Beggars, Neighbours, Free Riders and Free Traders : Buy-American Provisions

A lot of ink, virtual and otherwise, has been spilled over the last few days with respect to the “buy American” revisions to the Obama administrations 800 billion stimulus package.   In particular the whole of the Canadian continentalist establishment is up in arms, not to mention a good section of the respectable left.  Left or right in Canada it seems we are all continentalists and “free” traders now.  The question for Canadians is are we all Free Riders too?

On the one hand, for Canadians critical of NAFTA the buy-American provisions demonstrate once again that NAFTA was not quite the shibboleth that Canadian continentalists had hoped for.  Time and again when the going gets tough the Americans demonstrate their unwillingness to play by rules when it comes to free trade: soft wood lumber being and example of how American intransigence is actually reworded given the asymmetrical power relations between the US and Canada.  The buy-American provisions are just one more example of how despite what the Americans do, Canada will remain continentalists.  Is there anyone who actually takes the tough talk of Stockwell Day seriously?

On the other hand, it must be pointed out that the US has no obligation to introduce any stimulus at all.  If you listen to the right in the US like the Heritage Foundation you quickly realize that the necessity of stimulus (rightly or wrongly) is hardly a consensus position.  A policy of no stimulus would however amount to a beggar-thy-neighbour policy. That is, the US would be widely (and rightly viewed) as free-riding on other nations’ stimuli.

So how does a US stimulus package with the buy American provisions wash out on the free trade-autarky spectrum?   And it is a spectrum because no country can ever perfectly occupy one pole or the other.  Part of the problem lies in how even those who should know better explain the situation.  Paul Krugman argues thus:

“Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise. Yes, trade would be more distorted, which is a cost; but the distortion caused by a severely underemployed world economy would be reduced. And as the late James Tobin liked to say, it takes a lot of Harberger triangles to fill an Okun gap.”

That all sounds very good but there is a slip-up right in the first sentence “…if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy.”  However, the buy American policies do not attempt to contain the all of the effects of the stimulus within the domestic economy.  What they do attempt do is to contain the first round effects of the stimulus within the domestic economy.   That is, the buy American provisions are only partially protectionist in that they do not attempt to contain the second round effects of the stimulus to the domestic economy.

For example, imagine that a state government takes some stimulus money for an infrastructure program say 200 million.  The initial 200 million is spent on locally sourced material and labour but that is where the protection stops.  The incomes and profits earned from that 200 million is free to be spent (the second round effects) on any goods or service no matter of its country of origin (well ok not Cuba Iran or S-Korea).   Thus the second round effects of US stimulus will still leak out to the rest of the world.  It is so odd to see a New-Keynesian like Krugman miss this point given the whole basis of the effectiveness of stimulus relies on a multiplier.  The buy-American provisions do not apply after the first link in the chain of the multiplier.

Given the degree to which the production of goods and services is globally integrated and given that the buy-American provisions do not contain any calls for erecting barriers to trade in general such that the protectionism only applies to the first round effects of the fiscal stimulus it is hard to argue that this is the thin edge of Autarky’s wedge.

Moreover, there remains the problem of free-ridership by other nations.  The extreme case would be where the US was the only nation to engage in stimulus.  This is, of course, not the case other countries are engaging in stimulus of their own.  So the question of free-ridership comes down to degrees.  China, Japan and then the US have announced by far the biggest stimuli: well over 4 % of GDP (by some measures China’s totals 18% of GDP!  Cut that in half and it still pretty impressive).   Canada sits with Europe, including England, in the cheapo-seats not even managing to achieve 2% of GDP with their stimulus programs.   And curiously it has been Canada and Europe who have been crying the loudest about the tepid protectionist elements of the buy-American provisions.

If I was a US legislator I might conclude that Canadian continentalists were fair-weather friends as well.  And interestingly in Canada, the continentalist establishment which includes almost every major media outlet—including the CBC—was more than happy to focus on the buy-American provisions of the US stimulus package instead of focusing on how the inept, incoherent, ineffective and paltry Conservative stimulus package meant that Canada was basically hoping it could have an economic recovery on the cheap by begging-off of Asia and the US.

Such, I suppose, is the state of nationalism in Canada.

