Voters are Angry about Free Trade. What is the Right Policy Response?
The two most watched candidates of this presidential election season, Donald Trump and Bernie Sanders, have put anger over the effects of free trade at the center of their campaigns. In doing so, they have won millions of votes. Many of the arguments they use in their stump speeches are overly simplistic, but the anger is real. And, as Eduardo Porter noted recently, angry voters have a point: New research suggests that economists have long understated the costs of trade and underestimated the time required for the economy to adjust to trade shocks.
If that research is correct, if free trade really causes more pain than we thought, what is the right policy response? Not protectionism, in my opinion, but there are measures we could and should take to ease the pain. Read on.
What the New Research Seems to Show
Jared Bernstein, a Senior Fellow at the Center for Budget and Policy Priorities, points out that how we assess the balance between the costs and benefits of trade depends on whether we view people as consumers or as workers.
Consumers benefit from free trade through lower prices and access to a wider variety of products. The impact on workers is more complex. Some lose jobs at factories that can no longer compete with imports. Waiters at local restaurants lose income when unemployed factory workers stop taking their families out to dinner. At the same time, new jobs open up as trade expands employment in export industries, and as lower prices of imported goods leave consumers with extra money to spend on local goods and services.
The impact on workers depends to a large extent on whether those who lose their jobs to import competition can find their way to the new jobs created elsewhere. To take an example from my last post, suppose consumers save $1.1 billion from cheaper imported tires at the cost of 1,200 jobs lost in the tire industry. At more than $800,000 in gains to consumers per job lost, that sounds like a huge net gain for the economy as a whole. But is it a net gain for Joe, the tire worker? Not unless he quickly finds a new job as good, or nearly as good, as the one he lost.
But what if Joe, after losing his job at age 45, never finds steady work again? What if has to get by for the rest of his life on odd-jobs, food stamps, and Social Security? If that is typical, then the net gains from trade in tires would be smaller, and the losses would be more concentrated on the directly affected industry and region, rather than spread widely via labor and product markets.
Recent research seems to suggest that worst-case outcomes for Joe and other displaced workers may be more common that economists have assumed. David Autor, David Dorn, and Gordon Hanson summarize and extend that research in an influential new paper, “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade.” The authors reach several pessimistic conclusions:
- The costs of trade shocks include both lower wages and loss of jobs, and persist for years.
- They are concentrated on workers in specific local labor markets. Labor mobility is not sufficient to ensure widespread sharing of losses by workers across regions and industries.
- Especially when an increase in the overall trade deficit accompanies a trade shock (as was the case for the China shock), workers displaced from jobs impacted by import competition do not quickly find comparable jobs in export industries. Those who do find work often end up in services or other sectors serving the domestic economy. Their skills do not fit those jobs, so their wages are lower.
- The persistent local effects of trade shocks include increased uptake of unemployment benefits, disability benefits, food stamps, and other forms of government assistance.
- Trade shocks disproportionately affect low-wage workers within affected regions and industries.
This paper has touched off a lively discussion among economists (some samples). Some of them say that we already knew these things, we just didn’t talk much about them. Others say just one article should not be taken as definitive. Still others will critique the paper’s models, methods, and data sources, as good fellow professionals should. The question I find most interesting, though, is what the appropriate policy response is, if, for the sake of discussion, we take the pessimistic conclusions of Autor and his colleagues at face value?
The social safety net as a trap for displaced workers
One traditional response has been to offer some kind of social safety net to workers displaced by trade. The hope is that a mix of temporary income support, retraining, and help with job search and relocation could minimize the pain for the most affected individuals and regions, while ensuring that the costs of adjustment would be shared fairly by those who benefit from trade.
Those are the intended goals of the federal Trade Adjustment Assistance program (TAA). Unfortunately, TAA has a poor reputation. Some critics think the program is too narrow and inadequately funded. They urge expansion of TAA. Others see eligibility criteria as too broad. They point to studies that show the training offered to be poorly designed and ineffective. For whatever reason, TAA clearly has not prevented the persistent adverse effects seen in the Autor study.
But TAA is not the whole story. Autor et al. show that when a region is hit by a trade shock, the uptake of many other social benefits also increases, including unemployment benefits, Social Security retirement and disability benefits, and medical benefits. They calculate that in any given region, total annual social benefits increase by $57.73 for each $1,000 increase in trade. TAA itself accounts for only $3.65 of that, as the following chart shows:
For individual workers, each of these social programs may be part of the solution to trade-related job loss, but viewed as policy, they are part of the problem. The reason is that all of them carry strong disincentives to find new employment.
