Paul Krugman: Trade and Wages, Reconsidered

Paul Krugman posted a link to a very preliminary draft of a paper he is writing on the relationship between trade and wages. Here is the introduction and concluding paragraph:

Trade and Wages, Reconsidered, by Paul Krugman, February 2008: This is a very preliminary draft for the spring meeting of the Brookings Panel on Economic Activity. Comments welcome.

There has been a great transformation in the nature of world trade over the past three decades. Prior to the late 70s developing countries overwhelmingly exported primary products rather than manufactured goods; one relic of that era is that we still sometimes refer to wealthy nations as "industrial countries," when the fact is that industry currently accounts for almost twice as high a share of GDP in China as it does in the United States. Since then, however, developing countries have increasingly become major exporters of manufactured goods, and latterly selected services as well.

From the beginning of this transformation it was apparent to international economists that the new pattern of trade might pose problems for low-wage workers in wealthy nations. Standard textbook analysis tells us that to the extent that trade is driven by international differences in factor abundance, the classic analysis of Stolper and Samuelson (1941) – which says that trade can have very strong effects on income distribution – should apply. In particular, if trade with labor-abundant countries leads to a reduction in the relative price of labor-intensive goods, this should, other things equal, reduce the real wages of less-educated workers, both relative to other workers and in absolute terms. And in the 1980s, as the United States began to experience a marked rise in inequality, including a large rise in skill differentials, it was natural to think that growing imports of labor-intensive goods from low-wage countries might be a major culprit.

But is the effect of trade on wages quantitatively important? A number of studies conducted during the 1990s concluded that the effects of North-South trade on inequality were modest. Table 1 summarizes several well-known estimates, together with one crucial aspect of each: the date of the latest data incorporated in the estimate.

For a variety of reasons, possibly including the reduction in concerns about wages during the economic boom of the later 1990s, the focus of discussion in international economics then shifted away from the distributional effects of trade in manufactured goods with developing countries. When concerns about trade began to make headlines again, they tended to focus on the new and novel – in particular, the phenomenon of services outsourcing, which Alan Blinder (2006), in a much-quoted popular article, went so far as to call a second Industrial Revolution. Until recently, however, surprisingly little attention was given to the increasingly out-of-date nature of the data behind the reassuring consensus that trade has only modest effects on income distribution. Yet the problem is obvious, and was in fact noted by Ben Bernanke (2007) last year: "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." And there have been a lot of later developments.

Figure 1 shows U.S. imports of manufactured goods as a percentage of GDP since 1989, divided between imports from developing countries and imports from advanced countries.[1] It turns out that developing-country imports have roughly doubled as a share of the economy since the studies that concluded that the effect of trade on income inequality was modest. This seems, at first glance, to suggest that we should scale up our estimates accordingly. Bivens (2007) has done just that with the simple model I offered in 1995, concluding that the distributional effects of trade are now much larger.

And there’s another aspect to the change in trade: as we’ll see, the developing countries that account for most of the expansion in trade since the early 1990s are substantially lower-wage, relative to advanced countries, than the developing countries that were the main focus of concern in the original literature. China, in particular, is estimated by the Bureau of Labor Statistics (2006) to have hourly compensation in manufacturing that is equal to only 3 percent of the U.S. level. Again, this shift to lower-wage sources of imports seems to suggest that the distributional effects of trade may well be considerably larger now than they were in the early 1990s.

But should we jump to the conclusion that the effects of trade on distribution weren’t serious then, but that they are now? It turns out that there’s a problem: although the "macro" picture suggests that the distributional effects of trade should have gotten substantially larger, detailed calculations of the factor content of trade – which played a key role in some earlier analyses – do not seem to support the conclusion that the effects of trade on income distribution have grown larger. This result, in turn, rests on what appears, in the data, to be a marked increase in the sophistication of the goods the United States imports from developing countries – in particular, a sharp increase in imports of computers and electronic products compared with traditional labor-intensive goods such as apparel.

Lawrence (2008), in a study that shares the same motivation as this paper, essentially concludes from the evidence on factor content and apparent rising sophistication that the rapid growth of imports from developing countries has not, in fact, been a source of rising inequality. But this conclusion is, in my view, too quick to dismiss what seems like an important paradox. On one side, the United States and other advanced countries have seen a surge in imports from countries that are substantially poorer and more labor-abundant than the third-world exporters that created so much anxiety a dozen years ago. On the other side, we seem to be importing goods that are more skill-intensive and less labor-intensive than before. As we’ll see, the most important source of this paradox lies in the information technology sector: for the most part there is a clear tendency for developing countries to export labor-intensive products, but large third-world exports of computers and electronics stand out as a clear anomaly.

One possible resolution of this seeming paradox is that the data on which factor-content estimates are based suffer from severe aggregation problems – that developing countries are specializing in labor-intensive niches within otherwise skill-intensive sectors, especially in computers and electronics. I’ll make that case later in the paper, while admitting that the evidence is fragmentary. If this is the correct interpretation, however, the effect of rapid trade growth on wage inequality may indeed have been significant.

The remainder of this paper is in four parts. The first part offers an overview of changing U.S. trade with developing countries, in a way that sets the stage for the later puzzle. The second part describes the theoretical basis for analyzing the distributional effects of trade, then shows how macro-level calculations and factor content analysis yield divergent conclusions. The third part turns to the case for aggregation problems and the implications of vertical specialization within industries. A final part considers the implications both for further research and for policy.
...

Implications of the analysis

The starting point of this paper was the observation that the consensus that trade has only modest effects on inequality rests on relatively old data – that there has been a dramatic increase in manufactured imports from developing countries since the early 1990s. And it is probably true that this increase has been a force for greater inequality in the United States and other advanced countries.

What really comes through from the analysis here, however, is the extent to which the changing nature of world trade has outpaced our ability to engage in secure quantitative analysis—even though this paper sets to one side the growth in service outsourcing, which has created so much anxiety in recent years. Plain old trade in physical goods has become remarkably exotic.

In particular, the surge in developing-country exports of manufactures involves a peculiar concentration on apparently sophisticated products, which seems at first to put worries about distributional effects to rest. Yet there is good reason to believe that the apparent sophistication of developing country exports is, in reality, largely a statistical illusion, created by the phenomenon of vertical specialization in a world of low trade costs.

How can we quantify the actual effect of rising trade on wages? The answer, given the current state of the data, is that we can’t. As I’ve said, it’s likely that the rapid growth of trade since the early 1990s has had significant distributional effects. To put numbers to these effects, however, we need a much better understanding of the increasingly fine-grained nature of international specialization and trade.

Comments

[paine]

why the academy is useless in the tough spots

"How can we quantify the actual effect of rising trade on wages? The answer, given the current state of the data, is that we can’t. ..... To put numbers to these effects, however, we need a much better understanding of the increasingly fine-grained nature of international specialization and trade. "

[RW]

The academy is useless in the "tough spots"? Please, everything is useless at turning points, that is the nature of transformation; observation fits itself into the framework theory provides until it can not.

Condemning the academy because it can do no more than we can in such cases would appear to assign it a role beyond the typical; that is, we expect it to do more than deliver support of prevalent prejudice.

