Free Trade: You’re Doing It Wrong

The World Trade Organization made news last month because of the record number of candidates seeking to be its new director-general. Alas, they’re probably in it more for the salary and prestige than for any résumé-building accomplishments. After all, the WTO has done little to open global markets since the Doha round of trade talks began in 2001. The reason is simple: Its members are doing free trade all wrong.

That’s too bad, because basic economics teaches that two people who trade with each other always end up better off. Why else would they trade in the first place? Putting aside issues of coercion and uncertainty, the idea is that there are gains from trade to both sides whenever a transaction occurs. Realizing those gains by buying and selling goods, services, assets, and labor is one of the keys to economic growth.

The same is true for countries, but there’s a wrinkle: Though two countries that trade with each other will also achieve gains from trade, their people won’t necessarily share those gains equally. Indeed, both countries will be better off overall, but inside each country there will be winners and losers. This is why people ranging from Korean farmers to American autoworkers turn out in numbers to protest free trade agreements.

But free trade needn’t be such a divisive issue. At the national level, the benefits from free trade always outweigh the losses; this has to be true, since each new transaction creates its own gains from trade. Put another way, a country that opens its markets is always richer as whole. And so here’s the genius part: It should be possible for the winners to compensate the losers so that everyone is better off, or at least no worse off than they were before.

This redistribution of the gains from trade is not an afterthought. It is an essential part of the process of opening markets. Done right, it practically guarantees that everyone in a country can and will support free trade. Yet no one in the world does it well, or even tries to.

Sure, there are programs such as Trade Adjustment Assistance (TAA) in the United States and the Globalization Adjustment Fund in the European Union. But they’re tiny and relatively ineffective. TAA for workers amounts to about $1 billion a year — about 0.007 percent of U.S. GDP — and the program’s record of helping workers to find jobs that fit their skills is middling at best. The EU’s fund granted only 128 million euros in 2011, the last year for which complete figures are available, helping just 0.009 percent of the union’s roughly 240 million workers. More recent payments have been tied up in ongoing budget talks, and several countries have called for the fund to be abolished altogether. Clearly, there is little political appetite in the world’s two biggest economies for a more serious attempt at redistributing the gains from trade.

Not that it’s easy. To start, you have to know how much is gained and lost by whom. Consider the big winners from trade. They include shareholders and employees of export companies that find new customers abroad, importers that can offer new products at home, and other businesses that can get cheaper inputs. Then there are all the consumers who can buy new or cheaper goods and services. What is the value of trade to these people? Next, consider the big losers: workers whose jobs disappear and shareholders whose companies fold because of foreign competition. How much economic damage has been done to them?

Economists can — and routinely do — answer these questions with statistical estimates. The tougher question is how to accomplish the redistribution. You can’t tax new imports to skim off some of the benefits to consumers, since the whole point of a free trade agreement is to render imports tariff-free. You could, however, make people pay for the agreement itself.

But how? One idea would be to identify the prospective winners of a new trade agreement and ask them to contribute lump sums to a fund that would compensate the losers. The trade agreement would go forward much as buyouts do in the stock market; if enough of the winners signed up and contributed, the rest of them would be compelled to pay, perhaps on their annual tax bills. Then the fund — likely to hold a lot more than $1 billion for any major agreement — would be divvied up between the losers.

In addition to solving the redistribution problem, the fund would help everyone, winners and losers alike, to understand how trade affected their economic futures. Moreover, it would allow the losers to spend their compensation however they saw fit; some might choose to retrain for a higher-skill job, while others might prefer to take a lower-skill job and buy a new car. Of course, some people might try to weasel out of the winners’ category and paint themselves as losers. But the government already does a reasonable job of figuring out who should receive various payments and benefits, from emergency relief to unemployment insurance. Fraud in this case would be even harder — how do you fake a decades-long career in manufacturing?

No, the biggest obstacle for the new mechanism might be getting politicians and the public to trust economists, their statistical models, and a dose of new thinking. Until that happens, the WTO will continue to twiddle its thumbs, and gains from trade will still be left on the table.