Must Trade Kill Equality?

An Economic Strategy to Advance Opportunity, Prosperity, and Growth by Robert C. Altman, Jason E. Bordoff, Peter R. Orszag, and Robert E. Rubin (The Hamilton Project, 28 pages, free at Hamiltonproject.org)

How We Compete: What Companies Around the World are Doing
to Make It in Today's Global Economy
by Suzanne Berger (Currency/Doubleday, 334 pages, $27.50)

The European Economy Since 1945: Coordinated Capitalism and Beyond by Barry Eichengreen (Princeton University Press, 495 pages, $35.00)

In China's Shadow: The Crisis of American Entrepreneurship by Reed Hundt (Yale University Press, 200 pages, $26.00)

The Writing On the Wall: Why We Must Embrace China as a Partner or Face It as an Enemy by Will Hutton (Free Press, 421 pages, $28.00)

Egalitarian Capitalism: Jobs, Income, and Growth in Affluent Countries by Lane Kenworthy (Russell Sage Foundation, 232 pages, $32.50)

Inequality and Prosperity: Social Europe Vs. Liberal America by Jonas Pontusson (Cornell University Press, 242 pages, $19.95)

Making Globalization Work by Joseph E. Stiglitz (Norton, 358 pages, $26.95)

Imagine a modern democratic country that balances dynamic private business with effective social investments. This nation has progressive taxes to finance its generous public outlays, and regulations constraining private capital for the common good -- labor laws, environmental standards, rules protecting investors and pensioners. The citizens believe, with good reason, that this balance makes their economy not merely more equitable but also more efficient. To create that balance took a century of popular political mobilization, punctuated by depressions and predations that undercut the credibility of private business and free markets. It also took a lot of trial and error as well as revision of economic theory.

Now imagine that the country's business leaders propose to exempt its poorest provinces from the entire extra-market apparatus -- no social protections, not even democratic government. Presumably, the lower social costs would attract industry and promote growth. Citizens object that we have already had this argument, and the mixed economy won; allowing privileged businesses in backward provinces to despoil the environment and exploit workers will lower standards generally. But, asks business, don't you care about the poor? Indeed we do, respond the citizens, but if you corporate leaders truly care about equity, you will support consistent social protections and reject a race to the bottom.

Such an extreme proposal would not be taken seriously by any democratic nation. But it is happening globally. As we become an integrated economic system, many newly emerging economies are largely exempt from the rules of modern managed capitalism, while their exports undermine its norms. So must we constrain free trade to save our own mixed economy? Can we devise trade rules to help poor people in both poor countries and rich ones? There is no more fierce debate dividing center-left from center-right -- and the debate ramifies along sometimes improbable lines, with liberal economists such as James Galbraith invoking Third World development and opposing the "protection" that other liberals such as Jeff Faux view as a necessary defense of managed capitalism.

The debate traces a fault line between the congressional/labor wing of the Democratic Party, exemplified by Senator Sherrod Brown, and the party's executive/business wing, personified by Bill Clinton and Robert Rubin. It frames the argument between the Economic Policy Institute and the new Hamilton Project. To the center-left, deals like the North American Free Trade Agreement are less about trade than about helping U.S. manufacturers outsource production to platforms that lack even America's relative weak social protections. China's admission to the World Trade Organization, absent any enforceable commitment to respect basic human and worker rights, must undermine wages and social standards at home. Likewise, successive trade rounds are mainly about protecting global property rights, while allowing business to outrun hard-won social rights.

By contrast, the Hamilton Project contends that with more dynamic social assistance for people dislocated by trade, we could have both economic security and efficiency gains of trade. Representative Barney Frank offers a more explicit bargain: freer global trade in exchange for business support of social programs such as universal health insurance and enforcement of the right to unionize.

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Could such a bargain work? the European experience holds instructive and paradoxical lessons. Europe has twice the trade relative to gross domestic product as the United States. If the American center-left is correct and trade corrodes the welfare state, Europe's social model should be collapsing. But Europe, despite its death notices in much of the American press, is doing surprisingly well.

Jonas Pontusson's Inequality and Prosperity suggests that recent market liberalization (of which trade is only one element) has only slightly increased Europe's income inequality. And the most comprehensive welfare states are Europe's best performers. In Pontusson's account, the European welfare state has had to work more creatively to keep offsetting market-generated inequality, but though Europe's entire social model was given a premature burial in the late 1970s and 1980s, Europe bounced back surprisingly well and with little sacrifice of its social protections.

Pontusson's exemplary book is rich in both data and narrative. He carefully differentiates the variants on Europe's model and anatomizes the continuing political and fiscal strains. Much of the success of social Europe, especially Nordic Europe, he points out, reflects its labor-market policies, which produce a skilled and competitive workforce. Despite the high wages and social protections, the most advanced welfare states do not have job shortages. Norway, Sweden, Denmark, and Finland have a slightly higher ratio of working-age population employed than the United States does.

