Is Globalization Good for America’s Middle Class? Part 1
by Kenneth Thomas
Is Globalization Good for America’s Middle Class? Part 1
In this blog, I have frequently documented economic trends that have been bad for the middle class: Declining real wages, steadily falling bang for the healthcare buck, stagnant educational attainment, the gigantic cost of tax havens, etc. With this post, I want to begin exploring one possible reason for the economic insecurity of the middle class, namely globalization. Today, we will look at who wins and who loses from international trade, one of the key elements of globalization.
In some circles, one is likely to see a variant of the claim that “everybody” is better off because of freer trade. Even according to the most mainstream economic theory, this is simply false. The workhorse theory for determining the distributional effects of trade (i.e., who wins and who loses) is called the Stolper-Samuelson Theorem, first enunciated in an article by Wolfgang Stolper and Paul Samuelson in 1941.
To understand this theory, you need to know that economists think about national economies in terms of the amount of land, labor, and capital they have compared to all other countries in the world. These “factors of production” can be in relatively high supply compared to the rest of the world, in which case they are referred to as “abundant,” or in relatively low supply compared to the rest of the world, in which case we call them “scarce.”
The theorem can be stated in quite simple terms, but its consequences are not at all simple: As trade expands, owners of abundant factors of production benefit, and owners of scarce factors of production are harmed. Here, “benefit” means their real income increases, while “harmed” means their real income decreases.
Remember, trade can expand for two main reasons. First technological innovations can reduce the cost of transportation, making it first possible, then cheaper, to send goods long distances. For example, political scientist Ronald Rogowski, in his great book Commerce and Coalitions shows how the introduction of the steamboat made it possible to export North American wheat to Western Europe, displacing wheat from Eastern Europe. Second, policy changes like the North American Free Trade Agreement (NAFTA) or the trade agreements embodying the World Trade Organization (WTO) reduce or eliminate costly barriers to trade and lead to its expansion.
The grain example helps show why trade creates winners and losers. The Midwest U.S. and Canadian Prairie provinces are a gigantic breadbasket made possible by low population density, which implies abundant land and scarce labor. Expanding trade gave these farmers new markets and higher incomes. In much more densely populated Europe, the reverse is true: labor is abundant and land is scarce. As a result, expanding trade in grains meant more import competition and lower income for European farmers..
Fast forward to today and we can ask what U.S. factor endowments are currently. As a rich country internationally, the United States is necessarily a capital abundant country. As a comparatively low population density country, it is land abundant but labor scarce. The answer is to our initial question is then quite clear: expanding trade is harmful to U.S. workers because imports of labor-intensive products and services from abroad create competition for American workers, reducing their real wages. As I have discussed before, U.S. real wages have remained below their peak for 39 straight years, just as the Stolper-Samuelson Theorem would predict.
What about all the cheap goods we now buy at Wal-Mart? It doesn’t change this story at all, because the lower price of imported goods is already reflected in the inflation rate we use to calculate real wages.
Rogowski’s book also argues that we can expect certain pattens of political coalitions to form, with the winners from trade on one side and the losers on the other. NAFTA illustrated this well, with capital and agriculture generally in favor of the agreement (minus a few small specialty agricultural products like oranges), while labor was strongly opposed. And of course, this only helps us understand economic reasons for support or opposition to trade agreements; for non-economic reasons such as the environment, we have to look elsewhere. Although beyond the scope of this post, Rogowski’s analysis of the entire world through phases of rising and falling trade (i.e., the Great Depression) lends strong credence to his claims. You should definitely read his book sometime.
Economists are divided over how big this effect is. In the 1990s, when I first started teaching, the most common view of economists was that technological change was the driver increasing the premium for high skilled labor while reducing wages for low-skilled labor. Adrian Wood’s 1994 book, North-South Trade, Employment, and Inequality, argued that trade was in fact the main culprit, (a good, ungated analysis is Richard Freeman’s “Are Your Wages Set in Beijing?”). Although this met with a lot of resistance at the time, Wood’s view has gained a lot of traction among economists based on developments over the last 15 or so years. Paul Krugman, a particularly noteworthy example due to his Nobel prize, has gone from being a fanatic adherent of free trade to someone who sees trade as a big problem, though even today he is not quite willing to pull the plug on free trade.