The disincentives come from the fact that the programs automatically reduce beneifts as income rises. For example, the benefit reduction rate for a family’s food stamp benefits might be 20 percent, that is, a reduction of $20 for each $100 increase in income. Benefit reduction rates are additive, so that if the family also receives Medicaid, which has a benefit reduction rate of, say, 30 percent, the total benefit reduction rate would be 50 percent. Taxes, if any, are also additive. If there is a 7 percent payroll tax, then the total effective marginal tax rate would be 20 + 30 + 7 = 57 percent. The family’s net income, including both benefits and earned income, would increase by just $43 for each $100 earned.
The following chart gives an example based on a single-parent family with one child living in Pennsylvania. It uses data from the Congressional Budget Office that take into account earned income, federal and state income and payroll taxes, food stamps (SNAP), cash welfare (TANF), and medical benefits including Medicaid, CHIP, and subsidies for exchange-purchased insurance under the Affordable Care Act (ACA).
Notice that the earned income line is flattest in the range from just below the poverty level to twice the poverty level. From 120 to 125 percent of the poverty line, the effective marginal tax rate reaches 80 percent. There are also numerous “cliffs” where income after taxes and benefits drops suddenly because the family reaches a threshold of earned income beyond which some program cuts off entirely. For example, one such cliff occurs at an earned income of $21,900, a little above the poverty level. Just below that point, the family’s income after taxes and benefits reaches $30,800. Net income then falls by $1,000, and does not return to $30,800 until earned income reaches $25,100.
Effective marginal tax rates vary according to family structure. Another study found that effective marginal tax rates are especially high for secondary earners in two-earner households. If childcare, transportation, and other work-related expenses are taken into account, it often does not pay at all for a second household member to take a job. That situation might very likely fit a family in which one spouse lost a factory job due to import competition while the other spouse retained a job as, say, a retail clerk.
State-to-state variations in social safety net rules further undermine job search incentives for workers displaced by trade. So do disincentives in Social Security Disability Insurance, which some job losers turn to when their unemployment and TAA benefits run out.
The bottom line is that when workers lose their jobs through trade, the social safety net eases their pain but, at the same time, reduces their incentives to seek new work. Congressman Paul Ryan has warned that the social safety net can become a hammock for those who receive its benefits. In the case of trade shocks, however, the safety net seems less of a hammock than a trap.
Reforming the safety net
What can be done to mitigate the way the social safety net impedes adjustment to trade shocks? I am sure there are many places where tinkering with the rules could help, but here are two proposals that are more radical than mere tinkering.
One would be to move toward a system of universal health insurance that fully decouples coverage from employment, income, or place of residence. I discussed the advantages of such a system in this earlier post which discussed Sanders’ “Medicare for all” proposal and contrasted the US healthcare system with those of other wealthy countries.
Some people say that we don’t need a Euro-style healthcare system, since we now have the Affordable Care Act. The ACA has, in one respect, eased the pain for workers displaced by trade, in that people with pre-existing conditions are now able to purchase individual health insurance policies if they lose coverage from their employer. That is good in itself, but, at the same time, the ACA adds a new dimension to work disincentives.
Those disincentives arise from the way the ACA subsidizes individual policies purchased on insurance exchanges. The subsidies are subject to a substantial benefit reduction rate that come on top of the benefit reductions already built into other means-tested programs. The exact benefit reduction rate for ACA insurance subsidies depends on income and family circumstances, but estimates based on industry-provided subsidy calculators suggest that something like 15 percent is typical.
What is unusual about the ACA subsidies is not that the rate is so high, but that they extend further up the income scale than those of other income support programs. They do not entirely phase out until a household reaches 400 percent of the poverty level. That makes them relevant to workers even in relatively high-paid jobs and two-earner families, categories into which many workers displaced by trade would fall. For them, the ACA adds one more source of friction that contributes to slow labor market adjustment to trade shocks.
A second radical proposal would be to replace existing means-tested social safety net programs of all kinds with a universal basic income (UBI). In place of TANF, SNAP, housing subsidies, childcare subsidies and everything else, a UBI would offer all citizens, young or old, rich or poor, a monthly cash grant that would be entirely independent of earnings or labor market status.
