There is a famous theorem in international economics – the Stolper-Samuelson theorem – that says when a rich capital-abundant country (such as the U.S.) trades with a poor labor-abundant country (such as China), wages in the rich country fall and profits go up. The theorem’s economic logic is simple. Free trade is tantamount to a massive increase in the rich country’s labor supply since the products made by poor country workers can now be imported. Additionally, demand for workers in the rich country falls as rich country firms abandon labor-intensive production to the poor country. The net result is an effective increase in labor supply and a decrease in labor demand in the rich country, and wages fall.
The relevance of the Stolper-Samuelson theorem is clear. For the last two decades, U.S. policy makers, from both major political parties, have worked assiduously to create a global market place in which goods and capital are free to move. Over the same period, two and one half billion people in China, India, Eastern Europe and the former Soviet Union have discarded economic isolationism and joined the global economy. Now, these two tectonic shifts are coming together in the form of a “super-sized†Stolper-Samuelson effect, and they stand to have depressing consequences for American workers.
Much attention has been devoted to the adverse impacts of the U.S. trade deficit, particularly with China. And the U.S. government has been rightly criticized for failing to apply adequate pressure to get China to remedy its unfair and illegal trading practices. However, no one in Washington is talking about the deeper question of what happens to wages when two billion people from low wage countries join the global labor market.
Such an event is unprecedented in history. In the past, countries joined the international economy through a slow evolutionary process. Initially, they would export a few goods in which they specialized and had natural competitive advantage. Thereafter, countries would gradually deepen their involvement in international trade. The process was one of gradual integration, and production was largely immobile across countries.
Globalization has changed this by accelerating the process of international integration. It has also made capital, technology, and methods of production mobile, marking a watershed with the past. The new order is exemplified by China’s recent experiences. In less than two decades, China has become a global manufacturing powerhouse through massive foreign direct investment and technology transfer. The impact of this transformation on the U.S. economy is seen in the trade deficit, the loss of manufacturing jobs, and downward pressure on wages.
Whereas classical free trade connected goods markets across countries, globalization creates a global labor market and moves jobs. Previously trade arbitraged goods prices, now it also arbitrages wages through job shifting. With the emergence of China, India and Eastern Europe, the dam of Socialism that held back two billion workers has been removed. If two swimming pools are joined, the water level will eventually equalize. That is what is happening with globalization. Manufacturing has already been placed in competition across countries, with dire consequences for manufacturing workers. The internet promises to do the same for previously un-tradable services, and higher-paid knowledge workers will start feeling similar effects.
Not since the industrial revolution has there been a transformation of this magnitude, and that revolution took one hundred and fifty years to complete. By comparison the new revolution is a mere twenty-five years old. These developments have a significance that goes far beyond the currency manipulation and WTO rules violations that have been the focus of trade deficit policy discussions. There is no reason to think the end is in sight, and American workers can look forward to the international economy exerting downward pressure on wages and work conditions for the next several decades.
As is so often the case, workers have understood the new reality long before economists and policymakers. Workers realize that trade is no longer a matter of exchanging exotic commodities for manufactured products, and that the new system involves trading their jobs and arbitraging wages. Especially bitter, is the fact that the process of globalization is being driven by large American multinational corporations that American workers helped build. U.S. policymakers have also abandoned American workers by promoting free trade agreements that have de facto created a global labor market that threatens workers’ livelihoods and economic security.
Globalization demands that we begin anew the task of establishing fair and just rules that make the economy work for all. This challenge is the same as that faced by American workers at the beginning of the twentieth century. Unions, minimum wages, and fair labor practices were essential to meeting that challenge, and they are essential again. But such tools are no longer sufficient when applied nationally. They must be applied globally. That means China, India and other industrializing developing countries must agree to, and enforce, core labor standards and worker rights. Trade cannot be free without worker freedom and the right to share in the wealth created.
Successive administrations have pushed free trade without worker protections and they have given the green light to a global system without core labor standards. Through poor diplomacy and lax enforcement we have given away access to U.S. markets and valuable negotiating leverage without getting commitments on labor standards in recent free trade agreements. The consequences of these trade policies and the reality of the new global system must be exposed so that our approach can be changed. This is a task that will not be easy given Washington’s captive economic policy elite and big business’ interest in concealing the new reality.
