1. Trade & Growth Bakuriani, July 2008

2. Outline  Trade and wealth creation  The costs of openness to trade?  The race to the bottom?

3. Adam Smith and trade  Smith: pin’s factory  Division of labor, division of knowledge, enlargement of markets generates wealth  What if you have no talent?

4. Ricardo’s comparative advantage Production in an hour Of wool (kilograms) Of wine (liters) England22 Portugal36

5. Wealth creation Wool (kg) 200 E (100,100) P(180, 210) 200 E’E’ E*(110,100) P ’ (300, 150) P*(190, 250) 600

6. The costs of trade

7. Against trade  National independence (sovereign funds, national champions)  Others are not liberalizing (electricity, Airbus and Boeing)  Regional trade is preferable  A plane without pilot  Race to the bottom

8. An illustration: the race to the bottom argument Mentioned in many fields: Tax competition Labor standards and free trade Environmental standards and free trade

9. Race to the bottom scenario  Starting with two jurisdictions  Jurisdiction A has “high standards” Jurisdiction B has “low standards”  As trade opens, capital moves from A to B  Jurisdiction A cannot sustain “high standards”  Both jurisdictions end up with low standards

10. First impressions about the argument  Simple  Plausible: at the start of the 20th century, trade in primary products accounted for 2/3 of world trade, and by the end of the century the fraction had dropped to ¼ foreign direct investments were about 25 times larger in 1996 than they were in 1970

11. Theoretical support to RTB  Hecksher-Ohlin, Stopler-Samuelson: equalization of factor prices across trading partners  Important theoretical literature  “In sum, for all the reasons mentioned above, although economic integration may be expected to improve labour standards overall, the possibility of social dumping because of stronger international competition needs to be taken into account, and there is, in principle, ambiguity on the predicted sign and magnitude of the effect.” Dehejia and Samy (2006)

12. Empirical evidence? Mixed evidence:  “Overall, the results are not as grim as the conventional wisdom would have it. Even though integration may impose constraints on domestic policy, they are evidently not as severe as the pessimists would have predicted.” Dehejia and Samy (2006)  OECD (1996) no evidence that low standards perform better  Brueckner (2000): “social shopping” taking place in the US

13. Theoretical arguments against the possibility of a race to the bottom  To the extent that free trade combined with ‘market failures’ leads to inefficiency, suppress market failures and keep free trade (Bhagwati-Ramaswami)  Harmonization is not efficient Quality of standards is a superior good (“one size fits all” is inefficient) Competition among standards helps reveal the most appropriate standard

14. Arguing with new (basic) tools…  Freedom to trade is also freedom not to trade  True, as trading opportunities change, some might trade because they are “forced to,” or because they lose their trading partners  But, at least two people will be better off after the expansion of trade opportunities  A race to the bottom is logically impossible

15. The reality behind the race to the bottom  In a dynamic, entrepreneurial process of discovery, some will lose in the short run  Some might even lose in the long run…  But this is the case with any change. The change might be due to enlargement of the market or any “national” technological improvement  Why does the same government which promotes spending public money on R&D also oppose free trade? Why are ‘we’ sometimes promoting entrepreneurial spirit and sometimes raising barriers against it?

16. Who will have to adjust?  When you promote R&D you know that this will require adjustments, but you don’t know exactly who…  When you promote free trade, the groups who will have to adjust are more easily identifiable (privileged ones) “[E]ven if they are globally limited, the costs related to that opening are quite visible, tangible and concentrated in space and time; while its benefits— much higher but spread much more uniformly—are difficult to perceive in our day-to-day life and in the short run.” (Pascal Lamy, WTO)

17. To summarize:  The claim that free trade will lead to a race to the bottom has no validity  It is a fancy name for a well-known reality: change (and in particular, new opportunities) calls for adjustment  One may reject the enlargement of the market, but at least economists should be unanimous about the analysis of the process

18. (Free market) economists