Trade and wages

I have often read or heard the assertion that there is no respectable work by economists that attributes an important part of rising inequality in the U.S. to international trade, with the implication being that it's all (or mostly) due to skill-biased technological change. Greg Mankiw has made this argument in the past, and Alan Blinder implies as much in his recent NYT article.

I have never understood why the work of Rob Feenstra and Gordon Hanson is overlooked in this context. These two are among the very best empirical trade economists today (and Feenstra is the author of the most widely used graduate-level textbook in trade). In a series of papers, they have argued that outsourcing and global production sharing act just like skill-biased technological change, and they have played an important role in shaping wage inequality. Their empirical work is careful and driven by a compelling theoretical model of within-industry specialization. 

To get a flavor of their results, here is how they summarize their empirical work:

Thus, whether outsourcing is more or less important than computers depends of whether the latter are measured as a share of the capital stock, or as a share of investment. It is fair to conclude that both these variables are important explanations of the shift towards nonproduction labor, with their exact magnitudes depending on how they are measured.

Importantly, their framework helps explain how globalization contributes to inequality in both developed and developing countries. 

Comments

[Kenji]

Probably just intellectual laziness. It happens all the time in academia.

[save_the_rustbelt]

Spend a couple of days touring Ohio or Michigan.

Seven year recession still in progress.

Empty factories litter the landscape - almost all of the jobs offshored.

[dissent]

http://www.usnews.com/articles/business/best-careers/2007/12/19/best-careers-for-a-changing-job-landscape.html

Consider a career's resistance to offshoring. Well-publicized failures of offshoring may have led the public to think that companies are reducing its use. In fact, companies are quietly increasing offshoring efforts, even jobs previously considered to be better left in the United States: innovation and marketing research, for example. So, we have added offshore resistance to the criteria we used in selecting the Best Careers. Offshore resistance was one of the factors that led to adding these careers to this year's list: curriculum/training specialist, genetic counselor, ghostwriter, investment banker, mediator, and usability/user experience specialist.

Even college grads might want to consider blue-collar careers. Last year, because U.S. News readers tend to be college educated, we included only careers that typically require at least a bachelor's degree. This year we've added four careers that don't. Why? More and more students are graduating from college at the same time that employers are offshoring more professional jobs. So, many holders of a bachelor's degree are having trouble finding jobs that require college-graduate skills. Meanwhile, society has been telling high school students that college is the way, so there's an accelerating shortage of skilled people in jobs that don't require college. (Why else do you think you have to pay $100 an hour for a plumber?)

The four noncollege careers we added would be rewarding even to many college graduates, especially because college grads are likely to stand out against the competition. Those added careers are: biomedical equipment technician, firefighter, hairstylist/cosmetologist, and locksmith/security system technician. Other skilled blue-collar careers that scored well on our selection criteria: machinist (manufacturers report a shortage), nuclear plant technician (few people are entering the field, yet plans are on the books for building more plants), and electrician/electronics tech (above-average pay, and it's easier on the body than many other blue-collar careers). The takeaway: Many college graduates should consider skilled-trade careers.

[Per Kurowski]

The facts are correct but I do not agree with how Rodrik phrases his conclusion saying that “their framework helps explain how globalization contributes to inequality in both developed and developing countries”

Not only do I fail to see where this issue was studied in the developing countries but also because just saying so sends out the message that stopping globalization could somehow result in more equality in the developed countries, at no costs, of any sort. For instance, if you stop outsourcing then you might need to prepare yourself to receive even more much more immigrants to do those jobs that high-paid unskilled workers do not want to do; and of course you must also be prepared to pay higher relative prices for the not any longer imported goods.

The way I would prefer to phrase this whole issue is by saying that “outsourcing can produce more economic growth without creating more inequality if the benefits from the increased productivity of the outsourcing fully flow back to the country and in such a way that adequately considers the individual costs and sacrifices.

[Dominic]

I have to say I don't find their summary very elucidating, but that could just be me. But I do want to suggest that there is good evidence to argue that outsourcing and international trade and "globalisation" have not increased unemployment in the US. The evidence is simply that there is no statistical link and that unemployment has remained very low over the last few decades. What may have increased is job turnover (I haven't seen these statistics, but I suspect this is the case). The dynamic equilibrium hasn't changed a great deal though.