Stimulus as a % of GDP

Japan: (+/-) 15
China: (+/-) 9-18
US: (+/-) 5-7
Germany: (+/-) 1-2
France: (+/-) 1.4
UK: (+/- ) 1.1
Canada: (+/-) 1.5 *Reuters


Hey Dalton do you think you could display your desperate hand any more blithely? Can you really find nothing in the agreement that you would like to see improved? You would be against strengthening labour rights in the agreement? You would be against strengthening environmental protection? You would be against including soft wood? You would be against dealing with US agricultural subsidies? You can’t think of one thing you would want to see improved in NAFTA?

And if you really can’t, and if you really just want to keep the deal as is, and you really believe either of the two democratic clowns would actually renegotiate NAFTA, why would you write an article in the FT displaying just how desperate your position is if you sincerely believe Canada might have to sit at the negotiating table in the future?

It is one thing to be governed by evil men, it is quite another to be ruled by fools–to paraphrase Plato.

I think foreign trade falls under federal jurisdiction best you keep to your provincial bailiwick.

Social protection as an unfair subsidy?

Travis Fast

The Globe and Mail is running an article online
in which it is reported that the WTO is reviewing EI as a potential unfair subsidy to the fishing industry.

While there are lots of problem with the way EI / UI has been used as a poor stand in for regional economic development in the Maritimes, even the thought, however, that the WTO could consider social protection as an unfair subsidy to industry is both hogwash and dangerous.

This just opens up a Pandora’s box of problems. Is universal health insurance an unfair subsidy? Think about it. Why should a US company which has to shoulder some of the cost of its employee’s healthcare have to compete against a Canadian company which does not?

By employing such logic any number of social programs and supports could be declared trade and investment distorting. The good news is that despite what the Cons would like to happen—i.e. the WTO made us kill social protection—this dog will not hunt with the Europeans or with the many other nations.

That said, it is fine display of just how corrosive the managed trade and investment regime we now have under the WTO is. At a time when Free Trade dogmatists are pumping out reams of paper warning of a growing tide of sentiment against that great oxymoron called free trade, this is indeed bad timing.

If the free traders at the WTO do not want to be unmasked as vicious apologists that the they are, then they should decline this dance. Nothing could be worse PR.


Travis Fast 

There is an engineered recession in the offing with the US first place in the queue.  They (everyone from the FED to the editors at the FT)  are trying to sell it as a short six month respite. But though they may be masters of the universe it is going to take longer than that to coerce adjustment and work-off the overhang.  

First housing (durables), now autos (semi durables) and eventually terminating in non-durables: this is the familiar pattern. And that cannot be achieved in 6 months.  Given the new rules on bankruptcy in the US are matched with record levels of consumer credit and rising defaults it is going to take longer for the consumer to recover. Now add to that the eventuality of rising employment and stagnating wages as the recession sets in, and 6 months looks fanciful indeed.  

The good news in all this is that it is the markets and those who operate them who are to blame.  Unlike the last recession which was blamed on the fat welfare state and welfare queens that political dog is not going to hunt this time around.  What about Globalization? They can’t blame free trade because there is an easy solution to that: managed trade.  Well actually we have a managed trade regime right now but the question that dare not speak its name is “for whom is it managed?”  

The bad news is that people rarely blame abstractions like the markets .  Populist politics is most usually fought on the terrain of identifiable groups (minorities , immigrants) and institutions  (Unions , the welfare state). 

If I were part of the populist left my political holy  trinity would be Financial institutions such as, central banks and consumer credit agencies, a delinquent regulatory state, and mainstream economists (mostly because people need more than institutions to blame and after all economists have been the central cheerleaders in all of this).    

Hey Krugman it just ain’t so: get unreal

Travis Fast

I go away for one week and a simple article in the Nation has brought out the Dons to defend orthodox economics. Who leads that advanced charge you ask? Well not the “red in the tooth and claw” Chicago boys but their more cosmopolitan and media savvy brethren like Paul Krugman. And I say brethren because despite Krugman’s protestation to the contrary he is very much one of them: a real economist.

After participating as a partisan in the “state failure school” in an attempt to remain significant in the wake of a seismic shift in economics during the eighties and nineties. And after having loudly shilled for free trade by acting as though free trade benefits all, albeit whispering that some non-market distorting program of redistribution was required to spread the benefits to the losers. Now, Krugman assures us that there is nothing to the basic neoclassical model which tilts the public policy balance in favour of capitalism over democracy, or inequality over equality. Krugman of course knows better than this. For what else could explain all the triangulating he has done over the course of his career in an attempt to remain relevant? Why now is he willing to shout that gains from trade require government intervention, while only whispering that there are gains to be had? What is that you feel at your back Paul, the winds of change?

