The Foreign Service Journal, April 2007

The case of China is particularly illustrative. Since the country’s eco- nomic opening in the late 1970s under former President Deng Xiao- ping, its coastal regions have been transformed. Transport rapidly chang- ed from bicycles to motorcycles and, increasingly, cars. Since 1976, more the 300 million Chinese have been lifted out of poverty. In contrast, those regions of China left behind are still relatively unconnected to the world economy. Similarly, people in the least globalized countries also do not live very well. Life in places such as Myanmar, North Korea and sub- Saharan Africa is rarely envied else- where. Trade does not only benefit devel- oping countries. A 2005 study by Institute of International Economics economist Gary Hufbauer found that 50 years of globalization made the United States richer by $1 trillion per year, measured in 2003 dollars. This is equivalent to $9,000 of wealth add- ed per year for the average U.S. household. Although globalization costs $50 billion in adjustment ex- penses in the United States, that charge is far outweighed by the bene- fits. These gains from trade for both rich and developing countries are most abundant when economies are both export-oriented and allow imports. When domestic firms face competition, they are forced to do better. After the mid-1970s, GM, Chrysler and Ford were compelled to improve because of competition from Honda and Toyota. The Big Three could no longer afford to sell gas-guz- zling, poorly designed, unreliable cars for high prices. If U.S automakers failed to improve, people would buy a Civic or Corolla. In this way, open trade improves quality while keeping prices and inflation down. Most recently, Chinese exports to the United States have helped to slow inflation created by rising energy and other natural resource costs. Trade not only increases incomes but it ben- efits ordinary people by increasing the real value of their wages. Dangers of Protectionism If open trade has clear benefits, protectionism has real dangers. When a company is shielded from competition, it generally becomes inefficient, high-cost and inattentive to quality and service. Over time, a closed economy encourages these bad practices that eventually impede com- petitiveness in the protected sector — or across an entire economy. Through their inferior performance, protected firms essentially levy a tax on both industry and consumers to stay in business. Anyone who has tried to obtain a phone line from an unre- sponsive state phone monopoly or has driven an Indian or Russian car is already familiar with the results of uncompetitive markets. Protectionism also prevents com- panies and economies from using cap- ital and labor efficiently. As protected firms grow less capable, they usually go to the government for aid. This almost always makes things worse. If granted, subsidies usually allow firms to continue the same bad business practices that made them noncom- petitive in the first place. As they con- tinue to weaken, these firms ask for ever-higher levels of protection and support. This vicious cycle can impede pos- itive change. In the United States, major U.S. airlines continue to rack up losses and require bankruptcy pro- tection despite subsidies and repeated bailouts. Japan’s economy stagnated during the 1990s mostly because of the existence of “zombie” companies. The zombies never became competi- tive but continued to suck resources out of the system, preventing the growth of new and more competitive firms. Keeping an open economy also means resisting the temptation to reward bad management. Closed economies lose flexibility when they are not allowed to allocate capital and labor freely in order to prevent job losses. Although being laid off is extremely traumatic, pre- venting it by fiat also has serious con- sequences: If a company cannot shed labor during downturns, it will be very reluctant to hire in the future. Even worse, to avoid the rules, companies will either resort to informal labor, temporary contracts or other expedi- encies — all of which have significant costs. Informality is the worst re- sponse, because it is highly inefficient, sharply reduces tax revenue and often results in substandard or even unsafe products. For workers, the results are disastrous: low job security, no pen- sion protection and bad working con- ditions. To avoid regulation, firms may also stay uneconomically small or may increase use of capital to avoid hiring. Flexibility makes a big difference. Within the European Union, coun- tries with more flexible labor markets, such as the United Kingdom, the Netherlands and Sweden, have much lower unemployment rates than those that don’t (e.g., France, Italy and Spain). Since joblessness almost always hits the disadvantaged first, it is not surprising that the worst unrest in 50 F O R E I G N S E R V I C E J O U R N A L / A P R I L 2 0 0 7 “While the benefits of open trade are broadly shared, the costs are heavily concentrated.” — Gene Sperling, former economic adviser to President Bill Clinton