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Archive for the ‘trade’ Category

The LSE’s EUROPP blog has published my critique of Dani Rodrik’s The Globalization Paradox. It’s an expanded version of this blog post on Pileus from a few days ago.

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Dani Rodrik, the political scientist’s favorite economist, argues for a limit to globalization in his recent book Globalization’s Paradox. The LSE EUROPP blog has a nice little summary of the book’s argument:

  1. Markets require a wide range of non-market institutions (of regulation, stabilisation, and legitimation) in order to work well and remain socially sustainable.
  2. These institutions do not take unique forms, in the sense that ultimate goals such as efficiency or stability can be achieved under a variety of designs and blueprints.
  3. Different societies, organised around their own states, have patently different needs and preferences regarding the shape that market-supporting institutions can take.
  4. A world that is sufficiently responsive to democratic preferences will therefore be one of institutional diversity and heterogeneity rather than institutional harmonisation and convergence.
  5. Since institutional diversity inhibits the global integration of markets by raising transaction costs across jurisdictional boundaries, a world that is sufficiently responsive to democratic preferences will also be one that falls short of full globalisation.

The idea is that it is desirable to have different countries have different regulatory schemes, but full globalization demands complete harmonization of regulation in order to minimize transaction costs. Exporters and investors want to face the same regulations abroad as they do at home. Some of the premises of the argument are incorrect, but I actually agree with the conclusion for different reasons. First, the problems with the premises.

Premise #1 is disputable to some extent. It’s stated broadly enough that these “institutions” could be social or governmental, and the governmental institutions could be nothing more than enforcing appropriate rules of appropriation and exchange. Yet I suppose Rodrik means something more by the statement, as illustrated by his example of financial regulation. The sparer those institutions within which markets need to be embedded, the more harmonization is possible and desirable even if the rest of the argument is right.

Premise #3 is deeply problematic. It’s just not appropriate to speak of societies having “preferences,” and it’s even more naive to think of democracy as somehow translating those preferences into law. If the only reason for retaining national economic sovereignty is that the latter might permit different “societies” to enact their “preferences” into law, then the case is very weak.

My argument for an outer bound to globalization would be more contingent. Taking everything into account, the scales seem to tip against harmonization when: 1) different national approaches can give us better information about what works, rather than enshrining a subpar approach into law, 2) regulatory arbitrage allows better rules to develop, ultimately yielding harmonization but not through a centralized process, 3) smaller polities are less likely to be influenced by “insider” interest groups than some multilateral institution tasked with harmonizing regulations, or 4) citizens perceive globalization as a threat to sovereignty that they value, and therefore respond to harmonization attempts with a stronger backlash against globalization more broadly (Rodrik does address this last consideration in his book). Sometimes multilateral harmonization is justified and sometimes not; it depends on the balance of considerations. For instance, harmonizing customs rules, as was agreed recently by the WTO trade ministers in Bali, seems harmless.

Ultimately, I think Rodrik is pushing on a string. There is little risk that harmonization will go “too far,” given the extremely decentralized nature of global economic governance. And I disagree with Rodrik that globalization has gone about as far as it needs to go, and now requires defense from its own advocates. For instance, the West can do much more to repeal agricultural trade barriers that kill poor people around the world.

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Twenty years after its establishment, the World Trade Organization finally reached its first global trade deal last night at the meeting of the world’s trade ministers in Bali. The successful agreement foiled expectations that this meeting, like all others of the Doha Round, would end in failure and acrimony. Media outlets have been reporting the Peterson Institute’s estimate of $1 trillion in higher global output as a result of the deal, but what’s most interesting about the deal is that it happened only because the member states decided to focus on a narrow slice of the issues under discussion in the Doha Round. The deal focuses mostly on streamlining customs procedures to facilitate timely cross-border transportation, along with measures to eliminate tariff and quota barriers against exports from “least developed countries” to richer countries, to reduce agricultural export subsidies (here the deal merely makes a “strong political statement” and doesn’t require specific changes in law), and to permit developing countries’ governments to stockpile food.

