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This story was originally published in our April issue, and has been reposted to highlight the long history of Nobelists publishing in Scientific American. The real wage of the average American worker more than doubled between the end of World War II and Since then, however, those wages have risen only 6 percent. Furthermore, only highly educated workers have seen their compensation rise; the real earnings of blue-collar workers have fallen in most years since Why have wages stagnated?
A consensus among business and political leaders attributes the problem in large part to the failure of the U. This conventional wisdom holds that foreign competition has eroded the U. And because imports increasingly come from Third World countries with their huge reserves of unskilled labor, the heaviest burden of this foreign competition has ostensibly fallen on less educated American workers.
Many people find such a story extremely persuasive. In effect, the U. Persuasive though it may be, however, that story is untrue. A growing body of evidence contradicts the popular view that international competition is central to U. The manufacturing sector has become a smaller part of the economy, but international trade is not the main cause of that shrinkage.
The growth of real income has slowed almost entirely for domestic reasons. And -- contrary to what even most economists have believed -- recent analyses indicate that growing international trade does not bear signifcant responsibility even for the declining real wages of less educated U.
The fraction of U. So has the share of U. In value added in the manufacturing sector accounted for Before those who worried about this trend generally blamed it on automation -- that is, on rapid growth of productivity in manufacturing.
Since then, it has become more common to blame deindustrialization on rising imports; indeed, from to , imports rose from Yet the fact that imports grew while industry shrank does not in itself demonstrate that international competition was responsible.
During the same 20 years, manufacturing exports also rose dramatically, from Many manufacturing firms may have laid off workers in the face of competition from abroad, but others have added workers to produce for expanding export markets.
To assess the overall impact of growing international trade on the size of the manufacturing sector, we need to estimate the net effect of this simultaneous growth of exports and imports. A dollar of exports adds a dollar to the sales of domestic manufacturers; a dollar of imports, to a first approximation, displaces a dollar of domestic sales. The net impact of trade on domestic manufacturing sales can therefore be measured simply by the manufacturing trade balance -- the difference between the total amount of manufactured goods that the U.
In practice, a dollar of imports may displace slightly less than a dollar of domestic sales because the extra spending may come at the expense of services or other nonmanufacturing sales. The trade balance sets an upper bound on the net effect of trade on manufacturing. Undoubtedly, the emergence of persistent trade deficits in manufactured goods has contributed to the declining share of manufacturing in the U. The question is how large that contribution has been. In manufactured exports exceeded imports by 0.
Since then, there have been persistent deficits, reaching a maximum of 3. By , however, the manufacturing deficit had fallen again, to only 1. The decline in the U. Moreover, the raw value of the trade deficit overstates its actual effect on the manufacturing sector. Trade figures measure sales, but the contribution of manufacturing to GDP is defened by value added in the sector -- that is, by sales minus purchases from other sectors.
Our analysis of data from the U. Department of Commerce puts the figure at 40 percent. This adjustment strengthens our conclusion: Between and manufacturing declined from International trade explains only a small part of the decline in the relative importance of manufacturing to the economy. Why, then, has the share of manufacturing declined? The immediate reason is that the composition of domestic spending has shifted away from manufactured goods.
By the shares were It is hardly surprising, given this shift, that manufacturing has become a less important part of the economy. Between and the price of goods relative to services fell The physical ratio of goods to services purchased remained almost constant during that period.
Goods have become cheaper primarily because productivity in manufacturing has grown much faster than in services. This growth has been passed on in lower consumer prices.
Ironically, the conventional wisdom here has things almost exactly backward. Policymakers often ascribe the declining share of industrial employment to a lack of manufacturing competitiveness brought on by inadequate productivity growth.
In fact, the shrinkage is largely the result of high productivity growth, at least as compared with the service sector.
The concern, widely voiced during the s and s, that industrial workers would lose their jobs because of automation is closer to the truth than the current preoccupation with a presumed loss of manufacturing jobs because of foreign competition. Because competition from abroad has played a minor role in the contraction of U. Our data illuminate just how small that fraction is.
