Monday, January 12, 2004


Strange bedfellows Charles Schumer and Paul Craig Roberts wrote a remarkably obtuse editorial in the New York Times last week throwing over free trade in the face of the supposed threat posed to the U.S. economy by the exporting of jobs to India and China. Their argument rests on the notion that the principle of comparative advantage—first formulated by David Ricardo to combat the protectionist policies of mercantilist Britain in the 19th century, and the theoretical underpinning of the case for free trade ever since—ceases to hold in a world like ours where the factors of production are highly mobile.

Noam Scheiber ably refutes this in the New Republic Online:
[S]o-called factor immobility is NOT, in fact, one of the assumptions underlying the theoretical case for trade—at least not the way Schumer and Roberts seem to think it is. To see this, let's back up for a second. At its broadest level, the point of free trade is to expand the size of the global economic pie by eliminating production inefficiencies, which arise when one country tries to produce everything itself using only the "endowments" of capital and labor (i.e., machines and workers) it has within its borders. Now, there are two ways you can eliminate these inefficiencies: When it's not so easy to move machines and workers across borders, countries can specialize in the goods they produce most efficiently, which they then trade with one another. . . . When it is easy to move machines and workers across borders, you don't have to specialize (at least not by country) and trade, because every country already has access to the most efficient machines and workers.

Put differently, you can either trade machines and workers (which is basically what you're doing when you're outsourcing), or you can trade the goods these machines and workers make. But, as a theoretical proposition, the two scenarios are EXACTLY THE SAME: They both maximize productive efficiency. Indeed, one of the great accomplishments of international trade theory, post David Ricardo, was to prove mathematically that trade in goods accomplishes the exact same thing, efficiency-wise, as trade in machines and workers.
Schumer and Roberts seem completely blind to the positive dynamic effects of a global shift toward low-cost but highly skilled Indian and Chinese labor. If (to use their example) American firms can replace American software engineers making $150,000 per year with equally competent Indians making only $20,000, then—news flash!—software will become much cheaper to produce, and software prices will go down. Indian software engineers will benefit from this, but so will software consumers (many of whom are American) and shareholders in software companies (ditto). And don't forget that software is itself an input into countless other goods and services, so if software prices go down, so too will the costs of those other goods and services, including ones that don't yet exist because the costs of innovating them have been too high until now. You're going to have to try a lot harder than Schumer and Roberts did—and use much sounder logic—to convince me that this won't make us, on net, better off.

"On net," mind you; obviously there are losers here, chiefly the $150,000 American software engineers (in the short-term, at least). But Michael Kinsley makes a very good point about this in his skewering of Schumer and Roberts (the refs are going to throw a flag for piling on soon):
Traditionally, the most troublesome thing about free trade—apart from the difficulty of persuading people that it works—is the unequal distribution of its benefits. The whole country is better off, but there are winners and losers. Generally, the losers are lower-income workers, whose jobs are the easiest to duplicate in less-developed countries. It seems misguided to me to avoid a policy that makes the whole nation richer because it makes some individuals poorer. With more to play with, it ought to be easy to ease the burden on free trade's losers. Of course, under a Republican administration, we don't do nearly enough of that. So, a respectable case can be made that some trade restrictions are justified, even though they leave all of us a little worse off, if they prevent some of us from being a lot worse off.

But the real difference between traditional trade in heavy earth-bound objects and 21st-century trade in weightless electronic blips, or in sheer brainpower, is that the losers in new-style trade are more likely to be people that U.S. senators and fancy economic consultants actually know. These are people with advanced degrees and high incomes. Their incomes will likely be above average for our economy even if they are driven down by competition from poorer economies. Under these circumstances, denying the benefits of free trade to the whole nation—and denying opportunity to the rising middle class in developing countries—in order to protect the incomes of a relative few seems harder to justify, not easier, than it was back in the days when our biggest fear was Japanese cars.
Schumer and Roberts form their mouths around the conclusion that "[o]ld-fashioned protectionist measures are not the answer" and call instead for "new thinking and new solutions." Meaning new-fashioned protectionist measures, I'm guessing. And just to make sure that we didn't misunderstand their misunderstanding of free trade, they close with this: "one thing is certain: real and effective solutions will emerge only when economists and policymakers end the confusion between the free flow of goods and the free flow of factors of production." Well, we know at least one economist and one policymaker who are hopelessly confused about this, so it's good they got something right.


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