Globalisation, Labour Market and Inequality

Erik Haller Pedersen, Economics

INTRODUCTION AND SUMMARY

This article^[1] describes a number of potential implications of the growing integration of low and medium-income countries into the world economy. It focuses on the effect of globalisation on the remuneration of labour and on the degree of income inequality in society.

Both globalisation and the technological development have contributed to rising real wages in Denmark. Thanks to globalisation, Danish output has moved up the value chain, thus selling at higher prices, while on the other hand consumers benefit from low-cost imports from low-wage countries. This accounts for around 25 per cent of the increase in real wages since 1980. At the same time there has been downward pressure on the share of value creation that accrues to labour, i.e. the wage share has been declining while the profit share has been rising. The same pattern is observed in other industrialised countries.

Globalisation and technological advances in general tend to increase income inequality across individuals. The Danish social model to a large extent counters this underlying trend.

GROWTH IN THE GLOBAL LABOUR FORCE

The global population has grown by 60 per cent or 1.5 billion people over the last 25 years, cf. Table 1. The population growth almost entirely occurred in low and medium-income countries, including China and India. At the same time, technological advances and the removal of barriers to international exchange of capital, goods and services have led to higher output specialisation across countries. This has boosted international trade. Immigration flows have also increased, though far less than trade flows.

An estimate of the global labour force, measured as the part of the labour force which is competing in the international market, can be obtained by weighting the development of a country's labour force by the degree of openness, i.e. the sum of exports and imports as a ratio of GDP. Applying this measure, the International Monetary Fund, IMF, estimates that the global labour force has quadrupled over the last 25 years, cf. Chart 1. The rapidly increasing degree of openness makes the global labour force grow more than warranted by demographic developments alone. The number of people with little education or training in low and medium-income countries has shown a particularly high growth rate. Consequently, the labour force in the industrialised countries increasingly competes directly with the labour force in low and medium-income countries where wages are typically considerably lower, the spread between low and high-income groups is wider and working conditions are poorer.

POTENTIAL IMPLICATIONS OF AN INCREASE IN THE GLOBAL LABOUR SUPPLY

Globalisation has many facets, but this article focuses solely on the potential implications of an increase in the global labour supply. Strong growth in global labour makes labour more abundant relative to other production factors, including capital. According to classic economic theory this should lead to a decline in the remuneration of labour (the relatively less scarce production factor) compared with the remuneration of capital (the relatively scarcer production factor). Depending on the substitution ratios between labour and capital, this should result in a declining wage share, defined as remuneration of labour relative to overall income creation in the economy (GDP at factor cost). This is also what the figures show, cf. Chart 2.

In future, the downward pressure from globalisation on the wage share may subside, as the degree of openness cannot keep rising at the same pace as it has for the past few decades. At the same time the population growth is decreasing. On the other hand, many low and medium-income countries still have large population groups outside the part of the economy that competes internationally.

The increased supply of labour is not the only possible explanation of a declining wage share. Ellis and Smith (2007) point out that the rate of technological progress has accelerated. The higher the level of innovation, the faster the capital stock becomes obsolete and has to be scrapped, which leads to increased depreciation and dismissal of the related labour. This has strengthened the bargaining position of enterprises in relation to their staff, which may shift the distribution of income towards profits at the cost of wages. The more flexible the labour market is, the less plausible this explanation becomes.

The wage share is influenced not only by global conditions. Denmark is an oil and gas producing country and will as such be affected by the level of oil prices. The current high energy prices lead to excessive oil and gas production profits, which, all things being equal, will raise the profit share, calculated as 100 minus the wage share.

Calculating the wage share for the economy as a whole involves several compilation problems. For the public sector, GDP at factor cost is calculated on a cost basis, i.e. a without a profit element. The wage share is thus artificially high in this sector. The opposite applies to the owner-occupied housing sector's contribution to GDP at factor cost, which is compiled as an imputed return, reflecting, in principle, what a lessee would have to pay for a similar housing service. However, the imputed contribution to GDP at factor cost is not matched by any enterprise income, as the housing service is consumed by the homeowners themselves and thus cannot be distributed as payroll costs. This implies a very low wage share in the owner-occupied housing sector.

