Globalisation is the process of intensified international competition and trade. It enables the movement of goods, production factors, labour and technology across borders. If countries use their resources efficiently then globalisation can also enhance growth and social welfare. This depends on how much competition there is and a country has to have a certain stability and mobility of labour and resources for production. The common trade theory suggests that globalisation will equalise the prices of products and costs of production and free trade will lead to a more efficient allocation of resources. It is also beneficial for the customer since free trade suggests high competition and therefore companies will be able to offer low prices to their customers. This seems to be the case in the long run but problems that arise in the short run include high unemployment and income inequalities. Globalisation is an ongoing process that has been around for quite some time now. EU firms can offshore many tasks which were never possible before. This also means that international competition is completely changing and going through a transformation. Competition took place mainly between firms or different industries in different countries, however now since a lot of firms go abroad for their production, because it is cheaper, competition takes place between individual workers that use similar skills for their tasks in different countries, so they no longer compete within a nation. This of course can be beneficial for some workers but can also harm other workers. Europe is exactly facing this problem at the moment and this paper will focus on the impact globalisation has on the low skilled workers and income inequalities in Europe.
European Globalisation trends
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Globalisation is taking place in nearly every country on the planet, but it has different effects on different nations. Trade expansion in Europe seems to be proceeding at a rapid paste, especially trade with low wage countries. Due to immense improvements in technology, transportation and communication, it is now a lot easier to handle the production process and this might have caused some firms to move parts of their production process to other nations. Offshoring and outsourcing are the common terms used when companies move their production process abroad. There are many reasons for why companies move to other nations for production. But the main reasons could be because it is cheaper to produce in less developed countries, firms only have to pay low wages and get a better output than in the home country. Especially labour intensive goods are shipped to less developed countries because there are more people that would do the job for less money. Therefore globalisation seems to have a negative effect on employment, especially low skilled labour. Since a lot of firms moved their production abroad and the ones that didnâ€™t only employ high skilled labour, it makes it even harder for the low skilled labour to find employment. New technologies also lead to higher unemployment rates among low skilled workers, because the low skilled workers that used to have a job are no either replaced by new technological advancements or by high skilled labour. Overall one could say that globalisation lead to a high demand for skilled labour and on the other side a rise in unemployment among low skilled workers.
In Europe most of the countries are part of the EU, which has special trade agreements. Trade among industrialised countries differs significantly from trade with the developing world. This is mainly due to the fact that industrialised countries are relatively similar, in the sense that they use similar production technologies and have similar factor endowments, so one could say that they produce pretty similar goods. Trade between them therefore mainly exists among industries. So countries would import and export products from the same industry sector. For example Germany exports their yogurts brands and France French yogurts to Germany. These goods are similar because they are both yogurts but they have different tastes and characteristics, that is why these countries trade. It is the same with cars, Germany sells German cars to France and France sells French cars to Germany. Trade among industrialised and developing countries is different. Countries export goods belonging to one sector and import goods belonging to another sector. Germany would for instance export Volkswagens to China and import rice or computers in exchange.
Theoretical approach Comparative advantage Ricardian model
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Globalisation leads to increased trade amongst countries. Countries usually produce goods where it is the cheapest to produce them. Krugman discussed this in Chapter 3, if free trade exists with countries that pay low wages then this will harm the country that pays high wages. In the end the consumer profits from this because if firms have low production costs then they are able to offer the products at a lower price. And the producer benefits from a higher income if he uses his resources more efficiently. Krugman gave an example of this where
W represents the wage rate in the home country
W* represents the wage rate in the foreign country
And the home countries unit labour requirement for good i is aLi, and the unit labour required for good i of the foreign country is a*Li.
Now if WaLi < W*a*Li then the home country will produce the good I because it is cheaper, as wages are less at home. Or if the relative productivity of a country is higher than the wages, then the good will be produced in that country. This can be calculated as a*Li / aLi > W / W*. So overall if a country produces the good that uses the resources most efficiently then trade will be beneficial for that country.
To explain why Europe is facing this high unemployment ratio one has to look at the relative wages. This can easily be determined by looking at the relative demand and supply of labour services. If W / W* rises then the relative demand for home labour services will fall. If the home country would produce goods with expensive labour services then this can have a huge impact on society. Because it means that production costs are high as the producer has to pay high wages and therefore he canâ€™t offer the final goods at an attractive price. If nobody buys the products because they are too expensive then the demand for labour services will go down too. This can also lead to fewer goods being produced at home because costs are too high, which will lead to a further reduction in demand for labour services in the home country.
The Ricardian model only focuses on the productivity of labour across countries. According to this model a country gains from Trade if a country has a comparative advantage in producing a specific good. If the country produces the good it has a comparative advantage in, then it is able to use all its resources more efficiently and will gain more from producing this good.
So here this model shows that overall if a country trades according to rules mentioned above, then the relative price of the good will increase, wages will increase and the producer is able to offer the good at a lower price so therefore even the consumer profits from it.
Heckscher Ohlin Samuelson Model
The Ricardian Model suggests differences in productivity of labour between nations cause productive differences. The Heckscher Ohlin model suggests that there are other factors of production between different countries, not just differences in productivity of labour, that cause differences in production.
Usually the price of a good should be the same as its production costs, and the production costs also depend on how much wages they have to pay and the lending/renting rate of land. Changes in lending rates can affect the final price of a product, depending on how intensively you use land in production. For example if there are two products cloth and food, cloth is labour intensive and food is land intensive. If lending rates for land increase then this should have a bigger affect on the price of food than the price of cloth, because the production of food requires more land than the production of clothes.
Heckscher Ohlin model also suggests that an economy will be efficient at producing goods that are intensive in the factors of production in which the country has a lot of.
