A Ne\M Deal forGloba\tzation

Kenneth E Scbepe and Mattbew J. Slaugbter

W A G E S F A L L I N G , P R O T E C T I O N I S M R I S I N G

OvBn tnn last severalyears, a striking new feature ofthe U.S. economyhas emerged: real income growth has been extremely skewed, withrelatively few high earners doing well while incomes for most workershave stagnated or, in many cases, fallen. Just what mix of forces isbehind this trend is not yet clear, but regardless, the numbers arestark. Less than four percent of workers were in educational groupsthat enjoyed increases in mean real money earnings from 2ooo tozoo;;mean real money earnings rose for workers with doctorates andprofessional graduate degrees and fell for all others. In contrast toin earlier decades, today it is not just those at the bottom of the skillladder who are hurting. Even college graduates and workers withnonprofessional master's degrees saw their mean real money earningsdecline. By some measures, inequality in the United States is greatertoday than at any time since the r9zos.

Advocates of engagement with the world economy are now warningofa protectionist drift in public policy.This drift is commonlyblamedon narrow industry concerns or a failure to explain globalization'sbenefits or the war on terrorism.These explanations miss a more basicpoint U.S. policy is becoming more protectionist because the American

K n w N n r u F. S c n n v B is Professor of Political Science at Yale University.MatrHpw J. SlaucH'rBn is Professor of Economics at the TirckSchool of Business at Dartmouth and Adjunct Senior Fellow for Businessand Globalizationat the Council on Foreign Relations. He served on the

. White House Council of Economic Advisers from zoo5 to 2oo7.

[ :+]

A Nea; Dealfor Globalization

public is becoming more protectionist, and this shift in attitudes is aresult of stagnant or falling incomes. Public support for engagementwith the world economy is strongly linked to labor-market perfonnance,and for most workers labor-market performance has been poor.

Given that globalizatton delivers tremendous benefits to the U.S.economy as a whole, the rise in protectionism brings many economicdangers. To avert them, U.S. policymakers must recognize andthen address the fundamental cause of opposition to freer tradeand investment.They must also recognizethatthe two most commonlyproposed responses-more investment in education and more tradeadjustment assistance for dislocated workers-are nowhere nearadequate. Significant payoffs from educational investment will takedecades to be reaLized, and trade adjustment assistance is too smalland too 4arrowly targeted on specific industries to have much effect.

. The best way to avert the rise in protectionism is by institutinga New Deal for globalization-one that links engagement with theworld economyto a substantial redistribution ofincome. In the UnitedStates, thatwould mean adopting a fundamentally more progressivefederal ta;r system. The notion of more aggressively redistributingincome may sound radical, but ensuring that most Americanworkers are benefiting is the best way of saving globalization froma protectionist backlash.

R I S I N G P R O T E C T I O N I S M

U.S. rcoNoMlc pot,lcy is becoming more protectionist. First,consider trade. The prospects for congressional renewal of PresidentGeorge W. Bush's trade promotion authoritf which is set to expirethis summer, are grim. The rogth Congress introduced z7 pieces ofanti-China trade legislation; the uoth introduced over a dozen injust its first three months. In late March, the Bush administrationlevied new tariffs on Chinese exports of high-gloss paper-reversinga zo'year precedent of not accusing nonmarket economies of illegalexport subsidies.

Barriers to inward foreign direct investment (ru) are also rising.In zoo5, the Chinese energy company cNooc tried to purchase U.S.-headquartered Unocal.The subsequent political storm was so intense

FO RE I GN AF FAIRS . July/August 2oo7 [rs]

Kenneth E Scheve and MattheatJ. Slaughter

that cNooc withdrew its bid. A similar controversy erupted in zoo6over the purchase of operations at six U.S. Ports by Dubai*basedDubai Ports World, eventually causing the comPany to sell the assets.The Committee on Foreign Investments in the United States, whichis legally required to review and approve certain foreign acquisitionsof U.S. businesses, has raised the duration and complexity of manyreviews. Both chambers of the rogth Congress passed bills to tightencFIUS scrutiny even further; similar legislation has already passed inthe current House.