One important point Rogowski makes (and Stolper and Samuelson did before him) is that the theory of comparative advantage tells us that the winners from trade gain more than the losers lose, which makes it possible in principle to compensate the losers and have everyone be better off. But he also argued that those who benefit economically from trade will see their political power increase, something that has certainly been borne out in the United States in the more than 20 years since his book was published. This makes it less likely that such compensation will occur, and we certainly haven’t seen any policy in the U.S. that comes close to making everyone better off as a result of trade.
One small bit of comfort comes from Paul Krugman’s book The Conscience of a Liberal (pp. 262-3). He provides us some reason to think that the Stolper-Samuelson Theorem isn’t necessarily destiny, as he shows that the United State and Canada, two countries with the same factor endowments as each other, have distinctive differences in political outcomes, particularly with regard to unionization rates.
Overall, unfortunately, it looks like the answer to today’s question is clear: freer trade has harmed, and is harming, the American middle class. But globalization is more than trade, and I will continue to analyze other elements of globalization in my next few posts.
How has NAFTA affected Mexico? Thanks. 🙂
How has NAFTA affected Mexico? Thanks. 🙂
How has NAFTA affected Mexico? Thanks. 🙂
Min has the beginning of the right question there.
Allow me to change the set up a little. Let us not look at purely the national effect within the US. Let us, instead, look at the total global effect.
Take, for example, globalisation of trade in manufactured items with China and the US.
Let us, even, accept that US real wages have declined over this 40 year period (not that I believe that for a moment but let us just take what is alleged above as being true).
So, we’ve had static or possibly even falling US wages as a result of this globalisation. We’ve also had Chinese GDP per capita moving from $600 a year to $6,000 a year over the same 40 years.
Which leaves us with an interesting philosophic question. If we are of a left wing persuasion then we would usually think that it is right that there should be some redistribution from the rich to the poor. That those with should give up some of what they have in order to reduce the terror of absolute poverty.
What has globalisation given us? In the story above, we’ve had the American middle classes, collectively the richest group of people the planet has ever seen, giving up the benefit of economic growth: that benefit of economic growth being captured by the formerly absolutely poor and now middle class Chinese manufacturing workers.
Which is redistribution from rich to poor on a global basis.
Shouldn’t left wing types, liberals, be applauding this?
Tim implies some sort of behavior from types? Who says liberals are not both concerned and encouraged.. …and even working to encourage company and worker success abroad…the focus happens to be domestic impact and distribution of productivity withinin our borders, during an election year where distribution and spending is being debated. Seems reasonable to me.
I wonder how the traditional coalitions of our two party system will adjust. I am, and have always been an entrepreneur. I left the GOP because of the Bush/Cheney years. I believe Bush destroyed the GOP brand for an entire generation.
That said – I am experiencing extreme buyers remorse since I cast a vote for the lawn jockey for Wall st. There is no where for me to go.
Democrats would take your passport for unpaid taxes. A republican majority on the Supreme Court just ruled that a man can be strip searched for an unpaid parking ticket! [ that had been paid]
Insanity of the left and right will keep me at home in November. I will cast one vote. Gary Johnson for president and a pox on both houses for every other office – until there is a reshuffle of party politics. Demopublicans are evil.
Min:
Better question is how has drug demand in the US benefited Mexico? It hasn’t and our abuse is destroying a country. Prison for the US population has not worked as 1% of the adult population is residing there creating a thriving incarceration business which the law and order crowd thinks is necessary for non-violent crimes. The Mexican army can not control the cartel and the violence is spilling over into the US. The US is paying lip-service to the real issues in Mexico.
To answer your other question, there are several paradigms in Mexico.
– The multi-nationals in search of lower labor costs (all-encompassing) moved to Mexico which employed many of the nationals. As more companies proliferated, Labor moved from one company to another in search of higher wages.
– The nationals are looking for more than just wages (direct labor cost is minimal in an product) which now sets them up against the US costs of manufacture. The same thing is happening in China which will make them less competitive (read Boston Consulting Group report August 2011).
– The Multi-nationals have been shifting production back and forth to Asia, CAFTA, etc. to take advantage of the lowest cost possible. I tend to think this is a waste of resource and costly as bringing up production and becoming efficient takes time. Savings comes over time and is not instantaneous. Lots of self deceptive going on here in business and looking for the quick – hitters which typically fail.
