Trade and Inequality

If you haven't heard about it, Vox EU is a new blog from the Centre for Economic Policy Research and it has an impressive list of contributors. In this entry, Paul Krugman adds to his discussion in "Divided Over Trade" and "Winners and Losers from Trade" on the increasing role of trade as a source of inequality:

Trade and inequality, revisited, by Paul Krugman, VoxEU: Trade and inequality, revisited Paul Krugman 15 June 2007 Print Email Comment Republish

It’s no longer safe to assert that trade’s impact on the income distribution in wealthy countries is fairly minor. There’s a good case that it is big, and getting bigger. I’m not endorsing protectionism, but free-traders need better answers to the anxieties of globalisation’s losers.

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.

First, thanks to the rise of China, OECD imports of manufactured goods from developing countries have continued to rise rapidly since the early 1990s. Cline’s estimate of income distribution effects was based on data from 1993, when US imports of manufactures from developing countries were approximately 2% of GDP; now that number is close to 5%, and rising rapidly.

At the same time, the rise of China has prevented, for the time being, a development that I and others expected to mitigate the effects of trade on income distribution: up-skilling by the developing country exporters. “As newly industrializing countries grow,” I wrote in 1995, “their comparative advantage may shift away from products of very low skill intensity.” And that’s exactly what happened – for the countries that were the major exporters of manufactured goods to the OECD then. As John Romalis has shown, the exports of the original group of Asian newly-industrialising economies have shifted dramatically away from labour-intensive toward skill-intensive products.

But along has come China, which is far more labour-abundant now than the NIEs were then. A simple indicator is relative wage rates: in 1990, according to the US Bureau of Labor Statistics, the original four Asian NIEs had hourly compensation costs that were 25% of the US level. Now the BLS estimates that China’s labour costs are only 3% of US levels.

In 1995 I also believed that the effects of trade on inequality would eventually hit a limit, because at a certain point advanced economies would run out of labour-intensive industries to lose – more formally, that we’d reach a point of complete specialisation, beyond which further growth in trade would have no further effects on wages. What has happened instead is that the limit keeps being pushed out, as trade creates “new” labour-intensive industries through the fragmentation of production.

For example, the manufacture of microprocessors for personal computers is clearly a highly sensitive, skill-intensive process. Intel’s microprocessor production, however, now takes place in two stages: the “fabs,” which print the circuits on disks of silicon, are all located in high-wage advanced countries, but the assembly and testing, in which those disks are cut into individual chips and tested to be sure that they work, is conducted in China, Malaysia, and the Philippines.

Outsourcing of services, in both directions, adds to the possibilities of unequalising trade. The skill-intensive pieces of production processes that mainly take place in the third world are often now located in the OECD – for example, Lenovo, the Chinese computer company, has its executive headquarters in North Carolina.

What all this comes down to is that it’s no longer safe to assert, as we could a dozen years ago, that the effects of trade on income distribution in wealthy countries are fairly minor. There’s now a good case that they are quite big, and getting bigger.

This doesn’t mean that I’m endorsing protectionism. It does mean that free-traders need better answers to the anxieties of those who are likely to end up on the losing side from globalisation.

Dani Rodrik adds:

A new mainstream consensus on trade and wages?: 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...

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 ... would not actually explain current inequality... But there are other (non-Stolper-Samuelson) models, based on bargaining for example, that could.

In any case, ...[w]hat 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

[anne]

http://economistsview.typepad.com/economistsview/2007/04/on_the_other_ha.html

April 28, 2007

To Mark Thoma
From Paul Krugman

I'm a bit surprised by the whole debate here. Maybe it comes from being, first of all, a trade economist, but I thought the whole "but prices are lower" answer was killed 65 years ago by Stolper and Samuelson. Just making capital mobile isn't enough, because there's still the issue of distribution between skilled and unskilled workers. It's very hard to come up with a model in which at least some group of workers isn't hurt by trade (unless it's intraindustry specialization based on increasing returns between countries with similar resources, like auto trade between the US and Canada.)

