Should losers from free trade be compensated?

Fair enough: now let's extend it a little, as I do in response to a similar comment to that blog post.

A few years back the EU imposed import duties on Chinese shoes. This of course raised the price of all shoes inside the EU, as it was designed to do. It also saved the jobs of a certain number of shoe makers, as it was intended to do, at a (very small to be sure) loss to me as a regular consumer of Chinese shoes.

We now have that contract point, the status quo point, reversed. They have benefitted from a change in the law at my expense (and, of course, the expense of every other consumer of shoes in the EU: ie, everyone with the usual number of legs).

I was not compensated for this.

Your argument is that I should have been.

I was not: so I am unable to see in logic why such a change which benefits me but harms another should generate compensation from me to them.

I agree that if I had been the logic would work, but I wasn't and so.....

Tim but you were compensated for the import duties. They raise revenue that otherwise must have been raised in other ways. And ceterus parabus they push up the exchange rate making other imports that little bit cheaper. Unless you specialise in buying chinese shoes the argument is very complicated.

Good question. How to compensate the losers, most often the ordinary factory worker whose job was offshored? Despite the difficulty in making Chinese workers (who benefit) to pay compensation to US workers (who lost) in the short term (since in the long term a wealthier Chinese will demand goods & services from the US worker that s/he dont need at the moment - whether that is entertainment (films), financial investment, etc.)

A simple look would suggest that it were the capital owners that benefitted most, not really the workers. So, it should still be possible within nationalistic boundaries for winners to compensate losers, i.e. owners of capital to compensate previous workers that lost that job with the breakdown of the social contract. How exactly that will work is another matter.

A simple example: Using a market based approach, ordinary workers should also get shares in the company every year (on a relative scale the same as top management), and particularly when they are laid off when the factory relocates to another part of the world. Thus, ordinary workers will benefit through sharing the higher profits resulting from the offshoring long after they have been laid off. At least this way some of the super profits that US companies have been making over the past 10-20 years would have gone to the middle class / ordinary worker, not just to the top 1% (or even 0.1%) super rich capital owners. Using a Keyensian/govt approach would be to increase the taxes on capital gains and reduce taxes on the ordinary worker (but this is highly unlikely given the institutional capture of US administrations by companies & the super rich).

Perhaps someone can help me here.

Why, in the world as it is today, are we assuming that there are ANY gains from trade to be kept or shared out in the first place? Sure, theory says that comparative advantage etc. means that there should be. But, all of that theory is based on certain assumptions, such as a price mechanism. Pegged, or manipulated, currencies invalidate that assumption. Full employment is another assumption. How's that one working out?

Have we forgotten to check if the assumptions to our theories still apply? Or is there another theory that says we have gains from trade anyway, even though theories of comparative advantage etc. are inapplicable in the world of today? If so, what's that theory called?

Any words of wisdom will be gratefully received.

Thanks for the comments folks. Unfortunately, the same pressures that have kept me from blogging at all the last few months will prevent me from responding until this afternoon. I shall try to respond then.

"Tim but you were compensated for the import duties. They raise revenue that otherwise must have been raised in other ways."

Here in the EU import duties go to the EU. And while I realise that this is not quite responding to your point, I do not regard more money going to those thieves of liberty as compensation for anything. Hanging them all would compensate me quite nicely though...

"Professor Blinder has estimated that 30 million to 40 million jobs in the United States are potentially offshorable -- including those of scientists, mathematicians, radiologists and editors on the high end of the market, and those of telephone operators, clerks and typists on the low end."

First, who do the corporate executives think will be buying their goods and services if large portions of the US population are unemployed? A consumer-based economy needs consumers, who require paychecks in order to have the money needed to consume goods and services. We've seen in the last two years what happens when consumers stop spending - it's an economic disaster.

Do economists think that what's going on in Wisconsin is an isolated example of labor gone crazy? Certainly, state budgets need to be be controlled. However, if union members are willing to make concessions today, in the interests of controlling costs, why does collective bargaining have to be curtailed immediately? Do we really believe that teachers, who average 50K a year, should make sacrifices while corporate leaders whine and threaten to quit (like the bankers after the crash) when their bonuses are limited?

