In the Face of Globalisation

Protecting Low-Income Workers

Low-skilled workers here are fretting The world is integrating at a brisk pace. First the fall of the Iron Curtain, then the freer trade allowed by NAFTA between the US, Canada and Mexico, the opening of China and India to world trade, and the integration of the EU's internal market and its subsequent expansion to the east have all brought about changes to the returns to factors of production in industrialized countries. Capital has become a relatively scarce factor of production, and its price has increased; unskilled labour, in contrast, has become an abundant one, thus becoming the loser of an otherwise beneficial economic process.

The integration of markets allows countries to reap gains from trade, but due to the forces of factor price equalization these gains are accompanied by significant income losses among the working classes in industrialized countries, at least when compared with the trend that otherwise would have prevailed. The achievements of a hundred years of social democracy are thus at risk.

Hans-Werner Sinn, president of the influential Ifo Institute for Economic Research in Munich and author of the German economics best-seller Ist Deutschland noch zu Retten? ("Is there Any Hope for Germany?," soon to appear in English), argues in a recent paper that, in principle, the forces that put pressure on the wages of less-qualified workers in the industrialised countries already come into operation via trade specialisation and capital movements triggered by the principle of comparative advantage. However, in many countries these forces are reinforced by migration processes triggered by huge wage differences. The east-west migration taking place in Europe since the fall of the Iron Curtain and set to continue in the years to come is a case in point.

The average wage of the about 75 million people from central-eastern Europe that joined the EU in 2004 is about one fifth of the EU average and about one seventh of the west German average. After a transition period, to last no longer than 2010, workers from the new EU countries will be able to offer their services in any of the old EU countries.

Ordinary workers in western Europe are afraid of what will happen, and their fears may well be justified. They will not belong to the winners of this period of economic integration. The winners are capital owners and skilled workers. It is true that market integration is likely to bring about gains from trade, but these are gains only in the sense that the winners will gain more than the losers will lose. Whether the losers will be compensated, however, remains an open question.

From a social perspective, this is disquieting. It is understandable that the losers appeal to the welfare state to compensate them. The welfare state, however, cannot help much since the more it helps, the more it will come under pressure itself. The theory of systems competition has nothing but discomforting news in this regard. If only because of the mobility of labour, the welfare states will rather be engaged in a kind of deterrence competition in order to avoid becoming the target of welfare migration. Yet, at least in western Europe, the welfare state is still intact and will exert its influence on the migration processes involved.

Sinn’s paper looks at how existing social systems influence immigration and what effect they will exert on the wages of unskilled labour. It then proceeds to identify policy measures that would help to buffer low-skilled workers, in an economically efficient manner. The paper complements the existing fiscal competition literature. Where that literature deals with the reaction of welfare states to migration, it typically models the welfare state as an institution that pays wage subsidies, thereby increasing the incentive for emigration.

The typical European welfare state differs substantially from this. First, it offers social replacement income to those who do not work rather than paying out wage subsidies. Such replacement income makes wages rigid, unable to react to the competitive forces. Second, it sets labour standards that define the social environment of jobs. Both types of measures bring about reactions to the migration pressure that are different than those to the wage subsidies studied in the literature, notwithstanding the fact that such subsidies would indeed be better tools of the welfare state if combined with a Principle of Selectively Delayed Economic Integration, as the paper shows.

Sinn formulates his analysis in terms of labour migration, because this is where policy interferes most with market forces. On the one hand, governments impose constraints on migration. On the other, the redistributive fiscal measures of the state automatically act as welfare magnets for the poor. If the full gains from trade do not materialise in reality, it is mostly because government actions induce labour market distortions. Nevertheless, Sinn's proposals are fully compatible with the other forces that work towards partial factor price equalization.

Note: This text is the responsibility of the writer and does not necessarily reflect the opinion of either the CESifo Working Paper author(s) quoted or the CESifo Group Munich.