An open and shut case -...

October 1st 2016

S P E C I A L R E P O R T

T H E W O R L D E C O N O M Y

An open and shut case

20161001_SRworldeconomy.indd 1 19/09/2016 17:27

The Economist October 1st 2016 1

THE WORLD ECONOMY

A list of sources is atEconomist.com/specialreports

CONTENT S

5 Free tradeComing and going

8 MigrationNeeded but not wanted

10 Capital mobilityThe good, the bad and the ugly

13 Deregulation and competitionA lapse in concentration

15 Saving globalisationThe reset button

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THERE IS NOTHING dark, still less satanic, about the Revolution Mill inGreensboro, North Carolina. The tall yellow-brick chimney stack, withred bricks spelling “Revolution” down its length, was built a few yearsafter the mill was established in 1900. It was a booming time for local en-terprise. America’s cotton industry was moving south from New Eng-land to take advantage of lower wages. The number of mills in the Southmore than doubled between 1890 and 1900, to 542. By 1938 RevolutionMill was the world’s largest factory exclusively making flannel, produc-ing 50m yards ofcloth a year.

The main mill building still has the springy hardwood floors andoriginal wooden joists installed in its heyday, but no clacking of loomshas been heard here for over three decades. The mill ceased productionin 1982, an early warning ofanother revolution on a global scale. The tex-tile industry was starting a fresh migration in search of cheaper labour,this time in Latin America and Asia. Revolution Mill is a monument to anindustry that lost out to globalisation.

In nearby Thomasville, there is another landmark to past industrialglory: a 30-foot (9-metre) replica of an upholstered chair. The Big Chairwas erected in 1950 to mark the town’s prowess in furniture-making, inwhich North Carolina was once America’s leading state. But the successdid not last. “In the 2000s half of Thomasville went to China,” says T.J.Stout, boss of Carsons Hospitality, a local furniture-maker. Local makersof cabinets, dressers and the like lost sales to Asia, where labour-inten-sive production was cheaper.

The state is now finding new ways to do well. An hour’s drive eastfrom Greensboro is Durham, a city that is burstingwith new firms. One isBright View Technologies, with a modern headquarters on the city’s out-skirts, which makes film and reflectors to vary the pattern and diffusionof LED lights. The Liggett and Myers building in the city centre was oncethe home of the Chesterfield cigarette. The handsome building is now

The consensus in favour of open economies is cracking, says John O’Sullivan. Is globalisation no longer a good thing?

An open and shut case

ACKNOWLEDGMENT S

Apart from those mentioned in thetext, the author would like to giveparticular thanks for their help inpreparing this report to MichaelAmbler, Jennifer Aspell, Dean Baker,Matt Bennett, Josh Bivens, OlivierBlanchard, Heather Boushey, KevinGreen, Gary Hufbauer, OlivierJeanne, Michael Keen, Jim Kessler,David Lipton, Maurice Obstfeld,Adam Posen, Harrison Rutter, PaulRutter, Virginia Rutter, John Schmitt,Robert Scott, Poul Thomsen, AdairTurner, Vern Tyson, John Frisbie andJeff Schott.

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filling up with newer busi-nesses, saysTed Connerof theDurham Chamber of Com-merce. Duke University, thecentre ofmuch of the city’s in-novation, is taking some ofthe space for labs.

North Carolina exempli-fies both the promise and thecasualties of today’s openeconomy. Yet even thriving lo-cal businesses there grumblethat America gets the raw endoftrade deals, and that foreignrivals benefit from unfair sub-sidies and lax regulation. Inplaces that have found it hard-er to adapt to changing times,the rumblings tend to be louder. Across the Western world thereis growing unease about globalisation and the lopsided, un-stable sort ofcapitalism it is believed to have wrought.

A backlash against freer trade is reshaping politics. DonaldTrump has clinched an unlikely nomination as the RepublicanParty’s candidate in November’s presidential elections with thesupport of blue-collar men in America’s South and its rustbelt.These are places that lost lots of manufacturing jobs in the de-cade after2001, when America washitbya surge ofimports fromChina (which Mr Trump says he will keep out with punitive ta-riffs). Free trade now causes so much hostility that Hillary Clin-ton, the Democratic Party’s presidential candidate, was forced todisown the Trans-Pacific Partnership (TPP), a trade deal with Asiathat she herself helped to negotiate. Talks on a new trade dealwith the European Union, the Transatlantic Trade and Invest-ment Partnership (TTIP), have stalled. Senior politicians in Ger-many and France have turned against it in response to popularopposition to the pact, which is meant to lower investment andregulatory barriers between Europe and America.

Keep-out signsThe commitment to free movement of people within the

EU has also come under strain. In June Britain, one of Europe’sstronger economies, voted in a referendum to leave the EU after43 years as a member. Support for Brexit was strong in the northof England and Wales, where much of Britain’s manufacturingused to be; but it was firmest in places that had seen big increasesin migrant populations in recent years. Since Britain’s vote toleave, anti-establishment parties in France, the Netherlands, Ger-many, Italy and Austria have called for referendums on EU mem-bership in theircountries too. Such parties favourclosed borders,caps on migration and barriers to trade. They are gaining in pop-ularityand nowhold swayin governments in eightEU countries.Mr Trump, for his part, has promised to build a wall along theborder with Mexico to keep out immigrants.

There is growing disquiet, too, about the unfettered move-ment ofcapital. More of the value created by companies is intan-gible, and businesses that rely on selling ideas find it easier to setup shop where taxes are low. America has clamped down on so-called tax inversions, in which a bigcompanymoves to a low-taxcountryafteragreeing to be boughtbya smallerfirm based there.Europeans grumble that American firms engage in too manyclever tricks to avoid tax. In August the European Commissiontold Ireland to recoup up to €13 billion ($14.5 billion) in unpaidtaxes from Apple, ruling that the company’s low tax bill was asource ofunfair competition.

Free movement of debt capital has meant that trouble in

one part of the world (say, America’s subprime crisis) quicklyspreads to other parts. The fickleness of capital flows is one rea-son why the EU’s most ambitious cross-border initiative, theeuro, which has joined 19 of its 28 members in a currency union,is in trouble. In the euro’s early years, countries such as Greece, It-aly, Ireland, Portugal and Spain enjoyed ample credit and lowborrowing costs, thanks to floods of private short-term capitalfrom other EU countries. When crisis struck, that credit dried upand had to be replaced with massive official loans, from the ECB

and from bail-out funds. The conditions attached to such sup-port have caused relations between creditor countries such asGermany and debtors such as Greece to sour.

Some claim that the growing discontent in the rich world isnot really about economics. After all, Britain and America, atleast, have enjoyed reasonable GDP growth recently, and unem-ployment in both countries has dropped to around 5%. Instead,the argumentgoes, the revolt against economicopenness reflectsdeeper anxieties about lost relative status. Some arise from theemergence of China as a global power; others are rooted withinindividual societies. For example, in parts of Europe oppositionto migrants was prompted by the Syrian refugee crisis. It stemsless from worries about the effect of immigration on wages orjobs than from a perceived threat to social cohesion.

But there is a material basis for discontent nevertheless, be-cause a sluggish economic recovery has bypassed large groupsofpeople. In America one in six working-age men without a col-lege degree is not part of the workforce, according to an analysisby the Council ofEconomic Advisers, a White House think-tank.In Britain, though more people than ever are in work, wage riseshave not kept up with inflation. Only in London and its hinter-land in the south-east has real income per person risen above itslevel before the 2007-08 financial crisis. Most other rich coun-tries are in the same boat. A report by the McKinsey Global Insti-tute, a think-tank, found that the real incomes of two-thirds ofhouseholds in 25 advanced economies were flat or fell between2005 and 2014, compared with 2% in the previous decade. Thefew gains in a sluggish economy have gone to a salaried gentry.