This protectionist drift extends to much of the world. The DohaDevelopment Round of trade negotiations, the centerpiece of globaltrade hberahzation, is years behind schedule and now on the brink of

collapse. KeyU.S. trading partners are becoming increasingly averleto foieign investment, as expressed both in their rhetoric (recent gubligpronouncements by the governments of France and Germany) andin their actions (tt.* restrictions in China on foreign retailers).

At first glance, this rise in protectionism may seem puzzling. The

economic gtittt from globahzation are immense.In the United States,according to estimates from the Peter G. Peterson Institute for Inter-national Economics and others, trade and investment liberalizationover the past decades has added between $5oo billion and $r trillion

in annualincome-between $r,65o and $3,3oo ayer for everyAmer-ican. A Doha agreement on global free trade in goods and serviceswould generate, according to similar studies, $5oo billion a year inadditional income in the United States.

International trade and investment have spurred productivirygrowth, the foundation of rising ayeruge living standards. The rateof inct."te in output per worker hour in the U.S. nonfarm businesssector has doubl.a in the past decade, from an annual average ofr.35 percent between ry73 and1995 to an annual average of 2.7 percentsince 1995. Much of the initial acceleration was related to informationtechnoiogy (lr)-one of the United States' most globally engagedindustriei, at the forefront of establishing and expanding productionnetworks linked by trade and investment around the globe.

Gains from globalization have been similarly large in the rest of theworld. China and India have achieved stupendous rates of productivirygrowth,lifting hundreds of millions of people out of poverty. Central

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Globalization at Risk Wages Dropping, Inequality Rising

to this success has been the introduction of market forces, in particularinternational market forces related to trade and por. In Chinese man-ufacturing, foreign multinational companies account for over half ofall exports. And in the Indian rr secto! Indian and foreign multinationalfirms account for r'wo-thirds of sales.

Freer trade and investment can also enhance other foreign policygoals.The Doha Round was launched shordy after g/nbecause of theview that global poverty is intimately linked to international insecurity andinstability.The Doha Roundwas also intended to remedythewidespreadperception that previous rounds of trade negotiations had ffeated poornations unfairly by failing to open the very sectors-such as agriculturwhose openness would most likely help the world's poor. Accordingly,it is believed that a successf,rl Doha agreementwould enhance the UnitedStates'image and promote its interests around the world.

FO RE I GN AF FAIRS . July/August 2ooz lstl

QnnrnrvrNcELrrEAs most categories ofworkers experiencedfalling earnings,Americans at the verytop ofthe educationalladder saw. theireunings grow-Inequalityhas been on the rise.

lounct: US. Buru of Lrbor St.ti6tic6.

Kenneth E Scheae and MatthewJ. Slaughter

There are three common explanations forwhyprotectionism is on therise in the United States even though globalization is good for boththe U.S. economy and U.S. security interests. None, however, is convinc-ing. The first is that a narrow set of industries, such as agriculture andapparel manufacturing have been harrnedbyfreer trade and, in response,have lobbied hard to turn lawmakers against liberalization. But theincentives for these industries to oppose globalization have not changedin recent years, and there are also many industries that have benefitedfrom, and thus lobbied for, furtherliberchzatton. What is new today isthat special-interest protectionists are facing a more receptive audience.

The second explanation is that policymakers and the businesscommunity have failed to adequately explain the benefits of freertrade and investmentto the public. Butin fact,public-opinion data showthe opposite: large majorities ofAmericans acknowledge these broadbenefits. If anything, the public seems to understand certain benefitsbetter than everfor example, that its enjoyment ofrelatively affordabletoys, DvD players, and other products depends on globalization.