As for the whole Noble Lie theory of selling free trade with happy stories, this has a tendency to backfire. Case in point: there was and is a good argument for NAFTA, but the way supporters made the case back in 1992-3 - highly dubious arguments that the US trade surplus with Mexico would rise, creating jobs - was disreputable (I said so at the time) and quickly became a sick joke after the 1995 peso crisis. I actually covered that debate in my trade policy class last week, and felt ashamed all over again.

[paine]

dashing to get to the "real " effects
of
trade barrier removal
the financial nexus and its denizens
is by passed
by our model mongers

that by passed HI FI nexus
retains a goodly portion of the gains from opener trade

to look at skill non skill
as the prime factors of production
effected by change effects
is all well and good

even though no model requires one or the other to benefit
since both may lose in the long run

but more to the point
they ain't the nation

to think the national policy
is not shaped
by those lucky enough
to be scrambling
to scoop up a;ll those wild
dis equilibrium
profits of enterprise ......

(through labor tax reg cost arbitrage
indeed but ultimately availible because the regulator and closer of trade gaps
is pinned in frozen forex mode
by CB games .....

once further barriers drop piece by piece
the job strip mining passes thru and up
the domestic job system....

all this was clear ex ante to anyone with trheir eye on the prize

higher faster profits for the TNCs

the dynamic transition to the new long run
can be fun for the makers and shakers
up in the corporate towers
even if its purgatory road for all labor factors
down below ....skilled and unskilled

after all a skilled worker can be built
for far less
over the south seas too ....

we have an elite crowd able
to decisively
countervail our "national " motive
for a weaker dollar

even if over the greater haul
its lose lose for BOTH domestic labor factors ...

given the wind fall profits
for those at the top of the TNCs....

chance of course
without us hois putting up a huge fuss

well guess again charlie

[eightnine2718281828mu5]

Back in the 70's, it was clear that working in the old-line industrial industries wasn't a viable long-term option for people entering college; tech was an obvious alternative back then.

Now that tech isn't such an attractive option (not only due to off-shoring, but through corporate agitation for increased H1B permits) there's no obvious alternative.

The message of the markets seems to be that American labor should just get used to diminished expectations, but that they should cheerfully support policies whose benefits accrue to those at the C level.

And Greenspan's swan song of free money has done nothing to soften the blow; inflated housing prices have reduced labor mobility (since folks are loathe to relocate when it implies a loss on their primary investment) and increased the debt burdens of those folks now just entering the workforce. Anyone attempting to purchase their first home in the current climate must swallow hard when confronted with the prospect of lowered future income expectations.

For all his admiration of the flexibility of American labor, Greenspan chose a policy that has reduced this flexibility by limiting labor mobility and increasing its debt loads. I believe his actions were broadly anti-competitive with regard to American labor.

[save_the_rustbelt]

News flash:

Not only does Ohio lead the nation in foreclosures, but apparently Ohio may have set a record for the highest rate of foreclosures in modern times.

Michigan not far behind.

This in states where there was never a real estate bubble, housing values have been declining.

Maybe Krugman has a room for rent?

[save_the_rustbelt]

",,,there was and is a good argument for NAFTA, but the way supporters made the case back in 1992-3 - highly dubious arguments that the US trade surplus with Mexico would rise, creating jobs -...."

This humble bookkeeper feels a bit vindicated, I woke up and started singing this song in the late 90s when the avalanche was building.

[save_the_rustbelt]

THe (Toledo) Blade

Article published Friday, June 15, 2007
Ohio leads nation in foreclosures for quarter

"Even as late payments on mortgages nationally dropped in the first quarter of this year, Ohio led the nation in foreclosures, with the highest figure ever for a major state, a national study found.

Ohio had 5.14 percent of home loans with payments at least 90 days past due and in foreclosure proceedings in the January through March period, more than twice the national measure, the Mortgage Bankers Association said yesterday.

