Capitalism is the engine of prosperity.

Capitalism sows the seeds of its own demise.

 

Could both be right?

Luigi Zingales (University of Chicago) and Kate Waldock (Georgetown) share the sort of irreverent banter you’d hear between economists at a bar, if economists were capable of sarcasm and social enough to go out to bars.

 

Produced by Derek John



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In the second of a two-part look at global inequality Kate & Luigi talk about the downside of globalization. A listener's email sparks a conversation about what's driving the growing wage gap within the U.S. We survey the latest research on the lingering effects of the 'China Shock' and debate how to reverse the trend before the people revolt.

Kate: Hi, I’m Kate Waldock from Georgetown University.

Luigi: And I’m Luigi Zingales at the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And, most importantly, what isn’t.

Kate: We want to start out this episode with a note that we received from one of our listeners, Paul Driscoll, who wanted to hear us talk about globalization in technology. In his note, Paul described how he lost his IT job at HSBC Bank a couple of years ago, and it was under this internal slogan, “Moving IT to high-quality, low-cost locations,” which was just insulting. And after that, the next job he found was a pay cut from his prior job, and he said, “For me, this new liberalist viewpoint of most economists, treating people as mere widgets with none to little protection from the state, in my mind, no economics seems to have an answer.” And he blames a lot of this on globalization, automation and health care.

Luigi: Paul’s note is an excellent way to introduce our second episode on globalization. As our listeners remember, we started talking about populists, and then we moved to globalization because globalization is blamed for having created a lot of people who are disenfranchised—I suspect Paul is one of them—and who are very upset about what’s happening in the United States. And last episode, we looked at the positive aspects of globalization, the fact that billions of people were lifted out of poverty. Today, we’re going to look at the dark side of globalization, that is, an increase in income inequality in Western countries, and in particular, in the United States.

And, as Paul mentioned, it’s a bit difficult to separate globalization from automation or, generally, innovation. And the two, by the way, might combine to generate this phenomenon, but in today’s episode, we’re going to try to do our best to sort these things out.

Kate: Before we get into this, we should mention that what globalization means can be a complicated issue. So, it could refer to globalization of trade, to finance and capital markets, to immigration, to outsourcing of service jobs. Most economists focus on the trade element, and that’s what we’re going to talk about mostly today.

Luigi: And let’s start with the simplest example possible. Imagine that we have two countries, the United States and, let’s say, Cambodia, and those two countries don’t trade with each other in the beginning, and they both produce airplanes and T-shirts. And let’s assume that the United States is more technologically advanced, so they produce both T-shirts and planes better than Cambodia. But relatively, they are better at producing planes than T-shirts. Then, when the United States starts to trade with Cambodia, Cambodian T-shirts start to come into the United States, and they might be of slightly less quality, but they are much, much cheaper than the ones in the United States. And then, all of a sudden, the price of T-shirts in the United States drops, and as a result of this drop, the wages of low-skilled workers will go down, and the wage gap between high-skilled workers and low-skilled workers in the United States will most likely go up.

Now, let’s look at Cambodia. Cambodia, they probably are not going to import the T-shirts from the United States because they’re very expensive, but they love their US planes because they are much, much better than the Cambodian planes. And so, probably they even stop producing planes, but even if they do produce planes, the competition for planes would be quite harsh, and so prices of Cambodian planes will go down. And as a result, we should see, actually, a decrease in the wage gap in Cambodia, because the high-skilled workers working in the plane factory will get a wage cut, while the low-skilled workers working in textiles, because of the demand from the United States, will see prices go up, and so wages go up.

Now, what is interesting is if you look at the data, you do see the first phenomenon, you do see the fact that the wage gap in the United States goes up. You don’t see a similar phenomenon in Cambodia of the wage gap going down.

Kate: This is what’s known as the Stolper–Samuelson theorem. And the finding that Luigi just mentioned is part of why a lot of people in this literature, in this macro and international trade literature, they don’t think that globalization is what really is accounting for all of the increase in inequality within countries. Because, according to this theorem, we shouldn’t have seen inequality go up within countries like Cambodia. Instead, they think that automation and technology explain more of this increase in inequality, that machines and computers and robots are taking our jobs, and you don’t need as many people to make a T-shirt as you used to, because now we can automate that whole process.

