Free Trade on Trial - What are the Lessons for Economists?

This election season in the US there has been an extraordinary and disturbing trend at work: vilifying free trade as a "job killer". The main front runners in both political parties in this Primary season are all apparently questioning free trade as a way to garner more votes.

So although in January 2015 Ted Cruz said "I am a full-throated advocate of free trade. Free trade benefits America, produces jobs,

produces economic growth and it is good for our country", he has gone on record saying that he is not in favor of the Trans Pacific Partnership (TPP).  The front-runner on the Republican side, Donald Trump says that the Trans Pacific Partnership (TPP) is a "terrible, terrible deal", and that he would cancel most of the existing trade deals as well as building a wall between the US and Mexico. And lastly, John Kasich has said that "I think that we have, in some ways, been saps. We can't have people coming in here and dumping stuff and destroying our jobs in this country. That's where I grew up! I grew up with steel workers."

On the democratic side, Hillary Clinton also opposes the Trans Pacific Partnership (TPP), But probably the most vehement anti free trader in the Primaries has been Bernie Sanders. He has gone on record saying that "Let’s be clear: the TPP is much more than a “free trade” agreement. It is part of a global race to the bottom to boost the profits of large corporations and Wall Street by outsourcing jobs; undercutting worker rights; dismantling labor, environmental, health, food safety and financial laws; and allowing corporations to challenge our laws in international tribunals rather than our own court system".

So what is going on here? Why is one of the biggest trends of the last 3 decades now being questioned and vilified by our leading politicians? Well, there is plenty of analysis in the press (see here in the FT and here in the New York Times, for example), but we need to ask 4 basic questions here:

i) why is free (or freer) trade regarded as a good thing by economists?
ii) why is there now so much opposition to free trade among politicians?
iii) what would happen if we implement some of the suggestions coming from both ends of the political spectrum?
iv) what lessons can we as economists learn from this?

So first, why is free trade regarded as a good thing by economists?. As I explain in my Principles classes, the Ricardian theory of trade says if you have a comparative (relative) advantage in doing something, you should specialize and focus on doing exactly that thing. The unfortunate part of free trade is that if you don't have a comparative advantage in a specific good or service, then the theory says you should let someone else do it and import the good or service. The obvious implication is that people will lose their jobs. And that means that as barriers to free trade have come down over the past 60 years that we will lose jobs in certain industries. But that is not the end of the story - trade theory goes on to point out that in any country the gainers from trade could compensate those with losses from free trade, and we would still be better off. It is this second part that doesn't get taught in the textbooks or emphasized enough.

But what does this mean exactly? It means that from a macro perspective, the gains coming from the industries that can take advantage of comparative and expand to dominate international markets will make more income for the country than the loss in income from declining industries which will eventually be eliminated. Of course, that is the idea behind some of the government "adjustment programs" which usually accompany free trade deals: the government provides money to help workers transition out of an industry where the country does not have a comparative advantage into an industry where the country does have a comparative advantage. This extra transition spending should be temporary, as the dynamic adjustment to a new free trade deal causes workers to move from one industry to another. That is the theory at least.

So now we can answer the second question: why is there now so much opposition to free trade among politicians? One of the UK's leading politicians of the 1980s, Norman Tebbit coined an unfortunate phrase relating to the sectorally unemployed: "on yer bike". What he meant was simply if there isn't any work where you currently live, move to where there is work. The problem with this as relates to the economic theory is that workers often do not like to move - and particularly in a country as big as the US. The loss of social networks established over years, the uprooting of children from schools that they like, often the loss of property values as major parts of certain states see everyone trying to sell at once if the town or city is not industrially diversified, and the different cultural norms in different parts of the country, are all good reasons why we observe inertia in labor mobility. And much of this loss of jobs has come because by and large the US does not have a comparative advantage in manufacturing - that sector has been in long term decline, as it has in many developed countries.

