Trade and Wages: Choosing among Alternative Explanations

Abstract

The decline in unskilled workers' real wages during the 1980s in the United States and the increase in their unemployment in Europe (due to the comparative inflexibility of European labor markets vis-a-vis those in the United States)(1) have prompted a search for possible explanations. This search has become more acute with the evidence that the adverse trend for the unskilled has not been mitigated during the 1990s to date. A favored explanation, indeed the haunting fear, of the unions and of many policymakers is that international trade is a principal source of the pressures that translate into wage decline and/or unemployment of the unskilled. As Bhagwati and Dehejia (1994) put it: Is Marx striking again? I have examined the question of trade explanations at great length in Bhagwati and Dehejia (1994), and the issue has been extensively treated in Bhagwati and Kosters (1994). My conclusion is that the trade explanation is exceptionally weak for the 1980s, that there are good theoretical and empirical reasons why trade did not cause the adverse impact one might fear, and that the case therefore for the overwhelming role of technical change (biased against the use of unskilled labor) in explaining the misfortune of the unskilled is very strong, indirectly and directly as well. Here, I recapitulate and evaluate the main linkages that have now been advanced between trade and real wages, extending the argumentation beyond that in Bhagwati and Dehejia (1994), originally finished in mid-1993, in light of further research that has emerged since then. I also take the opportunity to speculate about the future instead of confining myself to the 1980s experience and its explanation. NORTH-SOUTH TRADE AND THE FALL OF UNSKILLED WORKERS WAGES: A STANDARD EXPLANATION Most economists' favorite explanation has been that trade with the unskilled-labor-abundant South (that is, poor countries), as a result of their entry into world markets and the freeing of trade barriers against them, has led to the fall in the real wages of unskilled workers. This argument requires, in general equilibrium, that the prices of the goods using unskilled labor should have fallen too--as I noted in 1991 when encountering the Borjas-Freeman-Katz paper (1991) asserting that trade was the cause of the decline in real wages without mentioning, leave aside examining, the behavior of goods prices (see the detailed critique in Bhagwati 1991a and 1991b, and subsequently in Bhagwati and Dehejia 1994 and Bhagwati 1994). I conjectured (1991a) that the goods prices had actually gone the other way from that required by the assertion. The detailed empirical investigation by Lawrence and Slaughter (1993), reported again by Lawrence in his paper for this conference, confirms my conjecture for the United States. The subsequent attempt by Sachs and Schatz (1994) to overturn the Lawrence-Slaughter findings will not hold water. It relies on removing from the data set the prices of computers, a procedure that can be debated. Even then, the new data set yields a coefficient of the required sign that is both extremely small and statistically insignificant. Some newspaper accounts (for example, the recent survey in the Economist of North-South issues and a recent Financial Times column by Sir Sam Brittan) have reported this finding without realizing that, while Noam Chomsky correctly argues that two negatives make a positive in every human language (while two positives do not make a negative in any), the two negatives of a small coefficient, and a statistically insignificant one to boot, do not add up to positive support for the assertion at issue! Lawrence (this conference and 1994) notes this and also reports that the goods price behavior in Germany and Japan, with and without computers, does not support the trade explanation either. Besides, the shifts in factor ratios also do not support the explanation for the U.S. …