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mises
Joined: 05 Nov 2007
Location: retired
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 Posted: Mon Oct 06, 2008 9:21 pm Post subject: Does trade liberalisation raise wage inequality? |
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Wage inequality between skilled and unskilled workers has increased in recent years, particularly in countries that opened their markets to international trade. This column explains how trade may push up the demand for skilled workers worldwide by creating larger international markets for differentiated goods.
Since the late 1970s, an unprecedented wave of trade liberalisations has taken place. The share of countries classified as open according to the Sachs-Warner (1995) criteria rose from 35% in 1980 to 95% in the late 1990s and the trade share of the average country rose from 59% of GDP to 74%. Over the same period, the skill premium � the difference between the wages of skilled and unskilled workers � rose on average by 8%.
Figure 1. Openness and skill premia
Figure 1 points to a strong positive association between openness and wage inequality. Analysing a sample of 35 developed and developing countries with available data, it shows the change in the openness ratio during the 1980s on the horizontal axis and the percentage change in the manufacturing skill premium on the vertical axis.1 The graph shows that countries such as Turkey, Mexico, Chile, Malaysia, which substantially increased their outward orientation, also experienced a concomitant increase in the skill premium. In contrast, countries such as Japan, Korea, Finland, Egypt, whose trade exposure fell, experienced a fall in the skill premium.
Figure 2. Openness and returns to education
The broad picture does not change when using a different proxy for the returns to skill. Figure 2 reports, for a sample of 40 countries observed for at least two years between the early 1960s and the late 1990s, the change in the openness ratio on the horizontal axis and the percentage change in the economy-wide private returns to education on the vertical axis.2 Again, countries such as Mexico, China, Korea, Philippines, Guatemala and Nicaragua experienced a substantial increase in the returns to education in periods of greater exposure to international trade. In contrast, other countries� periods of falling trade exposure are associated with falling returns to education.
From the evidence to the theory: A puzzle
These data suggest that trade openness and wage inequality may be related, yet we do not clearly understand why. In fact, the canonical trade models cannot easily reconcile the theory with this evidence. Consider the Heckscher-Ohlin model first. In this model, trade stemming from endowment differences (inter-industry trade) should allow countries to export the services of the abundant factor in exchange for the services of the scarce factor, thereby raising the relative demand for skills in the skills-rich OECD countries and reducing it in the skills-poor developing countries. Yet, a striking feature of the latest wave of globalisation is the dramatic increase in wage inequality in those developing countries that have enthusiastically embraced it (e.g., China, Mexico, Chile, Colombia, Argentina, etc.). Moreover, recent estimates suggest that endowment-based comparative advantage can account for only a tiny fraction of world trade flows.
Consider now the so-called �new trade theory�. According to this analysis, similar countries trade in similar products (intra-industry trade) because firms produce differentiated goods under increasing returns to scale and consumers enjoy having access to a greater variety of goods. Intra-industry trade represents an overwhelming and growing share of world trade, and it is therefore a likely culprit for the increase in wage inequality. Yet its distributional implications have long been overlooked. The reason is that intra-industry trade is, by definition, trade in goods that are produced with similar factor intensities, implying that intra-industry specialisation should leave relative factor demand and relative factor prices, such as the skill premium, unaffected.
In recent work (Epifani and Gancia, 2008), we argue that this seemingly plausible conclusion is wrong. More precisely, we show that intra-industry trade between identical countries leaves relative factor rewards unchanged only under very special and counterfactual circumstances.
The skills bias of intra-industry trade
Our theory builds on the observation that tasks performed by high-skilled workers are different from those performed by low-skilled workers, not only because of their higher cognitive content, but also because they often have the nature of fixed costs (think, for instance, of R&D and marketing activities). This crucial feature of skills-intensive activities implies that they naturally generate economies of scale. To have an idea of how intrinsically related skills-intensive and scale-intensive activities are, it suffices to note that, in the empirical trade literature, an industry�s ratio of non-production to production workers is used to measure both skills intensity and economies of scale (e.g., Helpman, Melitz and Yeaple, 2005).3
Moreover, skills-intensive goods are typically highly differentiated, implying that the benefit from having a wider variety of products is stronger in the skills-intensive sector. Intuitively, having the option to choose between different types of electronic equipment (from the iPod to refrigerators, serving very different purposes) is more valuable than having access to a variety of garments (all serving similar purposes).
