Income disparities fruit of free trade, January 2010

    * Published: 2/02/2010 at 12:00 AM
    * Newspaper section: Business

The closer link between trade and production has enabled businesses worldwide to make goods more cheaply and thrive. But many people agree that rising income inequality has been one of the pitfalls.

Eric Maskin, an American economist who won the 2007 Nobel Prize in economics, observed that countries in Latin America and Asia have witnessed increasing inequality since they liberalised international trade.

Mexico, for example, quadrupled its international trade five years after it signed a free trade pact with the US in 1975. But wages of high-skilled workers increased by 13% while those of low-skilled workers declined by 14%.

Prof Maskin said that the "comparative advantage" theory has failed to explain the widening income gaps that occur after trade barriers are removed. The theory hypothesised that once trade and services were liberalised, production bases would relocate based on the distinguishing factors for production in each country.

In the case of Mexico and the US, the theory would lead to a scenario in which Mexico would shift to low-skilled production and import high-skilled production of goods from the US. The US would do the opposite.

Ultimately, Mexico could see a decline in wages of high-skilled workers because there is less demand. It would have witnessed an increase in wages of low-skilled workers because there is more demand.

International trade and the production of goods has deepened over the past 25 years, owing to significant decreases in communications costs and the production of goods across borders. One premise is that such developments will help to reduce poverty.

China and India have grown spectacularly over the past 20 years and their successes have been highly related to the fact that they opened up their economies.

"It doesn't work that way in recent globalisation," Prof Maskin said recently in Bangkok in a forum held by International Peace Foundation. "And it makes people wonder perhaps if globalisation is not such a good idea after all.

"Even though inequality has increased, so has average prosperity. So globalisation is not an all-out failure."

He proposed a new theory which focuses on the fact that the rise in cross-border production would affect workers at various skill levels in each country. The new theory is based on a premise that the wealth of a country depends on its workforce's skill level.

Cross-border production changes the distribution of labour skills among trade partner countries as more competition in the labour market will force workers to improve their capacity, he said.

But it turns out that not all workers could match the higher skills and lift their capacity because those at the lowest end will be left to fend for themselves.

As a result of the rise in cross-border production, workers with the lowest skills will see their wages decrease, while workers with higher skills will see their pay packages get bigger. The situation today is far different from that in the pre-globalised world, he said.

"We need to make an investment in the low-skilled labour of the world so they too can benefit from globalisation."