Wednesday, April 27, 2016

The failure of the greatest triumph of economics

One of the greatest triumphs of economic theory is that agents gain from trading with each other. The proof either from a Ricardian or an Edgeworth box framework is irrefutable and together with the Heckscher-Ohlin model have formed the basis for argument for free trade.

Reality has always been more complex however and recent research shows the consequences.
Cross-referencing congressional voting records and district-by-district patterns of job losses and other economic trends between 2002 and 2010, the researchers found that areas hardest hit by trade shocks were much more likely to move to the far right or the far left politically.
“It’s not about incumbents changing their positions,” said David Autor, an influential scholar of labor economics and trade at the Massachusetts Institute of Technology and one of the paper’s authors. “It’s about the replacement of moderates with more ideological successors.”
Mr. Autor added: “In retrospect, whether it’s Trump or Sanders, we should have seen in it coming. The China shock isn’t the sole factor, but it is something of a missing link.”

Autor adds:
Mr. Autor, like most economists, is still persuaded of the long-established benefits that global trade confers on the economy as a whole. But he recognizes that angry voters have valid reasons to be frustrated.
“It’s a matter of diffuse benefits and concentrated costs, but our political system hasn’t addressed those costs,” he said.
Some staunch defenders of globalization, like Gary Clyde Hufbauer, a senior fellow at the Peter G. Peterson Institute for International Economics in Washington, also acknowledge that the federal government has failed to adequately address the needs of workers dislocated by lowered import barriers.
But the benefit of free trade is “10 times the size of the losses,” he said. “Free trade really helps working-class people in terms of lower prices for products. The benefits are skewed toward people with lower income because they spend a much larger fraction of their income on merchandise.”

If the gains from trade are as large as economists claim to be then why hasn't the political system found a way to fully compensate the losers in terms of lifetime incomes. Let's say free trade lowers the price of clothing by one dollar. Why not impose a tax of say 90 cents on clothing and use this tax to compensate the workers who have lost their jobs as a result for as long as they would have worked (perhaps until age 65)? Or, target the losers, calculate the size of their losses in terms of lifetime incomes and then find a tax rate that would equate these losses. The tax would not be permanent but it would trade off a higher rate with a lower time frame for the tax. 

No comments: