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April 29, 2007
What Are You Going To Believe -- Theory Or Your Own Lying Eyes?
The blogger epicenter of the free-trade debate is rumbling at Harvard, with Greg Mankiw and Dani Rodrik engaged in a terrific -- and important -- conversation about winners, losers, and how (or whether) economic theory divides the two. You can check-in on the state of the debate at Angry Bear, where pgl provides the appropriate links. It is highly recommended reading, but I think it ought to come with a few warning labels. For example, Professor Rodrik responds to Professor Mankiw with this claim:
... there is no theorem that guarantees that the partial-equilibrium losses to import-competing producers “are more than offset by gains to consumers from lower prices.”
In a related vein, pgl opens his post with:
Let's be perfectly clear: There are no theorems in economics that guarantee anything about the real world. Economic models are not descriptions of physical realities but formalizations of stories about how social interactions deliver particular outcomes. Different, equally coherent, stories deliver different predictions about the world. The claim that "free trade benefits everyone" is not a fallacy, but a particular outcome based on a particular model. Different models deliver different answers, so theory alone does nothing beyond eliminating stories that are internally inconsistent.
Or, perhaps, unconvincing. The missing ingredient in this most recent installment of the free-trade discussion is evidence in favor of one story or another, a task that is a good deal messier than writing down models. What makes matters worse is that adjudicating the issue is not a mere matter of counting up winners and losers. In the court of determining what is "good" or "bad", economists have standing to address one question, and one question only: Can someone be made better off without making anyone worse off? That too depends on the model at hand, and in fact it's even worse than that. The Rodrik-Mankiw debate revolves in part around a result known as the Stolper-Samuelson theorem. Greg Mankiw does a good job explaining Stolper-Samuleson and its relevance to the subject at hand, but I'll note one item from the Wikipedia description of the theorem:
If considering the change in real returns under increased international trade a robust finding of the theorem is that returns to the scarce factor will go down, ceteris paribus. A further robust corollary of the theorem is that a compensation to the scarce-factor exists which will overcome this effect and make increased trade Pareto optimal.
In simple terms, there are losers, but the winners can win enough to more than match those losses. All would be well with the world if the winners and losers could be easily identified, and an appropriate compensation scheme implemented. But what if that is not feasible? What is the right move then? To protect the losers at the expense of significant opportunity cost to potential winners? The other way around? I've yet to encounter an economist trained to answer those questions, and you should be very suspicious of any who speak as if they are.
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