International Trade and the Welfare of the American Dream

By Lara Loewenstein Note: The essay prompt asks about both international trade and the globalization of finance, butin my opinionthose are two very different questions. For the benefit of coherence and quality I have chosen to address only the international trade of goods and services. All figures and tables appear at the end.

Perhaps more than citizens of any other country, Americans view inequality as much as a symbol of potential as a sign of distress: attaching to inequality a promise that socio-economic circumstances are not stagnant. Embodied best in the American Dream, this belief is twofold: implying that one can continue in the footsteps of one's parents, reaping the same rewards and maintaining the same traditions or, alternately, that with hard work and perseverance one can improve their lot, forging a better life for oneself and one's family. This paradoxical dream of stasis and change became a motivating concept, especially in manufacturing sectorsthe backbone to America's unprecedented growthwhere hard, unskilled work paid a decent wage and children, at worst, looked forward to the same. But increased international trade (see figure 1), is threatening this dream. Children are no longer guaranteed the same prospects as their parents: those hard, unskilled jobs are disappearing and workers are finding themselves out of a job, cast into an uncertain future where the skills they have developed have become automated or outsourced and the skills they need to succeed feel unattainable. In contrast to this dire portrait, economists almost uniformly agree that free trade is good: a consensus based on the idea that trade increases welfare, both nationally and globally. But the welfare that economists refer to is total welfare: the sum of the welfare of each individual. Economists make no effort to hide the theoretical and empirical evidence that trade increases income inequality and may have temporary negative consequences for the average American. While this seems heartless, it is important to recognize that international trade has greatly improved living standards and created ample opportunities for individuals who know how to find them. The American dream may be shaken, but it is far from dead. Benefits of Trade Everyone in the US benefits from the availability of an increased variety of cheaper manufactured goods imported from other countries, but some of the benefits of trade are less visible. I benefit from less expensive electronic productssuch as the macbook on which I am writing this essay, which contains parts sourced from a variety of countries and was assembled at a Foxconn factory in the special economic zone in Shenzhen, China. 1 Supply chains have made many products that are developed in the US cheaper to produce and consume. But furthermore, supply chains have necessitated the creation of a new sector replete with jobs and prestige: supply chain management (see figure 2),2 only one exampleamong many3of opportunities created as a result of trade.
1 Glass, Ira (2012). This American Life: Mr. Daisey and the Apple Factory. National Public Radio. Last accessed: January 9, 2012. http://www.thisamericanlife.org/radio-archives/episode/454/mr-daisey-and-the-apple-factory Note: For a more substantive source with similar information, see Apple's reports on its production processes, but this episode of This American Life was fact-checked by NPR and is worth listening to. 2 Wailgum, Thomas (2008). Supply Chain Management Definition and Solutions, CIO.com. Last accessed: January 12, 2012. http://www.cio.com/article/40940/Supply_Chain_Management_Definition_and_Solutions 3 Others include language and communication skills and logistics management, but also sectors that are strong exporters such as manufacturing, maybe surprisingly the sector that exports the most from the US, and services, in which the US still has a trade surplus (source: http://www.uschamber.com/international/agenda/benefits-international-trade-and-

