The TPP, "Beating China" and the Challenge to Free Trade Theory

January 28, 2016


Free trade theory is being challenged at its core within the academic community. The upcoming US International Trade Commission study of the Trans-Pacific Partnership is at the vortex.

This NY Times article today, “So What Would It Mean to Beat China on Trade", focuses upon the academic paper I blogged about yesterday - the one that says labor markets don’t adjust to trade shocks so job losses do occur. In contrast to one of the basic assumptions of free trade theory, that there are no job losses because people find new jobs.

In my view, we are in the midst of a substantial challenge to the validity trade theory that is now making it to the mainstream debate, rather than just emanating from the "shrill voices in the cheap seats". Ian Fletcher's "Free Trade Doesn't Work", Gomory and Baumol's "Global Trade and Conflicting National Interests" and many others have laid the groundwork. But the challenge is gaining momentum in the popular mind.  The credibility of the establishment view on trade theory is drastically fraying.

I added this reader comment to the NYT website article.

Trade theory is being challenged at its core. The win-win assumption is based upon a few underlying false assumptions that were never tested. (1) Labor markets will adjust, so there is no job loss, just job reallocation. The paper in the article shows how this is not true. (2) Trade imbalances must not persists, there must be balance. The paper does not fully discuss this false assumption, but labor markets can't adjust if there is unbalanced trade.  (3) Rational markets exist rather than national strategies and state-influenced political economies. The US persists in believing other countries are like us. But China, Vietnam, Germany, Japan all use tools ranging from state-capitalism to industrial policy to benefit their state-owned, state-influenced or national champion industries. The tactics are designed to make them win the balance of trade and competition for jobs game for a period of years. Free market theory has nothing to say on these issues because it assumes them away.

The USITC study on the TPP is at the vortex, as I mentioned above, of this debate. The USITC’s econometric model (CGE - computable general equilibrium) is a free trade model that makes all these false assumptions. But the role of the USITC is not to make policy judgments or recommendations that the TPP should or should not be accepted.  The best case scenario for now is for USITC to reject the CGE model as not reflective of reality - which means there is often disequilibrium, not equilibrium. The assumptions are not true so equilibrium cannot be presumed. Thus the CGE is worthless.

More realistically, the USITC will use the CGE model but call it into question. And perhaps apply other models that don’t include those assumptions.

But the TPP debate may end up going deeper than past trade agreement debates.  It could spur the inevitable paradigm shift in thinking about trade.

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