Is free trade good? A plain English Explanation

There’s been a lot of discussion since the US election about whether free trade agreements are actually a good or a bad thing. Do they lead to cheaper consumer goods being available in western countries? Do they destroy jobs? Should we have any more?

rust-belt-states
The rust belt states

Some (including myself) have questioned whether the job losses caused by the North American Free Trade Agreement (NAFTA, the trade agreement between Mexico the US and Canada) helped Donald Trump win the US Presidency. Trump certainly campaigned to that effect in the rust belt states (the five or six states of the US in the north-east, where jobs have disappeared as industries relocated to Mexico.) One of the factors which seems to have cost Hillary the election is that the Democrats thought they had those states “in the bag”, and apart from Pennsylvania, she failed to campaign very much in them. The Democrats underestimated the depths of anger and resentment caused by those job losses.e trade agreements remove import taxes and quotas on imported goods. That means consumers in the country A  which removes the barriers get cheaper goods, and employment is boosted in that sector in country B. So when Australia removed barriers on clothing and textiles and footwear in the 1970s and 80s, Australians got cheaper clothing, and somebody in China or Vietnam got a job. Australian clothing workers lost jobs.

So if our own workers are going to lose jobs, why enter into an agreement? The two countries will maximise their joint production if they each specialise in what they do relatively more efficiently. I’ll borrow an example from David Ricardo, one of the first economists to white about this in the early 1800s.  If country A can produce ten blocks of cheese OR ten shirts, and country B can produce ten blocks of cheese OR twenty shirts, what happens?

Without trade, country A might devote half its resources to each task. It might produce five blocks of cheese and five shirts. Country B might do the same and produce five block of cheese and ten shirts.

Panel 1: TOTAL PRODUCTION IF COUNTRIES TRY TO PRODUCE BOTH GOODS

Country Cheese Shirts
A 5 5
B 5 10
Total 10 15

One the other hand, if country A produces all the cheese and country B produces all the shirts, total production will be ten blocks of cheese and twenty shirts.

Panel 2: TOTAL PRODUCTION IF EACH COUNTRY SPECIALISES

Country Cheese Shirts
A 10
B 20
Total 10 20

The theory is that the countries should specialise, and then trade approximately 5 block of cheese for 7 shirts.  Country A will end up with 5 cheeses and 7 shirts, B will end up with 5 cheeses and 13 shirts. Everyone is better off compared to Panel 1. That’s the theory. The situation will look like this:

Panel 3: TOTAL PRODUCTION IF THE COUNTRIES SPECIALISE AND TRADE

Country Cheese Shirts
A 10-5=5 0+7=7
B 0+5=5 20-7=13
Total 10 20

But notice that this treats each country as if its industries were the country. The model tells you that GDP (total production) will increase. The model tells you nothing about how employment is distributed, or whether a geographical area is better or worse off,  what happens to wages, or what happens to profits.

Some shirt workers in country A will become unemployed, and some cheese workers in country B will become unemployed. Will the unemployed people in both countries find jobs in another industry? In the US, the example would be that the US now exports corn to Mexico while Mexico exports cars to the US. Will the unemployed car workers in Michigan find jobs in the corn industry in Iowa? Perhaps not. Perhaps they can’t afford to sell their houses in depressed Michigan and move to Iowa. Will former corn farmers in Mexico gain employment in the car industry? Maybe. Maybe not.

Wages in the higher wage country (the US) may be held down by the threat of more job losses in manufacturing if the workers push for higher wages. The results may be wage stagnation and lingering regional unemployment. That’s what seems to have happened in the US.

If governments are to persuade their citizens to enter further free trade agreements, they need to be honest about the likely job losses, because jobs will be lost somewhere. This can be remedied somewhat if governments provide incentives to industries to relocate in the geographic areas of the job losses and provide retraining to workers who lost their jobs.

I suspect that the days of just putting a free trade agreement in place and then leaving displaced workers to fend for themselves may be over, and that may be a good thing. The question needs to shift from “will it increase GDP” to “who is going to lose from this, and what are we going to do for them?”

*   *   *

Did Hillary neglect the rust belt states here .

NAFTA failed to deliver benefits here, here, possible mixed benefits here.

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