20100105 ECFA set to cause wages to tumble

ECFA set to cause wages to tumble
　

By Chen Po-chih 陳博志
Tuesday, Jan 05, 2010, Page 8

‘Taiwan’s massive investment in China is a key reason behind Taiwan’s slowing wage increase rates and increasing unemployment rate in recent years.’

National Taiwan University (NTU) associate professor of economics Tu Jenn-hwa (杜震華) — who is also an adviser to the Chinese Nationalist Party’s (KMT) National Policy Foundation — published an editorial in the Chinese-language Apple Daily on Dec. 29, accusing me of distorting the factor-price equalization theory at an NTU forum on the economic cooperation framework agreement (ECFA). However, his viewpoint exposes his ignorance of the theory as well as his intent to mislead the public through specious reasoning.

Tu wrote that no leading economist is opposed to trading with low-wage countries. This statement may be right, but I am not opposed to trading with low-wage countries either. The controversy is not whether or not we should trade with China, but whether we should sign an ECFA with China and whether we should only be able to trade with China instead of developing close trade ties with other countries. He failed to make this distinction and many of his concerns dealt with other such issues.

International trade is necessary and very few are opposed to it. However, completely free trade is not necessarily the best option. Conducting completely free trade with countries like China that offer many government subsidies and rely on unfair interference in business is like facing someone with a knife unarmed.

That is why I have always suggested that negotiations are a must before Taiwan signs an ECFA with China, so Taipei can demand that Beijing removes unfair subsidies to Chinese industry and non-tariff trade barriers on imports.

If we take income distribution into consideration, even fair free trade is not necessarily good. In the 10th edition of the popular economics textbook entitled World Trade and Payments, authors Richard Caves, Jeffrey Frankel and Ronald Jones explain how free trade can hurt some people. Textbooks and theses are replete with examples of such reasoning. Apart from the assumption of fair competition, genuine academics also know that free trade is only good when those who benefit can compensate those who suffer as a result of it. Only then can we say that such trade is good for all. Tu, who has been an associate professor for a long time, should know this.

The most eye-catching effect of trade on income distribution is that wages or wage growth in high-wage countries might drop. This is the factor-price equalization theory that Tu criticized. This effect is in fact the simple and commonly seen market force.

Let us assume that locally made towels are priced at NT$100 each and that NT$40 of this goes to the workers as wages. If a low-wage country sells the same towel for NT$90 here, the price of Taiwanese made towels would have to be cut to NT$90, thus reducing workers’ wages to NT$30. If tariffs were removed, the price of imported towels would drop further to NT$80, and the Taiwanese employer would only be able to pay his workers NT$20. This logic is so simple that anyone with a brain can understand it.

Unfortunately, Tu and some others who are opposed to the theory criticize it for using the Stolper-Samuelson theorem. As a matter of fact, this theorem is a special example. The condition for the theorem — that wages in the two countries will be perfectly equal — is a sufficient, but not a necessary, condition. Even if the assumption is not completely satisfied, the wages in the high-wage country still tend to go down.

Saying that wages in the high-wage country will not be dragged down by wages in the low-wage country because Samuelson’s assumption is not fully satisfied is just as ridiculous as saying that someone who jumps off a building will float on air because of air resistance.

Tu cited economist Paul Krugman in claiming that the Stolper–Samuelson theorem is incorrect because the assumption does not stand up. In fact, what Krugman wrote is that the wages of the two countries will not become equal, not that they would not move closer to each other. In his article entitled Trade and Wages, Reconsidered from 2008, Krugman said clearly that wage decline must not be overlooked. He even used a model to show that the wages of low-skilled US workers are likely to drop drastically under such circumstances.

Tu also cited economist Robert Mundell as saying that free trade can replace international investment, so that Taiwanese businesses do not need to invest in China after an ECFA has been signed. This includes more than one mistake but I will only point out one here.

In an article entitled International Trade and Factor Mobility published in The American Economic Review in June 1957, Mundell wrote that international investment and free trade have the same factor-price equalization effect. In other words, Taiwan’s massive investment in China is a key reason behind Taiwan’s slowing wage increase rates and increasing unemployment rate in recent years.

Most of Tu’s and some others’ criticism of the factor-price equalization theory include these mistakes. Due to the limited space, I am unable to refute them one by one here. For those who are interested, more details can be accessed on the Taiwan Thinktank Web site. As the government and its think tank staff use a number of incorrect claims to refute the theory, I am afraid that the problem is not a lack of knowledge. Perhaps the government is afraid of revealing the truth — that an ECFA will lower wages further.

Chen Po-chih is chairman of Taiwan Thinktank.