Americans' beliefs about trade, and why compensation matters

Do people understand trade policy? Or rather, do they understand trade policy the way that economists understand it? Given current debates in the US and elsewhere, it would be fair to question people's (or politicians') understanding of trade policy, and to consider what it is about trade that generates negative reactions. After all, the aggregate benefits of free trade are one of the things about which economists most agree.

Last year, Stefanie Stantcheva won the John Bates Clark Medal (which is awarded annually to the American economist under age 40 who has made the most significant contributions to the field). Stantcheva's medal-winning work included three main strands, one of which was the use of "innovative surveys and experiments to measure what people know". One of the papers from that strand of research is this 2022 NBER Working Paper (revised in 2023), which describes Americans' understanding of trade and trade policy and importantly, it answers the question of why people support trade (or not).

The paper reports results from three large-scale surveys in the US run between 2019 and 2023, with a total sample size of nearly 4000. The surveys also included experiments that primed respondents to think about trade from particular angles. Overall, Stantcheva is interested in teasing out the factors that affect Americans' support for trade policies. Essentially, she tests the mechanisms that are described in Boxes I-V in Figure 2 from the paper:

Box I picks up views on whether trade lowers prices and increases variety for consumers. Box II picks up the threats from increasing trade to workers in import-competing sectors. Those two boxes together constitute self-interest as an effect on people's views on trade policy. Their views might also be affected by broader social and economic concerns, such as trade's efficiency effects (Box III), its distribution impacts (Box IV), and patriotism, partisanship, or geopolitical concerns (Box V).

Before we turn to the specific results on the mechanisms, it is worth considering Americans' overall views on trade first. Stantcheva reports that:

Most respondents (63%) are supportive of more free trade and decreasing trade restrictions in general... Only 36% believe that import restrictions are the best way to help U.S. workers.

Nevertheless, there is support for more targeted trade restrictions. 40% of respondents believe the US should restrict food imports to ensure food security. 54% think the US should protect their “infant” industries. 78% support protection of key consumer products, namely food items and cars. 50% believe the US should restrict trade in key sectors, such as oil and machinery...

And general knowledge about trade policy is not too bad, as:

...almost 80% of respondents know what an import tariff is, but just around half know what an import quota is. Two-thirds of respondents appear to understand the basic price effects of tariffs and export taxes, i.e., that an import tariff on imported goods will likely raise the price of that good and that an export tax will increase the price of the taxed good abroad. The final question... considers a scenario in which the US can produce a good (“cars”) at a lower cost than the foreign country. Respondents are asked whether, under some circumstances, it would still make sense to import cars from abroad. 68% of respondents agree that it could make sense. This suggests that respondents either understand the concept of comparative advantage or have in mind some model of love-for-variety or quality differential.

So far, so good. How do Americans perceive the impacts of trade? Figure 9 Panel A reports perceptions related to the self-interest motivation (Boxes I and II from the figure above):

From the bottom of that figure, it is clear that a majority of Americans believe that they are better off from trade, but a substantial minority (39%) believe that they are worse off. Still focusing on the self-interest motivations (Boxes I and II), Stantcheva finds that:

In general, a respondent’s (objective) negative exposure to trade through their sector, occupation, or local labor market is significantly positively correlated with a feeling that trade has made them worse off and that it has negatively affected their job. People exposed to trade through their job also feel worse off as consumers and are less likely to believe that trade has reduced the prices of goods they buy, perhaps because they feel that their purchasing power is lower than it would otherwise be. Furthermore, college-educated respondents are significantly less likely to feel negatively impacted in their role as consumers and workers.

Notice those results are mostly consistent with the figure above. What about consumer gains through reduced prices on imported products? Stantcheva reports that:

...the belief that prices decrease from trade is not significantly related to either support for trade or redistribution. Consistent with this lack of correlation, the experiment priming people to think of their benefits as consumers (precisely, the prices and variety of goods they purchase) does not move their support for trade either.

