I suspect that the average American assumes that low wage countries have a competitive advantage in international trade. Economists often rebut that argument using Ricardian trade theory. But the public cares little for “theory”, and remains unconvinced. So what about the real world?
There are many ways of looking at this question, but I suspect that many people are especially worried about the trade deficit. So let’s consider the question of whether low wages tend to lead to current account surpluses. Here’s some recent data from The Economist:
Let’s begin by focusing on the top half of the list, from the US down to Switzerland. What do you notice? With the exception of China and (perhaps) Russia, all are developed economies, with wage rates far above the global average. And yet, despite most of those countries having wage rates far above the global average, most run current account surpluses (in grey). Indeed some of the biggest surpluses are in places with the highest wages, such as the Nordic countries and Switzerland.
Now focus on the bottom half of the list, from Turkey down to South Africa. Most of those are developing countries with low wages, and most are running current account deficits (in peach color).
But even that understates the pattern. The bottom half of the list includes six developed economies (the 4 “tiger economies”, Israel and Australia.) And 5 of those 6 are now running current account surpluses. Remove those six developed countries, and the bottom half of the list becomes very strongly associated with current account deficits.
But it’s even worse than that. Most of the “exceptions” that are not fully developed but still run CA surpluses are higher middle-income places, such as Russia, Malaysia, and Argentina. If we use World Bank estimates of GDP per capita (PPP) in 2023, then Thailand ($23,423) is the poorest country with a CA surplus. China is estimated at $24,558. Both are slightly above the world average ($23,010.)
Admittedly, the Economist’s list excludes many of the world’s roughly 200 countries, mostly smaller nations. I suspect that there are a few low-income countries running CA surpluses. Nonetheless, it’s a pretty large sample and includes almost all of the world’s important economies, both developed and developing.
Perhaps you are one of those people that don’t trust economic theory, and prides yourself by looking at how things work in the real world. If so, you should be relieved to learn that low wages do not seem to give countries an unfair advantage in international trade.
So why do so many people believe the opposite? I suspect they put far too much weight on a single observation, the trade deficit that the US has with China. The plural of anecdote is data.
PS. I was being generous to the opposing view in characterizing Russia and Malaysia as middle income. The World Bank has Russia slightly ahead of Greece, and Malaysia only slightly behind.
PPS. I’ll consider fiscal policy on another day, but if you compare the US to other countries on the list, you will see why I worry much more about our budget deficit than our CA deficit. And take a look at the CA balances in the 5 countries that are running budget surpluses. As I keep saying, the Nordics and the East Asians are the world’s great savers.
READER COMMENTS
Jon Murphy
Aug 31 2024 at 7:37pm
Given low wage means low MPL, these results don’t surprise me. It’s the same reason that, despite the fact I’d be willing to work for League minimum wage, the New England Patriots didn’t sign me to be their quarterback.
Craig
Sep 1 2024 at 2:06pm
Don’t feel bad, look at the bright side, I highly doubt your university would pay Tom Brady minimum wage to teach economics.
vince
Sep 1 2024 at 3:16pm
Heh, until the first time you got sacked by a 300 pounder.
Jon Murphy
Sep 2 2024 at 8:46am
League minimum is $795,000. I’d get sacked by a 300 lb dude for $795,000
Matthias
Sep 2 2024 at 1:58am
So you are saying minimum wage laws are bad for employment? (I guess you’d have to accept a considerably negative salary to be allowed in that job, ie you’d need to pay them.)
Jon Murphy
Sep 2 2024 at 8:49am
Assuming they’d lose all their revenue if I was their quarterback (a strong assumption; they’d probably still get tv and ad revenue from existing deals, but let’s go with it to keep things simple), I’d have to offer them approximately $700 million to make them indifferent.
Knut P. Heen
Sep 2 2024 at 8:52am
Examples from team sports must be used with caution. In business you often can replace 1 skilled worker with 100 unskilled workers if necessary. You cannot do that in team sports because there are restrictions on how many players you can field at the same time. “Free labor” is often worthless in team sports because of the opportunity cost (fielding a much better player at some cost).
