Krugman on Trade and Inequality

by Will Wilkinson on June 15, 2007

Paul Krugman has published an interesting article on trade and inequality at VoxEu that nicely illustrates the morally puzzling nationalist assumptions of standard welfare economics.

After economists looked hard at the numbers, however, the consensus was that the effect of trade on inequality was probably modest. Recently, Ben Bernanke cited these results – but he recognised a problem: “Unfortunately, much of the available empirical research on the influence of trade on earnings inequality dates from the 1980s and 1990s and thus does not address later developments. Whether studies of the more recent period will reveal effects of trade on the distribution of earnings that differ from those observed earlier is to some degree an open question.”

But the question isn’t really that open. It’s clear that applying the same models to current data that, for example, led William Cline of the Peterson Institute to conclude in 1997 that trade was responsible for a 6% widening in the college-high school gap would lead to a much larger estimate today. Furthermore, some of the considerations that once seemed to set limits on the possible inequality-promoting effects of trade now seem much less constraining.

There are really two key points here: the rise of

China, and the growing fragmentation of production.

Conclusion:

What all this comes down to is that it’s no longer safe to assert, as we could a dozen years ago, that the effects of trade on income distribution in wealthy countries are fairly minor. There’s now a good case that they are quite big, and getting bigger.

This doesn’t mean that I’m endorsing protectionism. It does mean that free-traders need better answers to the anxieties of those who are likely to end up on the losing side from globalisation.

I’m just going to assume that Krugman is right about everything. Maybe he is. If a large part of Krugman’s argument is that we increasingly buy stuff from China (and other such countries), since they can produce it more cheaply, then it is a large part of Krugman’s argument that ”the economy” in which Americans participate is increasingly one in which parties to complex forms of exchange work and reside in different nation-states. Krugman, as far as I can tell, thinks the increasingly globalized network of exchange creates a larger overall surplus than would exist in a more highly protectionist world, and Americans on average are better off for it. But, the argument seems to be, the share of that larger surplus going specifically to low-skilled American workers is smaller than it would be in a more heavily protected economy. These folks are on ”the losing side.” The policy upshot, I’m sure, is that “winners” might need to compensate “losers.”

I think there are lots of conceptual problems here that flow from knee-jerk economic nationalism. Let’s imagine just U.S. - Chinese trade, to make things simpler.

First, it is not clear why the scenario of a continued, less-globalized status quo ante, in which low-skilled American workers earn higher wages, counts as the relevant baseline. That is a world in which, I guess, we are supposed to imagine that the Chinese economy has not been liberalized, and so there is less competition from Chinese workers. Implicit in this idea is that unreformed Chinese communism — which keeps its workers off the world labor market – is a subsidy to low-skilled American workers. But now the subsidy has been withdrawn, making low-skilled workers “losers.” There is clearly a kind of perspective relativity going on here. We could just as well say that the prior generation of low-skilled workers were winners, receiving a bonus from Chinese economic illiberalism. I think the normative baseline should be competitive world labor markets — a world in which individuals’ passports have no effect on their freedom to trade with one another. And so the opening of Chinese labor markets is a reversion toward the baseline, and a withdrawal (from other low-skilled workers) of a positive externality of injustice.

Second, it seems to me that American low-skilled workers are suffering from a classic pecuniary externality (that is, the withdrawal of a positive pecuniary externality). If you and I are both in the hot dog biz, and I sell my hot dogs for a lower price, a reduction in your profits may be (to you) a negative external effect of my offering a lower price. But this is not the kind of thing you can claim as a “harm” or a basis for compensation. Pecuniary externalities are essential to competitive markets: we want them. Nobody is doing anything to low-skilled domestic laborers. It is simply that their segment of the labor market has become more competitive, bidding down wages. It’s just as if you had to cut the price of your hot dogs to stay in business, resulting in lower profits. Now imagine that our friend Larry is now buying hot dogs from me rather than you, since my hot dogs are cheaper. There are gains from our trade, which he and I divide. Larry comes to me not you, because he gets a relatively bigger bit of the surplus than he did with you. At the end of the year, Larry has more cash in his pocket than he would have had if he had been trading with you. And you have less in your pocket than you would have had if he had been trading with you. So the inequality between you and Larry has increased, all because I’ve been offering a cheaper hot dog. But I had next to nothing before I was selling cheap hot dogs. So the inequality between me and Larry has decreased.       

