tariffs

The Race to the Bottom is not inevitable

pnrj development economics, ethics, inequality, macroeconomics, market failure, public policy , , , , , , , , , , , , , , , , , , , ,

Jul 19 JDN 2459050

The race to the bottom is a common result of competition, between firms, between states, or even between countries. One firm finds a way to cut corners and reduce costs, then lowers their price to undercut others; then soon every firm is cutting those same corners. Or one country decides to weaken their regulations in order to attraction more business; then soon every other country has to weaken their regulations as well.

Let’s first consider individual firms. Suppose that you run a business, and you are an upstanding, ethical person. You want to treat your employees, your customers, and your community well. You have high labor standards, you exceed the requirements of environmental regulations, and you make a high-quality product at a reasonable price for a moderate profit.

Then, a competitor appears. The owner of this company is not so ethical. They exploit their workers, perhaps even stealing their wages. They flaunt environmental regulations. They make shoddy products. All of this allows them to make their products for a lower price than yours.

Suppose that most customers can’t tell the difference between your product and theirs. What will happen? They will stop buying yours, because it’s more expensive. What do you do then?

You could simply go out of business. But that doesn’t really solve anything. Probably you’ll be forced to lower your standards. You’ll treat your workers worse, pollute more, reduce product quality. You may not do so as much as the other company, but you’ll have to do it some in order to get the price down low enough to still compete. And your profits will be lower than theirs as a result.

Far better would be for the government to step in and punish that other business for breaking the rules—or if what they’re doing is technically legal, change the rules so that it’s not anymore. Then you could continue to produce high-quality products with fair labor standards and good environmental sustainability.

But there are some problems with this. First, consider this from the point of view of a regulator, who is being lobbied by both companies. Your company asks for higher standards to improve product quality while protecting workers and the environment. But theirs claims that these higher standards will push them out of business. Who will they believe?

In fact, it may be worse than that: Suppose we’ve already settled into an equilibrium where all the firms have low standards. In that case, all the lobbyists will be saying that regulations need to be kept weak, lest the whole industry fail.

But in fact there’s no reason to think that stricter regulations would actually destroy the whole industry. Firm owners are used to thinking in terms of fixed competitors: They act in response to what competitors do. And in many cases it’s actually true that if just one firm tried to raise their standards, they would be outcompeted and go out of business. This does not mean that if all firms were forced to raise their standards, the industry would collapse. In fact, it’s much more likely that stricter regulations would only moderately reduce output and profits, if imposed consistently across the whole industry.

To see why, let’s consider a very simple model, a Bertrand competition game. There are two firms, A and B. Each can either use process H, producing a product of high quality with high labor standards and good sustainability, or use process L, producing a product of low quality with low labor standards and poor sustainability. Process H costs $100 per unit, process L costs $50 per unit. Customers can’t tell the difference, so they will buy whichever product is offered at the lowest price. Let’s say you are in charge of firm A. You choose which process to use, and set your price. At the same time, firm B chooses a process and sets their price.

Suppose choose to use process H. The lowest possible price you could charge to still make a profit would be a price of $101 (ignoring cents; let’s say customers also ignore them, which might be true!).

But firm B could choose process L, and then set a price of $100. They can charge just one dollar less than you charge for their product, but their cost is only $50, so now they are making a large profit—and you get nothing.

So you are forced to lower your standards, in order to match their price. You could try to undercut them at a price of $100, but in the long run that’s a bad idea, since eventually you’ll both be driven to charging a price of 51 and making only a very small profit. And there’s a way to stop them from undercutting you, which is to offer a price-matching guarantee; you can tell your customers that if they see a lower price from firm B than what you’re offering, you’ll match it for them. Then firm B has no incentive to try to undercut you, and you can maintain a stable equilibrium at a price of $100. You have been forced to used process L even though you know it is worse, because any attempt to unilaterally deviate from that industry norm would result in your company going bankrupt.

But now suppose the government comes in and mandates that all firms use process H, and they really enforce this rule so that no firm wants to try to break it. Then you’d want to raise the price, but you wouldn’t necessarily have to raise it all that much. Even $101 would be enough to ensure some profit, and you could even maintain your current profits by raising the price up to $150. In reality the result would probably be somewhere in between those two, depending on the elasticity of demand; so perhaps you end up charging $125 and make half the profit you did before.