This has fed a widespread sense that an open economy isgood for a small elite but does nothing for the broad mass ofpeo-ple. Even academics and policymakers who used to welcomeopenness unreservedly are having second thoughts. They hadalways understood that free trade creates losers as well as win-ners, but thought that the disruption was transitoryand the gainswere big enough to compensate those who lose out. However, abody of new research suggests that China’s integration into glo-bal trade caused more lasting damage than expected to somerich-world workers. Those displaced by a surge in imports from


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China were concentrated in pockets ofdistress where alternativejobs were hard to come by.

It is not easy to establish a direct link between opennessand wage inequality, but recent studies suggest that trade plays abigger role than previously thought. Large-scale migration is in-creasingly understood to conflict with the welfare policy neededto shield workers from the disruptions of trade and technology.

The consensus in favour of unfettered capital mobility be-gan to weaken after the East Asian crises of1997-98. As the scaleof capital flows grew, the doubts increased. A recent article byeconomists at the IMF entitled “Neoliberalism: Oversold?” ar-gued that in certain cases the costs to economiesofopening up tocapital flows exceed the benefits.

Multiple hitsThis special report will ask how far globalisation, defined

as the freer flow of trade, people and capital around the world, isresponsible for the world’s economic ills and whether it is still,on balance, a good thing. A true reckoning is trickier than it mightappear, and not just because the main elements of economicopennesshave different repercussions. Several otherbig upheav-als have hit the world economy in recent decades, and the effectsare hard to disentangle.

First, jobsand payhave been greatlyaffected by technologi-cal change. Much of the increase in wage inequality in rich coun-tries stems from new technologies that make college-educatedworkers more valuable. At the same time companies’ profitabili-ty has increasingly diverged. Online platforms such as Amazon,Google and Uber that act as matchmakers between consumersand producers or advertisers rely on network effects: the moreusers they have, the more useful they become. The firms thatcome to dominate such markets make spectacular returns com-pared with the also-rans. That has sometimes produced wind-falls at the very top of the income distribution. At the same timethe rapid decline in the cost of automation has left the low- andmid-skilled at risk of losing their jobs. All these changes havebeen amplified by globalisation, but would have been highlydisruptive in any event.

The second source of turmoil was the financial crisis andthe long, slow recovery that typically follows banking blow-ups.The credit boom before the crisis had helped to mask the pro-blem of income inequality by boosting the price of homes andincreasing the spending power of the low-paid. The subsequentbust destroyed both jobs and wealth, but the college-educatedbounced back more quickly than others. The free flow of debtcapital played a role in the build-up to the crisis, but much of theblame for it lies with lax bank regulation. Banking busts hap-pened long before globalisation.

Superimposed on all this was a unique event: the rapidemergence of China as an economic power. Export-led growthhas transformed China from a poor to a middle-income country,taking hundreds of millions of people out of poverty. Thisachievement is probably unrepeatable. As the price of capitalgoods continues to fall sharply, places with large pools of cheaplabour, such as India orAfrica, will find itharder to breakinto glo-bal supply chains, as China did so speedily and successfully.

This special report will disentangle these myriad influ-ences to assess the impact of the free movement ofgoods, capitaland people. It will conclude that some ofthe concerns about eco-nomic openness are valid. The strains inflicted by a more inte-grated global economy were underestimated, and too little effortwent into helping those who lost out. But much of the criticismofopenness is misguided, underplaying its benefits and blamingit for problems that have other causes. Rolling it back wouldleave everyone worse off. 7

IN MARCH 2000, two months before a crucial vote inAmerica’s Congress on whether to make normal trading re-

lations with China permanent, Bill Clinton gave a press confer-ence. In the first year of his presidency, 1993, he had made a boldcase for the North Atlantic Free Trade Agreement (NAFTA) withCanada and Mexico, claiming it would create 200,000 jobs inAmerica. Now, in the final year of his second term, he was evenmore bullish about a trade pact with China, which would allowthat country to join the WTO. It would require China quickly tocut its average import tariff from 24% to 9%, to abolish importquotas and licences and to open up some industries to Americaninvestment. America, for its part, would not have to do anything.“This is a hundred-to-nothing deal for America when it comes tothe economic consequences,” said Mr Clinton.

Sixteen years on the mood is rather different. Job losses inmanufacturing states such as Michigan, Ohio and Pennsylvaniahave made trade a key issue in America’s presidential election.Donald Trump has risen to prominence in part by promising toimpose steep tariffs on imports from China and Mexico, claim-ing America’s trade deficit with both countries (see chart, nextpage) shows it is “losing”. Hillary Clinton is no longer supportingthe TPP trade deal she had earlier favoured. The demise of furni-ture-makers and textile firms, unable to compete with low-costimports, belies the predictions made by her husband. BernieSanders, Mrs Clinton’s opponent in the Democratic Party prima-ries, said trade dealshad been “a disaster forAmerican workers”.A YouTube clip earlier this year showing the graceless manner inwhich bosses of Carrier, a maker of air-conditioners, told itsworkforce that it was moving production to Mexico seemed to

Free trade

Coming and going

Truth and myth about the effects of openness to trade

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confirm every fear about the exodus of jobs and the heartless-ness ofcapitalism.

What is behind the change in mood? The years after theNAFTA agreement came into force, in 1994, were actually rathergood ones for America’s economy, including manufacturing. ButChina’s accession to the WTO caused a big shock. The country’ssize, and the speed at which it conquered rich-world markets forlow-cost manufacturing, makes it unique. By 2013 it had capturedone-fifth of all manufacturing exports worldwide, comparedwith a share ofonly 2% in 1991.

This coincided with a fresh decline in factory jobs in Ameri-ca. Between 1999 and 2011 America lost almost 6m manufactur-ing jobs in net terms. That may not be as dramatic as it sounds,since America is a large and dynamic place where around 5mjobs come and go every month. Still, when David Autor of theMassachusetts Institute of Technology (MIT), David Dorn of theUniversity of Zurich and Gordon Hanson of the University ofCalifornia, San Diego, looked into the job losses more closely,they found something worrying. At least one-fifth of the drop infactory jobs during that period was the direct result of competi-tion from China.

Moreover, the American workers who had lost those jobsneither found new ones close by nor searched for work fartherafield. They either swelled the ranks of the unemployed or, moreoften, left the workforce. That contradicts the widespread beliefthat America’s jobs market is fluid and flexible. When men lose afactory job, they often stay put. Those who managed to find newjobs were paid less than before and were working in industriesthat were vulnerable to competition from imports. In subse-quent research, the authors found that lost factory jobs also hada depressing effect on aggregate demand (and thus non-manu-facturing jobs) in the affected areas. In total, up to 2.4m jobs mayhave been lost, directly and indirectly, as a consequence of im-ports from China.

In other rich countries, regions or industries with heavy ex-posure to Chinese imports also suffered material losses in fac-tory jobs. A study of Spain’s jobs market by

�icente Donoso, of

the Complutense University of Madrid, and others found thatprovinces with the greatest exposure to Chinese imports saw thelargest falls in the share ofmanufacturing employment between1999 and 2007, but this was compensated for by an increase innon-factory jobs. Research in Norway, though, found that themain effect was to raise unemployment. João Paulo Pessoa oftheLondon School of Economics found that British workers in in-dustries exposed to high levels of import competition from Chi-na spent more time out of work than those in other industries. Awide-ranging study of the effect on Germany ofmore trade with

China and eastern Europe in the two decades after1988 conclud-ed that industries competing with imports suffered job losses,but these were outweighed by job gains in regions focused on ex-port industries. Those gains were due almost entirely to tradewith eastern Europe, not China.

