Economics & Public Policy – New Readings

The Week 5 quiz is now on the course website.

Some more trade readings:

  • Paul Krugman’s essay Ricardo’s Difficult Idea is one of the nicest expositions as to why plenty of smart people don’t understand the theory behind free trade. There are plenty of other interesting trade pieces by Krugman here.
  • The World Trade Organisation has some useful material on their website, including a backgrounder, and the case for open trade. Folksy, but accurate.
  • I’ve written a couple of small pieces on trade, including an article on the politics of Australian tariff liberalisation from the 1970s to the 1990s, a review of some recent trade books for the Economic Record, and an obituary of one of Australia’s great free traders, the late Senator Peter Cook.
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31 Responses to Economics & Public Policy – New Readings

  1. Jason Soon says:

    I wish Krugman would write more on trade and microeconomics like he used to in his excellent Slate columns from years back. His Bush columns are really boring.

  2. I think economists do themselves and their profession a great disservice by dismissing arguments against free trade on the grounds of ignorance or insufficient intelligence, or any of the other ad hominem arguments Krugman uses.

    There is a perfectly respectable intellectual argument, not based on ignorance, against Ricardo’s argument. This is that his theory ignores the most important question in the debate, which is: Where does a comparative advantage come from? A national comparative advantage is almost never, despite what many free trade advocates seem to think, an act of God. It is almost always the the result of human actions, witting or unwitting. South Korea has no “natural” reason to be a world-leading steel-producer or large-ship-maker, but successive Korean Governments intended the nation to lead these industries, and they have have succeeded in doing so (through direct government investment, through subsidies to Korean companies, through discriminatary trade practices against foreign companies, and through large-scale, concerted, long-term public and private pressure on private Korean companies to invest in particular ways).

    So, you are a political leader of a country (eg, the UK in 1980) with an existing large-ship-building industry faced with Korean competition. Your economic advisor tells you that free trade is good, and that your market should be open, because the economic benefits outweigh the costs. They may or they may not in any particular case, and they may well fall differentially upon different stakeholders with different political power. Even if the economic benefits outweigh the economic costs, the social cost-benefit analysis may be very different (long-term unemployment, the destruction of local communities, the dispersal of a skills base, etc). Whatever the cost-benefit outcomes, what really sticks in the craw is that the advice from economists is to do nothing to protect local industrial capabilities, so that others who have ignored such advice (eg, the Government of South Korea) should prosper.

    The argument here is not between the ignorant and the wise, as Krugman seems to think, but between people with conflicting sets of values. My values tell me that economic theory should include discussions of political power, social structures, and the reasons for and consequences of differing preferences over outcomes, while most mainstream economists do not. To be called ignorant because I have different values to an economist is not only an insult, and disrespectful of my rights as a stakeholder, but is also revealing of the vapidity of mainstream economics, busy building theories which ignore all the most important questions.

  3. Ben Ticehurst says:

    Here here Peter,

    As a non-economist, the idea that free trade can be proven to be “right” by the performance of simple arithmetic is misguided. A country’s culture is at least partly identified and carried on through the trinkets in our homes, the clothes we wear, the music we listen to and create and so on. To surrender these things to the ravages of unbridled free trade is to cast away our control over who we are. Let us take a broader view of economics as a tool not an end in itself. The statement in Krugman’s essay that the assumption of full employment is a good approximation and that economies tend towards full employment seems odd. Several decades of trade liberalisation have not brought us any closer to this utopia.

  4. Am with you 100%, Ben!

    (And as someone with a University Medal in mathematics, my despair at the mathematicization of economics is not theorem-envy!)

  5. Sacha Blumen says:

    Also as a non-economist, I have to say that Peter raises some interesting points. If the argument is that free trade promotes a better overall economic environment, is introducing free trade saying that having an “overall-ly better” situation in which stakeholders may be differently affected is preferable to not having free trade. More succintly, are we saying that having an “overall-ly better” outcome is better than not letting stakeholders be adversely affected?

