Sunday, November 23, 2014

Free Trade and Costly Love

LONDON – The World Trade Organization’s ministerial conference in Bali in December produced a modest package of encouragements to global trade. More broadly, the WTO’s multilateral approach has shown its worth by preventing a massive increase in trade barriers, unlike in 1929-1930, when protectionism helped deepen and broaden the Great Depression. But the main question – whether globalization is a good thing, and for whom – remains unanswered.

The essence of globalization – free trade – rests on the theory of comparative advantage, which views international trade as profitable even for a country that can produce every commodity more cheaply (in terms of labor or all resources) than any other country.

The textbook example given by the Nobel laureate Paul Samuelson is that of a town’s best lawyer who is also its best typist. Provided that he is better at law than at typing, he should specialize in law and leave his secretary to do the typing. That way, both of their earnings will be higher.

The same logic applies to countries. Each country should specialize in producing those things that it produces most efficiently, rather than producing a bit of everything, because that way its income will be higher.

Economists regard understanding the theory of comparative advantage as a test of professional competence. But are the incompetents – say, the average person who believes that buying cheap imports from China destroys Western jobs – always wrong?

Samuelson, who called the theory of comparative advantage the most beautiful thing in economics, changed his tune a bit at the end of his life. Free trade, he said, works fine with unchanging technology. But if countries like China can combine Western technology with low wages, then trade with China will lower Western wages. True, the West will be able to get its goods more cheaply; but, as Samuelson put it, “being able to purchase groceries 20% cheaper at Wal-Mart does not necessarily make up for the wage losses.”

Nor, he might have added, would being able to buy goods more cheaply compensate for many other good things in life that are sacrificed to efficiency. The argument for free trade is an argument for welfare, but welfare defined exclusively in terms of money. Time is money: the more money you can squeeze out of an hour’s work, the better off you are. But what about all of the things that you enjoy doing, or that you think of as valuable, that do not maximize your earnings?

The economist responds that the more efficient you are at your work, the more time you will have for those other things. The trouble is that the more you start to think of your welfare in terms of money, the more likely you are to regard spending time with your friends or making love as an “opportunity cost” – the loss of money you would have made by working instead – rather than a benefit.

The goal of squeezing as much money as possible out of time makes a great deal of sense in poor countries, where inefficient use of time can lead to starvation. The whole point of economic development is, surely, to reduce the cost of inefficiency. Yet economists, not noticing that their logic is less applicable to rich countries, continue trying to extend it to more and more areas of life.

A newly luxuriant research area is “life outsourcing.” Paying someone else to fold your socks is a way to maximize your own earnings and those of the sock folder. Even as penniless graduate students, the economists Jon Steinsson and Emi Nakamura borrowed money to pay people to do their household chores, calculating that “spending an extra hour working on a paper was better for their lifetime expected earnings than spending that same hour vacuuming.”

Likewise, the economists Betsey Stevenson and Justin Wolfers, pioneers of “lovenomics,” cite the tax code as a reason for not marrying. They also conducted a cost/benefit analysis before having a child. As Wolfers explains,

“The principle of comparative advantage tells us that gains from trade are largest when your trading partner has skills and endowments that are quite different from yours. I’m an impractical bookish Harvard-trained empirical labor economist, while Betsey is an impractical and bookish Harvard-trained empirical labor economist. When your skills are so similar, the gains from trade aren’t so large. Except when it comes to bringing up our baby. There, Betsey has a pair of, um, endowments that mean that she’s better at inputs. And that means that I’m left to deal with outputs.”

As Stevenson helpfully clarifies, “it turns out that fathers can be pretty good at dealing with diapers.”

At this point, those untutored in economics are likely to start gnashing their teeth. “I enjoy doing lots of things that do not maximize my earning power,” they might protest. But as soon as we accept the premise that to be rational is to seek to maximize one’s utility – defined in terms of consumption, with money the way to maximize it – the economist’s logic wins.

At that point, we must admit that it is irrational to spend time on long conversations with friends if it is time stolen from inventing, say, new software (unless the conversation helps the invention). For Wolfers, it is a coincidence that what earns him the most money, economics, is also what he most enjoys doing.

Such reasoning crystallizes opposing views of the world, one in which time is a cost, and the other in which it is a benefit. The first sees time spent on enjoyment as a missed opportunity; the second as part of the good life. We should be clear about what is at stake in the choice between the two.

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    1. CommentedJoshua Soffer

      "Would you even consider, for a moment, engaging in free trade in your personal life?" Sure , why not? IF you redefine utility as anything that brings creative satisfaction, and then broaden the definition of consumption to include not just products that you pay others for, but also products of your own creative thought that you then consume(that includes writing poetry for your own enjoyment , repairing a motorcycle or consuming the affections of your partner). By understanding utility and consumption in these terms, it becomes clear that money is but one means of acquiring products to consume. One can then see that John and Sylvia are correct to outsource the aspect of the motorcycle experience that does not afford them the means to achieve what for them, given their talents and creative limitations, is the most rewarding aspect of the motorcycle experience. To use Skidelsy's example to make my point about consumption as creativity, I would gladly pay someone to fold my socks, not in order to maximize my future earnings, but in order to free up my time to concentrate on my comparative advantage, the consumption of poetry that I create for my own enjoyment.