China’s accession to the WTO was supposed to be a greatbonus for America. So why was its impact on trade and jobs sounexpectedly large? One reason was that China got a very signif-icant advantage out of the pact. A paper by Justin Pierce, of theFederal Reserve, and PeterSchott, ofYale School ofManagement,argues that joining the WTO removed the risk for China of asteep increase in America’s tariffs, making it less perilous for itscompanies to invest in new factories. The authors found that in-dustries where the threat of tariff increases was most reducedsuffered the greatest job losses in America. But the lopsided na-ture of trade between China and the rich world also played apart. After China joined the WTO, its current-account surpluswidened from an average of around 2% of GDP in the 1990s toabout 5% in the following decade. In other words, China savedmore. Thathelpsexplain the modestoffsettinggains in exports inthe regions affected by Chinese imports.

Done workin’It is important to note that America’s growing inability to

bounce backfrom losing manufacturing jobs predates the rise ofChina as an exporting power. A report published in June by theCouncil of Economic Advisers (CEA) charts the long-term de-cline in prime-aged men in America’s workforce. It shows that inthe mid-1960s almost all men aged between 25 and 54 were ei-ther in work or looking for a job, but that in the past half-centurythe participation rate for this group has dropped below 90%. Inevery recession the rate falls more sharply, and when the econ-omy picks up again it fails to make up all the lost ground.

But there are bigdifferencesbetween the participation ratesof different groups of men. In 1964 male high-school graduateswere about as likely to be in the workforce as college-educatedmen, butnowonly83% ofthose with a high-school degree or lessare in the workforce, against 94% of those who finished college(see chart). This mirrors a growing divergence in wages. In themid-1960s the pay of less educated men averaged 80% ofcollege-educated ones, but by 2014 that proportion had fallen to 60%.

It is unlikely that men are dropping out ofworkvoluntarily.More than a third of inactive men live in poverty; less than aquarterhave a workingspouse. So the mostobviousexplanationis a fall in demand for less-skilled men. That in turn is partlylinked to a long-term decline in manufacturing, whose share ofthe jobs market peaked in the days when almost all prime-age


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2 men worked. The CEA study found that states with a higher-than-average share of jobs in construction, mining and (to a less-er degree) manufacturing tend to have more prime-age men inthe workforce. It does not help that men who lose their jobs areincreasingly rooted in unemployment blackspots. The propensi-tyofpeople to move in search ofworkhasdropped sharply sincethe early1990s, for reasons that are not yet fully understood.

A steady drop in the share of prime-age men in the work-force going back half a century cannot be pinned on Americasigning free-trade agreements or China’s emergence as an ex-porter of manufactures, both of which happened fairly recently.Factory jobs peaked in the 1970s, but manufacturing output hascontinued to increase. Indeed, America’s share of world manu-facturing output, on a value-added basis, has been fairly stable ata bitundera fifth for the past fourdecades. Thanks to advances intechnology, fewer workers are needed to produce the samequantity of goods. But since trade with lower-cost countries andtechnological change have similar effects on labour-intensiveproduction in the rich world, it ishard to disentangle theireffects.

Still, some rich countries, such as Germany, Britain andCanada, have done rather better than America at keeping prime-age men in work, though others, including France, Italy andSpain, have done even worse. That is partly a matter of policy.Members of the OECD, a club of mostly rich countries, set asidean average of 0.6% of GDP a year for “active labour-market poli-cies”—job centres, retraining schemes and employment subsi-dies—to ease the transition to new types of work. Americaspends just 0.1% of GDP. By neglecting those whose jobs havebeen swallowed by technology or imports, America’s policy-makers have fuelled some of the anger about freer trade.

Have trade deals really been a disaster for American work-ers? Trade with China seems to have had an unusually large ef-fect. Since 1985, America has signed 15 free-trade agreements(FTAs) covering 20 countries. Exports to these countries accountfornearlyhalfofall the goodsAmerica sellsabroad, even thoughFTA countries make up just a tenth of GDP outside America. Inthe five years after a new trade pact comes into force, America’sexports to new FTA partners typically grow around three timesas fast as its overall exports, at least keepingpace with imports. In2012, exports to the 20 countries covered by FTAs grew twice asfast as the average. In America, exporting firms pay a wage pre-mium of between 13% and 18%, compared with non-exporters.This is hardly a disaster.

America has run a trade deficit everyyearsince 1976. On theother side of the global ledger are countries that consistently runbig trade surpluses. These days the record is held not by Chinabut by Germany, which last year had a current-account surplusof 8% of GDP (see chart). But this does not mean that America is“losing” at trade, as MrTrump suggests, and China and Germanyare winning. The purpose of exports is to pay for imports, eithernow or later. A trade surplus is not a virility symbol. In somecases, it is a sign of a strong national preference for saving(though other countries might describe it as a symptom of weakdomestic demand). Countries rarely have balanced trade, wherethe value of exports and imports is exactly the same. It mightseem plausible that restricting trade to eliminate deficits willcreate jobs, channelling existing demand towards goods made athome. But the reality ismore complicated. In most rich countries,particularly America, the trade deficit widens when GDP growthis strong, and shrinks during recessions. The factors that drive de-mand for imports are the same as those that drive overall de-mand, and thus jobs. To balance trade, Americans would have toinvest less or save more. Neither would create jobs.

It would help a sluggish world economy if surplus coun-tries, like China and Germany, were to spend more on imports.

But for America to aim to balance trade with any one countrywould be pointless. In any case, a finished product exportedfrom China to America, say, will include components made inthird countries, and probably only a small fraction of the valuewill have been added in China itself. Four-fifths of all trade takesplace along supply chains within, or organised by, multinationalfirms. Slapping a tariff on imports of intermediate goods from,say, Mexico would raise the price of America’s exports, whichwould probably be bad for its trade balance. Around 40% of thevalue ofMexico’s exports offinal goods to America, for instance,was added in America itself.

Sober advocates of free trade know that over time the gainsfrom it come from greater efficiency, not from more jobs, thenumber of which is largely determined by demography and thestrength ofaggregate demand. It is easier to spot the link betweenfreer trade and factory closures than the more dispersed benefitstrade brings to workers across other industries. Exporting firmsin all countries and across a variety of industries are more pro-ductive, grow faster and pay higher wages than non-exportingfirms. But a lot of the gains from trade come from the direct bene-fit ofcheaper imports and their indirect effect on productivity.

The cost of protectionismA study by Pablo Fajgelbaum of the University of Califor-

nia, Los Angeles, and Amit Khandelwal, ofColumbia University,suggests that in an average country, people on high incomeswould lose 28% of their purchasing power ifborders were closedto trade. But the poorest 10% of consumers would lose 63% oftheir spending power, because they buy relatively more import-ed goods. The authorsfind a biasoftrade in favourof poorerpeo-ple in all 40 countries in their study, which included 13 develop-ing countries. An in-depth study of European industry byNicholas Bloom, ofStanford University, Mirko Draca ofWarwickUniversity and J��an Reenen of the LSE found that importcompetition from China led to a decline in jobs and made lifeharder for low-tech firms in affected industries. But it also forcedsurviving firms to become more innovative: R&D spending, pat-ent creation and the use of information technology all increased,as did total factor productivity.

Taken together, these are large and permanent benefits.What is clear from the studies of Mr Autor and others is that theone-off integration of China had bigger and more lasting effectsthan expected. Too little attention has been paid in America tothose whose jobs are displaced by new technology or imports.That has given an opening to protectionists, who are peddling asolution that will hurt the poor most. A similar sort of populismis rearing its head in Europe in response to migration. 7

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STOKE-ON-TRENT in northern England is home to theworld’s second-oldest professional football club, Stoke City

FC. Founded in 1863, it enjoyed its heyday in the mid-1970s, whenthe club came close to winning the top division. The playingstyle was described by its manager, Tony Waddington, as “theworking man’s ballet”. These days the flair is often provided byplayers from far afield. More than half the first-team squadcomes from outside Britain, mostly from other parts of Europe.But that is about as far as Europhilia in Stoke goes. In June’s refer-endum on Britain’s European Union membership, the city votedstrongly for Brexit.

