David Hummels Purdue University

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David Hummels

Purdue University

What Is Globalization? (1)

Trade in Goods and Services (1)

International Mobility of Labor and Capital (2)

Integration: Old and New (3)
Why Countries Trade (5)

Arbitrage (6)

Absolute Advantage (7)

Comparative Advantage (8)

The Gains from Trade (9)

Sources of Comparative Advantage (10)

International Migration and Capital Flows (11)

Other Reasons for Trade (12)
Trade Policy (13)

Tariffs and Trade Barriers (13)

Political Explanations for Protection (14)
Loses from Trade in Factor Markets (15)

Unemployment (15)

Specific Factors and Mobile Factors (15)

Trade and the Returns to Education (16)
Trade and International Institutions (17)

Agriculture and Textiles (18)

Environmental Standards (19)

Labor Standards (20)

Product Standards (21)
Conclusion (22)
Appendix A: Trade Deficits (24)

Linking Trade and Investment (24)

Why Countries Run Trade Deficits (25)
Appendix B: Critics of Globalization and the International Monetary Fund (IMF) (28)
What is Globalization?

The word globalization has been used to mean many different things. It may conjure up visions of fleets of container ships moving goods worth trillions of dollars across all the worlds’ oceans, giant multinational firms with operations in every time zone, brand names and advertisements known by consumers on six continents, and telephone call centers in India providing customer service to American consumers who bought Japanese electronics while vacationing in the south of France. To some, globalization also conveys broader concerns and even fears, such as the erosion of labor and environmental standards and the loss of national sovereignty to international institutions that are not accountable to citizens of any nation.

In more general terms, however, globalization refers to increases in the degree of integration between national economies. Integration encompasses all of the ways national economies are connected in international markets, including trade in goods, services, and ideas; international movements of the factors of production; and coordination of public policies. After a brief look at historical trends in some measures of integration, the reasons why this growing integration has occurred and the effects it has had on national economies and different groups of people – including consumers and workers – will be discussed.
Trade in Goods and Services

One of the most important forms of international integration is merchandise trade. When U.S. firms sell goods and services abroad, these are U.S. exports. When people or firms in the United States buys goods and services from other countries, these are U.S. imports. Both U.S. exports and imports have risen rapidly since World War II.

From 1960 to 2003, after adjusting for inflation, U.S. exports increased by almost 800 percent. Over that same period U.S. imports increased even more, by 1300 percent. Part of this growth in both imports and exports simply reflects the growth in the size of the U.S. economy in these years, which expanded by a factor of about 400 percent. But clearly international trade grew much faster than the national economy, as shown in Figure 1.

Specifically, since 1960 imports grew from 4.2 to 13.8 percent of U.S. national income, or gross domestic product (GDP), while exports increased from 4.9 to 9.3 percent.

Despite this dramatic growth in international trade over the past five decades, the United States is far less reliant on trade than most other countries. For example, in 2003, exports of goods and services were about 25 percent of national output in France, 40 percent in Canada, and 80 percent in Belgium. And although U.S. exports as a percentage of GDP have grown sharply since 1960, they are comparable today to what they were in 1880, and actually less than they were at the end of World War I.

Another important trend in international trade, seen in the United States and in most other countries over the past 30 years, is that a growing share of trade takes place with countries that are nearby neighbors. Despite the relatively small size of their national economies, Canada and Mexico are the largest U.S. trading partners, purchasing over a third of U.S. exports and supplying a quarter of U.S. imports in 2003.

International Mobility of Labor and Capital

Another way national economies are integrated in the international marketplace is by movements of factors of production, or inputs, and in particular by labor (workers) and capital. Both labor and capital can cross national borders if the expected returns are high enough.

The United States is, of course, a nation of immigrants. Most current citizens can trace their ancestry back to migrants who arrived on these shores within the last three or four centuries. And migration is still important: in 2001 there were 31.8 million migrants in the United States, including 20 million in the U.S. labor force. That represents 11 percent of the nation’s population and 13.9 percent of the labor force, both percentages about twice as high as they were in the 1960s and 1970s. Although the absolute number of migrant workers in the United States is much higher than in other countries, foreign-born workers are a comparable fraction of the workforce in many other countries.

Capital is the other mobile factor of production, and there are many ways to invest capital in a foreign country. Private investors can buy government or corporate bonds to earn the interest that is paid on the bonds. Or they can buy shares of stock in foreign companies on foreign stock markets. Private firms also engage in foreign direct investment (FDI) by building or purchasing affiliate operations in other countries. That is different from buying shares of stock in foreign companies, because with FDI a company controls the affiliate operation.

In 2003, U.S. agents (meaning individual citizens, banks, other corporations, and government agencies) owned $7.8 trillion dollars of foreign financial assets. Meanwhile, foreign persons owned $10.5 trillion dollars of U.S. financial assets, including $3.4 trillion of U.S. corporate bonds and stocks, $2.4 trillion in foreign direct investment, and $1.7 trillion in U.S. government bonds. To put those numbers in perspective, the total capitalization (value) of U.S. equities in 2003 was $14.3 trillion, and the total value of U.S. government bonds was $3.9 trillion. A sizable fraction of the total U.S. capital stock is owned by foreign citizens.

