Excellent article on protectionism in Foreign Affairs

It took me a while to get around to the July/August issue of Foreign Affairs (journal of the Council on Foreign Relations). Interesting episodes in the souring of West-Western Communism relations (I’m not sure how to describe it):

The Ukraine is just wasting perfectly good health-care or child-services money (they truly are like the rest of us), but Russia’s isolationism is quickly becoming quite stark. If Bush employs his North Korea diplomacy, I imagine he’ll just pretend Russia doesn’t exist, while invading Iran. It should all go exceedingly well.

But back to the very good article in Foreign Affairs:

A New Deal for Globalization

Globalization has brought huge overall benefits, but earnings for most U.S. workers – even those with college degrees – have been falling recently; inequality is greater now than at any other time in the last 70 years. Whatever the cause, the result has been a surge in protectionism. To save globalization, policymakers must spread its gains more widely. The best way to do that is by redistributing income.

Non-increasing real incomes is not news, but it is nice to see it addressed more widely, as well as the false meme that wealth is exploding for all of us (in some of our faces, in fact). Electorally, the feeling is more and more that globalisation is too much for us, and protectionist tendencies are on the rise.

Advocates of engagement with the world economy are now warning of a protectionist drift in public policy. This drift is commonly blamed on narrow industry concerns or a failure to explain globalization’s benefits or the war on terrorism. These explanations miss a more basic point: U.S. policy is becoming more protectionist because the American public is becoming more protectionist, and this shift in attitudes is a result of stagnant or falling incomes. Public support for engagement with the world economy is strongly linked to labor-market performance, and for most workers labor-market performance has been poor.

The best way to avert the rise in protectionism is by instituting a New Deal for globalization — one that links engagement with the world economy to a substantial redistribution of income. In the United States, that would mean adopting a fundamentally more progressive federal tax system. The notion of more aggressively redistributing income may sound radical, but ensuring that most American workers are benefiting is the best way of saving globalization from a protectionist backlash.

Just what the “war on terror” reference is for, I don’t know (?). The problem, though, is an example of economic rationalism – the assumption in basic neo-classical economics that economic agents (you) are fully-informed, and making rational decisions. Why are we blaming globalisation and China for something that ought to lie, first, at the feet of good old US of A manufacturers and other industry, and the government? Is the US just some weak crybaby? Other countries are in the global market and doing fine (so fine in Australia, in fact, we’re going to fall apart if we vote for the wrong party).

Actually, I find the crying about the harshness of international trade, by a country (i) so subversively protectionist as the US, anyway, and (ii) so tough-posing, near enough to ironic to qualify, by modern standards.

Trade Protectionism

As it is called – which I don’t like much. Trade Preventionism is more appropriate, for it protects very little. At best it forces consumers to pay very high amounts to keep relatively few jobs in the hands of American workers, without offering them a choice in the matter.

Consider the two basic approaches to protectionsim – tariffs and quotas. Tariffs are a tax on imports. Quotas are a strict limit. Both are designed to increase the price of imported goods, when the world price of something is less than the US price. They are ‘preventionist’ because they amount to a withdrawal from international competitiveness, and favour focussing solely upon the ability of domestic producers to make money in a skewed domestic economy.

Consider the basic example (you’ll find this over at Wikipedia):

tariff graph

If we call this the US, we have a domestic equilibrium price of USD70, with Y* being sold and Producer Surplus (you can consider it profit, for our purposes) equal to the LAB triangle.

Enter international competitors, though, and the price drops to the world price Sw = $50. Now we’re buying Y2, but we’re importing the amount (Y2-Y1). US producers are only selling Y1 at $50, and their Producer Surplus has fallen to the triangle LFG.

Now we know where protectionism comes in. Those producers hire some lobbyists. They complain about this loss of Producer Surplus, loss of money, loss of American jobs as production scales back from Y* to Y1, etc. Similarly we complain to our representatives, either as our jobs are lost or our wages, benefits, etc. are scaled back. Either way, pressure is on the government to defend us against the evil world supply curve Sw.

Suppose – as in this case, a tariff is introduced. A tax of $10 per item on imported goods. The world price Sw = $60, now. We only consume Y4, and we only import (Y4-Y3) because US producers can now sell Y3, up from Y1. Producer Surplus increases to the area LCD, and we have more jobs, and (possibly, though unlikely) higher wages and benefits.

Now the flipside – who pays for this? Being a tariff, the government actually makes money from this (in the case of a quota, restricting imports will have the effect of increasing the price, but the government won’t make any money). Instead of Producers and Workers, what about the effect on you as a Consumer? What once was $50 is now $60. What you once consumed Y2 of, you now consume only Y4. Your Consumer Surplus was only the area KBA without trade, was KJF with free trade, and declines now to KEC with restricted trade.

You’ve lost out. Have you lost money? Consumer Surplus is hard to quantify, still less monetise. Think of it as the difference between what you would have paid be what the price was (so, ladies? When men make fun of you arguments about saving money buying shoes on sale, you are in fact behaving rationally. So kick them in the nuts). The loss in Consumer Surplus overall, though, can be. The areas of those triangles are money: Price x Quantity (halving one axis, yes I know).

