Free Trade as an Instrument of Justice: The Intellectual and Moral

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17 Οκτ 2013 (πριν από 3 χρόνια και 11 μήνες)

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Free Trade as an Instrument of Justice: The Intellectual and Moral
Benefits of International Trade and a Preliminary Empirical Analysis
Across Nations

John E. Charalambakis Ph.D., Professor of Economics, Asbury College

Introduction

In Plato’s
Republic

we f
ind Socrates asking the fundamental question that has been with
us for centuries, “What is justice?” It seems that for Plato, as well as for Aristotle who
followed him, justice is the essential virtue of a society. Socrates taught his disciples that
just
ice is giving and getting one’s due. Plato describes that justice must be counted as
desirable for its own sake (Plato, trans. Grube, 1982.) Justice in other words is harmony
in the soul and harmony in the state. Furthermore, Plato tells us that respons
ibility should
be delegated in accordance to one’s ability and place.

I believe that the latter could become the foundation for viewing international trade as an
instrument of justice, because what is produced, where it is produced, and by whom is
produc
ed, depends upon the ability to produce in an efficient manner. In such a case,
everyone can gain from the transaction, a concept that was taken to the next step by
Aristotle.

In this framework of thought, justice is viewed as fairness, power is restraine
d, the
disadvantaged are empowered, and the interests of the society as a whole are being
advanced. If that is the case, then, sectors in the economy would work together in
harmony (nowadays that would apply to the production and financial sectors), while
convergence would be observed across nations.

The paper discusses first international trade as a venue and instrument of justice from a
theoretical perspective, then builds a theoretical framework where international trade is
viewed as the main venue of ca
pital formation, which in association with social, physical,
and financial infrastructures creates and sustains a middle class, without which
democracy cannot function (Zakaria, 2003.) Finally, the paper tests the above hypothesis
by employing data from th
irteen countries (developed and less
-
developed) and by using
an algorithm and a support vector machine (SVM).

The empirical results verify the hypothesis that trade is a source of creating a middle
class, and thus serves as a venue of distributive and comm
utative justice. The paper

2

concludes with a thesis (which still needs to be tested) that when the financial interests of
collateralization and securitazation, are separated from production interests at a global
level, then Pandora’s box is being opened, f
inancial crises take place, and the reverse
route starts i.e. the destruction of the middle class and injustice prevails.


From Plato to Rawls and Nozick

In the
Republic
, Socrates refuses and rejects the argument of Thrasymachus who argued
that justice al
ways serves the interests of the rulers of the society, the interests of the
stronger in our midst. Moreover, Socrates rejects Glaucon’s argument who suggested a
more modest approach, that justice is ultimately a matter of self interest and that people
ob
serve justice to avoid punishment. Both of these negatives views about justice have
been rejected by Socrates who insists that justice is the ultimate responsibility of the
person, and should be delegated according to ability and place. Justice cannot be

viewed
as punishment, retribution or revenge. In the ancient time, in Platonic terms, justice is a
matter of social harmony and in Christian ethics it is a matter of mercy. In economic
terms we can talk about just wages, just distribution of rewards and

of income. Issues of
justice come at the forefront when there are exchanges. In his famous 1971 book,
The
Theory of Justice,

John Rawls takes the liberal approach to find the proper balance
between liberty and equality, with a particular concern for the

least advantaged. A few
years later his colleague, Robert Nozick takes a more libertarian approach to justice
defending a strong notion of entitlement where everyone gets what he or she is entitled to
based on endowments, without any reference to needs o
r inequalities.


I have the impression that any reference to justice by neglecting the concept of
community would have horrified Plato, Socrates, Aristotle and their followers. Cicero
has long argued that the leading virtue in a society is justice and th
at the definitive
ingredient of justice is merit. Therefore, meritocracy in society is a necessary condition
for justice to be administered. Meritocracy at the same time requires the observance of
the rule of law, because the rule of law distributes righ
ts and a just law advances fairness
(in the theoretical framework below, this will be titled the legal infrastructure.)


3

If production responsibilities are designated according to merit and ability (Plato and
Cicero) then, the responsibility of justice is
to enable the individuals across nations to
produce according to their natural and enhanced capabilities and endowments. If we take
the concept of justice a step further, we would probably understand that justice is
inseparable from righteousness, at leas
t in the Platonic and Aristotelian paradigms. In
that sense, Plato’s central claim of righteousness is “performing the functions for which
ones nature is best fitted.” It is also interesting to note that both Plato and Aristotle
defend inegalitarian view
s of justice.


In
The Ethics
, Aristotle gives us a complex concept of justice. He divides justice in two
broad categories as the lawful (he does not necessarily mean obedience to the laws of any
particular state) and the concept of fair and equal. It i
s the latter that is advanced in
Aristotelian ethics (Aristotle, transl. Irwin, 1985.) The literal meaning of the word justice
in Aristotelian ethics is the meaning of righteousness, which is the form of justice that
represents complete virtue of the soul

which cannot be understood unless it is
comprehended within the framework of community, i.e. in relationships. Aristotle
divides this kind of justice into distributive and rectificatory. For Aristotle, the student of
Plato, justice should be viewed as f
airness. Distributive justice for Aristotle is primarily
concerned with what people deserve. We also need to keep in mind that Aristotle is
particularly concerned with the justice of transactions. When Aristotle talks about justice
in transactions, he r
efers to commutative justice in voluntary exchanges such as buying,
selling and lending, or involuntary matters where we have victims of insults, thefts or
assassinations. When Aristotle talks about equality and justice he refers to proportional,
or what
he calls geometrical proportion in distributive justice. Through the centuries
since then, we understand that in Aristotelian ethics we need to treat equals equally, while
unequals deserve unequal treatment in proportion to their merit, in proportion to t
heir
abilities, and in proportion to their enhanced capabilities.