In general, the strongest decline in the wage share has been observed in the sectors most exposed to competition from low and medium-income countries. Thus, the wage share for the economy as a whole is also affected by sector shifts in employment.

After a considerable period of decline, the wage share in Denmark has increased slightly over the last decade, while continuing to decrease in other European countries. Historically, the wage share in Denmark has been high compared with other countries. One of the reasons is that Denmark's relatively large public sector makes for a high wage share, because it is very "wage intensive" in relation to other sectors, and because the sector's GDP at factor cost is compiled with out a profit element.

GLOBALISATION AND LABOUR AND CAPITAL REMUNERATION IN DENMARK

A declining wage share is not in itself an indication of labour losing out on globalisation. On the contrary, wage earners have to a large extent benefited from the increased international specialisation over the last 25 years. The correlation between real wages and the wage share is illustrated in Box 1.

CORRELATION BETWEEN REAL WAGES, WAGE SHARE AND PRODUCTIVITY	Box 1
The wage share indicates total payroll costs relative to total value creation (GDP at factor cost), both in current prices. The correlation between wage share, real wages and productivity is obtained by  the following conversion: The numerator in the fraction indicates the development in real wages per hour measured by deflating hourly wages before tax by the index of net retail prices, i.e. the price, excluding indirect taxes, paid by the consumer. It is an expression of the employee's purchasing power of the wages earned1. The denominator consists of two parts: Firstly, the development in hourly productivity. Productivity sets limits to real wages in that real wages calculated as wages deflated by producer price (GDP at factor cost deflator) can have a faster growth rate than productivity only if the wage share rises. Over the last 25 years, productivity has increased more than real wages calculated in this way. This means that payroll costs have not entirely been able to keep up with productivity growth, causing the wage share to decline. Secondly, the "terms of trade" between the price of finished goods/services, measured by the GDP at factor cost deflator, and net prices. The prices of goods and services produced in Denmark have increased more than net prices. This indicates that Danish output has moved further up the value chain, while net prices are kept down by importing goods from low-wage countries, including China. Thus, when calculated on the basis of the GDP at factor cost deflator, the increase in real wages per hour has been weaker than when calculated using net prices as the deflator, cf. Chart 3. The difference is an expression of the consumers' direct gain from globalisation. When calculated in this way, globalisation accounts for approximately 25 per cent of the increase in real wages since 1980, corresponding to the difference between the blue and the orange curve2. To some extent this "terms-of-trade gain" makes up for the failure of payroll costs to keep up with productivity.
REMUNERATION OF LABOUR AND PRODUCTIVITY IN DENMARK	Chart 3
Source: Statistics Denmark and own calculations. 1  Net prices rather than consumer prices have been used. If hourly wages before tax are deflated by consumer prices, real wages are not affected by an increase in direct taxation. On the other hand, an indirect tax increase would cause a decrease in real wages. As an increase in direct taxation is synonymous with indirect tax increases in this context, this asymmetry is unfavourable. Wages before tax deflated by the index of net retail prices is therefore a better measure. It is a net amount in as much as it is neither affected by direct nor indirect taxation changes. 2 The calculation used is a pure ex post calculation and makes no attempt to explain wage formation. The wage level may be influenced by both prices and taxes.

Chart 4 shows an international comparison of remuneration in real terms per capita, which has been steadily rising. In the case of Denmark, remuneration in real terms per capita increased slightly less than remuneration in real terms per hour as shown in Chart 3, as hours worked per capita has declined over time.

The profit share is the part of value creation that does not accrue to wages. The profit share can be measured in both gross and net terms. Thus, depreciation on real capital should typically be excluded from the gross profit share to obtain the real remuneration of the capital owners. The proportion of the value added that must be earmarked for depreciation has grown over time, mainly due to a lower average capital life, especially for IT investments. On the other hand, no trend-related increase in the capital intensity of output, measured as the value of the capital stock against GDP at factor cost, has apparently been observed for the economy as a whole. The measurement is subject to considerable uncertainty, however.

