[Globalization] Corporate earnings soar as wage growth stalls in Developed World; Wages rising in China

from Fin Facts Ireland

British economist David Ricardo (1772-1823) who purchased a seat in the House of Commons in 1819 as a representative of the Irish town of Portarlington, is renowned for his theory of comparative advantage. Using an example of two nations (Portugal and England) and two commodities (wine and cloth), Ricardo argued that trade would be beneficial even if Portugal held an absolute cost advantage over England in both commodities. Ricardo's case was that there are gains from trade if each nation specialises completely in the production of the good in which it has a "comparative" cost advantage in producing, and then trades with the other nation for the other good.

While most economists and policy makers now accept Ricardo's argument, the merits of globalization and free trade continue to be a focus of controversy in both the developed and developing world.

On Friday last, the Office of the United States Representative published the 2006 National Trade Estimate Report on Foreign Trade Barriers.

The reports says that US goods trade deficit with China was $201.6 billion in 2005, an increase of $40 billion from $161.9 billion in 2004. US goods exports in 2005 were $41.8 billion, up 20 percent from the previous year. Corresponding U.S. imports from China were $243.5 billion, up 24 percent.

China is currently the 4th largest export market for U.S. goods. US exports of private commercial services (i.e., excluding military and government) to China were $7.2 billion in 2004 (latest data available), and U.S. imports were $5.6 billion. Sales of services in China by majority US-owned affiliates were $3.8 billion in 2003 (latest data available), while sales of services in the United States by majority China-owned firms were not available in 2003 ($321 million in 2002).

The stock of US foreign direct investment (FDI) in China in 2004 was $15.4 billion, up from $11.5 billion in 2003. US FDI in China is concentrated largely in the manufacturing, wholesale, and mining sectors.

Stephen King, Chief Economist of HSBC Bank says that: “Sixty per cent of China's exports and imports are today accounted for by so-called foreign-invested companies. Ironically, then, America's unease about China is, indirectly, the result of actions by American companies in China. Should the protectionist faction in Congress ever manage to impose tariffs on China, they would be very much shooting themselves in the foot: tariffs on Chinese imports into the US would be tariffs on the profits and economic success of American companies operating in China.”

Protectionism has been on the rise in recent times in both Europe and the US. Politicians seek to protect their national companies but some of them appear to be oblivious to the emerging realities of globalisation.

Corporate earnings growth outweighs wage growth

Corporate earnings have soared in recent years. Data issued by the US Bureau of Economic Analysis on March 30, 2006, showed that from 2001 to the fourth quarter of 2005, corporate profits as a percentage of United States GDP. rose to 11.6 percent from about 7 percent.

In the past two years, the earnings per share of big listed companies have risen by over 100% in Germany, 50% in France, 70% in Japan and 35% in America.

In the US, big companies are flush with cash. Share buybacks have soared. Repurchases by companies whose shares comprise the Standard & Poor's 500 Index jumped to a record $349 billion in 2005, S&P says, up from $197 billion the year before.

Meanwhile, the rise of China and the acceleration of globalisation has depressed wage growth. Median incomes of American workers have only marginally risen since 2000, while corporate profits have nearly doubled. In Germany, wages have fallen in real terms in the last two years.

"All in all, the widespread prosperity of companies does not lead to prosperity for domestic economies or wage earners in Germany, France or Japan," wrote Patrick Artus, chief economist of IXIS, the Paris investment bank, in a report that was published last November.

The Washington D.C. based Economic Policy Institute (EPI), in an analysis of the Bureau of Economic Analysis March 2006 data, says that in the fourth quarter of 2005 corporate profits claimed the largest share of gross domestic income (GDI) in 37 years.1 The last time profits claimed this large a share of GDI was in the 4th quarter of 1968.

The EPI says that within the corporate sector, where all income is classified as accruing to either capital (profits plus net interest) or labor (wages plus benefits), the picture is even starker: labour's share of corporate income has fallen by 5.6 percentage points, and capital income's share rose by the same amount. Corporate profits' share rose by 7.8 percentage points, while net interest payments shrank by 2.2 percentage points. This rise in corporate profits' share is, by far, the largest that has occurred 19 quarters after a business cycle peak since World War II, and it is about eight times as large as the average shift that has characterized previous recoveries. If these shares had remained constant, labour incomes as an aggregate would be $346 billion higher today.

The EPI says that while productivity growth has been strong during the current recovery (averaging annual growth of 3.5%), the fruits of this growth have disproportionately flowed to profits instead of wages and benefits. This strong productivity growth provides the potential to generate broad-based increases in American living standards, but, so far corporate profits have been the only clear winner.

Globalization trend within big companies

Stephen King of HSBC says that "it's increasingly difficult to argue that companies themselves are attached to a country." He notes, for example, that Vodafone, the giant UK telecommunications company, has more than 80 percent of its sales and employment outside of Britain. And as of 2002, King found, that the 50 largest multinational companies had 55 percent of their employees and 59 percent of their sales outside of their home countries.

Patrick Artus of IXIS found that for the members of the German index, the DAX 30, about 53 percent of employment and 34 percent of sales were in Germany; for the companies in the CAC 40, the French index, 43 percent of employees and 35.5 percent of sales were in France.

The trend is not as strong in the United States. Standard & Poor's estimates that the companies in the S.& P. 500 derive about 60 percent of their sales at home, according to Alec Young, equity market strategist at S.& P. However, for some of the largest companies, like McDonald's, the domestic market counts for only one-third of revenue.

