Going Global

One thing that we should consider as we revise each of our sections (I made this point earlier today but I think this is a better example) – how do the purposes of macro theory intersect, and what are the consequences of failure in one area?

This article I think makes an interesting point in that direction (there’s a paywall but you can get past it using incognito mode on Chrome). It argues that the way economists teach comparative advantage and trade theory is misleading because it misses the distributional effects of trade agreements. We’re often taught comparative advantage using very simplistic assumptions – the Ricardian model of free trade assumes that workers and factors can easily switch between two different goods.

In reality, the economy is more complex. Comparative advantage may mean that the economy as a whole is better off (the economic pie may get bigger) but the losers of trade may end up with a smaller slice of the pie than they had before trade. BUT because people had been taught that trade makes everyone better off, programs like trade adjustment assistance quietly failed the workers losing their jobs to trade.

The point here isn’t that our models have failed to explain who wins and loses from trade. They seem to be doing a pretty good job of it; in the U.S., low skilled workers lose and higher skilled workers win from globalization. The problem is that the way we use these models to teach students about trade results in bad policy-making because those in charge simply conclude that “because trade results in a bigger overall economic pie, the distributional effects are less important.”

Some of the problem here might stem from conflation of welfare/efficiency and total utility. The economic pie may be at its biggest without redistribution (when it is at its most efficient) but redistribution may be better for total utility (which is admittedly hard to measure). Redistribution may cause the overall economic pie to shrink due to dead-weight loss,  but more people are better off because the marginal utility of $1 to someone making $30k a year is greater than the marginal utility of $1 to someone making $100k over the same time.