Of course, we cannot forget that the politics of the response to migration is not just one of misunderstood economics, but also one of identity politics. There is nothing new in the disconnect between economics and politics. US cities that received the most European migrants in the golden age of European migration benefited economically from them. But despite that, immigrants triggered widespread and hostile political reactions. Cities cut taxes and public spending in response to immigration. Within public spending, the cuts were particularly deep for services that made interethnic contact more likely (like schools) or those that helped low-income immigrants (such as sewerage, garbage collection, etc.). In cities that got the most migrants, the vote share of the Democratic Party, which supported immigration, declined and more conservative politicians, in particular those who supported the National Origins Act of 1924 (which put an end to the era of unrestricted immigration to the US) were elected. Voters were reacting to the cultural distance between them and the new migrants; at the time Catholics and Jews were considered irremediably alien, until of course they assimilated.88
The fact that history repeats itself does not make it less unpleasant the second or third time around. But perhaps it helps us understand better how to react to this anger. We will return to this question in chapter 4.
Ultimately, we also need to remember that many people, regardless of any incentives on offer, will choose not to move. This immobility, which runs against every economist’s instinct of how people should behave, has profound implications for the entire economy. It affects the consequences of a wide range of economic policies, as we will see throughout this book. We will see in the next chapter, for example, that it partially explains why international trade has been much less beneficial than many hoped, and in chapter 5 we will discuss how it affects economic growth. This requires a rethinking of social policy that takes this immobility into account, something we will attempt in chapter 9.
CHAPTER 3
THE PAINS FROM TRADE
IN EARLY MARCH 2018, President Trump signed new tariffs on steel and aluminum, surrounded by steelworkers in their hard hats. Shortly after, the IGM Booth panel, which we talked about in the introduction, asked its roster of experts, all senior economics professors at top economics departments, Republicans and Democrats, whether “imposing new US tariffs on steel and aluminum will improve Americans’ welfare.” Sixty-five percent “strongly” disagreed with the statement. All the others merely “disagreed.” No one agreed. No one was even unsure.1 When asked the additional question of whether “adding new or higher import duties on products such as air conditioners, cars, and cookies (to encourage producers to make them in the US) would be a good idea,” once again all of them agreed it would not be.2 Paul Krugman, the standard-bearer of liberal economics, likes trade but so does Greg Mankiw, a Harvard professor who headed the Council of Economic Advisors under President George W. Bush and a frequent critic of Krugman’s views.
In contrast, in the United States the general public opinion about trade is mixed at best, and more often than not these days, negative. On the steel and aluminum tariffs, opinions were split. In a survey conducted during the fall of 2018 where we asked a representative sample of Americans exactly the same question as in the IGM Booth panel, only 37 percent of people either disagreed or strongly disagreed with Trump’s proposal to increase tariffs. Thirty-three percent agreed.3 But, more generally, the sentiment seems to be, both on the right and on the left, that the United States is too open to goods from other countries. Fifty-four percent of our respondents agreed that using higher tariffs to encourage producers to produce in the US would be a good idea. Only 25 percent disagreed.
Economists mostly talk about the gains of trade. The idea that free trade is beneficial is one of the oldest propositions in modern economics. As the English stockbroker and member of Parliament David Ricardo explained two centuries ago, since trade allows each country to specialize in what it does best, total income ought to go up everywhere when there is trade, and as a result the gains to winners from trade must exceed the losses to losers. The last two hundred years have given us a chance to refine this theory, but it is a rare economist who fails to be compelled by its essential logic. Indeed, it is so rooted in our culture that we sometimes forget the case for free trade is by no means self-evident.
For one, the general public is certainly not convinced. They are not blind to the gains of trade, but they also see the pains. They do see the advantages of being able to buy cheap abroad, but worry that, at least for the direct victims of cheaper imports, the gains are swamped by the costs. In our survey, 42 percent of respondents thought low-skilled workers are hurt when the United States trades with China (21 percent thought they are helped), and only 30 percent thought everyone is helped by the fall in prices (27 percent said they thought everyone was hurt).4
So is the public simply ignorant, or might it have intuited something the economists have missed?
STAN ULAM’S CHALLENGE
Stanislas Ulam was a Polish mathematician and physicist, one of the co-inventors of modern thermonuclear weapons. He had a low opinion of economics, perhaps because he underestimated economists’ capacity to blow up the world, albeit in their own way. Ulam challenged Paul Samuelson, our late colleague and one of the great names in twentieth-century economics, to “name me one proposition in all of the social sciences which is both true and non-trivial.”5 Samuelson came back with the idea of comparative advantage, the central idea in trade theory. “That this idea is logically true need not be argued before a mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.”6
Comparative advantage is the idea that countries should do what they are relatively best at doing. To understand how powerful the concept it, it is useful to contrast it to absolute advantage. Absolute advantage is simple. Grapes don’t grow in Scotland, and France does not have the peaty soil ideal for making scotch. Therefore, it makes sense that France should export wine to Scotland, and Scotland should export whisky to France. Where it gets confusing is when one country, like China today, looks like it’s pretty much better at producing everything than most other countries. Wouldn’t China simply swamp all markets with its products, leaving other countries with nothing to show for themselves?
