The world redistribution of income

According to standard trade models, globalization ought to lower global inequality (by raising the wages of unskilled laborers abroad) while possibly raising inequality in the rich countries (by lowering the wages of the unskilled relative to the rewards to skill labor and capital). The middle classes in the rich countries, it seemed, could sit back and enjoy their cheaper imports and labor-intensive service goods. But the Financial Times ran a lengthy and rather provocative article this weekend summarizing the work and the warnings of several leading economists that suggests that may not be exactly what has been happening.

I've excerpted the article at great length and also put the full-text in the course documents section of blackboard:

Profits of doom. By Richard Tomkins.
Published in the Financial Times: October 13 2006

… Cheap labour, plus the opportunity to exploit new global markets, has brought a profit bonanza to western companies. But it has not been reflected in higher wages for employees at home because companies are no longer in thrall to employees at home. Instead, the gains have been split between capitalists, who have enjoyed higher returns; executives, whose emoluments go up with profits; and poor workers in the developing world, who have gained from the growth in jobs and rising wages that would once have gone to the west.

...Richard Freeman, a Harvard labour economist, estimates that the entry of China, India and the former Soviet bloc roughly doubled the number of workers in the market economy, from 1.46 billion to 2.93 billion. Since those countries brought little capital with them, the number of workers in the system shot up while the amount of capital increased very little. As the law of supply and demand might suggest, when labour is abundant and capital scarce, the returns to labour tend to fall and those to capital rise.

… the idea that only low-skilled factory workers have anything to fear from globalisation has turned out to be a myth. The former Soviet bloc already has many highly educated workers (the Soviets, remember, beat the Americans into space) and the less developed countries are pouring investment into higher education. “Indonesia, Brazil, China, India - name the country - have more than doubled university student enrolments in the 1980s and 1990s,” Freeman says. China is investing particularly heavily in science and engineering and “by 2010 it will graduate more PhDs in science and engineering than the US”.

...In a similar vein, the developing world has inconveniently departed from the script that said it would specialise in low-tech goods. “China has moved rapidly up the technological ladder, has greatly increased its high-tech exports and has achieved a significant position in research in what is purported to be the next big industrial technology - nanotechnology,” Freeman says. “Over 750 multinational firms have set up R&D facilities in China.”

...So globalisation is not just about a few blue-collar factory workers in the west losing their jobs and everyone else being better off. Because of plummeting telecom charges, all kinds of middle-class, white-collar jobs once thought of as non-tradable - not just in telemarketing and call centres but in accountancy, medical diagnostics and information technology - have started moving to the developing world.

...the force that is acting to suppress western wages is not so much offshoring as the threat of it. As Freeman says in his paper, by giving companies a new supply of low-wage labour, the doubling of the global labour force has weakened the bargaining position of workers - not, by the way, in the rich west alone, but in Latin America, South Africa and the more advanced economies of Asia, too.

...Certainly, globalisation has fulfilled part of its promise to western workers. Cheap imports have brought down the cost of many consumer goods, often very noticeably. Paradoxically, however, these gains have been offset by big increases in energy costs, caused in part by rising demand for energy from the very factories that produce these cheaper goods. That in turn has produced a vast redistribution of income from energy consumers to oil producers in the Middle East and elsewhere.

...Some western workers may also have benefited from rising share prices, either through direct investment in shares or through their pension funds. But rich people are much bigger shareholders than poor people, so they will have reaped greater gains.

...Indeed, the gains of globalisation have flowed disproportionately to the people who least need them - the rich and super-rich. According to the US Census Bureau, the top fifth of American households received 50.4 per cent of all household income last year, the largest share since records began in 1967, and the biggest gains have been going to those at the very top.

On the other hand, the gains are also flowing to the people who most need them: the poor workers of the developing world. While wages in the advanced countries are stagnant, wages in the developing world are rising rapidly, albeit from a small base. Freeman estimates that if Chinese wages double every decade, as they did in the 1990s, they will reach the levels found in the advanced countries today in about 30 years. Absorbing the labour forces of other countries could take a little longer but the transition could be complete in 40 to 50 years - at which point, presumably, western wages will start rising again and the balance between capital and labour will be restored.

… As Stephen King, chief economist of HSBC, the London-based international bank, and Janet Henry, the bank’s global economist, put it ...“Globalisation isn’t just a story about a rising number of export markets for western producers. Rather, it’s a story about massive waves of income redistribution, from rich labour to poor labour, from labour as a whole to capital, from workers to consumers and from energy users towards energy producers. This is a story about winners and losers, not a fable about economic growth.”

...But if western workers are emerging as globalisation’s losers, how come consumer spending has held up? Rising house prices have made a lot of people feel richer, encouraging them to lift their spending by saving less and borrowing more. Also, more spouses and partners are taking jobs or working longer hours, increasing total household income.
The problem is, these trends cannot go on masking workers’ stagnant wages forever. And as voters are confronted with the reality of the processes now taking place, they are likely to start demanding an end to outsourcing and a return to trade protection.

Princeton economist Alan Blinder, a former Federal Reserve vice-chairman, went further… he said economists had underestimated both the importance of offshoring and its disruptive effect on wealthy countries. “We have so far barely seen the tip of the offshoring iceberg, the eventual dimensions of which may be staggering,” he wrote. The “governments and societies of the developed world must face up to the massive, complex and multi-faceted challenges that offshoring will bring”.

As so often is the case, identifying the problem is easier than finding a solution. Education and training, the politicians’ usual panaceas, will not by themselves protect western workers from competition with the increasingly well-educated workforces of the developing world.

Clearly, taxes could be used to divert some of the gains made by capital and the rich towards ordinary wage-earners. Globalisation has made high taxes unfashionable because they encourage companies or people who pay them to move to countries with more forgiving tax regimes; yet if a voter backlash emerges, governments will have to find some way of responding.

…Imagine, at the birth of globalisation, western politicians had made an amazing proposition to voters. “Together,” they could have said, “we are going to end world poverty. In order to achieve this, we are going to ask you to accept a pay freeze in real terms for as long as it takes for the wages of workers in the developing countries to catch up, which we estimate will be about half a century. Until the adjustment is complete, the reduction in labour costs will produce the side-effect of extraordinarily high profits for companies, enriching many of those who are already among the richest in society.

“So there will be winners and losers. The bad news is that you, the ordinary, middle-class employees of the west, will be losers and everybody else will be winners. But the good news is, your sacrifice will make poverty history.”

Would you have voted for this?

How will the public continue to vote?