Check out this piece of dissembling from Krugman:

The other is the effects of trade on income distribution. Anyone who thinks that neoclassical economics says that everyone gains from free trade, and that you have to reject the assumptions of the field to raise concerns, obviously doesn’t know anything about the subject: ever since Stolper-Samuelson 1941 we’ve known that trade can easily hurt large numbers of people, so the question is always an empirical one. A dozen years ago I thought the effects were small, but that was based on the numbers, not a judgment in principle. Now I’ve revised my views up, because the numbers are bigger.

Now I do not know what Krugman was teaching to his undergrads; and this is key because it determines the most unnatural selection process of who goes on to grad school in economics, and I do not know what made it into his new intro text, but this strong of a position never made it into any of the articles when the big free trade debates were going down. He tells us as much when he states: “A dozen years ago I thought the effects were small, but that was based on the numbers, not a judgment in principle. Now I’ve revised my views up, because the numbers are bigger.” Ah you see, at the time the numbers said one thing, now they say something else, and like a good scientist (empiricist?) professor Krugman has amended his position. Comforting as it is that such a positive exercise like neoclassical economics can predict such rosy outcomes and then fail so miserably once the real data is in, or as the song lyric goes: “once the needle is in and the damage is done,” we can’t let Krugman off that easy. For there is a contradiction in Krugman’s defence.

Indeed, Krugman’s claim that for neoclassical trade theory “the question is always an empirical one” rings churlish to my ears—that is, of course if notes could prevaricate. Just what empirical data was Krugman looking at back then? If this was pre free trade data then how could it have much relevance for predicting post free trade outcomes. In order to do that Paul needed a model, for it is only a model that can transform the input into a predictive output. And by his own admission, the output was junk. In such a case, there are only two options; (a) either your input data was junk and your model was sound—junk in, junk out—or (b), your input data was good and your model was bad–angels in, devils out. Well I suppose there is a third option: (c) both the input data and the model were junk.

How do we know which one was the case? A little analytical logic can help us. Paul tells us that he is a dyed in the wool empiricist when it comes to trade: “just the facts ma’am, and only the facts.” Hence, the input data must have been good. But Paul tells us, that with hindsight, the output data (the prediction) was bad. Therefore, a simple process of elimination means that his trade model must have been junk—angels in, devils out.

Paul should not feel bad because almost every vintage of the standard trade model that were being used to bolster the case for free trade back then shared one thing in common: they all predicted minuscule to minimal negative effects. A coincidence? I should think not.

And is this not the very basis of the dispute that is now fluttering around the internets between heterodox and orthodox economists? Paul tells us that the methodology is neutral, that one can arrive at any number of policy conclusions from it, and yet orthodox economists almost always seem to come down in favour of policies that preserve the greatest field of choices for what Marxists would call owners of the means of production (capital), and thereby less government regulation and less democratic direction of the economy. See Paul the problem is not that we know nothing about the subject as you contend, it is just that we are not buying what you are selling. I know, I know, you are not selling anything…in that case come back when you have something new to sell.

There is room for hope however. In the 2007, AEA Presidential Address, Akerlof demonstrated the existence of identity (the objectiveness of subjectivity–existence if you like). Let us hope it does not take Paul the same amount of time it took him to finally digest Storper-Samuelson 1941.

As an aside, I look forward to the AEA Presidential Address of 2050 wherein some bright aging orthodox economist will discover society exists: then we will really be cooking with gas.

Two links to this commentary:

Je m’appelle comparative advantage et je suis tombé

Travis Fast

Some months ago I gave a talk on “what is neoliberalism.” And there I made reference to the curious mental gymnastics now being played by liberal economists in their attempt to square their faith in free trade with the actual outcomes being generated by free trade. Shameless I know, but I am going to quote myself at length.

