Tuesday, March 22, 2016

Apostasy on Free Trade Should Be Good News for Everyone

by Neil H. Buchanan

In a Dorf on Law post last week (cross-posted at Newsweek's website under the title "From Austerity to Free Trade, Elites Play Catch-Up"), I discussed some rather surprising recent concessions by some top-flight economists, who now admit that they have been over-selling the virtues of "free trade" for decades.  (I will explain the scare quotes below.)  I specifically stated that, notwithstanding this surprising news, almost "no one thinks that we should now rip up all trade agreements and go back to what economists call 'autarky.'"  That is, saying "freer trade is not always good" is not the same as saying that all trade is bad.  Conversely, however, we now can say with greater certainty than ever that not everything that purports to enhance "free trade" is automatically virtuous.

One of the things that makes economists' hearts beat with pride is the idea that their insights are deep and often counter-intuitive, which allows them to say that without economists, the world would be a worse place.  Yet their supposed insights are often a bit of a letdown.  Statements like "You can't just print money!" and "You can't just set prices!" are true as far as they go, but to be honest, those admonitions are hardly all that difficult for people to understand.  "You shouldn't run a closed economy," however, is much harder to explain, and it is based on a truly elegant insight known as the theory of Comparative Advantage (CA).  The central insight from CA is that even if one country were better than every other country in the world at producing every good and service, that country would still gain by producing the goods and services at which it is "more better," while importing the goods for which its absolute productivity advantage is smaller.  Truly brilliant.

Even so, it turns out that this insight only takes us so far.  In last Tuesday's post, I summarized some recent writing by Paul Krugman, who made his bones as an economist in the field of international trade and finance, but who now concedes that "the elite case for ever-freer trade, the one that the public hears, is largely a scam. That’s true even if you exclude the most egregious nonsense."  Eduardo Porter's "Economic Scene" column in last Tuesday's New York Times makes similar points while offering more detail.

One way of thinking about their point is that there genuinely are huge gains from opening up a country to trade, but we have already exploited almost all of those gains, so we are currently sitting on a flat part of a curve relating the "freeness" of trade and economic gains.  That is, we have already picked all the low-hanging fruit.  That does not deny that extreme movements back toward closed economies would be bad, but it does say that small movements either way are probably not going to make much difference -- which means that movements in one direction are not presumptively better than the other direction, even if we call one direction "free trade" and the other "protectionism."

The problem, however, is deeper than that, because the notion that the freeness of trade can be measured or described rigorously assumes that there is some natural baseline that counts as "free trade," and that every government action that deviates from that knowable baseline is in some sense protectionist.  But that is clearly not true, because there have to be some laws in place that set the table for trade to take place.  There are any number of such sets of laws, none of which is per se better than the others, because there is no state of nature that exists without rules for commerce.

For example, if a country requires all companies to put certain safety features into the products that they sell, or imposes environmental restrictions, or indeed if it sets any legal requirements at all for conducting commerce in the country, one can reasonably say that those laws create the basis for efficient market transactions, not that they are anti-free-trade.  Depending upon one's baseline, however, such legal requirements could just as easily be described as hampering trade.  (Child labor laws are a particularly interesting example of this concept.)

This is why scare-quotes are needed when people talk about "free trade," because there is no consistent way to say that commerce that is governed by one set of rules of the road rather than another is more free or less free.  In domestic economics, we understand that the types of contracts that we enforce, the protections that we provide to property (including intellectual property), and all of our other legal rules are the foundation that allows commerce to occur.  That is no less true in international trade than it is in domestic commerce.  (Longtime readers of this blog will note that I am merely applying "the baseline problem" to international trade.)

In any event, Krugman is making a much narrower (but still essential) point in support of his claim that the free-trade case is a scam.  He noted that "the numbers aren't huge" when it comes to measured gains from trade.  Working from a recent research paper to produce back-of-the-envelope estimates, he noted that global incomes have risen by about 45% since 1990, with 40% caused by non-trade-related factors and 5% by trade-related factors.  That is surely better than nothing, but Krugman correctly notes that this is hardly the kind of thing that most people imagine when they talk about the virtues of free trade.  Note as well that this is a period of unprecedented growth in global trade, with tectonic shifts in shipping technology, communications, finance, and international trade agreements that cannot be replicated again.  We truly are on the flat part of any curve, so if we are hoping for further gains from changing even more laws to try to increase global trade, we are likely to be disappointed.

