September 29, 2005
If the United States were to add two billion low-wage workers, you'd expect that wages would fall across the board, right? Well, there is a famous theorem in international economics—the Stolper-Samuelson theorem—that says when a rich capital-abundant country (such as the United States) 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 a 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 fewer 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 25 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 20th 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.
Dr. Thomas Palley was chief economist of the US–China Economic and Security Review Commission. Prior to joining the Commission, he was director of the Open Society Institute's Globalization Reform Project. He has written for The Atlantic Monthly, American Prospect and The Nation magazines. He can be reached at www.thomaspalley.com.
