In their work, economists are typically are not nationalistic. National boundaries mean little to them, other than that much data happen to be collected on a national basis. Whether a fellow American gains from a trade or someone in Shanghai does not make any difference to most economists, nor does it matter to them where the losers from global competition live, in America or elsewhere.

I say most economists, because here and there one can find some who do seem to worry about how fellow Americans fare in the matter of free trade.

In a widely noted column in The Washington Post, "Free Trade's Great, but Offshoring Rattles Me," for example, my Princeton colleague Alan Blinder wrote:

I'm a free trader down to my toes. Always have been. Yet lately, I'm being treated as a heretic by many of my fellow economists. Why? Because I have stuck my neck out and predicted that the offshoring of service jobs from rich countries such as the United States to poor countries such as India may pose major problems for tens of millions of American workers over the coming decades. In fact, I think offshoring may be the biggest political issue in economics for a generation. When I say this, many of my fellow free traders react with a mixture of disbelief, pity and hostility. Blinder, have you lost your mind?

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. He says he is rattled by the question of how our country will cope with this phenomenon, especially in view of our tattered social safety net.

"That is why I am going public with my concerns now," he concludes. "If we economists stubbornly insist on chanting 'free trade is good for you' to people who know that it is not, we will quickly become irrelevant to the public debate. Compared with that, a little apostasy should be welcome."

What do you think?

This led Mark Thoma to wisely say:

Saying that everyone could be made better off with increased international trade is not the same as people actually being made better off. There are winners and losers from increased international trade, and while I agree that the gains exceed the losses in almost all cases, the gains haven't been distributed in a way that leaves everyone, or even most everyone, better off (see, e.g., widening inequality and where the costs of these kinds of adjustments fall). When some people are made better off and others made worse off at the same time, economists cannot say it is unambiguously better or worse. If we are going to make the argument that trade is good because everyone could potentially be made better off, we should do much more than we have to ensure that this potential is realized, i.e. that the gains from trade are distributed widely across the population rather than concentrated among a smaller set of winners.

Which in turn led Tim Worstall to reply:

But this argument then generally morphs into an insistence that we should not have free trade until that compensatory mechanism is put in place, so that, say, I, who will be gaining from that free trade will be compensating those who will lose from that free trade.

Hmm. But do you see what is implicit in that argument?

That there are gains that I am not getting, gains that are going to some other, as a result of our not currently having free trade.

This is obvious: if free trade benefits me and disbenefits you, then not free trade must disbenefit me and benefit you.

Which leads to the question: are you compensating me for those benefits you are getting and the disbenefits I am getting from the absence of free trade?

Where, in short, is my check from those benefitting from protectionism?

I'd like to see Worstall defend that one in front of a class of principles of econ students who have seen jobs in their towns go overseas or south of the border.

Seeing as how for the last 16 years I've been defending free trade to classes of principles students who have seen jobs in their hometowns disappear because of free trade, I feel like I can take a crack at this.

Blinder gets it absolutely spot-on.  Print this one and post it on your wall.

If we economists stubbornly insist on chanting 'free trade is good for you' to people who know that it is not, we will quickly become irrelevant to the public debate.

That is exactly what 16 years of defending free trade to Midwestern college students has taught me.  And since I have no desire to become irrelevant to my students, I have found it useful to focus their attention on what I was taught about free trade.

You see, it is the potential for a Pareto improvement that makes free trade desirable. There are winners and losers.  But the winners gain more than the losers lose.  So effect a transfer from the winners to the losers that still allows the winners to gain but compensates the losers for what they lost.  Only then can you really say that free trade (with the compensating side payment) benefits everyone.  If the compensation is not there, then I cannot unconditionally advocate free trade.  I must call attention to the fact that some will lose.  Call it professional ethics.

I have shared this approach to teaching trade with liberal and conservative economists alike.  Economists, even many liberal ones, like Pareto improvements a lot better than redistribution--if a Pareto improvement is possible.  I've never really thought of this as controversial.  The devil is in the details, of course, since the transfer payment can be very hard to estimate and implement.  Economists are usually content to point out to their students that in the abstract it seems reasonable to try to compensate those who lose from free trade because the losers are usually few in number and identifiable (e.g. workers whose factory moves to Mexico) while the winners are numerous so a small tax on the many can compensate the few who lose their jobs.  We then leave it to the wonks to write legislation like the Trade Adjustment Assistance Act.

Worstall's logic seems appealing though.  If I gain and you lose from free trade, then the status quo harms me to enrich you.  That hardly seems fair.  So if you're not compensating me now, why should I compensate you under free trade?

There's a hint of utilitarianism in Worstall's logic as well.  If there is some inherent unfairness in either state of nature, then which one is preferred?  It must be the one that has the highest total utility.  If you're going to punt on the issue of distributional equity, then overall efficiency must be the primary, indeed maybe the only, criterion.

That's fine in a representative agent model, of course, because in such a model distributional equity means nothing.  The representative agent contains in his person both the winner and the loser, so there's no need to worry about compensation.  The representative agent model does allow us to gloss over some of the distributional questions to highlight the aggregate gains, but no responsible economist would stop there.