Astudy by Italo Colantone and Piero StanigofBocconi Uni-versity in Milan found that areas where jobs are vulnerable tocompetition from Chinese imports, mainly those in Britain’s fad-ed industrial north, tended to be in favour of leaving. Stoke CityFC are known as the Potters in tribute to the city’s once-great pot-tery industry. But Stoke also seemed predestined to be a Brexitsupporter on another count. An analysis by The Economist earli-er this year found that in places such as Stoke, where the foreign-born population had increased by more than 200% between2001and 2014, a vote to leave was almost certain.

Immigration of low-skilled workers has become an in-creasingly contentious political issue in both America and Brit-ain. Voters in host countries often see a sudden influx of peoplefrom places with lower wages, poorer working conditions and aless generous welfare system as a threat to their livelihoods andliving standards. In America the debate is about whether mi-grants hold down the wages of native workers. In Britain the

main concern is that migrants put additional pressure on hous-ing, public health services, schools and transport systems.

Along with trade, migration is one of the two main sourcesof public anxiety about globalisation. For the host economy, thegains and drawbacks are similar to those from trade. Immigra-tion enriches the workforce, allowing for a more finely gradedspecialisation that raises average productivity and living stan-dards. Diverse workforces are likely to be more productive, espe-cially in industries where success depends on specific knowl-edge, such as computing, health care and finance. By easinglabour bottlenecks, low-skilled migrants help to keep downprices ofgoods and services.

The drawback for native workers is competition for jobsand public services. In principle, an influxoflow-skilled workersdepresseswages forcompetingnative workers, in the same theo-retical way that opening up to trade with poor countries does.The balance of benefits and costs will depend on income: therich are likely to do better out of the bargain. Economists disputethe extent of the overall gains and losses to hosts and labour-sending countries respectively.

Come pick my strawberriesSome benefits are uncontested. For immigrants from

poorer countries moving to Stoke, or indeed to any part of Brit-ain, there are cleargains. They can hope fora better job, a markedimprovement in their quality of life and access to better publicservices such as health care. Economic migrants are by definitiona mobile labour force. Migration helps to deal with labour short-ages in low- or mid-skilled industries, such as mining or agricul-ture, and in remote places where it is difficult to attract nativeworkers. Migrants are also often granted work visas on thestrength ofhaving scarce skills.

Other elements ofmigration are more controversial. Ifhostcountries benefit from immigrants, then the countries that sendthem must be losing out on manpower, skills and tax revenue.The people who move are often the brightest and best—thosewith the get-up-and-go, the languages and the connections—sotheir country of origin may suffer a brain drain. A recent paperfrom the IMF puts a number on this. Between 1990 and 2012 al-

Migration

Needed but not wanted

Economic migrants are seen as a threat to jobs andthe welfare state. The reality is more complex


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most20m people moved from central, eastern and south-easternEurope to richer countries in western Europe. This east-west mi-gration accelerated after 2004 when eight eastern Europeancountries, including Poland, the Czech Republic and Hungary,joined the EU. The IMF researchers reckon this exodus loweredcumulative population growth in labour-sending countries byeight percentage points. If those mostly young and skilled work-ers had stayed put, the gap with the EU in income per personwould have been five percentage points narrower.

These results are open to dispute. Migrants typically movefrom places where economic prospects are poor, making it hardto establish whether weakgrowth is a cause or a consequence oftheir leaving. The chance of a better life elsewhere may alsocreate a stronger incentive for those who remain to acquire newskills. Michael Clemens of the Centre for Global Developmentand Satish Chand of the Australian National University used anatural experiment provided by a military coup in Fiji in 1987 tostudy the effects of emigration on that country. The economywas split between indigenous Fijians and those of Indian origin.A large chunk of the second group, generally high-skilled, leftafter the coup. Most of them went to Australia and New Zealand,which admitted well-qualified migrants. It seemed the ideal op-portunity to measure the effects ofa brain drain.

What the researchers found was that the Indian Fijianswho stayed behind started to acquire skillsata faster rate in orderto be able to emigrate (or at least to have the option of doing so).They also concentrated on disciplines that allowed them to meetthe skills-based immigration criteria most ef-ficiently. The increased investment in skillswas large enough to raise the stockof humancapital net of the first wave of emigration, inwhich a fifth of the Indian-Fijian populationleft. The brain drain was fully offset.

What about the impact on host coun-tries? Many native workers see uncontrolledimmigration as a break with an implicit contract: that the statewill look after its own. It creates a tension between immigrationand the welfare state. That tension, though, ismostlypolicy-relat-ed. Where migrants’ employment rate is higher than that of na-tives (as is the case with migrants within the EU), fears that immi-gration will add to the welfare burden are largely unfounded,though much depends on how welfare policies are designed. InAmerica, for instance, only those who have paid into the publicSocial Security (pension) scheme forat least ten years are entitledto benefits. A well-designed policy could make immigration andwelfare provision complementary.

The trouble is that at local level there is often a mismatchbetween the extra resourcesthat immigrants add and theextra demand they create. Ad-ditional pressures on localpublic services are a particu-lar problem in Britain, wherecentral government raises tax-es and allocates spending.Centralised budgets make itdifficult for local authorities torespond flexibly to changes inlocal conditions, and strictplanning rules limit the con-struction ofnew homes whendemand surges.

Some other Europeancountries deal with economicmigration rather better than

Britain does. In Denmarka lotof budgetary policy is madeat municipal level, says JacobKirkegaard of the Peterson In-stitute for International Eco-nomics. If an area has an in-flux of migrants, it receivesmore local tax revenues to ex-pand public amenities, buildmore schools, hire more doc-tors and so on.

Another concernamong natives has been thatimmigrants put downwardpressure on wages. In theorythey should, but empiricalstudies come to different con-clusions. On one side isGeorge Borjas, of HarvardUniversity, whose study in 2006 found that although immigra-tion did not depress overall wages between 1980 and 2000, it didhold down the pay of the low-skilled by 5-10%. On the other side,David Card, of the University of California, Berkeley, concludedthat there was no effect. His view was based on a study of the“Mariel boatlift”, an unexpected surge in Cuban migrants to Mi-ami in 1980. Mr Card reckoned that Miami had become accus-tomed to handling large inflows ofunskilled migrants. Mr Borjas

has recently looked at Mr Card’s analysis again and claims thathigh-school dropouts, a subset of the low-skilled native workersin Mr Card’s study, did in fact suffer a material fall in wages.

Until quite recently the academic literature treated mi-grants as substitutes for native workers. But what if they werecomplements; if low-skilled migrants helped to boost the pro-ductivity of low-skilled natives? Gianmarco Ottaviano, of theUniversity of Bologna, and Giovanni Peri, of the University ofCalifornia, Davis, find that forworkerswith at leasta high-schoolqualification, the wage effects of low-skill immigration are posi-tive ifyou drop the assumption that workers ofthe same age andeducation are perfect substitutes and that workers of one skilllevel, saycooks, do notaffect the productivityofworkers atotherskill levels, say waiters or restaurant managers. The effect on thewages of high-school dropouts is only mildly negative. A paperby Marco Manacorda, Alan Manning and Jonathan Wadsworth,of the London School ofEconomics, similarly concludes that im-migrants to Britain are imperfect substitutes for native-bornworkers, so they have little impact on natives’ job prospects orwages. New immigrants tend to affect only the pay ofrecently ar-rived immigrants.

From these muddy waters, it is possible to draw two tenta-tive conclusions about the broad impact of migration on wages.First, the effect on the bulk of low-skilled native workers hasbeen fairly muted—perhaps because the way work is donechanges in response to large-scale migration. However, the payofsome narrowcategoriesofworkers (say, farm labourers in Brit-ain or high-school dropouts in America) may still be affected.

