6 International Trade

Christopher Fries, Brayan Reyes, and Kenneth Schoolcraft

Introduction

The first section outlines the trend of job outsourcing and how that has affected the wages of workers as well as the displacement of and unions. The second section goes over different regions of the world in regard to foreign direct investment and how it affects those regions. The third section discusses how trade barriers and tariffs affect productivity of companies and what economies can do to try optimize their trade.

Jobs going overseas and over borders with effects of income inequality

Economies are more globalized in order to gain any sort of economic advantage. According to the graph from the St. Louis Federal Reserve overall trade in the United States has been consistently increasing. This increase in globalization can be shown from the graph below which depicts domestic imports in red and domestic.exports in blue. It is clear that overall trade going in and out of the United States has consistently been increasing with a huge spike in the past two decades.

 

Real U.S. Exports and imports have increased steadily since 1960. The trade deficit has been growing.
U.S. Real Exports and Imports – 1960-2019

Not only does this increase in international trade include the exchange of goods and commodities, but also the trading of services and labor. This outsourcing of labor has allowed firms to produce goods and services using labor that is much cheaper than in their native country. For example, in most Asian countries such as China and India real wage costs are much lower than in the U.S. (Liang 130). Not only has this had implications on the country that has experienced its labor move overseas, but it also drastically affects the nation in which the labor moves too which has contributed to an ever increasing income inequality.

The outsourcing of labor has contributed to income inequality both domestically and overseas through the changes of real wages that workers will experience. Feenstra and Hanson (1999) identified the changes in the wages of low-skilled labor and high skilled labor being moved overseas from 1979-1990. They also looked at how this was also influenced by improving technologies with the rise of the computer being one of the main focuses.Overall, it was found that the relative wage of high-skilled labor to low-skilled labor increased by at least .29%. The rise of skill based technology such as the computer eventually raised this by .56% (Feenstra 935-936).

This trend is also prevalent in low-skilled European labor markets affected by outsourcing. In European markets, for every 1% increase in outsourcing intensity, there is a real wage decrease of .36% for low-skilled workers (Kraciuk 40). Another economist, Geishecker (2005) observed how wages of low skilled and high skilled workers is influenced by outsourcing by using data from Germany. Wages of jobs in Germany that are eventually outsourced are examined across 21 different industries. These industries examined include anything from textiles to computers to printing and are split up into high skill-intensive industries and low-skill intensive industries. The only statistically significant occurrence was that low-skilled workers in low-skill intensive industries experienced a reduction in real wage after fragmentation. High skilled workers in high-skilled intensive industries were actually able to see an increase in real wage on the other hand (Geishecker 88-90). This trend can be explained by the rise of skill-intensive jobs in developed countries as outsourcing increases. When low-skill intensive production moves away from a developed country, an increase in the demand for skilled labor, in industries such as technology, occurs. This leads to a rise in the real wage of skilled labor, while low-skilled labor loses out because of a lack of human capital (Lee 33-34).  With this in consideration it is clear that the outsourcing of jobs has serious effects on wages especially of low-skilled workers which is a huge factor in the increase income inequality.

Income inequality has also been affected by a shift in labor unions which has contributed immensely to a decline in wages, particularly in the countries where production is moving towards. Anner (305-306) examined the effects of outsourcing on labor union participation in Honduras and El Salvador. It was ultimately found that labor union participation rates was lower in segmented firms than in traditional manufacturing firms. This has lead to weaker bargaining power for higher wages for those in the segmented industries which has ultimately led to lower wages and has furthered income inequality in those nations (Anner 311). This can ultimately debunk the ideology that jobs migrating to developing nations are helping these countries when in fact it has contributed to a greater issue increasing income inequality.

Foreign Direct Investment with effects of income inequality

(Adams 1-9) Initially direct foreign investment produces a negative effect on domestic investment. Over a longer period of time, Foreign Direct Investment produces positive effects like employment creation, technological know-how, and enhanced competitiveness. Such is the case in Sub-Saharan Africa which suggests a crowding-out effect. Domestic businesses are initially pushed out by foreign-based businesses, but the domestic companies tend to imitate through modernization, the practices of the outside companies to maintain a profitable process and with these practices the effects of foreign direct investment in Sub-Saharan Africa are less effective than in Latin America, such that it seems less intrinsic to their overall economy. This result means that the countries of Sub-Saharan Africa should be cautious of the type of FDI they attract to their domain and the kind brought by open doors is counter-intuitive.

Developing countries that are not affiliated with the Organisation for Economic Co-operation and Development have an increase in wage inequality with foreign direct investment, but the developed OECD countries wage inequality decreases with no apparent evidence to show the effect is nonlinear.(Görg, Figini, 1) In terms of which the countries that are not affiliated with the OECD have a higher probability of wage inequality with incoming outside investment. The thirty four countries that are affiliated with the OECD have more dominant factors that affect the wage inequality than outside investment making the effect to be insignificant to the wage inequality model as a whole. A couple of those dominant factors are poverty rates, and the rate of  increase of economic development that the OECD works on to keep the countries involved stable as well as some countries outside of the OECD that trade with its members like India.

