Trade, Jobs, and Political and Economic Disruption

 Two podcasts I listen to often include EconTalk with Russ Roberts, and Masters in Business, with Barry Ritholtz. No one could have called the election based on these episodes, and none of the guests  made any projections about it specifically, but each of the these guests below discuss issues that could have been informative about what's been going on in the minds of the electorate. And why non-conventional candidates like Bernie Sanders and Donald Trump had so much appeal. They also question conventional wisdom about the distributional effects of comparative advantage and free trade.

In a past podcast, just over a year ago, Gary Shilling offers some interesting thoughts on trade:(paraphrasing not quoting).

Basically globalization has led to income polarization, with 8 years of zero to no real income growth for a segment of the population and this frustration has been expressed politically through Bernie Sanders and Donald Trump. With regard to Trump, when you strip away the blustering, he may actually be more like an old school centrist politician. When you take the impacts of globalization, the recession, and the slow recovery, conventional politicians don't know how to react. 

I think this is the kind of environment in which it was possible for the 'blue wall' on the electoral map to crumble.

More recently, Aswath Damodaran touches on this: (again paraphrasing)

Brexit should be a warning sign that we've lost perspective. In the aggregate, trade and globalization can be good for the country, but the 55 year old steel worker in Pennsylvania gets little consolation out of the fact that free trade is going to create more world wealth when he says where the heck am I going to get my paycheck next month. 

"We are paying a price for almost deliberate blindness in the financial capitals of the world to the kind of costs that are being created sometimes."

Again this echoes Shilling above. In his paper, "The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade", David Autor takes a very detailed look at these issues and investigates them empirically. David was guest this past year on EconTalk with Russ Roberts. Some highlights:

• one of the standard arguments for free trade and globalization is that it makes the pie bigger, and sometimes the story sounds like some people get larger slices than others, but everyone gets a bigger slice, so on the net everyone is better off. 
• Another way of thinking about this is that trade increases aggregate wealth, and this increase more than offsets the losses for those that are displaced in the labor force.
• Autor points out that yes, gains can offset losses, but the gains are going to different people
• Example: sure consumers gain by saving 5 cents on the broom they buy at Wal-Mart, and if you add up all of those nickels its more than the total losses for people whose lives are ruined.
• But this is little consolation to those whose lives are ruined, it takes years to find alternative opportunities and often at a fraction of the salary they earned before
• In the past, maybe these distributional effects were of less concern because trade largely reflected differences in comparative advantage across different types of manufacturing- for example maybe we would lose jobs manufacturing electronics but make up for it with other jobs building tractors-And balanced trade resulted
• In the past, skillsets were much more congruent across different industries with changing comparative advantages- i.e. it was not extremely difficult to move from manufacturing one good to another if your former job was displaced by trade
• More recently, with globalization, things changed. Instead of reallocating across sectors of manufacturing, countries like China just supplanted manufacturing on a much larger scale. And instead of paying for imports with different exports for which we had a comparative advantage we ran trade deficits (of course with surpluses in capital accounts)
• However, the kinds of investments being made with the new wealth created by global trade are in areas and sectors where skills are not congruent for many workers supplanted by the trade outcomes
• Ultimately we have experienced a sharp decline in demand for labor that has been contractionary

Hence this is the 'stagnation' in real wage growth that so many have been talking about. Could it also be why conventional stimulus and monetary policy has not really moved the needle in terms of economic growth? Is this because our comparative advantage is in services, technology, marketing, research, and engineering and these sectors are not soaking up the excess labor freed up when manufacturers shut down or relocate overseas?

The conventional wisdom has always been with trade, labor and resources that were once tied up in lower valued uses are reallocated to higher valued uses creating more wealth making everyone better off. But Autor is arguing that this just isn't happening or is taking too long. Maybe its the next generation or two that reaps the rewards. But not necessarily. If you've got a good gig and lose it, you may end up living in an area with bad schools, or may not have the resources to provide your children or the next generation with the education and training required to take advantage of the new economy jobs where the gains more than offset the losses from globalization. 