But ultimately what is wrong with Worstall's logic?  For me, it boils down to the notion of a social contract.  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.

This is a big reason for the political process moving as slowly as it does sometimes.  There is rightly a reluctance to change if a change will harm people who made good faith decisions based on what they expected to prevail.

Take the mortgage interest deduction, for example.  Everyone who has a mortgage enjoys higher property values because the mortgage interest deduction is built into the capital value of the house.  I paid extra for my house to get it.  When I sell, I'll get it back.  If the present discounted value of the benefit equals the additional amount I paid for the house, then I'm not getting a free lunch.  I weigh the costs and benefits and made my decision--so did those who chose not to buy a house.  We all knew the rules.  The mortgage interest deduction is a thumb on the scale, but we all know that the thumb is there--and we all expect it to stay there and set our prices accordingly.

Take the thumb off the scale and it's no longer in balance.  Take away the mortgage interest deduction and my property value goes down in a way that I probably could not insure against, and certainly wasn't expecting.  I would feel wronged.  Since taking away the mortgage interest deduction would harm so many people, politicians will think twice about doing it.  People make decisions in good faith based on existing law.  We tend not to change the law arbitrarily and capriciously on them.

And that's why Worstall's logic fails the test of reality.  People make life decisions based on protectionism.  No, not directly just like that.  But trade protection has kept the factory in their hometown going.  They graduate from high school and apply for a job.  Maybe it was the only job in their hometown.  Sure, they could have gone to the big city to wait on tables or drive a cab but that would take them away from home and family.  The made the decision that was best for them based on what they knew and could in good faith expect.

And some people would say to heck with them.  What are we coming to?

When you break a contract in law, you must compensate the other party.  Sometimes it is in the best interest of both parties to allow that.  The social contract is no different.  We can, and indeed we should, at times rewrite the social contract, but when we do, the winners must compensate those who made good faith decisions based on the old contract.  If we do not, then the law is worth no more than the paper it is printed on, and that will lead to less economic activity for fear that it can always be taken away with the stroke of a pen.

Kansas City Fed President Thomas Hoenig continues to believe rates need to rise, which leaves him in opposition to the decision made just over a week ago to maintain the size of the Fed's balance sheet. St. Louis Fed President James Bullard, meanwhile, has talked of going even further than what's been done thus far, suggesting the Fed could again expand its balance sheet if the recovery falters further. Minneapolis Fed leader Narayana Kocherlakota thinks it's all a tempest in a tea cup, describing the Fed actions as technical and misunderstood by markets as a sign of growing worry over the outlook.

Bullard, however, framed the issue in a way that lined up neatly with the prevailing market view. He told The Wall Street Journal in an interview "I thought we should be in a position to return to a quantitative easing program if we got further disinflation."

Kocherlakota muddied the waters Tuesday, saying the market got the issue wrong. Low rates are driving more mortgage prepayments than the Fed anticipated, so purely for technical reasons, the Fed needs to act to keep its portfolio size up. "I would say that there is no new information about the current state of the economy to be learned from the FOMC's actions or its statement," the policymaker said.

Kocherlakota is refreshingly direct about it.  To say that there is "no new information" certainly puts the markets in their place.  That sort of candor, along with a plausible technical reason, is helpful to outside observers, even if it seems to "muddy the waters."  Kocherlakota's view is consistent with the notion that the Fed needs to make sure that they don't accidentally contract.  Certainly, that is a sensible position.  The question is whether it goes far enough.

Bullard wants to make sure the Fed can go further if they need to.  Will they?  That remains to be seen.  And in the remainder of 2010, that will be the big question.

It remains somewhat unclear to me what the Fed can do to improve the labor market, which is the primary concern now.  Fiscal policy, in a perfect world, would be better suited for that although fiscal policy is being held hostage to politics, and probably will be for a while.  So everyone will be looking to the Fed to do something.  Aside from making sure they don't passively and unintentionally contract the credit supply, it's not clear how they can achieve the effects that people want.

Ultimately, you can't quite square the two positions. The best I can do is to say that I agree with Kocherlakota today, but Bullard might be right tomorrow.  Pulling the trigger too early could be destabilizing and may not necessarily have the positive effects you want.  Policy lags notwithstanding, I wouldn't be ready to take the risk yet.

Finally, the idea that the world's rich countries need to cut spending and raise taxes has a lot of truth to it. The United States, Europe and Japan have all made promises they cannot afford. Eventually, something needs to change.

In an ideal world, countries would pair more short-term spending and tax cuts with long-term spending cuts and tax increases. But not a single big country has figured out, politically, how to do that.

So true.  I, too, would be cautious about allowing the economy to slip.  But is it that we need more stimulus, or is it that the original stimulus wasn't done right?  If the latter, that's a problem if we really do need something more, as there's little hope that they'd get it right the next time.

Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.

Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee's flexibility to begin raising rates modestly.