The notion that a UBI would increase work incentives seems paradoxical to many people. “If you just give people money,” they say, “why would they work at all, let alone work more than they do now?”
The answer to the paradox lies in a distinction that economists make between two effects of any social safety net program. One is the income effect: If you give people more money, other things being equal, they do have less incentive to work. The other is the substitution effect: If, while giving people money, you also decrease the amount of each added dollar of earned income they get to keep, that also reduces incentives to work. (The name “substitution effect” comes from the fact that when effective tax rates go up, people substitute leisure, or unpaid work like home repairs and childcare, for paid work.)
Empirical research has repeatedly found that the substitution effect is far stronger than the income effect. Eliminate the tangle of overlapping social programs that give rise to 80 percent effective marginal tax rates for the poor and near poor, and you are sure to get greater work incentives. Those incentives would be especially important for workers displaced by trade who need to relocate and retrain for new jobs.
The Bottom Line
There is no one policy response that will fully assuage the anger, the pain, and the economic damage that trade shocks do to individuals and communities. Still, some approaches hold more promise than others.
It is important to recognize that recent research like that of Autor and his colleagues does not directly challenge the classic economic argument that the total gains from trade are greater than the total costs. As they put it, “[Our] novel results do not at all suggest that international trade is in the aggregate harmful to nations.” Their point, instead, is that managing and mitigating the costs of trade adjustment deserve more attention from policymakers and applied economists.
Protectionism, then, is not the answer. Repudiating free trade agreements and restoring high tariff barriers would avoid the costs of trade only by abandoning the benefits, which in the aggregate are larger. Reducing those costs by smoothing the path to trade adjustment and reforming the social safety net to spread remaining costs more justly makes more sense.
In fact, a protectionist response taken now would only subject the economy to new dislocations. The original China shock, huge though it has been, has largely run its course, as Autor et al. acknowledge. Restoring tariffs and other trade barriers to their previous levels would, at this point, undermine the achievements of industries, regions, and individual workers who have, sometimes painfully, succeeded in relocating and retooling to meet the needs of a global economy. In order to restore the past industrial glories to which some romantics hark back, we would have to go through the whole painful adjustment process in reverse.
Furthermore, whatever we do on the trade front, our economy will remain vulnerable to other major shocks that are already underway. Automation and artificial intelligence, for example, are making whole classes of jobs obsolete, as relentlessly as Chinese toys and T-shirts have done. At the same time, climate change is spurring a massive shift from fossil fuels to renewable energy, and may soon (if we believe the pessimists) require us to move entire cities inland to higher ground. Measures to improve the flexibility of labor markets and reforms of the social safety net will make it easier to cope with those shocks, too.
38 Responses to “Voters are Angry about Free Trade. What is the Right Policy Response?”
Informative posting. However, empirically, technology shocks are far more important than trade shocks. There is no logical reason to have separate programs (Trade Adjustment Assistance) to deal with trade and technology shocks. It would be beneficial to merge them. A Universal Basic Income has merit as a substitute for the long list of safety net programs, not as an addition. It would also seem that with UBI in place, national healthcare would be unnecessary. Employer provided health insurance is prominent because of its special tax status. Why not remove the tax status and allow people to choose their own health insurance financed by the UBI or their own incomes? Finally, one should not generalize about the Chinese shock. How many times will one of the world's largest countries shift from zero trade before radical reforms to being one of the largest countries in the world?
You say, ” It would also seem that with UBI in place, national healthcare would be unnecessary”. In principle, you could do it that way. However, in my writings on a UBI, I prefer to treat health care as a separate issue. Yes, replace essentially all other elements of the social safety net with a UBI—not just SNAP and TANF, but unemployment insurance, TAA, and disability, too, along with a raft of “middle class welfare” measures like deductibility of home mortgage interest.
Why not do that for heath care, too? In order to make that work, everyone would have to have access to some kind of insurance that was uniform across states and had rates that were not dependent on gender, age or preexisting conditions. (Otherwise, the UBI would not be enough to pay for insurance for people with high health risks, but more than enough for people with low risks.) But if you go that far, you might as well go all the way to a Eurostyle universal health care system. Anyway, that is my thinking.
I think an important point missed here is that not all free trade is created equal. When the United States trades with, say, Germany we benefit from state-of-the-art Siemens industrial control systems which then spur US manufacturers to up their game to better compete. German companies compete with American companies on the strength of better ideas, better technologies, more durable products, etc. It is a race to the top.
