Wednesday, June 8, 2005

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The OECD's recipe for economic growth

Psst... hey, buddy -- want to make some more money?

Chris Giles writes in the Financial Times on the Organization for Economic Cooperation and Development's latest working paper:

Workers in advanced economies could gain the equivalent of a full year's income over their working lives if countries increased competition in their domestic economies and reduced trade barriers, the Organisation for Economic Co-operation and Development said on Tuesday.

The international body charged with improving the economic performance of its 30 member countries came down firmly on the side of market liberals after examining the effects of restricting competition.

“At a time when Europe may be losing momentum in its drive to open product and services markets, the study shows that the economic rationale for such liberalisation remains very strong,” said Jean-Phillippe Cotis, the organisation's chief economist.

You can access the OECD's summary here, and the full report here. By barriers, the authors are referring to tariffs, limits on foreign direct investment, and product market regulation. The bulk of the gains come from regulatory reforms.

How big are the benefits? This is from the report's cover letter:

The benefits to be expected from such a liberalisation exercise are... substantial:

  • In the United States, GDP per capita would increase by 1% to 2.5%;

  • In Europe, GDP per capita would be boosted by between 2 to 3%, which is equivalent to two years of growth. Compared with the United States, gains would be stronger in Europe, reflecting its tighter initial stance of regulation.

  • Spill-overs outside the European Union and the United States may be large: 2% for Canada and Mexico, 1.5% for Turkey, Japan and Central Europe....
  • An important lesson of this work is that product market deregulation rather than tariff lowering would provide the main source of economic gains. This finding should not come as a surprise, however, knowing that tariff and non-tariff barriers are now rather small while domestic product market regulations remain often substantial, especially so in the services sector.

    The magnitude of estimated output gains look very significant to us but they may seem too modest to some observers. A first answer would be that our estimation of the gains of liberalisation are indeed very prudent. In this exercise, we have only assessed the “one-shot”or “static gains”, coming from greater international trade specialisation and better allocation of resources. But many would argue that liberalisation produces “dynamic gains”, that is more open product markets stimulate research, innovation and technical progress on a sustained basis. Empirical research indeed suggests that these gains could be quite large although their estimated magnitude is still surrounded by substantial margins of uncertainty.

    Read the whole thing.

    UPDATE: Robert Tagorda at Outside the Beltway has some more thoughts on the OECD report.

    Meanwhile, Gary Hufbauer and Paul Grieco's op-ed in the Washington Post yesterday makes a similar point about the past benefits of economic openness:

    Using four different methods, we estimate that the combination of shrinking distances--thanks to container ships, telecommunications and other new technologies--and lower political barriers to international trade and investment have generated an increase in U.S. income of roughly $1 trillion a year (measured in 2003 dollars), or about 10 percent of gross domestic product. This translates to a gain in annual income of about $10,000 per household.

    Unfortunately for the cause of continued liberalization, Americans do not receive this money as a check marked “payoff from globalization.” Instead, the payoff is hidden within familiar channels: fatter paychecks, lower prices and better product choices (compare the telephones available now with the standard black model of 1980).

    Nevertheless, each of our four methods uncovers a large payoff. First, we parse international data that correlate the expansion of international trade with economic growth. This shows that the increase in U.S. income sparked by more intense trade equates to 13.2 percent of GDP. In the second method, we calculate how lower tariffs stimulate U.S. productivity through competitive forces and bring greater product choices to U.S. producers and consumers. The estimate for these benefits comes to 8.6 percent of GDP. Third, we draw on a computable general equilibrium model to suggest how today's economy would react to the restrictive Smoot-Hawley trading environment of the 1930s. That exercise indicates an estimate of 7.3 percent more in GDP from liberal trade. Finally, we calculate the productivity benefits arising from use of imported components and find a benefit of 9.6 percent of GDP. While none of the four estimates is perfect, the broad result is clear: The benefits of trade and investment liberalization are positive and large.