– There are more jobs in Mexico now than before; but, the circumstance I explained above has impeded it:
“but in recent years, it has declined as mobile manufacturers have sought even cheaper labor in Asia. Mexican manufacturing wages fell 21% during the 1990s and poverty worsened.” http://dollarsandsense.org/archives/2003/0103dollar.html
Maybe the issue is business after NAFTA was established and the off-shoring of profits.
– Unrelated to Mexico and NAFTA is this paradigm; where is the investment money flowing to? Certainly, it is not to labor intensive industry. Follow the money to Wall Street and TBTF. Look at Spencer’s graph http://www.angrybearblog.com/2009/10/labors-share.html to see where productivity gains have been going. Look at this BIS report to understand what has been growing in this country. http://www.bis.org/speeches/sp081119.htm Gambling by Wall Street and TBTF is paramont, more profitable, and still growing as witnessed by Chase Morgan.
I note that trade unionism’s “leaders” were asleep at the switch on globalization. In Detroit the UAW fought tooth and nail against automation; its only goal, as it seems to be with contemporary China, was full, in the case of Detroit, “union” employment at the highest wages possible. The UAW ignored the export market, because both labor and capital in the USA always thought of growth in terms of the expansion of the domestic market. Thus GM, Ford, and Chrysler were by choice literally frozen out of Asia even at a time when US political power was so assymetric that Japan, for example, could have been forced to admit “foreign” car makers. The much more far-seeing and much more trade dependent economies of Japan and Korea brought their cars and then their production to North America. They succeeded in thier primary goal, making profits that they could use to expand.
In the USA at that same time the trade unionists circled the wagons and maintained their diminishing ranks until they were overwhelmed.
Today, in what seesm to me to be an eyeblink, government and service workers unions have expanded in power and influence to replace the now fading UAW and AFL. The Wisconsin election however has dramatized the fact that politicians made the same mistakes as industrialists: They simply gave in to the unions demands for POWER as well as money until the bank began to be exhausted.
Can America adapt to globalization and live within its means? I think not.
So how does the power of unions control trade policy…please be more specific, and particular how ‘capital’ was squeezed out. And some figures for Wisonsin. And which America needs to ‘sacrifice’ and live within its means…
Kansas and Arizona among other states are dedicating their just happening increasing revenue (called surpluses for the year) to tax cuts of similar amounts.
Having spent some time in Toledo lately, I have to say no.
Abetted by bad business decisions and bad thinking at union halls to be certain.
But overall, devastating.
And then there is Flint……….
Hi Tim:
You can believe real wages declined or not; but, your belief defies logic as reported in quite a few places such as in the charting of Household Median Income (which is skewed upeards due to greater income going to a smaller portion of the taxpaying population), Spencer’s chart on where productivity gains are going http://www.angrybearblog.com/2009/10/labors-share.html , etc. Spencer’s chart is particularly interesting as it details the decrease of the sharing of productivity gains away from Labor and towards Capital (which can be derived). In any case, I do not understand your terminology “Real Wages.” I suspect this is very differet that direct labor cost in manufacturing. If one wishes to decrease direct labor cost, then you must improve throughput and the associated costs. This can be accomplished by moving manufacturing or eliminating labor in the manufacturing process. Since direct labor is the smallest of costs, the return is small. So there must be other reasons. In any case, this is not a lefty or righty argument, it is a fact which many of us have pursued in manufacturing in order to be competitive.
And what happens when the Chinese begin to demand the same benefits US Labor enjoys and what is the cost of such in comparison to direct labor costs? What happens when the Yuan equalizes with the Dollar and is not held artificially high (I told one Chinese supplier the Yuan being held high is not my problem and I will move production if prices go up)? Production will move out of China and to other places such as the US (a back to the future moment). Boston Consulting Groups believes this day is rapidly comng and within the next 3 years s mentioned in a recent study of their. In any case, the same as public pensions; we took action to move production for all the wrong reasons and exploited some of the more popular myths to convince the masses it was right to screw them.
Rather than the redistribution from income rich to income poor, the federal income tax should be allowed to go back to what it was pre-2001 for those making >$200,000 which is 3-4% of the taxpaying households today. This marginal increase is not catastrophic for this group of people and the adjustment will correct the skewing of income through tax breaks for this small percentage of households, which is the same as the skewing of tax breaks from income rich to income poor which you resist. And yes it will not fix the deficit; but such is a much larger problem beyond taxes involving job creation. Getting more people back to work will raise the tax revenue.