[wjd123]

Dominic,

Remember the question isn't fewer jobs but wage inequality.

[notsneaky]

"“their framework helps explain how globalization contributes to inequality in both developed and developing countries”

Not only do I fail to see where this issue was studied in the developing countries"

The closest I guess would be all the China inequality studies though that's more about the Chinese growth in general rather than the effects of trade on wages. And if you believe that trade affects unskilled wages in the developed countries through standard Stolper-Samuelson channels (I know this isn't Feenstra and Hanson - it's been awhile so I don't remember how this would play out in their model) then the flip side of that is of course higher wages and less inequality in the developing countries.

[pat toche]

And I have never understood why economists bother to distinguish technological growth and trade growth, aren't they just essentially the same thing?

[wjd123]

pat toche,

This is from a comment Dani Rodrik wrote about "Trade and procedural fairness":

"Yet when we teach comparative advantage and explain the gains from trade, we typically overlook this important conclusion. We expect our students to focus on the net gain triangles and disregard the rectangles of redistribution. In particular, we do not ask whether the trade opportunity involves an exchange that most people would consider unacceptable if it took place at home. So it is immaterial to our story if the gains from trade are created, say, by a company shutting down its factory at home and setting up a new one abroad using child labor. (By the way, I chose $3 and $2 in my example as these values are commensurate with the relative magnitudes that come out of trade models under reasonable elasticities.)

"The thought experiment clarifies, I think, why the archetypal man on the street reacts differently to trade-induced changes in distribution than to technology-induced changes (i.e., to technological progress). Both increase the size of the economic pie, while often causing large income transfers. But a redistribution that takes place because home firms are undercut by competitors who employ deplorable labor practices, use production methods that are harmful to the environment, or enjoy government support is procedurally different than one that takes place because an innovator has come up with a better product through hard work or ingenuity. Trade and technological progress can have very different implications for procedural fairness. This is a point that most people instinctively grasp, but economists often miss. (Notice that even in the case of technology, we have significant restrictions on what is allowable—c.f. human-subject review requirements—and wide-ranging debates about the acceptability of things like stem-cell research.)"--Dani Rodrik

http://rodrik.typepad.com/dani_rodriks_weblog/2007/04/trade_and_proce.html

[notsneaky]

"And I have never understood why economists bother to distinguish technological growth and trade growth, aren't they just essentially the same thing?"

Well, the menu of policy options is different. It's easier to throw rocks in your harbors then it is to go around smashing all your weaving looms.

[Tord Steiro]

Without claiming myself to be an expert on the issue, I still find it tempting to claim that a country's institutions matter on the effects of Globalization and outsourcing. In his 1994 paper; North-South Trade, Employment and Inequality, Adrian Wood claims that trade can explain the growing inequality in the US since the 70's. Building on his argument, one must consider the trade ratio, for instance measured by import + export to GDP, as explanatory for the inequality experienced in a country. However, in their 2003 study "likhet under press (equality under pressure - published in Norwegian)", economists Kalle Moene, Erling Barth, and Michael Wallerstein makes the point that Norway and Sweden, while having some of the highest trade to GDP ratios in the world have experienced declining inequality throughout the post-war era (althoug slightly rising in the last decade). Further, contrary to the Stolper-Samuelson theorem, factor prices in the Nordic countries have diverged from the global norm at the same time as trade to GDP ratios have increased. However, Feenstra (and Rodrik) points out that this seems not to be the same for the US. In the US increased globalization leads to increased inequality. My question would then be whether the institutional arrangements in the Nordic model explain why increased Globalization appears to give different effects in the Nordic countries relative to the US?

If so, there would be reason to believe that there exists an institutional arrangement to remedy this situation in the US as well. Investigating what this arrangement may look like would perhaps be an interesting academic, as well as political, excercise.

[pat toche]

wjd123 and notsneaky, thanks for your comments.

"But a redistribution that takes place because home firms are undercut by competitors who employ deplorable labor practices, use production methods that are harmful to the environment, or enjoy government support is procedurally different than one that takes place because an innovator has come up with a better product through hard work or ingenuity."