Even though the new regulation raised costs all the way up to the current price, they did not result in collapsing the industry; because the rule was enforced uniformly, all firms were able to raise their standards and also raise their prices. This is what we should typically expect to happen; so any time someone claims that a new regulation will “destroy the industry” we should be very skeptical of that claim. (It’s not impossible; for instance, a regulation mandating that all fast food workers be paid $200 per hour would surely collapse the fast food industry. But it’s very unlikely that anyone would seriously propose a regulation like that.)

So as long as you have a strong government in place, you can escape the race to the bottom. But then we must consider international competition: What if other countries have weaker regulations, and so firms want to move their production to those other countries?

Well, a small country may actually be forced to lower their standards in order to compete. I’m not sure there’s much that Taiwan or Singapore could do to enforce higher labor standards. If Taiwan decided to tighten all their labor regulations, firms might just move their production to Indonesia or Vietnam. Then again, monthly incomes in Taiwan, once adjusted for currency exchange rates, are considerably higher than those in Vietnam. Indeed, wages in Taiwan aren’t much lower than wages in the US. So apparently Taiwan has some power to control their own labor standards—perhaps due to their highly educated population and strong industrial infrastructure.

However, a large country like the US or China absolutely has more power than that. If the US wants to enforce stricter labor standards, they can simply impose tariffs on countries that don’t. Actually there are many free-trade rules in place precisely to reduce that power, because it can be easily abused in the service of protectionism.

Perhaps these rules go too far; while I agree with the concern about protectionism, I definitely think we should be doing more to enforce penalties for forced labor, for instance. But this is not the result of too little international governance—if anything it is the result of too much. Our free trade agreements are astonishingly binding, even on the most powerful countries (China has successfully sued the United States under WTO rules!). I wish only that our human rights charters were anywhere near as well enforced.

This means that the race to the bottom is not the inevitable result of competition between firms or even between countries. When it occurs, it is the result of particular policy regimes nationally or internationally. We can make better rules.

The first step may be to stop listening to the people who say that any change will “destroy the industry” because they are unable (or unwilling?) to understand how uniformly-imposed rules differ from unilateral deviations from industry norms.

On compromise: The kind of politics that can be bipartisan—and the kind that can’t

pnrj current events, public policy , , , , , , , , ,

Dec 29 JDN 2458847

The “polarization” of our current government has been much maligned. And there is some truth to this: The ideological gap between Democrats and Republicans in Congress is larger than it has been in a century. There have been many calls by self-proclaimed “centrists” for a return to “bipartisanship”.

But there is nothing centrist about compromising with fascists. If one party wants to destroy democracy and the other wants to save it, a true centrist would vote entirely with the pro-democracy party.

There is a kind of politics that can be bipartisan, that can bear reasonable compromise. Most economic policy is of this kind. If one side wants a tax of 40% and the other wants 20%, it’s quite reasonable to set the tax at 30%. If one side wants a large tariff and the other no tariff, it’s quite reasonable to make a small tariff. It could still be wrong—I’d tend to say that the 40% tax with no tariff is the right way to go—but it won’t be unjust. We can in fact “agree to disagree” in such cases. There really is a reasonable intermediate view between the extremes.

But there is also a kind of politics that can’t be bipartisan, in which compromise is inherently unjust. Most social policy is of this kind. If one side wants to let women vote and the other doesn’t, you can’t compromise by letting half of women vote. Women deserve the right to vote, period. All of them. In some sense letting half of women vote would be an improvement over none at all, but it’s obviously not an acceptable policy. The only just thing to do is to keep fighting until all women can vote.

This isn’t a question of importance per se.

Climate change is probably the single most important thing going on in the world this century, but it is actually something we can reasonably compromise about. It isn’t obvious where exactly the emission targets should be set to balance environmental sustainability with economic growth, and reasonable people can disagree about how to draw that line. (It is not reasonable to deny that climate change is important and refuse to take any action at all—which, sadly, is what the Republicans have been doing lately.) Thousands of innocent people have already been killed by Trump’s nonsensical deregulation of air pollution—but in fact it’s a quite difficult problem to decide exactly how pollution should be regulated.

