The Debate on Competitiveness,

Labour markets and Globalization

Competitiveness: “A Typical Statement
about International Economics”
1. “We need a new economic paradigm, because today
[our country] is part of a truly global economy.
2. To maintain our standard of living, [our country]
now has to learn to compete in an ever tougher
world marketplace
3. That’s why high productivity and product quality
have become essential
4. We need to move [our country’s] economy into the
high-value sectors that will generate jobs for the
future
5. And the only way we can [achieve this is to] forge a
new partnership between government and business”
Paul Krugman (1993) What Do Undergrads Need to Know About Trade?
The American Economic Review. Vol. 83(2): 23–26
The Need for a New Paradigm?
M. Porter (1990): The Competitive Advantage of Nations
• “A new theory must explain why firms from particular
nations choose better strategies than those from others
for competing in particular industries” (p. 19)
• “A new theory must move beyond comparative
advantage to the competitive advantage” (p. 20)
• “...the best measures [of competitive advantage are] (1)
the presence of substantial and sustained exports to a
wide array of other nations and/or (2) significant
outbound foreign investment based on skills and
assets created in the home country” (p. 25)
The Need for a New Paradigm?
• Krugman (1993)
o “probably the most important single insight an
introductory course can convey about
international economics is that it does not
change the basics: trade is just another
economic activity, subject to the same principles
as anything else”
Competing in
“an ever tougher world marketplace”
• President Clinton: each nation is “like a big
corporation competing in the global marketplace”
• Some bestselling titles
o Lester Thurow: Head to Head. The Coming Economic
Battle among Japan, Europe and America
o Jeffrey Garten: A Cold Peace: America, Japan and
Germany and the Struggle for Supremacy
o Ira Magaziner & Mark Patinkin: The Silent War

See P. Krugman (1995): The Illusion of Conflict in International Trade. Peace Economics,
Peace Science, and Public Policy (also in Pop Internationalism)
Competitive Advantage: Firms
• Competitive advantage of a firm
o “competitive strategy is about taking offensive or
defensive action to create a defendable position in an
industry, in order to cope successfully with competitive
forces and generate a superior return on investment”
(Value Based Management.net)

• if a firm is not competitive, it will bankrupt

• Firm’s competitiveness can be measured trough
profits / return on investment etc.
Competitive Advantage: Countries
• Countries are not companies
o while firms based in different countries sell products
that compete with each other, in the country-level there
are mutual benefits from trade
o Success of one country is likely to benefit other
countries (more demand for imports)
o The only meaningful “offensive or defensive action” in
the level of a country is strategic trade policy
• Imports are the purpose of trade
→ exports / current account is not the “bottom line” of a
country in a way profits are for a firm
 Competing in
“an ever tougher world marketplace”
P. Krugman (1994): Competitiveness: A Dangerous Obsession. Foreign Affairs

“While competitive problems could arise in

principle*, as a practical, empirical matter the
major nations are not to any significant
degree in economic competition with each
other”

