A new mainstream consensus on trade and wages?

Paul Krugman explains here why he thinks trade may be now a much larger factor behind rising U.S. inequality, compared to the 1980s and early 1990s. The reasons have to do with China and production fragmentation.

During the 1980s and 1990s, there was considerable concern about the possible role of globalisation in contributing to rising income inequality, especially in the United States. This concern was based on standard economic theory: since the 1941 Stolper-Samuelson paper, we’ve known that growing trade can have large effects on income distribution, and can easily leave broad groups, such as less-skilled workers, worse off.

After economists looked hard at the numbers, however, the consensus was that the effect of trade on inequality was probably modest. Recently, Ben Bernanke cited these results – but he recognised a problem: “Unfortunately, much of the available empirical research on the influence of trade on earnings inequality dates from the 1980s and 1990s and thus does not address later developments. Whether studies of the more recent period will reveal effects of trade on the distribution of earnings that differ from those observed earlier is to some degree an open question.”

But the question isn’t really that open. It’s clear that applying the same models to current data that, for example, led William Cline of the Peterson Institute to conclude in 1997 that trade was responsible for a 6% widening in the college-high school gap would lead to a much larger estimate today. Furthermore, some of the considerations that once seemed to set limits on the possible inequality-promoting effects of trade now seem much less constraining.

There are really two key points here: the rise of China, and the growing fragmentation of production.

Krugman was the co-author of a well-known 1994 paper (called "Trade, Jobs, and Wages") which laid out the case for trade's relative insignificance. Interestingly, his co-author on that paper, Robert Lawrence, does not see much of a footprint of trade behind the recent rise in inequality. In fact, he argues the case is even less compelling now than it was a decade ago.

How to reconcile the two perspectives? I think Lawrence is right to the extent that the skill premium has stopped rising since 2000, and therefore the type of approach that Cline and others used and which Krugman thinks would yield larger estimates of trade's contribution today, would not actually explain current inequality (which derives from the rise in incomes at the very top and from the increase in the profit share). But there are other (non-Stolper-Samuelson) models, based on bargaining for example, that could.

In any case, the trade-versus-technology debate of a decade ago is not worth reliving. What is remarkable is that a growing number of prominent economists--Bernanke, Summers, Krugman--are now willing to give globalization a starring rather than supporting role in the recent rise on inequality.

Comments

[Joe]

A strange thing happening in economics is that faced with the realities of their own country mainstream American economists are finally coming around to agree with the arguments of developing country economists (including those lefties in India). The latter have for long been ringing bells of caution on the issue of trade liberalization. What to make of it?

As for Krugman's comments, the guy is a brilliant economist, no doubt.His political commentaries are outstanding. But, sometimes,his economic commentaries are misleading: look at his verdict in 1994 that East Asian growth was all about "perspiration" (and not about technological change), which has now been discredited even by mainstreamers like Jagdish Bhagwati.

[paine]

joe

we must let past sinners repent without too much fanfare

the post bush II
krug is quite a different
and far far better and bolder fellow
then even his early
to mid 90's self
let alone
that earger for recognition
reaganite era self

but i'm fond
of that yearling bright bulb
that still
burns the midnight oil
and
still is achangin'

[Joe]

I agree, Paine. Krug is indispensable!

[Emmanuel]

Nice to see you here, slink.

Heckscher-Ohlin, Stopler-Samuelson, and ever more sophisticated trade models that show how labor loses out from globalization basically recycle Marx's notion of capitalism's "internal contradictions."

Innovation--the mainspring of capitalism--is what will cause a backlash against capitalism as innovation enables returns to capital to gradually outstrip those to labor.

I do not really see why this point strikes mainstream economists as so novel as Das Kapital came out in 1867. From a Marxist POV, offshoring/outsourcing/globalization just represent another innovation in a longstanding process of worker exploitation.

I don't like to think of myself as a commie pinko (who would!), but the "internal contradictions" hypothesis explains a lot of things going on today very well--especially wage stagnation despite higher labor productivity which neoclassical models typically punt on.

Marxist economics are the unspeakable evil in modern economics, but I'll make this challenge to everyone: If you have a better explanation of the contemporary political economy in the developed world, put it forward.

I have written more on how the pieces of contemporary political economy fit into a Marxist "internal contradictions" framework:

http://ipezone.blogspot.com/2007/06/marxism-on-wall-street-vs-main-street.html

[Marcos Ancelovici]

There was a similar discussion in yesterday's Wall Street Journal. It seems that now the consensus even includes former economic advisers of Bush:
http://mancelovici.wordpress.com/2007/06/14/make-the-rich-pay-for-the-sake-of-globalization/

[Diego]

Professor Rodrik, I have a great concern about the intellectual property rights treatment in the recently negotiated bilateral trade agreements between Latin American countries and the US. Recently Joseph Stiglitz proposed to change the way in which innovation should be retributed from patents to prizes. However there is little interest from pharmaceuticals and other corporations in changing this. Recently Brazil has shown the way by allowing the production of generics to aids treatment after unsuccessful negotiations with the lab. Do you think it is possible for smaller countries like Colombia to change patents to some other form of recognition to laboratories, and to do this facing free trade agreements?

[Joe]

Krugman states:
"in 1990...the original four Asian NIEs had hourly compensation costs that were 25% of the US level. Now ...China’s labour costs are only 3% of US levels."

One fundamental problem with this argument is that by the 1990s NIEs had almost become net importers of labor-intensive goods, and China had replaced both Japan and NIEs as the major net-exporter of these types of goods. As I have pointed out in my comment on Rodrik's latest entry "Globalization anxiety...", Chinese money wage is growing rapidly, which is likely to bring about the balance in US- China trade in the long run. My guess is that instead of comparing worker earning in NIEs in 1990 with worker earning in China today, we should compare the former with worker earning in China 10 years from now. That would, in my judgment, do more justice to the "ladders of comparative advantage"argument which Krugman seems to be alluding to.

[mik]

"Chinese money wage is growing rapidly, which is likely to bring about the balance in US- China trade in the long run."

Great!

Will it happen before 2100 by any chance?

Can we count on 2150 as an absolute deadline?

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