Saturday, March 22, 2008

The Chasm between Trade Economists and the Public

Arrogant economists (myself included) too often talk down to the working public about the gains from trade. Take this, from a New York Times Article by Gregory Mankiw:

NO issue divides economists and mere Muggles more than the debate over globalization and international trade. Where the high priests of the dismal science see opportunity through the magic of the market's invisible hand, Joe Sixpack sees a threat to his livelihood. This gap in perspective grows especially wide whenever the economy experiences short-run difficulties, as it is now.

Now, if I just lost my middle class job, and met this guy in a bar, I'd probably call him an asshole and punch him in the nose. It points out two things about economists: 1. We are arrogant S.O.B.'s, and; 2. We have an awkward sense of humor. I think his point would be more well-taken if he were more deprecating of economists, like so:

NO issue divides pinheaded economists and working class heroes more than the debate over globalization and international trade.

In either case, the globalization debate is trivialized by viewing it this way. First, there are multiple groups in opposition to trade and outsourcing. First you have the "working class heroes" who work hard, earn their keep, and view their jobs as under attack. This group tends to be socially conservative, vote republican (especially as the influence of unions has waned in their ability to prop up democratic candidates) have 2.2 kids to worry about, and be influenced by their own interests (with some help from Lou Dobbs). These folks want a better life for their children. Secondly, there is the "liberal hippie" crowd. This group opposes globalization for a diversity of reasons including a genuine concern for workers in foreign countries, poverty, the environment, women's rights, genocide, public health, and so on. This group tends to be pretty well educated, socially liberal, vote democratic, not have kids, and be influenced by English and Sociology Professors.

The arguments against free trade are not stupid or ill-informed, but on the national stage they rest on two common logical fallacies: 1. The fallacy of composition, and; 2. The "post-hoc ergo propter hoc" fallacy. The fallacy of composition is basically arguing that what's true of part of the economy is true of the economy at-large. In other words, it is a poor argument to say that a declining steel sector means a declining US economy, or that job losses in one area mean job losses in the aggregate. The second is the fallacy of assuming that correlation implies causation. For example, we trade with China and I lost my job does NOT imply that trade stole my job (it also doesn't mean that I won't find a job doing something else, or that my wages must fall).

Which group has more valid concerns, and ones that are better-supported by economic theory and empirical evidence: the Joe Sixpacks, or the English Professors? Well, as it turns out (and as much as I HATE Lou Dobbs), it's the Joe Sixpacks and their hero, Lou Dobbs. Let me set one thing straight: TRADE IS GOOD – THE GAINS FROM TRADE ARE POSITIVE IN THE AGGREGATE AND ON A PER-CAPITA BASIS. But, the distributional consequences of trade (and ANY major change in policy that impacts relative prices for that matter) are severe and the negative effects (though "small" in the aggregate) are highly concentrated among a relatively small number of people who bear none of the fault for their situation. But these consequences usually only last for the "short-run," and workers who seek employment in expanding (export-oriented) sectors can sometimes put themselves in a better position than the one they were in before the layoffs, but not always.

With trade, low-skill wages may fall in a country like the United States even in the long run, which is unfortunate. And it would be heroic to ask the Joe Sixpacks to sacrifice their own well-being to raise the living standards of people in China or Indonesia. But the skill intensive goods (and services) that we export will more than compensate and we may be able to subsidize low-skill wages to compensate for the losses. In addition, the impact of offshoring on wages (even with the goods simply shipping back to WalMarts in the US) is not clear. If the offshoring is able to reap gains in the form of scale economies in a vertically-integrated global supply chain then wages in the US may rise.

Wednesday, March 19, 2008

Diamond-Water Paradox, Revisited

How much diamonds cost relative to something as essential as water is one of the oldest puzzles in economics. The simple answer at first was scarcity – diamonds are scarcer than water, right? Well, that's not the whole picture, because the diamond market is riddled with a small number of people willing to pay a whole heckuva lot for a really pretty rock, all water is pretty homogeneous, and the diamond market itself is well-controlled by the DeBeers cartel. What's more, scarcity or not, not everyone is willing to pay even amount of their income for a diamond, whereas they would gladly give their own lives for more water.

I've blogged before about ethnic conflict and economic incentives (new path to victory and economic development in Iraq), and I kept wondering about some of the ethnic conflict and genocide. Basically, I'm running out of examples of conflicts that are purely ethnic in nature – the only one I can come up with is Palestine.

While most of Africa's famous conflicts and genocides revolve around diamonds and the high rents that can be captured by controlling their extraction, and much of the middle east fights over oil, some places have been a bit more difficult to understand. The answer might simultaneously explain their underdevelopment, difficulty developing institutions, and propensity for conflict. What might turn out to be the case is that they aren't really fighting over ethnicity or differences in traditions, but they're fighting over water, that essential resource (and arguably "public good") that every agrarian culture needs to break out of the Malthusian Trap. The sides of the fight are simply lining up on ethnic lines, which is interesting enough, but won't contribute to a solution (and neither will the military might of the US and Europe). By focusing on ethnicity instead of economics, we make the mistake of patching the problem with a band-aid (at best) by policing the conflict rather than driving to the root of the problem.

Clearly I've done some over-simplification of the problem here, but although the problems of the moment are complex, the solution is simple – water is coming at too high a price.