Globalization: The Long-Run Big Picture

by George Reisman

George Reisman, Ph.D. is Pepperdine University Professor Emeritus of Economics and is the author of Capitalism: A Treatise on Economics. His web site is www.capitalism.net and his blog is www.georgereisman.com/blog/. Send him mail. Comment on the Mises blog. This essay is found at the Mises Institute as well as the author's website.

Summary

Globalization, in conjunction with its essential prerequisite of respect for private property rights, and thus the existence of substantial economic freedom in the various individual countries, has the potential to raise the productivity of labor and living standards all across the world to the level of the most advanced countries. In addition, it has the potential to bring about the radical improvement in productivity and living standards in what are today the most advanced countries, and to provide the strongest possible foundation for unprecedented further economic advance everywhere.

These overwhelmingly beneficial results are often hidden from view by the fact that at the same time globalization implies a substantial decline in the relative or even absolute nominal GDPs of today's advanced countries, the experience of which engenders opposition to the process. What is not seen is that to whatever extent globalization might reduce absolute nominal GDP in today's advanced countries, it reduces prices many times more, with the result that it correspondingly increases their real GDP, and that to whatever extent it reduces merely their relative nominal GDP, it again increases their real GDP many times more.

This article shows that by incorporating billions of additional people into the global division of labor, and correspondingly increasing the scale on which all branches of production and economic activity are carried on, globalization makes possible the unprecedented achievement of economies of scale—the maximum consistent with the size of the world's population. First and foremost among these will be the very substantial increase in the number of highly intelligent, highly motivated individuals working in all of the branches of science, technology, and business. This will greatly accelerate the rate of scientific and technological progress and business innovation. The achievement of all other economies of scale will also serve to increase what it is possible to produce with any given quantity of capital goods and labor. Out of this larger gross product comes a correspondingly larger supply of capital goods, which makes possible a further increase in production, resulting in a still larger supply of capital goods, in a process that can be repeated indefinitely so long as scientific and technological progress and business innovation continue and an adequate degree of saving and provision for the future is maintained. The article shows that from the very beginning, the process of globalization serves to promote capital accumulation simply by dramatically increasing production in the countries in which foreign capital is invested, out of which increase in production comes an additional supply of capital goods.

Some critics of globalization, notably Paul Craig Roberts, do not understand how it promotes capital accumulation and instead believe that it deprives the advanced countries of capital. Others, notably Gomory and Baumol, view the effect of globalization on nominal GDP as though it were its effect on real GDP and are thus led to confuse competition for limited money revenue and income with economic conflict. This article answers both sets of errors, including related confusions concerning outsourcing.

Introduction

Globalization is the process of bringing the entire world into the system of division of labor and thus into the system of social cooperation, of which division of labor is the essence. Its completion will mark the highest level of division of labor and social cooperation that it is possible for human beings to achieve, given the size of the world's population.

In conjunction with its essential prerequisite of respect for private property rights, and thus the existence of substantial economic freedom in the various individual countries, its potential is nothing less than the elevation of the productivity of labor and of living standards all across the globe to the level of the most advanced countries, and at the same time the radical improvement in productivity and living standards in what are today the most advanced countries. And, finally, it will constitute the strongest possible foundation for further economic advance and, indeed, serve to accelerate the rate of economic progress. Its completion will represent a world as much or even more advanced beyond that of our own as our own is advanced beyond that of a century ago, and one poised to go further indefinitely and more rapidly.

What is to be feared in connection with globalization is not that it will occur but that it will not occur, that the process of its achievement will be aborted or, indeed, thrown into reverse. Progress toward globalization can be aborted by the outbreak of war, including large-scale global terrorism. In such conditions, outside sources of supply can no longer be relied upon, and greater economic self-sufficiency becomes necessary—which, of course, constitutes movement in the opposite direction of globalization. It can also be stopped by the failure of much or most of the world to adopt and then maintain the pro-free-market political-economic policies necessary to its achievement, including such failure in our own country.

It is essential to realize that the process of globalization can be aborted simply because of mistaken ideas about its consequences. Despite the enormous advantages it holds out, large numbers of people believe that they must suffer from the process, and thus wish to stop it. If such people become numerous enough and obtain political power, they will stop it, at least as far as their own country's participation is concerned.

In the United States and other advanced countries there is great and growing fear of having to compete with industries located in presently poor, impoverished countries with extremely low wage rates, and where labor is suddenly rendered dramatically more productive by the investment of capital coming from the advanced countries. The combination of radically lower wage rates coupled with dramatic increases in productivity results in foreign competitors in the backward countries with sharply lower costs of production. These lower costs, it is feared, enable those foreign competitors to be profitable at prices that producers in the advanced countries simply cannot match without selling at a loss or without requiring wage reductions from their own employees.

It is these fears that I want to address, and to do so by means of economic analysis.[1]  My analysis is inspired by the writings of my great teacher, Ludwig von Mises, who recognized the growth or decline of the division of labor as synonymous with the growth or decline of the foundations of economic progress and of society itself. Indeed, Mises titled a section of his book Socialism "The division of labour as the principle of social development." My analysis proceeds entirely in the spirit of the economic liberalism that no one has done more to advance than he.[2] 

However, the specific tools of analysis that I will employ come not so much from Mises as from an earlier great champion of economic liberalism, David Ricardo, and in one major respect, from Adam Smith. Ricardo is justly famous for the Law of Comparative Advantage, a principle with major application to foreign trade and international division of labor (and, as Mises later showed, equally to division of labor within countries as well, indeed, to human association). However, Ricardo's contributions to the analysis of globalization go far beyond the Law of Comparative Advantage, as I will attempt to show. Similarly, Smith is already famous for his explanation of the advantages of division of labor and his advocacy of free international trade. But as in the case of Ricardo, there is more of great importance in his writings that relates to globalization than he is given credit for, and which I will attempt to present.

The Economic World Today and in a Hundred Years

The logical place to begin a discussion of globalization is with a description of the global economy at the present time, in terms both of the output of goods and services and in terms of population. This can be done in a very concise way by means of the Gross Domestic Product (GDP) and population statistics that are available for virtually every country. Based on GDP statistics provided by the International Monetary Fund for the year 2004, and reported in the online encyclopedia Wikipedia, and on population statistics provided by the US Census Bureau and the CIA, the following table offers an essential overview in terms of approximate numbers.

Table 1: Global GDP

Where necessary, the numbers have been slightly altered for the purpose of making them add to more or less round figures that will be easy to work with. Thus World GDP is stated as 40 trillion rather than 40.895 trillion or 41 trillion, which is the actual figure shown in Wikipedia. The combined population of China and India and of the rest of the world outside China and India have both been stated as 2.5 billion and the shares of global output of China and India and of the rest of the world have both been stated as .1. As indicated in the table, this procedure somewhat overstates the actual data reported for China and India and correspondingly understates the actual data reported for the rest of the world outside China and India. As stated, the reason for doing this is that the slightly changed numbers are easier to work with and can thus facilitate the recognition of relationships that are applicable to any such data. (Furthermore, the relatively more rapid rates of increase in GDP applicable to China and India since 2004 serve to minimize the actual degree of error entailed in this procedure.)

The table is subject to criticism based on what it includes or excludes in the category "First World," that is, the group constituted by the world's modern, industrial economies. For example, New Zealand has not been included even though it clearly belongs in that category. The reason for its exclusion is simply that it is too small to make a difference and thus there is no explanatory purpose that would be served by providing a listing for it. More significantly, it could be argued that the data for the European Union should be reduced in order to exclude its new, East European members, whose economies clearly do not yet belong in the same category as those of the other members of the First World Group.

Such criticisms are not significant, however. The essential and vital point that the table makes clear is that countries representing a small minority of the world's population account for the production of the overwhelming bulk of its goods and services. It shows this fact in the relatively simple, straightforward way of attributing .8 of the world's output to countries containing just 1 billion of the world's 6 billion people.[3] 

These data imply a further major fact. Namely, that output per capita in the advanced, industrial economies is currently 20 times as great as it is in the rest of the world. This is because if 1 billion people produce .8 of the world's output, while 5 billion people produce only .2 of the world's output, those 1 billion produce 4 times as much as the 5 billion. And if the 1 billion people of the First World produce 4 times as much as the 5 billion people of the rest of the world, they produce 20 times as much as do just 1 billion people in the rest of the world. In the rest of the world, the output of 1 billion people is a mere .04 of the output of the world; it takes 5 billion people in the rest of the world to produce its .2 of the world's output. The ratio of the .8 of the world's output produced by the 1 billion people of the First World to the .04 of output produced by 1 billion people in the rest of the world is 20:1.

This radical difference in per capita productivity is the measure of the improvement needed in the rest of the world to achieve per capita parity with the First World and the standard of living of the First World.

A key assumption that we will make in our analysis of the effects of globalization is that by 100 years from now, i.e., the year 2106, based on the date of my writing this essay, globalization will indeed have succeeded in raising the productivity of labor and per capita output in the rest of the world by this factor of 20.

