This ain't your father's free trade

Morgan Stanley Economic Digest 5/19/06; Stephen Roach: A Tale of Two Asias

All this raises a profound question for the rest of the world: If India is to services as China is to manufacturing, what role does that leave for the high-cost developed world? Down the road, if India also succeeds in pushing into manufacturing while China makes successful forays into services, the same question becomes all the more threatening to the world’s major industrial economies. Protectionism is the biggest risk in all this. IT-enabled globalization is pushing economic development into manufacturing and services at a breakneck pace. Moreover, IT-enabled connectivity has increasingly transformed once non-tradable services into tradables -- and has moved rapidly up the value chain and occupational hierarchy in doing so. The result is a mounting sense of economic insecurity in the developed world that has become a lightning rod for political action that, unfortunately, has unleashed an increasingly worrisome protectionist backlash.

This is not the experience that orthodox economics understands. The win-win theory of globalization -- workers in poor countries get rich through trade but then turn around and buy things made by rich countries -- just isn’t working. That’s because both the speed and scope of an IT-enabled globalization has broken the mold of the classic theory of comparative advantage. In days of yore, it was fine -- albeit painful -- for rich countries to give up market share in tradable manufactured products. That’s because highly-educated knowledge workers could seek refuge and shelter in nontradable services. However, with nontradables becoming tradable and with educational attainment and skillsets rising rapidly in the developing world, the security of the old way has all but vanished. Sadly, that provides both the justification and the opening for protectionists.

Of course with unregulated illegal immigration many of the "last resort" low end nontradables have become tradable as well. The high rollers are going to have to choose, do they want a managed pullback from the imbalances they have created or a messy unmanaged one (which judging from history, will be quite destructive and also quite ineffective at redistribution).