Therefore, according to Vlastos (Vlastos, 1962)


a leading scholar for Plato and
Aristotle


a distribution to be just is almost always an unequal one. Vlastos writes, “the
meritarian vie
w of justice paid reluctant homage to the equalitarian one by using the
vocabulary of equality to assert the justice of inequality.”


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I believe that central to Aristotle’s overall argument is the concept of justice as a state of
attitudes, habits, customs

and cultivated policies that advance and enhance the
capabilities of persons, groups and nations. The enhancement of that capability leads to
the development of character and to the development of a nation. When individuals are
deprived from their poten
tial, their nations cannot prosper. This kind of justice according
to Aristotle is complete virtue, not complete virtue unconditionally, but complete virtue
in relation to another. Aristotle writes, “Moroever justice is complete virtue to the
highest deg
ree because it is the complete exercise of complete virtue and it is the
complete exercise because the person who has justice is able to exercise virtue in relation
to another not only in what concerns himself for many are able to exercise virtue in their
own concerns but unable in what relates to another… and for the same reason justice is
the only virtue that seems to be another person’s good because it is related to another for
it does what benefits another, either the ruler or the fellow member of the c
ommunity…
and the best person is not the one who exercises virtue only toward himself but the one
who also exercises it in relation to another since this is a difficult task… for virtue is the
same as justice, but what it is to be virtue is not the same as

what it is to be justice.”

In a few sections later, Aristotle would argue, “what is just then is what is proportionate
and what is unjust is what is counter proportionate, hence in an unjust action one term
becomes more and the other less and this is in
deed how it turns out in practice since the
one doing injustice has more of the good and the victim less.” This proportionality in
distributive justice is in accordance with merit, ability, and
-

in economic terms
-

efficiency. Therefore, in Aristotelian

ethics justice in order to be just has to have unequal
proportions.


St. Thomas Aquinas synthesized the Christianity of the Church with Aristotelian ethics
and came up with some articles relating to justice that can be summarized as follows
(Solomon and
Murphy, 1990):

First, justice is a habit whereby a man renders to each one his due by a constant and
perpetual will. Second, justice is always towards another, and third, justice is a virtue
and actually it’s the chief of all the moral virtues.


5

Aquinas
concludes his thesis on justice by echoing St. Augustine and Cicero by
suggesting that charity, generosity and liberality is an essential part of justice, especially
to the ones who are the least among us.

Now, if we go further back and examine the ancie
nt Chinese and far Eastern
philosophies, we will discover that there are two concepts that summarize the moral
elements of the mind and of the soul. Those two elements are the concept of li and ren.


The idea of li, is what is known in Confucian thought a
s the rules of conduct. The second
concept is the idea of ren or what we would call today agape, the benevolent love toward
others exhibited by rulers as well as the average person. In the far eastern thought when
the soul loses its sense of justice it l
oses its moral compass and as Confucius said it’s like
a mountain that has lost its trees (Mencius, 1970.)


In the midst of the seventeenth century Thomas Hobbes in his classic work (Hobbes,
1926),
The Leviathan,

describes the state of nature and a state

of affairs as one
underlined by fear and insecurity. It’s a state of affairs where there is no right or wrong,
no right to property, no mine or thine, no law and justice or injustice, only force and
fraud. It is in this state of affairs and in this clima
te of uncertainty where all members in
the society feel the need for a mutual social compass, a social contract that becomes a
matter of rational necessity. The need for this kind of social compass forms the basis of
Hobbes’ argument that people have a ba
sic ability to do damage to one another and in the
absence of any sense of duty towards one another, in the absence of any power over the
people, people become competitive, insecure, and mutually defensive. From a trade
perspective Hobbes views internatio
nal exchanges as a zero sum game where life on
earth and exchanges are nothing but unhappy transactions of a life where there is no
justice. Obviously Hobbes portrays a horrifying picture of relationships.

On the other hand, John Locke’s thesis gives us

a more optimistic picture of how a social
contract implements the natural law more fully and formally (Locke, 1983.) The primary
purpose, according to John Locke, of this kind of social contract is to unify individuals
into mutual transactions for the ben
efit of the community and it is a looser association

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and affiliation of individuals
-

who have freely chosen this kind of arrangement
-

than
Hobbes would have allowed.


Following John Locke in the midst of the eighteenth century, Jean
-
Jacuqes Rousseau
co
ntemplates a society where individuals, in contrast to the vision Hobbes has, will
wander the face of the earth picking up food, sleeping comfortably and getting what they
need from the naturally abundance around them. So they are happy creatures who are
not
compelled to enter into a social contract because of their meager provisions. However,
Rousseau believes that the foundational institution that perpetuates inequalities is the
invention is private property, and that all inequalities have resulted from

that. For him
our competitiveness and unhappiness arises from the institution of private property and
from the struggle between those in power and those without power. However, Rousseau
wants to look to the future and to the foundations of better societ
y and therefore he offers
his own version of the social contract not as an instrument and a vehicle for controlling
each other or protecting ourselves or our property, but as a way of giving the law to
ourselves, and therefore elevating people to become ci
tizens in a community of mutual
respect and mutual advancement. From a libertarian standpoint
Friedrich Hayek

(Hayek,
1976) and Robert Nozick (Nozick, 1974) would have emphasized the idea of
commutative justice whose purpose would be to enforce contracts,

to advance the liberty
of persons, the protection of property, and the advancement of individualism in a society
that doesn’t have a common scale of values because there is no wide agreement on
values, therefore in such a society justice in those terms do
es not reward merit in some
moral sense.