True to our task of dealing with globalization, we are going to assume that the increase applies to the whole rest of the world. Nevertheless, it would not be difficult to modify the analysis, to deal with partial globalization. We could, for example, easily assume that this rise in productivity occurred only in China and India, the two major countries that are presently seen as most likely to be able improve their production dramatically. Or we could apply the assumption to China alone, which seems to be the single most likely major candidate to achieve such success.

For all possible applications, however, we need to develop our framework of analysis further.

The first thing we need to do is introduce the concepts of demand and supply used by the old classical economists. When Ricardo and Say and the other classical economists spoke of "demand," what they usually meant was an amount of expenditure of money. And when they spoke of supply, what they usually meant was a physical quantity of a good produced and sold. On this basis, when they spoke of prices being determined by demand and supply, they conceived of prices as being determined by the ratio of the demand to the supply. Prices on this view were formed by the division of an amount of expenditure of money, the demand, by the quantity of goods or services produced and sold for that money, the supply. Prices, it was held, varied in direct proportion to the demand and in inverse proportion to the supply. For example, double the supply, and prices would halve. Halve the supply, and prices would double.[4] 

The classical economists' concept of demand has extremely easy application to our analysis of the global economic system. It can be taken as equal to the $40 trillion of global GDP shown above, in Table 1. This sum can be taken as representing the expenditure to buy the global gross product.

The classical economists' concept of supply finds equally ready application. Initially, today, the global supply of goods and services can be conceived of as consisting of 10 units. As we can see from Table 1, 8 of those units (.8 of the world's output) are produced by the First World countries. One of those units (.1 of the world's output) is produced by China and India. And the remaining 1 unit is produced by the rest of the world apart from China and India.

The classical economists' concept of demand, indeed, precisely the global expenditure of $40 trillion to buy the world's gross product, easily serves as the vehicle for a profoundly important and highly relevant concept that seems to be virtually unique to Ricardo. Namely, his concept of a money that was an invariable standard of value. The purpose of this concept was to be able to zero in on changes in prices resulting from causes originating on the side of goods rather than on the side of money. (Unfortunately, Ricardo developed the concept in a way that made it depend on the labor theory of value, which it was not necessary to do.)

The above $40 trillion of expenditure to buy the world's gross product can be made into an invariable standard of value. All we have to do is assume that between now and the year 2106, the annual expenditure to buy the world's gross product remains at $40 trillion. Forty trillion dollars will then be an invariable standard of value, one that will serve to make all price changes reflect changes on the side of goods, not on the side of money.

Making this assumption will first of all bring into clear relief what all the fears and complaints are about in connection with globalization. It will show the basis of the fears and complaints in the clearest possible light, in a form much sharper and stronger than we see it in the real world. What we see in the real world is a faint reflection of what we are about to see here.

One final assumption. For the sake of simplicity, we assume that the world's population and its distribution among the different countries also remains unchanged. (The effects of population change can be analyzed, but that's a separate job. We need to limit ourselves to one thing at a time.)

So here we are. The expenditure to buy the global gross product is constant at $40 trillion per year. And meanwhile, the world outside today's First World countries is in process of drawing even with today's First World countries. Let us look now at the world in 2106, by which time it has drawn even, by having succeeded in raising the productivity of its labor and per capita output by a factor of 20 times.

We are in a position to calculate the world's gross product in 2106 relative to its gross product in our starting year. The rest of the world, which initially had produced a mere 2 units out of the 10 units of the world's total output, now produces 40 units out of a world output of 48 units. The 40 units is the result of multiplying the initial 2 units by the 20-fold rise in productivity and per capita output that is assumed to take place there. The 48 units is the result of adding those 40 units to the 8 units that continue to be produced by the old First World countries. (We've implicitly assumed that their productivity and output have remained stationary. This is an assumption we'll drop very soon. But we need it for now.)

Let's look at the world of 2106 in terms of shares of global GDP. The world outside the old First World now produces an output of 40 out of the global output of 48. In terms of a fraction, that's 5/6 of global output, which is the same as the fraction its population bears to the world's population. In monetary terms that translates into 5/6 of $40 trillion. This is because if these countries are now producing 5/6 of the global gross product, we should expect them to take in 5/6 of the expenditure to buy the global gross product. That's $33.33 trillion. This is tremendous financial prosperity for this part of the world, going from $8 trillion of GDP to more than $33 trillion of GDP.

But what about the old First World? In monetary terms, it's fall is as great as the rest of the world's rise. Its share of global output has fallen from 8/10 to 1/6. In terms of money, its GDP has correspondingly plunged from $32 trillion (8/10 of $40 trillion) to $6.67 trillion (1/6 of $40 trillion). What could be bleaker?

Now nothing remotely this negative in financial terms has in fact taken place anywhere in the First World. In part this is because the increase in production in the rest of the world has thus far been only the barest fraction of what has been described here. China and India, for example, are only now approaching 1/10 of the world's output. Indeed, the change in the position of the two economic worlds would necessarily be relatively slight in any given year. This is because the compound annual increase in production in the rest of the world required to result in a 20-fold cumulative increase over a century is only on the order of 3 percent.[5]  Thus, the change in the overall dollar amounts of respective GDPs is correspondingly small in any given year.

In addition, in the real world, both globally and in every individual country, there is a substantial increase in the quantity of money and volume of spending every year, that easily overcomes any tendency toward a decline in a country's monetary GDP. The result is that the dollar amount of GDP all over the world continues to rise, and average money incomes continue to rise everywhere. Nevertheless, in the First World countries, a powerful downward tug on sales revenues and money incomes coming from abroad is being felt. And this, I believe, is the source of the complaints in the First World countries about globalization. The downward tug can be especially powerful when it is concentrated in a few industries, even in a single year.

Having described a situation in the First World countries of 2106 that in terms of their monetary decline appears as dire or even much more dire than that of the worst depressions in history, I now want to point out some as yet unnoticed but very important aspects of the situation. When we understand them, things will appear in a positive rather than a negative light, indeed, in an enormously positive light.[6] 

Ricardo to the Rescue: "Value and Riches, Their Distinctive Properties"

Let us begin by measuring the fall in money GDP in the old First World. In 2106 the money income of this group of countries is 1/6 of $40 trillion. Initially, it was 8/10 of $40 trillion. To measure the extent of the fall, we must divide the 2106 fraction of 1/6 by the initial fraction of 8/10. To do that, we must multiply 1/6 by 10/8. And when we have done this, we find First World GDP in 2106 to be 10/48 or 5/24 of its initial level.

This may be seem to be nothing more than stating the exact same bleak situation in the form of a fraction rather than in the form of an absolute amount. But something that I find worthy of astonishment is about to present itself.

Let us now use the classical economists' Demand/Supply formula to measure the extent of the fall in prices between the starting point and the year 2106. Initially, $40 trillion of global expenditure purchased a global gross product consisting of 10 units. Now $40 trillion of global expenditure purchases a global gross product that consists of 48 units, with each unit continuing to represent the same magnitude of supply.

To use the classical Demand/Supply formula to calculate the change in the price level over this period of time, all we need do is divide the price level of 2106, which is $40 trillion/48 units of supply, by the initial price level of $40 trillion/10 units of supply. To do this, of course, we once again need to invert and multiply by the second fraction. When we do that, we find that $40 trillion in the numerator and $40 trillion in the denominator cancel out, and we are left with a numerator of 10 units of supply and a denominator of 48 units of supply, which, of course, reduces to 5/24.

What I find astonishing here is that the fall in prices exactly matches the fall in First World GDP! The fall in First World GDP is to 5/24 of its initial level and so too is the fall in prices! Both are exactly the same!

Yes. The expansion in production in the rest of the world relative to production in the old First World has served to reduce the share of global GDP that goes to the old First World, but it has also equivalently reduced prices! The result is that, in real terms, when the dust has settled, there is no reduction in buying power or in real incomes or real GDP in the old First World. In real, physical terms, as opposed to monetary terms, the gain of the rest of the world has not been at the expense of the old First World. At 5/24ths the prices, 5/24ths the money GDP of the old First World buys just as much as did the initial GDP of the old First World.

Could this outcome be just some kind of bizarre coincidence? Or is it mathematically necessary that in the face of a constant amount of spending, increases in relative production by successful competitors serve to reduce prices to the same extent that they reduce the money incomes of unsuccessful competitors?

It can easily be shown that this last outcome is in fact mathematically necessary. The share of world income or world GDP that belongs to any particular country or group of countries is determined by its output relative to world output. To the extent that other countries increase their output while its output remains the same, the share of its output relative to world output correspondingly falls. Thus, if initially, world output was x and now world output rises to x + y, while its output remains the same, say, at x_a, then its share of world output, and thus of world GDP, falls in the ratio of x/(x + y). It was initially x_a/x and now it's x_a/ (x + y). Dividing the second expression, which is its present, lower share of world output and world GDP, by the first expression, which was its former, higher share of world output and world GDP, reduces to x/(x + y).

