Wednesday, October 31, 2012

Before You Criticize Free Trade, You Should Read Douglas Irwin's Book Free Trade Under Fire

Here is the the Amazon link:

Free Trade Under Fire: Third Edition

I think it does a good job of debunking and refuting many of the mis-conceptions about trade. Irwin is an economics professor at Darmouth Univiersity who has published many book. Here is the Aamzon description:

"Growing international trade has helped lift living standards around the world, and yet free trade is always under attack. Critics complain that trade forces painful economic adjustments, such as plant closings and layoffs of workers, and charge that the World Trade Organization serves the interests of corporations, undercuts domestic environmental regulations, and erodes America's sovereignty. Why has global trade become so controversial? Does free trade deserve its bad reputation?
In Free Trade under Fire, Douglas Irwin sweeps aside the misconceptions that litter the debate over trade and gives the reader a clear understanding of the issues involved. This third edition has been thoroughly updated to include the latest developments in world trade--including the practice of off-shoring services, the impact of trade on wages, and the implications of trade with China-based on the latest research."
My own review is below after a letter to the editor that I had published in the Wall Street Journal about NAFTA.

A student in my class said something like "free trade works in theory, but not in practice." I think it actually works pretty well in practice, as Irwin shows in his book. The Nobel prize winning economist Paul Krugman wrote a great article explaining how you need theory to understand what happens in practice. See The Accidental Theorist.

Now my letter and review. My letter is about how wages went up and unemployment went down in the years immediately after NAFTA was went into effect.

This was published for the most part as a letter to the editor to The Wall Street Journal on Wed., May 4, 2005, page A19. Links to all of the data sources from the Department of Labor are listed at the end of the article.

In the Sunday April 10 edition of the San Antonio Express-News, both Carlos Guerra and Stefanie Collins warned of the dangers of the Dominican Republic-Central American Free Trade Agreement (DR-CAFTA). Any trade agreement is likely to be complex, with many clauses and stipulations worked out over the negotiating table. Perhaps there are dangers to workers and the environment that should be discussed. But I don’t want to defend DR-CAFTA here, since Henry Cisneros had already explained its good points the previous Sunday.

I want to address the job loss issue that both Mr. Guerra and Ms. Collins mentioned in their critiques of DR-CAFTA. They both mentioned large job losses, especially in manufacturing, that resulted from NAFTA, which went into effect in 1994. Mr. Guerra wrote, “more than 2 million manufacturing jobs vanished, most moving to Mexico…” Ms. Collins was more specific (although she mentioned a smaller figure): “Since NAFTA was signed in 1993, the U.S. trade deficit with Canada and Mexico has risen and led to the loss of 879,280 jobs through 2002. Most were high-paying manufacturing jobs.”

Was this the case? Did NAFTA cause the U.S. to lose so many jobs, especially high-paying manufacturing jobs? Probably not. I say probably, since causality, in any social science (economics included), is difficult to prove since so many factors change so quickly in the real world. But if many high-paying manufacturing jobs were lost, it took many years until after NAFTA went into effect before they were.

Let’s start with jobs in general. The U.S. unemployment rate was 6.9% in 1993, the year NAFTA was agreed to. It was 6.1% in 1994. The rate fell steadily until reaching 4.0% in the year 2000. Even in 2002, the year after we had a recession, the rate was 5.8%, lower than the year NAFTA went into effect.

But what about manufacturing jobs? We had just about 17 million in 1994. It actually rose to 17.56 million in 1998 and was at 17.26 in 2000 (still higher than in 1994 the year NAFTA went into effect). Then we had a recession in 2001 and since then the number of manufacturing jobs has fallen quite a bit, down to 14.3 million. So that is a loss of nearly 3 million since 2000, which might be due to the recession. If it were due to NAFTA, then why did it take so long for the loss to happen?

But what about wages? Ms. Collins mentioned that we had lost many high-paying jobs. But real hourly wages have risen since 1994 for all workers. For all workers, hourly wages rose 38.4% while the Consumer Price Index (CPI) just rose 27.1%, hence the real gain. For manufacturing jobs, hourly wages also rose more than prices, with a 34.1% gain. But a pre-NAFTA comparison is in order. From 1984-1994, hourly wages for all workers rose 33.5%, while the CPI rose 42.2%, indicating a fall in real wages. The same happened for manufacturing jobs with hourly wages rising only 33%, well under the rise in prices. So it looks like workers did better in the years after NAFTA went into effect than before.