Another issue is the SS Withholding Tax which effectively has subsidized Corporations and the income rich. Now, they are all scrambling to find a way not to pay those treasury bills back to SS as revenues have decresed to due to more people on the sidelines. “Pay it back” as anyone making less than the cap has been subsidizing those who pay an incrementally decreasing portion of their income to SS and typically in the higher income groups >$500,000 annually.
The better question to ask about the Middle Class is, where would they be if 2001 had not happened and the Wall Street and TBTF crash had not happened. Far beyond what we are today, I would suggest. In any case, EPI suggests a family of 4 might need ~$48,000 to get by in the US (of course this is dependent upon where you live in the US [North Dakota vs New Jersey, etc.]). Household Median Income is ~$50,000 as skewed by the higher income brackets. Sounds like 50% of the nation is just getting by today. And yes, “collectively” is the right word to use.
It really is not about globalization as […]
STR:
And what part does management play in this scenario?
Jack:
Which is why Gettelfinger in Congressional Hearing said Direct Labor is ~10% of the cost of an auto? Which is very true so what are the other costs?
“GM and SAIC have been building cars jointly in China since the 1990s.”
Nixon went to China in the seventies so this occurrence is not that late since GM management was still engossed in large cars which do not fit well in Beijing, Shantou, or Hong Kong for that matter.
Unions in Wisconsin never had the power to strike legally. All they could do is bargain collectively. Power is in the ability to strike and is not in blue days which can be brought to court (which has happened before) and the union leader sent to jail. This recall was about replacing a governor mid-term which most Wisconsin resident would take issue. Lets see if Walker is endicted.
Many of the “bad business decisions” by management revolved around resistance to change. Others involved discounting of foreign competition.
The UAW was very resistant to change and very dismissive of foreign competition, until nearly 50% of market share had been lost.
The UAW shared these characteristics with Big 3 management.
The problem is not just globalization per se, but the trade deficit. See: http://anamecon.blogspot.com/2010/04/effects-of-unbalanced-trade.html
The trade deficit deprives domestic producers of revenue, cutting their domestic profits, driving some out of business, and costing jobs. The trade deficit with China alone costs 2.8 milion jobs.
It also cuts into the tax base.
If trade were balanced, these negative effects would be ameliorated. There would be losers, but there would also be winners. With a trade deficit, there are more losers than winners.
You are leaving out a crucial part of the picture. More than 100% of the gains from trade in the U.S. are going to capital and land in this scenario. If the winners in the U.S. compensated the losers, the middle class, the poor in China would be just as well of as in the current situation where the losers aren’t compensated. I don’t advocate harming the poor in developing countries at all. If the theory of comparative advantage is correct, there is no reason to.
Jack, i would not be so sure the U.S. could have forced Japan to admit U.S. carmakers. They of course dominated the Japanese market before WWII, but were forced out in the run-up to the war. Japan has since then always had a strategy of asymmetrical foreign direct investment, with lots of outward FDI and little inward FDI.
Even if the U.S. could have forced it in 1950, the government did not for the same reason it allowed discrimination against U.S. goods in Europe, South Korea, etc.: anti-Communism. But by, say, 1975, forcing FDI down Japan’s throat was probably impossible
From a strict theoretical standpoint, I don’t think this is correct. Even if trade were balanced, we would expect the abundant factors to benefit and the scarce factors to be harmed. But I think I agree that the deficit has independent effects–definitely something I should come back to. Thanks for the comment.
In some circles, one is likely to see a variant of the claim that “everybody” is better off because of freer trade. Even according to the most mainstream economic theory, this is simply false.
The falsity of economic arguments for “free trade” cannot be emphasized enough. All those arguments about “comparative advantage” are really nothing more than a rather trite observation about problems in linear programming: of course removing one or more constraints on the problem is going to increase/decrease the max/min!
That’s hardly a good economic argument.
It’s been a while since I posted here . . . but didn’t this site used to support the usual html tags?
Let me try this again, assuming there’s been some deprecation going on:
In some circles, one is likely to see a variant of the claim that “everybody” is better off because of freer trade. Even according to the most mainstream economic theory, this is simply false.
