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baumol
suppose, for simplicity, that we are dealing with a two-country, two-good world, with one economy developed and at the technological frontier, while the other country, with similar population size and resources, is far behind in terms of productivity, technical competence, and per-capita income, particularly in the production of one of the traded commodities, thus giving the technological laggard a comparative advantage in supply of the other commodity. As any elementary economics textbook will tell you, this represents an opportunity for mutual gains from trade, with each country specializing in supply of the good in which it has a comparative advantage. Assume also, for easier exposition, that there is no further technical progress in the wealthier country, while in the other economy there is catch-up, made possible by globalization of technology, with equipment and ability approaching those in the wealthier country. Before the technical change, both countries could expect gains from trading, that is, they were both better off as a result of exchange than they would have been if each had produced for itself the quantities of the two commodities its inhabitants consumed. But if the technical progress in the laggard country favors the good in which it was most incompetent before, it can catch up in its productivity of that item sufficiently so that the comparative advantage of the other country in supply of that good can disappear. With the laggard country now equally far behind in the productivity of both goods, the gains from trade that both economies formerly enjoyed will also vanish. The poorer country may still gain from the process thanks to the technical progress it has experienced via learning from the industrialized economy. But the wealthier country in the interim will be worse off than it would otherwise have been. It will then be harmed, perhaps markedly and enduringly, by the technical progress in the other country. In short, this scenario shows the possible dangers to wealthier nations that arise from globalization. It does not mean that globalization is inherently undesirable, or that wealthier nations should never make sacrifices to help impoverished societies. But it does mean that we should not proceed under the illusion that we will assuredly profit from the process. (5)
we economists do have something to answer for. We are all too prone to put more faith in the implications derived from our quite appropriately simplified models, and to draw from those implications policies that really only apply universally in the artificial world of the constructed model. The recommendation to ourselves that seems appropriate here is advocacy of somewhat enhanced modesty when we do offer advice, and more ready willingness to remind our listeners that, though we are offering the best advice we are in a position to provide, they must recognize that the recommended course may yet prove dangerous to the public health.
------------------------------------The purpose of this appendix is to show more extensively the way in which long-run damage to some countries from globalization and outsourcing may occur. I therefore, turn to a model that permits an analysis of the issue in more universal terms. That issue can be described as the determination of the effect on the welfare of one country when an industry leaves that country and that industry's production is taken over by its trading partner. It will be seen that there are indeed some circumstances in which the transfer is mutually beneficial, but there is also a large range of cases in which the acquisition benefits the recipient economy but damages the other. I will also indicate the circumstances that lead to the one conclusion or the other. Specifically, it will be seen that when the country that is the recipient of the industry is initially sufficiently poor relative to the other country, the industry shift will yield mutual gains, so the pertinent relative income range is called the "zone of mutual gains." But when the two countries' incomes are closer together, the shift will benefit the recipient and harm the loser of the industry, making the pertinent income range a "zone of conflict
------------------------------------For simplification, it will be assumed that the world consists of two countries trading in n commodities and that each commodity is produced under conditions entailing scale economies (it must be emphasized that the analysis, albeit somewhat more complicated, applies essentially unchanged to cases of technical progress in industries from which scale economies are absent). While scale economies normally complicate analysis in economic theory, here it is a simplification because any assignment in which Country 1 is the exclusive producer of any m of the n traded commodities and Country 2 is the exclusive producer of the remaining n - m items becomes a (locally) stable equilibrium. That is so because if, say, Country 1 is the exclusive producer of good X, then if Country 2 were to attempt small-scale entry into X production the resulting absence of scale economy will prevent it from competing successfully. Hence, since each and every such specialized assignment of the n industries between the two countries is a stable equilibrium, in this model there will be a vast number of locally stable equilibria, a number that increases rapidly as n, the number of traded goods, expands. (7) The scale-economies premise will allow an examination of the range of distributions of industries and the implications of each possible distribution for welfare in the two countries.
For each distribution of industries and its corresponding equilibrium there will be a determinate level of national income, call it [y.sub.1] and [y.sub.2], for countries 1 and 2 respectively. Country 1's share of world income can be readily calculated from the trivial formula,
(1) Z = [y.sub.1]/([y.sub.1] + [y.sub.2]).
