Dani Rodrik's weblog

Double standards on trade?

In response to my summary on trade and prices, DM asks an important question, which goes right to the heart of the debate on globalization:

Let us say an new barber moves into my neighborhood. He offers the same quality service as my old barber, but is cheaper. So I use the new barber.

A factory in China can make the the same socks, but for less than a factory in North Carolina. So I decide to buy my socks from China.

Why is it that Dani wants interfere with my sock purchases, but not where I get my haircut?

First of all, let me be clear that I am not advocating that we interfere with purchases of socks from China (or anywhere else) as a rule. But I do believe there are circumstances under which such an interference would be warranted--and that is why DM's question is germane.  Elaborating on why gives me an opportunity to revisit a theme I have already written on.

DM thinks we should not apply a different set of standards to exchanges involving international trade than we do to those that are purely domestic.  I agree!  What I think he overlooks is that in fact we do encumber domestic exchanges with a lot of restrictions, and in some cases even outright prohibitions.  Domestic laws prevent you from selling yourself into bondage, to hire out your children for factory work, to flout minimum wage requirements, to exceed maximum hours of work, to employ workers in conditions that violate mandated health and safety requirements, and so on.  DM's new barber would not remain in business long were he not to comply with standards set by the local health board--regardless of whether DM would want to use him or not. These are instances of what the political philosopher Michael Walzer has called "blocked exchanges."  In each of these instances, one could have made an argument that it is improper for the state to come in between two consenting adults. Maybe DM thinks these domestic restrictions should be removed as well. But no matter.  The point is that restrictions do exist in domestic exchanges as well.  Individuals are never completely free to sign certain contracts.

The reasons that we routinely restrict and regulate domestic exchanges are manifold. Sometimes we do so to uphold deeply held norms and values (as with anti-slavery laws). Sometimes we want to redress bargaining imbalances (as with a lot of labor legislation).  Sometimes we worry about informational shortcomings (as with health and safety standards).  When we try to disassociate international trade from such concerns, we in fact create a double standard: it is not OK for me to displace American workers by employing child labor at home, but it becomes OK for me to do the same by employing child labor abroad. (A society may of course choose to condone the latter after due consideration of the alternatives for children in the exporting country; my argument is just that there cannot be an automatic presumption to that effect.)

There are of course many instances when international trade does not impinge on social and moral considerations at home, and such difficulties do not arise.  But treating international trade just like domestic exchanges does raise difficult questions of fairness and distributive justice.  It is hardly a solid justification for free trade. 

Oligarchic capitalism in one country

Something funny happened to Russia on its way from socialism to capitalism. A bunch of politically-connected "oligarchs" managed to subvert the process while making themselves hyper-rich. In a fascinating paper, Serguey Braguinsky asks " whether oligarchic capitalism represents a transition stage that will eventually lead to a true market economy and political democracy, or whether it is a blind alley that can only lead to another inefficient socioeconomic system." He is not optimistic. A major contribution of the paper is its database of almost 300 oligarchs covering a period of ten years. Among its conclusions: the newer generation of oligarchs, who had little connections to the old nomenklatura system and who could have produced a true entrepreneurial class, ended up engaging in rent-seeking and asset-stripping instead, becoming virtually indistinguishable from the old kind. UPDATE: A couple of readers have taken me to task for using the word "funny" in the opening sentence. As they correctly point out, what has happened to Russia in this respect is hardly funny. I apologize for my poor choice of words.

Trade and prices: an attempted summary

Can we all agree on these?

1. Trade policy works through its effect on the relative prices of goods, not through the price level.
2. Depending on what side of the change in relative prices they find themselves, any specific group of consumers or producers can be made worse off by a move to free trade.
3. A corollary: there is no guarantee that free trade raises real wages.
4. The Carlos Diaz-Alejandro rule: For almost any particular conclusion you want to arrive at, there is some economic model that will take you there.
5. Throw in some scale economies (dynamic or otherwise), and then just about anything can happen (including free trade making some countries worse off).
6. The positive spin: This does not diminish the value of economic modeling; it simply means we have to be more careful with generalizations and be more explicit about the assumptions that lie behind our reasoning.
7. Bottom line: It is possible to have an illuminating (sometimes), intelligent (mostly), and entertaining (almost always) economic debate in the blogosphere.

