Criticism of NAFTA: Wage Stagnation

One of the criticisms of NAFTA (and often of globalization) is that it has led to wage stagnation in the US.
Public Citizen offered this argument in a report released this February:

Trade affects the composition of jobs available in an economy. The aggregate number of jobs available can be better explained by fiscal and monetary policy, the impacts of recessions and other macroeconomic realities. The United States has lost millions of manufacturing jobs during the NAFTA era, but overall unemployment has been largely stable (excluding the fallout of the Great Recession) as new low-paying service sector jobs have been created. Proponents of NAFTA raise the quantity of jobs to claim that NAFTA has not hurt U.S. workers. But what they do not mention is that the quality of jobs available, and the wages most U.S. workers can earn, have been degraded.

According to the U.S. Bureau of Labor Statistics, two out of every three displaced manufacturing workers who were rehired in 2012 experienced a wage reduction. Two out of every five displaced manufacturing workers took a pay cut of greater than 20 percent. For the average manufacturing worker earning more than $47,000 per year, this meant an annual loss of at least $10,000.

 Such displacement not only spells wage reductions for former manufacturing workers, but also for existing service sector workers. As increasing numbers of workers displaced from manufacturing jobs have joined the glut of workers competing for non-offshorable, low-skill jobs in sectors such as hospitality and food service, real wages have also fallen in these sectors under NAFTA.

 The shift in employment from high-paying manufacturing jobs to low-paying service jobs has thus contributed to overall wage stagnation. The average U.S. wage has grown less than one percent annually in real terms since NAFTA was enacted even as worker productivity has risen at more than three times that pace. Given rising inequality, the median U.S. wage has fared even worse and today remains at the same level seen in 1979. (Public Citizen, 2014, p 10-11).

In shifting the focus from the total number of jobs in the US economy to the quality of jobs, this argument side steps arguments based on the unemployment rate in the US, such as I made in a previous post. Therefore, this argument deserves separate consideration.

For a first cut we can turn to an interview with the Council on Foreign Relations in which Edward Alden argues

There is no question that [due to] NAFTA and the other trade agreements that have happened since the big Uruguay Round [of global trade talks] that concluded at the end of 1993, and the entry of China into the World Trade Organization in 2000, that the U.S. manufacturing sector is facing much tougher competition than it did twenty or thirty years ago. What we’ve seen happen are two things: We’ve seen manufacturing productivity in the United States increase dramatically, which means fewer workers. Industries have shed workers as they’ve become more capital intensive. They’ve become more efficient since that’s the only way they can compete. A lot of American companies have moved portions of their operations offshore to take advantage of lower wages. Overall, American manufacturing output hasn’t really shrunk—it’s grown slightly. 

First of all, where Alden says that American manufacturing output has "grown slightly", the Fred graph below shows that US manufacturing output (see graph below) increased 70% from 1993-2007 and is currently 64% larger than it was when NAFTA went into effect.

That quibble aside, Alden makes the argument that global competition, not just competition from Mexico and Canada have forced US companies to enhance productivity, cut down on employees, and use a higher proportion of skilled labor. In itself, this argument suggests that NAFTA itself is not to blame but rather that the global trade environment is behind the trend. However, saying that NAFTA is a small part of a larger trend is unlikely to sell anyone on the value of trade.

A better argument might come from asking the question, if it weren't for NAFTA, and international trade in general, would manufacturing productivity not have increased as it did? That is to say, without foreign competition, would US manufacturers not have invested in labor saving technology that has replaced large numbers of unskilled workers with fewer more highly skilled ones?

If you look at the graph of manufacturing output above, you will see that output climbed during the nineties until suffering a set back in the 2001 recession (the first shaded area in the graph). It then grew at a slightly slower rate than in the 1990s until the Great Recession (the second larger shaded area in the graph). I suppose you could blame the slower growth from 2002 to 2007 on increased foreign competition, particularly from China, but you would have to ignore the much larger impact of the two recessions.

The impact of these two recessions is even more evident if one looks at the number of people employed in the manufacturing sector. The FRED graph of manufacturing employment below shows that decreases in manufacturing employment line up with the two recessions (again indicated by shaded areas). Manufacturers shed 3 million workers during and after the 2001 recession and 2.5 million more during the great recession. These two reductions combined amount to a 31% decrease in the number of people employed in manufacturing, from 17.5 million  to 12 million workers.

In both recessions, manufacturing output shrunk (see first graph) and than fought its way back after the recession, but employment stayed down. This is because productivity was increased as manufacturers found ways to make more with less employees. As you can see in the FRED graph below, productivity (the blue line) increased at a higher rate immediately after each recession than immediately before it. However, if you look at the whole period, the overall trend is quite steady. I have inserted a dotted black line from the beginning and end point of the productivity graph and you can see that output per hour increased along that line in the 1990s before increasing above it from 2001-2008.  While the blue line climbs away from the dotted black line in the immediate aftermath of the 2001 recession, it doesn't trend back towards the dotted line until the Great Recession. Note that after the Great Recession, the blue line climbs away but then trends back towards it and follows it quiet closely for the last couple of years.

While this is a very informal and cursory look at one piece of data, it suggests to me that the increase in manufacturing productivity from 2002-2004 was probably a direct result of the 2001 recession. The growth from 2004-2008 may have been fueled by increased international competition to roughly the extent that productivity increased above the dotted trend line.

Here is where the red line, which represents real compensation per hour, comes in. Note that from 2004-2008 compensation stays flat. This may be the wage stagnation that NAFTA critics are talking about. Clearly from about 2004 on, wages do not follow the trend they did from 1993 to 2004 (the dotted red line). Of course, the fact that wages have not trended up since the Great Recession is not surprising given that unemployment  has been high. However, from 2004-2008, unemployment was quite low and trending downward. So we cannot entirely rule out some effect from international trade.

At the same time, it is hard to argue that this effect was determinant. Output per hour (the blue line) was not increasing that much above the trend line for the overall period. In 2008 the actual index of output per hour was at about 180 (up 40 points from the end of the 2004 recession) when the trend line would have put it at 170 (up 30 points from the end of the recession). If we attribute this difference entirely to global competition (and not to technological innovations or domestic market pressures), one could argue that international competition produced 25% of the growth in output per hour, but that 75% would probably have occurred without it.

Of course, this additional 25% may have been enough to blunt wage growth, so we can't reject the stagnation argument completely. Instead, we can put it in context by noting that trade may have exacerbated and existing trend for 4-5 years but that we are now exactly where we would have been if productivity had kept increasing at the rate it did in the 1990s. Of course, putting it in that sort of context rather undercuts the wage stagnation argument as a whole.

In general, I think the wage stagnation criticism of NAFTA is a case of confusing correlation with causality. We have clearly seen a trend of manufacturers and other employers using more technology and high skilled labor. This has resulted in the earnings of high skilled employees to go up while stagnating or deflating the wages of low skilled employees. It has gotten to the point that PEW Research talks about the rising cost of not going to college. However, this trend is not limited to manufacturing but affects all industries and has little to do with international trade.