trade policy, agreements and taxation of multinationals

Trade Policy, Agreements and Taxation of MultinationalsRising Wage Inequality and Trade

Lecture 1

Meredith Crowley

University of Cambridge

July 2015

MC (University of Cambridge) Trade Policy, Agreements and Taxation of Multinationals July 2015 1 / 63

Lecture 1: Rising Wage Inequality and Trade

In part 1 of this lecture, we will...

review empirical evidence on increasing wage inequality around the world,

review the shape of wage distribution,

discuss how to measure inequality,

examine different theories behind the rise in wage inequality.

We will break to read and then discuss recent evidence that inequality isdecreasing in Latin America.

In part 2 of this lecture, we will...

review the Ricardo-Viner Specific Factors Model,

apply this model to the offshoring of jobs by Multinational Enterprises,

review evidence on offshoring by US Multinational Enterprises.


Income and wage inequality: rising around the world

There have been dramatic increases in income inequality and wage inequality inmany countries around the world for the past few decades.

The share of a nation’s income going to the top 10 % of a nation’spopulation has increased in many countries.

The difference in the wage earned by the 90th percentile worker and the 10thpercentile worker has increased.

Wages earned by more educated workers have increased more rapidly thanthose earned by less educated workers.→ the returns to a college education have increased

Within demographic and within skill group wage inequality have increasedsubstantially (residual inequality)→ some college graduates earn much more than others


Income inequality: rising in the US and Europe

Total income consists ofwages and returns tocapital.

The y-axis measures theshare of total incomereceived by the top 10% ofearners in the US andEurope.

In 1970, the top 10% ofAmericans earned about33% of US income.

In 2010, the top 10% ofAmericans earned about47% of US income.

In both the US and Europe,income inequality has beenrising for several decades.

Top 10% incomeshare: Europe

Income inequality in Europe and the United States, 1900–2010 Share of top income decile in total pretax income

50 percent

45

40

35

30

25201020001990198019701960195019401930192019101900

Top 10% incomeshare: U.S.

Fig. 1. Income inequality in Europe and the United States, 1900 to 2010.The share of total income accruing to top decile income holders was higher inEurope than in the United States from 1900 to 1910; it was substantiallyhigher in the United States than in Europe from 2000 to 2010. The seriesreport decennial averages (1900 = 1900 to 1909, etc.) constructed usingincome tax returns and national accounts. See (24), chapter 9, Fig. 9.8. Seriesavailable online at piketty.pse.ens.fr/capital21c.


Income inequality: rising in China from 1986-2003

There is less incomeinequality in China thanin the US or Europe.

In 2000, the top 10% ofChinese received about25.5% of income,compared to 34% inEurope and 46% in theUS.

But income inequalityin China has beenrising.

Similar increases inincome inequality areobserved in Japan andthe United Kingdom.


Income inequality: rising in the United Kingdom and Japan

United Kingdom Japan


Rising inequality between “average” workers in the US

The previous figures showedthat the top 10% of incomeearners are earning more overtime.

What about the average ormedian worker?

In the US, the median incomeof a college-educated workerhas increased more than themedian income of a highschool-educated worker overthe last 30 years.

This is evidence of increasinginequality between skilled andunskilled workers.

What has caused increasinginequality?

College/high school median annual earnings gap, 1979–2012 In constant 2012 dollars

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000 dollars

1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

Household gap$30,298 to $58,249

Male gap$17,411 to $34,969

Female gap$12,887 to $23,280

Fig. 1. College/high school median annual earnings gap, 1979–2012. Figure is constructed usingCensus Bureau P-60 (1979–1991) and P-25 (1992–2012) tabulations of median earnings of full-time,full-year workers by educational level and converted to constant 2012 dollars (to account forinflation) using the CPI-U-RS price series. Prior to 1992, college-educated workers are defined asthose with 16 or more years of completed schooling, and high school–educated workers are thosewith exactly 12 years of completed schooling. After 1991, college-educated workers are those whoreport completing at least 4 years of college, and high school–educated workers are those whoreport having completed a high school diploma or GED credential.


The shape of the wage distribution

Labour economists observe that the typical wage distribution is skewed, witha long right tail.

A small number of people earn very high wages.

The median wage is lower than the average wage.

Why does the wage distribution have this shape?


Why is the wage distribution skewed?

Why do we usually observe that the wage distribution is skewed?

Consider the remuneration of human capital and ability

The most able people acquire more human capital and then are paid more(complementarity between human capital and ability).=⇒ the skewness is explained by the positive correlation between ability andhuman capital.


Measuring Inequality

There are many approaches to measuring inequality.

We have looked at

the share of earnings going to the top 10% of earners in several countries andthe median incomes of skilled versus unskilled workers.

