Jobs and other myths about trade

Stephen Gordon on a debunking spree


Politicians and pundits talk a lot about trade policy, but much of what they say either adds nothing to or subtracts from public understanding about trade. Here are a few talking points that are both popular and wrong:

1) Exports are good. Not true; exports are the costs we pay for engaging in international trade. Diverting domestic productive resources to producing more things for foreigners doesn’t increase our standards of living.

2) Imports are bad. This is point one restated: imports are the benefits from trade. The reason we engage in international trade is to obtain goods and services more cheaply than we can produce them for ourselves.

3) Trade deficits are bad. I went though this at length in this post: noting that a country has a trade deficit (or, more properly, a current account deficit) is the same thing as noting that domestic investment is larger than domestic savings. It’s not obvious why this is necessarily a bad thing.

4) Trade deficits are a sign of a slowing economy. The Canadian trade balance is generally counter-cyclical: falling during expansions and rising during recessions. A trade deficit is standard fare for Canadian expansions, not something to get concerned about.

5) Liberalized trade increases employment. Again, this is point one restated. Liberalized trade may increase the number of workers in certain export-oriented sectors. But the effect on total employment in the economy is zero.

6) Liberalized trade reduces employment. Again, this is point two restated. Liberalized trade may reduce the number of workers in certain sectors vulnerable to foreign competition. But the effect on total employment in the economy is still zero.

The best way of thinking about the effects of liberalized trade on the economy is the way we think about new technology. The following passage is taken from Steven Landsburg’s The Armchair Economist (an extended version of this passage is available here):

There are two technologies for producing automobiles in America.  One is to manufacture them in Detroit, and the other is to grow them in Iowa.  Everybody knows about the first technology; let me tell you about the second.  First, you plant seeds, which are the raw material from which automobiles are constructed.  You wait a few months until wheat appears.  Then you harvest the wheat, load it onto ships, and said the ships eastward into the Pacific Ocean.  After a few months, the ships reappear with Toyotas on them.

International trade is nothing but a form of technology.  The fact that there is a place called Japan, with people and factories, is quite irrelevant to Americans’ well-being.  To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert wheat into cars…

In 1817, David Ricardo—the first economist to think with the precision, though not the language, of pure mathematics—laid the foundation for all future thought about international trade.  In the intervening 150 years his theory has been much elaborated but its foundations remain as firmly established as anything in economics.  Trade theory predicts first that if you protect American producers in one industry from foreign competition, then you must damage American producers in other industries.  It predicts second that if you protect American producers in one industry from foreign competition, there must be a net loss in economic efficiency.  Ordinarily, textbooks establish these propositions through graphs, equations, and intricate reasoning.  [This] little story … makes the same propositions blindingly obvious with a single compelling metaphor.  That is economics at its best.

The arguments for and against liberalized trade are pretty much the same as the arguments for and against new technologies. Not everyone benefits, and the transition costs may not be trivial. But in the long run, suppressing trade has the same effect on our standard of living as suppressing new technologies. And trade liberalization has the same effect as the introduction of new technologies — increased incomes and improved standards of living.

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Jobs and other myths about trade

  1. “Exports are good. Not true; exports are the costs we pay for engaging in international trade. Diverting domestic productive resources to producing more things for foreigners doesn’t increase our standards of living.”

    Prof Gordon – Point one needs clarifying or else you think we should turn Canada into North Korea and adopt their juche philosophy. Exports are obviously good – Japan gets badly needed wheat and US gets better produced vehicles. Without exports to pay for these things, America has to steal cars from Japan, go without vehicles, or start producing vehicles that run on wheat instead of gas.

    • Perhaps you should read 2) before commenting on 1)

  2. It seems to me that much focus by politicians and many economists (Jack Mintz for example, and I believe present company included) have touted the fact that we need more foreign direct investment in order to develop our resource industries for greater exports, and hence higher standard of living.

    How do you square that circle?

    • I don’t see a contradiction.

      • So, exports are good then? Seems to contradict point #1.