* the terms-of-trade argument of strategic trade policy

What does “Competitive Advantage
of a Nation” mean, anyways?
• Porter (1990):
o “the only meaningful concept of
competitiveness at the national level is national
productivity”
• Krugman (1994):
o ”competitiveness” would turn out to be a funny
way to saying “productivity” and would have
nothing to do with international competition
“A Typical Statement about International
Economics”
1. “We need a new economic paradigm, because today
[our country] is part of a truly global economy.
2. To maintain our standard of living, [our country]
now has to learn to compete in an ever tougher
world marketplace
3. That’s why high productivity and product
quality have become essential
4. We need to move [our country’s] economy into
the high-value sectors that will generate jobs for
the future
5. And the only way we can [achieve this is to] forge a
new partnership between government and business”
 Why Productivity Matters?
• Example:
o productivity of a closed economy increases by 1 %
→ the consumption possibilities increase by 1%
o productivity of country A increases by 1 %, and
productivity of country B by 3 %
→ A’s consumption possibilities increase by 1%, B’s by
3% (unless there is a substantial terms-of-trade effect*)
• That is, productivity is beneficial for its own sake,
not because it helps us “to compete in the world
marketplace”
* In this case, it would be likely that the prices of the goods B is exporting would decrease (due to
increase of supply). That is, A’s consumption possibilities would increase by more than 1%
High-Value Sectors…
• “Our country’s real income can rise only if (1)
its labour and capital increasingly flow toward
businesses that add greater value per employee
and (2) we maintain a position in these
businesses that is superior to that of our
international competitors”
Ira Magaziner and Robert Reich (1982): Minding America’s Business. p. 4
“High-Value Sector” in a Simple
Ricardian Model
• England is more efficient in Cloth Wine
producing both products →
England’s wage rate will always be
higher England
1 hr. / 3 hrs. /
• England has comparative yd. bbl.
advantage in producing cloth →
in free trade England produces 2 hr. / 4 hrs. /
cloth → cloth is the “high-value” Portugal
yd. bbl.
sector
• Does this mean that the
Portuguese government should
promote reallocating resources to
produce cloth? Of course not.
 …that will generate jobs for the
future
• Krugman: “level of employment is a
macroeconomic issue depending
o in the short-run on aggregate demand
o in the long-run natural rate of unemployment
• with microeconomic policies like tariffs having
little net effect”

Paul Krugman (1993) What Do Undergrads Need to Know About Trade?

The American Economic Review. Vol. 83(2): 23–26
“A Typical Statement about International
Economics”
1. “We need a new economic paradigm, because today
[our country] is part of a truly global economy.
2. To maintain our standard of living, [our country]
now has to learn to compete in an ever tougher
world marketplace
3. That’s why high productivity and product quality
have become essential
4. We need to move [our country’s] economy into the
high-value sectors that will generate jobs for the
future
5. And the only way we can [achieve this is to]
forge a new partnership between government
and business”
A New Partnership between Government
and Business?
Robert Gilpin (2001): Global Political Economy: Understanding the international economic order.
Princeton University Press. p. 210-214

• “Governments can and do have an important

and even decisive role in promoting their own
national firms in international markets”
• “a government can take a long-term perspective
and establish policies that foster a favourable
domestic environment for those sectors most
likely to be competitive in international
markets”
A New Partnership between Government
and Business?
= infant industry argument
Remember from last lecture:
• Key assumption: market failure (due to
externalities, imperfect capital markets etc.)
• Problems
o identifying the right industries
o Time consistency: will the protection eventually
become permanent?
Partnership between Government and
Business?
• Krugman (1993):
o “the main competition going on is one of U.S.
industries against each other, over which sector
is going to get the scarce resources”
o “there are reasons, such as external economies,
why a preference for some industries over others
may be justified. But this would be true in a
closed economy, too”
 The Dangers on Obsession on
International Competitiveness
1. Wasteful spending of government money
2. Inefficient allocation of resources
o resources from nontradables to tradables
3. Possibility of protectionism & trade wars
4. Indirect impact on the quality of economic
policy making in general

P. Krugman (1994): Competitiveness: A Dangerous Obsession. Foreign Affairs

(also in Pop Internationalism)
The Globalization Debate
• The term “globalization” is so overused that it is not
clear what it means.
o Economists would think about things like trade, factor
mobility and diffusion of technology
o Other discussants (trade unions, environmentalists,
development lobbyist, consumer groups, human right activists,
religious groups, utopians…) often seem to talk about (alleged)
increased power of large companies and “Americanization”
• One of the main topics is the impact on labour
market, something we already discussed in the
empirical part of the course. Let’s now revisit the
subject.
 Rodrik: Shift and Increased Elasticity
of Labour Demand
capital-abundant country
• Autarky → Free trade and wage
capital flows SL

• (1) Demand for labour

shifts inward in capital- (1)
abundant countries (2)

wA
• and (2) the demand curve pFT
becomes more elastic DLFT
(change in wage rate creates now larger
impact on quantity of employment, i.e. DLA
production can be moved abroad)
QLFT QLA employment

Dani Rodrik (1997): Has Globalization Gone too Far?

