London School of Economics and Political Science Essays in Trade and Labour Markets Joa˜o Paulo Cordeiro de Noronha Pessoa Thesis submitted to the Department of Economics of the London School of Economics for the degree of Doctor of Philosophy, London, May 2015. Declaration IcertifythatthethesisIhavepresentedforexaminationforthePhDdegreeoftheLondon School of Economics and Political Science is solely my own work other than where I have clearly indicated that it is the work of others (in which case the extent of any work carried out jointly by me and any other person is clearly identified in it). The copyright of this thesis rests with the author. Quotation from it is permitted, provided that full acknowledgement is made. This thesis may not be reproduced without my prior written consent. I warrant that this authorisation does not, to the best of my belief, infringe the rights of any third party. I declare that my thesis consists of 39,071 words. Statement of Conjoint Work I confirm that Chapter 2 was jointly co-authored with Francisco JM Costa and Jason Garred and I contributed a minimum of one-third of this work. I confirm that Chapters 3 and 4 were jointly co-authored with John Van Reenen and I contributed a minimum of one-half of this work. Statement of Use of Third Party for Editorial Help I can confirm that Chapter 1 of my thesis was partially copy-edited for conventions of language, spelling and grammar by American Journal Experts. 2 Abstract My thesis studies aspects related to international trade, labour markets and productivity. The first chapter analyses how countries adjust to the rise of China considering that labour markets are imperfect. I provide a theoretical framework to structurally quantify the impact of trade shocks and I find that China’s integration generates overall gains worldwide. However, inlow-techmanufacturingindustriesintheUKandintheUS,which face severe import competition from China, workers’ real wages fall and unemployment rises. The second chapter studies the recent boom in commodities-for-manufactures trade between China and other developing countries. Brazilian census data show that local labour markets more affected by Chinese import competition experienced slower growth inmanufacturingwagesandin-migrationratesbetween2000and2010. However,locations benefitingfromrisingChinesedemandexperiencedhigherwagegrowthandpositiveeffects on job quality. Thethirdchaptersuggestsapossibleexplanationforpoorproductivityafterthe“Great Recession” in the UK: Low growth in the effective capital-labour ratio. This is likely to haveoccurredbecausetherehasbeenafallinrealwagesandincreasesinthecostofcapital due to the financial crisis. After accounting for (simulated) changes in the capital-labour ratio, theevolutionoftotalfactorproductivityappearsmuchmoresimilartoearliersevere recessions and possibly related to underutilised resources. The last chapter shows that there is almost no “net decoupling” (the difference in growth of GDP per hour and average compensation, both deflated by the GDP deflator) over the past 40 years in the UK, although there is evidence of “gross decoupling” (the difference in growth of GDP per hour deflated by the GDP deflator and median wages deflated by a measure of consumer price inflation) in the US and, to a lesser extent, in the UK. 3 Acknowledgments Foremost, I am eternally indebted to my supervisor John Van Reenen for all his immense support throughout the PhD. His motivation, encouragement and knowledge were greater than any supervisee would have hoped for. I am also very grateful to my advisors Emanuel Ornelas and Gianmarco Ottaviano for their valuable help and guidance during all these years. I would like to express my sincere gratitude to Mounir and Caroline Guen. Without their financial support through the LSE Guen Partnership Scholarship this work would have never been accomplished. I thank my friends Andy Feng, Daniel Silva, Daniela Scur, Dimitri Szerman, Frank Pisch, Francisco Costa, Jason Garred, Katalin Szemeredi, Markus Riegler, Oriol Carreras, PedroFranco, PedroSouzaandallmycolleaguesattheproductivityandinnovationgroup at CEP for the fruitful discussions and companionship during the last six years. Lastbutnotleast, Iwouldliketothankmyfamily: Mysisters, MariaClaraandMaria Beatriz, my mother, Cencita, and my grandfather, Jo˜ao Gabriel (in memoriam). I cannot thank them enough for their endless affection, encouragement and emotional support not only during the PhD but throughout my entire life. 4 Contents 1 International Competition and Labor Market Adjustment 13 1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 1.2 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 1.2.1 Set up . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 1.2.2 Steady State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 1.2.3 Implications of the Model . . . . . . . . . . . . . . . . . . . . . . . . 27 1.3 Quantification of the Model . . . . . . . . . . . . . . . . . . . . . . . . . . 29 1.3.1 Structural Estimation . . . . . . . . . . . . . . . . . . . . . . . . . . 29 1.3.2 Counterfactuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 1.4 Micro Implications of the Model . . . . . . . . . . . . . . . . . . . . . . . 