By Andrea Mariani
Hans is a construction worker in Berlin who works 40 hours per week and earns a monthly salary of 2000€. Wang is Hans’s Chinese counterpart working in Shanghai; he is also a construction worker and works 40 hours per week. However, unlike Hans, his monthly income is just the equivalent of 400€. Why is Hans’s income 5 times higher than Wang’s for exactly the same job? This is not only the case for construction workers; a similar ‘wage gap’ is frequently observed in a great number of other jobs, from bus drivers and shop assistants to engineers and computer programmers: why are people in poor countries paid significantly less than their counterparts in rich countries? The aim of this article is to provide readers with an intuition as to why this is the case. I will stick to construction workers for the sake of simplicity.
Initially, you may think that the reason why most workers in rich countries are paid much higher than their counterparts in poor countries is because they effectively face a higher cost of living. This seems to make sense: Hans would seriously struggle to survive in a city like Berlin with a monthly income of just 400€ as he would find it extremely difficult to even afford the most basic of his needs; Wang, on the other hand, may live a decent enough life in Shanghai with that exact same amount of money. However, you could argue, with their wage of 2000€ and 400€, Hans and Wang may actually have the same purchasing power and be living equally decent lives in their respective countries, so does this make the wage gap a false construction? No, it does not. The key aspect is that, while there may be little or no difference in their wages relative to their countries’ cost of living, there surely is a significant difference in their wage composition. What does that mean? Generally speaking, there is usually a difference between the amount workers are paid and what they should actually be paid; when comparing workers’ wages between countries, this distinction is often masked by higher costs of living, making it hard to determine what makes a wage what it is. The fact that most people in rich countries are paid more than they should be implies that we simply cannot look at cost of living as the only cause of the wage gap.
One may then observe what economists call ‘human capital’ as a possible explanation to our initial question. Could it be that that supposedly greater stock of knowledge, skills, and abilities is what determines the wage gap? Economists often assume that a higher human capital makes us more productive individuals, which means that we are likely to produce a larger output and should hence be paid more for our work than an individual with lower human capital. We could simply argue that people in rich countries are paid more than their counterparts in poor countries because they have a higher human capital, but let’s once again consider our two construction workers. Hans is likely to have completed at least 10 years of education, have no problems in reading and writing, and have gained some other valuable skills during his years in school; his human capital is likely to be high. Wang, on the other hand, may well be one of the hundreds of millions (literally!) of workers who have migrated from rural China to large urban areas like Shanghai in the hope to earn a better pay. He is likely to come from a relatively poor background and may have probably completed a few years of education only, if any at all. Evidently, his human capital is likely to be lower than that of Hans. Does this automatically make Hans a more productive worker? Certainly not! A higher human capital does not always imply greater productivity. Indeed, the proportion of jobs requiring specialist knowledge is rather small and many jobs actually require a narrow range of skills only, meaning that human capital is not necessarily a pre-requisite for high productivity, and thus should not be seen as a major factor influencing the wage gap.
Perhaps the best way to understand why workers in rich countries are paid more than their counterparts in poor countries is to think in terms of labour supply, a term used to indicate the total number of people in an economy who are willing to work (e.g., labour supply of construction workers). This makes understanding the wage gap intuitive: the more people there are willing to carry out a particular job, the greater the substitutability between two or more workers. What does this really mean? If I, a construction firm, employ 5 construction workers out of a total of 6 who are willing to do this job, I would only be able to substitute 1 of the 5 as the 6th (whom I’ve not employed) would be able to take their place. However, if I employ 5 construction workers and the total supply is of 100, I would easily be able to substitute any of them (assuming I see all construction workers as identical). Say, for instance, that one of my workers demands a higher wage; this is not really a problem for me because there are 95 other potential workers who might be willing to take his place, maybe at an even lower wage. Thus, a higher supply of workers pushes wages down and this is why in a country with high labour supply, like China (whose population is over 15 times that of Germany), wages are lower than in countries with a lower labour supply.
Finally, as suggested by Korean economist Ha-Joon Chang, we may even go as far as saying that wages are strictly politically determined and that this is the principal cause of the ‘wage gap’. In fact, if labour supply was all there is to determining wages, there would really be no reason why Chinese construction workers could not replace their German counterparts. Indeed, many of these Chinese workers would be happy with even a fraction of Hans’s wage. There is one fundamental problem however: Chinese workers cannot easily enter the German labour market because of strict immigration regulations in Germany (or indeed in any other developed country). This is a rather implicit form of protectionism: due to immigration control, Hans is protected from having his job replaced by workers who have migrated to Germany from poor countries. Countries have the right to decide how many immigrants they accept and in which part of the labour market; because of this, workers in rich countries can command wages that are much higher than those of their counterparts in poorer countries, even if their productivity is equal, and they do the exact same job.