Are we saying that Americans are bothered by trade growth because of child labor in their trading partners' countries? I wish it were true, but somehow I doubt it.

Is it so difficult to smash our weaving looms? Isn't that what taxes and bureaucracy essentially do?

Anyhow, your points are taken.

[wjd123]

"My question would then be whether the institutional arrangements in the Nordic model explain why increased Globalization appears to give different effects in the Nordic countries relative to the US?

"If so, there would be reason to believe that there exists an institutional arrangement to remedy this situation in the US as well. Investigating what this arrangement may look like would perhaps be an interesting academic, as well as political, excercise."--Tord Steiro

Tord Steiro,

I'm not familiar with Nordic models but my impression is one of higher taxes and greater spending on social interest. Perhaps that is a stereotype, but for the purpose of demonstrating a point lets accept my impression as true. I doubt that if our institutional arrangements were exactly the same as yours they would produce the same results if underlying social ideals weren't also harmonized. Without this harmonization, form might not follow function. In the words of Emile Durkheim "society substitutes for the world revealed to us by our senses a different world that is the projection of the ideals created by society itself."--Value Judgments and Judgments of Reality.

In another of his works The Rules of the Sociological Method, Durkheim gives this example of time changing an institutions function even when the institution hasn't changed its form. "The religious dogmas of Christianity have not changed for centuries, but the role they play in our modern societies is no longer the same as in the Middle Ages." So its not sufficient when adjusting to change just to get the arrangement of institutions to fit a model but to get the changing social ideals to function properly withing institutional arrangements.

This would mean that finding answers to the problems caused by globalization can't just be a simple matter of imitating the model of another society. Not that the act of imitating might not bring with it changes in social ideas, but the problem of how long it would take to get the imitated model to function in the same manner.

Before we start worrying about institutional arrangements shouldn't we consider first how institutional roles are generated. If roles follow changing ideals and value then how might changes in social ideals be generated if institutions can only be as effective as the underlying ideals of society allow them to be.

For instance, if the rules and regulations enacted by an institution don't square with the underlying ideas and values of a society it produces a problem of legitimacy institutions. Although solving problems of legitimacy isn't the same as finding a model that is a sufficient response to the effects of globalization on a society, not solving legitimacy problems can make the task that much harder since the power of institutions to enforce their rules and regulations is undermined. So before examining the role of institutions in solving problems of globalization shouldn't we first examine the role social ideals have in generating institutional values, rules, and regulations?

Here are two ways I believe social ideals can be changed. The first is a top down approach to change and the second is a bottom up approach.

In 1992, Robert C. Solomon in his book "Ethics and Excellence: Cooperation and Integrity in Business" complained of his undergraduates that when asked what the ultimate purpose of business was they would invariable answer "to make money." Solomon's complaint was that he thought differently, that the ultimate purpose of business was "to serve society's demands and the public good and be rewarded for doing so. "For Solomon those purposes were the criteria "according to which corporations and everyone in business can be praised or criticized." In 1972 when Senator George McGovern ran for president of the United States one of his campaign promises was to raise the inheritance tax on the rich. To McGovern's surprise this promise was rejected by the very voters who would benefit from the tax. His only comment was to ask if voters all thought they were going to win the lottery.

Solomon's complaint points the way for a top down change in values since graduate students have the opportunity to be exposed to a different view about the ultimate purpose of business which those who don't attend college are unlikely to encounter. Whether or not graduates accept this new social criterion for judging the actions of business is up to them. However if enough do accept the new criterion for judging business it should bring top down pressure for a change in the rules and regulations governing business.

McGovern's complaint points the way for a bottom up change. That if prospects get bad enough for workers and their families their individual hope for riches will be diminished opening their minds to entertaining the possibility of greater progressive taxation and social solutions to meet their needs.

If the Nordic model depends on a greater willingness to put social interests over individual interest, and accept higher taxes for the purpose of creating a more egalitarian society, than changing values count more than institutional arrangements.

Unfortunately, here in America there is tremendous pressure put on business managers to conform to American corporate culture while at the same time corporate culture through the use of the media bombards street culture with messages of individual greed and gratification.

