World Development, Vol. 16, No. 8, pp. 9OS912, 1988. 0305-75OW88 $3.00 + 0.00 Printed in Great Britain. 0 1988 Pergamon Press plc

Dual Factor Price Equalization: Elements of a Theory

GARY McMAHON Laurentian University, Sudbury, Ontario

Summary. - The article hypothesizes that, despite wide differences in wages and incomes between the developed and the developing countries, world-wide factor price equalization is taking place once the factors of production are correctly identified. In particular, the developed country’s counterparts to the informal sector workers in a developing country are its low-skilled service sector workers and unemployed. Factor price equalization is largely taking place by the creation of dual economies in the developed countries rather than by their eradication in the developing countries. While institutional forces are slowing down this equilibrating process, strong economic and political forces (such as so-called Thatcherism and Reaganomics) are threatening these same institutions. Some preliminary evidence is given in favor of the theory.

1. INTRODUCTION

According to the Heckscher-Olin theorem

(H-O), when two countries engage in inter- national trade each will export the product which uses intensively the factor of production with which it is relatively abundantly endowed. That is, if more labor-intensive methods are used to produce X than to produce Y, and country A has relatively more labor than country B, A will export X to B and import Y from B. In addition, the factor price equalization theorem (FPE) says that over time there will be a tendency for the re- turns on the factors of production in countries A and B to receive the same reward. That is, wA= tvB and rA=rB, where w is the return to labor and r is the return to capital. These results depend upon a number of assumptions, amongst which are: (i) markets are perfectly competitive; (ii) the two factors, capital and labor, are internally per- fectly mobile but externally immobile; and (iii) the technologies which A and B have access to are equivalent.’ (Note that if the factors of pro- duction were externally perfectly mobile then, given competitive markets, their returns would have to be the same in A and B.)

In the 195Os, beginning with the work of Leon- tief (1953; 19.56), the validity of H-O was ques- tioned. For example, he found that the United States imported goods which were more capital- intensive than the ones they exported, contrary to the prevailing view on the American factor en- dowments of that time. Over the subsequent 20

years, however, it was demonstrated that the problem with Leontief’s test was that it did not include enough factors. If H-O was modified to include human capital, along with physical capi- tal and unskilled labor, American exports were capital-intensive, i.e. human capital-intensive.2 Thus, the Leontief “paradox” was resolved.

The validity of FPE has not been such a con- tentious issue as almost all observers would agree that the prices of internationally immobile factors in many countries which have been involved in international trade for decades have had little or no tendency to converge. However, the same observers would probably also agree that this lack of convergence is not due to any fault with the theorem itself, but is due to the fact that many of the assumptions necessary for factor price equalization to take place are not valid in the real world. If these assumptions were re- alized, then FPE would be the order of the day.3

Perhaps the most questionable assumption when discussing FPE is the third one listed above - that countries have access to the same tech- nologies. While in the fairly recent past it seems unlikely that India and the United States, for example, had such access, in this age of multi- national corporations (MNCs) and highly mobile capital, the reverse is true. If MNCs locate wherever they will make the greatest profits, it is likely that India has access to the same tech- nology as the United States, even if, due to dif- ferential factor rewards, the technology in place is different. (Note also that the mobility of

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physical capital and the subsequent equalization of its return internationally has made the job of FPE easier: all that we have to be concerned with now is the return to labor.)

Does the removal of this objection suggest that we can make a serious case for the dismissal of FPE? The answer to this question must be nega- tive as there may be other assumptions which are not met, especially the one of competitive mar- kets. More importantly, we wish to suggest that FPE, like H-O, is taking place amongst the diverse trading nations of the world once factors and their return are properly identified. We call this a dual factor price equalization as it is first necessary to divide societies up into their dual sectors - a practice very common in the de- velopment literature but not so common else- where. Then we shall attempt to give preliminary evidence that the return to labor in the corres- ponding sectors of countries as diverse as the United States and India has had a tendency to converge and this tendency has become stronger in the past decade.