Let grotesque income disparities continue between executives and the employees, let unemployment mushroom, thanks to off-shoring in the interest of maximizing short term profits, and we'll be seeing much more of those explosive protests in the future.

Second, as prosperity comes to emerging economies, do we think the workers will be content with pennies a day for their work? How long before employees in India, China and other emerging markets will begin to want higher wages? Not an easy concept to force into an economic model, but something to consider, non-the-less.

Compensation of the victim is going to be complex.
1. Who is going to be the authorized agent to negotiate on behalf of the victim?
2. Who is going to determine the value of a lifetime career versus a quick "market value" determination of an "at will" wage slave job?
3. With whom is the negotiation to be with?

William seems to take a conservative approach here, privileging status quo over change.

Perhaps a more progressive take on this would be to acknowledge that much of a country's production is a joint output, not attributable (marginally) to any particular individual. So the question of "compensation" seems misplaced. In an ideal world, a country's total output in excess of each individual's marginal output would be distributed in a manner that all individuals agree is fair. In reality, it is difficult to reach complete agreement on a fair distribution.

Also in reality, not all distributional outcomes can be achieved in practice. Nor is it straight forward to distinguish between marginal output and joint output. Further, practical constraints often only permit us to achieve a limited number of alternative distributions. Given these limitations, I take it that the task at hand is to compare the alternative distributional outcomes that are practically achievable and ask which of those is the least unjust.

It seems to me that a redistribution that reduces disparity is less unjust than a redistribution that increases disparity. Thus if free trade leads to the less well off benefiting "at the expense" of the more well off, it seems to me most people would agree free trade is the way to go. On the other hand, if free trade leads the more well off to gain "at the expense" of the less well off, fewer people would agree that free trade is the way to go.

That said, the analysis should not stop at questions of intra-generational equality. We also need to consider the implications for future generations and ask whether greater inequality today is necessary to achieve better outcomes in the future.

We may need to broaden the inquiry even further and consider the impact of our decision (e.g., on whether to engage in free trade) on other countries.

I don't think there is a simple "one step" rule that we can follow. Rather, these decisions must be resolved through a process of public reasoning about what the requirements of justice are, taking into consideration uncertainty and ambiguity. It is unavoidably a moral judgement, not a technical decision. The moral judgement ought (in my view) to be based on very broad notions of "comprehensive wellbeing" taking into account culmination outcomes such as health, education, social inclusion and happiness, as well as the relationships and institutions (including procedural fairness) that lead to those outcomes. I don't think the moral judgement should be based narrowly on deontological rules only.

My reference for these comments is Amartya Sen's latest book on The Idea of Justice.

"Tim but you were compensated for the import duties. They raise revenue that otherwise must have been raised in other ways."

Taking that a little more seriously, you seem to be proposing something most odd.

I am the person paying these higher taxes because I am the consumer of the Chinese shoes. So, you are saying that I am compensated for having to pay these higher taxes because I have actually paid these higher taxes?

Good luck getting that one past the logic police.

"People make decisions, many of which are irrevocable or nearly so, on the basis of the best information and their expectations of the future. Sometimes the biggest influences on our expectations are the existing law and the political environment. If I then make a decision in good faith based on existing law, only to have the law change to my disadvantage, I will feel wronged. That I benefited from the way the law was should not be held against me when arguing to change the law."

Let us extend William's argument a little here. Or apply it to other examples perhaps.

Think, for example, of those benighted Goldman Sachs partners. Brought up in the one industry towns of Long Island or Connecticut, in a social milieu where not to join Wall Street, where not to wax fat off the blood sucked by the Vampire Squid, was unthinkable.

They have made their decisions upon this basis, gone to the right schools, made the chess team rather than partying with the cheerleaders, given up their gilded youth in order to make it into the right college. There they have again stuck to their books, worked hard and turned their backs on the sexn'drugs scene which is such a part of growing up. For they need the grades to make it into the Squid. Two decades of 70 hour weeks now face them until they reach partnership: and we are going to take away the rewards they have planned for just as the shiny ring is within reach.

