The Open Economy and Its Enemies
Protectionist Myths
Jagdish Bhagwati
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NEW YORK – At a debate in New York last year entitled “Buy American/Hire American Policies Will Backfire,” with hundreds of people in attendance, my team of three free-trade proponents took on a trio of protectionists who are often in the public eye. We expected that we would lose the final audience vote by 55% to 45%. As it happened, we wiped the floor with them, winning by an unprecedented margin of 80% to 20%. The feedback from several voters was that we had won handily because we had the “arguments and the evidence,” whereas our opponents had “assertions and invective.”
Evidently, the pessimism and despair that often overwhelms free traders today is unwarranted. The arguments of protectionists, new and old, are just so many myths that can be successfully challenged. Consider some of the most egregious examples.
Myth 1: “The cost of protection and its flipside, gains from trade, are negligible.”
This means, of course, that if protectionism is politically convenient, you need not shed tears over harming the country by surrendering to it, an attitude that many Democrats in the United States find convenient to adopt.
Ironically, this myth was a product of inappropriate methodology and resulted from the research of my eminent Cambridge teacher Harry Johnson; and it has inexplicably been a favorite thesis since 1990 of my celebrated MIT student Paul Krugman. But, while this theme continues to play well in Washington, no serious scholar buys into it, owing to the compelling refutations published in 1992 by Robert Feenstra, the most accomplished trade policy empiricist today, and in 1994 by Stanford’s Paul Romer.
Myth 2: “Free trade may increase economic prosperity, but it is bad for the working class.”
This claim has great credibility with labor unions that believe that trade with poor countries produces paupers in rich countries. They therefore argue for leveling the playing field – i.e., that the costs for their rivals in poor countries must be raised by imposing the same labor standards that exist in rich countries. Orwellian use of terms like “fair trade” masks the fact that this is nothing but an insidious form of protectionism that seeks to reduce import competition.
Many economists have concluded, however, that continual and deep labor-saving technological change, not trade with poor countries, is a principal culprit in the stagnation seen in rich-country wages nowadays. Moreover, workers profit from lower prices for imported goods like clothing and electronics.
Myth 3: “Free trade requires that other countries also open their markets.”
This is a refrain that recurs each time a new US administration takes office. But the facts are often fiction, and the logic is not compelling. US automakers were convinced during the years of Japan-bashing in the 1980’s that Japan was closed and the US was open. But it was the US that had a quota of 2.2 million units for Japanese cars, while the Japanese market was open but difficult to penetrate. The refrain is recurring with China today.
Even if other economies are closed, open economies still profit from their own free trade. There was skepticism about this long-standing wisdom when it was argued that, if Japan was closed and the US was open, Japanese firms would have two markets and American firms would have one. The former, it was claimed, would have lower unit costs than the latter. But the problem here, as always, is with the assumption that Japanese firms would continue to be as efficient as American firms, despite protectionism.
Myth 4: “Paul Samuelson abandoned free trade, and he was the greatest economist of his time.”
The latter is indeed true; but the former, asserted by many protectionists, is not. Even Hillary Clinton, in her campaign for the US presidency, mistakenly embraced this fallacy.
All that Samuelson showed was that any exogenous change could harm a trading economy; he did not argue that an appropriate response to that unfortunate situation was to abandon free trade. Consider an analogy. If Florida is devastated by a hurricane, its governor would only make matters worse if he responded by abandoning trade with other states.
Myth 5: “Offshoring of jobs will devastate rich countries.”
This scare arose during Senator John Kerry’s failed presidential campaign in 2004, when digitized x-rays were sent from Massachusetts General Hospital in Boston to be read in India. But no radiologists have lost jobs in the US since then, nor have their earnings fallen. Indeed, it is clear that the increased tradability of services has not unleashed an economic tsunami on rich countries.
Often, jobs that would have disappeared anyway, owing to high costs in the US and other rich countries, have resurfaced where costs are lower, thus providing services that would have been lost otherwise. So noted offshoring worriers like the economist Alan Blinder have now shifted to arguing merely that increased tradability of services means that we should extend long-standing Adjustment Assistance Programs for trade-distressed activities to include services.
To which the free trader responds: no problem there!
Jagdish Bhagwati, University Professor at Columbia University and Senior Fellow in International Economics at the Council on Foreign Relations, is completing a book entitled Terrified by Trade: How to Contain Protectionism Today.
Copyright: Project Syndicate, 2010.
www.project-syndicate.org
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uvadula 04:50 03 Jul 10
While I agree with some anti-protectionist sentiments, there's no arguing with the best protectionist evidence of all; China.
Charlesst 07:40 04 Jul 10
Unbalanced Trade bebefits the country with the surplus, at the expense of the country with the deficit
The basic idea is that the price level in the importing country goes down, decreasing the revenue available to its industries. However, that country’s demand is ultimately equal to the revenue of its industries. That is the key relationship. The country's demand declines with the decline of the revenue of its industries. With continued imports, the price level continues to go down, as does revenue and demand, along the Aggregate Supply curve. With the continued erosion of revenue, industries are increasingly idled, and unemployment increases. The importing country is forced into a deflationary spiral.