To deal with the tension between immigration and the wel-fare state, three rules suggest themselves. First, make benefits

Many native workers see uncontrolled immigration as abreak with an implicit contract: that the state will lookafter its own

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SHANNON AIRPORT ON Ireland’s west coast has been agateway from Europe to America since the 1940s. It was

built across the estuary of the river Shannon from Foynes, asmall town that had served in the interwar years as a refuellingstop for seaplanes and passengers on their way across the Atlan-tic. A local chef, Joe Sheridan, came up with the idea of Irish cof-fee when he added whiskey to the hot drinks served to shiveringpassengers from a Pan Am flyingboat. In 1947 a cateringmanager,Brendan O’Regan, set up the world’s first duty-free shop at Shan-non, allowing transit passengers to buy tax-exempt goods.

Capital also disembarks in this part of Ireland, a countrythat, more than most, has been transformed by flows of capitalfrom other places. In the 1980s Ireland seemed destined to bewestern Europe’s perennial laggard: “The poorest of the rich”, asa survey by The Economist put it in 1988. But within a decade Ire-

land had transformed itself into the Celtic tiger, Europe’sunlikelyanswer to the booming economies ofSouth-East Asia.

Central to this shift were American companies seeking afoothold in the EU ahead of the creation of the single market ingoods in 1992 and lured by a well-educated, English-speakingworkforce. The state offered inducements, such as grants and alow corporate-tax rate. Intel, a chipmaker, started production inDublin in 1990. Other big firms followed. Boston Scientific, amaker of medical devices, set up shop in 1994 in Galway, anhour’s drive from Shannon. A medical-technology and pharma-ceutical cluster emerged in the region.

A textbook exampleThanks to foreign direct investment (FDI) of this kind, Ire-

land went from the poorest of the rich to among the richest. Itwas a textbook example of the benefits of capital flows. But Ire-land is also an archetype of the malign side-effects of capital mo-bility. As it became richer, other countries took exception to itslow corporate-tax rate, which they saw as simply a device to al-low global companies to bookprofits in Ireland and save tax.

The scale of the problem was highlighted in July when Ire-land’s statistical office revealed that the country’s GDP hadgrown by 26% in 2015. The figure said little about the health oftheIrish economy. First, itwas inflated by“tax inversions” in which asmall Irish company acquires a bigger foreign one and themerged firm is registered in Ireland to benefit from its low cor-porate taxes. Last year saw a rush of transactions before a clamp-down by America. Second, the GDP figures were distorted by theaircraft-leasing industry. The world’s two largest lessor fleets aremanaged from Shannon, though many of the 4,000 registeredaircraft will never touch down there.

But it is the damage wrought by short-term capital flows inIreland that is most striking. After the launch of the euro in 1999,would-be homeownerswere seduced by irresistibly lowinterest

Capital mobility

The good, the bad andthe ugly

Foreign direct investment is mostly welcome, butlarge short-term flows spell trouble

conditional on having paid into the system. Second, tie the fund-ing of local public services to local tax revenues to ensure anautomatic response to an influxofmigrants. Third, restrict migra-tion to prime-age, skilled workers who are more likely to get jobsand less likely to lose them in a recession.

But this may not be as straightforward as it sounds. Almosttwo-thirds of the new jobs that will be added to America’s econ-omy in the next decade will be low-skilled or mid-skilled jobs,according to a projection by the country’s Bureau of Labour Sta-tistics. Care workers, kitchen staff, auxiliary nurses and builderswill be in strong demand in Europe, too. Such demand may noteasily be met by indigenous workers, even at higher wages.

Will these jobs be filled in a black market or in a formal la-bour market? This is a question America has faced before. In the1980s the baby-boomers were moving towards middle age, caus-ing a spike in demand for young, low-skilled labour. This coin-cided with a demographic bulge in Mexico. An overhaul ofAmerica’s immigration rules in 1986 regularised those Mexicanworkers who had arrived before 1982. Henceforth work visaswould be granted only to high-skilled migrants. The interplay ofsupply and demand created a black market, causing the numberof illegal migrants to reach 12m in 2007, when policing of the bor-derwas stepped up. It was only quite recently that the flow ofmi-grants was reversed (see chart, previous page).

Europe now faces a supply-demand dynamic similar toAmerica’s in the 1980s. It has an ageing population, whereas onits doorstep, in the Middle East and Africa, populations areyoung and growing rapidly. A lesson from America’s engage-ment with Mexico is that a formal system for low-skilled immi-gration, perhaps with fewer entitlements than for skilled work-ers, is far preferable to turning a blind eye to informal migration.

Only within the EU’s borders is the free movement of peo-ple tied to the free movement of trade and capital. For the mostpart, enthusiasts forglobalisation have rooted onlyfor freer tradeand open capital markets, not migration. Yet many of them arenow having second thoughts about the benefits of unfetteredcapital too. 7

rates set in Frankfurt. Irish banks borrowed heavily in the eurointerbank market to fuel the property boom and to speculate onassetsoutside Ireland. Bankloans to the private sector grewbyal-most 30% a year in 2004-06, at the peak of the boom. When thatboom turned to bust, the country suffered a brutal recession andhad to be bailed out by the IMF. Ireland still bears the scars. Pre-liminary figures from this year’s census show that almost 10% ofhomes in Ireland are permanently empty. Some of the worst-af-fected areas are in the west of Ireland, up or down the coast fromShannon. Ghost estates and failed bed-and-breakfast places arethe legacy of a building boom that by 2007 had drawn one ineight ofall workers into the construction industry.

Unimpeded capital flows should be a boon. Like global freetrade, global capital markets offer broader opportunities. Moreand better openings usually make people richer. Globalised cap-ital breaks the tie between domestic saving and investment, giv-ing poor and low-saving countries the wherewithal to speed upGDP growth. For developing economies, capital mobility is aconduit for new technology, management know-how and busi-ness networks. It also allows investors to vote with their feet, en-couraging governments to follow prudent regulatory, monetaryand fiscal policies.

For a long time the liberal orthodoxy was against any kindof restriction on cross-border finance. A succession of financialcalamities, starting in Latin America in the 1980s and continuingwith the East Asian crisis of 1997-98, prompted a rethink. Ratherthan imposing discipline, access to foreign capital seemed to al-low countries to get into bigger messes. Whereas academics ar-gue about the pros and cons of free movement of goods or peo-ple, they now mostly agree that liberalising capital flows cansometimesdo more harm than good. Politiciansmayoccasional-ly rue the fickleness of international investors, but capital mobil-ity is not, for the most part, a target for popular anger in the wayfree trade and immigration often are.

There is plenty of evidence of the trouble that floods ofshort-term capital can cause. In a paper published earlier thisyear, Atish Ghosh, Jonathan Ostry and Mahvash Qureshi, of theIMF, identified 152 “surge” episodes (periods of abnormally largecapital flows) between 1980 and 2014 in 53 emerging markets. Afifth of such episodes subsequently led to a banking or currencycrisis. The surges most likely to end in tears were those made upmainly of cross-border bank lending; FDI-based ones were lesslikely to create trouble. The euro crisis in general, and Ireland’sspectacular banking bust in particular, have shown that the syn-drome is not confined to developing countries.

Markets for capital are error-prone in a way that markets forgoods are not. Stocks, bonds and property are subject to wild

swings in value. When capital moves across borders, these fail-ures are amplified by distance, unfamiliarity and exchange-raterisk. There is more scope for getting things wrong, and the result-ing economic crises are typically on a larger scale. It is fine for for-eign companies to build or buy offices, factories and infrastruc-ture, but the benefits offoreigners buyingbonds orstocks are lessobvious, and such investments tend to be volatile. Developingcountries’ financial systems are not necessarily equipped to putinflows of this kind to productive use, still less to handle theirsudden exit. Short-term foreign borrowing is often used to fi-nance long-term domestic loans. The mismatch becomes evenstarker when the borrowing is in foreign currency. And countriessubject to sustained inflows of hot money often contract “Dutchdisease”, a condition that drives up their currency beyond its fairvalue, leavingtheirexportbusinessesunable to compete in inter-national markets.