You cannot put 100 unskilled drivers in a car either, but it is possible to build 100 rickshaws instead of 1 car. Abundance of labor and scarcity of capital usually leads to the rickshaw solution, and that solution may be more productive than 1 car with an unskilled driver and 99 people without access to capital (unemployed).
Car drivers don’t like competition from rickshaws. That is why they complain. Low wages are a competitive advantage, but so are other factors like skills, access to capital, etc. It is the whole package that determines whether you are competitive, not a single factor.
Jon Murphy
Sep 2 2024 at 9:23am
The exact same logic plays into other fields as well. Businesses face constraints, just as team owners do.
Warren Platts
Sep 1 2024 at 10:21am
Hold on a sec. Low wage developing countries running CA deficits are exactly what theory predicts because the obverse of a trade deficit is capital inflow. Presumably developing countries have productive investment opportunities that are going unfunded because their domestic savings are insufficient to fund all desired investment. This will grow their economy because the return on investment exceeds the cost of the debt. This was the U.S. in the 19th century: despite all those al those tariffs the 19th century is notorious for, we ran a trade deficit for most of that period but it was worth it because there were plenty of productive investments that were going unfunded.
Developed countries, on the other hand, tend to have a capital surplus almost by definition: if there is unfunded desired investment, that’s because of political gridlock or some other reason than a shortage of capital. Thus the exception to the theory is the United States and perhaps the UK. Do we need massive foreign capital inflows? No. Foreign financed greenfield factories and such are a tiny, tiny, tiny percentage (less than 1%) of total foreign inflows. So if foreign capital is not financing productive investments, then, logically, the only thing they are financing are unproductive speculative investments. Scott, you are always complaining about the housing crisis in California. Well, the trade deficit is at least partially responsible.
I guess this wouldn’t be a problem except that the debt we are wracking up as a result is increasing faster than our GDP and hence our debt-servicing capacity. Current Net International Investment Position (NIIP) is at 75% of GDP. NIIP is a measure of how much we owe the ROW in excess of what the ROW owes us. Historically, when countries get below negative 60%, bad things start to happen. We’ve been in the danger zone since the pandemic.
Why is this happening? Because we’re letting it happen! Mainly for free market purity ideological reasons as far as I can tell. What is happening is that households in the big mercantilists (EU, China, Japan) can’t afford to buy their own production; it’s absolutely scandalous that the EU is running a 3% GDP CA surplus. This is another way of saying they are suffering from a savings glut. Therefore, if they didn’t run these surpluses, they logically would have only two choices: (1) somehow redistribute their national income so that their households can consume more; or (2) increase unemployment. And since they refuse to do (1), and would rather not do (2), then basically they are exporting their unemployment to the United States.
This is not sustainable. As Bernanke himself stated, the 2008 crisis was the result of the worldwide savings glut. Apparently nobody learned their lesson. Hence our conundrum: the trade deficit will end one day, one way or the other. The only question is whether it ends in an explosion worse than 2008, or we intelligently manage the unwinding while we still can. And it’s you guys’ job, you economists, to tell us how to accomplish the unwinding…
Scott Sumner
Sep 1 2024 at 11:06am
There are so many mistakes in your comment I hardly know where to begin:
“it’s absolutely scandalous that the EU is running a 3% GDP CA surplus. This is another way of saying they are suffering from a savings glut. Therefore, if they didn’t run these surpluses, they logically would have only two choices: (1) somehow redistribute their national income so that their households can consume more; or (2) increase unemployment. And since they refuse to do (1), and would rather not do (2), then basically they are exporting their unemployment to the United States.”
They have no savings glut
Europe does roughly as much redistribution as the rest of the world combined.
The US has lower unemployment than Europe–we are a job-creating machine.
Focus on solving our budget deficit and the trade deficit will take care of itself.