    This sounds similar to the challenges of environmental protection, eg with loggers in far north qld in the late 80s and in tasmania nowadays. Here I can accept that the environmental needs are pre-eminent.

  6. Russell says:

    Students should be given the best to read – Krugman is rubbish (and what a nasty personality problem). I see from the WTO link that what I thought was comparative advantage is called by economists absolute advantage – but a much better explanation is at:
    http://www.economist.com/research/Economics/alphabetic.cfm?LETTER=C#COMPARATIVE%20ADVANTAGE
    That said, the WTO link is not a “case for open trade” – comparative advantage is just one tenuous proposition. A case should take into account criticisms and answer them. Are there not serious arguments – environmental, social / cultural, strategic etc against free trade ? I hope your students read Peter McBurney above – much better written than Krugman.

  7. Sacha Blumen says:

    Peter wrote “A national comparative advantage is almost never, despite what many free trade advocates seem to think, an act of God.”

    I was thinking that countries may have comparative advantages from things such as enormous mineral deposits (eg Australia), or cheap electricity from hydro-power from very high rain fall (say).

  8. Thanks, Russell.

    Sacha — Countries and regions do have natural resources or endowments, but I don’t believe these become comparative economic advantages unless and until some humans do something. And often, they don’t become advantages unless some other disadvantage is overcome.

    Australia, as you say, has large mineral deposits. But these are mostly very far from their potential markets (Europe and North America in the 19th centuries, Japan and China now). In order for Australia to exploit its mineral endowments, it has had to invest heavily in exploration, equipment, processing, transport, software, etc. As a consequence of these investments, we now have a comparative advantage in mining and associated industries, as shown by the success of Australian mining companies elsewhere in the world.

    Indeed, I find very interesting the idea (which I think was due originally to Michael Porter at Harvard Business School) that it is comparative disadvantage which is more important for national economic success. One of Australia’s key disadvantages in the 19th and 20th centuries was our distance from our main markets. So, to overcome this, we invented refrigeration, we created one of the first commercial airline companies (Qantas), we developed advanced telecommunications, etc. Indeed, we still punch above our weight in telecommunications.

  9. Matt Cowgill says:

    Peter: You asked “Are there not serious arguments – environmental, social / cultural, strategic etc against free trade?” Most basic economics textbooks do indeed take into account a range of anti-free-trade arguments (such as the ‘infant industry’ argument, etc) and comprehensively dismantle them. The arguments in favour of free trade are some of the most convincing in the entire canon of accepted economic theory, in my opinion. Also you should bear in mind that it is quite possible for social and environmental costs to be factored into otherwise conventional economic models through the recognition of externalities; social costs/benefits that modify the model.

    Ben: Krugman was referring to the notion of a NAIRU when he spoke of full employment, rather than what a layman might construe as full employment. The difference is important.

  10. Matt — On what basis do economics textbooks “dismantle” arguments against free trade? Is it on the basis of a mathematical model, due originally to Ricardo, which ignores the reasons why comparative advantages exist? If so, then the argument in favour of free trade is being made in terms of values I reject (i.e, the use of a model which ignores political and social aspects, and focuses attention on only part of the relevant real-world domain). Thus, for me, such arguments against free trade are not dismantled.

  11. Christine says:

    Russell: Krugman is very very far from rubbish. Sometimes sounds glib and he goes a far afield in his NYT columns, but he’s an absolutely first rate economist, is recognised as such within the profession, and deserves to be so recognised by all out there. Have you read any of his academic work? Let alone the brilliant Foreign Affairs article on East Asian growth – which is brilliant not for the original research (he did close to none himself for that paper) but for the fantastic opening paragraphs. Oh how I wish I could write something like that. [And for best opening sentence from fiction, I nominate Pride and Prejudice, but that’s off topic.]

    But don’t take my word for it. Read Avinash Dixit on the occasion of Krugman winning the John Bates Clark medal for best economist under 40:

    http://web.mit.edu/krugman/www/dixit.html

    Comparative advantage is not one tenuous proposition (and you can say this after you only just realised you didn’t know what it is???). It’s at the heart of trade theory.

