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Saturday, April 28, 2007

On the Other Hand . . . . Rodrik versus Mankiw (Others Also Weigh In)

Dani Rodrik and Greg Mankiw are debating a couple of issues. (Update: Paul Krugman also comments on this debate, see the first update at the end of the post. Update: See the response from Greg Mankiw and and his follow-up. Update: Tyler Cowen and Kash Mansori add their thoughts. Update: David Altig too. Update: Paul Krugman adds more thoughts. Update: Two more from Dani Rodrik. Update: PGL at Angry Bear follows up. Update: Two more from Alex Tabarrok and Brad Setser)

The first is the effect, if any, of globalization of the aggregate price level versus its effects on relative prices (PGL at Angry Bear comments on this as well), and the second is how to present economic results to the public and policymakers. e.g. how much to qualify results when advocating for policies such as free trade. I want to focus more on the second issue, but I'll include both:

The debate started with this post by Daniel Drezner:

The greatest threat this blog has ever faced, by Daniel Drezner: ...I have to take issue with the central argument of this Rodrik post:

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.... In other words, most of us would care about the manner in which the distributional change occurred--i.e., about procedural fairness....

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. ...

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.

I don't disagree with Rodrik's political argument here per se -- but I do have a few quibbles about it's generalizability... In focusing strictly on the employment effects, ... Rodrik elides the biggest gain from trade -- lower prices. ...

Drezner makes more points than this one, but it was this particular assertion about lower prices that brought a response from Dani Rodrik:

Does Free Trade Bring Lower Prices?, by Dani Rodrik: Daniel Drezner ... 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. ...

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...

Greg Mankiw then comes to the defense of the idea that trade can lower prices, at least as a debating point:

Does free trade lower prices?, by Greg Mankiw: Dani Rodrik debunks what he considers a myth:

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!

Dani is right about the theory, of course. But I am more sympathetic to the "lower prices" summary of it than he is, for two reasons.

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.

Dani Rodrik then responds to Greg with:

Can the wrong answer in the classroom be the right answer in public debate?, by Dani Rodrik: 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. ...

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. ...

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 ...

Finally, Greg updates his post above in response to Dani:

Update: Dani responds. I disagree with Dani when he says:

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.

If you go back to his example, he says that "these are export products for Argentina," whereas in point 1 above I was describing a country that is a net importer of the good. For net exporters, prices do rises when a country moves from autarky to free trade. In this case, the gains to producers more than offset the losses to consumers. For readers who want to see a diagrammatic explanation of these two cases, see chapter 9 of my favorite textbook.

The more interesting and difficult issue that Dani raises is how many caveats economists should include in their analysis when they present their ideas as part of the public debate. All economic analysis involves simplifying in order to clarify. This is, in a sense, the very essence of building a model. The big question is deciding when simplification becomes oversimplification. Without doubt, that judgment call is always tough. One has to be careful not to make the best the enemy of the good.

I agree this can be a tough call at the margin, but most of the time I think it's fairly clear-cut. If you are aware of important theoretical or empirical caveats to the ideas you are presenting, then those need to be identified. That's when I see a dishonest presentation - when the person making the argument knows about important contrary evidence that they themselves believe undercuts their position, but they leave it out so as not to "confuse" the public. The other side of this is to include theoretical or empirical results that you have reason to believe are questionable just because they support your argument. Either say clearly the work is questionable, or better yet leave it out entirely.

It's not easy. Very recently, I wrote:

I thought about saying that this [made people better off] - more choice and competition in programming would enhance consumer welfare - but I kept coming up with special cases in my head where that wasn't necessarily true so I didn't make that point (too many qualifications needed to make the assertion).

But as I said, much of the time it isn't that hard. If you know about related theoretical or empirical work and you think it makes an important point, even a contrary one, you have an obligation to note that somewhere in your argument. If something supports your case, but you have reason to question the validity or strength of the results, say that clearly or leave it out.

I'm guessing this isn't over. I will add updates as the debate unfolds.

