A few days ago, I saw Noah Smith’s piece on free trade and why opening up with China may have yielded some undesirable results. In essence, his argument is that labor market adjustments have been slow. It created a small storm in the economics blogosphere. I wanted to reply earlier. I did not and I regret that. However, better late than never. So here are my three key reactions to the piece written by Smith (see his blog here).
- Slow labor market adjustments are not a cause of free trade: If anything, they are the results of a series of government intervention. Countries like Denmark, which may have large governments combined with fewer regulations on businesses, are very well able to adapt to free trade. The ability to start businesses is basically the ability to properly channel inputs towards more valued output. If you prevent an entrepreneur from doing just that while you open your borders to more efficient producers, it is quite obvious that free trade could be “less” beneficial. This point can be well seen in the role of states with “right to work (RTW) laws”. Although there is a debate as to whether or not RTW laws increase wages (James Sherk at Heritage says yes, the good people at the Employment Policy Institute say no and I say that both don’t get it, we should care about regionally adjusted real wage growth), it does seem that it helps industrial activity while boosting employment levels (see here too). Unions would hinder adjustments to changes in trade patterns. In fact, its worth pointing out that of the 11 states that had RTW laws before 1948 – in only three of those states did the income share of the top 10% exceed that on the whole United States (see the data here) in 2013. While the entire country has seen an increase in income inequality, the RTW states have seen the share of all income of the top 10% increase by only 26% (1947 to 2013) compared to 42% nationwide. This suggests that RTW laws are probably helping workers adjusts to changes caused by free trade (otherwise, there would be a state-level increase in inequality). This finding seems to conform to large section of the literature on the links between RTW and inequality (here and here). I am sure that if the Autor, Dorn and Hanson study (on which Noah Smith relies) was to be redone with attempts to control for right to work laws, the effect would be concentrated in non-RTW states. Thus, if the problem is labor laws, don’t blame free trade for the poor adjustments!
- Nobody said that free trade was “costless” to adapt to. I do economic history. I see cases of industries being protected for decades. Protectionism not only raise prices, but it changes relative prices between different inputs. It incites the adoption of an artificially profitable production method. It is profitable to do so, but it is by no means the most efficient approach. It was made profitable only by the artifice of regulation and duties. Once you eliminate that artifice by removing the barriers, you still have “time to build” problem and a need to change production methods. That takes time. However, governments are very good at making sure this takes more time than needed (see point 1)
- Trade agreements with China are not free trade agreements: this is the point I keep repeating (and the point that actually make Paul Krugman interesting), free trade agreements should normally fit on a napkin. If it takes 10,000 pages, it is free trade with 10,000 exceptions. Noah Smith should realize that he may be looking at a case of such “managed trade”.
That’s all folks!