RELATIVE WAGE PATTERNS AMONG SKILLED AND UNSKILLED WORKERS AND INTERNATIONAL TRADE: EVIDENCE FROM CANADA

ASAC Toronto, Ontario, Ramdas Chandra John Molson School of Business Concordia University RELATIVE WAGE PATTERNS AMONG SKILLED AND UNSKILLED WORKERS AND INTERNATIONAL TRADE: EVIDENCE FROM CANADA International business scholars have become increasingly concerned with the impact of trade expansion on domestic wages, particularly those of skilled labor in developed nations. This study reports exploratory findings on the wage patterns among skilled and unskilled workers in Canada between 1998 and 22. Introduction One of the hottest topics in globalization these days is the impact of international trade and business on wages in the domestic market. Particularly, the recent trend of outsourcing has raised fears among many countries that expansion of trade will result in a reduction of returns to skilled labor, hitherto the competitive advantage of the developed countries. In Canada, a recent report by Price Waterhouse Canada (24) (PWC) raised similarly alarmist concerns. The study claims a loss of about 7, jobs that could potentially be lost in Canada, thanks to outsourcing. Last year, U.S. Senate Democratic leader Tom Daschle used the term Alice in Wonderland economics, blaming 2.9 million jobs lost on trade and outsourcing. What seems to worry a lot of current economists as well as politicians is the quality of jobs supposedly lost to international trade and investment. Through the 197s and 198s, the jobs that disappeared from North America were mostly manufacturing jobs, which were replaced by higher paying service jobs. However, the current wave of internationalization, particularly the offshoring trend involves highvalue addition jobs, including research and development. The impact of the emergence of these jobs on domestic wages, particularly to skilled labor is therefore an area of concern in countries like the United States, France and Canada. France, for instance, announced a plan in 24 to counter the outsourcing trend, offering monetary incentives to French companies that kept jobs in France rather than outsourcing them to lower-labor cost markets. The current study focuses on a specific, narrow aspect of this debate. We seek descriptive evidence on the last five-year relative wage patterns of skilled and unskilled workers in Canada, and examine whether trade, both imports and exports, appear to have any effect on relative wages. We argue that if high skilled labor would suffer from lower returns as a result of greater internationalization, then industries which are comprised of high levels of imports and exports should see downward pressure on wage levels, or even a decline of relative wage levels, particularly among skilled workers. We also seek to determine whether these relative wage patterns are affected by the knowledge intensity of the industry. We stress that the study is 21

exploratory in nature, and seeks to find patterns in Canadian wages, rather than offering and testing explanatory hypotheses. Background Ricardo s theory of comparative advantage has for long been one of the most dominant paradigms in international business. It has formed the intellectual basis of the arguments for free trade, and for forming responses to the anti-globalization protesters. Ricardian equilibrium analysis does not lead to any long run loss in jobs as a result of free trade, but rather focuses on the gains in net national product among free traders, that, again in the long run, leaves all countries with higher real wages. Of course, in the short run, it might lead to a job loss in the higher wage countries, but these losses are offset in the long run by consumer gains as well as expanded national output, thanks to a trade-induced rise in demand by consumers in all countries. Although condensed and simplified, the argument above is used by advocates of globalization to suggest that trade eventually benefits the economy and raises income levels. Opponents on the other hand argue that increased trade comes with an increase from foreign competition, particularly from developing countries, and hence depresses developed country wages, and even worsens income distribution in these countries. An enormous amount of literature has informed this debate for several decades now. Needless to say, the empirical evidence is rather mixed, ranging from minimal effects of trade on income to significant effects. We do not review the vast literature here, but merely offer a small sample of studies that offer different positions on this debate. For instance, Murphy and Welch (1991) find that tradable sectors of the economy face higher downward pressure on wages of unskilled workers. Similarly, Katz and Murphy (1992) find that relative demand for, and hence wages of unskilled labor falls as relative size of trade in the economy increases. Finally, Berman, Bound and Griliches (1994) also find that trade induces a shift in demand for skilled labor. Borjas, Freeman and Katz (1992) focus on the specific direction of downward pressure on wages, summarizing that imports tend to depress wages, while exports tend to raise wage levels in a country. The empirical results begin to look significantly more mixed when specific impacts of trade on skilled and unskilled labor is considered. For instance, Robbins (1994) and Robbins and Zveglich (199) both find persistent decreases in wage differentials among skilled and unskilled workers associated with increased international trade. On the other hand, Wood (1997) and Feenstra and Hanson (1997) find exactly the opposite result! Increased trade and liberalization widened income inequalities among skilled and unskilled workers. Several factors can be proposed to explain such contradictory findings, including the empirical context of the studies, the structure of the economy, the specific structural characteristics of the importing and exporting sectors of the economy and the cost of capital and capital intensity of the trading sectors. Most of these have not been however empirically tested. 22