The falsity of economic arguments for “free trade” cannot be emphasized enough. All those arguments about “comparative advantage” are really nothing more than a rather trite observation about problems in linear programming: of course removing one or more constraints on the problem is going to increase/decrease the max/min!
That’s hardly a good economic argument.
Tim some strawmen in your piece.
No. 1 “accept that Real Wages have declined”. Well there is a reason you don’t believe it because no one remotely familiar with the metrics would either. “Stagnant” doesn’t equate to “declined” The strict (as opposed to rhetorical overreach) progressive argument against universal/rising tide arguments for free trade is that the result has been differential rates of growth between real wage increases and capitals share of the returns on the increased productivity from that purported comparative advantage. Not as short and sexy as “stuck in the mud”, I mean everything is simple once you ignore the complexities, which doesn’t give you warrent to reduce all opposition to the position of the simplest slogan being deployed as it that was the totality of the argument.
In the 19th century Free Traders pointed to the fact that the English working class now could drink tea (previously a luxury item) as PROOF everyone gained from Free Trade, while pretending not to notice the huge palaces being built by the new capitalist class. Flash forward 2 centuries and you see the same argument being advanced, just now that the working class has refrigerators and cell phones and so can’t REALLY be poor. After all the Elder Pitt and the Directors of the East India Company had neither in 1778. Sorry that is just a bait and switch diverting attention from the actual question. Which is ON BALANCE and COMPARED TO ALTERNATIVES ‘cui bono ?’ from the current rounds of trade deals. And the answer is not be found on grounds of nominal growth and efficiency but instead on differential growth rates in real income and equity. Which is where the free trade argument falls. To reduce it back to slogans the Rising Tide Raised the Yachts higher and faster than the Rowboats. And left the new sea level closer to the gunnels of the latter. That is floating higher with less freeboard. Yet the rich want us to throw the bailing bucket over the side as obviously not being needed. Whereas all that happened is that the poor boater may be able to nibble on better survival rations while waiting for the boat to swamp. (“Oh Boy! MREs rather than K-Rations! God Bless the Commissary Corps!”)
And your second argument is similarly insulting. As good soldiers we are supposed to be happy that our former opponents now actually have K-rations while “collectively” we are the best fed enlisted soldiers in history, and oh yes just ignore the meals on the tables in the Officers’ Messes in both armies.
Well sorry even the best Chickena la King MRE is not freshly carved Prime Rib.
Welcome back Scent of Violets….html tags should be working, and so is rich text…will check.
Ken:
Exactly in much fewer words . . .
Scent:
Nice to see you again the heroine of stats
I’d love to see your discussion of the impact of cross-border money (“financial capital”) flows.
Some of the OCCUPY folks (that I work with) are asking if one of your forward thinking contributors would care to write a piece that would provide some guidance on can be done to repair the damage done to our economy.
Of the many suggested action items (a few examples are shown below) the OCCUPY folks are having a hard time deciding which one(s) would be considered more effective for restoring balance in our economy and making it work for all participants, and which ones would actually be detrimental to our economy:
1. Push for government policy changes (eg. reinstate Glass-steagall, Dodd-frank or the Volker rule)
2. Start a campaigns to boycott certain companies and their products and services while patronizing companies that being about greater good (eg. boycott Walmart and patronize COSTCO)
3. Fight against the privatization of public assets and enterprises (eg. sale of the Parking Lots in major universities to soverign funds)
Hope one or more of you will share your thoughts with us.
Thanks!
Some of the OCCUPY folks (that I work with) are asking if one of your forward thinking contributors would care to write a piece that would provide some guidance on steps they could take to repair the damage done to our economy.
Of the many suggested action items (a few examples are shown below) the OCCUPY folks are having a hard time deciding which one(s) would be considered more effective for restoring balance in our economy and making it work for all participants, and which ones would actually be detrimental to our economy:
1. Push for government policy changes (eg. reinstate Glass-steagall, Dodd-frank or the Volker rule)
2. Start campaigns to boycott certain companies and their products and services while patronizing companies that being about greater good (eg. boycott Walmart and patronize COSTCO)
3. Fight against the privatization of public assets and enterprises (eg. sale of the Parking Lots in major universities to soverign funds)
Hope one or more of you will share your thoughts with us.
Thanks!