Economists Do It With Models

Warning: “graphic” content…

Bookmark and Share
Let’s Talk About Trade, Baby…

July 30th, 2016 · 16 Comments

I’ve been thinking about trade a lot because of recent discussions regarding the Trans-Pacific Partnership. Turns out I’m not alone:

Why Voters Don’t Buy It When Economists Say Global Trade Is Good
by N. Gregory Mankiw

One defining characteristic of recent political debate — in the United States and abroad — is anxiety about foreigners.

Source: New York Times

As put forth by economists, strictly speaking, I’m not even sure that I buy the “trade is good” argument. I know, I know, but hear me out. For the most part, economists focus on efficiency (i.e. what maximizes the size of the economic pie to go around) rather than equity or distribution (i.e. what is fair). The reason for this is simple- what is efficient has a (relatively) scientific answer, whereas what is fair is a matter of opinion and values (read, no right answer). In a perfect world, economists would be leveraged in two ways:

  • Tell us what is efficient and we’ll try to make it work for everyone.
  • Tell us how much value we sacrifice to make things fair so we can decide whether the tradeoff is worthwhile (or where the appropriate balance is).

This division of labor, if you will, is usually not how things work. Instead, this last step is omitted and the economists’ contributions to the discussions are rejected. Case in point: the observation that trade is efficient. To see how, let’s work through the logic.

Consider a good where the US would want to import from foreign countries if it were opened to trade. (This will happen when foreign producers can offer the good at a lower price than domestic producers.) Opening up to trade helps consumers via lower prices, but it hurts producers due to low-priced competition. That said, consumers win more than producers lose, making trade the efficient outcome. (More technically, introducing trade satisfies the Kaldor-Hicks criterion.) BUT…trade creates a clear distribution problem, where there are a large number of consumers who gain a little and a smaller number of producers (or, somewhat equivalently, workers) that lose a lot on a per-producer basis. It’s not exactly a convincing argument, for example, to tell the auto worker to be happy about losing his job because it makes cars cheaper for a lot of other people. Unfortunately, it’s also not really reasonable to cost consumers $160,000 to save the job of one auto worker. (This is what the tradeoff was estimated to be during the voluntary export restrictions of the Reagan era.) It’s also not reasonable to remind the worker that he ends up being the winner in other trade scenarios so it totally balances out (it kind of does, but probably not entirely). so we have the economist talking about how trade is efficient and a decent number of people affected being like uh, @#$! no.

This doesn’t have to be the case- the fact that the winners win more than the losers lose means that the winners could compensate the losers and create a situation where everyone is better off. BUT…this doesn’t happen automatically, and the transfer probably introduces its own inefficiency. Overall, thankfully, the distribution of gains and losses isn’t likely an unsolvable problem that makes “to hell with trade” the right answer. Yes, I recognize the hyperbole, so let me try again- the distribution of gains and losses isn’t likely an unsolvable problem that makes “institute trade restrictions so that potentially displaced workers are essentially receiving consumer-financed work-based welfare.” (I know how much everyone loves the “w” word.) Yes, it requires creativity to think about what form the redistribution (I know you love that word too) should take- job training? (hasn’t had spectacular results) Enhanced unemployment? (how do you determine whether a layoff was trade based?) It may be an intellectual challenge (especially since a solution has to involve preserving the perceived dignity of displaced workers and such), but this is a worthwhile thought exercise and a conversation that we should be having.

Mankiw’s article points out that opposition to trade isn’t simply the result of losing parties objecting to lack of compensation, but it’s hard to believe that this consideration doesn’t play a role in some fashion. I also think that people often equate foreign producers producing cheaply as “cheating,” and behavioral economists know that people have a tendency to sacrifice their own well being in order to punish parties that they think are behaving unfairly. (see, for example, the ultimatum game) In the context of trade, this tendency results in giving up some economic value in order to prevent low-cost foreign producers from benefiting, and this is achieved by restricting trade. Lastly, many people seem to view the trade outcome as “regulation” rather than the other way around, perhaps because explicit free trade agreements frame, well, unfree trade as the default option. This doesn’t exactly garner support for free trade when people don’t like to feel like they are being regulated.

tl;dr: “Screw you, worker” and “let’s shoot ourselves in the foot so this guy gets to do a particular job” don’t have to be the only two options on the hypothetical policy table.

