24 The World Economy: Globalization and Its Problems

Consider this

 

Ports have always been busy places, but modern harbors are less about ships and more about the containers they carry.  Has this changed anything about what’s getting shipped?

 

We have seen that trade allows countries to specialize in producing the things they’re relatively best at making.  Specialization lets a country be more productive.  A more productive country can have a higher standard of living.  And while all that is very true and very important, not everyone is better off with specialization and trade.  A lot of  American workers lost their jobs in textiles, car production, electronics and more, to competition from lower-wage countries.  This has resulted in a strong ‘protectionist’ push from unions, who’ve sometimes found themselves joining their bosses in calls for tariff protection.

So is trade good, or not?

Trade is obviously more complicated in real life than it is in our welfare analysis or our simple comparative advantage model.  There are some important outcomes of trade to keep in mind.  First, we can never forget the people that specialization displaces:  a fourth generation Detroit auto worker is not going to pivot to working in home health care because the market has signaled it’s a good idea!

Competition from free trade can be a big obstacle for a developing country.  Consider the situation of Rwanda, one of many African countries trying to develop its own textile industry, but unable to compete with super-cheap imports of secondhand clothing from the developed world.  When a Salvation Army store in New York City can’t sell racks of clothes, the garments are baled up and sold to jobbers for export. These clothes often end up in African marketplaces where they are sorted and resold (or sent to a local landfill).  What felt like virtuous recycling in NYC is now disastrously cheap competition for a Ghanaian textile manufacturer.  Kenya used Covid fears that secondhand clothing could spread disease, to ban imports, which pleased local producers, who realized that import protection might boost their businesses.

There are some trade positives to consider.  Trade enables more price competition, so we, as consumers,  access cheaper goods and services.  Trade gives poorer countries access to markets with wealthier consumers.  If you are thinking, those poor countries get ripped off by the wealthy, remember, trade is voluntary.  If sellers don’t like the terms, they can say no and the deal doesn’t happen.   Or, you may be worried by the cultural  imperialism that trade may bring:  McDonald’s or KFC spoiling Thailand’s countryside, for example.  But McDonald’s, for example, joined a whole landscape of market options when they invaded Thailand.  If they ended up doing a lot of business, it means they are satisfying many people.  (Remember ‘revealed preference’?)  On the other hand,  some countries, like Bermuda and Iceland, for example, do restrict the opening of certain foreign franchises, to protect local businesses and/or their cultural heritage.

While it’s not a pretty thought,  the comparative advantage of many poor countries is their cheaper labor.   If Nike opens a factory in a low wage country and their workers line up to get those jobs–it means Nike is probably paying more than anyone else.  It might not be much by our standards, but our options are very different.  Furthermore, trading partners are often brought into raising their labor standards through provisions of trade treaties–a positive pressure.

These would be the standard economic arguments in favor of trade.  They’re based on the idea that workers and countries are free actors–if they don’t like the economics of the deal, they can walk away.  In the real world, political gamesmanship is probably more important than economic benefits, when shaping trade.  The price tags may be identical, but the U.S. will sell weapons systems to some countries, but not others.  Maybe the strongest argument that trade is good, is the fact that sometimes, when we want to punish a country, we ban all trade with them.  When the U.S. punishes Cuba and Iran and North Korea by shutting off trade–that’s a big clue that trade’s valuable.

Trade Issues: Problems with the global supply chain

The Covid pandemic taught all of us some new things about globalization.  We discovered that protective gear for medical workers was mostly produced in Asia.  We learned why it would take a long time for hospitals to get the ventilators they needed to save lives. The global supply chain, which had been invisible to most of us before the pandemic, was suddenly a hot topic. Planning for ‘strategic purchasing’ in the public health sector started to dominate discussions. As economies recovered, people realized that the furniture they’d bought the year before, was still sitting in a shipping container off the California coast.  Who even knew about container shipping anyway?

People in the recycling industries have known about shipping containers for a long time.  Historically, with China exporting more goods to the United States than it imports from us, some ships might have had to return to China with empty containers (what’s sometimes called ‘deadheading’).  With China offering to recycle world trash at cheap rates–what could be better than filling the departing containers with American recyclables?  Recycling was not a high profit margin business, but it did generate revenue for China-bound ships, at least until it was ended in 2017.

Bottom line, world trade and environmentalism have always been uncomfortable bedfellows.  World trade means spending scarce resources on the transportation of goods.  Transportation involves a lot of carbon pollution.  Environmentalists are most likely to have the stall at the farmer’s market urging people to ‘buy local.’  Self-sufficiency–even better!  So, are there any ways that a pro-trade person could also be green?  Perhaps  we could start by realizing that climate change already poses an existential threat to whole populations suffering drought-based famine, flooding, and more.  More than ever, the world’s people are moving, as well as the world’s goods and services.

Currencies and exchange rates

Underpinning all this trade are the national currencies which are exchanged when goods are bought and sold.  Normally, we only think about exchange rates when we’re visiting another country and we’re  changing some money at the airport.  But exchange rates are lurking in the background every time you buy an imported mango or that cup of Yirgacheffee coffee.  That exchange rate is often the result of a supply and demand market for some currency.