When we engage in trade with emerging economies by shifting manufacturing to Vietnam or China, the transfer of ideas, technologies, management techniques, etc. is mostly all in one direction and the quid pro quo, such as it is, is lower wages. Over the long term this will serve to elevate wages in the emerging economy. But it has the immediate effect of lowering wages in the developed economy. It starts at least, as a race to the bottom.
In the developed economy immediate benefits are realized by consumers and shareholders. But shareholders are also transferring significant technology and arguably over the longer haul, jump-starting competitors. And in the developed economy, the price is paid immediately by laid off workers who, as you not, may not easily find suitable employment at equivalent wages.
This, it seems to me, will be exacerbated by automation as more and more goods and services are produced by fewer and fewer workers. This can be seen in that classic FRED chart showing the disconnect between productivity and real wages that emerged in the mid-70s. Axiomatically, the brunt of offshoring and automation is born by workers with the most easily cloned skill sets.
None of this argues against free trade or automation or improving productivity. It does however demand that we assess the kind of community we are, the kind of community we aspire to be, and to develop an expanded view of how people contribute to society. In the near term steps such as UBI, expanded government support programs, and so forth will help with these economic disruptions. But I would argue that social cohesion requires a society's members to have a sense of responsibility to the community and to be able to take pride in their contribution. Therefore increase support programs are a necessary but not sufficient response.
I'm on board. Medicare for all + modest UBI would help the local disruption problem quite a bit. The very sensible $100/week version you proposed in your series wouldn't allow us to completely do away with all of the current means-tested assistance, but it would help with the work-disincentive problem, nonetheless.
It would also help if our trade deals did not allow corporations to sue nations when their people vote for environmental, worker, and consumer protections. There are still good ways to do trade deals and bad ways to do them.
I would also like to note that most of the same points apply whether the dislocation is caused by competition with foreign labor or with machines.
It is politically fashionable to advocate equal payments for insurance even if people are in different situations with different expected values for claims. This a large departure from the principles of insurance that base premiums and other costs on the value of expected claims.
Why would variation in insurance costs be a more severe problem than variation in housing
costs across the United States? Food costs? Insisting on equal payments for people in different situations is just a cross-subsidy from the more healthy to the less healthy. Should one expect more cross-subsidies in a government-managed system? Is it a good idea to have mandatory health insurance coverage for maternity care for 90 year olds?
"It would also seem that with UBI in place, national healthcare would be unnecessary"
But not necessarily undesirable. The United States pays significantly more per capita for healthcare than its OECD peers while recognizing relatively poorer outcomes, especially among those in the bottom two quintiles of income. One can imagine (I don't have data either way) that cost duplication and profits in the health insurance industry play a role in this cost differential.
Worse, our inefficient health care system puts the US economy at a competitive disadvantage with its peers as they typically do not directly subsidize health coverage.
"How many times will one of the world's largest countries shift from zero trade before radical reforms to being one of the largest countries in the world?"
India, for instance, may do something similar. Further, the shock needn't be as huge as the Chinese shock to still send meaningful disruption through the labor economy.
I agree with you in part, except I am not sure that automation "exacerbates" the effects of trade. If we did not have trade, and wages for low-skill workers were therefore higher, I would think we would, instead, have more automation. So automation are in a sense substitutes. To keep wages for low-skilled labor high, we would have to have tariffs not only on imported goods, but on goods produced in this country by robots.
"It would also help if our trade deals did not allow corporations to sue nations when their people vote for environmental, worker, and consumer protections. "
You are referring to the investor-state dispute settlement (ISDS) provisions of TPP and TTIP here, I guess. Yes, they are a magnet for much criticism and do not fall into the conventional "free trade agreement" template.
Funny that those countries with Euro-style universal healthcare have such problems with their unemployment rates.
The point, I think, is that health insurance, at least for congenital and chronic conditions, fails two of the classic requirements of insurability.
First, losses are not fortuitous, at least not on an insurable time scale. In some cases, say, diabetes, the losses are fortuitous to people who have not yet developed the disease, but once it is developed, coverage is required for life, likely for decades. It is difficult for purely private insurance to guarantee coverage over such a long time horizon, especially given the fragmentation of traditional insurance by state, and by separate individual and employer-sponsored markets. In other cases, say cystic fibrosis, the risk is fortuitous only before a child is conceived, and if you had mandatory genetic testing of parents, not even then.