Now that leads to a rather interesting question: Could an academy survive, much less gain sufficient prominence to gain influence, if they did not so deliver and, assuming survival at least, would we listen to them.

Obviously this question is rhetorical: The answer is scattered everywhere throughout history's detritus.

[Blissex]

«Could an academy survive, much less gain sufficient prominence to gain influence, if they did not so deliver and, assuming survival at least, would we listen to them.»

It depends on what it delivers and what competing voices are allowed.

The USA economics profession for example delivers a steady, consistent stream of propaganda and consequent high rewards for the beneficiaries of the propaganda which compensate the authors of it quite well.

As long as few people notice that in MBA schools the business classes teach a very different type of economics than the Economics taught in the theory classes...

But then consider also MBA schools themselves: they deliver a steady stream of corporate climbers trained in a standardized corporate attitude. Despite lots of efforts, the evidence that they perform better or worse than other corporate drones, but they are still popular with employer because of the attitude adjustement that is what doing an MBA actually delivers.

[hari]

The growth of income inequality is a function of educational standards. It seems that whereas Asian markets are gearing up to competition, US domestic labour force is not up to mark - otherwise the trade flow would not be what it has been for past two decades or so. The trend is discernable and explicit - comparative trade advantage is a changing factor.

MBA or no MBA, there is a deficit which is being foolishly aggregated by Russert and Co against NAFTA and FTA generally. The idiots don't know because they're safe with their multi-million media contracts. But the propaganda is damaging to US external realtions to a considerable degree.

Paul is trying - atleast - to find raison detre for the trade gap and its impact on income inequality, if any.
I suggest that if there's an impact, it's marginal and not a realistic factor endowment. Because the domestic economy is the problem, stupid, not the foreign trade!

Why do you think ECB is managing to incur the difficult political pressure of a +1.5 Euro to dollar? And still succeed? Productivity in export sector is high and Germans, for example, are still not complaining...

[ken melvin]

Hari, one of us needs to reread the piece.

[paine]

rw
pomposity of rendering aside
i agree
the ivy whore
won't slap the face of wall street

[paine]

"everything is useless at turning points, that is the nature of transformation; observation fits itself into the framework theory provides until it can not"

apologia for muddle thru

and much else
some what
less worthy of toleration

as in
wait on "convincing proof"
till its too late to wreck our plot

[paine]

"The growth of income inequality
is a function of educational standards"

as in

the growth of household inequality
is a function of credit standards

[paine]

hari

you read like the poor hopeful soul
walking up the deep slant
of the stern quarter of the titanic

"hey we're not all sinking
go to the fan tail folks
its getting further and further
from the ocean's surface "
not closer

[2slugbaits]

When economists talk about "growing global trade" do they mean growing for all economies, or are they mainly talking about growing globalization relative to US historical experience? Are there developed countries today with the same relative level of "globalizations" as they had say 30 years ago? If so, wouldn't you want to use those countries as a kind of benchmark?

[anne]

Beyond guessing at Paul Krugman's motivation in cautiously but essentially defending trade benefits, where precisely is the analytical weakness? I find no analytical weakness, but could easily understand arguing with the conclusions from either asking what are the rights to protection of selected workers and the political expectation such worker rights will be protected. The paper as such seems fine analytically and tempered in conclusion.

[anne]

Paine, assuming an increased loss of economic influence by orinary employees is the case, as I do assume, the question remains whether trade is a mechanism that has contributed to the loss of influence or balance against managements. Even if trade contributes to inequality, that does not make trade the problem as oppose to the way in which trade is being used.

Where is there an analytical weakness in Paul Krugman's paper?

[david]

"the question remains whether trade is a mechanism that has contributed to the loss of influence or balance against managements."

When the numbers are tough to get and not all that reliable, you can always try ethnography. Ask the union folks for a start.

[Alex Tolley]

I think this paper suffers from being too macro. I read a shifting use of terms - e.g. "income inequality" which means what exactly - the total income distribution/skilled vs unskilled/services vs manufacturing?

If electronics manufacturing is so extreme, then the effects should show up in this sector. Do they (anecdotally it might seem so)? If specific services can be outsourced, do the trade effects show up in this specific service?

I would rather see the effects of trade on specific sectors and then make the general trade case, rather than looking at what is obviously limited and muddy data in aggregate.

[Real Person from the Real World]

It's great to hear that a respectable economist is finally admitting that as the world changes, perhaps we need to start changing the ideas that underly old economic standby models. Education is not the main issue, as so many people have some post highschool coursework, but we need to nurture our own sectors such as technology, instead of blindly importing more and more people from the 3rd world, for what should be more common technology jobs, that our own people ought to be training for. While protectionism is not the answer, we need to develop some sort of economic base beyond sales, marketing, and advertising, and middleman business entities. We also need to get beyond the comoditization of the larger mass of our workforce, before we end up a 3rd world country: If the majority of jobs don't pay enough for US Citizens to buy the goods US companies make and pay their mortgages, there is something very wrong. Instead of vilifying "illegals" (Mexicans, et al), we need to develop an economy that provides a decent standard of living to those of us born here, and develop a borders policy with Mexico, that doesn't depend on putting up fences.

[anne]

David:

"When the numbers are tough to get and not all that reliable, you can always try ethnography. Ask the union folks for a start."

Alex Tolley:

"I would rather see the effects of trade on specific sectors and then make the general trade case, rather than looking at what is obviously limited and muddy data in aggregate."

Agreed; I would wish a series of sector specific analyses or analyses of management-labor balances and envrironment effects as trade patterns shift as they necessarily will.

[Bruce Wilder]

anne: "where precisely is the analytical weakness?"

He does not have a theory of trade, which adequately explains the patterns of trade, which he sees in the data.

He is hoping to get better data, which will show him, at a finer grain, that his theory still works.

He won't find corroboration for his theory, even if he gets better data.

Economists, even economists like Krugman whose professional work shows clearly that he ought to know better by now, love to use factor allocation models to explain trade. Comparative advantage from differences in ratios of factor abundance explain trade.

Except, mostly, they don't.

Theorists, including Krugman, like to think about problems, such as the possibility that large numbers of workers might be hurt by increasing trade, within the framework of some variation of a Heckscher-Ohlin model, in which allocative efficiency is the only consideration.

Tested against the actual pattern of trade in manufactured goods, though, Heckscher-Ohlin models almost always fail miserably and grossly. In any other discipline, they would be discarded in favor of some other theoretical construction, which could demonstrate more power to explain, say, pervasive patterns of intra-industry trade.

China's rise as workshop of the world has taken place in a world in which intra-industry trade is the rule.

Instead, the data is blamed. And, the data is bad: very dirty and inconveniently categorized. There's no doubt about that.

It is impossible, given the poor quality of the voluminous data on imports and exports, to actually say what, for example, the effects of NAFTA have been, based on a fine-grain analysis. So, instead, economists assure us, on the basis of a theory not supported by data, that, if we had the data, it would show the benefits.

Where's the analytical weakness?

It is in a theory of trade, derived from a theory of prouction, which is a falsehood. Allocative efficiency is not the dominating consideration in organizing manufacturing (or services).

