Beware the limitations of free trade

The economist Brad DeLong had a thoughtful response on his blog, arguing that the really big benefits of globalization come from technology diffusion, which make it a much more positive force than I suggested. 

I used to believe the same thing, and I still find myself thinking along those lines now and then. But I’d argue that economists need to be, at the very least, upfront about the argument’s limitations.

First, it doesn’t emerge from the models. As Mr. Delong says, “the map is not the territory,” but guesses about such things are, well, guesses. There was a time when everyone knew that import-substituting industrialization was the key to economic takeoff, based on loose historical reasoning (“America and Germany did it!”). Then developing countries tried it en masse, and the results weren’t great.

Furthermore, my sense is that nonstandard free trade arguments tend to involve, often unintentionally, a kind of bait-and-switch strategy. Economists love to talk about comparative advantage, which is a beautiful piece of reasoning that runs counter to lay intuition. The Princeton economics professor Alan Blinder once said that economists would almost all agree on the slogan: “Yay free trade.” But the seeming authority of the comparative-advantage case ends up being carried over, illegitimately, to arguments for trade that have nothing to do with comparative advantage. Yes, there could be positive externalities associated with trade, but there could be positive externalities associated with lots of things, and the models don’t give us any special reason to think that the externalities associated with trade are more important.

So how would you test such arguments? Well, in a way we’ve already done it. In the early 1990s there was a widespread orthodoxy that “outward-looking” development policies were much more favorable to growth than “inward-looking” policies. This belief had a lot to do with the rapid growth of Asian economies, which had followed an export-oriented path rather than the import substitution tried by much of the world in the 1950s and 1960s. The question, however, was whether you would see a dramatic acceleration of growth in other places, such as Latin America, when policy shifted away from an inward focus.

And the answer turned out to be: not so much. Look at the case of Mexico, which went through a period of radical trade liberalization between 1985 and 1988 before joining the North American Free Trade Agreement. The country has seen a transformation of its economy in many ways – it has gone from an economy that didn’t export much besides oil and tourism to a major manufacturing export power. And the effect on development has been … underwhelming.

So Mr. DeLong could be right; but the evidence is far from conclusive. I would still argue very strongly that it’s crucial to keep markets open for poor countries. But we should be cautious in our claims about the virtues of free trade.