Full text of Business Review (Federal Reserve Bank of Philadelphia) : March/April 1998

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Has Globalization Created a Borderless World?

Janet Ceglowski

Does Trade with Low-Wage Countries
Hurt American Workers?

T

here are gaping disparities in wages and
benefits around the world. In 1996, average
hourly earnings of production workers in
manufacturing were $31.50 in West Germany,
$17.20 in the United States, $1.51 in Mexico, and
less than $0.50 in India and China. How can
such huge wage differences exist? Are American workers’ wages and benefits forced down
by competition from low-wage countries? Are
trade barriers the solution? While there are
some genuine problems raised by trading with
low-wage countries, this article will try to show
that popular fears are based on misunderstand-

*Steve Golub is professor and chair, Department of Economics, Swarthmore College, Swarthmore, PA. When this
article was written, he was a visiting scholar in the Research
Department of the Philadelphia Fed.

Stephen Golub*
ing of the causes and effects of wage disparities.
The following quotation, from the concluding article in the September 1996 Philadelphia
Inquirer series “America: Who Stole the
Dream?” by Donald Barlett and James Steele,
forcefully expresses the widely held view that
competition from goods produced in low-wage
countries is unfair and detrimental to American workers.
"Companies that produce goods in foreign
countries to take advantage of cheap labor
should not be permitted to dictate the wages
paid to American workers."
"A Solution: Impose a tariff or tax on
goods brought into this country equal to the
3

BUSINESS REVIEW

MARCH/APRIL 1998

wage differential between foreign workers the American economy with trade restrictions,
and U.S. workers in the same industry. That it is better to ease the burden on the minority
way competition would be confined to who of Americans who are adversely affected.
makes the best product, not who works for
the least amount of money.
MAGNITUDE OF INTERNATIONAL
"Thus, if Calvin Klein wants to make DIFFERENCES IN WAGES AND BENEFITS
sweatshirts in Pakistan, his company would
Labor costs in the industrialized countries
be charged a tariff or tax equal to the differ- are much higher than those in the developing
ence between the earnings of a Pakistani countries, although labor costs vary greatly
worker and a U.S. apparel worker....
within each group, too (Table 1; Figure 1). U.S.
"If this or some similar action is not taken, manufacturing wages are well below those of
the future is clear. Wages of
American workers will conTABLE 1
tinue to slip, as well as their
standard of living."
Indicators of Hourly Labor Costs
These arguments ignore a fundamental point: differences in
wage rates between countries
largely reflect differences in labor
productivity (output per hour
worked). For example, wages
are low in India because productivity is low. Thus, the costs of
producing goods are not as different across countries as wage
rates suggest. Indeed, the United
States as a whole benefits from
international trade, irrespective
of the wage levels of its trading
partners, by specializing in what
we do well and importing goods
that are most efficiently produced elsewhere. By increasing
efficiency, international trade,
like technological change, increases the size of the economic
pie available to the nation.
Granted, international trade
does adversely affect some industries and individuals, especially in the short run, but there
are more than offsetting benefits
to the rest of the economy. Rather
than hobbling the efficiency of
4

For Production Workers in
Manufacturing
Selected Countries, 1996a
Labor Costs
(in $U.S.)

Hong Kong
Korea
Mexico
Singapore
Sri Lankab

17.74
16.66
19.34
31.87
18.08
21.04
14.19

100
94
109
180
102
119
80

5.14
8.23
1.50
8.32
0.48

United States
Canada
France
Germany
Italy
Japan
United Kingdom

Labor Costs
(As a Percent
of U.S.
Labor Cost)

29
46
8
47
3

a
Labor costs in other countries are converted to U.S. dollars at the
market exchange rate. Labor costs include wages and fringe benefits.
b
1995

Source: U.S. Bureau of Labor Statistics

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Countries Hurt American Workers?
Does Trade with Low-Wage Borderless World?

Germany but above those of the United Kingdom. For medium-income countries like Korea, labor compensation levels in manufacturing have reached nearly half of those in the
United States, while low-income countries such
as Sri Lanka, India, and China have labor costs
that are less than 5 percent of U.S. levels.1
THE PRINCIPLES OF COMPARATIVE
AND ABSOLUTE ADVANTAGE
Popular discussions confuse the relationships between international trade, wages, and
labor productivity. Wages are determined by the
overall productivity of labor (absolute advan-

1
Labor costs in manufacturing differ by industry; however, these industry variations are swamped by the overall
differences in wages between countries. Therefore, it is not
misleading to focus on manufacturing averages.

Janet Ceglowski
Stephen Golub

tage) and are therefore not an independent
source of international competitiveness. Trade
patterns depend on comparative advantage:
industry-by-industry differences in productivity across countries. We will first consider these
basic principles before turning to the evidence.
The important distinction between comparative and absolute advantage, first put forth by
David Ricardo in 1817, is best explained with a
simple example (Table 2). With no international
trade, the United States demonstrates higher
productivity than Mexico in both industries in
this example, but the productivity ratio is
greater in computer chips (10 to 1) than in shirts
(2 to 1).
To produce more shirts, a country must sacrifice chip output and vice versa, given a limited supply of workers. The number of chips
that must be given up to produce, say, one more
shirt is what economists call the “opportunity

FIGURE 1

Hourly Labor Compensation
Of Production Workers in Manufacturing*
Selected Countries

*Labor costs in other countries are converted to U.S. dollars at the market exchange rate. Labor costs include
wages and fringe benefits.
Source: U.S. Bureau of Labor Statistics

5

BUSINESS REVIEW

MARCH/APRIL 1998

TABLE 2

Output per Worker
Per Hour

United States
Mexico

Computer
Chips
10

Shirts
2

1

1

cost” of a shirt. Since a worker in the United
States can produce 10 chips or two shirts, the
opportunity cost of one shirt is five chips. In
Mexico, since a worker can produce one chip
or one shirt, the opportunity cost of one shirt is
one chip. Thus, the opportunity cost of shirts
is higher in the United States than in Mexico.
Therefore, Mexico has a “comparative advantage” in producing shirts, since it has a lower
opportunity cost: that is, producing shirts
“costs” fewer chips. Similarly, the United States
has a comparative advantage in producing
chips, since its opportunity cost in that industry is lower.
As the example suggests, the determination
of comparative advantage depends only on the
ratio of productivity in the two industries
within each country. For example, if Mexican
productivity were to double, so that each
worker could produce either two chips or two
shirts, the opportunity cost would be unchanged, and Mexico would retain its comparative advantage in producing shirts.
A related concept is that of absolute advantage. A country is said to have an absolute advantage in producing a good if a worker in that
country can produce more of the good than a
worker in the same industry in a different country. In the example above, the United States has
an absolute advantage in producing both chips
and shirts because a U.S. worker could produce
more of either good than a Mexican worker.
Despite this absolute advantage, however,
6

