Globalization's impact on labor's share of national income

Kevin B. Murray, The Daily Record Newswire

The second quarter of 2015 has seen job openings reach new highs as unemployment continues its downward trend. Yet the United States Bureau of labor Statistics just reported that the Employment Cost Index (the broadest measure of labor costs), went up in the second quarter by the smallest amount since 1982, the year they first reported this statistic.

Many anticipated that wages would start growing rapidly as unemployment approached the full employment level. Currently the unemployment rate is 5.3 percent (down from a high of 10 percent in October 2009), which is quite close to the 5 percent that the Federal Reserve Board and others say is the level consistent with everyone who wants a job has one. The 5 percent level represents the “natural rate of unemployment,” which is composed of members of the labor force who are temporarily voluntarily unemployed as they seek different or higher paying positions.

Economic theory suggests as we approach full employment, wages rise rapidly as employers needing new employees must bid for them, by offering higher wages to pull them from other jobs. One criterion the Federal Reserve is using to determine when to raise interest rates (reduce stimulus to our economy) is when wage rates begin to rise indicating a tighter labor market. Many are puzzled by the anemic wage growth that has been occurring as unemployment has dropped considerably since the end of the great recession. Data on wages for one quarter, while interesting, often is less important than longer term trends.

Wages make up the bulk of national income and are of course the largest and often sole source of income for most individuals and families. Between the end of WWII and 1980, wages in the United States grew at or slightly above the rate of productivity growth. This increased the living standards for working people and led to the creation of the huge middle class into which most Americans felt they belonged.

Since approximately 1980, however, the growth of U.S. wages has significantly lagged behind the rate of productivity growth. Many explanations for this have been given, the main ones being the impact of automation, information technology and outsourcing of jobs abroad.

The decline in relatively high paying manufacturing jobs in the United States has been blamed on both automation and globalization. A report by the prestigious Brookings Institute, says “that competition from cheap imports is a major source of driving wage declines in the United States and shifting income toward owners of capital.”

The study looked at several reasons why the share of income going to labor has trended downward for the last 25 years in the United States and decided increased international trade has been the major reason. Labor’s share of national income has fallen by about 4 percent over the past 25 years. This has a significant impact on those who depend almost entirely on wages for their standard of living. It has moved many who were considered comfortably in the middle class into economic distress.

The Brookings study said that in keeping with economic theory that globalization and increased international trade have helped to expand total world output of goods and services.
Furthermore it has both increased global welfare and reduced income inequality between the rich and poor nations of the world. Unfortunately within the United States, it has had a negative impact on both wages and income inequality.

The International Monetary Fund produced a study that indicates globalization leads to increased trade flows and specialization between countries. This “allows countries to specialize in areas of comparative advantage and tends to equalize factor returns across countries.” Capital-rich countries (U.S. and Western Europe) will specialize in capital intensive goods, with poorer countries specializing in labor intensive goods. The IMF models show this leads to a gradual decline (in the wealthy countries) in the return to labor and labor’s share in national income will fall as specialization progressed.

The conclusion of the IMF study is that. “Openness to trade and increasing trade with developing countries have had a negative on the labor share (of national income) in the industrial countries, consistent with the prediction” of the theory and model the IMF used.

Increasing world output and reducing inequality between the rich and poor nations of the world are in many ways laudable outcomes, but it appears they come at a great cost to wage earners in the United States and other developed and wealthy countries. A large middle class has been the pride of our nation and has in many ways distinguished the United States from the “old world” of privilege and inequality. There is nothing inevitable about what the future may bring. Policies determine outcomes and the United States needs to develop and set policies that protect wage earners and maintain a strong and prosperous middle class with a high standard of living.

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Kevin B. Murray is a vice president at Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, nonprofits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.