at which students are tracked (since early tracking can restrict opportunity). Among advanced democracies, only Japan and South Korea scored lower than the U.S. on this index. The Nordic countries scored the best.

Many readers may find this puzzling because the U.S. has so many fine schools, especially major research universities. But the quality of individual schools is not the same thing as educational opportunity. A good prep school that serves only the affluent does little to provide upward mobility.

In our majority-rule system, the interests of the downwardly mobile minority are not being well served. Their interests have diverged more sharply from those of more successful workers, making it harder for the traditional party of labor to represent them. This relates very much to the next topic, the threat that populism poses to democracies with high inequality.

Continued

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Democracy and Prosperity

July 17, 2019

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Torben Iversen and David Soskice. Democracy and Prosperity: Reinventing Capitalism through a Turbulent Century. Princeton: Princeton University Press, 2019

The authors are professors of political economy, Torben Iversen at Harvard and David Soskice at the London School of Economics. Their focus is the relationship between capitalism and democratic government in the most advanced capitalist democracies (ACDs).

The authors complain that too much of the recent literature describes that relationship too pessimistically, emphasizing the potential of capitalism to undermine democracy by generating too much inequality. In particular, they summarize Piketty’s Capital in the Twenty-First Century as arguing that “the power of capital to accumulate wealth is governed by fundamental economic laws which democratically elected governments can no longer effectively counter. If they try, capital just moves somewhere else.” This may be a little unfair to Piketty, since he does look to democratic government to curb wealth accumulation: “Although the risk is real, I do not see any genuine alternative: If we are to regain control of capitalism, we must bet everything on democracy–and in Europe, democracy on a European scale.” Nevertheless, Piketty does not seem entirely confident that democracy is up to the task, whereas Iversen and Soskice believe that it is.

A symbiotic relationship

Looking back at the last hundred years, the authors argue that “the advanced capitalist democracies, for all their instability and social problems not least at present, have been remarkably resilient and effective over this whole period.” The key to this resilience is the symbiotic relationship between democracy and capitalism. The democratic nation-state pushes advanced capitalism forward, and advanced capitalism reinforces democracy.

The first reason for this symbiotic relationship is that the state has to be strong enough to perform several crucial roles in the economy, if capitalism is to remain vibrant and innovative. The state must require businesses to engage in fair competition, as opposed to tolerating self-serving monopolies. It must require labor to moderate its demands and cooperate with management initiatives. It must invest in such public goods as education, research and infrastructure. It must negotiate changes in the rules to respond to shocks to the system, such as technological change.

A second reason for a symbiotic relationship is that the democratic electorate expects political leaders to manage advanced capitalism effectively. They have a stake in its success, and they expect results that they can see in their own lives. This is especially true of the citizens that the authors call “decisive voters.” These include the employees of advanced capitalist companies, who are usually well-skilled. In addition, they include many voters with aspirations for themselves or their children for upward mobility.

[T]he aspirational vote has a particular relevance in relation to advanced capitalism. By contrast to status-ordered societies, growth in the demand for skilled and educated labor is core to the idea of advanced capitalism as a result of technological change….Hence, while aspirational individuals, parents, and families have always existed to some extent, it is particularly associated with advanced capitalism.

Rather than simply being divided into the opposing interests of capital and labor, advanced democracies have a large middle class of actual or potential beneficiaries of capitalism. They support the system to the extent that they perceive themselves to be benefiting from it. But their incomes are lower than those of the principal owners and managers, and they depend more on public programs and services like public education and Social Security. “Accounting for more than one third of GDP on average, wide-ranging tax-financed middle-class programs ensure that those with high and rising incomes share some of their wealth with the rest of society.” The large middle class is a moderating influence. It doesn’t want the government to radically redistribute wealth from the rich to the poor, but it doesn’t want it to let the rich hog the wealth either.

A third reason for the symbiotic relationship is that capital remains “geographically embedded” within nation-states. A common initial reaction to global electronic communications was that geography might not matter much anymore. Work could be done anywhere, perhaps far from established urban centers. Instead, “knowledge-based advanced companies, often multinational enterprises (MNEs) or subsidiaries…are increasingly immobile because they are tied to skill clusters in successful cities, with their value-added embedded in largely immobile, highly educated workforces.” Skilled workers have many good reasons to locate close to others with similar or complementary skills, especially when skills are acquired through face-to-face interaction rather than from some manual. And companies that depend on multi-skilled workforces cannot easily move their entire operation elsewhere, although they can more easily outsource particular low-skill tasks. The dependence of capital on geographically embedded skilled labor gives national and even local governments some power to regulate capital, as well as some incentive to invest in human capital development for the good of the nation or other geographic territory.

For these reasons, democratic governments promote advanced capitalism, but also try to manage it in the interests of a large class of voters. Capitalism thrives, but democracy also works to the extent that voters get a good return on their political investments.

Challenges to the symbiotic relationship

The symbiotic relationship is not a static equilibrium. Capitalism is inherently dynamic, and democracy has to be flexible in order to manage it in the public interest.

Technological change is an important driver of economic change, but not in a simple deterministic way. The authors see a new technology as a political opportunity, something that can be managed for the good of the many, although not usually the all. How political responses to the revolution in information and communications technology (ICT) have shaped the knowledge economy is a central concern of the book.

Another challenge for democratic societies is the recent increase in economic inequality and the decline in economic mobility, which is especially pronounced in the United States. “We see the division between the new knowledge economy and…low-productivity labor markets as a new socioeconomic cleavage that has crystallized along educational lines and a deepening segregation between successful cities and left-behind communities in small towns and rural areas.” The rich have been getting richer and the poor have been left behind, but the impact on the middle class is more complicated. A modest reduction in their share of national income has been accompanied by an absolute increase in income, especially in the more educated middle class. The ultimate impact on democracy is yet to be determined.

A third challenge is political populism, an anti-establishment reaction from those who feel threatened by economic and cultural change. Whether it is a powerful enough reaction to do serious damage to either advanced capitalism or democracy is another issue to be considered. The authors doubt that it is.

Maintaining the equilibrium

Iversen and Soskice acknowledge the tension between democracy and capitalism. “One is based on a principle of equality (‘one person, one vote’), while the other is based on a principle of market power (“one dollar, one vote”). In practice, what democratic electorates support is neither an absolute economic equality inimical to capitalism nor a monopoly of market power inimical to democracy.

“Democracy has a built-in mechanism to limit anti-systemic sentiments.” Voters with a stake in capitalism support the freedom of capitalists to invest in profitable enterprises and keep a lot of their profits, but voters also have a stake in the extension of opportunity so they can earn a good share of the economic benefits.

The historical experience has been that joining the ranks of the advanced capitalist democracies is not easy. Many countries have gotten stuck in a system with powerful capitalist enterprises but weak governments, in which politicians are paid off to protect firms against market competition. On the other hand, where advanced capitalist democracy has become established, it has so far proved to be highly resilient. A long-run perspective on ACDs supports an optimistic view, one that is not too dismayed by recent increases in inequality and reactionary populism.

The next post will discuss the emergence of the knowledge economy and the role of government in that transition.

Continued

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