Warren Platts
Sep 1 2024 at 12:23pm
Scott,
If EU is running a 3% trade surplus, that logically entails that their national savings (S) vastly exceeds their investment (I). If you don’t want to call that a “glut,” that’s cool, but that was Bernanke’s term, not mine. Moreover, EU’s problem is not the level of government transfer payments; it’s that their wages are too low, which is another way of saying their percentage of national income that’s going to labor is too low.
Fully agree that (1) the budget deficit is a crisis of massive proportions that needs solved; and (2) the budget deficit is what is currently driving the trade deficit. That said, if the government were somehow able to balance its budget, then logically, the trade deficit will only go away if (a) the mercantilists (EU, China, Japan) voluntarily reduce their national savings by increasing consumption; or (b) the U.S. institutes massive taxes or other capital controls that stem foreign capital inflows — in that case we will inflict severe unemployment on the mercantilists and their savings will be forced down anyways.
If neither (a) nor (b) happens, foreign inflows will merely shift from the government sector to the private sector in the form of unproductive investments like subprime mortgages or other some such. Why? Because the world is a closed economy and S – I = 0 in a closed economy. Therefore, (i) excess savings in saver countries must find a home in deficit countries; or (ii) if there is no home, then countries attempting to force up savings will either have to suffer unemployment or increase their consumption. There are no other logical options.
PS None of this stuff is original to me. You might find interesting Trade Wars are Class Wars: How rising inequality distorts the Global Economy and Threatens International Peace (2020). On the back cover, Dan Rodrik says, “This is a book that everyone concerned with the global economy should read. A fascinating account of the damage that rising inequality — especially in China and Germany — has done to all our economies.”
Scott Sumner
Sep 1 2024 at 9:17pm
The problem is not that Europe saves too much, it’s that the US saves too little. But I am pleased to hear you don’t think Europe can solve the world’s problems by redistributing even more income.
And I was not aware that Germany is a country with high levels of inequality. How do they compare to the US?
Jon Murphy
Sep 1 2024 at 11:17pm
According to the World Bank’s GINI, Germany (31.7) is more equal than the US (39.8).
vince
Sep 2 2024 at 11:37am
The Rodrik quote refers to rising inequality. Here’s a related link. https://www.imf.org/en/Publications/WP/Issues/2020/06/26/Wealth-Inequality-and-Private-Savings-The-Case-of-Germany-49471
Warren Platts
Sep 2 2024 at 1:24pm
Jon, those are GINI scores for income, not wealth. Germany’s wealth GINI is in the 80s: the average German is twice as wealthy as the average Spaniard, yet the median Spanish household is much wealthier than the median German household that is about as wealthy as the median Greek or Polish household.
Anyways, Germany’s troubles, if you want to call them that, began with the fall of Communism and the reunification of Germany. In the 90’s Germany actually ran a current account deficit. But the welfare state that was grown to tide the East Germans over was deemed too much. Things were drastically cut back due to the Hartz reforms. Real wages declined by at least 5%. Hours were cut so more workers could be hired. In the 90s less than 40% of people between 55-64 worked; it’s now around 70%.
And of course German corporations were freaked out by low-wage competition not just from East Germany, but from the rest of eastern Europe as well. Much production was moved to eastern Europe as well as China. German auto production since the 90s has doubled, but that domestically produced within Germany has been pretty much flat. Meantime, the German wealth tax was abolished in 1997 and the way their inheritance taxes are structured, if you leave over 10 million you’ll probably pay 1% whereas if between 100K to 200K, you’ll pay on the order of 14%.
Net result was to transfer wealth from poor households to rich households who of course always save more than poor households. But poor households realized they couldn’t count on the government for retirement social security, so they also increased their savings as well, meagre though their incomes were.
And then to top it off, Germany imposed a fiscal straightjacket on themselves, the Schuldenbremse: literally “Debt brake” around 2010. Basically, this law requires the total government (federal, local, social security funds, etc.) budget to be balanced, on average. No execeptions for needed infrastructure investment allowed. Hence they were able to balance their budget by 2014. As of 2020, the fiscal surplus was 2%, thus although the Economist chart above shows a fiscal deficit of 1.6%, Germany’s fiscal budget can safely be deemed to be balanced.
