Even good economists sometimes go astray

and today's example is Austan Goolsbee (as reported by George Will):

Goolsbee ... says globalization is responsible for "a small fraction" of today's income disparities. He says "60 to 70 percent of the economy faces virtually no international competition." America's 18.5 million government employees have little to fear from free trade; neither do auto mechanics, dentists and many others.

What is wrong with this reasoning is that it neglects a key insight from economics: you need to think at the margin, not in terms of averages. The domestic price of oil is generated in world markets even if a very small share of a country's total consumption of oil comes from abroad. Similarly, domestic wages are strongly influenced by wages abroad when you have the ability to import the labor services of other countries through the labor-intensive goods that they sell you--even if a large part of your labor force is employed in non-tradables.

Now, Goolsbee could still be right that globalization is not the root cause of income disparities. But it wouldn't be for the reason he gives. 

Comments

[mk]

Similarly, domestic wages are strongly influenced by wages abroad when you have the ability to import the labor services of other countries through the labor-intensive goods that they sell you--even if a large part of your labor force is employed in non-tradables.

I'm not sure I understand. What kind of labor-intensive goods add pressure to the auto-mechanic labor market? Or the dentist or government employee?

I see your point about oil, but I don't see how it translates to the other examples.

[mk]

Hmm, the first paragraph there is a quote, in case it's not clear. Looks like the formatting was removed, or I forgot it.

[Dani Rodrik]

mk--

Here too you need to think on the margin. Don't you think the auto mechanic's wage is affected by what similarly qualified workers get in, say, auto plants? To a first degree of approximation, it is a single national labor market.

[mk]

I see, that makes sense.

If anyone else is confused, the thought experiment that finally convinced me was:

Suppose 60% of the country is working in non-tradables. Let's say the other 40% are working in manufacturing. Now, suppose the labor demand in manufacturing is instantly vaporized. 40% of the labor force is looking for a job. The non-tradables sector absorbs as much as it can, but it does so at lower wages, because the supply is so much bigger than it used to be.

Then you can back off this scenario by changing "instantly vaporized" to "faced with increasing low-cost competition from abroad."

And adding all the necessary caveats about stickiness, job search, skill sets, etc.

[PC]

I think there is still a part of Goolsbee's analysis that is right. If the fraction of the labor force that is subject to foreign competition is small, then the overall effect over wages will be small, simply because only very few workers are being displaced by the foreign cheap labor embedded in the imports.

Quantitatively it is not the same to have 70 percent of the workforce working in the tradable sector, than to have only 20 percent. I don't know the exact figures, but we know that for the rich industrial nations the service sector employs a large (and increasing) fraction of the labor force. And that was a trend that began before globalization.

As people get richer they want more personal trainers, hairdressers, financial advisers, cosmetic surgeons...

The real distinction for rich people is to have a butler, not to have a lot of cheap imports ;-)

[PC]

Dani,
re-reading your post I see that you actually said "even if a large part of your labor force is employed in non-tradables."

But in your oil analogy, the domestic price is set by the international price because domestic oil producers always can send their production abroad if the domestic price is below the international. Or if domestic is above international, consumers will buy foreign oil, instead of domestic. What would the labor-market analogy for this be?

If a large part of consumption is devoted to non-tradables, you cannot export/import non-tradables to adjust relative prices. At most you can import/export workers through migration, but not through international trade. And if very few people work in the tradable sector, then the downward pressure on wages will be small.

Am I wrong?

[Dani Rodrik]

PC --

If you import labor-intensive goods, you are effectively importing (services) of workers, which is no different than importing workers through immigration.

[PC]

Oh, what I meant was that you cannot import a hair cut (unless you import the hairdresser herself). If we spend the national income mostly in haircuts instead of tradables (and consequently most of the labor force works in the non-tradable sector), the few displaced workers in the tradable sector won't have much of an impact on the national labor market.

Consider this other scenario: a closed economy suddenly opens its borders to a single foreign product, let's say batteries. The few workers working in the batteries industry will seek employment in other sectors. But those will be only a few workers. How can they depress wages in the whole economy?

[PC]

(I don't want to presume that I understand this more than what you do, which is obviously not the case. I'm just trying to follow the thought experiment proposed by mk. I should thank you for taking your time to read my comment !)

[mk]

I think I see.

The effect from your battery example doesn't have to be huge, it depends on the size of the displaced industry.

But anytime imports go up, it means consumers were clamoring for produced goods. That is like clamoring for labor to produce those goods. That labor *might have otherwise come* from the U.S. The fact that it *didn't* come from the U.S. means that American workers lost out. The big contract went to a foreign firm, so to speak.

So in that sense, every increase in imports represents a missed opportunity for American workers.

But, paradoxically, this doesn't mean wages have to go down in the U.S. It just means there was a missed opportunity for wages to go up.

The other thing though, is let's say China sends us more plastic toys. The US flat out doesn't make plastic toys anymore. No one thinks we ever will. So while technically "an opportunity was missed" and "downward pressure was placed on wages," in a genuine sense there was no opportunity to miss. The U.S. doesn't have the cheap labor to support making the toys here. So it seems like a pretty abstract sense of "pressure."

Did I totally foul this up?

[Dani Rodrik]

PC --

Now think one step ahead. You have got to pay for your battery imports by exporting something, say machinery. Now your unit labor costs in machinery production better match up with those of your global competitors if you are going to have any chance of exporting. This has implications for your wages in that sector, and if you have a national labor market, for wages elsewhere. All of this is independent of the size of the nontraded sector. Competition takes place at the margin.

Don't get me wrong. I can come up with stories where trade does not force wages to the levels of your competitors. But these stories do not depend on the size of the nontraded sector either.

[PC]

Yeah, I see your logic.

It just seems so counterintuitive that "size doesn't matter", that I guess I fell into the trap.

Thanks for the lesson!

[Joe]

I wonder how foreign competition in sectors where US domestic production is very little would create a ripple effect throughout the economy. What about the differences in skill intensities across industries? The job losses in the relatively unskilled-labor intensive battery industry should have little effect on the relatively skilled-labor intensive machinery industry. Let's get real. Have the academic salaries (especially in economics!) in the US shown any sign of decline as a result of the import of labor-intensive goods from China? My bad; I am not getting the point!

[Tim Worstall]

"says globalization is responsible for "a small fraction" of today's income disparities."

That rather depends upon which income disparities we're talking about. If we're looking at the top 1%, top 0.1% (which are indeed the driver of much of the reported changes in inequality) then globalisation is, at least in my opinion, very important indeed. But it's not imports, it's exports. Those very few who have talents which are globally, as opposed to only nationally, desired, get to export those skills and earn off 6 billion, not 300 million.

[save_the_rustbelt]

Sitting in Michigan tonight, which has had severe damage from job offshoring, I note that the reduction in manufacturing, a result of globalization, has had immense ripple effects on just about every other segment of the economy.

[Pat Toche]

Something like this issue was addressed a few years back by Paul Krugman in a thought provoking piece:
http://web.mit.edu/krugman/www/xperi.html

So thought provoking that I'm still not sure what I believe...

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