For we are going to change the regulation of the financial markets: reduce the rewards available.

Do not forget, as William says, they are right to feel wronged, for while they did inderd benefit from the law as it was, they made their decisions in good faith based upon what the law was. And now we are to steal those prizes from them, the tens of millions in bonuses, the wealth necessary to get that second or third younger, hotter, wife, that fourth car and first proper yacht.

They've played by the rules as they were and as William says, we must therefore compensate them for the losses which our changing the rules will cause them.

This is, of course, a rhetorical device known as "reductio ad absurdam". But if your argument can, with such ease, be reduced to an absurdity, then that absurdity was inherent in the argument itself, is not due solely to the reduction.

Compensating Wall Street bankers for changing the rules on Wall Street (in however a Pareto maximising manner)would indeed be absurd.

BTW, please note that I am not against compensation in general for the vicissitudes of life. It is just and righteous that the poor are housed and fed, that the incapable and incompetent have societal provision made for them, that the unemployed get a check while they are so.

But no consideration need to be given to how they got that way: whether it's because we've changed the laws on Wall Street, reduced tariffs or allowed technological change.

@Tim,

First of all, thanks for stopping by my humble blog. I enjoy your blog and often agree with you, but not this time.

Your (first) comment though does help me see where you're coming from, and if that had been part of your original post I would not have objected so strenuously, or at least I would have objected differently. (I'll deal with your other comment later.)

Should you have been compensated for a tariff that was imposed on you? By my argument, yes you should have been. I'm with you there. But I would go further. Suppose we did require the people who benefited from the tariff to share their economic rent with those the tariff harms. There's a problem. Because the tariff causes deadweight loss, their economic rent is insufficient to compensate those who would be harmed.

If you require the winners to compensate the losers, you will tend not to get policies that return aggregate losses. A nice state of affairs, no?

@denim and @Kien,

Don't let the perfect be the enemy of the good. It's not an easy problem. We can all recognize that. But to me there is a wide gulf between the extremes of taking no account for people's sunk costs and insisting that the calculus of transfer payments be worked out to the penny. We will not get it 100% right... this we can say with confidence up front. But we must do our best to try.

Practical ways to do this are to phase in changes that affect people's long run decisions so as to reduce the negative impacts. Honor pension obligations, but work to reduce reliance on defined benefit plans among workers just staring out. Resist the temptation to tinker with the tax code for short term political gain. And so on.

"They have made their decisions upon this basis, gone to the right schools, made the chess team rather than partying with the cheerleaders, given up their gilded youth in order to make it into the right college. There they have again stuck to their books, worked hard and turned their backs on the sexn'drugs scene which is such a part of growing up. For they need the grades to make it into the Squid. Two decades of 70 hour weeks now face them until they reach partnership: and we are going to take away the rewards they have planned for just as the shiny ring is within reach."

Wow! You must not know many of these people. Some followed your path. Lots of them partied in college and were making those big bonuses in their 30s. The wait was not that long. I also think that making big bucks off of a very large Ponzi scheme is not quite the same thing as described in the post.

Steve

One issue that's rarely canvassed in this kind of discussion is that "compensation" has its own problems. If I have a skilled job, I have a network, duties, rights, a kind of property in my work, and with it some latitude in dealing with employers or officials. Monetary compensation for lost income does not bring me any of these - in fact it puts me in a situation of dependency. Whoever is handing out the cash can start putting on conditions and, even if they do not, I am conscious of my position as a recipient of a favour. This is why Jefferson, for instance, advocated a nation of small farmers. The opposite end of the spectrum is a nation of hacienderos and peons. Welfare recipients jump through official (and employer) hoops every day - hard to confront injustice if the kids meal is on the line. And even if it leads to an overall loss, some people will favour greater inequality for the psychic and other rewards it brings them.

If you want a society where gains in efficiency can be actually realised, you don't talk compensation, you talk structures. A tariff that keeps a town alive or limits class warfare may be well worth it.