Assuming that any loss of manufacturing jobs was made up by a gain of nonmanufacturing jobs -- an assumption borne out by the absence of any long-term upward trend in the U. Many observers have expressed concern not just about wages lost because of a shrinking manufacturing sector but also about a broader erosion of U.
But they often fail to make the distinction between the adverse consequences of having slow productivity growth — which would be bad even for an economy that did not have any international trade -- and additional adverse effects that might result from productivity growth that lags behind that of other countries.
To see why that distinction is important, consider a world in which productivity output per worker-hour increases by the same amount in every nation around the world -- say, 3 percent a year. Similarly, if productivity grew at 1 percent a year, so would earnings.
The relation between productivity growth and earnings growth holds regardless of the absolute level of productivity in each nation; only the rate of increase is significant. Concerns about international competitiveness, as opposed to low productivity growth, correspond to a situation in which productivity growth in the U.
If real earnings in the U. The rate of earnings growth is exactly the same as it would be if other countries were doing as badly as we are. The fact that other countries are doing better may hurt U. It makes sense to talk of a competitive problem only to the extent that earnings growth falls by more than the decline in productivity growth. Foreign competition can reduce domestic income by a well-understood mechanism called the terms of trade effect.
In export markets, foreign competition can force a decline in the prices of U. That decline typically occurs through a devaluation of the dollar, thereby boosting the price of imports. The net result is a reduction in real earnings because the U. During the past 20 years, the U. The ratio of U. Real earnings grew by about 6 percent during the s and s. Our calculation suggests that avoiding the decline in the terms of trade would have increased that growth to only about 8 percent.
Although the effect of foreign competition is measurable, it can by no means account for the stagnation of U. A more direct way of calculating the impact of the terms of trade on real income is to use a measure known as command GNP gross national product. Real GNP, the conventional standard of economic performance, measures what the output of the economy would be if all prices remained constant.
Command GNP is a similar measure in which the value of exports is deflated by the import price index. It measures the quantity of goods and services that the U. If the prices of imports rise faster than export prices as will happen, for example, if the dollar falls precipitously , growth in command GNP will fall behind that of real GNP. Between and , when U.
Between and , as real wages stagnated, command GNP grew more slowly than output, 0. Both these differences, however, are small. The great bulk of the slowdown in command GNP was caused by the slower growth of real GNP per worker -- by the purely domestic impact of the decline in productivity growth. If foreign competition is neither the main villain in the decline of manufacturing nor the root cause of stagnating wages, has it not at least worsened the lot of unskilled labor?
Economists have generally been quite sympathetic to the argument that increased integration of global markets has pushed down the real wages of less educated U. Their opinion stems from a familiar concept in the theory of international trade: When a rich country, where skilled labor is abundant and where the premium for skill is therefore small , trades with a poor country, where skilled workers are scarce and unskilled workers abundant, the wage rates tend to converge.
The pay of skilled workers rises in the rich country and falls in the poor one; that of unskilled workers falls in the rich country and rises in the poor nation. Given the rapid growth of exports from nations such as China and Indonesia, it seems reasonable to suppose that factor price equalization has been a major reason for the growing gap in earnings between skilled and unskilled workers in the U.
Surprisingly, however, this does not seem to be the case. We have found that increased wage inequality, like the decline of manufacturing and the slowdown in real income growth, is overwhelmingly the consequence of domestic causes. That conclusion is based on an examination of the evidence in terms of the underlying logic of factor price equalization, first explained in a classic paper by Wolfgang F. Stolper and Paul A.
The principle of comparative advantage suggests that a rich country trading with a poor one will export skill-intensive goods because it has a comparative abundance of skilled workers and import labor-intensive products. As a result of this trade, production in the rich country will shift toward skill-intensive sectors and away from labor-intensive ones. That shift, however, raises the demand for skilled workers and reduces that for unskilled workers.