The outline of the paper is as follows: Section 2 describes the main features of present-day coun- tries, developed or developing, and the inter- national economic order which are essential to our results. Section 3 outlines the main elements of a model which is then used to describe both the method by which a less developed country (LDC) becomes industrialized and how the re- turn to human capital becomes equalized across countries. Section 4 continues the discussion of Section 3, focusing on a third factor of produc- tion, labor which is “unskilled,” in a way to be defined below. Section 5 is a preliminary attempt to verify empirically the processes sketched in Sections 3 and 4. Conclusions, reservations, and possible future research are considered in the last section.

2. PRESENT-DAY ECONOMIC SITUATION

It is our contention that FPE does exist once the factors in different countries which should have a tendency towards similar rewards are cor- rectly identified. Although the absence of some of the other assumptions of the classical FPE theorem - especially the lack of competitive markets - may have slowed down or distorted this convergence, the basic process is taking place. Before we attempt to demonstrate this re- sult, however, it is necessary to remark on three very significant developments in various econ- omies since the end of World War II. While these developments are all common knowledge, much of the argument to follow hinges upon them.

The first is the existence of MNCs. As noted above, the very high level of international capital mobility attached to this development has re- sulted in both an approximate equalization to the price this factor receives across countries and the transfer of technology from developed countries (DCs) to LDCs.

The second development is the widespread phenomenon of dual economies; that is, coun- tries which have two very diverse sectors, one of which is mostly engaged in traditional productive activities while the other, smaller segment has been modernized and employs much more capital-intensive production techniques.4 The existence of dual economies suggests that when we compare US and Indian wage rates, for ex- ample, it is the wages paid to the workers in the modern enclave which are relevant. Then we must decide what to do with the masses in the traditional sector. In the development theories of the 1950s and 1960s these traditional or rural workers would slowly but surely be drawn into the modern sector in much the same way as they were in the present-day OECD countries.5 With few exceptions, this movement has not trans- pired. In most LDCs 60% to 80% of the people are still in the traditional sector. In 1982 indust- rial jobs accounted for about 15% of LDC em- ployment on average.’ In the next two sections we shall try to show why this occurred and, more importantly for the purposes of this essay, who are the counterparts in the DCs to the rural masses in the LDCs.

The third major development has been the growth of the welfare state in the OECD coun- tries. In the term “welfare state” we include the existence of both various transfer payments and a large government employer. In the rest of the essay one of the major arguments will be that it is the welfare state which has been most respon- sible for preventing or slowing down FPE.

3. ELEMENTS OF THE MODEL AND ITS EVOLUTION

In this and the following section the elements of the model and its evolution over time are pre- sented. While this part concentrates on the indus- trialization process and the return to human capi- tal, the emphasis of the next part is on the return to “unskilled” labor. For the most part we shall be concentrating on the theoretical aspects in both of these sections, waiting, with the excep- tion of some footnotes, until Section 5 to present data which we hope will support our hypotheses.

Assume that there are two countries, the LDC and the DC.’ There are two goods or bundles of

DUAL FACTOR PRICE EQUALIZATION vos

goods, X and Y, and three factors of production, unskilled labor, skilled labor, and (physical) capi- tal. X is produced with relatively more unskilled labor and relatively less skilled labor and capital than Y. (X can be thought of as a bundle of tradi- tional goods and Y as a bundle of relatively high technology goods.) There are no factor-intensity reversals.

The story begins with the DC having an ad- vanced economy with a large capital stock and a skilled, largely employed labor force which enjoys a high standard of living. The LDC has a very small capital stock and a very large labor force, most of which is employed in X- production, is subject to a large amount of dis- guised and open unemployment, and has a low standard of living. However, there are pockets (or enclaves as they are commonly called) in which Y is produced and the standard of living is somewhere between that of the LDC and DC. The trade pattern has the LDC exporting X and importing Y.

As time proceeds, two important and, in some ways, contradictory events occur. The MNCs take advantage of the cheap labor in the LDCs and move some of their production to these countries, either in whole or by subcontracting the more labor-intensive portions of the produc- tion process. At the same time the technology used in Y-production moves ahead, becoming more and more intensive in human and physical capital. While from the world perspective there are fewer manufacturing jobs (proportional to population), there are actually more of them in the LDC while the DC loses on both counts.’