On the dynamic effects of trade

Steve Randy Waldman has a terrific post on the ongoing debate on free trade. He refers to a passage in Tyler Cowen's recent post on the same subject which caught my attention. This is what Cowen says:

More empirically, having your export prices bid up is a wonderful driver of growth more than it is a distributional or efficiency nightmare.  The net externalities of that process are usually positive rather than negative, even without firm- or industry-level increasing returns in the traditional sense.  The exports help build a middle class and in the long run make democracy and rule of law possible.  The dynamic effects are the key to the benefits of trade, and neither the Ricardian nor the Heckscher-Ohlin model is satisfactory.  The best simple (ha!) model has trade bringing more innovation, new goods with high consumer surplus, greater reason to work hard and get ahead, greater domestic inequality, a growing middle class, and new and usually more liberal political coalitions.

The claim in this paragraph may or may not be true in general (I can certainly think of stark exceptions beyond oil and diamonds which Cowen subsequently mentions—think of cotton exports in antebellum U.S. for example).  But the reason the excerpt made me jump is the similarity it has to arguments that proponents of import substitution often make in support of trade protection. After all, if you believe higher prices for your industries are good for all kind of dynamic and political effects, why not apply the same reasoning to your import-competing industries as well—especially if they are the only industries you have (your exports being dominated by traditional commodities). Now, we can suppose that competing in world markets is different than producing for the home market and bring in additional considerations. But the main point is this: the more we depart from the standard models, the more we open up the field to all kinds of unconventional conclusions.

Which is totally fine by me. Really.

Can the wrong answer in the classroom be the right answer in public debate?

I don’t think so, but it looks like we may be disagreeing with Greg Mankiw here.

In an interesting comment on my previous post dealing with the effect of trade on the price level, Greg notes that I am right “in theory,” but that he is “more sympathetic to the ‘lower prices’” view than I am for a couple of reasons. He writes:

1.  Defenders of free trade rarely are in a position of having to defend exports, because people think that exports create jobs. When people complain about trade, it usually about the alleged job-destroying effect of imports. This partial-equilibrium complaint naturally encourages a partial-equilibrium retort: imports lower prices for consumers. The losses to producers in these markets are more than offset by gains to consumers from lower prices. True, the full story can only be told in general equilibrium, where it is relative prices that matter for the allocation of resources. But the distinction between the absolute price level (determined by monetary forces) and relative prices (determined by numerous market supply and demand curves) looms larger in the minds of economists than laymen. The reason is related to my second point.

2. People sometimes instinctively treat the nominal wage as the numeraire. That may be because it is one of the stickier prices around. So maybe when we hear people say that trade lowers prices, we should interpret the statement as meaning that trade lowers the price of a basket of consumer goods for a given price of labor. That is, trade raises real wages. This is one simple way of translating the basic Ricardian model (in which trade expands both trading partners' consumption opportunities) into a language that is a bit more familiar to the general public.

Now, neither of Greg’s arguments is exactly right. On his first point, there is no theorem that guarantees that the partial-equilibrium losses to import-competing producers “are more than offset by gains to consumers from lower prices.” My wheat-and-beef example in Argentina is exactly an instance where this supposition fails. And on his second, trade theory does not guarantee that real wages of workers rise as a result of free trade, as Stolper and Samuelson showed long ago. (Greg knows this of course, which is why he qualifies his statement by referring to the basic Ricardian model, which is a highly special model where labor is the only factor of production and gains from trade have to show up as higher real wages.)