Excluding the housing stock, the return accruing to capital net of depreciation has been flat since the late 1980s, cf. Chart 5. This is a real rate of return, which may be compared with a risk-free interest rate plus a risk premium. Since there has been no increase in the capital intensity, as mentioned above, the result is largely the same whether the net profit is compared with GDP at factor cost or the value of the capital stock.

Labour will share the benefits of the profit share through direct or indirect ownership of the capital stock, e.g. in connection with pension savings invested in shares, but the distribution of assets is much more uneven across individuals than the distribution of income, cf. Hornstrup and Madsen (2000).

PAYROLL COSTS FOR HIGHLY EDUCATED EMPLOYEES AND EMPLOYEES WITH LITTLE EDUCATION OR TRAINING – AN INTERNATIONAL COMPARISON

International output specialisation in the countries where production of certain goods or services is most efficient enhances international trade and prosperity^[2]. The disadvantages of globalisation tend to be concentrated, whereas the benefits are more widespread. While the disadvantages are mainly caused by adjustment costs, e.g. temporary unemployment in the event of outsourcing, the benefits are typically lower price increases as a result of increased imports from low-wage countries.

As illustrated in Chart 1, the share of the global workforce of employees with little education or training has shown particularly strong growth, especially in low and medium-income countries. Due to international specialisation, production requiring this type of labour is outsourced to low and medium-income countries^[3]. To a certain extent, labour movement is also caused by people with little education or training migrating to high-income countries. Both situations may put pressure on wages for employees with little education or training compared with highly educated employees in the industrialised countries. A study of Danish data by the Rockwool Foundation indicates that the immigration of people with little education or training to Denmark from less developed countries has put pressure on the wages of Danish employees with little education or training, cf. Malchow-Møller, Munch and Skaksen (2007). Viewed in isolation, this will tend to increase income inequality in society.

In addition to the effect of increased international specialisation and trade on the distribution of income, there is an equally important technology effect. Technological developments tend to amplify the skill bias. This intensifies the effect of globalisation. The overall implication of globalisation and technological advances is that payroll costs insectors with many highly educated employees increase compared with payroll costs in sectors with many employees with little education or training. To some extent, the tendency towards increased wage variation is also evidenced by data, cf. Chart 6.

The relative development in payroll costs per employee in sectors with a large number of highly educated employees or employees with little education or training, respectively, is mirrored in the employment patterns of the two sector groups, cf. Chart 7 and Box 2 as regards the definition of sectors.

In Denmark, payroll costs per employee in sectors with many highly educated, highly paid employees have risen compared with payroll costs per employee in sectors with many employees with little education or training. At the same time, employment in the highly paid sectors has increased relative to employment in low-wage sectors. This reflects the ongoing shift towards production of goods and services with increasing added value.

It should be noted that due to data availability the relation between sectors is measured rather than the direct relation between highly educated employees and employees with little education or training. Both sector groups comprise both types of employees, and different compositions in different countries may blur the image in international comparisons, cf. the example from the textile industry in Box 2.

GLOBALISATION AND DISTRIBUTION OF INCOME

Globalisation and technological progress generally entail increased efficiency, i.e. "the pie becomes bigger", but as described above this may be at the expense of the degree of equality in the distribution of income and may, in the short term, cause a rise in unemployment. How much unemployment rises during the adjustment process depends very much on the way the labour market works. The main cause of persistent unemployment is not globalisation. It would be more correct to say that the cause is insufficient flexibility and adaptability in the labour market. The more flexible the labour market, the more easily labour is shifted from declining sectors to growing sectors. The Danish labour market is characterised by a high level of flexibility, which is reflected in high job turnover, among other factors, cf. Chart 8.

The fairly smooth adjustment process in Denmark so far by no means indicates that globalisation does not involve challenges. Unless productivity can continually benefit from innovation and improvements, real incomes will be put under pressure. So far, Denmark has performed quite well. Resources have been moved up the value chain without any major problems, cf. the discussion in Pedersen (2007). This is illustrated by the employment pattern since 2000, with a fall by 50,000 in manufacturing, but a rise in overall employment by almost 100,000. The service sector has accounted for the strongest employment growth.

