Trade And Wages – A Cause For Inequality In Europe?

by Dirk Ehnts

Paul Krugman is on a roll again, this time it’s about US inequality. Much of the discussion comes out of his 2008 paper ‘Trade and Wages, Reconsidered’. Here is the last paragraph:

How can we quantify the actual effect of rising trade on wages? The answer, given the current state of the data, is that we can’t. As I’ve said, it’s likely that the rapid growth of trade since the early 1990s has had significant distributional effects. To put numbers to these effects, however, we need a much better understanding of the increasingly fine-grained nature of international specialization and trade.

I remember the paper very well, because I was interested in inequality at that time, too. I actually produced a European companion paper to Paul Krugman’s, which I never published, but put online at scribd. Here are my last two paragraphs:

However, it is hard to find evidence for the kind of inequality observed in most developed nations. Only the richest of the rich seem to move ahead, while everybody else is left behind. This kind of pattern is not consistent with inequality from trade, which should influence millions of workers, and not just the billionaires.

Gordon and Dew-Becker (2007) distinguish three different types of top in- come that have influenced US economic inequality. There are superstars, who have their performance magnified by electronic media. Then there are market-driven top incomes like that of law partnerships or investment bankers. Third come the incomes of top executives. These three groups might explain the increased skewness at the 99.99th percentile of US wage and salary income. The latter two groups might also benefit from the fact that 40 percent of US profits occur in the financial sector. It might be fruitful to continue the search in this direction.

The take-away lesson was that in Europe you would have the same difficulties to explain a rise in inequality with changes in international trade. While it might explain why some workers have accepted falling real wages, it is difficult to see how wages at the very top are effected by trade.

Of course, the problem of inequality in society is not a new one. As a European, I remember well my history books showing kings and queens, princes and princesses, who were rich because they owned all the property – and most of the people, too. While it might sound ridiculous today, this was reality in large parts of Europe. It was only during the Enlightenment that people stood up against this rule based on a different perception of social justice. David Hume (1711-1776) writes in his Essays:

A Government may endure for several ages, though the balance of power, and the balance of property do not coincide. This chiefly happens, where any rank or order of the state has acquired a large share in the property; but from the original constitution of the government, has no share in the power. Under what pretence would any individual of that order assume authority in public affairs? As men are commonly much attached to their ancient government, it is not to be expected, that the public would ever favour such usurpations. But where the original constitution allows any share of power, though small, to an order of men, who possess a large share of the property, it is easy for them gradually to stretch their authority, and bring the balance of power to coincide with that of property. This has been the case with the house of commons in England.

While Hume died in 1776, the Declaration of Independence became his legacy, as it was built on exactly this point:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.–That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, –That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.–Such has been the patient sufferance of these Colonies; and such is now the necessity which constrains them to alter their former Systems of Government.

It is well-known that unfettered markets, when left alone, first go through a stage of competition, but then a winner might come out holding a monopoly. Institutions have been built to deal with these issues, like art. 101, Treaty on the functioning of the EU. More indirectly, progressive taxes limit income inequality and the funds available for lobbying by the rich. There is a potential cumulative causation here as tax cuts increase lobbying funds for further tax cuts. It seems to me that political explanations for increasing inequality of incomes are superior to economic ones based on international trade.

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About the Author

Dr. Dirk Ehnts is a research assistant at the Carl-von-Ossietzky University of Oldenburg (Germany). His focus is on economic integration and economic geography, covering trade, macro and development. He is working at the chair for international economics since 2006 and has recently co-authored a book on Innovation and International Economic Relations (in German). Ehnts has written at his own blog since 2007: Econblog 101. Curriculum Vitae.