Before a Nordic model could be effective in solving problems of globalization for us it would among other problems have to get pass the roadblocks thrown up by America's powerful business culture.

[Tord Steiro]

wjd123, thank you for a good post!

I agree with what you are saying. Simply taking a blueprint model and impose it on another society is, as you clearly point out, simply not very clever. Nor is it any interesting academic excercise. That is why I did not suggest that any "Nordic Model" should be imposed in the US. Rather than claiming any universal superiority of a "Nordic Model" my point would be something very different.

This discussion where about trade and wages. The theory is that rich countries must accept increased inequality as a response to free trade. The history of the Nordic countries, however, contradicts this view, and show that one can combine equality and free trade at the same time (and even keep the benefits of free trade). My point, then, would be that it is much better to remedy any inequality resulting from trade with a change in institutions rather than with a change in trade regime. And if the Nordic countries managed to find a way to reap the benefits of free trade without the negative effects of higher inequality and a more volatile labour market, why should it not be possible in the US?

The US certainly need a different arrangement - a US model - but that is also why investigating one would be an interesting academic exercise.

And, we might find one that look very different! One thing that comes to my mind, is the effect geography and demography. Take Norway in the late 1930's (when the model developed), for instance: The population is small and scattered, giving prospects only for small and undeveloped markets. Autarky is obviously untempting. However, trade routes abroad are plentiful and cheap. In the late 1930's it where cheaper to bring large amounts of goods from Oslo to Copenhagen, Gothenburg, or Rostock than from Oslo to Norway's second largest city of Bergen. And transport where cheaper from Bergen to Newcastle, London, or Rotterdam than to Norway's third largest city, Trondheim.

So, even if free trade brings inequality and volatility in the labour market, for Norway in the 1930's it where the only viable option. No surprise, then, that Norwegians incrementally developed a model that solved the expected problems of trade as they arouse, while kept the benefits of more developed and larger markets.

In present US, the prospect of autarky must be considered much better than in Norway in the 30's. The US has a large population, good infrastructure, low transaction cost, and well developed, large, markets. But, even if the prospects of autarky are better, how are the prospects of free trade? Globalization today is very different from the 1930's. That is where the interesting academic exercise comes in to play: What is the optimal mix between autarky and free trade in the US, considering the road blocks different interest groups will erect? How can institutional arrangements bypass or neutralize vested interests (or change their interest)?

This is certainly the interesting part, and it calls for something else than a simple blueprint. Or, as Eisenhower put it: "Plans are nothing. The planning is everything!" With a blueprint model you have a plan, but no planning. With other words, you have nothing.

[wjd123]

"So, even if free trade brings inequality and volatility in the labour market, for Norway in the 1930's it where the only viable option. No surprise, then, that Norwegians incrementally developed a model that solved the expected problems of trade as they arouse, while kept the benefits of more developed and larger markets."--Tord Steiro

Tord Steiro,

Thank you for allowing me to think through a interesting question even if I may have misunderstood it.

In response to the above observation, I would point out that just because a society has a need to solve a problem it doesn't automatically follow that it will be lucky enough to hit upon a viable option to do so. The options avaiable to one society may be closed to another.

[Tord Steiro]

So true, so true.

Some good examples can be found in Jared Diamonds "Collapse", for instance. The Easter Islanders did not find a way to solve their problems of property rights regime to their trees, and the Norse Greenlanders failed to find a way to direct their resources into activities that could have saved their society. And their problems where clearly institutional in nature.

[CrisisMaven]

Wow, you have a very lively discussion on your blog! I may havesomething to chip in too for economists (students or researchers): I have just added an Economics Reference List to my economics blog (http://crisismaven.wordpress.com/references/) with economic and statistical data series, history, bibliographies etc. for students & researchers, probably the most comprehensive on the Internet. Currently over 200 meta sources, it will soon grow to over a thousand. Check it out and if you miss something, feel free to leave a comment. As for wage inequality: this should be a natural process of differentiation according to skill. As long as markets were protected, wages might, just as the price of grain, been different than when they would have to compete, but that is a natural process. Build awall around Caifornia or Vermont and you similar effects before and after you tear it down again.

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