People also benefit from the increased creation and spread of inventions and ideas. Open borders force countries to interact and communicate and as a consequence knowledge spreads. One such exampleamong billionsis paper, which was invented in China and traveled along trading routes to the Islamic world before it became known to Western Europe. 4 Other ideas are more simple, but often more important for quality of life, e.g. that contaminated water spreads cholera. Aside from facilitating the movement of ideas and goods, trade also increases the demand for them, creating a feedback loop, which both incentivizes people to innovate while providing them with opportunities to do so. For example, there is little incentive for pharmaceutical companies to invest money and effort into developing treatments for rare diseases. But the number of people in the world with a rare disease is far greater than the number in the US and access to those larger markets makes research and development economically viable. 5 Costs of Trade While international trade affects everyone differently, it is almost inescapable that, in general, it disadvantages lower skilled workers.6 Unfortunately, with only 40.3 percent of US citizens aged 25 to 64 having an associate degree or higher in 2007 7, this implies that the median person has a high school diploma at best qualifying them only for unskilled work. To be frank, prospects for the median seem bleak. Since the 1970s inflation-adjusted median income growth has slowed 8 and in the last decade, it has even declined (see figure 3).9 Whether or not this is caused by increased trade or some other phenomenon such as a slowdown in technological innovation 10 is unknown, but there is strong evidence that trade has some negative effect on income distribution 11 and that those who lose their jobs due to outsourcing are especially hurt12. A macroeconomic crisis affects everyone, and trade makes the US vulnerable to crises in other countries. Oil and turmoils in the Middle East immediately come to mind, but a glaring example of how a crisis in one country can cause a chain-like reaction to shut down trade worldwide is The Great Trade Collapse (GTC), which occurred between the third quarter of 2008 and the second quarter of 2009. It was sharpest collapse in world trade in recorded history and the deepest since World War II (see figure 4). Trade did not fall by as much as it did during the Great Depression, but the fall was much steeper: the same fall in trade that took 24 months during the Great Depression, took only 9 months during the GTC. The collapse was also almost uniform across countries and goods. It was
investment) 4 Burns, Robert I (1996). Paper Comes to the West, 8001400, Tradition and Innovation, pp. 413422 5 Alex Tabarrok makes this argument in his recent TED book: Launching the Innovation Renaissance: A New Path to Bring Smart Ideas to the Market Fast 6 For a great aural description of the difference between skilled and unskilled labor, listen to the recent Planet Money Podcast The Past and Future of American Manufacturing, which can be found at http://www.npr.org/blogs/money 7 Lee, John Michael Jr. & Anita Rawls (2010). The College Completion Agenda 2010 Progress Report, College Board Advocacy & Policy Center. 8 Kenworth, Lane (2008), Slow Income Growth for Middle America, Consider the Evidence, 3 September. Last Accessed: January 11, 2012. http://lanekenworthy.net/2008/09/03/slow-income-growth-for-middle-america/ 9 Leonhardt, David (2009), A Decade with no Income Gains, Economix Blog, New York Times, 10 September. http://economix.blogs.nytimes.com/2009/09/10/a-decade-with-no-income-gain/?pagewanted=all 10 Cowen, Tyler (2011), Innovation is Doing Little for Incomes, New York Times, 29 January. Las accessed: January 11, 2012. http://www.nytimes.com/2011/01/30/business/30view.html?_r=1&src=busln&pagewanted=all 11 Krugman, Paul (2008). Trade and Wage, Reconsidered, Brookings Papers on Economic Activity, Spring 12 Hummels, David, Rasmus Jrgensen, Jacob R. Munch & Chong Xiang (2011), Offshoring, inequality, and the value of college degrees, VOX, 10 December. www.voxeu.org

triggered by and helped spread The Great Recession. 13 One explanation is that supply chains allowed for more coordinated reductions in output as companies delayed orders in response to an uncertain future. However, while the GTC implies that the US is more vulnerable to economic downturns, it also implies that it is in a better position to take advantage of upswings since growing economic partners increase demand for US exports.14 The Net Effect It is very easy to qualify the positive and negative effects of trade, but very difficult to quantify them. An obvious place to start, is the effect of trade on wages. There was a significant amount of empirical work done on this in the 1990s (see table 1). All of these studies predicted a modest impact of trade on the skilled-unskilled wage ratio in developed countries, but the last data point used was never later than 1995. There have been a couple studies since that update the estimates using new data, but most notably, Paul Krugman recently revisited the question. 15 He notes that world trade has changed drastically since the 1990s. There has been a dramatic increase in the imports of manufactured goods by developed countries, which has involved a peculiar concentration in apparently sophisticated productsmost likely the result of supply chains and vertical specialization 16which greatly complicates the nature of trade. Krugman concludes that while it is likely that the rapid growth in trade since the early 1990s has had significant distributional effects, to put numbers on these effects would require a much better understanding of the increasingly fine-grained nature of international specialization and trade. If we cannot even estimate of the effect of trade on wages, how can we expect to have an accurate estimate of the net effect of trade on the median? We cannot. But we can make an informed guess as to the sign of the net effect. Given everything discussed so far, I propose that the effect is positive. If this seems surprising, remember that the positive effects come in the least quantifiable forms while the effect on wages is probably negative, so it is easier to imagine a negative impact overall. But we cannot ignore the historical importance of trade to economic growth and quality of life. Even if the effect on wages is significantly negative, it cannot outweigh the other improvements. Despite trade having undeniably enriched and lengthened the lives of everyone, any cost-benefit analysis is going to exaggerate the benefits to the average person because it will never include the emotional cost of living in an uncertain, shifting world. The helplessness and betrayal felt by someone who has lost their job due to outsourcing is impossible to quantify. This is the drawback to any costbenefit analysis: it is a cold, inhuman exercise that is meant to produce a single number that invariably leaves one wanting. Policy Implications There are policies in place in the US to help those hurt by trade. Recently prominent in the media was the Trade Adjustment Assistance (TAA). Workers file a petition to get certified as a tradeaffected worker to receive benefits such as reemployment counseling, job search or relocation