Explaining trade is just a subset of the problem of explaining the organization of production and distribution. If your theory of production is a total crock, you have, yes, an analytical weakness.

[Richard A.]

It would be interesting to look at Japanese imports of manufactured goods as a percentage of GDP since 1989 and earlier, divided between imports from developing countries and imports from advanced countries. I suspect you would see a similar trend as the US. Yet widening wage inequality is not as bad in Japan as it is in the US. Free trade is taking the blame for something else that's going on in the US economy.

[dissent]

It's worth noting (again) that the big tech employers, IBM, HP, and the like, have hired by the tens of thousands over the last 7 years in India. Even as employment here has stagnated. Even as computer science enrollments have fallen by over 50%.

Leave aside how this example undercuts the pablum about how we all just need "more education".

This is typical of the situation that economists have glibly praised for the last years. And now, as we slide into the upcoming recession, with nothing more than a stagnant and insecure job market as our high water point, now we are going to see the shake out. How ugly will it get?

The fact is, so-called "American" companies have been dumping their American workers. (They've also been trashing our health and safety through their resistance to nationalized health care and support for thugs, I mean Republicans.)

But notice how there is no other economy with the consumer strength to be the market of choice after we crash. That's because the current model of development is about replacing good jobs at good wages (and environmental regulation) with cheap products at bad wages -- with a rising tide of toxicity in the environment and ALSO in the products.

But that's all okay, because the essence of "free market" ideology is that it's fine to be brain-dead. Competence doesn't matter when you leave policy up to the "invisible hand".

[save_the_rustbelt]

"How can we quantify the actual effect of rising trade on wages?"

Ah, take a tour of Michigan and Ohio? Stop at local cafes and asked about the abandoned factory buildings down the street?

Spend a few days reading files at the Detroit and Toledo bankruptcy courts?

Drop by any county courthouse in the rustbelt and listen to foreclosure hearings?

Am I getting warm?

[anne]

No; the problem of factory workers in selected areas of the middle west are quite important, but attributing them to trade that has been at all unfair is simply not proven. By complaining of trade alone, the possibility of meaningful assistance has been made harder to gain. This is simply accepting traditional conservative arguments that have allowed for an erosion of employee assistance.

[Peter Schaeffer]

dissent,

You have this all wrong. Wal*Mart and the SEIU are promoting national health care. See "Wal-Mart, SEIU Outline Themes To Meet Health Coverage Goal By 2012" (http://www.medicalnewstoday.com/articles/62656.php).

'A coalition of business and union leaders led by Wal-Mart CEO H. Lee Scott and SEIU President Andy Stern on Wednesday gathered at a press conference to outline four general themes to meet a goal of affordable health care for all U.S. residents by 2012, the Wall Street Journal reports (Maher, Wall Street Journal, 2/8). The purpose of the coalition -- called Better Health Care Together -- is to "end the nation's reliance on employer-backed health insurance and develop a system for providing universal low-cost coverage within five years,"'

You aren't going to make some rude comment about Wal*Mart not having the best interest of its workers in mind, are you? Are you willing to suggest the Andy Stern might have a (not so well) hidden agenda?

Andy Stern is a saint isn't he?

[2slugbaits]

Bruce,

You've completely confused me. Okay, easy enough, but I'm sure you've confused a lot of other folks too.

"Comparative advantage from differences in ratios of factor abundance explain trade."
"Except, mostly, they don't."

What do you mean here?

"Tested against the actual pattern of trade in manufactured goods, though, Heckscher-Ohlin models almost always fail miserably and grossly."

To be fair, I believe Krugman was referring to the Samuelson-Stolper (S-S) twist to the H-O model. I think Krugman's point was that for a long time economists were aware of the S-S theoreom, but it did not seem to have much empirical support, until recently. Krugman's point is that S-S might now be finally starting to bite.

"...which could demonstrate more power to explain, say, pervasive patterns of intra-industry trade."

What do you mean by intra-industry trade? I'm not following you here.

"It is in a theory of trade, derived from a theory of prouction, which is a falsehood. Allocative efficiency is not the dominating consideration in organizing manufacturing (or services)."

I don't think the theory depends upon a specific theory of production. The theory only requires some kind of difference, which could be in the form of a difference in price, a difference in tastes between countries, or just about anything. Economists frequently do use allocative efficiency, but the theory still works if you use something different. In any event, it might be that the production functions are too simple. Instead of a two factor model, maybe it would make more sense to use a four factor KLEM model.

[zinc]

"No; the problem of factory workers in selected areas of the middle west are quite important, but attributing them to trade that has been at all unfair is simply not proven."

Speaking of pomposity......

Which company is now the number one automaker in the world ? And what is the trade deficit with their country of origin ?

Thankfully, the academic tut tut is being challenged. The balance of evidence supports the hypothesis that Japanese economic policy is mercantilist and does not qualify as "free" trade. Japanese pegging of the yen to restrain or defeat the unfettered tendency of currency adjustment for balancing trade is de facto unfair trade practice.

Certainly, the inefficiency of the big three has been a factor in their reversal of fortune. So have legacy costs, an issue that transcends one particular American industry and is highly germain to the issues of the effect of off- shore production and competition from low wage and benefit foreign producers. Even new plants in the US have comparative advantage over Motown. The auto producers are only the most visible of the manufacturing base in Ohio and Michigan that are being wiped out. The chain of suppliers that are competing, and losing, with Japan, China, South Korea, Viet Nam, etc. is much larger than just the auto companies.

"By complaining of trade alone, the possibility of meaningful assistance has been made harder to gain."

Let them eat cake !

How smugly lame is that. Meaningful assistance is a bottoms up program to invigorate the manufacturing industry in the heartland, including ameliorating the legacy costs and health care issues that our "government" ignores. Many of these costs are socially desireable and some mandated, not covered by the gulag labor providers or covered by the industrial policy of off-shore competitors.

The destruction of the manufacturing sector in the heartland is exactly what US government trade policy has been aimed at for the last thirty years. And the result is exactly what was hoped for. Shift the cost of benefits to the greedy union bums and throw them in the street. Minimum wage at Walmart is what they deserve.

Time to decide. More education and assistance my ass.

[Inflation Redistributes Trade Efficiency Gains]

Richard A..."Yet widening wage inequality is not as bad in Japan as it is in the US. Free trade is taking the blame for something else that's going on in the US economy."

Yes, Japan has deflation, we have inflation. Trade efficiency is not allowed to lower prices here. The entire burden of a rising standard of living depends upon rising income. This is a joke when trade competition lowers income. The only groups gaining ground are the de jure monopolies, which are protected from competition via regulations and licenses, and borrowers. Those forced to compete on the world market wind up with lower wages, and higher prices. The rising standard of living due to trade goes solely to those first in line to receive newly created dollars (borrowers), and de jure monopolies.

Fixed income people actually lose purchasing power due to trade under our system. To keep the CPI rising, domestically produced necessities are driven up in price faster than they otherwise would be, to compensate for lower import prices. Necessities tend to be a higher percentage of fixed income budgets.