Tom,
As someone who works for one of the world’s largest banks, I witness the daily effects of what outsourcing is doing to both the morale of American workers and our economy. On the one hand, our bank is making record profits and the senior executives are collecting massive bonuses, apparently not the least embarrassed that they’re making between 100 to 400 times more than the average worker, including bonuses and stock options–and this in an industry that pays higher than most.
We’ve seen not just technology jobs outsourced to India and other countries but marketing, finance, and personnel jobs as well. The executive attitude is that globalization is inevitable, that it’s now business as usual so accept it. If you don’t like it, then you’re not a team player. Well, it’s pretty hard to accept change like that when, like a colleague of mine, you’re training someone in India on information systems so that this person can have your job. Compund it with the insult that your manager has made that fate quite clear to you. Talk about a de-motivator! Who can build trust and teamwork, yadda yadda, in a corporate culture with such a twisted, duplicitous ethic?
One of the problems is that since life is still pretty good for most of the people at this and other banks, there’s a lack of understanding and empathy toward those who are have lost or are losing manufacturing jobs as the result of our economic policies and practices. They live in a state of denial. As long as they’re relatively well employed, they accept our current federal administrations policies without exploring their true ramifications on the poor to lower-middle class. Until they honestly acknowedge how that global economy could negatively effect them unless we put some protective measures in place against unfair partners such as China, they’ll remain willfully ignorant and disdainful of those with less. They’ll be like the people who shop at Wal*Mart who don’t realize that the more they buy the more they put their countrymen out of work.
Sorry about some of the misspellings– “effect” rather than “affect” and “administrations” rather than “administration’s”
Good points. I beleive William Baumol, a noted ecomonmist ,has computed that open trade is not necessarily good for the US for the same reasons you state. As well Clyde Prestolitz.
But I offer another point. What makes matters worse is that we appear to be in the midst of what I’m calling “immigrant fever.” Throwing away laws of supply and demand, the enabling classes of the left and right, advocate for a double whammy: not only can capital sail around the world for the cheapest labor cost, but american citizens should take it on the chin and accomodate many millions increases a year for the sake of ‘the immigrant’ – we must not turn away anybody or we are racist or culturalist or lazy, and/or in some cases one’s friends, and there families, and their friends and families, and so on still need to get here.
We’re attacked from both ends. Are we a nation anymore?
Would you please comment on the corollary? As wages fall as we see and you describe, won’t soon a house also cost what it costs in China? As labor in China is about a tenth of what it is here, won’t that be a problem for millions who could find their homes worth a tenth of what they are now?
Dear Sir,
The problem is it would take 6 to 9 planets for all the people of earth to live as well as I do. And I don’t live that well for an American.
So if there aren’t enough resources, food, water, and money for everyone to have indoor plumbing, 2 healthy meals a day, and minimal health care, what should we propose?
O, and then there are the other species with which we are mutually interdependent on the planet. There is not enough land and water to sustain healthy populations of most other species and let all those 2 billion poorer people eat well and be employed. The other species require ecosystems which we can’t destroy if they are to live, but which we must destroy if we are to employ people in a socialist or capitalist set of enterprises.
So it seems we need to come up with some quite different economic systems; some that incorporate sustainability, if that is even possible.
Thoughts?
Martha E. Ture
As wages fall in the rich country, who purchases the cheap goods? What ever happened to Henry Fords idea in the 20s that he had to pay decent wages so that his employees could buy his Fords?
It seems to me that falling wages mean falling purchasing power and a consequent depression, maybe a 1929 type depression or worse. What will prevent this? Can the billions of new low wage workers create sufficient demand?
As wages fall in the USA, wages are rising in China and India. US multinationals are partnering with local companies to reach these newly affluent consumers. The dollar we no longer have to spend here is being captured over there.
For Martha:
Surely you already realize the answer to your question:
Human populations must shrink.
Shrink in size or drown in our own excrement — that’s about where the human species is now.
I totally agree with Thomas Palley’s application of the well-known but totally ignored Stolper-Samuelson theorem to today’s global labor markets.
