Tuesday, February 20, 2007

Do tariff reductions reduce welfare?

James Townsend (University of Winnipeg) has a paper published in the February issue of The Canadian Journal of Economics (subscription required) where he states that relative wages fell in industries where tariff reductions mandated by the Canada-U.S. Free Trade Agreement (CUSFTA) were deepest.

Here’s an excerpt from Townsend’s paper, Do tariff reductions affect the wages of workers in protected industries? Evidence from the Canada-U.S. Free Trade Agreement:

By working with microdata and using hourly wages, I make several contributions to our understanding of how the CUSFTA tariff cuts affected earnings. First, by using hourly earnings and controlling for individual characteristics, I am able to isolate the effect of CUSFTA on the wage rate, which is a measure of the price of labour. Previous studies have worked with average weekly earnings for broad groups of workers. Changes in weekly earnings may come from a combination of price changes, changes in the composition of workers forming the group, and changes in the number of hours worked per week. Second, I am able to compare the response in the union and non-union sectors, which may have important implications for understanding the political economy of trade policy. My results indicate that the CUSFTA cuts resulted in a decline in the wages of those workers in sectors facing the largest cuts relative to the wages of the workers in sectors that already had low tariffs prior to CUSFTA. This result holds for both the union and the non-union sector. Wages in the union sector are also found to be responsive to changes in the industry-specific real exchange rate and to other sectoral shocks; no similar response is found in the non-union sector.

There are two things I wish Townsend would explore (or explore more). One is the annual welfare cost to Canada caused by job protection, the other is the barrier that tariffs build by not allowing the reallocation of resources to their most productive means.
Regarding the first point, the best study I’ve come across is by Gary Clyde Hufbauer and Kimberly Ann Elliott, "Measuring the Costs of Protection in the United States." (1994) For each tariff-protected industry, the authors calculate the number of jobs saved, the consumer cost per job saved, and the resulting annual welfare cost to domestic citizens. They found that consumer costs exceeded worker wages.
Don Boudreaux expressed my second point well at CafĂ© Hayek after being motivated by a speech once given by John C. Calhoun. Here’s the best part (or read the whole thing here):

The deep lesson here is that, just as moving to freer trade does indeed upset some economic apple carts, so, too, does protection upset some economic apple carts. Given that both free trade and protection cause some specific job and business losses, protection cannot be justified -- as so many try to justify it -- by pointing to people whose economic expectations will be upset by freer trade. Free-trade advocates can counter with similar accounts.

Of course, free trade's justification cannot, then, be found in the fact that protection upsets some economic expectations. Free trade's proper economic justification is, in part, this: given that both free trade and the "prohibitory system" "destroy" some jobs and "create" others, it's best to let commerce and industry be guided by market signals and consumer sovereignty so that each producer is more likely than under protection to specialize in that occupation for which he, she, or it has a genuine comparative advantage. Thus will grow the wealth of nations.

Townsend's counter-arguement is that perhaps resources shouldn’t be reallocated to a more productive means because the workers from the once-protected industries may not have the skills to get hired in more productive industries. (A recipe for growth, no doubt.)
Since skills cannot be transferred between industries, workers may be better off remaining in a declining industry at a lower wage than they would be by moving to an industry for which they have no skills. As a result, shifts in demand result in persistent changes to the wage.

1 comment:

BSF said...

I've just skimmed the paper; am I right in saying that there's no explicit discussion of Stolper-Samuelson effects?