Moreover, we are looking at global growth here, not merely U.S. growth.  If there is a reason to think that the U.S. benefited more from expanded global trade than, say, China did, I cannot think of it.  The super-fast growth in some economies was surely driven by export-focused policies.  But the U.S. was not one of those countries.  Moreover, the growth that the U.S. did see in its GDP over those years (and, in fact, going back to 1980) has not been shared widely, so that the generally defensible statement that "increased trade increases national income" would need to be understood as actually saying that "expanding trade by an unprecedented amount contributed to a small amount of income growth that was not shared at all equally."

To be sure, Krugman also takes people like Bernie Sanders to task for overselling the opposite case, which is that we could be doing much better domestically without "Hillary Clinton's free-trade policies."  Krugman argues that "[g]lobalization is only one of several factors behind rising income inequality, and trade agreements are, in turn, only one factor in globalization."  Krugman's point is thus that this is all overstated on both sides.  This is why he came out mildly against the Trans-Pacific Partnership last year, arguing that we have already seen the biggest gains that we are likely to reap from trade agreements, and noting correctly that TPP is actually a way to protect U.S. monopolies via intellectual property enforcement, which is hardly what Adam Smith had in mind when he talked about the importance of allowing free markets to function.  (Krugman adds more about Clinton's mixed support for supposedly pro-free-trade deals here.)

Yes, I know that there is a case that patents and so on end up helping the economy, but there are also good arguments of exactly the same sort showing that various trade restrictions can end up having similarly net positive effects.  Not all trade restrictions are good, but not all are bad, either.  Too many people have bought into a "trade is good, so more trade is better" notion that simply is not always true.

One of my points in Tuesday's post was that there are economists like Tom Palley who have known this all along, and they are rightly annoyed that their work was dismissed for years as "anti-free trade" (and therefore blasphemy), whereas mainstream economists like Krugman now seem to be suggesting that they never oversold the virtues of free trade.  Let me share three stories that, in various ways, illustrate why I find Palley's complaint persuasive:

(1) By pure happenstance, my first summer job in Washington during college was a research assistant position with an economic research firm that specialized in representing U.S. companies in trade complaints against foreign competitors.  These complaints are frequently litigated before the International Trade Commission, and my firm worked with BigLaw firms to provide the economic research to back up the U.S. companies' positions.  Because I had taken college-level economics, and in fact had just finished the upper-level International Economics class, I asked the hiring partner during my interview how he could be "against free trade."  He was not surprised by the question, not even when it was posed so impertinently by a naive college kid.  In fact, he and his partners spent a great deal of their time trying to explain to people that "free trade" is simply a convenient cover for policy choices that are no more (or less) free than many alternatives.  His argument was, in fact, a trade-specific version of the baseline question that I described above.  (See also the latter part of this Dorf on Law post from 2014).  Again, there is no default category of laws that is somehow "the state of nature," because every rule of commerce (domestically and internationally) is just as artificial as any other.

(2) Bill Clinton muscled the North American Free Trade Agreement (NAFTA) through Congress in 1993 by expending political capital that he never brought to bear on, say, policies to expand public investment.  Shortly before Congress was to vote on the deal, I was speaking with a friend from graduate school who was an acolyte of Krugman and his colleagues.  This friend told me that he and his economist friends were planning a party to watch the Congressional vote, cheering on the "yes" votes.  I asked why he thought that NAFTA was a good idea, and he said that it would "increase free trade."  I pointed out that it was in fact simply managed trade by a different name, and that this was merely one of many possible frameworks through which governments can manage trade.  Why is NAFTA the right one?  "Because it's for free trade," was his unhelpful reply.  Was he aware of the theoretical work in international economics that undermined the simple (but admittedly appealing) notion that countries are always better off due to expanded trade?  Yes, but he was unmoved by it, even though it was coming from some of the very people that Krugman now points to as having "known it all along."  Trade is good, so he was in favor of anything that was labeled "free trade."  Even if the literature was ambiguous at best, there was no ambivalence among even left-of-center economists who rallied around the free-trade flag.

(3) While I was still an economics professor, in the late 1990's, my department was interviewing entry-level international economists.  Because I had studied a fair amount of trade theory over the years (even though I had decided not to specialize in trade as part of my Ph.D. program), I had the sense that there were a million and one papers that had "proved" (in the sense that economics papers try to prove things, by deriving theorems from assumptions) that free trade was either bad or not always good.  (I was referring to some of those papers in point 2 above.)  In other words, even when the theory of Comparative Advantage was being used as the natural baseline against which we should measure countries' deviations from so-called free trade, even less-than-free trade could be shown mathematically to be superior to free trade, using any number of plausible assumptions.  During an interview of one of our job candidates, therefore, I asked, "What are the three most recent theories that you've seen that undermine that case for free trade?"  Without hesitation, that near-Ph.D. from a top department rattled off three clever models that he had seen that purported to show that trade limitations could be welfare-improving.

