Week 11 – Globalisation and Automation Shocks

*International trade and automation are not new events: nations have been trading for a
long time and human labour has been substituted by machines and robots since before the
Industrial Revolution.

Unit 16 Introduction

How long-term trends and differences in living standards and unemployment between
countries are the results of technological progress, institutions, and policies

 The increasing use of machinery and other capital goods in production have been the
foundation for rising living standards in the long run
 The ‘creative destruction’ of older ways of producing goods and organizing
production has led to continuous job loss as well as job creation, but no higher
unemployment in the long run.
 A country’s economic institutions and policies can be evaluated by their capacity to
keep involuntary unemployment low and to sustain increases in real wages
 Many successful economies have provided extensive forms of co-insurance against
the job losses arising from both creative destruction and competition from other
economies, so that most citizens of these nations welcome both technological
change and the global exchange of goods and services.
 The main difference between high-performing economies and laggards is that the
institutions and policies of high performers incentivize their main actors to increase
the size of the pie, rather than fighting over the size of their slice.
 Technological progress expands the resources the firm has to invest in increasing
production, and it also incentivizes continued investment.

Example: Those who lose their jobs bear substantial costs in the short run. The short run
may not seem very short to them: it can last years or even decades. Those who benefit may
be the children of the handloom weaver displaced by the power loom, or the children of the
unemployed typist who was displaced by the computer. They benefit by finding a job in an
occupation that is more productive that the job their parents did, and they may share in the
benefit from the new goods and services that are available because the power loom or the
computer exist.

 For better or worse, creative destruction as a result of technological progress is part

of the dynamism of the capitalist economic system. And while lives have been
disrupted and the environment increasingly threatened by this dynamism, the
introduction of improved technologies is also the key to rising living standards in the
long run.
Technological change is constantly putting people out of work
but the countries that have avoided high levels of unemployment are among those in
which the productivity of labour has increased the most.
From the Short-Run – To the Long-Run (Trade, Technology and Jobs, Winners and Losers)

Trade – a quick recap

 International trade has been growing fast since industrial revolution

Not always smooth-globalisation slowing down and stopped between the two
wars and during the Great Depression in the 20th century
Some observers suggest we might be on the verge of another change

 Trade occurs because specialisation is mutually beneficial as it expands the

consumption possibility frontier for the parties/countries involved
Country specialises because they have differences in factor endowments and they
specialise in the production of whatever they are comparatively advantaged
Country specialises to exploit economies of scale and agglomeration effects

 Trade expands consumption and growth for the countries involved, however
countries do not consist of one representative agent like Carlos and Greta.

Winners and Losers: Short Run

*opening trade increases countries’ consumption possibility sets, but sadly not everyone is a
winner:

 Sectors (workers and employers) exposed to more competitive imports from abroad
will lose
 Entire regions may be affected
 Firms and jobs may disappear

Winners and Losers: Short Run Hypothetical example based on differences in factor
endowments

Assumptions

1. Two countries: USA and China

2. There are 2 goods: passenger aircraft (capital-intensive) and consumer electronics
(labour-intensive).

Capital intensity: Making greater use of capital goods (for example machinery and
equipment) as compared with labour and other inputs.

Labour intensity: Making greater use of labour/workers as compared to other

inputs
 3. The US is relatively capital abundant, whereas China is relatively labour abundant
Specialization according to factor endowments

 Capital is cheaper in the USA relatively to labour

 Labour is cheaper in China relatively to capital (wages are lower in China)
 Winners in the US: Owners of capital  Inequality should rise : Capital is
basically owned by wealthier people, by firms, owners and building owners,
that might rent these to big firms in producing aircraft, while labour is owned
by workers. So workers on firms that produce consumer electronics in the US
now are subject to competition and imports from China because by
assumption consumer electronics will require more labour and therefore
more workers and capital in the US. This would cause more jobs to be
destroyed than created. It would be a net job loss in the short term
 Winners in China: Workers (higher wages)  Inequality should fall : In China,
however, workers earn higher demand as consumer electronic production
expands thanks to this specialisation. As electronics and production expands,
wages expect to rise as well as firms start competing for more workers.
Workers, therefore, benefit more from trade than owners of capital

Consequences

 Free trade is controversial Winners and Losers

 Sectors exposed to imports will lobby against free trade
 Workers in those sectors will also lobby against free trade
 Lobby in favour of so-called protectionism  which means protecting the industry
or the sector against competition from the rest of the world. (by introducing or
raising tariff)
 Higher tariff to impose on imports of specific goods to make imports more expensive
and less competitive
 Tariffs in general reduces the size of the pie
Winners and Losers: Short Run Mostly winners when trade is based on economies of scale
and agglomeration economies

 Let us not forget that very large, almost dominant share of international trade is not
based on differences in endowments but on economies of scales and agglomeration
effects.
 Similar countries trade with very similar countries
UK trade with EU and the USA
road vehicles makes up 10% of UK export to the EU and 18% of imports
The losses from trade are less pronounced and less controversial. Here they are
trading very similar things, so the losses from trade are less pronounced and less
controversial.

What about the long-run?

 Winners and losers more evident in the short run for the type of trade that is based
on factor endowments (Factor endowments are the land, labor, capital, and
resources that a country has access to, which will give it an economic
comparative advantage over other countries.)
 This trade has been rising significantly from the 1990s, especially because of the so-
called China Shock
The opening of China to international trade and free markets and its entering in
the World Trade Organisation (WTO) in 2001
China was very soon able to produce an enormous amount of goods (from clothes
to Iphones)
China exploits its labour supply(workers moved from rural areas to new cities)
Sectors in places in the USA exposed to china imports saw unemployment growing

 If losses are pretty substantial in the short run, what about the long-run?

