Macroeconomics – Case Study 1: Inequality and Globalisation Explain how trade liberalization may have led to inequality in the U.S. using the learnings from the Heckscher-Ohlin model lecture. When appropriate, use figures to facilitate your explanations. Trade liberalisation 1. Global economy integrates capital markets but only a handful of countries, institutions and companies benefit by creating ‘the rules of the game’, especially the World Bank and the International Monetary Fund 2. Disrupts local and regional economies to produce scale 3. Increasing financial market volatility with little accountability 4. Dumping duties and restrictions in areas of natural comparative advantage Inequality Inequality is particularly high in the US, rising from 39.7 in 1967 to 46.8 in 2009 using the Gini index. There are several compounding explanations: 1. Increasing returns to education, aka, the ‘college premium’ or ‘skilled wage premium’ 2. Increasing concentration of income at the extreme top end of the distribution 3. The probability of upwards income mobility decreased from 15% in 1975 to 10% in 2004 4. The implementation of aggressive market-oriented reforms such as deregulation, privatisation and trade liberalisation in the Reagan era 5. Globalisation: profit maximisation, destruction of trade/labour unions (denial of labour rights) 6. Technology: access to information and high-speed computing, increase in the rate of skill-based technology, communication and IT proliferation 7. US trade policy: enormous low-cost foreign labour pools in China and India (outsourcing), greater competition from abroad 8. Cultural norms: corporate hierarchy that demanded higher salaries independent of need or productive contribution, extreme pay differentials, 9. Political facilitation and wealthy bias in finance, corporate governance, taxation and industrial/environmental relations 10. The meaning and implications of the term as defined – poverty versus inequality Hecksher-Ohlin Expands on the Ricardian model by the introduction two factors – labour and capital resources (e.g., land, technology, minerals, etc.) – of production. However, the gains from trade are unequally distributed: the owners of land and those with access to capital gain, but owners of a country’s scarce factors lose from trade. Describe the constituent theorems- stopler, factor price-equalisation, Rybczynski, H-O th Use the US’ production possibility frontier: what does the US economy actually produce? According to the model, trade should be nationally advantageous, and will have characterizable effects on prices, wages, and rents when the nations differ in their relative factor endowments and when different industries use factors in different proportions. However, as the Stolper-Samuelson theorem shows, the model clearly demonstrates that some factor owners will experience an increase in their real incomes, while workers will experience a decrease in their factor incomes as the relative prices equalise. Yet, due to the political bias that favours the concentration of extreme wealth over national welfare systems, the compensation principle is not applied. Yet, if production technologies differ across countries, as we assumed in the Ricardian model, then factor prices would not equalize once goods’ prices equalize. Since the United States is capital abundant, then capital owners in the United States will experience an increase in the purchasing power of their rental income (i.e., they will gain), while workers will experience a decline in the purchasing power of their wage income (i.e., they will lose). What’s more, the country’s abundant factor benefits regardless of the industry in which it is employed. Thus, capital owners in the United States would benefit from trade even if their capital is used in the declining import-competing sector. Similarly, workers would lose in the United States even if they are employed in the expanding export sector. The compensation principle states that as long as the total benefits exceed the total losses in the movement to free trade, then it must be possible to redistribute income from the winners to the losers such that everyone has at least as much as they had before trade liberalization occurred. Trade increases the demand for goods produced by abundant factors, indirectly increasing the demand for the abundant factors themselves, raising the factor prices of the abundant factors across countries. However, the use of aggregate indifference curves (or preferences) ignores the issue of income distribution. Although it is correct to conclude from this analysis that countries benefit from free trade, it is not correct to conclude that all individuals in countries also benefit from free trade. By calculating changes in real income in the Heckscher-Ohlin (H-O) model, it can be shown that some individuals will likely benefit from free trade, while others will suffer losses. An increase in aggregate welfare means only that the sum of the gains exceeds the sum of the losses. To measure gains or losses to workers and capitalists, we must evaluate the effects of free trade on their real incomes. Increases in nominal income are not sufficient to know whether an individual is better off since the price of exportable goods will also rise when a country moves to free trade. By assessing the change in real income, we can determine how the purchasing power of workers and capitalists is affected by the move to free trade. a nation’s trade policy has nothing to do with its level of employment of its factors of production Income distribution data can be presented graphically using a Lorenz curve, a curve that shows cumulative shares of income received by individuals or groups. It was developed by economist Max O. Lorenz in 1905. To plot the curve, we begin with the lowest quintile and mark a point to show