Sunday, March 16, 2008

The Dishonesty of Economists about Trade

Trade policy is likely to grow into a larger issue in the course of the Presidential campaign. A good thing, I used to think. But is it?

A lot depends on how economists succeed in framing the issues as advisors to the candidates and as commentators in the media. Sadly, most economists cannot be trusted to portray the issues honestly.

That’s my view. Dean Baker, an economist who is co-director at the Center for Economic and Policy Research in Washington, D.C., has a similar view. He holds that “economists have been extraordinarily dishonest in their interventions in public debates over trade policy.”

He develops his case at length in an article, “Trade and Inequality: The role of economists,” in the March 15 issue of the Real World Economics Review. Leading his indictment is this charge: economists “have acted to conceal the fact that a substantial group of workers, quite likely the majority of the workforce, can expect to be losers from the recent path of trade liberalization.”

Baker’s analysis of economic theory applied to current trade patterns leads to this conclusion: “The winners are likely to be owners of capital and highly educated workers, with the rest of the populations ending up as losers.” This outcome isn’t accidental, he explains; “it is literally the mechanism through which the economy experiences gains from trade.”

Baker blasts the major media outlets for the “enormous respect” they show for the trade policy ideas of mainstream economists and for the ridicule poured on those who disagree.

As it happens, the March 16 New York Times has an example of that. It features a discourse “Beyond the Noise on Free Trade” by N. Gregory Mankiw, professor of economics at Harvard and onetime advisor to President Bush and to Mitt Romney in his Presidential campaign.

In his first paragraph, Mankiw writes: “No issue divides economists and mere Muggles more than the debate over globalization and international trade. Where the high priests of the dismal science see opportunity through the magic of the market’s invisible hand, Joe Sixpack sees a threat to his livelihood.”

Unfortunately in his view, the Muggles and Joe Sixpack don’t benefit from economic courses such as his at Harvard, and doesn’t understand that “trade between two countries creates winners and losers, but it leaves both nations with greater overall prosperity.” As a result, the general public is “less likely to take its cue from Adam Smith than from Lou Dobbs.”

For Mankiw, Senators Clinton and Obama have erred in making Nafta the “latest whipping boy of the ant-globalization crowd.” What consoles him is that their “populist rhetoric” will disappear after the election, and like President Bill Clinton, will rely on the advice of economic moderates like Robert E. Rubin, former Treasury Secretary.

Harvard economist Dani Rodrik on March 16 posted a short item on his weblog titled “Why doesn’t the public buy the economists’ advocacy of free trade?” The posting in full:

“Greg Mankiw bemoans the huge gap between the economics profession and the common people on free trade. Unlike him, I tend to think the fault with economists, who have traditionally proselytized free trade rather than communicated what economics really teaches on trade. Dean Baker offers a sensible guide.”

Rodrik’s words, really teaches, link to an earlier (September 22, 2007) posting praising an analytical paper by Robert Driskill, professor of economics at Vanderbilt, who Rodrik says “knows the theory of comparative advantage as well as anyone else.” Here is a quote from that Driskill paper:

“Unfortunately, most economic writing on the welfare implications of trade is not a balanced weighing of the evidence, or a critical evaluation of the pros and cons of arguments, but rather more akin to a zealous prosecutor’s advocacy of a point of view. As such, this writing is designed to persuade rather than to give the reader the information needed to form an educated point of view.”

To a Driskill passage on how poorly supported positions on trade can confuse people “into false positions about what economics really says about the effects of international trade,” Rodrik added the comment: “A pervasive such false belief, for example, is that trade necessarily benefits more people than it hurts.”

That such a false belief is regularly promulgated by the New York Times is bad enough. Far more troubling is that many economists are teaching this falsehood (and others) about trade in the nation’s colleges and universities.

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David Hummels said...

I'm one of those dishonest economists.