Again, to be extremely clear, none of what I have written here, or in my post last week, can reasonably be read to say that "trade is bad" or that trade restrictions will always make Americans better off.  In the article by Eduardo Porter that I noted above, however, he points out that Germany has expanded trade with China, but the German government has managed that trade in a way that was good for German workers, unlike in the U.S.  There are different ways to set up the rules of the road, and Germany wrote better rules than we did, to the benefit of all. 

Which brings us to Krugman's other concession.  As I noted on Tuesday, he now also says that the theoretical possibility of compensating the people who lose from expanded trade is even less realistic politically in the United States than it used to be.  Therefore, those who say that trade could be better for everyone (as in Germany) need to acknowledge that there will be people who will be worse off when we expand trade, because our political system has all but foreclosed the possibility of mitigating the harms to those who will be displaced.

That is probably the more politically important point in the current context, and it explains why Hillary Clinton got into such trouble by saying that "we're going to put a lot of coal miners and coal companies out of business, right?"  What she actually meant was that "we, the people of America, through a series of acts of commission and omission," are dooming the coal industry.  For a lot of reasons, that is a good thing.  Clinton was not saying that "we, the Clinton campaign and the Democratic Party, are eager to destroy coal as a viable business."

In fact, she was trying to say that she would try hard to make sure that, even though "we've got to move away from coal and all the other fossil fuels, ... I don't want to move away from the people who did the best they could to produce the energy that we relied on."  But her $30 billion plan to protect the pensions of those people, and to allow their communities to enter a post-coal future, would cost a large amount of money.  (Maybe even thirty billion dollars.)  And guess who is against having the government spend money?  The very people who tell us that trade is always good, and that economists who claim otherwise are just a bunch of union hacks who cannot understand simple economics.  It's enough to make a person cynical.


Shag from Brookline said...

I assume that economics has evolved over the years with changing circumstances and is not a pure science. Free trade (with or without scare quotes) is in the eye of the beholden.

Michael C. Dorf said...

Here's another illustration of the baseline problem. The internal trade law of the U.S. (dormant commerce clause) and the EU (free movement of goods and persons), as well as the inter-national rules of the WTO, all face the problem of when the application of an internal norm to an external trade partner is permissible. Suppose that the minimum wage in country 1 is $x, while the minimum wage in country 2 is less than $x. If country 1 imposes tariffs on goods from country 2 to compensate for the fact that the different laws in 1 and 2 give producers in 2 an advantage, is that an effort to undermine the comparative advantage of country 2? Or should the lower minimum wage in country 2 itself be deemed the problem? The same question applies to labor standards and environmental standards. One could say--as libertarians do--that the natural baseline is the completely unregulated market in each country, with no minimum wage, no labor standards, no environmental protection, no regulation at all. But if THAT's what it takes to have "free trade," then the free-trade-is-always-better folks ought to be honest about it and say that what they favor is no regulation of the economy anywhere.

Fred Raymond said...

The giant flaw in all this so-called "free trade" is that the participants are not REMOTELY conforming to similar standards of worker safety, environmental protection, worker compensation, waste stream treatment, intellectual property rights etc etc ETC!!

David Ricardo said...

A couple of things worth noting.

1. Economists have to get away from the idea that everything is measurable and quantifiable. The idea that all of the benefits of free trade are objectionably determinable is ludicrous. Data and models can help but they are not the end all- be all. The TPP has major geo-political aspects, all totally un-measurable (and hence largely ignored.)

2. Let’s look at the largest, oldest and most successful free trade agreement in history. This agreement is the United States Constitution. To their ever lasting wisdom the founders created a nation with near totally unrestricted free trade. The result has been the single most successful economy in history. Consider how different economic life would be in the U. S. if individual states were able to enact trade barriers and engage in protectionism. And consider how difficult it would be to remove those trade barriers if they had been allowed.

3. One of the strongest arguments against free trade is almost never mentioned. That argument is that while free trade creates non-Pareto optimal economic growth for all parties in the long run, it also creates inter-dependence which threatens the sovereignty of nations. The best example here is OPEC and its effect on the economies of the United States and Europe, particularly in the 1970’s. Or look at how Russia gains huge political advantages over Europe by its control of natural gas supplies critical to life in Europe. The United States and Europe tolerate and be-friend tyrannical regimes because of their dependence on energy from Russia and the Middle East.

Protectionism appeals because the negatives aspects of free trade are much more recognizable then the benefits. But myopia is not and should not be the rational basis for policy decisions.

Joe said...

"it also creates inter-dependence which threatens the sovereignty of nations"

see this as a positive in various ways myself

The reference to the U.S. Constitution is good but free trade within a country didn't start in 1789, did it? I gather "U.S" history was meant there.