For each equilibrium, as a further simplification here, the welfare of country j will be measured as its national income, [y.sub.j]. Because it can be shown that Z, the share of world income received by Country 1, increases monotonically if it adds to the list of the n commodities of which it is the exclusive producer, Z will be used as the indicator of Country 1's share of industries, with 1 - Z obviously representing this magnitude for Country 2. Finally, at any equilibrium total world income in this two-country world can be calculated,
(2) [y.sub.w] = ([y.sub.1] + [y.sub.2]).
Proceeding with the aid of a graph, each possible equilibrium is represented by three dots, one for Country 1, the second for Country 2 and the third for the world. For example, the Country 1 dot in the graph for some particular equilibrium will show on the vertical axis, [y.sub.1], the income that this equilibrium yields to that country, and on the horizontal axis it will show Z, the share of world income that accrues to Country I in that equilibrium. The graph will show all of these equilibrium points as well as the upper boundaries of the region they fill for the world and for each of the countries, respectively. That will also enable us to see how a transfer of industries that increases one country's share at the expense of the other (that is, a change in Z) affects attainable world income and those of the two countries.We start off with a graph of world income as a function of Z, which, we will argue intuitively, is hill-shaped. This means that attainable world income is not at its highest when either country has succeeded in capturing for itself the bulk of the world's industries (the right-hand or left-hand ends of the graph where the Country 1 share index, Z, is close either to zero or unity). Rather, the attainable world income will be relatively high toward the middle of the graph, where each country has a substantial share of the trading industries. While this has not been found to be subject to what may be deemed "rigorous proof," it will be seen to be highly plausible. But that hill shape is all that it will be necessary to assume in order to derive conclusions and complete the analysis.
Figure 1 is the graph of the upper boundary of world income, with Z shown on the horizontal axis and [y.sub.w] on the vertical axis. The boundary need not be symmetrical, but as shown and already stated, it is assumed to be hill-shaped. There are two primary reasons that make this shape plausible. First, at either the right-hand or left-hand end of the graph, one of the countries contains almost all of the industries. Hence, its labor force will be fragmented among many products, producing them in small quantities and forgoing their scale-economies advantage. Second, the country that has the bulk of the industries at such a point will be producing many products for which it has no "natural" absolute advantage, such as climate or culture, so that some inefficiency must result. Only where the value of Z is far from either zero or unity are both these sources of output loss weakened, and hence the maximum point of the world income frontier will lie somewhere toward the center of the graph, as shown.[FIGURE 1 OMITTED]
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The shape of the upper income frontiers for the two countries from that of the world frontier can be immediately deduced. This follows from (1), and (2) which gives:
(3) [y.sub.1] = [Zy.sub.w] and [y.sub.2] = (1 - Z)[y.sub.w]
The first of these tells us at once that at Z = 0 the upper production frontier for Country 1 will equal zero and that as Z increases toward unity that country's frontier will approach the world frontier asymptotically. The frontier for Country 2 will be a distorted mirror image of that of Country 1, now moving from zero at Z = 1 toward the world frontier as Z approaches zero (see figure 2).
[FIGURE 2 OMITTED]
There is one more step that is necessary to complete the story.
We have:
Proposition: Let [Z.sub.w], [Z.sub.1], and [Z.sub.2], respectively be the value of Z at the maximum point of the world frontier, the Country 1 frontier and the Country 2 frontier. Then, if the world frontier is horizontal at its maximum and the maxima of the frontiers of the two countries are unique and differentiable near Zw, one must have [Z.sub.1] > [Z.sub.w] > [Z.sub.2].
Proof: The derivatives with respect to Z of the two relationships in (3) are
(7) [y.sub.1]' = [y.sub.w] + [Zy.sub.w]' and [y.sub.2]' = - [y.sub.w] + (1 - Z) [y.sub.w]'
and since at the maximum of the world frontier [y.sub.w]' = 0, it follows that at Z = [Z.sub.w]
(8) [y.sub.1]' > 0, [y.sub.2]' < 0
so that the Country 1 frontier rises toward the right of [Z.sub.w], the maximum point of the world frontier, while that of Country 2 rises as one moves toward the left. If the Country 1 and Country 2 frontiers were known to be convex, (8) as they appear to be in the figure, it would immediately follow that [Z.sub.] > [Z.sub.w] > [Z.sub.2].