Save one critique I will not take the time here to rehearse all the limitations inherent to the basic neoclassical model as they are well known and described elsewhere in great detail. The neoclassical methodology necessarily leads to a process of abstraction that produces an ‘other-worldly’ ontology of capitalism. That is, the neoclassical model starts not with an axiomatic reduction of existing capitalism(s) and the behaviour of different classes and countries who occupy different structural locations and therefore have widely diverging utility functions on that basis alone, but, rather, with a series of axioms derived from an idealized economic system and a single representative agent. There is a basic problem involved when deriving an analysis not from what ‘is’ but from what ‘ought to be’ and declaring what ‘is’ to be a aberration from the ‘ought.’ To be clear, this is not a problem of modelling: all models are a parsimonious rendition of more complex phenomena. The neoclassical problem resides with deriving one’s analytical model from a trans historical and trans spatial meta-model when one’s object is both time and space bound.

For example, take the theory of comparative advantage upon which arguments for free trade are based. When Adam Smith outlined his defence of free trade he did so by making both a political and an economic argument. Economically he built his case on considerations of absolute costs (the idea that between two identical products the cheaper of the two should be purchased without regard to its national origins). Smith argued:

If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage. The general industry of the country, being always in proportion to the capital which employs it, will not thereby be diminished, no more than that of the above-mentioned artificers; but only left to find out the way in which it can be employed with the greatest advantage. It is certainly not employed to the greatest advantage when it is thus directed towards an object which it can buy cheaper than it can make.

Equally important however, Smith also argued for free trade on political grounds. He argued that a policy of free trade would prevent particular interests (one industry or sector) from gaining tariff protection and thereby directing a greater part of the social surplus into their pockets at the expense of society as whole. Free Trade was to be supported as a political principle because it prevented the formation of domestic monopolists who would not only use their privileged status to capture more of the social surplus but would also use their enhanced standing and resources to capture the state. Smith summarizes his argument thus:

This monopoly has so much increased the number of some particular tribes of them that, like an overgrown standing army, they have become formidable to the government, and upon many occasions intimidate the legislature. The member of parliament who supports every proposal for strengthening this monopoly is sure to acquire not only the reputation of understanding trade, but great popularity and influence with an order of men whose numbers and wealth render them of great importance. If he opposes them, on the contrary, and still more if he has authority enough to be able to thwart them, neither the most acknowledged probity, nor the highest rank, nor the greatest public services can protect him from the most infamous abuse and detraction, from personal insults, nor sometimes from real danger, arising from the insolent outrage of furious and disappointed monopolists.

We can conclude with Giovanni Arighi that it is a pity that Smith is often quoted but never read by our beloved liberal economists. By using Smith’s simple axiom about the tendency of powerful cartels of capital to capture the state and thereby shape public policy with respect to their own benefit we are moved closer to the reality of the political economy of liberal democracies then any axiomatic description of comparative costs will ever take us.

We can usefully contrast Smith’s promotion and defence of free trade with that offered most famously by David Ricardo and which has subsequent to Ricardo been turned into the iron law of comparative advantage upon which the near universal dogma of free trade is today based. Ricardo’s defence of free trade represents a hollowing-out of the substantive content of the reality of the political economy of capitalism. The Ricardian argument for free trade is grounded not on a general political insight about the realities of the tendency of individual capitalists to capture the state in pursuit of their narrow self-interest; nor on the real processes of capitalist competition which is ruled by considerations of absolute costs but rather on the technical merits of specialization and the potential gains from trade rooted in the concept of comparative advantage and relative prices.

As is well known, Ricardo demonstrates that gains from trade can be made even if one of the two nations involved entering into a free trade agreement is relatively backward in all branches of industry. To make a long story short, for Ricardian comparative advantage (and all subsequent iterations) to hold there must be a monetary mechanism which adjusts the terms of trade between two countries such that eventually at least one good in the least developed country can be exported competitively. Should this monetary mechanism not operate as such then the whole Ricardian law of comparative advantage is rendered nothing more than a scholastic enterprise with some merit as an intellectual puzzle which is applicable to a null domain. In order to illustrate more clearly what I mean here it is useful to provide a contemporary example.

One of leading lights of American neoliberalism, Brad Delong recently penned an article entitled “Has Neo-Liberalism Failed Mexico?” Delong’s immediate answer to his question is ‘yes free trade has failed Mexico’, as he observes:

…the 3.6% rate of growth of GDP, coupled with a 2.5% per year rate of population increase, means that Mexicans’ mean income is barely 15% above that of the pre-NAFTA days, and that the gap between their mean income and that of the US has widened. Because of rising inequality, the overwhelming majority of Mexicans live no better off than they did 15 years ago. (Indeed, the only part of Mexican development that has been a great success has been the rise in incomes and living standards that comes from increased migration to the US, and increased remittances sent back to Mexico).