the total output of the world economy—and the
standard of living in each country—will be
higher if U.S. workers produce more of those
items in which they have a comparative advantage and Mexican workers do the same, and the
two countries trade. In general, absolute advantage determines the overall level of wages in
each country, and comparative advantage determines trade patterns.
To put this concept simply, let’s suppose
wages in the United States are five times those
in Mexico—as they were before Mexico’s currency crisis in 1994—in both the shirt industry
and the chip industry.2 Since U.S. workers can
produce 10 times as many chips as their counterparts in Mexico, but their wages are only five
times as high, the United States will have lower
labor costs per chip. Similarly, since U.S. workers produce only twice as many shirts as Mexican workers, but their wages are five times as
high, the United States will have higher labor
costs per shirt. So, ideally, Mexico should produce more shirts, the United States should produce more chips, and the two countries should
trade. Such a transaction produces more goods
at lower cost because it allows each country to
produce more goods in the industry in which
it has a comparative advantage.
Both countries’ living standards will increase
from trading according to comparative advantage because the resulting world pattern of production is more efficient than if each country
produces only for its own market. The United
States can obtain shirts more cheaply from
Mexico than by producing shirts itself, paying
for these shirt imports with chip exports. International trade does not cost U.S. jobs, but it
does change the industry mix of U.S. output
and employment. American production of

2

Wages for workers with similar characteristics will be
the same in different industries within a country if the labor market is competitive and workers can freely move between industries.
FEDERAL RESERVE BANK OF PHILADELPHIA

That Thing Venture Created a Countries Hurt American Workers?
Has Trade with Low-Wage Borderless World?
DoesGlobalization Capitalists Do

chips will expand while shirt production contracts, resulting in corresponding shifts in labor demand. The reverse happens in Mexico.
There are two qualifications to this characterization of the benefits of trade. First, relocating workers between the shirt and chip industries may be difficult in the short run, resulting
in some unemployment of former shirt workers in the United States. Second, this kind of
trade may reduce unskilled workers’ real wages
in the United States, even after workers are relocated, if the chip industry employs a higher
ratio of skilled to unskilled workers than the
shirt industry. In the United States, as chip production expands and shirt production falls, the
demand for skilled labor rises, while the demand for unskilled labor declines. As discussed
later, however, the proper response to these distribution effects is not to restrict trade but to
ease the transition by retraining displaced
workers.
These days, international trade, which is often conducted by multinational corporations,
increasingly takes the form of trade in intermediate products, but the basic gains from trade
are unaffected. American companies locate the
simpler parts of their production processes in
developing countries, while the more sophisticated components are produced at home. For
example, 21 months after the North American
Free Trade Agreement (NAFTA) went into effect, the Key Tronic company, a large manufacturer of computer keyboards, laid off 277 workers in Spokane, Washington, as it relocated
some of its assembly jobs to a plant in Cuidad
Juarez, Mexico. But Key Tronic’s chief financial
officer reported that employment in its Spokane
plants actually increased overall because many
of the components used in the keyboards are
made in Washington, and the lower costs of
assembly in Mexico enabled the company to
lower prices and increase sales.3
Other studies show that economic integration with Mexico has entailed a boom in manufacturing production in U.S. cities along the

Mitchell Berlin
Janet Ceglowski
Stephen Golub

border because Mexican factories specialize in
assembly, which makes intensive use of unskilled labor, while border regions in the United
States specialize in high-technology tasks such
as production of components and product design.4 This international division of labor follows the principle of comparative advantage.
The United States is likely to have an absolute
advantage in all stages of the production process, because American workers are, on average, more skilled and educated than those in
developing countries, and infrastructure in the
United States is superior. But the United States’
advantage in terms of efficiency is likely to be
greatest in high-technology production processes, for which a highly skilled work force is
critical. The United States gains from the increase in efficiency resulting from the global
division of labor, just as in the simple chip/shirt
example.5
In fact, the chip/shirt example illustrates a
key point: low wages most likely reflect low
productivity. Furthermore, if low wages were
all that mattered in international trade, countries with rock-bottom labor costs, such as
Bangladesh, Bolivia, and Burundi, would be
major exporters. Yet, popular concern often focuses on countries such as Mexico and South
Korea—countries with wages well above those
in Africa and South Asia. Clearly, labor productivity matters, too.
Some people worry that as low-wage coun-

3
“NAFTA Tradeoff: Some Jobs Lost, Others Gained,”
New York Times, October 7, 1995.
4

See the article by Gordon Hanson.

5

Robert Feenstra and Gordon Hanson provide a theoretical analysis of this form of comparative advantage. One
difference between their results and the textbook analysis
is that skilled labor reaps the gains from trade in both the
United States and the low-wage country. This result is consistent with some evidence that the gap between the wages
of skilled and unskilled workers is widening in developing countries, just as it is in developed countries.
7

BUSINESS REVIEW

tries acquire technology and capital, their productivity will rise, giving them a competitive
edge. But there are two reasons not to be concerned about this. First, as productivity in a
country rises, wages tend to rise as well, so the
competitive edge lessens. Second, other factors,
such as low levels of human capital (knowledge
and skills) as well as poor public infrastructure
and transportation services, tend to hold down
productivity in low-wage countries, even when
they acquire new physical capital (computers
and factories). Except for products and production processes that require large amounts of unskilled labor, these factors offset the appeal of
low wages for companies considering relocating their production to poor countries.
In addition, developing countries may have
higher costs of other inputs, such as capital,
energy, and raw materials. Prices of these inputs are more likely than wage rates to be similar across all countries, because, unlike labor,
nonlabor inputs can be moved across borders
in response to international price differences.
Nonetheless, capital, energy, and raw material
costs per unit of output could be higher in developing countries if these countries use nonlabor
inputs less efficiently than developed countries.
In summary, both developed and developing countries can benefit from specializing in
what each produces relatively efficiently, regardless of the overall level of labor costs, because low wages do not necessarily mean low
production costs across the board. Low wages
may be offset by either low labor productivity
or higher costs of nonlabor inputs such as capital, energy, and raw materials. Only in low-skill
industries and unsophisticated production processes are developing countries likely to have
lower average costs of production and, hence,
a comparative advantage.6
6

China’s efforts to develop an aircraft industry are often presented as a counterexample. But China’s exports
consist overwhelmingly of low-technology items such as
clothing, shoes, and toys.
8

MARCH/APRIL 1998

WAGES, PRODUCTIVITY,
AND TRADE: EVIDENCE
Wages and labor productivity are related
(Figure 2).7 For example, in 1990 wages in Malaysia were 10 percent of wages in the United
States. But Malaysian labor productivity was
also about 10 percent of the U.S. level in 1990.
This means that unit labor costs (the ratio of
wages to productivity) were approximately the
same in Malaysia and the United States because
the difference in productivity almost exactly
offset the difference in wages between the two
countries. In this case, companies have no incentive to shift production from the United
States to Malaysia.
In general, international differences in unit
labor costs are much smaller than differences
in wage rates because the huge international
disparities in wages mostly reflect equally large
differences in productivity. In fact, these calculations indicate that, in 1990, unit labor costs in
the Philippines and India were actually higher
than those of the United States, that is, the productivity difference was even bigger than the
wage difference.
Some disparities between wages and productivity are to be expected for several reasons.