Why did it happen? Ten days ago, after talks in Geneva, WTO head Roberto Azevedo warned that global trade talks would collapse if ministers did not narrow down the scope of their deliberations to issues on which consensus was achievable. Global trade talks have been bogged down over the last 20 years over severe distributional issues: developing-country governments want sharp cuts in rich-world agricultural subsidies, tariffs, and quotas, while rich-country governments want their poorer counterparts to cut trade barriers on services, beef up intellectual-property enforcement, and liberalize foreign investment. None of those big issues were solved in Geneva and Bali. A narrow deal on customs procedures happened because the distributional and enforcement issues here are far less severe. Few governments have any interest in holding up traffic at the border longer than necessary. Simplifying customs procedures is more like a coordination game than a Prisoner’s Dilemma: everyone benefits if forms are standardized and simplified. Rich-country governments also promised poor-country governments help with hiring customs officials to help speed up processes.

The conventional wisdom in international relations is that a broad scope of issues helps international organizations solve distributional problems, all else equal, because broad scope makes it easier for governments to trade off gains to one side on one dimension with gains to the other on another dimension. But all else was not equal here: some issues faced much lower distributional conflict than others, and on those it was relatively easy for governments to reach agreement. They chose to go for a small deal rather than a big one because, frankly, the WTO needed a win. Another collapse of talks would have called into question whether multilateral trade liberalization is even possible.

This deal does not end the Doha Round. Talks will continue on the “big issues” mentioned above. This is fortunate, since the Bali deal does little to reduce the extent to which U.S. and European agricultural policies kill poor people. While the deal helps with market access for least developed countries, essentially all rich countries have already implemented duty-free, quota-free access for these countries’ exports, and least developed countries contain merely 12% of the world’s population and less than half of those living in extreme poverty. There need to be binding legal limits, actionable before the Dispute Settlement Body, on agricultural subsidies, quotas, and tariffs in rich countries.

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Nick Gillespie notes in a recent post:

[I]f working on Reason Saves Cleveland taught me one thing, it’s that there’s no simple solution to urban decline. Some of it is simply historical – the Northeast is not going to dominate American business and culture that way it did 100 years ago and cities such as Cleveland or Buffalo or Detroit will never regain their earlier populations or the density at which they lived…

But it’s also clear that private and public sector boosters are always more interested in laying big bets on giant development deals that won’t transform a city or region even if they happen to work out perfectly. What makes and keeps places livable and attractive are the smaller-ticket items, such as quality of basic services such as roads, law enforcement, business climate, schools, taxes, and regulations. These aren’t sexy items but they are the things that actually keep cities thriving.

I think Nick’s right that policy fixes will not be enough to restore places like Buffalo to past glories, though New York’s high-cost regulatory regime does harm upstate New York. International economic factors have made most of the U.S. Rust Belt uncompetitive: their legacy industries are in long-term decline.

This observation might seem to pose a problem for economic theory. The theory of comparative advantage shows that every economy benefits from free trade with the rest of the world, a conclusion that “new trade theory” has not overturned. But what about America’s former industrial heartlands? Surely they have lost out to competition from Japan and China (and Tennessee).

But in fact, Buffalo has benefited from comparative advantage and trade with the world. If Buffalo enacted trade barriers to Japanese and Chinese goods, Buffalo’s people would be worse off. Buffalo’s industrial decline happened not because Buffalo firms could no longer sell to Buffalo consumers, but because Buffalo firms could no longer sell to American consumers. The Rust Belt used to have a captive consumer audience; their potential Asian competitors were shut out of a relatively sheltered U.S. market (in part not because of trade barriers or even high shipping costs, but because in global context in the 1950s, Buffalo’s economy was capital-intensive and its labor force highly skilled). In that environment, Buffalo firms could compete. So yes, Buffalo might well be better off if the U.S. shut out foreign trade in automobiles, cereal, and other goods still manufactured in the area. In the same way, the U.S. might be better off if all of the Americas, say, shut out non-U.S. imports of semiconductors and wheat, but that does not mean the U.S. would be better off shutting out those imports on its own. (Arguably, preferential trade agreements like NAFTA and CAFTA are precisely aimed at giving U.S.-made goods an advantage over the Japanese and Europeans in nearby countries.) In the end, then, there seems to be no problem for the theory of comparative advantage. The theory does not say that the best of all possible worlds for every economy is a situation in which every other economy is free-trading. The terms of trade still matter.