In the exporting country, on the other hand, the price level goes up, and including the revenue from its exports, so does the revenue of its industries, and ultimately the country’s demand. Its industries, with increased revenue, grow, as does the country’s demand, along the Aggregate Supply curve. With continued exports and continuing increases of revenue, industries continue to grow. So does demand, and employment.
A closer argument, with diagrams, at http://anamecon.blogspot.com/2010/04/effects-of-unbalanced-trade.html
canadave 12:57 08 Jul 10
The argument is not whether free trade is good, it's whether and to what degree it actually exists. If it does not exist (say, as the result of exchange rate manipulation) then some protectionist measures are warranted (for instance, import tariffs). While some dislocation should be expected during a period of adjustment to globalization and economic advancement in emerging economies, artificially prolonged adjustment periods resulting in gutted domestic production capacity should not be tolerated.
wauch 06:35 08 Jul 10
Okay so I wasn't going to comment and just bite my tongue, but the more I debate this piece with friends, family, and colleagues the more I wonder how Dr. Bhagwati got out of that debate without being accused OF ALSO using “assertions and invective” as he put it. The fact is that aspects of capitalism and global flows do work no doubt and I don't know any rational person who could argue against that "assertion", "argument", or "evidence", BUT to say that any ISM whether Capitalism or Industrialism or Globalism is a suitable one size fits all approach is myopic at best and dangerous at worst. Believing that free-trade and capital markets are always the best solution borders on theology Dr. Bhagwati? Are you a religous fellow?
PS Is your former student Dr. Krugman not a "serious scholar"?
Morgenthau 02:02 18 Jul 10
It’s never easy to take on Mr. Bhagwati, because he is probably the best international trade theorist on the planet. Yet it must be done sometimes, for being the best does not necessarily mean being right. Let me make three points.
First, the article is a prime example of Mr. Bhagwati’s writing. For fresh undergraduates reading this post: Beware of social scientists using the form of "Myths & Refutation”! This is the typical procedure used by free traders who disparage protectionist arguments as “myths” and make counterclaims purported to be eternal “laws of nature.” Mr. Bhagwati is the perfect example of this form of writing. It took me a few semesters to understand that the “laws” in economics actually are based on shaky foundations. The reason is the fundamental difference between natural sciences and social sciences. While natural sciences study the nature and its material properties, social sciences study human beings and their patterns of behavior and interaction. Studying human behavior is both fascinating and frustrating for the same reason. And that is complexity. Not only do social variables abound, but they also interact in manifold ways. Consequently, social scientists could never make assertions with the certainty with which natural scientists do. For social scientists such as economists, this is a major reason for inferiority complex. They know perfectly that economics’ claim to scientific status will always be excruciatingly weak. So they take their revenge by excoriating those who use common sense and dare to doubt the validity of their “economic laws.” Take Mr. Bhagwati’s claim that “offshoring of jobs will devastate rich countries” is only a myth. How can he be so sure that it’s only a myth? Maybe the extent of the tradability of services will increase dramatically in the coming decades, and the sheer number of high-skilled Indians and Chinese will turn out to be a real threat. Fortunately for Mr. Bhagwati, he won’t be around to witness that, for he is already 75. So he can make all the claims he wants. He is probably trying to improve his credentials as a free trader so that he can get the Nobel Prize for Economics he is still craving for. But while he can brush away these things as “myths,” we and our kids are those who will have to bear the brunt.
The second point is directly related to the first one. The fundamental assumption underlying Mr. Bhagwati’s article is that free trade is good. He doesn’t use the word explicitly, but the concept of “comparative advantage” is what he draws on. Granted, it’s a powerful concept. Economic actors can increase efficiency by exploiting differences in relative opportunity costs. That is, they specialize in the production of goods and services they can do relatively well, and then they exchange these goods and services. Importantly, it’s about the relative advantage, not the absolute one. The concept of comparative advantage is full-fledged within economies. That explains, for instance, why Kobe Bryant plays basketball rather than washing cars. Maybe he can wash cars better than most people, but the time he spends washing cars represents a huge cost, for he could have spent it playing basketball and making a lot of money. Similarly, the concept of comparative advantage explains some, but only some, trade between nations. Why Saudi Arabia exports oil and African countries export all sorts of minerals doesn’t need much explaining. They have a plenty of these natural resources, something that most other countries need, but don’t have or have only in small quantities.
