Larry Summers’ Inadequate Solutions for Trade-Induced Woes

Sometimes I wonder if I am too critical of the punditocracy. But much should be expected of Larry Summers, former Treasury secretary and Harvard economics professor, yet many of his comment pieces in the Financial Times, which command considerable attention, appear to come up short.

Consider his current offering “A strategy to promote healthy globalisation.” In it, he states the problem fairly well, namely, that workers don’t clearly benefit from trade liberalization:

I suggested that opposition to trade agreements, and economic internationalism more generally, reflected a growing recognition by workers that what is good for the global economy and its business champions was not necessarily good for them, and that there were reasonable grounds for this belief.

Summers discusses in some detail how the interests of companies and trading partners are no longer aligned with those of employees. Fair enough. But then the article starts to go off the rails:

The public policy response of withdrawing from the global economy, or reducing the pace of integration,is ultimately untenable. It would generate resentment abroad on a dangerous scale, hurt the economy as other countries retaliated, and make us less competitive as companies in rival countries continue to integrate their production lines with developing countries. As Bill Clinton said in his first major international economic speech as president, “the United States must compete not retreat”.

Is anyone but Summers suggesting that the US cut itself off from international markets? This simplistic notion, that an economy is either open for trade or not, is a major distortion of the complexity of trade relationships. And the point is not to occupy one extreme pole or another, but to recognize that our policies have, as Summers points out, benefited our corporations more than average wage earners. Moreover, Summers and others too often fail to acknowledge that other countries enter into trade arrangements to pursue different aims (Ie, generating trade surpluses and protecting labor markets). We need to be shrewder in playing this game than we have been.

Moreover, Summers assets that further trade integration is desirable. It isn’t clear that the evidence supports that view. For instance, a recent paper by Kenneth Rogoff and Carmen Reinhart points out that larger international capital flows are associated with frequent financial crises. Large financial flows generally occur in the wake of large-scale trade. Thus it appears if you widen the frame of reference, the calculus of the gains and losses from further trade integration become more complex and harder to determine with confidence. Similarly, Dani Rodrik set forth another inconvenient truth:

Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches. I have an “impossibility theorem” for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.

Here is what the theorem looks like in a picture:

To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs…..

So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man’s land.

So what looks like a backlash may simple be these governments recognizing intuitively what Rodrik was able to make explicit: going further on economic integration would lead to tradeoffs they regarded as undesirable.

Back to Summers. Having said that workers are probably correct in thinking that opening markets further is not in their best interest, his proposals seem neither helpful nor viable:

The domestic component of a strategy to promote healthy globalisation must rely on strengthening efforts to reduce inequality and insecurity. The international component must focus on the interests of working people in all countries, in addition to the current emphasis on the priorities of global corporations.

First, the US should take the lead in promoting global co-operation in the international tax arena. There has been a race to the bottom in the taxation of corporate income as nations lower their rates to entice business to issue more debt and invest in their jurisdictions. Closely related is the problem of tax havens that seek to lure wealthy citizens with promises that they can avoid paying taxes altogether on large parts of their fortunes. It might be inevitable that globalisation leads to some increases in inequality; it is not necessary that it also compromise the possibility of progressive taxation.

Now weirdly, the discussion “we need to reduce insecurity so employees will go along” usually leads to a recommendation of more generous subsidies for displaced workers, particularly training, and more progressive taxation. But to suggest that the US can persuade other countries to change their tax policies is delusional. These are the subject of heated domestic debates; the idea that a foreign power, particularly one like the US whose standing has fallen badly, can and should influence these discussions is a non-starter.

To Summers again:

Second, an increased focus of international economic diplomacy should be to prevent harmful regulatory competition. In many areas it is appropriate that regulations differ between countries in response to local circumstances. But there is a reason why progressives in the early part of the 20th century sought to have the federal government take over many kinds of regulatory responsibility. They were concerned that competition for business across states, and their ease of being able to move, would lead to a race to the bottom. Financial regulation is only one example of where the mantra of needing to be “internationally competitive” has been invoked too often as a reason to cut back on regulation. There has not been enough serious consideration of the alternative – global co-operation to raise standards. While labour standards arguments have at times been invoked as a cover for protectionism, and this must be avoided, it is entirely appropriate that US policymakers seek to ensure that greater global integration does not become an excuse for eroding labour rights.

The idea of trying to prevent a race to the bottom is useful, but again, I don’t see this going anywhere. We can’t get China to stop sending toxic toys. And it isn’t clear we occupy the high ground we think we do. Our financial regulatory regime has been shown to be wanting; our minimum wages are low relative to most advanced economies, and our other forms of worker protection are typically weaker. Exactly what standard should be the benchmark? Summers seems to naively assume that the US is the starting point, but that idea is certain to be contested.

If this is the best that the pro-business Democrats have to offer, we are in sorry shape indeed.