In Dell Computer's most recent quarter, foreign sales amounted to 43 percent of total revenue, up from 40 percent in the previous quarter.

Global Integration

An IMF 1997 paper says that the share of imports and exports in overall output provides a ready measure of the extent of the globalization of goods markets. Although foreign goods are available in every country now more than ever before, the expansion of product market integration has not been continuous over time. World trade in relation to output grew from the mid-1800s to 1913, fell from 1913 to 1950 because of the two world wars and protectionist policies implemented during the Great Depression of the 1930s, and then burgeoned after 1950. Only in the 1970s, however, did trade flows reach the same proportion of output as at the turn of the century, a result of the easing of tariffs and quotas, more efficient communications, and falling transportation costs.

For many advanced economies the most important decade for globalization since World War II was the 1970s, when the ratio of trade to output rose markedly in both advanced and developing economies in the wake of the two oil shocks. In the developing countries, exposure to international trade picked up again in the late 1980s, coinciding with their movement toward trade liberalization.
Labour Market Developments

The IMF paper says that an important trend in labour markets in the advanced economies has been a steady shift in demand away from the less skilled toward the more skilled. This is the case however skills are defined, whether in terms of education, experience, or job classification. This trend has produced dramatic rises in wage and income inequality between the more and the less skilled in some countries, as well as unemployment among the less skilled in other countries.

In the United States, for example, wages of less-skilled workers have fallen steeply since the late 1970s relative to those of the more skilled. Between 1979 and 1988 the average wage of a college graduate relative to the average wage of a high school graduate rose by 20 percent and the average weekly earnings of males in their forties to average weekly earnings of males in their twenties rose by 25 percent. This growing inequality reverses a trend of previous decades (by some estimates going back as far as the 1910s) toward greater income equality between the more skilled and the less skilled. At the same time, the average real wage in the United States (that is, the average wage adjusted for inflation) has grown only slowly since the early 1970s and the real wage for unskilled workers has actually fallen. It has been estimated that male high school dropouts have suffered a 20 percent decline in real wages since the early 1970s.

In other countries, the impact of the demand shift has been on employment rather than on income. Except in the United Kingdom, the changes in wage differentials have generally been much less marked than in the United States. Countries with smaller increases in wage inequality suffered instead from higher rates of unemployment for less-skilled workers.

"Fair Trade for All"

In their recently published book, Fair Trade for All, Joseph E. Stiglitz, a professor of economics at Columbia, and Andrew Charlton, a research officer at the London School of Economics, argue that the poorer nations should move toward free trade gradually, each according to its own particular circumstances. The authors urge richer nations to help poorer ones prepare themselves for trade, while dismantling their own trade barriers, which prevent developing nations from selling them many goods and services.

The authors say, trade by itself can do more harm than good. They point out that inequality increased after trade was liberalised in Argentina, Chile, Colombia, Costa Rica and Uruguay. Ten years after the North American Free Trade Agreement went into effect, Mexico's real wages are lower than they were before, and both inequality and poverty have grown. Many of the manufacturing jobs that came to Mexico in the wake of Nafta have since been lost to China, partly because China invested heavily in education and infrastructure while Mexico, lacking tariff revenues, couldn't afford to do so. According to Stiglitz and Charlton, every developing country that has succeeded in achieving rapid growth has protected its market to some extent until it was ready to dismantle trade barriers. China's growth, for example, escalated in the 1970's, before it lowered its barriers.

In a review ion The New York Times, US labour economist Robert Reich says that while Stiglitz and Charlton nobly assert that trade agreements should be viewed as presumptively unfair if they bestow disproportionate benefits on richer nations, they fail to acknowledge that within richer nations free trade is already disproportionately benefiting the best educated and best connected. The wealthy are growing much wealthier while the middle class is being squeezed. In fact, the adjustment mechanisms the authors find lacking in most developing economies — good public schools, modern infrastructure and adequate social safety nets — are coming to be less and less available even in America. Free trade surely generates the gains Ricardo claimed for it. But until those gains are more widely shared — within richer countries as well as between richer and poorer — we can kiss any further round of trade liberalization goodbye.

Labour shortage in China may lead to Trade Shift

A report in today's New York Times (Apr 3, 2006) says that persistent labor shortages at hundreds of Chinese factories have led experts to conclude that the economy is undergoing a profound change that will ripple through the global market for manufactured goods.

The shortage of workers is pushing up wages and swelling the ranks of the country's middle class, and it could make Chinese-made products less of a bargain worldwide. International manufacturers are already talking about moving factories to lower-cost countries like Vietnam.

"The next great story in China is how they are going to move out of the lower-end stuff: the toys, textiles and sporting goods equipment," Jonathan Anderson, an economist at UBS in Hong Kong is quoted as saying. "They're going to do different things."

The New York Times says that according to government figures, minimum wages — which averaged $58 to $74 a month (not including benefits) in 2004 — have climbed about 25 percent over the past three years in big cities like Shenzhen, Beijing and Shanghai, mostly by government mandate.

Wages at larger factories operated on behalf of multinationals — which are typically $100 to $200 a month — are also on the rise.

The period of falling prices of manufactured goods such as in consumer electronics, may soon end but the impact of competition from China is likely to continue for many years to come.