Thursday, August 24, 2017

Who Is Really Benefitting from Freer Trade?

Updated September 2018

With the NAFTA talks dragging on endlessly, a look at why freer trade seems to be so important to the corporate world is key to understanding who gains and who loses in a more open environment.  Obviously, a regular part of Donald Trump's "raging against the machine" is his views on international trade, particularly how the United States comes out as the losing party in many of the trade deals that form part of the move toward globalization.  In actuality, as recent research has shown, there is one clear winner and it might not be particularly surprising when you find out who is the clear winner.

2017 paper by Wolfgang Keller and Willian Olney looks at a comprehensive data set that explains this trend:

As most of us are aware, compensation for the top one percent of earners in the United States has risen at far greater rates than compensation for all other earners, a trend that has led to increasing income inequality.  In fact, the vast majority of the growth in income inequality has been driven by income gains among the top 1 percent of earners.  The authors look at the role of one key factor that may have caused this earnings growth; the growth in exports, particularly the growth in exports that is unrelated to decisions made by company executives and management, that is, globalization.

There is no doubt that globalization increases access to foreign markets; this results in an increase in  sales as well as a reallocation of market share from less productive companies to more productive companies.  That said, over the past two and a half decades, there have been other factors at work that have increased exports, particularly improvements in computing power,  investments in capital goods including automation, improvements in communication and improvements in transportation, all factors that have relatively little to do with who resides in the upper floor corner offices in Corporate America. 

Since there are actually many other factors that could influence both executive compensation and exports, it is important to understand whether one trend creates the other (i.e. are more highly compensated executives more successful at promoting exports?).   As such, the authors looked at data for the years between 1992 and 2015, looking for a causal relationship between export growth and executive compensation.  For the purposes of the study, the authors used a dataset which included total compensation information (i.e. salary, bonuses, non-equity incentives, value from exercised stock options, deferred compensation etcetera) for 44,000 top executives at 3,500 publicly traded U.S. companies.  The data for the top five executives in each company is included in the study and all companies must have data for all of the years in the sample (1992 to 2015).  The trade data, both export and import, is taken from the United States Census Bureau with nominal trade flows converted to real U.S. dollars using the Consumer Price Index.  The two data sets are then merged to create a complete analysis of each firm.  As well, the authors were able to use the data to ascertain insider board relationships, a variable that may indicate whether an executive at a given firm serves on a committee that makes executive compensation decisions at their own firm or at another firm which has an executive serving on the board of their company.  When these data are combined, the dataset included 3,821 executives from 191 firms over 21 years for a total of 19,788 observations.

Now, let's look at the results.  The authors found that four factors had a positive impact on executive compensation:

1.) insider board relationships

2.) firm size

3.) technology

4.) trade 

The authors found that exports are just as important in driving executive compensation as technology, firm size and insider relationships.  Even after controlling for firm characteristics like assets and sales, exports still have a significant positive impact on executive compensation.  In fact, the authors found that a ten percent increase in exports leads to a two to three percent pay increase for executives that work in that industry.

In closing, let's look at a graphic which shows how average executive compensation for the top five executives and exports levels have risen in lockstep over the past 25 years:

Here is a quote from the author's conclusion:

"The results of this paper suggest that globalization is playing a more central role in rising top incomes than previously thought. The importance of globalization in explaining the growth of top incomes is often dismissed using basic comparisons across countries and occupations. Instead we use a comprehensive data set and rigorous empirical analysis to show that globalization has played an important role in the growth of executive compensation.

Identifying why top incomes are increasing so quickly is an important step forward. However, we remain cautious about interpreting these findings as a rational to restrict international trade. Globalization has generated enormous benefits that likely dwarf the distributional consequences highlighted here. In addition, the rapid increase in executive compensation, while startling, seems to be at least partly driven by the increasing difficulty of the job in a global economy. Instead policy makers concerned about these distributional implications, should think more carefully about how to ensure that the gains from trade are more equitably distributed."

At least now you know who is really benefitting from all of those freer trade deals that governments around the world, particularly the United States, are so anxious to make.

1 comment:

  1. Then what is the result of Trump's Fair Trade?