T U I M t t U i I t. The editor welcomes, letlci-. inai ccmmem on anicics m mi.s J-LMJC or (bat discuss other matters of iinporttmcc to managers. Letters need not cotnment on tiny ptirticulat article. Early responses to article.'^ have the best chance of beingpubliiheil. I'leaxe be concise, double-space your letter, and include your title and company affiliation. HBR reserves the ri^ht to edit letters and to republish letters as reprints. THIRD WORLD GROWTH Thea Lee Trade Economist Robert Scott Research Associate Economic Policy Institute Washington, D.C. Paul Krugman attacks tbose who argue that international-trade and investment flows, particularly with the Third World, have hurt employ- ees in the industrialized nations ("Does Third World Growth Hurt First World Prosperity?" July-Au- gust I994|. Krugman implies that people who raise this issue are self- ish, in that tbey begrudge economic growth to impoverished Third World nations, and, at the same time, not very smart, since Third World progress is at least as likely to help workers in the First World as it is to hurt them. Krugman's case falls short on sev- eral counts. First, the opponent he rails against is a straw man. Most critics of the free-trade agenda do not see Third World productivity growth or wage growth as a prohlem. The is- sue is, rather, that the form of com- petition between the First and tbe Third Worlds has in many cases driven down wages, working condi- tions, and environmental standards toward Third World levels. Second, Krugman inaccurately summarizes the theoretical models he presents to make his case. Tbird, his general- izations about empirical results do not reflect the consensus within the eeonomics profession. It is not even clear that Krugman's prescription of free trade is the best medicine for Third World growth. By many measures, in faet, develop- ing nations grew more before they adopted free-trade policies. Accord- ing to the World Bank, per capita gross domestic product in the Third World rose 4.3% annually from 1965 to 1973. But during free trade's as- cendaney, from 1980 to 1991, per capita GDP grew only .9% annually. Such figures should at least raise questions about the value of Krug- man's growth prescriptions for the world's poor. In arguing that low-cost labor in tbe Third World poses no threat to workers in industrialized nations, Krugman presents four models, each with an added layer of complexity. It is worth noting that only in the first model-a world with no eapital, no markets, and no trade-is it clear that workers in the industrialized world are not hurt hy low-cost lahor in the Third World. In the seeond model, the result is ambiguous. In the two last and most realistic mod- els, Krugman himself concludes that, in theory, workers in tbe indus- trialized world will he hurt. Yet he summarizes by saying, "The view that competition from the Third World is a major prohlem for ad- vanced countries is questionahle in theory [emphasis added] and flatly rejected by the data." Krugman's third model presents a world where capital is mobile. Theo- retically, it predicts that capital would flow from the industrialized world to the Third World, making workers in the industrialized world worse off. Model four presents a world with two types of labor and predicts that the relative wages of less educated workers in industrial- ized nations would fall as a result of competition with Third World workers. Krugman notes both tbese theoretical conclusions but claims that in practice, trade with, and capi- tal fk)ws to, the Third World have been too small to be of any conse- quence in the industrialized world. There are several prohlems with this analysis. Krugman seems to be- lieve that the quantity of capital is the only factor that affects domes- tic productivity. In fact, companies have made large prt)ductivity gains through reorganizing their work- place in ways that allow the fuller utilization of employees' knowledge and skills. However, hecause this option requires a significant time commitment and some risk, many short-sighted managers prefer the al- ternatives: either hiring low-wage workers in the Third World or bat- tering down wages through the threat to move. Xerox, which had been a leader in developing higb-performanee work systems, recently went the latter route when it coerced major conces- sions from workers at a plant in up- state New York by threatening to move overseas. The eoncessions will increase profits, at least temporarily, but will also end cooperation. Xe- rox's coerced concessions will mean lower wages for workers in the short run and lower productivity growth in tbe long run, even though no capi- tal moved to the Third World. Since 1979, productivity growth has exceeded real hourly compen- sation hy more than 10%. Since compensation usually tracks produc- tivity very closely, the increased bargaining power of employers that has heen created hy the availability of cbeap Third World lahor has to he considered as a possible explanation for this divergence. Anotber set of empirical questions arises from Krugman's fourth model, which indicates that less edueated workers should he hurt hy increased trade with the Third World. Since wages of high school graduates have fallen by about 20% since 1979 rela- tive to those of college graduates. 180 HARVARD BUSINESS REVTEW NdVL-mbcr-Dccemhcr 1994
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T U I M t t U i I t.
