Global Policy Forum

"Domestic Welfare in a Global Economy;


by Richard Rothstein

Research Associate, Economic Policy Institute

Presentation to the Second Annual Retreat of the Pacific Council on International Policy
September 6, 1996

Policymakers in industrialized and developing economies today face seemingly similar dilemmas. In both North and South, inequality has apparently increased, even while economies grow. Economic growth has combined greater returns to capital with lesser returns to labor; wages and family incomes of those at the bottom of the income distribution have declined. The once generally accepted nostrum that "a rising tide lifts all boats" has apparently ceased to apply: as one observer noted, in both First and Third World nations, a rising tide floats more yachts, but at the same time swamps more canoes.

This view is not universally accepted. Dissenters point to statistical anomalies, measurement uncertainty, atypical nations or long term trends that may contradict this portrait of growth-with- inequality. Dissenters suggest that, when confronted with ambiguous data, analysts and commonfolk have succumbed to a cultural pessimism that increasingly interprets glasses half-empty when they are also half-full. But disputes over details cannot alter the striking uniformity of the main trend. In a wide range of countries, the rich are getting richer and the poor are getting poorer, while those in the middle, whose perceptions are essential to political and social stability, expect themselves to be, and in fact are, more likely to become poorer than richer.

From the Economic Policy Institute's just-released report, "The State of Working America" by Lawrence Mishel, Jared Bernstein and John Schmitt, we know that in the United States, for example,

Average hourly wages and salaries of all workers grew at an annual rate of 0.4% from 1979 to 1994, from $14.96 to $15.89.

But the average hourly earnings of all production and nonsupervisory workers declined at an annual rate of -0.6% during the same 1979 to 1995 period, from $12.69 to 11.46. "Production and nonsupervisory workers" account for more than 80% of all wage and salary employment.

Thus, from 1979 to 1995, real wages for all workers at the tenth percentile of the wage distribution fell by -17%; at the twentieth percentile, by -11%; at the fortieth percentile, by -10%; at the sixtieth percentile, by -5%; at the eightieth percentile, by -0.4%. But real wages for workers at the ninetieth percentile of the wage distribution grew by 5% during this period.

Although there is variability among nations, and data is less precise, similar trends are broadly evident elsewhere in the world.

The United Nations Economic Commission for Latin America projects real economic growth for that region during the rest of the century, but also projects a simultaneous increase in the percentage of families living in poverty.

In Mexico, per capita GNP grew by a healthy average annual rate of 2.8% from 1965 to 1990, while the share of national income earned by the poorest 40% remained stagnant. Real wages today are lower than they were in 1981, before the first debt crisis and subsequent liberalization. Since the peso crisis of 1995, wages of working Mexicans have declined much further.

Poland's real per capita GNP grew slightly during the 1980s, but real manufacturing wages dropped by 25% during that decade. Poland is the most "successful" of the former Communist nations. In Russia and elsewhere in the Eastern block, inequality has grown even more, and living standards for the majority declined even more starkly.

Even before the current European recession, the share of national income going to Europe's wealthiest 20% was increasing; in the United Kingdom, it went from 40% in 1979 to 44% in 1988. In France and Germany, lesser increases in inequality, but increases nonetheless, occurred.

There is little agreement about the precise causes of this worldwide trend towards greater inequality and lower returns to labor (with higher returns to capital), and so there is also little consensus about solutions.

On the whole, policymakers have attempted to manage economic growth with supply-side rather than demand-side incentives. Keynesian approaches are out of fashion: even those policymakers who attempt to address inequality directly tend to emphasize supply-side approaches, like providing less-skilled workers with greater human capital through education, rather than demand-side approaches like boosting purchasing power by minimum wage increases, unionization, or direct redistribution (through progressive taxation, for example).

