Although large-scale international migration was a major force in the world economy before , since then all advanced countries have erected high legal barriers to economically motivated immigration. But most labor does not move internationally.
In contrast, international investment is a highly visible and growing influence on the world economy. During the late s, many banks in advanced countries lent large sums of money to Third World countries. This flow dried up in the s, the decade of the debt crisis, but considerable capital flows resumed with the emerging-markets boom that began after Many of the fears about Third World growth seem to focus on capital flows rather than trade.
Even Labor Secretary Robert Reich, at the March job summit in Detroit, attributed the employment problems of Western economies to the mobility of capital.
In effect, he seemed to be asserting that First World capital now creates only Third World jobs. Are those fears justified? The short answer is yes in principle but no in practice. As a matter of standard textbook theory, international flows of capital from North to South could lower Northern wages. The actual flows that have taken place since , however, are far too small to have the devastating impacts that many people envision.
To understand how international investment flows could pose problems for advanced-country labor, we must first realize that the productivity of labor depends in part on how much capital it has to work with. As an empirical matter, the share of labor in domestic output is very stable. But if labor has less capital at its disposal, productivity and thus real wage rates will fall. This might be because a change in political conditions makes such investments seem safer or because technology transfer raises the potential productivity of Third World workers once they are equipped with adequate capital.
Does this hurt First World workers? Of course. Capital exported to the Third World is capital not invested at home, so such North-South investment means that Northern productivity and wages will fall.
Northern investors presumably earn a higher return on these investments than they could have earned at home, but that may offer little comfort to workers. Before we jump to the conclusion that the development of the Third World has come at First World expense, however, we must ask not merely whether economic damage arises in principle but how large it is in practice. How much capital has been exported from advanced countries to developing countries?
During the s, there was essentially no net North-South investment—indeed, interest payments and debt repayments were consistently larger than the new investment. All the action, then, has taken place since How much pressure has this placed on wages in advanced countries? A back-of-the-envelope calculation therefore suggests that capital flows to the Third World since and bear in mind that there was essentially no capital flow during the s have reduced real wages in the advanced world by about 0.
There is another way to make the same point. Anything that draws capital away from business investment in the advanced countries tends to reduce First World wages. But investment in the Third World has become considerable only in the last few years.
Meanwhile, there has been a massive diversion of savings into a purely domestic sink: the budget deficits run up by the United States and other countries. The export of capital to the Third World attracts a lot of attention because it is exotic, but the amounts are minor compared with domestic budget deficits.
At this point, some readers may object that one cannot compare the two numbers. Savings absorbed by the federal budget deficit simply disappear; savings invested abroad create factories that make products that then compete with ours. It seems plausible that overseas investment is more damaging than budget deficits.
The conventional wisdom among many policy-makers and pundits is that we live in a world of incredibly mobile capital and that such mobility changes everything. We seem to have concluded that growth in the Third World has almost no adverse effects on the First World. But there is still one more issue to address: the effects of Third World growth on the distribution of income between skilled and unskilled labor within the advanced world.
Suppose that there are two kinds of labor, skilled and unskilled. And suppose that the ratio of unskilled to skilled workers is much higher in the South than in the North.
In such a situation, one would expect the ratio of skilled to unskilled wages to be lower in the North than in the South. As a result, one would expect the North to export skill-intensive goods and services—that is, employ a high ratio of skilled to unskilled labor in their production, while the South exports goods whose production is intensive in unskilled labor.
What is the effect of this trade on wages in the North? Trade with the South in effect makes Northern skilled labor scarcer, raising the wage it can command, while it makes unskilled labor effectively more abundant, reducing its wage.
Increased trade with the Third World, then, while it may have little effect on the overall level of First World wages, should in principle lead to greater inequality in those wages, with a higher premium for skill. What makes this conclusion worrisome is that income inequality has been rapidly increasing in the United States and to a lesser extent in other advanced nations.
Even if Third World exports have not hurt the average level of wages in the First World, might they not be responsible for the steep declines since the s in real wages of unskilled workers in the United States and the rising unemployment rates of European workers?