7

Productivity is calculated as real value-added per employee. Value-added is the value of output minus the costs
of raw materials and other intermediate inputs. Wages are
defined as earnings per employee. Earnings here include
all direct payments, including maternity and vacation pay
and payment in kind, but exclude employer contributions
to social insurance funds, as data on the latter are not available for most developing countries. The exclusion of social
insurance costs is likely to overstate relative labor costs in
developing countries, but only to a minor extent. Direct pay
is still, by far, the larger part of compensation, accounting
for 70 to 90 percent of total labor compensation even for
the United States and other rich countries. The ratio of employer-paid benefits to total labor costs is not that much
higher in developed countries compared with the few developing countries for which this information is available.
For details on sources and methods of the calculations of
wages and productivity, see my 1995 article.
FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Countries Hurt American Workers?
That Thing with Low-Wage Borderless World?
Does Trade Venture Capitalists Do

Janet Ceglowski
Mitchell Berlin
Stephen Golub

FIGURE 2

Labor Productivity, Wages, and Unit Labor Costs
in Developing Countries, Relative to the United States

Source: Golub (1995)

First, differences in wages sometimes reflect
temporary exchange-rate movements, which
may have little effect on long-term business
decisions about the location of production. For
example, the appreciation of the dollar against
the mark and the yen in the early 1980s sharply
lowered German and Japanese wages measured
in U.S. dollars (see Figure 1). The depreciation
of the dollar in the late 1980s and early 1990s,
however, led to a large increase in German and
Japanese wages expressed in U.S. dollars.8 Second, as noted above, some differences in unit
labor costs may be offset by nonlabor costs, so
low unit labor costs do not necessarily imply a
competitive advantage. Third, the available

measures of labor costs and productivity are not
always fully reliable and comparable, especially
for developing countries. Despite these qualifications, a fairly close correlation between la-

8

German unit labor costs in the mid-1990s reached levels nearly double those of the United States, as German
labor compensation rose well above U.S. wages and German productivity remained at about 80 percent of the U.S.
level. Germany’s high unemployment may reflect, in part,
the relatively high level of German labor costs. The depreciation of the mark in 1996-97 has partially restored
Germany’s cost competitiveness. A similar description applies to recent Japanese unit labor costs, but to a lesser extent.
9

BUSINESS REVIEW

MARCH/APRIL 1998

bor costs and labor productivity is observed
across countries.
Wages and labor productivity also move together over time for individual countries. For
example, Korea experienced both high wage
growth and high productivity growth in manufacturing over 1970-95, compared with the
United States (Figure 3). In 1970, Korean wages
were 8 percent of U.S. wages, while Korean productivity was 14 percent of U.S. productivity.
By 1995, Korean productivity had reached 69
percent of the U.S. level, while Korean wages
grew to 48 percent of American wages. Note
that U.S. manufacturing productivity and
wages grew steadily over this period, so Figure 3 indicates very strong growth in Korean
wages and productivity. Korean workers have
greatly benefited from Korea’s phenomenal
economic growth.
In Mexico, wages and productivity moved
closely together until the outbreak of the debt
crisis in 1982. This crisis led to policies of extreme austerity and steep depreciation of the
peso to enable Mexico to service its foreign debt
and, in turn, caused a steep decline in the dol-

lar value of Mexican wages (Figure 4). Mexican
wages recovered relative to productivity after
1986, but fell back after 1994. This decline in
Mexican wages and unit labor costs in 1994-95
and the subsequent shift of the Mexican trade
balance from deficit to surplus are often inappropriately cited by U.S. opponents of the North
American Free Trade Agreement as vindication
of their views that NAFTA would create a “large
sucking sound” of jobs being siphoned off to
Mexico. As in the early 1980s, the drop in Mexican wages after 1994 reflects the collapse of the
peso and deep recession in Mexico. Indeed,
manufacturing employment in Mexico dropped
nearly 10 percent in 1995. As the Mexican
economy recovers from the crisis, its wages and
unit labor costs are likely to increase, as they
did from 1987 to 1991.
The volume of trade is also inconsistent with
fears about the competitiveness of low-wage
countries (Table 3). Many developing countries’
exports of manufactures to the industrial countries have increased rapidly, but the majority
of these developing countries continue to run
trade deficits in manufactures, as their imports

FIGURE 3

FIGURE 4

Wages and Labor Productivity,
Expressed as a Ratio of U.S.
Wages and Productivity
KOREA

Wages and Labor Productivity,
Expressed as a Ratio of U.S.
Wages and Productivity
MEXICO

10

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Thing Venture Capitalists Do
That Trade with Low-Wage Borderless World?
Does Globalization Created aCountries Hurt American Workers?

Janet Ceglowski
Mitchell Golub
Stephen Berlin

TABLE 3

Developing Countries’ Trade in Manufactured Goods
with All Industrial Countries, Selected Years, as a percent of Developing Countries’ GDP

Brazil

1970
1980
1990
1995

Exports to
Industrial Countries
0.3
1.1
2.2
1.7

Imports From
Industrial Countries
2.8
2.2
1.5
3.1

Trade Balance

India

1980
1990
1995

1.1
2.1
3.8

1.8
2.2
3.3

-0.7
-0.1
0.5

Korea

1970
1980
1990
1995

6.1
14.3
15.2
12.3

9.8
11.4
11.6
13.9

-3.7
2.9
3.5
-1.6

Malaysia

1970
1980
1990
1994

8.0
9.3
19.1
33.2

13.6
19.1
31.3
45.0

-5.5
-9.8
-12.2
-11.8

Mexico

1970
1980
1990
1995

0.8
0.7
3.7
19.3

4.3
5.7
6.8
16.8

-3.4
-5.1
-3.1
2.5

Thailand

1970
1980
1990
1995

1.3
4.2
10.7
12.8

9.6
9.4
17.3
21.9

-8.3
-5.2
-6.6
-9.1

-2.5
-1.1
0.6
-1.4

Sources: United Nations, International Monetary Fund.