The second insurability test that chronic and congenital conditions fail is that of insurability. For some people, the fair actuarial value of a policy, once the risk is known, is greater than their entire income.
The upshot here is that these risks can be covered only by group insurance, with the entire population as the group–that is, by social insurance. The alternative is to let people die or to make them dependent on charity.
It would be possible, in principle, to develop a system in which the uninsurable component is covered by social insurance and the insurable component by private insurance. That is why the "universal" health systems of OECD countries have various kinds of exclusion for some kinds of vision, dental, and cosmetic procedures. My feeling is, though, that advances in medicine and medical genetics are constantly throwing more and more medical conditions in the uninsurable category.
Yes, India has a population size similar to China's, but its income per capita is less than half the size of China's ($5640 < $13,840 in 2014). Also, India begins from a much more open economy than China did. India has been a member of the WTO since its inception, and it participated in all the tariffs cuts that members enacted. The economic shock to the US from China came after it unilaterally liberalized trade and became a member of the WTO. Shocks from trade will occur, but I am skeptical about seeing one as large as the China shock. I also think technological shocks have been and will be more important for US labor than trade shocks.
Ed Dolan seems to be making the same argument as Casey Mulligan in his 'The Redistribution Recession.' Except that Mulligan says that for some poor people, the marginal tax rate can go well over 100%
“Casey Mulligan’s The Redistribution Recession presents a heterodox perspective on the Great Recession. The book argues that redistributive and other policies enacted to help cushion the blow of the financial and housing market collapses have reduced incentives to work, and thus had the unintended consequence of significantly lengthening and deepening the recession. The rich set of empirical analyses that Mulligan presents in support of this argument challenges the view that the problem of recovering from the Great Recession remains solely one of insufficient aggregate demand. Moreover, the analysis will likely provide a foundation for future research on the Great Recession and how policymakers responded to it.”
-David Neumark, Chancellor’s Professor of Economics and Director, Center for Economics & Public Policy, University of California-Irvine
"I also think technological shocks have been and will be more important for US labor than trade shocks."
You make good points about India. And I certainly agree entirely with your assertion that technological shocks will be the dominant ones in the future.
Correlation is not causation. Do you have an argument to mount or is this some sort of hit and run?
" I am not sure that automation "exacerbates" the effects of trade."
I apologize for an inelegant and inept sentence. It is not trade that I meant to suggest automation will exacerbate, it is the downward pressure on wages especially among less skilled workers.
Yes, every country has its problems. Are you suggesting a causal relationship in which having lots of uninsured people helps keep employment rates high? Or one in which placing the burden of health insurance on employers, US style, causes them to be more eager to hire people than the European system? If so, I'd be interested to hear you elaborate. The conventional wisdom seems to be that high European unemployment rates are caused, at least in part, by much higher levels of labor protection that in the US, for example, restraints on layoffs. Those provisions tend to bifurcate the labor markets of countries like Spain and France into a privileged market with high-paying lifetime jobs an a less privileged market of low pay and undependable employment. Right now, people are out in the street in France over efforts by the (nominally) Socialist government to free up the labor market at least a little to try to bring unemployment down.
Do you have an argument to make? The jacket blurb you quote and the blurbs on your link amount to nothing more than a weak rendition of the argumentum ad populum fallacy.
Do you have actual thoughts to present and argue or are you only passing through to leave small bags of chicken droppings hoping they'll be mistaken for profundities?
1. I really doubt that "universal health insurance" in any form would have much effect on the anger, regardless of what other merits or demerits it might have. Look at the issues that have arisen in Europe over migration, and the great drama that arises in France most any time they try to make their labor markets more fluid.
It's about jobs, not benefits or even consumption. For someone to be unemployed, especially in a time of low national unemployment, is in effect a very strong message from the Political Economy that "we literally have no idea what to do with you." In a way, being laid from a factory that makes something now made in say China is also telling the laid off "we prefer to get this from China than from you…."
Because of the dynamics around that, I am personally very skeptical that any measure that doesn't replace lost jobs with comparable (in money AND status) new jobs will resolve the anger.