Luigi: In general, it is very difficult to separate the impact of automation from the impact of globalization. And, in particular, from the impact of Chinese imports into the United States. And the interesting factoid is that until 2000, the number of jobs in manufacturing in the United States was fairly stable, and this was the result of two very different trends. On the one hand, the percentage of people working in manufacturing was dropping very fast. On the other hand, the quantity of manufacturing produced was going up, and the two things were conversating in a nice way, so that the total amount of workers was roughly the same. But then something happened dramatically in 2000, and between 2000 and 2007—so even before the financial crisis—we see a gigantic drop in the number of workers in manufacturing that goes from roughly 60 million to 12 million. And then, of course, with the financial crisis, there’s another drop from 12 million to 10 million.

Now, there is a paper, an economic paper that shows that the first drop, and maybe even the second, but certainly the first drop has been caused by a change in trade.

Kate: So, this change in trade was the result of what was called the permanent normal trade relations status. This is something that Bill Clinton pushed for a great deal towards the end of his presidency and was eventually passed in the late 1990s. And the whole idea behind this was that we wanted to normalize trade relations between the US and China. We wanted to give China this permanent status as a country that we could trade easily with. Eventually, he pressured Congress to pass this legislation, and it made it much easier for us to trade freely between the US and China, as well as move jobs over to China.

Luigi: Yeah. I think it’s useful to understand that before the passage of this law, China was considered a nonmarket economy, and so the possibility of trading freely between the United States and China was granted by Congress every year, at the beginning of the year. And while in the ‘80s, this was a no-brainer, after Tiananmen, there was a serious threat that the United States Congress would not renew this exemption. And so, the idea behind this paper is, up to 2000, when this law was passed, there was a lot of uncertainty about the long-term relationship between the United States and China, and so people were afraid, for example, to outsource a plant to China, because the next year you could stop trading. And in the same way, the Chinese were very much afraid to set up long-term relationships of exports to the United States for that reason.

And so, this paper looks at what happens to manufacturing, especially manufacturing that competes with China following that shock.

Kate: So, if you look at a chart that indicates the extent of imports and exports between China and the United States, what’s interesting is that you’ll see a gradual increase starting in the early 1990s, but this really takes off after 2000.

Luigi: The paper that we have been discussing has been written by Peter Schott at Yale and coauthors, and they have a follow-up paper that is pretty frightening, because they connect the increase in suicide rates at the country level with the decline in manufacturing caused by the opening of trade. And they find quite a remarkable effect, suggesting that the impact of globalization was not only a loss of income, but also some form of economic despair.

Kate: And in terms of the effects on inequality, there is a follow-up paper, a series of papers actually, by Autor, Dorn, and Hanson, and they pinned down the areas that were more exposed to trade with China, and the effect that that had on wages and labor force participation. And they found that in the counties exposed to the China shock, workers experienced lower lifetime income and had a really tough time readjusting their jobs and their skills. In some cases, it took more than a decade for people to transition into other industries.

Luigi: One aspect that is often forgotten is that in economics, it’s clear that trade improves overall welfare, but it’s not clear, in fact it’s clearly opposite, that trade increases the welfare of everybody. So, in economic theory, trade has winners and losers, and it does overall increase the size of the pie, but there are winners and losers, and these winners and losers need to be somewhat compensated in a political way, if we want trade to move ahead. And I think that part of what we have been seeing in the last 20 years is, we’ll push for more trade, ignoring the cost of the losers.

Kate: I think something that a lot of the macro literature on trade and inequality is missing is that for the most part they focus on the difference between low-skilled workers and high-skilled workers. So, people with no high school degree versus people with a college degree. That’s part of the inequality problem, but what’s really driving inequality at the high end isn’t all people with a college degree, it’s people in the top 1 percent. You could define that as income, but I think particularly wealth. And CEOs and top-paid executives are a big part of what’s driving within-country inequality.

There’s an interesting paper by Keller and Olney in 2016, and they showed this simple graph: if you look at exports from the 1950s to 2007, it’s a startling match for how much they went up versus how much executive compensation went up. Those two lines basically move in tandem. They don’t simply show one picture, they attempt to pin down the causal relationship between exports and CEO pay. But what they end up finding is, unsurprisingly, global trade did play a large role in increasing CEO salary, particularly for the top 50 companies.

Luigi: But I think this is a combination of expansion of markets, you can call it globalization, but the fact that now there is a global market, and technology. When I grew up, nobody was watching Italian soccer games except Italians. Today, there are people in China that regularly watch the Italian championship, because it’s better than the Chinese one. And I think that this expansion of the market, that is caused in part by technology, it is so much cheaper to transfer this information, and also by globalization, had an impact on wages and inequality that is independent of pure trade.