Finally, there is the security explanation: that the need to balanceeconomic interests with national securify concerns has resulted in amore protectionist stance. This may help explain policy debates oncertain issues, such as immigration. But generally, security concernsstrengthen rather than weaken the case for further trade and invest-ment libenhzation, as long as such liberalizatton is viewed as fair tothe developing world.

T H E R O O T S O F P R O T E C T I O N I S M

Tne TuNDAMENTAI explanation is much simpler: policy is becomingmore protectionist because the public is becoming more protectionist,and the public is becoming more protectionist because incomes arestagnating or falling. The integration of the world economy hasboosted productivity and wealth creation in the United States andmuch of the rest of the world. But within many countries, and certainlywithin the United States, the benefits of this integration have beenunevenly distributed-and this fact is increasingly being recognized.Individuals are asking themselves, "Is globalizationgood for me?" and,in a.growing number of cases, arriving at the conclusion that it is not.

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A Mat Dealfor Globalization

This account of rising protectionism depends on two key facts.First, there is a strong link benareen individuals'labor-market inter-ests and their policy opinions about globalization. Second, in the pastseveral years labor-market outcomes have become worse for manymore Americans-and globahzation is plausiblypart ofthe reason forthis poor performance.

R.r..t.h on polling data shows that opinions about trade,-ror, andimmigration are closely correlated to skill and educational levels; Lessskilled Americans-who make up the majority of the U.S. laborforce-have long led opposition ro open borders. Workers with onlyhigh school educations are almost rwice as likely to support protec-tionist policies as workers with college educations are.

This divide in opinion according ro skill level reflecs the impactthat less skilled Americans expect market hbenhzation to have ontheir earnings. It also reflects their actual poor real and relative earningsperformance in recent decades. It is nowwellestablished that income inequaliry acrossskill levels has been rising since (dependingon the measure) the mid- to late r97os andthat the benefits of productivity gains overthis time accrued mainly to higher-skilledworkers. For example, from ry66 to 2oor., themedian pretax infl ation-adjusted wage andsalary income grewjust u percent-versus 58

Given a lack of incomegrowth for mostAmericans, skepticismabout globilization isnotwithout cause.

percent for incomes in the goth percentile and rzl percent for those inthe 99th percentile. Forces including skill-biased technological changeplayed a major role in these income trends; the related forces ofglobat-izatron seem to have played a smaller role-but a role nonetheless.

There are two important points about this link between policyopinions and labor-market skills and performance. One is that it doesnot simply reflect different understandings of the benefits of global-ization. Polling data.arevery clear here: large majorities ofAmericansacknowledge the manybenefits ofopen borders-lower prices, greaterproduct diversity, a competitive spur to firms-which are also high-lighted by academics, policymakers, and the business community.At the same time, they perceive that along with these benefits, openborders have put pressures on worker earnings.

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Second, a worker's specific industrydoes not appear to drive his view otglobalization. This is because com-petition in the domestic labor marketextends the pressures of globalizaaonbeyond trade- and foreign-investment-exposed industries to the entireeconomy. If workers in asector such as automobilemanufacturing lose theirjobs, theycompete for newpositions across sectors-and thereby put pres-sure on pay in the entireeconomy. What seems tomatter most is what kindofworkeryou are in terms ofskill level, rather than whatindustryyou work in.

The protectionist drift also depends on worsening labor-marketoutcomes over the past several years. By traditional measures'such as employment growth and unemployment rates, the U.S.labor market has been strong of late. Today, with unemploymentLt 4.Spercent, the United States is at or near full employment. Butlooking at the number ofjobs misses the key change: for severalyears running, wage and salary growth for all but the very highestearners has been poor, such that U.S. income gains have becomeextremely skewed.

Ofworkers in seven educational categories-high school dropout,high school graduate, some college, college graduate, nonprofessionalmaster's, Ph.D., and M.8.A.4.D./M.D.-only those in the lasttwo categories, with doctorates or professional graduate degrees,experienced any growth in mean real money earnings between 2oooand zoo5. Workers in these two categories comprised ottly3.+ percentofthe labor force in zoo5, meaning that more than 96 percent ofU.S.workers are in educational groups for which average money earningshave fallen. In contrast to in earlier decades, since 2ooo even college

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graduates and those with nonprofessional master's degrees-zg percentofworkers in zoo5-suffered declines in mean real money earnings.