I was with you on this post until the very last line, which is totally wrong. Textbook models of trade -- almost by definition what we teach in the nation's colleges and universities -- have this to say. Trade leads to winners and losers, but the dollar gains exceed the dollar losses. In other words, trade raises real incomes in the aggregate. However, a particular household doesn't consume aggregate income, they consume household income so trade can make them better or worse off. We emphasize this very heavily when we teach this stuff. Everyone does since its at the very heart of the economic logic. That's Baker's point.

Now, the next thing we usually say is that because the gains exceed the losses, you could make everyone better off -- if you compensate the losing households along the way. I think that the fundamental problem is that we leave off that last conditional phrase when we're speaking in public.

As a final note, "compensating the losers" would generally require that you tax away some of the gains from globalization to owners of capital and highly skilled workers, and of course our domestic tax policy has gone in quite the opposite direction on this front. The arguments against taxing imports are not so different from the arguments against taxing capital and human capital -- they lead to efficiency losses in the economy. An important question is then which taxes lead to the smallest efficiency losses: would you rather tax capital and human capital directly through corporate income taxes, capital gains taxes and more steeply progressive personal income taxes; or would you rather tax these factors of production indirectly by engaging in less trade thereby lowering the returns to these factors? (If Microsoft can't sell in China, it lowers the return on their investment in Office, and makes Bill Gates and lots of software programmers poorer.) These are very subtle questions, which is perhaps why no one gets into it in public.

Pete Murphy said...

David, I have to disagree. While textbooks may teach that "trade raises real incomes in the aggregate," the real-world experience by the U.S. proves otherwise. Median income in the U.S. has been in decline for decades. This is happening because the whole premise of free trade - Ricardo's principle of comparative advantage - is flawed. It is flawed because it does not take into consideration the effect of population density and what happens when two nations with grossly disparate population densities attempt to trade freely.

As population density rises beyond some optimum level, per capita consumption begins to decline. This happens because when people are forced to crowd together and conserve space it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (which always rises), inevitably yields rising unemployment and poverty.

When a less densely populated nation like the U.S. attempts to trade freely with one that is much more densely populated, the economies and labor forces of the two nations combine. The work of manufacturing is spread evenly across this combined work force. But while the more densely populated nation gets free access to our healthy market we, in return, receive access to a market that is emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs for the less densely populated nation.

The results of free trade bear this out. Since 1976, the U.S.'s cumulative trade deficit now totals $8.6 trillion. In 2006, of the top twenty per capita trade deficits in manufactured goods, eighteen were with nations much more densely populated than the U.S. Even more revealing, when our trade partners are divided equally around the median population density, in 2006 we had a $17 billion trade surplus in manufactured goods with the half of nations below the median population density. With the half above the median we had a $480 billion deficit.

While free trade in natural resources and free trade among nations of approximately equal population densities is indeed beneficial, just as the textbooks predict, it is a sure-fire loser when attempting to trade freely with a nation much more densely populated.

Your suggestion about "compensating the losers" in free trade by taxing the winnners, by your own admission, would "lead to efficiency losses in the economy." Carrying this a step further, one realizes that efficiency losses will only exacerbate the trade imbalance. That solution would result in a downward spiral.

In every other field, the collective effort of experts yields positive results. The medical field yields new breakthroughs in the fight against disease almost daily, and the growth in life expectancy is proof. The collective effort of engineers and scientists produces incredible advances in computer and communication technology and, in fact, in every product imaginable. Economics is the one field that doesn't measure up. The collective effort of economists over the last several decades has virtually destroyed America's balance sheet. Our combined trade deficit and cumulative federal budget deficit (much of it money spent to counter-act the negative effects of the trade deficit) now total nearly $20 trillion. The U.S. has been transformed from the world's preeminent industrial power to the skid row bum of the world, literally begging other countries for cash to keep it afloat. The time has come for economists to recognize that they're missing something - that their beloved principle of comparative advantage is fatally flawed.

Pete Murphy
Author, Five Short Blasts