That’s what it’s like, isn’t it? Many Americans get a boost in real wages from the relative decline in prices due to cheaper stuff made in China. But that boost isn’t enough to fully compensate workers who would have been doing the work the Chinese are doing (if the ChiComs hadn’t opened their markets.) Meanwhile, hundreds of millions of Chinese edge ever slightly closer to American wages. Which change in inequality matters morally? It simply isn’t obvious that it’s the gap among fellow Americans.    

  Unites States and China GDP per capita 1975-2004

Now, it may be the case that if the class of citizens who suffer a pecuniary externality is large enough, they may drum up effective political demand for restrictions on trade (for reinstating their previous subsidy, by other means), which would make most other citizens worse off in the short term, and everyone worse off in the long term. So we might want to enact direct wage subsidies, or an increase in the EITC, retraining programs, or whatever, to get those on the ”losing side” of globalization from trying to use the political process to make themselves “winners” again. But, if that’s the real argument, we should be clear that the point of this is not to ameliorate the injustice of increasing national income inequality caused by global trade, because there is probably no such injustice. Increasing national inequality may be a side-effect of a straightforward improvement in justice globally.

It may also be that Krugman is not right about everything. 

Viewing 5 Comments

    • ^
    • v
    It looks like every day, in every way, justice is getting better and better. But why even talk about justice? Why not just talk about wealth or income? We don't want to confuse outselves, or other people, by confusing two things which are not the same. Although this tends to confirm my suspicion that most libertarians are really wealthitarians.
    • ^
    • v
    Two things: (1) Production may be "cheaper" in China because pollution is permitted, (2) Labor costs are relative to labor's bargaining strength, which is determined by state policies.

    Wrt (1), I think that we ought to see pollution as a subsidy; it's actually free waste disposal. Hence, it's a barrier to free trade and an impediment to realizing the on-paper benefits of markets. We ought to be orienting organizations like the WTO toward harmonizing nations' environmental standards by penalizing countries that subsidize industry through free waste disposal.

    Wrt (2), I would argue for much the same. We need to set an international baseline for labor rights like collective bargaining. Libertarians might even agree that failure by the state to protect workers' rights to voluntarily form unions artificially deflates the price of labor. Certainly, libertarians will agree that state taxation schemes designed to drive farming villagers into cities' industrial job markets artificially deflates wages.

    Conclusion: Fair trade is the way to realize the on-paper benefits of free trade. Moreover, a fair trade message that includes promoting international environmental and labor standards along with the opposition to tariffs and direct subsidies commonly associated with the "free trade" banner is an effective response to rising populist protectionism of the US political left. Of course, this all needs to be weighed with the foreign policy goals achieved through engagement with countries like China, but I do think the goals of a non-protectionist fair trade can at least be furthered.
    • ^
    • v
    (1) Sure. US environmental preferences cost the US jobs. Is that really an argument for imposing our environmental preferences on others? (2) The international baseline for labor rights should be that workers can, if they like, bargain collectively, and, if they like, negotiate their own labor contracts. Also all workers should have right to exit to other labor markets. People who are worried about the labor conditions of workers in other countries ought to be in favor of letting them move to countries with better conditions.
    • ^
    • v
    Through Paul Krugman's blog post for today

    http://krugman.blogs.nytimes.com/2007/12/30/con...

    I eventually linked to your comments on his Trade and Inequality, revisited piece at:

    http://www.voxeu.org/index.php?q=node/261

    I was intrigued by your tack of implying that Krugman's tilt towards giving fair trade arguments a bit more respect than has been the case – even by Paul Krugman in the past -- exposes his flank with respect to some sort of ideal notion of social justice.

    I understand your argument in the abstract, which is to say in the context of a theory of morality in general and social justice in particular which is highly individualistic. The flaw in your reasoning, at least from a philosophical if not a strictly economic point of view, is to imply a standard for social justice – and more generally morality überhaupt -- which need not be constructively mediated through socially (and historically) constituted political/communal structures, whether these structures be families, tribes, or, most importantly for your particular argument, nation states.