At first the displaced workers enter the service sector,” but as there is a natural limit to growth in this area and it is far from safe from new labor- saving technology, eventually unemployment occurs.10 It must be stressed that this unem- ployment is in addition to the types which are commonly called frictional and cyclical un- employment. It is also misleading to call it struc- tural unemployment if the implication of that term is that the problem will be rectified once wages and prices adjust and new skills are acquired. It will be argued below that neither of these phenomena is likely to occur.

As unemployment grows both unions and the government in the DC will be under pressure to save jobs. The unions will likely respond by re- sisting the companies’ desires to take advantage of the newest, most efficient methods. In that case there will eventually be an even greater loss of jobs as: (i) the country becomes uncompetitive internationally, such as has happened in the United Kingdom; and (ii) the MNCs transfer production to the LDC.

In its attempt to keep up the accepted standard of living, the DC government will increase the total amount of transfer payments and, more im- portantly, create increasing numbers of govern- ment jobs which do not produce physical goods. With the increase in taxes needed to support this growing sector of the economy, there is an addi- tional incentive for the MNCs to direct their new investment towards the LDC,” and the un- employment problem for the DC is exacerbated.

However, from a material point of view the situation is far from being serious in the DC. As it is still the center of almost all new research, the comparative advantage is constantly turning to- wards the DC due to its rapid technological advance.12 In fact, the DC finds itself at the stage where the same amount of physical goods (or even an increasing amount) can be produced by a work force which is declining in size at a speed unknown historically. As the living standard will be reasonably comfortable if the distribution of goods is not too inequitable, the problem facing the government and society is what is to be done with the redundant workers.13

The LDC, on the other hand, is delighted to accept the technology, however inappropriate it may be to local circumstances, as, like a hungry dog, it will take any bones thrown its way.” In the LDC you will now have a small but growing class associated with Y-production. The members of this group will acquire skills either before entering the industrial labor force, on the job, or most likely, from both formal or informal edu- cation and on the job. In any case they will move from the unskilled labor force to the skilled labor force, and, presumably, will be paid significantly higher wages in compensation for their human capital. Though there are limits to the growth of this class (due to the capital intensity of Y- production), there usually exists a large number of people who have attained the necessary skills but cannot get into the sector. In an article on segmented labor markets in LDCs, Mazumdar (1983) states:

Furthermore, since the number of jobs in the high wage sector is limited, many urban job seekers with skills or human capital endowments similar to those employed in the sector have only limited opportu- nities of getting into it.”

In other words, many people who have skills remain part of the “unskilled” labor force (which is why we are hesitant to use this somewhat pejorative term).

As time passes, the sector producing Yin the LDC takes on the appearance of the correspond- ing sector in the DC. Production techniques are similar and the rewards to human capital are

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similar. The MNCs move their operations from one country to another until returns on physical capital are equalized; human capital migrates un- til the returns on it are similar. We have now reached the point where FPE has taken place in the spheres of both physical and human capital. In the next part we look at the process by which FPE comes about in the market for unskilled labor.

4. UNSKILLED LABOR

Before we begin this section let us note that in- cluded in unskilled labor arc both those persons without any significant skills and those who are unable to use their skills at the moment or-in the foreseeable future (causing them to atrophy). Also. in contrast to the markets for human and non-human capital where FPE has by and large been completed, it is our belief that the tendency towards FPE in the market for unskilled labor has only begun in the last five to 10 years. While we shall try to hypothesize on how this equaliz- ation will come about in the future, we believe it will be a long process lasting for several generations. Consequently, the data given in Section 5 will not be conclusive but will, in our opinion, indicate a very pervasive and, perhaps. irreversible trend.

With regard to FPE of unskilled labor, it is use- ful to distinguish between two alternatives. The first we shall refer to as the optimistic solution, while the second will be called the pessimistic solution.

In the optimistic scenario the Y-producers in the DC are quite willing to share the fruits of their endeavors with the rest of the society. As long as per capita GNP is remaining steady or rising, this group, which is shrinking due to rapid technological change, continues “to sup- port” the rest of the populace, either through transfer payments or by employing them in “non- profitable but useful ventures.”

In the LDC the situation is quite different. The persons associated with Y-production do not feel under any historic compulsion to support their fellow citizens. In addition, this other group is relatively so large - due to both the late entry of the country into the technological age and rapid population growth - that members of the Y- group would have to make a much bigger sacri- fice than their counterparts in the DC. However, as more investment takes place in the LDC, tech- nology improves, and population growth stabi- lizes, one can envisage a situation in which the X-group - whose unemployment rate is rising as goods which formerly were included in the

X-bundle, such as many foodstuffs, become part of the Y-bundle - will fall under the protective blanket of the benevolent welfare state. If this situation arises - which is likely to take several generations - dual FPE has been attained. That is, the laborers in each country have now been divided or segmented into two groups, each of which has a comfortable living standard, and each of which receives an average “wage” equivalent to that of its counterpart.

Let us turn to the pessimistic solution. In this case there is increasing resistance to higher taxes by members of the Y-group in the DC, and, in fact new investment falls as tax rates increase, with production eventually falling (as in supply side economics). Any attempts at increasing taxes are stymied as higher tax rates result in a drop in taxable aggregate income which more than offsets the increased rate. There occur large budget deficits (as in supply side economics) which are ultimately followed by cuts in govern- ment employment and transfer payments as the tax base shrinks. Chronic unemployment he- comes pervasive at the same time as social assis- tance declines. With the erosion of the floor price of unskilled labor, formerly determined by trans- fer payments, the real wage fails. Some of the slack is taken up by service jobs, but these are low skilled and low paying.” (In effect, the econ- omic justification of those not in the Y-group is to cater to the needs of the members of the Y- group.) In addition to the dual economy which has been in existence for some time on the pro- duction side of the economy, there is now a dual economy on the income side. This situation has existed for decades in the LDC and continues to do so.

In this scenario dual FPE has arisen due to the pulling down of the incomes of those persons not in the Y-group in the DC rather than the pulling up of the X-group incomes in the LDC. There has been a Brazilianization of both countries.

5. LONG-RUN FACTOR PRICE EQUALIZATION

In Sections 3 and 4 we made a number of claims, without much evidence, and left out- standing at least one major theoretical issue. The four major propositions put forth were: (i) there has been a movement of manufacturing jobs to LDCs; (ii) the returns to physical and human capital have been approximately equalized throughout the world; (iii) the slack in employ- ment in the developed world has been taken up by governments and low paying service sector jobs; (iv) the resistance to tax increases by mem-

DUAL FACTOR PRICE EQUALIZATION 907

bers of the manufacturing (or technologically advanced) sector has made it more difficult for governments of developed countries to maintain the status quo with respect to income distribu- tion. Consequently, the members of the labor force who are not directly or indirectly involved with high technology production have seen their wage and transfer incomes decline over the past 10 years, a trend which is the beginning of along- run tendency towards factor price equalization.

Before the evidence on these issues is pre- sented, it is necessary to look at the outstanding important theoretical issue. That is, why have not wages adjusted so as to clear labor markets and, more important, so as to reduce the differential between the skilled and unskilled labor forces (given that many of the unskilled were or could easily have been qualified to work in skilled jobs)?

As the question we have posed above has been at the heart of research in macroeconomics for at least the last 15 years, by no means are we about to give a definitive answer. Nor are we about to survey the literature on the issue, a task beyond the scope of this paper. Instead, our much more modest task will be to briefly examine the empiri- cal data, discuss reasons for the existence of that data, and suggest that the trend indicated by this data points towards long-run factor price equal- ization.

While a great deal of the literature in the 1970s emphasized the importance of rapid turnover, temporary layoffs, and search as determinants of unemployment, we believe that, though these effects can possibly explain short-term rises in unemployment and a small portion of long-term unemployment, they are incapable of explaining long-term unemployment.” In their study of the American labor market, Clark and Summers (1979) have shown that the major part of the un- employment rate is due to long-term unemploy- ment (over six months) and it is highly unlikely that these people are involved in some sort of search (which they could not just as easily be do- ing while working at a less desirable job). More- over, only a small percentage of unemployment is due to temporary layoffs.lx Studies of other developed nations have come up with almost the same results.” Two of their findings are worth quoting at length:

Even in 1969, when it was widely believed that all but frictional unemployment was eliminated, the average person measured as unemployed at a point in time experienced 5% months of un- employment.”

