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Monday, May 19, 2008

"The Free-Trade Paradox"

James Surowiecki says closing markets will hurt middle and low income households because it will increase prices on goods that make-up a large fraction of their budgets:

The Free-Trade Paradox, by James Surowiecki, The New Yorker: All the acrimony in the primary race between Barack Obama and Hillary Clinton has disguised the fact that ... when it comes to free trade, ... the campaign has looked like a contest over who hates free trade more... The candidates are trying to win the favor of unions and blue-collar voters in states like Ohio and West Virginia, of course, but their positions also reflect a widespread belief that free trade with developing countries, and with China in particular, is a kind of scam perpetrated by the wealthy, who reap the benefits while ordinary Americans bear the cost.

It’s an understandable view: how, after all, can it be a good thing for American workers to have to compete with people who get paid seventy cents an hour? As it happens, the negative effect of trade on American wages isn’t that easy to ... quantify. But it’s safe to say that the main burden of trade-related job losses and wage declines has fallen on middle- and lower-income Americans. So standing up to China seems like a logical way to help ordinary Americans do better. But there’s a problem with this approach: the very people who suffer most from free trade are often, paradoxically, among its biggest beneficiaries.

The reason for this is simple: free trade with poorer countries has a huge positive impact on the buying power of middle- and lower-income consumers—a much bigger impact than it does on the buying power of wealthier consumers. The less you make, the bigger the percentage of your spending that goes to manufactured goods—clothes, shoes, and the like—whose prices are often directly affected by free trade. The wealthier you are, the more you tend to spend on services—education, leisure, and so on—that are less subject to competition from abroad. In a recent paper..., the University of Chicago economists Christian Broda and John Romalis estimate that poor Americans devote around forty per cent more of their spending to “non-durable goods” than rich Americans do. That means that lower-income Americans get a much bigger benefit from the lower prices that trade with China has brought.

Then, too, the specific products that middle- and lower-income Americans buy are much more likely to originate in places like China than the products that wealthier Americans buy. ... (By some estimates, Wal-Mart alone has accounted for nearly a tenth of all imports from China in recent years.) By contrast, much of what wealthier Americans buy is made in the U.S. or in high-wage countries like Germany and Switzerland. ...

This may not always be the case; as China’s economy continues to boom, its companies will likely move up the quality ladder and, eventually, become serious competition for high-end American and European manufacturers. But for the moment the benefits of free trade with China, at least when it comes to shopping, are concentrated overwhelmingly among average Americans. ... That means that free trade with China has made average Americans, at least as consumers, much better off—in the sense that it’s made their dollars go further than they otherwise would have.

Now, there’s a lot that’s left out of this equation, such as the fact that free trade may help richer Americans by increasing corporate profits. And cheap DVD players may not, on balance, make up for lost jobs. But the reality is that if we toughen our trade relations with China the benefits will be enjoyed by a few, since only a small percentage of Americans now work for companies that compete directly with Chinese manufacturers, while average Americans will feel the pain—in the form of higher prices—far more quickly and more directly than rich Americans will. Obama and Clinton, in their desire to help working Americans—and gain their votes—are pushing for policies that will also hurt them.

One comment. Just because someone gained, say, $10 doesn't necessarily mean they will be completely pleased. If they deserved $25 but only received $10, they might object. Thus, while trade may have benefited lower income households by lowering prices on the goods they are likely to consume, and that is certainly a positive, that doesn't mean they won't be frustrated if they aren't receiving what they view as a fair share of the gains from globalization.

We know, for example, that real wages for the working class have been stagnant in recent decades, or even declined slightly. So even if you argue that the CPI overstates inflation for low income groups because they consume a disproportionate share of goods with prices that have not risen as fast as the CPI, it's still hard to make the case that the gains have been large. Couple that with the rise in inequality, loss of health care and retirement benefits, decreased job security, etc., and it's easy to see why workers might not feel as though they have been adequately compensated for the change in labor market conditions and economic security that they have endured.

But I do agree with the main theme. The answer is not to close markets, the answer is, quoting Larry Summers, to "design more ways to insure that a more integrated and prosperous global economy is one from which all will benefit." We need to find a way to distribute the gains (and the pains) of globalization so they are shared more equally, to increase opportunity so that everyone has the chance to reach their full potential, and we need to reverse the declines in economic security, retirement benefits, and health care coverage that have occurred for middle and lower income households over recent decades.

    Posted by on Monday, May 19, 2008 at 12:33 AM in Economics, International Trade, Social Insurance | Permalink  TrackBack (0)  Comments (57)


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