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What if Paul Krugman were right about trade and wages?
For the sake of the world as a whole, I hope that we respond to the trouble with trade not by shutting trade down, but by doing things like strengthening the social safety net.
That is Paul Krugman, here is more. I have yet to see the evidence that trade has a significant negative impact on middle class wages, but for sake of argument assume it is true. However benevolent it may sound, strengthening the social safety net would not be my policy recommendation number one. After all, if Samuelson-Stolper factor price equalization is the main mechanism at work, wages would have a long way to fall downwards and if anyone in the middle class is to keep working, the safety net must eventually be cut, not increased. You might think we can fund all these trade-losers by taxing capital but of course the incidence of taxes on capital sometimes falls on labor, not to mention that at some point the Laffer Curve kicks in.
Is not the appropriate policy recommendation to create a budget surplus, create a U.S.A. Sovereign Wealth Fund, and invest the resulting capital in the corporate winners from this entire process? In other words, we would be giving the trade-losers a more direct share in capital. Since output is rising and wages are falling, the return to capital must be rising; let's make money off of that.
You might not trust the government with such investments but it is awkward for Krugman to push that argument too hard. Alternatively, you might think that share prices already have capitalized these gains, but that is hard to square with the view that Krugman is reporting a new result about trade. Share prices are driven by liquidity to some extent, and if you know something about the returns to labor and capital that the rest of the world does not, there ought to be a way to make money. Why spend more on consumption (a stronger safety net today) if the rate of return on investment is rising so high and we are going to need even more of a safety net in the future?
Posted by Tyler Cowen on December 29, 2007 at 07:55 AM in Economics | Permalink
Comments
After all, if Samuelson-Stolper factor price equalization is the main mechanism at work, wages would have a long way to fall downwards
In an integrated economy, wages are set at the margin of production. For this to be true, one must assume that foreign workers are going to crowd into labor-intensive sectors so that each individual worker will earn very low wages. This can definitely occur in the short run, but it's unlikely to be a lasting effect. So far, we've seen a sudden doubling of the low-wage workforce with wages soaring in poorer countries and a modest stagnation in the developed world.
and if anyone in the middle class is to keep working, the safety net must eventually be cut, not increased.
This is not an issue if the social safety net is properly designed. For instance, EITC subsidies do not have this problem.
Since output is rising and wages are falling, the return to capital must be rising; let's make money off of that.
If the return to capital is rising, why isn't this being reflected in real interest rates? When real interest rates rise, the recommendation to create a budget surplus becomes obvious.
Posted by: guest at Dec 29, 2007 9:33:04 AM
This seems like a good argument for cutting taxes, which of course would be anethema to Krugman.
Btw, in the You Tube video of Krugman's talk at Google, he claimed to have invented the field of currency crises. That would be news to Mises, Hayek, and a dozen other economists who lived through some real currency crises, then wrote about them before Krugman was born.
Doesn't his balloon ever land?
Posted by: Bill Stepp at Dec 29, 2007 10:17:46 AM
It seems like workers have done well since NAFTA went into effect, for example. Most of you probably know this but here are the numbers
Using Bureau of Labor Statistics data, hourly wages from 1994-2006 rose 47.8 percent while the Consumer Price Index went up 36 percent.
In the 12 years before NAFTA wages rose 44 percent while prices roses 54 percent.
The unemployment rate was 6.9 percent in 1993 and 6.1 percent in 1994. It fell steadily until reaching 4 percent in the year 2000. Even in 2003, two years after we had a recession, the rate was 6 percent, lower than the year NAFTA began. Now it's 4.7 percent. From 1981 to 1993, it averaged 7.1 percent a year. From 1994-2006, 5.1 percent. The percentage of the population employed is higher today than before NAFTA went into effect.
Krugman also mentions in his book "Pop Internationalism" that if cheap imports cost jobs, the Fed can lower interest rates to offset this (page 159). On page 123 he emphasizes that the level of employment is a macro issue as well, determined by AD and AS. It seems to me that if falling demand for US workers (causing either unemployment or lower wages) results from cheap imports, that demand can be increased by some type of macro policy. For some reason Krugman is not considering this anymore. Maybe it is a specific class of workers whose wages are falling and other wages are rising enough to more than enough to offset this. But wouldn't their wages increase with the appropriate macro policy?
