If trade liberalization makes America better off, how much better off?

Yves Smith is on vacation and has rerun here an excellent post from 2007 discussing estimates of how much trade liberalization may increase GDP.  She draws from a Dani Rodrik post showing deep flaws in the work of Bradford, et al. who presented large estimates of gains from trade liberalization.  What gives the Bradford work public policy significance is that it had been cited approvingly by Ben Bernanke in a then-recent speech. Smith also did some of her own analysis and linked to other work calculating total US gains as low as 0.1% of GDP from fully open global merchandise trade. That's the upside when the real world is functioning as imagined, not with its actual imperfections. 

The Smith/Rodrik work aligns with Paul Krugman who is telling current students this:

1. Major growth effects from trade policy, if they exist, must come from unconventional channels. Conventional trade theory DOES NOT justify claims of huge positive payoffs from free trade.

2.  In the politics of trade policy, distributional effects can easily swamp concerns about efficiency.

(Emphasis in original.)  It's worth keeping in mind that Krugman's Nobel Prize was for his contributions to modern trade theory. 

The gains from trade liberalization--if they are there at all--come at the social and economic cost of shifting distribution of income and wealth away from ordinary Americans and to capital and MNCs.  Clearly, we paid those costs, but whether there were any overall gains is questionable at best. 

Update on Monday, October 11, 2010 at 11:06AM by Skeptic

Mark Thoma stirred things up by posting for comment a column by Paul H. Rubin at WSJ. Richard Hoogesteger posted the following incisive comment highlighting some important distinctions that are typically not acknowledged. (Bolding added by me.)  

I'm not sure why I bother making this point again but here I go. Free trade between nations only increases total welfare if the gains in efficiency from trade specifically including increases in economy of scale and greater specialization of labor exceed the problems caused by increased market failure. In the U.S. we spent at least a century starting with Andrew Jackson and culminating in the new deal building a regulatory system which could at least more or less cope with the huge problems of market failure which early capitalism created. The final stage of this was in the 1970's with the passage of the EPA. All of the horrible problems of unregulated capitalism from forced labor to pollution to monopolies and massive financial fraud existed at some time in this country. Much of our history has been a struggle with problems created by inadequately regulated markets. The regulatory system which dealt with these problems of market failure and created the worlds first large middle class society after world war two was the practical application of the ideas of the great economists specifically John Stuart Mill, Thorstein Veblein and John Maynard Keynes. To remind those of you who have forgotten Mill wrote on the need to regulate monopolies and Veblein on problems with financial "predators". Keynes presumably everyone remembers. Modern international trade theory tends to assume problems with market failure out of existence. This is foolish. Unfortunately the WTO isn't really even designed to address problems with market failure.

The intellectual mistake at the core of modern trade theory, which is intuitively obvious to most lay people but ignored by economists, is that trade between individuals is inherently different from trade between groups of people. Two individuals making an exchange will only do so if it is advantageous to both. If you have trade between groups of people all that you know is that the elites in charge of the groups favor the trade. All sorts of non market based exploitation can take place within the trading groups. This is almost inevitable if the trading group is a non democratic nation.

Unsurprisingly our current economic crisis contains many problems with widespread market failure: everything from forced labor to pollution, financial fraud and monopolies.

Comments

[Sandy]

I was just reading "The Betrayal of American Prosperity" Prestowitz says "To imagine that a U.S. policy of laissez-faire globalization will optimize global investment flows and technology transfers for America is truly to be capable like the White Queen in Alice in Wonderland of imagining six impossible things before breakfast." I am just learning about such things. The issue here is "what is the truth about laissez faire globalization?" Trade liberalization I suppose is another term for laissez faire globalization. This author, as one can see from the quote, is definitely not on the side of liberalization. It looks like economists analyze the benefits to US and then it gets fuzzy. What are the benefits to the US? Are there any or has liberalized trade already had harmful effects for the US? It appears it is beneficial for MNC's but not for ordinary Americans. By the way, what are the unconventional channels Krugman is talking about?

[Skeptic]

Sandy, thanks for your comment and especially for the reference to Prestowitz, about which more here. http://www.amazon.com/Betrayal-American-Prosperity-Delusions-Post-Dollar/dp/1439119791 I think Krugman means the diagrams and notes in his PowerPoint presentation as the "conventional" textbook stuff based on Ricardo's theory of comparative advantage as refined by others over nearly two centuries.

So what are the "unconventional channels?" The presentation indicates (Slide #5) at least three ideas that he seems to think are important to understanding trade but are not part of that conventional theory: Economies of scale, dynamic effects, and realistic distribution issues. Krugman's Nobel was for explaining why most trade in the late 20th Century was between nations that were at a similar stage of development and exported and imported similar things, which is the opposite of what one would expect if comparative advantage were driving the trade. Krugman concluded that the biggest driving forces behind actual trade were economies of scale--not differences in national endowments and capabilities--now called "new economic geography." He observed that once certain industries got started in one locality, they tended to grow there and acquire and maintain dominance over other localities that might try to enter the market. Examples are carpets in Dalton, Georgia and computers in Silicon Valley. More details in his Nobel citation. http://nobelprize.org/nobel_prizes/economics/laureates/2008/ecoadv08.pdf In the venture capital world, this may be called "first mover advantages."

I'm not quite sure what he means by "distribution issues," but I suspect it relates to the controversy about whether growth is enhanced or inhibited by increasing or decreasing inequality of income distribution. Among the arguments are that low inequality puts a larger share of income in the hands of people who will spend most of it, creating consumer demand which would stimulate growth. A counter-argument is that inequality is necessary for the accumulation of wealth that can be used for capital investment, which is also necessary for growth.

Krugman also sees trade as strongly influenced by transportation costs and related to monopoly power.