Tuesday, March 15, 2016

The Fallacy of Free Trade and the Economists Who Knew It All Along

by Neil H. Buchanan

One of the most interesting aspects of the political conversation over the last several years -- on issue after issue -- has been seeing the safe, conventional, bipartisan, self-satisfied insider view exposed as fraudulent.  For example, decades of Democrats and Republicans agreeing that deficits are the worst thing ever led to President Obama's insane embrace of austerity in 2010, where Obama's people clearly believed that he was on solid ground with establishment thinkers.  He and his party quickly found themselves reaping the consequences of a slow, grinding economic recovery, but much more surprisingly, they also discovered that the professional consensus among economists was not what they thought it was.  Mainstream establishment liberals started to say, "You know, there really is not a good case for austerity.  Quite the opposite."

On tax policy, Democrats and Republicans alike spent years believing that the best way to guarantee prosperity (as well as electoral success) was to cut taxes.  Republicans were characteristically extreme about it, but Democrats were sure that economists all agreed that tax cuts are a good thing.  The only question was which taxes to cut, and how.  Then, as inequality became impossible to ignore, some highly credentialed economists were heard to say that marginal tax rates on the rich could go back to the 70-80 percent range without harming the economy.  Moreover, there was a sudden acknowledgement that there simply is no empirical case supporting the claim that tax cuts lead to higher economic growth.

The minimum wage?  We went from Democrats arguing in a pro forma fashion that the minimum wage is not terrible and should at least keep pace with inflation to a fight between those who would push the federal minimum to $12 within a few years and those who would go to $15.  Again, the inside-the-beltway belief that there was a professional consensus that minimum wages are bad was surprisingly exposed as a myth.  And it also turns out that the case against labor unions was always weak-to-nonexistent.

This is getting embarrassing.  Think about the list of things that conservatives and centrist liberals have always thought students should learn in Econ 101.  Because "markets are good," nearly everyone is apparently supposed to learn from their economics classes that the government should be small (so spending and deficits are bad, and taxes should be low) and that labor markets should not have "imperfections" like minimum wages and organized labor.  Oh, and don't forget the hoary belief that the Fed should never let rates stay too low lest inflation get out of hand, which also turned out to be completely contradicted by events.

What remains of the "economics proves center-right policies are best for the economy" belief system?  Well, at least everyone knows that Free Trade is a good thing, right?  Who but a dead-ender with ties to old-style industrial unions could be opposed to "liberalized" trade agreements among countries?  At this point, it will no longer be a surprise to learn that the supposed professional consensus on this issue was also a myth.

Jared Bernstein (Vice President Biden's former chief economist) and Paul Krugman have both written recently about the nonexistence of empirical (or even theoretical) support for the idea that expanded trade is an unalloyed good.  In particular, it turns out that we have always known that (a) the overall measurable gains from trade are extraordinarily small, even when assessed from an orthodox viewpoint, and (b) the idea that "winners can compensate losers" from trade is at best a dodge.

Of course, no one thinks that we should now rip up all trade agreements and go back to what economists call "autarky."  (No one, that is, except for the Republican front-runner, but he is truly an outlier on that issue, as on so many others.)  Still, the safe political ground has always been that if completely closed borders are bad, then completely open borders (to goods and services, at least) must be good.

On all of these issues, of course, there are still true believers, and the Republicans are still fully supporting the old orthodoxy across the board.  For example, Krugman recently called out Mitt Romney for claiming absurdly that trade barriers cause depressions.  Even so, The New York Times ran a column this past Sunday by an establishment thinker who said that tariffs in the 1930's "worsened the Great Depression," and that Donald Trump's apparent willingness "to slap high tariffs on Japan and China ... could trigger a global depression."

But what is most interesting about all of this discussion about trade is that the center-left and lefty economists are not saying, "Wow, we were wrong for so long and now we need to rethink things," but "This is nothing new, why is anyone surprised?"  The sub-debate on that side of the spectrum, in fact, is now between the people who can accurately say that they have always seen through the more-trade-is-always-good scam and those who are only recently claiming to have seen it all along.

This conflict is captured in a recent blog post by Tom Palley, who has been working on the left side of the economics profession for his entire career.  Palley chides Krugman for "tr[ying] to walk away from his own contribution as an elite trade economist to the damage done by globalization," pointing out that "Krugman has been a booster of trade and globalization for thirty years: marginally more restrained than other elite economists, but still a booster."  He argues that "the economics elite is moving to reinvent itself with a combination of minor backpedaling and its own studies that belatedly acknowledge the damage wrought by globalization."

Longtime readers of Dorf on Law might recall a series of posts that I wrote in the Spring and Summer of 2014 (the last of which is available here, with links back to the other posts available through this post).  My big point in those posts (most prominently here) was that the elite economists on the center-left, most obviously Paul Krugman and Larry Summers, could readily shape-shift even after having been cheerleaders for policies that led to disasters.  Or, as I quoted a graduate school friend from a conversation in the 1980's: "Look, even if the economy completely tanks, Larry Summers will still be an economics professor at Harvard.  And he's intellectually agile enough to try to make lemonade out of lemons (or maybe even lemons out of lemonade), even though he's currently very much embracing the dominant paradigm.  When the deluge comes, he'll come through it just fine."

Palley is thus right to say about the liberal elite group of economists that "[t]here is no professional cost to be paid for the grievous injuries it has helped inflict; no mention is made of the fact that outsider critical economists have long predicted and written about these injuries."  For people who have long been dismissed as outsider cranks by economists like Krugman, it must be especially galling to hear Krugman saying (probably accurately) that he never actually wrote anything that was as lacking in nuance as one sees in the pro-trade orthodoxy.  The fact is that, on trade as much as on the other Econ 101 issues, the outsiders have proved to be right all along, and the insiders are now claiming not actually to have been wrong.

