Online Extra: The Trade Challenge

For the global economy, the rise of China and India may well end up as the big story of the 21st century. Economists are naturally paying close attention. BusinessWeek Economics Editor Peter Coy and Senior Writer Pete Engardio have interviewed a number of experts on the subject and, for the next several days, BusinessWeek Online will feature the ideas of different leading cognoscenti.

Two such men, economist William J. Baumol and mathematician Ralph E. Gomory, have for more than a decade been collaborating on a theory of international trade that has scary implications for the U.S. economy.

USURPING JOBS. Baumol serves on the faculty of both New York University and Princeton University. Gomory is the former chief scientist at IBM (IBM) and current president of the Alfred P. Sloan Foundation. The two have written several academic papers together as well as some slightly less mathematical treatments, including a 2000 book, Global Trade and Conflicting National Interests, and the treatise Globalization: Prospect, Promise, and Problems.

Gomory and Baumol argue that as China and India produce higher- and higher-value goods and services, they'll take away work that until now has been done in the U.S. The total value of their production will increase. The value of production in the U.S. will decline relative to that of India and China. They say the value of production may even decline in absolute terms, depending on whether or not the U.S. can create new high-value industries.

Following are Coy's interviews with Gomory and Baumol:


BW: What does the economics profession think of your work on offshoring?

Gomory: Two years ago or even less than that, there was kind of a soft response by most economists that offshoring was not a problem, that it was just an issue of comparative advantage. [They said] if you deal with the transition, you come out ahead as a country. That was the almost unanimous view of the economics community, and held with a certain amount of vigor.

That has somewhat changed. Not very much, but somewhat. The reality of a lot of jobs going overseas, and that these jobs are not blue-collar jobs, has become more obvious.

BW: Are you arguing that the U.S. would be better off closing its borders?

Gomory: No. The gains from trading with China and India, which have historically been very big, could shrink. But there will always be at least some gains, so it makes sense to keep borders open.

BW: So the benefits of trade with China and India might shrink?

Gomory: Right. Let us assume free trade. The question is this: If your trading partners get better at things, does that harm you? Not relative to no trade, but relative to where you are today? The people who say outsourcing can hurt you are correct.

BW: So offshoring can be good for the industry that does it but not necessarily for the U.S. economy as a whole?

Gomory: Right. Suppose you make a good in the U.S. Why would you lose it to overseas? Because somebody outside can make it more cheaply. True, consumers are coming out ahead in that one industry. But they're paying a price somewhere else. The goods they always imported get more expensive.

BW: This becomes more of a risk as China and India modernize?

Gomory: Yes. If your trading partner is sufficiently underdeveloped, then if you lose industries to it, it's good for them and good for you. As the other country becomes more developed, the situation starts to turn around. You're importing lots of stuff from it. If you lose one more industry to it, you can lose overall.

BW: Why haven't more economists said this?

Gomory: They don't compute models, which Will [Baumol] and I really do.

BW: What you're saying is probably going to ring true to a lot of noneconomists.

Gomory: People have an intuition that is correct about this. If you lose your industries, you're worse off, because you're not making anything.

BW: How worried are you?

Gomory: I think the U.S. will be negatively affected [by the rise of China and India]. There's very little we do that they can't do. In some sense, we will come down while they come up, and we'll meet somewhere in the middle.


BW: Is the U.S. helped or hurt by the rise of China and India?

Baumol: At the moment, I think what developments in China and India have done is not so much to hurt the whole U.S. economy but to do terrible damage to some individuals who have either had their incomes severely reduced or lost their jobs altogether.

BW: Can anything be done about that?

Baumol: If it is true, as some economists believe, that this is nevertheless beneficial to the U.S. as a whole, then there is absolutely no excuse for failing to help those who have been badly hurt by the developments.

BW: Could the U.S. eventually be harmed by the rise of China and India?

Baumol: It could make very little difference if the U.S. continues with its rapid record of innovation and growing productivity. I'm 83 and going strong, working on five books. When I was young, I remember all the newspapers used to worry about all the competition of cheap foreign labor. Same story today. Yet wages didn't fall then. While other countries were moving ahead, we were moving faster.

BW: What would boost productivity?

Baumol: Everything depends on U.S. policy, whether we continue to support innovation, training, and research. If we don't and no longer stay ahead, then this outsourcing and resulting changes in the terms of trade can be very damaging.

BW: Are you and Gomory saying that trade is bad for the U.S.?

Baumol: No. That's precisely wrong. We strongly believe, as has been demonstrated, that there are gains from trade. What we are saying is that, if we do the wrong things, those gains from trade for the U.S. will be severely reduced. But it's even worse to cut off trade.

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