What about the long-run?

*In other words: how long does it take for the economy and especially the labour market to
adjust?

 The typical story goes

In the long run, increase cost savings arising from trade will imply investments in
other sectors and the jobs lost will be compensated by generation of new jobs. Other
sectors and workers who lost their jobs will be able to re-train (or their offspring will)
In the long run, opportunities will arise also because trading countries will provide
new markets for our goods and services (Germany was able to exploit China growth
by selling high quality machineries to Chinese new factories)

 But adjustment to the long run has been very painful because costs are very
localised in some countries, especially USA
 Actually labour markets not yet adjusted after 20 years
Video 1 of David Autor Notes

 The China shock is a shorthand term for a very disruptive integration of China into
Western trade and specifically in the context of US refers to China’s joining the
World Trade Organization in 2001 and the surge of Chinese exports that this
catalysed.

Unit 18.6 – Winners and losers from trade and specialization

 Nations are composed of people with differing economic interests. They are not like
our islands with only Greta and Carlos. Therefore, to understand these issues we
need to go further than assuming a single individual or a set of identical individuals
inhabits each nation.

Unit 16 (and Unit 18.10) Session 1

Technological change and automation

 Technological change is also behind the unprecedented growth in modern

economies in Western Europe, USA, Asia
 Innovation, technological change and automation are used interchangeably
 Technological shocks are behind long run changes occurring in our economies. The
more evident is the increased productivity (we produce more with less) of
agriculture and manufacturing over time and the declining share of agriculture and
manufacturing jobs, mirrored by the increase of services
 Technological change are disruptive (similar to trade) in terms of net job creation

The long-run effects on the labour market

  We have already seen that the labour market model can capture the medium run or
how the aggregate demand shifts were then reflected on the labour market model.
 In the medium run, you have this shift in aggregate demand that might be reflected
into higher or lower employment rates
 However, in this long run model, the unemployment rate will depend on how well a
country’s policies and institutions come together and address two big incentive
problems of modern economies (work incentives and investments incentives.
 Work incentives that are behind our wage setting curve: how can we make sure that
wage and salary for the workers are kept at a level that will motivate the workers to
work hard and well.
 On the other side is the investment incentive, which is reflected by the price setting
curve: how can we incentivise owners to keep on investing in job creation instead of
saving their profits
 In the long run than profit margin goes up because productivity goes up, then more
firms will enter the market attracted by higher profits.
 More firms entering the market will imply more competition, and this can be
represented by a shift upward of the price setting curve
 The first thing is an upward shift of the output per worker after specialisation in
trade and after a new technology, we expect the economy to be able to produce
more with less
 Second, this will be followed by a shift upwards of our price setting curve because
the distance between output per worker and price setting curve will measure the
profit margin. If there is more profit margin, this will attract new firms to enter the
market
 Now, we have a new intersection between the new price setting curve, which shifts
upwards along the wage-setting curve.
 The new Equilibrium point is B, and it shows that there is a lower unemployment
rate and a higher wage
.
How do you adjust to the new long run equilibrium

 In the short run, we know that technologies and specialization can destroy jobs as
well. Let us assume that we are specialising in trade and there are new technologies
and therefore our price setting curve shifts upwards.
 In the short run, jobs would be destroyed or point B.
 In the medium run, however, growth in export industry create new jobs in the
sectors that are affected by new export. Or POINT C.
 C shows lower unemployment, so firms have to set higher wages to secure adequate
worker effort.
 And in the long run, point C finally gets to point D this depends on the magnitude of
the shift of the price setting curve.
  Of course, one can imagine that the long run adjustment may also depend on the
wage curve. Now, we are in a situation here in which the real wages are
increased, and the unemployment rate is smaller than the initial situation.
 Maybe with this situation, policies have changed, or maybe governments are
starting to adjust unemployment benefits to make them more generous, or the
trade unions are back, and they feel they have more power and want to bargain
higher unemployment benefits and more protection laws for workers

 In this case, the wage setting curve shifts to the left. An example of this could be that
labour unions are asking for a lot of protection at very high unemployment benefits
 The long run equilibrium in this case is set at point E, and this gives as the same
unemployment rate as the initial level, but we know our real wage is higher at point
E, which means higher living standard for the workers.

 Or there can be a situation in which unemployment rate is lower than the initial
level. And in the long run get to point D.

The role of policies and institutions

Policies and factors for the long run

 To temper large trade shocks: gradual relaxation of tariff

 To promote innovation: investment in R&D and infrastructure, but also an
environment that allows firms to invest
 More generally, quality of institutions – inclusive institutions vs. exclusive institutions
e.g, inclusive labour unions (represent many firms and sectors and are aware of
long run objectives)

 Policies that are well-designed and take into account incentives and are based on
what works
Economic Performance: many recipes

*Some countries have benefited more from globalization than others, some countries seem
to innovate more than others. Economic success depends on how well policies have
managed growth due to economic integration.

 During first industrialization, Germany and the US achieved high economic growth
despite high manufacturing tariffs
 Scandinavian countries prospered through openness and strong inclusive labour
unions, with policies that help displaced workers.