The editor welcomes, letlci-. inai ccmmem on anicics m mi.s J-LMJC or(bat discuss other matters of iinporttmcc to managers. Letters need notcotnment on tiny ptirticulat article.
Early responses to article.'^ have the best chance of beingpubliiheil.I'leaxe be concise, double-space your letter, and include your title andcompany affiliation.
HBR reserves the ri^ht to edit letters and to republish letters as reprints.
THIRD WORLD GROWTH
Thea LeeTrade EconomistRobert ScottResearch AssociateEconomic Policy InstituteWashington, D.C.
Paul Krugman attacks tbose whoargue that international-trade andinvestment flows, particularly withthe Third World, have hurt employ-ees in the industrialized nations("Does Third World Growth HurtFirst World Prosperity?" July-Au-gust I994|. Krugman implies thatpeople who raise this issue are self-ish, in that tbey begrudge economicgrowth to impoverished Third Worldnations, and, at the same time,not very smart, since Third Worldprogress is at least as likely to helpworkers in the First World as it is tohurt them.
Krugman's case falls short on sev-eral counts. First, the opponent herails against is a straw man. Mostcritics of the free-trade agenda do notsee Third World productivity growthor wage growth as a prohlem. The is-sue is, rather, that the form of com-petition between the First and tbeThird Worlds has in many casesdriven down wages, working condi-tions, and environmental standardstoward Third World levels. Second,Krugman inaccurately summarizesthe theoretical models he presentsto make his case. Tbird, his general-izations about empirical results donot reflect the consensus within theeeonomics profession.
It is not even clear that Krugman'sprescription of free trade is the bestmedicine for Third World growth.By many measures, in faet, develop-ing nations grew more before theyadopted free-trade policies. Accord-ing to the World Bank, per capitagross domestic product in the ThirdWorld rose 4.3% annually from 1965
to 1973. But during free trade's as-cendaney, from 1980 to 1991, percapita GDP grew only .9% annually.Such figures should at least raisequestions about the value of Krug-man's growth prescriptions for theworld's poor.
In arguing that low-cost labor intbe Third World poses no threat toworkers in industrialized nations,Krugman presents four models, eachwith an added layer of complexity. Itis worth noting that only in the firstmodel-a world with no eapital, nomarkets, and no trade-is it clearthat workers in the industrializedworld are not hurt hy low-cost lahorin the Third World. In the seeondmodel, the result is ambiguous. Inthe two last and most realistic mod-els, Krugman himself concludesthat, in theory, workers in tbe indus-trialized world will he hurt. Yet hesummarizes by saying, "The viewthat competition from the ThirdWorld is a major prohlem for ad-vanced countries is questionahle intheory [emphasis added] and flatlyrejected by the data."
Krugman's third model presents aworld where capital is mobile. Theo-retically, it predicts that capitalwould flow from the industrializedworld to the Third World, makingworkers in the industrialized worldworse off. Model four presents aworld with two types of labor andpredicts that the relative wages ofless educated workers in industrial-ized nations would fall as a resultof competition with Third Worldworkers. Krugman notes both tbesetheoretical conclusions but claimsthat in practice, trade with, and capi-tal fk)ws to, the Third World havebeen too small to be of any conse-quence in the industrialized world.
There are several prohlems withthis analysis. Krugman seems to be-lieve that the quantity of capital isthe only factor that affects domes-tic productivity. In fact, companies
have made large prt)ductivity gainsthrough reorganizing their work-place in ways that allow the fullerutilization of employees' knowledgeand skills. However, hecause thisoption requires a significant timecommitment and some risk, manyshort-sighted managers prefer the al-ternatives: either hiring low-wageworkers in the Third World or bat-tering down wages through thethreat to move.
Xerox, which had been a leader indeveloping higb-performanee worksystems, recently went the latterroute when it coerced major conces-sions from workers at a plant in up-state New York by threatening tomove overseas. The eoncessions willincrease profits, at least temporarily,but will also end cooperation. Xe-rox's coerced concessions will meanlower wages for workers in the shortrun and lower productivity growthin tbe long run, even though no capi-tal moved to the Third World.
