Tuesday, March 22, 2011

Free trade and social safety nets - two sides of the same coin?

Uwe Reinhardt has a series of superb posts defending free trade and advocating social safety nets. This is appropriate at a time when both are under attack from ideologues and opinion makers on both sides of the political spectrum. About the benefits of free-trade, he writes,

Relative to a status quo of no or limited international trade, permitting full free trade across borders will leave in its wake some immediate losers, but citizens who gain from such trade gain much more than the losers lose. On a net basis, therefore, each nation gains over all from such trade.

The objections to this has both external and domestic dimensions. Externally, critics argue, and rightfully too, that countries apply these principles selectively and breach them through a variety of trade restrictions. This needs to be addressed through mutually agreeable international trade negotiations. While progress on this has been halting, it is the lesser challenge.

More importantly, and of immediate concern to politicians across the world, is the fact that free trade creates losers. The uncertainty that comes with being vulnerable to such disruptions amplifies the opposition. Further, the losers are much larger in number than the winners.

The sharp contrast between the winners - with the over-sized gains of a handful of mostly high-profile individuals and businesses - and losers - deprived off their livelihoods and left to fend for themselves - provides fuel for political backlash. In the circumstances, it is reasonable that the losers are adequately compensated or atleast cushioned against their vulnerabilities. And it is only right that winners give up a share of their gains to assist their less fortunate brethren, who have been made to suffer losses due to factors beyond their control. He writes,

Suppose the Jones family is hurt financially by low-cost imports from abroad, while the Smith family is hurt equally by home-grown disruptive innovation – such as the displacement of travel agents by online booking of airlines and hotels or of airline ticket-counter personnel by online check-in. Should only the Jones family be compensated for its loss because it involves foreign trade?

A far better approach would be to have in place a solid, general economic safety net that helps all families whose economic base is disrupted through forces beyond their control, whether such disruptions originate in foreign trade or domestic developments. Unfortunately, too many economists decry that approach as a welfare state – and that makes selling the case for free trade that much harder.

Who should be compensated and by how much? Who should pay for compensating the losers and how much? While economists can help answer these questions, the larger decisions are essentially political in nature. Economists would do themselves, their profession, and the issue of free-trade itself a lot good if they realize this and not stray deep into such re-distribution debates. Efficiency is a question of economic analysis, while fairness is a matter of moral and political judgement.

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