Priorities for the US trade policy agenda

Rightly or wrongly, some have interpreted Krugman’s recent Nobel address, which has gotten considerable play in Washington, as implying ambivalence about the benefits of trade for the U.S. What does trade theory tell us about the initiatives the US should make a priority in its trade policy agenda?

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6 Responses to “Priorities for the US trade policy agenda”

  1. annharrison Says:

    Krugman has written a number of pieces recently, including his review on the effects of international trade on US workers published in a Brookings anthology, suggesting that the negative impact of trade on the US labor force is much larger than he had predicted 10 or 20 years ago. In his Brookings review, he argues that we simply do not have enough information to be able to argue, as many trade economists do, that the net effects of trade have been positive for US workers.

    One area where we have a lot more information is on the effects of offshoring–when US companies set up affiliates in other countries to do work that might have been produced at home. While some of the President’s proposed legislation is intended to discourage offshoring, actual research suggests that a lot of this activity actually helps, not hurts, US job prospects. In particular, my latest research with Margaret McMillan shows very clearly that a lot of offshoring is to rich countries. That kind of offshoring actually creates MORE jobs in the US, not less. However, offshoring in low income countries is associated with less employment in the US. So a wise policy for the US government would be to encourage offshoring in wealthy countries (which raises US manufacturing employment) and to discourage offshoring in low income countries.

    The effects of international trade–i.e. export and import activity–has also been mixed in terms of its effect on US jobs and wages. My research suggests that export activity helps more educated workers but hurts less educated ones. The solution is not to curb trade activity but to find ways to make the American worker better educated. That is the right solution, but it is a lot more difficult to improve the educational system than it is to bash trade, the easy scapegoat.

    • jamesharrigan Says:

      Ann Harrison said
      “So a wise policy for the US government would be to encourage offshoring in wealthy countries (which raises US manufacturing employment) and to discourage offshoring in low income countries.”

      I don’t agree with this at all. Ann’s policy prescription is not correct even if the goal is to maximize US manufacturing employment (if that were the goal, a good policy is a direct subsidy to manufacturing employment).

      Similarly, if the policy goal is to help less educated workers today, fixing schools is beside the point. That might help the next generation, and is undoubtedly good policy for all sorts of reasons, but is unlikely to help those who graduated (or failed to graduate) from high school some time ago.

  2. kalakrishna Says:

    Offshoring to rich countries might create more jobs in the US than offshoring to poor ones, but that need not mean it is better to offshore to the rich ones. Offshoring to poor ones might be expected to reduce prices by more and presumably, this would have consumers and/or producers benefit more.
    I agree fully with the second statement: education in the US is a real problem. We need to fix this: both to make the US economy more dynamic and to give students from poor backgrounds more of a chance. National exams at the end of every couple of years, certainly at the end of High School, and a more standardized curriculum, more rationally funded might be able to both feed students to University or to technical (hands on training) institutes. This might be one way to go.

  3. kmaskus Says:

    I also think Ann’s suggestion to encourage offshoring to wealthy countries and to discourage it to poor countries is dubious. In the first place it’s not clear how one could make such a distinction in policy terms: which countries qualify and which do not? And how, exactly, would the encouragement and discouragement take place? Subsidies for one and taxes against the other? That really seems unworkable and a recipe for msichief. Surely the better approach is to remain open to investment in both directions and try to be as neutral as possible with respect to the treatment of domestic and international employment and capital and technology flows. Certainly I agree that we need to do a better job of educating a broad swathe of students.

  4. genegrossman Says:

    Krugman suggests the possibility of a recent decline in the importance of increasing returns as a motivation for world trade and a reassertion of the forces of comparative advantage. The evidence on this is not so clear to me. Be that as it may, both scale economies and comparative are sources of gains from specialization and trade. The main difference between them is that trade based on increasing returns may come without the social and political pain associated with redistribution of income, whereas trade based on comparative advantage often creates not only winners, but also losers. This does not mean that the US has less to gain from trade with China and India than it does with Canada, Europe, and Japan, but rather that we need an education policy that allows the US to exploit further its main source of comparative advantage and a social policy that provides support to those truly in need.

