Over the past two decades, labor has become increasingly globalized; that is, countries have access to an increasingly large global supply of labor through immigration, off shoring of the production of intermediaries, and imports of final products. Chapter 5 of the IMF’s April 2007 World Economic Outlook (WEO) estimates that the integration of China, India, and the former Eastern bloc into the world economy, together with population growth, has quadrupled the size of the effective global labor force since 1980. By 2050, it could more than double again.
Labor globalization has benefited advanced economies: it has expanded export opportunities considerably and, by lowering input costs and improving production efficiencies, has boosted productivity and output. As a result, labor compensation has risen in all advanced countries since 1980. For instance, calculations suggest that the decline in traded goods prices over the past 25 years has generated a 6 percent increase, on average, in both output and real labor compensation.
Research published in the WEO suggests that labor globalization, technological change, and labor market policies have all affected the share of income accruing to labor (the labor share) over the past two decades (see chart). The first two have reduced the proportion of income going to labor, with technological advances having the larger effect. This share has declined by about 7 percentage points, on average, since the early 1980s in advanced countries, with the European countries, Japan, and unskilled sectors of the economy experiencing the largest declines. In contrast, countries that have reduced the tax wedge, thereby lowering the cost of labor to business, and ensured that unemployment benefits do not deter workers from seeking employment have generally experienced a smaller decline in labor share.
Declining slice of a growing pie
Although labor compensation in advanced economies has risen, the proportion of income accruing to labor is falling as a percentage of GDP.
Source: IMF, World Economic Outlook, April 2007
The issue: Is globalization forcing down labor income in advanced economies?
The bottom line: Although the global labor force has swelled over the past two decades, it has contributed to rising labor compensation in advanced economies.
Is there a downside? Yes. Globalization is one of several factors that have reduced the share of income accruing to labor in advanced economies.
Technological change has hit the labor share in unskilled sectors particularly hard; growth in real labor compensation has been sluggish in those sectors. In the United States, unskilled employment has held steady, but the earnings gap between skilled and unskilled workers has widened by 25 percent. In Europe, real compensation per worker in both skilled and unskilled sectors grew at roughly the same rate, but employment in unskilled sectors lost ground to employment in skilled sectors.
Challenges for policymakers
Policymakers in advanced economies must seek to harness the benefits that the growing pool of global labor and technological progress are creating. This means continuing to liberalize trade while ensuring that domestic economies are flexible enough to adjust and respond to the pressures of ongoing changes. They must also be aware of adjustment costs and implement policies that support individuals adversely affected. Policies should meet three broad objectives:
• Improve the functioning of labor markets. Policies that reduce labor costs to business (specifically, that lower the tax wedge) and make it easier for workers to move from declining to expanding areas of the economy will help the adjustment. In some countries, making health care less dependent on continued employment and increasing the portability of pension benefits would also help.
• Increase access to education and training. Workers in skilled sectors have been better able to adapt to changing conditions caused by the revolution in information and communications technology than workers in unskilled sectors.
• Ensure adequate safety nets. Adequate income support should be available to cushion, but not obstruct, the process of change.
Florence Jaumotte and Irina Tytell
IMF Research Department