Thursday, February 24, 2011

Winners & Losers from Free Trade: the Boxer, the Economist & the Hot Girlfriend

Kash Mansori has resumed his economist blogging – something that makes all economist bloggers better off. Welcome back and thanks for making me laugh at the Uwe Reinhardt story about the boxer and the economist , which reminds us that not everyone necessarily gains from a movement towards free trade. But let me humbly suggests that this story needs something – a third player.

The usual economist parable as to why there are both winners and losers from free trade might go something like this. As we removed the trade restrictions from importing apparel from China, American households were able to buy quality clothing at lower prices. Chinese apparel workers also benefited from higher wages. But American apparel workers suffered reductions in their real income from the increase in competition from Chinese workers. While aggregate American income rises, some Americans suffer losses. The compensation principle suggests that it ispossible for the winners from free trade to compensate the losers in such a way that everyone is left better off. Of course in the real world this compensation is rarely executed.

Let me recast Kash’s and Uwe’s story by noting that one of my friends is indeed a former professional boxer and not is a personal trainer who I sometimes work out with (we’ll call him Jay). Jay is still in incredible shape and if he were to punch someone in the nose, it will really hurt. Let me be the economist and let’s pretend that I just start dating a very sexy lass (we’ll call this hypothetical hottie Kay). Kay decided to come watch one of my training sessions with Jay and afterwards Jay had an intense desire to punch me in the nose. So he asked Kay how much he would have to pay her to get permission to punch her new boyfriend out. Kay pulls me aside and say “honey, I really need $3000”. When I told her that Jay’s punches are devastating, she promised that she would more than make up for the pain later that evening. So I told her to go negotiate with Jay. She was elated that he actually offered her $5000 to let him punch me in the nose. The deal was consummated when he hit me so hard in the nose that it broke and I bled a lot. But he did give her the $5000. The only problem is that when she saw how awful my face looked, she said: “oh dear, you are now so ugly that I can’t go home with you. And we certainly are not having sex”.

So let’s recap on this notion that free trade supposedly makes everyone better off. Jay got want he wanted and Kay is now $5000 richer. But all I got was a broken nose. Compensation principle – FEH!


adam said...

I still don't find this example very compelling. You could basically simplify it to the following story: X and Y are dating. Z comes along and attracts attention of X. X dumps Y for Z. X and Z are better off from this "free trade", and Y is left worse off. Big deal.

I am not an economist, but I think it is a straw man when anti-free traders claim that pro-free traders believe that *everyone* is better off with free trade. Obviously there are negative externalities, and the law, to some extent mitigates this. In both your example and my example, it involves the breaking of a contract (although dating is not an explicit contract). And by and large, the law gets it right, in my opinion. You do not have a right to physically injure a third part through free trade, but it's a *very* slippery slope to say the law should attempt to compensate those are are hurt emotionally or (indirectly) financially. After all, in the real world, there is no such thing as a "right" to a job. If a small town factory closes down because of international competition, and people lose their jobs, well, that's life. It may be unfortunate, but it is not "unfair". If one attempts to make these "losers" of free trade whole, there is no logical limit to the things that people could file grievances for, in the name of "unfairness". I don't want to live in a world where people line up to tell us what the world owes them. It's out of control already, and there is no way I would ever support marginal measures that move it further in that direction.

ProGrowthLiberal said...

The contract was between Jay and Kay and that was not broken. OK, the economist in my example was stupid enough to believe Kay would have sex with him afterwards but that was only an implicit side deal.

adam said...

Whether your example depends upon breach of contract or personal injury law, the fact of the matter is that our legal system was created to protect people from these sorts of abuses, so that free trade could happen in mutually beneficial ways. It's much harder to build a persuasive story when you don't rely breaking basic laws that are already on the books...and that's the point. The moral of the original story is "we need contract laws" and the moral of your revised story is "we need personal injury laws". What I really think you are arguing for is, "we need laws that compensate the losers of free trade", which is a quantum leap of logic away from those other two cases.

adam said...

"Of course in the real world this compensation is rarely executed."

I'm also not sure what is meant by this generalization. If people lose their jobs, or their income decreases, the amount of redistribution to these people most certainly increases. Recently Congress has authorized extended unemployment compensation for those out of work -- who do you think is funding this? Increasingly, the tax burden is borne by a select few. You might call these "the people who benefit most from free trade policies," but it is defies reality to state that the losers of free trade aren't compensated through mechanisms such as job retraining opportunities, unemployment insurance, and negative effective tax rates.

Jack said...

SWhy bother with the analogous fairy tales. We are looking at the result of jobs exportation regardless of what quaint name, like free trade, may be put on it. In fact the trade is not at all free. It is a financial arrangement aimed at enriching some sectors of two separate but related economies, the traders.
If in either of those economies the result of the trading is to skew the distribution of income, shrink segments of that economy, reduce the general welfare of the workers, etc. there will be unintended consequences. We are there over here. What the results happen to be in China, Mexico or anywhere else on the globe is far less significant to our own results. Squeeze out a large segment of the economy for a long enough time and the pain will begin to spread within that economy. Kay is fortunate that her former boyfriend economist acted the role of supreme sap. He had other potential responses available given that Kay and Jay were involved in a criminal conspiracy.