December 1, 2017

News in Charts: Globalisation’s Downward Pressure on Prices Set to Ease

by Fathom Consulting

Cross-border integration in flows of trade, capital and people has deepened significantly during the past half-century. Basic economic theory concludes that globalisation has an unambiguously positive influence on the size of the global pie (world GDP), owing to exploitations of gains from comparative advantage boosting global productivity and reducing global inequality.

The process of globalisation has seen a shift in economic power away from developed economies and towards emerging economies. Poor economies have industrialised, reaching middle-income status very rapidly — most notably China which has followed a growth model of high investment, focused on export-orientated sectors, for many years now. In 2016, its investment as a share of output stood close to 45%, compared to an advanced-economy average of just over 20%. Its admission to the World Trade Organisation in 2001, opened it up to international markets, enabling a substantial build-up of productive capital to be exported abroad. China’s trade relative to world GDP reached almost 1% in 2015.

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Owing to China’s vast amounts of excess productive capacity, government subsidies to predominately state-owned export firms and relatively low labour costs, China has provided cheap goods to the rest of the world. The price of US imports from China is the same today as it was fourteen years ago. During the same timeframe, the price of imports from advanced countries has increased by around 20%.

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As well as lowering the cost of imported goods, globalisation has put downward pressure on wages in developed economies. Reallocating labour from low-productivity agricultural sectors to higher-productivity manufacturing sectors in emerging economies, has released a pool of cheap labour on to the global market. By enabling firms to either import goods or locate production abroad, globalisation has reduced the wage bargaining power of the average worker. As the next chart shows, the share of the pie accruing to labour via wages, salaries, bonuses and benefits in developed economies has reduced as globalisation has risen.

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This goes some way towards explaining why populist parties advocating protectionist policies have gained so much support in developed economies during the last couple of years. This, in turn, has led to an increase in restrictive trade policies, stunting the rise of globalisation. Not only has globalisation stalled, but the gap between unit labour costs in China and the US is closing — both factors will reduce the downward pressure on wages in advanced economies. Between 1992 and 2014, the average cost of labour per unit of output increased by 150% in China. During the same timeframe it rose by just 40% in US. We have focused on the relationship between the US and China for two reasons: China is the largest emerging and developing economy in the world; and no other emerging economy has the same capacity as China to influence prices. As relative unit labour costs come closer into line across emerging and advanced economies, the downward pull on wage settlements along with the gains from offshoring manufacturing should reduce.

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Evidence presented above suggests that globalisation will continue to put a downward pressure on global wages, but to a lesser extent. As we have discussed in a note to our clients (The Phillips Curve – rumours of its death are greatly exaggerated), we believe only two of the five factors which have led to a sustained decline in the labour share in developed economies still have further to run: labour-replacing technology and the rise of the ‘gig’ economy.

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