(K.Zhang, X.Zhang 2-20) China’s foreign direct investment since 1978 has made their export economy boom, but the income inequality across regions of China are quite substantial. The distribution of the Chinese Yuan has varying differences across city regions with the increase to GDP due to foreign direct investments. This happens because with more of foreign currency in a country, the less the home country’s currency is worth across the world. In such cases the United States of America and Great Britain have some of the most valuable forms of currency edging out the Euro by a small margin. The Chinese among other Asian countries have fairly cheap currencies compared to Europe and the United States of America which has them overproduce exports to keep their economy in check while practically ignoring domestic investment for the survival of the people or citizens. The current exchange rate of the Yuan(Chinese) to dollars is one Yuan is fifteen cents in U.S. dollars. The exchange rate to Euros is one Yuan to thirteen cents Euro. The exchange rate of the English pound Sterling to Yuan(Chinese) is one Yuan to eleven cents pound Sterling. The FRED diagram shows the effect on Chinese currency based on the investment from The United States and its’ negative relationship on Chinese currency.

 

Financial Account: Direct Investment Abroad for China
Financial Account Assets: Direct Investment Abroad for China

Latin and South America are affected by foreign direct investment and it is visible that with the widespread wage inequality across those countries since they are considered developing countries they tend to have a negative economic effect due to foreign direct investment. (Velde, Willem 4-38) An increase in skilled workers reduces the overall inequality in wages in theory, but has slowly made the wage gap between the skilled and unskilled population, increase the wage inequality. This occurs because the majority of a-lot of the Latin and South American countries populations work an unskilled labor job instead of a skilled service position. There is also a disparity of education levels between the skilled and the unskilled people, which keeps the income inequality high with or without outside investment.

 

Relationship Between Trade and Income Inequality

Through different levels of tariffs most countries thru the late 20th century and early 21st century were affected. Mainly discussing the long and short run effects tariffs have on economic activity and how that forces firms or policymakers to adjust wages. In turn can lead to income inequality which will also have effects on consumption of imports and exports with regards to incomes of unskilled and skilled workers.

In India in 1991 policymakers sought to try and help increase productivity through the liberalization of trade.The extensive changes to the Indian trade regime saw significant reductions of tariffs on a wide range of imports, rationalization of the tariff schedule and expansion of quota limits coming unexpectedly after several decades of restrictive external policies. (Parvin,1) With this market shake up competition increased with drastic reduction in tariffs on imports. This happened because Indian companies were able to cut back costs of having to maintain imports and exports flows. Results from surveys suggest increases in the growth rate of productivity in three industries: Electronics, Non-electrical machinery and Electrical machinery.(Parvin, 3) This led to a higher demand in labor input so for a weaker type economy income inequality shrunk relative to a more industrialized economies where the effect of trade liberalization would be smaller. This is because more unskilled workers in India sought to gain skills needed in order earn higher incomes. This decreased the size of the welfare state in India and allowed the government to increase their welfare funds. So the returns to scale was greater than expected, with growth in productivity and labor as well as tightening of the income inequality gap.

In a more industrialized economy like the United States, openness to trade and investment has substantially contributed to U.S. growth. But trade openness exerted downward pressure on the wages of unskilled workers in rich countries like the U.S. while increasing income from capital, raising inequality within these economies and we have seen this happen over the last 30 years.(Bergh)   We’ve seen trade agreements emerge like NAFTA occur where there is virtually little tariffs between the U.S., Canada, or Mexico. The main idea was to encourage a freer trade and to help balance out all three of the countries trade deficits. Since tariffs were reduced significantly domestic firms have to worry more about exporting their products to the other countries while also competing with other imported goods becoming cheaper. These countries have experienced increases in production and exporting goods in other sectors of the economy like Mexico’s agriculture products became the second most imported agricultural products for the U.S.. (Vha,4) Mexico became one of the highest importers of U.S. goods, as seen from the graph below, there was a huge exponential increase in consumption of U.S. imports from Mexico after NAFTA. But this did result in displaced labor for some firms because they have to reduce costs of production in order to stay competitive in their market. This would increase income inequality because of the loss of income from all of the displaced labor.

 

U.S. Imports of Goods from NAFTA with Mexico has been steadily growing
U.S. Imports of Goods from NAFTA with Mexico

 

Reductions in tariffs forces other economies to specialize in activities in which they have a comparative advantage. This means nations produce more goods and services for less and exchange those for goods and services from other countries, resulting in higher levels of consumption than would be possible without trade.  This leads to employment gains where production is most efficient, though it can also lead to employment losses in sectors where production is comparatively less efficient, an outcome of which policymakers should remain aware. This will subsequently grow the trade percentage of GDP with new demands in labor and call for more efficient production in some sectors. But with the same token the income inequality in the U.S. has grown in response with these reduced tariffs. If the U.S. were to raise tariffs on other foreign goods there would be an effect on international trade where countries won’t be willing to trade with us. So that would lead to less consumption and would be bad for wages thus increasing inequality between lower income households and it would stretch the income inequality gap far more then reduced tariffs would.

Work Cited

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Income Inequality and Intergenerational Mobility by John Kane, editor is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.

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