The demand for a currency is best understood as a derived demand. People want the currency because they want the goods that currency will get them.  The supply of a currency comes from people who want our goods and have exchanged their money for ours.  The intersection gives us the exchange rate between the currencies.  In other words, behind any exchange rate, stands the supply and demand for goods and services of the different countries.  If the exchange rate can move freely–with no one controlling it–its equilibrium rate should reflect the demand for the each country’s goods and services.

Exchange rates stabilize trade imbalances

Suppose that year after year, Americans bought more goods from China than China bought from the U.S.  This should mean, in currency markets, more demand for yuan (the Chinese currency) and an oversupply of dollars.  The dollar would fall in value relative to the yuan.  This fall  would cause Chinese goods to look more expensive to American consumers.  Americans would then buy fewer Chinese goods.  For Chinese consumers, holding stronger yuan means American goods look cheaper.  Chinese would buy more American goods.  The trade imbalance could gradually disappear!

While this is a grossly simplified description of how free floating exchange rates can make trade imbalances disappear–there’s one big problem.  Some countries do not allow the value of their currency to float freely.

How are exchange rates set?

Argentina’s president, Javier Milei, was elected on a platform that promised, among other things, to ‘dollarize’ Argentina:  to cure inflation (running over 160%) by getting rid of the peso and just using the American dollar for currency.  (Apparently, some 30 countries in the world already use the dollar instead of having their own money, so it’s a thing!)  By dollarizing, Argentina prevents its own government from continually printing more money to pay for its over-spending.  They are tying their own hands, as it were.  Whatever America’s Federal Reserve decides to do with the American money supply, will be what happens in Argentina as well.

Most countries do opt to create their own currencies.  If they like, they can peg the value of their currency to some other country’s at a fixed rate:  $2 Belize dollars = $1 American dollar.  Pegging value like this removes the need for an active monetary authority, while preserving a national identity.  Or, they can allow the value of their currency to move freely between upper and lower boundaries, creating a ‘currency band,’ a managed float.  Other countries may allow a fully floating exchange rate.  In rare cases, a country can ban the exchange of its currency with any other currencies.

What happens When a country keeps its currency artificially low in value?

First, how would we know if an exchange rate were ‘artificially’ low or high?

While career currency traders could easily tell you which currencies were undervalued or overvalued, it’s a little harder for the rest of us.  Fortunately, a team at The Economist magazine developed a useful tool for this: the Big Mac index.    They started out by trying to  imagine some product that’s sold worldwide, that’s standardized everywhere it’s sold, that has a balanced input mix (not all labor or all capital goods).   A haircut, for instance, might be a very similar service worldwide, but its inputs are almost all labor, and very little natural resources or capital.  They finally hit upon the Big Mac, which as a franchised product, has to be exactly the same everywhere in the world it’s sold (except India, where it’s not beef).  The Big Mac has labor and capital inputs.  Then they researched the price tag on the Big Mac around the world.  By comparing the dollar equivalent of that ‘street’ price to the country’s legal exchange rate, they could see if some currency was over or under valued.

Try this example.  In China the Big Mac costs 25 yuan on the street.  At the same time in the U.S., the Big Mac sells for $5.69.  Since it’s the same Big Mac, 25 yuan should equal $5.69.  By that Big Mac equivalency, $1 dollar should equal 4.39 yuan.  But the Chinese central bank sets the exchange rate at $1= 7.20 yuan.  The official exchange rate greatly undervalues the yuan.

Why would China undervalue its currency?

When a country undervalues its currency, its goods look cheaper to other countries.  That 25 yuan Big Mac would only cost an American $3.47 at the official exchange rate!  And it’s not just the Chinese Big Mac that looks cheap–all of China’s goods–electronics, fashion, food– look cheap to someone shopping with dollars at the official exchange rate.  And it’s not just the dollar that’s overvalued–other currencies are, as well.  The result?  People all over the world buy more Chinese goods!   On the other hand, that undervalued yuan means goods from the rest of the world look very expensive to the Chinese shopper.  By undervaluing the yuan,  Chinese imports will fall and exports will rise.

Export demand from wealthy countries expands the market for Chinese products, especially for higher end goods that are too expensive for Chinese shoppers.  Increased demand for China’s output can mean the construction of factories in rural areas, then roads from that region to port cities, and so forth.  When your own population is not yet able to afford the goods you can produce, it is important to have a world market full of consumers.  This is often called export-led growth, and it’s a very successful path that China and other “Asian tiger economies” have followed.

Up until 2024, that is.  Thee are signs that world economic leaders are beginning to resist.  In a significant departure from previous ‘all trade is good’ positions, Treasury Secretary Yellen has emphasized to her Chinese counterparts “that China should focus more on investing in domestic consumption and warned that flooding markets with exports would disrupt supply chains.”  Export-led growth is one thing when a country is small.  But in the world economy today, China is a huge player whose exports of electric vehicles or other green products can interfere with America’s attempts to stimulate its own green industries.  Tariff talk is definitely growing.

Still, as we shall see in the next chapter,  export-led growth remains an important development strategy.

Some Useful Materials

Watch a video explaining imports, exports, and exchange rates.

What happens when a country decides to “dollarize” and gives up using its own currency? Did you know over 30 countries use someone else’s currency as their own?

Our secondhand clothing often ends up in African marketplaces. Read about why that’s a problem.

See current prices of Big Macs around the world.