Hence the triple whammy of extreme wealth concentration, fear of the future among poorer households, and a government that refuses to run fiscal deficits has resulted in chronic surpluses, that according to the economist chart are at 6.6%. Meantime, about all of the former crisis countries with the exception of Greece apparently, have all gone through German-like periods of austerity and are now running CA surpluses as well.
This is not good. When the EU as a whole is running a 3.1% surplus that distorts the entire global economy. And guess where that surplus has to go: to the United States — the global source of demand of last resort. It’s hard to see how this can continue forever.
Scott Sumner
Sep 2 2024 at 1:36pm
Germany should be applauded for its sensible fiscal policy. It’s the US that needs to change course. And I am extremely skeptical of claims that Germany has more economic inequality than the US. Just the reverse is true.
Warren Platts
Sep 2 2024 at 3:50pm
Scott, Germany and the USA are more alike than you seem to realize. I’m not saying Germany has more inequality; I’m saying they both have skyhigh wealth inequality compared to the ROW as a whole. Both have offshored jobs (Germany to eastern Europe and China; USA to Mexico and China); both seen working class wages stagnate; both have seen labor’s share of the national income decline. Germany has it’s debt brake; USA has it’s debt ceiling. By all rights, USA should be running a trade surplus just like Germany. So what gives?
There is an old Wall Street saying: “When a duck quacks, feed it.” Because of the USD’s reserve currency status, excess saving countries like Germany, China, Japan need a safe, preferably liquid place to park those excess savings, even if the returns on capital aren’t that great. So what happens is insufficent spending causes excess savings in surplus countries; that in turn leads to purchases of USD denominated assets because the USD’s (regrettable imo) reserve currency status; that in turn leads to increasing U.S. debt (that is the obverse of American savings being forced down).
Thus to say that the current account deficit is caused by U.S. households not saving enough gets the causation backwards imho. Indeed, I wince whenever someone says Americans need to save more. Because what does that mean? Basically, that’s code for wages are too high; Americans consume too much; we need more trickle-up because at least rich people know how to save money.
I don’t know what the solution is, but squeezing American households more than they’ve already been squeezed doesn’t seem like a good answer.
Jon Murphy
Sep 2 2024 at 8:00pm
You didn’t say wealth. You said “inequality.” Since inequality usually refers to income and not wealth,* I assumed that’s what you meant.
But yes, if you want to look at wealth, Germany’s wealth inequality GINi is 0.79. US’s is .85. Both are below the world average (.89). At least, according to Credit Suisse.
*”wealth” can be very misleading. Someone with a lot of debt can appear poor even if they make six figures. Meanwhile, someone who has no debt can appear quite wealthy even if they make below poverty wage, but that’s a different story
Warren Platts
Sep 3 2024 at 1:10pm
Jon, wealth is simply assets minus liabilities. As for what’s misleading, that would be the GINI score itself because multitudes of distributions can go to the same number. Consider that Sweden, Russia, Oman, and Botswana all have virtually the same GINI (88) yet it’s hard to imagine four more different countries. Also, the world GINI score is obviously not the average GINI score: according to the Wikipedia, in 2021 the world GINI was .889, yet there are exactly 3 countries that exceed 0.889 (Brunei, Bahamas, Brazil). Therefore, your “average” must not be the average of all nations’ GINI scores, but was calculated for all 8 billion people.
vince
Sep 1 2024 at 3:22pm
What would our budget deficit be without cheap financing from the trade deficit?
https://prosperousamerica.org/how-budget-deficits-grow-due-to-trade-deficits/
vince
Sep 1 2024 at 3:14pm
Here’s a way. A CEO has to decide whether to pay $50 per hour to a US employee, along with Dept of Labor rules for working conditions, or pay $5 per hour to someone in a low wage country that lax regulations. Ceteris Paribus. Except profit of course.
Scott Sumner
Sep 2 2024 at 1:37pm
“Here’s a way.”
