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Trade and Unskilled Workers

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Two short papers in the December 2005 issue of the American
Economic Review
unintentionally but nicely complement each other.

The first paper is by Matteo Cervellatti and Uwe Sunde,
entitled “Human Capital Formation, Life Expectancy, and the Process of Development.” The second is by Chang-Tai Hsieh and Keong T.
Woo, entitled “The Impact of Outsourcing to China on Hong Kong’s Labor Market.”

Cervellatti and Sunde conclude that

Wages, which are determined by productivity, and life
expectancy are the crucial variables in the individual education decision. In turn, this education decision has
implications for the education decisions of future generations, both through
changes in life expectancy and the productivity of human capital. Thus, advances in technological progress,
human capital formation, and longevity potentially reinforce each other. The cost of acquiring skills are
prohibitively high, however, for large parts of the population in an
underdeveloped environment, that is, when life expectancy and productivity are
low. Only once the entire system is
sufficiently developed does the positive feedback loop have enough momentum to
overcome the retarding effects of costs for human capital formation.

Hsieh and Woo find

evidence of strong and persistent
relative demand shifts favoring skilled workers in Hong Kong since the early
1980s, which is when outsourcing to China started to take off.

We can infer from Hsieh’s and
Woo’s finding that Hong Kong’s comparative advantage today is in producing
goods and services with skilled labor. This fact is unsurprising given that Hong Kong has for several decades now been one of the freest societies on earth – and has
become one of the most prosperous. Cervellatti’s
and Sunde’s explanation drives this point home: because Hong Kong’s prosperity
is now long-lived and reasonably secure, people there a while back began
investing more heavily in the accumulation of human capital so that today most
people in Hong Kong enjoy a comparative advantage in skill-intensive sectors.

But shouldn’t we worry about Hong Kong’s unskilled workers? More generally, shouldn’t we worry about
unskilled workers whenever trade shifts demand from their output to that of
their more-skilled countrymen? I think
not. Or, put differently, here’s my
hypothesis for why the existence of low-skilled workers ‘left behind’ by freer
trade policies is no reason to reverse or even to slow movement toward free
trade.

By increasing labor productivity,
free trade increases general prosperity, which increases life expectancy.  So free
trade increases the returns to human-capital investments.  This fact, in turn, shrinks over time the size
of the group of people classified as “unskilled.”

In other words, because free trade
increases wealth (and, hence, life expectancy), it supplies increasingly
stronger ability and incentives for people to acquire work skills. Today’s group of unskilled workers (however
large or small it might be) would have been larger had trade policies been less
free.  And the size of tomorrow’s group of unskilled workers will be even smaller if free-trade policies are followed.

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