Just suppose the domestic country has an abundant amount of labour relative to land. This suggests that domestic country is abundant in labour and the foreign country is abundant in land. Likewise, the domestic country is scarce in land and the foreign country is scarce in labour. Because the domestic country is abundant in labour it would be very good at producing cloth, as cloth production is very labour intensive. The foreign country on the other hand should produce food as it is abundant in land and the production of food is very land intensive.(64-68)
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With trade the relative price of cloth should rise in the labour abundant country which is the domestic country, and should fall in the labour scarce country which is the foreign country. According to the Heckscher Ohlin Model, in the domestic country the rise in the relative price of cloth leads to a rise in the relative production of cloth and a decrease in the relative consumption of cloth. The same will happen to food in foreign economy. So what will happen is that the domestic country will become an exporter of cloth and an importer of food. And the foreign country will import cloth and export food. So one could say that a company would be very good at producing the goods that are intensive in its abundant factors, this just means a country produces the goods it has a comparative advantage in. And likewise a country should export goods that are intensive in its abundant factors of production and should import goods that are in its scarce factors of production. (58-63).
To explain the wage inequalities among European low skilled workers one has to understand The Heckscher-Ohlin-Samuelson factor endowment model.
This model predicts that trade among different countries derives from differing factor endowments across nations. This model looks at different countries that are trading with each other and these countries are also on the same technological level, which just means that they use the same technologies in their production process for both products. The production process for both goods in this case, requires two different inputs, this could be high skilled labour for one country and low skilled labour for the other country. For example, the production of one of the goods, for instance computers, requires more high skilled labour, while the production of the other good, for instance cloth, needs more low skilled labour. It is assumed that one of the two countries is relatively well equipped with either low skilled labour or high skilled labour, for instance Europe is equipped with relative large amounts of high skilled labour and the foreign country is relatively well equipped with low skilled labour. Usually when two countries trade industrialised countries have more high skilled labour and the developing countries have more low skilled labour. The Heckscher Ohlin theory in this case suggests that industrialised countries like Europe would export computers and the developing foreign country Europe is trading with should export cloth. The outcome would be that the relative price of cloth would fall in the industrialised country, but would do exactly the opposite in the developing country, the relative price would increase. This would lead to changes in wage distribution; low skilled labour in the industrialised country such as Europe would decline relative to the wages of high skilled labour. This can be explained because globalisation increased trade among countries and enabled countries access to products that were produced abroad, furthermore this implies that through trade the relative supply of low skilled labour has increased. According to this theory, inter-industry trade would as a result have the effect of increased wage inequality in industrialised countries like Europe, while inequality should decrease in developing countries. (58-61)
Overall it seems as if owners of abundant factors gain with trade and owners of scarce factors lose. This model assumes that after international trade factor prices will be equal in both countries. This just means that once the domestic country which has a higher ratio of labour to land than the foreign country trade with each other, the wage rate and the lending/renting rate of land are the same in both countries. But that is not the case with every country that trades because labour moves around and usually both countries are not exactly the same in terms of infrastructure, technology and communication as the Heckscher Ohlin model suggests (68-69). Because ever changing differences in relative product prices has a large effect on the relative earnings of resources, and with trade the relative price also changes, so trade has a negative impact on income distribution.
Causes and effects of international Labour mobility (chapter 7) p154
Heckscher Ohlin model focuses on trade as an explanation of bringing together factor prices, and capital / labour movements have similar effects. Capital tends to move from high wage countries to low wage countries. However labour migrates from low wage to high wage countries. Workers usually move to foreign countries in order to get paid more. Krugman suggested that labour will migrate to countries with higher labour productivity and higher real wages. And he further states that due to immigration wages will fall and due to emigration real wages should increase.
If wages do not fall despite immigration, employers have no incentive to create additional jobs, and the immigration and this causes unemployment.
Due to the fact that countries do not produce the same goods, due to differences in technology and due to immigration barriers, real wages across countries will never be equal (156-157).
Companies in Europe which is considered an industrialised country will outsource those activities that use a large amount of unskilled labour. Moving these activities abroad would then lead to a decrease in the relative demand for low skilled labour in Europe within each industry. This means that outsourcing has a similar effect on reducing the demand for low skilled labour relative to high skilled labour within an industry, as does skill-biased technological change.
Technological advancements and wages
Skill-biased technological change reduced the demand for unskilled workers leading to higher long-term unemployment among low skilled workers in Europe. So low skilled workers would have to receive training in order to retain a job. At the same time, international outsourcing also leads to a shift in relative demand for labour. Firms outsource the low skill intensive parts of production and therefore increase the relative demand for skilled labour. Technological advancements also enabled companies across the world to better communicate with each other. Fast communication is a key factor when you are trading. Better infrastructure and more ways of transportation also enabled and increased trade among different countries.
Benefits from globalisation
According to the traditional trade theory globalization will equalize the price of products and production factors. Free trade will lead to a more efficient allocation of world resources as competition will shift production to the producers with the lower production cost. This more efficient allocation of resources will boost growth with positive effects on social welfare.
Innovation and increased international competition can lead higher productivity, higher wages and improved living standards.
Consumersâ€™ welfare will improve due to a decrease in prices. However, the fall in prices relies on the level of competition in the product markets.
If economies have different capital/labour ratios, free factor mobility will encourage capital (labour) to move from the economies with a high (low) capital/labour ratio to those in which capital (labour) is relatively scarce. This process will affect the distribution of income since it will increase the relative income of capital (labour) in the countries initially with a high (low) capital/labour ratio.
As globalization accelerates further, both costs and benefits will tend to raise while costs such as higher unemployment and income inequality will be concentrated in the short run while benefits in the form of lower prices, higher productivity and income will only occur later on.