    Peter: I think Krugman is saying not that people who are not fully qualified economists are stupid or can’t get it, but that there are some very smart people who do not get it (probably because they haven’t put terribly much time into it because they are focusing on their day jobs as brain surgeons and only have a few minutes to spare for economics at the end of a tough day). And there are even some very well qualified economists who find CA tough. You’re right, there’s more to it than god-given endowments: though honestly, a god-given lack of endowments does explain a fair chunk of South Korea’s trade patterns (they import raw materials and export manufactures, surprise surprise!). But any decent trade economics course goes through those arguments in excruciating detail. Economists categorically do not dismiss the arguments against free trade – they have actively looked for the exceptions. Krugman himself wrote on the case of oligopoly, which is quite relevant to your shipbuilding example. The problem is that most economists are pretty convinced not just by the theory, but by real world empirical evidence that implementing non-free trade policies is as likely to stuff you up as to help you (India in the 70s, anyone?).

    As for Michael Porter – I read his theory of ‘competitive’ advantage book quite seriously. The opening chapters seemed to me to show a complete lack of understanding of comparative advantage, which he then went on to dismiss. The rest was an interesting description of the sort of patterns that economic geographers – hey, like Paul Krugman! – have worked on fairly extensively. I would certainly recommend students read his stuff, but only after they really really understand CA well.

    At base, what Krugman is trying to say is that he finds it a little bit offensive that people think he hasn’t thought through most of the possible reasons why free trade may not be the best policy in the real world, given that it is his JOB to think about things like this, he’s been doing it for a long time, and he’s bloody good at it. I think that’s fair enough.

  12. The theory of comparative advantage is essentially a logical idea. As such it is true. It is not the whole truth about trade in the sense that it (quite obviously) does not wholly determine trade. The critiques of comparative advantage need to show they understand that. If they don’t, in the immortal words of Paul A Samuelson, they’re ‘not even wrong’.

    Oh – and it’s not about maths. If you understand that you might not put your best player at full forward, even though he’s the best full forward in your team (because he’s relatively better at centre half forward) you understand comparative advantage. All this stuff about assumptions about full employment are no more valid than assumptions that Allistair Lynch will play well at full forward while Johnathon Brown is at centre half forward. They’re assumptions, they’re completely extraneous to the basic logic of the discussion.

  13. Russell says:

    Christine, I take it the Jane Austen reference was thrown in to bolster your credentials to claim that Krugman can write ? I’m impressed but unmoved. I read not 1 but 2 of his papers and that is the limit of human endurance. I skimmed through the Dixit you recommended and well, praise is the last thing the egomaniac needs. I read the first part of the Foreign Affairs article you find so memorable – if you thought that was good how did you feel when you read:
    “It was the best of times, it was the worst of times,
    it was the age of wisdom, it was the age of foolishness,
    it was the epoch of belief, it was the epoch of incredulity,
    it was the season of Light, it was the season of Darkness,
    it was the spring of hope, it was the winter of despair” – not bad opening lines either …. (OK, literary writing and academic writing are different, but I still think Krugman is awful)

    About free trade – – we run economies to try to at least satisfy our most important needs, no ? Of course there’ll be trade offs. But say the Japanese feel that basic food self-sufficiency is essential to their sense of security – why shouldn’t they protect those parts of their agriculture that will give them that sense of security?

    And say the French think that the structure of their society, with a large, varied and vibrant rural sector is essential to being French. Why should they put it at risk by letting in cheaper products from everywhere ? Why should they allow American TV and movies unrestricted access, and perhaps alter their culture in a way they wouldn’t like.

    Concerning “The theory of comparative advantage is essentially a logical idea. As such it is true. ” – logic is useful, but not everything. Peter Singer is very logical, doesn’t mean that everyone shares his values.

