Trade Truths for Turbulent Times

A Reply to Vladimir Masch

by Philip Levy

International trade has seen remarkable changes over recent decades. Transport costs have dropped, telecommunications have opened up trade in new sectors, and different countries have emerged as trading powers. The question raised by Vladimir Masch in an accompanying piece (see BusinessWeek.com, 2/14/07, "A Radical Plan to Manage Globalization") is whether these changes are so drastic as to require new trade restraints that would shake the foundations of the modern trading system.

The future will undoubtedly differ from the past (or, at least, that's what we would think if we were willing to rely on history). The question is whether the changes will be so radical that no old lessons apply—in which case it's anyone's guess what to do—or whether some verities carry through.

Ricardo's Model

Economists have been studying trade for quite some time, both to see what it does for countries and for the people within. In the most basic model of comparative advantage, David Ricardo assumed there was only a single type of labor. Thus, all labor would either gain or lose from trade (they didn't lose). That model's main point about comparative advantage—countries can gain through specializing in the production of goods they produce relatively cheaply—is most useful in addressing the perpetual concern that a country might lose all its jobs to trade.

Later models, such as that of Eli Heckscher and Bertil Ohlin, did have winners and losers from trade liberalization. The winners could compensate the losers if they chose to and thereby make everyone better off, but there was some work to be done. More recent studies have quantified the extent of job loss, the duration of unemployment, and the pay cuts that displaced workers take after losing jobs to import competition.

Through all these studies, there is a central theme that emerges: Openness and economic integration have been prerequisites for economic growth and prosperity. Trade allows specialization, it increases the variety of products available to consumers, it spurs competition, and it helps spread technological innovation.

Stress-Test Economics

If one goes through trade theory selectively, it is easy to think that key points are being ignored. Economists stay gainfully employed, though, not by musing happily on the utopian virtues of a beloved model, but by stress-testing it. What happens if there are monopolies instead of small competitors? What if workers have skills that are particular to one sector of the economy and won't carry over to another? The only concealment of these discussions occurs when the results are couched in technical terms and published in journals.

Other mathematically-oriented disciplines "conceal" their findings the same way.

Even in sophisticated presentations, studies try to isolate the features of interest from other potentially confounding factors. Thus in most discussions of comparative advantage there is no mention of trade deficits. It is certainly possible to ask, though, whether gains from trade arguments would still apply in a world of unbalanced trade.

In dealing with trade deficits, it is essential to distinguish between bilateral and multilateral trade balances. We care only about the latter. Even if we had a world in which the value of United States imports equaled the value of its exports, there is no reason to think that trade could or should balance bilaterally. We could imagine a world in which the United States sells financial services to Chile; Chile sells copper to China; and China sells manufactured goods to the United States. Each country could have multilaterally balanced trade, but would have a bilateral deficit with one partner and an offsetting surplus with the other.