These observations allow us to look at the distributional implications of intra-industry trade from a new perspective. Trade liberalisation expands the size of markets, and this in turn increases the demand for skilled labour for two related reasons. First, market size boosts skilled workers� productivity, because skills-intensive industries are subject to increasing returns to scale.
Second, larger international markets offer a wider variety of differentiated products, thereby inducing people to shift their consumption habits towards these goods. Given that differentiated products are skills-intensive, the demand for skills increases too. These simple mechanisms suggest that ability is more important in large markets. As globalisation is creating a huge world market, skilled workers benefit relatively more from this process.
We find big effects. Under plausible calibrations, our model suggests that a 50% fall in trade costs between two identical countries can increase the skill premium by 10%, whereas full integration can raise it by up to 30%. Moreover, if the skill bias of market size is strong enough, international trade can also widen wage differentials in developing countries.
In this respect, an interesting case study is Mexico�s drastic trade liberalisation in the mid-1980s, followed by an upsurge in the skill premium. In a simple numerical exercise, we show that trade integration between the skills-poor Mexico and its main trade partner, the skills-rich US, can account for a 15% rise in Mexico's skill premium, broadly matching actual data.
Our formal econometric analysis, using data for up to 68 countries observed between the early 1960s and the late 1990s, confirms these results. Countries that are larger and more open to trade tend to have a higher skill premium, and the effects are quantitatively similar to the predictions of the theoretical model. These findings suggest that a substantial fraction of the observed widening of wage inequality may be attributed to the growth of world markets due to globalisation. |
http://www.voxeu.org/index.php?q=node/2068
I'm off the free trade or "liberal" trade bandwagon. A full return to mercantalist or hard protectionist policy is not wise, but more intelligent government restriction is needed. |
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mindmetoo
Joined: 02 Feb 2004
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| Posted: Tue Oct 07, 2008 2:50 am Post subject: |
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| Wow imagine in advanced societies where there's a computer in everything, people without skills are valued less in the market place. I bet those women who kept trying to be milk maids found their wages decrease a lot between 1900 and 1940. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Tue Oct 07, 2008 6:27 am Post subject: |
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| Liberalized trade is not the reason that there is a "computer in everything". The argument could be made that consumer goods have been made more affordable via trade, but it has all been bought on credit so we couldn't afford it even at the reduced costs. |
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Hater Depot
Joined: 29 Mar 2005
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| Posted: Tue Oct 07, 2008 6:28 am Post subject: |
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| Of course it does. The only question is whether it offers enough benefits to enough people to make it worth it, and I think the answer is generally yes, and pretty much always yes for developed nations. |
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Bigfeet
Joined: 29 May 2008
Location: Grrrrr.....
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| Posted: Tue Oct 07, 2008 7:05 am Post subject: |
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| Trade inequality is a natural product of supply and demand. Wages are more equal in closed economies because of artificial boosts to the wages of unskilled labor. |
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Ya-ta Boy
Joined: 16 Jan 2003
Location: Established in 1994
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| Posted: Tue Oct 07, 2008 7:48 am Post subject: |
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| I'm off the free trade or "liberal" trade bandwagon. |
I'll believe that when you bring the steaming, bleeding heart of one of those Austrians to my door. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Tue Oct 07, 2008 8:46 am Post subject: |
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| The Austrians focus on monetary policy almost exclusively. And it is on that issue that I agree with them. They lose me at their opposition to universal health insurance, charity to support the disabled and the rest. But on monetary policy, they are correct. |
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Kuros
Joined: 27 Apr 2004
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| Posted: Tue Oct 07, 2008 8:55 am Post subject: |
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What do we mean by wage inequality?
It seems to me there's only a problem with free trade if a substantial class of peoples' salaries go down and stay down.
Also, it seems to me that I'd want to live in a society with a higher-skill premium. Unless I'm misunderstanding what is meant by high skill premium.
