The Debate Over the Effects of Free Trade Heats Up

As we were applauding Dani Rodrik, Greg Mankiw was defending the Dan Drezner lower prices from free trade benefits everyone fallacy. Greg starts where we ended – that free trade helps the export sector:

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 Dani WAS talking about the general equilibrium model. But let me turn the microphone back to Dani:

Can the wrong answer in the classroom be the right answer in public debate? I don’t think so, but it looks like we may be disagreeing with Greg Mankiw here … 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.

Mark Thoma helps pull together elements of this blog debate including this from Paul Krugman:

I thought the whole “but prices are lower” answer was killed 65 years ago by Stolper and Samuelson.

It was so why is Greg Mankiw still holding onto the fantasy that trade can make everyone better off without some form of compensation for those whose real income is reduced by a movement towards freer trade. His answer is strategic simplification. Strategic? Simplifying matters for public policy standards is fine – but to suggest no one loses from free trade is simply incorrect. They do teach Stopler-Samuelson at Harvard – don’t they?

Update: Greg Mankiw does consider Stopler-Samuelson via the Heckscher-Ohlin model then tosses in the capital mobility argument. But as various smart folks weigh in – including Paul Krugman – capital mobility alone does not get us back to the simple Ricardian model that Greg tends to lean on.

But I have another problem with Greg Mankiw’s dismissal of the various theorems that come out of the Heckscher-Ohlin model. One of them is the Factor Price Equalization theorem:

The fourth major theorem that arises out of the Heckscher-Ohlin model is called the factor-price equalization theorem. Simply stated the theorem says that when the prices of the output goods are equalized between countries as they move to free trade, then the prices of the factors (capital and labor) will also be equalized between countries. This implies that free trade will equalize the wages of workers and the rents earned on capital throughout the world.

In other words, free trade in goods accomplishes the same results as factor mobility. If we posit a capital abundant nation where wages are higher than wages in other nations but the returns to capital are lower. Free trade or factor mobility will raise the return to capital in this nation but also lower wages. OK, the real world is more complicated that what is envisioned in the Heckscher-Ohlin model, but it is also more complicated that what is envisioned in the Ricardian model as well. So how do these real world complications lead Greg Mankiw to his claim that movements towards free trade benefit everyone? His latest formulation doesn’t quite answer this question.

Update II: Greg Mankiw provides a comment here that he never said there were no losers from free trade. But he did write:

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.

Which prompted this from Dani Rodrik:

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.

If Greg is now agreeing with Dani – great! But then what was this debate about in the first place?