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Human Betterment Through Globalization
Human Betterment Through Globalization
By Dr. Vernon L. Smith
Nobel Prize in Economics, 2002
The following is abridged from a speech
delivered at “Evenings at FEE” in September 2005.
It’s a great pleasure to join FEE for their
“Saturday Night Live” and to be among both old friends and many new ones.
Several years ago Candace and I taught one of the FEE student seminars here
together. The experience was so wonderful that I married her!
My message today is an optimistic one. It is about
exchange and markets, which allow us to engage in task and knowledge
specialization. It is this specialization that is the secret of all wealth
creation and the only source of sustainable human betterment. This is the
essence of globalization.
The challenge is that we all function
simultaneously in two overlapping worlds of exchange. First, we live in a
world of personal, social exchange based on reciprocity and shared norms in
small groups, families, and communities. The phrase “I owe you one” is a
human universal across many languages in which people voluntarily acknowledge
indebtedness for a favor. From primitive times, personal exchange allowed
specialization of tasks (hunting, gathering, and tool making) and laid the
basis for enhanced productivity and welfare. This division of labor made it
possible for early men to migrate all over the world. Thus, specialization
started globalization long before the emergence of formal markets.
Second, we live in a world of impersonal market
exchange where communication and cooperation gradually developed through
long-distance trade between strangers. In acts of personal exchange we usually
intend to do good for others. In the marketplace this perception is often lost
as each of us tends to focus on our own personal gain. However, our controlled
laboratory experiments demonstrate that the same individuals who go out of
their way to cooperate in personal exchange strive to maximize their own gain
in a larger market. Without intending to do so, in their market transactions
they also maximize the joint benefit received by the group. Why? Because of
property rights. In personal exchange the governing rules emerge by voluntary
consent of the parties. In impersonal market exchange, the governing
rules—such as property rights, which prohibit taking without giving in
return—are encoded in the institutional framework. Hence the two worlds of
exchange function in a similar way: you have to give in order to receive.
The Foundation of Prosperity
Commodity and service markets, which are the foundation
of wealth creation, determine the extent of specialization. In organized
markets, producers experience relatively predictable costs of production, and
consumers rely on a relatively predictable supply of valued goods. These
constantly repeated market activities are incredibly efficient, even in very
complex market relationships with multiple commodities being traded.
We have also discovered through our market experiments
that people generally deny that any kind of model can predict their final
trading prices and the volume of goods they will buy and sell. In fact, market
efficiency does not require a large number of participants, complete
information, economic understanding, or any particular sophistication. After
all, people were trading in markets long before there existed any economists
to study the market process. All you have to know is when you are making more
money or less money and whether you have a chance to modify your actions.
The hallmark of commodity and service markets is
diversity—a diversity of tastes, human skills, knowledge, natural resources,
soil, and climate. But diversity without freedom to exchange implies poverty.
No human being, even if abundantly endowed with a single skill or a single
resource, can prosper without trade. Through free markets we depend on others
whom we do not know, recognize, or even understand. Without markets we would
indeed be poor, miserable, brutish, and ignorant.
Markets require consensual enforcement of the rules of
social interaction and economic exchange. No one has said it better than David
Hume over 250 years ago—there are just three laws of nature: the right of
possession, transference by consent, and the performance of promises. These
are the ultimate foundations of order that make possible markets and
prosperity.
Hume’s laws of nature derive from the ancient
commandments: thou shalt not steal, thou shalt not covet thy neighbor’s
possessions, and thou shalt not bear false witness. The “stealing” game
consumes wealth and discourages its reproduction. Coveting the property of
others invites a coercive state to redistribute wealth, thus endangering
incentives to produce tomorrow’s harvest. Bearing false witness undermines
community, management credibility, investor trust, long-term profitability,
and the personal exchanges that are most humanizing.
Only Markets Deliver the Goods
Economic development is linked with free economic and
political systems nurtured by the rule of law and private property rights.
Strong centrally planned regimes, wherever attempted, have failed to deliver
the goods. There are, however, plenty of examples of both big and small
countries (from China to New Zealand and Ireland) where governments have
removed at least some barriers to economic freedom. These countries have
witnessed remarkable economic growth by simply letting people pursue their own
economic betterment.
China has moved considerably in the direction of economic
freedom. Just over a year ago China revised its constitution to allow people
to own, buy, and sell private property. Why? One of the problems the Chinese
government encountered was that people were buying and selling property even
though those transactions were not recognized by the government. This invited
local officials to collect from those who were breaking the law by trading. By
recognizing property rights, the central government is trying to undercut the
source of power that supports local bureaucratic corruption, which is very
hard to centrally monitor and control. This constitutional change, as I see
it, is a practical means to limit rampant government corruption and political
interference with economic development.
Though this change has not resulted from any political
predisposition for liberty, it may very well pave the way toward a freer
society. The immediate benefits are already there: 276 of the Fortune 500
companies are currently investing in a huge R&D park near Beijing, based
on very favorable 50-year lease terms from the Chinese government.
