Topics in the Globalisation Debate 2: Labour Markets

This lecture draws, among other sources, from: Rodrik (1997): Has globalisation Gone too Far? Institute for International Economics.

Wolf (2004): Why globalisation Works? Yale University Press Haaparanta (2007): Reilu kauppa, kysyntä, tarjonta ja tasapaino: Kuka kaiken maksaa?

Globalisation and

Rich Countries’ Labour Markets

• • See Lecture 4 for discussion in the context of HO-model.

Rodrik (1997): Open economies are more responsive to changes in prices, including wages → Costs of improved working conditions cannot be shared with employers as easily as before (see previous slide) → Increased volatility of wages and/or employment → Decrease in labour’s bargaining power • → There are basis to argue that globalisation will have an

adverse impact on capital-abundant countries low-skilled workers

However, since the aggregate gain from free trade is larger than the aggregate loss, it is possible to compensate the losers and achieve a Pareto improvement. This might also explain the welfare states of some small, open economies.

Dani Rodrik (1997): Has globalisation Gone too Far? Available at Institute for International Economics website.

Rodrik: Shift and Increased Elasticity of Labour Demand

• • • Autarky → Free trade and capital flows

wage

(1) Demand for labour shifts inward in capital abundant countries and (2) the demand curve becomes more elastic (change in wage rate creates now larger impact on quantity of employment, i.e. production can be moved abroad) w A p FT

capital-abundant country

(2) (1) S L D L FT Q L FT D L A Q L A

employment

Dani Rodrik (1997): Has globalisation Gone too Far? Available at Institute for International Economics website.

Elasticity of Labour Demand and Imposing Labour Standards

• • Assume that higher labour standards are imposed (creates

wage

a new cost) decreases → supply curve shifts upward → wages decrease, employment E The more elastic the demand the more employment decreases, wages decrease and the larger share of the cost is paid by employees W S’ L D L FT S L

employment

E = employers share of the cost W = worker’s share

Changes in Wage Structure

• • Between 1979 and 1995 real wages of full-time working high-school dropouts declined by 20% and the real wage of college graduates increased by 3% (Katz & Author, 1999). The major candidates for explanation are: o

Skill-biased technological change

o “Most of literature”: trade has not played a major role because o the amount of trade is too small o

Increase in international trade

prices of (final) goods have not changed consistently o employment between industries has not changed consistently See Feenstra & Hanson (2003), Katz & Author (Handbook of Labor Economics, 1999) for discussion.

Change in the U.S. Real Wages

(per percentile between 1970 and 2002 ) Source: Smith (2006)

Outsourcing

• • • Feenstra & Hanson (2003) o o o Previous research has misread the data by comparing whole industries with each other In fact, a large amount of trade is in intermediate inputs (outsourcing), which occur inside the industries This can have a much larger effect on wages than trade in final goods F&H: “outsourcing can account for half or more of the observed skill upgrading” F&H: “Existing literature has just begun to scratch the surface”

Globalisation and

Poor Countries’ Labour Markets

• “Hopefully, there is presently no actual concentration camps anywhere. Instead […] some sort of labour camps seem to have become an essential part of our time” Ville Päivänsalo (referring to working conditions in the developing world) in Helsingin Sanomat, opinion pages, 31 October 2004 • “China’s rapid growth over the past two decades has delivered more people from desperate poverty, more quickly, than ever before. This does not suggest exploitation. Moreover [those] who have fled rural China to work in factories […] were not forced to do so by anything other than their poverty at home” Martin Wolf (2004, 185) in Why globalisation Works?

Impact of globalisation on Poor Countries’ Labour Markets

• • Globalisation critics o developing world workers are not able to bargain efficiently and are thus exploited → rich countries should impose universal minimum standards (wages, working conditions etc.) Mainstream economists o trade and FDI increase the demand for labour (and productivity) in the developing world → labour markets become “tighter”* → wages and working conditions improve * One way to understand “tighter” is that there are more opportunities employees can choose from. In other words, their “outside option” increases, which increases their bargaining power.

