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.