The Global Hand

Susan Lee and Christine Foster, 04.21.97

YOU CAN'T PICK UP a publication these days without reading about the growth of income inequality despite increasing general prosperity. The nattering is incessant. Worse, the search for a cause has been muddied by conventional wisdom. Well, we will now unmask the culprit behind the past 25 years of growing inequality in the U.S. and core OECD countries. No, it's not technology replacing humans with bytes. No, it's not those executives who ruthlessly downsize businesses. It's not Ronald Reagan, who cut taxes, thereby weakening the federal government's ability to help the poor. The rat is Richard Cobden. Who? This unlikely villain was a 19th-century British liberal who dedicated his life, with missionary energy, to freer trade. He's the chap who started a chain of circumstances that has made the whole world richer, but some people richer than others. Between 1839 and 1846 Cobden, an unprepossessing man with scruffy muttonchops, mercilessly (and successfully) nagged Parliament to repeal the Corn Laws. These laws, which protected British grain with tariffs, benefited the landed gentry at the expense of the middle and working classes, for whom bread was a staple. Cobden then turned his attention to promoting free trade between France and the U.K. "Commerce," Cobden orated, "is the grand panacea, which will serve to inoculate with the healthy and saving taste for civilization all the nations of the world." He was just getting started. "Not a bale of merchandise leaves our shores, but it bears the seeds of intelligence and fruitful thought to the members of some less enlightened community; not a merchant visits our seats of manufacturing industry, but he returns to his own country the missionary of freedom, peace and good government." What has this to do with the fact that in 1995 the average U.S. family in the top 20% of household incomes received 10 times as much income as the bottom 20%up from 7.3 times in 1966? Simply that Cobden's zeal helped set off a worldwide exchange of goods, capital and people very similar to the current global economic situation. The Cobden-Chevalier Treaty of 1860 marked the beginning of a 53-year period of intense global cohesiveness and economic wellbeing. But the new era didn't treat everybody equally well. In Great Britain (as well as in other rich countries) less skilled workers gained less than skilled onesthough the whole country got much richer.

Like today. In the late 19th century immigration boomed. During the 1880s the U.S. accepted more immigrants than in any previous decade. As Cobden's version of free trade spread its blessings throughout the world, investment followed it, and so did people. In the second half of the 19th century 15 million people crossed the Atlantic to settle in the U.S. Parts of Sweden and Germany were virtually depopulated, and so was much of the Irish countryside. This was a double blessing. The poor found a better life this side of the Atlantic and, as they drained the labor pools in their native lands, wages rose for the home folks. Take Sweden. As the Swedish countryside was emptied by the exodus to Minnesota and North Dakota, labor became scarcer. The result? Between 1870 and 1910 Swedish wages were 12% above what they would have been in the absence of emigration. Between 1870 and 1910 the free flow of labor was impressive, even overwhelming. During the decade of the 1880s, for instance, the U.S. accepted more immigrants than in any previous decade. Many of these immigrants were able to find workquite literallyright off the boat. Serbian immigrant Michael Pupin, who later became a distinguished physicist at Columbia University, arrived in New York City in 1874. He had 5 cents in his pocket and knew nobody. Within 24 hours, Pupin was at work on a farm in Delaware. 1860-1913 The glory days of the global hand. Goods, labor and capital flow freely between nations, and the standard of living rises across much of the world. Capital emigrated, too. British money, instead of staying at home, built railroads in the U.S. and Argentina, tea gardens in India, and literally created Hong Kong and Calcutta. In a single year, 1871, London absorbed over $100 million of American securities; by 1893 foreigners had sent $3 billion to the U.S. National boundaries did not disappear; bloody wars were yet to be fought over them. But for the first time in history people, money and goods were able to flow across them quite freely. It was as if a giant global handkind of like Adam Smith's "invisible hand" gone international rearranged the world economy. As Jeffrey Williamson, an economics professor at Harvard, says of this period, 1860-1913: "Capital and labor flowed across national boundaries in unprecedented quantity, and commodity trade boomed."