However, I believe that we need to move beyond commutative justice and even beyond
distributive justice as envisioned by John Rawls in his veil of ignorance (Rawls, 1971.) If
justice relates to relationships with

others, and if a person does not live only by bread,
then justice as fairness, where equals and treated equally and unequals are treated
unequally, should become a venue and an instrument to advance society to a better place
and could also become an instr
ument of empowerment for the person himself.


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Free Trade vs. the Philistines at the Gate

The pursuit of aesthetic, cultural and intellectual goals is part of the process of
rediscovering the image of God in our lives. However, it presupposes that people a
re fed,
clothed and have achieved the necessities of life. If we echo Mathew Arnold’s call to be
careful of the Philistines in our society
-

whose goal is to convert means to ends and
social beings into material amoral existences


then, we have to identi
fy the venues and
the instruments where people are freed from the fear of lacking the necessities of life
(Honan, 1983.)

The pursuit of higher ideals as well as intellectual achievements could only take place
when the fear of starvation and the fear of l
acking the necessities of life disappear. For
the latter to take place
-

which might be equivalent to the disappearance of the
philistinism mentality
-

in our culture, we have to reach a point of creating a middle class
that is sustainable. Justice in su
ch a society, where middle class can be created and be
sustained, is not achieved overnight, but over time, and its achievement is determined by
institutional arrangements.

This is exactly where free trade fits. Even if it is not the purpose of the paper

to
exemplify the advantages of free trade it would be proper to review that according to both
theoretical and empirical evidence, free trade could become an instrument of
convergence, of uplifting the poor from their misery, of restraining monopoly and
ol
igopolistic powers, of advancing opportunities to the least in the society, of offering
new horizons for the disadvantaged, and certainly of bringing better understanding and
dialogue among rivals. However, any instrument that is not being taken care of,
loses its
appeal, especially when it neglects those who are left behind. Free trade has the potential
of becoming an instrument of justice, and therefore of social equality where equals are
treated equally. However like any double
-
faced sword, when it ne
glects the
disadvantaged and allows inequalities to get out of hand (especially when the latter are
coupled with over
-
extension of credit via over
-
collateralization means), then social and
political instabilities feed the capital formation process, and ult
imately lead to economic
stagnation.



8

Speaking of the intellectual and moral consequences and benefits of international trade,
we would do great injustice if we fail to look at the writings of Charles Montesquieu
(Montesquieu, 1989), especially book twent
y of his
The Spirit of Laws
where he clearly
declares that, “commerce is a cure for the most destructive prejudices.” Later in the same
book Montesquieu will declare “peace is the natural effect of trade. Two nations who
traffic with each other become rec
iprocally dependent for, if one has an interest in
buying, the other has an interest in selling and thus their union is founded on their mutual
necessities.” Furthermore, Montesquieu will declare and articulate that trade among
nations produces a sense of

justice among them, as the latter has been understood by
Aristotle. I believe that when people exchange goods or services they start understanding
each other better, there is a dialogue that is being established, and therefore uncivilized
notions are bei
ng eliminated through communication. Moreover, they discover that there
are mutual benefits and advancements of efficiencies in their economies and
organizations, and through this mutual advancement peaceful resolutions could heal
particular disputes, whi
le creating an environment of better understanding among peoples
and nations.


It was easily understood even before the time of Adam Smith
-

and according to
Montesquieu’s arguments
-

that international exchanges will bring specialization and that
specia
lization will lead, as Montesquieu explains, from small to grand enterprises which
implies greater productivity and efficiency, and an ability to produce at a lower cost. The
latter will lead to lower prices, especially for the poor who previously could no
t get
particular goods or services. The standards of living then increase because of greater
efficiencies, lower costs, and the ability that is given to poor persons to not only purchase
goods but also to be actively involved in the production of goods.

From that perspective international exchanges and international trade becomes and
instrument of enhancing the capabilities of persons and especially of the least
advantaged. Montesquieu continues and shows through historical examples, how harbor
cities a
nd nearby communities to the port thrived by immigrants who came to those cities
to find jobs. The poor found good fortune where international exchanges were taking
place, whether it was at Tyre, Venice or the cities of Holland. The ability of the port

9

ci
ties to attract immigrants signifies the concept of mobility, because we all know that
without mobility there cannot be social progress.

However, if we read carefully Montesquieu’s arguments we will clearly see the
underpinning theory which advocates that

capital formation is the essence of establishing
the framework of prosperity for the average person. Capital formation then, could
become the alpha and omega of having a peaceful society that cares for the least
advantaged, for the sustainment of a middl
e class, and for higher values and ideals.
Montesquieu writes, “when the Dutch were almost the only nation that carried on the
trade from the South to the North of Europe, the French wines which they imported to the
North were in some measure only a capit
al or stock for conducting their commerce in that
part of the world.” Capital formation and the ability to generate stock of capital is the
essence of economic activity and commerce in a society that generates jobs, incomes and
the ability to consume the
necessities of life. Montesquieu will continue by saying that
even a losing trade will be beneficial for the society due to the kind of jobs that will be
created and the social environment that will be advanced. He writes, “Further it may
happen so that,

not only a commerce which brings in something is useful, but even a
losing trade shall be beneficial.”


