Saturday, February 16, 2008

Why doesn't economists stick to their comparative advantages?

Sometimes I wonder reading op-eds by some economists (eg. Stiglitz), why they don't stick to their fields of expertise or their own comparative advantages. Here's great talk by Jagdish Bhagwati;

Episode 3: India and China and Fear of Outsourcing: Alan Blinder. But outsourcing happened to revive again, a couple of years ago, when the distinguished macroeconomist Alan Blinder, with us today, who was deeply influenced by Thomas Friedman’s bestselling book on globalization --- which seemed to translate the credible statement by Bangalore’s remarkable IT entrepreneurs-cum-scientists such as Nandan Nilekani that they could do everything that Americans could do into the frightening non sequitur that therefore Indians would do everything that the Americans were doing --- published an essay in Foreign Affairs (April 2006) that bought into the line that outsourcing of services on the wire would increasingly export American jobs to these countries and imperil the US and its working and middle classes. So, he was now turned into a new icon for the protectionists even though Blinder always said that he was still a free trader but…! Davis and Wessel (Wall Street Journal) built their story against free trade around him; he made it to the National Public Radio and even to the iconic TV program, Charlie Rose.

But Blinder missed out on the fact that outsourcing on the wire (i.e. without the provider and the user having to be in physical proximity as with haircuts), which is Mode 1 of supplying services in the General Agreement on Trade in Services (GATS) in the Uruguay Round agreement in 1995, was the mode tha t the US and other rich countries were keenest about: they saw that they would be the big winners, as no doubt they are. For all the call-answer services and other low-skill services now imported from countries such as India, there are many more high-skill and high-value services by rich-country professionals in architecture, law, medicine, accounting, and other professions.

But Blinder has now shifted ground to arguing that, as services became tradable on line, the number of jobs which would become “vulnerable” would rise pari passu. And he lists upward of 40 million jobs today that are so afflicted. And he concludes that we need to augment adjustment assistance and improve education in response. There is much that may be contested here. E.g. if you wish to talk about flux, talking only about Mode 1 (online transmission of services) is incomplete. Trade economists know that this is only one of possible modes in the supply of services: e.g. transmission of services without the physical proximity of suppliers and users of the services. Transmitting x-rays digitally from Indiana to be read in India is one example. But then doctors can go to patients; and patients to doctors. The GATS agreement recognizes four distinct modes of Service “transactions”.

As it happens, the different Modes were distinguished in a couple of articles in The World Economy in the mid-1980s by me and by Gary Sampson and Richard Snape and astonishingly made their way into the GATS agreement within a decade: a remarkable triumph for us economists .I described the basic distinction between service transactions that required physical proximity and those that did not, whereas Sampson and Snape brilliantly sub-divided the former into those where the provider went to the user and the other way around.

Blinder who does not appear to have known all this when he wrote his celebrated Foreign Affairs article, any more than I know about the relevant intricacies of macroeconomics where he holds the comparative advantage instead, has been wrong therefore to think only of Mode 1. In fact, the possible flux arises in more ways today than he talks about. That is also true because of direct foreign investment. E.g. when Senator Kerry talked about outsourcing, he meant also, confusingly, the phenomenon where a CEO closes down a factory in Nantucket and opens it up in Nairobi, or when that same CEO simply invests in production in Nairobi instead of in Nantucket.
But the bottom line from the viewpoint of trade policy is that hardly any serious trade economist or policymaker has objected to providing adjustment assistance (or improving education) in living memory. The first Adjustment Assistance program in the US goes back to 1962 during the Kennedy Round negotiations: Kennedy and George Meany of AFL-CIO signed off on it. Virtually every trade legislation since has tried to improve on it. And many trade economists including myself in the late 1960s, and others such as Lael Brainard, Robert Lawrence and Robert Litan at Brookings in recent years, have written extensively and continually on the subject. Blinder, who started talking poetry, has therefore wound up talking prose. We free traders have no problem with him as he is on the same escalator even if he is behind us. If he is to remain the new icon for those who oppose free trade, they have to be pretty desperate.
So, these three balloons with journalists aboard, waving banners against free trade, have lost their helium. Free trade has continued to maintain its credibility among economists. Of course, there have been other, less influential assaults on free trade --- among them, I must count that by Baumol and Gomory (2000) who have enjoyed nonetheless some exposure, especially from the influential leftwing columnist William Greider in The Nation (April 30, 2007) and ironically also from the supply-side economist Paul Craig Roberts in his assault on outsourcing in the Wall Street Journal.

