Are your wages set in Beijing? Richard B. Freeman (1995)

1. Are your wages set in Beijing?Richard B. Freeman(1995)

2. Background 1980-90: demand for less–skilled workers fell in advanced countries • USA: Falling real wages and reduction in hours worked for less- educated men • OECD – Europe: Increased unemployment for less-skilled workers At the same time manufactures imports from third world countries to the US and Europe increased greatly. This lead to a debate about the economic consequences for less- skilled workers of trade between advanced and developing countries.

3. The debate focuses on one issue: whether in a global economy the wages or employment of low-skill workers in advanced countries have bee determined by the global supply of less-skilled labor, rather than by domestic labor market conditions. One side of the debate believe in price equalization In a global economy wages in advanced countries cannot remain above comparable wages in less- developed countries. The other side reject that the traded good sector can determine labor outcome in an entire economy The effects of trade on demand for less-skilled labor offset through social policies funded by the gain from trade.

4. Atlantic divide in the debate • American economists generally conclude that trade is not the cause of the economic problems for the less-skilled in advanced countries. • European economists generally take the view that that trade with the third world has caused joblessness in Europe and rising inequality in the U.S.

5. U.S/Europe trade with the third world • In the 1980s and 1990s both the U.S. and Europe increased trade with third world countries

6. The sources of increased trade • Reduction in trade barriers • Shift in development strategies in less-developed countries from import substitution to export promotion. • Advanced countries investment in manufacturing in less-developed led to increased competitiveness on the world market for less-developed countries. • Changes in the labor markets of less-developed countries (increased workforce, higher education) • Diffusion of technology through multinational firms.

7. Economic theory:Factor price equalization Consider a world where: • producers have the same technology • trade flows are determined by factor endowments advanced countries with many skilled workers compared to unskilled workers import commodities made by less- skilled workers in developing countries and visa versa • Trade establishes a single world price for a good.

8. Trade makes less-skilled labor in advanced countries and skilled labor in developing countries less scarce and can thus be expected to reduce their wages. • Tade will increase the production of goods made by skilled labor in advanced countries and by less-skilled labor in developing countries and can thus be expected to raise their wages. In the long-run equilibrium factor prices are equalized and workers of the same skill level are paid the same wages throughout the world.

9. Assumptions behind factor price eq. • Identical technology • Identical tastes • similar ranking of sectors by skilled to unskilled and capital to labor intensity at all prices • Absence of scale effects • countries are incompletely specialized (produce the full set of traded goods) Not very realistic

10. If the factor price equalization is true this implies that the domestic market developments have no effect on wages. • These predictions run counter to a wide body of evidence that domestic developments do affect wages. Example: In the United States, wage differences among states and localities have persisted for decades despite free trade, migration, and capital flows.

11. Empirical Work • Factor content analysis Estimates the impact of trade on the demand for labor at given wages or, alternatively, the nation's "effective” factor endowments, that is, the domestic and foreign labor inputs used to produce society's consumption bundle. 2. Price data analysis

12. Factor content analysis Borjas, Freeman and Katz (1992) Estimated what would happen to the relative employment of less-skilled Americans as a result of the change in trade in the 1980s and conclude that the reduction in employment was modest, due largely to the trade deficit. Sachs and Shatz (1994) Analyzed trade flows with less-developed countries with a more extensive data set for the period 1978-1990 and also concluded that increased import from less developed countries reduced manufacturing employment modestly. Cooper (1994) Estimated that the number of less-skilled workers displaced by imports in textiles, apparel and leather was small relative to employment in retail trade, which employs many such workers.

13. These studies find that changes in actual trade flows have not displaced all that many low-skill workers from manufacturing for one basic reason: that only a moderate proportion of workers now work in manufacturing. • In 1993, roughly 15 percent of American workers were employed in manufacturing. • The vast majority of unskilled workers were in nontraded goods, such as retail trade and various services. In such a world it is hard to see how pressures on wages emanating from traded goods can determine wages economy-wide.

14. Different approach: Adrian Wood • Wood argues that standard factor content analyses understate the effect of trade on employment. • Wood argues that estimated changes in effective labor endowments, based on existing labor input coefficients in advanced countries,are biased against finding a big disemployment effect. The reason is that less-developed countries export different and noncompeting goods within sectors than the goods produced by advanced countries.

15. To correct for this possible bias, Wood uses the labor input coefficients for developing countries, adjusted for labor demand responses to higher western wages, rather than those for the advanced countries. • With this procedure, he estimates that labor demand due to imports of manufactures fell by "ten times the conventional ones” • Wood (1994) also asserts that trade with less-developed countries Induced substantial labor-saving innovation in the traded goods sector. • Sachs and Shatz (1994) find virtually no difference in the rate of change of total factor productivity in industrial Sectors divided by skill intensity of labor, which runs against Wood's (1994) argument.

16. Criticisms of Factor Content Studies Some trade economists criticize factor content studies because observed trade patterns "do not necessarily capture the effects of price pressures that operate through trade”. • One problem is that factor content calculations treat changes in the Production of goods as output shocks that affect employment at existing wages. • A second problem is that the standard factor content studies ignore how demand for output may respond to changes in prices. By ignoring the likely consumer response to higher- priced domestic equivalents of imports, the factor content calculations overstate how much domestic production by low-skilled labor is displaced by imports.

17. 2. Price data analysis In the trade model, price declines in import-competing sectors should lower the relative wages of unskilled labor,which those sectors use intensely, and ultimately the prices of all goods and services produced by those workers. Lawrence and Slaughter (1993) correlate changes in import prices with the share of production workers across industries and find that when prices are adjusted for changes in total factor productivity, the prices of less skill intensive goods fell only slightly.

18. Sachs and Shatz (1994) Examined output prices for all of manufacturing, not just imports, which provides a larger sample of industries. • After adjusting for productivity changes that should independently affect prices, they find a modest negative relation between the production worker share of employment and changes in industry prices. • They also find that prices fell faster in sectors that make more intensive use of low-skilled workers in the 1980s than in previous decades compared with sectors that use fewer low-skilled workers. They conclude that relative prices exerted some pressure on the pay of the less skilled, but not by enough to account for a significant widening of wage inequality.

19. Criticisms of price effect studies • Price data is subject to seriousmeasurement problems. • Import prices exist for relatively few industries and cover only some goods in those industries. • Output prices suffer from an aggregation problem. • Changes in the quality of products not captured in the indices create measurement error, which may be correlated with the skill intensity of production. • Ignore potential determinants of changes in sectoral prices and potential reasons for the proportion of unskilled workers in a sector to be correlated with changes in prices, save for trade.

20. Conclusion • Trade matters, but it is neither all that matters nor the primary cause of observed changes. • As more and more low-skilled western workers find employment in the nontraded goods service sector, the potential for imports from less-developed countries to reduce their employment or wages should lessen. • In the past, other factors have been more important than trade in the well-being of the less skilled: technological changes that occur independent of trade; unexpected political developments, policies to educate and train workers; union activities; the compensation policies of firms; and welfare state and related social policies.