2. Sumner opens with "but it's very good for China" – I do wish econmists and libertarians would stop making arguments like that (even though I agree with them.) It's very clear that the people of most (all?) nations on Earth, and certainly in the US, really could not care less about what happens elsewhere. Essentially nobody who benefits from cheaper (or better) imported goods thinks that "it's also helping those people raise their living standards!" and the pool of displaced (and clearly very angry) VOTERs would appear almost to the last person to think "send them all to hell I want my job back"
By the way, I have begun to wonder if the real "solution" (over time) might be a kind of throttling of the rate of change. Literally a "quota" for how much "disruptive soical change" (automation, international trade, pension reform etc) can be tolerated/allowed in any one say decade. A very worrisome thought to be honest….
1. I really doubt that "universal health insurance" in any form would have much effect on the anger, regardless of what other merits or demerits it might have. Look at the issues that have arisen in Europe over migration, and the great drama that arises in France most any time they try to make their labor markets more fluid.
It's about jobs. Not just as a matter of supporting consumption, but for the value and status that comes with them. When a person is unemployed, especially in a time of generally high employment, that amounts to a message from the political economy of "we literally don't know what to do with you, you have no value."
So while changes in healthcare, or correction of nasty effective marginal tax rates, or a less complicated social support system, surely have various merits and demerits of their own, I don't think any of them will address this anger.
Only jobs, jobs as instruments of social value, personal utility to society, of status, of being part of the mainstream, will cure the anger.
2. I wish economists and libertarians would stop talking about how free trade improves the lives of people in other countries (even though I agree that's true and a good thing.) It seems very clear to me that the vast majority of people on Earth do not care about what happens in other countries, especially if they or their neighbors have lost jobs.
(If this posts twice, please delete one, but web site seems to want me to enter this again.)
[…] Angre about Free Trade — What is the Right Policy Response? – Ed Dolan […]
It seems this post misses the essential point.
The entire objective behind the deals branded as "free trade" was to enable labor arbitrage as a finance-type trade to benefit owners of financial capital and their agents.
The archetype is the maquiladora plants in Mexico enabled by NAFTA where initially parts manufactured in the USA were shipped to Mexico for final assembly and then shipped back to the USA for sale or export. There is zero comparative advantage in this operation. It's purely a labor cost trade, "trade" the way a stock broker thinks of it.
Everything else is a variation on this theme.
Economists need to focus on the problem of agency and the legalization of corruption.
Do the empirically important cases fall into these categories? Knee replacement? If not, why not put catastrophes into a special fund and allow people to choose their own insurance for most cases? The main advantage of UBI is that it replaces the large number of complex and often hidden subsidies with one simple and understandable program. If you make an exception for health insurance, someone can make an equally convincing argument for food, housing, education, etc. Then UBI becomes an add on rather than a substitute for other programs. Finland is now considering a UBI, and it will be interesting to see how many old subsidies are eliminated. My expectation is that UBI will be added onto existing programs. My final concern is the competence of the government to manage health insurance. For example, the government has done a horrible job of serving veterans through the Veterans Administration.
Well, we could compare Ed Dolan's:
'The answer to the paradox lies in a distinction that economists make between two effects of any social safety net program. One is the income effect: If you give people more money, other things being equal, they do have less incentive to work. The other is the substitution effect: If, while giving people money, you also decrease the amount of each added dollar of earned income they get to keep, that also reduces incentives to work. ….
'Eliminate the tangle of overlapping social programs that give rise to 80 percent effective marginal tax rates for the poor and near poor, and you are sure to get greater work incentives. Those incentives would be especially important for workers displaced by trade who need to relocate and retrain for new jobs.'
With Craig Neumark's blurb:
'The book argues that redistributive and other policies enacted to help cushion the blow of the financial and housing market collapses have reduced incentives to work, and thus had the unintended consequence of significantly lengthening and deepening the recession.'
As conclude as we wish, I think.
I'm suggesting that increasing the cost of employing people means fewer of them get 'purchased'. Say, in Sweden, where the employer gets assessed a 32% payroll tax (on top of a top marginal income tax rate of 31% for the employee, that kicks in at about $60,000). To the employers the net, take home, pay, the withheld income tax, and the payroll assessment are all a cost of employing a worker.
I used the term 'purchased' for Sweden, since the hiring decision more resembles a non-reversible one than in the USA, where 'renting' employees is comparatively more appropriate. Whatever the bookkeeping niceties are, the cost of employing someone includes the cost of their health insurance.