From Canada s standpoint, in his doctoral thesis, Zakhilwal (2) uses data from the Survey of Labor and Income Dynamics to find some evidence of the existence of a premium for skilled workers in Canada. One of the explanatory factors he offers for this premium is the international trade intensity. The data used however pertains to three years in the early 199s, and precedes the current wave of internationalization that is perceived to have a more dramatic effect on skilled wages. The current attention on the impact of trade on wages of course stems from the growing trade deficit of the United States, and the ongoing phenomenon of outsourcing, both of which are seen to defy conventional economic logic that comparative advantage should result in overall gains to both trading countries. This has spawned a growing stream of research investigating whether in fact there might be a case for negative impact of trade on income levels in a country. In an influential article, Samuelson (24) provides a Ricardian equilibrium analysis that allows for a productivity gain or innovation by a trading partner in a product in which the domestic country enjoys a comparative advantage. The Samuelson model, which appears to be a more deterministic, special-case version of Johnson (19), basically relaxes one of the important assumptions of traditional Ricardian analysis, namely that relative productivity and relative skill endowments are constant. Under these circumstances, Johnson (19) shows that the effect of trade is likely to be ambiguous, depending on exactly how much the consumption effects were offset by the production effects on growth, and hence the resulting terms of trade. However, Samuelson s model more sharply assumes that these productivity gains in foreign markets are exactly large enough to equalize the cost ratios between the trading countries, thereby evaporating any benefits from trade in the first place. The model therefore concludes that under such a scenario, new market clearing real wages for the developed markets will be lowered by free trade. The implications of the Samuelson model are fairly critical, especially for developed countries like Canada. If empirically valid, then we should expect to find further downward pressure on wages, especially of skilled workers in developed countries, as trade expands. As the supply of skilled labor in developing countries goes up, the relative returns to skilled labor in the developed countries should be lower. This would be particularly true in the most recent decade, which has seen the emergence of large markets like India, China and Brazil developing significant competitive advantage particularly in knowledge intensive sectors of the economy. The development of a significantly large skilled labor force in these markets should, according to the Samuelson model result in downward pressure on returns to skilled and even unskilled labor in the developed markets. We should emphasize that this does not necessarily mean lower absolute wages, but could simply translate to lower growth in real wages than before. The rest of this paper now examines Canadian wages of skilled and unskilled labor to identify trends and factors that appear to be consistent with the Samuelson model s predictions. 23

Data and Concepts The data is drawn from the 1998, 2 and 22 (latest available) Canadian Labor Force Survey files. The monthly survey involves around, Canadian households and provides current, monthly estimates of total employment estimates by industry, occupation, hours worked, wage, union status, job permanency and workplace size along with demographic data. We classify the sample as follows. Skilled labor includes all categories of workers who have post-secondary education or higher, while the remaining categories are grouped as unskilled. Following standard approaches, younger workers are those aged 3 and under, while older workers are aged between 36 and 6. The data files also provide the gender of the workers surveyed, allowing us to further break the data down by wages of male versus female workers. The Labor Force Survey also provides the industry of employment, based on three digit NAICS (North American Industrial Classification System). These NAICS codes allow us to classify industries into high-knowledge intensive, medium-knowledge intensive and low-knowledge intensive industries. The classification of specific industries follows a well-established procedure by Lee and Has (1996) and fine-tuned by Baldwin and Johnson (1999). Essentially, R&D and human indicators, such as R&D to sales ratio, proportion of R&D employees to total employment, ration of skilled workers to total employment, ration of employed scientists and engineers to total employment are used to determine the knowledge intensity of each sector of the economy. To conserve space, we do not reproduce the results of the classification here, but the interested reader is referred to Baldwin and Johnson (1999) or Morisette, Ostrovsky and Picot (24) for a complete and detailed listing of industries by NAICS and knowledge intensity. We simply use their classification system in our study to classify industries into one of the three categories of knowledge intensity. Finally, we use two measures of international trade reliance to classify each of the industries in our sample. One is the relative export reliance of the industry, the other the import reliance of the industry, in order to examine differences in wage patterns between export oriented and import oriented industries. Both these measures are simply a ratio of the exports or imports to the total output. The industries where this ratio is higher than the median are considered high export or import-reliant industries. Results and Discussion Figure 1a below shows overall data on average skilled and unskilled worker wages between 1998 and 22. 24

Figure 1a Skilled versus unskilled wages 3 Skilled wages- 14.4% growth 2 1 unskilled wages- 1.9% growth 1 1997 1998 1999 2 21 22 23 As the figure shows, skilled wages have grown faster than unskilled wages, and the relative ratio of skilled to unskilled wages has also grown over this five year period, increasing from 1.4 to a little less than 1.. Comparably, the ratio in the U.S. has increased to about 1.8 over the same time period. Therefore, relatively speaking, income inequality in Canada is still lower than that in the U.S. Figure 1b below shows similar trends for incomes in males versus females.

