Income Inequality and Globalization: The Protectionists Rule!

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Wednesday, 24 October 2012 12:47

David Leonhardt tells readers today that income inequality is primarily due to technology and globalization. It is possible to tell the story of technology if you are prepared to jump over a few hoops. (The big problem is that economists confidently told us in the 90s that technology favored people with college degrees. In the last decade it seems to only favor people with advanced degrees. If that sounds like a "make it up as you go along" story, welcome to the state of modern economics.)

However, the globalization story requires even more hand-waving. The simple story is that we have hundreds of millions of people in developing countries who are prepared to work for a fraction of the wages of our manufacturing workers. This has caused us to lose millions of manufacturing jobs, depressing the wages of both the remaining workers in the sector and the workers in other sectors who must compete with displaced manufacturing workers.

This is undoubtedly a true story. However the part of globalization that economists seem to have difficulty understanding is that there are also tens of millions of potentially highly educated workers in the developing world who are willing to work for much lower pay than their counterparts in the United States. For example, while the average doctor in the United States gets close to $250,000 a year, there would be no shortage of doctors in India, Mexico, China and elsewhere who would be happy to train to U.S. standards and work for half this wage. The same would be true of lawyers, dentists, economists and all the other highly paid professions.

The reason that huge numbers of foreign professionals have not come to the United States and depressed the wages of the highest earning workers in the United States is that we have a large number of professional and legal barriers that make it difficult for foreign professionals to work in the United States.

(Note the use of the word "difficult," rather than "impossible." Economists often believe that because they know an Indian economist who teaches at a major university they have proven that there are no obstacles to foreign professionals working in the United States. This is sometimes referred to as the "Mexican avocado" theory of international trade. According to this theory, if I can buy an avocado grown in Mexico at my local supermarket I have proven that there are no barriers to imports of agricultural goods in the United States. This is of course a ridiculous view, but one that nonetheless usually arises in any discussion of professional barriers.)

Trade agreements like NAFTA were quite deliberately crafted to make it as easy as possible for companies like General Electric to set up manufacturing operations in Mexico. In fact, the industry groups were invited to help write the treaty to ensure this outcome.

If we want to ensure that we enjoy same sort of free flow of professional services as we do of manufactured goods we would need to craft treaties designed by hospital administrators, major law firms, and university presidents that eliminated all the obstacles that made it difficult for them to hire foreign professionals.

While this move toward freer trade would offer enormous benefits to consumers and the economy by reducing the cost of health care, education, and a whole range of services, there have been few steps in this direction. In fact, in the 90s the United States deliberately restricted the inflow of foreign doctors out of a concern that they were depressing the wages of doctors in the United States (see, e.g., "Caught in the Middle," by Lena H. Sun, Washington Post, 3/19/96, Health Section, page 10; "A.M.A. and Colleges Assert There is a Surfeit of Doctors," by Robert Pear, New York Times, 3/1/97, page A7). 

In short, the fact that globalization has led to downward pressure on the wages of less educated workers is the result of a policy decision. It is not the result of some natural process. If policy were controlled by people who care about inequality and increasing economic efficiency, then the globalization would be directed in a way that lowered the wages of the most highly paid workers.

There are other ways in which policy has almost certainly contributed to inequality. For example, if the minimum wage had kept pace with productivity growth since the late 60s (when the unemployment rate was less than 4.0 percent), it would be close to $18 an hour today. Also, the fact that unionization rates have plummeted is almost certainly due in part to policies that have made it more difficult to unionize. Canada, which has a very similar economy and culture, has not experienced a decline in unionization rates of the same magnitude.

There are other ways in which policies can be identified that have contributed to massive upward redistribution of the last three decades. (Read The End of Loser Liberalism: Making Markets Progressive for more on this topic [it's free].) But it is far too simple and easy to just treat the surge in inequality as a natural phenomenon. It isn't.