"One is the income effect: If you give people more money, other things being equal, they do have less incentive to work."
Your understanding of the income effect is rather different from mine. I learned the income effect as relating incremental changes in income with incremental changes in consumption. You are equating incremental changes in income with incremental changes in incentive to work. How does that translate for someone like Steve Jobs or Warren Buffet?
Your understanding of the substitution effect is also different than mine. But sifting through the clues in your comment, we can all agree that discontinuities in the slope of tax versus income curve can have disincentivizing effects but those discontinuities are modest (as shown in Dolan's second graph) and any disincentives transient.
But you and Mulligan have taken a real if minor distraction and made it the centerpiece of an argument that it "had the unintended consequence of significantly lengthening and deepening the recession."
How about a different narrative: the cascade of the collapse of the housing market, destabilization of the financial sector, and sharp increase in unemployment made people feel poorer and made many of them actually poorer. This punctuates that cascade with a sharp drop in demand. People without money don't buy stuff.
This was a worldwide recession so there were not abundant supply sinks to replace that demand. Without brisk demand there is little incentive for producers to expand plant and hire workers. Absent appropriate stimulation of demand, you have a slow, soft recovery. Huh. Just like the one we've got.
That is Macro 1001. No 'heterodox' leaps to the absurd required.
John, I think you are eliding political motives and economic motives. Free trade from an economist's perspective makes markets more open, more responsive, and more effective in allocating resources. Labor arbitrage certainly plays a role there and I would probably agree with you that labor arbitrage is a large element of what gets Wall Street damp in the shorts with free trade agreements.
Free trade is by its very nature disruptive. So are many new technologies, new management schemes, new competitors entering a market. That doesn't mean we should have gotten off the train at the Mennonite stop in 1850. There is a cornucopia of benefits that come with free trade but they do take time to develop. In the mean time it is a political rather than an purely economic problem to mitigate the negative impacts of these disruptions on people's lives.
I appreciate the reply, but I don't think I elide the motives, rather, fairly stated the motive was and is to bring a market force that cannot be countervailed against labor, and not all labor, as doctors and economists are exempt, as Dean Baker would point out.
The economic "motive" seems better understood as the sales pitch. The policy makers surely understood the unstated tilting proposed by the deals.
Guys who are in the markets with their own money do not have patience for economists arguing from simplified assumptions that do not exist in the real world. Economists should not have that patience either. And an historical reading of guys like Adam Smith would indicate at one time economists did not have that patience, to the betterment of us all.
I have to disagree that trade between the US and Mexico (or China) that is primarily based on labor cost differences is devoid of comparative advantage. In fact, such trade is the essence of the classical trade paradigm, which arises from differences in opportunity cost of various activities between countries. It is completely natural for countries with low labor costs to specialize in labor-intensive production, just as it is natural for capital-intensive US farms to export corn to Mexico in return. Corn-for-auto assembly is just as much a comparative advantage exchange as Ricardo's example of English textiles for Portuguese wine.
Your reply seems to indicate that you find no broad benefit from free trade, only advantage to capital and certain protected labor. That you are demonstrably wrong isn't as interesting to me as the fact that you hold the opinion in the first place.
"fairly stated the motive was and is to bring a market force that cannot be countervailed against labor"
Motives and consequences are not the same thing. That disruption of employment and downward pressure on wages is a consequence is clear. That it was the or even a motive is arguable. But I will again point out that these trade agreements are political documents wrapped around economic principles. There are similarly political fixes for the disruptive consequences but labor has been relatively feckless in pursuit of them. Again, that is a political rather than an economic failure.
Labor is in for a rough future, John. Economies are producing more and more goods and services with fewer and fewer labor inputs both through offshoring and through automation. If we are to avoid becoming an economically bifurcated society – think Mexico – we need to do something about that. But John, the train to the future isn't going to stop just because labor* hasn't gotten its political act together.
*I'm not talking about labor unions per se here, but labor in the sense of the broad swath of population that does not get the majority of its income from equities.
Sorry John, I misposted. My reply follows but not appended to your comment.
I don't want to venture onto thin ice–but here goes. Think back to classical economics, I mean Ricardo and Marx. They firmly believed in the "iron law of wages," that is, that labor income was basically fixed at the cost of a subsistence diet. When they said gains from trade, I don't think they meant that they thought workers would be among the gainers. Even the advantage of cheaper imported clothing or salt cod would be competed away in lower wages, given their assumptions.