The results, in terms of global well-being, were fabulous. Railroad and steamship technology had made transportation much cheaper, but until political and economic barriers came down, people, goods and money couldn't take advantage of this technology. As these barriers fell, prices in the port cities of Liverpool and Chicago, which were far apart in 1870, were allowed to converge. For example, grain prices in Liverpool were 60% higher than in Chicago in 1870, but by 1912 Liverpool prices exceeded Chicago prices by only 10%; this convergence was also true for beef, pork, mutton, butter, cotton textiles, tin, copper, hides and cotton. Farmers in the U.S. and Canada had new markets: this meant Britons could eat more meat and Americans could wear better clothing. The explosion of global hand activity resulted in an impressive closing of the gap in living standards between poor and rich countries. Ireland and Sweden, for instance, underwent a spectacular catch-up from the time of the Great Famine to World War I. "Ireland was transformed from a poverty-stricken peasant economy to an economy that boasted urban wages close to those prevailing in English cities," says Williamson. There were, however, losers. The global hand socked unskilled workers in rich countries. Imports from poorer, lower-cost countries drove unskilled wages down; and, at the same time, immigration expanded the supply of unskilled labor, contributing to the slowing in real wage growth. 1913-1950 The global hand is rejected; nations turn inward. Williamson estimates that, in 1913, in the absence of immigration real wages would probably have been 5% to 6% higher in the U.S. The global hand, according to Williamson, accounted for more than half of the rising inequality in rich countries. No wonder that then, as now, organized labor was appalled by what the global hand had wrought. Samuel Gompers, president of the AFL, said in 1907: "Cheap labor, ignorant labor, takes our jobs and cuts our wages." This sentiment in the U.S. led to atrocities like the Chinese Exclusion Act of 1882, which sought to keep out immigrants from poorer countries. Only somewhat subtler, the AFL-CIO today seeks to keep out foreign goods that it says are made by "exploited" foreign labor. Rising inequality always makes people distinctly uncomfy. In the U.S. in the late 19th and early 20th centuries this concern gave rise to a bunch of radical reformers whose works were wildly popular. In 1888, for example, Edward Bellamy published Looking Backward, a utopian, socialist novel that sold over a million copies in its first years. (Then, as now, not quite everybody was

concerned. William Vanderbilt, the head of the New York Central Railroad, said in 1877: "Our men feel that, although I . . . may have my millions and they the rewards of their daily toil, still we are about equal in the end. If they suffer, I suffer, and if I suffer, they cannot escape.") In the U.K., growing inequality spawned the Fabian Society and, in France, the syndicalists. Thus did politics begin to stay the global hand. A slow retreat from global coherency began in the 1880s, starting with trade protectionism in Germany and France. At the same time, rising income inequality prompted restrictions on immigration. Today air freight can bring garments made in Hong Kong to New York almost as fast as garments made right in the city. In the 1870s, when Chinese immigration was running about 12,000 annually, the Union Pacific Railroad started hiring Chinese workers for $32.50 a month, $19.50 less than the firm had been paying other immigrants. There were riots and fights between Europeans and the Chinese. The result? The Chinese Exclusion Act of 1882, which restricted immigration. The lobbying was spearheaded by the Workingman's Party of California, led by Denis Kearneyan Irish immigrant. Between 1907 and 1924 the U.S. placed further restrictions on immigration, which reached a low point in 1930; indeed, fewer immigrants arrived during the decade of the 1930s than in the year 1907. The U.K., Canada and Australia also moved to limit immigrants by using outright restrictions, imposing a "landing" tax and withdrawing immigrant subsidies. This slow retreat from globalization became total rejection in 1914. Harvard's Williamson says: "International migration fell to a fraction of its prewar level, capital movements were severely restricted and commodity trade was suppressed." As trade protection rose and the flow of labor and capital slowed, world growth turned negative. Trends to inequality stopped, but the rise in living standards was halted. Did this rejection of the global hand help bring about the human catastrophe of World War I? The causes of WWI were manifold, but economics certainly played a role. Germany was impelled to military expansion in part because trade barriers deprived its efficient industry of markets; lack of immigration opportunities caused it to cast covetous eyes on Ukraine and on colonies. The implosion of the global hand continued after World War I with a wicked round of protectionist tariffs. In the U.S., trade barriers went up with the Fordney-McCumber and Smoot-Hawley tariffs.

