Globalization, Productivity, and Wages

In response to a question about globalization's role in breaking the link between productivity and wages arising from his latest column, Paul Krugman says:

Surprise! The Rich Get Richer and . . ., Paul Krugman's Money Talks: ...There's a dispute about how much of a role international trade has played in the disconnect between productivity and wages; standard economic models say that trade has played some role, but not the dominant one. It's worth pointing out that Wal-Mart — to pick a non-random example — while it sells a lot of imports, must use U.S. workers to operate its stores, so it really isn't in a position to outsource. Nonetheless, it pays low wages and offers minimal benefits. That's not a conclusive proof that trade isn't the villain, but it's a reminder that stories about manufacturing don't easily generalize to the economy. (And imagine how different things would be if service workers were members of strong unions, received universal health care, etc.)...

Comments

[farrar]

Mark, it seems that the NY Times lawyers have got to you and you are no longer able to post such long quotes from PK's columns. I'd been wondering how you were getting away with it up to now. I suppose I'll have to subscribe to Times Select, unless someone else takes the relay???

[Mark Thoma]

That's the entire quote from Krugman in Money Talks - the rest are letters from readers which I omitted.

[anne]

Paul Krugman:

"(And imagine how different things would be if service workers were members of strong unions, received universal health care, etc.)"

For reasons I do not understand, we simply do not allow that there has been an increasing bent for several decades to social-economic policy that neglects middle class worker needs. Where Wal-Mart is marginally successful in Europe, in which worker needs are not neglected and competition is not at the expense of workers, Wal-Mart is wildly successful in America and Mexico where competition can be directly at the expense of workers. Even a mild domestic policy bent to providing for worker needs should be welcome.

[save the rustbelt]

Krugman will never admit that destroying a large swath of American manufacturing in a relatively brief period of time is bad for American workforce.

His policy, in a nutshell, seems to be, "will let you wallow in a lousy job but give you health insurance and the EITC, and you can buy cheap stuff at Wal-Mart."

Gee, swell.

[Blissex]

«Wal-Mart — to pick a non-random example — while it sells a lot of imports, must use U.S. workers to operate its stores, so it really isn't in a position to outsource. Nonetheless, it pays low wages and offers minimal benefits. That's not a conclusive proof that trade isn't the villain, but it's a reminder that stories about manufacturing don't easily generalize to the economy.»

Ahhhh so Krugman can do a Mankiw too! :-)

Because it is very convenient to forget that manufacturing and retail are connected markets; and it does happen that all those middle aged almost unemployable people who have lost their career in manufacturing or services then compete vigorously to get a job a Wal*Mart.

Because the general weakening of terms of trade for all labor in the USA due to competition with large numbers of foreign workers does not reflect on the labor market for retail?

Krugman's argument is only a little more respectable than the headline «US offshoring boosts blue collar wages» to describe a paper which actually states that overall labor compensation has been bad, except for a few for which it has been less bad because their jobs cannot be easily offshored.

And there are two types of workers protected from international competition, with very different results:

* Those with a Yale MBA, where the protection is double: the prestigious degree, plus the limited supply due to barriers to entry like fabulous fees.

* Those restocking shelves: shelves cannot be restocked in China, but there are no barriers to entry and there is an ever increasing supply both domestically (thanks to massive downsizing in other industries) and through immigration.

I support free trade, but supporting it via propaganda does not seem that cool to me.

[anne]

Blissex, I do not understand this criticism, please explain further. Also the paper by Gene M. Grossman and Esteban Rossi-Hansberg is titled "The Rise of Offshoring: It's Not Wine for Cloth Anymore" and the argument strikes me as quite reasonable. What are you thinking?

[cm]

anne: Don't get too carried away with European worker protections. They "only" set the parameters differently. At the end of the day, when a case for "economic need" can be made, workers can be discharged no matter what. And then there is always the tool of "attrition", which can be arranged by methods of continuous harrassment. Some of those methods are fairly well documented, e.g. people are subjected to frequent "performance evaluations", allegations and investigations of theft or embezzlement (esp. in retail), assigned to unfavorable shift schedules, "difficult" clients, shitty projects etc. The law sets only minimal standards here.

As we say, where there is no plaintiff there is no judge. With high unemployment, benefit "reforms", and jobs less secure than you make it out, people who want to get or keep a job will tolerate more crap being put to them. And nobody likes to hire people with a history of legal disputes with prior employers, not even in Europe.

[thebizofknowledge.com]

It is often the chief criticism applied to capitalist economic systems that this form of congress exploits the poor and powerless. Recent reports, sadly, seem to be bearing this out!

[slink/js paine]

anne
grossman et al

are playing a trick on your benign mind
i'll explain in detail when i can

suffice this hint

split a firms employees into group a b and c

off shore a's jobs
pay b the same
split the gains from
the cost savings
by off shoring
the jobs lost by a
between stockholders your customers
and employees in group c

[anne]

Nicely done, Slink. I will read the paper again, later in the afternoon, but continue your critique.