At this point, the preponderance of the evidence seems to be that factor price equalization has not been a major element in the growing wage inequality in the United States, although the evidence is more indirect and less secure than the evidence we brought to our earlier models.
More careful research may lead to larger estimates of the effect of North-South trade on the distribution of wages, or future growth in that trade may have larger effects than we have seen so far.
At this point, however, the available evidence does not support the view that trade with the Third World is an important part of the wage inequality story. Moreover, even to the extent that North-South trade may explain some of the growing inequality of earnings, it has nothing to do with the disappointing performance of average wages.
This decline is at the heart of our economic malaise, and Third World exports have nothing to do with it. The view that competition from the Third World is a major problem for advanced countries is questionable in theory and flatly rejected by the data. Why does this matter? One answer is that those who talk about the dangers of competition with the Third World certainly think that it matters; the European Commission presumably did not add its comments about low-wage competition to its white paper simply to fill space.
If policymakers and intellectuals think it is important to emphasize the adverse effects of low-wage competition, then it is at least equally important for economists and business leaders to tell them they are wrong. Ideas matter. According to recent newspaper reports, the United States and France have agreed to place demands for international standards on wages and working conditions on the agenda at the next GATT negotiations. Developing countries are already warning, however, that such standards are simply an effort to deny them access to world markets by preventing them from making use of the only competitive advantage they have: abundant labor.
The developing countries are right. This is protectionism in the guise of humanitarian concern. Most worrisome of all is the prospect that disguised protectionism will eventually give way to cruder, more open trade barriers. For example, Robert Kuttner has long argued that all world trade should be run along the lines of the Multi-Fiber Agreement, which fixes market shares for textile and apparel. In effect, he wants the cartelization of all world markets.
We are not talking about narrow economic issues. What is new about the current debt situation is that the creditors - and therefore the debt structure - have changed significantly.
Developing countries have significantly increased their borrowing at market conditions, especially from new lenders such as China and India, and from private creditors.
According to the United Nations Conference on Trade and Development UNCTAD , public debt at market conditions as a share of total debt doubled between and in low-income countries, rising to 46 percent.
Compared to the concessional loans from traditional bilateral notably lenders in the OECD Development Assistance Committee and multilateral creditors such as the IMF and WB, these loans have higher interest and shorter maturities.
This further jeopardises the debt sustainability of developing countries. Compared to those countries that are not members of the Paris Club, public debt as a share of GDP in low-income countries doubled between and One of these lenders stands out in particular: China. In contrast, loans from members of the Paris Club have declined considerably.
In developing countries, the amount of public debt owed to private creditors as a share of total debt rose from around 40 percent in to 60 percent in , according to UNCTAD. Moreover, not only has foreign debt increased, but domestic debt has also risen sharply in developing countries. In order to prevent a renewed debt crisis in developing countries, it is of primary importance to establish good debt management practices.
The key takeaway from this brief review is that there is an imminent global debt-servicing problem of large but unknown dimensions that requires a globally coordinated solution to forestall damaging long-term economic consequences. No single forum can deliver on this, but a combination of agreements within different forums could be effective.
Their plan calls for a standstill on all official bilateral debt repayments, along with stepped up disbursements by multilateral organizations. Developing countries would commit to reform programs and greater transparency on their debt.
These are useful and important steps and Finance Ministers should endorse them. In terms of the framework of lessons laid out above, however, there remain gaps. A bolder plan is needed to cover all developing countries, not just the poorest. And the plan must deal with private creditors and with non-MLT debt elements like trade finance and well-functioning forex markets.
It should consist of two phases, Phase 1 being designed to address immediate liquidity issues and to buy time to understand how the crisis will unfold, while Phase 2 should address longer-term debt sustainability and reforms and investments to restore sustainable growth and social stability. It is an opportunity that should not be missed. Future Development. The Future Development blog informs and stimulates debate on key development issues.
This blog was first launched in September by the World Bank and the Brookings Institution in an effort to hold governments more accountable to poor people and offer solutions to the most prominent development challenges. Continuing this goal, Future Development was re-launched in January at brookings. For archived content, visit worldbank.
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