If States are not industrially diversified, there is no doubt that there will be pain - hence the so-called "rust belt" in the central US States, the fisheries in the Atlantic provinces in Canada, the dockyards of Glasgow in Scotland, and the garment industries of North Carolina are all good examples. This pain is clearly one of the festering scars of free trade policy in advanced economies around the world. So if you are a politician campaigning in these States where there has been a decline in specific industries, it is natural that you'll get votes if you oppose free trade - so politicians such as Donald Trump, Bernie Sanders and Hillary Clinton all know that if they are to have a chance of winning in these States they need to argue against free trade, and so they do. 

This leads into the third question. Donald Trump has advocated rejecting the Trans-Pacific Partnership (TPP - which I regard as a coalition type free trade deal against the emergent trading might of China), and said he would raise tariffs by 45% against all goods coming in from China and other countries that he deems to be unfair. I am assuming that the Transatlantic Trade and Investment Partnership (T-TIP) with Europe will also be on the ropes too, Bernie Saunders has also said that he would only do "fair trade" deals, where this is defined as trade where wages and environmental standards are roughly equivalent to those in the US. That implies that Saunders would be against TPP, but would actually be in favor of T-TIP. But it implies that a Saunders Presidency would see international trade collapse with the developing world ( - what a lot of economists call "North-South" trade).  Either of these two scenarios are not good for US economic prospects, as it implies that free trade deals which the US stands to benefit from, would possibly not come to pass, and also that we will see other countries erecting trade barriers against our goods and services.  

What lessons can economists (and the general public) draw from this?  

First, I think that from a theoretical standpoint we need to expand our proselytizing about free trade to make politicians and the general public understand better where the economic argument comes from, and how it needs to come as a complete package rather than just a narrow focus on the benefits. What we have failed to do as economists is recognize the costs, and how best to mitigate those costs. 

Second, what can we do in the policy realm?  It should mean that any free trade deal needs to come with a whole raft of moving grants and loans, retraining grants and loans, and pension and Social Security "top-ups" for those laid-off workers who are deemed to be close to retirement age). But I hear my economist friends saying - "but that might make the international rearrangement of production no longer economic, so that comparative advantage cannot fully operate.  Well my argument would be "so be it".  These are people's lives you are talking about, and government and business instigated policy changes should come with transitional arrangements that protect those that are most vulnerable.

Third, we need to be much more aware of the regional industrial specialization that occurs in the US when making trade deals - perhaps States could be given notice that a free trade deal will happen and then some kind of fiscal transfer can be arranged to help it generate new industries within it's borders. In this sense regional policy and trade policy are much more related than economists have recognized in the past.  

And lastly, and probably the most important lesson that can be learned from this, is that economists need to be much more vocal about these public policy issues, and suggest ways in which the well-being of all our citizens can be improved, or at least maintained.

Europe, the US and a missed opportunity to initiate a EUSATA

Spencer Gore - The Cinder Path (from the Tate Collection)

Now you're probably thinking "what has happened to this Crowley dude?"  Why hasn't he been posting like crazy with all that's been going on in Europe?  Well, to be honest I've been busy - very busy as a matter of fact - setting up and then hosting a workshop in Helsinki at the Bank of Finland (see here if you don't believe me). After getting over the jetlag, then catching up on the backlog of things that needed to be done at University, I have only had a chance over the last few days to really reflect on what has been going on (and is still going on) in Europe and indeed on the world stage.

And (as they say in Texas) it ain't pretty!  But rather than dwell on events that change by the day, hour and sometimes the minute, I thought I would reflect on what could have been done and what really   matters in Europe now.

I remember when the euro was first launched that I was sceptical - I wrote a few papers using cluster analysis  (still available on my website) that showed that the peripheral EU countries did not display the same macroeconomic dynamics as the "core" countries in the centre of Europe. Underlying this view in economics is something called the optimal currency area theory which basically says that if your cycles are different from a bunch of other countries, then you shouldn't be using the same money. And just to make the point here, when I say "cycles" I mean all cycles, not just the business cycle.  Of course we all know what happened - the euro area happened and the criteria for joining the euro had virtually nothing to do with the optimal currency area criteria.  At first I thought that the euro area wouldn't last, as not only was it not an optimum currency area but also the legal underpinnings did not appear to be in place to support the single currency. Well I was proven wrong on that one and indeed the euro lasted through it's 10th birthday in 2009 to much fanfare, but after 2009 things have started to fall apart, and not at the point that you'd expect - after a severe recession. If you look at the growth dynamic of countries emerging from a recession the dynamics are usually extremely aligned - I've also done some research on this using a technique from physics called "recurrence plots". The difference though here is the debt problem that Greece faces, the fact that the debt was much higher than it should have been on entering the euro area and also their inability now to do much about it as their economy is mired in a downward growth spiral caused by the cutbacks and tax increases necessary to put them on a "sustainable path".