11

BUSINESS REVIEW

have grown nearly as much. For many of these
developing countries, two-way manufacturing
trade with the industrial countries is now quite
large in relation to their gross domestic product (Brazil and India are exceptions). Trade in
manufactures is, on the whole, much more important for the developing countries than for
the developed countries, as measured by share
of respective GDP.
In summary, wage differences do mostly reflect productivity differences. Macroeconomic
shocks and exchange-rate fluctuations, however, can entail large discrepancies for several
years.
INTERNATIONAL TRADE
AND THE U.S. LABOR MARKET
U.S. Employment Performance. Critics argue that the overall U.S. trade deficit and the
deficits with particular developing countries
such as China and Mexico reduce the number
of jobs in the United States. As evidence, they
often cite the decline of manufacturing employment. They claim that other countries, such as
Japan and those in Western Europe, have less
open markets and consequently do not run
trade deficits like the United States. But these
arguments ignore the fact that overall U.S. employment growth has been extraordinarily impressive, far outpacing that of Europe and Japan. Indeed, there has been much discussion
in these countries about how to emulate U.S.
employment performance. In 1997, the U.S.
unemployment rate fell below 5 percent, its
lowest level since the early 1970s. In recent
years, the labor force and employment have
increased more rapidly than the population of
working age: 4 million workers were added in
1996 and the first half of 1997 alone. The New
York Times reported recently that the demand
for labor is so strong that “companies are recruiting among those ignored in the past: mothers at home with their children, older men who
had retired or been laid off, students, immigrants, people with criminal records. State offi12

MARCH/APRIL 1998

cials [in Louisville, Kentucky] who help former
prisoners get jobs say companies now reject
fewer convicted felons.”9
Therefore, while the U.S. trade deficits do
displace some workers, any associated job
losses have been more than offset by overall job
creation. In fact, the causation runs in the reverse direction: the strength of the U.S.
economy, which manifests itself in employment
growth, is an important cause of the overall U.S.
trade deficit, since imports rise with incomes.
Recessions in Japan, Europe, and Latin
America, meanwhile, have held down U.S. exports.
Even in manufacturing, international trade
has had a secondary role in affecting employment trends. In 1994, manufacturing accounted
for 16 percent of all U.S. jobs, down from 26
percent in 1970. A recent study found that the
U.S. trade deficit accounted for only one tenth
of this decline; the remainder is mostly due to
the difference in productivity growth between
manufacturing and the service sector.10 As
manufacturing productivity increases, fewer
workers are needed to produce a rising volume
of output, and the released workers shift to the
service sector. Much the same occurred in agriculture earlier in the century. Technological
change and capital investment lowered the
share of employment in agriculture from 44
percent in 1900 to 3 percent today. This process
was undoubtedly painful for many displaced
workers, but few today would consider reversing the clock on the gains in standard-of-living
afforded by the growth in agricultural productivity.
Nor is it true that the overall “quality” of
jobs has declined as the quantity has increased.

9
“Jobs Opening Faster Than They Can Be Filled,” New
York Times, July 10, 1997.
10

See the article by Robert Rowthorn and Ramana
Ramaswamy.
FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Countries Hurt American Workers?
That Thing with Low-Wage Borderless World?
Does Trade Venture Capitalists Do

Careful studies show a mixed picture. Job
growth has been strong in high-paying as well
as low-paying occupations, as industries have
shifted the occupational mix of their employees. Between 1983 and 1994, jobs in managerial, professional, and technical occupations
grew more rapidly than overall U.S. employment.11 Once again, this does not deny that
some workers have suffered because of job dislocation and wage declines, sometimes caused
by competition from imports. The overall performance of the labor market, however, is at
variance with the popular view that international trade is devastating American labor.
Wage Inequality. Increased inequality of
wages has been one of the most salient features
of the American labor market in recent decades.
While average family income has increased, the
gap between higher-paid and lower-paid workers has widened sharply.12 Much of the increase
in wage inequality reflects a greater demand
for skilled labor, as evidenced by a large increase
in the wages of college graduates relative to the
wages of workers without a college education.
While increased wage inequality is not necessarily a bad thing in itself, as it may reflect a
more competitive and discerning labor market,
the plight of those at the lower end of the income distribution is a source of concern. The
question here is the role international trade is
playing.
As suggested by the Mexico shirt/ U.S. computer chip trade example, international trade
with poor countries can be expected to increase
the relative demand for skilled labor in the
United States, since the United States expands
production in industries that make intensive

11

See the study published by the Committee on Economic Development.
12
See Peter Gottschalk’s article for a summary of the facts
and other articles in the same issue of the Journal of Economic Perspectives for further discussion.

Janet Ceglowski
Mitchell Berlin
Stephen Golub

use of skilled labor and it imports goods created largely by unskilled labor. Such trade may
cause not just a widening in the wage gap between skilled and unskilled labor but also an
absolute decline in the real income of unskilled
workers. Also, the widening wage inequality
has coincided with an increase in international
trade with low-wage countries, suggesting a
possible connection.
Although there may be a connection between
increased trade and income inequality, many
studies conclude that international trade with
low-wage countries has played, at most, a secondary role in increasing income inequality. As
a recent survey of the literature concludes,
“Nearly all of this research finds only a modest
effect of international trade on wages and income inequality.”13 The small effect of trade on
wage inequality in the United States is not so
surprising when one considers the small size
of such trade. Although imports of manufactured goods from developing countries have
expanded rapidly, in 1995 they still amounted
to only 3 to 4 percent of U.S. gross domestic
product (GDP) and 7 percent of the value of
manufacturing production. More than half of
U.S. imports of manufactured goods still come
from other industrialized countries, some of
which have higher wages than the United States
(see Table 1). Most economists think that technological change, which has increased demand
for workers with higher skills, is mainly responsible for the rise in the demand for skilled rather
than unskilled labor and the resulting increase
in wage inequality. Many economists believe
that advances in information technology, such
as computers and telecommunications, are at
the heart of the changes affecting the U.S.
economy.
In the case of technological change, the benefits to the overall standard of living outweigh

13
See the article by Matthew Slaughter and Phillip
Swagel.

13

BUSINESS REVIEW

the associated dislocations to those whose skills
become obsolete. The economic effects of international trade are similar: trade and new technology both raise the general standard of living while hurting those whose occupational
skills are devalued. Why accept technological
change while restricting trade? Many people
recognize that new technology entails a shift in
the composition of jobs rather than a net loss of
jobs but fail to understand that the same is true
for international trade. But, as discussed previously, by specializing according to comparative advantage, countries increase their productive efficiency with little net effect on job creation.
Although technological change is far more
important than international trade as a cause
of wage inequality, trade does adversely affect
some workers. Rather than restrict trade, the
United States should offer a social safety net
and retraining, which are better ways of helping displaced workers. That way, society can

14

MARCH/APRIL 1998

reap the gains from trade and share them more
equally.
CONCLUSIONS
Trade between the United States and lowwage countries benefits most people in both
places, irrespective of wage differences. Differences in wages largely reflect differences in labor productivity and are not a form of unfair
competition. Developing countries tend to specialize in products created mostly by unskilled
labor while the United States specializes in more
sophisticated goods. Some unskilled workers
in the United States are adversely affected by
such trade, although factors other than trade
are more important in accounting for increases
in wage inequality. In any event, restricting
trade is an inferior solution—it is better to help
displaced workers adjust rather than deny society the gains from specialization according to
comparative advantage.

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Countries Hurt American Workers?
That Thing Venture Capitalists Do
Does Trade with Low-Wage Borderless World?

