Yet it would take far more labor than one or two percent of the labor force to produce the goods that we currently import. In fact, one of the reasons we import the goods we do is that these goods use labor intensively. Because of higher US wages, making these products abroad is far less expensive than it would be at home. To produce these labor-intensive goods here, we would need to move labor away from its current occupations and toward those industries where we would no longer be importing goods.
Figure 3.1: Labor Force Participation is Not Driven Down by Imports
Notes: Data show labor force participation relative to the working-age population. Data sources: Federal Reserve Economic Data; World Development Indicators, World Bank.
Which industries would shrink as a result, and would that be a good thing? Natural candidates would be export industries, since the very policies that reduced our imports would also reduce our exports. Our trading partners would be unlikely to sit on their hands while we raised trade barriers. If they raised trade barriers, too, that would directly reduce US exports. The prospect is unappealing because, in general, US export jobs are more desirable than most jobs: they pay higher wages and are associated with higher productivity growth.5
Even if we managed to avoid foreign retaliation, the greater cost of input goods (which had previously been imported) would reduce exports by hurting the competitiveness of American producers. Consider the commercial aircraft industry. The higher cost of aircraft parts would make American airplanes more expensive, lowering Boeing’s worldwide market share relative to Airbus. US auto producers would similarly face higher prices for imported auto parts. Apple, Intel, and other globally integrated corporations would also see increased costs due to trade frictions.
Further, a US decision to cut imports would negatively affect our nation’s own production, given that many products manufactured abroad draw on global supply chains in which US producers participate as suppliers. For example, in the goods we import from Mexico, a very large share of the value is made up of US content.6 For that matter, it turns out that the US firms who are the biggest exporters are also often the biggest importers. It is difficult to reduce imports without creating collateral damage.7
Figure 3.2: Imports Help the Boeing 787 Fly
Reprinted with permission from Reuters Graphics, Thomson Reuters Markets LLC.
Apple products provide another good example. A recent study suggests that both iPhones and iPads, typically assembled in China and imported from there, have only about 2 percent of their value added as Chinese labor input. Meanwhile, 58 percent of the value of the iPhone, and 30 percent of the iPad, are attributed to Apple’s design and marketing activities in California.8 Apple keeps most of its high-wage jobs, including engineering, design, finance, marketing, and management, in the United States. Putting a tariff on imports of “Chinese” iPhones and iPads would mostly harm American workers.
Narrowly domestic industries would also face cost increases from trade barriers. The American construction industry would face higher costs if it had to rely solely on domestic steel, and the result would be fewer sales. The retail sector would likewise find that higher-cost items result in fewer customers, causing that sector to shrink. In short, the new jobs in the sectors making goods that were previously imported have to come from somewhere. These workers will likely be drawn from other sectors that are shrinking, including both the export sector and narrowly domestic sectors like construction.
Much of the country is trade reliant, and exports originate from all US states.9 A study by the Brookings Institution maps the regions that are most dependent on trade.10 The country’s biggest exporters are its cities; New York, Chicago, Los Angeles, Houston, Dallas, and Seattle together account for one quarter of all US exports. But many smaller cities and towns are even more trade-dependent, since trade represents a bigger part of their smaller economies. Four of the ten most trade-dependent towns are in Indiana; Columbus, Elkhart, Kokomo, and Lafayette all have export shares of income that exceed 30 percent.
If the United States embarked on policies that deliberately reduced international trade, there would surely be jobs created in some sectors and lost in others, but there is no reason to believe that the total number of jobs would change, since the unemployment rate is already as low as it can practically go and there is no evidence that reducing imports will increase labor force participation. The total number of jobs is driven by macroeconomic factors.11 Meanwhile, trade restrictions would create serious disruptions, by reallocating job opportunities across sectors. This would create new groups of unemployed workers, buffeting the economy with additional shocks. As Paul Krugman put it, “It’s like the old joke about the motorist who runs over a pedestrian, then tries to undo the damage by backing up—and runs over the victim a second time.”12
International Trade and Economic Growth
There is absolutely no evidence that countries that are more closed to trade have higher employment, due to either higher labor force participation or lower unemployment rates. On the contrary, there is evidence that engaging in international trade boosts a country’s economic growth and job creation. The simple bar chart below shows the economic growth rates of three groups of countries, categorized by their trade growth rates.
This chart follows the same method as a widely cited 2004 paper by economists David Dollar and Aart Kraay, who classified nations as mature-economy “rich countries,” developing-economy “globalizers,” or developing-economy “non-globalizers” and calculated the average of each group’s real per-capita GDP growth over four decades. Here, we update their findings using World Bank data.13 The globalizers among the developing economies consistently outperform the non-globalizers in terms of economic growth and, as shown in the next chart, employment. To be sure, correlation is not causality—but if trade were harming countries’ economic growth or job prospects, we would expect to see very different patterns in these data.