Since 1979, productivity growthhas exceeded real hourly compen-sation hy more than 10%. Sincecompensation usually tracks produc-tivity very closely, the increased
bargaining power of employers thathas heen created hy the availabilityof cbeap Third World lahor has to heconsidered as a possible explanationfor this divergence.
Anotber set of empirical questionsarises from Krugman's fourth model,which indicates that less edueatedworkers should he hurt hy increasedtrade with the Third World. Sincewages of high school graduates havefallen by about 20% since 1979 rela-tive to those of college graduates.
180 HARVARD BUSINESS REVTEW NdVL-mbcr-Dccemhcr 1994
trade seems to have had its predictedeffect. Krugtnati dismisses this pos-sibility by noting that the Organiza-tion for Economic Cooperation andDevelopment's trade with the ThirdWorld amounts to approximately1 % of its GDP. But, since the UnitedStates alone has seen the develop-ment of the large wage gap, it is theU.S. trade figures that matter. In1992, U.S, imports from developingcountries were 3.8% of GDP, andover 10.9% of manufacturing valueadded. It is not implausible thatimports of this volume would bavecontributed to the growth in the 'wage gap between college and non-college educated workers. Recentstudies by Lawrence Katz, RichardFreeman, and [effrey Sachs, amongothers, have pointed in this direc-tion. While the data are not conclu-sive, no responsible economist coulddismiss the possibility that eompeti-tion with low-wage labor has con-tributed to the growth of wage in-equality in the United States.
Kenneth P. HutchisonExecutive DirectorAsian-American EreeLabor InstituteWashington, D.G.
Paul Krugman is an economist ofconsiderable vision, hut I don't thinkhe ean look in my mind and read mymotives. Yet that is the mysticalpower he assumes when he aceusespeople hke me of promoting "pro-tectionism in the guise of humani-tarian eoneern."
He objects to the renewed effort tomake the global trading system-assafeguarded by the General Agree-ment on Tariffs and Trade [GATT)and the new World Trade Organi-zation (WTO)-take into accountworkers' rights instead of only busi-nesspeople's. But his argument forlow-wage competition and againstinternational standards on wagesand working conditions are wrongon the following counts:
1. There is no way that interna-tional labor standards ean take awaythe competitive advantage that poorcountries gain from their low-wagelevels. Jobs now in developing coun-tries will stay there. It is true, how-
ever, that if some minimal standardswere adopted and enforced, theremight be some job shifts from coun-tries with repressive regimes, suchas Ghina, to democratic countrieswith more humane work conditions,such as Sri Lanka.
2. Krugman erroneously attributesthe opposition to standards to devel-(tping countries. In reality, the oppo-sition he cites is from the govern-ments of Third World countries, themost outspoken being authoritariangovernments in Asia. Even in thosecountries, however, people con-cerned about freedom and humanrights often disagree with their gov-ernment's position, and some havethe courage tu do so publicly. For ex-ample, the Malaysian Trades UnionGongrcss, in a strong statement thatdiffers from the Malaysian govern-ment line, has come out in favor ofGATT standards.
3. Krugman errs in believing thatproposals for GATT rules on work-ers' rights are nothing but deviousdevices for "protectionism." As amatter of fact, almost imy one of the28 sets of eomplex new rules includ-ed in GATT can he used as instru-ments for blocking imports. But pre-venting that abuse is precisely theraisnn d'etre of GATT.
4. Krtigman is correct in hailingthe enormous potential benefitsfrom economie growth, but he mis-takenly assumes that economicgrowth and economic developmentare the same thing. GNP and GDPfigures hide the widening gaps he-tween the rich and the poor. Acrossthe world, both local and foreignelites arc getting richer from the ex-ploitation of the most vulnerable.It's no wonder, hecause as it is nowconstituted, the world trading sys-tem discriminates against workers,especially those in the Third World.In Indonesia last year, Marsinah, a23-year-old woman, was murderedafter leading her coworkers in aprotest against the failure of herwatch-factory owner to follow In-donesia's own labor laws. In SouthAsia, children as young as 10 or 11are working six and seven days aweek in sweatshops producing gar-ments mostly for U.S. customers.
The new GATT agreement goes to
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