Update: And here is one now. This follow-up from Greg Mankiw discusses which trade model is better to use for policy discussions about issues such as globalization, the Ricardian model or the Heckscher-Ohlin model? As Greg notes:

Ricardo vs Heckscher-Ohlin, by Greg Mankiw: ...The Heckscher-Olin model assumes two factors of production--capital and labor--which is surely more realistic. But more notable in the Heckscher-Olin model may be the assumption that capital cannot move from country to country. That assumption is key to many results. Yet, in today's global economy, capital is highly mobile across national borders. In light of this fact, I wonder whether it may be better to work with a model that includes labor as the only immobile factor of production. ...

As a tentative conclusion, therefore, I am inclined to think that in a world with significant capital mobility, the Ricardian theory of trade is more useful than Heckscher-Olin.

Greg has more explanation of this conclusion in his post. I think this is the right approach. Choose the model that best answers the question you are interested in (and that can vary with the question you are asking) and then, if there are weaknesses in the model you choose that may affect the conclusions, those ought to be clearly identified and explored. If the weaknesses in the existing models are significant enough, it's time to start building new models.

Update: By email, Paul Krugman adds (Dani Rodrik also talks about the NAFTA example):

Paul Krugman: I'm a bit surprised by the whole debate here. Maybe it comes from being, first of all, a trade economist, but I thought the whole "but prices are lower" answer was killed 65 years ago by Stolper and Samuelson. Just making capital mobile isn't enough, because there's still the issue of distribution between skilled and unskilled workers. It's very hard to come up with a model in which at least some group of workers isn't hurt by trade (unless it's intraindustry specialization based on increasing returns between countries with similar resources, like auto trade between the US and Canada.)

As for the whole Noble Lie theory of selling free trade with happy stories, this has a tendency to backfire. Case in point: there was and is a good argument for NAFTA, but the way supporters made the case back in 1992-3 - highly dubious arguments that the US trade surplus with Mexico would rise, creating jobs - was disreputable (I said so at the time) and quickly became a sick joke after the 1995 peso crisis. I actually covered that debate in my trade policy class last week, and felt ashamed all over again.

Update: Greg Mankiw emails:

Very odd. I wasn't proposing a Noble Lie, just a strategic simplification for purposes of clarity. If simplifying is lying, then all economic modelling is lying.

On the issue of skilled vs unskilled, I just posted an update on that topic.

Greg

And here's the update Greg did:

Update: Astute commenter mvpy points out the importance of human capital, which is left out of these conventional trade models. Human capital such as education is undoubtedly central to understanding cross-country differences, but it unclear to me what the best way to incorporate it for the issues at hand.

One might assume that physical capital moves internationally to equalize the marginal product around the world but that human capital cannot move. After all, as an American, I can easily invest in Toyota stock but not in a college degree of a Japanese worker. In this case, one might be lead to the conclusion that the right distinction for Heckscher-Olin is not capital and labor but instead skilled and unskilled workers.

But there's another way to think about the issue. Suppose every family decides how long to keep their children in school. Each faces a tradeoff between marginal investments in human capital and marginal investments in financial instruments, such as a savings account at a local bank. If financial returns are equalized around world through capital flows, and families make their human capital decisions based on opportunity cost, then rates of return on all forms of capital would move toward equality. Human capital could become, in effect, an internationally mobile factor of production.

Time horizon clearly matters here. Human capital is quasi-fixed. In the short run, we should take it as given. In the the long run, it adjusts in response to incentives. The same might true of physical capital because of adjustment costs, but for human capital, it takes longer to reach the long run.

Update: Tyler Cowen comments:

...The real gain from trade is the additional output; it should not be surprising if the pecuniary externalities (higher and lower prices) should prove a wash rather than an additional net gain. In fact a wash of the pecuniary externalities helps ensure that the output effect dominates the welfare calculus.

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.

Empirically, the troubled cases of trade typically involve exports of oil or diamonds and subsequent corruption. The relevant problem with trade is not higher prices for home consumption, in fact home consumption of those commodities is usually quite low. How much oil does Guinea-Bisseau use? We're left with Mexico and corn prices as a possible example, but note that Mexico would have much lower corn prices with free trade in corn. And it is U.S. government subsidy, not the market, bidding up the price of corn in the first place.

Maybe we're left with this as the relevant real world example: outsourcing in India drives up wages and makes life harder for people who want lots of servants.

