More Free Trade

First, this issue is important. Second, it seems to generate a lot of action in the comments. So I’ll keep harping on the subject until I encounter diminishing returns.

In practice, free trade is not an unmitigated good, but the world is better off when all goods and services are produced in the locations and by the people most able to efficiently produce them–all else equal. First an example, then back to the caveat.

Country A can produce either 20 units of food or 4 units of literature, or any linear combination in between (e.g., 10 food and 2 literature).

Country B can produce either 12 units of food or 2 units of literature, or any linear combination in between (e.g., 6 food and 1 literature).

Note that Country A can trade food for literature at the rate of 5 to 1–for every five units of food it gives up, it can get one more unit of literature. Similarly, Country B can trade six units of food for one unit of literature. Note immediately that Country A is the more efficient producer of literature. If Country A produces a unit of entertainment, the world loses five units of food, whereas if Country B produces the unit of literature, then the world would lose 6 units of food.

Does it make sense for Country B to produce literature? Not really. Country B should instead produce food and then trade between five and six (call it 5.5) units of that food to Country A, and receive a unit of literature in return. Both countries are then better off: Instead of getting only 5 units of food for a lost unit of literature, Country A gets 5.5 units of food. Instead of having to give up 6 units of food for a unit of literature, Country B only has to give up 5.5 units of food. Each country benefits by .5 units of food when they trade thusly!

It’s so simple, what’s the hold up? Well, there are losers in this trade, even though both societies benefit on balance. Literature producers in Country B are driven out of business, as are food producers in Country A. And history shows that, not surprisingly, they will vigorously oppose free trade. Nevertheless, there is a role for government in solving the transition to trade problem. Since after trade is established, each country has more of all goods (possibly the same amount of some and more of others, but less of none), both societies are wealthier after trade is established. Some or all of that extra wealth can then be directed to recompensating the affected sectors in each country–because of the increase in overall wealth, there is necessarily enough money to make them whole.

But this is a very stylized example, how might this work in the real world? First, the benefits from trade work out exactly the same if there are thousands, billions, or gazillions of different goods. So restricting the example to two goods does not limit the example’s relevance.

However, I did say “all else equal.” Perhaps one of the countries uses slave labor, child labor, sweatshops, or cheap but heavily polluting technology. Then, economics aside, there is a moral argument for tying free trade to environmental and working conditions standards. But there is also an economic rationale: each of these scenarios entail negative externalities (costs borne by society at large, rather than by those who engage in an activity). Countries will over-engage in activities that have negative externalities. In those cases, tying free trade to work and environmental standards can also increase economic efficiency (by reducing the over-production otherwise implied by the negative externality).

But what about the affected workers? Technological change is the engine of economic growth, but along the way, it renders once-thriving industries obsolete, to the detriment of workers in those industries. Can we have growth without misery among the workers in the declining industries? Possibly. A senior economist at Brookings (with what I find to be impressive credentials as a liberal) outlined what such a plan would look like. More tomorrow.