Ohio, Michigan, and Indiana combined for 20 percent of the nation's foreclosures, though the states had less than 9 percent of total loans countrywide, the report said.

"The level of foreclosures and foreclosure starts for those three states exceed what occurred in Texas during the oil bust of the mid-1980s," said Doug Duncan, the group's chief economist.

The problems in Ohio, Michigan, and Indiana cover all types of mortgages. The states were tops in the nation for foreclosures begun in the three-month period.

In Ohio, the report said, loans with payments 90 days or more past due amounted to 20 percent for subprime loans, or twice the national average, and were 1.9 percent for prime fixed-rate loans, or three times the national average.

Michigan had 4.16 percent of homes loans at least 90 days past due and in foreclosure proceedings; Indiana had 4.51 percent, the report said.

Nationally, total loans with overdue payments were 4.84 percent in the first quarter, down from 4.95 percent for the end of last year but up from 4.41 percent for the first quarter of last year. These rates do not include loans in the process of foreclosure..........."

Hey, I've got a great diea. let's gut our manufacturing sector so Wal-Mart can make more money!

[dissent]

One point: economists are now changing their characterization of globalization and inequality. But, according to Krugman, this is due to the unique characteristics of China (a huge unskilled labor force) not to any other factor.

This says to me that China is a special case, wrecking the general case.

Thus the solution should be crafted with particular and special attention to China. What do people think of the approach towards currency manipulation that is beginning to take shape in Congress: an approach that targets China.

[baileyman]

For a business manager who has an opportunity to carve out part of production for completion by overseas labor, the effect is pretty obvious.

[Wayne Jett]

Those who worry about the well-being of middle and low income workers in relation to trade policy should look with a more critical eye towards the harmful effects of protectionism on these same workers.

U. S. monetary policy is protectionist, regardless of the free trade rhetoric, because the tool of monetary policy (the funds rate target) is specifically designed and intended to manage domestic interest rates so as to subsidize domestic production as a means of achieving a positive balance in foreign trade. Who are the victims of that protectionism in monetary policy? Middle and low income workers, who usually have the least hard assets to float on the waters of inflation produced by the Fed's interest rate manipulation.

Of course higher income individuals achieve faster growth in income than do the middle and lower income people, because those with more assets invest those assets and add significantly to their income through those investment earnings. A person with $1 million to invest will earn income on those assets, while another person working paycheck to paycheck will lose ground on that investor. The growing gap is no surprise. The question is whether the people at the low end are improving their real standard of living. When the Fed inflates the dollar and raises rates to put people out of work so wage increases cannot push prices up, workers lose real ground in their standard of living. That is the problem in the U. S.

[2slugbaits]

I'm glad Krugman pointed out that it is hard to imagine any trade model that doesn't result in one group being made worse off. That's not only true of trade between the US and Mexico, but also between New York and New Jersey. But I do think Krugman is making too much of Stolper-Samuelson. For one thing, S-S is a gross oversimplification of winners and losers. The S-S framework can be thought of as a 2x2 matrix with domestic/foreign economies on one axis and skilled/unskilled labor on the other axis. Workers in at least one of those quadrants will be made worse off by trade. The problem is that the category "unskilled workers" is a bit crude. Free trade might help one segment of unskilled workers will hurting others. All this means that you cannot just trumpet concern for unskilled workers as a basis for restricting free trade. Textile tariffs might help unskilled workers in North Carolina, but are apt to hurt unskilled workers at Wal-Mart. Steel tariffs might help foundry workers in Ohio & Pennsylvania, but will hurt automobile workers in Michigan and Indiana.

What we really need is for Krugman to write another article on why it is important for those few politicians who still believe in free trade to make the world save for globalization. That means taking the idea of a social safety net seriously as well as actually getting down to the business of redistributing gains from trade so that the losers at least get some compensation.

[cm]

eightnine2718281828mu5: I'll just offer that one aspect of the (supposedly) diminished expectations of working in "tech" is that "back then" tech was heavily tied to actual advancements in productivity, and perhaps more importantly enabling certain modes of production (broadly speaking production processes physically beyond human ability, or tight tolerances beyond economical human capacity) and new business models, as well as high-impact improvements in living standards.

While that is still true, and will for some time and quite likely forever, it has become more a matter of incremental improvement than leaps. In other words, the glamor is largely gone from tech, and it has become commoditized.

The low-hanging fruit effect and the infamous S-curve are everywhere.

Another not unrelated angle is that new advances become ever more marginal and hence discretionary, and "market penetration" is limited by the customers' ability and willingness to pay up for new gadgets.

Then there is the adage of the "better mouse trap", showing this is not really a new insight.

[anne]

http://delong.typepad.com/sdj/2007/06/paul_krugman_wr.html

June 15, 2007

Paul Krugman Writes About Trade and Inequality
By Brad DeLong

Paul Krugman writes about the link between expanding trade--especially between the U.S. and China--and rising income and wealth inequality within the United States. I find myself skeptical. Yes, China is exporting a lot of goods that it produces using low-skill labor. But if those goods were to be produced here in the United States, they would be produced with higher-skil labor and with lots of capital. The key question is how has the shift in economic activity created by expanding trade affected the demand for different kinds of labor and capital here in the United States. We have had:

A shrinkage in export and import-competing manufacturing.

A tremendous expansion in construction.

An expansion in consumer services.

I don't see how those shifts significantly reduce the demand for factor of production "labor" and enhance the demand for factor of production "capital." Construction employs lots of capital--but so does tradeable manufacturing. I want to see Leontief input-output matrices for the U.S. before I upweight trade and downweight education, collapsing unions, migration, changing norms, monetary policy, and other factors as more likely to be responsible for the lion's share of the increase in U.S. inequality over the past generation and a half.

And "outsourcing": outsourcing seems at least as likely to me to equalize the U.S. income distribution as to give it a further inequality boost. Consider what kinds of jobs are likely to be outsourced.

[anne]

Brad DeLong:

"I want to see Leontief input-output matrices for the U.S. before I upweight trade and downweight education, collapsing unions, migration, changing norms, monetary policy, and other factors as more likely to be responsible for the lion's share of the increase in U.S. inequality over the past generation and a half."

Agreed; change the dynamic by allowing a strengthening of unions, federal-state revenue sharing to allow for minimal or no tuition for public colleges and universities, move to universal health care, and emphasize green infra-structure development and the conditions for American workers are profoundly improved. Couple this with an increasingly equitable tax structure and inequality can be dramatically limited.

[real person from the real world]

Anne's post above - mention of deLong, and limiting INequity. Sounds good! (Just putting in my little 2 cents worth.)

[Peter Schaeffer]

Could unabated mass immigration combined with an economic slowdown, be related to rising income inequality since 2000? I know this is heresy for the Open Borders crowd. But take a look at the following from Andrew Sum of Northeastern University

The Impact of New Immigrants on Young Native-Born Workers, 2000-2005
http://www.cis.org/articles/2006/back806.html

Over the 2000-2005 period, immigration levels remained very high and roughly half of new immigrant workers were illegal. This report finds that the arrival of new immigrants (legal and illegal) in a state results in a decline in employment among young native-born workers in that state. Our findings indicate that young native-born workers are being displaced in the labor market by the arrival of new immigrants.

Between 2000 and 2005, 4.1 million immigrant workers arrived from abroad, accounting for 86 percent of the net increase in the total number of employed persons (16 and older), the highest share ever recorded in the United States.

Of the 4.1 million new immigrant workers, between 1.4 and 2.7 million are estimated to be illegal immigrants. This means that illegal immigrants accounted for up to 56 percent of the net increase in civilian employment in the United States over the past five years.