In Japan, all consumers benefit more equally from trade and technological efficiency gains, as prices fall in response. More equality. Under our system, monopolists (e.g., lawyers) and borrowers (e.g., hedge funds) are the primary beneficiaries. Most everyone else loses, so they are forced to work overtime to compensate.

Its not like the Fed sends everyone an equal check for their share of newly created money, which would distribute purchasing power equally. There is also nothing equal about forcing some people to compete, but exempting others.

[anne]

There is stupidity and stupidity; there is no reason to believe that General Motors coul not have been and could not be Toyota with proper management. So, let us be stupid and find another country to blame for a problem solely ours. All countries are evidently bad unless we are colonizing them. Me, I prefer to learn how to be more competitive.

Do I make myself clear?

Now, proceed with the intimiating rottenness that is so wonderfully characteristic and noltice how intimiate I will be by mean-spirited stupidity.

[anne]

"The problems of factory workers in selected areas of the middle west are quite important, but attributing them to trade that has been at all unfair is simply not proven."

Precisely so.

There are many courses of assistance that can be taken and would have been taken, from national health care on, were it not for a continual legacy of fierce Republican opposition.

[Bruce Wilder]

2slugbaits: "You've completely confused me."

What I've done is climb on my soapbox, and gone into crank mode, railing as a voice in the wildnerness against my betters. The arrogance of challenging Krugman for analytic weakness is kind of borderline.

2slugbaits: "I don't think the theory depends upon a specific theory of production."

Oh, yes it does. All of the things we are talking about take place in the context of an analytic system of economic thought -- a kind of Euclidean Geometry of Economics -- where prior results are used to support more sophisticated formulations. Stolper-Samuelson is, quite literally, a theorem, in the Euclidean sense, which relates the prices of inputs to the prices of outputs: the relation of output to input is production. (Irrelevant trivia: I had Stolper as an undergraduate advisor and in seminar a zillion years ago.)

All models of trade seek to explain the origins of, and nature of, specialization in production. That was one of Adam Smith's great insights: that specialization of labor increased productivity, and that what limited specialization, and therefore productivity and wealth, was the ability to trade -- "the division of labor is limited by the extent of the market". Hence, the wealth of a nation could be enhanced by trade, which enabled a nation to increase specialization and productivity.

A theory of production that explains specialization is a theory of trade. A theory of trade is a theory that explains production specialization.

Heckscher-Ohlin is a name cavalierly given to a whole class of general equilibrium models of trade. The simplest H-O model is one, where specialization and trade is explained by relative factor abundance: a capital-abundant country will specialize in producing capital-intensive goods and trade with a labor-abundant country, specializing in labor-intensive goods. This aligns nicely with Ricardo's argument for trade on the basis of comparative advantage. It derives from an analysis of production that asserts that (maximum/maximized) output is a function of inputs, where the ratio of inputs can be varied, and efficiency is defined as minimizing input cost relative to the value of output.

There are lots of variations and elaborations to H-O and Stolper-Samuelson, but they are the conventional framework for parsing what drives trades and for parsing the benefit distribution.

I don't think Krugman is at all subtle about the fact that he is puzzled by the evolving pattern of trade that he sees. China -- and if there can possibly be a more labor abundant country, no one has discovered it -- is apparently specializing in producing capital-intensive products and exporting them to capital-abundant countries (i.e. the U.S.). Krugman is acknowledging the puzzle, but also asserting, I think, true faith in the paradigm -- that is, he remains committed to the idea that H-O can be rescued; if the old "capital-intensive" and "labor-intensive" do not quite cut it, maybe "skill-intensive" can be introduced to make sense of more finely-grained data, when we have that data.

Krugman's determination to sustain the existing paradigm would warm Thomas Kuhn's heart, I'm sure. It is exactly what Kuhn wrote about: the careful and meticulous elaboration of orthodox theory, solving puzzles, which is the ordinary business of science.

I, personally, find it exasperating.

H-O was never a particularly good model for explaining the pattern of actual trade patterns. Shipping commodities from places, with special endowments -- oil from Saudia Arabia, for example -- never needed much elaborate theoretical explanation. And, trade among fully-developed industrialized countries, did not need the explanatory power of capital-intensive vs. labor-intensive, so much as it needed an explanation for why the U.S. and Canada, or Germany and France, could develop a huge trade in automobiles and automotive parts, which flowed in both directions simultaneously (hence, my reference to intra-industry trade, which ought to be a puzzle, if your explanatory apparatus is H-O).

Back in the 1960's, the textbooks would point to how developing countries specialized in textiles and clothing -- supposedly labor-intensive goods. Points for H-O. And, the students would ask, how come the U.S. can export cheap denim clothing (Levi's)?

Back in the 1970's, as the Japanese rose to international dominance in automobiles and a number of other industries, people marvelled at the success of their industrial policy of well-managed protectionism and promotion of industrial quality-control. The very young Krugman became the prophet of the New Trade Theory, puzzling over such "fact" challenges to conventional notions of what should drive success in international trade.

In the late 1970's, I was an expert on the economics of the automobile industry, and I never forgot the insights I gained at that time, into what drives industrial competitiveness, efficiency and productivity. One thing I learned is that the production function is a lousy theory of production -- output is not a function of inputs. Management and organization matter . . . a lot! Financial capital may be fungible, but embodied capital is a sunk cost. And, the idea that there can be some important, continuous trade-off between capital and labor inputs in production is just nonsense. It is nonsense, because there can be technical efficiency gains from sunk cost capital investments, which increase total factor productivity so much that labor-intensive methods are eliminated completely from the realm of possibility.

As automotive production technology advanced, labor-intensive methods for building cars were just eliminated completely from the realm of possibility. Even a Rolls-Royce used the same automatic transmission as a Chevy. The Japanese figured out that the sunk cost investments necessary to advance a production technology could be made strategically, and used strategic investments to advantage themselves in international trade.

As manufacturing technologies, in general, have advanced, labor-intensity has declined to the vanishing point. A $1000 Maytag automatic washing machine might have an hour or two of direct labor in its make-up. Big deal! Whether Maytag pays $70 for that hour in Michigan, or $20 for that hour in China is not very important to the decision about where to locate the plant.

There is some sense behind the observation that many have made, that Ohio's problems are not entirely a matter of "exporting jobs". Manufacturing, in general, has been on a secular path toward eliminating direct labor for 70 years, and has been reaching the logical extreme of that trend. So, manufacturing in Ohio would have been shedding traditional industrial jobs, based just on technological trends.

But, it is not either/or. Trade and production are not an either/or. The pattern of trade is the pattern of production; the gains of trade are gains in productivity. You have to understand one to understand the other.

H-O is a bad theory of trade. It doesn't fit the facts, and never did, because it is derived from a bad theory of production, which does not account properly for technical or managerial (as opposed to allocative) efficiency.

End of rant.

[anne]

Bruce Wilder:

"Where's the analytical weakness?

"It is in a theory of trade, derived from a theory of prouction, which is a falsehood. Allocative efficiency is not the dominating consideration in organizing manufacturing (or services)."

Then, either allocative efficiency needs to be promoted and protected or evidence shown for an alternative prevailing model and compensation planned. Paul Krugman is thinking carefully through the standard model.

