Globalisation, China and the mystery of wage stagnation in developed countries

There is growing evidence that the wages of middle class workers in both North America and Europe have stagnated for the past several decades. For the first time in recent memory children in these countries face the prospect of earning less than their parents.

The initial reaction has been to blame the lower wages on the slower growth of productivity. But recent studies have shown that wages have failed to keep up even with the slower productivity. The prestigious Economic Policy Institute has calculated that between 1973 and 2013 production/ supervisory workers hourly pay increased 9% while productivity increased 74%.

There is a suspicion that the failure of wages to grow is due to globalisation and more specifically the recent trade treaties which have lowered barriers to imports, especially those from low wage developing countries.

The possible link between wage stagnation and trade liberalisation has fuelled growing opposition to new trade treaties. In the U.S., both major political parties contesting for the presidency have displayed not only a lack of enthusiasm but even downright opposition towards new trade pacts.

There is similarly disenchantment with trade liberalisation in Europe. After three years of discussions. Germany, Austria, Belgium have all voiced opposition to the Transatlantic Trade and Investment Talks (TTIP). France has called for an outright halt to these negotiations.

This is a marked reversal of previous trends. For decades the lowering of trade barriers was considered in a positive light. This was backed up by one of the most revered theories of economics. Some 200 years ago David Ricardo proved that free trade is a win-win situation. All countries party to such

treaties gain. So, what has gone wrong?

Although it is accepted that free trade will benefit all participant countries, very little is said about who (which groups) within these countries will gain and which might lose. Some insight into this is provided by another part of trade theory which goes by the daunting name of “factor price equalisation”. This simply means that with free trade, wages for similar workers in high wage and low wage countries will tend to converge. Wages in developed countries wages will tend to decline while those in low wage developing countries will tend to rise. The key word here is “similar”. Until relatively recently workers in developing and developed countries were not similar. There were major differences in productivity. The superior productivity of workers in developed countries underpinned their higher wages – a situation which many thought unlikely to change. But it has.

Countries such as Singapore, Hong Kong, Taiwan, Mexico have shown that when equipped with similar capital equipment, management, skills and technology, workers in developing countries can be every bit as productive and sometimes even surpass their counterparts in Europe and America. The small size of these countries (even when considered collectively) means that their exports are unlikely to have been the main source of the wage stagnation in the USA and much of Europe.

China is a different matter. China only opened its market to foreign business in the late 1970s. Since then its growth has been phenomenal. In 1990, China accounted for only 4% of the global economy. By 2012 this had grown to 14%. In the year 2000, Chinese exports were one third of those of the US. Only nine years later, China had become the largest exporter in the world. A research study by the US Federal Reserve found that “US job losses were concentrated in those sectors where Chinese exports grew most rapidly”. (Board of Governors of the Fed Reserve system, International Finance Discussion Papers, Number 1033, Nov 2011)

China’s exports include commodities such as steel and raw textiles. However, a large and growing proportion are high value, high tech products such as computers, mobile phones and branded goods aimed at the consumer markets of developed countries. Exports of this nature require more than technology. They require a combination of technology, management expertise and above all, intimate knowledge of fast moving consumer markets in the developed countries. They also require dependable sales outlets and logistic supply chains in the target countries.

Developing the necessary contacts, market expertise and facilities in these foreign markets normally takes many years. How did China manage to do this in such a short space of time and in markets that are culturally, economically and politically so different from those Chinese firms were accustomed to?

Multinational companies were quick to respond to the opening of the huge Chinese market. They were able to provide not only the much needed technology but also the required management expertise, close knowledge of Western markets together with the contacts and facilities required to market their Chinese produced goods there. More than half of China’s exports are from foreign companies based in China.

This helps to account for the rapid penetration of the foreign markets from which these multinational companies originated. The mobility of companies, technology, capital and expertise has changed enormously in recent years. Low wage workers in developing countries can now be more competitive with their counterparts in developed economies. It’s possible that the more traditional views of trade have to be adjusted to the new global environment.