Globalization, Jobs, and Wages: Some Additional Perspectives

My post last week on the New York Times’ Economix blog, which looked at how economists’ views are changing regarding the impact of globalization on the American jobs and wages, drew some very interesting responses. Most were of the “what took so long?” variety.

Indeed, the idea that a growing global market for labor would put downward pressure on U.S. wages is rather obvious. As one commenter put it: “Doesn't economics suggest a commodity that can be purchased at different areas in the world will tend toward the same price after frictional effects such as transportation, duties and time delays are accounted for?”

The most critical comments chided me for not endorsing import restrictions to respond to these trends. But as I suggested in the article, there is plenty of historical evidence that such a response only makes things worse. While targeted tariff protection can make sense for limited periods in sectors faced with a flood of low-cost imports (the scenario that WTO-legal “safeguard” measures are meant to address), or for dumped or subsidized goods (which U.S. trade laws are meant to address), broader measures are almost always counter-productive. Import protection raises costs, which makes the U.S. economy less competitive across the board, and invites retaliation that closes export markets. The challenge for the United States is to figure out how to compete more effectively in a global market, not to close itself to competition.

The most interesting comment, however, was one I got from far outside the United States. It came in an email from Lincoln Faruque, a lecturer in the Department of Development Studies at the University of Dhaka in Bangladesh. He suggests that many of the negative impacts of globalization on U.S. wages and job creation are likely to prove transitional, and that as wages rise in the developing world the competitive dynamics could change quickly. With his permission, I quote it here at length.

I strongly appreciate your perspective in the article. However, I felt that sharing my understanding on the subject might produce a fruitful conversation between us.

A careful look in the history of trade depicts that a symbiotic trade relationship between two countries which are strikingly different in terms of per capita income and labor force availability (not size) produces three different outcomes at three time periods - short term (roughly 10-15 years), medium term (15-35 years), and long term. In the short term, the country having higher wages will start losing manufacturing jobs to the other country. This happens because sophisticated machines have made manufacturing jobs easily transferrable (only a short period of training on how to operate these machines is enough!). This does not take place in the service sector for two reasons - a) in the service sector, output is largely dependent on men not machines, and b) the service sector has a large non-tradable part. This export of manufacturing jobs accelerates for a few years and then slows down sharply as the pool of available labor become scarce. This is the end of short term impact.

The findings of the studies that you have quoted in your article largely covered the short-term period and therefore have reached a similar conclusion. But as the short term ends and the medium term begins, this framework of transfer of manufacturing jobs just doesn't hold up. With labor scarce, companies soon feel the pressure of rising wages, which is also an indication of rising purchasing power in the relatively lower income country. So their decision where to create more jobs (whether in the high income country or low income country) depends on two questions: a) Where will the company enjoy lower input costs (raw material, electricity, land) and other related operating costs such as tax rates? The cost of labor drops from the equation. And b) In which country is the size of the market for the concerned product is bigger? Companies tend to locate in the larger market size country and export from there to other countries when other costs are similar.

Though the shaping of this new transformation starts at a snail’s speed, it can shift quickly. You have cited the case of Caterpillar. Please be happy that Caterpillar closed one of its factories in Canada in February 2012 and shifted the jobs to the state of Indiana. They are also abandoning production of some models in Japan and have started to build a new factory in Georgia, where they will produce these models. In both cases they offered the same explanation: “being close to the customer base.” So, the transformation in the medium term depends on economies of scale, not on wage rates. As more companies focus on this proposition and act accordingly, this turns into a wave and re-industrialization take place.

However, it's worthwhile to mention that in the long term, companies’ decisions on where to manufacture largely depends on a) Where they can build new technology, and b) Where they can retain the right of using the new technology exclusively or keeping the exclusiveness of the technology secret. Be assured that the United States will get highest mark in both of these cases. Only Germany and Japan can be a close competitor but they, in aggregate, will lose more than two million working age people in the next decade.

This is one of the better arguments I have read for why the United States, despite its many challenges, retains enormous advantages as a location for multinational business. Sometimes these things look clearer from abroad than they do from home.