The perverted way “economists” mis-apply and selectively apply international trade theory to modern realities is a shame on the profession. All we hear from “economists,” all of whom have the Stolpler-Samuelson theorem at the ready, is about how these theories show that, after all is said and done, more free trade always raises overall utility. They admit that “there will be some losers” but insist that the “overall gain provides enough to always allow conpensation of those losers.”
So, they are willing to ASSUME compensation of said losers, when we all know that said compensation is as rare as hen’s teeth.
Given all this, how can we prevent the collapse of our standard of living?
One: Institute progressive taxation to redistribute the wealth back down from the heights of concentration which are the inevitable result of the action of Stolper-Samuelson in today’s environment (wages fall, profits rise — the rich get richer and wealth becomes concentrated).
Two: Spend as much of that tax income as necessary to provide women’s health care to every human being on the planet, to the extent physically and politically possible. Our current government policy in this regard (yes, they just embargoed the paltry $34mn earmarked for the UNFDP again, for the fourth year) is benighted. Every woman, every couple on the planet should have access to contraception and well baby care.
Only when the supply of cheap labor is staunched will global wages start to rise again.
Why is this not obvious?
We should be working hard toward the stabilization of global populations at as low a level as possible as part of an enlightened struggle to allow the living standards of eveyone on the globe to converge to a decent level. The difference between global populations stabilizing and beginning to fall from 7 billion and 10 billion is HUGE HUGE HUGE. Not just for the hapless billions starving in Chad. For all of us.
Even Bangladesh has entered the global labor market — manufacturing textiles.
Our American living standards will converge with those of the Third World over the next 100 years. All will converge — excepting a tiny cabal small and rich enough to afford walled enclaves, bullet-proof cars, anti-kidnap microchips in their children, private armies ringing their real estate and governments in their hire. The rest of us will all converge — at some level.
Rather than to see mass poverty spread inexorably from the cesspools of humanity in places like Pakistan (5 children per woman) and Nigeria (7 children pre women) to take in more and more of the Third World and then lap up upon our shores, pulling more and more of our underclass and working poor into the same morass of endless work, struggle, disease and destitution, we must work to bring up the standard of living of all the masses of the globe by actively stressing the importance of the stabilization and shrinkage of the human population.
Jan VanDenBerg
To Dave Chisler:
Economic theory predicts that there will be an overall gain in utility from trade — they just don’t discuss who is going to get that utility.
Well, it is going to go into profits, here. Clearly.
So, the ultra-rich are going to buy all those cheap products.
I don’t see any reason why the full application of the Stolper-Samuelson theorem to the real world today would result in a depression. Just a very unequal distribution of the gains of trade.
So, the poor would be working hard producing luxury goods and services for the consumption of their bosses and their bosses’ wives and children. Producing goods like beautiful vacation homes and elaborate restaurant meals and services like nannies’ work, maids’ work and so on.
Dear Friends,
Thank you for your comments. They are a real pleasure and inspiration to read.
I sense a concern about the broader economic implications of eroding wages and incomes. This shows up in Luna Didi’s and Doug Page’s questions about what will happen to house prices and who will buy what gets produced. This concern is absolutely right, and I have a piece that I will be posting ten days from now on this subject.
One thing I must emphasize is that I believe we must resist becoming an “exclusionary” society. That means resisting ugly temptations to turn on those who have not. There is an “inclusionary” solution that can make the global economy work for all. Articulating that solution and building political support for it is a major goal of this weblog.
To turn on the have nots will take us down the political path of the 1930s. Such a path will not produce prosperity and happiness, and will only produce hate and the destruction of democratic and open society.
In solidarity,
Tom Palley
Mr. Palley this is the frist article that I have read which describes the facts , which are all G7 businesses are racing to the bottom to cut their costs and improve profits . The solution is a world minimum wage based on the minimum wages of the G7 Nations , don’t stop reading yet , this is not a true minimum wage ,it would only be paid by businesses that moved production outside their home countries borders initially and only paid on products or services to be exported to a G7 Nation , any other country or domestic products and services would be at the home country’s prevailing wage. If we look at the unemployment rate of the G7 Nations the outsourcing of jobs has cost them dearly . This policy would slow the outsourcing and allow the cheap labor to actually benefit from free trade , thus stimulating the local economies where these people work . The only way to acheive this policy given the special interests , GREED OF BUSINESS , influence over politicans , a world wide ad campaign describing this idea and some way for the G7 Nations to impose the will of the people on the business community , that is the problem . What do you think ?
