Donald Trump’s assault on multilateralism and on the World Trade Organisation, aided and abetted by an equally misguided team of advisers, requires a spirited response from free traders such as Paul Krugman and Douglas Irwin (both students of one of the authors of this article).
But Trump also attacks free trade itself, embracing the notion that it is a pernicious public policy. This “protectionist fallacy” is unfortunately not his alone. In fact, it is widely shared by many in the US, including by many Republicans, Democrats and US journalists.
We address here first the widely-shared common fallacies, especially those on the political left. Our belief is that throwing reasoned light on a subject where ideological heat is otherwise the rule, we will strike a needed blow against mindless protectionism.
Trade openness harms the overall economy
Much evidence opposes this proposition: see for example the postwar experience when progressive trade liberalisation coincided with increasing prosperity. This was interrupted only by periods of economic difficulties resulting from phenomena such as the success of Opec and consequent jump in oil prices and the deflation in the world economy, brought about by the policies of Paul Volcker, then chair of the Federal Reserve.The main liberalisation occurred in the developed countries, under many rounds of negotiations associated with GATT, the General Agreement on Tariffs and Trade, which persisted from its inception in 1947 to its eventual replacement in 1994 by the WTO. Developing countries (under the GATT provision of Special and Differential Treatment) were exempted from making trade concessions of their own while enjoying the benefits of trade liberalisation by the developed countries. Thus, they profited from greater market access offered by the latter’s liberalisation.
Trade openness with poor counties produces poor in the rich counties
This belief has led unions to endorse trade openness between like-wage countries—for example between US and Canada—but to oppose it between high- and low-wage countries (to include Mexico in NAFTA). But this is a fallacy.To see this, remember that we have two alternative narratives here: one anti-trade and the other pro-trade. The anti-trade narrative assumes that cheaper labour-intensive goods from the poor countries will harm labour in the labour-intensive industries of the richer nation—what economists call the Stolper-Samuelson effect.
Certainly there is a need for effective worker retraining programmes to help displaced workers regain productive employment, or for broader social safety nets in society.
But most of the labour-intensive industries in the rich countries have died out. And the remaining workers, as indeed workers in all sectors, gain as consumers from cheaper imported consumer goods (the Walmart effect).
Similarly, with labour-saving technologies putting pressure on wages, cheap labour-intensive imports cushion the impact of such technical change on workers’ real wages. So trade helps workers’ real wages.
Trade openness concentrates gains in the top 1 per cent
There is little evidence that trade is the cause of wealth and income concentration. In a detailed study of poverty levels in Indian states using household surveys, Devashish Mitra of the Maxwell School at Syracuse University, has found that trade was not associated with poverty rates.Indeed poverty rates have dropped dramatically in the Indian economy during the period in which it has become more globalised. Equally, in a paper for the National Bureau of Economic Research, Pravin Krishna and Guru Sethupathy found no association between trade and income inequality in India. The idea that openness has led to improved income distribution has been argued recently also by the World Bank.
Separately, Piketty, who has documented the apparent increase in concentration of wealth over recent decades, ignores the fact that the top 1 per cent is not made up of a static group. People move in and out of the group, so that there is inequality but also mobility. It is interesting that Piketty, who writes knowingly about English and French literature does not mention Thomas Mann who got the Nobel Prize for his novel Buddenbrooks where the third generation’s fortunes decline.
Openness to trade has hurt manufacturing
The notion that trade openness has led to a decline of manufacturing, by having US manufacturing shift to foreign countries with cheap labour, has fed a near-frenzy of protectionism.But there has been a steady decline in the share of the US workforce made up by manufacturing workers since the 1950s.
This decline is a broadly western phenomenon (see chart below).
Trade with China has hurt our economy
A study by Autor, Dorn and Hanson, The China Syndrome, of how Chinese imports damage US manufacturers has been widely cited by journalists and by economists. Some excitable economists and columnists have called it the most important study in recent times. But the study’s conclusion is questionable.As Phil Levy of the Chicago Council of World Affairs has pointed out, if safeguard actions had been invoked against China, the effect would most surely have been to shunt exports from China on to other exporters. Then the argument against competition with Chinese exports shifts to competition against total imports from China together with imports from these other countries. So import competition, as against competition only with Chinese exports, must be reckoned with. The exclusive focus on China as the villain in the analysis is misplaced.
Besides, when one looks at the total amount of wages lost due to the decline of employment in the Autor-Dorn-Hanson study, it is a miniscule amount: the average worker in their study is estimated to have lost less than $10 a week.
This is such a small amount that it is very likely to have been outweighed by the lower cost of imported goods from China. While the need for a social safety net is clear, the alarm raised by the findings of the Autor-Dorn-Hanson study has clearly done much harm by helping to shape the protectionist zeitgeist.
Nothing more is to be gained from further liberalisation
This fallacy, advanced by Dani Rodrik in writings including in Prospect and the FT and by others, has been rebutted by many trade economists: there is still much scope for liberalisation in agriculture and services; besides, even in manufacturing there are many peaks which need to be ironed out.Trade leading to growth is wrong; the causation is the other way around
Arvind Panagariya, of Columbia University, has shown that countries that have registered high growth rates of exports have also grown more rapidly. Rodrik argues that this does not indicate causality and that higher growth may well be the cause of the higher export growth. Of course, this is possible and countries that grow faster may well be able to liberalise more and hence may have higher growth of exports.But a number of in-depth studies of developing countries reinforce the notion that trade liberalisation leads to enhanced growth of income. For example India’s reforms, which began in 1991 and included reducing trade barriers, caused the growth rate to accelerate which, in turn, finally reduced poverty. It was the change in policies that improved trade performance which in turn led to an enhanced growth rate of GNP.