    Given the large gains from past liberalization, and today's low tariffs and modest investment barriers, skeptical commentators might say, "Been there, done that." But our estimates of future policy liberalization alone (excluding likely benefits from better communications and transportation) indicate that a move from today's commercial environment to global free trade and investment could produce an additional $500 billion in U.S. income annually, or roughly $5,000 per household each year. Much of the benefit would come from sectors of the economy that were effectively ignored during earlier rounds of liberalization: services, agriculture, transportation and trade with developing countries.

    [But the costs... what about the costs!!--ed. Ah, yes, they measure that too:

    Surveying several estimates, we arrive at a middle-of-the-road figure of roughly 225,000 trade-related job losses per year. Most dislocated workers find new jobs in six months, many far sooner; but some are unemployed for an extended period. Even workers who are re-employed may face significant pay cuts. Taking these features into account, we estimate that the lifetime costs of a year's worth of trade-related job losses is roughly $54 billion, about $240,000 per affected worker. This is a huge loss on a personal level, but only about 5 percent of the annual national gains from liberalization. (emphasis added)

    Click here to read more.

    posted by Dan on 06.08.05 at 12:36 AM


    Do economists ever recommend more regulation?

    Isn't it a bit like Marxists recommending full control of production be given to the proleteriat?

    The report seems to indicate that according the OECD's GTAP model there would be increases in GDP etc. The question is how accurate is the GTAP model and was it constructed in order to show the things that economists wanted to say?

    It's almost sad that Marxism has been so thoroughly discredited. If it were still around we could also have Marxists creating computer models that, amazingly enough, fully agreed with their theorems.

    posted by: Pete in Melbourne AU on 06.08.05 at 12:36 AM [permalink]

    The trouble with increased GDP per capita is that it is an average, and as we know from recent experience
    the distribution of the benefits is not very even.

    In fact, it appears to the casual observer the distribution is more skewed than is has been in a long time.

    posted by: save_the_rustbelt on 06.08.05 at 12:36 AM [permalink]

    Which, of course, implies that some, or a majority, or even a large majority of the population could lose income.

    posted by: Barry on 06.08.05 at 12:36 AM [permalink]

    1) As Thorstein Veblen would have recognized, the academic advocates of globalization
    use the techniques of medieval priesthood -- arguments based not on facts but on
    manipulation of a complex theory which only the officially anointed are qualified to discuss
    -- which is convenient because the unwashed might point out how the theory has
    little basis in reality.

    2) Why doesn't Dan discuss the salient FACTS about globalization? Such as the fact
    that the profits are flowing to the few while the enormous costs of defending foreign
    investments --costs borne in blood as well as money -- are dumped off onto US workers.

    3) The US is separated from the rest of the world by two large oceans. With a population of
    290 million owning 200 million firearms, we could defend the US mainland if the Department of
    Defense was scrapped overnight. So why does the US taxpayer have to shell out over $400
    billion/YEAR -- more than the next 25 largest military powers COMBINED? Especially since
    most of those other powers are our allies? Answer: To protect the foreign investments of the
    wealthy from nationalization and to twist the arms of foreign rulers.

    4) Why does Dan never discuss the enormous COSTS of globalization? Bush is using the "war on
    terror" to deploy US forces to Central Asia in order to take the huge Caspian Sea oil deposits
    away from Russia and Iran. The profits from Caspian oil --and Iraqi oil -- will flow to a few while
    blue collar US families only receive dead sons in coffins and have $Trillions stolen from their
    Social Security/Medicare Trust Funds to defend and advance globalization. Why does
    Dan think that the huge subsidy of the US Defense budget -- without which globalization would collapse -- is not worthy of discussion?

    5) Bush's tax cut for the rich --funded by stealing $Trillions from middle class
    America's Social Security Trust Fund --
    created jobs in China, not in the US. From 2001 to 2004, US Direct Investment Abroad increased by $102.8 Billion/YEAR. By contrast, US Fixed Investment,NonResidential (i.e., business investment in the USA) increased by only $52.7 Billion/YEAR.

