What the elites miscalculated about global trade

Tariff walls are going up. Trade wars are back. It is the bad old days all over again. How did we get here? It is timely to check in with elite thinking on the status of global trade. To that end your correspondent went — along with hundreds of eager others — to a lecture delivered by Nobel laureate economist and New York Times columnist Paul Krugman at Melbourne University on Tuesday night.

The topic was “Globalisation: what did we get wrong?”. Krugman opened by admitting mainstream trade theorists completely overlooked the way trade would cause such anger and hopelessness in parts of the US. He said the global trading regime might possibly face a “major crack-up” under Trump.

But Krugman also mounted a passionate defence of trade. By putting workers in China and Bangladesh in touch with wealthy American consumers those workers were able to raise their incomes far higher than would be possible serving domestic markets. (Krugman had a cute line about Bangladesh specialising in garments, referring to it as a “pyjama republic”.)

The lift in third world incomes is completely irrelevant to the rise of Trump. But it is very much relevant to hundreds of millions of people who use those incomes to buy rising standards of education, nutrition and health care. Bangladeshi incomes have risen more than three-fold since 2000. Poverty rates have halved. The under-five mortality rate is one-third what it was. All reasons we may hope to stop global trade from collapsing.

The three stages

In the long sweep of history, Krugman argues, previous tides of globalisation have stopped and reversed. There is no guarantee that this one is permanent. Public opinion on trade swings breezily this way and that — the issue is complex enough most voters follow the opinion of leaders.

Krugman argues for three stages of modern globalisation. The first was primarily British and to do with steamships. It ends in World War II. The second, beginning round 1970, was primarily American and “intellectual”; that is, due to the dismantling of protectionism. The third is ongoing, is primarily Chinese and is to do with containerisation of goods making it extremely cheap to ship things.

One explanation Krugman offered was that the second stage of globalisation misled theorists about the nature of the third. For a while there — he pointed to 1992 — rich countries were trading with other rich countries and it was a win-win, with few jobs or industries being displaced. The next phase of globalisation differed. When it did, the impact showed up in a way trade theorists were not trained or inclined to think about. This was the second explanation.

Industries tend to cluster together. America has many smaller cities and towns. Some of them specialise in one thing. For example the North Carolina town of Hickory is a centre of furniture making. When China is able to make something more cheaply than anyone in North Carolina it can have a severe and concentrated impact. Furniture employment in Hickory collapsed.

This point is crucial and completely overlooked by economists. When an industry disappears, adjustment can be far harder and far slower than the models expect. To see an example we need only travel to the Latrobe Valley east of Melbourne.

The rapid decline of employment in electricity generation associated with privatisation left many people without work. That disadvantage has travelled down through the generations and now disadvantage in the Latrobe Valley is endemic. Moe and Morwell have unemployment rates over 11%. In any map of socioeconomic status the Latrobe glows bright red.

The surprise for economic models is that people don’t simply move away. For one thing, property they own is now worth much less and buying a home in the city will cost much more. But that’s an economic factor and one economists can model.

The other factor is social networks. Family and friends matter. Moving to the big city might be wonderful for your income but people are not only optimising for that. Half the songs Bruce Springsteen ever launched into the charts are on this exact point — you get born in a dead-end town and you stay there.

Multi-generational costs

Failing to realise that people stay put as their town collapses has meant that adjustment assistance to industry collapse can be dramatically insufficient. The human cost of feeble policy in the face of large economic shifts is multi-generational.

The best defence against this disastrous outcome is cities. Big cities are generally economically diverse. Where they are not — hello Detroit — or even just less diverse — hello Perth — cities are more at risk from the vicissitudes of global trade. (Interestingly, this fact of economic geography helps explain the distribution of Trump support. US cities are not hurting from trade like small towns are.)

The charm of economic diversification is that it helps defend not only against disruption by trade but also technology. Notably, where manufacturing jobs are moving back to America they are doing so with more capital and less labour. Even if trade recedes, technology could be the next great disruptor of traditional jobs and traditional industries.