Free trade blinders

Redistributive outcomes enable the entire global economy

I was recently invited by two Harvard colleagues to make a guest appearance in their course on globalisation. “I have to tell you,” one of them warned me beforehand, “this is a pretty pro-globalisation crowd.” In the very first meeting, he had asked the students how many of them preferred free trade to import restrictions; the response was more than 90 percent. And this was before the students had been instructed in the wonders of comparative advantage.

We know that when the same question is asked in real surveys with representative samples – not just Harvard students – the outcome is quite different. In the US, respondents favour trade restrictions by a two-to-one margin. But the Harvard students’ response was not entirely surprising. Highly skilled and better-educated respondents tend to be considerably more pro-free trade than blue-collar workers are. Perhaps the Harvard students were simply voting with their own (future) wallets in mind.

Or maybe they did not understand how trade really works. After all, when I met with them, I posed the same question in a different guise, emphasising the likely distributional effects of trade. This time, the free-trade consensus evaporated – even more rapidly than I had anticipated.

I began the class by asking students whether they would approve of my carrying out a particular magic experiment. I picked two volunteers, Nicholas and John, and told them that I was capable of making $200 disappear from Nicholas’s bank account – poof! – while adding $300 to John’s. This feat of social engineering would leave the class as a whole better off by $100. Would they allow me to carry out this magic trick?

Those who voted affirmatively were only a tiny minority. Many were uncertain. Even more opposed the change.

Clearly the students were uncomfortable about condoning a significant redistribution of income, even if the economic pie grew as a result. How is it possible, I asked, that almost all of them had instinctively favoured free trade, which entails a similar – in fact, most likely greater – redistribution from losers to winners? They appeared taken aback.

Let’s assume, I said next, that Nicholas and John own two small firms that compete with each other. Suppose that John got richer by $300 because he worked harder, saved and invested more, and created better products, driving Nicholas out of business and causing him a loss of $200. How many of the students now approved of the change? This time a vast majority did – in fact, everyone except Nicholas approved!

I posed other hypotheticals, now directly related to international trade. Suppose John had driven Nicholas out of business by importing higher-quality inputs from Germany? By outsourcing to China, where labor rights are not well protected? By hiring child workers in Indonesia? Support for the proposed change dropped with each one of these alternatives.

But what about technological innovation, which, like trade, often leaves some people worse off. Here, few students would condone blocking technological progress. Banning the light bulb because candle makers would lose their jobs strikes almost everyone as a silly idea.

So the students were not necessarily against redistribution. They were against certain kinds of redistribution. Like most of us, they care about procedural fairness.

To pass judgment on redistributive outcomes, we need to know about the circumstances that cause them. We do not begrudge Bill Gates or Warren Buffett their billions, even if some of their rivals have suffered along the way, presumably because they and their competitors operate according to the same ground rules and face pretty much the same opportunities and obstacles.

We would think differently if Gates and Buffett had enriched themselves not through perspiration and inspiration, but by cheating, breaking labour laws, ravaging the environment, or taking advantage of government subsidies abroad. If we do not condone redistribution that violates widely shared moral codes at home, why should we accept it just because it involves transactions across political borders?

Similarly, when we expect redistributive effects to even out in the long run, so that everyone eventually comes out ahead, we are more likely to overlook reshufflings of income. That is a key reason why we believe that technological progress should run its course, despite its short-run destructive effects on some. When, on the other hand, the forces of trade repeatedly hit the same people – less educated, blue-collar workers – we may feel less sanguine about globalisation.

Too many economists are tone-deaf to such distinctions. They are prone to attribute concerns about globalization to crass protectionist motives or ignorance, even when there are genuine ethical issues at stake. By ignoring the fact that international trade sometimes – certainly not always – involves redistributive outcomes that we would consider problematic at home, they fail to engage the public debate properly. They also miss the opportunity to mount a more robust defense of trade when ethical concerns are less warranted.

While globalisation occasionally raises difficult questions about the legitimacy of its redistributive effects, we should not respond automatically by restricting trade. There are many difficult trade-offs to consider, including the consequences for others around the world who may be made significantly poorer than those hurt at home.

But democracies owe themselves a proper debate, so that they make such choices consciously and deliberately. Fetishising globalisation simply because it expands the economic pie is the surest way to delegitimise it in the long run.

Dani Rodrik, Professor of International Political Economy at Harvard University, is the author of The Globalisation Paradox: Democracy and the Future of the World Economy.

© Project Syndicate 1995–2012

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The May – June 2013 Issue

Highest corporate tax
rates in Europe

European countries are scrambling to raise every last penny of funds through taxes. But some countries may have gone too far...