The data suggests that the primary effect of a de-

cline in aggregate demand is a sharp increase in the incidence of long-term unemployment. Comparison of the 1969, 1974, and 1975 distributions shows that as unemployment rises, the incidence of short-term unemployment increases only modestly, while longer term unemployment rises precipitously.”

The importance of the work of Clark and Sum- mers was in demonstrating that the unemploy- ment problem is not largely that of a large number of people unemployed for short periods but due to a relatively small number of people being unemployed for long periods. Their work, however, stops short of explaining why the num- ber of hard core unemployed (or the so-called natural rate of unemployment) has been rising so rapidly in the last 15 years. Has the rigid wage be- come even more rigid?

We do not believe it has. While the original rigid wages which existed in the early 1970s were probably largely due to some sort of union power and implicit contracts, we feel that the wage dif- ferentials of the 1980s are not due to rigidities as they are mostly not disequilibrium prices. The key to the problem is the rapid and ongoing tech- nological change. This change has caused larger wage differentials and unemployment for two main reasons. First, it has increased the return to firm-specific skills, with technology-specific skills receiving higher differentials for longer periods of time. Morley (1982) found that despite a rise in the supply of skilled workers in Brazil in the 197Os, the skilled-unskilled wage gap did not fall due to the rise in the return to firm-specific skills. Tan (1982) found that in Japanese industries, the more rapid the technological change, the greater the wage differentials.

Second, technology has now reached a level beyond the learning capabilities of many people. Due to either a lack of innate ability or a lack of educational opportunities as a child, many persons are becoming incapable of learning a marketable skill. In fact, it is likely that the reward to the productivity of a growing propor- tion of the population would be below a subsist- ence level. Therefore, they do not work and have no choice but to remain on welfare of one sort or another. For example, 40% of the jobless in the United Kingdom in 1982 were unskilled. In addi- tion, an unskilled worker had six times the chance of being unemployed as a white collar worker.22 Beeghley (1983) has found a reduction in social mobility as the skill levels demanded by

society increase. The skill level attained, he argues, depends upon the level of education received, which is a function of the parents’ wealth.2’ Lillydahl and Singe11 (1982) show that investment in the education of children is a much

greater source of inequality in the United States of industrial workers of the total labor force from than inheritance transfers. 9% in 1960 to 13% in 1980 in low-income coun-

In the preceding paragraphs the argument is tries and from 1.5% in 1960 to 21% in 1980 in not that rapid technological change has caused middle-income countries suggests that manufac- structural unemployment as this would even- turing jobs as a proportion of the total work force tually be rectified as wages adjust and/or new are at least holding their own. Given their very skills are learned. The argument is that much of high population growth rates, one can conclude the unemployment caused by rapid technological that significant numbers of manufacturing jobs change is unlikely to go away in the foreseeable are being created in LDCS.‘~ future as the necessary wage adjustment would Rates of return on the physical capital of be below a subsistence level. (There is likely to MNCs are notoriously difficult to measure due to be some increase in employment as what is the great incentive for the companies to obscure commonly accepted as a subsistence level drifts them (through such devices as transfer pricing, downwards. Given the availability of very cheap for example). Given the data limitations (and unskilled labor in LDCs, this drift would have to space), we will plead that the return to physical be very large before there were significant em- capital has been approximately equalized world- ployment effects.) Moreover, many of the uneti- wide on the basis of the following argument. ployed lack the ability ever to attain a sufficiently Given the high amount of capital mobility in the remunerative skill. The alternative will be to world in the past three decades. if MNCs act as support the truly unskilled by transfer payments rational profitmakers. returns must have been and give those who have acquired skills a chance approximately equalized. (For example, US- to practice them (before they atrophy) in public based MNCs invested nearly as much overseas employment. as in the United States from 1960 to 198O.27)2x

While there is no doubt that growing unem- The equalization of the return to skilled work- ployment is one of the major problems of our ers can be argued in the same fashion. As skilled times. there has been a great deal of debate on workers, with the exception of the Soviet bloc its causes and remedies. The reasons we have countries, are highly mobile internationally, their sketched above for increasing unemployment return has to be equal. Of course, unlike the and wage differentials point in the direction of machines of the previous paragraph, human (and are partly caused by) dual factor price beings take other considerations into effect be- equalization. Let us now turn to more evidence fore emigrating from their country. Still, as we that we feel lends support to our hypotheses. are speaking of a tendency to converge over a

