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Monday, June 16, 2008

"Stolper-Samuelson for the Real World"

Dani Rodrik says that trade with other nations may not cause the wages of unskilled workers to fall as predicted by generalizations of the Stolper-Samuelson theorem. Instead, the main impact may be the losses associated with the displacement of workers as the least efficient firms are driven out of business. Here's a shortened version:

Stolper-Samuelson for the real world, by Dani Rodrik: (Warning: This is a long and wonkish entry, aiming at self-comprehension...)

The Stolper-Samuelson theorem is a remarkable theorem... But the theorem is also quite limited in its applicability. ...

But there is a version of the theorem that is remarkably general and powerful. It says that regardless of the number of goods and factors, at least one factor of production must experience a decline in real income [as a result of opening up to international trade]... All that this result requires is a very mild assumption... The stark implication is that someone will lose, even if the nation as a whole becomes richer. (Here is the proof. ...)

The theorem does not identify who exactly will lose out. The loser in question could be the wealthiest group in the land. But if the good in question is highly intensive in unskilled labor, there is a strong presumption that it is unskilled workers who will be worse off. ...

I have been thinking about this result in connection with Broda and Romalis's remarkable finding that

the rise of Chinese trade has helped reduce the relative price index of the poor by around 0.3 percentage points per year. This effect alone can offset around 30 percent of the rise in official inequality we have seen over this period.

The puzzle here, at least on the face of it, is that one would expect China's trade to have had the largest price impact on labor-intensive goods. And if so, wages of unskilled workers must have fallen even more, along the lines of the Stolper-Samuelson logic sketched out above. Can we still say that trade with China has helped reduce U.S. inequality? ...

What gives? The Auer and Fischer paper underlines another important result. What lies behind the decline in U.S. producer prices in trade-affected sectors is not wage or other input price reductions but mostly increases in total factor productivity. So perhaps what is going is that the Stolper-Samuelson logic is defeated by increases in sectoral productivity induced by import competition. The ... proof of the generalized S-S theorem ... breaks down whenever there is productivity change. After all, if TFP increases, employers can afford to pay unchanged wages even if the prices they face decline.

The next question inquiring minds will want to know is how and why this TFP improvement comes about. The available economic theory on the impact of market competition on firm-level efficiency is notoriously inconclusive and ambiguous. (Profit-maximizing firms should want to minimize costs regardless of how tough competition is.) Perhaps what is happening is a kind of industry rationalization--exit of the least efficient firms--in which case we should see this restructuring and the associated layoffs in the data as well. Moreover, labor does not exactly come out unharmed in this case either. It is after all job loss, and the threat thereof, that workers complain about.

But if this line of reasoning is correct, the main threat to workers is not a Stolper-Samuelson type permanent compression in wages, but the more temporary (and limited) wage losses incurred by displaced workers. This is the kind of problem that wage insurance is ideally suited for.

Stay tuned--if you managed to read this far...

[Note: Richard Serlin responds here.]

    Posted by on Monday, June 16, 2008 at 06:12 PM in Economics, Income Distribution, International Trade | Permalink  TrackBack (0)  Comments (20)

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