FAQ: But what about exports? Easy- just switch the outcomes of consumers and producers in the above discussion, as in “producers win more than consumers lose”.

UPDATE: David Henderson has thoughts. And a hat that you need to take a look at.

Tags: Policy

16 responses so far ↓

  • 1 Jeff // Jul 30, 2016 at 2:16 am

    This article illustrates clearly why Mankiw is disliked by those that are good at math.

    He states unequivocally:

    “That said, consumers win more than producers lose, making trade the efficient outcome.”

    This reminds me of a joke I tell sometimes to explain why local increases of production efficiency can’t be guaranteed to scale up to increased aggregate production in the closed system.

    A guy takes his car to the mechanic and says that it doesn’t have enough acceleration anymore.

    The mechanic says, “I just need to install a second fuel pump. That will be $800 and you can pick up your car on Monday.”

    “Don’t you want to look at it first?”

    “I don’t have to look at it. The only thing that can make a car go is the chemical energy trapped in gasoline. If you need your car to go faster, then all you need to do is make sure you have more fuel going into the carburetor.”

    “Say! Are you sure that you are a real mechanic?”

    “Actually I am a supply-side economist. I fix cars on the weekend for fun.”

    Every single unit of economic gdp is produced by production capability and consumption capability bumping into each other just as every unit of combustion is produced by fuel and oxygen bumping into each other. Mankiw’s assumption that Ricardian efficiency improvements on the supply side must lead to increases in overall production is no different than the supply-side mechanic above assuming that there is no such thing as a car getting flooded.

    I daresay that this is something fundamental that poor people get and the Mankiws of the world seem not to. This is why people get angry when he says stuff like:

    “One defining characteristic of recent political debate — in the United States and abroad — is anxiety about foreigners.”

    … in his explanation for why people don’t believe in his Ricardian version of the truth.

  • 2 Joseph Weber // Jul 30, 2016 at 8:21 am

    Jodi, I quite enjoy your insights, including your astute comments on trade. I wonder if you might weigh in on this proposition, one I learned in my graduate economics studies: presidents get entirely too much credit and blame for the performance of the economy. In fact, their efforts do little to change the forces that spur or slow the economy. The Fed is far more influential, while government policies are marginal in their effects at best. True or not? What does the evidence show us?

  • 3 econgirl // Jul 30, 2016 at 2:14 pm

    @Joseph: In a lot of ways, yes. I think the evidence shows that fiscal policy can have some success at mitigating recessions, but those effects seem to be trumped (I hate that word nowadays) by the effects of technological progress and such. We’ve also seen a variety of different tax rates over the last 100 or so years, and none of them really stand out as a spectacular success or failure. My guess is that the most effective policies work in far more subtle ways than we’re used to thinking about- childhood nutrition, education, etc.

    I was actually think about this recently, in the sense of “maybe people get that economic policies don’t move the needle that much and so they focus more on social issues when voting” kind of way.

  • 4 econgirl // Jul 30, 2016 at 2:30 pm

    @Jeff: The trade scenario that Mankiw is describing is basically akin to the following:

    Say country A can produce a good for $3 and sells it for $6.
    Say country B can produce the same good for $2 and sells it for $4. Country A can keep producing the good but isn’t going to be able to command a price higher than $4.

    Each time a consumer buys the good at $4, she is better off by $2. Each time a producer sells the good at $4, she is worse off by $2 than before. There’s no net change here, just a transfer. However, there are also customers who wouldn’t have bought the good at $6 who now are happy to purchase at $4. The value that they capture is essentially why the winners win more than the losers lose, and it’s difficult (I didn’t say impossible- I think Yoram Bauman has one that involves externalities) to construct a scenario where this is not the case.

    My point is that, as far as unequivocal economic statements go, this isn’t so far up the list in terms of being controversial. Your point is obviously more subtle than my (constant marginal cost, even) toy example, but from what I’ve read, the result that Mankiw refers to is not dependent on such basic assumptions. It also doesn’t necessarily in itself discuss the impact on overall domestic production since there is no general equilibrium component, but the idea is that consumers would take their savings and go buy other things, etc.