Imposing Minimum Standards to the Developing World (1)

• Assume a developing country with most of the labour force employed in unproductive agriculture → wages are set in agriculture (opportunity cost of not working in modern sector) → wages in modern sector are less than labour’s marginal product → (1) capital owners make very large profits → (2) more labour flows to the modern sector → less supply of labour in the agriculture → higher wages in agriculture → higher wages in the modern sector (i.e. the overall wages increase) Martin Wolf (2004, 186): Why globalisation Works? Yale University Press

•

Imposing Minimum Standards to the Developing World (2)

• Assume, now, that the labour in modern sector is paid their marginal product → (1) capital owners make normal profits → (2) no/less labour flows to the modern sector → dual labour markets   low incomes to the majority in agriculture high incomes for the few in modern sector “Indian workers are so well protected from exploitation by industrial bosses that they have no jobs at all. The exact opposite happened in South Korea and Taiwan” Martin Wolf (2004, 187): Why globalisation Works? Yale University Press

Wages, productivity and unit labour cost

Stephen Golub (1998): Does Trade with Low-Wage Countries Hurt American Workers? Fed of Philadelphia Business Review March/April 1998

The FAIRTRADE Mark

• • Certification system that demand traders to o pay a price to producers that covers the costs of sustainable production and living and a premium that producers can invest in development Minimum price system o o a guaranteed price that covers the cost of production and ensures a living wage for growers rises in line with market prices if they rise above the minimum Fairtrade price Source: http://www.fairtrade.org.uk/

Impact of FAIRTRADE: Overproduction and Quotas

price p FTr p 0 S 0 D Quantity • • • • FAIRTRADE provides a minimum price p price p 0 FTr , which is above the world equilibrium Given this price, supply is larger than demand To avoid this, quotas are allocated to producers e.g. Valkila (2007) surveys Nicaraguan FAIRTRADE coffee farmers and finds that they sell only 30% of their production to the FTr system (and rest to the regular world market) Haaparanta (2007): Reilu kauppa, kysyntä, tarjonta ja tasapaino: Kuka kaiken maksaa?

Valkila (2007): Better of Bitter Coffee? Implications of Fair Trade Coffee Certification…

Impact of FAIRTRADE: Competitive producer

price / cost p FTr Transfer to FT producer p 0 Q FT Q MC Quantity • • A producer that would produce given the world price, now sells Q FT to the FAIRTRADE markets at price p Q–Q FT market at price p 0 FTr to the world and From the producers point of view, identical impact would be generated by giving him the transfer in cash Haaparanta (2007)

Impact of FAIRTRADE: Non-competitive producer

price / cost p 0 loss from Q SF Q SF Q 0 AC Quantity • • • Suppose production has fixed-cost + rising marginal cost leading to U-shaped average costs Then the equilibrium price is p 0 and producers produce Q 0 and small farms that would be able to produce Q SF will not enter the market FAIRTRADE is aimed at small farms; if the transfer (previous slide) is larger than the loss here, the amount of

production will increase

Haaparanta (2007)

Impact of FAIRTRADE: Production increases, price decreases

price p 0 p 1 S 0 S 1 D Quantity • • • For any given world price, there is now more production → price decreases The weakest producers not participating in FTr will go bankrupt (prev. & next slide) Thus there is

transfer from weak regular producers

AND consumers of the regular product to the FAIRTRADE producers Haaparanta (2007)

Impact of FAIRTRADE: Regular production and demand decrease

price p p 0 2 p 1

Regular Market

S 2 D 2 S 0 S 1 • • D 0 Quantity • Since some of the regular producers leave the market, supply curve shifts from S 1 to S 2 At the same time, consumers shift consumption towards the FTr product and demand curve shifts from D 0 to D 2 However if FTr has increased total production, the price of regular product still decreases in comparison to no FTr Haaparanta (2007)

Summary of FAIRTRADE

• • • • FAIRTRADE creates a transfer from weak producers of the regular product to the FTr producers and consumers of the regular product Even FTr producers may be hurt, since they typically sell only a fraction of their production to the FTr system Further topics: Allocation of quotas, FTr as a device for price discrimation in rich countries (see e.g. Harford’s “the Undercover Economist”, 32-35).

More efficient policy: Direct conditional cash transfers such as PROGRESA Haaparanta (2007)

PROGRESA

(now called OPORTUNIDADES) • • • Launched in August 1997 to improve education, health and nutrition of poor families (particularly children and their mothers) in Mexico Consists of cash transfers to poor households

conditional on child school attendance and visits to health centers

Hard evidence on the effectiveness of the program exists due to random assignment of the pilot villages http://www.ifpri.org/themes/progresa.htm

Suggested Further Reading

• • • Martin Wolf (2004): Why Globalization Works? Yale University Press Joseph Stiglitz (2006): Making Globalization Work. W.W. Norton Paul Krugman (1996): Pop Internationalism. MIT Press