Can Globalization Lift All Boats?1

Unit Four
Contemporary Global Economic Issues and Policies
Chapter Ten

Can Globalization Lift All Boats?

I. Fundamental Issues
  1. What factors influence the demand for a nation’s labor resources?

2.How are market wage rates determined, and how can increased international trade affect the wages earned by a nation’s workers?

  1. What are the implications of the factor proportions approach to international trade for how trade affects workers’ earnings?
  2. Why do labor and capital resources often flow across national borders?
  3. How does greater openness to international trade affect wages and economic growth in developing nations?
  4. What are the pros and cons of increased capital flows to developing nations?
II. Chapter Outline
  1. International Trade and Wages
  2. The Alleged “Trade Threat” from Developing Nations
  3. Wages and International Trade
  4. Visualizing Global Economic Issues: The Labor Demand Curve
  5. Visualizing Global Economic Issues: The Wage and Employment Effects of Increased Competition from Abroad

2.Labor and Capital Mobility

  1. Labor Mobility Within Nations, International Trade, and the Distribution of Earnings
  2. Policy Notebook: How Much Training Do People Really Need to Pick Asparagus in Germany?
  3. International Trade and Labor and Capital Flows
  4. Management Notebook: Is the United States Importing Gender Earnings Equality?
  1. International Trade and Economic Development
  2. Trade and Wages in Developing Nations
  3. Online Globalization: The Global Digital Divide
  4. Stimulating Growth: Openness or Protectionism?
  5. Capital Flows and Developing Nations
  6. Online Globalization: Online Medical Services in Bangladesh
  7. Questions and Problems
III. Chapter in Perspective

This chapter introduces the concepts of marginal revenue, marginal product and marginal revenue product of labor and capital into the discussion of a factor proportions approach to explaining international trade. Capital mobility and pressures to immigrate are also explained in this context. Some of the basic conclusions of a factor proportions model are reiterated in this discussion. The chapter concludes with a brief discussion of some of the crises countries have faced that have been associated with volatile capital flows.

IV. Teaching Notes
  1. International Trade and Wages
  1. The Alleged “Trade Threat” From Developing Nations

Does international trade affect earnings? Can it help or hurt wages of workers? Many of these issues were dealt with theoretically in Chapter 3; in this chapter, the authors introduce more data about the growing wage inequality between high- and low-income workers. The disparity between these two groups has been getting larger, likewise the gap between the income of a high school graduate and a college graduate has also been widening. Is international trade behind the widening inequality? Trade is an easy target for politicians and labor unions, particularly trade with nations that have labor cost advantages relative to the U.S. Trade with developing nations has been increasing, for instance, U.S. imports of manufactured goods from developing nations have grown from one-sixth of the total to about one third since the 1970s. In this same time, period wages of manufacturing laborers in the developing nations have increased relative to wages of U.S. manufacturing laborers. At first glance at least the evidence seems to indicate that growing international trade with developing nations has hurt U.S. manufacturing laborers.

  1. Wages and International Trade

According to hourly compensation indexes of manufacturing wages in various countries, nominal wage rates do vary considerably among different countries and some countries have seen relative nominal wage gains compared to U.S. manufacturing workers (See Text Figure 10-2).

Wage setting mechanism:

In hiring employees, firms have to decide how much additional revenue will be generated by each unit of labor (measured as a person, an hour or person-hours worked), and how much additional cost is generated by hiring another unit of labor. Typically, all inputs experience diminishing marginal returns. As more labor is hired then, its marginal productivity falls. At the margin, the firm can afford to hire labor up to the point where the marginal revenue produced by the next additional unit of labor ―the marginal revenue product of labor― is equal to the wage rate.

Quantity of Labor / Total Weekly Output / Product Price
0 / 0 / $30
1 / 10 / $30
2 / 30 / $30
3 / 50 / $30
4 / 65 / $30
5 / 75 / $30

For example, given the data shown above, one can derive the marginal product of an additional unit of labor (MP), the marginal revenue (MR) and the marginal revenue product of labor (MRP), which is equal to MP MR.

Quantity of Labor / Total Weekly Output / Marginal
Product / Marginal Revenue / Marginal
Revenue Product
0 / 0 / – / $30 / $0
1 / 20 / 20 / $30 / $600
2 / 40 / 20 / $30 / $600
3 / 55 / 15 / $30 / $450
4 / 67 / 12 / $30 / $360
5 / 75 / 8 / $30 / $240

The marginal product is equal to the additional output generated by hiring one more worker. Notice the diminishing marginal returns to labor after hiring more than 2 workers. The product price is equal to the marginal revenue. The key column is the last: if the firm has two workers and hires the third worker, the third worker adds $450 in revenue per week. This is the marginal revenue product of the third worker. It would be profitable for the firm to hire the third worker only if the wage of the third worker is less than $450 per week. The same ideas can be applied to the other major input, capital.

