Monday, August 20, 2007

Shipping Out

I though this was interesting given the hyperventilating some people did on the "outsourcing" issue last week:

The received wisdom is clear. Globalisation in general, and offshoring of manufacturing production to low-wage countries in particular, raise wage inequality in industrialised countries. No wonder that a recent poll shows that an overwhelming majority of people in the US and Europe view globalisation as a negative force. Citizens of the US and the EU look to their governments to undertake actions that can reduce what they perceive as unjustified rewards to corporate executives triggered by globalisation. Among the most popular initiatives are trade protection and tax reforms.

I think we can agree that this is the case.


Globalisation triggers offshoring and vertical specialisation based on comparative advantages. Following the usual logic of trade theory, high-income, skill-abundant countries specialise in skill-intensive activities. This increases their relative demand for skilled labour and puts upward pressure on the relative wage of skilled workers. This ‘specialisation effect’ is the basis for the received wisdom about the relationship between offshoring and wage inequality.

However, there is another effect as well. As trade barriers fall and protective measures are abolished, globalisation brings fiercer competition among firms. Competition induces firm exit as well as mergers and acquisitions, implying a reduced number of firms. As a result, headquarters' activities such as management, marketing, accounting – all exclusively involving non-production workers – are squeezed. In relative terms, the demand for non-production workers falls and there is downward pressure on the relative wage of these workers.

We believe that these two opposing forces on the relative wage of non-production workers explains why the straight-line increase in globalisation and offshoring has not produced a straight-line growth in relative wages (as per Figure 1). Depending on the details of the exact nature of the globalisation and offshoring that is occurring, and the initial situation in the country, either force may dominate. Thus contrary to received wisdom, we may observe a decrease rather than an increase in wage inequality.

It's an interesting and provocative argument, but one that's neither new nor exhaustive.

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