Putting the free in free trade
THE economics commentariat has been seized this week with a debate over the value of trade liberalisation, of all things, sparked by a Greg Mankiw column in the New York Times, but really by Uwe Reinhardt's response to it, in which he cites Alan Blinder:“That is why I am going public with my concerns now,” he concludes. “If we economists stubbornly insist on chanting ‘free trade is good for you’ to people who know that it is not, we will quickly become irrelevant to the public debate.It's an uncomfortable truth for economists; perhaps all of whom have heard, at some point in their lives, the remark that "free trade is great in theory, but in practice...". Mark Thoma muses on the question and observes that just because trade can make everyone better off doesn't mean that it will. Trade liberalisation generally produces net benefits, such that some of the winners' gains can be redistributed to losers, leaving all in better shape than before. But this is not how policy functions in the real world. Should we support free trade if its Pareto improvements aren't actually realised?Tim Worstall responds that the same argument can be made in reverse—the parties that benefit from protectionism never compensate those that lose from the restrictions. Since optimal redistribution is lacking in both cases, the most efficient solution should be the one we support: free trade.William Polley is not happy with this conclusion:But ultimately what is wrong with Worstall's logic? For me, it boils down to the notion of a social contract. People make decisions, many of which are irrevocable or nearly so, on the basis of the best information and their expectations of the future. Sometimes the biggest influences on our expectations are the existing law and the political environment. If I then make a decision in good faith based on existing law, only to have the law change to my disadvantage, I will feel wronged. That I benefited from the way the law was should not be held against me when arguing to change the law...And that's why Worstall's logic fails the test of reality. People make life decisions based on protectionism. No, not directly just like that. But trade protection has kept the factory in their hometown going. They graduate from high school and apply for a job. Maybe it was the only job in their hometown. Sure, they could have gone to the big city to wait on tables or drive a cab but that would take them away from home and family. The made the decision that was best for them based on what they knew and could in good faith expect...When you break a contract in law, you must compensate the other party. Sometimes it is in the best interest of both parties to allow that. The social contract is no different. We can, and indeed we should, at times rewrite the social contract, but when we do, the winners must compensate those who made good faith decisions based on the old contract. If we do not, then the law is worth no more than the paper it is printed on, and that will lead to less economic activity for fear that it can always be taken away with the stroke of a pen.I can see how this logic appeals to people, but it seems dead wrong to me. I believe in the social contract, and so I'm bothered by this attempt to redefine it as the whole of the existing body of law and regulation, and perhaps custom as well. Laws change. This is a fact of life and has been true for as long as there have been laws. People take important decisions on the basis of laws, and that's a reason to choose laws carefully, but it's also a reason to take decisions carefully. As a matter of political economy, it is often necessary to compensate the losers from a policy change in order to build sufficient support for that policy change. But that's a reason to oppose the recasting of the social contract in this way. To define the state's (or society's) obligations in this way—to say that current law at the time an individual takes critical decisions about the future (which is all the time) constitutes a contractual promise to that individual—is to make the status quo all but unchangeable. And in that you do no one any favours.The best responses to Mr Polley's point that I've see are this:I prefer to argue in favor of free trade because I think the right to choose who I wish to deal with belongs to me and your right to choose who you deal with belongs to you. I think, ultimately, government policies respecting these rights will promote economic growth and development, but that is mostly just a happy coincidence.And this:I see the problem of adequately compensating the losers from international trade as just a part of the larger question of how we treat people in our society who, through no fault of their own, have fallen on hard times. International trade is just one of the many enormous, inexorable forces that constantly reshape our economy. Technological change, demographic change, or the fluctuations of the macroeconomic business cycle may devastate millions of families each year just as surely as international trade. An important measure (to me) of the type of society we live in is how we treat those individuals who are on the losing end of those impersonal economic forces that, in the long run, often help to make the world a more prosperous place.Much of this conversation has centred around what economists can convincingly argue to a class of Rust Belt students in first-year economics. I'd tell them that economies are based on the gains from voluntary, mutually-beneficial transactions, and the government should be very reluctant to prevent people from engaging in these transactions. No one wants to be told what or from which people they can buy. But what's price to one person is income to another. Sometimes people begin buying different things, for many different reasons—technological changes, policy changes, shifts in tastes, recessions—and that change in buying patterns will cost some people their income. Very often, these changes will strike the victim as unfair. But life, as parents have explained for millenia, is not fair. The proper response to this unfairness is not to try and undo it, to reject the choices of others engaging in voluntary transactions as illegitimate. The proper response is to work to build society's safety net so that those hit by life's inevitable unfairness aren't left destitute and hopeless because of it.Society doesn't owe anyone a factory job, and it doesn't owe factory workers a cheque if an improvement in trade rules leaves them jobless. It owes them precisely what it owes all of its members: a level of protection against the unpredictable sufficient to afford them the opportunity to get back on their feet.