Belgium

Though all business taxes in Belgium can be paid online with little effort and preparation, the rates are still sky-high at 57.7 percent, including a staggering 50.8 percent total rate on profits only in social security contributions.

Belarus

In Belarus, a company spends up to 338 hours annually preparing for and paying ten different taxes and duties. The total tax rate has incredibly been lowered to 60.7 percent, from 117.5 percent in 2008.

France

A company in France pays seven different taxes and duties, the sum of which can amount to 65.7 percent of profits; though President François Hollande has announced a wave of business tax rate cuts coming up.

Estonia

A business in Estonia pays 67.3 percent of profits in tax, 37.2 percent exclusively in social security contributions. The country has gone against the grain in Europe by raising businesses taxes from 48.6 percent in 2008 to the current rates.

Italy

While corporate income tax (IRES) in Italy is limited to 38 percent of taxable profit, a company operating in Italy can expect to pay 14 other taxes and duties, including social security contributions, bringing their total payable tax to 68.7 percent of profits, according to the World Bank.

Norway

Norway taxes motor fuels twice, with a road use tax and a CO2 emissions tax. Combined with strikes in the energy sector that have curbed output, the price of gas at a local pump has soared to $10.12 per gallon.

Turkey

Though Turkey sits on the Suez Canal and neighbours many oil rich countries, the price of a gallon of average gas clocks in at $9.41 in Turkish pumps, because of a 60 percent share of taxes. 

Israel

Like Turkey, Israel is surrounded by oil-rich neighbours, but drills very little itself. Gas prices are controlled by the government, so about half of the $9.28 per gallon goes to taxes.

Hong Kong

There are few gas stations in Hong Kong, but the ones available charge up to 76 percent more per gallon than mainland China, where the government caps the cost of fuel. A gallon at the pumps will cost around $8.61 on the island.

Netherlands

Expensive labour costs make the Dutch petrol prices the dearest in Europe, at $8.26 per gallon; though the 57 percent tax add-ons don’t help.

The credit crisis

8 February 2007
HSBC warns of subprime mortgage losses

2 April 2007
New Century goes bus

14 September 2007
Wholesale markets have dried up

17 March 2008
Rescue of Bear Stearns

7 September 2008
Rescue of Fannie Mae

15 September 2008
Lehman Brothers file for bankruptcy

3 October 2008
US congress approves $700bn bailout

14 February 2009
$787bn stimulus approved by congress

 

The effects of the current financial crisis are global and irrefutable. With the collapse of Lehman Brothers, the domino effect of irresponsible public monetary policies, huge levels of unsustainable debt, and a deregulated financial sector, has escalated to the point where no corner of the globe has been left untouched.

1973 oil crisis

October 1973
Syria and Egypt launch an attack on Israel on Yom Kippur and set off a twenty day war;

1977
US President Carter creates Department of Energy, which develops the US strategic petroleum reserve

 

The Organisation of Petroleum Exporting Countries (OPEC) used their oil reserves as a weapon with the Arab Oil Embargo against those who supported Israel. By January 1974, world oil prices were four times higher than they were at the start of the crisis, especially in the US, and the shock led to a huge drop in the stock market with NYSE losing $97bn in just six weeks.  The embargo lasted five months, and the effects are still seen today.

German hyperinflation

1922-1923

Hyperinflation
1923 – 1924
Stabilisation

 

The trouble began when Germany missed a repatriation payment, worth about one third of the German deficit in this period. Inflation was already high but by 1923 it was raging. Prices doubled within hours, and by late 1923, it cost 200bn marks to buy a single loaf of bread. People burned money as it was cheaper than buying firewood. Germany eventually regained control of its economy when it introduced the Rentenmark into circulation in 1923, and then the Reichmark in 1924.

The Great Depression

1929-1933
The Great Crash
1934-1939
Recovery and Recession

 

After the decadence of the Roaring Twenties, the 1930s saw the biggest economic slump of all time. The stock market crashed on 29 October 1929, and optimism and decadent living tumbled along with the figures. The GDP fell from $103.6bn in 1929, to $66bn in 1934 and the subsequent years of recovery were the most dramatic in US history.

1907 bankers’ panic

1907
Otto Heinze and his brother Augustus Heinze bought shares of United Copper.

 

The stock market was already cautious over the tight money supply, but the US was thrown into a depression after the stock market fell nearly 50 percent from its peak in 1906. The Heinze brothers thought they could influence market shares but ended up bankrupting lenders that provided the financing to buy the stock. A chain reaction left nine institutions bankrupt. By February 1908, the panic was over and the government created the Federal Reserve system, to prevent banks from exercising too much control over the economy.