Janet Ceglowski
Mitchell Golub
Stephen Berlin

REFERENCES
Barlett, Donald L., and James B. Steele. America: Who Stole the Dream? Kansas City: Andrews and
McNeel, 1996. Reprinted from Philadelphia Inquirer series, September 1996.
Committee on Economic Development. American Workers and Economic Change. CED: Washington,
1996.
Feenstra, Robert C., and Gordon H. Hanson. “Foreign Investment, Outsourcing and Relative Wages,”
in Robert C. Feenstra and Gene M. Grossman, eds., Political Economy of Trade Policy: Essays in
Honor of Jagdish Bhagwati. Cambridge: MIT Press, 1995.
Golub, Stephen S. “Comparative and Absolute Advantage in the Asia-Pacific Region,” Pacific Basin
Working Paper Series, Federal Reserve Bank of San Francisco, No. PB95-09, October 1995.
Gottschalk, Peter. “Inequality, Income Growth, and Mobility: The Basic Facts,” Journal of Economic
Perspectives 11, Spring 1997.
Hanson, Gordon H. “Economic Integration, Intraindustry Trade, and Frontier Regions,” European
Economic Review 40, April 1996.
Rowthorn, Robert, and Ramana Ramaswamy. “Deindustrialization: Causes and Implications,” IMF
Working Paper WP97/42, April 1997, forthcoming in International Monetary Fund Staff Studies for
the World Economic Outlook.
Slaughter, Matthew J., and Phillip Swagel. “The Effect of Globalization on Wages in the Advanced
Economies,” IMF Working Paper WP97/43, April 1997, forthcoming in International Monetary
Fund Staff Studies for the World Economic Outlook.

15

Has Globalization Created a Borderless World?

Janet Ceglowski

Has Globalization Created a
Borderless World?
Janet Ceglowski*

T

he newest buzzword in the popular business press is globalization, a word that evokes
images of a world in which goods, services,
capital, and information flow across seamless
national borders. In this world, the choices over
where to produce, shop, invest, and save are
no longer confined within national borders but
have taken on a decidedly global orientation.
Some analysts speculate that globalization has
blurred the economic distinctions between

*Janet Ceglowski is an associate professor, Department of
Economics, Bryn Mawr College, Bryn Mawr, PA. When this
article was written, she was a visiting scholar in the Research Department of the Philadelphia Fed.

countries, creating a “borderless world” in
which economic decisions are made without
reference to national boundaries. For instance,
in describing the sphere in which the major industrial economies operate, Kenichi Ohmae
asserts that “national borders have effectively
disappeared and, along with them, the economic logic that made them useful lines of demarcation in the first place.”
The view that national borders have become
economically meaningless is controversial. But,
if correct, it has potentially important implications for the world’s economies and their
policymakers. One current concern is that, by
enhancing access to the labor resources and
products of low-wage countries, globalization
17

BUSINESS REVIEW

could already be stunting workers’ living standards in relatively high-wage countries like the
United States.1 A truly borderless world would
place great limits on the ability both to confine
the effects of domestic economic policy within
national borders and to insulate countries from
foreign economic shocks. In such a world, financial capital, production activities, and even
workers could move in response to better opportunities elsewhere in the world almost as
easily as they could within a given country,
thereby undermining efforts to maintain economic or financial conditions at home that diverge substantially from those abroad.
The overall level of international economic
activity has escalated in recent years, spurred
by a variety of factors ranging from innovations
in information technology to efforts by national
governments to liberalize and deregulate markets. The result has been an impressive expansion in world trade, investment in overseas
operations, and international flows of financial
capital. Casual observation suggests that international economic developments are attracting
greater attention from policymakers, producers, and even individuals in their roles as workers and consumers. Both the growth in international economic activity and heightened public awareness are indications of strengthening
economic ties between countries. The United
States has participated in this trend and, by
most measures, is considerably more open today than it was even 25 years ago.
Does all this mean that national borders no
longer matter for economic decisions? This article assesses the relevance of the “borderless
world” view for U.S. product markets. Although the U.S. economy has become more
1

This is, itself, a hotly debated issue among economists.
The debate centers on the impact of trade on jobs, wages,
and income distribution. See, for instance, the article by
Paul Krugman and Robert Z. Lawrence and the symposium papers in the Journal of Economic Perspectives, 9 (Summer, 1995), pp. 15-80.
18

MARCH/APRIL 1998

open, recent research finds that national borders continue to affect U.S. trade flows and
product prices. In fact, the estimates of the
border’s effects are substantial. A number of
factors could be responsible for this finding,
including government-imposed barriers to
trade, fluctuations in exchange rates, and a variety of noneconomic factors such as national
historical and cultural ties. Even in the current
environment of global and regional trade liberalization, there is little reason to expect that the
influence of these factors on U.S. product markets is about to disappear.
GLOBAL AND REGIONAL INTEGRATION:
EVIDENCE FOR U.S. PRODUCT MARKETS
National economies are linked through trade
in goods and services, cross-border flows of financial assets, and labor migration. International economic integration is the process by
which reducing barriers between national
economies strengthens these ties. In the economics literature, integration traditionally has
been associated with explicit government actions to lower tariffs and other artificial barriers to the international movement of goods,
services, and inputs. Recent advances in communication and information technologies have
also promoted economic integration by enhancing knowledge of and access to foreign consumers and products. Both trade liberalization and
advances in communication and information
continue to be operative factors in the U.S.
economy.
Have U.S. product markets become more
integrated with the world economy as a result?2

2
While this paper is concerned with the economic integration of U.S. markets for goods and services, the term
can also be applied to markets for inputs like labor and
financial capital. By and large, labor market integration is
limited by government-imposed barriers to international
migration. In contrast, financial capital is perceived as
highly mobile internationally. That view is supported by

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Borderless World?

Janet Ceglowski

One common approach to quantifying the
strength of an economy’s ties with the rest of
the world is to measure the share of its economic
the fact that, at least for the major currencies, interest rate
differentials between identical offshore and domestic assets are insignificant. But as Martin Feldstein observes, this
merely reveals that financial capital can and does move
across national borders. In fact, despite the substantial
holdings of foreign stocks and bonds, recent research indicates that investors exhibit a strong home bias in their investment portfolios (see the articles by Kenneth French and
James Poterba; and Linda Tesar and Ingrid Werner). The
implication is that international capital markets are not fully
integrated.

activity made up of exchanges with other countries. A larger share is indicative of a more
“open” economy, one with stronger links to the
world economy. According to this measure,
markets for goods in the United States have
become more open. Measured relative to gross
domestic product (GDP), merchandise trade
more than doubled between 1970-71 and 199596 as a result of significant growth in both exports and imports (Table 1). Much of that gain
occurred in the 1970s, so that by 1980-81 merchandise trade was 16.5 percent of GDP. The
expansion in U.S. trade resumed in the 1990s,
albeit at a somewhat slower pace. Though

TABLE 1

U.S. Trade in Goods and Services Relative to U.S. GDP
(annual averages; in percent)
1970-71

1980-81

1990-91

1995-96

8.0

16.5

15.4

18.5

4.0
4.0

7.8
8.7

6.9
8.5

8.0
10.5

Private services

1.8

2.5

4.2

4.8

of which:

