The proposed benefits of globalization are: 1) increases in economic productivity achieved through efficient resource allocation, and 2) greater political stability achieved through economic interdependence. Hence, it is assumed that if nations become economically interdependent, they will be less likely to wage war upon one another or tolerate political instability at home. According to some sources, it was the desire to achieve political stability in post-WWII Europe that most influenced the development of the European Union, the first large-scale cooperative economic arrangement among Western, industrialized nations.
Principle of Comparative Advantage
To understand the economic motivation for globalization, it is important to understand the principle of comparative advantage. This principle, attributed to David Ricardo (1772 - 1823), posits that nations can be most productive through specialization in areas where they have a ratio advantage, relative to other nations, in the production of a good or service.
Consider this often used example. Two nations--England and Portugal--produce two commodities--wheat and wine. The cost per unit in labor hours to produce wheat is 15 hours in England and 10 hours in Portugal. The cost per unit in labor hours to produce wine is 30 hours in England and 15 hours in Portugal. Thus, Portugal has an absolute advantage in labor hours to produce both wheat and wine.
But, Portugal has a relatively better ratio at producing wine and England has a relatively better ratio at producing wheat. That is, the ratio of producing wheat to wine in Portuagal is 2/3 whereas the ratio of producing wheat to wine in England is only 1/2. So, even though Portugal has an absolute advantage at producing both wheat and wine, Portugal has a comparative advantage in the production of wine and England has a comparative advantage in the production of wheat.
How can these comparative advantages be used to improve the total production of wheat and wine?
Suppose England has 270 total labor hours at its disposal and Portugal has 180 hours of labor at its disposal (i.e., "labor hours" encompasses size of labor force and technical capacity). Suppose, before trade, that England produces and consumes 8 units of wheat (at 15 hours/unit = 120 hours) and 5 units of wine (at 30 hours/unit = 150 hours) and Portugal produces and consumes 9 units of wheat (at 10 hours/unit = 90 hours) and 6 units of wine (at 15 hours/unit = 90 hours). The total production of wheat equals 17 units and the total production of wine equals 11 units. Now, suppose England specializes in wheat production and Portugal specializes in wine production. England can produce 18 units of wheat (at 15 hours/unit = 270 hours) and Portugal can produce 12 units of wine (at 15 hours/unit = 180 hours). Note that total production of both wheat and wine have increased by one unit! Through specialization and trade, England and Portugal, taking advantage of their comparative advantage, can increase total production of both wheat and wine.
This principle assumes:
Economic leakage refers to the movement of profit margins from primary, to secondary, to tertiary markets.
Primary markets are oriented mainly toward the production of raw commodities (e.g., food commodities, such as corn, wheat, soybeans; mined goods, such as raw ore and minerals). Secondary markets focus mainly upon the further processing of raw commodities (e.g., corn syrup, bread, soy-based oil products, steel, cut minerals). Tertiary markets specialize in facilitating production and trade by providing financing, access to markets, and access to information about markets (e.g., the Chicago Mercantile Exchange, the NYSE, Citibank).
Typically, profit margin increases as goods move from primary to secondary to tertiary markets. Thus, a nation whose economy focuses almost exclusively upon primary commodity production will experience "economic leakage" of potential profits to nations involved in secondary and tertiary markets because it is not involved in these more lucrative ventures.
A concern expressed about the WTO and other organizations that govern international trade is that nations involved in primary commodity production will find it very difficult to develop secondary or tertiary markets. Suppose, for example, that Nation A, which is involved mainly in primary commodity production, wants to build an industry that can further develop its raw commodities. Such industrial development requires much investment of capital. Thus, Nation A might want to provide over the short run government subsidies to help the new industry bear the burden of start-up costs and operating losses until it can become efficient enough to compete in world markets. Such subsidies would be considered illegal under current and proposed WTO rules. Nations not yet developed enough to enjoy the increased profit margins of secondary and tertiary markets might never be able to do so under WTO regulation.
Another concern expressed about globalization is that nations wishing to establish laws to protect their environmental quality might not be able to do so under WTO regulations. Consider a case in 1996 when Venezuela brought a claim against the United States alleging that the U.S. Clean Air Act unfairly discriminated against Venezuela gas exports to the US because the act required foreign gasoline sold in the US to be no more contaminated than the average level of contaminants in US gas. The WTO ruled in favor of Venezuela. So, the US rewrote the Clean Air Act to allow both domestic and foreign gas producers to produce more contaminated gas. In another WTO ruling, Japan was forced to lift its import ban on certain fruits that might bear dangerous insects, even though to get rid of those insects Japan needed to use harmful pesticides.
Thus, in principle, any action taken by any country to protect its environment that might be perceived as restricting free trade can be overturned by the WTO.