Economists generally like trade since it allows each nation to specialize in the goods it can produce most efficiently. The increased output can be traded to other nations for their increased output. In that case, jobs move from one industry to another. For example, although we lost manufacturing jobs, we gained about 2 million construction jobs from 1994-2004, which paid well. In 2004, the average hourly wage for construction workers was $19.23. Construction wages also showed real gains from 1994-2004 while showing losses in the 1984-94 pre-NAFTA period.

So my educated guess is that NAFTA caused no significant job loss or wage loss. We probably should not be against DR-CAFTA based on the job impact of NAFTA. I used data from various U. S. Department of Labor websites. Feel free to email me about these sources.

Book Review

Free Trade Under Fire: Second Edition
By Douglas A. Irwin
Princeton University Press, $19.95

“No nation was ever ruined by trade,” said Ben Franklin. Simply put, but in addition to Franklin, the case for free trade has an impressive intellectual lineage that includes supporters such as Montesquieu, Adam Smith, David Ricardo and John Stuart Mill. Many of their theories and observations about trade have been verified by modern statistical and economic analysis. This is all covered Irwin’s book.

Irwin, who shows that many popular beliefs about trade are wrong, is an economics professor at Dartmouth University. He has published a large number of articles on trade in peer-reviewed journals, including several in the American Economic Review. But he also taps the research of many other noted economists like Paul Krugman and Jagdish Bhagwati.

What is good about trade? It increases specialization in each nation which leads to greater efficiency and productivity which in turn leads to greater incomes. Consumers can buy a greater variety of goods, not just more goods. Nations that opened up to trade have generally taken advantage of these forces.

When nations close themselves to trade, as the U. S. did in 1807, the economy suffers (the embargo was lifted after about a year since everyone knew it was causing serious economic damage in terms of higher prices and lower incomes).

What popular beliefs about trade are wrong? Trade does not necessarily hurt the environment. Pollution often results from non-trade reasons. Sometimes blocking trade hurts the environment, since doing so depresses incomes and in the long run, higher incomes mean more resources to clean the environment.

In some countries that block agricultural imports, farming expands into ecologically sensitive areas while increasing the use of pesticides and fertilizers (which happens less in nations that are better suited to farming).

Developing countries that embraced free trade (like China and India) have generally done better than those who have not. Workers in third world countries are often helped by foreign investment by multi-national companies.

Imports and rising trade deficits don’t necessarily hurt wages (which are greatly affected by productivity growth) or raise unemployment in the United States (and if we try to protect domestic jobs with higher tariffs, foreign countries earn fewer dollars so they buy fewer U.S. goods, which reduces jobs here). Irwin points out, as does Paul Krugman, that if unemployment rates really do rise due to trade agreements, the U.S. government can use the appropriate macroeconomic policies to increase aggregate demand, thus raising employment.

But jobs are not usually lost, since exports and imports generally increase and decrease together (and when the import to export ratio rises it is usually because oil prices have risen, not because we are being flooded with cheap imports). In fact, protectionism is rarely beneficial. Protecting jobs can be expensive. It costs consumers $140,000 a year to preserve each domestic textile job since tariffs raise prices.

The book contains many interesting tidbits. Many fewer American workers are exposed to international competition now than in 1960. The United States runs surpluses in the trade of services, even computer services. The opening of McDonald’s restaurants in Hong Kong in the 1970s forced other restaurants to keep their bathrooms clean (which were filthy before).

Dirty industries don’t migrate to third world countries. Tariffs on textiles and apparel are like a regressive tax, hurting low-income groups the most through higher prices. Most of what the United States imports are intermediate goods that are used to produce other goods (if we raise tariffs we would directly hurt American companies that need these resources).
A very small percentage (like 2-3%) of jobs lost each year are lost due to imports or outsourcing. The share of the GDP made up by manufacturing has changed little since 1970, so that sector is not in decline. Organizations like Oxfam are beginning to see the benefits of trade. Dumping of low price imports into the United States causes little damage.

In some cases he perhaps goes into too much detail. A few theoretical aspects of trade could have been better explained. But there is so much good material in this book reading only part of it is valuable. He also gives a fair presentation of the arguments against free trade.

Irwin’s knowledge and understanding of the legal, political and historical aspects of trade and trade agreements is as impressive as his economic knowledge. But, as he notes, “free trade is not a magic bullet” for prosperity. What is needed is “Stable macroeconomic policies, the rule of law, and the protection of property rights that enable the market mechanism to function properly [which] are preconditions for reaping the full benefits of international trade.” With issues like Dominican Republic-Central America Free Trade Agreement (DR-CAFTA) on the horizon, this book is timely and important.

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