THE GLOBAL CAPITAL MARKET: Fiscal Autonomy and Income Distribution 4
If tax competition nonetheless emerged as a threat to social cohesion or to free trade, formal international tax coordination might begin to appear attractive, despite the daunting difficulties in reaching a deal geographically comprehensive enough to be effective.
Debate on the changing distribution of United States wages and rising European unemployment has focused on imports from low-wage countries (as discussed in Feenstra’s contribution to this symposium). In principle, however, capital movements and commodity imports can have identical effects on wages, as shown in a classic analysis by Mundell (1957), which raises the possibility that the global capital market, in addition to hindering governments’ provision of social insurance, might increase inequality and raise the need for those same insurance services.
The Mundell (1957) story works as follows. According to the usual Heckscher-Ohlin reasoning, increased trade between high-wage United States and low-wage Mexico has a depressing effect on the wages of low-skilled American workers, who must find new jobs in sectors that previously had employed relatively few of them. Consider the effects, however, when a General Motors plant moves south of the border to avail itself of cheaper Mexican labor. Since there is now less capital in the United States relative to the supply of workers, wages will need to fall to restore full employment in the United States, while wages will rise in Mexico. Bottom line: low-wage Americans are threatened both by importing the goods low-wage foreign workers produce, and also by equipping foreign workers with exported U.S. capital.