And given that poor countries tend to run trade deficits, that’s obviously the wrong way, isn’t it?
vince
Sep 2 2024 at 4:00pm
Not for the CEO. And one reason poor countries run trade deficits is that they need the capital account surplus for investment.
What’s with moderation on this forum? Am I on a terrorist list? It takes a day long approval process before posts appear. Then the chronology is screwed up. Just tell me and I won’t bother posting.
John
Sep 1 2024 at 3:36pm
Cherry picking data can make anything se correct.
If it costs 1/2 the price to manufacture something overseas in Malaysia or China or another country with extremely low costs, that is a trade advantage.
Why do you think most of the manufacturing in these developed world economies happens somewhere else? Obviously it is a huge trade advantage to be cheap. China used that advantage to, quite literally, take control of the entire western supply chain. Now India is cheap as well, and many companies are going there from China not because they pay more but because China’s fsctories have bad quality control, which means high compliance costs to keep using them.
Jon Murphy
Sep 1 2024 at 4:15pm
Just because something is low-montary price does not mean it is low cost. Why the monetary price is low matters (see my example above of me playing in the NFL).
Jim Glass
Sep 2 2024 at 1:05am
Employers don’t want workers who are “cheap”, they want workers who are the most productive relative to their cost. Like sports teams’ GMs. See: Moneyball. If they wanted cheap workers, Haiti would have hit 100% employment decades ago.
Jon couldn’t get himself hired by the Patriots, but he made the mistake of asking for the league minimum.
I got serious. I have a long-time friend who works for the Mets and told him I’d play for the Mets for free. Free! Workers can’t get any cheaper than free! He laughed his drink out his nose.
Jon Murphy
Sep 1 2024 at 4:16pm
Every single thing here is objectively incorrect.
Scott Sumner
Sep 1 2024 at 9:15pm
I’d suggest you reread the post. It is simply not true that most rich countries run trade deficits.
Matthias
Sep 2 2024 at 2:00am
Scott, so your data is saying that high wages are a competitive advantage? Got it! Increase the minimum wage to fix the trade deficit.
(Please don’t take this serious.)
Christoph
Sep 2 2024 at 3:51am
Scott,
thanks for the article. I have one question: Would you not agree that in principle a country can increase it’s national savings rate by suppressing the overall wage level (and/or depressing overall consumption)? If so, would this not mean that ceteris paribus you can increase you current account by suppressing wages?
More generally, should we maybe not consider the overall wage level in relation to a country’s GDP or productivity? I would expect that the countries that have lower wages than their productivity would allow (which Germany is often blamed for) would show a higher current account.
Thanks.
Scott Sumner
Sep 2 2024 at 1:42pm
“suppressing the overall wage level”
I don’t know what this phrase means. Does Germany have laws restricting wages? Yes, countries can boost their national saving rates through sensible public policies. In reality, almost all countries discourage saving, it’s just that the high savers discourage it less than others.
BTW, there are also measurement issues, as Americans are earning large capital gains.
Jose Pablo
Sep 3 2024 at 6:43pm
How is the US government “discouraging” savings? (compared to the German government)
The German government pays for your college education, covers your health-related expenditures, and pays you a very generous (compared with your last earnings as an active worker) pension.
These three seem to me to be the top reasons why individuals save.
The US government doesn’t provide any of this (at comparable levels to the German one) and that is “discouraging” savings? (compare to Germany) how so?
So, now, the way of encouraging savings is increasing redistributions from 35% of GDP (US levels) to 50% of GDP (German levels)*?
* These % also include “direct spending” but redistribution makes up the bulk of government budgets. Even more so in the German case.
Warren Platts
Sep 3 2024 at 2:05pm
To get back to Scott’s prescription that Americans saving more is the cure to the trade deficit, I can understand why that seems to be the logical conclusion considering that S – I = NX. If NX is negative and that’s a problem, and since we generally think of investment I as a good thing, then raising savings S would seem to be the thing to do.
Yet when American companies are spending billions and billions on stock buybacks, that tells me that the “I” column is maybe too high?
