Economics: Southern imports and the skills gap

THE DRAMATIC shift over the past decade towards greater inequality of incomes and wealth will not be news to readers of this column. This trend is one of the most important changes occurring in the developed economies, affecting not merely the pattern of spending on goods and services but also the politics and the cohesion of our societies. Its causes, though, are still the matter of intense controversy. And this week saw the publication of a key contribution to the debate: Adrian Wood's North-South trade, employment and inequality *.

Let me summarise some of the facts. In Britain, the real income of the average household rose by 36 per cent between 1979 and 1990. The rise for the better-off was even bigger. But the bottom 10 per cent of households suffered a 14 per cent fall in their real incomes. There has been no trickle-down. There has been no genteel relative decline. Parts of our society have simply become poorer in absolute terms.

The most obvious cause is the tax and benefits system, which became less generous to the poor over the Thatcher-Reagan years. The Institute of Fiscal Studies recently calculated that the largest part of the increase in income inequality could be attributed arithmetically to policy changes affecting tax rates and benefit levels. Its study this week showed that the tax cuts for the better-off in the late Eighties have now been offset by tax increases for everyone.

However, policy is not solely to blame. There has also been a large shift towards greater inequality of gross incomes before taxes and benefits, and this is more widespread across continental countries as well as the Anglo-Saxon economies where the new market liberalism was particularly influential. In Britain, for example, the pay differentials of employees are now bigger than at any time since such figures were first compiled in 1886.

In the United States, the gap between high and low-paid workers is also larger than at any time since 1940. For the average US worker, real hourly pay actually dropped by 9 per cent between 1979 and 1989. The rewards for a college education have soared, while unskilled young men with 12 or fewer years of schooling have suffered a cut in real wages of a fifth. These are, by the standards of our economic history, large and sudden changes.

On the Continent, there has not been such a large shift in gross pay. In France, the change is relatively small. There is generally a more widespread network of minimum wage law and co-operation between the unions, employers and government. But that is arguably one reason why there has been instead such a large increase in unemployment for the unskilled: some economic force is competing with unskilled workers so that in countries where wages are flexible, their pay is pushed down. And in countries where their pay is not flexible, more of them lose their jobs instead.

So what is going on? The conventional wisdom is that this shift has taken place because of technological changes: there has been a move towards more knowledge- based and skill-based processes in industry. Labour-saving technology has spread like wildfire, replacing unskilled rather than skilled labour.

Mr Wood's new book confronts this conventional wisdom head-on, arguing that the most important reason for the change is not technology but trade with the low-labour-cost countries of the Third World. Essentially, cheap labour in the South is competing fiercely for jobs and pay with cheap labour in the North.

In making this case, Mr Wood touches several raw economic and political nerves. He risks shaking the free trade consensus and giving ammunition to the protectionists. For pessimists, he provides new fuel for the age-old contention, pace Malthus and Marx, that capitalism may tend to impoverish rather than enrich.

The traditional riposte to Mr Wood's argument is that Third World trade is simply not important enough to have the effects he claims; we spend too little money on Third World goods. If we spend only pounds 3.30 to pounds 3.70 on southern manufactured imports out of every pounds 100 we spend on manufactures, how can it be the key to such a profound change?

But this ignores the point that southern imports are concentrated on products where labour content is high and output per worker is low, precisely because the workers are unskilled. The impact on the labour market will therefore be much larger than the share of overall spending suggests.

Indeed, the evidence marshalled by Mr Wood is both fascinating and difficult to dismiss. The key point is the extraordinary growth of southern manufactured exports. As I have mentioned before in another context, it is now wholly misleading to assume that Third World countries are largely reliant on commodity exports. The table shows that there has been a steady rise in the share of manufactures in southern exports, although this is disguised in the figures for 1980 by the boost that high oil prices gave to commodity export values.

The line graph shows what this trend has meant in absolute terms to northern markets: it shows the rise in real terms (after stripping out both exchange rate and price changes) in southern exports to the North. Measured in 1980 dollars, the South is now selling nearly dollars 250bn of manufactured goods in industrial country markets, and the trend clearly accelerated sharply through the Eighties.

The third piece of evidence is the scattergram, which shows that the bigger the northern country's increase in manufactured imports from the South, the larger the drop in manufacturing jobs as a proportion of total employment. Both Britain and Norway lie outside the main cluster of countries, which may partly be attributable to their joint exploitation of North Sea oil over this period and partly to the pursuit by the Conservative government between 1979 and 1981 of economic policies that were peculiarly hostile to manufacturing and other tradable sectors of the economy.

Mr Wood says the old view that capital is at the root of North- South trade is simply wrong: these days, capital is increasingly mobile. Western manufacturers can happily invest in Taiwan or Korea, producing labour-intensive manufactures thousands of miles from their eventual markets. But skills are not so mobile. The North has a relatively large supply of skilled labour, and the South a relatively large supply of unskilled labour. Conventional trade theory would suggest that southern exports will be unskilled-labour intensive, while northern exports will be skill-intensive.

With tumbling trade barriers and cheaper transport costs, Mr Wood says that the expansion of trade with the South 'does not tend to drive down the average real wage in the North, nor to pull up the share of profits at the expense of labour, nor to push workers in general into unemployment. What it does instead is to widen the economic gap between skilled and unskilled workers.' The North as a whole benefits from this trade, because it provides cheaper goods and thereby raises general living standards, even though its unskilled lose out.

If Mr Wood is right, what should Western governments do? One temptation is protectionism, but that would deprive both the North and the South of a considerable source of greater prosperity. Growth led by labour-intensive manufacturing has proved to be a successful development path for the Asian tigers, and it helps to reduce inequality in Third World countries. So protectionism would only improve the position of a northern minority at the expense of everyone else.

The obvious, but hardly original, answer is to improve education and training in the developed countries so that they can gradually move up market, removing from the firing line those groups of their own workers most threatened by southern competition.

And what if Mr Wood is wrong, and the technologists are right? Fortunately, we arrive at the same answer: educate and train more. For once, economists can agree on the policy conclusions even while they continue to disagree on the diagnosis.

* IDS development studies series, Clarendon Press, Oxford, pounds 45.

(Graph omitted)