This also makes me wonder...supply side policies designed to promote economic growth and  aggregate wealth (under the terrible misnomer 'trickle down economics' ) might not work quite as well as they used to either given the structural environment depicted by Autor in his paper. But that probably goes the same for fiscal stimulus related to infrastructure. It might boost those sectors related to construction, but the traditional multiplier working its way through manufacturing and labor demand just likely won't work the way the Keynesians believed it would 30 years ago. 

So what is the answer? Surely a world with trade is in aggregate better than one without. Does this mean renegotiating NAFTA? Should we put the brakes on future globalization and phase in tariffs and trade restrictions and slowly fade them out so that sectors can readjust over a few generations? (things Donald Trump may seem in favor of) Or more aggressive and progressive policies called for  to provide a soft landing for those future displaced?  Some combination?  This gets to more spending on a number of programs, healthcare, and education. (things Hillary Clinton would have supported)

I'm not sure what the answer is after considering the incentive effects and the impacts for long term economic growth and development. Not to mention government spending. However, it was the lack of policy response to these questions that made this past election what it was. 

References:

"The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade," by David H. Autor, David Dorn, and Gordon H. Hanson. National Bureau of Economic Research Working Paper, January 2016.

Effects of the Minimum Wage on Employment Dynamics

Jonathan Meer, Jeremy West

NBER Working Paper No. 19262

Issued in August 2013

NBER Program(s):   LS   PE 

The voluminous literature on minimum wages offers little consensus on the extent to which a wage floor impacts employment. For both theoretical and econometric reasons, we argue that the effect of the minimum wage should be more apparent in new employment growth than in employment levels. In addition, we conduct a simulation showing that the common practice of including state-specific time trends will attenuate the measured effects of the minimum wage on employment if the true effect is in fact on the rate of job growth. Using a long state-year panel on the population of private-sector employers in the United States, we find that the minimum wage reduces net job growth, primarily through its effect on job creation by expanding establishments.

http://www.nber.org/papers/w19262

Sent from my iPad

An Estimate of the Impact of Regime Uncertainty on Current Unemployment

From:

http://economicsone.com/2013/07/31/policy-uncertainty-makes-firms-reluctant-to-hire-new-evidence/

  "In their paperUncertainty and the Slow Labor Market Recovery, they present "evidence that heightened uncertainty about economic policy during the recovery made businesses more reluctant to hire workers."

The Causes and Consequences of Antitrust: The Public-Choice Perspective:Amazon:Books

http://www.amazon.com/gp/aw/d/0226556352/ref=redir_mdp_mobile/175-7554683-8132925?keywords=mcchesney%20shughart&qid=1373541581&ref_=sr_1_1&s=books&sr=1-1

"The public-choice approach denies the assumption that government employees act in single-minded pursuit of the public interest, defined as allocative [Pareto] optimality. That belief lacks any theoretical or empirical basis. Oddly enough, many who support a shift in regulation from market to government processes because the market fails to provide the "right" incentives simultaneously disregard the possibility that government institutions also fail to provide the "right" incentives."

Recent Work from Valery Ramey re Multipliers

Owyang, Michael T., Ramey, Valerie A. and Zubairy, Sarah. Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data. [PDF Document]. Federal Reserve Bank of St. Louis. Economic Research Division. Working Paper 2013-004A. January 2013.

Externalities, Coase, Ostrom & Demsetz

Traditionally when it comes to environmental pollution, the general philosophy was that ‘the polluter pays’. A factory polluting the air or water should pay for the damages that are caused. In a much simpler case, if you build a house next to me and you don’t like the smell of livestock waste coming from my property, the traditional philosophy would hold that you could have the government stop my operation. In the article ‘The Problem of Social Cost’ Ronald Coase brought new insight to the way we view social costs and the principle of ‘polluter pays.’