But this resulting expression is also the exact expression of the fall in prices that results from production rising from x to x + y. In the face of an invariable money, the price level that results when production is x + y relative to the price level that existed when production was only x, is x/(x + y). Mathematically, what is present is that x + y and x are divided into respective numerators that remain the same and then cancel out, as soon as the first fractional expression is divided by the second. This leaves both the decline in share of world GDP and the decline in prices to reduce to x/(x + y).

Assuming they understand it, many people will undoubtedly respond to this analysis with the thought that however scientifically interesting it may be, it would be an awfully wrenching financial experience to go through merely in order to end up unscathed in real terms. And so it would.

Clearly our analysis needs further development. This is only its first significant finding.

To carry it further, we now need to realize that production in the old First World countries would not remain stationary, but would increase and, indeed, increase at a more rapid rate because of globalization than it would have done otherwise.

There has been a rapid rate of economic progress in at least some of the present First World countries, most notably Great Britain and the United States, for well over two centuries, and some significant rate of economic progress might be expected to continue in the present First World countries in this century too. Let us assume that without any further progress toward globalization, this rate of continued progress within the present First World would be at an average compound annual rate of 2 to 3 percent per year. With globalization, however, for reasons to be explained, the rate would be significantly higher. If it were just 1 percent per year higher, the results over the course of a century would be dramatic.

Using a pocket calculator or spreadsheet will quickly show the extent of the difference that would be made. At a 2 percent compound annual rate of increase, the cumulative increase over 100 years is 7.2 times. At a 3 percent compound annual increase, the increase over the course of a century is 19.2 times, and at 4 percent, the cumulative increase by the end of a century is 50.5 times. At 5 percent, the cumulative increase rises to 131.5 times.

The process of the rest of the world coming up to parity with today's First World would occur by virtue of the First World progressing more rapidly than it otherwise would and, at the same time, the rest of the world progressing at a rate significantly higher than that elevated rate. Thus, for example, while today's First World countries might progress at a compound annual rate of 4 percent instead of 2 percent, the rest of the world would draw even by progressing at a rate a little in excess of 7 percent. This difference in positive rates of progress is how the rest of the world would advance to equality. Its advance would not be at the expense of what is today the First World, but as the source of major gains to what is today the First World.

Let's look more closely at the arithmetic. As we've just seen, 1.04¹⁰⁰ amounts to a cumulative increase of 50.5. That represents a level of per capita output in the year 2106 in the countries of today's First World of over 1,000 times today's per capita output in the rest of the world, since the difference was already 20:1 and now it's multiplied by a further 50.5. But if the rest of the world could progress at a compound annual rate of slightly less than 7.25 percent, parity would be achieved nonetheless. This is because 1.0725¹⁰⁰ results in a cumulative increase of 1096 times.

In essence, the old, i.e., today's, First World countries would produce 50 times as much as they used to produce, while the rest of the world would produce 1000 times as much as it used to produce. The old First World countries would lose their 20:1 initial advantage in productivity by virtue of the rest of the world increasing its per capita productivity 20 times as much as the 50-fold increase in per capita productivity in the old First World countries.

What is present here is an ironic twist on the subject of economic inequality. Usually, there is unjust resentment against economic inequality, resulting from the failure to recognize the contribution that individuals who earn higher incomes, above all, businessmen and capitalists, make to the productivity and standard of living of people of lower incomes. Here there is unjust resentment against economic equality—international economic equality—and for essentially the same reason. Namely, a failure this time to recognize the economic contribution of those on the rise, to the standard of living of those with whom they are drawing even.

Before we proceed to demonstrating the nature of that contribution, we need to pause and reflect a little further on what we have seen up to now.

In the title of this section, I referred to Ricardo's doctrine of the distinction between "value" and "riches." Perhaps the easiest way to grasp this distinction is to think of global GDP continuing to remain invariable at $40 trillion, while world physical output increases in the manner I've just described it as increasing. In that case, the GDP of the old First World still falls from $32 trillion to $6.67 trillion, while the GDP of the rest of the world still rises from $8 trillion to $33.33 trillion. This, as before, would be the outcome in terms of "value"—i.e., in terms of plain old, simple monetary value. But in terms or real physical wealth, which Ricardo called "riches," both groups of countries would be vastly better off. The $6.67 trillion of GDP now earned by the old First World countries, would buy roughly 50 times more than did the $32 trillion of GDP originally earned by those countries. At the same time, the $33.33 trillion now earned by the rest of the world would buy 1000 times as much as did the $8 trillion of GDP it initially earned.

What brings about these results is the vast increase in the buying power of money that results from the respective 50-fold and 1000-fold increases in production and supply.

Based on the assumptions of this illustration concerning respective rates of economic progress, overall global production increases from its initial 10 to 2400 a century later. This is the result of the initial 8 units of production of the old First World rising 50-fold to 400 units, and of the initial 2 units of production of the rest of the world rising 1000-fold to 2000 units, with each unit, of course, still representing the same magnitude of supply. Thus global production in 100 years is 2400 instead of 10. In the face of an invariable money of $40 trillion of GDP, this 240-fold increase in production and supply implies a decline in prices to 1/240 of their initial level. At this level of prices, 5/24 the GDP in the old First World has 50 times the buying power of the initial GDP in the old First World.[7]  Likewise, at 1/240 of the initial price level, the rise in GDP in the rest of the world by more than 4 times (from $8 trillion to $33.33 trillion) serves to raise buying power there by 1000 times.[8] 

Thus, we have whole world growing dramatically richer, even while an important part of it declines in terms of monetary value. This is what Ricardo's doctrine makes it possible to see.[9] 

We now need to add an important further element to our analysis, which entails dropping our assumption of an invariable money, and allowing for an increase in the quantity of money. This is because even if the world possessed a 100-percent pure gold standard, there would in fact be some significant rate of increase in the quantity of money.

If the global quantity of money rose even at the very modest rate of just 2 percent per year, in the course of a century it would still increase by a very substantial amount. As we've seen, a sum that grows at a compound annual rate of 2 percent increases more than 7 times in 100 years. In the face of an unchanged demand for money for holding, the implication of this is a 7-fold rise in global GDP, from $40 trillion to $280 trillion. Thus, even with the old First World countries accounting for only one-sixth of global output at that point, the size of their GDP would show an increase. It would then be on the order of one-sixth of $280 trillion, or $46.67 trillion. And this, of course, would be a significant increase over the initial $32 trillion of GDP in those countries.

If the global quantity of gold money increased at a 3 percent compound annual rate, which would be more likely in view of the rapid rates of increase in production in general, the money supply 100 years later would be more than 19 times as large, as we've also seen from our examination of the effects of compounding. With an unchanged demand for money for holding, global GDP would then be $760 trillion. A sixth of that would be $126.67 trillion, which at that point would be the GDP of the old First World countries. Thus, in reality, the whole world would grow in monetary terms as well as in real terms. 

Indeed, given the rates of increase in global production and supply that we've assumed, prices would fall significantly over the course of a century even with a compound annual rate of increase in money and spending of 5 percent per year. In that case, as our examination of the effects of compounding showed, money and spending 100 years later would be 131 times as great. With production and supply 240 times as great, prices would be lower by almost half.

Of course, under a paper money regime, which is what presently exists in the world, no rate of increase in production and supply that might realistically be achieved is capable of comparing with the rate at which paper money can be increased. Paper money is easily capable of being increased at compound annual rates far in excess of the most rapid rates of increase in production and supply ever recorded. At 10, 20, 50, 100 percent annual rates of increase, the increase in the supply of paper money easily overpowers any increase in production and supply and succeeds in raising prices at rates that have no fixed limit.[10] ,[11] 

The Contributions of Globalization: Extending the Division of Labor

It's now necessary for me to explain just why globalization should have the kind of positive effects on production and supply that I've claimed for it.

The first and most fundamental reason comes under the heading of extending the division of labor. Adam Smith wrote that "the division of labour is limited by the extent of the market."[12]  By this, he meant that the division of labor is limited by the number of cooperating producers in the society. Smith pointed out that a worker capable of producing a thousand nails a day, if nail making were what he devoted his full time to, would not be able to pursue such an occupation in the Scottish Highlands. He wouldn't be able to do it, for the simple reason that he would probably not find enough people to buy more than a thousand nails in a year.

Globalization in contrast means bringing into the market all the producers in the entire world and thus making possible the maximum amount of division of labor consistent with the size of the world's population.

Let's turn to a different example than that of Smith's nail maker, in order to develop this point more fully and in its most important aspect.