0.9
0.9

1.4
1.1

2.5
1.7

2.9
1.9

Merchandise & services

9.8

19.0

19.6

23.3

of which:

4.9
4.9

9.2
9.8

9.4
10.2

10.9
12.4

Merchandise,
excluding military
of which:

exports
imports

exports
imports

exports
imports

Notes: The totals are the sums of the individual percentages for exports and imports. Private services trade is
calculated as total services trade minus transfers under U.S. military sales contracts, direct defense expenditures,
and U.S. government miscellaneous services.
Source: Author’s calculations based on data from Bureau of Economic Analysis

19

BUSINESS REVIEW

MARCH/APRIL 1998

smaller in value than goods trade, services trade
has grown even faster: measured relative to
GDP, it has nearly tripled since 1970-71. Together, exports and imports of goods and services have expanded from under 10 percent of
GDP in 1970-71 to over 23 percent in 1995-96.3
Do similar measures show evidence of growing regional integration? Recent trade agree-

3
It could be argued that trade statistics underestimate
the extent of product market integration because they do
not fully account for the contributions of companies’ overseas operations. For example, foreign companies have invested heavily in U.S. production facilities over the last 15
years or so. The result has been a significant rise in the level
of economic activity of foreign companies operating in the
United States. In fact, the Bureau of Economic Analysis estimates that the output of U.S. affiliates of foreign companies has grown faster than total U.S. output; as a share of
gross output originating in private industries, it has increased from 2.3 percent in 1977 to 6 percent in 1995.

ments between the United States, Canada, and
Mexico have created a tri-national free trade
area; the Canada-United States Free Trade
Agreement (CUSFTA) liberalized trade between the United States and Canada in 1989 and
the North American Free Trade Agreement
(NAFTA) extended the free trade area to Mexico
in 1994. As a result, numerous formal barriers
to trade and investment between the three
countries have been or will be eliminated. The
reduction in economic barriers should promote
greater integration of the three economies. In
fact, merchandise trade with Canada and
Mexico grew from 2.3 percent of U.S. GDP in
1970-71 to 5.4 percent in 1995-96 (Table 2). Some
of that growth predates the creation of the
North American free trade area, suggesting an
ongoing process of economic integration between the United States and the two other
NAFTA countries. However, the recent trade

TABLE 2

U.S. Trade with Canada and Mexico Relative to U.S. GDP
(annual averages; in percent)
1970-71

1980-81

1990-91

1995-96

Merchandise

2.3

3.9

4.1

5.4

of which: Canada
Mexico

2.0
0.3

2.9
1.0

3.0
1.1

3.8
1.6

Private services

NA

NA

0.71

0.69

of which: Canada
Mexico

0.30
NA

0.28
NA

0.45
0.26

0.44
0.25

Notes: The individual percentages for Canada and Mexico represent the ratios of the sum of exports and imports
to U.S. GDP. The totals for merchandise and services are the sums of the individual percentages for Canada and
Mexico.
Source: Author’s calculations based on data from Bureau of Economic Analysis

20

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Borderless World?

agreements could have played a part in the significant gain since 1990-91. They might also be
a factor in the sustained rise in the share of private services trade with Canada.
IS THE U.S. BORDER IRRELEVANT?
The preceding analysis indicates that U.S.
product markets have become more integrated
with global markets. There is some indication
of the same phenomenon at the regional level.
But evidence of greater economic integration
is not the same as evidence that national borders no longer matter for the worldwide distribution of goods and services. Although this
distinction may appear to be simply a matter
of degree, it is important. In a truly borderless
world, the strength of the economic ties between markets would not depend on whether
they are located in the same country. In particular, consumers and producers within a
given country would not trade more among
themselves simply because of shared nationality. In the language of economic integration,
borderless product markets would be tantamount to complete integration.
Do borders still matter for U.S. product markets? The border between the United States and
Canada is the most likely place to find evidence
that they don’t. Complete economic integration
requires that there be no trade barriers between
countries. Therefore, the strongest evidence of
borderless product markets should be found
among countries that have largely eliminated
barriers to trade between them. The United
States and Canada are clear candidates: not only
have CUSFTA and NAFTA eliminated numerous barriers to bilateral trade but, for many
goods, tariffs and other formal trade barriers
between the United States and Canada were
low or nonexistent well before the recent trade
agreements.
Several other features of the two countries
favor the development of strong bilateral economic links. Geographic proximity is one such
feature. Greater distances between markets

Janet Ceglowski

mean larger costs of transporting goods and
services between them, encumbering trade and
the development of close economic ties.4 But
the United States and Canada share a long border, much of which is easily negotiated by land
or water. Moreover, some Canadian cities are
closer to urban centers in the United States than
they are to other major Canadian cities. Indeed,
over three-fourths of Canada’s population lives
within 100 miles of the U.S. border. The nearness of the two countries extends beyond mere
physical proximity: Canada and the United
States share a number of social, political, and
cultural traditions, and a majority of people in
both countries speak the same language. Both
the geographic proximity and cultural similarities of the two countries are propitious for bilateral trade and other cross-border economic
activities.
In fact, Canada and the United States have
long been major destinations for each other’s
products and foreign investment. They currently exchange close to $1 billion in goods and
services each day, making theirs among the
world’s largest bilateral trade flows. But how
are we to gauge whether this cross-border economic activity is evidence that the U.S.-Canada
border no longer matters? One approach would
be to evaluate the economic ties between a Canadian market (say, Toronto) and a U.S. market
(say, Philadelphia). The strength of the ties between any such pair of markets could depend
on a number of factors, including the geographic distance between them and the composition and sizes of their respective economies.
But if economic activity were unaffected by the
political border between Canada and the United
States, the strength of the ties would not depend on the fact that the two markets are lo-

4

James Rauch argues that for all but a few relatively standardized products such as those traded in organized global markets, greater distances can also raise the costs of
locating appropriate sellers or buyers in foreign markets.
21

BUSINESS REVIEW

cated in different countries. Evidence to the
contrary would imply that the border does
matter and that the two economies cannot be
characterized as completely integrated.
Recent research finds that the relatively innocuous U.S.-Canada border has significant
economic effects. The evidence is twofold. First,
studies of Canadian merchandise trade reveal
that the average Canadian province trades
much more with other Canadian provinces than
with U.S. states of similar economic size and
geographic distance.5 Ontario, for instance, is
roughly equidistant from British Columbia and
the state of Washington. Yet in 1990, it traded
over seven times more with British Columbia
than with Washington, despite the fact that
Washington’s economy was almost twice the
size of British Columbia’s. This suggests significant home bias in Canadian merchandise trade
vis-a-vis the United States.
Second, evidence also comes from comparisons of consumer prices in the United States
and Canada. If the U.S.-Canada border were
economically irrelevant, there would be no
large, persistent differences between the prices
of identical products in Canadian and U.S.
markets, once they were expressed in terms of
the same currency. As every consumer has experienced firsthand, price differentials for the
same good can and do exist at any single point
in time. According to economic theory, however, the actions of buyers in search of low prices
and sellers in pursuit of profits should minimize these price differences over time. Econo-

