Economists Have No Idea What Replaces Free Trade

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(Bloomberg Opinion) -- One of the most interesting sessions I attended at last week’s American Economic Association meeting was a panel titled “Making global markets work for American workers.” The discussion, featuring economists Dani Rodrik, Kimberly Clausing and Josh Bivens, laid out the problems with free trade, the shortcomings of U.S. trade policy during the past few decades and some suggestions for improvement. But although the economists did a great job of critiquing the old free-trade consensus, there was no clear idea of what to replace it with.

Economists still tend to strongly back trade liberalization. But the cozy consensus in favor of removing trade barriers is eroding. The experience of the China shock, in which a sudden wave of import competition devastated the lives of many American manufacturing workers, was a wake-up call.  The bipartisan backlash against trade agreements, which threatened to leave economists in the political wilderness, was another. Economists such as Rodrik and Bivens, who have criticized the free-trade consensus for a long time, are getting heard more, while free-trade defenders such as Clausing are forging more nuanced arguments.

Economists are starting to agree that free trade has two big weaknesses: unfairness and politics.

Ever since the time of David Ricardo, the 18th-century economist who developed the idea of comparative advantage, it has been well-known that not everyone benefits when trade barriers fall. If the U.S. is relatively good at making shoes and Japan is relatively good at making blue jeans, American jeans makers and Japanese shoe companies have good reason to fear a trade agreement between the two countries.

This becomes especially dangerous when one country specializes in cheap labor. Bivens, like many others, suspects that this is what happened with China — the addition of a billion workers to the global labor force was a bonanza for the rich, who could buy cheaper consumer goods, and a disaster for the middle class in developed nations. As Bivens noted, the U.S. has gradually shifted toward trading with poorer and poorer countries — good for global development but perilous for many American workers.

In the old days, economists tended to address this problem by arguing that the winners from trade should compensate the losers. But it’s very hard to identify who won and who lost. Was a factory worker put out of a job by China, by automation, by bad corporate decisions, by the decline of unions or the inevitable market shifts? It’s possible to simply increase redistributive taxation — and Clausing calls for this — but government checks probably aren’t a satisfying compensation for a steelworker who suddenly finds his career gone and his skills unwanted.

The second problem is that actual trade agreements tend to bear only a passing resemblance to the idealized notion of free trade in an economics textbook. Thanks to lobbying by business interests, real trade agreements are tangles of rules and regulations that can restrain competition. One well-publicized example of this is the investor-state dispute settlement (ISDS) system, designed to shield intellectual property in international markets, which has been roundly criticized as a way to protect corporate profits over the interests of local populations.

At the very least, trade policy can be improved by increasing redistributive taxation and by removing corporate carve-outs from trade agreements. But there are a number of other problems with textbook free trade that those policies leave unaddressed. For example, Bivens noted that trade agreements might weaken environmental and labor standards at the national level, making it harder for producers in countries with tougher regulations to compete. The advantages from trade might also be ephemeral — a country that chooses to export natural resources and forsake manufacturing might have a gain in wealth in the short term, but in the long term it could miss out on technological improvement and productivity gains.

Economists are beginning to recognize these dangers, but so far there are few credible suggestions for how to deal with them without forsaking the very real gains from international trade. Imposing unrealistic rich-country labor standards on poor countries could hurt their development and trap them in poverty. And industrial policy, although spectacularly successful in some cases, is very tricky to get right.

One thing that economists almost all agree on, however, is that tariffs are a bad response to the drawbacks of free trade, serving mainly as a tax on domestic consumers. They also invite retaliation, causing more carnage.

But if not tariffs, then what? So far, there’s no clear answer. (My suggestion is export subsidies, but this hasn’t received much attention yet). Identifying the failings of free trade is a lot easier than crafting an alternative paradigm. Much work remains to be done.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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