Dear Mr. Palley:
After reading your very impressive analysis of the economic forces at work in our world right now I felt like sending you something I wrote on the subject recently. Your comment or criticism would be welcomed.
Fueled by the Industrial Revolution the capitalist system broke the brutish shackles of feudalism on the people of the day. If the economic system was a fresh young pup in that historic epoch, it today looms over humanity as a rabid nuclear-armed beast that will either be put down or destroy human life on this planet.
Time has seen the United States of America emerge as capitalism’s favorite son and sharpest instrument. During its formative years American capitalism actually encouraged a Civil War victory for anti-slavery forces. Later, in a time of severe crisis called the Great Depression, it saved itself with New Deal reforms and rose up to militarily defeat its fascist European and imperialist Japanese capitalist rivals.
The most serious attempt ever to build a socialist state after the Russian Revolution and the fleeting erratic effort in China after 1949, touched off a brief period challenge and uncertainty but American capitalism steeled itself throughout the Cold War and emerged with possibilities for world domination most immediately grasped by the so-called Neo-cons. So since the election of Ronald Reagan in 1980 has the US has accelerated toward a failsafe point, a Rubicon of sorts.
There is no turning back now! Unchecked by a revolutionary struggle based on the idea of sharing the world’s resources, capitalism will by its very nature turn the Earth into a giant slave labor camp. Even at that, the system will then stare into the eyes of one of its fatal contradictions. Slaves can not buy the products they produce. A Brave New World? Only for a handful at most.
Capitalisms appetite for profit simply can not be satisfied! For example U.S. oil corporations realized world record profits last year and this year as gasoline prices race past $3.00 a gallon they will increase that profit margin. But unless these entities make even greater profit into the indefinite future they will whither and die. There is only so much technology can boost production or wages can be depressed until a slave system must be created.
Capitalism has now armed itself with doomsday weapons and created an immune system for itself. It influences culture and controls the mass media and education across a growing part of the world, places its servants in seats of political and military power, and creates philosophy and myth to glorify its own existence. Much like the human body’s white blood corpuscles, the capitalist system can call on an army of economists from M.I.T. or the University of Chicago to repel threats to its lifeblood, profits.
Time grows short.
Mr. Palley
I give you an “A” for defining a problem but we need a solution.
Wages can equalize two ways: low wages can rise, or high wages can fall. I don’t see why globalization is necessarily a race to the bottom if trade is balanced. Wages abroad could slowly rise while the wage erosion here could be compensated for with lower prices–no net loss in real purchasing power need occur.
In the long run, money is a veil and trade is barter; imports can only be paid for with exports of real goods and services. This implies a migration of workers from sector to sector within our borders (as we play to our comparative advantages), but not unemployment. Isn’t the real problem the US trade deficit? Could we be in the fix we’re in without that flood of paper money issuing from our shores? Isn’t all that dollar liquidity sloshing around the world doomed to vaporize someday (since it isn’t going to be spent)?
Also, don’t the deficits, immigration policies, and scare mongering about demographic meltdown all have the common element of allowing elites to put public assets (assets in the very broadest sense) into their private pockets?
Ah, but your detractors are always ready to say: “yes, the off-shoring of work will cause the real wages of U.S. workers to stagnate, but off-shoring will also lower the price of consumer goods and services, and the net effect will be to increase the purchasing power of the U.S. worker.”
How do you respond to this statement? My hunch is that the decrease in real wages is not fully offset by lower prices of consumer goods and services. Meanwhile, the wealthiest Americans see large real gains in their incomes.
OK What happens when a war breaks out in this model then steel stops shipping. to make tanks and the assorted peraphenailia…such. and other raw material .and it will be too late to start up, build and initiate product. I will be too late to protect this model.
What do you think now. This crippling affect, how long do you expect it to last.??
Thank you!
Mr. Palley,
Can you direct me to the best and latest data available which quantifies the pattern of wage erosion we have sustained in the US over the course of Globalization?
Best Regards,
C Vanella