FORGET THE LOSERS
Even though they clearly overestimated the extent to which the market would take care of those directly affected by trade, trade theorists have always known some people would get hurt. Their response has always been that since many people do benefit, we should be willing and able to compensate those who are negatively affected.
Autor, Dorn, and Hanson looked at the extent to which the government stepped in to help the regions ill-affected by trade with China. They found that while they received somewhat more money from public programs, it was much too little to fully compensate for the lost incomes. For example, comparing the residents of the most affected commuting zones to those of the least affected, incomes per adult went down by $549 more in the former, whereas government welfare payments went up by only approximately $58 per adult.52
Furthermore, the composition of these transfers may have contributed to worsen the situations of the workers who lost their jobs. In principle, the primary program to help newly unemployed workers who have lost their jobs due to trade is the Trade Adjustment Assistance (TAA) program. Under the TAA, a qualifying worker can extend unemployment insurance for up to three years as long as they receive training to work in other sectors. They may also get financial help to relocate, to search for jobs, or to get health care.
TAA is a longstanding program, in place since 1974, and yet it provided a minuscule share of the already small transfers toward the affected counties. Of the $58 in additional transfers that went to the more affected regions, only twenty-three extra cents came from TAA. A very big part of what did grow was disability insurance; out of every ten workers who lost their jobs due to trade, one went on disability insurance.
The huge increase in disability insurance is alarming. It is unlikely that trade had a direct effect on the physical health of these workers, especially since the most physically demanding jobs were those that typically disappeared. Some workers were undoubtedly depressed; for others, disability insurance became a strategy they had to adopt to survive. Either way, unfortunately, going to disability is usually a one-way street out of employment. For example, research on a veterans’ program that newly recognized diabetes as a reason to claim disability for those exposed to Agent Orange showed that for every hundred veterans who entered the disability program as a result of the policy change, eighteen dropped out of the labor force for good.53 In the United States, those who join the disability rolls rarely leave them,54 partly because being classified as disabled hurts their employment prospects. Having to adopt disability after a trade shock to pay the bills is likely to push some people who could have otherwise found a new job out of the labor force entirely.
For workers who need to resort to disability benefits to survive, being classified as disabled adds insult to injury. When they go on disability, workers who have spent their lives in a physically demanding job lose not only their occupation, but their claim to dignity. So not only did the United States not come close to compensating the workers who lost out, but what little help people could get through the existing social protection apparatus seemed designed to make them feel denigrated.
Partisan politics has played a role in this disaster. When someone who has lost their job needed healthcare, a recourse was supposed to be Obamacare. Unfortunately, many Republican states like Kansas, Mississippi, Missouri, and Nebraska decided to make a show of resisting the federal government by denying their citizens this option. This pushed some people to apply for disability status in order to get healthcare. Indeed, after the adoption of the Affordable Care Act (a.k.a. Obamacare), disability claims increased by 1 percent in states that refused to expand Medicaid, while they decreased by 3 percent in expansion states.55
But the causes run deeper. US politicians are wary of subsidizing specific sectors (since others would feel slighted and would lobby for their own protection), which is probably partly the reason why TAA has remained such a small program. Economists have also traditionally been unwilling to embrace place-based policies (“help people, not places” as the slogan goes). Enrico Moretti, one of the few economists who has actually studied such policies, actively dislikes them. For him, channeling public funds into regions doing poorly is throwing good money after bad. Blighted towns are meant to shrink while others take their place. It is the way of history. What public policy needs to do is to help people move to the places of the future.56
This analysis seems to give too little weight to the facts on the ground. As we know, the same reasons that make clusters develop also mean they fall apart quickly. Theoretically, the obvious response to this wholesale unwinding ought to be for a lot of people to leave, but as we saw already, they don’t. At least not nearly fast enough. Instead, when their county was hit by the China shock, fewer people got married, fewer had children, and of the children who were born, more were born out of wedlock. Young men—and, in particular, young white men—were less likely to graduate from college.57 “Deaths of despair” from drug and alcohol poisoning and suicides skyrocketed.58 These are all symptoms of a deep hopelessness once associated with African American communities in inner cities of the United States but are now replicated in white suburbs and industrial towns up and down the Eastern Seaboard and the eastern Midwest. A lot of this damage is irreversible, at least in the short run. The school dropouts, the drug and alcohol addicts, and the children growing up without a father or a mother have lost a part of their futures. Permanently.
IS TRADE WORTH IT?
Donald Trump decided the solution to the negative effect of trade was tariffs. He welcomed a trade war. It started in the first few months of 2018, with new tariffs on aluminum and steel. Trump then talked about $50 billion in tariffs on Chinese goods, and then when China retaliated, suggested another $100 billion.
The stock market tumbled on the announcement, but the basic instinct that we should close our economy and, in particular, defend it against China is shared by many Americans on both sides of the aisle.