But there remains a subtler problem for comparative advantage in the experiences of Buffalo, Detroit, Cleveland, and Pittsburgh. Why have these cities seen net out-migration as a response to changing economic fortunes? The theory of comparative advantage suggests that in response to growing trade, people will retool and start to specialize in new lines of business. Moving away just isn’t part of the model. So why has the Buffalo metropolitan area lost people in every decade since the 1960s?

To answer this question, we need to look to transaction cost economics. A transaction cost is the cost associated with a particular exchange, the toll you have to pay just to be able to make a trade, in addition to the price you pay for the good or service itself.

Trade in goods and services, movement of capital, and movement of labor (migration) are all substitutes, in that they have essentially the same distributional and aggregate consequences, in the absence of transaction costs. But each of these types of transactions does face some costs. Trade in goods and services faces shipping costs, but there are also problems with trading goods when contracts are unenforceable or there are monopoly markets. In these cases, you might be better off investing rather than trading. For instance, Nike knows something special about designing and marketing footwear. Why don’t they just sell their good ideas to startup manufacturers in Vietnam? Because it’s difficult to enforce that kind of contract in ideas: what ideas exactly would the startup be buying, how could it evaluate their worth without examining them before buying, and if they examine them before buying, what’s to stop them from using the ideas without paying? Because of these problems, Nike chooses instead to direct-invest in Vietnam, building its own factories.

Direct investment faces transaction costs too: risks of expropriation, difficulties in managing across continents, etc. So sometimes firms trade rather than invest.

And workforces migrate. Why? Because transaction costs in trade and investment limit the extent to which those mechanisms of globalization can raise workers’ incomes. In the 19th century, European workers moved en masse to the New World because globalization wasn’t raising their wages fast enough. Shipping costs were high, though falling, and multinational investment was rare outside a few industries like railroads, mines, and large-scale agriculture concerns. Moreover, total factor productivity was lower in many European countries because of their dysfunctional political systems. It’s no accident that so many Italians, Germans, Irish, and Poles fled their homelands in the latter half of the 19th century, while comparatively few French, Swiss, Dutch, and even British (considering their common language with their former colonies) did so.

So why have workers fled Buffalo? The introduction of air conditioning has made southern climates more pleasant, to be sure, but Sioux Falls, South Dakota is colder than Buffalo and has actually attracted people. Buffalo has a comparative advantage now in relatively low-tech, labor-intensive manufacturing, by developed-world standards, rather like, say, Tennessee. But Tennessee attracts foreign direct investment, while upstate New York does not, even though upstate New York has had a workforce already trained in industries like auto parts manufacturing. Here we can look for policy explanations: politicians impose transaction costs that prevent workers in upstate New York from exploiting their comparative advantage. Favorable conditions for collective bargaining and expensive business regulations may not hamstring the financial economy of Manhattan, but they do harm upstate New York. Tennessee and South Dakota lack those regulatory obstacles.

So there we have it: in the absence of New York’s heavy regulatory burden, globalization would still have caused upstate New York incomes to decline, but net outmigration probably would have been significantly less.

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I teach my undergraduates that trade has no long-run effect on aggregate employment. I teach it because it’s right, and very few economists would disagree. Tyler Cowen’s recent postings on MR about the negative employment effects of trade have the potential to mislead. To the extent that trade and technology correlate with persistent disemployment in local areas, this is a reason to think that there are structural inefficiencies in the labor market. If these structural rigidities exist, then it can be hard for people who lose jobs to get new ones. Anything that disrupts existing employment patterns — trade, technology, macroeconomic changes like price shocks — will then associate with employment declines.

What are these structural inefficiencies? For market monetarists, the “zero lower bound” is a favorite. But we’re now five years out from the NGDP shock that plausibly caused the big increase in U.S. unemployment. The rise in the minimum wage, the extensions of unemployment insurance, the expansion of welfare programs like food stamps, and perhaps most importantly, housing lock-in due to the collapse of the real-estate bubble are all plausible candidates. But these structural rigidities deserve the real blame for disemployment, not trade and technology. Blaming trade and technology is a bit like blaming the weather. Labor markets will always be disrupted by something or other. Policy makers cannot insulate an economy from shocks. What they can do is gum up the works so that the economy cannot respond nimbly to these shocks.