So, in terms of self-interest, Americans' support for trade is more negative when they are negatively affected as workers, but is not more positive when they are positively affected as consumers. In my ECONS102 class, we talk about the tension between the gains from trade and loss aversion. Every trade involves gaining something, in exchange for giving something up. However, quasi-rational decision-makers are affected much more by losses than equivalent gains (what we call loss aversion). So, loss aversion might mean that many profitable trades are not undertaken, because the decision-makers prefer to keep what they have, rather than giving it up for something that may be objectively worth more. In the case of Stantcheva's survey respondents, the workers who are negatively impacted experience a loss, which would be weighed much more heavily than the gain that a consumer receives.

An alternative explanation is salience. Job losses are very visible and impactful on the people who lose their jobs and those around them. Consumers' gains in terms of lower prices and increased variety, on the other hand, are not really as visible - many people wouldn't even notice them, unless they were pointed out to them. So even if people weren’t loss averse, attention would still be drawn disproportionately to the negative impacts of trade, rather than the positive. Taken altogether, Stantcheva's results here are not surprising.

What about the broader social and economic concerns, and their impact on views about trade? In terms of efficiency effects (Box III), Stantcheva reports that:

Respondents are generally optimistic about these effects. For instance, 61% of respondents think that international trade increases competition among firms in the US, 69% that it fosters innovation, and 62% that it generates more GDP growth.

Moreover:

...efficiency gains from trade are significantly associated with more support for free trade... This relation can be seen in the correlations and the experimental effects: the Efficiency treatment significantly improves support for free trade.

And interestingly:

Respondents who believe that trade can improve innovation, competitiveness, and GDP are more supportive of redistribution policy to help those who do not benefit from these efficiency gains.

Turning to distributional impacts (Box IV), Stantcheva reports that:

Overall, respondents know that trade can have adverse distributional consequences through the labor market. Just around half of all respondents believe that trade has, on balance, helped US workers. 79% of people think that trade is the reason for “unemployment in some sectors and the decline of some industries in the U.S..” More respondents (63%) believe that high-skilled workers could easily change their work sector if their jobs were destroyed by trade than that low-skilled workers could switch sectors (37%)...

Consequently, around two-thirds of respondents think that trade is a major reason for the “rise in inequality” in the US. Notably, despite being aware of the potential adverse distributional consequences of trade, a majority (62%) of respondents believe that, in principle, trade could make everyone better off because it is possible to “compensate those who lose from it through appropriate policies.”

It is interesting that so many people believe in the compensation principle (although I bet that few of them would know that term for it). And it turns out that belief in the compensation principle is really important, as:

...the strongest predictor of support for free trade is the belief that, in principle, losers can be compensated... free trade. As long as respondents believe that adverse consequences from trade on some groups can be dampened by redistributive policy, they are likely to support more free trade, even if they believe that there are adverse distributional consequences. The perceived distributional impacts of trade also substantially matter for support for compensatory redistribution. Respondents who believe that trade hurts low-income and low-skilled workers and that it fosters inequality support redistribution much more.

Finally, in terms of patriotism, partisanship, or geopolitical concerns (Box V), Stantcheva reports that:

...those who worry about geopolitical ramifications from trade restrictions, i.e., retaliatory responses, are more likely to support policies to compensate losers from trade rather than support outright trade restrictions. Patriotism is significantly correlated with support for trade restrictions in many industries and to protect U.S. workers, as well as with lower support for compensatory transfers...

Stantcheva draws a number of conclusions from her results, including:

First, respondents perceive gains from trade as consumers to be vague and unclear but perceive potential losses as workers to be concentrated and salient. Actual and perceived exposure to trade through the labor market is significantly associated with policy views...

Second, people’s policy views on trade do not only reflect self-interest. Respondents also care about trade’s distributional and efficiency impacts on others and the US economy...

Third, respondents’ experience, as measured by their exposure to trade through their sector, occupation, and local labor market, shapes their policy views directly (through self-interest) and indirectly by influencing their understanding and reasoning about the broader efficiency and distributional impacts of trade.