Posted by: Cyril Morong at Dec 29, 2007 10:42:02 AM
When was the last time you were in Ohio or Michigan?
The impacts of trade have been extremely regional, which makes national averages worthless, except to economists I guess.
Take a look at the 2006 Ohio elections if you want to understand the impact - more Sherrod Browns in Congress.
Posted by: save_the_rustbelt at Dec 29, 2007 11:59:29 AM
I would much prefer that if economists are going to talk about "compensating" the losers from free trade that they talk not of justice or fairness but merely of buying out the political opposition to freer trade. I do not think that a case can be made that if some wages fall this is unfair or unjust or any such fancy sounding things. It is simply that some of these people who are earning less will try to forestall what is best for the most people and virtually everyone in the long run.
Posted by: Mario Rizzo at Dec 29, 2007 12:53:36 PM
So all the problems in Ohio and Michigan were caused by NAFTA and/or imports? Can you give me some numbers on wages and unemployment in Ohio and Michigan before and after NAFTA went into effect? Nowhere in the article does Krugman talk about individual states. He addresses the whole country/economy and talks of falling wages and job losses. We had growing trade deficits in the 1990s while unemployment and real wages were rising. People in Michigan and Ohio could move, although that is a tough thing to do.
Posted by: Cyril Morong at Dec 29, 2007 1:04:40 PM
In other news, California's workers wages have increased much faster than
those of Alabama.
Posted by: sa at Dec 29, 2007 1:33:08 PM
Krugman says:
"The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose."
So let me get this straight -- he claims that only a minority of elite, educated Americans benefit from trade with China and the number of those hurt is far greater. But he doesn't want his rhetoric to be used in favor of protectionism? Well, good luck with that. Does he really think if if he argues that trade hurts more Americans than it helps (and helps to convince a voting majority of that dubious proposition) that the voters will, nevertheless want to maintain free trade out of a concern for the world's poor. Yeah, right -- is he new around here? If a majority of Americans become convinced that trade is bad for them personally, the trade restrictions will be all but inevitable. Thanks, prof Krugman.
savetherust says:
"When was the last time you were in Ohio or Michigan?"
Well, personally, I've been living here in Michigan for more than 30 years.
"The impacts of trade have been extremely regional"
Yes, high-priced union labor and legacy costs (deriving from even more high-priced union labor, now retired, from decades past) have made the 'Big 3' (and their suppliers) uncompetitive with the lower-priced non-union 'foreign' labor located in ... Kentucky, Tennessee, South Carolina, Alabama, etc. NAFTA had nothing to do with it.
Posted by: Slocum at Dec 29, 2007 1:40:22 PM
Sloc wrote in response to rustbell:
high-priced union labor and legacy costs (deriving from even more high-priced union labor, now retired, from decades past) have made the 'Big 3' uncompetitive with the lower-priced non-union 'foreign' labor located in ... Kentucky, Tennessee, South Carolina, Alabama, etc. NAFTA had nothing to do with it.
Rustbell did not mention NAFTA in his post.
Sloc is being dishonest here.
Do you have a real answer to the rust, Sloc?
Posted by: mik at Dec 29, 2007 1:56:14 PM
"I have yet to see the evidence that trade has a significant negative impact on middle class wages"
With all due respect, you never see any evidence that virtually OpenBorder immigration causes harm to working folks. And dispite your arguably very limited knowledge of immigration issues.
The same is true for IQ issue.
So forgive me that untill I see that you do not have emotional attachment to the issue, I will discount your statement above.
Posted by: mik at Dec 29, 2007 2:00:52 PM
"if Samuelson-Stolper factor price equalization is the main mechanism at work"
Not being economist, have no idea what that S-S factor is.
But you said if, what if that factor is NOT the main mechanism?
Do you have the prove that S-S factor must be the main mechanism?
If you do, you certainly did not mention it.
Posted by: mik at Dec 29, 2007 2:04:38 PM
"So far, we've seen a sudden doubling of the low-wage workforce with wages soaring in poorer countries and a modest stagnation in the developed world."
It is a shame that you skipped world geography class in you middle school. You would have learned that available workforce is about 5 times of existing developed world workforce.
The rest of the post need a little reference backup.