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Factor price equalization due to trade and investment flows across economies would substantially reduce economic reasons for immigration to rich countries. (Trade and investment flows will not eliminate economic reasons for migration because if polities differ in total factor productivity due to political institutions, there can still be an advantage to migrating to a more efficient economy in a fully globalized world.) Therefore, if you are an American who is deeply concerned about immigration to the U.S. for cultural or political reasons, one way to encourage less immigration is to press for full trade and investment liberalization in this country and around the world.

Now, does opposition to immigration correlate positively or negatively with support for free trade and “outsourcing” in voters’ attitudes? In my experience, negatively.

Chalk this up to one more way in which politics is about symbolism rather than substance, due to public ignorance.

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Conservatives and taxpayer groups are ready to fight the $1 trillion farm bill when it comes up for a vote in the new Congress. Agricultural subsidies, price supports, and tariffs in developed countries (the U.S., Japan, and the European Union especially) not only harm consumers at home by hitting them with higher prices, but cause severe poverty abroad by shutting exports from less developed countries (LDCs) out of developed-country markets and by dumping developed-country surpluses on LDC markets at prices below marginal cost. Since the poorest people in the world are farmers in poor countries, and over 15 million people die from hunger and disease each year due to severe poverty, rich-country agricultural subsidies are literally killing poor people on a massive scale.

Here’s just one anecdote from the IFPRI report of how this works:

Harrison Amukoyi’s farm is perched on a hillside in western Kenya. On less than two acres of land, he raises several crops and a dairy cow. To sell milk, Harrison and his neighbors must compete with industrialized countries that dump their subsidized milk on local markets, depressing prices for Kenyan farmers. This unfair contest appears in countless guises throughout the developing world, intensifying conditions of poverty.

And here are some figures from the NCPA analysis on how poor farmers would benefit if cotton subsidies alone were eliminated:

The International Cotton Advisory Committee (ICAC) estimates that ending U.S. cotton subsidies would raise world prices by 26 percent, or 11 cents per pound. The results for African countries dependent on cotton exports would be substantial:

  • Burkina Faso would gain $28 million in export revenues
  • Benin would gain $33 million in export revenues
  • Mali would gain $43 million in export revenues.

We have seen reductions in severe poverty recently. The world’s biggest reduction in severe poverty has come in China over the last three decades. It’s clear that economic reform is the critical, long-term driver of poverty reductions. But where did China’s poverty reductions start? With growing agricultural productivity. The poorest countries of the world can’t just move straight into manufacturing. They need first to generate some agricultural surplus. Making it possible for poor farmers to sell to rich consumers, or even to their own people, is necessary to making that happen.

Removing rich-country agricultural subsidies could also have political-economy benefits. Many LDCs repress their agricultural markets in favor of the urban sector. Thus, their own governments deserve some share of the blame. The typical tool for this repression is a “marketing board” monopsony. The marketing board buys produce at coercively depressed prices and then tries to export it for a profit, plowing the proceeds back into urban subsidies. Rising world prices for farm goods would increase the profits of these marketing boards, potentially allowing them to raise the prices they pay farmers at home. While some nasty governments might find the new revenue reinforces their power, the new revenues would surely build useful state capacity in just as many places. Furthermore, rising farm incomes should increase the political power of the farm bloc in LDCs, which increases the probability of domestic liberalization.

Ending the rich world’s harmful policies would not eliminate global poverty. However, it would make a significant dent and could set in motion economic and political processes that would have far-reaching effects indeed.

Still, agricultural subsidies and trade barriers survive, amounting to well over $300 billion per year in the rich countries of the OECD, dwarfing the aid sent from rich to poor countries. They survive because of the collective-action problem: poor people have no voice at all in the political systems of the rich world, and rich-world consumers barely have one. Producers organize effectively because of the clear benefits they receive from subsidies, and even ideological opposition from both the left and the right cannot effectively fight them.

The only effective way to counter the greed of the few is with the white-hot moral passion of the many. (more…)

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