Free Trade Under Fire

Economics Issues from
Ed Dolan’s Econ Blog
Free Trade Under Fire
First posted Updated January 25, 2017
Updated January 25, 2017
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Free Trade under Fire from Politicians
 Free trade came under fire by both
parties in the 2016 election
 Protectionist Donald Trump
decisively beat traditionally pro-
trade Republican rivals
 Democrat Bernie Sanders pushed
Hillary Clinton to abandon support
for new trade agreements like TPP
and TTIP
 First result of election: TPP and
TTIP are officially pronounced dead
Updated January 25, 2017 Ed Dolan’s Econ Blog
“Our politicians have aggressively
pursued a policy of globalization …
Globalization has made the financial
elite who donate to politicians very
wealthy. But it has left millions of our
workers with nothing but poverty and
heartache.—Donald Trump

. . . and from Economists
Economists traditionally favor free-trade, but
some of them have spoken out, too:
 I used to believe in trade agreements. That
was before the wages of most Americans
stagnated and a relative few at the top
captured just about all the economic gains.”
--Robert Reich
 “Not all free-trade advocates are paragons of
intellectual honesty. In fact, the elite case for
ever-freer trade, the one that the public hears,
is largely a scam.”
--Paul Krugman
Paul Krugman

Full Krugman Quote
[N]ot all free-trade advocates are paragons of intellectual honesty. In
fact, the elite case for ever-freer trade, the one that the public hears, is
largely a scam.
What you hear, all too often, are claims that trade is an engine of job
creation, that trade agreements will have big payoffs in terms of
economic growth and that they are good for everyone.
Yet what the models of international trade used by real experts say is
that, in general, agreements that lead to more trade neither create nor
destroy jobs; that they usually make countries more efficient and
richer, but that the numbers aren't huge; and that they can easily
produce losers as well as winners.

Still, Many Anti-Trade Arguments Are Weak
The fact that opponents of free trade are
winning the political debate does not mean
their most popular arguments are sound,
nor that protectionism is the answer to
problems caused by trade
Weak arguments against free trade
 Deficits mean we are losers
 Blame it on currency
manipulation
 Bring back manufacturing jobs
 Don’t trade with the poor

Trade Deficits Do Not Mean We Are Losers
The US trade accounts are usually in
deficit, but the deficits are no higher
now than in the past. Reasons for
chronic deficits include:
 Foreign firms and governments
choose to use part of what they earn
from trade to invest in the US
economy rather than buying US
goods and services
 US savings rates are low
 The dollar is the world’s most
popular reserve currency and US
assets are seen as the world’s
safest and most secure

Don’t Blame It on Currency Manipulation
 Some blame US trade deficits on
Chinese currency manipulation
 China held yuan fixed before 2005
and in 2008-2009
 After 2009, yuan appreciated
strongly. More recently, it has
depreciated again.
 Or should we say the dollar has
gotten stronger?

A Broader Look at the yuan
 Bu the broad measure of real
effective exchange rates, China’s
currency has appreciated rapidly—
more rapidly than any other Asia-
Pacific currency
 Real effective exchange rates take
into account the value of a country’s
currency relative to those of all its
trading partners, adjusted for
differences in inflation rates.

China’s Currency Manipulation Then and Now
How currency manipulation works:
 A country can artificially weaken the
value of its currency by building up
foreign exchange reserves
 It can artificially strengthen its
currency rate by selling reserves
 As this chart shows, before 2014,
China did build up its reserves to
keep the value of the yuan artificially
weak
 However, since mid-2014, it has sold
off forex reserves to keep the yuan
artificially strong

Don’t Blame Loss of Manufacturing Jobs on NAFTA and China
 It is popular to blame the loss of
US manufacturing jobs on NAFTA
(1994) and China’s admission to
the WTO (2001)
 However, manufacturing jobs have
been declining since the 1970s
 Automation is the biggest factor
 NAFTA had only a tiny effect
 China’s effect was larger, but even
so, manufacturing jobs are now
near their long-term trend
 Protectionism might bring
manufacturing operations back but
it won’t bring back the jobs

Manufacturing Jobs Are Being Lost Throughout the World
 Manufacturing jobs are being lost
throughout the world, even in many
low wage countries
 Manufacturing jobs lost are
primarily low skill; high skill jobs in
the sector remain strong
 Peak year for manufacturing
employment by country:
 Mexico 1980
 Brazil 1986
 India 2002
 China 2015? (Preliminary)

Don’t Trade with the Poor
 During the campaign, Trump,
Sanders and others argued that
trade with low wage countries was
hurting the US economy
 Supposed implications:
 Trade with other rich countries is a
fair game but trading with the poor
is for chumps.
 Trade with poor countries forces US
workers into a race to the bottom in
wages and working conditions

What Makes American Workers Competitive?
However . . .
 American workers are not competitive
because they are supermen, but
because of education, technology, and
strong institutions
 Making America self-sufficient in low tech
products would require shifting workers
from industries where they are more
productive to low skill industries that low-
wage countries now dominate
 Wages would be lower in the new jobs
and more expensive products would hurt
low income consumers

Trade and Global Inequality
Besides . . .
 Refusing to buy from poor workers
would close their own path to the
global middle class
 It is not just big corporations that
gain from trade with poor countries:
 Average wages in China have risen
from $3,300 per year to $8,870 over
the past 10 years
 As wages have risen at home, net
migration of Mexicans to the US has
reversed
”The issue of wealth and income inequality
is the great moral issue of our time; it is the
great economic issue of our time; and it is
the great political issue of our time.”
--Bernie Sanders
BernieSanders.com

The Real Downside of Trade: Losers and Winners
 Free traders have never denied
that trade produces losers as well
as winners
 Instead, they have argued that . . .
 The gains are much larger than
the losses
 Losses are only temporary as
displaced workers and capital
move to new opportunities
 Those new jobs are created
automatically in export industries,
or at home, when consumers
spend the money they save
because imported goods are
cheap
A study from The Peterson Institute estimated
that the gains to consumers from Chinese tire
imports amounted to more than $800,000 for
each job lost in the US tire industry.