I thus sympathize with Palley's complaint about Krugman.  It truly is infuriating to see such a lack of self-awareness from someone who is so much a part of his profession's establishment.  (And Krugman's initial fame was built on his work in international economics, where trade orthodoxy is especially oppressive.)  In some sense, this exposes the deep corruption of the long-term policy conversation, and it has serious consequences for the economy and our society.

In the immediate moment, however, I am trying to look on the positive side.  We finally have people in high places using their megaphones to announce that the case for so-called free trade was always at best oversold.  That is progress.


john johnson said...

Really have to give credit for what seems some pretty awesome chutzpah by all those 'mainstream' economists who now admit they were wrong but were somehow right all along.

And people wonder why there are those of us who view economists and economics with more than a little skepticism

David Ricardo said...

As a professional economist and one of the strongest proponents of free trade (hence the nom de plume) I am somewhat taken aback by many of the statements, conclusions and observations in this post. This sentence is particularly puzzling

In particular, it turns out that we have always known that (a) the overall measurable gains from trade are extraordinarily small, even when assessed from an orthodox viewpoint, and (b) the idea that "winners can compensate losers" from trade is at best a dodge.

First of all it assumes that the gains from trade are completely measurable (or maybe this is a hedge to say that we are only talking about ‘measurable’ gains). One wonders if most of the gains are even ‘measurable’. For example, does anyone dispute that consumers of U. S. made autos have experienced huge non-measurable gains and that U. S. manufactured autos are better and lower priced because of foreign competition? (Want to buy a Chevy Vega, a Plymouth anything, a Ford Pinto?) Does anyone dispute that low income consumers have greatly benefited greatly in a non-measurable way from low prices at discount retail stores from Chinese imports and the entry level jobs those stores provide? Anybody want to envision life without foreign made electronics? Take a look at the student body of George Washington University ( or any non elite school) and see how dependent that school’s finances are on foreign students.

Most liberals who are opponents of free trade drive cars that were manufactured overseas or at least have their major components that were imported. They wear clothes made in foreign countries and drink imported beverages. They have iPhones, HDTV’s, tablets and a whole bunch of other electronics all made outside of the U. S. They travel extensively in Europe and their children study in foreign universities and they have portfolios that are diversified with international securities. They complain about high drug prices and would gladly import foreign made ones if they could.

And yes, winners can compensate losers, in fact they have a moral obligation to do so. The big problem with free trade agreements is that many people, mostly conservatives, want to just let those injured by free trade hang silently in the wind.

There is no dispute that in the long run that free trade is a requirement for a strong and growing world economy. Most of the people who dispute this either have a vested interest in protectionism or don’t understand comparative advantage. The founding fathers knew this more than two centuries ago which is why they put provisions in the Constitution to cause the United States to be an unrestricted free trade zone. The result, the strongest most dynamic economy in the world. Europe after millennia of fighting finally realized this in the post WWII era and gosh, look what has happened there. Any questions why Germany is the continent’s strongest economy? Any question that increased trade promotes world wide political stability? But of course those benefits are not ‘measurable’. Trying to stop increased free trade in the long run is like King Canute trying to stop the tide.

But in the short run there are serious negative consequences from new free trade agreements, it is not a Pareto optimality. And yes the United States must take actions to ameliorate the damages to various sectors of the economy. This can take the form of providing income support and health care availability for those who lose their jobs as a result trade agreements, and substantial public investment in those regions that are negatively impacted.

It is somewhat disturbing to see people like Krugman back track, but you know, that doesn’t change reality. Anti trade is a nice short term political position, and a nice long run position if one is interested in reduced world wide economic activity.

Greg said...

The argument here, if I understand it correctly, is:

1.) Free trade renders all wage-benefiting government actions worthless, as they will drive production to areas without those restrictions.

2.) Similarly, free trade causes bidding wars between governments, almost completely removing the ability to tax businesses.

Overall, #1 and #2 mean that all the power lies with capital whenever free trade is present, and produces a race to the bottom for both governments and labor in a capitalist economy.

I'm with the argument this far, because this was sort of always anticipated.

What I'm not following, though I can kind of see, is how this turns into a race to the bottom economically. I think the idea is that global demand falls as wages fall, because labor generally spends a higher percentage of their money than capital.

I especially don't see how increasing transaction costs does anything besides postpone the inevitable. Is the idea that if an economic region currently has the bulk of demand, that they can exploit transaction costs to access that demand as a stick to bring supply into the same region?

Unknown said...

If what you say is true, Professor, it should be rather easy to disprove each of the claims made about free trade and to account for the fact free trade zones tend to have fewer internal military conflicts independent of free trade. Do You have such disproofs?

wolflarson71 said...

The minimum wage statement doesn't seem right. Just today, I came across this:


"Today, it’s even clearer that the Card-Krueger conclusions in Myth and Measurement were without foundation. In a 2007 summary of the previous two decades of research, the economists Neumark and Wascher found that 85 percent of the most credible studies pointed to job loss following a minimum wage hike. A more recent literature review published by the Federal Reserve Bank of San Francisco, which included the latest and greatest research, still finds clear negative impacts on employment following a minimum wage increase.

The veracity of the flawed Card-Krueger study has become an article of faith on the left, even as the minimum wage debate has moved far beyond levels at which the study’s authors are comfortable. Krueger made news last year when he delivered a gentle rebuke to the 'Fight for $15' in the pages of the New York Times, declining to endorse their goal on the federal level. Bill Clinton used the Card-Krueger research to justify a federal wage hike, but today his former top economist at the Labor Department warns that a “$15-hour minimum wage could harm America’s poorest workers.”