Integration: Old and New

Migration and merchandise trade is old news, in the sense that countries have experienced that for thousands of years. The level of U.S. trade today is roughly comparable in size to trade a century ago, and migrants are a considerably smaller portion of the labor force than they were for the nation’s first 150 years. So why do many observers claim that we are experiencing an unprecedented era of globalization? Put differently, what’s new about the current forms of globalization? Two things stand out. First, the kinds of things being traded are very different from what was traded in earlier eras. Second, the ways countries are integrated now go far beyond the simple trading of goods.

Suppose we were to go back to the first era of globalization in the late 1800s and look at the cargoes carried by the great steamships that made the first era possible. For the most part we would see bulk commodities – such as coal, wheat, cotton, and iron ore – and some very simple manufactured products. Trade today is quite different. Figure 2 (on page 4) shows the growth in world trade relative to output for manufacturing, agriculture, and mining products. While agriculture and mining trade/output has been steady since World War II, manufacturing trade has grown very rapidly. Bulk commodities have become far less important than trade in manufactures and services. That is important because trade in manufactures and services requires a much higher degree of sophistication and coordination in production, consumption, and regulation than trade in basic commodities.

To understand why this is true, think about what is involved in producing and exporting coal. First, of course, you have to have coal. If there are no coal deposits in a country you cannot just dig a mine and expect to produce coal. If there is coal you can dig it up, put it on railroad cars or ships, and sell it abroad. The product itself is not sophisticated, and it doesn’t take extensive research and development to create it or to tailor it to

consumer uses. Nor are major marketing or education campaigns required to encourage consumers to buy the product. They buy the coal, throw it in stove or furnace, and the

transaction is done. The usefulness of the coal is a function of its natural physical properties: when you burn it, it produces heat.

In stark contrast, consider what is involved in producing and exporting a laptop computer. The first thing to note is that there are no natural deposits of computers to mine, so the location of natural resources does not determine where the computer can be produced. Instead, factories to produce computers can be built virtually anyplace in the world. That makes computer manufacturing much more “footloose,” or mobile, which means inefficient firms quickly face tremendous competitive pressure from firms that can produce and sell laptops at a lower cost.

The second key characteristic of laptops and many other products that are internationally traded today is that the value of the physical materials in the final product is often trivial. With the computers nearly all the value comes from the ideas – the technology – incorporated into the central processing unit, the disk drives, the flat panel screen, the long-life battery, and so on. New technologies have to be researched and developed, and the intellectual property created through this research has to be protected from those who try to copy and steal it. Because production can be moved to any country in the world that protection must be international in scope, too. Protecting a patent at home doesn’t save a company from foreign competitors.

The third characteristic of today’s international trade is that technologies can be repeatedly reused once they are discovered. That gives firms that develop successful new technologies a major cost advantage over their competitors, allowing them to expand production, sales, and profits. Especially good innovations can lead to enormous profits and even monopoly power for the firms that create them. Although international trade in goods increases competitive pressures in many markets, monopoly power from innovations that are protected by internationally recognized patents, copyrights, etc. does not end at national borders. Increasingly, therefore, firms that dominate a market in one nation are likely to dominate that market in other countries, also.

A fourth key difference between old and new forms of international trade is that it has become increasingly rare to find a purely “Japanese” or “American” computer (or any other complex manufactured product). Because the laptop embodies so many different technologies and so many different kinds of expertise, it is rare to find one company or even one country that excels in producing every part. Instead, the technologies embodied in final products usually come from dozens of labs and manufacturing plants located all around the world. Research laboratories themselves are increasingly multinational in scope, and leading laboratories in the United States rely to an increasing degree on hiring foreign-born scientists and engineers who were trained at U.S. universities.

Managing trade in goods that require many different technologies and hundreds of component parts is more difficult and entails far more coordination problems than producing the basic commodities that were the staples of international trade in earlier centuries. The coordination problems can be especially difficult when transactions are conducted between independent firms. As a result, large firms often “internalize” these transactions (that is, bring them under the direct control of one corporation). When this involves goods and ideas that are produced in many different countries, the result is a multinational corporation (MNC).

As noted earlier, when an MNC makes investments in other countries that is called foreign direct investment (FDI). In recent decades the number of MNCs and the amount of FDI have skyrocketed. Currently there are over 60,000 multinational corporations that direct nearly a million affiliates. Their total investments in 2003 totaled $8.2 trillion, 10 times more than in 1982. MNCs have invested heavily in the United States, with the real (inflation-adjusted) value of their investments about 35 times higher in 2000 than in 1960.

Worldwide, the spectacular growth in FDI was partly a result of relaxing laws and regulations that limited foreign ownership of domestic companies. But the main cause for these trends, all around the world, was the shift in world trade away from simple products such as wheat and coal to more complex, technology-based products such as computers, airplanes, and pharmaceuticals.

Because production and trade has become more complex, international treaties governing trade have also become more complex. International agreements must now be negotiated and ratified dealing with protection of intellectual property, regulation of foreign investment and monopoly power, and the mobility of highly skilled scientists and other workers. These issues are highly controversial and difficult to negotiate.

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