Stop the World! Second Thoughts by a First Rank Economist OR The Case for Free Trade Crumbles

When the 1970 Nobel laureate Paul Samuelson was asked what it takes to win a Nobel Prize, he volunteered, "It doesn't hurt to have good students."

But even Samuelson's overachieving students -- he has taught economics at MIT for six decades -- sometimes need to be put in their place. At least that seems to be the subtext of a new Samuelson paper in the Journal of Economic Perspectives.

Samuelson argues that, far from representing an unmitigated boon, free trade may in some circumstances prove a net loser. Among countless globalists who stand duly corrected, not the least chastened are two of Samuelson's own former students: Jagdish Bhagwati and Gregory Mankiw. Noted for their ardent embrace of globalism, the pair are identified by name as purveyors of "polemical untruth" in Samuelson's opening paragraphs.

Samuelson's insight is that if a low-wage country like China suddenly makes a major productivity leap in an industry formerly led by the United States, the result can be a net negative for the American people. Although American consumers may benefit via low-low prices at Wal-Mart, their gains may be more than outweighed by large losses sustained by laid-off American workers.

This conclusion, coming as it does from the pope of economic orthodoxy, is already (even before its official publication) causing a sensation in the economics profession.

Mainly the reaction is positive. Certainly this sudden flash of the obvious has come not a moment too soon for many of Samuelson's fellow liberals.

According to Jeff Madrick, author of Why Economies Grow and editor of Challenge, the take-home message is that the United States needs to do much more to support workers thrown on the scrap heap by globalism.

"The Samuelson paper is a strong argument from the most illustrious of neoclassical economists for a much stronger safety net for American workers," Madrick says. "The price being paid for free trade is falling on many workers, and there's little empirical doubt of that anymore. Moreover, I think the bias among free-trade advocates has skewed the empirical research in the field. Claims of finding that gains from free trade are many magnitudes larger than the losses have been based on extraordinarily poor studies that have hardly been criticized. Maybe some serious sense -- I would ask only for balance -- will now return to trade economics."

For James Fallows, a liberal-leaning critic of Washington's blink-first style in trade diplomacy, Samuelson's analysis is a call to policy-makers to break free from utopian theories and, instead, take a hard look at the real world.

"The great problem in Western discussion of trade theory has been its simpleminded Panglossianism," he says. "The main thing that has supported globalism, apart from the self-interest of many powerful participants, has been the idea that economic theory was 100 percent on the side of Dr. Pangloss. To have the most esteemed of all modern economists say that things are not this simple is a very important step."

On the moderate right, Pat Choate sees Samuelson's paper as essentially defensive, less a confident breakthrough than the correction of an embarrassing mistake.

“At the age of 89, Samuelson is finally stepping onto the road to wisdom,” says Choate. “It is a road where uncertainty prevails over the certainty of the ‘laws’ of economics, which are not laws but ruminations by closeted academics. His article is important, for it effectively gives permission to his disciples to begin to think about the real world, rather than try to postulate assumptions and develop elegant models which ultimately are irrelevant.”

Paul Craig Roberts, a fiercely anti-globalist economist who served as President Ronald Reagan’s assistant treasury secretary, puts it even more pointedly. Samuelson’s rethink, he suggests, is merely an attempt to patch up a leaking, and ultimately doomed, vessel.

As he points out, the paper is in large part a reaction to arguments made by Ralph E. Gomory and William J. Baumol, who in Global Trade and Conflicting National Interests have mounted a powerful challenge to the orthodoxy's utopian take on international trade. Roberts adds, “Gomory and Baumol show that, in the relevant zones, free trade is characterized by conflicting interests -- not by mutual benefit, as economists unthinkingly assume."

In Roberts' view, though the Samuelson paper is an important modification of free-trade theory, Samuelson has chosen his assumptions carefully to avoid any frank discussion of the widespread damage being caused by outsourcing.

If Roberts is disappointed by the narrowness of the Samuelson modification, many on the globalist side of the trade argument are evidently worried. A leader of the damage-control effort is none other than Bhagwati, the former Samuelson student singled out for obloquy in the paper.

Already Bhagwati, a Columbia University professor, has collaborated with two allies in a hastily written response that will be published in the same journal.

Judging by a bad-tempered recent contribution to The Wall Street Journal, Bhagwati is clearly rattled. Describing John Kerry's trade policies as "voodoo economics," Bhagwati embarrased his cause by hurling juvenile personal abuse at the anti-globalist CNN presenter Lou Dobbs.

What is clear is that Bhagwati has plenty to be rattled about. As one of the earliest and most extreme globalists, he has offered several hostages to fortune over the years, most notably in his indecent embrace of the Japan trade lobby in the 1980s. Blaming "bullying" American policy-makers for most of the tension at the time in U.S.-Japanese relations, he exonerated Japan from charges of protectionism. Writing in Fortune magazine in 1989, for instance, he argued that the evidence was "slim" that nontariff barriers significantly reduced Japan's appetite for American exports.