13 Baldwin, Richard (2009) The Great Trade Collapse: Causes, Consequences, and Prospects. A VoxEU.org publication. 14 Another, somewhat related, concern, is that of global imbalances: the high savings rate in Asia and the low savings rate in the US that correspond to the US's trade and budget deficits. Some economists claim that this will lead to disaster at some point. Whether or not that is true is debatable and is too complex to be explored fully in this essay. 15 Krugman, Paul (2008). Trade and Wage, Reconsidered, Brookings Papers on Economic Activity, Spring 16 The specialization in one component of a production process, e.g. assembly.

allowances, training, income support, and a health coverage tax credit. 17 Despite seemingly good, it is not clear why the TAA is separate from regular unemployment assistance. If the US had a strong enough safety net for the unemployed, then TAA would be redundant and it almost appears that TAA exists simply to provide politicians with a talking point in response to complaints about trade liberalization, or because providing assistance to those adversely affected by trade is more palatable to voters than helping the unemployed en masse. More problematic, is that the TAAor any unemployment insurance programis just a palliative. If the US wants to improve its economic standing and the outlook of the average worker, it should promote the development of the skills the US economy could use most. These might include language and communication skills since globalization invariably requires them. Or, more dramatically, it could mean a shift from subsidizing liberal arts higher education to investing in a German-style apprenticeship program. It is not clear that the standard liberal arts education provides students with the skills necessary to succeed. For example, in 2009, American universities graduated 94,271 students with psychology degrees when there were just 98,330 jobs in clinical counseling and school psychology in the entire country.18 That latter figure is not new jobsit is total jobs! And graduates with skills for which there are no jobs are less likely to create the kind of innovations that drive economic growth. Evidence for this is the fact that inflation-adjusted earnings have fallen for every educational group except for doctors, lawyers, MBAs, and PhDs19. Apprenticeships would allow people to develop the on the job technical know-how to better help themselves and the US thrive. 20 Conclusion While the concept backing the American dream may not be uniquely American, it is profoundly American. It is celebrated in gameshows promising instant celebrity and wealth and is championed in Alger-esque biographies of inventors, businessmen, and politicians. And it is difficult for Americans to accept any change in its promises. But an unfortunate consequence of the American dream stems from its celebration of the individual: the impression it gives that successful people are singularly responsible for their own success. If that were ever true, it is certainly not true anymore. The world is a much more complicated placetechnically, socially, economicallythan it was even a hundred years ago. Progress today requires collaboration; it requires the exchange of ideas; it requires trade. But economies are still transitioning to this new world, leaving citizens with a sense of economic uncertainty. The United States cannot hang onto the pastit is still, undeniably, the leader of the Western worldbut the US can set an example by not forgetting that it owes its success, at least in part, to a dream: a dream that motivated its citizens more than any propaganda machine or whip ever could. And while all the promises of the original dream cannot be kept, the dream can be kept alive by making sure not to leave too many people behind and by ensuring that at least a partthe part about forging a new life with hard work and perseverancestays intact.

17 Trade Adjustment Assistance (TAA) and Alternative Trade Adjustment Assistance (ATAA) Services and Benefits. United States Department of Labor. Last accessed: January 9, 2012. http://63.88.32.17/tradeact/benefits.cfm 18 US Bureau of Labor Statistics' Occupational Employment Statistics 19 Wessel, David (2011), Only Advanced-Degree Holders See Wage Gains, Real Time Economics Blog, Wall Street Journal, 19 September 20 For examples of the kind of on-the-job know-how a current skilled job in manufacturing requires listen to the recent Planet Money Podcast The Past and Future of American Manufacturing, which can be found at http://www.npr.org/blogs/money

Figure 1. Trade-to-GDP Ratio, 19702005

Source: OECD Macro Trade Indicators

Figure 2. Mentions of Supply Chain Management in books since 1900

source: http://books.google.com/ngrams/

Figure 3. GDP per capita and median family income, 19472007

source: Figure copied from Lane Kenworthy's blog Consider the Evidence; Data originally from US Census Bureau (http://lanekenworthy.net/2008/09/03/slow-income-growth-for-middle-america/)

Figure 4. The great trade collapses in historical perspective, 1965 - 2009

Source: Figure copied from the VoxEU.org publication The Great Trade Collapse: Causes, Consequences, and Prospects; Data originally from the OECD Quarterly Real Trade Data

Note: Table originally from Krugman, Paul (2008). Trade and Wage, Reconsidered, Brookings Papers on Economic Activity, Spring