The astonishing skewness ofU.S. income growth is evident in theanalysis ofother measures as well.The growth in total income reportedon til( returns has been extremely concentrated in recent years: theshare of national income accounted for by the top one percent ofearners reached zr.8 percent in zoo1-a.level not seen since 1928. Inaddition to high labor earnings, income growth at the top is beingdriven by corporate profits, which are atnearly 5o-year highs as a shareof national income and which accrue mainly to those with high laborearnings. The basic fact is clear: the benefits of srrong productivitygrowth in the past several years have gone largely to a small set ofhighly skilled, highly compensated workers.

Economists do not yet understand exactly what has caused thisskewed pattern of income growth and to what extent globalizationitself is implicated, nor do they know how long it will persist. Still, itis plausible that there is a connection. Poor income growth has coin-cided with the integration into the world economy of China, India,and central and eastern Europe. The lr revolution has meant that

()'nt$-ryu"

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Kenneth E Scheve and MattheuJ. Slaughter

certain workers are now facing competition from the overseas out-sourcing ofjobs in areas such as business services and computer pro-gramming. Even ifproduction does not move abroad, increased trade andmultinational production can put Pressure on incomes by making iteasier for firms to substitute foreign workers for domestic ones.

These t'win facts-the link berween labor-market performance andopinions on globalization and the recent absence ofreal income growthfor so many Americans-explain the recent rise in protectionism.Several polls ofU.S. public opinion show an alarming rise in Protection-ist sentiment over the past several years. For example, an ongoing NncNews/ Wall StreetJourialpo\,found that from December Lggg toMarch \zoo/t the share of respondents stating that trade agreements havehurt the United States increased by 16 percentage points (to 46 percent)while the "helped" share fell by u points (to just z8 percent). A zooo Galluppoll found that 56 percent ofrespondents saw ffade as an oPpoffunity and

36 percent saw it as a threat; by zoo5, the percentages had shifted to

44 percent arrd +gpercent, respectively. The March zooT Nsc News / WallStreet Journal polJ. found negative assessments of open borders evenamong the highly skilled: only 35 percent of respondents with a collegeor higher degree said they direcdybenefited from the global economy.

Given the lack of recent real income growth for most Americans,newfound skepticism about globalization is notwithout cause. Nor isit without effect: the change in public opinion is the impetus for theprotectionist drift in policy. Politicians have an incentive to proPoseand implement protectionist policies because more citizens wantthem, and protectionist special interests face an audience of policy-makers more receptive to their lobbying efforts than at any time inthe last two decades.

I N A D E Q U A T E A D J U S T M E N T S

BBcnusn THE protectionist drift reflects the legitimate concerns ofa now very large majority of Americans, the policy debate needs freshthinking. There is reason to worry even if one does not care aboutsocial equity.When mostworkers do not see themselves as benefitingfrom the related forces of globalization and technology, the resultingprotectionist drift may end up eliminating the gains from globalization

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A Ma: Dealfor Globalization

for everybody. Current ignorance about the exact causes of the skewedincome growth is not reason for inaction. Policymakers may not beable to attack the exact source (or sources) and likely would not want toeven if they could identify them, because doing so could reduce or eveneliminate the aggregate gains from globalization.

Supporters of globalization face a stark choice: shore up support foran open global system by ensuring that a majoriry ofworkers bel efit fromit or accept that firther liberalization is no longer sustainable. Given theaggregatebenefits ofopen borders, the preferable option is clear.