But once you go beyond natural resources, things get interesting. Let’s assume that Mr. Bhagwati has to explain to an alien which countries on this planet produce agricultural products, manufacturers, tradable services, and high-tech products. Mr. Bhagwati, of course, will draw on the concept of comparative advantage – which underlies the classical trade theory (Ricardo) and the neoclassical trade theory (Heckshcher-Ohlin) – and the alien will go back to its planet thinking that human beings and their countries always care only about EFFICIENCY in their economic exchanges. Mr. Bhagwati will make the alien believe that it’s obvious, for example, that India and China should specialize in manufacturing, because they have labor in abundance, and Germany should specialize in high-tech products, because it has capital in abundance. However, Mr. Bhagwati most probably won’t tell the alien that free trade is a historically contingent phenomenon, and that it was introduced in the mid-19th century by the hegemon of the day – Great Britain – and is underpinned today by the current hegemon – the United States. And he won’t tell that Western countries defended (and continue to defend) their industrial bases despite not having labor in abundance. For example, Great Britain, despite its free trade credentials, back then destructed India’s fledgling manufacturing capacity just to preserve its industrial dominance.
Third, Mr. Bhagwati and his fellow chaps in the ivory tower think that EFFICIENCY is all that what matters in international trade. In their view, protectionism is bad, and all countries would be better off if they would embrace free trade. But, like it or not, the real world is different from their textbooks. Mr. Bhagwati is a prime example of what is called “Fachidiot” in German. He is an expert in international economics, but his knowledge in history and international politics is questionable, to say the least. Free trade is an important concept, but Mr. Bhagwati and his fellow chaps seem not to understand that it’s only one principle for organizing international economic exchange, and that, more importantly, it won’t ever be the main one. To understand why free trade won’t ever be as full-fledged between countries as within countries, it’s necessary to understand the nature of international politics. International trade does not exist in a vacuum. On the contrary, it is profoundly shaped by fact that there is no legitimate hierarchy in the international realm and that POWER is unevenly distributed across the states. In particular, the states with the greater material resources – the great powers – and the relations among them largely shape international politics. The sobering reality of politics among nations is that, nolens volens, trade will always remain subordinate to power. (It’s not a mere coincidence that, historically, mercantilists preceded free traders). In the fundamentally competitive and potentially dangerous realm of international relations, states have an incentive to seek and preserve their own survival from external military and political threats. Only when survival is guaranteed can the state pursue other ends.
What I’m saying is not abstract theory. International politics is nasty. Just think about the devastating two world wars. Or take the example of China. Mr. Bhagwati will argue that China has a comparative advantage in manufacturing, for it has labor in abundance. And he will say that we should embrace free trade even if China engages in exchange rate protectionism in a historically unprecedented scale. What Mr. Bhagwati does not say, however, is that China is already translating its burgeoning economic clout into formidable military capacity. In other words, we are making with business with the Chinese who will exploit their economic success to flex their diplomatic and military muscles. Mr. Bhagwati will argue that the West is still better off if it engages in free trade with China, and that protectionist measures would make both worse off. But I’m not sure if it really makes sense to strengthen a country which might turn out to be a juggernaut wreaking havoc. Mr. Bhagwati says that the proposition “Free trade requires that other countries also open their markets”, too, is a myth, and that the same criticism used against Japan is now being used against China. Yet China is not Japan. While Japan was a competitor economically, it was and remains a strategic and diplomatic ally. China, however, is not an ally of the West. So making it stronger economically and militarily is a strategic suicide, to put it mildly. The day will come when China is economically and militarily so strong that it will dictate how international trade should be conducted. I’m not sure what the Western countries will then produce. Agriculture and manufacturing will be already gone, and China might use its formidable economic and military clout to get a huge chunk of the largely increased sector of tradable services in the West. Mr. Bhagwati and his fellow “Fachidiots” will tell us that “Everyone has a comparative advantage.” Well, that helps matters!
In sum, whatever Mr. Bhagwati will write in these pages, don’t take it at face value!
PS: I hope Mr. Bhagwati will get the Nobel Prize one day. At least he would stop boasting about having been the teacher of the outstanding Paul Krugman. By the way, I have never heard Mr. Krugman saying that Mr. Bhagwati had an influence in his intellectual formation. One more reason to take with a pinch of salt whatever will appear on these pages.
ehill200 09:03 27 Aug 10
Are Feenstra (1992) and Romer (1994) really the best works out there to substantiate Bhagwati's Myth 1?
juanpefernandez 02:16 03 Jul 10
Mr Bhagwati writes about the costs of protectionism, but he's quick to avoid the theme of the benefits of protectionism when it's accompanied with industrialization policies and an efficient state. Every episode of developent in history (England in the XVII, USA in the XIX, Europe, Japan, South Corea, China, etc) has been accompanied by protectionism. We all know that thanks to Ha Joon Chang and many subsequent work by other authors. Why does USA republicans are afraid of latinamerican agricultural exports? why does USA big tycoons were afraid that China's firms buy petroleum firms or Pepsi?. It's obvious that rich countries want freedom in capital and elaborate products markets and protectionism in agricultural and labor markets. It's the best scenario for them and thw worst for the poor countries.