A New Deal for Globalization

Kenneth F. Scheve and Matthew J. Slaughter

From Foreign Affairs, July/August 2007

Summary:  Globalization has brought huge overall benefits, but earnings for most U.S. workers -- even those with college degrees -- have been falling recently; inequality is greater now than at any other time in the last 70 years. Whatever the cause, the result has been a surge in protectionism. To save globalization, policymakers must spread its gains more widely. The best way to do that is by redistributing income.

Kenneth F. Scheve is Professor of Political Science at Yale University. Matthew J. Slaughter is Professor of Economics at the Tuck School of Business at Dartmouth and Adjunct Senior Fellow for Business and Globalization at the Council on Foreign Relations. He served on the White House Council of Economic Advisers from 2005 to 2007.

This divide in opinion according to skill level reflects the impact that less skilled Americans expect market liberalization to have on their earnings. It also reflects their actual poor real and relative earnings performance in recent decades. It is now well established that income inequality across skill levels has been rising since (depending on the measure) the mid- to late 1970s and that the benefits of productivity gains over this time accrued mainly to higher-skilled workers. For example, from 1966 to 2001, the median pretax inflation-adjusted wage and salary income grew just 11 percent -- versus 58 percent for incomes in the 90th percentile and 121 percent for those in the 99th percentile. Forces including skill-biased technological change played a major role in these income trends; the related forces of globalization seem to have played a smaller role -- but a role nonetheless.

There are two important points about this link between policy opinions and labor-market skills and performance. One is that it does not simply reflect different understandings of the benefits of globalization. Polling data are very clear here: large majorities of Americans acknowledge the many benefits of open borders -- lower prices, greater product diversity, a competitive spur to firms -- which are also highlighted by academics, policymakers, and the business community. At the same time, they perceive that along with these benefits, open borders have put pressures on worker earnings.

Second, a worker's specific industry does not appear to drive his view of globalization. This is because competition in the domestic labor market extends the pressures of globalization beyond trade- and foreign-investment-exposed industries to the entire economy. If workers in a sector such as automobile manufacturing lose their jobs, they compete for new positions across sectors -- and thereby put pressure on pay in the entire economy. What seems to matter most is what kind of worker you are in terms of skill level, rather than what industry you work in.

The protectionist drift also depends on worsening labor-market outcomes over the past several years. By traditional measures, such as employment growth and unemployment rates, the U.S. labor market has been strong of late. Today, with unemployment at 4.5 percent, the United States is at or near full employment. But looking at the number of jobs misses the key change: for several years running, wage and salary growth for all but the very highest earners has been poor, such that U.S. income gains have become extremely skewed.

Of workers in seven educational categories -- high school dropout, high school graduate, some college, college graduate, nonprofessional master's, Ph.D., and M.B.A./J.D./M.D. -- only those in the last two categories, with doctorates or professional graduate degrees, experienced any growth in mean real money earnings between 2000 and 2005. Workers in these two categories comprised only 3.4 percent of the labor force in 2005, meaning that more than 96 percent of U.S. workers are in educational groups for which average money earnings have fallen. In contrast to in earlier decades, since 2000 even college graduates and those with nonprofessional master's degrees -- 29 percent of workers in 2005 -- suffered declines in mean real money earnings.

The astonishing skewness of U.S. income growth is evident in the analysis of other measures as well. The growth in total income reported on tax returns has been extremely concentrated in recent years: the share of national income accounted for by the top one percent of earners reached 21.8 percent in 2005 -- a level not seen since 1928. In addition to high labor earnings, income growth at the top is being driven by corporate profits, which are at nearly 50-year highs as a share of national income and which accrue mainly to those with high labor earnings. The basic fact is clear: the benefits of strong productivity growth in the past several years have gone largely to a small set of highly skilled, highly compensated workers.

Economists do not yet understand exactly what has caused this skewed pattern of income growth and to what extent globalization itself is implicated, nor do they know how long it will persist. Still, it is plausible that there is a connection. Poor income growth has coincided with the integration into the world economy of China, India, and central and eastern Europe. The IT revolution has meant that certain workers are now facing competition from the overseas outsourcing of jobs in areas such as business services and computer programming. Even if production does not move abroad, increased trade and multinational production can put pressure on incomes by making it easier for firms to substitute foreign workers for domestic ones.

These twin facts -- the link between labor-market performance and opinions on globalization and the recent absence of real income growth for so many Americans -- explain the recent rise in protectionism. Several polls of U.S. public opinion show an alarming rise in protectionist sentiment over the past several years. For example, an ongoing NBC News/Wall Street Journal poll found that from December 1999 to March 2007, the share of respondents stating that trade agreements have hurt the United States increased by 16 percentage points (to 46 percent) while the "helped" share fell by 11 points (to just 28 percent). A 2000 Gallup poll found that 56 percent of respondents saw trade as an opportunity and 36 percent saw it as a threat; by 2005, the percentages had shifted to 44 percent and 49 percent, respectively. The March 2007 NBC News/Wall Street Journal poll found negative assessments of open borders even among the highly skilled: only 35 percent of respondents with a college or higher degree said they directly benefited from the global economy.

Given the lack of recent real income growth for most Americans, newfound skepticism about globalization is not without cause. Nor is it without effect: the change in public opinion is the impetus for the protectionist drift in policy. Politicians have an incentive to propose and implement protectionist policies because more citizens want them, and protectionist special interests face an audience of policymakers more receptive to their lobbying efforts than at any time in the last two decades.

INADEQUATE ADJUSTMENTS