In note 8 some evidence was given on the loss long time span, we can think of no strong reasons of manufacturing jobs in DCs and their move- why this process is not taking place. ment to LDCs. The growth rate of manufactur- It has already been shown above that there has ing of the industrial countries fell from 5.9% been a net loss of manufacturing jobs in most de- annually from 1960 to 1970 to 2.4% from 1970 to veloped countries in the past 10 years. It was also 1982. While this growth rate also fell in low- shown that not only has there been a large income countries (5.5% to 3.4%) and middle- increase in unemployment, the majority of the income countries (7.3% to 5.5%), the magnitude jobless are long-term or hard core. It was also of the drop was not as large, and by the early indicated that the unemployment situation would 1980s the growth rate in manufacturing in the be much worse if it were not for the increase in more advanced LDCs was 2.5 times that in the govermnent employment and the rapid expan- DCS.‘~ The share of manufacturing in GDP fell sion of low-paying service sector jobs. In fact, from 30% in 1960 to 24% in 1982 in the indust- from 1960 to 1980 the proportions of the work rialized countries, while declining slightly (21% force in the public and service sectors jumped to 20%) in the middle-income countries and from 12% to 18% and 44% to 56%, respectively, rising slightly (13% to 14%) in the low- in the industrialized countries. With respect to income countries. wages in the service sector, in the United States,

While data on the manufacturing labor force for example, the average wage of service sector are less available (and less aggregated), the employees - not including those in retail trades trends have been the same as for manufacturing - was 68% of the manufacturing wage, while production. In the United States, for example, that of workers in retail trades (which is also a the proportion of people working in manufactur- service) was 49% of the manufacturing wage.2Y ,ing fell from 24.7% in 1973 to 20.1% in 1982. The When the large jumps in unemployment of the similar figures for the United Kingdom are past decade are also taken into account,“” one 32.3% and 25.4%.25 For LDCs the Gata are can see a strong trend towards greater inequality. much more spotty, but the rise in the proportion However. this tendencv has been mitigated bv ,

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DUAL FACTOR PRICE EQUALIZATION 909

the expansion (or creation) of the welfare state. From 1972 to 1981 the proportion of GNP which went to taxes in the developed countries rose from 24.6% to 30.1%. Most of this increase un- doubtedly went to pay for the extra public sector employment and towards transfer payments, especially to the unemployed. In fact, the study by Katz, Mahler, and Franz (1983) found that countries which channeled a relatively larger share of domestic production into the public sec- tor had a more egalitarian pattern of post-tax income distribution.

Some results of two other studies are also worth mentioning in this regard. In a study of UK income distribution, Wilson and Wilson (1982) found that in 1979 the ratio of the unadjusted in- come of the top 20% to the bottom 20% was 85:1, while after adjusting for taxes and transfer this ratio became 2.4:1. In a similar study on Sweden, Lindbeck (1983) found that in 1979 the unadjusted ratio of income of the top 1% to the second lowest decile was 112: 1 while the adjusted ratio was 7:l.”

We have seen that there has been a large increase in the unemployed, civil servants, and low-paying service sector jobs in the industrial- ized world in the last 10 to 1.5 years. The first two events have resulted in a rise in tax payments, which has resulted in the well-known taxpayers’ revolts of the 198Os, and undoubtedly, has played a large part in the election of very conservative governments proposing (and attempting to fol- low) policies of the trickle down sort. For the majority of citizens who are still employed in jobs which pay a “comfortable” salary, there had de- veloped a strong resistance to supporting the rest of the nation, a sentiment exacerbated by the fact that most people are never unemployed for any significant length of time. As Gregory (1982,

p. 227) points out:

The narrower the incidence of unemployment the more likely it is that society will generate a wide range of myths and general intolerance towards the unemployed.

Out of such feelings arise the somewhat anomalous result that the majority of skilled union workers in the United Kingdom vote for Thatcher,3z not to mention that there has been a 200% to 400% increase in the number of lazy people in the industrialized world in the past 10 years, if we are to admit the inevitable conclusion of much of popular opinion on the unemployed!