5

See the papers by John McCallum and John Helliwell.
It is possible that the effects attributed to the border actually derive from differences in the composition of state and
provincial production. That is, interprovincial trade could
exceed trade between Canadian provinces and U.S. states
not because of the border, but simply because the provinces can obtain more of what they want from other provinces. However, when McCallum explicitly controls for this
possibility, he finds that it does not account for the large
effect of the border on provincial trade patterns.
22

MARCH/APRIL 1998

mists acknowledge that this process can take a
considerable amount of time. They also recognize that prices of similar products in different
locations may not be exactly equalized, owing
to such factors as the cost of transporting the
products between locations. When markets are
integrated, however, the forces of competition
should ensure that such prices move in parallel with one another over the long run. Yet recent research finds little evidence of such a correspondence between the U.S. dollar prices of
consumer goods in U.S. and Canadian markets,
even in the long run.6
The empirical evidence clearly indicates that
the border has economic effects—that is, the
border “matters”—for product markets in the
United States and Canada. This conclusion may
not be terribly surprising. After all, the free trade
arrangement between Canada and the United
States stops far short of establishing an economic union. A more interesting issue concerns
the magnitude of the border’s effects. That is, if
the border matters, does it matter a lot? The
answer appears to be yes. By one estimate, a
Canadian province engages in 20 times more
merchandise trade with another Canadian
province than with an equidistant U.S. state of
comparable economic size.7 Preliminary evi6

John Rogers and Michael Jenkins analyze ratios of U.S.
prices to Canadian prices (both expressed in U.S. dollars)
for various categories of consumer products. In constructing the ratios, they carefully pair U.S. consumer products
with similar Canadian products to ensure that they are comparing the prices of like goods. Even so, they fail to find
evidence of a stable, long-run relationship between most
product pairs. In a related study, Charles Engel compares
the variability of price ratios for pairs of consumer products in the United States and Canada. He reports that the
variation in the dollar price ratio of similar Canadian and
U.S. consumer products is typically much larger than the
variation in the price ratio of two different consumer goods
in either the United States or Canada.
7
This estimate comes from the studies by McCallum and
Helliwell. Shang-Jin Wei comes up with much smaller estimates of home bias for the merchandise trade of a broader

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Borderless World?

dence indicates the home bias is apt to be even
larger for U.S.-Canada services trade.8 Another
study translates the impact of the U.S.-Canadian border on consumer prices into an equivalent physical distance, estimating that crossing
the border is equivalent to adding a distance of
1780 miles between markets.9 Whether measured in miles or trade volumes, the economic
effect of the U.S.-Canada border is considerable.
Two conclusions can be inferred from this
evidence. First, the U.S.-Canada border has a
surprisingly large impact on both trade patterns
and product prices in the two-country region.
Second, if the relatively open U.S.-Canada border exhibits such substantial economic effects,
it is likely that borders have even greater impacts on trade flows and relative prices between
the United States and other countries. But why
do borders appear to have such large effects?

sample of industrialized countries. However, reconciling
Wei’s findings with those for U.S.-Canadian merchandise
trade is complicated by conceptual and measurement differences in the two sets of studies.
8
See the paper by Helliwell and McCallum. This is likely
for two reasons. First, the free trade agreements between
the U.S. and Canada did not include some service sectors,
such as health, transportation, basic telecommunications,
and legal services. Second, national regulations in two important service sectors, broadcasting and finance, could
limit the bilateral exchange of these services.
9
See Engel and Rogers (1996). Their study covers the
period 1978-93 while McCallum’s analysis of merchandise
trade is based on data for 1988. Because the two studies
include data from the period prior to the implementation
of the Canada-United States Free Trade Agreement, it might
be supposed that their estimates overstate the current impact of the U.S.-Canada border. However, Engel and Rogers
find that the border’s effect is no smaller when data prior
to 1990 are excluded. Likewise, Helliwell’s update of
McCallum’s work finds comparable estimates for merchandise trade through 1990. This could reflect the fact that the
effective trade barriers between the United States and
Canada were already low before the agreement. An alternative interpretation is that adjustment to the free trade
agreement was not complete by the early 1990s.

Janet Ceglowski

THE ECONOMIC ROLE OF THE BORDER
National borders can influence economic
activity in a number of ways. As political and
legal boundaries, they provide a means for governments to erect barriers to international flows
of goods, services, and factors of production.
These measures take a variety of forms and are
instituted for a number of reasons. Tariffs drive
a wedge between a domestic market and foreign supplies, frequently with the intention of
offering protection to domestic industries.10 The
same is true of quotas, nontariff trade barriers
that impose quantitative restrictions on imports.
Other so-called nontariff barriers often have
the same effect but may or may not be erected
for trade policy purposes. This broad category
of barriers includes technical standards, licensing and certification requirements, health and
safety regulations, border formalities, and government procurement practices. There are numerous instances in which regulators have been
accused of imposing measures to protect domestic industries under the guise of other concerns such as the environment or public health.
For example, in the early 1990s, Ontario levied
a 10-cent tax on all beer sold in cans. The stated
objective was to encourage container re-use. But
U.S. beer manufacturers viewed the tax as protectionist because, unlike Canadian beer, most
American beer is sold in cans and is thus subject to the levy. Practically speaking, of course,
determining whether a specific nontariff barrier was intended to shelter domestic markets
from foreign competition or had some other
primary objective is often difficult.
Other examples of government-imposed
barriers include controls on international flows
of capital and labor, limitations on holdings of
foreign exchange, and market-entry and ownership restrictions. All of these measures differentiate the products and inputs of the do-

10

Tariffs also raise revenue for the government.
23

BUSINESS REVIEW

MARCH/APRIL 1998

mestic economy from those originating outside
the border, effectively contributing to the establishment of an economic frontier between a
country and the rest of the world.
Tariffs and other formal barriers to trade between the United States and Canada have long
been lower than in most other parts of the
world. Thus, it is unlikely that they can account
for the lion’s share of the estimated border effects. A potentially larger effect could come
from past trade policies. High tariffs were key
components
of
Canada’s National
Policy, which was
instituted in the latter part of the 19th
century. The policy
sought to promote
economic development and east-west
transportation and
trade links within
Canada. To the extent that it led to the
integration of Canadian markets and
the formation of strong internal distribution
networks, this policy could bear some responsibility for the current home bias in Canadian
merchandise trade.11 Informal trade barriers or
nontariff barriers in both countries could also
contribute to the segmentation of U.S. and Canadian markets.
The economic impact attributed to the border might actually reflect the effects of geographic distance between markets. If transportation and information costs increase with dis-

tance, trade flows should be larger between
markets that are geographically close to one
another than between more distant markets. For
the same reasons, price differentials across markets should be smaller when the markets are
close to one another. Indeed, geographic distance is a significant factor in both merchandise trade flows and price dispersion within the
U.S.-Canada region. But the border between
Canada and the United States appears to have
a separate effect on both measures of economic
integration.
As
stated earlier, trade
between two Canadian provinces is
substantially greater
than that between a
province and an
equidistant U.S.
state. Moreover,
even after controlling for distance, the
variability of consumer prices between a city in
Canada and a city in
the United States is considerably higher than
that between either two U.S. cities or two Canadian cities.12
Borders are usually demarcations between
currency areas. Consequently, most international transactions require the exchange of one
currency for another. Currency exchanges typically entail some small cost associated with
translating one currency into another. A small
cost for each of millions of transactions can
amount to a considerable sum; one estimate
places foreign-exchange costs in Germany at 1
percent of GDP.13 However, there is a risk of

The economic impact
attributed to the
border might actually
reflect the effects of
geographic distance
between markets.

