The SanityPrompt

This blog represents some small and occasional efforts to add a note of sanity to discussions of politics and policy. This blog best viewed with Internet Explorer @ 1024x768

Monday, June 13, 2005

Let Us Raise the Pie Higher! Comparative Advantage Revisited

First a big thank you to Brad Delong for posting an excerpt from my blog speculating about the applicability of comparative advantage in today’s world. I am flattered by the attention that it received and the excellent commentary on both sides that was generated. I wondered about the holes in my argument and, as usual, he came back with integrity and thoughtfulness (aside from one flippant rejoinder to a comment that if our exports fall to zero and people keep sending us imports then it’s all free stuff). He also highlighted the importance of underlying government policy which always gets neglected in discussions about trade policy. I should have replied to all this much sooner, but that’s what happens when you hit a publishing deadline in the same week that the blog-world explodes.

What I was trying to do in my post was to challenge the conventional economics orthodoxy which pervades much of the elite media and elite Washington as well that, as one blogger put it, “free trade can only be good.” That’s an odd sentiment if you think about it, or even if you don’t think about it and are just a xenophobic troglodyte (troglodyte being my favorite insult these days). In particular, I have often wanted to remind people that the paradigm macro-economists use to evaluate free trade derives (or so it seems to me) from the Kaldor-Hicks framework of welfare economics (to which I express a deep thank you to PADRAIG for seeing this). Generally, in the policy world we like “Pareto” improvements – making at least one person better off without making anyone else worse off. Kaldor & particularly Hicks realized that this was a pretty limiting view of policy so they proposed a framework in which a policy improvement becomes one that makes the winners sufficiently better off that they could compensate the losers (and here is where it gets tricky and it’s not quite clear why they felt compelled to insert this) even if the compensation never takes place. Of course that broadens the realm of acceptable policy proposals quite a bit, especially when you do away with the inconveniences of the compensation.

My understanding of free trade as a policy is that it represents a Kaldor-Hick improvement. If it represents something more, there are a few million people in the Midwest who would like you to explain it to them. If it were anything less, that no one would be better off to a sufficient extent that we could compensate the losers sufficiently – the small possibility that Paul Samuelson speculates about and which, actually, I was not really discussing although the same logic flows from my argument – then we wouldn’t be having this discussion.

And so free trade is a worthwhile policy move if we can find economically efficient means to compensate the losers. And this is the basis for why people like Paul Krugman and Brad DeLong and others, decent caring progressives every one, argue in favor of free trade. The maddening part of this for progressives though is that the compensation invariably does not happen. Or it happens in the form of weak policy proposals like a few limp efforts to retrain or provide modest transition assistance to those workers who can demonstrate that they have been victimized by free trade. Ask all those workers in Wisconsin who lost manufacturing jobs in the last four years how happy they are with our trade adjustment policies.

So I have to confess a little uneasiness with Professor DeLong’s conclusion that if foreign competitors can improve their efficiency in areas where we export to such an extent that we export nothing, then “we are as badly off as if there were no international trade at all.” That is a statement which needs a lot of qualification since “we” is a pretty broad pronoun without a sufficiently accurate narrowing antecedent. Who exactly is as worse off? Who is better off? And who is about the same? Trying to compare a world of no free trade and saying it is about the same as a world of free trade with no comparative advantage whatsoever is a pretty hollow intellectual exercise and one my math skills just aren’t up to. At least I can comfort myself that I was not arguing in favor of no free trade. I was, alas, just trying to raise a question.

Which is something that KHarris doesn’t quite seem willing to believe. The extended discussion about the trade deficit and national savings rates seems to indicate a presumption that this was my prime concern. In fact, I agree that the two issues can be entirely separate since I grant that (by definition) the trade deficit is merely about consuming more than one buys. While I care a good deal about the trade deficit, I have no illusions that protectionism is likely to fix it.

Another accusation lobbed my way is that I have confused absolute with comparative advantage, just as so many non-economists before me. I will have to keep that one secret from my PhD micro professors at Harvard…shhhhhhh. But I will confess to having slept through my macro classes by and large (an indication of the surprising shallowness to be found on one of our parts and perhaps both) so I agree that it seems as though my argument confuses absolute with comparative advantage.

I suppose this is what you get for reverting to micro considerations in the midst of macro-economists. I was not actually challenging the view that free trade is good for the economy although I concede that this was an implication that was glaringly out there. There are really two arguments when it come to free trade: 1) whether the US economy is better off and I will grant the macroeconomists their claim that it is invariably so (although I will point with glee to Samuelson’s cautions in this regard) and 2) whether there are enough winners of a sufficient magnitude that we can compensate the inevitable losers from free trade in a compelling way that works within a market economy?

