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Free-Trade Economists Begin To See the Light on Trade and Globalization

May 08, 2018

By Jeff Ferry, CPA Research Director

For decades, economists have taught David Ricardo’s Law of Comparative Advantage as if it is an absolute law.  But the tide is turning, as some highly respected economists are now moving away from the doctrinaire position that all free trade is always good everywhere, and they begin to acknowledge that free trade and large trade deficits have inflicted substantial harm on the US economy.

From the mid-1970s on, growing trade has also meant the growing loss of good-paying jobs to competitor nations. Around the year 2000, the process accelerated. Globalization entered a new phase, which Harvard economist Dani Rodrik has labeled “hyperglobalization.” Three significant effects launched hyperglobalization: in 1993 the US signed onto NAFTA, in 1999 the European Union launched the euro, and in 2001 China joined the WTO. The NAFTA agreement effectively erased the border between the affluent US and low-wage Mexico. Creation of the euro tied together 19 economies with a single currency, effectively forcing 18 other economies to compete with Germany without the tool of an independent exchange rate. The admission of China to the WTO gave that nation a guarantee of long-term low tariffs that opened the US to Chinese imports and opened China to foreign investment by multinationals eager to produce in China.

The tsunami of imports into the US has led to some dire economic consequences:

  • Between December 1999 and December 2007, the US lost 34% of our manufacturing labor force.This was actually worse than the Great Depression, when we lost only 31% of our manufacturing employment, according to a Congressional Research Service study[1].

  • Real incomes of production and nonsupervisory workers have slumped. The average weekly income peaked in 1972 (see Figure 1). Today, at $756 a week, it is 10% below its 1972 peak. A 10% decline in 46 years! That’s unprecedented in modern American history.

  • Inequality has grown. According to the authors of a 2016 report from the bipartisan Congressional Research Service[2]: “Between the mid-1970s and 2000, high-income households experienced rapid real income growth relative to middle- and low-income households, but incomes grew on average for all quintiles. Between 2000 and 2015—a period that includes two economic recessions—average incomes fell in the bottom three quintiles of the distribution, and the previous rapid growth in mean incomes enjoyed at the top of the distribution stalled.” See Figure 2 below to see the shift in income towards the uppermost quintile.

  • The middle class has shrunk. A 2016 Pew Research Center study looked at Census data on household income for America’s 229 largest metropolitan areas. “Among American adults overall…the share living in middle-income households fell from 55% in 2000 to 51% in 2014…The decline was pervasive, with median incomes falling in 190 of 229 metropolitan areas examined…The decline of the middle class is a reflection of rising income inequality in the US.”[3]

Advisor_Perspectives-Real_Weekly_Erns_Prod-Nonsup_1967-2015-graph.jpeg

Figure 1: Real Weekly Earnings of US Production/Nonsupervisory Workers in 2018 dollars. Source: BLS via Advisor Perspectives.

CRS-Donovan_income_distribution_1967-2015_graph.png

Figure 2.  US real household income by quintile 1967-2015. Data shows large shift in income to top quintile over the period, minimal progress since 1967 for bottom three quintiles, and a slowdown for all five quintiles after 2000. Source: Congressional Research Service.

 

To the working and nonworking people living in the hundreds of towns and cities affected by the growth of imports, the connection between imports and economic hardship is obvious. But not to most economists. The overwhelming majority of economists have continued to defend free trade. In the words of Paul Krugman, the nation’s foremost trade economist, former Princeton professor, Nobel Laureate and New York Times columnist, back in 1997: “The idea of comparative advantage—with its implication that trade between two nations normally raises the real incomes of both—is, like evolution via natural selection, a concept that seems simple and compelling to those who understand it.”[4] This idea continues to be taught as absolute truth in virtually every undergraduate economics course in every college in America. On May 3rd, more than 1,100 economists signed a letter[5]to President Trump and Congress claiming that “fundamental economic principles” showed that Trump’s tariffs and his focus on the trade deficit would hurt the nation’s economy. “Economists urge you not to repeat that mistake,”they said.

Cracks in the Consensus

However, below the radar, a growing pile of academic studies is providing evidence that trade and, in particular imports from China and Mexico, are the primary cause of the deteriorating outcomes in employment, wages, and other key economic variables in the 21stcentury, including even the rise in early deaths of middle-aged Americans. Many economists have contributed to this literature but none more so than MIT professor David Autor.  In a series of studies over the last five years, Autor and his co-authors have used statistical techniques to show the close correlation between imports from China and economic and social costs inflicted on the affected communities.

In a 2016 paper entitled The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade[6], Autor, David Dorn of the University of Zurich, and Gordon Hanson of the University of California at San Diego used statistical analysis of Census data on 722 US “commuting zones” (CZs), to estimate the effect of Chinese imports on the local economy. They found that Chinese imports were associated with higher levels of unemployment, longer periods of unemployment, greater job churn, and lower lifetime earnings for affected individuals. They also found that China import penetration was significantly correlated with greater use of government social welfare programs including medical care, disability payments, and income support. They estimated Chinese imports were directly responsible for 2.4 million job losses, and the total figure could likely be higher. The job losses, income reductions, and other negative outcomes were all strongly concentrated among relatively lower-wage employees.

Standard economic theory holds that if workers lose their jobs due to imports, they ought to be able to find other jobs in other industries and/or different regions of the country paying similar wages—and ultimately move to higher-paying industries as America exploits its alleged “comparative advantage,” as first laid down by David Ricardo 200 years ago. Autor, Dorn, and Hanson showed that this has not been true of America’s experience with Chinese imports. On the contrary, instead of moving to jobs in other industries nearby, ADH found that the decline in jobs in an import-affected region was actually greater than the decline in jobs in that industry.