Conversely, voter suppression has a small, if any, effect on our actual outcomes. In a country of 320 million people, even tens of thousands of votes rarely make a difference, and the (Constitutional) Electoral College does far greater damage to the principle of “one person, one vote” than voter suppression ever could. But voter suppression is fundamentally, inherently anti-democractic. When you try to suppress votes, you declare yourself an enemy of the free world.

There has always been disagreement about both kinds of issues; that hasn’t changed. The fundamental rights of women, racial minorities, and LGBT people have always been politically contentious, when—qua fundamental rights—they should never have been. But at least as far as I could tell, we seemed to be making progress on all these fronts. The left wing was dragging the right wing, kicking and screaming if necessary, toward a more just society.

Then came President Donald Trump.

The Trump administration, at least more than any administration I can remember, has been reversing social progress, taking hardline far-right positions on the kind of issues that we can’t compromise about. Locking up children at the border. Undermining judicial due process. Suppressing voter participation. These are attacks upon the foundations of a free society. We can’t “agree to disagree” on them.

Indeed, Trump’s economic policy has been surprisingly ambivalent; while he cuts taxes on the rich like a standard Republican, his trade war is much more of a leftist idea. It’s not so much that he’s willing to compromise as that he’s utterly inconsistent, but at least he’s not a consistent extremist on these issues.

That is what makes Trump an anomaly. The Republicans have gradually become more extreme over time, but it was Trump who carried them over a threshold, where they stopped retarding social progress and began actively reversing it. Removing Trump himself will not remove the problem—but nor would it be an empty gesture. He is a real part of the problem, and removing him might just give us the chance to make the deeper changes that need to be made.

The House agrees. Unfortunately, I doubt the Senate will.

Most trade barriers are not tariffs

pnrj current events, development economics, macroeconomics, market failure , , , , , , ,

Jul 8 JDN 2458309

When we talk about “protectionism” or “trade barriers”, what usually comes to mind is tariffs: taxes imposed on imports or exports. But especially now that international trade organizations have successfully reduced tariffs around the world, most trade barriers are not of this form at all.

Especially in highly-developed countries, but really almost everywhere, the most common trade barriers are what is simply but inelegantly called non-tariff barriers to trade: this includes licenses, quotas, subsidies, bailout guarantees, labeling requirements, and even some environmental regulations.

Non-tariff barriers are much more complicated to deal with, for at least three reasons.

First, with the exception of quotas and subsidies, non-tariff barriers are not easily quantifiable. We can easily put a number on the value of a tariff (though its impact is somewhat subtler than that), but this is not so easy for the effect of a bailout guarantee or a labeling requirement.

Second, non-tariff barriers are often much harder to detect. It’s obvious enough that imposing a tax on imported steel will reduce our imports of steel; but it requires a deeper understanding of the trade system to understand why bailing out domestic banks would distort financial flows, interest rates and exchange rates (even though the impact of this may actually be larger—the effect on global trade of US bank bailouts was between $35 billion and $110 billion).

Third, some trade barriers are either justifiable or simply inevitable. Simply having customs screening at the border is a non-tariff barrier, but it is widely regarded as a justifiable security measure (and I agree, by the way, even though I am generally in favor of much more open borders). Requiring strict labor and environmental standards on the production of products both domestic and imported is highly beneficial, but also imposes a trade barrier. In a broader sense, differences in language and culture could even be regarded as trade barriers (they certainly increase the real cost of trade), but it’s not clear that we could eliminate such things even if we wanted to.

This requires us to look very closely at almost every major government policy, to see how it might be distorting world trade. Some policies won’t meaningfully distort trade at all; these are not trade barriers. Others will distort trade, but are beneficial enough in other ways that they are still worth it; these are justifiable trade barriers. Still others will distort trade so much that they cannot be justified despite their other benefits. Finally, some policies will be put in place more or less explicitly to distort trade, usually in the form of protectionism to prop up domestic industries.

