Running Head: TRADE AND WAGE DIFFERENTIALS 1

Trade and Wage Differentials

Jamie Wiggan
Econ 351
March 23rd 2017
TRADE AND WAGE DIFFERENTIALS 2

Abstract

This paper seeks to examine the relationship between international trade and wage

differentials within the US domestic economy. As Douglas Irwin (2015) points out in Free

Trade Under Fire “total unemployment is not a function of international trade, but of the

number of people in the workforce,” yet despite this, much of the political discourse about

the impact of trade has been reduced to arguments about its effect either for overall job

creation or job destruction. And while Irwin (2015) again suggests that “the quest to identify

trade’s impact on the overall number of jobs is largely futile” he adds that “trade does have

important implication for employment in different sectors of the economy and even the

wages paid to workers.” [Emphasis mine] Job creation or destruction across different sectors

also suggests changes in relative demand for those sectors, which affects wages. This paper

aims to show how trade has impacted wage-disparity within the broader context of US

economic policy. While accepting the conventional interpretation that “trade accounts for a

positive yet relatively small share of rising inequality,” (Slaughter, 1998) I conclude that the

effects of world trade on wage disparity have been more significant in the US employment-

sector due to the economic policies that have been pursued alongside it.
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Growing wage disparity along with a decline in social mobility are widely recognised

facts within the US. In his well-known essay, The Death of Horatio Alger, Paul Krugman

(2003) laments: “over the past generation upward mobility has fallen drastically.”

Alarmingly, he goes on to cite how “between 1973 and 2000 the average real income of the

bottom 90 percent of American taxpayers actually fell by 7 percent . . . the income of the top

1 per cent rose by 148 percent, the income of the top 0.1 percent rose by 343 percent and the

income of the top 0.01 percent rose 599 percent” (2003). The explanation for these

phenomena are surely complex and convoluted; certainly not the consequence of any one

single development. According to Matthew Slaughter (1998), the most commonly attributed

causes of growing wage discrepancy are “globalization in the form of increased international

trade in goods, and technological change - particularly change 'biased' towards skilled

labour.” Yet in the same work Slaughter (1998) notes that wage differentials have been more

dramatic in the US than in comparable economies which have been similarly subjected to

globalization, such as those of Western Europe as well as Canada, Australia and Japan. This

suggests that it is at least plausible that different policy choices and prevailing political

cultures could account for some of the differing effects on wages in respect to trade.

The aggregate gains from free trade are clear and undisputed. The prevailing

consensus that when two countries trade along their lines of comparative advantage, both

countries see an increase in GDP remains unchanged since Smith Published The Wealth of

Nations in 1776. However, as Steven Husted and Michael Melvin (2013) point out, what

makes trade contentious is that “not everyone within a country gains equally from trade.” It

follows that the rational pursuit of any government should be to seek to balance the benefits

of trade with a fair distribution of those benefits, however “fair” may be defined. What then

is the relationship between trade, wages and a country’s broader policies on issues such as

capital investment, monetary policy and job sector growth?

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In his, Global Decisions, Local Collisions, David Ranney (2003) describes the

development of the post-Fordist “new world order” arising as a consequence of new schools

of sociological and economic theory finding voice in US economic policy. Ranney (2003)

notes how—beginning with the field of sociology, before spreading to economics and finally

the public mainstream—the acceptance of “human capital” as the basis for individual

economic and social progression has become generally accepted. In this way, “employment is

now widely seen as an individual responsibility” and subsequently, led to “the abandonment

of employment as a social goal.” Coupled with this, Ranney (2003) also points out how the

Government and the Federal Reserve have adopted new fiscal and monetary policies

respectively, in order to pursue changed social objectives. In the era where the Phillips

curve— the perception of “a regular relationship between the rate of unemployment and the

rate of inflation”—was widely accepted in the US, Ranney (2003) notes that “there was a

general consensus that unemployment was a greater evil than inflation” and therefore fiscal

and monetary policies were the primary instruments of keeping this balance in favor of low

unemployment. As the 1970s wore on however, and the US economy saw persistently high

levels both of inflation and unemployment, the reliability of the Phillips Curve was called

into question in a movement spearheaded by Milton Friedman (Ranney, 2003). Friedman’s

theory of a natural rate of unemployment [NAIRU] gained acceptance, and consequently, “a

national goal of full employment made no sense because if unemployment fell below the

natural rate, gains would be wiped out by inflation” (Ranney, 2003).

