Removing some obstacles to a better understanding of the trade-growth relationship

1. Removing some obstacles to a better understanding of the trade-growth relationship What�s wrong with economics!? Europe & Liberty Seminar Leuven 2007

2. Progress made in the last 50 years 1951: �Free Trade is no longer accepted by economists, even as an ideal, in the way it used to be�the preponderance of economic opinion is no longer so certainly as it was on the Free Trade side.� (John Hicks) 2006: Free Trade as a default rule

3. Why such a change in opinion? Theoretical contributions: P. Bauer, J. Bhagwati, economic history� Collapse of �organized trade� systems Success of countries opening to free trade

4. Should we claim victory? Public opinion is not convinced (not to mention Sarkozy!!!) More regulations every day WTO philosophy is under attack New arguments pop out: race to the bottom

5. What can be done to increase our chances to win the case? More empirical studies? More theoretical work of the same type? � Or theoretical work based on new tools for analysis

6. The limits of empirical work We study complex phenomena It is almost impossible to find clear causality: �High-regulation jurisdictions will tend to be high-productivity jurisdictions, but high-regulation jurisdictions will have lower productivity than they would have but for excessive government regulation� (Cass and Haring, 1996)

7. The limits of existing tools Thierry Mayer (2005): �Countries more open to global trade have a higher probability of war because multilateral trade openness decreases bilateral dependence to any given country.� Dani Rodrik (JPE 1998), �Why do more open economies have bigger government�

8. A short history of the tools used to understand free trade and markets ( I ) Smith�s dynamic approach: enlargement of markets, division of labor, division of knowledge and increased complexity The sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society. (Essay on the Nature and Causes of the Wealth of Nations)

9. A short history of the tools used to understand free trade and markets (II) The raise of formalization (Ricardo, neo-classical economics) Crisis: Socialist calculation debate Hayek (Smith, Marshall, Menger, Young): The problem of knowledge, the centrality of change, market as a process of discovery (i.e., the austrian paradigm)

10. A short history of the tools used to understand free trade and markets (III) The irrelevance of the concept of efficiency to understand market processes When market is enlarged nothing is optimized One cannot say that everyone is better off Even a Kaldor-Hicks type of criteria is inappropriate: Subjectivity of preferences Market enlargement = A permanent increase in the potential for discovery and change

11. An illustration: the race to the bottom argument Mentioned in many fields: Tax competition Labor standards and free trade Environmental standards and free trade

12. Race to the bottom scenario Starting with two jurisdictions Jurisdiction A has �high standards� Jurisdiction B has �low standards� As trade opens, capital moves from A to B Jurisdiction A cannot sustain �high standards� Both jurisdictions end up with low standards

13. First impressions about the argument Simple Plausible: at the start of the 20th century, trade in primary products accounted for 2/3 of world trade, and by the end of the century the fraction had dropped to � foreign direct investments were about 25 times larger in 1996 than they were in 1970

14. Theoretical support to RTB Hecksher-Ohlin, Stopler-Samuelson: equalization of factor prices across trading partners Important theoretical literature �In sum, for all the reasons mentioned above, although economic integration may be expected to improve labour standards overall, the possibility of social dumping because of stronger international competition needs to be taken into account, and there is, in principle, ambiguity on the predicted sign and magnitude of the effect.� Dehejia and Samy (2006)

15. Empirical evidence? Mixed evidence: �Overall, the results are not as grim as the conventional wisdom would have it. Even though integration may impose constraints on domestic policy, they are evidently not as severe as the pessimists would have predicted.� Dehejia and Samy (2006) OECD (1996) no evidence that low standards perform better Brueckner (2000): �social shopping� taking place in the US

16. Theoretical arguments against the possibility of a race to the bottom To the extent that free trade combined with �market failures� leads to inefficiency, suppress market failures and keep free trade (Bhagwati-Ramaswami) Harmonization is not efficient Quality of standards is a superior good (�one size fits all� is inefficient) Competition among standards helps reveal the most appropriate standard

17. Arguing with new (basic) tools� Freedom to trade is also freedom not to trade True, as trading opportunities change, some might trade because they are �forced to,� or because they lose their trading partners But, at least two people will be better off after the expansion of trade opportunities A race to the bottom is logically impossible

18. Counterarguments ? Prisoner�s dilemma situation? This has nothing to do with trade. Underscores the benefit from contract Only the poor are made poorer The race to the bottom is a misnomer! Even this is impossible: the poor in jurisdiction B cannot lose

19. The reality behind the race to the bottom In a dynamic, entrepreneurial process of discovery, some will lose in the short run Some might even lose in the long run� But this is the case with any change. The change might be due to enlargement of the market or any �national� technological improvement Why does the same government which promotes spending public money on R&D also oppose free trade? Why are �we� sometimes promoting entrepreneurial spirit and sometimes raising barriers against it?

20. Who will have to adjust? When you promote R&D you know that this will require adjustments, but you don�t know exactly who� When you promote free trade, the groups who will have to adjust are more easily identifiable (privileged ones) �[E]ven if they are globally limited, the costs related to that opening are quite visible, tangible and concentrated in space and time; while its benefits�much higher but spread much more uniformly�are difficult to perceive in our day-to-day life and in the short run.� (Pascal Lamy, WTO)

21. To summarize: The claim that free trade will lead to a race to the bottom has no validity It is a fancy name for a well-known reality: change (and in particular, new opportunities) calls for adjustment One may reject the enlargement of the market, but at least economists should be unanimous about the analysis of the process

22. (Free market) economists