[save_the_rustbelt]

the problem of factory workers in selected areas of the middle west are quite important, but attributing them to trade that has been at all unfair is simply not proven.

Well here in the rustbelt we know which factories closed and where the jobs went, and we are fairly certain the issue is unfair trade, especially vis-a-vis China.

We know who is drowning and why even if the politicians and intellectuals haven't figured it out yet, sorta like NOLA after Katrina.

[hari]

@ Bruce Wilder -

Thanks for the insight from automotive industry.

It's fundamental to understand factor trade to guage what PK is trying to do with wages and external trade. For too long trade economists have been hooked on to H-O while factor endowments are changing globally in terms of comparative advantage. They need new tools to explain it.

My personal view is that they're trying to fit trade data to explain their preconceived notion of what is happening.
This, I suggest, is basically (intellectualy!) false. It won't get us to understand the underlying production factors, including intra-industry trade and specialization.

[anne]

"We know who is drowning and why even if the politicians and intellectuals haven't figured it out yet...."

What is important, always important, is to blame intellectuals. Please point to which intellectuals have not figured out what. Please point to which politicians are responsible say for an absence of universal health care that could have been assisting the American auto industry for decades; which politicians prevented the application of efficiency standards that might have given us a Prius from General Motors or Ford?

Which intellectuals are ignoring the need for infrastructure development and edcuation emphasi? in the middle west.

Which intellectuals and politicians are responsible for a $3 trillion war and occupation, where $3 trillion could have helped even workers through the middle west?

[anne]

The cost of the war in Iraq could have brought universal health care for the beset middle west, could have allowed for free tuition at middle western public colleges and universities, could have allowed for green infrastructure research and development programs designed expressly for the middle west. Evidently though there is never a connection made between the costs of war and occupation and social costs, and the blame for problems in the middle west must be set before terrible horrible intellectuals.

[save_the_rustbelt]

Please point to which intellectuals have not figured out what.

One of the brightest economists on the planet is only now discovering that increased unfair trade hurts wages of blue collar workers.

Vacation in Detroit, very enlightening. Great museum and hockey this time of year.

[paine]

optimal market size
leads to optimal location and unit scale of production

these barter like ratios
derived from techical and demand drivers
beyond the distortions and interuptions
of crude border effects
like quotas and other "real"barriers
and even putting aside
he distortions of relative price found under tariff regimes
location optimizers
have further deflectors

manipulated final prices
or cost prices can be used to locate production
just about anywhere
policy likes best

profit max
has its agenda
and it often clashes with real productivity max

example
whole price levels are raised and lowered
by forex policy targets
to locate production where it otherwise would not be located

[rh]

Bruce Wilder on mfg technology:

"As manufacturing technologies, in general, have advanced, labor-intensity has declined to the vanishing point."

and

"Manufacturing, in general, has been on a secular path toward eliminating direct labor for 70 years, and has been reaching the logical extreme of that trend."

Excellent points. Certainly fits with the data (admittedly imperfect) that even China's manufacturing employment is not much larger today than it was in the mid-1990s. And this for the country which is one of the top mfg. workshops of the world.

[Prasad Rao]

Prof. Krugman,

'Trade and Wages: Reconsidered' seems timely now that a Democrat seems quite likely to move in to the White House. Obama has already staked out a more 'pro-active', protectionist policy stance. Elsewhere though, many developing countries are progressively loosening their trade barriers as part of a multi-year commitment to bring down tariffs and non-tariff barriers. As to what happens to manufacturing wages depends as much on how much unions cooperate with capitalists as on the President's policies on immigration and minimum wage. In the US, much of the 'low fruit' from automation has already been pulled away, leaving behind meager pickings. Thus wages are being squeezed by labor-saving scale effects and automation from the top (and by the minimum wage law from the bottom). This leaves the manufacturing unions in a piquant situation in which they dare not demand too much lest firms leaves town.

Some of the wage data could reflect the 'after-shocks' of, for want of a better word, 'self-imports' by MNCs that have set shop in low-wage countries and import the manufactures for sale in the US. Thus, to the extent that past changes in policy regime at home and in low wage countries - in particular labor laws, safety and capital flow regulations - have not yet fully played out (remember the adjustment cost theory in investment economics), there may yet be residual impacts on employment and wages in the US manufacturing industry.

It seems to me that we are in the midst of a shift to a more 'diversified' trade pattern than in the past. With the advent of more conducive foreign investment policies, export of technology by MNCs to such countries has resulted in hitherto raw material and primary goods exporting nations to penetrate the manufactured goods sector too. In particular, the larger of the previously developing nations are now competitive against the US in exporting to smaller developing nations, especially in Africa, the Mid-East and South-East Asia. What impact does this have on wages in the US? Clearly, the rise of competitors to US manufacturing exports will exert pressure on costs, though the incidence of those pressures on the various factors of production is perhaps variable across industries.

And now to some preaching:

An important 'corollary impact' of the influence of trade on wages is on social security. If, as I expect, manufacturing wages in the US level off or even slide down, then the problem with social security may turn more severe than has been anticipated. In a potentially recessionary environment, unions in US are perhaps well-advised to seek a mutually beneficial solution with management and, specifically, not press home any new-found influence in a Democratic administration that could hurt the manufacturing base of the US over the long run. Thus, in an environment of cooperation with capitalists, labor wages are likely to hold but the labor share of value addition likely to fall.

Freight transport is a crucial part of manufacturing imports. Increased attention is being focused on pollution and GHG emissions from shipping and if, as anticipated, freight volumes grow, then it is quite likely freight rates will increase to reflect these factors. Whether that will affect the volume, composition and pattern of trade, and in turn wages, is an open question.

And finally, one could talk about quality niches in trade of raw materials and products in relation to the prevalent environmental standards. Will Mittal produce specialty steel in Europe with high grade ore from Brazil? Or, will he pump billions for a greenfield plant in Orissa, India?

Bridge anyone?

[paine]

the point pk is making
is the location of a production
process that is spreading its web wider and wider
as transport and communication gets cheaper and faster
the import from conutry x
may have made intermediate stops in conurty y or and z
the final import may have various factor intensity stages
the location of the last stage is not a reflection of all prior stages factor endowment ratios
onlty that stages factor intensity requirements and endowment

[2slugbaits]

Bruce,

Thanks for the lengthy reply, but I'm still confused about what you're saying. While it is true that S-S does apply to factor inputs, my comment was about H-O. I went back and double-checked with a few textbooks and they all make the argument that H-O applies even if factor inputs are the same. In any event, I think Krugman's argument is that S-S did NOT apply for a long time, but might be taking hold now. In other words, Krugman agrees with you that for the most part S-S, while always in the economists' bag of tricks, did not seem to be confirmed empircally...at least until fairly recently. Krugman is arguing that the data might be coming around to confirm the theory. Or not...we just don't know yet.

Part of the problem is this phony distinction between skilled and unskilled workers. There is this assumption that producing high tech products requires high tech skills. This is bunk. There is this assumption that the only factor inputs are capital and labor. Again, this is bunk. In real factor analysis you find that sometimes factor inputs are substitutes and sometimes they are complements. There is also this assumption that manufacturing is associated with high skill. I disagree. Twenty years ago someone who knew how to manipulate VisiCalc spreadsheets would have been considered a high skill worker. Today that would be considered a low tech clerical skill.