Delong tellingly goes on to reflect:

Intellectually, this is a great puzzle: we believe in market forces, and in the benefits of trade, specialization, and the international division of labor. We see the enormous increase in Mexican exports to the US over the past decade. We see great strengths in the Mexican economy – a stable macroeconomic environment, fiscal prudence, low inflation, little country risk, a flexible labor force, a strengthened and solvent banking system, successfully reformed poverty-reduction programs, high earnings from oil, and so on. Yet successful neoliberal policies have not delivered the rapid increases in productivity and working-class wages that neo-liberals like me would have confidently predicted had we been told back in 1995 that Mexican exports would multiply five-fold in the next twelve years.

Delong concludes his article without providing any indication of why he thinks free trade failed Mexico. Undoubtedly this is a complicated question of which no attempt will be made to provide a rigorous answer here. However, I would nevertheless like to suggest why neoliberal trade theory failed both the patient (Mexico) and the practitioner (Delong).

Where to begin? First off, leaving aside all the assumptions required to make the theory of comparative advantage yield its sanguine conclusions about the benefits of free trade – perfect competition between infinitesimally small firms that maximize profit and are price takers, perfectly mobile factors including labour, full employment of all resources in particular labour, zero transportation costs, homogeneous product markets, well behaved if not identical production functions and the like — there is the issue of the monetary mechanism which establishes relative prices between the two countries in such a way as to make the backward country competitive in a least one industry. Now even if we grant that something like the quantity theory of money is true or that some reasonable facsimile thereof (in terms of directing relative prices including interest rates) is the general case (which is empirically doubtful) there is simply no way in which the relationship between the US and Mexican currencies and interest rates can be said to mechanically adjust in that way.

The US dollar is not just any other currency, it is the international numeraire and fountainhead of the international financial system. And what is more, the US is not just any other country given its shear weight in the global economy. The US dollar enjoys the status it has, not because the US is the most productive country in the world, but, rather, because the US is the lone hegemon in a unipolar world. What attracts global savings to the US is only partly explained by economic fundamentals while the rest is explained by political realities which make US assets, in particular US treasury bills, some of the most risk free in the world. Hence, both the value of the US dollar and the US interest rate reflects an amalgam of factors that have almost nothing to do with the relative productivity between the US ands Mexico, nor with the health of their respective balance of payments. On this rather obvious observation alone (obvious insofar as even a cursory glance at the twin US deficits, US interest rates and the value of the US dollar reveals a less than tenuous link between them) it should be clear that the very mechanism that is said to reveal comparative advantage and force movement toward those industries, both in terms of capital and labour, does not exist.

If we were to add to the above observation all the ways in which the starting assumptions of the neoclassical trade model were violated it would not be long before our model became a near useless guide as to the likely path of adjustment upon the opening of free trade between Mexico and the US and its likely impact on income distribution. Even, however, if we are to disregard all these inconvenient facts there is the further issue of the substantive content of free trade deals. It is as if neoliberals like Delong think that free trade deals are an exercise in moving from a position of autarky to a position of complete free trade (the absence of any and all barriers to trade). As anyone familiar with NAFTA or indeed the present Doha round of world trade negotiations can well attest, free trade deals are anything but agreements to remove all the barriers to trade. Such deals decrease some tariffs, eliminate others, and leave others in tact not to mention all the ingenious forms of trade distorting policies nations come up with to protect particular industries and sectors after the deals are inked. Moreover, they do so in a way that reflects the relative hierarchy of the contracting parties in the international economy. In short, trade deals themselves have a political economy and this is nowhere truer than in ‘free’ trade deals that involve the US and the EU.

In such a world, a capitalist world I should add, the problem with neoliberal economics is not merely a problem of poor modeling but rather reflects a terminal problem with the very ontology of capitalism upon which its modelling exercises are carried out – the problem my dear Bradford is not in you but in the heavens of your ontology. All of the above speaks to the central reason why neoclassical (liberal) economics is not altogether very useful for understanding the political economy of neoliberalism although a critique of it can be quite revealing as an exercise in de-mystification.