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Thursday, September 07, 2006

Sharing the Gains from Trade and Standard Welfare Analysis

This is Edmund Phelps on sharing the gains from globalization from the comments to Martin Wolf's Forum. His solution? The gains from trade should be distributed through low wage subsidies to help those who need it most, and those most in need of help are not necessarily the losers from globalization:

Edmund Phelps: It is increasingly proposed that a nation must "share the gains" of globalization with the losers from globalization. But what does such "sharing" mean? Understood one way, sharing could create an unwelcome precedent. Understood another way, it could trigger an overdue improvement in economic policy.

The sympathy felt for the “losers” from globalization has been understood as providing popular support for government action to compensate them – possibly through a “hand up” in the form of retraining or interim allowances. For the staid economist, though, this is unfamiliar thinking. As a general proposition, the idea that a nation ought to share with the losers the gains headed for the winners was clearly rejected in the standard welfare economics of Hicks, Kaldor, Samuelson and Arrow. Those losing from foreign trade ... don’t have a monopoly on suffering. In that framework, those with the best claim to any windfall increase in the government’s taxable capacity that globalization’s gains might bring are those who would get the most from extra state aid (the greatest “marginal utility”) – thus those having low income, not in general those whose income has recently fallen.

Moreover, not all of the gains, if any, from globalization yield an increase in taxable capacity: Globalization makes our imports cheaper, so the same old tax revenues are blessed with greater buying power. But, ... there will not result an increase in potential tax revenue out of which increased subsidies and transfers could be made to losers. In contrast, outsourcing may boost productivity in the long run. ...[but] the immediate impact may be a fall of GDP and potential tax revenue, not a boost.

Yet the founders of standard welfare economics, in resting it on the “utilities” of people, left it open to the thesis of Daniel Kahneman that the pain from a loss of income is intense next to the joy of an equal gain in income. So, in the utilitarian view, those suffering a loss from globalization might well derive the greatest utility gain from an extra dollar of government benefits.

Rawls would have objected ... For him, economic justice is all about a structure of rewards, after taxes and subsidies, that encourages ... people in such a way as to bring the largest possible gain to those who are least rewarded. Utility and pain were not part of his terminology.

Rawlsians, of whom I am one, would make the point that any sharing of the gains from globalization would have to come, wholly or partially, at the expense of subsidies or earned-income tax credits that would have or could have gone instead to Rawls’s “least rewarded.” In this perspective, justifying retraining and allowances for those who have lost a middle-income job would require an argument that ultimately the rewards of the least advantaged will be served by diverting state outlays to address these job losses.

Another objection to retraining and allowances is that it might send us down a slippery slope, as Hayek would have put it, to many more such interventions. It is not just globalization that brings losers along with gainers in the home country. If the principle of sharing ... gains with losers were accepted, why not agree next to compensate the losers from the next thing that comes along? ... If this sort of economic policy came to be anticipated, it might have a chilling effect on the willingness of financiers to venture the capital required.

From a Rawlsian view, the proposal for “sharing” misidentifies the injustice from globalization. Rich nation like the U.S. or the U.K are unjust when they pocket a sizeable chunk of the terms-of-trade gain from trading with the third world. To be just, the rich countries would write checks to the third world to return to it their gains from the better terms of trade, leaving the third world with the whole of the gain from their trade with the rich.

Yet “sharing the gains” can evidently be understood in another way. It could mean, as Martin Wolf now suggests, low-wage employment subsidies, which I pleaded for throughout the 1990s. That may seem odd, since the working poor are not new. One way to make sense of endorsing such subsidies now, not before, is to say that the situation of low-wage earners was an injustice but the effect was not acute prior to globalization ... [B]ut now, with masses of Chinese and Indians lowering wage rates at the low-end, the effects of such inattention would become acute.

There is another way to explain the heightened interest in subsidies. Once our economic policy is seen to be addressing low-end work with the the largest subsidy the nation can afford, workers generally will feel well treated again and there will be more willingness to accept the ups and downs of the market. Then our countries can globalize full speed ahead.

I agree with the economics. Spending money where it does the most good at the margin provides maximum benefits. But I'm not quite as sure about the politics since this does little to reassure middle income workers that they will be helped if their wages and benefits are reduced due to heightened global competition, or if they are displaced through globalization and technological change.

    Posted by on Thursday, September 7, 2006 at 10:24 AM in Economics, Income Distribution, Politics | Permalink  TrackBack (0)  Comments (12)

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