  14. Russell,

    It’s funny isn’t it that these values you claim people are embracing are values that involve locking out foreigners produce. Why not lock up internal trade? Why not deal with the values that you want to promote directly, rather than by getting in the way of trade? If you want self-sufficiency in food (presumably for wars?) why not come up with a contingency plan for wars in which you have self sufficiency in food? Why keep others food out the rest of the time. If I agreed with you that trade restrictions were really about ‘values’ I’d be more tolerant of them. But in my experience other things are going on. And they’re not pretty. It’s not about values, as Smith argued all those years ago interested parties push for the change, and then defend it using sophistry which appeals to the ‘DIY’ economist in us all.

  15. Sacha Blumen says:

    I do love going to Galleries LaFayette in Paris – they have a fabulous selection of food and wine and a wonderful display of piles of spices, which you can of course choose from. And champagne is eminently affordable! If the French let in cheaper non-French produce, consumers can still buy the (more expensive) French produce. So instead of the government (or whoever it is) deciding that “a large, varied and vibrant rural sector is essential to being French”, French consumers could collectively decide this by their actions.

  16. Russell says:

    “It’s not about values” – clearly it is about values. And judgements where people prioritise things differently.

    I’m not against trade where people want to trade – we sell wheat to the Swiss, they sell watches to us, or whatever. But why do you want to force people to change their preferred way of living ? What’s wrong with promoting your values AND protecting them ?

    I don’t mind the idea of restrictions on internal trade – depends on the situation. I’d be happy to see milk from Victoria kept out of WA. If GM crops were being grown in the eastern states I’d be happy to see them kept out too….

  17. Russell says:

    “French consumers could collectively decide this by their actions.” – they do, by electing a government which has certain policies.

  18. Sacha Blumen says:

    “They do, by electing a government which has certain policies” – I have to protest a little, as people vote for a government for all sorts of reasons – it’s not completely clear that people voting for a government would be voting for a particular policy, although they may, of course.

    For example, no-one could claim that all those who voted for the Howard govt supported its communications policy, or its policy on medically assisted heroin injecting rooms (which is close to where I live).

  19. Matt Cowgill says:

    Russell: You said “‘I’m not against trade where people want to trade”. In a free trade environment, no transaction will take place that is contrary to the wishes of each party. If the French dismantled all protection of their agricultural sector, then Frenchmen wouldn’t be FORCED to purchase the (presumably) cheaper imports; they would only do so if it represented a better option to them. Free trade needn’t pose a threat to any domestic industry UNLESS that industry has something to fear by allowing consumers to freely choose according to their own preferences.

    Free trade does not “force people to change their preferred way of living”. Free trade allows people to choose their preferred way of living.

  20. Russell says:

    Sacha – you’re right, I just want to make that point that consumer choice, electing governments, forming pressure groups, voting in referenda – they’re all ways in which people express their preferences.

    Matt – I don’t agree that individual, particular consumer choices necessarily represent all that people want. When you buy something that’s cheaper or more convenient you’re not always aware of what the total consequences might eventually be. People might choose not to be given the option – a bit like the retail trading hours referendum in WA where people voted not to extend trading hours – we would like the convenience, but when the consequences were laid out most people didn’t like the possible changes to our lifestyle – a values thing.

  21. Sacha Blumen says:

    In 1988, the Qld Govt allowed stores to open 24 hrs and some did. However, this experiment didn’t last very long – from memory only a few months. I recall (hazily!) that the consumer demand just wasn’t there.

  22. Russell, I’m not dismissive of the way you’re arguing. I agree with you that if the community wants to make a collective decision on shopping hours that’s up to it. Ditto gambling for instance. But I’ve been around long enough to know that usually the political support for these decisions is not as it appears. It’s usually an abuse of power supported by hoodwinking voters and consumers.

    Also there’s the death of a thousand cuts. Why on earth shouldn’t Victorian milk producers be able to export to Perth and vice versa? Where’s the lifestyle, the values? It’s just a protection racket. That’s all it is. And do the voters of WA know enough to know what the next best use for the land is other than milk producing? Can they make an informed choice on that? Or are they just hoodwinked by some well funded lobbyists. I was rung today and offered a few thousands of dollars to do a research report justifying the FBT concessions to cars. They’re justified on all sorts of grounds, but they’re basically just dodgy protection.