    Recent trade theory emphasizes an ongoing change in the nature of trade. Trade today is less and less about the exchange of final products and more and more about global production sharing. That is, it is less about goods and more about tasks. The theory shows that globalization of the production process – or “trade in tasks” – generates a productivity gain that can benefit all American workers, even those at the bottom of the skill distribution. To reap such benefits, however, the American workers must have the flexibility to move from more routine tasks to less routine tasks that draw on their skills, at whatever level those may be. This may mean, for example, a new sort of employment relationship, and it may strengthen the argument that health care and other essential benefits should not tied to long-term employment.

    Recent trade theory also emphasizes another source of gains from trade, namely a productivity gain that comes from the market’s selection of the most productive firms. These gains require the free entry of firms into new product lines and markets, and a system that allows (indeed encourages) the exit of firms that are no longer profitable. Entry requires a vigorous competition policy that levels the playing field and rids it of barriers to entry. Exit requires an efficacious bankruptcy policy and a social safety net for displaced workers.

    As the division of labor moves from the industry level to the task level, open markets become even more of an imperative than before. Competitor firms will be scouring the globe for the lowest-cost source of every part and every task. American firms need the ability to do likewise, or they will find themselves at a terrible competitive disadvantage, one that will threaten their place at the top of the productivity chain.

  5. drodrik Says:

    A society’s gains from trade liberalization in different sectors depend on a lot of things, but as a rule of thumb, it is useful to focus on three things. (Here I will look at only U.S. policies, leaving aside the question of which initiatives should be pursued abroad.)

    First, how large is the trade restriction (or subsidy) in question? Economic theory tells us that the gains from removing a tax or subsidy rise with the square of the wedge. So sectors where there are large policy interventions are particularly ripe for liberalization, everything else held constant.

    Second, what is the likelihood that the liberalization will aggravate a pre-existing market imperfection? In the case of the U.S., the main imperfection I would worry about is technological externalities. These spillovers are likely to be associated with activities that employ lots of highly-skilled workers. My rule of thumb here would be that liberalization that results in the contraction of sectors that employ such workers is unlikely to generate much gains, and may even be harmful.

    Third, is the liberalization likely to worsen income distribution at home? Many economists disregard distributional concerns (either because they do not think these are important, or else because they assume other policy instruments are available to deal with equity). But I do not find this a tenable position. So I would argue that any potential efficiency gains have to be traded off against potentially adverse movements in income distribution.

    How do these considerations inform the question at hand, namely the nature of the initiatives the US should make a priority in its trade policy agenda?

    Consider some obvious initiatives. On narrow economic efficiency grounds, the reform that would generate the biggest bang for the buck by far is the relaxation of visa restrictions that prevent unskilled workers from poor nations from being employed in the U.S. This is because the magnitude of the barrier in question here (measured by the wedge between earnings of otherwise similar low skill workers here and in poor countries) is bigger than in any other area of international commerce. But the trouble is that the likely distributional impact is also very adverse. So we can generate the efficiency gains only at the expense of making domestic unskilled workers worse off. Considerations 1 and 3 clash.

    How about further trade liberalization in the conventional areas of manufactures? The problem here is that the barriers are already extremely low (in the low single digits), and the efficiency gains to be had are correspondingly small.

    How about outsourcing? Outsourcing of low-skilled labor is on the whole bad for income distribution, while out-sourcing of high-skilled labor may run against consideration 2, the need to keep sectors that are the likely depositories of technological externalities at home.

    So where does this leave us? I can think of two areas of liberalization where existing barriers are high and do not face the objections that I have considered so far.

    First, agriculture. Subsidies and other trade-distorting measures are rampant in agriculture, especially in crops like cotton and sugar. It is hard to argue that these activities generate externalities or that their contraction would be bad for income distribution as a whole. So this is clearly an area of priority. (Note that I am not considering the impacts on other countries, which is not my focus here. The positive impacts abroad are typically vastly exaggerated, but the domestic benefits are not in question.)

    Second, visa restrictions on highly-skilled foreign workers. The barriers here are large, since we know the visa quotas bind severely. Allowing more foreign scientists and engineers in will reduce incentives to outsource technologically-advanced operations abroad, and will help expand sectors that are likely to generate positive spillovers. The distributional effects are unlikely to be adverse, as it is the top of the labor market that will be affected.

    So the trade policy initiatives that deserve priority in the U.S. are: liberalize agricultural trade, and expand visa quotas for highly skilled foreign workers.

    Note that the U.S. can do both of these on its own, and does not need Doha or action on the part of the rest of the world to reap the gains from these reforms.

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