The Theoretical Framework

We are very fortunate to have the latest work published by William Bernstein entitled,
A
Splendid Exchange, How trade shape
d the world
, (Bernstein, 2008), who in a fascinating
and elaborate way reminds us that from Mesopotamia in 3000 B.C. to the globalization
debates in the Seattle battles, trade is the foundation of capital foundation. Bernstein in
his study reminds us how
the early traders floated ivory, copper and barley through the
Tigris and Euphrates and he reminds us how the Greeks fought wars in order to advance
the concept of trade. He also tells us the story of the Chinese and how they carried silk
from China to Ro
me, and how the Portuguese traded spices in the sixteenth century.
When he reviews for his readers how the British came to Jamaica and how American
trade policies in the late nineteenth and early part of the twentieth century became the key
elements of eco
nomic growth, then we could concur with him and Montesquieu that trade
is the foundational cornerstone of capital formation.


10

To that of course, we should add that it was the ability that the U.S. extended to
Europeans to reconstruct themselves and buy Ame
rican products, that helped not only the
American producers but also the local communities in Europe for their reconstruction
efforts, for employment, for income, for capital formation, and for growth. So unless
there is international trade, unless there
is the liberty to move things, to buy imported
goods, to move capital, to move technology, to move people across nations and
communities, unless there is freedom to move financial capital across oceans, there could
not be a case of capital formation. The l
atter is the seed that is necessary for any kind of
infrastructure to be produced whether that infrastructure is in the social sector (hospitals
or schools), in a physical form (highways, roads, bridges and water systems), or in the
financial field (banks,

exchanges, brokerages). The buildup of these kind of
infrastructures will create jobs and by creating jobs there will be savings and that savings
will become the seed for loans and for credit extension which is necessary for business
formation. Now, all
the above could be represented in the following diagram.




The spirit of the Philistines could only be defeated in a society which is able to explore,
which is open to new ideas, open to other cultures, which is open to other
forms of capital
formation, which in turn lead to a better and more prosperous society. In such a society
free trade is advanced for the sake of justice. Therefore, free trade is not an end in itself,
it is a means to a higher end and that higher end is t
o treat equals equally.


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The defeat of the Philistinian spirit is part of the process of growth, and it is a stimulated
intellectual process which presupposes the understanding that the benefits which come
from international trade may not be possible to be

quantified in terms of econometric
models and in terms of successes, but it certainly brings stability in a society, peace
among nations, and certainly justice in commercial transactions, because as Montesquieu
would remind us competition is the instrumen
t by which a just value is achieved when
exchanges take place. Furthermore, he explains that nations will eventually be enslaved
into poverty and misery unless they undertake international transactions and exchanges. I
believe the following table, taken f
rom Bernstein’s book would demonstrate that exact
point.























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Per Capita GDP in Nations Open and Closed to World Trade


Always Open



2006


Always Closed


2006

Nation



Per Capita GDP

Nation



Per Capita GDP



Barbados


$
17,610

Algeria


$7,189

Cyprus



$21,177

Angola



$2,813

Hong Kong


$33,479

Bangladesh


$2,011

Mauritius


$12,895

Burkina Faso


$1,285

Singapore


$28,368

Burundi


$700

Thailand


$8,368


Central African Rep.

$1,128

Yemen



$751


Chad



$1,519






China



$
2,001






Congo



$1,369






Cote d’Ivoire


$1,600






Dominican Republic

$7,627






Egypt



$4,317






Ethiopia


$823






Gabon



$7,055






Haiti



$1,791






Iran



$7,980






Iraq



$2,900






Madagascar


$900






Malawi


$596






Mauritani
a


$2,535






Mozambique


$1,379






Myanmar


$1,693






Niger



$872






Nigeria


$1,188






Pakistan


$2,653






Papua New Guinea

$2,418







Rwanda


$1,380






Senegal


$1,759






Sierra Leone


$903






Somalia


$600






Syria



$3,847






Tanzania


$723






Togo



$1,675






Zaire



$774






Zimbabwe


$2,607




When we contemplate on this last thought, two hundred and fifty years after those words
were drafted, we will wonder what has been happening to the distribution of income

13

across n
ations, what has been happening to inequality and poverty or the concept of
convergence among nations.

Just a couple of years ago, Xavier Sala
-
i
-
Martin (Sala
-
i
-
Martin, 2006) published a well
-

documented survey of the world distribution of income, and he c
oncluded that we have
been experiencing falling poverty and convergence around the globe, primarily in
continents and nations that were characterized prior to the 1970s by extreme poverty and
divergence. His chief examples are the nations of China and Ind
ia along with the whole
region of Southeast Asia. It would have been great if the survey had discussed the role
that free trade has played in uplifting those countries and those continents out of poverty.
However, before we explore in greater detail Sala
-
i
-
Martin’s arguments regarding the
reduction of poverty and convergence of global income, as well as discuss this paper’s
findings regarding the role that international trade plays in the formulation of capital, the
forming of infrastructures, and the esta
blishment of the middle class, I would like us to
review briefly what the classic arguments of John Stuart Mill (Mill, 1910) were in the
midst of the nineteenth century when he was writing on international trade.


