“No Nation Was Ever Ruined By Trade”

More trade means more jobs.

The headline is a quotation from Benjamin Franklin, who added, “Even seemingly the most disadvantageous.” Franklin believed that free trade was good for everybody. In the 21st century lots of Americans and their politicians believe the opposite: Being open to trade allows rapacious corporations to “ship jobs overseas.”

In the 2010 mid-term elections, the Democratic National Committee rolled out a television ad campaign accusing various Republican candidates of favoring policies that shipped jobs overseas. More recently, Senate Majority Leader Harry Reid (D-Nev.) declared, “I think we should do a lot more to stop shipping jobs overseas.” In the meantime, the Doha Round of international trade negotiations has been on the brink of collapse for a while, sparking fears the freer trade system painstakingly built over the last 50 years might begin to unravel.

A new study, Trade and Unemployment: What Do the Data Say?, by three European economists published in the journal, European Economic Review in March, forthrightly asks the question: Does exposure to international trade create or destroy jobs? Their answer strongly backs the observation made by Franklin more than 230 years ago. “A 10 percent increase in total trade openness reduces aggregate unemployment by about three quarters of one percentage point,” they conclude. To be a bit more precise, they find, “A 10 percentage point increase lowers the equilibrium rate of unemployment by about 0.76 percentage points.” Trade creates jobs.

In general, the higher a country’s volume of international trade, the higher is its degree of openness. Trade openness is generally measured by adding together the value of both exports and imports and dividing that sum by total gross domestic product (GDP). Crudely, let’s say an economy imports $10 billion annually and exports $10 billion annually and has a total GDP of $100 billion. That would yield a trade openness index figure of 20 percent. Another country with a GDP of $100 billion exports $15 billion and imports $15 billion, yielding a trade openness index of 30 percent.

Roughly speaking, U.S. GDP was $15 trillion in 2010, and exports and imports combined totaled just over $4 trillion, yielding a trade openness index figure of 27 percent. Without going into detail, the European economists derive a real trade openness index by taking differing price levels among countries into account.

The researchers then compare the relative trade openness of 20 developed countries in the Organization for Economic Cooperation and Development with their unemployment rates over time. They take into account other factors such as union membership, national employment protection policies, tax rates on wages, and the generosity of unemployment insurance.

The researchers report that generous unemployment benefits correlate slightly with higher unemployment, suggesting that workers have less incentive to look hard for work. Also, high unemployment correlates with the size of the tax wedge, that is, the difference between what employees take home in earnings and what it costs to employ them. Basically, this means the higher the income tax rate, the higher the level of unemployment.

The researchers go on to analyze the effect of freer trade on a selection of 62 developing countries. They take into account features like the size of the black market economy and whether a country is landlocked or not. Again, they find that openness to trade boosts employment, concluding that “the effect of a 10 percentage point increase in openness lowers unemployment by about 1 percentage point.”

So why does free trade create more jobs? The study suggests that freer trade boosts overall productivity, enabling companies to hire more workers. Trade enhances competition which weeds out inefficient firms and allows more productive ones to expand. As the average efficiency of firms in a country increases, they can earn more revenues by boosting production. And that leads to hiring additional workers. 

To get some idea of how much opening international trade further would benefit people, economists at the Peterson Institute for International Economics in Washington, D.C., calculate that concluding the Doha Round of free trade negotiations could boost global GDP between $165 billion and $283 billion per year.

So why do people, especially politicians, believe the opposite? The 19th century French economist Frederic Bastiat explained this sort of disheartening policy myopia his brilliant essay, “What is Seen and What is Not Seen.” People tend to focus on the seen consequences of a policy, in this case, competition from trade eliminating some jobs at relatively inefficient companies.

But they miss the unseen benefits, such as new jobs that result from increased average productivity. Naturally, the people who lose their jobs are worried and angry, so they call their member of Congress to complain about “unfair” trade. Fearing that they may lose their jobs, the denizens of Capitol Hill seek to enact legislation to block imports or mandate “Buy American” to protect their complaining constituents against “unfair” trade. In politics, as in much of life, the squeaky wheels get oiled.

The seen result of this political dynamic is that a few workers get to keep their jobs while the unseen outcome is that more people are out of work than would otherwise have been. In addition, protectionist legislation makes other Americans worse off by forcing them to spend more because they are denied access to cheaper and better exports. Our politicians get it backwards: Trade creates jobs for Americans and everyone else.

Science Correspondent Ronald Bailey is author of Liberation Biology: The Scientific and Moral Case for the Biotech Revolution (Prometheus Books). This column first appeared at Reason.com.

Ronald Bailey is Science Correspondent