Available at Institute for International Economics website.
 Elasticity of Labour Demand and
Imposing Labour Standards
S’L
• Assume that higher labour wage
standards are imposed (creates SL

a new cost) → supply curve

shifts upward → wages
increase, employment
decrease E
• The more elastic the demand W

the more employment DLFT

decreases, wages decrease and
the larger share of the cost is employment
E = employers share of the cost
paid by employees W = worker’s share
 Impact of Globalization on Rich
Countries’ Labour Markets
• Open economies are more responsive to changes in
prices, including wages
→ Costs of improved working conditions cannot be shared
with employers as easily as before (see previous slide)
→ Increased volatility of wages and/or employment
→ Decrease in labour’s bargaining power
→ There are sound basis to argue that globalization
will have an adverse impact on capital-abundant
countries low-skilled workers
• However, since the aggregate gain from free trade is larger than
the aggregate loss, it is possible to compensate the losers and
achieve a Pareto improvement. This might also explain the
welfare states of some small, open economies.
Dani Rodrik (1997): Has Globalization Gone too Far?
Available at Institute for International Economics website.
Globalization and
the Poor Countries’ Workers
• “Hopefully, there is presently no actual concentration
camps anywhere. Instead […] some sort of labour
camps seem to have become an essential part of our
time”
Ville Päivänsalo (referring to working conditions in the developing
world) in Helsingin Sanomat, opinion pages, 31 October 2004

• “China’s rapid growth over the past two decades has

delivered more people from desperate poverty, more
quickly, than ever before. This does not suggest
exploitation. Moreover [those] who have fled rural
China to work in factories […] were not forced to do
so by anything other than their poverty at home”
Martin Wolf (2004, 185) in Why Globalization Works?
 Impact of Globalization on Poor
Countries’ Labour Markets
• Globalization critics
o developing world workers are not able to
bargain efficiently and are thus exploited → rich
countries should impose universal minimum
standards (wages, working conditions etc.)
• Mainstream economists
o trade and FDI increase the demand for labour
(and productivity) in the developing world →
labour markets become “tighter”* → wages and
working conditions improve
* By “tighter” it is meant that there will be more opportunities from employees to choose
from. In other words, their “outside option” increases, which increases their bargaining power.
Imposing Minimum Standards to the
Developing World (1)
• Assume a developing country with most of the labour force
employed in unproductive agriculture
→ wages are set in agriculture (opportunity cost of not working in
modern sector) → wages in modern sector are less than labour’s
marginal product
→ (1) capital owners make very large profits
→ (2) more labour flows to the modern sector
→ less supply of labour in the agriculture → higher wages in
agriculture → higher wages in the modern sector (i.e. the overall
wages increase)

Martin Wolf (2004, 186): Why Globalization Works? Yale University Press
Imposing Minimum Standards to the
Developing World (2)
• Assume, now, that the labour in modern sector is
paid their marginal product
→ (1) capital owners make normal profits
→ (2) no/less labour flows to the modern sector
→ dual labour markets
ƒ low incomes to the majority in agriculture
ƒ high incomes for the few in modern sector

• “Indian workers are so well protected from exploitation by

industrial bosses that they have no jobs at all. The exact
opposite happened in South Korea and Taiwan”

Martin Wolf (2004, 187): Why Globalization Works? Yale University Press
 Child Labour
• Approximately 250 million children (5–14 years old)
are working, 70 percent of them in agriculture and
about 10–15 million in export industry
o “These children work not because their parents (if they
have any) are more wicked than those anywhere else, but
because of their poverty. Nothing is better established
than the tendency for better-off parents […] to have fewer
children and to invest more in their education”
o “Imposing export sanctions on countries is a way to
penalize them on their poverty while taking away the best
ladder out of it”
• Effective policy: Aid education of poor children and
(if necessary) compensate for the incomes lost
Martin Wolf (2004, 187-188): Why Globalization Works? Yale University Press.
See also, Jagdish Bhagwati (2004): In Defense of Globalization. Oxford University Press