West rich because Third World poor?

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    Hi everyone,
    As you know a  lot of western companies are producing their products in Third World countries like Taiwan, Bangladesh, Cambodia etc. This is mainly due to to the cheap labor available there. As a consequence we enjoy rather low prices.
    Is our succes then to a large degree based on the poverty of these countries?
    What happens if these countries become rich and their wages rise? And as these countries become richer, the purchasing power of the people increases as well, putting pressure on prices. Will the prices in the West then skyrocket? 
    These might be weird questions but I can’t get my mind across them.
    Thanks so much!  


    Here’s the way I understand it, I’m sure others can correct me if needed:

    To the extent that the labor in third world countries are acquired voluntarily, then those workers are choosing to work in factories because it is their best option. Whatever they receive in compensation, they perceive it to be worth more than their labor.

    Now, to the extent that the country imposes legal tender laws, central banking, or a currency peg (for example, China, Philippines), those wages the workers earn are devalued as fast as the US can print. This is why we’ve been able to export so much inflation, which keeps some third-world countries poor despite having produced so much for us. If these countries had free economies, the dollar would become worthless in those countries because there would be excess dollars relative to real goods, and the price of labor (in dollars) would go up which would collapse the trade deficit.


    People trade when there is a difference in value. Whether a consumer good, producer good, or money a difference in the value of something will result in trade away from lower-valued and toward higher-valued uses. As the good is arbitraged in this way its price will tend to become uniform.

    If bread prices are lower in the countryside and higher in the city, then sellers will shift supply to the city and buyers will shift demand to the countryside. The price will fall in the city and rise in the countryside until no additional advantage exists in such arbitrage.

    If wages are lower in one country and higher in another, then sellers of labor (workers) will move supply from the former to the later and buyers of labor (capitalist-entrepreneurs) will move demand from the later to the former. Wages will come together until no advantage exits in further arbitrage. Everyone benefits from the greater production of consumer goods made possible by the further extension of the division of labor. The greater production of goods will push their prices down generally, given no change in the money relation.


    Thanks for the answers. 
    Dr. Herbener, you say that over time the wages in the two different countries (mentioned in your example) come together and there ceases to be an advantage in further arbitrage. Accordingly, Americans would receive the same salary here as a factory worker in Vietnam for the same job. Is that correct? 

    I think a lot of Americans oppose outsourcing of production because they think they’d receive a higher wage than factory workers abroad, doing the same job. 

    But if that’s not the case, then the outrage about outsourcing is completely wrong. I think Americans would not accept factory jobs at such a low salary. Moreover, minimum wage laws and other regulations prohibit such work conditions and the low wage. 
    What are your thoughts about all that?

    Or, are the wages  really that much lower in foreign countries for the exact same job? In that case, I can at least understand the opposition to outsourcing etc. 

    At a recent discussion with friends, someone asked what would happen if the currently developing countries will be  developed one day and american companies will cease to outsource production (because as a consequence the price of labor increases in these countries). I see it like that: These countries can only prosper if they continue to increase production. Perhaps the cheap labor available now won’t be there in the future. However, this mass of workers with low wages will not be necessary. I imagine that it will be replaced by a smaller number of people (with a higher salary) who are far more efficient.  Hence, if these countries become rich, the world economy benefits. 
    What do you think about that? 


    Wages are determined by the productivity of labor. A worker is paid the Discounted Marginal Revenue Product of his labor, i.e., the present value of the extra revenue his labor adds to a production process. If wages are lower in Vietnam than America it’s because labor productivity is lower there than in America.

    If America established free trade with Vietnam, then American capitalist-entrepreneurs would invest in Vietnam . By raising the productivity of Vietnamese labor, the capital investment would move Vietnam wages up while American wages would not change (assuming no disinvestment in America). The equalization of wages would take time, so in transition American wages would remain higher than Vietnamese wages. The greater production of goods made possible by the capital investment implies that standards of living rise all around.


    Okay thanks Dr Herbener! Can you recommend me any books that deal with international trade, capital investment abroad etc. from an austrian (or free market) perspective?


    Austrians write little about international trade as a separate topic because we claim that economic laws are universal. Comparative advantage, for example, applies to people within the state Pennsylvania as well as between people in Pennsylvania and Ohio or Pennsylvania and China. And capital investment tends to be allocated to the highest-valued projects wherever they may be located in the world. To investigate such issues, any standard treatise will suffice, like Human Action or Man, Economy, and State.

