Does Free Trade Bring Lower Prices?

I'm confused. Dani Rodrik says that free trade does not bring lower prices:

Dani Rodrik's weblog: Does Free Trade Bring Lower Prices?: Advocates of globalization love to argue that free trade lowers prices, and the argument seems sensible enough. Think of all the cheap goods from China that we can buy at Wal-Mart.  But anyone who understands comparative advantage knows that free trade affects relative prices, not the price level (the latter being the province of macro and monetary factors).  When a country opens up to trade (or liberalizes its trade), it is the relative price of imports that comes down; by necessity, the relative prices of its exports must go up!  Consumers are better off to the extent that their consumption basket is weighted towards importables, but we cannot always rely on this to be the case.

Consider your typical Argentinian for example, who consumes a lot of wheat and beef. Since these are export products for Argentina, free trade implies a rise in the relative price of the Argentine consumption basket. (The gains from trade are still there, of course, but they derive from the usual allocative efficiency improvements, not from lower prices across the board.) And in the U.S., the Wal-Mart effect has to be qualified to take into account the fact that the relative price of the goods that the U.S. exports (including for example agricultural commodities) is higher than it would have been absent trade.  Similarly, when the U.S. gets better market access abroad for its agricultural exports (a key demand under the Doha round), you can be sure that this will raise domestic prices for these goods, not lower them. 

Yes, prices of exportables rise and prices of importables fall. But importables have a higher weight in consumption than in production (that's why we import them). And exportables have a lower weight in consumptio than in production (that's why we export them). So if the average price of production stays the same--and incomes stay the same, because everything paid to buy our production winds up as somebody's income--then the average price of consumption falls.

It seems perfectly fine to me to give the following shorthand description of trade: Trade on average raises the prices of what you make and sell, and lowers the prices of what you buy and consume. A better description might be: Trade raises your income relative to the prices you pay if you are a net buyer of importables, and lowers your income relative to the prices you pay if you are a net buyer of exportables--but as a country, on average, we are net buyers of importables (that's why we import them) and net sellers of exportables (that's why we export them). But the first shorthand description seems to me to be correct, if incomplete.

Comments

[TruePath]

Why does it even necessarily raise the price of exportables? Sure, for things like wheat and beef which probably have a constant marginal cost (right term?) but consider something like computer chips.

The US is a net exporter of computer chips but printing circuits has huge benefits from scale. Thus in a competitive market the existance of more consumers might very well lower the price.

Whether or not this is really true of computer chips it seems even the rise of exportable goods can't be settled without an idea of what sort of goods are exported.

[bigTom]

I think this is just another example of innuneracy. For those who aren't able to construct/solve equations that describe the whole (but simplified) system, coming to wrong results is easy. We see this all the time in economics and politics, where nearly any proposed change is going to have both winners and losers, and the proper question should be, does the good that will acquire to the winners outweigh the harm to the losers? Not the sort of question that 30second sound bites are likely to shed light on.

[Alex Tolley]

With our trade deficit, what exactly is it we are exporting that raises our incomes?

[Samuelson's Angry Angel]

Er, sorry but this is just plain wrong. The Stolper Samuelson Theorem states clearly and unequivocally that NO MATTER what consumption basket workers happen to have a taste to want to consume their real wage will fall (i.e. the price of ANY basket of goods they care to buy WILL RISE relative to their factor wage) if they are the factor used intensively in the industry where prices fall.

[I thought that's what I said: the intensive factor are not producers of importables, and so lose; the extensive factor are not consumers of importables, and so gain.]

I think all that Dani Rodrik was trying to say was this, but in plain English.

Brad de Long's reasoning sounds intuitive, but except in a world of representative agents (or one where workers own sufficiently large shares of the other factors in the economy) it doesn't make sense within the confines of a standard trade model -- the confines within which Rodrik was making his statement.

[kharris]

To the extent that Argentines will buy less beef and grain and more imports when going from less open to more open trade, their consumption basket has probably also improved. They were consuming "too much" beef and grain when they had fewer choices.

[DRR]

I think it's like this.