In the United States, it is apparent that the decline in real wages for the majority of workers, and growing inequality, is attributable in some combination to the following, although there is no consensus about the relative significance of each cause:

A declining minimum wage. Even after the new minimum wage increase, $5.15 still falls below the minimum's previous real value. In 1969, the minimum wage was $6.79 in today's dollars, equal then to over half Americans' average wage. In October, when the minimum goes to $4.75, it will be about 41 percent of today's average.

Liberalized trade. Workers competing with low wage imports have to accept lower wages to keep their jobs. Workers who don't compete with imports are also affected because import-impacted workers are willing to take their jobs at lower pay. Increasingly, even skilled workers -- designers or software engineers, for example -- also earn less because their jobs can be subcontracted to highly educated but poorly paid Third World workers.

Immigration. In its impact on wages, immigration differs little from trade. When products or services of native workers compete with products or services of lower-wage non-native labor, whether the low wage labor works here (as immigrants) or abroad (employed in export sectors), the economic effect is similar. While many immigrants work at jobs most Americans no longer seek (carwashes, kitchens, even garments), we have a single labor market; the possibility for workers to move from one sector to another assures that low wages in immigrant sectors spill over to low wages in similar sectors where most labor is native. And, as in trade, competition with lower-wage labor of immigrants is no longer restricted to unskilled labor-intensive industries like garments. In the United States, the median annual salary for engineers has declined in recent years by over 10%, while the number of foreign-born scientists and engineers admitted to the country more than doubled.

Deunionization. America's labor unions now represent barely 10 percent of private-sector workers, down from nearly 40 percent in the 1950s. Workers in unions earn more, but non-union workers also benefit from a more aggressive labor movement. When unions were stronger, non-union employers raised wages to dissuade workers from organizing, and to avoid losing trained workers to unionized companies.

Deunionization is also tied to trade. When low wage imports make some American jobs uncompetitive, new jobs in stronger industries (like exports or services) may replace them. But the old jobs were more likely to be unionized and the new ones hard to organize. So trade contributes to deunionization which, in turn, compounds wage stagnation attributable to trade.

Slow growth. Official unemployment is now below 5.5%, but this figure ignores people who work part-time because they can't find full-time work, and those unable to find jobs who've given up looking. When government statisticians count the "unemployed," they don't include these discouraged workers. If involuntary part-timers and discouraged workers were counted, unemployment would be about 9%, still lower than Europe's but less dramatically so. Unemployment not only affects the jobless but contributes to real wage decline of employed workers who compete with those unemployed who are willing to work for less. If the recently enacted welfare reform actually takes effect as planned, unemployment will be further exacerbated. It is already apparent that a fatal flaw in the welfare reform program may be the lack of jobs in which welfare recipients can be placed once automatic benefits end. (And many of the jobs in which welfare recipients could be placed are now filled by low wage immigrants.)

Unemployment is caused partly by tight money: the Fed helps keep interest rates high to ward off possible inflation. Unemployment is also exacerbated by declining federal budget deficits. Each program cut not only causes joblessness for federal employees and for workers supplying goods and services to government programs. It also reduces the "stimulus" of federal spending, because every dollar the government spends in excess of tax collections spurs greater economic activity and employment.

It is widely believed that much of today's unemployment is neither "cyclical" (the result of business cycles), nor "frictional" (a statistical reflection of increased job changes). Rather, it is noted, unemployment is "structural," the result of available workers not having the education or skills required by new jobs being created.

There are two difficulties with this explanation: one is that we also have a surplus of highly educated workers. In the 1980s, 20% of college graduates were working at jobs not requiring a college education; the Department of Labor expects this number to increase to 30% by the year 2000. Our "overproduction" of Ph.D.'s in engineering, math and some sciences is about 25%.

The second difficulty is that the "new" technologically advanced economy generates large numbers of low-skilled, low wage jobs, as well as high-skilled ones. According to the Department of Labor's new Occupational Outlook Handbook, "computer scientists and systems analysts" will be the fastest growing job category from 1994 to 2005. But of the next 9 fastest growing job categories, 7 require few skills and pay low wages: home health aides, retail sales workers, janitors, cashiers, food service workers, kitchen workers, and equipment cleaners. A more highly educated workforce will not change these realities.