Protectionist policies are of course the first things to get rid of. Honestly, it baffles me that people even want to impose them in the first place. For some reason they think of exports as the benefit and imports as the cost, when it’s really the other way around; when we impose protectionism, we go out of our way to make it harder to get cars and iPhones so that we can stop other countries from taking our green paper. This seems to be tied to the fact that people think of jobs as something desirable, when really it’s wealth that’s desirable, and jobs are just one way of getting wealth—in some sense the most expensive way. Our macroeconomic policy obsesses over inflation, which is almost literally meaningless (as long as it is not too unpredictable, really nothing would change if inflation were raised from 2% to 4% or even 10%) and unemployment, which is at best an imperfect indicator of what we really should care about, namely the welfare of our people. A world of full employment with poverty wages is much worse than a world of high unemployment where a basic income provides for everyone’s needs. It is true that in our current system, unemployment is closely tied to a lot of very bad outcomes—but I maintain that this is largely because unemployment entails losing your income and your healthcare.

Some regulations that appear benign may actually be harmful because of their effects on trade. Yet I should also point out that it’s possible to go too far the other direction, and start tearing down all regulations in the name of reducing trade barriers. We particularly seem to do this in the financial industry, where “deregulation” seems to be on everyone’s lips until it causes a crisis, then we impose some regulations that fix the worst problems, things look good for awhile—and then we go back around and everyone starts talking about “deregulation” again. Meanwhile, the same people who talk about “freedom” as an excuse for removing financial safeguards are the ones who lock up children at the border. I think this is something that needs to be reframed: Which regulations are you removing? Just what, exactly, are you making legal that wasn’t before? Legalizing murder would be “deregulation”.

Trade policy, therefore, is a very delicate balance, between removing distortions and protecting legitimate public interests, between the needs of your own country and the world as a whole. This is why we need this whole apparatus of international trade institutions; it’s not a simple matter.

But I will say this: It would probably help if people educated themselves a bit more about how trade actually works before voting in politicians who promise to “save their jobs” from foreign competition.

And so begins the trade war Trump promised us.

pnrj public policy , , , , , , , ,

Mar 18 JDN 2458196

President Trump (a phrase I will never quite feel comfortable saying) has used an obscure loophole in US trade law to impose huge tariffs on steel and aluminum. The loophole is based on the idea that certain goods are vital for national security, and therefore imposing tariffs on them is in some sense the proper role of the Commander in Chief. It’s a pretty flimsy justification in general (if it’s really so important, why can’t Congress do it?), and particularly so in this case: Most of our steel and aluminum comes from Canada, and we are still totally dependent on imports for bauxite to make aluminum. Trump did finally cave in on allowing NAFTA members to be exempt, so Canada won’t be paying the tariff. The only country that could plausibly be considered an enemy that will be meaningfully affected by the tariffs is (ironically) Russia.

The European Union has threatened to respond with their own comparable tariffs—meaning that a trade war has officially begun. The last time the US started a major trade war was in 1930—which you may recognize as the start of the Great Depression. There’s a meme going around saying that 1928 was the last time the Republican Party controlled the whole US government; that isn’t actually true. Republicans have controlled all three branches as recently as 2006. Of course, the late 2000s weren’t a great time for the US economy either, so make of that what you will.

Does this mean we’re headed toward another Great Depression? I don’t think so. Our monetary policy is vastly better now than it was then. But are we headed toward another recession? That seems quite likely. By standard measures, the stock market is overvalued. The unemployment rate is now at 4%. We are basically at the ceiling right now; the only place to go is down.

Of course, maybe we will stay here awhile. We don’t have to go down, necessarily. If Obama were still President and Yellen were still Fed Chair, I might believe that. But the level of corruption, incompetence, and ideological rigidity in Trump’s economic policy is something I’ve not seen in the United States within my lifetime.

Peter Navarro, Trump’s Director of the White House Trade Council, has described his own role in an incredibly chilling way:

“This is the president’s vision. My function, really, as an economist is to try to provide the underlying analytics that confirm his intuition. And his intuition is always right in these matters. […] The owner, the coach, and the quarterback are all the president. The rest of us are all interchangeable parts.”