The marginal revenue product schedule is then the demand-for-labor-schedule. It is a derived demand schedule that depends on:

1. the marginal revenue or price of the product, which is based on market conditions and,

2. the marginal product of the workers.

A profit-maximizing firm hires workers up to the point where the marginal revenue product of labor is equal to the wage rate that it pays the next worker hired.

The market wage rate is found at the intersection of the labor supply curve and the marginal revenue product curve (which is the labor demand curve):

Quantity of Labor Supplied / Weekly Wage Rate
0 / < $300
1 / $300
2 / $400
3 / $450
4 / $500
5 / $550

In this case, the equilibrium market wage rate is $450 per week, and the firm would hire 3 workers.

Note that since the marginal revenue product is a function of the market price of the product output, if the product’s price falls, wages will generally fall. This brings our discussion back to the effects of international trade and wages. We can now see that an increase in imports resulting from growing trade can result in a lower price of the good that is imported. This is the same conclusion made in Chapter 3. Recall that the Stolper-Samuelson theorem states that free trade raises (lowers) the real earnings to owners of the nation’s relatively abundant (scarce) factor. As the nations move to free trade, the good that uses the abundant (scarce) factor intensively is exported (imported). The result is that as nations move from autarky to free trade, the price of the good that intensively uses the abundant factor will rise due to foreign demand for that export good. Increased imports of the good that intensively uses the scarce factor (increased supply) will reduce the price of that good and will thus also reduce the earnings accruing to the scarce factor. In relatively skilled labor and capital abundant countries such as the U.S., goods and services that relatively intensively use skilled labor and capital will be exported, and goods and services that relatively intensively use unskilled labor will be imported.

The conclusion is as follows: If openness to trade results in net additional imports (exports) in an industry, then openness can lead to wage and employment reductions (increases) in these industries.

  1. Visualizing Global Economic Issues: The Labor Demand Curve

For Critical Analysis: A change in the wage rate results in a movement along a company’s labor demand curve. What would happen if an improvement in technology were to raise the marginal product of labor at every given quantity of labor that the company might hire?

The increase in the marginal product of labor would increase the marginal revenue product of labor, ceteris paribus, shifting the labor demand curve up and to the right.

  1. Visualizing Global Economic Issues: The Wage and Employment Effects of Increased Competition from Abroad

For Critical Analysis: If the U.S. workers who lose their jobs with online travel service companies are successful in offering their services to online retail companies located in the United states, what is likely to happen to the wages of workers in that industry? What is likely to happen to total employment in this online retail industry?

In the text example, employees at online travel service companies lost their jobs due to foreign competition. If these displaced workers move into the job market for online retailers then there will be an increase in supply of labor in online retailing. Holding the marginal revenue product equal, the increase in supply will result in lower wages and higher employment in the online retail industry. This is a spillover effect into another industry caused by international trade.

2.Labor and Capital Mobility

  1. Labor Mobility Within Nations, International Trade, and the Distribution of Earnings

When countries have different factor proportions of skilled and unskilled labor, as they move to free trade three things can be expected to happen:

1. International trade will tend to cause the relative wages of skilled labor to converge in the two countries. Similarly, trade will tend to cause the relative wages of unskilled labor to converge in the two countries.

2.In the country with relatively more unskilled labor, trade will cause the relative wage of the unskilled workers to increase relative to the wage of the skilled worker. This is because the market wage of skilled labor is reduced due to the falling marginal revenue product, which in turn results from the importation of goods and services that relatively intensively use skilled labor. Hence, unskilled labor in this country is likely to desire free trade.

3.In the country with relatively more skilled labor, trade will cause the relative wage of the skilled workers to increase relative to the wage of the unskilled worker. This is because the market wage of unskilled labor is reduced due to the falling marginal revenue product caused by the importation of goods and services that relatively intensively use unskilled labor. Hence, unskilled labor in this country is likely to oppose free trade.

Both countries may on net gain from free trade. From an overall global efficiency perspective, total global output should increase from moving to freer trade and better allocation of resources to the country’s comparative advantage.

