What's causing middle-class wage stagnation?

I really don't feel ready to answer this question with any authority - at least, not before I get over 80% on a macroeconomics exam. But as a blogger, I find it interesting to point out other people's answers to the question. And over the past few days, these two really caught my attention. Both of them are alternatives to the traditional view that a glut of cheap labor from China is to blame for falling wages.

The first was this article by Jagdish Bhagwati in the Financial Times. The title: "Technology, not globalization, driving wages down." Here's a few quick excerpts:

Examine the common arguments linking globalization to [rising inequality] and little survives.

First, all empirical studies, including those done by some of today’s top trade economists (such as Paul Krugman of Princeton and Robert Feenstra of the University of California, Davis), show that the adverse effect of trade on wages is not substantial...

Second, the same goes for the econometric studies by the best labor economists regarding the effects of the influx of unskilled illegal immigrants into the US. The latest study by George Borjas and Larry Katz of Harvard also shows a virtually negligible impact on workers’ wages, once necessary adjustments are made...

The culprit is not globalization but labor-saving technical change that puts pressure on the wages of the unskilled. Technical change prompts continual economies in the use of unskilled labor...There are assembly lines today, but they are without workers; they are managed by computers in a glass cage above, with highly skilled engineers in charge.

[The] process [of technological change] is continuous now—unlike discrete changes caused by past inventions such as the steam engine...The pressure on wages becomes relentless...[T]his technical change, which proceeds like a tsunami, has nothing to do with globalization. (emphasis mine)

On its face, this seems plausible enough. Better technology makes workers semi-obsolete, which keeps their wages down. Continuous improvements in technology are doing this now.

But wait!, you say. Doesn't better technology mean higher productivity, and higher productivity means higher wages? Well, that's higher marginal productivity, not higher total productivity. If I get a new machine that lets me make the same amount of product with 10 employees instead of 100, I'm going to lay off 90 (or thereabouts), and pay the remaining 10 a lot more than before - that, or pay the 90 a lot less money.

So Bhagwati's argument seems to make sense. But is history on his side? I don't think so. After all, when was the pace of technological change faster or more continuous than in the 1990s? And were't wages rising then (even as Mexican immigration boomed, I might add)? One of the reasons people look to China as the culprit in America's middle-class stagnation is that wages started flattening right around the same time our trade with China started booming.

Which brings me to the second, and even more interesting, article. Bhagwati's was plastered all over the Financial Times and the Council on Foreign Relations website (not to mention Brad DeLong's blog), but this next one, by China specialist Brad Sester, was buried deep in his blog and didn't get any press. Too bad, because it's the more interesting and original of the two.

Here's the post. The basic idea is that China's habit of subsidizing its exports through an undervalued exchange rate is widening the income gap here in the U.S. - pushing down wages for everyone except people who move around big amounts of money.

The Sester post is a bit denser than the Bhagwati article, but I still suggest reading it, even if you don't get all the economics (and I sure don't). But I'll try to summarize the argument.

China's government, by keeping the yuan undervalued relative to the dollar, floods our markets with cheap goods. This means American manufacturers have to move factories to China, or hold down wages here in the US. That holds down wages for service-industry people too, through the "multiplier effect."

But trade is a two-way street - so what do the Chinese buy from us when we buy their artificially cheap goods? The answer is, they buy our government bonds and other financial assets. That means lots of money for the people who package and sell those financial assets - Wall Street types. It also means that the interest rate on those bonds goes down, so mutual funds, hedge funds, etc. sell those bonds (to China) and buy other assets - for example, stock options held by CEOs. More fees for finance people to collect, more boosts to anyone with big money in the stock market.

So, China is distorting the market, not through its natural advantages, but through its government policies. They're changing the shape of our economy - taking money from our workers and giving it to our stockholders. The net result, as Sester puts it, is this:

"Over time, the US economy has become increasingly specialized in the production and sale of financial assets to the [People's Bank of China]."

That is a frightening sentence.

Sester sums it up nicely:

The key point is simple: China and others emerging market governments haven’t just subsidized the consumers of their goods. They also have subsidized those manufacturing financial assets -- the have-mores of the global economy.

As I said, I don't know enough economics (especially finance) to evaluate whether this explanation is right. Ask me in a year or three. But this certainly doesn't seem as obviously suspect as Bhagwati's technology-based explanation. China's massive trade distortion is something on a scale we've never really dealt with before; there's really no historical precedent.

Either way, middle-class wage stagnation is a problem we're going to have to address. But before we go trying to restructure our labor system, or - God forbid - slow down technological change, let's make China float their exchange rate, and see if that works.


Bonus Reading Guide
It helps to keep all this economics stuff in perspective by remembering that politics is still always #1. What the economy takes decades to build, fascist politicians can destroy in a heartbeat (just ask Venezuela and Russia). Which is why our number one goal is still to get Bush, and all Bushists, permanently out of office as soon as possible. If you're not yet convinced of that truth, just read this article by Dahlia Lithwick. It makes a clear-cut case that Bush's main goal is to turn the Presidency into a dictatorship.