Bad Trade

Michael Pettis in American Compass:

“China will compete for some low-wage jobs with Americans,” lectured Nobel laureate Robert Solow from the White House podium, amidst the U.S. debate over China’s ascension to the World Trade Organization. “And their market will provide jobs for higher wage, more skilled people. And that’s a bargain for us.” More than 20 years later, economists and policymakers are still searching for that bargain. Belatedly, they are discovering that whether or not trade benefits the global economy or any particular nation depends, like most things in economics, on the specific underlying economic conditions.

When it comes to trade, the key conditions are the approaches that countries take in their quests for international competitiveness. Trade can directly boost production and indirectly boost demand, so that the global economy is generally better off. But trade can also make the global economy worse off by directly constraining demand and so indirectly constraining production. The outcome depends on whether a country’s higher export revenues are recycled into higher consumption and imports or into higher savings.

In the traditional view, international trade allows a country or region to specialize in producing things that it can produce relatively more efficiently than its trading partners, and so trade shifts production to the locale in which a given amount of labor and capital yields the greatest output. In a world of scarce inputs, this allows the global economy to maximize production. According to that model, by definition, anything that impedes or distorts free trade, whether a regulation or tariff or quota, reduces global production. Mainstream economists accept that the benefits of free trade may be badly distributed, even to the point at which free trade can leave some sectors worse off, but this, they insist, is a distribution problem that should be solved politically.

More here.