No New Deal for Globalization

In their July/August 2007 issue, Foreign Affairs published an essay by Kenneth Scheve and Matthew Slaughter (a political scientist and an economist) titled, "A New Deal for Globalization." Their main argument was that increased globalization and open trade would require an expansion of national redistribution schemes that would compensate the losers (primarily labor) by taxing the beneficiaries of trade. I wrote a pointed critique at the time based upon my extensive research into the wide variation of national unemployment insurance across advanced industrial democracies (see Michael Harrington, 1998: Trade and Social Insurance: the Development of National Unemployment Insurance in Advanced Industrial Democracies, UCLA). My findings help reveal what were the true causes of the political responses to increased trade during the 20th century and contradict the basic premises for what Scheve and Slaughter advocated in their essay. I reprint that critique here:

Kenneth Scheve’s and Matthew Slaughter’s “A New Deal for Globalization” is an odd mismatch of a couple of old deals. As measured by the expansion of international trade, this is not the first go-round for globalization and their analysis of the politics would greatly benefit from historical comparisons. This is important both for similarities and differences between the present and the past.

At the turn of the last century industrializing European nations had been struggling with the economic and social effects of globalized markets for more than a generation. Many small European nations, like Belgium, the Netherlands, and Switzerland had trading sectors that greatly depended on foreign markets over which their governments had very little control. As trade fluctuated, so did domestic employment, giving rise to political demands for protection. The Grand Compromise, to which the authors allude, was a trade-off of labor compensation subsidized by public and private contributions to universal social insurance schemes in return for increased trade openness.

The conventional narrative claimed these compromises were engineered by trade unions and left labor parties. In actuality, a cross-national case study comparison reveals that international manufacturers and resource exporters had more important political influence in fostering these compromises. Trading industries favored the cross-subsidization of labor compensation schemes that primarily benefited their industries’ share of national wealth. The result was a significant expansion of world trade and economic growth so successful that it attracted imperialist regimes to pursue expansion by other means. The resulting war confounded trade agreements leading to the disaster of 1930s protectionism, but the lesson of managing trade was learned. However, the logic of these programs was not income redistribution, as that would not have attracted the support of capitalists. Rather, these schemes promoted national savings pools to manage the ups and downs of trade over time. They’re like saving for a rainy day.

Countries that were less trade dependent, such as the United States and Japan, instituted their own social insurance schemes much later for reasons stemming from the world depression. These were primarily redistributive schemes that had little to do with globalized trade. Scheve and Slaughter try to conflate these two logics, which is why I say theirs is a mismatch of two old deals.

The question is how can we apply the lessons of history to our current difficulties over globalization? The authors suggest a redistributive scheme of more progressive taxes on all labor incomes. Now, there are probably many good reasons to reduce the regressive tax burden on labor, but globalization is perhaps the least compelling. In fact, redistributive taxes on labor may do nothing to promote trade while simultaneously risking a decline in domestic investment, production and economic growth.

The true problem of globalization results from the maldistribution of the gains and losses from trade across the national, and indeed even the international, economy. But it’s not at all clear that globalization is the primary cause of growing income disparities, so the connection between income distribution and globalization is tenuous at best. A more likely culprit is the winner-take-all economy and the concentration of the returns to capital, of which globalization is but one contributing factor. However, the effects of redistributive tax schemes are well-known: they restrain investment and distort the allocation of labor and capital resources. The inevitable result is lower national wealth – the question is whether this political-economic trade-off is optimal. I will argue it is not as there are better trade-offs to be made.

First, historically, the politics of trade openness only compensated those directly hurt by trade with generous unemployment benefits and retraining. This is the proper nature of social insurance programs and why they make more economic sense than pure tax transfer schemes. Why should a general scheme that redistributes income from high to low for all workers be associated at all with the costs and benefits of trade? Why would such a scheme ever cause workers to stop favoring protectionism? A more rational strategy for workers would be to demand redistribution and protectionism in tandem.

Second, it is highly unlikely that reducing labor taxes will allow American workers to compete on labor costs with the international labor pools in China, India and Central America. More likely it will cause more jobs to be created in the non-tradables sector at equal or lower wage levels, increasing production and profits in these sectors. Workers gain little and we get more workers whose taxes don’t pay for their social benefits.

Third, progressive labor taxes are easy to avoid. At the management level it is a simple matter to substitute alternative compensation schemes to avoid labor taxes altogether. As the authors note, “income growth at the top is being driven by corporate profits, which are at nearly 50-year highs…” Top CEOs now make more in one day than the average worker makes in a year. Even if one believes this is not an economic problem, it most certainly is a political one. So let us accept that the increase in income inequality and the most direct effects of globalization are both reflected in the rise in profits. This cannot be overemphasized. The big gain in incomes in the last two decades has come through profit participation through stock options. (High salaries also come from the same slush fund of corporate profits.) When options are exercised, the income is all capital gain. For example, Steve Jobs’s salary in 2006 was $1, but his total compensation was $646 million, the value of his options. Increased labor taxes will not have much of an impact on Mr. Jobs and the compensation packages of all large earners will most definitely adjust to avoid redistributive taxes. Thus, the $256 million of tax revenues that the authors expect will likely never materialize and the median wage income threshold will fall to even lower levels. (For true redistribution, what the authors really want is a wealth tax, perhaps in the form of a flat consumption tax with a high threshold to protect lower income classes. But this has nothing to do with trade.)

It is time to think outside the box. The future of globalization will not be a return to national universal income compensation schemes based on wages and salaries. The problem we need to overcome with globalization is the mobility of capital relative to labor. We can see the disorderly response to this problem in illegal immigration and outsourcing. But compared to a century ago, the difference today is that labor incomes are the wrong focus for developed nations. Citizens of capital-rich, highly skilled labor economies need compensation schemes that enable them to participate in the profits gained from the international rationalization of production. Yes, labor taxes at the lower levels should be reduced, but the reason is to empower ordinary workers to accumulate capital assets. As citizens, all workers need to be shareholders in national wealth, not mere labor costs. Perhaps George W. Bush was right with his Ownership Society.

How this participation is accomplished is the subject of entirely different policy argument, but the direction should nevertheless be clear.