Winners and Losers from Free Trade

… a core concept in Economic Analysis and Atlas102

Click for Dorfman article

Click for Dorfman article

Concept description

Trade can increase net social welfare but does so through a process of reallocation of resources that, at least in the short term, produces diffuse winners and easily identified losers.

Jeffrey Dorfman, writing in the 3 April 2016 issue of Forbes, (reference below and link right) describes why this makes free trade a contentious economic and political issue:

“Free trade was long virtually the only issue about which all economists agreed. Free trade was good and moving toward freer trade was always better than protectionism. These basic lessons have been taught for over a century in millions of economics classes to many millions of economic students with an unchanging lesson: free trade creates a net benefit for all countries involved. Yet, as evidenced by candidates of both parties in the current American presidential election campaign and their supporters, support for free trade among the general public and political leaders is fading fast in the face of a myriad of complaints about the real world outcomes from free trade. Here are four reasons that economists are right on one level but opponents of free trade also have some legitimate facts on their side.

Diffuse winners, concentrated losers

“First, the benefits of free trade are diffuse while the harms are concentrated. Job losses from free trade tend to come from loss of market share to cheaper imports that manifests in factory closings at the companies that see greatly reduced sales. This means that the media can easily find hundreds or thousands of people who are losing their jobs all at once.

“In contrast, job gains are more spread out across the economy. Some job gains occur at exporting companies that gain sales in the other countries who have opened up their markets to our goods. However, since these companies already exist, the job gains are usually incremental gains to their current workforce. The remaining job gains are spread over the entire economy as consumers who save money on cheaper imports spend those savings on a variety of other goods. These consumer-spending driven gains materialize as a job here, a job there, so they are very difficult to see.

“Economic theory suggests that job gains will outnumber the job losses; the gains are bigger than the losses. But a lot of the winners do not realize that their new jobs at a restaurant, movie theater, or bank are fueled by consumers with extra spending power thanks to cheaper imports. Conversely, those who lose their jobs usually know exactly what happened to them. That means a bunch of the winners have no idea that they should be praising free trade while almost all the losers are very clear what is wrong with free trade.

Small benefits from trade

“As much as economists have trumpeted the benefits of free trade over the years, the benefits from free trade are surprisingly small. When tariffs around the world were more common and much higher, the potential gains from free trade were larger. Now that average tariff rates worldwide are rather low, the low hanging fruit is long gone. For example, the estimate of the gains from the Trans Pacific Partnership (TPP), the proposed free trade agreement of the moment, are a paltry 0.4 percent of GDP according to the Peterson Institute for International Economics). Further, this gain will be mostly in the form of higher incomes; any job gains are estimated to be tiny.

The real world does not match our theories

“The simple model of a free market economy that economists use to prove the benefits of free trade does not match the real world.  Economists have developed something called the Theory of the Second Best which says that a free market economy maximizes societal welfare (that’s the first best), but that the ordering among economies with one or more government interventions or distortions is tricky and has no universal ordering. What that means for trade agreements in practice is that because we have government interventions and market distortions, both before and after any trade agreement, there is no guarantee that freer trade (fewer interventions and distortions) will make things better.

“In other words, unless we move from wherever we are all the way to a completely free market economy, there is no guarantee that taking a step in that direction will improve societal welfare. A free market economy will also beat an otherwise free market economy with a trade restriction such as a tariff or quota, but an in economy with other distortions the answer is not so obvious. Within the subset of imperfect economies that we have to choose from, it is perfectly possible for a free trade agreement to actually lower societal welfare. A study of each trade agreement would be necessary to establish whether the agreement is a good or bad idea.

Free trade can increase inequality

“Free trade allows an economy to specialize more in the production of things it is best at making. The gains from trade, therefore, involve gains to those who work in export industries. Workers in export industries earn 15 to 20 percent more on average than other workers. Thus, the gains from trade that go to export industries tend to be captured by people who are already doing reasonably well economically. Remaining gains are distributed across the economy to all consumers who benefit from lower priced goods. These gains probably slightly favor lower-income Americans because they tend to consume more import goods.

“The losses from free trade are concentrated among those who lose their jobs to import competition. Thus, the losses from trade produce job losses, adjustment costs involved in retraining or searching for another job, and all the attendant difficulties of having your life uprooted. In this sense, free trade can increase economic inequality because those hurt by trade often have or end up with below average earnings and those who gain from it have above average earnings.

“These four reasons have a lot to do with the current pushback against trade agreements. While economists remain convinced in theory that free trade is good in an abstract, theoretical sense, economists now realize what non-economists (including some politicians) had already figured out: in practice free trade agreements can cause virtually as many problems as they bring benefits.”

Atlas topic, subject, and course

Trade, Adjustment, and Protectionism (core topic) in Economic Analysis and Atlas102 Economic Analysis.

Source

Jeffrey Dorfman, 4 Reasons Free Trade Has Become A Contentious Political And Economic Issue, Forbes.com, at http://www.forbes.com/sites/jeffreydorfman/2016/04/03/4-reasons-free-trade-has-become-a-contentious-political-and-economic-issue/#276def0865c2, accessed 11 May 2016.

Page created by: Ian Clark, last modified 11 May 2016.

Image: Trade Adjustment Assistance in Washington State, at http://www.taa-washington.org/income-support/, accessed 11 May 2016.