Free trade has not failed, quite the contrary
Sep 2021

Interview David Dorn

In the pandemic, the global economy was able to play to its strengths, says UBS Foundation Professor David Dorn. But globalization also creates net losers.

This interview by Lukas Leuzinger and Jannik Belser was first published in «Schweizer Monat, Ausgabe 1089 - September 2021». Translated and edited by the UBS Center, with permission.

Mr. Dorn, David Ricardo showed the benefit of free trade using the example of Portuguese wine and English cloth. Which products has free trade brought to Switzerland, that you are particularly happy about?

Currently I am particularly grateful for the vaccines against Covid-19: although some of these are produced in Switzerland, they would not be available to us without research carried out in the USA and components from various countries. The advantages of international exchange can be seen in numerous products: an everyday object such as a mobile phone already contains an incredible number of different parts that come from various countries. For a country like Switzerland, which is short of raw materials, it is simply inconceivable that such a product could be produced here in its entirety.

David Ricardo died in 1823. How has globalization changed since then?

World trade has increased sharply overall, with phases of expansion and contraction. The last major expansion was the globalization wave of the 1990's and 2000's, which lasted until the financial crisis of 2008. During this period, both the total volume of world trade and the international division of production chains increased enormously. With the collapse of state-controlled economies in the former Eastern bloc, many countries began to participate in world trade. China, formerly a very small player, quickly became a leading exporter. The catalyst was networking through the Internet, which made it possible to coordinate international supply chains, and the dismantling of trade barriers. In the last ten years, however, the enormous globalization boom has slowed down. Looking at volume of world trade, we have been on a high plateau for years.

So trade today is no longer just within the Western bloc, but actually worldwide. Does this have consequences?

In principle, trade with poorer countries gives them the opportunity to sell their products worldwide and to develop economically.

China, for example, gained access to much better machinery. These were essential for the country to increase its productivity allowing its economy to grow considerably within a short period of time and to become very competitive.

What role does China play in trade policy for the West today?

China is still an important exporter of goods such as textiles, toys and furniture. In recent years, more sophisticated products such as electronic devices, home electronics and machinery have been added to the range. There are hardly any differences between Western countries: In terms of size, they all import similar amounts of goods from China, and by and large the types of products are similar. On the export side, however, we see differences: countries like the US or the UK export much less to China than they import. Switzerland and Germany, on the other hand, have a relatively balanced trade with Beijing or even achieve a surplus.

Who benefits from free trade today? And who are the losers?

The companies involved in trade, by definition, derive a profit from trade - otherwise they would not be involved in the first place. Consumers profit from cheaply produced sneakers or laptops in the form of lower prices. It is only in the last ten years, however, that scholars have come to realize that there are also groups of people in Western countries who are net losers. Research I conducted with colleagues in the U.S. showed that there was a wave of factory closures in those industries that were facing very fast-growing Chinese import competition. The locations of these factories suffered permanent economic damage: even after the globalization surge levelled off over the last decade, one still sees lower employment and reduced incomes in the affected regions.

Many an economist would now reply: It's not so bad, people can be employed in other sectors.

In the U.S. in particular, it was assumed that workers were very mobile, that someone who lost his job would immediately move to another sector and perhaps even to another city. But we now know that even in the U.S. this mobility is very limited. When manufacturing plants close and people lose their jobs, unemployment often rises to the same extent - people often find it difficult to find employment in other industries.

Then economists who wholeheartedly advocate free trade are wrong?

Two mistakes have crept in: First, it has been pointed out that free trade usually leads to aggregate welfare gains. Therefore, in principle, the beneficiaries of a change could compensate for the losers, so that in the end everyone would win. The fact is, however, that in the U.S. in particular, where there is generally little redistribution, such compensation takes place only to a limited extent. Second, while trade theory recognized decades ago that trade between a country like the U.S., with many high-skilled workers, and a country like China, with many low-skilled workers, can lead to pressure on low-skilled wages in the first country. In reality, however, adjustments in the labor market often occur not through wage levels, but through the extent of employment: those workers who kept their jobs hardly suffered any reduction in their incomes - but there were more people who did not get any new jobs.

To what extent is globalization responsible for the increasing income inequality?

It certainly plays a role concerning inequality across Western countries. However, empirical analysis suggests that international trade explains only a small part of the increase in inequality between high and low skilled workers. Economic inequality depends on other crucial factors.

Which?

For example, the increasing concentration of supply in the modern economic structure. In many sectors, from retail to finance and even manufacturing, the largest firms are claiming an increasingly large share of the market. This has several consequences: On the one hand, large companies are often very profitable; within companies, a relatively large share of total income goes to the owners of capital, not to the employees. Since capital is highly concentrated, with only a few percent of the population owning the largest share of capital, large firms thus foster income inequality. On the other hand, the presence of dominant firms increases competition problems.

The U.S. has increased tariffs against China and other countries in recent years. Is this a promising response to the negative effects mentioned above?

The tariff dispute between the U.S. and China is undoubtedly a break: The fact that a nation like the U.S. is suddenly imposing tariff increases on a significant scale is new. Initial investigations show that the trade restrictions have almost exclusively had negative consequences. On the one hand, prices have risen for the goods on which the USA has imposed new tariffs. This has affected domestic consumers, as well as the manufacturing sector. On the other hand, studies show that the tariffs have not significantly increased employment in the industries concerned. Conversely, there have been job losses in sectors that have suffered from retaliatory tariffs, such as agriculture.

Is there anything at all that States can do to counter the negative consequences of globalization? Or do they simply have to accept the loss of jobs, for example in the textile industry?