Let's assume that in order for a physician to be kept tolerably busy, he needs a surrounding population of 1,000 people. With this number of people, we'll assume, there'll be enough colds, broken arms, cases of pneumonia, need for appendectomies, and so forth to keep him sufficiently occupied. Assume also that an efficient-sized medical school is capable of turning out 100 new physicians every year, and that its average graduate will practice for 40 years after graduating. This implies that ultimately, there will be 4,000 graduates of this medical school out in the world at any given time practicing medicine. It's obvious that in order for these 4,000 graduates to be kept reasonably busy, there needs to be a surrounding population of 4 million people.[13] 

Now assume that of the 4,000 physicians, only 1 in 1,000 is a heart specialist, or a brain specialist, or some other kind of specialist. Given this ratio, the implication is that with a population of only 4 million people integrated into the division of labor and able to support just 1 medical school, there can be only 4 such specialists. However, with a population of 400 million people integrated into the division of labor and able to support 100 medical schools, there can be 400 such specialists. With a population of 4 billion people integrated into the division of labor and able to support a thousand medical schools there can be 4,000 such specialists. And, finally, with 6 billion people, constituting the whole population of the globe, integrated into the division of labor and able to support 1,500 medical schools, there can be 6,000 such specialists.[14] 

Now the larger the number of such specialists, the larger is the number of intellectually gifted, ambitious people dedicated to working on the special problems of their field, and thus the greater is the likelihood of success in discovering new and improved methods of diagnosis and treatment. Six thousand such specialists each on the lookout for advances, and globally interacting with one another through medical journals, conferences, and now the more rapid methods made possible by computers and the internet, are almost certain to succeed in discovering more such advances than are 4,000 such specialists, let alone only 400 such specialists.

This principle, that a larger absolute number of intellectually gifted individuals dedicating themselves full time to solving the problems of a field is more likely to achieve success than is a smaller number of such individuals, applies to far more than just medical specializations. It applies to every branch and sub-branch of science, engineering, invention, and business innovation. It is the most important of all economies of scale.

Looking at the same facts from a different perspective, it should be clear that one of the greatest of all gains that results from the division of labor is the ability of geniuses to devote their full time to activities representing the discovery and application of new knowledge. Such is the general nature of their specializations. Instead of devoting their labor to growing their own food, they specialize to a high degree precisely in such fields as science, engineering, invention, and business innovation. The result is that instead of a particular pile of potatoes or rice being produced here and there by such people, which is almost all they can achieve in a non-division-of-labor society, new principles of science and mathematics are discovered, and new products and new methods of production are developed and brought to market. The rest of the population is taught to produce products it could never have imagined, by methods it could never have conceived, but which it quickly comes to value and is enabled to enjoy, thanks to the efforts of the ingenious innovators.

The proportion of geniuses, or at least of potential geniuses, to population is almost certainly pretty much the same throughout the world. There should certainly be no doubt that there is potentially the same proportion of Chinese and Indian geniuses as European and American geniuses. But everywhere, the proportion follows the pattern of the normal curve.

The fact that thus far only about one-sixth of the world's population has been fully integrated into the division of labor, implies that at the present time, the economic system of the world is operating far, far below its intellectual potential. Across the interior of China and India and the rest of Asia, across the interior of Africa and South America, there are billions of human beings still living in a state of substantial economic self-sufficiency, devoting most of their time simply to growing their own food. Among these billions are many thousands with the potential of making significant to major contributions to the productivity of labor throughout the world, but who will never be able to do so, so long as the time that they might have devoted to making advances in science and to improving products and methods of production must instead be devoted to growing their own food.

With globalization, remarkable developments will originate in what is today the middle of nowhere from the point of view of the rest of the world, and then spread throughout the world. Equivalents of Bentonville, Arkansas and Redmond, Washington will arise in what are now merely very obscure locales in India and China and other countries even less familiar. They will arise because major business talent will be able to appear and develop in such places.

All over the world, far more refined and differentiated wants and tastes will be able to be supplied. Goods and services that only one person in a million may want become more likely to be worthwhile producing when there are 6,000 such millions.

The tremendous surge in scientific and technological progress and increase in the effective supply of business talent that globalization will bring, will be a major foundation of the accelerated economic progress that I have argued will be its result.

Of course, globalization will also mean that in every branch of production, it will be possible to achieve the maximum of all kinds of other economies of scale as well, consistent with the size of the world's population. By its very nature, globalization will mean that every factory, every productive establishment of any description, located anywhere in the world, will be able to regard the entire population of the world as its potential market and to produce on a scale corresponding to the market it achieves. Larger-scale operations will mean that it will more often pay to use machinery and more specialized machinery, because their cost will be spread over more units of output, thereby reducing the cost per unit of product. Globalization implies the achievement of further economies of scale in the production of machines themselves, as the result of the greater frequency in which their use will pay and thus the increase in the quantity in which they will be produced.

Globalization and Capital Accumulation

Raising the productivity of labor almost always requires the use of more and better capital goods, that is, such things as more and better factories, tools, machines, and previously produced materials, components, and supplies, dedicated to producing for the market. In the countries of today's First World, generations have had to go by in order to achieve their present-day supply of capital goods.

Generations ago, through a process largely of scrimping and saving, an economy employing oxcarts and wagons and primitive iron forges became able to construct the first, primitive railroads and steel mills. Then with the aid of those primitive railroads and steel mills, it was possible to go on to produce more, bigger, and better railroads and steel mills, which, in turn, were used in the production of still more, still bigger, and still better railroads and steel mills, and numerous other capital goods as well, whose design was made possible by technological progress. Step by step, generation by generation, more and better capital goods were employed to produce still more and still better capital goods. The advances in capital goods in each generation were the foundation for the production of the still larger supply of capital goods embodying the still further technological advances of the next generation. This is a process that can be repeated indefinitely so long as scientific and technological progress and business innovation continue and an adequate degree of saving and provision for the future is maintained.[15] 

Today, the most backward economies of the world are able to skip over all of the generations that have had to go by to accumulate the capital goods of the advanced countries. They can start off with them, ready made, thanks to foreign investment.[16] 

As soon as they get modern capital goods, the productivity of their labor begins dramatically to increase. To the extent that they save and reinvest out of their resulting larger output, their increased output is itself the source of still more modern capital goods for them. Thus, for example, foreign investment supplies a backward country with a modern steel mill, a substantial part of whose great output serves in the construction of more such steel mills in that country. Or foreign investment provides the means of producing a substantially increased volume either of capital goods or consumers' goods that are exported and a substantial portion of the resulting sales proceeds is used to import additional modern capital goods of various types.

In this way, with high rates of saving and investment, on the pattern of Japan, South Korea, and Taiwan, a country that was previously miserably poor can be transformed within as little as two generations into a modern industrial economy, with a standard of living comparable to that of the United States. High rates of saving and investment provide the ability to take great and rapid advantage of the accumulated advances of generations in the capital goods supply of the First World countries and are what makes possible the very high rates of economic progress in previously backward countries. The same pattern now appears to be taking place in important parts of China and in other places in Asia.[17] 

Ricardo on Capital Accumulation: An Answer to the Fears of Capital Transfer

Recognition of the dynamic, inertial nature, as it were, of capital accumulation belongs do David Ricardo. By this description, I mean the fact that in raising the productivity of labor, an increase in the supply of capital goods makes possible a further increase in the supply of capital goods coming, in effect, out of the enlarged product itself. "Capital," Ricardo wrote, "is that part of the wealth of a country which is employed with a view to future production, and may be increased in the same manner as wealth. An additional capital will be equally efficacious in the production of future wealth, whether it be obtained from improvements in skill and machinery, or from using more revenue reproductively…."[18] 

The key point here is the recognition that more capital goods results from such things as improvements in machinery, which is to say, from a preceding increase in the supply of capital goods. And it itself, in turn, is capable of bringing about a still further increase in the supply of capital goods, potentially without any fixed stopping point.

This principle is extremely important in considering the process of globalization. For it implies that so far is the process from stripping advanced countries of their accumulated capital, that its actual effect is ultimately to increase the accumulated capital of the advanced countries. 

Fear of the loss of capital from advanced countries to the rest of the world has been expressed by Dr. Paul Craig Roberts.[19]  Dr. Roberts fears the outflow of capital from the United States to impoverished, low-wage countries. He states:

"The collapse of world socialism has made vast pools of cheap and willing labor in Asia and Mexico available to US capital and technology. The mobility of capital and technology means an Asian can work with the same capital and technology as the American. However, the Asian does not have to be paid the same wage. The large excess supply of labor in Asian markets means that the market wage is far lower. Our approach to the world is based on the assumption that we are experiencing free trade. If, instead, we are experiencing the flow of factors of production to absolute advantage, our entire trade policy will need to be revised."[20] 

There is a measure of truth in what Dr. Roberts states, and we can illustrate it by means of the following example. Thus, assume that an American firm is contemplating the investment of $10 million of capital, to build a factory. Construction materials and the use of construction equipment, along with the machinery to be installed in the factory, will cost $5 million of those $10 million. The remaining $5 million will have to be paid to cover the wages and benefits of 100 American construction workers for a year, at the rate of $50,000 per man.

In an impoverished country in Asia, however, the cost of equally capable construction workers is only $1,000 per man. In other words, a total labor cost of $100 thousand, instead of $5 million. The construction materials, construction equipment, and the machinery for the factory can all be shipped there. If the costs of transportation and any other costs associated with construction and set-up abroad, amounted to $900 thousand, the total cost of constructing the plant in Asia would still be just $6 million, instead of $10 million. This, of course, is a powerful incentive for building the plant in Asia. And, then, once the plant is built, whatever the number of workers it needs for its operation can be found locally at a comparably small fraction of the cost of employing American workers.

Exactly such considerations explain why a very substantial amount of American manufacturing has moved offshore. It's just so much cheaper.