David Ricardo argued in 1817 that even if China (or in his era, Portugal) was more productive at everything, it could not possibly sell everything, because then the buyer country would sell nothing and would have no money to buy anything from China or anywhere else.7 This implied that not all industries in nineteenth-century England would shrink if there was free trade. It was then evident that if any industries in England were to shrink because of international trade, it should be the least productive ones.
Based on this argument, Ricardo concluded that even if Portugal was more productive than England at producing both wine and cloth, once trade between them opened up, they would nonetheless end up specializing in the product for which they had a comparative advantage (meaning where their productivity was high relative to their productivity in the other sector: wine for Portugal, cloth for England). And the fact that both countries make the goods they are relatively good at making and buy the rest (instead of wasting resources producing a product ineptly) must add to the gross national product (GNP), the total value of goods people in each country can consume.
Ricardo’s insight underlines why there is no way to think of trade without thinking about all the markets together. China could win in any single market and yet there is no way for it to win in every market.
Of course, the fact that GNP goes up (both in England and in Portugal) does not mean there are no losers. In fact, one of Paul Samuelson’s most famous papers purports to tell us exactly who the losers are. Ricardo’s entire discussion assumed production required only labor, and all workers were identical, so when the economy becam
e richer everyone benefitted. Once there is capital as well as labor, things are not that simple. In a paper published in 1941, when he was just twenty-five, Samuelson set out the ideas that remain the basis of how we are taught to think about international trade.8 The logic, once you understand it, as is often the case with the best insights, is compellingly simple.
Some goods require relatively more labor than others to produce and relatively less capital; think of handmade carpets versus robot-made cars. If two countries have access to the same technologies of production for both goods, it should be obvious the country relatively abundant in labor will have comparative advantage in producing the labor-intensive product.
We would therefore expect a labor-rich country to specialize in labor-intensive products and move out of capital-intensive ones. This should raise the demand for labor compared to when there was no trade (or more restricted trade), and therefore wages. And, conversely, in a relatively capital-abundant country, we should expect instead that the price of capital goes up (and wages go down) when it trades with a more labor-abundant partner.
Since labor-abundant countries tend to be poor, and laborers are usually poorer than their employers, this implies freeing trade should help the poor in the poorer countries, and inequality should fall. The opposite would be true in rich countries. So opening trade between the United States and China should hurt US workers’ wages (and benefit Chinese workers).
That does not mean the workers in the United States must necessarily end up worse off. This is because, as Samuelson showed in a later paper, the fact that free trade raises GNP means there is more to go around for everybody, and therefore even workers in the United States can be made better off if society taxes the winners from free trade and distributes that money to the losers.9 The problem is that this is a big “if,” which leaves workers at the mercy of the political process.
BEAUTY IS TRUTH, TRUTH BEAUTY10
The Stolper-Samuelson theorem (as this result is now widely known in economics, after Samuelson and his co-author, Stolper) is beautiful, at least as much as any theoretical result in economics is beautiful. But is it true? The theory has two clear and encouraging implications, and one that is less encouraging. Opening up to trade should increase GNP in all countries, and in poor countries inequality should go down; however, in rich countries, inequality can go up (at least before any redistribution the government might undertake). The slight problem is that the evidence more often than not refuses to cooperate.
China and India are often portrayed as the poster children for trade-fueled growth in GNP. China opened up its markets to trade in 1978, after thirty years of communism. For most of those thirty years, China barely acknowledged the world market. Forty years later, it is the world’s exporting powerhouse, about to seize the position of the world’s biggest economy from the United States.
India’s story is less dramatic, but perhaps a better example. For about forty years, until 1991, its government controlled what it called the “commanding heights of the economy.” Imports required licenses that were at best grudgingly granted and in addition required the importer to pay import duties that could quadruple the price of the imports.
Among the things essentially impossible to import were cars. Foreign visitors to India would write about the “cute” Ambassador, a barely updated replica of the 1956 model of the Morris Oxford, a British sedan of no particular distinction, that was still the most popular car on Indian roads. Seat belts and crumple zones were entirely unknown. Abhijit can still remember his one ride in a 1936 Mercedes-Benz (this must have been in 1975 or thereabouts), and the sense of exhilaration from being in a car with a genuinely powerful engine.