        • Goal isn’t exporting oil per se. Goal is exporting oil because its price is high and we can buy lots of imported goods in return.

          • I get that. But as not-an-economist, it seems like a no-brainer that we would be even better off exporting upgraded product. I know that refineries are capital-intensive and low-margin, but wouldn’t a policy to encourage value-add capabilities be good for Canada?

          • Not if we don’t have a comparative advantage in processing.

          • I don’t disagree with that, but regardless, we are completely losing the labour component to the hierarchies of finished goods that we buy back. Isn’t that what creates wealth?

          • You certainly don’t create wealth by insisting on exporting goods for which you don’t have a comparative advantage.

          • Hmmm…again I don’t disagree with that, but the domestic wealth gained by digging stuff out of the ground and selling it barely registers in scale compared to the finished goods you buy back.

          • The technology in mining is pretty intensive… value added being applied only to refining or manufacturing starts to seem arbitrary when you think of the difference between shippable resources and how they got there, I think.

            An interesting point is protecting domestic sectors like dairy can cause problems in what are called value added – I think I’ve heard of special import deals to allow milk in to cheese or yogurt makers to allow them to export on a competitive basis and arguments made that the wheat board was a problem for processing operations in the west although I don’t remember why.

          • But we don’t have a comparative advantage in selling oil; we have to sell it at a fairly large discount compared to the world market price.

          • We were exporting oil when price was much lower. Point being, if we can sell something for more than it costs, why wouldn’t we export?

          • Yes, I have a house loaded with imported goodies that I bought from all the checks the oil companies sent me. No doubt, if we get those pipelines built (whose entire purpose is to export oil processing jobs,) Canadians can start paying down their record levels of personal debt with all the riches coming their way…

    • Much of what passes for “direct foreign investment” is not investing. It is getting bought out.
      Foreign companies buying up existing Canadian companies is not an investment in Canada. It is buying up and buying out Canada’s corporate crown jewels. Although beneficial to the former owners of the Canadian company, it is detrimental to the country as a whole.
      Foreigner who invest in new enterprises do some good if the resource would not have been developed otherwise.
      However, as a first world country we should be buying up other countries companies; not getting ours bought up. That is what happens to third world countries.
      As a first world country, our financial services industry should be finding and providing the money to invest in our raw materials and manufacturing industries and make all Canadians richer..
      If our financial services sector can’t do that it shows itself to be just high end gambling, trading, flipping of paper and swishing money around parasites and plunderer of the national economy.

  3. I’m not sure what saiding ships Eastward into the Pacific Ocean accomplishes, but I’m pretty sure it doesn’t get grain very far from Iowa…

    • I know, but I don’t know where the error is. I’ll have to look up the original quote in the book.

  4. While I don’t disagree with Gordon’s points, it strikes me that this 20,000 ft sort of economic theory is silent about wealth distribution. On the other hand, most of the concern about loss of jobs is precisely about wealth distribution. I think the concluding statement of increased incomes and improved standard of living requires more work; in particular the natural interpretation for the statement would be increased median incomes and improved quality of life.

    I have been to Qatar, and while it must be a great place for Sam Al Thani, not so great for some others; wealth distribution certainly matters. I still suspect that trade liberalization is good (in the long term) for quality of life although it can cause displacement and disenfranchisement of workers in the near term.

    • Just like new technology.

      • Absolutely, although usually new technology just happens rather than being the result of a concerted national strategic effort. That new technology will disrupt (and eventually hopefully improve) our economy is both inevitable and completely unpredictable. Trade policy is a choice, and while the eventual, net impact on employment may be negligible the specific impact on individuals is substantial, often permanent and highly predictable.

        Shorter version: I don’t think you can discount that a given trade policy will certainly devastate a community through an argument that the eventual reemergence of those jobs elsewhere is likely.

        Much shorter version: Macro-economics is rational & clean, real people are emotional & messy.

        • Actually macroeconomics is largely driven by political agendas. There are zombie economic policies (ones that should’ve been killed by the evidence) that still shamble along because they benefit the self-interest of groups who promote them. Far from rational and clean, like science.