While the unpleasant consequences of tax cuts have been somewhat mitigated bv ranidlv ex- panding (in some cases,- explo&ngj bidget deficits, this situation obviously cannot go on forever. In both the United States and the United

Kingdom there have already been significant cut-backs on social services,33 while in many other industrialized countries there are future plans in the same direction.

Data on income distribution are scarce and prone to many difficulties of interpretation, espe- cially when they are primarily concerned with post-tax and post-transfer distributions. How- ever, before concluding this section it is worth noting that the unadjusted share of income of the top 20% of households in the United States rose from 42.8% in 1972 to 50.3% in 1978.

6. CONCLUSION

In Section 5 it became obvious that we feel that many, if not all, of the developed countries are heading towards our “pessimistic solution.” A situation was described in which there are two very distinct groups of workers within each coun- try. One group works in a sector marked by high physical productivity while the members of the other group use labor-intensive production tech- niques, are unemployed, or work as government employees producing few physical goods. In contrast to the usual FPE where, after the intro- duction of international trade, workers in each country eventually receive the same wage, two classes of workers exist in each country, and there is a tendency for dual FPE in the sense that each country has a dual society and each of the two classes has a tendency to have the same in- come as their counterpart in the other country.

We believe that the theory may help in the understanding of the present world situation, one in which in the developed countries the same quantity of physical goods is being produced by fewer and fewer workers, causing both the size of the service sector and the so-called natural rate of unemployment to increase. In the developing countries the tendency towards dualism is being exacerbated by the technological improvements and the developments in the industrialized world. In both DCs and LDCs there is an alarming ten- dency in recent years for the two groups to be- come increasingly polarized, with governments rising or falling in support of one group or the other. With the use of advanced (and rapidly advancing) technology the trickle down effect be- comes less relevant as essentially there is nothing for other workers to do, except very low produc- tivity jobs. Young people are finding it difficult to enter into the more productive sector as job turnover and creation are very low. In the LDCs they have no other option but low productivity jobs, while in the DCs they historically have turned to the government, but this avenue of

employment is also being blocked off. (In the mean-time skills acquired at school dissipate.) The result is that instead of developing eco- nomies taking on the appearance of developed economies, the reverse is often the case.

Perhaps the most significant consequence of the movement towards dual FPE is the under- mining of the foundations of the welfare state. Implicit in our argument is the idea that the de- velopment of the social and welfare functions of the capitalist state is not an irreversible process, as Szamuely (1980) has suggested.jJ Nobel laureate Ilya Prigogine has shown that the large majority of chemical and physical processes are. in fact, irreversible (see Prigogine and Stengers. 1984). For most things which occur on earth there is no turning back the clock. It is easy to think of many social processes which seem very likely to be irreversible -for example, the aboli- tion of slavery - but we believe that with respect to the welfare state it is still too early to come to

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any conclusions. Both the internal pressures of technological change and the external pressures of factor price equalization may prove this social development to be reversible. In this paper we have attempted to point out some of the leading indicators to be aware of when examining this process.

The essay leaves much work to be done. More explicit evidence on the rate of return to physical capital (including indigenously owned capital in LDCs) and the rate of return to human capital in different countries needs to be gathered. More importantly. the composition and return to the members of the poorer part of the dual society needs to be determined, as well as the mobility between sectors. Income distribution statistics which take into account all aspects of income are also in great need. Verification for much of what we have hypothesized, however, will only bc granted or denied with time.

NOTES

I. For a full exposition of the theorems. see Samucl- son (1949).

2. For an illustration of this result, see Branson and Monoyios (1977).

3. The only paper on testing FPE which this author came across was by Tovias (lYti2). He found that there was a convergence of factor prices in the EEC from 1950 to 1968, but from 196X to 1973 they started to diverge. A major problem with his test was that labor and capital were both at least partially mobile bctwcen countries.

4. The first notable discussion of dual economies was Lewis (1954). Since that date the literature on the topic has been voluminous.

5. See, for example, Lewis (1954) and Fei and Ranis (1961).

6. World Developmenr Report, 1984

7. The LDC can refer to the less developed countries as a group without any serious change in the argument; similarly for the DC.

8. The AFL-CIO estimates that in the United States there was a loss of 400,000 jobs from 1966 to 1969 due to international sourcing. See the Trade Union (‘on- we.ss Economic Rev&s (1972), p. 41.

