The China (and India) Syndrome

Many progressive Canadian economists have noted recently that the share of GDP going to wages and salaries has dropped perilously low, as low as recorded statistics take us back in any event. This article from the Economist, via Mark Thoma’s Economist’s View, points out that this trend is not particular to Canada. They suggest that this is globalization at work, namely the integration of China and India into the global economy, a development that has shifted the terrain in favour of capital. Their solution: countries need to redistribute the gains through the tax and transfer system, else risk falling political support for globalization.

Avoiding Protectionism

The Economist is running a series this week on what the emergence of China, India and other developing countries means for developed countries. This article in the series examines the problems arising from globalization, the potential causes of those problems, and how to avoid a resurgence of protectionism in response:

More pain than gain, The Economist: Rich countries have democratic governments, so continued support for globalisation will depend on how prosperous the average worker feels. Yet workers’ share of the cake in rich countries is now the smallest it has been for at least three decades (see chart 5). In many countries average real wages are flat or even falling.

Meanwhile, capitalists have rarely had it so good. In America, Japan and the euro area, profits as a share of GDP are at or near all-time highs (see chart 6). …

[T]he redistribution of income from labour to capital can be largely explained by the entry of China, India and other emerging economies into world markets. Globalisation has lifted profits relative to wages in several ways. First, offshoring to low-wage countries has reduced firms’ costs. Second, employers’ ability to shift production, whether or not they take advantage of it, has curbed the bargaining power of workers in rich countries. … And third, increased immigration has depressed wages in sectors such as catering, farming and construction. …

Most of the fears about emerging economies focus on jobs being lost to low-cost foreign competitors. But the real threat is to wages, not jobs. … So long as labour markets are flexible, job losses in manufacturing should eventually be offset by new jobs elsewhere. But trade with emerging economies can have a big impact on both average and relative wages. …

Thus the usual argument in favour of globalisation—that it will make most workers better off, with only a few low-skilled ones losing out—has not so far been borne out by the facts. Most workers are being squeezed.

If GDP per person is growing fairly briskly, why are most workers missing out on real pay rises? Partly because a bigger share is going to profits, and partly because high earners have pocketed a huge slice of the gains in income, causing inequality to widen. …

It’s all comparative

Traditional trade theory, based on the ideas of David Ricardo, … argues that economies gain from trade by specialising in products where they have a comparative advantage. Developed economies have lots of skilled workers, whereas emerging economies have lots of low-skilled ones, so according to the theory advanced countries will specialise in capital-intensive products requiring skilled labour and emerging economies in low-tech products. Competition from cheaper imports will reduce the wages of unskilled workers in developed economies, but workers as a whole will be better off.

Yet, … the average worker does not seem to be enjoying his fair share of the fruits of economic prosperity. Richard Freeman, an economist at Harvard University, points to several reasons why the traditional theory may need modifying.

The first is that the sheer size of the emerging giants’ labour forces has shifted the global capital-labour ratio (which determines the relative rewards of capital and workers) massively against workers as a group. …. According to economic theory, this should reduce the relative price of labour and raise the global return to capital—which is exactly what has happened.

Over time, competition should reduce profit margins and distribute benefits back to consumers and workers in the form of lower prices. But downward pressure on wages in rich countries could continue for a long time….

A second reason why the traditional trade model needs modifying has to do with a rise in emerging countries’ skill levels. It used to be thought that only rich countries had educated workforces able to produce skill-intensive goods, but poor countries have invested heavily in education in recent years, allowing them to start competing in more sophisticated markets … In 1970 America accounted for 30% of all university enrolments worldwide; now its share is down to around 12%. …

A third flaw in the traditional trade model, says Mr Freeman, is its assumption that rich countries would make high-tech products and developing economies low-tech ones. In fact, rich countries no longer have a monopoly on high-tech capital and know-how. … As emerging economies start to export high-tech goods and services, this reduces the prices of such products in world markets, and hence the wages of skilled workers in the developed world.

…[G]lobalisation is benefiting America’s economy… But in practice the average family has not seen such a gain because much of it has gone to those at the top or into profits. This explains the lack of support for globalisation from ordinary people. Unless a solution is found to sluggish real wages and rising inequality, there is a serious risk of a protectionist backlash. Rather than block change, governments need to ease the pain it inflicts in various ways: with a temporary social safety-net for those who lose their jobs; better education to equip workers for tomorrow’s jobs; and more flexible labour markets to encourage the creation of new jobs.

More controversially, governments may need to redistribute the benefits of globalisation more fairly through the tax and benefits system. Studies suggest that countries with more generous social welfare policies are less likely to support protectionism. … In a riskier labour market, there may be a stronger case for health care to be financed by the state rather than by firms. …

It is often argued that generous social-insurance and redistribution policies are inconsistent with globalisation because in an open world governments cannot raise taxes and spending in isolation. But if real wages continue to stagnate and no compensation is forthcoming, political support for globalisation may fade and the vast gains from the biggest economic stimulus in world history will be lost.

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