I would like to emphasize that in his wr
itings, while he articulates well the advantages of
free trade in terms of lower prices, higher incomes, great efficiencies, reduction of costs,
allocation of resources, inviting new investments and in terms of higher productivity, he
makes a very good poi
nt when he says that international trade and foreign transactions
become the cornerstone of surplus capital that can be used to produce other things.
Therefore, it is the savings in capital which advances efficiency, prohibits misallocation
of resources, a
nd assists nations in the production of goods or in the consumption of
imports, all of which lead to higher standards of living, higher levels of disposable
income, and thus greater propensity for capital accumulation. However, all these benefits
from fre
e trade are not as important according to John Stuart Mill as the intellectual and
moral advantages that free trade carries with it. Mill writes:


14


Empirical studies throughout the world have documented that free trade of goods, capital,
and technology not

only reduce prices and enhance incomes, but also act as the conduit
for transferring the technologies that enhance productivity, increase competition and
therefore, stimulate industries to become more efficient. Moreover, the push for
efficiency forces u
nproductive businesses to reform or go out of business. Competition
stimulates efficiency, and over the years study
-
after
-
study has documented this
phenomenon. Therefore, when we look at studies by Keller (Keller, Wolfgang, and
Yerple, 2003), Hay (Hay 20
01), Edwards (Edwards, 1998), Crafts, (Crafts, 2000),
Harrison and Hanson (Harrison and Hanson, 1999), and Sachs and Warner (Sachs and
Warner, 1995), we can see that overall economic growth as well as productivity growth
can double and sometimes triple whe
n industries become less sheltered from foreign
competition. Mexico is a classic case because it can be demonstrated that after its trade
liberalization in 1985 its productivity increased dramatically. The same happened in
India as well as in South Korea
. These productivity gains, which we clearly understand
to be economic gains, take place due to the new allocation of resources within industries
as well as across industries. Empirical studies have also shown that trade liberalization

15

over the past few
decades in Spain, Chile and New Zealand have contributed to rapid
growth in productivity as well as greater growth in their economy. While there might be
a dispute as to whether trade is directly responsible for greater growth
-

studies actually
diverge i
n their conclusions, see Franklen and Romer, 1999 or Rodriguez and Rodrik,
2001
-

we do have however, a consensus which says that trade may not be directly
correlated with growth, however it stimulates growth indirectly through investments, i.e.
we have su
fficient evidence of indirect relationship where growth increases in countries
via the mechanism of international investments, which in our paradigm is the cornerstone
of capital formation.

Therefore, the idea that the free movement of capital goods or o
f intermediate goods, is
the cornerstone that promotes investments which in turn supports growth could be
supported by empirical evidence and could be clearly seen in the three graphs that follow,
and which have been adapted from Douglas Irwin’s book,
Free

Trade Under Fire
, (Irwin,
2002.) In the next three graphs we can clearly see starting with the case of South Korea
that the trade reforms that were initiated in 1964
-
65 have contributed to significant
increases in GDP per capita. In the second graph we c
an see a similar trend in a totally
different continent. Chile adopted trade reforms, both qualitative and quantitative
restrictions were lifted in 1974
-
75, and again we see a significant and dramatic increase
in the GDP per capita after trade liberalizati
on took place. Again, I would like to
emphasize that this became the cornerstone of capital formation. A more recent case
which is related to the famous BRICs (Brazil, Russia, India, and China) has to do with
the trade reforms that took place in India in

1991. Tariffs were reduced from an average
of 85% to an average of 25%, and the complex system of import controls was eliminated,
the Rupee was devalued and was also made convertible. It is interesting to observe the
significant increase in GDP per capit
a that India has experienced to the point that several
analyst has said that India lost several decades after its independence in 1947 because the
trade restriction suppressed economic liberty for almost 40 years and destroyed growth
for at least two gener
ations. The truth of the matter is that India since 1991 has been
formulating social capital, physical capital and infrastructure, and the proofs of financial
infrastructure become more evident year
-
after
-
year, as millions of Indians have start
taking par
t in the formation of a middle class.


16




17


Source: Irwin, 2002, pp. 42
-
44.


Now, if we return for a moment to our previous intellectual benefits, the non
-
economic
benefits from trade, we can still remember the perpetual peace advocated by Immanuel
Kant
who suggested that a durable peace could be built upon a tripod of representative
democracy, international organizations and economic interdependence. Of course, we
cannot neglect the expanding political science literature which illustrates that indeed
ec
onomic interdependence among nations reduces the risk of conflict, mitigates the risk
of war and finds that there is a positive link between trade and peace. Even if we are
tempted to question the plausibility of the relationship, we should not neglect th
e fact that
study
-
after
-
study points to the apparent link between political reforms as an outcome of
liberalization. So while trade may fail to generate movement towards democracy, there is
ample evidence to point that domestic institutions perform better
, and are less corrupt
when there is open trade and competition and when nations are open to each other in an
accountable manner (Irwin, 2002).


18

Is it Convergence or Divergence?

Of course, there is plenty of literature that reviews the distributional effe
cts of
globalization. We could point out reviews by Harrison and Gordon (1999), Adrian Wood
(1999), Goldberg and Pavcnik (2007.) The latter, points out to the fact that countries that
have experienced great forms of globalization either through more impor
ts and exports or
through the magnitude of capital flows, (FDIs, foreign exchange fluctuations, etc.) have
experienced higher levels of inequality. Particularly on pp.48
-
49 of that review, the
authors point out that countries from different continents have

experienced either
significant or slight increases in inequality, with the latter being measured either as skill
premium between skilled and unskilled workers, or by the Gini coefficient, and
sometimes by consumption or income patterns.