My Inner Misesian is uncomfortable with Rodrik's strong distinction between relative prices and the absolute price level. Productivity shocks (which are in critical regards analogous to an expansion of trade) can and do lower most of the prices we face, albeit not all of them.

I don't disagree with Rodrik's claims about positive economics, although they don't quite "shade" as I might wish. I would have liked to have seen the sentence: "The early 20th century trade theorists discussed by Jacob Viner and Gottfried Haberler knew about these problems, but they also realized they did not, when viewed in a realistic context, weaken the case for free trade."

Update: Kash responds to Mankiw's analysis of which trade model is best, the Ricardian model or the Heckscher-Ohlin model:

As you may be aware already, there has been an interesting debate going on in the econ blog world between Greg Mankiw and Dani Rodrik. ... The most recent entry is Mankiw's Ricardo vs Hecksher-Ohlin. He asks the question: "Which model is more useful in thinking through issues in trade policy: the Ricardian model or the Heckscher-Ohlin model?" After considering the implications of mobile capital, he then writes that "[a]s a tentative conclusion, therefore, I am inclined to think that in a world with significant capital mobility, the Ricardian theory of trade is more useful than Heckscher-Olin."

I'd like to contribute a different perspective on the issue. As every economist would surely agree, Mark Thoma is absolutely correct when he writes

Choose the model that best answers the question you are interested in (and that can vary with the question you are asking) and then, if there are weaknesses in the model you choose that may affect the conclusions, those ought to be clearly identified and explored.

But that is not what Mankiw does when he reaches his tentative conclusion in favor of the Ricardian model. Rather than work from the question that needs to be answered, Mankiw seems to be comparing them based on which model is less unrealistic (after all, we must acknowledge that both models are - by design - grossly unrealistic). Since economic models are not meant to be at all realistic, but rather are intended to help teach us through analogy, I find Mankiw's answer unsatisfying.

When I teach international trade theory, my students find that the Ricardian model is the simplest and easiest-to-grasp illustration of the answer to one big question: can international trade leave both countries better off? The Ricardian model makes it easy to see that the answer is yes, which is what the model was designed to show, and is the single best thing about it.

But I don't really think that that is the only important - or even most important - question asked about trade policy today. Instead, trade policy now is at least as concerned with much more subtle questions like what specific form(s) will the gains from trade take if we pursue trade policy xyz?, or who will gain and who will lose from trade policy xyz?

For better or worse (and I think it's probably for the better), trade policy today must have as a crucial component some consideration for the distribution of the benefits of trade, and not just be concerned with whether trade liberalization will make some aggregate measure of US economic activity go up or down. These concerns are vitally important for moral, economic, and political reasons, and must be addressed when it comes to the creation of trade policy.

And when it comes to questions of the distribution of the gains from trade, the Hecksher-Ohlin (H-O) model is ideally suited to give us important answers - because that is exactly what it was designed to do. The H-O model provides us a simple and clean insight into how and why there are winners and losers from any given international trade policy, and exactly who they might be. That's why I find my mind automatically turning toward the H-O model for guidance whenever any new trade policy issue comes up, not the Ricardian model.

The Ricardian model is great for illustrating that countries as a whole can benefit from trade. But trade policy today must consider a whole lot more than just that simple calculation. So for my money, when it comes to current questions of trade policy, the H-O model is the one that has much more relevance.

Update: David Altig says:

The blogger epicenter of the free-trade debate is rumbling at Harvard, with Greg Mankiw and Dani Rodrik engaged in a terrific -- and important -- conversation about winners, losers, and how (or whether) economic theory divides the two. You can check-in on the state of the debate at Angry Bear, where pgl provides the appropriate links. It is highly recommended reading, but I think it ought to come with a few warning labels. For example, Professor Rodrik responds to Professor Mankiw with this claim:

... 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.”

In a related vein, pgl opens his post with:

As we were applauding Dani Rodrik, Greg Mankiw was defending the Dan Drezner lower prices from free trade benefits everyone fallacy.

Let's be perfectly clear: There are no theorems in economics that guarantee anything about the real world. Economic models are not descriptions of physical realities but formalizations of stories about how social interactions deliver particular outcomes. Different, equally coherent, stories deliver different predictions about the world. The claim that "free trade benefits everyone" is not a fallacy, but a particular outcome based on a particular model. Different models deliver different answers, so theory alone does nothing beyond eliminating stories that are internally inconsistent.