The insight that Coase brought was the reciprocal nature of social costs and externalities and has been referred to as the Coase Theorem. The important elements of the Coase Theorem (in the context of the present example) can be demonstrated as follows:

 1) Yes it is true that my operation is harming you via air pollution

2) However, in stopping me via government or legal intervention (or taxing my waste        production) you are harming me

3) The assignment of property rights and the potential for bargaining results in behavior that is changed or altered to account for the negative impact our choices have on others, regardless of which party is initially assigned property rights

“But the ultimate result (which maximises the value of production) is independent of the legal position if the pricing system is assumed to work without cost.” –Coase, p. 8

Coase says that the issue is that no one owns the air that surrounds my livestock operation and your home. There then follows a dispute over how the air should be used- to absorb livestock odor, or to provide a scent free atmosphere in your back yard. An externality is an uncontracted effect. It’s a harm or benefit that goes uncompensated or is not captured by prices. Whenever the cost of one’s behavior is not factored into a price by which a choice can be valued, I can harm you without compensating you for it. ( i.e. a negative externality exists)

However, if I own rights to the air, then I can choose to pollute the air. If you own rights to the air, then you can prevent me from polluting it. If noone owns the air, then it is first come first served or winner takes all.

That is not the end of the story though. What Coase emphasizes is that if I own the rights to pollute, you can pay me to limit my pollution i.e. buy those rights from me. I can then use the proceeds to alter my livestock nutrition, genetics, and management to reduce the odor my operation is causing. On the other hand, if you own the rights to pollute I can purchase those rights from you, or invest in technology that will allow me to continue my operation without violating your rights. Decisions about how the air should be used will be based on the local knowledge and preferences of both parties. This can be accomplished without major government regulation, or the arbitrary imposition of a tax.

The assignment of property rights and the potential for bargaining results in behavior that is changed or altered to account for the negative impact our choices have on others, regardless of who holds the rights. This is the essence of what is known as the ‘Coase Theorem.”

The Coase Theorem holds in the case of zero transaction costs, and approximately in the presence of transaction costs that limit the bargaining process and establishment of a price that reflects local knowledge and preferences related to the externality.  In the case of high transaction costs, Coase argues that courts should do their best to anticipate the economics involved in making the initial assignment of property rights. Coase recognizes in some cases, governments may do a better job allocating resources in the face of high transaction costs, but is skeptical. Understanding the knowledge problem, and the issues related to government decision making from public choice theory make government intervention a questionable strategy for dealing with social costs.  In later work,

Other Related Work:

Based on field research and game theoretic reasoning, Elinor Ostrom concludes that in many cases social dilemmas like those recognized by Coase can be better handled through cooperation:

“If one sees individuals as helpless, then the state is the essential external authority that must solve social dilemmas for everyone. If, however, one assumes individuals can draw on heuristics and norms to solve some problems and create new structural arrangements to solve others, then the image of what a national government might do is somewhat different…National governments are too small to govern the global commons and too big to handle smaller scale problems.”

Howard Demsetz holds that technology and knowledge play a crucial role in the development and adoption of property rights:

Changes in knowledge result in changes in production functions, market values, and aspirations. New techniques, new ways of doing the same things, and doing new things-all invoke harmful and beneficial effects to which society has not been accustomed. It is my thesis in this part of the paper that the emergence of new property rights takes place in response to the desires of the interacting persons for adjustment to new benefit-cost possibilities.

References:

 The Problem of Social Cost. R. H. Coase. Journal of Law and Economics, Vol. 3 (Oct., 1960), pp. 1-44

A Behavioral Approach to the Rational Choice Theory of Collective Action: Presidential Address,

American Political Science Association, 1997. Elinor Ostrom. The American Political Science Review

Vol. 92, No. 1 (Mar., 1998), pp. 1-22

Toward a Theory of Property Rights. Harold Demsetz

The American Economic Review, Vol. 57, No. 2, Papers and Proceedings of the Seventy-ninth

Annual Meeting of the American Economic Association. (May, 1967), pp. 347-359

Democracy vs. Markets & Cooperation vs. Coercion in a Free Society

From:
http://cafehayek.com/2013/02/quotation-of-the-day-550.html

"In fact, of course, the alternative to governance by democratic majorities is not limited to subjection to the dictates of a nondemocratic tyrant such as a Chairman Mao. Another alternative is individual governance: each of us living our lives as we each choose, governed – through the laws of property, contract, and tort – in our dealings with strangers by the economic 'law' in such a free society that requires each person who wishes to improve his or her lot in life to assist others, through markets, in their efforts to improve their lots in life."