We need to point

out that, as I mentioned earlier, the Xavier Sala
-
i
-
Martin (2006) article
is very emphatic in demonstrating that worldwide poverty has been reduced and
convergence has been achieved through globalization. Sala
-
i
-
Martin points out that
China has a lot to
do with this kind of convergence, and he shows that if we use the $2
per day income line, then we could clearly see that poverty estimates have experienced a
significant decrease in China between 1980 and the beginning of the twenty
-
first century,
from abo
ut 48% to less than 15%. For China, Sala
-
i
-
Martin reports that more than 250
million people escaped poverty because of globalization. He further reports the same
thing for countries such as Indonesia and Thailand with the only exception is Southeast
Asia
being Papua New Guinea. Overall, and excluding China, more than 200 million
people escaped poverty because of globalization in the last quarter of a century. He does
point out that the big Asian success is dramatically different from the African experien
ce.
In Africa, the total number of those living in poverty has jumped by more than 200
million persons. In all African countries poverty and inequality has increased, with the
exception of Botswana and maybe some small countries like Mauritius. Sala
-
i
-
M
artin
composes what he calls the WDI (World Distribution of Income) and presents an
impressive time
-
series table of the WDI from the 1970s to the beginning of this century.
In that table, we could clearly see that all measures of inequality have been decl
ining,
whether we measure inequality using the Gini coefficient or the variance in the logs of

19

income. Moreover, he shows that that ratio of income of the top twenty percentile to the
bottom twenty percentile, as well as the ratio of income of the top ten

percentile to the
bottom ten percentile has been experiencing significant decreases by as much as 30%.
Therefore, the graph below summarizes the WDI from the 70s to the beginning of the
twenty
-
first century.


Source: Xavier Sala
-
I
-

Martin, 2006


The arg
ument of the paper is that the significant reduction in inequality which has been
empirically demonstrated by Sala
-
i
-
Martin is the effect and the outcome of capital
formation using the means of international trade. Now, this is a strong argument that
need
s further investigation and a lot more work, however from a theoretical standpoint as
well as from a historical standpoint we can say that nations, empires and economic
powers have built themselves up through savings and capital formation using the means
o
f international trade. As Bernstein clearly explains in his book,
A Splendid Exchange,

whether we talk about the Sumerians, Chinese, Portuguese, Spanish, British or the
Americans, they all have built their capital by opening or financing (in the case of t
he
U.S.) international exchanges. So, in our theoretical framework there is always a need
for a rule of law and the right to property, what we call the legal infrastructure.

However, this must always be accompanied by capital formation.


20

If historical e
xperience is teaching us anything, it is that capital formation is best done
through international trade, trade liberalization and international exchanges. Eventually,
trade liberalization becomes the venue or vessel of empowering people to experience
up
ward economic mobility. It is like having many people at a port on the coast and some
of them board a vessel, the vessel empowers them to get better acquainted with
technologies, to have better access to capital and other resources, exposes them to ideas,

to better education, because it takes them away from the port, to new places. The
distance between those who are left behind at the port and those who are now sailing
away from the port may be rising initially, but the ones who are on the vessel are the
ones
who are experiencing the phenomenon of being part of the middle class. In another
analogy, we can think of a moving escalator, the international trade becomes the escalator
of moving people up, being part of better educational opportunities (social i
nfrastructure),
better health care provisions (again, social infrastructure), being able to move around and
experience upward mobility, get better jobs, save and invest i.e. take advantage of
physical and financial infrastructures. The country as a whole i
n that case, is able to
export and import, to experience growth through investments and FDIs, capital
importation, better technologies and production techniques.


The country through export
-
led growth experiences physical and social infrastructure
invest
ments, which eventually empowers the people and the middle class to enjoy
savings. Those savings will become the seed for a financial infrastructure, both local and
foreign
-
owned. The emergence of the this kind of infrastructure will finance the
formation
of new vessels, which in turn will bring the people from the port/coast to the
ocean, thus sustaining the creation of the middle class.

So while we may be taking a leap forward without enough evidence at this point, I think
it would be normal to expect th
at globalization, as it is evolving may be showing some
measures of higher inequality. However, if properly realized that is simply a means to
create and sustain a middle class via capital formation, then over time liberalization and
higher international t
rade will lead to the creation of the middle class, leading eventually
to lower rates of inequality and poverty.


21

If convergence is indeed achieved, then justice has been implemented, because justice
relates to others and becomes reality when equals are tr
eated equally.


The Empirical Results: Methodology, Selection of Variables, and of Countries


I need to emphasize in the beginning of this section, that the results and analysis here is
preliminary and research is already underway for better understandi
ng of the ideas that
have been developed in this paper. Since part of the research is to determine which
factors in the four infrastructure areas would contribute to the emergence of a middle
class (once capital formation has taken place via the means of i
nternational trade), the
first (and admittedly most subjective) step was to develop an initial list of factors that
describe the infrastructure for each country.

The factors used in this paper (but which have been expanded significantly in the
undergoing
study) are as follows: Paved roads in kilometers per 1000 inhabitants, and the
percent of the population that has access to purified water (for physical infrastructure);
hospital beds per 10,000 inhabitants, and the age when mandatory schooling ends (for
the social infrastructure), personal credit per disposable income as a proxy for financial
infrastructure; the corruption index and barriers (in terms of number of steps needed) to
register property (for legal infrastructure), while average tariff rate, ba
lance in the capital
account, FDIs, imports per capita, exports per capita, current account balance, foreign
reserves per capita and external debt as a percentage of GDP were used as proxies for
openness and trade liberalization. Data were collected from d
ifferent sources, such as the
World Bank, the IMF, the different branches of the UN (UNDP, and UNCTAD) for the
2006 year. Note that the algorithm scaled the data by dividing by the maximum absolute
value that occurred to prevent the larger
-
scale factors fr
om overwhelming the smaller
-
scale factors in the model.