Meanwhile, economists were jumping up and down. They evoked the specter of the “worst ever tariff,” the Smoot-Hawley Tariff Act, which precipitated a global trade war in 1930 by imposing tariffs on twenty thousand goods imported into the United States. The Smoot-Hawley bill coincided with the onset of the Great Depression, and although it may or may not have caused it, it certainly gave sweeping tariffs a bad rep.
The idea that more trade is good (on balance) is deeply engrained in anybody who went to graduate school in economics. In May 1930, over a thousand economists had written a letter encouraging President Hoover to veto the Smoot-Hawley bill. And yet there is something else economists do know but tend to keep closely to themselves: the aggregate gains from trade, for a large economy like the United States, are actually quantitatively quite small. The truth is, if the US were to go back to complete autarky, not trading with anybody, it would be poorer. But not that much poorer.
Arnaud Costinot and his longtime collaborator Andrés Rodríguez-Clare managed to make themselves infamous in the community of trade economists for making that point. In March 2018, they released a timely new article, “The US Gains from Trade,” with the following prescient first paragraph:
About 8 cents out of every dollar spent in the United States is spent on imports.
What if, because of a wall or some other extreme policy intervention, these goods were to remain on the other side of the US border? How much would US consumers be willing to pay to prevent this hypothetical policy change from taking place? The answer to this question represents the welfare cost from autarky or, equivalently, the welfare gains from trade.59
This article builds on a line of research they developed over several years, both together and with others, and on decades of research in trade. The key idea is that the gains from trade depend primarily on two things: how much we import and the extent to which these imports are influenced by tariff, transportation costs, and the other costs of trading internationally. If we import nothing, clearly it does not matter if we e
rect a wall and stop importing. Second, even if we import a lot, if we stop doing so when import prices increase even a little bit, because it becomes a little more expensive to bring the goods here, it must mean we have many available substitutes at home, so the value of imports is not that high.
COMPUTING THE GAINS FROM TRADE: A SLIGHTLY TECHNICAL ASIDE
Building on this idea, we can compute the gains from trade. If the United States only imported bananas and produced apples, it would be fairly easy. We could look at the share of bananas in consumption, and the extent to which consumers were willing to switch between apples and bananas as the prices of bananas and apples changed. (These are what economists call cross-price elasticities.) In fact, the United States imports products in about eighty-five hundred categories, so to do this calculation properly, we’d need to know the cross-price elasticity between every product and the price of every other product around the world—apples and bananas, Japanese cars and US soybeans, Costa Rican coffee and Chinese undershirts—making this approach unfeasible.
But in fact we don’t actually need to look at products one by one. We can get reasonably close to the truth by assuming all imports are a single undifferentiated good that is either directly consumed (imports represent 8 percent of US consumption) or used as input for US production (another 3.4 percent of consumption).60
To get the final gains from trade, we need to know just how sensitive our imports are to trade costs. If they are very sensitive, it means it is easy to replace what we import with things we produce locally, and it is not very valuable to trade with other countries. If, on the other hand, the value remains unchanged even as the costs change, it means we really like what we buy abroad, and trade increases welfare a lot. There is some guessing involved here, since we are in fact talking about a good that does not exist, a composite of thousands of widely differing products. The authors therefore present the results for a range of situations, going from a scenario where traded goods can very easily be substituted with domestic goods (leading to gains of trade of 1 percent of GDP) to one where it is very difficult to substitute them (leading to an estimate of 4 percent of GDP).
SIZE MATTERS
Costinot and Rodríguez-Clare’s preferred estimate is that the gains from trade are about 2.5 percent of GDP. This is really not a lot. The US economy grew 2.3 percent in 2017,61 so one year of decent growth could pay for sending the US economy into complete autarky, in perpetuity! Did they get something wrong in their calculations? One can argue with many of the details, but the order of magnitude has to be right. Simply put, despite its openness to trade, the US import share (8 percent) is one of the lowest in the world.62 So the gains from international trade to the United States cannot be that large. Belgium, a small open economy, has an import share of above 30 percent, so there trade matters much more.
This is not so surprising. The US economy is very large and very diverse, and therefore capable of producing much of what is consumed there. Moreover, a lot of consumption is of services (everything from banking to house cleaning) not typically traded internationally (yet). Even the consumption of manufactured goods involves a significant share of locally produced services. When we buy an iPhone assembled in China, we also pay for US design and local advertising and marketing. The phone is sold in shiny Apple stores built by local firms and manned by local tech lovers.
We should not be carried away by the US example, however. Large economies like the United States and China have the skills and the capital to produce most things at a very high level of efficiency somewhere in the country. Moreover, their internal markets are large enough to absorb production from many factories in many sectors operating at the appropriate scale. They would lose relatively little by not trading.