Overall, I take away from this paper that Americans have more correct views about trade than I suspected. Their support for trade is not determined simply by self-interest, but is more nuanced. However, negative impacts weigh far more heavily for those who are negatively impacted than the weight attached to positive impacts for those who are positively impacted. That may relate to loss aversion, and to the more concentrated nature of negative impacts compared with more diffuse positive impacts. That asymmetry also explains why a majority have positive views of trade (since fewer people will have been negatively impacted on the whole). The most surprising aspect to me, though, was the views on the compensation principle. Those results provide a clear policy prescription. To get more people on board with trade, making compensatory policy more explicit and salient may help to ensure that there is greater support for trade. On the other hand, politicians who want to exploit the negative views on trade might benefit from obscuring any such compensatory policies. Unfortunately, there are too many who are willing to do just that.

[HT: Marginal Revolution, last year]

Immigration and the wages of the native-born population

Restrictions on immigration flows are getting a lot of policy attention of late. The argument is that immigration reduces wages for the native-born population. But, is there evidence for that? As you might expect, there are literally dozens of studies that have looked into this question, and there are now several meta-analyses that combine the results across many studies (including the meta-analysis that I referred to in this 2016 post. That post referred to this 2005 article by Longhi et al., which found that:

Overall, the effect is very small. A 1 percentage point increase in the proportion of immigrants in the labour force lowers wages across the investigated studies by only 0.119%.

Longhi et al. then followed up with another article in 2010, which also found a very small effect of immigration on wages, specifically:

...a 1% point increase in the immigration to population ratio reduces wages by only 0.03%.

A new meta-analysis article by Amandine Aubry (Université de Caen Normandie) and co-authors, published in the journal Labour Economics (open access), picks up those two earlier meta-analyses, and extends the analysis up to 2023. Specifically, their analysis includes:

...88 studies published between 1985 and 2023, encompassing 2,989 reduced-form estimates of the wage effects of immigration.

Many post-2010 studies use shift-share (Bartik) instruments to estimate the causal effect of immigration on wages. These instruments predict regional immigrant inflows by interacting a region’s pre-existing settlement shares by origin with national inflows from those origins. They then use the predicted inflows as an instrument for actual inflows in an instrumental variables framework. This approach helps address the concern that immigrants may sort into destinations with stronger labour markets, which would make immigration and wages correlated for reasons other than a causal effect of immigration on wages.

Now, Aubry et al. are more concerned with investigating the heterogeneity in the estimated effects of immigration on wages, rather than the overall estimate. Nevertheless, I think the overall estimate is interesting and important, and for that they find:

...a 1% rise in the immigrant labour force reduces native wages by about 0.033% on average.

This overall effect is very similar to that from the second meta-analysis by Longhi et al. But it's tiny - a 1 percent larger immigrant labour force would reduce the wages of a native-born worker earning $1000 per week by about 33 cents. And, there is substantial variation around that small overall estimate, which Aubry et al. investigate in some detail. They find that:

...contextual heterogeneity explains part of the variance in the estimates. Estimates for Anglo-Saxon and developing countries are systematically larger than those for other economies, and the historical period covered by a study also affects the results, with later periods being associated with smaller effects. Third, methodological heterogeneity is key... In particular, instrumental variable estimations, which are commonly used to infer causality, yield smaller coefficients than OLS...

More recent studies tend to estimate smaller effects of immigration on wages, as do studies that employ instrumental variables (which also tend to be more recent studies). That accords with the results from the two Longhi et al. meta-analyses, where the second study found a much smaller overall effect than the first study. The shift-share instrument only became established as a method by David Card and others in the early 2000s, so its use only began diffusing from then. Given that these sorts of analyses have become the industry standard now, we can generally expect future studies to find smaller effects than older studies.

The results for developing countries, where the effect of immigration on wages is more positive than for developed countries deserves more exploration. Aubry et al.'s sample includes estimates from only a handful of developing countries (Colombia, Costa Rica, Malaysia, Peru, South Africa, and Thailand). This also suggests that more studies on the effect of immigration on wages in developing country contexts would be useful.