Well, there you have it. It’s just as the saying goes: There are liberal professional economists, conservative professional economists, and professional conservative economists. Peter Navarro has officially and proudly declared himself a professional conservative economist. He seems proud to admit that his only function is to rationalize what Trump already believes.

We really shouldn’t be surprised that Trump brought us into a trade war. Frankly, it was one of his campaign promises. When he was announcing the tariffs, he declared, “Trade wars are good, and easy to win.” In fact, trade war is much like real war, in that the only winning move is not to play.

What really worries me about all this isn’t how it will affect the US. Maybe it’ll trigger another recession, sure; but we’ve had lots of those, and we make it through eventually. (Recession might even be good for our carbon emissions, as we’re well above the Wedge.) The US economy is very strong, and can withstand a lot of mistakes. Even on a bad day we’re still the richest country in the world.

What worries me is how it will affect other countries. It’ll start with countries that export steel and aluminum, like India, China and Brazil. But as tariffs and counter-tariffs proliferate, more and more exports will be brought into the trade war. Trade is one of the most powerful tools we have for fighting global poverty, and we are now pulling the plug.

Of course, hurting China was part of Trump’s goal, so I doubt he’ll feel much remorse if the trade war results in millions of people in China thrown back into poverty. People who voted for him on the grounds that he would keep the dirty foreigners down may well be celebrating such an outcome.

There will be pain. But most of it will be felt elsewhere from here. “But those were Foreign children and it didn’t really matter.”

The TPP sounds… okay, I guess?

pnrj development economics, public policy , , , , , , , , , , , , , , , , , , , , , , , , , , ,

JDN 2457308 EDT 12:56

So, the Trans-Pacific Partnership (TPP) agreement has been signed. This upsets a lot of people, from the far-left who say it gives corporations power over democracy to the far-right who say it makes Obama into a dictator. But more mainstream organizations have also come out against it, particularly from the center-left or “radical center”, such as the Electronic Frontier Foundation and Medecins Sans Frontieres.

Bernie Sanders was opposed to it from the beginning, and now Hillary Clinton is opposed as well—though given her long track record of support for trade agreements it’s unclear whether this opposition is sincere, or simply reflects the way that Sanders has shifted our Overton Window to the left. Many Republicans also opposed the deal, and they’re already calling it “Obamatrade”. (Apparently they didn’t learn their lesson from Obamacare, because it’s been wildly successful, and in about a generation people are going to say “Obamacare” in the same breath as “Medicare” and “the New Deal”, and sticking Obama’s name onto it is going to lionize him.)

In my previous post I explained why I am, like the vast majority of economists, strongly in favor of free trade. So you might think that I would support the TPP, and would want to criticize all these people who are coming out against it as naive protectionists.

But in fact, I feel deeply ambivalent about the TPP, and I’m not alone in that among economists. Indeed I feel a bit proud to say that my view on the agreement is almost exactly aligned with that of Nobel Laureate Paul Krugman. (Krugman is always one of the world’s best economists, but I’d say he should be especially trusted on issues of international trade—because that was the subject of his Nobel-winning research.) The original leaked version looked pretty awful, and not knowing exactly what’s in it worried me, but the more I hear tobacco and pharmaceutical companies complain about it, the more I like the sound of it.

First of all, let me say that I’m still very angry they haven’t released the full text. We have a right to know what our laws are, as a basic principle of democracy. If we are going to be bound by this agreement, we have a right to know what it says. This is non-negotiable. To be bound by laws you haven’t been told about is literally—and let me be clear on the full force I intend by that word, literally—Kafkaesque. Kafka’s The Trial is all about what happens when the government can punish you for disobeying a law they never told you exists.

In the leaked draft version, the TPP would have been the largest handout of corporate welfare in world history. By placing the so-called “intellectual property” of corporations above basic human rights, it amounted to throwing several entire Third World countries under the bus in order to increase the profits of a handful of megacorporations. It would have expanded “investor-state dispute resolution authority” into an unprecedented level of power for multinational corporations to influence the decisions of national governments—what the President of the Capital Institute called “trading away our sovereignty”.

