Topics in the Globalisation Debate 2: Labour Markets

1. 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?

3. 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.

4. Rodrik: Shift and Increased Elasticity of Labour Demand capital-abundant country • Autarky → Free trade and capital flows • (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) wage SL (1) (2) wA pFT DLFT DLA QLFT QLA employment Dani Rodrik (1997): Has globalisation Gone too Far? Available at Institute for International Economics website.

5. Elasticity of Labour Demand and Imposing Labour Standards • Assume that higher labour standards are imposed (creates a new cost)→ supply curve shifts upward → wages decrease, employment decreases • The more elastic the demand the more employment decreases, wages decrease and the larger share of the cost is paid by employees S’L wage SL E W DLFT employment E = employers share of the cost W = worker’s share

6. 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: • Skill-biased technological change • Increase in international trade • “Most of literature”: trade has not played a major role because • the amount of trade is too small • prices of (final) goods have not changed consistently • employment between industries has not changed consistently See Feenstra & Hanson (2003), Katz & Author (Handbook of Labor Economics, 1999) for discussion.

7. Change in the U.S. Real Wages(per percentile between 1970 and 2002 ) Source: Smith (2006)

8. Outsourcing • Feenstra & Hanson (2003) • 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”

9. 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?

10. Impact of globalisation on Poor Countries’ Labour Markets • Globalisation critics • 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 • 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.

11. 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

12. 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

13. 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

14. The FAIRTRADE Mark • Certification system that demand traders to • 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 • 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/

15. FAIRTRADE provides a minimum price pFTr, which is above the world equilibrium price p0 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) Impact of FAIRTRADE: Overproduction and Quotas price S0 pFTr p0 D Quantity Haaparanta (2007): Reilu kauppa, kysyntä, tarjonta ja tasapaino: Kuka kaiken maksaa? Valkila (2007): Better of Bitter Coffee? Implications of Fair Trade Coffee Certification…

16. A producer that would produce given the world price, now sells QFT to the FAIRTRADE markets at price pFTr and Q–QFT to the world market at price p0 From the producers point of view, identical impact would be generated by giving him the transfer in cash Impact of FAIRTRADE:Competitive producer price / cost pFTr Transfer to FT producer MC p0 QFT Q Quantity Haaparanta (2007)

17. Suppose production has fixed-cost + rising marginal cost leading to U-shaped average costs Then the equilibrium price is p0 and producers produce Q0 and small farms that would be able to produce QSF 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 Impact of FAIRTRADE:Non-competitive producer price / cost AC loss from QSF p0 QSF Q0 Quantity Haaparanta (2007)

18. 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 producersto the FAIRTRADE producers AND consumers of the regular product Impact of FAIRTRADE: Production increases, price decreases price S0 S1 p0 p1 D Quantity Haaparanta (2007)

19. Since some of the regular producers leave the market, supply curve shifts from S1 to S2 At the same time, consumers shift consumption towards the FTr product and demand curve shifts from D0 to D2 However if FTr has increased total production, the price of regular product still decreases in comparison to no FTr Impact of FAIRTRADE: Regular production and demand decrease price Regular Market S0 S2 S1 p0 p2 p1 D0 D2 Quantity Haaparanta (2007)

20. 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)

21. 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

22. 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