Nineteen ninety-one was the year after Saddam Hussein’s invasion of Kuwait that eventually led to the First Gulf War. This resulted in the interruption of oil flows out of Iraq and the Gulf, and sent oil prices through the ceiling. It delivered a huge shock to India’s oil import bill. Coming at the same time as the war-driven exodus of Indian émigrés from the Middle East, who therefore ceased sending money to their loved ones at home, the country experienced a massive foreign exchange shortage.
India was forced to seek help from the International Monetary Fund (IMF), an opportunity the IMF was waiting for. China, the USSR, Eastern Europe, Mexico, and Brazil, among others, had begun to take serious steps toward letting markets decide who should produce what. India at the time was the last of the big holdouts, an economy that continued to adhere to the anti-market ideology fashionable in the 1940s and 1950s.
The deal the IMF offered would change all that. India could have the funds it needed, but only if it opened its economy to trade. The government had no choice. The import and export licensing regime was abolished, and import duties came down very quickly from an average of nearly 90 percent to something closer to 35 percent, in part because many of the leading figures in the economic ministries had long desired a chance to do something like this, and they were not going to let the opportunity pass.11
There were, unsurprisingly, many who predicted this would lead to disaster. Indian industry, raised behind high tariff walls, was too inefficient to compete with the rest of the world’s powerhouses. The Indian consumer, starved of imports, would go on a binge and bankrupt the economy. And so on.
Remarkably, the dog hardly barked. After a sharp drop in 1991, by 1992 GDP growth was back at its 1985–1990 trend of about 5.9 percent per year.12 The economy did not collapse, nor did it dramatically take off. Overall, during the period 1992–2004, growth inched up to 6 percent and then jumped to 7.5 percent in the mid-2000s, where it has remained, more or less, ever since.
So should India be counted as a shining example of the wisdom of trade theory, or something closer to the opposite? On the one hand, that growth weathered the transition smoothly, echoing the predictions of trade optimists. On the other hand, that growth took more than a decade to accelerate after 1991 seems disappointing.13
WHEREOF ONE CANNOT SPEAK, THEREOF ONE MUST BE SILENT14
This particular debate has no real resolution. There is only one India with its one history. How would anyone know whether pre-1991 growth would have continued had there been no crisis and the trade barriers not been brought down in 1991? To complicate matters, trade was being liberalized gradually starting in the 1980s; 1991 just sped that up (a lot). Was the big bang necessary? We will never know unless we are allowed to rewind history and let it go down the other path.
Unsurprisingly, however, economists find it very hard to let go of this sort of question. The issue is less about India per se. There is no way around the fact that there was a large shift in Indian growth, at some point in the 1980s or 1990s, associated with the move from socialism (of sorts) to capitalism. The growth rate before the mid-1980s was around 4 percent. Now it is closer to 8 percent.15 Such changes are rare and what is especially rare is that the change seems to have been sustained.
At the same time, inequality increased dramatically.16 Something very similar, if perhaps even more dramatic, happened in China in 1979, in Korea in the early 1960s, and in Vietnam in the 1990s. It is clear that the kind of extreme state control these economies operated under before liberalization was very effective at keeping inequality down, but at a high cost in terms of growth.
Where there is much more disagreement, and therefore more scope for learning, is about the best way to run an economy once a nation gives up extreme government control. How important is it to get rid of the remaining tariff protections India holds on to, which are significant barriers to trade, but nothing like what there was before? Will that further speed up growth? What will happen to inequality? Will the Trump tariffs derail growth entirely in the United States? And will they actually help the people he is purportedly trying to protect?
To answer such questions economists often compare countries. The basic idea is simple: some countries (like India) liberalized trade in 1991 but others more or less like them did not. Which groups grew faster in the years immedi
ately after 1991, in absolute terms or perhaps relative to their pre-1991 growth rates? Those who liberalized, those who had always been open, or those who stayed closed all along?
There is a voluminous literature on this question, perhaps not surprisingly given the importance of free trade among economists and its popularity in the business press. The answers run the gamut from very positive assessments of the effect of trade on GDP to much more skeptical positions, though it must be said that there is little or no evidence for strongly negative effects.
The skepticism comes from three distinct sources. First, reverse causality. The fact that India liberalized trade, whereas another similar country did not, might reflect that India was ready for the transition, and would have grown faster than its comparator even without the change in trade policy. In other words, was it growth (or the potential for growth) that caused trade liberalization, and not the other way around?
Second, omitted causal factors. Liberalization in India was part of a much bigger set of changes. Among them was the fact that the government essentially stopped trying to tell business owners what they should produce and where. There was also a more nebulous but perhaps equally important shift in the attitude of the bureaucracy and the political system toward the business sector: the idea that business was a legitimate pursuit of honest people, something that could even be “cool.” It is essentially impossible to separate the effects of all these changes from that of trade liberalization.
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