Inefficiency of redistribution

Dean Baker, in his new lecture on trade and inequality, raises an interesting point:

Most of the supporters of the current trade agenda, and especially the more liberal supporters of this agenda, do make a point of advocating redistribution from winners to losers, so that in principle at least everyone can gain from trade. As noted, this redistribution usually takes the form of retraining or readjustment assistance for workers who can demonstrate that they directly lost their jobs due to trade. Although, it has never really appeared as a serious proposition in political debate, in principle it would be possible to tax away enough of the gains from the winners to compensate all the people who lose from trade...

Most forms of trade readjustment assistance are relatively small items in the federal budget. For example, the 2008 appropriation for trade adjustment assistance is less than $200 million, approximately 0.006 percent of the federal budget.

By contrast, suppose that trade had the effect of lowering the wages of the bottom 70 percent of the wage distribution by an average of 2.0 percent, a relatively conservative estimate of the impact of trade on inequality. In this case, the amount of money that would have to redistributed from higher income people to low wage workers would be close to $50 billion annually, or 1.6 percent of the federal budget. This would be a qualitatively larger sum to raise in taxes, which perhaps explains the reason that no politician has championed this effort to date.

There is a second more fundamental point that needs to be addressed in assessing such large redistributions from the standpoint of trade policy. The argument for trade liberalization depends primarily on the claim that it increases economic efficiency. However, any revenue that is raised to pay for compensation from winners to losers will require taxes. These taxes will themselves be distortionary. While it is easy to say that the distortions that result from the taxes necessary to fund a $200 million job retraining program will not create enough distortions to offset the gains from trade liberalization, it is far from obvious that this is true if it’s necessary to raise $50 billion to redistribute to the losers from trade...

As a practical matter then, an efficiency minded economist would want to compare the efficiency gains from reducing tariffs, or other obstructions to trade, with the efficiency losses associated with whatever taxes might be raised, both to offset lost tariff revenue and also to compensate the losers from trade...

Of course once this step is made, it is far from obvious that reducing trade barriers will always increase efficiency. In some cases, import tariffs can be a relatively efficient form of taxation... In this case, it is far from obvious, and certainly not obvious apriori that trade liberalization coupled with an effective program for compensating losers is a net efficiency gain. In this scenario, one source of inefficiency is eliminated – the barrier(s) to trade—but another source of inefficiency had been added, the tax needed to compensate losers and possibly also to replace lost tariff revenues.

So trade liberalization with massive redistribution could swamp efficiency gains, and trade liberalization without massive redistribution is CLASS WARFARE, i.e. in fact what we have on our hands. Does business EVER wish it could return to the days when it was okay to talk about Keynesian effective demand-boosting policies? It makes the workers AND bosses happy. Instead, they want to advance trade policy that is either inefficiency-producing or very-near-to-zero-sum gains.

I also recently came across Bob Pollin's piece from the New Labor Forum on a jobs and policy program for the new president, which includes talk about needed tax reforms and regulations on businesses. He concludes on this note:

WE HAVE PROCEEDED THUS FAR WITHOUT MENtioning immigration, trade, the value of the dollar, or globalization more generally. How can a progressive economic program be taken seriously in 2008 without tackling these questions head-on? In fact, the intense debates around these questions are really primarily about jobs and living standards in the United States, and they should be refocused on these central matters of concern...

From the standpoint of U.S. workers, restrictions on imports and immigrants are a form of social protection, aimed at preserving the workers’ jobs and bargaining power by reducing the pool of foreign workers with whom they have to compete. U.S. workers deserve effective social protections. But restrictions on trade and immigrants are poor substitutes for an aggressive jobs program. They do not explicitly target the expansion of decent jobs, and it isn’t clear that, as indirect measures, they would succeed in significantly promoting job expansion in the United States. By the same token, the case on behalf of generally open trade and migration policies becomes much stronger when government policy is seriously committed to promoting decent jobs. An effective jobs program will not, by itself, eliminate all tensions around trade, immigration, and the dollar. But it could downgrade these issues to second-order concerns.

Pollin may be right on the economics of job creation, but he totally misses the point on the politics and substance of so-called trade policy debates in our country. He echoes some themes from Jamie Galbraith in the American Prospect from last year, who at least is good enough to dig a little deeper into foreign policy themes.

The reason to fight trade deals like NAFTA and CAFTA is not because manufacturing jobs are instantaneously created in their absence. (Although raising the relative price of foreign labor endowments embodied in imported products does diminish the cost differential currently undermining U.S. labor's competitiveness, something one would think would not be a taboo topic in a democracy dominated demographically by a 70% less-skilled work-force.)

The reason to fight these pacts is because they are a necessary first step in carving out and protecting policy space for having the domestic policy and regulatory battles that we would like to be having in a new progressive era in this country. This includes building regional industrial policies, green building initiatives, and enhanced product safety and corporate accountability. This is part of the reason why you see more than just the older-line industrial unions (god bless em) in this battle: in the Peru FTA fight, for instance, the biggest champions were the Teamsters, the electrical workers, Latino and development groups. None of these groups is obsessed with the traditional concerns that commentators have been imputing to the fair trade movement (unfairly) for decades.