On the Berlin Wall

Three papers up on Voxeu examining the impact of the fall of the Berlin Wall, 20 years on.
Michael Burda's article Half-empty or half-full?East Germany two decades later concludes:
It’s my guess that East Germany in the 21st century will reproduce the existing north-south divide in the West. This is because convergence is not only about equating East and West Germans’ levels of physical and human capital but also endowing them with the same level of social, institutional, business and marketing infrastructure. On this metric, the Eastern German economy looks like a mixed bag, like much in life, a glass half-empty and half-full at the same time.


This is an important paper, its conclusion has interesting implications for all states with wide regional disparities


Volker Nitsch and Nikolaus Wolf's paper Tear down this wall:on the persistence of borders in trade  reports:
Notably, it makes hardly any difference whether we analyse data for 101 regional units and 10 industry groups or 27 regional units and 24 industry groups: the trade effect of the former Iron Curtain across Germany continued to be highly significant throughout the period under investigation, although this effect clearly declined over time. Given that we can extrapolate the results, we estimate that it would take between 33 and 40 years, or roughly one generation, to remove the effect of the former political border entirely.
These findings are difficult to square with the “political barriers” or the “artefact” explanation of border effects but strongly suggest that some fundamentals are driving the effect. We conclude that the biggest challenge to globalisation is neither technological nor political barriers to trade, but barriers stemming from economic fundamentals. While we can change infrastructure and even remove political borders, it takes at least a generation to tear down the wall in our heads.



Gerlinde Sinn and Hans-Werner Sinn's Muffed jumpstart puts their conclusion baldly:
Germany’s political unification has succeeded; its economic unification has not....
The failed unification of the East and West German economies has also dragged down West Germany in an international comparison. Until German unification, West Germany had grown properly and in terms of per capita national income had held a top position in Europe, at about the same level as Denmark. Under favourable conditions, it could have maintained this growth thereafter and Germany as a whole could have grown much faster than the rest of Europe due to the convergence of East Germany to the Western European level. But this is not what happened. Since 1995, both parts of the country have crept along in step and have taken turns with Italy for the lowest rung on the European ladder. Things turned out worse than we had expected.
The economic crisis has enforced a new realism in Germany. Net transfers to East Germany have been declining for a few years, wage increases have become more modest, and the constitution prohibits East German states to continue their policy of rising indebtedness from 2020. The times of easy money are past, and that is why a phase of growth may start now. Unfortunately, it is twenty years late.

Of Jobs Lost and Wages Depressed in the Philippines

By Melisa R. Serrano

The “jobs claims-higher wages” model is often used by supporters of free trade to argue for deeper integration and greater openness in trade and financial markets. In fact, neoliberal economists in cahoots with major organisations such as the World Trade Organization, the World Bank and the International Monetary Fund are inclined to push or impose a one-size-fits all deregulated export-led growth and development strategy. Developing countries often have to swallow the bitter pill of full liberalization in exchange for loans from the Word Bank and the IMF and for getting more market access in developed countries.

Trade liberalization is believed to lead to higher wages via price transmission. Free trade economists argue that a reduction of the after-tax or tariff price of imports lowers the prices of imported goods and import substitutes which in turn lead to increase in real incomes. And since a tariff reduction lowers the marginal cost of production (through a reduced cost of imported materials), this is expected to encourage and expand production. This purportedly increases the demand for labor.

But does a regime of free trade always create good jobs and increase wages in relative and real terms? The sad and sorry (and arguably continuing) state of stagnation in the Philippine economy in the heyday of liberalization – 1980 to 2000 – helps to debunk the causal link between trade and financial liberalization and job generating-high wages economic growth. For the Philippines’ dismal economic performance during the heyday of liberalization only brought stagnation, unemployment and declining real wages.

The lost decades in the heyday of liberalization

The period 1980-2000 has been alluded to as the era of rapid globalization when most of the developing world, including the Philippines, opened up further to world trade as part of structural adjustment efforts prescribed by the IMF-WB within the framework of the Washington Consensus. Total trade increase between 1980 and 1999 (49%) – touted as the more globalized decades - was higher than the period between 1960 and 1980 (31%). The dramatic rise of manufactured exports in the Philippines beginning 1981 also indicates the deepening of a free trade regime in the country.