I might say simply that these authors make one important but familiar point, with little policy relevance as I argue now. It is the old one, which I learnt as a student from R.C.O.Matthews, my Cambridge tutor in 1954-56, who had written a classic paper on increasing returns, with others such as the Nobel Laureate James Meade and Harry Johnson following soon after, showing that sufficiently increasing returns would imply multiple equilibria and that this in turn implied (among other things) that there could exist a better free trade equilibrium than the one we may be in. Matthews and Meade, and many others such as Murray Kemp, had made this observation but by using the analytical device that the increasing returns were external to the firm but internal to the industry, a device that enabled perfect competition to be maintained. By the time Paul Krugman was writing his dissertation in the 1970s, economists had learnt how to handle imperfect competition; and so Krugman managed brilliantly to show multiple equilibria in this different, and more realistic, setting. Trade economists had known these arguments for almost half a century and taught them from standard textbooks such as mine (with Panagariya and Srinivasan). The analytical buzz therefore from the Baumol-Gomory book of 2000 was muted.
But when translated into policy prescription, all it could mean was that industrial policy, buttressed Tyson-style by appropriately tailored trade policy, could nudge us towards the “better” equilibrium. But neither author managed to do this, as far as we know. So, paraphrasing Robert Solow on externalities, one might say: yes, if scale economies are important, there could be multiple equilibria and we could use trade and industrial policies to choose a “better” equilibrium; but, alas, who can plausibly compute this better equilibrium? Besides, it is hard to imagine today that, with world markets so large due to the death of distance and extensive postwar trade liberalization, there are any industries or products left where the scale economies do not pale into modest proportions. Baumol and Gomory, a brilliant pair indeed, therefore do not carry any policy salience, in my view 4.
But one assault that is ongoing, and has had an impact on the New Democrats for sure, is that by economists associated with the AFL-CIO (such as Thea Lee), and with the labour-movement-influenced think tank Economic Policy Institute (such as Lawrence Mishel). In their view the pressure on unskilled wages, and progressively on the middle class as well, is to be traced to trade with the poor countries. None of this seems to face up well to the empirical studies of the subject. In an op.ed. titled “Technology, not globalisation, is driving wages down” in the Financial Times (January 4, 2007), I argued that the vast numbers of empirical studies (including by Paul Krugman) had shown that trade with poor countries had a negligible impact on our workers’ absolute real wages (as against the relative wages of the skilled and the unskilled 5. [Nor did alternative ways of tying the depressed wages to trade (and even unskilled, illegal immigration) have any empirical salience.] Harvard University Kennedy School’s prolific trade expert Robert Lawrence, in a splendid unpublished recent paper, concurs with this view, concluding that the impact of trade on the slow growth of wages does not “show up” in his analysis of the data.

The New Democrats who continue to believe nonetheless in this imaginary downside of free trade are not doing anyone any good. In fact, they use these erroneous beliefs to stop trade liberalization and to use every trick in the book to intimidate weak nations into accepting inappropriate labor standards in the hope of raising their cost of production to moderate the force of competition that they fear 6.

Paul Krugman, in one of his columns in the New York Times (May 14, 2007) did say that his own research earlier had shown that trade did not depress wages. But then he added: “But that may have changed” (italics inserted). The suggested reason was that “we’re buying a lot more from third-world countries today than we did a dozen years ago”. But it is easy to show that you can multiply such imports and still not have any effect on real wages. This particular case against free trade remains unproven and will not rise above the level of innuendos until some dramatic empirical study demonstrates otherwise.

Here's a podcast of the lecture

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Free Trade, Free Markets: Rating Congress

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Alan Blinder on International Trade

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Trouble With Trade- Paul Krugman

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Does Free Trade Favor Rich Countries?
The University of Cambridge economist Ha-Joon Chang discusses his new book, Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism, with Tyler Cowen, a professor of economics at George Mason University

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