Current poliqy discussions addressing the distributional consequencesofglobalization typically focus on the main U.S. government programfor addressing the labor-market pressures of globalization-TradeAdjustment Assistance (ree)-and on investing more in education.These ideas will help but are inadequate for the problem at hand.. The problem with ren is that it incorrectly presumes that the key

issue is transitions across jobs forworkers in trade-exposed industries.Established in the Trade Act of ry74 (with a related component con-nected to the North American Free Trade Agreement), the programaids groups ofworkers in certain industries who can credibly claim thatincreased imports have destroyed theirjobs or have reduced theirworkhours and wages. Tha-certified workers can access supports includingtraining, extended unemployment benefits while in full-time training,and job-search and relocation allowances.

In short, ree is inappropriately designed to address the prorectionistdrift. The labor-market concern driving this drift is not confined tothe problem of how to reemploy particular workers in particular sectorsfacing import competition. Because the pressures ofglobalization arespread economy-wide via domestic labor-market competition, thereis concern about income and job security among workers employedin all sectors.

Today many are calling for reform and expansion of raa. Forexample, President Bush has proposed streamlining the processes ofeligibitity determination and assistance implementation to facilitatereemployment. This year, TAA is due to be reauthorized by Congress,and manylegislators have proposed broadening the number of industriesthat are rae-eligible. Tha improvements like these are surelywelcome.But they alone cannot arrest the protectionist drift.

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The idea behind investing in education is that higher-skilled workersgenerally earn more and are more likely to direcdy benefit from economicopenness. The problem with this approach, however, is that upgradingskills is a process that takes generations-its efFects will come far toolate to address today's opposition to globalization.It took 6o years forthe United States to boost the share of college graduates in the laborforce from six percent (where it was at the end of World.War II) toabout 33 percent (where it is today). And that required major govern-ment programs, such as the cr 8i11, and profound socioeconomicchanges, such as increased female labor-force participation.

If the United States today undertook the goal of boosting itscollege-graduate share of the work force to 50 percent, the graduationof that median American worker would, if the rate of past effortsare any indication, not come until about zo47.And even this far-offdate might be too optimistic. In the past generation, the rate ofincreasein the educational attainment of U.S. natives has slowed from itsr96os and r97os pace, in part because college-completion rateshave stalled. Rising income inequality may itself be playing a rolehere. Since 1988, T4 percent of American students at the 46 topU.S. colleges have come from the highest socioeconomic quartile,comparedwith just3 percent from the lowest quartile. Moreover, evencollege graduates and holders of nonprofessional master's degreeshave experienced falling mean real money earnings since zooo. Ifthis trend continues, even completing college will not assuage theconcerns behind rising protectionism.

G L O B A L I Z A T I O N A N D R E D I S T R I B U T I O N

GrvrNr rHB limitations of these two reforms and the need to providea political foundation for engagement with the world economy, thetime has come for a New Deal for globahzation-one that linkstrade and investment hberalization to a significant income redis-tribution that serves to share globahzation's gains more widely.Recall that $5oo billion is a common estimate ofthe annual incomegain the United States enjoys today from earlier decades of tradeand investment hberahzation and also ofthe additional annual incomeit would enjoy as a result global free trade in goods and services.

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A Mw Dealfor Globalization

These aggtegate gains, past and prospective, are immense andtherefore immensely important to secure. But the imbalance in recentincome growth suggests that the number ofAmericans not directlysharing in these aggregate gains may now be very large.

Truly expanding the political support for open borders requires aradical change in fiscal policy. This does not, however, mean makingthe personal income tax more progressive, as is often suggestgd. U.S.taxation of personal income is already quite progressive. In"stead,policymakers should remember that workers do not pay only incometures; they also pay the rlce (Federal Insurance Contributions Act)payroll tax for social insurance. This tax offers the best way to redis-tribute income.

The payroll tax contains a Social Security portion and a Medicareportion, each of which is paid half by the worker and half by theemployer.The overall payroll ta,r is aflattaxofr5.3 percent on the firstfig4,zoo of gross income for everyworker, with an ongoing z.g per-cent flat ta,x for the Medicare portion beyond that. Because it is aflat-nte tal( on a (largely) capped base, it is a regressive tan-that is, ittends to reinforce rather than offset pretax inequaliry. At fi76o billionin eoo5, the regressive payroll ta:r was nearly as big as the progressiveincome ta:r ($r.r trillion). Because it is large and regressive, the payrollta,x is an obvious candidate for meaningful income redistributionlinked to globali zation.

