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Why First World Nations Should Look After Third World Growth? An Answer To Krugman.

In his article “Does Third World Growth Hurt First World Prosperity?” Mr. Krugman analyses the fears that were spreading among US society as consequence of steady economic growth in Third World countries. Through the use of the theory of competitive advantage, Krugman explains how the increase in production in one part of the world does not negatively affect the other part of the world. Although I can subscribe everything written in that article, I think there are more perspective than these highlighted by Krugman. Basically I think that we shouldn’t look at the “Prosperity” in nominal terms, like Krugman do, but in relative terms. At the end of the day, how do we know if one country is rich and other is poor? By the difference among them. If the difference reduces, the rich country become relatively less rich than it was before.

But should we really care about our relative prosperity? There are at least two reasons why we care about it. The first one, stated above, is typically psychological. How do I measure the level of my salary? Basically doing a benchmark and comparing the other options in the market. If my salary is high compared to other, I feel myself better. If it’s the same, I’m OK, but I may start looking for something else. If the salary is lower than average in my industry, I definitely will underperform and run away from there as soon as opportunity arises. Is that applicable to countries? Yes, at some extent. We know that Switzerland is rich country because they are rich among their neighbors. But we don’t speak about Czech Republic that it is a rich country, although they are richer than other 150 countries of the world, ranked below Czech on GDP per capita (PPP). It’s because we think of Czech Republic in relative terms to their neighbors – a UE countries. But these Eastern European countries are catching momentum, and maybe in relatively close future they’ll debunk South European countries in the prosperity rank. Does it matter for the citizens of these countries? I think that yes, because there’s a psychological aspect in humans that push us to be better than others. So although nominally there’s no change in prosperity, relatively there is a negative effect when countries converge or change their “ranks”.

The other reason is described in the Krugman’s paper and specifically pointed as threat to First World wages:

Suppose, then, that Third World nations become more attractive than First World nations for First World investors. This might be because a change in political conditions makes such investments seem safer or because technology transfer raises the potential productivity of Third World workers (once they are equipped with adequate capital). Does this hurt First World workers? Of course. Capital exported to the Third World is capital not invested at home, so such North-South investment means that Northern productivity and wages will fall. Northern investors presumably earn a higher return on these investments than they could have earned at home, but that may offer little comfort to workers

But Krugman told that the amount of these investments are so ridiculously small, that they shouldn’t be taken into account (“The record capital flows of 1993 diverted only about 3% of First World investment away from domestic use”). The article was written in 1994, but it’s strange that Krugman couldn’t predict the explosion of what emerging economies will be in next 15 years. Let’s have a look on below graph, it’s self explanatory:


US Net International Investment Position

Interesting right? If we link it to “Capital exported to the Third World is capital not invested at home, so such North-South investment means that Northern productivity and wages will fall” we have one confirmation that the threat is real.

To be completely objective, I should point that there are also a Chinese investments in US. The below graph can give us a glimpse on who and how much invests. We can see that major investors are First World countries, thus above conclusion is applicable (but in long term is irrelevant because of imperfection of global monetary system – will develop it further below speaking about Bitcoin)

FDI graph

Global FDI

Also, Mr. Krugman adds that the difference in terms of trade may be somehow a reason for worries in case these are below 100 (we sell products less expensive than others) thus my customers will have to pay more for imported products. I wouldn’t like to elaborate on how wrong this may be (customers are unhappy but exporters are basically happy), what I can say is that I think after Bretton Woods was wrapped up, the Fed is manipulating the USD to make terms of trade as close to 100 as possible.

US terms of trade

Introducing scarcity. The world after Bitcoin.

And now let’s imagine a future (possible future among many others) where Bitcoin became a global currency. The nice world where’s no monetary policy and no reserve requirement coefficients. Money is genuinely scarce and you only can lend the money you have, not more nor less. What happens if in the world of one scarce resource one of the countries become more efficient? Two things happens – global value of labor appreciates (you produce more using the same labor), therefore products depreciates. But, since your relative weight in the economy against the other country is lower, the competition for scarce resource become more intense. You should work harder in order to get the scarce resource. There’s a win for humanity, but your prosperity may be undermined since you’ll be challenged more intensely for the global scarce resource.

Everything written above should be taken with a grain of salt. Although the evidence presented indicates that Third World increase in productivity may lead to negative effects in the First World, we should understand that for a long run humanity will win.  This article shouldn’t be considered as protectionist but rather a mental approach to different ways to understand global economy and possible effects on us when statu quo is challenged. If we look in nominal terms and especially if we look globally, on long term, global trade based on competitive advantage will produce win-win configuration for everybody on the planet who are not scared of healthy competition.

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