Or, perhaps, unconvincing. The missing ingredient in this most recent installment of the free-trade discussion is evidence in favor of one story or another, a task that is a good deal messier than writing down models. What makes matters worse is that adjudicating the issue is not a mere matter of counting up winners and losers. In the court of determining what is "good" or "bad", economists have standing to address one question, and one question only: Can someone be made better off without making anyone worse off? That too depends on the model at hand, and in fact it's even worse than that. The Rodrik-Mankiw debate revolves in part around a result known as the Stolper-Samuelson theorem. Greg Mankiw does a good job explaining Stolper-Samuleson and its relevance to the subject at hand, but I'll note one item from the Wikipedia description of the theorem:

If considering the change in real returns under increased international trade a robust finding of the theorem is that returns to the scarce factor will go down, ceteris paribus. A further robust corollary of the theorem is that a compensation to the scarce-factor exists which will overcome this effect and make increased trade Pareto optimal.

In simple terms, there are losers, but the winners can win enough to more than match those losses. All would be well with the world if the winners and losers could be easily identified, and an appropriate compensation scheme implemented. But what if that is not feasible? What is the right move then? To protect the losers at the expense of significant opportunity cost to potential winners? The other way around? I've yet to encounter an economist trained to answer those questions, and you should be very suspicious of any who speak as if they are.

Update: In a later post here, Paul Krugman adds a few more thoughts via email:

Paul Krugman: Another thought or two on distribution and trade policy:

The problem of losers from trade isn't new, obviously, either as a fact or concept. But if you look at the history of trade policy - say, in Matt Destler's book it's hard to avoid the sense that the issue has gotten bigger and harder. His final chapters have a definite sense both of nostalgia for the good old days and foreboding.

I'd put it like this: in the old days, when GATT negotiations were mainly with other advanced countries, the groups hurt tended to be highly specific and local - the left-handed widget makers of Northern South Dakota, worried about competition from their counterparts in Upper Lower Swabia. Economists could in good conscience argue that while individual groups were hurt by trade liberalization in their specific sector, the great majority of Americans benefitted from general trade liberalization. And politicians made trade deals by packaging together the interests of exporters, to offset the parochial interests of import-competing industries.

But now we're talking about broad swaths of the population hurt by trade. It's a good bet that almost all US workers with a high school degree or less are hurt by Chinese manufactured exports, at least slightly. You could in principle put together win-win packages - say, trade liberalization together with an increase in the EITC paid for with higher taxes on high-income Americans, who come out winners from trade. But the reality is that we don't make those deals.

For those who like their jargon, by the way, I'm basically saying that the right model for thinking about this has gone from many-good specific factors to Heckscher-Ohlin.

I don't have answers to this. The moral case for open markets is their importance to poor countries: America would do OK even in a highly protectionist world, but Bangladesh wouldn't. The domestic politics of trade, however, are now very hard, and getting harder.

 

Update: Two more from Dani Rodrik. First:

On the Dynamic Effects of Trade. Tyler Cowen's recent post ... 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.

Second, an attempt at a summary:

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.

Update: Two more entries. First, from Alex Tabarrok at Marginal Revolution:

Trade and the Moral Community, by Alex Tabarrok: Much of the recent trade debate between Rodrik, Mankiw, Tyler and others (see Tyler's excellent post for links) is primarily not about positive economics but about the relevant moral community. Rodrik, for example, hasn't argued that trade does not increase aggregate wealth he has argued that trade is not guaranteed to increase national wealth - something quite different. I consider three moral communities and the case for trade.

Peter wishes to trade with Jose. The individualist says the relevant moral community is Peter and Jose and presumptively no one else. Trade, the right of association, is a human right and on issues of rights the moral community is the individual. When Jose offers Peter a better deal than Joe it's wrong - a moral outrage - for Joe to prevent Jose at gun point from trading with Peter.

The more common view expressed implicitly by Dani Rodrik, but by many others as well, is the nationalist view, the moral community is Peter and Joe. Joe gets a vote on Peter's trades. Peter should be allowed to trade only if both Peter and Joe benefit, otherwise too bad. Jose counts for less.