[Blissex]

«please explain further.»

Uh? I hoped that was fairly clear. But perhaps I misunderstand what Krugman is trying to say.

My interpretation is that his argument works like this:

1) Trade is blamed for a bad job market in manufacturing.

2) But there is a bad job market for Wal*Mart employees too.

3) Since Wal*Mart workers are not exposed to trade competition, but manufacturing workers are, that the outcome is the same means that trade may not be (with a heavy hint of ''not'') the cause of the bad job market in manufacturing.

Put another way: if the job market was bad only in sectors affected by trade, it would be apparent trade were the cause; but since non tradable job markets are bad too, that is not such an clear conclusion.

The problem I see with that argument is that it is disingenuously based on the incorrect hidden assumption that the there are two separate job markets, for manufacturing workers and Wal*Mart workers, and when the job market for manufacturing workers goes down the drain, this does not affect the job market for Wal*Mart employees.

My impression instead is that while trade affects manufacturing workers directly, it also affects Wal*Mart workers indirectly, as displaced manufacturing workers end up begging for jobs at Wal*Mart. So trade can well be one of the causes of the miserable state of both job markets, because they are in effect the same job market, for wage earners.

Instead the job market for Yale MBAs is effectively disconnected from the job market for manufacturing or Wal*Mart workers because:

* India and China don't graduate any Yale MBAs, only Yale does, and the number of indians and chinese that came to the USA to get a Yale MBA and went back is nugatory.

* Very few Wal*Mart workers or manufacturing workers have a Yale MBA, and thus most cannot compete for jobs that in effect require a Yale MBA, but fired manufacturing workers can surely compete for Wal*Mart jobs.

«Also the paper by Gene M. Grossman and Esteban Rossi-Hansberg is titled "The Rise of Offshoring: It's Not Wine for Cloth Anymore" and the argument strikes me as quite reasonable. What are you thinking?»

The argument is quite reasonable in a purely ''maybe yes, maybe not'' sort of way. Then:

* I think quite slimy that they estimate the import of their argument at about .25% per year, or roughly 1.8% over the 8 years they take into account, without saying strongly that such an effect is so small that it is likely to be well within the error and rounding margins of the data and their method.

* To me it is outright prevarication to pithily summarize their argument as «US offshoring boosts blue collar wages», when they say something quite different.

How different? Well, I have discussed this in comments to another blog, here:

http://NewEconomist.blogs.com/new_economist/2006/08/us_offshoring_b.html#comment-21763977

[anne]

Thank you for the fine, clear critique; I tend to agreed on initial consideration and will think further. Sorry to put you to the trouble, but this helps considerably. Nice :)

[anne]

Blissex, what a fine argument you present....

[Blissex]

«Very few Wal*Mart workers or manufacturing workers have a Yale MBA, and thus most cannot compete for jobs that in effect require a Yale MBA, but fired manufacturing workers can surely compete for Wal*Mart jobs.»

To add to this, there is a very important details that bears repeating: in a situation in which the salaries and leverage of people working in tradable sectors weakens, the income of workers or asset owners in non tradable sectors goes up.

Suppose that there is a company, and it hires both line workers and consulting MBAs. The productivity of line workers goes way up, but their wage stays the same or falls. Then usually the rates going to the MBAs will go up because of that, because the company can afford to pay them more, and sensing that they relative leverage has increased, the MBAs will demand more compensation, and the company will be able to pay it with part of the savings from the lower wages. Since workers leverage has gone down, but executive, shareholder and consultant leverage has not, they latter will share the savings due to the lower wages.

That is a large reason why costs, profits and high end compensation, in trade protected sectors like universities or healthcare grow much faster than the average. Compensation depends not on productivity (even if in the long term is bounded by it) but on relative leverage.

[Bruce Wilder]

I usually don't like to get involved in the globalization, trade and productivity discussions, because I don't feel that even most of the economists really know what they are talking about, or (worse, sometimes) care to know. But, Blissex has set a high standard, so I will go where angels fear to tread.

I take it as a fundamental that trade is necessary, but not sufficient, to a prosperous economy. Smith's fundamental insight that the wealth of nations is due to the high productivity made possible by specialization, and specialization is limited by the extent of the market, still holds true.

I wish economists had chosen to expand on Smith's analysis of specialization, instead of opting for the sterile and static allocative efficiency of Ricardo's comparative advantage argument. I think it would make it easier to bring arguments and insights about increasing returns, technological advance and innovation, and rents and quasi-rent returns on sunk cost investments into the public discourse.

I also think economists and people like me would not fear so much that any discussion of globalization will just feed some ill-advised populist protectionist frenzy.

