Martin Wolf: How to deal with the rise of Asia?

money.jpg Martin Wolf from the FT speaks about how the Western economies should deal with the rise of Asian economies; hat tip to Mark Thoma.

Well, this recent piece has really gotten Martin Wolf to think about the distant (in his case very distant) teachings of economics 101 where free trade and comparative advantages secure mutual benefits for us all. The point is simple; western economies should not try to fend off globalization by protecting areas of their societies/production where Asia has a comparative advantage.

"The world is indeed going through a huge supply shock. But for the high-income countries, the best advice is: relax. The internal redistribution of income caused by trade is likely to be modest. Above all, deliberately shifting their structure of production in the direction of Asia’s comparative advantage, through protection, would be mad. Let us rejoice in trade’s ability to help people escape misery, take the benefits and facilitate necessary adjustments instead."

Wolf's main point of departure is the fact that the rise of emerging Asian economies translate into a global supply shock on the labour side of the basic H-O factor triangle; (ah yet another model from economics 101). The important question obviously is; what does this mean and this is actually also what interests me most about Martin Wolf's piece.

Especially as he points to the rise of emerging economies' (most notably China) exports in labor-intensive goods.

In an economics 101/Heckscher Ohlin framework this means that the abundant (export driven) factor in China (labor) will be rewarded on the expense of the scarce factor in e.g. USA (labor) because USA is importing labor intensive goods. This goes obviously only for trade in labor intensive goods. But what is the point of all this; I mean Leontief proved H-O wrong a long time ago, did ne not? Yes he did actually, but still; the H-O approach remains important precisely because it brings to our attention the income distribution effect of trade which is why I also spend the lines above on the example. 

That China has made the rest of the world better off, as a whole, does not mean it has made every single country better off. The more similar is a country’s comparative advantage to China’s the more likely it is to be a loser (and vice versa).

For high-income countries, the bigger the gain from falling world prices of labour-intensive imports, the larger the shift in the internal distribution of income against unskilled labour. Thus the benefit also creates the challenge."

I am obviosuly not trying to lecture Martin Wolf in basic economics here (he also seems to get the point ;)), but let us hold the last thought for a moment. The rise of Asia do indeed create benefits but as I have described above also loses or as Martin Wolf aptly(?) puts it; challenges.

"The forces pushing for global wage equalisation through trade are quite weak. Nevertheless, the end result is likely to be employment of unskilled labour almost exclusively in the production of non-tradeable goods and services. But provided controls are maintained on immigration of unskilled labour, that need be no disaster. Other measures are also worth considering. Among them are lowering taxes on low-wage incomes; subsidies to the wages of unskilled workers; and support for education and training."

This is not good enough or at least I believe Martin Wolf plays down the obvious. Low-skill labor in the Western societies is going to suffer (is in fact suffering) as a result of trade. Does this constitute a reason for protectionism? Not at all, but the real question at hand here obviously is how big the income distribution effect is and also what we are going to do about this.  As also Mark Thoma notes in his comments.

"I'm not as confident as he is that the "forces pushing for global wage equalisation through trade are quite weak" and that the "internal redistribution of income caused by trade is likely to be modest." Markets find ways to work and wage differentials such as $.60 versus $24 cannot persist."