More Than An Inconvenient Iota of Truth

Regular people everywhere are being deprived of purchasing power — and tricked by chauvinists and opportunists into believing that their interests are fundamentally at odds. A global conflict between economic classes within countries is being misinterpreted as a series of conflicts between countries with competing interests.

An extract twice removed, as it were, for Noah Smith extracted this bit in his excellent review of a book called Trade Wars are Class Wars, by Michael Pettis and Matthew C. Klein. I have not read it yet, but it has shot to the top of my reading list.

Any student who has attended a class in which I have taught aspects of international trade will tell you that I bore them to death with one particular theme: that the textbook study of international trade doesn’t adequately cover (in my opinion) the study of inequality.

Now that might sound weird if you are a student new to the study of international trade. What on earth, you might think, does inequality have to do with international trade?

Well, here’s the thesis put forward in the book, via Noah:

Trade Wars are Class Wars offers a provocative thesis — that what looks like economic competition between nations is actually just a manifestation of economic competition between classes within those nations.

Again, I haven’t read the book, but this is slightly confusing to me. I have always thought of the causality running the other way around: increased competition between nations has exacerbated economic competition (and therefore inequality) within nations. It would seem that the authors think of it differently. Excellent, more things to ponder upon!

Why do I think that international trade is one causal factor where inequality is concerned? Let’s begin with an excellent article published by The Economist a few years ago:

In rich countries, skilled workers are abundant by international standards and unskilled workers are scarce. As globalisation has advanced, college-educated workers have enjoyed faster wage gains than their less educated countrymen, many of whom have suffered stagnant real earnings. On the face of it, this wage pattern is consistent with the Stolper-Samuelson theorem. Globalisation has hurt the scarce “factor” (unskilled labour) and helped the abundant one.

Please, pretty please with a cherry on top, read the whole thing, especially if you have studied the Stolper Samuelson theorem. This article remains the best explainer that I have come across.

But what is being said here should be at least somewhat surprising to a student just beginning to study international trade. Trade, it would seem, may well be welfare enhancing, but it does not affect everybody a) equally and b) not necessarily positively! But, you might think as an Indian student, this might imply that unskilled labor in India might benefit from international trade.

Remember, one thing a good student of economics always bears in mind is a specific question: relative to what? That is, unskilled labor in India might well benefit from international trade, but relative to what? And the answer turns out to be, well, an unexpected one:

But look closer and puzzles remain. The theorem is unable to explain why skilled workers have prospered even in developing countries, where they are not abundant.

What might explain this?

Enter Professors Maskin and Kremer:

Nineteenth-century economist David Ricardo’s theory of comparative advantage predicts that China’s poorest workers should benefit most from the growth in trade. Before globalization, that country had a huge supply of unskilled workers and relatively few high-skill workers, who were thus in high demand; the situation was just the opposite in the United States. When two such countries begin to trade, the theory states, the less-developed nation has the advantage in producing relatively low-tech products—so demand and income for under-educated workers should shoot up, while their high-skill countrymen suffer. Thus, the theory predicts, globalization should lower inequality in the developing world.
Instead, as Gates professor of developing societies Michael Kremer explains, in much of the developing world, “The empirical evidence is not really consistent with the idea that trade is reducing inequality.” He and Adams University Professor Eric Maskin, a 2007 Nobel laureate in economics, have therefore proposed a new model to help explain the discrepancy between traditional theory and current reality. The key, they say, lies in a more nuanced understanding of how global production cycles sort workers into different jobs.

Here’s one way to understand their model. Note, before you proceed to read, that this is my explanation of their model, and I have simplified it a bit. I’ll add more nuance in as we go along:

Think of two countries, and two types of workers in both countries. Let’s say country 1 has Type A and Type B workers, and Country 2 has Type A1 and Type B2 workers. A and A1 are skilled workers, and B and B2 are unskilled workers. Maskin and Kremer make the point that international trade and the advent of modern globalization has resulted in skilled workers across countries “matching” with each other. As a result, their incomes go up, relative to unskilled workers in their own countries. So while the Stolper Samuelson theorem may be unable to explain why skilled workers have prospered even in developing countries, we now have a plausible answer to the question.