As for wage equality, it was actually slightly better in 2000 than in 1980 in Norway, Finland, Belgium, and Germany, almost identical in Denmark, and a little worse in Sweden and the Netherlands. The United States was already far more unequal than Europe in 1980, and that gap has dramatically widened over the past two decades. Meanwhile, the U.S. lead over European productivity has continued to narrow. Challenges to Europe's social model remain, Pontusson concludes, but they are far from insurmountable.

Complementing Pontusson, Lane Kenworthy's Egalitarian Capitalism, a little heavier on data and not quite as strong on policy analysis, definitively concludes that equality needn't compromise economic growth. Referring to the same time period, the 1980s and 1990s, he writes, "There is no apparent relationship between income inequality and growth in either direction during those two decades."

What, then, of the contention that trade kills equality? Though European political intellectuals still worry about whether its social model can survive, trade is not their prime concern. The Europeans worry about demographic change (more retired people to be supported by a dwindling workforce and flat or declining birth rates); immigration (unassimilated groups consuming a disproportionate share of social outlay and undercutting local support for welfare spending); and persistently high unemployment among the young (suggesting a welfare state of insiders and outsiders). To the extent that trade is a concern at all, there is more anxiety about competition from the former Soviet bloc nations -- German cars produced in Slovakia and Polish plumbers in Paris -- than about low-wage Chinese or Indian exports.

In his encyclopedic treatment, economist Barry Eichengreen's The European Economy Since 1945 recounts how western Europe shifted from an overly state-directed and bank-led system of economic reconstruction that worked superbly in the quarter century after World War II ("coordinated capitalism") to a more dynamic system with greater market discipline -- but without scrapping its social institutions.

Despite great skepticism and scorn and many bumps along the road, the European Union's single-market project and later its single currency have substantially succeeded. Eichengreen observes that by conventional measures, Europe's GDP per capita "has been stuck at barely two-thirds of U.S. levels" for three decades. But as a careful economist, Eichengreen adds that measured as output per hour worked, Europe's labor productivity is now almost 95 percent of U.S. levels, and Europeans, Eichengreen points out, have far more leisure time than their American counterparts, as well as lower rates of infant mortality, poverty, and violent crime. Eichengreen concludes by observing that financial globalization and technical shifts will intensify pressure on Europe to become more like the United States but that the legacy of business-labor-government tripartism and the welfare state, rooted in both social democratic and Christian Democratic values, "display remarkable continuity."

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Paradoxically enough, European success in reconciling a left-ish social market economy with increased trade would seem to vindicate the centrist Hamilton Project -- just buffer trade with social measures, and you can have both. But Europe does not just compensate losers. It is an entirely different model of capitalism rooted in a different politics, with extensive wage regulation as well as expensive social income. Continental Europe spends roughly 15 percentage points more of GDP on public social outlay than we do -- about $2 trillion a year by U.S. standards.

So, yes, relatively free trade can coexist with greater equality and economic security -- for only $2 trillion a year! Obviously, nobody on the Democratic center-right -- indeed, nobody in the Democratic Party -- is proposing anything like that. In fact, the Hamilton Project, obsessively concerned with deficit reduction, is coy about whether it is proposing net new social outlay at all.

And there may be more to Europe's defense of its model against global laissez-faire than just wage regulation and social spending. Europe seems bolstered against the downward pressures of trade in other, more subtle ways.

Suzanne Berger's superb How We Compete is the latest product of the MIT Industrial Performance Center's ongoing study of comparative capitalism. A sequel to the influential 1989 report by the late Michael Dertouzos et al.,Made in America, Berger's new book is co-authored by a team of 13 scholars who looked in detail at more than 500 international companies. Berger and colleagues found that there is no one best way to compete globally. A firm's business strategies reflect both "the institutions and values of the country in which the company was born," and the legacy of its interaction with customers. In a new world of modular, fragmented production possibilities, different companies, faced with similar business challenges, pursue different strategies. A strategy built mainly on low wages, Berger concludes, is a loser. "The activities that succeed over time are, in contrast, those that build on continuous learning and innovation."

Although there are variations even among multinational corporations based in the same country, European and Japanese multinationals tend to work harder to keep more of the good jobs at home. As an export region with a net trade surplus, Europe does remarkably well for a place with an expensive currency and high wages. Europe's system of corporate governance, its embrace of industrial policies, and its social partnership with labor seem to reduce the vulnerability of Europe's social model to low-wage imports. European business is as global as its U.S. counterparts but may also be more tacitly nationalistic. The EU used to be disparaged by American free-market conservatives as "fortress Europe." In the best sense, it has lived up to that billing, extending social standards as it widens and deepens and providing a haven for social-market capitalism on one continent.

It remains to be seen how China's increasing exports will affect Europe's high-wage society. But until America gets more serious about both social outlay and a healthy form of economic nationalism that creates and keeps more good jobs at home, trade with low-wage mercantilist nations like China will continue to be either a source of our economic insecurity or an all-too-plausible scapegoat.