    When I was a kid it was illegal for margarine producers to dye their margarine yellow – effectively preventing the competition with butter. Various health grounds, economies of scale for butter, land degredation arguments were used, and there was political support. So there you have it – a values driven decision. But it was just a protection racket, finally busted up.

    But I agree, in principle, there’s nothing wrong with people deciding to make some decisions collectively. But like Bismark said. Laws are like sausages – it’s best not to see them being made. Where there are good options to allow people to make individual decisions (like which milk to buy in WA) then I reckon there should be a strong bias to allow them to do so and to keep one’s lawmaking powder dry for where it might be needed.

  23. Russell says:

    “Why on earth shouldn’t Victorian milk producers be able to export to Perth and vice versa? Where’s the lifestyle, the values?”

    Well I’ll tell you. Apparently milk production in Victoria has had a lot more capital investment (they’ve probably got the miserable beasts in sheds) compared to our local cows grazing contentedly in the meadows of the Southwest. So maybe this Victorian milk can be sold cheaper – but apart from the environmental factors (transporting things long distance=bad, concentration of production = bad) I want a local dairy industry.

    We can do without mangoes (from Queensland) or apples (from Tasmania) but we can’t do without milk, and Victoria is a very long way from WA. I want people in this area who know how to dairy farm sustainably with cows suited to these conditions – I don’t want that knowledge to die out. I want the communities sustained by dairy farming to continue to be viable – because I don’t think you can prove that they will just move into some area of comparative advantage.

  24. I’m with you Russell. Don’t want the knowledge about how to bring up cows sustainably on land they’re not well suited to. And, why that idea that farmers will do something else with the land – that’s just theory. When right now we have cows and grass – not theory. If you didn’t have your own milk – that could be serious. For instance you could be in a war. With Victoria for instance. Actually it wouldn’t have to be with Victoria, it could be a war with someone else and they could bomb the railway lines from Victoria (the ones that were your lifeline to milk). Then I guess you’d have to – well drink water I guess or maybe just keep some of those cows (subsidised by the WA defence budget for those who really need cow’s milk – calves for instance. It all makes sense now. Values not profits. Mind you I hope you don’t buy that milk outside of shopping hours though. My goodness me no.

  25. Christine says:

    Russell: I put in the Austen reference mostly for fun, and because I think she doesn’t get enough recognition cf, say, Dickens. He always seems to win these polls on best opening lines, and I just think it’s wrong. So there. Seriously, I have no literary credentials, but I do have to read all sorts of horrible writing by economists and I think more recognition should be given to those among us who can string a sentence or two together.

    On the values front, I’m with Nicholas – the values being protected by trade barriers are generally those of the individuals being protected, not society at large, and they’re probably not the best way to do the protecting (outright govt subsidy would be better/more transparent). And even if you go with the values line, which is potentially reasonable, I also think that it’s really really important to have someone (economists?) telling us exactly how much it is costing us to protect those values. Without knowing that, how can we make good decisions? [And please please please don’t tell us economists that we don’t understand trade properly because we haven’t thought about the values argument. Honestly, we have.]

    Nicholas: sounding scarily like Joh there at the end. I speak only in friendly warning.

  26. Ben Ticehurst says:

    Christine: No problem with economists having a large input into the free trade question – they just shouldn’t own the debate. I believe most Australians would support the notion that cultural industries are of some value and deserve support (aren’t subsidies a form of protection in the eyes of the WTO and free traders?). And what of the recent WTO ruling against the EU blocking GMO food imports. From what authority does the WTO decide that a country or larger grouping cannot decide that it does not care to allow genetically altered organisms into the foodchain and environment. We don’t need an unelected unrepresentative body overruling the sovereign will of people in this way. Is no country to be allowed to set higher environmental, labour, health, culutral and educational standards than others. Its a race to the bottom. Listen to the screams when our universities start going under when the impending reforms allow “Harvard – Glebe campus” to go head to head with our own. Are none of you aware of the importance of the pharmaceutical benfits scheme to Austrlains with chronic illness. A trade distortion if ever there was one – thank God for the PBS.

