Free trade, Pareto improvements, and redistribution

Free trade doesn’t actually benefit everybody unless we adopt specific policies to compensate the losers.

James Kwak demonstrates that Greg Mankiw is talking through his hat on the trade issue, quoting Mankiw’s own textbook:

Trade can make everyone better off. … [T]he gains of the winners exceed the losses of the losers, so the winners could compensate the losers and still be better off. … But will trade make everyone better off? Probably not. In practice, compensation for the losers from international trade is rare.

We can now see why the debate over trade policy is often contentious. Whenever a policy creates winners and losers, the stage is set for a political battle.

To put it formally:

Reducing barriers to trade creates potential Pareto improvements: making them actual Pareto improvements requires redistribution. But of course it’s precisely the people loudest in their support of “free trade” who are most vehement in their opposition to income redistribution, insisting (mostly falsely) that in a globalized economy capital and the people who own it are necessarily too footloose to be adequately taxed.

There’s no reason in principle that the same web of treaties that reduces tariffs couldn’t also restrain tax-dodging and the associated money-laundering, but that’s not what Greg Mankiw, or the people who support his work, are interested in, so it mostly doesn’t happen.  If the corporate-lobby “free traders” were prepared to talk seriously about shared prosperity, most of the opponents of TPP would be more than willing to meet them halfway.

To be clear, I don’t have a clue about whether TPP is, on balance, good policy. If it helps strengthen a Western Pacific coalition against Chinese attempts at regional hegemony, maybe it’s worth doing for that reason alone. And on an international scale the distributional consequences are way positive; the Vietnamese workers who benefit from better access to U.S. markets for their products are pretty damned poor, and – despite how badly they’re treated in the exporting industries – even very bad factory work kicks the crap out of tending a rice paddy.

But the Theory of Comparative Advantage doesn’t answer the question, and pretending that it does is an insult to everyone’s intelligence. In the absence of a redistributive mechanism, the claim that “economics” proves that “free trade is good for everyone” is no better than a verbal trick.

Footnote  All that is aside from the fact that deals like the TPP embody not very much actual reduction in trade barriers (which are pretty low by now to start with) and lots of less desirable (except to special interests) provisions such as imposing the absurdly inefficient and unjust “intellectual property” regime the patent- and copyright-holders have bought from the U.S. government on the rest of the world, and subordinating local health and safety rules to the whims of unelected international tribunals dominated by servants of big business. (For example, the international tobacco companies are challenging Australia’s plain-pack rule for cigarettes as a WTO violation.) In principle, trade deals could also require respect for labor rights and environmental interests, but  those provisions are mostly for show. 




Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact:

7 thoughts on “Free trade, Pareto improvements, and redistribution”

  1. Traditionally, economists have treated almost all distribution issues as beyond their purview. (For example, the classic discussion of armed robbery and burglary say nothing about the losses to the victims of crime, but treat only the deadweight loss of spending on alarms and other security measures — which represents money that could be going to more productive uses.) This is, of course, baloney, but even in such an ostensibly-agnostic world view it's hard to miss the fact that economies with higher levels of inequality also tend to have lower longterm growth rates.

    1. ". . . it's hard to miss the fact that economies with higher levels of inequality also tend to have lower longterm growth rates."

      It's actually really easy to miss this, because it isn't really clear that it's true. Paul Krugman has dealt with this on a number of occasions, and uses it to warn about how easy it is to interpret data in a way that allows us to argue that what we want to be true actually is true. In this particular case, there are a number of confounding factors that make a simple correlation difficult to interpret, as well as the problem that even if there is correlation, whether or not there is any causation or which direction it runs. It also runs into the problem that it's probably true to different degrees not only at different points along a scale of inequality, but also at different points along a scale of per capita wealth and differently depending upon the makeup of an economy.

      Extreme inequality is worth arguing against for plenty of reasons that we don't need

      1. You're right. I should have said something like "If you accept the same standards of proof that people use when arguing in favor of "free" trade agreements…"

    2. "Traditionally, economists have treated almost all distribution issues as beyond their purview. "

      I disagree; I think that right-wing economists have pretended that. They are intensely concerned about redistribution upwards. Note how many right-wing economists have been howling about how we must raise interest rates now, lest inflation eat us all. They are very clearly worried about a labor market which doesn't favor employers by 100:1.

  2. I live in central Mexico, and the NAFTA experience has been a mixed bag (belaboring the obvious here, my apologies). I would say, offhand, that the country's richest ten percent did very well indeed. Another 25 percent entered the middle class, and now have high-speed internet, a late model car, a decent job, and maybe even a shitty little pre-fab house of their own. Another 25 or 30 percent fled farm work to factory work, or to better-remunerated farmwork in the U.S. And 25 percent got royally fucked. Part of the dilemma is akin to maintaining affordable housing for the original residents once a trendy urban neighborhood starts gentrifying. It requires aggressive redistribution, and as you mention, the cheerleaders for free trade (which has never existed anywhere, except in Adam Smith's primitive brain) are the ones most dead-set against fair taxation levels or recovery of taxes on overseas profits. Nor, heaven forfend, unionism and workers' rights.

    But the NAFTA negotiations were fairly transparent, there were lots of hearing, lots of hand-wringing, lots of op-ed space….so I think what people are most pissed off about is this secretive fast-tracking. Why is it necessary? What is so damning that you wouldn't want Ph.D. Econometricians and the AFL-CIO and the rank-and-file workers of America and Stephen Colbert to find out????

    1. You raise an important point. Farmers and farmworkers aren't necessarily poor by accident. I have heard a decent claim that Central American "free" trade policy is part of why we're seeing huge migration. (It's not just our export of homegrown criminals.) People get shoved off their land into slums. I think that may even be official Chinese policy now. I think it's facile to say that a slum is always better than the country. And if it's true, that's worse — plus, fixable.

      So I agree with you – not only is "free" trade suspicious to begin with, but even a cursory exam of the way US politics works makes me highly suspicious of this entire project. It is probably all written by lobbyists for the same 1% in each country.

      Just say no.

  3. Let's put aside for a moment the question of whether maximizing efficiency necessarily maximizes overall benefit to society, and the question of how much an economic model that assumes a make-believe fairyland where all actors behave rationally and have perfect information can be applied to the real world. Let's imagine that both of these are true.

    Does setting up a "free trade" pact actually promote free trade? Let's say we eliminate all the tariffs, import quotas, and so forth between two countries. Inside each country, there isn't going to be free trade: we'll have safety regulations, labor rules, environmental regulations, farm subsidies, a public sector funded by the taxpayers.

    Does removing tariff barriers between two entities, neither one of which has an economy based on free trade, bring us closer to the ideal of free trade?

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