Between 2000 and 2005, the number of young (16 to 34) native-born men who were employed declined by 1.7 million; at the same time, the number of new male immigrant workers increased by 1.9 million.

Multivariate statistical analyses show that the probability of teens and young adults (20-24) being employed was negatively affected by the number of new immigrant workers (legal and illegal) in their state.

The negative impacts tended to be larger for younger workers, for in-school youth compared to out-of-school youth, and for native-born black and Hispanic males compared to their white counterparts.

It appears that employers are substituting new immigrant workers for young native-born workers. The estimated sizes of these displacement effects were frequently quite large.

The increased hiring of new immigrant workers also has been accompanied by important changes in the structure of labor markets and employer-employee relationships. Fewer new workers, especially private-sector wage and salary workers, are ending up on the formal payrolls of employers, where they would be covered by unemployment insurance, health insurance, and worker protections.

[cm]

Peter Schaeffer: It is most certainly related, but is it the root cause? Redistribution of income/wealth shares and bargaining/decision-making power is not the doing of immigrants. (At least not in their capacity of being immigrants that is.)

[cm]

One could probably go so far and say that the presence of large immigrant pools or labor-reserve armies supports the execution of such balance-shifting policies. But "support" is not quite the same as "enabling".

[real person from the real world]

Back, when times were good, no one complained about illegal immigrants. And here I am talking about MEXICANS. The problem is the jobs at the top are being competed for, by legal immigration. Everyone is displaced down a notch. Now when times are tough, we look for scapegoats, and rant about those neglected disciplines of life, circumstance. Borders are porous, and porous borders are not fixed by building walls, shooting those who cross, or angry legislation. Let's deal with the real issues, that Republicans have ceded over economic control to huge multinationals over the last 30 years, and now we are starting to notice these entities have stolen the all the bread and cheese, and left very few crumbs on the plate.

[Peter Schaeffer]

CM,

I used the word “related”. I stand by it. Open Borders isn’t the only reason for rising inequality. It is a key one, however.

RPFTRW,

Congress passed immigration restriction legislation in the 1990s. See the The Illegal Immigration Reform and Immigrant Responsibility Act of 1996 (IIRAIRA). The problem is not new and Congress has utterly failed to deal with it.

Of course, reforms tend to occur in downturns, rather than booms. Social Security and the Norris-LaGuardia (enabling modern trade unions) were products of the Depression as was the SEC. Should we abolish them as a consequence?

“Let's deal with the real issues, that Republicans have ceded over economic control to huge multinationals over the last 30 years”

Last time I checked multinationals were strongly in favor of Open Borders and against immigration control. Indeed, corporate opposition to immigration control has been a key obstacle to effective border control for decades. So I guess corporate control over the economy is really OK as long as it blocks immigration enforcement.

Note that Eisenhower stopped mass illegal immigration with just 1075 Federal agents. They deported (or induced to leave) 1-2 million illegals. Borders can be enforced by any government that wants to. Ask the Israelis.

[evagrius]

Borders can be enforced by any government that wants to. Ask the Israelis.

Snort. Ask the Filipinos working in Israel. Oh....they're legal all right. But why Filipinos, actually Filipinas, working in Israel?

http://migration.ucdavis.edu/index.php

is a good source for international news on migration.

[Peter Schaeffer]

Evagrius,

Israel imports "guest workers" from non-Arab countries precisely because they are non-Arab, non-Muslim. Israel used to use the Palestinians for these jobs.

For political and security reasons, this is no longer acceptable, hence "guest workers" from Asia (mostly).

They are deported freely and many are treated badly. Type "Israel deport workers" into Google and you will see what I mean. "Guest worker" programs are typically grim affairs.

[real person from the real world]

Not just Israeli workers are treated badly, the emerates treat Fllipinas et al, almost like indentured servants. One Saudi princess in the US on vacation in Florida was chasing some maid around and got arrested.