Four fallacies about trade and globalisation

Trade typically figures prominently in U.S. presidential elections, and 2016 is no excep­tion. While campaign­ing, politicians tend to adopt anti-international-business positions that are theoretically unsound and lack empirical evi­dence.

Four fallacies underline these common political arguments.

1. THE MANUFACTURING FALLACY.

Since 1980 elections have included clarion calls to bring manufacturing jobs back to America. As a candidate, Barack Obama focused on reviving the manufacturing sector. In the cur­rent election, Republican Donald Trump vows to revitalize manu­facturing to “reclaim millions of American jobs” while Democrat Hillary Clinton has promoted a “make it in America” strategy on the stump.

Nonetheless, manufactur­ing continues to shrink as a per­centage of total employment. By some estimates, while U.S. man­ufacturing output increased six­fold between 1950 and 2008, the share of manufacturing jobs as a percentage of all jobs decreased from about 30% to 10%.

The reduction in the share of manufacturing jobs is primarily due to tremendous productivity gains since World War II, stem­ming from continual innovations in technology and management practices. This is neither new nor unique to the U.S. According to the Department of Agriculture, the share of U.S. farm-sector em­ployment fell from 90% to about 10% between 1790 and 1950. This was due to increased use of heavy machinery and automation, as well as a simultaneous migration of labor from the farm sector to the manufacturing and service sectors. All major industrialized nations have experienced job losses in the manufacturing sec­tor.

Political arguments often ne­glect the underlying structure of different economies. Most ad­vanced economies have become primarily service economies. As the structure of the U.S. economy has changed, so have its drivers of value creation.

Advanced economies add greater value by focusing on nonrepetitive, high-value-added specialized activities such as in­novation and marketing, while emerging economies concen­trate on repetitive, low-value-added standardized activities. Rich countries are service econo­mies, focused on finance, engi­neering, design and health care, and this is dictated by their com­parative advantage.

2. THE IMPORT FALLACY.

Another popular myth is that imports make a country poorer, and thus a country must export more than it imports to be pros­perous. There are two major problems with this view.

First, merchandise trade defi­cits, whereby countries import more goods and services than they export, are not detrimental to economic growth per se. Basic economics tells us that merchan­dise trade deficits must be offset by capital-account surpluses be­cause every country’s balance of payments must by definition be zero. Simply put, imports must be paid for with current goods, with exports or with past accu­mulations or future goods—in other words, with capital.

As long as the domestic econ­omy is an attractive destination for foreign capital, a country can afford to run trade deficits. An in­novation-driven economy such as the United States can sup­port trade deficits year after year, compensating with an inflow of foreign capital. Foreign invest­ment also brings benefits for the domestic economy, including more and higher-paying jobs.

In the long run, the only way to reduce trade deficits in a healthy manner is to encourage saving. Restricting imports only weakens the domestic economy.

Further, imports and exports go hand in hand. The top ex­port destinations for the U.S. — Canada, the European Union, Mexico and China — are also the top locations from which the U.S. imports. The top exporting states, Texas, Illinois, Kentucky and Michigan, also are the top importing states.

3. THE FOREIGN FIRM FALLACY.

“What’s good for General Mo­tors is good for America,” a mis­quote often attributed to former Secretary of Defense Charles Wilson, has become a motto of sorts for many politicians. The underlying rationale is that American companies are better for the American economy in terms of producing and keeping jobs in the United States.

The truth is that U.S. subsid­iaries of foreign multinationals have an annual payroll of $510 billion with average wages of $80,041, which is 30% higher than the national average. These foreign subsidiaries pay 14% of U.S. federal corporate income tax and produce $360 billion in U.S. exports, about 26% of the total. They also spend $45.2 billion an­nually on U.S.-based research-and-development activities, accounting for about 16% of all research and development per­formed by U.S. companies.

The reality of the global econ­omy is that few major compa­nies locate high-value activities based on the nationality of their headquarters. Such activities are based on local resource availabil­ity. So long as the United States remains a high-knowledge econ­omy with valuable technological resources and innovation capa­bilities, it will continue to attract high-value-creating subsidiaries of foreign enterprises.

Foreign companies in general, compared to local companies, source more locally, pay higher wages, perform more research-and-development-intensive ac­tivities and export more. More important, they provide strong linkages for domestic compa­nies to participate in global value chains.

This leads to the last fallacy.

4. THE EXPORT FALLACY.

Traditional thinking about exports is that nations must sell to buyers in foreign countries. This was true when companies operated in silos defined by or­ganizational boundaries, but it’s no longer true in the modern economy dominated by global value chains. Different organiza­tions add value at different parts of the chain. Thus, even though a company may not be engaged in selling directly to a foreign buyer, it may be part of a chain that gen­erates exports.

 

 

(Ajai Gaur is an associate pro­fessor of strategy and interna­tional business at Rutgers Busi­ness School in Newark and New Brunswick, New Jersey. Ram Mu­dambi is a professor of strategy at the Fox School of Business at Temple University in Philadel­phia, where he is the director of the Institute for Global Manage­ment Studies.)