Mark Thoma thinks that fiscal and monetary policy should be used more aggressively, citing this David Leonhardt column in the NY Times.  Leonhardt's column is worth quoting at length as it pretty succinctly describes the feeling that has been building in my mind and I'm sure in others over the first half of this year.

Ben Bernanke believes that he and his Federal Reserve colleagues have the ability to lift economic growth at their meeting this week. The Fed, he has said, "retains considerable power to expand aggregate demand and economic activity, even when its accustomed policy rate is at zero," as it is today.

Mr. Bernanke also believes that the economy is growing "not fast enough," as he recently put it. He has predicted that unemployment will remain high for years and that "a lot of people are going to be under financial stress."

Yet he has been unwilling to use his power to lift growth and reduce joblessness from near a 27-year high. Instead, Fed officials are expected to announce on Wednesday that they have left their policy unchanged, even if they acknowledge that the economy has recently weakened.

How can this be? How can Mr. Bernanke simultaneously think that growth is too slow and that it shouldn't be sped up? There is an answer -- whether or not you find it persuasive.

Above all, top Fed officials are worried that financial markets are fragile. They are not so much worried about inflation, the traditional source of Fed angst, as they are about upsetting the markets' confidence in Washington. Yes, investors remain happy to lend the United States money at rock-bottom interest rates, despite our budget deficit and all of the emergency Fed programs that will eventually need to be unwound. But no one knows how long that confidence will last.

In effect, Mr. Bernanke and his colleagues have decided to accept an all-but-certain downside -- high unemployment, for years to come -- rather than risk an even worse situation -- a market panic, a spike in long-term interest rates and yet higher unemployment. As the last few years have shown, market sentiment can change unexpectedly and sharply.

If you fear that the recovery is about to stall, today's news on new home sales probably increased your worries.  And in the midst this, an FOMC member, Hoenig (Kansas City), dissented from the consensus opinion, believing "that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee's flexibility to begin raising rates modestly."

Hoenig and Bernanke have similar concerns about stability.  Hoenig is of the opinion that keeping rates low will lead to risks to that stability.  Bernanke seems to be hoping that they can maintain the low rates, but seems to be drawing the line at providing any further support like, say, buying long-term bonds and pushing those rates down as well.

But what if GDP stalls in the 2nd half of 2010?  Do you pull the trigger and use unconventional monetary policy?  What is worse, another year of 10% unemployment or instability in the financial markets?  If you wait too long to decide, will you get both?

The person in the big chair has to make that decision, and for now he's content to sit on low short-term rates, even if that makes it hard to reverse course later.  And he's keeping his powder (what little remains of it, at least) dry.

As it seems to me that price pressures seem to be even more muted right now than 6 months ago, I would want to be ready to do something unconventional in case Congress has a fit of anti-deficit hysteria at the same time GDP stalls and unemployment edges back up.  We do not have to repeat past mistakes.

The 2nd half could go either way, but I'm a little more pessimistic today than a month ago.

On a related note, Bill Conerly thinks that the Fed has actually been doing a little quantitative tightening, but thinks they should continue easing.  Connerly sees tightening in the slight reductions lately in bank credit, slower growth of M2, and decline of MZM.  Maybe these are just short-term aberrations, but they are worth noting.  Eventually these quantities should return to a more normal trend reflecting a neutral stance, but now is not the time for that yet.  If we see this continue for a couple more months, I would be concerned about this apparent stealth tightening.  Stay tuned.

You would think that there were few barriers to switching cellphones. But the carriers try to make it harder to switch by locking customers into two-year contracts with high early-termination fees. And each handset maker also inspires loyalty by continually making improvements in its phones, as Apple announced last week for its iPhone. Some people may complain incessantly about their iPhone and AT&T's service for it, but not that many are switching. And that's just the way the companies have intended it.

...

In a classic bit of economic sleuthing, Minjung Park, an assistant professor of economics at the University of Minnesota, looked at the impact of the Federal Communications Commission's mandate that customers could keep their phone numbers when they switched carriers, starting in late 2003 in large markets and mid-2004 in smaller ones. (The phone companies had fought the decision because nonportability had been a very effective way to hold onto customers.)

She examined more than 100,000 calling plans and found that the prices of wireless plans dropped by as much as 6.8 percent in the seven months after the rule change. After adjusting for the overall trend in wireless prices, she calculated that the savings totaled $845 million during that period.

The article goes on to point out that economic theory would also predict that once they have you locked-in to the a particular phone technology (e.g. iPhone) they will raise the price on you.

Yep.

The bottom line? The Fed wants to get the junk off its balance sheet and return to a situation in which it has about $1 trillion in assets, the lion's share of them in the form of government bonds. To do so, it will need to rid itself of about $1.3 trillion in assets. That's a lot. But when you add up the components of the balance sheet that are shrinking, the task doesn't seem quite as daunting. By the end of 2011, by my rough calculations, at least $300 billion of the Fed's current assets will be gone with a substantial additional amount on the way out--and all without the Fed having to stage a huge sale of assets.