    Note that roughly $1 Trillion has to be invested EVERY YEAR in US plant just to keep our current level of employment
    --due to the rapid depreciation of modern manufacturing (five year useable life of computer systems today
    vice the 30 plus year life cycle of steel mills and railroads 100 years
    ago.) The diversion of needed capital abroad is why the ranks of permanently US unemployed have soared and number in millions. Why does Dan not consider this worthy of discussion?

    6) Dan's defense of globalization involves a lot of theory -- in the sense that medieval priests
    used "logic" to prove how many angels can fit on the head of a pin. Galileo cut through this
    bullshit by arguing that one should look at the FACTS shown by observation of the real world
    --and by measurement. That is SCIENCE. That is why the name of Mr Drezner's discipline --
    "Political Science" -- is so hysterically funny in this context.

    Daniel Drezner has scoffed in the past at the loss of computer jobs due to outsourcing. See, e.g., his article in Foreign Affairs.

    But if Dan looked at the real world , he would have seen what I noted over a week ago:

    Dell Computer's 10-K annual reports shows that Dell had 23,500 US employees in 2000 and 13,000 foreign employees.

    Five years later, on March 2005, Dell US employees had only increased by 1,100 to 24,600.

    By contrast, Dell foreign employment increased by 27,600 employees!! to 30,600.

    (Note that Dell's US employment actually dropped below the 2000 level in intervening years due to large layoffs).
    Ref: , select 10-K reports for 2000 and 2005 ,and search for"employees"

    7) Although I think Dan is palming a few cards, I have to agree that he is only one of many advocates for globalization found in academia and on Wall Street. When I wonder why the debate on globalization is so dishonest, I can only conclude that it's because the wealthy who profit from globalization also hand out high paying jobs, lucrative consulting contracts, and lavish grants. By contrast, the "national interest" and the common citizen can hand out nothing to the chattering classes. That's why academicans feel no sympathy for the blue collar workers who fight this country's wars and whose hard work and sacrifice has created this country's wealth and freedom.

    8) In 1776, historian Edward Gibbon noted the enormous misery and poverty that mankind has endured for two millenia. He notes that priests could have prevented this by using their influence to advocate for fair treatment of the common citizen. He notes, however, that history shows the priesthood has always been on the side of the powerful and wealthy.

    Priests support the powerful because the powerful ensure that priests do not have to work for a living.
    That's the real "political science".

    posted by: Don the Greater on 06.08.05 at 12:36 AM [permalink]

    Don's post reminds me very strongly of creationist posts on and elsewhere. A great many elements are common to the two.

    posted by: asg on 06.08.05 at 12:36 AM [permalink]

    I sure as hell hope that "Don the Lesser" never posts comments on this blog...

    At any rate, the articles Dan summarizes seem quite convincing. I still think, though, that we are not doing enough as a country to help the displaced workers. I still think there is not enough respect paid to the sense of self-worth individuals get from "good" jobs, and to the importance of this self-worth in republican government and citizenship. Cost-benefit analyses that deal with dollars only don't take into account every cost and benefit.

    posted by: Andrew Steele on 06.08.05 at 12:36 AM [permalink]

    It never ceases to amaze me how protectionists ignore the benefits to everyone of lower prices (i.e. higher real incomes) due to more sources of supply. These are widely distributed, populist gains from trade that account for the majority of the benefits found in the various economic studies. So even using the overly narrow, static distributional calculus urged by the critics of free trade, vast numbers of average citizens get immediate and significant benefit from the existence of foreign competition.

    As for self-respect and citizenship, how is it more respectable to force people to do business with you when they would rather get a better deal elsewhere? How can it be a fulfillment of good citizenship to coerce one's neighbors not to use their best judgment in choosing from whom to buy? Perhaps the mafia's linen services to restaurants provide lots of self-respect for the mobsters strong-arming their "customers," but it seems a poor model of citizenship for the rest of us.

    posted by: steve on 06.08.05 at 12:36 AM [permalink]

    Lower prices are great --- if you have a job, or have a job that pays a decent wage.

    In states with manufacturing losses, wages and benefits are plummeting, as workers take whatever service and retail jobs they can get. REal wages and real income trail.