I would concede that increasing trade liberalization should go hand in hand with offering affordable/subsidized education. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Tue Oct 07, 2008 9:01 am Post subject: |
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| Kuros wrote: |
| I would concede that increasing trade liberalization should go hand in hand with offering affordable/subsidized education. |
I strongly agree. Trade does toss people out of work and they should be retrained for vocations appropriate to the new reality. But as it happens, millions have fallen into so-called McJobs without any future. |
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mindmetoo
Joined: 02 Feb 2004
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| Posted: Tue Oct 07, 2008 5:24 pm Post subject: |
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| mises wrote: |
| Liberalized trade is not the reason that there is a "computer in everything". The argument could be made that consumer goods have been made more affordable via trade, but it has all been bought on credit so we couldn't afford it even at the reduced costs. |
Put it together. Trade leads to prosperity. Nations move up the value chain as they trade. As nations become richer they require people with skills and rely less on unskilled labor. Inequalities emerge. |
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sojourner1
Joined: 17 Apr 2007
Location: Where meggi swim and 2 wheeled tractors go sput put chug alugg pug pug
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| Posted: Tue Oct 07, 2008 6:00 pm Post subject: |
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| Trade does lead to prosperity, but not for most when there's no profit sharing within companies. The Bush years are a laissez faire environment where the executives take all which keeps the job markets lean and competitive to the point of absurdity. Skilled and educated people are only being paid $8 to $10 per hour with little or no benefits in most parts of America. That's not much more than an unskilled broom pusher makes. (about $6.25/hour) You are not paid by how valuable you are to a company or by your skills set, but in comparison to how cheap your job is in China and India since companies have been basing things on the cost of doing business overseas while taking a huge profit for executive bonuses. Fact is, things cost a lot less in India and China so they can tolerate cheap pay, but in America, the cost of living requires a whole lot more pay. These are tough times. |
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mises
Joined: 05 Nov 2007
Location: retired
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| Posted: Tue Oct 07, 2008 7:23 pm Post subject: |
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| mindmetoo wrote: |
| mises wrote: |
| Liberalized trade is not the reason that there is a "computer in everything". The argument could be made that consumer goods have been made more affordable via trade, but it has all been bought on credit so we couldn't afford it even at the reduced costs. |
Put it together. Trade leads to prosperity. Nations move up the value chain as they trade. As nations become richer they require people with skills and rely less on unskilled labor. Inequalities emerge. |
The many deficits that America has been running suggests that it has not become more wealthy, only more indebted. Wages have stayed flat for 30 years. Only a small portion are actually seeing wage increases.
I'm tired with the economic dogma and these platitude responses. Something is very seriously wrong with the way we are organizing our political economy. I have three parchments in economic related disciplines and ergo I know the classical responses to these issues by heart. But the responses and the real world are diverging. Something isn't working. |
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mindmetoo
Joined: 02 Feb 2004
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| Posted: Wed Oct 08, 2008 2:35 am Post subject: |
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| mises wrote: |
| mindmetoo wrote: |
| mises wrote: |
| Liberalized trade is not the reason that there is a "computer in everything". The argument could be made that consumer goods have been made more affordable via trade, but it has all been bought on credit so we couldn't afford it even at the reduced costs. |
Put it together. Trade leads to prosperity. Nations move up the value chain as they trade. As nations become richer they require people with skills and rely less on unskilled labor. Inequalities emerge. |
The many deficits that America has been running suggests that it has not become more wealthy, only more indebted. Wages have stayed flat for 30 years. Only a small portion are actually seeing wage increases. |
If you have more up to date stats, I'd like to see them. But this seems to argue against your point about America not becoming more wealthy.
http://townhall.com/columnists/WalterEWilliams/2007/12/05/income_mobility
Any trade deficit is balanced by a plus in investment. A trade deficit might suck if you build cars but good if you own property in LA or Manhattan.
Not many economists would agree with you that trade does not lead to prosperity for both traders.
You're also confusing the debt (be it national or personal) with a trade deficit. Those are two distinct things.
Last edited by mindmetoo on Wed Oct 08, 2008 8:00 am; edited 1 time in total |
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mindmetoo
Joined: 02 Feb 2004
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| Posted: Wed Oct 08, 2008 2:38 am Post subject: |
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| sojourner1 wrote: |
| Skilled and educated people are only being paid $8 to $10 per hour with little or no benefits in most parts of America. |
Could you back that claim up with a reference? |
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sojourner1
Joined: 17 Apr 2007
Location: Where meggi swim and 2 wheeled tractors go sput put chug alugg pug pug
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| Posted: Wed Oct 08, 2008 3:53 am Post subject: |
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| mindmetoo wrote: |
| sojourner1 wrote: |
| Skilled and educated people are only being paid $8 to $10 per hour with little or no benefits in most parts of America. |
Could you back that claim up with a reference? |
The reference is from ME who came from Americas heartland. That is all they pay at home. I'm from St. Louis, Missouri and it's hard knocks. I heard places pay $11 to $17 in places like Miami and New York, but the cost of living is crazy out there. |
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