    2. CommentedMatt Stillerman

      In my opinion, free trade is simply stupid. And, you don't need any fancy economic arguments--- it's just obvious. Would you even consider, for a moment, engaging in free trade in your personal life? Of course not, Prof Skidelsky's economist-examples not withstanding. So, why would you think that this is a good idea for a nation?

      I think that the point is made, most poignantly in Zen and the Art of Motorcycle Maintenance: An Inquiry Into Values, by Robert Persig. In that book, John and Sylvia are, in essence, pure consumers of the "motorcycle" experience. They have completely outsourced the other aspect of motorcycling, the "maintenance" that symbolizes doing things for yourself, and getting your hands dirty. The inadequacy and poverty of this mode of "motorcycling" is obvious in the narrative. In contrast, the protagonist, Phaedrus, revels in both romantic and practical aspects of motorcycling and his experience is more satisfactory.

      "The Tao that can be told is not the eternal Tao." (Laozi, as translated by Livia Kohn) I *insist* that if you govern your life or your nation via a utility function, whether denominated in dollars or otherwise, then you have lost your way. If you can capture it in a utility function then "it" is not the way.

      Of course, John and Sylvia are economically better off, but, would you rather be them than Phaedrus? Really?

    3. Commentedhari naidu

      I will leave the costly love business to the younger generation to compare in terms of cost/benefit analysis.

      However free trade, after Bali (WTO), is still stuck in the mud with non-tariff barriers to trade (see Lamy’s recent article printed here).

      Globalization, by definition, has forced national sovereignty (UN Charter) to be compromised and national boarders exposed to trade infringement, sought or unsought. Even the protection of rural population and its limited productive capacity, with official subsidy, is considered illegal (Doha Round) under WTO.

      So what in the world do you mean or understand by *free trade*? Free trade for whom? The producer or the consumer? Or the global banking system that provides the capital and credit to move goods and services at unprecedented scales across national frontiers?

      This week WEF(Davos) will be dealing with the subject of *economic and social inequality* since inception of WTO and its globalization ethos. IMHO, as a trade and development professional, we sort of overlooked the global (human) impact of what we’re negotiating under GATT Uruguay Round. Trade efficiencies are all very good and human capital, in final analysis, is what enforced globalization. And now we’re confronted with graphic illustration of how inequality has disrupted the welfare of most OECD countries, in particular.

    4. CommentedJose araujo

      Also very interesting, and the main tell that the free trade theories were developed to gain access to new markets, and were not focused on the maximization of utility, is that defenders of the free trade are usually also in favor of controlling immigration, especially in times of stagnation and economic problems.

      Labor specialization works at the individual level, but doesn’t work at higher level. Even companies will have trouble if they don’t keep an eye on the market, nurture technology development and innovation because they will end stuck themselves making the same product over time, and being replaced.

    5. CommentedJose araujo

      The main critic to the comparative advantage theory implies the specialization of the less developed countries in low tech technologies. Considering economics is a continuum of growth be committing yourself to lower paying jobs instead of developing skills isn’t a good strategy, nor are you maximizing your future earnings.

      So like the secretary for the lawyer, that instead of devoting to typing should study law and try to have a better living, a country shouldn’t forget to develop its competitive advantages in higher level economic activities.

      The traditional argument for Ricardo’s comparative advantages was illustrated with Portugal and England (based on the Methuen treaty) were Portugal should devote to the production of wine and England to textiles. This led to Portugal being stuck with a rural society and economic tissue, making it harder to transition to an industrial economy and lowering its utility in the long run.

    6. CommentedJoshua Soffer

      "To be rational is to seek to maximize one’s utility – defined in terms of consumption, with money the way to maximize it". The flaw in this argument is that if consumption is the means by which to maximize one's utlity, then the meaning of consumption needs to be broadened to include not just products received from others , but products generated by one's own experience. The novel writer can be entertained not just by paying for a book, but by writing one. Via this definition of consumption, money is only one means, and not the most efficient one, of maximizing one's utility. Put differently, money can't buy me love.

    7. CommentedProcyon Mukherjee

      Stolper-Samuelson theorem, proved that removing trade barriers would have different effects in different countries. If a country has lots of skilled labor, its exports will tend to be intensive in skilled labor, and skilled workers will gain from more trade. But if unskilled labor is more abundant, its exports will be intensive in unskilled labor, so workers with skills will lose.
      But there is more to it when we try to introduce incentives and taxes, which could deliberately incentivize or punish specific segments at the cost of others. Capital on the other hand and its formation could be at the cost of labor and here more efficiency could mean higher capital formation, not necessarily better wage.