So, in my 2012 book, A Capitalism for the People, I used this example that I think is quite useful. Take golf tournaments, there’s no trade in golf tournaments. And take the best golf tournament in the United States, it’s the Masters, the Augusta Masters. Now, look at the prices that are paid for the winners. So, in 1948, the first prize was only $2,500. That, in 2008 numbers, is $22,000. In 2008, the first prize was $1,350,000. So, 60 times in real terms. Certainly, the wage of the people working at the field has not increased that much, but interestingly, even the second, third, or fifth prize did not increase that match.

So, even in prizes, there is an enormous increase in inequality, where the winner takes all. The winner is rewarded disproportionately, and why? Because people in Japan wake up in the morning to see Tiger Woods playing golf. They don’t want to see the number fifth or the number 20th.

My colleague Steve Kaplan and Josh Rauh from Stanford wrote an interesting paper trying to document how important are various categories in the famous top 1 percent, or top 0.5 percent, or even top 0.001 percent. And what you find is that, if you look at the 0.001 percent, the people that make at least $7 million, actually top celebrities are only 0.5 percent, professional athletes are 1.5 percent, and the Wall Street people are roughly 5 percent. So, there are a lot of other people who make it to that threshold, who don’t belong to the categories that we think normally are superstars.

And another colleague of mine, Eric Zwick with coauthors, is trying to identify who those guys are, and they tend to be doctors, dentists, and car dealers. Why car dealers? Apparently, car dealers are small entrepreneurs that make a lot of money.

Kate: Yeah, but you’re talking about the income distribution. And I don’t think that the same logic applies to the wealth distribution. To be in the top 1 percent of the income distribution on a household basis, you have to make over roughly $430,000 to $440,000 per year. That’s a lot. But to be in the top 1 percent of the wealth distribution in the United States, you have to have over $10.5 million of wealth. And I don’t think that there are that many doctors and car dealers who go from having nothing to having $10.5 million of wealth at the end of their lives. I think those people for the most part, to be fair, it’s harder to study the wealth distribution, and so we don’t have as good of a sense of who those people are with $10.5 million of wealth, but my hunch would be that they’re more ... People represented ... There’s more representation from the finance industry, and there’s just more inherited wealth in that top percent.

Luigi: Maybe we deal with different doctors. I think that there are quite a bit of doctors that at the end of their life have accumulated, at least at the end of their working life, have accumulated $10 million in total wealth.

Kate:Yeah. Maybe there’s a couple of brain surgeons and orthopedic surgeons out there, but also keep in mind that $10.5 million is the minimum cut-off. In terms of the average in that category, it’s much, much higher.

Luigi: The wealth has been tremendously affected by the internet, and now social media, and the stock market. I think that in order to make that kind of money, you need to basically succeed in the stock market.

The first artist who has become a billionaire is actually Jay-Z. And Jay-Z has an estimated wealth of north of a billion now, and most of it does not come from his phenomenal record deals. He had two deals. One in 2008, when he got $150 million, and another one recently for $210 million. So, he’s very good at dealing with this stuff, but where he made real money is that he created the Tidal streaming service in 2015. That now is valued close to a billion dollars. So, I think the real wealth is in the stock market.

Kate: And this goes back to Piketty’s point, it’s the owners of capital, who are able to have enough to save and put that in the stock market, whose wealth increases the most.

Luigi: That’s absolutely not true, because the capital that Piketty is talking about is land and housing, and neither Jay-Z nor any of the guys that made really a lot of money have made money from land and housing. I think that Zuckerberg is a billionaire, not because he’s saved a lot. Zuckerberg’s a billionaire because he had a clever idea and was able to appropriate a lot of future rents. And the same can be said for Bill Gates and for Jay-Z and for a lot of other people.

Kate: The reason that Piketty focused on land and housing was because most of the time series he was studying was in the 1700s and 1800s, but obviously, if you were to apply that same logic just to the past 20 years, he wouldn’t just be looking at land and housing, he would be looking at all capital, which, for the most part, what’s important is the stock market.

Luigi: Yeah. Little detail, he called his book, Capital in the Twenty-First Century, and he should have called it Capital in the 19th Century.

Kate: We’ve already been through this. If you want to hear more about this debate, you can go back and listen to our Piketty episode.

Should we talk about solutions?

Luigi: Please.