My fear was that the TPP would just be a redone and expanded version of the TRIPS accord, the “Agreement on Trade-Related Aspects of Intellectual Property Rights” (somehow that’s “TRIPS”), which expanded the monopoly power of “intellectual property” corporations, including the music industry, the film industry, and worst of all the pharmaceutical industry. The expansion of patent powers reduced the availability of drugs, including life-saving drugs, to some of the world’s poorest and most vulnerable people. There is supposed to be a system of flexibility provisions that allow exceptions to intellectual property laws in the service of public health, but in practice these are difficult to implement and many Third World governments don’t know how to use them. Based on UNCTAD estimates, Thomas Pogge found that TRIPS and related trade agreements amount to a transfer of wealth from the Third World to the First World on the order of $700 billion per year. (I’m also a bit confused by the WTO’s assertion that “For patents, [TRIPS] allows governments to make exceptions to patent holders’ rights such as in national emergencies, anti-competitive practices, […]”; aren’t patents by definition anti-competitive practices? We’ll protect your monopoly, as long as you don’t try to have a monopoly?) If TPP makes these already too-strong provisions stronger, millions of people could be denied medicines they need—which is why Medecins San Frontieres is among the organizations opposing the agreement.

Yet, in principle free trade is a good idea, and it’s definitely a good thing to remove the ridiculous tariffs we still have on Japanese cars. Of course, Ford Motor Company is complaining about the additional competition, but that’s a good sign—corporations complaining about extra competition is exactly the sort of response a good trade agreement would provoke. (Also, “razor-thin profit margins”? I think not; car manufacturing is near the very top of capital-intensive industries with high barriers to entry, and Ford Motor Company has a gross profit margin of 16% and net income margin of 5%. So, that 2.5% you might have to cut prices because you no longer get the tariff support… well, you could just take it out of your profits, and I don’t see why we should feel bad if you have to do that.)

It still angers me that they won’t tell us exactly what’s in the deal, but some of the things they have told us are actually quite encouraging. The New York Times has a summary that suggests lukewarm approval on their part.

The TPP opens up Internet traffic, creating international regulations that prohibit the censorship of cross-border data. (With that in mind, I’m a bit baffled that the EFF is so strongly opposed; isn’t free data exchange your raison d’etre?) China hasn’t signed on, and this might well be why—they’d love to sell us products without tariffs, but they aren’t prepared to stop censoring the Internet in order to do that.

It lowers barriers on the cross-border exchange of services (as opposed to only goods). Many services really can’t be traded much across borders (think restaurant meals and haircuts), and in practice this mostly means finance, which is a mixed bag to be sure; but in general I think allowing services to compete across borders is a good ideas.

The TPP also places limitations on government-owned enterprises, though not very strict ones (probably because we in the US aren’t likely to give up the US Postal Service or the Federal Reserve anytime soon). Basically this is designed to prevent the sort of mass state expropriation that has destroyed the economies of several authoritarian socialist countries, like Cuba and Venezuela. It’s unlikely they would be strong enough to stop more legitimate nationalizations of industry or applications of eminent domain, since Japan, Canada, and probably even the US would have been unwilling to sign onto such an agreement.

The leaked draft of the TPP would have given extremely strong protections to drug patents, but the fact that pharmaceutical companies are angry about it says to me that the strongest of these provisions must not have made it in. It sounds like patents are being made stronger but shorter, which like most compromises makes both sides mad.

Best of all, it includes some regulations on human rights, labor standards, and environmental policies, which is something that has been sorely lacking in previous trade agreements. While the details are still sketchy (Have I mentioned how angry I am that they won’t release the full text?) it is claimed that the agreement includes a system of tariff penalties that can be implemented against countries that oppress LGBT people and other marginalized groups. Because Brunei, Malaysia, and Singapore currently criminalize homosexuality, they would already be in noncompliance from the moment they sign the treaty, and would be subject to these penalties until they change their laws. If this is true, it actually sounds like a step toward the “human rights tariff” that I would like to see implemented worldwide.

In general, the TPP sounds like a mess, a jumble of awkward compromises that does some good things and some bad things, and doesn’t really satisfy anyone. In other words, it sounds like policy.