Filtering the flowsLimits on capital flows other than FDI thus seem like a good

idea. In 2012 the IMF conceded that capital controls of a tempo-rary and targeted nature were warranted, as a last resort, wherethe scale of capital inflows put financial stability at risk and con-ventional monetary or fiscal policy was unable to respond effec-tively. But what can be done to stop bad capital flows while let-ting through the good ones?

One approach is an entry (or Tobin) tax, proportionate tothe size of the capital inflow and levied at the time when curren-ciesare exchanged. Such a taxwould bearmore heavilyon short-term inflows. Until recentlycontrolsofthiskind were believed tohave little effect on capital inflows. But a recent paper by MarcosChamon, of the IMF, and Márcio Garcia, of PUC-Rio, suggeststhat they may be more effective than previously thought.

The authors looked at the experience ofBrazil, which in Oc-tober 2009 imposed a 2% entry tax on portfolio investments.This was meant to stop the country’s currency, the real, from ap-preciating further. It was soon raised to 4% and then to 6% inshort order. At first the measures did not seem to work, but thatchanged when in mid-2011 they were supplemented with a taxon the notional value ofderivatives. Messrs Chamon and Garciaestimate that up to 10% of the subsequent fall in the real was dueto the intervention.

Once the real had fallen, in 2012, Brazil started to dismantleits capital controls. But if hot-money flows are an ever-presentthreat, would it not make more sense to have controls perma-nently in place? Michael Klein, of Tufts University, makes a dis-tinction between “gates”, episodic controls in response to sud-den inflows ofa certain kind, and “walls”, long-standingcontrolson a broader range of assets. In a study of 44 countries between1995 and 2010, he concluded that gates do not curb exchange-rateappreciation, raise GDP growth or stop the build-up of financialrisks. But long-standing capital controls (walls) might.

The ten countries in Mr Klein’s study with capital “walls”,including China, on average saw a slower rate of growth in priv-ate debt relative to GDP and weakergrowth in banklending thanthe 34 other countries. They were also less likely to experienceabnormal capital surges. That suggests walls are effective. Butcountries with walls are generally poorer than countries withgates. And when MrKlein controlled forGDP perhead, the statis-tical distinction between gated and walled countries mostly dis-appeared. Neither type ofcapital control had much effect.

This is an awkward finding. In principle, the flexibility ofgates should make them a better instrument of control thanwalls, which can deter even the right sort of capital. Ideally capi-tal controls should be tightened as inflows intensify. But gatesmay be ineffective for practical reasons. The tax rate required to


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2 stem a flood of inflows might be unfeasibly high. And gates arelikely to be more permeable than walls, because countries withlong-standingcontrolswill have learned howto police capital in-flows effectively. China, for instance, has been able to control itsnominal exchange rate from behind its imposing capital walls.

The best policy might be a mixture ofboth. Not everyone isconvinced by Brazil’s experiment. It showed that a tax has to befairly high and broadly applied before it has much effect. Thatmakes itdifficult to levy itonlyon “bad” capital flows. And just asheavier policing in one area may simply shift crime to a neigh-bouring area, Tobin taxes may simply divert capital flows ratherthan deter them altogether. A study by Kristin Forbes, now amember of the Bank of England’s monetary-policy committee,and others suggests that Brazil’s Tobin tax encouraged emerging-market bond and equity funds to flood into other commodity-rich countries instead.

Observers with longer memories recall that before Brazil’sexperiment, Chile was held up as an exemplar of the wise use ofcapital controls. In the 1990s capital imports into Chile were sub-ject to an interest-free deposit of 30% of the investment. Chile’scentral bankhassince eschewed controls in favourofdirect inter-vention in currency markets (selling pesos to build reserveswhen inflows are strong), a policy that has the virtue of beinghard to circumvent. This helps guard against incipient Dutch dis-ease, but it does little to deter inflows. If the main worry is toomuch lending on property, then macroprudential policy is prob-ably a better bet. One useful measure is to limit the amountbanks can lend as a proportion of the value of the property.

A taxing questionEconomists in Ireland once made a distinction between the

Celtic Tiger phase of the country’s economic boom, which waspowered by FDI, and a second, “bubble”, phase, inflated by lowinterest rates and short-term capital. But these days FDI does notalways result in a new factory, research facility or office building,with new jobs to match it. Often it amounts to a transfer of intan-gible assets for the purpose of lowering corporate tax.

Ireland is among the world’s top countries for foreign directinvestment relative to GDP (see chart). Most of the others on the

list are also small countries with low rates of corporation tax.Luxembourg, for instance, accounts for10% of the stock of globalFDI but only 0.07% of world GDP. Competition is generally agood thing, but in matters of taxation that is not always true.

Multinational companies are able to avoid tax becausethere are so few generally agreed principles of cross-border tax-ation. One approach, taken in America, is to tax a company’s glo-bal income on the basis of where it is “resident” (where its head-quarters are), regardless of where its profits are made. A secondmethod, widely adopted in Europe, is to tax profits where theyare generated. In practice the two are often used in combination.“�

ou can play one country off against another so you’re not resi-dent anywhere,” says an expert on the subject.

Globalisation and the growing importance ofintangible as-sets, such as patents, have made concepts such as residence andsources of income much less useful. Supply chains are now socomplex that it is hard to know where a source-based tax on pro-fits should be applied. If the value of a drugs company lies most-ly in itspatents, forexample, it can move to a taxhaven and enjoylow taxes without uprooting any of its physical operations.

Purists argue that, since all taxes are ultimately borne by in-dividuals, there is little point in chasing elusive companies allover the globe; better to abolish corporation tax and increasesales taxes instead. There are two objections to this. First, for rea-sons of equity it may be preferable to tax shareholders ratherthan consumers. Second, corporate taxes make up a large shareof revenues in resource-rich poorer countries, where few work-ers are on formal payrolls and sales taxes are easy to evade.

One way of dealing with that might be a special regime ofroyalties or land taxes levied on mining companies. Michael De-vereux, a tax expert at Oxford’s Said Business School, predictsthat in the long run tax competition and avoidance will eroderich countries’ corporate-tax base. He proposes a value-addedtax with deductions for labour costs and other inputs. Thatwould approximate to a tax on excess profits, or “rents”.

True FDI is an unalloyed benefit. But the growingpractice ofusing offshore investment to avoid corporate tax might makecapital mobility the target of popular anger, alongside trade andimmigration. The EU’s case against Apple may be just the begin-ning. Many people see footloose global companies and deregu-lation as the handmaidens of the worst kind of corporate prac-tice. Yet economic ills such as weak real incomes, inequality andimmobile workers may be partly due to a failure to liberalise pro-duct markets further. 7

The growingpractice ofusingoffshoreinvestmentto avoidcorporatetax mightmakecapitalmobilitythe targetof popularanger


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IN “THE FUGITIVE”, a 1960s television drama, David Jans-sen plays Richard Kimble, a doctor wrongly convicted of

murdering his wife who escapes on the way to his execution. Heclaims, but cannot prove, that he encountered a one-armed manminutes before he discovered his wife’s dead body. After his es-cape he drifts from town to town trying to find the ghostly figureand to elude the man obsessed with recapturing him.

