Trade and the skilled wage premium: Historical evidence from China

Kris James Mitchener , Se Yan , 12 February 2010

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While trade collapsed sharply last year in the fallout from the crisis, the long-run trend has been a very rapid expansion of global exports and imports. This global growth in trade is undeniable. What is more contentious are its effects on wages.

Much of the debate has focused on how the expansion in trade between developing and developed countries affects wages in the US and Europe. The logic of trade theories based on factor endowments suggests that an expansion of trade will raise the wages of skilled workers and lower those of unskilled workers in developed countries, which are well endowed with skilled labour. This has led some commentators to link growing trade between the US and the rest of the world with the growing wage inequality. Some have gone so far as to suggest that as US trade with China grows, wages for unskilled workers in the US will fall.

Wages and trade in developing nations

But how has the global trade boom altered wages in developing countries? For example, factor endowments also predict that the skill premium should be falling in rapidly developing countries like China where the stock of unskilled workers is large relative to developing countries. Using city-level data, Wei and Wu (2001) find evidence that inequality has fallen within China and that the decline in rural-urban inequality has been most pronounced in areas that increased their openness to trade. On the other hand, other empirical studies suggest that globalisation has increased inequality in developing countries in the last three decades. For example, Wan, Lu, and Chen (2007) present evidence that increased FDI and trade have widened inequality within China.

Analyses that focus on the impact of trade on wages in developing countries such as China face an array of challenging empirical issues. These include assessing the impacts of technological change, foreign direct investment, intra-industry trade, outsourcing, multinationals, and state intervention on factor prices. For example, using regional data on China from 1986-2001, Owen and Yu (2008) find that higher levels of provincial development raise the skill premium, but FDI’s effects on the skill premium appear to depend on whether the foreign investment is export- or import-oriented.

Moreover, when assessing the impact of expanding trade on the wage premium in developed countries today, empirical researchers may also need to take into account declining union power, falling minimum wages, increased rates of immigration of unskilled workers, and skill-biased technological change.

Since confounding influences make the task of causal inference extremely challenging, it is not surprising that estimates of the effects of trade and wages vary considerably across studies and depend on country-specific and time-specific factors.

One alternative to measuring the impact of trade on wages today is to use the lens of history and examine cases where trade flows perhaps conformed more closely to the theoretical assumptions of factor models. For instance, a number of scholars have suggested that the earlier period of globalisation, which occurred during the late nineteenth and early twentieth centuries, may be better suited for testing the empirical predictions of factor endowments models (Estevadeordal and Taylor 2002, O’Rourke and Williamson 1994, 1996, 1999).

Evidence from Chinese trade and wages in the early 20th century

In recent research (Mitchener and Yan 2010), we follow this historical approach. We have assembled new data on Chinese trade and wages for 1903–1928 to examine the effects on wages when developing countries open up to trade.

During the first three decades of the twentieth century, China experienced tremendous growth in trade with the rest of the world. Exports and imports roughly sextupled. China’s trade as a share of GDP almost tripled, an increase in the share that is roughly comparable to what China has experienced since 1978. With respect to the effects that trade had on wages, the most important change may have occurred in response to World War I – an event that altered global trade patterns and had lasting effects on Chinese trade. Figure 1 shows that the price of Chinese exports rose rapidly in response to the exogenous shock of World War I and continued to rise even after hostilities ended. Whereas the war disrupted trade in many other parts of the world, it caused an expansion in Chinese exports, creating new markets for Chinese goods that had previously been served by producers in belligerent countries. The volume of exports continued their upward trajectory, even after the war ended, as China’s products were integrated into the global trade network. In response, wages and employment rose for unskilled workers in China, which were used intensively in the production of exports.

Figure 1. Price index of Chinese exports, 1903 to 1928

Source: Hsiao (1974)

Marshalling new data from archives in Nanjing, we show that that China’s export boom in the first three decades of the twentieth century was characterised by a rapid expansion in the production and sale of unskilled-intensive products to the rest of the world, and, in the second decade of the twentieth century, China’s growth in exports of unskilled-intensive manufactures, mining, and agricultural products received an additional boost in demand from World War I (Figure 2).

Figure 2. Unskilled export and import shares, 1903-1928

Note: Unskilled trade as classified by educational attainment

Using empirical evidence, as well simulation results from a general equilibrium model of trade, we show that the growth in Chinese trade and the price shock of World War I largely account for the flattening out of the skill premium in the 1910s and the subsequent 8% fall in the skill premium between 1920 and 1928 shown in Figure 3.

Figure 3. Real wage premium in China (1900=100)

Our findings suggest that, when trade is dominated by the movement of relatively homogenous goods across borders, it may have a considerable effect on wages. The declining wage inequality in China during the second two decades of the twentieth century stands in contrast to studies examining the recent period of globalisation, which emphasise how trade and globalisation have widened skill premiums in developing countries (Goldberg and Pavcnik 2007).

The growth in Chinese exports during the first three decades of the twentieth century was centred on products that used unskilled labour intensively and this earlier era of globalisation was less influenced by trade in intermediate inputs (i.e., outsourcing), increases in capital flows, and capital for use with skilled labour. It is these factors that have likely played a role in widening skill premiums today in developing countries.

References

Estevadeordal, Antoni and Alan M. Taylor (2002), “Testing Trade Theory in Ohlin’s Time”, in Bertil Ohlin: A Centennial Celebration 1899-1999, Ronald Findlay, Lars Jonung, and Mats Lundahl (eds), Cambridge: MIT Press.

Goldberg, Pinelope and Nina Pavcnik (2007), “Distributional Effects of Globalisation in Developing Countries”, Journal of Economic Literature, March 45(1):39-82.

Mitchener, Kris James and Se Yan (2010), “Globalisation, Trade & Wages: What Does History tell us about China?”, NBER Working Paper 15679, January.

O’Rourke, Kevin H, Alan Taylor, Jeffrey G Williamson. (1996), “Factor Price Convergence in the Late Nineteenth Century”, International Economic Review 37 ,August:499-530.

O’Rourke Kevin H and Jeffrey G Williamson (1999), Globalisation and History: The Evolution of a Nineteenth-Century Atlantic Economy. Cambridge: MIT Press, 1999.

O’Rourke Kevin H and Jeffrey G Williamson (1994), “Late-nineteenth Century Anglo-American Factor Price Convergence: Were Heckscher and Ohlin Right?”, Journal of Economic History, 54(12):892-916.

Owen, Anne L and Bing Yu (2008), “Regional Differences in Wage Inequality Across Industries in China”, Applied Economics Letters 15(2):113-116.

Wan, Guanghua, Ming Lu, Zhao Chen (2007), “Globalisation and Regional Income Inequality: Evidence from within China”, Review of Income and Wealth 53(1):35-59.

Wei, Shang Jin, and Yi Wu (2001), “Globalisation and Inequality: Evidence from within China”, NBER Working Paper 8611, November.

Topics: International trade
Tags: China, international trade, US, wages

Robert and Susan Finocchio Professor of Economics at the Leavey School of Business, Santa Clara University
Assistant Professor of Economics at Guanghua School of Management, Peking University

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