Ranney (2003) suggests that not only was this an accepted development in terms of

pure economics, but that there were vested interests pushing to make it into policy. He notes

“people who make profits by lending money and by trading stocks, bonds, and financial

futures can lose out if the value of money is declining due to inflation” (Ranney, 2003), and

thus arguably, keeping inflation down favored the wealthy over the competing interest of
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raising employment—most vital to those most at risk of unemployment. Perhaps this is

symbolized by Carter’s move in 1979 to appoint former investment banker, Paul Volker as

chair of the Federal Reserve Board-- from where he pursued aggressive anti-inflationary

monetary policy (Ranney, 2003). According to Ranney (2003), as sociological trends

stressing self-reliance and political and economic policies stressing a less active role in

affecting employment consolidated, an emerging consensus that employment was being

restricted by a lack of “flexibility” in labor markets contributed another piece in the puzzle

towards an era of neoliberalism in the US. Ranney (2003) notes that “Lack of flexibility” in

labor markets was understood to mean “excessive wage and benefit expectations, rigid work

rules that constrained the production process, refusal of some workers to do certain kinds of

work, barriers to the use of temporary and part-time work, and government policies that

encouraged these things.” Evidently, this list is primarily concerned with domestic policies

that were largely the collective work of unions over many years. However, Ranney (2003)

notes that this was also part of a larger global movement as advanced by organizations such

as the IMF and the OECD, thus setting the scene for a global culture of free trade.

Interestingly, Ranney (2003) claims these ideals took hold most fervently in the United States

and Great Britain, the two nations that Slaughter notes as being most effected by income

divergence.

In his 1991 Essay, Why the Rich Are Getting Richer and the Poor, Poorer, Robert

Reich says the primary answer to his title-question lies in a bloated market for “routine

producers” as a consequence of outsourcing—both in manufacturing and services—which

has been coupled with a loss in “bargaining leverage” for the same group. As organizations

open up to outsourcing production factors, domestic unionizing and collective bargaining

would only serve to further this trend. Reich (1991) cites figures indicating a significant

reduction in union membership beginning in the 1960s as indicative of this. A consequence

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of the job losses in “routine production” tasks has been increased entry to “in-person service”

positions (Reich, 1991). Increased supply for these positions has brought down the wages in

already low-paying positions. Reich (1991) cites the Bureau of Labor Statistics as estimating

that “of the 2.8 million manufacturing workers who lost their jobs during the early 1980s,

fully one-third were rehired in service jobs paying 20% less”. Reich (1991) concludes his

essay by asking his readers to “recall the oft-repeated corporate platitude of the era about the

chief executive’s responsibility to carefully weigh and balance the interests of the

corporation’s disparate stakeholders . . . no stakeholder was to gain a disproportionate share

of the benefits of corporate activity.” He concludes, “these informal norms [are]

evaporating”. If Ranney is correct however, rather than simply “evaporating”, the erosion of

these informal norms is the work of a steady flow of ideology emanating from the social

sciences and percolating through governmental, political and economic institutions. While

Reich does not demonstrate empirically how much of the losses in routine-production work

can be accounted for by trade and outsourcing, the impression that is emerging is that the

culmination of exogenous (trade) and endogenous (policy) forces have been jointly at work

for some time in destabilizing low-skill positions.

Writing more recently for the New York Times, Robert Reich (2011) maintains his

bitter distain for globalization and corporatism, but he makes an important observation that

calls into question the inevitability of trade and automation producing wage disparity.

“Germany has grown faster than the United States for the last 15 years, and the gains have

been more widely spread” (Reich, 2011). The incomes of the top 1% have been largely

unchanged since 1970, while average real wages have risen by about 30% at the time the

article was published (Reich, 2011). Germany also happens to trade in much higher quantities

than the US in proportion to its GDP (Husted and Melville, 2013), clearly demonstrating that

trade on its own does not lead to rising inequality. This leads to Reich’s conclusion as to
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Germany’s comparative success: “Mainly by focusing like a laser on education, and by

maintaining strong labor unions”(Reich 2011). Clearly what Ranney (2003) dubs “the new

world order” has not infiltrated German policy, and despite a high trade openness index, it

maintains strong unions and high levels of exports in manufacturing industries (Husted and

Melville, 2013). This ties in nicely with Slaughter’s suggestion that “ different labour-market

institutions explain part of the cross-country differences in outcomes for wages and

employment” (1998).

The tentative conclusion of this study is that much of the harm to US economy

resulting from trade, is due to its own domestic policies with respect to employment, and

laws seeking to maintain high degrees of labor “flexibility”. Further study of this notion

would benefit from a detailed comparative study between The US and other developed

countries—such as Germany—where income inequality has taken a different course with the

advent of freed trade and globalization.

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Citations

Husted, S. L., & Melvin, M. (2013). International Economics (9th ed.). New Jersey: Pearson.

Irwin, D. A. (2015). Free Trade under Fire (4th ed.). Princeton, United States: Princeton
University Press.

Krugman, P. (2003, December 18). The Death of Horatio Alger. Retrieved March 27, 2017,
rom https://www.thenation.com/article/death-horatio-alger/

Ranney, D. C., & Ranney, D. C. (2003). Jobs, Wages and Trade. In Global decisions, local
collisions: urban life in the new world order. Philadelphia, PA: Temple Univ. Press.

Reich, R. (2011, September 3). The Limping Middle Class. The New York Times.

Reich, R. B., & Reich, R. B. (1994). Why the Rich Are Getting Richer and the Poor, Poorer.
In The work of nations: preparing ourselves for 21st-century capitalism. New York:
A.A. Knopf.

Slaughter, M. (1998). International Trade and Labour-market Outcomes: Results, Questions,

and Policy Options. The Economic Journal, 108(450), 1452-1462.