A country loses market share in individual industries primarily when it is no longer internationally competitive in these sectors. If policymakers now try to restore competitiveness by closing off the domestic market, this is a risky situation for companies. It would be more successful for the companies to develop innovative products that other countries cannot easily produce. The step from former industrial city to an innovation hub has also been successful in some places in the past, for example in Seattle, where Microsoft led to the emergence of an IT cluster.

Can this be driven forward in a systematic way?

The evidence on this is mixed: To a certain extent, it is possible to encourage people to acquire skills in the IT sector, for example, or to support regions in becoming potential settlement areas for future. However, such measures require a lot of money, so the question of efficiency arises. Clustering also requires a complex interplay of factors: It is not enough, for example, to simply offer tax advantages to IT companies or to have a good local university.

What does increasing automation mean for the development of labor markets?

Technological development is an important reason for increasing income inequality. However, there is a crucial difference to globalization: In some countries, the globalization shock between 2000 and 2007 was extremely sudden. There were large factory closures, with thousands of people with very similar skill profiles becoming unemployed. These people then all looked for similar jobs, which made success enormously difficult for the individual. Technological change, on the other hand, is more gradual: it does not lead to the closure of entire factories, but rather to the continuous replacement of individual work steps by machines.

So the speed of a shock has a significant impact.

Yes, speed is crucial for labor market adjustment. But it is also a question of the extent to which a development not only causes old jobs to disappear, but also creates new ones at the same time. This is certainly the case with technological development: We see in the statistics, for example, how software development has become one of the most sought-after professions in the Western economy. When it comes to trade, it is more complicated: Countries like Switzerland or Germany, which have a relatively balanced trade with China, have created new jobs in booming export sectors. Other countries, such as the U.S. or the U.K., which import mainly from China, have seen their industrial employment plummet.

Can Switzerland, in the long term, defend its high wages while keeping unemployment low?

Compared to other countries, Switzerland has extremely high wages. This is basically a disadvantage in world trade, because it means high production costs for a company. However, the high wages are justified on the one hand by the high qualifications of the workforce, and on the other hand by the fact that Swiss companies produce highly innovative products. These products are competitive on the world markets thanks to their quality, for which a higher price is also acceptable. Switzerland is fundamentally dependent on innovation.

In the wake of the pandemic, commentators have spoken of a decline in globalization. Was this swansong premature?

The start of the pandemic was definitely a shock when, for example, we had virtually no supply at times of protective materials such as masks. However, this is not primarily a failure of trade, but a reflection of the fact that global demand for these items skyrocketed many times over within a few weeks. Free trade has not failed; on the contrary, it was an impressive achievement of the world economy that we were able to ramp up production capacities for protective masks to such an extent within a few weeks that we soon had full shelves in the supermarkets again. After the crisis, the question will certainly arise as to how far we want to keep potentially critical quantities in stock, and if necessary we may even have to consider our own emergency production capacities. However, such precautionary measures will cost money: if we keep large stocks of products for many years that will never be used, the political pressure to reduce stocks and cut costs will increase.

How do you see the future of globalization?

There is no new China in sight: Today, practically all countries in the world are part of the global market economy system. In this respect, there are no major gains to be made from further globalization at the present time. But there are also hardly any reasons why globalization should be slowed down.

Where do you see world trade in jeopardy?

The greatest threat to globalization is at the political level. The systemic competition between the Western democracies and China could lead to a split in certain technological areas: In the case of chip technology, for example, a Chinese and a Western technological universe could form, which are kept apart as separate systems by the actions of the respective governments. At the same time, business leaders in both China and the U.S. are aware of how much economic prosperity depends on mutual trade: When the U.S. launched the punitive tariff actions, there were numerous protests from the American business community. The most realistic scenario is that there will continue to be tensions between the West and China on trade issues. In other areas, which are of lesser strategic importance to policymakers, pragmatism will probably ensure cooperation. Climate change, too, may be an area where common approaches can emerge. Climate change, too, may be an area where common approaches can emerge.

In the pandemic, the global economy was able to play to its strengths, says UBS Foundation Professor David Dorn. But globalization also creates net losers.

This interview by Lukas Leuzinger and Jannik Belser was first published in «Schweizer Monat, Ausgabe 1089 - September 2021». Translated and edited by the UBS Center, with permission.

Mr. Dorn, David Ricardo showed the benefit of free trade using the example of Portuguese wine and English cloth. Which products has free trade brought to Switzerland, that you are particularly happy about?

David Dorn, UBS Foundation Professor of Globalization and Labor Markets
David Dorn, UBS Foundation Professor of Globalization and Labor Markets

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Free trade has not failed, quite the contrary.

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UBS Foundation Professor of Globalization and Labor Markets

David Dorn is the UBS Foundation Professor of Globalization and Labor Markets at the University of Zurich. He also serves as the Director of the University of Zurich’s interdisciplinary research priority program on “Equality of Opportunity.” He was previously a tenured Associate Professor at the Center for Monetary and Financial Studies (CEMFI) in Madrid, a Visiting Professor at Harvard University, and a Visiting Scholar at Boston University, MIT, and the University of Chicago.

Professor Dorn`s research connects the fields of labor economics, international trade, economic geography, macroeconomics, and political economy. In particular, he studies how globalization and technological innovation affect labor markets and society.

UBS Foundation Professor of Globalization and Labor Markets

David Dorn is the UBS Foundation Professor of Globalization and Labor Markets at the University of Zurich. He also serves as the Director of the University of Zurich’s interdisciplinary research priority program on “Equality of Opportunity.” He was previously a tenured Associate Professor at the Center for Monetary and Financial Studies (CEMFI) in Madrid, a Visiting Professor at Harvard University, and a Visiting Scholar at Boston University, MIT, and the University of Chicago.

Professor Dorn`s research connects the fields of labor economics, international trade, economic geography, macroeconomics, and political economy. In particular, he studies how globalization and technological innovation affect labor markets and society.