    International trade, from our perspective, mainly addresses various arrangements of government intervention among different states. One state erects tariff barriers to imports from the territory of another state, for example. Or one state inflates its money stock relative to the money stock of another state. Such analyses tend to appear in articles on Protectionism or International Monetary Systems.

    David Osterfeld is good on development economics, an area in economics that addresses some of the issues you raise. You might consult his book, Prosperity versus Planning. Here’s a sample of his work:



    One element missing in Jeff’s analysis is the impact of minimum wage laws and unions

    Wages in a free market are determined by the productivity of that labor
    Wages in a controlled economy are determined by minimum wage laws and unions.

    Unions can exist in a free market and can perhaps facilitate in the price discovery of the cost of labor. HOWEVER if there are pro union laws on the books that give labor an advantage -ie such as in non right to work states, or regulations that prohibit a company from taking advantage of lower wages in right to work states,the true price of labor is distorted.

    The US/Vietnam example assumes free markets in both countries.

    Minimum wage laws and pro union laws prevent a true valuation of labor in the united states


    Social phenomena are complex. That’s why in economic theorizing we start with Crusoe and build progressively toward situations that capture the features of the circumstances we wish to analyze. The free market is an interim step in the analysis of such circumstances. It is the necessary ground upon which the theory of government intervention rests.

    If the circumstances we wish to explain are the difference in wages for textile workers in Vietnam versus America and how those wages will change over time, then we start with what would happen in the free market. After that we can add the complications of government intervention that are relevant to explain the circumstances we’re interested in.

    An effective, general, minimum wage law in America will make legally unemployable any worker whose productivity is less than the minimum wage. The workers who remain employed still have their wages determined by their DMRP. Depending on the line of production, a worker’s DMRP may be different after the imposition of the minimum wage as capital investment is reallocated away from low wage areas toward high wage areas. Minimum wages do not contradict the market principle of wages being determined by DMRP they simply modify the level of worker productivity.

    Whether or not this wage effect is significant in areas we are studying, like textile workers’ wages, is an empirical question. If a textile worker in America is making $20 an hour and the minimum wage is $7.25, the effect is probably insignificant. But, again, this is an empirical question that one needs to investigate to answer correctly.

    There is also the question of the underground economy. If American entrepreneurs are willing to illegally hire textile workers (and use less capital intensive production processes) at wages below the minimum wage, then the minimum wage would have only minor effects. Every so often a story about such production will appear in the L.A. Times. But, again, this is an empirical question that one needs to investigate.

    The effect of legally privileged unions is different than that of minimum wages. Minimum wages cause unemployment of workers with the lowest productivity. Unions exclude workers in one industry, raising DMRP and wages there, and push workers into non-union industries, lowering DMRP and wages there. If workers in the textile industry are unionized, then it is relevant for our investigation and if they are not unionize, it is largely irrelevant. But, unions do not raise wages generally throughout the economy.

    Unionized labor makes up less than 10 percent of the private labor force in America. It’s likely that their effect on international wages differences is not that great. But, again, one would have to do the empirical work to find out in each industry.

    There are also government restrictions on capital flows, different tax laws, the security of private property, and so on that would have to be considered in a full analysis.


    The size of the underground labor market and what impact the existence of unions or the threat of unions has on labor costs need to be taken into account in determining US labor costs.

    Also the United States’ labor costs extend beyond salaries. Each full time employee has additional expenses employers must bear related to their compensation packages including, health and dental insurance and social security taxes. (some of these are offered to be competitive with unions)

    US employers have to add to their labor costs the cost of complying with state and Federal work place regulations which involve training and sometimes physical alteration of the workspace. We must also average in the costs of lawsuits and fines for non compliance.

    We start with a simple Crusoe example, move towards simple medium of exchange examples and build progressively towards more complex situations that devolve increasingly away from fair exchanges and towards handouts, taxes, plunder and bailouts. The latter examples involve third party interference (by governments and unions) of transactions that are intended to be the result of the free actions between two parties.


    In Economics in One Lesson Henry Hazlitt argues that the impact of unions on the price of labor in greatly exaggerated (and in typical Austrian economics fashion gives no data to back up the claim)

    Hazlitt concedes that labor unions help in the price discovery of the cost of labor.

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