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FRBSF
WEEKLY LETTER
Number 94-40, November 18, 1994
International Trade and
u.s. Labor Market Trends
During the last 20 years, wage growth has stagnated and family incomes have diverged. The
slowdown in wage growth is illustrated in Figure 1.
From 1948 to 1973, real hourly wages grew on
average by about 2 percent per year. By 1973
the average realwage had risen to $8.55 (measured in 1982 dollars). Since then the average
real wage has actually declined, so that by 1992
average real hourly earnings had fallen to $7.42
(again measured in 1982 dollars). Even if we consider a broader measure of compensation that
includes nonwage fringe benefits, like employerprovided medical insurance, it is clear that wage
growth slowed dramatically after the mid-1970s.
As if this weren't bad enough, the slowdown in
wage growth has been accompanied by growing
inequality. Figure 2 portrays the varying fortunes
of different segments of the U.S. income distribution. The shaded bars show the rapid, broadbased growth that occurred in the 1950s and
1960s. If anything, incomes of poorer households
grew more rapidly than incomes of wealthier
households. This trend toward greater equality
came to an end in the 1970s. The stair-stepped
pattern of the unshaded bars shows that during
the past twenty years, and particularly during the
1980s, family incomes diverged. Households in
the bottom 40 percent of the income distribution
actually saw their real incomes decline, while
those in the top 40 percent experienced a mild
increase in income. Those who fell in the middle
20 percent saw their real income remain essentially frozen at its 1973 level.
Many explanations have been offered for these
disappointing developments, ranging from the
sociological to the political. However, one explanation in particular has been receiving widespread attention recently-namely, that the
declining fortunes of U.S. workers are somehow
related to the increasing 'globalization' of the
economy. The argument does have an air
of superficial plausibility to it, in the sense that
declining wages and growing inequality occurred at roughly the same time that international
trade grew in importance. For example, in 1973
u.s.
Figure 1
Real Hourly Compensation and Wages
1982-84 dollars
12
.......................
..
. . ' Hourly Compensation
10.5
9
7.5
6
4.5
3
1.5
O+--.---,r---r---.---,r---r----..-.---..,....--r--,
48 52 56 60 64 68 72 76 80 84 88 92
Figure 2
Average Annual Growth of
Mean Family Income by Income Quintile
I E147-73
Percent
3 2.99
2.5
2
1.5
0.5
o
-0.5
-0.69
- -1
Lowest
Second
073-92
I
FRBSF
imports and exports comprised only about 6
percent of GNP. By 1993, however, the share of
imports and exports had approximately doubled-to about 12 percent. While the timing of
these events is suggestive, one must remember
that correlation does not necessarily imply causation. !n fact, recent work by Lawrence and
Slaughter (1993) argues that international trade
had only a peripheral role to play in these domestic labor market developments. This Letter
will survey these arguments.
Does international trade explain
the decline in average real wages?
According to Lawrence and Slaughter, the answer to this question is no. They base their conclusion on the following three-step argument.
First, they demonstrate that once the proper price
deflator is used, real wage growth equaled productivity growth during the past twenty years.
That is, workers were paid for what they produced, so that declining wages were not the result of a shift in labor's share of income tovlard
capital owners or toward foreigners. Thus, to explain the stagnation in wages we must explain
the slowdown in productivity.
The second step of Lawrence and Slaughter's
argument is to demonstrate that most of the
productivity slowdown occurred in the service
sector. Specifically, between 1979 and 1990
output per hour in manufacturing grew by 30.7
percent, measured in 1987 dollars. This is quite
close to the historical average. However, during
the same period nonmanufacturing labor productivity grew by a mere 4.5 percent. Thus, the
dismal performance in nonmanufacturing productivity is the primary cause of the slump in
aggregate productivity growth, and therefore
in real wage growth.
