Julian Sanchez attacks trade protectionism:

Here’s a modest proposal, then: Let’s permit whatever restrictions on trade and globalization people like, but with the “winners” under those rules compensating the “losers” via some sort of special targeted tax. We’ll levy this on the workers and stockholders enriched by whatever form of protection from international competition they want to demand, and cut a check to workers, stockholders, and consumers in other sectors that would have benefited from lower prices or operating costs as a function of trade and outsourcing, in the amount of whatever the benefit to them would have been of less restricted trade…

The key thing to bear in mind here is that there’s nothing morally special about the level of globalization in 2007 or 1990 or 1970 as some kind of special baseline. We talk about “winners” and “losers” relative to some status quo ante where there happened to be a different level and pattern of globalization, but the point of comparison is—from the point of view of justice, if not realpolitik—arbitrary. Which is why compensations from the “winners” to “losers” under protectionism makes as much sense—probably more—than the parallel sort of compensation as globalization increases. The only reason to think otherwise is to suppose we’re specially and permanently entitled to the pattern of holdings we’d have at some particular but arbitrary level and kind of globalization.

Theory aside, given the strength of status quo bias, adjustment assistance or some other form of compensation is politically necessary to make trade liberalization feasible. Paying people to overcome their status quo bias echoes the political necessity of paying people to overcome another bias:

It is tempting to argue… that all changes require adjustment, and that assistance should be provided in a generic fashion… This viewpoint is valid in a cosmopolitan world… However, in the real world, the refusal to accept change – and hence the need to accomodate it and facilitate it through adjustment assistance – is greater when the source of disturbance is foreign… The case for differential adjustment assistance rests on this asymmetry in communities’ attitudes toward change from foreign and domestic sources. [Bhagwati, Protectionism, p.118-9]

Trade adjustment assistance facilitates liberalization by dampening both of these biases. But it might not if the general public knew its effectiveness.

Don Davis & James Harrigan provide theoretical grounding for public worries in “Good Jobs, Bad Jobs, and Trade Liberalization”:

Globalization threatens “good jobs at good wages”, according to overwhelming public sentiment. Yet professional discussion often rules out such concerns a priori. We instead offer a framework to interpret and address these concerns. We develop a model in which monopolistically competitive firms pay efficiency wages, and these firms differ in both their technical capability and their monitoring ability. Heterogeneity in the ability of firms to monitor effort leads to different wages for identical workers – good jobs and bad jobs – as well as equilibrium unemployment. Wage heterogeneity combines with differences in technical capability to generate an equilibrium size distribution of firms. As in Melitz (2003), trade liberalization increases aggregate efficiency through a firm selection effect. This efficiency-enhancing selection effect, however, puts pressure on many “good jobs”, in the sense that the high-wage jobs at any level of technical capability are the least likely to survive trade liberalization. In a central case, trade raises the average real wage but leads to a loss of many “good jobs” and to a steady-state increase in unemployment.

NBER working paper.

Don Davis & James Harrigan provide theoretical grounding for public worries in “Good Jobs, Bad Jobs, and Trade Liberalization”:

Globalization threatens “good jobs at good wages”, according to overwhelming public sentiment. Yet professional discussion often rules out such concerns a priori. We instead offer a framework to interpret and address these concerns. We develop a model in which monopolistically competitive firms pay efficiency wages, and these firms differ in both their technical capability and their monitoring ability. Heterogeneity in the ability of firms to monitor effort leads to different wages for identical workers – good jobs and bad jobs – as well as equilibrium unemployment. Wage heterogeneity combines with differences in technical capability to generate an equilibrium size distribution of firms. As in Melitz (2003), trade liberalization increases aggregate efficiency through a firm selection effect. This efficiency-enhancing selection effect, however, puts pressure on many “good jobs”, in the sense that the high-wage jobs at any level of technical capability are the least likely to survive trade liberalization. In a central case, trade raises the average real wage but leads to a loss of many “good jobs” and to a steady-state increase in unemployment.

NBER working paper.