In what must have been the ultimate bad hair day for Bhagwati, one of Japan's leading spokesmen has now admitted that Tokyo's 1980s denials of protectionism were poppycock. The admission came from Mitsubishi Corporation President Minoru Makihara, who told the Tokyo foreign correspondents' club that the Japanese market in the 1980s was "still closed and tightly protected.”

Bhagwati's demeanor cannot have been improved by the realization that Japan’s continuing trade surpluses (they never went away) are likely soon to re-emerge as a hot-button issue in Washington. The reason: Japan’s current account surplus is headed for a record $170 billion this year. By comparison, in 1989 -- which was both the last year before the Tokyo stock-market crash and the year of peak Washington lamentation about Japan’s “juggernaut” trade strategy -- Japan earned a current surplus of a mere $57 billion.

Under the circumstances, Bhagwati seems a weak candidate to lead what will obviously be a hard fight to defend academic orthodoxy. Certainly only the first casualty will be Henry Kissinger's cruel witticism about academic life: that the fights are so bitter because the stakes are so low. This is one dispute where the stakes justify the bitterness.

Thanks again for your thoughtful reply. We are appear to be in agreement that the assignment of duties for outcomes is not a purely economic question.

Not to belabor the point, and for whatever it's worth, I'd like to clarify a few points in the previous points (the responsibility for divergence is entirely mine).

1. When speaking of the first- and the second-best I used the term broadly: an introduction of any one constraint "reduces" the best by 1, from first to second. So, you may have a model with three constraints, but if some other, fourth constraint is in focus, then for the purpose of THAT model the three-constraint optimum is the first and and the four-constraint optimum is the second best. I understand that this terminology is usually applied in a more narrow sense -- to the absence/presence of informational asymmetries, as far as I know.

2. I was probably even less precise when I spoke of the role of government. I agree with you: I too think that it is the responsibility of the government to work towards the common good --- provided that what that good is and the commonality thereof are known.

What I spoke of earlier, especially referring to the post-war changes is not whether the government should work towards the common good but whether it alone should do so. What troubles me is the cultural decline of personal responsibility and accountability for one's actions. Under these circumstances, the government becomes the sole source of protection, and that inevitably deteriorates into socialism (the less we do ourselves, the more in trouble we get, the more help is need, the more we look to the gpv't to provide it). I believe, and others wrote extensively, that this narcissistic trait has appeared roughly after WWII and became increasingly more pronounces since then. (Your point about old roots of protectionism is well taken).

This is very far from being libertarian. In fact, I am usually somewhat irritated by the posts of libertarians on this board: they never tell me how they expect public goods to be provided, for instance. I am not for the absence of government but against big government -- there is great deal in between.

3. Back to the caveat about knowledge of what common good is. You write: "I am not. I believe that governments have a duty to work for the common good, and that includes protecting their citizens ability to earn high wages." The devil is, as usual in details: what constitutes "high?" Can the current wages be unreasonably high (in the sense of the national income)? DO you have any doubt that the income of IT labor was affected by what amounted to rationing? Do you find it fair that some retiree was paying that extra portion of wages?

The point is that nobody was arguing for any government intervention into IT wages, which were inflated for decades. It is only when they go down that we hear all the rhetoric.

What is "high" wage, then? It appears that we are not talking about high or low wages but about the sign of their changes: when wages rise, we are happy by default and don't expect the government to protect the investors and consumers; but when they decline, we all should be sad and ask the government to intervene to protect the status quo. Has anyone analyzed and questioned that status quo?

Sorry, I find that even on economics grounds completely unreasonable. But, again, who said that all these sentiments of the public are expressed by economic agents?

4. This is what I would like to make more precise: as you wrote,
) The first best outcome for the world may not be the best outcome for an individual country.
Undoubtedly true in the equilibrium state of a closed system. What is not clear to me whether it is true dynamically. [ To speak at the level of anecdote: an entity that adopts computers early may actually increase its advantages over others -- more generally, if there are increasing returns here). It is clear that social institutions are least vulnerable to free trade: most of the countries as we know them today did not exist when out Constitution was written --- how many of them have adopted it, or any sizable portion of it? I do believe that the main reason for the success of this nation is precisely in values and social/political institutions. Suppose I posit that our institutions translate into this specific comparative advantage: the ability to adjust, and make best use of, the ever changing environment (i.e., act when we do not know that the "common good" is). I understand that this all may be questioned. Buy suppose I take this as an assumption and ask, given that this comparative advantage is not likely to diminish, can free trade be disadvantageous for the country? As you can see, the question is intrinsically dynamic.