Appelbaum (1983) estimates that three million in- dustrial jobs were lost in the United States between 1979 and 1982. and she predicts that only one million new jobs will be created in the rapidly expanding high technology industries from 1983 to 1993:

In the 1970s two million jobs wet-e lost in manu- facturing in the United Kingdom. From lY7Y to lYX3 1.3 million manufacturing johs were lost. See Taylor (1982). p. lY8.

Rostow (lYX3) estimates that robots could replace four to eight million industrial workers in the United States by the year 2000.

9. The product of the service sector can be thought of as a non-traded good.

10. Hrilbronner (lY84) points out that historically jobs have moved from the agricultural to the industrial to the service sector. As scrvicc sector jobs are lost to higher technology, he wonders where the people will go. His suggestion is to have them do non-profitable useful tasks.

1 1. If the necessary skilled labor is not available in the LDC, the MNC can usually import the human capital along with the physical capital into its new base of oper- ations.

12. See Griffin (1974) for the importance of bringing the dynamics of time into any discussion of the gains from trade.

13. Rostow (19X3) suggests that they should be used to catch up on the backlog of public works programs. but presumably this source of work will eventually dry up. Heilhronner (1984) has them doing non-profitable. useful tasks. Galbraith (1962) says that we shall just have to support them, though he is taken to task by Schumacher (1973, p. 47), who stresses the importance of work in one’s personal development.

DUAL FACTOR PRICE EQUALIZATION 911

14. There is a vast and growing literature on the in- appropriateness of much of the technology used by the LDCs. See, for example, Stewart (1977).

15. Mazumdar (1983), p. 254. The question as to why the wage in this sector does not fall is the issue which his paper deals with. We will return to this issue in Section 5.

16. In contrast to the 1960s and the first half of the 1970s when most of the new service jobs were good jobs, in the sense that they involved creativity and self- fulfillment, the service jobs being created in the 1980s are bad jobs, such as waiters and maids.

17. See, for example, Phelps (1970), Bailey (1974), and Azariadis (1975).

18. Clark and Summers (1979) estimate that in 1976 between 7 and 13% of US unemployment could be clas- sified as due to temporary layoffs.

19. For evidence on Canada, Australia, and Great Britain, see Hasan and de Broucker (1982), Gregory (1982), and Main (1982), respectively.

20. Clark and Summers (1979), p. 39.

21. Clark and Summers (1979). p. 39.

22. Taylor (1982). p. 11.

23. Beeghley (1983). Chap. 7.

24. All the figures given in this section are from the World Development Report, 1983 and 1984, unless stated otherwise.

25. IL0 Yearbook of Labour Sfatistics, 1970. 1983.

26. Some comparisons are possible using data given in the IL0 Yearbook of Labour Statistics, 1974 and 1983. According to this source, the proportion of the labor force employed in manufacturing from lY7>75 to 198&82 rose marginally or remained the same in Paki- stan, India, Mexico, and the Philippines; rose signifi- cantly in Thailand, Kenya, and Colombia; and rose dramatically in Cameroun and South Korea.

27. Peet (1984)

28. Note that Branson and Monoyios (1977) found no significant tendency for US net exports to be physically capital-intensive. One possible interpretation of this result is that, given the international equalization of the return to physical capital, there should be no significant bias in net exports towards or away from physical capi- tal intensity.

29. U.S. Statistical Abstract, 1984.

30. From 1973 to 1982 unemployment in Australia, Canada, the United Kingdom, the United States, and West Germany rose from 2.3% to 7.1%. 5.6% to 11.0%. 2.6% to 12.2%. 4.9% to 9.7%. and 1.2% to 7.5%, ‘respectively.

31. Another interesting finding of Lindbeck (1983) was that the GINI coefficient for all households was 0.5, while that of full-time employees was 0.17.

32. Taylor (1982), p. 126.

33. For evidence on the United States, see Beeghley (1983), especially Chap. 3. For evidence on the United Kingdom, see Wilson and Wilson (1982).

34. Szamuely believes that except in some backwaters of capitalism (such as Peru) these functions are here to stay.

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912 WORLD DEVELOPMENT

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