Canada, by far our largest trading partner, retaliated with its own megatariff in 1930. And the U.K., once the mom of free trade, passed the Empire Preference in 1932, which favored imports from the dominions and levied tariffs on those from outside. The rejection of the global hand also helped tip the world into the Great Depression. And without doubt it was a precipitating factor in World War II. 1950-present The global hand returns, as countries knock down trade walls, capital barriers and stringent immigration rules. Asian countriesincluding Japan and South Korea particularly benefit from growth this time around. Per capita income in those countries soars. This time, however, the world learned its lesson. With peace came Bretton Woods and the GATT chats. Nations sought to break down the barriers to trade, to capital, to labor. And the global hand is again at work. (But the damage was severe; it has taken several decades to regain lost ground. Global trade relative to GDP only came back to where it had been in the 1970s. Capital flows didn't reach pre-1914 levels until the 1990s, and immigration has only begun to recover in the past two decades.) Trade is once again zooming. While world output has been growing at an average annual rate of 4% since 1950, trade has marked an average annual increase of 6%. Moreover, trade among rich and poor countries has blossomed. The share of output exported from poorer countries rose from 8% in 1969 to 18% in 1990 as Taiwan, Hong Kong and Singapore pushed exports of clothes, footwear and toys. Again, lower trade barriers are aided by cheaper, quicker transportation and communications. This means, as well, the easier movement of capital, components, machinery and even plants. Spurned at first as a challenge to national sovereignty, multinational companies have helped spread ideas and technology to distant corners. Companies have become expert in managing worldwide operations. Today air freight can bring garments made in Hong Kong to the New York market almost as fast as garments made right in the city. Many American-built cars are loaded with Japanese components, as Japanese-built cars are with American ones. Capital flows have also accelerated. At the end of World War II, only the U.S. had capital to export, but in the 1970s capital from OPEC started spinning around the world. "These were big in terms of total flows," says Joseph P. Quinlan, an economist at Dean Witter, "but 1985 marks a turning point in terms of sheer bigness." Japan, the U.S. and Germany all send money abroad, a lot to developing countries, especially in Asia. Along with goods and money, labor is once more flowing across national boundaries. The Philippines, for example, is the largest exporter of female labor in the world, and millions of

Asians worked as contract laborers in countries like the Gulf States between 1969 and 1989. Currently the United States receives 800,000 legal immigrants and 300,000 illegals a year. This period of global hand activity, just like the last one, has had one enduring payoffit leaves participating economies better off. All countries grow faster and experience higher living standards. Why? Because the global hand allows countries to specialize in their comparative advantages. Instead of producing its own cars and televisions, Chile buys them from Japan and sends back table grapes and copper. Moreover, the global hand is again promoting earning equality within poorer countries and, as their living standards rise faster than in richer countries, closing the gap between rich and poor countries. Hard to remember, but Japan, for all its military strength, was dirt-poor in the 1920s and 1930sso poor that farmers often sold their daughters into prostitution because they could not afford to raise them. Japan began by exporting low-skill manufactures like toys, then shifted to medium-skill electronic goods and finally focused on high-skill manufactures like luxury cars. In the process Japan has exported its textile and toy industries to poorer countries, making them richer. Japan, for all its current aches and pains, now has the second-highest per capita income among industrial democracies. Or consider South Korea, which started by exporting wigs and toys after World War II and then moved on to steel, ships, cars and semiconductors. Annual per capita income went from $87 in 1962 to $10,076 in 1995. But now, just as in the mid-19th century, the global hand has created a yawning earnings gap. Once again, as richer countries start to import the products of less-skilled labor, prices for those products fall and there is less demand for the domestic labor that makes them. Adrian Wood, a University of Sussex economist, points out that in extreme cases, "as developing countries learn to make low-skill manufactures, the labor-intensive sectors of developed countries have vanished." And at the same time immigration is swelling the supply of unskilled workers. A disproportionate number of U.S. immigrants are high school dropouts; thus they increase the number of unskilled workers and contribute to the decline in relative pay. George Borjas, an economist at Harvard University, says, "the export of skill-intensive products raises the demand for skilled workers, aggravating the gap between skilled and unskilled." Economist Wood thinks that globalization has probably accounted for almost all of the rise in