But the real reason for this post is different. I want to take issue with the general philosophy behind Greg’s argument, which is that a less than full (and possibly misleading) story in support of your argument is OK as long as it helps disarm your opponents in public debate.  His position seems to be this: Look, these anti-trade guys don’t understand comparative advantage anyhow, and it is pointless to waste our breath trying to explain it to them. So let’s instead argue our case in “their” language and within “their” framework. Never mind that Professor Greg Mankiw would flunk us if we ever gave the same answer in Ec. 10.

I am not sure I like this stance very much.  For one thing, it goes against the grain of what I think is the most important job of economists in public debate--to educate and not simply to be an advocate.  Second, it is bound to backfire, and ultimately undercut the credibility of economists.

Here is an apt example. Years ago, when NAFTA had just been negotiated and was being debated heatedly, the Institute for International Economics (now the Peterson Institute) put out a study that tried to counter widespread fears that the Agreement would destroy U.S. jobs. How did it do so?  By calculating the jobs that would be created by additional exports to Mexico.  And since Mexico had a whopping trade deficit with the U.S. at the time (in 1993, just before the peso crisis), it was relatively straightforward to show that more jobs would be created than lost!  Unfortunately for the IIE, soon after NAFTA was signed, the Mexican peso collapsed (no claim of causality here), and Mexico’s trade deficit turned into surplus. Anyone who used the same methodology could now calculate that NAFTA was in fact bad for U.S. employment.  Try now to explain to members of Congress that trade is all about efficiency in resource allocation and not about employment… 

There is a broader and potentially quite useful discussion to be had here on the manner in which economists should engage in the public debate.  Many of my colleagues are of the view that economists should just stick to their bottom line, and not "confuse" the public with the caveats and limitations of their arguments. Moreover, since anti-market views have enough supporters out there, economists often see their role as one of unqualified advocacy of the opposite position. I tend to disagree with this, which is why I am often accused of "giving ammunition to the barbarians."

To be continued ...

Does Free Trade Bring Lower Prices?

Daniel Drezner has some nice things to say about me and my blog, but then takes me to task for understating the gains from free trade in a recent entry. He writes:

In focusing strictly on the employment effects, however, Rodrik elides the biggest gain from trade -- lower prices.

Since Drezner’s point reflects a common misunderstanding about the effects of trade, it is worth some explication.

Advocates of globalization love to argue that free trade lowers prices, and the argument seems sensible enough. Think of all the cheap goods from China that we can buy at Wal-Mart.  But anyone who understands comparative advantage knows that free trade affects relative prices, not the price level (the latter being the province of macro and monetary factors).  When a country opens up to trade (or liberalizes its trade), it is the relative price of imports that comes down; by necessity, the relative prices of its exports must go up!  Consumers are better off to the extent that their consumption basket is weighted towards importables, but we cannot always rely on this to be the case.

Consider your typical Argentinian for example, who consumes a lot of wheat and beef. Since these are export products for Argentina, free trade implies a rise in the relative price of the Argentine consumption basket. (The gains from trade are still there, of course, but they derive from the usual allocative efficiency improvements, not from lower prices across the board.) And in the U.S., the Wal-Mart effect has to be qualified to take into account the fact that the relative price of the goods that the U.S. exports (including for example agricultural commodities) is higher than it would have been absent trade.  Similarly, when the U.S. gets better market access abroad for its agricultural exports (a key demand under the Doha round), you can be sure that this will raise domestic prices for these goods, not lower them. 

Of course, if you are running a huge trade deficit like the U.S., you can have cheaper prices all around—for all to go on a consumption binge as long as the party lasts.  But this is hardly the argument we make when we teach the benefits of free trade. 

Postscript:  It is interesting that many of the commentators below have appealed to scale economies as an explanation of how production costs and prices can fall all around as market size expands thanks to trade. Yes, this is a possibility.  But scale economies raise a whole set of new conundrums (which is why I had stuck with the standard comparative advantage story). In particular, since scale economies are not compatible with perfect competition, we find ourselves in a second-best world with all kinds of strange possibilities. Opening up to trade can leave some countries worse off, and in general trade-distorting policies like tariffs and subsidies can make individual countries better off. So be careful how you describe the world we live in...

Roberto Mangabeira Unger goes to Brasilia

It seems like stuff out of a dream. My Harvard Law School colleague Roberto Mangabeira Unger, at once the most erudite and impenetrable man I know, has just been appointed a minister by President Lula in Brazil.  Roberto will be heading a new ministry called, improbably, “the special secretariat for long-term actions.” His task: to draw out a long-term strategy for Brazilian government and society.

I taught a course called “One Way or Many” with Roberto for three years, and he has been one of my two most important sources of inspiration in recent years. He is not an easy man to follow, and I have often joked that it took me the whole three years to understand what he was saying in our course. Check this out for a sample of what I mean. But he is an incredibly imaginative and liberating thinker once you start getting the hang of his distinctive form of rhetoric.  My ideas on institutional pluralism, expounded here among other places, owe a great deal to my interactions with him.

Interesting times are in store for Brasilia …

What is in a name?

In one respect, starting a blog has taken me back to my early days as an academic economist.  Since I have an unusual name, references to my work initially often employed a variation on Rodrik, typically "Rodrick."  I was happy enough to get referred to, so I didn't fret too much about it, and in due time, the misspelling virtually disappeared. I took that as a definitive sign of having made it.

But I have been reliving this experience in the last couple of days, ever since Greg Mankiw set off (I think he is the one) an avalanche of references and links to my new blog.  "Rodrick" has remade its appearance, along with other imaginative variations. See here, here, and here.

Once again, I have no complaints. I have been called a lot worse things in recent years...

And in case you are interested (and let me know if you are), I will tell the longer story of how I got my name in some later entry.

Vice Squad hits it spot on

Jim of Vice Squad welcomes me to the blogosphere--the "world of misplaced priorities" as he calls it. Having observed my behavior over the last few days, my wife is convinced Jim's take on the blogosphere is right... 

Trade and procedural fairness

Economists fail to appreciate sufficiently that globalization often runs into a procedural fairness roadblock.

Imagine some change in the economy leaves Tom $3 richer and Jerry $2 poorer, and I ask you whether you approve of this change.  Few economists, regardless of their political and philosophical orientation, would be able to give a straight answer without asking for more information. Is Tom richer or poorer than Jerry to begin with, and by how much? What are their respective needs and capabilities? And what exactly is the nature of the shock that created this redistribution of income? It would be one thing if Tom got richer (and made Jerry poorer) through actions that we would consider unethical or immoral; it would be another if this was the result of Tom’s hard work and Jerry’s laziness. In other words, most of us would care about the manner in which the distributional change occurred--i.e., about procedural fairness. The fact that the shock created a net gain of $1 is not enough to conclude that it is a change for the better. 

    

Yet when we teach comparative advantage and explain the gains from trade, we typically overlook this important conclusion. We expect our students to focus on the net gain triangles and disregard the rectangles of redistribution.  In particular, we do not ask whether the trade opportunity involves an exchange that most people would consider unacceptable if it took place at home. So it is immaterial to our story if the gains from trade are created, say, by a company shutting down its factory at home and setting up a new one abroad using child labor. (By the way, I chose $3 and $2 in my example as these values are commensurate with the relative magnitudes that come out of trade models under reasonable elasticities.)

The thought experiment clarifies, I think, why the archetypal man on the street reacts differently to trade-induced changes in distribution than to technology-induced changes (i.e., to technological progress). Both increase the size of the economic pie, while often causing large income transfers. But a redistribution that takes place because home firms are undercut by competitors who employ deplorable labor practices, use production methods that are harmful to the environment, or enjoy government support is procedurally different than one that takes place because an innovator has come up with a better product through hard work or ingenuity.  Trade and technological progress can have very different implications for procedural fairness.  This is a point that most people instinctively grasp, but economists often miss. (Notice that even in the case of technology, we have significant restrictions on what is allowable—c.f. human-subject review requirements—and wide-ranging debates about the acceptability of things like stem-cell research.)