An analogy is two computers called America and China. If the first has a larger processor and memory, any FREE use of the resources of China cannot possibly be disadvantageous: a more computationally powerfull computer will be "a step ahead" in the game. Over time, the initial disparities may be expected only to increase. The only thing that can equalize the situation is to transfer some of the memory and processing power --- the analogue of social institutions that other countries are not willing to adopt. In sum, free trade cannot hurt unless other countries adopt our social/political institutions, which they have not done so far (if anything it is we who appear to be giving them up).

My question is therefore not even about the equilibrium but about a steady dynamic, perhaps. I know this is too vague (steady in terms of what? Constant rate of change? constant acceleration?) Sorry if I bore you with this vague intuition --- too vague to resemble even a rudimentary model.

In any case, thanks for your posts and pointers to the literature. I have enjoyed your comments.

The avoidance of some form slavery is a precarious economic situation. Beyond precarious. While it would sure seem to be an elevated social condition, as a quark you know what happens to overly elevated states of energy.

Who will there be to re-pump our -- the world's human condition laser -- when we fall all at once to a more grounded state?

We can not risk spurious triggers of that decay.

The Civil War was about that. The further development of the human condition in the North could not proceed further while the South relied on slavery and all the economics and politics that slavery brings with it.

"Free trade" -- a dubious name for what the practice is, is helpful in large scale at times, for temporary periods -- it does spread incentives for the improvement of the human condition around the world to places otherwise most dank and dark. It is helpful in some tiny level at all times -- smuggling, black market etc. In small as an outlet, as a necessary small testing of the economic immune system. As a channel against over-suppression and over-control of markets.

Yet it also goes to far, and will break -- a wonderful mastery if a nation or group of nations can minimize, mitigate and make harmless that break. And because of social and economic forces it is just about impossible -- unless a nation is able to elevate the human condition and at the same time take a very humble tack and prays to gain the grace and confidence of Divine Providence.

Again, one of the first things you'd hear in a marketing course if that it is impossible to produce profits at the expense of quality.

Patently untrue. The "expectations" of quality need to be lowered...that's all. I have to hand it to them; they have done that exceptionally well. The quality of products sold in nearly every category has nosedived to the point of hilarity. Buy a moderate quality, say, dresser in 1980; expect to have it for life. Buy one now (in the same price category in today's dollars) expect the front of the drawer to fall off in a year. When people don't have a moderately priced option, of course they will buy your junk.

In any course on Organizational Behavior you'd hear that it is impossible to achieve, or once achieved to sustain, success without employee loyalty (if tasks are complex).

Again, ridiculous; because employee loyalty is achieved today by the the "fear of loss"...not the hope of gain.

As Nietzsche said, "If only he could shake his head, his burden would roll off his shoulders. But who can shake his head?" If only you could open your mind to knowledge, a few minutes of your time devoted to reading would produce amazing results. But who can pick up a book after spending her life holding reading and education in contempt?

Unless you have a doctorate, my education is equal to, or better, than yours. It just wasn't an indoctrination by a bunch of 60's-era socialist business professors. Do you want to compare gradepoints...I'm MORE than willing. And, I read plenty, but in my various positions I have had a chance to observe the inner workings of many companies; some publicly traded and some not. I know what works...and what doesn't. My opinions on economic issues come from reality; not books. They used to be similar to yours.

Incidentally, the entire middle of your post is B.S. Maytag is on the ropes because of hideous management; going back for some years (I won't call the person out..but the current CEO is no better). They chose to "diversify" in an attempt to increase profits. They expanded on the low end and pulled the entire product line down the drain. That nearly always happens when you bring in an individual from a far-flung locale to run a business in which he/she has no vested interest other than stock options and bonuses. It WILL be sold, probably to a Japanese firm which is easily identifiable. And, no, I don't work for them.

Your first mistake is your assmption that the law of diminishing returns holds for all industries. In fact, it doesn't always hold. Some industries exhibit scale economies, i.e. marginal costs continue to decline with scale until you reach a large very market share. In such industries there is room for only a handful of producers, which gives rise to a natural oligopoly. Consumer electronics is just such an industry.

Here, let me help you with your own argument and correct for errors. The law of diminishing returns on the factors of production are always in play. A firm cannot continue to add variable factor inputs and expect to further reduce its total costs. While it is true that the average fixed costs decline as you get more output the marginal costs will at some point increase. What you are referring to in your example is a decreasing cost industry. Now then, in a decreasing cost industry, costs fall primarily because the labor pool gets more centralized and homogeneous and because new technologies become outdated rapidly - after the R&D has been recaptured by profits.

So, if the Japanese can provide products that are produced from a decreasing cost industry utilizing scale to undercut domestic would-be-producers, the displaced labor moves on to other things (to be fair to the argument, some move up and some don't), and the Japanese labor wage-rate will eventually fall (the nature of the decreasing cost industry). This being the case I should expect that you'd be ecstatic at the idea that the domestic laborer did not have to endure a decline in his/her standard of living like the worker in the Japanese decreasing cost industry.

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