Now Dr. Roberts sees this movement of capital offshore. But what he does not see is that the process is much more than just a movement of a given amount of capital from one place to another. That much, or, better, that little, is true in terms of monetary value, but in terms of actual physical wealth, and, in this case, physical capital, there is a substantial increase. Being able to obtain for $6 million what one would otherwise need to spend $10 million for, makes it possible for that same $10 million to obtain much more. It leaves $4 million of capital funds over for purchasing other capital facilities, perhaps another two-thirds of a second such factory in Asia.

An American firm that invested in this way, would be in a position to supply its customers with approximately two-thirds more output for the same money, because it conducted its manufacturing operations in Asia rather than in the United States. Even if it were the case, as is so often claimed, that displaced American factory workers must end up as mere hamburger flippers, the American economic system would have this additional output plus all the extra hamburgers the displaced factory workers would allegedly produce.

To describe the situation when the factory (or factories) have been completed and are up and running, the lower labor costs and resulting lower prices to American buyers simply mean that American buyers get a unit of a good for less money and have that much more money available to spend on other things.

Imagine that the factory turns out television sets. American-made television sets would have to sell for $200 to cover the high cost of American labor. But these television sets made in Asia can be sold profitably for only $100. Every American who buys one of these sets now has $100 left over to spend on other things. Workers no longer needed to produce American television sets can now produce these other things, or replace other workers, who now produce these other things.[21] 

Of course, that still leaves $100 of sales revenues and earnings that have not been made up. We should expect those $100 to be earned in producing American exports, to pay for the $100 of imports. Immediately, however, people will probably point out that for many years the American economic system has been badly deficient in exports. Exports have fallen far short of imports. Our balance of trade and our balance of payments have been chronically "unfavorable," chronically "negative."[22] 

Indeed, the American economic system has had a chronic excess of imports over exports. And this would actually be utterly amazing if the fears of Dr. Roberts and others who are concerned about the loss of capital from the United States were valid.

Any capital that the United States or other advanced countries might lose to the low-wage, impoverished part of the world would be in the form of exports. Just as in the example of a moment ago concerning a factory that costs $10 million to construct in the United States but only $6 million in Asia, there would need to be the export of construction materials, construction equipment, machinery, and also consumers' goods to supply the Asian workers engaged in the construction.

But the truth is, for many years, rather than exporting capital to the rest of the world, the United States has, on net balance, been importing substantial sums of capital from the rest of the world. This is clearly shown in Table 2, immediately below.[23] 

Table 2: Net Foreign Investment in the United States (in millions of US dollars)

China in particular has been a substantial source of capital funds coming into the United States. This is true not only of the direct investments Chinese firms have made, such as Lenovo's purchase of IBM's ThinkPad line of laptop computers. It is also true of China's holdings of over $500 billion of US Treasury securities. Even though these particular funds are not invested in US business firms, they make it possible for these firms, along with the US home-mortgage market and other users of credit, to have over $500 billion of capital that the US Treasury would otherwise have drained away from them in financing its deficits in competition with them for loanable funds.

Capital funds coming into the United States from abroad, with China prominent in the list of the countries supplying those funds, have made it possible for the United States largely to avoid the destructive effects on capital accumulation of its government's policy of deficit financing. They have also made it possible for Americans to import more than they export. As I've explained, an efflux of capital from the United States to the rest of the world would be manifested in the opposite condition, namely, an excess of American exports over imports, with the excess constituting America's contribution to capital formation abroad.

The truth is that at least as far as China and much of the rest of East Asia are concerned, the base has already been laid for rapid capital accumulation mainly on the foundation of what are now means of production existing within the borders of that region.[24]  East Asia is no longer a drain on Western capital, but, if anything, as we have just seen, a source of capital to the West. This has been the case with respect to Japan for many years.

There is nothing unusual or novel in this relationship. In the nineteenth century, Europe was the source of much of the capital used to develop the United States. But it was not very long before the resulting great expansion of production in the United States made the US a major supplier not only of consumers' goods but also of capital goods to Europe. Capital accumulation in Europe was increased as the result of Europe's investment of capital in the United States. And in exactly the same way, the investment of capital in the western United States, made possible by savings made in the eastern United States, soon so increased production in the western part of the country that it became a source of capital accumulation in the eastern United States.[25] 

Today, in addition to the fact that China is a major source of financing the US Treasury's deficits, one can see its contribution, and that of other East Asian countries, to the supply of capital goods in the United States in such forms as computer chips and motherboards, steel and automotive products, and electronic components of all kinds. The high quality and low cost of these capital goods have become essential to the competitive success of numerous American manufacturing firms.

Dr. Roberts, it thus turns out is probably at least a decade out of date in his worries that the United States is being drained of capital to build up the economy of China. China is now capable of accumulating capital on a massive scale internally and of supplying capital to others on a large scale.

This is probably not yet true of India, but to the extent that India will need substantial capital from the outside world, China will be present to help supply it along with the countries of the First World. And then, within a generation or so, if India pursues economic policies promoting capital accumulation to an extent comparable to those pursued by China, India too will become a source of capital accumulation for the rest of the world as well as for itself.

It should be realized that the economies of scale achieved by globalization—by movement in the direction of globalization—are themselves a major source of capital accumulation. This is true above all of the economies of scale associated with the increase in the amount of human talent devoted to scientific and technological progress and business innovation. These advances serve to maintain or even increase the output that results from the use of additional capital goods. They thus offset and possibly more than offset the operation of the law of diminishing returns in connection with capital accumulation. As Ricardo pointed out, since capital goods are themselves part of the output of the economic system, anything which increases that output promotes capital accumulation.[26]  Indeed, the contribution that we can expect globalization to make to human prosperity will very largely be precisely by way of its contribution to capital accumulation.[27] 

Capital accumulation, of course, is promoted by all of the economies of scale that result from a widening of the market, i.e., from movement in the direction of globalization. For they too serve to increase output, a major portion of which is capital goods.

The Anti-Globalization Arguments of Gomory and Baumol

While Dr. Roberts's fears are mistaken, his argument has the virtue at least of being cogent. Unfortunately, the same cannot be said of the critique of globalization and free international trade made by Gomory and Baumol in their book Global Trade and Conflicting National Interests.[28] 

In contrast to Roberts, who worries about competition from low-wage, backward countries that are becoming equipped with modern tools and machines provided by First World countries, Gomory and Baumol welcome such developments and instead worry mostly about competition from countries that have reached a comparable level of economic development. They write:

When we [sic] does development abroad help and when does it harm? Put somewhat loosely, our central conclusion is that a developed country such as the United States can benefit in its global trade by assisting the substantially less developed to improve their productive capability. However, the developed country's interests also require it to compete as vigorously as it can against other nations that are in anything like a comparable stage of development to avoid being hurt by their progress…. Thus, US interests are served by progress in trading partners such as India or Indonesia, but the United States is better off staying as far ahead as possible, in terms of productivity, of trading partners like France, Germany, or Japan.[29] 

In view of the apparently very different positions of Roberts, on the one hand, and of Gomory and Baumol, on the other, with respect to where the threat from foreign trade allegedly lies, it may seem somewhat remarkable that they are typically grouped together as having presented some kind of unified (and successful!) challenge to the doctrine of free trade. Apparently, just any old critique will do if the purpose is to discredit free trade.

The reason that Gomory and Baumol fear the progress of comparably advanced countries or of countries drawing within range of becoming comparably advanced is nothing more than that they fear the loss of significant relative "national income" to those countries. Their analysis is permeated—and fundamentally flawed—by the significance they attach to the relative size of a country's national income.[30] 

National income, of course, is a concept very similar and closely related to GDP. In fact, for practical purposes, it is simply GDP minus capital consumption allowances. Thus all that I have shown concerning the fundamental insignificance of a decline in a country's relative or even absolute monetary GDP resulting from other countries' increases in production applies equally to any decline in its relative or absolute monetary national income that results from other countries' increases in production.

Gomory and Baumol proceed as if they have not the faintest inkling of the distinction between "value" and "riches" and its significance. Essentially, they are stuck at the most superficial level of analysis in recognizing that gains in relative productivity by any given country serve to reduce the monetary income, or at least the relative monetary income, of other countries. It is on this basis that they conclude that there is a conflict of interests among countries in international trade.[31] 

Not realizing the confession of economic ignorance that they are making, they blatantly declare that "it is share of world income that matters primarily in our model."[32]  And they assert, "We have shown that if a nation loses its share of world industries because its productivity lags or for any other reason, national income and the nation's wage-earners are apt to be the ultimate victims."[33] 

Almost the entire substance of their allegations of conflict in international trade rests on their confusion of economic competition—and its resulting gain or loss of monetary income—with conflict. They might as well—with equal lack of justification—allege that conflict characterizes practically all other economic activity as well. This is because within each country the various industries and business firms and, more fundamentally, all individuals who seek to earn money, are in competition with one another for sales revenues and incomes that are always necessarily limited by the existing quantity of money and the desire of people to hold it. The competition between countries for monetarily limited sales revenues and incomes is fundamentally no different. Competition between countries and competition within countries is essentially the same. In both cases conflict is a matter of superficial appearance only. The actual substance of economic competition is one of a profound harmony of interests.[34] 

In a free market, the way that the competitors seek to obtain additional sales revenues and income is by increasing their production in terms of quantity and quality. Competition intensifies their efforts to do this. Because of competition each is given motive to strive to increase his production as much as possible.

