Wednesday, January 30, 2013

Thinking About What Inequality Means for Free Trade

Not sure why, but I've been reflecting a bit about what rising inequality means for the case for free trade. I don't question the general* case that free trade results in net benefits, ceteris paribus.

However, the rise in inequality, and the decline of labor's bargaining power, is making me wonder whether ceteris paribus conditions hold in the real world. If we assume that growth results primarily from the cumulative efforts of the bulk of society, rather than from the capital expenditures of the wealthy few,** then it is possible that the concentration of wealth will undermine growth and prosperity. If free trade shifts economic power in favor of holders of capital (such as by threatening to move a factory), their enhanced bargaining power may serve to shift economic rewards towards them and away from labor, increasing capital's share of a shrinking pie (as inducements for hard labor and skill acquisition decline relative to the rewards for simply holding wealth, to name one plausible mechanism, this would also be consistent with rational behavior on the part of individual owners of labor and capital, though it is irrational in the aggregate). If this inefficient shift away from labor outweighs the gains from trade, it would be possible for free trade to result in net loss.

As a second problem, as the safety net and redistribution comes under attack, the possibility for uncompensated losses become greater. There are always winners and losers from trade, the standard argument being that the winners can compensate the losers. As economic power shifts, this compensation becomes less likely and the winners more likely to simply pocket the gains while letting the losers fend for themselves. This isn't a threat in countries that have developed egalitarian institutions (it's striking how the ideal of American equality and egalitarianism has declined since the 19th century), but as the makers and takers nonsense becomes a common refrain among certain groups it appears increasingly less likely that the low-skill groups which tend to bear most of the costs while receiving a small share of the benefits through market mechanisms alone will receive any compensation for their losses through redistribution (targeted trade compensation programs appear to me to be both inefficient and inadequate, targeting the groups as a whole would be both more efficient and more just)

None of this means that I am willing to come down on the side of protectionism, I continue to believe free trade is a net good; if not as strongly as I did before. But I am listening now, where I wasn't before. Given economic indicators over the past 30 years the case against free trade is the strongest it has ever been and is worth at least hearing out.

*The specific case can be weaker. Particularly when there are high capital costs, monopoly effects, high skill labor needs, or intellectual property laws in place. Combine all these things and strong case arises for industrial policy with regards to a specific industry. If an industry requires very high fixed capital costs, high R&D expenditure with a concern for patent trolling, highly specialized labor that is immobile between industries, and a powerful tendency towards concentration and monopoly advantages then a very strong case exists for first mover advantages, government industrial policy, and protective tariffs for infant industries. These cases are rare, but acknowledging their existence helps to keep them distinct from the general case for free trade (aircraft manufacturers, some software companies, maybe pharma, maybe green energy are the ones that come to mind).

** This is one of those topics where I think convergence in the social sciences is so important, and where I feel the dominance by economists is such a problem. Histories of the industrial revolution are increasingly finding that the capital intensive industries generally associated with it explain very little of the growth, histories of technology point to a lot of innovation among small producers , political science is finding a lot of evidence that the wealthy and powerful can dominate informal power networks (probably more easily than they dominate the state), many sociologists have written about the negative impacts of poverty on a variety of indicators, and some economists have found empirical evidence of negative effects of inequality on growth (in periods of very rapid technological change and very high growth this doesn't hold as well as in periods of more moderate growth) as well as evidence that the income going to the wealthy and tax rates as having little income and growth. Opposing these converging lines of evidence is basically a single perspective of economics that has very little support from other fields, yet, this seems to mean basically nothing to anyone important. Personally, I think converging lines of evidence from separate perspectives to be the strongest form of evidence, but that's just me.


  1. I've slowly moved to this way of thinking for quite a while. It's a theme I've recently seen in the thoughts of relatively liberal free-traders whose chief concern is continuing support for liberalization; further liberalization can only come at the price of continuing strengthening of the social safety net.

    In a deeper sense, though, I think there's a fundamental tension best captured by Dani Rodrik's so-called trilemma: you can have a democratic polity, strong national sovereignty (in the form of privileges or institutions specific to citizens, such as a welfare state), and full integration, but only two of three. It describes the full range of options in political economy terms between three poles: an open but draconian nation-state like Singapore, a democratic union where trade is open but national sovereignty is subsumed like the EU, and a democratic but mercantilist state like, say, pre-1840s Britain (although I don't think any modern state really fits the bill of being both democratic and limiting integration). Rodrik's position is that since democracy cannot be compromised, we either have to go through the troubles of integration a la the EU or we have to limit integration as with the Bretton Woods system. My personal views are not as cautious in their embrace of free trade but I still highly recommend his work to further explore the subject.

  2. It's been a very long time since I've read anything by Rodrik, and I think all I've read is a paper or two by him. It is probably worth picking up some of his longer works. I remember I disagreed with his trilemma for one reason or another, but I can't recall why anymore.