Trade within versus between nations

I am doing one of the “Conversations with Tyler” events on September 24^th, and in preparation for that, Tyler Cowen asked his blog readers to submit possible questions. As of this writing, there was a terrific list of challenging questions on the list. I want to offer some thoughts on one of those questions here – both because it has come up before and because it calls for the kind of elaboration that may be difficult at an event of this sort.

Here is the question that Don Boudreaux would like me to address:

“Rodrik was quoted in a 2007 New York Times report as saying that, while he follows the methods of modern economics, he rejects the “faith” [his word] – that says, among other things, that free trade is always good. And, of course, Rodrik is known for his ‘heterodox’ refusal to join in mainstream economists’ embrace of free trade.

So, ask Rodrik if economists who embrace free trade within a country are guilty of faith-based policy recommendations in the same way that he thinks economists who embrace free trade between countries are guilty of faith-based policy recommendations? If he answers no, ask him to summarize the relevant differences that separate intranational from international trade, and press him explain why these differences are real or strong enough to shift the burden of persuasion away from those who oppose a general policy of free trade and onto supporters of free trade.”

Let me preface my answer by stating the obvious: economics does not offer unconditional policy prescriptions. Every graduate student learns that depending on the background specifications, any policy x  can be good or bad. A minimum wage can lower or raise employment (depending on whether employers have monopsony power); a natural resource discovery can raise or lower growth (depending on the likelihood of the Dutch disease); fiscal consolidation can expand or contract output (depending on the respective strengths of expectational versus Keynesian effects). And yes, the dictum that free trade benefits a nation depends on a long list of qualifying conditions.

So the proper response to the question “is free trade good?” is, as always, “it depends.” When an economist says “I support free trade” s/he must mean that s/he judges the circumstances under which free trade would not be desirable to be very rare or unlikely to obtain in the context at hand.

Many of the conditions under which free trade between nations is guaranteed to be desirable are unlikely to hold in practice. Market imperfections, returns to scale, macro imbalances, absence of first-best policy instruments are ubiquitous in the real world, particularly in the developing world on which I spend most of my time. This does not guarantee that import restrictions will be necessarily desirable. There are many ways in which governments can screw up, even when they mean well. But it does mean that a knee-jerk free trader response is faith-based rather than science-based.

OK then, what about trade restrictions within nations? If I am a skeptic on free trade between nations, should I not be a skeptic on trade within a nation as well?

No, not really, because I think the set of circumstances under which free trade within a nation may be undesirable is substantially smaller than the set of circumstances under which free trade between nations is undesirable. This is not because the economic logic that drives commerce within a country is different.  It is because there are many more degrees of freedom in both the way that a region adjusts to trade and in the possibilities of governmental response.

So consider a case where a region loses out from trade within a nation – say because it de-industrializes rapidly and ends up specializing in technologically non-dynamic primary activities. One thing that can happen within a nation – and not across nations – is that the workers in that region can migrate to other regions and therefore partake in the benefits of trade that accrue elsewhere. That is how, for example, Southern states in the United States adjusted to the industrial dominance of the North.

Another thing that happens is that there is an overarching state that will engage in transfer payments and other policies that aid the lagging region. The region will have political representatives in the national government who will push for the interests of those adversely affected.  

A third – particularly important – feature is that a nation shares a common set of regulations (in labor, product, and capital markets). Changes in inter-regional trade patterns are unlikely to be the result of what many people feel are “unfair trade practices” or “tilted playing fields.” When I lose my company or a job, it is because another company worked harder, invested more, or innovated better – not because it denied workers their bargaining rights, despoiled the environment, or received huge subsidies.

This is not to deny that there are differences in institutions and regulations even within nations. Federal systems, such as the one in the U.S., generally admit greater variation. And there is (limited) labor mobility among nations too. But no-one can deny that the borders of the nation state do demarcate jurisdictional boundaries. The possibilities of harmful competition between nations are much larger.

The boundaries of a nation are defined by shared sense of collective purpose, as embodied, in part, in that nation’s common laws and regulations and in its instruments of solidarity. (The problems of the euro zone are in large part the result of the absence of such a common purpose and solidarity.) When citizens of a nation lose that sense of common purpose, we get the demands for break-up and secession.

So the national market and the international market are different. The defining characteristic of a national market is that it is deeply embedded in a set of social and political institutions – a common legal and regulatory framework provided by the nation-state. The international market is at best weakly embedded in transnational arrangements, and the arrangements that do exist such as the WTO and bilateral investment treaties are commercial rather than fully-fledged political/redistributive/regulatory arrangements.  

For a libertarian, I suppose this might be a distinction without difference. A libertarian might view much of the regulatory apparatus of the nation-state as superfluous at best and detrimental at worst. For me, the apparatus is what makes capitalism feasible and sustainable at the national level – and problematic at the global level.