Could it be that the 20th century was a great historical anomaly–the idea that real wages of labor (raw labor, discounting returns to human capital) would rise decade after decade? Could it be that we are in a new classical phase, in which wages of raw labor are fixed at a minimum that depends on subsistence costs in the developing countries we trade with?
The exit from that state, I suppose, will come when all countries have gone through the cycle that Japan and Korea have completed, that China is moving through, that Vietnam and Bangladesh are just starting, and that Mali and Nepal have not even entered yet? Since our planet is a closed system, that will happen some day. If robots havent' taken all work before then, maybe the labor share of income will rise again.
Whether the "iron law of wages" is in fact a law (in the scientific sense) or simply an artifact of political realities in the 19th century is an interesting debate. The rough contra argument that I would make is that subsistence in any 21st century appreciation of the iron law of wages would have to be rather more commodious than was the case in the late 19th century. Wealth today comes not so much from corn and wheat but from 60" televisions and social networking services and genetically engineered drugs. A broad base of consumers with sufficient wealth to acquire these geegaws is necessary; the incentive to make a product is directly proportional to the likelihood of selling it for a profit.
Moreover, democracies were still rare oddities in David Ricardo's day. In more hierarchical governance systems, moneyed interests can more easily centrifuge down labor costs to skim all the cream for themselves. And I must admit those moneyed interests still do a pretty good job 😉 But in a democracy there are limits. In some ways Marx has been vindicated because the workers of the world – or at least the workers of the democratic industrialized world – if not united, have it within their ability to unite and press for more equitable distribution of wealth.
Indeed, a more socialized future is a certainty. It is already a reality in industrialized Europe and is moving in that direction in the US as is evidenced by the current strong performance of a 'democratic socialist' in a nation where socialism has been a third rail.
I don't think it will take worldwide labor equality before the labor share (taken as whatever isn't capital's share) again begins to rise. There is already increasing political resistance to upward GINI creep.
On the contrary, I firmly believe in the gains from trade, trade which flows from comparative advantage. However, I do not see any benefit from trading based on absolute advantage.
(Please do not use the propaganda term "free trade" without qualifying it with the thousands of pages required for one of these agreements. They are all better called "protectionism agreements" where some activities are protected and others not.)
Instead of doing the deals we did in the way we did, we could have put all workers of any kind in competition with the rest of the world. But we protected the professions among others, especially what we call intellectual property.
Or we could have written tariffs in such a way that the comparative advantage of manufacturing in one place could be preserved. Such as, tariff imports for the domestic cost of foreign labor content. Tariff imports for the domestic cost of environment regulation avoided in foreign manufacture. With such tariffs, advantageous production could have happened elsewhere without being a bludgeon against labor.
This is not rocket science. I realize we are both talking politics here. However I think you assume the economic principle contained in the agreements are neutral science. Tell me if that's a fair assessment of your position. If so that is the disagreement, since it is clear to me the principles as stated are not neutral.
Yes, we could write agreements in a way the protects labor by putting a tarrif on imports that reflects the extra cost of foreign labor. But then we would lose the advantage to consumers of using lower cost labor elsewhere. The question is not whether we could do it, but whether it is a good idea. It is a good idea for the protected classes of labor and a bad idea for others. That is pretty standard trade theory. In fact, what you say is simply a restatement of conventional trade theory.
'"One is the income effect: If you give people more money, other things being equal, they do have less incentive to work."
'Your understanding of the income effect is rather different from mine. '
Since you've quoted Ed Dolan, I guess you mean your understanding is different than Dolan's.
My understanding of the income effect is the one I learned at university. I've explained my understanding. I accept that my understanding may be incorrect or incomplete. But I have yet to have that demonstrated to me.
"Tell me if that's a fair assessment of your position."
Actually, it isn't. Our political positions aren't that different. But economics is economics and politics is politics. There are, of course, many advantages (in economic terms) to shoveling a lot of jobs to lower labor cost venues including lowering commodity prices and, over time, increasing the overall market size by incorporating these new earners/consumers into it.
It is arguably important to move those jobs without undo disruption of the domestic consumption pool. That is to ask, how much domestic consumption are you willing to discard today in exchange for a larger market tomorrow?
Politically, the calculus is, or should be, a little different. Economics is a tool. How that tool is used is an issue of politics.