For the last decade, if one argued that globalization and free trade drove up inequality in the U.S., one was arguing against the latest and most advanced economic research. For example, each of Krugman, Lawrence, Cline, and Borjas looked at “North – South” (think U.S. – China) trade in seperate studies, and each concluded that there was almost no impact on skilled-to-unskilled wage ratios (differential estimates of 3%, 3%, 7%, and 1.4% respectively). Point, set, match – the free traders win, so let’s just open the borders and we can all get rich!

But… it’s kind of hard to believe, isn’t it? It sure seems like there has been an extraordinary amount of downward wage pressure (and associated jobs losses) in the U.S. job market, so the argument doesn’t pass the all-important smell test for many. Moreover, wouldn’t common sense indicate that as free trade expands, wages for lower-skilled workers would go down (and inequality would go up) in rich countries, holding all else equal? You know, when wage differentials can be 20-fold or higher between countries, while capital and technology differences between the same countries continue to shrink?

Well it turns out the smell test might be right after all. One of the economists mentioned above (Krugman) is working on a paper called Trade and Wages, Reconsidered, in preperation for the Spring meeting of the Brookings Panel of Economic Activity. He’s posted the VERY preliminary draft online in order to get some early feedback… and what he has said so far is quite interesting. To quote Krugman precisely, here are two paragraphs from the paper – one from the intro, and one from the conclusion:

Nonetheless, the analysis presented here indicates that the rapid rise in manufactures imports from developing countries probably is, indeed, a force for growing inequality, and that factor content calculations suggesting otherwise are missing the essence of what is happening.

How can we quantify the actual effect of rising trade on wages? The answer, given the current state of the data, is that we can’t. As I’ve said, it’s likely that the rapid growth of trade since the early 1990s has had significant distributional effects. To put numbers to these effects, however, we need a much better understanding of the increasingly fine-grained nature of international specialization and trade.

I find this conclusion extremely refreshing. Recently I’ve plowed through a whole pile of economic research on the trade and wage debate, and each time it said there was minimal-to-no effect on wages and inequality it just didn’t sit right. While all the complicated equations and calculations looked good, something was missing. To summarize what this “something” was, I will quote Krugman again:

What really comes through from the analysis here, however, is the extent to which the changing nature of world trade has outpaced our ability to engage in secure quantitative analysis—even though this paper sets to one side the growth in service outsourcing, which has created so much anxiety in recent years. Plain old trade in physical goods has become remarkably exotic.

It’s a big problem for a lot of the empirical economic research, as it’s currently done - the world is changing too fast to rely on it for certain things. By the time you have the data you need, it might be too old to be relevent (or even worse, it can be turned on a “consensus” that is very misleading).

The trade and wages debate looks like one place such a problem has popped up, and once the traditional “empirical support” erodes it will be interesting to see how things like the Global Plant Floor evolve – do you think Obama and Clinton might be interested in Krugman’s thoughts as they argue over who would pull out of NAFTA first?