Declining public investment also contributes to declining wages because national productivity lags from inadequate national infrastructure. When roads and bridges deteriorate, truckers' productivity drops; so does the productivity of all workers who make the products that are shipped. When productivity drops, wages can't rise. Technological spin-offs from Cold War defense research (like the personal computer) are also in decline as public investment in military technology declines. This removes another spur to productivity.

Tax policy can undo the impact of declining wages by progressive redistribution, or it can exacerbate income inequality. Though the 1993 budget enhanced progressivity (the Earned Income Tax Credit and rates on wealthy Americans were increased), taxation is still more regressive than it was during the postwar boom years. The 1993 budget reversed less than half the tax cuts received by those in higher tax brackets in the late 1970s and early 1980s.

Other causes. Excessive executive compensation; deregulation of airline, trucking, and communications; and decline in benefit coverage (like health care or pensions), have also contributed to wage stagnation or inequality.

If each of these causes were independent, they would be easier to fix. But reforms in any one may exacerbate others; or reforms may have other unintended consequences, not yet foreseen by policymakers. This interdependence of causes leads not only to paralysis of policy, but to unproductive debates in which advocates focus on partial truths, speaking past each other.

For example, low wage imports may be a blessing when expanded trade stimulates the redeployment of capital in more efficient pursuits, contributing to economic growth. Trade with lower wage nations provides lower prices to American consumers. But well-off Americans share in this benefit, while the burden is mostly borne by workers whose wages decline. Our trade debates (NAFTA comes particularly to mind) are characterized by advocates of trade who proclaim its benefits in growth, and opponents who bemoan the decline of wages, with few developing a position that addresses each of these consequences of liberalized trade.

Immigration debates, as well, are characterized by widespread unwillingness to acknowledge complexity. Immigrant defenders note that both hardworking immigrants and skilled immigrants boost economic productivity and innovation, support price stability, and free domestic labor to expand into more efficient sectors -- in addition to enriching our uniquely multi-national culture. Restrictionists note that immigrants flood labor markets and depress wages. Both are correct. Policymakers remain hesitant to stimulate faster growth (by a more expansive monetary policy, for example), believing that, at a point not too far distant, growth would require employers to bid up wages, resulting in an accelerating spiral of inflation. But because of the downward pressures on wages from deunionization and freer trade, a minority of policymakers believe we can tolerate much lower unemployment without triggering inflation. Regardless of which viewpoint is correct, we clearly lack the capacity to fine-tune these trade-offs to the extent we like to pretend. Policymakers will inevitably err in the direction of too much inflation or too much unemployment; the real public decision we face is which error we prefer. One cause of the declining wage picture is that policymakers consistently prefer excessive unemployment to excessive inflation.

Developing nation policymakers face similar dilemmas, compounded by the mobility of capital that tends to stimulate a "race to the bottom." Governments that preserve consumer subsidies or institutional supports for higher wages face the danger of capital flight that will result in even lesser ability to preserve living standards or wage levels. A shrinking public sector may keep inflation in check, making the currency an attractive medium for international investment, but a shrinking public sector may also remove needed purchasing power from an underemployed economy or diminish the subsidies or other supports that protect living standards of the most vulnerable citizens.

Development economists and international financial institutions have hailed Argentina as one the world's most successful industrializing nations. From 1990 through 1994, inflation was nearly eliminated, while per capita GNP growth exceeded 5%. But unemployment doubled to over 10%, and manufacturing earnings per employee declined by over 10%. Today, the Argentine economy has rebounded from the fallout of the Mexican peso crisis, and industrial production and exports are again climbing. But to make the country more attractive to foreign investment, recently-appointed Argentine Finance Minister Roque Fernandez has submitted an additional "austerity package" to Congress, further cutting public expenditures. Last month, Argentine unions mounted a general strike against government policies.