the percentage of total income those households received. We then add the next quintile and its share and mark a point to show the share of the lowest 40% of households. Then, we add the third quintile, and then the fourth. Since the share of income received by all the quintiles will be 100%, the last point on the curve always shows that 100% of households receive 100% of the income The distribution of income among households in the United States became more unequal from 1968 to 2010. The shares of income received by each of the first four quintiles fell, while the share received by the top 20% rose sharply. The Lorenz curve for 2010 was more bowed out than was the curve for 1968. The degree of inequality is often measured with a Gini coefficient, the ratio between the Lorenz curve and the 45° line and the total area under the 45° line. The smaller the Gini coefficient, the more equal the income distribution. Larger Gini coefficients mean more unequal distributions. The Census Bureau reported that the Gini coefficient was 0.359 in 1968 and 0.457 in 2010 Clearly, an important source of rising inequality since 1968 has been the sharp increase in the number of families headed by women. In 2010, the median income of families headed by married couples was 2.5 times that of families headed by women without a spouse. The percentage of families headed by women with no spouse present has nearly doubled since 1968 and is thus contributing to increased inequality across households. Technological and Managerial Change Technological change has affected the demand for labor. One of the most dramatic changes since the late 1970s has been an increase in the demand for skilled labor and a reduction in the demand for unskilled labor. The result has been an increase in the gap between the wages of skilled and unskilled workers. That has produced a widening gap between college- and high-school-trained workers. Technological change has meant the integration of computers into virtually every aspect of production. And that has increased the demand for workers with the knowledge to put new methods to work—and to adapt to the even more dramatic changes in production likely to come. At the same time, the demand for workers who do not have that knowledge has fallen. Along with new technologies that require greater technical expertise, firms are adopting new management styles that require stronger communication skills. The use of production teams, for example, shifts decision-making authority to small groups of assembly-line workers. That means those workers need more than the manual dexterity that was required of them in the past. They need strong communication skills. They must write effectively, speak effectively, and interact effectively with other workers. Workers who cannot do so simply are not in demand to the degree they once were. The “intellectual wage gap” seems likely to widen as we move even further into the twentyfirst century. That is likely to lead to an even higher degree of inequality and to pose a challenge to public policy for decades to come. Increasing education and training could lead to reductions in inequality. Indeed, individuals seem to have already begun to respond to this changing market situation, since the percentage who graduate from high school and college is risingAmericans select a government that is smaller and engages in less redistributive activity than is selected by Europeans. Government in continental Western Europe is 50% larger than in the United States, the tax system in Europe is much more progressive than in the United States, regulation of labour and product markets is more extensive in Europe, and redistributive programs are more extensive in Europe than in the United States. As a result, the income distribution in Europe is much more equal than in the United States. American values and beliefs produce the American result: a society in which the distribution of income is more unequal, the government smaller, and redistribution relatively minor. Figures Limitations of the Gini Index Though useful for analyzing economic inequality, the Gini coefficient has some shortcomings. The metric's accuracy is dependent on reliable GDP and income data. Shadow economies and informal economic activity are present in every country. Informal economic activity tends to represent a larger portion of true economic production in developing countries and at the lower end of the income distribution within countries. In both cases, this means that the Gini index of measured incomes will overstate true income inequality. Accurate wealth data is even more difficult to come by due to the popularity of tax havens. Another flaw is that very different income distributions can result in identical Gini coefficients. Because the Gini attempts to distill a twodimensional area (the gap between the Lorenz curve and the equality line) down to a single number, it obscures information about the "shape" of inequality. In everyday terms, this would be similar to describing the contents of a photo solely by its length along one edge, or the simple average brightness value of the pixels. Though using the Lorenz curve as a supplement can provide more information in this respect, it also does not show demographic variations among subgroups within the distribution, such as the distribution of incomes across age, race, or social groups. In that vein, understanding demographics can be important for understanding what a given Gini coefficient represents. For example, a large retired population pushes the Gini higher. As we can see, the poorest individuals in the US have seen no real income growth in the period 1980-2014; while at the very top, the ultra-rich have enjoyed an average annual growth of about 6%. Without taxes and transfers, those at the bottom have actually seen their incomes shrinking.