    The effect of this highly individualistic notion of morality is that you uncritically cherry pick individually focused forms of social justice/morality and shrug off other more socially embedded notions and outcomes.

    One of your commenters, play_jurist, gets at this by noting that state sponsored policies in China of turning a blind eye towards (global) environmental considerations and denying Chinese labor Western-style bargaining rights dilutes to a considerable degree the force of the view that a simple narrowing in the wage gap between some workers in the developed world and other workers in the developing world (China, for example) is a sufficient basis to claim that this represents a net net advance in terms of social justice.

    Your response to play_jurist is somewhat flip and, indeed, borders on the intellectually embarrassing. Let me take it one thought at a time:

    "(1) Sure. US environmental preferences cost the US jobs. Is that really an argument for imposing our environmental preferences on others?"

    You seem try to avoid joining the debate over (global) environmental degradation by using the loaded term "imposing." Am I wrong to detect an unargued for assumption that, whatever else morality might mean, it means not imposing your moral views on someone else because morality is an intensely individual thing and not a social matter? Why this sort of view of morality does not even qualify for classical liberalism's view of morality where individual morality does have the minimal social obligation of doing no harm to others.

    So surely you jest if you are suggesting that there is no moral – forget political and economic -- asymmetry in terms of social justice, understood in a global context, between lax Chinese pollution standards and tighter American ones? Or have I somehow misunderstood what your riposte to play_jurist implied from the standpoint of your chosen cudgel, social justice?

    "(2) The international baseline for labor rights should be that workers can, if they like, bargain collectively, and, if they like, negotiate their own labor contracts. Also all workers should have right to exit to other labor markets."

    The naivete is in the frictionless "shoulds" and "if they likes." The problem with some versions of free trade is that these "shoulds" and "if they likes" happen not to be anywhere close to being operative. And it is hopelessly muddled to mount even a supposedly moral argument based on somehow turning a blind eye to this reality.

    "People who are worried about the labor conditions of workers in other countries ought to be in favor of letting them move to countries with better conditions."

    Leave aside once more the frictionless "ought." It is quite possible to argue that the U.S. – and other developed countries -- need not one fine day cease having regulated immigration policies, while still coming out considerably to the left of Lou Dobbs with respects to the economic, political, AND social justice aspects of immigration policy. Nor need they under these circumstances feel particularly vulnerable to the charge that they hold the equally naïve view that the modern liberal nation state stands at the end of history as the source of all (moral) goodness.

    I think you know this, and that is why it appears a bit sophomoric to throw out a suggestion about the (ideal) free movement of labor which ignores this reality.

    Otherwise, I very much enjoyed your piece.
    • ^
    • v
    billyblog,

    I am a liberal, as is Krugman, and liberalism is generally founded on a kind of moral individualism. If Krugman wants to argue for a kind of communitarian nationalism, as he sometimes seems to want to do, then he should just go ahead and do that and we can argue about it then. Now, I agree that, as a matter of fact, people are conformist, their moral views are saturated with local cultural assumptions, and this is a constraint on policy, for better or worse. But I am replying to Krugman on his own liberal egalitarian terms, and my point is that liberal egalitarianism is at odds with economic nationalism, a point he seems unwilling to admit.

    Your criticism of my "frictionless shoulds" seems to completely miss the point of the argument, which I no doubt could be clearer about. My argument is that egalitarian liberalism, which is incompatible with economic nationalism, demands that these frictions be removed. I don't deny that they exist. I am saying that if you care about what Krugman says he cares about, you should focus on enabling free trade and labor mobility -- things that will lessen global inequality.

    I don't think I understand your point about the environment and China.
 

Trackbacks

(Trackback URL)

  • Whimsley

    June 16, 2007 at 10:57 pm

    Watching the Economists - Magnetism and Experts... Yesterday I read that Paul Krugman has a lot more time for opponents of ...

close Reblog this comment
Powered by Disqus · Learn more
blog comments powered by Disqus

View My Stats