But lets expand the equation: NX = (Y – C – T) + (T – G) – I. In 2024, clearly (T – G) currently dominates. But as I pointed out above, as long as the mercantilists insist on consuming less than they produce, and as long as the U.S. continues to agree to accommodate them, then balancing the fiscal budget will merely push the CA deficit into the private sector. Is that a good idea? Probably not. As long as the USA is going to be in the business of absorbing capital inflows from mercantilist countries, it’s better that be a U.S. SOE for the following reasons:
Consider the worst case scenario: a financial crisis worse than 2008. It would be better if the government rather than the private sector was holding the bag because the government has more tools available to deal with the crisis, such as inflation, money printing, geopolitical blackmail; whereas the private sector can pretty much only declare bankruptcy. The government would likely do a bailout anyway.
Moreover, if the exorbitant burden is shifted to the private sector, what hope is there that the private sector will be able to end the CA deficit on its own? Answer: it can’t or it won’t; there will always be people willing to accept debt they probably shouldn’t. Thus to get the private sector to drastically increase their savings would require drastic government policies to force up private savings; but we don’t want austerity.
What else is there? Potentially, we can hold C,G, and I constant, and somehow grow Y. But how? But that would seem to require directly attacking NX. And there’s no way we can export our way out of the CA deficit as far as I can see. So that entails taxing foreign capital inflows, market access charges, real estate investment bans, other capital controls, probably combined with trade interventions like tariffs, export subsidies, and currency depreciations. Heck, between a capital gains tax on foreign investors and a 20% ad valorum import tax, I estimate we could raise close to a trillion dollars/year in extra revenue. But I know, I know, people are allergic to tariffs. They’d rather have a 20% VAT than a 10% tariff….
Worley
Sep 3 2024 at 2:06pm
It depends on what you mean by “a competitive advantage in trade”. An economist is rational and considers exports of software products from Silicon Valley to the world as global trade. But in ordinary parlance, “trade” means “trade in high-volume, labor-intensive, low-labor-skill manufactured goods”. Indeed, the sort of thing that fifty or a hundred years ago was considered the backbone of “economic prosperity”, how the mass of the workers made their living.
Jose Pablo
Sep 3 2024 at 6:32pm
Germany should be applauded for its sensible fiscal policy. It’s the US that needs to change course.
Wait a minute. I am really surprised by this statement.
Germany’s public spending is around 50% of GDP with a deficit of 2.5% of GDP. That means that Germany raises taxes for around 47.5% of its GDP.
The US public spending is around 38% of GDP (all levels of government) with a deficit of around 6% of GDP. Taxes should be around 32% of GDP.
So you basically mean that raising the public spending in the US by one-third (!) and simultaneously increasing the tax burden by 50% (!!!), so making the US like Germany, would be a “sensible fiscal policy in the US”.
I don’t know, seems very difficult to believe. Trust me, you don’t want to pay taxes in Germany (or France).
Reducing the US spending to 10% (or less) and taxes to 0%, let’s debtholder voluntarily financing this 10% government with cheap money!, seems like a way more sensible fiscal policy than the German one. Collect taxes if (and only if) you can’t find voluntary debtholders willing to finance your spending.
Jose Pablo
Sep 3 2024 at 7:07pm
Focus on solving our budget deficit and the trade deficit will take care of itself.
Since when consuming less and paying more taxes (basically what you are proposing here) is a desirable goal?
It seems that a much better advice would be: keep thinking in ways of having the rest of the world provide you with very real goods and services in exchange for book entries representing non-collateralize unenforceable liabilities or/and, even better, equity-like claims on new companies you manage to sell at prices way higher than the cost of the resources required to create those companies. Two activities in which the US certainly excels!
The US has done this consistently for more than 50 years now, time to start believing in our ability to keep doing it. Let’s use “trade deficits” as the right metric to asses our capacity to live out of these two abilities (that is what the trade deficit is). The bigger it is the better we are performing at those enviable tasks.
Europeans can only envy that.
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