This analysis totally fails to recognize the 3rd party in the equation, the consumer. There are two winners, the capitalist and the consumer and one potential loser the worker. And of course what happens in reality with any of the proposed transfer scheme is that the consumer becomes the loser too.

And, of course, there's a 4th party here that wins when transfer schemes are proposed and that's the regulator who now has increased his power if not his direct financial interest.

With regards to breaking social contracts, I feel sorry for the people that choose incorrectly but not sorry enough to keep supporting them as the create buggy whips on my dime. Change is a given, we work against at our own peril and our good intentions don't change that.

Finally, I reject the notion that people forced to re-evaluate and change jobs is always negative as is implied in the narrative. It's most likely a bell curve with some people benefiting and most ending up neutral, at least after a few years. For the majority it might be better than continuing efforts in dieing industry for diminishing returns.

"Because the tariff causes deadweight loss, their economic rent is insufficient to compensate those who would be harmed.

If you require the winners to compensate the losers, you will tend not to get policies that return aggregate losses. A nice state of affairs, no?"

Absolutely, an excellent state of affairs. By insisting on the reciprocity of the compensation we manage to insist that only positive sum policies get followed. Which is just marvellous.

I should note that part of my ire on this subject is less to do with the morals or even theory, but to do with the practice in reality. For within the EU we already have such a calculation built into the system.

Supposedly.

If a new tariff or trade restriction is to be introduced (usually for reasons of "dumping", as the EU does like to pretend that it is a free trade sorta place, both intra and inter) then as part of the process of evaluating it it has to be shown that it is positive sum.

That the gains to those protected are greater than the costs to others. You might be able to imagine how those calculations are corrupted by political finagling.

So, even when we do supposedly have the safeguards in place which should mean that we only have positive sum policies, politics over rides these.

Thus my extremely blunt conclusion to my original post.

In the end, my final moral or theoretic conclusion is that even if trade barriers were, possibly, at times, generally beneficial, they will always, but always, be imposed because of concentrated political power on the part of those benefitting and widely dispersed costs (and political power) upon those who suffer.

Which means that we will never, under any close to democratic political system, have an economically valid tariff system, thus we should simply go for the default option of unilateral free trade.

I'm rather appealing to Buchanan here, rather than to Smith, Ricardo, Friedman, Krugman even, etc. It's the politics which screws it all up, not the economics.

@Tim,

Your last comment is quite reasonable, and may be food for another post.

Your next-to-last comment is cute and clever, but fails to convince. First of all, to the extent that any of the gains were ill-gotten, I would find your argument invalid. But to be fair, yes, many people did make decisions to go to B-school and work on Wall St. based on the expectations of big money made possible by the laws passed as a result of lobbying by the rent seeking barons that hired them--all nice and legal.

Now the laws will change (a good thing) and they feel aggrieved. Do they deserve compensation? You seem to think that to be consistent I should say "yes," which would be seen as an absurdity to anyone with a conscience, and therefore my whole premise is absurd.

I don't think so.

The other alternatives for the B-school grads who were temporarily displaced by the Wall St. shakeout are a lot better than the alternatives for the high school grad working on an assembly line. Truth be told, in practice it may be impossible to fully compensate either one for their losses, but a pragmatic approach would be to try to help a person make the adjustment that brings them closer to their former lifestyle. I don't think I'm stretching credulity to suggest that the assembly line worker needs a little more help in making the adjustment than a B-school grad. The gap between their former earnings and their next best alternative is larger, certainly in relative terms if not in absolute terms.

The fact of the matter is that many of the less skilled workers who are displaced by free trade do, in fact, have other opportunities. They may just need help finding them, retraining for them, and getting some help in making the transition. That's what I would like politicians and economists (as some economists already do) to recognize. That's the sort of thing that gets you closer to the Pareto frontier. Your suggestion that by advocating this that I would also advocate giving aid to those who already have similar alternatives is off base. I never said to put these people on the dole forever. I specifically mentioned Trade Adjustment Assistance. Some will be better off as a result of retraining. Some will not achieve their former status. In practice, it may not be a Pareto improvement, but it will be better than nothing. We cannot control for all other variables and the inherent randomness.