  27. Sacha Blumen says:

    I’d be happy for really top-notch unis to set up local campuses and be excellent centres of teaching/research. Especially research.

  28. Russell says:

    Nicholas – Scorn is neither becoming nor an argument. We wouldn’t have to be at war with Victoria to suffer milk shortages – some years ago there was a transport strike which stopped those gigantic trucks rolling across the Nullabor. It took just a few days before supermarket shelves here were pretty empty – a big supermarket with lots of empty shelves is an unsettling sight.

    Or, if you have most of your dairy cows in one area, what happens if some disease like BSE breaks out there ?

    I don’t think the evidence supports you in claiming that rural communities can easily transition to other occupations. Besides which can’t you see the difference between working in the tourist industry and in farming, even if the income is the same ?

    Maybe you should be reading The Ecologist – in the April 2006 issue you can read “Research shows that the incidence of poverty increases unambiguously in those economies that adopt the most open trade regimes” (Page 013) Just throwing that in to annoy you.

    It is no surprise that Christine likes Austen, it’s so economical : “It is a truth universally acknowledged, that a single man in possession of a good fortune, must be in want of a wife.” So I quoted Dickens to show that there other ways of relating to the world – with great lavish slabs of emotion, for example. It’s good to be able to experience / appreciate both. But it seems some economists are stuck within a very limited perspective – economics – and think that there aren’t any ways of thinking about things other than by using economic concepts. That’s their loss.

    I agree subsidies might be better – perhaps the government here could build really good and cheap to use transport infrastructure from dairy farms to processors to market. Of course I agree that an economic perspective is good to have when making decisions.

    Christine – I’m encouraged when you say that the ‘values line’ is ‘potentially reasonable’. Could I slightly change your remark “values being protected by trade barriers are generally those of the individuals being protected, not society at large” to “values being furthered by free trade are generally those of the individuals who will be advantaged, not society at large”?

  29. Andrew Leigh says:

    Ben, the WTO hasn’t ruled on GMOs. Besides, there’s a reasonable issue here – if trade bans are backed by sound science, they’re ok; if not, they’re not. Given the number of protectionist pollies looking for excuses to block imports, this ain’t a bad rule.

    The PBS is a national drug-buying cartel, not really a trade barrier. I like it, and am happy to say that it’s perfectly WTO-legal. This is hardly surprising, given that many other countries have similar systems in place.

  30. Ben Ticehurst says:

    Andrew: The popular media have reported on a WTO ruling – see URL below:

    http://www.theaustralian.news.com.au/common/story_page/0,5744,18090027%255E1702,00.html

    I’ll have to check this out further. Perhaps the press have erred. I certainly agree with you that if we are to have a WTO making these broad, important decisions, then it must be rules-based and grounded in science, rational thought and thorough analysis. I question though whether the proper forum is a body who’s “…main function is to ensure that trade flows as smoothly, predictably and freely as possible.” (WTO website). For what its worth I am not terribly concerned with the immediate effects on human health of GMO’s. There are plenty of other reasons that the issue raises my hackles, primarily the question of effects on ecosystems/ecology/diversity and so on. Our understanding of these areas is primitive and the consequences are likely irreversible with a very long lag time before they become apparent (decades-centuries). I was pleased therefore to see that the WTO at least pay some (?lip service) attention to the principle of precaution. Cheers mate.

  31. Andrew Leigh says:

    Ben, thanks for the link. It’s hard to know whether we should prefer the WTO website (maybe the so-called ruling was really a technical point or a concession?) or the Oz (maybe the guys on Lake Geneva just haven’t updated their website yet).

    I’ve always preferred cost-benefit analysis to the precautionary principle.

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