Posted by: mik at Dec 29, 2007 2:09:32 PM
Cyril Morong confused me.
First he sez this:
"hourly wages from 1994-2006 rose 47.8 percent while the Consumer Price Index went up 36 percent.
In the 12 years before NAFTA wages rose 44 percent while prices roses 54 percent."
So nominal wages in the period in question - period includes dotcom bubble, went up by 3.5% a year and real wages by about 1% a year.
Why would anyone complain? Look like terrific performance to me.
There is no problem, right?
But then CM sez:
"if falling demand for US workers (causing either unemployment or lower wages) results from cheap imports, that demand can be increased by some type of macro policy. "
But you just proved, with some data backing, that wages growing very nicely, why would demand for US workers fall?
Do you believe in your own proof?
Posted by: mik at Dec 29, 2007 2:18:47 PM
"It is simply that some of these people who are earning less will try to forestall what is best for the most people and virtually everyone in the long run. "
How outrageous of those low earning losers.
But how do you know that it is the best for most people and how do you know about long run?
You certainly proveded no evidence for your assertions.
Perhaps someone died and appointed you an economics god.
Just 30 years ago an opinion of most establishment economists was that we are on a path of convergence with SovietUnion-like system and in the long run resulting system will be a beautiful hybrid heaven.
Posted by: mik at Dec 29, 2007 2:25:02 PM
I'm also confused about the Samuelson-Stolper factor price equalization theory. What is this?
However, I'm somewhat disturbed by this Sovereign Wealth Fund idea...if you just want Americans to share on the returns to capital, why not just give them the capital? Does it sound too...socialist?
Posted by: Robert Olson at Dec 29, 2007 2:27:17 PM
To mik:
I am basically paraphrasing what Krugman has in his book. He was essentially saying that even if economists are wrong and that all these cheap imports really do hurt wages and employment, that the government (possibley the FED) can do something to increase aggregate demand to get back to full employment. I mention this because this seems better than trying to restrict trade and apparently Krugman has forgotten that he made this argument or for some reason he no longer believes it.
Posted by: Cyril Morong at Dec 29, 2007 2:48:43 PM
Interesting idea... But I think the factor that is benefiting in Krugman's story is not capital, but human capital. That is, the two factors in the model are skilled and unskilled labor, where the wages of skilled labor are really returns to human capital. At the moment, there's no way to buy equity in that, but maybe one of our newly-unemployed "financial innovators" could set up a market where people could finance higher education by selling shares rather than taking out loans.
Posted by: Bill C at Dec 29, 2007 3:52:47 PM
Tyler:
Could you do your non-economist readers a favor and maybe do a post on what makes Krugman valuable as an economist in the profession? His popular writings have this tendency to become cartoonishly ideological. However, I gather that his peer-reviewed professional work is excellent. So, could you maybe do a post to the effect of "No-he's not just some shrill pundit: Here's the valuable stuff Krugman has contributed to economics."
Of course, by writing such a post, you aren't thereby committing yourself to my characterization of him.
Posted by: Some guy at Dec 29, 2007 4:02:12 PM
Aren't you and Krugman both saying that what is needed is to tax the haves and transfer to the have-nots?
Posted by: David J. Balan at Dec 29, 2007 4:59:16 PM
However, I'm somewhat disturbed by this Sovereign Wealth Fund idea...if you just want Americans to share on the returns to capital, why not just give them the capital? Does it sound too...socialist?
Actually a sovereign fund investing in equity makes a lot of sense economically, because government can bear risk far more effectively than a private investor; and it's well known that the risk premium on equities is abnormally high. But this is true regardless of whether returns on capital are increasing.
Posted by: guest at Dec 29, 2007 5:37:45 PM
Nobody is owed a certain standard of living and nobody has the moral right to tell me who I can and cannot associate with (which includes buying from and selling to). Those people who have their wages threatened by allowing me what is a fundamental human right shouldn't be asking for a "safety-net". Rather, they should be glad they aren't required to refund the money they've been able to extort through restricting who we're allowed to buy from over the years. Excuse me if I don't shed a tear for the poor bully who for years forced you to buy from him when we're finally "allowed" to choose for ourselves.