Since part of the purpose was to establish a proof of concept for using the Support Vector
Machine (SVM) and a broad scope of infrastructures, it was decided that limiting the
number of countries woul
d achieve the purpose. A small list of countries was selected
(again in the next phase that list is significantly expanded) that most economists would
agree have a middle class: the United States, Germany, Japan, and South Korea. We

22

selected a small list o
f countries that those same people would generally agree have few
people in the middle class, but still had proven that they would likely (due to underlying
assets) be able to develop one in the near future: Venezuela, Nigeria, Thailand, and
Kazakhstan. Th
ose would be the countries used for training the Support Vector Machine
(SVM) algorithm, described next. Finally, few countries were selected in which a middle
class was developing: Brazil, Czech Republic, Malaysia, India, and China. These would
then form
a basis for testing the algorithm’s validity. The expectation is that the values
generated by the SVM algorithm would lie in between those of the previous two
categories, if the algorithm was generally working.

Discussion of Algorithm

The mathematical tech
nique used to determine the significance of the factors was the
Support Vector Machine (SVM). This is a classification method from learning theory
that uses a set of input training data {(
x
1
,
y
1
), (
x
2
,

y
2
), . . ., (
x
k
,
y
k
)} where the
x
i

represents
vectors

of dimension
n

and the
y

values are assigned a value of +1 or
-
1, depending on
whether the point is inside a set or not. For the purposes of this study, the
x

vectors hold
the list of factors that describe the state of a given country that may be charact
erized as
having a middle class (
y
= +1) or not (
y

=
-
1). The SVM procedure builds a model
from the training data that can be used to classify other countries given their input
x

characteristic vector. The SVM model with a linear kernel is built by fin
ding the
‘dividing hyperplane’ that separates the points in the training set in such a way that the
distance between the two categories is maximized. A clever transformation of the input
space and reformulation in the ‘feature space’ reduces the problem to

a quadratic
optimization problem that has a unique solution. For the preliminary investigation of the
suitability of this method for the given application, linear kernel functions were used in
an

SVM
-
ν variation that allows some flexibility in the training point separation (Chen &
Lin & Scholkopf, 2008). The linear kernel was chosen because of the limited number of
countries in the data set, and because the linear kernel tends to be the worst per
former. If
this kernel works, then increased data and a non
-
linear kernel should work much better.


23

A non
-
linear kernel will be important as this study proceeds. An example will illustrate
the reason. One factor that is critical to the development of the mi
ddle class is the
extension of credit. People in the lower classes do not have the capital with which to start
a business and thereby move to a higher class. The marvelous success of microloans
illustrates this point. Therefore, in a linear model, the amou
nt of credit extended would
certainly have a positive coefficient. That would imply that as more credit is extended,
even greater benefits accrue. But at some point, credit may become overextended, and
become detrimental to the middle class (see concluding

note.) This is arguably a
significant factor in what caused the collapse of the middle classes of Argentina and
Mexico in the recent past. That means that the extension of credit must, at that point,
have a negative coefficient. Only a non
-
linear approach

to modeling the middle class can
accommodate both aspects of the extension of credit.


Analysis of Data: Initial Run

A comprehensive SVM run of all 13 countries and the 15 factors described above,
provided a validation case for the technique. The four cou
ntries in the developed set and
the four countries in the under
-
developed set combined to serve as the SVM training set
to build the model. The set of five developing countries were used as the test set.

The table below shows the coefficients produced by

the SVM and the one below it the
predictions that this initial run
-
test produced.








24

Paved Roads

0.238063387631642

Water Access Percent

0.044189772252655

Hospital Beds per 1000

0.563856201053485

Age Schooling Ends

0.294646921745445

Personal Credit

per DI

0.59120218782185

Corruption Index

0.477896583342331

Property Title Barriers

0.162076349656061

Average Tariff Rate

0.197824975175417

Capital Accounts

0.309170280462291

Foreign Direct Investment

0.307342160763761

Imports per Capita

0.6942833863
16445

Exports per Capita

0.529434501617049

Current Account Balance Per Capita

-
0.121678108839261

Foreign Reserves Per Capita

0.497608838681446

External Debt per GDP

0.296945713096165










25

Country

Value

SVM prediction

Venezuela

-
1

-
0.99990768822512
2

Nigeria

-
1

-
1.21304933737851

Thailand

-
1

-
0.803741437711771

Kazakhstan

-
1

-
0.677110135491991

USA

1

1.00009226697816

Germany

1

0.999890303694555

Japan

1

1.01258869617947

Republic of Korea

1

0.739595970834195

Brazil

-
1

-
0.559374556639729

Czech Rep
ublic

1

0.436088176526176

Malaysia

-
1

-
0.207411619377579

India

-
1

-
1.04513622346062

China

-
1

-
0.864359697591038


As the above table confirms, the method does accurately predict the categorization of the
countries. Note that the SVM algorithm prediction

is based upon the
sign

of the
calculated value. It should not be assumed that all the calculated values be at or even near
1. All positive calculations are given a prediction of 1, while all negative calculations
have a prediction of
-
1. The results of th
is run confirmed that the SVM technique could
differentiate between the developing states of each country. Note first that the predicted
values of the countries in the developed set (US, Japan, Germany, and S. Korea) were
clearly distinguished from those i
n the under
-
developed set (Venezuela, Nigeria,
Thailand, and Kazakhstan). The relative developmental state of the Czech Republic

26

might be different from what we could have predicted, but it might be possible that the
reforms taken and the EU membership, h
ave progressed much further than anticipated.
Notice also that the relative positions of the countries in each set, match the general
intuitive expectations. For example, the US is further away from a hypothetical
hyperplane dividing line than S. Korea, an
d Nigeria is further away than Thailand.