It follows that the income share of Country 1 at which its own absolute income is maximal must be greater than that at which the absolute income of Country 2 is maximized. In other words, the Country 1 peak, [m.sub.1] of its upper income frontier, must always lie to the right of the Country 2 peak. Two corollaries also follow:
Corollary 1. At [Z.sub.1], the maximizing Z for Country 1, the largest absolute income available to Country 2 will be below (and, very plausibly, substantially below) the Country 2 maximum, [m.sub.2] (figure 2). The relative positions of the two countries will be reversed at [Z.sub.2].
Corollary 2. Between Z = 0 and Z = [Z.sub.2], both country frontiers can be expected to be upward sloping. Between Z = [Z.sub.1] and Z = 1, both frontiers will normally be downward sloping. In the region between [Z.sub.2] and [Z.sub.1], the Country 1 frontier can be expected to have a positive slope while that of Country 2 will be negative.
The two corollaries lead immediately to the pertinent economic interpretation of our result. First, it can be seen from corollary 1 that the point on the frontier of one of the countries that permits maximization of either country's income will condemn the other country to an income below, and plausibly well below, that other country's maximum. In other words, the trade process can inherently entail conflict of interests, with each country able to achieve its maximum only at the expense of the other.
Second, near Z = 1 Country 1 will have acquired too many of the world's industries for its own good. Because both frontiers have negative slopes in this neighborhood of the graph, a leftward move (that is, a reduction in Z), will make them both better off. Thus, if Country 1 is relatively very rich and Country 2 very poor, both can gain by a more equitable sharing of the world's industries. A similar situation holds near Z = 0, only this time with Country 2 having co-opted too large a share of the n industries for its own welfare. Because near Z = 0 or Z = 1 both countries can benefit simultaneously by a reallocation of industries in which some industries move from the richer to the poorer economy, these two outer regions are called the "zones of mutual gains," as noted earlier (see figure 3). In contrast, in the central region between [Z.sub.1] and [Z.sub.2], the slopes of the two frontiers are opposite in sign, so that any move that benefits one of the countries must be detrimental to the other. Any change in Z that brings a higher level of income to one of the countries must reduce that of the other. This zone of conflict is the region in which neither county is exceedingly poor, but one may well be considerably less affluent than the other.
The interpretation should be clear, and relates to the issue of the ubiquity of the long-run benefits of globalization. Thus, far from invariably leaving all economies better off, globalization can lead to increased prosperity in the less-affluent country at the permanent expense of the country that remains, or at least formerly was, in the vanguard. For globalization and the resulting transfer of intellectual property leading to improved products and processes can enable the economy that is somewhat behind, say Country 2, to increase its income share. But if its initial income share, [Z.sub.2], was located inside the zone of conflict, that must plainly be harmful to its trading partner, Country 1, and there is nothing inherent in the behavior of the model to undo the damage. The most direct implication is that US labor unions may well be right in their concerns about globalization and their resistance to policy measures that facilitate it.
3.) Economists generally agree that in productivity growth calculations it is appropriate to take account of any rise in the quality of the output. But it does not follow that a productivity growth index that takes no account of quality change is irrelevant and invalid. Rather, the proper choice between a quality-adjusted productivity index and one that is unadjusted depends on the purpose for which it is to be used. If the purpose is to study how the change in productivity affects what consumers are getting for their money, then the appropriate index is quality adjusted. On the other hand, if budgeting is the issue, it is the unadjusted figure that, arguably, gives the right answer. For instance, if city X has a 2 million annual attendance at its public schools, and last year the cost per pupil was $9,000, then a 10 percent growth in unadjusted productivity (brought about, presumably, by an increase in average class size) can be expected to bring that cost down by $900, regardless whether the quality of the teaching has or has not increased and resulted in an improvement in student grades on standard tests. This logic also explains why the cost of health-care services continues to rise so quickly despite the extraordinary improvements in medical technology.
(4.) A few economists have recently claimed to have shown that the cost disease has been cured or is "in remission." To see that this is far from the reality, one need just ask anyone supporting a child in college or paying hospital bills. These writers assert that the services as a group have no cost-disease problem because of the falling costs of high-tech services such as computation. My coauthor, William G. Bowen, and I recognized three decades ago, using telecommunications as an example, that such declining-cost services are not subject to the cost disease. Nothing has changed since then, except that computer services have become more important and pulled up the average productivity performance of the services as a whole.
Posted by js paine at August 4, 2006 04:28 PM