The textbook I use for Economics lists numbers from the book, Measuring the Costs of Protection in Japan, to demonstrate the costs, in loss of Consumer Surplus, per job saved (all US dollars):

  • Rice: $51,233,000
  • Natural Gas: $29,987,000
  • Gasoline: $6,329,000
  • Paper: $3,818,000
  • Beef, Pork and Poultry: $1,933,000
  • Cosmetics: $1,778,000

That’s per job. Now, per individual consumer that may not come to much, but is USD51m a reasonable amount to spend on one job for a rice producer? This is key to trade protectionism: understanding what, as a consumer, you lose.

Wikipedia’s discussion of this extends beyond this simple example, which has kept Consumers and Producers separate, but the principle remains. I’m not suggesting politicians try to frighten us with stories of price increases – I’ve long-since had enough of being treated like an idiot child by the US government – but this should enter somewhere as a reality of the situation. All that money poured into protecting relatively few jobs is taken away from something else for which it could be used.

Similarly that grey rectangle in the graph, area DEIH: this is called Deadweight Loss, and it means exactly that. It used to exist, as goods bought and sold, and now doesn’t. It represents resources not being allocated to this market, when we want them there. Remember, economics is all about allocating scarce resources.

The New Deal for Globalisation

This is the authors’ recommended response. Of the two effects of world price Sw, the loss of jobs and income is the important one. The loss of Producer Surplus is, frankly, not. As long as the industry is profitable, producers will exist, at the most efficient scale. Free Trade and US manufacturers on the scale Y1 is the efficient level. Tariffs and Y2-scale manufacturers is not. In some instances, the protection also is demanded not of industries or firms but of profits, which is less important. I hear this, as a health economist, from PhRMA all the bloody time, crying about how non-obscene their profits are. I’m not sympathetic. This is why Adam Smith despised corporations (and, by extension, shareholders).

From the article:

Truly expanding the political support for open borders requires a radical change in fiscal policy. This does not, however, mean making the personal income tax more progressive, as is often suggested. U.S. taxation of personal income is already quite progressive. Instead, policymakers should remember that workers do not pay only income taxes; they also pay the FICA (Federal Insurance Contributions Act) payroll tax for social insurance. This tax offers the best way to redistribute income.

The payroll tax contains a Social Security portion and a Medicare portion, each of which is paid half by the worker and half by the employer. The overall payroll tax is a flat tax of 15.3 percent on the first $94,200 of gross income for every worker, with an ongoing 2.9 percent flat tax for the Medicare portion beyond that. Because it is a flat-rate tax on a (largely) capped base, it is a regressive tax – that is, it tends to reinforce rather than offset pretax inequality. At $760 billion in 2005, the regressive payroll tax was nearly as big as the progressive income tax ($1.1 trillion). Because it is large and regressive, the payroll tax is an obvious candidate for meaningful income redistribution linked to globalization.

A New Deal for globalization would combine further trade and investment liberalization with eliminating the full payroll tax for all workers earning below the national median. In 2005, the median total money earnings of all workers was $32,140, and there were about 67 million workers at or below this level. Assuming a mean labor income for this group of about $25,000, these 67 million workers would receive a tax cut of about $3,800 each. Because the economic burden of this tax falls largely on workers, this tax cut would be a direct gain in after-tax real income for them. With a total price tag of about $256 billion, the proposal could be paid for by raising the cap of $94,200, raising payroll tax rates (for progressivity, rates could escalate as they do with the income tax), or some combination of the two.

This is, of course, only an outline of the needed policy reform, and there would be many implementation details to address. For example, rather than a single on-off point for this tax cut, a phase-in of it (like with the earned-income tax credit) would avoid incentive-distorting jumps in effective tax rates.

This may sound like a radical proposal. But keep in mind the figure of $500 billion: the annual U.S. income gain from trade and investment liberalization to date and the additional U.S. gain a successful Doha Round could deliver.

Successive Treasury Secretaries, Reserve Chairs, etc. also fall against protectionism. The current Treasury Secretary also wants corporate taxation fixed (fat chance for the next few years)

Personally I just don’t see the Doha round coming off successfully, but who knows. Stranger things have happened. The authors’ argument about the payroll tax is also one found, every now and then, in relation to the minimum wage (just increased for the first time in a decade). Both arguments are assuming, perhaps naively, that payroll-tax savings will be passed on as income, although there’s no reason why legislation could not force the matter. It would be popular to pass, and it would not distort the labour market.

Can it work? It can, but in the same field in which universal health care and no more lobbyists can work. It is easy to look at a political economy of creating fixes for problems that used to be fixes for problems that used to be fixes… just look at the greater mess the tax code has become, under Bush. It’s paradoxically something only a government can fix, but at the same time something only a government could cock up this badly. We’re more likely to get trade barriers, lose consumer surplus, get all manner of needless lobbyist-lawyer legislation helping out this or that or the other industry or labour group, and so on and so on.

When a government has the temerity to ban all private campaign financing, then some of this intelligent government, about which we read, might begin to be observed. Until then, I won’t hold my cynical breath.

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