Dani Rodrik:

Advocates of globalization love to argue that free trade lowers prices, and the argument seems sensible enough. Think of all the cheap goods from China that we can buy at Wal-Mart. But anyone who understands comparative advantage knows that free trade affects relative prices, not the price level (the latter being the province of macro and monetary factors). When a country opens up to trade (or liberalizes its trade), it is the relative price of imports that comes down; by necessity, the relative prices of its exports must go up! Consumers are better off to the extent that their consumption basket is weighted towards importables, but we cannot always rely on this to be the case.

If Rodrik comes to play the same role in the blogosphere that he has in academia, I expect that many free traders will take an extra moment of reflection before hitting “post.”

Kala Krishna and Ling Hui Tan model importers (pdf):

Why is it important to model the role of traders explicitly? We do so not simply to inject a dose of realism into the analysis but because the size of the import industry matters for the amount of trade that takes place and the consequent level of social welfare. And the size of the import industry, in turn, is affected by the costs and risks involved in importing. This is where our model differs from the standard partial equilibrium analysis of trade policy under perfect competition: by explicitly introducing entry costs and an element of uncertainty for all potential traders – factors that are crucial in determining the entry decisions of traders and ultimately, the outcome of trade policies – we show that neglecting the role of traders can lead one astray in evaluating the effects of various trade restrictions. Thus, the fundamental contribution of this paper lies in its implications for trade policy, which differ quite substantially from the norm.

In Free Trade Under Fire, Douglas Irwin points to two examples of large exogenous trade policy shocks that allow us to calculate the static benefits promised by the theory of comparative advantage:

In 1859, a bit of gunboat diplomacy by Commodore Matthew Perry ended two centuries of Japanese autarky and exposed it to foreign trade. Japanese prices converged to world prices, so the country became an exporter of silk and tea while an importer of cotton and woolen goods. Estimates of these gains from trade are as high as nine percent. (Daniel Bernhofen & John Brown, “A Direct Test of the Theory of Comparative Advantage: The Case of Japan,” JPE 2004, pdf; “An Empirical Assessment of the Comparative Advantage Gains from Trade: Evidence from Japan,” AER 2005)

In 1807, President Thomas Jefferson ordered an economic embargo to punish Britain for interfering with American ships on the high seas. This termination of trade raised the domestic price of imported goods by 33 percent and lowered the domestic price of exported goods by 27 percent. The static welfare loss was around five percent. (Douglas Irwin, “The Welfare Cost of Autarky: Evidence from the Jeffersonian Trade Embargo, 1807–09,” RIE 2005)

Neat.

Virginia Di Nino, Rosen Marinov & Nadia Rocha – “Trade Liberalization and New Exporters’ Size: Theory and Evidence”

This paper tests an empirical implication of Melitz (2003) in the context of falling trade costs, using the EU’s intensive liberalization phase (1993−2002) as a natural experiment. Contrary to the model’s predictions, firms that switch from non-exporting to exporting over the studied period are not concentrated in a particular size range. Our findings, based on a rich data set of French manufacturing enterprises, suggest scope for fine-tuning of the theoretical framework.

Available here (pdf).

“One of the fundamental tenets of free trade is that currencies should float — or at the very least, move along with market forces.” True or False? Explain.

Greg Mankiw discusses.

A new NBER working paper by Richard Baldwin and Daria Taglioni looks like an important extension of the Anderson-van Wincoop approach for trade gravity model fans:

This paper provides a minimalist derivation of the gravity equation and uses it to identify three common errors in the literature, what we call the gold, silver and bronze medal errors. The paper provides estimates of the size of the biases taking the currency union trade effect as an example. We generalize Anderson-Van Wincoop’s multilateral trade resistance factor (which only works with cross section data) to allow for panel data and then show that it can be dealt with using time-varying country dummies with omitted determinants of bilateral trade being dealt with by time-invariant pair dummies.

I’ll get a chance to read the paper next week when I have NBER access, and then I’ll know if “Gravity for Dummies” incorporated the “Log of Gravity.”