Do Low Wages Cause Trade Deficits?

In recent posts we’ve examined the effect of population density upon the U.S. balance of trade in manufactured goods and found a strong correlation.  But when establishing a new cause for some phenomenon, it’s equally important to disprove the previously hypothesized explanations.  Economists are fond of blaming trade deficits on two primary scapegoats – currency valuations (often claimed to be manipulated to favor the offending trading partner) and low wages.

In my last post, we proved that currency valuations actually have no effect whatsoever.  Stronger currencies were no more likely to help America’s trade balance than they were to make it worse, and vice versa.  That’s not to say that currency valuations won’t impact the profitability of companies.  If the dollar gains strength, American companies make less money on exports.  But their reaction is to cut costs and become more competitive.  Have you ever heard of an American company throwing in the towel, closing up shop and moving overseas because of a fluctuation in the value of the dollar?  Of course not.  They stay and compete.

But what about low wages?  On the surface, that sounds like a more plausible explanation for shifting manufacturing off-shore.  Why make widgets here when I could move the factory to China, pay a fraction of the wages, and then import the products and sell them at the same price?  Almost sounds like a no-brainer.  But it’s not that simple.  There are other factors involved – huge factors – like logistics.

So let’s spend a little time examining some hard data on the subject.  While gathering trade data country-by-country for 2012, I also used the CIA World Fact Book to determine “purchasing power parity” (PPP)for each country (analagous to wages paid in each country), and used the “Index Mundi” web site to track how each nation’s  PPP has changed over the years.  Using that data, we can chart America’s balance of trade in manufactured goods relative to the wealth of each nation.

In this first chart, I simply took the 164 nations included in the study and divided them into quintiles – five groups with the same number of nations in each group.  If indeed wages (wealth) play a role in trade, what we should see are small deficits (or even surpluses) with wealthy nations, and progressively larger deficits with poorer nations.  Now, look at the chart:  with nations by quintile.

There is little evidence of any trend or consistency in this chart.  We actually have a relatively large trade deficit with the very wealthiest of nations which include virtually all of Europe, Japan, Taiwan and South Korea, nations which also happen to be very densely populated.  We actually have a small surplus with the 2nd quintile of nations which includes many South American nations and relatively few densely populated nations.  We have a very large deficit with the 3rd quintile of nations for one reason – China is included in this group.  With the 4th quintile – those nations ranked in the bottom 20-40% of wage earners, we have a small trade deficit.  And finally, among the very poorest of nations, heavily represented by African nations – seemingly fertile ground for taking advantage of low wages – the U.S. actually has a small surplus of trade.  To reiterate, among the bottom 40% of wage earners in the world who represent 3.1 billion people – almost half of the world’s population – the U.S. trade deficit is actually quite small.

This flies in the  face of the claim that low wages cause trade deficits.  Why don’t we manufacture more in Africa, where wages are dwarfed by those in China?  And China, not exactly awash in natural resources, actually turns to Africa for its supply of raw materials!  How inefficient is that?  Wouldn’t it make much more sense to build the factories in Africa, close to the supply of raw materials and an even shorter ship ride from the western coast of Africa to the eastern shore of the U.S.?  Something about this claim of low wages causing trade deficits already smells.

But let’s look at things another way.  Dividing countries into quintiles may be a little misleading.  We should actually divide the population of the world into quintiles by wealth, since that’s what we’re actually measuring here.  Otherwise, some nations in one quintile may have huge populations while another quintile of nations may be small and sparesely populated.  So take a look at this chart:  with people by quintile.

I will tell you that even I was blown away when I plotted these results.  Now the data shows a clear trend, but one that is precisely the opposite of what economists claim.  Our biggest trade deficits are with the wealthier people of the world, steadily declining as people become poorer.  How can this be?  The explanation lies in what really causes trade deficits in the first place.  Trade deficits are caused by disparities in per capita consumption, driven by disparities in population density, and nothing else.  And trade surpluses make people wealthier, not poorer.  By running huge trade deficits with nations like Germany, Japan, Korea, Taiwan, China and a host of others, we’re making them richer day-by-day as the U.S. grows poorer.

In fact, from 2001-2o12, of the 164 nations studied, the U.S. ranked near the bottom in terms of growth in PPP.  134 nations experienced growth in PPP that outstripped the U.S.  Only 30 nations lagged the U.S.

In that respect, globalization works.  It’s doing an excellent job of redistributing American wealth to other nations so heavily burdened by overpopulation that their economies would be destabilized if allowed to continue without our assistance.  That’s the goal of globalization – stabilization through spreading the pain, unemployment and poverty of overpopulation.  They cause the problems.  You pay the price.  And yet, the push for more growth – fueled largely by population growth – goes on.  Without that, income inequality would also begin to stabilize and we certainly can’t have that!


3 Responses to Do Low Wages Cause Trade Deficits?

  1. Does the question whether the surplus nation’s people are really richer in the end, depend on if and how they get paid?

    • Pete Murphy says:

      An outstanding question, Rainer. First of all, I should have prefaced my post with the explanation that I used PPP (purchasing power parity) as a substitute for wages because it’s simply impossible to calculate and compare average/composite wages for each nation for the mix of products that it exports.

      So the question is whether that PPP actually translates into higher wages. Do the manufacturing workers reap the benefits or do the exporting companies hoard the profits. This gets at what economists refer to as the “Gini index,” which is a measure of income equality/inequality. It raises a fascinating question as to how trade imbalances may affect income inequality. It seems reasonable to think that a nation that relies heavily on manufacturing for export might have less income inequality because of the upward pressure on wages driven by the abundance of manufacturing jobs. And vice versa – do nations with large trade deficits (like the U.S.) experience higher income inequality because of the shortage of manufacturing jobs.

      To satisfy my own curiosity, here’s a few examples:
      Ireland, with whom the U.S. has its worst per capita trade deficit in manufactured goods, ranks 96th (out of 140 nations for whom the data is available) in income inequality. (Higher Gini index rankings indicate greater income inequality.) Germany, with whom the U.S. has its 8th worse per capita deficit, ranks 129th. Japan, with whom the U.S. has its 9th worst per capita deficit, ranks 75th. South Korea, with whom the U.S. has its 12th worst per capita deficit, ranks 111th. China, with whom the U.S. has its 18th worst deficit, ranks 28th. By comparison, the U.S. (with the world’s worst trade deficit) ranks 40th.

      The countries where income inequality is the worst – ranking the highest (1, 2, and 3) on the Gini index are Lesotho, South Africa and Botswana.

      This small sample of data does seem to suggest that, in fact, the manufacturing workers in those nations who enjoy a surplus of trade are better paid.

      It’s a subject I plan to research further now. Again, thanks for the question!

  2. Hello! This post could not be written any better! Reading this post
    reminds me of my old room mate! He always kept chatting about this.
    I will forward this article to him. Fairly certain he will have a good read.
    Thank you for sharing!

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