Tuesday, February 26, 2008

Trade and Inequality

Paul Krugman opened up an intense debate about the role of trade in generating inequality, by claiming in his NYT article, Trouble with Trade, that "it's hard to avoid the conclusion that growing U.S. trade with third world countries reduces the real wages of many and perhaps most workers in this country."

He argues that while "trade between high-wage countries tends to be a modest win for all, or almost all, concerned... trade between countries at very different levels of economic development tends to create large classes of losers as well as winners". Krugman goes on to say that outsourcing and trade benefits the highly educated American workers by improving their wages and expanding their job oppportunities. However, the less educated suffer because their jobs get shipped overseas and downward pressure on their wages, due to other workers with similar qualifications crowding into their industries and looking for employment to replace the jobs they lost to foreign competition.

In a conclusion that generated sufficient debate in the blogosphere, Krugman concludes, "It’s often claimed that limits on trade benefit only a small number of Americans, while hurting the vast majority. That’s still true of things like the import quota on sugar. But when it comes to manufactured goods, it’s at least arguable that the reverse is true. The highly educated workers who clearly benefit from growing trade with third-world economies are a minority, greatly outnumbered by those who probably lose."

Alan Blinder has written about the steps needed to be taken to mitigate the harmful effects of international trade. He argues in favor of a stronger saftey net to cushion those affected from trade related issues, by way of "expanding some existing programs, like making unemployment insurance more comprehensive, and vastly increasing — and improving — job retraining programs. It also means enacting new programs like universal health insurance, guaranteed pension portability and so-called 'wage insurance'. Wage insurance would replace a portion of the wages lost by workers who do find new jobs at lower rates of pay."

He also argues in favor of reasonable safeguards for the environment and labor without interfering much with trade. In what can be seen as a veiled call back for the days of workers Unions, he even says, "The government should be protecting, rather than undermining, American workers’ rights to organize and bargain collectively."

Dani Rodrik draws attention to the work of Robert Feenstra and Gordon Hanson, which claims that “global production sharing,” is a potentially
important explanation for the increase in the wage gap between skilled and unskilled workers in the U.S. and elsewhere. Feenstra and Hanson claim that "trade in inputs has much the same impact on labor demand as does skill-biased technical change: both of these will shift demand away from low-skilled activities, while raising relative demand and wages of the higher skilled."

Striking a different note, The Economist feels that consumption inequality is a more appropriate parameter to judge individual economic well-being. While acknowledging that income inequality has widened, it draws on the study of Dirk Krueger of the University of Pennsylvania and Fabrizio Perri of New York University to claim that consumption inequality has barely budged for several decades. It is argued that the innovations in production and distribution have improved the quality of goods at the lower range of prices faster than at the top, thereby narrowing the range of experience and further masking a closing of real or “utility-adjusted” consumption inequality. The article also draws on the findings of some "happiness" researchers, whose findings show that inequality in self-reported “life satisfaction” has been shrinking in wealthy market democracies, suggesting that the quality of lives across the income scale are becoming more similar, not less.

I have tried to list out a few arguements as to why the simple "life satisfaction" surveys conceal more than they reveal, and widening inequality carries within itself germs of further division.
1. Life satisfaction is a highly subjective concept, which cannot be quantified without a very high probability of distortions, that fail to capture the full dimension of the issue. It varies across income groups (witness numerous studies that show that the poor in India or people of some poor African countries are very happy), and betweeen countries.
2. Unlike in the previous times, most of the basic necessities for helping individuals realize their potential - health care and education - are increasingly becoming out of bounds of the poor. The capital investments required to achieve success are becoming ever more higher.
3. Widening income inequality itself has an effect on aligning the price of basic services like education, skills upgradation, and health care. As incomes at the top rise spectaculalry, we see the emergence of a two or multi-tier system of education.
4. The consumption data does not account for the dis-utility associated with widening of "relative incomes", which by itself contributes substantially towards "life-satisfaction".
5. There are numerous studies to show that economic mobility has slowed down considerably. The NYT quotes of a study by the Brookings Institution to warn that "widening gaps in higher education between rich and poor, whites and minorities, could soon lead to a downturn in opportunities for the poorest families"
6. Almost every determinant of income - education, health, credit, insurance - have experienced widening inequality.

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