No Such Thing as a Free Lunch: Principles of Economics (Part 184)

The raw fact is that every successful example of economic development this past century ... has taken place via globalization.

Paul Krugman

Globalization

by

Charles Lamson

Globalization is an often-used word today. Despite the fact that the word is used so frequently, it is rarely defined clearly. Globalization is the process of increasing interdependence among countries and their citizens.

Defined this way globalization has social, cultural, political, and economic dimensions. Any attempt to address all the issues associated with increasing interdependence in a few blog posts, or even a single book, would be hopeless.

The purpose here is to explore the process of economic globalization. Economic globalization is the process of increasing economic interdependence among countries and their citizens. While the issues that we will discuss all have political and cultural dimensions, we will attempt to stick as closely as possible to economics by focusing on the causes and consequences of increased international trade of goods and services, increased cross-border movement of labor, and expanded international financial flows.

The Global Circular Flow

Figure 1 inserts the rest of the world on the circular flow diagram introduced in part 30. It has clearly become more complex. The basic diagram of a simple closed economy includes the supply and demand for goods and services, the supply and demand for labor, and the supply and demand for capital (saving and investment). Household income comes from working and from owning assets; firms demand labor and capital and supply products; households demand goods and services and supply labor and capital.

FIGURE 1 Economic Globalization: International Flow

Opening the economy adds 10 new flows to the diagram. The 10 new flows are shown in Figure 1: (A.) Domestic (in this case, U.S.) households can now buy goods and services from abroad---imports. This brings presumably greater choice and potentially lower prices. (B.) Domestic firms can now sell in foreign markets---exports. This opens up potential profit opportunities. (C.) Firms can hire workers from abroad (immigrants), in essence importing labor. (D.) U.S. firms can now turn to the rest of the world for capital. A U.S. firm may finance a new factory by borrowing from a German bank or by selling bonds in London. (E.) U.S. citizens can now look for a job in foreign labor markets. A laid-off high-tech worker may look for a job in Canada. (F.) Domestic households may put their savings into foreign stocks and bonds. During periods of low interest rates in the United States, higher rates in other countries may look attractive.

But that's not all: (G.) Foreign workers can work in the United States. Thousands of immigrants, many legal and many illegal, enter the United States weekly looking for work. (H.) Foreign citizens can buy U.S. stocks and bonds or put money into U.S. banks. One of the reasons for the big stock market boom in the late 1990s was that foreigners wanted to buy technology stocks in the United States. (I.) Foreign firms can demand labor, making jobs available to U.S. workers. Finally, (J.) Foreign firms may look to the United States for funds to use for investment in new capital. An Italian telephone company could finance the acquisition of new switching equipment with a loan from Citi Corp.

The basic argument for economic globalization can be found in the decisions behind each of these flows. A U.S. consumer buys a good or service from a foreign producer if the good being bought is cheaper than what he would have to pay for it in the United States or if it is of higher quality. Similarly, U.S. citizens put their savings into a foreign bond if it is yielding more than a similar U.S. bond. These choices are made on the basis of self-interest.

Think of the United States as a set of 50 independent states that are totally integrated economically. People, financial capital, and goods and services flow freely across borders in response to people's preferences. If we did not allow people to move freely across borders, or if we did not let New Jersey citizens buy shares in California companies, or if we barred the export of fish from the coasts to the interior, the system would clearly be inefficient. Efficiency in any economy, even the world economy, is achieved if capital and labor can move freely to where their productivity is the highest.

But wait a minute. If it were that simple, what is all the fuss about? Why are there such violent demonstrations over the process of globalization? Some contend that trade leads to domestic unemployment and lower wages as foreign workers compete with domestic workers. Others say that U.S. industry cannot compete with goods produced in countries with very low-wage labor. Still others contend that openness leads to unfair labor standards and sweatshop conditions in many countries or that openness leads to fierce competition and environmental degradation. Some just dislike the expansion of capitalism that they regard as inherently unjust.

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 713-715*

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