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International Capital Movements and Relative Wages: Evidence from U.S International Economic Studies Vol. 47, No. 1, 2016 pp. 17-36 Received: 08-09-2015 Accepted: 24-05-2016 International Capital Movements and Relative Wages: Evidence from U.S. Manufacturing Industries * Indro Dasgupta Department of Economics, Southern Methodist University, Dallas, USA Thomas Osang* Department of Economics, Southern Methodist University, Dallas, USA* Abstract In this paper, we use a multi-sector specific factors model with international capital mobility to examine the effects of globalization on the skill premium in U.S. manufacturing industries. This model allows us to identify two channels through which globalization affects relative wages: effects of international capital flows transmitted through changes in interest rates, and effects of international trade in goods and services transmitted through changes in product prices. In addition, we identify two domestic forces which affect relative wages: variations in labor endowment and technological change. Our results reveal that changes in labor endowments had a negative effect on the skill premium, while the effect of technological progress was mixed. The main factors behind the rise in the skill premium were product price changes (for the full sample period) and international capital flows (during 1982-05). Keywords: capital mobility, specific factors, skill premium, globalization, labor endowments, technological change JEL Classification: F16, J31. * Corresponding Author, Email: [email protected] * We would like to thank seminar participants at Southern Methodist University and Queensland University of Technology for useful comments and suggestions. We also thank Peter Vaneff and Lisa Tucker who provided able research assistance. 18 International Economic Studies, Vol. 47, No. 1, 2016 1. Introduction investment is an important factor in The U.S. economy has witnessed a explaining relative wage changes. Eckel [8] significant increase in volatility and formulates a 3x2 trade model with magnitude of international capital flows efficiency wages and demonstrates how since 1980, as shown in Figure 1. In capital movements, and not wage rigidities, addition, while there were moderate net are responsible for an increase in wage outflows of capital prior to 1980, the U.S. inequality3 . Feenstra and Hanson [11], economy experienced a strong net inflow of Taylor and Driffield [34], and Figini and foreign direct investment (FDI)1 between G¨org [13], using industry-level data for 1980-90 and then again from 1996 to 2001. Mexico, the UK, and Ireland, respectively, Between 2001 and 2005, net FDI flows find that international capital flows affect have become substantially more volatile the wage premium. Blonigen and Slaughter with large in-and outflows. One of the [4], in contrast, do not find significant interesting implications of this reversal in effects of FDI on U.S. wage inequality. U.S. international capital flows is its impact The goal of this paper is to study the on the relative wages between skilled and impact of capital flows on relative wages in unskilled workers, i.e. the skill premium. the U.S. over the period 1958-2005, while Provided that capital and skilled labor are at the same time taking account of other complementary factors of production2, net factors that potentially affect relative wages capital inflows constitute a positive demand such as international trade in goods and shock for skilled labor causing a rise in the services, total factor productivity (TFP) skill premium. Therefore, the reversal of growth, factor-specific technological international capital flows in the 80s and change, and changes in labor endowments. the second half of the 90s is a potential We formulate a multi-sector specific factors culprit for the rise in the U.S. skill premium (SF) model of a small open economy with that began in the early 80s and peaked perfectly mobile international capital4 . The around 2001 (see Figure 2). specific factor is skilled labor, while both The issue of whether capital flows cause capital and unskilled labor are mobile changes in the skill premium has been across sectors. Exogenous changes in the examined in papers by Feenstra and international interest rate trigger capital 5 Hanson [10], [11], [12], Sachs and Shatz outflows and inflows in this model . The [32], Eckel [8], Blonigen and Slaughter [4], solution to this multi-sector SF models Taylor and Driffield [34] and Figini and yields the G¨org [13],[14], among others. Feenstra and Hanson [10] and Sachs and Shatz [32] formulate theoretical models in which they examine the impact of capital outflows from a skilled labor abundant economy like the United States. In both papers the capital 3 outflow occurs in the form of outsourcing De Loo and Ziesmer [7] formulate a specific factors model with international capital mobility. Two forms intermediate goods production to an of globalization are examined: exogenous product unskilled labor abundant economy. Both price changes and exogenous changes in interest papers investigate empirically the rates. However, the model does not classify labor inputs as skilled or unskilled and thus