Figure 3.3: Countries that Trade More Have Faster Growth in GDP Per Capita
Note: Author’s calculations based on World Bank data. Data source: World Development Indicators, World Bank.
Beyond trade, there are likely more important factors that determine a country’s ability to sustain strong economic growth, including ones designed to build more inclusive economic and political institutions, as argued by Daron Acemoglu and James Robinson in Why Nations Fail. The argument here is not that international trade policy is the most important ingredient in sustained economic growth, but rather that there is no evidence that international trade is harming growth. Instead, it often appears to be helpful.
What do we really know about the relationship between international trade and economic growth? In general, analyses suggest a positive relationship between trade openness and growth, although the causal relationship is more difficult to show than mere correlations. Isolating the effects of openness is difficult, given that trade reforms tend to be enacted in moments of larger political reform.14 Furthermore, the intangible consequences of more global openness are often inseparable from greater trade volumes. Yet no reputable paper has been able to connect increased openness with decreased growth. If trade has an effect on a country’s trajectory, it appears to be a positive one.
Figure 3.4: Countries that Trade More Have Lower Unemployment Rates
Note: Author’s calculations based on World Bank data. Data source: World Development Indicators, World Bank.
Openness to the world economy has played an important role in one of the most encouraging developments in human history: the dramatic increase in worldwide living standards in recent years. This improvement in global living standards largely reflects progress in China, India, and other countries that have pursued policies conducive to economic growth and poverty reduction. In China, per-capita GDP was $1,500 in 1990; it rose to $13,400 by 2015, an enormous increase.15 In India, progress has also been substantial, with per-capita GDP growing from $1,700 in 1990 to $5,700 in 2015. Over the same time peri
od, the number of people on the planet living below the World Bank poverty line (now $1.90 per day) declined from 1.96 billion to 700 million, a fall from 37 percent of the world’s population to about 10 percent (fig. 3.5). Again, much of the improvement occurred due to economic growth in China and India (fig. 3.6). This astounding economic progress has been accompanied by gains in life expectancy, reductions in infant mortality, and improvements in educational attainment.
The World Bank poverty line is a very modest goal, $1.90 per day in 2011 dollars, but it measures something very serious: the amount of income needed to sustain the most basic needs of human survival. Between 1980 and 2012, the share of the Chinese population living in poverty fell from 88 percent of the population to 2 percent of their population (now about 1.35 billion people). One billion people were raised above the world poverty line. This is truly the most astounding economic progress in the history of the world.
Growth in India also resulted in big reductions in poverty. Although India’s data are less complete, the data show that 54 percent of the population were in poverty by the World Bank standard in 1983. By 2011, the population had grown by 66 percent (to 1.26 billion), but the share in poverty had shrunk to 21 percent, saving about 400 million people from absolute poverty.
International trade is not solely responsible for these impressive achievements, but it has played a key role. It is unlikely that India or China would have been so successful in achieving their impressive growth rates if they had been closed off to trade; foreign ideas, capital, imports, and markets were essential ingredients in their success. Indeed, adoption of foreign inventions and technology provide one reason why the economic growth of recent emerging economies has exceeded the growth of earlier economic transformations. It took the United Kingdom centuries to industrialize, but industrial revolution in the United States was faster, in part due to the adoption of earlier English inventions. Japan’s industrialization proceeded at an even quicker pace, South Korea and Singapore accelerated from there, and China has been the fastest of them all.
Figure 3.5: Growth in China Results in Huge Falls in Poverty Headcounts
Note: The poverty line used is the current standard, $1.90 per day in 2011 purchasing-power-parity adjusted dollars. Data source: World Development Indicators, World Bank.
Figure 3.6: Economic Growth in China and India Has Been Spectacular
Data source: World Development Indicators, World Bank.
How Do Countries Compete?
The gains from trade have been recognized for centuries. These gains hold even if wages differ across countries, and even if one country is more productive than its potential trading partners in making all things. This is the lesson of comparative advantage, an idea economist Paul Samuelson held up as exemplary of an economic insight that is both true and not immediately intuitive.
Consider first a simple example of a self-sufficient household with two family members, Karen and Peter. Karen is better at both of the key household tasks, hunting and gathering, but she is four times better than Peter at hunting and only two times better at gathering. One could argue that Karen should engage in both tasks, as should Peter. However, it is easy to show that if Karen spends all her time hunting and Peter spends all his time gathering, the household will have more of both products then if they did not specialize.16
Similar reasoning suggests that the college president should not shelve library books, even if she is better at shelving than anyone on the library staff. Her comparative advantage likely lies in fund-raising or management, where her skill superiority is even larger. The college will have more resources if she devotes her time toward these ends, and the books are shelved by someone else.