Other measures used are:

the Lorenz curve;the Gini coefficient;90-10 wage gaps: the percent wage differential between the worker of the 90thpercentile and the one in the 10th percentile;50-10 wage gaps: it measures the inequality between the “middle class” andthe low-income workers


Measuring Inequality: the Lorenz curve

To construct a Lorenz curve, we:

rank the households according to their income level;

divide the population in 5 groups (quintiles) of equal size;

calculate the share of income received by each quintile.

US 2010 (Bureau of the Census)

Quintile Share of CumulativeIncome share of income

First 0.034 0.034Second 0.086 0.120Third 0.147 0.267Fourth 0.233 0.500Fifth 0.500 1.000


The Gini coefficient:A summary measure of the information in the Lorenz curve

The area between perfect equality curve and actual Lorenz curve can be usedto measure inequality

Gini coeff . =area between perfect equality curve and actual Lorenz curve

area under the perfect equality curve

Gini = 0: perfect equality

Gini = 1: perfect inequality

This measure is not perfect. Two different distributions can give the sameGini coefficient.


Urban wages in China: Lorenz curve and Gini coefficient

0

.2

.4

.6

.8

1

L(p)

0 .2 .4 .6 .8 1Percentiles (p)

45⁰ line wage88

wage95 wage02

wage08

Figure 1. Lorenz Curves of Wages in Urban China 1988-2008

Chinese wage inequality increasedover 1988-2008.

China acceded to the WTO in 2001.

Year Gini coefficient1988 0.2371995 0.3452002 0.3482008 0.45

Source: “UnderstandingUrban Wage Inequality inChina 1988-2008: Evidencefrom Quantile Analysis” bySimon Appleton, Lina Song,Qingjie Xia. February 2013.CHINA GROWTH CENTRE(CGC) Discussion PaperSeries No. 18.


Changes in US wage inequality: the empirical evidence

Four facts about the US economy:

1 Since the 1970’s, the US economy has grown quite well – more than doubled,in fact. Along with this, labor productivity grew.

2 Over the same period, wages started to lag behind productivity growth.

3 Inequality in wages also increased; median wages have been stagnant, andbelow-median male wages have fallen.

4 This coincides with the big wave of globalization.


US productivity and wages: 1960-2006


Growing US wage dispersion: 1973-2007


Changes in US wage inequality: the empirical evidenceSource: Autor, Katz and Kearney (2008)

FIGURE 2.—THREE MEASURES OF WAGE INEQUALITY: COLLEGE/HIGH

SCHOOL PREMIUM, MALE 90/10 OVERALL INEQUALITY, AND MALE 90/10RESIDUAL INEQUALITY


Changes in UK wage inequality:Source: Brewer, Sibieta and Wren-Lewis (2007)


Inequality in developing countries: the empirical evidence

Wage inequality is not only a feature of high-income countries.

Middle-income and developing countries have seen a rise in wage inequalitythroughout the 1980s and 1990s.

These increases in wage inequality in developing countries have coincided with

reforms of domestic laws (labor market reforms),

structural (macroeconomic) adjustment programs,

better educational opportunities,

and trade liberalizations.


Changes in DC inequality: the empirical evidenceSource: Goldberg and Pavcnik (2007)


Changes in DC inequality: the empirical evidenceSource: Goldberg and Pavcnik (2007) cont.


Changes in wage inequality: why?

There are several competing explanations why we have seen such a dramaticincrease in inequality.

From the empirical evidence we see that:

there has been an increase in wage inequality between skilled and unskilledworkers;in the US there has been an increase in the proportion of high skilled workersover low skilled workers.

Go back to the basic demand and supply framework.


Changes in wage inequality: why?Demand and Supply Shift

The y-axis is the ratio of wages for high-skilled workers to the wage oflow-skilled workers.

The x-axis is the ratio of the number of high-skilled workers to the number oflow-skilled workers.


Changes in wage inequality: why?Supply Shift in the US

Fast growth in supply of educated workers in the 1970s, slowed downafterwards (baby boomers)

Immigration of low skilled workers

But, the absolute supply of educated workers was increasing at the same timeas the college wage premium was rising

=⇒ IT MUST HAVE BEEN A DEMAND SHIFT AS WELL


Changes in wage inequality: why?Demand Shift

INTERNATIONAL TRADE: The Heckscher-Ohlin Model

The North is abundant in high-skill workers.

The South is abundant in low-skill workers.

Countries export the goods which are intensive in the factor which they havein abundance.

In the North: the factor used in the exporting industry (skilled labour) gainsfrom trade while the factor used in importing industry (unskilled labour)losses from trade.

Trade increases wage inequality in the North!