The results of the validation run were encouraging. Moreover the nu factor (a proxy to
the goodness of fit) is pretty low 0.355 (the closer to zero the better the fit is.)

Reduction of Factors

Another run was attem
pted, using this time the same set of countries, but only the data
that reflect and approximate international exposure of the countries. The results are
reported below (the first table shows the factors used along with the predicted
coefficients), while th
e second one presents the predicted results.

Average Tariff Rate

-
0.22341526168295

Capital Accounts

0.55672736497184

Foreign Direct Investment

0.766633099966727

Imports per Capita

1.12999429972134

Exports per Capita

0.767698626336171

Current Account B
alance Per Capita

-
0.163135879173697

Foreign Reserves Per Capita

1.24408141341564

External Debt per GDP

0.578950191414749






27

Country

Value

SVM prediction

Venezuela

-
1

-
0.7916505366185

Nigeria

-
1

-
1.10277106395431

Thailand

-
1

-
0.612541629530786

Kaza
khstan

-
1

-
1.17160915182949

USA

1

0.999491474966721

Germany

1

1.00001103870761

Japan

1

1.00024879107754

Republic of Korea

1

0.92656528677645

Brazil

-
1

-
0.86637699192521

Czech Republic

1

0.752864311275141

Malaysia

1

0.583335737080341

India

-
1

-
1.288
5267028403

China

-
1

-
0.456819228483832


The following comments are in order: First, all developed countries show up with the
expected sign i.e. clearly as having formulated a middle class, while those less developed
ones (the first four in the table abov
e), exhibit the expected signs. Second, this time not
only the Czech Republic but also Malaysia shows with a positive prediction. This
complies with the liberalization and openness that both countries have exhibited over the
last two decades. Third, the p
redictions for both the Czech Republic and for Malaysia are
further away from the developed countries (as expected) in a hypothetical hyperplane
dividing line, but can be clearly be distinguished from the ones of Nigeria, Venezuela etc.
We could then, make

the claim that international openness and exchanges serve the

28

purpose of forming capital and thus, advancing the formation of the needed
infrastructures which in turn will lead to the creation of the middle class.

Fourth, the relative weak positions of In
dia and China need to be reviewed in a time
series before any conclusion is reached. At the same time their vast populations need to
be accounted for in terms of time that it takes for mobility and advancement to
materialize. However, it is worth mentionin
g that just by trade alone China performs
better in the SVM, a fact which by itself alone could help us understand a little better the
value of international trade in forming the necessary cornerstones that a middle class
needs. Finally, the nu in this run

is 0.674, higher than before, as expected, since the test
of the SVM was performed with only international data.

Conclusion: A Word of Caution and Direction for Future Research

The empirical part of this paper should be viewed as a proof
-
of
-
concept att
empt for using
a multi
-
factor and linear approach to quantifying the extent to which international trade
forms the basis of capital formation, which in turn advances the formation of
infrastructures that create a middle class. These results seem to indicat
e that using
international trade and the infrastructures as have been described above along with the
SVM algorithm, is a feasible methodology, and is worth continuing in broadly the same
direction.

However, at this point I would like very briefly to introd
uce the idea of what happens
when things go to the extreme, especially when the financial sector’s interests diverge
from the trade sector’s interests i.e. from the production or real economy’s interests.
When efforts are being made to sustain prosperity
and the middle class with paper means
rather than real assets and real production, then we will see a divergence of the
production and real sectors interests from the financial sector’s interests. The latter will
tend to produce paper assets which will be

over
-
collateralized, over
-
securitized, for the
purpose of generating significant short
-
term profits. The table below shows the explosion
of derivatives and other related instruments (CDOs, CLOs, etc.) in the last few years. It
demonstrates the extent of i
rrational collateralization of “assets”, where the financial
sector keeps pushing for more and more securitization of paper assets, which will be
sliced into pieces and sold to individual and institutional investors.


29


Source: Bank of International Settle
ments, 2008

Of course, it seems that we are just start learning the lesson that these paper
-
assets are
nothing more than paper, i.e. there is nothing behind them. This is the phenomenon of
extreme and irrational securitization and collateralization that i
s taking place in the U.S.
and the EU, and which has been destroying the financial sector, because it can only create
bubbles and bubbles usually burst. The bursting of the bubbles will create in turn
instability not only in the economic sector but also in

the political and social sectors, and
therefore the whole economy’s cohesiveness may become unstable and questionable,
which eventually may lead to significant destructions. As direction for future research, it
would be interesting to identify the possib
ility for economies to establish a rule by which
they collateralize and securitize assets in a way that will not destabilize the economies.
The proposal for future research would be to form an index of internationalization of the
economy
-

whether this is

imports and exports as a fraction of GDP, foreign reserves,
FDIs, currency swings, technology transfers, etc


and use this index as the compass of
collateralization and securitization, so that the interest of the real economy (production)
are not disasso
ciated from the interests of financial capital, and thus do not jeopardize the
sustainment of the middle class via misallocation of resources.



30

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