To the extent that in this process some competitors succeed in increasing their production relative to that of other competitors, they increase their sales revenues and incomes at the expense of the other competitors. This is not a net or long run loss to the losing competitors because, as I demonstrated earlier, the same process—the same increase in production—that reduces the sales revenues and incomes of the losers ultimately much more than equivalently reduces prices.

We have already had abundant illustration of this principle in our example of today's First World countries increasing their production fifty-fold over the next 100 years while the countries of the rest of the world increase theirs by one-thousand fold in that time. The loss of monetary income in the First World countries was so far exceeded by the fall in prices that they ended up with fifty times their original buying power—as much additional buying power as the increase in their production.[35]  And, of course, when one allows for the increase in the quantity of money that, under a gold standard, would take place as part of the process of a general increase in production, the money incomes of the losers end up substantially higher as well as their real incomes.[36] 

Competition increases the real wealth and income of all participants in the economic system not only by intensifying their motivation to increase and improve their production, but also by providing them with the material means of doing so. This last comes about as the result of the availability of the larger, better, and less expensive supply of means of production, i.e., capital goods, resulting from the competition of the producers of the means of production.

It is certainly true that, other things being equal, earning a higher income is preferable to earning a lower income and that this principle can be applied to countries as well as to individuals. But the principle applies only in the context of free competition, in which the higher income is earned on the foundation of superior productive performance, not when it is obtained on the basis of physical force and injury to others. In the one case, there is a net increase in wealth; in the other, a net decrease. The greater the pursuit of higher income by means of superior productive performance, the greater the improvement in human well-being; the greater the pursuit of higher income by means of physical force, including, of course, government interference, the less the improvement in human well-being and the greater the degree of impoverishment that results.

The higher income of a holdup man is unlikely to be of much benefit to him, because the harm he does to others leads them to take action against him of a kind that is likely ultimately to cause him a loss greater than his previous gains. Similarly, the higher income one might earn by means of sabotaging competitors or otherwise being installed in a position that someone more capable should have had loses its value to the extent that others get away with the same policy.

Thus, whatever I and my family might gain if somehow I could be installed as the head of a major corporation, despite my lack of qualification for such a job, would be more than lost back by my having to deal in my capacity as a consumer with suppliers as deficient in competence as I was. My loss would be driven home to me when I or a loved one died as the result of incompetence on the part of a hospital or airline, or any one of many other suppliers whose incompetence turned out to be a matter of life or death.

There is a net loss in every instance of the violation of free competition. This is because of the restriction of production that it entails. The party favored by the violation has more money income, while the party harmed by the violation has equivalently less money income, and, in addition, less is produced than otherwise would have been produced. That restriction on production is the net, overall loss that results from interference with the freedom of competition. The greater and more frequent the violations of free competition, the greater is the general loss.

It is truly to the self-interest of everyone that the ruling principle in economic life be that of free competition, in which all jobs can be filled by those best qualified to fill them and all industries can be in the hands of those best qualified to run them. This is the arrangement that can provide great and progressively growing gains to all. Its success depends on men—and countries—of lesser productive ability not being in a position to forcibly usurp the position of men—and countries—of greater productive ability, lest the whole economic system be greatly undermined in terms not only of what it is currently able to produce, but, more importantly, in terms of its ability progressively to increase production over time. This last is the consequence insofar as interference with free competition undermines the production of capital goods, and thus attacks the foundation on which future production rests.

Gomory and Baumol apparently do not realize that the parties concerned with competition are by no means exclusively those who win or lose a given competition. The whole rest of the society, national or international, is concerned as well. Thus when the automobile outcompeted the horse and buggy, it was not merely a matter with which auto producers and horse breeders were concerned. Much more was involved than a gain to the one and a loss to the other. There was a gain to the general consuming public from the success of the automobile over the horse and buggy, a gain that ultimately even the ex-horse breeders were able to share, once they found new ways to earn their living. Similarly, to the extent that more recently the Japanese automobile industry has come to offer better, less expensive automobiles than the American automobile industry, this is a gain to buyers of automobiles in the United States and throughout the world, and one which ex-American automobile workers too can share once they find new ways to earn their living.

Every time one industry or one country displaces another in free competition, there is a gain to the general economic system, because now the supply of goods produced is larger and better. Whatever the workers in a given industry or a given country may lose in a given competition, they make up over and over again as the result of all the competition going on in the production of the goods and services to which they are related only in their capacity as consumers, and, in addition, given the time required to find new ways to earn their living, they gain even from the competition that initially displaced them, just as ex-horse breeders and blacksmiths ultimately gained from the automobile.

Thus if it is now Japan or China displacing the United States in some cases, or Italy displacing France in some cases, or Slovakia and Hungary displacing Germany in some cases, in each instance there is a gain to consumers the world over insofar as the goods involved are exported. And to the extent that the countries involved have economic freedom, their workers are soon as fully employed as ever and in a position to take advantage of the improved supply of consumers' goods that initially may have caused their loss of employment.

Perhaps without being aware of it, the essential policy prescription of Gomory and Baumol is the application of physical force, in the form of government coercion, for the purpose of stacking the international competitive deck in favor of the industries of one's own country. For the most part, they appear as though they would be satisfied with protective tariffs for "infant industries."[37]  However, direct government subsidies to infant industries are not to be excluded as well.[38]  And they positively favor government spending in support of "basic research."[39]  In the case of the United States, the authors do not recommend a more comprehensive "industrial policy," i.e., what they describe as "an appropriate role for the government in encouraging, guiding, and financing industrial development"; however, they abstain from doing so only on purely pragmatic grounds, and they apparently believe that it is suitable for other countries.[40] 

Their faith in the benefits of a policy of protection for infant industries is so strong that more than once they imply that it would be desirable to pursue a policy of outright autarky in order to secure them, as when they assert that "no-trade can sometimes be better for a country than trade" and refer to "a country stuck in an equilibrium that is worse for it than autarky."[41] 

If one took these statements literally, keeping in mind the dictionary definition of "autarky," they would imply that total economic self-sufficiency is the path to economic development, and thus, for example, that if Singapore, which has no farm land, wishes to develop its electronics industry, it should, if necessary, cut itself off from foreign sources of food.

We can assume that Gomory and Baumol have simply expressed themselves rather badly here and do not really mean autarky but only an exclusion of foreign goods limited to those in competition with the products of the industries they wish to see developed domestically. If this is so, then apparently what they believe is that if a country wants to establish a motor-vehicle industry it is a good policy for it to prohibit the import of motor vehicles, that if it wants to establish a machine-making industry, it is good policy for it to prohibit the import of machines, that if it wants to establish a computer industry, it is good policy for it to prohibit the import of computers. Of course, such "good policies" overlook the fact that motor vehicles are employed in the production of motor vehicles, machines in the production of machines, and computers in the production of computers, and thus that keeping out any of these goods undercuts the development of the very industries the government supposedly wishes to promote, not to mention the development of all other industries that depend on these goods, and also, of course, immediately undercuts the general standard of living.

There is a further, wider point here that is very similar. Namely, the foundation of the development of industries is the accumulation of capital, and the essential basis of capital accumulation in real terms is the ability to save out of real income. Real income, and thus the ability to save and accumulate capital and establish industries, is higher under free trade than it is under protective tariffs. The clear implication is that the development of industries is fostered by a policy of free trade, not a policy of protective tariffs, irrespective of whether or not the alleged purpose of the tariffs is to protect "infant industries."

An analogy may be useful: I would like to go into business for myself. But at present, my capital is so modest that the only line of business I could afford to go into in the face of economic competition is that of a hot-dog vendor with a pushcart, a line of business in which I could make only the most meager living. I realize that I am far better off, instead, working for someone else for several years and saving heavily out of my higher income until I have enough capital to enter a more substantial and more rewarding line of business.

If to encourage my premature entry into business, the government were to give me some kind of monopoly privilege, say, by making me the sole lawful seller of hot dogs in a ten-block radius, all that would be changed is that instead of producing goods and services of greater value, I would be providing hot dogs, which people would pay much more for than otherwise. Their paying more to me would be at the expense of their paying equivalently less to the sellers of other goods and services. Any greater ability to save and invest that I might have would thus be at the expense of an equivalently reduced ability to save and invest by others. The net effect from the perspective of the economic system as a whole is that I would be producing a less valued good or service instead of a more valued good or service. Production and real income would thus be correspondingly less. Thus, the overall ability to save and invest and establish new industries would be correspondingly less.

True, it may be that if I receive enough government-provided loot at the expense of everyone else, I may be able to establish a successful business someday after all. Then again, I may not be able to. In the latter case, all that will have happened is that people have been forced to sacrifice to provide me with capital, which I end up squandering. And they meanwhile have been prevented from accumulating as much capital as they otherwise would have.