Of course, this does not rule out the possibility
that international trade is the culprit behind slow
wage growth because international trade could
have induced a shift out of manufacturing and
into services. Therefore, the final step in Lawrence and Slaughter's argument is to discredit
the idea that international trade has led to a 'hollowing-out' of the U.S. manufacturing base. First,
the relative decline of manufacturing has been
occurring for a long time, and has taken place
in all OECD economies. In fact, they claim that
manufacturing has declined because it has been
relatively productive. Just as in the earlier decline
of agriculture, mechanization has enabled industrial economies to satisfy their (income inelastic)
demands for manufactured goods with fewer and
fewer factory hands. Second, as an empirical
matter the argument that international trade
caused a massive shift out of manufacturing just
doesn't hold water. Even if you adopt the extreme
assumption that each dollar of manufactured imports displaces a dollar of domestic manufactures, it is not possible to attribute the magnitude
of the productivity slowdown to the U.S. trade
deficit in manufacturing. For example, in 1991
the U.S. trade deficit in manufacturing was $47
billion, or about 5 percent of manufacturing
value-added. Increasing the manufacturing sector
by 5 percent, however, would have increased aggregate productivity growth by only 0.3 percent.
Does international trade explain the
increase in inequality?
The trend toward greater inequality has been
driven by a growing discrepancy between the
earnings of skilled and unskilled labor. For example, between 1979 and 1988 the ratio of the
average wage of a college graduate to the average wage of a high school graduate rose by 15
percent. The divergence was even greater for the
relatively inexperienced. In 1979 the hourly wage
of a college graduate with fewer than five years
work experience was 30 percent more than the
\vage of a high schoo! graduate vvith similar experience. By 1989 this premium had soared to 74
percent. To attribute the increase in inequality to
international trade, we therefore have tb explain
how international trade could lead to a divergence between skilled and unskilled wages.
Here the argument seems more compelling.
According to traditional trade theory, a nation
exports goods that use its relatively abundant
factors intensively, and imports goods that use its
relatively scarce factors intensively. In a sense,
trading commodities that embody factors in different proportions allows nations to indirectly
trade the factor services themselves. (This theory
is known as the Heckscher-Ohlin modeL) Given
the United States' relative abundance of skilled
labor, this theory predicts that the U.S. should export products that make relatively heavy use of
skilled labor, while it imports products that make
relatively heavy use of unskilled labor.
Because trade in commodities is just an indirect
way of trading the underlying factor services, international trade tends to raise the real incomes
of owners of a nation's abundant factors and
depress the real incomes of those who own
its scarce factors. (This result is known as the
Stolper-Samuelson Theorem.) For example, from
the perspective of an unskilled U.S. worker it
makes little difference whether his wages are
driven down directly via relaxed immigration
laws that let in more people from low-wage countries, or whether his wages are driven down
indirectly via the importation of commodities
that make heavy use of unskilled labor.
Notice how the Stolper-Samuelson Theorem
predicts that international trade causes an increase in income inequality (at least in the
United States, where skilled labor is relatively
abundant). Skilled workers-who are already
in the upper end of the income distributionfind their incomes increasing as exports expand,
while unskilled workers are forced into accepting
even lower wages in order to compete with
imports.
To evaluate the empirical significanceof the
Stolper-Samuelson Theorem, Lawrence and
Slaughter examine two pieces of evidence. First,
the mechanism through which the Stolper-Samuelson Theorem works is a change in relative
prices. Price changes provide the incentives for
resources to shift between sectors. Those industries with rising prices try to expand and-those
with falling prices are forced to contract. However, because industries use factors in different
proportions, a change in the composition of domestic output will produce an excess demand for
the factors used intensively in the expanding sectors, and an excess supply of the factors used
intensively in the contracting sectors. This is the
basic, underlying reason why international trade
affects the distribution of income.
Unfortunately, after studying price developments
in dozens of U.S. manufacturing industries during the 1980s, Lawrence and Slaughter found
Iittle evidence that prices of goods that make
heavy useof skilled labor increased relative to
the prices of goods that make heavy use of unskilled labor. This casts doubt on the applicability
of the Stolper-Samuelson Theorem.
A second piece of doubtful evidence on the applicability of the Stolper-Samuelson Theorem concerns the relative use of skilled and unskilled
labor in production. If in fact wages of skilled labor were bid up at the expense of unskilled labor
due to a shift in production toward skilled laborintensive industries, we should observe that all
industries increased their relative use of unskilled
labor. This is because as skilled labor becomes
relatively more expensive, producers should
economize on its use by shifting toward a more .
unskilled labor-intensive mode of production.
Again, Lawrence and Slaughter found no evidence that such a shift has taken place. If
anything,
manufacturing industries have
increased their relative use of skilled labor.
u.s.