Income is not a simple reward for virtue. Blissex has made this point above, but I think not strongly enough. An industry, where productivity advances rapidly will probably (but not necessarily) be an industry where resources earn substantial if transitory rents (or if you are particular about these fine distinctions, some mix of economic profits, rents and quasi-rents on sunk cost investments), but while the incomes earned by factors of production in that industry may lead the economy for a time, even a long time, those incomes do not rise with productivity. On the contrary, that industry will see most of the productivity gains spread out through the economy in falling prices, and sucked away in rents earned by adjacent firms, many in unrelated fields (merchants and landlords and doctors and schoolteachers in local communities, for example).

A guy, who could run a movie projector in the days of highly flammable nitrate film, without burning up the film or burning down the theatre could earn a very substantial salary in 1925. A longshoreman without scruples about theft could do quite well in the days before container shipping. An airline pilot earned an excellent living under the Civil Aeronautics Board airline regime. IBM salesmen, in the early days, could earn small fortunes (e.g. H. Ross Perot). These things just naturally go away, and they should go away; it doesn't mean the economy is in decline, it just means that the benefits of productivity growth are spreading thru the economy. A reactionary impulse to preserve these transitory rents could be very destructive.

I am not sure there is much to be said for the concept of a trade-protected sector. Neither university education nor healthcare is "trade-protected", in any case; maybe the local hairstylist can be said to be trade-protected, but people can and do travel for education and healthcare, it's big business and has been for a long time; and in today's communicative world education and healthcare can be imported and exported. It is true that in sectors, which produce superior goods (superior in the sense that demand increases with income growth) and demonstrate relatively low productivity growth, compensation of factors will tend to grow. But, that's partly because as total factor productivity grows, resources, generally, become more expensive -- not just in the sectors, where productivity is growing most rapidly, but in also in sectors where productivity growth is low. If it's any comfort, the rise in factor cost puts pressure for productivity growth on sectors where productivity is lagging. Hence, the political agitation to reorganize those sectors of the economy.

[dryfly]

Great thread.

I like Blissex's explanation of how the tradeables sectors & non-tradeables interact... I mean they aren't islands all their own. Some sectors do better at isolating themselves from these affects but in the long run we all sink or swim together. Even health care & education will feel the pressure when incomes for workers in other sectors dry up.

I feel the real driver of this process is the severe price competition between a handful of manufacturers & service providers going to market through a few similar big box stores...

These 'stores' literally control the outlet channels for whole sectors of consumer products and increasingly services too... watch out if Wal*Mart gets into banking & financial services in a big way.

In such an environment the only REAL differentiator the consumer notices is price. I mean you walk down row after row of near identical products in a setting that makes them even look more alike... so why pay more if they really are same?

When price competition predominates, the only successful strategy is to be among the low cost producers. That way you can sell at established 'market price' yet receive a margin higher than your not-so-low cost competitors. Or if you have to, cut price forcing others to follow suit & lose money or hold price and lose market share. Either way its lose-lose for the not-low-cost.

In a world where capital, technology and raw materials are pretty much equivalent & cost the same everywhere that leaves labor cost as the only area where there is a significant cost differential... that is between developed and undeveloped worlds... at least for now. So as part of the low-cost strategy its natural to offshore & go global. Crazy not to.

So here in the developed world as workers get pushed out of the tradeable sectors by these forces they end up in the non-tradeables... by default... driving wages down there too.

So its no surprise to me that wages feel pressure first in tradeables & then later in non-tradeables... but eventually both get ratcheted down by the drive to lower cost in a price competitive world.

Globalization isn't the 'cause' of low wages, its the tool used to hammer the costs down via low wages.

BTW, there is a tie-in to B Wilder's comment (above). There are OTHER competitive strategies besides lowest price commodity offering... One is to compete on 'performance' rather than 'price'. Or at least to emphasize performance over low price.

But to be successful the seller/producer has to offer clearly superior products worth paying more for. People will pay more if they perceive there is real value.

And branding alone won't 'create value'. Too often companies think they can pass off the proverbial sow's ear as a silk purse if only they could 'brand' it better... doesn't work, or not for long.

If companies want to successfully compete via 'performance' they need to work hard on real technological advances and innovation.

Either that or use real creativity to produce products with style & class. Then when you have a superior product, either through technology or style, fully exploit this superiority via branding. Product first, brand second.

But developing superior products via creativity & innovation is hard work, expensive and takes time. Easier to think up a new advertising or branding strategy for a dog product and maybe offer a promotion or two (ie cut price) to make through this reporting period.

And the big box store probably isn't the best channel option for companies attempting to compete on performance. That too takes some thought & effort & isn't free.

The decision on the part of our firms to mostly offer me-too commodity products & services through almost identical big box-like outlet channels competing on price alone all but guarantees we'll have downwardly spiraling wages with globalization speeding it all up.