International trade is much more important for smaller and poorer countries, like those in Africa, Southeast Asia, or southeastern Europe. Skills there are scarce and so is capital, and the domestic demand for steel or cars is unlikely to be big enough, given that incomes are low and populations are small, to sustain production at scale. Unfortunately, it is precisely those countries that face the biggest barriers to becoming players in the international market.
But for larger developing countries like India, China, Nigeria, or Indonesia, the bigger problem is often internal integration. Many developing countries suffer from a lack of internal connectivity. Nearly a billion people worldwide live more than a mile from a paved road (one-third of them are in India), and nowhere near a train line.63 Internal politics sometimes add to that. China has excellent roads, but Chinese provinces have found ways to discourage domestic firms from importing goods from the rest of the country.64 And until the recent introduction of unified taxes on goods and services in India, each state had the power to set its own tax rates, and often used them to favor local producers.
IS SMALL BEAUTIFUL?65
But perhaps the very idea of comparative advantage is overrated, and even small countries can live in autarky. Or to push the logic even further, perhaps every community can learn to produce what it needs.
This idea has a long and somewhat infamous pedigree. During the Great Leap Forward in China, Chairman Mao argued, among other things, that industrialization could be willed to happen in every village, and that steel could be produced in backyard steel furnaces. The project failed miserably, but not before peasants melted down their pots and pans and plowshares to comply with the chairman’s wishes, and busied themselves producing steel while fields remained fallow and crops rotted on the ground. Many China observers think this might have contributed to the Great Chinese Famine of 1958–1960, when upward of thirty million people died.
The idea of self-sufficient village communities was also the centerpiece of Gandhi’s economic philosophy. His vision of a society clothed in homespun and living mainly off the land had a durable effect on Indian economic policy in the post-independence era. Until the WTO forced India to do away with the policy in 2002, 799 goods, from pickles to fountain pens, dyes, and many items of clothing, were reserved for tiny firms that could be set up in villages.
The problem of course is that small is not beautiful. A minimum scale is required to allow firms to employ specialized workers or to use high-productivity machines. In the early 1980s, Abhijit’s mother, Nirmala Banerjee, an economist with quite left-wing views, surveyed small firms in and around Kolkata, and was astounded by just how unproductive they were.66 Later evidence confirmed her insight. In India, small firms are much less productive than larger ones.67
But firms can only be large if the market is large. As Adam Smith wrote in 1776: “The division of labour is limited by the extent of the market.”68 This is why trade is valuable. Isolated communities cannot have productive firms.
Indeed, national integration via railroad has had transformative impacts in many economies. In India, between 1853 and 1930, the British colonial administration oversaw the building of nearly forty-two thousand miles of railroad in India. Before the railways, commodities were transported by bullocks on dirt roads, and could travel at most twenty miles per day. Railroads could transport these same commodities almost four hundred miles in a day, at a much lower cost, and with less risk of spoilage. Inland regions all but cut off from the rest of the country got connected.69 The railroad network dramatically reduced trade costs. The transportation cost per mile traveled was nearly two and a half times higher for roads than for railroads. And places brought together by railways started to trade more and became richer; the value of agricultural production increased 16 percent faster in districts that got a train line, relative to those that did not.
The United States was another large country integrated through a vast network of railroads at about the same time. Although the role of railroads in the development of the US economy has been controversial, recent research suggests agricultural land value would have been 64 percent lower in the absence of railroad construction.70 These land prices embody all the gains farmers expected from better connections with other cou
nties. And the gains came in large part from the ability to specialize in what each region was good at. Between 1890 and 1997, agriculture became more and more locally specialized. Farmers increasingly chose the crop that each field (due to its climate, soil, etc.) was ideally suited for, which led to large gains in overall agricultural productivity and income.71
Poor internal integration also makes economies sticky, eliminating the gains from international trade for the common men and women, or even turning them into losses. Bad roads discourage people from taking new jobs in cities. In India, the unpaved roads connecting villages to main roads have been shown to be a deterrent for rural dwellers to get nonagricultural jobs outside their villages.72 Bumpy rides add so much to the final price of goods that consumers in remote villages enjoy almost no benefits from international trade. In Nigeria and Ethiopia, by the time imported goods arrive at those villages, if they make it at all, they are unaffordable.73 Poor transportation, both for inputs and for the final products, erode the cost advantages of a cheap labor force. Internal connections must improve for international integration to be beneficial.
DON’T START THAT TRADE WAR
The examples and analyses in this chapter come from cutting-edge research conducted by the most respected departments of economics, yet the main conclusions may seem to put us at odds with decades of conventional wisdom. While every economics undergraduate learns there are large aggregate gains from trade, and that everybody can be made better off as long as we can redistribute those gains, the three main lessons from this chapter are decisively less rosy.
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