The case of Ireland illustrates the principle that you
don’t have to be a big country to grow wealthy through liberalizing
government economic policy. In the past, Ireland was a major exporter of
people. This worked to the advantage of the United States and Great Britain,
who received many bright Irish immigrants fleeing the stultifying life of
their homeland. Only two decades ago Ireland was mired in third-world poverty,
but has now surpassed its former colonial master in income per capita,
becoming a committed European player. According to World Bank statistics,
Ireland’s growth rate of Gross Domestic Product (GDP) jumped from 3.2% in
the 1980s to 7.8% in the 1990s. Ireland recently was the eighth highest in GDP
per capita in the world, while the United Kingdom was 15th. By fostering
direct foreign investment (including venture capital) and promoting financial
services and information technology, Ireland has experienced a formidable
brain-drain reversal—young people are coming back home.
These young people are returning because of new
opportunities made possible by expansion of economic freedom in their
homeland. They are examples of “can-do” knowledge-based entrepreneurs who
are creating wealth and human betterment not only for their native country,
but also for the United States and all other countries around the world. These
people’s stories demonstrate how bad government policies can be changed to
create new economic opportunities that can dramatically reverse a country’s
brain drain.
We Have Nothing to Fear
An essential part of the process of change, growth, and
economic betterment is to allow yesterday’s jobs to follow the path of
yesterday’s technology. Preventing domestic companies from outsourcing will
not stop their foreign competitors from doing so. Through outsourcing, foreign
competitors will be able to lower their costs, use the savings to lower prices
and upgrade technology, and thus gain a big advantage in the market.
One of the best-known examples of outsourcing was the New
England textile industry’s move to the South after World War II in response
to lower wages in the Southern states. (As was to be expected, this raised
wages in the South, and the industry eventually had to move on to lower-cost
sources in Asia.)
But the jobs did not vanish in New England. The textile
business was replaced by high-tech industries: electronic information and
biotechnology. This resulted in huge net gains to New England even though it
lost what had once been an important industry. In 1965 Warren Buffett gained
control of Berkshire-Hathaway, one of those fading textile makers in
Massachusetts. He used the company’s large but declining cash flow as a
launch pad for reinvesting the money in a host of undervalued business
ventures. They became famously successful, and 40 years later Buffett’s
company has a market capitalization of $113 billion. The same transition is
occurring today with K-Mart and Sears Roebuck. Nothing is forever: as old
businesses decline, their resources are diverted to new ones.
The National Bureau of Economic Research has just
reported a new study of domestic and foreign investment by U.S. multinational
corporations. The study demonstrated that for every dollar invested in a
foreign country, they invest three and a half dollars in the United States.
This proves that there is a complementary relationship between foreign and
domestic investment: when one increases, the other increases as well. McKinsey
and Company estimates that for every dollar U.S. companies outsource to India,
$1.14 accrues to benefit of the United States. About half of this benefit is
returned to investors and customers and most of the remainder is spent on new
jobs that have been created. By contrast, in Germany every Euro invested
abroad only generates an 80% benefit to the domestic economy, mainly because
the reemployment rate of displaced German workers is so much lower due to the
vast number of government regulations.
I believe that as long as the United States remains
number one on the world innovation index, we have nothing to fear from
outsourcing and much to fear if our politicians succeed in opposing it.
According to the Institute for International Economics, more than 115,000
higher-paying computer software jobs were created in 1999–2003, while 70,000
jobs were eliminated due to outsourcing. Similarly in the service sector 12
million new jobs were being created while 10 million old jobs were being
replaced. This phenomenon of rapid technological change and the replacement of
old jobs with new ones is what economic development is all about.
By outsourcing to foreign countries, American businesses
save money that enables them to invest in new technologies and new jobs in
order to remain competitive in the world market. Unfortunately we cannot enjoy
the benefits without incurring the pain of transition. Change is certainly
painful. It is painful for those who lose their jobs and must seek new
careers. It is painful for those who risk investment in new technologies and
lose. But the benefits captured by winners generate great new wealth for the
economy as a whole. These benefits, in turn, are consolidated across the
market through the discovery process and competitive learning experience.
Globalization is not new. It is a modern word describing
an ancient human movement, a word for mankind’s search for betterment
through exchange and the worldwide expansion of specialization. It is a
peaceful word. In the wise pronouncement of the great French economist
Frederic Bastiat, if goods don’t cross borders, soldiers will.
 Dr.
Vernon Smith, Professor of Economics and Law at George Mason University, grew
up on a farm in Kansas, during the Great Depression. His dream always was to
go to college. His diligence was rewarded, and he became a Caltech student
majoring in electrical engineering. As a senior, he became intrigued by
economics and stumbled upon his first free-market book—Mises’ Human
Action. Economics became his calling, and he earned an economics Ph.D. at
Harvard in 1955—and the rest is history. In 2002 Dr. Vernon L. Smith was
awarded the Nobel Prize in Economics for laying "the foundation for
experimental economics."
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