The problem is not just that the peripheral European countries shouldn't have been in the euro, the problem is that even with the low interest rates that the ECB is now delivering ( - now even lower after Draghi's surprise decision to lower rates last week) the peripheral euro area member states are just not growing, and the best way to get the debt to GDP ratio down is to have growth to lower the ratio as the UK is now also finding out.

So how do you stimulate growth? There are two approaches - spend and lower taxes ( - which is usually the favored route in the US) - or go for structural reforms which change the economy or its external relations in such a way that it gives businesses new incentives which jolts the economy into growth. It was heartwarming the other day to hear that that is exactly what is happening (and what I predicted) right now in Japan after the Tsunami. Just listed to this and you'll see what I mean. European member states cannot initiate more government spending or tax cuts, so structural reforms (so most economists say) are what is needed. But these are going to be hard - noone likes to lose job security in a high unemployment environment, and noone likes to have government programs reformed to give people less benefits (as has happened with teachers in the UK, Greece and it's on the tables in Italy as well).

But there is a solution that would help, and rather surprisingly the politicians who meet at the G20 summit in Cannes, France this week did not seem to get it. Indeed this was rather surprising given the motto of the summit in french read "New World, New Ideas" ( - sorry I know, I'm being sarcastic!) - in fact the lack of new ideas was enough to make anyone following all this to get out the St. John Wort tablets. This idea I had is not new, it's just that noone seems to have thought about it in the context of trying to solve the current global growth problems. At a roundtable of Consuls General from France, Germany and Italy in Houston lately, I asked it as a question and I seemed to get a bemused response from the participants. The Italian Consul General even said "it's just too complicated so it is never really considered an option", and the other Consuls General appeared to agree with this view.

So what am I talking about? In short, a TAFTA - which stands for a TransAtlantic Free Trade Agreement. Of course this is not technically correct as a TransAtlantic trade agreement should really include Canada....but wait, the Canadians are soon going to conclude their OWN trade agreement with the EU called the CETA (Comprehensive Economic and Trade Agreement) and the Mexicans already have agreements with the EU in place. I guess I would call what might emerge a EUSAFTA (- an EU-USA FTA).

But why now? First, the US Congress passed and President Obama recently signed and recently lauded new trade deals with both South Korea, Columbia and Panama. So although the US government is "broken", lawmakers on this side of the Atlantic seem to still be able to get their act together when it comes to trade deals, so there is at least a glimmer of hope there. Second, the trade flows that we're talking about are the largest in the world when you add up all the European Union member states - and yet these trade flows have not been liberalized (as anyone shopping for European cheeses knows only too well). But more to the point, the structural change (and hopefully "net boost") to the economies on both sides of the Atlantic would be significant, leading to an acceleration in growth, and indeed given how big both entities are, global growth. And third, as part of the G20 communique, leaders called for a study to be done on how to get an "early harvest" on some of the gains that could be culled from the failed "Doha round" of GATT talks which were held under the auspices of the WTO - well, hmmmm, let's think what caused the GATT talks to collapse in the first place - yes, you got it, the EU and the USA not being able to agree on agriculture! So getting them to push their heads together and negotiate something (even if you leave agriculture out) would get the diplomatic channels opened up further, and might allow a deal to also be done on agriculture which could allow the Doha round to be restarted.

Clearly getting agreement on a EUSATA would not be easy, but the potential payoff is just too great to ignore right now. We all know that just getting the trade representatives to sit down and talk will boost economic growth as businesspeople will become more optimistic about the fact that something is being done by our governments to try and boost growth. In my opinion it is the best way to get the economies on both sides of the Atlantic out of their current economic policy quagmires.