But, this model would also predict declining inequality in the labor-abundantSouth which we do NOT observe.


Changes in wage inequality: why?Demand Shift

SKILL BIASED TECHNOLOGICAL CHANGE

Introduction of technologies (computers) which are complementary to skilledlabour and substitute for unskilled labour.

This seems to be an important source of wage inequality within countries.

Is the timing correct? Not exactly. But it depends on which countries youexamine.


Changes in wage inequality: why?Alternative explanations for rising inequality in high-income countries

INSTITUTIONAL CHANGES IN LABOUR MARKETS

Deunionization.

Fall in the real minimum wage in the 1980s.

High unemployment and low wage inequality (European experience):countries with strong minimum wage settings and unions experience a lowerincrease in wage inequality.


Discussion topic: Wage inequality in Latin AmericaSee handout: Levy Yeyati and Pienknagura, Vox 10 June 2014

Please read the handout, “Wage compression and the decline in inequality in LatinAmerica: Good or bad?” by Levy Yeyati and Pienknagura.

In this article, the authors describe a decline in income inequality in Latin Americastarting in 2003.

What do the authors claim is behind the decline in Latin American incomeinequality?

Which arguments do you find most convincing and why?

Do you regard the decline in inequality as a good or bad outcome for LatinAmerica? Why?


Discussion topic: Wage inequality in Latin America

Figure 2. Supply of education across regions

Notes: LAC-7 & Uruguay: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Uruguay, and Venezuela. SEA MICs:

Indonesia, Malaysia, Philippines, South Korea, and Thailand.EE MICs: Estonia, Hungary, Poland, and Slovakia. PCEs:

Australia, Canada, New Zealand, Norway, and Sweden. AT MICs: South Korea, Singapore, and Thailand. Source:

Barro-Lee (2010) and de la Torre, Levy Yeyati, and Pienknagura (2013)


How has globalization impacted the distribution of wages?

“Globalization refers to many things”:

international trade;

capital and labour mobility;

the role of multinationals;

outsourcing;

the role of technological and information diffusion;

fewer trade barriers.

We will begin by studying the impact of trade liberalizations on the distribution ofwages.


The Specific Factors ModelThis is sometimes called the Ricardo-Viner model.

The Specific Factors Model lets us look at implications of trade for theDISTRIBUTION of income within country.

It helps us understand which productive factors gain and which lose from atrade liberalization in the short run.

What is a specific factor? A factor of production that is unable to move intoor out of an industry. A specific factor is not of any use in other industries inthe short run. A factor is specific if time or resources are needed to move itfrom one industry to another.

Examples:

High skill and low skill workers.Land.Machinery.


The Specific Factors Model: AutarkyOutline of the model

2 goods: Manufactures (M) and Food (F) .

2 specific factors:

Capital (K) used to make Manufactured goods andLand (T) used to make Food.

1 mobile factor: Labor (L) used in production of both goods.

Labor markets clear. All workers work in equilibrium.

LM + LF = L.


The Specific Factors Model: Autarky

CRS Technology: QM = QM (K , LM ), QF = QF (T , LF ).

Diminishing marginal product of labor→ MPL = ∂QM (K ,LM )∂LM

.


The Specific Factors Model: Autarky

The marginal product of labor in manufacturing output and labor spaceexhibits diminishing returns.

The marginal product of labor in food is similar.


The Specific Factors Model: Autarkic Equilibrium

Define FOOD as the numeraire good, that is, define all relative prices in unitsof food rather than in dollars.

PF ≡ 1 and PM ≡ PMPF

With competitive markets, the value of the marginal product of labor is equalto the wage.

The value marginal product of labor is the price*MPL.

So, w = VMPLM = PMMPLM and

w = VMPLF = PFMPLF .



Draw the value marginal product of labor curves in each sector subject to thelabor endowment constraint.

This shows the equilibrium wage (in terms of units of food) and the laborallocation.



In the Autarkic Equilirbrium, the relative price of manufactures to food is equal tothe ratio of marginal products of labor.

PMMPLM = PFMPLF

−PM

PF=−MPLF

MPLM

price ratio = slope of PPF.



The relative price (pa = PMPF

) is equal to the slope of the PPF!


The Specific Factors Model: Free Trade Equilibrium

Next, suppose there are two countries: Home and Foreign.

The countries are identical in terms of preferences and technologies.

The countries differ in that Home has a larger capital endowment: K > K ∗.

What does this imply about the PPF’s of each country and autarkic prices?



Home has more capacity to produce manufactures.

With identical preferences, the autarkic relative price of manufactures isgreater in Foreign than in Home. p∗a > pa.

(Abundant manufactures are cheap in Home).