Figure 1b Wages of male versus female workers 2 Males- 12.2% growth 1 1 Females- 13.% 1997 1998 1999 2 21 22 23 While the ratio of male to female wages has remained fairly constant at around 1.3 in Canada, female wages grew insignificantly faster than male wages over the time period in our sample. While we don t show it in this paper, a breakdown of the above numbers by age and gender lead to very similar conclusions. The growth in skilled female wages is almost identical to that in skilled male wages, while unskilled female wages have grown about 1.% faster than unskilled female wages. In general, we find that demographic differences in the growth of wages over this time period are insignificant; however, skilled wages have grown slightly faster than unskilled wages over this time period, which is quite consistent with data from other O.E.C.D. countries like the U.S. and those in Europe The next step is to determine whether there exist any differences based on the industry knowledge intensity. Figure 2a below shows trends in wages broken down by knowledge intensity of the industry. 26

Figure 2a Wages in High-, Medium- and Low-Knowledge Intensive Industries 2 1 High Medium Low 1 1997 1998 1999 2 21 22 23 As seen from the figure, there is very little change in the relative wages across all three types of industries. In fact, there remains a consistent 22% premium in the wages in high knowledge intensive industries over this time period. The growth in wages in these sectors is also relatively similar, with wages in high knowledge intensive industries growing by 13.6%, compared to 12.6% in low knowledge intensive industries. Figures 2b and 2c below show the relative wages of skilled and unskilled labor, across the three types of industries separately. While the skilled wages in both high- and low-knowledge intensive industries have increased at approximately the same rate of about 1%, those in medium-knowledge intensive industries have increased only at 1%. Interestingly, several of the service industries commonly associated with outsourcing are classified in the medium-intensive knowledge industries, lending some credence to the perception that wages in these sectors face downward pressure. 27

Figure 2b Skilled wages across knowledge intensity 3 2 1 1 1997 1998 1999 2 21 22 23 Figure 2c Unskilled wages across knowledge intensity 2 18 16 14 12 1 8 6 4 2 1997 1998 1999 2 21 22 23 The premium for skilled labor in high-knowledge intensive industries versus low knowledge intensive industries is a little less than that for unskilled labor, suggesting downward pressure on unskilled labor in low knowledge intensive industries. Finally, we present wage data separated by high versus low export reliance in figure 3a, followed by similar data for high versus low import reliance in figure 3b. Figure 3a Skilled versus unskilled wages in high and low export reliance industries 2 1 1 Skilled, hi exports Skilled, lo exports Unskilled, hi exports Unskilled, lo exports 1997 1998 1999 2 21 22 23 28

Figure 3b Skilled versus unskilled wages in low and high import reliance industries 2 1 1 Skilled, hi imports Skilled, lo imports Unskilled, hi imports Unskilled, lo imports 1997 1998 1999 2 21 22 23 The data permit some interesting observations, partially in support of traditional comparative advantage theory, but also raising some concerns about domestic wages in the presence of foreign competition. 1. Consistent with what one might expect from a Ricardian analysis, both skilled and unskilled wages in export-oriented sectors is higher than that in less export-oriented industries. Therefore, there is an export premium as previous literature has posited and demonstrated (e.g. Cline, 1997). What is perhaps more interesting is that the premium for skilled labor is almost % higher in high export-reliant industries compared to low export-reliant industries, up from 8% in 1998. Put another way, the ratio of skilled wages to unskilled wages rose from 1.3 to 1.4 in export-oriented industries, while declining insignificantly from 1.37 to 1.3 in less export-oriented industries. Therefore, outward trade is beneficial to income growth in Canada, while contributing to greater income inequality between skilled and unskilled labor. 2. The variance in wages in export-reliant industries is higher than that in import-reliant industries. As seen from figure 2b, import reliance seems to have very little impact on explaining wage differentials, both within and across skilled and unskilled labor. There is an insignificant difference in skilled wages across both high and low import-reliant industries; the same holds for unskilled wages as well. More importantly, this is quite consistent over the time period in our sample, suggesting that there is little downward pressure, if any on wages in import-oriented industries. The finding that this is true of skilled wages particularly is of importance in refuting the claim that high-skilled labor from cheaper trading partners might put downward pressure on high skill wages in import-reliant industries in Canada. 3. A cautionary note however is sounded when one compares skilled and unskilled wages in low import-reliant industries to low export-reliant industries. Wages in low import-reliant industries are consistently higher than those in low export-reliant industries, lending some credence to the claim that import competition might indirectly put downward pressure on wages of both skilled and unskilled labor in the domestic market. However, this is a caution that requires further investigation. 29