11

It could be argued that Canada’s current trade patterns are appropriate in view of its strong internal distribution networks. But a quick glance at a map suggests that,
were it not for Canada’s National Policy, Ontario might
today have stronger links with, say, New York than with
British Columbia.
24

12

See Engel and Rogers’ 1996 paper.

13
See “When the Walls Come Down,” The Economist, July
5, 1997, pp. 61-63.

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Borderless World?

substantially larger costs when a contract between parties in two countries calls for future
payment. Between the time the price is set and
settlement is made, unexpected changes in the
value of the exchange rate will alter the ultimate price of the transaction for one of the parties involved. Unlike exchanges within a single
country or currency area, international transactions often entail exchange-rate risk. This risk
could act as a barrier to international trade. In
empirical studies of international trade, currency risk is commonly measured by the volatility of the relevant exchange rate. However,
perhaps because financial instruments such as
forward exchange contracts are available to reduce or eliminate currency risk, such studies
have yielded mixed results, and there is currently no consensus among economists that
exchange-rate volatility has had a significant
negative impact on trade volumes.
When price comparisons are used to measure border effects, the exchange rate matters
in a different way. International price comparisons are made by using the nominal exchange
rate to translate prices into a common currency.
However, the nominal exchange rate is typically
more variable than product prices. By implication, much of the variation in the relative dollar prices of Canadian and U.S. consumer products could simply reflect fluctuations in the
nominal exchange rate between the two countries. Indeed, the empirical evidence indicates
that changes in the exchange rate are significant factors in the volatility of relative U.S.-Canadian prices. But they are far from the whole
story.14
Several economists have noted that consum-

14

Engel and Rogers (1996) explore the possibility that
the effect attributed to the U.S.-Canada border is, in fact,
the product of fluctuations in nominal exchange rates and
rigidity in local prices. They find that while local price rigidity is responsible for part of the measured border effect,
it accounts for less than half of it.

Janet Ceglowski

ers exhibit a distinct home bias, preferring to
deal with firms in their own country and to
purchase domestic products. Little is known
about the precise reasons for this preference,
but a number of factors may be involved. To
the extent that they define social boundaries,
national borders may also represent the economic effects of distinct tastes, history, traditions, and cultures. Alternatively, a preference
for home products may simply reflect ignorance
about or lack of access to alternatives. Regions
within a common border typically share networks of associations, as well as legal, financial, and regulatory systems. Not only can this
ease the acquisition of information but, once
obtained, such knowledge is often universally
applicable within the border. In addition, marketing and distribution networks for goods,
services, and inputs may be more integrated
within each country than they are across borders.15 These networks may make it easier to
learn about and gain access to domestic products, contributing to a home bias. Although it
is difficult to measure the contribution of these
factors to the economic role of the border, they
should not be dismissed as necessarily trivial.
CONCLUSION
Despite evidence that the U.S. economy has
become more open, recent empirical research
finds that the border between the United States
and Canada has a very large impact on bilateral trade flows and relative prices. Given the
relative openness of the U.S.-Canada border, it
is unlikely that the border’s effects are any less
significant between product markets in the
United States and other countries. This contradicts the notion that globalization has already
rendered national borders economically meaningless. But because most of the evidence is
based on relatively recent data, it is not known

15

See the 1995 paper by Engel and Rogers for a model
of international trade with marketing costs.
25

BUSINESS REVIEW

whether the border’s economic impacts are actually smaller now than in the past.
The reasons for the border’s substantial effects are not yet completely understood. Consequently, it is difficult to speculate how recent
advances in communication like the Internet
will ultimately reduce the economic boundaries

26

MARCH/APRIL 1998

between nations. However, the effects of the
border appear to extend beyond the economic
impacts of geographic distance and formal
trade barriers. By implication, merely liberalizing trade or reducing transportation costs between national markets may not be enough to
cause the border to disappear.

FEDERAL RESERVE BANK OF PHILADELPHIA

Has Globalization Created a Borderless World?

Janet Ceglowski

References
Engel, Charles. “Real Exchange Rates and Relative Prices,” Journal of Monetary Economics, 32 (1993),
pp. 35-50.
Engel, Charles, and John Rogers. “Regional Patterns in the Law of One Price: The Roles of Geography
vs Currencies,” Working Paper 5395, National Bureau of Economic Research (1995).
Engel, Charles, and John Rogers. “How Wide Is the Border?” American Economic Review, 86 (December, 1996), pp. 1112-25.
Feldstein, Martin. “Tax Policy and International Capital Flows,” Working Paper 4851, National Bureau of Economic Research (1994).
French, Kenneth, and James Poterba. “Investor Diversification and International Equity Markets,”
American Economic Review, 81 (May, 1991), pp. 222-26.
Helliwell, John. “Do National Borders Matter for Quebec’s Trade?” Canadian Journal of Economics, 29
(August, 1996), pp. 507-22.
Helliwell, John, and John McCallum. “National Borders Still Matter for Trade,” Policy Options, 13
(July/August, 1995), pp. 44-48.
Krugman, Paul, and Robert Z. Lawrence. “Trade, Jobs, and Wages,” Scientific American (April, 1994),
pp. 44-49.
McCallum, John. “National Borders Matter: Canada-U.S. Regional Trade Patterns,” American Economic Review, 85 (June, 1995), pp. 615-23.
Ohmae, Kenichi. The Borderless World. New York: Harper Business, 1990.
Rauch, James. “Networks Versus Markets in International Trade,” Working Paper 5617, National Bureau of Economic Research (1996).
Rogers, John, and Michael Jenkins. “Haircuts or Hysteresis? Sources of Movements in Real Exchange
Rates,” Journal of International Economics, 38 (1995), pp. 339-60.
Tesar, Linda, and Ingrid Werner. “Home Bias and the Globalization of Securities Markets,” Working
Paper 4218, National Bureau of Economic Research (1992).
Wei, Shang-Jin. “Intra-national versus International Trade: How Stubborn Are Nations in Global Integration?” Working Paper 5531, National Bureau of Economic Research (1996).

27