Squeal in the Dark, Part II

Hi Everyone…

I promised I’d provide more details on our great debate with the Department of Foreign Affairs and International Trade regarding trade economics, in particular the likely employment effects of their proposed Canada-Korea FTA.

The federal critique variously described the CAW study (which predicted significant post-FTA job losses in the auto industry and other high-value sectors) with the following terms: “unsound,” “unreliable,” “not relevant,” “not valid,” “egregious,” “gross errors,” “not robust,” “collapses under scrutiny,” “not scientifically sound,” and “extreme.”  And that was just the first page!  These folks clearly don’t have any problems expressing how they really feel about things.

The original CAW study is here:

http://www.caw.ca/campaigns&issues/ongoingcampaigns/korea/pdfs/KoreaTradeStudy1.pdf

The federal assessment is here:

http://www.international.gc.ca/eet/pdf/Analytical_Report_CAW-en.pdf

My full response to the federal critique is here (it will be especially useful for anyone suffering from insomnia):

http://www.caw.ca/campaigns&issues/ongoingcampaigns/korea/pdfs/responseKorea_Study.PDF

A shorter, punchier version of the argument was published in the Windsor Star, and is available here:

http://www.caw.ca/campaigns&issues/ongoingcampaigns/korea/pdfs/ResponseWindsorStar.pdf

As the great economist Joan Robinson once said, “The only thing worse than being exploited, is being ignored.”  In this sense, I am thoroughly gratified by the DFAIT response — not least because it is more proof that our fearless trade negotiators know they are in trouble (both politically at home, and in their bargaining with the Koreans) on this one.  The stars are lining up to block their rush to a Canada-Korea FTA deal: for example, George W. Bush’s newfound lame-duck status means that the proposed U.S.-Korea FTA is now doomed, and this raises further questions about the motivation for and viability of a Canada-Korea deal (Ottawa has been citing the U.S.-Korea negotiations as part of the rationale for their own).

Nevertheless, I welcome the opportunity to respond to the federal critique.  And for anyone brave enough to wade through the reports, this little tempest in a teapot actually provides an interesting example of a very important debate in theoretical economics about how to analyse international trade and trade liberalization.  The standard “neoclassical” approach, embodied in the DFAIT studies, is to assume that in the long-run labour (and all other resources) will be fully-employed.  Moreover, every economy is naturally and relatively efficient (and hence internationally competitive) at producing something.  Thus the only impact of international trade is to push workers from less efficient industries into more efficient ones.  Problems like unemployment and overall trade imbalances are assumed not to exist, and “competitiveness” is automatic: every country is inherently competitive at producing whatever its “comparative advantage” indicates it should.  As the DFAIT assessment of our report puts it, “Jobs are not permanently lost in this process; rather, jobs are shifted from weaker sectors to those which are more viable.”  That’s precisely the same argument we’ve heard regarding every trade agreement signed over the last 20 years.

In the Canada-Korea case, even the federal government admits that bilateral tariff elimination will hurt the Canadian auto industry (the only debate is by how much).  The “more viable” industries which will absorb the displaced autoworkers are presumably the sectors which currently account for most of our exports to Korea: namely, wood pulp, coal, and agriculture.  Right off the bat, I’m not sure I like that trade: chopping down trees in return for finished vehicles.

However, once you relax the assumption of full employment, then a very different set of results is obtained.  Trade and trade liberalization can increase or reduce unemployment (depending on whether it hurts or helps the competitiveness of a country’s products), and the resulting gains or losses of output can easily overwhelm the efficiencies that are believed to result from trade-induced specialization (in the lexicon, “Okun gaps outweigh Haberger triangles”).  Competitiveness is no longer automatic, trade imbalances can (and do) arise, and jobs can be lost — and not just temporarily, either.  Moreover, trade can have important effects on a country’s industrial structure: again, either helping or hurting desireable, innovative, high-technology sectors, depending on whether their competitiveness is helped or harmed.  This latter point is especially important in the case of non-resource-based industries, which can locate their activities anywhere.

Readers can decide for themselves (if they are still awake) which set of assumptions is most realistic.  What is important is that this debate has illustrated again how dependent the optimistic free-trade predictions of conventional economists are on their underlying assumptions.

Here is the penultimate paragraph of my longer response to DFAIT, on whether economics has truly proven that free trade is always mutually beneficial:

I found troublesome the implication in several places that the approach of the CAW study somehow indicates a failure to understand or properly utilize economic theory.  I do not accept this critique at all.  In fact, in contrast to the good old days of Heckscher-Ohlin comparative-advantage thinking, modern economic theory cannot make any definitive statements about the impacts of trade liberalization on specialization, employment, and welfare.  When economies are demand-constrained; when comparative advantage (if that term can even still be used) is created through innovation and learning-by-doing, rather than being a legacy of exogenous resource endowments; when capital (including human capital) is accumulated, not endowed, and can be moved across national borders; when economies of scale complicate the picture – then the traditional certainty of the old trade theory is utterly lost, and no-one’s economics can be questioned simply because their methodology is inconsistent with the Heckscher-Ohlin system.  Indeed, there is an abundant and scientifically credible economic literature associated with each of these “complications” in the real world of trade.  And policy-makers who are making conclusions based on traditional Heckscher-Ohlin formulations risk causing serious economic harm with their actions, since the real world does not in most cases resemble that assumed in the traditional comparative advantage understanding.

So let’s get ready to RRRRRRumble!  No doubt there will be further rounds to come in this battle of intellectual titans.  The Korea debate will rage on (up to and beyond the next federal election).  Moreover, the application of increasingly far-fetched economic models to quantify the expected gains from trade liberalization will become an even more common factor in other trade policy debates.  For example, the same DFAIT group that critiqued the CAW Korea study recently issued a report suggesting massive economic gains from a process of “deep integration” between Canada and the U.S. (potentially including a common currency and the elimination of border controls); the study reports eye-catching efficiency gains by quantifying various “unobservable” trade costs.  (These costs are unobservable, but quantifiable.  How convenient!)  My chapter in the CCPA’s new book (Living With Uncle) reviews these hypothetical models in more detail.

So we heterodox economists will need to keep chipping away at the continuing (but illegitimate) hegemony of comparative-advantage thinking, to help the grasroots campaigners stop the Korea FTA, Emerson’s “Plan B,” and the other deals on the table.  Otherwise, Canada’s emerging but unfortunate role as a supplier of primary commodities to other countries, which then transform that stuff and sell it back to us at a profit, will become cemented for generations to come.

2 comments

  • Congrats to Jim on not being ignored.

    Standard economic models lead to truly astonishing estimates of benefits. Remember the Richard Harris estimate from 1984 of an 8-10% increase in Canadian GDP as a result of Canada-US free trade? What a cruel joke that turned out to be (as an aside, his wife was one of my profs at SFU and I remember her disdain when I met her again a few years back that I worked for the CCPA — really, who is the hack?). Another study, a PhD thesis supervised by Harris came up with estimates of increased Canadian GDP of 2-3% from a customs union.

    These estimates are so preposterous because they use CGE models that are biased in favour of free trade due to the assumptions Jim points out above. But once produced they become “fact”, repeated ad nauseum in briefing notes and department communications material, and thus lead us to some bad policy decisions.

  • Hey Jim – I’m trying to get a hold of you as I have a good friend in Melbourne you might want to meet! Email me. Toodles, Christine

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