Trade Deals are about Winners AND Losers

Comparative advantage is rarely important in modern trade deals, such as TPP11 (CPTPP). Why bother?

Economics students have ‘comparative advantage’ drummed into them. The intuition seems commonsense; specialise in what you (or the country) do well and exchange the surplus for what you are not as good at. The economist’s Heckscher-Ohlin model which makes the intuition rigorous can be a bit trying; I regret that it is frequently taught as a proof of the benefits of free trade, and little attention is given to the assumptions that are necessary to get to the conclusion.

However, while comparative advantage lurks behind most advocacy of free trade deals, it is not so important.

In the 1970s, we economists (including Treasury ones) realised that even if the assumptions were true, the gains from trade may be small in practice. The theory says they exist but it does not say how big they are. Further investigation showed that the distributional gains and losses from free trade could be much greater. Some sectors would make big gains (and so would be keen advocates of any deal), others would make losses (they oppose the deals). Because the net overall gains were trivial, it was not practical for the winners to compensate the losers (which is one of the assumptions lurking under the H-O model).

But it does not follow that there were no advantages from reducing protection. At least two other reasons seem important.

The first is that external competition results in better quality (and choice). A simple example from the times: typists used to paste over a mistaken stroke (rather than retyping the entire page). The quality of the locally supplied whitener varied; sometimes it could be downright useless. Faced with sufficient complaints, the Department of Industries and Commerce would institute an enquiry, the local protected manufacturer (and monopolist) promised to do better, and did for a while – until the cycle repeated. Once the protection ended, the quality consistency improved; the threat of foreign competition kept them at speed; there was no need for enquiries.

The second reason can be best explained by an analogy with the earthquake design of a building. Make it too rigid and it cannot cope with a shock. That is true for the protected economy. Our domestic economy adjusted badly to the great shock of the 1966 wool price cash because the protection regime reduced its flexibility. The same was true for smaller shocks.

Such arguments underpin the benefits of an open economy connecting dynamically with the world. Even protectionists want to connect in ways that involve spending foreign exchange. But connection requires a commitment from the other side too. Hence the need for trade deals.

Only some economists accepted this analysis. Others stuck to the comparative advantage argument. Perhaps they had invested too much studying the H-O model to see that it is not very relevant. Meanwhile the Rogernomes (neoliberals), determined to impose their ideological prescriptions, stripped out protection in the 1980s.

There is no evidence that we got substantial material gains from the reduced protection just as the studies in the 1970s predicted we would not, and, just as predicted, there were marked changes in distributional impact with some winning and some losing.

Significantly, no other country was impressed by the sluggish performance of the New Zealand economy. It was a bit like unilaterally taking off all your clothes at a picnic, inviting others to follow you; they looked at the naked apparition and kept their clothes on.

But there were potential gains from trade deals – mutual undressing. The world entered into them enthusiastically. The latest for New Zealand has a dreadful name and acronym; I’ll call it TPP11.

New Zealand has a particular interest in trade deals because of the high level of protection against our primary exports. Any reduction gives us higher prices – and hence higher incomes.

But why should any other country reduce protection on their farmers? Normally we would offer them border concessions in return, but since we have virtually eliminated all our protection we cannot, so we find ourselves having to offer concessions behind the border.

For example, in the TPP12 (the TPP11 plus America) the US demanded that the term for copyright after death be increased from 50 to 70 years. As I wrote at the time, it is hard to justify the extension (indeed, it is hard to justify even 50 years). But there was the tradeoff of better access for some of our agricultural products which would boost farm income. This scholar, dependent on the free flow of information, found the tradeoff painful; some people (farmers) would gain from trade but others (including me) would be worse off. I reluctantly supported the deal.

Fortunately (for me ) the US has withdrawn from the TPP deal, and the TPP11 has no such copyright provisions. (It may be resurrected if the US decides to rejoin.) On the other hand we are getting no additional access to US food markets although that the markets of the other ten in the TPP11 – especially Japan – remain. Our farmers will do better but not as well as they would under TPP12.

So trade deals can have significant distributional outcomes. Not only does an improvement in access for our farm exports benefit our farmers (and the economy as a whole) but there are gains to the foreign consumers from lower prices and also to their non-farm sectors which are less burdened by an inefficient farm sector. But yes, their farmers are worse off.

Not all the public criticism of the new TPP11 has been informed; how can it be if we do not yet know the detail? Some of the concessions we make may not be onerous, some will be prudent but it is possible that some will be painful. Those who have been negotiating on the country’s behalf are aware of this; they have had to make distributional judgements.

So I am not uncomfortable if there is dissent against a deal which values the gains and losses differently (providing it is informed). I shall not be surprised if there is even parliamentary opposition; the Greens have indicated they may oppose the TPP11 deal. The distributional balances are for such as Parliament to judge. Worse would be to ignore the distributional issues.


PS. I have not dealt with the ISDS (Investor State Dispute Settlement) system. I wrote a column supporting the notion but regretting the proposed mechanism in the TPP12, another insistence of the US. I await the details of the revised system before I come to a conclusion.


PPS. A select committee was told that a number of our trade deals (including TPP11) had provisions which meant we could not put a tax on exported water. Does that reduce our sovereignty?

The short answer is ‘yes’ and ‘no’. Yes, for it is an example of my ‘all trade and all trade deals reduce sovereignty to some extent’. No, because if we felt really passionate we call on our sovereign rights, withdraw from the trade deals and impose the tax.

This seems unlikely in these circumstances (perhaps not in others). The government promises to find a way around the restriction. I may report on that in due course. And yes, I think that water users –  include those who export it – should pay for their water.