Conclusions and looking ahead Our preliminary exploratory forays into labor data from 1998-22 suggest that traditional Ricardian analysis still appears to hold well for the Canadian market. The data suggests that export-reliant industries likely to enjoy a wage premium both for unskilled and skilled labor. However, there is no such premium (or discount) for either skilled or unskilled labor in importreliant industries. We find some evidence of an increase in overall income inequality between skilled and unskilled labor. Export orientation, and hence trade seems to play a major role in this increasing inequality. Export oriented industries have a significantly higher and growing premium between skilled and unskilled labor, which will perhaps eventually contribute to an even greater overall income inequality, given the overall reliance of the Canadian economy on exports. We do not however find any evidence to support protectionist arguments against inward trade. Import orientation does not seem to affect either skilled or unskilled wages; or the ratio of these wages over time. Therefore, there does not appear to be any preliminary justification for the fear that growth in skilled labor endowments in foreign markets might lead to downward pressure on Canadian wages through imports. We again caution that we have simply presented descriptive evidence on the pattern of skilled and unskilled wages in Canada over 1998-22. A more comprehensive understanding of these patterns will emerge with fine-grained multivariate analysis, which is what we will undertake in the next phase of this research. We hope to have these results in the very near future, and suggest that our understanding of the impact of trade on income and income distribution will be enhanced from such analysis. References Baldwin, J.R and J. Johnson, The Defining Characteristics of Entrants in Science-Based Industries. Catalogue No. 88-17-XIE, Statistics Canada Berman, Bound, and Grilliches, Changes In The Demand For Skilled Labor Within US Manufacturing: Evidence From The Annual Survey Of Manufactures, Quarterly Journal of Economics, May 1994, 367-397. Borjas, G., R. Freeman and L. Katz, On the Labour Market Effects of Immigration and Trade, in Borjas, G. and R. Freeman (eds.), Immigration and the Work Force, 1991. Chicago: The University of Chicago Press Cline, William, Trade and Income Distribution. Institute for International Economics, 1997. Feenstra, R. and G Hanson, Foreign Direct Investment and Relative Wages: Evidence from Mexico s Maquiladoras, Journal of International Economics, Vol. 42. 1997, 371-392 Johnson, H., Economic Expansion and International Trade. Manchester School of Economic and Social Studies 23, 19, 9-112. 21

Katz, L. and K. Murphy, Changes in Relative Wages, 1963-1987: Supply and Demand Factors, Quarterly Journal of Economics 17, 1992, 3-78. Lee, F and H. Has, A Quantitative Assessment of High-Knowledge Industries versus Low- Knowledge Intensive Industries, in P. Howitt (ed.), The Implications of Knowledge-Based Growth for Micro-Economic Policies. Industry Canada Series, Vol 6. 1996. University of Calgary Press. Morissette, R, Y. Ostrovsky and G. Picot, Relative Wage Patterns among the Highly Educated in a Knowledge-based Economy, Research Paper No. 11F19MIE, Analytical Studies Branch, Statistics Canada, 24. Murphy, K. and F. Welch, The Role of International Trade in Wage Differentials, in Koster, M. (ed.), Workers and Their Wages: Changing Patterns in the United States, 1991, AEI Press Price Waterhouse Coopers Canada. A Fine Balance: The Impact Of Offshore IT Services On Canada's IT Landscape, 24. Robbins, D, Malaysian Wage Structure and its Causes, Harvard Institute for International Development, 1994. Robbins, D and T. Zveglich, Skill bias in Recent Taiwanese Growth, Harvard Institute for International Development. 199. Samuelson, P., Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists supporting Globalization, Journal of Economic Perspectives, 18(3), 24, 13-146. Wood, A, Openness and Wage Inequalities in Developing Countries: The Latin American Challenge to East Asian Conventional Wisdom, World Bank Research Observer, 1997, 33-7. Zakhilwal, O, The impact of International Trade on Wages of Canadians, Research Paper No. 11F19MPE No. 16, Family and Labor Studies, Statistics Canada. 211