So what is the explanation?
Lawrence and Slaughter conclude that technological change is the most likely source of
growing wage inequality in the U.S. Inparticular, they argue that the fears of 19th century
workers-that they would be replaced by machines- is probably closer to the truth than is
the Stolper-Samuelson Theorem. They point to
various technological changes that have put a
premium on skilled labor, the most obvious such
change being the 'computer revolution' of the
late '70s and early '80s.
Related changes have occurred in multimedia
and telecommunications. As discussed in a
prophetic article by Sherwin Rosen (1981), these
advances are producing a 'superstar' economy,
in which rewards are based on a winner-take-all
competition. Nowadays the best singer, violinist,
athlete, or whatever, can market their talents to
a vast audience at very low cost. Additional support for this phenomenon comes from evidence
that earnings inequality has become greater
within professions, so that growing inequality
has something of a 'fractal' quality about it.
Perhaps the most evocative image of this sort of
labor market has been attributed to economist
Avinash Dixit. Dixit has suggested that technological change is turning industrial nations into
"Sierra Madre economies:' a phrase borrowed
from the classic Humphrey Bogart film The Treasure of the Sierra Madre. In this film an old prospector explains why those who discover gold be
come so rich-"It's because they collect the wages
of all those who set out to find gold but don't!"
Whether these developments are good or bad is
unclear. Certainly, the popularity of state lotteries
suggests that people value ('excessively') minuscule possibilities of striking it rich. If the same
trade-offs are presented in the labor market, is
this such a bad thing?
.
Kenneth Kasa
Economist
References
Lawrence, Robert Z., and Matthew Slaughter. 1993.
"International Trade and American Wages in the
1980s: Giant Sucking Sound or Small Hiccup?"
Brookings Papers on Economic Activity.
Rosen, Sherwin. 1981. "The Economics of Superstars:'
American Economic Review 71, pp. 845-858.
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor or to the author.... Free copies of Federal Reserve publications can be
obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 974-2246, Fax (415) 974-3341.
Research Department
Federal Reserve
Bank of
San Francisco
P.O. Box 7702
S.an Francisco, CA 94120
Printed on recycled paper Q
.6,
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\V ~
Index to Recent Issues of FRBSF Weekly Letter
DATE NUMBER TITLE
4/29
5/6
SIB
5/20
5/27
6110
6/24
711
7115
7/22
8/5
8119
9/2
9/9
9116
9/23
9/30
10/7
10114
10/21
10/28
11 14
11111
94-17
94-18
94-19
94-20
94-21
94-22
94-23
94-24
94-25
94-26
94-27
94-28
94-29
94-30
94-31
94-32
94-33
94-34
94-35
94-36
94-37
94-38
94-39
California Recession and Recovery
just-In-Time Inventory Management: Has It Made a Difference?
GATS and Banking in the Pacific Basin
The Persistence of the Prime Rate
A Market-Based Approach to CRA
Manufacturing Bias in Regional Policy
An "Intermountain Miracle"?
Trade and Growth: Some Recent Evidence
Should the Central Bank Be Responsible for Regional Stabilization?
Interstate Banking and Risk
A Primer on Monetary Policy Part I: Goals and Instruments
A Primer on Monetary Policy Part II: Targets and Indicators
Linkages of National Interest Rates
Regional Income Divergence in the 1980s
Exchange Rate Arrangements in the Pacific Basin
How Bad is the "Bad Loan Problem" in japan?
Measuring the Cost of "Financial Repression"
The Recent Behavior of Interest Rates
Risk-Based Capital Requirements and Loan Growth
Growth and Government Policy: Lessons from Hong Kong and Singapore
Bank Business Lending Bounces Back
Explaining Asia's Low Inflation
Crises in the Thrift Industry and the Cost of Mortgage Credit
AUTHOR
Cromwell
Huh
Moreno
Booth
Neuberger/Schmidt
Schmidt
Sherwood-Call/Schmidt
Trehan
Cogley/Schaan
Levonian
Walsh
Walsh
Throop
Sherwood-Call
Glick
Huh/Kim
Huh/Kim
Trehan
Laderman
Kasa
Zimmerman
Moreno
Gabriel
The FRBSF Weekly Letter appears on an abbreviated schedule in june, july, August, and December.
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