A third view, that of the liberal internationalist, says that Peter, Jose and Joe count equally and are together the moral community.

Now how does the positive economics apply to these three cases? Peter and Jose presumptively are better off from trade otherwise they wouldn't trade so the individualist economist (the economist who takes Peter and Jose as the relevant moral community) will support free trade. The liberal internationalist will also support free trade because there is a strong argument from positive economics that trade increases total wealth (comparative advantage, specialization, competition etc.).

In between, we have the nationalist economist for whom it depends. The case for trade for the nationalist economist is pretty good - after all the individuals involved benefit and the world benefits - so the case is reasonably strong that Peter and Joe taken together will also benefit especially if we consider many trade pacts on some of which Joe benefits directly. Nevertheless, Rodrik is correct that when you exclude Jose it is possible to come up with examples where Joe's losses exceed Peter's gains.

I would argue, however, that economists are too quick to take the nation as the relevant moral community. It is quite possible, for example, for Peter to benefit from trade but for Peter's city to be harmed, for Peter's state to benefit but for his region to be harmed, for his country to benefit but for his continent to be harmed. Why should we cut the cake in one way, excluding some from the moral community, but not in another? Indeed, geography is not the only way we can define the moral community. Why not ask whether English speakers benefit from free trade or Christians or left handed people? Each of these is just as valid as asking whether the collection of people called the nation benefit from free trade.

I understand individual rights and I understand counting everyone equally but I see less value in counting some in and some out based on arbitrary characteristics like which side of the border the actors fall on.

Second, Brad Setser:

Dani Rodrik, Steve Waldman, China’s impact on US export prices and the risk of "financial" Dutch disease …, by Brad Setser: Dani Rodrik didn’t take long to stir up the blogosphere...

Rodrik makes an interesting point: Trade doesn’t cut inflation. Sure, it lowers prices for imports. But it also raises prices for exports …

Let’s step back and think for a second how that applies to the United States' trade with China. The US imports a lot of stuff from China (almost $300b worth last year). All the talk of the China price (or a trip to Walmart) suggests that Chinese supply has kept prices for a lot of goods that China makes pretty low.

The US doesn’t export that much stuff to China. ...[I]n aggregate, US goods exports to China are 20% of US goods imports from China. China tends not to pay full price on many of the “services” -- think audiovisual services like films and television programs – that it imports from the US, so adding services wouldn’t change the balance enormously.

So maybe the overall impact of trade with China has been to lower prices? Not so fast. While the US doesn’t sell that many goods to China, others do. Capital goods producers (think Germany). And above all commodity producers. The “China price” for copper, iron ore and soybeans is high – not low. One effect of China’s growing trade with the world has been to push up the price of commodities – and thus to push up the price of a certain set of US imports …

It also has pushed up the price of food since corn and sugarcane are – at least with a bit of help – substitutes for gasoline at the “China” price for gasoline.

There is another effect as well. China doesn’t buy a lot of US goods. But it does buy a lot of US assets. ... China buys way more US financial assets than US goods. ...

Chinese reserve growth picked up even more this year, so it looks like the US might be on track to export $300b of debt, if not a bit more, to China in 2007.

That demand presumably increases the price of long-term debt. Or, expressed differently, cut US long-term rates (See Francis Warnock: here, and here).

It also has pushed up the price of things that generate predictable returns that can be securitized. Think roads and bridges. Think mortgages – and then think houses. At least houses in those parts of the country that don’t produce goods that compete with Chinese goods. ... Trade with China has pushed down the price of PCs – and TVs. Maybe it will push down the prices of cars in the future But it also probably has pushed up the price of gasoline – and the price of living space. ...

That brings me to a question that Steve Waldman posed in a post last week: has the surge in financial demand for US assets – a surge that has come overwhelming from the official sector – produced a kind of Dutch Disease in the US. The financial sector has boomed, but the rest of the economy has atrophied? ...

    Posted by on Saturday, April 28, 2007 at 10:39 AM in Economics, Income Distribution, International Trade, Politics | Permalink  TrackBack (1)  Comments (26)

          

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