One last point. I still don't know what you mean by intra-industry trade and why this undermines conventional factor analysis.

[2slugbaits]

paine,

If GDP is measured correctly, then only the "value added" component of the final price that was produced domestically should be counted. For example, if China exports a computer worth $2000, but $1500 of that value was created in the US through management and engineering services, then China's contribution is only $500.

[zinc]

Do I make myself clear?

Yes; stupid

[Lafayette]

Yes, methinks so

Article: "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."

It is therefore propitious perhaps that the Economist's Charlemagne article this week speaks about just such a matter by mentioning some facts from a study by Hamilton and Quinlan of John Hopkins University, in a paper titled "Globalization and Europe: Prospering in the New Whirled (sic) Order" (Centre for Tranatlantic Relations).

The article is fairly conclusive in its proposition that Global Trade has done far more good than harm to Europe. And, the consequent question arises, is it not therefore a similar case for the US? Demographically and economically, I presume that the EU and US are more alike than unalike. So, I further presume that a similar case can be made for the US as well.

The study mentions that for all the folderol about hi-tech shipping off to China, the fact remains that, for instance, in the production of an iPod, only $4 of its total (that is, production and distribution) cost remains in China. The overwhelming bulk of the total is spent in developed countries where the machine is sold. About $160 dollars goes in distribution of the product through various sales outlets worldwide.

This is probably indicative of a great many such products, including PCs. And, it doesn't start and stop with hi-tech. European companies employ 3.4 million Americans to sell their products stateside. Should America start putting up trade barriers; there go, up the chimney, a good number of American jobs.

Moreover, we must allow that lower cost prices on a great many imported goods that WalMart and other such commercial outlets sell, which Americans seem to crave, make the American earned dollar go further. Thus, there has been an added benefit to American wage earners.

In terms of sacrificing jobs, I can attest to the fact that every time a plant closes in France, it is all over the evening news with abundant interviews of employees tearfully consternated, wondering where their next job is going to come from. This fuels the present European hysteria that takes the common name "globalisation" -- the same scapegoat as in America.

The fact of the matter is that only 3.4% of all French jobs lost are due to dislocations to foreign climes. I wonder if it is not about the same in the US. The worst case scenario, in Europe, is that of Portugal where fully a quarter of jobs were lost abroad, but mostly to new EU-member countries.

That still accounts for around 10% of jobs that went even further East. Of course, 10% is not all that much ... unless, however, it was MY job . Which makes it altogether another matter, doesn't it.

Like America, Europe has and is shedding manufacturing jobs, typical the lower-skilled variety, for those created in services. In fact, EU economies in the past decade have created 18 million more jobs than they may have lost.

Within this present brouhaha, maybe anti-NAFTA Americans are barking up the wrong tree? Yes, methinks so.

But, 'tis the presidential primary season, isn't it. One is liable to hear many a zany notion.

[dissent]

the fact remains that, for instance, in the production of an iPod, only $4 of its total (that is, production and distribution) cost remains in China. The overwhelming bulk of the total is spent in developed countries where the machine is sold. About $160 dollars goes in distribution of the product through various sales outlets worldwide.

It's not enough look at the cost. You need to look at something I'll call 'employment density' in relation to cost. What is happening is that aspects of the production process that have greater 'employment density' are being offshored. Those are the aspects of production for which a low wage makes offshoring attractive. That means that while it is true that American firms are maintaining a very high share of total cost, they are doing that with many fewer workers. Right there you have a cause of soaring inequality and insecure employment in the west.

Obviously our problem as been not lack of growth, but where the return from increasing productivity is going: to management, to ceo's, to profits, not workers.

It's clear. The failure of western wages to keep pace with productivity increases is not a bug: it's a feature, designed into the system.

[dissent]

I'm interested in the case of trade within Europe, and the influence of the EU. It seems to me that on the whole this offers is a far better case for trade than the case of America trading with the less developed world. The difference is that while there is a wage difference between e.g. Rumania and France, it is not as overwhelming as the difference between China and the USA. Also there are comparable environmental standards and compatible legal systems. All this fundamentally changes the trade calculus, so that instead of a 'race to the bottom' devastating the working people of France, Germany, etc, you have a system with dislocations mitigated by social welfare and overall growth.

It would be useful to compare the increase in pollution and global warming gases attributible to development in China with corresponding increases in the EU, scaled to adjust for differences in absolute growth of course.

Obviously you would find that development in China was vastly more destructive for the environment than development in the EU.

I think this goes to show that open trade between countries/blocs that have vastly different wages, legal systems, and environmental systems should not be regarded as a good thing. It should in fact be carefully controlled and monitored.

[Bruce Wilder]

2slugbaits: "I went back and double-checked with a few textbooks and they all make the argument that H-O applies even if factor inputs are the same."

Classic H-O assumes that the technology is the same across countries (though the technology for the two commodities produced must differ), and returns to scale are constant, so that if either country chose to use labor and capital in a particular ratio to produce either commodity, factor productivity would be the same across countries. It is, therefore, differences in relative factor abundance across countries, (interacting with the differing factor requirements of the two production techologies associated with the two tradeable goods), which explains the pattern of trade.

Stolper-Samuelson is about what happens to the prices (incomes) of the factors in the two countries, as they specialize, trade and reach an equilibrium in a H-O world.

Wikipedia covers this, in brief.

In strict, classic H-O, if two countries sharing the same (constant-returns-to-scale) technology had identical factor endowments, they would not trade, because there would be no gains from trade. (H-O also requires that the production technologies for tradeable goods differ across goods, in their input requirements.)

Now constant returns to scale is not something we observe much of, and rather obviously, economies of scale can be a very good reason to specialize and trade, even if factor endowments and technology are the same. (Economies of scale are the primary explanation for U.S.-Canada auto trade.)

Economies of scale, although rather obvious, can pose a challenge to theorists, because unexhausted increasing returns to scale bar a market equilibrium price. So, it can be hard to get a nice, neat, robust theorem to prove out.

Krugman made his reputation as a theorist working on the implications of increasing returns and other "special cases". Such "special cases" (external economies, network effects, etc.) is what intermediate and advanced trade theory consists of.

The trouble with these "special cases" is that they do not seem to theorists to have the robust generality of simpler models. They make the pattern of trade look like the outcome of happy accidents. "Motor City" Detroit, Hollywood, Silicon Valley -- such instances of highly productive, highly remunerative specialization all seem to be accidental "special cases", just as 'accidental' in their way as the fact that Saudi Arabia has oil.

The welfare implications of trade in Stolper-Samuelson are the welfare implications of a pattern of trade dictated by factor abundance. If trade arises from the reasons H-O says it does, then S-S follows, as a reasonable model of how the benefits of trade will be distributed in prices and rents.

The empirical evidence on trade is heavily, heavily weighted toward the view that H-O is not a good explanation for the pattern of international trade.

My soapbox objection to H-O is not empirical, though. I object to the underlying theory that output is a function of factor inputs. It is a wrong theory of production, that leads to a wrong theory of trade, imho.