    This of course has a ripple effect, lower tax collections, stagnant housing prices, lower retail sales, which leads to wage stagnation, ..... and we now have quite a vicious cycle.

    It seems, in a simplistic sort of way, that federal policies over two decades largely benefit those states that "touch an ocean," to the detriment of the heartland. California is hiring longshoremen at high wages, laid off manufacturing workers are going to work at big box stores.

    posted by: save_the_rustbelt on 06.08.05 at 12:36 AM [permalink]

    I guess I must be 'Don the Lesser'. ;)

    Speaking to Dan's actual point, I think there are two or maybe three things going on here.

    1) I don't doubt that the study is accurate. Liberalisation really does raise average incomes.

    2) What possibly doesn't appear in the study is that it also increases risks. The risk that large groups will be made unemployable or be forced to take major pay cuts (50% or more) very swiftly seems to accompany liberalisation. Factory workers in heavy industry are a perfect example and my fellow IT workers seem to be another.

    Another effect which seems to elude many economists is a drop in status. This has been extremely visible in the IT industry over the past 5 years. This was a high-status occupation but is no longer.

    The signals the market sent IT workers seem in retrospect to have been extremely misleading - and I submit that is the problem. Many intelligent people made and make large investments in time and money acquiring skills which the market seems to value - then the globalisation 'wind-shear' hits and returns on these investments drops to low or even negative levels.

    3) I wonder whether it's possible to put the cat in the bag - to return Western IT and other knowledge workers to the high status and pay they once enjoyed by removing things like the H1B visa program. Or whether natural market forces will return some of the lost ground more naturally. I don't think H1B is the fundamental problem, so I doubt that getting rid of the program will help. I think better enforcement of the rules could help - because it's obviously being abused.

    On the 'natural recovery' argument I don't know. Some days I'm optimistic - today I am not.

    posted by: DonS on 06.08.05 at 12:36 AM [permalink]

    One more point, I guess. When I look at countries like France and Germany who apparently try to insulate workers from the market forces of liberalisation Isee two things:

    1) It really does work for those who have good jobs. They are significantly more secure than I am - though their pay is lower.

    2) But I also see high levels of unemployment and anger among their young people, minority groups, and older factory workers. So I think these countries pay also. They have merely succeeded in displacing the impact of the global liberalisation within the labor force - not in avoiding it altogether.

    3) As long as liberalisation is going to happen anyway a country may as well enjoy the benefits as well as the hardships. I think France and Germany are getting the bad without enjoying the good. That seems wrong-headed to me....

    posted by: DonS on 06.08.05 at 12:36 AM [permalink]

    All investiments, including those in human capital, are (and should be) hostages to fortune, if we are not to straitjacket our fellow citizens in their search for the best trades they can get. Shoemakers were devastated by factory automation; watchmakers have been hurt by digital technology; paste-up artists went extinct due to desktop publishing; primary steelworkers were outcompeted by minimills in all but the highest-quality product lines; travel agents have been pounded by the internet. The list is endless. Change in what people do for a living, the rise and fall of various forms of specialization, is not a bug in the system--it is the essence of economic progress.

    Occasionally, a line of work (or an industry) hits a "sweet spot" where it can expand its operations for a number of years without significantly changing them. In such cases, the illusion that growth without change is possible may flourish. But these situations rarely persist for long without coercive regulation against, newer, better, and/or cheaper ways of doing things.

    DonS is correct that regulations aimed at stabilizing the division of labor lead to various forms of stagnation and push the costs of that stagnation onto marginal groups. Asser Lindbeck, a Swedish economist, has written about the "insider-outsider" structure of European economies under social democracy. Those who have jobs are protected insiders, while those on the outside have limited career prospects. In return for this divisive distributional policy, they also get a lower average standard of living over time, a classic lose-lose solution.

    posted by: steve on 06.08.05 at 12:36 AM [permalink]

    I'd reply that what's for the goose is sauce for the gander. If being naked to global market forces (and forced to compete with workers making 20% of what I do) is good for me - and that is the classical case being made....