Although society as a whole benefits from globalisation and technological development, individual groups may still lose out. Potentially, as described above, employees with little education or training are most exposed to any negative consequences of the development.

IMF (2007b) analyses inequality in a global perspective. It concludes that although real incomes for the lower quartiles of the income distribution have gone up, the degree of inequality has generally increased across countries and regions over the last few decades. This is mainly because the upper quartiles account for a growing income share. Thus, the trend towards a higher degree of income equality seen in the first part of the 20th century has been broken^[4].

Different countries have chosen very different approaches to tackling the pressure towards greater inequality. In the US and to some extent in the other Anglo-Saxon countries, wages are allowed a certain, even downward, elasticity. This reduces the negative consequences for employment and unemployment, but at the expense of income equality in society. There is more focus on the distribution of income in Western Europe, and wages are not allowed full downward elasticity. This is apparent e.g. in higher minimum wages, and there is more protection for those already employed. The price is higher unemployment and more people on public benefits financed by a heavier tax burden. There are considerable differences in the degree of inequality across countries, cf. Chart 9.

Despite the trend towards greater inequality of income between highly educated employees and employees with little education or training, the distribution of personal income in Denmark has been more or less unchanged over the last 10 years. Denmark seeks to ensure high employment and low unemployment with its flexicurity and welfare model, while a fine-meshed social safety net and extensive income distribution via the public budget sensure a high degree of income equality[5]. One indication of this is that the degree of income inequality is considerably lower for disposable incomes than for pre-tax incomes, cf. the last bar in Chart 10.

In conclusion it can be said that globalisation and technological advances tend to increase income inequality across individuals, but that this underlying trend is counteracted by the Danish economic model.

LITERATURE

Anand, Sudhir and Paul Segal (2008), What do we know about Global Income Inequality, Journal of Economic Literature, Volume XLVI, no. 1, March.

The Danish Economic Council (2001), Inequality and Redistribution of Incomes in Denmark (in Danish only), Danish Economy, Autumn.

Ellis, Luci and Kathryn Smith (2007), The global upward trend in the profit share, BIS Working Paper, no. 231.

Förster, Michael and Marco Mira d'Ercole (2005), Income Distribution and Poverty in OECD Countries in the Second Half of the 1990s, in OECD Social, Employment and Migration Working Paper, no. 22.

Hornstrup, M. and Bent Madsen (2000), Wealth in Denmark (in Danish only), the Economic Council of the Labour Movement in Denmark.

IMF (2007a), World Economic Outlook, Spring.

IMF (2007b), World Economic Outlook, Autumn.

Jean, Sébastien and Giuseppe Nicoletti (2002), Product Market Regulation and Wage Premia in Europe and North America: An Empirical Investigation, OECD Economics Department Working Paper, no. 318.

Kreiner, Claus Thustrup, Torben Tranæs (ed.), Henrik Jacobsen Kleven, Niels-Kenneth Nielsen and Peder J. Pedersen (2006), Tax, Work and Equality (in Danish only), the Rockwool Foundation.

Malchow-Møller, Nikolaj, Jacob Roland Munch and Jan Rose Skaksen (2007), Foreign Labour in Denmark, the Consequences for Wages and Employment (in Danish only), Rockwool Foundation Research Unit, Working Paper no. 16.

Pedersen, Erik Haller (2007), Globalisation and the Danish Economy, Danmarks Nationalbank, Monetary Review, 1st Quarter.

Pedersen, Erik Haller and Johanne Dinesen Riishøj (2007), Flexicurity – the Danish Labour-Market Model, Danmarks Nationalbank, Monetary Review, 4th Quarter.

Rosholm, Michael, Christian Scheuer and Anders Sørensen (2007), The Implications of Globalization for Firms' Demand for Skilled and Unskilled Labor, Aarhus School of Business, Copenhagen Business School and Centre for Economic and Business Research (CEBR), (unpublished paper).