But What if Adjustment Is Slow?
But new research* suggests that adjustment to trade shocks may be slow:
 Job loss and lower wages in hard-hit regions persist for years.
 Effects are geographically concentrated; mobility is not sufficient to ensure widespread
sharing of losses by workers across regions and industries.
 When an increase in the overall trade deficit accompanies a trade shock workers
displaced from jobs impacted by import competition do not quickly find comparable jobs
in export industries.
 Those who do find work often end up in services or other sectors serving the domestic
economy. Their skills do not fit those jobs, so their wages are lower.
 Effects of trade shocks include increased unemployment benefits, disability benefits,
food stamps, and other forms of government assistance.
 Trade shocks disproportionately affect low-wage workers within affected regions and
industries.
*David Autor, David Dorn, and Gordon Hanson, “The China Shock: Learning from Labor Market
Adjustment to Large Changes in Trade.”

Traditional Response Trade Adjustment Assistance
 The traditional response to displacement of
workers has been a combination of
temporary income support and retraining via
the federal Trade Adjustment Assistance
program
 However, critics say TAA is underfunded
and ineffective
 Despite TAA, it appears that the US labor
market has become less flexible and
adjustment to trade shocks has slowed
US Government training class in
basic computer skills

Indicators of Falling Labor Fluidity
 A recent paper shows that
several measures of labor
fluidity are falling in the US
Job reallocation: Number
of jobs created plus
number destroyed in new
and existing firms
Worker reallocation: Sum
of hires, quits, and
layoffs
Churn: Worker
reallocation minus Job
reallocation

Falling Interstate Migration Rates
 Another study shows that
interstate migration rates are
falling in the US, especially for
younger workers
 The falling migration rates
suggest growing barriers to
labor mobility

Five Factors that Slow Adjustment and What to Do About Them
 These five factors reduce labor
mobility and slow adjustment to trade
and technology shocks:
Disincentives in the social safety net
Insufficient portability of healthcare
Ownership bias in housing policy
Spread of occupational licensing
Growth of population with criminal
records
 What kind of reforms could improve
ability to adjust to shocks?

Reform of Social Safety Net
 One reason displaced workers are slow to
move to new jobs is that high benefit
reduction rates in safety net programs
reduce their incentives
 Moderate solution: Simplify and consolidate
safety net programs to reduce high benefit
reduction rates
 More radical solution: Replace conventional
welfare programs with a universal basic
income
For more, see The Economic Case for a
Universal Basic Income
A Congressional Budget Office
report shows that benefit reductions
on food stamps, EITC, health
subsidies, etc. can take back 60
percent or more of income earned
by low-income households.

Improve Portability of Health Care
 Despite the Affordable Care Act,
health care is not always easily
portable from job to job and from state
to state
 Reform proposals that give more
health care authority to individual
states could make it more difficult for
displaced workers to move from state
to state
 A European-style single payer system
could make health care for workers
more portable, just as it now is under
Medicare

Remove Ownership Bias in Housing Policy
 Trade shocks hit entire regions, making
it difficult for displace workers to sell
houses
 US tax policy is strongly biased toward
home ownership
 Reform of tax policy to treat owners and
renters equally would help increase
mobility
 Already, young workers are reluctant to
buy a house because they expect to
change jobs and move often

Reverse the Spread of Occupational Licensing
 In the 1950s, fewer than 5 percent
of US jobs required a license
 Today licensing has spread to
occupations like florists, hair
braiders, and interior designers.
 More than a quarter of all jobs
require an occupational license
 Licensing varies widely from state
to state making it had for licensed
workers to move if another family
member is displaced by trade
 Reform: Limit licensing to jobs
where risk of fraud and harm to
consumers is high

End Mass Incarceration and Help Those with Records Find Jobs
 Some 70 million Americans have
criminal records, many for minor
offenses
 Even a minor criminal record makes it
much more difficult for a displaced
worker to find a new job
 Reform: Reduce incarceration rates for
minor crimes and misdemeanors
 Reform: Make it easier for people with
records to find jobs with approaches
like “Ban the Box”

The Bottom Line: Protectionism is not the answer
Why protectionism is not the answer to trade
shocks:
1. A sharp change in trade policy would produce a
shock of its own that would displace millions of
workers
2. Trade is only one reason for loss of
manufacturing jobs. Automation is a bigger
factor
3. Even if protectionism brought back
manufacturing operations, it would not bring
back high-paid jobs for low-skill workers
A better approach: Reforms that improve labor
mobility and speed adjustment to trade and
technology shocks

The Bottom Line: Protectionism is not the answer
Related reading from Ed Dolan’s Econ Blog:
 How occupational licensing undermines labor fluidity
 How reform of the social safety net could mitigate the high costs of trade
adjustment
 The Trump-Sanders War on Free Trade

Click on the image to learn more about
Ed Dolan’s Econ texts
or visit www.bvtpublishing.com
For more posts and slideshows, Follow Ed Dolan’s Econ Blog
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Free Trade Under Fire

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