50 1.4.1 Empirical Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 1.4.2 Validation of the Results. . . . . . . . . . . . . . . . . . . . . . . . . 54 1.4.3 Empirical Robustness . . . . . . . . . . . . . . . . . . . . . . . . . . 57 1.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Appendices 62 1.A Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 1.B Counterfactuals and Robustness . . . . . . . . . . . . . . . . . . . . . . . 63 1.B.1 Additional Parameters . . . . . . . . . . . . . . . . . . . . . . . . . . 63 1.B.2 Transition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 1.B.3 Labour Movement Across Sectors . . . . . . . . . . . . . . . . . . . . 67 1.B.4 Wage Inequality in the UK . . . . . . . . . . . . . . . . . . . . . . . 69 1.B.5 Counterfactuals Robustness to Changes in Parameters . . . . . . . . 71 1.C Micro Implications of the Model: Data and Results . . . . . . . . . . . . 74 1.C.1 Data Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74 1.C.2 UK Import Exposure to China . . . . . . . . . . . . . . . . . . . . . 74 1.C.3 Summary Statistics. . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 1.C.4 Empirical Robustness . . . . . . . . . . . . . . . . . . . . . . . . . . 78 1.C.5 Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 5 2 Winners and Losers from a Commodities-for-Manufactures Trade Boom 84 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 2.2 Data and empirical strategy . . . . . . . . . . . . . . . . . . . . . . . . . . 89 2.2.1 Data sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 2.2.2 Baseline specification . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 2.2.3 Instrumental variables and robustness checks . . . . . . . . . . . . . 95 2.3 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 2.3.1 Wages and wage inequality . . . . . . . . . . . . . . . . . . . . . . . 100 2.3.2 Migration and employment . . . . . . . . . . . . . . . . . . . . . . . 105 2.3.3 Job quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 2.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 Appendices 112 2.A Additional Figures and Tables . . . . . . . . . . . . . . . . . . . . . . . . 112 3 The UK Productivity and Jobs Puzzle: Does the Answer lie in Wage Flexibility? 117 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 3.2 Some Basic Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 3.3 Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 3.3.1 Flexibility of the Labour Market . . . . . . . . . . . . . . . . . . . . 125 3.3.2 Other Causes of a Fall in the Effective Capital to Labour Ratio . . . 127 3.4 Other Explanations of the Productivity Slowdown . . . . . . . . . . . . . 130 3.4.1 Mismeasurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 3.4.2 Under-utilisation of Resources. . . . . . . . . . . . . . . . . . . . . . 130 3.4.3 Zombies: Misallocation of Capital . . . . . . . . . . . . . . . . . . . 131 3.4.4 Intangible Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 3.4.5 Labour Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 3.5 Putting it All Together . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134 3.6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137 4 Decoupling of Wage Growth and Productivity Growth? Myth and Reality 139 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139 4.2 Decoupling Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141 4.3 Macro Analysis of Decoupling in the UK . . . . . . . . . . . . . . . . . . 143 4.3.1 Data Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 6 4.3.2 Trends in Compensation and Wages . . . . . . . . . . . . . . . . . . 145 4.3.3 Labour Productivity Trends . . . . . . . . . . . . . . . . . . . . . . . 147 4.3.4 Decoupling between Hourly Productivity and Compensation in the UK? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 4.3.5 Weekly and Annual Measures of productivity and wages . . . . . . . 153 4.3.6 Summary on UK Decoupling . . . . . . . . . . . . . . . . . . . . . . 153 4.4 Macro Analysis of Decoupling in the US . . . . . . . . . . . . . . . . . . . 154 4.4.1 Data Sources in the US . . . . . . . . . . . . . . . . . . . . . . . . . 154 4.4.2 Trends in Compensation and Wages in the US . . . . . . . . . . . . 154 4.4.3 Labour Productivity Trends in the US . . . . . . . . . . . . . . . . . 156 4.4.4 Decoupling between Hourly Productivity and Compensation in the US . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157 4.4.5 Deflator Discrepancies . . . . . . . . . . . . . . . . . . . . . . . . . . 161 4.4.6 Annual Measures of Productivity and Wages in the US . . . . . . . 165 4.4.7 Summary on US Decoupling . . . . . . . . . . . . . . . . . . . . . . 165 4.5 Trends in the Labour Share of Income: Evidence from the UK, US and other OECD Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166 4.6 Industry- Level Analysis of Decoupling in the UK . . . . . . . . . . . . . 173 4.6.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 4.6.2 Overall Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174 4.6.3 Changes in the Shares of Sectors . . . . . . . . . . . . . . . . . . . . 174 4.6.4 Changes within Sectors . . . . . . . . . . . . . . . . . . . . . . . . . 177 4.6.5 Summary on industry-specific analysis . . . . . . . . . . . . . . . . . 181 4.7 Research and Policy Implications . . . . . . . . . . . . . . . . . . . . . . . 