Saturday, November 10, 2007

Neoclassical Trade Theory and Globalization Backlash

The same standard neoclassical trade theory that underlies many economists' arguments about the gains from trade also implies that those gains will be distributed unevenly. In the Guardian, Jared Bernstein and Josh Bivens write:
Last February, before the flurry of news stories about unsafe imports, a New York Times/CBS poll [PDF] found that 51% of respondents agreed the US had "lost more than it gained from globalisation." Further, while trade is not supposed to create political problems for Republicans, a recent Wall Street Journal poll of Republican supporters found that that 59% agreed that "foreign trade has been bad for the US".

These results are clearly alarming to many in the elite policymaking class, for whom protectionism seems to be the first-order threat to the American economy.

These poll results, however, should not surprise anyone who understands the economics of trade. Chapter one of the trade textbook was essentially written by David Ricardo, and it does indeed teach that trade, on the basis of comparative advantage, typically boosts a nation's average income. This genuinely powerful insight explains why, even if we're more productive than a potential trading partner, or they're able to produce with much lower wage costs, trade will raise national income in both countries.

Sadly, both for American workers and the quality of the trade debate, the textbook has other chapters. One of them explains the Stolper-Samuelson Theorem (SST), which points out that when the US exports insurance services and aircraft while importing apparel and electronics, we are implicitly selling capital - physical and human - for labour. This exchange bids up capital's price (profits and high-end salaries) and bids down wages for the broad working and middle-class, leading to rising inequality and downward wage pressure for many Americans.

Note that this is not just a story about laid-off factory workers, who obviously suffer the toughest losses. Rather, all workers in the US economy who resemble import-displaced workers in terms of education, skills, and credentials are affected. Landscapers won't lose their jobs to imports, but their wages are lowered through competition with those import-displaced factory workers.

To be sure, the theory is clear that there are gains from trade - but there is also a change in relative factor prices (i.e. the returns to capital and wages of different types of labor). So while total income rises, this does not necessarily mean that the income of the median worker rises.

Dani Rodrik makes an interesting point about the selective use of neoclassical theory in arguments about trade policy:

The workhorse model of international trade (the 2x2 Heckscher-Ohlin model) has very stark implications for the effect of trade with poor, labor-abundant countries. Low-skilled workers in rich countries (read the U.S.) must end up as losers--not in relative terms, but in absolute terms. Moreover, the larger the overall gains from trade, the bigger must this adverse distributional effect be. In that world, it is inconsistent to claim there are large gains from globalization while downplaying the distributional impacts. Which is why many economists teach the model in their classrooms, but shift to other, more complicated models when they engage in the public debate about the effect of trade on wages.
Brad DeLong adds two useful points to the discussion:
For competition to be head-to-head, the two countries have to be making very similar goods with similar production processes. Hand-spinners in Pakistan don't compete with labor here in the United States but with the capital embodied in our large automated spinning mills.
That is, the neoclassical "no factor intensity reversals" assumption is violated. Also,
What trade does to our distribution of income can be undone by normal domestic redistributionist policies. The right way to deal with the issue is to (a) maximize the third world's ability to take advantage of our demand to spur its own growth, and (b) use domestic redistribution here to compensate for any adverse distributional impact.
In general, as elegant as it is, the neoclassical theory has not worked well when tested against the data (e.g. Trefler, "The Case of the Missing Trade and Other Mysteries," Am. Econ. Rev., 1995). Therefore we need to be cautious when using it to make the case for the gains from trade, or to raise distributional concerns.

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