As an illustrative example, consider the fact that I joined a multinational firm called Genpact straight out of college.

And of course, one can think of many countries, not just two, and one can imagine a spectrum of skill sets across workers, rather than a binary framing. The point still holds!

And to complicate the matter further still, there may well be explicit/implicit choices made by policymakers in their own countries.

Back in the good old days, FT Alphaville used to be a free blog. And about seven years ago or so, it carried an excellent, excellent post written by Isabella Kaminska. The title of the (two-part) post was “What Are Chinese Capital Controls, Really?”. The post is a must-read for any student of international trade, but this excerpt is especially relevant for us today:

What those who accused China of using its exchange rate to gain advantage probably misunderstood was that it wasn’t the currency which was being undervalued, it was the people.

There are several other reasons why China should leave its currency unchanged. Contrary to widespread perception, China does not compete on the basis of an undervalued currency. It competes mainly in terms of labour costs, technology, quality control, infrastructure and an unwavering commitment to reform. (Emphasis Added)

“It competes mainly in terms of labor costs” is a dry, academic way to put it. Elsewhere in this post, Isabella puts it much more plainly, when she says that it sucked to be a Chinese worker. And it did! Not just because of low labor costs, but because of a whole host of other reasons that should excite students of macroeconomics. Read the whole thing to get a richer understanding of how China has gone about doing what it has. As I always say to folks in my classes who wish we “grew like China”: be careful what you wish for!

You might also want to take a look at David Autor’s work on The China Shock. A good place to begin would be Russ Roberts’ podcast with David Autor, and for those who are interested, there’s a follow-up symposium about this episode as well. The point I’m making is that where trade between China and the USA is concerned, it would seem that inequality has gone up in both countries, but for different reasons.

This applies to international trade in general, of course – I’ve used China and US as examples because we are more familiar with them.

So, to return to the original question: are trade wars class wars? And more importantly, are class wars causing trade wars, or is it the other way around?

And so here we get to the book’s primary thesis. The authors only return to it in the conclusion, having reached it by a circuitous route that took them through history, data, theory, and more history.
The conclusion they ultimately draw is more nuanced than the one initially promised (and that’s a good thing, since nuance is good). In Klein and Pettis’ telling, global imbalances feed inequality in the U.S., but the fundamental cause isn’t inequality.

Yup, that I completely agree with, and “get”. But it doesn’t solve the original problem of course, it only helps us understand that it exists: trade does seem to exacerbate inequality.

How we should think of this problem, how we might resolve it, and with what consequences, is likely to be fertile ground for economic research in the years to come. If you are a student wondering about how to go about picking a topic to work on, well, please do consider this one! And a good place to begin would be Noah’s post, (and the book itself sounds like a must read too).

Bonus material alert: I simply had to share this extract from Noah’s blog, written by Paul Krugman. If you have recently studied macro, you can thank me later for bringing this to your attention:

[E]conomic explanations…have to [describe] how the actions of individuals…add up to interesting behavior at the aggregate level.
And the key point is that individuals in general neither know nor care about aggregate accounting identities…. [I]f you want to claim that a rise in savings translates directly into a fall in the trade deficit, without any depreciation of the currency, you have to tell me how that rise in savings induces domestic consumers to buy fewer foreign goods, or foreign consumers to buy more domestic goods. Don’t tell me about how the identity must hold, tell me about the mechanism that induces the individual decisions that make it hold…. [O]nce you do that, you realize that something else has to be happening — a slump in the economy, a depreciation of the real exchange rate, it depends on the circumstances, but it can’t be immaculate, with nothing moving to enforce the identity….
Accounting identities… inform your stories about how people behave, [they do] not act as a substitute for behavioral analysis.

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