The force of ADH’s evidence and the critique of economic theory is turning into a tipping point. In the 18 months since The China Shockwas published, a number of leading economists have publicly admitted that they were wrong in dismissing imports as a problem for the US economy. For example, Brad DeLong of UC Berkeley, a former official in the Clinton administration, admitted at a public forum in April 2017: “I have had to substantially revise upward my own views about the negative U.S. domestic consequences of trade and the China shock that hit the U.S. starting the late 1990s as China’s industrialization shifted from something impressive for a very poor country to something that was of world historical consequence.”

Harvard economics professor Dani Rodrik published a book in 2017, Straight Talk on Trade[7] in which he blamed hyperglobalization for greater inequality and said free trade agreements and World Trade Organization decisions reflected the desire of multinationals for greater profits. He criticized the economic profession for ignoring real-world evidence: “Economists do not fully understand why expanded trade has interacted with the macroeconomy to produce the negative consequences for wages and employment that it has…we should not act as if our cherished standard model has not been severely tarnished by reality.”

But the most surprising admission of all came from Paul Krugman. In a little-noticed article[8] published in March 2018 on his academic website, he admitted he had been mistaken in the 1990s in dismissing the effects globalization could have on employment. After noting that manufacturing employment “fell off a cliff” in the decade after 1997, he wrote that he now believes the trade deficit was a major factor in employment decline and in economic hardship in the local areas affected by imports. “The deficit surge reduced the share of manufacturing in GDP by around 1.5 percentage points, or more than 10 percent, which means that it explains more than half of the roughly 20 percent decline in manufacturing employment between 1997 and 2005…What did the 1990s consensus that the adverse effects of globalization were modest miss? A lot…This was, I now believe, a major mistake—one in which I shared.”

With this admission, Krugman is now closer in his economic analysis to Donald Trump and Bernie Sanders than to the mainstream Democrats he usually supports. And his influence is certain to reverberate through academic economics, Washington think tanks, and politics. Once you concede that large-scale imports and trade deficits are bad for prosperity and economic growth, you need new economic policies. That’s a big question, which we will consider in a future article. Another interesting big question is: why is Ricardo wrong today? He was right in 1817 when he published his analysis. What has changed to make his win-win model of trade wrong? That’s another question worth looking at, because it raises a question about the validity of free-market economics in other areas too.

 

Footnotes:

[1]Linda Levine, Congressional Research Service, The Labor Market during the Great Depression and the Current Recession, 2009. Available here.

[2]Sarah Donovan, Marc Labonte, Joseph Dalaker, Congressional Research Service, The U.S. Income Distribution: Trends and Issues, December 2016. Available here.

[3]Pew Research Center, America’s Shrinking Middle Class: A Close Look at Changes Within Metropolitan Areas, 2016. Available here.

[4]Krugman, Paul, Ricardo’s Difficult Idea, 1997. Available here.

[5]National Taxpayers Union, More than 1,100 Economists Join NTU to Oppose New Tariffs and Protectionism. Available here.

[6]Autor, Dorn, Hanson, The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade, August 2016, Available here.

[7]Rodrik, Dani, Straight Talk on Trade: Ideas for a Sane World Economy,2017. Available here.

[8]Krugman, Paul, Globalization: What Did We Miss?March 2018. Available here.


Showing 4 reactions

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  • Jeff,
    A first rate piece that neatly bridges the transition between the realities of trade in the 18th century and in the 21st century. The widespread failure to respond with appropriate policies to the sharp differences between then now have inflicted heavy costs on America — as you show so clearly. Your survey of recent literature is most useful — informative and well documented.
    Now we face the task of getting national support for CPA’s “smart trade policies” — strategic responses to realities of the present including (a) targeted tariffs to fight trade cheating and (b) the CPA’s Market Access Charge.
    The latter is urgently needed to restore the link between exchange rates and balanced trade that existed in the 18th and 19th centuries, but was destroyed by the tsunami of global financialization during the past half-century.
  • There are a ton of problems with the “law” of comparative advantage. It may work for small groups, but does not scale to nations. When you lose a manufacturing business, you lose a huge number of smaller businesses as well. In addition, much innovation comes from the seat of the pants where a worker shows how to improve a product because he has done something. Today’s trade is ALL labor arbitrage not free trade.
  • Respectfully, notice how the previous commenter felt obliged to embrace the term “free trade”. This is testament to the success of the import lobby in shaping thought. Others try to “justify” protection of American productive capacity by using the term “fair trade”. The import lobby happily uses “fair trade” mantra then engages in endless litigation with little change. CPA has started using the term STRATEGIC TRADE. This term abandons the implied unobtainable, undefinable goal of fair and equitable global economic homogenization—-which in fact would harm most Americans. This rebranding is, I think, important in helping turn the tide against the import lobby who brandish the “products will cost more” club to good effect with short-sighted interests. It helps refocus public attention on our primary obligation to promote the general welfare of Americans.
  • Finally, some important people are starting to understand what those of us who were displaced by globalization have been screaming for fifteen years. All I can say is, “Welcome aboard!” Better late than never.

    David Ricardo was not wrong. He assumed that free trade would be fair and balanced trade. What we have had with China is NOT free trade — it is labor arbitrage — the opposite of free trade. Allowing China to steal our jobs, our technology, and our intellectual property, represents a major betrayal of the American people by our greedy, incompetent government.