    Where exactly does this representation not reflect reality in the way that you describe? Outside sources are also welcome.

  • 5 Matt R // Jul 30, 2016 at 3:38 pm

    Would it ever be possible to construct industry-specific trade deals or regulations? I feel like most of my trade deal discussions can’t even get into a specific example credibly because that’s never the only affect in the given deal.

    I also feel like a lot of the opposition to TPP in specific, at least as far as I hear regularly, is in the legal protections for companies with profit loss. As far as I can tell, TPP does contain that verbiage, I’m just not sure if there’s something I am missing about how it would work in effect.

  • 6 econgirl // Jul 30, 2016 at 4:05 pm

    @Matt: Definitely- see all trade deals regarding cars in the 80’s, for example- they were even specific enough to differentiate between cars and trucks, which is part of the reason SUVs are now a thing. You also have industry-specific tariffs- sugar, for example.

  • 7 econgirl // Jul 30, 2016 at 4:41 pm

    @Joseph: Here are a couple of sources for you:

  • 8 David // Jul 31, 2016 at 2:30 am

    I think the recent work on the trade effects with China (David Autor, David Dorn, and Gordon Hanson – and I think I’m required to like the work based on having a 2/3 ‘authors named David’ ratio) has helped focus my mind on this question. Regional impacts matter, and of course we knew that from the steel industry, coal industry, car industry, etc. But these regional impacts seem disparate, and there does come a point when we have to start taking things like ‘the lifespan of a human being’ into account – a local economic disruption that lasts long enough starts to become ‘all there ever is, and all there ever will be’.

  • 9 Links for 07-31-16 | Washington News Cloud // Jul 31, 2016 at 3:16 am

    […] at 3:16 on July 31, 2016 by Mark Thoma Let’s Talk About Trade, Baby… Jodi Beggs Rebuilding a mass social democratic party? – mainly macro […]

  • 10 Robert Driskill // Jul 31, 2016 at 7:12 am

    This is a subject near and dear to my heart. I agree with David that the “China Syndrome” paper is finally looking at the right data to answer questions about the effects of trade. As for Mankiw, I’m reminded of Ronald Reagan’s comment: “There you go again.” Look, economists as economists simply cannot make judgements about “whats good for the country.” I wrote about this in the following article:
    STUDY OF THE ROLE OF ECONOMISTS IN POLICY DEBATES, Economics and Philosophy, March 2012, I addressed Mankiw in a short article, “Why Do Economists Make Such Dismal Arguments About Free Trade?” Foreign Policy, web edition, May 2008. To be fair, Greg at least does bring some new ideas to light in this latest column. And my pet peeve: trade doesn’t lower prices for consumers. Think quinoa and Equador or beef and Argentina.

  • 11 rjs // Jul 31, 2016 at 4:50 pm

    there is not an insignificant number of us vaguely on the left for whom trade is not an issue in our opposition to these deals currently on the table…our concern is that they are a trojan horse enabling the corporate takeover of sovereign governments, through the vehicle of the investor state dispute settlement provisions, wherein governments can be sued and made to pay for regulations or laws that interfere with business…

  • 12 Matt R // Jul 31, 2016 at 9:02 pm

    I was just reading this and find it pretty relevant as well.

    Not a study or anything, but we’re probably going to just keep on destroying jobs with our good ideas as well.

  • 13 Matt R // Aug 1, 2016 at 12:52 am

    PS- I am STILL working on getting Salt-N-Pepa out of my head a day later. Thanks!

  • 14 Debasing The Human Mind: Part 3 – societyandeconomicsblog // Aug 1, 2016 at 2:47 pm

    […] be distributed between parties, and is one of the most pervasive issues in the area of trade. Here is a good article that summarized that […]

  • 15 econgirl // Aug 4, 2016 at 6:02 pm

    @Matt R: That is a good article! Here’s a similar one about the UK:

  • 16 vmware training in pune // Dec 21, 2016 at 2:20 am

    nice one…

Leave a Comment