If the B-school grad has other alternatives that are reasonably close, then I'm less sympathetic. B-school grads hopefully have the skills and information networks to allow them to make the transition without that help. And likewise, some of them will be better off in their new careers. Some not. Not a Pareto improvement perhaps, but they can probably get closer to the Pareto frontier without help than many unskilled workers can even with help.

There are other ways in which I think the situations differ, but this comment is long enough.

I don't think your comment is quite the reductio you think it is.

But like I said, your last comment was a much better effort, and I'll try to take that up another day.

We discussed this issue in class. My econ prof. asked us: When you move to a new apartment because it's cheaper and/or better, did you compensate your old landlord? When you switched from Blockbuster to Netflix, did you compensate Blockbuster? And so on...

The implication was that if we didn't do these things ourselves in our daily lives, then why do we think that, policy-wise, winners should compensate losers?

Maybe what we do (or don't do) doesn't imply anything about what we should do, but he did make me think that I was a bit hypocritical for being sympathetic to the idea that winners of trade should compensate the losers when I don't practice what I preach.

"We discussed this issue in class. My econ prof. asked us: When you move to a new apartment because it's cheaper and/or better, did you compensate your old landlord?"

If you break your lease (contract) you do. But more to the point, there is a huge difference between one person's decision to switch retailers and the government's decision to change a policy.

One person deciding to switch may do so *because they have observed* a change in the relative price.

The government deciding to change a policy will *cause* a change in the relative price.

Changes in relative price that are not caused by government are sometimes anticipated, sometimes insurable, and sometimes not. That's why we have long-term contracts and labor unions, and so forth. People are willing to give up some efficiency for some cushion against the random shocks of life. Why do you think supermarkets have loyalty programs? They want to force you to give up something if you switch. Why do cell phone companies lock you into a contract?

Likewise, why do some retailers not bother trying to lock in customers? Because it's not worth it perhaps. Waste no tears on them.

Cell phone companies have the right by law to hold you to an agreement you made to be their customer. In return, they promise to not raise their rate during that period.

Tax (and tariff, and regulatory, etc) policy, on the other hand, changes at the whim of the people who were elected. Your relationship with your cell phone provider (or landlord, etc.) is potentially more certain than your relationship with the government. One of them you can take to court, the other... well....

Attempts to equate the two are a bit off the mark.

The question is: Should losers from free trade be compensated?

I'll cut to the chase.

No one loses 100% from 100% of the trading activities 100% of the time.

If so, the person / nation is purely "lazy".

Do you want to encourage laziness?

This is an interesting blog post because the issues are laid bare. There are winners and losers due to trade, or even domestic competition. What is "fair" is an ethical issue that is for society to grapple with, not some technocratic economist that demonstrates on the chalk board that comparitive advantage can lead society to a point outside the domestic PPF curve.

This is my take on the free trade issue. It becomes a major issue because countries are usually not operating at full capacity. If we were, then we can consume as much as as we can produce domestically plus whatever foreigners are willing to net send us. Now that there is a large trade deficit income every year leaks out of the hands of domestic households and businesses. Unless compensated by an injection from G, I, or X- GDP falls. This leakage leads to smaller spending multipliers both because NX is negitive and because those who it benefits the most tend to be the wealthiest who are much more likely to save than say a middle class worker. Savings is also a leakage. This brings Y below Y* (full employment GDP) and it destroys the barganing power labor has due to the number of job openings falling far below the number of desperate job seekers. This could be countered by a government job guarentee program or major public works projects, or even lower taxes depending on your politics.

There is one more issue involved with free trade that hasn't been brought up. Some industries are vital to national security such as food and energy. A case can be made that industries that are vital to the functioning of our economy should not be sent offshore even at full employment.

If Americans are to get behind free trade, we need to ensure full employment.

The modern conservative is engaged in one of man's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness.

--John Kenneth Galbraith

Hey what gives? I left my comment weeks ago!