But suppose I succeed and my business turns out to be highly successful, more successful than the businesses of others would have been whose potential capital was diverted to me. (With this kind of potential success awaiting me, it's a mystery why I couldn't have persuaded anyone voluntarily to entrust me with their capital, including the bureaucrats who allegedly have all the necessary good judgment to spot such good prospects as me but somehow never want to invest their own money or go out and earn the kind of substantial income that investment bankers earn in arranging for capital to be voluntarily provided by others.) In any case, in the course of my success, I hire more and more workers, expand into foreign markets, and actually help to increase the size of my country's economy relative to that of the rest of the world. In a word, I help to bring general prosperity to my country above all.

These last developments, it should be realized, are precisely the kind of things that great businessmen in a free economy routinely do. The United States became the world's overwhelmingly largest economy precisely on the basis of the successes of its great businessmen, who invested privately owned capital for private profit, under conditions of substantially greater economic freedom than prevailed anywhere else in the world.[42] 

Ironically, no matter how successful my business may be, if the foundation of its success was government coercion—however improbable it may be that government coercion can ever be the foundation of economic success—that coercion takes away any objective basis on which to now label what I have achieved as a "success." Viewed prospectively, by people being compelled against their will to provide financing for my business, the value they attach to retaining their funds is greater than the value they attach to any prospective success I may have. Precisely that is why they wish to retain their funds rather than turn them over to the government and to me, and do turn them over only under the threat of physical force—i.e., they pay their taxes to avoid being hauled off to jail and offer no resistance to the tax collectors to avoid being injured or killed in a physical struggle with them.

And viewed retrospectively, after my alleged success, all those who were the victims of the coercion imposed to finance my business can no more reasonably view the outcome as a success than the victim of any other act of violence, such as an armed robbery or a rape, can view the outcome as a success even in the highly unlikely event that the perpetrator is in a position to pay substantial damages. In the nature of the case, no one who values his own person can ever desire to be the victim of any act that overrides the judgment of his mind and violates his freedom of choice, or accept the existence of such acts without the strongest possible rejection and protest. In the utmost favorable circumstances, Gomory and Baumol's policies could be a success only to those who attached no value to themselves.

The ultimate foundation of economic success is man's reasoning mind, which acts only on the basis its own voluntary free choice. The position of Gomory and Baumol, and all other supporters of statism and government intervention reduces to the absurdity of holding that the violation of the essential foundation of economic success is the cause of economic success.

The policies urged by Gomory and Baumol are based on the existence of imaginary conflicts. These imaginary conflicts are the product of ignorance of sound economic analysis and a resulting misunderstanding of the nature of economic competition. But these policies, based on imaginary conflicts, are nevertheless capable of igniting real conflicts. This is because their implementation can mean nothing other than governments acting with the deliberate intent of benefiting their own citizens by means of inflicting harm on other countries and their citizens. At the least, such behavior must create an environment of international hostility. Beyond that, it serves to promote war — war fought in the short-sighted, narrow-minded belief that one is harmed by others' ability to produce whenever that ability necessitates that one find a different field of production. It is war waged on the basis of the mentality of Luddites writ large on the stage of international relations.

Outsourcing

A discussion of globalization is incomplete if it does not deal with the fears raised in connection with "outsourcing," i.e., the use of modern means of communication to make possible the performance of services by lower-paid workers in foreign countries instead of by higher-paid American workers. Prominent examples of outsourcing are the shifting of telephone-support operations by software firms and by credit-card companies to India, in order to take advantage of the vastly lower wage rates prevailing there. Having MRIs read by radiologists in India, who are paid a fraction of what American radiologists earn, is another example.

Contrary to the negative associations it has, outsourcing serves to reduce the prices that Americans pay by more than it reduces their incomes. In fact, on overall, net balance, under today's monetary conditions, it does not even reduce the money income of the average American worker at all, while it does reduce the cost of production and price of some of the things that he buys. The reason for these results is that the reduction in cost of production, and ultimately in the price of a service that is outsourced, corresponds to the extent to which the relevant wage rates in India, or wherever else, are lower than those in the United States. At the same time, however, the fall in income of the American workers whose jobs have been outsourced is much less than this, and in the economic system as a whole, a fall in income is non-existent.

Thus, for example, assume that workers who provide telephone support to software buyers or credit-card holders must be paid $15 per hour in the United States, while comparably good workers can be employed in India at $1 per hour. The cost saving will probably not be as great as a reduction to one-fifteenth of its original amount, because now there is the cost of setting up and maintaining a longer-distance and probably more elaborate communications network. So let's say that when allowance is made for this additional cost, the cost works out to be the equivalent of Indian workers having to be paid $1.50 per hour. Thus the cost is ten percent of what it was.

Now when there are cost reductions, competition operates sooner or later to bring about corresponding price reductions, just as when there are cost increases there will sooner or later be corresponding price increases. To the extent that the cost of producing something is reduced by ninety percent, the corresponding part of its price will also tend to be reduced by ninety percent.

At this point, we must ask why the American workers who had been earning $15 per hour do not meet the competition of the Indian workers and retain their jobs by agreeing to work for just under $1.50 per hour. To ask the question is to answer it. There is no thought of meeting the competition of the Indian workers in this way because the alternatives available to the American workers while perhaps significantly less than $15 per hour are still far, far in excess of $1.50 per hour—say, $10 or $12 per hour.

Thus here we have a case in which the cost of production, and ultimately the price of something that Americans will pay, falls by ninety percent, while the wages of the affected workers fall by much less: twenty percent or thirty-three and a third percent. It should be obvious that the more widely that cases of this kind could prevail, the more would the American standard of living rise. If only everything that we now produce could fall in cost of production and price by ninety percent while our wage rates fell by only twenty percent or thirty-three and a third percent!

Of course, if one looks only at the situation of an isolated group of workers, such as the telephone-support workers, the decline in income is far more pronounced than any decline in the overall level of prices the members of this group must pay. Their incomes fall twenty percent or more, while at most it is only the prices of a very small segment of things that falls by ninety percent. But by the same token, in every such case the immense majority of Americans gets the benefit of some reduction in cost and price with no reduction in income. For example, all the people who earn their livings other than as telephone support workers or radiologists and whose credit-card fees and charges for tech support are less than they would otherwise have been and who can get their MRIs less expensively. They, the immense majority, get the benefit of lower prices with no reduction in income whatever. And as is very often the case—indeed, perhaps is more often the case than not—if the former telephone-support workers and radiologists could once again acquire a level of skill and ability in different lines of work sufficient to enable them to earn as much as they previously earned, then the long-term effect of outsourcing on them would be no different than it is on everyone else, namely, they would simply have the benefit of buying more efficiently produced services at lower prices.

Actually, the case of outsourcing is fundamentally no different than the case of adopting labor-saving machinery. The reason that machinery has again and again replaced workers in particular jobs is that the machines so reduce the cost of production that the only way that workers could retain their jobs would be by accepting wage rates far below those that are readily available to them elsewhere in the economic system. For example, workers using hand tools could have met the competition of workers using highly efficient machinery and thereby turning out hundreds of times more product per hour than they, if they had been willing to work for, say, a penny an hour. Then the unit cost of production by means of using hand tools would have been as low as the unit cost of production by means of using the highly efficient machinery. However, the hand-tool workers didn't dream of trying to become competitive with the machines in this way. They didn't, because jobs were readily available to them, or were expected soon to be available to them, at incomparably higher wage rates than a penny an hour. Outsourcing to India (or anywhere else) is thus essentially the same as that of substituting machinery for human labor, and, as far as it goes, is comparably beneficial to the American standard of living.

It does not cause unemployment, any more than labor saving machinery causes unemployment. And, as stated, it does not even reduce money wage rates on overall net balance.

Outsourcing does not cause unemployment because the American workers no longer required in the jobs that have been outsourced are now needed to produce goods and services that Americans will buy with the money they save in buying the goods whose production has been outsourced. Or they will be needed to replace workers leaving to take such jobs. And to the extent that there may be some lapse of time before the prices of the outsourced goods fall and the savings of consumers in those lines materialize, the American producers of the outsourced goods have the funds available from saving on their cost of production. Thus, to the extent that the customers of the software firms and the credit-card companies may not yet have funds available to spend elsewhere in the economic system, the software firms and the credit-card companies themselves certainly do. Either way, there is the basis of new employment.

And then, of course, there are additional new employment opportunities in producing exports, as the Indian recipients of dollars spent by the firms engaged in outsourcing in turn spend those dollars in buying American goods and services (or buy from others who do this). To the extent that the Indian recipients invest the funds in the United States instead of buying imports from the United States, then there will be additional employment opportunities in producing capital goods in the United States. The net upshot is that the same total labor will be employed, though in different lines of work than before in the case of those whose previous jobs have been outsourced, and will produce a larger total output.

Instead of producing the services now being outsourced, a much smaller quantity of American labor suffices to produce exports, or capital goods made possible by foreign investments. This smaller quantity of American labor serves to bring in the same supply of services from India as was previously produced in the United States. The rest of the labor previously used in the production of the services that are now outsourced, and not required in these ways, is the labor saved in their production. It is the labor that now makes possible an expansion in the overall production and supply of goods in the United States.