The damage that globalisation has done to America’s econ-omy is as obvious to some as Dr Kimble’s guilt was to his pursu-ers. Careful academic studies have linked competition by Chi-nese manufacturers to the growing propensity of prime-agedmen to drop out of the labour force. A pillar of trade theory saysthat increased commerce with labour-rich countrieswill depressthe payofthe low-skilled; and some reckoningsofwage inequal-ity in America pin part of the blame on trade and migration. GDP

growth has been sluggish during the long hangover from the fi-nancial crisis. The globalisation offinance provided the kindlingfor America’s subprime crisis and spread its effects around theworld. Globalisation is on the run. But might there be anotherbrigand who bears responsibility for its alleged crimes?

An intriguing line of research identifies an increase in theincidence of economic “rents” (profits over and above the levelsneeded to justify investment or input of work) as a possible vil-lain. A study last year by Jason Furman, of the Council for Eco-nomicAdvisers (CEA), and PeterOrszag, a formerbudgetdirectorfor Barack Obama, found that the top 10% of firms by profit havepulled away sharply from the rest (see chart). Their return oncapital invested rose from more than three times that of the me-dian firm in the 1990s to eight times. This is way above any plau-sible cost of capital and likely to be pure rent. Those high returnsare persistent. More than four-fifths of the firms that made a re-turn of25% or more in 2003 were still doing so ten years later.

Otherresearch suggests that this increasinglyskewed distri-bution ofprofitsgoesa longwayto explainingthe rise in wage in-equality. A paper in 2014 by Erling Bath, Alex Bryson, James Da-vis and Richard Freeman found that most of the growing

dispersion in individual pay since the 1970s is associated withvariations in pay between companies, not within them. In otherwords, the most profitable companies pay handsomely and peo-ple who workfor them earn more than the rest.

This finding was confirmed in a more recent study by Nich-olas Bloom and David Price, both of Stanford University, withothers, which found that virtually all of the rise in income in-equality is explained by a growing dispersion in average wagespaid by firms. This finding, the authors conclude, holds across allindustries, regions and firm sizes. One of the most striking impli-cations is that inequalitywithin firmshasnotchanged much: therelationship between managers’ and shop-floor workers’ pay ineach firm is still roughly the same. But the gap between what theaverage and the best firms pay theirworkers at all levels has wid-ened. Alan Krueger, ofPrinceton University, illustrated this pointnicely at a presentation he gave while workingat the CEA in 2013.Using data from the decade after 2003, he showed that wheremanagers are well paid, so are janitors (see chart).

More power, more profitThis wider range ofprofits is likely to be related to increases

in market power. Some of this is due to the rise of internet giants,which dominate their respective markets thanks to network ef-fects. But many of America’s industries have also become moreconcentrated by a slow creep of acquisitions. A study by The

Economist earlier this year divided the economy into 900-oddsectors covered by the five-yearly economic census and foundthat two-thirds of them were more concentrated in 2012 thanthey had been in 1997. The weighted average share of the totalheld by the leadingfourfirms in each sector rose from 26% to 32%.

America used to be famous for its workers’ willingness tofollowthe jobs, but theyhave become far lessmobile. A paperbyRaven Molloy and Christopher Smith of the Federal Reserve andAbigail Wozniak of the University of Notre Dame finds that overthe past three decades migration rates between states have fallenby at least a third for most age groups. For those aged between 20and 24, the most mobile group, the annual rate of internal migra-tion fell from 5.7% in 1981-89 to 3.3% in 2002-12.

Many of the reasons put forward for this are not whollyconvincing. It cannot be the rise of the two-income family, be-cause the trend to less mobility holds for workers ofall ages. Noris it the housing boom and bust: the decline in mobility startedlong before that, in the early 1990s, and has continued since. It iscertainly not trade unions (membership of which has declined),labour-market regulation or unemployment benefits, claims forwhich have dropped sharply.

A few researchers have made an intriguing link between

Deregulation and competition

A lapse inconcentration

A dearth of competition among firms helps explainwage inequality and a host of other ills

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2 the decline in labour mobility and wider profit dispersion. Theargument has several steps. The average age of established busi-nesses has risen steadily because fewer new firms are formed.Startups have a high labour turnover, but in mature firms fewerpeople join and leave in any given year. The lower the churn rateof jobs, the fewer the opportunities for job-changers to find newwork. So it is possible that less dynamism in American business,characterised by industry concentration and lower job turnover,has reduced the incentive for jobseekers to go and look for workin another state.

Another reason may be rent-seeking within the labourforce itself. Another paper from the CEA finds that the share ofAmerica’s workforce covered by state-licensing laws has risen to25%, from less than 5% in the 1950s. Much ofthis red tape isunnec-essary. On the most recent estimates, over1,000 occupations areregulated in at least one state but only 60 are regulated in allstates. The scope of the rules vary from state to state. A licensedsecurity guard requires three years of training in Michigan butonly around two weeks in most other states, for instance. Li-censed workers can command higher pay than the unlicensedkind because entry to the occupation is restricted, so consumershave to pay more.

Success storiesFor much of the past 40 years economic liberals have ar-

gued for the dismantlingofbarriers to the free flowof commerce,such as state monopolies, trade unions and restrictive practices.Such policies have produced some clear successes. In Britain theprivatisation of monopoly utilities, such as British Telecom, andthe opening up ofother sectors to competition was a spur to pro-ductivity and innovation, leading to better and cheaper servicesfor customers. In America the deregulation of airlines broughtlower fares and an increase in the number of trips. Labour mar-kets in America and Britain became more flexible, and unem-ployment has generally been lower than in continental Europe.

Deregulation is almost always a difficult task. Those whoseinterests are hurt by such reforms protest noisily. The political

costs quickly become apparent, whereas the gains may not be-come clear before the next polling day. It is even harder to makechanges when so many people feel that the cost of liberalisingmarkets in the past was unfairly distributed. Critics of such liber-alisation point to a decline in labour income as a share ofGDP asevidence that wage earners have the odds stacked against them.They argue that blue-collar workers provide the flexibility, hav-ing to accept lower pay and less job security, whereas white-col-lar workers and bosses are protected. Increased openness totrade and the growingmobility ofcapital have made it harder forworkers to push for pay rises, so they cling to the jobs they have.In an age of insecurity, it is hard to persuade anyone that theyshould give up such protections for the greater good.

Market power is supposed to be policed by competitionagencies, but they have lost some of their vim, particularly inAmerica, where competition cases are fought out in the courts. AlandmarkSupreme Court judgment in 2004 said monopoly pro-fits were the just reward for innovation. That has made it harderfor trustbusters to root out rent-seeking or block mergers. Mostbig firms got where they are by being good at what they do, notbecause ofcoddlingbyregulators. But iffirmscan hold onto theirmarket share for years, they create distortions in the rest of theeconomy. Incumbent firms are powerful lobbyists.

Big tech firms also have a penchant for so-called “shoot-out” acquisitions, whereby a startup is bought to eliminate abudding rival. For many tech startups and their financiers, a buy-out by one of the big platform companies is a badge of success.But if small firms cannot become independently big, the marketpower of incumbents is not sufficiently challenged.

Competition policy faces difficult questions in an age ofsu-perstarfirms thatdominate global markets. But the trickiest polit-ical problem for reformers is how to inject some dynamism intothe economy without getting people even more worried abouttheir livelihoods. Raising import tariffs or closing borders to peo-ple and capital is not the answer. Instead, policymakers shouldencourage more competition while putting in place adequateprotections for those who lose out from it. 7


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THERE MAY be few better advocates of the benefits toAmerica of an open economy than Pin Ni, boss of Wan-

xiang America Corporation, part of a private firm based inHangzhou that his father-in-law started as a bicycle-repair shop.Mr Ni launched the American subsidiary in 1994, suspending hisstudies at the University of Kentucky. He has been there eversince.

During the car-industry meltdown in 2007-09 the com-pany began buying moribund car-part suppliers and restoringthem to health. It pushed its acquisitions to concentrate on theirstrongest suits, usually the relationship with the car manufactur-ers and engineering. It helped them to source components morecheaply and to gain a foothold in the Chinese market. Mr Ni is ef-fusive about the prospects for American exporters. America hasfirms with technology and brands that are cov-eted around the world, he says.