Prevailing economic models often require developing nations to suppress wages during periods of rapid growth, so unit labor costs fall even faster than productivity rises. During its initial period of liberalization from 1980 to 1989, for example, Mexico's real manufacturing wages fell by 24 percent while industrial productivity jumped 28 percent. In Bangladesh, productivity grew by 20 percent during the same period, with no corresponding growth of wages.

In developing economies competing for foreign investment, child labor has become more widespread as export-led growth takes off. In 1993, the Philippines, to attract investors, abolished minimum age requirements for factory work. Indonesia in 1949 prohibited children working younger than age 15, but in 1987, to make Indonesia more attractive for investment, the country abolished this prohibition for "children forced to work for social or economic reasons." By 1991, there were 2.8 million Indonesian children "bonded" to factories -- i.e., mortgaged by parents to employers. World workforces now include 200 million children, many mortgaged to carpet and garment factories where accumulated bills for food, lodging and drugs (often amphetamines dispensed to sustain long hours) make redemption of mortgages impossible. About half the children in Pakistan's export carpet industry die from malnutrition and disease before age 12. A competitive "race to the bottom" precludes such nations from raising labor standards and attracting investment simultaneously. The carpet export industry migrated to India, Nepal and Pakistan after -- and because -- the Shah of Iran abolished child labor in his nation.

Both NAFTA and the WTO nearly failed to conclude when the Clinton Administration (and, in the case of the WTO, the French as well) insisted on incorporation of minimal requirements for international labor standards in free trade agreements. Since these instances, the U.S. Congress has prohibited the U.S. administration from again raising the issue of labor standards in future trade agreements.

Parallel economic trends -- growth with inequity -- evoke parallel instabilities. In Western Europe and the United States, a politics of resentment hints its emergence in popular reactions against immigrants or in protectionist pseudo-populism. In Mexico, a guerilla insurgency flares. Indonesia, too, faces its first rioting in many years, a reaction to government attempts to assure a compliant union movement that would offer no discouragement to foreign investment.

The picture is not uniform. Korea and Chile are two nations that may, recently, have combined rapid growth with improved living standards for the majority. Are the recent successes of these countries temporary aberrations? Do unique cultural and historical characteristics make their positive experiences not generalizable? Or have these nations discovered something about growth and development that remains obscure to others?

Without minimizing the insecurity and, in some cases, misery that afflicts many working and middle class citizens of many otherwise dissimilar nations, we live in an intellectually exciting period. From 1965 to 1980, demand-side Keynesianism was discredited and mostly abandoned. It was replaced by supply-side advocacy whose intellectual hegemony was, until recently, unquestioned. But today it is becoming apparent that new answers are needed; growth with inequity is not what we sought.

Will policymakers develop a new vision that can maintain economic growth while reversing the slide toward greater inequity, insecurity and impoverishment, both here and in the less industrial world?

If economic growth has social costs, to what extent should growth be sacrificed to competing political, social, or economic goals?

With capital so much more mobile than labor, are new institutional restraints on capital called for, both in industrialized and developing economies, to permit consideration of welfare goals? Are new institutional restraints politically conceivable?

Are there available models to replace or modify the supply-side preconceptions which inform economic policy both in industrial and developing economies? Should price stability remain the world's primary economic goal, or should it become one of several goals? Are labor standards an appropriate subject for trade negotiations? Are they an appropriate subject for domestic regulation?

Is it possible for any nation, in an increasingly integrated international economy, to modify its economic development model without coordinating this modification with other nations? What might the mechanism for such coordination be?

Preferred Citation: Richard Rothstein, "Domestic Welfare in a Global Economy,"(September 6, 1996 []).

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FAIR USE NOTICE: This page contains copyrighted material the use of which has not been specifically authorized by the copyright owner. Global Policy Forum distributes this material without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. We believe this constitutes a fair use of any such copyrighted material as provided for in 17 U.S.C § 107. If you wish to use copyrighted material from this site for purposes of your own that go beyond fair use, you must obtain permission from the copyright owner.