The truth about trade
Part of a weekly series on the economic choices facing the United States and its relations with the rest of the world. For previous entries, click here.
THE DEBATE OVER global trade and investment has played a central role throughout the 2016 campaign, as it did in the 1992 election. Back then, third-party candidate Ross Perot claimed that the proposed North American Free Trade Act with Canada and Mexico would cause a “giant sucking sound” of jobs out of the United States to low-wage Mexico. Now the debate is over two similar negotiations, the Trans-Pacific Partnership with Asian countries and the Trans-Atlantic Trade and Investment Partnership with Europe.
Both Hillary Clinton and Donald Trump have come out against the proposed trade agreements in their current form, as did Bernie Sanders. The Democratic Party platform emphasized opposition to key parts of the TPP. Yet President Barack Obama is now proposing to push TPP through the lame-duck session of Congress. The steadfastness of Clinton’s opposition to TPP has been doubted by foes of the trade agreement, remembering her support for it as recently as 2014, and also the speed at which Bill Clinton went from skepticism about NAFTA to becoming its champion after winning the 1992 election.
I am a believer in expanded international trade, but I am an opponent of TPP and TTIP. This isn’t a contradiction, but a reflection of two important realities. First, the proposed treaties are more than trade agreements. They would also establish many important rules of the economy beyond trade, and in fact would give far too much power to large multinational companies, the corporations whose lobbyists have helped to draft the agreements. Second, trade policy should not be crafted in isolation from related budget measures that would ensure the fairness of economic outcomes. Open trade is broadly beneficial only when combined with smart and fair budget policies. Alas, the United States does not yet have in place the fiscal policies that are needed to make new trade agreements broadly beneficial across the society.
To keep a scorecard on TPP, TTIP, and other related trade policy measures, it’s important to keep track of four components of international economics. The first is trade in goods and services, when the US exports or imports merchandise (like coffee) or services (like shipping). The second is the movement of foreign capital, such as when General Motors opens a subsidiary to manufacture parts in Mexico. The third is offshoring of jobs, such as when Apple contracts with the Taiwanese company Foxconn to assemble iPhones in China. And the fourth are global regulatory policies such as the terms of patents and copyrights. Modern trade agreements are not just about trade; they include all four parts of the international economic system.
WHEN IT COMES to trade, there are two key concepts to keep in mind. The first is efficiency, meaning the size of the economic pie (or Gross Domestic Product). The second is distribution, meaning how the economic pie is divided between capital and labor, and among different groups of workers (mainly those with college degrees, or higher, versus the rest).
The first major point about expanding US trade with lower-wage countries is that it tends to improve efficiency — enlarge the pie — but also to redistribute the US economic pie toward capital and highly educated workers and away from workers, especially less-educated ones. For capitalists and highly educated workers, greater international trade is a no-brainer, a very good thing indeed. For less-educated workers, it can be a curse, pushing down wages and pushing some lower-skilled workers right out of the labor force entirely.
The second major point about expanded trade is that the gains to the winners are usually large enough to compensate the losers. By taxing the gains from trade accruing to the capitalists and highly educated workers, the federal government could transfer some of the expanded “pie” to America’s less-educated workers (for example, through an expanded Earned Income Tax Credit, or EITC). The net result would be that all groups — the capitalists, highly educated workers, and less-educated workers — would then be better off with more trade after taking into account the taxes and transfers.
Here is a numerical example. Suppose that the US Gross Domestic Product is $18 trillion, divided as $8 trillion for capitalists, $5 trillion for highly educated workers, and $5 trillion for less-educated workers. Now suppose that international trade is expanded through a new trade agreement with several developing countries. Because of the efficiency gains from expanded trade, the US GDP increases in this example to $20 trillion (a larger pie), but now is divided as $10 trillion for capitalists, $7 trillion for highly educated workers, and only $3 trillion for less-educated workers.
In this example, trade increases the pie and shifts US national income toward capitalists and highly educated workers. The US Chamber of Commerce obviously would like such a trade deal, as would highly educated professionals. At the same time, less-educated workers would rightly oppose the trade deal. Yet rather than rail against China or developing countries, the low-skilled workers would do better to recognize that it is their own countrymen, the capitalists and professionals, who have “walked off with the prize” from the trade deal.
So is more trade a good thing or a bad thing? It depends on whose point of view we are considering.
A vote for expanded trade can be made unanimous if the winners are also taxed modestly to help compensate the losers. Continuing with our example, consider a federal tax surcharge — an extra tax — of $1.25 trillion on capitalists, and $1.25 trillion on highly educated workers. The combined tax proceeds, $2.5 trillion, are then distributed to the less-educated workers. If we consider incomes after taxes and transfers, the capitalists end up with $8.75 trillion, the highly educated workers with $5.75 trillion, and the less-educated workers with $5.5 trillion. Every group now is better off with expanded trade, once the trade is combined with the tax-and-transfer system.
The conclusion, backed by economic theory and recent history, is that America’s trade with lower-wage countries expands US national income but leaves America’s less-educated workers worse off unless the winners compensate the losers. Economists tend to emphasize the first point but too often downplay or simply don’t care about the second.