Krugman wants to use Stolper-Samuelson to evaluate the welfare implications of increasing trade. But, to do that he has to classify the winners and losers by criteria that make sense in an H-O world, which is to say, criteria that make no sense at all: "skill-intensive"! What the hell is that? (Which point about loose talk of "skills", I think, 2slugbaits, you were making earlier.)

[Bruce Wilder]

My soapbox objection to the production function as a theory of production is pretty easy to understand, I think, by the simple expedient of an earnest thought experiment.

Imagine making and baking bread -- obviously a production process involving a well-known technology.

Is your output a function of factor inputs? Not ingredients -- flour, eggs, yeast -- mind you. But, factor inputs -- your time and effort (labor) and the use of your oven (capital). Is it?

If you drop an egg on the floor? Spill some flour. What do you make of that, in your theory? Waste time re-reading the recipe? Looking for a measuring spoon?

And, that oven, which mostly sits idle in your kitchen? How do allocate a capital input from your oven to a loaf of bread?

The theory of the production function is that "maximum" output is a function of inputs, because, obviously, you can always produce less output with given inputs. But, it is really hard to think of what "maximum" could be made to mean. What's the most bread, you and your oven could produce over the course of, say, a week? Is that even a sensible question?

Common intuition ought to suggest that management and organization count for something, that isn't quite taken care of, by simply assuming "maximum" output.

And, capital embodied as tools and equipment and training tends to become a fixed or sunk cost, without unit marginal implications. Capital also embodies organization, which reduces error and waste, increasing total factor productivity.

In practice, we might be forgiven for confusing economies of scale with economies of experience and learning with the economies of organization and management: in the end, we make more bread, fewer mistakes, can utilize more special gadgets to help, and make more intense use of the oven.

I think capital embodied in tools, equipment, methods, tends to become a fixed, even a sunk cost, not a continuously variable unit input. And, I think as a production technology is developed, capital tends to embody the technology and organization, and as such, some of the gain to capital investment is a reduction in error and waste, which is an absolute gain in total factor productivity.

The kind of easy switching between labor-intensive and capital-intensive technologies, contemplated in H-O, is simply not possible, given the actual nature of production organization and its evolution over time. Over time, investment in advancing technology tends to mean that the "capital-intensive" form dominates. Because of the gains in total factor productivity from eliminating waste and error, the supposedly "capital-intensive" path will eventually use less of all factors for a given output. Dominance. The "quality" of "labor-intensive" products becomes unacceptable for trade.

To use the automotive example, a lot of people think an auto assembly plant is "capital-intensive" because the plant is so huge, or "labor-intensive" because so many people can be employed in a plant on a single shift. But, on a unit output basis, neither is true. Full assembly of a car can require less than 10 person-hours of work in an assembly plant, and the capital expended per auto produced is similarly small, because such intense use of the equipment is achieved. A couple of guys assembling a car in a garage would end up requiring more labor and more capital to produce one car.

I fear Krugman is going to come back from his abstract models with a conceptual vocabulary, which makes no sense, when applied to Ohio.

[2slugbaits]

Bruce,

"In strict, classic H-O, if two countries sharing the same (constant-returns-to-scale) technology had identical factor endowments, they would not trade, because there would be no gains from trade."

Well, the constant returns to scale assumption is important, because they will trade if that's not true. And as I said, my textbooks say that they would also trade if there is a difference in tastes between the countries. For example: "...even if two nations have exactly the same factor endowments and technology (and this identical production possibility curves), a difference in tastes can be the basis for mutually advantageous trade." I can remember having to work the proofs for that as well.

"The empirical evidence on trade is heavily, heavily weighted toward the view that H-O is not a good explanation for the pattern of international trade."

Again, I think Krugman agrees with you. Isn't PK's point that up until recently we could be fairly confident that the H-O and S-S did not predict very well. The point of his latest paper is that maybe we need to revisit the issue because what S-S predicts might be happening.

"I object to the underlying theory that output is a function of factor inputs. It is a wrong theory of production, that leads to a wrong theory of trade, imho."

This is really an attack against the crux of microeconomics. While I'll grant you that businesses don't usually work off of actual production functions, but they do use its "dual" in the form of cost functions. The harder issue is identifying the relevant inputs. Simplifying to some two input Cobb-Douglas function probably doesn't cut it; but that doesn't mean production functions (or cost functions) are useless.

[Lafayette]

New Skill-sets for a New Millennium Economy

dissent: That means that while it is true that American firms are maintaining a very high share of total cost, they are doing that with many fewer workers.

Only if the employment density lost in manufacturing were not balanced by employment density elsewhere being created. This has been the case in Europe. My comment suggests it is the same for the US. (Bearing some good research into the matter to prove / disprove it.)

Is job creation not happening in the US? Then ask yourself why. And, you will have put your finger on not only the problem but its solution.

It is useless to rail about jobs being lost overseas. The Schumpeterian process of Creative Destruction was identified a long time ago and it is happening presently in the US (and other developed Western economies). Look at how jobs are created, make an effort to create them. It will likely require some effort by central authorities and most probably revolves around New Skill-sets for a New Millennium Economy. We have been lax in not recognizing the challenge and our school system needs reformation and (human capital) resource investment.

These skill-sets are neither grown overnight nor do Markets prompt them spontaneously. They take time and persistent application to be nurtured.

Whatever, accept fate. The jobs that have gone are not coming back. And, all the bandwidth wasted in this Forum, or costly media time on the presidential campaign trail, lamenting that fact will not change it one iota.

All the Happpy Face candidates have to tell us is that they are going to "fix NAFTA", when "fixing NAFTA" is NOT THE SOLUTION.

The King is wearing no clothes. The collective reaction to the media hype, at a time when US unemployment has increased due to reasons having very little to do with the stated cause, is wasted energy.

The benefits of such Global Trade have been, on the whole, a benefit for most Americans. Wake up. You are now part of something bigger, called a Global Economy.

Get used to it. Settle in. Profit from it.

[Bruce Wilder]

2sb: "I'll grant you that businesses don't usually work off of actual production functions, but they do use its "dual" in the form of cost functions. The harder issue is identifying the relevant inputs."

No, and no. Businesses are structured, not to maximize constrained output or minimize costs, but to manage and control production/distribution processes in a way that yields rents on some factors -- real businesses are not profit-maximizers, they are rent-seekers. The hard issue is identifying the elements of production organization, which do not receive income (as a factor, by definition, does), but do create regularity and structure in the face of uncertainty, attenuating risk and capturing and channelling rents -- in other words, the key is identifying the control rationale or scheme.

2sb: "Isn't PK's point that up until recently we could be fairly confident that the H-O and S-S did not predict very well. The point of his latest paper is that maybe we need to revisit the issue because what S-S predicts might be happening."

Apparently, that is his point. My point is that his behavior qualifies as insane: repeating the same behavior, expecting a different result.

He sees trade apparently hurting some large numbers of people, and he has an abstract model, where trade hurts the income (prices, rents) of a class of factors, in a world where relative factor abundance drives production location choices and trade. Since Leontief, no one has ever seen factor abundance driving the dynamics of production location and trade, but Krugman thinks, if he just looks deeper, at more finely grained data, he will find that it does.