The overall takeaway from this meta-analysis is that immigration on average has a negligible overall effect on the wages of the native-born population on average. Unfortunately, this is one of those cases where the empirical results do not accord with 'folk economics'. Although the average effect is negligible, the wages of some subgroups may be negatively impacted by immigration in some contexts (and Aubry et al.'s results are consistent with the idea that the impacts are negative in some contexts or for some groups). The general public (and policy makers) will tend to focus on those negative impacts. Nevertheless, it should be possible in principle to address those negative impacts through policy (economists refer to this as the compensation principle), so that those who benefit from immigration (including immigrants themselves) can continue to do so.

Read more:

• The (small) effect of immigration on wages
• In the labour market, you can't have the best (or the worst) of both worlds
• Immigrant restrictions and wages for locals
• Immigration, native employment, and political backlash
• Michael Clemens vs. the Roy model of migration

Sunshine, the value of housing and compensation for externalities

In ECON110 today, we discussed hedonic demand theory (or hedonic pricing). Hedonic pricing recognises that when you buy some (or most?) goods you aren't so much buying a single item but really a bundle of characteristics, and each of those characteristics has value. The value of the whole product is the sum of the value of the characteristics that make it up. For example, when you buy a house, you are buying its characteristics (number of bedrooms, number of bathrooms, floor area, land area, location, etc.). When you buy land, you are buying land area, soil quality, slope, location and access to amenities, etc.

In a new Motu working paper, David Fleming, Arthur Grimes, Laurent Lebreton, Dave Maré, and Peter Nunns show that sunshine is one of the important characteristics that contributes to house values. The New Zealand Herald reported a couple of weeks ago:

Motu Economic and Public Policy Research Trust has released what it calls the first research carried out anywhere in the world to specifically evaluate the extra value house buyers put on extra sunshine hours.

Arthur Grimes, a senior fellow at Motu and co-author of the study, said there was a direct correlation between more sunshine and higher values and the study was precise about how much extra value is added.

"Direct sunlight exposure is a valued attribute for residential property buyers, perhaps especially in a cool-climate city such as Wellington. However, natural and man-made features may block sunlight for some houses, leading to a loss in value for those dwellings," the study said.

The effect is quite large. Quoting from the paper:

...each additional hour of direct sunlight exposure for a house per day (on average across the year) adds 2.4% to a dwelling’s market value.

The paper also has some interesting implications in terms of negative externalities. If a high-rise apartment development will block the sunlight from nearby houses, then it will reduce the value of those houses. This constitutes a negative externality imposed on the affected homeowners. Fleming et al. note that these externalities could be dealt with through compensation:

At a policy level, our estimates may be used to facilitate price-based instruments rather than regulatory restrictions to deal with overshadowing caused by new developments. For instance, consider a new multi-storey development that will block three hours of direct sunlight exposure per day (on average across the year) on two houses, each valued at $1,000,000. The resulting loss in value to the house owners is in the order of $144,000. Instead of regulating building heights or the site envelope for the new development, the developer could be required to reimburse each house owner $72,000. In return, the developer would be otherwise unrestricted (for sunlight purposes) in the nature of development. If the development cannot bear the $144,000 then the efficient outcome is that the development does not proceed. Conversely, if the development can bear that sum, then the socially optimal outcome is for the development to occur and, from an equity perspective, the neighbours are compensated for their loss of sunlight exposure.

The idea that compensation can be used to deal with externalities relies on the Coase Theorem - the idea that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without government intervention). In the case of a bargaining solution to an externality based on the Coase Theorem, the solution depends crucially on the distribution of entitlements (property rights and liability rules). In this case, the homeowners have existing rights to sunlight and because an apartment development would infringe on those rights, the developer would be expected to pay compensation to the affected homeowners. This will only be viable if the total amount of compensation paid to affected homeowners is not so great that it makes the development unprofitable.

The study was based on data from Wellington. Given that development in Auckland is happening faster and involves increasing density and greater numbers of taller mixed-use buildings, it would be interesting to see if the results hold there as well. As noted in the New Zealand Herald story:

"For places other than Wellington, the value of sunshine hours may be higher or lower depending on factors such as climate, topography, city size and incomes. Nevertheless, our approach can be replicated in studies for other cities to help price the value of sunlight in those settings," Grimes said. 

So the approach is transferable, even if the results are not. It's almost certainly extendable to considering the value of volcanic viewshafts in Auckland, and hopefully someone is already thinking about undertaking that work.