Such optimism about globalisation is alltoo rare these days. Neithercandidate in Amer-ica’s presidential race is an advocate of freetrade. “If Trump is elected, it’s a mandate forisolationism,” says a seasoned observer at a think-tank in Wash-ington, DC. “If Clinton is elected, the best we can hope for is wedon’t go back very far.” Britain’s trading relationships with therest of the world are up in the air, following the vote in June’s ref-erendum to leave the EU. France is hostile to TTIP, a proposedtrade agreement between the EU and America. Even in Ger-many, the self-declared world export champion, politicians areturning against the deal in the face of public opposition. Global-isation is increasingly blamed for job losses, rising wage inequal-ity and sluggish GDP growth.

How should politicians respond? Closing borders to trade,capital and people would cause great harm and do very little totackle inequities in the economy. In some respects it would in-crease them. People on low pay spend a far greater proportion oftheir income on imports than the well-off. A growing body of re-search links economic maladies to more oligopolistic econo-mies. Blocking imports would only entrench the market powerof rent-seeking firms, further harming the prospects for higherproductivity and pay.

Easing the painAs borders have been steadily opened up, policies needed

to complement globalisation have not kept pace, particularly inAmerica. They need to catch up. A good place to start is demandmanagement. The stability of the labour market depends onmacroeconomic policies, not trade. In Europe the most effectivepolicy would be to use public money to fix the banks. With mon-etary policy overstretched and bond yields low ornegative, it is ashame that countries with room to borrow more, notably Ger-many, are seemingly addicted to thrift. The case for free trade isundermined when many countries in Europe are free to rack uppersistent trade surpluses, which are a drag on global demand.

In America and Britain, a strong case can be made for lock-ing in low-cost long-term funding to finance a programme to fix

potholed roads and smarten up public spaces. Private pensionfunds with expertise in infrastructure have a role to play in suchschemes. Rich-country central banks, notably the Federal Re-serve, can afford to be more relaxed about the threat of inflation.An economyat full peltbegins to drawpeople into the workforcewho were thought to have opted out for good. “Ex-felons weredoing pretty well in 2000,” notes Larry Mishel, of the EconomicPolicy Institute, a think-tank in Washington, DC. The risks ofslamming the brakes on too quickly outweigh those ofexcessivepolicy stimulus.

Demand management is (or ought to be) the bread and but-terofeconomic policy. Curing the ills that feed public oppositionto globalisation requires efforts to address two other problems.The first is the job churn caused by shifts in trade and technology.Too little effort and money has been expended on taking care ofthose who have been hurt by the opening up of markets. Ameri-ca in particular makes little attempt to assist people find newjobs to replace lost ones. Extra help need not blunt the incentivesto look for work. For instance, more generous jobless benefitscould be made conditional on attending a back-to-work pro-gramme. A valid criticism of government training schemes isthat they cannot keep up with the fast-changing demands of thejobs market. A better option would be a system of wage insur-ance. Thatwould nudge workers to acquire newskillsby takingaless well-paid job when they lose a good one.

Yet there is little point in helping people change careers if alack of dynamism in the economy means that too few good jobsare being created. So a second prong of reform should be to spurgreater competition so that startups can thrive and incumbentfirms are kept on their toes. More competition is a hard sell whenmany people are already anxious about their jobs and income;but without it there is less chance of the dynamism that boostsproductivity (and earnings) and creates new job opportunities.Europe has long been notorious for restrictive practices such asoccupational licences, but state-level licences in America haveproliferated almost unnoticed. Some are necessary, but most aresimply a way ofkeeping prices higher and restricting entry.

Competition policy needs to become more vigorous. InAmerica the startup rate (the share ofnew firms in the total num-

Saving globalisation

The reset button

How to make economic liberalism fairer and moreeffective

More competition is a hard sell when many people arealready anxious about their jobs and income



2 national companies. Such adeal would give national gov-ernments more rather than lesspolicy autonomy.

Sceptics say that thosewho stand to lose from globali-sation are given little thoughtwhen trade deals are signed.That is a fair point. But there isalso a risk of the opposite error:that the enormous good thatfree trade has done for the bulkof humanity in both rich andpoor countries over several de-cades is forgotten at times whenpeople are feeling anxiousabout it. The benefits of globali-sation are widely dispersed, of-ten unseen and thus all too easi-ly taken for granted.

There is a wrong-headedtendency to conflate support forliberal internationalism withpushing the interests ofbig com-panies to the detriment of theless well-off. The opposite istrue. This newspaper started in1843 to campaign for free trade ingeneral, and in particular for therepeal of the Corns Laws, whichincreased the price of importedgrain to the advantage of land-owners. Richard Cobden, the manufacturer who led the cam-paign against the Corn Laws, remarked that the main barrier torepeal was the self-interest of the landowning classes, the“bread-taxing oligarchy, unprincipled, unfeeling, rapacious andplundering.”

Cobden argued that free trade would have four benefits. Itwould underpin the success of British manu-facturing by providing access to bigger mar-kets. It would lower the price of imports, nota-bly food, for the poorer classes. It would makeEnglish farming more efficient by creatingmore demand for its products in cities andmanufacturing regions. And it would usher ina new era of international peace and amity byfostering trade that would be to the benefit ofall countries that tookpart in it.

In contrast to popular caricature, free-traders are enemies of rent-seekers and thosewho are tryingto protect theireconomic privi-leges. James Wilson, the founder of The Econ-

omist, said ofthe Corn Laws: “Theyare, in fact,laws passed by the seller to compel the buyerto give him more forhisarticle than it isworth.Theyare lawsenacted by the noble shopkeep-ers who rule us, to compel the nation to dealat their shop alone.”

What Cobden and Wilson argued in the19th century still holds. The free movement ofgoods, capital and people across borders is asource of greater choice and opportunity forthose on both sides of the trade. What givesthese arguments their force and staying pow-er is that they happen to be true. 7

Russia October 22nd

Espionage November 12th

Fossil fuels November 26th

ber) has fallen steadily since 1980. Most industries have becomemore concentrated. The profits of the leading companies havepulled well ahead of the rest. America’s courts have tended toview windfall profits as the rightful reward for innovation. Thereis much to be said for redrawing the boundaries of intellectualproperty so that incumbents can be more readily challenged.The growing habit of big tech firms to swallow startups thatmight become rivals is worrying. Such deals often suit bothsides—the buyer gets the innovation and the startup makes a lu-crative exit—but the practice saps dynamism from the economy.Trustbusters might be given more discretion when making judg-ments about how markets might evolve in future, though this isdifficult to do well.

Make it a threesomeAthree-pronged agenda ofdemand management, active la-

bour-market policies and boosting competition would go a longway to tackling the problems that are unfairly laid at the door ofglobalisation. But a lot of the policies to make globalisation workbetter need international agreement to be fully effective. For in-stance, tackling troublesome capital flows requires co-ordina-tion. A country might be able to head off capital inflows by tax-ing them, but it would only be diverting them to other countriesthat are more reluctant to impose capital controls. The bestcourse would be to have a global standard on what sorts of con-trols are permissible and in what circumstances. The goal shouldbe to ensure that individual countries retain control over theirmonetary policy.

One way to put a speed limit on short-term capital flows isto require asset managers globally to lock in investors in fundsspecialising in less liquid emerging or frontier markets. Long-term capital flows are generally more beneficial, but they willlose public support if they are seen primarily as a way of avoid-ing tax. There are few agreed international rules on the taxationof cross-border firms, though the OECD has started to work onthis. Dani Rodrik, of Harvard University, argues that a good wayto build public support for globalisation would be to link tradepacts with agreements on, for instance, the taxation of multi-

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