I'm sorry, but I live in a world, where capital investment is a strategic choice, and so does Krugman. He needs to wake up.

Capital investment in production processes embodies advancing technology. The relative abundance of capital is not a given, which we optimize in stasis. Capital investment is part of the dynamic of advancing a production process control regime, of, for example, exploiting economies of learning or increasing returns to scale.

The ability to capture returns on sunk cost investment channels sunk cost investment into places and structures, where returns can be captured.

China has become workshop of the world, by reducing the financial risk of investment in manufacturing plant, by reducing the costs of such investments and by making it easy to capture rent returns on such investments.

Ohio is screwed, because the capital stock per worker is diminishing, as plant and capital stock becomes obsolete and is not renewed by investment. It is not because there's some class of low "skill-intensive" worker, hurt because labor abundance in China is attracting low skill-intensive production processes. That kind of muddled thinking, which Krugman appears to be planning, is not going to help us think clearly and productively about a strategic industrial policy.

[hari]

Thanks Bruce Wilder for a cogent argument that i've been trying to make with PK initial draft paper.

It's fundamental to recognize that technology is driving trade and... globalization with it.

[Mayson Lancaster]

Bruce Wilder's excellent comments on production processes as key reminds me of an example from World War II that Peter Drucker wrote about.

One major technical advance in that war was in bombsights. Both Germany and the US developed ones which allowed much more accurate bombing. However, the German one, developed (IIRC) by Zeiss, required assembly by trained optics technicians, while the US one, the Norden bombsight, was assemblable by anybody, after a few weeks of training. Drucker mentions that the labor force empoyed by GM for its production consisted mainly of "superannuated Negro prostitutes" - those constituting the only major un- or underemplyed class of workers in Detroit at the time.

The Norden bombsight was produced in large numbers, the Zeiss bombsight in trivial numbers.

Yes, production processes and their organization make major differences in competitive advantage between countries and companies.

Also: re jobs lost in Michigan and Ohio - many of them have moved to plants in Alabama and Tennessee, or in the case of designers, to southern California.

[EE]

""As manufacturing technologies, in general, have advanced, labor-intensity has declined to the vanishing point."

and

"Manufacturing, in general, has been on a secular path toward eliminating direct labor for 70 years, and has been reaching the logical extreme of that trend."

"

Seriously,

Enough with the automation comments.

Are the factories in China heavily automated? Or are they staffed with so many $0.41/hr workers from the countryside that Automation is moot.

Automation was intended to reduce the cost of production of goods. It achieves this at great investment expense. A large supply of labor that needs little training is FAR cheaper, FAR FAR cheaper than automation.

If automation was the culprit,

WHERE ARE THE HEAVILY AUTOMATED FACTORIES MANNED BY ONLY 5 PEOPLE IN THE UNITED STATES OR CHINA, OR ANYWHERE?

The answer is that what we have now is not Free Trade. We have Free Capital mobility--where it is free to earn the highest return on investment, and it is doing so nicely.

More education? If this was the case newspaper ads would be flooded with job openings demanding Master's Degrees, PHD,s or other professional certifications.

Open up THE EMPLOYMENT SECTION OF THE NYT. That is the market. That is reality--not theory, that is the reality of the job market. If you think your industry is getting obsolete, and you dont want to move, and you think going back to school is the only way----Look up the jobs you would be qualified to apply for with that nice shiny new grad degree FIRST.

The job market drives education beyond highschool--that is the market at work.

[Lafayette]

Unskilled labor priced itself out of the market

EE: WHERE ARE THE HEAVILY AUTOMATED FACTORIES MANNED BY ONLY 5 PEOPLE IN THE UNITED STATES OR CHINA, OR ANYWHERE?

They exist, but you have to look for them. Particularly in semi-conductor manufacturing.

The point is this: A great deal of the base manufacturing (nuts, bolts, components) and assembly production (transformation) that requires heavy labor content has fled. It can return if investments were made in automated production. That will only occur if the tax break in amortized cost is accelerated. Such makes the investment cost more interesting.

Then, the jobs listing in the NYT will be for Manufacturing Process Control Managers -- which will require at least basic training (two years, including apprenticeship) or entry-level job for some enterprising young engineer who wants to learn from the bottom up.

What is happening in manufacturing is inexorable. Go to the once heartland of the American plastics industry that was creating jobs in the postwar years up to the late 1970s. Then, it all gradually declined. The jobs first went south, then further south and have now ended up in China.

Why? Because plastics lost its hi-tech sheen and become one of inexpensive but nimble fingers fitting parts together into a whole (product) and placing it into a box for shipment. Meaning this: Unskilled labor priced itself out of the market.

PS: Worse yet. The migration posited above has not ended. The Chinese are already scouring Africa to seek the right places for installing textile manufacturing plants. And the Africans are schmoozing the Chinese in fervent hopes of getting just such FDI. Had America and Europe, two decades ago, taken that trek to Africa, they would still own the Textile Industry -- which is not the case today, is it.

[Bruce Wilder]

EE:

Are the factories in China heavily automated? Or are they staffed with so many $0.41/hr workers from the countryside that Automation is moot.

Automation was intended to reduce the cost of production of goods. It achieves this at great investment expense. A large supply of labor that needs little training is FAR cheaper, FAR FAR cheaper than automation.

You pose this, as a stark, empirical question. Congratulations on that.

The new factories in China, producing for export, are highly "automated" (a word, I consciously did not use, in my earlier comments).

Much of the Chinese economy, the old State communes and the infrastructure, is, of course, a mess. But, the export sector is, as you would say, "highly automated". (That's not to say that building these factories, or the roads to the factories, or the electrical grid, or any number of other ancillary activities are not labor intensive and backward.)

"Automation", or the designing of machines to do work, has been at the heart of the industrial revolution, since Watt worked on his steam engine. Two primary things are being accomplished, as production technologies advance:
1.) Energy is being applied and leveraged to do work, beyond what a human animal could supply;
2.) Finer control of production processes reduces waste and error.
The allocation of labor v. capital resources is incidental.

Specialization works to increase productivity, primarily because it promotes better and better control of the production process. Capital investment, dynamically, promotes and embodies advances in control, through the application of scientific knowledge and changes in social organization.

[Lafayette]

BW: Specialization works to increase productivity, primarily because it promotes better and better control of the production process. Capital investment, dynamically, promotes and embodies advances in control, through the application of scientific knowledge and changes in social organization.

Quite right. That holds in China as well.

Let's not diminish the Chinese. I am not implying that anyone has in this forum. But, the fact that they have been eating our lunch lately has bent a great many people out of shape.

For a culture that is 5000 years old, to have come back from the pits of brutal Communism since the late 1970s is nothing less than remarkable.

They deserve the credit they merit, even if they are a long way from being a truly democratic country. But, as regards democracy no one is perfect. Not even Uncle Sam.

At least the Chinese (that is, Deng Xiaoping) realized that they had got it wrong, both agriculturally and industrially. And, they set about to correct it. We've got some lessons to learn, there, regarding our vaunted pragmatism.