  1. Policy Notebook: How Much Training Do People Really Need to Pick Asparagus in Germany?

For Critical Analysis: How might the factor proportions approach be modified to account for differences in the extent to which nations’ governments provide unemployment compensation to domestic workers?

The factor proportions model assumes full employment. To put this situation in context of the model, as the country with relatively more skilled labor, in this case Germany, engages in free trade with other countries relative prices of unskilled-labor intensive goods would fall, reducing the demand for labor. As a result, the relative wages of unskilled workers in Germany should fall. At the new lower wage rate, the demand for labor would again equal supply and no lasting unemployment would occur. Unemployment compensation, however, can interfere with this adjustment process, perhaps preventing workers from accepting the wage if the level of unemployment compensation is sufficiently close to the new wage and thereby resulting in unemployment. This, in effect, puts a floor on wages that the factor proportions model would have to recognize. Different levels of unemployment compensation would then imply different minimum wage levels. Note that in the German asparagus case, the “labor migration” from Poland is a substitute for importing labor-intensive goods, as noted below. This is another way in which the factor model might be modified to account for unemployment compensation.

  1. International Trade and Labor and Capital Flows

The marginal revenue product of capital is equal to the marginal product of capital times marginal revenue. A change in the price to obtain capital or a change in the product price changes the optimal level of capital the firm employs.

If there are barriers to trade between countries (or if a good or service is not exportable) then labor and or capital can be exported directly rather than exporting labor or capital intensive goods. Capital can be exported via foreign direct investment (hereafter FDI), or by lending to a government or private entity within a foreign country or other means of investment. Labor can be exported by emigration. The text presents some interesting statistics on labor immigration into the United States for various time periods. Although total numbers of immigrants to the United States have been higher in recent years than in the past, as a percentage of the population at the time, the number of immigrants was higher in the 1901–1910 period than in any other period since 1821. Today’s immigrants are less likely to have a high school education than in the (recent) past, and are more likely to come from Asia and Latin America than Europe.

The factor proportions approach can be used to explain trade flows related to labor and capital (and associated wage gains and losses) similar to the skilled/unskilled discussion provided earlier. However, the factor proportions approach is limited in its ability to explain trade patterns. The model is better at explaining inter-industry trade rather than intra-industry trade. This is because the model generally assumes perfect competition with no product differentiation.

  1. Management Notebook: Is the United States Importing Gender Earnings Equality?

For Critical Analysis: Does a reduction in the gender gap necessarily imply that male and female U.S. workers experience overall wage gains as a result of increased international trade?

No and indeed the factor proportions model may be used to predict that in sectors that face the most import competition, the declining price brought about by the growth of imports should result in a reduced marginal revenue product, and lower wages for both male and female, ceteris paribus. More basically, the gap reduction could be brought about by a decline in male wages with steady female wages, or both could even be falling with male wages falling more.

  1. International Trade and Economic Development
  1. Trade and Wages in Developing Nations

Trade from developing nations constitutes an increasing proportion of global trade. Arguably, all nations can benefit from trade, perhaps none more so than developing nations. For instance, as the text indicates, when real wages begin to grow in developing nations, labor productivity increases as malnutrition is reduced. Global wealth is by no means evenly distributed among the global population. About 13% of the world’s population accounts for about two-thirds of global trade and owns roughly two-thirds of global wealth.

The developing world has a relative abundance of natural resources, hence its major exports are usually commodity-type products such as fuel, oil, minerals, precious stones, etc. Moreover, these countries are usually unskilled labor abundant and have lower wage costs than developed nations. This may or may not lead to a comparative advantage in the production of unskilled-labor intensive goods. Recall from the earlier discussion that the marginal revenue product of labor is a function of the marginal product of labor. If the marginal product of labor is low relative to the wages there may be no comparative advantage. This is the point made in text Table 10-4 on page 325. Because the marginal product of labor is likely to vary for different industries in different countries, income growth in different developing countries will likely vary.

Teaching Tip:

To cover ethics in an international class, one can use the Harvard Business Review article, “The Parable of the Sadhu,” B. McCoy, Harvard Business Review, May/June 1997. The point of the article is a simple question that can be used to generate wonderful classroom discussion. The question is this, “Am I my brother’s keeper?” To what extent does the developed world have a responsibility to help our poorer neighbors? Where does that responsibility begin and end? Can it be safely relegated to governments? Is there personal responsibility involved? What cost is too much? What does one do when national sovereignty, culture and traditions conflict with the need and the ability to help? These are the questions for our time as we move forward with globalization.