Posted by: freedom to trade is a human right at Dec 29, 2007 7:57:15 PM
"...Is not the appropriate policy recommendation to create a budget surplus, create a U.S.A. Sovereign Wealth Fund, and invest the resulting capital in the corporate winners from this entire process? In other words, we would be giving the trade-losers a more direct share in capital. Since output is rising and wages are falling, the return to capital must be rising; let's make money off of that..."
Tyler, you must be showing your age. We already have a "U.S.A. Sovereign Wealth Fund." It's called the Social Security Surplus. Instead of being invested in assets which are increasing in value due to increased output, right-wingers forced all of it to be invested in Treasury notes. Instead of being placed in a lock-box, as certain politicians insisted, the right-wingers decided to use it to offset the deficits generated by insane, misguided, outrageous tax cuts for the wealthiest tranches in our society. Now, Bush and the right-wingers are telling us that it doesn't exist. In other words, the right-wingers are planning on stealing it right out from under the voters' noses and expect that no one will notice the theft. That's the best way to build personal wealth - steal it. That's what Krugman wouldn't trust about your recommendation. The right-wingers won't allow it to happen because ultimately they lose control of the wealth.
Posted by: PrahaPartizan at Dec 29, 2007 10:06:28 PM
I'm usually happy to see Krugman attacked, but I don't think Tyler is being fair here.
In the simplest, Ricardian model of trade, there are no loosers: the wine-makers simply become cheese-makers, or assembly-line workers become IT consultants, and everyone is better off. In more complex models with non-transferable assets, the owners of the such assets can be loosers: vinyard owners, or owners of assembly-line skills but no IT skills, are worse off. The loosers in such models are permanent -- the vinyards and assembly-line skills are forever useless -- so a long-term stake in a rising industry is indeed a better compensation than a temporary social safety net. If this were Krugman's model, Tyler's critique would be a good one.
But I don't think this is Krugman's model. The more realistic model of loosers from trade involves temporary losses as the economy shifts: vinyards do become dairies and assembly-line workers do become IT consultants, but it takes time for capital to shift and workers to learn new skills. There are few economic models of this phenomenon, because economists' models are almost invariably quasi-equilibrium models, not true dynamic models derived from micro-behavior which could predict how re-equilibration unfolds in time. Still, Tyler and most economists would probably agree that a near-term depression of income below the societal average evolving in the long-term back toward the societal average is a better fit to the real experiences of trade loosers than either no depression or a permanent depression. Given the usual income-utility relationships, a social safety net to cushion the impact of the temporarily depressed income could indeed offer more utility than a stake in the new industries, which will only pay off in the long term.
Such a utilitarian argument is of course irrelevent if you simply take free trade and no income redistribution as ethical axioms. But that is the not perspective from which either Krugman or Cowen were arguing.
Posted by: David Wright at Dec 29, 2007 10:08:09 PM
"And lower prices at Wal-Mart aren’t sufficient compensation."
This is the major argument in favor of free trade mentioned in Prof. Krugman's article. I haven't shopped at wal-Mart in a while, so I guess I don't benefit from trade.
"When was the last time you were in Ohio or Michigan?"
The automobile production jobs in my area were outsourced to Michigan in 1912. How much better off would we be if we had produced our own cars for the last 95 years?
"Instead of being invested in assets which are increasing in value due to increased output, right-wingers forced all of it to be invested in Treasury notes. "
Oneof the major arguments against private social security accounts was that investment in private companies was extremely risky and consequently was not likely to provide satisfactory long-term returns.
Posted by: The Dirty Mac at Dec 30, 2007 12:02:53 AM
"...government can bear risk far more effectively than a private investor"
In what sense is this true? Not in the Miller-Modigliani sense or in modern portfolio theory. Unless you are indifferent to the risks borne by the residual claimants of government investment (i.e., the hapless taxpayer). Even if gov't could bear risk AS effectively as a private investor, the agency costs of government investment would surely swamp all possible benefits. And that's before the public choice issues raised by such a scheme.
"I haven't shopped at wal-Mart in a while, so I guess I don't benefit from trade."
TDM - Unless you're being facetious, you should know that if you were shopping at any Wal-Mart competitor, you are benefiting from trade (in this sense, at least).
Posted by: M. Hodak at Dec 30, 2007 12:44:52 AM
