26 September 2014

Do Trade Deals Create Jobs?

It is not a rhetorical question; I genuinely want to know if there is any sound economic theory in which an increase in trade between developed countries leads to an increase in employment. Basic macroeconomics says no, the benefits of trade do not extend to an increase in the level of employment.

The claim is frequently made in discussion of the EU- Canada trade deal, known as CETA, which is due to be signed today, or the EU - US deal, known as TTIP. The latter is supposed to be capable of boosting EU employment by up to 2 million jobs. The European single market too was promoted on a promise to create jobs. The 1980s Cecchini  report predicted an additional 2 to 5 million extra jobs. But is it true?

Firstly, lets agree that there are real and substantial benefits from trade. A larger market has more scope for efficiency (as Adam Smith argued) and trade allows countries to specialise in what they do best ( as David Ricardo argued). Trade also benefits consumers through increasing variety and reducing prices. So it is reasonable to expect trade to increase national income or GDP.

A starting point in macroeconomics is to recognise the difference between the demand side and the supply side. Short term fluctuations in employment are generally a question of demand. The supply side determines the level of potential income and potential employment. This is sometimes referred to as the economy at full employment.

That is a clue to where the argument is going. The supply side gives us the level of national income at full employment.

Monetary and fiscal policies work on the demand side to boost employment or restain overheating in the short term. Supply side policies affect the structure of the economy - promoting innovation, expanding promising sectors, removing market distortions etc. Supply side policies take time to work but aim to boost productivity over the long term. (A few polices operate on both sides. Increasing investment, for example, boosts demand while the money is spent and increases productivity as the new assets are put to use.)

Policies to expand trade operate on the supply side. For example, trade favours the most efficient producers, encourages the spread of innovation and improves the allocation of productive resources. So effective trade policies increase the potential income at full employment. It has no effect on the definition of full employment.

A simple thought experiment might make this point clear. Suppose we have an economy at full employment which agrees a trade enhancing deal. Does employment increase? That is a rhetorical question; employment doesn't go higher than full!

Paul Krugman explained it well nearly 20 years ago in an article in the Harvard Business Review. Suppose, he said,that the US economy were to experience an export surge. What would the Fed do? It would offset the expansionary effects of the exports by raising interest rates; thus any increase in export-related jobs would be more or less matched by a loss of jobs in interest rate sensitive sectors of the economy, such as construction.

Conversely, he argued, a loss of jobs from competition with imports would trigger a cut in interest rates to increase jobs elsewhere.

Politicians like to claim that their favoured trade policy is necessary for jobs, whether that be TTIP, CETA or even the European single market. Unless someone comes up with a convincing alternative macro theory I intend to remain unconvinced. There may be benefits from trade but jobs is not one of them.

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