My concern is with the staggeringly large numbers of losers that are becoming apparent under free trade and that run the entire economic and class spectrum in the US. My interest is in asking everyone to stop for a moment and imagine what the future might look like and what those areas of comparative advantage are that we will have (granting that we are likely to have a few at least). My interest is in asking people who know how intellectually advanced India and China are and how much human capital they already possess (and are likely to possess in the future), how this is likely to impact the large number of industries where we currently enjoy a comparative advantage. My worry is that so much of the US current advantage in services and technology and media is replicable and pirate-able – a dangerous ground to lay one’s economic advantage. I share some of Brad’s readers concerns that the much vaunted 5 M’s (never mind IPO’s) are unlikely to be our economic saviors under further trade integration.

Comparative advantage means there will be some things we do better than anyone else. That there are currently lots of things we do very well I don’t challenge at all although some of the comments seem to think I do. But again, here we seem to be confusing country effects with individual effects. While we are hardly likely to mimic the market in all its Hayekian intelligence, we might ask ourselves what is the future likely to bring? Who would have imagined the outsourcing revolution 10 years ago? That’s what concerns most Americans. Of course we have competitive sectors today. The question is what are those sectors likely to be in 30 years and who is likely to populate them?

Obviously we will need to keep finding things we do better than others. But as the world becomes more and more competitive with us in more and more industries, it would behoove us to stop for a moment and ask ourselves how likely it is we can do that for a sufficiently large fraction of our population? Not only do we have to train and retrain large numbers of our workers to be competitive at the highest skill levels, we need to train them to be sufficiently productive that they can maintain the real wage differentials between here and China/India (Chindia?) If an Indian worker can do exactly what I do for $10 while I demand $80 I either need to find another profession or hope that my countrymen and I can up my productivity sufficiently that I am 8 times more productive than my Indian competitor. All of Kharris’s examples of trade in the same industry between nations are of trade between economic equals. The case of machine tools between Switzerland and the US is a great exemplar of this. Workers in the US are happy to compete with Swiss workers because in most cases they are more productive (and certainly more poorly compensated). The question is, will these same workers compete with Indian workers without a diminution of their living standards? The one case which may offer some support for free traders is that of Japan which did rapidly increase its standard of living without diminishing that of the mean US worker (by and large – I add as a qualifier, just keep me out of this debate).

The frustration of most Americans when it comes to discussions of free trade stems from the absence of free trade champions like economists (and New Democrats) when it comes time to have debates about fixing our schools, our health care system, our competitiveness, our training and retraining systems, and associated government policies. Another frustration stems from people’s intuitive understanding that both sides in the globalization debate are arguing about different things. One side is arguing about distributional effects while the other is arguing about overall economic effects (that are measurable in economic terms). This last qualifier is important since there are lots of things that won’t show up in a GDP/GNP report which are integrally related to utility – what people rally care about. As I said in my original post, if we work 80 hours a week today when we once worked 40 hours a week we are likely to be wealthier but we may not be better off, and we may not be able to make the kinds of trades necessary to get us to the previous state if those kinds of markets are missing.

I reject and resent the insinuation that I feel a need to keep India poor. What companies like Infosys and Cognizant have brought to India is a modern day miracle and portends greatness for East Asia. We should celebrate the rise in freedom and entrepreneurship (and wealth) that the previously moribund bureaucratic-state/entanglement that was India is now experiencing. But we should also ask ourselves about the future of the globalization discussion as the number of losers and the scope of losers across American and European society, from the very bottom to the very top, grows. For us to realize both a “Pareto” like state and continued support for global integration we need to do one of two things:

1) We find ways to make to compensation work. How to do this? Well, we could hope that a rising tide lifts all boats. I suppose it is theoretically possible (again I don’t wish to do the math) that globalization could make say 10% of Americans sufficiently better off that their economic activity circulates throughout the economy to lift most Americans’ living standards along with them. The Real Estate boom has been good to more than just land owners. The stock market bubble was good to more than just shareholders. But I am skeptical. Unless you repeal my version of the iron law of oligarchy – what I call the iron law of economic hierarchy -- it is unlikely that the top 10-20% of Americans are going to circulate sufficient resources to all of us to lift all of us up with them. Things certainly didn’t work that way in the Industrial Revolution when millions (of often cushily insulated guildsmen) were made redundant by the rise of factory production and piece rates. And income (mal)distribution was at levels we approach today I might add. It wasn’t until progressive political power wrought change in the workplace and economy that we could look back at guild opposition to industrialization and call them all Luddites. So if the tide swamps the boats rather than lifts them, the alternative is likely to be government redistribution of the gains – but managing to get that on the table seems to be a non-starter and managing to achieve redistribution without attendant efficiency losses that can be severe seems tricky to say the least.

2) So our second alternative is - we integrate discussions of political integration with discussions of economic integrations. Which I guess brings us back to Marx. Unless the workers of the world do unite, there are going to be an awful lot of American workers who find themselves racing towards the living standards of the Indians rising the meet them – not so much a race to the bottom as a race to the middle ground. One which, nevertheless, marks a serious (i.e. nontrivial) decline for millions of Americans.

Or we could just throw in the towel and raise the protectionist banner. It’s your call.

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