Brookings Papers on Economic Activity Vol. 1994, No. 1 (1994), pp.

1-84 Written by:

Jeffrey D. Sachs Howard J. Shatz

Presented by:

Between 1978 and 1990, the volume of trade between the US and the rest of the world, particularly developing nations, increased dramatically.

At the same time, we notice particular industryspecific labor market trends.

For example, if we look at manufacturing, then we see that overall employment declined, fewer unskilled workers were employed, and the wage gap between skilled and unskilled workers grew larger.

These trends are not random, but have a theoretical basis: the Heckscher-Ohlin-Samuelson (HOS) model. According to HOS theory, if the low-wage trading partners of the US which formerly had protectionist trade policies suddenly adapt trade policies that favor market liberalization, then the following occur in the domestic country: Non-skill intensive goods become cheaper compared to skill-intensive goods (since the low-wage countries are exporting more non-skill intensive goods).

The wages of low-skilled workers declines relative to the wages of high-skilled workers, since the demand for low-skilled workers has diminished, which leads to an income gap, that is wage inequality.
Goods that require high-skilled labor will be produced in more abundance than those that require low-skilled labor.

US will export more skill-intensive goods and import more non-skill-intensive goods.
Productive sectors will employ more high-skilled workers compared to low-skilled ones. In low-wage nation, opposite of above trends occur.

What role has trade played in the labor market trends, such as unemployment, wage gap, decrease of manufacturing exports, etc. More specifically, is trade or technology the primary culprit?

Paul Krugman and Robert Lawrence: Competition from abroad has played a minor role in the contraction of US manufacturing. Foreign competition has had minimal impact on wages and employment . View also held by Matthew Slaughter, Vivek Dehejia, and Jagdish Bhagwati. They point to technological change as the primary driver of labor market trends; for example, high productivity growth (to be discussed in the next slide).

We want to know whether there is a link between the phenomena mentioned earlier. Krugman and Lawrence: Any such link is negligible. In their view, manufacturing is contributing less to GDP because of high productivity growth. Methods of production have become more streamlined and efficient, so that the relative price of manufacturing goods to non-manufacturing goods has fallen dramatically.

Assuming that the demand for manufactured goods is inelastic, then a fall in the relative price of manufactured goods means consumption will also decrease accordingly, which in turn translates into less production of manufactured goods.

Draws analogy to agriculture: As was the case with agriculture, high productivity growth has caused workers to leave manufacturing, leading to increased manufacturing unemployment.
Krugman and Lawrence may be right about predicting the pattern of long-term trends, but the short-term is a different story. Consider, for example, the period ranging from 19781990.

Between 1950 and 1978, manufacturing employment grew by 1.3 percentage points. If this trend had continued, then between 1978 and 1990, we should have seen an increase of 1.7 million jobs.
Instead what we see is a loss of 1.4 million jobs, which fails to account for the behavior of 1.7 + 1.4 = 3.1 million workers. In effect we have an employment puzzle. Similarly, we also have a wage puzzle. Refer to Table 2. Here we see that the ratio of the wages of unskilled workers to skilled workers shows a noticeable increase in the 1980s.

On the other hand, similar increases in wage inequality were detected in other industrial economies, suggesting that global rather than U.S.-specific effects were at play.
How do we explain this? One candidate for a "global" effect is increased trade competition with developing countries.

Why has trade with developed nations increased?

The increased in U.S. trade should be viewed as an exogenous force affecting the United States and other economies; in other words, it is not the direct result of US economic policy

Trade liberalization (e.g. Tokyo Round of GATT, 1979 and Uruguay Round, 1993)
Polices that favor market liberalization in developing world

Cheaper communications and transport.

Increasingly educated labor force in developing nations (average number of years of schooling was 2.4 in 1960 and 5.3 in 1986) From 1978-1990, most of the increased U.S. trade was with 9 developing countries: seven East Asian nations (China, Hong Kong, Korea, Malaysia, Singapore, Taiwan, and Thailand) and two Latin American economies (Brazil and Mexico)

1980s: East Asian economies were industrializing and Latin American nations adapted more liberal trade policies.

East Asian nations: experienced export growth due to low-wage labor, highly flexible labor markets (e.g. market adapts rapidly to fluctuations in supply and demand), macroeconomic stability (e.g. moderate rates of inflation, unemployment, etc.), very high rates of national savings, gov. support for manufacturing.