Let's say North Korea decides to open it's economy & enters a Free Trade agreement with all the Nafta countries. North Korea then becomes a net exporter of Kimchi. Kimchi is a product the average N. Korean consumer basket is heavily weighted toward, & it's very specialized/localized nature (heavily weighted toward the Koreas) means it's not likely to be something they'll import from anywhere else, especially not Mexico, U.S. or Canada.

As the market for N. Korean exporters of Kimchi expands, the domestic price of Kimchi for North Koreans must neccessarily rise, making North Korean consumers technically worse off to the degree their consumption basket is weighted towards this net exportable.

At least I think that's how it works.

[DRR]

I don't think Rodrik was referring to Stopler Samuelson.

Ok I just got this from internationalecon.com, Ch. 90-8 that I think explains what I was getting at;

Re: Effects of a Tariff

Importing Country Consumers - Consumers of the product in the importing country suffer a reduction in well-being as a result of the tariff. The increase in the domestic price of both imported goods and the domestic substitutes reduces the amount of consumer surplus in the market. Refer to the Table and Figure to see how the magnitude of the change in consumer surplus is represented.

Exporting Country Consumers - Consumers of the product in the exporting country experience an increase in well-being as a result of the tariff. The decrease in their domestic price raises the amount of consumer surplus in the market. Refer to the Table and Figure to see how the magnitude of the change in consumer surplus is represented.

[me]

It works like this. IBM fires 50,000 US workers, hires 53,000 Inidan workers, paying them less than 75%, but continues to bill thier US customers at $200 an hour. So the argument goes, how much higher would the hourly charge be if not for cheap Indian workers. Some of you may fall for this,but do not count me. I am paying more for food, fuel, energy, transportation and healthcare.

[johne]

About a century ago the goal of NE Washington state cattle drives were the stockyards and railroad loading points in Wenatchee. My grandfather told me that it was hard to find a piece of beef any place in town that wasn't attached to a critter on its way to Seattle or Chicago. Nowadays, some lumberyards advertise their "export grade" stock, much better quality and more expensive than what's usually available in the state. And I bought the best Washington state apples I've ever eaten at a grocery store in a middle-class neighborhood of San Jose, Costa Rica.

Just thought this might have something to do with the subject.

[JJR]

johne: You're thinking of the consequence of transportation cost on quality. It's called "shipping the good apples out." Because 'good' and 'bad' Washington state apples going to Costa Rica have the same transport cost, the relative price of a 'good' apple vs. a 'bad' apple in Costa Rica is lower than in Washington state. Hence Costa Ricans will eat better quality apples than do people in Washington state, all else the same.

I don't think this effect directly relates to the above discussion.

[bumkiss]

>>IBM fires 50,000 US workers, hires 53,000 Inidan workers, paying them less than 75%, but continues to bill thier US customers at $200 an hour

Or take the Microsoft argument. Allow more H1B/immigration. Wages for MS engineers fall.

But does it reduces the price of MS software? Hell, no!. It is protected by all sort of IP rackets and threats.

And US engineers are all hell bent of stopping H1B, immigration, and offshoring. A kind of "let MS extract its exorbitant costs from the economy, all we want is a cut of the loot" attitude.

It's not the looting per se that's the problem for them, it's that they dont get a cut.

Ditto for high paid professionals - lawyers, doctors, bankers, professors and so on. The Walmart goods/auto/Semi/farming industry workers have had their wages reduced, but none of the costs of services they purchase have fallen. Medical, dental, college, pharma - they are all well immune from competition by IP, professional accreditation and immigration barriers.

The prevailing wisdom can be summed up as - competition for thee, but not for me.

Or in other words, the prices of what I buy must fall, but the prices of what I produce must remain high. If the price of what I produce falls, it's the third-world-ization of America.

Thus do I get to leech of others.

[P.M.Lawrence]

Try running that reasoning past Solon's reforms for Athens. Agricultural exports of staples were banned, apart from value added products like olive oil; corn could no longer be exported. (I don't mean maize but generic cereal grains.)

The result probably was a drop in overall measured GDP (leaving out non-cash elements of the economy), but that wasn't the point. A gross measure like that averages out the kalos kai agathos with hoi polloi. It's not the right measure for the health of the polis, even without the distortion from omitting the non-cash economy - a sector that matters a lot in developing countries even now.