07 December, 2007

Trade Policy

Economist Dani Rodrik has some amazing thoughts on free trade agreements:

Trade was good for me...[w]as it good for you too?

You say it left you feeling really sore and that I did not even say a proper goodbye (let alone pay you for my share of dinner)? Well, I don't really care. I enjoyed it so much that we must have been both better off in aggregate. So we have to keep doing it. And in any case, if we stop you are likely to find some other way of hurting yourself.

Rodrik is, of course, right. Moving to freer trade, as with nearly all changes in policy, has winners and losers. Some people, typically the scarcer factor (in the U.S., labor, in China, capital) are made worse off because they must compete with foreign markets. Some people, in this case, consumers, are made better off. In most models of trade (certainly the ones that economists think are most important for describing the world), the benefits to consumers are larger than the costs to producers. Many of these consumers are also producers, and so some of these costs can be canceled out, but nonetheless there are many who are net losers from this sort of policy. As in, their permanent incomes are lower after the policy than before it.

To put this in economic terminology, trade agreements are Kaldor-Hicks improvements, but not Pareto improvements. The latter because not everyone is made better off, and the former because everyone could be made better off if only the winners would compensate the losers. In other words, the whole za gets larger, but some people end up with a smaller slice of za than they had before.

Let's talk about this pie:

1) Should we try to maximize the size of the pie? Or something else? This is fundamentally a philosophical question, not an economic one. Do we maximize average utility? Total utility? The utility of the least well-off? The sum of virtue? The well-being of communities?

At the risk of starting an argument about utilitarianism, I think that it's not a bad idea, for many things, for the government to try to maximize the average utility of society. We can safely assume that a dollar to a rich person is worth less than a dollar to a poor person, so that means that these sorts of trade agreements are bad. How can they be made good? By implementing some sort of social transfer program simultaneously with the trade agreement so that everyone or almost everyone gets something from it.

The problem with this is that all social transfer programs distort people's decisions and reduce the size of the pie at the same time. So there may well be trade agreements that are never worth pursuing because their effects will always be regressive. At the same time, there may be trade agreements that are actually progressive in their effects.

2) Do trade agreements actually maximize the size of the pie? This is not a philosophical question, this is an essentially economic one. Rodrik argues that this is not necessarily the case because too much trade without any social transfers weakens the political will for free trade and increases opposition to globalization, which can lead to sharp protectionism.

UPDATE: I should have linked to the post where I got the quote from.


Elliot said...

Are you going to be done with that book by Christmastime?

spencer said...

Yes, I'll bring it back.