Discussions

Protectionist trade policies to address the declining labour share of national income?

Protectionist trade policies to address the declining labour share of national income?

19 Apr 2017

Willemien Viljoen, tralac Researcher, discusses the need for improved domestic policymaking rather than the use of restrictive trade policies to redress the declining labour share of income

The labour share of national income; the share of national income paid in wages (including benefits) to workers has been on a global downward trajectory since the 1980s for many advanced economies and since the 1990s for many emerging and developing economies[1]. The declining labour share suggests that product wages grow more slowly than average labour productivity. In many countries the decline is due to the inability of product wage growth to keep up with weak productivity growth. At the global level a decline in labour share of income reflects the trend in advanced economies; the sharpest decline is in manufacturing and transportation while the share of labour income has increased in sectors like food, accommodation and agriculture. In emerging and developing economies labour’s share of income declined mainly in agriculture and increased in manufacturing, health services and construction.

According to the World Economic Outlook (WEO) April 2017 various factors contribute to the declining labour share of income; these include technological advancement; global integration (overall trade, participation in global value chains, and financial integration) and domestic policies, regulation and institutions. According to the WEO, both technological advancement and participation in global value chains have lowered the income share of middle-skilled workers. In the case of advanced economies the rapid advance of information and communication technology (and associated automation of routine tasks) has been the main contributing factor to the decline in the labour share of income. The participation in global value chains (as an increase in the importation of components for assembly and re-exportation) has had the most notable negative impact on labour’s share of income for emerging and developing economies (overall trade in goods and services has a negligible impact on the labour share), while financial integration has offset some of these negative effects. Due to a decline in middle-skill occupations and an increase in the share of income accruing to capital at the top end of the income distribution, the decline in labour’s share of income has also exacerbated income inequality. The decline in the labour share of income is not just associated with income inequality, but can also harm economic growth prospects, lead to resistance against economic integration and favour inward-looking policies. This is precisely the type of argument we are currently seeing in many countries across the world: buy local and protectionist policies to limit imports to protect domestic industries from a loss of employment. An increasing inward-looking focus has recently seen policy changes in countries including the United States, South Africa, Nigeria and Zimbabwe.

It is often easier to restrict trade than to improve domestic policy; however, restrictive trade policies can be very costly in the long-run – raising trade costs can lead to a reduction in aggregate output, increase prices, increased fragmentation of production processes, reduction in the purchasing power of lower-income groups and harm supply-side potential by reducing productivity growth. An increase in trade costs can also reduce expectation of future earnings and hamper investment and the creation of employment opportunities. The most effective way to address the declining share of labour in income is not through reducing trade, but rather by preserving the gains from trade while enabling domestic policy change to redistribute the benefits of trade (and subsequent economic growth) and to make these benefits more inclusive[2] through active labour market policies and complementary policies in the areas of trade, education, housing and credit.

Protectionist trade policies (for possible short term gains) should not be used as a substitute for addressing structural challenges (like youth unemployment, rigid labour market conditions, skills shortages and quality of education, long-term unemployment, inequality, social exclusion and poverty) in the labour market. The focus should be on labour market policies supported by good governance, structural reform and underlying monetary, fiscal and financial sector policies and regulations to improve productivity; investment in skills development and availability (in the short term improve the supply of needed highly skilled workers through the movement of persons and in the long-term investment in upgrading and deepening the existing skills); labour mobility and the adaptability of the workforce; the quality of education and the overall reallocation of resources. There is a need for appropriate domestic adjustment policies (labour market policies and macroeconomic policies), not for closing markets. The degree of factor market flexibility, access to education and access to financial, credit and insurance markets should all be considered in policy design. Labour market polices which are better suited to address current challenges in changing economic conditions include training programs to address the skills gap, job search assistance (like access to information), the elimination of labour market distortions (rigidity, mismatch of skills, rural-urban wage difference and labour mobility) and the improvement of technical, cognitive and non-cognitive skills.

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[1] International Monetary Fund. 2017. World Economic Outlook April 2017: gaining momentum? http://www.imf.org/external/pubs/ft/weo/2017/01/weodata/index.aspx

[2] International Monetary Fund, The World Bank, and World Trade Organization. 2017. Making trade an engine of growth for all: the case for trade and for policies to facilitate adjustment. https://www.tralac.org/images/docs/11504/making-trade-an-engine-of-growth-for-all-joint-wto-world-bank-imf-report-for-g20-sherpas-meeting-march-2017.pdf