Exactly the same logic applies to countries. Imagine Japan is better at car production than China, in that Japanese workers make more four times more cars per year than their Chinese counterparts, and Japanese workers can also make bicycles with twice the speed of their Chinese counterparts. If Japan specializes in cars, and China in bicycles, then both countries can have more of both goods through international trade. These examples rely on comparative advantage rather than absolute advantage; gains from trade occur even when one country is better at everything, as long as its margin of superiority is not the same across all goods.
These ideas are familiar to students of introductory economics. The main insights stretch back in time to David Ricardo’s 1817 work, On the Principles of Political Economy and Taxation. The Ricardian theory of trade is an oversimplified theory that neglects how gains from trade are distributed throughout society; this important issue is the topic of the next chapter. Still, the notion of comparative advantage provides powerful insights for understanding how trade affects countries.
One of Ricardo’s essential insights is that international trade is not a zero-sum game. This is important to reassert, since the rhetoric of today’s protectionists is not much different from the mercantilists of Ricardo’s time; both hold a common belief that, in international trade, one country’s gain is another country’s loss. Historically, mercantilists argued that national power and prestige were dependent on a high volume of exports, a low volume of imports, and large stores of precious metals, or treasure. As articulated by East India Company director Thomas Mun, mercantilists seek for the country to sell more to “strangers” than consuming of theirs in value, so that the kingdom accumulates treasure.17
The mercantilist devotion to this doctrine has echoes in today’s debate surrounding the trade deficit. But the logic of David Ricardo’s theory of comparative advantage shows that, by specializing and trading, nations have access to a more diverse, cheaper set of goods. Every country can gain; there need be no losers. Going back to our simple example, when Japan makes cars and trades them for Chinese bicycles, both China and Japan end up with more products than if they each tried to make both products themselves.
In addition to showing the gains from trade, these simple theories show how high-wage countries can compete. Their higher productivity justifies their higher wages and makes their products competitive on world markets. In our example, Japanese workers earn more than Chinese workers because their productivity is higher. These theories also show how low-productivity countries can compete: their wages are lower, and that makes their products competitive, even when they produce fewer goods per year.
But what if high-productivity countries have low wages? Not to worry: productivity and wages are tightly linked (fig. 3.7). As a country’s labor force becomes more productive (often due to investments in education and capital), wages rise.18 In fact, Chinese wages have risen dramatically in recent years, precisely because of China’s widespread productivity growth.
In summary, this chapter argues that countries have nothing to fear from international trade. Both rich and poor countries benefit from trade, as economic growth and efficiency are enhanced. This does not mean, however, that every individual in a particular country will gain from trade. Many may find themselves working in far more competitive conditions. Chapter 4 turns to these legitimate worries.
Figure 3.7: Countries with Higher Wages Have Higher Productivity
Note: The figure shows 2015 data. Data source: OECD Statistics.
Four
Winners and Losers from International Trade
While the basic logic of the overall gains from trade is undeniable, there are important features of the world that these arguments ignore. As countries open up to trade, their export sectors expand and their import sectors shrink. This Schumpeterian “creative destruction” entails serious transition costs, and may generate lasting changes in the distribution of income.
In the United States, international trade enlarges the sectors of our economy that make commercial aircraft, soybeans, medical instruments, integrated circuits, and software, while shrinking the sectors that make textiles, shoes, steel, and tires. In other sectors of the economy, the effect of trade is ambiguous, as we both export and import large quantities of cars, pharmaceutica
ls, manufactured goods, and machinery.
Sector contraction is painful. When people own equipment, buildings, or parcels of land that are well suited to producing a good that is increasingly imported, they are harmed by the increased foreign competition, and they may go out of business and lose much of the value of previously productive investments. When workers have skills that are suited to making products that are displaced by imports, demand for their labor decreases. They may experience lower wage growth, or even lose their jobs. Those that lose their jobs often have difficulty finding other jobs that use their skills and pay the wages they expect. Although other sectors are expanding, and other workers are receiving new job opportunities, this does not eliminate the real human costs associated with declining living standards and job loss in contracting industries.
Indeed, international trade is likely to have effects that worsen income inequality. In the United States, we export products that suit our advantages. Since the United States is well endowed with land that is ideal for many types of agricultural production, with a large capital stock that includes expensive, highly-mechanized farm equipment, and with technological knowledge about agricultural techniques, seeds, and fertilizers, it is unsurprising that we export many agricultural products.1 Likewise, since the United States is well endowed with technologically sophisticated engineers, scientists, and computer scientists, and spends large amounts on research and development to enhance what those workers can do, it also exports goods that reflect these advantages, such as medical equipment and software.
At the same time, the United States has fewer low-skill workers relative to other countries, and goods like textiles, shoes, steel, and many manufactured goods may be produced abroad at lower cost. This reduces demand for domestic workers in these industries, and lowers their wages. Since low-skilled workers are more likely to be in import industries and high-skill workers are more likely to be in export industries, trade may systematically worsen the income distribution.2
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