A New Deal for globalization would combine further trade andinvestment liberalization with eliminating the full papoll ta:r for allworkers earning below the national median. In zoo5, the median totalmoney earnings of all workers was fi3z,t4o,and there were about 67 mtl-lion workers at or below this level. Assuming a mean labor income forthis group of about $z5,ooo, these 67 million workers would receive ata>( cut of about $3,8oo each. Because the economic burden of this tar<falls largely on workers, this tax cut would be a direct gain in after-ta:r real income for them. With a total price tag of about $256 billion,the proposal could be paid for by raising the cap of fig4,zoo, raisingpayroll til( rates (for progressivity, rates could escalate as they do withthe income tax), or some combination of the two. This is, of course,only an oudine of the needed policy reform, and there would be manyimplementation details to address. For example, rather than a single

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Kenneth E Scheve and MattheuJ. Slaughter

on-offpoint for this tax cut, a phase-in ofit (like with the earned-incometax credit) would avoid incentive-distorting jumps in effective ta:( rates.

This may sound like a radical proposal. But keep in mind the figureof $5oo billion: the annual U.S. income gain from trade and investmentliberalization to date and the additional U.S. gain a successful DohaRound could deliver. Redistribution on this scale may be gequired toovercome the labor-market concerns driving the protectionist drift.Determining the right scale and structure of redistribution requires athoughtfrrl national discussion among all stakeholders. Policymakersmust also consider how exactly to link such redistribution to furtherliberalization. But this should not obscure the essential idea: to bepoliticallyviable, efforts for further trade and investment liberalizationwill need to be explicitly linked to fundamental fiscal reform aimedat distributing globalization's aggregate gains more broadly.

S A V I N G G L O B A L I Z A T I O N

AvBnrrNc e protectionist backlash is in the economic and securityinterests of the United States. Globahzation has generated-and cancontinue to generate-substantial benefits for the United States andthe rest of the world. But realizing those broad benefits will requireaddressing the legitimate concerns ofU.S. voters by instituting a NewDeal for globalization.

In manyways, today's protectionist drift is similar to the challengesfaced by the architect ofthe original New Deal. In August 1934, PresidentFranklin Roosevelt declared:

Thosewhowould measure confidence in this countryin the future mustlook first to the average citizen. . ..

This Government intends no injury to honest business. The Processeswe follow in seeking social justice do not, in adding to general prosperirytake from one and give to another. In this modern world, the spreading

out of opportunity ought not to consist of robbing Peter to pay Paul. In

other *bidt, we are concerned with more than mere subtraction and

addition. We are concerned with multiplication also-multiplication of

wealth through cooperative action, wealth in which all can share.

Today, such multiplicationwill depend on striking a delicate balance-between allowing globa[y engaged comPanies to continue to generate

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A Nea; Dealfor Globalization

large overall gains for the United States and usingwell-targeted fiscalmechanisms to spread the gains more widely.

Would addressing concerns about income distribution make votersmore likelyto support open borders?The public-opinion data suggestthat the answer is yes. Americans consistently rry that theywould bemore inclined to back trade and investment liberalizatiorr-if it werelinked to more support for those hurt in the process. The policy ex-perience of other countries confirms this point there is greater supportfor engagement with the world economy in countries that spendmore on programs for dislocated workers.

U.S. policymakers face a clear choice. They can lead the nationdown the dangerous path of creeping protectionism. Or they can

\

build a stable foundation for U.S. engagement with the worldeconomy by sharing the gains widely. A New Deal for globalizationcan ensure that globalization survives.@

FOREIGN AFFATF.S Juty/August2oo1 l+Zl