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The price of globalization

Globalization has brought about a convergence of prosperity between emerging and advanced economies but also a shift in labor and capital costs.

Discussions about globalization often involve the issue of wealth redistribution. Empirical studies conducted on this issue by economist Branko Milanovic1 show middle-class incomes in advanced economies have stagnated since 1988. The middle class in many Asian economies and the upper class in advanced economies, on the other hand, have enjoyed rising incomes. But globalization has also had another effect: a change in the cost ratio between labor and capital. This becomes more evident when looking at the number of hours a U.S. wage earner needs to work to be able to afford an S&P 500 Index basket of shares.2 These hours have been rising sharply since 1995.3 Companies in advanced economies have been among the real winners of globalization. By shifting their production abroad, they have been able to take advantage of the lower wage level in emerging economies. Workers in advanced economies, however, had to learn to be satisfied with low wage increases to keep jobs from wandering abroad.

The flexible labor market is most probably the main reason the United States has been able to avoid any sustained increases in unemployment after periods of crisis or economic downturns. A consequence of this flexibility, however, is that the proportion of non-supervisory employees in the production sector has increased by just under 8 percent since the mid-1960s. It can also be shown that this development is accompanied by a falling wage ratio (ratio of labor income to total income), which in turn means that the growth of labor income (average hourly wages) has not been able to keep pace with the growth of capital income. The moderate development in wages (lower costs) has further led to a significant increase in corporate profits. This again benefited U.S. equities. All of these developments combined have caused a change in the price relationship between labor and capital.

More winners than losers

The study by Branko Milanovic also shows that there have been more winners than losers. However, it suggests the divide between the rich and the poor within countries has widened. At the same time, he concluded that thanks to globalization, the income differential between workers in emerging economies and those in advanced economies has narrowed. Globalization has also brought greater global economic growth, which means a higher standard of living for everyone.

Companies also take a close look at tax rates when deciding where to locate. One result of this has been a decline in tax rates. Whereas the average corporate tax rate on gross earnings in the United States in 1974 was 46%, today it is just above 25%. This decline has also been a boon for the S&P 500 Index.

Since the mid-1990s, the S&P 500 Index has been trading at higher multiples. In the period from 1964 to 1994 – which also marked the beginning of the rise in the hours worked for a basket of shares – the average price-to-earnings (P/E) ratio for the S&P 500 Index4 hovered around 14.4. Since 1995, the average P/E ratio has risen to 25.5. This rise was fueled by the trend in interest rates, which declined as a result of lower inflation prompted by globalization. The result: shares became more attractive relative to bonds, and their P/E ratios climbed.

Redistribution effects are fading

We do, however, see early signs that the effects outlined above are fading. The wage ratio for private-sector-production and non-supervisory employees, which has declined for decades, has been lingering at around 23% since 2010. This is good news for about two thirds of wage earners in the United States. For U.S. shareholders, however, it’s nothing to be enthusiastic about. After all, a rise in the long subdued wage ratio could mean that corporate profits as a percentage of domestic income may fail to rise further.

It would be a mistake to deduce from the above that corporate profits are set to stagnate. Over the long term, it’s not the redistribution of income that boosts profits but productivity gains. The U.S. administration’s deregulation agenda may help speed up productivity increases and further fuel the U.S. stock market. This, combined with a low-interest-rate environment, is one reason in favor of staying invested in the stock market.

Number of working hours for an S&P 500 basket of shares

Over the past 24 years, the S&P 500 basket of shares has become significantly more expensive relative to wages.

Number of work hours for an S&P 500 basket of shares

Source: Thomson Reuters Datastream; as of 3/17/17

Income ratio for U.S. workers

Until 2009, the trend in income for non-supervisory employees declined.

Income ratio for U.S. workers

Source: Thomson Reuters Datastream; as of 3/17/17


1 Branko Milanovic: Global Inequality. Migration, the one percent and the future of the middle class. October 2016


2 Shares included in the S&P 500 Index weighted by market capitalization. The total value of these shares equals the S&P 500 Index and reflects its performance.


3 The price of the S&P 500 Index was compared to the average hourly wage of private-sector production and non-supervisory employees excluding agriculture. The average hourly wage includes employee social security contributions but not those of the employer.


4 Robert Shiller: U.S. Stock Markets 1871-Present and CAPE-Ratio. Online data, Yale University as of 3/17/17

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