From 1981 to 1985, a tariff reform program was adopted in the Philippines that narrowed down tariff rate structures. At the same time, an import liberalization program was launched which did away with non-tariff import measures. Beginning 1991, tariffs were gradually lowered over a five-year period until 1995. Overall, average tariff rates went down by a whooping 65% from 1994 to 2000.

Between 1993 and 1996, trade liberalization was vigorously pursued by locking in the country to international trade regulation and deeper integration through the ASEAN Free Trade Area (AFTA) in 1993, the World Trade Organization (WTO) in 1995, the Asia Pacific Economic Cooperation (APEC), and various bilateral trade agreements. A high degree of capital account liberalization was achieved in 1993 after being initiated in 1991 through the passage of the Foreign Investments Act. These reforms eased the entry and exit of foreign capital, largely in the form of short-term debts and portfolio investments (unhedged dollar borrowings or “hot money” used to finance real estate, construction, speculative and manufacturing activities), setting the stage for the country’s participation in the Asian financial crisis.

This regime of openness was marked by increasing frequency and depth of bust-recovery cycles pointing to a more volatile movement and a seemingly shorter cycle length compared to previous periods (Lim and Bautista, 2002). As a corollary, the country’s dependence on imports and unsustainable (private and short-term) foreign capital flows (or “hot money”) had been attributed to more frequent and shorter growth and recession cycles and the lack of macroeconomic development.

The result was devastating. It was only in the period 1980-2000 – the “lost decades”, a term coined by Bill Easterly in 2001 to refer to the growth performance of developing countries in the 80s and 90s - that the Philippines experienced negative growth. From a 66% rise of real per capita GDP (in 1985 US$) in the period 1960 to 1980, the country plummeted to -1% in the period 1980-2000 (Weisbrot et al 2001). The forgone increase in per capita GDP during the “lost decades” was estimated at 68%.

Does free trade create jobs? Challenging the “jobs claims” model

There is an abundance of economic literature pointing to the positive impact of trade liberalization on employment and wages. Neoliberal economists argue that although tariff reductions do have a negative impact on wages and levels of employment, any adverse effect can be wiped out by a tariff reduction’s effect on reducing domestic prices. However, as Akyuz (2005) points out, simulations done by the World Bank highlighting the benefits that developing countries could reap from further liberalization under the Doha Round are bereft of reality. These studies use “general equilibrium models” that assume automatic market clearing, rapid redeployment of resources and full or equal employment after liberalization. However, factors of production, including labor, capital and land are often sector or product specific and thus immobile. Expansion in sectors benefiting from liberalization requires investment in skills and equipment, rather than simply reshuffling and redeploying existing labor and equipment. Thus, like the case of the Philippines, the overall impact of rapid trade liberalization could be unemployment, deindustrialization and growing external deficits despite a significant increase in export growth.

The Philippines’ export participation in high-technology manufactures through international production networks (IPNs) involves mere assembly of components that adds little value and utilizes labor, the most abundant and least mobile factor. The bulk of Philipino exports are import-intensive, particularly electronics and garments. The high import intensity of these two sectors implies that they add very little value and have a moderate employment impact. In 2000, these sectors generated a meager 6.9% of total gross value added and 5.7% of total employment. A declining trend is similarly observed in employment growth rates between 1980 and 2000. Between 2000 and 2002, it is estimated that the annual layoff rate in the electronics sector was between five and 10 percent as a number of establishments have either closed down or reduced their workforce.

Does free trade lead to higher wages?

Between 1980 and 2000, increased frequency and depth of bust-recovery cycles brought about by the uncertainties of a trade and financial liberalization regime wreaked havoc on wage patterns, resulting in wage stagnation since the late 1980s. On average, the real wage rate in the Philippines in 2002 was around three quarters of what it was in the early 1980s. Felipe and Sipin (2004) note a clear downward trend of labor share at 0.6 percentage points per year during the period 1980-2002. The authors conclude that labor in the Philippines has lost at least 10 percentage points of its share in value-added during the last two decades. Although export performance was generally robust during the period, “strong increases in the manufacturing exports of developing countries – particularly those participating in IPNs – may have taken place without commensurate increases in incomes and value added” (UN 2006:75).