Solutions to the problem of squealing children, Japan edition

Back in December last year, I wrote a post on dealing with the problems of squealing children at least cost:

Now, squealing children is a classic negative externality - an uncompensated impact of the actions of one party on a bystander. The poor residents of Stonefields face a cost that is imposed on them by the unscrupulous actions of the children. Since the children have no incentives to take into account the costs that they are imposing on the residents of Stonefields, they generate too much noise compared to the socially efficient optimum.

How best to deal with the problem of squealing children? In Japan, they use a command-and-control policy - a daytime noise limit of 55 decibels (night-time 45 decibels) in residential suburbs. That's not much louder than bird calls, i.e. a pretty extreme limit not conducive to playing children. Parents can be fined if their children exceed the noise limit, a solution to the problem that is based on the "polluter pays principle". Under this principle, the party that is responsible for the pollution is solely responsible for making restitution for the damage they cause.

However, Robin Harding reports in the Financial Times that Tokyo is considering changes to the noise regulations:

“In the past this wasn’t an issue but recently more people have been complaining to city halls, saying ‘the children are too loud, please stop them’,” says Yukie Nogami, chairwoman of Tokyo’s environment and construction subcommittee. “The law says city halls have to act.”

Ms Nogami’s committee will soon debate a proposal to carve out an exemption from the noise rules, either for children under 12 or for certain places such as parks and kindergartens.

In line with what I argued in December, the 'least cost' solution to squealing children might not be command-and-control policies like noise bans (which entail a high cost in foregone fun for the children), but sound-proofing the neighbourhood homes. Sound-proofing entails a one-off cost for each home, versus an ongoing cost of foregone fun. Of course, the cost of soundproofing every residential property (rather than just those located near playgrounds or day care centres) would likely be prohibitive.

However, once you have a command-and-control policy in place (like Japan's noise limits), it's going to be difficult to back out of. The noise limit created a new property right (the right to extreme residential quiet), and once created there is no Pareto-improving way to remove the right - that is, there is no way to remove the noise limits without making at least some people worse off. Who is going to be worse off? From the FT article:

About two-thirds of respondents to a consultation support the change but a minority is strongly against, complaining about everything from the lax upbringing of modern children to the effect on property prices.

The effect on property prices may well be real. If extreme quiet is valuable to Japanese homeowners (and prospective home buyers), then removing that property right is going to lower the value of residential homes (especially those close to playgrounds and day care centres). So at least some homeowners are right to be worried.

Moreover, the homeowners whose properties will be affected have a large incentive to protest the change in noise limits - the cost of the changes (in terms of lost property value) are likely high for each homeowner relative to the cost of protesting. Whereas the gains from the change in noise limits are spread widely among children and their parents, each of whom probably only gain a little from the changes. So expect lots of argument over this planned change, unless the homeowners can be adequately compensated. Following the compensation principle, if those who gain from the policy change (children and parents) can adequately compensate those who lose (affected homeowners), then the new policy (no, or higher noise limits) should be preferred. Since it would be difficult for children and parents collectively to compensate homeowners (free riders, anyone?), the compensation would likely have to come from taxpayers instead.

Of course, the better solution would have been not to have the extreme noise limit in the first place. As I noted in December (in relation to playgrounds in Stonefields):

The Coase Theorem tells us that, if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own (i.e. without government intervention). In the case of a bargaining solution under the Coase Theorem, it depends crucially on the distribution of entitlements (property rights and liability rules). Do children have the right to play and make noise? If so, then the residents would have liability to pay the children to be quiet - maybe buy them a bunch of Playstations and send them indoors to be quiet. Either that, or the children can just keep having fun in the playground and making as much noise as they like. On the other hand, do the residents have the right to peace and quiet? If so, then the children would have liability to compensate the residents for the noise of their playing. Either that, or they have to give up the playground.

Who has the rights? At the moment in Japan it's the homeowners, but I'm not convinced that was ever the least cost solution. As one respondent to the survey discussed in the FT article notes:

“To play and cry and make a big noise is a child’s right.”