inequality in the U.S. and other OECD countries since the 1970s. And so history repeats. As happened in the previous great wave of globalization, concerns over worsening earnings inequality are surfacing. Some of this anxiety is expressed in anti-trade, anti-immigration sentiment by right-wing political parties. In France, for instance, the anti-immigrant, anti-European Union, National Front party just won control of a fourth city. For a while in the U.S., people even paid attention when Ross Perot complained that trade involves a "giant sucking sound" as richer economies export jobs to poorer countries. And then there's the group that blames income inequality on technology, which, they argue, endows everybody who sits in front of a computer with magic earnings power (see Technology hoax). A distant relative of this technology argument is that the income gap is becoming permanent and aggravated because IQs are becoming more polarized. All this is nonsense. You can slow or eliminate pressure on the lowest wages by staying the global hand, but you will make everyone poorer. Sure, banning or restricting the flow of shoes and textiles and garments from low-wage countries would benefit some low-wage workers in the U.S. But it would prevent China and India and Egypt from climbing out of poverty. As Sussex's Wood points out: "Greater intimacy between developed and developing countries has had large benefits for developing countries, raising average living standards and accelerating development." Absent the intimacy between developed and developing countries, rich countries would also suffer. If growth slows in China, for instance, Boeing would lay off workers in Seattle. We would be gaining low-wage jobs and losing high-wage jobs. There are other consequences to staying the global hand, too. What if every nation had to invent an airplane in order to use one? What if U.S. railroads in the 19th century could only have been built by U.S. capital, not British? Or what if the Aswan Dam had to be financed, engineered and constructed exclusively by Egyptians? What if Soviet tanks hadn't chased Andy Grove out of Hungary? Or suppose the U.S. had refused him entry because the Hungarian quota was filled that year? "As long as living conditions are goodand they arewe shouldn't focus on inequality". A broader view of history shows that periods of inequality come and go; the 1950s and 1960s, for example, had decidedly less inequality compared to both now and the prewar years. However, as this current period of intense international cohesiveness matures, inequality in richer countries has worsened. The process by which a worldwide global hand picks up labor, capital, technology and goods and puts them down where they earn their highest returns is not

always fair. Short of putting the kibosh on the global hand, there are two choices. European countries have compressed earnings by subsidizing unskilled workers. They have less inequality than the United States has, but the tradeoff is rather nastymuch higher unemployment and more unskilled workers and the rise of the radical right. (In the French city of Vitrolles, site of the National Front Party's most recent victory, unemployment is 19%.) The other route, one followed by the U.S., is to allow relatively higher wages for skilled workers in order to encourage workers to improve their skills. This results in less unemployment, fewer unskilled workers and more skilled ones. Indeed, many economists feel that the widening gap sharpens the incentive to get skills. If the government starts to subsidize the less skilled, the supply response will be slower, and the problem will be protracted. And people do respond to incentives. As Sussex's Wood points out: "Four or five years ago in the U.K., over 50% of the students left school at 16; that has now dropped to well under half as parents and kids understand that they can't get jobs without more education." Douglas Holtz-Eakin, an economist at Syracuse University, says: "I don't care if there's inequality in wages because markets are supposed to identify opportunities." The bigger test is whether a country has decent economic mobility. In the U.S., for example, there is good mobilityespecially for earners at the bottom (see Mobility matters). Simply put, a knee-jerk response to rising inequalityrestricting trade, migration and capital flowswould especially trounce the poor countries of South Asia, Latin America, Eastern Europe and the former Soviet Union, which are just beginning to globalize. Wouldn't we be better off with a prosperous, stable Mexico on our southern borderlike Canada on our northern border? "As long as living conditions are goodand they arewe shouldn't focus on inequality," says Holtz-Eakin. He's right. Achieving equality by lowering living standards is just like snipping off your nose to spite your face. Remember: Richard Cobden, the guy who started the whole thing, wasn't trying to drag down the British landed gentry. He was just trying to put more bread into people's larders.