It’s Time to Think for Yourself on Free Trade

What economists and populists both get wrong about the international economy.

OAKLAND, CA - AUGUST 16:  Container ships are positioned under cranes at the Port of Oakland August 16, 2010 in Oakland, California. The International Monetary Fund is predicting that China will surpass Japan as the world's second largest econmy by the end of 2010 with exports to reach $5.4 trillion. Japan's economic growth slowed to 0.4 percent in the second quarter.  (Photo Illustration by Justin Sullivan/Getty Images)
OAKLAND, CA - AUGUST 16: Container ships are positioned under cranes at the Port of Oakland August 16, 2010 in Oakland, California. The International Monetary Fund is predicting that China will surpass Japan as the world's second largest econmy by the end of 2010 with exports to reach $5.4 trillion. Japan's economic growth slowed to 0.4 percent in the second quarter. (Photo Illustration by Justin Sullivan/Getty Images)

Economists like to claim that the purpose of free trade is to eliminate barriers that impair the efficient global allocation of resources, while helping some of the world’s poorest people. It’s an argument undermined by a simple thought experiment. Suppose we wiped the slate clean of the Trans-Pacific Partnership, the Transatlantic Trade and Investment Partnership, and other similar trade deals, and the world’s trade negotiators banged their heads to figure out the best way of achieving their stated goals. What would they be negotiating about?

Tariffs? Rules on intellectual property rights? Investment regulations?

None of the above. They would go instead after barriers to international labor mobility and try to hammer out a deal over some kind of temporary work visa plan, along the lines I describe in an academic paper I recently published. There is practically nothing that would do more to enlarge the economic pie (nationally and globally) while improving the global distribution of income.

Of course, anything like that would be wildly unrealistic in the current political climate. But I bring up the thought experiment to illustrate that trade negotiations are only loosely about what they purport to be about: enhancing economic efficiency and economic opportunities. The problem with the present trade regime is not that it sacrifices the political and the social for the economic; it is that it has never made much sense from the economic perspective, either. Which is why it’s a mistake to judge real-word trade agreements strictly on economic terms, rather than social or political ones.

In some sense we all know this. Consider another thought experiment: Suppose Harry and John own two companies that compete with each other. How do you feel about each of the following four cases?

  1. Harry works really hard, saves and invests a lot, comes up with new techniques, and outcompetes John, resulting in John and his employees losing their jobs.
  2. Harry gets a competitive edge over John by finding a cheaper supplier in Germany.
  3. Harry drives John out of business by outsourcing to a supplier in Bangladesh, which employs workers in 12-hour shifts and under extremely hazardous conditions.
  4. Harry “imports” Bangladeshi workers under temporary contracts and puts them to work under conditions that violate domestic labor, environmental, and safety laws.

From a purely economic standpoint, these scenarios are what economists call “isomorphic” — they are formally indistinguishable because each creates losers as well as winners in the process of expanding the economic pie in the national economy. (That is, Harry’s gains are larger than John’s losses.)

But most people react very differently to these scenarios. The manner in which the gains and losses are generated matter to them. In particular, scenarios 3 and 4 appear problematic insofar as they produce competition that violates ground rules that have been set at home.

Furthermore, scenario 4 would be clearly illegal, but no different in its practical consequences from scenario 3. This raises the question of why we should be OK with scenario 3, while most observers would regard 4 as unconscionable.

The point of this second thought experiment is to suggest that certain kinds of international competition can undermine domestic norms with regards to what’s an acceptable redistribution. A similar thing happens when competition from tax havens undermines a domestic tax regime, or when imports from jurisdictions with poor safety enforcement undermine domestic consumer safety rules.

It’s important to distinguish between two versions of an argument as to why trade may be problematic from a social or political perspective. Some suggest trade is problematic because it redistributes income. The basis for that claim is true, but trivial. Pretty much everything else that happens in a market economy somehow redistributes income. Technology and market competition are the sources of endless churns in an economy. Moreover, plenty of other things, including skill-biased innovation and minimum-wage laws, have vastly greater effects on income distribution than trade.

So it makes very little sense to set international trade apart and decouple it from other domains or approaches for dealing with inequality in labor markets at large (progressive tax systems, active labor market policies, employment-friendly macro policies, etc.). Imports from Germany may adversely affect domestic companies that are displaced, but there’s no reason to treat the people who lose out any differently from workers who are adversely affected by, say, technological innovation. There is a coherent justification for compensating the losers of free trade for reasons of solidarity and equity, but the justification would apply in the case of innovation. Consequently, the preferred remedies should be the same as well.