          Of course, the scientists learned long ago how to suppress the charlatans. Plus they put rigorous requirements on theories/hypotheses to ensure they are supported by irrefutable evidence and are falsifiable.

          One would be hard-pressed to provide any evidence of the economic benefits of free trade. Over the past 25 years, we’ve seen: inequality soar; living standards decline for most people; GDP growth has become anemic, with recovery growth half of what it was in the 1980s; hundreds of thousands of good paying jobs destroyed and replaced with service-sector McJobs; etc. Of course, none of these facts matter to free-market doctrinaires. They don’t need evidence to promote their self-serving ideology; just good politics. (They remind me theologians who arrogate superiority to ridiculous, muddle-headed theories that “prove” the existence of God.)

        • I was going to try and make the same point; but you did it for me!

          I wonder if the solution lies in gradually lower trader barriers to allow for individuals/communities to recover from policy changes that may devastate their communities. Perhaps only targeting one sector of the economy at a time with more liberal trade policies may be the way to do it (e.g: start with cars, then go to electronic, etc, etc).

          Mr. Gordon, could you comment on Stewart Smith’s comment above vis-a-vis local impacts? Most people I heard comment on it usually state something to the effect of “too bad for those greedy unionists” without considering the fact that the rest of society will now have to support them in their unemployment through their taxes instead of keeping them employed due to protectionist policies.

    • ” I still suspect that trade liberalization is good (in the long term) for quality of life although it can cause displacement and disenfranchisement of workers in the near term.”

      Or it can cause displacement and disenfranchisement of workers in the long term and produce an eventual global depression. (Outsourcing of labor and wage-busting is actually getting worse, not leveling off.)

      Scientists and engineers know there’s a big difference between theory and the real world through experience. Economists are Aristotelian: they make assumptions based on other assumptions ignoring data that contradicts their predictions while cherry picking data to back their cause, which is often political (not fact-seeking.)

      If civilization is to survive itself, it will need to make macroeconomics a science. The economic havoc caused by flaky economics causes political havoc. The first free-market meltdown in 1929 led to Great Depression and world war. Who knows where this one will lead.

  5. I’ve heard this analogy a few times before but not the whole passage and I think this is where it really makes the point amazingly well:

    “Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa. A tax or a ban on “imported” automobiles is a tax or a ban on Iowa-grown automobiles. If you protect Detroit carmakers from competition, then you must damage Iowa farmers, because Iowa farmers are the competition.”

    • That only follows if the only thing the Iowa grain produces is cars.

      If it can also produce.. say.. computers.. then the reality is that protecting auto producers in Detroit is designed to favor them vs computer producers in Silicon Valley.

      While this sounds very similar, it allows us to see a way out of the problem. Protect those things we produce, in order to favor for import those things which we do not — ie, use protectionist policies to encourage specialization within your economy.

      • *sigh*

        If you have a comparative advantage, you don’t *need* to use protectionist policies.

        If you need to use protectionist policies, you don’t have a comparative advantage.

        • If we are to use the comparative advantage gospel, we must apply it to all aspects of the economy, including labor. China has the comparative advantage being a totalitarian oligarchy. It offers factory owners the leg up of keeping workers in line with machine-gun-toting guards. So in order to compete, we must break down the barriers to “job and wealth creation” in our own country. First we eliminate democracy; second, allow plutocratic oligarchs to put workers in their proper place.

          Next, there is the comparative advantage third world countries have of not being burdened with regulations that limit the work week, eliminate child labor, allow unions to organize, or force businesses to pay a minimum wage (a commie idea if I ever I heard one.) Clearly we must break down these barriers to “trade and wealth.”

          Of course, we must also get rid of the crazy socialist policy of providing public education free of charge. If parents want educated children they must pay for it themselves. The age of freeloading moochers is over! It goes without saying, EI benefits, public health care and government pensions have to go because they are an abhorrent distortion in the self-regulating market place.