The politically surprising reality is that President Obama championed a further expansion of trade with Asia and Europe without securing any agreement on further compensation of lower-skilled workers, even after 35 years of stagnant incomes of lower-skilled workers. These workers have now rebelled — many white, working-class workers joined Trump’s corner — and Clinton has scrambled to oppose TPP and TTIP, at least for now.
TWENTY-FIVE YEARS ago I supported NAFTA, because I believed that Congress and the President would provide the needed compensation for those workers left behind. My change of heart about trade agreements more recently — leading to my opposition to TPP and TTIP — flows heavily from the sad fact that neither the Republican-led Congress nor Democratic Party presidents (Clinton and Obama) have done much of anything to ensure that the benefits of trade are widely shared within the United States. American politics tends not to compensate the losers, but rather tries to ignore them.
The downside for American workers has been greatly exacerbated by the second and third components of the international economy: increased capital flows as well as offshoring. In the past two decades, many major US companies moved their operations to Mexico (under NAFTA) or to China, to take advantage of lower wages. The consequences of foreign investment in low-wage countries are roughly similar to the consequences of increased trade with those countries: Raising the incomes of US capitalists but also lowering the incomes of some or most lower-skilled American workers.
Once again, both foreign investment and offshoring of jobs increase the US economic pie by promoting greater efficiency in the economy. Once again, the increased income of the winners could, in principle, compensate the losers and thereby leave both American capitalists and workers better off. And once again, the American political system has largely lost interest in income redistribution through taxes and transfers. The losers are told that it’s just tough luck and that they should fend for themselves.
It’s important to understand that much of the firestorm over TPP and TTIP has little in fact to do with the gains and losses from trade or even from foreign investment and offshoring. Some of the biggest controversies are swirling around the regulatory framework that would be established by these trade agreements. Some of the proposed clauses in TPP would strengthen the intellectual property of the pharmaceutical industry, giving rise to legitimate concerns that the drug companies would have even greater monopoly power on their medicines, leaving even more people without access to life-saving drugs. The protections to workers on labor standards and human rights seem to many to be very weak and insufficient.
YET PERHAPS THE greatest controversy involves an arcane but very important part of the agreement: Investor-State Dispute Settlement, or ISDS. The ISDS provisions establish the right of foreign multinational companies to challenge the policies and regulations of host-country governments, and possibly to recover large financial damages. ISDS has given enormous, arbitrary and unfair power to multinational companies.
Under ISDS, the foreign company’s complaint is heard by an ad hoc, three-person tribunal that is not bound by the laws of the host country or even by precedents of ISDS tribunals. And there is no appeal. Moreover, only foreign companies can use ISDS. Domestic companies must go through the normal courts of law, and trade unions and other groups also have no protections under ISDS.
The original idea of ISDS was to prevent host governments from expropriating foreign investments. But now powerful companies are misusing ISDS to try to scare governments from making and enforcing environmental, public health, or labor regulations. And, if they fail to head off the regulations, to win large financial damages from governments that are merely trying to defend the public good.
In one recent and egregious example, the Canadian company behind the notorious Keystone XL Pipeline proposal, TransCanada, is now suing the US government for $15 billion. The proposed pipeline would have carried Canada’s high-carbon oil sands to US refineries. Obama correctly cancelled the project on the grounds of the pipeline’s danger for global warming. Now TransCanada is suing the US government for depriving the company of future profits on an investment that never took place! Such a complaint wouldn’t have a prayer of prevailing in a normal US court, under normal US law (the government was just carrying out its proper function, after all). Yet TransCanada could win in an ISDS tribunal, where the rule of law does not apply.
Given the broad-based opposition to TPP and TTIP, these agreements could not win congressional approval in a normal vote before the November election. Yet Obama is trying to force them through in the lame-duck session of Congress, immediately after the November election, when the voice of the people is the weakest (since the public voice is expressed mainly at election time). Obama’s behavior, in my view, is utterly unjustified, a parting gift to corporate lobbies.
The Obama administration also argues that the Senate should pass the TPP in order to bolster America’s credibility in Asia, claiming that TPP is key to US national security. (China is not a signatory to the TPP; hence, claims the administration, the TPP will give the United States an extra measure of power in Asia vis-a-vis China). This argument is both naive and irresponsible. The real effect of TPP on national security is that it would increase the inequality of income and power in American society, weakening rather than strengthening national security.
Trade agreements should be voted up or down on the basis of their likely economic and distributional impacts, not on a fictitious argument about national security. TPP and TTIP, in their current form, deserve to be voted down. They should be reformulated to remove ISDS and should be combined with new tax-and-transfer measures to bolster the incomes of the working class. The economic pie could then be enlarged with the gains from trade shared broadly across the society. At that point, the public would be much more likely to support the passage of the trade agreements in broad daylight, not in the dead of night of a lame-duck session of Congress.
Jeffrey D. Sachs is University Professor and Director of the Center for Sustainable Development at Columbia University, and author of “The Age of Sustainable Development.”