The quantity of money in the United States is not reduced by any of these operations and thus there is no basis for overall spending in the United States being reduced either. And to whatever extent the quantity of money might be reduced, say because Indians wish to add some of the dollars they have earned to their cash reserves, the reduction is more than made up by the continuing increase in the overall quantity of money, an increase that we have seen would occur even under the purest gold standard, though, of course, at a less rapid rate than is the case today.[43]  The only reasonable conclusion to be drawn from all this is that the overall average of money wage rates does not fall as the result of outsourcing. This is because the economy-wide aggregate demand for labor will be rising and almost certainly rising as fast or faster than any increase in the overall aggregate supply of labor.

Competition, Comparative Advantage, and Capital Accumulation

The preceding discussion of outsourcing illustrates the fact that innovation and competition continually change the specifics of comparative advantage, i.e., that which it is relatively most advantageous for a country or an individual to produce. Prior to the advent of modern, high-speed communications, comparative advantage did not include outsourcing. Today, as we have seen, it certainly does. The innovations that resulted in computers, the internet, and greatly improved telephone communications, and the further innovation of seeing how these developments could be fitted together to make possible outsourcing, have given India a comparative advantage that until recently it did not possess. They have also changed what constitutes comparative advantage for the American workers who have been displaced by Indian competition.

The changing, dynamic nature of comparative advantage is something that has apparently escaped Gomory and Baumol. They appear to believe that comparative advantage is something that once present should thereafter be fixed in its specifics for all time, and when they observe the repeated contradiction of this belief by the facts of reality, they describe the contradictions as matters of historical accident that are independent of market forces. Thus, they write: "In the wine-wool world, market forces, driven by demand and natural advantages, led the world to a single outcome. In today's world, market forces do not select a single, predetermined outcome, instead they tend to preserve the established pattern, whatever that pattern may be."[44] 

Gomory and Baumol fail to realize that what the market forces are preserving is precisely comparative advantage and that the comparative advantage was established by market forces emanating from innovation, including that entailed in responses to changes in circumstances. (Indeed, they themselves write: "A war may force some country to invest heavily in some military product, like aircraft, or to develop a chemical industry because the country is cut off from its traditional supplier. Or a single, farseeing entrepreneur can start a company that inaugurates an industry."[45]  ) At the same time, they complain about the difficulties of entering into an established industry with high capital requirements and extensive networks of dealers and suppliers without large-scale government aid,[46]  all the while not realizing that what they are complaining about is nothing other than the difficulties of overcoming someone else's comparative advantage when there is as yet no market-based reason to do so.

But enough of Gomory and Baumol. It is necessary to turn to the relationship between comparative advantage and capital accumulation.

We have seen that what enables a previously a backward country to begin to compete successfully with more advanced countries is the investment of capital in its territory. This serves dramatically to raise the productivity of its labor, which, combined with its prevailing low level of wage rates, gives it substantially lower costs of production and thus a corresponding advantage over its competitors in the more advanced countries with their higher level of wage rates.

As rapid capital accumulation proceeds in what has up to now been a backward country, it becomes a growing supplier in one industry after another, correspondingly displacing the producers within the countries to which it exports. Thus China and other East Asian countries now supply us with a major portion of our shoes, clothing, and electronic goods, and the domestic production of these goods has virtually ceased.

Just as in the case of outsourcing, but on a larger scale, the effect is not unemployment in the United States, but a redirection of employment, into lines whose expansion is made possible by means of funds released from the production and purchase of manufactures. Thus, by virtue of being able to buy their shoes, clothing, and electronic goods more cheaply, people have more money available for such things as the purchase of homes and the making of home improvements, for travel and leisure, and all manner of other services. And it is in these lines that new employment opportunities appear. The consequence is that there is no tendency toward a higher rate of unemployment as the result of foreign competition, but merely a change in the lines in which our comparative advantage now lies and thus a corresponding change in specific parts of the economic system in which we are employed.

If not thwarted by opposing developments, such as the rising costs imposed by environmental legislation and other government intervention, the effect of getting more and more of our manufactures more economically from abroad than we can produce them at home is to raise our standard of living. We no more suffer from the cheapness of foreign labor in producing the things we buy than we do from the cheapness of using machinery in the production of the things we buy.

In responding to the changing pattern of comparative advantage a critical factor is the availability of newly accumulated capital to be invested in the lines into which labor must now move and which must take the place of the capital lost in lines of production in which we no longer have a comparative advantage. To the extent that government policies of budget deficits, inflation, and progressive income and inheritance taxation prevent the accumulation of this new capital and of the further, additional capital that economic progress requires, there is a genuine economic problem, one that does represent a threat to the standard of living of the average American citizen.

Any form of government regulation that serves to reduce output per unit of capital invested is also a threat to capital accumulation and the domestic standard of living. As we have seen, capital goods are produced by means of the application of labor and existing capital goods.[47]  Anything that reduces the output of a given quantity of labor and capital goods or, what is equivalent, requires the application of more labor and capital goods to accomplish the same result, serves, other things being equal, to reduce the production of capital goods. Environmental legislation that requires substantial additional capital investment but results in no additional output thus operates to reduce the ability to produce and accumulate capital goods.[48] 

In sum, the real threat to the American standard of living comes not from foreign competition but from misguided economic policies of the American government, enacted on the basis of the mistaken beliefs and plain ignorance of millions upon millions of American voters about what benefits them and what harms them economically.

Historically, what underlay America's pattern of comparative advantage, including its ability to have wage rates far higher than those prevailing in the rest of the world and yet not to be widely undersold, was its radically higher productivity of labor. The productivity of labor in most of the rest of the world could not remotely approach that of the United States because the conditions required for substantial capital investment in most of the world were lacking. What was lacking were the security of property, economic freedom, and the enforcement of contracts. In their absence, there was no significant prospect of profit from investing in the backward countries.

What is different now is that in important parts of the world the conditions for foreign investment have become much more propitious. China in particular, at least in several major provinces, has gone from a bastion of communism to a form of capitalism. The security of property, economic freedom, and the enforcement of contracts are now present in China to an extent that has made substantial investment, foreign and domestic, worthwhile. But these necessary conditions still exist in China in a more or less precarious state and to a substantially lesser degree than they exist in the United States, and to a radically lesser degree than they would exist in the United States if the US were once again to adopt the degree of economic liberalism that characterized most of its history.

These fundamental political-cultural advantages of the United States undoubtedly explain its continuing attraction to foreign investors the world over. If the United States were once again to become the bastion of economic freedom that it was in the past, its attractiveness to foreign investors would be substantially further increased. And more than that, it would benefit far more from any given amount of foreign investment, because instead of going largely into the financing of US government budget deficits, the foreign investment would go into building up the actual capital of the country. And, of course, domestic capital formation would greatly increase and take place at a substantial rate. In addition, capital, foreign and domestic, invested in the United States would be employed more efficiently and more productively, thereby bringing about further capital accumulation and tending progressively to raise the productivity of labor in the United States at a substantially higher rate than is presently possible.

In this way, the United States might retain and even increase the proportion that its economy represents of the world economy, at least until the time came that other major countries adopted its degree of respect for property rights and economic freedom.

I confess to being something of an American nationalist. I do not look forward to the United States declining to a share of the global economy that is commensurate merely with its relative population. Restoration of America's traditional policy of economic liberalism, indeed, a more consistent and complete implementation of that policy than was achieved historically, would serve to postpone that day. If and when that day finally came, it would come only because the whole world had finally become as "American" in its values and institutions as the United States itself originally set out to be. At that point, American nationalism would be redundant and cease to have any purpose.

Whether or not globalization will continue and reach its ultimate potential depends on the global acceptance of America's traditional values of private property rights and economic freedom. The once seemingly insuperable obstacle of socialism has been swept away. Environmentalism, which is merely an enfeebled, primitivized reincarnation of socialism's hatred of capitalism, remains. It too will need to be swept aside if the world's presently backward countries are to have access to the raw materials they must have in order to achieve a modern standard of living. And, of course, it will also be necessary for the world's rogue states to be deprived of the ability to inflict harm on their neighbors or in any other significant way to harm the further development and maintenance of the global division of labor.

If these things can be accomplished and if the philosophy of economic liberalism can take hold across the world and further intensify in the areas in which it already has taken hold, then for the first time in human history a truly global economic system will be achieved, bringing unprecedented prosperity and economic progress everywhere.

Copyright © 2006 by George Reisman. All rights reserved.

Notes

George Reisman

George Reisman, Ph.D., is Pepperdine University Professor Emeritus of Economics and the author of Capitalism: A Treatise on Economics (Ottawa, Illinois: Jameson Books, 1996). His web site is www.capitalism.net. His blog is at georgereismansblog.blogspot.com. Send him mail. (A PDF replica of the complete book Capitalism: A Treatise on Economics can be downloaded to the reader's hard drive simply by clicking on the book’s title, immediately preceding, and then saving the file when it appears on the screen.)