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Thursday, May 01, 2008

"How Big a Deal is Trade?"

A recent article in The Economist states:

Krugman's conundrum, The Economist: "This paper is the manifestation of a guilty conscience." With those words, Paul Krugman began the recent presentation of his new study of trade and wages at the Brookings Institution. Mr Krugman ... had concluded in a 1995 Brookings paper that trade with poor countries played only a small role in America's rising wage inequality... Mr Krugman's paper convinced economists that trade was a bit-part player in causing inequality. Other factors, particularly technological innovation..., were much more important.  ...

In recent years ... the issue has returned. ...Mr Krugman has become more sceptical. “It's no longer safe to assert that trade's impact on the income distribution in wealthy countries is fairly minor,” he wrote on the VoxEU blog last year. “There's a good case that it is big and getting bigger.” .... His new paper set out to substantiate these assertions.

That proved hard. ... If you simply update the approach used in Mr Krugman's 1995 paper to take into account today's trade patterns, you find that the effect on wages has increased. Josh Bivens, of the Economic Policy Institute, a Washington, DC, think-tank, did just that and found that trade widened wage inequality between skilled and unskilled workers by 6.9% in 2006 and 4.8% in 1995. But even with that increase, trade is still far from being the main cause of wage inequality. Lawrence Katz, a Harvard economist who discussed Mr Krugman's paper at Brookings, estimates that, using Mr Bivens's approach, trade with poor countries can account for about 15% of the growth in the wage gap between skilled and unskilled workers since 1979. ...

While the New York Times says:

There is also no question that life for many American workers has gotten tougher since the 1970s. Paychecks have failed to keep pace with productivity as most of the spoils of growth have gone to a tiny elite.

Still, critics’ charges that trade is to blame are misguided. While trade can hurt some workers, most economists believe it plays a modest role compared with other forces in the economy, including advances in technology, the decline of trade unions and mushrooming executive pay. ...

No matter how hard economists look for trade’s fingerprints on these inequities, they find it plays only a bit part. Josh Bivens of the Economic Policy Institute estimated that rising trade with poor countries increased wage inequality between college and high school graduates by about 7 percent over the past quarter-century — but the wage gap has widened by more than six times that amount over that period. And many economists think Mr. Bivens overstates trade’s impact. Robert Lawrence of Harvard, who was an adviser to President Bill Clinton, concluded that the increase in wage inequality since the 1990s had little to do with trade. ...

Josh Bivens would like a chance to set the record straight:

How Big a Deal is Trade?, by Josh Bivens: The campaign to exonerate trade from any role in pressuring American living standards proceeded this weekend with a Sunday editorial in the New York Times. This time, my own research was dragooned into service.

This is the second time in recent weeks this research was referenced in media outlets, and, in both cases the writers claimed that what it showed was that trade's contribution to the wage problems of American workers just isn't that big a deal.

The method for arguing a de minimus effect of trade is tried and true: scale trade's impact against the sum total of all influences that have wedged wages apart in the US economy since the late 1970s. This total rise in wage inequality has been so large, and, its causes so varied, that any single influence looks pretty small when scaled against it.

In my paper referenced by the Economist and the New York Times, I explicitly refused to make this (misleading in my mind) calculation. Instead, I translated trade's impact into dollars lost per year by workers on the losing end of trade - those without a 4-year college degree.

While I continue to maintain this calculation has more real-world relevance, I guess it was hubris to think I could change an old chestnut in the trade debate, and, others decided to do the exercise of scaling trade's contribution to the total rise in inequality for me. Along the way, some errors of fact and interpretation have been made, so, I'll try to correct them here.

First, we need to agree on two things: (1) the relevant time-period to look at, and, (2) the total rise in the metric of inequality we're arguing about.

1979 is a popular year to start from, mostly because it is the high-point of wage equality in the last generation. However, a little-known fact is that the importance of trade in the US economy actually grew faster in the 1970s than the 1980s. Starting from 1979 implicitly says that the damage trade had inflicted on wages by then should be totally discounted.

1973 is a better choice for a starting year. It is the year that the Bretton Woods system finally disintegrated and the US exchange rate began to float, it is a business cycle peak, and, it is the year that sees imports from low-wage nations begin register in their importance to the broad US economy.

A popular metric of inequality is the wage of college graduates relative to non-graduates. Below I'm pasting the relevant wage measures for this comparison. The upshot is that this relative wage has risen by just under 20% since 1973.

It feels strange for an avowed inequality pessimist to chastise others for overestimating inequality, but, in the trade and wages debate (if nowhere else), those with a sanguine outlook on trade often inflate the total rise in inequality in an effort to make trade's contribution look small.

The New York Times, for example, wrote that wage inequality rose "six times as much" as my estimate of trade's contribution. This is flat-wrong - nobody thinks the relative wage of graduates has risen by 42% over any stretch of time in the past 50 years. I'm not sure how they got this wrong, but, there are some common errors people make in this debate.

Sometimes people reference the percentage point change in the relative wage of college graduates between 1973 and 2007 was around thirty (still not 42, but, closer). However, this relative wage didn't start from 100, so, the percent change in the relative wage was less (both percentage point and percent changes are shown below). My 7% number is a percent change, and, in percentage point terms would be closer to 11.

If one accepts 1973 as the starting point, and, accepts the correct numbers on the rise in the relative wage of college graduates, this implies that my research shows that trade has contributed roughly a third of the entire increase in this measure of inequality. No, international trade flows don't dominate all other sources of wage growth and/or decline in the American economy, but, their impact just isn't trivial.


I still submit that this "share of inequality" metric is a profoundly misleading benchmark, useful only for minimizing the impact of trade (or, actually, any other single influence upon wage inequality). The 7% swing in relative wages translates into more than a $1,000 cut in annual earnings for these workers, about double the wage-loss they experienced due to the last recession. And, unlike wage losses stemming from movements in the business cycle, those stemming from trade are permanent, and, promise only to grow.

    Posted by on Thursday, May 1, 2008 at 02:07 AM in Economics, Income Distribution, International Trade | Permalink  TrackBack (0)  Comments (98)



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