    Let's consider academic tenure. It's pretty well established that tenured faculty are on-average less productive than untenured faculty. Particularly in undergraduate teaching. Correct?

    So why tenure? Why is tenure for academic economists a good thing - therefore competition a bad thing - for academic economists? Perhaps they deserve a chance to kick back and relax a little.

    But then why don't I get that chance also? I've been a superior programmer for 22 years. But when I reached tenure age I was pitched straight into a battle for my career. 'Too Old' they said. Well I'm not - I've just proven it where I work now. And I'll have to keep proving it every damned day until I retire, die, or get shipped to the fool farm.

    Professor Drezner won't. Where is the justice in that? Professor, I challenge you to live by the principles you espouse. Turn down that tenure offer!

    posted by: DonS on 06.08.05 at 12:36 AM [permalink]

    A radical proposal - Deregulate the University. Many if not most faculty holding the PhD are abysmal teachers - so why not thow open the ranks of the professorate to truly talented teachers - without the PhD?

    You could argue that universities already do that for their lecturers - the ranks of the ABD's. But the path to the top isn't open to these people - many of them talented teachers. No, they are the sweated labor of the University monosony! You must hold the PhD and acquire tenure to progress.

    Why is that so? Why not offer tenure and top jobs to great teachers who don't hold the PhD?

    What you have is the Medieval Guild system applied to the modern university - it makes no sense. And how academics can argue that this oligopoly is a good thing - but deny all other profession #from setting up their own oligopolies - is completely beyond understanding!

    Anyone care to explain this to us?

    posted by: DonS on 06.08.05 at 12:36 AM [permalink]

    The OECD is a nice study all right. Problem is that it's a house of cards. It produces a nice result because, well, the assumptions underlying the abstract analysis are designed such that they can't produce a bad result. It's a neat little game. People like Dan don't question the results, because, well, it confirms prior beliefs. Such is the free trade pathology.

    posted by: Globalize This! on 06.08.05 at 12:36 AM [permalink]

    Adam: I hope your reading comprehension improves in graduate school, since the critique you link to does not address the OECD paper (indeed, the latter doesn't even cite the Brown, Deardorff and Stern paper).

    Furthermore, I hope your graduate training improves your knowledge of trade theory; your blog post critques the static model of comparative advantage and overlooks a fair amount of not-so-recent research (by Paul Romer among others) about the dynamic benefits of trade liberalization.

    posted by: Dan Drezner on 06.08.05 at 12:36 AM [permalink]

    Dan: I don't get to "See Spot Run" until next semester, but until then...

    I wrote: "those who observe that trading entails more competition in the market argue that trading yields dynamic gains as well, inducing producers to up productivity. But here the evidence is unclear which way causation runs: does trading cause firms to be more productive or is it that more productive firms tend to trade?"

    Coincidentally, I wrote this before I read your post or the OECD report.

    You quote the OECD: "many would argue that liberalisation produces “dynamic gains”, that is more open product markets stimulate research, innovation and technical progress on a sustained basis."

    In re the citation of Peter Dorman: You're right. The OECD study does not cite BDS (though they both use the same GTAP data). But that's not the point. Dorman provides a broader critique of using general equilibrium models to estimate welfare gains from trade: a comparative static equilibrium analysis. And of course underlying this is a host of unrealistic assumptions about how the world works. Of course there are people who try to make the general equilibrium tool more realistic by incorporating unemployment, underutilization of productive capacity, etc., but they tend to work at UNCTAD rather than the OECD.

    As for the estimates of dynamic effects of trade liberalization, here's how one World Bank modeler explained it to me recently (I'm paraphrasing): "Basically, do you want to multiply it by two, three, or four?"

    With or without a dynamic effect, all of these models are lacking a cucial element that should be obvious to a Chicagoan: optimizing micro-agents.

    I'm not saying that trade is bad or good. I'm just saying we should be circumspect about proclaimed measurements of the benefits of trade.

    Spin Better!!!

    posted by: Globalize This! on 06.08.05 at 12:36 AM [permalink]

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