Globalization and the Benefits of Trade

By Thompson, Robert L. | Chicago Fed Letter, March 2007 | Go to article overview

Globalization and the Benefits of Trade


Thompson, Robert L., Chicago Fed Letter


Globalization involves increasing integration of economies around the world, from the national to the most local levels, thereby promoting international trade in goods and services and cross-border movement of information, technology, people, and investments. This article examines the benefits and costs to the U.S. and other countries.

Since the conclusion of World War II in 1945, international trade has been greatly facilitated by agreement among trading countries on a set of rules for international trade, known as the General Agreement on Tariffs and Trade (GATT). These rules were developed through a series of eight "rounds" of international trade negotiations between 1947 and 1994. Through these negotiations, export subsidies were banned on everything but agricultural products, and import tariffs on manufactured goods were reduced to inconsequential levels. As a result, trade in manufactured goods has grown rapidly, achieving an unprecedented level of specialization and exchange among countries.

Developments in ocean shipping have also facilitated the latest wave of globalization, e.g., larger and faster vessels and containerization of their cargoes. These developments, combined with state-of-the-art logistics, have significantly lowered the cost of international transactions. Multinational firms now engage in just-in-time sourcing through global supply chains. Deregulation and increasing competition have further reduced costs of international transportation and telecommunications. Overbuilding of fiber optics capacity among countries during the dot-com boom in the 1990s also contributed to today's historically low prices of international telecommunications. At the end of World War II, most countries imposed barriers to free movement of capital across their international borders. These barriers have been largely eliminated among high-income countries and have been significantly lowered in middle-in co me countries, too. Billions of dollars of funds can move instantaneously among countries at the touch of a computer key.

Why trade?

Why do countries engage in international trade anyway? The U.S., for instance, engages in such trade to obtain goods and services that some other countries can produce at relatively lower cost than it can in exchange for goods and services that the U.S. can produce at lower cost than the other countries can. If everything cost the same to make in every country, there would be no basis for international trade.

When a country engages in international trade, its households' real purchasing power rises. Their incomes stretch further because they can obtain at lower cost the goods and services they have been buying. The country as a whole benefits, too. When a country engages in international trade, it can produce more gross domestic product (GDP) from its land, labor, and capital because it is not using them to produce things that other countries can produce at lower resource cost. When a country opens its borders to free movement in and out of goods and services, the market then provides the incentive to move the country's resources in to their highest-value uses, thereby facilitating economic growth.

Globalization has created the environment in which export-led economic growth can reduce poverty by bidding up wages in low-income countries. As poor people's incomes rise, they gain purchasing power and become better markets for the products that others produce more efficiently. This has happened over and over again, particularly in Asia.

At the end of World War II, Japan, Korea, Taiwan, and most other East Asian countries were very poor and their wage rates were very low. Japan's early post-war manufacturing exports were cheap in both price and quality; however, Japan's manufacturing industries developed and matured over time. Japan's wage rates were bid up by this export-led growth to the point that it could no longer compete in the production of the low-end labor-intensive products, and their manufacture moved to South Korea and Taiwan to take advantage of cheaper labor there. …

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