Saturday, January 19, 2008

Trade and Compensation, Again

. Saturday, January 19, 2008

Yet another round of debate on “trade, income, and compensation.” In case you are just tuning in, the trade, income, and compensation debate is the following: Trade liberalization reduces the income of one group of people and raises the income of a different group. Should those who gain compensate those who lose?

Here is why this is tiresome.

A. There is no “right” answer. There are good arguments to be made for yes, and there are good arguments to be made for no. There are no external grounds to which we can appeal to select one over the other.

B. Adherents to the yes side (winners should compensate losers) typically under-analyze the economics.

1. The moral obligation to compensate losers must be reciprocal. If tariff reductions redistribute income then tariff increases must redistribute income in the opposite direction. If we should compensate losers from tariff reductions then we should also compensate losers from tariff increases. As textile workers and farmers and (insert protected industry here) have not compensated losers from high tariffs, I do not see why those who win from low tariffs now have a moral obligation in the other direction. Appeals to “fairness” lose their purchase.

2. Losers from trade liberalization already have been compensated. The tariff enables workers to earn above-market returns. This rent compensates for the lower income they earn once the tariff is gone. Imagine that a worker in a protected industry saves the rent (the difference between the wage in the next best available job and her current wage). Once the tariff is eliminated and the worker is employed at a lower wage, those saved rents, spent slowly over time, provide an income higher than the new lower wage. The fact that people don’t behave this way is irrelevant to the broader insight—the rent the tariff provides is compensation for the risk that the tariff might one day disappear. It is not obvious that society has an obligation to compensate them again.

C. Adherents to the “no" side typically under analyze the political problem.

1. Tariffs reflect political influence. Eliminating a tariff, therefore, requires a policy exchange. This policy exchange need not be compensation for workers in the now-liberalized industry, but it must be something equal to the present value that the tariff holder attaches to the stream of rents the tariff generates. Normative arguments (aw, you should just surrender your property rights) are irrelevant. No free lunch in politics either.

2. Sustaining low tariffs in a democratic society requires popular support . The public is more likely to support trade if they believe they are somewhat insured against its downside risk. Hence, compensation might be a political necessity for openness in a democratic society.

D. Thus, debating whether we should or shouldn't compensate losers is pointless; the question is whether compensation is a necessary part of the policy bargain that must be struck in order to construct majority support for trade. As this is not a normative question, debating the question in normative terms—should we or shouldn’t we—is entirely beside the point.

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Trade and Compensation, Again
 
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