Kate: I think it’s a little disheartening to think about what the potential solutions are, because the solutions are things that we should have been thinking about in 2000, right? Coinciding with the permanent normal trade relations status of China in 2000, we should have also instituted labor retraining, labor mobility programs that would help out people who were working in manufacturing, and who lost their jobs because those jobs were exported to China. And we simply didn’t do that. We were assuming that everyone would be better off because we’d have cheaper goods, but we forgot about this huge swath of people who became unemployed.

And now, 20 years later, there’s the question of, is it too little, too late? Have those people permanently dropped out of the labor force? And what about the younger people in those areas, who are just entering the labor force? What can we do for them?

Luigi: Kate, you’re right, but I fear it’s even worse, because the issue should not have been thought of only in 2000. It should have been thought of even earlier. One reason why the American middle class is being so squeezed out by globalization is that it’s lost out in terms of relative education.

In 1950, high school graduates in the United States represented 35 percent of all the high school graduates in the world. And by 2000, they represented roughly only 5 percent. So, what this is saying is the world has caught up with the United States. The United States pioneered universal high school education in the early part of the 20th century, and since then, they have not pioneered universal college, but even worse, probably the quality of high school has gone down, while the rest of the world has understood the importance of education and has massively increased education, starting with the Asian tigers we were talking about last time, and most importantly, China.

Kate: And I think the answers are education, redistribution, and health care, but at this point I feel like, what’s the point of even talking about that, when we don’t have the political capital to really force through any of that legislation? Everyone knows that we need to solve these problems, but it’s depressing to talk about solutions.

Luigi: I think it’s important to explain to people that there was a negative effect of globalization, that this effect is not necessarily a reason to stop globalization, but it is a reason to join globalization with some other measures. And so, if you want to push for globalization, you need at the same time to think about some safety net to absorb some of the costs of globalization. If you want to go back, then you pay the cost of going back.

I think that, by and large, no one is proposing more globalization with better safety nets. You have people that say, more globalization, and people that say, no globalization, but the connection with the retraining, with the safety net, has been lost in many people’s view.

Kate: Sweden is a country that’s actually has done a pretty good job of that, though.

Luigi: Yeah. I think that they have a good safety net, and they are a very open economy. They’re just six million people. They can’t live just by themselves in a closed economy. So, they are very open. They favor markets. They also have some mechanism of a safety net that makes it difficult for people to fall behind.

Kate: The one thing I feel a little bit less depressed about is that I do think ... I mean, I’m sure there will be plenty of people on the right who would lobby hard against this, but I think one area where there’s probably some bipartisan consensus is that there needs to be less tax evasion, particularly on the part of the wealthy. And if we can do a better job of making sure that the wealthy pay their fair share of taxes, then that will help decrease the inequality problem.

Luigi: Except, though, the measures of inequality we look at are pretax. So, there’s no doubt that the after-tax measures can be improved with the redistribution, but at the moment, all the measures are pretax.

Kate: OK. That’s true. They probably won’t help the problem overnight, but over time, if there is more redistribution, then we should see wealth go up at the bottom.

Luigi: Yeah. But I fear that redistribution by itself is not the solution, because, of course, you need some safety net, but you can’t have people that live under it all their lives. I think there’s a human dignity aspect, which is at least as important as the income aspect. And I don’t want to demean the importance of support, but I think that people need to find a successful employment and meaning in life that is not just being paid off by the state.

Kate: So, going back to Paul, he said to us, “In my mind, no economics seems to have the answer.” And in a way, he’s sort of right. This goes back to the Rodrik dilemma, that you can’t have both economic globalization, and national sovereignty and democratic decision-making. And that’s kind of the point, that if you’re going to open up your country to globalization, then you’re going to end up having large swaths of the population who feel like they’ve been marginalized. And this inevitably, according to the Rodrik dilemma, will lead to trouble within our democratic system. And I think that that’s what we’ve been seeing with the rise of Trump and with the rise of populism.

Luigi: And it was easy for the United States to deride Latin American countries in the ‘60s, ‘70s, and ‘80s. They were very much affected by populism, but the reality is that those countries were much more exposed to global shocks than the United States was.

I remember as an undergrad student, I learned that whenever the United States sneezes, Canada catches a cold, because the United States was able to shock the rest of the world without being shocked. And today, the United States is shocked by the rest of the world. And if there is not a democratic response to that, people will revolt, and populism is a form of revolt.

Kate: So, Yascha Mounk was right. We’re all screwed.

Luigi: Join the worldwide movement against globalization. No, but the irony is, the worldwide movement against globalization.

Kate: The global movement against ... Yeah.