does not relationship between import shares, address the skill premium issue employment levels, and factor intensity and 4 For a discussion of why the SF model is an arrive at similar conclusions: foreign appropriate framework for analyzing the globalization and relative wage issue, see Engerman and Jones [9]. Also note that Kohli [24] contrasts the predictive capability of a SF model with a H-O 1 Throughout this paper the terms FDI and capital model and finds the former better suited to analyze flows are used interchangeably U.S. data. 2 See Griliches [15], amongst others, for empirical 5 In particular, an increase (decrease) in the world evidence supporting the capital-skill interest rate leads to an instantaneous outflow complementarity hypothesis (inflow) of capital from the economy. International Capital Movements and Relative Wages: Evidence from U.S. Manufacturing Industries 19 Figure 1: U.S. Inflows (+) and Outflows (-) of Net Foreign Direct Investment, 1950-2010. Source: BEA. Capital Inflows: FDI in the U.S.; Capital Outflows: U.S. Direct Investment Abroad (for years prior to 1977, Direct Investment Capital Outflows = Equity & Intercompany Accounts Outflows + Reinvested Earnings of Incorporated Affiliates). Numbers in Billion USD. Figure 2: Ratio of average non-production labor wage to average production labor wage in U.S. manufacturing industries, 1958-2005 change in the relative wage rate as a premium as predicted by the model and function of changes in international interest compare the predicted with the actual rates as well as changes in product prices, change1 . We then calculate the contribution TFP growth, factor-specific technological progress, and labor endowment changes. 1 Using estimates of factor-demand The literature on globalization and wage inequality deals primarily with U.S. manufacturing industries, elasticities and data on the U.S. mainly due to the unavailability of disaggregated manufacturing sector from 1958 to 2005, wage data for skilled and unskilled workers in non- we calculate the change in the skill manufacturing industries. As Figure 1 reveals, the manufacturing sector has experienced, by and large, 20 International Economic Studies, Vol. 47, No. 1, 2016 to the predicted change by each of the theoretical model is derived in section 2. In exogenous forces. In addition to the full section 3 and 4 we discuss model sample, we consider four subperiods: 1958- simulation results and data issues, 66, 1967-81, 1982-2000, and 2001-05. respectively. We present our main results in Our main results are as follows. First, section 5. Section 6 concludes. the net capital outflow that U.S. manufacturing industries experienced 2. The Theoretical Model during the period 1958-81 had a depressing Our model is closely related to a class of effect on the skill premium. In contrast, the models based upon the 2x3 SF model net capital inflows that occurred in the derived in Jones [18], which allow for majority of years between 1981 and 2000 international capital mobility (see, for had a positive effect on the skill premium. instance, Thompson [35] and Jones, Neary Second, trade effects working through and Ruane [21]). Our model is similar in product price changes caused an increase in this respect. However, it differs the skill premium for all periods. Third, significantly in that it incorporates the increases in non-production labor multi-sectoral feature of an economy endowments worked towards depressing following Jones [19]. We consider a small the skill premium, as did a fall in open economy which produces m production labor endowment. Fourth, commodities in as many sectors of production labor specific technical change production. There are three factors of increased the skill premium, while non- production in each sector. Two of these production labor specific technical change factors, capital (K) and production labor had the opposite effect on the skill (P), are perfectly mobile between sectors, premium. while the third factor, non-production labor In terms of relative contributions, (NP), is sector specific, i.e., immobile1. technology played the largest role in Production functions are continuous, twice affecting the skill premium, followed by differentiable, quasi-concave and exhibit changes in interest rates and product prices, diminishing returns to the variable factors. which had approximately equal Domestic prices are exogenous and are contributions. Labor endowment changes assumed to be affected by globalization had the least relative impact on skill shocks. Capital is also assumed to be premium changes. perfectly mobile internationally. Its return The finding of this paper that capital is determined in world markets and is movements played a significant role in exogenous. Production sectors are indexed affecting relative wages in the U.S. by j =1, ...., m, and factors of production provides strong empirical support for the are indexed by i = K, NP, P . Aggregate theoretical results of Feenstra and Hanson factor endowments are denoted by Vi. [10], Sachs and Shatz [32], and Eckel [8]. Thus, there are a total of m + 2 factors of In addition, our results reflect findings from production in the economy.
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