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China policy is where the trade debate is most vivid and contentious. The critics see a nation that not only drags down U.S. wages but also steals U.S. industrial leadership with statist policies that plainly violate the trading system from which China benefits. The free-traders insist that by importing China's goods, which are produced at very low wages, Americans not only help China to develop and alleviate some of the world's most dire poverty but also raise our own living standards. More people buy from Wal-Mart than work at Wal-Mart.

One useful short book by Reed Hundt, In China's Shadow, embraces elements of both views. For Hundt, China challenges U.S. industry to become more productive and American public policy to invest massively in education, training, research, and technology. But Hundt pulls no punches on the multiple ways that China subsidizes industry and steals intellectual property, in violation of the norms of the WTO. The United States, it would seem, needs both to compete more shrewdly and to hold China to symmetrical rules.

A rather surprising exponent of the benign view of China is Will Hutton, former editor of the London Observer, author of several good books on political economy, and a leading voice of Britain's moderate left. In The Writing on the Wall, Hutton has little patience with American push-back against China. He argues passionately that a convergence of China's political-economic system and that of the liberal West is both imperative and inevitable.

Hutton's book is a well-researched and finely narrated report on how the Chinese hybrid economy has produced growth rates of 10 percent a year. But Hutton's bet is that China's improbable "Leninist corporatism" cannot last and that its instability is more of a threat to the West than its low-wage mercantilism. The book is rich in insights about how China's economy operates and why, in his view, it is living on borrowed time. Most Chinese enterprises answer ultimately to bureaucrats and sacrifice productivity. Endless lines of credit from the state keep losing enterprises afloat. Hutton's exhaustive treatment downplays the benefits China gets from its many partnerships with Western companies and doesn't address whether China lowers wages in the West, though, as a Keynesian, he does call for increased Chinese domestic purchasing power.

"One way or another," Hutton writes, "China's economic model is certain to begin to change sometime in the next five to 10 years." And eventually, China's unstable situation will compel the Chinese to embrace pluralism and civil society. In this transition, China "requires our understanding and engagement -- not our enmity and suspicion."

Hutton's book is a prodigious achievement of research and reporting, but the reasoning of its conclusion is circular. "Because China must change," Hutton declares, "it will." But, as James Mann suggests in his new book, The China Fantasy, extracted elsewhere in this issue, that assertion is a premise, not a demonstrated fact. China has continued its odd (and stunningly successful) hybrid far longer than most China experts thought possible. The two books share roughly the same publication date, so Mann cannot have read Hutton, but The China Fantasy reads almost like a line-by-line rebuttal.

There is no better rendition of the two sides of the China argument than the Hutton and Mann volumes. One awaits the live debate. And though Suzanne Berger is not a Sinologist, her work helps put theirs in context because the larger debate is not just about China but about the interaction and coexistence of distinct brands of capitalism.

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Proponents of freer trade invariably use the most destitute nations as poster children for their brand of laissez-faire. Surprisingly, there is little discussion about strategies that might promote a social brand of capitalism in both the developing South and the advanced North. One exception is Joseph Stiglitz's Making Globalism Work.

Stiglitz is that rarest of critics, a mainstream, Nobel-prize–winning economist who served at the highest reaches of government, took careful notes, and came away a trenchant critic of the system he was recruited to promote. Unlike the caricatured "protectionists" of the debate, Stiglitz bends over backward to be a globalist and a passionate promoter of Third World growth. This is the third in a series of Stiglitz's non-technical books challenging market fundamentalism as bad for both the developing South and the advanced North.

Having begun with that premise, he devotes most of the book to a critique of how the current brand of globalism tilts the rules against poor nations and in favor of multinational investors, corporations, and banks. He is a scathing and well-informed critic of "corrupt privatization" and the abuse of intellectual property protections at the expense of local agriculture and public health. He calls for debt relief, respect for diverse models of development, more legitimacy for social protections and investments, and "a fairer trade regime." By the latter, he means that the West should remove its remaining barriers to trade from the Third World, such as its protection of agriculture. In this view, he sounds almost like the WTO's promoters of the aborted Doha Round, but he criticizes the actual bargain proffered by the West, which would have reduced some subsidies but made poor countries even more vulnerable to imported speculation and instability.

For all his critique of laissez-faire and his very explicit embrace of managed capitalism, Stiglitz comes out as largely a free trader. He even includes a summary of the enduring virtues of comparative advantage. He does support universal environmental regulation, but not the global labor or social standards promoted by the American left.

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At the end of the day, David Ricardo's view of the mutual benefit of trade is just an extrapolation of Adam Smith laissez-faire, which famously cited the mutual gains of specialization in a domestic economy. Ricardo simply substituted England and Portugal for Smith's butchers trading with pin-makers. But managed capitalism has a different logic, predicated on more than a century's evidence that efficiency itself requires social intervention. Yet the challenge of extending the regulations and social investments of managed capitalism to the entire globe, where there is no sovereign, poses a huge institutional challenge as well as an uphill political battle.

Business has tried, with mixed success, to make protections of intellectual and financial property universal. Advocates of universal standards for the environment, labor, and public health have had far less success. Defending managed capitalism on one continent, within one democratic polity, may be the best available second best. The book on how to do it globally has yet to be written.

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