Wednesday, 16 December 2015

The average gains from trade may depend on human capital

The gains from trade is one of the (few?) propositions of economic theory that is supported by virtually all economists. At least, the theory holds for individuals trading with each other. Despite this overall agreement there is still no consensus on whether international trade is equally good for all countries. Sceptics like Dani Rodrik and Nobel prizewinner Joseph Stiglitz argue that globalisation (and by extension, free trade) may have gone too far.

The basic argument that free trade is good for all countries relies on increases in aggregate wellbeing (gains in consumer and/or producer surplus), that are shared by consumers and producers in each country, making them better off. Also, openness places pressure on governments and households to invest more in human capital in order to compete in the global market, making the average citizen better off. The argument against this suggests that, because poorer countries rely on tariffs on trade goods for revenue, openness to trade undermines government income and makes it harder for the government to afford to pay for the welfare state, health and education expenditures. Reductions in these areas make the average citizen worse off.

A recent paper (sorry, I don't see an ungated version anywhere) by Stephen Kosack (University of Washington) and Jennifer Tobin (Georgetown University) suggests that both of these arguments may be true. How can that be? It all depends on the level of human capital of the country. Kosack and Tobin explain:
One consequence of the increased trade is the reallocation of economic activities that require high levels of human capital to countries with capable, productive workers. In countries that already have such work-forces, increasing trade appears to reinforce human development, adding both resources and rational for further improvements in people's lives and capacities. But in most countries, the workforce has not yet developed such capacities, and in these countries, increased trade tends to undermine the incentives and the ability of governments to invest in citizens and citizens to invest in themselves.
Kosack and Tobin use data since 1980 from the Human Development Index, and find that trade is overall negatively associated with human development. However, this relationship holds strongly for low-HDI countries, whereas for high-HDI countries the relationship is positive (i.e. trade further increases human development). Their results are robust to a number of different specifications and data.

However, I do have one concern. Many of the lowest-HDI countries are also the sub-Saharan African countries that have, since the 1980s, suffered the brunt of the HIV/AIDS epidemic. While my reading is that there is only weak evidence of an impact of the epidemic on GDP, there has certainly been a large impact on life expectancy (one of the components of HDI). Kosack and Tobin do not explicitly control for this. Having said that, when they exclude the health component of the HDI from their dependent variable, their key results do not change significantly. So, perhaps there is something to this.

Interestingly, New Zealand did rate an explicit mention in the paper. At New Zealand's level of HDI, the results suggest that openness to trade is good - "a one standard deviation increase in trade openness is associated with an increase in HDI Rate of nearly 2%". The turning point between 'good' and 'bad' is at the level of HDI of Mauritius or Brazil.

It is important to note that the average citizens of low-HDI countries were not made worse off by openness to trade in absolute terms, only relative to high-HDI countries with a similar level of openness to trade. My conclusion from reading the paper is that, while openness to trade is a good thing, it is better for some countries than others. I don't think anyone would have disagreed with that even before this paper was published. My take is that the debate on whether globalisation has gone too far is still not settled (and I'll continue to have spirited discussions of it in my ECON110 class each year, no doubt).

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