The argument that, in a deregulated export-led growth, job loss in the “restructuring” process results in greater efficiencies and new jobs with higher wages will replace old ones is flawed according to Ranney and Naiman (1997). This assumption is based on a situation of full employment. The market is seldom able to replace lost employment with comparable jobs. Even if new jobs were created, people who lose jobs often do not get the new ones. Moreover, many of the replacement jobs are of inferior quality. It should also be noted that higher wages in the export sector could be due to high unionization, labor shortages in specific occupations, or higher productivity. Moreover, imports can depress wages in certain industries and occupations.

The way forward

Clearly, the IMF-WB sponsored market liberalization prescriptions and the country’s obedience to such diktats, proved to be devastating as the Philippines went from being a poster girl of the WB-IMF to the basket case in the East Asian region. Unlike its more successful neighbors where liberalization took place gradually and cautiously over the past two decades after a period of successful industrialization and development, the Philippines pursued big bang liberalization as a way of getting out of its debt and development crisis without the necessary industrial or manufacturing base.

What is now certain is that the stagnation of developing countries during the “lost decades” was a major blow to the optimism surrounding the Washington Consensus. In fact, the IMF had already conceded in 2003 that, at least for many developing countries, capital market liberalization did not lead to more growth but to more instability. Unfortunately, this acknowledgment came after the dreadful effects of capital markets liberalization in many developing countries.

There are crucial factors for an economy to be able to reap economic benefits from external trade and financial liberalization. The major ones are: (1) producing export products with high technological content (high value added) located in growing global markets; (2) creating domestic linkages for these exports; (3) capacity to capture a share of value added in international production networks; (4) attracting greenfield FDI that is anchored in the domestic economy; (5) coherent industrial or production sector strategies that promote industrialization and/or support structural transformation of economies (macroeconomic policies, investments in physical infrastructure, incentives and support for innovation, protection of infant industries, selective policies targeting specific sectors or firms); and (6) timing and speed of liberalization (gradual integration is preferable to a big bang or premature approach). Unfortunately, these factors are still missing in the Philippines’ economic constellation.

Bibliography

Akyüz, Yilmaz. 2005. “Trade, Growth and Industrialization: Issues, Experience and Policy Challenges,” in www.twnside.org.sg/title2/t&d/tnd28.pdf

Felipe, Jesus and Grace C. Sipin. 2004. Competitiveness, Income Distribution, and Growth in the Philippines: What Does the Long-run Evidence Show? ERD Working Paper No. 53, Manila: Asian Development Bank, June.

Lim, Joseph Y. and Carlos C. Bautista. 2002. “External Liberalization, Growth and Distribution in the Philippines,” Paper presented for the international conference on “External Liberalization, Growth, Development and Social Policy,” January 18-20, 2002, Melia Hotel, Hanoi, Vietnam.

Ranney, David C. and Robert R. Naiman. 1997. Does `Free Trade’ Create Good Jobs? A Rebuttal to the Clinton Administration’s Claims. Chicago: The Great Cities Institute, January.

United Nations. (2006). World Economic and Social Survey 2006 – Diverging Growth and Development. Geneva: United Nations Economic and Social Affairs.

Weisbrot, Mark, Dean Baker, Egor Kraev and Judy Chen. 2001. “The Scorecard on Globalization 1980-2000: Twenty Years of Diminished Progress,” Center for Economy and Policy Research (CEPR), July 11, in www.cepr.net/publications/globalization_2001_07.htm.

Melisa R. Serrano is University Extension Specialist/Researcher in the School of Labor and Industrial Relations, University of the Philippines (U.P. SOLAIR). The article is part of a paper she presented at the International Conference on “Labour and the Challenges of Development”, 1-3 April 2007, University of the Witwatersrand, Johannesburg, South Africa, convened by the Global Labour University. Melisa holds two Masters degrees, one in Labour Policies and Globalization (from the Global Labour University, University of Kassel and Berlin School of Economics) and another in Industrial Relations (from U.P. SOLAIR). Melisa’s present research is on agrarian reform and labor and alternative development.