181 4.7.1 Research Implications . . . . . . . . . . . . . . . . . . . . . . . . . . 181 4.7.2 Policy Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181 4.8 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 Appendices 184 4.A Decoupling Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184 4.B Data Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186 4.C Net Decoupling in Terms of Gross Value Added (GVA) . . . . . . . . . . 188 4.D Decoupling Decomposition Tables . . . . . . . . . . . . . . . . . . . . . . 190 4.E Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191 4.F Labour Income Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196 7 List of Tables 1.1 Estimates of ρ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 1.2 Estimates of ζ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 1.3 Estimates of λ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 1.4 Parameters used in the Counterfactuals . . . . . . . . . . . . . . . . . . . 37 1.5 Employment and Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . 56 1.6 Heterogeneous Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 1.7 Country-Sector Labour Shares (β ) and Expenditure Shares (µ ) . . . 63 k,i k,i 1.8 Country-Sector Productivity Parameters: A . . . . . . . . . . . . . . . 64 k,i 1.9 Industry Employment and Import Exposure. . . . . . . . . . . . . . . . . 75 1.10 Summary Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 1.11 Employment and Earnings: Industry Quotas as IV . . . . . . . . . . . . . 79 1.12 Employment and Earnings: Shift-Share IV . . . . . . . . . . . . . . . . . 80 1.13 Normalised Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 1.14 Firms - Local Units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 2.1 Brazilian microregion-level summary statistics 2000 . . . . . . . . . . . . 94 2.2 Results - log average hourly wages . . . . . . . . . . . . . . . . . . . . . . 101 2.3 Results - Log Average Hourly Wages by Formality and Occupation . . . . 102 2.4 Results - inequality and social assistance . . . . . . . . . . . . . . . . . . 103 2.5 Results - in-migration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 2.6 Results - private sector employment . . . . . . . . . . . . . . . . . . . . . 107 2.7 Results – informality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 2.8 Results – occupational skill level . . . . . . . . . . . . . . . . . . . . . . . 110 2.9 List of sectors and additional summary statistics . . . . . . . . . . . . . . 113 2.10 Results - formal private sector jobs . . . . . . . . . . . . . . . . . . . . . . 115 2.11 Results - informal private sector jobs . . . . . . . . . . . . . . . . . . . . . 116 3.1 Example of Aggregate Productivity Growth Accounting Exercise . . . . . 135 4.1 Non-Wage Compensation Decomposition (millions of GB Pounds) . . . . 151 4.2 Data Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187 8 4.3 Decoupling Decomposition in the UK . . . . . . . . . . . . . . . . . . . . 190 4.4 Decoupling Decomposition in the US . . . . . . . . . . . . . . . . . . . . . 190 9 List of Figures 1.1 World Real Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 1.2 China Real Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 1.3 UK Relative Real Wages per Sector . . . . . . . . . . . . . . . . . . . . . 43 1.4 US Relative Real Wages per Sector . . . . . . . . . . . . . . . . . . . . . . 44 1.5 UK Unemployment per Sector . . . . . . . . . . . . . . . . . . . . . . . . 45 1.6 US Unemployment per Sector . . . . . . . . . . . . . . . . . . . . . . . . . 46 1.7 UK Import Shares from China by Sector . . . . . . . . . . . . . . . . . . 47 1.8 US Import Shares from China by Sector . . . . . . . . . . . . . . . . . . . 48 1.9 UK Relative Labour Force per Sector . . . . . . . . . . . . . . . . . . . . 67 1.10 US Relative Labour Force per Sector . . . . . . . . . . . . . . . . . . . . . 68 1.11 UK Wage Inequality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 1.12 UK Alternative Measure of Wage Inequality. . . . . . . . . . . . . . . . . 70 1.13 Change in parameter: ζ = 31.25 . . . . . . . . . . . . . . . . . . . . . . . 71 1.14 Change in parameter: λ = 6.453 . . . . . . . . . . . . . . . . . . . . . . . 72 1.15 Change in parameter: ρ = 0.0674. . . . . . . . . . . . . . . . . . . . . . . 73 1.16 Changes in industry log Employment against Chinese Import Exposure . 76 2.1 Evolutionoftheshareofagriculturalandextractivesectorsintheexports and imports of non-high-income countries . . . . . . . . . . . . . . . . . . 85 2.2 Evolution of the share of China in the imports and exports of non-high- income countries and Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . 87 2.3 Evolutionoftheshareofagriculturalandextractivesectorsintheexports and imports of Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 2.4 Import supply vs export demand measures . . . . . . . . . . . . . . . . . 93 2.5 Geographical distributions of top quintile of import supply and export demand measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 2.6 Raw measures vs instrumental variables measures . . . . . . . . . . . . . 98 2.7 Distributions of import supply and export demand measures . . . . . . . 112 3.1 Hourly Net Decoupling in the UK: growth in GDP per hour vs. Com- pensation per hour 1972-2012 (1972=1). . . . . . . . . . . . . . . . . . . . 118 10