          Just imagine: if we tear down all these barriers to trade, average Canadians can be just as wealthy and prosperous and as their third-world counterparts! Imagine the freedom!

          • Congratulations for coming up with a mistake so common it has its own name: the “pauper labour fallacy”

          • Ricardo came up with the “pauper labor fallacy” in the early 19th century. Back then there was no minimum wage, no Canada Pension Plan, no universal health care, no 40-hour work week, no child labor laws, etc., etc. Back then workers toiled long hours in dangerous factories, lived in (what we’d consider) poverty and died young (average lifespan was about 45.)

            Back then we had living standards like third-world countries have today. What changed everything was centrist Keynesian government in the post-war era which created modern living standards.

            These are clearly under threat today due to free-trade globalization and other anti-Keynesian free-market policies. They won’t put workers in the poor house; but they are a continuous assault on wages and benefits that show no sign of letting up.

            First free-market ideologues said their policies would bring prosperity (the biggest fallacy in the history of economics.) After that colossal failure which culminated in a global economic meltdown, they tell us today we have to suck it up and work more for a lot less pay and benefits.

        • And had I said anything about comparative advantage, you’d have a point.

  6. I had to
    endure the pedantic recitation of this theory and explanation during my
    university and grad school years. It was based on faulty logic and economic
    theorist’s view of life where theory and reality collide, theory is more
    relevant to reality than the real world.

    First, all
    theories are based on stated and unstated presuppositions, pre-assumptions, and
    preconditions both stated and unstated. If those presuppositions, pre-assumptions,
    and preconditions, then the theory’s worth, ability to model and give insight
    into the topic, and predictive capacity is diminished or even made nil.

    The much
    quoted benefits of free trade, as posited by long dead Scottish philosophers, is
    one of the best examples of this. None of their presuppositions,
    pre-assumptions, and preconditions are in place in the world we live in.

    Second, the
    presuppositions, pre-assumptions, and preconditions are not in place in a world
    where it has been repeatedly shown that countries of great wealth, power, and
    standards of living for their citizens became that way from adopting policies
    of autarky at home and mercantilism abroad.

    trading wealthy countries, who open up their markets, who freely trade with
    countries that adopt policies of autarky at home, mercantilism abroad, and
    predatory currency manipulation always become formerly wealthy countries as their
    industrial and economic base becomes shriveled under the attack of the
    predatory trade practices by the formerly poor countries who have become the
    newly rich countries by transferring the industrial, economic, and wealth
    creating base of the formerly wealthy countries to themselves through their ongoing
    trade surpluses.

    Third, the theory
    that countries export to trade to pay for their imports is quaint in a world of
    great trade surpluses, deficits, and massive financialization of the economy
    replacing real economic activity. As free trading countries are blocked from paying
    for their imports with exports from the mercantilism trade predatory, the only
    way the free trader countries can pay for their exports is by becoming
    progressively more indebted to the trade predator countries. The free trader
    countries become weaker both by transferring their industrial, economic, and by
    wealth creating base and then going into debt to buy the buy the goods they
    formerly made themselves but now have to be imported from the trade predator trade
    surplus nations who have devastated their economies.

    Fourth, the
    theory that countries export to trade to pay for their imports is silly. If a
    business professor made the equivalent theory that companies only make sales so
    that they can afford to pay their expenses, the quality of their logic and
    intellectual thought would deservedly be ridiculed. Companies make sales, same
    as countries export because that is how you get economically bigger and more
    prosperous and become wealthy. Companies try to minimize expenses, same as
    countries should try to minimize imports, because that makes them wealthy and is
    a cost and outlay to them.

    Fifth, the
    basic equation of determining GDP or GNP makes this quite clear (X – M). The
    amount that X(exports) is greater than M(imports) adds to the size of the GNP.

    The fairy
    tales that your postulate have relevance if free trading, equally developed
    countries trade with each other in a state of no surplus or deficit trade
    balances for all. That is not the worldwe live in and to keep repeating these theories does great harm to formerly rich countries
    rich areas of the world like Canada/US and northern western Europe.

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