1980s were especially important

East Asian nations; export growth in Southeast Asia (especially Indonesia and Malaysia) that started in the 1970s took off in the 1980s

Chinese trade reforms that began in 1978 resulted in especially high export growth after the mid-1980s.

Latin American export growth came in 1980s, example: Brazils manufacturing export sector saw especially high growth in the 1980s, following an earlier debt crisis.
Mexico emerged as a manufacturing exporter in mid1980s. Nine partner countries increased trade with entire world: proportion of total world trade was 7.4% in 1978 and 13.0% in 1990.

Does the HOS Model support the claim that the US became a net exporter of skill-intensive products and a large net importer of non-skill intensive products? Answer is YES for developing nations and NO for developed nations.
We can see this by looking at the data for net trade balance relative to total trade flows. If the net trade balance is positive, then exports are greater than imports. If net trade balance is negative, then imports are greater than exports.

We use a disaggregation of trading partners, as well as the equation (Xi Mi )/(Xi + Mi), where Xi is the dollar value of exports, Mi is the dollar value of imports, and i corresponds to the decile of the skill intensity.
A decile of 1 corresponds to the highest skill level, and 10 the lowest.

Table 7: As the decile increases, the trade deficit is much greater for trade with developing nations than it is for trade with developed nations.

Trade and Employment Changes in U.S. Manufacturing, 1978-90

The widening of the skilled-unskilled wage differential started in the late 1970s and early 1980.
Wages in export sectors have done better than wages in import-competing sectors. Since the export sectors are skill-intensive, high-wage sectors, a pattern in which export workers gain while importcompeting workers lose would be consistent with widening wage inequality.

The volume of trade is positively related to population and to partner per capita income . A doubling of per capita income leads to more than a doubling of trade. Trade is negatively related to distance. Foreign-based production in low-wage countries is used as an export platform for reexport to the United States.

Two basic forces are at work:

1) Increase in trade competition coming from low-wage countries as a result of trade and investment liberalization China, India, Mexico, and the former socialist economies increase in low-wage competition.
2) As economic development proceeds, the low wage countries of today will become the middle-wage countries of the future - Europe and Japan between the 1960s and 1980s ease some of the pressures on low-skill employment.

A cross-country equation shows that in 1990, each 1 % narrowing of the gap income (per capita GDP) with the U.S is associated with a 1.42 % narrowing of the wage gap with the U.S.

Continued rapid rise of trade with China for two reasons: 1) Continued rapid growth of Chinese GDP and very rapid increases in foreign direct investment in China, which promise a rise of TNC based trade. 2) China will remain a low-wage country for the foreseeable future.

With respect to the GDP gap of 1.4, after 10 more years of rapid Chinese growth, the Chinese wage will still be only 3.2 % of the U.S. wage. India. Former socialist economies. Mexico.

U.S trade with developing countries has grown markedly over the past 15 years -characterized by the patterns suggested by the Heckscher-Ohlin-Samuelson theory.

Internationalization - employment sharply in low skill sector, in high-skill sector. Trade - relative prices of less skill-intensive goods , inequality of earnings between low skilled and highskilled workers although the weight of the trade effect is uncertain.

U.S responds to the pressures of HOS-type trade by offering modest levels of trade protection to low-skill sectors - diminished in the future as a result of the new Uruguay Round, as the MultiFiber arrangement is phased out.

Increased trade with the developing countries is likely to exacerbate some of the observed trends.
Dislocations to low-wage manufacturing workers deserve continued policy attention-The Clinton administration's call for programs of enhanced job training and assistance in job relocation would seem to represent important policy initiatives in the face of the continuing internationalization of the economy.

We believe the vast majority of the trends described in the paper are consistent with the US economy transitioning from manufacturing-based to services-oriented. The net benefit to the USA of trade with developing nations is a positive one. Consumers in the USA benefit from lower prices, American workers gravitate towards higher-skilled, higher-wage jobs, and workers in the low-wage nations benefit from higher wages than otherwise, while industries in low-wage nations have potential for increased productivity growth.

Although trade has contributed to the labor market trends, technology has also played a vital role. In fact, we believe technology has played just as important a role as trade. On the one hand, such things as automation and advanced computing have taken the place of humans on the factory floor.

At the same time, it is technology that has enhanced trade by cutting down on the cost of transportation, increasing the speed of communication, and keeping track of the data.