Free Trade: You're Doing It Wrong

Want to make progress on trade? Pay off the losers.

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.


Daniel Altman

Why Can't Europe Save Itself?

The eurozone will be forever crippled unless it becomes a real currency union -- like the United States.

Pity Mario Draghi, the president of the European Central Bank. Even without having to endure constant sniping from finance ministers in the eurozone, maintaining a currency union among such diverse countries would be no easy task. Happily, several factors could help the eurozone to smooth out its differences in business cycles and economic prospects over the long term. Frustratingly, it refuses to use any of them.

In general, currency unions are three-legged stools, supported by fiscal policy, migration, and trade. From the beginning, in a feat of late 20th-century European design aesthetics, the eurozone was intended to have only the last two legs. Neither of them was particularly strong, however, and their weakness has made an initially challenging situation even more precarious.

To understand why, consider the basic setup. The members of a currency union don't just use the same money; they also cede all the power to make monetary policy to a single authority, in this case the European Central Bank. The ECB has a tough job, since it has to decide on one level of short-term interest rates for the 17 members of the eurozone. That can be practically impossible in times like these, when some countries are booming while others are in recession.

With the passage of years, the euro itself was supposed to make this job easier. In theory, trade between the members would help to synchronize their economies. The idea was that their companies and consumers would be so intertwined that they would all rise and fall on the same economic wave, with similar trends in employment and inflation.

This may seem paradoxical, since trade works best as an economic stabilizer when exchange rates can move freely. A country in a downturn typically sees the value of its currency fall as investors demand fewer of its securities, and so its exports become more attractive abroad. In the eurozone, this isn't possible. 

But trade still has a role to play. When some euro members are struggling -- and especially when their governments are having a hard time making ends meet -- the others can try to export some growth by stimulating their own economies. In other words, Germany -- Europe's economic engine -- could funnel extra money to its consumers through tax cuts or spending increases in hopes that they would buy more goods and services from Greece, Portugal, and Spain. This isn't the most direct way to support the laggards, but it could be more politically attractive than just giving them money. After all, domestic consumers get to choose how they'll spend the extra cash.

Yet Germany, supposedly the strongest advocate of the eurozone's integrity, has explicitly refused to do it. Angela Merkel, the German chancellor, has rejected a public plea by Spain's prime minister, Mariano Rajoy, to juice the German economy with new spending. By doing so, she has put her country's fiscal health above the health of the eurozone -- an understandable decision, but one that keeps the currency union in peril.

The situation wouldn't be so dire if the eurozone were taking full advantage of its other channel for smoothing out the differences between its economies: people. Free internal migration, a founding tenet of the European Union, can have a similar effect to trade. If one country is in the dumps, its people can move to another country where prospects for work are better. All other things being equal, the unemployment rate would drop in the first country and rise in the second, bringing their economic cycles closer together.

Alas, internal migration in the eurozone is not exactly free. Not every country recognizes the others' professional qualifications, and the requirements for starting a business can be completely different from member to member. Moreover, each country can have different administrative formalities for migration, and immigrants who lose their jobs can be forced to return to their countries of origin. Aside from these administrative issues, there are social and political barriers; in the midst of economic hardship, anti-immigrant sentiment is rising across the continent.

Of course, most successful currency unions don't just rely on trade and migration to synchronize their members' economies. Alongside a shared monetary policy, they also have a shared fiscal policy. That's right: Canada, India, the United States, and other big countries with regionally diverse economies are among the world's thriving currency unions. When one region is suffering, the central government can send cash to prop it up. It's no secret, for example, that federal tax revenues are redistributed from Washington toward some of the poorer states. 

There's also a degree of redistribution in the eurozone (and the EU as a whole) thanks to the recent bailouts, farm subsidies, and other programs. But the amounts of money pale in comparison to the entirety of the eurozone governments' budgets, which totaled about 4.7 trillion euros in 2012. In addition, there is no central authority for taxation in the eurozone or the EU, so half of fiscal policy is completely off limits.

Teetering on two unsteady legs -- the third is barely a stub -- the eurozone will continue to be a weak currency union at best. I say "at best" because its members' economies are heading in very different directions in the long term, with distinct risks and opportunities in each region. Indeed, as I wrote in a recent book, the EU could conceivably split into several contiguous economic blocs, each of which would have a much easier time maintaining its own currency union. For now, though, the eurozone seems feebler than ever, and no one is doing much to strengthen it for the future.

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