Let pw be the relative price of manufactures to food in the world, i.e. in thefree trade equilibrium.

Note that pa < pw < p∗a, so the relative price of manufactures will increasein Home under free trade.

What happens to aggregate welfare?



In the aggregate, there are gains from trade.

The economy is consuming on a higher indifference curve.



For labor, the model’s predictions for welfare are ambiguous.



Summarizing the predictions for workers:

The wage rises in terms of food, but the increase in the (relative) wage is lessthat the increase in the relative price of manufactures. w ↑ (but by < ∆PM).

Labor moves into manufacturing and out of food production: LM ↑, LF ↓.The amount of manufactures produced goes up and the amount of foodproduced falls: QM ↑, QF ↓. (Note: technology doesn’t change when theeconomy opens to trade).

The real wage declines in terms of manufactures and rises in terms of food.wPM↓, w

PF↑

Because of the ambiguous effects on real wages, it is unclear if labor is betteror worse off.

If we knew the utility function of workers, and how much they valueconsumption of manufactures versus food, we could make a definitivestatement about the welfare of workers.



But what about the capitalists? Are they happier? Yes.



What do land owners think? Are they happier? No.



Decomposing the gains from trade: gains from exchange and gains fromspecialization.



Returning to the discussion from part 1 of this lecture, what insights into changesin the income distribution do we gain from the specific factors model?

Under a trade liberalization, in the short run, the returns to fixed factors ofproduction will differ.

The fixed factor of production that was relatively abundant under autarky(but scarce globally) will experience an increase in its return.

The fixed factor of production that was relatively scarce under autarky (butabundant globally) will experience a decrease in its return.

For the mobile factor (labor), the real gains will depend critically on theutility function of workers.

In the long run, we would expect investment in capital and a decline in thereturn to capital.

Similarly, in the long run, land would lie fallow or be used to house factoriesso that the return to land would increase.


Applying the Specific Factors Model: OffshoringFrom McLaren, Chapter 11

Outsourcing: The process whereby corporations procure inputs from severalcountries and allocate the tasks of production across several countries inorder to minimize costs.

AKA: “Globalization of the production process” or “Fragmentation of thesupply chain”Example: the iPod – American product, assembled in many countries of partsmade in many countries.

Offshoring (or sometimes outsourcing): a firm hires workers abroad for a taskthat used to be done domestically

Examples: Maquiladoras - Mexican plants used by US firms; Indian callcenters.

What is the impact on workers in the country that outsources tasks?



Suppose we have two sectors, a Multinationals sector and aNon-multinationals sector.

Each has sector-specific capital, but labor can move freely between them.

This is the specific factors model we just learned.



Assume that only multinationals are able to offshore tasks.

What happens when it becomes easier to do offshoring?

It depends on whether foreign labor is a substitute for domestic labor or

Foreign labor is a complement with domestic labor.


Applying the Specific Factors Model: OffshoringForeign labor as a substitute for domestic labor


Applying the Specific Factors Model: Offshoring

Foreign labor as a substitute for domestic labor

Multinationals’ domestic employment shrinks relative to non- multinationalemployment as offshoring occurs.

Offshoring lowers the wages of Home workers.


Applying the Specific Factors Model: OffshoringForeign labor as a complement for domestic labor


Applying the Specific Factors Model: Offshoring

Foreign labor as a complement to domestic labor

Multinationals’ domestic employment expands relative to non- multinationalemployment as offshoring occurs.

Offshoring raises the wages of Home workers.


Applying the Specific Factors Model: OffshoringEvidence on US Multinational Employment - Green is Parent Employment


Applying the Specific Factors Model: OffshoringInterpreting the evidence on US Multinational Employment

Employment in US Multinational Parents trended up through the sampleperiod.

Employment in US overseas Affiliates of Multinationals also trended up.

Over the sample period of 1988-2006, US Multinationals increase theirdomestic workforce by just as much as their foreign workforce, suggestingthat the complements model is more appropriate for understanding offshoring.


Summary of Lecture 1

In part 1 of this lecture, we...

reviewed empirical evidence on increasing wage inequality around the world,

reviewed the shape of wage distribution,

discussed how to measure inequality,

examined different theories behind the rise in wage inequality, and

discussed recent evidence on inequality in Latin America.

In part 2 of this lecture, we...

reviewed the Ricardo-Viner Specific Factors Model,

applied this model to the offshoring of jobs by Multinational Enterprises,

reviewed evidence on offshoring by US Multinational Enterprises.


Readings

Levy Yeyati and Pienknagura, “Wage compression and the decline ininequality in Latin America: Good or bad?” at VoxEU.org, 10 June 2014.

McLaren, International Trade, Chapter 11.


trade policy, agreements and taxation of multinationals

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