Digifesto

Tag: trade policy

How trade protection can increase labor wages (the Stolper-Samuelson theorem)

I’m continuing a look into trade policy 8/08/30/trade-policy-and-income-distribution-effects/”>using Corden’s (1997) book on the topic.

Picking up where the last post left off, I’m operating on the assumption that any reader is familiar with the arguments for free trade that are an extension of those arguments of laissez-faire markets. I will assume that these arguments are true as far as they go: that the economy grows with free trade, that tariffs create a dead weight loss, that subsidies are expensive, but that both tariffs and subsidies do shift the market towards imports.

The question raised by Corden is why, despite its deleterious effects on the economy as a whole, protectionism enjoys political support by some sectors of the economy. He hints, earlier in Chapter 5, that this may be due to income distribution effects. He clarifies this with reference to an answer to this question that was given as early as 1941 by Stolper and Samuelson; their result is now celebrated as the Stolper-Samuelson theorem.

The mathematics of the theorem can be read in many places. Like any economic model, it depends on some assumptions that may or may not be the case. Its main advantage is that it articulates how it is possible for protectionism to benefit a class of the population, and not just in relative but in absolute terms. It does this by modeling the returns to different factors of production, which classically have been labor, land, and capital.

Roughly, the argument goes like this. Suppose and economy has two commodities, one for import and one for export. Suppose that the imported good is produced with a higher labor to land ratio than the export good. Suppose a protectionist policy increases the amount of the import good produced relative to the export good. Then the return on labor will increase (because more labor is used in supply), and the return on land will decrease (because less land is used in supply). Wages will increase and rent on land will decrease.

These breakdowns of the economy into “factors of production” feels very old school. You rarely read economists discuss the economy in these terms now, which is itself interesting. One reason why (and I am only speculating here) is that these models clarify how laborers, land-owners, and capital-owners have different political interests in economic intervention, and that can lead to the kind of thinking that was flushed out of the American academy during the McCarthy era. Another reason may be that “capital” has changed meaning from being about ownership of machine goods into being about having liquid funds available for financial investment.

I’m interested in these kinds of models today partly because I’m interested in the political interests in various policies, and also because I’m interested in particular in the economics of supply chain logistics. The “factors of production” approach is a crude way to model the ‘supply chain’ in a broad sense, but one that has proven to be an effective source of insights in the past.

References

Corden, W. Max. “Trade policy and economic welfare.” OUP Catalogue (1997).

Stolper, Wolfgang F., and Paul A. Samuelson. “Protection and real wages.” The Review of Economic Studies 9.1 (1941): 58-73.

trade policy and income distribution effects

And now for something completely different

I am going to start researching trade policy, meaning policies around trade between different countries; imports and exports. Why?

  • It is politically relevant in the U.S. today.
  • It is a key component to national cybersecurity strategy, both defensive and offensive, which hinges in many cases on supply chain issues.
  • It maybe ought to be a component of national tech regulation and privacy policy, if e-commerce is seen as a trade activity. (This could be see as ‘cybersecurity’ policy, more broadly writ).
  • Formal models from trade policy may be informative in other domains as well.

In general, years of life experience and study have taught me that economics, however much it is maligned, is a wise and fundamental social science without which any other understanding of politics and society is incomplete, especially when considering the role of technology in society.

Plenty of good reasons! Onward!

As a starting point, I’m working through Max Corden’s Trade policy and social welfare (1997), which appears to be a well regarded text on the subject. In it, he sets out to describe a normative theory of trade policy. Here are two notable points based on a first perusal.

1. (from Chapter 1, “Introduction”) Corden identifies three “stages of thought” about trade policy. The first is the discovery of the benefits of free trade with the great original economists Adam Smith and David Ricardo. Here, the new appreciation of free trade was simultaneous with the new appreciation of the free market in general. “Indeed, the case for free trade was really a special case of the argument for laissez-faire.”

In the second phase, laissez-faire policies came into question. These policies may not lead to full employment, and the income distribution effects (which Corden takes seriously throughout the book, by the way) may not be desirable. Parallel to this, the argument for free trade was challenged. Some of these challenges were endorsed by John Stuart Mill. One argument is that tariffs might be necessary to protect “infant industries”.

As time went on, the favorability of free trade more or less tracked the favorability of laissez-faire. Both were popular in Western Europe and failed to get traction in most other countries (almost all of which were ‘developing’).

Corden traces the third stage of thought to Meade’s (1955) Trade and welfare. “In the third stage the link between the case for free trade and the case for laissez-faire was broken.“. The normative case for free trade, in this stage, did not depend on a normative case for laissez-faire, but existed despite normative reasons for government intervention in the economy. The point made in this approach, called the theory of domestic distortions, is that it is generally better for the kinds of government intervention made to solve domestic problems to be domestic interventions, not trade interventions.

This third stage came with a much more sophisticated toolkit for comparing the effects of different kinds of policies, which is the subject of exposition for a large part of Corden’s book.

2. (from Chapter 5, “Protection and Income Distribution) Corden devotes at least one whole chapter to an aspect of the trade policy discussion that is very rarely addressed in, say, the mainstream business press. This is the fact that trade policy can have an effect on internal income distribution, and that this has been throughout history a major source of the political momentum for protectionist policies. This explains why the domestic politics of protectionism and free trade can be so heated and are really often independent from arguments about the effect of trade policy on the economy as a whole, which, it must be said, few people realize they have a real stake in.

Corden’s examples involve the creation of fledgling industries under the conditions of war, which often cut off foreign supplies. When the war ends, those businesses that flourished during war exert political pressure to protect themselves from erosion from market forces. “Thus the Napoleonic Wars cut off supplies of corn (wheat) to Britain from the Continent and led to expansion of acreage and higher prices of corn. When the war was over, the Corn Law of 1815 was designed to maintain prices, with an import prohibition as long as the domestic price was below a certain level.” It goes almost without saying that this served the interests of a section of the community, the domestic corn farmers, and not of others. This is what Corden means by an “income distribution effect”.

“Any history book will show that these income distribution effects are the very stuff of politics. The great free trade versus protection controversies of the nineteenth century in Great Britain and in the United States brought out the conflicting interests of different sections of the community. It was the debate about the effects of the Corn Laws which really stimulated the beginnings of the modern theory of international trade.”

Extending this argument a bit, one might say that a major reason why economics gets such a bad rap as a social science is that nobody really cares about Pareto optimality except for those sections of the economy that are well served by a policy that can be justified as being Pareto optimal (in practice, this would seem to be correlated with how much somebody has invested in mutual funds, as these track economic growth). The “stuff of politics” is people using political institutions to change their income outcomes, and the potential for this makes trade policy a very divisive topic.

Implication for future research:

The two key takeaways for trade policy in cybersecurity are:

1) The trade policy discussion need not remain within the narrow frame of free trade versus protectionism, but rather a more nuanced set of policy analysis tools should be brought to bear on the problem, and

2) An outcome of these policy analyses should be the identification not just of total effects on the economy, or security posture, or what have you, but on the particular effects on different sections of the economy and population.

References

Corden, W. Max. “Trade policy and economic welfare.” OUP Catalogue (1997).

Meade, James Edward. Trade and welfare. Vol. 2. Oxford University Press, 1955.