A Healthy Re-Examination of Free Trade's Benefits and Shocks

NEWS ohn Van Reenen: Free trade means allowing good and services to move as freely as possible across different countries. As countries developed, they started making and swapping things among people within the borders of their own country. As transport improved, they could start buying and selling stuff abroad. For a long time there were big...

NEWS

ohn Van Reenen: Free trade means allowing good and services to move as freely as possible across different countries. As countries developed, they started making and swapping things among people within the borders of their own country. As transport improved, they could start buying and selling stuff abroad. For a long time there were big barriers to international trade. At a time when governments struggled to raise tax from their own people, levying heavy import duties on things coming in from abroad was easier to implement. But economists eventually won the argument, which said that keeping those barriers as low as possible was sensible policy.

With free trade, you come into more contact with foreign companies, new ideas, new people

The Economist: Is free trade good for economic growth?

John Van Reenen: As I see it, there are four big benefits. The first one can be traced all the way back to David Ricardo in the early 1800s. It allows countries to specialise in producing what they do best. For instance, the French are good at making wine, the British not so good. But the British are good at producing The Economist. Without trade, Britain would have to produce and consume its own its own wine. But with trade, Britain and France can focus on what they do best, with the French exchanging wine for more copies of The Economist. This is sometimes called “comparative advantage”.

As time has gone by, trade is increasingly not just about exchanges in final goods—newspapers versus wine—but “intermediate” goods. Think of a car. Thousands and thousands of parts go into making a car. Increasingly what has happened is that one part is made in France, another in Germany, another in Japan, and so on. Then they can all be combined in a fourth country like Britain. Even for a complex thing like a car, nations can specialise in what they are good at.

The second benefit of trade is that it makes markets bigger. If you are producing just for one country, your market is quite limited. But with trade, you can also start selling things to customers all over the world. That means that things like spending large amounts of money on research—self-driving vehicles or whatever—looks a lot more viable. The lump-sum costs of such investment are spread out, so we can get more innovation, which is the key to growing national income.

Free trade increases the size of the pie. But it doesn’t mean that everyone is better off. Some get a smaller slice of the pie

The third benefit relates to productivity differences between firms. Some firms are really productive, others are really poorly managed. What happens when you have trade, is that you have much stronger competition. Domestic firms are competing not just with other domestic firms but with firms all over the world. The less-efficient ones face more competition, so they shrink and they exit the market. Or they shape up. And the really innovative firms can expand. So it’s about creative destruction, really—shifting resources from less productive firms to more productive ones.

The final benefit, which economists sometimes forget, relates to politics. With free trade, you come into more contact with foreign companies, new ideas, new people and so on. That’s mutually beneficial. And it is a political force for cooperation. Think of Europe. Since the second world war, those countries have had lower trade barriers, and that period has coincided with an unprecedented period of peace and cooperation.

The Economist: What are the downsides of free trade?

John Van Reenen: There are well-known downsides. The way I like to think about it is that free trade increases the size of the pie. The overall amount of material wellbeing expands. But just because the size of the pie expands, it doesn’t mean that everyone is better off. There are going to be some losers whose slice of the pie is so much smaller that they would have been better off with less trade. However, because the overall size of the pie has got bigger, the government can compensate the losers which can still make everyone better off.

Let’s think about how this might happen. In the 1980s China began opening up to the rest of the world. China was a low-wage country, so it started selling a lot of low-end manufactured goods like clothes. Although that’s a great thing—people can buy cheaper clothes—workers in richer countries who were producing manufactured goods now faced much tougher competition. Workers in Bradford no longer just competed with those in Birmingham, but also those in Beijing. Those workers, especially less skilled ones in those industries, can be very seriously affected.

It’s important to take a longer-term view. The education system needs to make people resilient to shocks

I think economists underestimated the China shock. That may explain why policies to compensate the losers were insufficient—especially in America where the social safety net, such as for health care, is so threadbare. If there had been better policies, there would be much less of a political backlash against trade than we are seeing right now.

The Economist: What can countries do to compensate those people who do lose out?

John Van Reenen: There are lots of different options. The first thing I would emphasise is that you want to grease the wheels of mobility—to make it easier to move from one firm to another, or one industry to another, or one place to another. Putting up barriers to doing that is costly. For instance, planning regulations sometimes make housing in dynamic parts of the country very expensive, which makes it difficult for people in struggling areas to move there.

You also want to help citizens get the skills to move. So-called “active labour market policies” are important here. Scandinavian countries like Denmark do these quite well. Rather than protecting jobs by increasing the costs of downsizing which ends up making employers reluctant to hire, these nations have generous unemployment-benefit systems combined with a lot of help for people who have become unemployed. Retraining is well resourced. Governments also enforce looking for work pretty strongly.

It’s also important to take a longer-term view. Your education system needs to make people resilient to shocks. You want people to be well educated, and you want that education not to be too tightly linked to a particular skill. Having general skills—literacy, numeracy, social skills—is the right idea. So, when people are hit by tough times, they can reskill and move around more easily.

But it is also important to be realistic. Some people, especially older people, are not going to be able to retrain if they were made unemployed by structural economic changes. For these people, there is nothing wrong with a reasonably generous welfare state and direct investment to support communities that are under stress from trade, technology or any other crisis. But remember: thanks to free trade, you can afford that, because the overall size of the pie is bigger.

https://www.economist.com/blogs/openfuture/2018/05/open-markets-0

Source: www.formag.com