That brings us to a different social and political objection to trade — that trade violates norms embodied in our institutional arrangements. The suggestion here is that trade may undercut the social bargains struck within a nation and embedded in its laws and regulations.

This argument corresponds to scenario 3 in the thought experiment above. In that case, compensating the losers would be beside the point, because what is at stake is the surreptitious modification of the rules of the game — the undermining of domestic social bargains through the back door. Trade is not merely a market relationship, but an intervention into domestic institutions and an instrument for reconfiguring them to the detriment of certain groups. It would be entirely legitimate to respond to such an injury by directly curtailing the trade flows that have the alleged effect. After all, this is no different from keeping out imports that violate, say, domestic health and safety regulations, which most countries already do.

And this brings us to “fair trade.” Fair trade is much derided by economists who view it as a thinly disguised cover for self-interested protectionism. But it is already enshrined in trade laws (in the form of anti-dumping and safeguard remedies), although in a very skewed, corporation-friendly way.

So rather than abandon the fair trade concept, we should broaden it, as it exists in trade law, to include social dumping — cases, like scenario 3, which undercut domestic social arrangements. Just as countries can impose duties on goods that are sold below costs, they should be allowed to restrict imports that demonstrably threaten damage to domestic regulatory arrangements. (I discuss what such a process may look like in the concluding chapter of my book The Globalization Paradox. And, no, this would not open the trade regime to more protectionist abuse than anti-dumping practices already do!)

The benefit of thinking about fair trade along these lines is that it allows the drawing of a clear line between trade flows that threaten legitimate domestic political arrangements and those that don’t. For example, there is a clear distinction between situations where a trade partner’s low wages are due to low productivity, and the abuse of worker rights (including, say, the absence of collective bargaining, or freedom of association). Both may generate distributional implications at home, but there is a problem of unfair trade only in the second case.

Economists should be more willing to accept that trade may fail to pass the fairness or legitimacy test in certain circumstances. Paradoxically, this would strengthen their defense of international trade in the bulk of cases where the test is easily passed. It would enable them to speak to popular concerns about fairness in trade without undermining the general case for trade.

By refusing to acknowledge the possibility of social dumping — and failing to put in place remedies for it — the trade technocracy has opened the door to populists and demagogues on trade. It has allowed trade in general to come under attack instead of the specific problematic flows that probably constitute a very small share of imports. It is a clear instance of trade purists damaging their cause.

Some regional trade agreements take social dumping concerns on board, but trying to “improve” other countries’ labor, environmental, or social standards through trade agreements is generally ineffective — and also misguided to the extent that it puts commercial interests in the driver’s seat of what is a deeper developmental problem. There is an important difference, often eluded in fair trade discussions, between using trade policy to prevent the undermining of domestic standards, and the use of trade policy to export our standards to other countries. The first is legitimate, the second much less so.

Even if we care about human rights, labor standards, and environmental safeguards in other countries, we should pursue these goals in other international forums, dedicated to these goals, and not through trade deals. If Vietnam has a labor problem, let us not delude ourselves that we can fix it through the TPP. And if that problem threatens to undercut our labor standards, let’s deal with that as an instance of social dumping, through domestic trade remedies.

It should go without saying that fair trade of this sort isn’t anti-trade — quite the opposite. Globally, the principle of fairness should include leeway for poorer countries to grow their economies. That means not saddling them with the restrictive rules on intellectual property, industrial policies, capital-account regulations, and investor rights as current regional trade agreements typically do.

I recognize that such considerations leave me at odds with all the established strands of thinking on trade. Populists such as President Donald Trump have correctly identified the malaise with trade and have capitalized on it. But they greatly exaggerate the real-world significance of the “fairness” concern and seem determined to fix a surgical problem with a sledgehammer.

Meanwhile, economists rightly point out that trade is only weakly implicated in the major economic problems of the day — deindustrialization and income inequality. They are correct that the distributional consequences of trade are better addressed with safety net programs and nontrade remedies. But they have systematically downplayed these consequences — especially when the requisite compensatory programs have remained on paper. And they seem unable to grasp the valid core of the public’s concern about social dumping.

Finally, progressive voices and their allies affiliated with the labor movement in the United States have been keenly aware of the potential for social dumping. But they want to fight it with revamped global governance measures that are at best ineffective and at worst the cause of populist backlash in the countries subjected to them.

Responding to the economic and political crises of our day requires that we restore a healthy balance between an open global economy and the prerogatives of the nation state. That requires us to be honest about trade’s consequences — not just the economic opportunities they create for our businesses and consumers, but the stresses they generate for our social compacts.

Photo credit: JUSTIN SULLIVAN/Getty Images)

Dani Rodrik is professor of international political economy at the John F. Kennedy School of Government at Harvard University.